January brought us a New Year, but a lot of the same old problems around the world. Countries are finding it difficult to deal with all the debt they've accumulated, global growth seems to have found a sliver of light (but is it for real or a false dawn?), and the President-elect was inaugurated. What now? We'll discuss all of this and more as we head into February—the Sweetheart month!
Trump Throws The Dollar Under The Bus
In the past couple of years, we've seen European Central Bank (ECB) President, Mario Draghi, throw the euro under the bus several times. In fact, he has done it so many times that it is now widely expected of him to do so whenever he speaks. The Reserve Bank of New Zealand (RBNZ) Governor, Graeme Wheeler, has also taken to this form of verbal jawboning his currency, the New Zealand dollar or kiwi as it is more affectionately known, almost as many times as he has spoken publicly. So, the use of this tool to affectively weaken what is thought to be a strong currency by a central banker is a common practice; one that I find to be shameful, for it takes the “market driven” value away from the currency. And longtime readers know that I'm all about the markets setting values and interest rates, and anything else that is involved in “price discovery.”
However, having said that it is common, I didn't say that it is common for the U.S. President to jawbone a currency, or in this case, the President-elect. On January 16, 2017, President-elect, Donald Trump, took a walk on the currency jawboning side and said the “dollar is too strong…”, and then went on to say that the reason the dollar is too strong is because China has kept its currency so weak.1 So, was he attempting to get the dollar weaker? Or was he setting some groundwork for his negotiations on trade with China? I believe it to be the latter of the two, and I don't think we'll have the new President, who was inaugurated in January, become another version of Mario Draghi, or Graeme Wheeler.
But maybe he will decide that this is something that he needs to be on top of. In that case, another foundation of currency trading will be removed. We haven't traded on fundamentals, very much, since the financial meltdown of 2007/08. Since then currencies have been traded on sentiment for the most part. But if the U.S. President decides that he can direct the dollar in whatever manner he believes to be the right direction, then even sentiment will be removed, and the markets will resort to waiting for the next tweet from the U.S. President. Is that what we want to have happen?
I sure hope not, even though this time he did say, in effect, what I've been saying all along, which is that the strong dollar trend is lasting too long. I believe in currency trends, and that fundamentals confirm a trend, and that charts only tell us what has happened inside a trend. I do not believe in verbal jawboning or physical intervention. There are times when a central bank needs to do some small intervening to even out trade, but other than that, I believe central banks need to keep their hands out of the cookie jar at all times!
The Clock Begins The Countdown
The countdown on the new President's first 100 days has begun, and it began on January 21, the day after his inauguration. So, what will his first 100 days look like when we get to April? A couple of months ago, I wrote that I truly believed our national debt was going to widen by a significant amount in the Trump years, for he is known to love debt as a way of financing things he wants to get done.
I think that the new President's best bang for his buck will come with a tax redo. And that is certainly something that can be accomplished in the first 100 days. I think that the tax code in this country is ridiculously burdensome, and should be simplified ASAP!
The repealing of the Affordable Care Act (ACA) is also something that I would like to see done, if only to remove the government from the health care business. Unfortunately, I believe that the replacement system is still going to be a government controlled system, maybe less involved but still involved, and therefore we will have traded oranges for apples.
And finally, infrastructure is in need of a facelift here in the U.S., but couldn't we put it out for bid to entrepreneurs instead of footing the bill with taxpayer funds? That's been my call to order for years now, and I truly believe that the government doesn't need to be getting involved in building bridges or roads. But think about this infrastructure thing a little bit with me here. So, let's say in the first 100 days, $1 trillion has been allocated for infrastructure projects here in the U.S. Well, then the request for proposals (RFPs) have to be submitted by the local entities who believe they have a bridge or highway in need of repairs. Then the proposals have to be reviewed and either approved or denied. One would think that most of them will be approved, and then the materials will have to be bought, the equipment will have to be moved to the area, and so on. This is a process that takes months, folks. So, no real infrastructure projects will really, truly take place until the fourth quarter of this year. And so, the real “see what we did” moments are going to have to wait, and by the time they do come around, people will have forgotten about them.
All in all, I don't see the reflation that the markets saw when the new President was first elected. And therefore, I have to think that by the end of the first year, the economy could be in real trouble.
On January 11, 2017, I wrote in the Daily Pfennig that, “There were four cases where a Republican succeeded a Democratic president. In each of these cases – Eisenhower, Nixon, Reagan, and Bush II, the market fell during the Republican's first year in office by an average of 10%. Further, recent presidents that succeeded two-termers faced daunting economies during their first terms.”
So, history may not repeat itself, but it sure does rhyme. And, unfortunately, for the new President, and the economy, this is what he's facing. Now some of you might be saying, “this is a currency, metals and economies letter, why all this discussion of the President's first 100 days?” Well, that's all true, but a discussion on the President's first 100 days is important as it could impact the direction of the dollar, folks.
Global Growth Shows Signs Of Recovery
It could very well be a false dawn, but there have been signs recently that global growth is recovering. The Australian dollar (A$), which I call the proxy for global growth, has been in recovery mode for the past month. Additionally, the most recent Japanese trade balance returned to a surplus after a year of negative results each month. And even the tiny nation of Singapore reported two strong months of exports for November and December. Add to these things the fact that the prices of commodities have risen, stealth-like, but risen in recent weeks: the price of iron ore has picked up, and so has the price of copper. Of course we'll need a few more months of these kinds of stories and results to confirm a recovery, so you know me, I'll keep an eye on this for sure.
Central Banks Reserves Are Falling
In a follow up to last month's dissertation on Treasuries and who's selling them these days, I have some additional information that could be very troubling for Treasuries and their issuance in the U.S.
International Reserves are falling. And no I'm not playing Chicken Little here, although someone should. I'm merely pointing out something that could be troublesome, I do believe, should it continue. Here's the skinny: International Reserves in the world's central banks peaked on August 2, 2014, at $12.032 trillion, but have fallen to $10.814 trillion as of January 13, 2017, as registered by Bloomberg. This is a decline of about 10.12%.
And more bleeding is going to occur going forward, in my opinion, which could be wrong, but didn't the new U.S. President make a big deal out of reducing the Trade Deficit, and even wiping it out? Why yes, Chuck, he did. And why is this being talked about here? Because dear reader, what feeds those international reserves? U.S. dollars from our Trade Deficit. See? So, if Trump is successful in narrowing the Trade Deficit, then there will be less international reserves.
Now, let's take this one step further. Most of those dollar reserves are converted to U.S. Treasuries. So, that could mean other countries would have less money to buy Treasuries. Now, add that to the information I gave you last month about how China and Saudi Arabia have reduced their Treasury holdings, and how Russia has stopped buying Treasuries to buy gold instead, and Houston, we have a problem!
And just when you thought, “well, I think we can deal with all this supply,” U.S. Federal Reserve (Fed) members come out and sing from the same song sheet about unwinding their Balance Sheet, which is chock-full-o-Treasuries. Now, even if that means they won't buy new bonds when the bonds they hold mature, it means one less buyer is at the auction when new bonds are introduced to the markets. And believe me, new bonds are introduced on a regular basis to fund our debt. Here are some Fed members and their comments on the Balance Sheet.
We had Fed member Harker saying that “When rates are 1%, we need to look at unwinding the Balance Sheet.” We had Fed member Kaplan saying that, “the Fed should probably be debating the Balance Sheet in 2017.” And we had Fed member Bullard saying that, “The Fed is in a better position to end the Balance Sheet reinvestment.”
Now all three of these Fed members were sent out to make these statements, trust me on that. I don't think that all three of them just came up with those thoughts independently. This may be the Fed jawboning yields higher. Yes, they jawboned them before, and kept rates down, and bought bonds for a long time to keep them lower, but apparently they can see the writing on the wall. Our debt is going to go higher, less big buyers will be at the auction table, so to attract new investors, yields will have to go higher. Now, I know quite a few people would applaud higher interest rates here in the U.S., but we must be careful what we wish for, because there may be unintended consequences of higher rates.
I'm going to discuss the consequences, but first, it's my contention that we never really left the Great Recession. The economy has been propped up by large amounts of stimulus funding, bond buyers, and 0% interest rates for a long time now. Hey, even if the Fed does hike rates three times in 2017, the Fed Funds internal rate would only be 1.50%. But back to the possible consequences of higher rates: so, if the economy is a start and miss proposition, as I believe it is, then higher interest rates could bring it to a complete stop. But maybe that's what some people want. I just shudder thinking about how the Fed has circumvented longer, drawn-out recessions for over 20 years now. So in my mind they have just been pushing the bad stuff down the road, over and over again, and one day, when we least expect it, we may experience a Minsky Moment. And I think the next recession will be the granddaddy of them all. Uh-oh! Now, I'm not saying that this is written in concrete, it's just the way I see it playing out, and I could be wrong of course.
And Right About The Time…
The central banks around the world are going to need everyone to be on their sides moving forward. Then along came this Bloomberg article, which we printed in the Daily Pfennig on 1/17/17. The author believes 2017 will be the year of central bank bashing by politicians, and gold will be the main beneficiary of that bashing. Here's a snippet:
“Baring Asset Management's Christopher Mahon has one major conviction about 2017: it will be the year in which central-bank bashing by politicians becomes the new normal, so he's seeking shelter in gold.
“‘This year is the turning point,’ Mahon said in an interview on Monday. ‘For seven years or so, central banks have largely escaped critique even though one could argue that their policies have been pretty inadequate in many senses. It's very plausible now that politicians stand up and throw stones at central bankers.’”2
Central bankers have generally expected to have a sense of autonomy to ensure they can manage growth efficiently, and for the first time in more than two decades, politicians are encroaching on that autonomy. Donald Trump has criticized the Federal Reserve for creating a “big, fat, ugly bubble” in the market by holding interest rates near zero. U.K. Prime Minister Theresa May said in October that a change has to come to Bank of England monetary policy. German Finance Minister Wolfgang Schäuble has suggested that the European Central Bank share the blame for the “rise of populism in Europe.”3
So in reality, this thought has already begun. It's not what central bankers need right now as they attempt to balance their respective economies.
I didn't get the opportunity to talk about currencies and gold this month, but what I can say in a short frame of space here is that currencies continue to repeat their moves from the early part of 2016—when it appeared that they were leaving the strong dollar trend. The currency roundup chart below will show you how good the performance has been so far in 2017.
The same can be said for gold (and silver, platinum and palladium) in 2017. I recently read a MarketWatch article that projected gold will outperform the stock market in 2017.4 We already see the shiny metal trading at more than $1,200/oz. in early January, and $1,200 had been a real toe-stubbing point for gold until, well, until it wasn't!
So, watch for signs that currencies and metals are truly on a real run again. And keep in mind that by the time you read this article, you'll have just a few days, to a few hours, to make sure your sweetheart is taken care of this year for Valentine's Day. Don't forget, or there will be unintended consequences! HA!