Common Cents for November 9, 2018

It would seem I have no shortage of topics on which to pontificate, if not bloviate, this week, What, with the elections, FOMC meeting, and a whole litany of other attention-grabbing headlines? Certainly, there is ample fodder to wax on finance, politics, society, how they are intertwined, and the impact on your pocketbook. Indeed.

However, I am going to resist temptation, at least for about 800 words, to do what most other people are doing and discuss what would have been a momentous story in a simpler time. However, these days it doesn’t register or interest many people outside of obscure, history Internet message boards.

This Sunday marks the 100th anniversary of the official end of the First World War, what they once called the war to end all wars. At the time, it was the most brutal, deadly, and hellish conflagration between nations in recorded history. The rise in military technology which started with American Civil War and developed during the Franco-Prussian and Russo-Japanese Wars came fully home to roost in the bodies of soldiers and civilians from all corners of the world. Killing had become easy, efficient, and impersonal.

By the time the dust had settled, the smoke cleared, and the last bullet shot, almost 10 million soldiers were dead. In excess of 20 million more carried the scars of their wounds for the remainder of their lives. Further, an additional roughly 8 million civilians were what we might call ‘collateral damage’ today. What is that? 38 million directly killed or wounded during this war?

While these numbers are significantly less than the carnage of the Second World War, the First World War forever changed how people viewed their governments and their individual roles in society. As historian Samuel Hynes wrote of the British experience:

“A generation of innocent young men, their heads full of high abstractions like Honour, Glory and England, went off to war to make the world safe for democracy. They were slaughtered in stupid battles planned by stupid generals. Those who survived were shocked, disillusioned and embittered by their war experiences, and saw that their real enemies were not the Germans, but the old men at home who had lied to them. They rejected the values of the society that had sent them to war, and in doing so separated their own generation from the past and from their cultural inheritance.”

The same could be said of the French, Italians, Russians, Austrians, Hungarians, Germans, their colonial populations, and the remainder of Europe. So torn was the societal fabric of Europe, the Second World War was almost inevitable, and the word inevitable itself is questionable. Whatever idealism remained in Europe made its way across the Atlantic to the United States, and has arguably been there since.

One of the best summations of the War, if not the best, are 15 lines of poetry by a Canadian, Lt. Colonel John McRae, who wrote “In Flanders Fields” in response to his experience(s) during the Second Battle of Ypres. He had noticed how quickly the poppies grew around the mass graves of the dead:


In Flanders fields the poppies blow

Between the crosses, row on row,

That mark our place; and in the sky

The larks, still bravely singing, fly

Scarce heard amid the guns below.


We are the Dead. Short days ago

We lived, felt dawn, saw sunset glow,

Loved and were loved, and now we lie

In Flanders fields.


Take up our quarrel with the foe:

To you from failing hands we throw

The torch; be yours to hold it high.

If ye break faith with us who die

We shall not sleep, though poppies grow

In Flanders fields.


100 years later, it is still hard to read this poem and not feel something, even if we can’t fathom the squalor and terror of the trenches, let alone the acrid smell of chlorine gas and death wafting over the short, churned up distances which separated the two sides. I can’t. This was hell, a hell on earth which forever changed the way we look at it and our individual place(s) in it. In a lot of ways, IT engendered, begat, spawned, bred, you name it, globalization and shrunk the world like no other single event in human history had to that point.

…and for what, really? Politics, politicians, and political gamesmanship. The causes for it were outrageous by contemporary standards.

On this Sunday, November 11th, much of the world will observe Remembrance, Armistice, Veterans, Memorial, or Anzac Day(s). To that end, it is easy to remember when the Allies and Germany signed the armistice for the cessation of armed hostilities: the 11th hour of the 11th day of the 11th month. However, in the United States, we honor veterans, both living and dead, on Veteran’s Day, and have our official day of remembrance of the dead-on Memorial Day in May.

Still, on Sunday, I would ask you to stop for a second, be still, and give thanks to all of those who have served our country.

With that said, I suppose I should mention something about the economy and the markets. So, let me start with this: mid-term elections be darned. CNN correspondent Jim Acosta who? Trade barriers, huh? All of the headline stuff? Out the window. This IS about the Federal Reserve moving forward.

Sometimes ‘it’ isn’t terribly difficult. This is one of those times.

While we ALL know the ‘Fed’ has been raising interest rates, a lot of us have forgotten it is also shrinking its balance sheet or ‘unwinding’ some of the quantitative easing it employed to right the ship after the financial crisis. While the Fed isn’t shrinking the balance sheet THAT much in any given month, the combination of rate hikes and selling of securities HAS had a noticeable impact on M2, or the money supply.

For the last 30 years, M2 has grown at roughly a 5.5% annualized clip. Over the last decade, the growth rate has been right at 6.0% In 2017, it was around 4.5%, but faster in the first half of the year. Thus far this year, with most of it gone already, M2 (again, the money supply) is growing at a 4.2% annual clip, which has slowed to around 3.5% for the last 6 months.

Obviously, this is slower growth. As a result, the $64K Question is: how can you have debilitating inflation when the money supply is increasing at a, somewhat, rapidly decreasing rate? Particularly when that rate of growth is well less than 4%? Couple that with a 104 basis point spread between the overnight rate and the 30-Year US Treasury Bond, and you have to wonder: just how in the world will the supply of money grow significantly when: 1) the Federal Reserve is sucking $30-50 billion of reserves out of the banking system each month; 2) the inducement to lend, and therefore create money in the system, is reduced by a flatter lending curve, and; 3) the Fed is telegraphing future rate hikes which will undoubtedly only serve to flatten the lending curve more since the supply of money is already slowing down well below normal?

Throw in the markets’ expectations for inflation being 2.1% until I am likely to die, assuming I live to my actuarial table estimate, and you have to wonder what it is the Fed is seeing which the markets apparently don’t. After all, it is NOT EITHER the rate hikes or the drawdown of $30-50 billion per month (in practice closer to $50B). No, it is the COMBINATION of the two which makes US monetary policy far more aggressive than the average individual might appreciate.

Inflation? Regardless of the Producer Price Index headline number this morning, look no further than the prices for crude oil, other commodities, and precious metals. If there IS inflation in the economy, this is where you/we/I will see it first. I will cut to the quick: it ain’t currently there. In fact, it is quite the opposite.

This is why the Federal Reserve scares me at times. What is it the few, the very few, on the FOMC see which a lot of other very bright people don’t see? Hmm.

Actually, I would contend the folks at the Fed DO SEE, and in incredibly sharp focus, everything I have written…or should. However, what they will NOT say is they would like to get to, drum roll please, a 3.0% overnight lending target and a balance sheet of less than $3 trillion as fast as they can WHILE the economy is in strong enough shape to absorb the slowdown in M2 growth from the contractionary policies. To justify their actions, there are more than enough complicated formulas, equations, and data sets behind which to hide. Peek a boo.

Put another way, this is a sprint to the finish, a dash if you will. It isn’t about the economic data; it isn’t about trend lines or any other form mental gymnastics. This is about getting back to the finish line, which also happens to be the start line, while the runner still has some strength left. A poor analogy, perhaps, but an apt one.

In the end, IF the Fed maintains its two contractionary policies AT the same time and IN the same manner, it WILL cause an economic slowdown, perhaps even a recession, by some point in 2020. Period, and end of discussion. Will it? Right now, as I type, there is enough wind in the economy’s sails for a couple of more quarters of reasonable growth and corporate profitability yet…especially through the end of this calendar year.

However, IF the Fed maintains its current hawkish posture at the December FOMC meeting, we will likely start to consider making more conservative economic sector allocation shifts in our equity positions in January or February. That is a fancy way of saying: it will be time to take a little risk off the table.



I hope all have a safe and happy weekend. If you see a veteran, thank them for their service, and if you have never been in combat, be thankful they have made it so you likely won’t have to be.


John Norris