Will the Trump Trade War Result in a Spike in Gold?

Gold-stock analyst John Doody holds in a Kitco interview that the Trump tariffs will result in job losses. He says that, in turn, the Fed will cut interest rates. The result of further monetary expansion will be a 2001-2011-like upswing in gold prices. The trouble with his thesis is that interest rates are already so darn low that the Fed doesn't have very far to cut even if it wants to cut. I'm sympathetic to his opinion that a trade war will contribute to a declining economy, resulting in increased Fed intervention. The whole house of cards of the post-Reagan era can fall.

I'm Betting on a Rising Stock Market

The belief that the stock market will go up forever is  a bubble psychology that goes back to the South Sea Bubble, which fooled even Sir Isaac Newton. Since 2009, and especially since President Obama's reelection in 2012, the stock market has been going at a tear. The tear will continue. The editorial page of the New York Times proves it.  The Times wrote this yesterday: 

On one side is a small yet vocal minority of Fed officials who want to head off inflation by raising rates sooner rather than later. On the other is a majority that thinks a near-term rate hike would stifle growth and, with it, any chance of restoring health to the labor market. That group includes Janet Yellen, the Fed’s chairwoman, and most members of the Fed’s policy committee…The economic evidence indisputably favors Ms. Yellen, who has indicated that rate increases should not begin until sometime next year, at the earliest. It will take until then to be able to say with confidence whether recent improvements in growth and hiring are sustainable.

The reason that the Times's editorial is important is that the nation's hierarchy of decision making with respect to interest rate policy is as follows:

Investment banker cronies--> Ochs Sulzberger family-->The New York Times--> public opinion among Democrats --> President Obama's opinon --> Janet Yellen's opinion --> Federal Open Market Committee decision

If a Republican were in office, the Wall Street Journal would play the equivalent role.

Rates will be lower, or will increase less, than stock market participants expect because the Democrats have a commitment to boosting the stock market. The Times goes on to make the curious claim that keeping interest rates low will improve real wages; that real wages have declined while interest rates have been kept at historically low levels for the past 43 years does not deter them.  Recall the old saying about insanity.  

 Seeking Alpha says that George Soros is currently hedging the S&P 500. I'm sure that there is a logical or statistical basis for his tactic  because all evidence says that the stock market is high now.  The support of the Fed will continue to keep the market at high levels into next year, though.  I'm not buying the S&P short ETF, SH, just yet. However, I have about 1% of my portfolio in the VIXX index and an interest rate short index, both of which have declined and are near all-time lows. The VIXX index measures market volatility, and it goes up when the stock market goes down.  It is at all-times low, which is an indicator that the stock market will go down.  

From a policy standpoint the New York Sun's Seth Lipsky continues to offer a still, small voice of financial sanity among the Sodom and Gomorrah of the American media.  Sadly, Paul Krugman will have to turn into a pillar of salt before any change in America's addiction to print-and-spend economics ends. 

For now, I'm buying a little more Chicago Bridge and Iron (CBI).  It's gone up a few percent since Buffett bought a second set of shares; according to Seeking Alpha several other hedge funds are piling in.  The sharp decline due to rumors about improper accounting and the firm's president's illness seems to have offered Buffett and other hedge funds a buying opportunity; including pension fund holdings, Berkshire may own 25%. 

Stock Market Volatility

As of this writing the Dow Jones Industrial Average is up 389 points today, and it was up 450 points an hour ago.  The graph above, from IStockAnalyst.com is of Thursday's Dow.  The 700 point intra-day dip is widely attributed to a trading error.

The trading error scenario spooks me.  If a trader's error can move the Dow 700 points, then that same trader can manipulate the market 700 points.  Saying that a single, unidentifiable trader can manipulate the entire stock market 700 points changes my world view. 

I do not believe in conspiracy or market manipulation theories because economic incentives and the power of imitation are powerful enough to explain virtually all patterns.  Conspiracies exist at times, but they cannot explain most real world phenomena.  Add to that the psychological bias known as fundamental attribution error, the tendency for people to see situations as due to human causes.  For example, for most of human history people believed that Zeus or similar anthropomorphic gods caused thunder and lightening. Conspiracy theories are Zeus-like explanations.

If you had asked me last week whether a single individual could cause a ten percent fall in the Dow by manipulating price, I would have answered absolutely not.  But everyone else, every major financial news source, says I'd have been wrong.  There are enough players who can do this that (1) a simple mistake caused Thursday's 7% intra-day dip and (2) no one can figure out who it was, which means that there are enough such players to make it hard to figure out.  Short term market fluctuations are even less meaningful than I would have thought.


The VIX, a measure of stock market volatility, had mushroomed in recent days (see Yahoo! chart here)  but it fell sharply today, 30% as of 10 AM, following the announcement of a European rescue plan for Greece. Nevertheless, it is still high.  High volatility is associated with stock market bottoms, at least in the intermediate term.

Let's say the sharp dip on Thursday and the sharp increase today are due to the Greek crisis. It seems to me that the Greek cure will work for several years but not forever.  In order to solve their problems, Europeans will need to curtail spending, which would seem to have a detrimental effect on demand, hence profits, hence the markets.  Sounds like the US as well. Without monetary expansion the world economy is burnt toast. The real quality of life has been falling for decades as Federal Reserve Bank monetary expansion has subsidized government, hedge funds and Wall Street at the expense of productive Americans.

One analyst on Kitco  is predicting hyper-inflation as the US and Europe continue to subsidize real estate and stock markets through monetary expansion.  Bloomberg reports today that Ben Bernanke and the Fed have redefined what they mean by "tightening."  Undergrad economics students learn that the Fed tightens by selling treasury bonds to big money-center banks.  The cash received for the bond sales is taken out of circulation, reducing the money supply. In turn, that pushes interest rates up.  But here is what Bloomberg says the Fed now means by "tightening", according to Mitch Stapley of Fifth Third Asset Management:

"Altering a pledge to keep short-term borrowing costs low or articulating plans to begin selling the $1.1 trillion in mortgage-backed securities it now holds will amount to a tightening of monetary policy because the announcements will send bond yields higher, raising borrowing costs, said Mitch Stapley, chief fixed-income officer at Fifth Third Asset Management in Grand Rapids, Michigan."

In other words, the Fed will tighten by saying it will tighten, not by actually tightening.  That sounds a lot like my diet plan, except saying I'm going to diet doesn't have any real long term effect.

The central banks are painted into a corner.  If they raise rates then the world markets will fall.  If they continue to keep them at extraordinarily low levels (money market funds are essentially paying zero now) then there will be escalating inflation.   When inflation starts, there will be few ways to stop it.  One option might be to let the inflation ride. The Kitco analyst is thus predicting a 50,000 Dow, up five-fold from today.

A 50,000 Dow would mean that a dollar today would be worth a small fraction of its current value.  I don't subscribe to that prediction (who knows?) but it does need to be considered.  The other alternative, responsible tightening, would lead to falls in employment and an economic slow down.  Given that unemployment increased recently to 9.9%, according to the Bureau of Labor Statistics, I suspect that Bernanke, et al. aren't in a hurry to raise rates.*

The response to the rising unemployment will likely be additional infusions of money into an already bloated monetary base (recall that Mr. Bernanke and the Fed tripled the monetary base in 2008, and that money is still ready for banks' use).

I happen to have "A" credit (I'm insane, I should have bought a McMansion and gotten the Fed to pay off the mortgage) and have started to get those invitations for credit card checks like I used to get a few years ago.  Might inflation be right around the corner?

The one factor that has offset the inflationary bias in the economy is China.  But China is likely to be thinking about expanding its home market rather than continuing to work for ever lower wages selling exports bought in a depreciating US dollar.  If China starts pulling out of the dollar, then stock market increases will be over-matched by commodity increases as the dollar dwindles into the dust heap.



*The BlS writes:

"Nonfarm payroll employment rose by 290,000 in April, 

the unemployment rate  edged up to 9.9 percent, and 

the labor force increased sharply, the U.S. 
Bureau of Labor Statistics reported today. 

Job gains occurred in manufacturing, professional 

and business services, health care, and leisure 

and hospitality. Federal government employment 

also rose, reflecting continued hiring 
of temporary workers for Census 2010."

How Federal Reserve Policy Has Reduced Wages

The economists who have been managing the money supply since the 1930s have generally followed a low interest rate policy in order to stimulate employment. When the Fed introduces extra money into circulation interest rates fall. This in turn stimulates economic activity because it is cheap to borrow. The additional economic activity results in hiring, and employment increases and unemployment decreases. This is the pattern that has motivated the Federal Reserve Bank's officially-induced inflation since the 1930s.

However, the long run effects of low interest rates may be opposite to the short run effects. There are strategic as well as stimulative effects of easy money.

The economic historian TS Ashton notices this in his little book The Industrial Revolution: 1760-1830.* Ashton notes that the course of innovation in 18th century Great Britain tended to respond to the availability of labor. Early innovation focused on harnessing the forces of nature. The success of this early innovation led to increasing population. But in the 1730s and '40s labor was still scarce and capital abundant, so:

"attention was centered on labour-saving mechanisms, such as those of Kay and Paul in the textile industries; and the search continued until in the 'sixties and 'seventies it culminated in the appliances of Hargreaves, Arkwright and Crompton. By this time the nature of the economic problem was changing: population was beginning to press on resources. The quickening of the pace of enclosure and the breaking in of the waste were the outcome of a growing demand for food; Watt's first engine and the Duke's canals were the answer to a problem set by a shortage of coal...Towards the end of the century and later, when rates of interest were moving up, some (though by no means all) of the inventors turned their minds to capital-saving ends. The newer types of engine of Bull and Trevithick and the newer ways of transmitting power, dispensed with much costly equipment...It would be dangerous, however, to press these generalizations far. There was often a lag of years between an invention and its application, and it was this last, rather than the discovery itself, that was influenced by such things as a growing shortage of materials or a change in the supply of labor or capital."

Taking Ashton at his word that the effects of policies are often approximate and long term, what would be the long as opposed to the short run effects of artificially stimulating the amount of available capital, i.e., the Federal Reserve Bank's artificially increasing the amount of money?

In the short run, in which the ratio of labor to capital is constant, demand for labor will naturally increase in proportion to the increased capital due to the Fed's monetary expansion. In the short run, the production function is constant, so the increased supply of capital increases labor demand.

In the long run, however, the production function is no longer constant. Production and innovation will focus on cost saving with respect to the relatively most expensive resources. Since capital has been made artificially cheap, the cost saving on which industry focuses becomes, because of Fed policy, finding new methods to save on labor costs. Capital investment focuses on saving labor through new machinery or alternative uses of capital such as plant relocation.

This, rather than enhanced transportation and reduced trade impediment may explain the relocation of plants overseas. General Motors, for example, has moved the majority of its plants to Mexico yet still complains about labor costs with respect to the slim percentage of remaining US employees. It costs money to move plants overseas. The learning required to competently manage a foreign plant is significant. Errors with respect to cultural differences, misunderstanding of legal systems, political risk, transportation costs (themselves reflecting capital costs) all amount to non-labor costs that are financed through reductions in capital costs.

Thus, over the long run, the Federal Reserve Bank effectively increases firms' strategic focus on capital investment by reducing the cost of capital. This has the perverse effect of reducing labor demand while increasing firms' profitability. This in turn leads to a two-tier economy in which technological workers who benefit from employment in excessively capital intensive firms earn super-normal wages while a large number are excluded because excessive capital investment has made their services redundant.

Traditional macro-economic models do not assume change in technology due to monetary policy. But firms have moved plants overseas because Fed policy has reduced the cost of doing so because it has increased the advantage of utilizing capital over labor (because it reduces capital costs). Strategically planning firms shift their production functions to invest more in labor-replacing capital investment. This reduces wages over the long term even as it stimulates labor demand over the short term. The labor-stimulating effects of new money are reduced over the long term, and like a drug addiction, the amount of money needed to achieve full employment increases at an increasing rate.

Thus, Keynesian policy in the long run produces results that differ from those in the short run. If this is so, we would expect to see higher wages from Keynesian policies from the 1940s to the 1960s, and lower wages from the same policies thereafter. This is what has occurred. However, rather than question their own assumptions, Keynesian economists seek elaborate, often illogical excuses in areas like blaming trade, income and capital gains tax policy and free market processes for declining real wages. This in turn leads them to advocate further capital investment and injections of money that stimulate labor demand in the short run but add to further replacement of labor by capital investment in the long run. Perhaps this is what futurists refer to as a coming "singularity", the ultimate replacement of human agency with machinery because of super-acceleration of technological advance.

*T.S. Ashton, The Industrial Revolution 1760-1830. London: Oxford University Press, 1948, p. 91.

Bernanke, Ridin' That Train, Lowers Rate 75 Basis Points

"Ridin' that train. High on cocaine. Casey Jones you better, watch your speed. Trouble ahead; trouble behind. And you know that notion, just crossed my mind."--The Grateful Dead

Money News on Newsmax reports that the Fed has lowered interest rates 75 basis points (from 4.25 to 3.5 percent), "the biggest one day move in recent memory".

Gold stocks continue to perform well, but at 11:40 the Dow is down 138 points to 11961, the S&P 500 is down 23 points to 1302 and the Nasdaq is down 55 points to 2285.

The Fed is concerned is concerned about recession fears and the recent sharp stock market declines. The interest rate cuts should boost stock values but will also continue to depreciate the dollar. The Fed reduces interest rates by printing money. Lower interest rates enable unproductive firms to remain in business because their costs of borrowing are reduced. Firms that do not create a market-determined value that would enable them to exist are subsidized by increasing the money supply, which reduces wage earners' inflation-adjust salaries. Thus, the Fed is taxing the productive sectors of the economy to subsidize the unproductive ones. The unproductive sectors are centered on big business, the financial sector and Wall Street, who have (1) extracted excessive CEO and investment banker salaries; (2) repeatedly made terminally stupid business decisions; and (3) and now go to the Federal Reserve welfare trough for a bail out.

Meanwhile, the dollar will depreciate and inflation will escalate.

Although the markets are cool now, they likely will heat up in response to the reduced rates, but the response will be temporary.

The American Economy and Premium Dog Food

Scanning the September 10, 2007 New York Sun, New York's best newspaper, I notice several articles about international affairs and several about the economy. Of the articles about the economy, one is reluctantly bearish while the others argue on behalf of "accomodative" Fed policy, i.e., reduction of interest rates, expansion of the money supply and (although the pieces do not mention it) subsequent inflation.

Dan Dorfman's bearish article on the front page notes that Oppenheimer and Company's Michael Metz has forecast a 1,600 point drop in the Dow because there is a "90%" chance of "a long-term recession". Dorfman quotes Metz as citing reasons like declining consumer spending, withdrawals of money from hedge funds, and reduced analyst estimates, all of which result from insufficient market response to Fed Chairman Bernanke's interest rate cuts a couple of weeks ago. The article does not mention whether Mr. Metz would favor additional interest rate cuts.

Of course, inflation already moves full speed ahead. I noticed that a half gallon of organic milk in a Manhttan grocery store was $5.95 the other day, twenty percent more than a couple of years ago. As Howard S. Katz has pointed out, Wall Street's selfish fixation on low interest rates, an important source of income inequality, leads to a reallocation from the poor to the rich. The poor devote most of their income to consumption and so are worst hurt by inflation, while the rich are the largest beneficiaries of the increasing stock markets that result from reduced interest rates. Not surprisingly, the Ivy League economists who claim to oppose income inequality and whose graduates dominate Wall Street mostly oppose increasing interest rates and steadying the money supply. Over a multi-decade period money supply increases lead to inflation, and dog food consumption among the poor and elderly. Like Howard S. Katz, Metz recommends gold stocks.

More openly arguing in favor of the elderly's eating dog food, although not explicitly stating that he favors welfare subsidies for multi-millionaires extracted by government fiat from the poor via the Fed, on page 11 Lawrence Kudlow argues that "you don't have credit blowups, liquidity freezes, dysfunctional commercial paper markets, suspect bank loan quality...when bank policies are easy and accomodative".

Mr. Kudlow is concerned that higher interest rates lead to lack of financial confidence, fewer jobs and less "economic growth". There is naturally a trade-off in the short run (but not the long run) between employment and inflation. That is because the monetary depreciation that Mr. Kudlow, Wall Street and the Keynesian liberals advocate encourage unproductive businesses that would not exist in a market system. For instance, developers sell large, environmentally unfriendly houses in part because low interest rates subsidize their true cost. Expensive Manhattan restaurants flourish when Wall Streeters take home $750,000 salaries and can afford to eat weeknight dinners out at $300 for two. Tighter interest rates mean that the Palm, the 21 Club and the Homestead Steak House will not be as crowded. Mr. Kudlow's Keynesian policies would subsidize inefficient businesses that do not produce value, relying instead on government welfare policies that take wealth from the poor and elderly to subsidize investors. Short-term declines in payrolls are not a bad thing when subsidies to incompetent corporate gamesmen who do not create value are ended, and I feel much less sorry for them than I felt for the those taken off welfare during the 1990s welfare reforms. Kudlow's plan is to stem slight decreases in payroll and potential layoffs by inefficient businesses (inefficient because they do not generate enough profit to cover slight increases in interest rates) by printing more money, causing more inflation, and reducing interest rates from 5.25% to 4%. Mr. Kudlow is the best friend the dog food industry ever had, and I am certain to invest in Nestle, the owner of Purina and Alpo, if Mr. Kudlow's policy prescriptions are adopted, since lots of old people will be eating it while Mr. Kudlow enjoys his favorite Manhattan watering hole.