“There is No Such Thing as a Free Lunch” for Central Banks

After last week’s historic rise to a seven-year record high for, this week when compared to last week the range is extremely contracted. While traders were relieved to see that the daily range in gold was much more manageable, rightfully so many were disappointed in the small price moves.

Gold futures did close very near the opening price on Monday, near the high of the week. However, the price difference between the high and low this week was roughly $18, a mere blip when compared to last week’s price range.

With that in mind it is quite obvious that after reaching $1613 on Wednesday of last week gold entered a corrective phase. Which means the real question becomes how deep will this correction go and at what price point we can expect to find price support?

The other interesting facet that must be taken into account when comparing recent price action are the fundamental events that occurred over the last 10 days. First was the conflict between the United States and Iran which could have easily escalated into a very scary geopolitical scenario. The good news is that conflict deescalated as quickly as it appeared. Wednesday’s signing of the ‘phase one’ accord was a critical component which influenced the global economic outlook is for the first time in 18 months it seemed real progress had been made. Then there is the solid economic data which emerged at the end of this week indicating that the United States economy is strong and healthy.

This was partially responsible for the dynamic upside move in U.S. equities which resulted in new all-time record highs. Any one of these of events could have had a traumatic bearish impact on gold pricing, but the net result was the opposite of those expectations. In fact, gold pricing has held up extremely well considering these three events that occurred during this week.

Over the last week we have speculated as to why gold was so resilient in light of so much overwhelming news that typically would put selling pressure on the precious yellow metal. The simple answer, which is by no means a complete picture, is recent actions by central banks. Although each country took a different approach their objective was aligned and designed to obtain the same result; continued economic expansion. But as everyone knows there are intrinsic costs to these actions and at some point, the bill must be settled.

There is a cost intrinsic to central bank action. The best expression to describe that cost intrinsic to economic expansion being “there is no such thing as a free lunch”. This Aphorism which was highly quoted by Milton Freeman, and the title of one of his books “there is no such thing as a free lunch” was not coined by him. The phrase appeared in print as early as 1938 in the form of “their ain’t no such thing as a free lunch,” in El Paso Herald post.

Whoever created the saying made an observation that is as true today as it ever was. In other words, they all mean the cost of goods or services has to come from somewhere. This truism continues to be that these actions have final financial consequences.

Which brings us back to today’s basic topic which is the major pivot by the central banks through the use of interest rate cuts, purchasing of assets to provide liquidity will invigorate the economy associated with a particular central bank, with the addition of costs which have to be paid at a later date.

The United States carry one of the biggest financial burdens and debt, which will have to settled down the road. The current budget deficit has swelled to a mind-boggling number, and continues to grow to this day. The Federal Reserve has purchased $400 billion in additional assets since September of last year - they will in fact result in real costs later on down the road.

While current economic theory has been utilizing Keynesian Economics developed in the 1930s and utilized initially to unravel the hardships created by the Great Depression, it advocates increased government expenditures and lower tax rates to stimulate demand. These theories which have been used for just under 100 years and its use in monetary policy used by governments have not spanned the test of time necessary to ascertain the real repercussions and pitfalls of the strategy. We are in uncharted territory that has only occurred following a transformation which allowed governments to spend more than they produce.

While they have effectively transformed economy since World War II the truth remains there is no such thing as a free lunch and at some point will have to be paid for.

Wishing you as always, good trading,