Fed can't keep the rates low

[stahleyp]

hey wa, wanted to get your thoughts on Burry's recent tweets.

 

Do not underestimate the power of stimulus checks. This chart, courtesy

@LynAldenContact

, compares M2 Money to QE assets to direct cash payments (green) - those checks play a big role, & unlike QE, direct payments don't trap inflation in the securities markets. #helicoptermoney

 

 

and

 

#Gold is expected to move with real yield, and hence a little inflation mirroring an increase in real yields would not be good for gold bulls. This is the relationship of the last few decades. In a high/#hyperinflation #paradigmshift, gold will serve its purpose. It always has.

[wabuffo]

In short - they both (Burry, Alden) don't know what they are talking about.  Alden, in particular is constantly misinterpreting the data and in 2019 thought Fed liquidity was inflating the stock market (now she says the Fed's reserves go nowhere, LOL)

 

Gold and Treasury bond yields are heading down.  I've explained why in other posts as well as this thread.  The dollar will strengthen.  There is no inflation - people always assume that a strengthening economy will cause inflation - and it never does.

 

wabuffo

[stahleyp]

In short - they both (Burry, Alden) don't know what they are talking about.  Alden, in particular is constantly misinterpreting the data and in 2019 thought Fed liquidity was inflating the stock market (now she says the Fed's reserves go nowhere)

 

Gold and Treasury bond yields are heading down.  I've explained why in other posts as well as this thread.  The dollar will strengthen.  There is no inflation - people always assume that a strengthening economy will cause inflation - and it never does.

 

wabuffo

 

good to know. Thanks. I do value your input.

 

On another note, what would be the biggest risk of inflation in your view?

[wabuffo]

On another note, what would be the biggest risk of inflation in your view?

 

1) defaulting on sovereign debt issued in another currency (oh wait, the US govt has none)

2) massive tax increases (eg, 70% marginal tax rates, wealth taxes, etc)

3) failed political system

 

The reality is that this last stimulus package is probably unnecessary since the economy appears to be in full recovery mode.  But its not permanent spending - just a lot of one-timers sprinkled here and there.  That'll juice things a bit - but the deficit will roll over back to a more normal % to GDP ratio (especially as the denominator recovers).  Hopefully, that'll be it.

 

I think Japan-ification style monetary repression due to the Fed and US Treasury messing things up is the bigger risk here and I've talked about it upthread.  I think its even possible we see slight negative yields in the short end of the Treasury curve by May-June.

 

wabuffo

[Spekulatius]

In short - they both (Burry, Alden) don't know what they are talking about.  Alden, in particular is constantly misinterpreting the data and in 2019 thought Fed liquidity was inflating the stock market (now she says the Fed's reserves go nowhere, LOL)

 

Gold and Treasury bond yields are heading down.  I've explained why in other posts as well as this thread.  The dollar will strengthen.  There is no inflation - people always assume that a strengthening economy will cause inflation - and it never does.

 

wabuffo

 

I am not sure you are talking about the past future but recently, the USD has been very weak relative to the EUR, GBP and Yen  and the US interest rates have been moving up (Euro and Uk interest rates not so much).

 

I do think the USD will strengthen  - I don’t know what is chicken or egg, but the interest rate differential relative to the EUR and the GBP suggests the USD is now attractive:

 

Maybe it is just an indication that the economic recovery in the US will be stronger than in the Euro Zone or the UK. I do think the inflation scare could end up just like 2010/11 inflation scare - a short flare that ended up meaning very little in the long run.

[stahleyp]

On another note, what would be the biggest risk of inflation in your view?

 

1) defaulting on sovereign debt issued in another currency (oh wait, the US govt has none)

2) massive tax increases (eg, 70% marginal tax rates, wealth taxes, etc)

3) failed political system

 

The reality is that this last stimulus package is probably unnecessary since the economy appears to be in full recovery mode.  But its not permanent spending - just a lot of one-timers sprinkled here and there.  That'll juice things a bit - but the deficit will roll over back to a more normal % to GDP ratio (especially as the denominator recovers).  Hopefully, that'll be it.

 

I think Japan-ification style monetary repression due to the Fed and US Treasury messing things up is the bigger risk here and I've talked about it upthread.  I think its even possible we see slight negative yields in the short end of the Treasury curve by May-June.

 

wabuffo

 

Sorry in advance for the machine gunning of questions but here it goes:

 

 

So would something like UBI not cause inflation?

 

Why would tax increases cause inflation? Would it just take reduce market valuations and have minimal effects on the real economy?

 

Do you have any thoughts on Danelle Dimartino Booth?

[wabuffo]

Spek - I think there are two factors in my macro thinking (which is worth what you are paying for it -- nothing).

 

1) The US recovery will be very strong throughout 2021 - remember we are feeling the effects of stimulus plus the low personal and corporate tax regime of the Trump administration (for now until the Biden folks dismantle it)

 

2) the US monetary authorities have messed up and now have a Treasury account that must hit its 2019 account balance by August 1st of this year when debt ceiling suspension is removed per Congress's 2019 bill (debt ceiling was suspended for two years on Aug 1st, 2019).  I'm not sure if that is the July 31st, 2019 amount ($176b) or the August 1st, 2019 amount ($118b) - but the current balance is $1.4t.  With the Fed still on auto-pilot buying Treasuries - it will create two problems for the US economy:

 

a) bank reserves will surge to over $5b (vs $21b of total US banking sector assets).  Yes the Fed will relax some regulatory measures (ie not counting reserves as part of regulatory leverage/capital ratios) - but it still moves the US banking system closer to Japanese style zombie banks.

b) the combination of Fed buying and Treasury spending its TGA without much Treasury bond issuance might actually shrink the supply of o/s Treasury debt.  That's actually a bad thing - especially for a rapidly growing US economy that we will see over the next six months.

 

While none of this should affect our stock-picking, I think it will be an interesting monetary experiment to watch in real-time.  Cool stuff.

 

wabuffo

[Spekulatius]

 

So would something like UBI not cause inflation?

 

Why would tax increases cause inflation? Would it just take reduce market valuations and have minimal effects on the real economy?

 

Do you have any thoughts on Danelle Dimartino Booth?

 

It will be interesting to hear Wabuffo‘s opinion, but UBI alone won’t cause all that much inflation. It will increase spending and deficits but that alone won’t really cause inflation, in particular as they likely will go hand in hand with a stronger USD.

I do think that increases in minimum wage could increase inflation as they affect services and goods that part of the basket goods and services that is used to calculate inflation. Min wage has been stagnant for a long time before that, which I think was deflationary.

 

I think the bigger question for investors and in particular growth investors is that if longer term interest rates stay relatively high (steeper yield curve), some of the weird justification for the high growth stocks multiples is harder and harder to justify. After all, from a monetary perspective, we might look more like 2018 or 2016 and multiples at those points in time weren’t really that extended for growth stocks than they are right now.

[wabuffo]

So would something like UBI not cause inflation?

 

I have no opinion on it.  I'm generally a libertarian and think the less govt the better - but I don't know that another spending program makes a difference.

 

Why would tax increases cause inflation? Would it just take reduce market valuations and have minimal effects on the real economy?

 

Taxes create a wedge against the real economy.  Also higher tax rates encourage evasion (both legal and illegal).  The only thing that gives the sovereign currency its value is one needs it to extinguish one's Federal tax obligations.  That's why we accept the govt's money.  If you weaken tax collection, you start to weaken the currency, IMHO.  Low taxes, sound money - its that simple.  Empires crumble not because they overspend, but because they overtax and collection falls apart followed by the empire.

 

Good book on the subject that I recommend:

https://www.amazon.com/Good-Evil-Impact-Course-Civilization/dp/1568332351/ref=sr_1_1?crid=2REHOBTDPUVDW&dchild=1&keywords=for+good+and+evil&qid=1614655409&sprefix=For+good+and+ev%2Caps%2C186&sr=8-1

 

Do you have any thoughts on Danelle Dimartino Booth?

 

I haven't really followed her stuff.  Should I?  What do you think of her economic commentary?

 

wabuffo

 

 

 

 

[hasilp89]

Spek - I think there are two factors in my macro thinking (which is worth what you are paying for it -- nothing).

 

1) The US recovery will be very strong throughout 2021 - remember we are feeling the effects of stimulus plus the low personal and corporate tax regime of the Trump administration (for now until the Biden folks dismantle it)

 

2) the US monetary authorities have messed up and now have a Treasury account that must hit its 2019 account balance by August 1st of this year when debt ceiling suspension is removed per Congress's 2019 bill (debt ceiling was suspended for two years on Aug 1st, 2019).  I'm not sure if that is the July 31st, 2019 amount ($176b) or the August 1st, 2019 amount ($118b) - but the current balance is $1.4t.  With the Fed still on auto-pilot buying Treasuries - it will create two problems for the US economy:

 

a) bank reserves will surge to over $5b (vs $21b of total US banking sector assets).  Yes the Fed will relax some regulatory measures (ie not counting reserves as part of regulatory leverage/capital ratios) - but it still moves the US banking system closer to Japanese style zombie banks.

b) the combination of Fed buying and Treasury spending its TGA without much Treasury bond issuance might actually shrink the supply of o/s Treasury debt.  That's actually a bad thing - especially for a rapidly growing US economy that we will see over the next six months.

 

While none of this should affect our stock-picking, I think it will be an interesting monetary experiment to watch in real-time.  Cool stuff.

 

wabuffo

 

Trying to keep up here and appreciate the insights (especially the double entry thought process)

Two questions

1) can you clarify who exactly is sitting on too many treasuries and will have to reduce if debt ceiling is not extended. I assumed the fed but was not clear - if so does that unwinding of their balance sheet not cause issues or will banks buy them back and then that cash sits with the fed as reserves (trying to think of it double entry!)

2) with the comment about reserves going up in point b) wouldnt there be an impact on banks profitability/performance (I was thinking their roa/roe would come down but may just be thinking about this all completely wrong based on answer to first question)

[stahleyp]

So would something like UBI not cause inflation?

 

I have no opinion on it.  I'm generally a libertarian and think the less govt the better - but I don't know that another spending program makes a difference.

 

Why would tax increases cause inflation? Would it just take reduce market valuations and have minimal effects on the real economy?

 

Taxes create a wedge against the real economy.  Also higher tax rates encourage evasion (both legal and illegal).  The only thing that gives the sovereign currency its value is one needs it to extinguish one's Federal tax obligations.  That's why we accept the govt's money.  If you weaken tax collection, you start to weaken the currency, IMHO.  Low taxes, sound money - its that simple.  Empires crumble not because they overspend, but because they overtax and collection falls apart followed by the empire.

 

Good book on the subject that I recommend:

https://www.amazon.com/Good-Evil-Impact-Course-Civilization/dp/1568332351/ref=sr_1_1?crid=2REHOBTDPUVDW&dchild=1&keywords=for+good+and+evil&qid=1614655409&sprefix=For+good+and+ev%2Caps%2C186&sr=8-1

 

Do you have any thoughts on Danelle Dimartino Booth?

 

I haven't really followed her stuff.  Should I?  What do you think of her economic commentary?

 

wabuffo

 

Interesting perspectives for sure.

 

I personally don't know a lot about Booth. I listened to an interview with her a while ago though. From what I remember she seemed like a gold bug. Gundlach seems to like her though. This is not an area I'm very knowledgeable about so I'm just trying to figure out who understands the plumbing the best. Do you think Gundlach or Hoisington are good?

[wabuffo]

I personally don't know a lot about Booth. I listened to an interview with her a while ago though. From what I remember she seemed like a gold bug

 

stahleyp - that was my impression too that she was a gold bug/Austrian type. 

 

who understands the plumbing the best.

 

Surprisingly, very few do.  Monetary policy is talked about by so many people, yet I find so few truly understand the mechanics of it.  Someone I learned a lot from is George Selgin.  He's a Fed watcher and economist who has written many books on the subject of the Fed.  He's also pretty active on twitter so you can give him a follow there.

 

https://www.amazon.com/s?k=george+selgin&i=stripbooks&crid=322T05JTCR395&sprefix=George+Selgin%2Caps%2C173&ref=nb_sb_ss_c_2_13_ts-doa-p

 

"Floored" is a good one.

 

wabuffo

[stahleyp]

Thanks for the book recommendations. I'm following him now on Twitter. I'll assume your silence on Gundlach and Hoisington means you don't care for them then. ;)

[Cigarbutt]

^When the Treasury creates a bond or a bill, the balancing cash 'created' ends up, somehow and through the private accounts, as a liability of the Federal Reserve, as circulating currency or a reserves deposited at the Fed. The Fed acts as the fiscal agent of the Treasury and when the created cash is deposited in the TGA (as a Fed liability), it is simply a temporary listing until the cash is directed to private accounts, after which the cash becomes a typical Fed liability (one-for-one).

The role of the TGA is clearly technical, like a central checking account and the Treasury could use this account as a tool to manage reserves. This reserves-management idea is controversial and has been periodically discussed since the 30s. It's interesting that the person in charge of the Treasury now used to be in charge of the Fed.

The potential problems related to building excess reserves within the financial system (excessive liquid capitalization of banks (especially with an asset cap, liquidity issues in the repo market) can be dealt with using various technical tools. Excessive capitalization of banking institutions is not a bad or a good thing in itself (it may become a feature however) but it may be symptomatic of an underlying problem (leverage problem related to uneasiness in investing in US large banks at this point even if valuations appear reasonable).

The defining feature of the last 20 years for US commercial banks has been the high rate in deposit growth (CAGR 7.6% since 2000 and 7.0% since 2009), well ahead of loan growth.

Because of deposit growth rising rapidly secondary to money creation and outpacing loan growth, banks have been forced to increase their allocation to securities. As a result of this excessive liquidity, banks, like a typical investor, have been driving various yields to very low levels in the markets in which they're involved (including the Treasury market!). Interestingly, when the Treasury will drive down its TGA account, with the excess-reserves system in place, it will flood the private market with cash and increase the demand for its own debt securities!

In all Q4 announcements and conference calls, big banks described (not literally) this dynamic and indicated that they were patient and prudent with their securities portfolio...(environment of record low real yield and record low spreads)

In conclusion, the system put in place (if and until it breaks down) by the Fed makes sure that rates can't increase and, in fact, self-perpetuates low rates (for better or for worse).

 

US commercial banks, all numbers in %

                                                2000    2007    2009    2019    2020

loans/deposits                            98.6      96.6      83.6    75.5      64.2

Tr.+agency sec./total assets        12.9      10.4      12.3    16.9      18.2 

loans/total assets                        60.5      59.7      55.0    56.5      50.5

 

The trend has been first to lower interest rates, then to get to the zero bound and then to initiate unconventional tools, what's next? The big potential hole in this thesis is that deep secular trends start to reverse and private loan growth becomes, once again, the locomotive of productive growth resulting in significant and self-sustaining growth, significant and sustained federal tax receipts and a progressively lower debt to GDP ratio with all living happily ever after.

That may be a reason why Mr. Buffett did not discuss the pandemic in his 2020 letter. The virus was an extrinsic supply side shock that was neutralized (sterilized in Fed language) and that did not, really, changed the underlying fundamentals playing out over the longer term.

i've been looking at some money flows (created or not) and there is a bimodal distribution. Most have used the free cash to pay bills and installment debt and some (some on an absolute basis but just as important as the other group on a relative money-weighted basis) have used the funds they did not need to 'invest' and to drive down the yield on government debt. In a way, the Fed people are true geniuses.

 

[stahleyp]

hey wa,

 

If gold moves due to inflation why did it spike from 2008-2011 and then from 2018-2020? In other words, why trust that the gold market knows what inflation will do if its been wrong in the past? I'm looking at GLD since it's the easier to measure from my view.

[wabuffo]

If gold moves due to inflation why did it spike from 2008-2011 and then from 2018-2020? In other words, why trust that the gold market knows what inflation will do if its been wrong in the past? I'm looking at GLD since it's the easier to measure from my view.

 

Hey ps!  Good questions!

 

First i like to think of the USD like any other commodity.  Like lumber or wheat, the USD has its own supply and demand curves.  What gold does is it gives you a real-time price signal on the USD's supply and demand (like any other commodity).  Gold does this because gold is very stable - its one of the most stable commodities because of its annual mining to above ground inventory ratio.

 

Ok - so we'll come to demand in a moment.  First supply.  Supply of USD assets comes, not from the Fed, but from the US Treasury.  As I've rambled on in a number of posts - US Treasury deficit spending creates new financial assets in the private sector banking system.  Treasury debt issuance and Fed operations are asset swaps and don't create new financial assets, they just change the composition of the private sector's US governments asset mix between currency/reserves/Treasury debt.

 

So the first answer to your question deals with US Treasury deficit spending.  Here's an annual chart of US cash deficit (as measured by the US Treasury monthly statements) vs annual US GDP.  In my mind, any time the deficit goes over 4% of GDP - its probably creating too much USD's.  I've highlighted the years where it was above 4%.

 

 

Right off the bat - the data matches your observations (almost).  2008-2012 and then 2018-2019 were years of "overproduction" of USDs and gold being sensitive to supply - noticed it.  2020 of course has also been a year of oversupply (especially during the April-August period).  Since then, its moderated a bit but I haven't updated my numbers fore the last few months.  I should do that soon.

 

Back to USD demand.  I think the big difference now vs the 1970s, is that there is a lot more wealth than there was back then.  So demand for dollars today is less about groceries and gasoline.  It is more about wealth and assets.  The dollars today chase real estate, stocks, etc...  So that's where the overproduction of USD goes and gold once again is sensitive to it.

 

What is happening right now?  Its hard to say - but if I had to guess....

 

Demand for USD and USD assets is revving up.  Supply of USDs is moderating.  If you look at tax receipts, they are picking up and I think March, April and June will be big months with surprisingly large Fed tax receipts.  We'll see how this stimulus package shakes out in terms of spending.  The result is that gold is falling which signals a fast recovery in 2021 for the US economy.  A fast growing economy signals very high demand for USDs.  That suppresses gold if the supply of dollars does not keep up.

 

What about Treasury yields?  I think that's noise right now.  There are a lot of monetary plumbing things happening over the next 4-5 months that could create a lot of noise in Treasury yields.  We'll see.  Because of some of things that may or may not happen (SLR regs getting extended, Congressional debt limit kicking back in on Aug 1st, etc) - its really hard to make a prediction.  But if I had to guess, SLR will get extended but the US Treasury will have to suppress its net bond issuance so as to hit its account balance requirement before Aug. 1st.  That would put pressure on Treasury yields and cause them to go lower - especially if the Fed is still buying $100b of Tsys per month.

 

I'm not sure if I answered your question.  But the bottom line is its less about product price inflation these days and more about asset price inflation because that's where all the money goes.

 

wabuffo

 

 

[JRM]

How much is GDP influenced by debt and deficits?  I can borrow a lot more money to spend at 0% than at 15%.  Have 40 years of falling interest rates skewed the USD to GDP comparison? 

 

For a while I've given into the narrative that the boomers are robbing from the younger generations.  Now I'm starting to think the retired boomers are the ones who will get screwed.

[Spekulatius]

If gold moves due to inflation why did it spike from 2008-2011 and then from 2018-2020? In other words, why trust that the gold market knows what inflation will do if its been wrong in the past? I'm looking at GLD since it's the easier to measure from my view.

 

Hey ps!  Good questions!

 

First i like to think of the USD like any other commodity.  Like lumber or wheat, the USD has its own supply and demand curves.  What gold does is it gives you a real-time price signal on the USD's supply and demand (like any other commodity).  Gold does this because gold is very stable - its one of the most stable commodities because of its annual mining to above ground inventory ratio.

 

Ok - so we'll come to demand in a moment.  First supply.  Supply of USD assets comes, not from the Fed, but from the US Treasury.  As I've rambled on in a number of posts - US Treasury deficit spending creates new financial assets in the private sector banking system.  Treasury debt issuance and Fed operations are asset swaps and don't create new financial assets, they just change the composition of the private sector's US governments asset mix between currency/reserves/Treasury debt.

 

So the first answer to your question deals with US Treasury deficit spending.  Here's an annual chart of US cash deficit (as measured by the US Treasury monthly statements) vs annual US GDP.  In my mind, any time the deficit goes over 4% of GDP - its probably creating too much USD's.  I've highlighted the years where it was above 4%.

 

 

Right off the bat - the data matches your observations (almost).  2008-2012 and then 2018-2019 were years of "overproduction" of USDs and gold being sensitive to supply - noticed it.  2020 of course has also been a year of oversupply (especially during the April-August period).  Since then, its moderated a bit but I haven't updated my numbers fore the last few months.  I should do that soon.

 

Back to USD demand.  I think the big difference now vs the 1970s, is that there is a lot more wealth than there was back then.  So demand for dollars today is less about groceries and gasoline.  It is more about wealth and assets.  The dollars today chase real estate, stocks, etc...  So that's where the overproduction of USD goes and gold once again is sensitive to it.

 

What is happening right now?  Its hard to say - but if I had to guess....

 

Demand for USD and USD assets is revving up.  Supply of USDs is moderating.  If you look at tax receipts, they are picking up and I think March, April and June will be big months with surprisingly large Fed tax receipts.  We'll see how this stimulus package shakes out in terms of spending.  The result is that gold is falling which signals a fast recovery in 2021 for the US economy.  A fast growing economy signals very high demand for USDs.  That suppresses gold if the supply of dollars does not keep up.

 

What about Treasury yields?  I think that's noise right now.  There are a lot of monetary plumbing things happening over the next 4-5 months that could create a lot of noise in Treasury yields.  We'll see.  Because of some of things that may or may not happen (SLR regs getting extended, Congressional debt limit kicking back in on Aug 1st, etc) - its really hard to make a prediction.  But if I had to guess, SLR will get extended but the US Treasury will have to suppress its net bond issuance so as to hit its account balance requirement before Aug. 1st.  That would put pressure on Treasury yields and cause them to go lower - especially if the Fed is still buying $100b of Tsys per month.

 

I'm not sure if I answered your question.  But the bottom line is its less about product price inflation these days and more about asset price inflation because that's where all the money goes.

 

wabuffo

Well, the $1.9T stimulus bill has passed so that will keep the supply of USD going. Total US GDP is 20.9T, so this spending is 9.1% of the GDP. I don’t know when the stimulus bill kicks in and the duration, but it sure looks like it will have an inflationary to me. Those are USD hitting the economy and most of it goes into spending and as we have seen in the past, part of this gets invested in stocks as well.

[alertmeipp]

Feb printed tons of money in 08/09.... we didn't have inflation then? why now?

[Spekulatius]

Feb printed tons of money in 08/09.... we didn't have inflation then? why now?

Because printing money doesn’t do anything. The Fed can print all the money they want, it doesn’t do anything if it is put in a locker. Only spending money does and that’s why 2020/21 is different as the Treasury sent out stimulus checks for example to almost everyone (=helicopter money).

 

In 2008, we printed money but effectively put it into a locker. Later there was a a lot of talk about QE, but QE didn’t really give you or me an extra dollar to spent so I don’t think it has done much.

 

Today we are printing money and the treasury is sending checks out within the $1.9T stimulus package which is 9.1% of GDP. We have some slack in the economy to absorb some stimulus , but not 9.1% our economy.

 

So, I think we will see inflation, but it likely will be a short term spike.

[wabuffo]

Today we are printing money and the treasury is sending checks out within the $1.9T stimulus package which is 9.1% of GDP. We have some slack in the economy to absorb some stimulus , but not 9.1% our economy.

 

So, I think we will see inflation, but it likely will be a short term spike.

 

Spek - I basically agree with your thesis.    People always focus on the spending but a reduction in the deficit is really a three-legged stool.  First, spending will almost certainly go down after this year (though I am afraid that politicians have discovered a new toy -- sending stimulus checks to constituents).  Second, the economy will also grow pretty rapidly this year -- maybe 5-6% for the full year.  And finally, tax revenues always collapse in a downturn (especially a severe one like 2020 where 20% of the population lost their employment income).

 

So one could see the actual spending fall 40%, tax revenues boom (think of all those capital gains taxes that have to be paid plus growing employment income) and a couple years of rapid GDP growth and we could be back to a 3-4% deficit to GDP ratio by 2022 or 2023.

 

But a lot can happen between now and then so its never a sure thing.

 

wabuffo

[Cigarbutt]

^The supply of money is kind of straightforward but ‘demand’ for money (like money velocity) are fuzzy concepts. Who doesn’t want free money?

Money supply should correlate to underlying economic growth (as an endogenous source of money demand). However, for the last 20 years (variable but increasingly), money supply has outstripped real economic growth and it feels like the Treasury-Fed industrial complex’ strategy is to continue on the same trajectory (more and more money supply and less and less growth).

---

Gold prices are determined by a variety of factors (some of which shared with cryptocurrencies) but it seems the three following factors are most significant now:

1-gold seen (perception to a significant degree) as an alternative to fiat money and as an inflation hedge

2-gold seen (again mostly a perception) as a safe haven

3-gold being attractive as a result of the ‘wealth’ effect

 

In the 70s, gold did well as a result of 1- and, to some degree, because of 2-.

 

1- makes sense if one believes that recent inflationary forces are more than transitory. With the Treasury directly crediting bank accounts and with debt growing faster than the underlying economy, there is bound to be at least some inflationary effect but unless this translates to endogenous money creation through the private system (unlikely under present leveraged circumstances) in correlation to productive growth, the deflationary forces should take over.

 

2- makes sense if one looks at what happened to gold held by central banks. The US central bank remains the largest owner and, for the last few years, mostly in emerging economies, there has been significant net buying.

 

3- makes sense as ultra-low interest rates have driven a wide search for alternatives to cash and low yielding securities (low opportunity cost of not holding them). The problem with 3- is that it’s proven to be quite a powerful transmission mechanism (feeding easy money into asset price inflation) but eventually a detrimental and mean-reversion one. What happened to housing pricing in developed countries in 2020 is a clear example of that (risk-free rates down ++ and the spread between the 30-yr fixed mortgage rate and the risk-free 10-yr way down). Housing has become quite unaffordable for the bottom 60-80% and people are bound to notice eventually. The negative side of the wealth effect (and the impact on gold prices) is that the whole assumption (and now a subterfuge) rests on the capacity of the productive forces of the market to take over when the markets get eventually weaned from this artificial support (support in place for more than 10 years at this point). Who knows what will happen in 2021 (?) (related to the reflation aspect and the impact on growth and related tax receipts) but an interesting trend to look at will be the evolution of income levels without government transfers (the more enduring part of the reflation trade).

 

---

Comparing the 70s and now is interesting. In 1971, the US unilaterally abandoned the gold standard (there’s nothing wrong with that per se but perception about the value of the USD changed for a while). Inflation forces had clearly taken hold during the 60s, way before. In the 70s decade, the CAGR real economic growth was 3.2% (despite two negative reading years), the federal debt held by the public was about 25% of GDP and the demographic profile still looked quite favorable. In the 2010s decade, the CAGR real economic growth has been 2.3% (no negative reading years and with huge artificial support), the federal debt ratio is now at around 90% and the demographic profile looks a lot less favorable.

 

Real rates have clearly entered negative territory and there is a climate of apprehension with barely rising inflation expectations. And the Fed appears ready to intervene at any minute. And the worry is that 1-inflation is about to take off? 2-the Fed won’t be able to keep rates down? Opinion: one should discount the possibility that 2- will be the least of their problems and 1- will remain the unachievable goal absent more 'heroic' attempts.

 

[Spekulatius]

In the 70s decade, the CAGR real economic growth was 3.2% (despite two negative reading years), the federal debt held by the public was about 25% of GDP and the demographic profile still looked quite favorable. In the 2010s decade, the CAGR real economic growth has been 2.3% (no negative reading years and with huge artificial support), the federal debt ratio is now at around 90% and the demographic profile looks a lot less favorable.

 

 

Well, I was a kid in the 70‘s, but I sometimes think the 70‘s now get a worse reputation than they deserve. I grew up in Germany where the inflation was significant, but not as bad as in the US, so that may be a factor. Yes, there were oil price shocks, but those lasted maybe 12 month. In this decade we have an epidemic, which are comparable. The real economic growth was higher than it was today. Interest rates and inflation were higher and asset prices were lower.

 

If you owned a house back than that was worth $100k (adjusted for inflations since then) and now a similar house is worth 500k - are we really 5x richer?

[JRM]

This all is reasonable and makes sense.  I think less sophisticated people see the debt and deficit spending and think something must be wrong.  The idea of matching money supply with demand makes a lot of sense to me, and is the biggest detractor for having a fixed gold monetary system (could still create reserve system backed by gold though).

 

What I don't understand is if this is the best monetary system, why is deflation treated like kryptonite?  Deflation is a good thing for the individual consumer.  Deflation is not good for the indebted nation.  It seems like the fed mandate has changed from stable prices and low unemployment to propping up the stock market and triggering inflation.

[stahleyp]

If gold moves due to inflation why did it spike from 2008-2011 and then from 2018-2020? In other words, why trust that the gold market knows what inflation will do if its been wrong in the past? I'm looking at GLD since it's the easier to measure from my view.

 

Hey ps!  Good questions!

 

First i like to think of the USD like any other commodity.  Like lumber or wheat, the USD has its own supply and demand curves.  What gold does is it gives you a real-time price signal on the USD's supply and demand (like any other commodity).  Gold does this because gold is very stable - its one of the most stable commodities because of its annual mining to above ground inventory ratio.

 

Ok - so we'll come to demand in a moment.  First supply.  Supply of USD assets comes, not from the Fed, but from the US Treasury.  As I've rambled on in a number of posts - US Treasury deficit spending creates new financial assets in the private sector banking system.  Treasury debt issuance and Fed operations are asset swaps and don't create new financial assets, they just change the composition of the private sector's US governments asset mix between currency/reserves/Treasury debt.

 

So the first answer to your question deals with US Treasury deficit spending.  Here's an annual chart of US cash deficit (as measured by the US Treasury monthly statements) vs annual US GDP.  In my mind, any time the deficit goes over 4% of GDP - its probably creating too much USD's.  I've highlighted the years where it was above 4%.

 

 

Right off the bat - the data matches your observations (almost).  2008-2012 and then 2018-2019 were years of "overproduction" of USDs and gold being sensitive to supply - noticed it.  2020 of course has also been a year of oversupply (especially during the April-August period).  Since then, its moderated a bit but I haven't updated my numbers fore the last few months.  I should do that soon.

 

Back to USD demand.  I think the big difference now vs the 1970s, is that there is a lot more wealth than there was back then.  So demand for dollars today is less about groceries and gasoline.  It is more about wealth and assets.  The dollars today chase real estate, stocks, etc...  So that's where the overproduction of USD goes and gold once again is sensitive to it.

 

What is happening right now?  Its hard to say - but if I had to guess....

 

Demand for USD and USD assets is revving up.  Supply of USDs is moderating.  If you look at tax receipts, they are picking up and I think March, April and June will be big months with surprisingly large Fed tax receipts.  We'll see how this stimulus package shakes out in terms of spending.  The result is that gold is falling which signals a fast recovery in 2021 for the US economy.  A fast growing economy signals very high demand for USDs.  That suppresses gold if the supply of dollars does not keep up.

 

What about Treasury yields?  I think that's noise right now.  There are a lot of monetary plumbing things happening over the next 4-5 months that could create a lot of noise in Treasury yields.  We'll see.  Because of some of things that may or may not happen (SLR regs getting extended, Congressional debt limit kicking back in on Aug 1st, etc) - its really hard to make a prediction.  But if I had to guess, SLR will get extended but the US Treasury will have to suppress its net bond issuance so as to hit its account balance requirement before Aug. 1st.  That would put pressure on Treasury yields and cause them to go lower - especially if the Fed is still buying $100b of Tsys per month.

 

I'm not sure if I answered your question.  But the bottom line is its less about product price inflation these days and more about asset price inflation because that's where all the money goes.

 

wabuffo

 

You're awesome. thanks!

 

In the recent past you said you were buying value stocks (I'm assuming you meant something like like low p/b, low p/e or whatever - but my assumptions could be wrong!). So if the interest rates are low and the fed is providing a ton of liquidity shouldn't the "growth" stocks continue the same way they've been on over the past decade?