Rigged Markets

It is hard to separate market truths from market lies. By this I mean distinguishing between honest pricing based on genuine supply and demand, and markets rigged by governments and their central banks. Obviously, markets rigged by governments make any rational assessment of future prices impossible. Instead analysts are forced to replace their natural and rational market instincts with an assessment of future actions by the state.

There are four ways in which markets are rigged by governments. The first and most traditional tool is interest rates. By suppressing interest rates bond yields are in turn artificially lowered, and the extra quantities of base money and bank credit that are issued as a result provide finance for other financial assets. The second is falsification of statistics, particularly the rate of inflation. The third and most surreptitious rigging is buying and selling of investments by government agencies, including but not limited to exchange stabilisation funds, sovereign wealth funds, state-directed pension funds, and their so-called independent central banks. The most recent estimate of their total available for intervention is $30 trillion equivalent, but more can be created out of thin air. The fourth and last is relatively new, and that is forward guidance, where the state tells you what to expect and by implication you must be stupid to ignore the state’s investment advice.

Make no mistake these are four very powerful tools driving the markets. They have ensured that those of us who know that the whole financial system is extremely fragile are not listened to and dare not bet against it. Indeed, so fragile is the financial system that all four methods of market rigging are being used to the max. All we can do is keep away from markets, because to do otherwise is to go against our instincts and to gamble that governments will not fail. And do not make the mistake ordinary savers make, of entrusting their money to professional money managers, because their investment mandates with very few exceptions amount to supporting market rigging by governments.

If markets truly reflected the economic and financial outlook, government bonds would be priced for risk. There is no way that 10-year sovereign bond yields for over-indebted Eurozone states should be as low as they are. Just imagine if Spain, for example, had to pay a coupon based on her ability to repay the loan. What would it be: 5%, 7.5%, or 10% perhaps? At what rate would you lend money to the Italian government for 10 years, bearing in mind a debt-to-GDP ratio of 130%? No one would blame you for thinking the higher the coupon the worse the deal, and passing on the opportunity.

Imagine if US Treasuries were priced solely on their own merits. We should take a realistic inflation rate instead of the US Government’s corrupted figure and add two or three per cent. John Williams’s estimate of inflation based on pre-1980 statistical method is about 7%, which suggests, without taking into account market assessments of the future inflation trend that the 30-year bond should yield 9 or 10 per cent.

What would that do to the S&P, or house prices, or any other investible asset? The answer is obvious and that is what those of us who truly understand markets fear most. Equally, these are the reasons realistic market valuations cannot be permitted by the state. The markets are effectively nationalised, and we must be good little boys and girls and accept it.

None of this will be much of a surprise to regular Gold-Eagle readers, and perhaps I express it more plainly than most. But there is a vital consequence of which we must be aware. When governments supress risk by distorting markets they ultimately commit the currency. To illustrate the point, let’s us assume a new banking crisis erupts. At that point the big four central banks, doubtless with the support of all the others in the “free world”, will go into overdrive to contain and neutralise it. The only way this can be done is to make available infinite amounts of currency and credit to settle and support the markets. Whether or not this succeeds remains an open question.

However, there can be little doubt that a second round of currency debasement will collapse the economy. This point is poorly understood and not accepted by Keynesians and monetarists at all, yet it is vital to our understanding. The reason rapid currency debasement collapses an economy is this: when you print money, you end up robbing wealth from everyone’s savings and crucially the purchasing power of their wages. They don’t notice it at the time, but when the extra money works through the system this truth becomes horribly apparent.

It is called the Cantillon effect after Richard Cantillon, who became the world’s richest commoner acting as John Law’s banker in Paris at the time of the Mississippi Bubble.  Cantillon was in a position to notice that the greatest beneficiaries of money and credit inflation are the first receivers, in his case his bank and the Royal finances. The benefit diminishes as the extra money circulates from there, until those that are robbed most are the last to receive it, the lower and middle-class savers and those on fixed salaries. Therefore, expanding money and credit ends up as a stifling imposition on the large majority of economic actors.

The reason this appears not to have happened so far is down to our second method of rigging markets: fiddling the inflation rate. The distinction between consumer spending and deployment of savings is wholly artificial. Putting aside the conceptual flaws of a general price level for the purpose of this article, a properly constructed inflation index should include everything, including all forms of property and other investment media. Such an index would be a better reflection of price inflation.

This being the case, it is apparent that even the Shadowstats.com estimates do not go far enough. Now imagine the price effect of the next wave of currency and credit inflation. It is obvious that there is a risk that confidence in the currency’s purchasing power will be completely undermined. In that event, assets such as property and shares of companies that survive a major currency crisis will rise in nominal terms, but fall adjusted for purchasing power. We enter the realms of Argentinian, or possibly even worse, Zimbabwean economics, where rising stock prices can’t keep pace with a collapsing currency.

The best insurance against this risk is physical gold and silver. I look forward to investing gold and silver in stocks and property after the currency collapse and not before, and I expect that to be the opportunity of at least two centuries. And a big thank you to the governments and the banks which have helped keep prices down so I can buy them cheaply.

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Alasdair Macleod | Head of Research

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