Monthly Archives: August 2016

This Time, it IS Different

This Time it IS Different

It's Different

It IS Different

The four most dangerous words in the world of finance, often repeated, are “This time it’s different.” During both of the last two major booms and busts, a common belief was that the new internet age was different (2000) and later, that housing was also different (2008).

However, used to describe our current interest rate environment (particularly negative interest rates), the over-worked phrase actually does ring true.

Financial journalist and observer Jim Grant noted at a recent investment conference that research on interest rates shows that over the past 5,000 years of history, there has never been an instance of negative interest rates… until now.

The ever quick-witted Grant remarked, “If these are the first sub-zero interest rates in 5,000 years, is this not the worst economy since 3,000 B.C.?” Perhaps. Or maybe this is just the first time in history where we have central banks active in monetary policy, attempting to drive interest rates as low as possible.

Record Negative-Yield Debt

The current amount of debt sporting a negative yield continues to grow. In early 2016, there was over $5 trillion in negative yielding debt. This grew to nearly $12 trillion by the end of June, and it is now closer to $13.4 trillion!

Not only has more debt become negative in yield, but it is increasingly happening to longer term debt. Yields on 10-year government bonds have become negative for Germany, Switzerland and Japan.  

Remember that bond yields are an inverse to bond prices. As bond prices get bid up, their yields go down.

What makes this unique is that bonds are a relatively simple financial instrument. Bonds do not have the subjective valuation that applies to stocks, and this makes the math and the logic of bonds fairly straightforward.

A person can buy a stock from another person while thinking it still has the potential to go higher, given higher growth prospects for the company. The price is based on one person’s subjective valuation.

On the other hand, bonds are not as subjective. If you buy a bond at a certain price, with a certain coupon payment, then the yield is a mathematical certainty. It is the yield you will receive per year if you hold the bond to maturity, and if it pays the principal in full without defaulting.

What Bond Buyers are Saying

By stark contrast, today’s current bond buyers are purchasing a security where they know they will lose money if it is held to maturity. For example, if you buy a bond today with a negative 0.5% yield, and it has five years until maturity, then after five years, you will be paid back less than what you originally paid for the bond. Even with the coupon payments you received during the life of the bond, the total payout will be equivalent to getting a minus 0.5% return on your money.

Therefore, we must make one of two different assumptions about current buyers of negative yielding debt. One assumption is they could be anticipating the bonds will continue to go up in price and that they will then sell them for a profit. In other words, the negative yields will become even more negative, and they will sell the bonds before maturity.

Unfortunately, this requires the buyer to believe there will always be a ‘greater fool’ out there who is willing to accept a higher price than what the original buyer paid. It it not unlike those who bought houses before 2007 on the premise they would flip them to a higher bidder. Remember that with bonds, someone must be holding these financial instruments at all times.  

The second assumption is that buyers are perfectly fine accepting a negative yield, and are willing to ‘pay for the privilege’ of lending out their money. This goes against all basic laws of finance. It only makes sense insofar as these buyers have no other place to put their money, and are therefore choosing the lesser evil.

But this is a weak explanation, because they could put their money in cash and get at least a zero percent return. Also, this doesn’t seem to make sense for longer maturity debt, as it means these buyers think negative interest rates are here to stay for at least ten years or more.

Both of these scenarios point out how this time, it is very different, and we are living in a twisted financial world, a world only exists because of the manipulations and distortions of central banks.

It is always precarious to try to make predictions, but it seems that there will come a time in the not too distant future when people will look back at this period and say “What were people thinking?”Secure Your Wealth

Like a frog languishing in a slowly heating pot of water, investors have warmed up to the environment of negative interest rates, not realizing how absurd and dangerous the situation has become. But take time now to assess, and be well prepared for the inevitable.

In this zero/negative interest rate environment, it is stunning to consider that since 2000, the DJIA (Dow Jones Industrial Average) has increased in value 63% while silver has increased in value 289% and gold has increased 380%…. an annualized return of 23.75%!

Cash, anyone? Or gold!

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Helicopter Money

Helicopter Throwing money from a piggy Bank. Yen versionPost Brexit jitters have faded away and the market has gone on to crack new highs, partly aided by the rumors swirling of ‘helicopter money’ coming to central banker’s toolboxes around the world, but most notably Japan in the near future.

Once thought of as an imaginative or hypothetical example of what central bankers could do to combat deflation and get economies jump-started, helicopter money is now being seriously talked about. This is further evidence of the central banker’s mindset and why it is important now more than ever to make sure investment portfolios are fortified with a certain allocation of physical gold.

So when will money start dropping from the sky?

Surprisingly, the term helicopter money was first most famously used by the free-market economist Milton Friedman as a simple illustration of how money could be injected into an economy.

Former Federal Reserve Chairman Ben Bernanke then repeatedly used this term to additionally mean injecting money into the economy, but he also advocated for it in terms of central bank purchases of bonds and other financial assets, or to help the government finance fiscal stimulus. This earned him the nickname, Helicopter Ben.

It was therefore not lost on market participants when Helicopter Ben visited Japan a number of days ago and spoke with Prime Minister Shinzo Abe, the father of Abenomics – the grand experiment of trying to boost Japan’s economy by aggressive monetary and fiscal stimulus.

Mr. Bernanke did not specifically mention helicopter money in subsequent interviews, but he did note that Japan has more tools at their disposal to continue monetary easing. Ever since the meeting, market participants have continued speculating that some kind of easing will take place, sending the yen lower and stock markets higher.

Call it what you will, the result will be the same

Central bank actions have taken many forms over the past years since the crisis: lower (or even negative) interest rates, quantitative easing, monetary stimulus, and now helicopter money.

While it is not certain what helicopter money will actually look like if implemented, it would likely be some arrangement whereby the central bank directly finances government spending. In its extreme (and most literal) form, it could involve somehow getting newly printed money into the hands of consumers.

These are all slightly different programs and they work in different ways, but they all have the same thing in common: creating (printing) money and credit and then injecting it into the economy in an effort to try to boost spending, depreciate the domestic currency (thereby boosting exports), stoke inflation, or a combination of all three.

Add gold to your portfolio – now

This highlights why it is so important to be holding some physical gold. Bernanke is right in one sense: there is nothing physically holding back central bankers to continue these programs, and central banks will continue them because efforts thus far have proved unsuccessful.

What was once thought unthinkable and merely a thought experiment is becoming a reality. If in doubt, think of all those who thought negative interest rates were a crazy idea that would never be implemented.

Secure Your WealthMonetary easing, in whatever form, will likely continue until there is a severe depreciation or collapse of currency and correspondingly high inflation. Unfortunately, Japan already learned this lesson in the 1930’s and 1940’s when it embarked on a similar program of using the central bank to directly finance government spending, which unsurprisingly resulted in an inflationary surge.

History is repeating, and the chances of central banks admitting their policies do not work, and ceasing them or reversing course, is slim. Therefore, it is especially prudent at this time to allocate a portion of your investments to physical gold, and that is why we recommend a 10-20% allocation.