The Debasement Trade

In today's post, I discuss what the debasement trade is and whether it's real

Markets have watched mounting government debt levels for years and - for the most part - stayed quiescent. The “debasement trade” is the idea that this is changing, that markets have begun front-running what they see as inevitable debt monetization and are fleeing into safe haven assets. This is a hot topic currently because gold - perhaps the ultimate safe haven asset - has had such a crazy rally in recent months.

There’s actually lots of push-back on whether there is a “debasement trade,” so today’s post goes through those. The first pushback is that there isn’t really just a gold rally, but a huge rise across all precious metals. That makes things look more like any old speculative bubble and not a “debasement trade.” The second is that the Japanese Yen hasn’t rallied against the Dollar since Jackson Hole, which is odd because it usually does when there’s a rush for safe havens. The third is that the sharp rise in longer-term government bond yields has largely come to a stop since Jackson Hole, so - if anything - it looks like market anxiety over high debt levels has lessened.

None of these arguments have much merit in my view. The “debasement trade” is really just about fiscal policy being on an unsustainable path in many of the G10 economies. That’s unquestionably true. That doesn’t mean the rush for safe havens will be linear or rational. Of course there’s going to be speculative bubbles as part of this. In fact, since so much of the “debasement trade” is about the fear your savings could be inflated away, that’s pretty much inevitable. In what follows, I go through these push-backs and give my perspective on why they don’t - in any way - nullify the “debasement trade.”

• The precious metals bubble: Chair Powell’s dovish speech at the Jackson Hole symposium on August 22 sparked a huge rally in gold prices, which spilled over into other previous metals as the chart below shows. Two things are clear. The first is that - at this point - the move in precious metals is very much a speculative bubble and, given all the discussion at this week’s IMF/WB meetings, is at serious risk of a reversal. The second is that the Fed’s dovish shift at Jackson Hole clearly set this off, so - as crazy as things may now be - there’s a perfectly understandable fear at the root of this bubble, which is the fear that the Fed is capitulating to the White House and we’re heading for currency debasement over the medium term. The fact that precious metals have gone into overdrive thus doesn’t invalidate the “debasement trade” in any way. No one said the safe haven rush would be rational.

• The Japanese Yen and safe haven currencies: there’s no question that the Japanese Yen has underperformed other currencies against the Dollar since Jackson Hole. That’s not an argument against the “debasement trade” because Japan is at the center of the global debt overhang, which is causing its safe haven status to wobble. As the chart below shows, other countries with low government debt have seen their currencies rise against the Dollar, including Switzerland (CHF), Sweden (SEK) and Norway (NOK). Dollar debasement is clearly happening since Jackson Hole, just not against Japan (JPY), which has its own problems.

• Longer-term bond yields have stabilized: the chart below shows the massive trend-rise in longer-term government bond yields across advanced economies, but this rise has come in fits and starts, as periodic reminders of dysfunctional fiscal policy hit markets. We’re currently in another one of these pauses. After all, fiscal policy remains out of control in much of the G10. Nothing’s changed.

In my view, the “debasement trade” is real and signals a shift in how markets feel about run-away debt levels. That means higher risk and term premia, a rush for safe haven currencies like the Swiss Franc and periodic buying frenzies as other safe haven assets pop into investors’ awareness. None of this is going to be linear or rational. There will be pauses and bubbles. But the ongoing mess that is fiscal policy across the G10 means this trade is rooted in fundamentals and here to stay.