Central Banks Driving Gold

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Gold as an asset class is confusing to most investors. Even sophisticated investors are accustomed to hearing gold ridiculed as a “shiny rock” and hearing serious gold analysts mocked as “gold bugs,” “gold nuts” or worse.

As a gold analyst, I grew used to this a long time ago. But, it’s still disconcerting when one realizes the extent to which gold is simply not taken seriously or is treated as a mere commodity no different than soy beans or wheat.

The reasons for this disparaging approach to gold are not difficult to discern. Economic elites and academic economists control the central banks. The central banks control what we now consider “money” (dollars, euros, yen and other major currencies).

Those who control the money supply can indirectly control economies and the destiny of nations simply by deciding when and how much to ease or tighten credit conditions, and when to favor (or disfavor) certain types of lending.

When you ease credit conditions in a difficult environment, you help favored institutions (mainly banks) to survive. If you tighten credit conditions in a difficult environment, you can more or less guarantee that certain companies, banks or even nations will fail.

This power is based on money and the money is controlled by central banks, primarily the Federal Reserve System. However, the money-based power depends on a monopoly on money creation.

As long as investors and institutions are forced into a dollar-based system, then control of the dollar equates to control of those institutions. The minute another form of money competes with the dollar (or euro, etc.) as a store of value and medium of exchange, then the control of the power elites is broken.

This is why the elites disparage and marginalize gold. It’s easy to show why gold is a better form of money, why it’s more reliable than central bank money for preserving wealth, and why it’s a threat to the money-monopoly that the elites depend upon to maintain power.

Not only is gold a superior form of money, it’s also not under the control of any central bank or group of individuals. Yes, miners control new output, but annual output is only about 1.8% of all the above-ground gold in the world.

The value of gold is determined not by new output, but by the above-ground supply, which is 190,000 metric tonnes. Most of that above-ground supply is either owned by central banks and finance ministries (about 34,000 metric tonnes) or is held privately either as jewelry (“wearable wealth”) or bullion (coins and bars).

The floating supply available for day-to-day trading and investment is only a small fraction of the total supply. Gold is valuable and is a powerful form of money, but it’s not under the control of any single institution or group of institutions.

Clearly gold is a threat to the central bank money monopoly. Gold cannot be made to disappear (it’s too valuable), and it would be almost impossible to confiscate (despite persistent rumors to that effect).

If gold is a threat to central bank money and cannot be made to disappear, then it must be discredited. It becomes important for central bankers and academic economists to construct a narrative that’s easily absorbed by everyday investors that says gold is not money.

The narrative goes like this:

There’s not enough gold in the world to support trade and commerce. (That’s false: there’s always enough gold, it’s just a question of price. The same amount of gold supports a larger amount of transactions when the price is raised).

Gold supply cannot expand fast enough to keep up with economic growth. (That’s false: It confuses the official supply with the total supply. Central banks can always expand the official supply by printing money and buying gold from private hands. That expands the money supply and supports economic expansion).

Gold causes financial panics and crashes. (That’s false: There were panics and crashes during the gold standard and panics and crashes since the gold standard ended. Panics and crashes are not caused or cured by gold. They are caused by a loss of confidence in banks, paper money or the economy. There is no correlation between gold and financial panic).

Gold caused and prolonged the Great Depression. (That’s false: Even Milton Friedman and Ben Bernanke have written that the Great Depression was caused by the Fed. During the Great Depression, base money supply could be 250% of the market value of official gold. Actual money supply never exceeded 100% of the gold value. In other words, the Fed could have more than doubled the money supply even with a gold standard. It failed to do so. That’s a Fed failure not a gold failure).

You get the point. There’s a clever narrative about why gold is not money. But, the narrative is false. It’s simply the case that everyday citizens believe what the economists say (usually a bad idea) or don’t know enough economic history to refute the economists (and how could you know the history if they stopped teaching it fifty years ago).

The bottom line is that economists know that gold could be a perfectly usable form of money. The reason they don’t want it is because it dilutes their monopoly power over printed money and therefore reduces their political power over people and nations.

To marginalize gold, they created a phony narrative about why gold doesn’t work as money. Most people were too easily impressed by the narrative or simply didn’t know enough to challenge it. Therefore the narrative wins even if it is false.

If gold is viable as a form of money, what does gold’s recent price trading range combined with fundamental factors tell us about its investment prospects?

Right now, my models are telling me that gold is poised to breakout of its recent narrow trading range.

As always in technical analysis, the term “breakout” can mean sharply higher or sharply lower prices. Using fundamental analysis, a breakout to sharply higher prices is the expected outcome. This may be the last opportunity to buy gold below $2,000 per ounce.

For the past three months, gold has been trading in a range between $1,685 per ounce and $1,790 per ounce (it’s trading at about $1,782 today). For most of those three months gold was trading in a fairly narrow band.

When trading a volatile asset narrows to that extent, it’s a sign that the asset is ready for a material technical breakout. The question is will gold breakout to the upside or downside?

To answer that question, we can turn to fundamental analysis. (Technical analysis is data rich and is useful for spotting patterns, but it has low predictive analytic power).

One of the most important fundamental factors forcing gold higher is shown in Chart 1 below. This shows central bank purchases of gold bullion from 2017 to 2020 (each year is shown as a separate line measured in metric tonnes on the left scale).

Chart 1 – Central Bank purchases of gold
(in metric tonnes) 2017 – 2020

IMG 1

Chart 1 shows significant purchases of gold with 2019 running ahead of 2017 and 2018 at about 500 metric tonnes.

The chart also shows over 150 metric tonnes of gold purchases through April 2020, which puts 2020 on track to show 450 metric tonnes purchased for the year if present trends hold.

Of course, the actual result could be higher or lower. Cumulative central bank purchases from January 2017 to April 2020 are approximately 2,050 metric tonnes.

In fact, central banks went from being net sellers to net buyers of gold in 2010, and that net buying position has persisted ever since. The largest buyers are Russia and China, but significant purchases have also been made by Iran, Turkey, Kazakhstan, Mexico and Vietnam.

Here’s the bottom line:

Central banks have a monopoly on central bank money. Gold is the competitor to central bank money and most central banks would prefer to ignore gold. Yet, central banks in the aggregate are net buyers of gold.

In effect, central banks are signaling through their actions that they are losing confidence in their own money and their money monopoly. They’re getting ready for the day when confidence in central bank money will collapse across the board. In that world, gold will be the only form of money anyone wants.

Central banks are voting with their printing presses in favor of gold. What are you waiting for?

Here’s a once in a lifetime opportunity to front run central banks and acquire your own gold at attractive prices before the curtain drops on paper money.

Regards,

Jim Rickards
for The Daily Reckoning

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Central Banks: Gold’s Greatest Ally

This post Central Banks: Gold’s Greatest Ally appeared first on Daily Reckoning.

You’re likely aware of the price action in gold lately. Gold has rallied from $1,591 per ounce on April 1 to $1,782 per ounce as of today. That’s a 12% gain in less than three months.

My earlier forecast was that gold would hit $1,776 by the Fourth of July. I guess I was a bit early!

Today’s price of $1,782 per ounce is the highest since 2012 and a 70% gain from the low of $1,050 per ounce at the end of the last bear market in December 2015.

The history of gold bull markets (1971–80 and 1999–2011) shows that the most powerful gains come toward the end of the bull market, not at the beginning.

That means even if you’ve missed out on the gold rally so far, you could still score huge gains as gold trends toward $10,000 per ounce or higher over the next four years.

As I’ve stated on multiple occasions, I didn’t just come up with that number out of the blue or to be controversial.

It’s simply the implied nondeflationary price of gold based on the M1 money supply and assuming it will have a 40% gold backing.

What’s driving this bull market in gold?

It’s not retail investors (apart from a small number who understand the dynamics) and it’s not institutional investors (institutional portfolio allocations to gold are typically about 1–2%).

Instead, the steady buying is coming from central banks (especially Russia and China) and from the super-rich, who typically store their gold in private nonbank vaults in Switzerland and other good rule-of-law jurisdictions.

The drive toward larger portfolio allocations to gold (in some cases up to 10%) is coming not just from the rich themselves but from their wealth managers and portfolio advisers.

This is a sea change.

For decades, wealth managers have rejected gold and pushed their clients into stocks, corporate credit and alternative investments including private equity. Recently all of those portfolio allocations have backfired. Equity markets crashed in March and are set for another fall soon after recovering over half the losses.

Corporate credit downgrades are at an all-time high and that market is being propped up by the Fed in nonsustainable ways. Private equity looks increasingly illiquid as IPO markets dry up and most hedge fund investors have badly underperformed.

This leaves gold as one of the best performing asset classes around.

But it’s still early. Here’s how I expect the process to play out…

As confidence in the dollar is eroded due to Fed money printing and congressional super-deficits, investors gradually look for alternative stores of wealth including gold.

These trends begin slowly and then gather momentum. As the dollar price of gold begins to soar, investors take notice. Even more people invest in gold, driving the price still higher.

Investors like to say that the price of gold is going up. But what is really happening is that the value of the dollar is going down (it takes more dollars to buy the same amount of gold).

This is the real inflation and the real dollar collapse most investors miss at the early stages.

Eventually, confidence in the dollar is lost completely, central bankers need to restore confidence, and they turn to some type of gold standard to do so.

We’re a long way from that point right now.

But if central banks, the super-rich and their advisers are all jumping on the gold bandwagon, what are you waiting for?

Gold’s worst ever bear market (2011–15) is behind us and gold is positioned for new highs of over $2,000 per ounce in the short run and much higher over the next several years.

The time to go for the gold is now.

Regards,

Jim Rickards
for The Daily Reckoning

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Goodbye, Free Market

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Fremdschämen.

Fremdschämen is a noun of the German language. It translates this way:

Embarrassment for those incapable of feeling embarrassment.

Today we suffer embarrassment for Mr. Jerome Powell and his fellows of the Federal Reserve…

For no action they take lowers their heads in shame… or blushes their cheeks with embarrassment.

Mr. Powell is simply in the hands of Wall Street… and on his knees to Wall Street.

Well does he know the taste of shoeblack.

Yesterday Mr. Powell got a fresh coat on his tongue. Details to follow.

But first, let us look in on his masters…

A Banner Day on Wall Street

Wall Street was in full roar today.

The Dow Jones jumped an additional 582 points. The S&P gained 58 points; the Nasdaq, 169 points of its own.

CNBC, by way of explanation:

Stocks rose on Tuesday as a record jump in retail sales — coupled with positive trial results from a potential coronavirus treatment and hopes of more stimulus — sent market sentiment soaring.

Government number-torturers reported this morning that May retail sales jumped a record 17.7%.

The chronically erring Dow Jones survey of economists had projected a 7.7% increase.

Yet we are not surprised by the surge. April’s numbers were true abominations. But certain economic restrictions were waived in May.

A trampolining back was therefore expected.

Meantime, a medicine named dexamethasone — a widely available medicine — is evidently effective in the treatment of deathly ill coronavirus patients.

It reportedly axed hospital deaths by perhaps one-third.

Thus the market had its spree today. But it merely added to yesterday afternoon’s joys…

Powell Licks Wall Street’s Shoes

The Dow Jones had been off 762 points in early trading yesterday, quaking with coronavirus-related fear.

But then Mr. Powell sank to his knees… and tongued Wall Street’s wingtips…

For the Federal Reserve announced it intends to purchase individual corporate bonds — not merely ETFs.

By its own admission, it will:

Begin buying a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers.

We will not burden you with the plan’s intricacies. You need only know this:

Yesterday’s announcement “pressed the risk-on button,” as money man Bill Blain styles it…

“Central Banks Are Now de facto Guarantors of the Corporate Bond Market”

Fears about the rising number of reopening coronavirus hotspots and economic threats were superseded by unbounded joy as the Fed announced it will buy secondary market corporate bonds direct[ly] rather than through ETFs, without any need for companies to certify their eligibility. That pressed the risk-on button — and markets recovered.

And so the free market sinks deeper into oblivion:

Central banks are now de facto guarantors of the corporate bond market.

What has all this QE Infinity and ZIRP interest rates created?… Where market prices have become meaningless as a result of financial asset inflation? Where junk bonds are priced like AAA securities, allowing private equity funds to thrive?

I am beginning to wonder if there is any point in thinking about markets any more… Just follow the central banks… don’t think. Just buy.

“Don’t think. Just buy.”

We think the proper advice might rather run this way: “Don’t buy. Just think.”

Yet we do not dispense financial advice.

Picking Winners and Losers

Our own Nomi Prins penetrates to the core of yesterday’s message. Nomi rings dead center when she says:

As if the Fed hasn’t done enough to destroy honest markets, now it plans to start buying individual corporate bonds. It’s just another step closer to the Fed deciding the winners and losers in the market.

Thus the Federal Reserve is a referee who has taken a bribe, a butcher who thumbs the scales, a rogue, a traitor to justice.

A central banker with a conscience might lower his head in shame… and a red flush of embarrassment might stain his cheeks.

Yet Mr. Powell holds his head high and puffs his chest, proud as any peacock.

His cheeks, meantime, are pale.

Yet ours are scarlet — scarlet with embarrassment for the man incapable of embarrassment.

“From Lender of Last Resort to Stockjobber”

The Federal Reserve was originally fashioned to be the “lender of last resort.” Yet that designation is presently a cruel and mocking jest.

It has passed from lender of last resort to stockjobber.

Economist Thomas M. Humphrey is the author of Lender of Last Resort: What It Is, Whence It Came, and Why the Fed Isn’t It.

From which:

While there exists such an entity as the classical lender of last resort (LLR) — the traditional, standard LLR model, to be exact — the Fed has rarely adhered to it… The Fed has deviated from the classical model in so many ways as to make a mockery of the notion that it is an LLR. In short, the Fed may be many things, crisis manager included. But it is not an LLR in the traditional sense of that term.

What is the proper function of the central bank, by Humphrey’s lights?

Six Mandates of Sound Central Banking

As summarized by Wikipedia, a central bank exists to:

(1) protect the money stock instead of saving individual institutions; (2) rescue solvent institutions only; (3) let insolvent institutions default; (4) charge penalty rates; (5) require good collateral; and (6) announce the conditions before a crisis so that the market knows exactly what to expect.

A word of explanation, perhaps, on “penalty rates.”

The central bank should charge interest rates above the market rate.

Otherwise the central bank would be a lender of resort — not the lender of last resort.

A high rate further encourages debtors to retire their debts rapidly… to shake loose the heavy burden as soon as circumstances allowed.

Yet what does the Federal Reserve’s actual record reveal?

(1) “Emphasis on credit (loans) as opposed to money,” (2) “taking junk collateral,” (3) “charging subsidy rates,” (4) “rescuing insolvent firms too big and interconnected to fail,” (5) “extension of loan repayment deadlines,” (6) “no pre-announced commitment.

Professional Incompetence

That is, the Federal Reserve takes sound central banking and knocks it 180 degrees out of phase.

It wars against all six mandates and massively against Nos. 1, 2, 3, 4 and 5.

Imagine a plumber who does not patch leaks but creates leaks… a doctor who does not mend bones but cracks bones… a head shrinker who does not shrink heads but expands heads.

Now you have the flavor of it.

Yet the Federal Reserve’s professional pride is unruffled. It displays no embarrassment, no shame at a job done wrong.

In fact, it believes it is a job done right…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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TOTAL CATASTROPHE OF THE CURRENCY SYSTEM

As the Nasdaq makes a new high for the year, the world outside the stock market timebomb is falling apart. For example the UN agency, The International Labour Organisation (ILO) reports that 1.6 billion jobs are at risk in the global economy. That is half of the global workforce of 3.3 billion. Read more...

Go Big or Go Home

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To understand why the financial dominoes toppled by the Covid-19 pandemic lead to global insolvency, let’s start with a household example. The point of this exercise is to distinguish between the market value of assets and net worth, which is what’s left after debts are subtracted from the market value of assets.

Let’s say the household has done very well for itself and owns assets worth $1 million: a home, a family business, 401K retirement accounts and a portfolio of stocks and other investments.

The household also has $500,000 in debts: home mortgage, auto loans, student loans and credit card balances.

The household net worth is thus $1,00‌0,00‌0 minus $500,000 = $500,000.

Let’s say a typical financial crisis and recession occur, and the household’s assets fall 30%. 30% of $1 million is $300,000, so the market value of the household’s assets falls to $700,000.

Deduct the $500,000 in debts and the household’s net worth has fallen to $200,000. The point here is debts remain regardless of what happens to the market value of assets owned by the household.

Then the speculative asset bubbles re-inflate, and the household takes on more debt in the euphoric expansion of confidence to buy a larger house, expand the family business and enjoy life more.

Now the household assets are worth $2 million, but debt has risen to $1.5 million. Net worth remains at $500,000, since debt has risen along with asset values.

Alas, all bubbles pop, and the market value of the household assets decline by 30%, or $600,000. Now the household assets are worth $2,00‌0,00‌0 minus $600,000 or $1,400,000. The household net worth is now $1,40‌0,00‌0 minus $1,50‌0,00‌0 or negative $100,000. The household is insolvent.

On top of that, the net income of the family business plummets to near-zero in the recession, leaving insufficient income to pay all the debts the household has taken on.

This is an exact analog for the entire global economy, which pre-pandemic had assets with a market value of $350 trillion and debts of $255 trillion and thus a net worth of around $100 trillion.

The $11 trillion that has evaporated in the market value of U.S. stocks is only a taste of the losses in market value. Global stock markets has lost $30 trillion, and once yields rise despite central bank manipulations (oops, I mean intervention), $30 trillion in the market value of bonds will vanish into thin air.

The market value of junk bonds has already plummeted by trillions, and that’s not even counting the trillions lost in small business equity, shadow banking and a host of other non-tradable assets.

Then there’s the most massive asset bubble of all, real estate. Millions of properties delusional owners still think are worth $1.4 million will soon revert to a more reality-based valuation around $400,000, or perhaps even less, meaning $1 million per property will melt into air.

Once the market value of global assets falls by $100 trillion, the world is insolvent.

Everyone expecting the financial markets to magically return to January 2020 levels once the pandemic dies down is delusional. All the dominoes of crashing market valuations, crashing incomes, crashing profits and soaring defaults will take down all the fantasy-based valuations of bubblicious assets:

Stocks, bonds, real estate, bat guano, you name it.

The global financial system has already lost $100 trillion in market value, and therefore it’s already insolvent. The only question remaining is how insolvent?

Here’s a hint: companies whose shares were recently worth $500 or $300 will be worth $10 or $20 when this is over. Bonds that were supposedly “safe” will lose 50% of their market value. Real estate will be lucky to retain 40% of its current value. And so on.

As net worth crashes below zero, debts remain. The loans must still be serviced or paid off, and if the borrowers default, then the losses must be absorbed by the lenders or taxpayers, if we get a repeat of 2008 and the insolvent taxpayers are forced to bail out the insolvent financial elites.

Here’s the S&P 500. Where is the bottom?

There is no bottom, but nobody dares say this. Companies with negative profits have no value other than the cash on hand and the near-zero auction value of other assets. Subtract their immense debts and they have negative net worth, and therefore the market value of their stock is zero.

But don’t worry, the government is on the case…

That governments around the world will be forced to distribute “helicopter money” to keep their people fed and housed and their economies from imploding is already a given. Closing all non-essential businesses and gatherings will crimp the livelihood of millions of households and small businesses that lack the financial resources to survive weeks without any revenues.

The only question is whether governments which can borrow or print fresh currency will get ahead of the implosion or fall behind, creating a binary choice: go big now or go home.

Half-measures in helicopter money work about as well as half-measures in quarantine, i.e. they fail to achieve the intended objectives. Dribbling out modest low-interest loans is a half-measure, as is cutting payroll taxes.

Neither measure will help employees or small businesses whose income has fallen below the minimum needed to pay essential bills: rent, food, utilities, etc.

Meanwhile, the ruling elites will be under increasing pressure to bail out greedy financial elites and gamblers. Those are the scoundrels and parasites they bailed out in 2008-09. But this is not just another speculative bubble-pop, this is a matter of life and death and solvency for the masses of at-risk households and small businesses.

It is a different zeitgeist and a different crisis, and bailing out greedy parasites (banks, indebted corporations, speculators, financiers, etc.) will not go over big while households and small businesses are going bankrupt.

The Federal Reserve has been handed a lesson in the ineffectiveness of the usual monetary “bazooka” in bailing out the predatory-parasitic class of overleveraged gamblers. Nearly free money for financiers isn’t going to save the economy or non-elites sliding toward insolvency.

Instead of leaving the bottom 99.5% to twist in the wind while enriching the predatory-parasitic class, the ruling elites will have to let the top 0.5% twist in the wind and save the bottom 99.5%. This will require going against all the thousands of lobbyists, all the chums at the club, and all the millions in campaign contributions, but it’s a binary choice.

Either save your citizenry or sacrifice your legitimacy by bailing out the predatory-parasitic class. If the ruling elites save their parasitic pals, the public will demand the scalps of the predatory-parasitic class, and as the crisis deepens, they will eject every craven, greedy elected toady who caved in to the predatory-parasitic class.

So listen up ruling elites: either go big or go home. Either accept that it’s going to take several trillion dollars in helicopter money to insure the most vulnerable households and real-world enterprises remain solvent, or quit and go home.

The pandemic crisis isn’t going to end in April or May, though the urge to indulge in such magical thinking is powerful. It might still be expanding in August and September.

This is why it’s imperative to go big now, and make plans to sustain the most vulnerable households and small employers not for two weeks but for six months, or however long proves necessary.

Regards,

Charles Hugh Smith
for The Daily Reckoning

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Here’s Where the Stock Market’s Going

This post Here’s Where the Stock Market’s Going appeared first on Daily Reckoning.

The Federal Reserve ordered seven “emergency” rate cuts since 1998. Tuesday’s was its eighth.

Going off the first seven… where will the S&P end the next 12 months?

Your choices are these:

  1. -9.2%
  2. -4.7%
  3. +6.1%
  4. +11.3%

But we are in devilish spirits today.

Let us therefore bewilder you with a fifth option: zero. The S&P will end precisely where it began.

Have you made your selection? You will have your answer shortly, your tour of the horizon.

First to a far more immediate source of bewilderment…

The seesawing market swung again today — down. And we are down with vertigo attempting to follow it one day to the next.

The Dow Jones plunged 600 points to open the day. It gave up another 369 points to end the day — a 969-point slating in all.

The S&P lost another 106 points today; the Nasdaq, 279.

Gold went rampaging again today, up another $29.00.

Meantime, the 10-year Treasury yield slipped to an impossible 0.899% this afternoon.

The mind staggers and reels.

But where does history argue the S&P will trade in one year’s time?

Again — prior to Tuesday — the Federal Reserve mandated seven “emergency” interest rate cuts since 1998.

These transpired in:

October 1998. January 2001. April 2001. September 2001. August 2007. January 2008. And October 2008.

All but two were 50 basis point hatchetings. October 1998 (25 basis points) and January 2008 (75 basis points) form the lone exceptions.

Tuesday’s emergency cut was right at par — the standard 50.

To help instruct your decision and speed you along, let us consider S&P action in the shorter term…

Deutsche Bank’s Jim Reid has ransacked the data in search of light. He first glanced one week out.

Where does the S&P stand one week after an emergency rate cut?

The answer is a 2.8% median gain.

Two trading sessions in, results do not encourage. Yet three are ahead. And time yet remains.

But let us now shimmy up the mainmast… and train our monoscope on the farther horizon.

Where does the S&P stand six months following an alarmed rate cut?

Substantially lower, according to Mr. Reid’s researches.

The answer is -4.3%.

The S&P is up 2.8% after one week, that is — but down 4.3% after six months.

But what about the entire year? Does the S&P continue to slip? Or does the seesaw swing positive again?

Or does it end flat — an entire year upon the hamster wheel?

Again… here are your choices:

  1. -9.2%
  2. -4.7%
  3. +6.1%
  4. +11.3%
  5. 0%

We have held you suspended in the air long enough. The answer is…

A. The S&P sheds a median 9.2% the year following an emergency rate cut.

And there you are. Thus you can expect the S&P to close March 2, 2021 near 2,760.

But one exception stands prominent… as a diamond stands prominent among the stones… as an honest congressman stands prominent among congressmen.

That lovely exception is October 1998. The S&P roared 24.1% by October 1999.

Yet this capital fact remains: The S&P ended the year down six occasions of the prior seven.

Alas, we have no corresponding data for the Dow Jones. But the two rarely fall much out of step. We can therefore assume similar results.

But comes the inevitable question:

Why doesn’t the market take to the emergency dose of cuts?

The gentlemen of Zero Hedge answer as well as anyone:

Traditionally when the Fed engages in such an unexpected move, it means that the economy (or markets, or both) are already in free fall, and the Fed is far behind the curve.

Who can be surprised?

The Federal Reserve generally lags so far “behind the curve”… it never has to turn the wheel. It goes forever on the straightaway.

But in fairness, we speak today of averages.

As we have noted before, climate is what a fellow can expect. Weather is what he actually gets.

The S&P could well burst upon a wondrous 12-month spree. It has laughed off the odds before.

Yet 22 years of history argues it will not…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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A World Gone Mad

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Today we gasp, stagger, reel.

The enormity of it all has finally overmatched our capacities. Consider…

Total global debt presently piles up to 322% of GDP — a record.

Total “developed world” debt piles higher yet — 383% of GDP — another record.

The world’s stock markets combine to $88 trillion, or 100% of global GDP. That is another record yet.

Record upon record upon record has come down… as debt has gone relentlessly up.

And what does the world have to show for the deluge?

Little Bang for the Buck

Real United States GDP growth gutters along under 2%. Fair estimates place European and Japanese 2020 growth under 1%.

Interest rates, meantime, are coming down. And so the supply of “dry powder” available to the central banks is coming down. They will require heaps of it come the next crisis.

Project Syndicate, in summary:

The major developed economies are not only flirting with overvalued financial markets and still relying on a failed monetary-policy strategy, but they are also lacking a growth cushion just when they may need it most.

Direct your attention now to the Bank of England. Specifically, to its balance sheet…

Where’s the Crisis?

As a percentage of GDP…

Not once in three centuries has this balance sheet swollen to today’s preposterous extreme…

Not when England was life and death with Napoleon, not when England was life and death with the kaiser, not when England was life and death with Hitler:

IMG 1

The Bank of England’s balance sheet — again, as a percentage of GDP — presently nears 30%.

It never cleared 20% even when England was absorbing obscene debts to put down Herr Hitler.

Where is today’s Napoleon? Where is today’s kaiser? Indeed… where is today’s Hitler?

Yet the balance sheet indicates England is battling the three at once. And on 1,000 fronts the world across.

We razz our English cousins only because the Bank of England is nearly the oldest central bank going (est.1694) and keeps exquisite records.

It therefore offers a detailed, three-century sketch of central banking’s shifting moods.

Our own Federal Reserve’s history stretches only to 1913. But its compressed history offers a parallel example…

Crisis-Level Balance Sheet

Its balance sheet expanded to perhaps 20% of GDP against the twin calamities of the Great Depression and Second World War.

It then came steadily, inexorably and appropriately down, decade after decade. Pre-financial crisis… that percentage dropped to a stunning 6%.

But then the great quake of ’08 rumbled on through… and shook the walls of Jericho to their very foundations.

The Federal Reserve got out its mason kits and set to patching the damage.

Patching the damage? It built the walls up higher than ever…

By 2014 quantitative easing and the rest of it swelled the balance sheet to 25% of GDP. That, recall, is five full percentage points above its 20th-century crisis peaks.

Mr. Powell’s subsequent quantitative tightening knocked down some of the recent construction.

The balance sheet — as a percentage of GDP — slipped beneath 20% by 2018.

But last year he pulled back the sledgehammers. Then, in September, the short-term money markets began giving out… and Powell rushed in with the supports.

The Fastest Expansion Ever

He has since expanded the balance sheet some $400 billion in a four-month span — over 10%. Not even the financial crisis saw such a violent expansion.

As we have presented before, the visual evidence:

IMG 2

The balance sheet presently nears $4.2 trillion, only slightly beneath its 2015 maximum.

Here then is irony…

“A Magnet for Trouble”

Observe the 2012–14 comments of Carlyle Group partner Jerome Powell — before he was Federal Reserve chairman Jerome Powell:

I have concerns about more purchases. As others have pointed out, the dealer community is now assuming close to a $4 trillion balance sheet and purchases through the first quarter of 2014. I admit that is a much stronger reaction than I anticipated, and I am uncomfortable with it for a couple of reasons.

First, the question, why stop at $4 trillion? The market in most cases will cheer us for doing more. It will never be enough for the market. Our models will always tell us that we are helping the economy, and I will probably always feel that those benefits are overestimated…. What is to stop us, other than much faster economic growth, which it is probably not in our power to produce?…

[W]hen it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response…

Continues the present chairman:

My [next] concern… is the problem of exiting from a near $4 trillion balance sheet… It just seems to me that we seem to be way too confident that exit can be managed smoothly. Markets can be much more dynamic than we appear to think…

I think we are actually at a point of encouraging risk-taking, and that should give us pause…

I kind of think that a large balance sheet might prove to be a magnet for trouble over time… So I tentatively land on a floor system with the smallest possible balance sheet…

“Why stop at $4 trillion?”… “It will never be enough for the market”… “faster economic growth, which it is probably not in our power to produce”… “a large balance sheet might prove to be a magnet for trouble over time”… “I tentatively land on a floor system with the smallest possible balance sheet”…

Again — here is irony.

What Happened to Powell?

Where a fellow stands often depends upon where he sits. And this particular fellow sits in the chairman’s seat at the Federal Reserve.

The Federal Reserve has a certain institutional… perspective.

And so he leans whichever way it slants.

Our co-founder Bill Bonner puts it this way:

“People come to believe whatever they must believe when they must believe it.”

What does Mr. Powell’s 2012–14 self, the conscience tapping naggingly on his shoulder, tell him?

That no enormity is ever enough for the market? Something about a magnet for trouble? A preference for the smallest possible balance sheet perhaps?

But Jerome Powell has come to believe what he must… when he needed to believe it.

We shudder at what he will come to believe come the crisis — or whatever his successor will come to believe.

Meantime, the world runs to record debt, its stock markets run to record highs…

And we are about ready to run for the hills…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Central Banker Comes Clean

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Reuters broadcasts the confession:

I do think the growth in the balance sheet is having some impact on the financial markets and on the valuation of risk assets…

Here we have the unassailable and unimpeachable testimony of one Robert Kaplan. He, Mr. Kaplan, presides over the Federal Reserve’s Dallas branch office.

And so a central bank grandee gives it straight… and stamps our dark suspicions with an official seal.

For this has been our claim:

The latest stock market fever owes not to trade, not to economics, not to “fundamentals.”

It owes rather to a delirious four-month expansion of the Federal Reserve’s balance sheet.

Irrefutable Evidence

Let us re-enter Exhibit A into evidence:

IMG 1

And Exhibit B:

IMG 2

This, as we have noted repeatedly, is a direct response to liquidity shortages in the short-term lending markets. In brief summary:

The Federal Reserve has expanded its balance sheet $400 billion these past four months — a $1.2 trillion annualized rate.

The same balance sheet presently rises near $4.2 trillion… a mere holler from its $4.5 trillion record.

As Goes the Balance Sheet, so Goes the Stock Market

Now let Exhibit C go into the record:

IMG 3

As revealed, the stock market pandemonium since October matches nearly perfectly the balance sheet engorgement.

The Dow Jones once again crossed 29,000 today, as it did briefly last week. As last week, it lost its purchase… and skidded back down.

It ended the day at 28,939.

But tomorrow promises a fresh assault upon the peaks.

Should we then be surprised that investor sentiment presently runs to extreme greed?

Extreme Greed

Behold CNN’s Fear & Greed Index:

IMG 4

This Fear & Greed Index presently reads a sinfully avaricious 90 — “extreme greed.”

What did it read one year ago today?

It read 30… verging on “extreme fear.”

But that was before the Federal Reserve furled back its sleeves, spat upon its hands… and set to work…

Before it began hacking interest rates, before it halted quantitative tightening — before it sent the balance sheet ballooning.

One year later the stock market rises to record highs and sentiment runs to extreme greed.

“The Bullish Sentiment We’re Getting Now Has Reached the Uncomfortable Stage”

Here at The Daily Reckoning, our distrust of crowds approximates our distrust of politicians, sellers of used autos… and statistics.

When the crowd goes herding into the same railcar, we instinctively jump tracks.

And the railcar is filling fast…

“The bullish sentiment we’re getting now has reached the uncomfortable stage,” affirms Jeff deGraaf, chairman of Renaissance Macro Research, adding:

“Some of the levels we’ve seen are, frankly, similar to what we saw in January of 2018.”

In reminder: The stock market “corrected” over 10% between Jan. 26 and Feb. 8, 2018.

We believe it is preparing to correct again. But not until the market uncorrects further yet…

“Peak Bullishness and Dovishness”

Tomorrow the president puts his signature to the “phase one” trade accord with China.

The United States will cancel scheduled tariffs on Chinese wares… and China will agree to purchase additional American bounty.

The computer algorithms will pluck the joyful news from the wires. They will proceed to pummel the “buy” button.

Thus you can expect CNN’s Fear & Greed Index to lurch even further into greed.

Meantime, the Federal Reserve huddles at Washington in two weeks.

It will not lower rates — but nor will it raise them up. Federal funds futures presently give 87.3% odds that rates remain in place.

Conditions will remain accordingly benign. And markets can continue their journey into the record books, unruffled and undisturbed.

That is why Bank of America warns markets presently careen toward “peak bullishness and dovishness.”

What lies the other side of these lofty and treacherous peaks?

We hazard the stock market will correct in February, once across. We suspect it will correct on the same general scale as 2018.

Let us now turn our attention to the great bugaboo of today’s market, the skunk lurking in this growing woodpile…

Too Many Eggs in Too Few Baskets

Merely five stocks — Apple, Microsoft, Alphabet (Google’s parent company), Amazon and Facebook — presently constitute 18% of the S&P’s total market capitalization.

As Morgan Stanley reminds us, that is the highest percentage in history.

“A ratio like this is unprecedented, including during the tech bubble,” says Mike Wilson, who directs Morgan Stanley’s U.S. equity strategy.

These stocks account for much of the S&P’s 2019 outperformance. Apple and Microsoft accounted for nearly 15% of all S&P gains.

Rarely before, we conclude, have so many investors… owed so much… to so few stocks.

But what if these wagon-pullers crack under the strain — and throw off the burden of leadership?

CNBC:

These mega tech firms have been the front-runners in this record-long bull market as investors bet on superior growth and dominant market share in their respective industries. They were the biggest contributors to the market’s historic gains last year and the trend shows no signs of stopping in 2020. However, multiple Wall Street strategists are sounding alarms on the increasing dominance of Big Tech, warning of a potential pullback in the stocks ahead.

Will anyone carry the standard forward should the leaders falter?

No, suggests Goldman Sachs:

“Narrow bull markets eventually lead to large drawdowns.”

The Tide Rises, Until It Doesn’t

Next we come to the strategy of “passive investing.”

Passive, because it rises or falls with the prevailing tide.

After the 2008 near-collapse, the Federal Reserve inundated markets with oceans of liquidity.

The tide rose, and all boats with it.

Technology stocks like Apple and Microsoft have led the way up.

Much of Wall Street has poured into these stocks… sat back on its oars… and rode the current to record highs.

The biblical-level flooding flattened existing financial signposts. “Fundamentals” no longer mattered.

“Active” asset managers fishing for winners could no longer separate them from the losers. The nets came up full of winners and losers alike.

All is peace while the tide of liquidity rises. But the danger is this, as we have written before:

When the tide recedes… it recedes.

Panic Selling Begets Panic Selling

The same handful of stocks that hauled markets up on an incoming tide can drag them rapidly down on an outgoing tide.

Panic selling begins. And panic selling begets panic selling — which begets panic selling.

Explains Jim Rickards:

In a bull market, the effect is to amplify the upside as indexers pile into hot stocks like Google and Apple. But a small sell-off can turn into a stampede as passive investors head for the exits all at once without regard to the fundamentals of a particular stock…

The technical name for this kind of spontaneous crowd behavior is hypersynchronicity, but it’s just as helpful to think of it as a herd of wildebeest that suddenly stampede as one at the first scent of an approaching lion. The last one to run is mostly likely to be eaten alive.

Meantime, the Federal Reserve’s balance sheet continues to expand, the fools continue to rush in…

And the gods continue to plot.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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“Last Hurrah” for Central Bankers

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We’ve all seen zombie movies where the good guys shoot the zombies but the zombies just keep coming because… they’re zombies!

Market observers can’t be blamed for feeling the same way about former Fed Chair Ben Bernanke.

Bernanke was Fed chair from 2006–2014 before handing over the gavel to Janet Yellen. After his term, Bernanke did not return to academia (he had been a professor at Princeton) but became affiliated with the center-left Brookings Institution in Washington, D.C.

Bernanke is proof that Washington has a strange pull on people. They come from all over, but most of them never leave. It gets more like Imperial Rome every day.

But just when we thought that Bernanke might be buried in the D.C. swamp, never to be heard from again… like a zombie, he’s baaack!

Bernanke gave a high-profile address to the American Economic Association at a meeting in San Diego on Jan. 4. In his address, Bernanke said the Fed has plenty of tools to fight a new recession.

He included quantitative easing (QE), negative interest rates and forward guidance among the tools in the toolkit. He estimates that combined, they’re equal to three percentage points of additional rate cuts. But that’s nonsense.

Here’s the actual record…

That QE2 and QE3 did not stimulate the economy at all; this has been the weakest economic expansion in U.S. history. All QE did was create asset bubbles in stocks, bonds and real estate that have yet to deflate (if we’re lucky) or crash (if we’re not).

Meanwhile, negative interest rates do not encourage people to spend as Bernanke expects. Instead, people save more to make up for what the bank is confiscating as “negative” interest. That hurts growth and pushes the Fed even further away from its inflation target.

What about “forward guidance?”

Forward guidance lacks credibility because the Fed’s forecast record is abysmal. I’ve counted at least 13 times when the Fed flip-flopped on policy because they couldn’t get the forecast right.

So every single one of Bernanke’s claims is dubious. There’s just no realistic basis to argue that these combined policies are equal to three percentage points of additional rate cuts.

And the record is clear: The Fed needs interest rates to be between 4% and 5% to fight recession. That’s how much “dry powder” the Fed needs going into a recession.

In September 2007, the fed funds rate was at 4.75%, toward the high end of the range. That gave the Fed plenty of room to cut, which it certainly did. Between 2008 and 2015, rates were essentially at zero.

The current fed funds target rate is between 1.50% and 1.75%. I’m not forecasting a recession this year, but if we do have one, the Fed doesn’t have anywhere near the room to cut as it did to fight the Great Recession.

I’m not the only one to make that point. Here’s what former Treasury Secretary Larry Summers said:

[Bernanke] argued that monetary policy will be able to do it the next time. I think that’s pretty unlikely given that in recessions we usually cut interest rates by five percentage points and interest rates today are below 2%… I just don’t believe QE and that stuff is worth anything like another three percentage points.

Summers goes on to call Bernanke‘s speech “a kind of last hurrah for the central bankers.”

He’s right. But if monetary policy isn’t the answer, what does Summers think the answer is?

Fiscal policy. The government is going to have to spend money directly into the economy instead of relying upon some trickle-down “wealth effect” to stimulate the economy.

Here’s what Summers said:

“We’re going to have to rely on putting money in people’s pockets, on direct government spending.”

Remember the term “helicopter money”? Milton Friedman coined the term 50 years ago when he made the analogy of dropping money from a helicopter to illustrate the effects of aggressive fiscal policy.

That’s essentially what Summers is advocating. It might sound a lot like the idea behind Modern Monetary Theory, or MMT, but it’s not necessarily the same thing. MMT takes helicopter money to a whole new level, and Summers has actually been highly critical of MMT.

But the idea of direct government spending to stimulate the economy is the same, and it’s gaining traction in official circles.

There’s good reason to believe it’s coming to a theater near you. And maybe sooner than you think.

Regards,

Jim Rickards
for The Daily Reckoning

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Bigger Isn’t Better

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What caused the overnight lending market to unexpectedly seize up in September? There’s a good reason to believe JPMorgan Chase (JPMC) may have been at the heart of it.

JPMorgan Chase is the largest bank in the U. S., and has about $1.49 trillion in deposits. It’s one of the big banks that provide much of the loans in the overnight money markets.

But it seems the mega-bank had gone on a stock buyback spree from January through September of this year.

Buybacks, which are designed to boost stock prices, have been enabled for years by the Fed’s artificially low-interest rates. Corporations, in fact, have been the largest purchasers of stocks, which is heavily responsible for the bull market that’s now over a decade old.

According to the SEC, JPMC has spent about $77 billion on buybacks since 2013. But the money JPMorgan Chase used for buybacks on its most recent buyback binge was, therefore, unavailable to be loaned out in the repo market.

This information is from the bank’s annual SEC filing (hat tip to the Wall Street on Parade blog):

In 2019, cash provided resulted from higher deposits and securities loaned or sold under repurchase agreements, partially offset by net payments on long-term borrowing… cash was used for repurchases of common stock and cash dividends on common and preferred stock.

That diversion of money likely contributed to the liquidity crunch, which forced the Fed had to intervene in order to make up the difference.

Here’s how Wall Street on Parade sums it up:

Had JPMorgan Chase not spent $77 billion propping up its share price with stock buybacks, it would have $77 billion more in cash to loan to businesses and consumers — the actual job of its commercial bank. Add in the tens of billions of dollars that other mega banks on Wall Street have used to buy back their own stock and it’s clear why there is a liquidity crisis on Wall Street that is forcing the Federal Reserve to hurl hundreds of billions of dollars a week at the problem.

But altogether, JPMorgan has actually withdrawn $158 billion of its liquid reserves from the Fed in the first half of this year. That’s an extraordinarily large amount of money to withdraw in such a short amount of time, as my friends at Wall Street on Parade point out. That’s bound to have an effect on the market.

And that’s what we’ve seen.

Of course, JPM is one of those Wall Street banks that are “too big to fail.” It’s the largest commercial bank in the nation, with $1.6 trillion in deposits.

But it’s not just JPM.

It’s just one part of a system rigged in favor of Wall Street that has been deemed too big to fail. It’s a corrupt and incestuous system filled with perverse incentives and conflicts of interest. Here’s an example…

82% of bank analysts on Wall Street recently gave Citigroup stock a “buy” rating. What you didn’t hear reported on CNBC or Fox Business News is that the major banks they work for — like JPM, Goldman Sachs, Morgan Stanley, Deutsche Bank, UBS and Bank of America — have strong incentive to recommend Citigroup.

That’s because all the major banks are interconnected through derivatives. And weakness in one bank could spill over into the others. So it’s not a level playing field at all. It’s tilted in favor of the big banks.

But as one observer asks, “Why should any Wall Street bank be allowed to make research recommendations on stocks and then trade in those very same stocks?”

It’s a corrupt system designed by insiders for insiders. I should know because I used to be one of them.

I worked at four of the world’s major banks for a decade and a half until I finally had enough and walked away. Two of the four banks I worked for, Bear Stearns and Lehman Bros., were destined to implode.

That’s because they overleveraged themselves, taking on too much debt to bet on risky credit instruments. These credit instruments included subprime loans, credit derivatives and Wall Street’s version of a debt buffet called CDOs, or collateralized debt obligations.

It’s now been over a decade since the world’s major central banks reacted to the financial crisis with record-low interest rates and quantitative easing.

Today the big banks are bigger than ever and the amount of debt in the system is larger than ever. There’s been no substantial reform since the financial crisis, just some cosmetic moves that have been passed off as major reform. The big banks are always ahead of the regulators.

My research for my book Collusion: How Central Bankers Rigged the World revealed how central bankers and massive financial institutions have worked together to manipulate global markets for the past decade.

Major central banks gave themselves a blank check with which to resurrect problematic banks; purchase government, mortgage and corporate bonds; and in some cases — as in Japan and Switzerland — buy stocks, too.

They have not had to explain to the public where those funds are going or why. Instead, their policies have inflated asset bubbles while coddling private banks and corporations under the guise of helping the real economy.

The zero-interest rate and bond-buying central bank policies that prevailed in the U.S., Europe and Japan were part of a coordinated effort that has plastered over potential financial instability in the largest countries and in private banks.

It has, in turn, created asset bubbles that could explode into an even greater crisis the next time around.

The world’s debt pile sits near a record $246.5 trillion. That’s three times the size of global GDP. It means that for every dollar of growth, the world is borrowing three dollars.

Of course, this huge debt pile has done very little to support the real economy. Even the IMF now admits that global central bank policies to lower interest rates in order to stave off immediate economic risks have made the situation worse.

Their actions have led to “worrisome” levels of poor credit-quality debt as well as increased financial instability.

The IMF noted that 40% of all corporate debt in major economies could be “at risk” in the event of another global economic downturn, with debt levels greater than those of the 2008–09 financial crisis.

That huge pile of debt is basically the kindling for the next financial fire. We’re just waiting for the match to light it.

So today we stand near — how near we don’t yet know — the edge of a dangerous financial conflagration. The risks posed by the largest institutions still exist, only now they’re even bigger than they were in 2007–08 because of the extra debt.

It’s not sustainable. But that doesn’t mean the central banks won’t try to keep it going with monetary easing policies in place.

It could work for a while, until it doesn’t.

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