domingo, 11 de junio de 2017

domingo, junio 11, 2017

Gold: Whoever Has the Gold, Makes the Rules

by: John Ing

Remember The Golden Rule


Leaked memos, recorded conversations, impeachment talk and a plunging stock market.

Trump and his White House problems? No. Brazil. The Brazilian stock market took a nose dive wiping out this year's gains on newspaper reports that Brazilian President Michel Temer, installed only last August after the impeachment of his predecessor Rouseff, is involved in a cover-up and bribery scheme. It seems that Washington is not the only swamp to drain.

Amid the controversy over yet another firing, the Washington circus is again caught up in another dysfunctional gridlock. As he careens from one controversy to another, Mr. Trump is determined on fixing America- his way. Lost in the hysteria is his economy-boosting agenda is divided along party lines. Washington is intensely polarised and the American system is undergoing yet another stress test, with echoes of Watergate. Donald Trump's impulsiveness and distaste for orthodoxy, Congress, the media and even his own party, is at the root of this political turmoil. As a result, the Trump bump has turned into the Trump slump and while the dollar slips to six month lows, business is concerned that his plan to overhaul healthcare, the federal budget and tax code will be sidelined by his antics.

However, impeaching Donald Trump requires two things. The first, the Republican controlled House of Representatives would need to vote for impeachment by two-thirds and then the Republican controlled Senate would have to ratify impeachment by a two-third majority. Thus, impeaching Trump becomes a political, not a legal question, difficult when polls show that likely US voters approve of his job performance (Rasmussen Reports) by a 48 percent margin.

Everyone should take a deep breath – four more years.

The Trump Card

But true to his word, the Trump administration focuses on the biggest wholesale changes to the tax code since the Reagan era. While laudable and ambitious, the plan is to reduce seven tax brackets to three and slash the corporate tax rate to 15 percent from 35 percent. While the tax cuts are at the centre of his economic agenda, they require congressional cooperation, not an easy task today. Yet all this will cost trillions with the ratio of public debt to GDP already at 100 percent, set to soar again.

To be sure his cabinet has loads of business experience but their cultural DNA consists largely of financial experience and transactional relationships, particularly in distress debt rather than the operation of a big company. Some are a coterie of tycoons whose wealth came from risky bets and reward, taking advantage of the cheap prices following the global crisis of 2008. That explains the potential mess up over trade with their instinct to use brinksmanship or a zero-sum view as part of the negotiations, led by the master negotiator, Donald Trump. Give a little and instead of diplomacy, stick to generalities, obfuscate and if the deal, goes badly, just walk away. No nuance here. In Mr. Trump's first hundred days, pulling out of TPP, challenging NATO, the threat to tear up NAFTA are good examples of the cut and thrust of his "take no prisoners" negotiations. America's enemies should be so lucky.

Honey, I Shrunk the......

Last year, the Fed financed roughly 40 percent of America's budget deficit. The risk is that if the Fed advances plans to unwind its massive $4.5 trillion balance sheet, amassed during the crisis, the supply could destabilize the market just at the same time as Mr. Trump attempts to finance his huge deficits. Most likely the Fed will allow the securities to mature, minimizing the impact but problematic, since the Fed is the biggest buyer of its securities. There is even concern that the balance sheet which has grown fivefold since the crisis could actually be used as a piggy bank to finance Trump's programs, simply because Americans have few savings. The crowding out effect last occurred in the 2007 – 2009 recession when the deficit last hit $1 trillion. Ironically Mr. Trump's portfolio of spending plans is to cost over $1.1 trillion so his deficits are set to soar, and not only roar. So without the obvious tax increases, how to fund the deficits?

Worrisome is that in the face of those numbers, the "exit strategy" coincides with a deterioration in relations with America's so-called trading allies he is bashing today, at a time when their capital is most needed to fund Trump's programmes.

History illustrates that unfunded deficits are unsustainable and there is a cost. Timing this time is a factor since Congress must pass Trump's reforms before next year's mid-term congressional elections in 2018, when his party could lose seats and control of the House. Also Congress and Trump must lift or suspend the debt ceiling since the spending limit extension expires this September. As Trump's predecessors from Reagan to Bush learned, tax cuts that are to be revenue neutral, instead blew large holes in the federal budget and always, were paid with more borrowings. The hard truth is that politicians and Mr. Trump find it easier to spend and for that reason, deficits are set to soar. The other, of course is that despite plans to lower the rates of tax, America's tax code continues to encourage businesses and consumers to borrow, because interest remains tax-deductible.


Let's Do the Time Warp, Again

Central banks have become the world's largest buyer of government bonds, in an incestuous arrangement to lower rates to revive the global economy. The world's central banks have manufactured some $20 trillion of liquidity as part of a global quantitative easing binge that caused an explosion in bank reserves which has not yet filtered into the economy in the form of increased money supply. Central banks believe they should keep their feet on the monetary pedal because core inflation, which excludes volatile energy and food remains stuck at only one percent.

Nonetheless, we would argue that there has been an inflation in asset prices, not in services. The lack of headline inflation is because trillions of printed money, remains on the balance sheets of the central bankers' surrogates, in the form of higher reserves as a knee jerk reaction to the 2008 financial crisis. That cheap money has driven up a series of risky credit bubbles in stock markets, real estate, and even art ($110 million for a black skull) last seen before the financial crisis of 2008. Simply borrowers are artificially subsidised and every bubble-like asset class has become dependant upon this addiction to cheap money, driving down risk premiums.

Today, the average age of the baby boomers is about 62 and rather than a surge in consumer spending, boomers instead are saving for their retirement. Consequently, lagging retail sales, car purchases and mall vacancies are not surprising. For the past couple decades, consumer spending made up about two-thirds of the economy as those boomers bought cars and houses.

Worrisome is that retail accounts for about a tenth of US jobs and since the beginning of this year, the US retail sector has lost some 89,000 jobs – more than America's total employment in either coal or steel. In addition, the much bally-hooed manufacturing sector which actually employs less than 9 percent of America's workers, represents some 12 percent of GDP, but receives about 100 percent of Mr. Trump's "America First" obsession.

Unfortunately, he, our politicians and central bankers are still stuck in a Rocky Horror show time warp and their ready-made solutions are for another dose of money and credit creation which is not surprisingly, ineffective. And now, President Trump is looking for expensive tax cuts to make America great again. What ageing boomers really need is better healthcare, more retirement savings and not more debt. With subprime auto loans and credit card debt at record levels, boomers are encouraged to pile on yet more debt, initially for schools, houses and today for more of the same consumption with borrowing costs so cheap. Let's do the time warp, again.

The Consequence of Fiscal Irresponsibility

We believe the dollar standard is the Achilles heel to America's greatness. The US government has incurred a record amount of debt for more than half a century and is a beneficiary of the dollar dominance. The Federal Reserve has become the world's central bank. Also American imports caused a tide of dollars to go overseas. And then, quantitative easing resulted in another flood of dollars. We believe Trump's threats to fix the soaring current account deficit will only exacerbate the problem. Already, German chancellor Merkel has warned about relying on US economic hegemony. She is right.

The White House may be in turmoil today but that also undermines America's profligacy and power.

America is the world's biggest borrower. Since yearend the dollar has fallen 5 percent dropping to pre-election levels as the Trump administration suffers legislative and legal setbacks. The dollar has recently met competition as America's trading partners seek to end their monetary hegemony and vulnerability to the whims of a president.

Gold Is Alternative Money For The World's Central Bankers

Lately, the US dollar has swooned, bitcoin has soared and gold has reversed as a consequence of global quantitative easing. If central bankers can seemingly print money with impunity, the value of money eventually erodes. After all, the only thing underpinning this fiat currency is the faith and credit of the US government and that faith is testing its limits. Under the classic gold standard, countries accumulated gold in order to conduct their business and backed their respective currencies with gold. Exchange rates were fixed against gold just as they are fixed against the dollar today. Then countries could not print their way nor pay their bills with paper obligations to conduct business. The strongest currencies reflected the strongest economies.

Today, the main argument against reverting to a gold standard is because there's not enough gold in their world, which overlooks the fact that most central banks already hold gold in their reserves. The European Central Bank (ECB) for example was set up with contributions of gold from its member countries. Ironically. America today is the largest holder at 8,100 tonnes but is also the world's largest debtor. Canada unfortunately sold its gold and their cupboard is bare.

Nonetheless, in the past few years, some nineteen central banks continue to be net buyers of gold. Russia has made monthly purchases. China regularly accumulates gold, and officially holds over 2,000 tonnes making it the fifth largest holder in the world, up from only 600 tonnes a few years ago. We believe China's purchases are a hedge against their huge $3 trillion dollar of reserves and is a step towards the realignment of the global monetary order which will see a gold backed renminbi.


One Belt, One Road, One Ambition

China is rebuilding the Silk Road that underpinned its golden age over a thousand years ago.

The scheme is to bring about a new "golden age" of globalisation as President Xi Jinping recreates the Silk Road in a trillion-dollar massive infrastructure initiative to strengthen trade links between China, Russia, and Europe. China's new Silk Road involves huge investments in infrastructure, energy and includes building deep water ports in Pakistan, new rail links, new maritime routes, and highways along the trade corridors to Europe. China's One Belt, One Road will be financed by various state run banking entities cementing China's trade, development and influence. Meantime, its private sector companies such as HNA are making ambitious bets acquiring an almost 10% stake in Deutsche Bank.

We believe China has taken these important steps to reduce the dollar's hegemony. In contrast, China has strengthened its domestic currency role as a trading currency with swaps for oil with Russia and bilateral trade deals in Africa and Latin America. Deliveries from the Shanghai Gold Exchange (SGE) were a whopping 2,000 tonnes in contrast to Comex's paltry 50 tonnes last year. Volumes surged 43 percent reflecting strong demand. China remains the world's largest consumer of gold and its largest producer but that production remains within China's borders because demand exceeds supply. While hedge funds in the west have been dumping gold, China has been purchasing massive amounts, as gold moves from the west to the east. It is believed that soon, China will have more gold than the Americans. Remember the golden rule, whoever has the gold, makes the rules.

The Eye of the Storm

Overlooked is that historically low rates have lowered the discount that investors put on future cash flows which in turn, debases returns and risk. The VIX index often called the "fear index" measures the implied volatility of the market, recently reached the lowest level in more than 25 years. Is this the eye of the hurricane or the continuation of an ageing bull market which has bred a complacency that has ignored Trump's tweets, Middle East uncertainties or even a Brexit? We believe the bastardization of our capital markets by algo and high frequency trading is behind the dampened activity. Our belief is that credit markets are simply addicted to low rates becoming overly complacent to both geopolitical and financial risks. Many are surprised that faith in the status quo remains which is as big a risk as the low rates themselves.

This is not healthy, normal and unsustainable.

Another reason for the lack of volatility is the development of derivatives that were supposed to hedge risk which caused an explosion in algorithmic trading following the collapse of 2008. In fact, the value of the VIX relates to the cost of insuring against price changes via the derivative market. The price is set by supply and demand.

Today, the number of market indices now exceeds the number of US stocks. As opposed to popular indices, like the Dow Jones or Standard & Poors (S&P 500), the new indices are based on baskets of investment tactics or strategies which are tracked by derivatives or structured products. Rather than pay the hefty fees of an actively managed fund, a fund manager today can easily buy an ETF and, to make matters worse, Wall Street created a derivative on the indices (bull or bear) which tracks the ETF, itself a derivative. To no surprise then, Harvard University Endowment's largest holding is a high-yield bond ETF. Many have forgotten Warren Buffett warnings over derivatives who called them "financial weapons of mass destruction" in 2003. In not following his own advice, it cost him almost $200 million to close his derivative position last year.

Trump is Good for Gold

We believe that Trump's deficits, the decline in civility and the lack of funding will fuel rates and that in turn will increase risk, causing a global demand for safe assets. Financial crises ten year ago still casts long shadows. The biggest question remains how to pay for America's debts?

Debasement led to the worst financial crisis since the 1930s. The problem is that there are too many different instruments that are the equivalent of money. While, monetary policy rather than fiscal policy has helped the recovery, the exponential build-up of debt is unsustainable.

Consequently, we believe that gold is the ultimate hedge against the risk that the government's fiscal plans will run against the funding problems mentioned earlier. Unlike the "weapons of mass financial destruction", there is no counterparty risk with gold.

In sum, gold will continue to rise as long as the US budget remains in deficit, the US trade account is in deficit and Donald Trump is in the White House. Trust in Trump has disappeared both at home and now abroad. Ironically,Mr. Trump will be very reliable as an agent of dollar devaluation, which is good for gold.

Gold's new bull market has just begun.

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