Right now the deflationary forces are getting the upper hand. You look around the world: Russia is in recession, Brazil is in recession with stagflation, Japan is in recession, Canada is in recession, China and the US are not technically in recession but they are both slowing down very abruptly and a lot of emerging markets are suffering from very dramatic capital outflows, as I mentioned the situation in South Africa this weekend – so that’s a very powerful story. Now a lot of this is caused by the Fed. The Federal Reserve has been tightening for two years! When I said that to people, they think I’m crazy; they are like: “What are you talking about? Rates have been zero, how could they be tightening?” But it’s about two and a half years ago, all the way back in May 2013, that Bernanke started talking about tapering, he didn’t actually taper but he talked about it. Then in December 2013, they began to taper, in November 2014, they finished tapering, and in March 2015, Janet Yellen removed Forward Guidance.
And ever since then, they have been saying over and over again that they are going to raise interest rates. Well, I’m sorry, rates have been at zero, or close – but taper talk, tapering, removing forward guidance and talking tough is tightening! It’s all about expectations: if we say we’ve got to tighten, the market doesn’t wait until you actually tighten, until you actually raise rates. The reaction function is to anticipate raising rates and act as if the raise has already happened. So, we’ve seen this tightening, which means it’s not a surprise to see capital abandoning emerging markets, emerging markets’ currencies are falling and emerging markets’ stock markets are going down.
Now what has happened recently is that all of that whole dynamic which goes back almost 2 1/2 years, was based on an assumption that the US economy was fundamentally strong enough to bear the cost of higher interest rates and a stronger currency – those two things go together. Obviously if you even talk about raising interest rates in a world where everyone else is cutting interest rates, then your currency is going to be the strongest currency. And just to shed a little bit more light on that, of course throughout the last two years until August 2015, China had informally pegged its currency to the dollar. So, when you peg your currency to another currency, in effect you’re outsourcing your monetary policy to the other central bank, because if they tighten, you have to tighten in order to maintain the peg – that’s how pegs work. So long as the Fed was tightening, the dollar was getting stronger and China had to tighten in order for it to maintain the peg. They were selling dollar assets and using the dollars to buy their own currency – buying the yuan for dollars, reducing the money supply, which is a foreign tightening. And so the Fed not only took the US economy down, they took the Chinese economy down with them, because the two central banks are co-dependent and the PBOC is joined to the Fed in this tightening stage, which makes absolutely no sense.
Now, the Fed’s blunder was to say that the economy was stronger than it was and strong enough to actually bear tightening and bear a strong currency. That is based on their forecaster models, which are completely obsolete. So, you had their forecast regarding their policy. The forecast showed strength, and they thought they could tighten because the strength would bear it. It turns out that the forecast was wrong, which was not surprising – so, they actually tightened into weakness, which made the US economy even weaker.
Now that all comes tumbling down through the data, it’s impossible to deny the data on employment. Job creation in the United States peaked in November 2014. Forget about the monthly noise, go back and look at job creation trends from last November until September, which just came out last week, job creation went down precipitously: it was about 360,000 last November, then it went down to 250, 230, 220, 175, 145 etc. as the months went by. The US job creation stalled last year.
Not only is job creation falling rapidly, the labor force is in decline, the labor market is shrinking, real wages are slumping. By the way, of all the data points – they are all important in different ways, but real wages is the single most important data point because that’s where the two sides of the dual mandate come together. The tenets of the dual are price stability and job creation. Other central banks usually have just price stability, a single mandate. The Fed has this dual mandate. Well, real wages are where the two things converge, because if real wages are going up that means labor market conditions are tightening, labor can demand a raise, a real raise – and when you get a real raise, then it will begin to flow through the supply chain and cause demand inflation. So, that’s really what the Fed is worried about. Minimum wages are flat, minimum wages are not showing any tightness at all, so notwithstanding the fact that the unemployment rate is down to 5.1%, all the other indicators – labor force participation, efficiency of labor force, real wages, job creation –, every other indicator is showing a weakening in the labor market and more slack.
The PCE price inflator year-over-year is declining, it’s 1.2%, nowhere near the Fed’s 2% goal. So, take all the data points, apply them to growth and inflation: they’re all far away from the Fed’s forecast and moving in the wrong direction at the same time. So, I see no way the Fed can raise interest rates this year, I think the earliest rate increase is probably the end of 2016. I expect the Fed’s next step will be easing, not tightening – which of course is very bullish for gold!
So, the Fed is blundering, and taking the world with them. I expect a global growth depression in 2016. I think the next move by the Fed will be some form of easing, probably in the form of a reinstating Forward Guidance, giving the market some words or phrases that make it clear that the Fed is not going to raise interest rates for an extended period of time.
The Fed’s next move
The Fed’s next move will be towards ease because of the weakness in the US economy. However, it would not happen right away, I expect it in the first quarter of 2016, so perhaps in March or April of 2016 I think the Fed will give some kind of easing. What happened in the last 30 days is exactly what we were expecting, but I think it’s come as a shock to them, because their forecasting models are different. And so they’re beginning to wake up to the fact that we’re going to a global depression and growth depression. But now the Fed is waking up to that, they don’t do anything quickly, it’s going to take a few months to digest all of this, they’re going to hope that things bounce back, but I don’t think that they will. Finally, I expect them by maybe the end of the first quarter of 2016 to ease.
The Fed has 5 ways to ease. A lot of people say, how can you ease when you are at zero? But they actually have five different ways to do it. The first I’d like to mention, is negative interest rates; the second one is a cheaper dollar, so back to the currency wars; the third one is helicopter money; the fourth one is reinstating some kind of Forward Guidance, which we also talked about; and the fifth one is setting up QE4. So, you have helicopter money, Forward Guidance, QE4, currency wars and negative interest rates. Those are the five policy tools.
Now, I do not expect them to go to negative interest rates, and here is why. Actually in the five things that I mentioned that might actually be the most effective one that might deliver the most powerful results. And we’ve seen negative interest rates in Europe (ECB) and Switzerland. But the US is different because we have a very large money market industry, which you really don’t have in Europe, and negative interest rates would destroy the money market industry – it’s a trilliondollar-industry.
Well, if you put negative interest rates on the money market instruments, these funds are not going to have any money and they would have to shut down, as they really only have a few basis points to pay their expenses. I think this would destroy the industry and that’s why the Fed won’t do it. I actually don’t think they would do QE4 either, only because it’s been so discredited and of course 2016 is an election year in the United States and quantitative easing has such a bad flavor, particularly among conservatives and Republicans, that if the Fed went to QE4, they would just be putting themselves in a political crossfire. But independent of politics, the research shows that it doesn’t really do anything. So, I don’t think they’ll go with QE.
I’ve heard about people’s QE from a German program in the UK – people’s QE is just another name for helicopter money. The problem there is that the central bank cannot do it alone, they need the corporation and fiscal authority, which in our case would be the Congress and the White House. The Congress and the White House don’t even talk to each other; I see now, and again in an election-year, I see no prospects of any cooperation. So I think we can knock down negative interest rates, QE and helicopter money for different reasons.
That only leaves two instruments: one is currency wars, the other one is Forward Guidance.
The easiest, and it would work, is Forward Guidance. It’s just put back on with another word for “extended” or “patient”. It doesn’t matter, they’ll come up with some word that tells the market: “Hey, we’re not going to raise rates for the foreseeable future. As long as this world is not as good as we like it, we’re not going to raise rates. If we change our minds, we’ll take the word out and give you some advance warning.” It will be a replay of what they did with Forward Guidance in March 2015. The reaction function there has been slaughtered. I mean, people went to do carry trades and they bought dollars, they invested in emerging markets. And to make the interest tighter, because right now all the capital is coming out of the emerging markets, but if the Fed will reinstate Forward Guidance, the capital would flow back into the emerging markets. So, you can see a very final reversal of a lot of the trends that we have been following and it’s dangerous to stop. I mean, in that event all of a sudden you will see the Malaysian currency start to rally, in Korea, Asia (but probably not Brazil), if the Fed goes back to Forward Guidance. So, we have to be really careful, I would be watching them very closely.
The last one, currency wars, is another strong probability, so that’s where then we just basically call it “driving” and say: “Okay, you’ve had a drink from the canteen, we’re taking the canteen back, we need a drink” – so the US is going to cheapen the dollar. Thus, you might look for Forward Guidance and a cheaper dollar, not now, not before the quarter end, but in the first quarter of next year, if the US economy gets much worse.
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