On the heels of extraordinary turbulence in key global markets, today 40-year veteran, Robert Fitzwilson, put together another tremendous piece. Fitzwilson, who is founder of The Portola Group, discussed financial meltdown, and what this all means for battered traders and investors in the gold market. Below is Fitzwilson’s outstanding and exclusive piece for KWN.
Fitzwilson: “Friday was an extraordinary day. Stocks and oil posted strong gains while precious metals were sold off. The strength in the stock market was attributed to a positive jobs report, and the rise in the price of oil was associated with the unrest in Egypt. Precious metals hit another air pocket, but the source of the selling was managed money, not from the bullion banks.
But what was really significant was the carnage in the bond market….
“We cannot recall a worse one-day selloff in bonds. With continued talk of the Federal Reserve tapering their bond and mortgage buying, one would expect interest rates to rise in a controlled, gradual, and engineered manner. That certainly was not what we witnessed on Friday.
In the 1970s, we talked about “crowding out” as an explanation for why rates began large secular increases. As the government demanded more from the private sector to fund the Vietnam War and the social programs, that meant less capital for individuals and corporations. The competition for capital caused rates to rise. There was not enough capital to go around, and some contenders were crowded out.
That is not our situation today. Cash flow, particularly for large corporations, has been extremely strong and has been piling up on the corporate balance sheets. In addition, many corporations took advantage of low interest rates to refinance their debts, further enhancing their cash flow and this also allowed for massive stock buy back programs. Small businesses have not had such fortunate access to capital, but there was virtually an unlimited supply for those major corporations with strong balance sheets and cash flow.
While tax receipts were very strong for the Federal government, the shortfall in spending versus receipts was met by the Federal Reserve buying Treasury securities when offered. There has been virtually no crowding out in a traditional sense. Capital has been freely available in our post-market financial world, and at extraordinarily low and artificial rates.
Friday was extraordinary for the violent price declines. Those declines were not indicative of a controlled, engineered rise in rates. It looked more like a panic for the exits. China and Japan are the two major foreign holders of Treasury securities that would be the likely candidates for the selling as their needs for capital are well known at this point.
However, under any reasonable scenario we would expect the Federal Reserve to perform their magic and make sure that the liquidations were orderly and did not cause interest rates to spike. That did not happen on Friday. Entities wanted to sell, the selling was in size, and interest rates exploded to the upside. There was no crowding out as scarce capital was bid up in price. It looked like the crowd simply wanted out.
With the ECB and the Bank of England sounding less collegial this week, could it be possible that there is discord among the central bankers? Has the financial system finally reached the instability that has been predicted? We should soon see. What happened on Friday certainly suggests that something major could be just around the corner. It is well known that a rise in interest rates beyond certain levels will lay naked the insolvency of governments around the world.
While we certainly do not relish the chaos that would result from a meltdown of the bond market, it will not come as a shock to those who have studied financial history. It is always the result of the fiscal and monetary policies which have been irresponsibly pursued, whether well-intended or not.
There are no examples in history of any paper currency not culminating in a violent collapse. None. It has been tried by all of our ancestors throughout human history. All examples resulted in failure. The lesson never learned is that humans cannot be trusted with the ability to create money out out thin air. The list of those who have come before us include the Mongols, Chinese, French, Germans, Romans, Hungarians, etc. It is not about a particular culture or a period in time. It just does not work.