BATTEN DOWN THE HATCHES / MACLEOD FINANCE

Batten down the hatches

A credit storm is about to hit US markets, to be reflected in portfolio shifts from equities to bonds, and bonds to gold. It will be driven by an impending economic slump.

ALASDAIR MACLEOD

The negative consequences of MAGA are beginning to hit the fan. 

Elon Musk’s aggressive actions through DOGE are undermining or threatening to undermine government contracts upon which a significant element of private sector activity depends. 

The consequences for business confidence, particularly in service sectors, are dire. 

Looking at potential job losses, influential voices in establishment institutions are now expressing fears of a deep recession.

We are beginning to see these fears reflected in markets. 

In the last six trading sessions, the NASDAQ 100 Index has fallen over a thousand points, about five per cent. 

And bitcoin has lost 16% from its December peak. 

The dollar’s trade weighted index has declined. 

The signs are of increasing uncertainties ahead, threatening volatility in financial markets which will prove difficult for ordinary investors to navigate.

Is this marking the end of the largest credit bubble ever seen and the start of a vicious bear market in equities? 

Will the Fed cut interest rates more rapidly than previously thought? 

And what are the likely consequences for gold?

The economy is already contracting

In a recent article, I demonstrated that stripped of inflationary government deficit spending that the private sector is already contracting. 

It is important to differentiate between demand for credit applied to genuine production, and inflationary credit generated by government deficits. 

No distinction between the two is made in GDP forecasts, undoubtedly because of the Keynesian belief that deficit spending stimulates the private sector.

I included the following table of estimated outcomes for the US private sector, based on the Congressional Budget Offices’ own forecasts.

Taking out deficit spending from the CBO’s nominal GDP forecasts leaves the private sector contracting in nominal terms by 2.19% this fiscal year to end-September. 

Adjusted for the CBO’s inflation estimate it becomes a contraction of 5.19% in real terms. 

In other words, before DOGE began wielding its chainsaw to government departmental spending, the US economy was already heading into a deep recession. 

And this is based on numbers produced by government statisticians discouraged from any extrapolation other than those based on generally optimistic assumptions.

Look at it from a foreign investor’s viewpoint. 

Collectively, they have $33 trillion in bank deposits, bond investments, and nearly half of that in equities. 

To a foreigner at least, the US scene under Trump appears to be politically and economically unpredictable, so they are nervous holders of dollar financial assets at best. 

Doubtless, this nervousness has contributed to the dollar’s trade weighted index declining from 110 in mid-January to 106.43 today, and the recent rise in gold.

And where the foreigners go with their investment sentiment, you can be sure that large and savvy US investors will not be far behind.

In previous posts, I have also made the point that with the exception of a gold standard, the position today has worrying similarities with the Wall Street Crash in 1929: the end of a Fed-induced credit bubble (the Roaring twenties) colliding with the Smoot-Hawley Tariff Act, passed by Congress in 1929 but signed into law by President Hoover in 1930. 

The parallels with today are uncanny.

There are two material differences compared with the 1929—32 slump. 

This time, global supply chains are being dismantled, with unknown consequences not just for nations which export goods to the US but significant disruption for US manufactures as well. 

Furthermore, in the absence of a gold standard, successive US governments have ensured the buildup of the largest credit bubble ever recorded. 

Commentators are generally unaware of it, but it is the other side of debt. 

And we all know how that has grown to record levels, much of it unproductive in nature. 

We see the debt, but fail to notice the balancing credit.

The US economy was already contracting, as I demonstrate in the table above. 

It will now do so at a faster rate. 

A debt and credit implosion has two principal consequences: it is their values which implode as opposed to its quantity. 

And the risk associated with exposure to credit rises, requiring higher interest rates to compensate for that risk and loss of value. 

Naturally, the Fed would want to reduce interest rates to stop indebted enterprises, the banks, and government itself from descending into irretrievable insolvency. 

That is the support promised to debtors. 

But debtors’ counterparties which are creditors will be eying credit risk and declining credit values, including exposure to government finances.

The US Government’s budget deficit is set to soar in these circumstances. 

Tariff income will fall far short, as will other revenue sources. 

And welfare costs will increase. 

The consequences for the government debt to GDP measure will be catastrophic. 

Not only will debt issuance rise far higher than currently forecast adding to debt outstanding, but with a contracting GDP the ratio will quickly rise to 150% and beyond.

This brings us to gold — real money without counterparty risk, as opposed to all forms of credit with increasing risk. 

We can be in no doubt that the Fed will have no option other than to supress short-term interest rates below the levels to adequately compensate creditors for credit risk. 

Consequently, the dollar will decline against gold. 

And it will continue to lead the way down for other currencies. 

Below, I repeat the chart showing how the loss of value for the four major fiat currencies is accelerating:

For the record, over the last 25 years, similar to the euro the dollar has lost 90% of its value, sterling 92.4%, and the yen 93.2%. 

A credit implosion will only accelerate this process further because credits’ values, which will be even further undermined, are completely detached from real money which in everyone’s common law is gold.

Short-term, as the credit bubble implodes there will be considerable volatility between equities, bonds, and gold. 

But above all else, these evolving conditions are bound to favour hoarding gold. 

It will be the phoenix which rises out of the ashes of the final fiat credit collapse.