FINANCIAL-POLITICAL COMPLEX, MARKETS…….AND GOLD By Navin Doshi (June 2012)
June 19, 2012 5:32 pm
Markets stay in bullish trend as long as the economy is expanding and the interest rates are falling. Bernanke has kept the gas paddle to the floor for so long, keeping the interest rate near zero to invigorate the economy. However the economy, like a zombie, does not seem to respond in matters of job growth and housing.
This is what David Stockman, former Republican U.S. Congressman and director of the Office of Management and Budget in the Reagan administration has to say in matters of Fed’s policy and actions. He refers to it as a “paralyzed” Federal Reserve Bank, in its “final days,” held hostage by Wall Street “robots” trading in markets that are “artificially medicated”. The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing more, piling up more debt. Wall Street is arbitraging the Fed’s monetary policy by borrowing at 10 basis points and investing it in high yielding government guaranteed bonds. The Fed has become a captive of the traders and robots on Wall Street.
Because of Fed’s near zero interest-rate, the yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors—none of these free market forces matter. Wall Street merely takes the advantage of the situation. As long as the fast-money traders believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades. When that happens, traders are forced to start selling in order to liquidate their carry trades because they don’t want to lose. When the crisis comes, there will be insufficient private bids—the market will gap down hard unless the central banks buy on an emergency basis.
The question is: Will the central banks be able to keep going, given that they have already expanded their balance sheets? The Fed balance sheet was $900 billion (B) when Lehman crashed in September 2008. It took 93 years to build it to that level from the time the Fed was created in November 1914. Bernanke then added another $900B in seven weeks and then he took it to $2.4 trillion in an orgy of money printing during the initial 13 weeks after Lehman. Today (April 2012), it is nearly $3 trillion. Worldwide it’s the same story; the top eight central banks had $5 trillion of footings shortly before the crisis; they have $15 trillion today. Overwhelmingly, this fantastic expansion of central bank balance sheet has been used to buy or discount sovereign debt. This was the mother of all monetization. The U.S. Treasury needs to be in the market for $20B in new issuances every week. When there are all offers of more debt and no bids, the music will stop. Instead of being able to borrow at near zero interest rate, the market may demand much higher interest rate. All of a sudden the politicians will ask what happened to all the free money? Once the bond market starts unraveling, all the other risk assets will start selling off like mad.
Too much money printing and debt expansion drove the prices of all asset classes to an artificial non-economic height. The danger to the world is not classic inflation or deflation of goods and services; it’s a drastic downward re-pricing of inflated financial assets. This is not the free market at work, this is Fed’s money printers and their Wall Street cronies perverting what used to be a capitalist market.
The crisis can occur at any time; on Dec. 31, the tax cuts expire, defense cuts occur, and we hit the debt ceiling. Never before have we seen three such powerful vectors reinforced at the same time. First, the debt ceiling will expire around election time, so the government will face another shutdown and it will be politically brutal to assemble a majority in a lame duck session to raise it by the trillions. Second, the whole set of tax cuts and credits that have been enacted over the last 10 years totalling up to $500B annually will expire on Dec. 31. That will hit the economy like a ton of bricks, if not extended. Third, we have the sequester on defense spending that was put in last summer as a fallback, which cannot be changed without a majority vote in Congress. If one defers the sequester, one needs more debt ceiling. If one extends the tax expirations, one needs a debt ceiling increase of $100B a month.
Defense purchases and non-defense purchases will be hit with brutal force by the sequester. As we go into 2013, there will be a shocking hit to the reported GDP numbers as discretionary government spending shrinks. The number of the unemployed has to rise. In fact, the unemployment problem worsens since it is a global problem in an interconnected world. Stockman advises to stay out of harm’s way and try to preserve cash. His investing model is ABCD: Anything Bernanke Cannot Destroy: flashlight batteries, canned food, gold, a cabin in the mountains.
Views on Wall Street, as described in Barron’s Roundtable dated June 11th, are somewhat similar but with some optimism. They expect high market volatility. They are concerned about European debt problem and the slowdown in China and India. The cover story in the latest issue of Barron’s warns about the rising cost of social security, health care, and entitlements that could drain the federal budget totally, unless Washington acts now. Majority opinion of the round table participants is that the Fed will launch a third round of quantitative easing, or Treasury bond purchases, in an effort to create more jobs. Their investment recommendations include banks like Wells Fargo, pharmaceuticals like Pfizer, technology like Microsoft and Qualcomm, Australian and Mexican bonds, and finally gold and gold/silver miners. The bond fund manager Bill Gross observed that soaring debt to GDP ratio, and ever decreasing yield and the quality of the debt, may become the cause of a breakdown of the 40 year old global monetary system. He then added that more investor’s money was moving into hard assets like land and gold.
To invest in gold and gold mining, is to go against most governments and central banks, because it implies less confidence in all fiat paper currencies including dollar. Bullion banks like JP Morgan, employing the HFT algorithm, have been successful in keeping the spot gold price around $1600 per troy ounce for over nine months.
However, here are the key developments in the physical gold market in favor of gold and gold miners. Chinese gold imports from Hong Kong surged by 641 % in a year; they imported 489 metric tons in 2011 as opposed to 66 in 2010. China’s central bank also buys all the gold mined in China. Not only China, but central banks of many countries are net buyers of gold to diversify their foreign reserve since the 2009 melt down. Japanese pension funds have finally discovered the value of investing in gold…. after 20 years of lack-luster returns. There are talks in Euro land to elevate gold to a tier one asset from tier three, which would strengthen the balance sheet of European banks. Tier one assets are allowed to be fully valued (100%), as opposed to 50 % value of tier three assets. Please note that Euro land holds about 10,000 metric tons, the largest gold backing of Euro than any other currency. There has been a material change in the gold investing landscape in last 30 days. Though the spot gold has not changed much, but mining ETF (GDX) and the likes have moved up over 18 % from the low made around May 16th.
There is a rise of a financial-political complex, not just in America but many other competing countries in Europe and Asia. So the government stands behind the banks, and in turn they buy government debt. This financial-political complex, as described in the magazine, Economist , dated May 26th, is reinforced by the general unwillingness of governments to let banks go bust. The argument their advocates make is that it is better to intervene in markets than repeat the mistake of the depression. However, once the governments get involved, they find it hard to withdraw. This indeed is a new financial and economic era. No one knows how long it will last. Links below are about, the debt carried by US, market manipulation by the plunge protection team, and manipulation of gold price.
(Mr. Doshi, a writer, trader, and a philanthropist, posts his articles at www.nalandainternational.org)