The United States: “Flawed Democracy”

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The annual edition of The Economist’s Intelligence Unit Democracy Index is out.

Across several democratic categories nations are ranked. These include but are not limited to:

Civil liberties…  the functioning of government… political participation… electoral process… pluralism… and political culture.

Where does the United States rank among the nations of the Earth?

Is it the most democratic? Perhaps the fifth? Or the eighth?

Answer shortly…

We admit it at the outset — we find the spectacle of democracy vastly amusing, grand and gorgeous.

The charming fraud, the innocent delusion… the mushy-headedness of it all.

The “people” give the orders in democracy say the civics books.

But did anyone ask you — for example — if invading Iraq was a grand idea?

Or if your tax dollars should bail out Wall Street in 2008?

Or if your government should bury itself under $22 trillion of debt?

At the community level the business is not necessarily improved.

Consider this case:

A red light camera was recently installed outside our Baltimore office. It presently mounts watch over the intersection of St. Paul and Madison Streets.

But were residents asked if we wished to be so deeply and elaborately policed?

What do you suppose would have been the answer if we were?

Yet the camera is on duty… hooking every felonious automobilist who crosses under one-billionth of one second too late.

Somehow it all seems beyond democratic agency, beyond all control.

It is simply the way the political machinery operates, a fellow concludes.

He may cluck-cluck his opposition to it… but he is largely a man resigned.

And if “the people own the government,” as the democratic gospel singers tell us, we suggest you put the theory to this test:

Approach the guardhouse at the nearest military installation. Demand immediate entrance, asserting your rights of property.

The ownership theory hinges upon the reaction you receive.

But to return to our question…

Where is the United States’ democratic ranking among the nations?

Is it first… third… sixth… perhaps — heaven forfend — ninth?

The answer, says The Economist’s Intelligence Unit Democracy Index, is…

Twenty-fifth — the United States is the 25th most democratic nation on Earth.

It finds itself sandwiched between Estonia and the Jeffersonian paradise known otherwise as Cabo Verde.

Thus America is sorted into the category of “flawed democracies,” coming beneath the “full democracies” of the world.

Listed here are the world’s top 10 “full democracies,” seriatim:

Norway, Iceland, Sweden, New Zealand, Denmark, Canada, Ireland, Finland, Australia… and Switzerland.

Of course, we recommend you take it all with requisite dose of table salt.

The Economist is globalist to the very tips of its fingers.

Unsurprisingly, the report labels Trump a unique menace to American democracy:

[President Donald] Trump has repeatedly called into question the independence and competence of the U.S. judicial system with regard to the ongoing federal investigation, led by Robert Mueller, into potential ties between Mr. Trump’s presidential campaign and Russia, and various courts’ efforts to block some of his policy orders, particularly regarding immigration… As a result, the score for political culture declined in the 2018 index.

Be it so.

But is democracy the gold standard of government?

Under our system We the People delegate the business of governing to officials we elect.

Should these officials execute their office to the dissatisfaction of voters, they are ousted from office.

Others come in.

But time often reveals the replacement is a scalawag on par with the original — if not worse.

It is easy to indict the politician as a whole. But if we haul the politician into the dock… We The People must go with him.

We perpetually holler about ‘them rascally, no-good, lyin’ politicians’…

Them silver-tongued, glad-handing, baby-smooching mugs who babble one thing to get elected — but do another once in office.

Kick the bums out is the eternal bellow.

But we contend the politicians act as they do… because We the People act as We do.

We demand a shining military machine with every bell and whistle… heaping doses of Social Security… Medicare… a Rolls-Royce education… a million gaudy baubles.

But we do not wish to pay for it all.

Hand it over, we bark out one corner of our mouth. But don’t dare raise our taxes, we belch out the other.

Many of us say we’re heart and soul for limited government

But We are heart and soul for limited government… as long as it’s the other fellow’s heart and soul feeling the blade.

Give me that tax break, says the one. No, give it to me, says the other.

You can both go scratching, says the third. I deserve it more.

A fourth files a claim of his own.

Meantime, the hard-luck farmer wants his back scratched. The hard-pressed businessman wants his belly rubbed. The overlabored teacher wants her apple.

And millions more are hard at the business…

All trying to work the angles, to get a bucket in the stream, to get a snout in the trough… to catch a penny.

It is the evil of “special interests” when the other fellow gets his.

But it is “democracy in action” when it butters our own parsnips.

We do not exempt ourself from criticism. We are out for No.1 as much as anybody.

Let the politician take an honest man’s attitude before the American public 

Let him tell us we can have either A. Or B. But not A and B — and certainly not A, B and C.

Not without paying for it, that is.

Then observe the fleets of rotting eggs and tomatoes raining upon his head.

Ten times of the 10, our honest Abe is licked by the silver tongue who tickles our ears with false but catchy jingles.

This is the man who wins our franchise when we enter the vote booth.

But still the circus goes on, entertaining as ever, paraded out daily in a dozen rings…

The great warfare of factions, the thundering collision of interests… each fellow trying to get it over on the next.

Pity the poor politician who has to referee and score the bout.

He cannot please us all. Yet he tries.

So today we lift our modest hymn of sympathy for the poor, fimble-fambling politician.

He is a man in an impossible fix.

Stow your objection that the nation is nearly $22 trillion in debt largely because the election-minded politician has thrown the Treasury doors wide open.

We will not listen!

Under what alternate type of government would you be so royally entertained?

A dictatorship, for example, offers no comparable entertainment. All oars pull in one direction. And the fantastic combats of democracy are unknown.

We will occasionally find ourself out of joint for one reason or the other.

But we always take solace in the pleasant fact that we are quartered under the democratic folds of the stars and stripes.

Yes, we concede that “democracies have ever been spectacles of turbulence and contention,” as James Madison notes in Federalist No. 10.

We further grant his point that democracies:

“Have ever been found incompatible with personal security or the rights of property; and have in general been as short in their lives as they have been violent in their deaths.”

All true and more.

We even admit the possibility that American democracy is closer to the end of the chapter than the beginning.

But this you cannot deny:

What a show while it lasts…


Brian Maher
Managing editor, The Daily Reckoning

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The Date Stocks Will Reach New Highs

This post The Date Stocks Will Reach New Highs appeared first on Daily Reckoning.

The S&P recently tumbled 19.8% before finding its legs — coming within an ace of the official 20% defining a bear market.

Bet let us declare it a bear market and have done.

Based on history’s telling, when can you expect stocks to recapture their early October 2018 highs?

A) 11.4 months

B) 1.6 years

C) 3.2 years

D) 5.7 years

The answer shortly.

But first a progress report…

The Dow Jones marched 164 points forward today.

The S&P added 20; the Nasdaq, 49.

Meantime, we see today that Daily Reckoning associate John Mauldin is lacing into the Federal Reserve.

For what reason?

Scientific incompetence — conducting a “two-variable” experiment.

That is, for raising interest rates while simultaneously trimming its balance sheet.

Do one. Or do the other.

But not both at once, he laments:

No serious scientist would run a two-variable experiment. By that I mean, you run an experiment with one variable to see what happens.

If you have two variables and something happens — either good or bad — you don’t know which variable caused it.

You first run the experiment with one variable, then do it again with the second one. After that, you have the knowledge to run an experiment with both.

So disturbed is Mr. Mauldin that he labels it “decidedly the stupidest monetary policy mistake in a long line of Fed mistakes.”

A remarkable achievement, if true. It is a line already stretching horizon to horizon.

But we suspect Mauldin has hooked onto something here.

The fed funds rate — whose range the Federal Reserve’s “Open Market” Committee establishes — stands presently between 2.25% and 2.50%.

But when combined with quantitative tightening, the “true” federal funds rate may approach 5%… or double the official rate.

Explains analyst Michael Howell of the CrossBorder Capital blog:

In other words,[it is] equivalent to the Fed undertaking around 20 rate hikes rather than the nine it has so far implemented this cycle.

Twenty rate hikes since December ’15!

How can it fail to leave its impact?

We have further suggested that the fed funds rate may now have crossed the “neutral rate” of interest.

Above the neutral line rates no longer offer economic support. Nor do they merely hold the scales even.

They instead form an active drag.

Meantime, global liquidity is evaporating before our eyes… like a puddle in the searing equatorial sun.

Global central banks heaved forth some $2.7 trillion of credit growth in 2017.

And in 2018?

Global credit contracted $410 billion.

Never before in history, Atlas Research reminds us, has the world witnessed a $3.1 trillion reversal in central bank liquidity.

Do you require further explanation for the market’s negative returns last year?

Or for the bear market October–December?

It is said one picture is worth a thousand words. Here is an example brilliantly in point:


No one should therefore be surprised to find the global economy going backward.

Chinese exports have plunged to two-year lows. Imports are also reversing.

Export powerhouse Germany is now reporting its steepest industrial decline in a decade.

As we reported this week:

The world has almost certainly sunk into recession if we take industrial growth as a thermometer of global economic health.

The so-called Organisation for Economic Cooperation and Development (OECD) runs its own economic health diagnostic.

Its composite leading indicator ran to 99.3 in November (the most recent available data).

The December number will likely dip beneath 99.3.

For 50 years running, we learn from Reuters, the United States has entered recession whenever the index slips below 99.3.

The roster includes 1970, 1974, 1980, 1981, 1990, 2001 — and 2008.

1998 supplied the lone exception.

But to return to our original question — how long must you wait before the stock market makes good its 20% losses?

The answer assumes added significance the nearer you come to retirement.

Assume the recent bear market knocked you back 20%.

Must you wait up to six years to merely catch up?

Or perhaps you are already retired and things are tight.

Must you now confront the nightmare reality of running out of money?

An Allianz Life survey reveals retirees fear going broke more than death itself.

61% to 39% they preferred the grave to the gutter.

And so… can you expect the stock market to recover its bear market losses in:

A) 11.4 months

B) 1.6 years

C) 3.2 years

D) 5.7 years

Stretching back to 1900, financial journalist Mark Hulbert ran the numbers through his mill… in search of light.

He took account for dividends and inflation to give the truest reading.

What was the final answer?

C — 3.2 years.

Not 11.4 months, that is — but not 5.7 years either.

If the historical average holds, the stock market will attain new heights in December 2021.

But examine the median recovery, says Hulbert — “such that half of the bear market recoveries were shorter and half longer” — and a brighter image emerges.

The median recovery period is 1.9 years… putting the market at new heights next September.

But statistics are lovely liars.

The market may recover quicker yet… or slower yet.

We suspect slower as we gaze out upon the gathering gloom.

Recall, the Federal Reserve is executing “decidedly the stupidest monetary policy mistake” in its history.

Recall further that global liquidity is in deep contraction.

Recall further still that leading economic data suggest the world is sinking into recession.

But we concede… we have no answer.

Veritatem dies aperit, said the Roman Seneca — time reveals truth.

Time — only time — will tell.


Brian Maher
Managing editor, The Daily Reckoning

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Volatility Holds the Key to Markets in 2019

This post Volatility Holds the Key to Markets in 2019 appeared first on Daily Reckoning.

Over the last two weeks, after making good on the four-rate interest hike of 2018, Fed Chairman, Jerome Powell, became more dovish to start 2019.

His change in tone is worth considering because of his historical stance on reducing the amount of artificial stimulus coming from the Fed. Last week, after the required five-year holding period for Fed transcripts were up, we got a glimpse into Powell’s thoughts from 2013, before he was Chairman.

Powell tried to persuade then-Chairman, Ben Bernanke, to reduce the Fed’s stimulus, even though it would lead to greater near-term market volatility. That was when the third round of the Fed’s asset-buying program (QE3) was in full swing. The Fed was purchasing an estimated $85 billion per month mix of Treasuries and mortgage-backed securities.

To indicate that the Fed wouldn’t buy bonds forever, Bernanke floated the idea of slowing down its program, or “tapering,” at some non-defined future date.

Powell, on the other hand, believed the market needed a specific “road map” of the Fed’s intentions. He said that he wasn’t “concerned about a little bit of volatility” though he was “concerned that there may be more than that here.”

Indeed, once Bernanke publicly announced the possibility of the Fed’s bond-buying program slowing down, the market tanked, in a response that became known as a “taper tantrum.” As a result, Bernanke backed off the tapering idea.

Fear of more taper tantrums kept the Fed in check after that. The Fed ultimately waited until it had raised rates sufficiently, before starting to cut the size of its balance sheet. But now Powell is the Chairman. And it seems that he is much less comfortable with volatility than he was under Bernanke, as his most recent remarks indicate.

But it certainly wouldn’t be the first time a Fed chairman has modified his views when he was in control. Alan Greenspan, for example, was a staunch advocate of the gold standard when he was younger (and as presented in Foreign Affairs). But once he was Fed head, suddenly he thought a gold standard wasn’t such a hot idea after all. Go figure.

In the case of Jerome Powell, his new sensitivity to volatility means the Fed will be watching the markets for high volatility that causes sell-offs, even if also espousing their “data driven” mentality. And that he is prepared to act should that happen by backing off the Fed’s current forecast for reducing its balance sheet.

I’ve argued before that the Fed isn’t reducing its balance sheet as aggressively as it would have you believe. And I certainly expect it to dial back even more so in light of the recent volatility.

The reason is obvious.

The main catalyst for the bull market that surfaced over the past 10 years since the financial crisis in 2008 was stimulus that was fueled by the Fed and other leading central banks. This money acted as an artificial stimulant or “drug” to financial asset prices.

The world’s leading central banks have been following the Fed’s lead in withdrawing liquidity. And even though global liquidity really began drying up late last year to a minimal degree relative to its size, it should come as no surprise that markets have threw a tantrum.

Since early October, we’ve seen a lot of price volatility, with several hundred-point daily swings in the markets becoming the norm. Powell calmed the waters with his dovish comments on January 4 and the following week as well. But make no mistake, the waters are still choppy.

Many on Wall Street expect to see more volatility ahead and are forecasting that 2019 will be rocky for the stock market. But others on Wall Street are, in direct contrast, forecasting a continued bull market.

That’s the other driver of volatility — clashing opinions and wildly divergent market forecasts. We haven’t had much volatility in recent years because nearly everyone was on the same side of the bet. That’s all changed now.

To add to the market turmoil, the federal government shutdown has now officially entered its fourth week. It is now the longest shutdown on record. But the shutdown also has real economic ramifications outside of the DC beltway.

First, in a climate where the expansion of business activity is already slowing down, the shutdown is causing economists to further lower first-quarter GDP estimates. That puts a lid on expansion and hiring plans for both psychological and actual risk reasons.

More than 800,000 federal workers have missed paychecks, which means less money to pay bills and purchase goods and services that contribute to the American economy. But that’s not the only problem, although it might seem far more important, especially to those missing paychecks.

From an information standpoint, the state of the economy is tough to predict without data produced by agencies like the Department of Commerce. For instance, farmers, already hurting from trade wars, won’t be able to get key data on figures like monthly international shipments to plan crop schedules.

Then there’s the Federal Reserve itself. Whether you think it should or not be setting interest rates at all, the Fed determines interest rates while considering factors such as market volatility, slowing economic figures and trade wars. The best way to do that is to access real data. Now, business conditions will be hard to gauge accurately if reports aren’t available due to the shutdown.

That means the shutdown will stoke volatility in the markets until an agreement is reached. And when that will be is anybody’s guess right now. No real progress has been made and there doesn’t appear to be an end in sight.

But this week, the markets will be getting new information to digest. The release of fourth-quarter earnings reports will begin with big banks. These will provide more insight into how companies performed during the year-end volatility in 2018.

The corporate earnings outlook on Wall Street is fairly negative. Companies have been managing expectations downward. Apple, for instance, chopped its forecasted revenue figures last month, citing the slowdown in China’s economic growth as a reason for less iPhone sales. Apple stock lost about 10% on the day of the announcement, taking the overall market down with it.

Analysts are now estimating fourth quarter profit growth of 14.5% for the S&P 500 companies. That’s down from the 20.1% they forecast at the start of the quarter. But that could actually be a good thing for share prices.

The lower the bar, the greater the possibility it can be exceeded. There’s more upside potential in that case, in other words. That means if earnings begin to outperform prior forecasts next week, it could very well lift the markets. This tension of negative and positives factors will foster a see-saw of a quarter in the markets mixed with volatility, so being aware and nimble will be the best strategy.

But the volatility could present a great trading opportunity. Wall Street knows that it doesn’t matter if information is positive or negative — there are still ways to profit from the right information.

Something called the Cboe Volatility Index (VIX) is widely considered a “fear gauge.” That’s because it’s supposed to reflect what swings in the S&P 500 index could be over the next month.

The VIX computes its levels based on outstanding options contracts which are supposed to indicate the price that investors, or speculators, are willing to pay for protection against their positions going bad.

Currently, the VIX should be higher than it is. It recently spiked, but then settled down much lower than what the real volatility of the S&P has been this past month.

Usually, options tend to over-price volatility. That’s because people buy options in order to place bets on the future, or to protect themselves from wild swings in share prices. The less certain they are, the more they are willing to pay for that protection.

Yet, right now, the cost of protection is cheap. That’s like your health insurance premium all of a sudden dropping just when you catch a major illness. It doesn’t quite make sense.

That means that while fourth-quarter earnings season reports are emerging, it’s a good time to take advantage of buying these cheap options. Buying them on certain companies can protect you against adverse swings in share prices due to earnings announcements. It’s a form of portfolio insurance. And again, it’s relatively cheap.

That’s one pivotal key to being a great investor — accessing information. Sure, the more insights and information you have, the more overwhelming it can seem. However, if you can stay focused, your portfolio will thank you.


Nomi Prins
for The Daily Reckoning

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Markets Hang “Between Order and Chaos”

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Today we bear dramatic news:

Markets have entered a “phase transition zone”… the “magic space between order and chaos.”

This we have on the authority of the brains at Fasanara Capital.

But what will emerge on the other side — order or chaos?

Today our mood is heavy, our brow creased with thought… as we hunt the answer.

We begin with a hypothesis:

Since the financial crisis, central banks have acted as an overprotective parent… or an overzealous referee of a prize fight.

They have kept the bears separated from the bulls, chained in a neutral corner where they could do no harm.

That is, they have throttled off the violent combats, the savage brawls of the market.

“This stock is worth x,” shout the bulls in a normal market. “No — it is only worth y,” roar the protesting bears.

They are soon upon each other’s throats.

Into a cloud of dust they vanish, arms, legs, elbows, flying — and may the better man win.

Ultimately a winner emerges with the proper price.

The professional men call it price discovery. 

Price discovery represents, to mix the figure a bit, the democracy of the marketplace.

Each investor has a vote. His vote may contrast bitterly with the other fellow’s.

But the better ideas will generally win the election… and the worse will lose.

The world is left with better mousetraps, superior companies, happier customers.

An Amazon cleans out a Sears. An Apple pummels a Compaq into nonexistence. A Google shows an AOL its dust.

And so on. And so on.

But after the financial crisis, the central banks rolled in with their tanks… and declared martial law.

The democracy of the marketplace went under the treads.

Is this company superior to that one? Does it deserve its stock price?

No one could say.

QE and zero interest rates put blindfolds over everyone’s eyes… and tape over their mouths.

“Passive” investing waged additional war on price discovery.

“Passively” managed funds make no effort to pinpoint winners. They track an overall index or asset category — not the individual components.

Passive investing has rendered actively picking stocks a fool’s errand.

Some 86% of all actively managed stock funds have underperformed their index during the last 10 years.

Explains Larry Swedroe, director of research at Buckingham Strategic Wealth:

“While it is possible to win that game, the odds of doing so are so poor that it’s simply not a prudent choice to play.”

Despite the gaudy averages, only a handful of stocks accounted for most of the market’s gains these past few years.

Through last August, for example, the FAANG stocks  — Facebook, Amazon, Apple, Netflix, Alphabet (Google’s parent company) —  accounted for half of the S&P’s gains.

But it was the false stability of Saddam Hussein’s Iraq. Hang the leader and the place goes to pieces.

In October the FAANGs began going to pieces. A period of vast instability resulted.

And the stock market came within an inch of a bear market by year’s end.

Since investors were all going blind, who could take up the load?

Markets began approaching Fasanara’s “phase transition zone.”

In a word… central banks have destroyed the market’s “resilience.”


The market has lost its key function of price discovery, its ability to learn and evolve and its inherent buffers and redundancy mechanisms. In a word, the market has lost its “resilience”… 

Our inability as market participants to properly frame market fragility and the inherent vulnerability of the financial system makes a market crash more likely, as it helps systemic risk go unattended and build further up. 

It is this systemic risk and loss of resilience that heightens the likelihood of a crash:

Conventional market and economic indicators (e.g., breaks of multiyear equity and home price trendlines, freezing credit markets, softening global [manufacturing]) have all but confirmed what nontraditional measures of system-level fragility signaled all along: that a market crash is incubating, and the cliff is near. 

But how close is the cliff?

Complex systems like markets, argues Fasanara (and Jim Rickards), are especially vulnerable in this “phase transition zone.”

The butterfly flaps its wings in Brazil and normally that is that.

But in highly unstable conditions, the butterfly flaps its wings and whips up a hurricane off Florida.

Small inputs, that is, have outsized effects under instability… shifting “order” into “chaos.”

What are some of the flapping butterflies that could conjure the hurricane?

Among the eight Fasanara identifies:

Trade war. China. Oil. Trump and the Mueller investigation.

Any one of these —  in theory — could tip markets over the chaotic border.

“Given our overall view for market system instability,” warns Fasanara, “it becomes crucial to monitor upcoming catalyst events, as any of them may be able to accelerate the large adjustment we anticipate.”

Meantime, we remain, suspended in the “magic space between order and chaos.”


Brian Maher
Managing editor, The Daily Reckoning

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Jay Powell’s Gift to Markets

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Fed Chair Jay Powell did not deliver any early Christmas presents to the markets last month, but he did pop the cork on a bottle of Champagne as a belated New Year’s gift on Friday, Jan. 4.

With just a few words, Powell sent the most powerful signal from the Fed since March 2015. Investors who understand and properly interpret that signal stand to avoid losses and reap huge gains in the weeks ahead.

First, let’s focus on Powell’s comments. Then we’ll explain what they actually meant.

The Fed has taken a March rate hike off the table until further notice. At a forum in Atlanta two Fridays ago, Powell joined former Fed chairs Yellen and Bernanke to discuss monetary policy.

In the course of his remarks, Powell used the word “patient” to describe the Fed’s approach to the next interest rate hike. When Powell did this, he was reading from a script of prepared remarks in what was otherwise billed as a “roundtable discussion.” This is a sign that Powell was being extremely careful to get his words exactly right.

Fed Chairman Jay Powell (left) joined former Fed chairs Janet Yellen and Ben Bernanke

Fed Chairman Jay Powell (left) joined former Fed chairs Janet Yellen and Ben Bernanke at a roundtable in Atlanta recently. Powell revived the word “patient,” which was last used by the Fed in December 2014. It’s a powerful signal of no rate hikes until further notice.

When Powell said the Fed would be “patient” in reference to the next rate hike, this was not just happy talk. The word “patient” is Fed code for “No rate hikes until we give you a clear signal.” This interpretation is backed up by the Fed’s past use of verbal cues to signal ease or tightening in lieu of actual rate hikes or cuts.

The word “patient” has a long history in the Fed’s vocabulary. Prior to March 2015, the Fed consistently used the word “patient” in their FOMC statements. This was a signal that there would not be a rate hike at the next FOMC meeting. Investors could do carry trades safely.

As long as the word “patient” was in the Fed’s statements, investors knew that there would be no rate hike without warning. It was like an “all clear” signal for leveraged carry trades and risk-on investments. Only when the word “patient” was removed was the Fed signaling that rate hikes were back on the table. In that event, investors were being given fair warning to unwind carry trades and move to risk-off positions.

In March 2015, Yellen removed the word “patient” from the statement. That was a signal that a rate hike could happen at any time and the market was on notice. If you had a carry trade on and were relying on no rate hike, then shame on you.

In fact, the first rate hike (the “liftoff”) did not happen until December 2015, but the market was on notice through the June and September 2015 FOMC meetings that it could happen. (The liftoff was originally planned for September 2015, but was postponed because of the U.S. market crash in August 2015. This crash was due to the shock 3% China currency devaluation on Aug. 10; U.S. stocks fell 11% in four weeks.)

Now, for the first time since 2015, the word “patient” is back in the Fed’s statements. This means no future Fed rate hikes without fair warning. This could change again based on new data and new statements, but a change is unlikely before March at the earliest. For now, the Fed is rescuing markets with a risk-on signal. That’s why the market rallied that Friday and has reversed December’s downward trend.

But we’re not out of the woods. Just because the Fed signaled they will not raise rates in March does not mean that all is well with markets. The U.S. stock market had already anticipated the Fed would not raise rates in March. The statement by Powell confirms that, but this verbal ease is already priced in. As usual, the markets will want some ice cream to go with the big piece of cake they just got from Powell.

On the one hand, if we’re at or near the start of a bear market it will take more than a Fed pause to offset that. On the other hand, there’s no reason for markets to crash based on the U.S. economy alone since the Fed may make more candy available by continuing to use the word “patient” in March. So we’re in wait-and-see mode.

Meanwhile, there’s an even bigger threat on the horizon — China. Unobserved by many analysts, the Chinese are reducing their money supply even faster than the Fed.

The Fed’s signal on rates says nothing about Fed reductions in the money supply under the quantitative tightening (QT) program. The U.S. money supply reductions are going ahead at $600 billion per year.

China is burning money even faster to prop up the yuan in the midst of a trade war with Trump. What does it mean when the world’s two largest economies, comprising 40% of global GDP, both hit the brakes on money supply?

Nothing good. Milton Friedman demonstrated that monetary policy operates with a lag of 12–18 months. These U.S. and Chinese monetary tightening policies started just over a year ago. The initial impact of what has already been done by the central banks is just being felt now.

This means that the U.S.-China tightening will continue to be felt over the next year regardless of what the Fed does in March. Stopping rate hikes now is like hitting the car brakes when you’re driving on a frozen lake. You’re going to slide a long time before the car comes to a halt. Let’s hope you don’t hit a soft spot before then or you’ll end up underwater.

Of course, the China and U.S. domestic growth and monetary policy narratives converge in the trade war discussions going on now. The continuing trade war is another head wind to growth. No doubt Powell had this scenario in mind when he opted to use the word “patient.”

The risk to investors is that markets are on a sugar high because of Powell’s recent comments. But the sugar will soon wear off and the Fed won’t provide more until March at the earliest. By then, the reality of slower growth in China and the U.S. and a lack of substantive progress in the trade wars will give the market a dose of reality like getting hit with a cold bucket of water in the face.

Evidence for this slowing comes from the latest Atlanta Fed update to their fourth-quarter GDP forecast, which now projects 2.6% growth after being as high as 3% earlier in the quarter.

What are the implications for investors of belated Fed ease combined with signs of weaker growth in China and the U.S.?

Right now, my models are saying that Powell’s verbal ease is too little too late. Damage to U.S. growth prospects has already been done by the Fed’s tightening since December 2016 and the Fed’s QT policy that started in October 2017.

The U.S., China and Europe are all slowing at the same time. Markets see this (despite Fed ease) and are preparing for a recession at best and a possible market crash at worst.

One potential catalyst is the start of the Chinese New Year celebration of the Year of the Pig. Kicking off with the Little New Year on Jan. 28, this celebration actually stretches over two weeks and is accompanied by reduced productivity and liquidity in Chinese markets. That’s a recipe for volatility.

We also have a Fed FOMC meeting on Jan. 30. No rate hike is expected, obviously, but there will be a written statement issued. Markets will be looking for the word “patient” in print, and if they don’t find it, there could be a violent reversal in the sugar high that started two Fridays ago.

Investors should prepare now before markets reprice.


Jim Rickards
for The Daily Reckoning

The post Jay Powell’s Gift to Markets appeared first on Daily Reckoning.

REVEALED: When Recession Starts

This post REVEALED: When Recession Starts appeared first on Daily Reckoning.

Today we reveal the time frame of the next recession — to within three months.

The surprising details anon. But first to a far more immediate catastrophe…

We are informed the partial government “shutdown” has entered a record-extending 25th day.

It is information we must take on faith, and at second hand.

That is because we have suffered not the slightest disruption to our affairs… nor has anyone within our orbit.

We would prolong the calamity until the very last cow reports to the butcher… or the first honest politician reports to Washington.

That is, we would prolong the calamity permanently.

But those more publicly minded insist we are mistaken.

They claim the shutdown is already casting a shadow, broad and heavy, over the United States economy.

Over 800,000 federal employees have been thrown from the public payrolls, they argue.

Data technology company Enigma estimates the shutdown has “blown a nearly $5 billion hole in federal workers’ finances.”

And the economy is deprived of their labor’s fruit.

Private contractors who guzzle from the federal trough are likewise going thirsty.

In turn, so are merchants downstream of the central catastrophe.

Moody’s chief economist Mark Zandi says the shutdown will drain 0.5% from first-quarter GDP:

We estimate (the shutdown) will reduce first-quarter real GDP growth by approximately 0.5 percentage points. Of this, about half will be due to the lost hours of government workers, and the other half to the hit to the rest of the economy.

But we would remind the calamity-howlers:

All furloughed federal employees will be issued full back wages once the “shutdown” ends.

And all water drained from first-quarter GDP will go back in the tub.

Meantime, the paid vacationers can snooze deep into the day, laze before the television, munch popcorn… secure in the knowledge that all back pay is due them.

But to return to the question under consideration… the time frame of the next recession.

Global growth is coming to a crawl.

Chinese exports have plunged to two-year lows. December imports also dropped 7.6% — a portent of softening domestic demand.

Meantime, European factory output wallows at three-year lows.

If we use global industrial growth as a proxy for global economic health, Zero Hedge reminds us, the world has almost certainly sunk into recession.

The United States economic machine still runs forward. But at a reducing rate.

Morgan Stanley, for example, projects U.S. growth will slip to 1% by 2019’s third quarter.

All the while, growth of global central bank balance sheets went negative last August.

Bank of America reports global money growth (measured by M1 money supply) nears its lowest point since mid-2008.

And Morgan Stanley confirms that each time M1 money supply growth tips negative — as it presently is — trouble of some type is on tap:


So is recession dead ahead… like an iceberg in the North Atlantic night?

Here our tale gathers pace…

The Federal Reserve has essentially announced a halt to its rate hikes.

A March hike has already been removed from the card table. Later hikes are also in question.

But will it be enough to sustain the show?

Once a global slowdown becomes obvious even to the Federal Reserve, it may be forced to take one additional step… and actually cut rates again.

That will be the point we suspect recession is close.

But is it not common knowledge that Federal Reserve tightening precedes a recession — not loosening?

Yes, but monetary policy features a delayed fuse.

Previous tightening will have already worked its damage. By the time it is appreciated, it is time again to back off.

The Fed begins cutting rates. But it is too late.

Let the record show:

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

Explains Zero Hedge.

While many analysts will caution that it is the Fed’s rate hikes that ultimately catalyze the next recession and every Fed tightening ends with a financial “event,” the truth is that there is one step missing from this analysis, and it may come as a surprise to many that the last three recessions all took place [within] three months of the first rate cut after a hiking cycle!

Does the rate cut itself frighten the horses… and turn a slowdown into a rout?

One can argue that it was the Fed’s official admission of economic weakness — by cutting rates — that triggered the economic contraction that was gathering pace as a result of [previous]higher rates and tighter financial conditions.

Once again — if the past three recessions are true indicators:

The next recession will commence within three months of the next rate cut.

The supreme irony:

Wall Street will consider the rate cut a beautiful omen for the stock market…


Brian Maher
Managing editor, The Daily Reckoning

The post REVEALED: When Recession Starts appeared first on Daily Reckoning.

EXPOSED: the “Green” New Deal

This post EXPOSED: the “Green” New Deal appeared first on Daily Reckoning.

We took command of The Daily Reckoning fully aware of the bodily risk, reduced here to words by our co-founder Bill Bonner:

In our trade as newsletter publishers, hardly a day passes without a good laugh. Our only occupational hazard is a rupture of the midriff.

Each day tosses up a fresh roster of fools, scoundrels, frauds, knaves, rogues, ne’er-do-wells, world improvers, lunatics and pitchmen.

Sometimes — though rarely — they combine in the form of a single person.

The trouble with them all is that they are vastly amusing. Hence the constant threat of an abdominal tear.

Sunday night the odds caught up with us… our belly was ripped from its moorings…

For there she was on 60 Minutes, the latest political sensation, Alexandria Ocasio-Cortez — AOC from here forward.

A former waitress, AOC was serving food 1.5 years ago. As the newly installed representative of New York’s 14th Congressional District, today she is serving notice…

Notice that a New Deal is in prospect — a “Green” New Deal…

That every American is to be guaranteed productive employment…

That Medicare for all will cure the nation’s ailments…

That free college is as elemental a right as life itself…

And that the ultra-rich will pay all the freight.

AOC’s solution is a 70% tax on all income exceeding $10 million per year.

“There’s an element where, yeah, people are going to have to start paying their fair share in taxes,” said she in the Queen’s English.

We have no objection to a man paying his fair share.

But what is fair? And who decides?

“Render unto Caesar what is Caesar’s,” said Jesus our Lord.

But He never specified precisely what was Caesar’s.

Was it 5%… 20%… 60%… 99%?

For the United States government, the answer was 7% when the income tax went upon the law books in 1913.

This was the top combined tax rate for those earning $500,000 or more.

Incidentally… $500,000 in 1913 dollars equals $12,729,191.92 in 2019 dollars.

But America is a much fairer society today.

It is such a shame the AOC plan will never make it ashore.

It is fatally holed below the waterline… like the Titanic by its iceberg.

Any third-rater can see there aren’t enough super-rich to fleece.

Our agents inform us some 16,000 Americans earn over $10 million per annum — at least as of 2016.

What is the tax haul once the 70% rate kicks in?

According to Mark Mazur, former Treasury Department official now laboring for the Tax Policy Center — some $72 billion annually when all factors are considered.

But how will a slight $72 billion bump substantially fund a Green New Deal… jobs for all… universal Medicare… free college tuition?

And that is assuming the rich sit still, waiting for the tax man to seize them by the collar.

But the rich are moving targets

They tuck into loopholes within the tax code. They dodge into overseas tax shelters. They hide under shell companies.

Who knows how much money the tax would haul aboard once the accountants are done with it?

And as anyone who has looked at it honestly knows — the great broad middle class is where the real tax money is.

As famous bank robber Willie Sutton supposedly answered when asked why he robbed banks:

“That’s where the money is.”

But the fact is best not mentioned in polite company… or at campaign rallies.

Ah, but the great and the good have leapt to AOC’s defense, including Paul Krugman — winner of the Nobel Memorial Prize in Economic Sciences:

Peter Diamond… in work with Emmanuel Saez — one of our leading experts on inequality — estimated the optimal top tax rate to be 73%. Some put it higher: Christina Romer, top macroeconomist and former head of President Obama’s Council of Economic Advisers, estimates it at more than 80%.

But how would they know?

Have any of them ever earned over $10 million per year?

If they did… might they think of better things to do with their millions than hand them off in taxes?

But our enthusiasts will counter that the top tax rate exceeded 90% during the 1950s — when Eisenhower’s America bestrode the world like an economic Colossus.

It was obviously to no detriment whatsoever, they say. To the contrary in fact.

Yes, but misguided roosters claim credit for the dawn…

We might remind the 70%-90% crowd that the United States industrial machine was unscratched by WWII.

Meantime, much of the industrial world remained under rubble in the 1950s.

Thus America stole a lovely march on the competition. How could it be other than first?

The 8th Air Force likely explains the business far better than any tax on America’s rich.

And American economic kingship gradually yielded as Europe and Japan rebuilt the factories.

But to return to our budding young democratic socialist…

Sunday night AOC pounded her tom-toms for a “Green New Deal.”

Its objectives include “eliminating greenhouse gas emissions from the manufacturing, agricultural and other industries” and “meeting 100% of national power demand through renewable sources.”

But if you think its purpose is to simply lower a global fever, you are far off the facts.


The Plan for a Green New Deal shall recognize that a national, industrial, economic mobilization of this scope and scale is a historic opportunity to virtually eliminate poverty in the United States and to make prosperity, wealth and economic security available to everyone participating in the transformation.

Was any Soviet five-year plan one fraction so ambitious?

The communists could never get a handle on their own steel, iron and rubber.

But AOC and her fellows would command Nature herself… and dictate her temperature across all four corners of Earth.

And eliminate poverty into the bargain!

This much is certain:

It would be a “green” New Deal in one sense:

Loads of green would fall into the pockets of the clean energy industry.

It cannot go on its own without massive taxpayer subsidies.

Thus the corporations AOC normally thunders against would get their buckets in the stream, their snouts in the trough… and their hands in taxpayer pockets.

There is a term for it: crony capitalism. Endorsed, no less, by a socialist.

Let it never be said that politics lacks ironies.

If you happen to believe the plan is radical, you are in excellent company. AOC herself:

“If that’s what radical means, call me a radical”

We have nothing against radicals. In fact, we much esteem them.

They are far more interesting to listen to than members of the rotary club… or dentists… or presidents of banks.

Those who actually believe the absurdities issuing from their own mouths take on additional fascination.

We suspect AOC is pleasant enough off duty.

In her personal life she may be amiable, engaging and — like most people — reasonably sane.

But put her in power, put a nightstick in her hand… and you have unleashed a public menace.

She becomes the humanitarian with the guillotine.

As the great Mencken styled it:

“The urge to save humanity is almost always a false front for the urge to rule it.”

A nation can survive its fools, argued writer Taylor Caldwell — but not its traitors.

But we begin to suspect it’s the other way around…

The fools are far more common. And much more likely to succeed.

But what spectacle it all provides, what theater, what circus. And we enjoy a front-row seat to the entire show.

We would not give it up for all the perfume of Arabia.

A man in our seat is truly a man enthroned…

Despite the occupational hazard of a ruptured midriff…


Brian Maher
Managing editor, The Daily Reckoning

The post EXPOSED: the “Green” New Deal appeared first on Daily Reckoning.

Are Stocks Cheap Again?

This post Are Stocks Cheap Again? appeared first on Daily Reckoning.

Are stocks “cheap” again?

Is it time once again to cast your bread upon the waters… and buy?

Today we rise above the daily hurly-burly of the market… take the long view… and ransack the past for clues about the future.

The major averages were negative for 2018. And the stock market has just emerged from its bleakest December since 1931.

But the market has found a toehold, bleats the consensus. The way ahead is higher. It is time to hunt bargains.

There is doubtless justice here — in specific cases and in the short run at least.

But are stocks cheap overall? And what can you expect for the next 10 years?

In general terms…

If stocks are cheap today, you can expect — generally, again — lovely returns for the following decade.

The reverse obtains if stocks are expensive today.

So once again: Are stocks presently cheap? Is it time to buy?

Warren Buffett’s preferred metric is the TMC/GNP ratio.

That is, the ratio of total market cap to U.S. GNP (which approximates but does not equal GDP).

If the total valuation of the stock market is less than GNP, stocks are cheap.

If it is greater than GNP… stocks are dear.

Mr. Buffett claims this formula is “probably the best single measure of where valuations stand at any given moment.”

Any ratio below 50% means stocks are “significantly undervalued.”

A ratio above 115% means they’re “significantly overvalued.”

Stretching four decades, the TMC/GNP ratio was lowest in 1982 — at 35%.

Not coincidentally, 1982 marked the onset of the lengthiest bull market of all time.

In violent contrast, the TMC/GNP ratio was highest in 2000, at 148%.

The dot-com catastrophe was close behind.

What is the TMC/GNP ratio today, Jan. 9, 2019?


That is, despite the worst December since 1931… by this measure stocks remain “significantly overvalued.”


What does that 127.5% imply for the stock market over the next decade, based on the historical record?

Negative 0.5% returns per year, including dividends.

You can expect negative returns for the next decade — if you take this TMC/GNP ratio as your guide.

Is it an infallible prophet?

It is not. None exists this side of eternity.

But financial journalist Mark Hulbert tracks eight market indicators he deems most credible. And he ranks it among the better of them.

But could negative 0.5% returns per year for the next decade — including dividends — actually be optimistic?

John Hussman captains a hedge fund, Hussman Strategic Advisors by name.

Mr. Hussman is what is known as a “perma-bear.”

Yet his crystal ball occasionally yields frightfully accurate pictures.

For example:

In March 2000 he soothsaid tech stocks would soon plummet 83%. How much did the Nasdaq lose between 2000 and 2002?


He also forecast in March 2000 that the S&P would post negative returns the following decade. It did.

In April 2007 Hussman said the S&P could plunge 40%. His vision was only off slightly. The S&P lost 55% from 2007–09.

And what does Hussman’s crystalline sphere reveal for the decade ahead?

First another question…

Assume you bought the S&P in 1999. You have held ever since — over hill, over dale, through every peak, every valley.

Keep in mind the S&P has raged some 300% since bottoming in 2009.

What has been your average yearly gain since 1999?

4.8% — again, dividends included.

A gain, yes.

But boring old gold would have yielded you a superior return since 1999… incidentally.

Perhaps “buy and hold” should read “buy and hope.”

But to return to the question at hand…

What can you expect for the next 10 years based on current stock market valuations?


At the March 2000 bubble peak, an understanding of market history… enabled my seemingly preposterous but accurate estimate that large-cap technology stocks faced potential losses of approximately 83% over the completion of the market cycle…

At the 2007 market peak, by contrast, stocks were generally overvalued enough to indicate prospective losses of about 55%…

And this market cycle?

In our view (supported by a century of market cycles across history), investors are vastly underestimating the prospects for market losses over the completion of this cycle… We presently estimate median losses of about 63% in S&P 500 component stocks over the completion of the current market cycle.

Kind heaven, no — a negative 63% return!

Take this vision with a heaping spoon of table salt… as you should with any forecast.

And the further out the reading the heavier the dose.

But if a hangover exists in direct proportion to the binge that caused it… investors may be laid up for the next decade.



Brian Maher
Managing editor, The Daily Reckoning

The post Are Stocks Cheap Again? appeared first on Daily Reckoning.

Here’s Where the Next Crisis Starts

This post Here’s Where the Next Crisis Starts appeared first on Daily Reckoning.

The case for a pending financial collapse is well grounded. Financial crises occur on a regular basis including 1987, 1994, 1998, 2000, 2007-08. That averages out to about once every five years for the past thirty years. There has not been a financial crisis for ten years so the world is overdue. It’s also the case that each crisis is bigger than the one before and requires more intervention by the central banks.

The reason has to do with the system scale. In complex dynamic systems such as capital markets, risk is an exponential function of system scale. Increasing market scale correlates with exponentially larger market collapses.

This means a market panic far larger than the Panic of 2008.

Today, systemic risk is more dangerous than ever because the entire system is larger than before. Due to central bank intervention, total global debt has increased by about $150 trillion over the past 15 years. Too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system and have much larger derivatives books.

Each credit and liquidity crisis starts out differently and ends up the same. Each crisis begins with distress in a particular overborrowed sector and then spreads from sector to sector until the whole world is screaming, “I want my money back!”

First, one asset class has a surprise drop. The leveraged investors sell the sinking asset, but soon the asset is unwanted by anyone. Margin calls roll in. Investors then sell good assets to raise cash to meet the margin calls. This spreads the panic to banks and dealers who were not originally involved with the weak asset.

Soon the contagion spreads to all banks and assets, as everyone wants their money back all at once. Banks begin to fail, panic spreads and finally central banks step in to separate winners and losers and re-liquefy the system for the benefit of the winners.

Typically, small investors (and some bankrupt banks) get hurt the worst while the big banks get bailed out and live to fight another day.

That much panics have in common. What varies in financial panics is not how they end but how they begin. The 1987 crash started with computerized trading. The 1994 panic began in Mexico. The 1997–98 panic started in Asian emerging markets but soon spread to Russia and the big banks. The 2000 crash began with dot-coms. The 2008 panic was triggered by defaults in subprime mortgages.

The problem is that regulators are like generals fighting the last war. In 2008, the global financial crisis started in the U.S. mortgage market and spread quickly to the overleveraged banking sector.

Since then, mortgage lending standards have been tightened considerably and bank capital requirements have been raised steeply. Banks and mortgage lenders may be safer today, but the system is not. Risk has simply shifted.

What will trigger the next panic?

Prominent economist Carmen Reinhart says the place to watch is U.S. high-yield debt, aka “junk bonds.”

I’ve also raised the same argument. We’re facing a devastating wave of junk bond defaults. The next financial collapse will quite possibly come from junk bonds.

Let’s unpack this…

Since the great financial crisis, extremely low interest rates allowed the total number of highly speculative corporate bonds, or “junk bonds,” to rise about 60% — a record high. Many businesses became extremely leveraged as a result. Estimates put the total amount of junk bonds outstanding at about $3.7 trillion.

The danger is that when the next downturn comes, many corporations will be unable to service their debt. Defaults will spread throughout the system like a deadly contagion, and the damage will be enormous.

This is from a report by Mariarosa Verde, Moody’s senior credit officer:

This extended period of benign credit conditions has helped many weak, highly leveraged companies to avoid default… A number of very weak issuers are living on borrowed time while benign conditions last… These companies are poised to default when credit conditions eventually become more difficult… The record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives.

If default rates are only 10% — a conservative assumption — this corporate debt fiasco will be at least six times larger than the subprime losses in 2007-08.

Many investors will be caught completely unprepared. Once the tsunami hits, no one will be spared. The stock market is going to collapse in the face of rising credit losses and tightening credit conditions.

But corporate debt is not the only dagger hanging over the economy. Credit conditions have already begun to affect the real economy. Student loan losses are also skyrocketing. Losses are also soaring on subprime auto loans, which has put a lid on new car sales. As these losses ripple through the economy, mortgages and credit cards will be the next to feel the pinch.

Have we already seen the beginning of the next crisis? No one knows for sure, but the time to prepare is now. Once the market falls apart, it’ll be too late to act.

That’s why the time to buy gold is now, while it’s cheap. When you need it most, once the crisis hits, it’ll cost a fortune.

Both the panics of 1998 and 2008 began over a year before they reached the level of an acute global liquidity crisis.

Investors has ample time to reduce risky positions, increase cash and gold allocations and move to the sidelines until the crisis abated. At that point there were bargains galore for those with cash.

An investor with cash in 2008 could have preserved wealth during the crisis and nearly quadrupled his money since then by buying the Dow Jones index at 6,550 (even with the recent turmoil, today it’s still around 23,600).

Relatively few investors did this. Instead they suffered from “fear of missing out” as markets rose until the panic began. They persisted in the mistaken belief that they could “get out in time” if markets reversed, not realizing that reversals happen much faster than rallies. They held onto losing positions hoping they would “come back” (they did after 10 years) and so on.

Simple behavioral biases stand in the way of doing the right thing almost every time.

For now, it’s not clear which way things will break next. Volatility is back and markets are still in a precarious position. Fed chairman Jay Powell threw markets a bone last Friday when he basically said all rate hikes are off until further notice and that he’s willing to scale back QT “if needed.” Markets have naturally rallied since Powell’s remarks.

If you still need proof that today’s rigged markets still require support from the Fed, here it is. But it’s far from clear the next crisis can be avoided at this point.

You don’t want to be heavily exposed to these markets. It’s far better to get out too early than too late. You should not be the last to be get ready. Start now to decrease equity allocations and increase your allocations to cash and gold so you can weather the coming storm.

Preparation means 10% percent of your investible assets in gold or silver and another 30% in cash. That allocation will preserve wealth and provide dry powder for bottom-fishing in the crisis to come.


Jim Rickards
for The Daily Reckoning

The post Here’s Where the Next Crisis Starts appeared first on Daily Reckoning.

The Origin of the Next Financial Crisis

This post The Origin of the Next Financial Crisis appeared first on Daily Reckoning.

Today, additional evidence that recession — or worse — is in sight.

But first, it appears the “Powell put” may extend the countdown clock…

Since Jerome Powell’s dovish comments on Friday, the Dow Jones has been up and away… as an addict thrills to the promise of additional stimulant.

It leaped another 256 points today.

Both S&P and Nasdaq have been similarly seduced.

The S&P ended the day up another 24 points; the Nasdaq, 73.

Thus Mr. Powell becomes the latest dealer to backstop Wall Street’s addiction to easy credit.

First came the “Greenspan put” after October 1987’s Black Monday.

The “Bernanke put” was on tap after 2008 — and was it ever.

This was of course succeeded by the “Yellen put.”

And now… Jerome Powell.

But the stuff at Powell’s disposal is far weaker his predecessors’.

The fed funds rate rose as high as 4.75% in September 2007 — as the foundations gave way on the housing market.

But it squatted at 1.50% when Powell came on station last February.

That is, he has far less space to cut rates.

Meantime, Bernanke and Yellen were able to inflate the balance sheet from a pre-crisis $800 billion to a delirious $4.5 trillion.

Powell could not possibly work an operation on that scale.

This at least partly explains why he has been withdrawing the narcotic since he came aboard — to rebuild his stocks for future use.

But Mr. Powell suggested last Friday that he is willing to call a halt “if needed.”

And so Pavlov’s dogs began drooling. And the stock market began its merry run.

But it is a false promise — as the promise of the needle is false — or the promise of the bottle.

It may put off reckoning day… but it only intensifies the ultimate and inevitable withdrawal.

Come we now to our evidence that recession is within view…

We have argued previously that sub-4% unemployment means recession is almost invariably close by.

Today we observe that recession is also close when corporate debt attains present heights.

U.S. corporate debt swelled a preposterous $2.5 trillion post-financial crisis… some 40% higher than its 2008 summit.

Corporate debt presently equals some 46% of GDP — the highest percentage on record.

And whenever corporate debt rises to present levels, recession is in the air… at least for the past 40-odd years:

Corporate Debt Far Into Red Zone

But whom shall we blame?

As is our wont, we point an accusing finger at the Federal Reserve…

Year upon year of ultra-low interest rates hammered borrowing costs lower and lower.

Marginal corporations that would have been denied access to credit under normal circumstances took on debt.

And many corporations have issued bonds to raise funds rather than issue stock. It has proved less expensive given the bargain rates.

Did corporations use the borrowed money to increase productivity… increase research and development… or expand operations?

No, not particularly.

Many corporations have been using the money to purchase their own stock, which has artificially inflated their prices.

And as we have stated before, corporations have been the largest source of all stock purchases.

But interest rates have been climbing… like water in a flooding basement.

And the cost of existing debt is rising with it.

How will they meet their debts?

Bonds rated “BB” are considered “junk bonds.”

“BBB” is one level removed from junk.

MarketWatch informs us that the volume of the bond market rated BBB currently rises to $2.5 trillion — a record high.

That is, 50% percent of all investment-grade corporate bonds are presently one inch from junk status.

And once they start going over… watch out.

Explains Daily Reckoning associate John Mauldin:

This is the sort of thing that can quickly snowball into a financial crisis. Something similar happened with commercial paper in 2008, but this has the potential to be even worse… and, if it happens, could come at a time when the Federal Reserve and Treasury can’t help much. I see serious risk of a corporate bond crisis in 2019…

Analyst Jesse Colombo is similarly alarmed:

The U.S. corporate debt bubble will likely burst due to tightening monetary conditions, including rising interest rates. Loose monetary conditions are what created the corporate debt bubble in the first place, so the ending of those conditions will end the corporate debt bubble. Falling corporate bond prices and higher corporate bond yields will cause stock buybacks to come to a screeching halt, which will also pop the stock market bubble, creating a downward spiral. 

In conclusion:

There are extreme consequences from central bank market-meddling, and we are about to learn this lesson once again.

From where we sit… the only question is when.


Brian Maher
Managing editor, The Daily Reckoning

The post The Origin of the Next Financial Crisis appeared first on Daily Reckoning.