Coronavirus Slams Chinese Economy

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How bad is the coronavirus pandemic in China? It’s worse than the Chinese government knows and worse than the world believes.

Here are the official statistics on the coronavirus (technically COVID-19) as of today: There are 75,685 confirmed infections worldwide, with 98% of that total in China alone. Of those cases, 82.5% are in the single province of Hubei, mostly centered in the city of Wuhan, with 11 million residents.

Of the over 75,000 worldwide cases, there have been 2,236 deaths; that’s a mortality rate of roughly 2.5%. If a 2.5% mortality rate sounds low, it’s not. That’s roughly comparable to the Spanish flu pandemic of 1919–20 that killed 50 million people by some estimates.

IMG 1

Coronavirus has reached pandemic proportions in China. Over 60 million people are locked down, which means they cannot leave their homes except once every three days to buy groceries. Streets are empty, stores are closed, trains and planes are not operating. The Chinese economy is slowly grinding to a halt.

While the disease has been predominately centered in China, and Wuhan in particular, there have been significant outbreaks in Singapore (58 cases), Hong Kong (56 cases), Thailand (33 cases) and Japan (29 cases including one fatality). Approximately 218 cases have been identified among those trapped on cruise ships where all passengers are under quarantine. Fifteen cases have been identified in the United States.

These statistics barely scratch the surface of what is happening with coronavirus in China. There is good reason to believe that the actual incidence of the virus may be five–10 times the official numbers.

Tencent (a popular internet search and social media platform in China) reported on Feb. 1, 2020, that actual infections were 154,000 and deaths from the disease were 24,589. (A screenshot of the Tencent release is shown below; source: Taiwan News).

The infection figure was approximately 10 times what the official figure was on the same date.

The death toll was more than 300 times the official figure. Applying this death toll to total infections gives a fatality rate of 16%, which is over seven times the official fatality rate.

IMG 2

There is no reason for a high-profile platform such as Tencent either to fabricate data or incite panic. It is reasonable to conclude that these figures are close to actual data. The Tencent posting was suppressed by the Chinese government within minutes of what may have been an accidental release of accurate data.

The preeminent U.K. medical journal The Lancet also published an article on Jan. 31, 2020, using hard data (city populations, incidence of travel, estimated transmissibility, etc.) and a reliable SEIR model (susceptible, exposed, infected, resistant).

That article estimated total infections of 75,815 in Wuhan as of Jan. 25. That figure is 17 times the official figure of 4,400 available on Jan. 27. The multiple of the estimate by The Lancet to the official figure is roughly in line with the multiple of the Tencent release to official data five days later.

Using either The Lancet or Tencent as a baseline suggests that the official infection and death rates are grossly understated.

Anecdotal evidence is consistent with the view that official data are materially understated.

Many bodies have been picked up off the streets and sent for cremation without blood samples or autopsies. It is highly likely that these victims died from coronavirus but are not included in official counts because no tests were performed.

Authorities are running out of body bags and refrigerated trucks, so bodies are simply being wrapped in plastic sheets and hauled away in ordinary vans.

A shortage of face masks, latex gloves and testing kits has also emerged. This means that doctors and medical personnel are highly susceptible to infection. It also means that patients who complain of fever and difficulty breathing are sent away because officials have no way to test them for coronavirus.

These developments simultaneously inflate the number of infected and deflate the official count.

The story gets worse. Wuhan, the city that is ground zero for coronavirus infections, is also the location of the sole bioweapons laboratory for the Chinese military and Chinese Communist Party.

One of the scientists at the laboratory is Zhengli Shi, a virologist. Shi formerly worked at a laboratory at the University of North Carolina, where he engineered a hypervirulent bat-based coronavirus that bears a striking resemblance to the COVID-19 coronavirus, including gene sequences not found in nature.

These linkages at least suggest that the outbreak of the coronavirus in Wuhan may be linked to an accidental release of the virus from the biological weapons laboratory located there.

If this thesis is correct, the coronavirus may be difficult to contain with vaccines or drug therapies since it would have been engineered to be highly resistant to such treatments.

What impact will the coronavirus pandemic have on the Chinese economy and global supply chains, especially in the technology sector?

Right now my models are telling me that the impact of coronavirus on the Chinese economy is orders of magnitude greater than most analysts estimate. In fact, the Chinese economy, second largest in the world, may be grinding to a halt.

The following excerpt from an article by Ambrose Evans-Pritchard in The Telegraph on Feb. 12, 2020, tells the tale:

Property sales in 30 big cities released every day… have collapsed to zero and have yet to show a flicker of life.

Property is a slow-burn issue compared to ruptured manufacturing supply chains, but by March it will start to bite for developers with dollar debts on Hong Kong’s funding market. Companies deemed “stressed” (borrowing costs above 15%) have to repay $2.1 billion of offshore dollar notes next month. Standard & Poor’s says they rely on a constant flow of sales to cover past debts.

Some 25 provinces and municipalities were supposed to go back to work this week but this clashed head on with virus control measures. Companies may not reopen plants unless they can track the exact movements and medical data of each worker and comply with a 14-day quarantine period where necessary (we now learn the incubation may in fact be 24 days). Officials dare not be lenient after Xi Jinping’s latest tirade.

The Guangzhou authorities have ordered plants to remain closed until early March in large parts of the city with warnings of ferocious penalties. Apple supplier Foxconn has yet to restart its core iPhone plants in Zhengzhou and Shenzhen. Just 10% of its workers have turned up. Caixin reports that Foxconn may wait until March before restarting.

Meanwhile the near complete shutdown of Shanghai’s manufacturing hub in Songjiang belied early claims that 70% of plants were going back to work.

This article contains valuable vignettes of what is happening in China, but they barely scratch the surface. An even bigger story is the extent to which the disruption in China from coronavirus is not only slowing the Chinese economy but is also disrupting global supply chains and slowing output around the world.

IMG 3

This chart prepared by the Johns Hopkins University based on official data provided by China and other nations shows the total number of confirmed cases of coronavirus infection as of Feb. 14, 2020 (orange line). Wall Street was encouraged by a prior update that showed 44,700 confirmed cases. Then cases increased by over 15,000 in a single update. The resulting near-vertical slope of the graph blew up Wall Street wishful thinking and triggered a downdraft in stock markets worldwide. As of Feb. 15, confirmed cases had increased to 64,447. The pandemic is far from under control and spreading quickly.

Production shutdowns in China are reducing exports of high-tech inputs from South Korea, Japan and Germany. Likewise, the extreme reductions in exports from China (due to plant closures) are hurting sales by European and U.S. distributors and retail outlets.

Independent of production and sales bottlenecks, there are massive transportation bottlenecks as vessels and crews are quarantined or refuse to enter Chinese ports at all.

The tech sector may be the hardest hit of all. In addition to coronavirus disruption, the U.S. Department of Justice last week indicted China’s largest telecommunications device and network provider, Huawei, on racketeering charges.

The Pentagon also reversed a prior determination and agreed that the Commerce Department can put Huawei on an export control list, which prohibits sales of processors and other high-tech components to Huawei by U.S. firms.

These measures are certain to invite retaliation by China against U.S. firms in the tech supply chain.

This story isn’t going away anytime soon.

Regards,

Jim Rickards
for The Daily Reckoning

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Not Over by a Long Shot

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Are you tired of hearing about the coronavirus? Well, you shouldn’t be because it’s a serious situation with global consequences.

Markets have been following the spread of the coronavirus (COVID-19) closely for good reason.

The Chinese economy, second largest in the world, is shutting down in stages. In affected areas, streets are empty, stores are closed, planes and trains are not running.

Over 60 million people are “locked down,” which means they are confined to their homes and can only leave once every three days to buy groceries (if they can find any due to hoarding).

The effects go far beyond China because of global supply chains. If Chinese factories are closed, they are not buying components from South Korea, Japan and Germany. Likewise, if Chinese factories are closed, they cannot supply finished goods to U.S. buyers.

The result is that factories and sales are also slowing in developed economies.

Still, markets are taking a measured view. Some epidemic models showed the disease would peak in April 2020 and tail off quickly from there.

The other assumption was that any dip in the Chinese economy would be made up later in the year so that the total impact would be minimal when viewed on an annual basis.

All of those assumptions were blown-up in a matter of minutes in the late evening of Wednesday, Feb. 12.

In a single update, 14,840 new infections were reported, moving the total from 45,000 to about 60,000 cases.

This did not mean that 14,840 people were infected in one day.

It meant that China suddenly became more transparent and decided to include existing cases using more valid diagnostic criteria.

But the change did move the official statistics closer to the amount shown in a leak on Tencent (that showed about 150,000 infections) and a Lancet (a preeminent medical journal) model-based input that also estimated about 150,000 cases.

Officially, China has reported 118 new deaths, bringing the number of (official) deaths nationwide to at 2,236.

China has also reported 1,109 new confirmed cases, dramatically up from 349 cases the previous day.

And now, for the third time in eight days and the second time in 24 hours, Chinese officials made changes to how they count coronavirus cases.

When asked if he thought the virus will be contained, World Health Organization director Tedros Adhanom Ghebreyesus said, “The window of opportunity is narrowing, so we need to act quickly before it closes completely.”

The bottom line is that the disease is worse than Wall Street believed, the economic damage is greater and it will take longer to get the disease under control. Stock prices fell after the news was reported.

As more bad news dribbles out, that stock price adjustment has further to fall.

Regards,

Jim Rickards
for The Daily Reckoning

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2020 Forecast for Markets & Elections

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Just because impeachment is almost over and it’s an election year does not mean that Congress won’t be the scene of anti-Trump activity. Congress is set to keep up the pressure on Trump on a daily basis, and the attacks will continue.

Investors should not be shocked if the House impeaches Trump a second time.

There’s no legal limit on the number of times a president can be impeached or the number of articles of impeachment that can move forward. The House impeached Trump in 2019 on bogus claims that aren’t even crimes. If they did it once, they can do it again.

Some of the new charges being floated include whether it was legal for Trump to order the killing of mastermind terrorist Maj. Gen. Qasem Soleimani. The killing was clearly legal since Soleimani had officially been declared a “terrorist” under the Authorization for Use of Military Force Act (AUMF) and Iran had been declared a state sponsor of terrorism.

Both designations allowed the U.S. legally to kill a terrorist on foreign soil who was planning terrorist acts against the U.S. Obama had used the same legal rationale to kill hundreds of terrorists in Pakistan, Afghanistan and Yemen.

Still, Democrats are claiming that this was an “assassination,” which is illegal under U.S. law. You can expect congressional hearings and possible impeachment charges along these lines this spring.

Another potential impeachable offensive consists of violations of the Emoluments Clause of the U.S. Constitution alleging that Trump profits when foreign diplomats stay in his hotels. He doesn’t; Trump returns any revenues to the U.S. Treasury.

The House of Representatives can also be expected to hold hearings on alleged Trump “money laundering” in connection with property development in Russia. There’s no evidence of this, but that won’t stop Democrats from making the allegation.

Trump’s relationship with Deutsche Bank and its financing of his hotels and other properties including the identities of third-party investors will also come under scrutiny.

Other anti-Trump efforts will include hearings to get testimony from Secretary of State Mike Pompeo related to the Soleimani killing and testimony from former National Security Adviser John Bolton related to the Ukrainian military aid that triggered the first impeachment.

New matters related to Ukraine are also emerging in connection with reported Russian hacking of Burisma, the Ukrainian company that paid Hunter Biden (Joe Biden’s son) millions of dollars for a no-show job for which he was unqualified.

Somehow Democrat critics of Trump can’t get enough of the Russian collusion allegations, even though the Mueller investigation showed no connection at all between Russia and Trump.

All of these matters (Soleimani, property finance, Ukraine and War Powers in Iran) may form the basis for new articles of impeachment against Trump.

This could play out over the course of the spring and summer just as the campaign season is heating up. This may be designed to stir up the Democrat base, but it will probably have the opposite effect of increasing turnout of Trump supporters.

With or without new articles of impeachment, the congressional hearings, bogus claims and anti-Trump rhetoric will continue without relief. Trump will stay on track, but markets may weary of the uncertainty and be worn down by the hyperbolic rhetoric.

Alongside the drama of impeachment and the scandals yet to be revealed, we still have the economy and stock market for investors to focus on. And right now they’re looking good for Trump.

There is almost zero risk of a recession in the next three months and less than a 20% chance of a recession before November. That’s good news for Trump because a recession (or lack of one) is the single strongest indicator of whether an incumbent president will be reelected.

The probability of Trump’s reelection is roughly the inverse of the probability of a recession before the election. If recession odds are 20%, then Trump’s reelection odds are roughly 80% (with adjustment for various factors).

Each month that goes by reduces the odds of a preelection recession even further, which means that Trump’s reelection odds go up. Trump should have a 90% chance of winning by Election Day absent extreme and unexpected economic shocks in the next nine months.

Trump’s chances are also helped by the weakness of his opponents. Americans have shown no appetite for the kind of socialism being touted by Bernie Sanders and Elizabeth Warren. Pete Buttigieg lacks African-American support, which is indispensable for a Democrat. Joe Biden lacks energy and is exhibiting some cognitive problems that will raise serious doubts among voters and hurt his debate performance.

What about the Fed?

The Fed will cut interest rates at least once before the election. This rate cut will not happen at the March or April FOMC meetings because that’s too soon after the Fed told markets it was hitting the “pause” button last December.

The rate cut will not happen in the July or September FOMC meetings because that’s too close to the election and the Fed does not want to appear to be tipping the scales in favor of one party or the other. The Fed will be on hold from July until after the election.

Through a simple process of elimination, the Fed will cut rates in June.

The Fed’s reasons for the rate cut (which markets do not expect) will not be explicitly to help Trump’s reelection (although that will be one consequence). The reason will be to provide an insurance policy against disinflation and recession. The Fed knows its hands will be tied until December, so it will provide a rate cut just to be on the safe side.

A June rate cut will give another boost to stocks, which should continue to perform well. As the election approaches and Trump’s victory becomes more apparent, stocks will gather momentum in expectation of four more years of lower taxes, less regulation and a pro-business environment.

Gold will also get a boost from another rate cut. This comes on top of continued strong buying from Russia, China and Iran and flat output by miners. Geopolitics play a big role in gold prices as a “flight to quality” trend emerges during each overseas crisis. The coronavirus has been a major factor that has taken gold past $1,600 an ounce. The next crisis will send gold even further.

But how might this November’s election affect the political balance in Congress?

As things stand today, not only will Trump be reelected but Republicans should hang onto control of the Senate and possibly retake the House of Representatives. Control of the White House and the Senate alone gives Republicans control of judicial appointments (including one or two more Supreme Court Justice seats) and control of treaties.

Retaking the House will be more difficult but not at all impossible. Presidents typically lose seats in the House in their first midterm election after winning the White House. Trump’s losses in 2018 were actually fewer than Clinton’s in 1994 (when Newt Gingrich led Republicans to the majority for the first time since 1955) and Obama’s in 2010 (when the tea party arose to reject Obama’s policies).

There were 31 Democrats elected in 2018 in districts that Trump had won by five or more points in 2016. All but two of those Democrats voted in favor of impeachment. One of those two has since switched to the Republican Party.

Today, the Republican Party holds 197 seats in the House. Control of the House requires 218 seats. The Republicans need a net gain of 21 seats to take control of the House. With 30 highly vulnerable Democrats (because of impeachment) and demonstrated coattails on the part of President Trump, picking up 21 of those 30 seats (while holding all existing seats) seems well within reach.

A Republican clean sweep of the White House, the Senate and the House with ongoing control of the Supreme Court and other judicial appointments is the most likely outcome for November 2020.

But, there will be a lot of land mines exploding between now and then. Call it another year of living dangerously.

Regards,

Jim Rickards
for The Daily Reckoning

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Are They Going to Impeach Trump Again?

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The Democratic candidates held another debate last night. Michael Bloomberg took a lot of heat from the others, and he did not handle it well. He showed real weakness for the first time.

Joe Biden, meanwhile, put in a strong performance last night. We’ll have to see if he can generate any momentum from it. After Iowa and New Hampshire, his campaign is in serious trouble.

Speaking of Iowa, they still haven’t resolved that mess…

The Iowa caucus was officially over on Feb. 3. But it’s not over yet and may never be over.

The conduct of the caucus was one of the biggest fiascos in modern political history and the repercussions are still being felt. You probably know the story by now.

A caucus is not a primary election. It’s a physical gathering of voters at about 1,600 precinct locations such as school gyms and similar venues around the state.

That’s a limiting factor right away because many voters don’t have the flexibility to show up at an appointed time and place. Voters organize in groups backing a certain candidate.

An initial count of support for each candidate is taken. Candidates’ groups who have less than 15% of the total are then told they can either go home or switch sides (with less than 15% support you get zero delegates).

Voters then reorganize — for example, a Biden supporter can switch to Liz Warren — and a second count is taken.

That second count is then used in a mathematical formula to assign delegates for the Democratic convention.

The number of delegates for each candidate is not proportional to votes in the second count because some precincts are overweighted. Got it?

Don’t worry; neither does anyone else. That system is nuts. But it gets worse…

A new mobile phone app was created to send in results. The app had never been used in actual voting and it crashed.

Precinct organizers were told to phone in results. The phone lines were jammed and organizers couldn’t get through. That didn’t matter because party officials in the central locations were told to leave their mobile phones outside.

Others could not get online. Some did not know how to use spreadsheets. TV network anchor desks were on the air with nothing to report.

Candidates were robbed of bragging rights, both on caucus night and in the days leading up to the New Hampshire primary on Feb. 11. Iowa results dribbled out over days in a way that seemed intentionally designed to hurt Bernie Sanders.

Finally, the chair of the Iowa Democratic Party resigned in disgrace.

As of now, it is reported that Bernie Sanders won the most votes in the first and second alignments, but Pete Buttigieg got the most delegates because of the quirky math formula.

But even that reported result is not final because a “re-canvass” recount is underway.

The biggest loser was not among the candidates. The biggest loser was the Democratic Party itself.

Commentators were quick to ask how Democrats can run the economy if they can’t even count votes in Iowa. Good question.

But could they be so dumb as to actually try to impeach Trump again?

If the Democrat effort to impeach Trump was grounded in political hatred rather than constitutional law, why would the Democrats not do it again?

The answer is that the impeachment efforts are not stopping.

House Democrats are already planning hearings on Trump’s reassignment of Lt. Col. Alexander Vindman and his firing of Ambassador Gordon Sondland, both of whom provided anti-Trump (but incompetent, irrelevant and immaterial) testimony during Adam Schiff’s unconstitutional impeachment show trial.

Trump also reassigned Vindman’s twin brother, Yevgeny, for subversive activities in the National Security Council.

Other avenues of anti-Trump inquiry include an expected appeals court ruling that may require testimony from former Trump White House counsel Don McGahn, further inquiry into Russian collusion allegations (the hoax that won’t die), possible violations of the Emoluments Clause (despite court rulings dismissing partisan lawsuits against Trump) and pursuit of testimony from John Bolton that was not part of the Senate trial.

In short, there is no shortage of fake allegations on which to base a new impeachment.

We can’t be certain there will be another impeachment this year, but it cannot be ruled out. Impeachment hearings could begin again this spring ahead of a new impeachment vote this summer and a trial in August just in time for the Republican convention.

Another possibility is Trump wins a second term (likely, in my view) and the Democrats keep control of the House, in which case another impeachment in 2021 is a high probability.

This is bad for the country and is actually bad for Democrats, as shown in the polls. Yet the Democrats seem to be the last to know.

Regards,

Jim Rickards
for The Daily Reckoning

P.S. It’s the Democrats’ worst nightmare.

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“Conservative Economics”

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We learn of the pending birth of a new organization — American Compass by title.

Its existence will serve one high and noble purpose, claims executive director Oren Cass:

“Helping American conservatism recover from its chronic case of market fundamentalism.”

Just so. Yet we were unaware that American conservatism was down with the disorder.

American conservatism congregates broadly under the Republican Party’s tent.

This same Republican Party gives few symptoms of the virus described…

A Chronic Case of Market Fundamentalism?

It might suffer a slight wheeze, a sniffle, a light cough, perhaps a rare gag — but no chronic or debilitating symptoms.

Its core temperature never exceeds 99.2 degrees of Fahrenheit.

These fellows may argue that a 39% rate represents a dangerous flirtation with socialism, a menace to American liberty and civilization.

But a 36% top marginal tax rate is nearly freedom itself.

Government spending may safely consume 20% of the gross domestic product, they allow. But should it exceed 23%… poor Adam Smith would do 100,000 revolutions in his grave.

We exaggerate for effect, perhaps. But we believe the central case is sound…

Cleaning up the Whorehouse

We believe most conservative anti-government enterprise aspires to “clean up the whorehouse,” while “keeping the business intact”… in libertarian Frank Chodorov’s unimprovable words.

Consider one example exquisitely in point…

The late Butler Shaffer was a retired professor of law at Southwestern University.

Here he recalls the 1964 Republican National Convention — where a modern Patrick Henry, Barry Goldwater, thundered in defense of liberty. But in reality?

I sat in the Cow Palace in San Francisco as part of my state’s delegation to the Republican National Convention (i.e., the Goldwater Convention)… Afterward, I was enjoying a drink at the top of the Mark Hopkins Hotel with one of Goldwater’s advisers. I asked: “Now that Goldwater has the nomination, let us suppose that he gets elected president. What do you think he would do to begin cutting back on federal government power?”

“What do you mean?” my acquaintance answered. I reminded him of Goldwater’s book The Conscience of a Conservative, wherein he proposed eliminating a few government programs (federal involvement in education being one area).

The other man answered: “Don’t be absurd: If Goldwater gets elected president, the most we would hope to accomplish would be to slow down the rate of growth of government.”

That is, to tidy up the cathouse… while “keeping the business intact.”

And that was under the firebrand Goldwater. What could you possibly expect of feebler conservatives?

The business has remained intact ever since. Indeed, it has expanded to dimensions truly pornographic…

Not so Conservative

Market fundamentalism holds a disdainful view of government deficits. Yet…

Did not presidents Ronald Reagan, George Walker Bush, George Herbert Walker Bush, Donald Trump — Republicans all — vastly expand deficits?

And was it not a Republican who shook off deficits entirely?

They do not matter, said he.

Did not the Republican-held Senate vote to uphold the Patient Protection and Affordable Care Act — Obamacare — when presented the opportunity to scotch it?

As we recall, it did.

Many of these same gentlemen and ladies insist health insurance providers cover “preexisting” medical conditions…

Not Exactly Market Fundamentalism

These fine people may be the soul of compassion.

And the mandate itself may be more humane than humanity itself. It may even count as the “right thing to do.”

Yet market fundamentalism it is not. It wars against the most elemental concept of insurance.

As well demand fire insurance once the house has burned to the earth, or life insurance when the body is in the morgue.

And we might remind the aforesaid Mr. Cass…

The Obamacare mandate to purchase health insurance has a close relative, a kissing cousin, in an earlier proposal by the conservative Heritage Foundation.

Freedom Isn’t Enough

Yet Mr. Cass is somewhat ruffled that all conservative “thinks tanks” labor incessantly to:

Advance the principles of “limited government, free enterprise and individual liberty” or “free markets and limited, effective government” or “free enterprise, limited government, individual freedom” or “individual liberty, limited government, free markets” or “economic choice and individual responsibility” or “individual, economic and political freedom, private enterprise and representative government.”

Please understand — this fellow has no heat against any of these. To the contrary!

“Without question,” he affirms, “those principles are vital.”

But he insists they are unequal to the times in which we live. He argues these times instead require a “conservative economics.”

A Manifesto

What precisely constitutes a conservative economics, Mr. Cass?

Conservative economics will take seriously the effects of social and market forces on each other. It will concern itself with the pernicious effects that high levels of economic inequality can have on the social fabric, the market’s functioning and people’s well-being, regardless of absolute material living standards…

Conservative economics will also accord equal respect to the concerns of capital and labor, rather than claiming that whatever is best for shareholders in the short run will eventually prove best for workers as well. It will favor collective worker representation that affords real influence in setting the terms and conditions of employment over the fiction that individual employees enjoy the freedom to each negotiate their own terms. It will be aware that cheerfully abandoning the world’s industrial supply chains to Asia was, is and always will be irresponsible.

Many details of this conservative economics remain dim, to us at least.

More of the Same

But we are certain conservative economics equals:

More government poking, harassing, bossing, wrenching, manhandling and roughhousing.

In two words… more government.

In four additional words, more of the same.

That is, it will not leave you to tend your own affairs.

This Cass fellow means the best in the world, we are convinced of it.

But if he is so hot about “the pernicious effects that high levels of economic inequality can have on the social fabric, the market’s functioning and people’s well-being, regardless of absolute material living standards”…

Why not have a go at the Federal Reserve? Why not put the thing on trial?

A Report Card on “Unconventional Monetary Policy”

Its war on interest rates has vastly prospered the asset-owning classes — the rich. It has worked very little benefit for Americans residing on what is called Main Street.

In 2018 Deutsche Bank released what it terms “a report card for unconventional monetary policy.”

“Unconventional monetary policy” of course refers to quantitative easing, zero interest rates, negative interest rates and the devil and the rest of the tools in the central banker’s deepening kit.

Deutsche Bank examined their impact on several metrics of economic performance around the world.

The telling results, as summarized by analyst Daniel Lacalle:

1. In eight of the 12 cases analyzed, the impact on the economy was negative.

2. In three cases, it was completely neutral.

3. It only worked in the case of the so-called QE1 in the U.S. and fundamentally because the starting base was very low and the U.S. became a major oil and gas producer.

For emphasis:

In 11 of 12 instances… “unconventional monetary policy” proved either negative or insignificant.

And eight of the 12 proved outright negatives.

We enter the following graphic into the record as evidence of central bank futility:

IMG 1

Meantime, the total market cap of the United States stock market presently rises to 158% of United States GDP — a record high.

What about “cheerfully abandoning the world’s industrial supply chains to Asia”?

Trade and the End of the Gold Standard

Well, Mr. Cass, we suggest you broaden your inquiry.

America abandoned the world’s industrial supply chains to Asia long ago.

But you can blame the United States dollar as much as traitorous corporations…

In the mid-1970s, Richard Nixon scissored the dollar’s final tether to gold.

The gold standard, a poor imitation in its dying days, nonetheless kept the balance of trade in a range.

A nation running a persistent trade deficit placed its gold stocks at risk. The more foreign goods came in… the more domestic gold went out.

The ersatz dollar removed all checks.

America no longer had to produce in exchange for goods… or fear for its gold.

Scraps of paper, rolling off an overworked printing press, became America’s primary production.

Ream upon ream went abroad in exchange for goods — real goods.

The international division of labor was opened to hundreds of millions, particularly peasants from the labor-rich fields of China.

What does “conservative economics” have to say about all this?

Little, we suspect.

The Real Whorehouse

It is far easier to dragoon the American people with this law, to club them on the head with that law, to shove them this way or that way.

Which is — incidentally — precisely what any “progressive economics” would promise.

We prefer economics instead — that is, economics without adjectives.

Or if you must have one… sound economics.

But that would require, in our telling, cleaning out the Federal Reserve as it presently exists.

That is, cleaning out the whorehouse itself.

And both sides are determined to keep that business intact…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Too Many Eggs in Too Few Baskets

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Never before have so many owed so much… to so few.

We refer not to Sir Winston Churchill and the Battle of Britain. We refer instead to the Federal Reserve and stock market.

Set aside the latest coronavirus rattles…

The market has been on a gorgeous spree since Mr. Powell and his mates reopened the liquidity spigots last January.

But only a very few stocks account for its joy. These are the wagon-pullers of this market, the draft horses hauling the laggards along.

We refer to Apple, Microsoft, Alphabet (Google’s parent company), Amazon and Facebook.

The Heavy Lifting

These combined behemoths boast a market cap in excess of $4.1 trillion — over 10% of the stock market’s overall $34 trillion.

When they move, they drag the market along. And moved they have…

Apple has returned some 112% this past year. Microsoft has gained over 75%. Alphabet has added perhaps 20%. Amazon has gained roughly 25%. Facebook has put in a 44% advance.

You hear references to the top 1% of Americans? These represent the top 1% of stocks.

These mighty five account for virtually all of last quarter’s S&P earnings upside. Wash them out — and the S&P’s earnings amounted to naught.

And as SocGen data hound Andrew Lapthorne informs us…

S&P net income actually plunges 7.5% if you minus out the contributions of these five colossi.

We should not be surprised, then, that the vast majority of S&P components have taken in their sails… and reduced their stock buybacks.

The Rich Get Richer

Mr. Lapthorne reveals that buybacks outside the mighty five plunged 32% last quarter.

But these titans?

Their buybacks increased 10.5% over the same space. Buybacks tend to inflate — artificially — the stock price.

Is it then a wonder that these stocks presently outpace the broader market by the largest margin ever… as Lapthorne informs us?

It is no wonder whatsoever.

But what if these wagon-pullers pull up lame?

All the Market’s Eggs in Five Baskets

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.

Consider, for example, Apple…

The coronavirus has taken a deep bite of this Apple.

Much of their gadgetry rolls out of Chinese factories. Yet the coronavirus has these factories running far beneath capacity.

And Apple has closed the doors on all 42 of its Chinese stores. None has reopened.

Apple is shaving down first-quarter revenue projections in consequence.

What is more, the woes may continue…

Falling Inventories

A certain Bill Lu directs Asian semiconductor research at UBS. From whom:

The impact starts looking bigger and bigger, and in the coming weeks, the impact will grow. Inventory is low in the smartphone supply chain.

What if the coronavirus extends its siege into the second quarter, the third… the fourth?

We issue no prediction of course. We merely raise possibilities. Meantime…

The total market cap of the United States stock market presently rises to a stratospheric 158% of United States GDP.

That is a record — never has the market tested dizzier heights.

But if investors — or the computer algorithms — drop the Apple, gravity should give the overall market a good hard tug…

The Higher They Rise, The Farther They Fall

Again, a mere handful of stocks are doing a majority of the pushing. Apple is one of them.

But if a mere handful of stocks push the market higher… they can also drag it in the other direction.

As reports Goldman Sachs:

“Narrow bull markets eventually lead to large drawdowns.”

Compounding the trouble is the strategy of “passive investing.”

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

After the 2008 near-collapse, the Federal Reserve emptied in oceans of liquidity.

The tide rose — and all with it.

The Facebooks, Apples, Amazons, Googles and Microsofts of this world have led the way up.

Much of Wall Street poured into these stocks… put its feet up, loafed… and let gravity take it to record highs.

“Fundamentals” no longer mattered. The Federal Reserve has rendered them quaint.

The Death of Fundamentals

And so the Federal Reserve has blown an artificial bubble. Laments analyst Sven Henrich of NorthmanTrader:

A market that never discounts any reality by force of constant intervention is by definition an artificial bubble.

Central banks have made a mockery of price discovery and the free flow of capital.

All markets are now are a central bank policy chase operation…

Only the outperformance of the mighty five has masked the warts within:

The larger market of stocks is in a much larger earnings recession already and five stocks have been masking it all.

Five stocks are the safe haven in a market that’s been forced to chase yield and growth where it can find it…

And so global markets are at all-time highs with Japan in a recession, Germany at 0% GDP growth and the second-largest economy in the world [China] with 330% debt to GDP at a virtual standstill.

All is peace while the tide rises… and gravity lightens. But the danger is this, as we have written before:

When the tide recedes… it recedes with fearful vengeance.

And gravity dramatically reasserts its dominion.

Panic Selling Begets Panic Selling

The same handful of stocks that hauled markets up on one tide can drag them rapidly down on another.

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

The result is a delirium.

It is this panic selling that gave the Dow Jones an impossible 22% whaling on 1987’s “Black Monday.”

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.

Jim closes with a thumping conclusion:

“This is one more reason why the next stock market crash will be the greatest in history.”

Let the record reflect:

That history includes 1929… 1987… 2000… 2008.

And five stocks may well lead the way down next time…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Too Many Eggs in Too Few Baskets appeared first on Daily Reckoning.

“Mandate of Heaven” in Jeopardy

This post “Mandate of Heaven” in Jeopardy appeared first on Daily Reckoning.

The U.S. markets are closed today for Presidents Day. If you have the day off, I hope you’re enjoying your long weekend.

But one event is taking center stage in the world that affects not only basic survival for millions of people, but the health of the global economy overall.

Of course, I’m talking about the coronavirus outbreak currently playing out before our eyes in China.

China’s economy was slowing substantially before the outbreak of the highly contagious and deadly virus last fall. This slowing was the predictable result of excessive debt levels, Trump’s retaliation in the trade wars, and China’s encounter with what development economists call the “middle-income trap.”

Developing economies can grow at double-digit rates as they move from low-income (about $3,000 annual per capita income) to middle-income (about $10,000 annual per capita income).

The main requirements are limits on corruption, a large pool of available labor, and an attractive legal environment for foreign direct investment. Once investment is used for infrastructure and labor is mobilized, large-scale basic manufacturing can commence.

This powers growth and the accumulation of hard currency reserves from export earnings.

The difficulty begins when an economy tries to move from middle-income to high-income (about $18,000 annual per capita income). That move requires more than cheap labor and infrastructure investment. It requires applied technology to produce high-value added products.

Only Taiwan, South Korea and Singapore have made this transition, (excluding Japan after World War II, and oil-exporting nations).

This explains why China has been so focused on stealing U.S. intellectual property.

Trump has been closing that avenue. China cannot generate the needed technology through its own R&D. China is stuck in the middle-income trap and a slowdown in growth is the inevitable result.

The story gets worse for China.

As of Friday, the total reported number of people infected by the coronavirus was 64,435. And the death toll was up to 1,383, including three people outside of China.

Those figures are official statistics released by China and other countries around the world where the virus has spread.

However, there is substantial medical, anecdotal, and model-based evidence that the actual infection rate and death rate may be ten to twenty times higher than those official statistics.

Over 60 million Chinese in several major cities are under “lock-down” where individuals are confined to their homes and may only leave once every three days to buy groceries.

Streets are empty, stores are closed, trains and planes are not moving, and factories are shut. The Chinese economy is slowly grinding to a halt.

This not only affects China’s economy as a whole, but the contagion filters down into individual companies that are dependent on China both for supply chain inputs and final sales.

And it will have a rippling effect on the U.S. economy also. This story has a long way to run.

Regards,

Jim Rickards
for The Daily Reckoning

The post “Mandate of Heaven” in Jeopardy appeared first on Daily Reckoning.

Beware the Yield Curve

This post Beware the Yield Curve appeared first on Daily Reckoning.

If you’re a regular Daily Reckoning reader, you’ve probably heard of the “yield curve,” and an “inverted yield curve.” A yield curve inversion is a classic recession warning signal. This is a very powerful indicator because it has preceded every recession of the last 60 years.

That means an inverted yield curve has preceded recession on seven out of seven occasions for the past 60 years. Only once did it give a false positive, and that was in the mid-1960s.

And when recessions hit, stocks are vulnerable to crashes. An inverted yield curve has provided warning of every major stock market “event” of the past 40 years.

That’s why several different measurements of the yield curve are important to monitor. The most-cited yield curve calculation is the 10-year U.S. Treasury yield minus the 2-year U.S. Treasury yield.

But a market crash is not an immediate reaction to a yield curve inversion. During the last two major bear markets, for example, the worst of the selling didn’t start until a few years after the yield curve hit zero or negative. So when you hear that the yield curve has inverted, it doesn’t mean you have to run out and sell all your stocks. It can be a very long time before it shows up in the stock market.

But you should watch the Fed. During these bear markets, the selling of stocks coincided with a panicked series of rate cuts from the Fed.

If investors become risk averse and fear an imminent recession, Fed rate cuts cannot stop investors from selling stocks and de-risking their portfolios. It’s important to realize that Fed interest rate policy can only exert control over the stock market if investors maintain a strong appetite for risk.

The message from a different measure of the yield curve — like the 10-year Treasury yield minus the 3-month Treasury yield — is similar. Incidentally, the Fed places more importance on this part of the bell curve than the 10-year/2-year part of the curve.

The change in this yield curve, shown in the green line below, has been substantial thus far in 2020:

IMG 1

If these two yield curves remain near zero (or below zero) for an extended period of time, then the machinery of bank credit creation can grind to a halt. That’s why anytime the yield curve gets too depressed, the Fed tends to react by cutting short-term rates. Lower short-term rates in turn “re-steepen” the yield curve. In other words, it’s an attempt to restore the normal shape of the yield curve.

It’s no wonder the fed funds futures market has boosted its probability of a 25 basis point Fed rate cut at the June 2020 meeting from about 15% to 37% in just the past few weeks.

Far ahead of this move in the futures market, my colleague Jim Rickards predicted that the Fed would cut rates 25 basis points at the June meeting in an effort to re-steepen the yield curve. If the Fed doesn’t cut rates soon, then the supply of bank loans is likely to tighten in the months ahead.

Having described these trends, we need to ask: How does the yield curve affect the real economy?

During credit booms, banks are happy to make new loans because the interest rate on loans generally exceeds the cost of funding those loans (through deposits and the like). And when banks create those loans on the asset side of their balance sheet, they simultaneously create new money supply on the liability side of their balance sheet.

A growing money supply usually means there’s plenty of money flowing through the economy. As this money flows from consumers to producers, it can be used to service outstanding debts that have been made in the past.

U.S. government deficits and Fed balance sheet expansions also add to the money supply, but most of today’s money supply (the so-called “M2” supply) was loaned into existence by the banking system.

As banks’ “net interest margins” compress, they tend to get pickier about what loans they make. And as loan growth slows, money supply growth slows.

The yield curve foreshadows the trend in future bank profit margins, and it doesn’t look bullish.

If banks aren’t earning decent profit margins on new loans, that’s a problem for a highly indebted economy with many borrowers that must constantly refinance their loans.

Within a matter of months, loan defaults can spike. When defaults get bad enough to threaten the banking system, the Fed panics and cuts rates. We haven’t seen many defaults in recent bank earnings reports, but there are concerning trends in credit card defaults.

This credit cycle has lasted an extraordinarily long time because the Fed kept emergency-style monetary policy in place from 2008 up until it started timidly hiking rates in December 2015.

Super-easy policy has allowed an epic boom in credit — especially in corporate bonds — to hit unprecedented heights. The burden of bank debts and bond debts is as big as ever, so the U.S. economy has become less tolerant of a flat yield curve over time.

Many investors have been waiting to sell stocks and de-risk portfolios until six or 12 months past the point of yield curve inversion. Such investors are confident that we’re in the equivalent of 1999 or 2006 in the cycle, so they expected one last “melt-up.”

The sharp rebound in stocks since December 2018 certainly looks like a melt-up, despite the latest concerns about the coronavirus, which have affected the stock market. But the market’s still at or near record highs, depending on the day.

Maybe the market has more room to run. But most stocks have risen long past the point of being supported by valuations and are dependent on more and more new buyers entering the market to continue rallying.

But with each economic cycle, the heavily indebted U.S. economy clearly has less tolerance for tight monetary policy, yield curve inversion and slowing money supply growth.

Corporate profits have been getting squeezed for several quarters, but investors largely have not cared. They only care that the Fed reversed its policy course rapidly in 2019, switching to radical easing.

Could another 25 basis point cut in mid-2020 rekindle another wave of speculation?

Perhaps. But the next Fed rate cut would likely be in response to deteriorating credit conditions. And stocks rarely rise under such conditions.

So this is the time to be careful.

Regards,

Dan Amoss
for The Daily Reckoning

The post Beware the Yield Curve appeared first on Daily Reckoning.

Beware the Yield Curve

This post Beware the Yield Curve appeared first on Daily Reckoning.

If you’re a regular Daily Reckoning reader, you’ve probably heard of the “yield curve,” and an “inverted yield curve.” A yield curve inversion is a classic recession warning signal. This is a very powerful indicator because it has preceded every recession of the last 60 years.

That means an inverted yield curve has preceded recession on seven out of seven occasions for the past 60 years. Only once did it give a false positive, and that was in the mid-1960s.

And when recessions hit, stocks are vulnerable to crashes. An inverted yield curve has provided warning of every major stock market “event” of the past 40 years.

That’s why several different measurements of the yield curve are important to monitor. The most-cited yield curve calculation is the 10-year U.S. Treasury yield minus the 2-year U.S. Treasury yield.

But a market crash is not an immediate reaction to a yield curve inversion. During the last two major bear markets, for example, the worst of the selling didn’t start until a few years after the yield curve hit zero or negative. So when you hear that the yield curve has inverted, it doesn’t mean you have to run out and sell all your stocks. It can be a very long time before it shows up in the stock market.

But you should watch the Fed. During these bear markets, the selling of stocks coincided with a panicked series of rate cuts from the Fed.

If investors become risk averse and fear an imminent recession, Fed rate cuts cannot stop investors from selling stocks and de-risking their portfolios. It’s important to realize that Fed interest rate policy can only exert control over the stock market if investors maintain a strong appetite for risk.

The message from a different measure of the yield curve — like the 10-year Treasury yield minus the 3-month Treasury yield — is similar. Incidentally, the Fed places more importance on this part of the bell curve than the 10-year/2-year part of the curve.

The change in this yield curve, shown in the green line below, has been substantial thus far in 2020:

IMG 1

If these two yield curves remain near zero (or below zero) for an extended period of time, then the machinery of bank credit creation can grind to a halt. That’s why anytime the yield curve gets too depressed, the Fed tends to react by cutting short-term rates. Lower short-term rates in turn “re-steepen” the yield curve. In other words, it’s an attempt to restore the normal shape of the yield curve.

It’s no wonder the fed funds futures market has boosted its probability of a 25 basis point Fed rate cut at the June 2020 meeting from about 15% to 37% in just the past few weeks.

Far ahead of this move in the futures market, my colleague Jim Rickards predicted that the Fed would cut rates 25 basis points at the June meeting in an effort to re-steepen the yield curve. If the Fed doesn’t cut rates soon, then the supply of bank loans is likely to tighten in the months ahead.

Having described these trends, we need to ask: How does the yield curve affect the real economy?

During credit booms, banks are happy to make new loans because the interest rate on loans generally exceeds the cost of funding those loans (through deposits and the like). And when banks create those loans on the asset side of their balance sheet, they simultaneously create new money supply on the liability side of their balance sheet.

A growing money supply usually means there’s plenty of money flowing through the economy. As this money flows from consumers to producers, it can be used to service outstanding debts that have been made in the past.

U.S. government deficits and Fed balance sheet expansions also add to the money supply, but most of today’s money supply (the so-called “M2” supply) was loaned into existence by the banking system.

As banks’ “net interest margins” compress, they tend to get pickier about what loans they make. And as loan growth slows, money supply growth slows.

The yield curve foreshadows the trend in future bank profit margins, and it doesn’t look bullish.

If banks aren’t earning decent profit margins on new loans, that’s a problem for a highly indebted economy with many borrowers that must constantly refinance their loans.

Within a matter of months, loan defaults can spike. When defaults get bad enough to threaten the banking system, the Fed panics and cuts rates. We haven’t seen many defaults in recent bank earnings reports, but there are concerning trends in credit card defaults.

This credit cycle has lasted an extraordinarily long time because the Fed kept emergency-style monetary policy in place from 2008 up until it started timidly hiking rates in December 2015.

Super-easy policy has allowed an epic boom in credit — especially in corporate bonds — to hit unprecedented heights. The burden of bank debts and bond debts is as big as ever, so the U.S. economy has become less tolerant of a flat yield curve over time.

Many investors have been waiting to sell stocks and de-risk portfolios until six or 12 months past the point of yield curve inversion. Such investors are confident that we’re in the equivalent of 1999 or 2006 in the cycle, so they expected one last “melt-up.”

The sharp rebound in stocks since December 2018 certainly looks like a melt-up, despite the latest concerns about the coronavirus, which have affected the stock market. But the market’s still at or near record highs, depending on the day.

Maybe the market has more room to run. But most stocks have risen long past the point of being supported by valuations and are dependent on more and more new buyers entering the market to continue rallying.

But with each economic cycle, the heavily indebted U.S. economy clearly has less tolerance for tight monetary policy, yield curve inversion and slowing money supply growth.

Corporate profits have been getting squeezed for several quarters, but investors largely have not cared. They only care that the Fed reversed its policy course rapidly in 2019, switching to radical easing.

Could another 25 basis point cut in mid-2020 rekindle another wave of speculation?

Perhaps. But the next Fed rate cut would likely be in response to deteriorating credit conditions. And stocks rarely rise under such conditions.

So this is the time to be careful.

Regards,

Dan Amoss
for The Daily Reckoning

The post Beware the Yield Curve appeared first on Daily Reckoning.

U.S. GDP Could Get Hammered

This post U.S. GDP Could Get Hammered appeared first on Daily Reckoning.

February is half over, and we’re that much closer to spring.

As far as the markets go, this past week has been driven by a lackluster set of new economic data and heightened concerns about whether the coronavirus is contained or not, whether the Chinese have downplayed the figures or not and what the real economic impact in China and around the world might be.

But we could already be feeling the effects here at home…

The latest information reveals that consumer spending dropped substantially in January. And core retail sales dropped off.

Clothing sales, for example, dropped 3.1% last month. That’s the largest month-over-month decline since March 2009.

U.S. factory output also slackened. Manufacturing output slipped 0.1% from December, mostly due to Boeing’s ongoing production halt for the 737 Max.

Export demand is also a source of concern, as the coronavirus could affect critical supply chains and hamper demand in the weeks and months ahead.

Meanwhile, weak corporate investment could also put a drag on growth.

All these factors may combine to put a big dent in this quarter’s growth…

A new CNBC survey of 11 economists projects that first-quarter 2020 GDP growth will drop dramatically to 1.2%, far below the 2.1% rate from Q4 2019.

A Bloomberg survey is somewhat better, but not much. These economists project a 1.5% growth rate.

While these numbers are weak, economists surveyed by Bloomberg don’t believe the Fed will be cutting rates soon. But they do believe the drop-off in personal consumption makes the economy vulnerable to “exogenous shocks”:

While the economic outlook remains strong enough for the Fed to keep interest rates on hold, personal consumption moderating from last year’s robust pace makes the economy vulnerable to exogenous shocks, such as the halt in production at Boeing and potential supply chain disruptions stemming from the coronavirus.

Since consumer spending is about 70% of GDP, a downturn in spending could hit the U.S. economy hard.

Federal Reserve Chairman Jerome Powell spoke at his regularly scheduled testimony before Congress this week.

What did he have to say?

The upshot was he reconfirmed the fact that the coronavirus would have an economic impact, but it was too soon to tell the extent of it. So he left it as an excuse, in my opinion, to ease policy if needed down the road.

If the coronavirus threat continues into the second quarter and beyond, he may not have a choice.

What about the ongoing trouble in the “repo” market?

When you add up all the Fed’s support for the “repo” market since September, it comes to over $6.6 trillion.

When pressed by Congress about whether he saw financial risks in the banking system, he pointed to how well the Fed’s bank stress tests have been working.

That’s great, but it seems the liquidity issues are getting worse, not better. The Fed’s latest repo operations were three times oversubscribed, meaning the demand for fresh funding in the repo market far exceeded the supply.

Although the Fed won’t make the information publicly available, the ongoing problems suggest that one or more trading houses on Wall Street are having problems.

The Fed has basically said these loans will continue “at least” through April. But they could continue longer. At the going rate, total loans would reach $29 trillion by the middle of the year.

That would equal the $29 trillion bailout the Fed handed out between 2007 and 2010.

When you add everything up, the economic effects from the coronavirus coupled with ongoing problems in the repo market, things can get really shaky this year.

Regards,

Nomi Prins
for The Daily Reckoning

The post U.S. GDP Could Get Hammered appeared first on Daily Reckoning.