Unusual Times and Circumstances: Fasten Your Seat Belt!

A confluence of unusual factors promises an unusually interesting year ahead for the U.S. economy, politics and financial markets. Discussed first, the economy appears headed into its first formal recession since the Great Recession, as signalled by an “inverted yield curve” among other indicators. The oncoming recession already has begun to unfold.  

Second, with U.S. federal debt levels up against the debt ceiling, a euphemistically entitled Modern Monetary Theory (MMT) has generated some political turmoil in Washington. Largely dismissed out of hand by mainstream economists and politicians, MMT offers a rapid downhill ride into a U.S. hyperinflation. In contrast, mainstream U.S. politicians already have the U.S. on a slower, albeit just as calamitous downhill ride into hyperinflation.  


The March 28th initial estimate of first-quarter 2019 U.S. Gross Domestic Product (GDP) showed annualised 3.2% real or inflation-adjusted quarter-to-quarter growth, well above consensus expectations, picking up from what had been a weakening 2.2% growth rate in fourth-quarter 2018. That first-quarter gain was despite most of the underlying consumer-related numbers showing headline economic activity falling into a new recession. Rate hikes and liquidity tightening by the U.S. Federal Reserve of the last eighteen months had constrained consumer income and finances, and related consumption slowed markedly in fourth-quarter 2018, due to the intensifying consumer liquidity stresses. 

What eventually should gain recognition as a formal U.S. recession has been camouflaged partially by economic reporting distortions and disruptions from the partial shutdown of the U.S. Government in December 2018 into January 2019. Going forward, with new reporting and July 26th GDP benchmark revisions, both fourth-quarter 2018 and first-quarter 2019 should appear much weaker in revision than they do now. 

Where the consumer accounts directly for 72% of the GDP, the first half of 2019 already faces a rapid slowdown. First- and second-quarter 2019 GDP likely will set the stage for a formal recession call in third-quarter 2019, accompanied by renewed liquidity easing and interest rate cuts by the Federal Reserve’s Federal Open Market Committee (FOMC), despite any current protestations to the contrary by the U.S. central bank.   


If you were to plot a graph of market yields on Treasury instruments against their maturities, from left to right, from shorter-term to longer-term, the plot of yields or the “yield curve” normally would have a “positive” or increasingly rising slope, from left-to-right, from shorter-term to longer-term maturity. That circumstance reflects yield risk perceptions in the markets, where generally longer-term investments command a higher return than the shorter–term investments. With a pending recession, the risk shifts to the near term, with higher yields upfront and relatively lower yields in the longer term as flight capital seeks the longer-term rate stability. The current circumstance with higher near-term yields reflects an “inverted yield curve.”

Indeed, prior to the initial “strong” first-quarter GDP release, the financial markets had been anticipating an economic downturn, where the yield curve on U.S. Treasury Bills, Notes and Bonds had turned negative. Yet, despite some fluctuation and flattening, after the initial first-quarter GDP report, the yield curve remains inverted, as this article is put to bed in the second week of May 2019. 


The current “inverted yield curve” signal represents what would be the first formal recession—back-to-back real quarterly contractions in real GDP—since the Great Recession, and since the FOMC’s Quantitative Easing (QE) was used to bailout an insolvent banking system in the 2007/2008 collapse. There could be some market distorting factors in the Federal Reserve’s continued massive holdings of U.S. Treasury securities from the QE, combined with its continued close targeting of near-term interest rates.  

Some argue that imbalances in the supply of certain-term Treasury securities could be distorting the yield curve.  I would argue that the yield shifts and coincident economic news have been meaningful and consistent enough to confirm that the usual “yield curve” recession warning is in play.


Previously discussed in Executive Global:[ Executive Global Autumn 2018, “Returning to a Gold Standard Is Not a Substitute for Fiscal Restraint”] “Without a near-term, massive shift in U.S. fiscal policies to raise significant new revenues (taxes) and/or to cut outlays (expenses and obligations) meaningfully, the U.S. Treasury faces long-range insolvency. Yet, raising taxes and cutting spending enough to restore fiscal discipline does not now appear to be politically feasible, at least in the United States.

“Standard & Poor’s downgraded its rating of U.S. Treasury securities in 2011. Then former Federal Reserve Chairman Alan Greenspan noted at the time that there was zero risk of the U.S. Treasury defaulting on its obligations. He noted that Treasury obligations were denominated in U.S. dollars, and that the U.S. always could print as many dollars as it needed. Dr. Greenspan was correct, where unbridled printing of U.S. dollars would not be an event of default for Treasury securities, although such likely would be considered an implicit default, likely triggering massive flight from the U.S. dollar.  Nonetheless, such a circumstance would lead eventually to runaway domestic inflation and full debasement of the purchasing power of the U.S. dollar.”


William F. “Bill” Mitchell, Ph.D., Professor of Economics at the University of Newcastle in Australia, not only is a primary proponent of Modern Monetary Theory (MMT), but also named the theory. He also is a noted reggae guitarist, who suggests that his guitar playing likely is more painful to people than his economic theories. He has good sense of humour there.

MMT centers on the concept that a sovereign state, such as the United States, can print its money at will, no need to balance a budget or to sell bonds. The theory goes that the U.S. cannot default on debt denominated in its sovereign currency, the U.S. Dollar, since the U.S. simply can print any dollars needed to cover its obligations. 

Applied to the United States, the theory advocates that the government simply print whatever dollars it needs to provide a guaranteed minimum income and/or employment to the general population. There is no need to issue bonds. Should inflation pick up and become a problem, the U.S. government simply has to take excess cash out of the system to contain it, by raising taxes or then by selling bonds, per MMT.  

Having reviewed the MMT approaches, I find that this system effectively guarantees a hyperinflation, and a full debasement of the purchasing power of the U.S. dollar, rather quickly.

Nonetheless, the MMT concept has been embraced by Democratic Socialists in the U.S. Congress. That circumstance could foment particularly contentious and tumultuous political conditions coming into the 2020 Presidential and Congressional elections, where elements of the popular U.S. media already have embraced the MMT concepts. In contrast, Federal Reserve Chairman Powell indicated, “The idea that deficits don’t matter for countries that can borrow in their own currency I think is just wrong.” MMT largely has been denounced and dismissed out of hand by establishment economists, politicians and Federal Reserve officials, who otherwise have brought the U.S. economy, U.S. fiscal conditions and the U.S. Dollar to their current states of extreme peril.


The accompanying graph plots historic gold prices since 1665 in New Amsterdam (New York City) to date, showing relative price of gold against headline inflation, and what inflation otherwise would have been without formal redefinitions by the U.S. government to cut cost-of-living adjustments for Social Security recipients, for example. Where holding gold covers actual inflation over time, it remains an extraordinarily valuable option, should anyone’s circumstance be caught up in an MMT or current mainstream “no inflation” economic euphoria.

With such as background, today is a good time to look to preserve the long-range purchasing power of your wealth and assets with physical holdings of gold and silver.   EG