The Fed’s Conundrum

Stocks rallied last week interrupting what looked like a possible set-up for a correction.  Despite the rally stocks are extended here.

Gold and silver continued their respective rallies as did US Treasuries.

As inflation is heating up worldwide, there is growing interest in protecting oneself from the loss in purchasing power that comes with higher levels of inflation.

Russia recently passed legislation to allow the country’s sovereign wealth fund to invest in gold.  This from “Zero Hedge” (Source:  https://www.zerohedge.com/commodities/russia-lines-new-gold-buying-through-its-sovereign-wealth-fund) (emphasis added):

In a significant and strategic development for monetary metals, the Government of the Russian Federation has just introduced legislation which will allow Russia’s giant National Wealth Fund (NWF) to invest in gold and other precious metals. The NWF is Russia’s de facto sovereign wealth fund, and has assets of US$185 billion.

Introduced as a resolution to the procedures for managing the  investments of the National Wealth Fund and signed off by the Russian prime minister Mikhail Mishustin on Friday 21 May, the changes will allow the National Wealth Fund to buy and hold gold and other precious metals with the Russian central bank, the Bank of Russia.

In a note accompanying the gold announcement, the Russian government refers to gold as a traditional protective asset, and says that the move to add gold will introduce more diversification into NWF’s investment allocation, while promoting overall safety and profitability for the fund.

Up until now, the National Wealth Fund, through its 2008 investment management decree has been allowed to allocate funds to all main financial asset classes, such as foreign exchange, debt securities of foreign states, debt securities of international financial organizations, managed investment funds, equities, Russian development bank projects, and domestic bank deposits. The latest amendment now adds gold and precious metals to that list.

As the NWF soon will begin to buy and hold gold as part of its investment remit, it will be interesting to watch the NWF’s asset allocation reports, which can be found in the statistics section of the NWF pages of the Russian Ministry of Finance website here.

If this recent news about the NWF investing in gold look familiar, that’s because it is. Back in November 2020, the Russian government proposed a plan to allow the NWF to buy and hold gold, at the time introducing draft legislation for that purpose. It is this draft legislation which has now been signed into law on 21 May by Prime Minister Mikhail Mishustin.

However, nearly a year earlier in December 2019, Russia’s Finance Minister Anton Siluanov had originally raised the idea that the National Wealth Fund should invest in gold, saying at the time that he saw gold “as more sustainable in the long-term than financial assets.”

Meanwhile, the United States Mint issued a statement last week about silver (Source:  https://www.facebook.com/UnitedStatesMint/) (emphasis added):

The United States Mint is committed to providing the best possible online experience to its customers. The global silver shortage has driven demand for many of our bullion and numismatic products to record heights. This level of demand is felt most acutely by the Mint during the initial product release of numismatic items. Most recently in the pre-order window for 2021 Morgan Dollar with Carson City privy mark (21XC) and New Orleans privy mark (21XD), the extraordinary volume of web traffic caused significant numbers of Mint customers to experience website anomalies that resulted in their inability to complete transactions.

In the interest of properly rectifying the situation, the Mint is postponing the pre-order windows for the remaining 2021 Morgan and Peace silver dollars that were originally scheduled for June 1 (Morgan Dollars struck at Denver (21XG) and San Francisco (21XF)) and June 7 (Morgan Dollar struck at Philadelphia (21XE) and the Peace Dollar (21XH)). While inconvenient to many, this deliberate delay will give the Mint the time necessary to obtain web traffic management tools to enhance the user experience. As the demand for silver remains greater than the supply, the reality is such that not everyone will be able to purchase a coin. However, we are confident that during the postponement, we will be able to greatly improve on our ability to deliver the utmost positive U.S. Mint experience that our customers deserve. We will announce revised pre-order launch dates as soon as possible.

Interesting that Russia has adapted her laws to allow the National Wealth Fund to buy gold and the US Mint is openly stating that demand for silver is greater than the supply.  This is something we have noted recently in obtaining precious metals for clients.  We have been able to find the metals but its much more difficult.

There is a growing disparity between the spot price (paper price) of gold and silver that the price one pays (when buying) or receives (when selling) for physical metals.  In the current market, with growing demand for physical metals, both purchases and sales take place above the metal’s spot price.

Despite the Federal Reserve’s insistence that inflation is ‘transitory’, actions of investors in the precious metals’ markets are telling us a different story.  Simply put, precious metals investors don’t believe the Fed.

And with good reason.

When current levels of inflation are adjusted for reality, using inflation calculation methodologies that were used pre-1980, one would have to conclude that we are presently at or near 1970’s inflation levels.

In 1980, as we’ve discussed previously, the Federal Reserve increased interest rates to the 20% level to get inflation under control.  It worked.

Would a similar policy response today do the same thing?

It would.  Inflation is an expansion of the money supply so taking action to reduce the money supply would once again get inflation under control.

So can we expect the Fed to increase interest rates soon?

There are analysts who insist the Fed will have to do so or risk a hyperinflationary outcome.  There are other observers, including me, who think the Fed will keep interest rates low and continue the policy of money creation for the near future.

I believe this is the case for a couple of reasons.

First, the recently proposed budget calls for more than $6 trillion in spending, the highest ever.  (Source:  https://www.zerohedge.com/political/biden-unveils-6-trillion-budget-will-raise-federal-spending-highest-post-ww2-level)  Federal spending would reach $8.2 trillion by 2031.  The budget deficit under the proposed budget would exceed $1.8 trillion and be twice the $900 billion deficit in 2019, pre-COVID,

Massive deficits combined with a declining economy mean that the Fed will be forced to continue to monetize government spending.  And, I’d bet the biggest steak in Texas that should this proposed budget become reality, the deficit is bigger than the forecasted $1.8 trillion due to overly optimistic tax revenue assumptions.

More and more analysts are predicting deflation.  This from “Fox Business News” (Source:  https://www.foxbusiness.com/economy/stagflation-worries-comparisons-jimmy-carter-1970s) (emphasis added):

Surging consumer prices and gasoline shortages have sparked concerns the U.S. economy could relive the nightmarish stagflation of President Jimmy Carter’s administration in the late 1970s. 

Stagflation is defined as a period of inflation with declining economic output.  

Strategists at Bank of America predict the stagflation narrative will begin to take hold in the second half of this year. 

Second, should the Federal Reserve go full Volcker and raise interest rates to fight inflation, a deflationary collapse is the likely result with real estate and stock valuations at nosebleed levels.

The Fed is painted into the proverbial corner.

Keep printing and the outcome is stagflation.

Begin to tighten monetary policy and risk a deflationary collapse.

Neither choice is a good one but past actions by the Fed and the politicians in charge tell us that they will make the choice that kicks the can down the road a little further.  That probably leads to inflation followed by deflation as Thomas Jefferson predicted two centuries ago.

If you know of someone who 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.

Money Printing, Inflation and Unintended Consequences

As I have been discussing for a very long time, the current economic policies being pursued will likely result in the realization of Thomas Jefferson’s warning to us more than 200 years ago.

If you are a new reader, Mr. Jefferson warned us that we should not allow private bankers to control the issue of our currency.  Should we do so, he cautioned, first by inflation then by deflation the banks and corporations that will grow up around us will deprive the people of all property until our children wake up homeless on the very continent our fathers conquered.

In the “New Retirement Rules” class that I taught beginning in 2011, I suggested that there were two potential economic outcomes depending on what the policy of the Federal Reserve was moving ahead.  We would have deflation, like we saw in the 1930’s during The Great Depression or we would have inflation followed by deflation as Mr. Jefferson suggested should the Fed elect to print money.

It is now clear that we are on the latter path and the one that Mr. Jefferson warned us about.

Signs of inflation are everywhere.

In last week’s issue of “Portfolio Watch”, I discussed the statements made by Warren Buffet at the Berkshire Hathaway meeting.  During his lengthy address, Mr. Buffet stated “We are seeing very substantial inflation.  We are raising prices.  People are raising prices to us and its being accepted.”

That statement (and reality) flies in the face of recent statements made by Federal Reserve Chair, Jerome Powell who insisted that inflation is “transitory”.  To think that the Fed has expanded the money supply by ridiculous amounts and we will have only short-lived or temporary inflation is ludicrous.

Bank of America this past week suggested something similar.  The bank stated that the US will experience a “transitory hyperinflation”.  (Source:  https://www.zerohedge.com/economics/and-now-rents-are-soaring-too)

To some extent, that statement is accurate.  History teaches us that hyperinflations are typically temporary and often last until faith in the currency is lost at which point a reset has to occur.

For many years, I have been suggesting a two-bucket approach to managing assets with one bucket invested to protect assets when the deflation part of the cycle hits and another to hedge from what is now inevitable inflation.

Just this past week, reliable news sources reported on the ever-increasing levels of inflation now hitting the economy as a result of the Fed’s money printing.  And now, with talk of another $4 trillion stimulus package heating up, more money creation to fund more spending is probably on the horizon.

At the risk of being too political for this publication, in which I try to focus on economic and investing issues, there are actually politicians (in both parties) who are calling the proposed $4 trillion stimulus package an ‘investment’ not an expense.

That is pure rhetoric and not based in fact.  In order to make an investment, you need to have money to make the investment.

As we all know, the government has no money, and the current levels of debt and unfunded liabilities simply cannot be funded by any kind of tax increases.  As I’ve discussed in the past, 100% of household wealth in the US could be confiscated via a 100% wealth tax and the financial house of the US would still not be in order.

The reality is this.  Current policies being pursued by the Fed will result in a tax on savers and investors. 

Not in the form of a physical tax, but rather an inflation tax that sees the purchasing power of investments and savings diminish.

As I’ve been noting here each week, it seems that the inflation part of the cycle is now upon us.  What we’ve been discussing as theory for the past several years is now transforming into an ugly reality.

Rents are increasing significantly.  This will adversely affect the lower income workers who typically rent and don’t own their home.

This from “Zero Hedge” (Source:   https://www.zerohedge.com/economics/and-now-rents-are-soaring-too):

On Thursday, American Homes 4 Rent, which owns 54,000 houses, increased rents 11% on vacant properties in April, the company reported in a statement:

.           .. Continued to experience record demand with a Same-Home portfolio Average Occupied Days Percentage of 97.3% in the first quarter of 2021, while achieving 10.0% rental rate growth on new leases, which accelerated further in April to an Average Occupied Days Percentage in the high 97% range while achieving over 11% rental rate growth on new leases.

Invitation Homes, the largest landlord in the industry, also boosted rents by similar amount, an executive said on a recent conference call. Or, as Bloomberg puts it, record occupancy rates are emboldening single-family landlords to hike rents aggressively, testing the limits of booming demand for suburban rentals.

While soaring housing costs had put homeownership out of reach for most Americans, rents had been relatively tame for much of 2020. But in recent months, rents have also soared as vaccines fuel optimism about a rebound from the pandemic, and a reversal in the city-to-suburbs exodus.  The increases, as Bloomberg so eloquently puts it, “may add to concerns about inflation pressures.” Mmmk.

“Companies are trying to figure out how hard they can push before they start losing people,” said Jeffrey Langbaum, an analyst at Bloomberg Intelligence. “And they seem to be of the opinion they can push as far as they want.”

The article states that “Bloomberg” eloquently stated that increasing rents ‘may add to concerns about inflation pressures’.  I’d suggest it’s evidence of inflation.

There are many other examples of ‘inflation pressures’.  One of these examples, food, also disproportionately affects lower income households.  Michael Snyder commented this past week (Source:  http://theeconomiccollapseblog.com/what-will-you-do-when-inflation-forces-u-s-households-to-spend-40-percent-of-their-incomes-on-food/)

Did you know that the price of corn has risen 142 percent in the last 12 months?  Of course corn is used in hundreds of different products we buy at the grocery store, and so everyone is going to feel the pain of this price increase.  But it isn’t just the price of corn that is going crazy.  We are seeing food prices shoot up dramatically all across the industry, and experts are warning that this is just the very beginning.  So if you think that food prices are bad now, just wait, because they are going to get a whole lot worse.

Typically, Americans spend approximately 10 percent of their disposable personal incomes on food.  The following comes directly from the USDA website

In 2019, Americans spent an average of 9.5 percent of their disposable personal incomes on food—divided between food at home (4.9 percent) and food away from home (4.6 percent). Between 1960 and 1998, the average share of disposable personal income spent on total food by Americans, on average, fell from 17.0 to 10.1 percent, driven by a declining share of income spent on food at home.

Needless to say, the poorest Americans spend more of their incomes on food than the richest Americans.

According to the USDA, the poorest households spent an average of 36 percent of their disposable personal incomes on food in 2019…

Needless to say, the final numbers for 2020 will be quite a bit higher, and many believe that eventually the percentage of disposable personal income that the average U.S. household spends on food will reach 40 percent.

That would mean that many poor households would end up spending well over 50 percent of their personal disposable incomes just on food.

As benevolent and perhaps even as well-intentioned as stimulus to help those who have been harmed financially over the past year sounds, the fact that money has to be created out of thin air to fund stimulus payments ultimately ends up hurting those that were supposed to be helped.

Stagflation is here.  The economy is contracting, and prices are rising.  If you have not yet seriously investigated how the two-bucket approach to managing assets might help you navigate what lies ahead, I would urge you to do so. 

And I would do so soon.

If you know of someone who 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.