[This blog post is an excerpt from a commentary published at TSI last week]

In most countries/regions, the money-supply growth rate bottomed in 2019 and by the beginning of this year was in a clear-cut upward trend. Then came the “coronacrisis”, involving widespread economic lockdowns and unprecedented central bank money/credit creation designed to counteract the effects of the lockdowns. A result was a veritable explosion in monetary inflation rates around the world during March and April (April being the latest month for which there is complete money-supply information). Here are some examples:

1) The combination of US and euro-zone money supply that we call G2 True Money Supply (TMS) was at a 10-year low in the middle of last year. It is now at an all-time high. This is by far the most bullish force currently acting on equity and commodity prices.

2) Early last year Australia was in danger of experiencing monetary deflation, but this country’s monetary inflation rate has since rocketed to an all-time high of 24%. This is not bearish for the A$ relative to other currencies and especially not relative to the US$ (we suspect that the A$ will trade at parity with the US$ within two years), because the A$’s exchange rate is influenced to a far greater extent by the commodity markets than by the local monetary inflation rate. However, it suggests that in Australia the prices of goods, services and assets will go up a lot over the next few years.

3) The Bank of Canada has been a little more circumspect than most other central banks over the past few months, but in response to the recent crisis it has done enough to boost the country’s monetary inflation rate to near a 10-year high. A year ago it was near a 20-year low.

4) We occasionally read articles that attempt to make the case that central bank money pumping does not lead to higher prices, with the situation in Japan cited as evidence. Japan supposedly is relevant because the Bank of Japan (BOJ) has been aggressively monetising assets for a long time with minimal effect on prices.

As we’ve noted many times in the past, prices have been stable in Japan because Japan’s monetary inflation rate has oscillated at a relatively low level for decades. Whatever the BOJ has been doing, it has NOT been pumping money at a rapid rate. Even now, in the face of additional monetary stimulus, the year-over-year rate of growth in Japan’s M2 money supply is below 4%. This contrasts with a US money-supply growth rate of almost 20%.

Therefore, the low rate of price inflation in Japan is in no way mysterious. It’s exactly what would be expected from an economy with a low rate of monetary inflation and some productivity growth.

In summary, outside of Japan the supply of currency is increasing at such a fast pace that there WILL be substantial price increases over the next two years. However, the price increases won’t be uniform. For example, due to a high unemployment rate the price of labour probably will be a laggard, and due to their relative supply situations the price of oil probably won’t rise by as much as the prices of uranium, natural gas, copper, nickel and zinc.

[This blog post is an excerpt from a commentary posted at TSI last week]

The rebound from the H1-2020 plunge into recession probably will look like a ‘V’, at least initially. This is not because conditions will become positive as quickly as they became negative, but because conditions got so bad so quickly that charts of economic statistics such as industrial production and retail sales will appear to make a ‘V’ bottom in Q2-Q3 of this year. However, the ‘V’ won’t mark the start of a genuine recovery.

The following charts show what we mean by “got so bad so quickly”.

The first chart shows that within the space of three months the Small Business Optimism Index collapsed from a level that indicated a high level of optimism to one of the lowest levels in the 34-year history of the index. The only other decline of this magnitude occurred during the 2005-2008 period and took more than two years.

The second chart shows that Industrial Production has just registered its largest month-over-month decline in at least 101 years. By this measure, even the worst months of the Great Depression were not as bad as April-2020.

Source: dshort

Source: Hedgeye

There are thousands of people who have lost their businesses — in some cases, businesses that they spent the bulk of their adult lives building — over the past two months as a result of the lockdowns. These people probably are feeling angry and/or devastated. However, we get the impression that the vast majority of people have accepted the lockdowns with equanimity. They haven’t taken to the streets to protest the economic destruction that has been wrought by their political overlords. Instead, they have shrugged off the most rapid decline in industrial production in history and a sudden rise in the unemployment rate from below 4% to above 20%. How is this possible?

It’s possible only because the government and the Fed have showered the people with money. The money that has been created out of nothing is acting like pain-suppressing medication. In effect, the government and the Fed have administered anaesthetic so that the patient felt no pain as vital organs were removed. Without this anaesthetic, the populace would not have remained docile as its basic rights were cancelled and its economic prospects were greatly diminished.

Money, however, is just the medium of exchange. It facilitates the division of labour*, but it does not constitute real wealth. For example, if every current dollar were instantly replaced by ten dollars, there wouldn’t be any additional wealth. The point is that the government and the Fed cannot make up for the decline in real wealth caused by the lockdowns by providing more money. All they can do is change the prices of the wealth that remains.

There will be a ‘V’ shaped recovery, but due to the destruction of real wealth stemming from the lockdowns the rising part of the V is bound to be much shorter than the declining part of the V. This will lead to a general realisation that life for the majority of people will be far more difficult in the future than it was over the preceding few years.

Returning to our medical analogy, eventually the anaesthetic will wear off and the patient will have to start dealing with the consequences of having lost a kidney, a spleen, a lung and half a liver.

*In the absence of money, a tomato farmer who needed some dental work would have to locate a dentist who needed a few crates of tomatoes.

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

At around this time last month we noted that the Fed had pushed the year-over-year rate of growth in US True Money Supply (TMS)*, also known as the US monetary inflation rate, to a multi-year high of 11.3%, and that based on what the Fed subsequently had done the monetary inflation rate could reach 15%-20% by the middle of this year. With the monthly monetary data for April having been published last week, we now know that the aforementioned range has been reached already. As illustrated below, as at the end of April the US monetary inflation rate was close to 20%. Next month’s rate should be even higher.

This is banana-republic-style money creation, although it isn’t unprecedented for the US. The above chart shows that a near-20% monetary inflation rate also was attained in January-2002. Back then it was the bursting of the stock market bubble followed by the 9/11 attacks that caused the Fed to panic and flood the financial system with new money.

In a way, the shock to the financial markets resulting from the attacks by terrorists in September-2001 is similar to the shock to the financial markets resulting from the COVID-19 lockdowns. That’s despite the huge differences in the economic ramifications (the damage inflicted on the overall economy by the 9/11 attacks was minor and short-term, whereas the damage inflicted on the overall economy by the virus-related lockdowns of 2020 will prove to be major on both a short-term basis and a long-term basis).

The similar reactions of the financial markets (most notably the stock market) to the events of 2001 and 2020 firstly can be put down to the fact that both situations involved a sudden increase in uncertainty. Investors and speculators knew that the world had changed for the worse, but were ‘in the dark’ regarding many of the details. Secondly, in both cases there was an immediate and aggressive attempt by policy-makers to ‘reflate’.

Some of the results of this year’s monetary inflation moonshot should be similar to the results of the 2001 episode. In particular, this year’s explosion in the supply of US dollars should lead to a weaker US$ on the foreign exchange market (the Dollar Index commenced a multi-year bearish trend in January-2002 and probably will do the same within the next few months), a higher gold price, higher commodity prices and — eventually — higher equity prices.

The most important difference is that over the years ahead the economy will stay weak and, as a result, the unemployment rate will stay high. This is because flooding the economy with new dollars not only does nothing to make up for the destruction of real wealth caused by the lockdowns, it gets in the way of wealth creation by falsifying price signals and keeping ‘zombie companies’ alive.

*TMS is the sum of currency in circulation, demand deposits and savings deposits. It does not include bank reserves, time deposits or money market funds.

According to my Gold True Fundamentals Model (GTFM), the gold market’s “true fundamentals” most recently shifted from bearish to bullish in December of last year. As indicated on the following weekly chart by the blue line being above 50, at the end of last week they were still bullish. This means that the fundamental backdrop is still applying upward pressure to the gold price.

As previously explained, I use the term “true fundamentals” to distinguish the fundamentals that actually matter from the largely irrelevant issues that many gold-market analysts and commentators focus on.

According to many pontificators on the gold market, gold’s fundamentals include the volume of metal flowing into the inventories of gold ETFs, China’s gold imports, the amount of “registered” gold at the Comex, India’s monsoon and wedding seasons, jewellery demand, the amount of gold being bought/sold by various central banks, changes in mine production and scrap supply, and wild guesses regarding JP Morgan’s exposure to gold. These things are distractions at best. For example, a gold investor/trader could have ignored everything that has been written over the past 20 years about the amount of gold in Comex warehouses and been none the worse for it.

On an intermediate-term (3-12 month) basis, there is a strong tendency for the US$ gold price to trend in the opposite direction to confidence in the US financial system and economy. That’s why most of the seven inputs to my GTFM are measures of confidence. Two examples are credit spreads and the relative strength of the banking sector. The model is useful, in that over the past two decades all intermediate-term upward trends in the gold price occurred while the GTFM was bullish most of the time and all intermediate-term downward trends in the gold price occurred while the GTFM was bearish most of the time.

However, upward corrections can occur in the face of bearish fundamentals and downward corrections can occur in the face of bullish fundamentals. For example, there was a sizable downward correction in the gold market in March of this year in the face of bullish fundamentals. Such corrections often are signalled by sentiment indicators.

Right now, the fundamentals are supportive while sentiment is warning of short-term downside risk.

As long as the fundamentals remains supportive, any short-term decline in the gold price should be ‘corrective’, that is, it should be within the context of a multi-year upward trend.