In my post No reflation?, I discussed the perma-bulls’ continued recommendation of “buying the dips.” In support of their position, TV talking heads speak of an “improved economy and higher corporate earnings” as reasons to continue buying stocks.
However, if I’m reading David Stockman’s reports correctly, what the perma-bulls are really counting on is “reflation” by the Fed and other central banks, that is a return to buying bonds and flooding the markets with money, which will again force interest rates artificially lower.
Central banks’ bond buying is where the money came from to drive interest rates to record lows, and much of the money was diverted to stocks. In fact, some central banks, namely the Swiss National Bank and the Bank of Japan, printed money and bought stocks directly. However, David Stockman says, “. . . there will be no rapid reflation or other bailout from Washington.” I’m not so sure about that.
The five years following the 2008 World Financial Crisis, the Fed increased its holdings by $3.6 trillion, expanding its balance sheet from $900 billion to $4.5 trillion. All with money created out of thin air.
Now, the Board of Governors of the Fed has said a “modest reduction” is in order but has not indicated how much they are going to shrink the Fed’s holdings. There is speculation that the reduction will be $2 trillion over the next few years, which will come by selling bonds and by letting holdings mature but not reinvest the funds coming in.
Early last year, Jerome Powell, then a Fed governor but now Chairman of the Fed, said that the Fed’s balance sheet is unlikely to shrink much below $3 trillion, which – if that’s the way the Fed goes – means a reduction of $1.5 trillion.
In its announcement last year about its balance sheet shrinkage, the Fed said it would start in October with reductions of $10 billion a month and gradually increase to $50 billion a month by late 2018. At $50 billion a month, that’s $600 billion a year drained from the money supply.
But, what if stock prices turn down without big upside days to give investors hope? What if there’s a serious bear market, with declines of 20% or more?
Worse, what if the economy turns recessionary?
Will the Fed stand by its guns and continue to reduce its balance sheet? Will the pressure to implement another quantitative easing program be too great for the Fed to ignore? History suggests that the Fed will reflate. Further, history shows that whenever fiat currencies have been used, they have been printed until worthless. Will more QE be another step in the destruction of the dollar?
While the best-known currency destruction via inflation occurred in Germany 1918-1924, an example that more closely parallels our present situation was the destruction of the assignat during the French Revolution (1789-1798).
When most people think of the French Revolution, they think of the violence. More than 40,000 people died in prisons, and thousands had their heads lopped off via the guillotine. King Louis XVI met his fate that way January 21, 1793, and his wife, the famous Marie Antoinette, was guillotined later that year.
For gold and silver investors, though, they should understand that France’s paper currency, the assignat, was destroyed for the same reasons that have been used over the past five decades for the printing of more and more dollars: the belief that increases in the number of dollars in circulation increase the demand for goods and services.
The National Assembly would print, and business would be robust for a few months but would later falter. Then more assignats would be printed. From the first printing of assignats (April 1790) to the destruction of the plates used for printing assignats (February 1796), there were 13 issuances. The first issuance was 400 million. When the plates were destroyed, 40 billion circulated, which was a 100-fold increase.
To replace the worthless assignats, the Assembly issued another paper money, the mandat, at a 30:1 ratio. The people, by this time not trusting the Assembly, rejected mandats, which promptly fell to 3% of face value. In 1797, the legal tender qualities of both the assignats and the mandats were withdrawn and they became worthless. In the turmoil, Napoleon Bonaparte became Emperor.
While the French destroyed their assignat in six short years, the Fed has had virtually unlimited right to print dollars since August 1971, and the dollar is still the world’s most desired currency. However, since 1971, when President Nixon closed the gold window,” the money supply in the US has mushroomed and inflation along with it. An item that cost $1 in 1971 would cost $6.12 today.
When the dollar was redeemable in gold, the US had a much more cautious monetary policy. When the dollar became redeemable in nothing, the Fed could print at will and did to help pay for the massive deficits that the federal government has run since the Vietnam War.
Our warfare state has exploded, with the Defense Department getting more money virtually every year. The same has been true with our welfare state. All this in the face of 10,000 Baby Boomers turning 65 daily for the next 19 years, which will bankrupt Social Security as 30 million Americans are added to the Social Security/Medicare rolls the next decade.
Further, consider the “bi-partisan” budget passed early Friday morning, February 9 to avert a government shutdown. No federal spending was cut. The deal turned the GOP fiscal hawks into doves. The Pentagon received an increase of $82 billion annually over the next two years, and the Democrats garnered an increase of $66 billion for welfare over each of the next two years.
Much of this will be paid for with freshly printed dollars. It is so easy. Just print. No need to tax and upset voters. No need to borrow from the private sector and put upward pressure on interest rates. The Treasury prints bonds, delivers them to the Fed, which prints dollars. That’s not exactly how it works, but the net result is the same. The graph shows how fast the money supply can grow when the Fed feels the heat as it did in 2008.
So, as the economy slows, or, worse, turns down and as stocks fall in price, there will be a great hue and cry across the land for the government “to do something,” but it will not cut spending. It will go back to quantitative easing but probably call it something else. And, there will be gargantuan increases in the money supply, as was the case during the 2008 World Financial Crises and during the French Revolution. Eventually, the dollar will be wiped out as was the assignat.
The dollar will not be destroyed in the next few years. It will take many years because the whole world is on a fiat monetary system, and people have come to accept fiat money as the norm. However, prices across the board will rise as the Fed prints, and gold and silver will lead the way. In fact, gold and silver will rise in price on a much greater percentage than other goods. Historically, that’s the way it’s been when people lose faith in paper currencies.