Category Archives: The Daily Reckoning

The Government Could Shut Down Tonight

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Remember the “tea party” revolt in 2009–2010 against government bailouts and government spending? Remember the “fiscal cliff” drama of Dec. 31, 2012, when Congress raised taxes and cut spending to avoid a debt default and government shutdown? Remember the actual government shutdown in October 2013 as Republicans held the line against more government spending?

Well, congratulations if you do, because everyone else seems to have forgotten.

The days of caring about debt and deficits are over. Republicans passed the Trump tax cuts that will increase the deficit by $1.5 trillion on a conservative estimate, and probably much more. Then Republicans and Democrats “compromised” on eliminating caps on defense spending and domestic spending by agreeing to more of both.

That repeal of the so-called “sequester” will add over $300 billion to the deficit over the next two years.

Then there’s a tsunami of student loan debts in default that the Treasury has guaranteed and will have to pay off. Finally, the higher interest rates from this debt will add $210 billion to the annual deficit for every 1% increase in average federal debt funding costs.

Today we are looking at $1 trillion-plus deficits as far as the eye can see. That’s extraordinary enough. What is more extraordinary is that no one cares! Democrats, Republicans, the White House and everyday Americans are all united in totally ignoring the fact that America is going broke.

This euphoric mood in response to more spending won’t last. The growth is not there to pay for the tax cuts, and the economy is not even growing fast enough to keep up with the growth in the debt. Credit rating agencies are preparing reviews that will likely lead to a downgrade in the U.S. credit rating and higher interest costs for the Treasury.

When the crisis of confidence in the dollar and related inflation arrive, there will be no particular party to blame. The entire system is turning a blind eye to debt, and the entire system will have to bear some part of the blame.

We have a highly dysfunctional political system, with plenty of blame to go around.

Which brings me to a looming government shutdown scheduled for midnight tonight if a budget deal cannot be worked out.

Each fiscal year (Oct. 1 through Sept. 30) the government must be funded either through individual appropriations bills for separate departments and agencies or through “omnibus” legislation that funds multiple agencies with one gigantic bill that very few members of Congress actually read.

Any failure to pass an appropriation bill or omnibus bill on time results in the affected agency or the entire government shutting down at least with respect to “nonessential” personnel.

If a deadline is going to be missed, the Congress can pass a “continuing resolution,” or CR that keeps the government open using the prior year’s spending levels until the new appropriation can be worked out.

Eventually the appropriations bills must be passed, which is why they are the one vehicle where some bipartisan cooperation is needed.

Currently, a December 7 continuing resolution has been extended by two weeks to today because of the death of former President George H.W. Bush and the subsequent congressional activities surrounding his funeral services.

We can expect either a decision on a funding agreement by midnight tonight, another continuing resolution, or a federal government shutdown.

President Trump has insisted that over $5 billion be apportioned to fund the border wall that he promised during his campaign. Last year Trump suffered a political defeat when he didn’t get his funding. This year he seems determined to get it.

The House has actually passed a spending bill that allocates $5.7 billion for the wall. But it has to pass the Senate in order to go ahead. Senate Minority Leader Chuck Schumer has insisted that it wouldn’t get through the Senate. But Trump insists he won’t sign the bill unless it includes funding for the wall, and he says he’s prepared to let the government shut down:

“If the Dems vote no, there will be a shutdown that will last for a very long time.”

This could come right down to the wire. It no deal is reached the government will (partially) shut down. You might not remember, but the government actually shut down for two days back in January. Before that, the last shutdown occurred in 2013, which lasted 16 days.

But despite pervasive political dysfunction in Washington DC, there is one important piece of legislation that I expect to achieve bipartisan support in the coming months. This legislation would be a one-trillion dollar infrastructure spending bill that would extend its spending to all fifty states.

Both parties agree that enormous improvements are needed in highways, bridges, airports, railroads and public amenities. Democrats like infrastructure spending because most of the jobs created are union jobs that offer relatively high pay and benefits.

Republicans like infrastructure spending because the suppliers include firms that provide steel, heavy equipment, cement, asphalt and the technology behind the operating systems.

Both parties like infrastructure spending because it’s popular with voters and results in tangible progress unlike the intangible benefit programs that voters can’t see.

The Democrats can support “jobs, jobs, jobs” while the White House can say they’re out to “Make America Great Again.”

It’s a win-win for the two parties and the voters.

Of course, a bill of this type will add one-trillion dollars to the deficit, but at least politicians could claim that the benefits to the economy in terms of wages, equipment sales, safer highways and airports and reduced travel times will outweigh the added deficits; the new infrastructure will produce added growth for the economy.

Best of all, the infrastructure spending would be “made in America.” These are not the kind of projects that can be outsourced to Mexico or China. The projects would use U.S. steel, U.S. equipment and U.S. workers. At a time when the U.S. political process is breaking down into acrimony and accusation, both parties might like a bill the benefits the country and makes the politicians look reasonable.

Funding the Department of Transportation, which oversees infrastructure spending, could be the catalyst for companies that provide materials for structural improvements to the nation’s highways and bridges.

This is a great opportunity for investors who take advantage of the infrastructure spending spree that could begin soon.

Regards,

Jim Rickards
for The Daily Reckoning

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The “True” Money Supply Is Plunging

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The battered bulls sprung from the mat this morning, dukes up and fighting mad.

All three major averages rallied hard in early trading.

But late morning the bears landed another clout… and the bulls were back on the canvas, taking the count.

The Dow Jones ended the day down another 220 points.

The S&P lost 30; the Nasdaq, 195.

We now have it on excellent authority — Deutsche Bank — that 2018 is the “worst year on record.”

The bank tracks some 70 asset classes. These include global stocks, bonds, commodities, currencies, real estate — everything, A through Z.

And 93% of these assets are negative on the year… eclipsing the 84% mark set in 1920.

Here is your graphic proof:

2018: The Worst Year Ever

For perspective on the profound difference one year can make, consider:

Only 1% of these asset classes yielded negative returns last year — 1%.

And this year… 93%.

Might central banks somehow account for the Jekyll and Hyde act?

Do not forget, the Federal Reserve commenced quantitative tightening (QT) last October.

Foreign central banks are likewise tightening the taps, though to a lesser extent.

Deutsche Bank:

This is what happens when the vast majority of global assets are expensive historically due to extreme monetary policy… It’s perhaps not a surprise that in this time major… central banks have moved from peak global QE to widespread QT.

As a Daily Reckoning reader, you are likely chockablock with knowledge of quantitative tightening.

But let us now direct your attention toward monetary analysis of which few are aware.

That is, let us consider the “true money supply,” or TMS.

Economists of the “Austrian School” crafted the metric in the 1970s and ’80s.

Existing measures of money supply gave false readings, they claimed.

The true money supply consists of cash, demand deposits (i.e., checking accounts) at banks, savings… and government deposits at the Federal Reserve.

That is, it consists of money immediately available for transaction. It excludes money market funds, for example.

As Austrian economist Frank Shostak explained in Strategic Intelligence:

We take the figures published by the Federal Reserve and remove some items that shouldn’t be there and add some items that should. For instance… they include money market funds. (A money market fund is an investment in income-paying securities. It’s not really money in the sense that money sitting in your checking account is.) What we’re doing is removing all the transactions of lending and credit, and we only add those items that are pure money, which are claim transactions, like demand deposits.

This TMS business is complicated… and we refer you to Professor Google if its inner wizardry interests you.

But here our tale acquires its point…

If the TMS is a reliable weather vane of monetary conditions… the breeze is dying.

As analyst Jeff Peshut at the financial blog RealForecasts.com said earlier this year:

“It’s easy to see that the growth of TMS could grind to a halt and even begin to contract later this year.”

It appears that moment has come.

Here, the variable winds of the “true money supply” since 2003:

The 'True Money Supply' Is Plunging

Note the red arrow to the right.

Does it not align with the arrow on the left… that preceded the 2008 financial crisis?

Economist Joseph Salerno helped develop the TMS.

Says he:

What is of great interest is that the recent deceleration of monetary growth (the second red arrow) almost exactly matches in extent and rapidity the monetary deceleration (the first red arrow) that immediately preceded the financial crisis of 2007–08.

But perhaps Salerno chases a shadow, a phantom, a chance correlation trussed up as evidence.

No, he insists. He stands on solid bedrock, his eyes glued only to fact:

The qualitative relationship between TMS growth, credit crisis and recession has been remarkably clear since 1978.

He hauls forth the following chart in evidence:

Credit Crisis or Recession?

Let the record show:

Recession or credit crisis followed previous occasions when the true money supply decelerated at the present clip.

Not to the month, day or hour, of course.

But economies run to a lagging schedule.

Does the foregoing mean recession — or credit crisis — will soon be upon us?

The top-right line in the chart suggests a recession starting in March.

We take any economic forecast with truckloads of table salt — as should you.

But given its record, this true money supply rates a serious consideration.

This Wednesday Jerome Powell said quantitative tightening will proceed apace — on “autopilot” no less.

He further believes monetary policy is presently approaching “neutral.”

But if the true money supply is a reliable indicator, it is already in violent reverse…

And the economy is speeding for a brick wall.

Meantime, a government shutdown is looming for midnight tonight in the absence of a budget deal. Trump has threatened “a shutdown that will last for a very long time” if denied funding for the border wall.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Jerome Powell Crosses the Rubicon

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Mr. Jerome Powell entered this day hung from the hooks of a mighty dilemma.

Should he deliver another rate hike… or hold steady?

In two opposite directions he was yanked plenty hard…

His inner lights, his inner mother-in-law, urged him to hike.

GDP expanded an average 3.85% the two most recent quarters, they reminded him.

Unemployment — at 3.7% — plumbs depths unseen in a half-century. Wages are on the upswing.

Loading the scales in favor of a hike was the eager American consumer.

November retail sales jumped 0.9% — a Reuters poll of economists had forecast only 0.4%.

In all, an accelerating economy justifying a foot on the brake.

Bloomberg in summary:

“These conditions speak of an economy at full capacity and don’t square with the current benchmark interest rate of just 2.25%.”

Bank of America CIO Michael Hartnett took the business one further.

Should Powell not hike today, he counseled, a stock market rout would ensue.

“What does the Fed know?” would be the market’s response.

A recession would be the answer.

Thus, Hartnett feared a nay would “prompt U.S. stocks to join the global bear market.”

There, in a walnut shell, the aggregated case for a rate hike today.

But from the opposite direction, Wall Street — and the president — pulled Powell violently.

The stock market rests precariously upon a teeter-totter as things stand. Another rate hike may tip it right over, they warn.

And another rate hike could take the oomph out of the economy.

There is justice in their argument…

The Dow Jones has lost some 3,000 points since early October. The S&P and Nasdaq have been similarly trounced.

And half the S&P trades in bear market country.

Are these conditions that warrant a rate hike?

No, says Bloomberg — not if history is a guide:

It’s exceedingly rare the Federal Reserve raises interest rates when stocks are behaving this badly.

In fact, were policymakers to follow through with their widely expected hike Wednesday, it would be the first time since 1994 they tightened in this brutal a market. Right now the S&P 500 is down over the last three, six and 12 months, a backdrop that has accompanied just two of 76 rate increases since 1980.

And the United States economy?

GDP has been expanding, yes — but the trend is down: 4.2% for the second quarter, 3.5% for the third and fourth-quarter GDP estimates come in at roughly 2.4%.

And most 2019 projections range between 2–2.7%.

Meantime, first-quarter business investment expanded at a roaring 11.5% clip. By the third quarter… it was reduced to a sickly 2.5%.

Furthermore, the credit markets have ground to a standstill… like a seizing engine.

And where — exactly — is inflation? asks the anti-rate hike crowd. The Federal Reserve cannot even swing a lowly 2%, they moan.

And it wants to hike rates?

Atop it all the global economy has caught a flu — a contagious flu.

Explains renowned hedge fund manager Stanley Druckenmiller in The Wall Street Journal:

Global trade growth also slowed markedly, running about one-third lower than earlier in the year. Growth in some important economies, like China, is significantly weaker. No ocean is large enough to insulate the U.S. economy from slowdowns abroad. And no forecasting model adequately captures the spillovers and spillbacks between the U.S. economy and the rest of the world.

So if you think current conditions warrant another rate hike, critics conclude, you are far off the facts.

Adding to the doomy chorus was a voice with a Queens accent, rising from his residence at 1600 Pennsylvania Ave.:

It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike. 

But would Powell listen to the man who appointed him?

Strangely, the stock market was in jolly spirits leading up to today’s announcement.

The Dow Jones was up some 300 points by noon. The S&P and Nasdaq were similarly enraptured.

Were they expecting good news?

Then at 2 p.m., with all eyes centering, the white smoke billowed from the Vatican chimney… and word came down…

A rate hike it was — to 2.50%.

Powell tuned out the whines and put aside all pleas for mercy — including the president’s.

The stock market took a severe stagger when the announcement crossed the wires. It soon went over… and remained flat on its back the rest of the day.

After being up 300 points at noon, the Dow Jones closed the day down 352 points — a 652-point whiplashing.

The S&P ended 39 points in red; the Nasdaq, 147.

“I think the market reaction to all of this is the Fed is going to overdo it,” says James Paulsen, chief market strategist at Leuthold Group, adding:

“How else can you look at this than it just smells, at a minimum, like a really big slowdown in the economy coming, maybe even something worse.”

Mr. Powell held court at 2:30 in explanation of the decision.

His statement carried a noteworthy revision concerning the “neutral rate.”

As we have explained previously, the neutral rate neither stimulates nor depresses.

Hence it is neutral.

Rates stimulated for a decade. But no longer.

“Policy at this point does not need to be accommodative,” said Powell today. “It can move to neutral.”

The Fed concluded in September that the neutral rate ranged somewhere between 2.8% and 3.0%.

But today it claims the neutral rate may be as low as 2.5%.

Thus, by its own telling, the Fed concedes it is hard against the neutral line.

But as we have discussed recently, today’s rate hike may have actually crossed over the neutral rate.

You can see trouble is on tap once the fed funds rate (blue) crosses the neutral rate (red) — at least since the early 1980s:

Don't Cross the Neutral Rate!

You can also see that the blue line is presently rising past the red.

The record shows something usually snaps six–12 months after the Fed crosses the neutral line.

The arithmetic therefore puts June 2019 on watch — if the theory holds.

But Mr. Powell’s statement today contained a message perhaps even more distressing for markets.

Answer tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Who’s in Charge of Wall Street?

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Anarchy is amok on Wall Street, a scene of riot.

“Neither the bulls nor the bears are in charge,” cries Michael Kramer of Mott Capital Management.

Thus we find bull and bear, bovine and ursine, pitted in savage brawling, each battling for control of the nation’s capital.

One day the bulls wrest command and the Dow Jones leaps 500 points.

The next day bears pull off a countercoup… and retake the 500 points the bulls won the day before.

The rascals may claim an additional hundred or two before the bulls come back at them the following day.

Investors are glued to the desperate back-and-forth, like breathless spectators at a tennis match with everything on the line.

Which side wins ultimately — bull or bear?

Today we assess opposing forces… and hazard an ultimate victor.

The bears put the bulls to rout again today.

The Dow Jones plunged 497 panic-stricken points. The S&P sank 51, while the Nasdaq lost another 160.

MarketWatch reports on today’s combats:

U.S. stocks fell sharply… as investors focused on a batch of weaker-than-expected economic data out of China and Europe, sparking fresh worries about the state of the world’s second-biggest economy and prospects for global growth.

Freshly released data out of China revealed that November industrial output and retail sales underperformed expectations.

“Indeed,” says Stephen Innes, head of Asia-Pacific trading at Oanda, “investors are right to be worried about global growth as China economy continues to sputter.”

Meantime, data out this morning revealed that both German and French private sectors pulled back sharply in November.

And so the “globally synchronized growth” the professionals crowed about last year is nearly turned upon its head.

The United States economy is still growing… though trending in the incorrect direction.

GDP growth crested in this year’s second quarter at 4.2%. Third-quarter growth slipped to 3.5%, while fourth-quarter estimates converge at roughly 2.4%.

Bloomberg tells us today that excluding autos, U.S. manufacturing has stagnated two of the past three months.

Today brings further word that rating agencies have downgraded a thumping $176 billion of corporate debt this quarter — a possible portent of a credit crisis.

And we have it on reliable authority — Jeffrey Snider, head of global investment research at Alhambra Partners — that the banking system has contracted for the second consecutive quarter.

“This,” says a gulping Snider, “hasn’t happened since 2009.”

Meantime, the marauding bears think they have victory within sight…

The S&P peaked in late September. It presently trades more than 10% below that summit — meaning it is in official correction.

Thus the index is halfway to full bear market territory, defined commonly as a 20% fall from its most recent heights.

And as notes financial journalist Mark Hulbert:

“The stock market’s late-September peak looks disturbingly like the beginning of a bear market.”

Here he stands behind data from the widely respected Ned Davis Research.

They reveal the stock market’s third-quarter showing tracks closely with a pattern matching bull market tops for nearly 50 years.

Hulbert:

[Ned Davis] calculated the average return of the S&P 500’s 10 sectors over the last three months of each prior bull market top (back to the early 1970s). This enables them to periodically look at how that historical ranking compares with how the sectors are actually performing.

For example…

Davis Research reveals the health care sector performed second best of the 10 S&P sectors (on average) the three months prior to previous bull market tops.

“Ominously,” notes Hulbert, health care ranked first the three months prior to the Sep. 30 market top.

Meantime, the utilities sector typically ranks last of the 10 sectors for the final three months of previous bull markets.

Its current ranking: eighth.

How do these sector rankings inform us of our place in the market cycle?

Once again, Hulbert:

One reason is that the stock market may be anticipating an imminent economic slowdown, in the process favoring more defensive sectors such as health care… Another reason is that interest rates typically start rising in the latter stages of a bull market, and higher rates have a disproportionately negative impact on “financials” and “utilities.”

Interest rates may rise once again next week, when the “Open Market” Committee of the Federal Reserve huddles at Washington.

Market odds of another rate hike presently stand at 76% — in favor.

This, as the global liquidity stream is going dry.

The Federal Reserve chiefly accounts for the drought… but the other central banks are falling in behind it.

And so the tide swings in favor of the bears after a nearly unbroken string of defeats stretching a decade.

So today we wonder:

How much fight do the bulls have left?

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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The 7 Stages of a Financial Bubble

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“Is there a market bubble?” That’s the question I’m asked repeatedly. When I reply honestly, “I hope so,” the person asking me will sometimes get angry.

“You want the market to crash?” asked one young man incredulously, at an event where I was a featured speaker.

“Yes,” I replied. “I love market crashes.”

Apparently not wanting to hear the rest of my explanation, he stomped off muttering something like “moron.”

I’ve covered this subject of booms, busts, and bubbles before in my columns and books. But since the world seems to be on the brink of so many different booms and busts, I think it’s a good time to revisit it.

Look at the market right now. The Dow is about 3,000 points off its October high. And it could get a lot worse.

Over the years, I have read several books on the subject of booms and busts. Almost all of them cover the Tulip Mania in Holland, the South Seas Bubble, and, of course, the Great Depression. One of the better books, Can It Happen Again?, was written in 1982 by Nobel Laureate Hyman Minsky. In this book, he described the seven stages of a financial bubble. They are:

Stage 1: A Financial Shock Wave. A crisis begins when a financial disturbance alters the current economic status quo. It could be a war, low interest rates, or new technology, as was the case in the dot-com boom.

Stage 2: Acceleration. Not all financial shocks turn into booms. What’s required is fuel to get the fire going. After 9/11, I believe the fuel in the real estate market was a panic as the stock market crashed and interest rates fell. Billions of dollars flooded into the system from banks and the stock market, and the biggest real estate boom in history took place.

Stage 3: Euphoria. We have all missed booms. A wise investor knows to wait for the next boom, rather than jump in if they’ve missed the current one. But when acceleration turns to euphoria, the greater fools rush in.

By 2003, every fool was getting into real estate. The housing market became the hot topic for discussion at parties. “Flipping” became the buzzword at PTA meetings. Homes became ATM machines as credit-card debtors took long-term loans to pay off short-term debt.

Mortgage companies advertised repeatedly, wooing people to borrow more money. Financial planners, tired of explaining to their clients why their retirement plans had lost money, jumped ship to become mortgage brokers. During this euphoric period, amateurs believed they were real estate geniuses. They would tell anyone who would listen about how much money they had made and how smart they were.

Stage 4: Financial Distress. Insiders sell to outsiders. The greater fools are now streaming into the trap. The last fools are the ones who stood on the sidelines for years, watching the prices go up, terrified of jumping in. Finally, the euphoria and stories of friends and neighbors making a killing in the market gets to them. The latecomers, skeptics, amateurs, and the timid are finally overcome by greed and rush into the trap, cash in hand.

It’s not long before reality and distress sets in. The greater fools realize that they’re in trouble. Terror sets in, and they begin to sell. They begin to hate the asset they once loved, regardless of whether it’s a stock, bond, mutual fund, real estate, or precious metals.

Stage 5: The Market Reverses, and the Boom Turns into a Bust. The amateurs begin to realize that prices don’t always go up. They may notice that the professionals have sold and are no longer buying. Buyers turn into sellers, and prices begin to drop, causing banks to tighten up.

Minsky refers to this period as “discredit.” My rich dad said, “This is when God reminds you that you’re not as smart as you thought you were.” The easy money is gone, and losses start to accelerate. In real estate, the greater fool realizes he owes more on his property than it’s worth. He’s upside down financially.

Stage 6: The Panic Begins. Amateurs now hate their asset. They start to dump it as prices fall and banks stop lending. The panic accelerates. The boom is now officially a bust. At this time, controls might be installed to slow the fall, as is often the case with the stock market. If the tumble continues, people begin looking for a lender of last resort to save us all. Often, this is the central bank.

The good news is that at this stage, the professional investors wake up from their slumber and get excited again. They’re like a hibernating bear waking after a long sleep and finding a row of garbage cans, filled with expensive food and champagne from the party the night before, positioned right outside their den.

Stage 7: The White Knight Rides in. Occasionally, the bust really explodes, and the government must step in—as it did in the 1990s after the real estate bust when it set up an agency known as the Resolution Trust Corporation, often referred to as the RTC.

As it often seems, when the government does anything, incompetence is at its peak. The RTC began selling billions of dollars of unbelievable real estate for pennies on the dollar. These government bureaucrats had no idea what real estate is worth.

In 1991, my wife Kim and I moved to Phoenix, AZ, and began buying all the properties we could. Not only did the government not want anything to do with real estate, amateur investors and the greater fools hated real estate and wanted out.

People were actually calling us and offering to pay us money to take their property off their hands. Kim and I made so much money during this period of time we were able to retire by 1994.

There you have the seven stages of a financial bubble. And we could be nearing the end. But let me say it again: I love market crashes. I love them because that’s the best time to buy — finding true value is a lot easier during such periods.

And since so many people are selling, they’re more willing to negotiate and make you a better deal. Although a crash is the best time to buy, the market’s high pessimism also makes it a tough time to do so.

I remember buying gold at $275 an ounce in the late 1990s. Although I knew it was a great value at that price, the so-called experts were calling gold a “dog” and advised that everyone should be in high-tech and dot-com stocks.

Today, with gold above $1200 an ounce, those same experts are now recommending gold as a percentage of a well-diversified portfolio. Talk about expensive advice.

My point is that this current period is a tough time to buy or sell. Real estate is high, interest rates are high — and climbing, the stock market is a roller coaster, the U.S. dollar is low, gold is high, and there’s a lot of money looking for a home.

So, the lesson is: Now, more than ever, it’s important to focus on value, not price. When prices are low, finding value is easy.

When prices are high, value is a lot harder to find — which means you need to be smarter, more cautious, and resist your knee-jerk reactions. A final word from Warren Buffett: “It’s only when the tide goes out that you learn who’s been swimming naked.”

Now you know why I say, “I love market crashes.”

Although my wife and I continue to invest, we’re more like hibernating bears waiting for the party to end. As Warren Buffett says, “We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful.”

So instead of asking, “Is it a bubble?” it’s more financially intelligent to ask, “What stage of the bubble are we in?” Then, decide if you should be fearful, greedy, or hibernating.

Based on recent action, it might be time to get greedy.

Regards,

Robert Kiyosaki
for The Daily Reckoning

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Jerome Powell Better Get “Real”

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

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

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

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

We have it on official word:

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

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

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

This is the question we tackle today…

Let us first sit down with the facts…

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

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

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

By March 1980… inflation roared a mighty 14.7%.

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

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

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

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

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

There is simply no comparison between periods, you say.

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

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

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

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

Your objection is noted and entered into the record.

But we encourage you to get “real.”

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

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

Further assume that inflation runs to 1%.

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

Now consider the case before us…

Nominal interest rates averaged 13.35% in 1980.

Meantime, 1980 inflation averaged 13.5%.

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

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

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

Once again:

1980’s average nominal interest rate was 13.35%.

But its average real interest rate was -0.15%.

Now roll the reel forward to 2018…

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

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

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

What do we find?

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

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

Shocking — but there you are.

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

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

It penetrates numerical mists. It scatters statistical fogs.

It clarifies.

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

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

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

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

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

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

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

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

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

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

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

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

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

The economy was in recession by summer ’81.

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

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

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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America Has a “Neo-feudal” System

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The conventional definition of a Bear is someone who expects stocks to decline. For those of us who are bearish on fake fixes, that definition doesn’t apply: we aren’t making guesses about future market gyrations (rip-your-face-off rallies, dizziness-inducing drops, boring melt-ups, etc.).

No, we’re focused on the impossibility of reforming or fixing a broken economic system.

Many observers confuse creative destruction with profoundly structural problems. The technocrat perspective views the creative disruption of existing business models by the digital-driven 4th Industrial Revolution as the core cause of rising income inequality, under-employment, the decline of low-skilled jobs, etc. — many of the problems that plague the current economy.

I get it: those disruptive consequences are real. But they aren’t structural: crony capitalism and the state-cartel system is structural, because cartels can buy political protection from competition and disruptive technologies. Just look at all the cartels that have eliminated competition: higher education, defense contractors, Big Pharma — the list is long.

The fake fixes to the structural dominance of cartels and entrenched elites come in two flavors: political reforms that add complexity (oversight, compliance, etc.) but never threaten the insiders’ skims and scams. And monetary policies such as low interest rates and unlimited liquidity that enrich the already-wealthy by funneling whatever gains are being reaped to them rather than to labor.

I explain how this neo-feudal economy is the inevitable result of our system in my new book Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic.

Our political system, dependent on campaign contributions and lobbying, is easily influenced to protect and enhance the private gains of corporations and financiers. Combine this with the gains reaped by those with access to cheap credit and you have a financial nobility ruling a class of debt-serfs.

Cartels and quasi-monopolies eliminate competition by buying start-ups and political protection, raising barriers to entry for upstarts. This kills innovation and productivity, which are corralled to serve existing cartels.

The wealthy own productive assets, the poor own debt. Debt accrues interest which flows to those who own the debt — student loans, auto loans, mortgages, etc.

Wages have stagnated for the bottom 80% for decades for a variety of reasons. But quantitative easing and zero real interest rates haven’t fixed this structural problem — rather, they’ve exacerbated wealth and income inequality:

Meanwhile, the highly profitable credit machine is no longer boosting growth. It took $4 in new debt to create $1 in GDP in 2016, for example. Needless to say, that’s not a lot of bang for the buck.

Our neo-feudal system has offered perverse incentives to borrow vast sums to buy back stocks and other unproductive uses benefit the few at the expense of the economy as a whole.

Beneath the bullish narrative of eternal growth and ever-rising profits, the financial system’s buffers have been thinned. As I explain in my book, the global financial system is now “hyper-coherent,” meaning that instability in one corner of the system quickly spreads to the entire system.

This systemic vulnerability is largely invisible, and so the inevitable contagion will surprise most observers and participants.

A funny thing happens in a fast-spreading financial contagion: markets go bidless, meaning there’s no buyers at any price. The entire global financial system rests on this one assumption: markets will always be liquid, but liquidity vanishes in contagions.

The fake-fix of the past decade is for central banks to buy impaired assets to create an artificial market. That works if you throw trillions of dollars, yuan, yen and euros into the artificial market, but that process destroys organic markets.

Fake fixes don’t fix what’s actually broken. They’re duct tape holding together a broken system.

The basic idea here is the socio-economic-political system is structured such that the only possible output is neo-feudalism. In other words, neo-feudalism isn’t a flaw in the system that can be changed with policy tweaks or electing a new president or prime minister — it’s the result of the system working as designed.

Neo-feudalism is a peculiarly invisible hierarchical structure of power: The New Nobility (or aristocracy if you prefer) wields vast concentrations of political, social and financial power, and does so without the formalized aristocrat-serf relationships and obligations of classic neo-feudalism.

We appear to be free but we’re powerless to change the power asymmetry between the New Nobility and the commoners. This reality is reflected in social relations that form just appearances of actual power, pantomimes acted out in media-theaters to instill the belief that the old myths of democracy and social mobility are real rather than misleading shadows.

Neo-feudalism is fundamentally a financial-political arrangement, marketed and managed by cultural elites who strive to convince us that we still have some shreds of power. These elites have a variety of tools at their disposal. One has been described by filmmaker Adam Curtis as pantomime: Trump says or does something outrageous, the Democrats cry “impeachment,” and so on.

This theater of pantomime serves two purposes: it projects a simulation of functional democracy that makes us believe impeaching one president and getting another one in office will change anything about the neo-feudal power structure; it won’t.

The theater of pantomime also distracts us from the remarkably stable asymmetry of power in our social-political-financial construct:

Various ambiguities are blown into “the most important issue of today,” a revolving performance in which virtue-signaling has replaced actual action to remedy the vast imbalances of power, and appeals to myths that no longer manifest in the real world (democracy and social mobility). They are used to suppress and marginalize the search for new structures that would upend the cozy incest of neo-feudalism’s financial and political power.

Again, I discuss the structure of neo-feudalism in my new book Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic at some length. One key takeaway is this:

$100 million invested in influencing the central state guarantees $1 billion in private-sector profits. Or $10 billion. The point is the return on investment is unbeatable, and so is the security of the gains.

This marriage of state power to create credit and its monopoly on force with private-sector financial power is the core relation of neo-feudalism. The only possible output of this structure is a mass of powerless debt-serfs enriching the New Nobility, who are slavishly served by a class of “liberal” technocrats and managers tasked with promoting pantomimes passing as “the real thing.”

Despite the ubiquity and sophistication of this marketing and management machinery, the debt-serfs sense the entire system is both false and precarious, two intimately related realities, for fakery is always precarious: the truth about the asymmetries of power might slip out and spread like wildfire.

Regards,

Charles Hugh Smith
for The Daily Reckoning

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Are We in a Recession Already?

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Are we in a recession already?

The cheerleaders in the mainstream financial press assure us the economy is going gangbusters. But recessions are typically only visible to statisticians long after the fact. They are, however, often visible in real time on the ground.

Business volume drops, people stop buying houses and vehicles, restaurants that were jammed are suddenly half-empty and so on.

There are well-known canaries in the coal mine in terms of indicators. These include building permits, architectural bookings, air travel and auto and home sales.

Home sales are already dropping in most areas, and vehicle sales are softening. Airlines and tourism may continue on for a while, as people have already booked their travel, but the slowdown in other spending can be remarkably abrupt.

All nations are mosaics of local economies, and large nations like the U.S. are mosaics of local and regional economies, some of which (California, Texas, New York) are the equivalent of entire nations in and of themselves.

As a result, there can be areas where the Great Recession of 2008–09 never really ended, and other areas that have experienced unprecedented building booms (for example, the San Francisco Bay Area, where I live part time.)

Changes in sentiment are reflected in different sectors of the economy: People become hesitant about big purchases first (autos, houses) and then start deciding to save more by spending less on smaller things (Christmas shopping, eating out, vacations, etc.).

Given the structural asymmetries of our economy (a few winners, most people lucky to be losing ground slowly), each economic class also responds differently. The lower 60% of households don’t have the disposable income of the top 10%, so “cutting back” for them might be buying fewer fast-food meals per week.

The top 10% have the majority of the nation’s disposable income, just as they own two-thirds of the wealth. If the sources of their income tank (tech bubble pops, etc.), then signs of recession in this class will be a decline in high-cost consumption: sales at luxury stores, fancy restaurants, etc.

In other words, different classes, sectors and regions of the economy can be in recession while others are still doing fine.

As a result, the value of declaring the entire nation in or out of recession is limited. While national conditions such as mortgage rates and Treasury yields are consequential, the recessionary effects will likely be as asymmetric as the economy. The effects will vary considerably depending on how each sector, class and region is doing.

To summarize: The top 10% may never experience a recession that guts the bottom 90%, who depend on wages rather than earnings from capital. And wages have been in structural decline.

The 90% will feel a recession very hard.

Regards,

Charles Hugh Smith
for The Daily Reckoning

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The Fed Is Panicking

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This week I’ve been in Washington, D.C. for high level meetings focused on the economy. While meeting with senior officials and members of the House and Senate, it became clear that a troubling phenomenon is building.

Nomi at the Eccles Building in D.C.

Your correspondent at the Eccles Federal Reserve
Board Building in Washington D.C.

In the wake of recent stock market volatility and uncertainty surrounding monetary policy, it seems that political figures are starting to grow concerned.

There is growing consensus that the makings of a financial crisis of some sort is building — and could drop sooner rather than later. While there is speculation over whether it will be as big as the last one, and whether it will come in waves, the belief is that something is wrong.

With those fears, I turned the Federal Reserve itself. While meeting at the Fed, I was given the impression that bank regulators have been routinely chastised by Wall Street bankers. What I learned is that some of the biggest playmakers in finance don’t want to disclose the true nature of their positions and money-making schemes. This confirmed my own experiences as an former investment banker.

In addition, it became clearer that Fed Chairman, Jay Powell, and Vice Chairman, Randal Quarles, will be closely studying real economic and bank data when rendering decisions about the path of interest rates. Many have speculated about such dealings, and whether they will be swayed by President Trump’s pressure.

The truth is that the leaders at the Fed have a firmer understanding of what’s really going on in the economy than they allude to publicly. Even though the Fed has been able to avoid another financial crisis the last decade, with quantitative easing (QE) policy — or what I call dark money — their “toolkit” might not render us “safe enough.” They need to grapple with this reality.

Jerome Powell

Jerome Powell, left, and Randal Quarles.
AP Photo/Cliff Owen.

You see, the Fed manufacturers dark money that the markets have come to rely on. Through quantitative easing (QE) the central bank has accumulated a balance sheet that hit a high of $4.5 trillion of assets last year.

By having purchased these assets with electronically created money, the Fed was able to keep rates at the middle and longer end of the yield curve low, while they specifically set low rates for the short end of the yield curve, too.

Just to remind you, the yield curve is the difference between short- and long-term interest rates. Long-term rates are normally higher than short-term rates. When the two converge, it often means markets are anticipating low growth ahead. When the yield curve inverts, when long-term rates fall below short-term rates, it’s almost always a sign of looming recession, historically speaking.

Currently the Fed’s book of assets has been reduced by only a bit — to about $4.1 trillion — but it’s still historically large.

If the Fed continues to sell those assets (which consist of treasury and mortgage bonds) there is a risk that their value will drop too much, too quickly. If bond values drop, then rates will rise in the middle and longer end of the yield curve. This would make it more expensive for most companies to repay, or extend, their corporate debts.

The Fed knows it is currently in a catch-22. That’s why over the last two weeks, it has barely sold any of its assets as volatility in the markets picked up.

Here’s something else you might not know: Two weeks ago, it even quietly increased its book of assets. That’s the opposite of the policy of unwinding, or selling its assets through quantitative tightening (QT), which is what Chairman Powell promised he would be doing.

That’s another sign that the Fed is afraid of a possible new financial crisis. For more proof, consider that former Fed Chair, Janet Yellen, just did a 180 on her prior comments related to the possibility of another crisis. Last June, she said that she didn’t think there would be another financial crisis in her lifetime, attributing this to banking reforms made since the 2008 financial crisis.

Now, everything has changed. Earlier this week, she told the New York Times that, “Corporate indebtedness is now quite high and I think it’s a danger that if there’s something else that causes a downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector.”

She noted that CLOs could be a real problem, as I’ve been warning for months. CLOs, or collateralized loan obligations, are a Wall Street product stuffed with corporate loans. If that sounds familiar to you, there’s a reason. Wall Street is doing exactly what they did with mortgage loans before the 2008 financial crisis, but with corporate ones.

Her timing was not random. Just because she’s no longer running the Fed doesn’t mean she has no contact with its new leader, who was her number two. The people and connections within central banks and Wall Street are always in play.

The danger in her analysis is that she’s largely mistaken that “current holders of corporate debt do not appear to be levered to excess, mitigating risk of any credit ripple effects.” The data bears this out.

Companies are holding $9.1 trillion of debt now in contrast to the $4.9 trillion in 2007 before the last financial crisis. The financial system, and those who take money from banks, are more highly levered than they were prior to the last financial crisis.

In its inaugural Financial Stability Report, the Fed stressed lurking dangers in corporate debt. Although the Fed also used the opportunity to pat itself on the back for how well capitalized banks were, just as Janet Yellen did, the trouble was still highlighted.

The Fed noted that corporate debt relative to GDP is at record highs, and that credit standards have gotten worse again. The amount of junk bonds and leveraged loans or “risky debt” has risen by 5% in the third quarter of 2018 to over $2 trillion in size.

The central bank pointed to a number of other risks facing the markets. Those include the outcome of Brexit, Italy’s finances and a slowing European economy which could lead to more dollar appreciation. If the dollar were to continue to rise in value, it would make it harder for foreign companies that took out dollar-denominated debt to repay it.

The Fed also used the report to warn that trade wars, geopolitical tensions and slowdowns in China and other emerging market economies could negatively impact the U.S. economy and markets.

All of these factors could not only impact the markets, as we’ve seen over the past several weeks, but also begin to creep in on how companies are able to repay their debts.

Next week is the big Fed meeting. I don’t believe the Fed will raise rates this time, which would give markets a boost heading into the new year. If they do, the announcement will be accompanied with much more dovish language and guidance for 2019. Regardless, the problems aren’t going away and neither is volatility.

Regards,

Nomi Prins
for The Daily Reckoning

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New Cold War With China Possible

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On Saturday, Dec. 1, at the end of the G-20 meeting in Buenos Aires, President Trump and his team of trade and finance advisers had dinner with President Xi Jinping of China and his team.

The purpose was to discuss the ongoing trade war between China and the U.S. Trump’s team had presented the Chinese team with 142 specific trade demands.

The two sides went over the demands one by one during the course of their two-hour dinner. When they were done, both sides announced a 90-day “truce” in the trade wars. China agreed to negotiate in good faith on the demands and the U.S. agreed to delay the imposition of tariffs scheduled to go into effect Jan. 1, 2019, until March 1, 2019, to give the negotiations time to proceed.

This was not a final deal, but it did allow markets to breathe a sigh of relief. The initial response of the stock market was a rally.

But just hours after the Trump-Xi announcements, Canada arrested Meng Wanzhou, the CFO of Huawei, in Vancouver, British Columbia. The arrest was at the request of the United States, which had issued an arrest warrant for Meng last August on numerous charges including money laundering, espionage and selling telecommunications equipment to Iran in violation of U.S. sanctions.

Meng was arrested during a stopover in Vancouver on a flight from China to Mexico. She was avoiding U.S. territory but was apparently unaware of the U.S. arrest warrant and the degree of cooperation between Canada and the U.S. on criminal matters and extradition.Huawei is the largest telecommunications equipment manufacturer in the world and one of the largest tech companies in China. Meng is the daughter of Huawei founder Ren Zhengfei.

The arrest of Meng threw global markets into turmoil. The Dow Jones industrial average index fell over 1,400 points, a 5.5% swoon, from the close on Monday, Dec. 3 to the close on Friday, Dec. 7. As of the Friday close, the Dow was down for the month, quarter and year. By the way, as of today, Dec. 13, it’s still down on the year.

By Sunday, Dec. 9, Canada was asking that Meng remain in jail pending the outcome of a hearing on whether she should be extradited to the U.S. to face a criminal trial. Meng’s lawyers were arguing that she should be granted bail and was not a flight risk because she owned property in Vancouver. She also argued that her health would be adversely affected by further incarceration. The Canadian court took these claims under advisement and planned to rule soon on the bail and extradition.

Jim in China

On a recent trip to Nanjing, China, I was permitted inside a secure research facility of Huawei, one of the top technology companies in China. Huawei is the world’s largest telecom equipment provider and a leader in the global rollout of 5G smartphone systems. Canada has arrested the CFO of Huawei, who is being held for extradition to the U.S. on charges of money laundering, espionage and violation of U.S. sanctions on Iran.

The Huawei arrest was more than a shock to markets. It was also a shock to the U.S.-China trade war negotiations. Both sides pledged to keep the negotiations on track, but China was publicly outraged by the arrest.

China told the Canadian ambassador that there would be “severe consequences” if Canada did not immediately release Meng. China’s Vice Foreign Minister Le Yucheng told the U.S. ambassador to China that “the actions of the U.S. seriously violated the lawful and legitimate rights of the Chinese citizen, and by their nature were extremely nasty.” Le also said, “China will respond further depending on U.S. actions.”

The Meng arrest is significant in its own right, but is even more significant when taken in the full context of U.S.–China relations and the possibility of a new Cold War.

Huawei is not only China’s largest telecommunications firm; it is a leader in the rollout of 5G technology for mobile phones. Huawei is alleged to have deep ties to the Communist Chinese government and the People’s Liberation Army (PLA).

Huawei founder Ren Zhengfei started his career as a military technologist at the People’s Liberation Army research institute. U.S. intelligence estimates that Huawei is de facto controlled by PLA and has engineered trapdoors and other devices in Huawei equipment that allow Huawei to spy on customer message traffic and to capture private data.

The U.S. has already refused to allow Huawei to make acquisitions of U.S. companies and has banned Huawei from sales of equipment to the U.S. government. The U.S. has also urged its intelligence partners in the “Five Eyes” (U.K., Canada, Australia and New Zealand) to do likewise. Huawei’s business is suffering worldwide just as the 5G tech implementation begins.

The next steps in the case are still pending. The British Columbia court needs to decide on bail and possible extradition. If Canada extradites Meng to the U.S., she will almost certainly face a trial on criminal charges unless a plea deal can be worked out. In a worst case, Meng will spend years in a U.S. prison. At best, the case will inflict major damage on U.S.-China relations and the prospects for peace in the trade wars.

In the meantime, the 90-day “truce” that Trump and Xi negotiated in Buenos Aires is still officially in force.

The Chinese could offer token concessions and use the 90-day window to cook up new happy talk. Their hope will be that after 90 days of negotiations and some minor concessions, the U.S. will be reluctant to break the peace or impose the additional tariffs.

The 90-day period will also give the Chinese lobbyists time to gin up opposition to tariffs from U.S. agricultural importers. This is an important political constituency for Trump as we move closer to the 2020 presidential election season. Trump needs support from agricultural states like Missouri, Iowa and Wisconsin to win his second term as president. It seems the Chinese understand U.S. politics better than most Americans.

The Chinese are also notorious for saying one thing and doing another. They will gladly sign an agreement that calls for reductions in the theft of intellectual property and then turn around and keep up the thefts (perhaps with a more covert method).

The Chinese have consistently broken their word when it comes to trade, beginning with their admission to the World Trade Organization in 2001. They will do it again once they tie the U.S.’ hands on tariffs.

The good news for the U.S. is that the Chinese tricks are fairly well-known by now. Trump’s most trusted and powerful adviser on trade is ambassador Robert Lighthizer, who was at the dinner. Lighthizer sees the Chinese for what they are and knows the litany of broken promises and lies better than the Chinese leadership.

If substantive improvements with adequate verification cannot be agreed upon with the Chinese by April 1, 2019, Lighthizer is ready to immediately raise tariffs on China. President Trump agrees with Lighthizer and will not hesitate to raise the tariffs. At that point, the trade wars will be back with a vengeance.

Regards,

Jim Rickards
for The Daily Reckoning

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