Paycheck Protection Works!

It seems like another “risk off” week with both gold and T-bonds down while stocks and commodities rose. Silver is a quasi-monetary metal. It was up strongly on the week indicating a trend toward rising prices perhaps serving both a monetary purpose and an inflationary hedge in the minds of common folks. 

My IDW, which is comprised of the universe of stocks and commodities, has rebounded by 14.8% since March 20, suggesting a V-shaped recovery. 

But how seriously can we take this notion of a V-shaped recovery in the economy simply because stocks and commodities are on the rise? When I look at several of the charts published by Danielle DiMartino Booth last week I can only shake my head in wonderment. What are the markets really seeing, because there is nothing in the real economy that justifies that kind of optimism, much as I wish it to be true.

But wait! Maybe the stocks and commodities are being rational after all. The chart above left shows inflation expectations (blue line left scale) rising to over 6%, compared to the 2% the Fed has been trying to achieve. At the same time income expectations have declined to a slight negative number. That’s certainly not as dire as during the financial crisis, but wait until the paychecks stop coming from the CARES Act set to expire on June 30. If that happens, you can expect income expectations to drop further. Interestingly enough, the predictions of Nebraska Senator Sasse that the CARES Act would convince lower-income people not to return to work appears to be an accurate prediction, and even those who would like to go back to work may find jobs hard to come by. The chart above right from Google Trends shows a dramatic rise in permanent closings (blue line) related no doubt to restaurants and other retailers (green line). That makes sense, given the decline in Google Trends “temporary layoffs.”  

Now all of a sudden, the notion of a guaranteed paycheck of $2,000 or whatever amount the masses demand doesn’t seem so farfetched as it did a few months back when one Democrat candidate said we should go in that direction. So let’s think about this. You have businesses closing, which means less supplies of goods and services. But you keep money coming to couch potatoes, so the demand surges. What can you expect except rising prices when supplies are curtailed and demand continues constant? You get higher prices. So then what happens when the mobs (like those raising hell in the streets of our major cities) demand $5,000 or $10,000 per month? Well, the government will have to give it them so that the Fed will be like a dog chasing its own tail. It will be a vicious inflationary circle that is endless until the system crashes. So perhaps the markets are starting to figure this thing out. Perhaps we can look forward to more “risk off” scenarios until the inflation fears start to result in a trashing of dollars and other fiat currencies in exchange for tangible assets, starting with the most obvious—precious metals.

Of course, then you have dramatic geopolitical disruptions related to COVID-19 as well as a new cold war, this time with China. President Trump ramped up the rhetoric against China today, which, based on what we are told here in the U.S. regarding the way China handled the outbreak of COVID-19, is justified. But there is the very real possibility that all of these events collectively may pull the rug out from our civilization. Not only the violence in the streets aided by left-wing mayors in major cities that won’t allow their police to stop lawless behavior, but there is a very real possibility that the global financial system may come unglued, not just because of massive loan losses related to the global shutdown of economic activity but also because of possible financial warfare between China and the West.

A couple of thoughts Re: China’s move on HK. The announcement last week by China of new national security laws aimed at Hong Kong appears to me to be aimed more at the international financial system following than a call for an international COVID19 board of enquiry. Here are some points regarding that:  ·        

  • May 5 SCMP “European Union backs international inquiry into origins of coronavirus outbreak,”
  • May 21 China announces national security laws targeting HK.·        
  • Hong Kong Dollar (HKD) decay will impact HSBC in particular with both capital flight from Hong Kong as well as decay of HSBC’s Asian USD loan book.·        
  • Regarding HSBC:
  1. It is the largest bank in Europe.
  2. It is a central clearing member of LBMA w/the majority of London’s OTC gold market clearing trades processed by JPM & HSBC.
  3. It is custodian vault for 36 million ounces backing the GLD ETF.
  4. HSBC holds an ~ $40 tonnes of gold behind its global derivatives book in total. 

I believe other Asian banks will be hit by this but HSBC looks to me like a critical global Jenga block that China has just pulled. Apparently they have flipped the table on HSBC.

We shall see how this trade turns out. But keep in mind that Monday could be a pivotal day in the markets because we can expect Xi Jinping to respond to President Trump’s very strong remarks about China spreading the virus around the world and how we would be cutting various perks that Hong Kong receives from the U.S.  David may well be right regarding the Hong Kong-based HSBC, which, lest we forget, was once named the Hong Kong Shanghai Bank. David’s point is that any kind of retaliation against the U.S. could set the global financial system tottering over. Do you suppose China might have its eyes on all that gold stored by HSBC?

About Jay Taylor