"Has Everyone Lost Their Freaking Minds?"

Submitted by Joseph Calhoun via Alhambra Investment Partners,

“How low do you have to stoop in this country to be President?”

? Hunter S. Thompson, Fear and Loathing on the Campaign Trail ’72


“The main problem in any democracy is that crowd-pleasers are generally brainless swine who can go out on a stage & whup their supporters into an orgiastic frenzy—then go back to the office & sell every one of the poor bastards down the tube for a nickel apiece.”

? Hunter S. Thompson, Fear and Loathing on the Campaign Trail ’72


The whole framework of the presidency is getting out of hand. It’s come to the point where you almost can’t run unless you can cause people to salivate and whip on each other with big sticks. You almost have to be a rock star to get the kind of fever you need to survive in American politics.”

? Hunter S. Thompson, Fear and Loathing on the Campaign Trail ’72


“In a closed society where everybody’s guilty, the only crime is getting caught. In a world of thieves, the only final sin is stupidity.”

? Hunter S. Thompson, Fear and Loathing in Las Vegas


“When the going gets weird, the weird turn professional.”

? Hunter S. Thompson, Fear and Loathing on the Campaign Trail ’72

Negative interest rates. The war on cash. More quantitative easing. Monetary policy described as a “helicopter drop”. An avowed socialist running for President – and competing well. Another candidate under investigation by the FBI for mishandling classified information. A debate that featured a candidate begging for someone to attack him so he could get some air time. One candidate accusing another of stealing from the party and calling another a liar. The closed captioning for most of the debate reading “unintelligible yelling”. An accomplished, serious-minded governor getting drowned out by three buffoons competing to see who can get the biggest guffaws from a crowd that makes the audience at a professional wrestling match look reserved and intellectual.

It’s getting weird and the market is having a tough time figuring out what to take seriously, what to ignore, what to laugh nervously about and what to just laugh at. Are we really about to put up our very own American version of Silvio Berlusconi as the Presidential candidate of a formerly serious political party? Is the other party really having a competitive race with one candidate running on an overtly socialist agenda that is barely distinguishable from his opponent’s? Who doesn’t claim to be a socialist? Are central banks actually considering pushing interest rates more negative after getting basically no positive response from the initial push below the previously sacrosanct zero bound? Has the Federal Reserve actually told banks to prepare for negative interest rates here in the US right after raising rates for the first time in years? Are serious economists actually have a debate about whether it is a good idea to just print up cash and pass it out? Is that really monetary policy? Are governments really talking about banning actual currency, the very money created by that government? Money that depends, oh by the way, solely on people’s trust that the government will stand behind the money they are about to outlaw? Has everyone lost their freaking minds?

I was in a restaurant yesterday having lunch and watching a rally for Donald Trump. I say watching because the sound was turned down in favor of a stereo playing a tune by the Allman Brothers (ironically or not, The Whipping Post). As I watched Trump karate chop the air with wild arm movements, it occurred to me that audio was completely unnecessary. This was not serious political rhetoric at work. It was campaigning by the wild gesture, campaign promise and/or hand. It was meant to work the crowd into a frenzy, to stir the anger – righteous though it may well be – of a populace that feels left out, left behind and powerless against the insiders, the cronies, the big money that controls both parties. What it reminded me of frankly was a certain Austrian corporal and I turned away just a little more frightened than I was before I saw it.

Now before you fire up the old email program to complain that I’m picking on the Donald let me just say that the other candidates that scare me are Sanders, Clinton, Rubio, Cruz and Carson. As far as I can tell there is one sane, serious candidate on either side and his supporters wouldn’t fill a phone booth. And honestly, I don’t think much of him either. I’ve always tried to be fair when I’ve ventured into politics in these weekly rants, skewering both sides as equally as I can, adhering to an extreme public choice view of politics. So don’t think I’m singling out Mr. Trump; there isn’t a single candidate I would feel good about voting for.

In any case, I’m only venturing into the political space because it is part of the general atmosphere of anxiety, the funk of fear, the cloud of consternation that seems to have enveloped markets lately. The global economy isn’t in outright contraction right now – although as noted last week, trade figures are flashing some very worrisome signs – but there is an unease about the situation driven by the constant policy discussion coming from the world’s central banks. Would Mario Draghi be promising more action, more easing, more negative rates at the ECB meeting this week if all was hunky dory with global growth? Would there be widespread expectation that the BOJ would cut rates further into negative territory – even after getting exactly the opposite response as the one expected last time – when they meet again? Would there be hope – almost desperate hope – that the G20 meeting this weekend might produce some kind of coordinated response, a Plaza Accord redux? When that group would have a hard time agreeing on lunch?

Even the widely acknowledged best economy in the world – the US if you can believe that – offers little solace to the economic bulls. There is almost zero expectation that the Fed will continue with their rate hiking during their next meeting at the ides of March. In fact, the futures market says rate hikes are unlikely until at least late this year and more likely to happen next. And we saw testimony from Janet Yellen that the Fed has studied and continues to study the use of negative interest on reserves, a policy of taxing the very reserves the Fed created to begin with. If they’re studying negative rates why would anyone expect them to keep hiking? If they’re studying negative rates and telling banks to prepare for it, what does that say about their outlook for US growth really?

Economic data continues to disappoint, manufacturing still in contraction and showing little sign of improvement outside of a very volatile Durable Goods report tainted by some questionable seasonal adjustments. Home sales were pretty good – taking a better than expected existing number with a weaker than expected new homes tally – but that might be more a reflection of the monetary policy discussion that centers more and more on how to destroy the value of money most efficiently. Personal income is a bright spot but consumption figures mean inventories are likely to need further paring, constraining production in the immediate – at least – future.

The recent discussion labeled the war on cash, the idea to ban large denomination bills in the US and Europe – $100 bills here and 500 Euro bills there – is possibly the most bizarre economic discussion I’ve witnessed in my entire career. Governments are seriously considering banning the money they’ve created. Money is a fragile social construct to begin with and governments should be very careful about doing anything that undermines the public’s confidence in it. If they ban $100 bills will that undermine confidence in all paper money? Will they come for the Fifties next?

It goes hand in hand with the discussion and implementation of negative interest rates. All these radical policies – negative rates, banning cash, QE – are designed in one fashion or another to reduce the value of money, to force people to spend today before the money they have becomes worth less tomorrow. It assumes that spending is spending, all equal before the statisticians and is the source of economic growth. It is a line of thinking that is flawed, the very reverse of reality, as if drinking caused thirst.

The practical result of this environment, one marked by already weak growth and discussions of radical remedies, is that individuals and companies are reluctant to invest for a future they fear won’t be bright enough to justify the capital outlay. Until now, the radical monetary policies have carried only an implied threat to one’s purchasing power but now governments are openly discussing more explicit means of destruction. Faced with that threat individuals will certainly take action to rid themselves of their excess cash, but probably not in the way economists imagine. Faced with a loss of purchasing power individuals will do something to protect themselves, stashing their capital in assets that have proven through the course of history to be reliable stores of real value – hard assets such as gold, silver, commodities and real estate.

This urge to preserve purchasing power is on display right now. Wealthy Chinese are doing everything in their power to get their capital out of China before what they perceive as an inevitable devaluation of the Yuan. The capital flight actually creates the downward pressure on the currency from which they are fleeing. And where is that capital going? Ask anyone trying to buy a house in Vancouver or a co-op in NYC or a house in California. Talk to a gold dealer in Hong Kong or anywhere else in Asia. We saw the same phenomenon a few years ago in Brazil when the wealthy sold their Rio condos in favor of South Beach and Manhattan, getting their capital out before the next, always inevitable in Brazil, devaluation.

Faced now with the prospect of something similar happening in the US but with no other country to which to flee, investors have been flocking to assets that protect their purchasing power. Gold is up 14% in the last three months while the companies that produce the stuff, the miners, are up over 37%. TIPS, Treasury inflation-protected securities, are up 1.76% in the last month, investors so eager for protection they’ve driven the yield on the 5-year maturity into negative territory. Next best performing after gold are long-term Treasuries, long-term rates falling faster than short rates, the yield curve flattening rapidly.

There are economic consequences for these market moves if sustained. The fear – of politics, of radical monetary policies – has pushed capital into non-productive investments in an economy already starved of the same. Ironically too, fear of economic slowdown, fear of the loss of purchasing power, fear of a radical change in the political status quo makes these outcomes more likely. Lack of investment, lack of consumption driven by fear creates the economic slowdown everyone is trying to avoid which makes the radical monetary policies and radical political outcome more likely.

There is no certainty as to how all these things will be resolved though. Negative interest rates – at least in the US – may not happen. Indeed, while Yellen didn’t dismiss the possibility, she hardly endorsed it either. The war on cash may be over before the first battle; there has recently been a pretty strong pushback on civil forfeiture that would seem to fly in the face of these proposals. There seems little appetite at the Fed for more QE and even less in Congress where Yellen would eventually have to defend the policy. As for the politics, I’ve been observing that particular cesspool for a long time and governing reality is often quite sobering for politicians who promise radical changes. It isn’t easy in our system to make big changes – ask the current resident of the White House about that one.

But right now it is fear that is moving markets and we have to live in that world until sanity returns. The current trends in gold, TIPS, bonds and stocks are ones that may be predicting or even contributing to a more severe economic downturn. As for Mr. Trump, I’m reminded of something else Hunter S. Thompson wrote and something the Donald should keep in mind: “Beware of enthusiasm and love, both are temporary and quick to sway.”