“You Are a Traitor!”

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“You are a traitor, go back to Great Britain!”

This weekend’s reckoning, “Was the American Revolution a Mistake?” argued that the American colonies in 1775 were perhaps the freest society on Earth.

The subsequent revolution raised the curtain on a ruinous inflation, the article continued. And that the American tax burden tripled after 1783.

Never again did the American people regain their prerevolutionary economic freedoms.

The issue drew a heavy mail — and an impassioned mail.

We opened with the comments of reader Charles H… who fingers us for treason.

He further banishes us to the crowned and sceptered isle, in the footsteps of Benedict Arnold.

Reader Emrich S. even offers us a royal title:

How about I sell you the title Duke of BS. You and Rupert Murdoch think it was a bad idea and he and you have been undermining our ideals ever since. Why?

For no other reason — perhaps — that we are traitorous, seditious, malicious, villainous… and treacherous.

Of course, we cannot address the motivations of Mr. Murdoch.

And above the name Lenny M. we are dealt with as follows:

Revisionist-history socialism and rules for radicals… You make Saul Alinsky proud.

Just so. But the article banged a drum for those dreamy days when Americans paid out perhaps 1–2.5% in taxes.

Would a socialist sob over higher taxes?

Sample excerpt:

What would libertarians — even conservatives — give today in order to return to an era in which the central government extracted 1% of the nation’s wealth? Where there was no income tax?

Meantime, reader Stephen K. suggests we are merely working an angle… to catch a penny:

The colonists left England and the continent to obtain freedom that they did not have before. Don’t whitewash history to sell your books.

But not all readers would pack us off to the gallows…

Joining us in treason, for example, is reader Ken H.:

Brilliant and accurate analysis… Thank you! I discovered the same in my advanced-placement American history class quite some time ago!

Randy M. adds: “This is an interesting angle on U.S. history I’ve never heard.”

Finally, reader Eric P. says: “Thank you very much for this piece of history.”

Was the American Revolution a mistake?

Upon deep and sober reflection this weekend, we have come around to the belief it was not.

That is because we are heart and soul for freedom.

Imagine that America remained an English colony to this day.

Further imagine the tyrannical crown spent us into oblivion… and buried these colonies under a crushing $22.4 trillion debt.

Can you conceive of such a despotism?

But as independent Americans…

We can be proud that we accomplished it all by ourselves… freely.

Regards,

Brian Maher
for The Daily Reckoning

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Was the American Revolution a Mistake?

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I did not celebrate the Fourth of July on Thursday. This goes back to a term paper I wrote in graduate school. It was on colonial taxation in the British North American colonies in 1775. Not counting local taxation, I discovered that the total burden of British imperial taxation was about 1% of national income. It may have been as high as 2.5% in the southern colonies.

In 2008, Alvin Rabushka’s book of almost 1,000 pages appeared: Taxation in Colonial America (Princeton University Press). In a review published in the Business History Review, the reviewer summarizes the book’s findings.

Rabushka’s most original and impressive contribution is his measurement of tax rates and tax burdens. However, his estimate of comparative transatlantic tax burdens may be a bit of moving target. At one point, he concludes that in the period from 1764–1775, “the nearly 2 million white colonists in America paid on the order of about 1% of the annual taxes levied on the roughly 8.5 million residents of Britain, or 1/25 in per capita terms, not taking into account the higher average income and consumption in the colonies” (p. 729). Later he writes that on the eve of the Revolution, “British tax burdens were 10 or more times heavier than those in the colonies” (p. 867). Other scholars may want to refine his estimates, based on other archival sources, different treatment of technical issues such as the adjustment of intercolonial and transatlantic comparisons for exchange rates or new estimates of comparative income and wealth. Nonetheless, no one is likely to challenge his most important finding: the huge tax gap between the American periphery and the core of the British Empire.

Was the Declaration of Independence Built Upon a Lie?

The colonists had a sweet deal in 1775. Great Britain was the second-freest nation on Earth. Switzerland was probably the most free nation, but I would be hard-pressed to identify any other nation in 1775 that was ahead of Great Britain. And in Great Britain’s Empire, the colonists were by far the freest.

I will say it, loud and clear: The freest society on Earth in 1775 was British North America, with the obvious exception of the slave system. Anyone who was not a slave had incomparable freedom.

Jefferson wrote these words in the Declaration of Independence:

The history of the present King of Great Britain is a history of repeated injuries and usurpations, all having in direct object the establishment of an absolute Tyranny over these States.

I can think of no more misleading political assessment uttered by any leader in the history of the United States. No words having such great impact historically in this nation were less true. No political bogeymen invoked by any political sect as “the liar of the century” ever said anything as verifiably false as these words.

The American Revolution Tripled Taxes

The Continental Congress declared independence on July 2, 1776. Some members signed the Declaration on July 4. The public in general believed the leaders at the Continental Congress. They did not understand what they were about to give up. They could not see what price in blood and treasure and debt they would soon pay. And they did not foresee the tax burden in the new nation after 1783.

In an article on taxation in that era, Rabushka gets to the point.

Historians have written that taxes in the new American nation rose and remained considerably higher, perhaps three times higher, than they were under British rule. More money was required for national defense than previously needed to defend the frontier from Indians and the French, and the new nation faced other expenses.

So as a result of the American Revolution, the tax burden tripled.

The debt burden soared as soon as the Revolution began. Monetary inflation wiped out the currency system. Price controls in 1777 produced the debacle of Valley Forge. Percy Greaves, a disciple of Austrian economist Ludwig von Mises and for 17 years an attendee at his seminar, wrote this in 1972.

Our Continental Congress first authorized the printing of Continental notes in 1775. The Congress was warned against printing more and more of them. In a 1776 pamphlet, Pelatiah Webster, America’s first economist, told his fellow men that Continental currency might soon become worthless unless something was done to curb the further printing and issuance of this paper money.

The people and the Congress refused to listen to his wise advice. With more and more paper money in circulation, consumers kept bidding up prices. Pork rose from 4 cents to 8 cents a pound. Beef soared from about 4 cents to 100 a pound. As one historian tells us, “By November 1777, commodity prices were 480% above the prewar average.”

The situation became so bad in Pennsylvania that the people and legislature of this state decided to try “a period of price control, limited to domestic commodities essential for the use of the army.” It was thought that this would reduce the cost of feeding and supplying our Continental Army. It was expected to reduce the burden of war.

The prices of uncontrolled, imported goods then went sky high, and it was almost impossible to buy any of the domestic commodities needed for the Army. The controls were quite arbitrary. Many farmers refused to sell their goods at the prescribed prices. Few would take the paper Continentals. Some, with large families to feed and clothe, sold their farm products stealthily to the British in return for gold. For it was only with gold that they could buy the necessities of life which they could not produce for themselves.

On Dec.5, 1777, the Army’s quartermaster-general, refusing to pay more than the government-set prices, issued a statement from his Reading, Pennsylvania, headquarters saying, “If the farmers do not like the prices allowed them for this produce let them choose men of more learning and understanding the next election.”

This was the winter of Valley Forge, the very nadir of American history. On Dec. 23, 1777, George Washington wrote to the president of the Congress “that, notwithstanding it is a standing order, and often repeated, that the troops shall always have two days’ provisions by them, that they might be ready at any sudden call; yet an opportunity has scarcely ever offered, of taking an advantage of the enemy, that has not been either totally obstructed, or greatly impeded, on this account… we have no less than 2,898 men now in camp unfit for duty, because they are barefoot and otherwise naked… I am now convinced beyond a doubt, that, unless some great and capital change suddenly takes place, this army must inevitably be reduced to one or other of these three things: starve, dissolve or disperse in order to obtain subsistence in the best manner they can.”

“There Was no British Tyranny, and Surely not in North America”

Only after the price control law was repealed in 1778 could the army buy food again. But the hyperinflation of the continentals and state-issued currencies replaced the pre-Revolution system of silver currency: Spanish pieces of eight.

The proponents of independence invoked British tyranny in North America. There was no British tyranny, and surely not in North America.

After the American Revolution, 46,000 American loyalists fled to Canada. They were not willing to swear allegiance to the new colonial governments. They retained their loyalty to the nation that had delivered to them the greatest liberty on earth. They had not committed treason.

The revolutionaries are not remembered as treasonous. The victors write the history books.

The Boston Tea Party: A Protest Against Lower Tea Prices

What would libertarians — even conservatives — give today in order to return to an era in which the central government extracted 1% of the nation’s wealth? Where there was no income tax?

Would they describe such a society as tyrannical?

That the largest signature on the Declaration of Independence was signed by the richest smuggler in North America was no coincidence. He was hopping mad. Parliament in 1773 had cut the tax on tea imported by the British East India Company, so the cost of British tea went lower than the smugglers’ cost on non-British tea.

This had cost Hancock a pretty penny. The Tea Party had stopped the unloading of the tea by throwing privately owned tea off a privately owned ship — a ship in competition with Hancock’s ships. The Boston Tea Party was, in fact, a well-organized protest against lower prices stemming from lower taxes.

So, once again, I did not celebrate the Fourth of July on Thursday.

Regards,

Gary North
for The Daily Reckoning

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Three Steps to Save America from Collapse

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Our monetary system is broken. It’s given us low growth, a shrinking job force, inequality beyond what a healthy economy would produce, inefficiency, and the unnatural growth of finance as a portion of the economy.

Our aging Federal Reserve System starves both small businesses and Silicon Valley of the capital needed to grow jobs and wages.

Fed policy translates into zero-interest-rate loans for the government and its cronies, and little or nothing for savers or small businesses. And it has transformed Wall Street from an engine of innovation into a servant of government power.

But I believe America can be set on the right path towards a robust and broadly shared capitalism again with just three steps. 

Step 1: Abolish Capital Gains Tax on Currencies 

This country already allows gold currency. The Treasury mints millions of one-ounce silver eagle dollars that are worth more than twenty dollars apiece and one-ounce gold eagle fifty-dollar pieces that are worth $1,150 apiece. 

Virtually all of these are hoarded. 

Though it has been legal since 1987 to use them at their metallic value, that route leads to a capital gains tax on their appreciation. 

Since the appreciation of a gold or silver piece is by reasonable definition all inflation, the tax is simple confiscation (like all capital gains taxes on spurious inflationary profits). 

The move of gold and silver coins into circulation would offer a corrective of constitutional money for any dollar debauchery by the Fed. 

Step 2: Remove Obstacles to Alternative Forms of Money

Despite imprudent governmental interference, the internet remains a bastion of American power, with U.S. companies such as Apple, Google, Amazon, Microsoft, Facebook, eBay, Cisco, Qualcomm, and scores of others capturing the bulk of all internet revenues. 

The internet plays a central role in the American economy. But there is a profound flaw in its architecture, as I have explained before. It was designed for communications, not transactions.

Around the globe, transactions are shifting toward the internet. Although online purchases remain between 6-7% of all commerce, internet trade is expanding rapidly. 

But to buy something on the Internet, you often have to give the supplier sufficient information — credit card number, expiration date, address, security code, mother’s maiden name, and so on — to defraud you or even to steal your identity. 

This information therefore has to be protected at high cost in firewalled central repositories and private networks, which are irresistible targets for hackers. 

With transactional overhead dominated by offline financial infrastructure, micropayments are uneconomic, and the internet fills with fake offers, bogus contracts, and pop-up hustles. Some 36% of web pages are bogus, emitted by bots to snare information from unwary surfers. 

The internet today desperately needs a new trusted and secure payment method that conforms to the shape and reach of global networking and commerce. 

It should eliminate the constant exchanges of floating currencies, more volatile than the global economy that they supposedly measure. It should be capable of transactions of all sizes. And it should partake of the same monetary sources of stable value that characterize gold. 

The new system should be distributed as far as internet devices are distributed: a dispersed organization based on peer-to-peer links between users, rather than a centralized hierarchy based on national financial institutions. 

Fortunately such a payment system has already been invented. It is set to become a new facet of internet infrastructure. 

It is called the bitcoin blockchain. 

The bitcoin blockchain is already in place. It functions peer-to-peer without the need for outside trusted third parties. And it follows theorist Nick Szabo’s precursor, bitgold. Its value, like gold’s, is ultimately based on the scarcity of time. 

Even if bitcoin proves flawed, scores of companies are developing alternatives based on the essential blockchain innovation that can serve as a successful transactions medium for digital commerce. The existence of such a system would enable sellers on the internet, such as content producers, to name their own prices and collect their funds directly. 

And the very process that validates the transaction would prohibit spam. There would be no hassle of bartering content for advertising revenues at some aggregator such as Google. Aggregators with advertising clout would merely add inefficiency to an automated system that minimize transaction costs. 

The internet would have a money system of its own.

With a low market price for goods and services — Google and other players could charge millicents for their services and still make a mint — the internet economy would transcend its current den of thieves and hustlers. 

It could attain its promise as a frictionless facilitator of human creativity rather than as a channel of chicanery. Its markets would impel the world toward new realms of knowledge and wealth. 

But the success of a new global standard of value on the internet entails a ban on taxation of internet currencies. If only government currencies escape taxation, alternative currencies such as bitcoin will always be relegated to niches.

Step 3: Fix the Dollar 

That brings us to the third step: fixing the U.S. dollar.

How do we do this? 

Monetary scholar Judy Shelton already devised a play. The chief instrument would be the creation of Treasury Trust Bonds — five-year Treasuries redeemable in either dollars or gold. They could be enacted either through legislation or as a Treasury initiative.

Legislation would specifically authorize the issuance of five-year Treasury securities that pay no interest, but provide for payment of principal at maturity in either ounces of gold or the face value of the security, at the option of the holder. 

The instrument would be an obligation of the U.S. government to redeem the nominal value (“face value”) in terms of a precise weight of gold stipulated in advance or the dollar amount established as the monetary equivalent. The rate of convertibility (in gold grams) is permanent throughout the life of the bond; it defines the gold value of the dollar.

As Alan Greenspan declared in the Wall Street Journal during the previous era of monetary turmoil, in 1981: 

In years past a desire to return to a monetary system based on gold was perceived as nostalgia for an era when times were simpler, problems less complex and the world not threatened with nuclear annihilation. But after a decade of destabilizing inflation and economic stagnation, the restoration of a gold standard has become an issue that is clearly rising on the economic policy agenda.”

In fact, Greenspan suggested that “Shelton bonds” would pave the path to the future…

“The degree of success of restoring long-term fiscal confidence will show up clearly in the yield spreads between gold and fiat dollar obligations of the same maturities. Full convertibility would require that the yield spread for all maturities virtually disappear.”

Of course, as Fed chairman, Greenspan went on to become a major maestro of monopoly money at the Fed. And in his subsequent books he expressed many regrets and misgivings about the nature and role of central banks. 

But in an era of new monetary turmoil, Shelton bonds still have traction. In addition, as bitcoin blockchain innovations spread through the internet, borrowers could also issue bonds with a bitcoin payoff. So new systems based on gold and blockchain innovations can evolve into a new world monetary infrastructure.

These are the three steps that can restore integrity to the monetary system. 

As I explained yesterday, this is how we can save Main Street from the menace of monopoly money, transcend the dismal science of stagnation and decline, and restore the American mission and dream.

Regards,

George Gilder
for The Daily Reckoning

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GDP: The New “Slow” Normal

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“Is Slow Still the New Normal for GDP Growth?”

The Federal Reserve Bank of San Francisco raises the question… and proceeds to answer it:

Estimates suggest the new normal pace for U.S. GDP growth remains between 1.5% and 1.75%, noticeably slower than the typical pace since World War II…

A larger challenge is productivity. Achieving GDP growth consistently above 1.75% will require much faster productivity growth than the United States has typically experienced since the 1970s.

Productivity — as we have argued prior — is the spring of enduring prosperity.

Productivity growth transformed these United States from a bucktoothed backwater into a global behemoth… a modern Colossus bestride the world.

Productivity growth averaged 4–6% for the 30 years post-WWII. But after 1980?

Average productivity has languished between 0–2%.

Meantime, labor productivity averaged 3.2% annual growth from World War II to the end of the 20th century.

But since 2011… a mere 0.7%.

What might account for America’s declining productivity growth?

We have previously implicated Richard Nixon and his 1971 murdering of the gold standard.

The gold standard, though a sad caricature in its dying days, nonetheless enforced an honesty.

A wastrel nation that consumed more than it produced would eventually run through its gold stocks.

The fiat dollar, the unbacked dollar, lifted the penalty.

A liberated Federal Reserve finally broke loose from its golden shackles… spread its nets… and ensnared the nation in debt.

Michael Lebowitz of Real Investment Advice:

The stagnation of productivity growth started in the early 1970s. To be precise it was the result, in part, of the removal of the gold standard and the resulting freedom the Fed was granted to foster more debt… Over the last 30 years the economy has relied more upon debt growth and less on productivity to generate economic activity.

“Unfortunately, productivity requires work, time and sacrifice,” he adds.

But the emerging American economy left behind the grimy toil of the factory floor and the workbench…. and headed for Wall Street.

It went chasing after the fast buck — the easy buck.

The financialization of the American economy was underway.

Ten percent of GDP in 1970, the finance industry grew to 20% of GDP by 2010… like weeds in an abandoned factory.

And like spreading weeds, finance choked the path of labor…

The bottom 90% of American earners advanced steadily from the early 1940s through the early 1970s.

But they’ve been sliding back ever since — or held even at best.

In contrast we find the top 1% of earners…

From 1920 to the early 1970s they lost ground to the bottom 90%.

But beginning around 1980 they went leaping ahead… and began showing society their dust:

Read more here.

But perhaps we can declare the race a wash.

Labor’s loss is simply capital’s gain. And the economy as a whole comes out even. Perhaps the transaction even benefits it.

But has it? Has the United States economy benefited from financialization?

The facts may run precisely the other way…

Economists Gerald Epstein and Juan Antonio Montecino slaved over the numbers.

Since 1990, they conclude…

The financial sector has drained as much as $22 trillion from the United States economy:

What has this flawed financial system cost the U.S. economy?… We estimate these costs by analyzing three components: (1) rents, or excess profits; (2) misallocation costs, or the price of diverting resources away from nonfinancial activities and (3) crisis costs, meaning the cost of the 2008 financial crisis. Adding these together, we estimate that the financial system will impose an excess cost of as much as $22.7 trillion between 1990 and 2023, making finance in its current form a net drag on the American economy.

Meantime, we sag and groan under majestic mountains of debt.

A financialized economy demands perpetually increasing credit — debt, that is — to keep the show going.

Servicing that debt absorbs increasing amounts of society’s income. That in turn leaves less to save… and to invest in productive assets.

It is a dreadful cycle.

Eventually it leaves the cupboards bare… and the future empty.

Average real annual economic growth since 2009 runs to 2.23%.

Compare the past decade’s 2.23% with the larger 3.22% trend since 1980.

One percentage point may seem a trifle. And one year to the next it is.

But Jim Rickards calculates the United States would be $4 trillion richer — had the 3.22% trend held this decade.

Run it 30, 50, 60 years… Jim concludes the nation would be twice as rich over a lifetime.

Here is Lebowitz with the sting in the tail:

“Given the finite ability to service debt outstanding… future economic growth, if we are to have it, will need to be based largely on gains in productivity.”

But from where?

Below, George Gilder shows you how real money could “work miracles of growth.” Read on.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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The War of Stocks and Bonds

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Jerome Powell dangled the morsel yesterday — rate cuts are on the way.

And like Pavlov’s famously conditioned dogs, Wall Street heard the opening bell this morning… and began drooling.

The major indexes were instantly up and away.

They lost momentum after the president intimated he may take a swing at Iran for downing a U.S. drone.

“You’ll soon find out” was his response when asked if the U.S. would retaliate.

The bulls nonetheless won the day…

The Dow Jones was up 249 points at closing whistle. The S&P gained 28; the Nasdaq, 64 points.

Gold, meantime, went skyshooting $44.50 today — $44.50!

Combine the prospects of vastcentral bank easing with possible fireworks in the Persian Gulf… and you have your answer.

What about the bond market?

Stocks vs. Bonds

The bellwether 10-year Treasury slipped to 1.98% this morning… its lowest point since the 2016 election.

And so the infinitely expanding gulf between stock market and bond market widens further yet.

One vision is bright, cheery, trusting. The other is dark, dour… and morose.

One of these markets will be proven right. One will be proven wrong.

Our money is on the bond market.

We have furnished ample evidence that recession is likely on tap within three months of the next rate cut.

Here analyst Sven Henrich reinforces our deep faith in the calendar of misfortune:

Every single time the Fed cut rates when unemployment was below 4%, a recession immediately ensued & unemployment shot to 67%. Again: Every. single. time.

We remind you:

The United States unemployment rate presently stands at 3.6% — the lowest in 50 years.

“A Gorgeously Wrapped Gift Box Containing a Time Bomb”

An unemployment rate below 4% is a false prize, a sugar-coated poison… a gorgeously wrapped gift box containing a time bomb.

Unemployment previously slipped beneath 4% in April 2000 — at the peak of the dot-com delirium.

The economy was in recession by March 2001.

Prior to 2000, unemployment had previously fallen below 4% in December 1969.

The economy was sunk in recession shortly thereafter.

The pattern stretches to the 1950s.

The proof, clear as gin… and equally as stiff:

Chart

And unemployment often bottoms nine months before recession’s onset… according to the National Bureau of Economic Research.

Meantime, it is 10 years into the present economic “expansion.” Next month will establish a record.

A Very Strange Expansion

An expanding economy is generally a time of surplus.

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

These savings will see you through.

But during this economic expansion, during this season of bounty… the United States has only sunk deeper into debt.

The cupboards are empty.

Trillion-dollar annual deficits are presently in sight.

The national debt rises to $22.3 trillion — some 105% of GDP.

And interest payments on the debt alone will likely eclipse defense spending by 2025.

Come the inevitable recession, Uncle Samuel will plunge even deeper into debt.

That is, he will reach even further into the future… to rob it for our benefit today.

Deficits may double — or more.

How is the business at all sustainable?

But it’s not only a doddering old uncle going under the water…

The Corporate Debt Bomb

Corporations have loaded themselves to the gunwales with cheap debt — cheap debt coming by way of the Federal Reserve.

First-quarter nonfinancial corporate debt increased to $9.93 trillion. That is a record.

And this we learn from the Treasury Department:

Today’s nonfinancial corporate debt-to-GDP ratio is the highest since 1947… when records began.

And here we spot a straw swaying menacingly in the wind…

Fitch informs us nearly $10 billion of high-yield corporate bonds have already defaulted in the second quarter — double the amount of first-quarter defaults.

Warns Troy Gayeski, co-chief investment officer at SkyBridge Capital:

“Whatever the cause [of the next recession] may be, the acute point of pain will be in corporate credit.”

Depends on it.

Finally we come to the fabulously and grotesquely indebted American consumer…

Consumers Drowning in Debt

Total U.S. consumer debt notched $14 trillion in the first quarter — exceeding the roughly $13 trillion before the financial crisis.

Twenty-three percent of Americans claim that life’s essentials — food, rent, utilities — constitute the bulk of their credit card purchases.

And 60% of Americans hold less than $1,000 in savings.

How will they keep up come the next recession? How will they meet their debts?

They already groan under the load — and the economy is still expanding.

Meantime, the cost of a middle-class lifestyle has surged 30% over the past two decades.

But Pew Research reports the average American worker wields no more purchasing power today… than he did 40 years ago.

That is, he has jogged in place 40 years.

Utter and Complete Failure

The past 10 years of central bank intervention on a grand and heroic scale have worked little benefit.

The coming recession will bring yet more intervention— on an even grander and more heroic scale.

But why should we expect it to yield any difference whatsoever?

For the overall view, we turn to Mr. Sven Henrich:

The grand central bank experiment of the last 10 years has ended in utter and complete failure. The games of cheap money and constant intervention that have brought you record global debt to the tune of $250 trillion and record wealth inequality are about to embark on a new round… The new global rate-cutting cycle begins anew before the last one ever ended. Brace yourselves, as no one, absolutely no one, can know how this will turn out…

We are witnessing a historic unraveling here. Everything every central banker has uttered last year was completely wrong. Every projection they made over the last 10 years has been wrong… Why place confidence in people who are staring at the ruins of the policies they unleashed on the world and are about to unleash again?…

All the distortions of 10 years of cheap money, debt, wealth inequality, zombie companies, negative debt… will all be further exacerbated by hapless and scared central bankers whose only solution to failure is to embark on the same cheap money train again. All under the banner to “extend the business cycle” at all costs. Never asking whether they should nor considering the consequences. But since they are not elected by the people and face zero consequences for failure, they don’t have to consider the collateral damage they inflict.

Unfortunately, the rest of us do…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Capitalism Is Broken

This post Capitalism Is Broken appeared first on Daily Reckoning.

The announcement came rolling from the Eccles Building at 2 p.m. Eastern…

No rate hike today.

Jerome Powell has decided to sit on his hands — for now.

In his very words:

It’s important that monetary policy not overreact to any one data point… The FOMC will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.

That is precisely why the next move will be a rate cut.

We have reckoned lots lately about the inverted yield curve… and the recessionary menace it represents.

The 10-year versus 3-month yield curve recently inverted to its lowest level since April 2007.

Meantime, 10-year Treasury yields hover at two-year lows — 2.04%. One Bloomberg opinion piece instructs us to prepare for 1% yields.

As the old-timers know… the bond market gives a truer economic forecast than the chronically dizzied stock market.

Meantime, the New York Fed’s recession model reveals a 30% probability of recession within the next year.

It last gave those same odds in July 2007 — merely five months before the Great Recession was underway.

JP Morgan places the odds of recession in the second half of this year at 40%.

And Morgan Stanley gives a 60% likelihood of recession within the next year — the highest since the financial crisis.

Yes, the Federal Reserve will soon be cutting rates.

One clue?

Conspicuously absent from today’s statement was the word “patient.” Thus Mr. Powell telegraphs that he is ready to move.

Federal funds futures presently give nearly 90% odds of a July rate cut.

The market further expects as many as three rate cuts by this time next year — perhaps four.

We are compelled to restate the blindingly obvious:

The Federal Reserve has lost its race with Old Man Time.

The opening whistle blew in December 2015… when Janet Yellen came off the blocks with a 0.25% rate hike.

If the Federal Reserve could cross the 4% finishing line in time, it could tackle the next recession with a full barrel of steam.

Alas… it never made it past 2.50%.

The Federal Reserve cannot return to “normal.”

The stock market will yell blue murder and take to violent rebellion if it tried — as happened last December.

No, Wall Street has Mr. Powell in its hip pocket — as it had Janet Yellen, as it had Ben Bernanke, as it had Alan Greenspan before him.

But it is not only the Federal Reserve…

Last year the world’s major central banks were pledging to “normalize.”

But now they are in panicked retreat…

All have taken to their heels, hoofing 180 degrees the other way.

For example:

Both the Bank of Japan and European Central Bank are now gabbling openly about rate cuts and/or additional quantitative easing.

“It’s all in the open now. Front and center. The new global easing cycle has begun before the last one ended.”

This is the considered judgment of Sven Henrich, he of NorthmanTrader.

We must agree.

Yet the central banks have only themselves to blame…

They grabbed hold of the poisoned apple during the financial crisis.

They gulped… and took the first fateful nibble. It proved nectar to the stock market.

Encouraged by the results, they soon munched the full dose… and later went plowing through the entire tainted orchard:

Zero interest rates, QE 1, 2 and 3 — Operation Twist — the lot of it.

Even with trade war raging and recession hovering, stocks are within 1% of record heights.

And so the banks are too far gone in sin to turn back now.

Their greatest casualty?

Capitalism itself.

Henrich on the wages of central bank sin:

Let’s call a spade a spade: Equity markets and capitalism are broken. Neither can function on any sort of growth trajectory without the helping hand of monetary stimulus. Global growth figures, expectations and projections are collapsing all around us and markets are held up with promises of more easy money, in fact are jumping from central bank speech to central bank speech while bond markets scream slowdown.

We fear Mr. Henrich is correct.

We further fear capitalism will get another good round pummeling in the years to come…

The Federal Reserve’s false fireworks will land as duds against the next recession.

Cries will then go out for the artificial savior of government spending — Modern Monetary Theory (MMT).

Free college tuition… universal Medicare… jobs for all… a $15 minimum wage…a possible Green New Deal…

These and more will be in prospect.

Politicians will go running through the Treasury as a bull runs through a china shop… and leave the nation’s finances a shambles.

Only then — too late — will they discover that debt and deficits matter after all…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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REVEALED: How Far Stocks Will Fall

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How far might markets plunge next time around?

And will you be able to recover your losses rapidly?

Answers — possibilities, rather — shortly.

And is one of Wall Street’s oldest chestnuts of investment wisdom tragically wrong?

This question too we will tackle.

But first to that vicious den of sin and iniquity — the stock market.

The Dow Jones roared 353 points today. The S&P rallied 28 points and the Nasdaq… 109.

For reasons we turn to the president’s comments this morning:

Had a very good telephone conversation with President Xi of China. We will be having an extended meeting next week at the G-20 in Japan. Our respective teams will begin talks prior to our meeting.

That G-20 meeting transpires June 28-29.

We shall see.

But how much value can you expect the stock market to shed in the next bear market?

The United States economy has endured recession every five years since World War II — on average.

Yet the present economic expansion runs to 10 years. It will be crowned history’s longest next month.

How much longer will the gods of chance be put off, cried down, ridiculed and shooed away?

10-year Treasury yields have slipped beneath 3-month Treasury yields.

This yield curve inversion has preceded each and every recession 50 years running.

And last week the yield curve inverted to its steepest degree since April 2007.

Meantime, Morgan Stanley’s Business Conditions Index just endured its largest-ever monthly plummet.

It presently languishes at its lowest level since December 2008 — the teeth of the financial crisis.

In Morgan Stanley’s telling, the American economy may already be sunk in recession.

But today or 18 months from today… a bear market will likely come dragging in on recession’s coattails.

Thus we arrive at the inevitable question:

How much value might the stock market lose in the next bear market?

Financial journalist Mark Hulbert interrogated the history since 1900 (based on data from research firm Ned Davis).

Investors have withstood 36 bear markets in these 119 years.

Hulbert then zeroed in on stock market valuations.

In particular, to the cyclically adjusted P/E ratio (CAPE) hatched by Yale man (and Nobel winner) Robert Shiller.

At 30.2, CAPE is mountain-high — that is, stocks are vastly expensive by history’s standards.

Today’s valuations rise even above 1929’s — and put 2008’s in the shade.

Only during the dot-com delirium were stocks dearer than today.

Chart

Hulbert’s research reveals bear markets tend to greater severity when stock valuations are elevated.

And so given today’s wild valuations, how far might the Dow Jones drop next time?

The answer, says Hulbert… is 35.3%:

A simple econometric model whose inputs are past bear markets and CAPE values predicts that, if a bear market were to begin from current levels, the Dow would tumble 35.3%. Though that’s less severe than the 2007–09 bear market, it still would sink the Dow below 17,000. 

In fairness…

Hulbert concedes his findings do not rise to the 95% confidence level he seeks. But can you safely throw them aside?

Assume the Dow Jones does go tumbling 35.3% — beneath 17,000.

Worry not, says Wall Street.

Hold on for the long pull. Buy and hold is the way.

The stock market always comes back, the learned gentlemen assure us.

The magic of annually compounding returns will ultimately leave you in easy waters.

But have another guess, says analyst Lance Roberts of Real Investment Advice…

Perhaps you seek 10% compounding annual returns for five years.

Ten percent is handsome — but not extravagant.

Assume 10% is precisely what you receive the first three years. But you lose 10% the fourth.

What then happens to your gorgeous five-year 10% compounding?

You would need to haul in a ludicrous 30% return the fifth year… to catch up.

Chart

Roberts:

The “power of compounding” ONLY WORKS when you do not lose money. As shown, after three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required.

If you are approaching retirement — or already in retirement — can you afford to stagger 10%?

Or 20%?

You must further consider today’s extreme valuations.

The higher the valuation… the lower returns you can expect over the next several years.

At today’s valuation extremes…

Would you be better off placing $3,000 into the stock market each year — or wedging it under your mattress?

Roberts has given the numbers a good, hard soaking. At 20x valuations, he finds…

Your stock market money would finally exceed your snoozing cash… in twenty-two years.

22 years!

“Historically, it has taken roughly 22 years to resolve a period of overvaluation,” affirms Roberts, adding:

Given the last major overvaluation period started in 1999, history suggests another major market downturn will mean revert valuations by 2021.

And recall — today’s CAPE is 30.2%. Perhaps stocks must wait even longer to break ahead.

But can you afford to wait?

Regards,

Brian Maher
for The Daily Reckoning

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The Perfect Storm

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What are the three elements of the perfect political and market storm I see coming together this fall?

The first is an effort by the Democratic House of Representatives to impeach President Trump. The second is the socialist-progressive tilt in the 2020 presidential election field. The third is the fallout from the Mueller report and the Russia collusion hoax — what I and others called “Spygate.”

These components are independent of each other but are at high risk of convergence in the coming months.  Let’s look more closely at the individual elements of impeachment, electoral chaos and Spygate that comprise this new storm with no name.

The first storm is impeachment. Impeachment of a president by the House of Representatives is just the first step in removing a president from office. The second step is a trial in the Senate requiring a two-thirds majority (67 votes) to remove the president. Two presidents have been impeached, but neither was removed. Nixon resigned before he could be impeached.

If the House impeaches Trump, the outcome will be the same. The Senate is firmly under Republican control (53 votes) and there’s no way Democrats can get 20 Republicans to defect to get the needed 67 votes needed. So House impeachment proceedings are just for show.

But it can be a very damaging show and create huge uncertainty for markets. There are powerful progressive forces in Congress and among top Democratic donors who are fanatical about impeaching Trump and will not be satisfied with anything less. One poll shows that 75% of Democratic voters favor impeachment (including almost 100% of the activist progressive base).

Speaker of the House Nancy Pelosi and House Majority Leader Steny Hoyer have both poured cold water on impeachment talk. They feel it’s a distraction from Democratic efforts to enact their legislative agenda. But some of the party’s biggest private money donors, including Tom Steyer, are also demanding impeachment.

If Steyer does not get an impeachment process, he looks to support primary challenges to sitting Democrats who don’t join the impeachment effort. This could jeopardize Pelosi’s speakership in a new Congress. So Pelosi could come under heavy pressure to go along with impeachment.

The final outcome is irrelevant; what matters is the process itself. Impeachment fever is not likely to last long into 2020, because at that point the election will not be far away. Voters will turn their backs on impeachment and insist that disputes about Donald Trump be settled at the ballot box. That’s why you can expect impeachment fever to come to a head by the fall of 2019. And that will create a lot of uncertainty for markets.

The second storm is the 2020 election.

Trump is on track to win reelection in 2020. My models estimate his chance of victory is 63% today and it will get higher as Election Day approaches. The only occurrence that will derail Trump is a recession.

The odds of a recession before the 2020 election are below 40% in my view and will get smaller with time. Meanwhile, Trump will keep up the pressure on the Fed not to raise interest rates and will ensure that the U.S.-China trade war comes in for a soft landing.

This may sound like a rosy scenario for the economy. But it’s not so rosy for the Democrats. Every piece of good economic news will cause Democrats to dial up their political hit jobs on Trump. Each one will try to outdo the next.

There are now 24 declared candidates for the 2020 Democratic presidential nomination. That’s more than the Democrats have ever had before. Currently Joe Biden and Bernie Sanders are out in front. Biden is considered the most moderate of the candidates.

But I don’t expect Joe Biden to stay in front for long, and I don’t believe he’ll win the nomination. But the only way for a Democrat to stay in the race is to stake out the most extreme progressive positions. This applies to reparations for slavery, free health care, free child care, free tuition, higher taxes, more regulation and the Green New Deal.

If Biden does fall away, then the choices are back to Sanders, Elizabeth Warren or maybe Kamala Harris. But one is more radical than the next. So, you could have a shock effect where all of a sudden it looks like the Democratic nominee is going to be a real socialist. And that would rattle markets.

This toxic combination of infighting among candidates and bitter partisanship aimed at Trump will be another source of market uncertainty and volatility until Election Day in 2020 and perhaps beyond.

But the third storm is the most dangerous and unpredictable storm of all: Spygate. It involves accountability for those involved in an attempted coup d’état aimed at President Trump.

The Mueller report lays to rest any allegations of collusion, conspiracy or obstruction of justice involving Trump and the Russians. There is simply no evidence to support the collusion and conspiracy theories and insufficient evidence to support an obstruction theory. The case against Trump is closed.

Now Trump moves from defense to offense, and the real investigation begins.

Who authorized a counterintelligence investigation of the Trump campaign to begin with? Did surveillance of the Trump campaign by the U.S. intelligence community (CIA, NSA and FBI) begin before search warrants were obtained? On what basis? Was this surveillance legal or illegal?

These are just a few of the many questions that will be investigated and answered in the coming months.

These criminal referrals will be taken seriously by Attorney General William Barr along with other criminal referrals coming from Congress. Barr will take a hard look at possible criminal acts by John Brennan (CIA director), James Comey (FBI director) and James Clapper (director of national intelligence) among many others.

At the same time Lindsey Graham, Republican senator from South Carolina, will hold hearings in the Senate Judiciary Committee about the origins of spying on the Trump campaign and lies to the FISA court. These may be the most important hearings of their kind since Watergate.

Trump will be running for reelection against this backdrop of revelations of wrongdoing by his political opponents in the last election. Actual indictments and arrests of former FBI or CIA officials will cause immense political turmoil. Such charges may be fully justified (and needed to restore credibility). They will certainly energize the Trump base.

But they are just as likely to infuriate the Democratic base. Cries of “revenge” and “witch hunt” will be coming from the Democrats this time instead of Republicans. Markets will be caught in the crossfire.

How do these three storms — impeachment, the 2020 election and Spygate — converge to create the perfect storm?

By November 2019, the impeachment process should be well underway in the form of targeted House hearings. The 2020 Democratic debates (starting in June 2019) will be red-hot. Trump’s counterattacks on the FBI and CIA should be reaching a fever pitch based on real revelations and actual indictments.

The impeachment process and Trump’s revenge represent diametrically opposing views of what happened in 2016. The Democrats will continue to call Trump “unfit for office.” Trump will continue to complain that the Obama administration and the deep state conspired to derail and delegitimize him.

The 2020 candidates will have to take a stand (even though they may prefer to discuss policy issues). There will be nowhere to hide. The bitterness, rancor and leaking will be out of control.

Any one of these storms would create enough uncertainty for investors to sell stocks, raise cash and move to the sidelines. The combination of all three will make them run for the hills. That’s my warning to investors.

The next six months will present unprecedented challenges for investors. Markets will have to wrestle with fights over impeachment, election attacks and Spygate. Trump will be trying to improve his odds with Fed appointments and an end to the trade wars. Democrats will be trying to derail Trump with investigations, accusations and leaks.

Some of this will be normal political crossfire, but some of it will be deadly serious, including arrests of former senior government officials and revelations of an attempted coup aimed at the president.

A perfect storm with no name is coming. The only safe harbors will be gold, cash and Treasury notes. And make sure you have a life preserver handy.

Regards,

Jim Rickards
for The Daily Reckoning

The post The Perfect Storm appeared first on Daily Reckoning.

Rickards: “Perfect Storm” Is Coming

This post Rickards: “Perfect Storm” Is Coming appeared first on Daily Reckoning.

People often refer to the “perfect storm.” A perfect storm is generally understood as two or more events that are independent but converge to produce an outcome much worse than either event alone.

The term is an overused cliché, and as a writer I avoid clichés whenever possible. But though rare, perfect storms do exist. The most common example is the devastating 1991 storm popularized by the book and movie of the same name, although it was initially known as the “Halloween storm.”

In that case, three separate weather dynamics all converged in one place on one day to produce a perfect storm. The odds of all three coming together at once were less than one in 100,000. That’s less than once in 270 years. That’s a perfect storm.

Do metaphorical perfect storms happen in politics and capital markets?

The answer is yes, provided the conditions of the perfect storm definition are satisfied. The multiple events that make up the true perfect storm must be independent and rare and come to converge in an almost impossible way.

Unfortunately, a political and market perfect storm is now on the way and may strike as early as Halloween 2019, marking a new “Halloween storm.” Get ready.

Today I’ll be discussing the components making up this perfect storm, and how I see them all coming together at the same time.

In my 40-plus years in banking and capital markets, I have lived through a number of financial fiascos that arguably qualify as perfect storms. Here’s a partial list:

  • 1970: Penn Central bankruptcy, the largest in history at that time
  • 1973–74: Arab oil embargo
  • 1977–80: U.S. hyperinflation
  • 1982–85: Latin American debt crisis
  • 1987: One-day 22% stock market crash
  • 1988–92: Savings and loan (S&L) crisis
  • 1994: Mexican tequila crisis
  • 1997: Asian financial crisis
  • 1998: Russia/Long Term Capital Management (LTCM) crisis
  • 2000:Dot-com crash
  • 2007: Mortgage market collapse
  • 2008: Lehman Bros./AIG financial panic.

I was not just a bystander at these events. From 1977–85, I worked at Citibank and dealt with inflation, currencies and Latin America from a front-row seat.

From 1985–93 I worked for a major government bond dealer that financed S&Ls and traded their mortgages.

From 1994–99, I was at LTCM and dealt in all the major international markets. I negotiated the LTCM rescue by Wall Street in September 1998.

In 1999–2000 I ran a tech startup, and in 2007–08 I was an investment banker and financial threat adviser to the CIA.

That’s a lot of action for one career, but it also makes the point that financial perfect storms happen more frequently than standard models expect.

Here’s what I learned: Every one of these episodes was preceded by mass complacency or euphoria.

Before the Arab oil embargo, we expected cheap oil forever. Before the Latin American debt crisis, countries like Brazil and Argentina were “the land of the future.”

No one worried about a stock market crash in 1987 because we had “portfolio insurance.” The S&Ls could not get in trouble because they had FSLIC (Federal Savings and Loan Insurance Corp.) insurance.

Mexico could not get in trouble because it had oil. Asia could not get in trouble because it had cheap labor, high growth and “fixed” exchange rates.

Russia would not go broke because it was a “nuclear power.” LTCM would not go broke because it had two Nobel Prize winners. Dot-coms would not go broke because they attracted “eyeballs.”

Mortgages were solid because we had never seen a simultaneous nationwide decline in home values. Lehman Bros. was “too big to fail.” AIG was the Rock of Gibraltar.

In short, the fiascoes I witnessed were “not supposed to happen.” They all did. The worst panics are always preceded by a sense that nothing can go wrong.

We are there again. Stocks are approaching all-time highs again. The bond bust hasn’t happened. Mortgage interest rates are near the lows of the early 1960s. Exchange rate volatility is low.

Unemployment is at 50-year lows. Real wages are rising (at least a little). There are more job openings than job seekers. ISIS is defeated. Brexit is on indefinite hold.

It’s all good. What, me worry?

I saw a recent poll asking investors when they thought a market crash might happen. Something like 80% of the respondents answered not anytime soon.

I cannot imagine a better setup for catastrophe. No one ever sees disaster coming. That’s the point.

I believe a perfect storm is coming. It’s hard to foresee the full magnitude of it, but it will likely be dramatic. It will have a major impact on markets. How it impacts you depends on how far in advance you see it coming.

What are the three specific elements of the new perfect storm I see coming for markets? Read on.

Regards,

Jim Rickards
for The Daily Reckoning

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The Coming Gold Breakout

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I read headlines all day and focus extensively, if not exclusively, on gold. If gold is the best form of money (it is), and if gold had unique properties as money (it does; it’s the only form of money that is not also debt), then gold is well worth the focus.

With that said, it’s hard to surprise me on the subject. After a while, you think you’ve seen it all. Yet, there are exceptions. This headline stopped me in my tracks: “Bank of Russia may consider gold-backed cryptocurrency.”

The idea itself is not exactly new. I first suggested that Russia might be acquiring gold with a view to a new gold-backed currency at a financial war game hosted by the Pentagon at a top-secret laboratory in 2009.

Jim Rickards

Your correspondent at the Homestake Mine in Lead, South Dakota. Homestake was one of the largest and most productive gold mines in U.S. history, and was the foundation of the Hearst family fortune. Global gold output has flatlined in recent years while demand for gold remains strong.

In my upcoming book, Aftermath, I describe a more sophisticated monetary arrangement among Russia, China, Iran and other nations to use a gold-backed cryptocurrency for international settlements.

Still, theory is one thing, reality is another. Here was a real central bank taking real steps toward a gold-backed cryptocurrency. Of course, the announcement came with lots of caveats about the need to stick to hard currencies. This gold initiative involves review of a report, not a live plan at this stage.

Still, it was a significant moment in the move away from the hegemony of the U.S. dollar as the dominant global reserve currency toward another system that included gold.

By itself, this announcement is not a reason to load up on gold. In fact, the spot price of gold barely budged on the news. Gold prices are far more likely to be affected by strength or weakness of the U.S. dollar, real interest rates, inflation prospects and geopolitical stress.

But, the announcement is highly significant in another way. It signals that the demand for physical gold by major central banks is here to stay. Whether a new gold-backed cryptocurrency emerges next year or five years from now does not alter the fact that you need gold to have a gold-backed currency.

Neither Russia nor China has all the gold it needs for that purpose yet. Therefore, demand for physical gold will remain strong even as supply has flatlined.

This creates an asymmetric trading pattern where gold has good potential to rise, but only limited prospects of a material fall. Those are the best kinds of markets for trading and investment. Taking into account both these fundamental and technical factors, what is the outlook for the dollar price of gold and gold mining stocks in the near term?

Right now, the evidence is telling us that the dollar price of gold is poised to breakout to the upside after a prolonged period of range-bound trading.

Chart 1 below illustrates recent price action in gold and shows why the prospects are good for near-term price appreciation.

After a rally from $1,215 per ounce in late November 2018 to $1,293 per ounce in early January 2019, gold remained in a tight trading range.

Over the past five months, gold has traded between about $1,270 and $1,345 per ounce (as of yesterday after gold’s big run over the past week).

That’s a range of about 2.8% above and below a mid-point of $1,305 per ounce. A 2.8% range is not unusual when governments try to peg two currencies to each other. In effect, gold has been pegged to the dollar at $1,305 per ounce.

Chart 1

Chart 1

However, this trading range exhibits another pattern called “lower highs.” Each spike at the high end of the range is slightly lower than the one before. Conversely, the bottom in each gyration has been more tightly bunched forming a kind of floor under gold prices.

The combination of a strong floor and declining highs results in a compression of the trading range. What this pattern presages is a breakout. Of course, the question is whether gold will breakout to the downside or the upside. This week we saw gold break higher, to $1,345.

The evidence is strong that gold is poised for a sustained upside breakout. The reason for the floor around $1,270 per ounce has to do with fundamental supply and demand. Russia and China continue to buy gold at a prodigious rate.

Russia has been buying between 15 and 25 metric tonnes per month, sometimes more, for over ten years. Russia’s gold reserves now stand at 2,183 metric tonnes, over 25% of the U.S. total with a far smaller economy. China is less transparent in its gold buying but also has over 2,000 metric tonnes, perhaps much more.

Neither Russia nor China have their targeted amount of gold yet, which would be 4,000 metric tonnes for Russia and 8,000 metric tonnes for China to achieve strategic gold parity with the U.S.

Iran and Turkey have also embarked on major gold accumulation efforts.

What all of these gold buying strategies have in common is a desire to escape from dollar hegemony and the imposition of dollar-based sanctions by the U.S. The practical implication for gold investors is a firm floor under gold prices since Russia and China can be relied upon to buy any dips.

The primary factor that has been keeping a lid on gold prices is the strong dollar. The dollar itself has been propped up by the Fed’s policy of raising interest rates and reducing money supply, so-called “quantitative tightening” or QT. These tight money policies have amplified disinflationary trends and pushed the Fed further away from its 2% inflation goal.

However, the Fed reversed course on rate hikes last December and has announced it will end QT next September. These actions will make gold more attractive to dollar investors and lead to a dollar devaluation when measured in gold.

The price of gold in euros, yen and yuan could go even higher since the ECB, Bank of Japan and People’s Bank of China will still be trying to devalue against the dollar as part of the ongoing currency wars. The only way all major currencies can devalue at the same time is against gold, since they cannot simultaneously devalue against each other.

A situation in which there is a solid floor on the dollar price of gold and a need to devalue the dollar means only one thing – higher dollar prices for gold. A breakout to the upside is the next move for gold.

Regards,

Jim Rickards
for The Daily Reckoning

The post The Coming Gold Breakout appeared first on Daily Reckoning.