The King of Sovereign Subprime

Doug Nolan


The past week witnessed 6.6 million new U.S. unemployment claims, pushing the two-week surge to a sickening almost 10 million. The U.S. economy is sliding into the steepest of downturns, with awful consequences for society, economic structure and financial stability. But this week’s CBB will focus more on the global economy.

April 2 – Bloomberg (Emily Barrett): “Foreign official holdings of Treasuries stashed at the Federal Reserve fell $109 billion in March, the largest monthly drop on record, as international governments and central banks struggled with the economic fallout from the new coronavirus. The decline showed up in the Fed’s weekly custody data, with the latest figure released Thursday showing a $24 billion drop in the week to April 1. The sales amid the past month’s pandemic-fueled turmoil are a further signal of the global rush to raise U.S. dollars…”

The Greenspan Fed in the early nineties collapsed short-term rates to, at the time, an unprecedented 3.0%. With the banking system severely impaired following late-eighties excess – and exploding fiscal deficits exacerbated by Saving & Loans and bank bailouts – Greenspan orchestrated a covert banking system bailout. The capacity of banks to borrow cheap (3.0%) and lend dear (7-8%) provided a powerful mechanism for replenishing depleted capital.

Aggressive reflationary policy measures come with consequences. Federal Reserve policies were a godsend to the fledging leveraged speculating community. The “government carry trade” (borrow at 3% to lever in higher-yielding Treasury and Agency securities) was tantamount to free money.

With speculative leverage boosting liquidity and securities prices – along with hedge fund assets – speculative excesses soon gravitated to corporate Credit, derivatives and, importantly, the emerging markets.

The Fed’s 25 bps rate increase in February 1994 pierced the speculative Bubble. Mexico, having been on the receiving end of large speculative flows, was in deep crisis by the end of the year. The peso, which had essentially been pegged to the U.S. dollar, collapsed in December.

The “Tequila Crisis” saw contagion effects ripple throughout Latin America and other developing markets.

I thought at the time the destabilizing flow of speculative Bubble “Wall Street Finance” to EM had run its course. But the Clinton administration partnered with the IMF for a $50 billion Mexican bailout. Emboldened, the hedge fund industry bounced back strongly from the 1994 bond and derivatives market dislocation.

The inflationary boom in securitizations, GSE Credit, and market-based finance more generally didn’t miss a beat. Rather quickly, powerful speculative flows (and underlying leverage) to the emerging markets resumed – with the booming Southeast Asian “Tiger Economies” a prime target.

Pegged currencies (“fixed currency regimes”) were an integral facet of 1990s boom and bust dynamics. Why not borrow cheap in these exciting new Wall Street funding markets to lever in higher-yielding EM debt instruments with currencies pegged to the U.S. dollar.

At the same time, the booming U.S. derivatives industry was cranking out term sheets, making EM speculation easier than ever before. If you weren’t playing the melt-up in late-1996, you were a nobody.

By early-1997, booms were overheating. The Thai baht suffered huge speculative outflows in the spring and was forced to devalue by the summer. A devastating regional collapse had begun – Indonesia, Malaysia, Philippines, South Korea and beyond. The pegged currencies regime suffered a spectacular domino collapse.

It was a catastrophic crisis - utter financial, economic and social meltdown. I most recall the deplorable ethnic strife that erupted in Indonesia (specifically, attacks on ethnic Chinese businesses). Currency collapse in South Korea provoked its citizens to donate $2 billion of its gold to be melted down and used to service the nation’s international debt obligations.

EM contagion made it to the Russian ruble and bond market in 1998, with the spectacular Russia/LTCM collapse pushing a severely impaired global financial to the edge. The dangers of New Age speculative finance were conspicuous. So was the extent global policymakers were willing to go to backstop this financial apparatus.

The Fed orchestrated another bailout in 1998 – providing powerful stimulus to U.S. Bubble Dynamics that had attained critical momentum. It was off to the races (Nasdaq almost doubling in 1999).

Speculative finance is just too enticing to resist. After the dreadful 1990s experience, I expected EM economies to adopt measures to insulate their systems from “hot money” flows. What unfolded was something altogether different – and fundamental to the current unfolding collapse of the global Bubble.

Following the nineties' episode, EM economies came to believe (or were convinced) that holding large stockpiles of dollar reserves was key to currency and system stability. And stockpile they did. After beginning 2003 at $2.3 TN, total International Reserve Assets held globally surpassed $12 TN by 2014.

Over this period, Chinese reserves jumped from $300 million to $4.0 TN. South Korean reserves jumped four-fold to $400 billion. Brazil $36 billion to $390 billion; Mexico $40 billion to $200 billion; Russia $42 billion to about $500 billion; Indonesia $30 billion to $130 billion; Taiwan $15 billion to $480 billion; Thailand $12 billion to $45 billion; and Turkey $20 billion to $110 billion.

I’ve long had issues with this global structure. For one, unrelenting demand for dollar reserves accommodated persistent U.S. trade and Current Account Deficits – with attendant domestic and international imbalances. There was no market mechanism to discipline U.S. over-borrowing and spending.

Dollar liquidity flowed to EM, where EM companies would exchange dollars for local currency from the local central bank – with these dollars immediately recycled into U.S. Treasury, agency and other debt securities.

The lack of market discipline was also fundamental to U.S. deindustrialization, with our fateful shift into consumption and “services” (why produce, among other things, ventilators, face masks and other “PPE” when they can be cheaply acquired from China).

The flooding of dollars globally ensured mounting excess and deepening complacency. Leverage finance flowed freely into EM, spurring protracted booms and New Paradigm thinking by EM policymakers. For China and EM more generally, 2008 was but a hiccup.

Reflationary finance flooded the world, pushing fledgling Bubbles to unprecedented extremes.

In the U.S., the recycling of “Bubble dollars” back into Treasurys was instrumental in bolstering the view that any amount of debt issuance could be financed at low yields (“deficits don’t matter”).

This dysfunctional global Financial Structure ensured a protracted period of self-reinforcing Credit and speculative excess coupled with deep structural impairment. The massive accumulation of non-productive debt and speculative leverage was always an accident in the making. A momentous consequence of the unfolding crisis is a likely breakdown of this global financial arrangement.

Federal Reserve Assets expanded another $557 billion this week, with a five-week gain of $1.653 TN. The Fed has been aggressively buying Treasury and Agency securities, along with announcing a program to purchase U.S. corporate bonds (and bond ETFs). The Fed is employing a long list of lending facilities - backstopping the banking system, primary dealers, commercial paper, municipal debt, corporate Credit and, soon, even “main street.”

The Federal Reserve has also expanded international swap arrangements, where it exchanges dollars for foreign currencies with its global central bank partners. This week the Fed announced a new program that allows central banks to borrow against Treasury holdings held in custody at the New York Fed.

There is no doubt that unprecedented policy measures come with unintended consequences.

There have already been complaints that Fed purchases have worsened instability and market distortions throughout the MBS marketplace.

I fear more momentous market dynamics globally.

In all the late-nineties global market chaos, U.S. securities provided a bastion of stability. The Fed and Treasury Department’s capacity to employ system-stabilizing measures was unmatched. The Fed’s ability to stabilize U.S. securities markets provided a momentous competitive advantage over other regions and nations. The resulting U.S. market and economic resiliency were fundamental to late-nineties “king dollar” strength – that came at the expense of deflating EM Bubbles.

The dollar index gained 2.2% this week to 100.576, just below recent multi-year highs. I fear “king dollar” dynamics are exacerbating an unfolding EM crisis poised to dwarf the nineties. Of the more than $16 TN foreign currency-denominated debt globally, $11.9 TN is denominated in U.S. dollars (BIS, June 2019). Estimates vary, with EM dollar-denominated debt as high as $5.8 TN (Barron’s).

One unintended consequence of massive U.S. fiscal and monetary stimulus has been an escalation of flight out of EM currencies. Especially over recent years, the combination of rampant dollar liquidity and sizable troves of EM international reserves underpinned massive “hot money” flows into EM financial systems and economies.

And with the dollar The International Currency of Leveraged Speculation, EM economies responded to the intense demand for their higher-yielding securities with unprecedented debt issuance – way too much dollar-denominated.

This week from the Wall Street Journal (Avantika Chilkoti and Caitlin Ostroff): “Emerging markets borrowed $122.6 billion through sovereign dollar-denominated bonds last year, according to the latest Dealogic estimates, up from $63.3 billion in 2009. Nearly $24 billion of sovereign emerging market dollar-denominated bonds are set to mature this year.”

From the Financial Times: “The overall debt burden of so-called ‘frontier’ markets — the smaller, lesser-developed countries — reached a record $3.2tn last year, equal to 114% of their annual economic output.” And from Bloomberg: “Households around the world now have $12 trillion more debt than they did during the run-up to the 2008 financial crisis.”

It is difficult to envisage this terrible pandemic attacking a global financial system and economy at more fragile states. A heavily indebted world is heading into the worst crisis since World War II. I fear the emerging markets are at the epicenter, with dollar-denominated debt the Achilles heel.

The South African rand sank 7.4% this week. Currencies were down 6.7% in Mexico, 5.8% in Hungary, 4.7% in Brazil, 4.5% in the Czech Republic, 4.1% in Turkey, 4.0% in Poland, and 3.5% in Chile. In the changed environment, scores of companies, financial institutions and countries will struggle mightily to service large debt loads. For many, dollar-denominated liabilities will prove unmanageable.

No nation has accumulated more dollar-denominated debt than China. With its trove of international reserves, large trade surpluses with the U.S., and a quasi-pegged currency, Chinese companies and financial institutions have enjoyed unlimited access to cheap dollar funding markets.

Notably, China’s now fragile banks and homebuilders have accumulated enormous dollar-denominated liabilities. This debt mismatch heightens systemic vulnerability to disorderly renminbi devaluation. How large is the levered China “carry trade”?

From the “Periphery to Core” analytical framework, China remains the “Core” of this problematic global currency mismatch. Crisis Dynamics have engulfed the “Periphery,” with key EM economies now succumbing to a “contagion” of illiquidity and market dislocation. Expanded Federal Reserve swap facilities worked to arrest global collapse. I expect effects to prove fleeting.

That China appeared to gain the upper hand on the virus has provided hope. Beijing’s aggressive efforts both to bolster its markets and restart its economy support the constructive view of China pulling EM economies and markets back from the brink. But with pandemic conditions rapidly deteriorating around the world, it may prove more a case of EM pushing a wavering China toward the precipice.

Over this incredible boom cycle, China became banker to the world. As financier to “frontier” economies, the Chinese banking system evolved into the King of Sovereign Subprime. Funding “belt and road” and other initiatives, China formulated a massive “captive finance” operation for nations previously starved of finance and investment. It now faces the prospect of a dramatic drop in capital goods export orders and thousands of customers lacking wherewithal to pay their bills.

As an analogy, automobile manufactures repeatedly succumb to the urge to “go subprime.” Lending to buyers previously unable to obtain financing is a sure way of boosting revenues. And so long as the general economy holds up, manufactures report booming profits both on auto sales and from “captive finance” businesses lending at above-market rates.

Unfortunately, things invariably turn really sour when the bust arrives. Not only do auto sales tank and used car prices sink (vast buildup in used-car inventories). The finance business turns into an unmitigated disaster.

The perils of subprime surface as soon as growth slows. Before long, massive losses wipe out all previously reported “profits,” as bad loan charge-offs and servicing costs spiral.

Years of Federal Reserve market interventions and the perception global central bankers have everything under control are coming home to roost. The same can said for the belief that the great Beijing meritocracy can handle any crisis.

The deeply-embedded view that Chinese officials could adeptly and, when necessary, forcefully manage their economy, financial system and currency created precarious fragilities that are in the process of being exposed.

China’s economy is today acutely vulnerable to collapsing demand, both domestically and internationally. Its $40 TN plus banking system goliath (add “shadow” lending) is a spectacular accident in the making. In the past, I’ve made the point that China’s huge international reserve position appears relatively less impressive with each passing year (of booming Credit and financial system expansion).

With China’s reserves at $4.0 TN and Total Banking System Assets at $26.9 TN, reserves were about 15% of bank assets in mid-2014. Today, with reserves down to $3.1 TN and Bank Assets up to $41.7 TN, this ratio has been cut in half to 7.4%. There is also the issue of the liquidity, availability and transparency of these reserve holdings.

“The West will never allow Russia to collapse.” “Washington will never tolerate a housing bust.” “Central banks have everything under control.” I greatly fret ramifications for the day markets question Beijing’s capacity to stabilize China’s currency and Credit system. Perhaps they have the coronavirus situation contained.

Yet it’s foolhardy to disregard the reality that Chinese officials have lost control of their economic and financial systems. Sure, massive liquidity injections and “national team” support have bolstered securities market prices (Shanghai Composite down only 9.4% y-t-d). Yet I believe this only ensures more destabilizing adjustments in the near future. Beijing is losing its bet that the coronavirus is a short-term financial and economic phenomenon.

I’m comfortable with the analysis that the Chinese economy suffers from epic maladjustment.

Running trade deficits with many EM economies, there is no doubt that weakness in Chinese demand will hit many economies hard. And the EM and global downturn will be one more blow to the already disabled Chinese export machine.

With my view of no near-term return to normalcy, spiraling bad debt problems are a certainty.

The Chinese banking system hangs in the balance.

From Henry Kissinger’s Friday evening Wall Street Journal op-ed: “Nations cohere and flourish on the belief that their institutions can foresee calamity, arrest its impact and restore stability. When the Covid-19 pandemic is over, many countries’ institutions will be perceived as having failed. Whether this judgment is objectively fair is irrelevant. The reality is the world will never be the same after the coronavirus. To argue now about the past only makes it harder to do what has to be done.”

That the coronavirus crisis is a catalyst for piercing history’s greatest Bubble greatly broadens the scope of institutional failure. “The Coronavirus Pandemic Will Forever Alter the World Order,” is the title of Mr. Kissinger’s insightful piece. “While the assault on human health will—hopefully—be temporary, the political and economic upheaval it has unleashed could last for generations.”

Confidence in government will be shattered for years to come. Here in the U.S., we run up national debt past $21 TN - and fail to accumulate a reasonable stockpile of ventilators, masks and PPG. No preparation for a pandemic?

After the downfall, it will take generations to restore faith in central banks. If trust in Wall Street has been thin, just wait. And right now Washington is hell-bent on destroying trust in government finances. We continue to witness behavior ensuring a systemic crisis of confidence in the financial markets and policymaking.

It’s a different world now. The chasm that developed between inflated expectations and deflating economic prospects gapped wider than ever. Prospects for a ravaging EM meltdown keep me awake at night.

The existing financial structure, dominated by unsound debt, leveraged speculation, derivatives and free-flowing finance – I don’t see how it works going forward.

When EM citizens come to appreciate their boom experience has left them with unmanageable debt loads – and see their nation’s reserve holdings depleted in fruitless currency support operations – there’s going to be hell to pay.

The house of cards is being exposed – and a crisis of confidence is at this point unavoidable. A domino collapse of currencies, Credit and banking systems, and economies has become a frighteningly high probability outcome.

In such a scenario, how would a crisis of confidence in Chinese finance be held at bay?

Will Beijing turn more insular as it confronts calamitous domestic issues?

Or would a more aggressive global stance be considered advantageous in the face of mounting domestic insecurity and dissent?

The upside of Bubbles, buoyed by an optimistic view of an expanding “pie,” is conducive to cooperation, assimilation and integration.

The downside unleashes a demoralizing slide into antipathy, disintegration and confrontation.

Kissinger: “We went on from the Battle of the Bulge into a world of growing prosperity and enhanced human dignity. Now, we live an epochal period. The historic challenge for leaders is to manage the crisis while building the future. Failure could set the world on fire.”

We’re about to find out how smart the big banks have been

Fears over coronavirus effects have battered share prices, especially for card lenders

Robert Armstrong

A pedestrian wearing a surgical mask and gloves walks past the New York Stock Exchange on Thursday, March 19, 2020, in New York. Stocks are swinging between gains and losses in early trading on Wall Street Thursday, but the moves are more subdued than the wild jabs that have dominated recent weeks. At least for now. (AP Photo/Kevin Hagen)
Should the banks make it through the coronavirus crisis, they will have passed the ultimate test © AP


“This is a huge opportunity for the banks.”

This comment, from a fund manager, is the most surprising comment I have heard since the start of the Covid-19 outbreak. What was shocking was not the callousness — investors are paid to be callous. What was surprising was his explanation.

He does not think the banks will scrape extraordinary profits from desperate borrowers. The opportunity is “to prove how stable their businesses actually are”. More than a decade on from the global financial crisis, markets still demand a discount for bank shares, fearing that horrors are hidden on the balance sheet. Should the banks make it through the coronavirus crisis, they will have passed the ultimate test, and that discount should disappear.

Markets are not looking that far into the future, of course. The shares of the biggest US banks have all dropped between a third and a half within the last month.

This epic sell-off has taken place before the banks have started to feel the impact. Bankers all tell a similar story: as of the start of this week, spending on credit cards, delinquencies and requests for forbearance were not far off normal levels. Of course the bankers do not think that this will continue. But we are still in the calm before the storm. The one large financial company that did publicly update the market this week — American Express — said that it still expected its revenues to rise in the first quarter.

So bank shares are priced on guesswork. There is much speculation about where the first blow will fall. The focus in the past few weeks has been on revolving credit lines. Several companies in the hardest-hit industries, from travel to energy, have tapped their facilities, and the headline numbers are large. AB InBev drew a $9n revolver all the way down, for example, and Carnival Cruise Lines took $3bn.

This means banks’ effective exposure to corporate debtors in vulnerable industries is rising.

This increases the banks’ risk. But it is important to be clear about the type and scale of that risk.The drawdowns will not, in themselves, leave the banks undercapitalised or drain them of liquidity.

Non-financial companies rated by S&P have $729bn in available revolving credit lines. But the four biggest banks in the country — representing perhaps a third of the American banking system — have at least $140bn each in tier 1 equity.

Even a huge run of defaults on revolvers would not, in itself, pose a systemic risk.

Similarly, the liquidity risk is limited. Where does the cash go when it is drawn? Often back into a bank — and often the same bank from which it was borrowed. If the money is spent instead, it gets recycled back into the system. If one particular bank gets more withdrawals than deposits, the US Federal Reserve has made cheap liquidity available to banks through its discount window. The Fed also said in recent days that it “supports firms that choose to use their capital and liquidity buffers to lend”.

The rush to tap lines is a measure of the dire situation of a few companies, and a sign of acute nerves at many others. But making a big deal of the credit lines as a threat to the banks is too clever by half. It speaks to the well-earned neuroses of both investors and journalists, who remember how banks’ hidden exposures to mortgage debt turned a house price bubble into a global financial calamity.

This time around, the problem is unlikely to be risks concealed in complex structures or hidden in the fine print of loan agreements. Instead the problem will be more simple. Banks lend people and companies money.

If the economy grinds to a halt for half a year or more, the banks are not going to be paid back.

No liquidity crunch, no satanically structured securities, no mismatch of short- and long-term funding. Good old the-money-ain’t-coming-back credit risk.

Markets are starting to recognise this. Some of the few stocks that have been hit even harder than the big banks are the speciality credit card lenders, especially those that lend to less affluent borrowers than Amex. Discover Financial, for example, has lost more than 60 per cent of its value in a month. Synchrony, which issues store credit cards to the likes of Old Navy and JC Penney, has dropped more than half.

Either the banks have enough capital to absorb the inevitable credit losses to come, or they do not. This will depend on the duration of the crisis, and how sensibly the banks have lent money in the years leading up to this point.

But if they do emerge solvent when the economy begins to grow again, the sceptics will indeed
have been vanquished, and bank investors will be positioned to make a great deal of money.

An Investor’s Primer on Gold




Albert Lu: Rick, thanks for joining me here on Sprott Media.

Rick Rule: Albert, thank you for producing these. I’ve gotten wonderful feedback from clients and other people in the Sprott universe about the great job you’re doing with all the information products that you are putting out.

AL: I appreciate that, Rick. Last week we promised viewers that we would do a deep dive into gold and silver this week. I want to deliver on the first half of this promise and discuss gold with you.

RR: Let’s frame the discussion in two parts. First of all, gold the commodity, the physical, and, then later, the gold securities, if that’s okay.

AL: That’s fine and the other thing I want to lay out before we begin is from which vantage point will you be discussing these topics: Rick Rule the investor or Rick Rule the speculator?

RR: I think to begin with Rick Rule the investor. I think that one invests before one speculates and we’ll talk about why that’s important later in the discussion. Okay, let’s start with gold itself. I think it’s important to say now that the wind is very likely in gold’s sails.

That is, that the macro set of circumstances strongly favors gold. I probably had 50 questions in the last four weeks as to why gold didn’t respond more dramatically to the liquidity crisis, so let’s address that first. Gold did respond to the liquidity crisis — people who owned gold had liquidity and their liquidity was called on. They had to sell what had a bid, and that included gold, to add to the liquidity.

The Sprott trading desk, which, as you know, Albert, is very active in the physical bullion market, heard from their own sources that as much as $60B worth of gold was held in leveraged-long commodity trading accounts, [with] some of these accounts leveraged as much as 33:1. When credit dried up overnight that gold had to go to gold heaven to extinguish the credit. And, on top of that, gold held in other leveraged, even general securities, accounts often had to be sold to meet margin debt. So the truth is that gold’s deep liquidity served the buyers in times of crisis as it always does.

It’s important to note, Albert, that if you look back at past liquidity squeezes — by this I’m thinking about primarily 2008, but also 2000, 1987 and 1988 — that the crisis itself, the panic [and] liquidity crisis, didn’t drive the price of gold because gold [was] sold off to meet the needs of liquidity. What drove the gold price subsequently was the policy response to the liquidity crisis.

The big thinkers of the world, the central banks, the legislators, those kinds of people, always seemed to deal with liquidity-driven crises with three things: spending stimulus, quantitative easing, which as you know I refer to as counterfeiting, and, of course, artificial lowering of interest rates. It’s that triumvirate — spending money we don’t have on things we don’t need, conjuring money out of thin air and artificially reducing the compensation for saving — that moves the gold price.

The most important determinant in my career of the gold price — I’m not trying to say that there haven’t been geopolitical events or other things moving the price of gold — but the thing that’s moved the price of gold mostly in my career has been faith, or lack of faith, in the ongoing purchasing power of the U.S. dollar, most importantly the U.S. dollar expressed by the U.S. 10-year Treasury.

So let’s look at the factors behind it, which we’ve done before, but let’s summarize them. The first is that quantitative easing, which is adding to the stock of currency with no basis. This isn’t borrowing. This is conjuring currency [which] must, by itself, debase the currency. You’re increasing the float without increasing the value.

The second is that the on-balance sheet operations, which is to say the borrowing, adds to an already precarious debt situation facing the U.S. government. We’ve done these numbers before but let’s do them again. They bear repeating. At the federal level, $23T in recourse liabilities, $18T net of the balance sheet of the Fed and over $100T in off-balance sheet liabilities.

That means simply, at the federal level, Albert, the U.S. government, which is to say indirectly unfortunately us, have $120T in liabilities.

It’s important to note that these don’t include state liabilities or local liabilities, nor do they include the underfunded pension funds at the public and private levels. Now this debt number is ugly in isolation, but you need to look at the debt number relative to our ability to service it.

You service this $120T in liabilities with, of course, the national income taxes and fees less expenses. The problem is that the number is upside-down, meaning it’s negative to the tune of $1.5T. It is, as you know, impossible to derive a positive sum by adding a column of negative numbers and it would appear that the deficit goes on ad nauseam.

So the top of the equation, that is to say the credit quality of the borrower, is I think very much in question. How do we get out of this? Well, either a good old-fashioned default — it seems politically unlikely to me — or further debasement of the currency, which is to say further erosion of the purchasing power of your savings, and the quantitative easing, of course, goes on.

Any of our listeners who paid any attention to the Christmas tree legislation last week, by Christmas tree I mean the $2T in stimulus that awarded a reward to every politically connected constituency in the country, whether or not they happen to have the coronavirus, is ample evidence of what fiscal action is all about in the face of a crisis. Every politically favored constituency got a handout.

The people who need it, of course, got very little because they don’t have very much clout. Today, of course, Trump announced phase 2 which is a $2T infrastructure stimulus bill. Governments are famous for allocating infrastructure investments to politically favored constituencies, so I would suggest to you but one thing: What the coronavirus has spawned is $4T in additional expenditure with very little probable long-term benefit. So I think that is pretty clear that, firstly, the debasement of the currency as a consequence of quantitative easing or counterfeiting is occurring.

The second thing that’s occurring is that we’re incurring recourse liabilities, and probably non-recourse liabilities, very, very quickly as well, which means that the debit side of our balance sheet is increasing at the same time that our ability to service it is decreasing. Finally, of course, there is the reward for savings. Who’s going to buy these bonds?

The U.S. 10-year Treasury, as I look at it today, is paying about 60 basis points — six-tenths of 1%. The CPI stated rate of inflation is 1.6%, meaning that the government is telling you that the value of your savings held in U.S. Savings bonds declines by 1% a year for the next 10 years.

To reiterate, our mutual friend Jim Grant calls this return free risk. This conjunction of factors — the debasement of the currency, the deteriorating balance sheet and the extraordinarily low [return] to investors for assuming risk to their purchasing power — I think can only be good for gold. When? I don’t know.

Again, looking at past crises, it often takes three months or four months for the effect, or the anticipation of the effect, of the policy response to a crisis to impact the gold price. It’s worthy to note, Albert, that you and I are not the only ones who have noticed this phenomenon. At the retail level across the United States, retail physical products, small denomination gold products like 1 oz. gold products or 100 gram gold products coins or small denominations silver products, are either sold out of retail dealers or only are available with astonishing premiums, to the extent where I heard today that there are several one ounce gold premiums that are selling for $2,200 in the face of the spot market, which is much below that.

So what I’m suggesting to you is that the anticipation of the fiscal response to the liquidity crisis is already such that people are beginning to diversify their savings to include, of course, gold.

AL: Rick, I understand the temptation to go out and get gold now, and that is, I believe, the correct thing to do if you’re not adequately diversified but, really, the smart place to be would have been to have listened to Rick Rule months or years ago, to have listened to Ray Dalio, Jim Grant, Doug Casey, even Jim Cramer, allocating 10, 15, 20% of your portfolio to gold and for the people who had metaphorical fires in their portfolio due to margin calls, the liquidity of gold would have been very helpful in putting out that fire.

What about people who weren’t suffering from margin calls? I think many of us tend to look at gold priced in U.S. dollars, which is a very important metric but not the only metric. You could have looked at gold as priced in Dow Jones stocks, or other stocks, or other income generating things.

If you look at it in those terms, gold did respond very well. It’s responded well in terms of the dollar, with six straight quarterly gains, but in terms of other assets, it’s really done well. Should people be looking at maybe moving out of gold to take advantage of some of these opportunities in, you know, productive assets?

RR: My belief, Albert, is that almost all investors, including most investors who listen to us who are inclined to like the gold story, are still under-invested in gold. I say this for two reasons.

A major bank study, which I read, and I’ve quoted it before in interviews with you, says that between 0.3%-0.5% of savings and investment assets in the United States involve precious metals or precious metals securities. That may have gone up because the denominator has declined the value, the Dow is an example, but the three decade-long mean was between 1.5%-2%. So gold is still very broadly under-owned, and I would suggest it’s even under-owned among people who are listening to this broadcast.

Now, the second thing is that when you have a circumstance where confidence is compromised, the gold tends to not move 10% or 15% — you’ll remember the early part of the decade that was 2000 to 2010 gold began that decade at $252 an ounce if my memory serves me well and ended the decade closer to $1,900.

When gold moves it tends to really, really move, so yes, the gold price in U.S. dollars has moved from what? $1,100 to $1600. The gold price in Canadian dollars, Australian dollars, euro, yen, yuan has moved even more.

The truth is that the circumstances that would cause a rational investor to own gold are very much intact and we are very much in the early days. Does this ignore buying productive investments? Of course not.

Gold moves so well that a little bit of it in your portfolio generates a whole bunch of portfolio insurance. But by way of a little bit I mean somewhere between 3% and 10% of your portfolio. I would suggest that most of the people listening to this broadcast have 1% or 2% of their portfolio in precious metals, even today.

Others among you, and you will know who you are, have adequate amounts of gold in your portfolio. Congratulations. I’m sure you don’t need my congratulations; you are already smiling.

The truth is, for two reasons, the macro circumstance and also the extraordinary performance of gold when it performs, I would suggest that it isn’t too early to buy now.

What’s important, irrespective of the form that your precious metals ownership comes in, [is] that you have some precious metals in your portfolio to shelter you against the policy responses that we see from the current economic circumstance.

AL: Rick, one of the ways the market has changed since that epic run we had in gold, that began roughly in 2002, is that the policy response happens almost coincidentally with the crisis. So the Federal Reserve and the Treasury are very quick to act now, unprecedented. Danielle DiMartino Booth said the other day we had 5 years’ worth of policy action just in a couple press conferences. So that would suggest that we’re not going to have as much time to position in gold to benefit from the run that we expect will be coming as a result of the policy?

RR: That’s an excellent observation, Albert, and one that I hadn’t thought of it before. I certainly never think of the political class as being efficient, but when you think of their efficiency in terms of using broad panic to change the way we live — I’m being polite — they’re extremely efficient. Quoting Rahm Emanuel, who was of course the Obama advisor,

“Never let a good crisis go to waste.” Certainly the policy response that we’ve seen, the $2T stimulus package last week, [is] a wonderful excuse to aid politically favored constituencies. And the $2T announced today would suggest that what you say is very true. The policy responses are bipartisan.

The first thing that Democrats and Republicans have been able to agree on during the whole of the Trump administration is that they could agree that they could use the crisis to appropriate $2T to aid their allies and they did that very, very efficiently. I suspect that what you’re saying is true and it might be that the response of the precious metals to policies will be accelerated too because, as you say, the policy response is coming much more quickly than it has in prior crises.

I remember, and I even forget what the crisis was, a sort of a putative crisis in the Clinton administration, before Mr. Clinton learned that he didn’t have to borrow, he could just print, and he talked about the most powerful first force on Earth being the bond vigilantes. There was some discussion that the United States would give a Treasury auction and no one would come. Well, the Democrats and the Republicans don’t worry about that anymore. They don’t sell bonds. They buy them, and they don’t buy them with savings. They buy them with the freshly created specie.

So they have learned to be extremely, extremely efficient in the policy response. And I take your suggestion with some interest.

AL: Let’s shift the discussion to gold equities now, Rick. The same case that you make for gold, it trickles up to the gold equities. But how are they different and how would you approach them from an investment point of view?

RR: As they are different we’re going to delve into a little history here because in my career gold has moved and then the gold stocks have moved and the gold stocks have moved because, first of all, the gold stock buyer is less of an insurance buyer. The gold buyer was an insurance buyer. The gold stock buyer is looking for out-performance in a company and it has been my experience that the gold stocks move after the increase in the gold price has been reflected in the income statement and the balance sheet of the individual companies.

What happens historically is that the biggest and best of the gold stocks move first. Then, the second tiers move as people go down the quality trail. And then lastly, the junior producers and the juniors move the last, but they move in fact the farthest.

It’s important to know though that the gold stocks move in response to gold and gold moves in response to policy. So the period, the distance in time, which as you point out, may now be compressed but the distance in time before the crisis and the move in the gold equities historically has been six to nine months, because the increase in the gold price has to show up in the income statement of the gold producers.

It’s important too, Albert, — you didn’t ask me this question but I’m going to use your questions [as] a platform for a statement — that the strong U.S. dollar relative to other currencies is an important consideration in the gold equities. If a gold company is producing gold in Australia or Canada with declining currencies, what it means is that the costs of those operations are declining in U.S. dollar terms.

The company’s inputs are declining at the same time that the price that they’re receiving for their product is increasing, which is great on margins. Secondly, this is also important, usually one of the top three most important inputs in a goldmine is energy, fuel as an example, and the incredible low prices that we’re seeing for oil and the increasingly low prices that we’re seeing for refined petroleum products, and also other forms of energy, lower the input costs for gold miners.

So I would suspect that the impact of the increasing gold price will have on the income statements of gold mining companies will be particularly impressive for companies who produce outside of the United States where their costs are declining as a function both of energy prices but also declining currencies like the Australian dollar and the Canadian dollar.

AL: Rick, two questions related to energy actually because I was going to ask you that before you mentioned it. Is there anything in place, hedges or things like that, that will prevent the lower energy prices from showing up on the income statements anytime soon?

RR: There may well be gold producers who locked in energy prices for fear of energy price increases that now will show losses on hedge books. I’m not familiar with that. Certainly, there are a reasonable number of gold producers who looked at the increase in the gold price pre-COVID-19 who had hedged gold production to lock in what they thought might be high gold prices.

And those companies, while those hedges are in place, will not benefit as much as they would have had they been unhedged. But the truth is that the magnitude of the gold price increase and the magnitude of what I believe will be the gold price increases to follow will be such that the industry as a whole will shake off the hedges without too much damage to either the income statement or the balance sheet.

AL: Rick, when you’re shopping for mining companies do you prefer mining companies that are exposed to the markets — unhedged to energy, unhedged to currency, unhedged to the gold price?

RR: That depends on for who, Albert. The most important consideration for me, for most investors right now, is simply to buy the best of the best. We’ve talked about this in prior interviews that you and I have done, particularly that interview with the gold mining index chart, which we could of course make available to anybody who wants it.

The magnitude of the increase in gold mining equity prices during recoveries from oversold bottoms like this it’s so extraordinary, if my memory serves me well 150% to 1,200% over periods of time as brief as 17 months or as long as 42 months, that you don’t have to get too cute.

Buy the best of the best even though, ironically, the best of the best underperform the index over the course of the market, they outperform early on and they give you most of the market performance but with much less risk. More sophisticated strategies come around understanding gold companies well enough to understand those companies that will have production increases over the next three to five years or offer the most leverage.

To go looking for companies that offer the most leverage for gold involves, paradoxically, having the courage to own the high-cost producers whose operating margins increase the most when the gold price increases and finding those companies that had the courage, or some would say the foolishness, not to lock in prices that they thought were high prices. So, certainly, the unhedged producers generate the most speculative appeal.

What I would ask our listeners to do right now, the ones who don’t own much gold or gold equities, is buy some gold [and] pray that the price doesn’t go up because the circumstance that leads to vastly higher gold prices is invariably hard on the rest of your portfolio. After you’ve done that, position yourself in the gold equities, the best of the best gold equities — a teaser if you don’t know what the best of the best gold equities are, call your Sprott Global broker and if you don’t have one, get one. I think it’s important to your financial future.

AL: Rick, I’ve got a follow-up question regarding energy. I understand the argument that foreign gold producers would have the advantage in the currency, particularly as it applies to labor. What about the prospects for a U.S. producer with domestic oil production exceeding the demand and the possibility of having oil available, you know, sub-$10 a barrel domestically? Would that provide any kind of tailwind for those producers?

RR: Huge tailwind, Albert. Most American gold production is in northeast Nevada in the Battle Mountain-Carlin Trend and these are gigantic open pit operations with 400-ton haul trucks. These haul trucks’ fuel consumption is measured in gallons per mile, not miles per gallon. Gallons per mile.

Similarly, remote power often relies on fossil fuel to run the mills and things like this. Oil and other forms of energy are enormous input costs in the U.S. gold production industry because the U.S. gold production industry takes place on such a massive scale. It’s not a labor-intensive business.

It’s a capital- and fuel-intensive business. The tailwind that will be enjoyed by the big American producers, Newmont and Barrick in particular, as a consequence of low oil prices on their U.S. operations are difficult to overstate.

AL: Rick, that’s all I have. Do you have any parting thoughts for the viewers?

RR: Yes, I do. The truth is that many of our viewers are more sophisticated gold equities buyers. There are people that already own the best of the best. This is the time for those people to begin to look at the best of the rest. In a normal circumstance, gold moves, then the gold stocks move. Silver moves sort of concurrent with the gold stocks moving, and silver stocks move last.

What the Fed Learned from Lehman, the Treasury Must Learn from Covid-19

Officials have created a safety net for the international financial system, but don’t have the same tools to quickly cushion the economy

By Jon Sindreu


Treasury Secretary Steven Mnuchin spent the weekend negotiating over the U.S. fiscal response to the crisis. / Photo: mary calvert/Reuters .


The Covid-19 crisis has driven Western nations to embrace government spending after a decade in which monetary policy has proven powerless to boost economic growth. Investors’ focus should be on whether fiscal policy can match one of central banks’ best attributes: speed.

Last week, the U.K. announced a fiscal response that is expected to initially amount to more than 10% of gross domestic product. But size may not be all that matters.

As the lengthy debate taking place in the U.S. Congress right now showcases, fiscal policy is more politically contentious and harder to focus than cutting interest rates.

Yet the clock is ticking to prevent a vast number of small and medium enterprises from severing their relationships with workers and suppliers—actions that would almost certainly prolong the impending recession.

Britain’s proposals are encouraging. Among other measures, the government will give grants to companies covering 80% of the wages of workers at risk of being dismissed. The key is that, although initially projected to last three months, they could automatically extend for as long as it takes for the current coronavirus paralysis to lift.

Officials may want to take a page out of central banks’ playbook after all.

Despite the modern—flawed—idea of monetary policy as controlling growth and inflation, its two main jobs have always been different: to ensure a stable market for government debt and to prevent liquidity crunches.



The Bank of England was created in 1694 to finance Britain’s war against France, and in the 19th century started to become a “lender of last resort,” lending freely to cash-strapped banks at a cost. In 2008, it became apparent that simply backing banks wasn’t enough in an era in which globalized finance happens through insurers investing in money-market funds that purchase securities intermediated by market makers—transactions often done overseas with the U.S. dollar as the ultimate settlement currency.

The Fed learned then that, to do the same old job, it had to open facilities to lend dollars to all corners of this complex system. It is now doing that again.

And it is working. Despite the vast number of dislocations in equity and debt markets caused by business and investor responses to the coronavirus, the world’s financial plumbing seems to be coping.

Indicators of worrying dollar scarcity overseas suddenly corrected after the Fed announced Friday that it would provide dollars on a daily basis to foreign central banks. The Fed has also managed to rein in disruptions in the Treasury market, which is crucial to allow for any fiscal stimulus.

There are many lessons fiscal policy makers can learn from central banks’ success.



One is that providing an “income of last resort” to firms, freely and without limit but under strict conditions—as the U.K. seems to be doing—may be much more effective than a more generous but limited cash injection, because authorities can never predict the size or length of a crisis, or determine who really deserves the funds.

Another is about speed and simplicity. Budget deficits already tend to balloon during recessions regardless of governments’ decisions, because tax receipts fall and unemployment benefits surge—the so-called automatic stabilizers.

There should be more of them. U.S. proposals to send checks to every citizen are an excellent first line of defense, but they are designed to be exceptions. Instead, such payouts should be triggered automatically in emergencies, rather than through congressional approval.

For all of its ills, the global financial crisis did force central bankers to create a robust safety net for financial markets. Investors should now welcome any measures that do the same for the economy.

What Would Roosevelt Do?

The US government should pull out all the stops in mitigating the economic fallout from COVID-19, not just by disbursing cash to all households, but also by implementing a federal job guarantee and many other long-overdue policies. After all, for a self-financing government, money is no object.

Pavlina R. Tcherneva

tcherneva1_MPIGetty Images_rooseveltnewdeal


NEW YORK – The fallout from the coronavirus pandemic will be nothing like that of the 2008 financial crisis, nor will a V-shaped recovery be achieved through conventional stimulus – not even through truly massive conventional stimulus. We are at war with COVID-19, and in wartime, civilian production grinds to a halt and the only work that is needed is for the war effort itself.

Moreover, a recession is sadly necessary to stop the spread of this virus. In the United States, over 50% of jobs are at risk from layoffs, furloughs, reduced pay, and lost hours. Virtually every sector of the economy stands to lose a large chunk of its business, household incomes will be devastated, and spending by consumers and firms will rapidly decline. The manufacturing collapse has already begun; the service economy, which employs 80% of all workers, will be next.

One pandemic thus will lead to another – of unemployment. The avalanche of layoffs will bring a wave of defaults, bankruptcies, and depressed profits. The domino effect will continue across many domains, from collapsing state and municipal tax revenues and business failures to impoverished communities, declining health outcomes, homelessness, and “deaths of despair.”

How should governments respond? The same way the US government did under President Franklin D. Roosevelt in the World War II era.

The first priority is to mobilize. That means building temporary field hospitals, drive-through clinics, and emergency health centers. It means cranking up production of essential equipment and medication, staffing health facilities adequately, and establishing support services for the hungry, homeless, and most vulnerable. And it means deploying an army to disinfect airports, schools, and critical public places.

Second, we need to make it easier for people to stay home, such as by implementing short-term debt deferments (including on small business and mortgage loans) and suspending utility bills, as some European countries are already doing. Governments also should be providing income support in the form of extended unemployment insurance, food stamps, and housing benefits. In the US, all work requirements for public benefits should be abolished, and the federal government should extend immediate financial assistance to state governments constrained by balanced-budget laws.
The coronavirus-response package recently adopted by the US does not go nearly far enough. As it stands, the legislation still would leave 80% of private-sector workers without medical and paid-leave coverage. The provision for free testing offers no solace to those who are already critically ill, or who will have lost their health insurance as a result of unemployment. The US should use this occasion to make universal paid leave and Medicare for all permanent policies.

Another top priority is to provide emergency cash support to households. Talk of a universal $1,000 disbursement has gotten Americans excited – $2,000 would be better. But cash assistance alone will not be enough. On the contrary, without the aforementioned provisions and bold measures to plug the hole in the cratering labor market, much of the cash payout will be wasted.

When employment and income prospects are uncertain, sending cash to families is like pouring water into a leaky bucket. What the US and other countries really need are policies to create good jobs once the crisis has passed.

That’s why, after taking all of the steps necessary for today, governments should mobilize again. Only big government, big public investments, and big public-employment programs will ensure a quick bounce back, rather than another protracted jobless recovery. In the last crisis, much of the stimulus fueled runaway inequality; this time needs to be different.

The situation demands not “nudges” or “incentives” but direct action on the model of the New Deal, the US Interstate Highway System, and the Apollo Program. Governments should use this crisis as an opportunity to launch a bold investment program for clean, green infrastructure, as envisioned in the Green New Deal. After all, another viral epidemic is inevitable, and the climate crisis demands FDR-like ambition and resolve.

Once the pandemic is behind us, we need to start hiring. Policymakers should already be preparing public-service and guaranteed-job programs for anyone who shows up at the unemployment office. And that job guarantee should be paired with training and education, to help workers qualify for better-paid private-sector employment when the economy recovers.

Until last month, commentators in the US were still talking about labor-market slack from the 2008 financial crisis, and despite historically low official unemployment numbers. How long will it take to return to current employment levels after a pandemic that knocks a significant portion of the economy offline?

Without direct, guaranteed employment, we are looking at decades of elevated unemployment. Alternatively, a person with a living-wage job can pay a mortgage, buy a plane ticket, and go to restaurants. An ample supply of good jobs for all who want them is the surest way to bring every sector of the economy back to full health.

But how will the government pay for it all? The same way it pays for everything else. It should not take a pandemic or a world war to remind citizens that the US government is self-financing. US public financial institutions – the Treasury and the US Federal Reserve – ensure that all government bills get paid, no questions asked.

All that is needed, then, is for Congress to appropriate the budget and design an effective policy for managing this crisis and those that will come after it. No one is calling for wealthy taxpayers or foreign lenders to “pay for” the response. That is not how a government that controls its own currency finances itself. So, let us stop asking the trivial question of how to pay for it. Finding the money is never the problem. The focus should be on creating good jobs for the unemployed.


Pavlina R. Tcherneva, Associate Professor of Economics at Bard College, is a research scholar at the Levy Economics Institute and author of the forthcoming book, The Case for a Job Guarantee.