Fed Balance Sheet Expansion, Unicorns, Unintended Consequences And The Gold Price

The Bank for International Settlements (BIS) – the Central Bank of Central Banks – released two reports on “unconventional policy tools” – e.g. QE/money printing and interest rate suppression. It concluded that the extreme Central Bank interference since 2008 has had a negative impact on the way in which financial markets function.

While Jerome Powell and his “Gang That Couldn’t Shoot Straight” at the Fed prefer to use the term “balance sheet growth” in reference to money printing, the big-thinkers at the BIS call it UMPT (Unconventional Monetary Policy Tools).”

“Last month’s spike in short-term US borrowing costs was just the latest in a series of market shocks that have fueled investors’ suspicions that this radical monetary policy is having an impact on how financial markets function.” (Financial Times)

“Moral Hazard” is defined as the “lack of incentive to guard against risk where one is protected from its consequences.” In economics (real economics, not the Keynesian psycho-babble of the current era) this would refer to the egregious misallocation of investment capital caused by the unfettered creation of fiat currency injected into the global financial system.

Additionally, unprecedented permissiveness by the regulators, who are charged with enforcing laws originally established to prevent or at least contain the escalating financial fraud that accompanies asset bubbles, further enables and accelerates the formation and inflation of investment bubbles.

The BIS report of course neglected to discuss the extreme moral hazard engendered by the trillions in money printing. The “unicorn” IPOs are the direct evidence of this. The extreme  overvaluation of the equity in the ones that have sold stock into the public markets reflects the complete disregard of historically accepted tools and guidelines used for business model appraisal and financial valuation analysis. “But it’s different this time.”

The losses racked up by these companies, the ones with public equity plus the ones yet to be IPO’d, will aggregate well into the $100’s billions, possibly trillions before this era dies. A journalist from The Atlantic, in an article titled “WeWork and The Great Unicorn Delusion,” correctly asserted that “most [of these companies] have never announced, and may never achieve, a profit.” But he lost me when he asserts that these companies are “extraordinary businesses with billions of dollars in annual revenue and hundreds of thousands, even tens of millions, of satisfied global customers.”

Quite frankly, the business model of almost every Silicon Valley unicorn is predicated on building revenues and gaining market share by selling products and services for a significant discount to the all-in cost of production and fulfillment.

Every single unicorn IPO’d over the last several years that I have evaluated is not only highly unprofitable, but also burns legendary amounts of cash. Of course there are “millions of satisfied customers” globally – the unicorn business model functions in a way that is the equivalent of selling $1 bills for 75 cents.

The more relevant proposition is that, in all probability, many of these companies would have never  spawned if the Central Banks had not inflated the global money supply well in excess of real economic growth generated by the global economy.

I find it difficult, if not impossible, to refer to these appallingly unsustainable businesses models as “extraordinary” when in fact most if not all of them are nothing more than the product of the extreme moral hazard created by the Central Banks’ printing presses running overtime.

The economic losses incurred by the Silicon Valley unicorns are funded by the “private equity” funds which have managed to harness a significant share of the cash flowing from Central Bank money-spigots and transmitted through the primary dealer banks into the financial system. Little noticed is the fact that since 2014, roughly $1.3 trillion has drained out of the banks’ excess reserve account at the Fed and disappeared into the financial system’s “black hole.”

The 2008 Great Financial Crisis – which was a de facto financial system collapse until money printing bailed out banks and reckless investors – was fueled by the easy monetary and credit policies of Alan Greenspan and Ben Bernanke. Those policies stimulated huge mortgage, housing general stock market bubbles. The unintended consequences bankrupted a large swathe of households and banks.

But that decade’s reckless Central Bank policies pale in comparison to the current era of unfettered money printing cranked up by Ben Bernanke (recall that he was affectionately called “Helicopter Ben”). The ensuing widespread asset bubbles have fomented into a financial Frankenstein that has broken free from its chains as evidenced by the sudden implementation of the Fed’s repo program, which has yet to be accompanied by a credible explanation.

Jerome Powell yesterday (October 8th) asserted in a speech that “balance sheet expansion is not Quantitative Easing.”  But make no mistake, the repo operations function as emergency room triage until the Fed and the Treasury Department formalize another round of money printing, or QE or whatever you want to call it. At this points it is nothing more than a game of Orwellian semantics.

If you’re curious as why the price of gold has risen 37% since the end of May, look to the events unfolding at the Fed and in the banking system. Just like in late October 2008, the price-action in gold is sending a loud alarm that is no longer containable with manipulative efforts in the paper derivative gold market. Eventually the Government’s Working Group on Financial Markets will be helpless in coaxing the hedge fund trading robots to help hold up the stock market.

Dave Kranzler

http://investmentresearchdynamics.com