29 Jul THE DOLLAR, GOLD AND THE FED

Today marks the conclusion of the two-day FOMC meeting.  No change in monetary policy is expected and most believe the Fed will continue with its dovish outlook.

Yesterday Goldman put a spotlight on the suddenly growing concern over inflation by issuing a bold warning that the dollar is in danger of losing its status as the world’s reserve currency.  Congress is closing in on another round of fiscal stimulus to shore up the pandemic ravaged economy and the Federal Reserve has already welled its balance sheet by $2.8 trillion because of Covid.

Goldman cautioned that US policy is triggering currency “debasement fears” that could end the dollar’s reign as the dominant force in global foreign exchange markets.

I must write this is clearly a minority view and Goldman does not say they believe it will necessarily happen, it is capturing the nervous vibe that is infiltrating into the markets—money printing will trigger inflation in years ahead, selling the dollar and buying gold.

Many other firms are hesitant to even make even a guarded similar pronouncement given how most were wrong back in 2009 when similar warnings were the mantra of Wall Street.

The 10 year break even rate, or the gap between nominal and inflation rate debt has risen to about 1.51% up from as low as 0.47% in March.  The real yield, which strips out the impact of inflation plunges the rate to -0.92%.  Such is consistent with inflation and declining currency.

As noted many times there are only two ways to over come massive debt; inflate or restructure.  Restructuring is not an option.

Nominally changing topics, today will the Fed alter the rate that it pays member banks on excess bank reserves?  Excess reserves are gargantuan, totaling trillions of dollars.  Pre-2008 excess bank reserves were consistently under $50 billion.

During the financial crisis, the Federal Reserve commenced paying interest on these reserves to help recapitalize the banking system and as recently as 15 months ago the interest rate on these reserves was over 2.35% and in February it stood around 1.6%. The economy was accelerating Today the yield is around 0.10% thus encouraging banks to lend and increase monetary velocity and economic activity.

Monetary velocity or the turnover of money is bouncing along all time lows.  If monetary velocity accelerates to 50% of its historical norm, growth could hypothetically exceed 10% on a consistent basis.

Wow! I will argue that if the economy consistently grows at this pace inflationary expectations could radically change.

Like most I do believe the Fed today will make a dovish pronouncement discussing the Covid induced headwinds which may hinder growth.

Last night the foreign markets were mixed.  London was up 0.20%, Paris up 0.76% and Frankfurt down 0.11%.  China was up 2.06%, Japan down 1.15%  and Hang Sang up 0.45%.

The Dow should open nervously flat ahead of the Fed meeting, earnings and vaccine optimism. The 10-year is off 3/32 to yield 0.59%.