'Stalling Markets': The Last Time This Happened Was October 1929
Fri, 07/19/2019
Great article from GoldMoney, focusing on the US and the mercantilist policies of the Trump administration.
It is unfortunate that China is not included in the broad picture as the Chinese economy is also slowing down fast with a highly leveraged financial system.
"History does not repeat, it rhymes!"
October 1929 it may not be but there can be little doubts that we are approaching a new paradigm.
The combination of American trade protectionism and the
end of a failing credit expansion is leading into a global economic downturn,
and potentially a systemic crisis. Meanwhile, investors still believe more extreme monetary
policies will stabilise economies and that the ultra-low interest rate
environment will persist without renewed price inflation. As Samuel Johnson
reputedly said of a second marriage, it represents the triumph of hope over
experience.
Introduction
There is a moment just after the top of every credit
cycle where positive momentum stalls before a new reality emerges. When the stall begins, as appears to be the
case today, everything is still read positively. Perennial bulls say “Don’t
worry, the central bank will reduce interest rates and inject enough money into
the banking system to ensure any recession will be minor and growth will
resume”. With interest rates falling, confidence in the final outcome means
stocks continue to rise. With this mindset, bad news for the economy is always
good news for stocks.
This investors’ paradise is populated by devotees of the
new economics, supporting progressively increased state intervention. They don’t actually believe that free markets
should set stock prices anymore and have become hooked on central banks
pursuing inflationary policies. In their minds, the relationship between
monetary inflation and rising stock prices amounts to a financial equivalent of
perpetual motion. However, their enduring belief in the might of central banks
and the importance they place on maintaining asset prices makes inflationists
blind to the message from stalling markets.
We all get caught up in it. And when evidence of the
stall in economic growth mounts, we clamour for lower interest rates, credit
expansion, and finally competitive exchange rates. Even President Trump is now
telling us the Fed must weaken the dollar to boost exports and the American
economy. As it is already doing his bidding with interest rates, surely the Fed
will oblige.
The naivety of this reasoning is endemic, and as a naïve
supporter of free markets, President Trump is beginning to trot it out again.
In Britain, the same old inflationist story, wrapped up in proposed tax cuts to
be paid for later by economic growth, is now being pushed by Boris Johnson,
almost certain to be the next Prime Minister. Let us hope this is just
electioneering rhetoric. But so widely are the myths of monetary stimulus
believed that they are now certain to be renewed in a push to sustain economic
growth.
That gold prices measured in dollars will be guaranteed
to rise is indirectly becoming officially sanctioned. Those of us in the gold business would be
grateful for President Trump’s endorsement of gold if it was not for the economic
consequences of his weak dollar policies on ordinary people whose money is
about to be trashed. Nevertheless, the gold price has now jumped to a new level
and markets are trying to discount the consequences of what is now unfolding.
As the gold price continues to rise, those who wonder whether it is worth
buying miss the point. It is not gold that rises, but their money that’s
falling. Money is falling because governments through more aggressive monetary
policies are about to deliberately undermine their own currencies.
The naivety over the consequences of weak money is not
restricted to the leaderships of the US and UK. The maintenance of negative
interest rates and bond yields in the EU and Japan are already testament to
that. But we now see two world
leaders (assuming Boris succeeds May) who indicate they are aware of the
failings of the economic establishment, but publicly endorsing the inflationism
that has been central to the establishment’s failure. By promising the tax jam
of today for a better outlook tomorrow, Boris Johnson is roughly where Trump
was before he was elected president. Let’s hope an enterprising journalist asks
him to clarify whether he thinks a lower sterling (which we already have) is
good for the economy. Very likely, he will agree, perhaps with the proviso that
price inflation remains under control.
Therefore, central banks are committed to address
stalling economic growth by snorting more of the drug that is giving us the
downer. But our leaders and
central bankers are ignorant of sound theories of money and credit and are
driven almost entirely by statistical information. And here we hit a further
problem. Government statistics are not fit for purpose.
Statistics are misleading
Statistically, inflation is under control, because the
statisticians with their methods have ensured it is so. In giving the central banks a passport to
accelerate the rate of monetary inflation by suppressing the consequences, they
are storing up trouble for us all. There will come a time when not even the
manipulation of consumer price statistics will hide the fact that the
purchasing powers of the dollar, sterling, euro and even the yen are all
falling at an alarming rate. It is when we begin to sense that this is a
problem that the stalling feeling turns our greed, or complacency, into concern
and then outright fear.
Exactly two hundred years ago, Lord Canning, who was
briefly prime minster of Great Britain, warned that you can prove anything with
statistics, except the truth. This was over a century before modern econometrics evolved to make
statistics more meaningful. But statisticians have missed what was behind
Canning’s point: statistics prove nothing because they cannot replace sound
reasoning. Instead, they only assume the relationships between cause and
effect. Rather than attempting to understand the manner of the link, their
approach is to monitor the relationship between monetary inflation and changes
in prices, to ensure that increases in the CPI remain within a target range. As
long as this is the case, monetary policy makers can carry on issuing money out
of thin air.
You cannot measure the general level of prices, because
it is a concept and not a fact. Strictly speaking, it is hardly a concept either, because it is not the
unmeasurable general level of prices that inflates, but the purchasing power of
the currency that diminishes. It may take time to work through, but if you
increase the quantity of unbacked state money and the bank credit in
circulation, a unit of currency will simply buy less.
Not enough recognition is given to the draining effect on
the productive members of society and their businesses. Monetary inflation
undermines the value of their earnings and profits, transferring wealth from
savers, and it impoverishes the poorest labourers for the benefit of government
finances.
Far from obtaining something for nothing, the government
gets its seigniorage by impoverishing the same people that pay its taxes. If one could measure the general level of
prices, it is more likely that they have been rising by between seven and ten
per cent annually for a considerable time, as illustrated by John Williams’s
ShadowStats, and confirmed by the Chapwood Index. The official two per cent
target is poppycock. If we assume the two independent calculations are more
realistic, US citizens have been getting collectively poorer every year since
the financial crisis of 2008/09. Not only is this evidence that Canning’s
aphorism about statistics telling us everything but the truth still holds, but
governments now fully depend on the concealment of the true state of affairs by
statistical suppression.
Governments have arrived at this point because funding
through inflation faces the law of diminishing returns. The more a government inflates, the more it
impoverishes its people. And the more the people are impoverished, the less
both taxes and inflationary financing yield. And as we look down from the
heights of inflated asset prices, the more evidence emerges that our economies
are stalling, the more important this will become.
With the establishment, investing institutions and
regular investors all being misled by official statistics, it is no wonder that
an understanding of the true position hardly exists. It is an
Alice-in-Wonderland world where the more you inflate, the more GDP statistics
say the economy is growing. Under-recording the price deflator has become
central to maintaining the delusion. Almost no one realises that an increase in
nominal GDP is no more than a reflection of more money and credit being
injected into the economy. It confuses this increase in the quantity of money
and credit with progress. But progress suffers the disadvantage, like the
general price level, of being impossible to measure with statistics.
Reliance on statistical method has encouraged wrongheaded
government intervention.
Long ago, we dismissed the certain knowledge that society thrives by
cooperation and governments only by intervention. The former progresses, the
latter interferes. It prevented governments from trying to improve on free
markets, but that ended following the First World War. Consequently, decades of
intervention from the 1920s onwards have increasingly distorted our world away
from free-markets to embrace the Gospel of Government. The gospel has been a
drip-feed upon which modern economies have become increasingly dependent.
Stalling into a nose-dive
That drip-feed is now augmented by American trade
protectionism, reversing the expansion of trade from which we have all
benefited. The harmful effect on the American economy will become apparent.
The combination of a long period of credit expansion and trade tariffs will
very likely drive it into a deepening recession, possibly a slump, as these
conditions today repeat those of 1929-1932.
If the inflationary effect on prices is to be limited, it
will require foreign investors to buy dollars and increasing quantities of US
Treasury debt to cover an escalating budget deficit. Global funds will have to
be diverted to the dollar from other investment opportunities, notably the
widescale development of Asia. From its policy towards China’s economic
development, elements of the American deep state appear to understand this. President
Trump appears not to. And now, he proposes to weaken the dollar the foreigners
are expected to buy to finance his escalating budget deficits.
It is a difficult trap he has unwittingly set for his
administration. And as the US
economy stalls further, and the dollar weakens in a vain attempt by
policy-makers under The Donald’s cosh to make America great again, the dollar’s
slide will require rising interest rates for its purchasing power to be
stabilised, forcing US Treasury prices into a bear market. The US Treasury’s
finances will be plainly ensnared in a debt trap.
Other currencies, driven for decades by the same
Keynesian logic, are to greater and lesser extents in the same boat. But every
currency has two driving forces that determine their valuations. There is the
collective assessment of the foreign exchanges, and changes in preferences
between holding money and buying goods in the domestic economy. Sometimes, the
foreigners might feel a fall is overdone, and buy a currency when its domestic
purchasing power is still falling. At other times, the slide towards oblivion
is deferred by the general public who cannot get their heads round what is
happening to their government’s money. But despite these interacting forces,
once the world’s reserve currency begins to decline, interest rates everywhere
have to rise.
If this increasingly likely event happens, the effect on
forward-looking markets is certain to be brutal. Today’s stall becomes a
free-fall tomorrow. That is why it is likely that by the end of this year it
will be increasingly apparent that national economies, emasculated by continual
wealth-transfer through monetary debasement and over-burdened by non-productive
debt, will begin to rhyme with the crash of 1929-32 and the subsequent
depression. The most notable difference is that with today’s currencies being
unbacked fiat instead of tied to gold, prices will rise instead of falling as
they did in the 1930s.
Implications for gold
The last time the destructive forces of an
end-of-credit-cycle coincided with trade protectionism was in October 1929.
They were the driving factors behind the Wall Street crash and the subsequent
depression. This
time, the tariffs are not nearly as high as those of the Smoot-Hawley Tariff
Act, but the magnitude of the credit cycle is far greater. While we can hope
that this time the combination is not as disruptive as the 1929-32 episode,
there is no doubt that today there is enough of a build-up of market
distortions ready to wash out of the global economy to justify considerable
unease.
This unease is yet to be manifest in widespread
investment opinion, which still hopes for a miracle from monetary policies. But
both our analysis and the empirical observations of events ninety years ago
demonstrate why a miracle is impossible. A slump in global business activity is
already developing, and the only policy response will be inflationary. Monetary
expansion is effectively guaranteed in a vain attempt to stop a downturn and to
ensure the banking system is preserved. This compares with a 25% contraction in
broad money between 1929 and 1933 as thousands of American banks went under.
Through the medium of the dollar, in 1929-33 prices were
measured in gold, which was fixed at $20.67 to the ounce. This time, there is
no sheet anchor, and the dollar will simply lose purchasing power. This means there will be more dollars to the
ounce of gold. There is no point in speculating how many dollars there will be
to the ounce; you might as well debate how many angels can dance on the head of
a pin. More importantly, it is difficult to see how the slide in the dollar’s
purchasing power can be stopped once it starts.
Just as the ability of the productive sector to pay taxes
is being increasingly undermined at the same time as the government’s
expenditure rises, we can also see time preferences adding a further layer of
destruction to government finances. Foreigners in particular will need far
higher interest rates to stop them selling dollars and to persuade them to buy
again. This was the policy of Paul Volcker, as Chairman of the Fed addressed in
the early eighties, when he increased interest rates to 20%. Federal government
debt then stood at only 30% of GDP, while today it stands at 105%. Putting
aside the bad debts escalating at the banks from a grossly overindebted private
sector, a rise in interest rates sufficient to stabilise the fiat dollar would
almost certainly wipe out government finances and therefor faith in the dollar
itself.
That is the extent the debt trap has now reached, and the
problem is not confined to America. All major economies are in the same boat with very few
notable exceptions. The Eurozone includes governments with severe debt
problems, and the Japanese government has the highest debt to GDP ratio of them
all. Lesser currencies have always had difficulties, which will simply escalate
if dollar interest rates rise.
For the moment, very few see the true extent of the fiat
currency problem. It
is hard for them to visualise an economic slump when overall demand for goods
drops, and for their prices to rise at the same time. They are fixated on the
objective value of money in transactions, and do not realise that if people
lose faith in it, a currency’s purchasing power will slide.
When it starts, the process could be rapid. The education
of the masses in this matter, thanks to cryptocurrencies, is more advanced now
than it has ever been. If bitcoin soars to $20,000, $50,000 and more,
millennials round the world will understand that the dollar, or their local
currency, is going down. The rush out of fiat bank deposits into crypto on its
own could easily precipitate a widespread currency and systemic crisis.
This is not to advocate buying bitcoin, or gold for that
matter. It is just to warn of the approaching end of the road for unbacked fiat
currencies at a time when governments themselves face bankruptcy.
There is a well-known saying, that governments can’t go
bust. Don’t you believe it: it depends on fools continuing to place value in
their fiat currencies. We can begin to see that end in sight.
