Retaliation!

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“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…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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“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.

Regards,

Jim Rickards
for The Daily Reckoning

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

Trump Attacks!

This post Trump Attacks! appeared first on Daily Reckoning.

The trade war is back on. The trade deadline came and went at midnight last night without a deal. So 25% tariffs on $200 billion worth of Chinese goods took effect at 12:01. The tariffs had previously been set at 10%.

Based on Trump’s comments, 25% tariffs may possibly be applied to an additional $300 billion of Chinese goods.

China said it would respond with unspecified but “necessary countermeasures,” although negotiations continued today in Washington.

Some analysts say China can dump its large holdings of U.S. Treasuries on world markets. That would drive up U.S. interest rates as well as mortgage rates, damaging the U.S. housing market and possibly driving the U.S. economy into a recession. Analysts call this China’s “nuclear option.”

There’s only one problem.

The nuclear option is a dud. If China did sell some of their Treasuries, they would hurt themselves because any increase in interest rates would reduce the market value of what they have left.

Also, there are plenty of buyers around if China became a seller. Those Treasuries would be bought up by U.S. banks or even the Fed itself. If China pursued an extreme version of this Treasury dumping, the U.S. president could stop it with a single phone call to the Treasury.

That’s because the U.S. controls the digital ledger that records ownership of all Treasury securities. We could simply freeze the Chinese bond accounts in place and that would be the end of that.

So don’t worry when you hear about China dumping U.S. Treasuries. China is stuck with them. It has no nuclear option in the Treasury market.

How did we get here?

Trump’s trade representatives have complained that China had backtracked on previous agreements and that China was trying to renegotiate key points at the last minute. The Chinese are not accustomed to such resistance from U.S. officials. But Trump and his team are unlike previous administrations.

China assumed it was “business as usual” as it had been during the Clinton, Bush 43 and Obama administrations. China assumed it could pay lip service to trading relations and continue down its path of unfair trade practices and theft of intellectual property. Trump has proven them wrong.

Trump was never bluffing. He means business, which China is finally learning.

There’s still time to reach a deal, however, before the tariffs actually have any practical impact. The tariffs only apply to Chinese goods that leave port after last night’s deadline. That means goods already en route to the U.S. will not be affected.

So it will be at least two weeks until Chinese goods are actually subject to the extra tariffs. So that leaves the window open for a deal.

Trump announced on Twitter early this morning that “there is absolutely no need to rush” to get a deal done, which removed any urgency from negotiations for the moment. You can expect the cat and mouse to continue for the next couple of weeks, with volatile swings in the stock market depending on the news of the day.

But Trump holds the superior hand as far as trade goes. China exports far more to the U.S. than the U.S. exports to China, so China has far more to lose in the trade war. Since the trade war began, the U.S. has suffered only minor impacts, while the impact on China has been overwhelming. The new tariffs will have even more serious effects on the Chinese economy.

A 25% tariff on $200 billion of goods could take 0.3–0.4% off Chinese growth. And if Trump carries through with 25% tariffs on an additional $300 billion of Chinese goods, it could subtract an additional 0.5% from Chinese growth.

That would cost China 0.8–1% of lost GDP at a time when the Chinese economy is struggling and can least afford it.

To go along with slowing growth, the Chinese financial sector is totally insolvent. Consumers’ savings have been used to finance ghost cities, white elephants, capital flight, Ponzi schemes, bribes and kickbacks.

There are some real assets to show (their trains are the best in the world) and some growth, but not nearly enough to cover liabilities.

With a debt-to-GDP ratio of about 250%, China is already well into the danger zone. How much more debt-financed stimulus can it take?

Research by economists Kenneth Rogoff and Carmen Reinhart indicates that debt-to-GDP becomes a drag on the economy at 90%.

China’s leadership can only hope the damage can be limited before the people begin to question its legitimacy.

Could China’s leadership lose “The Mandate of Heaven?”

Regards,

Jim Rickards
for The Daily Reckoning

The post Trump Attacks! appeared first on Daily Reckoning.

What Trump’s Really Thinking

This post What Trump’s Really Thinking appeared first on Daily Reckoning.

Last week the president thundered for a 100-basis-point rate cut… and a resumption of quantitative easing.

But why has President Trump raged anew for rate cuts?

After all…

Latest GDP officially hums at a tuneful 3.2% — and official unemployment scarcely has existence.

Is it simply because the president is a “low interest rate guy”?

Is he merely setting his cap for 2020? Or is his concern far more immediate?

Today we don our detective hat, open our sleuth kit… and piece things out.

But first, another day of long faces on Wall Street — the fourth consecutive losing session.

The Dow Jones shed another 139 points. The S&P lost nine; the Nasdaq 33.

The tariffs go up tonight at 12:01 Eastern should final hour diplomacy fail.

And the hourglass runs low.

But why again the president’s latest shouts for rate cuts?

“Given the Economic Situation, the Federal Funds Rate Should Be Closer to 5% than the Current 2%”

Scratching his head is Michael Carino, CEO of Greenwich Endeavors:

President Trump tweeted that the Federal Reserve should lower the federal funds rate by 100 bps and reengage their bond buying program known as quantitative easing to accelerate the current and longest-ever expansion in the U.S.

What could possibly convince President Trump that such aggressive monetary policy is required. After all, GDP is running well above average at 3.2%, unemployment is at historic lows of 3.6% and… given the economic situation, the federal funds rate should be closer to 5% than the current 2%. Talking about unconventional monetary policy that should only be used in times of extreme crisis is, to be polite, premature.

Then why?

Carino began sniffing for clues…

Instantly he plucked one from the presidential tweet above mentioned:

“China is adding great stimulus to its economy while at the same time keeping interest rates low.”

China?

Now he had the president’s scent. Down dark and bending roads he pursued it:

Trump’s Real Motivation?

… The trade war with China is about to get expensive with tariffs increasing from 10% to 25%.

With China trade at $500 billion, a 25% tariff would be the equivalent of taxing the U.S. $125 billion. This tax is enough to bring the change in GDP in any quarter from a healthy 2–3% to zero or negative. 

Zero or negative GDP growth would pry from Trump his principle selling point — the economy.

At last, this Carino ran down his quarry, seized him by the collar… and hauled him in:

Though a simplistic thought process, it’s obvious President Trump wants to use the Federal Reserve to offset costs of upcoming government action…

Putting it bluntly, China’s central bank is funding state policies and subsidizing the costs of those policies and President Trump wants to do the same. 

Have we solved a puzzle?

Perhaps it explains the president’s most recent wailing for drastic rate cuts and quantitative easing.

But even if inclined, it is far from certain the Federal Reserve can equal the task.

A Decade of Futility

Ten years running the central bank has nailed interest rates to the floor — or just above it.

Rates still remain at levels historically low.

Yet the present economic expansion remains the most punchless on record.

And growth today pegs along at roughly the same rate as under Mr. Barack Obama.

Even he had his scintillating and bedazzling quarters of growth. Yet each proved a false start, a false dawn — a false hope.

Have conditions materially changed under No. 45?

Alas… they have not.

Prior to 2019’s first-quarter 3.2%, growth has trended wrong since 2018’s second quarter.

And Q1’s 3.2% likely owes to transient and passing factors — business inventories to name one.

Second-quarter GDP Will Likely Disappoint

The perpetual bright-siders at the Federal Reserve’s Atlanta wing project Q2 growth of 1.6%.

How about the wizards at Morgan Stanley?

1.1%

And what figure does Goldman Sachs hazard for Q2 GDP?

Only marginally greater — 2.2%.

But these are mere crystal gazings, you say. These seers badly botched the first quarter’s reading.

Maybe they’ll blunder again.

Perhaps they will.

But let us glance again beneath the first quarter’s shimmering 3.2% GDP…

Subtract from the mix inventories and the “addition” of government spending.

We are left with GDP expansion not of 3.2%… but 1.3%.

More:

Consumer durable goods spending sank 5.3% — the steepest plunge in 10 years.

Private-sector consumption and investment trickled to a semicomatose 1.3%.

Consumer spending overall increased a mere 1.2%… off from 2.5% the quarter previous.

And from the previous quarter’s 5.4%, Q1 business investment halved — to 2.7%.

Can the Federal Reserve work a reversal of existing trends?

Not in our telling — its ammunition is largely blank.

The Federal Reserve Is “Largely Irrelevant”

Here, here and here we have presented this argument: The central bank is a false fee-fi-fo-fum.

It pulls false levers, yanks false pulleys.

It is not, in fact, central.

The Daily Reckoning, one week ago today:

The Fed is, largely outside of temporary sentiment, irrelevant. The central bank is not central… The thing people have the most trouble with is the idea that central banks are not central. It flies in the face of everything you have been taught and told your whole life… 

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

The true kingpin of the banking system — we maintained — is an invisible “shadow” banking system.

This shadow system consists of the major banks and their offshore subsidiaries.

This shadow banking system has never recovered from the Great Financial Crisis.

Until it does, the economy will likely wallow along at existing speeds — or perhaps slower.

But if the Federal Reserve is a helpless homunculus and the banking system crippled… what might “fund state policies and subsidize the costs of those policies?”

MMT Is “Inevitable”

Modern Monetary Theory (MMT)… or “QE for the people.”

The Treasury will seize the role of the Federal Reserve. It will hose money directly onto Main Street. It will also fund extravagant government programs.

We suspect MMT will gain a vastly wider hearing come the next downturn.

And why wouldn’t President Trump line up behind it if he is in office at the time?

He has demonstrated little opposition to spending money. Quite the contrary… in fact.

There is even a “conservative” version of MMT he could pull from his hat as a “responsible” alternative.

Tycoon Ray Dalio spots the handwriting scribbled upon the wall.

“Inevitable” is how he describes MMT:

To me the most important engineering puzzle policy makers around the world have to solve for the years ahead is how to get the economic machine to produce economic well-being for most people when monetary policy does not work…

It is inevitable that this shift will happen because it is inevitable that central bankers will want to ease when interest rates are pinned at 0% and when quantitative easing will be ineffective in achieving the goal.

We fear Mr. Dalio may be correct.

Unfortunately, this cure will likely prove worse than the disease…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post What Trump’s Really Thinking appeared first on Daily Reckoning.

The Trade War Is Back

This post The Trade War Is Back appeared first on Daily Reckoning.

President Trump shocked markets yesterday when he announced that a new, heavy round of tariffs on Chinese goods will take effect this Friday. Complacent markets had assumed that a trade deal would get done, that it was just a matter of sorting out the details. Now that is far from certain. Failing a last minute deal, which is certainly possible, the trade war is back. And it could get worse.

What most surprised me about the new trade war was not that it started, but that the mainstream financial media denied it was happening for so long. The media have consistently denied the impact of this trade war. Early headlines said that Trump was bluffing and would not follow through on the tariffs. He did. Later headlines said that China was just trying to save face and would not retaliate. They did.

Today the story line has been that the trade war will not have a large impact on macroeconomic growth. It will. The mainstream media have been wrong in their analysis at every stage of this trade war. And it did not see this latest salvo coming.

The bottom line is that the trade war is here, it’s highly impactful and it could get worse. The sooner investors and policymakers internalize that reality, the better off they’ll be.

For years I’ve been warning my readers that a global trade war was likely in the wake of the currency wars. This forecast seemed like a stretch to many. But it wasn’t.

I said it would simply be a replay of the sequence that prevailed from 1921–39 as the original currency war started by Weimar Germany morphed into trade wars started by the United States and finally shooting wars started by Japan in Asia and Germany in Europe.

The existing currency war started in 2010 with Obama’s National Export Initiative, which led directly to the cheapest dollar in history by August 2011. The currency war evolved into a trade war by January 2018, when Trump announced tariffs on solar panels and appliances mostly from China. Unfortunately, a shooting war cannot be ruled out given rising geopolitical tensions.

The reasons the currency war and trade war today are repeating the 1921–39 sequence are not hard to discern. Countries resort to currency wars when they face a global situation of too much debt and not enough growth.

Currency wars are a way to steal growth from trading partners by reducing the cost of exports. The problem is that this tactic does not work because trade partners retaliate by reducing the value of their own currencies. This competitive devaluation goes back and forth for years.

Everyone is worse off and no one wins.

Once leaders realize the currency wars are not working, they pivot to trade wars. The dynamic is the same. One country imposes tariffs on imports from another country. The idea is to reduce imports and the trade deficit, which improves growth. But the end result is the same as a currency war. Trade partners retaliate and everyone is worse off as global trade shrinks.

The currency wars and trade wars can exist side by side as they do today. Eventually, both financial tactics fail and the original problem of debt and growth persists. At that point, shooting wars emerge. Shooting wars do solve the problem because the winning side increases production and the losing side has infrastructure destroyed that needs to be rebuilt after the war.

Yet the human cost is high. The potential for shooting wars exists in North Korea, the South China Sea, Taiwan, Israel, Iran, Venezuela and elsewhere. Let’s hope things don’t get that far this time.

But the easiest way to understand the trade war dynamics is to take Trump at his word. Trump was not posturing or bluffing. He will agree to trade deals, but only on terms that improve the outlook for jobs and growth in the U.S. Trump is not a globalist; he’s a nationalist. That may not be popular among the elites, but that’s how he sets policy. Keeping that in mind will help with trade war analysis and predictions.

Trump is entirely focused on the U.S. trade deficit. He does not care about global supply chains or least-cost production. He cares about U.S. growth, and one way to increase growth is to reduce the trade deficit. That makes Trump’s trade policy a simple numbers game rather than a complicated multilateral puzzle palace.

If the U.S. can gain jobs at the expense of Korea or Vietnam, then Trump will do it; too bad for Korea and Vietnam. From there, the next step is to consider what’s causing the U.S. trade deficit. This chart tells the story. It shows the composite U.S. trade deficit broken down by specific trading partners:

The Gap https://s3.amazonaws.com/paradigmpress-uploads/wp-content/uploads/2019/05/chart_the-gap-in-trade.pnin Trade - Chart

The problem quickly becomes obvious. The U.S. trade deficit is due almost entirely to four trading partners: China, Mexico, Japan and Germany. Of those, China is 64% of the total.

President Trump has concluded a trade deal with Mexico that benefits both countries and will lead to a reduced trade deficit as Mexico buys more U.S. soybeans.

The U.S. has good relations with Japan and much U.S.-Japanese trade is already governed by agreements acceptable to both sides. This means the U.S. trade deficit problem is confined to China and Germany (often referred to euphemistically as “Europe” or the “EU”).  The atmosphere between the U.S. and the EU when it comes to trade is still uneasy, but not critical.

But the global trade war is not global at all but really a slugfest between the U.S. and China, the world’s two largest economies. In the realm of global trade, the United States is an extremely desirable customer. In fact, for most, we are their best customer.

Think the still export-based Chinese economy can afford to sell significantly less manufactured goods across borders? Think that same Chinese economy can allow for a significant devaluation of U.S. sovereign debt? That’s their book, gang.

But China has finally come to the realization that the trade war is real and here to stay. Senior Chinese policymakers have referred to the trade war as part of a larger strategy of containment of Chinese ambitions that may lead to a new Cold War. They’re right.

Trump seems to relish the idea of bullying the Chinese in public. That’s certainly his style, but it’s also a risky strategy. To quote Sun Tzu: “Do not press a desperate foe too hard.”

China doesn’t like to be chastised publicly any more than anyone else, but culturally, saving-face may be more important to the Chinese. The Chinese are all about saving face and gaining face. That means they can walk away from a trade deal even if it damages them economically. Saving face is too important. But Trump is playing for keeps and will not back down either.

Unlike in other policy arenas, Trump has enjoyed bipartisan support in Congress. The Republicans have backed Trump from a national security perspective and the Democrats have backed him from a pro-labor perspective. China sees the handwriting on the wall.

This trade war will not end soon, because it’s part of something bigger and much more difficult to resolve. This is a struggle for hegemony in the 21st century. The trade war will be good for U.S. jobs but bad for global output. The stock market is going to wake up to this reality. The currency wars and trade wars are set to get worse.

Investors should prepare.

Regards,

Jim Rickards
for The Daily Reckoning

The post The Trade War Is Back appeared first on Daily Reckoning.

To the Brink

This post To the Brink appeared first on Daily Reckoning.

The cannons are readied, bayonets are fixed… the bugle is ready to blow.

Diplomacy has failed.

The trade war will resume this Friday — should 11th-hour negotiations fail.

The 10% tariff on $200 billion worth of Chinese wares becomes 25%.

And President Trump threatens to order 25% imposts on an additional $325 billion “soon.”

Existing tariffs are “partially responsible for our great economic results,” he justifies.

Meantime, Chinese negotiators have dallied, dithered and dawdled.

The president, Sunday:

For 10 months, China has been paying Tariffs to the USA of 25% on 50 Billion Dollars of High Tech, and 10% on 200 Billion Dollars of other goods. These payments are partially responsible for our great economic results. The 10% will go up to 25% on Friday. 325 Billions Dollars… of additional goods sent to us by China remain untaxed, but will be shortly, at a rate of 25%. The Tariffs paid to the USA have had little impact on product cost, mostly borne by China. The Trade Deal with China continues, but too slowly, as they attempt to renegotiate. No!

So Mr. Trump drops the carrot… and seizes the stick.

He undoubtedly hopes to pummel China into last-minute concessions.

Then he can thump his chest about a “wonderful” trade deal… wrested only in the nick of time.

Export-driven China needs the United States more than the United States needs China, he believes.

Following Sunday broadside, China threatened to back away from scheduled talks this week.

But it has since come around… and discussions will evidently proceed on the timetable agreed.

Goldman Sachs believes the feuding parties will come to terms before Friday. Sixty percent odds, they give, for a peaceful resolution.

But a dangerous game is underweigh…

China takes its honor very heavily. Will it be publicly shoved around?

Trump’s country hardball, explains Rabobank analyst Michael Every:

Puts [China’s]chief negotiator Liu He in a very awkward position. While it may be Trump’s style to be impulsive in the final stages of a deal, the Chinese government will lose face if they cave in to his demands following a public threat on Twitter. It could be perceived as a breach of trust and the Chinese may conclude that the U.S. has been negotiating in bad faith after all. 

What if China walks away from the negotiating table? Does Trump go chasing after it, sobbing for peace?

Or does he let them slip away — knowing retaliation ensues?

But only when they decide to walk away and announce their retaliation will we truly know Trump’s intentions. Is he really willing to cancel trade talks and to put the recent rally of his beloved stock market at risk? And this with just 18 months left before the U.S. elections? Or will he somehow regain control over his emotional intelligence and still find a way around this strong May 10 deadline?

These are the questions that rise before us. For the moment, no answers are issuing.

But Jasper Lawler — who heads research at London Capital Group — fears the Great Negotiator may be overplaying the cards in his hand:

“We know from experience that this could be one of Trump’s infamous negotiating tactics, but there is a good chance that this time it will backfire.”

We shall see… soon.

But what about the all-important stock market? How did markets take yesterday’s news?

Dow futures plunged 500 points Sunday evening. And the major indexes opened the day deeply in red.

But by mysterious coincidence, eager buyers soon fell upon Wall Street in throngs.

Stocks clawed their way back… and the Dow Jones regained some 300 points by midmorning.

Who came rushing in at the fatal moment?

We have no specific answer at this time.

But the wags at Zero Hedge pointed a jeering finger at the Plunge Protection Team.

By the closing bell the Dow Jones closed to within 66 points of even.

But should diplomacy fail, Friday’s tariffs will represent the largest increase since hostilities commenced last year — some $30 billion.

And the American consumer would bear the blast this time…

Previous tariffs centered largely on capital or intermediate economic goods. But perhaps 25% of Friday’s tariffs target consumer goods.

Can the consumer absorb the blow?

Renegade economist John Williams of ShadowStats believes the economy is already sunk in recession — damn the official statistics.

We have a recession in place. It’s just a matter of playing out in some of these other funny numbers… The economy is tanking, and I’ll contend it already has, although we have not seen it in the GDP reporting. 

And the sting in the tail:

“The underlying weakness is with the consumer.”

That is, the very consumer likely to absorb the worst of the tariffs… should they proceed Friday.

The clock ticks.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post To the Brink appeared first on Daily Reckoning.

Why the Economy Won’t Recover

This post Why the Economy Won’t Recover appeared first on Daily Reckoning.

We have spent the past two days contemplating the nature of money… and the international monetary system.

We hypothesized that there is no actual money in monetary policy. And that central banks are helpless giants, tissue paper tigers, all mush and milk.

We even vented the extravagant theory that a “shadow banking system” governs the global monetary system.

Today we sink deeper into the shadows… and widen our investigation of this twilit banking underworld.

Has the world failed to recover from the financial crisis… because the shadow banking system has failed to recover from the financial crisis?

This is the question we tackle today.

If you missed yesterday’s reckoning, we refer you here for background.

But in brief review…

The Shadow Banking System Supplied the World with Dollars

The major banks and their offshore divisions constitute the shadow banking system.

Across Europe, Asia, the Caribbean and elsewhere this shadow extends.

It first acquired existence in the 1950s, years after Bretton Woods enthroned the dollar king of the world.

It proliferated vast amounts of dollars independently of the United States banking system. These offshore dollars oiled the gears of international commerce.

Explains Jeffrey Snider, likely the world’s primary authority on the shadow banking system:

Through the 1960s, the [shadow banking] system created new U.S. dollar money supply out of thin air… with no backing by gold or by physical cash issued by the U.S. Treasury… The [shadow banking] system evolved outside of the Fed… [It was a] market operating entirely outside of the U.S. banking system and therefore without U.S. regulation…

The world needs dollars for the purposes of a global reserve currency. It gets them from this [shadow banking] system.

The Shadow Banking System: A Bubble Machine

Soaked in dollar liquidity, ultimately it emerged a parallel banking system. It operated independently of central banks… and without supervision.

The shadow banking system — not central banks — formed the invisible brick and mortar of the global monetary system.

By the early 2000s it grew fat, decadent, rich beyond avarice.

As suggested yesterday, the shadow banking system may have been the true culprit of the housing crisis.

That was largely owing to derivatives, credit swaps and other exotic financial instruments that detonated so gorgeously in 2008.

Snider:

The reason we got asset bubbles in both the stock market and the housing market in the United States was the fact that the [shadow banking] system was growing exponentially at those time periods. In other words, the shadow system was creating both the liquidity as well as the credit resources for those things to actually happen…

It was essentially a self-contained system that operated beyond the reach of everybody around the world…

All of this was taking place in a place that wasn’t supposed to exist. So it was an enormous hidden, misunderstood, misplaced banking system, misplaced monetary system, that was just waiting to be a big problem. 

And it’s not coincidence… that we see this major inflection, especially in stocks and housing in the United States around 1995. Because that is when the [shadow banking] system… really started to fully mature into its final state… 

And what we find is the derivative system, or the derivative part of the [shadow banking] system, going essentially parabolic in the 2000s. In other words, once all of these evolutions in money started coming together in the late ’90s and early 2000s, the system just took off on itself… By the time the Fed started to get a sense that something was awry it was already too late. 

Then we come to 2008…

The Powerful Lesson of Bear Stearns

The shadow banking fell into a panicked delirium. All its derivatives and financial innovations became combustible gunpowder — attached to a rapidly burning fuse.

The system managed to withstand the worst of the blast — if barely.

But the collapse of Bear Stearns struck the fear of Almighty God into these shadow banks.

Again, Snider:

Bear wasn’t some subprime peddler, it was everyone. For the first time, liquidity risks had proven to be very real and immediate…

Prior it was believed by everyone to be riskless returns. Bear taught them, via global dollar liquidity, it had really been the reverse…

In other words, Bear’s final chapter… caused every single global [shadow] bank to really consider, most for the first time, what was actually at stake… 

So the 2008 panic was very instructive in a way, because it showed banks the Fed had no idea what it was doing, and even if it did know what it was doing it was incapable of solving these problems… The liquidity lesson of Bear Stearns remains the overriding property of the global money system.

But 2011 was the true end of the line.

The Demise of the Shadow Banking System

2011 witnessed the eurozone debt crisis. And the shadow banks pulled in their oars as risk raced ahead of reward:

That point was driven home especially hard in 2011, when despite two QEs, the Fed had expanded the level of bank reserve in the system by $1.6 trillion to the middle of 2011, yet there was another liquidity even in that year… For banks in that position and time period, it was a huge wake-up call that shadow banking activities were enormously risky. In fact, they were so risky that it wasn’t worth the effort… 

It really isn’t any mystery as to why [2011] was the final blow… 

Even in the quantitative easings that happened afterward whether it was in Europe or in the United States or even Japan none of those really had much of an effect. Because once the [shadow banking] system started to fall apart there was no stopping it.

“No More Growth in Global Money, No More Global Growth. It’s That Simple”

The shadow system has never recovered. Neither has the economy.

Coincidence? No, says Snider:

The shadow system has been nothing but dysfunctional ever since, and so has the economy…

Banks have been studiously shrinking ever since, only a few like Goldman or Deutsche Bank “brave” (read: stupid) enough to wade back into those money dealing activities, only to get burned every time… The risk-takers are the outliers, and always regretful at that. What the [shadow] system gave the global economy (extraordinary lift), following 2011 it has taken it away (persistent drag)… 

The [shadow bank’s] dollar is the world’s true reserve currency, therefore problems in it are going to be problems shared by the whole interconnected global economy… Banks have been shrinking their balance sheets. Therefore, to alleviate the monetary strain we need to get them increasing their balance sheets… The banks are broken and this worldwide economy needs them not to be… When global money was growing, the global economy was too. No more growth in global money, no more global growth. It’s that simple.

Can you expect the Federal Reserve to patch the system, to wrest some order from this lawless jungle?

Must we ask?:

The Federal Reserve Has No Answers

The Federal Reserve has no idea what it takes to fix the broken monetary system (they can’t even get the simplest part right)… All these central bankers did was prove they had, and have, no answers. 

But why no fix? And why is the Federal Reserve so incurably botched?:

As far as economists are concerned, the U.S. economy is a closed system. In other words, it has its own money supply, there are trade linkages to foreign sources, but monetarily there isn’t supposed to be much transit between the U.S. and outside the U.S. [The shadow banking system is beyond] the orthodox framework of understanding how all of these things work… 

Officials never saw it that way and still don’t; they were, and are, incapable of such a realization. Economies are, in the orthodox textbook, treated as closed systems. There is no global economy to a central banker… 

But by 2016 the truth could no longer be denied…

By 2016, the Fed was forced to admit defeat. They had tried four different QEs that had no success. It didn’t create the inflation they thought it would, and therefore there was no inflation and no wage gain and no recovery, so they had to admit what most other people had finally figured out many years before, that there was never going to be a recovery… 

The [shadow banking] system is no longer functioning… So the lack of a global recovery after the Great Recession is a monetary problem. And it’s one that the Federal Reserve, so long as it persists in believing that the United States is a closed system, and that the Federal Reserve is at the center of the U.S. money supply, will never be able to fix… 

If after 11 years… you still haven’t gotten it right… what are the chances you ever will?

Indeed… what are the chances they ever will — get it right?

But if they don’t?

Fix the Banks or Prepare for Social and Political Upheaval

We’re kind of stuck in this disinflationary depression condition… Unless the monetary system is substantially reformed, I don’t think this will change… [The present system] is in fact heading in the wrong direction and the political and social order is slowly being taken down with it…

There has to be a breaking point where either the political system realizes the dangers inherent in that condition and actually responds favorably by taking hold of the [shadow banking] system [or] actually reforming it rather than trying to throw another QE into the mix.

Just so. But what Winston Churchill probably never said of Americans, we might say of the Federal Reserve:

“You can always count on the Americans to do the right thing after they have tried everything else.”

Prepare for more QE, followed by MMT once it fails.

Only the Lord knows what follows once that fails…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Why the Economy Won’t Recover appeared first on Daily Reckoning.

Why the Economy Won’t Recover

This post Why the Economy Won’t Recover appeared first on Daily Reckoning.

We have spent the past two days contemplating the nature of money… and the international monetary system.

We hypothesized that there is no actual money in monetary policy. And that central banks are helpless giants, tissue paper tigers, all mush and milk.

We even vented the extravagant theory that a “shadow banking system” governs the global monetary system.

Today we sink deeper into the shadows… and widen our investigation of this twilit banking underworld.

Has the world failed to recover from the financial crisis… because the shadow banking system has failed to recover from the financial crisis?

This is the question we tackle today.

If you missed yesterday’s reckoning, we refer you here for background.

But in brief review…

The Shadow Banking System Supplied the World with Dollars

The major banks and their offshore divisions constitute the shadow banking system.

Across Europe, Asia, the Caribbean and elsewhere this shadow extends.

It first acquired existence in the 1950s, years after Bretton Woods enthroned the dollar king of the world.

It proliferated vast amounts of dollars independently of the United States banking system. These offshore dollars oiled the gears of international commerce.

Explains Jeffrey Snider, likely the world’s primary authority on the shadow banking system:

Through the 1960s, the [shadow banking] system created new U.S. dollar money supply out of thin air… with no backing by gold or by physical cash issued by the U.S. Treasury… The [shadow banking] system evolved outside of the Fed… [It was a] market operating entirely outside of the U.S. banking system and therefore without U.S. regulation…

The world needs dollars for the purposes of a global reserve currency. It gets them from this [shadow banking] system.

The Shadow Banking System: A Bubble Machine

Soaked in dollar liquidity, ultimately it emerged a parallel banking system. It operated independently of central banks… and without supervision.

The shadow banking system — not central banks — formed the invisible brick and mortar of the global monetary system.

By the early 2000s it grew fat, decadent, rich beyond avarice.

As suggested yesterday, the shadow banking system may have been the true culprit of the housing crisis.

That was largely owing to derivatives, credit swaps and other exotic financial instruments that detonated so gorgeously in 2008.

Snider:

The reason we got asset bubbles in both the stock market and the housing market in the United States was the fact that the [shadow banking] system was growing exponentially at those time periods. In other words, the shadow system was creating both the liquidity as well as the credit resources for those things to actually happen…

It was essentially a self-contained system that operated beyond the reach of everybody around the world…

All of this was taking place in a place that wasn’t supposed to exist. So it was an enormous hidden, misunderstood, misplaced banking system, misplaced monetary system, that was just waiting to be a big problem. 

And it’s not coincidence… that we see this major inflection, especially in stocks and housing in the United States around 1995. Because that is when the [shadow banking] system… really started to fully mature into its final state… 

And what we find is the derivative system, or the derivative part of the [shadow banking] system, going essentially parabolic in the 2000s. In other words, once all of these evolutions in money started coming together in the late ’90s and early 2000s, the system just took off on itself… By the time the Fed started to get a sense that something was awry it was already too late. 

Then we come to 2008…

The Powerful Lesson of Bear Stearns

The shadow banking fell into a panicked delirium. All its derivatives and financial innovations became combustible gunpowder — attached to a rapidly burning fuse.

The system managed to withstand the worst of the blast — if barely.

But the collapse of Bear Stearns struck the fear of Almighty God into these shadow banks.

Again, Snider:

Bear wasn’t some subprime peddler, it was everyone. For the first time, liquidity risks had proven to be very real and immediate…

Prior it was believed by everyone to be riskless returns. Bear taught them, via global dollar liquidity, it had really been the reverse…

In other words, Bear’s final chapter… caused every single global [shadow] bank to really consider, most for the first time, what was actually at stake… 

So the 2008 panic was very instructive in a way, because it showed banks the Fed had no idea what it was doing, and even if it did know what it was doing it was incapable of solving these problems… The liquidity lesson of Bear Stearns remains the overriding property of the global money system.

But 2011 was the true end of the line.

The Demise of the Shadow Banking System

2011 witnessed the eurozone debt crisis. And the shadow banks pulled in their oars as risk raced ahead of reward:

That point was driven home especially hard in 2011, when despite two QEs, the Fed had expanded the level of bank reserve in the system by $1.6 trillion to the middle of 2011, yet there was another liquidity even in that year… For banks in that position and time period, it was a huge wake-up call that shadow banking activities were enormously risky. In fact, they were so risky that it wasn’t worth the effort… 

It really isn’t any mystery as to why [2011] was the final blow… 

Even in the quantitative easings that happened afterward whether it was in Europe or in the United States or even Japan none of those really had much of an effect. Because once the [shadow banking] system started to fall apart there was no stopping it.

“No More Growth in Global Money, No More Global Growth. It’s That Simple”

The shadow system has never recovered. Neither has the economy.

Coincidence? No, says Snider:

The shadow system has been nothing but dysfunctional ever since, and so has the economy…

Banks have been studiously shrinking ever since, only a few like Goldman or Deutsche Bank “brave” (read: stupid) enough to wade back into those money dealing activities, only to get burned every time… The risk-takers are the outliers, and always regretful at that. What the [shadow] system gave the global economy (extraordinary lift), following 2011 it has taken it away (persistent drag)… 

The [shadow bank’s] dollar is the world’s true reserve currency, therefore problems in it are going to be problems shared by the whole interconnected global economy… Banks have been shrinking their balance sheets. Therefore, to alleviate the monetary strain we need to get them increasing their balance sheets… The banks are broken and this worldwide economy needs them not to be… When global money was growing, the global economy was too. No more growth in global money, no more global growth. It’s that simple.

Can you expect the Federal Reserve to patch the system, to wrest some order from this lawless jungle?

Must we ask?:

The Federal Reserve Has No Answers

The Federal Reserve has no idea what it takes to fix the broken monetary system (they can’t even get the simplest part right)… All these central bankers did was prove they had, and have, no answers. 

But why no fix? And why is the Federal Reserve so incurably botched?:

As far as economists are concerned, the U.S. economy is a closed system. In other words, it has its own money supply, there are trade linkages to foreign sources, but monetarily there isn’t supposed to be much transit between the U.S. and outside the U.S. [The shadow banking system is beyond] the orthodox framework of understanding how all of these things work… 

Officials never saw it that way and still don’t; they were, and are, incapable of such a realization. Economies are, in the orthodox textbook, treated as closed systems. There is no global economy to a central banker… 

But by 2016 the truth could no longer be denied…

By 2016, the Fed was forced to admit defeat. They had tried four different QEs that had no success. It didn’t create the inflation they thought it would, and therefore there was no inflation and no wage gain and no recovery, so they had to admit what most other people had finally figured out many years before, that there was never going to be a recovery… 

The [shadow banking] system is no longer functioning… So the lack of a global recovery after the Great Recession is a monetary problem. And it’s one that the Federal Reserve, so long as it persists in believing that the United States is a closed system, and that the Federal Reserve is at the center of the U.S. money supply, will never be able to fix… 

If after 11 years… you still haven’t gotten it right… what are the chances you ever will?

Indeed… what are the chances they ever will — get it right?

But if they don’t?

Fix the Banks or Prepare for Social and Political Upheaval

We’re kind of stuck in this disinflationary depression condition… Unless the monetary system is substantially reformed, I don’t think this will change… [The present system] is in fact heading in the wrong direction and the political and social order is slowly being taken down with it…

There has to be a breaking point where either the political system realizes the dangers inherent in that condition and actually responds favorably by taking hold of the [shadow banking] system [or] actually reforming it rather than trying to throw another QE into the mix.

Just so. But what Winston Churchill probably never said of Americans, we might say of the Federal Reserve:

“You can always count on the Americans to do the right thing after they have tried everything else.”

Prepare for more QE, followed by MMT once it fails.

Only the Lord knows what follows once that fails…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Why the Economy Won’t Recover appeared first on Daily Reckoning.

Central Banks Don’t Matter

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

“There is no money in monetary policy.”

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

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

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

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

The emperor is well and truly nude.

Who then actually controls monetary policy today?

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

The details — the shocking details — to follow.

Monetary Policy Is Actually About Credit and Debt

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

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

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

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

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

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

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

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

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

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

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

The Central Bank Is Not Central

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

Here Snider strips the emperor bare:

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

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

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

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

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

The Fed’s Target Audience: You 

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

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

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

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

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

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

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

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

Blasphemy mounts upon blasphemy!

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

Who, then, is running monetary policy?

The Shadow Banking System

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

The shadow banking system?

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

They include the large banks and their offshore units.

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

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

But this shadow banking system is invisible.

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

Only a properly trained sleuth can sniff them out:

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

The United States dollar is the coin of this realm.

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

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

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

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

Did the Shadow Banking System Cause the Great Financial Crisis?

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

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

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

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

To repeat:

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

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

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

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

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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

EXPOSED: The Fed’s Deepest Secret

This post EXPOSED: The Fed’s Deepest Secret appeared first on Daily Reckoning.

The announcement came issuing at 2 p.m. EST.

As roundly expected… Jerome Powell and his fellows sat idly upon their hands.

The fed funds rate remains chained in place, at 2.50%.

Mr. Powell, by way of explanation:

We think our policy stance is appropriate at the moment and we don’t see a strong case for moving in either direction. We say in our statement of longer-run goals and monetary policy strategy that the Committee would be concerned if inflation were running persistently above or below 2%.

The good chairman went on to dismiss last month’s weak inflation numbers as “transient.”

But is this the picture of “transience”?

Chart

Observe the trendline.

Where’s the (Official) Inflation?

Nearly 10 years on, the Federal Reserve pursues a grail agonizingly beyond its grasp — 2% inflation, sustained.

The latest data reveal March inflation increased only 1.6% year over year. January gave a reading of 1.8%.

Thus the Fed’s 2% target slips further beyond its outstretched fingers.

What — if any — credibility remains?

We can only cough sadly behind our hands, sink into our chair and look away in pity… as from a stage magician whose abracadabra has failed to conjure the rabbit.

So the time has come to expose the fraud sweating and writhing upon the stage… and reveal its deepest secret.

What is it?

To the answer we turn shortly. But first to the magic show on a parallel stage…

The Market Wanted a Rate Cut

The Dow Jones scraped along in positive numbers until word came down shortly after 2.

Upon which point it sank deeper and deeper into red, closing the day down 163 points.

Both S&P and Nasdaq followed nearly identical tracks.

The S&P ended the day 22 points lower; the Nasdaq 46.

Why the long faces on Wall Street?

The audience demanded a trick — a rate cut. And Mr. Powell failed to deliver.

Peter Boockvar, CIO of Bleakley Advisory Group:

“The market was pricing in this rate cut. They want a rate cut and this was basically Powell saying, ‘Sorry, but we’re not.’”

Not this time at least.

But to resume our exposé of the Federal Reserve… and its deepest secret…

The Federal Reserve Cannot Even Define Money

We begin with a premise:

The Federal Reserve can no longer define money. That is correct. It cannot even define money.

Imagine a butcher who cannot cut you a pound. Imagine a map maker who cannot measure a mile.

Now you have the flavor of it.

Under the Coinage Act of 1792, a dollar equaled one Spanish milled dollar — containing “371 grains and 4/16th parts of a grain of pure, or 416 grains of standard silver.”

Under the classic gold standard a dollar was defined as 1/20th of one ounce of gold. It was later defined as 1/35th of one ounce of gold.

But once old Nixon scissored the dollar’s final golden tether… the dollar defied all measurement.

It was as if 2.54 centimeters no longer defined an inch but a mile. Twelve inches no longer defined a foot but an inch. Three feet no longer defined a yard but a mile.

Perhaps you define a dollar as 100 cents. Well then, what is a cent? 1/100th of a dollar. But what again is a dollar?

And so you embark upon an infinite chasing of your tail.

We must conclude that today’s money is largely abstraction — wispy as gossamer, slippery as eels, elusive as quicksilver.

It is measured by a warring arrangement of alternate “money supplies” — none of which meet full requirements:

Unit of account, medium of exchange… store of value.

Alan Greenspan Comes Clean

Thus the Federal Reserve steers by the swaying and erratic lights of M0, M1, M2, MZM, etc.

Here we have money, near money, money at second and third remove, money somewhere in the ghostly ether.

And so the monetary authority cannot heave forth a working definition of money… or its true supply.

But do not rely upon our slanted word.

This we have on the authority of the maestro himself — Alan Greenspan — who confessed nearly 20 years previous that:

The problem is that we cannot extract from our statistical database what is true money conceptually…

One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near money data is continuously changing… 

While of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition. 

Two decades, a great financial crisis and multiple rounds of QE later, the proposition has grown more dubious yet.

What and where is money? Where is inflation?

As notes Jeff Snider of Alhambra Investments, wryly:

“If you can’t ‘locate’ money, you can’t locate inflation.”

A Basic Definition of Money

We would argue that it is located in the asset classes — equities, real estate, etc.

But let us cleave to the simplest definition of money as defined by the late “Austrian” school economist Murray Rothbard:

The thing that all other goods and services are traded for, the final payment for such goods and services on the market.

True money is the “final” payment, that is. Only this money satisfies all obligations, retires all debts.

Economists of the Austrian School crafted a metric they labeled the “true money supply” (TMS) in the 1970s and ’80s.

Existing measures of money supply gave distorted 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.

The TMS broad money supply is therefore more restrictive than the Federal Reserve’s broadly defined M2, for example.

March 2018 to March 2019, the official M2 money supply expanded 3.8%.

But TMS-2 year-over-year growth speaks a different tale…

Year-over-year TMS-2 money supply expanded a mere 2.2% in March, says analyst Michael Pollaro — its slowest pace in 12 years.

And preliminary data indicate year-over-year TMS-2 expansion has slipped to 1.7% in April.

That is, by the narrow TMS-2 reading, money supply is expanding at a far lesser clip than official M2.

Might this vast discrepancy explain the soft inflation data as officially presented?

An Arresting Conclusion

We cannot say for certain — we are not a credentialed member of the professional economics guild.

Thus we lack all official standing.

Might the theory wobble, might it stagger before an onslaught of evidence?

It may very well.

Then you can add it to the existing list of quack theories.

But the fact remains:

Nearly 10 years on, the Federal Reserve cannot work a sustained 2% inflation.

After long, hard pummeling of our cerebral centers, thus do we arrive at this arresting conclusion, the Federal Reserve’s deepest secret:

The Federal Reserve exerts little actual control upon the monetary system.

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post EXPOSED: The Fed’s Deepest Secret appeared first on Daily Reckoning.