As Equities Fly, Hang on to Your Gold

As Equities Fly, Hang on to Your Gold  

The equity markets are now setting new all-time highs every day as speculators and especially short-sellers quiver in anticipation of the next round of central bank easing. The market calls it ‘helicopter money’ but the next step being promoted by leading economists is ‘Cold Fusion’.

What is Cold Fusion? The term encompasses make-work government programs such as infrastructure funded by bonds which are issued by government agencies and purchased directly by central banks. The aim is to by-pass debt markets and animate more fiscal spending by governments that are otherwise too broke to fund it. Helicopter money suggests money dropped indiscriminately into the hands of consumers and businesses…monetary carpet bombing if you will. We think Cold Fusion will come first because it’s more targeted. The money comes down in a pre-determined spot, more like a smart bomb. Happy you if it’s your spot.

This is very exciting to the stock market, at least until the unintended consequences emerge. And what are those consequences? There are three that concern us most: excess demand driving consumer price inflation; loss of confidence in the currency; and collapse of the bond market.

Unintended Consequences

Cold Fusion increases cash within the economy and demand for goods and services without increasing investment in the production of goods and services. The government becomes an undisciplined buyer of good and services, using free money to bid them away from private consumers.

Cold Fusion is very different from Quantitative Easing, in which the central bank creates currency to buy financial assets, thereby boosting asset price inflation. Cold Fusion money printing is designed to create consumer price inflation and we think it will succeed in this respect very handsomely indeed. We are already seeing the beginnings of consumer price inflation. Cold Fusion promises inflation on steroids.

Wouldn’t Cold Fusion stimulate capital investment? We already know that radical monetary policies depress investment, the exact opposite of what the central bankers have predicted. Consider this. Would you put your money into more capacity in response to a demand boom based not a strong economy but rather on a weak one wholly dependent upon printed money? How long will the madness last, you might ask? Why not simply profit from the extra demand by simply raising prices?

In a Cold Fusion economy, how confident are you in a currency that is freely printed and spent by government? Does it lose value in the eyes of ordinary consumers and savers? Wouldn’t you rather hold gold?

Hyper-inflation begins when ordinary citizens no longer want to hold the mandated currency. We know from history that, in these circumstances, citizens store value in goods, commodities and especially gold. Hyper-inflation is not caused by a gradual acceleration towards run-away prices; rather, it is loss of confidence in the currency which happens suddenly as citizens lose faith in monetary authorities.

Finally, how does the traditional bond market retain its value in a Cold Fusion economy? Do bonds that can be created and funded with no repayment obligation put in question the value of all debt? How can the market set interest rates if this is the case?

Only in Japan You Say?

You may think that Cold Fusion and helicopter money could never happen in America, only crazy places like Japan. But 10 years ago, QE was thought to be totally impossible. Yesterday’s crazy is today’s normal.

Speaking on July 12, 2016 in Australia, Cleveland Fed head Loretta Mester said "helicopter money" could be considered to stimulate America's economy if other monetary policies fail. As Australia's ABC reports, Mester, a voting member of the rate-setting Federal Open Market Committee, signalled that direct payments to households and businesses to stoke spending were an option if interest rate cuts and Quantitative Easing fail. (Haven’t they already failed, we ask?).

"We're always assessing tools that we could use," Mester said. "In the U.S. we've done quantitative easing and I think that's proven to be useful.

"So it's my view that helicopter money would be sort of the next step if we ever found ourselves in a situation where we wanted to be more accommodative.”

Let’s be clear. The Fed has only one approach to economic weakness; more accommodation, more of what’s not working, because they are too frightened of the alternative…recession and asset price compression.

The problem with Cold Fusion is that it cannot fix our most important economic problem…too much unproductive debt. By injecting more money into the system, this policy would perpetuate an inefficient, corrupt, bloated and unsustainable status quo. The global economy does not need more spending; in our view it desperately needs the discipline of higher interest rates which would reduce debt and draw money into savings and investment and out of speculation. This will be a very painful transition with many a default. But in our view, the economy badly needs to clear the burden of bad debt, increase private investment and reward savers with sustainable retirements.

The jury is in. We have surely seen enough in Japan, Europe, China and America. Central bank innovations in monetary policy…ultra-low administered interest rates and Quantitative Easing…have not spurred economic growth. Rather, these policies have destroyed the incentive to save and invest and they are now encouraging investors to take refuge in gold…an eminently rational choice under the circumstances.

If you expect central bank policy to become even more extreme, as we do, before it finally returns to sanity, hang on to your gold. If you don’t own gold, we think now might be a good time to start acquiring some, before the next stage of central bank madness begins.