Extraordinary Q2 2020 Z.1 Flow of Funds 

Doug Nolan

The numbers are just monstrous.

The Fed’s own data illuminate the historic Monetary Disorder that today runs wild. 

The Federal Reserve’s balance sheet. Treasuries. Debt and Equities Securities. The banking system. The Household balance sheet. Rest of World holdings.

In short, finance has completely run amuck, with the data corroborating the super cycle “end game” thesis.

Non-Financial Debt (NFD) increased $3.522 TN during Q2, more than doubling Q1’s record $1.449 TN gain. This pushed first-half NFD growth to an incredible $4.971 TN. 

For perspective, NFD expanded $2.439 TN in 2019 and averaged $1.826 TN annually over the past decade. Q2 growth actually surpassed 2004’s annual record $2.912 TN NFD expansion.

At $59.304 TN, Non-Financial Debt surged to a record 304% of GDP. NFD-to-GDP ended 1999 at 184%, 2007 at 227%, and 2019 at 250%.

“Off the charts,” as they say.

Unprecedented deficit spending saw Treasury Securities jump $2.852 TN during the quarter to a record $22.371 TN. Treasuries were up $3.352 TN during the first-half.

Over the past year, Treasuries jumped $4.556 TN, or 25.6%. This dwarfs the previous annual record (2010’s $1.645 TN). After ending 2007 at $6.051 TN, outstanding Treasury Securities ballooned $16.320 TN, or 270%. Treasuries ended Q2 at 115% of GDP. This is up from 44% to end the nineties; 41% to conclude 2007; and 69% to close out 2010. 

Agency Securities declined $25 billion during Q2 to $9.746 TN. Agency Securities were up $481 billion during the past year and $786 billion over two years. Having increased an incredible $5.037 TN over the past four quarters, combined Treasuries and GSE Securities ended Q2 at $32.117 TN, or 165% of GDP.

Total Debt Securities jumped $3.364 TN during Q2 to a record $51.690 TN. Over the past year, Debt Securities jumped $5.959 TN (more than double 2007’s record $2.669 TN increase). As a percentage of GDP, Debt Securities surged to 265%. For comparison, Debt Securities ended 2007 at 200% of GDP; the nineties at 157%; the eighties at 126%; and the seventies at 74%.

Total Equities surged $9.121 TN during the quarter to $51.956 TN, with a one-year increase of $884 billion (1.7%). Equities as a percentage of GDP rose to a record 267%. This compares to cycle peaks 181% at the end of Q3 2007 and 202% to conclude Q1 2000. 

Total (Debt and Equities) Securities increased an unprecedented $12.485 TN during Q2 to a record $103.646 TN. This more than doubled Q1 2019’s record $5.970 TN gain. 

For comparison, Q4 2009’s $3.449 TN gain was the largest increase prior to 2019. Total Securities ended Q2 at a record 532% of GDP, compared to cycle peaks 379% during Q3 2007; and 359% to end Q1 2000. Total Securities ended the eighties at 194% and the seventies at 117%.

The Household balance sheet always offers fruitful Bubble Analysis. Unprecedented growth in the Fed’s balance sheet, debt and securities translated into record Household perceived wealth. Household Assets jumped $7.637 TN during Q2 to a record $135.435 TN. And with Liabilities only increasing about $29 million, Household Net Worth inflated a quarterly record $7.607 TN - to an all-time high $118.955 TN. Net Worth was up $5.0 TN over the past year. Net Worth ended the quarter at a record 610% of GDP. This compares to previous cycle peaks 492% (Q1 2007) and 446% (Q1 2000). 

Household holdings of Financial Assets increased $7.0 TN during the quarter (up $3.758 TN y-o-y) to $94.548 TN (record 485% of GDP). For comparison, Financial Assets ended 2007 at $54.557 TN (372% of GDP) and 1999 at $34.656 TN (350% of GDP). Real Estate holdings ended Q2 at a record $34.406 TN, with a y-o-y gain of $1.493 TN. At 177% of GDP, Real Estate holdings as a percentage of GDP reached the highest level since Q4 2007.

Banking system (“Private Depository Institutions”) Assets jumped $859 billion (almost 16% annualized) during the quarter to a record $22.780 TN – a gain second only to Q1’s $1.869 TN jump. Loans increased (a measly) $24 billion, or 0.8% annualized (with mortgages up $36bn). The Asset “Reserves at the Fed” jumped another $313 billion to a record $2.787 TN. “Fed Funds and Repos” Assets rose $204 billion to a record $863 billion. Debt Securities holdings surged a record $359 billion to an all-time high $5.241 TN. Treasuries gained $207 billion, surpassing $1 TN ($1.102TN) for the first time, and Agency/GSE MBS rose $110 billion to a record $2.934 TN. 

Over the past year, Bank Assets surged $3.268 TN, or 16.7% (more than doubling 2008’s annual record $1.249 TN).

Reserves at the Fed jumped $1.366 TN, while Loans expanded $862 billion and “repos” increased $507 billion. Bank Debt Securities holdings surged $743 billion, or 16.5%, with Treasuries up $331 billion, or 43%, and Agency Securities gaining $353 billion, or 13.7%. Corporate, muni and open-market paper gained moderately during the quarter and y-o-y. 

On the Bank Liability side, Total (Checking and Time & Savings) Deposits surged a record $1.376 TN during Q2 to an all-time high $18.037 TN. Total Deposits rose $2.515 TN during the first half, or 32% annualized – and were up $3.056 TN, or 20.4%, year-on-year. Over the past year, Total Deposits ballooned from 70% to 93% of GDP. Banking system Total Deposits (Liabilities) peaked at 70% of GDP in 1986; ended the eighties at 66%; and the nineties at 48% - before rising back to 65% by 2009.

Rest of World (ROW) holdings of U.S. Financial Assets increased $3.364 TN (more than reversing Q1’s $2.665 TN decline – having been significantly impacted by the recovery in equities prices) to a record $35.465 TN. Debt Securities holdings gained a record $464 billion (after declining only $34bn during Q1) to a record $12.501 TN. Treasury holdings rose $82 billion to a record $6.892 TN, while Agency Securities declined $60 billion to $1.200 TN. 

In an intriguing development, ROW boosted holdings of U.S. Corporate Bonds by an unprecedented $427 billion during Q2 to a record $4.177 TN. How much of this gain was associated with buying from foreign domiciled hedge funds, offshore financial entities and structured finance, and other elements of global leveraged speculation – following the Fed’s move to backstop U.S. corporate Credit and ETFs? 

Over the past six quarters, ROW holdings of U.S. Debt Securities jumped $1.315 TN. Treasuries gained $222 billion, and Agency Securities increased $112 billion. Meanwhile, holdings of U.S. Corporate Bonds surged $572 billion. Equities holdings surged $1.608 TN over the past year. 

Having doubled over the past decade, Total ROW holdings of U.S. Financial Assets jumped to a record 182% of GDP to end Q2. This compares to 108% to end 2007; 74% at the end of the nineties; 31% to conclude the eighties; and 16% to round out the seventies.

Federal Reserve Assets jumped $1.185 TN, or 19.2%, during the quarter to a record $7.364 TN. This pushed first-half growth to $2.985 TN, or 68.2%. This compares to the $729 billion increase during Q4 2008 – and 2008’s $1.320 TN second-half expansion. The Fed’s balance sheet ballooned $3.355 TN over the past year, or 83.7%. 

Fed Assets ended 2008 at $2.271 TN, surging from year-end 2007’s $981 billion. Fed Assets ended 1999 at $697 billion (after a $107bn Q4 gain); the eighties at $315 billion; the seventies at $167 billion; and the sixties at $81 billion. Fed Assets averaged 6.4% of GDP during the three-decade period of the seventies through the nineties. This ratio jumped to 15% in 2008, rose to as high as 28% during Q1 2015, and ended Q2 at 38%.

Unprecedented stimulus and market intervention from the Federal Reserve and global central bank community unleashed epic market speculation (in the face of rapidly deteriorating fundamental prospects). There are indications this speculative cycle has commenced the process of succumbing to reality.

“Risk off” is gathering momentum across global markets.

While Friday’s rally cut U.S. equities losses for the week, painful losses were suffered elsewhere. Major equities indices were down 5.0% in France, 4.9% in Germany, 4.4% in Spain and 4.2% in Italy. Hong Kong’s Hang Seng Index sank 5.0%, with China’s CSE 300 index down 3.5%. Real estate jitters rekindle China housing Bubble anxiety.

September 25 – Bloomberg: “China Evergrande Group is facing a crisis of confidence among creditors who’ve lent the world’s most indebted developer more than $120 billion. Long-simmering doubts about the property giant’s financial health exploded to the fore on Thursday, following reports it had sent a letter to Chinese officials warning of a potential cash crunch that could pose systemic risks. The news sparked a bondholder exodus that continued into Friday, sending the price of Evergrande’s yuan note due 2023 down as much as 28% to a record low. Losses in the company’s dollar bonds spread to high-yield debt across Asia.”

September 25 – Bloomberg (Rebecca Choong Wilkins and Denise Wee): “Average spreads on Asian dollar bonds widened 3-5bps by noon in Hong Kong, reversing earlier tightening, according to a trader, amid jitters from a looming cash crunch at Evergrande. This week is set for the biggest widening since March, according to a Bloomberg Barclays index.”

Emerging Markets were under significant pressure.

South Korea’s Kospi Index sank 5.5%, with India’s Sensex down 3.8%. Taiwan’s TWSE index fell 5.0%. In EM currencies, the Mexican peso lost 5.4%, the South African rand 4.7%, the Colombian peso 3.9%, the Polish zloty 3.6%, the Russian ruble 3.2%, the Brazilian real 3.1%, the Chilean peso 3.0%, and the Hungarian forint 2.6%. Ten-year (dollar) yields surged 25 bps in Brazil, 25 bps in Ukraine, 12 bps in Indonesia, and eight bps in Philippines. 

Global “risk off” squeezed the U.S. dollar bears, as the dollar index rallied 1.8% to a two-month-high.

The dollar rally hit commodities markets, with gold dropping 4.6%, Silver 14.9%, Copper 4.7%, and Platinum 8.8%. The industrial metals were all under pressure.

Global bank stocks were under heavy selling pressure.

European banks were hit 7.8%, closing Friday near March lows. Hong Kong’s China H-Financials Index fell 5.8% to the lows since March. U.S. banks sank 6.8%, trading near four-month lows. Bank debt Credit default swap (CDS) prices jumped to near three-month highs. 

“Risk off” is making some headway in U.S. Credit.

At $4.86 billion, high-yield bond funds suffered their largest outflows since March. High-yield CDS prices jumped about 50 bps this week to a one-month high 400 bps. A natural gas company postponed its junk bond sale. Investment-grade CDS rose a notable 13 bps this week to a four-month high 74 bps. 

The unfolding global de-risking/deleveraging episode only heightens U.S. market fragility.

With U.S. elections now about 40 days away, the backdrop is set for extreme instability.

The degree of speculative excess experienced over recent months would typically ensure vulnerability to a disorderly downside reversal and market dislocation. These times are, of course, anything but typical. It’s an incredibly worrying backdrop, to say the least.

The Q2 report presented by far the most troubling data I’ve encountered in my 20 years of chronicling quarterly Z.1 data.

The next subprime crisis could be in food

If trade financing is out of reach for small and midsized farmers, everyone may suffer

Rana Foroohar

Matt Kenyon illustration of Rana Foroohar column ‘The next subprime crisis could be in food’
© Matt Kenyon

Of all the many problems caused by Covid-19, three of the most visible have been food insecurity, the demise of small businesses and asset market volatility.

All of those things might be poised to get worse, thanks to an unexpected but important financial shift. Big banks, including ABN Amro, ING and BNP Paribas, are either pulling out of commodity trade financing or scaling it back.

This will leave a funding hole for some farmers, agricultural producers and distributors, as well as grocery chains and other small and medium-sized companies that represent crucial parts of the global food supply chain.

The problem is like a gigantic iceberg under the surface of financial markets, one that we can’t yet see but are nonetheless headed for, according to Michael Greenberger, a professor at the University of Maryland’s Carey School of Law and former director of trading and markets at the US Commodity Futures Trading Commission.

He is worried that if second and third-tier agricultural companies — who depend on such financing for things like shipping or manufacturing but also to hedge prices in a volatile industry — cannot get funding or are forced to pay higher rates to shadow lenders, we could see a food price surge. We might also see greater corporate concentration and increased market risk, he notes, possibly within the next couple of months.

“Every commercial producer has to hedge risk by buying futures contracts,” says Prof Greenberger, who points out that growing cycles take months, during which time prices can fluctuate wildly. In order to do that, they may need short-term trade financing.

If banks are willing to lend only to the largest and most established players, for example the big global commodities traders such as Vitol Group, Trafigura and Mercuria, or American agricultural giants including Cargill, ADM or Bunge, then small and midsized producers will be forced to go to shadow banks, a practice that is already common.

That, along with the lack of transparency that comes with having no single clearinghouse for such deals, makes it nearly impossible for lenders to tell if, for example, a borrower may have pledged the same collateral more than once.

Already, there are signs of the looming risks. Last spring, a series of commodity trading scandals in Singapore — including the blow-up of Hin Leong Trading after its founder hid $800m in losses — highlighted not only garden variety fraud, but the fact that opacity, leverage and volatility in the commodities sector make it a particularly risky area for large banks to do business.

Given the pressure that banks are already under, with higher capital requirements from international regulations compounded by new funding pressures from the pandemic, it’s no wonder that many of them have simply decided to pull out, or just do business with the largest brand name clients that have the biggest balance sheets.

This exacerbates an existing trend that is gaining steam post-Covid-19: the biggest companies are getting even bigger. This was true in agriculture, as in so many sectors, long before the pandemic hit. But Covid-19 has starkly exposed the vulnerabilities of monopoly power in food, creating supply gluts in some areas and shortages and higher prices in others.

A handful of large companies have controlled areas such as meat packing and grain production, often doing business with only one type of distributor — a restaurant, for example, but not a grocery store. The result was certainly an economically “efficient” system, but one that turned out to be quite fragile as well.

Prof Greenberger and some other experts believe that the shifts of big banks away from trade finance could expose more such fragility. “The first order of worry is being able to get a futures contract — will small producers have to pay a lot more for one? Then, if the contract goes against you, can you make your margin payment?”

If some of them can’t, it is easy to imagine another disruption in supply chains creating more chaos and food insecurity later this year. That could possibly provoke market volatility if enough highly leveraged agricultural companies went out of business at once.

Not only would the demise of smaller farmers have a knock-on effect on other businesses, including packaging, manufacturing and transport, but their debt — particularly if packaged into risky securitised products — could become a broader market risk.

At the very least, given higher lending costs for a large chunk of producers, higher food prices would seem a foregone conclusion. That won’t be happy news for the legions of unemployed consumers struggling to make ends meet.

This underscores a key point — the ramifications of commodity price disruptions are very often not just economic. They become political, too. Social unrest and even revolutions often start when the prices of food and fuel spike.

Bread riots were one of the catalysts for the Arab uprising of 2011. In the US, the oil price spike that began the same year led to senate hearings about whether the problems of the 2008 financial crisis, including risky trading on the part of big banks, had yet been solved.

Big banks have thrived despite the restrictions put on them over the past decade. Big Agriculture and commodities traders will probably do the same now. Others may not be so lucky.

The COVID Silver Linings Playbook

The old adage that every crisis represents an opportunity is certainly true in the case of COVID-19. Now that the pandemic has lasted longer and wrought more destruction than many initially anticipated, it is all the more important that policymakers seize on the positive trends it has incidentally set in motion.

Mohamed A. El-Erian

elerian129_Thibault Savary_afp_coronavirus research

CHIPPING NORTON – The human tragedies and massive economic disruptions caused by COVID-19 have rightly commanded the attention of the public and policymakers for more than six months, and should continue to do so. But in managing the immediate crisis, we must not lose sight of the opportunities. The oft-quoted line about not letting a crisis go to waste has rarely been more relevant.

The old adage that every crisis represents an opportunity is certainly true in the case of COVID-19. Now that the pandemic has lasted longer and wrought more destruction than many initially anticipated, it is all the more important that policymakers seize on the positive trends it has incidentally set in motion.

For companies, governments, households, and multilateral institutions navigating this unsettling period, the basic task is the same: to overcome pandemic-induced disruptions in ways that also emphasize the silver linings of the crisis. Now is the time to look to lock in trends and conditions that will reshape our society and economy for the better over the long term. With this overarching objective in mind, here are the top six silver linings that I see.

The first is that we are living through one of the most exciting and promising periods of medical invention and innovation in history. While the immediate focus is rightly on COVID-19 vaccines and therapies, we should expect the research currently underway to produce a host of other discoveries, many of which will yield significant, durable benefits.

Moreover, the crisis is forcing us to confront a battery of complex issues concerning drug pricing and distribution, both domestically and globally, as well as the range of social and other inequalities that we have allowed to worsen.

Second, deeper cross-border private-sector collaboration, often outside the purview of governments, is fueling this process of scientific leapfrogging. In mobilizing against the coronavirus, scientists around the world are sharing information like never before, and pharmaceutical companies are collaborating in unprecedented ways.

These collective efforts are being supported by dynamic public-private partnerships, showing that this instrument of development can indeed be “win-win” when it is properly focused and there is clear alignment.

Third, the economic disruptions resulting from the pandemic have fueled multiple private-sector efforts to collect and analyze a broader range of high-frequency data in domains extending far beyond medicine.

In the economics discipline, for example, there is a massive surge of interest in innovative new methods of measuring economic activity through granular high-frequency indicators like mobility (smartphone geolocation), electricity consumption, and retail traffic, as well as credit card usage and restaurant reservations.

These metrics are now supplementing the official statistics compiled by governments, providing considerable scope for compare-and-contrast exercises that can improve the quality and policy relevance of data-collection efforts.

Fourth, the COVID-19 shock has raised our collective awareness and sensitivity to low-probability, high-impact “tail risks.” Suddenly, many in the private and public sectors are thinking more in terms of the full distribution of potential outcomes, whereas in the past they focused only on the most likely events.

Policymakers have become more open to scenario analyses and the broader range of “if-then” conversations that such analyses elicit.

In the case of climate change – a major risk that some wrongly perceived as a distant tail instead of a baseline – the sharp reduction in harmful emissions during the current crisis has provided clear evidence that a new way is possible.

And it is now widely accepted that governments have an important role to play in underwriting a durable and inclusive recovery. The door is open for more public investment in climate mitigation and adaptation, and there is a growing chorus demanding that the new normal be “green.”

This speaks to a fifth silver lining. The pandemic has led country after country to run a series of “natural experiments,” which have shed light on a host of issues that go well beyond health and economics. Systems of governance and modes of leadership have come under scrutiny, revealing a wide divergence in their capacity to respond to the same large shock.

These issues have not been limited to the public sector. Corporate responsibility has also been brought to the fore as company after company scrambles to respond to what was once unthinkable. And multilateral cooperation has been shown to be lacking, increasing the threats to all.

Finally, the crisis has required many companies to hold candid conversations about work-life balance, and to devise innovative solutions to accommodate employees’ needs. There have already been far-reaching changes in how we work, interact with colleagues, and consume goods and services, and only some of these are likely to be reversed after the pandemic has passed.

These six silver linings constitute only a preliminary list of the opportunities offered by the pandemic. The point is not to discount the severity of the shock and uncertainty that have confronted the majority of the world’s population. The pandemic has lasted much longer than many expected, and continues to leave tragedy and destruction in its path.

But that is all the more reason to make the most out of our collective response. The challenge now is to expand and refine this list, so that we can seize the opportunities on offer and lock in more positive trends for the long term. By acting together, we can transform a period of deep adversity into one of shared wellbeing for us and for future generations.

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.

3 Reasons Why This Gold Correction Could Be The Last Below $2,000



Deliveries of September spot gold have intensified during gold's correction, October deliveries begin September 29 with over 60,000 contracts open, and Registered Comex gold supplies are falling.

A second round of lockdowns will crimp the supply of real goods and services and spur the next round of central bank money printing.

A no-deal Brexit looks imminent with the passage of the UK Internal Market Bill that overrides the Brexit agreement regarding Northern Ireland.

Coupled with a second UK lockdown already in force, some weak bank is going to fall and trigger the next global banking crisis.

Gold will continue to fall initially until the next round of money printing begins, at which point it should break through $2,000 for the last time. This could be the last opportunity to buy sound money at these prices.

Back in March 2008, six months before the lid was blown off the financial crisis, gold breached the $1,000 level for the first time. The developing banking crisis and deflationary panic brought it down by 34% by October, and from there it took another year before gold crossed the $1,000 threshold for the very last time. 

We got close to testing that zone at gold bear market bottom in late 2015 at $1,045, but it is now nearly universally conceded that, barring a gold standard and massive deflation of the money supply, gold will never again go below $1,000 an ounce.

Gold has been in a correction since hitting a high of $2,090 in early August, but since monetary developments are moving much faster now than they were back then, I doubt it is going to be another year before it re-crosses the $2,000 barrier for the last time. Judging from political, economic, and monetary developments, gold could easily say good bye to the $1,000s for good before the end of this year.

I will lay out three reasons why this is likely, but first, take a look at this:

Gold vs M1

The top chart is the gold price relative to the S&P GSCI Commodity Index. The GSCI is weighted by daily production volumes, so plotting it against gold shows gold's per-ounce claim on the world's daily production of commodities, in other words gold's real-asset purchasing power. 

What this chart shows is that in real terms, gold's bull market actually began in 2008 during the last financial crisis, not back in 2001. 

It also shows that gold's 34% crash in 2008 was a total illusion. Same thing with gold's selloff last March, when gold's purchasing power in real terms actually doubled. 

What was really happening during both these periods was that as all commodities were collapsing in deflationary panics, gold was falling much less, so its real purchasing power was rising strongly.

You could say that the dollar's purchasing power was also rising during these times, and that is true, but only ephemerally so, and the answer as to why is simple. 

Deflationary panics like these are always coupled with a major burst of money printing, which is the bottom chart in the M1 money supply. 

This inevitably brings the dollar's purchasing power back down, but it brings gold's even higher. 

The result is that while gold has significantly increased in purchasing power against real assets since 2008, the dollar's purchasing power has fallen. You can see the correlation more clearly here, with the gold:GSCI ratio plotted directly against the M1 money supply:

Gold vs M1 Money Supply

Here's the same index in dollar terms since bottoming in February 2009:

S&P GSCI Commodity Index

The dollar has still lost 13% (307 to 348) of its purchasing power in these terms, while gold has gained almost exactly 100% in the same timeframe.

With this in mind-and yes we will circle back here to hammer the point home-here is why the next time gold crosses $2,000, it could easily be the last time.

#1 Strong Deliveries, Meager Contract Rollover, And Gold Moving Off Comex

The September spot gold contract expires on September 29, three trading days from time of writing. As I detailed in a previous article on this contract, there have been buyers opening new contracts every single day since deliveries began, and calling for delivery on those spot contracts. Since spot cannot be rolled over into a futures contract, spot buyers can either call for delivery or cash settle. There is no other alternative. On September 21, the gold price breached its 50 day moving average for the first time since June, confirming a downtrend was in play.

Gold Breaks 50DMA

Since then gold has sold off hard, and yet September deliveries have kept coming. 

The day gold broke the 50DMA, 326 September spot gold contracts were bought (276 net change in September open interest despite 50 delivery closings = 326 net increase):

The screenshot above says September 22, but the data is on a one day lag, as you'll see from the delivery report below. The next day, 298 of those 326 contracts stood for delivery, the highest daily total since September 2 and the third highest for the month:

September Gold Deliveries Comex

The fact that deliveries spiked specifically on a downtrend confirmation suggests that there are eager buyers using the discount in order to acquire physical gold. 

I say this not simply because of the delivery numbers themselves, since deliveries only mean an exchange of warrants, and not necessarily the removal of gold from the Comex vaults physically. 

In this case though, there is evidence that this gold is in the process of being physically moved out, or at the very least taken off the sale registry and hoarded.

The Comex delivery notice page uploads new registry data daily. The problem is there is no archive available so in order to track trends, the Excel files need to be downloaded and archived each day. 

The earliest I have for September is for the 9th, and registered gold stocks on that day were 16,188,264.934 troy ounces. The latest for September 23 has 15,752,126.236. The difference is 436,138.7, or 4,361 contracts worth. That's awfully close to the September total so far of 4,707, evidence that much of the gold being delivered this month will not return for sale to satisfy future contracts. 

Eligible stocks have risen by the equivalent of 4,202 contracts over the same period, indicating former Registered stocks have been moved to Eligible. The rest has ostensibly been moved out of the vaults.

Adding weight to this is that the last day to roll over October gold is September 28, which means that at time of writing there are 3 trading days left to roll over before longs must either take delivery or cash settle. 

Yet, there is little evidence that October gold longs are interested in rolling over to avoid delivery. The number of contracts open for October gold has fallen by only 3% since last week. See red boxes in the two screenshots below:

September Gold Open Interest

Septembe Gold Rollover

60,288 October gold contracts remain open as of September 23 versus 62,206 on September 16. Big deal, you could say. There are still 3 days left. 

Yeah, we'll probably see some degree of rollover, except compare this with platinum, which has the same rollover deadline, and open interest has fallen by 54% over the same timeframe, from 36,442 to 16,791 contracts as of September 23 data. 

If rollover is progressing so strongly in platinum, it should also be for gold but it clearly is not, indicating that many of these 60,288 contracts will probably end up standing for delivery as well. The all time record for one month is last June at 55,102. 

It will be very interesting to see what happens with Registered Comex gold stocks once October deliveries begin.

#2 A Second Round of COVID-19 Lockdowns

Fundamentally, lockdowns are very bullish for gold because they diminish the supply of real goods and services and spur intense money printing from central banks at the same time. The United Kingdom is already under a resurgence of severe lockdown restrictions, and the European Union looks likely to follow soon, possibly within days. The March lockdown initially took down gold prices in dollar terms, though not in real terms as gold declined much less than all other commodities and the Gold:GSCI ratio reached new all time highs. The slingshot from there in dollar terms was one of the most powerful advances in the price of gold since January 1980. The next lockdown should have similar consequences for the gold price, first bringing it down strongly, followed by money printing, which could bring gold back over $2,000 permanently.

#3 A No-Deal Brexit Triggering a Global Systemic Bank Crisis

A no-deal Brexit looks only weeks away from becoming inevitable now. 

European bank stocks are already at multi-decade lows, and some are making new all-time lows. HSBC (HSBC), a global systemically important market-making gold bullion bank, broke through the $20 handle for the first time ever on September 18th, going well below its post 2008 financial crisis lows of $23.59, and HSBC is actually one of the better performing European bank stocks since 2007 (see chart below). Bloomberg reports that HSBC loyalists are losing faith in the stock now.

G-SIB Banks Since 2007

Lloyds (LYG), the largest domestically-focused UK bank, is in danger of breaking the $1 handle on the New York Stock Exchange and may get delisted as a result. French SocGen (OTCPK:SCGLY) is approaching its all time lows again and just announced that it is divesting its asset management arm

Deutsche (DB) is closing in on its all time lows hit in May and just announced the impending closure of 20% of all its branches. I can't see what this signals other than the next financial crisis is imminent, or perhaps already starting.

The contentious UK Internal Market Bill, which would override portions of Brexit agreement dealing with Northern Ireland, has already passed through the British parliament easily and heads to the House of Lords next week for final approval. 

I cannot see how, if a no-deal Brexit happens in conjunction with strict lockdowns in the UK suffocating the real economy, that at least one of these already extremely weak banks doesn't just keel over and start a domino effect that leads to mass bailouts, the next financial crisis and the next and perhaps final round of money-printing by central banks across the world.


In the short term, gold probably still has further to fall before it bottoms again, and silver, too. We've seen deflationary panics like this before, and I will be scaling in on panic days with available cash. How far exactly the metals complex will fall I can't say, but I would loosely guess gold won't get much lower than $1,700 before the next round of money-printing begins. This may be the final opportunity of our lifetimes to pick up some sound money at these dollar prices.

In real terms though, there will almost certainly be no decline in the price of sound money. Meaning versus production-weighted real assets, the GSCI Commodity Index, gold will likely skyrocket again as it did during the deflationary panics of 2008 and March 2020, because gold tends to fall much less in dollar terms than other commodities during these periods. 

Meanwhile, the dollar price will inevitably catch up as it always does after the money supply skyrockets once again. For all these reasons, this ongoing correction in gold could be the final opportunity to buy below $2,000. 

Once we cross that threshold a second time, we will likely never see anything below $2,000 gold again, and it will be off to the races.    

The Real Problem Behind The $26.8 Trillion U.S. National Debt

Cashflow Capitalist


- Ample economic research has shown that excessive debt, above a certain threshold of GDP, begins to drag down economic growth. US national debt is now well above that threshold.

- But ballooning debt, in itself, is not the fundamental issue. It is the result of the core problem.

- In the coming decades, the US economy will be asked to do the impossible: grow faster even while the government extracts more of its resources.

- There are no easy solutions. There are only painful trade-offs.

There are no solutions. There are only trade-offs.

—Thomas Sowell

Macroeconomic Thesis

In the past, on multiple occasions, I've written about how the United States' enormous national debt burden will slow economic growth going forward. Academic studies have demonstrated that, above a certain threshold of debt-to-GDP (ranging from 60% to 90%, depending on the study), government debt becomes a growing drag on GDP.

However, the problem is not really debt per se. Debt is a consequence of the problem, and it exacerbates the problem. But the fundamental issue is more straightforward, hiding in plain sight.

It's the reason why the European Union, with lower debt-to-GDP than the US, has actually experienced worse economic growth. It's the reason that aging developed economies across the world will continue to see more sluggish productivity and wage growth in the decades ahead.

In the past, I've fingered unproductive debt as the culprit behind waning economic growth, but there's another villain who deserves more of the blame. And that is unproductive government spending.

In what follows, I'll explain the (somewhat paradoxical) economics of why excessive government spending leads to slower GDP growth.

The Problem Behind the Problem

As I've written about elsewhere, there is a very simple way to measure whether government debt is productive or unproductive. Just look at the amount of GDP generated by each unit of additional debt. It may not work well during recessions, but it is informative during expansions and over long periods of time.

As I explained in The Monetary Death Spiral Is Accelerating, as global debt has exploded in the last half century, the GDP generating capacity of debt has steadily declined. Just looking at advanced economies in the last twenty years, we find the productivity of debt falling by one-fifth to one-half:

Source: Hoisington Investment Management Company

Each additional dollar (or euro, pound, yen, yuan) of debt is increasingly unproductive. The law of diminishing returns is taking effect.

My "Monetary Death Spiral" thesis, laid out in detail in the above cited article, explains my thesis for why this is. Aggressive monetary easing over the last three and a half decades has prevented normal market self-correction mechanisms from operating, and it has shielded the government from the normal consequences of overspending.

As interest rates have approached zero, all sorts of market, economic, and social distortions have manifested. These distortions have expanded economic inequality, weakened productive investment, spurred unproductive investment (or malinvestment), caused wage stagnation, and dampened economic growth.

Mainstream economics asserts that there is a government spending multiplier effect. That is, when the government spends by sending money to households, subsidizing healthcare or housing, or even paying out interest payments to American holders of Treasury securities, this leads to more consumer spending, which means more profits for businesses, more capital investment, more employment, higher wages, and so on in a virtuous cycle.

When the government spends by putting money into the private economy, it multiplies economic output more than would otherwise have occurred without it.

What this idea gets wrong is that last clause of the previous sentence: "more than would otherwise have occurred without it." That money has to come from somewhere. In fact, it can only come from two potential places: (1) taxation, or (2) private savings. Either it gets taxed from the income or wealth of productive individuals or businesses, or the savings of the private economy are used to buy government debt issuance.

Proponents of the government spending multiplier effect theory rarely attempt to measure the opportunity cost of government spending. That is, they point to the beneficial economic ripple effects of the spending without considering the potentially beneficial economic effects of allowing that money to remain under the control of private actors.

Would the money taxed from the incomes of taxpayers have been spent in an even more economically beneficial way if not taxed? Would the private savings have been used for more economically productive purposes if left in the hands of households and businesses?

During the Great Depression, economist John Maynard Keynes famously suggested that the government spend money on anything, even if unproductive, just to get money into the hands of consumers. Pay workers to dig a ditch, and if that doesn't provide enough economic stimulus, pay them to refill the ditch. It will result in a positive return on investment in terms of GDP.

Over the last half century, that theory has not been borne out by the data. Instead, government spending has resulted in increasingly less economic dynamism. Notice how the impressive growth of government spending has negatively correlated with money velocity (the rate of turnover of a unit of currency in the economy) over the last two decades:


The core problem, then, isn't really the national debt. Rather, the debt is merely a symptom or consequence of the core issue, which is excessive unproductive spending.

Even if the United States managed to eliminate the fiscal deficit and run a balanced budget while leaving its current level and allocations of spending in place, the result as far as economic growth is concerned would be pretty similar.

In fact, it may even produce worse growth, because it would require much higher taxation.

This goes against the theory that the core problem is low tax rates. Certainly, tax rates may need to rise in countries like the US in the future in order to help fill the revenue gap. But debt-to-GDP levels are rising in almost all advanced countries around the world, both relatively high tax and relatively low tax nations.

That is because government spending as a percentage of GDP remains elevated across the developed world and will likely rise due to the COVID-19 recession.

In the Eurozone, where tax receipts make up a much higher share of GDP than the US (a little over 40%, on average), government spending has vacillated between 45% and 51% of economic output for 25 years.

The average EU fiscal deficit during that period was ~2.5%, compared to the US's slightly larger ~3.0% average deficit over the same years. During that timeframe, EU GDP growth has persistently weakened, making lower highs and lower lows:

Source: Trading Economics

The US annual GDP growth rate unsurprisingly tracked that of the EU pretty closely over this time period, only with a higher average of ~2.5% versus the EU's ~1.9%. Meanwhile, EU government debt-to-GDP is lower than that of the US and has been lower since the early 2000s.

How about the United States? From 1969 to 2019, federal government spending has averaged 20.3% of GDP, while federal revenues (i.e. tax receipts) have averaged 17.4% of GDP, according to the Tax Foundation. See the chart below. The blue line is federal government outlays / spending, and the red line is receipts.

Source: St. Louis Fed

Notice a few things. First, prior to the Great Depression, the federal government was less than 5% of the economy, whether measured by spending or revenue.

The size of the federal government back then was roughly five times smaller than its average from 1947 to 1970 and almost six times smaller than its average from 1970 to 2019.

Second, since 1971, the federal government has run a fiscal surplus only four years: 1998, 1999, 2000, and 2001. This despite federal receipts holding steady around their average of 17.4% from the 1970s through the 1990s. From 2002 to 2019, however, federal receipts as a percentage of GDP have fallen to an average of 16.3%, while spending has remained slightly above its long-term average at 20.5%.

The point here is that debt is not the fundamental problem. The fundamental problem is excessive unproductive government spending. Significantly higher government spending as a share of GDP in European Union nations — more than double that of the US — goes a long way in explaining the discrepancy in economic growth between the two.

Currently, however, the US seems determined to narrow the gap in government spending with the EU. According to the CBO (via the Committee for a Responsible Federal Budget), for the US federal government,

Revenue will total 16 percent of GDP in 2020 and average 17.5 percent over the subsequent decade – around its historic average of 17.4 percent. Spending will total 32 percent of GDP in 2020 and average 22.5 percent over the 2021-2030 window, above its historic average of 20.3 percent.

The problem is not debt in itself. Massive debt buildups in virtually all developed economies are really just a side effect of consistently spending too much money on unproductive uses. When put in these terms, it's easy to see how mounting national debt, beyond a certain portion of the economy, drags down economic growth.

By necessity, it results in some combination of (1) resources being extracted from the mostly productive sector of the economy (the private market) via taxation to pay the bills of the mostly unproductive sector (government) and (2) private savings being sapped to purchase government debt, thereby crowding out private investment.

In this sense, national debt loads can be seen not as an accumulation of debt capital that correspondingly increases the total assets of the nation. Rather, they are the cumulative effect of many decades of consumption brought forward in time. It is akin to the total balance on one's credit card after rolling a maxed out balance from one card onto another dozens and dozens of times.

For the most part, government debt has not been used to invest in infrastructure, basic research, education, or anything else that might result in a higher GDP than would otherwise have occurred if the money had remained in the private sector. It has not, on net, added assets to the national economy. Instead, federal spending is mostly used for purposes of current consumption — i.e. redistributing resources from taxpayer income/wealth and private savings to consumers.

What The Federal Government Spends Money On

When we look at the federal budget, we find that the vast majority of it goes toward what I called above "current consumption" rather than long-term investment:

2019 Federal Outlays:

                                                                 Source: Congressional Budget Office

The "Other" category of mandatory spending includes unemployment insurance, federal employee pension obligations, veterans' benefits, and various means-tested welfare benefits such as the earned income tax credit, SNAP program, etc. Only a minority of non-defense discretionary spending goes toward what might be considered investment.

When looking at federal government spending, it's important to distinguish economic arguments from moral arguments. Perhaps another way of expressing this sentiment is to differentiate between two questions: (1) What should we spend money on as a nation? And (2) what effects do our spending decisions make on the economy? The former is a moral question, the latter an economic one.

We must acknowledge that there are many examples of morally good yet economically unproductive uses of money. Taking time off work and flying across the country to visit family members may be both morally good and unproductive at the same time. Think also of money spent easing the pain of loved ones in their final months of life. Think of the resources expended caring for the mentally or physically disabled who will never be able to hold a job.

Not everything in life is about economic efficiency or productivity. Questions about the morality or proper scope of government spending are beyond the purview of this article.

However, it's also important to acknowledge that, in economics, there is no free lunch. There are no solutions, only trade-offs. It's crucial to understand those trade-offs in order to make more informed moral decisions. And for our purposes here, those trade-offs are necessary to understand in order to forecast macroeconomic trends.

The Big Trade-Off

The trade-off I am highlighting in this piece is the one between current consumption and productive investment. This happens in two ways: First, as previously suggested, increased unproductive government spending is financed in no small part by debt, much of which is bought with private savings. The private savings used to fund this government spending most likely would have found a more productive use otherwise. This is how government spending, via the debt financing channel, crowds out private investment.

Second, as I explained in The Monetary Death Spiral Stubbornly Persists, excessive unproductive government spending also crowds out the government's own investment spending. We can see this by comparing all the various transfer payments to investment spending as a share of the federal budget over time:

Source: Concord Coalition

Since the late 1960s, government investment in such purposes as education & training, research & development, and major physical capital like infrastructure has shrunk as a percentage of total spending, while transfers (current consumption) have risen.

It's important to note that it doesn't make a difference to GDP whether this spending was debt-funded or not. There are two reasons this is the case: First, because, as the name would suggest, transfer payments simply transfer the capacity to consume from one group to another.

Second, because consumption spending has increased so much over the decades, it would be nearly impossible for investment spending to keep up. There simply aren't that many productive investments for government dollars to fund.

This is how, when government spending is literally one of the components of GDP, an increase in government spending on something economically unproductive can actually result in flat or even decreased GDP. It takes money away from investment and gives it to consumption, a more fleeting and fickle component of GDP. Or it takes money away from some consumers, via taxation, in order to fund other consumers — with some leakage in the process due to bureaucratic expenses.

Unlike investment, consumption cannot, on its own, make the economy more efficient, productive, or innovative and thus cannot produce more economic growth or a higher standard of living. Only investment can do that. And when investment dollars are being pillaged in order to fund consumption, economic output inevitably suffers.


The next time you hear economic pundits bemoaning the lack of additional trillions spent by the federal government (yet) for pandemic relief, remember this trade-off. If more stimulus money is passed by Congress and signed into law, it will almost certainly come at the cost of lower economic growth in the future. This is because money spent by the government on current consumption today will inevitably come from a combination of taxpayer income/wealth and private savings.

The $4 trillion dollars that have been spent this year (above and beyond the original 2020 federal budget) will already depress growth over the long-term and exacerbate the Monetary Death Spiral, even if that spending has prevented immediate economic damage. And, of course, the CBO's projections for continual $1 trillion+ fiscal deficits for the remainder of the decade do not even consider the coming exhaustions of major federal trust funds, which will almost certainly result in further tax- or debt-funded government spending. (More drag on growth.)

As I've explained to subscribers of High Yield Landlord, I believe one of the best places for investors to hide out in the coming decades will be publicly listed real asset companies that own real estate, natural gas midstream assets, infrastructure, farmland, and renewable energy assets.

As weak growth, low inflation, and near-zero interest rates persist, the generous and stable cash flows from real assets will become increasingly attractive for all kinds of investors.

The Hollowing Out of Hong Kong

China’s tightened grip on the finance hub will make it harder for Hong Kong to diversify its economic base and keep pace with regional rivals in Singapore and Shenzhen

By Nathaniel Taplin

Riot police stood in front of a bank branch in Hong Kong on August 31 as pro-democracy demonstrators gathered to mark the one-year anniversary of a violent confrontation with police.

Does Beijing’s imposition of a draconian yet murky national security law mean the end of Hong Kong as we have known it?

For financiers, the answer is probably no: The city retains many of its core advantages, especially preferential access to Chinese markets, a stable currency, and open capital markets.

But in other ways, the damage from the law could be profound: it will make diversifying the economy away from finance to aid struggling middle class residents even harder. Everyday Hong Kongers face an unpalatable choice between relocating to faster growing mainland cities, emigrating further abroad, or worsening life prospects at home as good opportunities in Hong Kong remain scarce and civil rights erode.

Hong Kong’s incredible success as a banking center—the finance sector’s economic output has more than tripled over the past two decades—masks the reality of much slower average income growth than rival Asian hubs like Singapore and Shenzhen. Outside finance, businesses have found themselves squeezed between sky-high property prices, tycoon-led monopolies in domestic sectors, and rising regional competition in another of the city’s historic strengths—shipping and logistics. Hong Kong residents, wealthier than Singaporeans on a per capita basis in 2003, now earn nearly $20,000 less a year on average, according to the World Bank. Residents in Shenzhen, who earned 15% as much as their Hong Kong counterparts at the turn of the century, now earn 60% as much. 

To help average Hong Kongers thrive again would require developing new growth industries like tech or high-end manufacturing, as Singapore and Shenzhen have successfully done. Unfortunately the new security law makes this less, not more likely.

Most banks and insurers will likely stay put: Hong Kong’s legal protections remain stronger, even now, than on the mainland, and joint stock listings in Shanghai and Hong Kong remain a popular option for Chinese companies. But outside of finance, the picture looks bleaker.

Beijing is clearly hoping Hong Kong can follow the Singapore model in a different respect. Singapore scores poorly on measures like freedom of the press and government accountability according to the World Bank, but is ranked in the top 5% on rule of law. Global companies trust that commercial disputes will be fairly handled.

But so far, businesses in Hong Kong don’t seem assured the territory can achieve a similar balance. Nearly 40% of all U.S. firms surveyed by the American Chamber of Commerce in early August said they were considering moving assets or operations out of the city.

That marks a sharp deterioration in sentiment since just October of last year, when antigovernment protests were near their height and only 24% of surveyed U.S. firms said they were considering moving. The U.S. decision to remove Hong Kong’s special customs status will hit tech and logistics companies hard. And overall fixed capital formation in Hong Kong was already dropping at its fastest rate since the Asian financial crisis in the fourth quarter of 2019.

Hong Kong is very different from Singapore in one key respect: As an independent nation Singapore is free to give priority to its own core interests, including maintaining its reputation as a safe and fair place to do business. But the events of the last year have made clear that in a pinch, Beijing will always prioritize its perceived interests in Hong Kong, even if that entails considerable collateral damage to the city’s prospects. By leaving crimes like subversion ill-defined in the new law, Beijing has given itself plenty of latitude.

Even before the security law was passed, there was anecdotal evidence that companies were losing some faith in the ability of Hong Kong’s legal system to protect them. Hong Kong had already been overtaken by Singapore as a top spot for arbitration in the middle of last decade.

If Hong Kong’s government had acted more decisively to tackle other economic problems, the additional headwinds from the security law and the U.S. response might be less damaging. But high property prices make it more difficult to nurture capital and land-intensive industries like manufacturing and tech. Public funding for research has also been paltry —the government typically spends just 0.4% of GDP on publicly funded research and development, about half the equivalent figure for the U.S. and Singapore over the past decade.

Little wonder then that Hong Kong’s economy has become more finance-centric as other industries have largely withered on the vine. Finance, which was only 10% of the economy at the turn of the century, is now 20% according to official figures. Manufacturing has all but evaporated. Singapore, in contrast, has been able to maintain a significant manufacturing and high-tech sector even as finance has grown: in 2019, manufacturing still accounted for 20% of gross domestic product.

These trends now look likely to accelerate further. Hong Kong will survive, and even prosper, as a key Chinese financial center barring truly punishing U.S. sanctions. And Beijing’s solution to middle class woes— further integration with Guangdong across the border—may provide an outlet for some who are willing to seek jobs or housing there.

For others who stay put, the future looks less promising. Deng Xiaoping, China’s famous reformer, assured Margaret Thatcher in 1982 that after Hong Kong’s handover to China horses would still run and stocks would still sizzle. Forty years later, that is still true. But the promise of a better life looks ever farther away.