Before I get to this week’s topic, I would be remiss if I didn’t comment on market price action last week.
The short analysis is this: volatility continues to rage on in the financial markets.
After the worst week in stock market history, stocks rebounded last week although Friday’s price action in stocks confirmed the high level of volatility that exists. After strong rebounds for most of the week, stocks fell hard on Friday. The Dow Jones Industrial Average fell more than 4 % in one day. Despite the decline, the Dow finished almost 13% higher for the week.
Gold and silver also rebounded. The yellow metal rallied more than 8.5% and silver advanced more than 15% for the week.
There is an interesting, and not unexpected development in the metals markets presently. The spot price of gold and silver which I track weekly has broken from the actual prices being paid in the actual physical metals markets. Premiums for physical gold and silver went through the proverbial roof last week and it was nearly impossible to find any quantities of gold or silver even with the much higher premiums.
Congress passed a record stimulus package on Friday in response to the Coronavirus situation. The initial package is for more than $2 trillion.
While I am still sorting through the provisions of the stimulus package, there is one provision that is as interesting as it is alarming.
Briefly, this provision allows for the use of SPV’s or Special Purpose Vehicles to allow the US Treasury to take an interest in private bond issues. At least that’s where it is starting.
This, in my view, ultimately puts control of the printing press in the hands of the politicians. What could go wrong?
This provision, included in the CARES Act, emerges after the Federal Reserve has cut interest rates to zero and committed to unlimited quantitative easing (money printing). We are definitely in uncharted territory here. It’s obvious that they’re pulling out all the stops to reinflate the bubble.
As I have previously stated, it is my belief that the Coronavirus situation is the pin that popped the bubble. I will continue to focus on the potential financial and economic aspects of the current situation. I am not qualified to discuss the medical implications and consequences. I would urge you to follow all recommendations of the authorities when it comes to dealing with the Coronavirus situation.
SPV’s, or Special Purpose Vehicles have been used previously, just not as they will be used moving forward. The alarming development in my view is that the US Treasury and ultimately politicians are now directly involved in the decision to print more money. History teaches us that whenever politicians can print money – they will. And, always in ever more copious quantities.
Jim Bianco wrote an opinion piece that was published on “Bloomberg” that describes this new “partnership” between the Federal Reserve and the US Treasury. (Source: https://finance.yahoo.com/news/feds-cure-risks-being-worse-110052807.html). Here is a bit from that piece (emphasis added):
But it’s the alphabet soup of new programs that deserve special consideration, as they could have profound long-term consequences for the functioning of the Fed and the allocation of capital in financial markets. Specifically, these are:
CPFF (Commercial Paper Funding Facility) – buying commercial paper from the issuer.
PMCCF (Primary Market Corporate Credit Facility) – buying corporate bonds from the issuer.
TALF (Term Asset-Backed Securities Loan Facility) – funding backstop for asset-backed securities.
SMCCF (Secondary Market Corporate Credit Facility) – buying corporate bonds and bond ETFs in the secondary market.
MSBLP (Main Street Business Lending Program) – Details are to come, but it will lend to eligible small and medium-sized businesses, complementing efforts by the Small Business Association.
To put it bluntly, the Fed isn’t allowed to do any of this. The central bank is only allowed to purchase or lend against securities that have government guarantees. This includes Treasury securities, agency mortgage-backed securities and the debt issued by Fannie Mae and Freddie Mac. An argument can be made that can also include municipal securities, but nothing in the laundry list above.
So how can they do this?
The Fed will finance a special purpose vehicle (SPV) for each acronym to conduct these operations. The Treasury, using the Exchange Stabilization Fund, will make an equity investment in each SPV and be in a “first loss” position. What does this mean? In essence, the Treasury, not the Fed, is buying all these securities and backstopping of loans; the Fed is acting as banker and providing financing. The Fed hired BlackRock Inc. to purchase these securities and handle the administration of the SPVs on behalf of the owner, the Treasury.
In other words, the federal government is nationalizing large swaths of the financial markets. The Fed is providing the money to do it. BlackRock will be doing the trades.
This scheme essentially merges the Fed and Treasury into one organization. So, meet your new Fed chairman, Donald J. Trump.
In 2008 when something similar was done, it was on a smaller scale. Since few understood it, the Bush and Obama administrations ceded total control of those acronym programs to then-Fed Chairman Ben Bernanke. He unwound them at the first available opportunity. But now, 12 years later, we have a much better understanding of how they work. And we have a president who has made it very clear how displeased he is that central bankers haven’t used their considerable power to force the Dow Jones Industrial Average at least 10,000 points higher, something he has complained about many times before the pandemic hit.
When the Fed was rightly alarmed by the current dysfunction in the fixed-income markets, they felt they needed to act. This was the correct thought. But, to get the authority to stabilize these “private” markets, central bankers needed the Treasury to agree to nationalize (own) them so they could provide the funds to do it.
In effect, the Fed is giving the Treasury access to its printing press. This means that, in the extreme, the administration would be free to use its control, not the Fed’s control, of these SPVs to instruct the Fed to print more money so it could buy securities and hand out loans in an effort to ramp financial markets higher going into the election. Why stop there? Should Trump win re-election, he could try to use these SPVs to get those 10,000 Dow Jones points he feels the Fed has denied everyone.
What this means is that moving ahead, the rules have been changed. The US Treasury will invest in the SPV which will invest in commercial paper and corporate bonds. Where will the Treasury get the money to do this?
From the Federal Reserve.
Where will the Federal Reserve get the money?
They will create it.
As I stated when the money printing began, this is a slippery slope. Once money printing begins, history teaches us it never stops. Over time it just becomes more extreme; more and more money is created until it doesn’t produce the desired outcome and a reset occurs. I believe we may be nearing that reset point.
Since this provision of the stimulus package virtually ensures that more money printing will occur, look for the continued devaluation of the US Dollar over time. And, don’t expect the real inflation numbers to be reflected in the official inflation rate. But, watch the nominal cost of tangible assets, that’s where you’ll see evidence of the inflation.
Beginning this week, I am conducting weekly educational webinars for clients and also for the general public. If you are a client of our company, you will receive an invitation to the informational webinars via email.
If you would like to participate in a public webinar update, give the office a call at 1-866-921-3613 and we will arrange for your participation until we reach our technical capacity. Feel free to invite friends and family members who would appreciate additional educational information for this webinar.
Blessings to all of you in these difficult times.