[This blog post is an excerpt from a recent commentary at www.speculative-investor.com]

Both Kamala Harris and Donald Trump are espousing policies that will be bearish for the US$ and bullish for gold. This means that regardless of what it turns out to be, the outcome of the November-2024 Presidential Election will be consistent with our view that the US dollar’s foreign exchange value will continue to trend downward and the US$ gold price will continue to trend upward for at least another 12 months. However, apart from having similar ramifications for the longer-term trends in the currency and gold markets, there are substantial differences between the candidates’ main policies. Let’s delve into some of the details.

Harris has talked about raising the capital gains tax rate and introducing a tax on unrealised capital gains to ensure that very wealthy taxpayers pay a minimum tax rate of 25%. If implemented, these changes would have the effect of reducing investment and therefore economic progress. Also, they would be a boon to the IRS and the private tax planning/reporting industry, because the additional complexity introduced by incorporating calculations of unrealised capital gains into taxable income would require substantial extra resources in both the government and the private sector. These extra resources wouldn’t just be non-productive, they would be counterproductive.

As an aside, when politicians introduce new taxes they usually make the assumption that the world will continue as before except with more money being paid to the government. However, taxes change behaviour, sometimes to the extent that new or increased taxes lead to a reduction in government revenue. This is exemplified by the fact that almost every country that has imposed a wealth tax has ended up scrapping the tax because it led to the exodus of capital, resulting in a weaker economy and lower revenue for the government. The reality is that while a promise to extract more money from the extremely wealthy can sound good to many voters, the wealthier a taxpayer the more mobile their wealth tends to be.

Although she has attempted to soften her stance on energy-related issues (for example, she claims to no longer favour a ban on fracking and she has stopped talking about the “Green New Deal” that she once supported), under a Harris regime it’s likely that, as part of a general increase in the amount of government regulation of business, it would be more difficult to get approvals for oil and gas projects. Also, it’s almost certain that the government would direct a lot more resources towards intermittent energy (sometimes called renewable energy). These actions would drive up the price of energy and increase the risk of energy shortages, with knock-on negative implications for the US economy.

Lastly, a Harris administration probably would prolong the Ukraine-Russia war, with devastating additional consequences for Ukraine — and potentially for all of Europe if the war is allowed to escalate — in terms of lives and infrastructure, as well as negative consequences for the US government’s budget deficit. A Trump administration, on the other hand, would be more likely to negotiate a settlement that ends the senseless destruction.

Trump is advocating lower taxes, which would be a plus if he were also advocating government spending cuts to offset the associated reduction in government revenue. However, it seems that no meaningful spending cuts are being considered. Therefore, the tax cuts would accelerate the rate of increase of the federal government’s debt, leading to higher interest rates and private-sector debt being ‘crowded out’ by government debt.

Trump also is advocating tariffs on all imports, with huge tariffs to be imposed on any imports from China. Furthermore, he has stated that he will use tariffs as a weapon against any country that acts in a way that he deems unacceptable, including against any country that attempts to move away from the US$-based international monetary system.

Tariffs that are imposed on US imports are paid by the US-based importers and would get passed on to US consumers, so an effect of the tariffs would be a sizable increase in the US cost of living. Another effect would involve the start of a process to change supply chains and relocate manufacturing in response to the sudden government-forced changes in costs. This process would be long and expensive.

There is no doubt that the Trump tariffs would lead to retaliation from other governments, with predictable effects being smaller markets and smaller profit margins for US companies exporting from the US or operating outside the US. Also, it’s likely that international trade blocs would form that excluded the US.

Most significantly from a long-term perspective, the tariffs and the threat to use tariffs as a weapon to punish governments deemed by the President to be recalcitrant would reduce the international demand for the US$ and could bring forward the demise of the current global monetary system (the Eurodollar System discussed in the 12th August Weekly Update). This is not primarily because the tariffs would lead to less international US$-denominated trading of goods and services, although they certainly would do that. Instead, it is because the non-US demand to hold US dollars is based on the US having large, liquid, open and secure markets. The US financial markets will remain large and liquid for the foreseeable future, but the international demand for the US$ will decline to the extent that these markets are no longer perceived to be open and secure.

The shift away from the US$ would occur over many years, because currently there is no alternative. However, the introduction of Trump’s tariffs would increase the urgency to establish an alternative and could have noticeable effects on the currency market as soon as next year.

By the way, although it was ineffective the Biden administration’s decision in 2022 to ban Russian banks from using the SWIFT system possibly was viewed as a ‘shot across the bow’ by many foreign governments, corporations and wealthy individuals. If Trump gets elected and does what he has said he will do with tariffs, it would be a ‘shot directly into the bow’.

Summarising the above, a Harris administration would attempt to establish higher tax rates, which would lead to reduced investment and a weaker US economy. Also, the price of energy would be higher, more resources would be directed towards inefficient sources of energy and the Ukraine-Russia war probably would either grind on or escalate. A Trump administration wouldn’t make these mistakes, but via aggressive and far-reaching tariffs it would raise the cost of living and throw the equivalent of a giant spanner into the international trading and investing works. One thing that Harris and Trump have in common is that their planned actions will ensure that the US government’s debt burden continues to increase at a rapid pace.

It’s almost as if both sides of the US political aisle have a weaker dollar and a higher gold price as unofficial goals.

The US yield curve is considered to be a good leading indicator of US recession, with an inversion of the curve invariably occurring prior to the start of a recession. However, the Wolf Street article posted HERE questions the yield curve’s reliability. The article notes that part of the US yield curve recently ‘uninverted’, which is true. What’s not true is the claim in the article that since 1998 the US yield curve failed twice by warning of recessions that didn’t occur.

According to the article, the yield curve’s 2019 inversion was a failure because even though there was a recession in 2020, the recession was the result of a pandemic and not a business cycle downturn. This is strange reasoning, to put it mildly.

The only way that you could argue logically that the yield curve’s 2019 inversion was a failure would be if you could re-run history to show that in the absence of the COVID pandemic there would not have been a recession. Since this is not possible, the 2019 inversion should not be viewed as a failure. Either it was a success or it should not be counted.

Also according to the article, there was a yield curve inversion in 1998 that was not followed by a recession.

The problem here stems from interpreting a multi-day spike into inversion territory as a recession signal. This problem goes away if you base your analysis on monthly closing or monthly average prices, which generally is what should be done with long-term indicators.

Here is a monthly chart showing that since the late-1960s every inversion of the US 10year-3month yield spread was followed by a recession. Consequently, if this cycle’s yield curve inversion does not lead to a recession then it will be the first failure of this type (the first false positive) in more than 50 years. Note, though, that the monthly chart of the 10year-3month yield spread shows that there was no yield curve inversion prior to the 1990 recession, so this could be viewed as a false negative.

Regardless of whether or not this cycle’s yield curve inversion leads to a recession, a yield curve inversion/uninversion clearly isn’t a useful trading signal. The time between the warning signal and the projected outcome is simply too long and too variable.

There are many problems with the calculation methodology of the Consumer Price Index (CPI) and with the whole concept of coming up with a single number to represent the purchasing power of money. Interestingly, however, if we calculate the inflation-adjusted (‘real’) gold price by dividing the nominal US$ gold price by the US CPI, which is what we have done on the following monthly chart, we see that the result has peaked at around the same level multiple times over the past 50 years and that the current value is around this level. Does this imply that gold’s upside is capped?

It adds to the reasons that we should be cautious about gold’s short-term prospects. These reasons include the size of the speculator net-long position in gold futures, the August-September cyclical turning-point window for the gold mining sector, the likelihood of a reduced pace of US federal government spending during the months following the November-2024 election, the fact that gold’s true fundamentals are not definitively bullish, the high level of the gold/GNX ratio (gold is expensive relative to commodities in general), the extent to which the financial markets have discounted Fed rate cuts (four 0.25% Fed rate cuts are priced-in for 2024, creating the potential for a negative surprise from the Fed), and the high combined value of gold and the S&P500 Index relative to the US money supply. However, we expect that within the next 12 months the gold/CPI ratio will move well into new high territory, mainly because:

1) The US economy finally will enter the recession that has been anticipated for almost two years and that has been delayed by aggressive government spending, leading to efforts by both the Federal Reserve and the federal government to stimulate economic activity.

2) Despite the rise in government bond yields over the past few years, it is clear that neither of the major US political parties nor their presidential candidates have any concern about the level of federal government indebtedness. Putting it another way, currently there is no political will to reduce government spending. On the contrary, both presidential candidates are going down the well-worn path of trying to buy the votes of influential groups while ‘turning a blind eye’ to the government’s debts and deficits.

3) Using our own method of adjusting for the effects of inflation*, which generally will not be accurate in the short-term but should be approximately correct over periods of several years or more, the current ‘real’ gold price is a long way below its 1980 and 2011 highs (our method indicates inflation-adjusted highs of around US$5000/oz in 1980 and US$3400/oz in 2011). Refer to the following monthly chart for more detail.

So, while the proximity of the gold/CPI ratio to its long-term resistance adds to the short-term risk, this resistance probably won’t act as a ceiling for much longer.

*The theory that we apply can be summarised as follows: The percentage reduction in a currency’s purchasing power should, over the long-term, be roughly equal to the percentage increase in its supply minus the percentage increase in the combination of population and productivity.

By our reckoning, during the first half of 2022 the US economy entered the bust phase of the economic boom-bust cycle caused by monetary inflation (rapid monetary inflation causes a boom that inevitably is followed by a bust as the receding monetary tide exposes the boom-time malinvestments). The bust phase almost always culminates in a recession, although it doesn’t have to.

So far, the performances of commodity prices in both US$ terms and gold terms are consistent with an economy in the bust phase, in that last week the GSCI Spot Commodity Index (GNX) tested its cycle low in US$ terms and made a new 3-year low in gold terms. The following daily chart shows GNX in gold terms, that is, it shows the commodity/gold ratio. Booms and busts are defined by the commodity/gold ratio, with booms being multi-year periods during which the commodity/gold ratio trends upward and busts being multi-year periods during which the commodity/gold ratio trends downward.

Note that it is not unusual for the stock market, as represented by the S&P500 Index (SPX), to trend upward for a considerable time after the start of an economic bust. For example, an economic bust started in October of 2018 but the SPX didn’t peak until February of 2020. Therefore, the fact that the SPX made a new all-time high as recently as last month is not inconsistent with the US being in the bust phase of the economic cycle.

What is inconsistent with the bust phase are credit spreads, which prior to the turmoil of the past 1.5 weeks were at their boom-time lows. However, the relatively low average level of US credit spreads does not mesh with the relatively large number of corporate bankruptcies, so it’s likely that credit spreads are sending a misleading signal.

The misleading signal could be the result of junk-rated corporations delaying their re-financings for as long as possible in the hope that if they wait long enough, they will be able to re-finance at lower interest rates during the next Fed rate-cutting cycle. The problem that many of these companies will encounter is that a Fed rate-cutting cycle probably will begin near the start of a recession and a multi-quarter period during which interest rates fall on high-quality debt while rising rapidly on low-quality debt.

In a blog post earlier this year we wrote that the conflict between the signal from the commodity/gold ratio and the signal from credit spreads would have to be resolved either by credit spreads widening substantially in response to evidence of economic weakness or by the prices of industrial commodities rising substantially in response to evidence that a new boom had been ignited. Our view then and now is that the former is by far the more likely outcome. In fact, there’s a good chance that last week’s rise in the credit-spreads indicator shown on the following daily chart marked an important turning point.