5,000 Years of Interest Rates, Part II

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Yesterday we hauled out evidence that interest rates have gone persistently down 500 years running.

And the high interest rates of the mid- to late 20th century?

These may be history’s true aberration, a violent but brief lurch in the chart… like a sudden burst of blood pressure.

Let us here reintroduce the graphic evidence:

IMG 1

Here is an extended picture of downward-trending rates — with the fabulous exception of the mid-to-late 20th century.

As Harvard economics professor Paul Schmelzing reckoned yesterday, as summarized by Willem H. Buiter in Project Syndicate:

Despite temporary stabilizations such as the periods 1550–1640, 1820–1850 or in fact 1950–1980… global… real rates have persistently trended downward over the past five centuries…

Can you therefore expect the downward journey of interest rates to proceed uninterrupted?

We have ransacked the historical data further still… rooted around for clues… and emerged with worrisome findings.

Why worrisome?

Details to follow. Let us first look in on another historical oddity, worrisome in its own way — the present stock market.

A Lull on Wall Street

It was an inconsequential day on Wall Street. The Dow Jones took a very slight slip, down nine points on the day.

The S&P scratched out a single-point gain; the Nasdaq gained 12 points today.

Gold and oil largely loafed, budging barely at all.

Meantime, humanity’s would-be saviors remained huddled at Davos. There they are setting the world to rights and deciding how we must live.

But let us resume our study of time… and money.

For light, we once again resort to the good Professor Schmelzing.

The arc of interest rates bends lower with time, he has established. But as he also establishes… no line bends true across five centuries of history.

Put aside the drastic mid-to-late 20th century reversal. Even the long downturning arc has its squiggles and twists, bent in the great forges of history.

To these we now turn…

“Real Rate Depression Cycles”

Over seven centuries, Schmelzing identifies nine “real rate depression cycles.”

These cycles feature a secular decline of real interest rates, followed by reversals — often sudden and violent reversals.

The first eight rate depression cycles tell fantastic tales…

They often pivoted upon high dramas like the Black Death of the mid-14th century… the Thirty Years’ War of the 17th century… and World War II.

IMG 2

The world is currently ensnared within history’s ninth rate depression cycle. This cycle began in the mid-1980s.

Schmelzing says one previous cycle comes closest to this, our own. That is the global “Long Depression” of the 1880s and ’90s.

This “Long Depression” witnessed “low productivity growth, deflationary price dynamics and the rise of global populism and protectionism.”

Need we draw the parallels to today?

It is here where our tale gathers pace… and acquires point.

A Thing of Historic Grandeur

Schmelzing’s research reveals this information:

This present cycle is a thing of historical grandeur, in both endurance and intensity.

Of the entire 700-year record… only one cycle had a greater endurance. That was in the 15th century.

And only one previous cycle — also from the same epoch — exceeded the current cycle’s intensity.

By almost any measure… today’s rate depression cycle is a thing for the ages.

Turn now to this chart. The steep downward slope on the right gives the flavor of its fevered intensity:

IMG 3

Schmelzing’s researches show the real rate for the entire 700-year history is 4.78%.

Meantime, the real rate for the past 200 years averages 2.6%.

Beware “Reversion to the Mean”

And so “relative to both historical benchmarks,” says this fellow, “the current market environment thus remains severely depressed.”

That is, real rates remain well beneath historical averages.

And if the term “reversion to the mean” has anything in it, the world is in for a hard jolt when the mean reverts. Why?

Because when rates do regain their bounce — history shows — they bounce high.

Schmelzing:

The evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable… Most reversals to “real rate stagnation” periods have been rapid, nonlinear and took place on average after 26 years.

Twenty-six years? The present rate depression cycle runs to 36 or 37 years. We must conclude it goes on loaned time. What happens when the loan comes due?:

Within 24 months after hitting their troughs in the rate depression cycle, rates gained on average 315 basis points [3.15%], with two reversals showing real rate appreciations of more than 600 basis points [6%] within two years.

The current rate depression cycle ranges far beyond average.

It is, after all, the second longest on record… and the second most intense.

If the magnitude of the bounceback approximates the magnitude of the cycle it ends… we can therefore expect a fantastic trampolining of rates.

That is, we can likely expect rate appreciations of 6% or more.

What Happens When Rates Rise?

The stock market and the decade-long economic “recovery” center upon ultra-low interest rates. And so we recoil, horrified, at the prospect of a “rapid, nonlinear” rate reversal.

We must next consider its impact on America’s ability to finance its hellacious debt…

A violent rate increase means debt service becomes an impossible burden.

How would America service its $23 trillion debt — a $23 trillion debt that jumps higher by the minute?

Debt service already represents the fastest-growing government expense.

Interest payments will total $460 billion this year, estimates the Congressional Budget Office (CBO).

CBO further projects debt service will scale $800 billion by decade’s end.

$800 billion exceeds today’s entire $738 billion defense budget. As it exceeds vastly present Medicare spending ($625 billion) and Medicaid spending ($412 billion).

CBO Doesn’t Account for Possible End to Rate Depression Cycle

But CBO pays no heed to the rate depression cycle. It — in fact — projects no substantial rate increases this decade.

But what if the present rate depression cycle closes… and interest rates go spiraling?

Debt service will likely swamp the entire federal budget.

Financial analyst Daniel Amerman:

If the interest rate on that debt were to rise by even 1%, the annual federal deficit rises by $200 billion. A 2% increase in interest rate levels would up the federal deficit by $400 billion, and if rates were 5% higher, the annual federal deficit rises by a full $1 trillion per year.

Recall, rates rocketed 6% or higher after two previous rate reversals.

Given the near-record intensity of the present rate depression cycle… should we not expect a similar rebound next time?

Hard logic dictates we should.

But what might bring down the curtain on the current cycle?

Unforeseen Catastrophe

Most previous rate depression cycles ended with death, destruction, howling, shrieking.

Examples, again, include the Black Plague, the Thirty Years War and World War II.

Perhaps a shock on their scale will close out the present cycle… for all that we know. Or perhaps some other cause entirely.

Of course, we can find no reason in law or equity why the second-longest, second-most intense rate depression cycle in history… cannot become the longest, most intense rate depression cycle in history.

The cycle could run years yet. Or it could end Friday morning.

The Lord only knows — and He is silent.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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5,000 Years of Interest Rates

This post 5,000 Years of Interest Rates appeared first on Daily Reckoning.

“At no point in the history of the world has the interest on money been so low as it is now.”

Here the good Sen. Henry M. Teller of Colorado hits it square.

For 10 years plus, the Federal Reserve has waged a nearly ceaseless warfare upon interest rates.

Savers have staggered under the onslaughts. But the timeless laws of economics will not be forever put to rout.

We suspect they will one day prevail, and mightily. Interest rates will then revert to historical averages.

When they do, today’s crushing debt loads will come down in a heap. They will fall directly on the heads of governments and businesses alike.

This fear haunts our days… and poisons our nights.

Wait… What?

Let us check the date on the senator’s declaration…

Kind heaven, can it be?

Our agents inform us Sen. Teller’s statement entered the congressional minutes on Jan. 12… 1895.

1895 — some 19 years before the Federal Reserve drew its first ghoulish breath!

Were the late 19th century’s interest rates the lowest in world history?

Here at The Daily Reckoning, we are entertained infinitely by the dazzling present.

Its five-minute fads, its 15-minute fames, its popinjay actors strutting vainly across temporary stages…

All amuse us vastly and grandly.

They amuse us, that is — but they do not fascinate us.

It is the long view that draws us in — the view of the soaring eagle high overhead, the view from the mountaintop.

So today we rise above the daily churn, canvass history’s broad sweep… and report strange findings.

Quite possibly scandalous findings. Scandalous?

That is, we will investigate the theory that falling interest rates the historical norm… rather than the exception.

And are central banks powerless to direct them?

The Lowest Rates in 5,000 Years

The chart below gives 5,000 years of interest rate history. It shows the justice in Sen. Teller’s argument.

Direct your attention to anno Domini 1895. Rates had never been lower. Not in all of recorded history:

IMG 1

Rates would sink lower only on two subsequent occasions — the dark, depressed days of the early 1930s — and the present day, dark and depressed in its own way.

The Arc of the Universe Bends Toward Low Interest Rates

Paul Schmelzing professes economics at Harvard. He is also a visiting scholar at the Bank of England. And he has conducted a strict inquiry into interest rates throughout history.

Many take the soaring interest rates of the later 20th century as their guide, he begins:

The discussion of longer-term trends in real rates is often confined to the second half of the 20th century, identifying the high inflation period of the 1970s and early 1980s as an inflection point triggering a multidecade fall in real rates. And indeed, in most economists’ eyes, considering interest rate dynamics over the 20th century horizon — or even over the last 150 years — the reversal during the last quarter of the 1900s at first appears decisive…

Here the good professor refers to “real rates.”

The real interest rate is the nominal rate minus inflation. Thus it penetrates the monetary illusion. It exposes inflation’s false tricks — and the frauds who put them out.

In one word… it clarifies.

And the chart reveals another capital fact…

The Long View

Revisit the chart above. Now take an eraser in hand. Run it across the violent lurch of the mid-to-late 20th century. You will then come upon this arresting discovery:

Long-term interest rates have trended downward five centuries running. It is this, the long view, that Schmelzing takes:

Despite temporary stabilizations such as the period between 1550–1640, 1820–1850 or in fact 1950–1980 global real rates have shown a persistent downward trend over the past five centuries…

This downward trend has persisted throughout the historical gold, silver, mixed bullion and fiat monetary regimes… and long preceded the emergence of modern central banks.

What is more, today’s low rates represent a mere “catch-up period” to historical trends:

This suggests that deeply entrenched trends are at work — the recent years are a mere “catch-up period”…

In this sense, the decline of real returns across a variety of different asset classes since the 1980s in fact represents merely a return to long-term historical trends. All of this suggests that the “secular stagnation” narrative, to the extent that it posits an aberration of longer-term dynamics over recent decades, appears fully misleading.

Is it true? Is the nearly vertical interest rate regime of the mid-to late 20th century a historical one-off… a chance peak rising sheer from an endless downslope?

What explains it?

Interest Rate Spikes, Explained

Galloping economic growth explains it, says analyst Lance Roberts of Real Inves‌tment Advice.

He argues that periods of sharply rising interest rates are history’s lovely exceptions.

Why lovely?

Interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time.

In this view, rates soared at the dawn of the 20th century. It was, after all, a time of rapid industrialization and dizzying technological advance.

Likewise, the massive post-World War II rate spike owes directly to the economic expansion then taking wing. Roberts:

There have been two previous periods in history that have had the necessary ingredients to support rising interest rates. The first was during the turn of the previous century as the country became more accessible via railroads and automobiles, production ramped up for World War I and America began the shift from an agricultural to industrial economy.

The second period occurred post-World War II as America became the “last man standing”… It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding the countries that they had just destroyed.

Let the record show that rates peaked in 1981. Let it further show that rates have declined steadily ever since.

And so we wonder…

Was the post-World War II period of dramatic and exceptional growth… itself the exception?

The Return to Normal

Let us widen our investigation by summoning additional observers. For example, New York Times senior economic correspondent Neil Irwin:

Investors have often talked about the global economy since the crisis as reflecting a “new normal” of slow growth and low inflation. But just maybe, we have really returned to the old normal.

More:

Very low rates have often persisted for decades upon decades, pretty much whenever inflation is quiescent, as it is now… The real aberration looks like the 7.3% average experienced in the United States from 1970–2007.

That is precisely the case Schmelzing argues.

Now consider the testimony of a certain Bryan Taylor. He is chief economist at Global Financial Data:

“We’re returning to normal, and it’s just taken time for people to realize that.”

Just so. We must nonetheless file a vigorous caveat…

A Pursuit of the Wind

Drawing true connections between historical eras can be a snare, a chasing after geese, a pursuit of the wind.

Success requires a sharpshooter’s eye… a surgeon’s hand… and an owl’s wisdom.

The aforesaid Schmelzing knew the risks before setting out. But he believes he has emerged from the maze, clutching the elusive grail of truth.

Today’s low rates are not the exceptions, he concludes in reminder. They represent a course correction, a return to the long, proper path.

How long will this downward trend continue, professor Schmelzing?

The Look Ahead

Whatever the precise dominant driver — simply extrapolating such long-term historical trends suggests that negative real rates will not just soon constitute a “new normal” — they will continue to fall constantly. By the late 2020s, global short-term real rates will have reached permanently negative territory. By the second half of this century, global long-term real rates will have followed…

But can the Federal Reserve throw its false weights upon the scales… and send rates tipping the other way?

With regards to policy, very low real rates can be expected to become a permanent and protracted monetary policy problem…

The long-term historical data suggests that, whatever the ultimate driver, or combination of drivers, the forces responsible have been indifferent to monetary or political regimes; they have kept exercising their pull on interest rate levels irrespective of the existence of central banks… or permanently higher public expenditures. They persisted in what amounted to early modern patrician plutocracies, as well as in modern democratic environments…

We have argued previously that central banks wield far less influence than commonly supposed. Here we are validated.

But we are unconvinced rates are headed inexorably and unerringly down.

Tomorrow, another possible lesson — a warning — from the book of interest rates.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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A World Gone Mad

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Today we gasp, stagger, reel.

The enormity of it all has finally overmatched our capacities. Consider…

Total global debt presently piles up to 322% of GDP — a record.

Total “developed world” debt piles higher yet — 383% of GDP — another record.

The world’s stock markets combine to $88 trillion, or 100% of global GDP. That is another record yet.

Record upon record upon record has come down… as debt has gone relentlessly up.

And what does the world have to show for the deluge?

Little Bang for the Buck

Real United States GDP growth gutters along under 2%. Fair estimates place European and Japanese 2020 growth under 1%.

Interest rates, meantime, are coming down. And so the supply of “dry powder” available to the central banks is coming down. They will require heaps of it come the next crisis.

Project Syndicate, in summary:

The major developed economies are not only flirting with overvalued financial markets and still relying on a failed monetary-policy strategy, but they are also lacking a growth cushion just when they may need it most.

Direct your attention now to the Bank of England. Specifically, to its balance sheet…

Where’s the Crisis?

As a percentage of GDP…

Not once in three centuries has this balance sheet swollen to today’s preposterous extreme…

Not when England was life and death with Napoleon, not when England was life and death with the kaiser, not when England was life and death with Hitler:

IMG 1

The Bank of England’s balance sheet — again, as a percentage of GDP — presently nears 30%.

It never cleared 20% even when England was absorbing obscene debts to put down Herr Hitler.

Where is today’s Napoleon? Where is today’s kaiser? Indeed… where is today’s Hitler?

Yet the balance sheet indicates England is battling the three at once. And on 1,000 fronts the world across.

We razz our English cousins only because the Bank of England is nearly the oldest central bank going (est.1694) and keeps exquisite records.

It therefore offers a detailed, three-century sketch of central banking’s shifting moods.

Our own Federal Reserve’s history stretches only to 1913. But its compressed history offers a parallel example…

Crisis-Level Balance Sheet

Its balance sheet expanded to perhaps 20% of GDP against the twin calamities of the Great Depression and Second World War.

It then came steadily, inexorably and appropriately down, decade after decade. Pre-financial crisis… that percentage dropped to a stunning 6%.

But then the great quake of ’08 rumbled on through… and shook the walls of Jericho to their very foundations.

The Federal Reserve got out its mason kits and set to patching the damage.

Patching the damage? It built the walls up higher than ever…

By 2014 quantitative easing and the rest of it swelled the balance sheet to 25% of GDP. That, recall, is five full percentage points above its 20th-century crisis peaks.

Mr. Powell’s subsequent quantitative tightening knocked down some of the recent construction.

The balance sheet — as a percentage of GDP — slipped beneath 20% by 2018.

But last year he pulled back the sledgehammers. Then, in September, the short-term money markets began giving out… and Powell rushed in with the supports.

The Fastest Expansion Ever

He has since expanded the balance sheet some $400 billion in a four-month span — over 10%. Not even the financial crisis saw such a violent expansion.

As we have presented before, the visual evidence:

IMG 2

The balance sheet presently nears $4.2 trillion, only slightly beneath its 2015 maximum.

Here then is irony…

“A Magnet for Trouble”

Observe the 2012–14 comments of Carlyle Group partner Jerome Powell — before he was Federal Reserve chairman Jerome Powell:

I have concerns about more purchases. As others have pointed out, the dealer community is now assuming close to a $4 trillion balance sheet and purchases through the first quarter of 2014. I admit that is a much stronger reaction than I anticipated, and I am uncomfortable with it for a couple of reasons.

First, the question, why stop at $4 trillion? The market in most cases will cheer us for doing more. It will never be enough for the market. Our models will always tell us that we are helping the economy, and I will probably always feel that those benefits are overestimated…. What is to stop us, other than much faster economic growth, which it is probably not in our power to produce?…

[W]hen it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response…

Continues the present chairman:

My [next] concern… is the problem of exiting from a near $4 trillion balance sheet… It just seems to me that we seem to be way too confident that exit can be managed smoothly. Markets can be much more dynamic than we appear to think…

I think we are actually at a point of encouraging risk-taking, and that should give us pause…

I kind of think that a large balance sheet might prove to be a magnet for trouble over time… So I tentatively land on a floor system with the smallest possible balance sheet…

“Why stop at $4 trillion?”… “It will never be enough for the market”… “faster economic growth, which it is probably not in our power to produce”… “a large balance sheet might prove to be a magnet for trouble over time”… “I tentatively land on a floor system with the smallest possible balance sheet”…

Again — here is irony.

What Happened to Powell?

Where a fellow stands often depends upon where he sits. And this particular fellow sits in the chairman’s seat at the Federal Reserve.

The Federal Reserve has a certain institutional… perspective.

And so he leans whichever way it slants.

Our co-founder Bill Bonner puts it this way:

“People come to believe whatever they must believe when they must believe it.”

What does Mr. Powell’s 2012–14 self, the conscience tapping naggingly on his shoulder, tell him?

That no enormity is ever enough for the market? Something about a magnet for trouble? A preference for the smallest possible balance sheet perhaps?

But Jerome Powell has come to believe what he must… when he needed to believe it.

We shudder at what he will come to believe come the crisis — or whatever his successor will come to believe.

Meantime, the world runs to record debt, its stock markets run to record highs…

And we are about ready to run for the hills…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Now What?

This post Now What? appeared first on Daily Reckoning.

Stocks were up and away this morning, aloft on happy wings. And as stocks went up… records came down.

Both the Dow Jones and S&P established fresh highs today.

Today is — after all — when the United States and China stowed their differences… and came formally to terms.

President Trump and Chinese Vice Premier Liu He signed their names to a “phase one” trade accord late this morning.

What precisely did they pledge? AP draws the overall sketch:

Under the Phase 1 agreement, which the two sides reached in mid-December, the administration dropped plans to impose tariffs on an additional $160 billion in Chinese imports. And it halved, to 7.5%, existing tariffs on $110 billion of goods from China.

For its part, Beijing agreed to significantly increase its purchases of U.S. products. According to the Trump administration, China is to buy $40 billion a year in U.S. farm products — an ambitious goal for a country that has never imported more than $26 billion a year in U.S. agricultural products.

Once the handshakes were over, the president seized a microphone and gushed:

Today we take a momentous step, one that has never been taken before with China, toward a future of fair and reciprocal trade with China. Together we are righting the wrongs of the past.

And so there is more joy in heaven this day. But will there be more joy on Earth the next?

We are not half so convinced. The wrongs of the past — if they be wrongs at all — may well remain wrong.

The warring parties have signed a truce, it is true. But truce is not peace.

Truce may be no more than a mere respite from arms, a temporary cessation of fire, a brief clearing of battlefield smoke.

Consider the terms of this truce…

It cuts in half tariffs on certain Chinese wares from 15% to 7.5%. Yet tariffs on some $360 billion of Chinese exports stand in place.

Perhaps two-thirds of Chinese goods remain under penalty. As do more than half of all United States shipments to China.

Today’s signing scarcely budges them.

Meantime, this phase one armistice leaves unaddressed China’s war aims, its peace terms, its strategic objectives.

Continues the AP wire:

The so-called Phase 1 pact does little to force China to make the major economic reforms — such as reducing unfair subsidies for its own companies — that the Trump administration sought when it started the trade war by imposing tariffs on Chinese imports in July 2018…

Most analysts say any meaningful resolution of the key U.S. allegation — that Beijing uses predatory tactics in its drive to supplant America’s technological supremacy — could require years of contentious talks. And skeptics say a satisfactory resolution may be next to impossible given China’s ambitions to become the global leader in such advanced technologies as driverless cars and artificial intelligence.

Adds The New York Times:

The deal also does not address cybersecurity or China’s tight controls over how companies handle data and cloud computing. China rejected American demands to include promises to refrain from hacking American firms in the text, insisting it was not a trade issue.

Affirms Eswar Prasad, who formerly directed the International Monetary Fund’s China desk:

“[The deal] hardly addresses in any substantive way the fundamental sources of trade and economic tensions between the two sides, which will continue to fester.”

And so the generals remain huddled over their charts… the cannons are still loaded… and the troops are ready to answer the bugle.

They only await orders from the commander in chief.

Ultimate peace — lasting peace — will therefore require a “phase two” treaty…

The president has vowed to tackle China’s multiple trade atrocities in phase two of negotiations.

That is why he has held most existing tariffs in place. These represent the stick end of the “carrot and stick” polarity.

He will wield them as clubs, forcing Chinese concessions in this crucial second phase.

But phase two must wait. The president has suggested — strongly — that negotiations may not proceed until this year’s election is decided.

Assume they do proceed…

Will Mr. Trump club China into submission? Will China throw down its arms… and come marching into camp?

Not if it means losing “face,” argues Jim Rickards:

Culturally, saving face may be more important to the Chinese. The Chinese are all about saving face and gaining face. That means they can walk away from a trade deal even if it damages them economically.

Meantime, the truce, the uneasy truce, enters force.

The Lord only knows if it holds…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Now What? appeared first on Daily Reckoning.

Now What?

This post Now What? appeared first on Daily Reckoning.

Stocks were up and away this morning, aloft on happy wings. And as stocks went up… records came down.

Both the Dow Jones and S&P established fresh highs today.

Today is — after all — when the United States and China stowed their differences… and came formally to terms.

President Trump and Chinese Vice Premier Liu He signed their names to a “phase one” trade accord late this morning.

What precisely did they pledge? AP draws the overall sketch:

Under the Phase 1 agreement, which the two sides reached in mid-December, the administration dropped plans to impose tariffs on an additional $160 billion in Chinese imports. And it halved, to 7.5%, existing tariffs on $110 billion of goods from China.

For its part, Beijing agreed to significantly increase its purchases of U.S. products. According to the Trump administration, China is to buy $40 billion a year in U.S. farm products — an ambitious goal for a country that has never imported more than $26 billion a year in U.S. agricultural products.

Once the handshakes were over, the president seized a microphone and gushed:

Today we take a momentous step, one that has never been taken before with China, toward a future of fair and reciprocal trade with China. Together we are righting the wrongs of the past.

And so there is more joy in heaven this day. But will there be more joy on Earth the next?

We are not half so convinced. The wrongs of the past — if they be wrongs at all — may well remain wrong.

The warring parties have signed a truce, it is true. But truce is not peace.

Truce may be no more than a mere respite from arms, a temporary cessation of fire, a brief clearing of battlefield smoke.

Consider the terms of this truce…

It cuts in half tariffs on certain Chinese wares from 15% to 7.5%. Yet tariffs on some $360 billion of Chinese exports stand in place.

Perhaps two-thirds of Chinese goods remain under penalty. As do more than half of all United States shipments to China.

Today’s signing scarcely budges them.

Meantime, this phase one armistice leaves unaddressed China’s war aims, its peace terms, its strategic objectives.

Continues the AP wire:

The so-called Phase 1 pact does little to force China to make the major economic reforms — such as reducing unfair subsidies for its own companies — that the Trump administration sought when it started the trade war by imposing tariffs on Chinese imports in July 2018…

Most analysts say any meaningful resolution of the key U.S. allegation — that Beijing uses predatory tactics in its drive to supplant America’s technological supremacy — could require years of contentious talks. And skeptics say a satisfactory resolution may be next to impossible given China’s ambitions to become the global leader in such advanced technologies as driverless cars and artificial intelligence.

Adds The New York Times:

The deal also does not address cybersecurity or China’s tight controls over how companies handle data and cloud computing. China rejected American demands to include promises to refrain from hacking American firms in the text, insisting it was not a trade issue.

Affirms Eswar Prasad, who formerly directed the International Monetary Fund’s China desk:

“[The deal] hardly addresses in any substantive way the fundamental sources of trade and economic tensions between the two sides, which will continue to fester.”

And so the generals remain huddled over their charts… the cannons are still loaded… and the troops are ready to answer the bugle.

They only await orders from the commander in chief.

Ultimate peace — lasting peace — will therefore require a “phase two” treaty…

The president has vowed to tackle China’s multiple trade atrocities in phase two of negotiations.

That is why he has held most existing tariffs in place. These represent the stick end of the “carrot and stick” polarity.

He will wield them as clubs, forcing Chinese concessions in this crucial second phase.

But phase two must wait. The president has suggested — strongly — that negotiations may not proceed until this year’s election is decided.

Assume they do proceed…

Will Mr. Trump club China into submission? Will China throw down its arms… and come marching into camp?

Not if it means losing “face,” argues Jim Rickards:

Culturally, saving face may be more important to the Chinese. The Chinese are all about saving face and gaining face. That means they can walk away from a trade deal even if it damages them economically.

Meantime, the truce, the uneasy truce, enters force.

The Lord only knows if it holds…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Now What? appeared first on Daily Reckoning.

Central Banker Comes Clean

This post Central Banker Comes Clean appeared first on Daily Reckoning.

Reuters broadcasts the confession:

I do think the growth in the balance sheet is having some impact on the financial markets and on the valuation of risk assets…

Here we have the unassailable and unimpeachable testimony of one Robert Kaplan. He, Mr. Kaplan, presides over the Federal Reserve’s Dallas branch office.

And so a central bank grandee gives it straight… and stamps our dark suspicions with an official seal.

For this has been our claim:

The latest stock market fever owes not to trade, not to economics, not to “fundamentals.”

It owes rather to a delirious four-month expansion of the Federal Reserve’s balance sheet.

Irrefutable Evidence

Let us re-enter Exhibit A into evidence:

IMG 1

And Exhibit B:

IMG 2

This, as we have noted repeatedly, is a direct response to liquidity shortages in the short-term lending markets. In brief summary:

The Federal Reserve has expanded its balance sheet $400 billion these past four months — a $1.2 trillion annualized rate.

The same balance sheet presently rises near $4.2 trillion… a mere holler from its $4.5 trillion record.

As Goes the Balance Sheet, so Goes the Stock Market

Now let Exhibit C go into the record:

IMG 3

As revealed, the stock market pandemonium since October matches nearly perfectly the balance sheet engorgement.

The Dow Jones once again crossed 29,000 today, as it did briefly last week. As last week, it lost its purchase… and skidded back down.

It ended the day at 28,939.

But tomorrow promises a fresh assault upon the peaks.

Should we then be surprised that investor sentiment presently runs to extreme greed?

Extreme Greed

Behold CNN’s Fear & Greed Index:

IMG 4

This Fear & Greed Index presently reads a sinfully avaricious 90 — “extreme greed.”

What did it read one year ago today?

It read 30… verging on “extreme fear.”

But that was before the Federal Reserve furled back its sleeves, spat upon its hands… and set to work…

Before it began hacking interest rates, before it halted quantitative tightening — before it sent the balance sheet ballooning.

One year later the stock market rises to record highs and sentiment runs to extreme greed.

“The Bullish Sentiment We’re Getting Now Has Reached the Uncomfortable Stage”

Here at The Daily Reckoning, our distrust of crowds approximates our distrust of politicians, sellers of used autos… and statistics.

When the crowd goes herding into the same railcar, we instinctively jump tracks.

And the railcar is filling fast…

“The bullish sentiment we’re getting now has reached the uncomfortable stage,” affirms Jeff deGraaf, chairman of Renaissance Macro Research, adding:

“Some of the levels we’ve seen are, frankly, similar to what we saw in January of 2018.”

In reminder: The stock market “corrected” over 10% between Jan. 26 and Feb. 8, 2018.

We believe it is preparing to correct again. But not until the market uncorrects further yet…

“Peak Bullishness and Dovishness”

Tomorrow the president puts his signature to the “phase one” trade accord with China.

The United States will cancel scheduled tariffs on Chinese wares… and China will agree to purchase additional American bounty.

The computer algorithms will pluck the joyful news from the wires. They will proceed to pummel the “buy” button.

Thus you can expect CNN’s Fear & Greed Index to lurch even further into greed.

Meantime, the Federal Reserve huddles at Washington in two weeks.

It will not lower rates — but nor will it raise them up. Federal funds futures presently give 87.3% odds that rates remain in place.

Conditions will remain accordingly benign. And markets can continue their journey into the record books, unruffled and undisturbed.

That is why Bank of America warns markets presently careen toward “peak bullishness and dovishness.”

What lies the other side of these lofty and treacherous peaks?

We hazard the stock market will correct in February, once across. We suspect it will correct on the same general scale as 2018.

Let us now turn our attention to the great bugaboo of today’s market, the skunk lurking in this growing woodpile…

Too Many Eggs in Too Few Baskets

Merely five stocks — Apple, Microsoft, Alphabet (Google’s parent company), Amazon and Facebook — presently constitute 18% of the S&P’s total market capitalization.

As Morgan Stanley reminds us, that is the highest percentage in history.

“A ratio like this is unprecedented, including during the tech bubble,” says Mike Wilson, who directs Morgan Stanley’s U.S. equity strategy.

These stocks account for much of the S&P’s 2019 outperformance. Apple and Microsoft accounted for nearly 15% of all S&P gains.

Rarely before, we conclude, have so many investors… owed so much… to so few stocks.

But what if these wagon-pullers crack under the strain — and throw off the burden of leadership?

CNBC:

These mega tech firms have been the front-runners in this record-long bull market as investors bet on superior growth and dominant market share in their respective industries. They were the biggest contributors to the market’s historic gains last year and the trend shows no signs of stopping in 2020. However, multiple Wall Street strategists are sounding alarms on the increasing dominance of Big Tech, warning of a potential pullback in the stocks ahead.

Will anyone carry the standard forward should the leaders falter?

No, suggests Goldman Sachs:

“Narrow bull markets eventually lead to large drawdowns.”

The Tide Rises, Until It Doesn’t

Next we come to the strategy of “passive investing.”

Passive, because it rises or falls with the prevailing tide.

After the 2008 near-collapse, the Federal Reserve inundated markets with oceans of liquidity.

The tide rose, and all boats with it.

Technology stocks like Apple and Microsoft have led the way up.

Much of Wall Street has poured into these stocks… sat back on its oars… and rode the current to record highs.

The biblical-level flooding flattened existing financial signposts. “Fundamentals” no longer mattered.

“Active” asset managers fishing for winners could no longer separate them from the losers. The nets came up full of winners and losers alike.

All is peace while the tide of liquidity rises. But the danger is this, as we have written before:

When the tide recedes… it recedes.

Panic Selling Begets Panic Selling

The same handful of stocks that hauled markets up on an incoming tide can drag them rapidly down on an outgoing tide.

Panic selling begins. And panic selling begets panic selling — which begets panic selling.

Explains Jim Rickards:

In a bull market, the effect is to amplify the upside as indexers pile into hot stocks like Google and Apple. But a small sell-off can turn into a stampede as passive investors head for the exits all at once without regard to the fundamentals of a particular stock…

The technical name for this kind of spontaneous crowd behavior is hypersynchronicity, but it’s just as helpful to think of it as a herd of wildebeest that suddenly stampede as one at the first scent of an approaching lion. The last one to run is mostly likely to be eaten alive.

Meantime, the Federal Reserve’s balance sheet continues to expand, the fools continue to rush in…

And the gods continue to plot.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Central Banker Comes Clean appeared first on Daily Reckoning.

Daily Reckoning 2020-01-09 17:55:42

This post appeared first on Daily Reckoning.

Dear Reader,

“Journalism is about covering important stories,” said one scalawag. “With a pillow.”

A staggering bailout of the banking system presently proceeds apace.

The mainstream financial press has seized a bed pillow, placed it over this important story… and pressed down murderously.

Today we pry away the pillow… and vent in desperately needed oxygen.

Here we refer to the Federal Reserve’s ongoing support of the “repo” market.

Precisely how large is this bailout? Might it exceed the entire Wall Street bailout of 2007–10?

Answers, elusive answers, anon.

What Is the Repo Market Again?

Here again is a brief sketch of the repo market:

Financial institutions borrow or lend money in the overnight money markets as need dictates.

This short-term borrowing and lending activity takes the form of “repos”… or repurchase agreements.

If a firm wishes to borrow monies, it goes before the “repo” market with an open hat.

It holds up high-grade securities such as Treasury bonds as collateral.

Another financial institution accepts the collateral. It then agrees to loan the overnight money.

The next day the borrower “repurchases” the collateral it originally put up… and returns the borrowed money (with some slight interest into the bargain).

Hence the term “repo.”

The repo market oils the gears of the financial system. Should the lubricant run dry, this system would suddenly and violently seize.

Yet the repo market goes nearly entirely unnoticed. It quietly and routinely hums beneath the thundering din of the stock market.

Explains one Alexander Saeedy in Fortune:

One of the most vital pieces of plumbing that powers the global financial system usually runs so smoothly that it gets overlooked by market watchers. It’s the “repo market”…

“The repo market is at the center of the U.S. financial system but it is little understood even by most people working in finance,” adds another observer, John Carney by name.

How Can It Be Coincidence?

The stock market has gone on a gorgeous spree since the second week of October.

The primary media lavishes credit upon a trade war truce. Some lovely economic data, recently rolled in, have livened the pace.

Yet we are deeply suspicious of the account. Come pull up to the facts…

In September repo market liquidity began to evaporate. The Federal Reserve’s New York branch rushed in with emergency hoses

Come next to this capital fact:

On Oct. 11 the Federal Reserve announced plans to purchase $60 billion of Treasury bills monthly.

And mirabile dictu… the stock market was immediately up and away.

In brief, the stock market rampaged only after the Federal Reserve commenced “QE lite.” Or as some wags have labeled it, QE4.

In all… the Federal Reserve has expanded its balance sheet $400 billion these past four months — a $1.2 trillion annualized rate.

The Federal Reserve shrieks in protest, denying it is QE of any sort, shape, form.

But the balance sheet argues it is.

An Ocean of Liquidity

The grand scale of the operation flabbergasts, staggers, astounds.

Put it against recent history, for example. Look first to 1999…

The Fed laid in $120 billion to support the repo market before “Y2K” — to prepare for the worst.

It likewise backstopped this market after Sept. 11, 2001… and during the Great Financial Crisis.

But these operations are minnows besides today’s whale.

The Federal Reserve is currently carrying on at such a gait… it shames all previous examples. Behold:

An Ocean of Liquidity

Now this question:

Will today’s repo bailout exceed even the supercolossal Wall Street bailout of the Great Financial Crisis?

A $29 Trillion Bailout

Wall Street on Parade sets the backdrop:

During the 20072010 financial collapse on Wall Street the worst financial crisis since the Great Depression the Fed funneled a total of $29 trillion in cumulative loans to Wall Street banks, their trading houses and their foreign derivative counterparties between December 2007 and July 21, 2010.

Last Friday — while the media were fabulously distracted — the Federal Reserve quietly released the minutes to its December meeting…

What did these minutes reveal? Wall Street on Parade:

The Fed’s minutes… acknowledge that its most recent actions have tallied up to “roughly $215 billion per day” flowing to trading houses on Wall Street. There were 29 business days between the last Federal Open Market Committee (FOMC) meeting and the latest Fed minutes, meaning that approximately $6.23 trillion in cumulative loans to Wall Street’s trading houses had been made in that short span of time.

For emphasis: The Federal Reserve has extended $6.23 trillion of loans in 29 days. That is equal to $215 billion per day.

If the business goes on at the present rate… the repo bailout will exceed $29 trillion by June.

That is, it will exceed the scale of the 2007–10 Wall Street bailout by June — if you can believe it.

Can you?

The Deafening Silence

Will it go along at existing rates? Perhaps not. But the Federal Reserve will hold up the repo market through April — by its own admission.

We bet high it will extend beyond April. Beyond June. Beyond August. Beyond October.

Come the end, whenever it is…

We conclude the present operation will ultimately outsize even the great bailouts of the financial crisis.

Yet in the primary press… all is silence.

One question nonetheless hovers in the air: What happens when the Federal Reserve eventually yanks the crutches — and the market is left to stand alone?

We have located a clue. Glance backward to 1999–2000, to “Y2K”…

A Parallel Example

As noted, the Federal Reserve was bracing the repo market in event the world’s computers lost track of time.

From October 1999–April 2000, it emptied in some $120 billion to prepare.

How did the stock market initially take it?

Analyst Jim Bianco of the eponymous Bianco Research:

The Nasdaq went on a tear rarely seen in American finance, starting literally the day the Fed opened its Y2K lending facility.

In reminder, the major averages began going amok in October — precisely when the Federal Reserve announced it would begin monthly Treasury bill purchases:

The Fed announced it would start buying T-bills on Oct. 11, 2019. Stocks have gone [on] a tear since… 9% of the stock market’s gains [this year] came after Oct. 11, when the Fed announced its T-bill purchase problem. So a big part of this year’s nearly 30% stock market gain has come on the heels of Fed moves, much like last year’s 20% decline was coincident with the Fed’s hawkish rhetoric.

Return now to 2000. That April the Federal Reserve announced a halt to the business… and walked away.

Did the Nasdaq stand up, Mr. Bianco?

It crashed 25% the week the facility closed (April 7–14, 2000).

That is our example, nearly a perfect parallel to today. We expect a similar trouncing when the Federal Reserve withdraws present support.

And recall — today’s operation vastly outdoes 1999’s. It may therefore come down with a correspondingly greater thud.

A Tiger by the Tail

And so Jerome Powell has a tiger by the tail…

He can let it go now, and allow the thing to maul the repo market. It would likely proceed against the stock market next.

Or Mr. Powell can hold on until the repo market can stand up alone.

But the stock market bubble may inflate to dimensions truly obscene if he does hold on.

And how could he let go then?

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post appeared first on Daily Reckoning.

The Case Against Economists

This post The Case Against Economists appeared first on Daily Reckoning.

Dear Reader,

Whenever despair slumps our shoulders and the sorrows of the world gnaw our liver… we can rely on CNBC to bring us up:

“Latest Data Show the Economy Ended 2019 on a Strong Note, Putting Recession Fears to Bed.”

Thus we are caressed, soothed, cheered, lifted.

And mortified.

When fear goes to bed… we vault instantly up from our own, hemorrhaging icy sweat.

That is because danger is highest when the guard is lowest — when fear dozes and snoozes.

A Jinx?

CNBC continues in the same lovely, terrifying vein:

The fourth-quarter growth scare is a thing of the past, as the U.S. economy looks set to close the books on 2019 with a solid rise.

Manufacturing and trade reports Tuesday confirmed that GDP is on pace to rise more than 2% for the period.  An Atlanta Fed gauge estimates the gain at 2.3%, better than the 2.1% in the third quarter and enough to close out the year with [an] average quarterly gain of about 2.4%.

While that would mark a slowdown from the 2.9% increase in 2018, it would still be indicative that the decade-old expansion is alive and well and prepped to continue into 2020.

Just so. But we might remind the joymongers that recession is nearly always an invisible menace.

It often comes in on tiptoe… like a noiseless thief in the night.

The Shockingly Short Route From Expansion to Recession

As we have written before:

Periods of jogging, even galloping, growth may immediately precede recession.

We invite you again to consult the following dates. Each reveals the real economic expansion rate — the economic growth rate adjusted for inflation — immediately before recession’s onset:

  • September 1957:     3.07%
  • May 1960:                2.06%
  • January 1970:          0.32%
  • December 1973:      4.02%
  • January 1980:          1.42%
  • July 1981:                4.33%
  • July 1990:                1.73%
  • March 2001:             2.31%
  • December 2007:      1.97%.

(Again we acknowledge Lance Roberts of Real Invest‍ment Advice for the data).

No Indication of Recession “Anywhere in Sight”

Review the figures. You are immediately seized by this strange and remarkable fact:

Recession has followed hard upon jumping growth of 3.07%, 4.02%… and 4.33%.

“At those points in history,” Roberts reminds us, “there was NO indication of a recession ‘anywhere in sight.’”

Let the record further reflect:

Growth ran 2% or higher immediately prior to five of nine recessions listed.

Third-quarter 2019 GDP came ringing in at 2.1%. And the Federal Reserve projects Q4 2019 will turn in 2.3% growth when the tally comes in Jan. 30.

What was GDP before the last recession — the Great Recession?

It was 1.97% — a workable approximation of the rate presently obtaining.

“Very, very few recessions have been predicted nine months or a year in advance,” affirms economist Prakash Loungani.

Adds George Washington University economist Tara Sinclair:

“There’s no economic data or research or analysis that suggests we can look 12 months into the future and predict recessions with any confidence.”

The facts are with them…

A Failure Rate Second to Few

The world has endured 469 downturns since 1988. How many did the IMF see coming?

Four.

This we have on authority of one Andrew Brigden, chief economist at Fathom Consulting.

But perhaps IMF economists are uniquely blinded and botched. Their private-sector brethren may enjoy superior vision. Private-sector economists are, after all, closer to the field of action.

But the record indicates private-sector economists are equally sightless, equally unable to penetrate the fog of data that surrounds them.

Between 1992 and 2014… 153 combined recessions came to 63 countries the world over.

How many recessions did private-sector economists spot coming — as a whole?

Five.

What is more, these bunglers generally undershoot recession’s severity.

Do we condemn the erring and wayward vision of professional economists, their phantom vision?

No. We question their value, certainly. But we do not condemn them.

“A Bedlam of Unpredictability”

The economy is a bedlam of unpredictability, an infinitely complex Rube Goldberg contraption — a chaos of billiard balls in endless and delirious collision.

Try to keep track of it…

A cue ball goes careening into a rack. A six ball lights out in one direction. A nine ball strikes out in a second, a four ball in a third…

A three ball goes knocking into an 11 ball, a two ball into a seven ball, a one ball into a 14 ball, a five ball into a 12 ball, a 13 ball into an eight ball, a 10 ball into a 15 ball…

Each in turn shoots in a random direction. Each then runs into another previously sent on its own indeterminate course.

Another dizzying chain reaction begins… with its own set of imponderables.

Into which pocket will each ball drop ultimately?

The answer is not only difficult to determine at the outset. It is impossible to determine at the outset.

The number of variables is endlessly boggling.

And so the economic outcome is impossible to determine too far out. And for the same exact reason.

As well hazard the winner of the 2096 presidential election… the number of angels that can fit on a pinhead… or the precise number of rocks in a senator’s skull.

Besides, we are in no position to mock the faulty psychic eyesight of economists…

A Prediction, Horribly Failed

That is because our own crystal gazing gives a consistently false image. For instance:

Roll back the calendar — to last Jan. 3.

The stock market had just come within one whisker of correction, defined as a 20% stagger.

We believed the curtain was coming down at last. We divined the Dow Jones would close 2019 at roughly 18,000… and the S&P near 2,000.

But we underestimated the Federal Reserve’s ferocious response and the vast pull of its magnetism.

Jerome Powell went into his trick bag. And our apocalypse went into oblivion…

The Dow Jones concluded the year above 28,500; the S&P above 3,200.

This year we tempted fate further yet. That is, we came out flat-footed with a prediction of the future, 10 years out.

We claimed the S&P will end this newly hatched decade between 1,500 and 2,300.

Today it floats at 3,265.

We claimed additionally the Dow Jones will be similarly trounced percentage wise.

Bulls, take heart! You need only glance at our record if concerned.

But come back home…

Few respectable economists forecast recession this year — or a stock market calamity.

And look at their record…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post The Case Against Economists appeared first on Daily Reckoning.

Is War Next?

This post Is War Next? appeared first on Daily Reckoning.

Dear Reader,

Stocks ran red this morning… stained crimson by the blood of Iranian Gen. Qassim Soleimani.

A Reaper drone of the United States Air Force sent this hellcat over the rainbow early Friday.

The late departed was no second-rater, no minion. Explains Matthew Hoh of the Center for International Policy:

The equivalent of the killing of Gen. Soleimani would be as if the Iranians assassinated Gen. Richard Clarke, the U.S. four-star general in charge of all U.S. special operations, but only if Gen. Clarke had the name recognition of Colin Powell and the competency of Dwight Eisenhower.

And so fresh geopolitical anxieties have riled the markets.

The First Shot of World War III?

Iran’s No. 1 man Ayatollah Khamenei insists the “criminals” responsible will face “severe revenge.”

And a red flag ominously rises above the Jamkaran Mosque in Iran’s holiest city, Qom:

Building Iran 540px

Our agents, far more familiar with such matters, tell us this flag nearly always flies blue.

But in ancient Iranian tradition — we are told — blue switches red when an enemy perpetrates a murder.

It stays red until the murder is repaid in identical coin, avenged.

Iranian state television has demanded the head of President Donald Trump. Whoever presents it is to collect an $80 million jackpot.

Meantime, Soleimani’s replacement — a certain Esmail Qaani — pledges to push America out of the Middle East.

And so the warhawks circle overhead… and blood drips from the moon.

“The first shot of World War III has been fired,” shrieks forecaster Gerald Celente.

“The region (and possibly the world) will be the battlefield,” intones Council on Foreign Relations President Richard Haass, his face taut with urgency.

Is it true? Is war next?

Answer shortly. But our beat is money. Let us first take the historical view of Friday’s murder… and the monetary view.

British and American Imperial Weapons

As we have written before:

“The guinea and the gallows” were the true instruments of British imperial power.

The guinea represented the coined wealth of Great Britain.

The gallows represented its… constabulary zeal to put down and scotch irksome natives.

This is the 21st century of course — a time of enlightenment.

The British Empire is a distant and cobwebbed memory. As is the guinea. As are the gallows.

But their example lives on in the American Empire…

America’s imperial weapons are not the guinea and the gallows.

They are rather “the dollar and the drone.” They serve precisely identical functions.

Yes… the dollar and the drone are America’s nonhuman janissaries, its imperial enforcers.

Different, Yet Identical

Like the 19th-century pound (which replaced the guinea), today’s dollar is the world’s reserve currency.

Like the 19th-century pound, the dollar finances some two-thirds of global trade.

And the gallows?

Britain hanged its overseas nuisances. America disintegrates its own:

Baghdad Airport Attack

Here is civilization. Here is progress.

The sun eventually sank on the British Empire… the gallows came down… and the pound fell off its global perch.

The United States has its drones, as Mr. Soleimani’s ethereal form can presently attest.

But is America’s other weapon — the dollar — near to losing global reserve status?

The Global Counterattack Against the Dollar

The United States has employed its dollar to bludgeon its enemies. It is a weapon the president holds close.

As our colleague Dave Gonigam of The 5 Min. Forecast half-jestingly wonders:

“Is the Trump administration trying to kill off the U.S. dollar’s status as the globe’s reserve currency?”

And “for every action, there is an equal and opposite reaction,” says Jim Rickards:

The U.S. has been highly successful at pursuing financial warfare, including sanctions. But for every action, there is an equal and opposite reaction.

As the U.S. wields the dollar weapon more frequently, the rest of the world works harder to shun the dollar completely.

I’ve been warning for years about efforts of nations like Russia and China to escape what they call “dollar hegemony” and create a new financial system that does not depend on the dollar and helps them get out from under dollar-based economic sanctions.

The “Axis of Gold”

Jim reminds us that Russia and China — among others — are hoarding gold to break their dollar shackles.

Thus they are forming an “axis of gold”:

A major blind spot in U.S. strategic economic doctrine is the increasing use of physical gold by China, Russia, Iran, Turkey and others both to avoid the impact of U.S. sanctions and create an offensive counterweight to U.S. dominance of dollar payment systems.

This is the axis of gold.

This gold-based payments system will dilute and ultimately eliminate the impact of U.S. dollar-based sanctions.

Gold offers adversaries significant defenses against these dollar-based sanctions. Gold is physical, not digital, so it cannot be hacked or frozen. Gold is easy to transport by air to settle balance of payments or other transactions between nations.

Gold flows cannot be interdicted at SWIFT, the international payment system. Gold is fungible and untraceable (it is an element, atomic number 79), so its origin cannot be ascertained.

SWIFT (Society for Worldwide Interbank Financial Telecommunication) is a network that facilitates trillions of dollars in international money transfers each year.

It is the oil that lubricates the machinery of the international financial system — or as Jim styles it, “the oxygen supply that keeps the global financial system alive.”

Can we be surprised the Russias and Chinas and Turkeys and Irans of this world seek alternate sources?

The message, clear as a rifle shot on a still morning: The dollar’s days of “exorbitant privilege” are ending.

Slowly at First…

Of course… the dollar will not lose its throne tomorrow, next week, next year. But beware the trend, warns Jim:

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.

How does one go bankrupt?

Slowly at first, said Hemingway — then all at once.

That is how the dollar will likely lose its reserve status. Slowly at first… then all at once.

But to return to our central question:

Will the Soleimani murdering plunge the United States into war with Iran?

Will There Be War?

The war hawks circle menacingly, as noted.

But they will scatter. The doves of peace will chase them off…

The dueling parties will break a lance or two upon each other’s shields. But the swords stay in the sheaths.

Argues Jim:

The media are buzzing with stories about how Soleimani’s death will lead to a major war with Iran. The killing of Soleimani was a big deal and a clear win for the U.S. It’s true that Iran may well retaliate in some way, at least for the sake of its honor. But it’s unlikely to do anything that will invite a major U.S. response.

It will not turn into a full-scale war. Iran would lose and they know it. It will ratchet up the anti-American rhetoric for sure, but Iran does not have a lot of options.

They’ll fire a few missiles (we’ll fire back), shout threats and then that will be that. The real action will be in Iraq (will U.S. troops leave or not; I say no) and Israel (a target of opportunity and Iran’s real goal in the Middle East).

And so we conclude the hounds of war will stay on their leashes.

Do not forget: It is an election year…

Why Trump Doesn’t Want War

War with Iran — and its skyshooting oil prices — would send these fiendish canines tearing into the economy. And onto Wall Street.

Who requires an intact economy… and an intact stock market… for reelection?

That is correct.

The president will therefore keep the war dogs tethered tight — at least until the election passes.

But we depart with caution…

Nations can stumble into war… as easily as men can stumble into love.

The June 1914 assassination of Austrian Archduke Franz Ferdinand did not automatically fire off the guns of August. War was far from inevitable.

But blunders were made… and miscalculations. That is, human beings were at their normal follies.

And the guns roared for the next four years.

The dogs of war are willful creatures, ever hot to break free.

And this president is easily distracted.

If he isn’t watchful, they could just slip their leashes…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Is War Next? appeared first on Daily Reckoning.

REVEALED: The Trade of the Decade

This post REVEALED: The Trade of the Decade appeared first on Daily Reckoning.

Dear Reader,

Yesterday we snuck into the future… and smuggled out a worrisome vision:

The S&P will end the decade 50–60% lower than where it began the decade.

Our snooping revealed that “mean reversion” will run down the elusive stock market at last.

That is, the long arm of statistical law will finally collar its man.

Yet as we wondered yesterday: Can a “trade of the decade” lock in your wealth?

Can it be your Rock, your anchor against stock market catastrophe?

If so… what can it be?

Today we rip the wrapping paper off the trade of the decade.

But first, what other visions did our adventure into the future reveal?

Here is a brief sketch of the 2020s as we saw them, a tour of the horizon…

The Next Two Presidential Elections

President Trump will retain his throne this November.

The economy will gutter along before sinking into woeful recession in 2022 or early 2023.

The Federal Reserve will leap to action. Interest rates will go to zero — and yes, below zero.

Quantitative easing on the scale of the Marshall Plan you will see.

But all attempts will be vain.

The Federal Reserve will stand discredited, embarrassed, helpless.

In the 2024 presidential election, the American people will invite in a “progressive.”

He/she/hir, we could not identify the winner — the haze was thick, the picture grainy — will sign into law some version of Modern Monetary Theory (MMT).

It will differ vastly from the Federal Reserve’s quantitative easing. Quantitative easing was contained within the banking system. It largely prospered Wall Street… and largely bypassed Main Street.

The American people were left to scratch by on the leavings.

But MMT promises to pour money directly onto Main Street — and Maple Street and Oak Street and Pine Street and Birch Street.

Everything for Everyone

The print press will go into fantastic and ceaseless operation. It will promise to fan a roaring whirlwind of prosperity.

Off the presses will fly the wherewithal for Medicare for All, universal college education, guaranteed employment at $15/hour, a Green New Deal, etc.

It will give a good original impression. The economy will jump, thrill and excite… after dozing lo so many years.

And the authorities will finally have their 2% inflation, sustained.

MMT will receive a highly favorable press. What ogre, what misanthrope, what dastard could be against it?

But a paper prosperity is a false prosperity. It is the eternal quest to lunch for free… and the immemorial dream of cranks.

That world has no existence… at least not upon this Earth.

MMT will give an overall increase of the price level — but without a corresponding increase in goods, products and services.

The Stirrings of Inflation

After decades of muted (official) inflation, inflation’s initial gurglings and bubblings will catch the American people off their guard.

But after some hard experience, they will recalibrate their expectations. They will begin to hunker in against the expectation of rising prices.

A chance spark will light an inflationary brush fire. It will soon jump the perimeter. Before long it will spread like prairie fire… carried along by the gusting winds of sentiment.

And so MMT will ultimately kindle a fine inflationary blaze.

The authorities will be eager to get water on it. But they will discover it rages beyond all control.

Can it happen so fast? Yes, it can happen so fast.

Explains Jim Rickards:

MMT advocates also seem to think inflation can be dialed back or tweaked at will. Maybe they’ll say we’ll only spend $90 million on a Green New Deal instead of $97 trillion. They think they can dial it down. But they can’t. Once inflationary expectations set in, they take on a life of their own. It’s a nonlinear system.

It’s like moving the control rod in a nuclear reactor. If you get it wrong by just a little, you can melt the reactor down and kill a million people…

Inflation is not a linear phenomenon but a nonlinear phenomenon that can spiral out of control before you can do anything about it.

The fiscal authorities will truly have a tiger by the tail. But what can they do?

No Good Options

They can kink off the oxygen feeding the fire. That is, they can turn off the print press.

But a paper prosperity requires ever-increasing amounts of paper. Shutting down the press would murder it.

The late-lamented Paul Volcker put down inflation in 1981 by lifting interest rates to 20%. But the debt level then prevailing was a trifle — a pimple against today’s Matterhorn.

Today’s creaking, debt-addled economy may not withstand 5% rates… much less 20%.

But if authorities let the fire run, it may burn until nothing remains to burn.

What will they decide?

It is at this point — 2027 or 2028 — that our vision of the future turned to static.

And perhaps it is just as well, given the hell-mouth scene we report.

‘It Can’t Happen’

You may laugh the preceding out of court. The “experts” certainly will.

But did the experts foresee the 2001–02 dot-com smash-up? Did those same experts holler about a subprime mortgage crisis beforehand?

And how many would have told you this in 2007?

That negative interest rates would soon become reality… or that “quantitative easing” would soon become a household term?

Indeed… how many would have told you Mr. Donald J. Trump would one day be president?

Yet they came to be, all of them.

Do you wish to peer around the next bend? Do you wish to steal an unauthorized glimpse of the future?

Then you must range out ahead of the herd. You must venture out upon the thin, spindly branches, risking a fall. You must shoo away consensus.

And you may need to fall in with disreputable company. As our co-founder Bill Bonner recently reminded us:

To find the new truth, we have to go far out on the knowledge spectrum to the edgy part… the shady and speculative part… where the kooks, geniuses and gurus are.

Come we now to the “trade of the decade”…

The Candidates

Is the trade of the decade some promising, youthful technology company?

Is it a manufacturer of driverless autos, or artificial intelligence?

Is it a wager on China — or a wager against China?

Is bitcoin the trade of the decade — or a rival cryptocurrency?

None of these is the answer. Then what is the answer?

Colleague Byron King recently sat at a business meeting where Mr. Bonner was likewise sitting.

During the proceedings Byron cleared his throat, faced Mr. Bonner… and requested his trade of the decade:

“Well,” he said…

“When I look at what’s going on with the world, with the U.S. dollar, politics, everything…”

The room was silent. You could hear a pin drop. You could detect the vibe of grinding vertebrae as people strained their necks to pick up on Bill Bonner’s latest Trade of the Decade…

Mind you — gold was Mr. Bonner’s trade of the previous decade. It was also his trade of the decade prior.

Did gold satisfy its advertising?

“If you followed Bill Bonner’s Trade of the Decade for 2000–09,” Byron reminds us, “you more than tripled your money, in terms of dollars.”

Plenty handsome. But what about the decade just vacated?

“If you bought into Bill’s Trade of the Decade for 2010–19, you went from $1,100 to just over $1,500, or a 36% gain… admittedly with a ride.”

The Trade of the Decade

So what is Mr. Bonner’s trade of this freshly hatched decade? Has he found an alternative to gold?

In Mr. Bonner’s own words:

I’d have to say stick with gold. I can’t think of anything else that’s as well set up to hold value and deliver gains.

Thus you have your trade of the decade — gold — ancient, fusty, unresponsive, unglamorous gold.

Gold will provide you a potent antidote to the monetary toxins above described. And if the stock market is knocked flat this decade?

Gold should help keep you upright.

Thus we speak our piece for gold.

Might we report a faulty vision of the future?

It is entirely possible. Our eyes have failed us before.

If erring, we find solace in this one supreme fact:

We face no consequences for our botchwork.

On Jan. 3, 2030 — 10 years from today — no living soul will recall a single word we wrote this day.

But if proven correct, we will be certain to remind you…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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