Fed Independence

In the wake of the turmoil in Washington, DC, over his performance in Helsinki, President Trump also took a sideswipe at the Federal Reserve, criticizing the FOMC’s recent efforts to normalize policy.

He argued that raising rates threatens the expansion and on top of it has contributed to the rise in the value of the dollar, just when the euro was shrinking, the effect of which is to further disadvantage US producers.

Most presidents – though not all – have understood that Fed independence ensures separation from the Treasury and serves as a check on fiscal excesses. When a central bank takes orders from the fiscal side of government, history shows that inflation and economic decline soon follow. Witness the German inflation of the Weimar Republic, the 1992–1994 experience in Yugoslavia, the 1990 experience in Peru when inflation doubled every 13 days, the persistent problems in Venezuela, and the hyperinflation of Zimbabwe, just to name a few.

There have been many times in the past when presidents expressed frustration with Federal Reserve actions, but those criticisms lacked teeth when it came to actually affecting the Fed’s conduct of monetary policy. One noteworthy period when there was a cozy relationship between Fed leadership and the president was during the chairmanship of Arthur Burns. Burns steered policy in such a way to accommodate the fiscal interests of President Nixon, and the result was stagflation in the 1970s and a disastrous experiment with wage and price controls. We experienced an unprecedented inflation that took courageous action by then-Chairman Paul Volcker to break the back of inflation at the cost of a recession, thus proving that the lack of independence represents a severe threat to economic stability and prosperity. Similarly, President George H. W. Bush blamed the Fed for not cutting rates, and that reluctance to act he alleged cost him the election.

Interestingly, the issue of independence came up last week, on Wednesday, in two entirely different contexts and different venues, in both instances during hearings by the House Financial Services Committee. The first occurred during Chairman Powell’s semiannual testimony on monetary policy before the full House Financial Services Committee, when Congressman Hensarling suggested that the size of the Fed’s balance sheet in itself might pose a threat to its independence because of the temptation on the part of Congress to induce or cause the Fed to purchase private sector assets. As evidence he also referenced the fact that raiding the Fed’s balance sheet has already taken place. Two examples he gave were the use of Fed resources to fund the Consumer Financial Protection Bureau and the deployment of some of the Fed’s surplus to fund the Highway Bill. While Congressman Hensarling’s concern is valid, neither congressional action was related to the size of the Fed’s balance sheet per se. The Fed doesn’t act like a private bank, attracting deposits and then making loans. Rather, it purchases assets – in the present case Treasuries and mortgage-backed securities (MBS) – by simply creating reserves. That is, it purchases assets and pays for them with high-powered money – which ends up as reserves on commercial bank balance sheets.

The real threat is simply that Congress has viewed the Fed more and more as a piggy bank whose resources can be tapped to fund pet projects, seemly at zero cost to the budget. This temptation has been stoked, in part, by the Fed’s willingness to purchase newly issued MBS – which in this case were liabilities of another set of now-government entities, Freddie and Fannie, which are in conservatorship and whose liabilities are effectively guaranteed by the Treasury.

If Congressman Hensarling and his colleagues are truly interested in protecting the independence of the Fed, to counter this trend they should restrict the Fed’s asset purchases to US Treasury obligations – except in extreme emergencies, such as envisioned in the Dodd-Frank Act – and encourage the rundown of the Fed’s holdings of MBS as soon as feasible.

The second time the issue of Fed independence was implicitly raised was in an entirely different context during a hearing on digital currencies that took place that same Wednesday before the House Financial Services Subcommittee on Monetary Policy and Trade. The discussion was wide-ranging, but some participants argued that if digital currencies proved to be a more efficient means of payments than cash, then such currencies should be made legal tender. Furthermore, the Fed should get into the retail digital currency business. But what was lost in their brainstorming was the logical implication of the Fed’s getting into retail payments. Fedcoins, by virtue of the government’s backing, would likely dominate private sector digital currencies and would surely supplant demand deposits as a component of payments as well. However, the advent of Fedcoins would also imply a huge increase in the Fed’s balance sheet on the liability side, an increase that would have to be balanced with assets – presumably Treasuries. But banks rely upon demand deposits to fund their lending activities; and to the extent that this funding source was significantly reduced or disappeared, then banking as we know it would also be adversely impacted. The political fallout from this disruption would be large, and we do not know what implications such a change would have for financial stability or the implementation of monetary policy. Worst case is that the Fed would be dragged into consumer lending. So the role of digital currencies in the US economy is, as of this writing, not clear; nor is the structure of Bitcoin and similar currencies as anonymous or safe as proponents would have us believe [1].

The threats to Fed independence from the legislative branch have a long history. Congressman Wright Patman (in Congress from 1929–1976) was longtime chairman of what was then the House Committee on Banking, Finance, and Urban Affairs [2]. A populist, he favored low interest rates and continually threatened to subject the Fed to appropriations and/or audit [3]. His main concern was that the Fed was too independent and lacked transparency in its operations and decision-making [4]. Remember, during that period the Fed did not reveal its decisions, nor did it produce meeting minutes. Furthermore, Fed chairmen and governors made only infrequent appearances before Congress.

Patman’s crusade was picked up by Henry Gonzales, another Texan, who rose to the chairmanship of the House Banking Committee in 1989, and who vigorously sought to make the Fed more accountable [5]. Under Gonzales it was revealed that the Fed kept secret minutes of its meetings, destroyed many meeting records, and concealed information on a fleet of airplanes it operated, just to mention a few examples of covert Fed actions [6]. Gonzales even initiated an unsuccessful proceeding to impeach Fed Chairman Paul Volcker. Under Gonzales’ tenure the Fed began publishing minutes of its meetings.

So attacks on the Fed from both the executive and legislative branches of government are real but have mainly succeeded – appropriately so – in making the Fed’s decision process more transparent. But those efforts have had minimal influence on actually policy decisions. The president may not appreciate that the Fed is a creature of Congress and not the executive branch, and that he has little or no power to force either the chairman of the Board of Governors or the FOMC to do his bidding. Nor can he fire them.

How will the Fed respond to these recent pressures? Some have speculated that attempts to influence the Fed will cause the Fed to overreact and accelerate its tightening policy just to demonstrate its independence. If the past is any guide, however, there is little evidence that the Fed has deviated from what it deems to be the appropriate policy path just to stick it to its critics. While most of the FOMC participants and governors are relatively new to the table, the best guess is that Fed’s culture and history will provide them with the backbone to steady the course and not bow to outside political pressures. The bigger risk is that the economy could weaken sufficiently towards the end of this year to cause a change in policy, especially if this slowdown occurs before the election. A backtrack on policy in that economic scenario would pose a formidable communications challenge for the Fed – to explain the change while not appearing to be bowing to outside pressure, especially from a president who is likely to claim credit for the change in policy. This is where the real short-term threat to Fed independence will come from. Over the longer run, however, the real threats may come from a Congress tempted to look for cheap financing for projects, and we can only hope there that the true issues are understood.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] Anyone who doubts this assertion should just read the recent indictment handed down by the Justice Department in the case of 12 Russians accused of meddling in the US 2016 election. See https://www.vox.com/2018/7/13/17568806/mueller-russia-intelligence-indictment-full-text.
[2] I concentrate here on the period after the 1951 Treasury-Fed Accord and after the Fed stopped pegging interest rates, a policy instituted during WWII that made the Fed effectively subservient to the Treasury.
[3] Having been at the Board of Governors during part of Patman’s tenure in Congress, I can attest to the fact that the mere threat of appropriations or an audit instilled more financial discipline in the Fed’s operations than could be observed in agencies that were subject to appropriations and audit.
[4] See Harrison, William B., “Annals of a Crusade: Wright Patman and the Federal Reserve System,” American Journal of Economics and Sociology, Vol. 40, No. 3, July 1981.
[5] The Committee’s name has changed several times, so for simplicity it is simply referred to as the House Banking Committee.
[6] See history.house.gov/People/Detail/13906.


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Bursting Bitcoin Bubble?

Fundstrat Daily reports that “YTD, the crypto market is down -60.7%” as of July 2.

We have been asked again about Bitcoin and “bubbles” following the recent gyrations and the plunge. “Should I buy it?” asked a reader.


First, we offer the required disclosure: We don’t own any cryptocurrency in any Cumberland managed account. And we don’t own any derivative or other form of crypto. We have avoided the group. We don’t see crypto as a deep-enough and mature-enough assemblage of tokens to qualify as an asset class – yet. That assessment may change at some point but not likely soon.

Nick Colas and Jessica Rabe have been tracking Bitcoin for a while. They write about it from time to time. See http://datatrekresearch.com.

“We’ve been tracking Bitcoin wallet growth and Google search term volumes… as the carnage has unfolded. Our repeated message in these pages: the former is growing only slowly, and the latter is in outright decline. Bitcoin is ultimately a technology, and without incremental adoption growth it has a tough row to hoe.”

Later in their research they add the following warning: “To be clear: we’re not calling a bottom on Bitcoin, but its complete decoupling from stocks may be one sign of a washout [s]ince it now resembles the time before anyone but computer nerds really cared about it.”

Thank you, Datatrek, for keeping us up to date.

Readers may recall that in previous writings we argued that the world wants the use of crypto and security of blockchain linkage in a secret transaction. Illegal use is one reason. Privacy is another. So is having a wealth-hoarding mechanism that cannot be confiscated if the owner has to flee. As Fundstrat Daily noted (on July 2), “When comparing Bitcoin to other major asset classes (stocks, bonds, hedge funds, oil and gold), Bitcoin has the highest correlation to Gold (4.4%) and the lowest correlation to S&P 500 (-15.2%).”

We also see the eventual rollout of credible asset-backed crypto as an evolution in progress. Many gold-backed tokens are in the works or are in the start-up phase of issuance. That activity is mostly outside the US. We think it will expand and will intensify once the Venezuelan selling of gold has run its course. For more information about gold-backed crypto, see Goldscape’s weekly blog and guide at http://www.goldscape.net.

Note that Russia and China are continuously buying gold, according to official reports. Also note that a Sharia-approved, gold-backed crypto called OneGram (https://onegram.org/whitepaper) has launched in the Arab world. (This link is provided so readers can see this evolutionary development in crypto. It is not an endorsement.)

In sum, crypto is not over, though the Bitcoin bubble, having burst, may yet have more deflating to do.

The bursting of bubbles has a long history in finance and economics. That means the making of those bubbles is equally long in history. For a great recitation of bubble history see Charles MacKay’s famous classic, Extraordinary Popular Delusions and the Madness of Crowds (https://www.amazon.com/Extraordinary-Popular-Delusions-Madness-Crowds/dp/1539849589/ or find the PDF online.)

Commodities have bubbles. Silver, gold, copper and oil are examples.

Real estate has bubbles – housing, shopping centers, offices, the Florida land boom a century ago. The Florida condo boom today may become a future bubble.

Stock market bubbles are renowned –  bowling alley stocks, casinos, tech stocks, home builders, banks, savings and loans. From tulips to Trump’s Taj Mahal, the history of bubbles is littered with casualties.

Could FAANMG be the current stock market bubble? Is the hotel, leisure, cruise ship sector about to become a bubble, too?

Note that the bursting of a bubble doesn’t mean the selloff goes to zero. When the Nasdaq bubble burst 18 years ago, the Nasdaq lost two thirds of its value from peak to trough, but it didn’t go to zero. Some of the start-up companies that traded at price/fantasy ratios went to zero. Similarly, some start-up crypto ventures are now at zero.

In the end, markets clear to reasonable values, and the range of those reasonable values includes zero if the value is worthless.

Some have argued that Bitcoin’s rise was tied to stock market success and that the cryptocurrency’s subsequent decline portends a stock market crash. We’re not so sure of that linkage. We agree with the Datatrek conclusion: Despite occasionally looking like a barometer for systematic risk appetite, there continues to be no proof that Bitcoin’s price presages where the S&P 500 may go in the near term.”

We’re a lot more worried about the consequences of a trade war than we are about Bitcoin. We think the US economy is peaking in growth rate in Q2. The Trump-Navarro policy and an escalating trade war are already starting to bite. Ask Harley-Davidson. Ask a soybean farmer. Ask a Maine lobsterman. This is only the beginning.

We have some cash reserve. We took a defensive position in consumer staples. We favor small and midcap and domestic US versus international. We sold the overweight tech exposure.

David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


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Cryptocurrency Investors Worry, Wait After Bitcoin Price Drop

Excerpt below:

In the wake of this week’s crash, the top post in the Reddit forum /r/CryptoCurrency was about how to contact a suicide hotline, apparently a response to distress on the part of recent investors.

Some economists say this is a familiar pattern.

“Twenty years ago, the technology stocks and new Internet stocks achieved an excess valuation of $7 trillion because of speculation,” said David Kotok, chairman and chief investment officer of Cumberland Advisors. “The prices of shares were bid up to very high levels. When they collapsed, investors … they got very hurt. We see similar characteristics in cryptocurrencies right now.”

Bitcoin investors know this trend as well.

“I think [cryptocurrencies] are highly speculative,” Kotok said. “Putting money into cryptocurrencies is a speculative thing to do. You might make a profit, but what we are seeing is people who — in the last month or two — put money into bitcoin, are having trouble getting cash back when they sell and are now watching the price fall and panicking.”

Read the complete article at WPSU Radio




Longboat Kiwanis Club hosts financial expert to discuss Bitcoin

An expert on one of the world’s suddenly hot, but still mystifying, investments is the scheduled luncheon speaker at the Kiwanis Club of Longboat Key’s Jan. 18 meeting at Portofino Restaurant at the Longboat Key Club.

David Kotok, chairman and chief investment officer of Sarasota based Cumberland Advisors, will discuss Bitcoin, Blockchain and other financial topics at his 11:45 a.m. presentation.

Read full article at YourObserver.com




Bitcoin price WARNING: HILARIOUS moment investor compares cryptocurrency to CHOCOLATE COIN

BITCOIN is as tangible as a chocolate coin a top investor has warned in a hilarious quip about the cryptocurrency.

 

Appearing on Bloomberg, Mr Kotok offered the hosts a “New Year’s gift” – a chocolate coin shaped like a bitcoin.

Handing out the sweet treat, he said: “I brought proof that bitcoin can be tangible, here’s a New Year’s gift for each of you.”

The delighted presenters asked if the gift was chocolate.

Mr Kotok said that the chocolate version of the cryptocurrency had more value than the real thing.

He said: “That is a chocolate covered bitcoin, that is the most tangible value you will see in bitcoin.”

See original article here: https://www.express.co.uk/finance


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Fed, Bonds & Interest Rates

Ben White had this to say about Fed appointments last week in his Politico “Morning Money” column:

“FED TALK – Look for the vice chair nomination to come fairly soon. Mohamed El-Erian remains in the mix but could also be a candidate for the New York Fed. John Taylor sounds like a no-go for vice chair. The White House is looking for a hard-core economist for the vice chair slot, given that with Jay Powell, Randy Quarles, and Michelle Bowman for the community banker slot, Brainard would be the only remaining economist.

“The White House could also look to fill all the remaining slots after Chair Yellen leaves, bringing the Fed board up to its full seven and giving President Trump a massive imprint on the make-up of the nation’s central bank.” (https://www.politico.com/newsletters/morning-money/2017/11/22/murkowski-looks-like-a-yes-on-taxes-030978)

My colleague Bob Eisenbeis has just written on this subject. Bob’s distinguished career has included serving at the Fed under five different chairmen. Here is the link to his recent missive: http://www.cumber.com/chair-yellen-resigns/.

What do we know?

A year from now the central bank of the United States – the lender of last resort to the US banking system and therefore to the world – will be a very different assemblage of folks than we have been accustomed to. Ten years of QE 1-2-3 and near-ZIRP are over.

What else do we know?

The last ten years of financial tailwinds are giving way to headwinds. Note that one may sail forward against a headwind by tacking back and forth. The process is slow and requires hard work. That is different from the ease of movement experienced with a tailwind.

The US federal deficit ran high for the last ten years, and aggregate US debt under three presidents has increased by nearly $11 trillion in a decade. Meanwhile, the interest expense line item in the federal budget has been flat as interest rates remained low and US debt service was refinanced at low rates. That tailwind is over.

The tax reform bill will raise the authorization to borrow and to add $1.5 trillion to the deficit. This is incremental to existing deficit projections which are already rising.  The total interest bill will be rising. The total debt-to-GDP ratio is headed for 100% with the tax reform bill addition, a level that reminds us of the end of World War II.

In its early stages, trouble in financial markets appears in places where credit and lending issues can be seen and measured. That is where to look for warnings. A partial list of such places follows, along with some stellar observations by Chris Whalen.

Chris has penned an essay on the Fed and on a bright yellow flag. He asks, “Q. Besides stocks, what asset class has benefitted the most from the radical monetary policies of the Federal Open Market Committee? A: Multifamily real estate. And what asset class most worries federal bank regulators today? Same answer.”

See https://t.co/4XvERiw8du for the discussion. We thank Chris for permission to share this with our readers. To subscribe to Chris’s The Institutional Risk Analyst, please email your request to info@rcwhalen.com.

There are other places to worry about credit risk, too. Credit card delinquencies have started to rise. High Yield spreads are very low by historical standards but are recently starting to widen.  Private equity financing of commercial real estate shows trouble spots. Note that twice as many retail spaces closed as opened in the last report period. Note empty mall and highway retail space. Note the secondary effects of these changes on employment and on city, county, and school board tax receipts.

Finally, we have the credit risk around the hot topic of Bitcoin, with its wild price fluctuations. New buyers of crypto and crypto derivatives emerge every day. Some are leveraging; thus credit risk is added to speculative risk.

Even outgoing Fed Chair Janet Yellen admits that too much QE for too long with a ZIRP can lead to difficulty.

We are in the post-Thanksgiving to New Year’s period, which is traditionally upbeat. We encourage you to enjoy the season – but when you ring the bell, we advise you not to drop it on your foot.

Our Cumberland US stock market ETF portfolios are now overweight the smaller and mid-cap area. Our overweight of Tech has been reduced.

Our bond accounts emphasize higher-quality credit, and we are not chasing the high-yield space.

We expect a tax reform bill to pass both houses of Congress and to be signed into law. Political leaders are desperate to produce it, so they will do anything to make a deal and get an “aye” vote.

Next year portends rising volatility and massive political swings of sentiment as we run up to the midterm elections.

Current polling suggests that the Democrats may capture the House majority and thus chair all House committees. An impeachment bill is likely if they prevail.

2018 promises to be an interesting year.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Wealth Managers Are Being Inundated With Calls About Bitcoin

At 74, Cumberland Advisors’ David Kotok has guided wealthy clients through a long career’s worth of bubbles and crashes. Now he’s being inundated with questions about the latest soaring asset to confound investors — bitcoin.

“Clients bring up bitcoin all the time,” said Kotok. “They think it’s cool. It has the newness, which is attractive to some people, though others would say newness is a risk they don’t want to take.”

Read full article here: https://www.bloomberg.com




More on Bitcoin

Following up on our recent commentary, and with permission, we continue to quote the excellent work of Nick Colas and Jessica Rabe of DataTrek Research. We encourage readers to give their newly launched service a try. Their website is http://datatrekresearch.com/.

In this segment, Nick focuses on the question “Are cryptocurrencies an asset class?”

“Over my 30+ year career on Wall Street, I have seen scores of investments touted as an ‘Asset Class’. A few examples: US farm land, rare cars and watches, equity market volatility, livestock, high-end real estate, diamonds/rare gems, Asian and other antiques, and expensive artwork. Typically, such chatter picks up after a strong run-up in prices and feels like the smart money looking for an exit rather than a legitimate opportunity.

“For the fiduciary-minded investor, ‘Asset class’ has a very specific and important connotation/meaning. To reach that level of recognition, the assets in question should:

“• Be comprised of investments that have common fundamental characteristics and robust regulatory/legal structure

“• Be large enough in aggregate size to allow institutional liquidity, although this can vary depending on the investment (US equities vs. real estate, for example)

“• Provide non-correlated returns to other asset classes because of their unique fundamentals, so as to provide the benefit of diversification to asset owners

There is a lot of excellent academic work out there which analyzes investments through the lens of ‘Asset Class’, going all the way back to the 1980s (Gary Brinson et al are the most cited). Over the years, most institutional investors have adopted this work, making it a cornerstone of their investment process. The need for higher returns drives allocations to equities, for example. More conservative portfolios own more bonds. Cash, real estate, currencies, and commodities round out the menu. A place for everything, and everything in its place…

“Do cryptocurrencies like bitcoin meet the definition of an ‘Asset class’ for investors that care about that designation? At the moment, the answer has to be ‘No’. A few reasons why:

“• They are too small. The combined market cap of all crypto currencies is just under $200 billion. Compare that to just a slice of the fixed income asset class – US sovereign debt – with $14+ trillion outstanding. Or US stocks at $20+ trillion.

“• Cryptocurrencies do not yet have as robust a regulatory framework around them as stocks, bond, currencies or other traditional asset classes. Some prominent financial markets professionals even think that governments may eventually ban them. No one talks that way about stocks and bonds.

“• Cryptocurrency exchanges and wallet operators around the world operate with varying levels of know-your-customer and anti-money laundering laws. There is no absolute assurance, for example, that a bitcoin you just purchase online didn’t have a member of the North Korean military or Iranian Revolutionary Guards ultimately on the other side of the trade.

“• An asset class needs some level of homogeneity among its constituent investments. GM and Facebook are wildly different companies, but the equity of each represents the same type of claim on residual corporate cash flows. Bitcoin and Ethereum – the two largest cryptocurrencies by market cap – are not the same in terms of structure or purpose. In fact, they aren’t even close.

“• There is not enough history to assess the price relationship between cryptocurrencies to other asset classes. Investors responsible to asset owners need a track record of prices to determine its ability to deliver diversification. There is no shortcut for this requirement.”

We stand by our concern that the mathematically derived crypto has no store of value mechanism since it can be replicated infinitely. The proof is found in the increase in ICO numbers which suggests there is no limit to creation and hence price discovery is a function of speculation and momentum.

Meanwhile, Kerry Smith, a retired Stanford law graduate and serious student of the electricity grid, emailed an observation about how crypto is a large consumer of electricity. He notes that risk.

We contrast it with a gold linked token which can use block chain successfully but is not subject to the electricity constraint. We shall see if gold tokens catch on. The turmoil in the Middle East may be the catalyst.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Kotok On Bitcoin, Gold & Trump’s Approval Ratings




Bitcoin, Gold & President’s Approval Ratings

Readers have seen us previously comment on the developing Bitcoin-crypto phenomenon. And our clients know that we are not investing in crypto today but are watching this carefully. Our clients also know we have a position in a gold-miner ETF. Our email from clients, media, and readers has the Bitcoin versus gold argument and the evolution of crypto at the top of the topic list. There is a lot of buzz.

The buzz is not surprising when a new financial element appears whose price fluctuations can be $1000 in a week. Interest in Bitcoin and crypto in general is expanding at an exponential rate, and the range of opinions for crypto can fill a chasm. At one extreme is the “tulip mania” assessment of crypto. We discussed it last month. See: http://www.cumber.com/tulip-fever/. On the other extreme are forecasts that crypto will replace gold as a reserve and that the ultimate Bitcoin token price level may reach $50,000. We are highly skeptical but realize that our skepticism may be a product of age and experience. Maybe we are guilty of a Luddite mentality.

We are also watching the development of the gold-backed-crypto alternative. We think that is a significant direction that blockchain transactions will take. We wrote about that recently. See http://www.cumber.com/bitcoin-gold-money/.

A perceptive reader asked about the relationship between President Trump’s activities and the gold price. This question was posed in the context of the developing global crypto-gold nexus that we are seeing with the introduction of the Sharia-approved, gold-backed cryptocurrency. The reader struck a chord.

So, we set about examining the relationship of presidential approval ratings and the gold price. There is no history regarding a correlation between presidential approval ratings and the cryptocurrencies, since the only data points are very recent and were mostly established in the Trump administration era, which is only one year old. There is no way to know if the rise in crypto attention originates in a worldwide reaction to the dwindling approval of Donald Trump as a world leader. We can debate this question as a political matter from all points of view, but we cannot find any historical evidence on which to base a solid conclusion. Crypto is just too new.

We can find some solid evidence when we examine the gold price.

Readers are reminded that gold was priced at $20 an ounce a century ago. The “double eagle” was the largest-denomination gold coin. In the Depression era the US government altered that price and restricted the ability of our citizens to own gold. See https://en.wikipedia.org/wiki/Executive_Order_6102.

Under the Bretton Woods (https://en.wikipedia.org/wiki/Bretton_Woods_system) fixed-currency regime, established in 1944, the United States, under President Franklin Delano Roosevelt, agreed to a fixed exchange rate of $35 per ounce of gold, and we settled international transactions with intergovernmental gold exchanges at that price. This agreement defined the operational structure until 1971, when President Richard Nixon closed the “gold window” and reneged on the previous US pledge. The US raised the official price to $42, but that meant nothing, as transactions ceased. See https://en.wikipedia.org/wiki/Nixon_shock.

As Nixon’s presidency deteriorated, the gold price on world markets tripled. Thus the Nixon era is the first case study that can be examined in response to the question posed by our reader. The second case study involves President Bush the younger. Bush Jr. also faced a period of deteriorating approval that correlated with a noticeable gold price change.

These are the only two case studies that have some statistical basis; they are a very limited data set.

We have boiled this exercise down into three slides with help of Cumberland’s Tom Patterson. The link to the three slides, in PDF form, is http://www.cumber.com/pdf/GoldApprovalWebsite.pdf.

The first slide shows all the presidential approval ratings from Richard Nixon to present. Note how most presidencies start off with higher approval ratings, which decline with time under most circumstances. Also note how Donald Trump’s starting point is lower than others, and note how his decline has been persistent. The persistence of decline is not unusual in history, but the rapidity of Trump’s decline is an outlier in history. Trump’s starting point is lower than for the other cases in this study. Of the nine presidents in the study, and at this point in time in his presidency, Trump is clearly the least approved. Note that the rate of change of deterioration is intense.

Readers may also note that the reasons for approval declines are not listed – we are going strictly on the numbers. The reasons may be the subject of discussion and debate, but for the purpose of this analysis, we ignored them. Whether it was Jimmy Carter and Iran’s detention of Americans or Donald Trump’s nasty tweets and belligerent behavior, the causal nature of approval decline was ignored. It isn’t why approval declined that matters; it’s the decline itself. The approval numbers are sourced from the American Presidency Project and Gallup data. The gold price data is from Bloomberg.

Chart two shows the Nixon shock and the change in the gold price at that time. The depiction of gold prices is scaled vertically so that readers can see the rates of change in the gold price as opposed to its absolute level. Thus a gold price move of $80 to $160 has the same visual impact and spacing in the chart as a price change from $160 to $320. The horizontal axis is approval ratings over time, falling from left to right.

In chart two we observe that the approval rating of Richard Nixon worked its way down below 40% and then accelerated downward as the Watergate scandal unfolded. Concomitantly, the gold price doubled. After Nixon resigned, gold traded at a range-bound level throughout the Ford and Carter administrations and until the very end of the Carter period, when the gold price rise became pronounced and accelerated.

The third chart shows the approval ratings of Reagan, Bush Sr., and Clinton. Gold was again broadly range-bound while presidential approvals fluctuated above the 40% threshold. Only when Bush Jr. became unpopular did we see his falling approval coincide with a steeply rising gold price. Why this happened is a subject for political speculation, but the statistical events are clearly observable in the data.

Under Obama and Trump, gold has again been range-bound and approval ratings have fluctuated in the same 40%+ levels as in previous range-bound periods. But now President Trump’s approval level is falling below the threshold that has previously marked a significant gold price rise. That trend raises the specter of another upward price shift in gold. However, this time there is a cryptocurrency alternative to gold that didn’t exist in the other two case study periods.

So, we don’t know how much of the gradually rising uptrend in the gold price that has occurred in the last two years is related to presidential approval ratings for Obama and Trump. And we don’t know how much the cryptocurrency price increases originate from crypto substituting for gold. Maybe it is some of each.

We do know that there are movements in some official gold transactions. We have seen transactions reported by Turkey. (See http://www.barrons.com/articles/gold-a-loser-despite-turkeys-mysterious-demand-1509736352.) And we have seen official sales by Venezuela, which is desperate for liquidity. We are also watching China increase its gold reserve holdings. We know that the collective central banks of the world have increased their assets to about $22 trillion USD equivalent; and even though the Fed is now starting to shrink its balance sheet, combined central bank asset growth is running at about $300 billion per month. (Sources: Bloomberg and hat tips to Dennis Gartman, Mark Grant, and Ed Yardeni.) We know that those reserve additions are mostly in fiat currency asset denominations, very little in gold, and not in crypto at all.

Let’s segue to the crypto-gold debate.

With permission, we are extensively quoting Nick Colas and Jessica Rabe from their newsletter. We know their excellent work from previous affiliations and are delighted to see them venture into this newly launched service. Readers are encouraged to give it a try. Their website is http://datatrekresearch.com/.

Regarding Bitcoin and gold they wrote:

“Physical gold is the world’s oldest store of value; bitcoin is a baby-faced newcomer. But the two have many common features, such as limited supply, efficiency/portability, and privacy. Bitcoin has a long way to go (about 5,000 years) before it can match gold’s success, of course. Gold has a different but equally important challenge – maintaining its relevance in an ever-more digital world.

“That’s what makes the whole bitcoin vs gold debate so interesting. A long-time incumbent and a new kid on the block, competing for attention. It’s not quite the Rumble in the Jungle, but close enough.

“We looked at Google Trends, which counts the number of searches for key words, to see the relative interest in “buy gold” and “buy bitcoin” to see which asset is more popular around the world. Google searches should be a reliable indicator of purchase intent, or at least interest.

“Here’s what we found:

“• On a worldwide basis, “Buy bitcoin” is a more popular search than “buy gold”. The crossover happened in mid-May of this year. As of today, bitcoin Google query volume is 17% higher than that for gold on a global basis.

“• Google Trends also allows you to zero in on what countries search more for bitcoin than gold. Over the last 90 days, for example, bitcoin beats gold across all of Europe and Russia. Even gold producing countries like South Africa and Canada show more bitcoin searches than for gold.

“• Based on Google searches, the United States is undecided on the bitcoin-gold debate. Search volumes are similar over the last 90 days. They do, however, show regional biases. Bitcoin wins in New York, Illinois, and California, for example. Gold still holds the lead pretty much everywhere else.

“The upshot of this analysis: in just a few short years bitcoin has caught up with gold in terms of global interest. Does that mean it has the staying power of gold? Of course not. It needs about 4,995 years to get there.

“Our perspective on this debate: both bitcoin and gold serve a similar purpose, namely to provide investors with a liquid asset outside the global banking system. If that’s your thing, there’s no need to choose one over the other.”

Many thanks to our brilliant reader who triggered today’s discussion with a sharply perceptive question. And many thanks to Nick and Jessica for permission to quote their research work. Please note that they will be present at the GIC discussion of crypto on January 12 in California. For details see the GIC website at www.interdependence.org. You will find the date listed under coming events. Registration is about to open. The meeting will feature Boston Fed president Eric Rosengren. A special conversation with Harry Markowitz is also planned, along with the discussion of crypto.

Only time will reveal the answer to our reader’s question about Trump’s approval rating and the gold price. If Trump’s approval deteriorates further below 40% and if gold rises in price, the history we documented with the Nixon and Bush Jr. eras will be repeated and validated. As for the effect on gold of crypto substitution, that remains impossible to determine today.

At Cumberland, we do not hold any Bitcoin or other crypto positions for our clients. We do have clients who are speculating in cryptocurrencies on their own. They have told us they are doing it. We wish them well.

We continue to maintain a small position in the gold-mining ETF in our US-based ETF portfolios. And we continue to hold some cash reserve in the US portfolios. We are not fully invested.

Of course, any of those decisions and strategies may change at any time.

David R. Kotok
Chairman and Chief Investment Officer
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