Axel Merk: “Economy To Die A Traditional Death…Inflation Is Going To Move Higher”

May 18, 2019

Mike Gleason: It is my privilege, now, to welcome in Axel Merk, president and, chief investment officer at Merk Investments and, author of the book Sustainable Wealth. Axel is a well-known market commentator and, money manager and, is a highly sought-after guest at financial conferences and, on news outlets throughout the world and, it's great to have him back on with us.

Axel, it's always a pleasure and, thanks for joining us again.

Axel Merk: Thanks for the kind introduction.

Mike Gleason: Well, Axel, we'd like to get your thoughts on the recent escalation in our trade war since that seems to be the big news. Tariffs on China were increased to 25% on about two hundred billion dollars in goods. The president is getting lots of support for his effort to level the playing field with China and address their theft of intellectual property and so forth. But, now is, we think, where the rubber starts to meet the road.

Prior to now, the impacts of tariffs have been limited for U.S. consumers. You mentioned something insightful on Twitter recently. There is discussion about how U.S. firms will respond to tariffs on goods they import. Some may be able to source goods elsewhere, some may absorb the higher costs and some may raise prices. But, there is another possibility that isn't getting much consideration, that being that some U.S. firms won't be able to do those other things and, will wind up going out of business.

So, what do you make of the quality of discourse over tariffs? Do you think people, including the President, have a good handle on the repercussions of tariffs and, do they have the fortitude to endure what may be coming?

Axel Merk: Oh my God, how many hours do you have?

Mike Gleason: Loaded question, I know.

Axel Merk: Well let's maybe start off with what you said. The President has lots of support and, I'm not questioning this or, endorsing it but, that's really the gist of it. It's all about politics.

Now, if you're a politician, obviously if you're the worker who has to shut down his business or, lose your job, it's a little different. But, if you think about it, just from a political point of view, tariffs are good politics. I'm not a fan of tariffs, just as a background but, from a political point of view, its good politics. Now the challenge Trump faced was that the negotiations were going well, he was accused of being too soft, also had he had an agreement, it might have been out of the news come election time.

And so, in order to be in the news at election time, he needs to have a solution later and, call my cynical but, that's just the nature of politics. So, he has an incentive to drag this out, and you can argue whether he does the right or wrong things but, just from a political point of view.

Now, the other thing you mentioned is about kind of shutting down business. The biggest loser in this is small business and the reason small business, U.S. small business is the biggest loser is that, if you're a big business, you can change your procurement channels, you can substitute goods, and whatnot but, if you're smaller, you don't have the financial flexibility to resources to change as quickly and stomach the period where things are more uncertain. And also, these price swings, you might not be able to absorb the shock and the temporary losses you might have if you're a small business.

Now, the question is, what do we care about any of this? And, since we're talking, we care about commodities, we care about the economy as a whole and so, from a big picture point of view, the initial tariffs are really geared at hurting the Chinese. Now, almost by definition, the more tariffs you put in place, the less you can tailor them to actually hurt the Chinese and so, you're going to hurt more U.S. companies as well and, so forth.

And, if you do something like the famous thing is, if you buy a toaster, well you buy a toaster from Malaysia or, maybe you buy one made in the U.S. but, other goods you cannot quite as easily substitute from somewhere else and, it's more disruptive.

From a market point of view, what you really want, ultimately, is clarity. Give me the rules of the land and, I'll deal with them. The uncertainty that comes with the kind of rule by Tweet type of thing is not very helpful in my view.

Now obviously there's a strategy behind it, you want to rattle the cage in order to get things done, and some people like it, some people don't like it but, if you want to induce change, that is a fair point of view.

As far as something like gold is concerned, sure, that may go up in times of uncertainty, especially when people are kind of fleeing risk assets. But then again, a lot of people, I believe, continue to believe that this is pasturing, this is to get a deal and things will settle down. And then of course, if that's the case, well, then there will be some temporary damage to economic growth and depending on how you think it's going to pan out, maybe we're going to have structure reform but, more importantly, this noise is going to abate over time.

Mike Gleason: The equity markets have been resilient; stocks have regained what was lost in the turbulence late last year. Now a bit of fear and volatility is returning. Is this trade dispute going to be more than the equity markets can bear or, do you think the U.S. economy is strong enough to withstand it? For instance, some economists are estimating the tariffs will only shave say, 0.2% off of GDP.

Axel Merk: Well let's keep in mind that the U.S. economy is really a very domestically focused economy whereas, China or, Europe is very much focused on exports. The U.S. is a consumer driven economy.

Now, clearly if consumers have to pay more maybe they buy a little bit less but, the tight job market we have in the U.S. is really not so much driven because of trade.

Now, some international companies, many of them, might suffer a little bit and, also, what does impact the U.S. economy is the Chinese really had a severe downturn. Financial markets have shown to be very sensitive to that and, we've seen some hiccups in the markets, obviously, that elude to that.

But, overall the U.S. domestic economy is less dependent on trade than many others, and that's one of the reasons why Trump can kind of put the foot down and get those things.

Now obviously if you are affected by this, if you are a farmer in the Midwest, then, yeah, it might impact your business directly but, because the U.S. economy's diverse, what matters more is the certainty, and, when you have uncertainty on policy, you will be less likely to invest. You see that with companies not investing in the U.K. because of Brexit, you see that on other things.

The other thing that will happen, Germany, Volkswagen, I'm not giving an investment recommendation, just announced that they're investing a billion Euros into a battery plant in Germany. So, they decide why bother doing it in China or, in the U.S. or elsewhere in the world and so, American companies may do the same with investing in the U.S., and obviously that's part of the point of these policies but, if everybody does that, I doubt people are better or worse off. Ultimately, it's not our thing to say whether we like these policies or not, the question is, what are the implications for investors.

And your question whether the equity markets will stomach it, well, let's put this into context. I think the economic expansion continues to be in place but, we're in late stages of that. Interest rates have also been moving higher. And when you're in that environment it is normal for volatility to be higher and, when volatility is higher, risk is higher, it is also prudent for investors to make appropriate decisions.

Most people have a certain risk profile and then, when volatility goes up, that means they should pair down their risk. Now, preferably, you do that ahead of time, obviously, rather than when things plunge but, it's always natural for people to become a little bit more defensive. It's not that they're becoming more defensive, it's the investments that become riskier so, they're just rebalancing their portfolio and if they have a plan, they'll be able to ride this out.

And so, our baseline scenario is that, actually this economy is going to continue to grow. I actually think inflation, that everybody says is not a problem, is it going to tick up because of the tight labor market and while the market is pricing in an ever greater chance of a rate cut later this year, I don't think that's in the cards at this stage.

Mike Gleason: Do you think it's possible that China is going to dump a bunch of U.S. Treasuries as a retaliation to the trade war, Axel? And, what would happen if they did that?

Axel Merk: Well that topic comes up all the time. The reason why they hold treasuries is because it's in their interest. And I think, what the Chinese do is, they will think about ways of being less dependent on the U.S. But, if they were to dump the treasuries, that would increase the value of their currency, they have no interest in that, they want to have a weaker currency, if anything, right?

And so, that's one of the reasons why it's unlikely to happen, unless, of course, there's always the talk about it's going to shoot up our rates. Well, already, if you just take this scenario – which I think is less realistic of them “dumping treasuries” aside – in recent months, foreigners have been participating less and less in auctions in the U.S., in treasury auctions, and then, conversely, of course, the U.S. government is issuing a boatload of debt because, deficits are high, which is unusual for this time in the economic expansion.

And, yet rates are very low. And so, there's still, apparently, sufficient demand but, the demand is more domestic. Ultimately it doesn't matter for the price, whether it's a foreign or domestic buyer. Medium term, like any country, you've got to make it attractive to buy the debt and, these days, yeah, you can give a gazillion reasons as to why they buy it, the fact is that people continue buying the debt.

I happen to think that, U.S. inflation will tie up these rates that we have right now and, not justified but, that's just one person's view, right? I mean, it's the market already that obviously, that sets the tony up.

Mike Gleason: Getting back to Fed policy for a moment, you alluded to that a moment ago. There are many that are expecting that the next move now will be to cut rates. Give us more of your thoughts on monetary policy, Axel. What do you see Powell and his cohorts doing here?

Axel Merk: I attended a conference at Stanford, at the Hoover Institute the other day, and this takeaway I had is that people say, we’ve had inflation less than 2% for a decade now so, it's been below our target, and, it is a problem. Meaning that, this time is different, we need to move it higher, the most radical person might have been the San Francisco Fed President that says, "Well if we want to tell people and downturn when we can't go below zero, that we are willing to push inflation back higher, we’ve got to be willing to take inflation about 2% this time around to be credible on the way down."

And, so he's the most explicit about it but, the theme with several of them, obviously not all of them necessarily but, with several of the folks at the Fed is that inflation is too low.

Now, obviously there have been many reasons why inflation has been lower, most notably the financial crisis. The question is, is this time different? And, people argue, yes there's more competition from abroad and so forth, the Asian population, all that. That may all be the case but, what hasn't changed is that we are in an environment where unemployment is very low, where wages are already increasing at a very steep pace year over year, it just hasn't translated to measures that the Fed considers inflationary.

Now, fool you not, there comes a point where it will be inflation when we cannot pull in people on the sidelines anymore. Nobody knows when that is but, simply because it hasn't happened to say that, we cannot have inflation, I think is a dangerous game. And, the Fed having that view, that mindset, increases the odds that we're going to get there. And, if we do get there, I very much disagree with the San Francisco Fed (chair) saying, “hey, yeah, then we've shown that we're willing to do it.” No, then you have a mess on your hands. And so, the risk of that is there.

Now, I'm not suggesting that necessarily has to happen, but a Fed that's complacent is an issue. If there is one thing I'm concerned about is complacency. There was complacency about the tech valuation in the 90s there was complacency about housing then, and its complacency about lack of inflation now.

And, usually that doesn't have a good ending. And so, that is one of reasons why I say, at some point, if this economy keeps growing and we don't kind of push it into a recession with the trade concerns, and as you pointed out, the odds of that happening are currently not all that high, then we do have to worry about creating jobs at a pace that's not sustainable. The Fed is not doing that, and that is why I do think that, I've argued that this economy will die a traditional death, which means that inflation is going to move higher, the Fed has to hike into a slowing economy, I don't rule that out.

Now, will it necessarily be the case? No. Do I expect the rate cut by December? Nope. Does the market expect a rate cut in December? Yes, the market does.

Mike Gleason: Switching to metals now, our take has been absent any big increase in price inflation, that it would be hard for metals markets to get anything going while the stock market and bond markets are rallying. Gold and silver prices need a driver, that could either be fear over inflation or safe haven buying from people worried about the equity markets topping and turning lower. What is your take? Would you agree that either price inflation or trouble in the stock markets will be needed to give metals a boost in the months ahead or, are there other drivers, perhaps, that you're looking at?

Axel Merk: Well, it's the fear of those things happening, rather than the actual thing happening that, I would think, that's going to drive it.

Remember that, usually when inflation numbers are higher than expected, in any country, the currency rises. And the reason the currency rises is because it is expected that the central bank will do the right thing. It's only when the market then realizes that the central bank doesn't do the right thing that the currency then weakens.

And so, in the current environment, yes, when there's the threat of high volatility in the markets, gold, because it doesn't have any cashflow, there's no increase discounting, it tends to well. And so, when people are concerned about valuations, yes, gold does well. And then, on interest rates, it's the fear of the downturn.

Now, the moment, as we talk right now, there's, again, the glass is half full on the economy and so, gold takes a little step back. And if then the next day the glass if half empty, it goes a little higher and, that's why I think we're in the range bound. And if you've listened to the scenarios I laid out, these things are a process and, there are different people on different sides of that trade and, by the way, we do have trading positions on interest rates to express those views.

But, the point being is that the reason why gold has been trading in a range is precisely because of that, because some people argue one way, some people argue the other way and, that's precisely what makes a market.

My view is that, as these inflationary pressures will rise, and the Fed is going to be late to react to that, that should be favorable to the price of gold. And so, for me, that combined with the fact that we're in the late stages of the cycle, that gold, I call it the easiest diversifier, not always the best, but the easiest one because of its long term near zero correlation to stocks, and, because it has done well in most of the markets in the past several decades, with the exception of when real interest rates were very, very high.

And so, that's kind of getting people interested in the price of gold, but then, once in a while you have good economic numbers there and saying, hey, maybe rates should be higher and then again it gets pushed back a little bit.

Mike Gleason: Yeah and, that's well explained. There's a lot of push pull going on that's sort of keeping it in that range.

Well, as we begin to wrap up here, Axel, give us any final thoughts you may have for us today or, anything you believe people should be looking at or thinking about that maybe we haven't commented on yet, as we close.

Axel Merk: Well the only thing I can tell people is to have a plan. It doesn't even have to be a good plan, but a plan is better than no plan. And, the reason I say that, if you just listened to the latest blurb that you hear from me or anybody else, you've got to switch your mind and, with the sort of volatility we've seen, then you're almost certain to lose money. But, have a plan, obviously, revise once in while whether it makes sense, but people just listening to the latest and switching their thing, is no good.

And the other thing, also, is that, don't just listen but, also act. To just listen to everybody doesn't help either. You've got to have a plan, and, implement it.

Mike Gleason: Yeah, good advice. Well, thanks, as always, Axel, we always appreciate your time and, love getting your perspective on the state of things. Now, before we let you go, please tell folks a little bit more about your firm and, your services and also, how they can follow you more closely.

Axel Merk: Sure. Well, is our website. I'm on Twitter, that's @AxelMerk. We have a newsletter, we publish chart books on all kinds of things, we have several investment products including gold products that I can't go into detail without opening a Pandora's box on regulatory disclosures, but our website can give you a lot more information about the services that we offer.

Mike Gleason: Excellent. Thanks again, Axel. I'm sure we'll talk again before too long and, I hope you have a great weekend. Take care.

Axel Merk: My pleasure.

Mike Gleason: Well that will do it for this week. Thanks, again, to Axel Merk, President and, Chief Investment Officer of Merk Investments and, manager of the Merk Funds. For more information, be sure to check out


Peru became the world’s largest producer of silver in 2012.

Silver Phoenix Twitter                 Silver Phoenix on Facebook