Negative Interest Rates In The U.S. Go Mainstream - With Some Glaring Omissions
By Daniel R. Amerman, CFA
The discussion of negative interest rates in the United States has now officially gone mainstream, with the front page of the August 12, 2019 print edition of the Wall Street Journal carrying a prominent discussion of the possibility.
Most of the article consists of various institutional investors talking about why this could be a real possibility. However, as will be explored herein, there were three glaring omissions in the article.
1) What the real source of the negative interest rates would be.
2) The historically unprecedented profits that would be created by such a move.
3) Who those unprecedented profits would mostly go to (and it isn't to the average investor).
This analysis is part of a series of related analyses, which support a book that is in the process of being written. Some key chapters from the book and an overview of the series are linked here.
Omission #1: The Source Of Negative Interest Rates Is Not The Market
The possibility of negative interest rates coming to the United States in the not too distant future has been the subject of increasing speculation. I have been exploring the reasons for such a potential move and the implications in the book that I am currently in the process of writing, particularly in Chapter Fourteen.
When the Wall Street Journal covers a previously obscure concept for (most) investors on page one and "above the fold" - one could say that it is no longer being treated as wild speculation, but has instead become a respectable possibility, something that is getting the full attention of professional investors. The article is linked here, and for those with WSJ subscriptions, it is well worth reading if you have not already done so.
While the article was significant - what was even more significant was what was left out of the discussion. If negative nominal interest rates do indeed come to the United States, it will be one of the most significant financial events in a lifetime for most financial professionals, as well as for retirement and other investors.
The first issue is one of where negative interest rates come from. In reading the WSJ article there was only minimal discussion of the central banking policies that create the highly artificial conditions necessary for negative interest rates. Instead, there was a discussion of slow growth and falling yields, along with trade and currency concerns, as if (implicitly) a lack of growth itself could create negative interest rates in a free market.
The problem with that way of thinking is that we have a very long history of slow or negative growth periods around the world, as well as trade and currency disputes - and we know those don't lead to markets creating negative nominal interest rates on their own (meaning rates that are explicitly negative, rather than just being less than the rate of inflation).
No matter how low growth rates or rates of inflation go, all of financial history shows us that they don't directly create the bizarre anomaly of negative interest rates, where an investor literally pays a borrower for the privilege of losing money.
What creates negative interest rates is extraordinary and massive interventions by central banks - such as the Bank of Japan and European Central Bank - that use monetary creation to completely override natural market forces. If negative interest rates come to the United States - it will not be a true market development, but a change in the degree of the already massive interventions of the Federal Reserve that dominate all investment markets in the U.S. today.
As a starting point, and as can be seen above, negative interest rates in inflation-adjusted terms would not be new in the United States. As explored in earlier chapters, the Federal Reserve went into new territory in the attempt to contain the damage from the crises created by the tech stock asset bubble collapse in 2001, and the Financial Crisis of 2008 (which was caused in part by the collapse of the real estate bubble).
In each case a cycle of crisis was followed by a cycle of the containment of crisis, which involved extraordinary interventions by the Federal Reserve. The Fed forced inflation-adjusted interest rates to the irrational place of being negative for 12 of the 18 years since then (annual averages), with a cumulative average inflation-adjusted interest rate for the 18 years of 2001 to 2018 being an extraordinary negative 0.60%.
Many people say that the current low level of interest rates is due to lower inflation rates, which should happen as the result of free market forces, and there is an element of truth to that. But forcing real interest rates down from a previous 39 year average of being a completely rational 2.16% above the rate of inflation, to an irrational 0.60% below the rate of inflation - is not the result of purely market forces, but is the product of heavy-handed Fed interventions distorting the investment markets.
As covered in previous chapters, forcing the effective "risk free" rate into a negative range for an extended period of time has changed the very fundamentals of investment pricing, creating much higher averages for stock, bond and real estate valuations than what is historically normal.
The other extraordinary change is the Fed taking the unprecedented step of literally creating trillions of dollars out of the nothingness, and using the money to buy medium and long term Treasury notes and bonds (as well as mortgage-backed securities) at artificially high prices. This can be seen in the blue area above (from a previous chapter).
So, we have artificially low medium and long term interest rates not because of market forces - but because of the most extraordinary and direct instances of the Fed using its power to override market forces, that we have seen in financial history.
Let's return to this idea of the market anticipating that lower growth or trade disputes or currency wars (or some combination thereof) could lead to explicitly negative interest rates, and therefore dropping interest rates in advance. There is certainly an element of truth to that, in that the input of lower growth or trade war may very well lead to the output of negative interest rates coming to the United States, as they have already come to Europe and Japan, and it is logical for investors to therefore change investment prices in anticipation of this.
However, what is missing is "the middle", the causality - why that happens. It has less to do with the markets, and everything to do with the known policies, agenda and tools of the Federal Reserve and other central banks.
Highly sophisticated institutional investors anticipate that lower economic growth, recession, or trade/currency warfare, will lead the Federal Reserve to force short term interest rates down to zero percent or below.
In an earlier chapter, we looked at key language from a recent Federal Open Market Committee (FOMC) meeting, and looked at how (if needed), the Fed intends to aggressively and preemptively use quantitative easing (QE) to create what could be trillions of dollars of new money (illustrated by the yellow area in the graph above), and use that to pursue a Maturity Extension Program (MEP), which would create potentially fantastic profits for investors who understood the Fed's unprecedented plans.
One of the potential uses of QE is to create negative interest rates. Negative interest rates would not exist in Japan and Europe if the Bank of Japan and European Central Bank had not engaged in massive monetary creation to get the money to force the markets to the completely unnatural place of negative interest rates.
So, if negative interest rates come to the United States - it will be because the Federal Reserve creates the money to make negative interest rates come to the United States as a matter of policy. Where market forces come in is in anticipating the change in interventions by an extraordinarily powerful outside agency, which then change investment prices across all the major categories. (In the extreme, there is a case that the markets could create negative interest rates in the U.S. before a new QE, but it would be the anticipation of the QE and change in Fed policies that would do it, and while possible, this scenario is in my opinion unlikely.)
And yes, once negative interest rates exist, then the markets can indeed expand or shrink the amount of bonds carrying negative interest rates on their own - but the process involved begins with an artificial situation that would not exist without massive central banking interventions. What causes the movements will then be dominated by the anticipation of what will happen in "the middle", what the input of economic and financial changes will do to central bank policies and the degree of intervention.
It is all in "the middle" - the outside interventions. Leave the middle out, and try to connect the input of changes in economic growth directly to the output of negative interest rates, without going through unprecedented and heavy-handed changes in Federal Reserve policies - and nothing will make any sense.
Something else to keep in mind is that markets so thoroughly dominated by central banking interventions are also completely outside the assumptions governing conventional financial theory and conventional retirement planning. Indeed, they invalidate the presumptions for returns and safety that most retirement planning is implicitly based upon - even as the new sources of artificial returns are missed.
Omission #2: Historically Unprecedented Profits
Keep in mind - those trillions of new dollars are created to be spent. They are spent in creating the highest investment prices in history in some categories, prices that are so high that they are completely unnatural. So the creation of negative interest rates will involve the Federal Reserve creating new money on an extraordinary scale to overpay some investors in an unprecedented manner. Those new profits will be entirely real, they will be spendable - and they will go to someone.
How this happens, where the money comes from and where it goes was explored in more detail in Chapter 14, and I won't fully repeat it here. However, as a quick review, negative interest rates do not usually involve literal negative interest payments, as in investors literally paying money to borrowers. Instead, negative interest rates are more commonly created by so overpaying for an investment, paying so much money up front, that it becomes impossible to earn a positive return, and a negative return is locked in at the time of purchase.
The graph above is from an illustration example in Chapter 14. The blue area is paying for $100 in bond principal, in full and up front. The green area is paying for all future interest payments, in full and up front. By combining the blue and green areas - it becomes impossible for the investor to earn any money. Those would by themselves lock in a zero percent rate of return, where $122.50 is invested, $122.50 is returned, and there is not a penny of earnings over the entire holding period.
The bizarre anomaly of negative interest rates - which could be on the way to the United States - involves the creation of the red area, where the investor deliberately pays more money than they will get back, in order to lock in a major loss - of $16.20 in the illustration above. (With that loss then being compounded by the inflation being created by the Fed or other central bank over that time, as a matter of policy).
No rational investor would ever do this in ordinary circumstances. This is not about free markets or rational investors - but the antithesis thereof. This is why we don't have a history of negative interest rates in the previous many bouts of recession, depression and trade wars the world has experienced - no sane person would go there, all else being equal.
Omission #3: Where The Money Would Go
Again, this is all about "the middle" - sophisticated investors anticipating the tools and intended policies of the Federal Reserve in the event of slow growth, recession or trade/currency wars, and how the Fed's response could create lucrative investment opportunities.
How the possibility of the Fed using quantitative easing to create negative interest rates would necessarily involve putting massive amounts of money into the pockets of (predominately) insiders can be seen in the illustration above (also from Chapter 14).
The Fed creates a trillion dollars - and that money is in no way theoretical, but is every bit as good as the money in your savings or retirement account. The money is created in order to spend it.
The Federal Reserve spends $721 billion to buy the bonds at par, call it the basis for the bond owners. It spends another $162 billion to pay for all the interest payments in advance. The Fed then pays another $117 billion to create the highly artificial state of locking in $117 billion in losses. This is something no rational investor would do with their own money - but it is something that the Bank of Japan and European Central Bank have been doing with money created via quantitative easing, and something the Fed may be doing as well in the not too distant future.
With this illustration, $279 billion of the $1 trillion in the new money would be handed out as up front profits. With potentially trillions in new money being created it would be one of the largest wealth redistributions in history, and it would disproportionately be going to a somewhat geographically concentrated group of insiders and "elites" - rather than to average investors and voters around the nation. Very few people would understand what was happening, even as it happened.
This brings us back to "the middle", and rational market behavior. The average investor (or voter) may have no idea what is going on, but for the sophisticated investors who do understand the very different ways in which our financial world currently works - if they think recession or trade difficulties could lead to negative interest rates, then they are going to want a piece of that action.
If the Fed is going to use the situation of a national emergency to hand out hundreds of billions of dollars in easy money, then those investors are going to want to own some long term bonds in order to participate. So, as the chances of intervention rise, the prices of those bonds should rise fast, which means that yields should be plunging - and that is exactly what has been happening with the prices and yields for the 10 year bonds illustrated above.
This is something that I have been writing about for more than a year now, which is why yield curve inversions matter. The point isn't statistical treatises about how different portions of the yield curve moving correlated with recessions and stock market movements in the 1960s and 1970s. Those days are long gone, and detailed statistical analyses that don't distinguish between the more free market yield curve changes of days long gone by, and yield curve changes during a time of massive central banking interventions that deliberately target and change the yield curve - are likely to be more or less worthless (in my opinion).
Yield curve inversions happen, as covered in previous analyses, because of (predominately) institutional investors seeking profits. This has worked great in the past, and it has worked very well for many investors through 2019 to date. When we take into account "the middle", and our current very different situation, then this increases the profit potential, even while having less and less in common with the past.
1) We have huge problems with economic growth in Europe and Japan, and these problems could be getting worse there while also spreading to the United States.
2) Over the last couple of decades, central banks have moved to using massive and historically unprecedented market interventions to try to contain crises and stimulate growth.
3) These extraordinary interventions in the United States have already radically changed the investment markets - creating record or near record asset prices across all the major investment categories, with record or near record capital gains being generated along the way.
4) Much of the focus of the institutional markets has moved to anticipating how economic changes will create changes in the central banking interventions, that could create some of the largest profits seen in history in the still coming years.
5) These sophisticated investors are not investing for the naive assumption of free market forces and prices being determined in a discovery process by investors acting in their own self-interests - but for our modern reality of the overriding of free market forces on a deliberate and massive scale by the Federal Reserve.
6) The great majority of individual investors do not at this time fully understand the new sources of profits, and are therefore unlikely to participate except by happenstance (or education).
7) These amplified cycles of ever greater interventions creating ever more artificial prices could persist for years to come - but are likely to end very badly at some point, with life changing implications for millions of retirees and other individual investors who do not understand how the new sources of risk completely override the assumed protections for long term investors that are built into conventional financial planning.
8) The great majority of the population is likely to miss out on most of the profits while bearing most of the risk (again) - even while a relatively small minority of elite institutions and individuals will (again) take most of the huge but artificial profits that will be created as a matter of national policy.
9) The largest determinants of financial security for retirement and other investors over the coming decade are not likely to be based on financial history, or the assumption that the past endlessly repeats itself for each asset class in an environment of free markets, but rather the ability to anticipate and participate in the new forms of artificially induced wealth redistributions, while being prepared for and mitigating the effects of the potentially disastrous downside when it does arrive.
As regular readers know, I've worked out an organizational framework for exploring how cycles of crisis and the containment of crisis change investment decisions across all asset categories, including stocks, bonds, real estate and precious metals. What we've been exploring in this analysis could be useful in better understanding how the Red/Black matrix works.
(More information on the matrix and how to use it is linked here).
In the past, we had the ordinary business cycles, which included ongoing Federal Reserve interventions, but they weren't anywhere near as powerful as what we see today. What the matrix above is about is what was referred to in this analysis as being "the middle."
If we have a crisis developing, then that will change investment prices and results for all the major categories. For instance, recessions will bring down stock prices and real estate prices all else being equal, even as bond prices increase (also all else being equal).
The difference since around 2000 or so, is that we have far more pervasive Federal Reserve interventions, so we are no longer just looking at the ordinary investment responses to ordinary changes in the business cycle. Because the Fed is using massive interventions that distort interest rates, investment prices and the yield curve - all investment prices are increasingly being driven not by the market fundamentals, but by the markets anticipating and responding to the outside interventions by the Federal Reserve.
What applying the matrix does is that it adds "going to the middle", so we look not just how a recession would ordinarily change stock prices - but how a recession could trigger extraordinary interventions by the Federal Reserve, and how the 1-2 combination of recession and the resulting interventions would change stock prices, in ways that are potentially quite different from long term norms.
To better understand this future, we need to better understand the past, and just how it is that stock, bond, real estate and precious metals prices have been working differently inside the cycles of crisis and the containment of crisis over the years since around the turn of the millenium.
As developed in the book, and as can be seen above, we have seen sharp differences in all four major asset categories, which come down to what is now in "the middle" - the unprecedented and extraordinary central bank interventions including zero percent interest rates and quantitative easing.
When the Wall Street Journal put possibly imminent negative interest rates for the United States on page one and above the fold - it is (effectively) saying these changes are not in the past, but may just be getting started. The greater the degree of distortions, the less important that long term investment history in freer markets becomes, and the greater the importance of having a framework for understanding what is in "the middle" and how these extraordinary and heavy-handed interventions by the Fed transform the investment decision making process.
I will be the first to admit I did not fully understand this other than buy my book.
The value of the market will not, and can not, be sustained by the young who are broke as the older generation dies off.
Just like Japan. There will simply not be enough bag holders. Assets devalue & the shrinking rich class will gobble the assets up.
People in the middle will turn to buy here pay here so they can charge interest, rentals & land contracts. The rest of the world are or will become debt slaves. When you leave a man no escape expect the unexpected.
We have a young person at work. "Life" is scaring them to death. Smart but not equipped to handle reality. Almost zero wisdom. Yet saw what happened to older people in the family with downsizing etc...... I can see where the small house craze came from. When you live like that you don't want any part of extra responsibility of family, children etc........
Oil prices fell sharply on Wednesday as weak economic data out of China and crude oil inventory gains in the United States’ spooked oil markets.
WTI fell more than 5% on Wednesday after booking sizable gains the day prior. At 1:11pm EDT, WTI was trading down -$3.07 (-5.38%) at $54.03. Brent crude fared almost as poorly, with the global benchmark falling $2.96 per barrel (-4.83%) to below $60 again, at $58.34.
On Tuesday, the API reported a surprise crude oil inventory build of nearly 4 million barrels, unsettling markets that had seen huge gains on earlier news that the United States was pushing back tariffs for some of the items it was expected to go into effect in the beginning of September.
Then on Wednesday, grim economic data game in from China, which showed a sharp—and surprise—decline in industrial output growth to a 17-year low. Germany too reported weak economic data for Q2 as its exports slowed, hinting at a possible recession.
The final straw on Wednesday was the Energy Information Administration (EIA) report that backed up Tuesday’s API report of a build in US crude oil inventory.
Rising crude oil inventory, faltering demand growth, and fears that the China and US trade war will further depress China’s economy definitively tipped the scales into bear territory, with tensions in the Middle East over the Persian Gulf and Strait of Hormuz able to push up prices.
OPEC’s production cuts were insufficient as well, with most analysts agreeing that global oil inventories are still too high. But OPEC has limited options to cut even further, with its largest oil producer, Saudi Arabia, already making large sacrifices in this regard. Russia, too, is likely uninterested in further cuts.
By Julianne Geiger for Oilprice.com
The latest sign that absolutely nothing makes sense
August 19, 2019
Dallas, Texas, USA
In the latest sign that absolutely nothing makes sense anymore, WeWork filed formal regulatory paperwork with the Securities and Exchange Commission last week, officially notifying the world that it will soon be going public.
If you haven’t heard of WeWork (or it’s parent-- ‘The We Company’), it’s a real estate company that owns practically zero real estate.
Instead, they lease vast amounts of office space in commercial buildings on long-term contracts, and then sub-lease that space to individual tenants-- often small businesses-- with short-term contracts.
It’s essentially the same business model as Regus-- which provides virtual office services, business addresses, and short-term office space, in pretty much every major city around the world.
Yet Regus is actually profitable. Its parent company, UK-based International Workspace Group, reported a profit of nearly 300 million British pounds (about $350 million USD) for the first six months of 2019. And the company consistently makes money.
WeWork, on the other hand, consistently burns cash and has no expectation of making money “in the foreseeable future” according to its own SEC filing.
In fact, WeWork lost almost $1 billion in the first six months of 2019, putting it on pace to lose even more money than the $1.9 billion it lost in 2018.
WeWork currently has around 10 million square feet of office space, and hopes to grow to 40 million in total.
But Regus already has nearly 60 million square feet of office space worldwide. And it’s still expanding.
So Regus is MUCH larger and turns a healthy profit. WeWork is smaller and loses tons of money.
You’d think that Regus would be a much more valuable company. But no. Regus is valued at less than $5 billion. While WeWork is going public at a valuation of nearly $50 billion-- ten times higher.
Much of this excess is due to WeWork’s legendary silver-tongued and messianic co-founder/CEO, Adam Neumann.
Neumann has actually been able to convince people that WeWork is a technology company, as a way to justify its absurdly high valuations.
In addition to extolling their ‘culture of inclusivity’ and ‘energy of an inspired community’, the company’s SEC filing refers to their ‘extensive technology’ more than 120 times.
Of course, there’s never any description of the technology, or what it actually does.
There’s also not a SINGLE line item in WeWork’s financial statements that shows ANY research and development.
For technology companies, this is ALWAYS an important item in their financials.
Google spent $16 BILLION on research & development last year, amounting to roughly 14% of its revenue. Amazon spent $22 billion, 12% of its revenue. Facebook spent $7.8 billion, nearly 20% of its revenue.
And even stodgy old Johnson & Johnson, which doesn’t even pretend to be a tech company, spent more than $10 billion (13.8% of revenue) on research & development in 2018.
WeWork claims to be a tech company, even though all they really have is a reservation system that is slightly less impressive than what Enterprise Rent-a-Car uses.
They keep saying how important technology is to their business (as if technology isn’t important to EVERY business in 2019. Duh.)
But WeWork doesn’t even investment enough money in R&D to register a single footnote in their financial statements.
This proves, beyond all doubt, that it’s just a big, giant farce.
The biggest farce of all, though, is WeWork’s mission to “elevate the world’s consciousness.” That’s straight out of the company’s SEC filing.
Jeez I thought this was supposed to be a real estate company.
This reminds me of when Snapchat went public a few years ago; investors thought Snapchat was a sexting app for pedophiles-- um, I mean a social media app for teenagers.
But according to its own SEC filing, Snapchat claimed to be a camera company… which was incredibly bewildering to investors.
WeWork has totally blown Snapchat away on the absurdity scale with this nonsense about consciousness.
What does that even mean?
Business is about focusing capital, energy, and brainpower to achieve specific, tangible outcomes that support a coherent strategy.
You’re supposed to be able to measure those outcomes… otherwise it’s impossible to tell whether or not management is properly executing the plan.
How exactly does one measure ‘global consciousness’? How do you know if your plan to elevate said consciousness is working?
And most importantly, how are you supposed to make money elevating consciousness? Because that doesn’t strike me as an especially profitable venture.
But that’s exactly the point. We’re living in a world now where profits don’t matter.
I mean… there’s more than $10 TRILLION worth of bonds in the world with negative yields. Banks are even loaning money to borrowers at negative interest rates.
And some of the most popular (and expensive) investments in the world lose billions of dollars each year with no end in sight.
August 20, 2019
Real Estate is one of the biggest purchases anyone will make in their lifetime. It can account for 30x to 300x one’s annual income and take over 30 years to pay off. After you’re done paying for your property, now you have to keep paying to maintain it and to support the property taxes to keep it. What has happened to the US Real Estate market since the 2008-09 global credit market collapse and is the US Fed behind the curve?
The University of Michigan's consumer sentiment for the US was revised lower to 89.8 in August 2019 from a preliminary estimate of 92.1 and well below the previous month's final 98.4. It was the lowest reading since October 2016, as both consumer expectations and current conditions sub-indexes came in weaker than initially thought. Consumer Confidence in the United States averaged 86.58 Index Points from 1952 until 2019, reaching an all time high of 111.40 Index Points in January of 2000 and a record low of 51.70 Index Points in May of 1980.
On January 20, 1841, after delivering a series of military defeats to Imperial China in the First Opium War, British forces landed in Hong Kong and took control of the island.
Hong Kong was hugely important for the British economy because it ensured access to the Chinese market. And they went to war multiple times to keep control of the island.
In 1898 the two empires signed a lasting peace treaty whereby Britain agreed to turn the island over to China in 1997. And Hong Kong prospered for decades under British rule.
But by early 1980s, Hong Kong started experiencing more turbulent times.
International businesses, bankers, and traders were becoming concerned about the Chinese handover that would take place 15 years later.
And when China’s Deng Xiaoping expressed his desire to hit the gas pedal on Hong Kong’s return to China, investors panicked.
Between September 1982 and September 1983, the Hong Kong dollar lost 25% of its value against the US dollar.
Within a week, by early October, it had lost another 15% of its value. And it continued losing ground by the day.
The currency was in free-fall. So in mid-October 1983, the Hong Kong government stabilized the currency by fixing the exchange rate to the US dollar.
It has remained that way for the past 36 years.
This ‘pegged’ exchange rate provided a lot of benefit to Hong Kong back then, helping cement its status as an international financial center.
And I’ve been writing about this for years: the pegged exchange rate means that the Hong Kong dollar has all the benefits of the US dollar, without any of the baggage.
The US dollar has international recognition and stability. Hong Kong’s currency is pegged to the US dollar, so it shares those benefits too.
But while the United States is drowning in debt with $50+ trillion in unfunded pension liabilities, Hong Kong has massive financial reserves, positive cash flow, and a healthy current account surplus.
For the past months we’ve watched Hong Kong’s most dramatic political turmoil in decades.
Millions of people have protested, and it’s becoming a full-blown revolution.
Just this morning the Chinese government asserted its right to declare a state of emergency-- pretext for sending armed troops into Hong Kong to quell rebellion.
Does this mean Hong Kong’s pegged exchange rate is finished?
Throughout financial history there are a examples of central banks that tried, and failed, to maintain a pegged exchange rate.
The most notorious example is the UK in the 1990s, which had pegged the British pound to the German Deutsche Mark at minimum level of 2.773.
The market did not believe that Britain could maintain the peg. And they were right.
In 1992, a group of speculators (including George Soros) bet so heavily against the British pound that the central bank spent all of its cash reserves defending the exchange rate.
With an insolvent central bank, the British government finally capitulated and devalued the pound.
In the case of Hong Kong today, though, that scenario is highly unlikely.
Hong Kong’s Monetary Authority (HKMA) has an absurd amount of firepower to maintain the exchange rate indefinitely.
HKMA is, by far, one of the most well-capitalized central banks in the world. For every Hong Kong dollar in circulation, the HKMA has TWO dollars of foreign currency in reserve.
In other words, the HKMA could fend off speculators and defend the pegged exchange rate to the very last Hong Kong dollar... and STILL have hundreds of billions of dollars left over.
And HKMA will still have those cash reserves even in a nightmare scenario where Chinese tanks and millions of people are in the streets.
This is a political issue. A MAJOR political issue. But it’s not a financial one.
It’s also important to remember that Hong Kong’s pegged exchange rate has survived plenty of apocalyptic events before.
There was the Asian Financial Crisis in 1997, the dot-com crash in 2000, the Global Financial Crisis in 2008, plus plenty of other non-financial crises like swine flu, bird flu, and, of course, the handover to the Chinese.
The peg has always survived.
But here’s a VERY critical point: just because the HKMA is ABLE to maintain the peg, and just because they have done so for decades, doesn’t mean they will continue to do so.
At the end of the day, Hong Kong’s pegged exchange rate needs to make sense for Hong Kong. And for China.
It’s becoming more clear that this is no longer the case.
Back in the 1980s, the US was Hong Kong’s primary trading partner. Having a dollar peg was incredibly convenient.
It was also a convenience for mainland China, because the peg gave Chinese businesses (through their Hong Kong subsidiaries) easy access to foreign markets and US dollars.
Today those things are no longer necessary.
Hong Kong is now a first-world economy that no longer requires US economic support.
Hong Kong’s primary trading partner today is China, not the US. And China has so much economic power that its businesses don’t need US dollar convertibility through Hong Kong.
The biggest issue is that maintaining the peg requires Hong Kong to mirror US interest rate policy, essentially sacrificing part of its economic sovereignty.
That’s something that definitely doesn’t make sense, for Hong Kong, OR for China-- especially with a trade war looming.
It’s worth noting that HKMA’s CEO, Norman Chan, a long-time defender of the currency peg, is retiring this month.
And it remains to be seen whether his successor will share the same enthusiasm to spend hundreds of billions of dollars maintaining a peg that might not make sense anymore.
Bottom line-- Hong Kong will unlikely be ‘bullied’ by speculators into dropping its currency peg.
But it’s entirely possible they may choose to willingly do so… simply because the US dollar peg doesn’t make as much sense as it did in 1983.
So if you’re holding Hong Kong dollars, please do bear this possibility in mind.
each time it has went to overbought, it has went sideways with a small down stroke,
this time with a larger overbought and a larger move, might see a bit more than a minor down,
could be enough to get your interest peaked
50% of the move is down to support in mid 17's
which is quite incredible considering it plowed thru 18 like it wasn't even there,
that was unexpected to me, after all the commotion around 18 in years gone by
Summary. This was posted a while back and Has turned out correct for some parts. Global QE at work. Increasing equity valuations. However strengthening dollar crates a problem for repayment of interest on dollar denominated debts.
This also can create chaos outside USA. Argentina not again. The strength of the dollar is at the expense of other currencies which are relatively weaker. Good to buy gold if you are outside the USA to hedge against loosing local currency. Aka Russia, Venezuela, Iran etc. also explains why gold and dollar are rising in tandem.
1-2% of global cash were to go into gold it would double the price.
At some point global economies are going to beg for a weaker dollar or come up with a news plaza accord.
At some point this leads to a blow up top of equities. Dow 50,000?
Buckle up, this one’s going to be entertaining… because I should have called this note “Why you should always read the fine print.”
This morning I read through the prospectus and annual reports of the most popular Gold ETFs in the world.
First, some background:
ETF stands for ‘exchange-traded fund’. It’s sort of like a mutual fund that’s listed on the stock exchange, meaning investors can buy/sell shares of an ETF just like they would buy/sell shares of Apple, Ford, or (God help us) Netflix.
But unlike Apple, which is an operating business with employees, products, revenue, etc., an ETF is NOT an operating business. It’s a fund that merely pools capital to own assets.
The benefit for investors is that ETFs can be an easy and convenient way to invest in certain assets which would otherwise be difficult to buy.
If someone wants to buy Egyptian stocks, for example-- they could open a brokerage account in Cairo… or buy an Egypt ETF that’s listed on the New York Stock Exchange.
The ETF is a LOT easier for most investors.
But there are also ETFs for gold and silver. And I find this mystifying.
We’re not talking about Egyptian stocks. Gold and silver are easy to buy. You could have Canadian Maple Leaf gold coins delivered to your home with a few mouse clicks.
So gold ETFs provide no added convenience.
Yet there’s an enormous amount of downside.
First off-- it’s important to know that if you buy an ETF, you’re paying for a ton of unnecessary expenses.
The ETF has to pay custodian fees, marketing fees, listing fees to the New York Stock Exchange, audit fees, management fees, etc.
I’m chairman of the Board of Directors for a company that’s listed on a stock exchange, and trust me-- the listing fees are REALLY expensive.
If you own physical gold in your own safe, you wouldn’t have to suffer the cost of paying lawyers, auditors, and investment bankers.
But GLD does. Which means that as a GLD investor, YOU are fundamentally paying those costs.
And remember that ETFs aren’t operating businesses. Apple makes money selling overpriced hardware. But GLD has no products, and hence doesn’t generate any revenue.
So how do they pay for this mountain of expenses?
By selling gold.
GLD trustees periodically sell off the gold (that’s supposedly owned by the investors) in order to pay expenses.
Right in its own prospectus, GLD tells us:
The amount of gold [held by GLD] will continue to be reduced during the life of the Trust due to the sales of gold necessary to pay the Trust’s expenses”
And like I said, those expenses are NOT cheap. I’ll come back to that.
This is important because GLD (and several other ETFs) are structured as ‘flow-through’ trusts.
So when they sell gold to pay expenses, this can create hidden tax headaches for GLD investors. The IRS could treat those gold sales as if you personally had sold gold, triggering capital gains consequences.
GLD’s 2018 annual report states this clearly on page 21:
“When the Trust sells gold . . . to pay expenses, a U.S. Shareholder generally will recognize gain or loss. . .”
But aside from the excessive costs and possible tax consequences, ETFs are simply not designed for your benefit. They’re designed for Wall Street’s benefit.
GLD, for example, has a terribly complex structure involving a ‘sponsor’, ‘marketing agent’, ‘trustee’, ‘custodian’, and various ‘Authorized Participants’.
These middlemen standing between you and your gold are all big Wall Street banks who suck value from your investment.
Here’s something really incredible: with GLD, the physical gold is supposed to be held with the ‘Custodian’, which is HSBC Global.
But according to GLD’s legal documents, the Custodian has the right to use Sub-Custodians. Yet they’re not required to have any written agreement with the sub-custodians.
Those sub-custodians can then shift your gold even further to sub-sub-custodians, which also does not require a written agreement.
This is directly from GLD’s report:
“The Custodian’s selected subcustodians may appoint further subcustodians.”
“These further subcustodians are not expected to have written custody agreements with the Custodian’s subcustodians that selected them.”
This is where it gets really ridiculous:
“[T]he Custodian does not undertake to monitor the performance by subcustodians of their custody functions or their selection of additional subcustodians and is not responsible for the actions or inactions of subcustodians.”
In other words, the gold could end up with some sub-sub-sub-custodian. No written agreement is required.
And, even though the primary custodian (HSBC) is receiving handsome fees, they have no obligation to monitor the sub-custodians, nor can HSBC be held responsible if someone screws up.
Moreover, the report states:
“The Custodian and the Trustee do not require any direct or indirect sub-custodians to be insured or bonded with respect to their custodial activities…
“Therefore, Shareholders cannot be assured that the Custodian maintains adequate insurance or any insurance with respect to the gold held by the Custodian on behalf of the [ETF].”
So, not only is there zero requirement to even have a written agreement before storing your gold with some sub-custodian, there’s also no requirement to insure the gold that they’re storing.
SOUNDS LIKE ANOTHER WIN FOR THE LITTLE GUY!
Seriously, you have to be insane to buy GLD.
Sure, it’s convenient to click a button and buy GLD with your brokerage account.
But it’s also convenient to buy physical gold coins on Amazon. Jeff Bezos can deliver them to your house via drone strike later this afternoon.
Yes, GLD is liquid. You can sell shares anytime during market hours. But physical gold is also liquid. You can sell it anywhere in the world.
So gold ETFs have no real advantage.
But the disadvantages are numerous. You’re paying a ton of unnecessary expenses, dealing with potential tax consequences, and enriching big Wall Street banks who have no obligation to do anything on your behalf.
FWIW. Mr. Pento does seem to have a valid argument with the inverted yield curve on a historical basis. Or is it more "he said she said" doublespeak from the bankers, MSM, and Fed, fear mongering by author, etc.?
September 9, 2019
One of the best examples of Wall Street’s propaganda machine at work is its willingness to dismiss recessionary signals. The inverted yield curve is a perfect example. Case in point, look at the story that was put out on Market Watch dated November 27th, 2006—exactly one year before the Great Recession officially began, the stock market started its decline of more than half and the global economy started to collapse.
Here’s how some on Wall Street and the Fed described what was happening on the precipice of the global financial crisis regarding the inversion of the yield curve at that time: “Bernanke, and his predecessor Alan Greenspan, have attributed the inverted yield curve to a ‘global savings glut’ that has sparked fervid demand for Treasuries and U.S. corporate bonds. Economists have noted that this buying spree is inconsistent with the possibility of a looming recession. In the past inverted yield curves have been harbingers of recession, but a number of economists, including Federal Reserve Chairman Ben Bernanke, do not think this is the case in the present instance.”
A few years earlier, Alan Greenspan told Congress during his annual testimony on November 2005 that he: “Would hesitate to read into the actual downward tilt of the yield curve as meaning necessarily as it invariably meant 30 or 40 years ago. This used to be one of the most accurate measures we used to have to indicate when a recession was about to occur. It has lost its capability of doing so in recent years.”
In 2006, his successor Ben Bernanke appeared to be even more confident that the flat yield curve was caused by the “significant increase in the global supply of savings” and nothing to say about the faltering economy. In his March 2006 speech to the Economic Club of NY Bernanke stated he “would not interpret the currently very flat yield curve as indicating a significant economic slowdown” instead he bloviated on about four other anomalies adding to the demand for US long term debt that was putting downward pressure on the long end of the curve. First and foremost, among his excuses was strong international demand for US debt. Perhaps it was his indifference to the curve inversion that caused him to assure investors in May of 2007 in a speech given at the Federal Reserve Bank of Chicago, “Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited.”
In other words, he wanted investors to ignore the yield curve inversion because in the Fed’s infinite wisdom everything was just fine.
The first lady Chair of the Federal Reserve, Janet Yellen, is now taking her turn assuring investors of the yield curve’s irrelevance; explaining very recently on a Fox Business Network interview dated August 14th, 2019: “Historically, [the yield curve inversion] has been a pretty good signal of recession and I think that’s when markets pay attention to it, but I would really urge that on this occasion it may be a less good signal.”
And, turning to the current dictator of monetary policy, Jerome Powell, he said in his March of 2018 news conference that while the inverted yield curve has had its prescience in the past, “but a lot of that was just situations in which inflation was allowed to get out of control, and the Fed had to tighten, and that put the economy into a recession. That’s really not the situation we’re in now.”
The Fed and Wall Street are great at concocting stories to claim that it is different this time. One of their favorite and reliable false narratives is that an inverted yield curve is not a harbinger of recession. Well, this time is most likely not at all different, despite the fact that a never-ending parade of gurus come on financial news networks and explain why this time the yield curve inversion is irrelevant.
What is the major point here? Besides the fact that central bankers and Wall Street Shills never learn their lessons, it is that an inverted yield curve is not some exogenous event that is coincidentally linked to recessions. It is always a sign of a slowing global economy and the imminent collapse of unstable asset bubbles that were built on cheap credit. This is because an inverted yield curve causes credit to shut down. When the difference between where banks can borrow funds (short end of the curve) and what income their assets can generate (long end of the curve) shrinks towards zero, the incentive to lend money erodes. And, since the slowing economy dramatically increases the risk of loan defaults, lending institutions become much more reticent to extend new credit at low margins to those that have higher potential to default. The result is a significant reduction in the amount of money created; the same money that fuels these asset bubbles and the overleveraged economy.
Therefore, the inverted yield curve isn’t different this time, and the countdown to recession and equity market collapse has begun. An official recession has always occurred in less than two years after the initial inversion. And in 60% of those inversions since 1955, the stock market topped out just three months after the date of that first inversion, according to BOAML. It should be noted that the spread between the Fed Funds Rate and the 10-year Note has already been negative for the past four months. Indeed, the August report from the ISM proved that the manufacturing recession in the US has officially arrived.
The sad truth is there’s a record amount of debt extant in the world that sits on top of a massive global bond bubble. From which central banks—because of their love affair with ZIRP and even NIRP–have almost no room left to remediate a recession and market collapse. That is, other than the full deployment of massive helicopter money—where new money is created by governments and central banks and then handed out directly to the private sector. What could possibly go wrong with that?
This is why a static buy and hold, or dollar-cost averaging investment strategy isn’t working any longer. You have to know what sector of stocks to own and when it is time to short stocks or bonds; or both. Such are the consequences of having both fixed income and equities in a record-breaking bubble together for the first time in history.
people have been braying about it non stop as of course the propaganda machines are begging for anything to prevent a tramp II
yet, then few others have come thru and stated that this inversion is kind of a problem, as it is due to outside sources rather than internal,
wherein the declines to negative in zero land, slowing economies in other areas, etc are all skewing the results, with us receiving a inversion as a result of this.
if true what they state though, we don't live in a vacuum, far from it. If there is indeed significant weakness in zero land and possibly some weakness in asia, we could certainly expect to see a retraction here also.
presenting quite a problem. They really don't have much to fall in rates, they are already running over $1T per year in deficit, and we are in the middle of a trade war.