When the stock market sharply sold off in March, fiscal and monetary policymakers sprung into action. Congress passed somewhere in the ballpark of $2.7 trillion in stimulus, mostly in the form of the CARES Act, while the Federal Reserve initiated quantitative easing to flood the market with liquidity, and to buy many of the Treasury securities that the U.S. government issued to fund its stimulus programs.
The fiscal response took the form of one-time $1,200 checks to most Americans, $600/week in extra federal benefits on top of the normal state unemployment programs, hundreds of billions of dollars’ worth of PPP loans to small and mid-sized businesses that can mostly turn into grants, and some other stimulus measures as well.
This was paid for by issuing trillions of dollars in Treasury securities. However, the foreign sector sold $300 billion in net Treasuries in March and April, and has only been buying back at a relatively slow rate in recent months. And trillions in Treasury security issuance was too much for the private domestic sector to buy either. So, the Federal Reserve created new dollars, and used those dollars to buy a big portion of the Treasury issuance. The Federal Reserve also purchased mortgage-backed securities, municipal bonds, and corporate bonds, in what amounted to a big liquidity injection and period of deficit monetization.
In fact, the Federal Reserve’s sharp increase in their balance sheet from buying all of those assets (red line below) corresponds pretty well to the recovery in the broad U.S. equity market (blue line below):
However, by the end of July, the $600/week in extra Federal employment benefits expires, with unemployed people set to receive only the normal amount of state aid. This affects about 17 million current unemployed people, plus another 13 million people covered by the Pandemic Unemployment Assistance program that provides assistance to self-employed people that lost income, totaling over 30 million people.
Congress is currently working on the next round of stimulus, but it remains unclear when it will pass or what the full details will be, since it’s a work in progress and needs to get through the House, Senate, and President to come into effect.
Many commentators are referring to this as the “fiscal cliff”, meaning that if we move into August without another stimulus, things could get interesting, for lack of a better word.
Thirty million unemployed people will receive a $600/week reduction in income, which is likely to eventually affect landlords, banks, consumer companies, and a variety of things in the equity market.
In this very macro-heavy investing environment, with unprecedented unemployment levels and unprecedented levels of stimulus, this is unfortunately probably the key thing to watch this month as it pertains to markets. Stocks rallied pretty hard, and their valuations are quite high, so we certainly have some risk here if some of the stimulus high starts to wear off.
Gold Soars to New Highs
Speaking of stimulus high, gold has been on a bull run lately.
The price of gold has been at record highs in many currencies for quite some time, but during the past week it reached a new daily closing high in dollar terms as well, at over $1,900 per ounce. It’s still roughly in line with previous intra-day highs.
Gold historically has a strong inverse correlation with inflation-adjusted interest rates. Whenever inflation-adjusted interest rates are low or negative, gold usually does pretty well, and whenever inflation-adjusted interest rates are high, gold usually suffers.
This is because as a zero-yielding asset with some degree of inflation-hedging built in due to its scarcity, gold has a high opportunity cost if bank accounts and Treasuries can pay savers big inflation-adjusted interest yields, but has no opportunity cost or even a negative opportunity cost if real interest rates on bank accounts and bonds are low or negative, which is what we have today.
This environment of rapid monetization of Treasury issuance by the Federal Reserve to fund this years’ stimulus programs, combined with super low interest rates, has been good for gold and silver.
Unlike gold, silver hasn’t yet touched anywhere close to new all-time highs, but it has broken out to a multi-year high level in recent weeks. During this cycle, both gold and silver have outperformed U.S. equity indices such as the S&P 500 (which the C Fund tracks) since autumn 2018.
In a recent article, I discussed the Fed implementing yield caps for the G Fund and other Treasury securities. There is no free lunch in economics, and the release valve for that sort of blended monetary and fiscal policy tends to be some degree of currency devaluation compared to more scarce/older forms of money like precious metals. That has historically been the case, and it seems to be playing out similarly in this current environment as well.
Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.