Stalling Markets

Jul 18, 2019·Alasdair Macleod

The combination of American trade protectionism and the end of a failing credit expansion is leading into a global economic downturn, and potentially a systemic crisis. Meanwhile, investors still believe more extreme monetary policies will stabilise economies and that the ultra-low interest rate environment will persist without renewed price inflation. As Samuel Johnson reputedly said of a second marriage, it represents the triumph of hope over experience.


There is a moment just after the top of every credit cycle where positive momentum stalls before a new reality emerges. When the stall begins, as appears to be the case today, everything is still read positively. Perennial bulls say “Don’t worry, the central bank will reduce interest rates and inject enough money into the banking system to ensure any recession will be minor and growth will resume”. With interest rates falling, confidence in the final outcome means stocks continue to rise. With this mindset, bad news for the economy is always good news for stocks.

This investors’ paradise is populated by devotees of the new economics, supporting progressively increased state intervention. They don’t actually believe that free markets should set stock prices anymore and have become hooked on central banks pursuing inflationary policies. In their minds, the relationship between monetary inflation and rising stock prices amounts to a financial equivalent of perpetual motion. However, their enduring belief in the might of central banks and the importance they place on maintaining asset prices makes inflationists blind to the message from stalling markets.

We all get caught up in it. And when evidence of the stall in economic growth mounts, we clamour for lower interest rates, credit expansion, and finally competitive exchange rates. Even President Trump is now telling us the Fed must weaken the dollar to boost exports and the American economy. As it is already doing his bidding with interest rates, surely the Fed will oblige.

The naivety of this reasoning is endemic, and as a naïve supporter of free markets, President Trump is beginning to trot it out again. In Britain, the same old inflationist story, wrapped up in proposed tax cuts to be paid for later by economic growth, is now being pushed by Boris Johnson, almost certain to be the next Prime Minister. Let us hope this is just electioneering rhetoric. But so widely are the myths of monetary stimulus believed that they are now certain to be renewed in a push to sustain economic growth.

That gold prices measured in dollars will be guaranteed to rise is indirectly becoming officially sanctioned. Those of us in the gold business would be grateful for President Trump’s endorsement of gold if it was not for the economic consequences of his weak dollar policies on ordinary people whose money is about to be trashed. Nevertheless, the gold price has now jumped to a new level and markets are trying to discount the consequences of what is now unfolding. As the gold price continues to rise, those who wonder whether it is worth buying miss the point. It is not gold that rises, but their money that’s falling. Money is falling because governments through more aggressive monetary policies are about to deliberately undermine their own currencies.

The naivety over the consequences of weak money is not restricted to the leaderships of the US and UK. The maintenance of negative interest rates and bond yields in the EU and Japan are already testament to that. But we now see two world leaders (assuming Boris succeeds May) who indicate they are aware of the failings of the economic establishment, but publicly endorsing the inflationism that has been central to the establishment’s failure. By promising the tax jam of today for a better outlook tomorrow, Boris Johnson is roughly where Trump was before he was elected president. Let’s hope an enterprising journalist asks him to clarify whether he thinks a lower sterling (which we already have) is good for the economy. Very likely, he will agree, perhaps with the proviso that price inflation remains under control.

Therefore, central banks are committed to address stalling economic growth by snorting more of the drug that is giving us the downer. But our leaders and central bankers are ignorant of sound theories of money and credit and are driven almost entirely by statistical information. And here we hit a further problem. Government statistics are not fit for purpose.

Statistics are misleading

Statistically, inflation is under control, because the statisticians with their methods have ensured it is so. In giving the central banks a passport to accelerate the rate of monetary inflation by suppressing the consequences, they are storing up trouble for us all. There will come a time when not even the manipulation of consumer price statistics will hide the fact that the purchasing powers of the dollar, sterling, euro and even the yen are all falling at an alarming rate. It is when we begin to sense that this is a problem that the stalling feeling turns our greed, or complacency, into concern and then outright fear.

Exactly two hundred years ago, Lord Canning, who was briefly prime minster of Great Britain, warned that you can prove anything with statistics, except the truth. This was over a century before modern econometrics evolved to make statistics more meaningful. But statisticians have missed what was behind Canning’s point: statistics prove nothing because they cannot replace sound reasoning. Instead, they only assume the relationships between cause and effect. Rather than attempting to understand the manner of the link, their approach is to monitor the relationship between monetary inflation and changes in prices, to ensure that increases in the CPI remain within a target range. As long as this is the case, monetary policy makers can carry on issuing money out of thin air.

You cannot measure the general level of prices, because it is a concept and not a fact. Strictly speaking, it is hardly a concept either, because it is not the unmeasurable general level of prices that inflates, but the purchasing power of the currency that diminishes. It may take time to work through, but if you increase the quantity of unbacked state money and the bank credit in circulation, a unit of currency will simply buy less.

Not enough recognition is given to the draining effect on the productive members of society and their businesses. Monetary inflation undermines the value of their earnings and profits, transferring wealth from savers, and it impoverishes the poorest labourers for the benefit of government finances.

Far from obtaining something for nothing, the government gets its seigniorage by impoverishing the same people that pay its taxes. If one could measure the general level of prices, it is more likely that they have been rising by between seven and ten per cent annually for a considerable time, as illustrated by John Williams’s ShadowStats, and confirmed by the Chapwood Index. The official two per cent target is poppycock. If we assume the two independent calculations are more realistic, US citizens have been getting collectively poorer every year since the financial crisis of 2008/09. Not only is this evidence that Canning’s aphorism about statistics telling us everything but the truth still holds, but governments now fully depend on the concealment of the true state of affairs by statistical suppression.

Governments have arrived at this point because funding through inflation faces the law of diminishing returns. The more a government inflates, the more it impoverishes its people. And the more the people are impoverished, the less both taxes and inflationary financing yield. And as we look down from the heights of inflated asset prices, the more evidence emerges that our economies are stalling, the more important this will become.

With the establishment, investing institutions and regular investors all being misled by official statistics, it is no wonder that an understanding of the true position hardly exists. It is an Alice-in-Wonderland world where the more you inflate, the more GDP statistics say the economy is growing. Under-recording the price deflator has become central to maintaining the delusion. Almost no one realises that an increase in nominal GDP is no more than a reflection of more money and credit being injected into the economy. It confuses this increase in the quantity of money and credit with progress. But progress suffers the disadvantage, like the general price level, of being impossible to measure with statistics.

Reliance on statistical method has encouraged wrongheaded government intervention. Long ago, we dismissed the certain knowledge that society thrives by cooperation and governments only by intervention. The former progresses, the latter interferes. It prevented governments from trying to improve on free markets, but that ended following the First World War. Consequently, decades of intervention from the 1920s onwards have increasingly distorted our world away from free-markets to embrace the Gospel of Government. The gospel has been a drip-feed upon which modern economies have become increasingly dependent.

Stalling into a nose-dive

That drip-feed is now augmented by American trade protectionism, reversing the expansion of trade from which we have all benefited. The harmful effect on the American economy will become apparent. The combination of a long period of credit expansion and trade tariffs will very likely drive it into a deepening recession, possibly a slump, as these conditions today repeat those of 1929-1932.

If the inflationary effect on prices is to be limited, it will require foreign investors to buy dollars and increasing quantities of US Treasury debt to cover an escalating budget deficit. Global funds will have to be diverted to the dollar from other investment opportunities, notably the widescale development of Asia. From its policy towards China’s economic development, elements of the American deep state appear to understand this. President Trump appears not to. And now, he proposes to weaken the dollar the foreigners are expected to buy to finance his escalating budget deficits.

It is a difficult trap he has unwittingly set for his administration. And as the US economy stalls further, and the dollar weakens in a vain attempt by policy-makers under The Donald’s cosh to make America great again, the dollar’s slide will require rising interest rates for its purchasing power to be stabilised, forcing US Treasury prices into a bear market. The US Treasury’s finances will be plainly ensnared in a debt trap.

Other currencies, driven for decades by the same Keynesian logic, are to greater and lesser extents in the same boat. But every currency has two driving forces that determine their valuations. There is the collective assessment of the foreign exchanges, and changes in preferences between holding money and buying goods in the domestic economy. Sometimes, the foreigners might feel a fall is overdone, and buy a currency when its domestic purchasing power is still falling. At other times, the slide towards oblivion is deferred by the general public who cannot get their heads round what is happening to their government’s money. But despite these interacting forces, once the world’s reserve currency begins to decline, interest rates everywhere have to rise.

If this increasingly likely event happens, the effect on forward-looking markets is certain to be brutal. Today’s stall becomes a free-fall tomorrow. That is why it is likely that by the end of this year it will be increasingly apparent that national economies, emasculated by continual wealth-transfer through monetary debasement and over-burdened by non-productive debt, will begin to rhyme with the crash of 1929-32 and the subsequent depression. The most notable difference is that with today’s currencies being unbacked fiat instead of tied to gold, prices will rise instead of falling as they did in the 1930s.

Implications for gold

The last time the destructive forces of an end-of-credit-cycle coincided with trade protectionism was in October 1929. They were the driving factors behind the Wall Street crash and the subsequent depression. This time, the tariffs are not nearly as high as those of the Smoot-Hawley Tariff Act, but the magnitude of the credit cycle is far greater. While we can hope that this time the combination is not as disruptive as the 1929-32 episode, there is no doubt that today there is enough of a build-up of market distortions ready to wash out of the global economy to justify considerable unease.

This unease is yet to be manifest in widespread investment opinion, which still hopes for a miracle from monetary policies. But both our analysis and the empirical observations of events ninety years ago demonstrate why a miracle is impossible. A slump in global business activity is already developing, and the only policy response will be inflationary. Monetary expansion is effectively guaranteed in a vain attempt to stop a downturn and to ensure the banking system is preserved. This compares with a 25% contraction in broad money between 1929 and 1933 as thousands of American banks went under.

Through the medium of the dollar, in 1929-33 prices were measured in gold, which was fixed at $20.67 to the ounce. This time, there is no sheet anchor, and the dollar will simply lose purchasing power. This means there will be more dollars to the ounce of gold. There is no point in speculating how many dollars there will be to the ounce; you might as well debate how many angels can dance on the head of a pin. More importantly, it is difficult to see how the slide in the dollar’s purchasing power can be stopped once it starts.

Just as the ability of the productive sector to pay taxes is being increasingly undermined at the same time as the government’s expenditure rises, we can also see time preferences adding a further layer of destruction to government finances. Foreigners in particular will need far higher interest rates to stop them selling dollars and to persuade them to buy again. This was the policy of Paul Volcker, as Chairman of the Fed addressed in the early eighties, when he increased interest rates to 20%. Federal government debt then stood at only 30% of GDP, while today it stands at 105%. Putting aside the bad debts escalating at the banks from a grossly overindebted private sector, a rise in interest rates sufficient to stabilise the fiat dollar would almost certainly wipe out government finances and therefor faith in the dollar itself.

That is the extent the debt trap has now reached, and the problem is not confined to America. All major economies are in the same boat with very few notable exceptions. The Eurozone includes governments with severe debt problems, and the Japanese government has the highest debt to GDP ratio of them all. Lesser currencies have always had difficulties, which will simply escalate if dollar interest rates rise.

For the moment, very few see the true extent of the fiat currency problem. It is hard for them to visualise an economic slump when overall demand for goods drops, and for their prices to rise at the same time. They are fixated on the objective value of money in transactions, and do not realise that if people lose faith in it, a currency’s purchasing power will slide.

When it starts, the process could be rapid. The education of the masses in this matter, thanks to cryptocurrencies, is more advanced now than it has ever been. If bitcoin soars to $20,000, $50,000 and more, millennials round the world will understand that the dollar, or their local currency, is going down. The rush out of fiat bank deposits into crypto on its own could easily precipitate a widespread currency and systemic crisis.

This is not to advocate buying bitcoin, or gold for that matter. It is just to warn of the approaching end of the road for unbacked fiat currencies at a time when governments themselves face bankruptcy.

There is a well-known saying, that governments can’t go bust. Don’t you believe it: it depends on fools continuing to place value in their fiat currencies. We can begin to see that end in sight.


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