EC Economic And Monetary Outlook For 2021

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The most important event in the new year is likely to be the Fed losing control of its iron grip on markets. The dollar’s declining trend is already well established against other currencies and commodities, leading to this outcome.

Events in 2021 will be the consequence of a developing hyperinflation of the dollar. Foreign holders of dollars and dollar assets — currently totaling $27.7 trillion — are sure to increase the pace of reducing their exposure. This is a primal threat to the Fed’s policy of using QE to continually inflate assets in the name of promoting a wealth effect and continuing to finance a rapidly increasing federal government deficit by suppressing interest rates.

Bubbles will then pop, leaving establishment investors exposed to a combined collapse of fiat currencies, bonds, and equity markets, which could turn out to be very rapid. The question remaining is what will replace collapsing fiat currencies: limited issue distributed ledger cryptos, such as bitcoin, or precious metals, such as gold?

Clearly, when the dust settles, it will be gold for no other reason that central banks already own it in their reserves, and it has a long track record of success as money in the past.

This article examines the 2020 economic and financial background to likely developments in 2021 before arriving at its conclusions.


It is that time again when we reflect on recent events and what might be ahead of us in the new year. 2020 was dominated by a pre-March descent into a financial slump, when the S&P500 index lost a third of its value between January and March, until the Fed cut its funds rate to zero on 16 March and followed up with a statement of intent to expand QE without limit on the following Monday.

Publicly, the trigger for the Fed’s inflationary magnanimity was the covid-19 virus and the lockdowns it triggered in Europe, and then to a developing extent in America. But, reflecting on events, such as the repo crisis the previous September, when the banking system ran out of balance sheet capacity, and the economic consequences of an equity bear market loomed, one wonders. The covid crisis provided cover for an unprecedented monetary expansion that was required to save the economy from the maelstrom of bank credit contraction. It worked like a charm, as the chart in Figure 1 showed.

Screen Shot 2020 12 30 at 3.08.14 PM

Everything turned on the Fed’s March announcements. But for simplicity and clarity I have included copper representing commodities and raw materials, the S&P representing non-fixed interest financial assets, and gold, representing non-government money.

Ahead of the Fed’s March announcements, the performance of all three representatives was consistent with a slump in the economic outlook, with gold rising as a hedge against the economic impact. Following that turning point the consequences of monetary inflation became the dominant theme, and the dollar’s trade weighted index went into a decline. The effect on a wider list of assets is shown in Figure 2.

Screen Shot 2020 12 30 at 3.08.24 PM

Generally, when the prices of most commodities and financial assets other than fixed interest rise together, we can say that they reflect a fall in the purchasing power of the currencies in which they are measured. This is confirmed by the performance of items listed in the table under the money-heading relative to all the others. The dollar has even fallen against other currencies, reflected in the trade weighted index and the modest rise of the other currencies listed. It should be noted that in common with the dollar all the national currencies listed saw increases in their money supplies, but the effect has been greatest on the dollar. The table in Figure 3 gives us an idea of the scale of it in the context of US federal finances, and it can be seen that of sources of finance, more of it was raised in the bond markets through QE than through taxes.

Screen Shot 2020 12 30 at 3.08.31 PM

To be forced to raise more through monetary inflation than by taxation in one year is unfortunate, but to have to do it two years on the trot is venturing down the path to hyperinflation. The CBO’s estimate of the budget deficit for the current fiscal year, which was made in early-September, was it would contract to $1.81 trillion, considerably less than the $3.311 trillion for fiscal 2020. Events are proving this estimate to be far too optimistic and will need revising, likely to be as much or even larger than 2020’s deficit. And with tax revenues estimated by the CBO to be slightly lower for fiscal 2020, QE is set to end up financing an even greater proportion of government spending.

This is unlikely to be a two-off. Mainstream commentary had bought into the Fed’s propaganda in March, when the Fed implied that its monetary policy was a response to covid only. It was not for nothing that global trade slumped in the wake of tariff wars between America and China two years ago, and that repo rates in September 2019 suddenly told us that the then prevailing interest rates were far too low without repo stimulus being dramatically increased. And a collapse in the S&P 500 index between January and March began accurately tracking the experience of the Wall Street Crash of 1929.

The more one looks at it, the more convincing it is that Covid was cover for far larger cracks in the US economy and its monetary system, and therefore for the global economy. The reference to 1929 above is not made lightly. The combination of a turn in the cycle of bank lending and the infamous Smoot-Hawley Tariff Act is a doppelganger for recent events. The most significant difference is in the money: in 1929 prices were measured in gold through the dollar acting as a gold substitute. Today prices are in an infinitely expanding fiat currency backed only by faith in the US Government.

Understanding the credit cycle, the deleterious effects of trade tariffs and the economic differences between sound and unsound money are prerequisites for anyone seeking to understand what is in store for 2021. There is no sense in following brokers’ practice in making specific forecasts, which is a pointless exercise. More to the point is understanding the monetary and economic forces which are the backdrop to markets in the new year.

Inflation of money is the Fed’s only management tool

One thing must be clearly stated, and that is the most important tool at the Fed’s disposal is economically destructive — inflation of the money supply. The more it inflates, the more wealth is transferred from the productive economy to the government. The more the Fed successfully encourages commercial banks to expand bank credit, the more wealth is transferred from the wider economy to themselves and their favoured customers. The more money is diluted by increasing its quantity, the more wealth is transferred from savers to borrowers. Yet, those who make monetary policies have convinced themselves that monetary inflation is force for good. But now that it is on course for an uncontrollable acceleration, monetary inflation will be the underlying destructive force exposed in 2021.

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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