The Fed Isn’t a Magic Money Tree

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There seems to be no end to the Federal Reserve’s arrogance. Fed officials believe that through their wise actions, they can eliminate the business cycle, lower unemployment and make society prosperous.

But it’s actually much more limited in what it can do.

All the Fed can reliably do is stop bank runs and limit liquidity panics. It can also fund (or “monetize”) the U.S. federal deficit, as it has done in recent months.

By buying essentially the same amount of U.S. Treasury securities the government has issued, the Fed has taken pressure to fund mammoth federal deficits off of the private sector.

But such actions are not cost-free.

They store up trouble for the future. These actions swell the Fed’s balance sheet, which will limit the Fed’s flexibility and its willingness to tighten policy during the next inflation spike.

The more the Fed intervenes, the harder it is for it to reverse course without causing damage.

By promising the public that it can do anything more than offer dollar liquidity, the Fed is setting up both investors and workers for disappointment.

Yet it’s going to try anyway. And it’ll only undermine its limited reputational capital in the process.

“Yield Curve Control”

The Wall Street Journal recently reported that the Fed is considering implementing “yield curve control” in the Treasury market. This policy hasn’t been used since WWII and the early postwar period.

It essentially funded the war effort. If unleashed today, it wouldn’t be done to support a civilization-saving war effort but to maintain the debt-saturated economy to which we’ve become accustomed.

Here’s how it would work in practice:

The Fed would set a target range, or cap, on yields for Treasury bonds of a specific maturity — say, 3-, 5- or 7-year Treasuries.

It would defend this target by buying unlimited amounts of Treasuries at that yield — however many it took to bring the yield down to its target rate (remember, bond prices and yields move in opposite directions. Buying bonds lowers their yield).

If adopted, the Fed would switch its QE policy from a fixed dollar amount (currently $120 billion per month) to an unknown amount that will depend on supply and demand in the Treasury market.

Yield curve control has been underway in Japan for the past few years. It has proven to not be effective at stimulating the economy, so there’s little reason to expect it would work here.

Here Comes Helicopter Money

We’ve had our fill of quantitative easing over the years, but it’s mostly inflated assets while doing little for overall economic growth.

The quantitative tightening, or QT, process that occurred from early 2018–mid-2019 slowly reversed that process until the Fed ran into a wall of resistance from the markets. Since then, we’ve obviously had another epic wave of QE.

But here’s what’s different about the current round of QE from the QE programs of the past decade:

A much greater proportion of the money the Fed has created to buy bonds will be injected into the real economy through the federal budget. It won’t just be sequestered on Wall Street, where it pumps up asset prices.

As the brand-new U.S. money supply that is currently sitting in the U.S. Treasury’s General Account at the Fed is injected into citizens’ checking accounts through stimulus checks, unemployment insurance, tax refunds, Social Security checks and more, consumers will have plenty of purchasing power.

The Treasury General Account balance is currently $1.5 trillion, which is easily 10 times higher than the historical average. This will be sent out to recipients of federal dollars in the months ahead.

Will the recipients spend it all at once?

No, they won’t. They’ll likely hold precautionary savings in a weak economy. But make no mistake: The cash is there, it will get into consumers’ hands and it will eventually be spent — even if the economy remains sluggish.

It’s like water that’s built up in front of a dam. All it takes is to open the sluices (in this case have the Treasury spend down its cash balance) to inject an unprecedented amount of cash into the economy.

The U.S. job market (and wages) won’t necessarily have to fully recover for a chronic inflation problem to set in, because the tool for the Fed to inject newly printed cash into the economy (through the federal budget) is well established.

That’s a recipe for stagflation.

Turning Money Into a Hot Potato

It involves a chronically high federal deficit, a Fed balance sheet that is expanding with the deficit and private-sector productivity growth that lags the growth in newly printed money.

Historical evidence shows that when government debt and deficits are high, central bank balance sheets are growing rapidly and private-sector productivity growth lags the growth in newly printed money, inflation will be the result.

When the public starts to recognize that supply of a fiat currency is too plentiful today and expects money supply to grow much faster than production of goods and services, then the public will start treating that currency as a hot potato.

This is the psychological part of inflation that’s so difficult for mainstream economists to grasp. It’s nonlinear and unpredictable. This is why Jim Rickards calls inflation a “psychological phenomenon.”

And that brings me to Modern Monetary Theory, or MMT.

MMT Doesn’t Understand Money

Consider this question: Do you hold cash as a store of value solely for the purpose of paying taxes?

Of course not. Thus, legal tender laws do not give fiat money intrinsic value. Fiat money only has value to the extent that its holders believe it can be exchanged for goods and services both now and in the future.

But Modern Monetary Theory (MMT) is ultimately based on the notion that fiat money derives its value from the fact that citizens need it to pay their taxes.

But MMT advocates might be surprised if they survey the public and discover that the public does not, in fact, save money for the sole purpose of paying federal taxes.

The exchange of fiat money for goods in the future is critical. In Chapter 5 of his book Aftermath, titled “Free Money,” Jim identifies the essential problem with MMT:

“The problem with… MMT is not that the theory is wrong as far as it goes; the problem is that it does not go far enough. MMT fails not because of what it says but because of what it ignores. The issue is not whether there is a legal limit on money creation but whether there is a psychological limit.”

Promoters of MMT consider taxation the solution to inflation. If inflation becomes a problem, their solution is to raise taxes, which would drain money out of the economy. But they don’t understand the psychology of inflation.

They focus on the accounting mechanics of dollar creation and downplay how their policy proposals might affect the use of dollars in the real world. I’ve seen no successful real-world case study showing that MMT works.

It’s an abstract theory that is not supported by historical evidence. That’s why detractors often make fun of MMT by calling it “Magic Money Tree.”

The Fed is not a Magic Money Tree today… and it wouldn’t become one even if MMT were officially adopted in the future.

Owning gold and gold-related assets is the best protection against the damage that the Fed and the federal government are doing today and what they’ll do in the future.

The damage isn’t yet obvious, but it will be more noticeable in time.


Dan Amoss
for The Daily Reckoning

The post The Fed Isn’t a Magic Money Tree appeared first on Daily Reckoning.

Are We in for a 20-Year Winter?

This post Are We in for a 20-Year Winter? appeared first on Daily Reckoning.

The shifting passions of the stock market entertain us, as the shifting passions of a soap opera entertain us.

They entertain us, that is. But they do not fascinate us.

It is the longer view, the overall view that commands our attention… the eagle’s view.

Today the horizon drifts into focus. Yes, we have the future in sight.

How will the stock market fare these next 20 years?

Today we undertake a tour of the horizon.

We first take a canvass of the passing scenery…

One Day, Two Markets

The stock market shook off early staggers to close strong. Yahoo! Finance:

Earlier, stocks traded choppily after Texas said it was pausing its reopening process due to a renewed surge in COVID-19 infections in the state. Investors also monitored incoming economic data, with a new report showing stubbornly high levels of new unemployment claims.

New unemployment claims came in at 1.48 million for the week ending June 20, marking the 14th-straight week that claims held above 1 million. Consensus economists had expected new claims to total 1.32 million.

But late today the Federal Deposit Insurance Commission offered stocks a hand up. It announced it is easing its grip on the banks.

CNBC explains the lighter restrictions would:

Allow banks to more easily make large investments into funds such as venture capital funds. Also, banks will not have to set aside cash for derivatives traders between different affiliates of the same firm, potentially freeing up more capital.

We hazard our Nomi Prins has a thing or three to say about this.

And so the Dow Jones surged late to a final 298-point gain. The S&P leapt 33 points and the Nasdaq vaulted to a 107-point advance.

But now we avert our gaze from the hurly-burly of the present… and face the distant horizon…

The Seasons of the Stock Market

The weather has its seasons. And so the stock market has its seasons…

Summer, winter, bull market, bear market.

As we have argued before, climate is what you can expect. But weather is what you actually get.

Sometimes summer extends far into Indian summer before letting go… before nature slips off her green dress… and into her autumn pastels.

And sometimes winter holds its iron grip deep into calendar spring.

The winter of 1929 — for example — was so fierce the ice held 25 years.

Only in 1954 did stocks thaw to their pre-freeze levels.

The investor who lost all in 1929 waited 25 ice age years to make his losses good.

The years 1982–2000 — conversely — were extended summer for the stock market.

Between August 1982–December 1999, compounded real returns on the Dow Jones ran to 15% per annum.

A chill northern gust occasionally blew on in… as in 1987… and 1990. But they quickly blew on out.

Investors believed they had discovered endless summer.

The Return of the Seasons

Investors had another guess when an arctic gale came barreling in, 2001–02.

But summer’s warmth soon returned investors to the beaches… until the harsh winter of 2008–09.

Then 11 balmy years of summer, under the warming influence of the Federal Reserve.

But the weather turned in 2020 as never before…

Summer yielded to winter in record time… and the deep freeze of 2020 held the world in siege.

The unprepared, tee-shirted stock market lost over 30% within weeks.

But record heat from the Federal Reserve soon broke the ice. The stock market has thawed some 30% since March.

And its February heights are in sight.

Summer or Winter Thaw?

Is it summer once again for the stock market?

Or is it heading into a 20-year year winter… similar to the 25-year winter of 1929–54?

We remind you:

By spring 1930, the stock market had made good many of its October ’29 losses.

And fevers raged through 1931. As Jim Rickards notes:

Stocks rose 28.6% from Nov. 17, 1929–April 20, 1930. They rose 13.2% from June 22–Sept. 7, 1930. Stocks rallied again by 17.5% from Jan. 18–Feb. 22, 1931. Finally, stocks rallied 22.2% between May 31–June 28, 1931.

Yet these sweatings proved fleeting, mere winter thaws.

Despite these fiery stretches… the Dow Jones plunged a frigid 89.2% from 1929–32.

And the ice age did not pass until 1954.

And so again we ask: Is it summer once again — or the initial thaw of long, harsh winter?

“Stock Market Valuations Are a Sort of Farmers’ Almanac, a Generally Accurate Farmers’ Almanac”

For clues, we look to stock market valuations. For stock market valuations are a sort of Farmers’ Almanac, a generally accurate Farmers’ Almanac.

These valuations are indicated by price-earnings ratios — P/E ratios.

A low P/E ratio indicates stocks are cheap. A high P/E ratio indicates stocks are dear.

The lower the valuation… the higher returns investors can expect over the next several years.

The opposite likewise holds true.

A P/E ratio of 17 is about par… historically.

That is, P/E ratios below 17 indicate stocks are cheap. Above 17, stocks are expensive.

What is today’s P/E ratio for the S&P as a whole?

Twenty-two — high by history’s standards.

It indicates investors are willing to ladle out $22 for each $1 of earnings.

It also means they will likely meet disappointment…

If there is anything in the term “mean reversion”… investors may soon be in for winter…

“Starting From This Level, Stocks Are Likely to Disappoint Over the Next 20 Years”

Times of expensive stocks are followed by times of cheap stocks.

That is, winter follows summer. Indian summer may delay winter’s onset. But eventually Jack Frost pays his visit.

And he may presently be preparing an extended stay.

Given present P/E ratios… how long might the coming winter last?

Mr. Michael Carr instructs technical analysis at New York Institute of Finance. Says he:

“Starting from this level, stocks are likely to disappoint over the next 20 years.”

Twenty years?

When the P/E ratio is near all-time highs, as it is now, the S&P 500 delivers annual returns averaging about 5% over the next 20 years. When the P/E ratio is near all-time lows, returns are about three times higher, averaging 15.4% a year over the next 20 years.

$163,665.37 vs. $26,532.98

Assume you have $10,000 to adventure in the stock market.

If you invest it at a time of low P/E ratios, Mr. Carr’s calculations reveal $10,000 would ultimately become a handsome $163,665.37.

A $10,000 investment at a time of average P/E would come out at $67,275.00.

But a $10,000 at a time of high P/E ratios… as today?

You would have a mere $26,532.98 on your hands — a minus 61% deviation from average.

“Imagine finding yourself 61% below target at retirement,” warns Mr. Carr.

Imagine it — if you can take the jolt.

The line at the bottom is this: Your long-term prospects are poor when you invest at a time of elevated P/E ratios.

Lance Roberts of Real Investment Advice draws this identical conclusion…

Better off Stuffing Your Cash in Your Mattress for 22 Years

At today’s valuation extremes, Roberts asks…

Would you be better off placing $10,000 into the stock market each year — or wedging it into your mattress?

Roberts has given the numbers a good, hard soaking. At 20x valuations, he finds…

Your stock market money would finally outperform your bed-bound cash… in 22 years.

Twenty-two years!

“Historically, it has taken roughly 22 years to resolve a period of overvaluation,” adds Mr Roberts.

We remind you that today’s S&P trades at 22x valuations — higher than 20.

Are you prepared for a 22-year winter?

Hedging Our Bets

Summer, winter… we do not know which will prevail ultimately.

We are presently outfitted for summer.

And perhaps the Federal Reserve can extend the season, hold the sun up in the sky a bit longer.

It has extended summer before.

But the Horae — the Greek goddesses of the seasons — are fickle and capricious beings.

They resent man’s encroachments upon their natural prerogatives.

And so we have our winter apparel ready…


Brian Maher
Managing editor, The Daily Reckoning

The post Are We in for a 20-Year Winter? appeared first on Daily Reckoning.

“Stocks Only Go Up”

This post “Stocks Only Go Up” appeared first on Daily Reckoning.

How crazy have markets become lately?

One new investor has said, “Stocks only go up,” while unemployed people are using their stimulus check to trade stocks:

“It was basically free money,” said one of them… “It’s like a gambling game.”

If you want to talk about craziness, just look at Hertz…

Fools Rush In

Hertz filed for bankruptcy on May 22. Then a bizarre thing happened. Some of those newbie investors who had just received their coronavirus stimulus checks opened online retail accounts at brokers like Robinhood and started buying Hertz!

The stock was sure to end up with zero value, but they didn’t care. If you bought it for $1.00 per share and could dump it for $3.00 per share, you tripled your money even if the stock ends up at zero.

That’s crazy enough, but then things got crazier.

Hertz saw its stock price going up and decided to sell $1 billion of stock in a new issue.

Investment bank Jefferies Co. agreed to underwrite the deal. The SEC signed off on the offering document.

Of course, in bankruptcy you have to get approval from the bankruptcy court. Many assumed the judge would put an end to the nonsense, but he didn’t. The judge approved the deal.

Just to be clear, if Hertz raises $1 billion, that money will go straight to creditors. Stockholders will still get zero. That’s why the judge approved the deal, because his job is to help the creditors.

This will be an expensive lesson in bankruptcy law for those who buy the equity, unless they sell to another sucker just in time.

I wish them all well.

Stocks Can Go Down After All

But the frenzied market rally of the past few weeks hit a snag last week. The Dow lost 5.5% on the week, while the S&P gave up 4.7%, making it the worst week since March 20.

I guess stocks go down after all.

The market was down big this morning, extending last week’s losses, before rebounding this afternoon.

But it’s clear that investors are getting nervous about the resurgence in U.S. coronavirus infections, which places the prospects of a V-shaped recovery further in doubt (it wasn’t going to happen anyway).

The Good News

Well, we’ve all lived through the first wave of coronavirus infections (technically the SARS-CoV-2 virus and the COVID-19 disease).

Along with that came an unprecedented economic lockdown that has triggered a global depression.

Even during the Spanish flu pandemic of 1918–19 that killed 100 million people, there was no full-scale lockdown, although many large gatherings, sporting events and concerts were cancelled.

We’re just now starting to come out of our self-quarantines and small businesses are gradually reopening. That’s the good news.

The Bad News

The bad news is we’re hearing a lot about a so-called “second wave” of infections that could bring back another lockdown.

One professor of medicine at the Vanderbilt University School of Medicine has said, for example, “The second wave has begun.”

These concerns are causing market declines and volatility. But I don’t think many people really understand what a true second wave is.

There are new outbreaks of the disease, but these are still part of the first wave. We’re still experiencing the first wave, in other words.

Watch out for the Second Wave

The virus has a predictable pattern in a given locale. That generally means about an eight–10-week course with a peak after five weeks, then a gradual diminution.

But it does not hit every locale at the same time. What’s happening in Florida, Arizona, Texas and elsewhere today is just another version of what already hit New York. It’s just happening later in the timeline because of population density and different lockdown rules.

But again, it’s still the first wave. A true second wave happens after a period of relative calm. The virus mutates into a more lethal form and strikes again.

Those with antibodies from the first wave may do better, but others are highly susceptible to the second wave and the fatality rate can be much higher.

That’s what happened in the Spanish flu a century ago. The first wave was March–June 1918. It was fatal but tailed off quickly. The second wave hit in October 1918 and was much more fatal.

Bodies were piled up like firewood. They ran out of coffins. They ran out of grave diggers. They ran out of graveyards and dug mass graves, wrapped people in sheets and dusted them with disinfectant and threw them in. That’s how bad that was.

COVID-19 isn’t anywhere near as bad as the Spanish flu was. But if we get a second wave, it could be more lethal than the first. It is likely to strike in December 2020. Let’s pray it doesn’t happen, but it’s too soon to rule it out.

The Rise of the Pezzonovante

What we can count on is that power-hungry politicians and bureaucrats will continue to throw their weight around…

Pezzonovante is a colorful Sicilian term famously used in the script for The Godfather. It basically means “big shot” or “self-important.”

It’s used in a derogatory sense to describe politicians who think they’re better than everybody else. One of the unpleasant side effects of the coronavirus lockdown is the rise of a new pezzonovante class among U.S. politicians.

It is true that political figures, especially governors and mayors, do have emergency powers to deal with public health crises or natural disasters. However, all such powers must be conducted in a constitutional framework with consideration for economic, medical and other factors balanced out.

The problem is that every elected official has an inner dictator who can’t wait to start bossing people around with arbitrary executive orders and no due process of law. That’s what’s been happening since the lockdowns began.

State governors were issuing “lockdown” orders, arresting people without face masks and revoking business and liquor licenses from small-business owners trying to earn a living, all without legal authority.

When these neofascist tactics are challenged in court, the state often loses. But not every small-business person can afford the legal fees to bring suit.

The lockdown did slow the spread of the virus and did save some lives, that’s true. But, the gains may only be temporary.

Remember, “flattening the curve” does not mean reducing total infections and deaths. It just means stretching them out over a longer period so the hospital system is not overwhelmed.

Let’s look at one pezzonovante…

An Offer You Can’t Refuse

New York Gov. Andrew Cuomo was responsible for 5,000 unnecessary deaths because he ordered COVID-19 patients to be forced into assisted living facilities where residents got ill and died as a result.

Now he’s threatening to reimpose a lockdown on New York beach resorts and Manhattan if people don’t follow his version of “social distancing” and face mask etiquette.

(Never mind that the science of face masks is not at all clear; many experts take the view that they don’t work and can do more harm than good except for medical personnel who face constant exposure.)

The point is that transparency and good communication with the public combined with voluntary compliance can get the job done. Orders and threats don’t help and prompt many people to do the opposite.

Leaders like Andrew Cuomo will just delay the economic recovery without doing anything to slow the spread of the virus. This is just one example of the new pezzonovante throwing their weight around without concern for the public good.

The “inner dictators” are on the loose and economic recovery will suffer as a result.

Unfortunately, they’re not going away.


Jim Rickards
for The Daily Reckoning

The post “Stocks Only Go Up” appeared first on Daily Reckoning.

The Great Disconnect Between America and the Market

This post The Great Disconnect Between America and the Market appeared first on Daily Reckoning.

America may be down with disease and disorder. But the stock market is up on faith and the Federal Reserve.

Thus America gets pulled this way… while the stock market gets pushed that way.

As a certain Marshall Gittler styles it, he who directs inves‌tment research at BDSwiss:

The disconnect between what the average person sees happening in the world and what they see happening in the financial markets is getting wider and wider.

We hazard this disconnection may soon span so broad… the average person will see only the market’s distant dust.

The gap expanded today…

2.76 Million Private Sector Jobs Lost, the Stock Market Jumps

We learn the private sector dispensed 2.76 million pink slips of paper last month. This information comes by way of the May ADP National Employment Report.

Yet while the American worker continues falling backward, the stock market raced further ahead today…

The Dow Jones pulled ahead 742 points. The S&P jumped out another 27 points; the Nasdaq, 74.

Gold, meantime, took a severe trouncing today — down nearly $31.

And the 10-year Treasury yield surged nearly 12% today… to 0.081%.

Why did bullish optimism win the day?

A Massive Surprise

A survey of Refinitiv economists had projected 9 million lost private-sector positions.

Thus they “missed” dreadfully — to the downside.

But is the 2.67 million a true figure? Or is it a statistical phantom, a false return?

Even one of the president’s economics henchmen — Mr. Kevin Hassett — scratches his scalp in wonder:

This number is so much below expectation, or what you would get if you built up from the claims number, that I wonder about it… The number is so good, it’s such good news, that I really have to dig deep into it and see if there’s not something funny going on, because it’s pretty far removed from what we’d get if we just added up the claims data and so on from the last survey.

Our wager is on “something funny going on.”

“Merely Because We Like the Devil’s Chances Does Not Mean We Like the Devil”

We could be mistaken of course. We would be pleasantly mistaken… if mistaken.

Merely because we like the devil’s chances does not mean we like the devil.

Our hopes are rather with the angels. We are with them.

Friday may nonetheless reveal a clearer image. That is when the United States Department of Labor issues its own, more comprehensive unemployment report.

Economists as a body forecast 8 million total May pink slips.

They further project the May unemployment rate to come in at 19.7% — a good stretch past April’s 14.7% — and the worst since the Great Depression.

A 19.6% reading would nonetheless defeat consensus. The stock market would likely declare a victory, run further ahead… and speed further from view.

76 Months to Come Back?

The United States economy — meantime — may scratch, may claw to merely keep up.

When may unemployment return to its pre-pandemic lows?

To steal a possible glance into the future… let us first look back to the certain past… to the previous recession.

Over six years lapsed before employment fully recovered — 76 months.

Assume a parallel projection.

Pre-pandemic unemployment would come back in 2026.

It could be sooner than 2026 of course. Yet it could be later than 2026.

Later, because the pandemic may flatten multiple industries for years and years.

These include the travel and hospitality industry, the restaurant industry, the entertainment industry, et cetera.

Again we declare for the angels. We hope these industries emerge intact… and far sooner than we imagine.

But we fear the angels face long odds.

Each Recovery Recovers Less

Meantime, today’s debt burden sits heavier on the economy than in 2008. And debt drags on an economy… as an anchor chain hung about a man’s neck drags on the man.

Total pre-pandemic debt levels ran to $75 trillion or some other enormity. And debt is coming on in heaps.

Headway will therefore be limited, the sledding more difficult.

Here Michael Lebowitz and Jack Scott of Real Inves‌tment Advice pencil an imaginary line. This line connects the 1990 recession, the 2001 recession, the 2008–09 recession… and the present recession.

And the line forms a downward arc:

  • The [2008–09] recession was broader based, and affected more industries, citizens, and nations, than the prior recessions of 1990 and 2001
  • The 2008–09 recession and recovery also required significantly more fiscal and monetary policy to boost economic activity
  • The amount of federal, corporate and individual debt was significantly lower in 1990 and 2001 than 2008–09
  • The natural economic growth rate for 1990 and 2001 was higher than the rate going into the 2008–09 recession.

What about growth rates to come?

Half the Previous Rate of Growth

These two gentlemen draw up to this conclusion:

“The economic growth rate going forward may be half of the already weak pace heading into the current recession.”

As we have asked before: From what sources will growth originate?

Meantime, the Congressional Budget Office estimates:

The pandemic will hack $8 trillion off real GDP these next 10 years… and $15.7 trillion off nominal GDP.

Real GDP minuses out inflation’s false additions, of course. Nominal GDP does not.

This lost GDP — if the figures are accurate — is GDP lost forever.

What Will Never Be

It is aborted wealth, pre-murdered wealth.

It represents houses never constructed, automobiles never assembled, airplanes never flown, jobs never offered, dream vacations never taken…

It represents computers that will never compute, televisions that will never televise, hacksaws that will never hacksaw, medicines that will never medicate, air conditioners that will never condition the air…

It represents businesses that will never do business.

That is, this lost GDP represents a diminished national life. And potentially a vastly diminished national life if the true numbers prove even worse.

One year of slack growth, two years of slack growth, these are endurable.

Yet a string of annual losses are not…

The Long Run

Average real annual economic growth since 1980 runs to 3.22%.

Yet since 2009… that figure has fallen to 2.23%.

What if pre-2009 3.22% growth held steady?

Jim Rickards estimates the United States would be $4 trillion wealthier.

Run it 30, 50, 60 years, Jim concludes… and you arrive at a dismal conclusion:

A society that grows at 3.22% will be twice as rich as one that grows at 2.23% over the course of an average lifetime.

Absent a return to trend… ours will be the society half as rich…


Brian Maher
for The Daily Reckoning

The post The Great Disconnect Between America and the Market appeared first on Daily Reckoning.

Jamie Dimon’s Big Admission

This post Jamie Dimon’s Big Admission appeared first on Daily Reckoning.

Yesterday the S&P crested 3,000 for the first instance since March 5.

The same S&P outdistanced its 200-day moving average — a “bullish” portent.

Yet its reach exceeded its grasp…

The bears, rousted and alarmed, launched an afternoon counterraid.

They threw the overextended and outweaponed index back beneath 3,000… which ended the day’s jousts at 2,991.

But as the chart men will remind you…

The S&P’s initial probe above the 200-day moving average rarely holds. The second assault often does.

Did today’s assault succeed where yesterday’s failed?

Yes Under covering fire from the Federal Reserve… it took the terrain.

For that fire is heavy. That fire is accurate. And that fire is sustained.

The S&P ended the day at 3,036.

The Fed’s “Bazooka” Is Responsible

Even JPMorgan head man Jamie Dimon concedes:

The Fed’s liquidity, bringing out the bazooka, is propping up stock prices (as well as all other asset classes).

Where the S&P would sit without “the bazooka” covering its advance… we do not know. But we hazard it would languish far beneath 3,000.

We further hazard the Dow Jones industrial average would average a great deal less than its present 25,548.

And so the reputation of the Wall Street man as a rugged and swashbuckling fellow, as a sort of daredevil carving his own way through constant peril… has died the death.

He is now perceived — justly in part — as a man on the dole, as a man on public relief.

The Federal Reserve clears his way. It bazookas all resistance. It mends his erring ways… and insures him against loss.

“Heads I Win, Tails You Lose”

The Wall Street man collects all his winnings in flush times.

Yet when a fate is against him, when he faces hardship… the Federal Reserve lifts his losses from his hands… and slips them into taxpayer pockets.

Thus he is perceived almost as a man in possession of stolen property.

He has certainly enjoyed a good steal… and he has certainly enjoyed a long steal.

“Heads, I win,” he seems to say to our hapless taxpayer. “Tails you lose.”

Is this justice?

Real Capitalism

We are heart and soul for the unchained capitalist system.

If a man speculates successfully in the combats of the free and open market, he has our loudest applause.

He confronts danger from all directions… and often sees off odds that would make us quail.

He earns his money. And the better he speculates the more he takes in.

If he fails, he fails in an honest system of profit and loss. He hangs upon his own hook. And he enters the business knowing it.

This is the way it should be. Alas, it is not the way it is.

Fake Capitalism

As much as we are heart and soul for the unchained capitalist system… we are heart and soul against the corrupted capitalist system…

That is, we are against the rigged deck, we are against the tilted game board, we are against the loaded die…

We are against thumbs on scales, we are against artificial winds at backs, we are against referees who pick sides.

That is, we are against the system that presently obtains.

That system has put Wall Street back in funds… or largely so. America’s billionaires — for example — have fattened $434 billion since March.

The bright-siders insist the stock market has come barreling back because the economy will come barreling back.

The market is merely “discounting the future,” they croon.

Yet we find ourselves severely at outs with this assessment. We gaze ahead and see a discount vastly reduced…

42% of Job Losses Could Be Permanent

Some 40 million Americans presently wither in unemployment, idled, hands in pockets.

Economist Nicholas Bloom — a Stanford man — estimates 42% of them may remain in unemployment.

Their jobs will never return.

We do not know if 42% will prove the correct figure. It appears precious high to our notion.

Yet we wager the true number will nonetheless reflect a calamity.

Even a 20% figure leaves 8 million Americans permanently idled.

Meantime, we learn today that Boeing is cutting out 12,000 positions. It further projects “several thousand remaining layoffs” in the months to come.

That is because it fears the airline industry will not recover for years.

We project the same for the travel industry in its entirety. And for other industries currently knocked flat…

Six Feet Apart Means Six Feet Under

How, for example, will the restaurants come back if they must choke the inflow of eaters?

Restaurants generally go along on the knife’s edge, on profit margins truly slender. Most cannot endure a diminished customer flow.

Six feet apart — to draw upon our co-founder Bill Bonner — means six feet under for the restaurant business.

We can think of two capital Baltimore restaurants that did a brisk trade. They were constantly thronged with patrons.

Yet we are informed that neither will reopen once the present siege lifts. They are permanently killed.

We are certain many more will follow.

And the restaurant industry, like the airline and travel industries, touches other industries.

Like a great ship sinking beneath the waves… when one goes under it tugs mightily upon those close by.

Extend the dilemma nationwide and you will find an economy in hard shape.

Where will the next batch of jobs originate?

Don’t Count on the Jobs Coming Home

Some believe millions of offshored jobs will come swimming home. That is because the virus has rubbed the shine off globalism.

We must produce essentials ourselves, they insist. Global supply chains are too fragile. Hacksaw one link and the entire chain is undone.

We cannot tie our fate to hostile China, for example. We must brew our own medicines and stitch our own surgical masks.

But the jobs originally jumped the ocean for this reason: Business costs were lower across the ocean.

Business costs remain lower across the ocean. And business costs will remain lower across the ocean.

Wages are often a slender fraction of American wages. Occupational safety regulations scarcely exist. Neither do environmental regulations.

China’s Losses Will Be Someone Else’s Gains

How many American businesses will repatriate operations if it places them at a competitive disadvantage?

Precious few, we hazard.

They may quit China (many already have due to rising labor costs).

But China’s losses would likely become Vietnam’s gains, or Malaysia’s gains, or Indonesia’s gains.

In brief… we do not expect millions of jobs to make the swim home.

The Fed’s Bazooka Did Nothing for the Economy

The Federal Reserve’s bazooka may give the stock market its cover. Yet for the economy overall… its bazooka has proven a mere pop gun, a spitball blaster, a shooter of blanks.

It has done little but load the economy with cheap debt. Much of it, unproductive debt.

Total United States debt eclipsed $75 trillion even before the virus blew in.

For a decade and more the economy hunched along, weighted down by this overloaded cargo of debt.

As we recently noted:

GDP growth did not attain 3% one year during this past decade. From 1996–2005 — conversely — GDP exceeded 3% seven years of the 10.

Meantime, even heavier debt loads are heaping down. The economy will squat even lower in the water.

It is an economy headed for the doldrums. We sincerely hope it can avoid the shoals…


Brian Maher
Managing editor, The Daily Reckoning

The post Jamie Dimon’s Big Admission appeared first on Daily Reckoning.


As the Nasdaq makes a new high for the year, the world outside the stock market timebomb is falling apart. For example the UN agency, The International Labour Organisation (ILO) reports that 1.6 billion jobs are at risk in the global economy. That is half of the global workforce of 3.3 billion. Read more...


Is gold market going to reset in 6 months? Is there enough physical gold to satisfy the outstanding paper commitments? Egon recommended as early as 2002 for people to hold 25 – 50% of investable assets in gold, when the price was $300. It's $1725 now, and this is only the beginning. Read more...

Investing Is Now Simple

This post Investing Is Now Simple appeared first on Daily Reckoning.

The raging pandemic has served one high and worthy purpose:

It has made obvious — to all with open eyes — that the stock market is a crook’s game, a vast swindle.

How else could the stock market regain so many of its initial pandemic losses… while 16 million Americans file unemployment claims… and second-quarter GDP may contract 40%?

The Federal Reserve has expanded its balance sheet some $1.6 trillion these past four weeks.

There is your answer.

All vestiges of fair and honest markets have gone whooshing down the chute.

A Tremendous Gambling Racket

The Federal Reserve heads a tremendous gambling racket. It deals dishonest cards. It weights the dice. It tinkers the slots.

Anything and everything it will do to rook bears out of their rightful jackpots.

And so we ask:

Where would the stock market presently sit without the Federal Reserve’s massive fixing?

The numbers men at One River Asset Management have tackled the question.

Their conclusion shortly.

First we look in on the blackjack table…

A Touch of Reality

The Dow Jones shed 445 points today. The S&P gave back 62; the Nasdaq, 122.

Why today’s setback?

We learn this morning that March retail sales plunged a savage 8.7% — a record jolt to business. No previous figure approaches it.

We further learn that United States industrial production plunged 5.4% month over month.

That represents its steepest monthly fall since January 1946… not long after the nation began beating its belligerent swords into peaceful plowshares.

Meantime, earnings season is once again upon us. And corporate earnings are presently dropping away…

Bank of America claims first-quarter profits plummeted 45%. Citigroup profits went 46% backward. Goldman Sachs also reported a violent 46% retreat.

Quincy Krosby — Prudential Financial’s chief market strategist — drips icy sweat as he canvasses the numbers:

If this is a precursor to what we can expect throughout the U.S.… there’s no word for it. This reflects the complete shutdown of the economy.

Yes it does. Yet the abysmal numbers were all but guaranteed. And still the stock market jumped for weeks.

Yes, the market was down today.

Yet we suspect further pledges of Federal Reserve trickery will coax stocks up again — for a time at least.

The New Investment Strategy

BlackRock is the largest asset manager on Earth. It is also in command of the Federal Reserve’s asset-purchasing program.

This is the program that is lifting creaky debt off corporate balance sheets… and dropping it into taxpayers’ laps.

And what is BlackRock’s present investment strategy?

To simply hitch its cart to whichever assert the Federal Reserve purchases. Explains Mr. Rick Rieder, director of BlackRock’s global allocation unit:

We will follow the Fed and other [developed market] central banks by purchasing what they’re purchasing, and assets that rhyme with those.

That is, the central banks will ultimately select BlackRock’s investments. What kind of capitalism is this?

And is there not something uniquely swinish about this arrangement… perhaps even unlawful?

BlackRock is directly involved in the Federal Reserve’s asset purchases. It therefore knows which assets will get a lift. It can place its wagers accordingly — before all others.

Where is the Securities and Exchange Commission to investigate insider trading?

Ecstatic Markets

But markets are “ecstatic,” says Rabobank’s Michael Every.

That is because they need only lean back on their oars… and drift with the Federal Reserve’s gravitational tide:

Markets are ecstatic because there is no need to actually do any thinking at the moment. The Fed has made clear that there are to be no losers — or at least that one does not have to bother trying to pick the winners.

And so the Federal Reserve has quieted capitalism’s mighty gales of creative destruction. These are the gusts that push progress along, that push society along.

They blow away the inept and inefficient… and sweep in the new and improved.

Improved mousetraps, superior widgets, better living — these come out of capitalism’s destructively creative gales.

But the Federal Reserve has hushed them down.

Each Intervention Adds More Unproductive Debt

Each intervention piles up additional debt within the system. Thus the system sags under the added weight.

Progress slows as the laggards absorb capital that could have flowed into worthier hands. Yet the inefficient know they will not sink under. They realize the authorities will keep them up.

Deutsche Bank strategist Jim Reid:

The authorities have been so reluctant to see the creative destruction that’s so important to successful capitalism that they had to make another stunning major intervention.

Ever since the Fed of the late 1990s decided to bail out the financial system post the Long Term Capital Management collapse, we’ve had rolling state-sponsored capitalism and large moral hazard. This has meant that each subsequent default cycle (or mini market cycle) has been less severe than the free-market parallel-universe version would have been and has left increasingly more debt in the system as a result and meant that the intervention necessary to protect the system has got greater and greater. In my opinion, it also helps lock in lower productivity as you keep more low/no growth entities alive.

This fellow cites productivity. Productivity is the source of authentic long-term prosperity…

No Productivity, No Growth

Productivity growth averaged 4–6% for the 30 years after WWII. But average productivity has languished between 0–2% since 1980.

Meantime, labor productivity averaged 3.2% annual growth from World War II through the end of the 20th century. But since 2011?

A mere 0.7%.

The United States government borrowed perhaps $12 trillion since the financial crisis — even before the latest debt delirium.

But the American economy expanded only $5.1 trillion over the same space.

That is, GDP increased 35%. But the national debt increased 122%.

Where Will Productivity Originate?

We presently confront spiraling debt… and diminishing growth. The unfolding cataclysm will only deepen the trend.

Concludes Michael Lebowitz of Real Inve‌stment Advice:

“Given the finite ability to service debt outstanding… future economic growth, if we are to have it, will need to be based largely on gains in productivity.”

If we only knew the source of that productivity.

But we conclude by returning to our question of the day:

Where would the stock market presently sit without the Federal Reserve’s mammoth manipulations?

One River Asset Management has taken up the question. Here is their answer:

Down 50–80%…


Brian Maher
Managing editor, The Daily Reckoning

The post Investing Is Now Simple appeared first on Daily Reckoning.

Worst Recession in 150 Years

This post Worst Recession in 150 Years appeared first on Daily Reckoning.

The stock market had another big day today, spurred by the Fed’s massive recent liquidity injections.

But you really shouldn’t be terribly surprised by the rally. Even the worst bear markets see substantial bouncebacks. And you can expect the market to give back all of its recent gains in the months ahead as the economic fallout of the lockdowns becomes apparent.

This bear market has a long way to run. And we could actually be looking at the worst recession in 150 years if one economist is correct. Let’s unpack this…

My regular readers know I have a low opinion of most academic economists, the ones you find at the Fed, the IMF and in mainstream financial media.

The problem is not that they’re uneducated; they have the Ph.D.s and high IQs to prove otherwise. I’ve met many of them and I can tell you they’re not idiots.

The problem is that they’re miseducated. They learn a lot of theories and models that do not correspond to the reality of how economies and capital markets actually work.

Worse yet, they keep coming up with new ones that muddy the waters even further. For example, concepts such as the Phillips curve (an inverse relationship between inflation and unemployment) are empirically false.

Other ideas such as “comparative advantage” have appeal in the faculty lounge but don’t work in the real world for many reasons, including the fact that nations create comparative advantage out of thin air with government subsidies and mercantilist demands.

Not the Early 19th Century Anymore

It’s not the early 19th century anymore, when the theory first developed. For example, at that time, a nation that specialized in wool products like sweaters (England) might not make the best leather products like shoes (Italy).

If you let England produce sweaters and Italy make shoes, everybody was better off at the end of the day. It’s a simple example, but you get the point.

But in today’s highly integrated and globalized world, where you can simply relocate a factory from one country to the next, comparative advantage has much less meaning. You can produce both sweaters and shoes in China as easily as you can produce them in England and Italy (and much more cheaply besides).

There are many other examples of lazy, dogmatic analysis among mainstream economists, too many to list. Yet there are some exceptions to the rule.

A few economists have developed theories that are supported by hard evidence and do a great job of explaining real-world behavior. One of those economists is Ken Rogoff of Harvard.

The Worst Recession in 150 Years

With his collaborator, Carmen Reinhart and others, he has shown that debt-to-GDP ratios greater than 90% negate the Keynesian multiplier through behavioral response functions.

At low debt ratios, a dollar borrowed and a dollar spent can produce $1.20 of GDP. But at high ratios, a dollar borrowed and a dollar spent will produce only $0.90 of GDP.

This is the reality behind the phrase “You can’t borrow your way out of a debt crisis.” It’s true.

Meanwhile, the U.S. debt-to-GDP ratio was about 105% even before the crisis. It’s only going higher. We’re just digging a deeper hole for ourselves.

So when Ken Rogoff talks (or writes), I listen. In his latest article, Rogoff offers a dire forecast for the recovery from the New Depression resulting from the COVID-19 pandemic.

He writes, “The short-term collapse… now underway already seems likely to rival or exceed that of any recession in the last 150 years.”

That obviously includes the Great Depression and many other economic crises.

This is something you should really consider before you decide the coast is clear and it’s time to jump back into stocks.

Complex Systems Collide

Zooming out a bit, and as I’ve argued before, the pandemic is a prime example of complex systems colliding into one another…

Investors and everyday citizens are focused on how the COVID-19 pandemic (one complex dynamic system) is crashing into the economy (another complex dynamic system) and influencing the political process and the upcoming U.S. presidential election (still another complex dynamic system).

Analyzing the operations of one complex dynamic system is difficult enough; most analysts can’t do it because they’re using the wrong paradigms.

Analysis becomes far more challenging when multiple complex systems interact with each other and produce feedback loops. That’s where the real so-called “Black Swans” reside.

And this crisis is the blackest swan most people alive today have ever seen, especially if Rogoff’s insight is correct — 150 years is a very long time.

That’s not to minimize in any way recent events like 9/11 or the 2008 financial crisis. Both were devastating. But neither led to a virtual lockdown of the entire economy like we’re seeing now. The current crisis simply has no precedent.

What we’re seeing is a full-fledged global contagion.

Biological and Financial Contagions

Let’s discuss the word “contagion” for a minute because it applies to both human populations and financial markets — and in more ways than you may expect.

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

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

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

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

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

A similar dynamic applies in financial panics.

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

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

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

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

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

We’re seeing those effects now.

Get Ready for Social Disorder

Yet even this three-system analysis I just described (pandemic > economy > politics) does not go far enough. The next phase has been little noticed and less discussed.

It involves social disorder. An economic breakdown is more than just economic. It leads quickly to a social breakdown that involves looting, random violence, fraud and decadent behavior.

The Roaring ’20s in the U.S. (with Al Capone and Champagne baths) and Weimar Germany (with riots and cabaret) are good examples.

Looting, burglary and violence in the midst of a state of emergency are the shape of things to come.

The veneer of civilization is paper-thin and easily torn. Most people don’t realize how fragile it is. But they’re going to learn that lesson, I’m afraid.

Expect social disorder to get worse long before it gets better.


Jim Rickards
for The Daily Reckoning

The post Worst Recession in 150 Years appeared first on Daily Reckoning.

Markets and Black Swans

This post Markets and Black Swans appeared first on Daily Reckoning.

I began studying complexity theory as a consequence of my involvement with Long-Term Capital Management, LTCM, the hedge fund that collapsed in 1998 after derivatives trading strategies went catastrophically wrong.

After the collapse and subsequent rescue, I chatted with one of the LTCM partners who ran the firm about what went wrong. I was familiar with markets and trading strategies, but I was not expert in the highly technical applied mathematics that the management committee used to devise its strategies.

The partner I was chatting with was a true quant with advanced degrees in mathematics. I asked him how all of our trading strategies could have lost money at the same time, despite the fact that they had been uncorrelated in the past.

He shook his head and said, “What happened was just incredible. It was a seven-standard deviation event.

In statistics, a standard deviation is symbolized by the Greek letter sigma. Even non-statisticians would understand that a seven-sigma event sounds rare. But, I wanted to know how rare. I consulted some technical sources and discovered that for a daily occurrence, a seven-sigma event would happen less than once every billion years, or less than five times in the history of the planet Earth!

I knew that my quant partner had the math right. But it was obvious to me his model must be wrong. Extreme events had occurred in markets in 1987, 1994 and then 1998. They happened every four years or so.

Any model that tried to explain an event, as something that happened every billion years could not possibly be the right model for understanding the dynamics of something that occurred every four years.

From this encounter, I set out on a ten-year odyssey to discover the proper analytic method for understanding risk in capital markets. I studied, physics, network theory, graph theory, complexity theory, applied mathematics and many other fields that connected in various ways to the actual workings of capital markets.

In time, I saw that capital markets were complex systems and that complexity theory, a branch of physics, was the best way to understand and manage risk and to foresee market collapses. I began to lecture and write on the topic including several papers that were published in technical journals.

I built systems with partners that used complexity theory and related disciplines to identify geopolitical events in capital markets before those events were known to the public.

Finally I received invitations to teach and consult at some of the leading universities and laboratories involved in complexity theory including The Johns Hopkins University, Northwestern University, The Los Alamos National Laboratory, and the Applied Physics Laboratory.

In these venues, I continually promoted the idea of inter-disciplinary efforts to solve the deepest mysteries of capital markets. I knew that no one field had all the answers, but a combination of expertise from various fields might produce insights and methods that could advance the art of financial risk management.

I proposed that a team consisting of physicists, computer modelers, applied mathematicians, lawyers, economists, sociologists and others could refine the theoretical models that I and others had developed, and could suggest a program of empirical research and experimentation to validate the theory.

These proposals were greeted warmly by the scientists with whom I worked, but were rejected and ignored by the economists. Invariably top economists took the view that they had nothing to learn from physics and that the standard economic and finance models were a good explanation of securities prices and capital markets dynamics.

Whenever prominent economists were confronted with a “seven-sigma” market event they dismissed it as an “outlier” and tweaked their models slightly without ever recognizing the fact that their models didn’t work at all.

Physicists had a different problem. They wanted to collaborate on economic problems, but were not financial markets experts themselves. They had spent their careers learning theoretical physics and did not necessarily know more about capital markets than the everyday investor worried about her 401(k) plan.

I was an unusual participant in the field. Most of my collaborators were physicists trying to learn capital markets. I was a capital markets expert who had taken the time to learn physics.

One of the team leaders at Los Alamos, an MIT-educated computer science engineer named David Izraelevitz, told me in 2009 that I was the only person he knew of with a deep working knowledge of finance and physics combined in a way that might unlock the mysteries of what caused financial markets to collapse.

I took this as a great compliment. I knew that a fully-developed and tested theory of financial complexity would take decades to create with contributions from many researchers, but I was gratified to know that I was making a contribution to the field with one foot in the physics lab and one foot planted firmly on Wall Street. My work on this project, and that of others, continues to this day.

This approach stands in stark contrast to the standard equilibrium models the Fed and other mainstream analysts use.

An equilibrium model like Fed uses in its economic forecasting basically says that the world runs like a clock. Every now and then, according to the model, there’s some perturbation, and the system gets knocked out of equilibrium. Then, all you do is you apply policy and push it back into equilibrium. It’s like winding up the clock again. That’s a shorthand way of describing what an equilibrium model is.

Unfortunately, that is not the way the world works. Complexity theory and complex dynamics explain it much better.

Distress in one area of financial markets spread to other seemingly unrelated areas of financial markets. In fact, the mathematics of financial contagion are exactly like the mathematics of disease or virus contagion. That’s why they call it contagion. One resembles the other in terms of how it’s spread.

What are examples of the complexity?

One of my favorites is what I call the avalanche and the snowflake. It’s a metaphor for the way the science actually works but I should be clear, they’re not just metaphors. The science, the mathematics and the dynamics are actually the same as those that exist in financial markets.

Imagine you’re on a mountainside. You can see a snowpack building up on the ridgeline while it continues snowing. You can tell just by looking at the scene that there’s danger of an avalanche.

You see a snowflake fall from the sky onto the snowpack. It disturbs a few other snowflakes that lay there. Then, the snow starts to spread… then it starts to slide… then it gains momentum until, finally, it comes loose and the whole mountain comes down and buries the village.

Some people refer to these snowflakes as “black swans,” because they are unexpected and come by surprise. But they’re actually not a surprise if you understand the system’s dynamics and can estimate the system scale.

Question: Whom do you blame? Do you blame the snowflake, or do you blame the unstable pack of snow?

I say the snowflake’s irrelevant. If it wasn’t one snowflake that caused the avalanche, it could have been the one before or the one after or the one tomorrow.

The instability of the system as a whole was a problem. So when I think about the risks in the financial system, I don’t focus on the “snowflake” that will cause problems. The trigger doesn’t matter.

In the end, it’s not about the snowflakes, it’s about the initial critical state conditions that allow the possibility of a chain reaction or avalanche. The coronavirus was just the snowflake that triggered the current crisis.

So now we’ve got the avalanche. And digging out won’t be easy.


Jim Rickards
for The Daily Reckoning

The post Markets and Black Swans appeared first on Daily Reckoning.