It’s not an overstatement to say that over the 6-year period beginning in September-2008, the US Federal Reserve went berserk with its Quantitative Easing (QE). The following chart shows that the US Monetary Base, an indicator of the net quantity of dollars directly created by the Fed*, had a gentle upward slope until around August of 2008, at which point it took off like a rocket. More specifically, the Monetary Base gained about 30% during the 6-year period leading up to September of 2008 and then quintupled (gained 400%) over the next 6 years. Is it therefore fair to say that the Fed has now ‘shot its load’ and will be unable to do much in reaction to the next financial crisis and/or recession?
Let us all grab the reins on the dollar. Yes, it is true: the buck is up some 25% from a year ago, and at the highest level in more than a decade. After retracing recently, the dollar index has been chugging higher again although it has yet to penetrate recent highs. But put this all into context. In the early 1980s, the dollar index exceeded 160 before dropping nearly by half. A subsequent rally into the early 2000s was a 50% rally from the lows and took the index to 120. This latest rally is a clear third place, but also a distant third place (see chart, source Bloomberg).
We can probably draw some instruction from reviewing these past circumstances. The rally of the early 1980s was launched by the aggressively hawkish monetary policy of Paul Volcker, who vowed to rein in inflation by restraining money growth. He succeeded, and took core inflation from nearly 14% in 1980 (with the dollar index at 85) down to 4.5% in 1985 (with the dollar index at 160). If you make a thing, in this case dollars, more scarce, its price rises. An optimistic press wrote about the “Superdollar” and the return of that signature American optimism.
Guest Post by Steve Saville
Changes in asset prices or any other prices do not cause changes in money supply, although many of the people who comment on the financial markets and economics believe otherwise. We were recently reminded of this mistaken belief when reading an analysis of oil’s large price decline that included the assertion that hundreds of billions of dollars had been eliminated from the economy as a result of this price change.
Guest Post by Steve Saville
Some comments by John Mauldin towards the bottom of a recent article reflect popular opinions about money that can be summarised as: “a growing economy needs a growing money supply” and “there isn’t enough gold in the world for gold to be used as money today”. These opinions reflect a basic misunderstanding about money.
Here are the Mauldin comments to which we are referring. We’ve put notes below each excerpted comment, but the main part of our response is further down the page.
“The current structure of Bitcoin carries the same inherent flaw that gold does (and to some extent the euro, too): in a world of ever-increasing abundance, gold is massively deflationary and provides unreasonable “rents” to those who hold it. Even given that inherent flaw, it has been the most stable store of value for millennia.”
We take the Way Back machine to a time of normalcy and plenty, in the 50’s when the stock market did okay but savers were paid (through T Bill yields) to do the most prudent thing people in a natural economy can do… save. Ever since 1980 the theme has been for the nation to eat its seed corn, with asset owners getting increasingly more portly in the process and savers nudged ever further out to the margin. The S&P 500 has sure got no complaints these days. It’s in lockstep with policy.
The 10 year view shows savers have been erased from the picture. ‘Screw them’ is the implication as the brave new world of finance follows one rule, ‘asset appreciation or bust!’ In service to asset appreciation has been the duel input of ZIRP (zero rate policy) and a rising money supply, much of which we’d presume was instigated by QE’s money printing and Treasury and MBS asset purchases. S&P 500? Still not complaining.
Guest Post by Steve Saville
US money pumping by decade and Fed chairman
A large increase in the money supply will always lead to large increases in prices somewhere in the economy. However, monetary inflation affects different prices in different ways at different times, so the pertinent question is: which prices? The answer to this question is important from the perspective of almost everyone and is always obvious with the benefit of hindsight, but it is often difficult to determine ahead of time. Also, depending on which prices are affected the inflation will sometimes be widely perceived as a problem and at other times be widely perceived as a benefit or a non-issue.
The US Fed is pumping the money supply and trying to manage the unmanageable. There is now ‘QE exit’ hand wringing at each FOMC meeting, which comes out later in the minutes as the markets hang on every fretting statement that these policy clerks utter. Then the jawbones come out and talk nicey nice in the media and the market calms down.
They are not going to be able to manage this to anything other than a very sad outcome. They actually seem to think that policy making is bigger than the market and the economy. But it isn’t.
We are in an economic contraction and even after gold has been blown up, its ratio to the 3 Amigos of positive economic correlation continues to indicate the counter cycle.
Gold bugs need to be really careful here. There is still bottom calling going on and it is best not to root root root for the home team in any kind of a speculative casino patron type manner because the precious metals may have entered the realm of macro economic indicator and exited the realm of near term profit play.
The destruction in gold and gold stocks along with the now pronounced weakness in key commodities like copper and oil bring the prospect of deflation front and center, or rather the prospect that the inflation is not taking in economically sensitive materials and resources.
Yesterday the St. Louis Fed updated the Monetary Base data and it is still boinking upward.
But then the dBoys would immediately produce this picture for contrast…
We are in an economic contraction and they are still inflating against it. The big question – the one for all the marbles – is ‘is it deflation first and then hyperinflation or the other way around?’
I cannot shake the feeling that what the precious metals and now commodities are indicating is much darker than what the pom pom waving gold bug community may believe. It’s an economic contraction and that is the only environment that the accursed gold mining sector has a chance to thrive.
But in that scenario they go down first. And boy have they been going down. They may have bottomed and they may not. I have refused to bottom call a thing since HUI lost 460’s parameter to normalcy. I’ll just keep it that way, pending what any new data points that any coming bounces may produce.
But a bigger question is what are the PM’s forecasting? People need to get that answered right.
Updated just 7 whole minutes ago by the St. Louis Fed. The money supply measure that actually matters just ticked up again, painting any stock market correction (pretty please?) to come as a potentially healthy one, if anything in this circus can be called healthy anymore.
I dunno, it looks like the consolidation is broken doesn’t it? Behold the picture that will bring on the next bust. Because it will one day.
Below is a copy of this week’s free eLetter that went out this morning.
Goldilocks Ends & ‘Currency Wars’ Begin
Amid continuing inflationary policy, the US Dollar is at a critical juncture by both daily and weekly charts. Euro targets 142+ and the Yen approaches our target. Currency war kicks off; gold just sits there biding time.
From last week’s eLetter:
“A Goldilocks atmosphere was expertly created in large part due to the fact that Operation Twist (yes, we are still dealing with its effects) by its very definition held long-term interest rates down (buying long-term T bonds) while sopping up any money supply implications and inflationary signals by sanitizing the process with the sales of equal amounts of short-term bonds.”
Policy makers have not found a new way to indefinitely manage the economy. Traditional laws of economics have not been repealed. The Federal Reserve used the equivalent of a macro parlor trick to dampen inflation signals and help produce today’s Goldilocks atmosphere, which features stocks rising now that the public and its mainstream money managers feel the worst is over with respect to the Fiscal Cliff non-event and the Debt Ceiling noise.
But in economics and macro finance, there is is always a price to be paid for unnatural (read: man-made) distortions. The Fed ran out of short-term bonds to sell and now something has to give, as its ongoing inflationary operation is now unsanitized.
A bearish Head & Shoulders pattern has formed on the currency for which the Fed is supposedly a steward. If the neckline breaks, the measured target is 76.50.
The weekly chart of USD targets 74 off of an even more significant H&S, with the baby H&S of the first chart merely representing the right shoulder of the big daddy H&S.
A breakdown in the US dollar would confirm that the recent tick higher in Adjusted Monetary Base is the beginning of a new trend up in inflationary policy.
Unsurprisingly, USD’s chief rival, the Euro is in an inverted and bullish H&S. We have been targeting 142 in NFTRH since the break above the neckline. The Euro appears to be attracting a ‘long Euro/short Yen and gold’ momentum (read: hedge funds) crowd playing the opposite game to that from mid 2011 when Yen and Gold rose strongly in reaction to the Euro crisis.
Yen has been played to the hilt by the hedgies. We have had 106 as the downside target since the neckline to the massive H&S broke down. Yen could be a heck of a contrarian play for a counter trend rally, as the short-covering should be massive.
Meanwhile, the currency that resides outside the system bides its time. Gold is unofficial money and with all the hype about currency war people who are not patient may have expected a rocket launch in the precious metals.
Here we bring it back to the Euro and realize that too many unhealthy would-be gold bugs came aboard during the acute phase of the Euro crisis in 2011. That is being worked off now in gold’s ongoing consolidation.
US dollar looks bearish. Euro looks to complete its rally to 142+ where it will by the way, encounter a bigger picture DOWN trend line. Yen is bearish but due for a whale of a short-covering bounce soon.
In the near-term some currencies are bullish and some are bearish. But the US Fed, Europe’s ECB and the BOJ are not going to engineer their way out of their respective ‘inflate-or-die’ predicaments. Gold may have a few more months of correction/consolidation but that is a drop in the bucket when viewing its entire history as a monetary anchor to value.