Friday, 7 June 2024

By Nick Hubble Editor, Strategic Intelligence Australia

[6 min read]

Dear Reader,

The halls of power are filled with the mutterings of a new theory. One which will change the world.

Just like those that came before it…

The new ideology is replacing Modern Monetary Theory. MMT, in turn, replaced Austerity. The Great Moderation came before that.

Before I tell you about this new theory, let me emphasise…

The importance of such beliefs cannot be overstated…because so often they break down just as they reach critical mass.

For example, not long after MMT became popular with governments, we got the inflation which MMT critics warned about.

Between 2003 and 2007, the Great Moderation belief was ascendant. It was the idea that centrals banks could engineer low inflation, full employment and end the boom bust economy.

We got a massive financial crisis in 2008.

Between 2010 and 2019, austerity trashed the economies of Southern Europe.

In each case, the fashionable ideological beliefs of the moment determined what happened next… before being abandoned as flawed.

Such an ideological reversal has just happened again.

A new theory is spreading amongst the elites who control the levers of economic power. It will be behind the next series of shocking policy mistakes.

If you understand the theory, you can predict what they will do.

The new theory you’ll soon be hearing about daily is called… ‘Fiscal Dominance’

In a way, it’s a very simple idea.

Government debt across Europe and in the US is too high to raise interest rates. Any more hikes would send the relevant governments bust.

That means central banks are now powerless. Monetary policy is moot.

Fiscal policy (government spending and taxation) now holds the cards when it comes to economic policy.

If the government spends too much and taxes too little, you get inflation.

If it spends too little and taxes too much, you get a recession.

Central banks have no choice but to fund the government and keep interest rates low to avoid a sovereign debt crisis.

This makes inflation a fiscal phenomenon.

The implication? Politicians now run the show, not central bankers.

That’s a concerning idea.

Politicians can’t run an economy and certainly can’t be trusted to manage inflation. That’s why we came up with central bank independence in the first place.

That said….

Fiscal dominance is really nothing more than a theory.

But I think it’s a load of hokum. In fact, I believe precisely the opposite is the case.

Let me prove it to you, before I explain the implications...

The Fiscal Dominatrix

At the end of 2022, the new UK Prime Minister published the first half of her budget. It unveiled a load of tax cuts. The associated spending cuts would come later.

But the market ignored that second part. It reacted as though the UK government’s deficit was about to go through the roof.

The unusually large spike in bond yields caused a domino effect in the bond market. Pension funds began panic selling bonds.

This got out of control quickly. At one point, a good chunk of the UK pension fund industry was about to go bust.

Within months, the Prime Minister was fired for her bungled budget and the chaos it caused.

At the time, I wondered why the Bank of England didn’t intervene in the bond market faster. Why didn’t they buy bonds to stabilise prices? It’s their job, after all.

Lately, the Former Prime Minister Liz Truss is claiming something sinister. She argues that the whole thing was a deliberate ploy to get her out of government. The Bank of England conspired to undermine her.

This may sound shocking. But consider that it’s not particularly rare for bond markets to help boot out governments. Or to interfere in the political process.

During the European Sovereign Debt Crisis, the Greek government was so afraid of spiking bond yields that it ignored a referendum result!

Despite Greeks voting ‘No,’ their government accepted the European Central Bank backed austerity program.

The Greeks in power “resigned” their Finance Minister Yanis Varoufakis for good measure…because he didn’t want to go along with it.

Similar shenanigans happened in 2018 with the Italian government. Each time the government tried to exert its democratic mandate; bond yields would go up. Each time the government gave in to central bankers’ demands; bond yields would go back down.

Behind the scenes, the ECB was buying and selling government bonds at the time.

The question we don’t know is whether they were behind the marginal moves. And were they controlling the bond market to pressure the Italian and other EU governments?

Even US President Bill Clinton was forced to reverse his whopping budget deficit when the bond market plunged under his reign too. His reputation as a fiscal conservative came from the bond market whipping him into place.

There are countless other examples. Each time, governments attempt to implement the economic policy they were elected to. But then players in the bond market push up their borrowing costs. And so politicians abandon their plans.

My point being is that Fiscal Dominance
has it precisely backwards.

Governments are not in control at all.

They are so reliant on central banks to finance them in the bond market that central banks are the ones that remain in control.

If central bankers don’t like a tax cut, they can just allow the bond market to intimidate a prime minister.

If central bankers want austerity, they can allow the bond market to force the government to impose it.

If central bankers don’t want a country to leave the EU or eurozone, they can allow bond markets to remind the government what that would mean for their borrowing costs.

The central bankers are in complete control of the world’s most powerful politicians. They are pulling the purse strings like puppeteers. 

If you want to predict what happens next in the world, don’t ask what politicians have planned. Ask what central bankers want them to do.

I’m keeping that for my subscribers’ eyes only, over at Strategic Intelligence Australia. But I will reveal my conclusion here…

You can expect a series of inflationary “surprises” as central banks attempt to pay off the government debt by inflating it away. Instead of repaying the money owed, the money will become worth less over time.

That’s what inflationary “surprises” achieve. But they have to come as a surprise to have the intended effect. Otherwise bond investors will just demand higher interest rates, offsetting the effect.

In such an environment, investors should own hard assets and energy. That’s because their globally traded prices can just rise with inflation.

Find out more here.

Until next time,

Nick Hubble,
Editor, Strategic Intelligence Australia

Nick Hubble found us at Fat Tail Investment Research in 2010 after a stint inside Wall Street’s most notorious bank, Goldman Sachs, during the 2008 GFC. That’s where he saw the true nature of the investment banking business. Since then, he’s been the editor of the Daily Reckoning Australia and the UK-based Fortune & Freedom and Gold Stock Fortunes.

He’s delighted to work as Investment Director and Editor for Jim Rickards’ Strategic Intelligence Australia. Here he helps turn Jim’s big-picture views into specific actionable advice and ideas for Australian investors.

By Bill Bonner Editor, Fat Tail Daily

[3 min read]

First a happy note from Fox: 

‘Many elections are marked by reports of dead people voting, but a dead person being elected is far less common. Yet that’s exactly what happened on Tuesday when Rep. Donald Payne Jr. won a primary in New Jersey’s 10th congressional district. 

‘The beloved congressman and member of the Congressional Black Caucus suffered a fatal heart attack on April 24th, according to the NY Post. The filing deadline for primary campaigns in New Jersey was in March. Congressman Payne Jr. was the only candidate to register.’ 

We wish the candidate well in the general election. He would certainly get our vote. He would be the least corruptible member of Congress — by far. The most reliable and steadfast, too... unwilling to go along with the latest scams and boondoggles. Alas, he would be in a very small minority. Most members of Congress are still above ground... and a threat to us all. 

But now, back to our regularly scheduled programming: 

Why can’t we win a war... even with a 30-to-1 advantage (measured in GDP)? 

If we’re so rich, why can’t we pay our own way... rather than passing the bill for current programs onto future generations? 

Why does it seem to average citizens that things are getting worse... while politicians insist that we are better off than ever? 

On this last point... Business Insider: 

‘A survey conducted by financial services firm Primerica found that 67% of middle-class respondents said their income was falling behind the cost of living over the first quarter. Among those people, 74% said they were pulling back on discretionary purchases, such as eating out.’ 

More broadly, it has been widely reported that millennials will be the first generation in American history to earn less than their parents. 

What gives? 

Donald Trump claimed that he presided over the “greatest economy ever.” Now, Joe Biden claims the same thing for himself.  Why then did they need to borrow so much money?  In 2016, the US had $20 trillion in debt. Together, over the next eight years, they added $15 trillion — more than any dynamic duo in the history of the country.

But even with these record deficits behind us... and estimated deficits of $1.5-$2 trillion per year going forward, US GDP growth rates are slumpy and consumer price increases make it hard for people to keep up. As a result, Americans are forced to give up one of their simple pleasures — eating out. 

In this month’s edition of his marvellous Gloom, Boom and Doom Report, our old friend Mark Faber takes a look at the status of the chain restaurant business. In a word: bad. 

The huge cash infusion of the Covid years has mostly played itself out. The stimulus did not produce higher output or greater wealth. It just increased prices — particularly real estate prices. 

Shelter is the biggest single item in most family budgets.  So, this leaves families a little short of cash.  The ‘casual dining’ sector seems to be feeling the pain most sharply.  

Labor and food bills have increased dramatically for the restaurants, especially in California, where fast-food workers get a minimum wage of $20 per hour. Restaurants have been forced to raise prices. Prices at McDonalds, for example, have more than doubled since 2014. 

Faber reports that about two in five restaurants didn’t make a profit last year. Red Lobster is said to be considering bankruptcy. TGIF is in ‘distress.’ Appleby’s is closing restaurants. Boston Market is going bankrupt. Cracker Barrel reports “weaker than expected traffic.” He continues, listing a few notable bankruptcies:   

‘The New York–area Sticky Fingers Joint (in part due to “unprecedented” chicken and potato price increases), Tijuana Flats (a casual Mexican restaurant chain located in Florida), and Rubio’s Coastal Grill (a chain of 150 restaurants throughout Arizona, Nevada, and California). According to Bloomberg: Prices are rising more slowly at the supermarket, meaning families can still stretch a paycheck further buying staples rather than ordering prepared foods... 

‘Across the board, you have higher labor and food input costs and hesitant consumers,” said Mark Levin, a co-founder of advisory firm Asterisk Capital. “Some people will trade down from mid-priced to lower-priced restaurants, but a lot of lower-priced customers will just stay at home.’ 

A ‘Restaurant Apocalypse’ is said to be sweeping across America, according to Michael Snyder. Why? Because ‘consumers simply have a lot less discretionary income now’.  

Less discretionary income? What happened to that $15 trillion of new credit that the feds pumped into the market? Distributed evenly, that should have put another $150,000 per family into consumer pockets. Where is it? 

Tomorrow, we return to French economist Emmanuel Todd and his idea that much of US wealth is ‘fictitious’. Whether it is the prices of stocks or bonds…or property…or the wealth of Wall Street or Main Street’s US GDP — much of it is a fantasy. 

More to come...  

Regards,

Bill Bonner,
For Fat Tail Daily