The Coming Gold Breakout

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I read headlines all day and focus extensively, if not exclusively, on gold. If gold is the best form of money (it is), and if gold had unique properties as money (it does; it’s the only form of money that is not also debt), then gold is well worth the focus.

With that said, it’s hard to surprise me on the subject. After a while, you think you’ve seen it all. Yet, there are exceptions. This headline stopped me in my tracks: “Bank of Russia may consider gold-backed cryptocurrency.”

The idea itself is not exactly new. I first suggested that Russia might be acquiring gold with a view to a new gold-backed currency at a financial war game hosted by the Pentagon at a top-secret laboratory in 2009.

Jim Rickards

Your correspondent at the Homestake Mine in Lead, South Dakota. Homestake was one of the largest and most productive gold mines in U.S. history, and was the foundation of the Hearst family fortune. Global gold output has flatlined in recent years while demand for gold remains strong.

In my upcoming book, Aftermath, I describe a more sophisticated monetary arrangement among Russia, China, Iran and other nations to use a gold-backed cryptocurrency for international settlements.

Still, theory is one thing, reality is another. Here was a real central bank taking real steps toward a gold-backed cryptocurrency. Of course, the announcement came with lots of caveats about the need to stick to hard currencies. This gold initiative involves review of a report, not a live plan at this stage.

Still, it was a significant moment in the move away from the hegemony of the U.S. dollar as the dominant global reserve currency toward another system that included gold.

By itself, this announcement is not a reason to load up on gold. In fact, the spot price of gold barely budged on the news. Gold prices are far more likely to be affected by strength or weakness of the U.S. dollar, real interest rates, inflation prospects and geopolitical stress.

But, the announcement is highly significant in another way. It signals that the demand for physical gold by major central banks is here to stay. Whether a new gold-backed cryptocurrency emerges next year or five years from now does not alter the fact that you need gold to have a gold-backed currency.

Neither Russia nor China has all the gold it needs for that purpose yet. Therefore, demand for physical gold will remain strong even as supply has flatlined.

This creates an asymmetric trading pattern where gold has good potential to rise, but only limited prospects of a material fall. Those are the best kinds of markets for trading and investment. Taking into account both these fundamental and technical factors, what is the outlook for the dollar price of gold and gold mining stocks in the near term?

Right now, the evidence is telling us that the dollar price of gold is poised to breakout to the upside after a prolonged period of range-bound trading.

Chart 1 below illustrates recent price action in gold and shows why the prospects are good for near-term price appreciation.

After a rally from $1,215 per ounce in late November 2018 to $1,293 per ounce in early January 2019, gold remained in a tight trading range.

Over the past five months, gold has traded between about $1,270 and $1,345 per ounce (as of yesterday after gold’s big run over the past week).

That’s a range of about 2.8% above and below a mid-point of $1,305 per ounce. A 2.8% range is not unusual when governments try to peg two currencies to each other. In effect, gold has been pegged to the dollar at $1,305 per ounce.

Chart 1

Chart 1

However, this trading range exhibits another pattern called “lower highs.” Each spike at the high end of the range is slightly lower than the one before. Conversely, the bottom in each gyration has been more tightly bunched forming a kind of floor under gold prices.

The combination of a strong floor and declining highs results in a compression of the trading range. What this pattern presages is a breakout. Of course, the question is whether gold will breakout to the downside or the upside. This week we saw gold break higher, to $1,345.

The evidence is strong that gold is poised for a sustained upside breakout. The reason for the floor around $1,270 per ounce has to do with fundamental supply and demand. Russia and China continue to buy gold at a prodigious rate.

Russia has been buying between 15 and 25 metric tonnes per month, sometimes more, for over ten years. Russia’s gold reserves now stand at 2,183 metric tonnes, over 25% of the U.S. total with a far smaller economy. China is less transparent in its gold buying but also has over 2,000 metric tonnes, perhaps much more.

Neither Russia nor China have their targeted amount of gold yet, which would be 4,000 metric tonnes for Russia and 8,000 metric tonnes for China to achieve strategic gold parity with the U.S.

Iran and Turkey have also embarked on major gold accumulation efforts.

What all of these gold buying strategies have in common is a desire to escape from dollar hegemony and the imposition of dollar-based sanctions by the U.S. The practical implication for gold investors is a firm floor under gold prices since Russia and China can be relied upon to buy any dips.

The primary factor that has been keeping a lid on gold prices is the strong dollar. The dollar itself has been propped up by the Fed’s policy of raising interest rates and reducing money supply, so-called “quantitative tightening” or QT. These tight money policies have amplified disinflationary trends and pushed the Fed further away from its 2% inflation goal.

However, the Fed reversed course on rate hikes last December and has announced it will end QT next September. These actions will make gold more attractive to dollar investors and lead to a dollar devaluation when measured in gold.

The price of gold in euros, yen and yuan could go even higher since the ECB, Bank of Japan and People’s Bank of China will still be trying to devalue against the dollar as part of the ongoing currency wars. The only way all major currencies can devalue at the same time is against gold, since they cannot simultaneously devalue against each other.

A situation in which there is a solid floor on the dollar price of gold and a need to devalue the dollar means only one thing – higher dollar prices for gold. A breakout to the upside is the next move for gold.


Jim Rickards
for The Daily Reckoning

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Investors Are Falling Into a False Sense of Security Again

This post Investors Are Falling Into a False Sense of Security Again appeared first on Daily Reckoning.

In January 2018, two significant market events occurred nearly simultaneously. Major U.S. stock market indexes peaked and volatility indexes extended one of their longest streaks of low volatility in history. Investors were happy, complacency ruled the day and all was right with the world.

Then markets were turned upside down in a matter of days. Major stock market indexes fell over 11%, a technical correction, from Feb. 2–8, 2018, just five trading days. The CBOE Volatility Index, commonly known as the “VIX,” surged from 14.51 to 49.21 in an even shorter period from Feb. 2–6.

The last time the VIX has been at those levels was late August 2015 in the aftermath of the Chinese shock devaluation of the yuan when U.S. stocks also fell 11% in two weeks.

Investors were suddenly frightened and there was nowhere to hide from the storm.

Analysts blamed a monthly employment report released by the Labor Department on Feb. 2 for the debacle. The report showed that wage gains were accelerating. This led investors to increase the odds that the Federal Reserve would raise rates in March, June and September (they did) to fend off inflation that might arise from the wage gains.

The rising interest rates were said to be bad for stocks because of rising corporate interest expense and because fixed-income instruments compete with stocks for investor dollars.

Wall Street loves a good story, and the “rising wages” story seemed to fit the facts and explain that downturn. Yet the story was mostly nonsense.

The fact is that stocks and volatility had both reached extreme levels and were already primed for sudden reversals. The specific catalyst almost doesn’t matter. What matters is the array of traders, all leaning over one side of the boat, suddenly running to the other side of the boat before the vessel capsizes.

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.

Markets are once again primed for this kind of spontaneous crowd reaction. After coming to within a fraction of an official bear market in December, the Fed capitulated to markets by pausing on rate hikes and ending QT far ahead of schedule.

Financial conditions eased dramatically. The markets rallied hard, and the stock market turned in its best first quarter in 20 years. The S&P and Nasdaq stormed back to record highs this week, while the Dow is only about 1% away from its own previous record.

Meanwhile, CNNMoney’s Fear and Greed Index has gone from “greed” to “extreme greed” within the span of a week. Good times are here again and investors are getting complacent again, just like last year.

But there are just as many if not more catalysts for a sharp market selloff.

Despite today’s surprising GDP report, which is likely an outlier that doesn’t mean much, there are signs the economy is slowing down.

In March, for example, the yield curve inverted. The yield on the 10-year Treasury note fell below the rate on the three-month note. Thats happened prior to each of the past seven recessions.

That doesn’t mean a recession is imminent; it could still be another year or more away. But it is an ominous sign.

Meanwhile, a recent report revealed a record seven million Americans are now at least 90 days behind in their car loan payments. There is also a student loan crisis unfolding.

Total student loans today at $1.6 trillion are larger than the amount of junk mortgages in late 2007 of about $1.0 trillion. Default rates on student loans are already higher than mortgage default rates in 2007. This time the loan losses are falling not on the banks and hedge funds but on the Treasury itself because of government guarantees.

Not only are student loan defaults soaring, but household debt has hit another all-time high. Student loans and household debt are just the tip of the debt iceberg that also includes junk bonds corporate debt and even sovereign debt, all at or near record highs around the world.

But it’s not just the U.S.

Other signs are appearing on the horizon also as the global economy is slowing down. Europe and Asia are showing marked declines.

China’s problems are well-known. And while the causes may vary, growth in all of the major economies in the EU and the U.K. is either slowing or has already turned negative. The world is discovering the limits of debt-fueled growth.

According to the Institute of International Finance (IIF), it required a record $8 trillion of freshly created debt to create just $1.3 trillion of global GDP. The trend is clear. The massive debts intended to achieve growth are piling on every day. Meanwhile, many of the debts taken on since 2009 are still on the books.

The U.S. debt-to-GDP ratio is now 106%, the highest since the end of the Second World War. The Chinese debt-to-GDP ratio is a more reasonable 48%, but that figure is misleading because it does not include the debts and guarantees of provinces, state-owned enterprises, banks, wealth management products and numerous other entities that the government in Beijing is directly or indirectly obligated to support.

When that additional debt is taken into account, the real debt-to-GDP ratio is over 250%, about the same as Japan’s.

Debt-to-GDP ratios below 60% are considered sustainable; ratios between 60% and 90% are considered unsustainable and need to be reversed; and ratios in excess of 90% are in the red zone and will produce negative growth along with default through nonpayment, inflation or other forms of debt repudiation.

The fact is, the world’s three largest economies — the U.S., China and Japan — are all now deep in the red zone.

What is striking is the speed with which synchronized global growth has turned to synchronized slowing. Indications are that this slowing is far from over. While growth can create a positive feedback loop, slowing can do the same.

Warnings of economic collapse are no longer confined to the fringes of economic analysis but are now coming from major financial institutions and prominent economists, academics and wealth managers. Leading financial elites have been warning of coming collapses and dangers.

These warnings range from the IMF’s Christine Lagarde, Bridgewater’s Ray Dalio, the Bank for International Settlements (known as the “central banker’s central bank”), Paul Tudor Jones and many other highly regarded sources.

We have had major stock market crashes or global liquidity crises in 1987, 1994, 1998, 2000 and 2008.

That’s five major drawdowns in 31 years, or an average of about once every six years. The last such event was 10 years ago. So the world is overdue for another crisis based on market history.

The trouble is, most investors will never see it coming.

Smart investors can profit from this with a combination of long-volatility strategies, safe-haven assets, gold and cash.


Jim Rickards
for The Daily Reckoning

The post Investors Are Falling Into a False Sense of Security Again appeared first on Daily Reckoning.

GDP: Fake News

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The first-quarter GDP number was released this morning. And at 3.2%, it came in far above estimates. Consensus was about 2.3%. It was also the highest Q1 GDP print since 2015.

But there’s probably less here than meets the eye.

About half the GDP gain came from a surge in inventories and a sharp reduction in the trade deficit, neither of which is sustainable. They are likely one-time boosts.

The economy has been growing since June 2009, making this the second-longest economic expansion on record. However, it has also been the weakest economic expansion on record. That has not changed under President Trump.

Even during Obama’s weak expansion we saw strong quarters including the first quarter of 2015, which was 3.2%, and the second quarter of 2015, which was almost 3%. The problem is that these strong quarters soon faded; growth in the fourth quarter of 2015 was only 0.5%, almost recession level.

Under Trump, second-quarter 2018 growth was a very impressive 4.2% annualized. Third-quarter 2018 growth was 3.4%. Trump’s tax cuts seemed to be producing exactly the kind of 3–4% sustained trend growth Trump had promised.

But then the economy put on the brakes and growth slowed to only 2.2% in the fourth quarter. It looked like the 2018 “Trump bump” in growth was over and growth was returning to the 2.2% trend that had prevailed during the Obama administration.

And despite the first quarter’s 3.2% outlier, I expect lower GDP in the quarters ahead, returning to the same punk levels we’ve seen for nine years.

For the year, economists believe GDP will expand 2.4%, down from last year’s 2.9% gain, as the boost from the 2017 tax cuts and increased government spending over the past two years start to fade.

What about the possibility of recession?

Most investors are familiar with the conventional definition of an economic recession. It’s defined as two consecutive quarters of declining GDP combined with rising unemployment and a few other technical factors.

But investors may not be as familiar with two other aspects of recession timing. The first is the exact body that makes the determination, and the second has to do with the timing of that body’s announcements.

The group that “officially” decides when the U.S. economy is in a recession is called the National Bureau of Economic Research (NBER) based in Cambridge, Massachusetts, although there’s nothing official about what they do.

NBER is a private nonprofit think tank that receives substantial input from scholars at Harvard and MIT, but it is not a government agency. Their decisions on the start and finish of recessions are not technically “official,” but they are widely accepted by Washington, the Fed and Wall Street.

Less well known is the fact that recessions are not called by NBER until well after they have begun. In this respect, NBER looks backward at the data rather than forward like a forecasting firm.

On occasion, the NBER might not identify the start date of a recession until nine months or a year after the recession began. By that method, the U.S. could be in a recession next month and we would not know about it until a year from now when the data were all in.

The Fed may be on pause, but previous Fed action has been catching up with the economy. Monetary policy operates with a lag of six–18 months, so the slowing of the economy we saw in the fourth quarter of 2018 was the result of Fed tightening in late 2017 and early 2018.

Don’t be surprised if we wake up a year from now only to find the NBER says the recession began in April or May of 2019.

The Fed move to a rate pause in January 2019 and the end of QT in September 2019 will not be felt in the real economy until late 2019 and early 2020.

The timing has serious implications for next November’s presidential election. If the economy improves ahead of the election, Trump has an excellent chance. If it falls into recession, the Democratic candidate will probably win, whoever it is.

In that case, get ready for class warfare, much higher taxes and even more government spending than today.

Got gold?


Jim Rickards
for The Daily Reckoning

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The Coming Economic Winter

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To everything there is a season, Ecclesiastes tells us…

Is the economy entering winter?

In spring the thrusting saplings of tomorrow shoulder their way out of the earth.

Buds form upon the trees. The days lengthen with the late-afternoon shadows.

It is the season of possibility.

Summer is nature in full flower. It is green. And lush. It is the promise of spring come to fruition.

The days are long, they are radiant… and they are carefree.

In autumn the first wrinkles of age appear. The trees go gray. And they begin losing their hair.

The first frosts arrive a foretaste of days to come.

Then comes winter. Snow. Ice. Dark. Desolation. It is the season of death.

It can be said economies follow a similar cycle of the seasons. They sprout, blossom, fade… and die.

The Daily Reckoning’s Charles Hugh Smith has argued winter may be closing in…

Charles says the world is marked by “souring social mood, loss of purchasing power, stagnating wages, rising inequality, devaluing currencies, rising debt, political polarization and elite disunity.”

“These are all characteristics,” Charles laments, “of the long-wave social-economic cycle that is entering the disintegrative (winter) phase.”

Charles leans on the work of historian Peter Turchin.

Turchin explores historical cycles of social disintegration and integration over 50-, 150- and 200-year cycles in his book Ages of Discord.

He identifies three primary forces driving these cycles:

An oversupply of labor that suppresses real wages… an overproduction of parasitic elites… a deterioration in state finances (Charles explores these in greater detail below).

These cycles are as natural as the seasons… and maybe as inevitable.

Turning to America…

Real American wages have been essentially flat for decades. Evidence suggests the bottom half of American adults earn no more than they did in the 1970s.

An overproduction of parasitic elites? We append no comment.

A deterioration in state finances? The Treasury groans under a $22 trillion national debt that is growing… daily.

Meantime, unfunded liabilities such as Social Security and Medicare currently exceed $50 trillion by some estimates.

$50 trillion liabilities cannot be met. They can only be repudiated in one form or another.

It is fashionable in some quarters to compare the present United States to ancient Rome.

The comparisons are often overwrought. Often but maybe not always.

Rome had its spring. It had its summer, its fall… and then its winter.

That seasons glided one into the next so easily hardly anyone noticed.

From The Empire of Debt, co-written by our founders Addison Wiggin and Bill Bonner:

In Rome, the institutions evolved and degraded faster than people’s ideas about them. Romans remembered their Old Republic with its rules and customs. They still thought that was the way the system was supposed to work long after a new system of consuetude fraudium — habitual cheating — had taken hold…

As time went on, the empire came to resemble less and less the Old Republic that gave it birth. The old virtues were replaced with new vices.   

We cannot help but think of these United States as we reflect upon these lines.

Our nation shows many of the same telltales, in ways large and small.

But we are cynical by nature. And a man sees what he expects to see. Perhaps the best days are to come.

We cannot truly identify America’s present season. Our vision simply does not extend the required distance.

But we have our jacket and gloves ready… just in case.


Brian Maher
for The Daily Reckoning

The post The Coming Economic Winter appeared first on Daily Reckoning.

China Snared in “Middle-income Trap”

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A large number of China analysts are concluding that growth in China is slower than the official government reports. In fact, growth is even worse than the pessimists imagine.

The statistics on Chinese GDP growth for the fourth quarter of 2018 and the full-year have been widely reported. Quarterly growth was 6.4% (annualized), the lowest ever reported. Full-year growth for 2018 was 6.6%, the lowest since 1990.

Those weak figures have to be adjusted downward to take account of consistent cheating by China in terms of accurate reporting of data. Private surveys show even lower annual growth, about 5.7%, compared with the official figures of 6.6%.

But that’s not the end of the downward adjustments. Both the official Chinese growth figures and the private surveys show investment is about 45% of total Chinese growth. About half of Chinese investment is pure waste in the form of white elephant infrastructure that is unneeded and cannot pay for itself and ghost cities that will never be occupied or used before they are obsolete.

These infrastructure projects do provide hundreds of thousands of jobs and billions of dollars spent on cement and excavation, along with steel and glass, but they produce no value. If China’s reports were subject to customary accounting standards, that “investment” would be written down to zero.

This write-down puts actual Chinese growth closer to 4.2%. Considering the exponential growth in debt needed to support these investments, China is best viewed as an inverted pyramid of massive debt supported by modest growth; this is a recipe for a debt panic and financial collapse.

As dire as these numbers may be, there’s no surprise in them. China is behaving like almost every emerging-market economy, albeit with more debt. Only naive Wall Street analysts and cheating Chinese Communist officials would extrapolate the former high-growth figures into the future. Expert development economists know better.

Multilateral agencies such as the IMF and the Organisation for Economic Co-operation and Development (OECD) divide economies into “low income,” “middle income” and “high income.” The dividing lines are measured in annual per capita income denominated in U.S. dollars. Low income is zero to $7,000 per year. Middle income is $7,000–17,000 per year. High income is above $17,000 per year.

China today is about $8,800 per person; near the center of the middle-income category. For comparison, the U.S. figure is about $60,000 per person and Switzerland is about $80,000 per person.

As late as the 1960s and 1970s, development economists believed that the most difficult economic task for poor countries was to move from low-income to middle-income. From there, it was believed that the path to high-income would be direct and self-sustaining. It turns out these assumptions were incorrect.

Moving from low-income to middle-income is actually straightforward. It’s just a matter of reducing corruption, providing for a reasonable rule of law and facilitating migration from the countryside to cities.

From there, simple assembly-type jobs will be plentiful with the help of domestic savings and foreign capital. The path to middle-income status follows directly.

The truly difficult task in development economics is moving from middle-income to high-income. For this transition, more is needed than simple low-cost manufacturing. The economy must employ high technology and create more high-value-added products.

This is difficult because of the resources needed to obtain the high technology in the first place and the expense and time needed to train a workforce to utilize the technology. This is why companies such as Apple guard their technology so carefully and why countries like China work so hard to steal the technology.

The only countries since the Second World War to make the transition from middle-income to high-income are South Korea, Taiwan, Japan and Singapore. The rest of Asia, South America and Africa (if they are not low-income) are stuck in what’s called “the middle-income trap.”

In short, it’s easy to grow at 10% per year (China’s growth rate just a few years ago) when millions are flocking from the countryside to the cities and low-value factory jobs are plentiful.

It’s not easy to grow above 4% when the migration stops, the factory job growth stagnates and a trade war begins. China is moving quickly to the 4% growth plateau, a not-unusual result in emerging markets.

China has no clear path out of the middle-income trap despite their well-honed ability to steal Western technology. Technology theft is being made more difficult by Trump’s confrontation with China over trade.

China’s problems will not be going away anytime soon.


Jim Rickards
for The Daily Reckoning

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You’ve Been Bamboozled

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“From time immemorial proverbial wisdom has taught the virtues of saving,” wrote Henry Hazlitt, “and warned against the consequences of prodigality and waste.”

Hazlitt authored his masterly primer on economics, Economics in One Lesson, in 1946.

Yet he etched it in the rock of ages with its insights timeless.

“But there have always been squanderers, and there have apparently always been theorists to rationalize their squandering.”

Today these theorists invade us, batter us and torture us ceaselessly… like a thousand alarm clocks joined in hellacious chorus.

Yesterday we alerted you to the latest assault upon savings — negative interest rates.

During economic stress, negative interest rates would crack open the piggy bank… and spill its contents into the productive economy.

This is the way to recovery, say its drummers. And savings are in the way.

But today we leap to savings’ defense. We illustrate why savings are a blessing at all times, in all seasons…

The Virtue of Savings

Saving is a passable evil in normal times, modern economists allow.

But in dark times saving locks needed capital out of the productive economy.

Investment, meantime, answers a higher calling. It is publicly minded. It pitches in… and expands the economy.

The central bank must therefore suppress savings to increase spending… and investment.

Negative interest rates, they claim, are one solution.

But there can be no investment without savings, say the old economists… as there can be no bread without grain.

Explained the late economist Murray Rothbard:

Savings and investment are indissolubly linked. It is impossible to encourage one and discourage the other. Aside from bank credit, investments can come from no other source than savings… In order to invest resources in the future, he must first restrict his consumption and save funds. This restricting is his savings, and so saving and investment are always equivalent. The two terms may be used almost interchangeably.

The more accumulated savings in the economy… the more potential investment.

An economy built atop a sturdy foundation of savings is a rugged economy, a durable economy.

No passing gale will knock it over.

Consider for example the frugal farmer…

He has deferred present gratification… and stored up a full silo of grain.

There it sits, seemingly idle.

But this silo contains a vast reservoir of capital…

The farmer can afford to sell part of his surplus.

With the proceeds he can purchase more efficient farm equipment, which increases his yield.

His purchase gives employment to producers of farm equipment and those further along the production chain.

Or he can invest in additional land to expand his empire. The added land yields further grain production.

This in turn extends Earth’s bounty in wider and wider circles — and at lower cost, no less.

That is, his capital stock expands and the world benefits.

Only his original surplus allows it.

But he retains a healthful portion of his siloed grain against the uncertain future.

There is next year’s crop to consider.

If it fails, if the next year is lean, it does not clean him out. He has plenty laid by.

And so his previous willingness to save has paid him a handsome dividend.

He can then proceed to rebuild his capital from a somewhat diminished base.

We will call this man Farmer X. Contrast him with Farmer Y…

The Perils of Living Only for Today

This man has rather extravagant tastes for a farmer. And he likes to parade his wealth before his fellows.

He squanders his surplus on costly vacations, restaurants, autos, etc.

It is true, his patronage keeps local businesses in funds.

But his grain silo is perpetually empty.

That is, his capital stocks are perpetually empty.

He has little savings. He therefore has little to invest.

He has deprived the future so that he may gratify the present… and taken food out of future mouths.

And should next year’s crop fail, Farmer Y is in an awful way.

Assume it does.

The surplus grain that could have sustained him he has dissipated. He has nothing left to see him through.

He is thrown into bankruptcy and must sell his farm at a fire sale.

If only he had saved.

Ah, but our tale takes an additional twist…

Let us now reintroduce Farmer X.

He purchases the wastrel’s farm — at a fire sale price — and transforms it into a vastly productive asset.

The world is that much richer… and happier.

All because of his original willingness to save.

Multiply this example by millions and it becomes clear…

A healthy economy requires a full silo of grain — of savings, that is.

An empty silo means no investment in the future. And society has nothing stored against to weather future crises… like an imprudent squirrel that has failed to save against approaching winter.

We must therefore conclude:

Negative interest rates and the war against savings are essentially wars upon the future.

Debunking the “Paradox of Thrift”

Returning to Hazlitt:

The artificial reduction of interest rates discourages normal thrift, saving and investment. It reduces the accumulation of capital. It slows down that increase in productivity, that “economic growth” that “progressives” profess to be so eager to promote.

The critic of savings will concede that saving may make individual sense.

But if everybody saved, he argues, consumption would wind to a halt.

The economy would sink deeper further and deeper further into the deeps, until finally imploding upon itself.

The “paradox of thrift,” they call it.

Explains arch-Keynesian Dr. Paul Krugman:

The story behind the paradox of thrift goes like this. Suppose a large group of people decides to save more. You might think that this would necessarily mean a rise in national savings. But if falling consumption causes the economy to fall into a recession, incomes will fall, and so will savings…

The government must therefore race in to supply the demand that individual savers will not.

Its role must be “the spender of last resort.”

But there is no paradox, say the old economists, with their starched collars, pursed lips… and straight laces.

What applies to the individual applies to society at large, they insist.

When society saves in lean times, it is not eliminating consumption — merely delaying it.

The demand that is supposedly lost is not lost at all. It is simply shifted toward the future.

Today’s savings are therefore tomorrow’s spending, tomorrow’s consumption.

Or to return to Hazlitt:

“‘Saving,’ in short, in the modern world, is only another form of spending.”

And by reducing consumption today, society allows wasting enterprises absorbing valuable resources to finally die the death.

It clears out the deadwood created by the previous boom, now artificially sustained.

Society’s deep pool of savings can then nourish the “thrusting saplings” of future growth — newer, better, more efficient industries.

These are tomorrow’s redwoods.

Low interest rates drain the pool of savings… and choke off nutrients from the emerging forest.

Negative interest rates double and triple the error.

Meantime, government spending to extend the boom simply keeps dying enterprises on respirator support. They become the living dead.

These are the errors that presently afflict and lacerate us all.

We Need to “De-bamboozle” Ourselves

But the crank, the charlatan, the quack, the pitch man, the rogue, the honest-to-goodness fraud… he will always be with us.

Author Hunter Lewis wrote a withering critique of Lord Keynes:

Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles and Busts.

He tells a tale in which British Prime Minister David Lloyd George “bamboozled” U.S. President Woodrow Wilson.

George then discovered “it was harder to de-bamboozle [Wilson] than it had been to bamboozle him.”

Concludes Lewis:

“This describes our predicament today. Keynes has bamboozled us and it is very difficult to de-bamboozle ourselves.”

Negative interest rates are your proof we are bamboozled yet…


Brian Maher
Managing editor, The Daily Reckoning

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Jerome Powell Better Get “Real”

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The stock market resumed today where it ended last week — with bears pressing the attack.

The Dow Jones broke below the 24,000 mark today for the first time since March.

It ended the day down 507 total points, to close at 23,593.

Percentage wise, both S&P and Nasdaq were hard on its heels.

We have it on official word:

Not since 1980 have the three major indexes turned in such a woeful December.

By July 1981 — incidentally — the economy was sunk in recession.

Is today’s stock market giving off a recession warning for summer 2019?

This is the question we tackle today…

Let us first sit down with the facts…

In 1980, as today, the Federal Reserve was hard at the business of raising interest rates.

Of course the economic and monetary dynamic was vastly different in 1980.

Annual inflation ran to a menacing 13.3% in 1979, the year new Federal Reserve chairman Paul Volcker came aboard.

By March 1980… inflation roared a mighty 14.7%.

So Volcker was battling to cage a tiger. And he had his whip and chair out…

Volcker drove the fed funds rate (the rate the Fed controls directly) to a tiger-taming 20% by late 1980.

In contrast — violent contrast — today’s inflation is as tame as a tabby.

Official inflation purrs at a domesticated 2% once monthly variations are ironed out.

And today’s fed funds rate squats at a lowly 2.25%.

There is simply no comparison between periods, you say.

Paul Volcker had a raging tiger on the loose. Jerome Powell has a kitten by the scruff.

And today’s interest rates are not within 100 miles of 1980’s.

But could it be that today’s interest rates are actually higher than 1980’s?

A lunatic question, you thunder, worthy of a bedlamite in an asylum.

Your objection is noted and entered into the record.

But we encourage you to get “real.”

The “real” interest rate is defined as the nominal interest rate minus the inflation rate.

Assume a nominal interest rate of 3%, for example.

Further assume that inflation runs to 1%.

In this instance we find the real rate is 2% (3 – 1 = 2).

Now consider the case before us…

Nominal interest rates averaged 13.35% in 1980.

Meantime, 1980 inflation averaged 13.5%.

Let us then apply fingers-and-toes mathematics to arrive at the real interest rate in 1980…

We take 1980’s average nominal interest rate (13.35%) and subtract the inflation rate (13.5%).

We then come to the arresting conclusion that 1980’s real interest rate was not 13.5%… but -0.15% (13.35 – 13.5 = -0.15).

Once again:

1980’s average nominal interest rate was 13.35%.

But its average real interest rate was -0.15%.

Now roll the reel forward to 2018…

Today’s nominal fed funds rate rises between 2% and 2.25%.

Meantime, official consumer price inflation (again, the distinction is necessary) runs in the vicinity of 2%.

To discover today’s real interest rate, we once again subtract the inflation rate from the nominal rate.

What do we find?

We find that today’s real interest rate ranges between 0% and 0.25%.

That is, despite today’s vastly lower nominal rate (13.35% versus 2.25%)… today’s real interest rate exceeds 1980’s -0.15%.

Shocking — but there you are.

We must then conclude that nominal interest rates lack all meaning absent the inflation rate.

There is a reason why it is called the real interest rate.

It penetrates numerical mists. It scatters statistical fogs.

It clarifies.

As explains Jim Rickards, “Real rates are what determine investment decisions.”

A 10-year Treasury bond yielding 7% might reel you in, for example.

But what if inflation averaged 8% over the same period?

Inflation would gobble your 7% yield — and a bit more into the bargain.

You would require a 9% yield just to paddle ahead of inflation.

Meantime, you may balk at a 10-year Treasury bond yielding 3%.

But if inflation runs at 2%… then your 3% Treasury yields you 1%.

A slender gain, yes. But you escape with your skin — and a slight surplus.

Your 3% 10-year Treasury, under these terms, infinitely bests a 7% Treasury if inflation is 8%.

Coming home, we must grapple with the fact that today’s real rate of interest exceeds 1980’s.

And rates will likely increase further when the Federal Reserve concludes its meeting on Wednesday.

Market odds of a rate hike presently rest at 76.6%.

Meantime, the stock market is turning in its worst December since 1980.

The economy was in recession by summer ’81.

Will today’s economy be in recession by summer 2019?

We do not pretend to know… but perhaps it’s time Jerome Powell got real.


Brian Maher
Managing editor, The Daily Reckoning

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