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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Central Banker Comes Clean

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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

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“Last Hurrah” for Central Bankers

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

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

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

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

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

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

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

Here’s the actual record…

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

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

What about “forward guidance?”

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

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

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

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

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

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

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

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

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

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

Here’s what Summers said:

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

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

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

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

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

Regards,

Jim Rickards
for The Daily Reckoning

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Bigger Isn’t Better

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What caused the overnight lending market to unexpectedly seize up in September? There’s a good reason to believe JPMorgan Chase (JPMC) may have been at the heart of it.

JPMorgan Chase is the largest bank in the U. S., and has about $1.49 trillion in deposits. It’s one of the big banks that provide much of the loans in the overnight money markets.

But it seems the mega-bank had gone on a stock buyback spree from January through September of this year.

Buybacks, which are designed to boost stock prices, have been enabled for years by the Fed’s artificially low-interest rates. Corporations, in fact, have been the largest purchasers of stocks, which is heavily responsible for the bull market that’s now over a decade old.

According to the SEC, JPMC has spent about $77 billion on buybacks since 2013. But the money JPMorgan Chase used for buybacks on its most recent buyback binge was, therefore, unavailable to be loaned out in the repo market.

This information is from the bank’s annual SEC filing (hat tip to the Wall Street on Parade blog):

In 2019, cash provided resulted from higher deposits and securities loaned or sold under repurchase agreements, partially offset by net payments on long-term borrowing… cash was used for repurchases of common stock and cash dividends on common and preferred stock.

That diversion of money likely contributed to the liquidity crunch, which forced the Fed had to intervene in order to make up the difference.

Here’s how Wall Street on Parade sums it up:

Had JPMorgan Chase not spent $77 billion propping up its share price with stock buybacks, it would have $77 billion more in cash to loan to businesses and consumers — the actual job of its commercial bank. Add in the tens of billions of dollars that other mega banks on Wall Street have used to buy back their own stock and it’s clear why there is a liquidity crisis on Wall Street that is forcing the Federal Reserve to hurl hundreds of billions of dollars a week at the problem.

But altogether, JPMorgan has actually withdrawn $158 billion of its liquid reserves from the Fed in the first half of this year. That’s an extraordinarily large amount of money to withdraw in such a short amount of time, as my friends at Wall Street on Parade point out. That’s bound to have an effect on the market.

And that’s what we’ve seen.

Of course, JPM is one of those Wall Street banks that are “too big to fail.” It’s the largest commercial bank in the nation, with $1.6 trillion in deposits.

But it’s not just JPM.

It’s just one part of a system rigged in favor of Wall Street that has been deemed too big to fail. It’s a corrupt and incestuous system filled with perverse incentives and conflicts of interest. Here’s an example…

82% of bank analysts on Wall Street recently gave Citigroup stock a “buy” rating. What you didn’t hear reported on CNBC or Fox Business News is that the major banks they work for — like JPM, Goldman Sachs, Morgan Stanley, Deutsche Bank, UBS and Bank of America — have strong incentive to recommend Citigroup.

That’s because all the major banks are interconnected through derivatives. And weakness in one bank could spill over into the others. So it’s not a level playing field at all. It’s tilted in favor of the big banks.

But as one observer asks, “Why should any Wall Street bank be allowed to make research recommendations on stocks and then trade in those very same stocks?”

It’s a corrupt system designed by insiders for insiders. I should know because I used to be one of them.

I worked at four of the world’s major banks for a decade and a half until I finally had enough and walked away. Two of the four banks I worked for, Bear Stearns and Lehman Bros., were destined to implode.

That’s because they overleveraged themselves, taking on too much debt to bet on risky credit instruments. These credit instruments included subprime loans, credit derivatives and Wall Street’s version of a debt buffet called CDOs, or collateralized debt obligations.

It’s now been over a decade since the world’s major central banks reacted to the financial crisis with record-low interest rates and quantitative easing.

Today the big banks are bigger than ever and the amount of debt in the system is larger than ever. There’s been no substantial reform since the financial crisis, just some cosmetic moves that have been passed off as major reform. The big banks are always ahead of the regulators.

My research for my book Collusion: How Central Bankers Rigged the World revealed how central bankers and massive financial institutions have worked together to manipulate global markets for the past decade.

Major central banks gave themselves a blank check with which to resurrect problematic banks; purchase government, mortgage and corporate bonds; and in some cases — as in Japan and Switzerland — buy stocks, too.

They have not had to explain to the public where those funds are going or why. Instead, their policies have inflated asset bubbles while coddling private banks and corporations under the guise of helping the real economy.

The zero-interest rate and bond-buying central bank policies that prevailed in the U.S., Europe and Japan were part of a coordinated effort that has plastered over potential financial instability in the largest countries and in private banks.

It has, in turn, created asset bubbles that could explode into an even greater crisis the next time around.

The world’s debt pile sits near a record $246.5 trillion. That’s three times the size of global GDP. It means that for every dollar of growth, the world is borrowing three dollars.

Of course, this huge debt pile has done very little to support the real economy. Even the IMF now admits that global central bank policies to lower interest rates in order to stave off immediate economic risks have made the situation worse.

Their actions have led to “worrisome” levels of poor credit-quality debt as well as increased financial instability.

The IMF noted that 40% of all corporate debt in major economies could be “at risk” in the event of another global economic downturn, with debt levels greater than those of the 2008–09 financial crisis.

That huge pile of debt is basically the kindling for the next financial fire. We’re just waiting for the match to light it.

So today we stand near — how near we don’t yet know — the edge of a dangerous financial conflagration. The risks posed by the largest institutions still exist, only now they’re even bigger than they were in 2007–08 because of the extra debt.

It’s not sustainable. But that doesn’t mean the central banks won’t try to keep it going with monetary easing policies in place.

It could work for a while, until it doesn’t.

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Central Banks Pushing for Negative (Real) Interest Rates

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

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

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

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

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

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

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

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

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

The reason has to do with real interest rates.

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

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

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

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

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

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

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

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

The situation today is much closer to the latter example.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Regards,

Jim Rickards
for The Daily Reckoning

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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.

Regards,

Jim Rickards
for The Daily Reckoning

The post The Coming Gold Breakout appeared first on Daily Reckoning.

Central Banks Don’t Matter

This post Central Banks Don’t Matter appeared first on Daily Reckoning.

“There is no money in monetary policy.”

Could it be true? Is there no money in monetary policy?

Yesterday we argued the Federal Reserve cannot even define money… much less measure it to any reasonable satisfaction.

Today we venture upon a heresy deeper still — that central bank “monetary” policy has no actual existence.

No money stands beneath it, behind it, beside it.

The emperor is well and truly nude.

Who then actually controls monetary policy today?

The answer may very well lie hidden in the “shadows.”

The details — the shocking details — to follow.

Monetary Policy Is Actually About Credit and Debt

First moneyman par excellence Jeff Snider — author of today’s opening quotation — rams a sharp stake through the heart of the monetary myth:

Monetary policy has been quite intentionally stripped of money. Banks evolved and there was really no easy way to define money beyond a certain point (in the ’60s), so economists just gave up trying… 

Money as it relates to “monetary” policy is not really money at all. What monetary policy refers to in contemporary terms is something wholly different… When the Federal Reserve… act[s] on monetary measures, they seek not to increase the supply of money to the economy but rather the supply of credit… Monetary policy in the modern sense of the word actually has little to do with money. Instead, it is always and everywhere about credit and debt…

All money is debt-based money in today’s lunatic and preposterous world.

The dollar in your wallet you consider an asset. But only someone else’s previous debt fanned it into existence.

Technically it is a Federal Reserve note. A note is a debt instrument.

None of the foregoing will stagger or flabbergast Daily Reckoning readers.

Money is debt in today’s world. Debt represents a claim upon the future. The Federal Reserve is a vast engine of debt, a menace.

But this Snider fellow strays far beyond the normal run of grievances…

He commits perhaps the grandest heresy in the universes of economics and finance:

That the Federal Reserve and all central banks are largely powerless…

The Central Bank Is Not Central

They are merely men behind curtains… irrelevancies… and the emperor in fact wears no clothing.

Here Snider strips the emperor bare:

The Fed is, largely outside of temporary sentiment, irrelevant. The central bank is not central… The thing people have the most trouble with is the idea that central banks are not central. It flies in the face of everything you have been taught and told your whole life. The media still give these guys every benefit of every doubt, and central bankers (ab)use that privileged platform to perpetuate their myth. 

Central banks are not central? The Federal Reserve is irrelevant?

As well argue that gravity is a vicious fiction, that 2 and 2 is 9, that Washington never axed the cherry tree.

Snider further argues that the interest rate the Federal Reserve monkeys — the fed funds rate — is likewise an irrelevancy:

There is absolutely no legitimate reason why anyone should [notice federal funds.] The federal funds market is a nonentity… pocket change… It is the sparest of spare liquidity… Today, federal funds is nothing, an extraneous anachronism.

The Fed’s Target Audience: You 

Why then does the Federal Reserve target the fed funds rates?

Because it wants you to believe that it bosses the markets, that its false fireworks are real:

What was decided, essentially, was to keep federal funds as the primary monetary policy focus. The reason? You.

Monetary policy contains no money; it runs entirely on expectations. Therefore, according to this view, what ultimately matters is how you perceive monetary policy…

So the FOMC decided that for the public they would still use federal funds to signal to you their intentions… There is no money in monetary policy; it is entirely psychology.

What about quantitative easing? Was it not about “printing money”

QE accomplished next to nothing….QE’s real purpose was …in trying to manage expectations which central bankers were more than happy to let you believe this was all money printing… 

Then you might act in anticipating all that “money printing” was going to have stimulative and even sharp inflationary effects. You might then pull forward purchasing activity, or, if a business, hiring and production, before the expected higher costs arrived.

Blasphemy mounts upon blasphemy!

But if not the central banks… who or what is central?

Who, then, is running monetary policy?

The Shadow Banking System

You will find the answer in the shadows, says Snider — the shadow banking system.

The shadow banking system?

That is the deeply interconnected network of banking institutions that operate outside direct control of central banks.

They include the large banks and their offshore units.

This shadow banking system extends through Europe, the Caribbean and Asia, the world over.

In 2017, the Bank for International Settlements — the central bank of central banks —  estimated $13 trillion to $14 trillion dwell within the shadow system.

But this shadow banking system is invisible.

It hides in shadow, leaving only traces of its activity… as a thief leaves traces of his crime.

Only a properly trained sleuth can sniff them out:

No one can directly observe this global [shadow banking] system, what is actually the world’s reserve currency. First of all, it is primarily based offshore from everywhere, therefore outside of official recognition. There are no direct statistics. The term “shadow” is, in this case, perfectly appropriate.

The United States dollar is the coin of this realm.

The shadow system first took shape in the 1950s and ’60s after Bretton Woods placed the dollar at the center of the international monetary system.

It expanded through the 1980s, ’90s… into the early aughts.

And beneath notice, the shadow banking system shouldered the central banks out of the international monetary system. Snider:

“The global money system moved on without central banks bothering to notice.”

Did the Shadow Banking System Cause the Great Financial Crisis?

These shadow banks traded heavily in derivatives and other risky instruments. All without oversight.

Where do asset bubbles come from, asks Snider? “They came from the shadows” is his answer — including the U.S. housing bubble:

Especially from the 1960s forward, and particularly in the 1990s forward, was that as the [shadow banking system] replaced other forms of mediation in global trade. What actually happened was it became a parallel banking system unto itself… not so much that a company in Japan could import goods from Sweden. But so that the banks in Japan or Sweden or Switzerland or anywhere around the world could participate in this [shadow banking] system that at the time was stoking a U.S. housing bubble, while at the same time creating vast bubbles in emerging market[s]… 

So what we’re describing here is almost an entire massive complete system… that existed offshore and wholesale, in the shadows, because there was no regulatory authority… no government authority over the conduct of this system. It was essentially a self-contained system that operated beyond the reach of everybody.

To repeat:

Snider argues that the 2008 crisis was not merely a housing crisis. It was rather a crisis of the shadow banking system:

The Great Financial Crisis has been laid at the doorstep of subprime, a bunch of greedy Wall Street bankers insufficiently regulated to have not known any better.

That was just a symptom of the first. The housing bubble itself was more than housing. What was going on in the shadows wasn’t bounded by national borders or geography… The Great Financial Crisis was a [shadow banking] event, nothing less. 

Why hasn’t the global economy recovered from the Great Financial Crisis? Might the answer involve the shadow banking system?

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Expect the Buyback Wave to Continue This Year

This post Expect the Buyback Wave to Continue This Year appeared first on Daily Reckoning.

A crucial theme from last year is continuing into this year — stock buybacks. Last year was a banner year for companies buying back their own shares. A month into 2019, it appears that Wall Street is set to continue that trend.

Last year, U.S. companies announced a whopping $1.1 trillion worth of buyback plans. Armed with extra cash from favorable corporate tax policy enacted in 2017, they enthusiastically bought back their own shares.

But as of mid-December, only about $800 billion of those buybacks had actually occurred. That means there could be another $300 billion of the total 2018 target still waiting to hit the market.

In fact, Wall Street is already gearing up for another banner buyback year. In a recent report, J.P. Morgan strategist Dubravko Lakos-Bujas wrote, “It’s expected that S&P 500 companies will execute some $800 billion in buybacks… in 2019.”

The Wall Street strategist also explained that the quality of 2018 buybacks were high. He revealed that companies were using their cash, rather than borrowed money, to fund buybacks. Using cash toward buybacks is expensive less than using debt.

But why did the wave of buybacks slow down late last year?

The first reason is that companies involved had already purchased stock at a very rapid rate through last September. That was one major reason we saw the market peak around that time, and in fact, hit new records.

The second was that despite trade war fears and uncertainty, companies felt confident enough to go ahead with their buybacks initially. That’s why we saw market players largely shrug off warning signs through the first three quarters of 2018.

But sentiment shifted dramatically during the last quarter of the year, culminating in essentially a bear market by late December. And more reports around the world began to point to slowing economic growth ahead.

A key factor cited for this slowdown was the impact of prolonged trade wars, which could curb real economic activity and create more uncertainty. In turn, growing volatility would keep businesses from planning expansions, or using the cash originally set aside for buybacks.

A third reason for the drop off in buybacks late last year was a record amount of public corporate and consumer debt that had to be repaid or at least serviced regularly. This overhang of debt was weighing on growth expectations. That debt load would become even more expensive if the Fed kept up with its forecasted rate hike activity in December and throughout 2019.

Some analysts even warned that the Fed might go ahead with another four rate hikes this year. That triggered fears on Wall Street that the central bank stimulus game could truly be over.

The reason for the concern is simple: The higher the interest rates, the more expensive it is to borrow and repay existing debt. For more highly leveraged corporations and emerging market countries, this would be an even greater threat. A higher dollar, resulting from more Fed tightening, could cause other currencies to depreciate against the dollar. That would make it harder to repay debt taken out in dollars.

Finally, there was heightened tension in the financial markets due to political uncertainty. With U.S. election results ensuring added battles between Congress (with Democrats taking the majority in the House of Representatives) and the White House, doubt set in over the functionality of the U.S. government going forward.

Those reservations were justified. The government shutdown that kicked off 2019 had a lot to do with shifts in the political balance in Washington.

Geopolitical tensions also rose at the end of 2018, including Brexit in the United Kingdom, street revolts in France, potential recession fears in Italy and growing unrest in South America.

All these factors combined ensured that markets were extremely volatile during the last quarter of 2018, and why it was the worst one for the markets since the Great Depression. It was not conducive to buybacks. Buybacks are supposed to raise the stock price. But strong market headwinds could have largely canceled their effects.

The prudent approach for companies facing such a negative environment was to wait out the problems until the new year.

But Jerome Powell subsequently gave into Wall Street and took a much more dovish position on both rate hikes and balance sheet reductions. That means the coast is clear again to resume the buybacks.

Back in December, some major players announced plans for 2019 buybacks. These include Boeing, which announced an $18 billion repurchase program. It also includes tech giant Facebook, which plans to buy back $9 billion of its own shares, in addition to an existing $15 billion share repurchase program started in 2017.

Also in on the buyback wave is Johnson & Johnson, which announced a $5 billion stock buyback. Others include Lowe’s and Pfizer, which both announced a $10 billion stock buyback program.

These plans are now much more likely to go forward.

Furthermore, many large corporations like Microsoft, Procter & Gamble, Home Depot and Walmart didn’t even announce buybacks in 2018.

They could well announce them for 2019. Companies that did announce big buybacks last year, like Apple, could also engage in more, adding a potential $100 billion share repurchases this year to match 2018.

Another indicator for a sizeable 2019 buyback wave is that stock prices are lower now than they were going into the fourth quarter of 2018. That means companies can buy back their shares at cheaper prices. They could buy at a discount, in other words, or at least what they hope will be a discount.

My old Wall Street firm, Goldman Sachs, has already forecast $940 billion worth of buybacks for 2019. They previously had predicted over a trillion dollars’ worth of buybacks for 2018. The number of buybacks for 2018 even exceeded their predictions.

By mid-January, of the S&P 500 companies that reported their fourth-quarter earnings, nearly 70% of them have exceeded Wall Street’s profit expectations. It’s a favorable environment for buybacks.

Yet, it may still take some time for companies to move forward with this year’s buybacks. That’s because we are still in the “black-out” period that the Securities and Exchange Commission (SEC) has created.

The period covers the time just before and after companies post earnings results. The sell-off in October coincided with the third quarter earnings season’s “blackout period.” The combination of negative environmental factors plus fewer buybacks drove markets even lower.

Now, once earnings season and the current blackout period is over, Wall Street will be unleashed to buy large blocks of stock for their major corporate clients.

If the Federal Reserve truly holds back on its former interest rate and quantitative tightening plans, as it seems likely to do, expect central bank stimulus to continue to fuel markets.

Of course, buybacks do not come without negative implications. That’s because companies are not using their cash for expansion or to pay workers more, which would generate more buying power in the overall economy. But in the short run at least, they tend to raise the stock price.

Even if Wall Street comes up against headwinds of volatility, slowing economic growth, political strife and trade wars, they can now expect the Fed and other central banks to have their backs.

Buybacks could become a very powerful force once again this year, and keep the ball rolling a while longer.

Regards,

Nomi Prins

The post Expect the Buyback Wave to Continue This Year appeared first on Daily Reckoning.