China’s Collapse Has Only Begun

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The market bounced back today after Friday’s 600-point plunge in the Dow. But we haven’t heard the last of the coronavirus…

We’re still in a period of great uncertainty when it comes to the human and economic cost of the pandemic and the extent of the pandemic itself.

As I write, there are over 17,000 reported cases. Of those, 362 deaths have resulted and 487 people have recovered. The remaining roughly 16,200 cases are in various stages of treatment with uncertain outcomes.

Still, the 2% fatality exhibited so far is comparable to the Spanish flu pandemic of 1919–20, which ultimately killed an estimated 50 million victims.

Almost 99% of the reported cases are in China, with 62.5% of those Chinese cases in the vicinity of Wuhan, a major city of over 11 million people.

But the disease has spread (mostly through air travel from China or contact with Chinese travelers). There are 20 cases in Japan, 19 cases in Thailand and 18 cases in Singapore. The U.S. has 11 reported cases as of this morning.

It often takes laboratories six months or more to discover an effective cure or treatment for a virus of this type.

In the meantime, quarantine is the most effective approach. But how do you quarantine a city of 11 million, let alone a country of 1.3 billion people?

It’s very difficult to project growth rates. But if the virus stays on its current growth trajectory, more than 100 million people could be infected by the end of this month alone.

Many countries have banned arrivals from China and leading airlines have discontinued flights to China. That helps, but the virus continues to spread.

This all comes at a time that should be a period of great joy in China — the Lunar New Year. If you can imagine a two-week Christmas celebration, that’s about the magnitude of it.

While the long-term medical outcome is uncertain, the short-term economic damage is not. And China cannot afford a sustained economic setback.

China’s economy is already suffering extreme damage.

Their consumer economy has stalled as people stay home and avoid public transportation, stores and restaurants. The epicenter of the virus, Wuhan, is the capital of China’s Hubei province, a critical manufacturing center that represents 4% of Chinese GDP.

It now looks like a ghost town.

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Many other major Chinese cities have been shut down, with no citizens allowed to leave and transportation systems closed.

Tourism is dead and many businesses are requiring that executives cancel trips to China until further notice.

This comes at a time when the Chinese economy was slowing anyway. And some economists project that China’s growth rate could drop two full percentage points this quarter. That would translate to roughly $62 billion in lost growth.

Meanwhile, Chinese stocks promptly crashed over 8% in a matter of minutes this morning, after being closed for a number of days.

Stimulus measures in the form of monetary ease are being tried. The People’s Bank of China (PBOC) says it will buy 1.2 trillion yuan ($173 billion) in short-term bonds to add liquidity to the financial system.

But the net amount of liquidity that will make it into the system is actually much lower.

According to PBOC data, over 1 trillion yuan ($22 billion) worth of other short-term bonds matured today. So the net amount of liquidity entering the system is actually significantly less than the raw number indicates.

And the stimulus is unlikely to work because of China’s sky-high debt levels. China’s debt-to-GDP ratio, for example, is about 310%, which is astonishing.

Research by economists Ken Rogoff and Carmen Reinhart persuasively demonstrates that once debt surpasses 90% of GDP, it is impossible to grow our way out of the debt. Again, China’s debt-to-GDP ratio is much, much higher.

Let’s hope the coronavirus is contained soon. Unfortunately, the damage to China’s economy is already happening and will persist even if the virus is soon under control.

And given China’s impact on the global economy, the rest of the world will suffer as a result.

Regards,

Jim Rickards
for The Daily Reckoning

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Elites Have Destroyed a Possible U.S. – Russia Alliance to Contain China

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There’s no need to rehash the sordid politics of the U.S.-Russia relationship since 2014. That relationship became collateral damage to gross corruption in Ukraine.

The U.S. and its allies, especially the UK under globalists like David Cameron, wanted to peel off Ukraine from the Russian orbit and make it part of the EU and eventually NATO.

From Russia’s perspective, this was unacceptable. It may be true that most Americans cannot find Ukraine on a map, but a simple glance at a map reveals that much of Ukraine lies East of Moscow.

Putting Ukraine in a Western alliance such as NATO would create a crescent stretching from Luhansk in the South through Poland in the West and back around to Estonia in the North. There are almost no natural obstacles between that arc and Moscow; it’s mostly open steppe.

Completion of this “NATO Crescent” would leave Moscow open to invasion in ways that Napoleon and Hitler could only dream. Of course, this situation was and is unacceptable to Moscow.

Ukraine itself is culturally divided along geographic lines. The Eastern and Southern provinces (Luhansk, Donetsk, Crimea and Dnipro) are ethnically Russian, follow the Orthodox Church and the Patriarch of Moscow, and welcome commercial relations with Russia.

The Western provinces (Kiev, Lviv) are Slavic, adhere to the Catholic Church and the Pope in Rome, and look to the EU and U.S. for investment and aid.

Prior to 2014, an uneasy truce existed between Washington and Moscow that allowed a pro-Russian President while at the same time permitting increasing contact with the EU. Then the U.S. and UK overreached by allowing the CIA and MI6 to foment a “color revolution” in Kiev called the “Euromaidan Revolution.”

Ukrainian President Viktor Yanukovych resigned and fled to Moscow. Pro-EU protestors took over the government and signed an EU Association Agreement.

In response, Putin annexed Crimea and declared it part of Russia. He also infiltrated Donetsk and Luhansk and helped establish de facto pro-Russian regional governments. The U.S. and EU responded with harsh economic sanctions on Russia.

Ukraine has been in turmoil (with increasing corruption) ever since. U.S.-Russia relations have been ice-cold, exactly as the globalists intended.

The U.S- induced fiasco in Ukraine not only upset U.S.-Russia relations, it derailed a cozy money laundering operation involving Ukrainian oligarchs and Democratic politicians. The Obama administration flooded Ukraine with non-lethal financial assistance.

This aid was amplified by a four-year, $17.5 billion loan program to Ukraine from the IMF, approved in March 2015. Interestingly, this loan program was pushed by Obama at a time when Ukraine did not meet the IMF’s usual borrowing criteria.

Some of this money was used for intended purposes, some was skimmed by the oligarchs, and the rest was recycled to Democratic politicians in the form of consulting contracts, advisory fees, director’s fees, contributions to foundations and NGOs and other channels.

Hunter Biden and the Clinton Foundations were major recipients of this corrupt recycling. Other beneficiaries included George Soros-backed “open society” organizations, which further directed the money to progressive left-wing groups in the U.S.

This cozy wheel-of-fortune was threatened when Donald Trump became president. Trump genuinely desired improved relations with Russia and was not on the receiving end of laundered aid to Ukraine.

Hillary Clinton was supposed to continue the Obama policies, but she failed in the general election. Trump was a threat to everything the globalists, Democrats and pro-NATO elites had constructed in the 2010s.

The globalists wanted China and the U.S. to team up against Russia. Trump understood correctly that China was the main enemy and therefore a closer union between the U.S. and Russia was essential.

The elites’ efforts to derail Trump gave rise to the “Russia collusion” hoax. While no one disputes that Russia sought to sow confusion in the U.S. election in 2016, that’s something the Russians and their Soviet predecessors had been doing since 1917. By itself, little harm was done.

Yet, the elites seized on this to concoct a story of collusion between Russia and the Trump campaign. The real collusion was among Democrats, Ukrainians and Russians to discredit Trump.

It took the Robert Mueller investigation two years finally to conclude there was no collusion between Trump and the Russians. By then, the damage was done. It was politically toxic for Trump to reach out to the Russians. That would be spun by the media as more evidence of “collusion.”

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Russian President Vladimir Putin (l.) has recently named a new Prime Minister, Mikhail Mishustin (r.). This is part of a complex government reorganization designed to extend Putin’s rule beyond existing term limits. This is a setback for democracy, but may be a plus for the economy because it adds stability and continuity to Putin’s programs.

This whirl of false charges, cover-ups, and deep state sabotage finally led to Trump’s impeachment on December 18, 2019. Fortunately, the Senate impeachment trial may soon be behind us with Trump’s exoneration in hand (although new impeachment charges and false accusations cannot be ruled out).

Is the stage finally set for improved U.S.-Russia relations, relief from U.S. sanctions, and a significant increase in U.S. direct foreign investment in Russia?

Right now, my models are telling us that Russia is one of the most attractive targets for foreign investment in the world. Just because U.S. policymakers missed the boat does not mean that investors must do the same.

Russia is often denigrated by Wall Street analysts and mainstream economists who know little about the country. Russia is the world’s largest country by area and has the largest arsenal of nuclear weapons of any country in the world.

It has the world’s 11th largest economy at over $1.6 trillion in annual GDP, ahead of South Korea, Spain and Australia and not far behind Canada, Brazil and Italy.

It also is the world’s third largest producer of oil and related liquids, with output of 11.4 million barrels per day, about 11% of the world’s total. The U.S. (17.8 million b/d), Saudi Arabia (12.4 million b/d) and Russia combine to provide 41% of the world’s liquid fuels. The latter two countries effectively control the world’s oil price by agreeing on output quotas.

Russia has almost no external dollar-denominated debt and has a debt-to-GDP ratio of only 13.50% (the comparable ratio for the United States is 106%).

In short, Russia is too big and too powerful to ignore despite the derogatory and uninformed claims of globalists. Importantly, Russia is emerging from the oil price shock of 2014-2016 and is in a solid recovery.

The stage is now set for significant economic expansion as illustrated in the chart below from Moody’s Analytics:

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This graphic analysis from Moody’s Analytics divides major economies into categories of Recovery, Expansion, Slowdown and Recession. Economies revolve clockwise through these four phases. The U.S. is in a Slowdown phase with some risk of Recession. Russia is in the Recovery phase heading toward Expansion. The Russian situation is the most attractive for investors because it offers cheap entry points with high returns as the Expansion phase begins.

Russia has also gone to great lengths to insulate itself from U.S. economic sanctions. Their reserves have recovered to the $500 billion level that existed before the 2014 oil price collapse with one important difference. The dollar component of reserves has shrunk substantially while the gold component has increased to over 20%.

With the recent surge in gold prices, Russia’s reserves get a significant boost (when expressed in dollars) because of the higher dollar value of the gold reserves. Gold cannot be hacked, frozen or seized, as is the case with digital dollar assets.

Russia’s fortunes have been improving not only because of low debt and higher gold prices but also because of higher oil prices. The country is poised for a strong expansion, even if U.S. hostility caused by the Democrats continues.

If Trump regains his footing after impeachment and wins a second term (which I expect), investors can expect warmer relations with Russia and an even more powerful Russian economic expansion than the one already underway.

Regards,

Jim Rickards
for The Daily Reckoning

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Russia: The Lost Opportunity

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The biggest story out of China right now is the coronavirus that I addressed in yesterday’s reckoning.

But while it’s important, the bigger story is the geopolitical dynamic between the U.S., China and Russia.

Today I’m going to address that dynamic and show you how Washington has squandered a major opportunity to turn it in America’s favor.

When future historians look back on the 2010s, they will be baffled by the lost opportunity for the U.S. to mend fences with Russia, develop economic relations and create a win-win relationship between the world’s greatest technology innovator and the world’s greatest natural resources provider.

It will seem a great loss for the world. Here’s the reality:

Russia, China and the U.S. are the only true superpowers and the only three countries that ultimately matter in geopolitics. That’s not a slight against any other power.

But all others are secondary powers (the U.K., France, Germany, Japan, Israel, etc.) or tertiary powers (Iran, Turkey, India, Pakistan, Saudi Arabia, etc.).

This means that the ideal posture for the U.S. is to ally with Russia (to marginalize China) or ally with China (to marginalize Russia), depending on overall geopolitical conditions.

The U.S. conducted this kind of triangulation successfully from the 1970s until the early 2000s.

One of the keys to U.S. foreign policy in the last 50 or 60 years has been to make sure that Russia and China never form an alliance. Keeping them separated was key.

In 1972, Nixon pivoted to China to put pressure on Russia. In 1991, the U.S. pivoted to Russia to put pressure on China after the Tiananmen Square massacre.

Unfortunately, the U.S. has lost sight of this basic rule of international relations. It is now Russia and China that have formed a strong alliance, to the disadvantage of the United States.

China and Russia have forged stronger ties through the Shanghai Cooperation Organization, for example — a military and economic treaty — and the BRICS institutions. Part of it is an anti-dollar campaign.

One leg of the China-Russia relationship is their joint desire to see the U.S. dollar lose its status as the world’s dominant reserve currency. They chafe against the ways in which the U.S. uses the dollar as a financial weapon.

But ultimately, this two-against-one strategic alignment of China and Russia against the U.S. is a strategic blunder by the U.S.

Russia is the nation that the U.S. should have tried to court and should still be courting. That’s because China is the greatest geopolitical threat to the U.S. because of its economic and technological advances and its ambition to push the U.S. out of the Western Pacific sphere of influence.

Russia may be a threat to some of its neighbors, but it is far less of a threat to U.S. strategic interests.

Therefore, a logical balance of power in the world would be for the U.S. and Russia to find common ground in the containment of China and to jointly pursue the reduction of Chinese power.

Of course, that hasn’t happened. And we could be paying the price for years to come.

Regards,

Jim Rickards
for The Daily Reckoning

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Contagion!

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The world is confronting the effects of the “coronavirus.” It likely originated in Wuhan, China, where it jumped from animals to humans at a local food market. It has since spread to other parts of China and beyond.

So far, there are 2,886 confirmed total cases of the coronavirus. All but 61 of them are in mainland China. The death toll so far is 81.

But cases have also been found in France, the U.S., Canada, Australia, Japan, South Korea and elsewhere. That list includes the world’s three largest economies (the U.S., China and Japan).

For many, it recalls the SARS outbreak of 2003, which also originated in China. It ultimately killed 774 people and infected more than 8,000 in different parts of the world.

Not surprisingly, global markets are on edge over fears of the “coronavirus” contagion spreading. And the U.S. stock market sold off today.

The Dow lost 454 points. The S&P and Nasdaq also had awful days. But gold has a good day, up over $10 to $1,582, as investors looked for safety.

But let’s discuss the word “contagion,” because it applies to both human populations and financial markets — and in more ways than you may expect.

There’s a reason why financial experts and risk managers use the word “contagion” to describe a financial panic.

Obviously, the word contagion refers to an epidemic or pandemic. In the public health field, a disease can be transmitted from human to human through coughing, shared needles, shared food or contact involving bodily fluids.

An initial carrier of a disease (“patient zero”) may have many contacts before the disease even appears.

Some diseases have a latency period of weeks or longer, which means patient zero can infect hundreds before health professionals are even aware of the disease. Then those hundreds can infect thousands or even millions before they are identified as carriers.

In extreme cases, such as the “Spanish flu” pandemic of 1918–20 involving the H1N1 influenza virus, the number infected can reach 500 million and the death toll can run over 100 million.

A similar dynamic applies in financial panics.

It can begin with one bank or broker going bankrupt as the result of a market collapse (a “financial patient zero.”)

But the financial distress quickly spreads to banks that did business with the failed entity and then to stockholders and depositors of those other banks and so on until the entire world is in the grip of a financial panic as happened in 2008.

Still, the comparison between medical pandemics and financial panics is more than a metaphor.

Disease contagion and financial contagion both work the same way. The nonlinear mathematics and system dynamics are identical in the two cases even though the “virus” is financial distress rather than a biological virus.

But what happens when these two dynamic functions interact? What happens when a biological virus turns into a financial virus?

We’re seeing it happen in China.

It’s the time of the Lunar New Year holiday in China, China’s most important public holiday. It’s traditionally a time of widespread celebration.

But, for many Chinese cities, not this year.

Many major Chinese cities have been shut down, with no citizens allowed to leave, and their transportation systems have been closed.

Retails sales are also suffering as consumers remain home instead of risking contagion with trips to the store.

The disease is causing financial panic in China at a time when it can least afford it. GDP growth has hit a wall and investors have curtailed new investment.

Could it unleash a global financial panic that ultimately results in a lockdown of the banking system?

It’s possible, but it’s far too soon to say. This is the type of catalyst that could take a year to build.

But it definitely bears watching.

Regards,

Jim Rickards
for The Daily Reckoning

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Don’t Mess With the U.S. (Financially)

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I’ve been documenting financial warfare in my articles for years, but it still doesn’t get the mainstream attention it deserves.

Because as you’ll see below, it can directly impact your wealth.

Financial warfare tools include account seizures and freezes, expulsion from global payment systems, secondary fines and penalties on banks that do business with targeted entities, embargoes, tariffs and many other impositions.

These tools are amplified by the unique role of the U.S. dollar, which is the currency behind 60% of global reserves, 80% of global payments and almost 100% of transactions in oil.

The U.S. controls the banks and payments systems that process dollar transactions. This leaves the U.S. well positioned to impose dollar-related sanctions.

Much has been made of the recent killing of Iranian terrorist mastermind Qasem Soleimani. Many say it was an act of war. But guess what, folks?

We’ve been in a full-scale war with Iran for two years now. It’s just that most people don’t realize it.

It’s not a kinetic war with troops, missiles and ships (except Iran’s use of terrorist bombs and the U.S.’ use of drones). And it’s severely damaged the Iranian economy, which has led to protests against the regime.

From the U.S. side, it’s a financial war. People need to stop thinking about financial sanctions as an extension of trade policy, for example.

This is warfare. It’s just a different form of warfare.

It’s critical to understand that financial war is not a sideshow. It may actually be the main event in today’s deeply connected and computerized world.

North Korea is also the current target of a U.S. “maximum pressure” campaign, where harsh sanctions are applied to a wide range of banks, companies and individuals.

As with Iran, sanctions have been instrumental in destabilizing the regime and bringing North Korea to the bargaining table to discuss its nuclear weapons programs.

Now, Iraq is the latest country to feel the sting of U.S. dollar sanctions.

Following the killing of Soleimani on Iraqi soil, Iraq threatened to expel all U.S. troops from Iraq. Trump answered in two parts.

He said U.S. troops would not leave until Iraq repaid the U.S. for building bases and other infrastructure in Iraq. Trump also warned that Iraq’s access to its account at the Federal Reserve Bank of New York could be terminated.

That would make it impossible for Iraq to purchase and sell oil in dollars. It could also cause Iraq to lose access to about $3 billion currently held in that account.

Iraq has heard the U.S. threats loud and clear. As of now, U.S. troops are still in Iraq and not planning to leave anytime soon.

The fact that Iraqi policy could be conditioned without a shot being fired shows the raw power of financial warfare.

The trouble is private businesses and investors can get caught in the crossfire of financial warfare.

According to one survey, last year saw a 42% increase in cyberattacks on private companies around the world (attributable to foreign governments).

About 20% of businesses reported daily attacks, many in the banking and financial services sectors. Only 6% of businesses in the survey claimed they weren’t targeted by a cyberattack in 2019.

You as an investor trying to mind your own business or build wealth or expand your portfolio may get caught in the crossfire of a financial war. So you have to take that into account in your portfolio allocations and risk management.

In today’s world, everyone’s a potential casualty of financial warfare.

Regards,

Jim Rickards
for The Daily Reckoning

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Helicopter Money Is No Panacea

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In recent decades, the Fed has engaged in a series of policy interventions and market manipulations that have paradoxically left it more powerful even as those interventions left a trail of crashes, collapses and calamities.

This contradiction between Fed omnipotence and Fed incompetence is coming to a head. The economy has been trapped in a prolonged period of subtrend growth. I’ve referred to it in the past as the “new depression.” And the Fed has been powerless to lift the economy out of it.

You may think of depression as a continuous decline in GDP. The standard definition of a recession is two or more consecutive quarters of declining GDP and rising unemployment. Since a depression is understood to be something worse then a recession, investors think it must mean an extra-long period of decline. But that is not the definition of depression.

The best definition ever offered came from John Maynard Keynes in his 1936 classic, The General Theory of Employment, Interest and Money. Keynes said a depression is, “a chronic condition of subnormal activity for a considerable period without any marked tendency towards recovery or towards complete collapse.”

Keynes did not refer to declining GDP; he talked about “subnormal” activity. In other words, it’s entirely possible to have growth in a depression. The problem is that the growth is below trend. It is weak growth that does not do the job of providing enough jobs or staying ahead of the national debt. That is exactly what the U.S. is experiencing today.

Long-term growth is about 3%. From 1994 to 2000, the heart of the Clinton boom, growth in the U.S. economy averaged over 4% per year.

For a three-year stretch from 1983 to 1985 during the heart of the Reagan boom, growth in the U.S. economy averaged over 5.5% per year. These two periods were unusually strong, but they show what the U.S. economy can do with the right policies. By contrast, growth in the U.S. from 2007 through today has averaged something like 2% per year.

That is the meaning of depression. It is not negative growth, but it is below-trend growth.  And growth under Trump has been no greater than it was under Obama.

The bigger problem is there’s no way out, as I said. One manipulation leads to another. My greatest fear is that the U.S. is becoming like Japan, which has used every trick in the book to no avail.

In my 2014 book, The Death of Money, I wrote, “The United States is Japan on a larger scale.” That was six years ago now.

Japan started its “lost decade” in the 1990s. Now their lost decade has dragged into three lost decades. The U.S. began its first lost decade in 2009 and is now entering its second lost decade with no real end in sight.

What I referred to in 2014 was that central bank policy in both countries has been completely ineffective at restoring long-term trend growth or solving the steady accumulation of unsustainable debt.

In Japan this problem began in the 1990s, and in the U.S. the problem began in 2009, but it’s the same problem with no clear solution.

Now in 2020, central banks have been cutting rates again, as the trade war and slowing global growth have policymakers considering the implications of a new recession without the firepower they need. As things stand, the next recession may be impossible to get out of. And the odds of avoiding a recession are low.

The only way out is for the Fed to guarantee inflation “whatever it takes.” Nothing else has worked. So why not try a more active fiscal policy? Why not load the helicopters with cash and dump it out over Main Street?

First, we need to understand what helicopter money is, and what it isn’t.

The image of the Fed printing paper money, and dumping it from helicopters to consumers waiting below who scoop it up and start spending is a popular, but not very informative way to describe helicopter money.

In reality, helicopter money is the coordination of fiscal policy and monetary policy in a way designed to provide stimulus to a weak economy and to fight deflation.

Helicopter money starts with larger deficits caused by higher government spending. This spending is considered to have a multiplier effect. For each dollar of spending, perhaps $1.50 of additional GDP is created since the recipients of the government spending turn around and spend that same money on additional goods and services. The U.S. Treasury finances these larger deficits by borrowing the money in the government bond market.

Normally this added borrowing might raise interest rates. The economic drag from higher rates could cancel out the stimulus of higher spending and render the entire program pointless.

This is where the Fed steps in. The Fed can buy the additional debt from the Treasury with freshly printed money. The Fed also promises to hold these newly purchased Treasury bonds on its balance sheet until maturity.

By printing money to neutralize the impact of more borrowing, the economy gets the benefit of higher spending, without the headwinds of higher interest rates. The result is mildly inflationary offsetting the feared deflation that would trigger helicopter money in the first place.

It’s a neat theory, but it’s full of holes.

The first problem is there’s not much of a multiplier at this stage of the U.S. expansion. The current expansion is already the longest in U.S. history. It’s also been the weakest expansion in history, but an expansion nonetheless. The multiplier effect of government spending is strongest at the beginning of an expansion when the economy has more spare capacity in labor and capital.

At this point, the actual multiplier is probably less than one. For every dollar of government spending, the economy might only get $0.90 of added GDP; not the best use of borrowed money.

The second problem with helicopter money is there is no assurance that citizens will actually spend the money the government is pushing into the economy. They are just as likely to pay down debt or save any additional income. This is the classic “liquidity trap.” This propensity to save rather than spend is a behavioral issue not easily affected by monetary or fiscal policy.

Finally, there is an invisible but real confidence boundary on the Fed’s balance sheet. After printing $4 trillion in response to the last financial crisis, how much more can the Fed print without risking confidence in the dollar itself?

Quantitative tightening brought the balance sheet back down to $3.8 trillion. But now it’s over $4 trillion again, as the Fed has added hundreds of billions to its balance sheet since September, when it starting shoring up short-term money markets. It’s basically been “QE-lite.”

Modern monetary theorists and neo-Keynesians say there is no limit on Fed printing, yet history says otherwise.

Importantly, with so much U.S. government debt in foreign hands, a simple decision by foreign countries to become net sellers of U.S. Treasuries is enough to cause interest rates to rise thus slowing economic growth and increasing U.S. deficits at the same time.

If such net selling accelerates, it could lead to a debt-deficit death spiral and a U.S. sovereign debt crisis of the type that hit Greece and the Eurozone periphery in recent years.

In short, helicopter money could have far less potency and far greater unintended negative consequences than its supporters expect.

Regards,

Jim Rickards
for The Daily Reckoning

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“Last Hurrah” for Central Bankers

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We’ve all seen zombie movies where the good guys shoot the zombies but the zombies just keep coming because… they’re zombies!

Market observers can’t be blamed for feeling the same way about former Fed Chair Ben Bernanke.

Bernanke was Fed chair from 2006–2014 before handing over the gavel to Janet Yellen. After his term, Bernanke did not return to academia (he had been a professor at Princeton) but became affiliated with the center-left Brookings Institution in Washington, D.C.

Bernanke is proof that Washington has a strange pull on people. They come from all over, but most of them never leave. It gets more like Imperial Rome every day.

But just when we thought that Bernanke might be buried in the D.C. swamp, never to be heard from again… like a zombie, he’s baaack!

Bernanke gave a high-profile address to the American Economic Association at a meeting in San Diego on Jan. 4. In his address, Bernanke said the Fed has plenty of tools to fight a new recession.

He included quantitative easing (QE), negative interest rates and forward guidance among the tools in the toolkit. He estimates that combined, they’re equal to three percentage points of additional rate cuts. But that’s nonsense.

Here’s the actual record…

That QE2 and QE3 did not stimulate the economy at all; this has been the weakest economic expansion in U.S. history. All QE did was create asset bubbles in stocks, bonds and real estate that have yet to deflate (if we’re lucky) or crash (if we’re not).

Meanwhile, negative interest rates do not encourage people to spend as Bernanke expects. Instead, people save more to make up for what the bank is confiscating as “negative” interest. That hurts growth and pushes the Fed even further away from its inflation target.

What about “forward guidance?”

Forward guidance lacks credibility because the Fed’s forecast record is abysmal. I’ve counted at least 13 times when the Fed flip-flopped on policy because they couldn’t get the forecast right.

So every single one of Bernanke’s claims is dubious. There’s just no realistic basis to argue that these combined policies are equal to three percentage points of additional rate cuts.

And the record is clear: The Fed needs interest rates to be between 4% and 5% to fight recession. That’s how much “dry powder” the Fed needs going into a recession.

In September 2007, the fed funds rate was at 4.75%, toward the high end of the range. That gave the Fed plenty of room to cut, which it certainly did. Between 2008 and 2015, rates were essentially at zero.

The current fed funds target rate is between 1.50% and 1.75%. I’m not forecasting a recession this year, but if we do have one, the Fed doesn’t have anywhere near the room to cut as it did to fight the Great Recession.

I’m not the only one to make that point. Here’s what former Treasury Secretary Larry Summers said:

[Bernanke] argued that monetary policy will be able to do it the next time. I think that’s pretty unlikely given that in recessions we usually cut interest rates by five percentage points and interest rates today are below 2%… I just don’t believe QE and that stuff is worth anything like another three percentage points.

Summers goes on to call Bernanke‘s speech “a kind of last hurrah for the central bankers.”

He’s right. But if monetary policy isn’t the answer, what does Summers think the answer is?

Fiscal policy. The government is going to have to spend money directly into the economy instead of relying upon some trickle-down “wealth effect” to stimulate the economy.

Here’s what Summers said:

“We’re going to have to rely on putting money in people’s pockets, on direct government spending.”

Remember the term “helicopter money”? Milton Friedman coined the term 50 years ago when he made the analogy of dropping money from a helicopter to illustrate the effects of aggressive fiscal policy.

That’s essentially what Summers is advocating. It might sound a lot like the idea behind Modern Monetary Theory, or MMT, but it’s not necessarily the same thing. MMT takes helicopter money to a whole new level, and Summers has actually been highly critical of MMT.

But the idea of direct government spending to stimulate the economy is the same, and it’s gaining traction in official circles.

There’s good reason to believe it’s coming to a theater near you. And maybe sooner than you think.

Regards,

Jim Rickards
for The Daily Reckoning

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A New Gold Standard: Orderly or Chaotic?

This post A New Gold Standard: Orderly or Chaotic? appeared first on Daily Reckoning.

Over the past century, monetary systems change about every 30 to 40 years on average. Before 1914, the global monetary system was based on the classical gold standard.

Then in 1945, a new monetary system emerged at Bretton Woods. I was at Bretton Woods this past summer to commemorate its 75th anniversary.

Under that system, the dollar became the global reserve currency, linked to gold at $35 per ounce. In 1971 Nixon ended the direct convertibility of the dollar to gold. For the first time, the monetary system had no gold backing.

Today, the existing monetary system is nearly 50 years old, so the world is long overdue for a change. Gold should once again play a leading role.

I’ve written and spoken publicly for years about the prospects for a new gold standard. My analysis is straightforward.

International monetary figures have a choice. They can reintroduce gold into the monetary system either on a strict or loose basis (such as a “reference price” in monetary policy decision making).

This can be done as the result of a new monetary conference, a la Bretton Woods. It could be organized by some convening power, probably the U.S. working with China.

Or they can ignore the problem, let a debt crisis materialize (that will play out in interest rates and foreign-exchange markets) and watch gold soar to $14,000 per ounce or higher, not because they wanted it to but because the system is out of control.

I’ve also said that the former course (a conference) is more desirable, but the latter course (chaos) is more likely. A monetary conference would be far preferable. Why not avoid the train wreck rather than clear up the wreckage? But will probably be ignored until it’s too late. Either way, the price of gold soars.

The same force that made the dollar the world’s reserve currency is working to dethrone it. It was at Bretton Woods that the dollar was officially designated the world’s leading reserve currency — a position that it still holds today.

Under the Bretton Woods system, all major currencies were pegged to the dollar at a fixed exchange rate. The dollar itself was pegged to gold at the rate of $35 per ounce. Indirectly, the other currencies had a fixed gold value because of their peg to the dollar.

Other currencies could devalue against the dollar, and therefore against gold, if they received permission from the International Monetary Fund (IMF). However, the dollar could not devalue, at least in theory. It was the keystone of the entire system — intended to be permanently anchored to gold.

From 1950–1970 the Bretton Woods system worked fairly well. Trading partners of the U.S. who earned dollars could cash those dollars into the U.S. Treasury and be paid in gold at the fixed rate.

Trading partners of the U.S. who earned dollars could cash those dollars into the U.S. Treasury and be paid in gold at the fixed rate.

In 1950, the U.S. had about 20,000 tons of gold. By 1970, that amount had been reduced to about 9,000 tons. The 11,000-ton decline went to U.S. trading partners, primarily Germany, France and Italy, who earned dollars and cashed them in for gold.

The U.K. pound sterling had previously held the dominant reserve currency role starting in 1816, following the end of the Napoleonic Wars and the official adoption of the gold standard by the U.K. Many observers assume the 1944 Bretton Woods conference was the moment the U.S. dollar replaced sterling as the world’s leading reserve currency.

In fact, that replacement of sterling by the dollar as the world’s leading reserve currency was a process that took 30 years, from 1914 to 1944.

In fact, the period from 1919–1939 was really one in which the world had two major reserve currencies — dollars and sterling — operating side by side.

Finally, in 1939, England suspended gold shipments in order to fight the Second World War and the role of sterling as a reliable store of value was greatly diminished. The 1944 Bretton Woods conference was merely recognition of a process of dollar reserve dominance that had started in 1914.

The significance of the process by which the dollar replaced sterling over a 30-year period has huge implications for you today. Slippage in the dollar’s role as the leading global reserve currency is not necessarily something that would happen overnight, but is more likely to be a slow, steady process.

Signs of this are already visible. In 2000, dollar assets were about 70% of global reserves. Today, the comparable figure is about 62%. If this trend continues, one could easily see the dollar fall below 50% in the not-too-distant future.

It is equally obvious that a major creditor nation is emerging to challenge the U.S. today just as the U.S. emerged to challenge the U.K. in 1914. That power is China. The U.S. had massive gold inflows from 1914-1944. China has been experiencing massive gold inflows in recent years.

Gold reserves at the People’s Bank of China (PBOC) increased to 1948.31 tonnes in the fourth quarter of 2019. For comparison, it held 1,658 tonnes in June, 2015.

But China has acquired thousands of metric tonnes since without reporting these acquisitions to the IMF or World Gold Council.

Based on available data on imports and the output of Chinese mines, actual Chinese government and private gold holdings are likely much higher. It’s hard to pinpoint because China operates through secret channels and does not officially report its gold holdings except at rare intervals.

China’s gold acquisition is not the result of a formal gold standard, but is happening by stealth acquisitions on the market. They’re using intelligence and military assets, covert operations and market manipulation. But the result is the same. Gold’s been flowing to China in recent years, just as gold flowed to the U.S. before Bretton Woods.

China is not alone in its efforts to achieve creditor status and to acquire gold. Russia has greatly increased its gold reserves over the past several years and has little external debt. The move to accumulate gold in Russia is no secret, and as Putin advisor, Sergey Glazyev told Russian Insider has said, “The ruble is the most gold-backed currency in the world.”

Iran has also imported massive amounts of gold, mostly through Turkey and Dubai, although no one knows the exact amount, because Iranian gold imports are a state secret.

Other countries, including BRICS members Brazil, India and South Africa, have joined Russia and China in their desire to break free of U.S. dollar dominance.

Sterling faced a single rival in 1914, the U.S. dollar. Today, the dollar faces a host of rivals. The decline of the dollar as a reserve currency started in 2000 with the advent of the euro and accelerated in 2010 with the beginning of a new currency war.

The dollar collapse has already begun and the need for a new monetary order will need to emerge. The question is whether it will be an orderly process resulting from a new monetary conference, or a chaotic one.

Unfortunately, it’ll probably be chaotic. Don’t count on the elites to act in time.

Regards,

Jim Rickards
for The Daily Reckoning

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Rickards: Here’s Where Gold Will Be in 2026

This post Rickards: Here’s Where Gold Will Be in 2026 appeared first on Daily Reckoning.

Dear Reader,

Gold spiked after last Friday’s drone strike that took out a top Iranian military official and is trading at seven-year highs.

Yes, the news was dramatic and made a major impact. But geopolitics is just one factor driving gold. Even without the latest geopolitical tensions, gold is poised for a historic run.

The first two major gold bull markets were 1971–80 and 1999–2011. Today, gold is in the early stages of its third bull market in 50 years.

If we simply average the performance of the past two bull markets and extend the new bull market on that basis, we would expect to see prices peak at $14,000 per ounce by 2026.

What’s driving the new gold bull market?

From both long-term and short-term perspectives, there are three principal drivers: geopolitics, supply and demand and Fed interest rate policy (the dollar price of gold is just the inverse of dollar strength. A strong dollar = a lower dollar price of gold, and a weak dollar = a higher dollar price of gold. Fed rate policy determines if the dollar is strong or weak).

The first two factors have been driving the price of gold higher since 2015 and will continue to do so. Geopolitical hot spots like Iran, Korea, Crimea, Venezuela, China and Syria remain unresolved. Some are getting worse.

Each flare-up drives a flight to safety that boosts gold along with Treasury notes, as the latest incident shows.

The supply/demand situation remains favorable with Russia and China buying over 50 tons per month to build up their reserves while global mining output has been flat for at least five years.

The third factor, Fed policy, is the hardest to forecast and the most powerful on a day-to-day basis.

But there’s little chance that the Fed will be raising rates anytime soon. It’s much more likely to cut rates as the U.S. economy faces strong headwinds, especially from rising debt levels. Debt is growing faster than the economy.

Debt is now at the highest levels since World War II. We’re nearly in the same position on a relative basis as we were in 1945.

Because of the natural deflationary state of the world and the high debt-to-GDP ratio, growth has been snuffed out.

And based on Congressional Budget Office (CBO) projections — which I think are conservative — the debt-to-GDP ratio is going to keep going up.

There is no way out except inflation.

Add it all up and the environment is highly favorable for gold. But if you want evidence that owning gold is probably the best way to guard your wealth, just look at the “smart money.”

I’m sure you’ve seen plenty of billionaire hedge fund managers on business TV or streaming live from Davos. They like to discuss their investments in Apple, Amazon, Treasury notes and other stocks and bonds.

They love to “talk their book” in the hope that other investors will piggyback on their trades, run up the price and produce more profits for them.

What they almost never discuss in public is gold. After all, why have gold when stocks and bonds are so wonderful?

Well, I worked on Wall Street and in the hedge fund industry for decades. I also lived among the players in New York and Greenwich, Connecticut, at the same time. I’ve met the top hedge fund gurus in private settings. And here’s the thing:

I’ve never met one of them who does not have a large hoard of physical gold stored safely in a nonbank vault. Not one.

Of course, they won’t say so on TV because they don’t want to spook retail investors into dumping stocks and bonds. But watch what they do, not what they say.

If gold bullion is the go-to asset for billionaires, why don’t small investors have at least a 10% allocation to gold and silver bullion just in case?

Some do, but most don’t. They’ll find out the hard way what individuals have learned over centuries and millennia. Gold preserves wealth; paper assets do not.

Below, I show you why a global monetary reset is coming, with gold at its center. It can either be an orderly process — or a chaotic one.

Which will it likely be? Read on.

Regards,

Jim Rickards
for The Daily Reckoning

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Central Banks Pushing for Negative (Real) Interest Rates

This post Central Banks Pushing for Negative (Real) Interest Rates appeared first on Daily Reckoning.

This summer I was in Bretton Woods, New Hampshire, along with a host of monetary elites, to commemorate the 75th anniversary of the Bretton Woods conference that established the post-WWII international monetary system. But I wasn’t just there to commemorate  the past —I was there to seek insight into the future of the monetary system.

One day I was part of a select group in a closed-door “off the record” meeting with top Federal Reserve and European Central Bank (ECB) officials who announced exactly what you can expect with interest rates going forward — and why.

They included a senior official from a regional Federal Reserve bank, a senior official from the Fed’s Board of Governors and a member of the ECB’s Board of Governors.

Chatham House rules apply, so I can’t reveal the names of anyone present at this particular meeting or quote them directly.

But I can discuss the main points. They essentially came out and announced that rates are heading lower, and not by just 25 or 50 basis points. They said they have to cut interest rates by a lot going forward.

They didn’t officially announce that interest rates will go negative. But they said that when rates are back to zero, they’ll have to take a hard look at negative rates.

Reading between the lines, they will likely resort to negative rates when the time comes.

Normally forecasting interest rate policy can be tricky, and I use a number of sophisticated models to try to determine where it’s heading. But these guys made my job incredibly easy. It’s almost like cheating!

The most interesting part of the meeting was the reason they gave for the coming rate cuts. They were very relaxed about it, almost as if it was too obvious to even point out.

The reason has to do with real interest rates.

The real interest rate is the nominal interest rate minus the inflation rate. You might look at today’s interest rates and think they’re already extremely low. But when you consider real interest rates, you’ll see that they’re substantially higher than the nominal rate.

That’s why the real rate is so important. If you’re an economist or analyst trying to forecast markets based on the impact of rates on the economy, then you need to focus on real rates.

Assume the nominal rate on a bond is 4%; what you see is what you get. But the real rate is the nominal rate minus inflation. If the nominal rate is 4% and inflation is 2%, then the real rate is 2% (4 – 2 = 2).

That difference between nominal and real rates seems simple until you get into a strange situation where inflation is higher than the nominal rate. Then the real rate is negative.

For example, if the nominal rate is 4% and inflation is 5%, then the real rate of interest is negative 1% (4 – 5 = -1).

The U.S. has never had negative nominal rates (Japan, the eurozone and Switzerland have), but it has had negative real rates.

By the early 1980s, nominal interest rates on long-term Treasury securities hit 13%. But inflation at the time was 15%, so the real rate was negative 2%. The real cost of money was cheap even as nominal rates hit all-time highs.

Nominal rates of 13% when inflation is 15% are actually stimulative. Rates of 3% when inflation is 1% aren’t. In these examples, nominal 2% is a “high” rate and 13% is a “low” rate once inflation is factored in.

The situation today is much closer to the latter example.

The yield to maturity on 10-year Treasury notes is currently around 1.8%, which is extremely low by traditional standards. Meanwhile, inflation as measured by the PCE core deflator (the Fed’s preferred measure) is currently about 1.6% year over year, below the Fed’s 2% target.

Using those metrics, real interest rates are above zero. But more interestingly, they’re higher than the early ’80s when real rates were -2%.

That’s why it’s critical to understand the significance of real interest rates.

And real rates are important because the central banks want to drive real rates meaningfully negative. That’s why they have to lower the nominal rate substantially, which is what these central bank officials said at Bretton Woods.

So you can expect rates to go to zero, probably sooner or later. Then, nominal negative rates are probably close behind.

The Fed is very concerned about recession, for which it’s presently unprepared. It usually takes five percentage points of rate cuts to pull the U.S. out of a recession. During its hiking cycle that ended last December, the Fed was trying to get rates closer to 5% so they could cut them as much as needed in a new recession. But, they failed.

Interest rates only topped out at 2.5%. The market reaction and a slowing economy caused the Fed to reverse course and engage in easing. That was good for markets, but terrible in terms of getting ready for the next recession.

The Fed also reduced its balance sheet from $4.5 trillion to $3.8 trillion, but that’s still well above the $800 billion level that existed before QE1 (“QE-lite” has since taken the balance sheet up above $4 trillion, but the Fed has done its best to downplay it).

In short, the Fed (and other central banks) only partly normalized and are far from being able to cure a new recession or panic if one were to arise tomorrow.

The Fed is therefore trapped in a conundrum that it can’t escape. It needs to rate hikes to prepare for recession, but lower rates to avoid recession. It’s obviously chosen the latter option.

If a recession hit now, the Fed would cut rates by another 1.50% to 1.75% in stages, but then they would be at the zero bound and out of bullets.

Beyond that, the Fed’s only tools are negative rates, more QE, a higher inflation target, or forward guidance guaranteeing no rate hikes without further notice.

Of course, negative nominal interest rates have never worked where they’ve been tried. They only fuel asset bubbles, not economic growth. There’s no reason to believe they’ll work next time.

But the central banks really have no other tools to choose from. When your only tool is a hammer, every problem looks like a nail.

Now’s the time to stock up on gold and other hard assets to protect your wealth.

Regards,

Jim Rickards
for The Daily Reckoning

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