Greg Canavan

Dear Reader,

I left off on Friday blaming the atrocious behaviour of our political and business elite on the state of ‘money’. It’s a simple formula, erode the value of a currency and you erode the morals of a society.

The people who get their hands on a greater quantity (but of much less quality) of this money think they are morally and intellectually superior. Rules that apply to other, lesser beings don’t apply to them.

Hence their behaviour.

The weird thing about 21^st century currency devaluation is that it’s not accompanied by inflation. At least, not in the traditional sense of high and rising consumer price inflation. We’re told that barely exists.

But there has been rampant asset price inflation. Because as interest rates decline, bond yields fall and that increases the future value of income producing assets. One unit of currency therefore buys you much less of one unit of income producing assets.

To show the effect of this ‘inflation’ is simple. You just denominate a share index by an ounce of gold, rather than a unit of fiat currency.

Let’s have a look at the ASX 200. The value (or, more accurately, price) you get each day is in Aussie dollars. The chart below shows the ASX 200 denominated in gold. The data only goes back to 2009, but that will do.

As you can see, over the past 11 years, the ASX 200 has nearly halved.

In other words, the post GFC recovery in the market has been nothing more than a result of lower interest rates. Put more accurately, it’s the result of deflationary forces pushing bond prices lower. Falling bond prices mean high share prices via their impact on discount rates.

A simple example is in order:

Say you want to capitalise $100 of earnings using a 10% discount rate. 100 divided by 10% = $1,000.

If interest rates fall to 5%, it looks like this: $100 divided by 5% = $2,000.

So earnings can stay the same, but the asset price can double from a halving of interest rates.

The chart above seems like a much truer reflection of the Aussie economy over the past 10 years, doesn’t it?

Real economic wealth (as reflected in the stock market) has declined markedly.

What about in the US?

Here things are a little different.

Have a look at the chart…

Economically, you can see that the US peaked in the late 90s/early 2000s. It’s been all downhill from there. There was a recovery starting in 2012, as tech finally made a resurgence, but it topped out in 2018.

The trend looks to have turned down again.

Whichever way you cut it, in the 21^st century asset prices have relied on monetary stimulus. Real economic wealth creation is increasingly hard to come by.

I wonder why?

Could it be the increasing involvement of government in our economy and lives?

Surely not! They are here to make things better.

I know you don’t believe that, dear reader. And if you do, have a look at the charts above again.

This brings up another point, one that I think is hugely important to understand for the next few years.

There is a widespread view that the Fed’s QE is the same as ‘printing money’, that it creates liquidity and pumps stocks prices up.

This is wrong.

QE creates bank reserves, not cash. When a bank sells a Treasury bond to the Fed, the Fed credits the banks account at the Fed. These are bank reserves, not cash that the bank can go out and buy something else with.

So why do stock prices rise with QE?

Two reasons…

Firstly, think of why central banks do QE…

It’s not because things are going well, is it?

No, QE happens because the economy is slowing. When the economy slows, bond yields decline to reflect a slowing/deflationary/recessionary economy. QE doesn’t cause bond yields to decline…a bad economy does!

And as I just explained, when bond yields fall, asset values (assuming earnings don’t fall too much) move higher.

This raises the question, if the economy is in recession, why haven’t earnings tanked?

Well, that’s because most developed economies are running massive fiscal deficits and propping up household incomes. Given consumption accounts for nearly 70% of economic growth in the West, this support makes a huge difference.

The other reason why stock prices rise with QE?

Belief.

Belief is the most important element of financial markets. You never hear it put this way though. It’s referred to as ‘sentiment’.

Because there is a common belief that QE creates liquidity and makes stocks go up…guess what, QE creates liquidity and makes stocks go up!

Everyone knows that everyone knows that QE is bullish for stocks. It’s a self-fulfilling prophecy.

Where it will break down though is via the inflation narrative.

The next logical step for such ‘massive’ QE (which is apparently ‘money printing’) is that it will lead to inflation. Or so the thinking goes.

But it’s wrong. QE is a result of deflationary forces. In this case, the unnecessary shutdown of the global economy due to COVID. With loads of spare capacity in the economy, how is inflation going to eventuate?

Come back in two to three years, and it might be a different story. But for now, deflation remains the biggest risk.

Regards,

Greg Canavan,
Editor, The Rum Rebellion

Hell Can Wait
By Bill Bonner

‘…the future is somebody else’s problem…’

The Stansberry Digest paraphrasing US Secretary of the
Treasury Steve Mnuchin’s remarks to Congress yesterday

And so, we come to the end of another week. Let’s see if we can summarise what we learned.

The old economy is fading away…

The new economy is a dangerous bubble…

One grows cold. The other is too hot to touch.

What are we to do?

No friends

Economies always evolve. And governments always try to look into the future and stop it from happening.

The future has no friends. It generates no revenues. It pays no taxes.

It can’t vote…it can’t riot in the streets…it can’t even write a letter to the editor.

The present, though, is Mr Popularity. It makes profits, pays wages…and has deep pockets. After all, it owns 100% of the US’ wealth.

It has lobbyists, too, and trade unions, political parties, and 535 members of Congress ready to do its bidding.

What’s more, the future is where hell is located. The planet is overheating! Two million COVID-19 deaths! China is overtaking us! Robots are stealing our jobs!

Oh…and here comes a depression!

Full Weimar

Whatever the threat, the feds mobilise to stop it…with green energy subsidies, tariffs, sanctions, lockdowns, hiring credits…a Patriot Act…or a Paycheck Protection Program (PPP)…

Naturally, the feds are most eager to stop a depression.

But they will not admit that they had any role in causing it…that their own policies (ultra-low interest rates and fake money) created excesses that need to be purged…

Nor should you expect them to confess that their quack remedy (more money printing) will only make the eventual correction worse.

So far this century, they’ve held off three major corrections.

From October 2000 to July 2003, they chopped 5% off their key lending rate and set off the mortgage finance blow up of 2008/09.

Then, they stymied that correction, too, again cutting their key rate by more than 500 points…and printing up an additional $3.6 trillion.

And this year, they’ve gone Full Weimar, with rates back down to zero…and another $3 trillion in new money.

Old economy fails

But try as they will, the world still spins. And the future happens anyway. It just takes another shape.

Their efforts to prevent necessary changes and corrections in the old economy — by flooding Wall Street with cash, for example — created a bubble in the new economy.

Most old economy stocks are down for the year. In terms of gold — the only measure we trust — the old economy Dow stocks have lost about 19% of their value since January.

And of all the US-listed stocks, only three are actually ahead of the game for the year.

New economy thrives

But look at what’s happened in the new economy. The four leaders — Apple, Amazon, Microsoft, and Google — are worth about $6 trillion in total. There are only two countries in the world with a GDP greater than that — the US and China.

Amazon alone is valued at 43% of the entire S&P 500 Consumer Discretionary Index. And Tesla is now worth almost as much as the US’ largest retailer, Walmart, even though it has only 5% of its sales.

The feds’ foolish shutdown and their clumsy attempts to stop a much-needed reckoning have only accelerated the shift from old to new.

The internet darlings — Zoom, Amazon, Netflix, etc — sucked up the new money like an escapee from a dry-out clinic.

Obsolete

And suddenly, much of the old economy infrastructure was obsolete.

The new economy doesn’t need so much office space — people are working from home. Nor does it need so many parking places — who needs them?

Restaurant tables…airplane seats…big city housing…cruise ships…theatres…

And if people don’t commute to work, they don’t need so many automobiles, either. Or so much gasoline…(Exxon stock has been cut in half so far this year).

And the old industries don’t need so many workers, either. The trend has been in motion for a long time — replace human employees with robots. But come the coronavirus…and factories had to shut down, because humans were afraid of getting sick. And coming back to work, they expect more protective measures.

But no robot ever put on a facemask. Robots don’t strike. They don’t complain. They don’t demand equal pay…or fear the virus. They don’t need a lunch counter. They don’t expect overtime pay…or hazard pay…or nighttime bonuses. Or air conditioning. They don’t take breaks. They don’t vote. And they don’t give the boss any lip.

So, when the feds try to buck up the old economy with more free money and below-inflation lending rates, what do employers do? Call back the old workers? Or hire electronic brains and machine-powered arms?

Poor schmucks

The trend is so unmistakable that even the Robinhooders can see it. They take their government cheques ($1,200…or unemployment), turn their backs on Ford (down almost 30% this year) and GM (down almost 20%), and buy Tesla (up 363%!).

They think they’re joining the future, not fighting it. But the feds’ fake money has turned the future into such a speculative bubble that it is ready to blow up again — for the fourth time this century.

The poor schmucks…they lost their jobs in the old economy  and had to move in with their parents (more young people currently live with their parents and grandparents than at any time since the Second World War). And now, they’re going to lose their money in the new economy.

Zoom towns

But it’s not all gloom and doom. Many people are older, richer…and moving to zoom towns. A dear reader, James P, comments:

‘Living in a remote mountain valley, about 90 minutes from Colorado Springs, our economy is booming. New housing construction is booked out through late 2021. Available houses are getting offers above asking prices and selling in as little as 6 days. And this is in a place with only two paved roads – the rest are dirt; only dial-up DSL internet; no traffic lights; no hospital; a tiny pharmacy that opened two weeks ago; and where jobs and homes are simply unavailable for the working classes. The economy here is booming. But only because people are abandoning the cities as fast as they can move.’

Some people are saving money at twice to three times last year’s rate — and sitting pretty. Many of them are retired…or able to work (remotely) in the new economy.

They made the transition from old to new smoothly. And they’re too smart (or too poor) to put their retirement money in the go-go FAANG stocks.

But even for them…the future may not be easy. Having dodged one danger and avoided the other…they are now set up like bowling pins…ready to be knocked down when the next big balls come rolling down the alley.

Killer blow

The first will bring deflation and depression, as the new economy blows up…and the old economy fails to recover.

The second will be the killer, as the feds fight the depression with trillions in printing press money. According to the Financial Times, 90% of the American public favours more ‘stimulus’. And probably 100% of Congress.

They want the money now. The future can wait.

But when the future shows up, it will almost certainly be hell on wheels — wiping out savings, reducing Social Security, destroying the economy and the ‘social contract’…and raising the cost of living for everyone.

When will it be over? In five years? 10? More?

We don’t know.

But when it is over, we predict there will be few pins left standing.

Regards,

Bill Bonner,
For The Rum Rebellion