Beware the “Adjusted” Yield Curve

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

Yesterday we furrowed our brow against the latest inversion of the “yield curve.”

The 10-year Treasury yield has slipped beneath the 3-month Treasury yield — to its deepest point since the financial crisis, in fact.

Inverted yield curves precede recessions nearly as reliably as days precede nights, horses precede carts… lies precede elections.

The 10-year Treasury yield has dropped beneath the 3-month Treasury yield on six occasions spanning 50 years.

Recession was the invariable consequence — a perfect 1,000% batter’s average.

But an inverted yield curve is no immediate menace.

It may invert one year or more before uncaging its furies.

But today we revise our initial projections — as we account for the “adjusted” yield curve.

The “adjusted” yield curve indicates recession may be far closer to hand than we suggested yesterday.

When then might you expect the blow to land?

Now… you realize we cannot spill the jar of jelly beans straight away. You must first suffer through today’s market update…

Markets plugged the leaking today.

The Dow Jones gained 43 points on the day. The S&P scratched out six. The Nasdaq, meantime, added 20 points.

Gold — safe haven gold — gained nearly $7 today.

But to return to the “adjusted” yield curve… and the onset of the next recession.

The Nominal vs. the Real

We must first recognize the contrast between the nominal and the real.

The world of appearance, that is — and the deeper reality within.

For example… nominal interest rates may differ substantially from real interest rates.

Nominal rates do not account for inflation.

Real interest rates (the nominal rate minus inflation) do.

That is why a nominal rate near zero may in fact exceed a nominal rate of 12.5%…

Nominal interest rates averaged 12.5% in 1979. Yet inflation ran to 13.3%.

To arrive at the real interest rate…

We take 1979’s average nominal interest rate (12.5%) and subtract the inflation rate (13.3%).

We then come to the arresting conclusion that the real interest rate was not 12.5%… but negative 0.8% (12.5 – 13.3 = -0.8).

Today’s nominal rate is between 2.25% and 2.50%. Meantime, (official) consumer price inflation goes at about 2%.

Thus we find that today’s real interest rate lies somewhere between 0.25% and 0.50%.

That is, despite today’s vastly lower nominal rate (12.5% versus 2.50%)… today’s real interest rate is actually higher than 1979’s negative 0.8%.

The Standard Yield Curve vs. The “Adjusted” Yield Curve

After this fashion, the standard yield curve may differ substantially from the “adjusted” yield curve.

Michael Wilson is chief investment officer for Morgan Stanley.

He has applied a similar treatment to distinguish the adjusted yield curve from the standard yield curve.

The standard yield curve — Wilson insists — does not take in enough territory.

It fails to account for the effects of quantitative easing (QE) and subsequent quantitative tightening (QT).

The adjusted yield curve does.

It reveals that QE loosened financial conditions far more than standard models indicated.

It further reveals that QT tightened conditions vastly more than officially recognized.

The adjusted curve takes aboard the Federal Reserve’s estimate that every $200 billion of QT equals an additional rate hike… for example.

The standard yield curve does not.

Thus the adjusted yield curve reveals a sharply more negative yield curve than the standard.

Here, in graphic detail, the adjusted yield curve plotted against the standard yield curve:


The red line represents the standard 10-year/3-month yield curve.

The dark-blue line represents the adjusted yield curve — that is, adjusted for QE and QT.

The adjusted yield curve rose steepest in 2013, when QE was in full roar.

But then it began a flattening process…

QT Drastically Flattened the Adjusted Curve

The Federal Reserve announced the end of quantitative easing in late 2014.

And Ms. Yellen began jawboning rates higher with “forward guidance” — insinuating that higher rates were on the way in 2015.

Thus financial conditions began to bite… and the adjusted yield curve began to even out.

By the time QT was in full swing, the adjusted curve flattened drastically. The standard curve — which did not account for QT’s constraining effects — failed to match its intensity.

Explains Zero Hedge:

The adjusted curve shows record steepness in 2013 as the QE program peaked, which makes sense as it took record monetary support to get the economy going again after the great recession. The amount of flattening thereafter is commensurate with a significant amount of monetary tightening that is perhaps underappreciated by the average investor.

Now our tale acquires pace — and mercifully — its point.

The Adjusted Yield Curve Inverted Long Before the Standard

After years of flattening out, the standard yield curve finally inverted in March.

Prior to March, it last inverted since 2007 — when it presented an omen of crisis.

But since March, the standard curve bounced in and out of negative territory.

The recession warning it flashed was therefore dimmed and faint — until veering steeply negative this week.

But the adjusted yield curve did not invert in March…

It inverted last November — four months prior. And it has remained negative to this day.


Adjusting the yield curve for QE and QT shows an inversion began at the end of last year and persisted ever since.

Thus it gives no false or fleeting alarm — as the standard March inversion may have represented.

We refer you once again to the above chart.

Note how deeply the adjusted yield curve runs beneath the standard curve.

A “Far More Immediate Menace”

Meantime, evidence reveals recession ensues 311 days — on average — after the 3-month/10-year yield curve inverts.

But if the adjusted curve inverted last November… we are presented with a far more immediate menace.

Here Wilson sharpens the business to a painful point, sharp as any thorn:

Economic risk is greater than most investors may think… The adjusted yield curve inverted last November and has remained in negative territory ever since, surpassing the minimum time required for a valid meaningful economic slowdown signal. It also suggests the “shot clock” started six months ago, putting us “in the zone” for a recession watch.

If recession commences 311 days after the curve inverts — on average — some 180 days have already lapsed.

And so the countdown calendar must be rolled forward.

Perhaps four–five months remain… until the fearful threshold is crossed.

If the present expansion can peg along until July, it will become the longest expansion on record.

But if the adjusted yield curve tells an accurate tale, celebration will be brief…


Brian Maher
Managing editor, The Daily Reckoning

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

Has Recession Already Started?

This post Has Recession Already Started? appeared first on Daily Reckoning.

“Sit down before fact like a little child,” Thomas Huxley instructed, and “follow humbly wherever and to whatever abyss Nature leads…”

Today we sit down before facts, childlike… and follow humbly wherever and to whatever abyss they lead.

But what if the facts lead straight to the abyss of recession?

Facts 1: April orders for core nondefense capital goods slipped 0.9%.

Facts 2: April orders for durable goods — items expected to endure three years or more — sank 2.1%. Durable goods shipments overall dropped 1.6%… the most since December 2015.

Facts 3: April orders for transportation equipment plunged 5.9%.

Facts 4: April retail sales slipped 0.2%.

Facts 5: The “yield curve” has inverted good and hard — a nearly perfect omen of recession.

Has Recession Already Arrived?

Stack facts 1–5 one atop the other. What can we conclude?

“U.S. recession probably started in the current quarter.”

This is the considered judgment of A. Gary Shilling. Mr. Shilling is a noted economist and financial analyst.

And he gazes into a crystal ball less murky than most.


In the spring of 1969, he was one of only a few analysts who correctly envisioned the recession at year’s end and was almost a lone voice in 1973… the first significant recession since the Great Depression.

But is not the economy still expanding?

Q1 GDP rang in at a hale and hearty 3.2% — after all.

But peer behind the numbers…

Much Less than Meets the Eye

Much of the jauntiness was owing to transitory factors such as inventory accumulation.

Firms squirreled away acorns to jump out ahead of looming tariffs, giving Q1 GDP a good jolt.

But that jolt has come. And that jolt has gone.

Meantime, Q2 GDP figures will come rising from the bureaucratic depths tomorrow morning.

What can you expect from them?

A severe letting down, it appears…

Q2 GDP Estimates Revised Downward

Morgan Stanley has lowered its Q2 GDP forecast from 1.0%… to a sickly 0.6%.

J.P. Morgan has lowered its own sights from 2.25% to 1%.

Meantime, the professional optimists of the Federal Reserve’s Atlanta command ring in at a slender 1.4%.

Miles and miles — all of them — from the first quarter’s 3.2%.

Might these experts botch the actual figure?

They may at that… and it would not be the first instance.

But the weight of evidence here assembled loads the scales in the other direction.

Besides, recessions first appear in the rearview mirror. They are only identified several months to one year post factum… if not longer.

Perhaps the economy has already started going backward, as Mr. A. Gary Shilling suggests.

Or perhaps he has spotted a phantom menace, a shadow, a false bugaboo.

What does the “yield curve” have to say?

The Message of the Yield Curve

The yield curve is simply the difference between short- and long-term interest rates.

Long-term rates normally run higher than short-term rates. This happy condition reflects the structure of time in a healthy market.

The 10-year yield, for example, should run substantially higher than the 3-month yield.

The reason is close by…

The 10-year Treasury yield rises when markets anticipate higher growth — and higher inflation.

Inflation eats away at money tied up in bonds… as a moth eats away at a cardigan.

Bond investors therefore demand greater compensation to hold a 10-year Treasury over a 3-month Treasury.

And the further out in the future, the greater the uncertainty. Thus the greater compensation investors demand for taking the long view.

Compensated, that is, for laying off the sparrow at hand… in exchange for the promise of two in the distant bush.

Time Itself Inverts

But when the 3-month yield and the 10-year yield begin to converge, the yield curve flattens… and time compresses.

When the 10-year yield falls beneath the 3-month yield, the yield curve is said to invert. And in this sense time itself inverts.

The signs that point to the future lead to the past. And vice versa.

In the careening confusion, future and past run right past one another… and end up switching places.

Thus, an inverted yield curve wrecks the market structure of time.

It rewards pursuit of the bird at hand greater than two in the future.

That is, the short-term bondholder is compensated more than the long-term bondholder.

That is, the short-term bondholder is paid more to sacrifice less… and the long-term bondholder paid less to sacrifice more.

That is, something is dreadfully off.

“A Nearly Perfect Omen of Lean Days Ahead”

An inverted yield curve is a nearly perfect omen of lean days ahead. It suggests an economic winter is coming… when investors expect little growth.

Explains Campbell Harvey, partner and senior adviser at Research Affiliates:

When the yield curve inverts, it’s not the time to borrow money to take a vacation to Orlando. It is the time to save, to build a cushion.

An inverted yield curve has accurately forecast all nine U.S. recessions since 1955.

Only once did it yell wolf — in the mid-1960s.

It has also foretold every major stock market calamity for the past 40 years.

The yield curve last inverted in 2007. Prior to 2007, the yield curve last inverted in 1998.

Violent shakings followed each inversion.

History reveals the woeful effects of an inverted yield curve do not manifest for an average 18 months.

And now, in 2019… the doomy portent drifts once again into view.

The Bond Market’s Strongest Signal Since the Financial Crisis

The 3-month and 10-year yield curve inverted in March. It has since straddled the zero line, leaning with the daily headlines.

But this week the inversion has gone steeply negative.

We are informed — reliably — that the yield curve has presently inverted to its deepest point since the financial crisis.

Why is the 3-month versus the 10-year yield curve so all-fired important?

Because that is the section of the yield curve the Federal Reserve tracks closest. It believes this portion gives the truest reading of economic health.

Others give the 10-year versus the 2-year curve a heavier weighting.

But it is the Federal Reserve that sets policy… not others.

Federal fund futures presently offer 86% odds that Mr. Powell will lower interest rates by December… and 60% odds by September.

If recession is not currently underway, we are confident the Federal Reserve’s next rate cut will start the countdown watch.


Come the next rate cut, recession will be three months off — or less.

Why do we crawl so far out upon this tree limb?

President Trump Should Demand Jerome Powell Not Raise Interest Rates

The next rate cut will be the first after a hiking cycle (which commenced in December 2015).

And the past three recessions each followed within 90 days of the first rate cut that ended a hike cycle.

Assume for now the pattern holds.

Assume further the Federal Reserve lowers interest rates later this year.

Add 90 days.

Thus the economy may drop into recession by early next year.

Allow several months for the bean counters at Washington to formally identify and announce it.

You may have just lobbed recession onto the unwanting lap of President Donald John Trump… in time for the furious 2020 election season.

Could the timing be worse for the presidential incumbent?

Mr. Trump has previously attempted to blackjack Jerome Powell into lowering rates.

But if our analysis holds together…

The president should fall upon both knees… and beg Mr. Powell to keep rates right where they are…


Brian Maher
Managing editor, The Daily Reckoning

The post Has Recession Already Started? appeared first on Daily Reckoning.

Get Ready for Bitcoin Mania 2.0

This post Get Ready for Bitcoin Mania 2.0 appeared first on Daily Reckoning.

Right now bitcoin (BTC) is back above $8,000 after suffering a substantial “flash crash” last week. This is a major milestone that I’ve spoken about quite a few times this year.

It signifies that the bottom is over and that we’re now in the beginnings of a choppy bull market.

Of course, we will continue to see dips in the market. But the highs will get higher and higher.

Fortunately for investors in bitcoin, while that’s up all the other cryptos are down. Any dips in prices create opportunity for those looking to accumulate.

To top off bitcoin’s news, it looks like Fidelity will enter crypto trading within a few weeks.

Add this to TD Ameritrade and E-Trade’s recent move into crypto and suddenly you have almost 100 million brokerage accounts with access to crypto.

And this doesn’t even take into account all the on-ramps that are being built for institutional money to enter the space

This is an exciting time for anyone invested in crypto. And with bitcoin skyrocketing higher, I want to address some of the most frequent questions I get asked about it:


(Q) What is backing bitcoin? Gold, for example, is REAL.

Gold is a rock. It doesn’t have any real intrinsic value. All money is money because people agree to use it. Same with gold. It’s only “real” because many people agree that it is.

(Q) What if the government hates bitcoin?

Doesn’t matter. Bitcoin is already a worldwide resource owned in every country, $150 billion worth.

And by the way, my extensive networks in the Intelligence Community of the U.S. government show MASSIVE interest in bitcoin to get cash overseas undetected. One of the biggest owners of bitcoin is Uncle Sam.

(Q) What about all of these hacks stealing bitcoin?

The exchanges we’ve recommended for bitcoin have never been seriously hacked. And those that have (like Binance recently) have responded quickly and resolved the issue.

Plus, the NYSE, Microsoft and Starbucks are building their own exchange (which will be unhackable and backed by their insurance), along with Fidelity.

(Q) Don’t all the best investors hate bitcoin?

Not true. Marc Andreessen, Peter Thiel, Tim Draper, etc.

(Q) Will companies use bitcoin?

Every Fortune 500 company from Walmart to FedEx to JPMorgan to Goldman Sachs is already using bitcoin and/or blockchain in one form or other.

(Q) But still, what is BACKING bitcoin? The dollar has the faith of the U.S. government.

  • 10,000 years of math and computer science that have won Nobel-level awards
  • The full power of contract law

The fact that hundreds of billions of dollars are already invested by top investors who are trusting bitcoin over any country’s fiat money.

(Q) Why did bitcoin fall?

Like any financial innovation, there are booms and busts. Prior examples of booms and busts in financial innovation:

  • Junk bonds in the ’80s
  • S&L institutions in the early ’90s
  • Massive leverage in currencies in the mid-’90s
  • The internet IPO boom of the late ’90s and early ’00s
  • The securitization of energy in 2000–01 (Enron, etc.)
  • The mega-securitization of housing derivatives in the mid-’00s
  • EVEN the South Sea Co. bounced back to become bigger than it was in its bubble in the 1700s (see my book Trade Like a Hedge Fund).

AND the internet came back and is now worth trillions. Local banks are bigger than ever. Currency trading is larger than ever. All of the energy companies are bigger than ever. Housing is higher than ever.

Bitcoin will bounce back and be higher than ever. There’s never been an asset that had this much money invested that went to zero.

(Q) What about all the s***coins?

I estimated on CNBC that 95% of alt-coins were scams. Since then, 80%-plus of all coins have gone to zero, with more to come. I was the ONLY one predicting this. NONE of the coins I follow has been a scam. I do the research.

(Q) Where is bitcoin going?

Just like gold replaced barter, paper money replaced gold and fiat money replaced paper money (backed by gold), digital currencies will replace all fiat money in the world. Why?


Bitcoin solves all the problems of paper money: privacy, forgery, human error, excess fees, intermediaries, lack of trust, trade finance, etc.

There is $15 trillion worth of fiat money in the world. There is $150 billion worth of bitcoin.

One day, ALL fiat money will be replaced by bitcoin.

And since the supply of bitcoin is FIXED and demand is going to go up 10,000% (the difference between $15 trillion and $150 billion), then bitcoin’s price will be $7,800 (current price) times 100 = $780,000.

Bottom line: If you’ve been on the sidelines up until now waiting for the next bull run to start, now’s the time to jump on board!


James Altucher
for The Daily Reckoning

The post Get Ready for Bitcoin Mania 2.0 appeared first on Daily Reckoning.

America’s True Patriots

This post America’s True Patriots appeared first on Daily Reckoning.

Here is the trouble with America’s jingos, warhawks, drum-beaters, glory hounds and idealists:

They are not patriotic.

Come again, you say?

Do they not cry tears red, white and blue?

Do they not howl about American “greatness”… American “exceptionalism”… the shining city atop the hill?

That and more they do, yes.

Yet they are not patriotic.

That is the surprising case we haul before the jury today.

Yes, we are stepping away from our normal beat… and reflecting upon the virtue of patriotism.

This at a time when war shouts are rising against Iran, Venezuela, Russia — or whichever hellcat presently menaces the happiness of the United States.

(We first bow before the shade of late writer Joseph Sobran, upon whose insights we rely today.)

Country or Empire

Famed English writer G.K. Chesterton once denounced Rudyard Kipling’s “lack of patriotism.”

Lack of patriotism?

Kipling was chief rah-rah man for the British Empire, its loudest bugler.

English civilization overtopped all rival powers, he bellowed — as Everest overtops all rival peaks.

And as it should… Great Britain gave the law in all four corners of Earth.

From Kipling’s story Regulus, citing Virgil’s Aeneid:

“Roman! let this be your care, this your art; to rule over the nations and impose the ways
of peace…”

Substitute Britain for Rome and you have Kipling.

Why then did Chesterton deny his patriotism?

The reason is subtle. Yet vital.

“He Admires England, but He Does Not Love Her”

Chesterton argued that Kipling admired England because of her power. He did not love her for who she was:

He admires England, but he does not love her; for we admire things with reasons, but love them without reasons. He admires England because she is strong, not because she is English.

In contrast, Chesterton loved England as England — its customs, its eccentricities, its people — even its food.

A man loves his mother.

It is a wordless love, wide and deep.

He requires no reason. He need offer no explanation.

And as he loves his mother… so he loves his country.

His country is simply his country — be it China, Russia, Chile, Romania.

And so it is worthy of his love.


Of course Chesterton was right. You love your country as you love your mother — simply because it is yours, not because of its superiority to others, particularly superiority of power.

A Spacious Patriotism

Does the other fellow believe his own mother towers 900 feet over all others?

Well, friends, maybe he does.

But that in no way irritates, annoys or undoes the genuine patriot.

No harm flows from it. After all…

Adults allow children to cherish the fiction that reindeer fly and round men descend chimney chutes.

A man allows his wife to cherish the fiction that she is a superior cook and automobile driver… as she allows her husband to cherish the fiction that he is a skillful and formidable lover.

These are harmless fictions conducive to the domestic peace and happiness.

In that spirit, the patriot’s attitude toward foreigners is relaxed. It is accommodative. And spacious.

But a Kipling does not love his country as a man loves his mother.

His country must show all others its dust. It must outrace them all… else he feels diminished.

The Patriot Loves His Country Regardless

The United States of America stables many such fellows.

They are dizzied, wobbled, staggered by a higher American vision. Their eyes roll perpetually heavenward.

To these fellows, America must always be up to something big in this world.

She must be forever charging up San Juan Hill, going over the top, storming Normandy beach, bearing any burden, paying any price…

She must be beating the Russians to the moon, beating the world at basketball, beating democracy into somebody’s head.

Tall deeds, many of these. And sources of authentic pride.

But would the patriot love America any less if she fell short of the glory… if she left a gaping hole in the history books?

He would not.

It is — after all — his country.

And he loves it as he loves his mother.

But to the professional American, America must dazzle and strut upon the world’s stage.

She must be the “indispensable nation.”

If not indispensable… then dispensable.

If dispensable, then unworthy of his deep affections.

Hence his lack of patriotism.

The Difference Between the Patriot and the Nationalist

Sobran takes their measure:

Many Americans admire America for being strong, not for being American. For them America has to be “the greatest country on Earth” in order to be worthy of their devotion. If it were only the second greatest, or the 19th greatest, or, heaven forbid, “a third-rate power,” it would be virtually worthless… Maybe the poor Finns or Peruvians love their countries too, but heaven knows why — they have so little to be proud of, so few “reasons.”

And so Sobran peels away the patriot from his photographic negative — the nationalist ideologue:

The nationalist, who identifies America with abstractions like freedom and democracy, may think it’s precisely America’s mission to spread those abstractions around the world — to impose them by force, if necessary. In his mind, those abstractions are universal ideals… the world must be made “safe for democracy” by “a war to end all wars”… Any country that refuses to Americanize is “anti-American” — or a “rogue nation.” For the nationalist, war is a welcome opportunity to change the world.

We might list some offending names — but our legal counsel has just whispered into our ear.

But the patriot and the thunder-thumper babble the same American tongue. The one is therefore mistaken for the other.

Yet listen closer. They in fact speak alien languages:

Because the patriot and the nationalist often use the same words, they may not realize that they use those words in very different senses. The American patriot assumes that the nationalist loves this country with an affection like his own, failing to perceive that what the nationalist really loves is an abstraction — “national greatness,” or something like that. The American nationalist, on the other hand, is apt to be suspicious of the patriot, accusing him of insufficient zeal, or even “anti-Americanism.”

A Patriotism of the Heart

The patriotism Sobran hymns is a relaxed, healthful patriotism.

It is a patriotism of the heart.

This patriotism flies no ideological flags, hauls no metaphysical cargo, steers by no heavenly star.

It is the patriotism of the prairie, of the plain, of the lonely jackrabbit crossroad, of the greasy spoon, of the truckstop, of the front porch, of the pool hall… of Main Street.

And his fellow countrymen, the patriot takes them as he finds them.

Might they sometimes forget to wash behind the ears?

Sometimes they may. But it makes no nevermind.

They are his countrymen… and that is enough.

The patriot allows himself to laugh. Not at his fellow Americans — but with them.

The nationalist, meantime, does not laugh.

He scolds.

“Patriotism Is Relaxed. Nationalism Is Rigid.”

“Patriotism is relaxed,” as Sobran concludes. “Nationalism is rigid.”

We in turn conclude, paraphrasing Chesterton:

The relaxed patriot, the average American, the American who tends to his own business and sweeps his own stoop, the American who loves his country as he loves his mother — the fellow is all right.

But the rigid American, the 100% American, the thunder-thumping American, the American determined to put the world to rights — the American who admires America for her strength — but fails to love her as herself?

This fellow, he’s all wrong…


Brian Maher
Managing editor, The Daily Reckoning

The post America’s True Patriots appeared first on Daily Reckoning.

Crypto Is Here to Stay. Bitcoin Isn’t

This post Crypto Is Here to Stay. Bitcoin Isn’t appeared first on Daily Reckoning.

Bitcoin is back! So say the true believers, even with Friday’s flash crash. But there less there than meets the eye.

Bitcoin has staged a notable comeback from its 2018 crash. From a level of about $4,000 through the month of March, 2019, bitcoin had a two-day 23% spike from $4,135 on April 1, 2019 to $5,102 on April 3, 2019.

Bitcoin then moved sideways in the $5,000 to $6,000 range until May 8, 2019 when it staged another three-day spike from $5,932 on May 8 to $7,255 on May 11, a 22% surge.

Combining the April 1 and May 8 spikes, the bitcoin price moved from $4,135 to $7,255 for a spectacular 75% price rally in six weeks.

By last Thursday morning, it soared even higher, to over $8,300.

This rally was bitcoin’s best price performance since its 83% collapse from $20,000 in late December 2017 to $3,300 in December 2018. That crash marked the collapse of the greatest asset price bubble in history, larger even than the Tulipmania of 1637.

The questions for crypto investors are what caused the recent rebound in the price of bitcoin and will it last? Is this the start of a new mega-rally or just another price ramp and manipulation? Has anything fundamental changed?

If you’re beginning to suspect these are leading questions, you’re right.

Of course, bitcoin technical analysts are out in force explaining how the 100-day moving average crossed the 200-day moving average, a bullish sign. They are also quick to add that the 30-day moving average is gaining strength, another bullish sign.

My view is that technical analysis applied to bitcoin is nonsense. There are two reasons for this. The first is that there is nothing to analyze except the price itself. When you look at technical analysis applied to stocks, bonds, commodities, foreign exchange or other tradeable goods, there is an underlying asset or story embedded in the price.

Oil prices might move on geopolitical fears related to Iran. Bond prices might move on disinflation fears related to demographics. In both cases (and many others), the price reflects real-world factors. Technical analysis is simply an effort to digest price movements into comprehensible predictive analytics.

With bitcoin (to paraphrase Gertrude Stein) “there is no there, there.” Bitcoin is a digital record. Some argue it’s money; (I’m highly skeptical it meets the basic definition of money).

Either way, bitcoin does not reflect corporate assets, national economic strength, terms of trade, energy demand or any of the myriad factors by which other asset prices are judged. Technical analysis is meaningless when the price itself is meaningless in relation to any goods, services, assets or other claims.

My other reason for rejecting the utility of technical analysis is that it has low predictive value when applied to substantial assets and no predictive value at all when applied to bitcoin.

If you follow technical analysis, you’ll see that every “incorrect” prediction is followed immediately by a new analysis in which a “double top” merely presages a “triple top” and so on.

Technical analysis can help clarify where the price has been and help with relative value analysis, but its predictive analytic value is low (except to the extent the technical analysis itself produces self-fulfilling prophesies through herd behavior).

That said, what can we take away from the recent bitcoin price rally, putting aside its flash crash for the moment?

The first relevant fact is that no one knows why it happened. There was no new technological breakthrough in bitcoin mining. None of the scalability and sustainability challenges have been solved. Frauds and hacks continue to be revealed on an almost daily basis. In short, it’s business as usual in the bitcoin space with no new reasons for optimism or pessimism.

The second relevant fact is that the bitcoin price has been the target of rampant manipulation by miners in recent years. Bitcoin miners have rising costs of production due to the increasing complexity of the math problems that must be solved to validate a new block on the blockchain.

Bitcoin miners also have large inventories of coins mined in the past that have not been released on the market through exchanges or otherwise.

As a result, miners have huge incentives to pump-up prices, both to cover costs of production and to create demand for undistributed coins. These price ramps are conducted through wash sales, “painting the tape,” joint action, low volume price pumps, and other classic manipulations.

The evidence is strong that this kind of activity has taken place in the past and there is no reason to believe it is not taking place now. As mentioned above, JP Morgan & Chase have estimated bitcoin’s intrinsic value at about $2,400.

The last potential contributor to the bitcoin price spike is simple speculation. Bitcoin buyers who missed their chance to reap fortunes when the price went to $20,000 may see another chance to ride a wave of much higher prices.

Since nothing fundamental has changed about bitcoin for better or worse, some combination of miner manipulation and naive speculation is the most likely explanation for the price action we’ve seen lately. This means the price could just as well crash as rally further.

Nothing has changed in the bitcoin blockchain technology. A use case for bitcoin has yet to emerge (and probably never will). Bitcoin is still unsuitable as an investment although it may work fine for those who just like to roll the dice. Count me out.

A second wave or new generation of cryptocurrencies is now emerging with better governance models, more security, and vastly improved ease of use. These new wave coins represent the future of the cryptocurrency technology. These cryptos have much greater potential to disrupt and disintermediate established payments systems, and financial intermediaries such as banks, brokers and exchanges.

On the one hand, mature cryptocurrencies such as bitcoin, ripple and ethereum are showing their inherent limitations and non-sustainability. These cryptocurrencies all have major flaws in terms of investor safety and ease of use.

The solutions proposed invariably involve backing away from the original promise of safe, anonymous transactions. Government authorities are converging from all sides looking for tax evasion, securities fraud, evasion of capital controls and other improprieties.

Second-generation cryptocurrencies have a much greater chance of competing successfully with existing payment channels such as Visa, MasterCard, PayPal and the traditional banking system.

The potential value of these new wave cryptos can be measured by the current franchise value of the institutions that will be disrupted. If these cryptocurrencies can disintermediate centralized financial behemoths like Citibank and the New York Stock Exchange, their value can be measured in the trillions of dollars.

If bitcoin is still unsuitable (despite a recent price rally), where do the opportunities lie in the cryptocurrency space? The answer is that the blockchain is growing up and new tokens and use cases are emerging all the time.

These new opportunities are in permissioned distributed ledgers such as JPMorgan’s payment token and synthetic world money proposed by the IMF. This means that the companies who will benefit most from the rise of new cryptocurrencies are not garage band start-ups, but technology giants such as IBM, Intel and Nvidia as well as financial giants such as JPMorgan and Citi.

Crypto has a bright future. But bitcoin doesn’t.


Jim Rickards
for The Daily Reckoning

The post Crypto Is Here to Stay. Bitcoin Isn’t appeared first on Daily Reckoning.

The Biggest Fraud in History

This post The Biggest Fraud in History appeared first on Daily Reckoning.

My readers know that I’m a longtime critic of bitcoin. Bitcoin rose from about $2,000 in May 2017 to $20,000 by December 2017 in one of the greatest asset price bubbles in history.

I argued repeatedly that it was nothing but a massive bubble and that the bubble would probably burst when it hit $20,000.

In late 2017 it did.

Bitcoin crashed from $20,000 all the way to $3,300 by December 2018 — an 83.5% collapse in one year and the greatest recorded asset price collapse in history.

The crash of bitcoin was even more dramatic than the infamous collapse of tulip prices in the tulipomania in Netherlands in the early 17th century.

But suddenly, bitcoin is back in the news.

You’ve probably seen the headlines about bitcoin’s return. Bitcoin rose from $3,900 on March 26, 2019, to $8,100 on May 15, 2019, a gain of 52% in less than seven weeks.

Happy days are here again! Bitcoin mania is back!

60 Minutes even ran a feature on bitcoin last night.

Is this the start of a new rally back to the heights of $20,000? That seems highly unlikely.

Early Friday bitcoin plunged well over $1,000 in a massive flash crash, about 10% in one day. Easy come, easy go.

What caused the crash?

It seems that a bitcoin “whale” unloaded a massive holding.

A “whale” is a term for a cryptocurrency investor with a large amount of units, or “coins.” That gives them significant influence on the market control.

It’s been estimated that less than 450 people or entities own 20% of the entire bitcoin market.

And when someone buys or sells a massive amount, prices can swing dramatically, as we saw on Friday.

It is still not clear if the large sell order was deliberate or an accidental “fat finger” error.

Prices have recovered to some extent, and bitcoin’s trading around $7,800 today. But either way, Friday’s flash crash highlights a major weakness of bitcoin. It can all come crashing down like a house of cards, as bitcoin’s 2017–18 hair-raising plunge proves.

As an asset, bitcoin has very little to offer outside of speculation.

Bitcoin still has no use case except for gambling by speculators or the conduct of transactions by terrorists, tax evaders, scam artists and other denizens of the dark web. Bitcoin is still unsustainable due to extreme demands for electricity in the computer “mining” process.

It is still nonscalable due to the slow and clunky validation process for new blocks of transactions on the bitcoin blockchain. Bitcoin has no future as “money” because the supply of bitcoin cannot grow beyond a preset amount.

That feature makes bitcoin inherently deflationary and therefore not suitable for credit creation, which is the real source of any system of money. Bitcoin has been subject to continual price manipulation by miners through wash sales, front-running, ramping and other tried-and-true techniques for price manipulation.

The bitcoin infrastructure has been plagued with hacking, fraud, bankruptcy and coin theft measured in the billions of dollars. Bitcoin may go higher from here; it’s entirely possible. But it will then come crashing down again.

What is bitcoin’s intrinsic worth?

JPMorgan Chase has tried to break it down. They examined bitcoin as a commodity.

To arrive at its worth, JPMorgan Chase estimated the cost of producing each individual bitcoin by looking at factors such as electrical costs, computational power and energy efficiency. I mentioned these factors above.

When they crunched the numbers, what number did they come up with?

JPMorgan Chase estimated the intrinsic value of bitcoin at around $2,400. Let’s assume for now that’s accurate, or a reasonable approximation. Then even at $8,000, we can conclude that bitcoin is severely overvalued.

JPMorgan Chase compared bitcoin’s recent run-up to the bubble it experienced two years ago. Even though it is still far from $20,000, if we see another speculative frenzy it could undergo a similar run. But it would end the same way.

The bottom line is I would advise you to stay far away from bitcoin. Do not get sucked in by the hype.

Sadly, some people never learn. And my guess is that many will get burned all over again.

Read on for more.


Jim Rickards
for The Daily Reckoning

The post The Biggest Fraud in History appeared first on Daily Reckoning.

Debt “Death Spiral” Approaching

This post Debt “Death Spiral” Approaching appeared first on Daily Reckoning.

Today our spirits wallow. And our brow is creased with worry…

For we are informed the United States is racing into a “death spiral” of debt.

That is, when every public dollar it borrows must service its debt… crowding out all other demands.

That debt presently exceeds $22 trillion.

It expands by day, by hour, by minute, by second.

But when does America finally go corkscrewing into the fatal abyss?

Eight years, 10 years — perhaps a dozen?

The all-important answer shortly.

But first a brief canvas of Wall Street… and the stock market.

The Trade War Strikes Again

The opening whistle blew this morning and the Dow Jones instantly sank triple digits.

Once again we must look to trade.

Chinese state media indicated early today that China is in no special hurry to resume peace talks.

This is because the United States once again crossed Chinese interests…

It has put Chinese telecommunications behemoth Huawei under the ban — the firm can no longer purchase components from American firms.

But stocks absorbed the initial blow… and gradually clawed their way back.

But not enough to break even. The Dow Jones ended the day 99 points lower.

The S&P lost 17 points; the Nasdaq 82.

And so the merry-go-round spins.

But when will the United States enter the “death spiral” of debt?

To begin we sit down with the facts…

Interest on the Debt: The Fastest-Growing Budget Item

Four items alone constitute 78% of the federal budget — Medicare, Medicaid, Social Security and interest on the national debt.

All other programs scratch along on the remaining 22%.

These include “defense,” education, scientific research, all bread, all circuses — all remaining programs.

But the fastest-expanding sinkhole in the budget… is interest on the national debt.

Interest on the debt is the great villain of our tale, the horseman of our apocalypse.

The United States government ladled out $221 billion in interest on the national debt through the first four months of fiscal year 2019.

That is nearly 10% greater than last year’s payments over the same space.

And this we have on official authority of the United States Department of Treasury:

Interest on United States public debt will stretch to some $591 billion this fiscal year — a record.

$2,000 out of Your Pocket

Could you put an extra $2,000 to good use this year?

Perhaps you could heave an extra $2,000 into savings, investment, leisure, charitable causes, etc.

But if you are the average American, the national debt denies you that option.

That is because over $2,000 of your tax bill is being siphoned to service this debt.

All of which transpires while the gross domestic product continues to expand.

In a growing economy, the old-time Keynesians preached a gospel of fiscal restraint.

It is the time to store in reserves, to save against the rainy day — the inevitable rainy day.

Come the recession, the government can then proceed against it with a brimming war chest.

“Countercyclical” policy, academic men style it.

But the old Keynesians currently preach before an empty church. The flock has gone winging off for the heretic faith of perpetual deficit.

And the United States is passing rapidly beyond all hope of heaven…

The Tragic Math

When unemployment last sunk to today’s 3.6% — in 1969 and 2000 — the United States government boasted surpluses.

In lean seasons these surpluses it could sacrifice upon the altar of “countercyclical” fiscal policy… and push back against recession.

But the Congressional Budget Office (CBO) projects this year’s deficit will verge upon $900 billion.

And CBO estimates GDP will limp along at an average 1.9% per annum the next decade.

But again, debt is piling on at 6% per year.

Trillion-dollar annual deficits are therefore in prospect for the next decade — at least.

Annual interest costs on the debt will scale $724 billion by 2025, estimates CBO.

And $928 billion by 2029… or nearly 25% of the entire budget.

When inevitable recession descends the war chest will not only be empty. It will have a gaping hole in its bottom.

But let us add another strand to the hangman’s noose…

CBO Numbers Don’t Account for Recession

CBO’s figures do not admit the possibility of recession for the following 10 years.

A handsome assumption, that is, given the present expansion will rank history’s longest come July.

How can it peg along another decade without recession?

Even the Federal Reserve is giving out visible and audible signals of the coming rough-house.

It is publicly airing mentions of negative interest rates, “standing repo facilities” (a variant of QE) — and more.

Would it ransack its toolkit for policy options if not expecting to use them?

Does a man ransack his closet for an umbrella… if not expecting rain?

$2–3 Trillion Annual Deficits

If the economy does sink into recession — depend on it — the government will plunge even deeper into debt to “stimulate” the economic machinery.

“We get a recession,” affirms analyst Sven Henrich, “and you are looking at $2–3 trillion [annual] deficits.”

Interest on the debt will swamp the budget — especially if interest rates rise.

CBO’s current 2029 forecast of $928 billion then appear quaint.

As stands, CBO estimates the average interest rate on the debt will rise from 2.3% last year… to 3.5% in 2029.

The Lord help us all if interest rates run much higher.

But when — again — will the United States go spinning into the death spiral of debt?

The “Primary Deficit”

The United States Treasury Department’s Office has issued its Fiscal Year 2019 Q1 Report.

In in, Treasury’s Office of Debt Management projects total U.S. government borrowing from the public.

Among the metrics it tracks is the “primary deficit.”

The primary deficit is:

The amount by which total spending exceeds total revenue — excluding interest payments on debt.

For the next number of years interest on the debt approximates other elements of the budget deficit.

But beginning in 2024, Treasury projects the primary deficit will fall to zero… and then turn negative.

Explains Zero Hedge:

While in 2019 and 2020 surging U.S. interest expense is roughly matched by the other deficit components in the U.S. budget, these gradually taper off by 2024… The real red flag is that starting in 2024, when the primary deficit drops to zero according to the latest projections, all U.S. debt issuance will be used to fund the U.S. net interest expense, which depending on the prevailing interest rate between now and then will be anywhere between $700 billion and $1.2 trillion or more.

And that is when the “death spiral” begins — 2024 — five years from today.

That is, when every new dollar Uncle Samuel borrows from the public goes to service interest on the debt.

The “Ponzi Finance” phase

Continues Zero Hedge:

In short… the U.S. will enter the penultimate Ponzi finance phase — the one in which all the new debt issuance is used to fund only interest on the debt — sometime around 2024.

Setting the business in concrete is Craig Eyermann, research fellow at the Independent Institute:

When the national debt reaches the point where all newly borrowed dollars must be used to pay this mandatory expenditure, the U.S. government will have passed the event horizon that marks the boundary of the national debt death spiral.

Of course, the United States may enter the fatal orbit later than 2024.

But also earlier.

Either case, it is dead on course…


Brian Maher
Managing editor, The Daily Reckoning

The post Debt “Death Spiral” Approaching appeared first on Daily Reckoning.

Prepare for Trench Warfare

This post Prepare for Trench Warfare appeared first on Daily Reckoning.

What if China isn’t half so desperate for a deal as the president believes?

Are we in for an extended siege of economic trench warfare?

Today we explore possibilities… and their implications.

We first direct our gaze to Wall Street.

Investors came crouching from their shelters this morning… as if expecting an aftershock to the quake that drove them underground yesterday.

With Monday’s 617-point battering — piling atop last week’s losses — three months of stock market gains have vanished into the ether.

The S&P 500 endured its 15th-largest decline in history yesterday. It has shed $1.1 trillion since May 5 alone.

Markets Bounce Back

But the Earth held today. And investors cleared away some of yesterday’s wreckage.

The Dow Jones rebounded 207 points.

The S&P reclaimed 23 of the 70 points it lost yesterday. The Nasdaq gained 87.

Markets were encouraged by President Trump’s comments that he will strike a deal with China “when the time is right.”

He will have an opportunity at the G20 summit in late June. There he will meet China’s Xi Jinping, for whom his “respect and friendship is unlimited.”

But is China sweating dreadfully for a trade deal as Trump assumes?

China Braces for Escalation

China does — after all — ship some $500 billion of products to these shores each year.

It cannot afford to sit on them like a broody hen.

But you might have another guess, says the director of monetary policy at the People’s Bank of China:

As for the change in the domestic and external economic environment, China has sufficient leeway and a deep monetary policy toolkit, and so has full ability to deal with [economic] uncertainties.

But here we cite a government mouthpiece, a marionette in human form. You no more trust his word than you would trust a dog with your dinner.

Just so.

But affirms Brad Setser, senior fellow for international economics at the Council on Foreign Relations:

Trump’s escalation comes at an awkward time, but if push comes to shove, they’re quite capable of supporting growth through more investment and credit.

There may be justice here.

Twice as Much Stimulus as During the Financial Crisis

If you believe the Federal Reserve is a gargantuan spigot of credit, the People’s Bank of China brings it to shame.

ING estimates China has pledged 8 trillion yuan in economic support — twice as much “stimulus” as it offered during the global financial crisis.

And the Organization for Economic Cooperation and Development (OECD) estimates China’s fiscal stimulus this year equals 4.25% of GDP… up from 2.94% last year.

Meantime, Chinese domestic consumption has been on the increase.

Growth through increased consumption — say the economics wiseacres in practice among us — reduces dependence on exports.

Is most of this stimulus woefully wasteful? Does it finance vastly unproductive economic activity?

Yes and yes.

Is the way to wealth through consumption — rather than production?

No, it is not.

But if Chinese authorities believe they can offset lost exports by bellowing credit and vomiting money… they may choose to dig in for the long haul.

“A nation is never as happy as when it’s at war”

A trade war may even rally the people to the colors…

A nation is never as happy as when it’s at war — even trade war.

War gives the people enemies to hate… and leaders to love.

What better way to distract a people from their own government’s eternal swinishness, its infinite rascality?

Despite all contrary appearance, the United States government does not run a corner on either.

In fact, China’s state media took to the warpath Monday.

It shouted for a “people’s war” against Mr. Trump’s “greed and arrogance.”

And why not? It could argue…

‘China is a proud, accomplished and ancient nation, with roots sunk deep into history.

It is the “Middle Kingdom,” the center to which all the world’s divergent rays bend.

Who are these upstart Americans to shove us around?’

Economic “Trench Warfare”

We would remind the president — respectfully — that wars are far easier to start than finish.

The boys will be home by Christmas, they gloated in August 1914.

Four years later they were still in the trenches — or in boxes.

Could the United States and China soon be locked in the extended stalemate of economic “trench warfare”?

The strategists at Deutsche Bank’s chief investment office fear so:

Unless a deal can be struck quickly in the coming weeks, markets will need to prepare themselves for an extended period of economic trench warfare. And large listed U.S. companies in particular could well find themselves in the line of fire.

China has previously chosen to “wait, strategically inflict pain, delay and hope U.S. pressure eventually goes away.”

But China has heaved aside that option, argues Deutsche Bank.

Now it is reaching for its shovel… and preparing to hunker in.

In conclusion:

The nature of trade wars (like actual wars) is that they foster nationalist sentiment and jingoism. The first shots are fired in the hope of quick victories. And before you know it, both sides are stuck in the trenches, with no obvious and politically feasible way out.

The coming weeks may well yield the answer.

But how will markets hold up if diplomacy collapses?

All Pressure May Fall on Trump

A failed trade deal was sufficient to send stocks careening this past week.

President Trump has all his cargo loaded on two wagons — the stock market and economy.

If either cracks an axle, if either collapses under the strain, his reelection prospects collapse in turn.

Therefore, argues analyst Sven Henrich of Northman Trader, all pressure rests upon the presidential shoulders of Donald J. Trump:

Because for Trump there’s an election to worry about. The Chinese don’t have an election to worry about and that puts the time pressure on Trump, not the Chinese. The Chinese will continue to intervene and yesterday they showed backbone and followed through on retaliation. But because the U.S. election cycle clock is ticking Donald Trump cannot afford a trade war extending into the end of the year, especially if the consequences of such a protracted trade war would spill into the larger economy.

Will the Great Negotiator be the one to blink first?


Brian Maher
Managing editor, The Daily Reckoning

The post Prepare for Trench Warfare appeared first on Daily Reckoning.


This post Retaliation! appeared first on Daily Reckoning.

“The next few weeks could be rocky.”

Bank of America’s fortune cookie writers may have undersold their case…

The trade war famously reopened Friday. The United States imposed 25% tariffs on $200 billion of Chinese products.

Come this morning, China announced retaliatory tariffs on $60 billion of United States products.

They enter effect June 1 — unless a negotiated truce first washes them out.

CNBC lists the butcher’s bill:

Beijing will increase tariffs on more than 5,000 products to as high as 25%. Duties on some other goods will increase to 20%. Those rates will rise from either 10% or 5% previously. 

American agricultural products were not excepted. Soybean and cotton prices went plummeting today… in consequence.

Additional retaliation, suggest some Chinese sources, may await.

Trade war, like any other war, is harder to stop than to start.

China Maximizes the Market Impact

Was it coincidence that this morning’s blast arrived in time for opening whistle on Wall Street?

Samantha Azzarello, global market strategist at JPMorgan:

China retaliating as fast as they did was a clear signal they’re not going to be pushed around… It was interesting it wasn’t done on the weekend. It was done just in time Monday morning for markets to open.

On cue the floodgates swung open at 9:30… and a red deluge came washing down the canyons.

The Dow Jones was instantly 400 points under… then 500… 600… and 700 by early afternoon.

By midafternoon the worst of the hemorrhaging was plugged.

The Dow Jones ended the day down 617 points.

But for the first occasion since February, it has slipped beneath its 200-day moving average — which has the chart watchers shaken and rattled.

The S&P lost another 70 points today.

But percentage wise, the trade-sensitive Nasdaq withstood the worst slating of the three — down 270 points on the day — or 3.41%.

“Very bad for China, very good for USA!”

President Trump laughed off all concerns this morning… and insisted China is brunting the true impact.

Their [sic…] is no reason for the U.S. Consumer to pay the Tariffs, which take effect on China today… Also, the Tariffs can be completely avoided if you by from a non-Tariffed Country, or you buy the product inside the USA (the best idea). That’s Zero Tariffs. 

Here he digs his thumbs into China’s eyes, and gives them a good hard twist:

Many Tariffed companies will be leaving China for Vietnam and other such countries in Asia. That’s why China wants to make a deal so badly! There will be nobody left in China to do business with. Very bad for China, very good for USA!

The American Consumer: Hidden Casualty

But the president’s top economics man — Larry Kudlow — conceded this weekend that American consumers will in fact pay much of the freight.

Companies that accept imports actually pay the tariffs at water’s edge.

These costs they pass along to the consumer further down the line.

Thus tariffs represent a tax increase upon Joseph and Jane Average American… who must stretch deeper into their pockets to purchase the same goods.

And now that China has responded in kind, Chinese demand for American products will slacken.

Oxford Economics has issued a new report. It reveals…

That a 25% tariff on $200 billion of Chinese goods imports would cost the United States economy $62 billion once all scales are balanced, once all accounting is settled.

That figure amounts to $490 per household… incidentally.

What if the president levies additional tariffs on all Chinese wares, as he has threatened?

Oxford estimates total economic losses would cost the United States some $100 billion by next year — or $800 per household.

The Seen vs. the Unseen

The president must have misplaced his copy of Economics in One Lesson by legendary economics journalist Henry Hazlitt.

From which:

This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups…

The bad economist sees only what immediately strikes the eye; the good economist also looks beyond… The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.

Hazlitt’s is a faint and feeble voice coming from the tomb.

There is the seen, he reminds us… as he struggles to rise above the din of the living.

But there is also the unseen.

You must consider the unseen effects of any given policy.

But it requires a special effort of the imagination. And few can conjure the image…

The Unseen

They cannot observe the lost jobs, the money unspent on other goods, the cost of retaliatory tariffs.

Here is what the president does not appreciate…

The businesses that will not open or will not expand because the inputs of industry are costlier…

The money Americans will not spend on other goods and services because they are expending more for these goods…

The American products that will go unsold abroad because of the tariffs China throws up in retaliation.

Or as another president, Woodrow Wilson, once said in reference to the sugar tariff:

“Very few of us taste the tariff in our sugar.”

Few ask the right questions… connect the proper dots… draw the right conclusions.

Heave 100 bricks off a rooftop in any American city.

One — perhaps two — will find a man who tastes the tariff in his sugar.

That is precisely how the political men prefer it.

But the costs are nonetheless real.

In the Unseen… We Will See the Light

Yes, it is true… tariffs may open one door for one American.

But they slam one door shut on the nose of another.

For every extra dollar that jingles in the one fellow’s pocket… one less dollar jingles in the other fellow’s pocket.

This fellow will see his pay envelope shrink — in effect, his taxes raised.

In conclusion, tariffs benefit few. And damage many.

Let us instead direct our focus to the unseen, as a wise voice whispers from beyond the grave.

It is here — in the unseen — that we will see the light…


Brian Maher
Managing editor, The Daily Reckoning

The post Retaliation! appeared first on Daily Reckoning.

“Mandate of Heaven” in Jeopardy

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

U.S. policy through the Bush and Obama administrations was to soft-pedal questionable Chinese trade practices, pirating technology and theft of intellectual property in return for cheap manufactured goods and China’s willingness to finance trillions of dollars of U.S. government debt.

Now Trump has changed the rules of the game. He’s said lost jobs in the U.S. are not worth the cheap goods and cheap financing. He bet that China had no alternative but to keep producing those goods and keep buying our debt, even if the U.S. imposes tariffs to help create manufacturing jobs here.

President Trump and President Xi had been on a collision course involving issues of trade, tariffs, and currency manipulation, which are coming to a head.

It’s important to understand that China’s economy is not just about providing jobs, goods and services. It is about regime survival for a Chinese Communist Party that faces an existential crisis if it fails to deliver. It is an illegitimate regime that will remain in power only so long as it provides jobs and a rising living standard for the Chinese people. The overriding imperative of the Chinese leadership is to avoid societal unrest.

Once the Chinese job machine stalls out, popular unrest could emerge on a scale much greater than the 1989 Tiananmen Square protests. This is an existential threat to Communist power.

If China encounters a financial crisis, Xi could quickly lose what the Chinese call, “The Mandate of Heaven.” That’s a term that describes the intangible goodwill and popular support needed by emperors to rule China for the past 3,000 years.

If The Mandate of Heaven is lost, a ruler can fall quickly.

China has serious structural economic problems and its internal contradictions are catching up with it. Economies can grow through consumption, investment, government spending and net exports. The “Chinese miracle” has been mostly a matter of investment and net exports, with minimal spending by consumers.

The investment component was thinly disguised government spending — many of the companies conducting investment in large infrastructure projects were backed directly or indirectly by the government through the banks.

This investment was debt-financed. China is so heavily indebted that it is now at the point where more debt does not produce growth. Adding additional debt today slows the economy and calls into question China’s ability to service its existing debt.

China is now confronting an insolvent banking system, a real estate bubble, and a $1 trillion wealth management product Ponzi scheme that is starting to fall apart.

Up to half of China’s investment is a complete waste. It does produce jobs and utilize inputs like cement, steel, copper and glass. But the finished product, whether a city, train station or sports arena, is often a white elephant that will remain unused.

Chinese growth has been reported in recent years as 6.5–10% but is actually closer to 5% or lower once an adjustment is made for the waste. The Chinese landscape is littered with “ghost cities” that have resulted from China’s wasted investment and flawed development model.

What’s worse is that these white elephants are being financed with debt that can never be repaid. And no allowance has been made for the maintenance that will be needed to keep these white elephants in usable form if demand does rise in the future, which is doubtful.

Essentially, China is on the horns of a dilemma with no good way out. On the one hand, China has driven growth for the past eight years with excessive credit, wasted infrastructure investment and Ponzi schemes.

The Chinese leadership knows this, but they had to keep the growth machine in high gear to create jobs for millions of migrants coming from the countryside to the city and to maintain jobs for the millions more already in the cities.

The two ways to get rid of debt are deflation (which results in write-offs, bankruptcies and unemployment) or inflation (which results in theft of purchasing power, similar to a tax increase).

Both alternatives are unacceptable to the Communists because they lack the political legitimacy to endure either unemployment or inflation. Either policy would cause social unrest and unleash revolutionary potential.

China has hit a wall that development economists refer to as the “middle income trap.” Again, this happens to developing economies when they have exhausted the easy growth potential moving from low income to middle income and then face the far more difficult task of moving from middle income to high income.

The move to high-income status requires far more than simple assembly-style jobs staffed by rural dwellers moving to the cities. It requires the creation and adoption of high-value-added products enabled by high technology.

China has not shown much capacity for developing high technology on its own, but it has been quite effective at stealing such technology from trading partners and applying it through its own system of state-owned enterprises and “national champions” such as Huawei in the telecommunications sector.

Unfortunately for China, this growth by theft has run its course. The U.S. and its allies, such as Canada and the EU, are taking strict steps to limit further theft and are holding China to account for its theft so far by imposing punitive tariffs and banning Chinese companies from participation in critical technology rollouts such as 5G mobile phones.

My view is that a crisis in China is inevitable based on China’s growth model, the international financial climate and excessive debt. A countdown to crisis has begun.  Geopolitical issues will make the economic issues even harder to resolve.

Yes, headlines are dominated by the trade war. That escalating confrontation is a big deal, but it’s not the only flash point in U.S.-China relations, and not even the most important. China is as much concerned about a military confrontation in the South China Sea as it is about the economic confrontation in the trade wars.

China dredged sand surrounding useless rocks and atolls in the South China Sea and converted them into artificial islands and then built out the islands to include naval ports, air force landing strips, anti-aircraft weapons and other defensive and offensive weapons systems.

Not only are the Chinese militarizing rocks, but they are trampling on competing claims by the Philippines, Vietnam, Brunei, Malaysia and other countries surrounding the sea.

The world has developed rules-based platforms for resolving these issues without military force. The U.S. is guaranteeing freedom of passage, freedom of the seas and the territorial rights of allies such as the Philippines.

So far, the U.S.-Chinese confrontation has been about naval vessels passing in close quarters and surveillance aircraft being harassed by fighter jets. The risk of such tactics is an accidental collision, a rogue shot fired or a command misunderstood.

Any such incident could lead to retaliation, and there’s no telling where it might stop. Trump is not someone to back down, and Chinese leadership does not want to appear weak before the U.S.

That’s especially true at a time of great economic uncertainty. China does not want war at this time. But diverting the people’s attention away from domestic problems toward a foreign foe is an old trick leaders use to unite the people in times of uncertainty. Rallying the people around the flag is a tried and true method to garner support.

If China’s leadership decides that the risk of losing legitimacy at home outweighs the risk of conflict with the United States, the likelihood of war rises dramatically.

I’m not predicting it, but wars have started over less. This is a very dangerous time.

Be sure to hold cash, gold, silver, land and other assets that will cushion you against a market crash.


Jim Rickards
for The Daily Reckoning

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