Happy Birthday Carol Paul

Happy birthday to Carol Paul, wife of the great libertarian Ron Paul.

Carol Paul is celebrating her 20th birthday.  But before you think that Ron Paul married a much younger woman, consider that Carol Paul was born on February 29, 1936.  Since her birthday was on a leap day, the actual date of her birth only comes around once every four years.

Ron Paul and Carol Paul will celebrate their 60th wedding anniversary next year.

Ron Paul has converted more people to the ideas of liberty than perhaps anyone in history.  Thankfully, he has had one of the greatest supporters in his wife.

Happy birthday Carol Paul!

The Dow to Gold Ratio

I am not a big chart person, but they can still be useful for reference and some historical perspective.  One interesting chart is the Dow-to-gold ratio.  It tells us how many ounces of gold it takes to buy the Dow Jones Industrial Average.

For example, if the gold price is $1,000 and the Dow is trading at 16,000, then the Dow-to-gold ratio is 16.  It would take 16 ounces of gold to buy the Dow index.

The current ratio is between 13 and 14.  It has gone down from over 16 in late 2015.  This is a result of a higher gold price and lower stock prices.

The ratio actually went over 42 back in 1999.  This is when gold was trading for under $300 per ounce.

On the other hand, the ratio briefly went close to one back in late 1979 and early 1980.  This was when gold briefly went over $800 per ounce before crashing down.  This was the biggest bubble in gold in American history.  The bubble popped after Paul Volcker, then chairman of the Fed, adopted the appropriate policy of stopping the monetary inflation and letting interest rates go higher.  This saved the dollar.

Again, there is nothing magical about the Dow-to-gold ratio, just as there is nothing magical about the gold-to-silver ratio.  There is nothing to say that it can’t break a certain range.  It is even less accurate using the Dow as a measure because of the change in the 30 stocks that make up the index.

It is just interesting to note how wide the variances are.  It is hard to believe that in 1979/ 1980, you could nearly buy the whole Dow index with one ounce of gold.  Then, 20 years later, it would take you 40 ounces of gold to buy the same Dow index.

Just think what it would take for the Dow-to-gold ratio to get back to one.  If the Dow fell by over 50% to 8,000, then gold would still have to go up by more than 6 times its current price.  A lot will have changed if we see the Dow at 8,000 and gold at $8,000 per ounce.

As of right now, we seem to be in an economic downturn.  This makes sense due to the tight monetary policy of the Fed since QE3 ended in October 2014.  While interest rates have remained low, the Fed has stabilized the monetary base for well over a year.  As long as we have a Fed, this is the right policy.  The problem is the massive monetary inflation from 2008 to 2014.  All of the misallocated resources from this loose monetary policy mean we will have a correction at some point.  The only question is whether we are near that full correction.  We have already seen it in the oil market.

Gold has done well in the last two months in the face of a falling stock market.  I believe investors are looking for positive yield.  With interest rates near zero – or even negative in some countries – it makes sense that at least a few investors would be looking at other asset classes.

The only way we will see anything close to a 1 to 1 ratio for the Dow to gold is if the Fed starts inflating again.  This is certainly a good possibility if the economy shows further signs of weakness, including falling stocks.

We should not hope for a 1 to 1 ratio.  This would mean some form of economic chaos.  We really don’t want a repeat of 1979/ 1980.  We should only want a repeat of the Fed’s response, which was to maintain a tight monetary policy, despite recession.

Still, what we want is not the same as what we should prepare for.  We should know that a Dow-to-gold ratio of 1 is a possibility, even if it seems remote at this time.

If we ever do get anything close to that, I hope I am smart enough to sell some of my gold to buy stocks.  If someone had done that in early 1980, they would have made out very well.

CPI Update – February 2016

The latest Consumer Price Index (CPI) numbers were released on February 19, 2016 for January.  While the CPI is flat, the year-over-year change is now 1.4%.

The more stable median CPI ticked up, as the 12-month change is 2.4%.  You can view the numbers here.

Energy prices have had a big impact on the numbers.  It is the primary reason for such a low CPI reading.  For example, while the 12-month change in the CPI is 1.4%, it is 2.2% when you remove food and energy.  This is actually above the Fed’s supposed target of 2%.

I continue to stress that although the CPI is a government statistic that is far from perfect, it is still useful for a couple of reasons.

First, the CPI can show us trends.  As long as the weightings are the same, it does give us a picture of whether consumer prices are trending up or down.

Second, we have to believe that the Federal Reserve uses the CPI statistics in its decision making.  I believe that the numbers are probably understated, especially when it comes to health insurance premiums.  The weighting and methodology for including health insurance premiums is complicated to say the least.  We all know that premiums have skyrocketed while the actual health plans cover far less.

But to the Fed, consumer prices look tame.  In most things, prices are relatively tame in our fiat currency era.  Prices are going up, but nothing compared to the 1970s.

For this reason, I think it is more likely that the Fed will not be afraid to lower its target rate again, or start another round of so-called quantitative easing.

I know we hear about negative interest rates now, but the Fed is currently paying banks 0.5% on reserves.  This is to support its targeted federal funds rate.  So before the Fed imposes a negative interest rate, it would first have to actually stop paying the banks to not lend.

The Fed is sitting in a sweet spot right now in terms of lower unemployment and relatively low price inflation.  Therefore, the Fed will probably sit tight until the stock market falls a lot more, or until it is more evident that we are in, or heading into, a recession.

Things can happen quickly as we saw in the fall of 2008.  You could wake up on Monday morning and see the Dow futures down by 1,000 points.  If we see a few days in a row of plunging stocks, the discussion can change quickly.  It won’t be talk of whether the Fed will raise interest rates again, but whether the Fed will lower them or start more money creation.

The Fed has had a tight monetary policy since October 2014 when it ended QE3.  It has not been expanding the monetary base since that time.  Due to the tight money, I believe the misallocated resources built up from the easy money of 2008-2014 will be exposed shortly.  As stocks fall and long-term yields fall, a recession is looking more and more likely.

If the CPI were running at 3 or 4 percent, then I might think the Fed would sit still in the face of plunging stocks.  But since consumer prices are relatively low, the Fed may not hesitate as much to inflate.  We should consider this going forward.  It looks as though gold investors are already considering this, as the price has risen in the face of falling stocks and falling yields.

Thomas Sowell Endorses Ted Cruz

I have been a harsh critic of Thomas Sowell.  I fully understand that he has done some great things for liberty, and that on some issues of economics, he writes clearly and concisely.

Still, I know a lot of libertarians who like, or at least sympathize, with Sowell.  I do not.  I think he is a statist.  He wants to inject your children with vaccines.  He is generally a militarist.

I agree with Sowell on some economic issues.  So what?  I agree with some leftists on the drug war and foreign policy.  Even on some important economic issues, I am not with Sowell.  He is largely silent on the damages of the Federal Reserve.

Sowell recently wrote a column effectively endorsing Ted Cruz.  He doesn’t come right out and say it, but it is as close as you can get to an endorsement without actually uttering the words.

Sowell cites the importance of the passing of Justice Antonin Scalia.  I recently wrote a piece on why libertarians should not be so quick to revere Scalia.

Sowell comes across as the typical conservative, saying that the vacancy on the Supreme Court “makes painfully clear the huge stakes involved when we choose a President of the United States, just one of whose many powers is the power to nominate justices of the Supreme Court.”

The Supreme Court is used to divide the nation politically.  Both sides will come out and tell us how important this election is because of the nomination of Supreme Court justices.  We are always told that this is one of the most important elections of our lifetime.  It is left unsaid on what has gone wrong that 9 justices are deciding on policy for over 300 million Americans.

Sowell concludes his article saying that he has criticized Cruz before and will undoubtedly criticize him again.  But, “As someone who once clerked for a Chief Justice of the Supreme Court, he will know how important choosing Justice Scalia’s replacement will be.  And he has the intellect to understand much more.”

Ted Cruz is a politician.  His wife is part of Goldman Sachs.  He has a reputation of being outside of the establishment.  I have to admit that he is far from the establishment’s first choice as a nominee.  But they prefer him over Trump.

Cruz says he wants to bomb ISIS to see if sand can glow in the dark, meaning he wants to nuke the Middle East.  He occasionally questions U.S. foreign policy in subtle ways, but we can be sure he will be terribly pro war in office.

Even when it comes to economics, Cruz is not that great.  He is not preaching a major cutback in the federal budget.  I don’t hear him making constant calls to abolish the Department of Education or any other major departments or programs.

Sowell has gone from endorsing Newt Gingrich to Ted Cruz.  Meanwhile, he has little nice to say about Ron Paul.  And some people want to associate Sowell with being a libertarian, or even sympathetic to libertarianism?

In his article, Sowell talks about the extreme dangers in our world “where our adversaries’ military power and aggressiveness are increasing, while our military forces are being cut back.”

Sowell is a conservative.  He is preaching the line about our military being cut back as the U.S. government occupies most of the world in some form or another.  He thinks others are being more aggressive, yet he can’t bring himself to question U.S. foreign policy at all.

If you read an article by Sowell that helps explain an economic issue clearly, then by all means share it with your friends.  Just please don’t delude yourself into thinking that Thomas Sowell has anything to do with libertarianism.  He is a conservative and a statist.  Occasionally his thoughts overlap with libertarians.

2016 South Carolina Republican Primary

My analysis of the presidential race will continue, even though I don’t support any of the candidates.  You could say that I despise some less than others though.  I have occasional sympathy for Trump, and even a little for Sanders, just for giving such headaches to the establishment.

Before discussing the South Carolina Republican primary, I just want to say a couple of things about Nevada, where caucuses were held for the Democrats.  Hillary Clinton won, although not by a big margin.

Even though Bernie Sanders has strong support from young people and the grassroots, he is not coming away with victories in the caucus states.  Of course, these states are a bit more prone to rigging, as we saw with all of the strange happenings in Iowa with coin flips and everything else.  When there is room for shenanigans, it will favor the establishment candidate.

We don’t really have a good measure yet in the Democratic race because Iowa and Nevada both had caucuses and New Hampshire has open primaries, which would tend to favor Sanders.

I have said that I think Sanders is the third biggest threat to Hillary Clinton right now.  The second biggest threat is an indictment by the FBI for her secret emails that aren’t as secret anymore.  Her biggest threat is an economic recession.

On the Republican side, Donald Trump won easily with about one-third of the voters going for him.  It looks like Marco Rubio will just barely edge out Ted Cruz, but just by a fraction of a percent.  They are both just over 22%.  Perhaps Rubio is recovering from his New Hampshire debate.

Jeb Bush is finally dropping out of the race.  No matter how bad Donald Trump ends up being, I will forever be thankful to him for stomping on Jeb Bush like a little cockroach.

At this point, we can basically write off Kasich and Carson as well.

So it is left between Trump, Rubio, and Cruz.  I can’t help but think that Cruz was damaged in South Carolina though.  It is evangelical country.  If Cruz can’t win there, or at least make a strong second place showing, then I can’t imagine him doing well anywhere else, except maybe Texas.

It is interesting that the three candidates still in the hunt are not governors.  Two are senators and one is a businessman.  Although the 2008 matchup was two senators (Obama and McCain), it is not that common.

At this point, I think we should expect Trump to be more guarded in his comments, but that may seem hard to believe.  Even if all of the Bush votes had gone to Rubio, he still wouldn’t have had enough to beat Trump.

Rubio would have to get most of the other supporters to coalesce around him quickly.  That would mean Kasich and Carson supporters would have to go to Rubio as well, which is far from certain, especially with Carson.

Trump’s best scenario is that Cruz and Rubio both stay in the race for the long haul to split votes.  He should hope that Carson and Kasich stay in as well.  He wants the anti-Trump vote to be split up for as long as possible.

A Trump vs. Clinton matchup is looking more likely.  It is hard to believe that the bigger pro war candidate will be coming from the Democratic side.

Scalia, Libertarianism, and the Constitution

With the recent death of Supreme Court Justice Antonin Scalia, there has been much reflection of his life and his beliefs.

Scalia has the reputation of being an originalist, meaning he interpreted the U.S. Constitution according to its original intent.  He also has the reputation of being a conservative.

I have heard the typical comments about Scalia from the left and the right, which seem to be mostly talking points.  But I have also heard some libertarian commentary on him, which I will comment on below.

I would like to say that everything I have heard and seen about Scalia indicate that he was highly intelligent.  Even many on the left will admit that.  He also seemed to have a good sense of humor and to be likable in person.

In terms of his time as a Supreme Court justice, there is no question that he was a little different.  His written opinions were often well thought out and he was skilled at using rhetoric.  He is beloved by the conservative wing of the Republican Party, which is not surprising given his conservative stances.

Scalia also makes Ronald Reagan look good to conservatives.  Reagan’s other nominees who made it through confirmation were Sandra Day O’Connor and Anthony Kennedy, who are not known to be nearly as conservative.  Reagan also nominated Robert Bork, but he was blocked by the Senate.

I have heard and read some commentary by libertarians on Scalia including a piece by Judge Andrew Napolitano, who was actually a friend of Scalia’s.  The great Tom Woods also did a podcast with Kevin Guzman on the topic.

These are libertarian greats that I admire and learn from.  With that said, I thought they were much too soft on Scalia.  It is understandable that Napolitano does not want to criticize his friend who just passed away.  As far as the discussion between Woods and Gutzman, they did have some light criticism of Scalia, but I thought they could have gone deeper in some respects.

I don’t expect libertarians to agree on everything and that is fine.  But for those who don’t know a lot about Scalia, I just want to shed a little bit of light.

In terms of disagreement, libertarians often disagree on the U.S. Constitution.  Some think that we should defend it and uphold it.  Some think it is just a piece of paper that is meaningless.  Some think its adoption was a coup against the Articles of Confederation to centralize power.

Despite disagreements between constitutionalists and anarchists and others, most libertarians agree that we would be much better off if the U.S. government actually obeyed the Constitution and its enumerated powers as compared to the monstrosity that we have now.

I will also acknowledge that libertarians have differing views of certain aspects of the Constitution including the 14th Amendment and how it applies to states, and also about judicial review.  On the latter, there is a question of whether the U.S. Supreme Court should strike down laws that it deems unconstitutional.

Scalia had nearly 3 decades on the bench, so there are obviously a lot of rulings to examine.  There are many cases where libertarians could reasonably disagree.  But I just want to focus on one particular case where I’m guessing at least 99% of hardcore libertarians would agree on what the ruling should have been.  It is a case where, for me, it shows that Scalia was a conservative first, and a constitutionalist second, if at all.

The case is Gonzales vs. Raich.  It was argued in 2004 and decided in 2005.  The Court ruled by a 6 to 3 vote that the U.S. Congress can criminalize the production and use of home-grown cannabis where a state has legalized its use for medicinal purposes.  The ruling was justified under the Commerce Clause.

Realize that this doesn’t even involve the trading or selling of marijuana across borders, although I still believe that the only way this could be a legitimate case in front on the U.S. Supreme Court is if there were some kind of dispute between the states.  The federal drug laws are still unconstitutional, regardless of whether drugs are crossing state lines.

Still, this case was very narrow in just referring to home-grown marijuana.  In this case, the so-called originalist, Antonin Scalia, sided with the majority.

Of course, Scalia wrote his own opinion, separate from the majority, trying to dance around his interpretation.  But for me, this case makes it rather clear that Scalia was a conservative first and foremost.

The three dissenting opinions were Sandra Day O’Connor, William Rehnquist, and Clarence Thomas.  Actually, it was Justice Thomas in this case who had strong rhetoric on his side.  He wrote a scathing dissenting opinion, pointing out the absurdity of it all.

Thomas wrote that if the federal government can regulate this, “then Congress’ Article I powers – as expanded by the Necessary and Proper Clause – have no meaningful limits.”

Thomas also wrote: “If the majority is to be taken seriously, the Federal Government may now regulate quilting bees, clothes drives, and potluck suppers throughout the 50 States. This makes a mockery of Madison’s assurance to the people of New York that the ‘powers delegated’ to the Federal Government are ‘few and defined’, while those of the States are ‘numerous and indefinite.'”

I have had my disagreements with Clarence Thomas over the years as well, but by looking at this case, it is clear that there may be a much stronger case for libertarians to at least sympathize with Thomas over Scalia.

The federal drug war is a great issue to test conservatives who supposedly pledge allegiance to the Constitution.  There is obviously no enumerated power in the Constitution giving Congress the authority to legislate drug laws.  If a conservative believes that drugs should be illegal in all 50 states, but that ultimately it is up to the states to decide, then that would be consistent with taking an originalist approach in interpreting the Constitution.  But let’s face it; most conservatives strongly favor the federal war on drugs.

Again, I know libertarians can have differing views that are reasonable, but I thought it was important to point out this one particular case to show that Scalia was nothing close to a libertarian and was not even a strict constructionist or originalist when it conflicted with his personal conservative views.

Cash in the Permanent Portfolio

I am a strong advocate of a permanent portfolio as described in Harry Browne’s book Fail-Safe Investing.  I believe it should make up the majority of one’s investable assets outside of any real estate or business ownership aside from stocks.

The permanent portfolio is simple.  Anyone with a little financial knowledge should be able to set one up with relative ease.  It just takes a little discipline in sticking to it and occasionally rebalancing.

The portfolio consists of cash, long-term government bonds, stocks, and gold.  The four investment categories are divided up equally.  You will have approximately 25% of each.  If any one investment gets too far above or below the 25%, then you can rebalance it.

I have mentioned ways before of tweaking the portfolio.  If you are a particularly aggressive investor, you could consider reducing your cash portion and adding it to the other portions.

For example, you could put just 10% into cash, and put 30% each into stocks, bonds, and gold.  This would make it more volatile.  You would also probably get hit harder in a recession.  Of course, the lack of volatility is one of the main attractions of the permanent portfolio.

When we talk about cash, it isn’t really cash.  Most of your cash will be in a checking account or short-term debt instruments.  You might have your “cash” in a money market fund, a savings account, or even a very short-term cd.

While I have made the suggestion of possibly reducing the cash portion for aggressive investors, I do want to emphasize the importance of cash in the portfolio.

First, as I already alluded to, cash is good to have in a recessionary environment.  It provides some stability.  As the saying goes, cash is king in a recession.

Second, even though cash would be seemingly bad in an environment of high inflation, it isn’t necessarily terrible.  If you have an environment of high price inflation and high interest rates as was seen in the 1970s, then cash won’t be as bad as you might think.  The reason is that you are still earning high interest rates.  The real interest rate (as opposed to nominal) may still be slightly negative, but at least it is somewhat keeping up.  In today’s environment, you are definitely getting a real negative interest rate on short-term debt.

Third, and probably most important, is that cash is there for rebalancing in a recession.  That is one of the reasons cash is king in a recession.  You have cash to buy beaten down investments while almost everyone else is feeling broke.

If we hit a recession and stocks and gold both go down, while bonds stay about even or even go up, then you will be able to use some of your cash position to buy gold and stocks when they are down.  That is one of the big benefits of the permanent portfolio.  You are forcing yourself to buy low and sell high.

The permanent portfolio has a bias built in for higher price inflation.  Overall, I think this is positive.  You obviously need higher returns during a time when you are losing purchasing power.

The permanent portfolio has basically done nothing over the last several years in terms of returns.  We are in an environment of low interest rates, relatively low price inflation, and struggling growth.  It is not a surprise that the portfolio is not up, especially considering the major downturn in gold until recently.

I still think the permanent portfolio is the best option for the passive investor.  It is probably the best option for most non-passive investors as well.  It is designed to hold up in any economic environment.

I believe that we are likely headed into some kind of a recession.  I am not stating that here for speculative reasons, but just to confirm the importance of having 25% cash in your permanent portfolio.  The bonds are also vitally important, as interest rates could fall even further.

If stocks plunge, then you will have other assets available, such as your cash, to buy stocks when they are low.

The permanent portfolio may not seem too exciting right now, but you will be happy when stocks are plunging and your friends can’t sleep at night.  You won’t worry too much if you lose a few percentage points here and there.  And you will have cash available to buy when virtually nobody else wants to buy or nobody else has the money to do so.

Stocks and Recession

Stocks have been taking a pounding so far in 2016.  It may or may not be a coincidence that they have been in virtual free fall since the Fed’s decision to “hike rates”.

I fear that people are going to blame the Fed for the wrong reasons.  The Fed is certainly at fault, along with the massive spending by the government, but it is not because of the Fed’s little rate hike in December.

The reason the economy is on the verge of recession is because of the massive monetary inflation from 2008 to 2014.  The Fed ended QE3 in October 2014.  Despite the low interest rates, the Fed has been in tight monetary mode for over a year now.

The Austrian Business Cycle Theory teaches us that when the money supply stops expanding, or even decelerates, the unsustainable bubbles that occurred due to the easy money will be exposed.  The malinvestment is exposed as malinvestment.

A recession will occur, which is basically a correction of the misallocated resources.  The only viable way for a recession to be avoided is for the money supply to grow again, and even this may not be enough.  And if the recession is avoided, it is only temporary, as the resources continue to be misallocated.

The sinking stock market is a strong indication of a recession.  There is even talk of it in the media (outside of the internet).

Like so many things in economics, cause and effect are often confused.  It is important not to make this mistake in terms of falling stocks and recession.  There is a correlation of falling stocks and recession, but falling stocks do not cause a recession.  The falling stocks are a symptom.  Correlation does not mean causation.

Treasury rates are telling us a similar story.  The 10-year yield is now around 1.64%.  The 30-year yield is about 2.5%.  The yield curve is not close to inversion, but it has flattened a bit.  An inverted yield curve, or even a flattening yield curve, is a classic sign of a recession.

Perhaps the most interesting thing to me is that gold has done really well.  It has burst above $1,200 per ounce.  It is surprising it has done so well in the face of a possible recession.  Gold does not typically do well in a recession that is coupled with relatively low price inflation.

Gold stocks, which have been beaten down badly over the last several years, have shown a lot of signs of life.  I don’t know whether this is the start of a new bull market for gold stocks, but it is encouraging.  When a new bull market in mining stocks does emerge,  there will be huge potential profits in this sector.

I think everyone should be preparing for a recession.  I hope the Fed keeps a tight monetary policy and allows it to happen.  Maybe one day we can actually have a real and genuine recovery.  The last time anything close to that happened was in the early 1980s when Paul Volcker allowed interest rates to skyrocket with a tight monetary policy.

I am still a strong advocate of the permanent portfolio, or something similar.  It has not performed very well over the last several years, but this is an environment of low interest rates and low price inflation.  Still, the permanent portfolio has been great to have over the last two months.  It also shows why bonds are still an important piece to the puzzle.

If you are a conservative investor, stick with the permanent portfolio.  Even if you are more aggressive, I still think you should have over half of your investable assets in such a setup.  For the speculative money, I am looking at mining stocks.  I also want to consider silver, but silver has yet to show the same signs of promise that gold has.

Most importantly, it is a time to make sure that you have a reliable source of income.  It is also important to have a good Plan B.

Unless the Fed steps in and starts another round of money creation, we should assume that a recession is likely.  The plunge in stocks is not causing the recession.  It is telling us to watch out for one.

2016 New Hampshire Primaries – A Libertarian Perspective

What do Peyton Manning and Marco Rubio have in common?

They both like to recite rehearsed lines multiple times.

What is the difference between Peyton Manning and Marco Rubio?

In the case of Peyton Manning, repeating the same line isn’t what ended his career.

Ok, so maybe Rubio isn’t done yet.  I really don’t know.  After the Iowa Caucuses, I thought Rubio was the frontrunner for the Republican nomination.  I figured that Bush, Kasich, and Christie would all drop out soon and the establishment would all get behind Rubio.  Rubio was the favorite according to the betting sites.

Then the Saturday night debate happened.  Rubio stood and there and recited a line about Obama.  Chris Christie then accused Rubio of reciting memorized lines.  So what does Rubio do, but simply recite the same line over again.

After winning the Super Bowl, Peyton Manning said in back-to-back interviews that he wanted to kiss his wife and drink some Budweiser.  It seemed like a rehearsed line, since he repeated it.  But at least Manning is a football player.

Chris Christie severely damaged Rubio.  It didn’t do a lot for Christie, as he will likely finish just behind Rubio in New Hampshire.  But Christie did a huge favor for Donald Trump and Ted Cruz.

Now Trump is back to being the favorite.  He easily won in New Hampshire, as he was expected to do.  John Kasich will take second, but it is hard to imagine Kasich doing anything significant after New Hampshire.  Cruz will likely finish in third, with Bush just behind him.

Where will the establishment turn?  Will they get behind Kasich?  Will they return to Bush?  Will they go back to “repeating Rubio”?  Or maybe they will just accept Ted Cruz in order to beat out Donald Trump.

On the Democratic side, Bernie Sanders will win New Hampshire as expected.  But Sanders is winning by a wider margin than expected.  Hillary Clinton is really feeling some heat.  If she looks one way, she sees the FBI investigating her no-longer-secret emails.  If she looks the other way, she sees Bernie Sanders.  And if she gets by both of them, then she looks behind her at a looming recession.

Although Ron Paul is not part of this presidential race, it has still been somewhat unexpectedly pleasing.  If there are two anti-establishment candidates in this race, they are Trump and Sanders.  I don’t think they would bring any major changes to this country, but the establishment can’t stand them.

So while I have my many issues with Trump, and I have even more issues with Sanders, it is nice to see them causing an uproar.  It is also nice to see a little rebellion in the citizenry, even if the candidates are not very good.

It probably won’t make much difference who wins the presidency, but at least the voters are showing discontent.  If there is one area that a president can have some influence, it is in regards to foreign policy.  And while Sanders and Trump are not non-interventionists, they are seemingly less pro war than the rest of the candidates.  We don’t know what they will do if in office, but we know the other candidates are basically a guarantee for more war.

The answers to our societal problems do not lie in politics.  But at least the voters are turning away from the conventional politics of the establishment.

The Fed’s Tight Monetary Policy

The Federal Reserve currently has a tight monetary policy.  This tight monetary policy may speed up our way to a recession.  But this is as it should be.

If we get a recession, it is because of the previous loose monetary policy from 2008 to 2014.  It was a giant misallocation of resources.  A recession would be the market’s attempt to correct this.  That is why “correction” is a good term to use.

If the Fed kept a loose monetary policy, it wouldn’t make things better.  It would make things worse.  But it may delay the inevitable correction.  It will also make the correction more severe, thus more painful when it arrives.

When I say the Fed currently has a tight monetary policy, sometimes I get a quick retort to the effect of, “Yeah, raising interest rates up to a half percent is really tight.”  But it is a mistake to pay attention to the Fed’s interest rate – the federal funds rate – instead of paying attention to the money supply.

Since the banks hold well over $2 trillion in excess reserves, there is little need for overnight lending.  Therefore, the federal funds rate is almost meaningless in terms of the money supply.  The Fed did not have to severely deflate the monetary base in order to hike the federal funds rate.  It raised the rate paid on excess reserves, helping to put a floor under the federal funds rate.

I recently noticed that excess reserves held by banks had gone down quite significantly over the last few months.  They are down by about $300 billion.  Is this a sign that lending has increased and that massive price inflation is on the way?

But then I looked at the adjusted monetary base.  That is also down.  So the decrease in the Fed’s monetary base is down in correspondence with the excess reserves.

I don’t believe this is a result of the Fed selling off assets.  If it is, then the Fed is going against its own policy, which is to keep a stable monetary base by rolling over maturing debt.

The most likely explanation is an increase in reverse repurchase agreements, also knows as reverse repos.  Reverse repos are a tool used by the Fed to temporarily borrow deposits from depository institutions.  It has the effect of reducing the Fed’s assets.

When the Fed announced its hike in the federal funds rate in December, it notated at the bottom of the FOMC statement two ways it would do this.  One was to increase the rate paid on excess reserves from 0.25% to 0.5%.  The second was to increase the rate paid on reverse repos to 0.25% (25 basis points), which had previously been around 5 basis points.

I believe this change can explain the reduction in the monetary base and the corresponding reduction in excess reserves.  As long as these two pieces of data stay in line, then it means the money supply is relatively stable.  This means a tight monetary policy by the Fed.  It is not deflating, but it is also not inflating.

Since the easy money is drying up, the malinvestments from the previous loose monetary policy will be exposed.  We are going to get a correction soon unless the Fed changes course.

If the Fed starts QE4 and follows Japan with negative interest rates on excess reserves, then it might delay the recession.  Even with that, it may not be enough to delay it for long.

Timing the market is tough to impossible.  I am not trying to time the market precisely here, but some kind of a correction looks inevitable, whether it is beginning now or a year from now.  My guess is that it will start this year, if it hasn’t already.