Wall Street’s Lucre
Lucre: money, especially when regarded as sordid or distasteful or gained in a dishonorable way.
The shock of the Panama Papers rippled with sensational headlines involving over 100 politicians from Iceland, Russia, China, United Kingdom and Argentina amid allegations of illegal offshore accounts set up by Mossack Fonseca, a Panamanian law firm. A whopping 11.5 m leaked documents exposed collusion among some of the world’s largest law firms and more than 500 banks which helped their clients over a 40 year period to set up offshore structures. Panama is now known for more than the site of the canal or Noriega. To date a sustained global crackdown has closed former tax havens like Switzerland, Luxemburg, and Cyprus, ironically leaving America as the largest tax haven of choice because Nevada, South Dakota and Delaware do not have to disclose beneficial ownership of shell companies incorporated in their jurisdictions. How strange then, that among the Panama Papers’ 2.6 terabytes of data, there are so few US players.
Part of the reason is that populist governments, desperate for revenues to close their budgetary deficits are looking for ways to fund their existence in the wake of the 2008 financial crisis and subsequent recession. Politicians too have capitalized on the rising anger of voters unhappy with the idea of giving wealthy companies tax breaks. The release of millions of documents from Mossack Fonseca served as a lightning rod for public anger at the one percenters perceived to be using offshore structures to stash their cash. This newly created Black Swan attack has unsettled the stock markets crushing underlying players like the big hedge funds (inversions), corporate lawyers (Panama Papers) and big investment banks (billion dollar fines). No wonder the cost of insurance against defaults have skyrocketed.
More is now clear. The Panama Papers and tax inversion issue (or lack thereof) have become part of the White House’s Robin Hood policies of attacking big money, despite having the highest tax rate in the corporate world. The voters, street protesters in Europe and supporters of Trump/Sanders are mad as hell with the establishments’ inertia to keep their promises which have fueled a rage transcending political boundaries. And, institutions like their central banks are also under fire because most investors have no idea what central banks are really doing with their trillion dollar experiments.
The Tide Turns
Plenty of problems are in evidence. There is deep concern that America is mired in legislative gridlock, due primarily to partisan rivalry with the November election turning both parties into a mud-fest and the likelihood of an “open” convention. Oft promised tax, healthcare and social security reform were shelved. Most significant is that the Fed’s insatiable requirement for credit remains unfulfilled with a buyer strike of US Treasuries, led by the Chinese and offshore players who are balking at the negative returns. And, growth of the world’s second largest economy, is pegged at 6.5 percent, insufficient to pull other Asian countries along as worries continue that China’s pump priming will inflate already large bubbles. Yet, everyone misses that the sums owed are primarily to the government which has abundant lending room. And for those worried about capital shortfalls, the Chinese appetite for overseas assets (other than Treasuries) were at record highs in the first quarter reflecting China’s biggest export to date, cash.
Elsewhere, the refugee crisis has caused the European Union’s leaders anguish as voter hostility to immigration has caused a dip in political popularity in line with the increased social services expense. Then there was disappointment that “do whatever, it takes” Mario Draghi’s big bazooka fired yet another blank. Italy has unveiled an “Atlas” bank rescue fund too small to fix the problem. Both Italy and Greece are saddled with the heaviest public debts with Greece at almost 200 percent of GDP and the IMF has not yet extended the necessary loans for a third bailout. Problems remain. The UK Brexit referendum in June not only threatens the EU itself but its Schengen open border policy as well. These cans can’t be kicked down the road.
Topsy Turvy World
Against the backdrop of slow to nonexistent growth and awash in a red tide of debt, the Fed is reluctant to raise rates after increasing them a modest quarter point in December. Fed Chair Janet Yellen with little room to maneuver is reluctant to move rates amid mixed economic numbers as well as being seen to influence events in the shadow of a presidential election year. How did the Fed lose room to maneuver? The answer is rooted in Obama’s misguided economic policies. Repeatedly the US has spent more than they earned, borrowing trillions from abroad just to balance its books. And, Bernanke and now Yellen’s wholesale money-printing (aka debasement) has become the policy du jour. At 110 percent of GDP, America’s debt stands at $19 trillion, the largest in the world. Meantime, the market’s fear of stagflation has caused the markets to swoon.
We believe funding the largest debtor in the world will be a problem this year. While property bubbles eight years ago were deflated, they have inflated again as a consequence of over-easy monetary policies. Another boom (and bust) was fueled in part by overseas buyers. Ironically, homeowners blinded by cheap mortgages, loose lending standards, and greedy banks are due for another bust. Home prices have exceeded wage growth in nearly two-thirds of US markets. The average homeowner needs to spend 30 percent of monthly wages just to make monthly payments. Déjà vu.
And unlike Wall Street which had protection in the last bust, homeowners aren’t offered the same bailout. To be sure an increase in the cost of money would tip the economy into a recession. This housing recovery is built on sand. Instead, much of the Fed’s intervention created cheap credit which benefited the financial engineers of Wall Street and its debt-financed M&A activity giving the White House an excellent opportunity to scapegoat business in an election year.
In this world of cheap credit, negative interest rates have produced a topsy-turvy world where debtors are paid to borrow. Savers are again penalized. What this means is that the underlying debt burden just mounts higher with increased volatility. Worrisome is that junk debt yields are estimated at 8.5 percent and the debt to asset ratios are creeping up led by leveraged energy stocks, recent M&A busts and share buybacks. Debt defaults have become a reality. Eight years ago the governments bailed out Wall Street. With empty government coffers, Cyprus and now Canada, have implemented a “bail-in” regime that leaves depositors with the bill. Not only must you pay the bank to hold your cash but it is at risk to bail out the very same institution. Gold is a good thing to have.
Gold Is The Ultimate Currency
Gold is a beneficiary of negative interest rates and its best performance in four decades is due more to haven buying on fears of fragile global growth exacerbated by our central banks’ lame attempts to revive the global economy, saddled with too much debt. After eight years of central bank intervention using unorthodox and experimental measures, our monetary maestros simply have run out of options. Gold gained 16 percent in the first quarter, reversing the three-year downtrend. A new bull market has just begun. Gold’s rise shows investors are nervous. There has been another reason for the rise in gold. Last year central banks purchased almost 500 tons of gold led by China and Russia. They remain big buyers with some repatriating their stores of gold moving their reserves “closer to home”. The year before, nineteen banks were net buyers of gold continuing a trend starting as far back as 2008. Yet their purchases have been largely price insensitive. China and Russia having more dollars than they want have become enormous purchasers of gold partly as a hedge against the currency debasement and inflationary consequences of the west’s central banks’ radical measures to revive the global economy. They also fear a collapse in the purchasing power of their dollar stocks. Instead of FX purchases, the gold purchases allow these central banks to hedge against a volatile greenback, lessening pressure on their own currencies and ironically, the inflation risk. Both countries have become the fifth and sixth largest holders, ahead of Switzerland, Japan, and Canada who sold its last ounce last year.
Gold is also a barometer of anxiety, and today there is much anxiety. The mighty metal is highly liquid and easily exchanged for other currencies. It’s controlled supply serves as a limit for central banks from printing money, putting a cap on profligate government spending. Former Fed Chair, Alan Greenspan, once wrote that ‘without a gold standard in place, there is little to prevent governments indulging in wild credit creation.” The balance sheets of many central banks are stuffed with debt, so their gold holdings have become increasingly important. We believe their gold purchases and repatriation are part of the refashioning of the global monetary architecture, ending US financial hegemony. Of course, gold can go higher.