GDP: Fake News

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The first-quarter GDP number was released this morning. And at 3.2%, it came in far above estimates. Consensus was about 2.3%. It was also the highest Q1 GDP print since 2015.

But there’s probably less here than meets the eye.

About half the GDP gain came from a surge in inventories and a sharp reduction in the trade deficit, neither of which is sustainable. They are likely one-time boosts.

The economy has been growing since June 2009, making this the second-longest economic expansion on record. However, it has also been the weakest economic expansion on record. That has not changed under President Trump.

Even during Obama’s weak expansion we saw strong quarters including the first quarter of 2015, which was 3.2%, and the second quarter of 2015, which was almost 3%. The problem is that these strong quarters soon faded; growth in the fourth quarter of 2015 was only 0.5%, almost recession level.

Under Trump, second-quarter 2018 growth was a very impressive 4.2% annualized. Third-quarter 2018 growth was 3.4%. Trump’s tax cuts seemed to be producing exactly the kind of 3–4% sustained trend growth Trump had promised.

But then the economy put on the brakes and growth slowed to only 2.2% in the fourth quarter. It looked like the 2018 “Trump bump” in growth was over and growth was returning to the 2.2% trend that had prevailed during the Obama administration.

And despite the first quarter’s 3.2% outlier, I expect lower GDP in the quarters ahead, returning to the same punk levels we’ve seen for nine years.

For the year, economists believe GDP will expand 2.4%, down from last year’s 2.9% gain, as the boost from the 2017 tax cuts and increased government spending over the past two years start to fade.

What about the possibility of recession?

Most investors are familiar with the conventional definition of an economic recession. It’s defined as two consecutive quarters of declining GDP combined with rising unemployment and a few other technical factors.

But investors may not be as familiar with two other aspects of recession timing. The first is the exact body that makes the determination, and the second has to do with the timing of that body’s announcements.

The group that “officially” decides when the U.S. economy is in a recession is called the National Bureau of Economic Research (NBER) based in Cambridge, Massachusetts, although there’s nothing official about what they do.

NBER is a private nonprofit think tank that receives substantial input from scholars at Harvard and MIT, but it is not a government agency. Their decisions on the start and finish of recessions are not technically “official,” but they are widely accepted by Washington, the Fed and Wall Street.

Less well known is the fact that recessions are not called by NBER until well after they have begun. In this respect, NBER looks backward at the data rather than forward like a forecasting firm.

On occasion, the NBER might not identify the start date of a recession until nine months or a year after the recession began. By that method, the U.S. could be in a recession next month and we would not know about it until a year from now when the data were all in.

The Fed may be on pause, but previous Fed action has been catching up with the economy. Monetary policy operates with a lag of six–18 months, so the slowing of the economy we saw in the fourth quarter of 2018 was the result of Fed tightening in late 2017 and early 2018.

Don’t be surprised if we wake up a year from now only to find the NBER says the recession began in April or May of 2019.

The Fed move to a rate pause in January 2019 and the end of QT in September 2019 will not be felt in the real economy until late 2019 and early 2020.

The timing has serious implications for next November’s presidential election. If the economy improves ahead of the election, Trump has an excellent chance. If it falls into recession, the Democratic candidate will probably win, whoever it is.

In that case, get ready for class warfare, much higher taxes and even more government spending than today.

Got gold?

Regards,

Jim Rickards
for The Daily Reckoning

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The Fight For 2020 Has Begun

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The focus of the anti-Trump forces has shifted. Trump was not removed from office as his opponents had hoped. And the long-awaited Mueller report on “collusion” by Trump with Russia has turned out to be an anticlimax showing no collusion. In fact, Trump is on track to complete a mainly successful first term.

Instead, the “resistance,” aided by the deep state and the media, have turned their attention to the 2020 election. Efforts to harass and distract Trump are now mainly for the purpose of weakening Trump’s reelection prospects and promoting the election of an opponent from among a field of Democratic candidates.

The greatest question facing President Trump over the next 18 months is whether or not he can avoid a recession. If he can, he stands an excellent chance of reelection. If he doesn’t, then a Democrat will likely win.

Trump supporters will be the first to tell you that the stock market has rallied from 18,529 on the Dow Jones industrial average index the day before Trump was elected to about 26,680 as of today. That’s nearly a 45% gain in 29 months.

Unemployment is near 50-year lows. African-American and Hispanic unemployment is at an all-time low. Labor force participation is steady after falling during the Obama years. Food stamp usage is down. Housing prices are up. Inflation is under control.

Growth in 2018 was above the 10-year trend since the end of the last recession and 2018 was the best full-year growth of that entire period. Real wages have shown their best gains in over 10 years.

While the economy is not booming by historical standards, it is producing its best performance since the global financial crisis. The U.S. economy looks particularly strong when compared with major trading partners such as the U.K., France, Italy, Japan and Germany. Even China is slowing dramatically as the U.S. continues to perform as a reliable engine of world growth.

The foregoing economic track record is repeated by Trump supporters and their (few) media allies on a daily basis. Most of the media simply ignore these data and continue the Trump bashing about the Mueller report and Trump’s business practices. These dueling narratives are by now business as usual when it comes to Trump.

But behind the media spin curtain, there is some reason to be concerned about the economy.

Manufacturing output is declining, both on a month-over-month and year-over-year basis. U.S. capacity utilization is showing a recent slight decline. Certain indexes of new orders and shipments are also showing declines. Imports and trade deficits have both increased sharply. The yield curve is slightly inverted in the 2–5-year sector.

None of these indicators is declining to extreme levels and there are other indicators showing positive results. None is pointing to a recession in the short run, but all should be worrisome to Trump.

His supporters continually recite the claim that this is “the best economy ever.” It’s not.

The Fed continues to tighten (through balance sheet normalization if not rate hikes) despite signs of a slowing economy. The problem is that monetary policy acts with a lag of 12–18 months. The economy is slowing now, not because of the December 2018 rate hike, but because of rate hikes in December 2017 and March 2018. The Fed’s later rate hikes in 2018 have yet to take hold.

They will soon and the economy will slow further. This dynamic can be seen clearly in Chart 1 below:

Chart 1

When the trend is not your friend. While GDP got a bump in the second quarter of 2018 as a result of the Trump tax cuts (4.2% annual growth), it appears that growth is declining rapidly toward the 2.24% average annual growth since the end of the last recession in June 2009. Obama also achieved several quarters of over 4% growth, but those strong quarters quickly reverted to the 2% level or lower. 

Trump boosters pointed to the 4.2% annual growth in the second quarter of 2018 as “proof” that the president’s economic policies were returning the U.S. to sustainable above-trend growth. My view at the time was that Q2 growth was a temporary pop from the late–2017 tax cuts (effective Jan. 1, 2018), but we needed more data before drawing conclusions.

Now the data are in. Growth dropped from 4.2% to 3.4% in the third quarter and dropped again to 2.6% in the fourth quarter. Estimates for the first quarter of 2019 by the Atlanta Fed call for annual growth of only 2.8%. In short, the “Trump bump” is over and U.S. growth is trending towards the post-2009 trend of 2.24% (well below the post-1980 long-term trend of 3.23%).

None of these trends (tight money, inverted yield curve, slower growth, etc.) is a sure predictor of recession, but all give some cause for concern. The current expansion (118 months long) is just a few months short of being the longest expansion in U.S. history. However, it is also the weakest expansion in U.S. history. The current expansion shows none of the inflation, labor shortages or capacity shortages that historically cause the Fed to raise rates and trigger a recession.

The Fed is conducting a balancing act between higher rates (to get ready for the next recession) and rate hike “pauses” (to avoid causing a recession now). So far, this finesse has worked, but it’s a delicate balance that could easily tip into recession. In addition, there are other factors (trade wars, global slowdown, financial panic) that are beyond the Fed’s control and could also lead to a recession.

Essentially, the difference between no recession and a recession over the next 18 months is also the difference between Trump’s re-election and the election of a Democrat in 2020.

But recession is the hardest to forecast with great accuracy and is therefore the biggest wild card. Trump was elected in large part, despite his off-putting demeanor, because he promised a better economy. He has delivered in part, but has to keep delivering.

In effect, Trump’s probability of victory is simply the inverse of the probability of a recession in the next 18 months. If recession odds are 40%, then Trump’s chance of losing is also 40%. The inverse is a 60% chance of winning. As goes the economy, so goes Trump.

If the economy goes into a recession, that could translate into a voter search for a new economic solution and that could lead straight to the Democratic promise of “free everything.”

Will the present odds change? You bet. As investors, the key is to stay nimble and stay alert to updates. As a Daily Reckoning  reader, you’ll be the first to know.

The impact of this election cycle on markets will be profound and the stakes for investors have never been higher. The time for investors to prepare is today.

That means you’ll want to be ready with a portfolio of gold, silver, fine art, land, cash, intermediate-term Treasury notes, and private equity.

And buckle in. It could be a very bumpy ride ahead.

Regards,

Jim Rickards
for The Daily Reckoning

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Will Trump Nominate Gold Standard Advocate to Fed?

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Trump has already exerted more influence over one institution than any other president in over 100 years — the Federal Reserve.

That’s because Trump has had more control over Fed personnel than any president since the Fed was founded in 1913. As I’ve written before, Trump now “owns” the Fed.

When Trump was sworn in, he inherited two vacant seats on the seven-person board of governors of the Federal Reserve System. Holders of those two seats are also members of the Federal Open Market Committee (FOMC), the group that sets U.S. interest rates and monetary policies.

President Obama also had the same vacancies, but he did not nominate anyone to fill the seats because he doubted his chances of getting the nominees past the Republican-controlled Senate and he was sure “President Hillary” would do the right thing and appoint pro-Democratic nominees.

In the end, Trump beat Clinton and the vacancies fell to Trump. Then Trump got another windfall. Within 14 months of becoming president, three additional Fed governors resigned (Dan Tarullo, Stan Fischer and Janet Yellen), and Trump suddenly had five vacancies to fill, or 70% of the entire Fed board.

Trump promoted Jay Powell to chair and appointed Richard Clarida as vice chair, Randy Quarles as vice chair for regulation and Michelle Bowman to fill a seat reserved for community bankers.

All of those appointments were well regarded by Wall Street and the media. But that still left Trump with the two original vacancies.

Trump indicated he wanted to appoint Herman Cain and Steve Moore to fill those seats. Cain is a former presidential candidate, chair of the board of the Federal Reserve Bank of Kansas City and CEO of the Godfather’s Pizza chain. Moore is a think tank analyst, founder of the Club for Growth and a former member of the editorial board of The Wall Street Journal.

Cain has now withdrawn his nomination after running into opposition from Senate Republicans based in part on old allegations of sexual misconduct. Moore is also being opposed by those who fault him for not having a Ph.D. in economics.

Whatever the merits, the real reason they have been opposed by monetary elites is that they are “friends of Trump” and will hold Jay Powell’s feet to the fire to cut interest rates and keep the economic expansion going ahead of the 2020 election.

But if Moore withdraws next or if his nomination is defeated, no worries. There’s some indication that Trump’s next nominee will be Judy Shelton.

She does have a Ph.D. and is a well-known advocate of a new gold standard. Just this Sunday she wrote an article in The Wall Street Journal, “The Case for Monetary Regime Change,” that challenged the current system and defended the classical gold standard.

She has also defended Trump’s trade policies, arguing that those who embrace unfettered free trade dogma “disregard the fact that the ‘rules’ are not working for many American workers and companies.”

For those who want Moore to step aside next, the best advice may be “Be careful what you wish for.”

Regardless, the 2020 presidential election is already beginning to take shape.

A few weeks ago, I unveiled my first forecast on the outcome of the 2020 presidential race. My estimate was that Trump had a 60% chance of winning.

I was also careful to explain that my forecasting model includes constant updating and would no doubt change between now and Election Day on Nov. 3, 2020.

That’s normal. Politics is a highly volatile process and it’s foolish to put a stake in the ground this early. My model has quite a few factors, but the leading factor right now is that Trump’s chances are the inverse of the probability of a recession before the third quarter of 2020.

If recession odds by 2020 are 40%, then Trump’s chances are the inverse of that, or 60%. With the passage of time, Trump’s odds go up because the odds of a recession go down.

If a recession does hit, then Trump’s odds go way down. This dynamic can be used to explain and forecast Trump’s economic policies, including calls for interest rate cuts and efforts to place close friends on the Fed Board of Governors.

It’s all connected.

As usual, I found myself out on a limb with my forecast; the mainstream media are sure Trump will lose in 2020, if he’s not impeached sooner. So it was nice to get some company who sees things my way…

A new Goldman Sachs research report also projects that Trump will win in 2020. Goldman shows a narrower margin of victory than my model, but a win is a win.

Of course, their forecast will be updated (like mine) but we’re starting to see more signs from other professional analysts that Trump is a likely winner after all.

Regards,

Jim Rickards
for The Daily Reckoning

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Dollar Dominance Under Multiple, Converging Threats

This post Dollar Dominance Under Multiple, Converging Threats appeared first on Daily Reckoning.

For years, currency analysts have looked for signs of an international monetary “reset” that would diminish the dollar’s role as the leading reserve currency and replace it with a substitute agreed upon at some Bretton Woods-style monetary conference.

That push has been accelerated by Washington’s use of the dollar as a weapon of financial warfare, including the application of sanctions. The U.S. uses the dollar strategically to reward friends and punish enemies.

The use of the dollar as a weapon is not limited to trade wars and currency wars, although the dollar is used tactically in those disputes. The dollar is much more powerful than that.

The dollar can be used for regime change by creating hyperinflation, bank runs and domestic dissent in countries targeted by the U.S. The U.S. can depose the governments of its adversaries, or at least blunt their policies without firing a shot.

But for every action, there is an equal and opposite reaction.

As the U.S. wields the dollar weapon more frequently, the rest of the world works harder to shun the dollar completely.

I’ve been warning for years about efforts of nations like Russia and China to escape what they call “dollar hegemony” and create a new financial system that does not depend on the dollar and helps them get out from under dollar-based economic sanctions.

These efforts are only increasing.

Russia has sold off almost all of its dollar-denominated U.S. Treasury securities and has reduced its dollar asset position to almost zero. It has been amassing massive quantities of gold, and has increased the gold portion of its official reserves to over 20%. Russia has almost 2,000 tonnes of gold, having more than tripled its gold reserves in the past 10 years. It has actually acquired enough gold to surpass China on the list of major holders of gold as official reserves.

This combination of fewer Treasuries and more gold puts Russia on a path to full insulation from U.S. financial sanctions. Russia can settle its balance of payments obligations with gold shipments or gold sales and avoid U.S. asset freezes by not holding assets the U.S. can reach.

And Russia is providing other nations a model to achieve similar distance from U.S. efforts to use the dollar to enforce its foreign policy priorities.

Certainly any talk of a monetary reset must involve China. Despite its present weakness, China is still the second-largest economy in the world and the fastest-growing major emerging market. Like Russia, China is amassing gold, and likely has far more gold than it officially lists. It has also been helping to suppress gold prices so that it can buy gold cheaply without driving up the price.

Europe has also shown signs that it wants to escape dollar hegemony. For example, German Foreign Minister Heiko Maas has called for a new EU-based payments system independent of the U.S. and SWIFT (Society for Worldwide Interbank Financial Telecommunication) that would not involve dollar payments.

SWIFT in the nerve center of the global financial network. All major banks transfer all major currencies using the SWIFT message system. Cutting a nation off from SWIFT is like taking away its oxygen.

In the longer run, these are just more developments pushing the world at large away from dollars and toward alternatives of all kinds, including new payment systems and cryptocurrencies. The signs of a reset are everywhere, but at least for now the dollar is still king of the hill.

The dollar represents about 60% of global reserve assets, 80% of global payments and almost 100% of global oil sales. With such a dominant position, the dollar will not be easy to replace. Still, the trends are not good for the dollar. The international reserve position may be 60%, but as recently as 2000 it was over 70% and just a few years ago it was still at 63%. That trend is not your friend.

Another challenger to the dollar is the IMF’s special drawing rights or SDRs. The SDR is a form of world money printed by the IMF. It was created in 1969 as the realization of an earlier idea for world money called the “bancor,” proposed by John Maynard Keynes at the Bretton Woods conference in 1944.

The bancor was never adopted, but the SDR has been going strong for 50 years. This article describes how the IMF could function more like a central bank through more frequent issuance of SDRs and by encouraging the use of “private SDRs” by banks and borrowers.

At the current rate of progress, it may take decades for the SDR to pose a serious challenge to the dollar. But that process could be rapidly accelerated in a financial crisis where the world needed liquidity and the central banks were unable to provide it because they still have not normalized their balance sheets from the last crisis.

In that case, the replacement of the dollar could happen almost overnight. Individuals will not be allowed to own SDRs, but you can still protect you wealth by buying gold. That’s what Russia and China are doing. Both countries have more than tripled their gold reserves since 2009.

But attacks on the dollar are not limited to gold or SDRs themselves. The most imminent threat to the dollar actually comes from a combination of gold and digital currency.

The fact that Russia and China have been acquiring gold is old news. Still, there are practical problems with using gold as a form of currency, including storage and transportation costs. But Russia is solving these transactional hurdles by combining its gold position with distributed ledger, or blockchain  technology.

Russia and China could develop a new cryptocurrency that would be transferred on a proprietary encrypted ledger with message traffic moving through an internet-type system not connected to the existing internet. Other countries could be allowed into this new system with permission from Russia or China.

The new cryptocurrency would be a so-called “stable coin,” where the value was fixed with reference either to a weight of gold or another standard unit such as the SDR. Goods and services would be priced in this new unit of account. Periodically, surpluses and deficits would be settled up in physical gold.

Such net settlements would require far less gold than gross settlements (where every transaction had to be paid for in real-time). This type of system (also called a “permissioned blockchain”) is not pie-in-the-sky, but is already under development and will be deployed soon. But you can count on the U.S. government being the last to know.

The development of a gold-backed digital currency is just one more sign that dollar dominance in global finance may end sooner than most expect. And we may be getting dangerously close to that point right now.

Regards,

Jim Rickards
for The Daily Reckoning

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Japan on a Larger Scale

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In my 2014 book, The Death of Money, I wrote, “The United States is Japan on a larger scale.” That was five years ago.

Last week, prominent economist Mohamed A. El-Erian, formerly CEO of PIMCO and now with Allianz, wrote, “With the return of Europe’s economic doldrums and signs of a coming growth slowdown in the United States, advanced economies could be at risk of falling into the same kind of long-term rut that has captured Japan.”

Better late than never! Welcome to the club, Mohamed.

Japan started its “lost decade” in the 1990s. Now their lost decade has dragged into three lost decades. The U.S. began its first lost decade in 2009 and is now entering its second lost decade with no end in sight.

What I referred to in 2014 and what El-Erian refers to today is that central bank policy in both countries has been completely ineffective at restoring long-term trend growth or solving the steady accumulation of unsustainable debt.

In Japan this problem began in the 1990s, and in the U.S. the problem began in 2009, but it’s the same problem with no clear solution.

The irony is that in the early 2000s, former Fed Chair Ben Bernanke routinely criticized the Japanese for their inability to escape from recession, deflation and slow growth.

When the U.S. recession began during the global financial crisis of 2008, Bernanke promised that he would not make the same mistakes the Japanese made in the 1990s. Instead, he made every mistake the Japanese made, and the U.S. is stuck in the same place and will remain there until the Fed wakes up to its problems.

Bernanke thought that low interest rates and massive money printing would lead to lending and spending that would restore trend growth to 3.2% or higher.

But he ignored the role of velocity (speed of money turnover) and the unwillingness of banks to lend or individuals to borrow. When that happens, the Fed is pushing on a string — printing money with no result except asset bubbles.

The bottom line is that this extravaganza of zero rates and money printing worked to ease the panic and prop up the financial system. But it did nothing to restore growth to its long-term trend or to improve personal income at a pace that usually occurs in an economic expansion.

Now, after a 10-year expansion, policymakers are considering the implications of a new recession. There’s only one problem: Central banks have not removed the supports they put in place during the last recession.

Interest rates are up to 2.5%, but that’s far lower than the 5% rates that will be needed so the Fed can cut enough to cure the next recession. The Fed has reduced its balance sheet from $4.5 trillion to $3.8 trillion, but that’s still well above the $800 billion level that existed before QE1.

In short, the Fed (and other central banks) have only partly normalized and are far from being able to cure a new recession or panic if one arises tomorrow. It will takes years for the Fed to get interest rates and its balance sheet back to “normal.”

Until they do, the next recession may be impossible to get out of. The odds of avoiding a recession until the Fed normalizes are low.

In the meantime, get ready for more disinflation (or deflation) and slow growth. The central banks are stuck and there’s no way out.

They cannot escape the corner they have painted themselves into.

Regards,

Jim Rickards
for The Daily Reckoning

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Saudis Threaten to End Petrodollar

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Investors have been speculating for years about the demise of the “petrodollar” deal struck by Henry Kissinger and Treasury Secretary William Simon in 1974.

It was first set up between the U.S. and Saudi princes to prop up the U.S. dollar. At the time, confidence in the dollar was on shaky ground because President Nixon had ended gold convertibility of dollars in 1971.

In 1974, the price of oil was skyrocketing, partly due to inflationary policies pursued by the Federal Reserve, and partly due to an Arab oil embargo in response to U.S. aid to Israel in the Arab-Israeli Yom Kippur War of 1973.

The world economy was under threat unless a way could be found to “recycle” the dollars the Arabs were receiving back into U.S. banks. President Nixon and Henry Kissinger asked Simon to negotiate with Saudi Arabia on this issue.

Kissinger and Simon worked out a plan. If the Saudis would price oil in dollars, U.S. banks would hold the dollar deposits for the Saudis.

The Saudis and other OPEC members agreed that oil would be priced in dollars (the “petrodollar”) and the dollars would be deposited with U.S. banks so they could be loaned to developing economies who could then buy U.S. manufactured goods and agricultural products.

This would help the global economy and help the U.S. maintain price stability. The Saudis would get more customers and a stable dollar, and the U.S. would force the world to accept dollars because everyone would need the dollars to buy oil.

Behind this “deal” was a not so subtle threat to invade Saudi Arabia and take the oil by force. I personally discussed these invasion plans in the White House with Kissinger’s deputy, Helmut Sonnenfeldt, at the time. But the petrodollar plan worked brilliantly and the invasion never happened.

Now, almost 50 years later, the entire arrangement is in jeopardy.

According to a recent Reuters article, the Saudis themselves are confirming that they may be getting ready to push the dollar to one side when it comes to setting the price for oil. Why?

The reason is that the U.S. Congress is considering legislation that would expose OPEC members to U.S. antitrust lawsuits. Saudi Arabia has said that if that pending legislation becomes law, they will end the petrodollar deal.

The result would be that oil could be priced in euros, yen, yuan or even gold. The result for the U.S. dollar and U.S. economy would be catastrophic. It may not happen, but the fact that such threats are being voiced in public should give you pause. The cracks in the dollar are already getting larger.

The best protection for investors is to allocate part of your assets to gold as insurance against a collapse in the dollar.

Regards,

Jim Rickards
for The Daily Reckoning

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Brexit: No Good Options

This post Brexit: No Good Options appeared first on Daily Reckoning.

The Battle of Britain (1940) was one of the most famous and important conflicts in history. The Battle of Brexit is proving no less decisive even if the weapons are financial and political, not kinetic.

The U.K. joined the European Communities in 1973 and that membership was ratified by a U.K. referendum in 1975. Membership divided the right and left in U.K. politics in the late 1970s and 1980s with the left initially opposing membership.

Over time, the left began to favor the concept and it was the right, led by Margaret Thatcher, that voiced opposition. In 1993, the European Communities transformed into the European Union, EU, as a result of the Maastricht Treaty. The U.K. was a full member of the EU and seemed set to remain a member indefinitely.

Jim Rickards in London

Your correspondent on St. James’s Street in London during a recent visit to the U.K. The period 2016–19 has been one of the most politically fraught in U.K. history. A referendum on exiting the EU (“Brexit”) was announced in February 2016 and held in June 2016. Subjects voted to “leave” the EU, but that vote merely started the turmoil and did not resolve anything. Politicians have been arguing over Brexit terms ever since.

While the U.K. joined the EU, it did not join the eurozone of countries that adopted the euro as a common currency. The U.K. rejected the eurozone and maintained its currency as the pound sterling (GBP). Given the size of the U.K. economy (fifth-largest in the world), this made for an awkward relationship with other major EU members including Germany, France and Italy, which all adopted the euro.

Yet the economic benefits of EU membership, including free trade and the “passport” concept (a business licensed in one member country can expand throughout the EU with minimal registration requirements) were undeniable. Both the EU and U.K. prospered as a result.

Still, opposition to EU membership never disappeared in U.K. politics. The right’s concerns were transferred from the Tories to a new U.K. Independence Party (UKIP), which grew in popularity from the 2010s forward. Despite UKIP, Euroskeptics remained a force in Tory politics.

The U.K. held a general election in 2015. Tory leader and Prime Minister David Cameron promised a referendum on leaving the EU as a way to shore up support from the Tories and attract votes from both Euroskeptics and some UKIP members. Cameron’s party won, and in February 2016 he announced the referendum scheduled for June 23, 2016.

Cameron would probably have won the election without the referendum pledge. His decision to hold the referendum was based on his overconfidence that the U.K. as a whole would vote to remain in the EU. This turned out to be one of the greatest miscalculations in the history of U.K. politics.

On June 23, 2016, the U.K. voted to leave the EU by a margin of 52% for leave and 48% to remain. Cameron promptly resigned as prime minister and party leader. He was succeeded by the current prime minister, Theresa May.

Theresa May favored remaining in the EU but promised to fulfill the will of the voters by commencing the negotiations to leave. On March 29, 2017, the U.K. formally notified the EU of its intention to leave under Article 50 of the Treaty on European Union.

May compounded her political difficulties by calling a snap general election scheduled for June 8, 2017. May expected to expand her Tory majority to give her more leverage in the Brexit negotiations. The opposite happened. May lost her majority and had to form a coalition with the Democratic Unionist Party (DUP) of Northern Ireland to remain in power.

However, the DUP favored a “soft Brexit” (leaving the EU relationship mainly intact), which further limited May’s negotiating power. May’s snap election decision was as misguided as Cameron’s referendum decision. Together, the two elections left the U.K. in the worst possible position when it came to Brexit itself and the exit negotiations.

The biggest political problem in the negotiations is that the 2016 referendum offered two choices (“leave” and “remain”), but the political parties have argued over four choices: a “hard Brexit” with no exit plan, a “soft Brexit” that retains features of EU membership, a “no Brexit” that wants to leave things as they are, and a “new referendum” that hopes to undo the results of the 2016 referendum.

All of these choices are highly problematic. A hard Brexit could lead to financial and economic turmoil along with damage to the U.K. economy for years to come. A soft Brexit lacks support from the Euroskeptic hard-liners. The no-Brexit approach is viewed as a betrayal of those who voted to leave and could lead to demonstrations and civil unrest.

The new referendum approach favored by globalists at the Financial Times and Economist is also a betrayal and could shock the political class by producing another “leave” majority, despite expectations to the contrary.

Political differences aside, a four-way division means there is no majority for anything. 

Successive votes in the Parliament have resulted in one plan or the other being defeated, but no single plan gaining support. The U.K. Parliament members have been playing a gigantic game of chicken with the fate of one of the largest economies in the world hanging in the balance.

The Brexit talks between the U.K. and EU have continued for the past two years. Some political posturing was always to be expected. Significant progress has been made. But now the crunch has arrived. The deadline to leave the EU is March 29, 2019, just four days away.

Yet regardless of the outcome, the prospects for the U.K. economy are decidedly negative. Either a hard Brexit or soft Brexit will damage the U.K.’s trading relations with the EU. The U.S. has recently announced its intention to renegotiate its own trading agreements with the U.K. in ways that can only lead to a reduction in U.K. exports to the U.S.

The U.K. itself is caught in the global slowdown from which the only escape seems to be devaluation designed to import inflation, export deflation and stimulate exports. All paths point to a cheaper pound regardless of the specifics of the final Brexit plan.

But we could soon see some real fireworks at a time when the global economy can least afford it.

Regards,

Jim Rickards
for The Daily Reckoning

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No Good Options

This post No Good Options appeared first on Daily Reckoning.

The U.K. Brexit referendum on whether to remain with or leave the European Union (EU) took place on June 23, 2016. The result was a clear victory for the “leave” forces. But markets were shocked. All the “experts” had predicted voters would elect to stay.

I was among the few to prepare investors for that shock. In the days before the vote, I urged my readers to short the British pound and buy gold. Those who did made huge gains. Some readers even wrote to me to say thanks for paying their kids’ college tuitions for that year — that’s how much money they made.

Why was I so convinced of the outcome that shocked virtually the entire economics profession?

Since the original vote, the U.K. government has been negotiating with the EU about the exact terms and timing of Brexit. But there has been no resolution. And those negotiations are coming to a head because a deadline for final exit with or without negotiated terms is just four days away, March 29.

U.K. Prime Minister Theresa May has been caught between a rock and a hard place. Many members of Parliament are opposed to Brexit and have done nothing to support her in the negotiations with the EU.

Other members of her own party support Brexit but believe May’s compromises in the negotiations leave the U.K. too close to the EU and defeat the purpose of the original referendum.

In other words, that many existing EU regulations and political control would still come from Brussels instead of London. Some of these involve the hot-button issues that led to Brexit in the first place, like immigration.

Also opposing May have been officials in Northern Ireland and Scotland who are strongly anti-Brexit and do not want to see their relations with the EU disrupted.

Between the anti-Brexit forces and the hard-line Brexit forces, May cannot get a majority to support her. I was watching C-SPAN last night and saw footage of May appearing before the House of Commons last Wednesday. Let’s just say the debate was heated.

Meanwhile, the anti-Brexit forces have been trying to undo the original Brexit vote with calls for a new referendum.

Among these uber-globalists is Anatole Kaletsky, a financial analyst and global activist. I debated Kaletsky in Switzerland last year. He was condescending and a bit arrogant, which is what one expects from the globalists. He was also out of touch with popular sentiment, which is why he got it wrong in his original Brexit “remain” forecast.

Kaletsky has been banking on widespread opposition and political stalemate to force another referendum as a way to ratify the final deal. He has been convinced that a new referendum would reject Brexit.

But this is wishful thinking on Kaletsky’s part, the same wishful thinking that caused him to miss Brexit in the first place. But it’s a good lesson in the relentless methods of the globalists, who treat all setbacks as mere pauses in their quest for one world government.

Now we’re just four days away from when Britain is scheduled to leave the EU. The EU has offered two alternative deadlines — one if the U.K. can agree on a deal, and one if they cannot.

If May can convince Parliament to accept her most recent proposal, Britain will have until May 22 to finalize the details. But if she can’t persuade Parliament to accept the deal they’ve already rejected twice, Britain will only have until April 12 to sort out the next steps.

If Britain can’t figure it out by April 12, “the option of a long extension will automatically become impossible,” says Donald Tusk, president of the European Council.

The latest Brexit uncertainty comes at a very bad time. Global growth has hit a wall, and a poorly implemented Brexit could only bring additional head winds to the global economy. And it will spill over into U.S. stocks.

That’s why Brexit could affect you personally, even if you don’t think you have a stake in the outcome.

You might want to stock up on gold and keep your wealth in dollar-denominated assets. You definitely do not want heavy exposure to the British pound, which is set up for a significant fall.

Regards,

Jim Rickards
for The Daily Reckoning

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The Real Problem With Modern Monetary Theory

This post The Real Problem With Modern Monetary Theory appeared first on Daily Reckoning.

MMT supporters will point to 2008 and say, “Just look at QE. In 2008, the Federal Reserve Balance sheet was $800 billion. But as a result of QE1, QE2, and QE3, that number went to $4.5 trillion. And the world didn’t end. To the contrary, the stock market went on a huge bull run.We did not have an economic crash. And again, inflation was muted.”

Fed chairman Jay Powell has criticized MMT, for example. But its advocates say Powell and other Fed officials hoist themselves on their own petard. That’s because they are the ones who actually proved that MMT works. They point to the fact that the Fed printed close to $4 trillion and nothing bad happened. So it should go ahead and print another $4 trillion.

This is one of the great ironies of the debate. The Fed criticizes MMT, but it was its very own money creation after 2008 that MMT advocates point to as proof that it works.

Their only quibble is that the benefit of all that money creation went to rich investors, the major banks and corporations. The rich simply got richer. MMT advocates say it will simply redirect the money towards the poor, students, everyday Americans, people who need healthcare and childcare. It would basically be QE for the people, instead of the rich.

And it will go into the real economy, where it will boost productivity and finally give us significant growth.

When I first encountered these arguments, I knew they weren’t right. Both my gut feeling and my more rigorous approach to my own theory of money told me MMT was wrong. But I must admit, their arguments were more difficult to answer than I expected. I had a tough time uncovering the logical flaws.

Their points are internally consistent, and they did have a point. After all, the Fed did create all that money and it didn’t produce a calamity. Who’s to say they couldn’t do a lot more of it?

In other words, the Keynesian argument does not hold water when you look at the facts or certainly recent economic history.

Without doing any more serious thinking about it, I probably would have lost a debate with any leading MMT proponent who’s done a lot of work on it, despite “knowing” they were wrong. I couldn’t easily refute their basic arguments.

You can never win a debate if you don’t understand your opponent’s position. Over the past several years I got dragged into endless gold versus bitcoin debates, and I always thought they were silly because gold is gold, and bitcoin is bitcoin. Contrasting them never made sense to me, but that’s what everybody wanted to hear, so I participated in a lot of gold versus bitcoin debates.

I won every debate according to the judges or the audience, but the point being I had to understand bitcoin in order to see its shortcomings. I wasn’t about to debate somebody about bitcoin and get blindsided or embarrassed because I didn’t understand their arguments. I had to become a complete expert on bitcoin to win these debates.

The same applies to MMT. If you’re going to debate somebody on MMT, you’d better know it better than they do or you’re going to lose that debate. It just so happens that I’ll be debating a leading MMT proponent on April 3, in just a few weeks. So I had to immerse myself in it to learn it inside and out.

I knew I had to go beyond the standard arguments that we can’t afford it, that it would explode the deficit, etc. I’m happy to say that I worked out an answer refuting MMT, but it wasn’t easy. It took a lot of hard thinking. Today I’m giving you a preview of what I’ll argue at the upcoming debate.

Here’s what it comes down to…

The real problem with MMT can be traced to its very definition of money. The MMT advocates say they know what money is. Money derives its value from the fact that you need it to pay your taxes. In the U.S. case, money is dollars.

But their definition of money is flawed. In other words, the whole theory is built on quicksand. And this is the point that everyone is missing, including the usual critics. No one else has raised it.

The basis of money, the definition of money, has nothing to do with paying taxes. I can think of a hundred ways to hold money and store wealth where you don’t owe any taxes. Here’s one example…

If you buy a share of stock and stick it in your portfolio for 10 years without selling it, how much do you owe in taxes? Zero. You don’t owe any taxes until you sell it. This is one of the reasons why Warren Buffet is so rich, by the way. He pays very little taxes.

But it’s not just stocks. What if you bought some land instead? You sit on it for 10 years, 20 years, 30 years, and ultimately give it to your kids. They keep it as a family homestead. How much do you owe in income tax? Zero. You don’t owe a nickel until you sell it.

The same applies to gold. You buy it and stick it in a safe for years. If you don’t sell it, you don’t owe taxes on it. That’s my point. In other words, there are innumerable ways to convert money into assets that preserve wealth where you don’t owe any taxes. You don’t have to pay taxes if you have stores of wealth and don’t sell them.

The bottom line is, people have lots of alternatives. They are infinitely resourceful when it comes to getting out of the tax system and preserving wealth without having to pay taxes. So the whole idea that money derives its value from taxation fails. Money is not based on paying taxes at the end of the barrel of a gun.

What is money based on then?

Ultimately, it’s based on trust. We all need to trust in the money we use or else it wouldn’t be of much value. I could offer you seashells as a form of payment, but it’s highly unlikely you’ll accept it. When it comes your turn to buy goods and services, you need to know that someone else will accept your money.

It’s that trust in the system that creates value. That system is very fragile and can be lost. And once lost, it’s almost impossible to regain. That’s why fiat currencies always fail in the long run.

MMT advocates say trust has nothing to do with it, that you need to pay your taxes with money, or else. But look at a place like Venezuela today. It’s one of the worst cases of hyperinflation in the history of the world. I don’t think anybody in Venezuela is worried about paying their taxes. They’re worried about finding food and water so their family doesn’t starve today.

And if they happen to have some local money they’re getting out of it as fast as they can. If they can find gold or dollars or euros, they’re buying it. They’re dumping their currency faster than the government can print it. When confidence is lost, when trust is lost, people get out of rapidly depreciating money as fast as they can.

That’s where the whole modern monetary theory breaks down, at its foundation. It fails because they substitute the threat of violence and jail for what really drives money, which is trust. They don’t understand that. And this trust can be lost very quickly.

MMT advocates also seem to think inflation can be dialed back or tweaked at will. Maybe they’ll say we’ll only spend $90 million on a Green New Deal instead of $97 trillion. They think they can dial it down. But they can’t. Once inflationary expectations set in, they take on a life of their own. It’s a non-linear system.

It’s like moving the control rod in a nuclear reactor. If you get it wrong by just a little you can melt the reactor down and kill a million people. It’s a non-linear system.

So, my point is that MMT advocates misunderstand what money is. Money is not about coercion, it’s about trust. They don’t understand that there are plenty of non-taxable alternatives people can resort to. They misunderstand what inflation is. Inflation is not a linear phenomenon, but a non-linear phenomenon that can spiral out of control before you can do anything about it.

And I use Venezuela as my case study, not QE. So, the point being they don’t understand money. This is what I’ll argue at my upcoming debate.

I expect to win.

Regards,

Jim Rickards
for The Daily Reckoning

The post The Real Problem With Modern Monetary Theory appeared first on Daily Reckoning.

A Recipe for Massive Government Spending

This post A Recipe for Massive Government Spending appeared first on Daily Reckoning.

I try to avoid partisan politics in my analysis. And I never try to tell people how to vote or what they should think. I trust my readers to make their own judgments. But sometimes I can’t avoid partisan politics because they can have a major impact on markets and the economy.

Leading Democratic presidential hopefuls Elizabeth Warren, Kamala Harris and Bernie Sanders have expressed desires to increase income taxes to 70% or even 90% on the rich, impose “wealth taxes” on their net worth and impose estate taxes that are equally onerous when they die.

The result would be that working people would pay state and local income tax on their wages, super-high income taxes on interest and dividends and annual wealth taxes and whatever was left over would be confiscated when they die.

In case you think these proposals are too extreme to become law, you might want to check out the polls. Recent polls show 74% of registered voters support a 2% annual wealth tax on those with $50 million of assets and 3% on those with $1 billion of assets.

Don’t assume you’re exempt just because your annual income is lower. Those tax thresholds are on wealth, not income, and could include stocks, bonds, business equity and intangible business equity for doctors, dentists and lawyers.

Another poll shows 59% of voters support the 70% income tax rate proposed by Rep. Alexandria Ocasio-Cortez (D-New York). Politicians go where the votes are. Right now, the votes are in favor of much higher taxes on you.

The history of these taxes is that the rates start low and the thresholds start high, but it’s just a matter of time before rates rise, thresholds drop and everyone is handing over their wealth.

But taxes become very unpopular when too many people get clipped. And politicians are very sensitive to that. Now some Democrats are calling for a system that would allow them to spend much, much more money on social programs without appreciably raising taxes. For politicians, it’s a dream come true — if it could work.

The leading Democratic candidates for president and numerous members of Congress have come out in favor of Medicare for All, free child care, fee tuition, a guaranteed basic income even for those unwilling to work and a Green New Deal that will require all Americans to give up their cars, stop flying in planes and rebuild most commercial buildings and residences from the ground up to use renewable energy sources only.

The costs of these programs are estimated at $75–95 trillion over the next 10 years. To put those costs in perspective, $20 trillion represents the entire U.S. GDP and $22 trillion is the national debt.

It used to be easy to knock these ideas down with a simple rebuttal that the U.S. couldn’t afford it. If we raised taxes, it would kill the economy. If we printed the money, it would cause inflation. Those types of objections are still heard from mainstream economists and policymakers, including Fed Chair Jay Powell.

But now the big spenders have a simple answer to the complaint that we can’t afford it. Their answer is, “Yes, we can!” That’s because of a new school of thought called Modern Monetary Theory, or MMT.

Daily Reckoning managing editor Brian Maher previously discussed MMT here and here.

This theory says that the U.S. can spend as much as it wants and run the deficit as high as we want because the Fed can monetize any Treasury debt by printing money and holding the debt on its balance sheet until maturity, at which time it can be rolled over with new debt.

What’s the problem?

Bernanke printed $4 trillion from 2008–2014 to bail out the banks and help Wall Street keep their big bonuses. There was no inflation. So why not print $10 trillion or more to try out these new programs?

There are serious problems with MMT (not the ones Jay Powell and mainstream voices point to). But very few analysts can really see the flaws. I’ll be in an MMT debate with a leading proponent in a few weeks, where I will point out what I believe to be the biggest flaws with MMT. To my knowledge, no one else has raised them.

For now, get used to the rise of MMT. It will be a central feature of the 2020 election campaign. The disastrous consequences are a little further down the road.

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