Lords of Finance by Liaquat Ahamed (pg. 228)

He was acutely aware that British prices were still 10 percent too high, and that further deflation to cut them would bring further hardship. But he had become increasingly convinced that the British needed to be pushed into making the big decision–force majeure, he called it. The shock therapy of forcing Britain to compete in world markets, while painful, would bring about the neccessary realignment in prices more efficiently than a long drawn–out policy of protracted tight credit.

The Americans recognized that if Britain did go back to gold, it was imperative that the link not snap at the first signs of trouble. Otherwise, the credibility of the whole system might be called into question, throwing all the world’s currencies into turmoil.

Lords of Finance by Liaquat Ahamed (pg. 204)

Convinced that finance had become war by other means, officials resorted to military analogies. Prime Minister Poincaré declared in the National Assembly that he had in his possession a secret document outlining a “plan for an offensive against the franc,” which Stresemann was supposed to have circulated to a conclave of German bankers at the Hotel Adlon. The “attack” was to be “launched” from Amsterdam, where German business houses had allegedly accumulated a reserve fund of 13 billion francs. It was reported in a U.S. newspaper that the Lutheran pastors of America had received a letter suggesting that they urge their flock to dump francs in order to “assist in bringing France to its knees.” The French were then, and would remain for many decades, obsessed with the specter of foreign speculators.

Lords of Finance by Liaquat Ahamed (pg. 168)

But more than anything else it was Keynes’s ability to strip away the surface of monetary phenomena and reveal some of its deeper realities and its connections to the society at large that has made the Tract such an enduring classic. For example, by tracing through the consequences of rising prices on different classes in a stylized picture of the economy–what economists today might call a model–he showed that inflation was much more than simply prices going up, but also a subtle mechanism for transferring wealth between social groups–from savers, creditors, and wage earners to the government, debtors, and businessmen.

Lords of Finance by Liaquat Ahamed (pg. 159)

While gold was the international currency par excellence, the pound sterling was viewed as its closest substitute, and most trading nations–the United States, Russia, Japan, India, Argentina–even kept part of their cash reserves in sterling deposits in London. The pound had a special status in the gold standard constellation and its devaluation would have rocked the financial world.

Lords of Finance by Liaquat Ahamed (pg. 156)

There were essentially only two ways to restore the past balance between the value of gold reserves and the total money supply. One was to put the whole process of inflation into reverse and deflate the monetary bubble by actually contracting the amount of currency in circulation. This was the path of redemption. But it was painful. For it inescapably involved a period of dramatically tight credit and high interest rates, a move that was almost bound to lead to recession and unemployment, at least until prices were forced down.

The alternative was to accept that past mistakes were now irreversible, and reestablish monetary balance with a sweep of the pen by reducing the value of the domestic currency in terms of gold–in other words, formally devalue the currency.

FOMO is getting the best of the crowd right now

When fundamentals no longer support markets, the only answer to continued rising asset prices must be liquidity.

Liquidity in my mind can be broken down into direct and potential liquidity.

I would like to define direct liquidity as central bank open market purchases a.k.a. expanding their balance sheets. Below you will find a chart that is the most up to date aggregate of central bank assets that I can find. I am unsure why the PBOC is not included, but this chart is still a useful proxy.

The main point is that there is a clear correlation between growth in central bank balance sheets and rising equity prices, and it appears that the contraction has resumed its course.

http://spiralcalendar.com

Next, we can touch on potential liquidity. Companies have the option to either buyback their stock with the money they earn or accumulate via debt issuance. Should the company choose to allocate their capital towards buybacks, then it should be fairly straightforward that this is a form of a liquidity injection to the price that will help to support or to boost prices. Below, you will see the trend in stock buybacks over time.

https://www.yardeni.com/pub/buybackdiv.pdf

The reason I called this potential liquidity was not just due to the fact that it was the companies’ choice of how to allocate their funds, but that during earnings season some companies will go into what is called a buyback blackout period. The “potential” ceases temporarily as these companies are restricted from purchasing their own stock via buyback. Below, you will see that one is approaching now.

At the cusp of a liquidity drag, it should come as no surprise to the contrarian investor that investors are possibly jumping in at one of the worst times. This can be seen in the below tweet, which displays that investors are piling into a growth equity ETF at the fastest pace ever.

At times like these, prices can always get a lot crazier before they return to “normal,” but it is imperative to proceed with caution.

How to view the Bond Market Right Now?

A unique opportunity is upon us. The FED has signaled to the market that it will not raise rates in 2019 and they say there will only be one hike in 2020.

Anyone who has been in the game long enough will tell you that the bond market precedes the equity market. I would just like to expand that it precedes all markets including the Federal Funds Rate “market.”

The Federal Funds Rate (FFR) is what the FED uses to “fight” recessions.

The rest of the yield curve (2-year, 10-year, 30-year bonds) has many pricing mechanisms, but if the FFR is moving then they will move with it.

The smart money sees that the FED has ceased rate hikes, and that the next logical step will be rate cuts. With this in mind, they will begin to front run the FED’s move.

We do not know exactly when the FED will go to zero again with the FFR, but what we do have is a strong conviction towards that it will cut rates when bear market and recession talks heighten.

Pay attention to the beginning of the smart money forecasting the inevitability of the FED going to zero again. Once the FOMC release occurred on Wednesday at 2PM, the 10-year and 30-year tanked.

https://www.cnbc.com/quotes/?symbol=US10Y
https://www.cnbc.com/quotes/?symbol=US30Y

For historical reference, you will notice that the 10-year and 30-year tend to initially lower in anticipation of the cut to zero. This usually occurs during the pause phase. Then, the rest of the move occurs once the rate cut announcement is made or becomes fully baked into expectations.

You may say well why would I want to buy a 30-year for a 2.87% interest rate. The answer is not that you will hold it to maturity, but you will sell it when the market yield for 30s is 2-2.5%, thus locking in a capital gain.

Do you own research. This is not trade advice.