Corporate America has been in recession since 2014

September 23, 2016

This blog post is an excerpt from a recent TSI commentary.

The following three charts tell an interesting story.

The first chart shows that the real output of the US manufacturing sector has essentially flat-lined since Q4-2014.

The next chart shows that Total US Business Sales has been down on a year-over-year basis during every month subsequent to December-2014.

The third chart shows that US corporate profits peaked in Q4-2014 and in the latest completed quarter (Q2-2016) were almost 10% below their peak.

The story is that there has been a business recession in the US since the end of 2014. The business recession hasn’t yet transformed into a full-blown economic recession, but it will possibly do so within the next three months and it will probably do so by mid-2017.

The US business recession hasn’t been caused by the relatively strong US$. We know this firstly because a strong currency logically cannot be the cause of persistent economic weakness and secondly because the following chart shows that Net US Exports have improved slightly since the end of 2014.

Economic weakness outside the US has almost certainly played a part in the US slowdown, but the biggest part has been played by the Fed. Monetary policy has simultaneously caused stock prices to remain high and underlying businesses to languish, with the most obvious evidence being the favouring of debt-funded stock buybacks over capital investment.

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Using statistics to distort reality

September 19, 2016

Two months ago I posted a short article in which I discussed an example of how the change in an economic statistic was greatly exaggerated — in order to paint a misleading picture — by showing the percentage change of a percentage. I’ll now discuss another example of using the same trick to make the change in an economic number seem far more dramatic than was actually the case.

Before getting to the specific example, the general point is that when analysing economic data — or any other data for that matter — it won’t make sense to consider the percentage of a percentage unless it’s the second derivative that you are primarily interested in. When you take the percentage change of a percentage you cause a change in the underlying number from 0.5 to 1.0 to become the same as a change in the underlying number from 5 to 10 or 100 to 200, but in the real world the change in an economic number from 5 to 10 will usually have vastly different implications to the change in the same number from 0.5 to 1.0. For example, there is a huge difference between a change in the rate of GDP growth from 0.5% to 1.0% and a change in the rate of GDP growth from 5% to 10%, but both constitute a 100% increase in the rate of growth.

On a related matter, it can also be problematic to look at percentage changes of economic numbers when the numbers are fluctuating near zero. This is because a move from one miniscule value to another can be large in percentage terms. For example, a move from 0.01 to 0.03 is a 200% increase.

The specific example that prompted this post appeared in John Mauldin’s recent article titled “Negative Rates Nail Savers“. The gist of the Mauldin piece is completely correct, but during the course of the long article some mistakes were made. I’m zooming-in on the mistake contained in the following excerpt:

Here is a long-term chart of the federal funds rate, the Fed’s main policy tool:

The gray vertical bars represent recessions. You can see how the Fed has historically dropped rates in response to recessions and then tightened again when those recessions ended. I red-circled the particularly drastic loosening and retightening under Paul Volcker in the early 1980s and Ben Bernanke’s cuts to near-zero in 2008.

To this day, the Volcker rate hikes are legendary. No Fed chair has ever done anything like that, before or since. You hear it all the time. Problem: it’s not true.

Here is the same chart again, this time with a log scale on the vertical axis. This adjusts the rate changes to be proportionate with percentage rises and falls. The percentage change between 5% and 10% is the same as between 10% and 20%, since both represent a doubling of the lower number.

Looking at it this way, the Volcker hikes are tame, almost unnoticeable. Meanwhile the Bernanke cuts dwarf all other interest rate changes since 1955. Nothing else is even close. Bernanke’s rate cuts were far, far more aggressive than Volcker’s rate hikes.

The fact that looking at it this way “the Volcker hikes are tame, almost unnoticeable” should have told Mr. Mauldin that it was the wrong way to look at it. Moreover, looking at it Mr. Mauldin’s preferred way, even the tiny up-tick in the Fed Funds Rate last December makes Volcker’s hikes seem tame. After all, when the Fed nudged the target Fed Funds Rate up from 0.125% to 0.375% last December it could be described as a 200% rate increase (since 0.375 is three-times 0.125). This means that by taking the percentage change of a percentage, or in this case by charting percentages using a log scale, it can be shown that last December’s rate hike was the most aggressive monetary tightening in the Fed’s history!

I suspect that Mr. Mauldin’s mistake was innocent, but a sure way to reduce the credibility of an otherwise good argument is to use flawed statistical methods to support it.

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What is/isn’t a risk to the global economy

September 16, 2016

This post is an excerpt from a recent TSI commentary.

Quantitative Easing (QE) is a risk. Negative Interest Rate Policy (NIRP) is a big risk. Governments using the threat of terrorism as an excuse to dramatically increase their own powers and reduce individual freedom is a huge risk. X hundred trillion dollars of notional derivative value is meaningless.

The hundreds of trillions of dollars of notional derivative value and the associated counterparty risk is a potential life-threatening problem for some of the major banks, but if you believe that derivatives are like a sword of Damocles hanging over the global economy then you’ve swallowed the propaganda hook, line and sinker. The claim during 2008-2009 that the major banks had to be bailed out to prevent a broad-based economic collapse was a lie and it will be a lie when it re-emerges during the next financial crisis.

The global economy could easily handle JP Morgan, Goldman Sachs, Bank of America, Citigroup and Deutsche Bank all going out of business. The shareholders of these companies would suffer 100% losses on their investments, the bondholders of these companies would suffer substantial ‘haircuts’, most employees in the investment-banking and proprietary-trading parts of these companies would lose their jobs, but it’s unlikely that depositors would be adversely affected as the basic banking businesses would simply come under new management. Furthermore, while there would be short-term disruption, Apple would continue to sell loads of iPhones, Exxon-Mobil would continue to sell loads of oil, Toyota would continue to sell loads of cars, and both Walmart and Amazon would continue to sell loads of everything. Life would go on and in less than 12 months most people would not notice that some of history’s banking behemoths had departed the scene.

The real economic threat posed by derivatives is that when there is a blow-up the central banks and governments will swing into action in an effort to keep the major banks afloat. Rather than doing nothing other than ensuring that there is a smooth transfer of ownership for the basic banking (deposit-taking/loan-making) parts of the businesses, we will likely get a lot more of the policies that transfer wealth from the rest of the economy to the banks. That is, we will get a lot more price-distorting QE and programs similar to TARP.

The justification will be that saving the banks is key to saving the economy, but in reality the biggest threat to the economy will come from the policies put in place to save the banks.

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Is the Fed surreptitiously tightening?

September 14, 2016

The following chart shows that on a monthly closing basis, bank reserves held at the Fed peaked in August of 2014 at $2.79T and by August-2016 had shrunk to $2.35T. This amounts to a $440B decline in bank reserves over the space of two years. Furthermore, $320B of this $440B decline happened since last October. Does this mean that while the financial world vigorously debates whether the Fed will/should take a ‘baby step’ along the rate-hiking path next week, behind the scenes the Fed has been tightening the monetary screws for 2 years and especially over the past 10 months?


In a word, no. Up until now the Fed has done nothing to tighten monetary conditions.

I am, of course, aware that there was a tiny increase in the Fed’s targeted interest rate last December, but this rate hike was not implemented via a money-supply or reserve reduction and therefore did not constitute genuinely-tighter monetary policy. What, then, is the explanation for the significant reduction in bank reserves held at the Fed?

Before getting to the explanation I’ll reiterate that there are only three ways for US commercial bank reserves to decline. They can be converted to physical currency in circulation in response to increasing demand on the part of the public for notes and coins, they can be shifted to other accounts at the Fed, or they can be removed by the Fed. Only the last of these constitutes monetary tightening by the Fed.

Part of the explanation for the decline in bank reserves is the increasing demand on the part of the public for notes and coins. Due to “inflation”, this demand increases almost every year and is satisfied by the conversion of reserves into physical currency. This naturally has the effect of reducing bank reserves, but the process does not change the money supply because the physical currency replaces electronic currency. For example, when you withdraw $100 at an ATM, $100 is converted from electronic form to paper form while the total money supply is obviously unaffected. This $100 of ‘paper’ comes from the bank’s reserves.

The following chart shows the steady increase in “Currency in Circulation” over the past 5 years. As noted above, this increase involves the siphoning of reserves (in physical form) out of the banking system to replace electronic money. An implication is that if the Fed does nothing and the public’s demand for physical notes/coins is rising, bank reserves will dissipate over time.


Since last October, when the rate of decline in bank reserves accelerated, “Currency in Circulation” has risen from $1392B to $1464B, or by $72B. In other words, increasing demand for physical notes/coins only explains $72B of the $320B reduction in reserves since last October. If the remaining $248B reduction wasn’t due to the actions of the Fed, what caused it?

Before I answer the above question I’ll provide evidence that the reserve reduction wasn’t engineered by the Fed. The evidence is the following chart showing total Federal Reserve Credit. Notice that Total Fed Credit has flat-lined since the end of QE in October-2014. This indicates that since October-2014 the Fed has not made any sustained additions to or deletions from the quantity of money or the quantity of bank reserves.


Getting back to the question asked above, the answer is the US Treasury. More specifically, about 90% of the remaining $248B reduction in bank reserves has been caused by the US Treasury hoarding a lot more cash than usual at the Fed.

As I mentioned earlier in this piece, bank reserves can’t leave the Fed unless they are removed by the Fed or get converted to physical currency in response to increasing public demand for notes/coins, but they can get shifted to other (non-reserve) accounts at the Fed. One of these accounts is called the US Treasury General Account, which, as the name suggests, is the US government’s account at the Fed.

As illustrated by the following chart, the Treasury General Account was about $50B at the end of October last year and was about $275B at the end of August this year. This means that over the 10-month period beginning in November of last year the US Treasury removed about $225B from the economy-wide money supply and removed the equivalent amount from bank reserves.

Just to be clear, the government removes trillions of dollars per year from the economy, but it normally recycles the money very quickly. Usually, money comes in one door via taxation or borrowing and immediately goes out another door. The difference this year is that the Federal Government has been maintaining a much higher ‘cash float’ than usual.


I don’t know why the US Federal government has suddenly started keeping a lot more cash in reserve. Perhaps the leadership wants to make sure that, come what may, there will always be plenty of ready cash to pay the salaries/benefits of politicians and senior bureaucrats.

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Explaining the moves in the gold price

September 9, 2016

Here is a brief excerpt, with updated charts, from a recent commentary posted at TSI.

If you read some gold-focused web sites you could come away with the belief that movements in the gold price are almost completely random, depending more on the whims/abilities of evil manipulators and the news of the day than on genuine fundamental drivers. The following two charts can be viewed as cures for this wrongheaded belief.

The first chart compares the performance of the US$ gold price with the performance of the bond/dollar ratio (the T-Bond price divided by the Dollar Index). The charts are almost identical, which means that the gold price has been moving in line with a quantity that takes into account changes in interest rates, inflation expectations and currency exchange rates. The second chart shows that the US$ gold price has had a strong positive correlation with the Yen/US$ exchange rate. As we’ve explained in the past, gold tends to have a stronger relationship with the Yen than with any other currency because the Yen carry trade makes the Yen behave like a safe haven.



There are two possible explanations for the relationships depicted above. One is that the currency and bond markets, both of which are orders of magnitude bigger than the gold market, are being manipulated in a way that is designed to conceal the manipulation of a market that hardly anyone cares about. The other is that the gold price generally does what it should do given the performances of other financial markets. Only one of these explanations makes sense.

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Sorry, the trend is not your friend

September 7, 2016

There’s an old saying in the financial markets that the trend is your friend, meaning that you will do well as long as you position your trades in line with the current price trend. This sounds good. The only problem is that you can never know what the current trend is; you can only know what the trend was during some prior period. How is it possible for something you can never know to be your friend?

Market ‘technicians’ often make comments such as “the trend for Market X is up” and “Market Y is in a downward trend” as if they were stating facts. They are not stating facts, they are stating assumptions that have as much chance of being wrong as being right.

A statement such as “Market X’s trend is up” would more correctly be worded as “I’m going to assume that Market X’s trend is up unless proven otherwise”. The proving otherwise will generally involve the price moving above or below a certain level, but the selection of this level is yet another assumption and the price moving above/below any particular level will provide no factual information about the current trend.

To further explain, let’s say that a market made a sequence of higher highs and higher lows over a 3-month period. It can be said that during this period the market’s trend was up. That’s a fact, since the definition of an upward trend is a sequence of rising highs and lows. However, even if this market has just made a new high it is not a fact that the current trend is up, because the high that was just made could turn out to be the ultimate high prior to the start of a downward trend. Nobody knows whether it will or won’t be the ultimate high, but some traders will assume that it was — or was very close to — the ultimate high and sell, while other traders will assume that the trend is still up. The members of the first group have approximately the same probability of being right as the members of the second group, but many members of the second group (the trend-followers) will unequivocally state “the trend is up”.

In the above hypothetical case, let’s assume that the first group was right and that the price immediately started to trend downward. Most members of the second group will have in mind price levels at which they will stop assuming that the trend is up, but the point at which their assumption changes could turn out to be the bottom. In other words, having wrongly assumed that the trend was still up after the price had just peaked, they might subsequently make the incorrect assumption that the trend has changed from up to down at the time that it is actually changing from down to up.

The impossibility of knowing the direction of the trend in real time is one of the reasons that the majority of trend-following traders end up losing money. Looking from a different angle, if it were possible to KNOW the direction of the trend in real time then every half-decent trend-follower would generate good returns, but very few of them do generate good returns over the long haul.

As an aside, the majority of non-trend-following traders also end up losing money. The fact is that regardless of what method is used, trading success over the long haul is primarily about risk management.

So, just be aware that when you read comments along the lines of “the trend is up”, the author is not stating a fact. He is, instead, announcing an opinion (making an assumption) that could be wrong.

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Is the US economy too weak for a Fed rate hike?

September 6, 2016

Some analysts argue that the US economy is strong enough to handle some rate-hiking by the Fed. Others argue that with the economy growing slowly the Fed should err on the side of caution and continue to postpone its next rate hike. Still others argue that the economy is so weak that the Fed not only shouldn’t hike its targeted interest rate, it should be seriously considering a rate CUT and other stimulus measures. All of these arguments are based on a false premise.

The false premise is that the economy is boosted by forcing interest rates to be lower than they would otherwise be. It should be obvious — although apparently it isn’t — that an economy can’t be helped by falsifying the most important of all price signals.

When a central bank intervenes to make interest rates lower than they would be in a free market, a number of things happen and none of these things are beneficial to the overall economy.

First, there will be a forced wealth transfer from savers to borrowers, leading to less saving. To understand why this is an economic problem in addition to being an ethical problem, think of savings as the economy’s seed corn. Consume enough of the seed corn and there will be no future crop.

Second, construction, mining and other projects that would not be economically viable in a less artificial monetary environment are temporarily made to look viable. A result is that a lot of real resources are directed towards projects that end up failing.

Third, investors seeking an income stream are forced to take bigger risks to meet their requirements and/or obligations. In effect, conservative investors are forced to become aggressive speculators. This inevitably leads to massive and widespread losses down the track.

Fourth, debt becomes irresistibly attractive and starts being used in counter-productive ways. The best example from the recent past is the trend of US corporations taking-on increasing amounts of debt for the sole purpose of buying back their own equity. Going down this path is a much quicker way of boosting earnings per share than investing in the growth of the business, so, naturally, the increasing popularity of debt-financed share buy-backs has gone hand-in-hand with reduced capital spending.

Fifth, “defined benefit” pension funds end up with huge deficits.

The reality is that the economy cannot possibly be helped by centrally forcing interest rates to be either lower or higher than they would be if ‘the market’ were allowed to work. The whole debate about whether the US economy is strong enough to handle another Fed rate hike is therefore off base.

The right question is: How much more of the Fed’s interest-rate manipulation can the US economy tolerate?

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An exploration-stage gold miner bets against gold

September 2, 2016

I saw a press release today that boggled my mind. The press release is from Gold Road Resources (GOR.AX), a company in the process of exploring/developing a large gold deposit in Western Australia, and is linked HERE.

According to the press release, GOR is pleased with itself for having short-sold 50K ounces of gold and having given itself the option of short-selling an additional 100K ounces of gold.

Now, it’s one thing for a current gold producer to forward-sell part of the coming year’s production in order to ensure a certain cash-flow, but GOR is not a current producer. It doesn’t even have a completed Feasibility Study and is therefore years away from having any production. In fact, there is no guarantee that it will ever have any production.

What GOR is doing cannot be called hedging. It is an outright bet against a further rise in the A$-denominated gold price. Moreover, the bet is subject to margin calls, so GOR shareholders better hope that the gold price doesn’t skyrocket over the next 12 months.

It’s quite possible that GOR won’t be hurt by its bearish gold bet. It’s also quite possible that I won’t be hurt if I play Russian roulette, but that doesn’t mean it’s a good idea for me to play.

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Hyperinflation is coming to the US…

August 31, 2016

but possibly not in your lifetime.

As I mentioned in a blog post back in April of last year, I have never been in the camp that exclaims “buy gold because the US is headed for hyperinflation!”. Instead, at every step along the way since the inauguration of the TSI web site in 2000 my view was that the probability of the US experiencing hyperinflation within the next 2 years — on matters such as this there is no point trying to look ahead more than 2 years — is close to zero. That remains my view today. In other words, I think that the US has a roughly 0% probability of experiencing hyperinflation within the next 2 years.

I also think that the US has a 100% probability of eventually experiencing hyperinflation, but this belief currently has no practical consequences. There is no good reason to start preparing for something that a) is an absolute minimum of two years away, b) could be generations away, and c) is never going to happen with no warning. With regard to point c), we will never go to bed one day with prices rising on average by a few percent per year, 10-year government bond yields below 2% and the money supply rising at around 8% per year and wake up the next day with hyperinflation.

It takes a considerable amount of time (years, not days or weeks) to go from the point when the vast majority is comfortable with and has confidence in the most commonly used medium of exchange (money) to the point when there is a widespread collapse in the desire to hold money. Furthermore, many policy errors will have to be made and there will be many signs of declining confidence along the way.

The current batch of policy-makers in central banking and government as well as their likely replacements appear to be sufficiently ignorant or power-hungry to make the required errors, but even if the pace of destructive policy-making were to accelerate it would still take at least a few years to reach the point where hyperinflation was a realistic short-term threat in the US.

In broad terms, the two prerequisites for hyperinflation are a rapid and unrelenting expansion of the money supply and a large decline in the desire to hold money. Both are necessary.

To further explain, at a time when high debt levels and taxation underpin the demand for money, a collapse in the desire to hold money could not occur in the absence of a massive increase in the money supply. By the same token, a massive increase in the money supply would not bring about hyperinflation unless it led to a collapse in the desire to hold money.

Over the past three years the annual rate of growth in the US money supply has been close to 8%. While this is above the long-term average it is well shy of the rate that would be needed to make hyperinflation a realistic threat within the ensuing two years. Furthermore, high debt levels in the US and counter-productive policy-making in Europe will ensure that there is no substantial decline in the desire to hold/obtain US dollars for the foreseeable future.

The upshot is that there are many things to worry about, but at this time US hyperinflation is not one of them.

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Read the opposite of what you believe

August 30, 2016

People are naturally attracted to viewpoints that are similar to their own and to information that supports what they already believe. In fact, most people go out of their way to find articles and newsletters that are biased towards their pre-existing views of the world. However, they should do the opposite.

If you seek-out information that supports what you already think you know and exclusively read authors whose opinions match your own, you will never learn anything. All you will do is increase your comfort in, and therefore entrench, views that may or may not be correct. You will never find out if your views are incorrect because you are refusing to objectively consider any alternatives.

Even when a particular belief leads to a decision that, in turn, leads to a devastating loss, you probably won’t accept the possibility that the premise behind your decision was wrong. Instead, you will assume that the decision was soundly based but that unforeseeable external factors intervened to bring about the bad result. Rather than acknowledge that your premise was wrong you might, for example, conclude that a nefarious force manipulated events such that a logically prudent course of action on your part was made to look ill-conceived.

Seeking out and focusing on information, analyses and opinions that mesh with your existing beliefs is called confirmation bias. An antidote is to go out of your way to read articles and other pieces of literature that challenge your dearly-held beliefs.

For example, if you strongly believe that financial Armageddon lies around the next corner then the last thing you should do is devote a lot of your finance-related reading time to the Zero Hedge web site. Instead, you should seek-out sites that present less-bearish analyses and conclusions. This way you can make decisions based on a wider range of information, not just information that has been carefully selected to support one particular outcome.

If you can keep an open mind while reading articles and assessing information that does not agree with your current beliefs, then you have a chance of learning something and avoiding pitfalls. After all, it ain’t what you don’t know that gets you into trouble; it’s what you know for sure that just ain’t so*.

*A Mark Twain quote

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