Fed Revelations

        Stocks continued their losing ways last week.  The major stock market indices are now in a bear market officially.

        Stocks are following the script from 2018, the Fed tightens, and stocks fall.

        The big question here is whether the fed stays the course and continues to tighten.  Count me among the doubters.

        Peter Schiff, a past guest on my radio program, had an interesting take on Fed options and also reported on some past Fed discussions that are nothing short of eye-opening.  Here are some excerpts from his piece (Source:  https://schiffgold.com/commentaries/peter-schiff-the-fed-girds-for-battle/) (emphasis added):

It’s the Fed’s “hold my beer” moment.

After more than a year in which Federal Reserve leadership appeared clueless, pollyannish, and indecisive, the Fed is conducting a full-throated messaging campaign to show that it is as serious as cancer about the inflation surge that is scaring the bejesus out of consumers, investors, and economists.

Their public pronouncements in recent weeks go something like this: “Out of a good faith misreading of post-pandemic data we had concluded, mistakenly as it happens, that the inflation wave, which began in 2021, was transitory. But now that we know it is not, we are moving with great speed and resolve to bring the problem to heel. Given the power of our tools, the underlying strength of our economy, and our hard-earned credibility, we are confident we can get the job done quickly, and without inflicting undue harm on the economy. We will continue until inflation gets closer to our 2% target. And so, if you don’t mind, kind sir, please step aside and let us do the job we were created to do. We got this!”

This newly found resolve may assure many that at least the Fed is no longer in denial and has a plan to get us out of this mess. In reality, these open-mouth operations are simply a desperate Hail Mary designed to convince us that the Fed can do what it clearly has no stomach or power to do. I would suggest that Fed officials hold onto their beers and drink. They are going to need it.

While most observers have focused on Chairman Jerome Powell’s press conference last week as the clearest insight into the Fed’s thinking, I think more can be gleaned from the extensive conversation two days later in Minneapolis between Christopher Waller, a member of the Federal Reserve Board of Governors (a current voting member of the FOMC) and Neel Kashkari, the President of the Federal Reserve Bank of Minneapolis (and an FOMC alternative member). In particular, Waller offered a very clear assessment of the Fed’s battle plan.

Right off the bat, he confronted mounting criticism that the Fed failed to read the economy accurately over the past 18 months, thereby grossly miscalculating policy, which let the inflation genie out of the bottle. His defense, which essentially boils down to “don’t blame us, no one with mainstream credentials in government, economics, or finance saw this coming,” is both bizarre and inadvertently illuminative. Not only does this ignore the 2021 predictions of former Treasury Secretary Larry Summers, who used to have at least some mainstream credibility, but it completely ignores all those like me who had been shouting from the rooftops that this danger was lurking. Waller’s admission, which shows how deeply embedded Fed leaders are in their own echo chamber, is more of an indictment of the entire economic elite rather than an excuse for their errors.

Waller then admitted that inflation data that was released way back in September 2021 revealed to them that the “transitory story’ that they had been spinning since the beginning of 2021, would no longer hold water. He explained that members of the FOMC were so alarmed that they immediately responded with plans to roll out new messaging that hinted strongly at tighter policy. Say what?

They determined nine months ago that very high inflation had been running rampant for the better part of a year, that it showed no signs of slowing, that the Fed Funds rate (which was then at 0%, and likely 800 basis points below the rate of inflation) was adding fuel to the fire, and the only thing they were prepared to do was to start talking tougher?

The Fed did not implement its first rate hike (25 basis points) until March of this year, fully seven months later! And during that entire time, it continued to expand its balance sheet by hundreds of billions of dollars through quantitative easing rather than immediately stopping the program or, better yet, reversing it. That’s insane. Captain, there is a huge gash in the hull of the ship but rather than try to repair the damage now, let’s think about how we are going to word our next few press releases!

Instead of taking bold steps back in the fourth quarter of last year to get ahead of the curve, or to at least not fall far further behind, the Fed irresponsibly took a slow and muted path. Given its admitted understanding of the conditions nine months ago, its actions seem hard to justify.

Despite these past missteps, Waller claims that the Fed is well-suited to make up for lost time. Emboldened by what he sees as a “historically” strong labor market, Waller believes the current economy can absorb the negative effects of higher interest rates without succumbing to recession. As a result, he predicts the Fed will not be deterred by weaker jobs or economic reports that may emerge in the coming months. In fact, he claims such data would be welcome developments. In his view, the economy needs to lose jobs to be put back into balance. Reduced hiring, he argues, will diminish upward wage pressure, which he sees as the root cause of inflation.

To justify his confidence that higher rates will kill inflation but not the broad economy, Waller took pains to draw a sharp contrast between today’s conditions and those that predominated in the late 1970s/early 1980s, which was the last time the Fed confronted nearly double-digit inflation with bold monetary tightening. Back then, the sharp rise in interest rates brought down inflation AND plunged the country into a recession. But as he views the current economy as benefiting from a “historically strong” labor market, he believes that fate will be avoided.

But Waller is looking at the rear-view mirror. He assumes that the economy that arose during the last decade of almost zero percent interest rates and historically stimulative fiscal policy will persist after those props are removed. But now, as rates increase and stimulus is removed, the economy must contract and change. We are already seeing such a change in the more speculative end of the economy. That’s where the problems are usually first manifest.

In case you hadn’t noticed, the wheels are coming off the technology and the cryptocurrency sectors. The technology-heavy Nasdaq composite index is down more than 25% thus far this year. The ARK Innovation ETF, which tracks the highest-flying growth-oriented technology, and “new economy” stocks are down 56%. E-commerce bellwethers such as Netflix and Shopify are down even more. The carnage in the crypto space is also spectacular. Although bitcoin is down about 60% from its high, that’s the good news. Lesser-known cryptos are down 70% or 80%. Some have been nearly wiped out completely, even those “stable” coins that were supposed to be pegged to the dollar. The pain extends to the businesses that worked in the crypto space. Financial firm Microstrategies, which borrowed to invest in bitcoin, is down 60% year to date while Coinbase, the crypto trading platform, is down 72%. (Bear in mind that all the losses listed above are just this calendar year. If you started measuring from the November 2021 highs, the losses are significantly greater.)

Recall that the Recession of 2001 and 2002 largely resulted from the implosion of the dot-com bubble when the pain in Silicon Valley rippled through the broader economy. But this time the outsized gains were even bigger and less tethered to reality. Many tech firms have already announced large-scale layoffs. Hundreds of thousands of highly paid workers may suddenly find themselves looking for jobs. Falling stock prices may also encourage recent retirees, who may have been coaxed out of the labor force by oversized stock market gains, or millennials who’ve been trading meme stocks and cryptocurrencies on Robinhood for a living, to join former Netflix, Twitter and Peloton employees in looking for work. Boom will go bust, and the unemployment rate may rise much quicker than Fed models suggest.

Here is the big takeaway from the piece.  The fed knew inflation was not transitory yet did nothing for months.  Then, when the Fed did take action, it was anemic and more form than substance. I would encourage you to read the entire piece; it is very well done.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

An Inevitable Outcome

          Last week, I discussed that stagflation was the most likely immediate economic outcome in my view.

          Just in case you missed last week’s post, stagflation is defined as price inflation combined with a shrinking economy.

          Ultimately though, I believe we will see a very painful deflationary environment that may rival the 1930s.  This past week, Mr. Egon von Greyerz, whose work I follow and admire, analyzed the current situation.  Excerpts from his piece follow: (Source:  https://www.silverdoctors.com/headlines/world-news/viscous-cycle-of-self-destruction-gold-outperforming-all-asset-classes/)

The current fake monetary system will collapse under its own worthless weight…

“The first panacea of a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permeant ruin. But both are the refuge of political and economic opportunists.”

-Ernest Hemingway

As the West is standing on the edge of the precipice, there are only unpalatable outcomes.

At best, the world is facing a hyperinflationary depression later followed by a deflationary depression.

But sadly, there is today much more at stake as the West is frenetically escalating the sound of war drums against Russia’s invasion in Ukraine.

As the global economy reaches the point of collapse, countries get the leaders they deserve. There is today no leader or statesman in the West who can stand up to Putin in order to negotiate peace. Biden sadly neither has the vigor nor the ability to play any significant role in solving the conflict. Also, he has the neocons pressuring him to attack and defeat Russia. And Biden’s rhetoric against Putin is certainly not conducive to peace, with words like war criminal and genocide. Biden mustn’t forget that just like in the Vietnam war, the North Vietnamese and Viet Cong are estimated to have lost one million soldiers and two million civilians. Unprovoked wars are, of course, always senseless, whoever starts them.

President Zelensky is doing all he can to involve the rest of the world militarily by demanding more money and more weapons from the West rather than putting his efforts into peace negotiations. Ukraine can, of course, never win the war against Russia alone. And dragging in the US and NATO can only lead to a war of incalculable consequences and potentially a WWIII which could be nuclear.

And in the West, not a single leader is making a serious peace attempt. From Biden to Johnson, Macron, and Scholz, we only hear talk of more weapons and more money for Ukraine. This is terribly tragic and a sign of totally incompetent leadership in the West.

So the US and the West have no ability or desire to achieve peace. And Boris Johnson has welcomed the war as a diversion from his domestic “Partygate” political pressures and therefore has taken an aggressive position against Russia rather than finding a peaceful solution.

Macron is an opportunist who stands with one foot in each camp by being chummy with Putin and at the same time condemning him.

And Scholz, the German chancellor, is in an impossible position caused by Merkel’s poor management of Germany’s energy position. The three remaining German nuclear power stations will be closed down, and fossil fuels are politically unacceptable. Nearly 60% of German gas imports come from Russia. German industry would not survive without Russian gas. So Scholz wants to have his cake and eat it, sanctioning Russia on the one hand and simultaneously spending billions of Euros buying their energy and other natural resources, including food.

Quite a precarious position for Germany to be totally dependent economically on its war enemy. At the same time, this is good for the world as Germany has a vested interest to achieve peace.

But we must remember that only a minority of countries are backing the actions of the US and Europe.  Africa, South America, and most of Asia are not taking sides and continuing to trade with Russia, and these regions represent around 85% of the world population.

So the vast majority of the world has no desire for war with Russia, but their voice is seldom heard in the Western-dominated media.

Politics and money cannot be separated, and the geopolitical situation that has now arisen will act as a perfect catalyst to the end of the monetary era since the creation of the Fed in 1913.

But what we must remember is that it is primarily the Western-controlled monetary system  (including Japan) which will come to an end.

America’s and the EU’s final desperate attempt to save their broken system by sanctions on world trade will eventually fail as the Western economies gradually decay in an economic and social breakdown brought about by a quagmire of currency collapse, deficits, debts, and history’s most epic of asset bubbles.

The Phoenix emerging will clearly be the East, led by China, with Russia as an important partner. China is, population-wise, the biggest country in the world and will soon be the biggest country in GDP terms. With total US assistance in the form of know-how and technology, China has built up a strategic and advanced manufacturing base with dominance in many sectors.

For example, 18% of all US imports come from China, including 35% of all computers and electronics. Chinese sellers represent 40% of all top brands on Amazon and 75% of all new sellers.

The US and the rest of the world criticize Germany for being dependent on Russian energy, but the US folly of shifting much of its manufacturing to China certainly qualifies for joint first prize in commercial and strategic idiocy.

Since gold is the ultimate money and the only money that has survived in history, it will have a very important role in the coming years as the fiat currency system collapses.

Empires normally suffer a drawn-out and painful death. The fall of the US and the West has certainly been long, starting over half a century ago. But the fake prosperity has benefitted a small elite and lumbered the masses with colossal debts.

In 1971, US debt was $1.7 trillion, and 50 years later, it is $90 trillion, a mere 53x increase. 

As the finale of the debt and currency collapse approaches, the desperation rises exponentially. Consequently, increasing amounts of money need to be created and wars initiated to justify the debt explosion, all in a vicious cycle of self-destruction.  

For over half a century, the US has destroyed its currency and initiated unprovoked military actions in numerous countries – virtually all of them unsuccessful.

Yes, the US has certainly experienced a temporary false prosperity. But that could only be achieved with deficits, debt, and printing fake money.

The massive cost of the failed Vietnam war led to Nixon closing the gold window in 1971.

As Nixon said at the time, “the strength of the currency is based on the strength of the economy”! 

          Hmmm, half a century later, that currency has lost 98% in real terms (GOLD), and the Federal Debt has grown 75-fold from $400 billion to $30 trillion. It took 22 years, from 1971 to 1993, for the debt to expand by $15 trillion. Just in the last 2 years, the debt is up by the same amount of $15 trillion.

            This debt will ultimately have to be dealt with.  Simple math has one concluding that this level of debt can never be paid. 

          It is the massive defaults on debt that will have to come that will ultimately lead to a painful deflationary environment.

          Stocks will fall, real estate prices will collapse, and unemployment will soar.

          It’s ironic that the currency creation that has taken place on such a reckless scale since the financial crisis has allowed the debt to build.

          Worldwide, at the time of the financial crisis, total debt was $120 trillion.  Today, worldwide debt stands at $300 trillion.  That’s an eye-popping increase of 250%!

          This can’t possibly end well.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Possible Economic Outcomes

          From where I sit, it seems that stagflation is the most likely economic outcome near term.

          Stagflation is defined as inflation combined with economic contraction.

          The official inflation rate is 8.5%, but any long-term reader of “Portfolio Watch” knows this official number is highly manipulated.  The actual inflation rate, absent favorable adjustments to make the reported number appear more palatable, is higher, likely mid-teens, depending on whose data you want to believe.

          No matter, inflation is rampant.  The Fed is ever-so-incrementally increasing interest rates to ostensibly fight inflation.  The reality is that the level of increase so far will probably not subdue inflation.

          The economy is still growing officially, but from my perspective, once the ultimate revisions are made, we are probably in a recession presently.

          On my weekly “Headline Roundup” webinar, I discussed the opinion of Mr. Peter Grandich, founder of Peter Grandich and Company, relating to inflation.  Grandich is of the opinion that the Fed is well behind the curve when addressing the inflation problem.  Long-time readers of “Portfolio Watch” know that I agree completely.

          Grandich says that inflation today is a completely different animal than it was in the 1970s which was the last stagflationary environment experienced by the country.  Grandich says “the situation is beyond what the Fed can do now”.

          “Social and political disharmony is at the highest level since the onset of the Civil War in the U.S.,” Grandich said, “and with the world suffering economic challenges, it does not paint a good picture for the future.”

          Grandich added, that he is investing only in the gold market presently.

          As far as the topic of economic contraction is concerned, Deutsche Bank recently became one of the world’s first major banks to forecast a recession.

          This from “CNN Business”:

“Deutsche Bank raised eyebrows earlier this month by becoming the first major bank to forecast a US recession, albeit a mild one.

Now, it’s warning of a deeper downturn caused by the Federal Reserve’s quest to knock down stubbornly high inflation.

‘We will get a major recession,’ Deutsche Bank economists wrote in a report to clients on Tuesday.

The problem, according to the bank, is that while inflation may be peaking, it will take a long time before it gets back down to the Fed’s goal of 2%.  That suggests the central bank will raise interest rates so aggressively that it hurts the economy.”

          As I have often stated, the Fed is between the proverbial rock and a hard place, all of their own making.  If the bank increases interest rates in a meaningful manner, recession will have to be the ultimate outcome.

          On the other hand, if the economy officially enters a recession and the Fed reacts by easing once again, the inflation monster will be further fueled.

          There are already signs that the economy, addicted to the artificial stimulus of the Fed is reacting negatively to the very modest tightening to date.

          Stocks are declining in 2022.

         

          The chart is a weekly chart of the Standard and Poor’s 500.  Each bar on the price chart represents one week of price action in this market.  The green bars represent weeks the market finished up, and the red bars represent weeks that the market finished lower.

          Note the uptrend line drawn on the chart from the most recent market bottom in 2020 to the end of 2021. 

          That trend was broken as we entered 2022.  And, since the trend was broken, we are now seeing the market ‘stair-step’ lower with a series of lower highs and lower lows.

          In this report, shortly after the first of the year, I suggested that the top in stocks might be in.  At this point, that seems to be the case, and I expect the series of lower highs and lower lows to continue.

          At this juncture, the Fed is continuing with its modest program of tightening.  The question will be how they react if stocks fall harder and go much lower.

          As noted above, more easing will mean more inflation.

          There are three economic outcomes here, in my view:

          One, the Fed stays the course, raising interest rates modestly and intermittently.  This course of action means that inflation may accelerate more slowly, but we also have a recession.  This is the stagflation outcome I discussed above.

          Two, the Fed, fearing recession, reverses course and begins currency creation once again while reducing interest rates.  This could mean more inflation, even hyperinflation, which will ultimately transition to a severely deflationary environment, perhaps after a currency event of some type.

          Three, the Fed, to get inflation in hand, increases interest rates so we have net positive interest rates after factoring in inflation.  This course of action likely leads almost immediately to the deflationary outcome.  In order to pursue this option, the federal budget would also have to be balanced or be a lot closer to balanced.

          Near term, I expect option one or a stagflation outcome. 

          However, it would not be surprising to see the Fed revert to option two when the economy worsens.

          And that seems to be what is occurring.

          Credit card debt that Americans are carrying increased almost unbelievably last month.  This from “Zero Hedge” (Source:  https://www.zerohedge.com/economics/shocking-consumer-credit-numbers-everyone-maxing-out-their-credit-card-ahead-recession):

While it is traditionally viewed as a B-grade indicator, the March consumer credit report from the Federal Reserve was an absolute shock and confirmed what we have been saying for months: any excess savings accumulated by the US middle class are long gone, and in their place, Americans have unleashed a credit-card fueled spending spree.

Here are the shocking numbers: in March, one month after the February print already came in more than double the $18 billion expected, consumer credit exploded to an absolute blowout of $52.435 billion, again more than double the expected $25 billion print, and the highest on record!

And while non-revolving credit (student and car loans) rose by a relatively pedestrian 21.1 billion (which was still the 6th highest on record)… … the real stunner was revolving, or credit card debt, which more than doubled from the already elevated February print of $14.2 billion to a stunning $31.4 billion, the highest print on record… just in time for those credit card APR to start moving higher, first slowly and then very fast.

            Yes, you read that correctly; credit card debt doubled and then some from February to March. 

          The best explanation, in my view, is that consumers are forced to borrow money or use credit to meet their household living expenses.

            That is a trend that is also unsustainable.

            There are many unsustainable trends; consumer debt levels, government debt levels, government spending, overvalued markets, and currency creation, to name a few.

            A reversal of these unsustainable trends is inevitable.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Has a Stock and Real Estate Price Correction Begun?

            The premise of my best-selling book “Revenue Sourcing” is that an aspiring retiree needs to plan for one of two economic outcomes, either inflation followed by deflation or just deflation.

            As time has evolved, it has become increasingly apparent that we are seeing inflation soon to be followed by deflation.

            Deflation occurs when debt in the financial system exceeds the level that the financial system can effectively purge using ‘honest’ methods.  Easy money strategies feed inflation and allow debt levels to build.

            When debt is purged from the financial system and deflation emerges, stock prices and real estate prices fall.  There is now, in my view, a growing amount of evidence that deflation as a result of debt purging may be beginning to show up.

            Stock prices took a big hit last week.  This from Yahoo News (Source:  https://news.yahoo.com/us-stocks-crater-dow-sheds-202007420.html)

US stocks fell Friday, as each of the three major indexes capped off losing months. The tech-heavy Nasdaq closed out its worst-performing month since 2008, shedding more than 3% for the day as investors fled the e-commerce giant after downbeat earnings.

“Some investors may be hoping for May flowers after these April showers, but historical tendencies suggest bulls should remain vigilant — down Aprils tend to be followed by down Mays,” Chris Larkin, Managing Director of Trading at E*Trade said. “And on top of that, May’s average return is even worse when the SPX is red for the year heading into the month.”

Mixed tech earnings have weighed heavily on investors, as many pandemic winners begin to deflate in the face of tighter monetary policy from the Federal Reserve. The Federal Open Market Committee is set to meet next Tuesday and Wednesday. It is widely expected that the central bank will hike rates by 50 basis points, with markets also pricing in a chance of a 75 basis point hike at the June meeting.

Bank of America trimmed its S&P 500 forecast from 4,600 to 4,500, and its analysts said markets are pricing in a one-in-three chance the US economy will enter a recession.

Cathie Wood’s Ark Innovation is about to cap off its worst month ever, with a 29% decline in April. That puts Wood’s flagship fund roughly 70% below its record-high in 2021 when pandemic stars like Zoom and Teladoc were surging.

            But it may not be just stocks that are feeling the pinch of debt excesses.  Real estate may be on the ropes as well.  This from Wolf Richter (Source: https://wolfstreet.com/2022/04/26/the-most-splendid-housing-bubbles-in-america-april-update-raging-mania-on-the-eve-of-the-spike-in-mortgage-rates/):

Home prices spiked in crazy leaps – including by about 30% or more in Phoenix, Tampa, and Miami year-over-year – according to the S&P CoreLogic Case-Shiller Home Price Index today. But this raging mania took place with mortgage rates of late last year, given the long lag of the Case-Shiller Index.

The long lag of the Case-Shiller Home Price Index.

The home price data released today was called “February” and represents the three-month average of closed sales that were entered into public records in December, January, February, reflecting deals that were agreed to a few weeks earlier, roughly in November, December, and January.

But wait… Many of these homebuyers were pre-approved and had rate locks from prior weeks and months. In November and December last year, the average 30-year fixed-rate hovered at around 3.2%, according to Mortgage Bankers Association data, which is when homebuyers got the rate locks for most of these deals in today’s data (green circle in the chart):

 The home price data in the charts below (Editor’s Note:  Will be showing only a few of the many charts Mr. Richter published in the article referenced above) does not yet reflect any part of the spike in mortgage rates that commenced in January. But it reflects the crazed run-up beforehand when buyers were desperately trying to buy a home with their still low rate locks.

The mad scramble at the time.

During the time reflected in today’s Case-Shiller home price data, there was a mad scramble to get the deals done before mortgage rates would rise, and this mad scramble is splendidly reflected here with some crazy spikes.

The overall National Case-Shiller Home Price Index for “February” (average of closed deals entered into public records in December, January, and February, and made in prior weeks and months) jumped 1.7% from the prior month and 19.8% year-over-year.

San Diego metro: Prices of single-family houses spiked by a holy-moly 4.5% in “February” from the prior month, and 29.1% year-over-year. The index value of 401 means that home prices exploded by 301% since January 2000, when the index was set at 100.

This price growth amounts to 4.3 times the rate of CPI inflation (+70%) over the same period, crowning San Diego the Number 1 most splendid housing bubble on this list:

Los Angeles metro: The Case-Shiller index spiked by 3.2% in February from January and 22.1% year-over-year. With an index value of 397, house prices exploded by 297% since January 2000, crowning the Los Angeles metro as the Number 2 most splendid housing bubble on this list.

It’s just house price inflation: the dollar losing purchasing power.

The Case-Shiller Index’s “sales pairs” method – comparing the price of a house when it sells in the current period to the price when it sold previously – tracks how many dollars it takes to buy the same house over time. The index includes adjustments for home improvements. By tracking the purchasing power of the dollar with regard to the same house, the index is a measure of house price inflation.

All charts here are on the same index scale, going just past 400.

Seattle metro: House prices spiked a holy-moly 4.4% for the month, and 26.6% year-over-year. Since January 2000, house price inflation in the Seattle metro amounts to 281%, four times the rate of CPI inflation:

Miami metro: House prices spiked 2.3% for the month, and 29.7% year-over-year, the fastest since January 2006, on the eve of Miami’s can-never-happen-here epic Housing Bust:

            While stocks may already be well on their way to deflating with the S&P 500 stock index down 13.31% YTD, it seems that there are signs the real estate market may soon follow suit.

            Should the real estate market and the stock market both see big price declines, we will see inflation subside to some extent (although food prices and energy costs may still rise), but we will then be looking at a different set of economic problems.

            The signs of deflation are now coming into view even as inflation is the primary economic trend.

            I see asset prices falling and consumer prices continuing to rise moving ahead.  That will inevitably lead to a recession.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

How Evolving Money Affects Investing Markets

         I just finished writing a special report for the month of May that is titled, “How Evolving Money Affects Investing Markets”.

          This week, I want to give you a preview as I think it’s important to understand how evolving money leads to economic seasons and what I believe are predictable investing conditions.

          While the whole idea of economic seasons may sound a bit crazy on the surface, a study of history has one concluding that these economic seasons have repeated themselves over and over again.

The severity and intensity of each season is affected by the currency system that is in place as the economic season changes.

There are many economists who have written extensively on the topic of economic seasons.  Mr. Ian Gordon, of the Long Wave Group, now retired, introduced me to the concepts many years ago.  It was an important “connect the dots” moment for me helping me understand why financial markets were doing what they did.

While economic seasons are predictable, the exact time at which one season ends and the next economic season begins is not precise from a forecasting perspective.  Yet, like the seasons of the year, we know that at some point, summer weather will follow spring weather.

For ease in understanding these economic seasons, we will name them after the seasons of the year: spring, summer, autumn, and winter.  Like the four seasons of the year, each economic season also has its own characteristics.

Here is a brief overview of the economic seasons and the characteristics of each one.  (These definitions are taken from the “New Retirement Rules” book.)

Spring Economic Season

During spring, an economy experiences a gradual increase in business and employment. Consumer confidence gradually increases. Consumer prices begin a gradual increase compared to the levels seen during the previous cycle (the winter cycle). Stock prices rise and reach a peak at the end of the spring cycle, and credit gradually expands. At the beginning of the spring cycle, overall debt levels are low.

Summer Economic Season

During summer, an economy sees an increase in the currency supply, which leads to inflation. Gold prices reach a significant peak at the end of the summer period. Interest rates rise rapidly and peak at the end of the summer season. Stocks are under pressure and decline throughout the period, reaching a low at the end of the summer cycle.

Autumn Economic Season

During autumn, money is plentiful and gold prices fall, reaching a gold bear market low by the end of the autumn season. During autumn, there is a massive stock bull market and much speculation. Financial fraud is prevalent, and real estate prices rise significantly due to speculation. Debt levels are astronomical. Consumer confidence is at an all-time high due to high stock prices, high real estate prices, and plentiful jobs.

Winter Economic Season

During winter, an economy experiences a crippling credit crisis and money becomes scarce. Financial institutions are in trouble. There are unprecedented bankruptcies at the personal, corporate, and government levels. There is a credit crunch, and interest rates rise. There is an international monetary crisis.

          The economist who first discovered that these economic cycles exist was Nikolai Kondratieff who outlined his work in a book first published in 1925 titled, “The Major Economic Cycles”.

          The economic winter season from 1929 to 1949 was particularly devastating.  That period of time we now refer to as The Great Depression.

          The reason the depression occurred was that debt levels were unsustainable.  During a winter economic season or a depression, debt needs to be purged from the system.

          There are only two ways to eliminate debt, pay it down by making principal and interest payments or default on it by walking away from the responsibility to repay the debt.

          It’s instructive to quickly look at each of the winter seasons in US history and then draw a parallel to today.

          Let’s begin with the winter season that began in 1837.  Like the winter season that commenced in 1929 with the crash of the stock market, the winter season that began in 1837 was catalyzed by the Panic of 1837.

          It’s interesting that the winter season of 1837 was preceded by easy money policies.  After the War of 1812, the country was dealing with mammoth levels of debt.  The politicians of the day predictably established a central bank that could create paper currency with a loose link to precious metals.

          This loose link to metals characterizes the money systems in place prior to the first three winter seasons in US history.  Policymakers reduced the backing of the paper currency by precious metals without eliminating the link and making the currency a pure fiat currency.

          This is what happened with the establishment of the Second National Bank which opened for business in January of 1817.  The bank began to issue paper notes that could be redeemed for precious metals.  As typically happens, the bank issued more paper currency than it had precious metals to back resulting in a large increase in the currency supply.

          It was the early 1800’s version of quantitative easing or currency creation.

          It was inevitable that this expansion of the currency supply would lead to a price bubble in some assets.  With the Panic of 1837, stocks and real estate crashed and banks failed.

          The second winter season in US history occurred after the Civil War.  In order to fund the Civil War, President Lincoln and congress changed the banking rules to allow US Dollars to be backed by gold, silver, and US Government debt.  Prior to these changes being made, gold and silver were money.

          These changes resulted in a huge increase in the currency supply and predictably, bubbles formed in real estate and stocks. 

          Stocks and real estate collapsed and banks failed during the Long Depression of 1873.

          The country once again returned to a currency system that was more sound, using gold and silver as currency.

          The Federal Reserve, the nation’s third central bank and the same central bank that controls monetary policy today, was founded in 1913.

          Almost immediately, the Fed reduced the backing of the US Dollar by gold from 100% backed by gold to only 40% backed by gold creating a large increase in the currency supply.

          Predictably, the Roaring Twenties followed this evolution to more loose money policies.  Stock prices, fueled by extremely loose margin requirements, soared.  As did real estate prices with the State of Florida being the site of wildly increasing real estate values.

          The Great Depression followed.  Stock prices fell as did real estate prices and banks failed.

         In each of these historical, U.S.-based winter economic seasons, easy money allowed for the building of debt-fueled bubbles that eventually collapsed.

          It’s also important to point out that in each of these historical examples, the US Dollar was still linked to gold to some extent.

          That brings us to where we now find ourselves.

          There has been no link between the US Dollar and a precious metal since 1971 making the US Dollar a full fiat currency for more than 50 years.  That has allowed debt levels in the private and public sectors to soar.        

          Around 15 years ago, real estate prices began to fall and stock prices followed.  The Federal Reserve’s response has been currency creation literally out of thin air.

          That action has reinflated what I call the “everything bubble”. 

          At some point, the everything bubble will deflate resulting in what I believe could be the worst economic winter season in US history.

          Why do I theorize this?

          Simple, debt levels are far more extended presently than at any time historically.  That will have to make the debt purging process more painful.

          We may now be seeing the beginning of the effects of debt excesses.  Stocks are falling and interest rates are rising.

          I fully expect the Fed to reverse course and ease in a last-ditch effort to avoid a deflationary outcome but history teaches us that is where we will ultimately end up. 

          The question is how much inflation we endure in the meantime.  And, the answer to that question lies with the Fed.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Inflation Heats Up, Are Price Controls Coming

            The big economic news the week before last week was the big decline in US Treasuries.  Last week, the big economic news was once again the big decline in US Treasuries.

            While the US Dollar Index is higher once again this week, as I discussed last week, it’s important to remember that this measure of the US Dollar’s purchasing power is a relative measure and compares the purchasing power of the US Dollar to a weighted basket of 6 other fiat currencies.

            On an absolute basis, the US Dollar’s purchasing power is declining as the official inflation rate rose to 8.5% last week.  The real inflation rate is much higher than this heavily manipulated Consumer Price Index number.

            John Williams, the economist at www.shadowstats.com, uses the inflation rate calculation methodology that was used pre-1980 to determine the inflation rate.  Using that calculation methodology, which was used the last time we had inflation at these levels, the current inflation rate is 16.77%.

            That feels more like what we are all experiencing.

            Inflation levels are now either at or approaching levels that will cause more inflation.  When inflation levels get high enough, the inflation cycle begins to feed on itself, creating even more inflation.

            In today’s inflationary environment, it’s nearly impossible for a builder to comfortably and confidently quote a proposed building project.  Assuming a building project will take a year or two to complete, the prices of the materials needed to complete the project will likely rise enough by the time the materials are actually needed to render any current quote attempts fruitless.

               The same could be said about farming.  Input costs have risen a staggering amount.  Many farmers are not planting the same crops or the same quantity of crops as in past years due to uncertainty about the ability to make a profit.

            And, of course, there is always the concern about what politicians might decide to do about inflation.  That concern is rightfully heightened in an election year like this one.

            In past posts, I have forecast that we will likely see price controls or perhaps even rationing of certain products, especially as the election approaches.

            While history unequivocally teaches us that price controls never work, that fact has never kept self-serving politicians from implementing price controls on an uninformed public to make it seem like the politicians are doing something to address the problem.

            In the 1970’s, after stating that “the (expletive deleted) things don’t work” referring to price controls, President Nixon reversed course and implemented price controls when his advisor reminded him he needed to navigate re-election. 

            Ironically, Nixon was right.  Price controls didn’t work.  As always happens price controls lead to empty store shelves as producers stop producing when the profit incentive is gone.

            Now, as I predicted we would see earlier this year, there is talk among some Washington politicians to implement price controls.  Here is an excerpt from an op-ed piece written by Stephen Moore in “The New York Post” (Source: https://nypost.com/2022/04/06/threatened-price-controls-wont-curb-biden-flation/)

Now the Biden administration complains that producers are taking advantage of product shortages and supply-chain constraints by jacking up their prices. He wants to penalize the meat packers for the high beef prices, the poultry industry for the rising expense of a chicken dinner, the drug companies for the high cost of pharmaceuticals and the oil and gas industry for recording record profits while gas prices soar. 

He wants the Federal Trade Commission and other regulatory agencies to impose price ceilings to be monitored by an army of federal price-control police.

This is economic amnesia. We tried all these government manipulations in the 1960s and 1970s. The ruinous price regulations on industry made inflation worse. Back then we had Soviet-style central planners imposing price limits on everything: long-distance phone calls, oil and gas, airlines, rail service, trucking and banking services.

This was supposed to protect consumers, but by making it illegal for prices to rise, we got hit with empty shelves, shortages and gas lines.

The price ceilings became de facto price floors. Inflation shot up from 5% to 8% to 10% by 1980.

Even Democrats Jimmy Carter and Ted Kennedy realized that things were going haywire. They took the lead in ushering in an era of decontrol of prices. And when President Ronald Reagan was elected, his first executive order was to end oil and gas price controls.

What was the result? A famous study by the Brookings Institution found that the airline prices collapsed by one-third (ushering in an era of everyday Americans being able to afford to fly here, there and everywhere) and banking charges fell by half, as did trucking and rail costs. The price of oil briefly rose when the price controls were lifted, but then as energy supplies were unleashed, prices fell by more than 60%.

Brookings found “in every industry” in which price controls were lifted, “prices fell and service quality improved.”

Why is this history lesson so hard for the modern Democrats to learn? 

Just this week, Bernie Sanders called for a backdoor form of price controls with his proposal of a 95% windfall-profits tax on such firms as oil companies, pharmaceuticals, and meat producers. No one told the senator that when you tax something, you get less of it. This will only make supply-chain problems worse and fuel even higher prices.

Businesses aren’t charities. And it’s not “greed” or price gouging to make a profit. Adam Smith taught us in 1776 that it’s profit, not “benevolence,” that induces companies to produce more of the things we want at prices we can afford. That eventually brings prices down. 

How depressing that here we are 250 years later and our politicians in Washington still don’t understand that enduring economic lesson.

            Hopefully, price controls don’t get taken out of the tired bag of tricks, but this is an election year and inflation is continuing to accelerate.  I’m hopeful but not holding my breath.

            The reality is that inflation is a result of extremely loose, I would argue reckless, monetary policy.  Paul Volcker ended the inflation in the 1970s by raising interest rates to nearly 20 percent which caused the money supply to meaningfully contract.

            Here’s the problem with following Volcker’s plan of action today – the Federal Reserve is indirectly monetizing government deficit spending.  To tighten monetary policy permanently, the federal government’s budget will also have to be tightened.

            That’s why I believe the Fed’s current actions to tighten will be reversed at some future point citing another economic emergency that requires more currency creation.

            Meanwhile, following increasing yields on US Treasuries, mortgage rates rose as well with interest rates on a 30-year mortgage now rising past 5% for the first time in more than 10 years.  This from “The Guam Daily Post” (Source:  https://www.postguam.com/business/real_estate/mortgage-rates-hit-5-ushering-in-new-economic-uncertainty/article_396d6358-bc70-11ec-b78e-8b82b1f2f504.html)

Mortgage rates swelled above 5% for the first time in more than a decade – an unexpectedly rapid ascent that has begun to temper the U.S. housing boom and could usher new uncertainty into an economy dogged by soaring inflation.

The 30-year fixed-rate mortgage, the most popular home loan product, hit the threshold just five weeks after surpassing 4%, according to Freddie Mac data released Thursday. The average has not been this high since February 2011.

The run-up comes as the Federal Reserve has launched a major initiative to rein in the highest inflation in 40 years. Fed officials are betting that higher interest rates will slash inflation and recalibrate the job market. But their plan also rests on the assumption that higher rates will cool demand for housing, especially while homes themselves are in such short supply.

Low rates fueled the revival of the U.S. housing market after the Great Recession and have helped drive home prices to record levels. But after two years of hovering at historical lows, rates have been on a tear: In January, the 30-year fixed average was 3.22%. It was 3.04% a year ago. And while mortgage rates had been expected to rise, they’ve done so more quickly than many economists predicted.

“I’m not surprised that rates have hit 5%, but I am surprised that everyone else is surprised,” Curtis Wood, founder and chief executive of Bee, a mobile mortgage app, said via email. “If you look at historical action by the Fed in a high-rate environment and compare that to what the Fed is doing today, the Fed is underreacting to the reality of inflation in the economy.

“I’m surprised that rates aren’t at 6% right now,” he added, “and wouldn’t be shocked if they’re at 7% by end of year.”

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Are Currency Changes Imminent? – Part 2

          The big news in financial markets last week was the big decline in US Treasuries.  Not surprising given the news I discussed last week; Russia has now loosely tied its currency, the Ruble, to gold and required any country that Russia deems to be unfriendly to use Rubles or gold when trading with Russia.

          As I noted last week, this move will likely be bullish for gold and negative for the US Dollar.  Many readers could be looking at the performance numbers in the databox above and noting that the US Dollar moved significantly higher last week.  It’s important to understand that the US Dollar Index is a relative measure of the purchasing power of the US Dollar, not an absolute measure.  The US Dollar Index measures the US Dollars purchasing power relative to the purchasing power of the Japanese Yen, the Euro, the Swedish Krona, the British Pound Sterling, the Swiss Franc, and the Canadian Dollar.

          All one needs to do is visit a grocery store or purchase any consumer item to quickly realize that the US Dollar is losing absolute purchasing power.  The other fiat currencies used in the US Dollar Index are simply performing more poorly than the US Dollar on a collective basis.

          This move by Russia, I believe, is the biggest economic news of our time.  As big as when Nixon eliminated the convertibility of the US Dollar for gold.

          Interestingly, at the time Nixon made that move, the ultimate implications of the action were not widely understood by the populace.  I think one could reasonably state that the same could be said about this move by Russia that could be the catalyst for big currency changes globally moving ahead.

          From my perspective, currency changes typically occur slowly.  It’s taken more than 50 years for the US Dollar to lose 98% of its purchasing power.  The US Dollar has been the preferred currency for international trade since the Breton Woods agreement of 1944.  After Nixon eliminated the US Dollar redemptions for gold in 1971, an agreement was struck with Saudi Arabia to sell its oil exports in US Dollars in exchange for military favors.

          Now though, as has happened many times throughout history, currencies are beginning to evolve more rapidly.  Many years from now, looking back, I believe this move by Russia will be viewed as the catalyst for major currency changes that are yet to come.

          Past RLA Radio Guest, Peter Schiff, recently commented (Source:  https://schiffgold.com/key-gold-news/russia-is-quietly-making-the-case-for-owning-gold/):

The head of the Russian Parliament, Pavel Zavalnymade comments recently addressing the subject of economic and financial sanctions. It’s clear that gold is playing a large role in protecting Russian wealth. That role may get bigger and it could create a paradigm shift in how the world does business.

Russia has a lot of natural gas and oil. And it sells a lot of natural gas and oil to the world. Zavalny made it clear that Russia is happy to sell — in hard currency. And what is hard currency? Not dollars.

“If they want to buy, let them pay either in hard currency, and this is gold for us, or pay as it is convenient for us, this is the national currency. As for friendly countries, China or Turkey, which are not involved in the sanctions pressure. We have been proposing to China for a long time to switch to settlements in national currencies for rubles and yuan. With Turkey, it will be lira and rubles. The set of currencies can be different and this is normal practice. You can also trade bitcoins.”

Zavalny said Russia has no interest in dollars, saying “this currency turns into candy wrappers for us.”

In an op-ed published by “MarketWatch”, Brett Arends said this might not mean anything. But it could mean a lot if other countries like China and India follow Russia’s lead. As Arends notes, a lot of countries aren’t thrilled with the United Sates’ ability to control the global financial system with a monopoly on the reserve currency.

Arends also says this adds to the argument for having gold in a long-term investment portfolio.

Not because it is guaranteed to rise, or maybe even likely to. But because it might — and might do so while everything else went nowhere, or went down. Like in a geopolitical or financial crisis where the non-western bloc decides to challenge America’s financial hegemony and ‘king dollar.’”

Arends calls himself “gold agnostic,” but he said there is no question “it has its uses.”

Gold is completely private. It is completely independent of the SWIFT or any other banking system. And despite the rise of cryptocurrencies, it remains the most widespread and viable global currency that is not controlled by any individual country.”

Moves made by Russia in recent weeks could represent a huge paradigm shift in global finance. Many countries have been building toward this for years as the US has weaponized the dollar.

In effect, Russia put the ruble on a gold standard that is now linked to natural gas.

Russia holds the fifth-largest gold reserves in the world. After pausing during the COVID-19 pandemic, the Central Bank of Russia resumed gold purchases in early March before suspending them again a couple of weeks later. The Russian central bank resumed buying gold from local banks on March 28 at a fixed price of 5,000 roubles ($52) per gram. Since Russia is insisting on payment of natural gas in rubles and they’ve linked the ruble to gold, natural gas is now indirectly linked to gold. The Russians can do the same to oil, as ZeroHedge explained.

If Russia begins to demand payment for oil exports with rubles, there will be an immediate indirect peg to gold (via the fixed price ruble – gold connection). Then Russia could begin accepting gold directly in payment for its oil exports. In fact, this can be applied to any commodities, not just oil and natural gas.”

So, what does this mean for the price of gold?

“By playing both sides of the equation, i.e. linking the ruble to gold and then linking energy payments to the ruble, the Bank of Russia and the Kremlin are fundamentally altering the entire working assumptions of the global trade system while accelerating change in the global monetary system. This wall of buyers in search of physical gold to pay for real commodities could certainly torpedo and blow up the paper gold markets of the LBMA and COMEX.”

“The fixed peg between the ruble and gold puts a floor on the RUB/USD rate but also a quasi-floor on the US dollar gold price. But beyond this, the linking of gold to energy payments is the main event. While increased demand for rubles should continue to strengthen the RUB/USD rate and show up as a higher gold price, due to the fixed ruble – gold linkage, if Russia begins to accept gold directly as a payment for oil, then this would be a new paradigm shift for the gold price as it would link the oil price directly to the gold price.”

We could be seeing a slow unwinding of the petrodollar. And the petrodollar is one of the foundations of the dollar’s position as the world currency. We’ve already heard rumblings of Saudi Arabia accepting yuan for oil.

The US and other western powers have tried to lock down Russia’s gold. But as Arends explains, that is virtually impossible in effect.

“Despite some laughable suggestions that the West might somehow sanction ‘Russian gold,’ there is no way of tracing the identity, nationality, or provenance of bullion. American Eagle coins or South African Krugerrands can be melted down into bars. Gold is gold. And someone will always take it. Carry a Krugerrand to any major city anywhere in the world and you will find people willing and eager to take it off your hands in return for any other currency you want.”

            Back in 2011, when I wrote the book “Economic Consequences”, I noted that the Federal Reserve would ultimately determine whether the United States experienced deflation or inflation followed by deflation.  I reasoned that the outcome would depend entirely on monetary policy.

          It now seems that the latter outcome is inevitable and perhaps even imminent.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Are Currency Changes Imminent? – Part 1

        Despite the ever-so-slight rally in stocks this week, I view the primary stock market trend as down.  Unless the market highs of the end of 2021 are exceeded, this will be the case.

        This week, I want to discuss an event that has not been covered extensively so far as I can tell.  But this event that recently occurred has the power to change the way the world does a lot of its business.

        Here is why that could be a big deal to you – the rest of the world uses a lot of US Dollars in trade.  As I have discussed in this publication previously, there has been a gradual, ever-intensifying move away from the US Dollar over the past twenty years or so.  With this recent event, that move could really strengthen.

        To what event am I referring?

        This from “Fox Business” on February 28 (Source:  https://www.foxbusiness.com/markets/us-freezes-russian-central-bank-assets-held-by-americans):

The U.S. said it is blocking financial transactions of Russian central bank assets, effectively freezing any of those assets held by Americans.

The freeze is effective immediately, a senior administration official said in a briefing for reporters on Monday. The official said that the U.S.’s actions are in conjunction and cooperation with the European Union, Japan, the UK, Canada, and others. This means that not only will Russia not be able to access funds in U.S. dollars, they will be unable to use dollars in the other countries turn to other banks and other currencies.

By making the move effective immediately, before markets open, the official said, Russia will be unable to move assets to avoid or mitigate the consequences.

“Our strategy,” the official said, “is to make sure that the Russian economy goes backward as long as President Putin decides to go forward with his campaign.”

        As one would expect, Russia fought back.  The country is now demanding payment for its vast natural resource exports in either gold or rubles giving any of the rest of the world that does business with Russia another reason not to inventory US Dollars.

        Analyst and economic writer, David Kranzler, whose work I have discussed previously recently penned a piece on this topic titled, “Did Russia Intentionally Trigger a Monetary System Reset?” (Source:  https://www.investing.com/analysis/did-russia-intentionally-trigger-a-monetary-system-reset-200621146).  It is a thought-provoking article, here are some excerpts:

Fiat currency is a “promise” to repay a debt obligation and nothing more. A hard asset-backed currency is a guarantee that repayment will occur.

On Mar. 7, Zoltan Pozsar, who formerly worked at the NY Fed, was an advisor at the U.S. Treasury, and currently is a strategist at Credit Suisse, published a research report titled “Bretton Woods III.”

Anyone familiar with the Bretton Woods agreement understands the reference. Nixon’s snipping of the final thread connecting currency to gold is considered to be Bretton Woods II. Pozsar makes the case that Bretton Woods III is a reversion back to a monetary system in which currency is backed by commodities as opposed to being backed by a sovereign issuer’s “full faith and credit.”

The post-1971 fiat currency reserve banking system enabled by the removal of gold from the monetary system is nothing more than a Ponzi scheme. “Inside money” refers to the interbank repo/lending mechanism from which the fractional bank reserve monetary system blossoms.

Pozsar distinguishes “inside money” from “outside money.” Inside money” is created by the Central Bank/inter-bank lending mechanism that can magically turn one dollar of reserve capital into nine dollars of “credit” capital. And the one dollar of reserve capital is backed by nothing tangible—just the “full faith and credit” of the issuing entity.

Think of this monetary system as an inverted pyramid, e.g., something like Exter’s Pyramid. In bankruptcy law, “full faith and credit” would be considered, at best, an unsecured loan. Get in line and pray that there’s value left over to be distributed to the unsecureds.

In contrast, Pozsar references Bretton Woods III as the “rising allure of outside money over inside money,” where “outside money” is “commodities collateral,” meaning tangible assets for which definitive value can be determined, as opposed to the sovereign promise of “full faith and credit.”

In periods of banking crises, banks are reluctant to participate in the “inside game” (see 2008 and September 2019, for instance) because, at that point in time, they don’t trust the fiat currency collateral on which the fractional reserve banking system is predicated and thus are reluctant to lend money to their banking peers.

Every time this occurs, the Central Banks have to print more money to “lubricate” the system enough so that it functions. This in turn further devalues the “inside money” on which the system is predicated.

But if currency issued by Governments and printed by Central Banks is backed by hard assets, this problem is avoided. In this system, the counterparty to trade or financing transactions would have the option of demanding payment in the hard asset or assets backing the currency—most likely gold or possibly a pre-agreed upon commodity asset. Remember, fiat currency is nothing more than an unsecured debt instrument of the issuing entity.

It’s likely that Putin knew ahead of time that the West’s response to Russia’s invasion of Ukraine would be to freeze Russian currency reserves held at western Central Banks. Of course, this response by the U.S./West brought to light the inherent Achilles’ Heel of the modern Central Bank fiat currency reserve system.

Any country that keeps currency reserves for trade settlement purposes at foreign Central Banks, specifically the Federal Reserve and the ECB, is at risk of having those reserves confiscated, thereby rendering them worthless.

In response, Russia is now demanding payment for energy in either rubles or gold from what it deems to be “unfriendly” countries. Whereas in the “inside money” banking system, settlement of trade is merely a matter of accounting ledger adjustments at the respective Central Banks, in this trade settlement arrangement, a country purchasing oil or gas from Russia in exchange for gold would need to 1) demonstrate that the gold being used for trade payment actually exists, and 2) transfer the ownership rights to Russia. Russia ultimately would likely demand repatriation of the gold. The U.S./G7 made it crystal clear that possession of assets is 100% of the law.

The response by the West—led by the U.S. and its control of the global reserve currency—in all likelihood has triggered a reset of the global monetary system. I actually do not like the term “Bretton Woods III” because it references an agreement which, in its essence, destroyed the gold-backed global monetary system.

Regardless, it appears for now that Russia—likely with China’s tacit support—has set in motion a global monetary system reset. In the new system countries which supply the world with goods that have price inelasticity of demand—oil, natural gas and food commodities, for instance—will have the power to enforce trade settlement in hard currencies, e.g., gold or other hard assets, rather than fiat currency Central Bank accounting ledger adjustments.

        “Coindesk” recently published a piece (Source:  https://www.coindesk.com/policy/2022/03/08/credit-suisse-strategist-says-were-witnessing-birth-of-a-new-world-monetary-order/) that provided additional perspectives from Zolton Pozsar:

Former Federal Reserve and U.S. Treasury Department official, and now Credit Suisse (CS) short-term rate strategist, Zoltan Pozsar has written the U.S. is in a commodity crisis that is giving rise to a new world monetary order that will ultimately weaken the current dollar-based system and lead to higher inflation in the West.

“This crisis is not like anything we have seen since President [Richard] Nixon took the U.S. dollar off gold in 1971,” wrote Pozsar.

As the initial Bretton Woods era (1944-1971) was backed by gold, and Bretton Woods II (1971-present) backed by “inside money” (essentially U.S. government paper), said Pozsar, Bretton Woods III will be backed by “outside money” (gold and other commodities).

Pozsar marks the end of the current monetary regime as the day the G7 nations seized Russia’s foreign exchange reserves following the latter’s invasion of Ukraine. What had previously been thought of as risk-free became risk-free no more as non-existent credit risk was instantly substituted for very real confiscation risk.

What occurred surely isn’t lost on China, and Pozsar sees the People’s Bank of China (PBOC) faced with two alternatives to protect its interests – either sell Treasury bonds to buy Russian commodities, or do its own quantitative easing, i.e., print renminbi to buy Russian commodities. Pozsar expects both scenarios mean higher yields and higher inflation in the West.

        Last week, I discussed how governments and central banks around the world are pursuing digital currencies with a great deal of determination.  Perhaps this development helps to explain the sudden level of increased urgency.  It certainly makes the case for non-US Dollar-denominated assets in a portfolio like gold and silver.

“Money is the barometer of a society’s virtue. When you see that trading is done, not by consent, but by compulsion–when you see that in order to produce, you need to obtain permission from men who produce nothing–when you see that money is flowing to those who deal, not in goods, but in favors–when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you–when you see corruption being rewarded and honesty becoming a self-sacrifice–you may know that your society is doomed.”

                                                                   -From “Atlas Shrugged”

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Digital Currency Update

            As noted last week, I view the current rally in stocks as counter-trend with the primary trend being down.  The Dow to gold ratio continued to fall. Ultimately, I expect this ratio to reach two or perhaps even one.

            For new readers, the Dow to gold ratio is calculated by taking the value of the Dow and dividing by the price of gold per ounce.  The Dow is measured in US Dollars, a rapidly changing metric as the US Dollar continues to devalue.

            When the Dow is measured in gold, which is a constant metric, one gets a clearer picture as to the actual value of stocks.  At the tech stock bubble peak, the Dow to gold ratio was well over 40.  At the close of the last big inflationary cycle in the US in 1980, the Dow to Gold ratio was one.  I expect that as the present economic climate evolves, we will ultimately see a similar ratio.

            Of course, world central banks will do everything they can to keep this ratio as constant as possible, but over the long term, economic laws will have to prevail.  History teaches us that it is never possible to print your way to prosperity.

            Thomas Paine, a hero at the time of the Revolutionary War but later much maligned over his views said, “Money is money and paper currency is paper.  All the invention of man cannot make them otherwise.”

            It may be wise to keep the perspective of Mr. Paine as we move forward.  There are now 90 world central banks that have issued a central bank digital currency or are experimenting with them.

            This is an excerpt from a piece (Source:  https://www.nakedcapitalism.com/2022/03/the-world-quietly-took-another-step-toward-embracing-central-bank-digital-currencies.html) penned by Nick Corbishley (emphasis added):

Given how much is at stake, this financial revolution is among the most important questions today’s societies could possibly grapple with. It should be under discussion in every parliament of every land, and every dinner table in every country in the world.

Around 90 central banks are either in the process of experimenting with or are already piloting central bank digital currencies (CBDCs). In a world of just over 190 countries that is a large contingent, but given they include the European Central Bank (ECB) which alone represents 19 Euro Area economies, the actual number of economies involved is well over 100. They include all G20 economies and together represent more than 90% of global GDP.

Three CBDCs have already gone fully live in the past two years: the so-called DCash in the Eastern Caribbean, the Sand Dollar in the Bahamas, and the eNaira in Nigeria. The International Monetary Fund, the world’s most powerful supranational financial institution, has been lending its expertise in the roll out of CBDCs. In a recent speech, the Fund’s President Kristalina Georgieva lauded the potential benefits (on which more later) of CBDCs while heaping praise on the “ingenuity” of the central banks busily trying to conjure them into existence.

Also firmly on board is the world’s largest asset manager, BlackRock, which helps many of the world’s largest central banks, including the Federal Reserve and the ECB, manage their assets while obviously keeping all potential conflicts of interests at bay. The fund was the largest beneficiary of the Federal Reserve’s bailout of exchange-traded funds during the market rout of Spring 2020.

In his latest letter to investors, the CEO of BlackRock, Larry Fink, said the Ukrainian conflict has the potential to accelerate the development of digital currencies across the world.

“The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades As a result, a large-scale reorientation of supply chains will inherently be inflationary…

“The war will prompt countries to re-evaluate their currency dependencies. Even before the war, several governments were looking to play a more active role in digital currencies and define the regulatory frameworks under which they operate…

A global digital payment system, thoughtfully designed, can enhance the settlement of international transactions while reducing the risk of money laundering and corruption. Digital currencies can also help bring down costs of cross-border payments, for example when expatriate workers send earnings back to their families.”

On Tuesday (March 22), the Bank for International Settlements published the findings of a study it had conducted with four central banks — the Reserve Bank of Australia, Bank Negara Malaysia, the Monetary Authority of Singapore, and the South African Reserve Bank — into the practical challenges of executing cross-border payments between different central bank digital currencies. The report concludes that while major hurdles still remain, financial institutions could use CBDCs issued by participating central banks to transact directly with each other on a shared platform:

The Bank for International Settlements (BIS) Innovation Hub, the Reserve Bank of Australia, Bank Negara Malaysia, the Monetary Authority of Singapore, and the South African Reserve Bank today announced the completion of prototypes for a common platform enabling international settlements using multiple central bank digital currencies (mCBDCs).

Led by the Innovation Hub’s Singapore Centre, Project Dunbar proved that financial institutions could use CBDCs issued by participating central banks to transact directly with each other on a shared platform. This has the potential to reduce reliance on intermediaries and, correspondingly, the costs and time taken to process cross-border transactions.

The project was organized along three workstreams: one focusing on high-level functional requirements and design, and two concurrent technical streams that developed prototypes on different technological platforms (Corda and Partior).

The project identified three critical questions: which entities should be allowed to hold and transact with CBDCs issued on the platform? How could the flow of cross-border payments be simplified while respecting regulatory differences across jurisdictions? What governance arrangements could give countries sufficient comfort to share critical national infrastructure such as a payments system?

The project proposed practical solutions for addressing these issues, which were validated through the development of prototypes that demonstrated the technical viability of shared multi-CBDC platforms for international settlements.

The findings of the experimental CBDC program could assist in the adoption of CBDC international settlement for G-20 nations, though given the rising geopolitical fissures in the so-called “international rules based order”, it is far from clear which countries would be willing to engage with one another in such a way.

China has already launched its own digital yuan and is piloting its use in more than a dozen cities and regions. It has also been experimenting with its cross-border functionality. This has ignited fears in the West that that U.S. “financial leadership” is under threat — fears that have been magnified by the way US and EU sanctions against Russia, particularly the confiscation of a large chunk of Russia’s foreign currency reserves have backfired, encouraging not just Russia but many countries on the planet to seek out an alternative cross-border payments system.

At the same time, the U.S. is determined to continue playing a leading role in the new global financial architecture. To that end, it has cobbled together a tentative consortium of “seven of the largest Western-aligned central banks, led in practice by the U.S. Federal Reserve and the European Central Bank… aimed at creating a system of ‘interoperable’ CBDCs,” reports Washington DC-based blogger and analyst NS Lyons in the article, Just Say No to CBDCs.

But what are CBDCs? How will they work? What purposes could they serve? How might they affect the general populations of the countries where they are introduced? To answer the first two questions, here’s an excerpt from “Just Say No to CBDCs“:

You might assume that you are already using “digital currency” regularly if you rarely use physical cash anymore and instead buy almost everything with a credit card or a digital payment app. In truth, the process of moving money from A to B is vastly more complicated than that. It involves a tangle of payment processors, banks, financial clearinghouses, and, if your money is crossing borders, international communication and exchange systems, such as the Society for Worldwide Interbank Financial Telecommunication (SWIFT). The money itself doesn’t move anywhere fast, so each intermediary institution must assume risks to fulfill your transaction by accepting promises, sending transfers, verifying receipt of funds, and so on. Many fees get collected along the way for such services.

A CBDC system would be radically simplified. A customer would open an account directly with a country’s central bank, and the central bank would issue (create) digital money in the account. Crucially, this makes the money a direct liability of the Fed, rather than of a private bank. Using a simple smartphone app or other tools, the customer can then initiate direct transactions between Fed accounts. The digital money is deleted in one account and recreated in another instantaneously. Moving money across borders no longer requires something as complex as SWIFT or wire transfers, and currencies can be exchanged instantly as long as friendly central banks have agreements to do so. No promises or trust are necessary; every transaction is permanently recorded on a digital cryptographic ledger in real time—a bit like Bitcoin, but exquisitely centralized rather than distributed.

            In his article, Corbishley points out the four primary ways that a central bank issued digital currency could affect our lives.

One, central banks will have more power over our payment behavior.  Another way to phrase this is that central banks will have more control.  Agustin Cartens, general manager of the Bank of International Settlements, stated this intention in 2020 at a Summit hosted by the International Monetary Fund when he said, “We don’t know who’s using a $100 bill today and we don’t know who’s using a 1,000 peso bill today. The key difference with the CBDC is the central bank will have absolute control over the rules and regulations that will determine the use of that expression of central bank liability, and also we will have the technology to enforce that.”

A digital currency gives the central bank complete control over money.  There is no financial privacy and should the government not like the behavior of an individual, freezing assets is easy.

Two, our spending could be programmed.  NS Lyons, referenced above, had this to say on this topic.  “The Fed could directly subtract taxes and fees from any account, in real-time, with every transaction or paycheck, if it wished. There could be no more tax evasion; the Fed would have a complete record of every transaction made by everyone. Money laundering, terrorist financing, any other unapproved transaction would become extremely difficult. Fines, such as for speeding or jaywalking, could be levied in real-time if CBDC accounts were connected to a network of “smart city” surveillance. Nor would there be any need to mail out stimulus checks, tax refunds, or other benefits, such as universal basic income payments. Such money could just be deposited directly into accounts. But a CBDC would allow the government to operate at much higher resolution than that if it wished. Targeted microfinance grants, added straight to the accounts of those people and businesses considered especially deserving, would be a relatively simple proposition.”

Three, negative interest rates could be imposed with no limits.  In a society with no cash, there would be no limit on how negative interest rates could go.

Four, the financial exclusion could accelerate.  This from Mr. Corbishley’s piece:

Even proponents of CBDCs admit that central bank digital currencies could have serious drawbacks, including further exacerbating income and wealth equality.

“The rich might be more capable than others of taking advantage of new investment opportunities and reaping most of the benefits,” says Eswar Prasadm a senior fellow at the Brookings Institute and author of The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance. “As the economically marginalized have limited digital access and lack financial literacy, some of the changes could harm as much as they could help those segments of the population.”

So, not only will the introduction of CBDCs strip global citizens of one of the last vestiges of freedom, privacy, and anonymity (i.e., cash), it could also exacerbate the upward transfer of wealth and power that many societies have witnessed since the COVID-19 pandemic began.

            Stepping back, it’s easy to see that the increased use of cryptocurrencies and now this intensified talk of central bank-issued digital currencies is occurring because the existing system is breaking down.  Currency creation on a widespread scale is causing inflation.  Accelerating inflation is causing faith in world currencies to diminish.

            Central banks and governments around the world don’t want to lose the monopoly that they have on currency.  So, in response to the problems that their own policies have caused, they are looking to take even more control over the currency system.

            These efforts, in the long run, will fail as well in my view.  In the words of Thomas Paine, “Money is money and paper currency is paper.  All the invention of man cannot make them otherwise.”  While a digital currency was not a thought when Mr. Paine made his statement, Mr. Paine’s observation will still hold true in my view.

            All the inventions of men will not make digital currency money.  Should digital currencies become a reality worldwide (and I remain skeptical), our current economic problems of growing inflation and a widening wealth gap will worsen in my opinion.  Digital currencies will just make poor monetary policies easier to implement.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Are We on the Verge of a Crack-Up Boom?

         Stocks rallied and gold fell last week.  At this point, I don’t view these developments as trend-changing, rather as counter-trend rallies.  The Dow to Gold ratio continued to fall last week.  As currency devaluation continues, this is an indicator that becomes more meaningful in my view.

          At its last meeting, the Federal Reserve increased interest rates by .25%.  As I have been stating, I expect Fed action to counter inflation will be more form than substance.  This increase of .25% certainly fits in that category in my view.

          There is more to this inflation story than meets the eye.  While an increase in the currency supply leads to inflation, it also creates other undesirable side effects, particularly when the currency is the world’s reserve currency.

          As long-time readers of “Portfolio Watch” know, I have often discussed the concept of a ‘crack-up boom’ put forth by Austrian economist, Ludwig von Mises.  For newer readers of “Portfolio Watch”, a crack-up boom is defined as currency inflation or hyperinflation coupled with a simultaneous recession or depression.

          Current monetary policy and credit expansion, if it continues, could lead to such an outcome.  Arguably, we are on the fringe of such an outcome presently.

          Larry Lepard, manager of the EMA GARP fund recently commented on the probability of such an outcome in light of the Russia-Ukraine situation.  (Source:  https://www.zerohedge.com/markets/fiat-currencies-are-going-fail-spectacularly-lawrence-lepard).  Here are some excerpts from his excellent analysis piece:

What just happened in the last two weeks is enormously important and misunderstood by many investors.

The Russian invasion of Ukraine and the corresponding Western sanctions and seizure of Russian FX reserves are nothing short of a monetary earthquake. The last comparable event was Nixon’s abandonment of the gold standard in 1971. 

Russia, with the backing and support of China, just told the world that it is no longer going to sell its oil, gas, and wheat for Western currencies which are programmed to debase. 

The West in its response just said to all countries around the world: “If you have foreign exchange reserves, held in our system, they are no longer safe if we disagree with your politics.” 

It is similar to what the Canadians did when they moved to seize the bank accounts of Canadians who had demonstrated support for the truckers without due process of law.

Both of these political moves are blatant advertisements for what I call “non state controlled money without counterparty risk”, like gold and bitcoin. If governments can weaponize their money when they do not like what you are doing, what is the natural defense?

The US Dollar has been the reserve currency of the world since WW II and the Bretton Woods agreement. This has given the US an enormous advantage and subsidy from the rest of the world because everyone else needs to produce goods and services to obtain dollars and the US can simply produce dollars at no cost by printing them.   

Putin is now cast in the role of Charles de Gaulle who complained about the “exorbitant privilege” of the US with its dollar hegemony. As we all know, de Gaulle demanded gold in exchange for France’s US dollar FX surpluses and this outflow forced Nixon to close the gold window.   

Recall that post this event, gold went from $35 per ounce to $800 per ounce (23x).  Russia’s move will lead to a similar move in favor of gold. Putin could see that the US fiscal and monetary situation was becoming untenable and he decided to use this to create an existential threat to the US and the world financial system. 

He undoubtedly knows that the West has artificially suppressed the price of gold and that is why he has been building his gold reserves steadily for the past 20 years.

Putin just shot “King Dollar” in the head. 

We can see it in the financial markets, as the price of everything commodity-related is going up relentlessly in dollar terms. 

Russia is long commodities, long gold, and doesn’t need fiat currency. His debt to GDP ratio is low and taxes are low. If the world financial markets collapse on a relative basis, the position of Russia will be improved significantly. This is what I believe he is playing for. If investors do not recognize this, they will be caught wrong-footed as I believe many are today.

The implications for investors are quite clear. None of us own enough gold, real assets or commodities. Fiat currencies are going to fail spectacularly, and soon, in my opinion.

        In the April issue of the “You May Not Know Report”, I report on another potential development that, should it occur, will be another blow to diminishing US Dollar dominance.  “The Wall Street Journal” ran a story (Source:  https://www.wsj.com/articles/saudi-arabia-considers-accepting-yuan-instead-of-dollars-for-chinese-oil-sales-11647351541) reporting that Saudi Arabia is now in serious discussions with China to price the kingdom’s oil sales or at least part of the oil sales in the Chinese currency.  Here is an excerpt:

Saudi Arabia is in active talks with Beijing to price some of its oil sales to China in yuan, people familiar with the matter said, a move that would dent the U.S. dollar’s dominance of the global petroleum market and mark another shift by the world’s top crude exporter toward Asia.

The talks with China over yuan-priced oil contracts have been off and on for six years but have accelerated this year as the Saudis have grown increasingly unhappy with decades-old U.S. security commitments to defend the kingdom, the people said.

The Saudis are angry over the U.S.’s lack of support for their intervention in the Yemen civil war, and over the Biden administration’s attempt to strike a deal with Iran over its nuclear program. Saudi officials have said they were shocked by the precipitous U.S. withdrawal from Afghanistan last year.

China buys more than 25% of the oil that Saudi Arabia exports. If priced in yuan, those sales would boost the standing of China’s currency. The Saudis are also considering including yuan-denominated futures contracts, known as the petroyuan, in the pricing model of Saudi Arabian Oil Co., known as Aramco.

            As I discuss in detail in the April “You May Not Know Report”, since 1974, all of the oil exports of Saudi Arabia have been priced in US Dollars.  Should that change, it will be more bad news for the US Dollar and more inflation as there will be another reason not to inventory US Dollars by other countries around the world.

          Of course, none of these developments is at all surprising or shocking.  History teaches us that fiat currency systems have a 100% failure rate.  We are not debating the ‘what’, we are only debating the ‘when’.

          In the meantime, we will probably continue to see accelerating inflation or hyperinflation which will be coupled with an economic slowdown as von Mises described the ‘crack up boom’.

          There is growing evidence that we are now in a recession or, at the very least, moving toward one.  The Federal Reserve Bank of Atlanta recently revised 1st quarter growth projections to 0%.  This from “Seeking Alpha” published prior to the Fed’s ¼ point rate hike (Source:  https://seekingalpha.com/article/4492503-stagflation-warning-atlanta-fed-cuts-q1-gdp-projection-to-zero_):

On Tuesday, the Atlanta Fed cut its GDP estimate for the first quarter of 2022 to zero.

Just a few days ago, the estimate was for 0.6% growth. That was down from 1.3% just a few days before that.

This is not an encouraging trend.

Keep in mind, Atlanta Fed GDP estimates tend to start high and then fall as the quarter progresses. We’re still early in the quarter.

Just a few weeks ago, a collapse in economic growth seemed impossible. We’re coming off 7% GDP growth in Q4, capping off the fastest growth year on record.

But here we are.

Stagflation is defined as little to no economic growth coupled with high inflation.

And here we are.

This puts the Federal Reserve in a nasty spot. The central bank would typically respond to an economic contraction with rate cuts and quantitative easing. But the Fed is supposed to be tightening monetary policy to deal with surging inflation.

          In the book “New Retirement Rules”, I wrote about the two potential economic paths that were before us.  Inflation followed by deflation or we would go direct to deflation.  The latter could only happen if the Fed ceased easy money policies.

          The Fed did not cease easy money policies but instead, doubled down on them.  The inflation followed by deflation that I wrote about, now looks a lot like a ‘crack-up boom’.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.