13 Nov Expiring Canaries*
Expiring Canaries
The June 24th TLR quoted several prominent hedge fund managers who in June asserted that gold was entering a new bull market when it broke through the $1400/oz. price level. That June 24th TLR, “The Canary in the Gold Mine,” suggested that if gold were able to hold the $1400/oz. level, and then consolidated and began climbing, it would be acting as the proverbial canary in the global economic coal mine, heralding a period of economic turbulence. So far, that is precisely what has happened. Legendary fund managers Jeffrey Gundlach, Paul Tudor Jones, Stanley Druckenmiller, David Einhorn, and Paul Singer have believed for some time that the global economy may be running on fumes (powerful fumes, but fumes nonetheless), that economic and/or geopolitical danger lies ahead (how far ahead they’ve emphasized is unclear), and that fundamental economic analysis is signaling caution (though not yet danger). They’ve therefore from time-to-time invested significant amounts in gold against what they’ve perceived to be a potential an inevitable global meltdown. Although timing is everything, they’ve cautioned that value comes from paying attention to dying canaries in order to safeguard against a sudden end to the current virtuous cycle.
The July 24th TLR discussed a subsequent commentary by Ray Dalio entitled “Paradigm Shifts” that explained the reasons why, in Dalio’s view, developed economies are on the verge of significant economic, political and social change. In “There’s Something Happening Here,” TLR pointed to a July break-out in the price of silver as providing a further indication that “something’s happening here …, [although] what it is ain’t exactly clear.” There is sufficient evidence that things economic are not quite right, and that there’s a substantial degree of dissonance in economic fundamentals. The silver canary bit the dust shortly after the gold canary …, and the public pronouncements of economic superstars like Dalio thereafter added to the canary warnings. The July 26th TLR (quoting Pericles) warned that “The key is not to predict the future, but to prepare for it.”
Additional dead canaries have been turning up …, and in oddly disturbing ways.
Anne Korin, co-director of the Institute for the Analysis of Global Security, sees a cabal of countries working at ways to weaken the US Dollar. She cautioned that China, Russia and their allies (see “Axis of the Sanctioned” in the June 21st TLR), as well as the European Union, have a motivation to de-Dollarize – that is, break away from the global hegemony of the US Dollar by strengthening other modes of payment. The Dollar has been the linchpin of global growth and stability since the 1940s – see, for example, “A Weaker US Dollar?” in the August 26th TLR and “Be Careful What You Wish For” in the July 19th TLR. China has been actively working on Dollar end-arounds, in part by promoting a “Petro-Yuan,” initially through the introduction of Chinese-currency-denominated crude oil futures, and it intends to pay for imported oil (from Saudi Arabia, Russia, and other oil-producing countries) in its own currency, the Yuan, instead of the Dollar. In this regard, see “Red Storm Rising” in the April 12th TLR, “Axis of the Sanctioned” in the June 21st TLR, and “The Failure of American Foreign Policy” in the September 30th TLR.
Interestingly, Korin punctuated her analysis with, “I think [de-Dollarization is] a canary in the coalmine [an interesting choice of terms, no?]…. If [the Dollar ceases to be the sole currency used for payment of crude oil], that’s a nudge in the direction of de-Dollarization…. We don’t know what’s going to come next, but what we do know is that the current situation is unsustainable.”
“Unsustainable” is a rarely-used term.
Insofar as the EU’s intentions are concerned, Korin added that “Europe wants to do business with Iran. It doesn’t want to be subject to U.S. law for doing business with [anyone]…. Nobody wants to be picked up at an airport for doing business with countries that the U.S. isn’t happy that they’re doing business with.”
Korin is not the first to warn about the risks of a weakening US Dollar (the same subject was addressed in the August 26th TLR). Should the Dollar begin to weaken, the concern is that its slide might get slippery …, and that another canary might bite the dust.
And then there’s the Repo Crisis. In case you missed the drama, on September 17th the overnight “repo rate” jumped from ~2.5{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} to 10{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35}. For those unversed in market dynamics, such a move is unprecedented and the fourfold overnight jump understandably spooked the market … as well as the Federal Reserve. Repos are the way banks and big businesses obtain liquidity. A repurchase agreement – or a “Repo” – is a sale of U.S. government securities from a borrower to a creditor, with an agreement to buy them back – repurchase them – at a set date in the future for a specified price. It’s therefore the equivalent of a gigantic financial pawn shop where banks can “pawn” their US Treasury securities (which regulations force banks and financial institutions to hold as reserves) in order to free up cash to use in their businesses. We all are aware that the Federal Reserve sets U.S. interest rates through its published “target rate.” What you may not know is that the Repo market is integral to how the Fed implements that “target rate.” On a day-to-day basis, it ensures that interest rates remain within its “target range” by adding and subtracting liquidity in the Repo market …, of course only on a micro basis through gentle nudging. Except, that is, in September 2019 when interest rates skyrocketed … forcing the Fed to react massively to avoid a Dollar-liquidity crisis.
The Fed’s reaction was to commence a new round of Quantitative Easing monetary easing liquidity-enabling (which the Fed has announced isn’t really QE …, not at all). The prior last final round of QE – that is, QE3 – lasted from 2012-2015 and consisted of Fed purchases of Treasury bonds equal to $85 billion/month. The newest round of QE monetary easing liquidity-enabling – “QE4” – commenced on September 17th. For the first 30 days, that liquidity-enablement totaled over $205 billion which, the Fed announced, would continue through at least the 2nd quarter of 2020 at the rate of at least perhaps $60 billion/month. There are any number of thoughtful, carefully-researched theories about what is occurring in the Repo market – what it is that has occurred that would require such an massive amount of QE monetary stimulus liquidity-enablement less than a year after the Fed had raised interest rates in an ongoing liquidity-tightening strategy …, but no consensus. Whatever the cause(s), this isn’t a good thing.
There most certainly is something happening here …, and what it is indeed is unclear.
A picture is worth a thousand words, which is why the chart below is worth a look. It shows the Fed’s overnight Repo activity from and after 1999. As can easily be seen, 9/11 saw quite a spike, as did the financial crisis of 2008-09. In both periods, the Fed stepped into a chaotic situation as lender-of-last-resort to ensure that there was adequate liquidity in the U.S. monetary system. And, yet, neither of the Fed’s responses to the 2001 or 2008-09 “chaotic situations” compares to the Fed’s liquidity-enablement response in 2019.
The Repo market may be another canary that has bitten the coal dust.
Add the Repo canary to the gold, silver, Dalio-and-friends ones … and you have four 2019 bodies.
The wealth gap in the U.S. has reached historic levels. The net worth of the top 1{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} of Americans now approximates the net worth of the bottom 90{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35}. That amounts to a social and political canary-in-a-coal-mine. Geopolitical risks exist aplenty, as does a unique confluence of farming, industrial, technological, biotechnological and weapons revolutions. See “Red Storm Rising” in the April 12th TLR and “Foggy Economics” in the October 7th TLR. Economic, social and geopolitical canaries like these rarely die a natural death. Most often, they die for a reason.
However (isn’t there always a “however”?), U.S. consumers remain healthy, America has strong labor and housing markets, and manufacturing is ever-so-slowly creeping up. For these and other reasons, one reasonably might conclude that the inevitable a forthcoming recession isn’t imminent.
Finally (from a good friend)
*┬® Copyright 2019 by William Natbony. All rights reserved.
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