Tag Archives: credit crisis

Jerome Powell Fails The Gold Standard Test

“You’ve assigned us the job of two direct, real-economy objectives: maximum employment, stable prices. If you assigned us [to] stabilize the dollar price of gold, monetary policy could do that, but the other things would fluctuate and we wouldn’t care,” Powell said from Capitol Hill. “We wouldn’t care if unemployment went up or down. That wouldn’t be our job anymore.” – Jerome Powell in response to a question about returning to the gold standard

Everything about that answer is incorrect. To begin with, the Fed apparently now has three “assigned” jobs: employment maximization, price stability and “moderate long-term interest rates” (federalreserve.gov).  How can we take anything Powell says seriously if he’s not aware of the the duties of his job?

But let’s set that issue aside.  In fact, if the dollar was backed by gold, the Fed would be irrelevant – the gold standard would take away completely any need for a Central Bank. Powell and his cohorts would not have any job at the Fed.

The function of a gold standard is not to “stablize” the price of the currency which is backed by gold.  Interest rates can be used to “stabilize” the value of currency.  Free markets, if ever allowed, would set the price of money.  The function of the gold standard, fist and foremost, is to stabilize the supply of currency in relation to the wealth output of an economic system.

A Central Bank is not necessary to any economic system which has its currency backed by gold.  If the U.S. had its monetary system tied to the value of the gold it holds in reserve,  it would automatically serve the function of price stability. Remove gold from the equation and the macro variables fall apart rather quickly.

But let’s use reality to test this.  Prior to the closure of the “gold window,” the U.S. largely was a creditor nation and never incurred unmanageable Government spending deficits except during wars.  In fact, the amount of Treasury debt issued to fund the Viet Nam war ultimately led to the removal of the last remnants of the gold standard.  This is because the U.S. Treasury did not have enough gold left to redeem debt issued to foreigners with that gold per the Bretton Woods Agreement.  In short, the U.S. ran out gold so Nixon closed the gold window.

Take a look at the economic and fiscal condition of the United States from inception to 1971 and post-1971.  Any “economist” or Central Banker (Powell is not an economist and probably never thought about gold until he was prepped to answer the possibility of a gold standard question) who opposes the gold standard is ignorant of historical facts or has ulterior motives.

Aside from his inability to respond intelligently to the gold standard question (he should have taken notes from Greenspan), Powell knows that  a zero interest rate policy and money printing are the only ways that he and his elitist cronies can keep the system from collapsing until they finish extracting the last remnants of wealth from the public.  A gold standard would stand in the way of this effort.

Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. – Alan Greenspan, “Gold And Economic Freedom,” 1966

The Economy Continues To Deteriorate

Trump’s trade advisor, Peter Navarro, was on CNBC today asserting that the economy was expanding at an unprecedented rate.  Either Navarro is tragically ignorant or an egregious liar. Either way he looks like an idiot to those us who study the real numbers and understand the truth.

The Global Manufacturing PMI (Purchasing Managers Index) dropped to 50.4 – the lowest since July 2016. It’s been falling almost nonstop since mid-2017. The current period of decline is the longest in the 20-year history of the index. The index includes the purchase of inputs for the manufacturing of consumer goods, investment goods (capex material) and intermediate goods (semi-finished goods used as inputs for final goods).

The pace of decline for auto sales in China, Europe and the U.S. is the fastest in at least three decades excluding the great financial crisis time period. Visible evidence of the contracting global/domestic economy is Ford’s announcement that it’s cutting 10% of salaried (white collar) workforce, about 7,000 jobs, by the end of August.

The trade war is not the cause of U.S. economic weakness. If anything, it’s nothing more than an effort by the Trump Government to manufacture a scapegoat for the inevitably severe economic recession engulfing  the system. China’s exports to the U.S. were 5% of its GDP in 1995. By 2005 exports to the U.S. had risen to 9% of China’s GDP. Currently exports to the U.S. represent just 3% of China’s GDP.  These numbers show that the trade war between the U.S. and China is not the cause of global economic weakness.

Rather, the cause is the massive misapplication of capital from 10 years of over $21 trillion in money printing and debt issuance. This artificially over-stimulated economic activity. Now that the stimulus has worn off, the major economies – especially the U.S. and China – face the problem of servicing their debt load and the consequences of a decade of misallocated capital.

Bond guru, Jeffrey Gundlach, recently asserted in a webcast that “nominal GDP growth over the past five years would have been negative is U.S. public debt had not increased.” He went on to state that analysts and financial journalists “seem to not understand that the growth in the GDP it looks pretty good on the screen but is really based exclusively on debt – Government debt, also corporate debt and mortgage debt.” I have been saying this for quite some time because it’s pretty obvious to anyone who looks more deeply into the numbers beyond reciting the headline reports.

The Fed released Q1 household debt numbers two weeks ago. It showed that total household debt grew by $124 billion in the first quarter of 2019, boosted by increases in mortgage, auto and student loan balances. That increase in debt is not translating into economic growth. Part of the reason for the increase in mortgage debt balances is the proliferation of cash-out refinancings, which are now back to 2006-2008 levels (chart sourced from bubblesbottoms.blogspot.com):

Much of this cash-out refinancing is being used to pay off large credit card balances, which does not help stimulate economic spending but it does result in larger mortgage balances per household and lets the consumer “reset” its credit balance for more debt-based consumption. Again, this is similar to what the financial landscape looked like prior to the great financial crisis except it’s worse now.

The above commentary is an excerpt from last week’s Short Seller’s Journal.  In each issue I undress the economic propaganda and provide short ideas, including options plays.  This week I’m featuring a retail-based “unicorn” stock which burns more cash every quarter.  You can learn more about this newsletter here:    Short Seller’s Journal information

Powell Just Signaled That The Next Crisis Is Here

Housing and auto sales appear to have hit a wall over the last 8-12 weeks.  To be sure, online holiday sales jumped significantly year over year, but brick-n-mortar sales were flat. The problem there:  e-commerce is only about 10% of total retail sales.  We won’t know until January how retail sales fared this holiday season.  I know that, away from Wall Street carnival barkers, the retail industry is braced for disappointing holiday sales this year.

A subscriber asked my opinion on how and when a stock market collapse might play out. Here’s my response: “With the degree to which Central Banks now intervene in the markets, it’s very difficult if not impossible to make timing predictions. I would argue that, on a real inflation-adjusted GDP basis, the economy never recovered from 2008. I’m not alone in that assessment. A global economic decline likely started in 2008 but has been covered up by the extreme amount of money printed and credit created.

It’s really more of a question of when will the markets reflect or catch up to the underlying real fundamentals? We’re seeing the reality reflected in the extreme divergence in wealth and income between the upper 1% and the rest. In fact, the median middle class household has gone backwards economically since 2008. That fact is reflected in the decline of real average wages and the record level of household debt taken on in order for these households to pretend like they are at least been running place.”

The steep drop in housing and auto sales are signaling that the average household is up to its eyeballs in debt. Auto and credit card delinquency rates are starting to climb rapidly. Subprime auto debt delinquencies rates now exceed the delinquency rates in 2008/2009.

The Truth is in the details – Despite the large number of jobs supposedly created in October and YTD, the wage withholding data published by the Treasury does not support the number of new jobs as claimed by the Government. YTD wage-earner tax withholding has increased only 0.1% from 2017. This number is what it is. It would be difficult to manipulate. Despite the Trump tax cut, which really provided just a marginal benefit to wage-earners and thus only a slight negative effect on wage-earner tax withholding, the 0.1% increase is well below what should have been the growth rate in wage withholding given the alleged growth in wages and jobs. Also, most of the alleged jobs created in October were the product of the highly questionable “birth/death model” used to estimate the number of businesses opened and closed during the month. The point here is that true unemployment, notwithstanding the Labor Force Participation Rate, is much higher than the Government would like us to believe.

Fed Chairman Jerome Powell signaled today that the well-telegraphed December rate hike is likely the last in this cycle of rate-hikes, though he intimates the possibility of one hike in 2019. More likely, by the time the first FOMC meeting rolls around in 2019, the economy will be in a tail-spin, with debt and derivative bombs detonating. And it’s a good bet Trump will be looking to sign an Executive Order abolishing the Fed and giving the Treasury the authority to print money. The $3.3 billion pension bailout proposal circulating Congress will morph into $30 billion and then $300 billion proposal. 2008 redux. If you’re long the stock market, enjoy this short-squeeze bounce while it lasts…

Could GE’s Slow Collapse Ignite A Financial Crisis?

Will GE be the proverbial “black swan?” – It had come to my attention that General Electric was locked out of the commercial paper market three weeks ago after Moody’s downgraded GE’s short term credit rating to a ratings level (P-2) that prevents prime money market funds from investing in commercial paper. Commercial paper (CP) is an important source of short term, low-cost, liquid funding for large companies. At one point, GE was one of the largest users of CP funding. As recently as Q2 this year, 14.3% of GE’s debt consisted of CP. Now GE will have to resort to using its bank revolving credit to fund its short term liquidity needs, which is considerably more expensive than using CP.

Moody’s rationale for the downgrade was that, “the adverse impact on GE’s cash flows from the deteriorating performance of the Power business will be considerable and could last some time.” Keep in mind that the ratings agencies, especially Moody’s, are typically reluctant to downgrade highly regarded companies and almost always understate or underestimate the severity of problems faced by a company whose fundamentals are rapidly deteriorating.

As an example, Moody’s had Enron rated as investment grade until just a few days before Enron filed bankruptcy. At the beginning of November 2001, Moody’s had Enron rated at Baa1. This is three notices above a non-investment grade rating (Ba1 for Moody’s and BB+ for S&P). Currently Moody’s and S&P have GE’s long term debt rated Baa1/BBB+. In the bond market, however, GE bonds are trading almost at junk bond yields.

Once a company that relies on cheap short-term funding is locked out of the commercial paper market, it more often than not precedes the rapid financial demise of that company. Because GE is GE, it may not be rapid, but I would bet GE is on the ropes financially and could go down eventually. GE’s CEO was on CNBC two weeks ago on a Monday proclaiming that the Company’s number one priority is to bring “leverage levels down” using asset sales. One asset GE is said to be considering selling is its aviation unit, which is considered its crown jewel. This is the classic signal that a company is struggling to stay solvent – i.e. burning furniture to keep the lights on and heat the house. It’s not a bad bet that GE might file chapter 11 – or even Chapter 7 liquidation – in the next 18-24 months (maybe sooner).

I wanted to discuss this situation because I opined on Twitter recently that a sell-off in GE’s stock below $5 could trigger an avalanche of selling in the stock market. Just as significant, an event in which a company like GE is shut off from commercial paper funding is the type of “pebble” that is tossed onto an unstable financial system and starts a credit market crisis. The downgrade of GE’s short term funding rating is a reflection of rising and widespread systemic instability and the general financial deterioration of corporate America. I predict that we’ll start to hear more about GE’s collapsing operational and financial condition and we’ll start to see a lot more companies head down the same path as GE.

Note:  The above commentary is an excerpt from the November 18th Short Seller’s Journal.  Since then, GE’s stock price has dropped another 5.5%.  I had recommended shorting GE at $30 in the January 29, 2017 issue of SSJ.  GE’s tangible net worth (book value minus goodwill + intangibles) is negative $31.3 billion.

GE also has a $28.7 billion+ underfunded pension obligation. It is by far the largest underfunded pension in corporate America.  I say “$28.7 billion+” because I’m certain that if an independent auditor plowed through the pension fund assets and liabilities, it would discover that the assets are overstated and the liabilities (future beneficiary payouts) are understated.

In other words, GE’s balance sheet is the equivalent of financial Fukushima.  The previous CEO borrowed $6 billion to cover pension payments through 2020. This is like throwing napalm on a gasoline fire.