Endgame: Monetary Debasement
13 September 2019
Precious Metals Commentary
This week saw the metals falling on choppy trading, particularly yesterday following the European Central Bank’s monetary policy meeting. While the ECB’s multiple aggressive easing measures (minus 0.5% rates, Euro 20 billion of quantitative easing) saw prices rise, it wasn’t enough to overcome softening geopolitical risk (i.e. John Bolton being “you’re fired” by Trump) and wholesale market reports of tepid Chinese and Indian demand.
Having said that, we are encouraged that gold has held above $1,480 and looks to be consolidating in a $70 range, much like it did after it first broke out from the long-term resistance of $1,375.
Silver dropped more than gold during the week, pushing the gold:silver ratio up to the 83s, and the longs and shorts are currently battling around $18.00.
The Aussie dollar didn’t move much this week, strengthening slightly so A$ gold got under $2,200 and silver through $26.50.
Commodity trading firm INTL FCStone sees gold trading between $1,460 and $1,566 for the rest of the month with a derailment of the U.S.-China trade talks or China’s move into Hong Kong as factors that would take it past recent highs.
Citigroup grabbed some headlines this week with reference to US$ 2,000 but it was a pretty weak forecast in our opinion as that was a target “in the next two years” and was only upgrading its bets to $1,575 for the end of the year.
Billionaire investor Mark Mobius was back in the news reiterating his pro-gold position from a few months ago, saying that “gold will be the last global currency standing” and that “people are going to finally realize that you got to have gold, because all the currencies will be losing value.” With business strong at ABC Bullion’s Sydney and Perth offices, we’d say more and more Australians are coming to that realisation every day.
Endgame: Monetary Debasement
Late last week Jay Powell, chairman of the US Federal Reserve, proposed make-up inflation as “a great idea” to the problem of how to forestall a potential downturn when interest rates are already close to zero.
The idea is that if a central bank undershoots its inflation target then it aims to overshoot in the future. For example, if inflation averaged 1% for 5 years when the target was 2%, then in the 6th year the central bank would aim for 7% inflation.
A great idea? To us, that sounds like a goofy idea. It seems that rather than admit they can’t force people to spend in a way that creates inflation, central bankers will instead double down on failed policies.
Australian investment manager Narrow Road Capital agree saying that “central banks need to admit their errors and acknowledge they are powerless to solve problems that require tax, structural and productivity reforms” with their “Frankenstein monetary policy.”
As an aside, we do like their idea that financial repression should be forbidden by the RBA following this interest rate policy:
In other words, interest rates should, after you have paid your tax, equal inflation. Now that is a great idea.
Demonstrating how out of touch central bankers are, the article notes that for make-up inflation to work, “everyday consumers need great confidence in their central bank.” Here’s a tip: telling people you are going to give them a big dose of inflation when most people are struggling isn’t going to crate confidence in a central bank.
Powell did say that it would require people to “go out on a limb, so to speak, raising spending in the midst of a downturn.” We don’t see that happening. Consider the chart below from AMP Capital. You can see after the financial crisis the preference for bank deposits/paying back debt increased and have remained at that level since.
People, not surprisingly, became risk adverse and that is reflected in the declining preferences for share and real estate investment.
We also note a Bloomberg article on the $1,080 tax refund scheme which reported a Westpac poll showing that “over half planned to save part or all of the cash” due to concerns about the economy, international issues and employment.
Powell also said that make-up strategies are “hard to find a way to implement practically.” We don’t think it is an issue of practicality, but of proportion. Add a couple of zeros to those refund cheques so everyone gets $108,000 and we suggest you might see some impact on prices. Go hard or go home, Mr Powell.
BlackRock, an Mutual Fund/ETF issuer with $5.1 trillion of assets under management, says that central bankers are ignoring structural changes in the economy that create falling inflation:
- slowing population growth
- peak in female participants in the labour force
- globalisation, primarily opening up of China
- OPEC keeping oil prices from becoming too volatile
- technological innovations.
With lower and lower interest rates, quantitative easing and other strategies failing to fight these trends, BlackRock say that the endgame for central banks in their battle to get inflation will be monetary debasement.
Their suggestion for investors is “to hold an asset that maintains its real value … that can participate in an inherent devaluation of the local currency, which is to say: equities, real estate, and even hard assets that have historic value-relevance, such as gold.”
Even though BlackRock operate gold and silver ETFs, we consider it significant that such a large mainstream investment firm even mentioning gold as an option is indicating that gold is starting to become respectable.
Perpetually in Debt? Issue Perpetuities
As governments rarely ever pay back their debt, when a government bond matures they are effectively paying back the bond holders with money from new bonds they issue. Sounds a bit Ponzi-ish to us, but then we are just simple sellers of physical gold so maybe there is something we are missing.
As there is something farcical about a government issuing a bond with a maturity date when across all of its bonds it has no intention of paying the debt back, we find ourselves agreeing with academic economist John Cochrane that governments should issue Perpetuities, which are bonds with no principal payment and just pay interest forever.
Doing so would make it explicit that the government really has no intention (or is that capability) to repay its debts. Cochrane argues that there are benefits in that it would do away with multiple debt securities and thus by consolidating all government debt into a single security, create more liquidity and lower the interest rate.
Perpetuities are not theoretical, as the UK first issued them in 1751. The valuation of a perpetuity is very simple – one just divides the dollar interest amount by the current interest rate. So if a perpetuity pays $1 and interest rates are 2%, an investor would pay $50 to a government and receive $1 forever thereafter.
Of course with over $16 trillion worth of government bonds trading at negative rates and talk of central banks pushing for negative interest rates, that would means that $1 divided by -2% = um, that a government would pay $50 to a investor and receive $1 from an investor forever!? Hmm, we think we’ll give this fancy fiat finance a miss and just stick to physical gold and silver.
A recent blog post from the Bank of England says that “housing” is actually two things: the physical dwelling “asset” and the “service” of living in it. People can obtain a living space by either:
- purchasing the asset and consuming the services (an owner occupier) or
- buying housing services (be a renter) from someone who owns the asset (a landlord).
Based on a recent report from the Australian Institute of Health and Welfare, sometime this year the buyers of “housing services” from landlords will exceed those who own their own home.
The report notes that while the overall home ownership rate has remained around 67–70% from the mid-1960s, the rate for different age groups has varied markedly over this time, as demonstrated by the chart below.
Those under 40 years seem to be particularly below where older generations were at the same age. The report notes that the trend to reduced household sizes and increasing single-people and single-parent households is a factor, but we would argue that affordability is the main reason. Consider these “median multiple of house prices to income” ratios:
- US - 3.5
- UK - 4.8
- Melbourne - 9.7
- Sydney - 11.7
As AMP Capital noted, “there is no denying housing affordability is poor, household debt is high and some households are suffering significant mortgage stress.” Analysing the UK housing market, the Bank of England conclude that home prices are driven by the general inflation rate and lower interest rates, with scarcity having very little role.
That makes for a double squeeze for first home buyers. As the RBA drops rates it pushes up home prices while at the same time reducing the amount of interest one can earn while trying to save for a deposit.
It is not just lower interest rates. CoreLogic observe that the gap between term deposit rates and standard variable mortgage rates is much wider than it's been historically.
Their conclusion is that it is much harder to break into the housing market now than it has been in the past. As we have noted previously, with housing prices in terms of gold having been remarkably stable first home buyers may have been better off putting their regular cash deposit savings in a Gold Saver account rather than in the bank.
It is not just the younger generations who are suffering. The Australian Housing and Urban Research Institute finds that between 1987 and 2015 mortgage debt has outstripped both house price and income growth for those over 55 years with nearly half of homeowners aged between 55 and 64 still paying off a mortgage compared to only 14%, 30 years ago.
Another example of the pressures people are under comes from a report a few weeks ago that “Foodbank South Australia has been approached by banks wanting to refer their clients to the charity, in the hope it will prevent people from defaulting on mortgage payments.”
AMP Capital, however, does not see a national housing crash on the horizon, says that most borrowers are servicing their mortgages and a 0.9% non-performing mortgage rate remains low. They say that to get a national housing crash we would “need much higher unemployment, much higher interest rates and/or a big oversupply”, none of which they see as likely.
Whether those three things are likely or not, we don’t think one could say the housing market is in the strongest of positions either and it may not take much to tip it over.
Until next time,
John Feeney and Bron Suchecki
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.
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