Expect Buybacks to Sustain Markets

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With uncertainty swirling around the financial markets right now, many are warning about a financial storm brewing and how to navigate through it.

Let’s consider the storm elements in the world right now. The ongoing trade war is obviously a major concern, which is nowhere near being resolved. Growth is slowing in many parts of the world and central banks are preparing to begin cutting rates again.

Geopolitical tensions are also rising again, especially in the Persian Gulf. Late last week, Iranian forces seized a British-flagged tanker in the Strait of Hormuz, one of the world’s most important chokepoints. Britain has demanded the ship’s release.

On the U.S. domestic front, we are facing government dysfunctional, trade war uncertainty and a looming debt ceiling deadline. A deal will likely be reached, but that is not a guarantee. If a deal isn’t reached, the federal government would run out of money to pay its bills.

That’s why you should consider the tactics of Warren Buffett along with the strategy used by some of the most skilled sailors.

Buffett, one of the most successful investors in history, has made billions by knowing how to steer through storms. One of my favorite Buffettisms has to do with keeping your eye on the horizon, a steady-as-she-goes approach to investing. It also happens to relate to sailing.

As he famously said, “I don’t look to jump over seven-foot bars; I look around for one-foot bars that I can step over.”

What that means is that you should carefully consider what’s ahead and choose your course accordingly. Buffett doesn’t strive to be a hero if the risk of failing, or crashing against the rocks (in sailing lingo), is too great.

In a storm, there are two possible strategies to take. The first one is to ride through it. The second is to avoid it or head for more space in the open ocean. In other words, fold down your sails and wait it out until you have a better opportunity to push ahead.

While there is no perfect maneuver for getting through a storm, staying levelheaded is key.

We are at the beginning of another corporate earnings season, which is the period each quarter when companies report on how well (or poorly) they did in the prior quarter.

The reports can lag the overall environment but still give insight on how a company will be positioned in the new quarter. But to get the most out of them requires the right navigation techniques.

This season’s corporate earnings results have been mostly positive so far. But what you should know is that Wall Street analysts always tend to downplay their expectations of corporate earnings going into reporting periods. That because corporations downplay them to analysts. It’s Wall Street’s way of gaming the system.

When I was a managing director at Goldman Sachs, senior members of the firm would gather together each quarter with the chairman and CEO of the firm, Hank Paulson, who went on to become the Treasury secretary of the United States under President George W. Bush.

He would talk with us about the overall state of the firm, and then the earnings figures would be discussed by the chief financial officer.

This would be just before our results were publicly disclosed to the markets. There was always internal competition amongst the big investment banks as to what language was being provided to external analysts about earnings and how the results ultimately compared with that language.

You couldn’t be too far off between “managing expectations” of the market and results of the earnings statements. However, there was a large gray area in between that was exploited each quarter.

When I was there, it was very important for Goldman to have better results than immediate competitors at the time like Morgan Stanley, Merrill Lynch or Lehman Bros.

It was crucial to “beat” analysts’ expectations. That provided the greatest chance of the share price rallying after earnings were released.

The bulk of our Wall Street compensation was paid in annual bonuses, not salaries. These bonuses were in turn paid out in options linked to share prices. That’s why having prices rise after fourth-quarter earnings was especially important in shaping the year’s final bonus numbers.

Here’s what that experience taught me: There’s always a game when it comes to earnings.

Investors that don’t know this tend to get earnings season all wrong. However, successful investors that take forecasts with a grain of salt will do better.

Years later, I realized this was also Warren Buffett’s approach to analyzing earnings. As he has told CNBC, “I like to get those quarterly reports. I do not like guidance. I think the guidance leads to a lot of bad things, and I’ve seen it lead to a lot of bad things.”

We’ll have to see how earnings season turns out. But good or bad, markets are finding support from the same phenomenon that powered them to record heights last year: stock buybacks.

Of course, years of quantitative easing (QE) created many of the conditions that made buybacks such powerful market mechanisms. Buybacks work to drive stock prices higher. Companies could borrow money and buy their own stocks on the cheap, increasing the size of corporate debt and the level of the stock market to record highs. Corporations actually account for the greatest demand for stocks..

And a J.P. Morgan study concludes that the stock prices of U.S. and European corporations that engage in high amounts of buybacks have outperformed other stocks by 4% over the past 25 years.

Last year established a record for buybacks. While they will probably not match the same figure this year, buybacks are still a major force driving markets higher.

And amidst escalating trade wars and all the other concerns facing today’s markets, executing buybacks makes the most sense for the companies that have the cash to engage in them. If companies are concerned about growth slow downs in the future, there is good reason to use their excess cash for buybacks.

What this means is that the companies with money for buybacks have good reason to double down.

As a Reuters article has noted, “the escalating trade war between the United States and China may prompt U.S. companies to shift money they had earmarked for capital expenditures into stock buybacks instead, pushing record levels of corporate share repurchases even higher.”

So buybacks could prop up the market through volatile periods ahead and drive the current bull market even further.

Of course, buybacks also represent a problem. They boost a stock in the short term, yes. But that higher stock price in the short may come at the expense of the long run. It’s a short-term strategy.

That’s because companies are not using their cash for expansion, for R&D, or to pay workers more, which would generate more buying power in the overall economy. Buybacks are not connected to organic growth and are detached from the foundation of any economy.

But buybacks could keep the ball rolling a while longer. And I expect they will. One day it’ll come to an end. But not just yet.

Regards,

Nomi Prins
for The Daily Reckoning

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Why Powell Might NOT Cut Rates

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The market’s been bouncing around lately, anxiously waiting to see it the Fed cuts interest rates next week. All indications now suggest that it will. The question is by how much?

Minutes from June’s Federal Open Market Committee (FOMC) meeting that were released earlier this month indicated support for a rate cut. Certain committee officials noted that as long as uncertainty still weighed on its outlook, they would be willing to cut rates.

And during his much-awaited biannual testimony before the House Financial Services Committee, Federal Reserve Chairman Jerome Powell hinted — strongly — that a rate cut was around the corner.

Powell told the committee, “It appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.”

But the subsequent release of better-than-expected June employment figures complicated the matter of rate cut size and timing.

They raised the possibility that those positive jobs numbers would keep the Fed from cutting rates. After all, it doesn’t make a lot of sense to cut interest rates when the job market is so hot and unemployment is at 50-year lows.

But despite that concern, markets are still placing the odds of a rate cut of 25 basis points at 100%, with lower expectations for a 50 basis point cut.

This means a rate cut is already “baked into the cake.” However, the risk is that if Jerome Powell and the FOMC don’t cut rates next week, it could cause a sharp sell-off.

We’ll have our answer next week. But despite the overwhelming market expectations for a rate cut, I think there’s a chance the Fed won’t cut rates yet. That’s because Powell may still want to signal the Fed’s ability to act independently from White House pressure.

I realize that puts me in the extreme minority. But that’s OK, it certainly isn’t the first time.

But there’s something else going on right now that could trip up markets.

Earnings season is underway. Over the next few weeks, all of the S&P 500 companies will be rolling out their earnings figures. And more than a quarter of them will report earnings this week.

Firms from Google’s parent company, Alphabet, to Amazon, McDonald’s and Boeing are among the more than 130 companies that are reporting.

Even with a rate cut, poor corporate earnings could spell trouble for stocks. The trade war would be partly responsible. Certainly, there remains no resolution on the U.S.-China trade war front. And the trade war combined with slowing growth could amplify the effects of weak earnings.

As one article reports, “Stocks could struggle if the earnings message from corporate America focuses on the murky outlook for the economy and negative impacts from the trade wars.”

Earnings so far have been positive, but that can be misleading. That’s because second-quarter earnings expectations were kept low so that corporations could easily beat them.

Their actual earnings may not be underwhelming. But if they beat expectations, that’s all that counts.

And as I learned on Wall Street, corporations often talk down their earnings estimates in order to set a low bar. That way they can easily beat the forecast, which produces a jump in the stock price.

As Ed Keon, chief investment strategist at QMA explains:

No matter what the economic circumstances are, no matter what the backdrop is, there’s this dynamic that companies like to lowball and analysts like to give them headroom. The fact that numbers are coming in better than expected — it’s been the case for decades now.

Of the 114 companies that provided second-quarter guidance as of last week, 77% released negative forecasts, according to FactSet.

But it’s still early and there’s a long way to go.

Most industrial companies haven’t reported earnings yet. And they could reveal extensive damage from the trade war. As CFRA investment strategist Lindsey Bell says:

As we get more industrials in the next couple of weeks, I think that will create more volatility and drive the market lower in the near term… Chemicals and metals are two areas where I expect pressure.

We’ll see. But if markets do stumble, you can expect the Fed will be ready to cut rates at its meeting in September. That means more “dark money” will be coming to support markets, even if the Fed doesn’t cut rates next week.

And that’ll keep the bull market going for a while longer. One day the music will end. The imbalances in the system are just too great.

But we’re not at that point yet, and you can expect markets to rise on additional dark money injections.

Enjoy it while you can.

Below, I show you one major factor that will continue to support stocks this year. It doesn’t have to do with the trade war or earnings. What is it? Read on.

Regards,

Nomi Prins
for The Daily Reckoning

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Into the “Tractor Beam” of Zero Rates

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“We’re probably never going to go away from zero rates.”

So concludes hedge fund grandee Kyle Bass.

Mr. Bass believes the economy will plunge into recession next year. And the Federal Reserve will hound interest rates back down to zero.

There they will remain forever and ever… world without end.

The economy will fall within the inescapable “tractor beam” of zero rates:

As we have all learned, once an economy falls into the tractor beam of zero rates, it’s almost impossible to escape them… Growth numbers are going to come down and real growth might go to zero. We’re probably never going to go away from zero rates.

We fear Bass is correct.

Like a man hooked to a respirator, the economy cannot breathe on its own.

The financial crisis collapsed its lungs.

The Federal Reserve rushed over, plugged in the oxygen… and never took it out.

The economy’s natural breathing apparatus has atrophied from disuse.

Yank the oxygen now… and you will have a situation on your hands.

Dr. Powell attempted to wean the patient off support. But it gurgled, sputtered and flailed.

He will not try again. He is in fact preparing to pump in more oxygen.

But the economy might breathe freely today… if they had only let it recapture its own wind post-crisis.

The initial gasping might have been frightful.

But it would have coughed out the excesses of the previous boom… and gradually filled its lungs with the invigorating air of honest capitalism.

It would have come around on its own.

In went the breathing tube instead…

United States debt — public and private — has moonshot some $21 trillion this past decade.

It presently totals an impossible $73 trillion.

Meantime, GDP equals $20 trillion.

That is, each dollar of GDP holds up nearly $3.65 of debt.

The economy pants and sweats mightily under the burden.

And rising interest rates would increase the cost of that debt.

Any meaningful interest rate increase would pile on too much weight… and the economy would buckle under the strain.

Compare today’s debt-to-GDP with 1970’s — when the Federal Reserve was still jailed in by the gold standard:

Read more here.

No, the economy cannot withstand higher interest rates — or even historically normal interest rates.

The Federal Reserve is trapped.

But here is the problem:

The Federal Reserve cannot raise interest rates, as we have attempted to establish.

But like trying to breathe life into a corpse… or Hillary Clinton… lowering rates will not work the trick.

Today’s debt load is simply too behemoth.

Explains our former colleague David Stockman:

[We are at] a condition best described as Peak Debt, which reflects the fact that a large share of domestic household and business balance sheets are tapped out.

Accordingly, cutting interest rates has increasingly less potency on Main Street due to the crushing absolute level of debt. As of Q1 2019, in fact, total public and private debt weighed in at $73 trillion and is up by $21 trillion from the pre-crisis peak in Q4 2007…

There are now two turns of extra debt on the national income (3.47x versus 1.48x) compared to the long-standing leverage ratio which prevailed during the century between 1870 and 1970. In quantitative terms, those extra turns amount to $40 trillion of extra debt being lugged around by the U.S. economy.

Needless to say, it is becoming ever harder for the Fed to stimulate more borrowing and spending relative to the nation’s $21 trillion of nominal income. It’s simply a matter of diminishing returns to small reductions in what are already rock bottom rates coupled with the exhaustion of balance sheet capacity.

And so the Federal Reserve wields far less wallop than commonly supposed.

As we have argued before…

The Federal Reserve is a helpless giant, a man behind a curtain, a tissue-paper tiger.

That is why we expect it to flunk the inevitable recession.

And also why we expect a fiscal rescue attempt next time — not monetary.

Read on to see why central banks do not much matter these days. As you will see, there is no actual money in monetary policy.

But if central banks are largely irrelevant, then who… or what… is pulling the monetary strings?

Answer below…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Trump Declares War

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Trump has had it!

He is apparently declaring a currency war on the rest of the world. Trump resents China and Europe cheapening the yuan and the euro against the dollar in order to help their exports and hurt ours.

He says it’s time for the U.S. to cheapen the dollar also. Trump has a point. If you put a 25% tariff on many Chinese exports to the U.S. (as Trump has done) or a 25% tariff on German cars exported to the U.S. (as Trump has threatened to do), it can be a powerful way to reduce the U.S. trade deficit and generate revenue for the U.S. Treasury.

But a trading partner can undo the effect of the tariff just by cheapening its currency.

Let’s say a Chinese-made cellphone costs $500 in the U.S. If you slap a 25% tariff on the imported phone, the immediate effect is to raise the price by $125.

A simple solution to tariffs is to devalue your currency by 20% against the dollar. Local currency costs do not change, but the cellphone now costs $400 when the local currency price is converted to U.S. dollars.

A 25% tariff on $400 results in a total cost of $500 — exactly the same as before the tariffs were imposed. Tariff costs have been converted into lower production costs through currency manipulation.

There’s only one problem with Trump’s currency war plan. There’s nothing new about it. The currency wars started in 2010 as described in my 2011 book, Currency Wars. 

As soon as one country devalues, its trading partners devalue in retaliation and nothing is gained. It’s been described as a “race to the bottom.” Currency wars produce no winners, just continual devaluation until they are followed by trade wars.

That’s exactly what has happened in the global economy over the past 10 years. But the final step in the sequence is often shooting wars. That’s what happened leading up to WWII. Let’s hope the currency wars and trade wars don’t turn into shooting wars as they did in the 1930s.

Meanwhile, the Fed is a critical player in the currency war because it has a major influence on the dollar.

The world is waiting to see what it does at its policy meeting on July 31. There is almost no chance the Fed will raise rates. The choices are to cut rates or keep rates unchanged. The market is betting heavily on a rate cut, for what it’s worth.

If the Fed cuts rates, we’ll have to see how other central banks react. But the Fed has many factors to consider when it meets later this month…

For the past 10 years, Fed policy changes have been relatively straightforward to forecast, based on a simple model. The model said the Fed would raise rates consistently in 0.25% increments until rates are normalized around 4% (the amount needed to cut in case of recession).

The exceptions (where the Fed would “pause” on rate hikes) would occur when job creation is low or negative, markets are disorderly or strong disinflation threatens to turn to deflation. Markets certainly became disordered late last year, when the U.S. stock market nearly entered a bear market. And so the Fed paused.

None of those conditions apply today. Job creation is strong, markets are at all-time highs and disinflation is mild. But a new factor has entered the model, which is the fear of causing a recession.

Estimated growth for the second quarter of 2019 is 1.3% annualized, compared with 3.1% in the first quarter. Using the Fed’s own models (which are different from mine), the Fed is concerned that if they don’t cut rates, a market correction and recession may occur.

But if they do cut rates, inflation may result due to tight labor markets and higher costs due to tariffs.

This Fed decision will likely come down to the wire. Second-quarter GDP will be reported on July 26, and personal income and outlays will be reported on July 30. Both data points (and underlying inflation data) will be available right before the July 31 decision date.

Markets will cheer a rate cut and probably sell off if the Fed does not cut rates. But both the markets and the Fed itself will have to wait until the last possible minute before this conundrum is resolved.

And the world will be watching very closely.

Below, I show you how Fed policy is one of three factors driving a new multiyear rally in gold. What are the other two? Read on.

Regards,

Jim Rickards
for The Daily Reckoning

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Jerome Powell Caves

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Jerome Powell chummed the seawater this morning. And the voracious sharks rose to the bait… 

In written testimony to Congress, Mr. Powell informed us that:

Crosscurrents have reemerged. Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened. Since [the Fed meeting in June], based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook… Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy.

What is more… he re-babbled his oath that the Federal Reserve would “act as appropriate to sustain the expansion.” 

Translated into good hard English: Expect a rate cut later this month.

Affirms Bloomberg Federal Reserve-ologist Steve Matthews: 

“Powell didn’t say so explicitly, but it’s hard to read this other than he thinks a cut in July would be appropriate.”

Powell’s dispatch, adds Peter Boockvar of Bleakley Advisory Group…

“…fully endorsed the July rate cut and did absolutely nothing to pull the markets back from that expectation.” 

The stock market was up and away on the news…

The S&P Tops 3,000 For The First Time In History 

For the first occasion in its 62 years… the S&P poked its head above the 3,000 mark this morning.

The Nasdaq registered a fresh record of its own. And the Dow Jones bounded nearly 200 points.

But the opening frenzy squandered much of the day’s energy… and the averages gradually lost their steam.

The Dow Jones ended the day up 75 points, at 26,859. 

After catching its first glimpse of 3,000, the S&P dipped back down to 2,992. The Nasdaq, meantime, closed the day with a 61- point gain. 

And so it goes…

100% Chance Of A July Rate Cut

Federal funds futures — incidentally — now give 100% odds of a rate cut later this month.

But what about the rest of the year… and next year? To what inky depths will the Federal Reserve lower rates?

Perhaps even lower than markets expect — if you take history as your teacher.

Markets presently expect Mr. Powell and his goons to cut rates 75 basis points by January.

Seventy-five basis points imply three rate cuts (a typical rate cut — or hike — is 25 basis points).

Three rate cuts by year’s end are plenty heady.

But according to Michael Lebowitz of Real Investment Advice, history argues even stronger drink is in prospect…

Markets Underestimate How Far Rates Could Sink

If the Federal Reserve undertakes a hike cycle, he maintains, it often elevates rates higher than markets project.

And when the Federal Reserve begins cutting rates… it hatchets them even lower than markets expect.

Lebowitz:

Looking at the 2004–06 rate hike cycle… the market consistently underestimated the pace of fed funds rate increases…

During the 2007–09 rate cut cycle, the market consistently thought fed funds rates would be higher than what truly prevailed…

The market has underestimated the Fed’s intent to raise and lower rates every single time they changed the course of monetary policy meaningfully.

Lebowitz says markets have underestimated rate cut intensity for the previous three cycles.

And Mr. Powell currently has his hatchet out.

In conclusion:

If the Fed initiates rate cuts and if the data… prove prescient, then current estimates for a fed funds rate of 1.50 –1.75% in the spring of 2020 may be well above what we ultimately see. 

And here Lebowitz seizes us by the shoulders… and gives us a good hard shaking:

Taking it a step further, it is not far-fetched to think that that fed funds rate could be back at the zero-bound or even negative at some point sooner than anyone can fathom today.

Who could? Fathom it, that is.

Just last year the monetary authorities gloated about “globally synchronized growth” and their march back to “normalcy.” 

Now they are preparing to about-face… and go scurrying back to zero? 

Who can take these gentlemen and ladies seriously?

The Fed Can Never Normalize Interest Rates

Here is our guess: Once they turn around, they will never come back. 

The Federal Reserve cannot return to normal. 

Returning to normal would knock the economy flat. And the stock market would come down in a thundering heap.

Only low interest rates keep it all vertical.

But as we have noted repeatedly… watch out for the next rate cut.

The past three recessions each commenced within three months of the first rate cut that ended a hiking cycle.

We find no reason to believe “this time will be different.”

The next rate cut — likely this month — starts the clock ticking.

We could be wrong of course. 

The inscrutable gods keep their own schedule. Who knows how long the show might run?

Out of Ammunition

But come the inevitable recession…

The Federal Reserve will have very little ammunition to hurl against it.

And the closer it gets to zero, the less ammunition it will hold.

History says it requires interest rates of at least 4% to wage a successful battle.

Rates are presently between 2.25% and 2.50%.

They are about to sink lower. Perhaps drastically lower. 

That is, the Federal Reserve is badly outgunned as it presently stands.

If the economy somehow pegs along until rates are zero — or near zero — the Federal Reserve would be on its knees… defenseless.

It will have another desperate go at quantitative easing. But multiple rounds did little (nothing) to raise the economy last time.

Why would it work next time?

The Next Crackpot Cure

That is why we expect the next anti-recession cure — disaster, that is — will not be monetary.

It will be fiscal.

The cries will go out…

“QE for Wall Street did nothing for the economy. The time for QE for Main Street has come.” 

The authorities will take to their helicopters, hover over Main… and begin shoveling money out the side.

The throngs below will haul it all in. They will proceed to go spreeing through the stores. The resulting delirium will give the economy a wild jolt.

That is the theory… as far as it runs.

It in part explains the loudening shouts for Modern Monetary Theory (MMT).  

Its drummers claim it can invigorate the wilting American economy.

They further claim it can fund ambitious social programs — all without raids upon the taxpayer.

And if interest rates are shackled down, without blasting the deficit.

The printing press will supply the money.

But as we have argued prior, MMT is the eternal quest for the free lunch… water into wine… something for nothing.

And that world has no existence.

MMT would likely yield a gorgeous inflation. But the economic growth it promises… would be a promise broken.

It will join the broken promise of monetary policy…

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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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.

A Tour of the Future

This post A Tour of the Future appeared first on Daily Reckoning.

Sharp, bracing winds have scattered the fog. The horizon is now visible… and the future drifts into focus.

Yes, we have the future in sight.

Today we report the way ahead.

We begin where we stand — upon creaking and groaning floorboards…

Recessionary Warnings in all Directions

Manufacturing surveys indicate global manufacturing contracted in May… for an unprecedented 13th-consecutive month.

The Manufacturing PMI (Purchasing Managers’ Index) surveys indicate manufacturing crawls at its slowest rate since September 2009.

United States factory orders expanded merely 1.0% in May — the lowest rate since President Trump took the throne.

The Cass Freight Index — a broad measure of domestic shipping activity and a plausible thermometer of economic health — has dropped 3.2% since last April.

Meantime, the bond market flashes warnings of a lean season ahead.

Ten-year Treasury yields have dropped to their lowest levels in two years, to 2.12%.

And the yield curve has inverted. An inverted yield curve nearly always precedes recession.

Thus we stand upon our precarious perch, wary of the shifting, sandy foundations beneath us.

But it is the future we have in mind today…

Morgan Stanley: 60% Chance of Recession Within One Year

The professional optimists of the Federal Reserve’s Atlanta branch office expect Q2 GDP to ring in at a slender 1.3%.

J.P. Morgan has lowered its own sights from 2.25% to 1%.

It also projects 10-year Treasury yields will sink to 1.75% by year’s end… and 1.65% by next March.

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

It placed those same odds at 25% one month prior.

Morgan Stanley has also revised its Q2 GDP forecast from 1.0%… to a pale and sickly 0.6%.

It further gives a 60% likelihood of recession within the next year — its highest percentage since the financial crisis.

Of course, the Federal Reserve looms large in our vision…

Rate Cuts A2re Coming

The current rate hike cycle is ended. The Federal Reserve will next slash interest rates.

Its Federal Open Market Committee gathers in two weeks’ time.

As Craig Hemke of Sprott Money News notes, two options rise before the august ladies and gentlemen of the committee.

Neither is desirable:

1. Admit defeat and immediately cut the fed funds rate by up to 50 basis points.

2. Stall. And if they do this, bonds will rally even higher as the bond market will anticipate an even more dramatic global economic collapse.

The market votes heavily for Option 1.

Federal funds futures currently give nearly 70% odds of at least one rate cut by July.

By September these odds rise to over 90%, and by next January… to over 98%.

Some crystal gazers even hazard three rate cuts by this year’s end alone.

The Trigger for Recession

But as we have noted repeatedly… the next rate cut is a phony cure.

It is fool’s gold, a snare, a desert mirage.

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

Affirms Zero Hedge:

While many analysts will caution that it is the Fed’s rate hikes that ultimately catalyze the next recession… it may come as a surprise to many that the last three recessions all took place [within] three months of the first rate cut after a hiking cycle!

We have every reason to expect the trend continues uninterrupted.

We further allow the possibility that the economy has already slipped into recession.

Recessions are often only identified several months after they commence — or longer.

Early next year, the bean counters may well point to Q2 2019.

Regardless, the recessionary straws are swaying in the stiffening breeze. Even Jerome Powell spots them.

“It’s Time to Rethink Long-run Strategies”

Mr. Powell realizes the standard rate cuts will fizzle woefully… like July Fourth sparklers that fail to spark.

So he will be on hand with more potent pyrotechnics.

From comments this week:

It’s time to rethink long-run strategies… Perhaps it is time to retire the term “unconventional” when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in the future… The next time policy rates hit the lower bound and there will be a next time it will not be a surprise.

Quantitative easing. Zero interest rates. Negative interest rates.

These and more tricks he doubtless has in mind.

And did you catch this bit?

“Perhaps it is time to retire the term “unconventional” when referring to tools that were used in the crisis.”

Just so.

Central banks have inflicted these “unconventional” tools upon the world’s citizens for 10 years — to varying degrees.

But if these gaudy and flashy devices met their advertising… why is the economy plunging into recession at all?

It is true, they have lit up the stock exchanges. But they fell as duds upon Main Street.

Why should they dazzle the crowd now?

They worked one primary effect:

To drill the world trillions of dollars deeper into debt.

Global debt has doubled post-financial crisis… as has the United States national debt.

Yet we return to the future…

Prepare for the Cannons of Fiscal “Stimulus”

We observe that the Federal Reserve’s punchless old fireworks have failed.

That is when the national authorities will haul out the cannons…

They will load them full of Modern Monetary Theory (MMT) — or “QE for the people.”

Rolling barrages of fiscal “stimulus” they will send raining down onto Main Street.

If a Democratic commander in chief is barking the orders at the time, he may load a Green New Deal into the breeches.

Free college tuition… universal Medicare… jobs for all… a $15 minimum wage.

All these and more it will promise — and save the world into the bargain.

The False Miracle of Debt

Like most crank ideas, these fevered schemes will fail in grand and spectacular style.

The false miracle of debt is their common delusion.

All debt-based consumption steals from the future to gratify the present. It is tomorrow’s consumption pulled forward.

It depletes the capital stock… and leaves the future empty.

It signs a perpetual check against an overdrawn future.

Mark Jeftovic of the Guerrilla Capitalism blog on MMT, which can extend to a Green New Deal:

Think of an MMT crisis as an economic black hole sucking all value from further and further future generations into a gravitational vortex of the present moment, where all value collapses in on itself and disappears forever.

Thus we conclude our tour of the horizon.

Mercifully, we can see no farther…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post A Tour of the Future appeared first on Daily Reckoning.

Why the Economy Won’t Recover

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

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

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

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

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

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

This is the question we tackle today.

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

But in brief review…

The Shadow Banking System Supplied the World with Dollars

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

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

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

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

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

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

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

The Shadow Banking System: A Bubble Machine

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

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

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

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

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

Snider:

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

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

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

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

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

Then we come to 2008…

The Powerful Lesson of Bear Stearns

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

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

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

Again, Snider:

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

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

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

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

But 2011 was the true end of the line.

The Demise of the Shadow Banking System

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

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

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

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

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

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

Coincidence? No, says Snider:

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

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

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

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

Must we ask?:

The Federal Reserve Has No Answers

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

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

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

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

But by 2016 the truth could no longer be denied…

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

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

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

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

But if they don’t?

Fix the Banks or Prepare for Social and Political Upheaval

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

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

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

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

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

Only the Lord knows what follows once that fails…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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

Why the Economy Won’t Recover

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

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

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

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

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

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

This is the question we tackle today.

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

But in brief review…

The Shadow Banking System Supplied the World with Dollars

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

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

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

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

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

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

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

The Shadow Banking System: A Bubble Machine

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

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

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

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

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

Snider:

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

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

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

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

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

Then we come to 2008…

The Powerful Lesson of Bear Stearns

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

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

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

Again, Snider:

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

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

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

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

But 2011 was the true end of the line.

The Demise of the Shadow Banking System

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

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

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

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

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

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

Coincidence? No, says Snider:

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

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

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

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

Must we ask?:

The Federal Reserve Has No Answers

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

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

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

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

But by 2016 the truth could no longer be denied…

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

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

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

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

But if they don’t?

Fix the Banks or Prepare for Social and Political Upheaval

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

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

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

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

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

Only the Lord knows what follows once that fails…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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