A few weeks ago on the 20th of September the United States Federal Reserve announced it would begin unwinding it’s $4.5 trillion balance sheet starting in October. The Federal Reserve undertook unprecedented action in the wake of the 2008-2009 financial crisis when it expanded it’s balance sheet from $900 billion to as high as $4.5 trillion in order to buy worthless mortgage backed securities and other assets that no one else would–as well as government bonds.
As the Fed unwinds it’s balance sheet by selling assets and not rolling over existing assets, the money supply in circulation will shrink.
If the money supply shrinks will the value of the S&P 500 as well?
So why does this matter? Well, as pointed out at the beginning of the year over at Benzinga.com, the S&P 500 is 97% correlated with the Adjusted Monetary Base. As the Adjusted Monetary Base goes up, so does the S&P 500, as the Adjusted Monetary Base goes down, the S&P 500 goes down.
The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks.
So the by reducing it’s balance sheet, the Fed will lower the Adjusted Monetary Base and thus the S&P 500 would experience downward pressure.
But that isn’t the only headwind.
Reduction in Share Buybacks
The Federal Reserve lowered interest rates to near zero for almost seven years. Low interest rates means it’s less expensive to borrow money. A lot of companies have taken advantage of these low interest rates to issue bonds (a way of borrowing money) at low interest rates and then used the proceeds not to invest in people, factories, or equipment, research and development or other business growing endeavors, but instead to use the borrowed money to buy back their own shares.
Bond issues increases the debt companies have on their balance sheets, but also boosts their share prices, even when the companies aren’t performing any better. An example Simon Black of Sovereign Man uses is Exxon Mobil. Exxon is #4 on the Fortune 500.
In 2006, the last full year before the Federal Reserve started any monetary shenanigans, Exxon reported $365 billion in revenue, profit (net income) of nearly $40 billion and free cash flow (i.e. the money that’s available to pay out to shareholders) of $33.8 billion.
At the time, the company had $6.6 billion in debt.
Ten years later, Exxon’s full-year 2016 revenue was $226 billion, net income was $7.8 billion, free cash flow was $5.9 billion and the company had an unbelievable debt level of $28.9 billion.
In other words, compared to its performance in 2006, Exxon’s 2016 revenue dropped nearly 40%, due to the decline in oil prices.
Plus its profits and free cash flow collapsed by more than 80%. And debt skyrocketed by over 4x.
Exxon Mobil is just one example. There are a variety of other blue chip stocks with shares prices that are higher despite lower profits and higher debt.
Share buybacks have declined in 2017. While the trend looks to continue upwards, rising interest rates will make it more expensive for companies to issue bonds and use the proceeds to buy back stock.
Despite the article image and title I certainly don’t know that October will see the stock market dip into the red. It would make sense if it did, but the S&P 500 continues to make new highs in spite of the Federal Reserve tightening, lackluster GDP growth and saber rattling from both North Korea and the United States.
But it is another headwind.
At some point there will be a stock market correction. That is simply how markets work since the advent of central banking and hence the business cycle. It has take much longer than I expected for there to be a correction. I didn’t believe that President Barrack Obama would leave office without seeing a stock market crash, but he did.
But markets have been on a steady climb since early 2009 and the bull market is looking long in the tooth. The S&P 500 could continue to rise for the foreseeable future, but with this new headwind of balance sheet reduction in addition to interest rate hikes, it might be time to take some dollars off the table and pivot some assets into alternative opportunities.
Whatever vestigial link between US dollars and gold ended after Bretton Woods was terminated on 15 August 1971. The classic gold standard was abolished long before in 1933 when the despotic executive order of United States President Franklin D. Roosevelt that made it illegal for citizens in the land of the free to own gold.
There are periodic calls to return to a gold standard as a way to reign in government spending. The return to a pre-1933 gold standard would be a huge step in the right direction.
A true gold standard uses gold as money. A true gold standard in the US would redefine dollars as a quantity of gold. A true gold standard is NOT saying that gold is worth $35 per ounce as was the case in Bretton Woods.
This is explained in fantastic detail by Mises Institute Senior Fellow Joseph T. Salerno in his lecture Gold Standards: True and False.
A Return to the Gold Standard in the US?
It sounds click-baity to me too, but Jim Rickards is predicting $10,000 gold as the result of a currency reboot. The link above is to a sales page (which I get zero benefit from and considered not linking to) that explains in his own words why Rickards thinks Trump will return the US to a “gold standard”.
James G. Rickards is a New York Times bestselling author who appears on networks like RT, CNBC and Bloomberg. He’s testified in front of congress, he’s done some consulting on currency for the CIA and Pentagon. So there are some reasons to listen to what he says and at least evaluate his rationale and his arguments.
If I can quickly summarize his argument it’s that the US is deeply in debt, debt has crushed the middle class, a gold standard is one of the keys to “Making America Great Again” and so President Trump going to move the US back onto a gold standard. Rickards also claims he has some inside information that gives him additional reason to believe a return to such a gold standard is likely.
I agree the US is deeply in debt. I also agree the economy is broken and stacked against the middle class in favor of the super-wealthy. I also agree that a return to a classic gold standard similar to what existed pre-1933 would help America.
There is also some evidence that Trump is receptive to the gold standard.
Would Trump Support a Gold Standard?
Trump has stated to GQ: “Bringing back the gold standard would be very hard to do, but boy would it be wonderful. We’d have a standard on which to base our money.” In the same montage of questions he also stated that Justin Bieber shouldn’t be deported and that he’s not a fan of Man Buns.
Trump has also tweeted this:
Although “gold” here could simply mean wealth.
As far as I can tell Donald Trump is not a systematic thinker. He doesn’t have a set of principles with which he evaluates problems and situations. I think Trump’s “philosophy” is basically “I’m a smart guy with good business sense. So I’m going to use my gut and my experience to make ad hoc judgments about what to do.”
Although he probably wouldn’t use the term ad hoc.
So could Trump be in favor of a gold standard? Who knows? Even if he was in some way at some point in the past who knows what he would decide today. Just look at his 180 turn on the war in Afghanistan as one example of his fickleness.
Where does Rickards get $10,000?
Rickards uses a fairly basic calculation based on what he thinks the world money supply will be, how much gold there is and a 40% backing to get $10,000 gold.
Rickards writes that the US government would keep the price at this level by simply conducting some “open market operations” in gold:
The Federal Reserve will be a gold buyer if the price hits $9,950 per ounce or less and a gold seller if the price hits $10,050 per ounce or higher
And this is really the rub. Such a price peg is not a return to a true gold standard. It would not change the US government’s fiat monetary system in any meaningful way.
Dollar to Gold Price Pegs are not a True Gold Standard
The plan Rickards describes is essentially the same as a bill that was proposed in 2013. Mises Institute fellow Joseph T. Salerno explains how such a fake gold standard would not help at all. A true gold standard defines dollars (or other currency) as a certain weight of gold. For example, the definition of a dollar used to be 1/20th of an ounce of gold (roughly). A $20 bill was not the money per se but a claim to one ounce of gold.
The “gold standard” Rickards speaks of is simply fixing the price of gold in dollars.
I Would Like Gold at $10,000
All else equal I would like gold at $10,000. Sure, if I wanted to add to my holdings it would be cost prohibitive, but since I already own some gold a price increase to $10,000 via Federal Reserve open market operations would be of benefit to me.
However, if the dollar collapsed and a loaf of bread costs $10,000 I’m probably not better off. After all no sane person would want to be a millionaire in Zimbabwean dollars in 2008.
This fake gold standard Rickards is predicting certainly wouldn’t help the US economy at large. As I mentioned above, it would not be any significant change to the fiat monetary system. A price peg of gold in terms of dollars is NOT a gold standard. If anything I think it would be horrible optics for the US government and shake the world’s confidence in the dollar. It would effectively be a revaluation down of the dollar, at least relative to gold, and the Fed’s balance would very likely have to massively expand in order to bid gold up to $10,000.
A Return to the Gold Standard Seems Unlikely
A return of the United States to a true gold standard seems very unlikely. A fake gold standard as described by Rickards is more likely than a return to a true gold standard–but still a long shot. I do believe gold is a fantastic long term investment but I also believe it will take the market waking up to the problems of the global financial system and not an act of government.
Article image above is by Chloe Cushman
Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall.
All the king’s horses and all the king’s men
Couldn’t put Humpty together again.
Denslow’s Humpty Dumpty
Back in February of 2016 Candidate Donald J. Trump stated, “I hope I’m wrong, but I think we’re in a big, fat, juicy bubble.”
In the first presidential debate in September of 2016 Trump stated the US economy is, “in a big, fat, ugly bubble.”
He also presciently said that when Obama returns to the golf course (did Obama ever leave the golf course?) that the U.S. Federal Reserve would raise interest rates.
Candidate Trump seemed to have some understanding that U.S. Stocks and Bonds are in a Bubble.
So President Trump should be concerned that the bubble is going to pop on his watch. But he seems to have pivoted to taking credit for the stock market just a few weeks after his election.
“We’re doing really well. The fake news media doesn’t like talking about the economy. I never see anything about the stock market” setting new records every day, he said.
I don’t know that Trump listens to any of his advisors, but if he did and I was one of his advisors, I’d encourage him to distance himself from the stock market.
President Obama got the advantage of the stock market high induced by low interest rate monetary heroin, and Trump is likely going to have to cope with the inevitable stock market crash and withdrawal.
President Trump is a Humpty Dumpty, perched upon the top of a stock market bubble, which is about to collapse.
President Obama had just 2 rate hikes over 8 years
President Obama began his presidency going into a time when the US Federal Reserve was providing extremely accommodative monetary policy. He then had near zero interest rates for the first 2,521 days of his presidency (just one month shy of 7 years out of 8) then the Fed Funds rate was hiked once for his last year.
Technically it was hiked a second time, but only for the last month he was in office and after Trump had won the election.
Effectively, rates were only hiked once in 8 years.
Rates have been hiked 3 times since Trump was elected
If you count the last rate hike during the Obama presidency, Obama had two rate hikes. If you consider the second hike during Obama’s Presidency was just 37 days before he would vacate the White House, he really only saw one rate hike.
Within 54 days of Trump’s inauguration the Fed raised rates from 0.50–0.75% range to the 0.75-1.00% range. Within 145 days of Trump’s inauguration, rates increased again to the 1.00-1.25% range. So Trump has began his presidency going into less accommodative monetary policy and has already seen 2 hikes during his presidency and 3 since he was elected.
Setting Trump up for a Fall
Virtually no one who lives inside the Washington, D.C. beltway likes Trump. The established powers in Washington hate Trump. The leaders in Trump’s own party hate him.
Trump’s whole presidency was based on spitting in the face of the established powers in the Imperial City of Washington, D.C.
Fed Chair Janet Yellen is a Democrat appointed by Obama and she was criticized by Candidate Trump during the campaign–if she is like virtually everyone else in the Imperial City then she can’t stand Trump.
Artificially low interest rates that are manipulated down by the US Federal Reserve and other central banks cause asset values to become artificially inflated in a bubble. President Obama received the “benefit” of these artificially low interest rates: the economy was able to limp along and the stock market continued to rise as valuations were artificially inflated by the cheap money.
In order for the US Federal Reserve to normalizes interest rates they need to pop the asset bubble they’ve created. I don’t know if the Fed realizes they’ve created a bubble, but if they do, then popping it on Trump’s watch would be ideal from their perspective.
What better way to get Trump out of office than to raise interest rates, pop the stock market bubble which would result in a recession and then ensure that President Trump is not reelected?
In the Machiavellian world of short term political expediency, Trump would do well to distance himself from the markets and put pressure on the fed to retain a more accommodative policy. It will make the problems worse but it will delay the pain. It’s certainly not the right thing to do but it’s what Presidents have been doing for decades.
The United States is steadily becoming a worse place for individuals to do business.
The financial services industry in particular faces onerous regulations imposed by the US government–under the auspices of security and combating terrorism.
While the efficacy of the US regulators’ draconian standards in preventing money laundering and terrorism is debatable–the impact on law abiding consumers is certain.
US consumers and investors alike are the victims of the US government’s attempt to control.
A recent example is that US citizens will no longer be allowed to have accounts on Bitfinex. Bitfinex announced earlier this month they would be dropping U.S. accounts and list the following reasons:While we have been able to normalize banking for some corporate customers and individuals in certain jurisdictions, compliant banking solutions for U.S. individuals remain elusive. We have been slowly and selectively inviting users in particular jurisdictions who meet set criteria to start using banking channels that have come online. This process is ongoing.A surprisingly small percentage of our revenues come from verified U.S. individual accounts while a dramatically outsized portion of our resources goes into servicing the needs of U.S. individuals, including support, legal and regulatory.We anticipate the regulatory landscape to become even more challenging in the future.
Bitfinex is not based in the United States. Exchanges based in the U.S. are better positioned to properly service retail U.S. customers.
1) It’s difficult to comply with US banking regulations
2) It’s expensive to comply with US banking regulations
3) Bitfinex expects regulations to become more challenging (probably meaning more expensive and more difficult) in the future
If the United States wants to remain competitive in the future and the new economy regulators need to back off.
Margin funding on Bitfinex is one of the methods I use to grow and protect my wealth. Very soon this will no longer be an option.
Former President Barrack Obama had many advantages in his presidency. He had the vast majority of the media firmly behind him, a sense of inevitability, support from the establishment, strong support from higher education institutions and he ran against weak candidates.
One of his greatest advantages was the unprecedentedly low interest rates throughout his eight years in office.
In fact no President has ever had lower rates for longer.
As President Obama was fond of reminding folks: America was recovering from the worst economic crisis since the great depression. His defenders can point to the fact that rates were that low because they needed to be.
Before we go Any Further
Now before I go any further, I want to make two points. One, the United States President does very little to impact how the US economy fairs.
In my opinion the President has more power than he should have but less than people realize. The President gets blamed when the economy is doing poor and gets credit when it is doing well. But it’s all unwarranted.
The second point is that artificially low interest rates are destructive. They cause bubbles and the ensuing financial crises. The 2000 dot com bust, the 2008-2009 financial crises were caused by a number of factors, but one large and consistent factor was artificially low interest rates set by the U.S Federal Reserve. Interest rates should be determined via a market based price discovery system not by the soviet style central planners occupying the Eccles Building.
The Obama Presidency was marked by the Lowest Interest Rates Ever
It’s almost comical how tightly low interest rates corresponded with the Obama Presidency. After he was elected, but before he took office the US Federal Reserve lowered interest rates to 0.25%. The lowest they have ever been.
Artificially low interest rates do in the short term provide an economic high similar to the short term euphoric feeling narcotics are reported to produce. But in the long term they are incredibly destructive to an economy.
But politicians either don’t understand this or simply don’t care and want to goose the economy so they can get re-elected. More likely both.
The US Fed Funds rate during Obama’s Presidency were the lowest ever for the longest ever
Now the Fed (probably by design to at least have the superficial appearance of impartiality) can point to the fact that they began raising interest rates in November of 2015. They also raised rates a second time in the 8 years of Obama’s reign on Dec 14, 2016, after Donald J. Trump won the presidential election.
In other words, leading up to and for nearly the first 7 years (2,521 days) of Obama’s presidency, the Fed Funds rate was set at 0.00-0.25%. For roughly the next year they were set at 0.25-0.50%. Then about a month after Trump’s election, for the last month of Obama’s presidency, interest rates were raised to 0.50–0.75%.
This is the most accommodative monetary policy the United States has ever had. This low interest rate policy began to be withdrawn as Obama prepared to vacate his residency at the White House.
Practically speaking rates were only hiked once in 8 years.
The Political Nature of the U.S. Federal Reserve
Democratic President Barrack Obama nominated Democratic party member Janet Yellen as US Federal Reserve Chairwoman
Despite the ridiculous and hollow rhetoric that the US Federal Reserve is impartial, it is a political institution that is integrated within the Federal Government.
Like all Federal Reserve Chairmen (or in this case Chairwoman) Janet Yellen was nominated by the President and confirmed by the Senate. Janet Yellen is a member of the Democratic party and was nominated by the de facto leader of the Democratic party.
Is a rational person really supposed to believe that Janet Yellen (or any other Fed Chair) who is a member of a political party, who is nominated by the leader of a political party, suddenly becomes a completely impartial overseer of the economy?
Of course not.
Obama got the High
The key takeaway is that the Obama administration was supported by an ultra-loose monetary policy that provided a strong tailwind for stock prices albeit at the expense of the real economy. A stock and bond bubble was also re-inflated.
The Fed has reversed gears and has begun a tightening cycle.
Obama was very fortunate to have gotten out of office before the next Federal Reserve fueled economic crisis hits. The economy is even weaker than it was before the great recession of 2008-2009.
Obama was the Fed’s sweetheart but he’s no longer in the office. So the Fed might not be as motivated to keep the bubble inflated and the charade going.
This is doubly true because Obama’s successor is universally despised. The powers that be would love to remove Trump from office and prevent him finishing out his first term, but at a minimum they will work to ensure he never sees a second term.
One way to do that is to crash the economy while Trump is president and hang the blame around his neck.
More on that in another article.
A group of people go camping. Two of them are central bankers. The group decides to divvy up jobs. A couple people are in charge of setting up the tents, another group goes and gets some water, a third group is in charge of preparing food for cooking and the central bankers are put in charge of building a nice fire for cooking.
The central bankers have never
had jobs in the real economy built a fire, but they went to Harvard and Yale so they’re smart and they are certain they can figure it out.
“Lets think about fires first.” says the Harvard trained economist.
“Great idea!” says the Yale grad, “Whenever I see a fire, there is smoke. I saw a video of a building burning down once and I could see the smoke long before I saw any flames.”
“I’ve seen that as well. Smoke obviously causes fire, so if we get enough smoke I’m sure we’ll have a nice fire going in no time.”
So the central bankers asked someone else to stack up some firewood while they figure out a way to get smoke onto the firewood. They have a few hours before dusk, more than enough time to smoke up a nice fire.
They rig a hose up to the exhaust of one of their vehicles and feed the exhaust smoke over to the firewood.
No fire starts.
They try revving up the engine to get more exhaust smoke onto the firewood. They try a diesel engine from one of the other cars.
They continued to feed smoke into the firewood, confident that if they just got enough smoke a fire would ignite.
The people setting up the tents and preparing the food looked over and see all the smoke. “They must have a large fire going!” said one person preparing some beautiful steaks. “I can’t wait to cook these up and eat!”
But despite creating an unprecedented amount of smoke the central bankers are not able to start a fire.
The sun set and darkness falls on the campsite. They aren’t able to cook the steaks so the food is wasted, the cars are out of gas and everyone goes to bed hungry and frustrated.
As they drift off to sleep the central bankers sigh, “If only we’d been able to get enough smoke onto the firewood…”
Central Bankers in the Real World
The logic of central bankers is completely backwards.
Fires often have smoke. However, smoke does not cause a fire to burn. Smoke is a side effect of fire.
Similarly, when an economy is humming along rising consumer prices can sometimes be observed. But rising prices are a side effect and not the cause of a healthy productive economy.
There is nothing particularly helpful to an economy as a whole about rising consumer prices (some of America’s most prosperous years were during periods of falling prices). Most recently the computer industry and cell phone industries have grown and expanded despite the price of computers and cell phones falling.
Central bankers like Ben Bernanke (Federal Reserve Chair before and after the 2008 financial crisis) often can’t forecast the present
However, central bankers mistake a side effect for the cause, and they believe price inflation is what causes economic growth.
It’s an idea so absurd that only someone with a Ph.D in economics could come up with it.
If a non-Ph.D went around saying that the key to economic growth is to make things unaffordable people would rightly think that person was crazy just like people would think it’s crazy to try to start a fire with smoke.
There has been unprecedented central bank intervention in the economy. Interest rates were at nigh zero for roughly 8 years following the 2008 financial crisis (which was also caused by central banks). This is the economic equivalent of blowing smoke onto firewood to create a fire. It wastes resources and time and it causes damage with no benefit.
Often people will point to the historic highs of the stock market and low unemployment as evidence of a recovery. However, people dropping out of the labor force causes the unemployment rate to go down and if one person loses a full time job and gets 2 part time jobs that counts as a net job gain.
While the US stock market is at all time highs, this provides little benefit to people who don’t own stocks. It is also of little benefit to people who own stocks, if they don’t sell the stocks before there is an inevitable stock market crash. Printing money (and it’s digital equivalent) out of thin air to buy US government debt, which lowers yields and incentivizes investors into stocks rather than bonds (which in many cases pay a negative real yield) does not make for a safer and healthier economy. Companies issuing bonds and borrowing money to buy their own stock back (thus raising the price) does not grow the economy. It does create a lot of paper wealth as well as a stock market bubble.
Because the high stock market value isn’t due to economic fundamentals, eventually the stock market will crash.
If a camper believes that smoke causes fire they won’t be able to successfully start a fire no mater how much smoke they pour onto their firewood. If a central banker believes that price inflation causes economic growth they won’t be able to “stimulate” the economy regardless of how much inflationary monetary policy they adopt.
As long as central bankers continue to misunderstand what makes an economy grow, they will continue to pursue failed policies that waste resources, create financial crises and make recessions worse.