The guns of August

The trade war escalates, and the fog of war descends

America brands China a currency manipulator, and global markets swoon

CARL VON CLAUSEWITZ, the Prussian military theorist, never wrote about currency wars. But some policymakers see them in his terms: as the continuation of trade politics by other means. That, at least, is how the Trump administration views China’s decision on August 5th to let its currency weaken past seven yuan to the dollar for the first time since 2008. Though arbitrary, that threshold has assumed huge symbolic importance among traders, economic officials and fund managers. They were left stunned.

America’s Treasury quickly branded China a “currency manipulator”, a charge it has not levelled against any country for 25 years. China, in the Americans’ view, was cheapening its currency to gain an unfair edge in retaliation for President Donald Trump’s surprise announcement four days earlier that he would impose new tariffs of 10% on roughly $300bn of Chinese godos.

This marked the end of investors’ hopes for a peaceful summer. At the end of July the Federal Reserve had cut interest rates to guard against a slowdown in America’s respectable growth rate, and trade tensions had “returned to a simmer”, as Jerome Powell, the Fed’s chair, noted with satisfaction.

But after the yuan’s move America’s stockmarket suffered its worst day this year. Emerging-market currencies, including the Brazilian real, Indian rupee and South African rand, fell. The price of Brent crude oil tumbled below $60 a barrel and safe havens, such as gold, rallied. The same search for safety pushed American ten-year government bond yields to 1.7%, as investors bet that the Fed would be forced to slash interest rates further to prevent a recession. The Reserve Bank of New Zealand cut its benchmark interest rate by twice as much as expected, citing “heightened uncertainty” and “historically low” global bond yields. The Australian dollar fell to its lowest level in a decade.

In matters of war and peace, countries must prepare for the worst. But precautions can look like provocations. In allowing the yuan to fall, China signalled it is prepared for a protracted trade war. It let the yuan weaken in response to the threat of tariffs much as a floating currency would. Otherwise it would have needed to defend an arbitrary line against the dollar every time America turned belligerent. Its move nonetheless makes further belligerence more probable. Mr Trump is now unlikely to change his mind about the new tariffs before they kick in on September 1st.

Both sides blame the other for starting the fight. China has raised tariffs only in response to America’s. But America sees its combative economic diplomacy as a belated response to decades of intellectual-property theft and other misdeeds. Each side’s attempt to get even looks to the other like one-upmanship. China views a weaker yuan as a reasonable response to Mr Trump’s trade duties; Mr Trump, according to the Wall Street Journal, sees those tariffs as retaliation for China failing to commit to buy more American farm goods.

The irony is that Chinese purchases of American soyabeans and pork were already rising, and the government was offering buyers exemptions from some tariffs. But after Mr Trump’s new tariff threat it has reportedly told state-owned companies not to buy American farm goods after all. Thus Mr Trump’s tariffs may have caused the decision they were designed to punish.

Whatever the cause of the new levies, what might be their effect? Some of America’s existing tariffs (of 25% on roughly $250bn-worth of merchandise) had been imposed on Chinese goods that American importers can buy elsewhere. That minimised the harm to American buyers and maximised the harm to China’s exporters, which lost business to close rivals elsewhere. Indeed, according to Goldman Sachs, other Asian countries have filled around half of the gap created by the previous round of tariffs.

The next round of tariffs will hit goods for which China has fewer competitors. That should make it harder for American buyers to switch suppliers. Nonetheless the new tariffs’ direct impact could reduce China’s growth by at least 0.3 percentage points in 2020, according to UBS, to below 6% for the first time since 1990.

To support a slowing economy, China’s government has already cut taxes, increased infrastructure spending and relented in its campaign to restrain credit growth. But it is reluctant to boost the property market, which helped pull the economy out of previous slowdowns, points out Andrew Batson of Gavekal, a research firm. House prices have risen mercilessly and developers have accumulated worrying levels of debt. China, in short, wants to keep growth stable, stand up to America in the trade war and constrain excesses in the housing market. It is becoming harder to do all those things at once.

The damage to America’s economy is less tangible. A survey by the Federal Reserve Bank of Atlanta suggested that tariffs and trade-war uncertainty had hurt private investment by 1.2% (and manufacturing investment by over 4%). The unease has also made it harder for the Fed both to preserve stable growth and to raise interest rates to more normal levels. That will give it less room to act if the economy flounders for other reasons.

In a tweet, Mr Trump called on the Fed to respond to China’s weakening currency. Although the dollar is technically the responsibility of America’s Treasury, the Fed’s decisions have a profound influence over its value. It does not take orders from the president and treats the exchange rate with benign neglect. But if the uncertainties of the trade war inflict enough harm on confidence and spending, it might cut interest rates anyway. The futures market prices in a roughly 40% chance of at least 0.75 percentage points of easing by the year’s end. The fog of war can be as damaging as war itself.

The trade fight has reverberated globally. America’s Treasury had already expanded the list of countries it is monitoring for signs of currency manipulation. None of the countries listed met all three of the Treasury’s criteria (a large bilateral surplus with America, a material overall surplus and persistent currency intervention by the central bank). But then, neither did China. The definition of manipulation is, it seems, highly manipulable.

One of the currencies most affected has been Japan’s yen. A haven in troubled times, it rose sharply after Mr Trump’s surprise announcement. A strong yen makes it harder for Japan’s central bank to revive inflation, especially as its interest rates already lie below zero. Although Japan has not intervened directly in the currency markets since 2011, its officials are watching the yen’s rise with alarm. If the currency strengthens closer to the psychological threshold of 100 to the dollar, Japan’s authorities might feel compelled to act. Currency wars can also be the continuation of monetary policy by other means.

Nor has Europe escaped. Industrial production in Germany fell by 5.2% in the year to June. “Foreign macro shocks” account for about two-thirds of Germany’s slowdown since 2017, according to Goldman Sachs. European banks, including ABN AMRO, Commerzbank and UniCredit, this week warned of squeezed interest margins, rising provisions or flagging revenues. In a recent economic bulletin, the European Central Bank worried that trade uncertainty had delayed global investment, damaging European exports of manufacturing, machinery and transport equipment. In a globalised economy, everything is a continuation of everything else.

"Hot Money" Watch

Doug Nolan

In the People’s Bank of China’s (PBOC) Monday daily currency value “fixing,” the yuan/renminbi was set 0.33% weaker (vs. dollar) at 6.9225. Market reaction was immediate and intense. The Chinese currency quickly traded to 7.03 and then ended Monday’s disorderly session at an 11-year low 7.0602 (largest daily decline since August ’15). While still within the PBOC’s 2% trading band, it was a 1.56% decline for the day (offshore renminbi down 1.73%). A weaker-than-expected fix coupled with the lack of PBOC intervention (as the renminbi blew through the key 7.0 level) rattled already skittish global markets.

Safe haven assets were bought aggressively. Gold surged $23, or 1.6%, Monday to $1,441, the high going back to 2013 (trading to all-time highs in Indian rupees, British pounds, Australian dollars and Canadian dollar). The Swiss franc gained 0.9%, and the Japanese yen increased 0.6%. Treasury yields sank a notable 14 bps to 1.71%, the low going back to October 2016. Intraday Monday, 10-year yields traded as much as 32 bps below three-month T-bills, “the most extreme yield-curve inversion” since 2007 (from Bloomberg). German bund yields declined two bps to a then record low negative 0.52% (ending the week at negative 0.58%). Swiss 10-year fell two bps to negative 0.88% (ending the week at negative 0.98%). Australian yields dropped below 1.0% for the first time.

It’s worth noting the Japanese yen traded Monday at the strongest level versus the dollar since the January 3rd market dislocation (that set the stage for the Powell’s January 4th “U-turn). “Risk off” saw EM currencies under liquidation – with the more vulnerable under notable selling pressure. The Brazilian real dropped 2.2%, the Colombian peso 2.1%, the Argentine peso 1.8%, the Indian rupee 1.6% and the South Korean won 1.4%. Crude fell 1.7% in Monday trading. Hong Kong’s China Financials index dropped 2.5%, with the index down 4.4% this week to the lowest level since January. European bank stocks dropped 4.1%, trading to the low since July 2016.

A Monday Bloomberg headline: “China Retaliation ‘11’ on Scale of 1-10, Wall Street Warns.” Global markets were shocked Beijing would interject the renminbi into tit-for-tat trade retaliation. Trade war morphing into currency war? The White House was not impressed.

August 5 – Reuters (Susan Heavey and Dan Burns): “U.S. President Donald Trump slammed China’s decision to let its yuan currency breach the key seven-per-dollar level for the first time in more than a decade, calling it ‘a major violation’ and jabbing the U.S. central bank. ‘China dropped the price of their currency to an almost a historic low. It’s called ‘currency manipulation.’ Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!’ Trump tweeted.

The U.S. market selloff intensified after President Trump’s tweet, with the S&P500 ending the session down 3.0% - 2019’s biggest one-day decline. The Nasdaq100 dropped 3.6%, with the Semiconductors slammed 4.4%. The Bank index was hit 3.6%. Junk bond spreads widened 40 bps in Monday trading to 437 bps, trading near the highest level since January – weighed down by the energy sector. Investment-grade corporate and bank CDS rose, although not the dramatic moves suffered in high-yield.

Tuesday morning from People’s Bank of China Governor Yi Gang: “As a responsible big country, China will abide by the spirit of the G20 leaders’ summit on the exchange rate issue, adhere to the market-determined exchange rate system, not engage in competitive devaluation, and not use the exchange rate for competitive purposes and not use the exchange rate as a tool to deal with external disturbances such as trade disputes.” Yi’s statement along with the PBOC’s Tuesday “fix” at 6.9683 – a smaller decline versus the dollar than markets had expected – helped calm fears of a destabilizing devaluation.

By Thursday, fears of renminbi dislocation becoming a catalyst for global “risk off” had subsided. The renminbi gained 0.21% against the dollar in Thursday trading, as Asian and EM currencies posted modest gains. The Shanghai Composite recovered almost 1%. European stocks rallied sharply, with Germany’s DAX gaining 1.7% and France’s CAC40 jumping 2.3%. The S&P500 rallied 1.9%, with the Nasdaq100 up 2.3%.

Curiously, the safe havens were happy to disregard bouncing risk markets. Treasury yields declined two bps Thursday to 1.72%, while the yen and Swiss franc both posted small gains. Gold gave back hardly anything.

The VIX surged to 24.81 during Monday trading, the high since January 3rd. By Thursday’s close, the VIX was back down to 17. Option players were betting that the worst of the selling was likely over for the near-term – the critical time horizon for option traders. The recurring pattern has been a spell of “risk off” trading spurs hedging and put option buying. And after a flurry of put option purchases, the game then becomes getting to option expiration with as little value as possible left in these instruments.

Large quantities of outstanding put options (and other hedges) create the potential for a self-reinforcing self-off, where the writers of hedges are forced into the marketplace to aggressively sell futures and ETFs to offset mounting losses on the options they had previously sold. Yet market players have been conditioned to believe policymakers are keenly attuned to derivatives meltdown risk. After Monday’s scare, the bet is both President Trump and Beijing will avoid rocking the markets next week (U.S. options expiration Friday).

And while the VIX closed the week below 18 (17.97), Friday’s session was not without its share of drama. The S&P500 traded down 1.3% in early-Friday trading. After stating “We’re not going to be doing business with Huawei,” the President’s comments were later clarified. The U.S. will be moving ahead with its special licensing process for Huawei’s U.S. suppliers. The S&P500 traded back to little changed on the day, before reversing lower into the close.

The collapse of Italian bond yields has been one of the more dramatic global market moves.
After trading to almost 3.60% last October, Italian 10-year yields ended Wednesday trading at 1.42%. For a country so hopelessly over-indebted ($3 TN plus), Italian bond prices are arguably one of the more distorted assets in a world of distorted asset markets. Italian yields reversed sharply higher into the end of the week, rising 12 bps Thursday and a notable 27 bps on Friday – on political instability after Deputy Prime Minister Matteo Salvini called for early elections (breaking with its Five Star Movement coalition partner). Italian stocks were hit 2.5% in Friday trading, ending the week down 3.4%. Global “risk off” could prove an especially challenging backdrop for vulnerable Italian assets.

August 9 – Bloomberg (Sophie Caronello): “Britain’s pound ended the week at its lowest closing level versus the greenback since Margaret Thatcher was ensconced in No. 10 Downing Street. Sterling posted a fourth straight-weekly decline, sliding 1.1% to $1.2033 in a five-day period that witnessed mounting concern over the country’s exit from the European Union and a report indicating that the British economy shrank for the first time in six years.”

Italy, the U.K., China, India, Brazil and others… Global central bank-induced liquidity excess has kept numerous remarkably leaky boats afloat in recent years. There will be systemic hell to pay when the dam finally breaks.

I’ll assume Monday’s global market convulsions will have the U.S. administration and Beijing treading cautiously next week. Yet I expect it will prove more difficult this time to squeeze the genie back into the bottle. To see such high cross asset correlations around the globe is disconcerting. And we saw Monday how critical a stable renminbi has become to global finance. It’s not a stretch to say this global party comes to rapid conclusion the moment markets fear a disorderly Chinese currency devaluation.

August 6 – Bloomberg (Michelle Jamrisko, Anirban Nag, and Karlis Salna): “It used to be that a buildup in foreign reserves was seen as a bulwark against currency shocks and swift turns in investor sentiment. Those days seem far away -- and that defense less robust -- as the trade conflict between the U.S. and China evolves into a full-blown currency war that’s threatening emerging markets globally. Reserves of central banks in developing Asian nations, which have risen to almost $5 trillion this year, will now be put to the test as currencies slide. ‘The key lesson from 2008 is that you can never have too much reserves,’ said Taimur Baig, chief economist at DBS Group… ‘But they were for fighting a fire in a conventional world,’ noting that today’s environment is quite unconventional.”

China’s $3.0 TN of reserves are less imposing than in the past. Indeed, reserves throughout EM will likely become a market focus. My sense is analysts have little grasp of potential capital flight risk, for China or EM more generally. How much “carry trade” leverage (borrow in low-yielding currencies to fund purchases in higher-yielding instruments) has accumulated during this most-protracted of speculative cycles?

What other “hot money” vulnerability lurks (i.e. ETF flows, derivatives…). Such issues garner little notice when “risk on” is bubbling and liquidity is flowing abundantly. But we were reminded Monday how abruptly “risk off” deleveraging/de-risking can erupt – and how quickly fears of illiquidity and dislocation can take hold.

I’ll stick with the analysis that global markets are moving toward a very problematic scenario.

Having witnessed previous EM crises (i.e. Mexico in ‘94/’95, Southeast Asian in ’97, Russia in ’98 and Brazil in ‘01/’02), it’s worth recalling how currency market dislocations become instrumental in systemic crises. Rapid drawdowns in international reserve holdings stoke fears of illiquidity, leading to a destabilizing “hot money” exodus. Rapidly shrinking reserve holdings force central banks to raise interest rates to support domestic currencies, with the resulting rapidly tightened financial conditions bursting fragile financial and economic Bubbles.

EM central bankers learned from past predicaments. Over this cycle, it became increasingly common for central bankers to support their currencies in the derivatives marketplace, a mechanism where vulnerable currencies could be bolstered without resorting to precious international reserve holdings.

Central bank derivative operations successfully stabilized currencies during previous fleeting bouts of “risk off”. The repeated rapid recovery of global liquidity abundance reassured – policymakers along with the markets – that these derivative trades could be unwound with little notice. Recurrent EM resilience emboldened the view that large reserve stockpiles had fundamentally upgraded EM risk profiles.

Like so many aspects of this long boom, it works miraculously – until it doesn’t. At this point, the key analysis is that reserve holdings surely overstate resources available for countries to combat a more enduring period of “risk off” capital flight. Moreover, the perception of EM resilience has ensured unprecedented Credit and speculative excess throughout a systemic EM Bubble.

August 6 – Reuters (Winni Zhou and Andrew Galbraith): “China’s major state-owned banks have been active in the yuan forwards markets this week, sources said, using swaps to curb greenback supply as authorities sought to slow the currency’s decline after its break past the key 7 to the dollar threshold… Four sources with knowledge of the matter told Reuters that state banks were seen swapping yuan for dollars in onshore forwards market to support the Chinese unit. ‘Yesterday big banks were all selling one-year onshore forward swaps, then in the afternoon the spot dollar-yuan fell,’ said a trader… in Shanghai.”

China’s major state-owned backs can support the renminbi through clandestine derivatives trading, while supporting the faltering small bank sector with liquidity and capital injections along with bolstering the faltering Chinese Bubble with aggressive Credit growth. This, as well, is an ostensible miracle – until it all blows up. To repeat: How large is the “carry trade” in higher-yielding Chinese securities? Add to this: How large are the big Chinese banks’ derivatives positions in support of the renminbi?

I am clearly not alone in the view that Beijing took a huge gamble in moving to devalue the Chinese currency this week. They today have a large international reserve position. Over the coming weeks and months, I expect analysts to increasingly question the adequacy of these reserves in light of extraordinary financial and economic vulnerabilities.

The key take-away from another critical week: As the marginal provider of global liquidity and economic growth, Chinese finance has become the epicenter of crisis dynamics. Global markets are highly correlated; speculative dynamics remain extraordinarily synchronized. At this point, a bet on global risk markets is a bet on China – a bet on the ongoing inflation of China’s historic Bubble. Developments – market, policy, economic and geopolitical - are corroborating the analysis that it’s very late in the game. I’ll assume the flow of “hot money” away from global risk markets has commenced.

Trade Disruption Is a Symptom of a Deeper Malaise

Trade tensions are a symptom rather than a cause of the world’s underlying economic and financial malaise. Moreover, an excessive focus on trade could deflect policymakers’ attention from other measures needed to ensure faster and more inclusive growth in a genuinely stable financial environment.

Mohamed A. El-Erian


NEW YORK – It’s only a matter of time until the escalating tensions between China and the United States prompt many more economists to warn of an impending global economic recession coupled with financial instability. On August 5, Bloomberg News said that the yield curve, a closely watched market metric, “Blares Loudest US Recession Warning Since 2007.”

And Larry Summers, a former US Treasury Secretary who was also closely involved in crisis-management efforts in 2008-09, recently tweeted that “we may well be at the most dangerous financial moment … since 2009.”

Many economists argue that resolving US-China trade tensions is the best way to avoid significant global economic and financial disruption. Yet, while necessary, this would be far from sufficient.

Don’t get me wrong: the focus on the deteriorating relations between China and America is entirely understandable. After all, their worsening dispute increases the risk of a trade war which, coupled with a currency war, would lead to “beggar-thy-neighbor” (that is, lose-lose) outcomes cascading throughout the global economy. As growth prospects deteriorated, debt and leverage issues would come to the fore in certain countries, adding financial instability to an already damaging economic cocktail.

And with the US-China row now extending beyond economics to include national-security and domestic political issues, the best-case scenario on trade is a series of ceasefires; the more likely outcome is escalating tensions.

Yet, when viewed in the broader context of the past decade, trade tensions turn out to be a symptom rather than a cause of the world’s underlying economic and financial malaise. In fact, an excessive focus on trade risks is deflecting policymakers’ attention from other measures needed to ensure faster and more inclusive growth in a genuinely stable financial environment.

Policymakers must also contend with growing political pressure on central banks, the backlash against the inequality trifecta (of income, wealth, and opportunity), the politics of anger, the growth of anti-establishment movements, the loss of trust in governments and expert opinion, regional economic and geopolitical tensions, the growing risk of financial instability, threats to long-term financial-protection products, and a general sense of economic insecurity.

As I argued in The Only Game in Town, all of these recent developments – and also, of course, the growing US-China tensions – are related in a meaningful way to two basic and persistent features of the global economy since the 2008 financial crisis.

The first is the prolonged period in which economic growth has been not only too low but also insufficiently inclusive. As a result, growing segments of the population have felt marginalized, alienated, and angry – leading to unexpected election outcomes, the rise of populist and nationalist movements, and, in a few cases, social unrest.

The second post-crisis feature is the persistent over-reliance on the pain-numbing but distortionary medicine of central-bank liquidity, rather than a more balanced policy mix that seeks to ease the (mainly structural, but also cyclical) impediments to faster, more inclusive growth. Monetary policy has not been very effective in boosting sustainable growth, but it has lifted asset prices significantly. This has further fueled complaints that the system favors the already-rich and privileged rather than serving the broader population – let alone helping more disadvantaged groups.

If both these features persist, the global economy will soon enough come to an uncomfortable binary prospect on the road ahead. At this “T-junction,” the current, increasingly unsustainable path will give way either to a much worse outcome involving recessions, financial instability, and rising political and social tensions, or, more optimistically, to a pick-up in inclusive growth and genuine financial stability as the governance system finally responds to popular pressure.

Moreover, the journey to the neck of this T-junction is itself increasingly uncertain. In particular, the protracted use of unconventional monetary policies has entailed costs and risks that have intensified over time. These include attacks on the operational autonomy of central banks, the excessive decoupling of asset prices from their underlying economic and corporate fundamentals, and systemic overpromising of liquidity to end users (particularly in the non-bank sector). Today, a policy mistake or a market accident could make the journey much faster and a lot bumpier.

To avoid a nasty outcome for the global economy and financial system, China and America need to resolve their differences in the context of a more comprehensive policy compact that also involves other leading economies (especially Europe).

Efforts to revitalize free but fairer trade should start by addressing genuine US and European grievances vis-à-vis China regarding intellectual-property theft, forced transfer of technology, excessive subsidization, and other unfair trade and investment practices. And this in turn should serve as the foundation for a comprehensive multilateral effort to remove constraints on actual and potential growth.

Such an initiative would include infrastructure rehabilitation and modernization in Europe and the US, more balanced fiscal policies in Europe and a stronger regional economic architecture, stronger social safety nets around the world, and targeted liberalization and deregulation in China and Europe.

With concerted global action of this type, the world economy could navigate the upcoming T-junction favorably. Without it, current complaints about economic and financial instability and insecurity could pale in comparison to what comes next.

Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He is President Elect of Queens’ College (Cambridge University), senior adviser at Gramercy, and Part-time Practice Professor at the Wharton School at the University of Pennsylvania. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers four years running. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.

Il Capitano

Will Matteo Salvini wreck the euro?

The most powerful man in Italy is perhaps the most dangerous in Europe

“HE’S ALMOST here...he’s arrived! He’s arrived!” bawls the mayoral candidate, as a sea of blue and white flags declaring Prima L’Italia, Italy First, wave in the summer evening air of the ancient Umbrian hill city of Orvieto. And as the cheers and the shouts of “Mat-te-o! Mat-te-o!” swirl around the medieval buildings, the man the crowd is really here to see walks onto the stage: Matteo Salvini in chinos and an open-neck shirt, sleeves rolled up, slightly tubby, as ordinary-looking as any of the adoring fans jammed into the little square.

They call him Il Capitano. No Italian can fail to hear an echo of Mussolini’s nickname, Il Duce. Critics see neo-fascist overtones everywhere—from the fact that Mr Salvini recently published a book using a publishing house with links to a far-right outfit, CasaPound, to the observation that he has been seen in a jacket made by a designer the CasaPounders favour. His personality cult, driven by dozens of daily tweets and Facebook posts, expertly crafted to show him as a man of the people, on the side of the little guy against the elite, comes in for similar suspicion.

But you don’t have to believe that Mr Salvini is a neo-fascist, or could succeed as one in a place as pluralistic as Italy, to be alarmed by his rise. Nominally, his party, the right-wing Northern League, is the junior partner in an unlikely and unstable coalition government with the anti-establishment Five Star Movement (M5S).

In reality, Mr Salvini has been the most powerful man in Italy since shortly after he became a deputy prime minister in June last year. His relentless rise in the opinion polls, and the League’s stunning victory at the European Parliament elections in May, mean that he, more than anyone, makes the political weather. It is quite a feat for a man and a party that six years ago won just 4% of the vote. The League took 17% in last year’s general election, 34% in May, and is polling even higher now.

The problem is that Mr Salvini has not risen to pre-eminence by solving or showing how he might solve any of Italy’s obvious malaises. Its economy is stagnant. Between 2008 and 2018 Italy’s GDP fell by 3% in total, compared with a 13% rise in Germany, a 10% rise in France and a 4% rise in Spain, the three other big euro-zone economies. It has stubbornly high unemployment, at around 10%. He has won support, rather, by the well-tested populists’ method of finding others to blame. And that carries big risks, for Italy and for Europe.

There are two favourite enemies: migrants and Brussels. As he revs up the crowd in Orvieto (the local candidate he was there to back last month went on to win the mayoralty easily in what has traditionally been Italy’s central left-dominated “red belt”), Mr Salvini takes swipes at both. He tells listeners that he respects the right of people to believe in other gods, “Just so long as that God does not come and tell me that women are worth less than men and that they must go around in a burqa.” Vast applause ensues. “More carabinieri! Fewer irregular aliens!” he cries. Loud cheers.

Since taking the additional post of interior minister in the coalition government, Mr Salvini has used his powers to clobber migrants. As one of his first actions, he closed Italian ports to NGO boats carrying people rescued from the sea, and has now passed a new law making those who try to land them vulnerable to huge penalties. (Carola Rackete, the 31-year-old German captain of one such vessel, is currently facing charges after docking in Lampedusa.)

The coastguard does land small numbers of rescued migrants, but these days patrols a much smaller area of sea than before. Mr Salvini has slashed funding for reception centres, and tightened the criteria for migrants being granted protected status. The flood of arrivals, at 181,000 in 2016, has become a trickle, just over 3,000 so far this year. Mr Salvini has scooped up the credit for this, even though the decline is mostly the result of tough actions by the previous government.

Migrant-bashing carries few costs for Mr Salvini, except in the court of liberal opinion, for which he cares little. His fellow European leaders mostly turn a blind eye. They do not want to help Italy cope with its migrants, or take many more themselves. Emmanuel Macron, France’s president, openly detests Mr Salvini (and complains that populism is spreading across Europe “like leprosy”), but has pointedly refused to take the rescue ships that Mr Salvini turned away. Mr Salvini’s skilful stoking of anti-migrant feeling has made him the most popular politician in the country. But since so few migrants are now arriving, this has its limits.

The enemy beyond

The other enemy Mr Salvini rages against is more likely to fight back. But threatening a showdown still pays electoral dividends. “We will put up a fight in Europe, because if you don’t even put up a fight, like the governments in the past, who went to Brussels cap in hand and their trousers round their ankles, it’s clear you can’t win,” Mr Salvini told selfie-snapping supporters in Orvieto.

This has the markets and other European governments spooked. Mr Salvini’s confrontation with Brussels waxes and wanes, but never goes away; and until he abandons it, the threat to the euro zone itself is real, and potentially deadly. In the past Mr Salvini has spoken of a desire to take Italy out of the euro, and perhaps even the EU itself, which he has called a “gulag”. That is not his current policy, doubtless because there is no majority support for either. But he clearly chafes at their restrictions, and no one knows when he might decide to try to break free of them, by ignoring the rules despite the risk of a bond crisis, or even by going back to his earlier position and leaving altogether.

The drama has been going on for a year now. When the populist coalition came into office in June 2018 its costly economic promises posed immediate problems. M5S, led by Luigi Di Maio, had pledged a guaranteed income for the hard-up; the League a low, flat rate of income and corporation tax. Both had vowed to reverse unpopular reforms that had raised the state pension age. Together they showed little regard for the EU’s fiscal rules. These require that Italy’s vast public-debt burden—over 130% of GDP, second only to Greece in Europe—fall towards 60% at a prescribed pace.

Twice now Brussels has threatened to penalise Italy for its excessive debt, and twice the government has meekly toned down its deficit plans. In autumn last year ten-year government-borrowing spreads over German bunds approached 3.4 percentage points, leading the coalition to curb its deficit plans for 2019 from 2.4% to a cunningly precise 2.04%. In June Brussels made threatening noises again as it became clear that Italy’s debt ratio had risen in 2018, rather than fallen. On July 1st the coalition promised a round of savings and spending cuts, worth €7.6bn (0.4% of GDP). This week euro-zone finance ministers declared themselves satisfied by the concessions. Spreads are narrower: as of July 10th they stood at two percentage points.

But a bigger confrontation is looming. The government has begun its “citizens’ income” scheme for the poorest households. Nodding slightly at the notion of a flat tax, it has lowered tax rates for some self-employed people. But these watered-down versions of electoral promises have underwhelmed supporters. Both coalition partners face pressure to do more next year; especially M5S, whose popularity has collapsed. Even without extra commitments, Brussels expects Italy’s budget deficit in 2020 to break through not just the 2% ceiling that is there to get the debt under control, but the larger 3% one that all countries are meant to stick to. If no compromise is reached, Italy could eventually be fined as much as 0.2% of GDP (€3.5bn). That is unlikely: no country has ever been punished in this way. But the threat of it would alarm markets.

Other sources of anxiety are growing. Although Mr Salvini and other ministers have since the election said they have no plans to leave the euro, occasional noise from others adds confusion. On May 28th the parliament passed a non-binding motion asking the government to consider issuing “mini-BoTs”, low-value bills designed to help the state pay commercial suppliers. The clause on mini-BOTs had reportedly been inserted into the motion at the last minute, catching many lawmakers unawares. Claudio Borghi, a Euro-sceptic League economist and close adviser to Mr Salvini who heads parliament’s finance committee, has previously argued that mini-BoTs could be “spent anywhere to buy anything”, raising suspicion that they would act as a parallel currency in preparation for leaving the euro. As investors became uneasy, Giovanni Tria, the finance minister, was forced to respond, attempting to rule out the idea. But Mr Salvini has said he still considers it an option.

Mr Tria and Giuseppe Conte, the technocratic prime minister, would surely resign and bring down the government rather than permit mini-BoTs. But an election (which he might well choose to trigger anyway) could bring Mr Salvini to power as prime minister of a right-wing coalition with the far-right Brothers of Italy. But either way, an accidental bond crisis triggered by the issue remains possible.

The battle round the corner

The coalition’s truce with the commission on the public debt is anyway likely to prove fleeting. The next flashpoint is close: the government must thrash out next year’s budget by October or thereabouts. If Mr Salvini and Mr Di Maio keep their promises and enact lavish spending rises and tax cuts, investors and ratings agencies may again panic. If instead they cave in and choose to comply with the EU’s rules, as they finally did last year, they will either need to back down from their plans, or find a way to plug a hole in the public finances of tens of billions of euros. Either of those options will be politically very tricky.

The commission already expects Italy to run a budget deficit of 3.5% of GDP next year, at odds with the government’s projection of 2.1%. The difference comes down to whether or not a value-added-tax increase, which has already been legislated for, comes into effect. The commission points out that such stopgap clauses have consistently been repealed in recent years. Both Messrs Salvini and Di Maio, aware of its unpopularity, have already promised to avert the increase. That means somehow finding an additional €23bn. No one knows where that money would come from. Mr Di Maio has already ruled out cuts to welfare spending. And on top of the expected big deficit, Mr Salvini wants to cut taxes further in pursuit of his promised flat tax of 15% for companies and individuals.

Mr Salvini’s call for more fiscal flexibility is not by any means absurd: many economists reckon the EU’s rules are too tight. The problem is that Mr Salvini has antagonised the commission and northern member states, which are wary of being on the hook for other countries’ profligacy. So Mr Salvini is not likely to get much slack from European leaders. Though the European Parliament elections in May were a triumph for him domestically, at the European level they were a disaster. He had staked out a claim to lead a pan-European alliance of nationalists that would change the face of European politics, the nationalist cause failed to make headway beyond Italy. Mr Salvini’s reckless rhetoric has made it less likely, not more, that Germany and the “New Hanseatic League” of fiscally orthodox northern European countries will indulge him.

Mr Salvini has done nothing to help his cause in Europe by courting Vladimir Putin. He has been spotted wearing a Putin T-shirt, is a frequent visitor to Moscow and has allowed the Veneto region, run by the League, to recognise Crimea, a chunk of Ukraine that Russia has illegally annexed. This infuriates the eastern Europeans who might otherwise be his allies. The suspicions of a sinister Moscow-Rome axis have been stirred by tapes, published this week and confirming earlier reports, that appear to show a former close aide to Mr Salvini meeting unidentified Russians in Moscow to discuss the secret funding of the League with money derived from a dodgy oil deal. Mr Salvini says he has never taken “a rouble, a euro, a dollar or a litre of vodka”, and there is no evidence that any money was ever actually paid to anyone.

Long range effects

Even if a crisis is again averted this autumn, a deeper fear about Mr Salvini remains. It is not so much what he has done, as what he has failed and will fail to do. Matteo Renzi, prime minister from 2014 to 2016 and a genuine reformer, is scathing. “He seems macho, but what has he ever done that is brave?” he asks. “He is not a leader, he is an algorithm.” Certainly the first year of Mr Salvini’s pre-eminence has seen nothing that suggests that the all-populist government has any interesting plans for doing anything about Italy’s chronically low growth. Fighting with Brussels and turning away boatloads of migrants are good ways to fire up supporters, but such gestures do not create jobs.

Italy’s problems remain what they always were: a labyrinth of regulations that discourage companies from growing, and labour laws that entrench the power of unions in larger companies, doing more to protect those already in work than open up chances for those outside it. Francesco Grillo of Vision, a think-tank in Rome, notes that Italy spends more than four times as much on pensions as on education. And yet one of the early acts of the new coalition was to undo modest pension reforms that would have made the system more affordable. If you join the workforce at 18 and work continuously, you can now retire at 60.

The new government has done virtually nothing that would help with any of this. The League has, to be fair, pushed for new procedures that could speed up the approval of infrastructure projects. The proposed sblocca cantieri (“unblocking works”) bill, however, has so far been opposed by the M5S. One of the M5S’s main appeals to voters has, after all, been the promise to crack down on corruption, and short-circuiting the approvals process risks undermining that fight.

Added to that, the government policies that have been enacted have been shoddily executed. The size of the “citizen’s income” that the state will hand out was set arbitrarily, says Tito Boeri, formerly the head of the national social-security administration. It is too generous to single people, particularly in the south. Payments taper off as soon as a recipient earns more, which risks discouraging the unemployed from taking up work.

The government has also done little or nothing to tackle vested interests. Important reforms such as broadening the tax base, eliminating tax loopholes and overhauling the judicial system have fallen by the wayside. This lack of focus on economic growth and lingering doubts over the commitment to the euro might be why Italy’s bond spreads are higher now than before the elections in 2018.

Mystery man

The next few months will reveal if the coalition prizes its credibility with investors. Financial markets have been relatively calm this year, with investors pricing in compromise, not confrontation, with Brussels. But spreads could quickly widen if the coalition does not restrain its budget plans. The banking system too is vulnerable: holdings of Italian sovereign debt account for a tenth of Italian lenders’ assets, well above the euro-area average. Part of that portfolio would be repriced as bond prices fall, eroding banks’ ability to withstand losses. A hit to the economy would close the “doom loop”, where weak sovereigns and banks drag each other down.

Past experience, in 1992 and in 2011, shows that governments tend to buckle under pressure from the markets. So far this coalition has been no different. And the elements of a compromise do exist. Mr Salvini could further moderate his programme of tax cuts. A small increase in VAT might help plug the gap, and have the virtue of signalling a commitment to fiscal discipline. Meanwhile Brussels may be content to accept a slightly higher deficit, provided it does not breach the 3% threshold.

But Mr Salvini may decide otherwise. He may stick to his guns; or he may surrender. He may force an early election; he may not. The troubling fact for Europe is that no one knows what this meteor that has flashed across Italy’s skies will do next.

The problem with the amazing, disappearing Bund market

Restraint in German public spending means eurozone bond markets are short of their safest assets

Tommy Stubbington in London

If there are not enough German government bonds around, banks could run short of high-quality collateral for lending

Germany has just sold €3.2bn of new 10-year bonds at a negative yield: the latest demonstration that investors are prepared to pay for the privilege of lending to Europe’s largest economy.

But despite the red-hot demand for its debt, Berlin is resisting any temptation to go on a borrowing spree. Quite the opposite. Germany’s finance agency announced in April that its ratio of debt to gross domestic product would this year drop below 60 per cent — a sharp decline from more than 80 per cent as recently as 2012, meaning that Germany is the first big EU economy to meet the Maastricht guidelines on public debt since the financial crisis.

Rather than saluting this Teutonic restraint, some investors are raising concerns that the country’s dwindling debt pile is actually a problem. Bunds — as German bonds are known — are the eurozone’s benchmark safe asset. If there are not enough of them around, banks could run short of high-quality collateral for lending, while the European Central Bank will struggle to find enough bonds to buy if it wants to revive its quantitative easing programme to combat a downturn.

“A German public spending splurge appears about as likely as a clear head after a day at the Oktoberfest, given that responsible management of public finances is a cornerstone of any mainstream political proposition,” said Christopher Jeffery, a fixed-income strategist at Legal & General Investment Management. “But at some point soon there will have to be some serious thinking about the implications of the amazing disappearing Bund market.”

Mr Jeffery has modelled German debt levels over the next two decades, and thinks that — even with conservative assumptions about growth, inflation and budget surpluses — the decline in the debt relative to the size of the economy is likely to be precipitous. Interest costs are set to fall even further over the next five years as maturing German bonds get refinanced at lower rates, according to the analysis.

“By the mid-2030s there is a very plausible scenario where German government debt has almost entirely disappeared,” he said.

Does it matter if a country has too little debt? After all, at the height of the eurozone crisis the “bond vigilantes” focused their attention on countries such as Greece, Portugal and Italy that were thought to have borrowed too much. Germany’s finance ministry, for its part, notes that the outstanding amount of Bunds has been practically flat over the past seven years, despite fiscal consolidation — and that demand has been pushed up by the ECB’s bond-buying.

But critics say Berlin’s parsimony is a missed opportunity to renew creaking infrastructure and boost public services at home. It also exacerbates the woes of the eurozone’s periphery, the critics say, by robbing the currency bloc of a potential fiscal boost that more fragile nations are not in a position to provide. Those arguments have largely fallen on deaf ears in Germany itself, which enjoyed a relatively robust economic rebound after the crisis. The country’s “debt brake”, a 10-year old rule enshrined in the constitution, essentially bans Berlin from running budget deficits.

“People have been saying for years Germany should be loosening the purse strings,” said Mike Riddell, a senior fund manager at Allianz Global Investors. “But if their economy is growing rapidly, why should they?”

For markets, however, there are some uncomfortable implications. Banks rely on a ready supply of highly rated government debt to use as collateral for lending. But the amount of such debt shrank dramatically during the crisis, thanks to a slew of downgrades from credit rating agencies. According to a speech earlier this year by ECB executive board member Benoît Cœuré, triple A-rated sovereign debt in the eurozone amounts to just 10 per cent of GDP, compared with 70 per cent in the US.

A further decline in Germany’s debt pile would leave lenders scrapping over a dwindling supply, depressing the government’s debt interest costs.

A shortage of German debt is already complicating the ECB’s stimulus plans. The central bank’s own rules currently limit it to buying up to one-third of any issuer’s outstanding debt. In practice, this means Germany’s bond market is a bottleneck for further QE. ECB president Mario Draghi has recently indicated these limits could be relaxed to allow for a revival of bond buying — a hint that helped fuel the recent global debt rally.

Even so, if Mr Jeffery’s forecast is anywhere close to accurate, even allowing the ECB to buy half of all German bonds might leave it with too few to purchase in a future downturn.

“The scarcity becomes a much more significant concern in the event of a recession,” said Jamie Stuttard, a portfolio manager at Dutch asset manager Robeco.

Such a possibility appears to be lurking. German growth has slowed this year as the country’s dominant manufacturing sector is knocked by global trade tensions.

A protracted soft patch could quickly shift the conversation toward loosening public borrowing constraints in Germany, particularly as a rapidly ageing population fuels higher demand for public services, according to Jim Leaviss, head of retail fixed interest at M&G Investments.

“To get down to sub-50 per cent [of GDP] debt levels in a world where there are some big headwinds seems like a heroic assumption,” he said. “There will be social pressure to raid the piggy bank.”

Additional reporting by Guy Chazan

Gold's Path To $5,000: The 'New Economic Reality'

by: Victor Dergunov
- GLD/Gold has appreciated by around 30% since the Fed flipped on its monetary policy late last year.

- You can expect a brief short-term correction, but this should be another extraordinary long-term buying opportunity.

- It's not just Fed easing, as there is an essential "race to the bottom" amongst major central banks around the world.

- The Fed is likely only getting started with its easing cycle and the monetary base should expand substantially over the next 3-5 years.

- Gold has a direct correlation with the U.S.'s monetary base, and as the "new normal economic environment" becomes evident, gold should go much higher.
Gold's Path to $5,000: The "New Economic Reality"
SPDR Gold Shares (GLD)/Gold has appreciated by about 30% since my "Don't Panic: This Is a Golden Long-Term Buying Opportunity" article I wrote on August 16, 2018. This was a time when the Fed was tightening and gold hit a short-term bottom at around $1,175 following a vicious sell-off.
Gold 1-Year Chart
Gold chart
In this article, I called out the Fed on its tightening program, mentioning that the economy was unable to sustain higher rates, and the Fed would need to reverse policy and, eventually, introduce new rounds of QE to support markets and the slowing economy.
Here we are, roughly 1-year later, the Fed is now cutting instead of tightening, is putting an end to its QT program, is likely to continue to bring rates down close to zero (or zero, possibly negative), and should eventually introduce new rounds of QE.

Therefore, my thesis has not changed. Moreover, the recent rally, while very impressive is likely only the beginning of a long-term bull market in gold that should take gold/GLD prices much higher over the next several years.
GLD: Great Way to Build Exposure to Gold
GLD is the largest physically-backed (reportedly) gold exchange-traded fund in the world, with roughly $40 billion worth of net assets. It offers market participants an efficient way to access the gold market, as it mimics the price of gold almost identically.
In addition, the ETF is an attractive alternative to trading gold futures, as it can be traded much like a stock on the NYSE Arca exchange, instead of dealing with alternative exchanges and trading requirements pertaining to futures contracts.
Furthermore, it is an appealing alternative to trading physical gold, as investors get exposure to the same price action as the metal but can buy and sell gold with great fluidity of an ETF using GLD.
Chart Data by YCharts
Since the ETF mimics the price of gold almost identically, I will refer to GLD and gold interchangeably throughout this article.
A Closer Look at the Recent Move Higher
Gold has skyrocketed by nearly 20% over the past 2.5 months. Now, this is due to several factors, the main one being the Fed and its recent embankment on a new easing cycle. However, I must say, the recent move looks excessive, and gold is now substantially overbought on a short-term basis.
Gold 6-Month Chart

This does not mean that the rally is over. Nevertheless, a correction seems very likely. In fact, gold is already starting to correct and is trading slightly below $1,500 at the time of writing this article.
Gold Price 5-Day Chart
Now, gold could consolidate around the $1,480-1,500 level and proceed higher or gold could possibly correct to around the $1,440-1,450 level. This would represent a textbook 5% correction and would very likely create an incredibly lucrative long-term buying opportunity.
I do not expect gold to fall below $1,440 in this easing economic environment, and in my view, gold may never fall below this level again.
It's Mostly About the Fed
It would typically be all about the Fed as the Fed has pulled a complete 180 on monetary policy over the past year. Last year, it was tightening, and even as late as mid-December, the consensus was that the benchmark rate would be between 2.5% and 3% by December of this year. However, if we look at probabilities now, the benchmark rate will likely be around 1.25-1.75% by this December.
Then (August 16, 2018):
And Now (August 8, 2019):
Moreover, I believe the Fed will continue to cut the funds rate until it reaches zero (possibly go negative), like Japan for instance, and will very likely introduce fresh rounds of QE.
Why will the Fed do all this?
The Fed "officially" has a dual mandate, to promote maximum employment, and ensure price stability (keep inflation at around 2%). However, the Fed appears to have a few other mandates as well. These appear to be to support the U.S. economy, prop up equity markets, and attempt to delay the recession by any means necessary.
Fed chair Powell
Thus, the Fed is essentially prepared to use multiple tools at its disposals to keep the U.S. economy from falling into a recession. Naturally, this will require extremely low rates and probably a lot of QE. Everything the Fed is likely to do over the next several years is extremely bullish for gold.
Also, it is not just the Fed. Central banks all around the world are easing, and by easing, I mean" printing" enormous amounts of fiat currencies. Look at the recent move in China to essentially devalue the yuan.
The ECB has implemented QE in the past and has held their benchmark rate at zero since 2016. So, I see no reason why the ECB will not implement additional QE as the global slowdown continues.
ECB Benchmark Rate 10-Year Chart
These are just a few examples, but the fact is that major central banks around the world are doing several things. They are trying to weaken their currencies to "improve economic activity", make their exports cheaper in foreign markets, bring down bond/treasury rates, etc.

This is essentially a race to the bottom, where central banks are "creating" enormous amounts of currencies while there is only so much gold in the world. This is extremely bullish for gold and GLD, gold/silver/miners GSMs in general.
Gold's Direct Correlation with U.S. Monetary Base
In my 2019 February 22nd article "Gold: The Big Picture", I outlined in detail gold's direct correlation with the U.S.'s expanding monetary base. In the article, I discussed how gold has appreciated by about 3,760% since 1970, while the U.S.'s monetary base had expanded by roughly 4,300 in the same time frame.
Now gold is up by around 4,200% since 1970, as the monetary base is getting set to expand again, but this time not only in the U.S. but around the globe. Here is what happened the last time the Fed expanded the monetary base with zero rates and QE following the 2008 recession.
Also, a factor to notice is that since the monetary base has decreased to about $3.2 trillion due to recent Fed tightening and QT, gold is now starting to outperform on a historic basis, up by 4,200% (using the recent high of around $1,520) vs. the monetary base's 4,000% in the same time frame.
I believe this trend of gold outperformance could and will continue as the world becomes flooded with more dollars, euros, yens, yuans, etc.
Source: St. Louis Fed
From 2008 to 2015, the monetary base surged from around $800 billion to roughly $4 trillion, an increase of about 400% or 5-fold. Gold prices lagged percentage wise because market participants were led to believe that this would be a temporary measure and that the Fed would eventually normalize rates and decrease the monetary base through QT.
However, we recently learned that the U.S. economy cannot withstand higher rates and QT.
That is probably predominantly why the economy began to slow down substantially late last year and the stock market (S&P 500) crashed by 20%.

Thus, it is now clear that for the U.S. economy to expand (or to at least not to go into a recession), lower rates are required. Furthermore, more QE will very likely be required as well to keep growth alive, and probably even more QE will be needed to eventually pull the U.S. economy out of the upcoming recession.
Therefore, the monetary base is likely to increase substantially over the next several years.
Instead of $4 trillion, the U.S.'s monetary base may balloon to $8 trillion or more over the next 5 years.

Perhaps more importantly, market participants may begin to understand that these monetary expansions are not simply temporary measures, but are the "new normal".
Hence, gold prices have a lot of catching up to do. While the U.S.'s monetary base has more than quadrupled over the last 10 years (up by about 307%), gold prices have only risen by about 88% in the same time frame. This was again because many market participants believed the Fed would ultimately normalize rates and contract the monetary base substantially.
However, as the new economic reality sets in; meaning that instead of contracting the monetary base, the Fed is about to expand it again and could continue to expand it substantially for an indefinite period of time, gold is likely to go much higher to keep up with its historic correlation and the ever-expanding money supply.
The "Easing" is Just Getting Started

Let's presume that over the next 3-5 years, the Fed continues its easing policy to first attempt to delay the recession, and then to stimulate economic growth following the recession.
Let us also presume that in this time, the Fed expands the monetary base to around $8 trillion. In my view, this may be a relatively conservative estimate considering that the Fed is already starting to ease and will likely continue to ease up to, through, and after the recession. Let's also contemplate that this will not be a temporary measure, but a sort of "new normal economic reality".

This would mean that the monetary base could expand by 10-fold from 2008 to around 2022-2025. So, if gold continues its historic correlation with the expanding money supply it can only go much higher.
The $64,000 question: How much higher?
Well, since the monetary base can expand by 10-fold from 2008 to 2022-2025, then why couldn't gold? Gold was trading at around $800 in 2008, so it is entirely plausible that gold could also expand by around 10-fold and reach a price of roughly $8,000 by 2025.
However, even if we take a much more conservative approach and say gold increases in value by around 5-fold, we arrive at a price of $4,000. In this scenario, percentage wise, the U.S.'s monetary base and the price of gold would both appreciate by around 10,500% from their levels in 1970. Gold from roughly $37 to $4,000, and the U.S.'s monetary base from around $75 billion to $8 trillion.
However, due to gold's recent outperformance and the likelihood of this trend continuing due to the immense fiat production around the globe (not just in the U.S.), a $5,000 price target on gold within the next 5 years seems more plausible in my view.
The Bottom Line: Buy Gold, GLD, and GSMs, in General
The Fed, along with other major central banks, around the world are in a race to the bottom to devalue their currencies. They are doing this to make exports cheaper, stimulate economic activity, prop up asset prices, attempt to delay recessions, bring bond and interest rates down, etc.
There is only so much gold in the world to go around, yet the money that the Fed and other central banks can print is essentially limitless. Also, we see that normalizing rates, raising the benchmark rate in the U.S. to 4-5%, and deflating the monetary base are fantasies. The U.S. economy, much like many other developed economies cannot continue to expand or to even function properly under such conditions.
The "new normal" is for the monetary base to continue to expand indefinitely. This is largely due to the enormous amounts of government debt developed nations have accumulated over past decades. You can read in detail about America's debt problem in my "America's Impending Debt Crisis" article.

I won't go into too much detail about it now, but basically America's national debt, at over 106% of GDP is going to lead to a "new normal" of extremely low or negative interest rates, and a much weaker dollar. This is a perfect environment for gold and GSMs, in general, to thrive in.
U.S. Debt to GDP Ratio 20-Year Chart
Ultimately, to sustain this new normal economic environment the Fed will need to keep most key rates at zero or negative and will need to implement QE so it can expand the monetary base to devalue our national debt. Naturally, this will reflect very poorly on the USD.
Therefore, gold at $5,000 in 3-5 years seems plausible, and it is likely to continue to go higher after that. Naturally, there will be corrections along the way but I believe we are in the beginning stages of a multi-year bull market in GLD/gold.
$5,000 in gold would equate to roughly $466 in GLD, about a 233% gain from current levels.