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Fiscal and Monetary High-wire Act

August 11, 2020

Bankrupt Balance sheets

The US National debt has now soared to 130% of GDP; that $26.6 trillion equates to around 1,000% of Federal revenue. Our government will add $4 trillion to that dung pile this year alone, which is an incredible 20% of GDP. The Wuhan virus has completely destroyed the balance sheet of the US Treasury. If not for the Fed’s promise to purchase an unlimited amount of sovereign bonds, the bond market would have already collapsed.

State and Local government balance sheets are suffering greatly as well. Revenues are plunging just as expenses are soaring, with a huge number of businesses closing their doors and 10’s of millions of people getting laid off. Indeed, many states are projected to lose between 20-25% of revenue. The Center on Budget and Policy Priorities reported that in just the last four months, state and local governments have furloughed or laid off 1.5 million workers— twice as many as in all of the Great Recession. And now, state budget shortfalls expected from COVID-19’s economic fallout will be a cumulative $555 billion over state fiscal years 2020-2022, according to Federal Reserve and CBO data. In addition, major US cities, such as New York, L.A., and Chicago, were already on thin fiscal ice prior to the pandemic. The Wuhan virus has now melted all that the support away.

Corporate balance sheets are not faring any better. The first half of 2020 saw the most retail sector bankruptcies on record, according to Bloomberg. There have been 75 filings among all companies with liabilities of at least $50 million in the last three months, matching the same period of 2009—making it the second-worst quarter ever. Business debt was already at a record high as a percentage of GDP before the Wuhan crisis broke out. And now, Non-financial business debt has reached an incredible $17 trillion—surging at a further 24.27% annual pace in the first quarter. Hence, corporate and government balance sheets are thoroughly saturated in debt.

Now for the good news. Consumer balance sheets are in much better shape in comparison. But this is solely thanks to Washington’s efforts to offset the consumption crash from COVID-19 by further exacerbating its own fiscal imbalances. Lawmakers approved back in late March the distribution of Helicopter Money for most Americans; to the tune of $1,200 per each adult making less than $198k married filing jointly, and $500 per dependent child under age 17—even if you did not lose your job. And, for those that did become unemployed, enhanced unemployment insurance paid you on average about $1,000 per week, which in most cases was more than their previous income derived from being employed.

So, this is where the rubber meets the road: since the government’s balance sheet is already utterly destroyed, its ability to keep borrowing and printing money with impunity is almost over. Therefore, in order to keep consumption habits in place, the Wuhan virus needs to cease being an issue within the next few months. Otherwise, the consumption-driven economy will collapse. Also, there must be a place for consumers to regain employment once the danger finally ebbs.

However, as I’ve thoroughly laid out in the past few communiques, this, unfortunately, should not be the case. The announcement of FDA approval of a COVID-19 vaccine does not at all equate to automatic sterilization immunity. What it does mark, though, is the time when the real challenges could begin: How long will it take to distribute the vaccine across the globe? Will it be a one-shot deal or will there need to be multiple doses given? What percentage of the population rushes off to take a vaccine that was developed at “warp speed”? And, of course, how effective is the inoculation, and how long does the immunity last?

This is where the MSFM gets it wrong. They are promulgating the false notion that the worst economic contraction in US history is all about the virus and has nothing to do with the economics behind a typical economic contraction. But the fact is, the path towards recession was already firmly in progress well prior to 2020. Hence, the reason why the Fed had already cut rates three times and was re-engaged with QE before the pandemic struck. The Wuhan virus served to severely weaken balance sheets that were already very much in disarray. So, what we have now is an abnormally severe recession that features the very normal component of an overleveraged economy.

What happens next is crucial. Will consumer balance sheets become debt-disabled just like those in the corporate and government sectors? The answer is probably yes because government’s willingness and ability to further support the private sector is ending.

Let’s be clear. The consumer wasn’t in terrific shape prior to the health crisis. Household debt was already at a record $16 trillion prior to the Wuhan outbreak. However, this figure is much lower as a percentage of GDP than it was leading up to the Great Recession. But now, with 30 million people still unemployed and one more round of government assistance on its way, the household balance sheet should start to crumble in the next few months just like the other sectors. That is, once the Helicopters bearing government transfer payments become grounded.

To sum up the situation: our government will not be able to continue borrowing $4 trillion deficits per annum. Neither can our Nation’s debt to GDP ratio leap past 130%, and then just continue soaring upwards from that level without dire consequences. And, the Fed cannot assent to expanding its balance sheet at a rate that has seen its asset holdings surge by 75% in the last six months alone. These trillions of dollars in debt were monetized for the purpose of suppressing borrowing costs and inflating asset bubbles into even more rarified air. But how much longer can it continue at this pace without destroying the purchasing power of the dollar?

The hope is that science can kill the virus in the next few months with treatments and vaccines that are now in development. Then, consumers will immediately head back to being fully employed. But how realistic is this scenario? Well, Yelp—a company that offers a platform for businesses and consumers to engage and transact–reported that 132,440 businesses who listed on their site had closed their doors since the outbreak. And of that number, 72,842 have closed their doors permanently. Of course, the data from Yelp provides only a partial glimpse of the full damage report.

What condition will the nation be in whenever the virus is finally subdued, and some semblance of normalcy returns? The catalyst towards “Normalcy” (a vaccine) may also bring about the end of government’s fiscal and monetary high-wire act without a net. After all, it is an untenable position that the Treasury’s lotto-for-life windfall for most Americans—all of which is monetized by the Fed—can last much longer without destroying the dollar and bond market.

We must look to history for answers, …and the verdict is clear. The longevity of viruses (especially those of the corona variety) tends to last much longer than those nations that seek to engender prosperity through the printing press can remain solvent.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

Will Vaccines Become a Bridge to Nowhere?

July 20, 2020

 The monthly U.S. budget deficit for June 2020 was a heart-stopping record $864 billion. For reference, last year’s deficit for all of fiscal 2019 was just under $1 trillion. In other words, the June deficit was almost as much as the entire amount of red ink spilled one year ago. This year will see the worst annual amount of fiscal hemorrhaging ever—and by a whole lot. The figure will be at least $4 trillion in total, which is $2.6 trillion more than the peak suffered under the Great Recession. One has to imagine that with the Department of Labor reporting, there are now 32 million people collecting unemployment insurance as of June 27th–the amount of additional debt continues to pile up fast.

Along with the Federal Government, corporations around the world have seen their balance sheets suffer. They have issued an additional $2 trillion in new debt in the first half of 2020–a record amount. That is a 55% increase from last year’s pace. $800 billion of that total dung pile was in the U.S. Of course, our central bank has destroyed capitalism by ensuring the businesses that still make typewriters and white-out can continue to borrow money. This means a tidal wave of bankruptcies has been put temporarily on ice, but the size of the insolvency storm is rapidly intensifying. Indeed, 1 out of every 5 U.S. companies are now considered Zombies. Meaning, they don’t make enough profits to cover the interest expense on existing debt. The number of these zombies is surging because they feed off of the Fed’s falsification of credit markets.

Corporate profits are not doing much better. The Q2 earnings season has kicked off this week, and S&P profits are expected to plunge by 44%. It is indeed prudent in these uncertain times that these companies are refusing to put out EPS guidance as well. However, the total market cap to GDP ratio has surged back to an all-time high of over 153% of GDP. But only a small number of stocks are carrying the market higher. The equal-weighted S&P 500 returns so far in 2020 are down about 12%. However, you have just a handful of tech stocks in that market-cap-weighted index, which has caused it to be down only 1% this year and have also carried the NASDAQ to a record high. In fact, AAPL, AMZN, and MSFT have a market cap that is equal to nearly 25% of the entire GDP of the United States!

Consumers are feeling the pinch too, despite receiving a windfall from Uncle Sam, 32% of U.S. Households did not make a full mortgage payment in July, according to a survey done by Apartment List. That is the case even with the extra $600 per week in Enhanced Unemployment (E.U.) and the one-time $1,200 per adult and $500 per child sent via central bank helicopters. Once July 31st comes and the E.U. expires, 10’s of millions of people will see a 60% reduction in their income. That is unless D.C. extends the program, which they are highly unlikely to do in its current form, but will instead seek to give a small one-time bonus for those rejoining the workforce.

The Great Wall is Getting Higher

President Trump recently reported that any hopes of an imminent phase 2 trade deal is dead–there was no phase one deal in reality either. He also signed an executive order ending the preferential treatment for Hong Kong stipulating, “Hong Kong will now be treated the same as mainland China. No special privileges, no special economic treatment, and no export of sensitive technologies. In addition to that, as you know, we are placing massive tariffs and have placed very large tariffs on China.” But Mr. Trump didn’t stop with China; he is also placing 25% tariffs on $1.3 billion worth of French goods starting Jan 1st 2021.

Adding to this poop pile is the fact that the number of Wuhan virus cases are spiking with; infection rates, hospitalizations, and deaths rising alongside. This is prompting states and cities to re-locking down parts of their economies.

Also, we have sleepy Joe Biden trouncing Trump in the polls. And, the former V.P. has indicated he will be no friend of Wall Street. Translation, corporate tax rates will be heading higher along with a re-regulation of the economy.

To recap:

  • we have the most narrow and expensive stock market in history
  • the worst earnings season in the last 12 years
  • there are nearly 32 million people collecting unemployment insurance when you include all government programs
  • the fiscal cliff is nigh
  • increasing hospitalizations and deaths from the Wuhan virus,
  • a deteriorating relationship with China and Europe
  • a socialistic surge in November is becoming more likely

Will Vaccines Be A Panacea?

Wall Street is hoping that all of these troubling situations will be offset by potential vaccines coming in the fall. July 14th‘s intraday rally on inside information about some good results from Moderna’s vaccine trial, which was released after the close, is a great example. It should be noted that COVID-19 vaccines will not be cure-alls that produce sterilization immunity, like inoculations against measles and polio. Rather, the vaccines in development should be more like those that protect against the influenza flu virus–reducing the risk of contracting the disease and lowering the chances of becoming gravely ill in some instances.  Also, the immunity period will be measured in months, not years, according to vaccine experts reporting to STAT News.

Therefore, the salient questions remain; how effective will these prophylactics be, and what percentage of the population will actually take them? Most importantly, to what extent do consumers’ and businesses’ balance sheets become impaired while we wait for a solution? In other words, once treatments and vaccines restore confidence to consumers, the benefit to the economy will hinge on if they have the spending power to consume. There must be a good job waiting for them and they cannot be encumbered by the debt accumulated while the economy was shutdown.

The odds of a significant market correction between now and November are rising. That is, unless, D.C. agrees to dig a much bigger fiscal hole to stick its head into. Of course, we are still headed for a more permanent wipeout of these asset bubbles once the stagflation sets in. Unfortunately, the inflationary and insolvency wipeout of the bond market will be devastating for those without an effective investment plan.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

Fiscal Cliffs and the Self-destructing Treasury

July 13, 2020

 We can all be very confident that there will be no change to monetary policy for a very, very long time. But there is a fiscal cliff coming—and indeed has already begun.

It is clear that Mr. Powell is all-in on his unlimited QE and ZIRP. And, that he is “not even thinking about thinking about raising interest rates.” Therefore, the stock market does not have to worry about a contraction in the rate of money printing any time soon. However, equities could soon plunge due to the crash in the amount of fiscal support offered to the economy.

  • Last month, the auto-loan and credit-card forbearance period ended
  • On July 1, state and local government budget cuts kicked into high gear, as the $330 billion in aid already dispensed has been wasted
  • Come July 15, the delayed federal income tax payments are due
  • On July 31, the $260 billion in enhanced unemployment insurance expires
  • September 30 sees the end of student loan forbearance
  • August 31st marks the end of mortgage foreclosure forbearance
  • The end of 2020 will mark the end of the Payroll Protection Program grace period, which will coincide with most of the $1.1 trillion already being exhausted
  • The $290 billion in helicopter money ($1,200 per adult and $500 per child) given to households back in April will have been spent

Of course, I’m all for helping people through this pandemic. But, why are we incentivizing people to remain unemployed by paying them more than they would being gainfully employment? Why did the Treasury send thousands of dollars to families even if they didn’t suffer any damage from the virus? And, why is the Fed printing money to buy junk bonds and making loans to bankrupt businesses?

In any case, in order to prevent the sharp fallout from this fiscal train wreck, Trump and the democrats want yet another round of stimulus to be enacted. The House of Representatives passed the $3 trillion Heroes Act on May 15th, which was dead on arrival to the Senate. Incredibly, President Trump has stated that he wants to spend even more on direct payments to consumers than the democrats on the next round of aid…fiscal prudence has gone extinct in both parties.

But there is good reason for D.C. to panic. The Labor Department reported that the total number of people claiming benefits for unemployment insurance in all programs (including PUA) for the week ending June 13th was 31,491,627, an increase of 916,722 from the week prior. To put this number in context, continuing jobless claims are now 4.7 times higher than they were at the peak of the Great Recession in 2009. To make matter worse, the total number of people claiming benefits in all programs for the week ending June 20 was 32,922,335. This crucial figure is going in the wrong direction. Hopefully, the real continuing claims number will shrink significantly in the near future; but it must get much better just to get back to the worst level during the financial crisis.

There is little doubt something will get done in Washington, as both parties have shown an intense proclivity to spending money. But adding more debt to the insolvent Treasury pile is very dangerous for the world’s reserve currency. And, even if one more round of fiscal prolificacy does get passed, all that will do is temporarily reset the clock on the inevitable fiscal timebomb. The U.S. already has a $4 trillion deficit and $26.5 trillion in National Debt. Our debt has grown to a daunting 850% of revenue.

The problem is, Washington needs to pass another multiple trillion-dollar fiscal boost just to maintain the economic growth rate and to prevent consumer and business balance sheets from suffering further damage. But by doing so, it will pour more incendiary fuel on the Treasury’s balance sheet that is already self-immolating. Making matters worse, the gigantic pile of new debt being added is of the unproductive variety. Meaning, it was not incurred to generate capital goods, but rather merely printed to try and prevent consumption levels from falling off a cliff.

Our government has once again managed to defer the ultimate reconciliation of asset prices and the economy by taking on trillion of dollars in new debt that is primarily monetized by the Fed. But, it has also destroyed any vestiges of capitalism that remained in the process. The markets are now completely dependent on Fed purchases of government and corporate debt, while the economy is completely reliant upon consumers receiving a stipend from Uncle Sam to keep up the pace of consumption. In other words, without exploding deficits that are monetized by our central bank, the whole economy will meltdown in spectacular and devastating fashion.

This is one of the reasons why monitoring the progression or regression of the virus is key. The longer it takes to produce a vaccine (if there is one coming that works and people actually get vaccinated) the further away from recovery the economy gets. And, the more reliant t becomes on continuous massive deficits and helicopter money. This is especially true given the recent surge in new cases and, more importantly, hospitalizations and deaths.

In contrast, the deep state of Wall Street will claim that once the virus dissipates into history, the fiscal and monetary crutches can be safely removed. However, the rate-rebellion that occurred during the fall of 2018 and the REPO crash in the second half of 2019, have already proved beyond a doubt that markets can’t function on their own. This is exactly because asset prices and interest rates have been so egregiously falsified that any move towards mean reversion equates to economic Armageddon. After all, it is virtually impossible for interest rates to normalize in innocuous fashion when normalization entails the 10-year Note surging to 6% from 0.6%.

The Fed is now the 3rd largest holder of the biggest corporate bond ETF (LQD). And, it owns big positions in 15 other corporate bond ETFs–including junk bonds. You can forget about our central bank ever selling these holdings. However, whenever Mr. Powell stops buying these assets, the carnage will begin. Unfortunately, this is the mandatory result that will occur when a record number of insolvent junk bond issuers get to borrow a record amount of money at the lowest rates in history.

A successful money manager needs to stay on top of all these dynamics in order to correctly allocate a portfolio. And, knowing how to navigate these cycles of inflation and deflation is an investor’s only chance for improving their standard of living.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

Trampoline Cliff Diving

June 29, 2020

We start this week’s commentary with some rather depressing news from Reuters:

The ratio of downgrades to upgrades in the credit ratings of leveraged loans has spiked to a record level, five times above that hit during the last global financial crisis, reflecting the unprecedented stress in risky assets due to the coronavirus pandemic. Leveraged loans, which are loans taken out by companies that have very high levels of debt, usually with non-investment grade credit ratings–tend to be used by private equity firms as a way to fund acquisitions of such companies. The U.S. leveraged lending market has grown to more than $2 trillion, up 80% since the early 2010s, according to credit rating agency Moody’s Investors Service.

Add in the $1.2 trillion junk bond market and the $3.2 trillion in BBB debt, which is just barely above the junk category, and you end up with nearly six and a half-trillion dollars’ worth of corporate debt that is primed for varying degrees of default. The catalyst for this default is the worst economy since the Great Depression.

Is it any wonder why the Fed doesn’t allow even a small correction to occur in the stock market or a slight decline in GDP any longer? But perhaps it’s about time that it did. The valuation of equities is now back to an all-time high of 150% of GDP. And incredibly, just three stocks (AAPL, AMZN, and MSFT) are valued at $4.4 trillion. This means Wall Street has deemed it ok that just three companies have the same worth as 22% of the entire U.S. output per year. Of course, this makes Mr. Powell’s cronies, along with the top 10% of households—who own 88% of stocks—most happy for sure.

The consumption-driven U.S. economy is under attack from many angles. There are still 29 million people collecting some form of unemployment insurance. This includes the over 9 million “off balance sheet” individuals covered under the Pandemic Unemployment Assistance program that the MSFM and the White House are fond to ignore.

We also have 2.2 million people that are finding gainful employment inside Zombie companies. Unfortunately, these businesses were being kept alive by record-low borrowing costs for junk debt and a reasonably good economy. However, now the cost of rolling over this debt has increased while their business models have been torpedoed by the Wuhan virus.

The major averages are struggling to get back towards all-time highs, but the underlying economic support is disintegrating quickly. Hence, the economic chasm between the rich and poor is plunging deeper into record depths. But the mirage of semi-normalcy is being perpetuated by massive and unprecedented fiscal and monetary stimuli.

Therefore, what we are witnessing now is the economic equivalent of a person’s bounce off a trampoline after a 1,000-foot cliff dive. That is, a dramatically sharp ascent from the bottom but nowhere near from whence you started—and with a quick retreat back down from that much lower high. At the core of this “V”-shaped illusion is the $2.3 trillion fiscal stimulus already approved by D.C.

Now, the house has approved an additional $3 trillion package known as the HEROES Act; but the Senate Leader McConnel only wants $1 trillion. And, the President has indicated that he desires to split the difference with a $2 trillion package. Of course, all of it will be monetized courtesy of Fed Chair Jerome Powell. But here’s the point, none of this new red ink is guaranteed to be passed into law, and even it is, there is no chance such budgetary lunacy can continue. The national debt is already at $26 trillion and that is 850% of annual revenue. Our fiscal deficit for 2020 is slated to come in at record breaking $4 trillion (20% of GDP). And, total U.S. debt has soared to $72 trillion! A continued pace of this red-ink hemorrhaging would surely place our bond market in the ICU. In truth, it is already on the life support system of the Fed that has expanded its balance sheet by $6.4 trillion in the last dozen years to keep the Treasury’s debt service payments low and the government appearing solvent.

This leads us to the fiscal cliff diving exhibitions coming in August and early 2021. The over $1.1 trillion in the PPP program will be mostly exhausted, $260 billion in enhanced unemployment insurance expires, the $330 billion given to state and local governments will have been already wasted, and the $290 billion in helicopter money given to households making under $198k will be spent. Therefore, unless there is another multi-trillion-dollar rescue plan passed come this fall, the economy will go over Niagara Falls without a barrel. Of course, even if the democrats and republicans agree to force Mr. Powell to produce more monetary magic before August arrives, the inevitable free fall will still occur. And, even in the event of a relatively small infrastructure package getting through congress, the vast majority of aid to consumers and businesses will expire in the February thru May 2021 timeframe.

So, which path will the Fed and D.C wander? Will they keep on borrowing and printing multiple trillions of dollars each year until stagflation destroys all asset prices, and the market for Treasuries disintegrates? Or, will they voluntarily cut off the fiscal and monetary spigots and watch the Greater Depression unfold before them? I have a good idea as to the direction they will take, but I’ll be prepared to try and profit from their inextricable conundrum either way.

 Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

Intractable Inflation

June 22, 2020

 The Fed mistakenly believes it can control the rate of inflation with relative ease. While it believes it is far easier to fight a rising rate of inflation than deflation, it is still completely convinced the puppet strings of extant price levels rest firmly in its hands.

To start with, the academics that sit on the FOMC don’t actually know what causes consumer price inflation (CPI)—or at least that don’t want to admit to its actual progenitor. The Fed has been historically wedded to the belief that CPI is related to the unemployment rate. This is known as the Phillips Curve. Phillips curve analysis relies on the belief that inflation comes from a low unemployment rate and that deflation comes from a high level of unemployment. But this logic is both simplistic and specious in nature. Indeed, throughout history, it is commonplace to have a rising rate of unemployment associated with higher rates of inflation and a falling unemployment rate correlated with low rates of inflation.

Inflation is not caused by how many people are successfully employed in gainful and productive work. It is the result of degradation in the faith of a fiat currency’s purchasing power. Such a loss can come from a nation losing the ability to defend itself. More often, a currency begins a protracted and significant erosion when extreme fiscal profligacy causes an insolvent government to begin massively monetize its own debt.

What we now all should be fully aware of is that the Powell Fed will keep interest rates at zero percent and will continue Q.E. until inflation runs well above the 2% target. He learned a painful lesson in 2019 when the FFR was raised to just 2.5%, and the stock market and economy began to fall apart. The FOMC is now extremely reticent to raise rates and is not “even thinking about thinking about raising interest rates.” Hence, its target rate has become completely symmetrical. Meaning, it very well may have to go above 2% for the same duration and extent that it went below the target rate. The Fed’s balance will continue to explode higher until holders of USD become convinced that its value will erode on a perpetual basis with a floor of at least 2% per annum.

The clueless and fatuous Fed is once again turning a blind eye towards asset bubbles. Only this time around its existence is so humongous that one would have to be totally and willfully ignorant to ignore it.

But once the Fed achieves escape velocity on inflation is when its luck runs out. This is because it is a historical fact that all central banks have displayed a tremendous amount of difficulty controlling inflation in either direction. It cannot easily raise CPI above 2%. In 7 out of the last 12 years, the Fed has been unable to achieve average annualized CPI of at least 2%. Yep, 58% of the time, the Fed has failed to reach its minimum inflation goal. This is true despite the fact that our central bank printed $6.4 trillion and left interest rates at 1% or below for 9 of those 12 years. And, by the way, it is easier for the Fed to achieve its 2% target using the CPI metric than the more benign Core PCE Deflator.

Also, contrary to what the Fed and the MSFM would have you believe, our central bank has also had a miserable history of getting inflation under control once it becomes intractable. Back in 1971, both the Fed Funds Rate and CPI were in the mid-single digits. This was when the great monetary experiment began when President Nixon ceased all redemptions of the USD for gold. Inflation then spiked to double digits by 1975 and, after a brief pause in ’76-’77, eventually spiked to 14.6% by early 1980. During this process, our central bank found it necessary to raise rates from 3.75% in February 1971, all the way to 20% by the middle of 1980.

The truth is there is nothing in this data that lends any credibility to the idea the Fed can easily fight deflation. It is also true that it cannot easily bring inflation under control after the confidence in the dollar begins to get significantly hurt.

There is zero evidence the Fed can eventually bring year over year inflation to 4%–or whatever rate it thinks is symmetrical after years’ worth of disinflation and deflation–and then automatically prevent CPI from rising higher from that point.  As mentioned, the great Fed Chair Paul Volcker had to raise rates to 20% before the inflation monster was vanquished. But while Mr. Volcker did engender a sharp recession in the early ’80s to accomplish this task, he had a much better economy to start off with. Total U.S. debt to GDP was just over 150% during the ’70s and early ’80s. Today, that figure is close to 400%. And, the stock market was much less inflated 40 years ago. That ratio spent most of its time, around 40%. However, that ratio now stands around 150%!

Just imagine the carnage that would occur to asset prices and the economy if our current regime of central bankers had to boost interest rates from 0% to double digits!

Therefore, in the not-too-distant future central banks may have to decide whether to let inflation run wild on the back of absolutely unprecedented monetary and fiscal madness (bankrupt governments + unlimited Q.E. + permanent ZIRP), which will wipe out our standard of living. Or, progressively jack up interest rates and cut spending in dramatic fashion, which will obliterate the asset bubbles and the economy in the process. Sadly, in either scenario, the pernicious outcome is very much the same.

 

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

Gold

June 8, 2020

The sad truth is that few people really know very much about gold, especially when it comes to investing in the metal. They don’t understand what makes it so valuable and unique, and they know even less what moves its price. Since I don’t want to spend an hour on why it is so precious, I’ll just try and sum it up in a sentence: Gold is extremely rare, beautiful, portable, transferable, divisible without losing value, and virtually indestructible. Very few things on this earth can meet all those criteria, and that is why it is the most perfect form of money humankind has ever found.

Now more than ever, investors desperately need to know what really influences the dollar price of gold. This is the case given the unprecedented falsification of asset prices and debt monetization taking place today. Gold is not driven by the fear of a crash in the major market averages. Nor is it even primarily concerned about the inverse correlation to the U.S. dollar (USD). Indeed, the massive interest rate suppression scheme by the Fed since the Great Recession has been the main reason behind the outperformance of gold compared with the S&P 500. This is true even in the context of a rising USD.

 

This is why the astute investor begins his portfolio allocation with a 5% investment to physical gold.

The above chart proves that a secular gold bull market can and does occur while the USD and stocks are rising. So then, what does have the highest correlation with the price of gold?  The direction of real interest rates is what matters the most. Hence, it is always important to determine both the direction of nominal interest rates along with the rate of inflation in factoring in how much above the minimum 5% physical gold allocation investors should garner.

If nominal Treasury yields are rising in the context of relatively benign Consumer Price Inflation (CPI), then gold may significantly underperform. This is especially the case with the miners, which are simply a leveraged play on the price of the metal. It is clear that exposure to miners during a gold bear market can be a very dangerous thing.

However, when bonds yields fall in the context of rising inflation, gold can really boost your overall performance. Just take a look at the Gold Miners Index (GDX) shown in blue vs. the Physical Metal (GLD) shown in green in the chart below.

The truth is physical gold competes with cash and the “risk-free rate” on U.S. Treasuries. This comparison is calculated by using the interest your money receives in the bank and/or sovereign bonds, minus the rate of decline in its purchasing power (inflation). This is what hedge funds and the machines on Wall Street are most focused on. Another way of looking at this is that the carrying cost of gold moves in tandem with real interest rates. Therefore, the ideal scenario for gold ownership is when real interest rates are falling. And, that environment is best when nominal interest rates are virtually zero and inflation is rising. This means the carry cost on gold becomes negative, while the lost opportunity for holding cash is next to nothing.

So, where does the gold sector go from here? Well, we can be fairly certain that the Fed will peg the short end of the yield curve at zero for the foreseeable future. But the salient question remains to what extent Mr. Powell will allow longer-duration Treasury yields to rise. Our central bank rejoined the ECB and BOJ in the yield capping game back in Mid-March when the 10-year Note shot up to 1.26% on March 18, from 0.31% on March 9. Such volatility in Treasury yields is indeed off the standard deviation chart and scared the Fed out of its mind. Since then, Mr. Powell has authorized the purchase of $1.5 trillion worth of bonds during the past ten weeks. However, as yields have since settled back into the mid-single-digit range, the Fed has reduced its purchases from the peak of $75 billion per day, to just $4.5 billion. For now, the bond market is ok with Fed tapering in the context of a $4 trillion annual deficit.

Perhaps this is because the predicted depression is now here. For example, in 1930, the U.S. Gross Domestic Product plunged by 8.5%. Economists now predict that 2020 GDP will crash by 6% after a sharp rebound from Q2, which is expected to suffer an output catastrophe of more 52.8%, according to the Atlanta Fed! This type of data is helping to suppress yields even while the Fed exits the market. Hence, yields are still near record lows.

In contrast to the depression I predicted earlier this year, I am now predicting some of the best economic data on record to be reported in late June and July. Of course, this will only mean we are moving from a deep depression to a seriously bad recession. Nevertheless, the rate of change in the data will be profound. For example, Continuing Jobless Claims, which surged from 2 million in March, to 25 million in May, will be plunging by the millions each week during the summer. This should still leave the unemployment rate, which is above 20% currently, a budding teenager by year’s end. But again, it is the rate of change in the data that is most important. Will Mr. Powell cap the 10-year Note yield at 1%, or will it be 2%? Or, will he just let real rates rise until gold and the stock market once again fall apart under the weight of surging borrowing cost on an overleveraged corporate sector?

Again, determining the direction of real interest rates—and therefore, the direction of gold—is critical because getting caught on the wrong side of this trade can become a complete portfolio debacle. For instance, from 1980 through 2000, gold fell from $800 to $250 per ounce, as CPI was falling faster than nominal rates. Likewise, it can spare you from the $1,900 to $1050 plunge that took place from 2011 through 2015 when a similar dynamic was in place. By the way, this is also why gold tends to crash during times when the rate of deflation is profound—nominal rates tend to stop around the zero percent floor, but real rates can still rise due to rampant deflation.

Therefore, in the next couple of months, I will be myopically focused on the “better” news and how it affects interest rates and the rate of inflation.  An improving economy in the context of a dissipating Wuhan virus–coupled with Fed tapering–could (temporarily) send nominal yields rising much faster than inflation. This is especially true given the ridiculously low level of Treasury yields and the incredible amount of supply that must be taken in by whatever is left of the free market.

But this is the purview of active managers like myself who try to avoid big drawdowns in the portfolio. Of course, in the longer-term stagflation is the most likely macroeconomic destination, which is the perfect storm for gold. The inflation will come from the Fed’s new proclivity towards Helicopter money and its unshrinkable $7 trillion balance sheet that has grown 7-fold in the past dozen years. The stag part will be derived from trillions of dollars in unproductive new debt being issued and the damage it is causing to public and private sector balance sheets.

This means the Fed will be forced to peg the entire yield curve close to the zero-bound range indefinitely, as the economy does not recover sufficiently enough to allow the 10’s of millions of newly unemployed people to find work. Hence, your stated return on risk-free money will be zilch, just as rising CPI causes real yields to fall into record-low territory.

The Conclusion: Knowing when (and when not) to overweight gold in your portfolio can provide an opportunity to vastly increase your overall returns.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

Money Printing Can’t Trump a Depression

May 26, 2020

The Atlanta Fed’s GDP Now Estimate for Q2 Economic growth is minus 41.9%.

Thirty-nine million people filed Initial Jobless Claims in the past nine weeks. Continuing Jobless Claims (including Pandemic Unemployment Assistance) surged to over 31 million individuals.

US home construction fell by 30.2% in April.

The fiscal deficit in April (which is always a surplus month) was minus $738 billion!

Yes, unfortunately, we are in a depression. But that fact is not at all reflected in stocks.

The total market capitalization of equities is now back to 140% of GDP. That level is at the ceiling of the ratio’s history, and it is purely due to unprecedented central bank actions. However, even that eye-popping level is understating things by a great deal because the ratio is calculated using a denominator based on previously reported GDP data, which has since crashed. But it is critical to note that money printing has its limitations even when governments are buying stocks.

Look at a chart comparing the S&P 500 vs. Japanese stocks (EWJ) and China’s shares (CNYA).

As you can see, the S&P 500 is up 34% in the past 5 years, even though the Fed hasn’t yet resorted to buying stocks. For now, it has instead bought everything else, including junk bonds. In contrast, the PBOC and BOJ have purchased everything, including stocks. In the case of Japan, its central bank has been buying equities since 2013, and the Communist/Dictatorship that controls China has commanded the PBOC to support the market since at least 2015. And yet, China’s shares are up a paltry 13%, while Japanese stocks have actually made zero progress throughout the past five years. Meanwhile, both of those country’s indexes are still 50% off of their all-time highs.

The truth is that central bank equity purchases do not at all guarantee there will be a roaring bull market, but they can support stocks even when an economy has become zombified.

Indeed, Mr. Powell is breaking records in his attempt to reflate the market. The balance sheet of the Federal Reserve, which is a proxy for the amount of debt monetization undertaken by the central bank, has skyrocketed by $3.2 trillion (from September 2019 through today) –that is a grand total of only eight months. This compares to a $3.7 trillion increase in Fed money printing from the start of the great recession (in December 2007), through 2018–which is a total of over ten years.

Nevertheless, the bluffing game is over for central banks, as they can no longer pretend there is a pathway to normalcy. Perhaps this is what the gold market has been sniffing out over the past 20 years. The precious metal has soared by over 500% since 2000, while the S&P 500 has merely doubled in the past two decades. The fact that gold has trounced the S&P proves that the faith in fiat currencies is collapsing, and the Wuhan virus has expedited this process.

The current illusion of stock market prosperity has three predicates. The first is that there will be a robust reopening of the economy as the virus dissipates in the context of imminent therapies and vaccines. The second is that inflation is far off in the future, which will enable the Fed to control the level of long-term interest rates much more easily. And, the third is that central banks will have no interest in letting up on the monetary throttle for a very long time. The second and third conditions are indeed far off in the future. However, whether or not we have a successful reopening of the economy depends entirely on the progression of the virus; and that verdict will be known in the very near future.

This begs the question: even though the predicted economic depression has arrived, where do markets go from here? We should all understand that in the longer term, a viable economy cannot be engendered through the process of diluting the purchasing power of a currency and falsifying asset prices. But what will happen to stocks while we wait for stagflation to run intractable? To help answer that question, we must monitor the number of new Wuhan virus infections and deaths.

The hope is for a viable treatment and/or a vaccine by the fall. On the subject of vaccines, it should be noted that Moderna Pharmaceutical made positive comments about finding an effective and safe vaccine on May 18, which sent the Dow up 900 points. However, it is very disturbing that Moderna only partially released results of an interim Phase 1 trial without any specific data on neutralizing antibody counts; and then conveniently announced a $1.34 billion stock offering the following day. If the company’s confidence in the vaccine was robust, then why not wait a few more weeks until the Phase 1 trial data could be fully released, with peer-reviewed status, and then make the secondary offering at a much higher price?

It also should be noted that the Wuhan virus is a coronavirus. The common cold is also a type of coronavirus, and so is SARS and MERS. These differ from the influenza virus, and there has never been a vaccine approved for any coronavirus…ever. In addition, vaccines normally take years to develop in order to ensure both their safety and efficacy. Nevertheless, President Trump wants one ready to disseminate in just a few months’ timeframe. The President’s “operation warp speed” is seeking 100 million vaccine doses by November. But a vaccine not only must not harm people, it also cannot give them a false sense of protection. Despite all this, Moderna has amazingly created its mRNA-1273 vaccine within just two months from the first breakout of this novel virus.

In any event, the economy is now in the reopening phase, and it is imperative to analyze the capacity levels within the leisure and hospitality sector to determine how consumers are responding to being let out of lockdown. For example, airlines breakeven at 75% capacity but are currently flying at just around 28%, with bookings plunging by 95%. According to the WSJ, after the 9/11 terrorist attacks, it took three years before airline capacity recovered; eight years before the average fare got back to what it was in 2000, and it was six years before airlines turned profitable once again. Looking at hotels, occupancy on the island of Oahu, for example, during the week ending April 6 was down 90%. Turning to the foodservice industry, regulators are requiring restaurants to open at between 25%-50% capacity; but they need around an 80% capacity level to breakeven.

Analyzing the rate of change with this data will be critical to determine how to correctly allocate the portfolio according to the appropriate economic cycle. Our IDEC Model currently has the portfolio positioned in 25% stocks, 15% gold, and 10% TIPs. Our 50% cash hoard is being used to generate income right now until we can determine the quality of the reopening. Much more will be known during June, and I will analyze how the 20 components of the IDEC Model react to it and then take the appropriate action.

 

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

 

Fed Now Owns All Markets

May 11, 2020

 Since the Great Recession hit in 2008, central banks have been in the business of keeping insolvent governments from defaulting through the process of pegging borrowing costs near zero. These money printers are now in the practice of propping up corporations–even those of the junk and zombie variety–by ensuring their cost of funds bears absolutely zero relationship to the credit quality of the issuer. To be clear, central banks have been falsifying public and now private bond prices to historic and monumental degrees just as the intensity of issuances and insolvency deepens.

And now, the Fed is bailing out bankrupt consumers with helicopter money in the form of enhanced and extended unemployment, grants through the Payroll Protection Plan and direct UBI to consumers through the CARES Act Recovery Rebates clause. All together there has been about $2.8 trillion worth of deficit spending so far.

But the bailouts won’t end there. Nancy Pelosi is now seeking an additional $1 trillion for states and cities in the next round of government “stimulus.” The Wuhan virus is now causing a Pension fund crisis. States’ revenues are plunging from an income and sales tax vacuum at the same time spending is surging. This is from Moody’s:

Moody’s investors service estimated that state and local pension funds had lost $1 trillion in the market sell-off that began in February. The exact damage is hard to determine, though, because pension funds do not issue quarterly reports. “You’re not going to see real data on the market crash until Christmas,” said Girard Miller, a former chief investment officer of the Orange County, Calif., pension fund and a former member of the Governmental Accounting Standards Board.

According to the NY Times, as of 2018 state pension funds had on average invested 74 percent of their money in risky assets; including stocks, private equities, hedge funds and commodities. That was up from 69 percent in 2010, after the 2008 crash, and from 61 percent in 2001. Of course, going out on the risk curve to overweight stocks in a portfolio–which are in a bubble–simply because bonds are in an even bigger bubble, carries huge consequences.

This is what Yahoo Finance has to say on the subject of bankrupt pension funds:  Declines in the financial markets may have cost the funds as much as $1 trillion in assets, or about 25% of their total, according to Moody’s Investors Service. That would bring the aggregate funding ratio—the value of assets divided by actuarial value of liabilities—from 52% based on the last report by the Census Bureau down to perhaps 37%. But it’s not aggregate numbers or official reports that will trigger a crisis. It’s the big {state} funds in the worst shape. Connecticut could be looking at a 28% funded percentage, Kentucky 25%, New Jersey 24% and Illinois 20%.

This is what my friend John Rubino of Dollar Collapse.com has to say about the Pension crisis:

“Letting Illinois go bankrupt would send the muni bond market into a “who’s next?” seizure, which would quickly spread to corporate bonds, equities, and real estate, cratering the U.S. and then the global economy. At least that’s the worst-case scenario economists will present to policymakers.”

“With no stomach for presiding over the end of the world during an election year, Washington will cave, agreeing to whatever governors demand. And so the grossest mismanagement in the history of U.S. state and city government will be swept under the rug – or more accurately will be swept onto taxpayer balance sheets along with that of all the other sectors that are – surprise! – too big to fail.”

Meanwhile, the resulting multi-trillion-dollar addition to the national debt will hasten the fiery end of the fiat currency/fractional reserve banking/unlimited-government-debt world. One can only hope that future historians will get the story right while the perps are still alive to answer for their sins.

The Fed is trying to once again re-inflate asset bubbles by offering free money and buying all kinds of debt. Hence, new borrowings are surging as Mr. Powell provides a toxic dump site for banks to unload their waste, just as he is providing a lifeline for consumers and businesses to take on more liabilities. Commercial bank lending in the U.S. increased by 17.0% year-over-year as of April 15th, according to the Federal Reserve. And, Household debt rose to $14.3 trillion through the first three months of 2020, which is $1.6 trillion greater than its peak at the height of the Great Recession.

In other words, government is once again bailing out an overleveraged economy by encouraging it to take on even more debt. Only this go around lending standards have totally evaporated, and there is no pretense of vetting the loans. Lenders are completely cognizant that most of the borrowers are either currently unemployed or have no revenue. Most of them can’t and won’t pay back the money, and the bill will end up on the taxpayers’ balance sheets. But since the tax base has been destroyed, it will all need to be monetized by the Fed. The amount of new money printing has to also cover the run rate of a 25% increase in corporate debt. Then there is the $3 trillion of new Treasury borrowings in the second quarter alone, which will accreditive at a record pace to the $25 trillion National Debt! Indeed, that Q2 borrowing will be more than 2x greater than entire deficit for all of 2009.

This is the only explanation behind the existence of one Narayana Kocherlakota. Here is what the former President of the Minneapolis Fed said while he was pontificating about negative interest rates in a recent interview on the MSFM: the presence of physical cash in society is restraining the Fed’s hands from seeking higher inflation much like a gold standard tied its hands prior to 1971. In other words, the Fed couldn’t easily expand the money supply when dollars were linked to gold; and neither can it now easily impose negative interest rates on consumers while physical money is in existence.

Adding to this stagflation crisis will soon be the Fed’s ability to purchase stocks. This is what Former Fed Chair Janet Yellen has to say on the subject: “It would be a substantial change to give the Federal Reserve the ability to buy stocks,” Yellen told CNBC. “I frankly don’t think it’s necessary at this point…but longer term it wouldn’t be a bad thing for Congress to reconsider the powers that the Fed has with respect to assets it can own.”

For now, the primary concern is disinflation and depression. But that should morph into stagflation later this year as debt levels surge alongside massive and unprecedented global central bank monetization. As far as the stock market is concerned, in the immediate term there is a lot of hope about a V-shaped recovery with the global economy opening up the virus dissipating. However, come June and July, the risks to the economy and markets increase significantly concomitant with a failed reopening:

  • Businesses experience only 25%-50% of the revenue received prior to closing the economy and cannot rehire their furloughed workers
  • The Wuhan virus partially rebounds as consumers let down their guard and become more socially interactive
  • The 2-month requirement to keep employees under the PPP expires resulting in a second round of mass layoffs
  • Enhanced Unemployment keeps potential re-hires safely on the sidelines and making more money doing so until the program expires in August

We will continue to monitor the 20-components of the Inflation/Deflation and Economic Cycle Model S.M. to understand if the above scenario is becoming manifest and take the necessary steps in our portfolio to protect from any such mid-summer decline.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

Money Printing is the New Mother’s Milk of Stocks

May 4, 2020

My friend Larry Kudlow always says that Profits are the mother’s milk of stocks. That used to be true when we had a real economy. But sadly, that is no longer factual because we now have a global equity market that is totally controlled by central banks.  To prove this point, let’s look at the last few years of earnings. During the year 2018, the EPS growth for the S&P 500 was 20%; yet the S&P 500 Index was down 7% over that same time-frame.

Conversely, during 2019, the S&P 500 EPS growth was a dismal 1%; yet the Index surged by nearly 30%. What could possibly account for such a huge divergence between EPS growth and market performance? We need only to view Fed actions for the simple answer: it was the degree to which our central bank was willing to falsify asset prices.

During 2018, the Fed raised the overnight bank lending rate 4x and by a total of 100bps, and at the same time, it increased the amount of its Quantitative Tightening Program from $10 billion per month to $60 billion per month. In sharp contrast, Mr. Powell indicated one month before 2019 began that the Fed would stop raising interest rates; and by early ’19 he indicated that the pace of balance sheet runoff was flexible and its termination was in sight. The Fed then announced in July of ’19 that it would cease the selling of its assets come August. Most importantly, by the end of the summer, the Fed did a complete 180-degree pivot–it was once gain cutting interest rates and re-engaged with Quantitative Easing. The Fed ended up cutting interest rates by 75bps during 2019.

Hence, 2018 was a terrible year for equities despite surging EPS growth. However, 2019 turned out great for stock investors despite having virtually zero earnings expansion.

Turning to 2020, the S&P 500 EPS growth rate is projected by FactSet to decline a whopping 15.8% during Q2, and GDP is tracking to shrink by around 25-30% at a seasonally adjusted annualized rate. Adding to the misery, the unemployment rate is projected to reach a depressionary 17%. Nevertheless, the S&P 500 is down a very ordinary and pedestrian 10% YTD. How did the Fed pull off this magic trick yet again? Take a look at what its balance sheet has done so far this year.

Mr. Powell has committed to buying everything at this point except stocks. This includes junk bonds, issuing primary loans to businesses, and purchasing corporate bond ETFs. It has so far printed nearly $2.5 trillion in less than two months just to boost equities back to the thermosphere.

Because of these actions, the stock market is far more expensive today than it was prior to the start of the Wuhan virus crisis. This is because the ratio of total market cap to GDP has increased. Simply stated, the numerator is down just slightly while the denominator has crashed. Equity market capitalization is reported to be 138% of GDP as of this writing. This is down from the record high of 150% reached at the start of this year. Nevertheless, the current ratio is still extremely high, historically speaking. However, that figure is based on antiquated GDP data. As the new data is reported for Q2, expect the ratio to soar.

There are now over 30 million newly unemployed Americans who have lost their jobs in the past six weeks. We have now completely wiped out the 22.7 million new jobs created since the Great Recession ended in June 2009 plus another near 8 million. The damage to US balance sheets is immense, and that debt is accretive to the $71 trillion already oppressing growth. Tremendous psychological injuries have occurred to consumers and corporations, as they are forced to take on new debt due to a dearth of liquidity. For example, listed US companies took on an additional over $300 billion in new debt since March alone. At that pace of corporate debt accumulation—which was already at an all-time high both nominally and in terms of GDP pre-virus–will surge by nearly 25% in just one single year. But what else would you expect when the Fed is promoting more borrowing by providing a huge fat bid for businesses to sell all the debt they need…and more.

The stock market has already priced in a “V” shaped recovery in the economy, but the rebound will most likely be of the insipid variety. The question is will stocks care even if economic growth doesn’t rebound? It is my view that the economy and EPS will certainly not return to pre-Wuhan virus levels for a very long time.

Therefore, the answer to how stocks react to a sluggish economy even after the lockdowns are lifted can be found within the confines of D.C. Will the continued panoply of negative earnings news and economic data cause the Federal government to announce even more fiscal stimulus programs to bail out states and municipalities? And, will the Fed continue to monetize all that debt? I believe the answer to those questions is a resounding yes, but only after we see another crash in asset prices that results from a negative reaction to a failed reopening of the global economy. This is the salient risk during the mid-May through July time-frame. A failed opening can be defined as one in which consumers don’t return to normal activities because of balance sheet, unemployment, and wealth effect issues. And, the virus makes a comeback in the context where there is no effective treatment or vaccine yet available.

One sentence from the Fed’s meeting of April 29, which produced an unusually-horrific statement even for the FOMC, “The Committee expects to maintain this target range (of zero percent interest rates) until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”.  In other words, the Fed will be offering free money until the 30 million displaced workers find a job, and inflation runs well above its 2% target on its core PCE favorite metric, which removes all prices that go up—interpretation; expect ZIRP for another decade.

We continue to hold 20% gold-related investments, 15% invested in defense, healthcare, and clean energy, and 10% TIPS. Passive Index investing has become a sure way to lower your standard of living, and therefore, we will continue to actively trade the portfolio with a continued vigilance on the cyclical dynamics of growth/recession & inflation/deflation. Is your wealth manager monitoring these changes? Or are they just telling you to hang on to their brand of an index fund that is blindly and passively heading towards the slaughterhouse yet again?

 

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

Inflationary and Insolvency Implosion of the Bond Market

April 13, 2020

We are all praying for the Wuhan virus to die. But there is something the virus can actually “cure” itself: deflation. I put the word cure in quotes because it’s not an actual issue in reality. Low inflation and disinflation are actually great conditions to enjoy and help an economy thrive. Increasing the purchasing power of consumers is something that should be cherished and targeted goal. Increases in productivity, along with a strong currency, raises your standard of living. In sharp contrast, Central Banks think any rate of inflation that is less than 2% is a deadly economic disease that must be vanquished faster than the Wuhan virus.

Many Austrian economists believed the money printing that occurred during the Great Recession of 2008 would engender massive inflation. That indeed turned out to be the case; but only with asset price inflation. The Fed’s balance sheet expansion left Consumer Price Inflation (CPI) far behind. This is because the Fed bailed out banks, not consumers. Mr. Bernanke printed trillions of new dollars to purchase bad assets from banks’ balance sheets. Thus, it gave banks credit in exchange for those assets; and that base money was primarily parked back at the Federal Reserve. In other words, there was a huge increase in Fed credit but not in loans that would have led to an increase in the broader monetary aggregates—the kind of money supply increase that leads to rising CPI. What money that was lent out arrived directly to Wall Street by the process of banks selling MBS, ABS and other troubles assets and then using that credit to buy more bonds and stocks. The rich got richer and the lower classes were, for the most part, left out in a big way.

However, this current virus-induced depression is being fought by central banks using some different tactics. Of course, the Fed—along with every other central bank in the developed world and beyond—is buying all the same bad assets from banks that existed during the Great Recession. But, this time around it is also purchasing corporate debt issued in the primary market, purchasing corporate bond ETFs, and making new loans directly to corporations and businesses. Most importantly, the Fed is also working directly hand and hand with the Treasury to send 100’s of billions in cash payments directly to consumers–A.KA. Helicopter Money. Therefore, Central banks aren’t just bailing out Wall Street like they did back in 2008; but are now directly increasing the broader monetary aggregates of M1, M2 and M3.

Hence, the Wuhan virus is going to solve the Fed’s inflation deficiencies by paving the way towards its ultimate destiny, which is where all central banks have wanted to end up for a long time, using Helicopter money to send both asset prices and CPI much higher.

Of course, pushing prices higher in the context of a failing economy is no panacea to say the least. The Depression of 2020 will cause an even larger chasm between stock prices and the economy than what existed prior to the outbreak.

Abetting this stagflation will be the loss of confidence in global central banks to maintain the purchasing power of their paper currencies.

 

Much More Fiat Paper Will Be Needed and For a Very Long Time

Once central banks abrogate markets, and indeed become the market, they can never fully step away. The ECB and BOJ never were able to lift off zero percent interest rates once arriving at that level in the aftermath of the Great Recession; and the BOJ could never even exit QE. The ECB did briefly end QE at the end of 2018 but then had to quickly re-enter that dirty business in September of 2019. The Fed ended QE in October of 2014 and was able to reach 2.5% on FFR. However, by August and Sept of 2019 it had to begin cutting rates and went back into QE because of the soaring borrowing costs found in the REPO market. Please note that this trip back into QE and towards ZIRP was before the COVID-19 virus existed. What makes anyone think central banks can ever exit the capital and money markets? They cannot.

Shortly before the outbreak, the WSJ reported that 40% of all listed companies had not made any money in the prior 12 months. And, the Bank of International Settlements stated that 12% of corporations in the developed world needed to tap the junk bond market just to pay interest on existing obligations in order to stay afloat. According to the BLS, During the Great Recession the lasted from 12/07-06/09, a total of 19 months in duration, the economy lost 7.3 million jobs. The Wuhan virus that pricked the everything bubble has caused a total of 16.8 million jobs to be lost in just the last 3 weeks. What condition do you think these same Zombie corporation are in now that the global economy has been shut down and borrowing costs for many businesses have spiked some 10 percentage points above where they were pre-crisis?

The truth is Central bank balance sheets can never be unwound and will only grow inexorably from here. Investors need to ignore central bank bluster about returning to normalcy. For example, Jerome Powell predicted that the Fed’s balance sheet would retreat to around $2 trillion by this time. In sharp contrast, the value of Fed assets has skyrocketed to $6 trillion already and is on its way to $10 trillion by year’s end—and then far beyond from there. These money printers can no longer pretend this is only a temporary expansion of the money supply that can be quickly and permanently reversed. That game is over and with it should terminate the confidence in fiat paper currencies to hold value.

Hence, double digit CPI and intractable stagflation is on the way. This will lead to the real crash; an inflationary and insolvency implosion of the bond market where there is nothing governments can do to mitigate the crisis. For, if they stop printing money the record amount of debt outstanding crashes in price from the thermosphere due to the exit of its primary buyer. Or, central banks can continue to print yet more money in an attempt to keep soaring interest rates under control. But, creating more inflation will only cause the private market to push the sell button faster as short sellers pile on top of plunging fixed income prices and skyrocketing yields. The Wuhan virus has simply hit the FF button on when this pernicious crisis appears; but is was surely on its way regardless. Prepare now while you still have some time left before the real crash begins.