Disclaimer: The content from The Daily Reckoning Australia’s global cast of characters is their own view and opinion. It is not to be taken as investment advice.
Fed squeezes US economy
You hand me one thousand dollars.
I tell you to come back in six years, and I will give you back more than three times your money.
I won’t put the money in the bank.
I won’t invest it in stocks.
I’ll simply roll the notes into a wad, then shove it under the mattress, in the back of the wardrobe or even in the freezer and leave it there.
Just let it sit in the darkness. Gathering dust. I won’t touch it at all during that six-year period.
Yet somehow, in six years’ time, that one thousand dollars will transform into six thousand dollars all by leaving it alone.
Impossible, you say.
Triple or nothing
We live in a world where we are encouraged to make our money ‘work for us’. Whether that be investing in stocks, or storing cash in the bank, or taking control of our super.
There’s this idea that we can’t leave our hard-earned dollars idle.
That – just like us – our money should always be doing ‘something’.
Which is why whacking a grand under a mattress – and then tripling it six years later – sounds unrealistic. There’s no possible way that could happen.
Except exactly when that did happen in 2008.
If you had swapped currencies – converted some Aussie dollars into gold – your money would’ve been worth three-times more, just sitting as a lump of metal.
At the start of 2002, US$1,000 would’ve bought you 3.53 troy ounces of fine gold.
by March 2008 those same 3.53 ounces of gold would’ve been worth US$3,628.
Compounding interest may be the eighth wonder of the world, but there’s no way it could TRIPLE your money in six years.
In fact, if you put that US$1,000 in a term deposit for 6 years, you’d have earnt less than $300 in interest.
Why the difference?
The value of cash is determined by central banks.
Over that period of time, even though the Reserve Bank of Australia was increasing the cash rate, rates didn’t rise as fast as the price of gold.
Therefore, the purchasing power of cash sitting at the bank dropped.
And that scenario is even worse today.
The RBA now has a cash rate of 1.50%. Meaning that if you left the same thousand bucks sitting in a bank for the next six years – and interest rates didn’t change – you would ‘earn’ $127 in interest.
Remember, that cash must be locked up for six years with a bank. And at the end of that period, your cash hasn’t even kept up with the rate of inflation.
The yellow metal acts as an insurance policy against the inflation rate. It tries to shield your wealth from central bank policies.
This is one of the reasons why I suggest all Australians have a small allocation to physical gold.
Since 2007, I have analysed not only the price of gold, but the importance of why people should own physical gold.
And I’m not the only gold advocate.
My colleague Jim Rickards released a book called ‘The New Case for Gold’ a couple of years ago. It’s the most comprehensive guide to why you should own the precious metal.
Later in the week, I’ll show you exactly how you can get your hands on a copy. For less than half the bookshop sticker price.
Until then, I’ll hand you over to Jim. Today, he’ll show you what the Fed is doing with monetary policy in the US.
In my opinion, it’s just another reason why you should own gold.
Fed squeezes US economy
Jim Rickards, Strategist
I’m currently in Dublin, Ireland, where I was honoured and humbled to receive a writing award from Trinity College.
It’s my job to continue pointing out the risks to the financial system that we still face and to try to help people prepare for the next crisis.
Of course, central banks are a big part of the problem.
If you have defective and obsolete models, you will produce incorrect analysis and bad policy every time. There’s no better example of this than the Federal Reserve.
The Fed uses equilibrium models to understand an economy that is not an equilibrium system; it’s a complex dynamic system.
The Fed – and the Reserve Bank of Australia – uses the Phillips curve to understand the relationship between unemployment and inflation when 50 years of data say there is no fixed relationship.
More specially, the Fed uses ‘value at risk’ modelling based on normally distributed events when the evidence is clear that the degree distribution of risk events is a power curve, not a normal or bell curve.
Nine increase in a row
As a result of these defective models, the Fed printed US$3.5 trillion of new money beginning in 2008 to ‘stimulate’ the economy, only to produce the weakest recovery in history.
That’s over now.
The Fed’s cycle of monetary tightening has been ongoing in various forms for over five years. First came Bernanke’s taper warning in May 2013. Next came the actual taper in December 2013 that ran until November 2014.
Then came the removal of forward guidance in March 2015, the lift-off in rates in December 2015, seven more rate hikes to date and the start of quantitative tightening in October 2017.
Another rate hike is already in the queue for December, which would be the ninth rate hike since lift-off.
During much of this tightening, the US dollar was actually lower because markets believed the Fed would not raise in the first place or was overdoing it and would have to reverse course.
Now that the Fed has shown it’s serious and will continue its tightening path (at least until they cause a recession), markets have no choice but to believe them.
And since last October, the Fed has also been reducing its balance sheet with quantitative tightening (QT).
When the Fed started QT last year, they urged market participants to ignore it.
They said the QT plan was on autopilot, the Fed was not going to use it as an instrument of policy and the money burning would ‘run on background’ just like a computer program that’s open but not in use at the moment.
It’s fine for the Fed to say that, but markets have another view.
Analysts estimate that QT is the equivalent of two to four rate hikes per year over and above the explicit rate hikes. Markets have already suffered two significant sell-offs this year, the most recent being October’s.
While there were other contributing factors, like the trade war and political uncertainty leading up to last week’s election, this monetary tightening cannot be dismissed.
Fed squeezes US economy
Tighter monetary conditions in the US have led to a stronger US dollar, capital outflows from emerging markets (EMs) and disinflation.
The US dollar is up about 4.5% this year against major competing currencies such as the euro, pound and yen.
A stronger US dollar is itself a form of monetary tightening.
A stronger US dollar cheapens imports for US buyers because they need fewer greenbacks to purchase goods.
That’s a deflationary vector that will make the Fed’s goal of achieving a persistent 2% inflation rate even harder to reach.
The US is now getting a triple shot of tightening in the form of higher rates, reduced money supply and a stronger US dollar.
At this rate, we may be in a recession sometime next year unless the Fed reverses course.
We’ll see if the Fed wakes up to the danger before it’s too late.
I’m not holding my breath. The Fed is always the last to know.
All the best,