Market Memo: Normalization, Tax Cuts, Geopolitical, and Gold

Despite ample evidence that we have entered a new monetary normal defined by the advent of negative interest rates and stagnated growth, few understand the implications of massive excess reserves on Fed policy.  Trump’s potential tax cuts are being equated with Reagan’s tax cuts.  Most analysis still dismisses the role of monetary policy on Reagan’s tax cuts and focuses solely on the fiscal side.  The conventional economic wisdom is that the success of Reagan’s supply-side revolution was mainly the result of tax cuts. The understanding of monetary policy’s role is foggy or dismissed.  Yet, monetary policy played an equal role with fiscal policy.  In the 1980s the market set interest rates, and Greenspan had an innate understanding of gold’s historical properties.  The stabilization of the dollar during Greenspan’s Great Moderation around $350/oz of gold did not happen by accident.  This was the magic formula of stable money and low taxes.

With the conflation of Trump’s tax cuts in the same fiscal terms as Reagan’s, many are predicting similar growth results.  But monetary policy again has an equal role in the efficacy of tax cuts and a return to real growth.

Trump’s tax cuts—amid issues of trade and geopolitical tension, and cryptocurrency and global sovereign challenge to the fiat dollar—are no less dependent on the monetary environment today then they were during Reagan’s tax cuts.

Yet, the monetary environment today is completely different with little understanding of the massive changes wrought by Bernanke’s QE experiment.  The Fed has ceded control of the dollar to a sort of defacto monetary equilibrium that determines the dollar’s value.  The Fed is attempting to address its lack of real control over dollar supply through normalization.  In reality this is a baby step that maintains the Fed’s bloated balance sheet and excess reserves for many years at merely a reduced amount with no change to IOR.  A return to pre-2008 Fed policy of insignificant excess reserves is nowhere visible on the horizon.

This is not a dismissal of the efficacy of fiscal policy.  Reduced taxes from the upper region of the Laffer Curve, less regulation, small government, and beneficial free trade are proven hallmarks for growth.  Yet, this requires a foundation of stable money upon which fiscal growth thrives.  It is the lack of prospects for truly stable money after nine years of massive Fed monetary distortion that differentiates today from the Reagan era.  

What this means is that the POG will continue to adhere to the Kendall Rule.  The initial steps of normalization, tax cuts, and trade issues will not disrupt this.  Only serious geopolitical issues or another financial crises may disrupt the POG’s continuation of tracking the duration of debt.  Absent these concerns, a fall of the POG below $1250 becomes a buying opportunity.

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