Crumbling Confidence

Earlier this week, the New York Times reported on the American public’s dwindling confidence in public institutions. Even though the newspaper’s focus was on the poor standing of the Supreme Court, the administrative and legislative branch of the government fared even worse. Only 23% of those surveyed have any confidence left in the presidency, and when it comes to Congress the public’s trust drops to 7%.

To me that sounds about right. The bottom line is that the nation who criticizes others for duplicity and corruption most frequently, is itself deeply flawed. America’s campaign finance laws virtually guarantee that.

It’s not the welfare of the public that legislators cater to, but the prosperity of the monopolists in industries such as defense (think armaments), health (think big pharma), or technology (think digitization and AI).

To be sure, this state of affairs has been in place for some time, but what’s changing is people’s tolerance of it. For the past half century people have lived in a state of comfort, consuming more than they could afford—a dynamic that was first enabled by the invention of numerous new loan facilities, then followed by the forceful effects of globalization and technology, which ushered in years of falling prices and near-zero interest rates.

But globalization is now in reverse, inflation is relentlessly pushing prices higher, and interest rates have soared—all while indebtedness keeps increasing. Looking back at the past two decades makes for a grim picture: while a China we once pitied has managed to build a sizeable middle class, America has managed to achieve the opposite. Today’s U.S. income and wealth disparities are near the bottom of the developed world.

Of course, government and its parrots in the legacy media keep telling the public that most things American are still the best, but few believe it any longer. The only remaining question is when the public’s frustration will erupt into social upheaval and what form it will take?

Problems Within and Without

Other serious challenges to America come from without. As I’ve said on many occasions, the callous use of sanctions against governments, corporations and individuals who are deemed to be acting against Washington’s economic and political interests has long been detested—not just among rivals, but also unaligned nations and allies.

The result: increasingly many major economies are seeking alternatives to the use of the dollar as a trade settlement and central bank reserve currency. France’s highly publicized purchase of 65,000 tons of liquid natural gas from China (paid for in Yuan!) and Brazil’s recent decision to de- dollarize its trade with China are just the latest examples. To be sure, the dollar’s displacement will unfold over a period of years, but it will nevertheless prove painful to the country—especially in light of the dramatically escalating debt servicing cost brought on by higher interest rates.

Geopolitically, things aren’t going well for America either. President Macron’s most recent statement on the need for Europe to “build strategic autonomy away from the United States” (while visiting China) was as embarrassing as Saudi Arabia’s overtures toward Iran, Syria and even Yemen. Meanwhile, the massive leak of classified information has seriously undermined key parts of the U.S. and British government’s narratives on the Ukraine war. Yet none of this is stopping Washington from engaging in its next military adventure. Consider the recent public statements by U.S. Secretary of the Army Christine Wormuth that America has “to be prepared to fight and win that war” against China. With military bases in 85 countries, the odds of serious U.S. strategic overreach are now considerable, especially in light of an emerging Russia-China military axis. As we all know, strategic overreach was the very dynamic that brought virtually all of history’s empires to an end.

Of course, the unravelling of the U.S. dominated post-war order will take time—after all what is unavoidable is not necessarily imminent. And I should also add that I can think of at least five major Western nations where economic, social and political realities are as worrisome as they are in America. But sadly, the fate of those countries is in global terms inconsequential.

If the UK becomes the weakest G-10 economy (as it currently is), it doesn’t affect the lives of Americans or even continental Europeans in any discernible way. If Japan has the developed world’s highest debt/GDP ratio (according to the IMF 221%, compared to America’s 115% or Switzerland’s 14%), the eventual consequences will be harshly felt by the Japanese public, but won’t much matter elsewhere.

In sharp contrast, the U.S. is so interconnected that any meaningful economic decline will reverberate not only throughout the mature economies, but also the less developed ones—even more so, if it coincides with social unrest and declining geo-political influence. Current developments strongly suggest that we’re in trouble on all three fronts.

What Else Can Go Wrong?

What else can go wrong in our rapidly changing world? Details of the ‘Restrict Act’, a bi- partisan bill introduced to the U.S. Senate, have been revealed since I last wrote. Nominally, the proposed legislation targets Chinese social media platform Tik-Tok. But even a superficial reading reveals much more. In essence, the Reveal Act is yet another hodgepodge of egregious overreach, essentially allowing the government to control online content if it is deemed to be against the U.S. government’s interests.

Oh, and yes, then there is New Zealand, where Marama Davidson, the Minister for the Prevention of Family and Sexual Violence, announced that, “Trans people are tired of being oppressed and discriminated.” Fair enough, we can probably all agree to that. But then she added that, “I know who causes violence in the world, it is white cis men.” I confess that I had to look up what a cis man is. Apparently, it’s someone who was born male and, against all odds, is still male.

And, all along, the march toward the implementation of central bank digital currencies continues. As Agustin Carstens, the General Manager of the Bank of International Settlements suggested a couple of years ago, a central bank does not know who’s using a $100 bill today and what it’s being used for. Wouldn’t it be much better if they could monitor and, in time, influence what money is used for? While central banks in many nations seem intent on expanding their reach, there are a few voices of reason.

In the U.S., Federal Reserve Governor Michelle Bowman this week noted that “it is difficult to imagine a world where the trade-offs between benefits and unintended consequences could justify a direct access CBDC for uses beyond interbank and wholesale transactions.”

Other manifestations of digitization abound as well—increasingly often directed by artificial intelligence. My central concern with AI: who will control and govern it? What we’ve learned from technology is that its development consistently outpaces the capacity of governments, public institutions and corporations to keep up. So, as the stakes become higher and higher, who will decide what rules should be in place to ensure that AI is used responsibly?

Your Portfolio

It’s about five years ago that I recommended an overweighted gold holding for a balanced portfolio. The yellow metal then hovered between US$1,200 and $1,400, building a drawn-
out bottom. In 2000, the bullion price peaked near $2,070, a level it tested again less than two years later. Last week, gold vaulted above $2,000 a third time. Now, I have no idea whether it’s destined to make new all-time highs next week or next year, but looking at the countless uncertainties around us I see no reason to abandon our exposure. Gold’s solid fundamentals, its intriguing technical situation and its historical role as a preserver of value in both deflationary and inflationary times all speak for themselves.

What about inflation? The most recent data tell us that consumer prices are declining in most developed economies, but a closer look confirms that this is largely due to a decline in energy prices. On the other hand, costs in the service sector remain at elevated levels. This is troubling, because services inflation tends to be sticky. Another risk is that commodity prices may rebound again, now that the Chinese economy is in robust recovery mode.

U.S. M2-Money Supply Since 1960

Some analysts point to the growing risk of a U.S. recession, mainly as the result of a brisk drop in the money supply. M2, as the chart below shows, has fallen for three consecutive months and is now declining at the most rapid pace since the Great Depression.

To me, the recession scenario would suggest that we’re in for prolonged period of stagflation—the outcome our portfolios are currently positioned for.

Of course, there is always the possibility that this time will be different and that the Federal Reserve and foreign central banks will stay their restrictive course until inflation is vanquished. But that, at least in the context of recent monetary history, would be most unusual. Still, as I’ve repeatedly stated during the past few years, we have to be open to numerous possible outcomes and, as things take shape, adjust our portfolio mix accordingly.

With best regards,

Peter Cavelti