One week ago, Deutsche Bank’s top credit strategist, the often whimsical amateur piano player, Jim Reid, did the unthinkable, admitting that he is “a gold bug”, and adding that in his opinion, “fiat money will be a passing fad in the long-term history of money”, a shocking admission for most career financial professionals who are expected to tow the Keynesian line and also believe in the primacy of fiat and its reserve currency, the US Dollar.
In any case, Reid was just getting warmed up, and in his Friday “chart of the day” reminds his long-term readers that in his view, “central bank balance sheets will explode in the decade ahead and probably beyond.” To bolster his case, he refered to a recent report written by another DB strategist, the bank’s chief US economist Matt Luzzetti, who suggests that the Fed may need to add up to $12tn to its balance sheet over the next few years to reach what he thinks is the equivalent to a shadow Fed Funds rate of -5% to fill what he calls the policy gap.
For those who missed it, here is the punchline from Luzzetti’s note:
We find that the Fed will need to provide significant accommodation – roughly equal to a fed funds rate of -5% — and that QE and forward guidance could be insufficient. Assuming limited impact from forward guidance given that markets are pricing negative rates, our estimates range from an additional $5tn to $12tn more of balance sheet expansion needed. Our preferred calibration sits towards the high end of that range.
As the economist ominously concludes, “the lessons for the monetary policy outlook are somewhat discouraging. In the absence of a considerably better economic outlook due to factors exogenous to the Fed – for example more rapid development and widespread availability and usage of a vaccine or a significantly more robust fiscal response — eaningfully more aggressive QE is needed.“
That said, the Deutsche strategists caveat that “this is not a projection but more of what would be needed if they choose the balance sheet route alone. A decision to supplement QE with other tools, such as YCC and more bank or credit-oriented policies (which Matt views as likely), would reduce this amount.”
Alternatively, Luzetti quotes NY Fed president Williams who recently noted, “necessity is the mother of invention”, adding that the need to provide substantial accommodation in an environment where the Fed’s conventional tools may be limited could thus lead, over time, to more serious exploration of alternative tools.
And yes, all of the above means that the Fed will need to catalyze another market crash to usher in the next round of massive stimulus.
In any event, going back to the stunning balance sheet forecast, Reid calculates that if the balance sheet was used as the only tool, hitting this amount would take roughly 8 years at the current QE run rate, and writes that the graph above “puts this into some perspective based on 100 years plus of the Fed balance sheet in real adjusted terms. In nominal terms it took 94 years to hit the first trillion of Fed balance sheet. 12 years later we are at $7tn. Could we be approaching $20 trillion within a decade?”
Well… of course.
But regardless of whether or when it takes place, this forecast backs up Reid’s own long standing view on balance sheet growth based on the huge past, present and future debt burden the financial system has been saddled with.
And yes, anyone asking how to best hedge against the monetary insanity that is coming, the answer is very simple: keep buying gold, whose surge to $3,000 – which is also Bank of America’s price target – is just a matter of time.
And yes, silver has a long way to go to catch up to where it should be based on the long-term gold/silver ratio.
Finally, Reid has conducted a a flash poll, with the question: “Where do you think the Fed balance sheet will be in a decade?” Click here to take part.