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

Gold mining is — to use technical jargon — a crappy business. It doesn’t have to be, it just works out that way due to irresistible incentives associated with the post-1970 monetary system. We explained why in TSI commentaries and some articles at the TSI Blog (for example, HERE) during 2014-2015.

The explanation revolves around the boom-bust cycle caused by the monetary machinations of the banking establishment (the central bank and the commercial banks). For the economy as a whole, malinvestment occurs during the boom phase of the cycle and the bust phase is when the proverbial chickens come home to roost (the investing mistakes are recognised and a general liquidation occurs). For the gold mining industry, however, the malinvestment occurs during the economy’s bust phase, because the boom for gold mining coincides with the bust for the broad economy.

To further explain, rapid monetary inflation distorts relative price signals and in doing so incentivises investments that for a while (usually at least a few years) create the impression that the economy is powering ahead. Eventually, however, many of these investments are revealed for what they are (ill-conceived), with the revelation stemming from rising costs, declining profits or the absence of profit, resource shortages within the economic sectors that ‘boomed’ the most, and rising short-term interest rates due to a scramble for financing to complete projects and/or deal with cash flow problems.

After it starts to become clear that many of the boom-time investments were based on unrealistic expectations, a general drive to become more liquid gets underway. Many people sell whatever they can in an effort to pay expenses and service debts, thus kicking off an economic bust (recession or depression).

For the average person, becoming more ‘liquid’ usually involves obtaining more cash. However, corporations and high-net-worth individuals often prefer other forms of ‘liquidity’, including Treasury Bills and gold. That, in essence, is why the demand for gold tends to rise during the bust phase of the economy-wide boom-bust cycle.

The rising demand for gold pushes up gold’s price relative to the prices of most other assets and commodities, which elevates the general interest in gold mining. Eventually there will be a flood of money towards the gold mining industry that boosts valuations and that the managers of gold mining companies will use for something. That something will be project developments or acquisitions.

Regardless of how high market valuations move or how costly new mine developments become, gold-mining company managers will never say: “We don’t want your money because there currently are no acquisitions or new projects that make economic sense.” Instead, they will take the money and put it to work, based on the assumption that current price trends can be extrapolated into the distant future. The result invariably will be an artificial boom in the gold mining industry characterised by a cluster of high-cost investments that eventually get revealed as ill-conceived. Massive write-offs and an industry-wide retrenchment will ensue as surely as night follows day, thus obliterating the wealth created by the industry during the boom.

Gold itself is not made less valuable by the monetary-inflation-caused inefficiencies and widespread wastage that periodically beset the gold-mining industry. That’s why the gold mining sector, as represented on the following weekly chart by the Barrons Gold Mining Index prior to 1995 and the HUI thereafter, has been in a downward trend relative to gold bullion since 1968. That’s right — gold mining stocks, as a group, have been trending downwards relative to gold for more than 50 years!

The trend illustrated by the above chart is a function of the current monetary system and won’t end before the current system is replaced. The trend could end within the next ten years, but it didn’t end in 2020 and almost certainly won’t end in 2021 or 2022. An implication is that if you want to make a long-term investment in gold, then buy gold. Gold mining stocks are for trading.

1. There is no longer any correlation between bank reserves and the economy-wide money supply, meaning that the “money multiplier” taught in economics classes no longer applies.

2. In the US the government-Fed combination can increase the money supply to almost any extent independently of the private banks. That is, monetary inflation does not rely on the expansion of credit via the private banking industry.

3. The Fed is not constrained in any way by the need/desire to maintain a strong balance sheet.

4. The bulk of the central bank’s money creation involves the monetising of EXISTING assets, meaning that the central bank can increase the money supply without increasing the economy-wide quantity of debt. Furthermore, the central bank is capable of monetising almost anything.

5. A motivated central bank will always be able to increase the money supply, and growth in the money supply always leads to higher prices SOMEWHERE in the economy. For speculators and investors, the challenge is to figure out where.

6. The bond and currency markets eventually could impose practical limits on government borrowing and monetary inflation, but the government will be free to borrow and the Fed will be free to inflate as long as the bond and currency markets remain cooperative.

7. A corollary of points 5 and 6 is that the probability of the US experiencing deflation will remain low until after the T-Bond and/or the US$ tank. Putting it another way, the probability of the US experiencing deflation will remain low until after inflation is widely perceived to be a major problem.

8. There are long and variable time delays between changes in the money supply and the appearance of the price-related effects of these changes. This leads to an inverse relationship between the rate of monetary inflation and the fear of inflation, because the average person’s fears/expectations are based on the effects of previous money-supply changes as opposed to what’s currently happening on the monetary front.

9. An increase in the general price level is not the most important effect of monetary inflation. Of far greater importance: monetary inflation changes the STRUCTURE of the economy in an adverse way, by a) distorting relative prices, leading to malinvestment on a broad scale, and b) transferring undeserved benefits to the first receivers of the new money at the expense of everyone else.

10. Because monetary stimulus changes the structure of the economy, its bad effects cannot be cancelled-out by the subsequent withdrawal of the stimulus. Instead, the distortions/wastage caused by monetary stimulus will be revealed after the flow of new money is restricted. An attempt to sustain the stimulus indefinitely, and thus avoid the collapse that inevitably follows a period of inflation-fueled ‘growth’, will end in hyperinflation.

11. “Money velocity” is a redundant concept at best and a misleading one at worst. The same can be said about the famous Equation of Exchange (MV = PT), which is where money velocity (V) comes from. In the real world there is money supply and there is money demand; there is no such thing as money velocity.

12. Falling prices are never a problem — they are either the natural consequence of increasing productivity (real economic growth) or part of the solution to a problem (in the case of a bursting credit bubble).

13. A corollary of point 12 is that the central bank’s attempts to force prices to rise either counteract the benefits of increasing productivity or prevent the correction of the problems stemming from a credit bubble.

14. Credit expansion can foster sustainable economic growth only when it involves the lending of real savings by private individuals or corporations.

15. Economic growth is driven by savings and production, not consumer spending.

16. The government and the central bank have no real capital or wealth that can be used to help the economy in times of trouble. Therefore, monetary and fiscal “stimulus” programs involve stealing from one set of people and giving to another set of people. Obviously, the economy cannot be strengthened by large-scale theft.

A lot of widely held beliefs associated with the financial markets and the economy are in conflict with the historical record and/or logic. One that I have addressed many times in the past (most recently HERE) is the belief that gold tends to be relatively strong when inflation expectations are rising.

Rising inflation expectations eventually could transform into a collapse in monetary/economic confidence, at which point gold would exhibit extreme relative strength. However, the run-of-the-mill increases in inflation expectations that occurred over the past few decades generally led to weakness in gold relative to the basket of commodities represented by the S&P Spot Commodity Index (GNX).

Here’s an update of the chart I have presented in previous blog posts that illustrates the relationship mentioned above. The chart shows a strong positive correlation over the past four years between the GNX/gold ratio and RINF, an ETF designed to move in the same direction as the expected CPI. That is, the chart shows that a broad basket of commodities tended to outperform gold during periods when inflation expectations were rising and underperform gold during periods when inflation expectations were falling.

As an aside, related to the above chart is the following chart comparing the commodity/gold (GNX/gold) ratio with the yield on the 10-year Treasury Note (TNX). Given the positive correlation between the commodity/gold ratio and inflation expectations, it isn’t surprising that there is a positive correlation between the commodity/gold ratio and the 10-year interest rate.

This year, inflation expectations bottomed in March and then trended higher. That’s the main reason why, in TSI commentaries over the past seven months and especially over the past two months, I have written that it was appropriate to favour industrial commodities over gold.

I currently expect the rising inflation expectations trend to continue for another 2-3 quarters. This means that I expect continued outperformance by industrial commodities for another 2-3 quarters, of course with corrections along the way. A correction (a period of relative strength in the gold price) actually could begin soon, partly because the gold price is now stretched to the downside while the prices of commodities such as copper, zinc, oil and iron-ore are stretched to the upside.

[Below is an excerpt from a TSI commentary published about two weeks ago. This discussion is being reproduced at the blog because it updates an opinion that was outlined at the blog way back in 2015-2016.]

Goldmoney (XAU.TO) originally was called BitGold and first began trading on the stock market in 2015. We wrote about the company four times at the TSI Blog during 2015-2016 (HERE, HERE, HERE, and HERE). The general theme of these writeups was: The company has a great product, but the stock is wildly overpriced.

Here’s how we summed up the Goldmoney business in the last of the above-linked blog posts:

“From the perspective of a Goldmoney user, the business is great. Customers can store gold, use gold as a medium of exchange and even take delivery of physical gold in manageable quantities, all at a low (or no) cost. From the perspective of a Goldmoney shareholder, however, the business is not so great. Of particular significance, unlike a mutual fund that charges a fee based on AUM (Assets Under Management), Goldmoney charges nothing to store its customers’ assets (gold bullion). This means that the larger the amount of Goldmoney’s AUM, the greater the net cost to the owners of the business (Goldmoney’s shareholders).

It’s important that under the current fee structure, Goldmoney will generally lose money on customers who use the service primarily for store-of-value purposes. This is where PayPal has a big advantage over Goldmoney. Nobody views their PayPal account as a long-term store of value. Instead, they view it as short-term parking for money to be spent, and when the money is spent PayPal usually gets a commission. This results in PayPal being very profitable, with earnings of US$1.2B (US$1.00/share) in 2015. Many of Goldmoney’s customers, however, view the service as a convenient way to store their physical gold. They don’t want to spend their gold, they want to save it.

Based on what I’ve seen to date I continue to believe that Goldmoney offers a great product, but is operating an inherently low-margin business deserving of a low valuation. Use the service, but don’t buy the stock.”

Since 2016 the company has grown a lot, mainly by acquiring similar or related businesses. Most importantly, it has modified its business model and now generates revenue/earnings from precious metals storage and lending. The fee structure is outlined HERE.

Over the same period the share price has trended down from highs of C$8.00 in 2015 and 2017 to a current level of C$2.18. Incredibly, the fundamental value of an XAU share is higher today with the stock trading near C$2 than it was in 2015-2017 when speculative fervour briefly caused the shares to trade as high as C$8.

Goldmoney Inc. now owns/operates two precious metals businesses called Goldmoney.com and Schiff Gold. Revenue for these businesses is earned as a weight of precious metal each time a client buys, sells, exchanges, takes delivery or stores precious metals through one of these businesses. Also, Goldmoney owns 37% of a jewellery manufacturer called Mene Inc. (MENE.V) and earns interest (in precious metals form) through the lending of precious metals to Mene. Lastly, Goldmoney owns/operates a company called Lend & Borrow Trust (LBT) that generates income by making fiat currency loans that are fully secured by precious metals.

The bulk of XAU’s earnings is in the form of precious metals that accumulate on the balance sheet. Furthermore, balance sheet assets not allocated to current working capital, investments and intangible assets are used to purchase and hold physical precious metals, the idea being that XAU’s holdings of gold, silver, platinum and palladium ounces will grow steadily over time.

With a Goldmoney account it is easy to buy and sell physical precious metals (PMs) at very competitive bid-ask spreads, with the PMs stored in secure vaults on an allocated basis (each client has ownership of specific pieces of metal). Also, it is possible to take delivery of your metal. Therefore, it could make sense to build up direct ownership of PMs via a Goldmoney.com account.

Alternatively, as long as the shares are purchased when they are trading near book value (BV), owning XAU shares is a reasonable way to build up indirect ownership of PMs. Owning the shares has the added advantage that if the company is well-managed then the amount of physical metal per share will increase over time.

The current BV is C$2.28/share including goodwill and C$1.79/share excluding goodwill. We think the latter number is the more relevant and therefore that the shares would be very attractive for long-term investment purposes at around C$1.80. However, the current premium to the C$1.79/share BV is not excessive, so if you are interested in XAU then it could make sense to take an initial position near the current market price of C$2.18.

[This post is an excerpt from a recent TSI commentary]

This year has been nothing if not interesting. Many unprecedented things have happened, one example being the performance of the US Industrial Production (IP) Index. As shown below, IP effectively fell off a cliff during March-April of this year. During May-July it climbed about half-way back up the cliff face before stopping in its tracks over the past two months. Nothing like this ever happened before.

When we say nothing like this ever happened before we are referring to the speed of the change. In magnitude terms the IP Index suffered a similar peak-to-trough decline during the Global Financial Crisis, but what took eighteen months during 2007-2009 took only two months in 2020. And after the 2007-2009 recession it took about two years for the IP Index to recover half of what it lost, as opposed to three months in 2020. In other words, what took 3.5 years during 2007-2011 took only five months in 2020.

The reason for the unprecedented speed of this year’s collapse is that the US economy didn’t fall off a cliff; it was pushed. The government (meaning: politicians and bureaucrats at the federal and state levels) deliberately crashed the economy. Policymakers then mounted such an extraordinary rescue attempt that personal income actually rose while the economy crashed and unemployment soared, which explains the unprecedented speed of the rebound.

The economic recovery stalled over the past two months (the IP Index for September was roughly the same as the IP Index for July), mainly because the government slowed the pace at which it was doling out ‘free’ money. The pace of the government’s money distribution is bound to ramp up after the November election, which probably will enable the economy to look strong during the first half of next year. However, there is no chance of a self-sustaining recovery. The main reason is that deluging the populace with newly created money does nothing to repair the damage caused by the lockdowns. On the contrary, it leads to capital consumption and sets the stage for another plunge into recession territory.

The biggest risk, however, isn’t that the ‘stimulus’ efforts won’t work and that the US economy will be back in recession within the next two years. That’s more of an inevitability than a risk. The risk of greatest concern is that policymakers will become even more aggressive in their misguided efforts to help and that these efforts will lead to hyperinflation.

For the first time since we started publishing these reports two decades ago, we cannot write that the probability of the US experiencing hyperinflation within the next two years is close to zero. The probability isn’t high, but it is significant.

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

Moore’s Law, which is based on a comment by Intel co-founder Gordon Moore in the 1960s, states that the number of transistors on a chip doubles every two years. In effect, it states that the computer industry’s efficiency doubles every two years. Moore’s Law worked well in the semiconductor/computer industry for a few decades, but that was due to a set of circumstances that existed in that particular industry over a certain time rather than the general applicability of the ‘law’. The ‘law’ no longer works in the computer industry and can’t be applied in a useful way to technology in general. Wright’s Law, on the other hand, is more useful when it comes to explaining and predicting the effects of technology-driven improvements in efficiency. Wright’s Law pre-dates Moore’s Law by about 30 years (it was postulated by Theodore Wright in 1936) and states that for every cumulative doubling of units produced, costs will fall by a constant percentage.

The reason that Wright’s Law works better than Moore’s Law (Wright’s Law can be applied to all industries and has even been more accurate than Moore’s Law in the computer industry) is that it focuses on cost as a function of units produced rather than time. The beauty of Wright’s Law is that once an industry has been around for long enough to determine the relationship between the increase in units produced and the reduction in unit cost, accurate predictions can be made regarding what’s likely to happen over years and even decades into the future. The limitation is that a certain amount of history is required to establish the percentage reduction in cost that accompanies a certain increase in the production rate.

It should be possible to apply Wright’s Law to any growing industry. Of particular relevance to this discussion it should apply in the Electric Vehicle (EV) industry over the next several years, whereas it should no longer apply in the Internal Combustion Engine (ICE) vehicle industry. It probably won’t apply to ICE vehicle manufacturing in the future because the production rate of such vehicles appears to have peaked on a long-term basis. As evidence we cite the following chart of light vehicle sales in the US since the mid-1970s. This chart shows that the 9-month moving average of annualised light vehicle sales in the US peaked in 2005 and is lower today than it was in the mid-1980s.

Chart Source: advisorperspectives.com

Total light vehicle sales have peaked in many parts of the world, but EV sales are experiencing exponential growth. This implies that vehicle components that are specific to EVs, most notably batteries and electric motors, are going to get cheaper and cheaper. This will not only improve the economics of EVs in absolute terms, it will improve the economics of EVs relative to ICE vehicles.

Taking into account the life-of-vehicle cost, that is, the cost to buy plus the on-going costs to run and maintain, EVs already are competitive with ICE vehicles without the requirement for government subsidies, but within the next three years the economic benefits of choosing an EV over an ICE vehicle will become irresistible to most new car buyers in developed countries. This will happen with or without government incentives to buy EVs. It will happen because of Wright’s Law.

An implication is that current car and truck manufacturers that can’t figure out how to make EVs that consumers want to buy will disappear. Another implication will be a large increase in demand for the commodities that go into vehicle components that are specific to EVs. The commodities that spring to mind are the rare earth metals Neodymium and Praseodymium (NdPr), which are used in electric motors, and lithium, nickel and manganese, which are used in EV batteries.

Keep in mind, though, that the size of the EV market is limited by an overall light vehicle market that probably will be smaller in 15 years than it is today, because the combination of self-driving and ride-sharing will bring the age of personal car ownership to an end.

Wright’s Law naturally results in huge benefits for the average person, but central bankers think that they have to fight it. Even though prices naturally fall over time due to economic progress, central bankers believe that prices should rise, not fall. Therefore, they deliberately try to counteract the efficiency improvements that people in the marketplace are constantly trying to create. They do so by pumping new money into the economy or by encouraging commercial banks to lend new money into existence.

In general, the fast-growing industries that are focused on technological advancement are still able to reduce prices in the face of the central bank’s price-distorting efforts. This leads to the price rises being concentrated in industries where, due to government regulations or the nature of the industry, there is less scope for technology to drive prices downward. For example, Amazon.com was able to drive prices downward in the face of the Fed’s “inflationary” efforts, but most of its brick-and-mortar competitors were not. Other examples are the education and healthcare industries, where regulations and direct government ownership get in the way.

It’s hard to overstate the stupidity of a central bank strategy that is designed to make the economy less efficient. Currently we have the absurd situation in which the faster the rate of technological progress, the more that central banks do to create “inflation” and thus offset the benefits of this progress. They aren’t doing this because they are malicious, they are doing it because they are trapped within an ideological framework that prevents them from understanding the way the world works.

I discussed the relationship between gold and inflation expectations a couple of times in blog posts last year (HERE and HERE). Contrary to popular opinion, gold tends to perform relatively poorly when inflation expectations are rising and relatively well when inflation expectations are falling.

The relationship is illustrated by the chart displayed below. The chart shows that over the past seven years there has been a strong positive correlation between RINF, an ETF designed to move in the same direction as the expected CPI, and the commodity/gold ratio (the S&P Spot Commodity Index divided by the US$ gold price). In other words, the chart shows that a broad basket of commodities outperformed gold during periods when inflation expectations were rising and underperformed gold during periods when inflation expectations were falling.

This year, inflation expectations crashed during February-March in reaction to the draconian economic lockdowns imposed by governments and then recovered after central banks and governments tried to mitigate the lockdown-related devastation by showering the populace with money. This resulted in a crash in the commodity/gold ratio early in the year followed by a rebound in commodity prices relative to gold beginning in April.

The above chart shows that the rebound in the commodity/gold ratio from its April-2020 low was much weaker than the rebound in inflation expectations. This happened because there are forces in addition to inflation expectations that act on the commodity/gold ratio and some of these forces have continued to favour gold over commodities. Of particular relevance, the rise in inflation expectations has been less about optimism that another monetary-inflation-fuelled boom is being set in motion than about concerns that a) the official currency is being systematically destroyed and b) the private sector’s ability to produce has been curtailed on a semi-permanent basis.

Inflation expectations probably will continue to trend upward over the coming 12 months and this should lead to additional strength in industrial commodities relative to gold, but less strength than implied by the relationship depicted above. It probably will happen this way because more and more economic activity will be associated with government spending, which does nothing for long-term progress.

Eventually the relationship depicted above will be turned on its head due to plummeting confidence in both the government and the central bank, that is, at some point rising inflation expectations will start being associated with an increase in the perceived value of gold relative to commodities and pretty much everything else.

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

It is estimated that about 50% of the production costs of the average gold miner are linked to energy. That’s why the gold/oil ratio is a reasonable proxy for the average profit margin across the gold mining industry.

The gold/oil ratio peaked in April of this year and then plunged. Refer to the following chart for the details. It’s a good bet that the April-2020 peak was the major (long-term) variety since it was driven by a spectacular collapse in the oil price that almost certainly won’t be repeated within the next few years. This implies that the industry-wide gold mining profit margin peaked on a long-term basis during the first half of this year.

For two reasons, the high probability that the gold/oil ratio peaked on a long-term basis 5-6 months ago is not bearish for gold mining stocks.

The first reason is that the plunge in the gold/oil ratio from its April-2020 peak ended with the ratio at a multi-decade high. In other words, by historical standards the gold price is still very high relative to the cost of energy, meaning that gold mining profit margins remain elevated. That’s why we expect the gold mining indices/ETFs to trade at much higher levels within the next 12 months.

The second reason is that when the gold/oil ratio retains about half of its gain from a major low (in this case in 2018) to a major high, which it has done to date, the time from a major gold/oil ratio peak to a major gold mining peak tends to be 1.5-2.5 years. This implies that the cyclical advance in the gold mining sector that began in 2018 won’t end before the second half of 2021, although be aware that a sustained move below 40 in the gold/oil ratio would warn a multi-year peak was either in place or close.

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

The 4-8 year period beginning in February of this year potentially will contain three or more official recessions and come to be referred to as the Depression of the 2020s. If so, unlike the Depression of the 1930s the Depression of the 2020s will be inflationary.

The Depression of the 1930s was deflationary in every sense of the word, but the primary cause of the deflation was the performance of the money supply. We don’t have the data to calculate True Money Supply (TMS) during the 1930s, but we have the following chart showing what happened to the M1 and M2 monetary aggregates from 1920 to 1953. The chart shows that there was a substantial contraction in the US money supply during 1929-1933 and that the money supply was no higher in 1938 than it had been at the start of the decade.

Clearly, the money-supply situation today could not be more different from the money-supply situation during the early-1930s*.

One reason for the difference is that during the 1930s the Fed was restricted by the Gold Standard. The Gold Standard was diluted in 1933, but throughout the 1930s the US$ was tethered to gold.

The final official link between the US$ and gold was removed in 1971. This made it possible for the Fed to do a lot more, but as far as we can tell the Fed actually didn’t do a lot more in the 1990s than it did in the 1960s. It has been just the past 20 years, and especially the past 12 years, that the Fed has transmogrified from an institution that meddles with overnight interest rates and bank reserves to a central planning agency that attempts to micro-manage the financial markets and the economy. After history’s greatest-ever mission creep, it now seems that there is nothing associated with the financial markets and the economy that is outside the Fed’s purview.

In parallel with the expansion of the Fed’s powers and mission there emerged the idea that for a healthy economy the currency must lose purchasing power at the rate of around 2% per year. This idea has come to dominate the thinking of central bankers, but it has never been justified using logic and sound economic premises. Instead, when asked why the currency must depreciate by 2% per year, a central banker will say something along the lines of: “If the inflation rate drops well below 2% then it becomes more difficult for us to implement monetary policy.”

As an aside, because of the way the Fed measures “inflation”, for the Fed to achieve its 2% “inflation” target the average American’s cost of living probably has to increase by at least 5% per year.

Due to the central-banking world’s unshakeable belief that money must continually lose purchasing power and the current authority of the central bank to do whatever it takes to achieve its far-reaching goals, the greater the perceived threat of deflation the more monetary inflation there will be. We saw an example of this during 2001-2002 and again during 2008-2009, but 2020 has been the best example yet. The quantity of US dollars created since the start of this year is greater than the entire US money supply in 2002.

It actually would be positive if deflation were the high-probability outcome that many analysts/commentators claim it is, because deflation is relatively easy to prepare for and because 1-2 years of severe deflation would set the stage for strong long-term growth. However, one of today’s dominant driving forces is the avoidance of short-term pain regardless of long-term cost, so there will be nothing but inflation until inflation is perceived to be the source of the greatest short-term pain. This doesn’t mean that a depression will be sidestepped or even postponed. What it means is that the next depression — which may have already begun — will be the inflationary kind.

*US True Money Supply (TMS) has expanded by 35% over the past 12 months.

Since the Fed implemented its first Quantitative Easing (QE) program in 2008-2009, many analysts have claimed that QE adds to bank reserves but does not increase the money supply (bank reserves aren’t counted in the money supply). Such claims are patently wrong.

Anyone who bothered to do some basic calculations would see that when the Fed monetises securities, as it does when implementing QE, it adds to the economy-wide supply of money. Specifically, if you add-up the increases in the dollar amounts of demand and savings deposits within the commercial banking system during a period in which the Fed ran a QE program and subtract from this the amount of money loaned into existence during the period by commercial banks, you will find that the difference is approximately equal to the net dollar value of securities purchased by the Fed.

The fact is that when the Fed buys X dollars of securities from a Primary Dealer (PD), either as part of a QE program or a non-QE open market operation, it adds X dollars to the PD’s deposit at a commercial bank AND it adds X dollars to the reserve account at the Fed of the PD’s bank. Another way to look at the situation is that the Fed’s purchases of securities add covered money (money in commercial bank deposits covered by reserves at the Fed) to the economy.

The process is described at the top of page 6 in the Fed document linked HERE. Some parts of this document are out of date in that it was written well before the Fed started paying interest on reserves and before commercial banks were able to reduce their required reserve amounts to zero via the process called “sweeping”, but the mechanics of the Fed’s direct money creation haven’t changed.

The persistent claims that the Fed’s QE doesn’t boost the money supply are not only wrong, but also dangerous. The creation of money out of nothing distorts relative prices, leading to mal-investment and slower economic progress. Consequently, the failure to identify the direct link between QE and money-supply growth makes the QE seem far less harmful than is actually the case.

[This blog post is an excerpt from a recent TSI commentary, with updated charts and minor modifications]

As is the case with the natural gas price, the price of the S&P Agricultural Index (GKX) appears to have made a cycle low via a double bottom in April and June of this year. At this stage the rebound from the Q2-2020 bottom doesn’t look more significant than any of the other rebounds of the past five years (see chart below), but the combination of rampant monetary inflation, rising inflation expectations and increasingly-volatile weather due to natural climate cycles is the recipe for a much longer and larger rally.

For at least the past 12 months we have argued that owning the stocks of fertiliser producers such as Mosaic (MOS) and Nutrien (NTR) is the best way for most people to participate in the agricultural (‘ag’) commodities bull market that potentially will unfold during 2020-2022. That continues to be our view. Although the fertiliser producers only provide indirect exposure to rising prices for ag commodities, obtaining direct exposure via the stock market involves owning ETFs that usually suffer substantial value leakage due to the “futures roll”.

The following daily charts show that the aforementioned stocks have rebounded strongly from their March-2020 lows but remain well below their highs of the past 12 months.

Not evident on the above daily charts is the fact that MOS and NTR are trading at small fractions of their 2008 peaks. The following weekly charts provide some additional perspective.

We think that the risk/reward ratios of these stocks are roughly equivalent, with NTR being less risky and MOS offering greater leverage. Both companies were very profitable in the June-2020 quarter and should become even more profitable over the quarters/years ahead.

[This blog post is an excerpt from a TSI commentary published within the past two weeks]

Many analysts downplay the Fed’s influence on bond yields, but we don’t think it’s possible to explain the following chart without reference to the massive yield-suppressing boot of the Fed. The chart compares the 10-year T-Note yield with the 10-Year Breakeven Rate, a measure of the market’s inflation (CPI) expectations. The Breakeven Rate is calculated by subtracting the Treasury Inflation Protected Security (TIPS) yield from the associated nominal yield.

The chart reveals that the 10-year T-Note yield generally moves in the same direction as the 10-Year Breakeven Rate. This is hardly surprising, given that the expected “inflation” rate is usually the most important determinant of the long-term interest rate. In particular, a higher expected “inflation” rate usually will result in a higher long-term interest rate. However, something very strange has happened since March of 2020. Since that time there has been a large rise in the expected CPI while the nominal 10-year yield has drifted sideways near its all-time low.

As far as we can tell, there are only two ways that the sort of divergence witnessed over the past five months between inflation expectations and nominal bond yields could come about.

One way is capital flight from outside the US to the perceived safety of the US Treasury market that overrides other effects on bond prices/yields. This is what happened during 2011-2012, which is the only other time that a substantial rise in inflation expectations coincided with flat or declining nominal US bond yields. In 2011-2012, capital flight to the US was prompted by the euro-zone’s sovereign debt crisis.

Manipulation by the Fed is the other way that the divergence could arise.

Over the past five months there has been no evidence of capital flight to the US. Therefore, it’s clear that the Fed has maintained sufficient pressure to prevent the nominal 10-year bond yield from responding in the normal way to a large rise in the bond market’s inflation expectations. Not without ramifications, though.

A large rise in the expected “inflation” rate in parallel with a flat nominal interest rate equates to a large decline in the ‘real’ interest rate. In this case, it equates to the ‘real’ US 10-year interest rate moving well into negative territory. This has put irresistible downward pressure on the US$ and irresistible upward pressure on the prices of most things that are priced in dollars, including gold, equities, commodities and houses. It has even put upward pressure on the price of labour, despite the highest unemployment rate since the 1930s.

At the moment the Fed undoubtedly is pleased with its handiwork. The rise in the gold price to new all-time highs could be viewed as a rebuke, but these days no-one in the world of central banking cares about the gold price. Central bankers do, however, care about the stock market, and the Fed’s governors will be patting themselves on the back for having helped the S&P500 Index fully retrace its February-March crash. They also will be pleased that the CPI is rising in spite of the deflationary pressures resulting from the lockdowns. After all, the concerns they have expressed over the years about insufficient “inflation” make it clear that the last thing they want is for your cost of living to go down*.

However, the Fed is ‘playing with fire’. Putting aside the long-term negative economic consequences of the mal-investment caused by the Fed’s money pumping and interest-rate suppression, if the Fed continues to prevent bond yields from reflecting rising inflation expectations then the steady shift currently underway towards hard assets and anything else that offers protection against currency depreciation will become a stampede. And once that happens, the sort of central-bank action that would be required to restore confidence would crash both the stock market and the economy.

If the Fed continues along its current path then an out-of-control rise in prices won’t be an issue to be dealt with in the distant future. It possibly will become an issue before the end of this year and very likely will become an issue by the middle of next year.

*Nobody with common-sense can figure out why.

[This is an excerpt from a commentary published at TSI on 16th August 2020. The message remains applicable.]

The US$ commenced a cyclical decline in March of this year and probably will trade well below current levels during the first half of 2021. From the perspective of our investing and trading, the main consequences of this weakness in the senior currency are:

1) Broad-based strength in the commodity markets. As illustrated below, the S&P Spot Commodity Index (GNX) has been trending upward since shortly after the US$ peaked.

2) Strength in emerging market equities, especially the equities that are based in emerging economies that rely heavily on commodity exports. For example, Brazilian equities. Despite the debilitating effects on Brazil’s economy of virus-related lockdowns, the following chart shows that the iShares Brazil ETF (EWZ) has done well since the US$ began trending downward.

Note that it could make sense to buy EWZ if there’s a pullback to US$26-$28 within the next several weeks.

3) Rising US inflation expectations. As illustrated below, the US 5-Year Breakeven Rate (the annual CPI increase that the market expects the US government to report over the next few years) has been trending upward since the US$ peaked.

The above consequences have been apparent over the past few months and should become more pronounced within the next 12 months, especially during the first half of next year. However, we think that in the short-term the focus of investors/speculators should be on the potential for a US$ rebound.

It’s possible that the Dollar Index (DX) will become more stretched to the downside before it commences a meaningful countertrend rally, but once a US$ rebound begins in earnest the prices that have been elevated over the past few months by US$ weakness, which means the prices of almost everything, will fall.

It does not make sense to exit all anti-US$ trades in anticipation of a short-term US$ rally. Doing so would be risky because these trades would make large additional gains if the US$ rebound were to be postponed for a month or two. Also, making a complete exit would create the problem of having to time the re-entry. However, it would make sense to hedge against a short-term US$ recovery while maintaining core exposure in line with the dollar’s longer-term weakening trend.

Gold market sentiment is complicated at the moment. There are signs of speculative froth, but at the same time the total speculator net-long position in Comex gold futures is close to its low for the year despite the US$ gold price recently hitting an all-time high. A likely explanation is that large speculators are focusing more on gold ETFs than on gold futures.

The price of a gold ETF that holds physical gold will track the gold price automatically. Therefore, there never will be an increase in the amount of gold held by such an ETF unless bullish speculators become sufficiently enthusiastic to push the market price of the ETF above its net asset value (NAV). When this happens it creates an arbitrage opportunity for the ETF’s Authorised Participants (APs), which results in the addition of gold bullion to the ETF’s inventory.

The following charts from http://www.goldchartsrus.com/ show large gains in the amounts of physical gold held by GLD and IAU, the two most popular gold ETFs. Specifically, the charts show that about 400 tonnes (12M ounces) of gold was added to the combined GLD-IAU inventory over the past few months. This actually isn’t a huge amount within the context of the global gold market, but it points to aggressive buying of the ETFs.

In other words, the evidence of gold-related speculative froth is in the stock market rather than the futures market.

The next chart shows that the silver story is similar. Specifically, the chart shows that about 7,000 tonnes (220M ounces) of physical silver have been added to the inventory of the iShares Silver ETF (SLV) since the March-2020 price low, including about 1,900 tonnes (60M ounces) during the three-week period culminating at the early-August price high.

The fundamental backdrop remains supportive for gold and silver, but sentiment suggests that a multi-month price top was put in place in early-August or will be put in place via a final spike within the next three weeks.

Many things have happened in 2020 that have never happened before, so in some respects it certainly is different this time. The most important of these differences, four of which are discussed below, revolve around the policy responses to the COVID-19 pandemic.

In the context of human history and in terms of the amount of death that it has caused, the COVID-19 pandemic is not particularly unusual. On average, there have been about two major pandemics every hundred years going back several centuries. Over the past hundred or so years, for example, there was the “Spanish Flu” in 1918 and the “Asian Flu” in 1958. Almost everyone has heard about the Spanish Flu and its horrific death toll, but the Asian Flu is less well known. Suffice to say that the death toll per million of global population resulting from the Asian Flu was about four times the current death toll per million of global population resulting from COVID-19.

The big difference this time is not the disease itself but the reaction to the disease. In particular, never before have large sections of the economy been shuttered by the government in an effort to limit the spread of the disease. Now, however, it has become accepted practice that as soon as the number of COVID-19 cases in an area moves beyond an unspecified low level, the orders go out for many businesses to close and for the public to stay home.

If locking down large sections of the economy is the optimal response to a pandemic, why wasn’t it tried before? Why did it take until 2020 to figure this out?

The answer is associated with the fact that COVID-19 is the first major pandemic to strike under the monetary system that came into being in the early-1970s. Under this system there is no limit, except perhaps an arbitrary level of increase in an arbitrary indicator of “inflation”, to the amount of money that can be created out of nothing. Previously there were limits to money creation imposed by some form of gold standard.

If there were rigid limits to the supply of money, the sort of economic lockdown implemented by many governments this year would cause immediate and extreme hardship to the majority of people. Therefore, it wouldn’t be an option. It is an option today because the ability to create an unlimited amount of money out of nothing presents the opportunity for the government to alleviate, or even to completely eliminate, any short-term pain for the majority of people. It should be obvious that this is an exchange of short-term pain for greater pain in the long-term, but hardly anyone is thinking about the long-term. In fact, the short-term fix that involves showering the populace with money is being advocated as if it didn’t have huge long-term costs.

Another difference between the current pandemic and earlier pandemics is the availability of information. For the first time ever during a major pandemic, almost everyone has up-to-the-minute data regarding the number of cases, hospitalisations and deaths. The widespread fixation on the cases/deaths data has fostered the general belief that getting the numbers down takes precedence over everything, long-term consequences be damned.

The third difference is linked to the first difference, that is, to the ability to create an unlimited amount of money out of nothing. This ability has existed for almost half a century, but 2020 is the first time it has been used by the government to provide money directly to the public. Prior to this year it was used exclusively by the central bank to manipulate interest rates and prop-up prices in financial markets. A consequence WILL be much more traditional “inflation” next year than has occurred at any time over the past decade.

The fourth and final difference that I’ll mention today is also linked to the money-creation power. It is that in 2020 some developed-world governments, most notably the US government, have stopped pretending to be concerned about their own indebtedness. Previously they made noises about prudently managing deficits and debts, as if the debt eventually would have to be repaid. However, this year they have tacitly acknowledged the reality that there has never been any intention to pay off the debt, and, therefore, that the debt can expand ad infinitum.

2020 certainly has been a watershed year.

[This blog post is an excerpt from a TSI commentary published on 19th July]

Sometimes, financial market relationships that have applied for a very long time stop working. This usually happens because the monetary system undergoes a major change or because the economy is altered in a permanent way by government and/or central bank intervention. It also can happen due to a major technological change that, for example, permanently reduces the demand for a commodity.

As a result of increasing central bank manipulation of money and interest rates, for the past 12 years gold has been getting more expensive relative to commodities that are consumed*. This is because the manipulation has been a) making it more difficult to earn a satisfactory return on investment and b) reducing the appeal of saving in terms of the official money. As central banks reduce the returns available from investing in productive enterprises and punish anyone who chooses to save cash, the demand for a store of value that central banks can’t depreciate naturally rises.

A knock-on effect is that some gold/commodity ratios appear to have been permanently elevated to higher ranges. There still will be periods when gold falls in value relative to these commodities, but the former ceilings no longer apply. In fact, in some cases it may be appropriate to view the former ceilings as the new floors. The two long-term monthly charts displayed below are cases in point.

The first chart shows the gold/platinum ratio. From the early-1970s through to 2015, gold was always near a long-term peak relative to platinum whenever the ratio moved up to 1. However, in 2015 the ratio broke above 1 and continued to trend upward.

A few years ago we speculated that gold/platinum’s former ceiling near 1 had become the new floor, that is, that the gold price would never again make a sustained move below the platinum price. The probability that this is so has since increased, although it’s likely that gold/platinum made an important high in March-2020 and is in the early stages of a 1-2 year decline.

The second chart shows the gold/oil ratio. From 1970 through to the start of 2020, gold was always near a long-term peak relative to oil whenever the ratio moved up to 30. However, during March-April of this year the gold/oil ratio reached a multiple of its previous long-term peak.

As is the situation with the gold/platinum ratio, it’s likely that the gold/oil ratio is in the process of establishing a higher long-term range that involves the former ceiling (30) being the new floor. As is also the situation with the gold/platinum ratio, it’s a good bet that the gold/oil ratio made an important high in April-2020 and is in the early stages of a 1-2 year decline.

It could be a similar story for the gold/silver ratio, although to a lesser degree. It’s likely that the gold/silver ratio has been permanently elevated, but not to the extent where the former ceiling (80-100) is the new floor. Our guess is gold/silver’s new floor is 50-60.

*That’s right, central banks are inadvertently manipulating the gold price upward, not deliberately manipulating it downward.

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

Gold is more money-like and silver is more commodity-like. Consequently, the relationships that we follow involving the gold/GNX ratio (the gold price relative to the price of a basket of commodities) also apply to the gold/silver ratio. In particular, gold, being more money-like, tends to do better than silver when inflation expectations are falling (deflation fear is rising) and economic confidence is on the decline.

Anyone armed with this knowledge would not have been surprised that the collapse in economic confidence and the surge in deflation fear that occurred during February-March of this year was accompanied by a veritable moon-shot in the gold/silver ratio*. Nor would they have been surprised that the subsequent rebounds in economic confidence and inflation expectations have been accompanied by strength in silver relative to gold, leading to a pullback in the gold/silver ratio. The following charts illustrate these relationships.

The first chart compares the gold/silver ratio with the IEF/HYG ratio, an indicator of US credit spreads. It makes the point that during periods when economic confidence plunges, the gold/silver ratio acts like a credit spread (credit spreads rise (widen) when economic confidence falls).

The second chart compares the silver/gold ratio (as opposed to the gold/silver ratio) with the Inflation Expectations ETF (RINF). It makes the point that silver tends to outperform gold when inflation expectations are rising and underperform gold when inflation expectations are falling.

We are expecting a modest recovery in economic confidence and a big increase in inflation expectations over the next 12 months, meaning that we are expecting the fundamental backdrop to shift in silver’s favour. As a result, we are intermediate-term bullish on silver relative to gold. We don’t have a specific target in mind, but, as mentioned in the 16th March Weekly Update when the gold/silver ratio was 105 and in upside blow-off mode, it isn’t a stretch to forecast that at some point over the next three years the gold/silver ratio will trade in the 60s.

Be aware that before silver commences a big up-move in dollar terms and relative to gold there could be another deflation scare. If this is going to happen it probably will do so within the next three months, although we hasten to add that any deflation scare over the remainder of this year will be far less severe than what took place in March.

*The gold/silver ratio hit an all-time intra-day high of 133 and daily-closing high of 126 in March of this year. This was one of the many unprecedented market/economic events of 2020.

[This blog post is an excerpt from a TSI commentary published about two weeks ago]

MMT (Modern Monetary Theory) revolves around the idea that governments with the ability to create money are not limited in the way that individuals and corporations are limited. Whereas private entities can only spend the money they have or the money that another private entity is willing to lend to them, a government with the ability to create money is only limited in its spending by the availability of real resources. As long as there is ‘slack’ (what the Keynesians refer to as “idle resources”) in the economy, the government can spend whatever amount of money is necessary to bring to fruition whatever projects/programs the majority of voters desire. MMT’s appeal to the political class is therefore obvious. The only problem is that MMT is based on misunderstandings about money, debt, and how the economy actually works.

If you read the explanations put forward by MMT advocates you could come away with the impression that the ‘theory’ is a discovery or original insight, but nothing could be further from the truth. What MMT actually does is employ accounting tautologies and a very superficial view of how monetary inflation affects the economy to justify theft on a grand scale.

Expanding on the above, when the government creates money out of nothing and then exchanges that money for real resources, it is exchanging nothing for something. In effect, it is diverting resources to itself without paying for them. This is a form of theft, but it is surreptitious because the seller of the resources does not incur the cost of the theft. Instead, the cost is spread across all users of money via an eventual reduction in the purchasing power of money.

According to the MMT advocates, the surreptitious theft that involves diverting resources from the private sector to the government is not a problem until/unless the CPI or some other price index calculated by the government rises above an arbitrary level. In other words, surreptitious government theft on a grand scale is deemed to be perfectly fine as long as it doesn’t result in problematic “price inflation”.

Further to the above, there is a major ethical problem with MMT. However, there are also economic problems and practical issues.

The main economic problem is that the damage that can be caused by monetary inflation isn’t limited to “price inflation”. In fact, “price inflation” is the least harmful effect of monetary inflation. The most harmful is mal-investment, which stems from the reality that newly-created money is not spread evenly through the economy and therefore has a non-uniform effect on prices. That is, monetary inflation doesn’t only increase the “general price level”, it also distorts relative prices. This distortion of the price signals upon which decisions are based hampers the economy.

Another economic problem is that the programs/projects that are financed by the creation of money out of nothing will not consume only the “idle resources”. Instead, the government will bid away resources that otherwise would have been used in private ventures. The private ventures that are prevented from happening will be part of the unseen cost of the increased government spending.

A practical issue is that the government’s ability to spend would be limited only by numbers that are calculated and set by the government. There is no good reason to expect that this limitation would be any more effective than the limitation imposed by the “debt ceiling”. The “debt ceiling” was raised more than 70 times over the past 60 years and now has been suspended.

A second practical issue is that it often takes years for the effects of monetary inflation to become evident in the CPI. Therefore, even if there were an honest attempt by the government to determine a general price index and strictly limit money creation to prevent this index from increasing by more than a modest amount, the long delays between monetary inflation and price inflation would render the whole exercise impossible. By the time it became clear that too much money had been created, a major inflation problem would be baked into the cake.

It’s often the case that what should be is very different to what is, so MMT being bad from both ethical and economics perspectives probably won’t get in the way of its implementation. After all and as mentioned above, it has great appeal to the political class. Also, it could be made to seem reasonable to the average person.

In fact, even though it hasn’t been officially introduced, for all intents and purposes MMT is already being put into practice in the US. We say this because the US federal government recently ramped up its spending by trillions of dollars, safe in the knowledge that “inflation” is not an immediate problem and that the Fed is prepared to monetise debt ‘until the cows come home’. Furthermore, another trillion dollar ‘stimulus’ program is in the works and there is a high probability that a multi-trillion-dollar infrastructure-spending program will be approved early next year. Clearly, there is no longer any concern within the government about budget deficits or debt levels. They aren’t even pretending to be concerned anymore.

The good news is that the implementation of MMT should accelerate the demise of the current monetary system. It means that there is now a high probability of systemic collapse during this decade. The bad news is that what comes next could be worse, with a one-world fiat currency, or perhaps a few regional fiat currencies, replacing today’s system of national currencies.

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

Financial market discussions and analyses often focus on fundamental issues that don’t matter, or at least don’t provide useful clues regarding the likely future performance of the market in question. A good example is the so-called “global US$ short position”, which is regularly cited in support of a bullish outlook for the US$.

The argument is that the roughly $12 trillion of US$-denominated debt outside the US constitutes a short position that will create massive demand for dollars and thus put irresistible upward pressure on the Dollar Index (DX). There is an element of truth to the argument, but the “global US$ short position” always exists. It exists during US$ bull markets and it exists during US$ bear markets, because it is simply an effect of the US$ being the currency of choice for the majority of international transactions. Furthermore, the shaded area on the following chart shows that the quantity of dollar-denominated debt outside the US steadily increases over time and that even the 2008-2009 Global Financial Crisis resulted in only a minor interruption to the long-term trend. Consequently, the existence of this debt isn’t a major intermediate-term or long-term driver of the US dollar’s exchange rate.

Source: https://www.bis.org/statistics/gli2004.pdf

The element of truth to the “global US$ short position” argument is that a significant strengthening of the US currency relative to the currencies of other countries will increase the cost of servicing dollar-denominated debt in those countries. This lessens the ability to borrow additional US dollars and puts pressure on existing borrowers to reduce their US$ obligations. In effect, it leads to some short covering that magnifies the upward trend in the US dollar’s exchange rate. This means that while the “global US$ short position” won’t be the cause of a strengthening trend in the US$, it can exacerbate such a trend.

We mentioned above that there is no empirical evidence that the “global US$ short position” drives trends in the US dollar’s exchange rate, but that doesn’t guarantee that the pile of US$-denominated debt outside the US won’t become an important exchange-rate driver in the future. The reason it won’t become important in the future is that prices are driven by CHANGES in supply and demand. The US$12T+ of foreign dollar-denominated debt represents part of the existing demand for dollars, meaning that the demand-related effects of this debt on the dollar’s exchange rate are ‘in’ the market already. At the same time, the total supply of dollars is growing rapidly.

At this point it’s worth addressing the idea that the Fed would be powerless to stop the US$ from appreciating if a major ‘debt deflation’ got underway. This is nonsense. Until the law of supply and demand is repealed, someone with the unlimited ability to increase the supply of something WILL have the power to reduce the price of that thing.

The Fed’s power to reduce the relative value of the US dollar was very much on display over the past few months. The financial-market panic and economic collapse of March-2020 predictably resulted in a desperate scramble for US dollars, leading to a fast rise in the Dollar Index. However, it took the Fed only two weeks to overwhelm the surging demand for dollars with a deluge of new dollar supply.

The upshot is that the so-called global US$ short position is not a valid reason to be a US$ bull.

With regard to performance over intermediate-term (3-18 month) time periods, the fundamentals that matter for the US$ are relative equity-market strength and interest rate differentials. This combination of drivers has been neutral for more than a year but soon could turn bearish for the US$.

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

The year-over-year rate of growth in US True Money Supply (TMS), a.k.a. the US monetary inflation rate, has continued its journey “to da moon.” Based on the monthly monetary data for May-2020, it is now at 27% and still rising rapidly. The following chart shows that the money-supply growth surge engineered by “Mississippi Jay” Powell* now dwarfs the earlier efforts of “Easy Al” Greenspan and “Helicopter Ben” Bernanke.

Anyone who thinks that this year’s monetary inflation moon-shot won’t lead to much higher prices for many things is kidding themselves. It has already fuelled the fastest 40% rise in the S&P500 Index in history, but unlike the other money-supply growth surges of the past 20 years the current episode also should lead to substantial gains in what most people think of as “inflation”. Not so much this year, because in the short-term there are counter-balancing forces such as an increasing desire to hold cash, but during 2021-2022.

Apart from its larger scale, there are three reasons that the money-supply growth surge engineered by “Mississippi Jay” should lead to much higher “price inflation”** than the money-supply growth surges engineered by his predecessors. The first is that although the Fed is still buying US government debt via Primary Dealers as opposed to directly from the government, it is crystal clear that the Fed is monetising the US government’s deficit. That’s why the Federal government is no longer even pretending to be concerned about the level of its spending and indebtedness. In effect, MMT (Modern Monetary Theory) is now being implemented in the US.

MMT is based on the ridiculous idea that there should be no upper limit on government spending/borrowing, facilitated via the creation of new money, as long as the CPI’s growth rate is below a certain level. It completely ignores all effects of monetary inflation apart from the most superficial. It also ignores the reality that government spending tends to be counterproductive because it is driven by political considerations and not market forces.

The good thing about MMT is that it should short-circuit the boom-bust cycle, in effect almost skipping the boom and going directly to an inflationary bust. This is because it lays bare the crudeness of the central bank’s monetary machinations. No longer is the central bank (incorrectly) perceived as finely tuning interest rates to keep the economy on an even keel. Under MMT it is seen to be pumping out whatever amount of new money the government demands.

The boom associated with this year’s monetary inflation moon-shot began in April and probably will end within the next six months. Actually, it might have ended already.

The second reason to think that this year’s money-supply growth surge will be followed by substantial “price inflation” is that the lockdowns of the past few months have damaged supply chains. This, combined with the shift away from globalisation, will lead to reduced supply and/or less efficient production of goods.

The third reason is supply constraints on important commodities. Firstly, this year’s lockdowns caused the mining industry to delay expansion plans and cancel new developments. Secondly, in labour-intensive mining countries such as South Africa, the requirement to implement social distancing following the return to work has made and will continue to make the mines less efficient. Thirdly, many small-scale commodity producers that together account for a significant portion of total supply have been put out of business by the lockdowns. Fourthly, the “El Nino” weather event of 2020-2021 and the Grand Solar Minimum that should start becoming influential in 2021-2022 probably will result in extreme weather volatility, which potentially will disrupt the supply of important agricultural commodities during 2021-2022. Lastly, due to the virus-related lockdowns and associated economic pressures there is heightened risk of war in the Middle East, implying heightened risk of an oil supply shock.

In summary, the latest flood of new money created by central banks will be more widely perceived to be “inflationary” than the other ‘money floods’ of the past 20 years. In addition, the latest money flood has occurred near the start of a multi-year period during which the production of many commodities and manufactured goods will be hampered. A likely result is substantial “price inflation” during 2021-2022.

*“Mississippi Jay” is the nickname we’ve given to current Fed Chair Jerome (Jay) Powell. The name links Powell with John Law, the roguish Scotsman (is there any other kind?) who, while residing in France in the early-1700s, engineered the Mississippi Bubble via a scheme that involved creating an extraordinary amount of new currency.

**We don’t like the term “price inflation”, because there is no such thing as an economy-wide average price level and because at any given time some prices will be rising while others are falling. However, we use the term because it is generally understood to mean a rising cost of living for most people.