Please excuse the longish quote to kick things off today. But it’s important. From Greg Ip at the Wall Street Journal:
‘The Federal Reserve now believes its monetary policy is back to normal. That should worry you: if this is normal, then the Fed has precious little ammunition for when economic conditions again turn abnormal.
‘Since 2015, the Fed has been “normalizing” monetary policy by raising interest rates and shrinking its bondholdings from levels intended for a weak, postcrisis economy.
‘This week, it declared the process all but done: Fed officials see no more rate increases this year and perhaps one next year, and they will stop shrinking the balance sheet this September.
‘Yet by any historical benchmark, this “normal” stance of monetary policy is extremely stimulative. The federal-funds rate, at between 2.25% and 2.5%, is just 0.25% when adjusted for long-term expected inflation. By comparison, the real rate was 2.75% at the end of the Fed’s last tightening cycle in 2006, and 4% at the end of the prior cycle in 2000.
‘And the Fed will still hold more than $3.5 trillion in bonds in September, equal to 17% of gross domestic product, compared with 6% in 2006.’
In case you didn’t notice, the Fed is going down the same path as the Bank of Japan and the European Central Bank. These institutions have been unable to raise rates or shrink their balance sheets despite healthy economic growth.
That’s because they simply have too much debt. And as soon as you raise interest rates in a debt-soaked economy, it causes a slowdown. Central banks believe they can avoid slowdowns, so they ease rates again.
Another build-up of debt that makes it even harder to raise rates back to ‘normal’ levels. The tragically hilarious thing about all this is that central banks have created the problem, and we’re all standing around expecting them to deliver a solution.
It’s not going to happen!
Central banks ARE the problem. I’m not saying there are painless solutions to all this. But that is the point. In a boom, you get a misallocation of capital and resources. In a bust, that capital should be written off and extinguished so the economy can recover without the burden of having to support unproductive debt.
But that doesn’t happen anymore. The debt created by the boom never has to deal with the discipline of the market. It may be unproductive, but by central banks keeping rates so low, it can survive and slowly drain the economy of life.
That’s why the next step in this lunacy is ‘quantitative easing’. This is the process of the central bank creating money to keep debt prices at an acceptable level.
It tells you the private sector no longer has the capacity to carry this debt. Central banks — the last resort — now must expand their balance sheets to keep the party going.
Let’s not get too far ahead of ourselves though. The Fed had not gone back to quantitative easing. It has just signalled it is giving up on its attempt to return its balance sheet to any semblance of normality.
What does all this mean for markets though?
Well, immediately after the announcement, stocks fell, bond yields dropped along with the US dollar, and gold prices surged.
But overnight, stocks had a re-think. The S&P 500 jumped 1%.
I think it’s going to take the market a while to work out what’s really going on. Much of the ‘good news’ was already priced in. Now, it’s a matter of working out the extent of the global slowdown that is currently underway.
Trying to get a read on it amongst all the competing forms of monetary stimulus (Japan, Europe, China, and now, a Fed on hold) is a tough ask.
What isn’t so difficult to work out, as least as far as I’m concerned, is that this is all good for gold. I mean, gold in Aussie dollars is trading near record highs and looks solid, as you can see in the chart below.
If it can continue to consolidate around this level in the coming months, then I think it sets up the potential for another move higher later in the year.
The US dollar gold price also looks constructive. As I pointed out in my video update earlier this week, if gold can consolidate between the green dotted lines for a few months (see chart below), it will be very bullish indeed.
The thing is, when unorthodox policy becomes the norm, central banks are no longer the last report. Gold is the last resort. That may not be apparent now. And it may still take some time to dawn on the broader market.
But physical gold is the only safe haven monetary asset that is not debt. That is, it doesn’t come with counterparty risk. When central banks decide it’s normal to create money at will to ‘monetise’ existing debt in the system, gold will catch a bid.
What’s the difference between now and back in 2010–15 when all the central banks are doing just this, and the gold price actually fell after peaking in 2011?
Well, back then, the market thought they were emergency measures and correctly assumed these measures would revive the economy. As such, there was no need to hold insurance in the form of gold.
The market will tell us what it thinks of this latest episode soon enough. But it appears to me as though central banks are saying what was once an emergency is now just normal policy. If that is the case, gold should react very differently this time around.
Editor, The Rum Rebellion
PS: Three Aussie gold stocks to watch in 2019. Download your free report here.