by Ivan Martchev

July 28, 2020

We have a new player that is meaningfully affecting various measures of money supply in the U.S. economy, and it’s not the Federal Reserve. It’s the U.S. Department of Treasury. It’s almost like having “two Feds,” by fusing fiscal and monetary policy to practice Modern Monetary Theory in tandem.

To be fair, the Federal Reserve still is the most direct determinant of various money supply measures. The “real” Fed most directly affects the narrowest definition of money supply, called the monetary base (M0), and less directly affects the broader monetary definitions, called M1 and M2. The Fed Chairman said so himself in his latest 60 Minutes interview, in these now-classic words:

“We print it digitally. So as a central bank, we have the ability to create money digitally. And we do that by buying Treasury Bills or bonds for other government guaranteed securities. And that actually increases the money supply. We also print actual currency and we distribute that through the Federal Reserve banks.”

Here is a graphic representation of how rapidly the Fed “printed money digitally” since last March:

United States Central Bank Balance Sheet versus United States M0 Money Supply Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

In addition to the (real) Fed, the federal government now directly affects bank lending, thereby increasing the money supply via guaranteed loans. If the Treasury Department provides a loan guarantee, the bank can make the loan, subject to conditions, without risk. Paycheck Protection Program loans are a good example of that process. In that regard, the federal government directly affects the flow of credit in the economy, and therefore the money supply.

United States M1 Money Supply versus United States M2 Money Supply Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I am not sure that I like Modern Monetary Theory that much, but that is beside the point when it comes to the markets. It is this extreme fusion of fiscal and monetary policy that is supporting stocks, bonds, and commodities at the moment. It is why the silver market is going parabolic, despite being pretty bombed out in late March (see my column: “The economic and monetary conditions are perfect for gold”).

I would consider all precious metals-related investments I mentioned in March to still be buys, with the caveat that they have moved up a lot since then. I do not think they will pull back too much, as in March, buying silver-related investments was somewhat of a contrarian play while four months later it is starting to look like chasing momentum. Still, both gold and silver bullion can go a lot higher if this surge in Fed-related money supply growth continues.

The World War II Precedent

In some respects, the coronavirus-related shutdowns affected the U.S. economy more adversely than during and after World War II. There was no fighting in the continental U.S. during WW2. Both WW2 and the coronavirus-related shutdowns blew up the federal budget and the Federal Reserve stepped in with its balance sheet in both cases. In WW2, the Fed practiced yield curve control and created serious inflation by increasing the money supply and holding Treasury yields well below the level of inflation.

United States Inflation Rate versus United States Ten-Year Government Bond Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Between 1940 and 1950, the vast majority of trading in 10-year Treasuries happened below 2.5% yields, even though we had three notable surges in double-digit inflation, the largest of which was in 1947, peaking at a 19.6% annual rate. That would have produced a negative real interest rate of -17.4% that year, as 10-year Treasuries yielded an average of about 2.2% that year.

To be fair, real risk-free rates in the U.S. are already negative this year. Every single individual Treasury inflation-protected security quoted on wsj.com already has a negative yield. If one looks at the indexes of Treasury-inflation protected securities (TIPS) produced by the St. Louis Fed, they are all negative. The five-, 10-, and 30-year St. Louis Fed TIPS indexes show yields of -1.08%, -0.84%, and -0.30%.

Treasury Inflation Protected Securities Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Buying TIPs with negative market-driven yields may not be stupid, as their principal is indexed for inflation even if their yields are negative, as investors bid up prices (the coupons of the bonds are still positive). If inflation becomes a problem, those coupon payments will grow even if the coupon is fixed.

It’s also worth pointing out that in the last yield curve control cycle in the WW2 era, the price of gold was fixed at $35 per ounce, and there were no TIPS, so other real assets, and stocks in general, were your only inflation hedge. Today we have more options, should the Feds decide to go the inflation route.

Platinum is the Forgotten Precious Metal

When gold was at $1,000 per ounce in 2008, platinum was at $2,000. Today, gold has reached $1,900 while platinum is barely $900. The issue with platinum – and palladium for that matter – is that they are primarily industrial metals. Their “precious” demand does not drive their prices. Still, if inflation becomes a problem, platinum should move to the upside. There are platinum bullion ETFs, but I think taking delivery of the physical bullion is better, if one is buying it as an inflation hedge. I was a little wary of industrial precious metals in March, but a lot has changed since then, when it comes to money growth.

Platinum versus Palladium Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

There is a valid reason why the Federal Reserve and U.S. Treasury may want higher inflation. Debts are serviced out of nominal dollars, so higher inflation can service debts better with fixed interest rates, while the Fed holds interest rates below the level of inflation. Because there are a lot of debts to be serviced in the U.S. economy, without higher inflation the debts can choke off economic growth.

I doubt that inflation will rise quickly, because there is a lot of slack in the economy – what economists call the “output gap” – but with a vaccine or a treatment for COVID-19, that gap will quickly close.

If one were considering applying for an adjustable or fixed-rate mortgage now, my answer is fixed-rate. There may be a couple of years left for adjustable-rate mortgages, but not much, in my view. Fixed rates are at all-time lows, despite the spreads to Treasuries being high, which is normal in a recession.

It is a bad precedent for elected governments to control the money supply via loan guarantees, but the Feds feel that it’s necessary. To hedge the inflation risk they are creating – to get out of a deflationary problem we’re facing – buy precious metals bullion and Treasury inflation-protected securities with negative market-driven yields now, but not if we actually get the inflation problem I fear is coming.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

Global Mail by Ivan Martchev
The Federal Government is Pushing Higher Inflation

Sector Spotlight by Jason Bodner
What a Difference a Year (or More) Makes

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Read Past Issues Here

About The Author

Ivan Martchev INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev

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