MT Capital Research Musing #3
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My next deep-dive will be released next weekend. Stay tuned for that.
Let’s get started.
On January 21st of 2020, the CDC confirmed the first case of the novel 2019 coronavirus in the United States. Shortly thereafter, the WHO went on to officially declare Covid-19 a pandemic. What would follow would truly become an unprecedented time in human history. A world that prided itself on its hustle and bustle screeched to a halt, the imposition of isolation and social distancing became widespread, and industry came to a stand-still. At first, though as ludicrous as it seems now, the unknown nature of the pandemic and the many directions it could’ve taken instilled an uncertainty into day-to-day life.
Faced with the unpleasantness of unforeseeable outcomes, the resultant policy response was truly unique. In order to attempt to stifle out economic calamity, rates were quickly cut to zero, the Fed and other Central Banks engaged in massive purchases of securities, and fiscal stimulus seemed be endlessly abundant as governments around the world dropped helicopter money to all those that would take it. The degradation of the sanctity of money itself appeared to be unbounded as its supply expanded at truly unprecedented levels.
What would follow was to be expected. As liquidity sloshed around the system, as individuals cooped up at home consumed rapidly, and as semi locked-down economies spurred on supply side shocks galore, inflationary pressures eventually reared their ugly head. Though down from its peak, we now have persistent inflation that remains at levels that haven’t been seen in nearly forty years. The erosion of purchasing power continues to no avail.
In addition, the continued manipulation of markets is diminishing their ability to function in a healthy manner. Over the course of the last few decades, we have seen increasing levels of Central Bank intervention, a phenomenon that would disgust economists of the Austrian variety. Arguably, these happenings can be traced back to Alan Greenspan, the man that held the position of Fed Chair from 1987 to 2006. Throughout his tenure, the market became acquainted with the notion of the Fed put, a belief that markets had an embedded level of safety since the Fed tended to intervene when a downturn was underway. Intervention examples include 1987, when the Fed rapidly cut the Fed Funds Rate amidst a market crash in an attempt to cauterize the bleeding, strengthen the economy, and counter deflation, in 1998 when the Fed organized a group of 14 different banks and brokerage firms to invest billions in LTCM, an almost defunct hedge fund at the time whose imminent collapse posed a risk to the stability of Global Markets, and in the early 2000s when rates were rapidly cut in response to the pin-prick in the Tech Bubble that threatened to do some serious damage. Although Greenspan arguably gave birth to the Fed put, it didn’t fade into the void when his time at the Fed came to an end. Ben Bernanke, the later Fed Chair, leveraged a similar tool-kit as his predecessor during the Great Financial Crisis, cutting the FFR from the 5% range in 2006 all the way down to the low zero bound as economic turmoil spread. However, unlike typical instances of rapid rate cuts, their effect on the economy left much to be desired. Contraction continued to occur, and a new tool had to be employed as a result. Enter Quantitative Easing. In its simplest form, QE is a form of monetary policy where a Central Bank purchases securities from an open market in order to put continual downwards pressure on yields, and to stimulate the economy by way of the provision of liquidity. The use of QE started with QE1, where the Fed purchased large quantities of securities from December of 2008 to the beginning of 2010, continued with QE2 where weak employment and output spurred the Fed to purchase treasuries into the second half of 2011, occurred again with QE3 where billions in treasuries and MBS were purchased each month from September 2012 to October 2014, and crescendoed with QE4, when the pandemic spurred drastic responses. Not only is the Fed intervening in markets at a higher rate, but they continue to adopt new tools in order to achieve their aims as tactics of the past potentially loose their efficacy.
The byproduct of these happenings are evident. Valuations reached astronomical levels and arguably still remain elevated relative to history, the narrative of “there is no alternative”, driven by consistently negligible real yields, spurred exorbitant levels of risk taking across all asset classes, creating an everything bubble that continues to nastily deflate, and business models that would not survive outside of an environment with zero cost of capital somehow clung and continue to cling onto questionable existences.
With Central Banks essentially winging it with tools that have not gone through enough empirical testing for my liking, I find it unlikely that there is no long-term implications associated with their widespread application. I feel very uncomfortable holding any meaningful amount of cash when at the turn of a dime total money supply can increase by 30%+ in response to a crisis that has emerged. With the current over-financialization of the very world around us, and the tendency for Central Banks to continue their endless array of experimentation in order to pursue their agenda of “price stability”, I am concerned with the ability for markets to function properly.
With all of this in mind, gold helps assuage my fears. I find comfort in the fact that humans have assigned value to gold for thousands of years and will likely continue to do so for thousands more, that gold offers a certain degree of independence from economic and financial systems and is not subject to the erosion of its value as a result of Central Bank and Government policy, and that no matter the economic environment we find ourselves in, whether it be a secular decline, rebirth, boom, or prolonged period of stagnation, gold historically has been able to maintain its value. Although this may be viewed as an old-school take, I believe gold is valuable in a portfolio setting, and at the very least offers an attractive alternative to other assets commonly held as reserves that are much more subject to deterioration in both quality and sanctity over time.
Next week I will touch upon gold further & discuss a company that offers an attractive mechanism to gain exposure to the precious metal.
MT Capital Research.