The answer to the above question is yes and no. If the question is does the Fed use the combination of monetary policy and ‘jawboning’ in an effort to push equity prices upward then the answer is definitely yes. However, if the question is does the Fed buy index futures or ETFs in an effort to elevate the stock market then the answer is almost certainly no.

It is no secret that today’s Fed considers the performance of the stock market when deciding on what monetary measures to implement. In fact, over the past 8 years the Fed has overtly targeted higher stock prices based on the erroneous belief that higher stock prices lead to greater consumer spending and a stronger economy. It is also clear that the public utterings of senior Fed representatives are often influenced by the stock market’s recent performance. For example, soon after the stock market takes a tumble you can safely bet your life on at least one Fed governor coming out with a public comment suggesting easier monetary policy. However, the idea that the Fed brings about higher stock prices by directly purchasing futures contracts or ETFs is just an appealing fantasy.

An obvious retort is that some other central banks, most notably the BOJ, are known to have bought ETFs as part of their efforts to boost economic activity, so why shouldn’t we believe that the Fed has gone down the same path?

My response is: How do we know that the BOJ et al have made these stock-market-related purchases? We know because the purchases have not happened in secret. They have been openly declared.

Doing it openly is the only way that a central bank such as the BOJ or the Fed could ever directly intervene in the stock market, especially if the intervention is designed to be large enough to have a significant effect on the overall market. A central bank trying to surreptitiously support the stock market via direct purchases would be akin to an elephant trying to surreptitiously make its way through your living room. That is, the evidence of the central bank’s actions would be blatant. There would be an obvious paper trail and a lot of people (a lot of potential whistleblowers) would have to be involved.

Another retort is that the Fed does its purchasing of equity-related instruments via an intermediary such as a major private bank.

Yes, if the Fed made stock-market purchases then it would, of course, act through an intermediary, but this doesn’t enable the purchases to be kept secret. For example, all of the Fed’s bond purchases have been made through intermediaries, but the evidence of the purchases is as plain as day on the Fed’s balance sheet and most people involved in the markets know exactly what the Fed has done.

The belief that the Fed secretly buys and sells in the stock market as part of a largely-successful effort to keep the stock market in an upward trend is therefore ridiculous. However, the idea that the Fed will eventually intervene directly in the stock market is not farfetched. Actually, there’s a high probability that it will happen in the future. But if/when it does happen there will be no need to make wild guesses regarding the central bank’s actions, because the actions will be publicly announced ahead of time in the same way that the bond-buying programs were publicly announced ahead of time.

Some commentators have been anticipating a “commercial signal failure” in the gold market for more than 15 years. Moreover, whenever the gold price experiences a large rally the same commentators routinely cite the potential for a commercial signal failure (CSF) as a reason to maintain a full position, the argument being that the coming CSF is bound to result in massive additional price gains. The reality, however, is that whereas a CSF is an extremely unlikely event in any commodity market, in the gold market it is an impossibility.

A CSF theoretically becomes possible in a commodity market after the price has been trending upward for some time, and speculators, as a group, have built-up an unusually-large net-long position in the commodity futures. Naturally, if speculators have a large net-long position then “commercials” have an equivalently-large net-short position, since one is a mathematical offset of the other.

Commercials are generally hedging or spread-trading, so once they have established a position they will usually be indifferent with regard to future price direction. Whatever they lose on the futures they will make in the physical, and vice versa. However, in some commodity markets it is possible for the supply or demand in the physical market to undergo such a sudden and dramatic change that exploding margin requirements on the futures side of a commercial-trader’s hedge or spread-trade could force the commercial to exit (buy back) the short futures position, even though the short position in the futures is ‘covered’ by a long position in the physical. For example, take the case of a wheat farmer who has locked in the price of his yet-to-be-harvested crop by selling wheat futures. If extreme and unexpected weather suddenly causes a moon-shot in the wheat price then the farmer might — depending on how his price hedging has been structured — be faced with a huge margin call on his futures position and forced to exit his hedge, even if his own crop is unaffected by the extreme weather. Exiting the hedge would involve buying wheat futures into a sharply rising market, which would only exacerbate the price rise.

If it happens on a market-wide scale, the hypothetical case of the wheat farmer described above could be part of what’s called a “commercial signal failure”. The so-called signal failure involves commercial traders being forced, en masse, to cover their short futures positions at large losses despite the short futures positions being offset by long positions in the physical commodity. By definition, it can only happen when speculators have built up a large net-long position in the futures market (meaning, when commercial traders have built up a large net-short position in the futures, thus generating the bearish warning signal), a situation that will usually only arise after the price has been in a strong upward trend for several months. Due to the CSF, speculators on the long side make more money more quickly than they were expecting.

However, even in a market where a CSF is technically possible, a prudent speculator would never bet on it. The reasons are that 1) a CSF requires a sudden and totally UNPREDICTABLE change in either supply or demand, and 2) CSF’s almost never happen. In the rare cases when a CSF happens it tends to be the result of an unexpected supply disruption. In agricultural commodities, the most likely cause is an unforeseeable bout of extreme weather.

Major supply disruptions are possible in the markets for all agricultural and industrial commodities, but they are not possible in the gold market. This is primarily because almost all the gold ever mined still forms part of the supply side of the equation, which means that shifts in the current year’s mine production will always be trivial relative to total supply. In other words, in the gold market there is no chance that a CSF could be caused by a major supply disruption.

Although a major supply disruption is not possible in the gold market, there could at some point be a large and unanticipated demand disruption (note that the bulk of the world’s gold is demanded (held) for investment, store-of-value, speculative or monetary purposes). However, such a disruption would not cause a “commercial signal failure”; it would be the EFFECT of a total monetary-system failure.

A “commercial signal failure” is, by definition, an event that results in bullish futures speculators making large and rapid gains, but bullish speculators in gold futures could not profit from a total monetary-system failure. In fact, they would be big losers because the futures market would shut down in such an outcome.

The bottom line is that it is not a good idea to bet of a “commercial signal failure” in any market, because the probability of it happening is extremely low. It is, however, a particularly bad idea to make such a bet in the gold market because in the gold market the event has a probability of zero.

Here is an excerpt from a recent TSI commentary about another absurd course of action now being seriously considered by the monetary maestros.

Once upon a time, the concept of “helicopter money” was something of a joke. It was part of a parable written by Milton Friedman to make a point about how a community would react to a sudden, one-off increase in the money supply. Now, however, “helicopter money” has become a serious policy consideration. So, what exactly is it, how would it affect the economy and what are its chances of actually being implemented?

“Helicopter money” is really just Quantitative Easing (QE) by another name. QE hasn’t done what central bankers expected it to do, so the idea that is now taking root is to do more of it but call it something else. Apparently, calling it something else might help it to work (yes, the people at the upper echelons of central banks really are that stupid). The alternative would be to question the models and theories upon which QE is based, but such questioning of underlying principles must never be done under any circumstances. A Keynesian economist calling into question the principle that an economy can be made stronger via methods that artificially stimulate “aggregate demand” would be akin to the Pope questioning the existence of god.

The only difference between QE as practiced by the Fed and “helicopter money” is the path via which the new money gets injected. Under the Fed’s previous QE programs, new money was created via the monetisation of debt and ended up in the accounts of securities dealers*. Under a “helicopter money” program, new money would still be created via the monetisation of debt. However, in this case the new money would be placed by the government into the accounts of the general public, via, for example, tax cuts and welfare payments (handouts), and/or placed by the government into the accounts of contractors working for the government.

If promoted in the right way, “helicopter money” could have widespread appeal among the general public. Unlike the Fed’s traditional QE, which had the superficial effect of making the infamous top-1% richer and the majority of the population poorer, the average member of the voting public could perceive an advantage for himself/herself in “helicopter money”. Unfortunately, regardless of who gets the new money first there is no way that an economy can be anything other than weakened by the creation of money out of nothing. The reason is that the new money falsifies the price signals upon which economic decisions are made, leading to ill-conceived investments and other spending errors.

Due to the distortions of price signals that they bring about, both traditional QE and “helicopter money” are bad for the economy. However, an argument could be made that “helicopter money” is the lesser of the two evils. The reason is that with “helicopter money” the effects of the monetary inflation will more quickly become apparent in everyday expenses and the popular price indices. That is, “helicopter money” will quickly lead to inflationary effects that are obvious to everyone. This limits the extent to which the policy can be implemented.

Putting it another way, traditional QE had by far its biggest effects on the prices of things that, according to the average economist, central banker and politician, don’t count when assessing “inflation”, whereas the effects of “helicopter money” would soon become obvious in the prices of things that do count. A consequence is that a “helicopter money” program would be reined-in relatively quickly and the long-term damage to the economy would be mitigated.

With regard to the chances of “helicopter money” actually being implemented, we think the chances are very good in Japan, very poor in the euro-zone (due to there being a single central bank ‘serving’ a politically-disparate group of countries) and somewhere in between in the US.

Although it presently seems like the more extreme policy, the US has a better chance of experiencing “helicopter money” than negative interest rates within the next two years. This is because a) the next US president will be an economically-illiterate populist (regardless of who wins in November), b) the average voter will likely perceive a financial advantage from “helicopter money”, and c) hardly anyone outside the halls of Keynesian academia will perceive anything other than a disadvantage from the imposition of negative interest rates.

In summary, then, “helicopter money” is QE by a different name and path. It would inevitably reduce the rate of economic progress, but it has a reasonable chance of being implemented in the US the next time that policy-makers are desperate to do something.

*Every dollar of Fed QE adds one dollar to the commercial bank account of a Primary Dealer (PD) and one dollar to the reserve account at the Fed of the PD’s bank, meaning that every dollar of QE adds one reserve-covered dollar to the economy-wide money supply.

Here is an excerpt from a commentary posted at TSI last week. Not much has changed in the interim, so it remains applicable.

The US Treasury Bond (T-Bond) entered a secular bullish trend in the early-1980s. As evidenced by the following chart, over the past 30 years this trend has been remarkably consistent.

There is no evidence, yet, that the long-term bull market is over. Furthermore, such evidence could take more than a year to materialise even if the bull market reaches its zenith this month. The reason is that for a decline to be clearly marked as a downward leg in a new bear market as opposed to a correction in an on-going bull market it would have to do something to differentiate itself from the many corrections that have happened during the course of the bull market. In particular, it would have to result in a solid break below the bottom of the long-term channel. This is something that probably wouldn’t happen until at least the second half of next year even if the bull market just reached its final peak.

However, we don’t need to have an opinion on whether or not the bull market is about to end to see that the risk/reward is currently favourable for a bearish T-Bond speculation. What we need to do is look at a) future “inflation” indicators, which point to rising price inflation over the coming months, b) sentiment indicators, which suggest the potential for a large majority of speculators to be caught wrong-footed by a T-Bond decline, and c) the position of the T-Bond within its long-term channel.

With regard to the channel position, to become as stretched to the upside as it was at the 1986, 1993 and 1998 peaks the T-Bond would have to move about 5 points above this month’s high, but it is already at least as stretched to the upside as it was at the 1996, 2003, 2008, 2012 and 2015 peaks.

Needless to say, we continue to like the bearish T-Bond trade.

A chart similar to the one below was included in a blog post under the heading “Bank C&I Loan Charge-Offs Soaring Again”. This chart caught my attention because it seems to indicate that bank C&I (Commercial and Industrial) loan charge-offs are happening at one of the fastest rates of the past 30 years — the sort of rate that would be consistent with the US economy being in recession.

The problem is that the above chart shows the percentage change of a percentage, which opens up the possibility that what is in reality a small increase is being made to look like a large increase. For example, an increase from 1% to 2% over the course of a year in the proportion of loans charged-off would be a 100% increase if expressed as a year-over-year percentage change in the percentage of charge-offs, whereas all you’ve actually got is a 1% increase in the total proportion of loans that have been charged-off.

The next chart is based on exactly the same data, but instead of displaying the year-over-year percent change in the percentage of C&I loans that have been charged off it simply displays the percentage of C&I loans that have been charged off. This is not just a more correct way of looking at the data, it is a way that has not given any false recession signals over the past 30 years.

The first chart’s message is: an economic recession is either in progress or imminent. The second chart’s message is: the US economy is not in recession and is presently not close to entering recession.

The same data, opposite messages.

Rarely does a month go by when I don’t read at least one article in which interest rates are said to be the price of money. This is wrong. The price of money is what money can buy. The rate of interest is something completely different.

If an apple sells for 1 dollar then the price of a unit of money in this example is 1 apple. If a car sells for 30,000 dollars then the price of a unit of money in this example is 1/30,000th of a car. In more general terms, just as the price of any good, service or asset can be quoted in terms of money, the price of money can be quoted in terms of the goods, services and assets that it buys. In a large economy, at any given time a unit of money will have millions of different prices.

As an aside, this is why price indices that purport to represent the purchasing power of money will always be bogus. Regardless of how rigorous and well-intentioned the effort, it is not possible to come up with a single number that properly indicates the “general price level”. There is simply no such thing as the general price level.

What, then, is the interest rate?

The interest rate is the cost incurred or the payment received for exchanging a present good for a future good. If there is no risk of loss involved in the transaction then the interest rate will reflect nothing other than the time preferences of the person who parts with the present good (usually called the lender) and the person who receives the present good (usually called the borrower). In other words, if there is no risk of loss then the interest rate can correctly be thought of as the price of time.

In most cases there will, of course, be a risk of loss due to the possibility that the borrower will default or the possibility — if it was money that was exchanged — that the loan will be repaid in terms of money that doesn’t buy as much as it did when the initial exchange took place. In most cases the interest rate will therefore be the price of time plus a premium to account for default risk and “inflation” risk.

Time preference sets a lower limit on market interest rates and time preference will always be positive. The negative interest rates set in place by some central banks therefore have nothing to do with market forces and everything to do with heavy-handed manipulation by people who have far more power than sense.

In a recent letter John Mauldin worries that central banks are ‘out of bullets’, but this is not something that any rational person should be worried about. Instead, they should be worried about the opposite.

The conventional view is that with interest rates at all-time lows and with vast amounts of debt having already been monetised, if a recession were to occur in the not-too-distant future there would be nothing that the central banks could do to ameliorate it. However, this view is based on the false premise that central banks can smooth-out the business cycle by easing monetary policy at the appropriate time. The truth is that by distorting interest rates, central banks get in the way of economic progress and cause recessions to be more severe than would otherwise be the case.

Think of it this way: If it is really possible for a committee of bureacrats and bankers to create a better outcome for the economy by setting interest rates (the price of credit), then it logically follows that a healthier economy would result from having all prices set by committees comprised of relevant ‘experts’. There should be an egg committee to set the price of eggs, a car committee to set the price of cars, a massage committee to set the price of massages, etc. After all, if it really is possible for a committee to do a better job than a free market at determining the most complicated of prices then it is certainly possible for a committee to do a better job than a free market at setting any other price.

However, hardly anyone believes that all prices should be set by committee or some other governing body. This is undoubtedly because that type of price control proved to be an unmitigated disaster wherever/whenever it was tried throughout history. Most people therefore now realise that it would make no sense to have committees in place to control prices in general, but are strangely incapable of making the small logical step to the realisation that it makes no sense to give a committee the power to control the most important price in the economy — the price of something that influences the price of almost everything else.

Getting back to the worry that central banks are out of bullets, it would actually be good news if they were. This is because a central bank does damage to the economy every time it fires one of its so-called monetary bullets. The damage usually won’t be apparent to the practitioners of the superficial, ad-hoc economics known as Keynesianism, but it will inevitably occur due to the falsification of price signals.

Unfortunately, central banks have an unlimited supply of bullets. This has been demonstrated over recent years by zero not proving to be a lower boundary for the official interest rate and by asset monetisation proving to be not restricted to government bonds. We should therefore expect central banks to keep firing until they are reined-in by market or political forces.

The real worry, then, isn’t that central banks are out (or almost out) of bullets. The real worry is that they are not remotely close to being out of bullets.

When the Baltic Dry Index (BDI), an index of international ocean-going freight rates, plunged to a multi-decade low early this year it provoked excited commentary from the “economic armageddon is nigh!” crowd. An example can be found HERE. However, bearish commentary is unhelpful after the prices of useful things have fallen to the point where the suppliers of these things are financially in dire straits.

There’s always a risk that the stock price of an individual company will go to zero, but there’s never a risk that freight rates or the prices of useful commodities will go to zero. Therefore, the further they move into an area where they are low by historical standards, the lower the downside risk will generally be.

I’m lumping ocean-going shipping rates and commodity prices together in this post because they are linked. They usually trend in the same direction and reach important peaks/troughs at around the same time. A consequence is that it doesn’t make sense to be bullish on commodities and at the same time anticipating a large decline in shipping rates, or bearish on commodities and at the same time anticipating strength in shipping rates. For example, after commodity prices reversed upward during January-February of this year it made no sense to expect a continuing downward trend in shipping rates.

The link between shipping rates (as represented by the BDI) and commodity prices (as represented by the Goldman Sachs Spot Commodity Index – GNX) is illustrated below. The two indexes have been positively correlated for a long time. Divergences are not uncommon, but the divergences are always short-term.

So, here’s an idea: Rather than piling onto the bearish bandwagon, when the real price of an indispensable service or commodity drops to a multi-decade low it might make more sense to be bullish.

A popular line of thinking is that the US banking system is not making as much use of its “excess” reserves as it should be because of the interest rate that the Fed now pays on these reserves. This line of thinking reflects a basic misunderstanding of how the banking system works.

There are two reasons why it is wrong to believe that the 0.50% interest rate now being earned by US banks on their reserves is encouraging the banks to stockpile money at the Fed rather than take a risk by making more loans. The first reason is that there is no relationship between bank lending (and the associated creation of new bank deposits) and bank reserves. I’ve covered this concept in previous blog posts, including HERE, so today I’ll focus on the second reason.

The second reason is that the banking system has no control over its reserves. An individual bank can reduce its reserves by lending reserves to another bank, but banks as a group have no say in the total quantity of reserves. In other words, even if the US banking system desperately wanted to reduce its collective reserve quantity it would be powerless to do so.

By way of further explanation, there are only three ways that reserves can leave the US banking system. They can be removed by the Fed (the Fed has unlimited power to add or delete reserves), they can exit in the form of notes and coins in response to increasing public demand for physical cash, or they can be transferred to governmental accounts at the Fed. The third way will always be temporary because the government is always quick to spend any money it gets, so there are really just two ways that the banking system’s reserves can decline: a deliberate action by the Fed or increased demand for physical cash within the economy.

In other words, regardless of how many loans are made and how many new commercial bank deposits are created, every dollar of reserves currently in the US banking system will remain there until the Fed decides to change the system-wide level or until it leaks into the economy via the conversion of electronic deposits to physical cash.

An implication is that changing the rate of interest that the Fed pays on reserves will not affect the pace at which banks expand/contract credit within the economy. For example, if the Fed increased the interest rate on reserves from 0.50% to 1.00% the banks would generate more interest income from their reserves, but there would be no change in the incentive to make new loans because the banks will earn this additional income regardless of whether they lend more or less money into the economy (the creation of a bank loan doesn’t cause bank reserves to disappear). For another example, if instead of paying banks a positive rate on their reserves the Fed started charging banks, that is, if the Fed adopted Negative Interest Rate Policy (NIRP), the banking system as a whole would have no additional incentive to grow its loan book since there would be nothing it could do to avoid the cost. In fact, the cost imposed by the NIRP could indirectly REDUCE the incentive to make new loans.

As an aside, this doesn’t guarantee that NIRP won’t happen in the US, especially given the evidence that the Fed’s senior management is almost as clueless as Mario Draghi. However, the obvious failure of the policy in Europe lessens the risk of it happening in the US.

Summing up, the interest rate paid on reserves cannot be a reason for either more or less bank lending. As explained previously, the only reason that the Fed began paying interest on bank reserves in late-2008 was to enable it to maintain control of the Fed Funds Rate while it pumped huge volumes of dollars into the economy and into the reserve accounts of banks.

in Australian dollar (A$) terms.

The A$-denominated gold price (gold/A$) made a correction low in April of 2013, spent about 18 months forming a base and then resumed its long-term bull market in late-2014. It will probably soon make a new all-time high.

It is useful to follow gold’s performance in terms of the more-junior currencies, for two main reasons. First, gold tends to bottom in terms of these currencies well before it bottoms in terms of the senior currency (the US$). Second, money can sometimes be made by owning the stocks of gold-mining companies operating in countries with relatively weak currencies even when the US$ gold price is in a bearish trend.

A good example is Evolution Mining (EVN.AX), an Australia-based mid-tier gold producer that I’ve followed at TSI for the past few years. As illustrated by the following chart, EVN commenced a powerful upward trend in late-2014 after basing over the preceding 18 months (just like gold/A$). It is now well above its 2011-2012 peak.

As a gold bull market progresses, the more junior currencies and especially the commodity currencies begin to strengthen relative to the US$. This causes the mining companies with operations in the US to start doing relatively well.

Most rational people with some knowledge of economic history will realise that the US$ will eventually be the victim of hyperinflation. The hard reality is that whenever money can be created in unlimited amounts by central banks or governments, it’s inevitable that at some point the money will experience such a dramatic plunge in its purchasing power that it will be at risk of soon becoming worthless. However, knowing this is only slightly more useful than knowing that the star we call the Sun will eventually die.

The relevant question is never about whether hyperinflation will happen; it’s about the timing, and at no point over the past 20 years (including right now) has there been a realistic chance of the US experiencing hyperinflation within the ensuing two years. Furthermore, the same can be said about deflation. A sustained period of deflation (as opposed to a short-lived deflation scare) will eventually happen, but at no point over the past 20 years (including right now) has there been a realistic chance of it happening within the ensuing two years.

So, when I say that the hyperinflation and deflation arguments are both wrong I mean that they are both wrong when dealing with practical investment time-frames. They are both actually right when dealing with the indefinite long-term.

By the way, when considering inflation/deflation prospects I only ever attempt to look ahead two years, partly because two years is plenty of time to take protective measures and partly because it is futile to attempt to look further ahead than that.

How do I know that neither hyperinflation nor deflation will happen in the US within the coming two years?

I don’t know, but I do know that neither will happen without warning. We are not, for example, going to go to bed one day with government and corporate bond yields near multi-generational lows and wake up the next day immersed in hyperinflation. Also, central banks are not going to be rigidly devoted to pro-inflation monetary policies one day, to the point where theories/models are never questioned and failure is viewed as the justification for ramping-up the same policies, and the next day be willing to implement the sort of monetary policies that could lead to genuine deflation.

Some people are so committed to the “deflation soon” forecast that they ignore any conflicting evidence. It’s the same for people who are committed to the idea that hyperinflation is an imminent threat to the US economy. However, an objective assessment of the evidence leads to the conclusion that it currently makes no sense to position oneself for either of these extremes. The evidence includes equity prices, corporate bond yields, credit spreads, the yield curve, commodity prices, the gold price, and future “inflation” indicators such as the one published by the ECRI.

The evidence could change, but what it currently indicates is that the signs of “price inflation” will become more obvious over the coming 12 months. No deflation, no hyperinflation.

Whenever there’s a major financial crisis, the largest commercial and investment banks invariably take big hits. This causes them to either go bust or go in search of a bailout. In fact, as far as I can tell there has never been a case over the past 50 years of an elite financial institution being on the right side of a major financial crisis. The same goes for central banks. Judging by their words and their actions, the heads of the world’s most important central banks have been blindsided by every major financial crisis of the past 50 years. And yet, I regularly see blog posts, articles or newsletters in which it is explained that the financial crises that have occurred in the past and are going to occur in the future are part of a grand plan hatched by the most prominent members of the financial establishment.

The idea that market crashes and crises are purposefully arranged by the financial elite is what I’ll call the “Masters of the Universe Fallacy” (MOTUF). For some reason this idea is very appealing to many people even though there is no evidence to support it. Furthermore, the simple fact that the supposed master schemers are always on the wrong sides of financial crises is enough to refute the idea.

As far as understanding economics and markets are concerned, the current heads of the world’s three most important central banks are complete buffoons. Obviously, if you don’t have a thorough understanding of good economic theory and how markets work then any strategies you concoct to bring about specific economic and financial-market outcomes are going to fail. The retort is that the heads of the most important central banks are just puppets whose strings are pulled by the real master manipulators. The real master manipulators apparently include the heads of the world’s most influential commercial banks, such as the senior managers of Goldman Sachs and JP Morgan.

Don’t get me wrong; it is certainly the case that the government takes advantage of crises to expand its reach and that the likes of Goldman Sachs and JP Morgan have great influence over the actions of the central bank and the government. This allows them to avoid the proper consequences of their biggest mistakes, but the fact is that they keep making mistakes of sufficient magnitude and stupidity to threaten their survival on an average of once per decade.

Take the specific example of the 2007-2009 global financial crisis. It wasn’t until mid-2007 that the senior managers of Goldman Sachs realised that there was a huge problem looming for the credit markets in general and the US sub-prime mortgage market in particular, but by then the company was so heavily exposed to ill-conceived investments that it was too late to re-position. If not for the combination of TARP, various asset monetisation programs implemented by the Fed, the US government bailout of AIG, Warren Buffett and changes to official accounting rules, Goldman Sachs would have gone bust in 2008 or 2009.

Furthermore, having either died (in the cases of Bear Stearns, Merrill Lynch and Lehman Brothers) or suffered near-death experiences (in the cases of Goldman Sachs, JP Morgan, Citigroup and Bank of America) in 2007-2009, the elite bankers of the world again found themselves in potential life-threatening situations just 2-3 years later due to the euro-zone’s sovereign debt crisis. This time the ECB came to the rescue.

In general, when a financial crisis happens it’s the outsiders who profit from the calamity, not the insiders. The insiders are always up to their eyeballs in the credit-fueled investment boom of the time. For example, in 2007-2008 it was the likes of Michael Burry, Steve Eisman, John Paulson, Kyle Bass and David Einhorn who correctly anticipated the events and reaped the large profits from the market action, while the likes of Chuck Prince, Dick Fuld, Lloyd Blankfein and Jamie Dimon were forced to either exit the banking business or go ‘cap in hand’ to the government.

It will be the same story in the next crisis. Goldman Sachs won’t see it coming and therefore won’t be prepared, which means that it will once again be in the position of needing a bailout to avoid bankruptcy.

So, if you want to make me laugh just send me an email explaining that the periodic crises are all part of a grand plan formulated by members of the financial establishment.

Gold has probably peaked for the year. Not necessarily in US$ terms, but in terms of other commodities.

In fact, relative to the Goldman Sachs Spot Commodity Index (GNX) the peak for this year most likely happened back in February. The February-2016 peak for the gold/GNX ratio wasn’t just any old high, it was an all-time high. In other words, at that time gold was more expensive than it had ever been relative to commodities in general.

Also worth mentioning is that when the US$ gold price spiked up to its highest level in more than 18 months as part of the “Brexit” mini-panic late last week, the rise in GNX terms was much less impressive. As illustrated below, last Friday’s move in the gold/GNX ratio looks more like a counter-trend bounce than an extension of the longer-term upward trend.

The February-2016 extreme in the gold/GNX ratio had more to do with the cheapness of other commodities than the expensiveness of gold, and the subsequent relative weakness in the gold price was mostly about other commodities making catch-up moves. This is actually the way things normally go at cyclical bottoms for commodities. The historical sample size is admittedly small, but it’s typical for gold to turn upward ahead of the commodity indices and to be a relative strength leader in the initial stage of a cyclical bull market. Gold then relinquishes its leadership.

Perhaps it will turn out to be different this time, but over the past 8 months the story has unfolded the way it should based on history and logic. An implication is that if the US$ gold price made a major bottom last December then the general commodity indices aren’t going to get any cheaper in US$ terms or gold terms than they were in January-February of this year.

Around cyclical lows, gold leads and the rest of the commodity world follows.

I was blown away by the following two charts from Jeffrey Snider’s article titled “The European Basis For New Monetary Science“.

As most of you probably know, the Mario Draghi-led ECB embarked on a ‘suped-up’ QE program in March of 2015. The idea behind this program was that by monetising 60B euros of bonds per month the ECB would promote faster credit expansion throughout Europe. The two charts from the aforelinked Snider article show the results to April-2016.

The first chart shows that as at April-2016, 727 billion euros of ECB asset monetisation had been accompanied by an increase in total lending of only 71 billion euros. As neatly summarised by Snider, this means that there was less than one euro in additional lending for every ten in ECB foolishness.

The second chart shows loans to European non-financial corporations, which actually contracted slightly during the first 13 months of the ECB’s suped-up credit-expansion program.

The QE program was therefore a total failure even by the jaundiced standards of the central-banking world, that is, it failed even ignoring the reality that faster credit expansion cannot possibly be good for an economy labouring under the weight of excessive debt. The weirdest thing is, the obvious failure is not viewed by Draghi as evidence that QE doesn’t do what it is supposed to do. Instead, it is viewed as evidence that more of the same is needed. Hence the increase in the pace of asset monetisation from 60B to 80B euros per month announced in March-2016 and implemented this month.

I shudder to think how Draghi’s monetary experiment will end.

[This post is a modified excerpt from a recent TSI commentary.]

A lot of good economic theory boils down to the acronym TANSTAAFL, which stands for “There Ain’t No Such Thing As A Free Lunch”. TANSTAAFL is an unavoidable law of economics, because everything must be paid for one way or another. Furthermore, attempts by policymakers to get around this law invariably result in a higher overall cost to the economy. Unfortunately, central bankers either don’t know about TANSTAAFL or are naive enough to believe that their manipulations can provide something for nothing. They seem to believe that the appropriate acronym is CBCCFLAW, which stands for “Central Banks Can Create Free Lunches At Will”.

ECB chief Mario Draghi is the leader in applying policies based on CBCCFLAW. Despite his economic stimulation measures having a record to date that is unblemished by success, he recently launched new attempts to conjure-up a free lunch.

I’m referring to two measures that were announced in March and have just started to be implemented, the first of which is the ECB’s corporate bond-buying program (starting this month the ECB will be monetising investment-grade corporate bonds in addition to government bonds). This program is designed to bring about a further reduction in interest rates, because, as we all know, if there’s one thing that’s holding Europe back it’s excessively high interest rates, where “excessively high” means above zero.

Unlike the situation in the US, very little corporate borrowing in Europe is done via the bond market. The ECB’s new corporate bond-buying program is therefore unlikely to provide even a short-term boost, but, not to worry, that’s where the ECB’s second measure comes into play.

The ECB’s second measure is a new round of a previously-tried program called the Targeted Long Term Refinancing Operation (TLTRO). Under the TLTRO program, commercial banks get encouraged — via a near-zero or negative interest rate — to borrow money from the ECB on the condition that the banks use the money to make new loans to the private sector.

The combination of the ECB’s two new measures is supposed to promote credit expansion and higher “inflation”. In other words, to the extent that the measures are successful they will result in more debt and a higher cost of living. In Draghi’s mind, this would be a positive outcome.

In the bizarre world occupied by the likes of Draghi, Yellen and Kuroda, the failure of an economy to strengthen in response to a policy designed to stimulate growth never, ever, means that the policy was wrong. It always means that not enough was done. It’s not so much that these central planners refuse to see the flaws in their policies, it’s that they cannot possibly see. They cannot possibly see because they are looking at the world through a Keynesian lens. Trying to understand how the economy works using Keynesian theory is like trying to understand the movements of the planets using the theory that everything revolves around the Earth.

So, the worse things get in response to counter-productive ‘economic stimulation’ policies, the more aggressively the same sorts of policies will be applied and the worse things will eventually get. This is what I’ve referred to as the Keynesian death spiral.

The price action in many financial markets was nothing if not interesting on Thursday 16th June. Of particular interest, there were several price reversals that could be significant (for TSI subscribers, the significance will be discussed in this weekend’s commentary).

One reversal of potential consequence happened in the gold market, with the gold price moving well above its early-May high and last year’s high ($1308) before turning around and ending the day with a loss.

Another reversal happened in the silver market. Silver’s reversal looks more important than gold’s because it resulted in an “outside down day” and created a bearish divergence between the gold and silver markets (a new high for gold combined with a lower high for silver).

Not surprisingly, the downward reversal in gold coincided with an upward reversal in the US stock market. For example, the Dow Transportation Average, which has led the more-senior US stock indices over the past 18 months, broke below short-term support early on Thursday and then recovered to end the day above support.

In the currency market there were actually two reversals, with the Dollar Index first reversing upward after trading well below the preceding day’s low and then reversing downward after trading well above the preceding day’s high to end the day roughly unchanged.

The financial markets are obviously being buffeted by Brexit-related news and are likely to remain more news-dependent than usual for another 1-2 weeks.

Chris Powell of GATA has taken issue with my recent blog post titled “Four charts that invalidate the gold price suppression story“. Interestingly, he did so without addressing the most important information in my short post. Instead, he dismissed the information because it was presented in chart form and simply regurgitated the usual GATA rhetoric*.

Responding to Powell’s article is not a good use of my time. This is not because my time is so precious, but, as mentioned above, because Powell’s article sidesteps the main points. If he develops an understanding of gold’s fundamental price drivers and employs this understanding to demonstrate errors in my thinking, I’ll gladly respond.

However, just to set the record straight:

1) I don’t have anything against technical analysts, but I’m not one of them. I do use some TA, but I’m primarily a fundamental analyst. Unbeknownst to Chris Powell, charts can be used to show fundamental relationships.

2) If my main purpose in writing was to increase the number of subscribers to my newsletter then I would pay lip service to GATA’s arguments. The reason is that I have lost many subscribers over the years due to my regular disparaging of these arguments. While I don’t go out of my way to lose subscribers, this is not a major concern because I am a trader/investor who happens to write a newsletter as opposed to someone who relies on newsletter sales to make a living.

3) Unlike Chris Powell, I am not promoting an agenda. I am not trying to sell a particular view of the financial world. Instead, I’m focused on trying to understand why the markets do what they do and profiting from it. Sometimes I get it right, sometimes I get it wrong. When I get it wrong, I acknowledge that the blame is 100% with me and try to learn from the experience so that the mistake is not repeated.

*He used exactly the same tactic in response to a previous blog post of mine.

Every experienced trader knows that the financial markets are manipulated. They always have been manipulated and they always will be manipulated. Railing against gold-market manipulation is therefore akin to railing against the Earth revolving around the sun. Moreover, the attempts to manipulate, which, by the way, will be designed to move prices upward just as often as downward, will never be effective beyond the very short-term. As evidenced by the following charts, there is certainly no sign of a successful long-term gold-price suppression scheme.

The first chart compares the US$ gold price with the bond/dollar ratio (the T-Bond price divided by the Dollar Index). This chart shows that the gold price has roughly done what it should have done, considering what was happening in the currency and bond markets, each step of the way over the past 10 years.

The next chart compares the US$ gold price with the SPX/BKX ratio (the broad US stock market relative to the banking sector). Those who understand gold would expect to see a positive correlation between the gold price and the SPX/BKX ratio, because gold should benefit from falling confidence in the banking sector and become less desirable during periods when investors are becoming increasingly confident in the banking sector’s prospects. There are naturally periods of overshoot and undershoot, but a positive correlation is readily apparent.

The third chart compares the US$ gold price and the Yen (the Yen/US$ rate). The gold price held up much better than the Yen during 2013-2015, but the positive correlation has been maintained.

Due to the Yen carry trade, gold’s positive correlation with the Yen has been stronger than its negative correlation with the Dollar Index for at least the past 10 years. The Yen carry trade causes the Yen to behave like a safe haven (even though it isn’t one), because carry trades tend to get put on during periods of rising confidence and taken off during periods of falling confidence.

The final chart simply shows the gold/commodity ratio (gold relative to a basket of commodities represented by the Goldman Sachs Spot Commodity Index – GNX). This chart indicates that relative to commodities in general gold is almost 3-times as expensive today as it was 10 years ago. Also, for anyone who clearly remembers what happened in the financial world over the past 10 years it reveals that large and sharp rises in the gold/commodity ratio occurred exactly when they should have occurred — during periods of crisis and plunging confidence. Specifically, there were large and sharp rises: a) from mid-2015 through to early-February of 2016 as equity markets tanked around the world, b) in late-2014 and early-2015 as the financial markets fretted over what the ECB was going to do, c) in the second and third quarters of 2011 in parallel with a substantial stock-market correction and rising fears of euro-zone government debt default, and d) from mid-2008 through to February-2009 in response to the Global Financial Crisis.

By the way, gold is in a multi-generational upward price trend relative to commodities that dates back to 1971.

I look at a lot of charts comparing gold’s performance with various financial-market and economic indicators, only four of which are presented above. The overarching message is that if gold has been subject to a long-term price suppression scheme, the scheme has been totally unsuccessful.

Almost anything can be a good investment or a bad investment — it all depends on the price. Relative to the prices of other commodities the gold price is high by historical standards and in dollar terms gold is nowhere near as cheap today as it was 15 years ago, but considering the economic backdrop it offers reasonable value in the $1200s. Furthermore, considering the policies that are being implemented and the general lack of understanding on display in the world of policy-making, there’s a good chance that gold will be much more expensive in two years’ time.

The policies to which I am referring are the money-pumping, the interest-rate suppression and the increases in government spending that happen whenever the economy and/or stock market show signs of weakness. These so-called remedies are actually undermining the economy, so whenever they are applied in response to economic weakness they ultimately result in more weakness. It’s not a fluke, for example, that the most sluggish post-recession economic recovery of the past 60 years went hand-in-hand with history’s most aggressive demand-boosting intervention by central banks and governments.

It’s a vicious cycle that can aptly be called the ‘Keynesian death spiral’. The Keynesian models being used by policy-makers throughout the world are based on the assumption that when interest rates are artificially lowered and new money is created and government spending is ramped up, the economy gets stronger. The models are completely wrong, because falsifying price signals leads to investing errors and therefore hurts, not helps, the overall economy, and because the government doesn’t have a spare pile of wealth that it can put to work to create real growth (everything the government spends must first be extracted from the private sector). However, the models are never questioned.

When a sustained period of economic growth fails to materialise following the application of the demand-boosting remedies, the conclusion is always that the remedies were not applied with sufficient vigor. More of the same is hence deemed necessary, because that’s what the models indicate. It’s akin to someone with liver damage caused by drinking too much alcohol being guided by a book that recommends addressing the problem by increasing alcohol consumption. A new dose of alcohol will initially make the patient feel better at the same time as it adds to the existing damage, just as a new dose of demand-boosting intervention will initially make the economy seem stronger at the same time as it gets in the way of genuine progress.

The upshot is that although gold is more expensive today than it was 15 years ago, the level at which gold offers good value is considerably higher today than it was back then because we are now much further along the Keynesian death spiral.

When the central bank lowers interest rates in an effort to prompt greater current spending it brings about a wealth transfer from savers to speculators of various stripes. While this is unethical, in economics terms the ethical problem isn’t the main issue. The main issue, and the reason that monetary stimulus doesn’t work as advertised, is TANSTAAFL (There Ain’t No Such Thing As A Free Lunch). At a very superficial level (the level at which all Keynesian economists operate) the interest-rate suppression policies appear to provide a free, or at least a very cheap, lunch, but the bill ends up being much higher than it would have been if it had been paid up front.

The likes of Bernanke, Yellen, Draghi and Kuroda admit that their so-called “monetary accommodation” hurts savers in the present, but they claim that the benefits to the overall economy outweigh the disadvantages to savers. Central bankers are apparently — at least in their own minds — endowed with a god-like wisdom that enables and entitles them to determine who should become poorer and who should become richer, all with the aim of elevating the economy. For example, here’s how the ECB justified its interest-rate suppression policy in June of 2014:

“The ECB’s interest rate decisions will…benefit savers in the end because they support growth and thus create a climate in which interest rates can gradually return to higher levels.”

And:

“A central bank’s core business is making it more or less attractive for households and businesses to save or borrow, but this is not done in the spirit of punishment or reward. By reducing interest rates and thus making it less attractive for people to save and more attractive to borrow, the central bank encourages people to spend money or invest. If, on the other hand, a central bank increases interest rates, the incentive shifts towards more saving and less spending in the aggregate, which can help cool an economy suffering from high inflation. This behaviour is not specific to the ECB; it applies to all central banks.”

It’s now two years later and the ECB is heading down the same policy path despite the complete absence of any success. The benefit that savers are supposedly going to get “in the end” appears to be even further away now than it was back then, although it is fair to say that European savers have definitely got it ‘in the end’.

Only the final sentence of the above excerpt is true (it’s true that the ECB is just as bad as other central banks). In order to believe the rest, you must have a poor understanding of economic theory.

‘Time’ is the most important element that central bankers deliberately or accidentally ignore when they make the sort of statements included in the above ECB quote. Increased saving does not mean reduced spending; it means reduced spending on consumer goods in the present in exchange for greater spending on consumer goods in the future. By the same token, reduced saving does not mean increased spending; it means increased consumer spending in the present in exchange for reduced consumer spending in the future.

Isn’t it obvious that this tradeoff between current and future consumer spending will happen most efficiently and for the greatest benefit to the overall economy if it is allowed to happen naturally, that is, if interest rates are allowed to reflect peoples’ actual time preferences? To put it another way, isn’t it obvious that if people are in a financial position where it makes sense for them to increase their saving (reduce their current spending on consumer goods) in order to repair balance sheets that have been severely weakened by excessive prior consumer spending, then the WORST thing that a policymaker could do is put obstacles in the way of saving and create artificial incentives for additional borrowing and consumption?

It obviously isn’t obvious, because monetary policymakers around the world continue to do the worst things they could do.