Unusual conditions and strange economic events seem to be occurring with greater frequency, and potential policy missteps are creating foreboding signals in the economy.
The Federal Reserve was expected to lower interest rates again in September, but that is now in question with expectations for a cut falling below 50% this week, from 92% last week. Additionally, the Fed had to intervene to defend its interest rate peg as overnight rates surged above 10%.
Jim Puplava discussed his take on where current conditions are headed, what it means for the future of markets and for Trump’s presidency on a recent edition of Financial Sense Newshour.
See Monetary Magic + Socialism = Gold for audio.
Interest Rates and Currency Wars
Rates are heading into negative territory around the world with countries already there. We are essentially involved in a currency war, Puplava noted, and this is one of the last weapons central banks use to help prop up their economies.
Both Japan and the European Central Bank (ECB) have had negative interest rates for some time, and it hasn’t worked to inflate their economies, Puplava stated. Both economies rely heavily on exports, which explains why they have attempted to devalue their currencies to make their goods more attractive to international markets.
The U.S., in contrast, is a much more self-sufficient economy, Puplava noted. Interestingly, however, Europe is the No. 1 trading partner of the U.S. We export more to Europe than any other country. As the euro weakens, it makes our goods more expensive in European markets.
Right now, there is $17 trillion of negative-rated debt, mostly within in Europe and Japan. In contrast, U.S. interest rates headed higher last week. However, the Fed is widely expected to cut interest rates this week.
“Everybody’s cutting,” Puplava said. “President Trump did remark that if the Fed was not to cut, the dollar would remain stronger. So you compare the negative interest rates of a half a percent in Europe to interest rates that are 2.5% higher in the U.S. This helps keep the dollar strong. … We're in a race to the bottom.”
How Do Interest Rates Impact the Economy?
Some have argued lower interest rates don’t spur capital spending as some might hope, because borrowers expect rates to continue falling in the future. The reality is somewhat more complicated, Puplava stated.
There are several positive effects from lowering interest rates. For one, lower rates make it cheaper to borrow. Mortgages today are cheaper than where they were five years ago. In theory, this should help spur capital spending.
Additionally, lower interest rates create a wealth effect in the stock market. The lower rates are, the higher stock price-to-earnings ratios are, and thus the higher stock prices are.
The third effect is seen in the currency. Lower interest rates also lower the relative value of the currency, which makes exports more competitive.
However, there are negative effects to lowering interest rates. For one, income earned from interest is negatively impacted. Thus, retirees and savers suffer as a result of lowering interest rates.
Another negative is the psychological effect lowering interest rates has in the economy. Many people have the expectation that the Fed only cuts interest rates when conditions are beginning to deteriorate in the economy. This has a negative impact on confidence, Puplava noted, similar to how deflation is perceived to impact spending habits. There is more to the story, however.
“Here's the other thing that they don't talk about,” Puplava said. “There is a massive amount of debt, both at the consumer level, the government level and at the corporate level. Central banks assume that if they cut the cost of money and make it cheaper to borrow, people will borrow. Well, if you are tapped out up to your eyeballs in debt, it doesn't matter what interest rates are. If you can't qualify, you can’t borrow. … That's why these central bank policies are becoming less effective.”
Deficits Don’t Matter…Until They Do
The idea of Modern Monetary Theory (MMT) has been surfacing more frequently, along with the idea that deficits don’t matter. We’re currently running a trillion-dollar deficit in the United States, and is likely to continue for some time.
Normally, in a growing economy, deficits are reduced as tax revenues increase. In contrast, we’re in a growing economy, and yet deficits are projected to remain high. The Treasury has been tapping bond markets for more than a trillion dollars, and this will be the second year in a row that it has had to do this, Puplava stated.
The main driver of deficits right now is not a reduction of tax revenues created in the wake of a falling economy, Puplava noted. In fact, tax revenues are up seven percent on the back of the expanding economy. At the same time, government spending is up nine percent, thanks to ballooning entitlements, military spending increases and higher interest rates driving up the cost of servicing debt.
“More baby boomers—10,000 of us every single day—are heading into retirement, which means they're tapping into Medicare and Social Security,” Puplava said. “That's on auto pilot. You can't touch it. The Congressional Budget Office predicts we’ll have a trillion-dollar deficits, not just this year, but every single year over the next decade. And that's assuming the U.S. doesn’t have a recession."
Will the Economy Impact Trump’s Reelection Chances?
Puplava believes the key factor to impact the president's reelection is whether the U.S. veers toward socialism. The idea’s popped up on the Democratic side, but it isn’t the only factor that will play into the president’s chances come next November.
Right now, markets are focused on whether the economy will continue to grow, Puplava noted. However, outside of the current problems in the manufacturing sector, there are few signs the U.S. is about to enter a recession. Whether that tailwind continues for Trump into next year is an open question, Puplava stated.
The ongoing trade war is a big concern. Right now, tariffs are absorbed by manufacturers and retailers. Eventually, and inevitably, these costs will be passed on to consumers, at which point the tariffs may impact the president’s chances for reelection.
“In terms of where the president stands next year, it's going to be dependent on whether the country wants to get rid of the capitalistic system and move to socialism,” Puplava said. “The second issue for Trump, is where will the economy and the stock market be? A recession and a bear market, I believe, would end his presidency or his chances for reelection.”
Is the U.S. Really Headed for Socialism?
That seems to be the push coming from the left in the U.S. Almost all Democratic candidates are proposing one scheme or another to redistribute wealth, Puplava noted, whether it’s in the form of Medicare for All or free college tuition or even guaranteed minimum income. When it comes to who will pay for all of this, Puplava noted, some Democratic candidates suggest the richest Americans will foot the bill.
Two recent proposals stood out highlighting this change in American politics, Puplava stated. Last week, House Representative John Larsen of Connecticut proposed an increase in Social Security taxes of 2.5%.
Right now, Puplava noted, the combination of Medicare and Social Security taxes is 15.65%. Larsen’s proposal would raise taxes on both employers and workers by 1.25%. Additionally, his proposal would lift the caps on Social Security taxable income, which currently sit at $132,000.
On the other side of Congress, Senator Ron Wyden from Oregon is proposing what is essentially a wealth tax, Puplava noted. Wyden’s proposal would eliminate capital gains and favorable taxation of dividends, and furthermore would place a tax on unrealized capital gains.
This could create many potential problems and would substantially harm financial markets in the U.S. Puplava stated. It would not just apply to stocks, either, but to bonds, real estate holdings and potentially other assets as well.
How will the government assess such a tax? And how will savers and investors be impacted? Also, what happens if, after a year of substantial gains in the stock market, we enter a recession and stock values decline substantially? How will loses be accounted for on a tax basis? The likely result would be a mess, Puplava noted.
“In a practical sense, this would basically end capitalism,” he said. “Many people would be forced to sell off their holdings in order to pay for this tax. … In my opinion, this would destroy the capitalistic structure and the financial structure in this country.”
Where Is This Likely to Lead?
If we look at the example of socialist countries—such as Argentina, Venezuela, and others—many are running massive deficits and have much higher rates of inflation. It is possible similar conditions will take hold in the U.S. We may also see interest rates continue to head lower. There is even potential for negative interest rates to appear in the U.S.
The potential for rising deficits and lower interest rates in combination are bullish for gold, Puplava stated. Analysts and commentators in the U.S. tend to be more U.S.-centric when it comes to the gold price, but as it is priced in other currencies, gold is at all-time highs, Puplava noted.
“All of this central bank monetary policy coupled with socialism to me equals gold strength,” Puplava said. “It'll be interesting to see what the Fed says later this week. It's been widely expected that the Fed will lower interest rates a quarter of a point. We’ll see if they cut a quarter of a point and if they hint that they’re still thinking of cutting further. … Also, we are getting closer to the end of the third quarter. Earnings are down year-over-year. … It looks like we may be heading into a profit recession.”
Written by Ethan D. Mizer.