The stock market has been
soaring, unemployment is low, and there is some improvement in wages
and corporate earnings, though significantly less than from other
recession recoveries. But there are other issues here that should be
of concern. First of all, it should be noted that stocks are at lofty
levels that marked the tops of major bull markets preceding the Great
Recession, the “dot.com” (tech stock) bubble in 2000, and the
crash of 1929. In the third quarter of 2008, U.S. household debt
peaked at $12.7 trillion; today it is $13.3 trillion, 20 percent
higher than five years ago. Since 2008, Student debt has more than
doubled, to $1.5 trillion. Delinquent auto loans have risen 53 percent, to $1.2
trillion, with 6.3 million borrowers being 90 days or more late on
auto loan payments. These delinquencies have been increasing
steadily since 2011 and are now the highest in 15 years.
Total global debt—sovereign,
corporate and household debt—spiked 75 percent in the past decade.
During this period total corporate debt rose 78 percent to $66
trillion, and nonfinancial bonds rocketed 172 percent, from $4.3
trillion to $11.7 trillion. A recent report by McKinsey says 40 % of
U.S. companies are rated one notch above “junk” or lower. And the
Bank for International Settlements says 10 percent of the legacy
companies in the developed world are “zombies,” meaning earnings
before interest and taxes don't cover interest expenses. That is
what zero interest rates and quantitative easing will get you: more
debt and lower credit quality.
Because of the recent Great
Recession, Ben Bernanke, then chairman of the Federal Reserve, set the Fed on a course that
more than quintupled it's 2008 balance sheet by 2018 by buying long
term bonds and mortgage-backed securities. He explained this
“unconventional” monetary policy of easy money would lead
investors to shift out of bonds and into the stock market and real
estate. Supposedly, this would raise household wealth, which would
increase consumer spending and strengthen the economy. Instead, this
Fed policy inflated price bubbles in stocks and residential housing
that produced trillions of dollars in losses when those bubbles burst
and household wealth nosedived. As Martin Feldstein, former chairman
of the Council of Economic Advisers under President Reagan, put it:
“In short, an excessively easy monetary policy overvalued equities
and a precarious financial situation.” During the Great Recession,
the real estate industry lost $7 trillion,
the stock market crash added another $11 trillion in
losses, and retirement accounts lost $3.4 trillion.
Those gigantic losses
stimulated a politically tolerable solution but failed to
provide an economic solution, which is why so many economic
metrics are now worse than in 2008, setting the stage for another
major crash. Every borrowed dollar since 2008 has generated only 44
cents of economic output. The
GDP has
increased 35% since 2008, but the national debt has increased 122%.
Now the national debt is over $21.5 trillion, compared to $9.5
trillion in 2008.
Though
there has been no link between gold and the dollar since 1971, gold
prices factor into such things as the relative desirability of
holding dollars, interest rates on U.S. treasury securities, the
price of oil, and political considerations. For example, whether the
dollar is strong or weak is likely to influence the prevailing
sentiment for buying gold.
Central
banks are buying gold for their reserves at the
fastest pace in 6 years, adding 264 tonnes to their holdings in the
January-to-September 2018 period. That includes 9 tonnes by Poland,
the first European Union country to buy gold in the 21st
century. The biggest buyers were Russia, Turkey, and Kazakhstan,
accounting for 86 percent of central bank buying. “Egypt bought
gold for the first time since 1978, while India, Indonesia, Thailand
and the Philippines re-entered the market after multi-year absences.
The Reserve Bank of India added 8 tonnes of gold, buying for the
first time in almost nine years, and then added another 7 tonnes by
the end of August,” according to the World Gold Council. The
people of India, avid fans of gold, value it for religious and
ceremonial purposes as well as aesthetic, sentimental and monetary
reasons. They are estimated to own 20,000 tonnes of gold in jewelry,
coins and bars.
After
President Nixon severed the last link between the dollar and gold in
1971, he sent Secretary of State Henry Kissinger to negotiate a deal
for buying Saudi Arabian oil. Saudi Arabia lies in a violent part of the
world, where wars, revolutions and assassinations occur more often
than in most other parts of the globe. In 1973 the U.S. offered to sell
Saudi Arabia, then the world's leading oil exporter, airplanes, tanks, and other weapons and
provide U.S. military protection to the ruling family and the government.
All the U.S. asked in return was that Saudi Arabia's oil be sold only
for dollars and that surplus revenue available for investment by the
Saudis from oil sales, after deducting for the needs of government,
would be invested in U.S. Treasury securities. Such a deal! By 1975
all of OPEC (Organization of Petroleum Exporting Countries) members
agreed to the same deal.
Since
every country in the world was either buying or selling oil, they
were all dealing in dollars because oil was priced in dollars. These
“petrodollars” gave support to the American currency, but that is
now all but gone. As a result of fracking, horizontal drilling,
deep-water drilling, and the discovery of new oil fields all over the
world, neither Saudi Arabia, nor the United States nor any other
nation can set the price of oil—and the currency—irrespective of
what is happening in the industry all over the globe. Japan is buying
oil from Iran priced in Japanese yen. India buys oil from Iran in
rupees. Russia agreed to the sale of $400 billion of natural gas to
China over the next 30 years with the gas priced in Chinese yuan, not
dollars. China also has agreements with at least 23 other countries
for bilateral trade agreements in currencies other than the dollar.
The BRICs (the large developing nations of Brazil, Russia, India and
China) have agreed to trade in each others currencies rather than
using the dollar as an intermediary. Australia, South
Korea, Turkey and Kazakhstan have agreed to conduct trade in currency
swaps of their own respective currencies. Germany has agreed to trade
with China in yuan and euros. The
importance of the dollar is receding from the position it held since
the 1970s.
That
may help to explain the world's central banks increased purchases of
gold, aligning their assets with what they see as a growing trend.
Since the formation of the European Union in the 1990s, there was a
concerted political effort to phase out gold in the international
monetary system and replace it with a fiat currency, the euro. The
euro experience has shown that an unlimited ability to print money
with no backing cannot replace the effectiveness of a tangible
monetary asset, gold. Central bank buying of gold now may be
recognition of that. But it may also reflect the historical
importance of gold in four central bank agreements. The
first Central Bank Gold Agreement took place in 1999. At that
time, central banks held nearly a quarter of all gold held above
ground, about 33,000 tones. The second gold agreement (CBA2)
took place in 2004. CBA3 followed in 2009 and CBA4 followed in 2014.
The
first clause in each of these four agreements began: “Gold will
remain an important element of global monetary reserves.”
In one of its first pronouncements, the ECB governing council decided
the capital subscriptions of euro-zone members would be paid
partially in gold, (with the balance determined by a formula of other
currencies and the population and GDP of the countries.) For
many years the central banks and the International Monetary Fund sold
gold in the belief the future world money would be fiat currency.
That policy began to change about a decade ago.
When it became possible to
buy oil with something other than dollars, there was less demand for
dollars that could go to buying U.S. treasury securities to finance
America's deficit spending. What else could foreign governments do
with the dollars they acquired for U.S. trade deficits? Since 1971,
they couldn't convert them for U.S. Treasury gold—but that was
changing with the establishment of the Shanghai Gold Exchange. Unlike
the gold markets in New York and London—which deal primarily in
paper contracts for future delivery, which seldom occurs—the SGE
deals in the physical metal for immediate delivery. Countries which
could not exchange their dollars for gold from the U.S. Treasury
could now trade those dollars for actual gold on the Shanghai Gold
Exchange.
When I wrote my book, I
concluded that the two possibilities for the future were severe
depression or runaway inflation—or possibly both, with one bringing
on the other. But I figured the possibility of runaway inflation
would so frighten our monetary managers that they would try to avoid
that at all costs. Now, however, I think they are somewhat more
likely to do what they have done since 2008: simply print more money.
There is also the possibility that they would lose control of
interest rates, which in turn could bring about hyperinflation.
There is also the question
of what will happen to the $6 trillion that are held by foreigners.
Nations' central banks have been holding them as reserve assets
because they were needed to buy oil, but they are no longer needed
for that. Would the central banks be better off trading them for gold? Or yuan? Or
stocks, bonds, ETFs or real estate?
When the Federal Reserve
buys bonds from the U.S. Treasury, it creates—out of thin air—a
corresponding deposit in one of the large commercial banks where the
Treasury has an account. The money from that deposit gets into
circulation when the government spends it by buying something with
it, for which the seller makes a deposit in his own account. The
seller then spends the money from his account to buy something else,
and the process of sales and deposits is repeated as the money is
circulated in accounts throughout the economy.
The Fed is not the only
central bank increasing its money supply in this manner. Other
central banks are doing the same thing with their national currencies
in the hope of stimulating growth in their economies. Japan is a
prime example, having employed this and other “stimulative”
policies for more than two decades with poor results. Those decades
are called the “lost decades.” From 1991 to 2011 Japan's annual
economic growth averaged less than one percent. It now has a
debt-to-GDP ratio of 250%, the highest in the world, and more than
three times what it was (65 %) in 1990 when the first of its ten
stimulus programs began. But that hasn't stopped Japan from trying
larger doses of the same failed policies.
Shinzo Abe was elected prime
minister of Japan in large measure on his campaign for monetary
easing. In 2013 he said, “Countries around the world are printing
more money to boost their competitiveness. Japan must do so too.”
He called for more aggressive action along the lines of the Fed and
the European Central Bank. That was his prescription for a degree of
“needed” inflation to bring Japan out of two decades of economic
stagnation and avoid the growing fear that deflation was now a
greater threat than inflation. Whereas the Fed buys only U.S.
Treasury securities, the central bank of Japan would henceforth buy
at the market more than twice the amount of new bonds issued by its
government, and it would buy not just government bonds but stocks,
ETF's (exchange traded funds), and real estate funds. These
purchases would increase Japan's money supply just the way the Fed
increases the U.S. money supply by buying U.S. treasury securities.
Other central banks were
particularly interested in common stocks. Easy money policies made
stock prices look cheap, and with near zero interest rates on
government securities, buying common stocks at least offered the
prospect of higher yield. The five largest central banks raised their
financial assets in ten years from less than $4 trillion to $14.6
trillion.
Swiss National Bank
purchased a record $17 billion in US equities in just the first
quarter 2017, bringing its total U.S. equity holdings to an all time
high above $90 billion, about 30% more than at the end of 2016.The
Swiss National Bank bought almost 4 million shares of Apple stock in
the first three months of 2017. It owned more publicly-owned shares
of Facebook than founder Mark Zuckerberg, whose holding was worth
almost $24 billion. SNB also has over $1 billion each in Exxon Mobile
and Johnson & Johnson stocks. SNB is the world's eighth largest
public investor. The bank of Japan is a top-five owner of most of
the 81 companies in Japan’s Nikkei Stock Average, and it owns 62
percent of the domestic ETF market. If countries around the world are
printing more unbacked money, the potential for runaway inflation
increases since there is no limit on the amounts they may print.
Perhaps this is the reason the world's central banks have greatly
increased their purchases of gold.
The conditions favoring gold
as the world's reserve currency have altered significantly, and the
dollar will not be the world's reserve currency forever.
Petrodollars cannot save the dollar from depreciation as they did in
the decades following the agreements with Saudia Arabia and other
OPEC countries, and Saudi Arabia is no longer the undisputed leader
in the oil industry as it once was. Saudi Arabia now exports more oil
to China than it does to the U.S. China is accumulating gold as fast
as it can, not only domestically but by investing in foreign gold
producers and buying prospective properties. And it is helping
finance Saudi production of new oil wells. For example, it financed
the giant oil refinery in Saudi Arabia at the port city of Yanbu that
processes 400,000 barrels of crude per day.
