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>>> Heading Into Negative (Real) Interest Rates
BY JAMES RICKARDS
MARCH 5, 2020
https://dailyreckoning.com/heading-into-negative-real-interest-rates/
Heading Into Negative (Real) Interest Rates
Last July I was in Bretton Woods, New Hampshire, along with a host of monetary elites, to commemorate the 75th anniversary of the Bretton Woods conference that established the post-WWII international monetary system. But I wasn’t just there to commemorate the past —I was there to seek insight into the future of the monetary system.
One day I was part of a select group in a closed-door “off the record” meeting with top Federal Reserve and European Central Bank (ECB) officials who announced exactly what you can expect with interest rates going forward — and why.
They included a senior official from a regional Federal Reserve bank, a senior official from the Fed’s Board of Governors and a member of the ECB’s Board of Governors.
Chatham House rules apply, so I still can’t reveal the names of anyone present at this particular meeting or quote them directly.
But I can discuss the main points. They essentially came out and announced that rates are heading lower, and not by just 25 or 50 basis points. Rates were 2.25% at the time. They said they have to cut interest rates by a lot going forward.
Well, that’s already happened. The Fed cut rates last September and October (each 25 basis points), bringing rates down to 1.75%. And now, after Tuesday’s emergency 50-basis point rate cut, rates are down to 1.25%.
That’s a drop of one full percentage point. If the Fed keeps cutting (which is likely), it’ll soon be flirting with the zero bound. And if the economic effects of the coronavirus don’t dissipate (very possible), the Fed could easily hit zero.
But then what?
These officials didn’t officially announce that interest rates will go negative. But they said that when rates are back to zero, they’ll have to take a hard look at negative rates.
Reading between the lines, they will likely resort to negative rates when the time comes.
Normally forecasting interest rate policy can be tricky, and I use a number of sophisticated models to try to determine where it’s heading. But these guys made my job incredibly easy. It’s almost like cheating!
The most interesting part of the meeting was the reason they gave for the coming rate cuts. They were very relaxed about it, almost as if it was too obvious to even point out.
The reason has to do with real interest rates.
The real interest rate is the nominal interest rate minus the inflation rate. You might look at today’s interest rates and think they’re already extremely low. And in nominal terms they certainly are. But when you consider real interest rates, you’ll see that they can be substantially higher than the nominal rate.
That’s why the real rate is so important. If you’re an economist or analyst trying to forecast markets based on the impact of rates on the economy, then you need to focus on real rates.
Assume the nominal rate on a bond is 4%; what you see is what you get. But the real rate is the nominal rate minus inflation. If the nominal rate is 4% and inflation is 2%, then the real rate is 2% (4 – 2 = 2).
That difference between nominal and real rates seems simple until you get into a strange situation where inflation is higher than the nominal rate. Then the real rate is negative.
For example, if the nominal rate is 4% and inflation is 5%, then the real rate of interest is negative 1% (4 – 5 = -1).
The U.S. has never had negative nominal rates (Japan, the eurozone and Switzerland have), but it has had negative real rates.
By the early 1980s, nominal interest rates on long-term Treasury securities hit 13%. But inflation at the time was 15%, so the real rate was negative 2%. The real cost of money was cheap even as nominal rates hit all-time highs.
Nominal rates of 13% when inflation is 15% are actually stimulative. Rates of 3% when inflation is 1% aren’t. In these examples, nominal 2% is a “high” rate and 13% is a “low” rate once inflation is factored in.
What is the real rate today?
The yield to maturity on 10-year Treasury notes is currently at a record low of under 1% (it actually fell to 0.899% today before edging slightly higher). That’s never happened before in history, which is an indication of how unusual these times are.
Meanwhile, inflation as measured by the PCE core deflator (the Fed’s preferred measure) is currently about 1.6% year over year, below the Fed’s 2% target.
Using those metrics, real interest rates are in the neighborhood of -.5%. But believe it or not, that’s actually higher than the early ’80s when nominal rates were 13%, but real rates were -2%.
That’s why it’s critical to understand the significance of real interest rates.
And real rates are important because the central banks want to drive real rates meaningfully negative. That’s why they have to lower the nominal rate substantially, which is what these central bank officials said at Bretton Woods.
So you can expect rates to go to zero, probably sooner or later. Then, nominal negative rates are probably close behind.
The Fed is very concerned about recession, for which it’s presently unprepared. And with the coronavirus, now even more so. It usually takes five percentage points of rate cuts to pull the U.S. out of a recession. During its hiking cycle that ended in December 2018, the Fed was trying to get rates closer to 5% so they could cut them as much as needed in a new recession. But, they failed.
Interest rates only topped out at 2.5%, only halfway to the target. The market reaction and a slowing economy caused the Fed to reverse course and engage in easing. That was good for markets, but terrible in terms of getting ready for the next recession.
The Fed also reduced its balance sheet from $4.5 trillion to $3.8 trillion, but that was still well above the $800 billion level that existed before QE1 (“QE-lite” has since taken the balance sheet up above $4 trillion, and it’s probably going higher since new cracks are forming in the repo market).
In short, the Fed (and other central banks) only partly normalized and are far from being able to cure a new recession or panic if one were to arise tomorrow.
The Fed is therefore trapped in a conundrum that it can’t escape. It needs to rate hikes to prepare for recession, but lower rates to avoid recession. It’s obviously chosen the latter option.
If a recession hit now, the Fed would cut rates by another 1.25% in stages, but then they would be at the zero bound and out of bullets.
Beyond that, the Fed’s only tools are negative rates, more QE, a higher inflation target, or forward guidance guaranteeing no rate hikes without further notice.
Of course, negative nominal interest rates have never worked where they’ve been tried. They only fuel asset bubbles, not economic growth. There’s no reason to believe they’ll work next time.
But the central banks really have no other tools to choose from. When your only tool is a hammer, every problem looks like a nail.
Now’s the time to stock up on gold and other hard assets to protect your wealth.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
IMF Substitution Fund -- The US Fed is the only main central bank not already at zero % interest rates. Everyone is talking about fiscal stimulus, ie deficit spending, tax cuts, and helicopter money, which is about all you can do if you can't lower interest rates.
However, once all monetary and fiscal tools are exhausted, the IMF could step in and begin bailing out smaller countries using SDRs, and work their way up from there. So in the beginning the SDR transition could be gradual and piecemeal.
In Q2 last year they apparently activated the IMF's 'Substitution Fund', which allows central banks to swap their dollar denominated debt for SDRs without having to use the financial markets to sell the dollars. This ominous development coincided almost exactly with gold's sudden breakout and big surge (late May 2019). Within 3 months gold had zoomed 20%.
The activation of the IMF Substitution Fund was a clear signal that the transition to the SDR would be coming. The Substitution Fund approach allows central banks to replace their dollar reserves for SDRs without involving the financial markets and thus avoids tanking the dollar.
>>> Why Is Gold Tanking?
BY JAMES RICKARDS
FEBRUARY 25, 2020
https://dailyreckoning.com/why-is-gold-tanking/
Why Is Gold Tanking?
The coronavirus continues to take its toll on the stock market.
If you were expecting a major recovery today after yesterday’s bloodbath, you were very disappointed.
Stocks opened higher this morning but soon fell back into red territory again, where they stayed throughout the day.
The Dow ended up losing another 879 points today after yesterday’s 1,031-point hammering.
The S&P and Nasdaq were also big losers today, down 98 and 256 points respectively.
For investors accustomed to “buying the dip,” this is quite a change. As noted macroeconomic analyst Mohamed El-Erian said earlier today:
I understand the inclination to buy on the dip. I understand that the path of least resistance in this market is to bounce up… but I stress, this is different.
Meanwhile, the all-important 10-year Treasury yield fell to a record low this morning as investors continue to pour into safe-haven assets.
The 10-year yield dropped to 1.32%, falling beneath its previous record low of 1.325%, which it set in July 2016 following Brexit.
That means the bond market is projecting a poor outlook for the global economy. And over the long haul, the bond market has an excellent track record of being right.
Gold was down big today, losing $45.20. But that’s not because of gold itself. It’s all about the falling stock market.
When you think about it, it doesn’t make sense.
After all, if investors are fleeing for safety, which we’re seeing in the Treasury market, why wouldn’t they be buying up gold as well?
Gold was up close to $30 yesterday, before the price began dropping late in the day.
Here’s the likely reason why gold is falling right now when it should be rising…
With the stock market plummeting, hedge funds and other institutional investors have had to suddenly raise cash to meet margin calls on their positions in the equity markets. And they had to get the cash from somewhere.
Gold is a very liquid asset that can quickly be traded for cash.
They can either sell the actual gold bullion they own or they can unload their positions in gold ETFs (like GLD).
So my estimate is that they dumped their gold positions to raise the money. And that’s been driving the listed gold price lower.
It has nothing to do with gold’s fundamentals, which are actually very strong. Demand is increasing, central banks are hoarding record amounts of gold and new supplies are dwindling.
That’s a recipe for skyrocketing prices, and the bull market in gold is still very much intact.
The latest selling is just a quirk of the market, in which institutions have to raise cash in order to cover their positions when the market’s dropping.
Again, it has really nothing to do with gold itself. This is just a temporary blip.
If you haven’t bought gold yet, this is an ideal opportunity to scoop up gold at a bargain-basement price. Or, if you already own gold, to stock up on more.
For gold at least, it’s an ideal opportunity to “buy the dip.”
Gold is going much, much higher.
I’m not sure how many more opportunities like this we’re going to see. I urge you to take advantage of it while you can.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> “1984” Has Come to China
BY JAMES RICKARDS
FEBRUARY 24, 2020
https://dailyreckoning.com/1984-has-come-to-china/
“1984” Has Come to China
You’re probably familiar with George Orwell’s classic dystopian novel Nineteen Eighty-Four; (it’s often published as 1984). It was written in 1948; the title comes from reversing the last two digits in 1948.
The novel describes a world of three global empires, Oceania, Eurasia and Eastasia, in a constant state of war.
Orwell created an original vocabulary for his book, much of which is in common, if sardonic, usage today. Terms such as Thought Police, Big Brother, doublethink, Newspeak and memory hole all come from Nineteen Eight-Four.
Orwell intended it as a warning about how certain countries might evolve in the aftermath of World War II and the beginning of the Cold War. He was certainly concerned about Stalinism, but his warnings applied to Western democracies also.
When the calendar year 1984 came and went, many breathed a sigh of relief that Orwell’s prophesy had not come true. But that sigh of relief was premature. Orwell’s nightmare society is here today in the form of Communist China…
China has most of the apparatus of the totalitarian societies described in Orwell’s book. China uses facial recognition software and ubiquitous digital surveillance to keep track of its citizens. The internet is censored and monitored. Real-life thought police will arrest you for expressing opinions opposed to the government or its policies.
Millions of Chinese have been arrested and sent to “reeducation” camps for brainwashing (the lucky ones) or involuntary organ removal without anesthetic (the unlucky ones who die in excruciating pain and are swiftly cremated as a result).
While these atrocities are not going to happen in the U.S. or what passes for the West these days, the less extreme aspects of China’s surveillance state could well be. And while you might not be arrested for expressing unpopular opinions or challenging prevailing dogmas (at least not yet), you could face other sanctions. You could even lose your job and find it nearly impossible to find another.
You can certainly be banned from social media…
Anything seems to go on social media (primarily Facebook, Twitter, Instagram, Snapchat, YouTube and a few other platforms) — unless you’re a conservative personality or politico. That’s where the censorship begins.
Many conservative social media participants have had their acco?unts closed or suspended, not for threats or vulgarity but for criticism of “progressive” views (albeit criticism with some sharp edges).
Meanwhile, those with progressive views can say almost anything on social media, including the implicit endorsement of violence. But nothing happens.
Other conservatives report being the targets of “shadow banning.” That’s where your acco?unt is open and seems to operate normally, but unbeknownst to you, much of the network is being blocked from seeing your posts and popular features such as “likes” and “retweets” are being truncated and not distributed.
It’s like being a pro athlete who finds out the stadium is empty and no tickets are being sold. That’s bad enough. But Twitter took the war on conservatives a step further.
Well, one of the most widely followed acco?unts on Twitter is none other than Donald J. Trump’s, with 68 million followers. President Trump uses Twitter to announce policy initiatives and personnel changes and to offer pointed criticism of political opponents. It’s a major platform for him.
Last month Trump issued a tweet that identified the so-called “whistleblower” of the Ukraine phone call that led to his impeachment. That’s not as big a deal as it sounds because everyone in Washington knew who the whistleblower was (you can look his name up on the web), and he wasn’t even a real whistleblower because he didn’t meet statutory requirements.
Still, Twitter blocked Trump’s tweet. Twitter blamed a temporary system “outage,” but that claim was highly suspicious. Later, Trump’s tweet was restored, but the original acco?unt that Trump linked to had been deleted. No one ever said that politics was fair.
But Twitter’s blatant interference in the election could have adverse consequences for the company in Trump’s second term.
And a few social media companies are now de facto censors, taking over the job from the government. Given their massive media footprint, they wield extraordinary influence over the American public.
They’re in essence becoming propaganda outfits.
It’s not just here of course. Canada, for example, is actively pursuing digital surveillance to track the activities of law-abiding citizens.
A report for the Bank of Canada says that financial information gathered from digital transaction records could be used for “sharing information with police and tax authorities.”
If all transactions are digital (including credit and debit cards), authorities can track your whereabouts, buying habits, restaurant choices and much more. They could also reveal your political orientation and personal associations.
It’s not difficult to imagine the police and tax authorities using that power to make life extremely difficult for those who criticize the government or sacred ideologies like “climate change.” If you think that sounds extreme, some have actually advocated jailing climate change “deniers.”
Do you think I’m making that up?
Well, the executive director of an outfit called Climate Hawks Vote said “Put officials who reject science in jail.”
The Nation also ran an article called, “Climate Denialism Is Literally Killing Us: The victims of Hurricane Harvey have a murderer — and it’s not the storm.”
“How long,” its author asked, “before we hold the ultimate authors of such climate catastrophes accountable for the miseries they inflict?”
And Robert F. Kennedy Jr. said the Koch brothers “should be in jail,” “with all the other war criminals.”
Well, David Koch has since died, so he’ll escape Kennedy’s justice.
But their “war crimes” consisted of funding organizations that question the climate change alarmism the media is constantly feeding us.
But guess what? There’s plenty of hard scientific evidence that refutes the alarmist view. This article isn’t the venue to get into it, but the scientific case against climate alarmism is much stronger than the case for it.
But if you dissent against the official view, today’s tech censors will silence or marginalize you, no matter how valid your point.
The problem is, the trend is moving very quickly in this direction and it’s difficult to stop. And sophisticated surveillance technology to monitor citizens is already in place…
For example, cameras with the latest surveillance technology can spot and match millions of faces in real time with an accuracy rate of over 99%. They’re touted as anti-terrorism and anti-crime tools, which they certainly are.
But as Stalin’s ruthless secret police chief Lavrentiy Beria said, “Show me the man and I’ll show you the crime.” It’s easy to see that power being abused to target everyday citizens.
(By the way, Beria would ultimately prove his own point, as he was later arrested and executed for treason).
And actually, many people welcome intrusive surveillance technology on the grounds of convenience. As an example, look at microchipping, where people are injected with a small microchips beneath their skin. Microchipping has been associated with an Orwellian nightmare in which Big Brother constantly monitors your every move.
Well, over 4,000 Swedes have already happily volunteered to have it done.
In addition to acco?unt information that negates the need to carry cash or credit cards to pay for goods, these chips can contain personal information. It’s all happened fairly quickly. Just a few years ago, the very idea of it would have sent chills down the spines of most people.
But that’s how fast Big Brother can go from nightmare to reality, and appear benign or even beneficial.
Big Brother’s on full display in China right now, but he could be on his way here before too long.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> The World’s Biggest Economies Get a Jolt of Government Spending
Bloomberg News
February 20, 2020
https://www.bloomberg.com/news/articles/2020-02-21/the-world-s-biggest-economies-get-a-jolt-of-government-spending?srnd=premium
Governments across the world are starting to use more fiscal firepower to boost economies, though the shift may not be happening fast enough to appease central bankers who say they’re sick of carrying the burden of stimulus alone.
In more than half of the world’s 20 biggest economies, analysts now expect looser budgets this year — in other words, bigger deficits or smaller surpluses — than they did six months ago, according to a Bloomberg survey of economist forecasts.
Who’s Stimulating?
Economists expect looser budgets in most of the world’s top economies
Asian economies like China and South Korea are using fiscal policy to counter the menace of the coronavirus, which has shut down swaths of industry and devastated supply chains, while governments in the U.K. and Russia have ditched long-held commitments to austerity.
The world remains far from an across-the-board easing. Japan recently raised sales taxes, Germany still holds its surplus sacred, and U.S. policy is gridlocked by upcoming elections. And some of the change in budget forecasts are a consequence of weaker growth expectations, rather than higher spending or lower taxes.
Where’s the Stimulus?
2020 budget balance forecast as percent of GDP
As finance ministers from the Group of 20 major economies prepare to meet in Riyadh, here’s a roundup of budget forecasts and recent policy shifts in some key countries.
U.S.
U.S. Budget Balance
2020 forecast: -4.8% of GDP (deficit)
2021 forecast: -4.8%
President Donald Trump has delivered stimulus in the form of tax cuts and higher government outlays, and got a bump in growth as a result. This month, Trump submitted a budget proposal to Congress that would pare back some of the spending, though he’s also dangling a promise of more tax cuts targeted at the middle-class. But neither proposal is expected to get past House Democrats who control the purse strings, so any major fiscal initiative is likely on ice until after November’s elections.
China
China Budget Balance
2020 forecast: -4.8% (deficit)
2021 forecast: -4.6%
With entire industries and regions in lockdown because of the virus, and the government adamant that it won’t lower growth targets, China is set for more fiscal stimulus. The government said this week it’s preparing additional measures including cuts in corporate taxes and fees. There’s already some strain on the budget as a result of trade war with the U.S., and Finance Minister Liu Kun acknowledged there’ll be “short-term challenges.” But he said China must “take a longer-term view and take resolute steps.”
Japan
Japan Budget Balance
2020 forecast: -2.9% (deficit)
2021 forecast: -2.7%
Japan was already in danger of recession even before the scale of the coronavirus threat became clear – partly because it tightened fiscal policy. An increase in sales taxes in October 2019 contributed a plunge in output, just as it did the last two times the policy was tried. Lawmakers approved a supplementary budget worth about $29 billion last month, and on paper that extra stimulus should arrive by the end of March — but history suggests the government probably won’t manage to spend it all within the allotted time.
Germany
Germany Budget Balance
2020 forecast: 0.7% (surplus)
2021 forecast: 0.2%
Europe’s biggest economy has long been seen as a prime candidate for fiscal easing, since it has significantly less public debt than many neighbors. The European Central Bank and the French government are among those calling for action. But while Chancellor Angela Merkel’s coalition has begun limited stimulus focused on green projects, there’s no appetite to open the fiscal floodgates in a country where budget discipline remains a symbol of political virility. A lingering manufacturing recession and the coronavirus outbreak probably aren’t enough to revisit that stance.
U.K.
U.K. Budget Balance
2020 (fiscal year) forecast: -2.4% (deficit)
2021 forecast: -2.6%
Fresh from an unexpectedly decisive election win, Prime Minister Boris Johnson has signaled he’s ready to open the taps of government spending — and has already ditched a finance minister seen as less enthusiastic about that project. Johnson aims to cement support among the working-class voters who helped deliver his landslide. He’s outlined plans for infrastructure investment that skew toward poorer areas in northern England, and his new chancellor may be more amenable to relaxing the fiscal rules that would cap borrowing. It’s a departure for his Conservative party, which has prided itself on a reputation for fiscal discipline — and been slammed by critics for embracing austerity.
France
France Budget Balance
2020 forecast: -2.4% (deficit)
2021 forecast: -2.3%
France heeded the call for fiscal stimulus before central bankers even made it. Under pressure from the prolonged and often violent disruption of the Yellow Vest protests, President Emmanuel Macron tacked away from consolidating finances at the end of 2018 by unleashing around 17 billion euros of tax cuts. That has contributed to keeping public debt near 100% of economic output, leaving France with little margin for further stimulus should it be needed.
India
India Budget Balance
2020 forecast: -3.7% (deficit)
2021 forecast: -3.5%
India has heeded its central bank’s call for easier fiscal policy to a boost a flagging economy. In February, it announced cuts in personal taxes that will cost the government $5.6 billion in revenue, a few months after a similar $20 billion handout to companies. The tax cuts will likely lead to India missing the targets on what it calls a fiscal “glide path,” which is supposed to bring the central government’s deficit below 3% of GDP by March next year.
Italy
Italy Budget Balance
2020 forecast: -2.5% (deficit)
2021 forecast: -2.4%
Italy has increased tax revenues even as the economy struggled, and has plans for a fiscal overhaul starting in the next quarter. It has also introduced a tax on digital sales. But it’s unlikely that the extra money will all be spent. Italy has repeatedly run up against EU-imposed budget limits, and keeping this year’s deficit in line with commitments will be difficult if the country falls into recession.
Brazil
Brazil Budget Balance
2020 forecast: -5.5% (deficit)
2021 forecast: -5.3%
Brazil’s government is committed to trimming deficits, with last year’s overhaul of state pensions as the plan’s long-term centerpiece. The budget shortfall in 2019 was the smallest in five years, though that was partly due to one-time injections of cash, including an oil auction. And while ministers are promising more belt-tightening measures, such as lower salaries for new public servants, they may struggle to persuade lawmakers ahead of municipal elections in October.
Canada
Canada Budget Balance
2020 forecast: -0.9% (deficit)
2021 forecast: -0.9%
Prime Minister Justin Trudeau’s government has already delivered a dose of fiscal stimulus in recent years, providing enough of a boost to allow the Bank of Canada to refrain from cutting interest rates. But the federal government’s ability to continue feeding growth is expected to fade in coming years, given Trudeau’s pledge to keep the country’s public-debt-to-GDP ratio on a declining path.
Russia
Russia Budget Balance
2020 forecast: 1.1% (surplus)
2021 forecast: 0.8%
Russia’s government is gearing up to spend from its $124 billion rainy day fund, after five years of some of the world’s toughest budget austerity. The shift is aimed at boosting the stagnant economy and improving living standards in President Vladimir Putin’s final term as president. Extra spending this year on infrastructure and social support could reach 1.3% of gross domestic product. Further stimulus may be capped by Russia’s budget law, which says revenue from oil above $42 a barrel (it currently trades around $60) must be saved, not spent.
South Korea
South Korea Budget Balance
2020 forecast: -1.3% (deficit)
2021 forecast: -1.4%
South Korea is set to post its first deficit since the global financial crisis as the government tries to support a recovery in exports and consumer spending. The Moon Jae-in administration is front-loading its budget in the first half of this year, and bolstering support for firms hurt by the coronavirus outbreak in China, South Korea’s biggest trading partner. Some lawmakers from the ruling party are calling on the government to go further and draw up a supplementary budget.
Australia
Australia Budget Balance
2020 forecast: 0.3% (surplus)
2021 forecast: 0.2%
Australia’s government is seeking to return its budget to surplus for the first time since 2008. It’s been resisting calls for more spending from central bank chief Philip Lowe, who argues that historically low interest rates offer a chance to finance infrastructure. But the recent wildfires, which devastated the east coast, have forced Treasurer Josh Frydenberg to loosen the purse strings in order to fund reconstruction.
Mexico
Mexico Budget Balance
2020 forecast: -2.4% (deficit)
2021 forecast: -2.3%
As Mexico’s economy stagnated over the last year, President Andres Manuel Lopez Obrador has kept fiscal policy tight. His government has been cutting spending on salaries, helping to deliver a budget surplus before interest payments of 1.1% in 2019 – and the goal is to stay in primary surplus this year. That likely leaves the central bank, which has cut interest rates at five straight meetings, carrying the burden of stimulus for now.
Indonesia
Indonesia Budget Balance
2020 forecast: -2.2% (deficit)
2021 forecast: -2.1%
Indonesia will front-load spending in the first half of 2020 to boost an economy growing at its slowest pace in four years. Its ability to inject more fiscal stimulus is limited by a hard ceiling on the budget deficit of 3% of GDP. That may leave the heavy lifting to the central bank — which delivered another rate cut this week, even though governor Perry Warjiyo insists that the bank “cannot be the only game in town.”
Saudi Arabia
Saudi Arabia Budget Balance
2020 forecast: -6.8% (deficit)
2021 forecast: -6.1%
Saudi Arabia’s budget outcomes usually depend on the price of oil, the kingdom’s main source of revenue. Even before crude slumped this year, the government was expecting a bigger budget deficit in 2020. In an effort to limit the shortfall, it plans to reduce spending by about 3% in 2020 and continue cutting through 2022, part of a wider plan for the private sector to take a more prominent role in the state-dominated Saudi economy.
Turkey
Turkey Budget Balance
2020 forecast: -3.6% (deficit)
2021 forecast: -3.3%
Fiscal easing has propped up growth in Turkey as President Recep Tayyip Erdogan’s preferred engine of stimulus — credit expansion supported by low interest rates — foundered amid a corporate-debt crisis. The government posted an annual deficit of about 3% of GDP last year, when back-to-back elections drove a spending spree, and expects a similar ratio in 2020.
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>>> “Mandate of Heaven” in Jeopardy
BY JAMES RICKARDS
FEBRUARY 17, 2020
https://dailyreckoning.com/mandate-of-heaven-in-jeopardy-2/
“Mandate of Heaven” in Jeopardy
The U.S. markets are closed today for Presidents Day. If you have the day off, I hope you’re enjoying your long weekend.
But one event is taking center stage in the world that affects not only basic survival for millions of people, but the health of the global economy overall.
Of course, I’m talking about the coronavirus outbreak currently playing out before our eyes in China.
China’s economy was slowing substantially before the outbreak of the highly contagious and deadly virus last fall. This slowing was the predictable result of excessive debt levels, Trump’s retaliation in the trade wars, and China’s encounter with what development economists call the “middle-income trap.”
Developing economies can grow at double-digit rates as they move from low-income (about $3,000 annual per capita income) to middle-income (about $10,000 annual per capita income).
The main requirements are limits on corruption, a large pool of available labor, and an attractive legal environment for foreign direct investment. Once investment is used for infrastructure and labor is mobilized, large-scale basic manufacturing can commence.
This powers growth and the accumulation of hard currency reserves from export earnings.
The difficulty begins when an economy tries to move from middle-income to high-income (about $18,000 annual per capita income). That move requires more than cheap labor and infrastructure investment. It requires applied technology to produce high-value added products.
Only Taiwan, South Korea and Singapore have made this transition, (excluding Japan after World War II, and oil-exporting nations).
This explains why China has been so focused on stealing U.S. intellectual property.
Trump has been closing that avenue. China cannot generate the needed technology through its own R&D. China is stuck in the middle-income trap and a slowdown in growth is the inevitable result.
The story gets worse for China.
As of Friday, the total reported number of people infected by the coronavirus was 64,435. And the death toll was up to 1,383, including three people outside of China.
Those figures are official statistics released by China and other countries around the world where the virus has spread.
However, there is substantial medical, anecdotal, and model-based evidence that the actual infection rate and death rate may be ten to twenty times higher than those official statistics.
Over 60 million Chinese in several major cities are under “lock-down” where individuals are confined to their homes and may only leave once every three days to buy groceries.
Streets are empty, stores are closed, trains and planes are not moving, and factories are shut. The Chinese economy is slowly grinding to a halt.
This not only affects China’s economy as a whole, but the contagion filters down into individual companies that are dependent on China both for supply chain inputs and final sales.
And it will have a rippling effect on the U.S. economy also. This story has a long way to run.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Powell Suggests the Fed May Lack Ammo to Combat Next Recession
Bloomberg
By Rich Miller and Craig Torres
February 12, 2020
https://www.bloomberg.com/news/articles/2020-02-12/powell-suggests-the-fed-may-lack-ammo-to-combat-next-recession?srnd=premium
Fed chief says it’s important for fiscal policy to help out
Federal Reserve Chairman Jerome Powell came close to acknowledging that the central bank may not have the firepower to fight the next recession and called on Congress to get ready to help.
The current low level of interest rates “means that it would be important for fiscal policy to support the economy if it weakens,” he told the House Financial Services Committee on Tuesday.
The remark, which came in opening testimony that Powell is due to repeat to a Senate panel on Wednesday, was an unusual appeal by the head of a politically independent institution that is used to combating economic contractions on its own.
But it highlights the difficulties that the Fed and other major central banks face in a world of historically low interest rates and why tax cuts and government spending increases may also be needed to fight future downturns.
Fed has little room to cut rates in a recession
“There is very little central banks can do” when both short- and longer-term rates are near zero, said Mark Spindel, a co-author of a book about the Fed’s relations with Congress. “We are much closer to a fiscal-monetary collaboration. They are out of optimal monetary policy tools.”
Speaking in Strasbourg on Tuesday, European Central Bank President Christine Lagarde was more explicit than Powell about the limits to central bank power. “Monetary policy cannot, and should not, be the only game in town,” she told European lawmakers. Admitting he was “straying a bit” from his remit, Bank of England Governorr Mark Carney also backed the U.K. government’s new spending program.
The Fed is engaged in an in-depth review of its policies and practices that is aimed at finding ways to enhance its recession-fighting abilities.
Powell’s comment on Tuesday though suggests he recognizes that there’s just so much the central bank can do in that regard.
After three reductions last year, the Fed’s target for short-term interest rates now stands at 1.5% to 1.75%, less than half the 500 basis points in cuts it has made to fight past downturns.
Policy Toolkit
Powell said that the Fed would resort to tools it used in the last recession if it’s again forced to lower short-term interest rates to zero.
They are quantitative easing -- in which the Fed buys Treasury bonds to drive down long-term interest rates -- and forward guidance on the future direction of short rates.
The Fed chief though made clear that the central bank would not follow the lead of its counterparts in the euro zone and Japan and push rates below zero. “In the U.S. context, that’s not a tool we’re looking at,” he said.
He also dismissed a suggestion that the central bank consider directly funding the government so it can cut taxes and boost spending in a recession.
“That’s really an untested and not widely supported perspective,” he said.
Policy Coordination
Some economists though think the Fed might have to go that far if the economy turns bad enough.
In a paper last year, former Fed Vice Chairman Stanley Fischer and ex-Swiss National Bank chief Philipp Hildebrand said “unprecedented policy coordination” may be needed to deal with the next downturn, including central banks explicitly financing bigger government budget deficits.
To make room for future fiscal actions to aid the economy, Powell urged lawmakers on Tuesday to rein in budget deficits now.
“Putting the federal budget on a sustainable path when the economy is strong would help ensure that policy makers have the space to use fiscal policy to assist in stabilizing the economy during a downturn,” he said.
His comment came in the wake of the release on Monday of President Donald Trump’s latest budget plans, which would push the gross federal debt above $30 trillion over the next decade.
Some economists argue fiscal policy isn’t a decent substitute for monetary policy when trying to boost economies in the short-term. Harvard University Professor Kenneth Rogoff wrote recently that government stimulus “inevitably involves messy, hard-fought compromises” that limit its effectiveness.
Political Independence
There are dangers for the Fed in collaborating too closely with elected officials because it could undermine its political independence.
Breaking with recent presidential tradition, Trump has repeatedly attacked the central bank for keeping interest rates too high, including posting a tweet on Tuesday that delivered a dig at Powell for his performance on Capitol Hill.
But the president is not alone in seeking favors from the Fed. At Tuesday’s hearing, Democratic Representative Rashida Tlaib from Michigan repeatedly pressed Powell to explain why the central bank hadn’t helped Detroit avoid bankruptcy as it did during the crisis for major U.S. banks.
In the end, economists said there may be no alternative for the Fed in the next contraction but to accept some form of disciplined fiscal-monetary cooperation.
“They are running low on ammunition,” given that they are unlikely to use negative interest rates, said David Beckworth, a senior research fellow at the Mercator Center at George Mason University. “It does seem like they are going to be in a bind in a next recession.”
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>>> China’s Collapse Has Only Begun
BY JAMES RICKARDS
FEBRUARY 3, 2020
https://dailyreckoning.com/chinas-collapse-has-only-begun-2/
China’s Collapse Has Only Begun
The market bounced back today after Friday’s 600-point plunge in the Dow. But we haven’t heard the last of the coronavirus…
We’re still in a period of great uncertainty when it comes to the human and economic cost of the pandemic and the extent of the pandemic itself.
As I write, there are over 17,000 reported cases. Of those, 362 deaths have resulted and 487 people have recovered. The remaining roughly 16,200 cases are in various stages of treatment with uncertain outcomes.
Still, the 2% fatality exhibited so far is comparable to the Spanish flu pandemic of 1919–20, which ultimately killed an estimated 50 million victims.
Almost 99% of the reported cases are in China, with 62.5% of those Chinese cases in the vicinity of Wuhan, a major city of over 11 million people.
But the disease has spread (mostly through air travel from China or contact with Chinese travelers). There are 20 cases in Japan, 19 cases in Thailand and 18 cases in Singapore. The U.S. has 11 reported cases as of this morning.
It often takes laboratories six months or more to discover an effective cure or treatment for a virus of this type.
In the meantime, quarantine is the most effective approach. But how do you quarantine a city of 11 million, let alone a country of 1.3 billion people?
It’s very difficult to project growth rates. But if the virus stays on its current growth trajectory, more than 100 million people could be infected by the end of this month alone.
Many countries have banned arrivals from China and leading airlines have discontinued flights to China. That helps, but the virus continues to spread.
This all comes at a time that should be a period of great joy in China — the Lunar New Year. If you can imagine a two-week Christmas celebration, that’s about the magnitude of it.
While the long-term medical outcome is uncertain, the short-term economic damage is not. And China cannot afford a sustained economic setback.
China’s economy is already suffering extreme damage.
Their consumer economy has stalled as people stay home and avoid public transportation, stores and restaurants. The epicenter of the virus, Wuhan, is the capital of China’s Hubei province, a critical manufacturing center that represents 4% of Chinese GDP.
It now looks like a ghost town.
Many other major Chinese cities have been shut down, with no citizens allowed to leave and transportation systems closed.
Tourism is dead and many businesses are requiring that executives cancel trips to China until further notice.
This comes at a time when the Chinese economy was slowing anyway. And some economists project that China’s growth rate could drop two full percentage points this quarter. That would translate to roughly $62 billion in lost growth.
Meanwhile, Chinese stocks promptly crashed over 8% in a matter of minutes this morning, after being closed for a number of days.
Stimulus measures in the form of monetary ease are being tried. The People’s Bank of China (PBOC) says it will buy 1.2 trillion yuan ($173 billion) in short-term bonds to add liquidity to the financial system.
But the net amount of liquidity that will make it into the system is actually much lower.
According to PBOC data, over 1 trillion yuan ($22 billion) worth of other short-term bonds matured today. So the net amount of liquidity entering the system is actually significantly less than the raw number indicates.
And the stimulus is unlikely to work because of China’s sky-high debt levels. China’s debt-to-GDP ratio, for example, is about 310%, which is astonishing.
Research by economists Ken Rogoff and Carmen Reinhart persuasively demonstrates that once debt surpasses 90% of GDP, it is impossible to grow our way out of the debt. Again, China’s debt-to-GDP ratio is much, much higher.
Let’s hope the coronavirus is contained soon. Unfortunately, the damage to China’s economy is already happening and will persist even if the virus is soon under control.
And given China’s impact on the global economy, the rest of the world will suffer as a result.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> Corporate Debt: A Slow-Motion Train Wreck
FEBRUARY 4, 2020
BY SCHIFFGOLD
https://schiffgold.com/key-gold-news/corporate-debt-a-slow-motion-train-wreck/
Corporate debt has blown through the roof over the last several years. So much so that the Federal Reserve has issued warnings about the increasing levels of corporate indebtedness.
Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid weak credit standards.”
But as Brandon Smith of alt-market.com noted in an article published at LewRockwell.com, this is a subject the mainstream media “seems specifically determined to avoid discussing these days when it comes to the economy.
Smith called corporate debt “the key pillar of the false economy.”
It has been utilized time and time again to keep the Everything Bubble from completely deflating, however, the fundamentals are starting to catch up to the fantasy.”
Business debt skyrocketed to a record $16 trillion in 2019. That represents a 5.1% year-on-year, much faster than economic growth. As a result, debt levels have also reached historic highs in terms of percentage of GDP. According to the Federal Reserve report, debt growth has outpaced economic output “through most of the current expansion.”
Smith pointed out that corporations have been using borrowed money for stock buybacks. He called this the single most vital mechanism behind stock market inflation.
Corporations buy their own stocks, often using cash borrowed from each other and from the Federal Reserve, in order to reduce the number of shares on the market and artificially boost the value of the remaining shares. This process is essentially legal manipulation of equities, and to be sure, it has been effective so far at keeping markets elevated.”
Smith said that corporate stock buybacks appear set to decline in 2020. But he doesn’t think this is because companies want to stop using the tactic. The problem is the amount of accumulated debt is outpacing falling profits. Corporate profits peaked in Q3 2018 and have been falling ever since.
Price-to-Earnings ratio, as well as the Price-to-Sales ratio, are now well above their historic peak during the dot-com bubble, meaning, stocks have never been more overvalued compared to the profits that corporations are actually bringing in.”
It’s not just that massive level of corporate debt that is worrisome. Much of the debt is categorized as risky. The Fed report expressed concern about the high level of leveraged loans and what it describes as “weak underwriting standards.” There are more than$1.1 trillion in leveraged loans outstanding. These are loans made to firms already deeply in debt. Think subprime loans for corporations.
A broad indicator of the leverage of businesses—the ratio of debt to assets for all publicly traded nonfinancial firms—is at its highest level in 20 years.”
As Smith points out, this level of borrowing always comes with consequences.
Even if central banks were to intervene on a level similar to TARP, which saturated markets with $16 trillion in liquidity, the amount of cash needed is so immense and the economic returns so muted that such measures are ultimately a waste of time. The Federal Reserve fueled this bubble, and now there is no stopping its demise. Though, they’re behavior and minimal response to the problem suggests that they have no intention of stopping it anyway.”
Peter Schiff has been saying the record stock market valuations have no real connection to the actual economy. He insists stocks really should be coming down and the only thing really supporting them is the Federal Reserve and all the money they’re printing with their QE program. Smith made a similar point.
While corporations, the Fed and Trump have been putting some effort into keeping stock markets from imploding, the real economy has been evaporating. Global import/exports are crashing, US manufacturing is in recession territory, US GDP is in decline (even according to rigged official numbers), US retail outlets are closing by the thousands, the poverty rate jumped in 30% of US counties in the past year, and high paying jobs are disappearing and being replaced with minimum wage service sector jobs.”
Smith called the corporate debt situation a “slow-motion train wreck.” And as he put it, a slow-motion wreck is still a wreck.
The damage can only be mitigated by removing one’s self from the train, and preparing for the fallout. Do not think that simply because the system has been able to drag it’s nearly lifeless body along for ten years that this means all is well. All bubbles collapse, and corporate debt has already sealed the fate of the Everything Bubble.”
<<<
>>> Elites Have Destroyed a Possible U.S. - Russia Alliance to Contain China
BY JAMES RICKARDS
JANUARY 28, 2020
https://dailyreckoning.com/elites-have-destroyed-a-possible-u-s-russia-alliance-to-contain-china/
Elites Have Destroyed a Possible U.S. - Russia Alliance to Contain China
There’s no need to rehash the sordid politics of the U.S.-Russia relationship since 2014. That relationship became collateral damage to gross corruption in Ukraine.
The U.S. and its allies, especially the UK under globalists like David Cameron, wanted to peel off Ukraine from the Russian orbit and make it part of the EU and eventually NATO.
From Russia’s perspective, this was unacceptable. It may be true that most Americans cannot find Ukraine on a map, but a simple glance at a map reveals that much of Ukraine lies East of Moscow.
Putting Ukraine in a Western alliance such as NATO would create a crescent stretching from Luhansk in the South through Poland in the West and back around to Estonia in the North. There are almost no natural obstacles between that arc and Moscow; it’s mostly open steppe.
Completion of this “NATO Crescent” would leave Moscow open to invasion in ways that Napoleon and Hitler could only dream. Of course, this situation was and is unacceptable to Moscow.
Ukraine itself is culturally divided along geographic lines. The Eastern and Southern provinces (Luhansk, Donetsk, Crimea and Dnipro) are ethnically Russian, follow the Orthodox Church and the Patriarch of Moscow, and welcome commercial relations with Russia.
The Western provinces (Kiev, Lviv) are Slavic, adhere to the Catholic Church and the Pope in Rome, and look to the EU and U.S. for investment and aid.
Prior to 2014, an uneasy truce existed between Washington and Moscow that allowed a pro-Russian President while at the same time permitting increasing contact with the EU. Then the U.S. and UK overreached by allowing the CIA and MI6 to foment a “color revolution” in Kiev called the “Euromaidan Revolution.”
Ukrainian President Viktor Yanukovych resigned and fled to Moscow. Pro-EU protestors took over the government and signed an EU Association Agreement.
In response, Putin annexed Crimea and declared it part of Russia. He also infiltrated Donetsk and Luhansk and helped establish de facto pro-Russian regional governments. The U.S. and EU responded with harsh economic sanctions on Russia.
Ukraine has been in turmoil (with increasing corruption) ever since. U.S.-Russia relations have been ice-cold, exactly as the globalists intended.
The U.S- induced fiasco in Ukraine not only upset U.S.-Russia relations, it derailed a cozy money laundering operation involving Ukrainian oligarchs and Democratic politicians. The Obama administration flooded Ukraine with non-lethal financial assistance.
This aid was amplified by a four-year, $17.5 billion loan program to Ukraine from the IMF, approved in March 2015. Interestingly, this loan program was pushed by Obama at a time when Ukraine did not meet the IMF’s usual borrowing criteria.
Some of this money was used for intended purposes, some was skimmed by the oligarchs, and the rest was recycled to Democratic politicians in the form of consulting contracts, advisory fees, director’s fees, contributions to foundations and NGOs and other channels.
Hunter Biden and the Clinton Foundations were major recipients of this corrupt recycling. Other beneficiaries included George Soros-backed “open society” organizations, which further directed the money to progressive left-wing groups in the U.S.
This cozy wheel-of-fortune was threatened when Donald Trump became president. Trump genuinely desired improved relations with Russia and was not on the receiving end of laundered aid to Ukraine.
Hillary Clinton was supposed to continue the Obama policies, but she failed in the general election. Trump was a threat to everything the globalists, Democrats and pro-NATO elites had constructed in the 2010s.
The globalists wanted China and the U.S. to team up against Russia. Trump understood correctly that China was the main enemy and therefore a closer union between the U.S. and Russia was essential.
The elites’ efforts to derail Trump gave rise to the “Russia collusion” hoax. While no one disputes that Russia sought to sow confusion in the U.S. election in 2016, that’s something the Russians and their Soviet predecessors had been doing since 1917. By itself, little harm was done.
Yet, the elites seized on this to concoct a story of collusion between Russia and the Trump campaign. The real collusion was among Democrats, Ukrainians and Russians to discredit Trump.
It took the Robert Mueller investigation two years finally to conclude there was no collusion between Trump and the Russians. By then, the damage was done. It was politically toxic for Trump to reach out to the Russians. That would be spun by the media as more evidence of “collusion.”
IMG 1
Russian President Vladimir Putin (l.) has recently named a new Prime Minister, Mikhail Mishustin (r.). This is part of a complex government reorganization designed to extend Putin’s rule beyond existing term limits. This is a setback for democracy, but may be a plus for the economy because it adds stability and continuity to Putin’s programs.
This whirl of false charges, cover-ups, and deep state sabotage finally led to Trump’s impeachment on December 18, 2019. Fortunately, the Senate impeachment trial may soon be behind us with Trump’s exoneration in hand (although new impeachment charges and false accusations cannot be ruled out).
Is the stage finally set for improved U.S.-Russia relations, relief from U.S. sanctions, and a significant increase in U.S. direct foreign investment in Russia?
Right now, my models are telling us that Russia is one of the most attractive targets for foreign investment in the world. Just because U.S. policymakers missed the boat does not mean that investors must do the same.
Russia is often denigrated by Wall Street analysts and mainstream economists who know little about the country. Russia is the world’s largest country by area and has the largest arsenal of nuclear weapons of any country in the world.
It has the world’s 11th largest economy at over $1.6 trillion in annual GDP, ahead of South Korea, Spain and Australia and not far behind Canada, Brazil and Italy.
It also is the world’s third largest producer of oil and related liquids, with output of 11.4 million barrels per day, about 11% of the world’s total. The U.S. (17.8 million b/d), Saudi Arabia (12.4 million b/d) and Russia combine to provide 41% of the world’s liquid fuels. The latter two countries effectively control the world’s oil price by agreeing on output quotas.
Russia has almost no external dollar-denominated debt and has a debt-to-GDP ratio of only 13.50% (the comparable ratio for the United States is 106%).
In short, Russia is too big and too powerful to ignore despite the derogatory and uninformed claims of globalists. Importantly, Russia is emerging from the oil price shock of 2014-2016 and is in a solid recovery.
The stage is now set for significant economic expansion as illustrated in the chart below from Moody’s Analytics:
IMG 2
This graphic analysis from Moody’s Analytics divides major economies into categories of Recovery, Expansion, Slowdown and Recession. Economies revolve clockwise through these four phases. The U.S. is in a Slowdown phase with some risk of Recession. Russia is in the Recovery phase heading toward Expansion. The Russian situation is the most attractive for investors because it offers cheap entry points with high returns as the Expansion phase begins.
Russia has also gone to great lengths to insulate itself from U.S. economic sanctions. Their reserves have recovered to the $500 billion level that existed before the 2014 oil price collapse with one important difference. The dollar component of reserves has shrunk substantially while the gold component has increased to over 20%.
With the recent surge in gold prices, Russia’s reserves get a significant boost (when expressed in dollars) because of the higher dollar value of the gold reserves. Gold cannot be hacked, frozen or seized, as is the case with digital dollar assets.
Russia’s fortunes have been improving not only because of low debt and higher gold prices but also because of higher oil prices. The country is poised for a strong expansion, even if U.S. hostility caused by the Democrats continues.
If Trump regains his footing after impeachment and wins a second term (which I expect), investors can expect warmer relations with Russia and an even more powerful Russian economic expansion than the one already underway.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> Russia: The Lost Opportunity
BY JAMES RICKARDS
JANUARY 28, 2020
https://dailyreckoning.com/russia-the-lost-opportunity/
Russia: The Lost Opportunity
The biggest story out of China right now is the coronavirus that I addressed in yesterday’s reckoning.
But while it’s important, the bigger story is the geopolitical dynamic between the U.S., China and Russia.
Today I’m going to address that dynamic and show you how Washington has squandered a major opportunity to turn it in America’s favor.
When future historians look back on the 2010s, they will be baffled by the lost opportunity for the U.S. to mend fences with Russia, develop economic relations and create a win-win relationship between the world’s greatest technology innovator and the world’s greatest natural resources provider.
It will seem a great loss for the world. Here’s the reality:
Russia, China and the U.S. are the only true superpowers and the only three countries that ultimately matter in geopolitics. That’s not a slight against any other power.
But all others are secondary powers (the U.K., France, Germany, Japan, Israel, etc.) or tertiary powers (Iran, Turkey, India, Pakistan, Saudi Arabia, etc.).
This means that the ideal posture for the U.S. is to ally with Russia (to marginalize China) or ally with China (to marginalize Russia), depending on overall geopolitical conditions.
The U.S. conducted this kind of triangulation successfully from the 1970s until the early 2000s.
One of the keys to U.S. foreign policy in the last 50 or 60 years has been to make sure that Russia and China never form an alliance. Keeping them separated was key.
In 1972, Nixon pivoted to China to put pressure on Russia. In 1991, the U.S. pivoted to Russia to put pressure on China after the Tiananmen Square massacre.
Unfortunately, the U.S. has lost sight of this basic rule of international relations. It is now Russia and China that have formed a strong alliance, to the disadvantage of the United States.
China and Russia have forged stronger ties through the Shanghai Cooperation Organization, for example — a military and economic treaty — and the BRICS institutions. Part of it is an anti-dollar campaign.
One leg of the China-Russia relationship is their joint desire to see the U.S. dollar lose its status as the world’s dominant reserve currency. They chafe against the ways in which the U.S. uses the dollar as a financial weapon.
But ultimately, this two-against-one strategic alignment of China and Russia against the U.S. is a strategic blunder by the U.S.
Russia is the nation that the U.S. should have tried to court and should still be courting. That’s because China is the greatest geopolitical threat to the U.S. because of its economic and technological advances and its ambition to push the U.S. out of the Western Pacific sphere of influence.
Russia may be a threat to some of its neighbors, but it is far less of a threat to U.S. strategic interests.
Therefore, a logical balance of power in the world would be for the U.S. and Russia to find common ground in the containment of China and to jointly pursue the reduction of Chinese power.
Of course, that hasn’t happened. And we could be paying the price for years to come.
Regards,
Jim Rickards
for The Daily Reckoning
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The repo situation explained. This is the best explanation I've seen, and shows how the Fed's system worked pre-2009, post-2009 under QE, what happened in September 2009 to the repo market, and the unintended consequences -
Part - 1
>>> Contagion!
BY JAMES RICKARDS
JANUARY 27, 2020
https://dailyreckoning.com/contagion/
Contagion!
The world is confronting the effects of the “coronavirus.” It likely originated in Wuhan, China, where it jumped from animals to humans at a local food market. It has since spread to other parts of China and beyond.
So far, there are 2,886 confirmed total cases of the coronavirus. All but 61 of them are in mainland China. The death toll so far is 81.
But cases have also been found in France, the U.S., Canada, Australia, Japan, South Korea and elsewhere. That list includes the world’s three largest economies (the U.S., China and Japan).
For many, it recalls the SARS outbreak of 2003, which also originated in China. It ultimately killed 774 people and infected more than 8,000 in different parts of the world.
Not surprisingly, global markets are on edge over fears of the “coronavirus” contagion spreading. And the U.S. stock market sold off today.
The Dow lost 454 points. The S&P and Nasdaq also had awful days. But gold has a good day, up over $10 to $1,582, as investors looked for safety.
But let’s discuss the word “contagion,” because it applies to both human populations and financial markets — and in more ways than you may expect.
There’s a reason why financial experts and risk managers use the word “contagion” to describe a financial panic.
Obviously, the word contagion refers to an epidemic or pandemic. In the public health field, a disease can be transmitted from human to human through coughing, shared needles, shared food or contact involving bodily fluids.
An initial carrier of a disease (“patient zero”) may have many contacts before the disease even appears.
Some diseases have a latency period of weeks or longer, which means patient zero can infect hundreds before health professionals are even aware of the disease. Then those hundreds can infect thousands or even millions before they are identified as carriers.
In extreme cases, such as the “Spanish flu” pandemic of 1918–20 involving the H1N1 influenza virus, the number infected can reach 500 million and the death toll can run over 100 million.
A similar dynamic applies in financial panics.
It can begin with one bank or broker going bankrupt as the result of a market collapse (a “financial patient zero.”)
But the financial distress quickly spreads to banks that did business with the failed entity and then to stockholders and depositors of those other banks and so on until the entire world is in the grip of a financial panic as happened in 2008.
Still, the comparison between medical pandemics and financial panics is more than a metaphor.
Disease contagion and financial contagion both work the same way. The nonlinear mathematics and system dynamics are identical in the two cases even though the “virus” is financial distress rather than a biological virus.
But what happens when these two dynamic functions interact? What happens when a biological virus turns into a financial virus?
We’re seeing it happen in China.
It’s the time of the Lunar New Year holiday in China, China’s most important public holiday. It’s traditionally a time of widespread celebration.
But, for many Chinese cities, not this year.
Many major Chinese cities have been shut down, with no citizens allowed to leave, and their transportation systems have been closed.
Retails sales are also suffering as consumers remain home instead of risking contagion with trips to the store.
The disease is causing financial panic in China at a time when it can least afford it. GDP growth has hit a wall and investors have curtailed new investment.
Could it unleash a global financial panic that ultimately results in a lockdown of the banking system?
It’s possible, but it’s far too soon to say. This is the type of catalyst that could take a year to build.
But it definitely bears watching.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Don’t Mess With the U.S. (Financially)
BY JAMES RICKARDS
JANUARY 23, 2020
https://dailyreckoning.com/dont-mess-with-the-u-s-financially/
Don’t Mess With the U.S. (Financially)
I’ve been documenting financial warfare in my articles for years, but it still doesn’t get the mainstream attention it deserves.
Because as you’ll see below, it can directly impact your wealth.
Financial warfare tools include account seizures and freezes, expulsion from global payment systems, secondary fines and penalties on banks that do business with targeted entities, embargoes, tariffs and many other impositions.
These tools are amplified by the unique role of the U.S. dollar, which is the currency behind 60% of global reserves, 80% of global payments and almost 100% of transactions in oil.
The U.S. controls the banks and payments systems that process dollar transactions. This leaves the U.S. well positioned to impose dollar-related sanctions.
Much has been made of the recent killing of Iranian terrorist mastermind Qasem Soleimani. Many say it was an act of war. But guess what, folks?
We’ve been in a full-scale war with Iran for two years now. It’s just that most people don’t realize it.
It’s not a kinetic war with troops, missiles and ships (except Iran’s use of terrorist bombs and the U.S.’ use of drones). And it’s severely damaged the Iranian economy, which has led to protests against the regime.
From the U.S. side, it’s a financial war. People need to stop thinking about financial sanctions as an extension of trade policy, for example.
This is warfare. It’s just a different form of warfare.
It’s critical to understand that financial war is not a sideshow. It may actually be the main event in today’s deeply connected and computerized world.
North Korea is also the current target of a U.S. “maximum pressure” campaign, where harsh sanctions are applied to a wide range of banks, companies and individuals.
As with Iran, sanctions have been instrumental in destabilizing the regime and bringing North Korea to the bargaining table to discuss its nuclear weapons programs.
Now, Iraq is the latest country to feel the sting of U.S. dollar sanctions.
Following the killing of Soleimani on Iraqi soil, Iraq threatened to expel all U.S. troops from Iraq. Trump answered in two parts.
He said U.S. troops would not leave until Iraq repaid the U.S. for building bases and other infrastructure in Iraq. Trump also warned that Iraq’s access to its account at the Federal Reserve Bank of New York could be terminated.
That would make it impossible for Iraq to purchase and sell oil in dollars. It could also cause Iraq to lose access to about $3 billion currently held in that account.
Iraq has heard the U.S. threats loud and clear. As of now, U.S. troops are still in Iraq and not planning to leave anytime soon.
The fact that Iraqi policy could be conditioned without a shot being fired shows the raw power of financial warfare.
The trouble is private businesses and investors can get caught in the crossfire of financial warfare.
According to one survey, last year saw a 42% increase in cyberattacks on private companies around the world (attributable to foreign governments).
About 20% of businesses reported daily attacks, many in the banking and financial services sectors. Only 6% of businesses in the survey claimed they weren’t targeted by a cyberattack in 2019.
You as an investor trying to mind your own business or build wealth or expand your portfolio may get caught in the crossfire of a financial war. So you have to take that into account in your portfolio allocations and risk management.
In today’s world, everyone’s a potential casualty of financial warfare.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> Helicopter Money Is No Panacea
BY JAMES RICKARDS
JANUARY 13, 2020
https://dailyreckoning.com/helicopter-money-is-no-panacea/
Helicopter Money Is No Panacea
In recent decades, the Fed has engaged in a series of policy interventions and market manipulations that have paradoxically left it more powerful even as those interventions left a trail of crashes, collapses and calamities.
This contradiction between Fed omnipotence and Fed incompetence is coming to a head. The economy has been trapped in a prolonged period of subtrend growth. I’ve referred to it in the past as the “new depression.” And the Fed has been powerless to lift the economy out of it.
You may think of depression as a continuous decline in GDP. The standard definition of a recession is two or more consecutive quarters of declining GDP and rising unemployment. Since a depression is understood to be something worse then a recession, investors think it must mean an extra-long period of decline. But that is not the definition of depression.
The best definition ever offered came from John Maynard Keynes in his 1936 classic, The General Theory of Employment, Interest and Money. Keynes said a depression is, “a chronic condition of subnormal activity for a considerable period without any marked tendency towards recovery or towards complete collapse.”
Keynes did not refer to declining GDP; he talked about “subnormal” activity. In other words, it’s entirely possible to have growth in a depression. The problem is that the growth is below trend. It is weak growth that does not do the job of providing enough jobs or staying ahead of the national debt. That is exactly what the U.S. is experiencing today.
Long-term growth is about 3%. From 1994 to 2000, the heart of the Clinton boom, growth in the U.S. economy averaged over 4% per year.
For a three-year stretch from 1983 to 1985 during the heart of the Reagan boom, growth in the U.S. economy averaged over 5.5% per year. These two periods were unusually strong, but they show what the U.S. economy can do with the right policies. By contrast, growth in the U.S. from 2007 through today has averaged something like 2% per year.
That is the meaning of depression. It is not negative growth, but it is below-trend growth. And growth under Trump has been no greater than it was under Obama.
The bigger problem is there’s no way out, as I said. One manipulation leads to another. My greatest fear is that the U.S. is becoming like Japan, which has used every trick in the book to no avail.
In my 2014 book, The Death of Money, I wrote, “The United States is Japan on a larger scale.” That was six years ago now.
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 real end in sight.
What I referred to in 2014 was 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.
Now in 2020, central banks have been cutting rates again, as the trade war and slowing global growth have policymakers considering the implications of a new recession without the firepower they need. As things stand, the next recession may be impossible to get out of. And the odds of avoiding a recession are low.
The only way out is for the Fed to guarantee inflation “whatever it takes.” Nothing else has worked. So why not try a more active fiscal policy? Why not load the helicopters with cash and dump it out over Main Street?
First, we need to understand what helicopter money is, and what it isn’t.
The image of the Fed printing paper money, and dumping it from helicopters to consumers waiting below who scoop it up and start spending is a popular, but not very informative way to describe helicopter money.
In reality, helicopter money is the coordination of fiscal policy and monetary policy in a way designed to provide stimulus to a weak economy and to fight deflation.
Helicopter money starts with larger deficits caused by higher government spending. This spending is considered to have a multiplier effect. For each dollar of spending, perhaps $1.50 of additional GDP is created since the recipients of the government spending turn around and spend that same money on additional goods and services. The U.S. Treasury finances these larger deficits by borrowing the money in the government bond market.
Normally this added borrowing might raise interest rates. The economic drag from higher rates could cancel out the stimulus of higher spending and render the entire program pointless.
This is where the Fed steps in. The Fed can buy the additional debt from the Treasury with freshly printed money. The Fed also promises to hold these newly purchased Treasury bonds on its balance sheet until maturity.
By printing money to neutralize the impact of more borrowing, the economy gets the benefit of higher spending, without the headwinds of higher interest rates. The result is mildly inflationary offsetting the feared deflation that would trigger helicopter money in the first place.
It’s a neat theory, but it’s full of holes.
The first problem is there’s not much of a multiplier at this stage of the U.S. expansion. The current expansion is already the longest in U.S. history. It’s also been the weakest expansion in history, but an expansion nonetheless. The multiplier effect of government spending is strongest at the beginning of an expansion when the economy has more spare capacity in labor and capital.
At this point, the actual multiplier is probably less than one. For every dollar of government spending, the economy might only get $0.90 of added GDP; not the best use of borrowed money.
The second problem with helicopter money is there is no assurance that citizens will actually spend the money the government is pushing into the economy. They are just as likely to pay down debt or save any additional income. This is the classic “liquidity trap.” This propensity to save rather than spend is a behavioral issue not easily affected by monetary or fiscal policy.
Finally, there is an invisible but real confidence boundary on the Fed’s balance sheet. After printing $4 trillion in response to the last financial crisis, how much more can the Fed print without risking confidence in the dollar itself?
Quantitative tightening brought the balance sheet back down to $3.8 trillion. But now it’s over $4 trillion again, as the Fed has added hundreds of billions to its balance sheet since September, when it starting shoring up short-term money markets. It’s basically been “QE-lite.”
Modern monetary theorists and neo-Keynesians say there is no limit on Fed printing, yet history says otherwise.
Importantly, with so much U.S. government debt in foreign hands, a simple decision by foreign countries to become net sellers of U.S. Treasuries is enough to cause interest rates to rise thus slowing economic growth and increasing U.S. deficits at the same time.
If such net selling accelerates, it could lead to a debt-deficit death spiral and a U.S. sovereign debt crisis of the type that hit Greece and the Eurozone periphery in recent years.
In short, helicopter money could have far less potency and far greater unintended negative consequences than its supporters expect.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> “Last Hurrah” for Central Bankers
BY JAMES RICKARDS
JANUARY 13, 2020
https://dailyreckoning.com/last-hurrah-for-central-bankers/
“Last Hurrah” for Central Bankers
We’ve all seen zombie movies where the good guys shoot the zombies but the zombies just keep coming because… they’re zombies!
Market observers can’t be blamed for feeling the same way about former Fed Chair Ben Bernanke.
Bernanke was Fed chair from 2006–2014 before handing over the gavel to Janet Yellen. After his term, Bernanke did not return to academia (he had been a professor at Princeton) but became affiliated with the center-left Brookings Institution in Washington, D.C.
Bernanke is proof that Washington has a strange pull on people. They come from all over, but most of them never leave. It gets more like Imperial Rome every day.
But just when we thought that Bernanke might be buried in the D.C. swamp, never to be heard from again… like a zombie, he’s baaack!
Bernanke gave a high-profile address to the American Economic Association at a meeting in San Diego on Jan. 4. In his address, Bernanke said the Fed has plenty of tools to fight a new recession.
He included quantitative easing (QE), negative interest rates and forward guidance among the tools in the toolkit. He estimates that combined, they’re equal to three percentage points of additional rate cuts. But that’s nonsense.
Here’s the actual record…
That QE2 and QE3 did not stimulate the economy at all; this has been the weakest economic expansion in U.S. history. All QE did was create asset bubbles in stocks, bonds and real estate that have yet to deflate (if we’re lucky) or crash (if we’re not).
Meanwhile, negative interest rates do not encourage people to spend as Bernanke expects. Instead, people save more to make up for what the bank is confiscating as “negative” interest. That hurts growth and pushes the Fed even further away from its inflation target.
What about “forward guidance?”
Forward guidance lacks credibility because the Fed’s forecast record is abysmal. I’ve counted at least 13 times when the Fed flip-flopped on policy because they couldn’t get the forecast right.
So every single one of Bernanke’s claims is dubious. There’s just no realistic basis to argue that these combined policies are equal to three percentage points of additional rate cuts.
And the record is clear: The Fed needs interest rates to be between 4% and 5% to fight recession. That’s how much “dry powder” the Fed needs going into a recession.
In September 2007, the fed funds rate was at 4.75%, toward the high end of the range. That gave the Fed plenty of room to cut, which it certainly did. Between 2008 and 2015, rates were essentially at zero.
The current fed funds target rate is between 1.50% and 1.75%. I’m not forecasting a recession this year, but if we do have one, the Fed doesn’t have anywhere near the room to cut as it did to fight the Great Recession.
I’m not the only one to make that point. Here’s what former Treasury Secretary Larry Summers said:
[Bernanke] argued that monetary policy will be able to do it the next time. I think that’s pretty unlikely given that in recessions we usually cut interest rates by five percentage points and interest rates today are below 2%… I just don’t believe QE and that stuff is worth anything like another three percentage points.
Summers goes on to call Bernanke‘s speech “a kind of last hurrah for the central bankers.”
He’s right. But if monetary policy isn’t the answer, what does Summers think the answer is?
Fiscal policy. The government is going to have to spend money directly into the economy instead of relying upon some trickle-down “wealth effect” to stimulate the economy.
Here’s what Summers said:
“We’re going to have to rely on putting money in people’s pockets, on direct government spending.”
Remember the term “helicopter money”? Milton Friedman coined the term 50 years ago when he made the analogy of dropping money from a helicopter to illustrate the effects of aggressive fiscal policy.
That’s essentially what Summers is advocating. It might sound a lot like the idea behind Modern Monetary Theory, or MMT, but it’s not necessarily the same thing. MMT takes helicopter money to a whole new level, and Summers has actually been highly critical of MMT.
But the idea of direct government spending to stimulate the economy is the same, and it’s gaining traction in official circles.
There’s good reason to believe it’s coming to a theater near you. And maybe sooner than you think.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> A New Gold Standard: Orderly or Chaotic?
BY JAMES RICKARDS
JANUARY 7, 2020
A New Gold Standard: Orderly or Chaotic?
Over the past century, monetary systems change about every 30 to 40 years on average. Before 1914, the global monetary system was based on the classical gold standard.
Then in 1945, a new monetary system emerged at Bretton Woods. I was at Bretton Woods this past summer to commemorate its 75th anniversary.
Under that system, the dollar became the global reserve currency, linked to gold at $35 per ounce. In 1971 Nixon ended the direct convertibility of the dollar to gold. For the first time, the monetary system had no gold backing.
Today, the existing monetary system is nearly 50 years old, so the world is long overdue for a change. Gold should once again play a leading role.
I’ve written and spoken publicly for years about the prospects for a new gold standard. My analysis is straightforward.
International monetary figures have a choice. They can reintroduce gold into the monetary system either on a strict or loose basis (such as a “reference price” in monetary policy decision making).
This can be done as the result of a new monetary conference, a la Bretton Woods. It could be organized by some convening power, probably the U.S. working with China.
Or they can ignore the problem, let a debt crisis materialize (that will play out in interest rates and foreign-exchange markets) and watch gold soar to $14,000 per ounce or higher, not because they wanted it to but because the system is out of control.
I’ve also said that the former course (a conference) is more desirable, but the latter course (chaos) is more likely. A monetary conference would be far preferable. Why not avoid the train wreck rather than clear up the wreckage? But will probably be ignored until it’s too late. Either way, the price of gold soars.
The same force that made the dollar the world’s reserve currency is working to dethrone it. It was at Bretton Woods that the dollar was officially designated the world’s leading reserve currency — a position that it still holds today.
Under the Bretton Woods system, all major currencies were pegged to the dollar at a fixed exchange rate. The dollar itself was pegged to gold at the rate of $35 per ounce. Indirectly, the other currencies had a fixed gold value because of their peg to the dollar.
Other currencies could devalue against the dollar, and therefore against gold, if they received permission from the International Monetary Fund (IMF). However, the dollar could not devalue, at least in theory. It was the keystone of the entire system — intended to be permanently anchored to gold.
From 1950–1970 the Bretton Woods system worked fairly well. Trading partners of the U.S. who earned dollars could cash those dollars into the U.S. Treasury and be paid in gold at the fixed rate.
Trading partners of the U.S. who earned dollars could cash those dollars into the U.S. Treasury and be paid in gold at the fixed rate.
In 1950, the U.S. had about 20,000 tons of gold. By 1970, that amount had been reduced to about 9,000 tons. The 11,000-ton decline went to U.S. trading partners, primarily Germany, France and Italy, who earned dollars and cashed them in for gold.
The U.K. pound sterling had previously held the dominant reserve currency role starting in 1816, following the end of the Napoleonic Wars and the official adoption of the gold standard by the U.K. Many observers assume the 1944 Bretton Woods conference was the moment the U.S. dollar replaced sterling as the world’s leading reserve currency.
In fact, that replacement of sterling by the dollar as the world’s leading reserve currency was a process that took 30 years, from 1914 to 1944.
In fact, the period from 1919–1939 was really one in which the world had two major reserve currencies — dollars and sterling — operating side by side.
Finally, in 1939, England suspended gold shipments in order to fight the Second World War and the role of sterling as a reliable store of value was greatly diminished. The 1944 Bretton Woods conference was merely recognition of a process of dollar reserve dominance that had started in 1914.
The significance of the process by which the dollar replaced sterling over a 30-year period has huge implications for you today. Slippage in the dollar’s role as the leading global reserve currency is not necessarily something that would happen overnight, but is more likely to be a slow, steady process.
Signs of this are already visible. In 2000, dollar assets were about 70% of global reserves. Today, the comparable figure is about 62%. If this trend continues, one could easily see the dollar fall below 50% in the not-too-distant future.
It is equally obvious that a major creditor nation is emerging to challenge the U.S. today just as the U.S. emerged to challenge the U.K. in 1914. That power is China. The U.S. had massive gold inflows from 1914-1944. China has been experiencing massive gold inflows in recent years.
Gold reserves at the People’s Bank of China (PBOC) increased to 1948.31 tonnes in the fourth quarter of 2019. For comparison, it held 1,658 tonnes in June, 2015.
But China has acquired thousands of metric tonnes since without reporting these acquisitions to the IMF or World Gold Council.
Based on available data on imports and the output of Chinese mines, actual Chinese government and private gold holdings are likely much higher. It’s hard to pinpoint because China operates through secret channels and does not officially report its gold holdings except at rare intervals.
China’s gold acquisition is not the result of a formal gold standard, but is happening by stealth acquisitions on the market. They’re using intelligence and military assets, covert operations and market manipulation. But the result is the same. Gold’s been flowing to China in recent years, just as gold flowed to the U.S. before Bretton Woods.
China is not alone in its efforts to achieve creditor status and to acquire gold. Russia has greatly increased its gold reserves over the past several years and has little external debt. The move to accumulate gold in Russia is no secret, and as Putin advisor, Sergey Glazyev told Russian Insider has said, “The ruble is the most gold-backed currency in the world.”
Iran has also imported massive amounts of gold, mostly through Turkey and Dubai, although no one knows the exact amount, because Iranian gold imports are a state secret.
Other countries, including BRICS members Brazil, India and South Africa, have joined Russia and China in their desire to break free of U.S. dollar dominance.
Sterling faced a single rival in 1914, the U.S. dollar. Today, the dollar faces a host of rivals. The decline of the dollar as a reserve currency started in 2000 with the advent of the euro and accelerated in 2010 with the beginning of a new currency war.
The dollar collapse has already begun and the need for a new monetary order will need to emerge. The question is whether it will be an orderly process resulting from a new monetary conference, or a chaotic one.
Unfortunately, it’ll probably be chaotic. Don’t count on the elites to act in time.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> Rickards: Here’s Where Gold Will Be in 2026
The Daily Reckoning
BY JAMES RICKARDS
JANUARY 7, 2020
Rickards: Here’s Where Gold Will Be in 2026
Dear Reader,
Gold spiked after last Friday’s drone strike that took out a top Iranian military official and is trading at seven-year highs.
Yes, the news was dramatic and made a major impact. But geopolitics is just one factor driving gold. Even without the latest geopolitical tensions, gold is poised for a historic run.
The first two major gold bull markets were 1971–80 and 1999–2011. Today, gold is in the early stages of its third bull market in 50 years.
If we simply average the performance of the past two bull markets and extend the new bull market on that basis, we would expect to see prices peak at $14,000 per ounce by 2026.
What’s driving the new gold bull market?
From both long-term and short-term perspectives, there are three principal drivers: geopolitics, supply and demand and Fed interest rate policy (the dollar price of gold is just the inverse of dollar strength. A strong dollar = a lower dollar price of gold, and a weak dollar = a higher dollar price of gold. Fed rate policy determines if the dollar is strong or weak).
The first two factors have been driving the price of gold higher since 2015 and will continue to do so. Geopolitical hot spots like Iran, Korea, Crimea, Venezuela, China and Syria remain unresolved. Some are getting worse.
Each flare-up drives a flight to safety that boosts gold along with Treasury notes, as the latest incident shows.
The supply/demand situation remains favorable with Russia and China buying over 50 tons per month to build up their reserves while global mining output has been flat for at least five years.
The third factor, Fed policy, is the hardest to forecast and the most powerful on a day-to-day basis.
But there’s little chance that the Fed will be raising rates anytime soon. It’s much more likely to cut rates as the U.S. economy faces strong headwinds, especially from rising debt levels. Debt is growing faster than the economy.
Debt is now at the highest levels since World War II. We’re nearly in the same position on a relative basis as we were in 1945.
Because of the natural deflationary state of the world and the high debt-to-GDP ratio, growth has been snuffed out.
And based on Congressional Budget Office (CBO) projections — which I think are conservative — the debt-to-GDP ratio is going to keep going up.
There is no way out except inflation.
Add it all up and the environment is highly favorable for gold. But if you want evidence that owning gold is probably the best way to guard your wealth, just look at the “smart money.”
I’m sure you’ve seen plenty of billionaire hedge fund managers on business TV or streaming live from Davos. They like to discuss their investments in Apple, Amazon, Treasury notes and other stocks and bonds.
They love to “talk their book” in the hope that other investors will piggyback on their trades, run up the price and produce more profits for them.
What they almost never discuss in public is gold. After all, why have gold when stocks and bonds are so wonderful?
Well, I worked on Wall Street and in the hedge fund industry for decades. I also lived among the players in New York and Greenwich, Connecticut, at the same time. I’ve met the top hedge fund gurus in private settings. And here’s the thing:
I’ve never met one of them who does not have a large hoard of physical gold stored safely in a nonbank vault. Not one.
Of course, they won’t say so on TV because they don’t want to spook retail investors into dumping stocks and bonds. But watch what they do, not what they say.
If gold bullion is the go-to asset for billionaires, why don’t small investors have at least a 10% allocation to gold and silver bullion just in case?
Some do, but most don’t. They’ll find out the hard way what individuals have learned over centuries and millennia. Gold preserves wealth; paper assets do not.
Below, I show you why a global monetary reset is coming, with gold at its center. It can either be an orderly process — or a chaotic one.
Which will it likely be? Read on.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
QE Forever? - >>> Fed Wins Year-End Repo Battle, But War to Control Rates Drags On
Bloomberg
By Alex Harris
December 30, 2019
https://www.bloomberg.com/news/articles/2019-12-30/fed-wins-year-end-repo-battle-but-war-to-control-rates-drags-on?srnd=premium
Recent repo action results suggest year-end pressure abating
Questions remain about how Fed pares back liquidity measures
The Federal Reserve may have succeeded in thwarting major year-end turmoil in funding markets, but 2020 is likely to bring a whole new set of concerns.
The U.S. central bank has been injecting liquidity into markets through repurchase-agreement operations since mid-September in a bid to keep control of short-end rates. Earlier this month ramped up its offerings to help smooth the market’s path into January. It has also been bolstering system reserves through Treasury bill purchases.
The results of the most recent repo actions, which were undersubscribed, suggest that there is now ample funding for the year-end turn. That means the kind of spike seen in September -- when overnight repo rates surged to 10% from around 2% -- is unlikely to be repeated for now. Whether the Fed can end its interventions without chaos re-emerging, though, is less clear.
“Stopping operations will be difficult since the market is still short of reserves when excluding repo operations,” said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities. “If the Fed were to pare back liquidity too quickly, they could risk sparking another shortage.”
Chairman Jerome Powell said during his press conference following the Dec. 11 Federal Open Market Committee meeting that there would come a time when it’s appropriate for overnight and term repo operations to “gradually decline.” He did not, however, offer any indication as to when that would be and officials have so far said they would conduct the repo operations through January. The release of the minutes from that meeting on Friday could provide more hints as to how policy makers are thinking about removing temporary liquidity from the system.
The Fed has provided roughly $230 billion of liquidity for the end of the year to avoid a cash crunch. There is also a further $150 billion of overnight money available at its final overnight operation of 2019 on Tuesday, although close to $31 billion in existing overnight funding will also be rolling off that day.
The Fed has injected more than $200 billion of temporary funding
Mark Cabana, head of U.S. interest rates strategy at Bank of America, expects the Fed’s repo offerings to continue beyond January, but reckons officials will adjust the interest rate on operations rather than the size of them, when the time comes.
“If they boost the rate, the dealers will likely naturally decrease reliance on the Fed for funding,” he said. “This is especially true since bill purchases keep adding reserves.”
On top of the temporary liquidity that’s been added via repo operations, the Fed has also bolstered permanent reserves by around $157 billion through its bill-purchase program, and that is set to continue at a pace of $60 billion per month until some time in the second quarter at least.
Powell has also said the Fed would be willing to extend its reserve-management purchases of Treasuries to coupon-bearing securities, if needed, although such a move could add fuel to the debate about whether the program can be considered quantitative easing.
TD’s Goldberg said the Fed won’t begin weaning the market off of repo operations until the end of the first quarter or the beginning of the second, once the central bank has had a chance to increase the reserves in the system. Any earlier risks upending the repo market once again.
“The Fed will not want to exit repo operations until they are absolutely certain the market can stand on its own two feet,” he said.
<<<
>>> Say Goodbye to Banking as We Know It
China is poised to launch the first national digital currency. There will be no counting the disruption.
Bloomberg
By Andy Mukherjee
December 29, 2019
https://www.bloomberg.com/opinion/articles/2019-12-29/china-has-edge-over-silicon-valley-to-end-banking-as-we-know-it
So is China readying its own Bitcoin? Banish the thought.
It’s far bigger than that. Yes, just like any other cryptocurrency — or for that matter, cigarettes in prisoners-of-war camps — the upcoming digital yuan will be “tokenized” money. But the similarity ends there. The crypto yuan, which may be on offer as soon as 2020, will be fully backed by the central bank of the world’s second-largest economy, drawing its value from the Chinese state’s ability to impose taxes in perpetuity. Other national authorities are bound to embrace this powerful idea.
Little is known about the digital yuan except that it’s been in the works for five years and Beijing is nearly ready to roll. The consensus is that the token will be a private blockchain, a peer-to-peer network for sharing information and validating transactions, with the People’s Bank of China in control of who gets to participate. To begin with, the currency will be supplied via the banking system and replace some part of physical cash. That won’t be hard, given the ubiquitous presence of Chinese QR code-based digital wallets such as Alipay and WeChat Pay.
It may start small, but the digital yuan can disrupt both traditional banking and the post-Bretton Woods system of floating exchange rates that the world has lived with since 1973. No wonder that for China, “blockchain and the yuan digital currency are a national strategic priority — almost at the level of the internet,” says Sanford C. Bernstein & Co. fintech analyst Gautam Chhugani.
Ever since the advent of the 17th-century goldsmith-banker in London, the most crucial thing in banking has been the ledger, a repository of irrefutable records to establish trust in situations where it doesn’t exist. When Peter in Vancouver agrees to send money to Paul in Singapore, they’re forced to use a chain of interlinked intermediaries because there’s no ledger in the world with both of them on it. Blockchain’s distributed ledgers make trust irrelevant. Paul devises a secret code, and shares its encrypted version with Peter, who uses it to create a digital contract to pay Paul. A cumbersome and expensive network of correspondent banks becomes redundant, especially when it comes to the $124 trillion businesses move across borders annually. Imagine the productivity boost; picture the threat to lenders.
China isn’t the only one experimenting. Fast, cheap cross-border payment settlement is one application of JPMorgan Chase & Co.’s Quorum, an Ethereum-based platform on which the Monetary Authority of Singapore is running Project Ubin, an exploration into central bank digital money. These are early days, but if blockchain technology shows promise in handling a large number of transactions simultaneously, then digital currencies could become substitutes not just for physical cash but also for bank reserves.
That’s when the game changes. Reserves at a central bank are maintained by deposit-taking lenders. A digital yuan — or Singapore dollar or Indian rupee — could bypass this system and allow any holder of the currency to have a deposit at the central bank, potentially making the state the monopoly supplier of money to retail customers. As Agustin Carstens, the general manager at the Bank for International Settlement, noted recently, “If the central bank becomes everybody’s deposit-taker, it may find itself becoming everybody’s lender too.”
But why would central banks want to demote their own banking systems? One answer, looking at Europe and Japan, is that negative interest rates are doing that anyway. Lenders are starved of profit because while the central bank charges them for keeping money on deposit, they can’t as easily pass on those negative interest rates to their own depositors. If the global economy gets mired in long-term stagnation, official digital currencies will at least be an efficient way of monetary easing without involving banks.
The other, more concrete, reason may be that technological progress is making the status quo untenable. It’s no coincidence that China hastened its national cryptocurrency after Facebook Inc. announced the Libra project, which was touted as an alternative dollar. Perhaps that was fanciful, and the Libra has hit a wall of regulatory concerns. But if they’re offered like Spotify gift cards at the local 7-Eleven, there will be demand for tokens that are acceptable across borders, stable in value against baskets of national currencies, and can be used in global trade and investing. Someone in Silicon Valley will eventually succeed, blowing away the fig leaf of monetary sovereignty in emerging markets in the process.
The changes won’t end with banking and monetary arrangements. Token transactions will be pseudonymous: If the central bank wants to see who’s spending where, it can. Anonymity disappears when cash does. While that will make life difficult for money launderers and terrorists, it could also become a tool to punish political activism. Meanwhile, currency as a foreign policy weapon loses some sting. Pariah states will covet a crypto they can access by circumventing banks that are terrified of flouting Western sanctions. As Harvard University economist Kenneth Rogoff notes, technology “is on the verge of disrupting America’s ability to leverage faith in its currency to pursue its broader national interests.”
A roller-coaster decade — not just for for banking and money but also for privacy and politics — may just be beginning.
<<<
>>> The Fed Is Entrenched in the Repo Market. How Does It Get Out?
Bloomberg
By Alex Harris
December 21, 2019
https://www.bloomberg.com/news/articles/2019-12-21/the-fed-is-entrenched-in-the-repo-market-how-does-it-get-out?srnd=premium
The central bank has plans to keep intervening into 2020
Participants want answers from Fed about long-term plans
At the Federal Reserve, 2020 will be all about making the repo market boring again. Policy makers will find this easier said than done.
The central bank’s liquidity injections -- including almost half a trillion dollars earmarked to ensure New Year’s Eve is a snooze -- and Treasury bill purchases have nudged the vital market for repurchase agreements back toward normalcy after a funding crunch sent rates soaring in September. This has anchored the Fed’s benchmark rate firmly within policy makers’ preferred range of 1.50% to 1.75% and caused T-bill yields to fall.
But next year will test whether the Fed can end its interventions without chaos re-emerging. Chairman Jerome Powell recently said the Fed isn’t trying to eliminate all volatility from markets. However, if the repo market is erratic, it signals the Fed doesn’t have good control over the financial system’s plumbing. That’s something policy makers and the broader market can’t tolerate.
“It is all about credibility,” said Peter Yi, senior vice president of short duration fixed income at Northern Trust Asset Management in Chicago. “Even if you announce some fancy new trains, you also have to make sure they run on time. The Fed is going to have an important role in how 2020 plays out.”
Since the rate on overnight repo spiked to 10% on Sept. 17 from around 2%, the central bank has been conducting overnight and term repo operations to help rebuild banking reserves, adding $237 billion of liquidity. It’s also prepared to inject up to $490 billion around Dec. 31.
The central bank has injected more than $200 billion of temporary funding
This year proved the repo market isn’t working without the Fed’s help, and the next issue is how to wean the market off of these liquidity injections without causing a disruption, according to Lale Topcuoglu, senior fund manager and head of credit at J O Hambro Capital Management Ltd.
“We may have December in control,” Topcuoglu said on Bloomberg Television. “The question is, there’s January. There’s February. There’s March quarter-end. There’s April.”
The last month on her list could be especially tricky. The U.S. tends to issue fewer Treasury bills in April because Americans’ income-tax payments leave the government flush with cash. This could eventually create “intense competition” for T-bills, especially with government-fund assets at record levels, said Jefferies money-market economist Thomas Simons. That could drive bill rates even lower.
Money-market fund managers are already having to adjust their allocations. Rob Sabatino, global head of liquidity at UBS Asset Management, said the Fed’s intervention has caused funds to put less into repo and move out of T-bills and into coupons in order to boost their returns by a few basis points.
If downward pressure continues on short-term rates, Sabatino said money funds may opt to return to the central bank’s infrequently used overnight reverse repo facility. Usage of that program has dwindled to $5 billion a day in 2019, down from $11.9 billion in 2018.
The Fed says it plans to buy $60 billif T-bills to keep boosting reserves until sometime in the second quarter. But the timing is fluid given that policy makers haven’t figured out exactly how much the appropriate level of reserves is. Officials have said it’s probably at least where reserves were in September, which was about $1.3 trillion. Strategists at TD Securities and Bank of America suspect it’ll end up around $1.6 trillion to $1.7 trillion.
“The Fed has not given the market really any good guidance about what the end game is, and frankly it’s high time,” said Mark Cabana, head of U.S. interest rate strategy at Bank of America. He wants more concrete guidance on the level of reserves the central bank is targeting and on the prospects for regulatory changes.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said in October that the bank was unable to deploy cash to calm the market because of liquidity regulations put in after the 2008 financial crisis. Powell said he’s open to ideas for modifying supervisory practices that don’t undermine the safety and soundness of the financial system.
Many market participants want a sense from the Fed on whether it will create a standing repo facility, a tool that would let eligible banks convert Treasuries into reserves on demand at an administered rate. Powell said Dec. 11 that it will take some time to evaluate and create parameters for that.
Northern Trust’s Yi said the Fed will eventually have to establish a more permanent facility with expanded counterparties, as well as continue bill purchases to boost excess reserves. Given Powell’s comments, UBS’s Sabatino is skeptical the central bank will ever introduce such a tool, even though many are clamoring for it.
“I wouldn’t hold my breath on a standing repo facility in the first half of next year or any time at all,” he said.
This lack of clarity on the Fed’s long-term objectives increases the likelihood the central bank becomes more entrenched in the daily fabric of the funding markets. That will make it harder for the space to function on its own and even more difficult for policy makers to untangle themselves.
“Every single day we’re getting our funding from the Fed, that starts to get ingrained in the business,” said NatWest Markets strategist Blake Gwinn. “The longer they go on as the major source of liquidity, the harder it’s going to be to extricate themselves.”
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That repo article helps to de-mystify what has been happening in the repo market, and the Fed's dramatic response since September.
So it thankfully isn't the finance ghouls purposely trying to induce the SDR transition. But it may mean that the financial system can't function without some type of 'QE-forever', which suggests that we've entered into the endgame. Like a heroin addict, the financial system can no longer survive without constant infusions from the Fed.
So at minimum, we can probably forget about the Fed's dream of 'normalization'. The Fed's balance sheet was 800 bil in 2007, and ballooned dangerously to 4.5 trillion, then was briefly trimmed back to 3.8 tril, but now is back to 4.5 tril and heading higher.
As Rickards points out, there is an upper limit to how high the Fed's balance sheet can get. The limit is determined by confidence in the dollar. A completely fiat currency like the dollar only has 'value' for as long as people have confidence in it. It's a confidence game, so at what level will confidence be lost? A Fed balance sheet of 8 tril, 10 tril, 15 tril? Looks like we're going to find out.
Rickards has discussed the ways this can end -- either the Fed gradually reaches the tipping point where confidence is lost, or more likely, a financial crisis or recession hits that is too big for the tapped out Fed to handle, and then the IMF has to bail out the Fed and world with SDRs.
Rickards thinks the crisis scenario is most likely, but says that another possibility (fairly remote) is that the global financiers will realize their predicament and proactively move to a new system, similar to how the Bretton Woods agreement occurred after WW 2. This new system would likely be the SDRs, so either way, our future will be with the SDRs of the IMF.
>>> Repo Oracle Zoltan Pozsar Expects Even More Turmoil
The Credit Suisse analyst foresaw the recent trouble in the financial system’s plumbing. He says it’s not over.
Bloomberg
December 20, 2019
https://www.bloomberg.com/news/articles/2019-12-20/repo-oracle-zoltan-pozsar-expects-even-more-turmoil?srnd=premium
In September an often overlooked but vital part of the global financial system short-circuited. It’s called the overnight repurchase agreement, or “repo,” market, and when it seized up, the interest rate that institutional borrowers had to pay for very short-term loans went (briefly) through the roof.
In the aftermath, people in the market sought answers—to understand both what had gone wrong and the risk of it happening again. Many have turned to a Credit Suisse Group AG analyst named Zoltan Pozsar, who predicted the breakdown with almost eerie accuracy in an August research note.
Pozsar has some bad news: There’s more trouble ahead. Despite the Federal Reserve’s recent move to pump almost $500 billion into the repo market to prevent a yearend funding squeeze, deep-rooted problems remain.
U.S. Dollar Overnight General Collateral Repurchase Agreement Rate
Last price
The extent of those problems could become clear before the close of 2019, as banks scramble to get their books in order for regulators. “If the yearend is less of a problem because of the repo bazooka we got from the Fed, and if the message of my report played a part in getting that bazooka, then that’s a nice way to be proven wrong,” Pozsar says. “But now we’re getting into a point in the year when balance-sheet problems are going to flare up, and I think the system will get gummed up again.”
If he’s right, it means there’s something amiss in a more than $2 trillion market that lubricates the gears of finance. The repo market is where the cash-rich of the financial system lend to the cash-poor, with banks, money-market funds, hedge funds, broker-dealers, asset-managers, and others borrowing and lending to each other short-term. While borrowers in this system have plenty of longer-term assets, on a day-to-day basis they may not have the liquidity they need. Repo lets them borrow cash against those assets to tide them over.
In finance, a lack of liquidity “kills you quick,” says Perry Mehrling, a Boston University economics professor who co-authored a 2013 paper with Pozsar. “How do you not get killed by liquidity? By rolling it over. By saying, ‘I can’t make the payment today. I’ll make it tomorrow.’ That’s basically what overnight repo does.”
On Sept. 17, throughout Wall Street, fund managers were suddenly hurting for this short-term cash, and big banks seemed unwilling or unable to provide it. At the heart of Pozsar’s argument is the idea that two grand experiments—one in monetary policy, the other in regulation—have collided to make the repo market more prone to clogging up in this way.
The monetary experiment is quantitative easing. After the financial crisis, the Fed began stimulating the economy by buying bonds. The money it spent to do so added to the excess reserves held by banks. After years of QE, big banks became accustomed to always having cash to lend in the repo market—they were swimming in excess reserves.
But then the Fed began tapering off QE, buying fewer bonds and reducing the excess reserves in the system. There’s still a lot, but this is where the regulatory experiment comes in. To prevent a repeat of the 2008 crash, bank watchdogs have tightened rules in such a way that the biggest lenders feel they have to keep more reserves on hand. So falling reserves and banks’ desire to hold on to more began to pinch.
At the same time, other financial players were starting to rely more on the repo market. “There’s been a very sharp increase in the demand for funding in the last 12 months, in particular from levered investors such as hedge funds,” says Joseph Abate, money-market strategist at Barclays Plc. In September all these forces combined with a few other quirky events—such as corporations needing cash to settle quarterly tax bills—to create a brief systemwide shortage of ready cash.
“He’s like a spider in the middle of the web, where he can gather this information and then try to make sense of it”
Pozsar says another squeeze is likely. The potential results? Pain for hedge funds that use the repo market as a source of cheap money and a potential ripple effect on assets such as stocks and bonds as investors are forced to cut back on positions. His boldest prediction is that the Fed could push more liquidity into the system by buying longer-term Treasuries again. Pozsar says that would amount to a new round of QE.
In this case, the goal would be to keep things running smoothly, not to stimulate the economy. Some analysts say the central bank is already on top of the situation. “The Fed has been very proactive in addressing the liquidity concerns that emerged in September,” says Jerome Schneider, head of short-term bond portfolios at Pacific Investment Management Co. The issue, he says, “is not that there won’t be enough liquidity, but what the cost of that liquidity will be.”
Pozsar’s warnings get attention on Wall Street because he has a big-picture view of this complex market and can explain it well—at least to those fluent in the language of repoland. “I think he has every short-term interest-rate trader in the world on his speed dial,” Mehrling says. “He’s like a spider in the middle of the web, where he can gather this information and then try to make sense of it.”
Born in Hungary, Pozsar moved to the U.S. in 2002 and began his career at research company Economy.com. In 2008, shortly before the collapse of Lehman Brothers, he went to work at the Federal Reserve Bank of New York, where he became known for creating a map of the financial system that included repo and “shadow” banks outside of traditional lending. It’s so detailed that anyone viewing it on a computer has to zoom in seven or eight times to read any part of it. A poster version was pinned up in the New York Fed’s briefing room. Pozsar encouraged co-workers to stop by to review it, saying otherwise they’d be looking at only “10% of the picture.”
After a stint at the U.S. Treasury Department, he landed at Credit Suisse in 2015, where he began writing research notes about the mechanics of the Fed’s coming interest-rate hike. Pozsar has an MBA but not an economics degree, and his analytical approach differs from that of other bank interest-rate strategists. He focuses more on the human behavior inside banks. “Finance is anthropological,” he says. He thinks it’s important to understand that every bank has a different business model, and how that shapes people’s decisions to lend—or not. Even at a time when the numbers say they have plenty of money.
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>>> Central Banks Pushing for Negative (Real) Interest Rates
BY JAMES RICKARDS
DECEMBER 16, 2019
https://dailyreckoning.com/central-banks-pushing-for-negative-real-interest-rates/
Central Banks Pushing for Negative (Real) Interest Rates
This summer I was in Bretton Woods, New Hampshire, along with a host of monetary elites, to commemorate the 75th anniversary of the Bretton Woods conference that established the post-WWII international monetary system. But I wasn’t just there to commemorate the past —I was there to seek insight into the future of the monetary system.
One day I was part of a select group in a closed-door “off the record” meeting with top Federal Reserve and European Central Bank (ECB) officials who announced exactly what you can expect with interest rates going forward — and why.
They included a senior official from a regional Federal Reserve bank, a senior official from the Fed’s Board of Governors and a member of the ECB’s Board of Governors.
Chatham House rules apply, so I can’t reveal the names of anyone present at this particular meeting or quote them directly.
But I can discuss the main points. They essentially came out and announced that rates are heading lower, and not by just 25 or 50 basis points. They said they have to cut interest rates by a lot going forward.
They didn’t officially announce that interest rates will go negative. But they said that when rates are back to zero, they’ll have to take a hard look at negative rates.
Reading between the lines, they will likely resort to negative rates when the time comes.
Normally forecasting interest rate policy can be tricky, and I use a number of sophisticated models to try to determine where it’s heading. But these guys made my job incredibly easy. It’s almost like cheating!
The most interesting part of the meeting was the reason they gave for the coming rate cuts. They were very relaxed about it, almost as if it was too obvious to even point out.
The reason has to do with real interest rates.
The real interest rate is the nominal interest rate minus the inflation rate. You might look at today’s interest rates and think they’re already extremely low. But when you consider real interest rates, you’ll see that they’re substantially higher than the nominal rate.
That’s why the real rate is so important. If you’re an economist or analyst trying to forecast markets based on the impact of rates on the economy, then you need to focus on real rates.
Assume the nominal rate on a bond is 4%; what you see is what you get. But the real rate is the nominal rate minus inflation. If the nominal rate is 4% and inflation is 2%, then the real rate is 2% (4 – 2 = 2).
That difference between nominal and real rates seems simple until you get into a strange situation where inflation is higher than the nominal rate. Then the real rate is negative.
For example, if the nominal rate is 4% and inflation is 5%, then the real rate of interest is negative 1% (4 – 5 = -1).
The U.S. has never had negative nominal rates (Japan, the eurozone and Switzerland have), but it has had negative real rates.
By the early 1980s, nominal interest rates on long-term Treasury securities hit 13%. But inflation at the time was 15%, so the real rate was negative 2%. The real cost of money was cheap even as nominal rates hit all-time highs.
Nominal rates of 13% when inflation is 15% are actually stimulative. Rates of 3% when inflation is 1% aren’t. In these examples, nominal 2% is a “high” rate and 13% is a “low” rate once inflation is factored in.
The situation today is much closer to the latter example.
The yield to maturity on 10-year Treasury notes is currently around 1.8%, which is extremely low by traditional standards. Meanwhile, inflation as measured by the PCE core deflator (the Fed’s preferred measure) is currently about 1.6% year over year, below the Fed’s 2% target.
Using those metrics, real interest rates are above zero. But more interestingly, they’re higher than the early ’80s when real rates were -2%.
That’s why it’s critical to understand the significance of real interest rates.
And real rates are important because the central banks want to drive real rates meaningfully negative. That’s why they have to lower the nominal rate substantially, which is what these central bank officials said at Bretton Woods.
So you can expect rates to go to zero, probably sooner or later. Then, nominal negative rates are probably close behind.
The Fed is very concerned about recession, for which it’s presently unprepared. It usually takes five percentage points of rate cuts to pull the U.S. out of a recession. During its hiking cycle that ended last December, the Fed was trying to get rates closer to 5% so they could cut them as much as needed in a new recession. But, they failed.
Interest rates only topped out at 2.5%. The market reaction and a slowing economy caused the Fed to reverse course and engage in easing. That was good for markets, but terrible in terms of getting ready for the next recession.
The Fed also 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 (“QE-lite” has since taken the balance sheet up above $4 trillion, but the Fed has done its best to downplay it).
In short, the Fed (and other central banks) only partly normalized and are far from being able to cure a new recession or panic if one were to arise tomorrow.
The Fed is therefore trapped in a conundrum that it can’t escape. It needs to rate hikes to prepare for recession, but lower rates to avoid recession. It’s obviously chosen the latter option.
If a recession hit now, the Fed would cut rates by another 1.50% to 1.75% in stages, but then they would be at the zero bound and out of bullets.
Beyond that, the Fed’s only tools are negative rates, more QE, a higher inflation target, or forward guidance guaranteeing no rate hikes without further notice.
Of course, negative nominal interest rates have never worked where they’ve been tried. They only fuel asset bubbles, not economic growth. There’s no reason to believe they’ll work next time.
But the central banks really have no other tools to choose from. When your only tool is a hammer, every problem looks like a nail.
Now’s the time to stock up on gold and other hard assets to protect your wealth.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Rickards: World on Knife Edge of Debt Crisis
BY JAMES RICKARDS
DECEMBER 16, 2019
https://dailyreckoning.com/rickards-world-on-knife-edge-of-debt-crisis/
Rickards: World on Knife Edge of Debt Crisis
Herbert Stein, a prominent economist and adviser to presidents Richard Nixon and Gerald Ford, once remarked, “If something cannot go on forever, it will stop.”
The fact that his remark is obvious makes it no less profound. Simple denial or wishful thinking tends to dominate economic debate.
Stein’s remark is like a bucket of ice water in the face of those denying the reality of nonsustainability. Stein was testifying about international trade deficits when he made his statement, but it applies broadly.
Current global debt levels are simply not sustainable. Debt actually is sustainable if the debt is used for projects with positive returns and if the economy supporting the debt is growing faster than the debt itself.
But neither of those conditions applies today.
Debt is being incurred just to keep pace with existing requirements in the form of benefits, interest and discretionary spending.
It’s not being used for projects with long-term positive returns such as interstate highways, bridges and tunnels; 5G telecommunications; and improved educational outcomes (meaning improved student performance, not teacher pensions).
And developed economies are piling on debt faster than they are growing, so debt-to-GDP ratios are moving to levels where more debt stunts growth rather than helps.
It’s a catastrophic global debt crisis (worse than 2008) waiting to happen. What will trigger the crisis?
In a word — rates. Low interest rates facilitate unsustainable debt levels, at least in the short run. But with so much debt on the books, even modest rate increases will cause debt levels and deficits to explode as new borrowing is sought just to cover interest payments.
Real rates can skyrocket even as nominal rates fall if deflation takes hold. Real rates are nominal rates minus the inflation rate. If the inflation rate is negative, real rates can be significantly higher than the nominal rate. (A nominal rate of 1% with 2% deflation equals a real rate of 3%.)
The world is on the knife edge of a debt crisis not seen since the 1930s. It won’t take much to trigger the crisis.
Meanwhile, the stock market is set up for a sharp decline in the days and weeks ahead. Here’s why…
Stock market behavior has become remarkably easy to predict lately. Stocks go up when the Fed cuts rates or indicates that rate cuts are coming. Stocks also go up when there’s good news on the trade war front, especially involving a “phase one” mini-deal with China.
Stocks go down when the trade war talks look like they’re breaking down. Stocks also go down when the Fed indicates it may stop raising rates or actually goes on “pause.”
Good news (rate cuts in July, September and October and good prospects on the trade wars) has outweighed bad news, so stocks have been trending higher. You don’t have to be a superstar analyst to figure this out.
The key is to understand that markets are driven by computerized trading, not humans. Computers are dumb and can really only make sense of a few factors at a time, like rates and trade.
Just scan the headlines (that’s what computers do), weigh the factors and make the call. It’s easy! What’s not so easy is understanding where markets go when these factors are no longer in play.
Stocks are in bubble territory, based on weak earnings, and have been propped up by expected good news on trade.
The other driver is FOMO — “fear of missing out” — that can turn to simple fear in a heartbeat. If the phase one trade deal and a successor to NAFTA (USMCA) are both approved by late December and the Fed pauses rate cuts indefinitely, which are both likely, what’s left to drive stock prices higher?
It won’t be earnings or GDP, which are both weak. Once the good news is fully priced in, there’s nothing left but bad news. And we’re at the point right now.
That leaves stocks vulnerable to a sharp decline around year-end or early 2020. Simple solutions for investors include cash, gold and Treasuries. Get ready.
Here’s another way to get ready for what 2020 has in store. I’d like to invite you to join myself, Robert Kiyosaki, Nomi Prins and other world-class experts as we discuss what you can expect for 2020.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> When It Becomes Serious You Have To Lie: Update On The Repo Fiasco
Zero Hedge
Authored by Michael Lebowitz and Jack Scott via RealInvestmentAdvice.com
https://www.zerohedge.com/markets/when-it-becomes-serious-you-have-lie-update-repo-fiasco
Occasionally, problems reveal themselves gradually. A water stain on the ceiling is potentially evidence of a much larger problem. Painting over the stain will temporarily relieve the unsightly condition, but in time, the water stain will return. This is analogous to a situation occurring within the banking system. Almost three months after water stains first appeared in the overnight funding markets, the Fed has stepped in on a daily basis to “re-paint the ceiling” and the problem has appeared to vanish. Yet, every day the stain reappears and the Fed’s work begins anew. One is left to wonder why the leak hasn’t been fixed.
In mid-September, evidence of issues in the U.S. banking system began to appear. The problem occurred in the overnight funding markets which serve as one of the most important components of a well-functioning financial and economic system. It is also a market that few investors follow and even fewer understand. At that time, interest rates in the normally boring repo market suddenly spiked higher with intra-day rates surpassing a whopping 8%. The difference between the 8% repo rate recorded on September 16, 2019 and Treasuries was an eight standard deviation event. Statistically, such an event should occur once every three billion years.
For a refresher on the details of those events, we suggest reading our article from September 25, 2019, entitled Who Could Have Known: What The Repo Fiasco Entails.
At the time, it was surprising that the sudden change in overnight repo borrowing rates caught the Fed completely off guard and that they lacked a reasonable explanation for the disruption. Since then, our surprise has turned to concern and suspicion.
We harbor doubts about the cause of the problem based on two excuses the Fed and banks use to explain the situation. Neither are compelling or convincing.
As we were putting the finishing touches on this article, the Bank of International Settlements (BIS) reported that the overnight repo problems might stem from the reluctance of the four largest U.S. banks to lend to some of the largest hedge funds. The four banks are being forced to fund a massive surge in U.S. Treasury issuance and therefore reallocated funding from the hedge funds to the U.S. Treasury. Per the Financial Times in Hedge Funds key in exacerbating repo market turmoil, says BIS: “High demand for secured (repo) funding from non-financial institutions, such as hedge funds heavily engaged in leveraging up relative value trades,” – was a key factor behind the chaos, said Claudio Borio, Head of the monetary and economic department at the BIS.
In the article, the BIS implies that the Fed is providing liquidity to banks so that banks, in turn, can provide the hedge funds funding to maintain their leverage. The Fed is worried that hedge funds will sell assets if liquidity is not available. Instead of forcing hedge funds to deal with a funding risk that they know about, they are effectively bailing them out from having to liquidate their holdings. If that is the case, and as the central bank to central bankers the BIS should be well informed on such matters, why should the Fed be involved in micro-managing leverage to hedge funds? It would certainly represent another extreme example of mission creep.
Excuse #1
In the article linked above, we discussed the initial excuse for the funding issues bandied about by Wall Street, the banks, and the media as follows:
“Most likely, there was an unexpected cash crunch that left banks and/or financial institutions underfunded. The media has talked up the corporate tax date and a large Treasury bond settlement date as potential reasons.”
While the excuse seemed legitimate, it made little sense as we surmised in the next sentence:
“We are not convinced by either excuse as they were easily forecastable weeks in advance.”
If the dearth of liquidity in the overnight funding markets was due to predictable, one-time cash demands, the problem should have been fixed easily. Simply replenish the cash with open market operations as the Fed routinely did prior to the Financial Crisis.
Since mid-September, the Fed has elected instead to increase their balance sheet by over $320 billion. In addition to conducting daily overnight repo auctions, they introduced term repo that extends for weeks and then abruptly restarted quantitative easing (QE).
Imagine your plumber coming into your house with five other plumbers and a bull dozer to fix what you assumed was a leaky pipe.
The graph below, courtesy Bianco Research, shows the dramatic rise in the Fed’s balance sheet since September.
Based on the purported cash shortfall excuse, one would expect that the increase in the Fed’s balance sheet would have easily met demands for cash and the markets would have stabilized. Liquidity hole filled, problem solved.
However, as witnessed by the continuing growth of the Fed’s balance sheet and ever-increasing size of Fed operations, the hole seems to be growing. It is worth noting that the Fed has committed to add $60 billion a month to their balance sheet through March of 2020 via QE. In other words, the stain keeps reappearing and getting bigger despite increasing amounts of paint.
Excuse #2
The latest rationale used to explain the funding problems revolves around banking regulations. Many Fed members and banking professionals have recently stated that banking regulations, enacted after the Financial Crisis, are constraining banks’ ability to lend to other banks and therefore worsening the funding situation. In the words of Randy Quarles, Federal Reserve Vice Chair for Banking Supervision, in his testimony to the House Financial Services Committee:
“We have identified some areas where our existing supervision of the regulatory framework…may have created some incentives that were contributors”
Jamie Dimon, CEO of JP Morgan, is quoted in MarketWatch as saying the following:
“The turmoil may be a precursor of a bigger crisis if the Fed doesn’t adjust its regulations. He said the liquidity requirements tie up what was seen as excess reserves.”
Essentially, Quarles and Dimon argue that excess reserves are not really excess. When new post Financial Crisis regulatory requirements are factored in, banks only hold the appropriate amount of reserves and are not exceeding requirements.
This may be the case, and if so, the amount of true excess reserves was dwindling several months prior to the repo debacle in September. Any potential or forecasted shortfalls due to the constraints should have been easily identifiable weeks and months in advance of any problem.
The banks and the Fed speak to each other quite often about financial conditions and potential problems that might arise. Most of the systemically important financial institutions (SIFI banks) have government regulators on-site every day. In addition, the Fed audits the banks on a regular basis. We find it hard to believe that new regulatory restraints and the effect they have on true excess reserves were not discussed. This is even harder to believe when one considers that the Fed was actively reducing the amount of reserves in the system via Quantitative Tightening (QT) through 2018 and early 2019. The banks and the regulators should have been alerting everyone they were getting dangerously close to exhausting their true excess reserves. That did not occur, at least not publicly.
Theories and Speculation
A golden rule we follow is that when we think we are being misled, especially by market participants, the Fed, or the government, it pays to try to understand the motive. “Why would they do this?” Although not conclusive, we have a few theories about the faulty explanations for the funding shortage. They are as follows:
The banks and the Fed would like to reduce the regulatory constraints imposed on them in recent years. Disruptions demonstrating that the regulations not only inhibit lending but can cause a funding crisis allow them to leverage lobbying efforts to reduce regulations.
There may be a bank or large financial institution that is in distress. In an effort to keep it out of the headlines, the Fed is indirectly supplying liquidity to the institution. This would help explain why the September Repo event was so sudden and unexpected. Rumors about troubles at certain European banks have been circulating for months.
The Fed and the banks grossly underestimated how much of the increased U.S. Treasury debt issuance they would have to buy. In just the last quarter, the Treasury issued nearly $1 trillion dollars of debt. At the same time, foreign sponsorship of U.S. Treasuries has been declining. While predictable, the large amount of cash required to buy Treasury notes and bonds may have created a cash shortfall. For more on why this problem is even more pronounced today, read our article Who Is Funding Uncle Sam. If this is the case, the Fed is funding the Treasury under the table via QE. This is better known as “debt monetization”.
Between July and November the Fed reduced the Fed Funds rate by 0.75% without any economic justification for doing so. The Fed claims that the cuts are an “insurance” policy to ensure that slowing global growth and trade turmoil do not halt the already record long economic expansion. Might they now be afraid that further cuts would raise suspicion that the Fed has recessionary concerns? QE, which was supposedly enacted to combat the overnight funding issues, has generously supported financial markets in the past. Maybe a funding crisis provides the Fed cover for QE despite rates not being at the zero bound. Since 2008, the Fed has been vocal about the ways in which market confidence supports consumer confidence.
The analysis of what is true and what is rhetoric spins wildly out of control when we allow our imaginations to run. This is what happens when pieces do not fit neatly into the puzzle and when sound policy decisions are subordinated to public relations sound bites. One thing seems certain, despite what we are being told, there likely something else is going on.
Of greater concern in this matter of overnight funding, is the potential the Fed and banks were truly blindsided. If that is the case, we should harbor even deeper concern as there is likely a much bigger issue being painted over with temporary liquidity injections.
Summary
In the movie The Outlaw Josey Wales, one of the more famous quotes is, “Don’t piss down my back and tell me it’s raining.”
We do not accept the rationale the Fed is using to justify the reintroduction of QE and the latest surge in their balance sheet. Although we do not know why the Fed has been so incoherent in their application of monetary policy, our theories offer other ideas for thinking through the monetary policy maze. They also have various implications for the markets, none of which should be taken lightly.
We are just as certain that we are not entirely correct as we are certain that we aren’t entirely wrong. Like the water spot on the ceiling, financial market issues normally reveal themselves gradually. Prudent risk management suggests finding and addressing the source of the problem rather than cosmetics. We want to reiterate that, if the Fed is papering over problems in the overnight funding market, we are left to question the Fed’s understanding of global funding markets and the global banking system’s ability to weather a more significant disruption than the preview we observed in September.
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>>> Is it time for a 'true global currency'?
(From the World Economic Forum website)
Apr, 8 2019
by Jose Antonio Ocampo
Professor of Development Practice in International and Public Affairs, Columbia University
https://www.weforum.org/agenda/2019/04/is-it-time-for-a-true-global-currency
We celebrate two key events in the development of the global monetary system this year.
Global Economic Imbalances
The International Monetary Fund’s global reserve asset, the Special Drawing Right, is one of the most underused instruments of multilateral cooperation. Turning it into a true global currency would yield several benefits for the global economy and the international monetary system.
This year, the world commemorates the anniversaries of two key events in the development of the global monetary system. The first is the creation of the International Monetary Fund at the Bretton Woods conference 75 years ago. The second is the advent, 50 years ago, of the Special Drawing Right (SDR), the IMF’s global reserve asset.
When it introduced the SDR, the Fund hoped to make it “the principal reserve asset in the international monetary system.” This remains an unfulfilled ambition; indeed, the SDR is one of the most underused instruments of international cooperation. Nonetheless, better late than never: turning the SDR into a true global currency would yield several benefits for the world’s economy and monetary system.
The idea of a global currency is not new. Prior to the Bretton Woods negotiations, John Maynard Keynes suggested the “bancor” as the unit of account of his proposed International Clearing Union. In the 1960s, under the leadership of the Belgian-American economist Robert Triffin, other proposals emerged to address the growing problems created by the dual dollar-gold system that had been established at Bretton Woods. The system finally collapsed in 1971. As a result of those discussions, the IMF approved the SDR in 1967, and included it in its Articles of Agreement two years later.
Although the IMF’s issuance of SDRs resembles the creation of national money by central banks, the SDR fulfills only some of the functions of money. True, SDRs are a reserve asset, and thus a store of value. They are also the IMF’s unit of account. But only central banks – mainly in developing countries, though also in developed economies – and a few international institutions use SDRs as a means of exchange to pay each other.
The SDR has a number of basic advantages, not least that the IMF can use it as an instrument of international monetary policy in a global economic crisis. In 2009, for example, the IMF issued $250 billion in SDRs to help combat the downturn, following a proposal by the G20.
Most importantly, SDRs could also become the basic instrument to finance IMF programs. Until now, the Fund has relied mainly on quota (capital) increases and borrowing from member countries. But quotas have tended to lag behind global economic growth; the last increase was approved in 2010, but the US Congress agreed to it only in 2015. And loans from member countries, the IMF’s main source of new funds (particularly during crises), are not true multilateral instruments.
The best alternative would be to turn the IMF into an institution fully financed and managed in its own global currency – a proposal made several decades ago by Jacques Polak, then the Fund’s leading economist. One simple option would be to consider the SDRs that countries hold but have not used as “deposits” at the IMF, which the Fund can use to finance its lending to countries. This would require a change in the Articles of Agreement, because SDRs currently are not held in regular IMF accounts.
The Fund could then issue SDRs regularly or, better still, during crises, as in 2009. In the long term, the amount issued must be related to the demand for foreign-exchange reserves. Various economists and the IMF itself have estimated that the Fund could issue $200-300 billion in SDRs per year. Moreover, this would spread the financial benefits (seigniorage) of issuing the global currency across all countries. At present, these benefits accrue only to issuers of national or regional currencies that are used internationally – particularly the US dollar and the euro.
More active use of SDRs would also make the international monetary system more independent of US monetary policy. One of the major problems of the global monetary system is that the policy objectives of the US, as the issuer of the world’s main reserve currency, are not always consistent with overall stability in the system.
In any case, different national and regional currencies could continue to circulate alongside growing SDR reserves. And a new IMF “substitution account” would allow central banks to exchange their reserves for SDRs, as the US first proposed back in the 1970s.
SDRs could also potentially be used in private transactions and to denominate national bonds. But, as the IMF pointed out in its report to the Board in 2018, these “market SDRs,” which would turn the unit into fully-fledged money, are not essential for the reforms proposed here. Nor would SDRs need to be used as a unit of account outside the Fund.
The anniversaries of the IMF and the SDR in 2019 are causes for celebration. But they also represent an ideal opportunity to transform the SDR into a true global currency that would strengthen the international monetary system. Policymakers should seize it.
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>>> The Fast Track From No Inflation to Runaway Inflation
BY JAMES RICKARDS
DECEMBER 9, 2019
https://dailyreckoning.com/the-fast-track-from-no-inflation-to-runaway-inflation/
The Fast Track From No Inflation to Runaway Inflation
Today’s environment is drastically different than it was in the late ‘70’s and early ‘80s when inflation was nearly out of control. Today, disinflation is the primary challenge central banks face, not inflation.
It’s impossible to imagine another Volcker today. Today’s markets depend on the artificially low interest rates that the Fed’s been generating since 2009. Raising interest rates would devastatingly pop the asset bubbles in stocks and elsewhere.
Remember how markets revolted against the possibility of further rate increases last December, when rates were still under 3%? Imagine 20% interest rates.
But the problems in the economy today are structural, not liquidity-related. Federal Reserve officials have of course misperceived the problem. The Fed is trying to solve structural problems with liquidity solutions. That will never work, but it might destroy confidence in the dollar in the process.
Fiat money can work but only if money issuance is rule-based and designed to maintain confidence. Today’s Fed has no rules and is on its way to destroying confidence. Based on present policy, a complete loss of confidence in the dollar and a global currency crisis is just a matter of time.
Consumer price inflation has remained persistently low, despite the Fed’s best efforts. This has led many people to ask where the inflation is, because the Fed has created trillions of dollars since the financial crisis.
But there has been inflation. It’s just been in assets like stocks, bonds, real estate, etc. The market’s back to record highs again, in case you haven’t heard.
The bottom line is, we’ve seen asset price inflation, and lots of it, too.
But the question everyone wants to know is when will we finally see consumer price inflation; when will all that money creation catch up at the grocery store and the gas pump?
The Fed is aiming for sustained 2% inflation. But it’s proven extremely difficult to accomplish.
Personal consumption expenditures (PCE) is the core price deflator, which is what the Fed looks at. Currently, it’s stuck below 2%. It hasn’t gone much of anywhere. But the Fed continues to try everything possible to get it to 2% with hopes to hit 3%.
But the reason the Fed has struggled to attain its goals is that inflation is not purely a function of monetary policy. It’s a partial function of monetary policy. Psychology is the other factor.
Milton Friedman had a famous quote, that inflation is always and everywhere a monetary phenomenon. But it’s not really true.
Inflation is also a partial function of behavioral psychology. It’s very difficult to get people to change their inflation expectations after a trend has continued for a long time. So it’s very hard to raise inflation from under 2% to 3%.
But once it does, a psychological shift could occur, and it could lead to expectations of further inflation to come.
That’s because double-digit inflation is a non-linear development. What I mean is, inflation doesn’t go simply from 2%, to 3%, to 4%, to 5%, etc.
Inflation can really spin out of control very quickly if expectations change. In other words, it can gap higher very quickly. Inflation can go from 3% to 5% to 7% or more fairly quickly. Double-digit inflation could quickly follow.
So is double-digit inflation rate within the next five years in the future?
It’s difficult to say exactly. But it is possible. If it does happen, inflation will likely strike with a vengeance.
Please understand, I am not forecasting it. But if it happens, it would happen very quickly. We would see a struggle from 2% to 3%, and then jump to 6%, and then jump to 9% or 10%.
Everyday people would be the greatest casualties.
Central bankers try to use inflation to reduce the real value of the debt to give debtors some relief in the hope that they might spend more and help the economy get moving again.
Of course, this form of relief comes at the expense of savers and investors who see the value of your assets decline.
It’s part of what I call the “money illusion.”
Money illusion has four stages. In stage one, the groundwork for inflation is laid by central banks but is not yet apparent to most investors. This is the “feel good” stage where people are counting their nominal gains but don’t see through the illusion.
Stage two is when inflation becomes more obvious. Investors still value their nominal gains and assume inflation is temporary and the central banks “have it under control.”
Stage three is when inflation begins to run away and central banks lose control. Now the illusion wears off. Savings and other fixed-income cash flows such as insurance, annuities and retirement checks rapidly lose value.
If you own hard assets prior to stage three, you’ll be spared. But if you don’t, it will be too late because the prices of hard assets will gap up before the money illusion wears off.
Finally, stage four can take one of two paths.
The first path is hyperinflation, such as Weimar Germany or Zimbabwe. In that case, all paper money and cash flows are destroyed and a new currency arises from the ashes of the old. The alternative is shock therapy of the kind Paul Volcker imposed in 1980.
In that case, interest rates are hiked as high as 20% to kill inflation, but nearly kill the economy in the process.
Right now, we are in late stage one, getting closer to stage two. Inflation is here in small doses and people barely notice. Savings are being slowly confiscated by inflation, but investors are still comforted by asset bubbles in stocks and real estate.
That’s why you should begin to buy some inflation insurance in the form of hard assets before the Stage Three super-spike puts the price of those assets out of reach.
This is why having a gold allocation now is of value. Because if and when these types of development begin happening, gold will be inaccessible.
I’m on record predicting that gold will go to $10,000 an ounce. To this point, I am often asked, “How can you say gold prices will rise to $10,000 without knowing developments in the world economy, or even what actions will be taken by the Federal Reserve?”
Well, the number is not made up. I don’t throw it out there to get headlines, et cetera. It’s the implied non-deflationary price of gold. Everyone says you can’t have a gold standard, because there’s not enough gold. But there’s always enough gold, you just have to get the price right.
That was the mistake made by Churchill in 1925, as described above. The world is not going to repeat that mistake. I’m not saying that we will have a gold standard. I’m saying if you have anything like a gold standard, it will be critical to get the price right. Paul Volcker said the same thing.
The analytical question is, you can have a gold standard if you get the price right; what is the non-deflationary price? What price would gold have to be in order to support global trade and commerce, and bank balance sheets, without reducing the money supply?
The answer, based on today’s money supply, is $10,000 an ounce.
The now impending question is, are we going to have a gold standard?
That’s a function of collapse of confidence in central bank money, which we’re already seeing. But monetary resets have happened three times before, in 1914, 1939 and 1971. On average, it happens about every 30 or 40 years. We’re going on 50.
So we’re long overdue. Got gold?
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> Paul Volcker: The Last of His Kind
BY JAMES RICKARDS
DECEMBER 9, 2019
https://dailyreckoning.com/paul-volcker-the-last-of-his-kind/
Paul Volcker: The Last of His Kind
One of the most important figures in the history of U.S. monetary policy, Paul Volcker, died Sunday at the age of 92.
Volcker is famous for having raised interest rates all the way to 20% in June 1981, the highest rates since the Civil War.
His actions are widely credited for ending the great inflation of the 1970s and setting the stage for the Reagan economy of the ’80s (although his sky-high rates nearly sank the economy at first).
Volcker didn’t kill inflation right away — it took another couple of years to finally end it, but rates were never that high again.
Volcker had a solid understanding of inflation and had opposed going off the gold standard in 1971.
He was one of the people in the room at Camp David when Nixon made the decision to close the gold window. He was actually one of the move’s primary strategists.
People assume Nixon and his team intended to permanently sever the dollar from gold. But it’s not true.
What Nixon actually said — and Paul Volcker confirmed this when I spoke to him — is that they didn’t think the U.S. was permanently going off the gold standard.
Nixon, and others involved with the decision, considered it a temporary suspension until the major global powers could get together, rewrite the system and get back to a gold standard at a much higher gold price (it was then pegged at $35/ounce).
Volcker understood that it was necessary to get the gold price right before a gold standard could resume. After all the money printing that went to fund Vietnam and the Great Society in the 1960s, he knew that a higher gold price was necessary.
In other words, Volcker knew the U.S. would have to avoid the mistake Winston Churchill made in 1925 as Great Britain’s chancellor of the Exchequer, the equivalent of the U.S. Treasury.
Churchill was determined to fix the gold price (measured in sterling) at the pre-WWI parity. He felt duty-bound to live up to the old value.
But he neglected all the money printing that occurred to pay for the war. A higher gold price was required to reflect the inflation that took place. Otherwise, setting the gold price too low would be extremely deflationary.
And that’s what happened. Churchill fixed gold at the pre-war value.
By failing to set gold at a higher price (again, measured in sterling), Churchill essentially cut the money supply in half. That threw the U.K. into a depression.
While the rest of the world ran into the depression in 1929, in the U.K. it started in 1926. In other words, Churchill’s decision plunged the U.K. into recession three years ahead of the rest of the world.
Going back to gold at a much higher price measured in sterling would have been the right way to do it. Choosing the wrong price was a contributor to the great depression.
So in 1971, Volcker realized that gold would have to be fixed at a higher price to reflect the money-printing that had taken place during the preceding years. Otherwise, it could have dire consequences.
Of course, the point was moot because the U.S. never did reopen the gold window. And the ’70s were certainly marked by inflation, not deflation.
Most people don’t know how close to hyperinflation the U.S. came by the late ’70s, and how close the world was to losing confidence in the dollar.
In 1977, the U.S. had to issue Treasury bonds denominated in Swiss francs because no one wanted dollars, at least at an interest rate that the Treasury was willing to pay.
They were called Carter bonds.
Not surprisingly, the economic morass of the late ’70s cost Carter reelection. Inflation was between 14% and 15% by the time Reagan was sworn in.
Many people forget that Carter appointed Volcker, not Reagan. He began raising rates right away, although they only rose to 20% under Reagan.
Volcker’s extreme interest rates helped send the economy into recession, first in mid-1980 and again in 1982.
Although Volcker had Reagan’s support, many voices in the Republican Party wanted him replaced by a more accommodating Fed chairman. So Volcker was not extremely popular at the time.
But he knew the dollar is ultimately backed by confidence, and he was determined to restore it.
Volcker did tame inflation, which was back down to about 3% in 1983 after peaking near 15% in 1980. The dollar strengthened, the economy recovered and one of the greatest bull markets in stock market history was underway.
So Paul Volcker remains one of the most important Fed chairmen ever.
May he rest in peace.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Hong Kong Turmoil Threatens Banking Giant
BY JAMES RICKARDS
NOVEMBER 27, 2019
https://dailyreckoning.com/hong-kong-turmoil-threatens-banking-giant/
Hong Kong Turmoil Threatens Banking Giant
Most investors recall how the global financial crisis of 2008 ended. Yet how many recall the way it began?
The crisis reached a crescendo in September and October 2008 when Lehman Bros. went bankrupt, AIG was bailed out and Congress first rejected and then approved the TARP plan to bail out the banking system.
The bank bailout was greatly magnified when the Fed’s Ben Bernanke and other bank regulators guaranteed every bank deposit and money market fund in the U.S., cut rates to zero, began printing trillions of dollars and engineered more trillions of dollars of currency swaps with the European Central Bank to bail out European banks.
This extreme phase of the crisis was preceded by a slow-motion crisis in the months before. Bear Stearns went out of business in March 2008. Fannie Mae and Freddie Mac both failed and were taken over by the government and bailed out in June and July 2008.
Even before those 2008 events, the crisis can trace its roots to late 2007. Jim Cramer had his legendary, “They know nothing!” rant on CNBC in August. Treasury Secretary Hank Paulson tried to bail out bank special purpose vehicles in September (he failed). Foreign sovereign wealth funds came to the rescue of U.S. banks with major new investments in December.
Still earlier, in June 2007, two Bear Stearns-sponsored hedge funds became insolvent and closed their doors with major losses for investors.
Yet even those late-2007 events don’t trace the crisis to its roots.
For that you have to go back to Feb. 7, 2007. On that day, banking giant HSBC warned Wall Street about its Q4 2006 earnings. Mortgage foreclosures had increased 35% in December 2006 compared with the year before. HSBC would take a charge to earnings of $10.6 billion compared with earlier estimates of $8.8 billion.
In short, the 2008 financial crisis began in earnest with a February 2007 announcement by HSBC that unforeseen mortgage losses were drowning the bank’s earnings. At that time, few saw what was coming. The warning was considered to be a special problem at a single bank. In fact, a tsunami of losses and financial contagion was on the way.
Is history about to repeat? Is HSBC about to lead the world into another mortgage meltdown?
Of course, events never play out exactly the same way twice. Any mortgage problem today does not exist in the U.S because mortgage lending standards have tightened materially including larger down payments, better credit scores, complete documentation and honest appraisals.
HSBC’s mortgage problem does not arise in the U.S. — it comes from Hong Kong.
Almost overnight, Hong Kong has gone from being one of the world’s most expensive property markets to complete chaos. The social unrest and political riots there have generated a flight of capital and talent. Those who can are getting out fast and taking their money with them.
As a result, large portions of the property market have gone “no bid.” Sellers are lining up but the buyers are not showing up. At the high end, owners paid cash for the most part and do not have mortgages. But HSBC has enormous exposure in the midrange and more modest sections of the housing market.
High-end distress also has a trickle-down effect that puts downward pressure on midmarket prices.
IMG 1
Your correspondent during my most recent visit to Hong Kong. Behind me are the hills of Hong Kong leading up to “the Peak,” the highest point in Hong Kong. Homes on the hills below the Peak are among the most expensive in the world. Due to recent riots, they are in danger of becoming “stranded assets” with no buyers due to capital flight and fear of worsening political conditions.
It’s important for investors to bear in mind that mortgage losses appear in financial statements with a considerable lag once the borrower misses a payment. Grace periods and efforts at remediation and refinancing can last for six months or more. Eventually, the loan becomes nonperforming and reserves are increased as needed, a hit to earnings.
Property price declines and mortgage distress that started last summer as the Hong Kong riots worsened will not hit the HSBC financials in a big way until early 2020. The HSBC stock price may be floating on air between now and then. But the reckoning with a burst bubble in Hong Kong will be that much more severe when it hits.
Another threat to the HSBC stock price comes from Fed flip-flopping on monetary policy. Throughout 2017 and 2018, the Fed was on autopilot in terms of raising short-term interest rates and reducing the base money supply, both forms of monetary tightening.
Suddenly, in early 2019, the Fed reversed course, lowered interest rates three times (July, September and October) and ended its money supply contraction.
The result was that a yield-curve inversion (short-term rates higher than longer-term rates) that emerged in early 2019 suddenly normalized. Short-term rates fell below longer-term rates. That is extremely positive for bank earnings and bullish for bank stock prices.
Now the Fed may be ready to flip-flop again. In their October 2019 meeting, the Fed’s FOMC indicated that rate cuts are on hold. This means that short-term rates may stop falling, but longer-term rates will continue to fall for other reasons including a slowing economy. The yield curve may invert again. This is a negative for bank earnings and a bearish signal for bank stocks including HSBC.
Will history repeat itself with a mortgage meltdown at HSBC leading the way to global financial contagion?
Right now, my models are telling us that the stock price of HSBC is poised to fall sharply.
This is due to the anticipated mortgage losses (described above), but also to an inefficient management structure, repeated failures to reform that structure and management turmoil as a new interim CEO, Noel Quinn, attempts to repair past blunders without the job security or support that comes with being a permanent CEO.
When Noel Quinn accepted the job of interim chief executive of HSBC in August, he had one condition. He told Chairman Mark Tucker he did not want to be a caretaker manager who would keep the bank chugging along until a permanent successor was appointed, according to people briefed on the negotiations.
Instead, Mr. Quinn, a 32-year veteran of HSBC, has embarked on a major restructuring of Europe’s largest bank.: He wants to rid the lender of its infamous bureaucracy while reducing the amount of capital tied up in the U.S. and Europe, where it makes subpar returns. To do so, he will have to slash thousands of jobs.
Investors are understandably skeptical. This is the third time the bank has attempted a big overhaul in a decade, following similar efforts in 2011 and 2015. But returns still lag behind global peers such as JPMorgan despite HSBC’s unparalleled exposure to high-growth markets in Asia, which accounts for about four-fifths of profits.
The stock has declined 11% in a year when stock markets were rallying robustly. Most of the drawdown occurred in August and was a direct response to the worsening political situation in Hong Kong.
While this drawdown is notable, it mostly reflects political anxiety and is not reflective of the mortgage losses that are just beginning to enter the picture. Once the reserves for mortgage losses are expanded to meet the rising level of nonperformance, look out below.
So I repeat the question: Is HSBC about to lead the world into another mortgage meltdown?
We might have an answer sometime next year.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Why Elites Are Winning the War on Cash
BY JAMES RICKARDS
OCTOBER 25, 2019
https://dailyreckoning.com/why-elites-are-winning-the-war-on-cash/
Why Elites Are Winning the War on Cash
The global elites are pushing negative interest rates and inflation to make your money disappear. The whole idea of the war on cash is to force savers into digital bank accounts so their money can be taken from them in the form of negative interest rates.
Of course, these efforts are always portrayed in the most favorable light. Private parties talk about convenience and lower costs. Governments talk about putting pressure on tax cheats, terrorists and criminals.
Governments always use money laundering, drug dealing and terrorism as an excuse to keep tabs on honest citizens and deprive them of the ability to use money alternatives such as physical cash, gold and these days, cryptocurrencies.
But the so-called “cashless society” is just a Trojan horse for a system in which all financial wealth is electronic and represented digitally in the records of a small number of megabanks and asset managers.
Once that is achieved, it will be easy for state power to seize and freeze the wealth, or subject it to constant surveillance, taxation and other forms of digital confiscation.
That’s what they won’t tell you.
The war on cash has two main thrusts. The first is to make it difficult to obtain cash in the first place. U.S. banks will report anyone taking more than $3,000 in cash as engaging in a “suspicious activity” using Treasury Form SAR (Suspicious Activity Report).
The second thrust is to eliminate large-denomination banknotes. The U.S. got rid of its $500 note in 1969, and the $100 note has lost maybe 90% of its purchasing power since then. With a little more inflation, the $100 bill will be reduced to chump change.
The European Central Bank has already discontinued the production of new 500 euro notes. Existing 500 euro notes will still be legal tender, but new ones have not been produced.
This means that over time, the notes will be in short supply and individuals in need of large denominations may actually bid up the price above face value paying, say, 502 euros in smaller bills for a 500 euro note. The 2 euro premium in this example is like a negative interest rate on cash.
The real burden of the war on cash falls on honest citizens who are made vulnerable to wealth confiscation through negative interest rates, loss of privacy, account freezes and limits on cash withdrawals or transfers.
The whole idea of the war on cash is to force savers into digital bank accounts so their money can be taken from them in the form of negative interest rates. An easy solution to this is to go to physical cash. And that’s why they want to close off that escape route.
The war on cash is a global effort being waged on many fronts. My view is that the war on cash is dangerous in terms of lost privacy and the risk of government confiscation of wealth.
The good news is that cash is still a dominant form of payment in many countries including the U.S. The problem is that as digital payments grow and the use of cash diminishes, a “tipping point” is reached where suddenly it makes no sense to continue using cash because of the expense and logistics involved.
Once cash usage shrinks to a certain point, economies of scale are lost and usage can go to zero almost overnight. Remember how music CDs disappeared suddenly once MP3 and streaming formats became popular?
That’s how fast cash can disappear.
Once the war on cash gains that kind of momentum, it will be practically impossible to stop. That’s why I’m always saying that savers and those with a long-term view should get physical gold now while prices are still attractive and while they still can.
Given these potential outcomes, one might expect that citizens would push back against the war on cash. But in some places, the opposite seems to be happening.
As an example of how a fringe idea can begin to gain wider acceptance, look at microchipping, where people are injected with a small microchips beneath their skin. Microchipping has been associated with an Orwellian nightmare in which Big Brother constantly monitors your every move.
But over 4,000 Swedes have already happily volunteered to have it done.
In addition to other personal information, these chips can contain account information that negates the need to carry cash or credit cards to pay for goods. Just a swipe of the hand and voila, you’re done. It’s all happened fairly quickly. Just a few years ago, the very idea of it would have sent chills down the spines of most people.
By the way, Sweden is well on its way to going cashless, with cash and coins now constituting just 1% of its economy. So you can expect the trend to continue.
How long before it spreads to many other advanced economies?
One survey revealed that more than a third of Americans and Europeans would have no problem at all giving up cash and going completely digital.
Specifically, the study showed 34% of Europeans and 38% of Americans surveyed would prefer going cashless.
It will come to the U.S. soon enough.
Of course, there’s no denying that digital payments are certainly convenient. I use them myself in the form of credit and debit cards, wire transfers, automatic deposits and bill payments.
The surest way to lull someone into complacency is to offer a “convenience” that quickly becomes habit and impossible to do without.
The convenience factor is becoming more prevalent, and consumers are moving from cash to digital payments just as they moved from gold and silver coins to paper money a hundred years ago. Just look at the Swedish example.
But when the next financial panic comes, those without tangible wealth will be totally at the mercy of banks and governments who will decide exactly how much of your own money you’re allowed to have each day.
Just ask the citizens of Cyprus, Greece and India who have gone through this experience in recent years.
Other dangers arise from the fact that digital money, transferred by credit or debit cards or other electronic payments systems, are completely dependent on the power grid. If the power grid goes out due to storms, accidents, sabotage or cyberattacks, our digital economy will grind to a complete halt.
That’s why it’s a good idea to keep some of your liquidity in paper cash (while you can) and gold or silver coins. The gold and silver coins in particular will be money good in every state of the world.
For now, Germans are the most resistant to going cashless. Almost 80% of transactions in Germany are done in cash, and many Germans never use credit cards. The German experience with hyperinflation after WWI and additional monetary chaos after WWII certainly plays a part in this resistance to the cashless society.
Incidentally, the German word for debt, schuld, also means guilt.
Other countries, such as Romania and Bulgaria, which have recent experiences with currency and financial crises, also tend to use cash extensively.
I hold significant portion of my wealth in nondigital form, including real estate, fine art and precious metals in safe, nonbank storage.
I strongly suggest you do the same. The cashless society could be here quicker than you think.
Regards,
Jim Rickards
for The Daily Reckoning
<<<
>>> The Shock and Awe Era for Central Banks Is Over
Bloomberg
By Enda Curran
December 8, 2019
https://www.bloomberg.com/news/articles/2019-12-08/-quantitative-failure-risk-mounts-for-central-banks-in-2020s
Investors don’t expect much of a pick up in bond yields
Confidence in central bank’s to fight recession has drained
More than ten years of crisis fighting -- including this year’s rush to support global growth -- have left policy makers in key economies facing a new decade with few good options to fight the next downturn.
Interest rates are either already around historic lows or negative after more than 750 cuts since 2008, spurring concerns they are doing more harm than good.
At the same time, leading central banks are buying bonds again -- so called quantitative easing -- after the purchase of more than $12 trillion of financial assets wasn’t enough to revive inflation.
Year of Cuts
With the Federal Reserve, European Central Bank and Bank of Japan set to hold their final policy meetings of the year (and decade) over the coming two weeks, the worry is the next ten years could be their most testing yet.
The mounting fear is that the lackluster expansions and inflation which have plagued Japan since the early 1990s will now be witnessed globally. Bank of America Corp. analysts are among those warning investors to be alert to “quantitative failure or monetary policy impotence.”
“After finding that the drawn-out battle by central banks has been largely in vain, people are adjusting themselves towards a view which is closer to the truth,” said Kazuo Momma, a former executive director for monetary policy at the Bank of Japan.
“Effectiveness of monetary policy will be clearly limited going forward. If anything, suspicion over possible side effects will become an increasingly big issue.”
Investors are among the doubters.
Back in 2009, 10-year bond yields -- a proxy gauge for estimates of monetary settings -- tipped a big rebound for major economies. Instead, yields in Europe and Japan that were expected to surge have gone negative, U.S. yields are about 350 basis points lower than markets had bet and China’s about 130 points lower.
Traders today are more cautious: they’re betting on gains of less than 1 percentage point on 10-year yields for all four regions.
It’s not that central banks are completely out of ammunition -- the Fed has room to cut and the ECB could accelerate its bond buying. It’s more that to surprise from here they will need some monetary acrobatics.
A recent study published by the Peterson Institute for International Economics concluded that while some have remaining ammunition, it’s limited. The Fed could fight a mild but not a severe recession given it has room for stimulus equivalent to a 5 percentage point cut in its benchmark, but the ECB and BOJ have just 1 point’s worth left, it said.
Those limitations will be on display in the upcoming meetings. The Fed is forecast to hold steady on Dec. 11. A day later the European Central Bank is expected to stay on hold while the BOJ is also seen treading water on Dec. 19.
That quiet end to the year comes despite inflation staying soft in most of the world. UBS Group AG reckons about two-thirds of central banks it monitors currently have inflation below their goals.
JPMorgan sees its measure of the average global interest rate at 2% at end 2020
This year’s rate cuts did help put a floor under the world’s slowest expansion in a decade and help labor markets tighten even further as evidenced by the blockbuster U.S. payrolls report on Friday.
But there’s also the view that ultra easy policies -- and negative interest rates especially -- are doing some damage.
Pacific Investment Management Co. last week became the latest contributor to the debate over whether the negative rates witnessed in the euro-area and Japan hurt rather than help. Going below zero squeezes bank profitability and so reduces lending, depresses market returns and by extension consumption, according to the bond giant.
Such spillovers help explain why Fed Chairman Jerome Powell has all but ruled out negative rates for the U.S. despite pressure from President Donald Trump. Reserve Bank of Australia Governor Philip Lowe has done the same. Sweden’s Riksbank made clear it wants to put an end to half a decade of life below zero even as growth slows.
China’s policy makers don’t want to make the same mistakes. In a recent essay, People’s Bank of Governor Yi Gang doubled down on a pledge to stick to conventional monetary policy.
Aware of the hurdles ahead, Powell’s Fed is already conducting a review of strategy, with ECB President Christine Lagarde set to follow. Yet the early signs are that neither will start a revolution and will probably stick to noodling with their inflation targets.
“There are few things as certain as the ECB (and the Fed) not changing policy in this week’s meetings,” according to Marc Chandler, chief market strategist at Bannockburn Global Forex.
It all means the mantra of monetary heroes saving the world economy -- as labeled by OECD Secretary General Angel Gurria -- needs to pass to their fiscal counterparts.
There are some signs of that happening: Japan on Thursday announced a stimulus package to support growth. The U.K. election is set to open the door to a return to 1970s-style spending no matter who wins. But budget deficits and political differences mean many governments won’t chip in.
What Bloomberg’s Economists Say...
“The failures of fiscal policy have forced monetary policy first to extremes and now to the brink of exhaustion. When the next downturn comes, it’s Ministries of Finance, not central banks, that will have to provide the solution.”
--Chief Economist Tom Orlik
As if contending with depleted armories and the mountain of debt their decade of easy money has wrought wasn’t enough, new challenges from digital currencies to climate change will test central banks’ ability to stay in control.
“Central bank effectiveness is now challenged by the rise of private cyber-currency,” said Andrew Sheng, China Banking and Insurance Regulatory Commission chief adviser. “This will change the game.”
For now, much depends on how the U.S. and China trade war plays out and what it means for economic growth everywhere.
“If central banks are ‘pushing on a string,’ monetary policy alone will not stave off recession risks or populism,’ Bank of America strategists wrote in a report this month.
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>>> Repo Blowup Was Fueled by Big Banks, Hedge Funds, BIS Says
Bloomberg
By Liz McCormick
December 8, 2019
Banks couldn’t quickly fund market when rates spiked: report
Hedge funds ‘compounded the strains’ in vital part of finance
https://www.bloomberg.com/news/articles/2019-12-08/repo-blowup-was-fueled-by-big-banks-and-hedge-funds-bis-says?srnd=premium
The September mayhem in the U.S. repo market suggests there’s a structural problem in this vital corner of finance and the incident wasn’t just a temporary hiccup, according to a new analysis from the Bank for International Settlements.
This market, which relies heavily on just four big U.S. banks for funding, was upended in part because those firms now hold more of their liquid assets in Treasuries relative to what they park at the Federal Reserve, officials at the Basel-based institution concluded in a report released Sunday. That meant “their ability to supply funding at short notice in repo markets was diminished.”
And hedge funds are financing more investments through repo, which “appears to have compounded the strains,” the researchers added.
This brings the BIS, the central bank for central banks, into a controversy that has vexed observers for almost three months: Why did the repo market get so bad, so quickly? On Sept. 17, rates on general collateral repo briefly surged to 10% from around 2%.
Many, including the Fed, concluded in the immediate aftermath that two transitory events collided: investors used repo to finance the purchase of a large batch of newly auctioned Treasuries at the same time that quarterly corporate tax payments drained liquidity from that market.
But the BIS doubts an ephemeral supply-and-demand imbalance is totally to blame.
“None of these temporary factors can fully explain the exceptional jump in repo rates,” Fernando Avalos, Torsten Ehlers and Egemen Eren wrote in the latest BIS Quarterly Review.
---------------------------------------------------
READ MORE ABOUT REPO MARKET TURMOIL
Repo-Market Minnows Say Fixing Mess Means Going Beyond Big Banks
Repo Fretting Shifts to Treasuries as Market Faces Next Test
Repo Rout Didn’t Have to Happen. Powell Is Trying to Avoid Rerun
Repo Market’s Liquidity Crisis Has Been a Decade in the Making
Why the Fed’s Pumping Big Money Into the Repo Market: QuickTake
Repo Fragility Exacerbated by a Hot New Corner of Funding Market
----------------------------------------------------
Reserves -- or cash that banks stash at the Fed -- are the easiest asset for banks to tap when they want to quickly move money into repo. And it would’ve been logical for banks to pour cash into repo to get those 10% returns from an overnight loan.
The four banks that dominate the market hold about 25% of the reserves in the U.S. banking system, but 50% of the Treasuries. That mismatch likely slowed the movement of cash into repo, the BIS researchers postulated.
Cash Buffers
Volatility in the amount of cash the U.S. Treasury keeps parked at the Fed also affected banks’ reserves. “The resulting drain and swings in reserves are likely to have reduced the cash buffers of the big four banks and their willingness to lend into the repo market,” the team wrote.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon has put the blame on regulators themselves. He said in October that his firm had the cash and willingness to calm short-term funding markets but liquidity rules for banks held it back.
Some analysts have also pointed to a new corner of the market which has seen immense growth: sponsored repo. This allows banks to transact with counterparties like money-market funds without impacting their balance sheet constraints. The downside is that it’s only available on an overnight basis, and as a result has further concentrated funding risk.
Along with changing market structure, the researchers also connected the repo ruckus to banks being somewhat out of practice in daily reserve management. That’s because trillions of dollars worth of Fed asset purchases -- the so-called quantitative easing program meant to help the economy recover from the 2008 financial crisis -- had left the banking system flush with cash for years.
Fed Campaign
“The internal processes and knowledge that banks need to ensure prompt and smooth market operations may” have started to decay, BIS wrote. “This could take the form of staff inexperience and fewer market-makers, slowing internal processes.”
The Fed in 2017 started shrinking its balance sheet and shortages began to re-emerge last quarter. The central bank stopped paring back holdings in August and started buying Treasury bills in October, an attempt to add reserves to the banking system. That was part of its campaign to keep the repo market calm, an effort that began in September with overnight and then longer-term repo operations.
“These ongoing operations have calmed markets,” the BIS researchers wrote.
Still, market participants are wary that trouble may resurface at year-end -- a time when repo liquidity has historically been scarce. There’s been high demand from money-market participants for cash via repo that the Fed’s been offering with tenors that will extend into the new year.
The report also took a look at the European repo market, which escaped the kind of turmoil that engulfed the U.S. in September. But that doesn’t mean all is calm. Beneath the surface, the 8-trillion-euro ($9 trillion) market is becoming increasingly fragmented, raising the risk that cash may not flow through properly, the BIS said.
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>>> BIS Wants Central Banks at Center of Digital Cash Revolution
Bloomberg
By Catherine Bosley
December 5, 2019
https://www.bloomberg.com/news/articles/2019-12-05/bis-wants-central-banks-at-center-of-digital-cash-revolution?srnd=premium
Central banks must embrace the revolution under way in digital money to ensure they remain at the heart of the global payments system, according to the head of the Bank of International Settlements.
Agustin Carstens’s argument is that while the private sector “excels at customer-facing activity,” central banks provide the basis for trust, ensure liquidity and set standards. He’s unenthusiastic about Bitcoin and is worried that big tech companies like Facebook offering payment services means they could become unfairly dominant because of their existing data resources.
“We have a responsibility to be at the cutting edge of the debate,” BIS General Manager Agustin Carstens said in a speech on Thursday. “There is really no choice but to do so, as otherwise events will overtake us.”
Carstens, who kicked off his BIS term urging authorities to rein in digital currencies, has since overseen the implementation of a hub to foster collaboration in financial technology. But his caution is clear, and he warns that people shouldn’t be blinded by shiny new things at the expense of stability in the financial system.
“A gleaming skyscraper is an awesome sight. But when we admire one, we often overlook its foundations. These are out of sight, below ground level. But just because they are not visible, it does not mean that they don’t matter. On the contrary, they matter a lot.”
In his speech at Princeton University, Carstens addressed central bank issued digital currencies. While institutions are looking into the idea, caution still rules. Speaking in the European Parliament this week, ECB President Christine Lagarde said it’s “an area where we have to rush slowly,” noting risks for customer security and financial stability.
Carstens gave a green light to wholesale CBDCs, as they’re known, because they’d be restricted to institutions that already have access to central bank deposits, but said issuing them to the general public is perilous.
“Imagine if anybody could open an account at the central bank” he said. “In extreme cases, the central bank could become the one-stop banker for almost everybody in the economy,” which would constitute a “daunting” risk.
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Jim Rickards tweeted - >>> "The beat goes on. Russia added 9.3 metric tonnes of gold to its official reserve position in October. Gold is now 22% of official reserves. Total gold reserve is now 2,252 metric tonnes, twice as much as the U.S. on a gold-to-GDP basis. It's happening." <<<
https://twitter.com/JamesGRickards
Another tweet - >>> "The worldwide run on gold vaults continues. Poland pulls 100 tonnes of bullion from London. It means the Poles are more troubled by London bankers than Russian tanks" <<<
>>> Economists Join Congress in Not Worrying About the Deficit
Two emerging schools of thought favor more government debt — but for very different reasons.
Bloomberg
By Karl W. Smith
November 21, 2019
https://www.bloomberg.com/opinion/articles/2019-11-21/do-deficits-matter-economists-increasingly-say-no
Viewing debt from a different angle.
For at least a generation, economists have been all but unanimous in warning Congress about the dangers of excessive government debt. Yesterday the U.S. House Budget Committee held a hearing about whether debt might not be so bad after all — and the star witnesses were economists.
The committee heard testimony about two rising schools of thought that at first seem to agree about the debt. But proponents of so-called modern monetary theory and those of what might be called the “New View” have deep disagreements about how the economy works.
First, some history: The consensus among economists has long been that, while budget deficits are sometimes necessary (in case of war, for example, or recession), they are ultimately a threat to economic growth. That’s because when the government borrows, it “crowds out” investment in the private sector. At this point, one of three things can happen: Private investors competing over the smaller pool of savings can bid up interest rates until some borrowers are pushed out of the market; foreign savers can step in and add to the pool of savings; or some combination of both. In any case, future Americans will be worse off, either because domestic investment will be lower or foreign debt will be higher.
So economists customarily recommended that Congress get serious about reducing the long-term deficit. Congress mostly didn’t listen, though the U.S. government did run a surplus for a few years in the late 1990s.
After 2000, everything changed. A mixture of recession, tax cuts, wars, a global financial crisis and the Great Recession sent the deficit soaring. Rather than rising, however, interest rates fell — and rather than being saddled with billions in net payments to foreigners, the U.S. earned net income from overseas.
Soaring Debt, Moderate Interest Payments
The U.S. federal debt has more than doubled since 2001, but it hasn't led to higher interest payments
Advocates of modern monetary theory find these facts encouraging. They argue that the sluggish growth of the last two decades has been caused by deficits that were too small, not too large. If the large deficits were truly unsustainable, they argue, they would have led to rising inflation, not an economic downturn. But inflation has been falling since the 1980s.
Underlying this hypothesis is the view that the economy is fundamentally demand-driven. Investment occurs in response to rising sales, not falling interest rates. Rising sales, in turn, are the result of more spending — by either the government or consumers. This leads modern-monetary theorists to favor such programs as a federal job guarantee or a Green New Deal to ensure the flow of spending continues. They do not favor cutting the deficit.
The proponents of the New View don’t either — but they see very different forces at work. As a result of an aging population, global uncertainty and unpredictable changes in technology, they say, there is an unprecedented international demand for safe assets such as government bonds. Private-sector investments, meanwhile, have had trouble expanding in the wake of the Great Recession. Tech startups that offer potentially enormous returns can attract financing, but small businesses can’t.
This is ultimately a supply-side problem: The economy is lacking the capital investment necessary for healthy growth. To address this, proponents of the New View recommend that the government either cut taxes on business investment or increase spending on infrastructure. In effect, they see government as a financial intermediary, borrowing cheaply from the pool of risk-averse savers to fund investments that would increase long-run productivity.
So both schools of thought are more accepting of budget deficits than the previous consensus. But their rationales differ. And members of Congress should be aware that while many economists say the deficit is not a problem now, that’s not the same as saying it never will be. More generally, politicians should be wary of approving transformative spending programs without considering how they will be financed when economic circumstances change.
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>>> Why It’s So Hard to Overthrow the Mighty U.S. Dollar
Bloomberg
November 2, 2019
https://www.bloomberg.com/news/articles/2019-11-02/why-it-s-so-hard-to-overthrow-the-mighty-u-s-dollar-quicktake?srnd=premium
Russian President Vladimir Putin is acting on a pledge to shrink the role of the U.S. dollar in international trade. Jean-Claude Juncker, outgoing president of the European Commission, says it’s “absurd” that Europe uses the greenback for 80% of energy imports. Chinese President Xi Jinping has railed against economic “hegemonism.” Can the mighty dollar retain its global dominance when attacked from so many sides? Don’t count it out yet.
1. Why are some people fed up with the dollar?
Because it’s so prevalent. The U.S. currency is on one side of almost 90% of foreign-exchange transactions and accounts for two-thirds of international debt. Almost all international trades in oil are priced in dollars, hence the term petrodollars. That ubiquity makes nations beholden to fluctuations in its value and ties their economies to decisions made in Washington. As Juncker intimated, it makes sense for European countries to pay for their energy needs in euros rather than dollars. Then there are the countries that get on the wrong side of American policy.
2. What’s the issue there?
Sanctions. U.S. leverage rests with the central role its banks, and the dollar, play in the global economy; any country, company or bank that violates sanctions could see their U.S.-based assets blocked or lose the ability to move money to or through accounts held in the U.S. A spate of such penalties has pushed Russia to target faster “de-dollarization.” And European leaders began work on a payments system that would enable their companies to do business with Iran without getting snagged, though progress has been slow.
3. Is dollar concern a new thing?
The U.S. currency has dominated since the end of World War II, when world leaders met at Bretton Woods, New Hampshire, to establish a system to manage foreign exchange and agreed to link their currencies to the dollar. The push to dial back the greenback has its origins partly in the 1998 currency crisis, when Asian nations got caught borrowing too many dollars and were plunged into recession as their currencies plummeted and debt repayments soared. Fast forward a decade, and Asia’s amassing of dollars to build currency reserves helped fuel a U.S. credit binge that triggered the global financial crisis. Back in 2010, Brazil, Russia, India and China set up the BRIC partnership with the aim of establishing a new world order. More recently, China has put its weight behind developing a “Belt and Road” trade route across Asia and Europe lined with infrastructure projects financed in local currencies. Those efforts accelerated after the U.S. instigated a trade war.
4. Is the dollar’s market share shrinking?
No. The Bank for International Settlements’ triennial survey showed the share of currency trades in dollars had increased marginally since 2016 to 88%. The euro’s share climbed a percentage point to 32% in 2019. Emerging-market currencies gained 3.5 points to 24.5%, mostly at the expense of the yen, while China’s yuan accounted for 4%, the same as in 2016. The share of foreign reserves held in dollars (about 62%) has remained steady over the past decade, while the dollar’s usage in global payments tracked by financial institutions has actually risen since the start of the decade.
King Dollar
Despite a push for "de-dollarization," the greenback remains a part of most currency trades
5. Why is it so hard to get rid of the dollar?
Too much bother. Shifting to the euro, yuan or ruble means higher costs and difficulties finding banks to handle business. The euro’s allure as currency to back trade and investment has hardly been boosted by the region’s 2010 sovereign debt crisis and the European Central Bank’s use of negative interest rates. Volatility and scant volumes in emerging currencies make for higher trading and hedging costs. Russia’s first year of diversifying away from the dollar illustrated another peril: In a strong period for the dollar, the country missed out on $7.7 billion in potential returns on its foreign exchange reserves.
6. Can any currency compete with the dollar?
The euro is the only currency anywhere close. That was the conclusion of a European Commission report on strengthening the international role of the currency in June 2019. Rifts with U.S. President Donald Trump over trade tariffs as well as the sanctions on Iran have pushed the EU to seek greater financial independence. The report also found potential for boosting the share of commodities transactions in euros. With so many national governments to appease, though, progress on big European projects like this tends to be slow-moving. Bank of England Governor Mark Carney says it would be a mistake to switch one dominant currency for another; he advocates a global digital currency to supersede the dollar.
7. Why is Russia pressing ahead?
“We aren’t ditching the dollar, the dollar is ditching us,” is how Putin put it in 2018. Successive rounds of U.S. sanctions over Ukraine and alleged election-meddling in the U.S., and the threat of more to come, have given Russia good reason to try to move as much of its economy as possible out of the reach of Washington. Last year the central bank sold $100 billion in dollars from its reserves and spread the money between euro and yuan. A campaign to get companies to switch contracts to local currencies appears to be working. The euro is on course to overtake the dollar in Russia’s trade with the EU and China.
Narrowing Gap
The euro's close to becoming the main currency for Russian exports to the EU
8. Is China on board?
China’s drive to make the yuan a more widely used global currency reached its pinnacle in 2015, when the International Monetary Fund decided to make it the fifth currency in its prestigious special drawing rights currency basket -- a kind of overdraft account it holds for global central banks. Yet the People’s Bank of China’s focus has shifted during a six-year weakening of the yuan to keeping a tighter rein on capital outflows and trading. Bond sales raising currency outside the mainland -- so-called offshore yuan -- have flagged. Offshore yuan deposits are down 33% from their 2015 high. On the other hand, China has been on a mission to open domestic exchanges that are priced in yuan for commodities such as oil and iron ore.
9. Is anyone actively challenging the dollar?
Putin said in a meeting with Xi in June that using the dollar as an instrument of pressure was “undermining its role as a global reserve currency.” (A reserve currency is one that’s held by others in significant quantities as part of their foreign-exchange reserves.) Xi, with an eye on trade talks with the U.S. that involve a currency pact, obliquely described “hegemonism” as a global challenge. But watch closely for what China is doing. The focus has shifted from turning the yuan into a freely convertible currency, without government restrictions, to nurturing real economic activity through loans for its Belt and Road initiative. And keep an eye on Russia settling energy deals in euros and defense contracts in rupees. The dollar may be winning the war on the trading floors of London, New York and Tokyo, but it is losing peripheral skirmishes engineered in Moscow, Delhi and Beijing.
The Reference Shelf
Putin leads the charge to shrink the role of the dollar.
The BIS survey underlines the dollar’s ubiquity.
Bloomberg Economics details how China’s shifting priorities for the yuan slowed internationalization.
A Brussels think-tank explains Russia and the EU’s common ground on the dollar.
Bloomberg’s “Functions for the Markets” shows how to track progress in yuan internationalization.
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>>> Is it time for a 'true global currency'?
World Economic Forum
08 Apr 2019
Jose Antonio Ocampo
Professor of Development Practice in International and Public Affairs, Columbia University
https://www.weforum.org/agenda/2019/04/is-it-time-for-a-true-global-currency
Global Economic Imbalances
The International Monetary Fund’s global reserve asset, the Special Drawing Right, is one of the most underused instruments of multilateral cooperation. Turning it into a true global currency would yield several benefits for the global economy and the international monetary system.
This year, the world commemorates the anniversaries of two key events in the development of the global monetary system. The first is the creation of the International Monetary Fund at the Bretton Woods conference 75 years ago. The second is the advent, 50 years ago, of the Special Drawing Right (SDR), the IMF’s global reserve asset.
When it introduced the SDR, the Fund hoped to make it “the principal reserve asset in the international monetary system.” This remains an unfulfilled ambition; indeed, the SDR is one of the most underused instruments of international cooperation. Nonetheless, better late than never: turning the SDR into a true global currency would yield several benefits for the world’s economy and monetary system.
Have you read?
Christine Lagarde: Is it time for a new digital currency?
Could the Euro become a true global currency?
Does global finance need a new Bretton Woods?
The idea of a global currency is not new. Prior to the Bretton Woods negotiations, John Maynard Keynes suggested the “bancor” as the unit of account of his proposed International Clearing Union. In the 1960s, under the leadership of the Belgian-American economist Robert Triffin, other proposals emerged to address the growing problems created by the dual dollar-gold system that had been established at Bretton Woods. The system finally collapsed in 1971. As a result of those discussions, the IMF approved the SDR in 1967, and included it in its Articles of Agreement two years later.
Although the IMF’s issuance of SDRs resembles the creation of national money by central banks, the SDR fulfills only some of the functions of money. True, SDRs are a reserve asset, and thus a store of value. They are also the IMF’s unit of account. But only central banks – mainly in developing countries, though also in developed economies – and a few international institutions use SDRs as a means of exchange to pay each other.
The SDR has a number of basic advantages, not least that the IMF can use it as an instrument of international monetary policy in a global economic crisis. In 2009, for example, the IMF issued $250 billion in SDRs to help combat the downturn, following a proposal by the G20.
Most importantly, SDRs could also become the basic instrument to finance IMF programs. Until now, the Fund has relied mainly on quota (capital) increases and borrowing from member countries. But quotas have tended to lag behind global economic growth; the last increase was approved in 2010, but the US Congress agreed to it only in 2015. And loans from member countries, the IMF’s main source of new funds (particularly during crises), are not true multilateral instruments.
The best alternative would be to turn the IMF into an institution fully financed and managed in its own global currency – a proposal made several decades ago by Jacques Polak, then the Fund’s leading economist. One simple option would be to consider the SDRs that countries hold but have not used as “deposits” at the IMF, which the Fund can use to finance its lending to countries. This would require a change in the Articles of Agreement, because SDRs currently are not held in regular IMF accounts.
The Fund could then issue SDRs regularly or, better still, during crises, as in 2009. In the long term, the amount issued must be related to the demand for foreign-exchange reserves. Various economists and the IMF itself have estimated that the Fund could issue $200-300 billion in SDRs per year. Moreover, this would spread the financial benefits (seigniorage) of issuing the global currency across all countries. At present, these benefits accrue only to issuers of national or regional currencies that are used internationally – particularly the US dollar and the euro.
More active use of SDRs would also make the international monetary system more independent of US monetary policy. One of the major problems of the global monetary system is that the policy objectives of the US, as the issuer of the world’s main reserve currency, are not always consistent with overall stability in the system.
In any case, different national and regional currencies could continue to circulate alongside growing SDR reserves. And a new IMF “substitution account” would allow central banks to exchange their reserves for SDRs, as the US first proposed back in the 1970s.
SDRs could also potentially be used in private transactions and to denominate national bonds. But, as the IMF pointed out in its report to the Board in 2018, these “market SDRs,” which would turn the unit into fully-fledged money, are not essential for the reforms proposed here. Nor would SDRs need to be used as a unit of account outside the Fund.
The anniversaries of the IMF and the SDR in 2019 are causes for celebration. But they also represent an ideal opportunity to transform the SDR into a true global currency that would strengthen the international monetary system. Policymakers should seize it.
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IMF’s ‘Substitution Fund’ to kick-start
SDR as new global currency?
Aug 2016
http://www.cdfund.com/wp-content/uploads/2016/08/SDR-Special-aug2016-DEF.pdf
After seven years of Chinese pressure, a plan allowing investors to exchange their U.S.
Treasury holdings for SDRs through a ‘substitution fund’ is being discussed
The Big Reset (2013) fully explains the need for a major reform of the world’s financial system.
At that time of publication, most people still had no clue what form the unfolding financial
endgame would take. A few years further on, and as interest rates have reached a level not seen
in 500 years, many are now starting to agree major monetary changes are needed urgently.
Two major problems need to be addressed. First we will need to find a new anchor for the
world’s monetary system, and secondly, worldwide debt restructurings, comparable to debt
jubilees in ancient times, have to be arranged. Debt jubilees are still a step too far in the current
global mental state, hence full focus is on the structuring of a new anchor.
Since the outbreak of the financial crisis, the Chinese have pressured the U.S. to change the
current dollar-based monetary system. The Chinese, ever more in the driving seat of global
finance, have made it very clear that the Special Drawing Rights (SDR or IMF-money) of the
IMF is the preferred future international world reserve currency. A great example of China’s
frustration over U.S. monetary policies can be found in comments distributed by the Chinese
official state press agency Xinhua a few years ago;
‘Politicians in Washington have done nothing substantial but postponing once
again the final bankruptcy of global confidence in the U.S. financial system’
These words echoed complaints about the dollar from Zhou Xiaochuan, the most powerful
Chinese central banker and governor of the People’s Bank of China (PBoC), shortly after the
fall of Lehman Brothers. He claimed the dollar has led to increasingly frequent global financial
crises since the collapse in 1971 of the Bretton Woods system, when president Nixon cancelled
the gold backing of the greenback. In an article published on the PBoC’s website, in 2009, he
called for ‘a sweeping overhaul of the global monetary system’ and proposed for the dollar to
be replaced by the IMF’s Special Drawing Right (SDR).1
The SDR, an international reserve currency (asset) created by the International Monetary
Fund in the late 1960s, could serve ‘as the light in the tunnel for the reform of the international
monetary system’, he believes.
1 http://www.pbc.gov.cn/publish/english/956/2009/20091229104425550619706/2009 1229104425550619706_.html
SDR Special August 2016
www.cdfund.com Page 2 of 10
Now some seven years later, the preparations for such an overhaul by using SDRs, seems to be
well underway. The Chinese leadership has been speeding up the internationalization of the
Chinese Renminbi so it can officially be added to the SDR by October 1st 2016. Currently, the
SDR is a currency basket of the four most important currencies, the dollar, euro, pound and
yen. Once the renminbi is added as a fifth currency, the SDR will be ready to be used as a truly
world currency.
Wall Street insider James Rickards was the first to explain the importance of SDRs in his books:
‘The brilliance of the SDR solution is that it solves Triffin’s dilemma. Recall that
the paradox is that the reserve-currency issuer has to run trade deficits, but if you
run deficits long enough, you go broke. But SDRs are issued by the IMF. The IMF is
not a country and does not have a trade deficit. In theory, the IMF can print SDRs
forever and never go broke. The SDRs just go round and round among the IMF
members in a closed circuit. Individuals won’t have SDRs. Only countries will have
them in their reserves. These countries have no desire to break the new SDR system,
because they’re all in it together. The United States is no longer the boss. Instead,
you have the “Five Families” consisting of China, Japan, the United States, Europe
and Russia operating through the IMF. The only losers are the citizens of the IMF
member countries—people like you and me—who will suffer local-currency inflation. I’m preparing with gold and hard assets, but most people will be caught unaware, like the Greeks who lined up at empty ATMs in June 2015. This SDR system
is so little understood that people won’t know where the inflation is coming from.
Elected officials will blame the IMF, but the IMF is unaccountable. That’s the beauty
of SDRs—Triffin’s dilemma is solved, debt problems are inflated away and no one is
accountable. That’s the global elite plan in a nutshell.’2
We know that the structure of ‘a new global financial order’ has been subject of high-level discussions for the past few years, and that the role of China in these is prominent.3
Participants
from the UN, World Bank and IMF talked about ‘the new framework for the global financial
and economic system’ for three days in late 2014, during the prestigious Chinese International
Finance Forum (IFF). Jean-Claude Trichet, the former president of the ECB, also a co-chairman of the IFF, told the forum via a video link:
‘New rules have been discussed, not only inside advanced economies, but with all
emerging economies, including the most important emerging economy, namely,
China.’
2 From The Big Drop by James Rickards
3 http://www.ifforum.org/en/index.php?m=content&c=index&a=lists&catid=31
‘A new global financial order’ has been subject
of high-level discussions for the past few years
SDR Special August 2016
www.cdfund.com Page 3 of 10
This news was later confirmed by a high-ranking executive of China’s largest bank (ICBC) who
remarked:
‘With the status of the U.S. dollar as the international reserve currency being shaky,
a new global currency setup is being conceived.’
The last monetary reset of the ‘global financial order’ was executed in 1944, at the end of
World War II, when the U.S. invited 44 countries to the Bretton Woods conference. The U.S.
proposed a new monetary system centered on the U.S. dollar, which would be backed by gold.
The U.S. convinced the European countries with the American promise that paper dollars
could always be exchanged for gold. This promise was the only reason the Europeans accepted
the American plan.
However, when the U.S. started to print large amounts of dollars in the 1960s to finance the
Vietnam war, more and more countries became nervous about the future value of the dollar
and started to exchange surplus dollars for gold. In just a few years, the U.S. lost half of their
20,000 tonnes gold reserves. This was a drain to the U.S., and in the summer of 1971, President
Nixon therefore refused to exchange an extra few hundreds of millions of dollars of the Bank
of England for gold. He decided to ‘close the gold window’. In a nationwide television address
he announced:
‘I have directed to suspend, temporarily, the convertibility of the American dollar
into gold [..] in full cooperation with the IMF and those who trade with us we will
press for the necessary reforms for a urgently needed new international monetary
system’.
This decision is seen as a U.S. default, since it not longer could fulfill its 1944 obligations. In the
years after this ‘Nixon shock’, a number of ideas about reforms for the international monetary
system were being discussed. The issue with SDRs as a true reserve currency thus far had been
its lack of liquidity. There were simply not enough SDRs in circulation for it to play a major role
in international monetary finance. To cope with countries that wanted to get rid of large dollar
positions, a ‘Substitution Fund’, run by the IMF, was proposed. This fund could facilitate a direct exchange of dollars for SDRs. The liquidity issue would be resolved with one stroke of the
pen, as an SDR would be created for every dollar that was exchanged. But this concept never
materialized because the dollar crisis waned after Paul Volcker introduced a shock therapy
with interest rates exceeding 10%. Volcker’s drastic measures worked, so the U.S. no longer
had an interest to promote the SDR.
The substitution fund was little more than a thought experiment, until the Chinese brought
about its revival earlier this year. In the May 2016 edition of International Monetary Review,
China’s most prominent international monetary magazine, an article titled ‘Revive the IMF’s
SDR Substitution Fund’ was published. It explained in detail how a transition from a dollarcentered system towards an IMF-SDR system was planned as early as the early 1970s:4
4 http://www.imi.org.cn/en/?p=627
The last monetary reset of the ‘global
financial order’ was executed in 1944
SDR Special August 2016
www.cdfund.com Page 4 of 10
‘In 1972, at the IMF Annual Meetings, then U.S. Treasury Secretary George Shultz
offered the international community a bold plan to reform the international monetary system and end the special role of the dollar as a reserve currency. The U.S.
proposal came after a complete disruption of the then existing monetary order and
as key countries growing mistrust in the U.S. administration’s willingness to make
necessary economic policy adjustments to ensure the stability of the dollar. Shultz
presented the outlines of a plan including:
Substituting the dollar for the SDR to become the formal numeraire of the system,
offering an exchange of existing reserve assets (dollars) into other reserve assets
[…] In 1979 the IMF reconsidered a substitution account to exchange dollars for
SDRs. The idea attracted considerable interest and consisted of an account administered by the IMF that accepts deposits on a voluntary basis of eligible dollar-denominated securities in exchange for an equivalent amount of SDR-denominated
claims.’
Now, almost 40 years after its introduction, an SDR Substitution Fund could well be the best
approach to kick-start the SDR as a truly World Reserve Currency (WRC).
If only half of the almost 20 trillion outstanding U.S. treasuries would be exchanged through
this Substitution Fund, almost 10 trillion of SDRs would be created instantly. The SDR would
become one of the most liquid financials instruments almost immediately. A number of (academic) publications about this topic have been published recently. The most important one is
working paper no. 444 by the BIS titled ‘Reforming the international monetary system in the
1970s and 2000s: would an SDR substitution account have worked?5
‘One recently revived proposal would transform U.S. dollar official reserves into
claims denominated in the IMF’s key currency basket, Special Drawing Rights
(SDRs) […] a substitution account would have allowed central banks to diversify
away from the dollar into the IMF’s Special Drawing Right (SDR)’.
‘To diversify away from the dollar’ is central banker speak for dropping the U.S. dollar as the
anchor for the world’s monetary system. A dollar panic has to be avoided at all cost, so the
diversification has to be ‘orderly’ according to this study:
‘The scope for supporting the orderly diversification of reserves via a mechanism
allowing their conversion into SDR-denominated claims could be re-examined […]
The prospect of a destabilising rush out of the U.S. dollar led the Committee of
Twenty (representing the executive directors of the IMF) to consider a substitution
account in 1973-1974. The plan would allow official reserve holders to replace a
portion of their foreign exchange reserves with SDRs, issued by a special account
overseen by the IMF. By February 1973, the U.S. Treasury was prepared to envisage a one-time conversion of some existing U.S. dollar reserves into SDRs, replacing
5 http://www.bis.org/publ/work444.pdf
An SDR Substitution Fund could well be the
best approach to kick-start the SDR
SDR Special August 2016
www.cdfund.com Page 5 of 10
liabilities to national creditors with a liability to an IMF-based substitution account
[…] Lurking behind these issues was the European desire to require the U.S. Treasury to amortise the dollar assets in the fund over time by exchanging them for SDRs.
Europeans saw such settlement of dollar obligations in a medium not created by
the United States as making the International Monetary System more symmetric
and as exerting collective control over international liquidity.’
Another publication, from 2009, written by Onno Wijnholds, a former Dutch Executive Director of the IMF and titled ‘The dollar’s last days?’, also elaborates on the idea of a dollar-SDR
Substitution Fund: 6
‘a substitution account to absorb unwanted U.S. dollar reserves and increase the
role of the SDR have attracted International Monetary System reformers for over
30 years. In the 1970s, part of the appeal of such schemes was to develop a mechanism that might ultimately require the United States to redeem its liabilities in SDR,
or at the very least would create an SDR-denominated reserve asset that could rival
the dollar.’
This idea by Wijnholds was also discussed in a OECD publication that same year: 7
‘The approach attracting most attention is a new global reserve system based on
an extended version of the International Monetary Fund’s Special Drawing Rights
(SDR) , an international reserve asset set up in 1969 to supplement member countries official reserves. Building on the SDR, the main global reserve currency would
be represented by an extended basket of significant currencies and commodities.
The UN-appointed Stiglitz Commission on reforming the international monetary
and financial system has suggested a gradual move from the U.S. dollar to the SDR.
Moreover, following the G20 Summit in London earlier in the year, the IMF plans to
distribute to its members $250 billion in SDRs. But as this will increase the share
of SDRs in total international reserves to no more than 4%, some extra steps will
be needed. To make the SDR the principal reserve asset via allocation, close to $3
trillion in SDRs would have to be created. One expert, Onno Wijnholds, has suggested a so-called SDR substitution account. This would permit countries who feel
their official dollar holdings are uncomfortably large to convert dollars into SDRs.
Because conversion would occur outside the market, it would not put downward
pressure on the dollar. This suggestion, however, carries exchange risks because the
SDR substitution account is likely to hold mostly dollars. Another step to enhance
the SDR would be to make its currency composition more neutral to global cycles
and more representative of the shift in economic power witnessed over the last two
decades. This implies an increase in the commodity content and the inclusion of
major emerging-market currencies.’
6 http://www.project-syndicate.org/commentary/the-dollar-s-last-days
7 http://www.oecdobserver.org/news/archivestory.php/aid/3075/Towards_a_new_reserve_currency_system_.html#sthash.FEzjErwq.dpuf
‘The dollar’s last days?’, also elaborates on the
idea of a dollar-SDR Substitution Fund
SDR Special August 2016
www.cdfund.com Page 6 of 10
So there you go, to include a commodity like gold into the SDR as a sixth currency component
could help to make the SDR, ’more neutral to global cycles and more representative of the shift
in economic power witnessed over the last two decades’.
The idea of adding gold to the SDR was also studied by professor Catherine Schenk in 2011.
According to her study to ‘re-introduce a role for gold in the international monetary system’ it
would ‘provide a counterweight to the impact of the depreciation/appreciation of the U.S.$’, and
could ‘reduce vulnerability to the USD exchange rate’. 8
Professor Robert Mundell, a special advisor to the Chinese government, is also in favor of
bringing gold back in to the monetary system:9
‘There could be a kind of Bretton Woods type of gold standard where the price of
gold was fixed for central banks and they could use gold as an asset to trade within
central banks. The great advantage of that was that gold is nobody’s liability and it
can’t be printed. So it has a strength and confidence that people trust. So if you had
not just the U.S. but the U.S. and the EU (area) tied together to each other and to
gold, gold might be the intermediary and then with the other important currencies
like the yen and Chinese Yuan and British pound all tied together as a kind of new
SDR that could be one way the world could move forward on a better monetary
system.’
So plans for substituting dollars for SDRs and linking SDRs to gold have clearly been around
for quite some time. But when can we expect the SDR to become more openly promoted? José
Antonio Ocampo, former minister of Finance of Colombia, recently published an interesting
article in which he explains China’s current G20 leadership could well be used to ‘launch major
reforms of the global monetary system’ and to reconsider the ‘dollar’s outsize role’: 10
‘China’s G20 leadership could be the impetus the group needs to initiate this shift […] (it) represents an important opportunity to improve macroeconomic cooperation and launch major reforms of the global monetary system […] Such reform must include a reconsideration of the U.S. dollar’s outsize role in shaping the international monetary system. In an increasingly multipolar world, would it not be more appropriate to build a multicurrency system and make greater use of the only global currency that has ever been created: the IMF’s Special Drawing Rights (SDRs)? Establishing the SDR as the leading global reserve currency would have far-reaching benefits. It would allow all countries – not just major economic powers – to enjoy “seigniorage,” or the profits brought by money creation.
8 https://www.chathamhouse.org/sites/files/chathamhouse/field/field_document/0212gt_schenk1.pdf
9 http://www.forbes.com/sites/ralphbenko/2011/06/13/the-emerging-new-monetarism-gold-convertibility-to-save-theeuro/#5bbac336e659
10 https://www.project-syndicate.org/commentary/g20-summit-global-monetary-reform-by-jose-antonio-ocampo-2016-07
China’s current G20 leadership could well be used to ‘launch major reforms of the global monetary system’
Ocampo’s analysis should be given extra weight since he is also the author of an important paper published in 2010 titled ‘Building an SDR-Based Global Reserve System’:11
‘The second and better path would be to fulfill the aspiration of transforming the Special Drawing Right (SDR) into the dominant global reserve asset, as well as the instrument for funding IMF emergency financing during crisis. This reform can be complemented with other features: enhancing the use of SDRs, launching a substitution account, and creating regional reserve pools. And, of course, it has to be matched by a more ambitious reform of IMF quotas and governance. The renewed interest in this instrument of international cooperation shown by the G-20 in 2009 makes this reform agenda a viable one.’
The IMF now shares these ideas. At the end of June 2016, president Christine Lagarde wrote a special note to the Board of Governors of the IMF, in which she advised: ‘a general allocation of Special Drawing Rights (SDR)’ could be ‘a source of global liquidity’, during a ‘reform of the international monetary system’.12
In a following IMF-note, prepared to be presented to the most important IMF body, the G20 board,13 we find more details of this new SDR-system.14 It is the first to describe how new SDR-money (M-SDRs) can be issued by commercial ‘parties’ as well, next to the official O-SDRs;
‘Following the recent diagnostic of the international monetary system (IMS), the IMF will explore whether a broader role for the SDR could contribute to its smooth functioning [..] The note sketches some key issues bearing on the role of the SDR in each of three concepts:
- The official SDR, or “O-SDR”, the composite reserve asset issued by the IMF - SDR-denominated financial market instruments, or “M-SDRs,” which could be both issued and held by any parties;
- The SDR as a unit of account […] for such uses as reporting economic statistics and financial statements, and pricing transactions—examples of the latter include Suez Canal fees and the Montreal Convention on damages, such as lost baggage, incurred by air carriers
11 Ocampo, José Antonio., 2010, “Building an SDR-Based Global Reserve System,” Journal of Globalization and Development 1, Article
12 http://www.imf.org/external/np/pp/eng/2016/062916.pdf
13 The membership of the G20 includes the heads of state and government, and finance ministers and central bank governors of the
G7, 12 other key countries, and the European Union. China is the 2016 chair of the G20, to be followed by Germany in 2016.
14 http://www.imf.org/external/np/pp/eng/2016/072416.pdf
‘a general allocation of Special Drawing Rights (SDR)’
could be ‘a source of global liquidity’
So, according to this idea commercial banks could be used to issue ‘Market-SDRs’, just like they now create money by providing new loans. Epoch Times was the first publication to understand the importance of this IMF note:
‘It echoes Ocampo’s idea of private corporations issuing bonds in SDR and banks making loans in SDR, or a special version of it called M-SDR, presumably standing for “market” based instruments like bonds. The IMF experimented with these M-SDRs in the 1970s and 1980s when banks had SDR 5-7 billion in deposits and companies had issued SDR 563 million in bonds. A paltry amount, but the concept worked in practice.
So after the G20 meeting on July 25, the deputy director of the People’s Bank of China’s (PBOC) International Office Zhou Juan immediately countered the concern about a lack of market demand. He said an international development organization like the Asian Infrastructure and Investment Bank (AIIB) could issue SDR bonds in China as late as August, according to Chinese newspaper Caixin.
China insider David Marsh, the founder of finance think tank OMFIF (Official Monetary and Financial Institutions Forum) wrote on Marketwatch in late April about another benefit of launching the M-SDR in China, although he did talk about a wider range of applications rather than just the issuance by the development institution;
‘Beijing’s SDR capital market initiative will allow domestic Chinese investors to subscribe to domestic bond issues with a significant foreign currency component, a means of helping dampen capital outflows that have gained prominence in the last 18 months as a result of progressive capital liberalization.’
In other words: If Chinese investors can buy bonds or other debt instruments in SDR in China, they could circumvent the capital controls and hold a diversified portfolio of euros, dollars, yen, and pounds with a small amount of renminbi mixed in. And they don’t have to go out of their way smuggling gold across the border to Hong Kong or buying up Italian soccer clubs. China lost $676 billion in capital in 2015 alone and foreign currency reserves are nearing the critical level of $2.7 trillion (now $3.2 trillion), the minimum the IMF thinks the country needs to run the economy. So it’s safe to say the IMF had the same issue in mind when it wrote its paper, whose authors we don’t know. In mid-July it stated:
‘In China, there may be untapped demand among domestic investors for exposure to reserve currencies as capital controls are gradually lifted. From this perspective, M-SDRs issued in the onshore market could potentially reduce demand for foreign currency and reduce capital outflows by allowing domestic market participants to diversify their foreign exchange risk.’
Commercial banks could be used to issue ‘Market-SDRs’
James Rickards called this IMF-note in a tweet, ‘a cruise missile at the dollar’. In a recent edition of his newsletter Strategic Intelligence he explained ‘the elite plan’ to kick-start the SDR
in more detail:
‘What’s the evidence that the elites are planning to start up the SDR printing press?
Here’s an excerpt from an article dated April 25, 2016, by Andrew Sheng, former chairman of the Hong Kong Securities and Futures Commission and a professor at Tsinghua University in Beijing. Sheng’s co-author is Xiao Geng. The article is called “How to Finance Global Reflation”:
An incremental expansion of the SDR’s role in the new global financial architecture, aimed at making the monetary policy transmission mechanism more effective, can be achieved without major disagreement. This is because, conceptually, an increase in SDRs is equivalent to an increase in the global central bank balance sheet (quantitative easing) […] Central banks would expand their balance sheets by investing through the IMF in the form of increased SDRs […] Consider a scenario in which member central banks increase their SDR allocation in the IMF by, say, $1 trillion. A five-times leverage would enable the IMF to increase either lending to member countries or investments in infrastructure via multilateral development banks by at least $5 trillion. Moreover, multilateral development banks could leverage their equity by borrowing in capital markets…’
This work on SDRs is not merely theoretical. China is building a platform to expand borrowing and trading in SDRs. It will be launched this summer. This is only the second platform of its type in the world. The only existing SDR trading platform today is inside the IMF itself.’
China indeed seems to be planning the creation of a market for SDR-denominated bonds. The government-linked China Development Bank will issue $300 - $800 million SDR denominated notes later in 2016, the first float of SDR-denominated bonds by an individual financial institution. Japan’s three megabanks recently also expressed interest in selling SDR bonds, while other major Chinese banks are planning SDR bond offerings as well. The Chinese government has already said it would open trading of these instruments on the interbank market.
All this clearly points to coming changes for the world’s financial system. China’s G20 presidency will present the perfect timing to make them public. In a statement on the official G20
website Chinese central bank Governor Zhou Xiaochuan calls for a:15
‘broader role of the Special Drawing Rights (SDR) to jointly shape a more stable and orderly international monetary and financial environment.’
15 http://www.g20.org/English/China2016/FinanceMeetings/201603/t20160321_2205.html
China is building a platform to expand
borrowing and trading in SDRs
SDR Special August 2016
‘President Xi Jinping hopes to cite a successful SDR bond float as progress toward the yuan’s internationalization when G-20 leaders meet September 4th in
Hangzhou, China.’
I would like to end with an interesting side note. One of China’s most senior central bankers,
Mr. Min ZHU, who was one of the IMF’s Deputy Managing Directors since 2011 left the IMF
at the end of July. Prior to joining the Fund in 2010, Min served as Deputy Governor of the
People’s Bank of China. I expect him to return to the PBoC to become the next Governor of the
People’s Bank of China. Christine Lagarde seems to be aware of this new position by stating:
‘I will miss Min dearly, both as a friend and a loyal and trusted advisor […] and wish
him the very best in the next exciting chapter of his life.’
Willem Middelkoop is the founder of the Commodity Discovery Fund and author of The Big Reset, first published in
2013. In 2007 his first book was published in the Netherlands, titled Als de dollar valt (When the dollar falls)
<<<
>>> Facebook Could Do to Banks What It Did to Newspapers
Libra isn't just another cryptocurrency. It's a bid for power.
Bloomberg
By Elaine Ou
October 24, 2019
https://www.bloomberg.com/opinion/articles/2019-10-24/facebook-s-libra-currency-is-zuckerberg-s-attempt-to-copy-wechat?srnd=premium
On Wednesday, Mark Zuckerberg, Facebook’s chief executive, testified about his company’s cryptocurrency project at a hearing held by the House Financial Services Committee. In his testimony, Zuckerberg tried to reassure Congress that Facebook’s Libra cryptocurrency would square the circle between financial inclusion and regulatory adherence, consumer privacy and proactive fraud detection. The one thing he didn’t manage to address is whether the world really wants a crypto offering from the social media giant.
Cryptocurrency has acquired an unseemly status where any use is automatically assumed to have nefarious ends. It doesn’t help that the most prominent example, Bitcoin, has been implicated in some horrific criminal conduct. At the same time, a lack of mainstream adoption gives cryptocurrency few redeeming advocates. No surprise, then, that regulators regard Facebook’s proposal with suspicion.
It’s not that legitimate businesses don’t want crypto; it’s that their customers don’t want to use it for payment. When buying stuff on the internet, consumers will choose the payment method that imposes the lowest transaction cost on themselves — that’s generally the credit card option, which allows deferred payment as well as the accrual of miles or points. An online business that refuses to accept credit cards will always lose out to a competitor that does.
But what if you don’t have any competitors? Facebook enjoys quasi-monopoly status when it comes to consumer attention, controlling the reach and distribution of content across its network of users. 1
As the driver of over one-fourth of web traffic, Facebook has a lot of influence over who sees what on the internet. And with over 2.3 billion monthly active users around the world, it’s not a stretch to imagine that the company could have similar influence over who pays whom, and how.
Mark Zuckerberg’s Congressional testimony makes it clear that he takes inspiration from China, where WeChat serves as a one-stop portal to the greater internet. There, users conduct their banking, shopping, and bill payments without ever leaving the app. The ability to control users’ economic interactions comes with the privilege of deciding the medium of exchange. If it follows suit, Facebook may end up looking like another familiar monopolist — our own government, which creates the national currency we use to pay our taxes.
It’s no wonder regulators and central banks view the Libra project as a threat to the international monetary system. In a recent report, the G7 Working Group warns that global cryptocurrencies could undermine cross-jurisdictional efforts to combat illicit finance. All international transactions using U.S. dollars currently clear through the New York Federal Reserve, where they can be monitored and stopped if deemed unsavory. Previously, members of the Senate Banking Committee have expressed concern over Facebook’s ability to handle economic sanctions on foreign regimes.
Zuckerberg has promised that Calibra, Facebook’s payment app, will include robust compliance systems to fulfill regulatory obligations. However, the greater risk is that Calibra will go above and beyond its regulatory duty. Facebook already employs a more restrictive speech code than legally required — the platform blocks various forms of hate speech, harassment, misinformation and inauthentic behavior. Publishers must accept Facebook’s opaque Terms of Service or risk not being seen at all. It’s one thing to deny politically incorrect figures the ability to share inflammatory content; it’s another thing to leave them economically isolated.
In a competitive market, those who disagree with Facebook’s terms could simply take their business elsewhere. The Libra Association currently includes twenty-one member companies, after some early members dropped out. If Facebook mimics WeChat in establishing itself as a go-to payment portal, those former members may have no choice but to return to the cartel.
Global regulators are so worried about preserving their own monopoly status that they’ve forgotten that monopolies have victims. Just look at what Facebook did to publishers. When Facebook emerged as the arbiter of eyeballs, publishers lost control of their audiences and ad revenue, and consumers ended up with a barrage of clickbait. If Facebook disintermediates the banking system, it could take control of the economic relationship between businesses and their customers, with greater restrictions on financial transactions than ever before. It’s almost enough to make you wish for a decentralized currency.
<<<
>>> The Almighty Dollar Needs a Rival
America’s currency has become the lingua franca of commerce. That’s “putting the global economy under increasing strain.”
Bloomberg
By Peter Coy
August 29, 2019
https://www.bloomberg.com/news/articles/2019-08-29/the-almighty-dollar-needs-a-rival?srnd=premium
There’s a serious imbalance at the heart of the world economy. Even though the output of the U.S. has shrunk as a share of world gross domestic product, the U.S. currency remains as essential as ever. The dollar is actually more important than it deserves to be, because of a network effect: People use dollars because other people use dollars, just the way people learn English because the people they have to deal with speak English.
The main harm is to less developed countries whose economies are discombobulated by fluctuations in U.S. interest rates and the value of the dollar. This was discussed in an important paper delivered at the recent monetary policy conference in Jackson Hole, Wyo., by Mark Carney, governor of the Bank of England, who warned against “blithe acceptance of the status quo.” Here’s a link.
If you heard anything about Carney’s paper, it’s probably his approving mention of Libra, the digital currency proposed by Facebook Inc. But that’s one small part of his bigger argument, which is simply that the dollar’s status as a “hegemon” is “putting the global economy under increasing strain” and needs to end, somehow.
In 1971, President Richard Nixon’s Treasury secretary, John Connally, is supposed to have told European finance ministers that the dollar “is our currency, but your problem.” Carney wrote that in the almost half-century since, America’s message has broadened to “any of our problems is your problem.”
What, exactly, is so bad about the dollar’s centrality? Carney’s paper cites a wealth of research by other economists, including Gita Gopinath of Harvard, now the chief economist of the International Monetary Fund. A key problem—which is a little confusing when you first hear it—is the seemingly minor issue of how imports are invoiced.
Here’s the idea in a nutshell: “The dollar represents the currency of choice for at least half of international trade invoices, around five times greater than the U.S.’s share in world goods imports,” Carney writes. So let’s say some poor nation needs to buy oil. It’s priced in dollars, even though the oil isn’t from the U.S. Now the local currency falls versus the dollar. Suddenly the same volume of oil costs more—a huge burden on ordinary citizens.
It would be nice if the poor country’s higher bill for imports were offset by a big increase in exports. But if its exports are also priced in dollars, that’s not what happens. Export volumes are unchanged because their dollar price is unchanged. So the country loses on the import end and doesn’t win on the export end. True, the poor country’s exporters earn windfall profits because their costs are in the local currency, but it takes time—maybe years—for the export sector to expand as a result and put more people to work.
A 2017 paper by Gopinath and others concluded that a 1% appreciation of the dollar against all other currencies is associated with a 0.6% to 0.8% decline in total trade among countries in the rest of the world. Here’s a layman’s explanation of the paper from the National Bureau of Economic Research.
This invoicing issue has ripple effects. Because companies need dollars to pay for imports, they build up (or try to build up) big war chests of dollars. “Two-thirds of both global securities issuance and official foreign-exchange reserves are denominated in dollars,” Carney writes. The demand for dollars pushes down U.S. interest rates. This makes it attractive to borrow in dollars. That means countries need dollars to pay off the loans, so it makes sense for them to invoice even more in dollars, and so on in a dollar-demanding spiral.
“The global financial cycle is a dollar cycle,” Carney writes, citing Helene Rey, a French economist at London Business School. If a poor nation’s currency falls against the dollar, all that dollar debt becomes harder to service. When the Federal Reserve raises interest rates, borrowing costs can rise in developing nations. “Bank research suggests that the spillover from tightening in U.S. monetary policy to foreign GDP is now twice its 1990-2004 average, despite the U.S.’s rapidly declining share of global GDP,” Carney writes.
Carney considers whether the rise of China’s renminbi could ease the problems by creating a second global reserve currency. Things got messy the last time something like this happened, when the U.S. dollar began to supplant the British pound, he writes. “Some would argue,” he writes, that “the lack of coordination between monetary policy makers during this time contributed to the global scarcity in liquidity and worsened the severity of the Great Depression.”
Rather than counting on China, he writes, the better bet “would be to build a multipolar system.” That’s where Facebook’s Libra might come in. He describes it as “a new payments infrastructure based on an international stablecoin fully backed by reserve assets in a basket of currencies including the U.S. dollar, the euro, and sterling.” But Carney says it’s also possible that a new currency “would be best provided by the public sector, perhaps through a network of central bank digital currencies.”
“It was a remarkable speech,” Olli Rehn, who sits on the European Central Bank’s Governing Council, told Bloomberg. “It’s an idea worth pondering in a wider context of the digitization of our monetary and banking system.”
Even for the U.S., the dollar’s centrality isn’t all upside. True, the dollar’s dominance gives the U.S. some important geopolitical advantages, such as the ability to sanction countries by depriving them of access to dollar-based payments networks, as I wrote in a Remarks column, “The Tyranny of the U.S. Dollar,” for Bloomberg Businessweek last year. But the world’s appetite for dollars can push up the exchange rate, making American goods more expensive in global markets and hurting U.S. employment.
Carney doesn’t have all the answers, but he’s asking the right questions. He concluded his address in Jackson Hole with this: “Let’s end the malign neglect of the IMFS [international monetary and financial system] and build a system worthy of the diverse, multipolar global economy that is emerging.”
<<<
>>> Central Banks Can’t Save the World Economy: Jackson Hole Update
Bloomberg
By Michael McKee , Rich Miller , and Matthew Boesler
August 24, 2019
https://www.bloomberg.com/news/articles/2019-08-24/curse-of-the-commodity-boom-bust-experience-jackson-hole-update?srnd=premium
Central bankers debated for a second day at the Kansas City Federal Reserve’s annual policy retreat in Jackson Hole, Wyoming.
Their discussion about the challenges facing monetary policy takes place against an increasingly tense global economic backdrop, with investors nervous about the risks of recession stemming from President Donald Trump’s escalating trade war with China.
Here’s a summary of news and commentary from the second and final day of the conference presentations:
Central Banks to the Rescue (Not): 2:10 p.m.
In the closing session of the conference, Reserve Bank of Australia Governor Philip Lowe told the audience that central bankers have limited ability to cushion the global economy from the headwinds of mounting political uncertainty.
“We are experiencing a period of major political shocks,” Lowe said, citing developments in the U.S., Brexit, Hong Kong, Italy and elsewhere. “Political shocks are turning into economic shocks.”
Infrastructure investment and structural reform in economies around the world would have much greater impact than cutting interest rates. But politicians are reluctant to act. Ending the political uncertainty would also bring benefits.
“With these three levers stuck, the challenge we face is monetary policy is carrying too much of a burden,” he said.
Triffin’s Dilemma Redux: 11 a.m.
In the 1960s, Yale economist Robert Triffin famously warned about the contradiction at the heart of a global monetary system organized around the gold standard: a fixed supply of gold in a growing global economy would eventually cause a crisis.
Known as Triffin’s Dilemma, and sure enough, by 1971, U.S. President Richard Nixon was forced to close the gold window, ending the shiny yellow metal’s dominance in the global financial system.
The second paper presented Saturday at Jackson Hole suggests the dilemma has returned, but in a different form: this time, U.S. dollar-denominated debt is the new gold.
Stanford University economists Arvind Krishnamurthy and Hanno Lustig point to the role dollar-denominated investments -- especially U.S. Treasury securities -- play in providing global investors safe assets. They find that increased demand for such investments, as well as tighter U.S. monetary policy, causes an appreciation in the U.S. dollar exchange rate against other currencies.
But unlike gold, providing more safe assets under the dollar system means borrowers have to take on more debt.
“The supply of safe dollar assets is no longer backed by gold; however, the supply is fueled by increases in public and private leverage,” Krishnamurthy and Lustig wrote. “Will dollar leverage be supplied in a manner consistent with financial stability? The events of the last 15 years suggest that policy makers should pay close attention to this question.”
Read More:
Fed Says It’s Trade, Not Rates, That’s Undermining U.S. Economy
Powell Warns of ‘Significant Risks,’ Hardening Rate-Cut Bets
Carney Urges Libra-Like Reserve Currency to End Dollar Dominance
Carney Says No-Deal Brexit Would Probably Lead to BOE Easing
Clarida Says Global Outlook Has Worsened: Jackson Hole
Curse of Commodities: 10 a.m.
It’s not just the major central banks in advanced economies trying to figure out what lies ahead for them at Jackson Hole: monetary policy makers in emerging markets are pondering their own challenges as well.
Saturday’s conference got under way with a paper examining how central bankers in small, open economies in which commodity exports comprise a significant share of economic activity -- such as Chile or Argentina -- might respond to booms and busts in commodity prices. These have become more frequent in recent decades as commodities have become more important as an investment product for global portfolio managers.
The authors -- Thomas Drechsel of the University of Maryland and Michael McLeay and Silvana Tenreyro of the Bank of England -- outline how an increase in global commodity prices can lead to financial booms in exporting countries. That’s because the rise in prices allows them to borrow more. In turn, that pushes up their exchange rates and domestic inflation.
“The growing contribution of commodity price shocks to business cycles, their role in relaxing borrowing constraints and the discussion around the financialization of commodity markets make it ever more important to think about the potentially special role of commodity trade in setting monetary policy,” they wrote.
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>>> UK Central Bank Chief Sees Digital Currency Displacing US Dollar as Global Reserve
Yahoo Finance
Coindesk
Nikhilesh De
August 23, 2019
https://finance.yahoo.com/news/uk-central-bank-chief-sees-201715816.html
UK Central Bank Chief Sees Digital Currency Displacing US Dollar as Global Reserve
A central bank-supported digital currency could replace the dollar as the global hedge currency, said Bank of England governor Mark Carney.
Speaking at the Economic Policy Symposium in Jackson Hole, Wyoming, on Friday Carney discussed the need for a new international monetary and financial system (IMFS), noting that while the U.S. dollar has played a dominant role in the world order over much the past century, recent developments such as increased globalization and trade disputes may have stronger impacts on national economies at the present moment than they would have in the past.
Carney highlighted the dollar’s use in international securities issuance, its use as the primary settlement currency for international trades and the fact that companies use dollars as examples of its dominance. However, “developments in the U.S. economy, by affecting the dollar exchange rate, can have large spillover effects to the rest of the world.”
Related: China’s Digital Fiat Wants to Compete With Bitcoin – But It’s Not a Crypto
“While the world economy is being reordered, the U.S. dollar remains as important as when Bretton Woods collapsed,” Carney continued.
Carney suggested a number of possible replacements to the dollar, including the Chinese renminbi, and most notably, a digital currency supported by an international coalition of central banks. He said:
“It is an open question whether such a new Synthetic Hegemonic Currency (SHC) would be best provided by the public sector, perhaps through a network of central bank digital currencies.”
“An SHC could dampen the domineering influence of the U.S. dollar on global trade,” Carney said.
Related: Bank of England Governor Says Facebook’s Libra Crypto Will Be Scrutinized
Technology can disrupt the current network effects that protect the dollar, he explained, noting that an increasing number of transactions occur online and use electronic payments rather than cash.
While he did not explicitly reference cryptocurrencies, he did note that “the relatively high costs of domestic and cross border electronic payments are encouraging innovation, with new entrants applying new technologies to offer lower cost, more convenient retail payment services.”
Libra example
One example is Facebook’s proposed Libra crypto project, he noted. The social media giant has proposed Libra as a payments infrastructure and stablecoin backed by a basket of national currencies.
To succeed, Libra needs to address regulatory issues, Carney said.
“The Bank of England and other regulators have been clear that unlike in social media, for which standards and regulations are only now being developed after the technologies have been adopted by billions of users, the terms of engagement for any new systemic private payments system must be in force well in advance of any launch.”
While a digital currency might not yet be ready to replace the dollar as a global currency, “the concept is intriguing,” Carney said.
“It is worth considering how an SHC in the IMFS could support better global outcomes, given the scale of the challenges of the current IMFS and the risks in transition to a new hegemonic reserve currency like the Renminbi,” he said.
If this new SHC were to take on a greater share of global trade, “shocks in the U.S. would have less potent spillovers,” he suggested, adding:
“By the same token, global trade would become more sensitive to changes in conditions in the countries of the other currencies in the basket backing the SHC.”
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Interesting new interview with Jim Rickards discussing his latest book and other topics (link below). He sees US interest rates going a lot lower, possibly even negative.
Rickards was recently at a confab at Bretton Woods commemorating the 75th anniversary of that 1944 monetary agreement, with people like Larry Summers attending, and said there was an 'off the record' panel discussion with two very senior Fed officials and one top ECB official, and these officials said matter-of-factly that US and European interest rates definitely have to come down. Rickards also said he was surprised at the relaxed attitude toward the idea of negative interest rates by the two top Fed officials -
>>> China: Paper Tiger
BY JAMES RICKARDS
AUGUST 12, 2019
https://dailyreckoning.com/china-paper-tiger/
China: Paper Tiger
China’s shock currency devaluation last week begs the following questions: Is China a rising giant of the twenty-first century poised to overtake the United States in wealth and military prowess? Or is it a house of cards preparing to implode?
Conventional wisdom espouses the former. Yet, hard evidence suggests the latter.
Your correspondent in the world famous Long Bar on the Bund in Shanghai, China. The Long Bar (about 50-yards long) was originally built in 1911 during the heyday of foreign imperialism in China just before the formation of the Republic of China (1912-1949). Bar regulars were divided into “tai-pans” (bosses who sat near the window), “Shanghailanders” (who sat in the middle), and “griffins” (newcomers who sat at the far end).
I made my first visits to Hong Kong and Taiwan in 1981 and my first visit to Communist China in 1991. I have made many visits to the mainland over the past twenty years and have been careful to move beyond Beijing (the political capital) and Shanghai (the financial capital) on these trips. My visits have included Chongqing, Wuhan, Xian, Nanjing, new construction sites to visit “ghost cities,” and trips to the agrarian countryside.
I spent five days cruising on the Yangtze River before the Three Gorges Dam was finished so I could appreciate the majesty and history of the gorges before the water level was lifted by the dam. I have visited numerous museums and tombs both excavated and unexcavated.
My trips included meetings with government and Communist Party officials and numerous conversations with everyday Chinese people, some of who just wanted to practice their English language skills on a foreign visitor.
In short, my experience with China goes well beyond media outlets and talking heads. In my extensive trips around the world, I have consistently found that first-hand visits and conversations provide insights that no amount of expert analysis can supply.
These trips have been supplemented by reading an extensive number of books on the history, culture and politics of China from 3,000 BC to the present. This background gives me a much broader perspective on current developments in China and a more acute analytical frame for interpretation.
An objective analysis of China must begin with its enormous strengths. China has the largest population in the world, about 1.4 billion people (although soon to be overtaken by India). China has the third largest territory in the world, 3.7 million square miles, that’s just slightly larger than the United States (3.6 million square miles), and only slightly behind Canada (3.8 million square miles).
China also has the fifth largest nuclear arsenal in the world with 280 nuclear warheads, about the same as the UK and France, but well behind Russia (6,490) and the U.S. (6,450). China is the largest gold producer in the world at about 500 metric tonnes per year.
China has the second largest economy in the world at $15.5 trillion in GDP, behind the U.S. with $21.4 trillion, and well ahead of number three Japan with $5.4 trillion. China’s foreign exchange reserves (including gold) are the largest in the world at $3.2 trillion (Hong Kong separately has $425 billion in additional reserves).
By way of contrast, the number two reserve holder, Japan, has only $1.3 trillion in reserves. By these diverse measures of population, territory, military strength and economic output, China is clearly a global super-power and the dominant presence in East Asia.
Yet, these blockbuster statistics hide as much as they reveal. China’s per capita income is only $11,000 per person compared to per capita income of $65,000 in the United States. Put differently, the U.S. is only 38% richer than China on a gross basis, but it is 500% richer than China on a per capita basis.
China’s military is growing stronger and more sophisticated, but it still bears no comparison to the U.S. military when it comes to aircraft carriers, nuclear warheads, submarines, fighter aircraft and strategic bombers.
Most importantly, at $11,000 per capita GDP, China is stuck squarely in the “middle income trap” as defined by development economists. The path from low income (about $5,000 per capita) to middle-income (about $10,000 per capita) is fairly straightforward and mostly involves reduced corruption, direct foreign investment and migration from the countryside to cities to purse assembly-style jobs.
The path from middle-income to high-income (about $20,000 per capita) is much more difficult and involves creation and deployment of high-technology and manufacture of high-value-added goods.
Among developing economies (excluding oil producers), only Taiwan, Hong Kong, Singapore and South Korea have successfully made this transition since World War II. All other developing economies in Latin America, Africa, South Asia and the Middle East including giants such as Brazil and Turkey remain stuck in the middle-income ranks.
China remains reliant on assembly-style jobs and has shown no promise of breaking into the high-income ranks.
In short, and despite enormous annual growth in the past twenty years, China remains fundamentally a poor country with limited ability to improve the well-being of its citizens much beyond what has already been achieved.
With this background and a flood of daily reporting on new developments, what do we see for China in the months and years ahead?
Right now, China is confronting social, economic and geopolitical pressures that are testing the legitimacy of the Communist Party leadership and may lead to an economic crisis of the first order in the not distant future.
In contrast to the positives on China listed above, consider the following negative factors:
Trade wars with the U.S. are escalating, not diminishing as I warned from the start in early 2018.
Trump’s recent imposition of 10% tariffs on the remaining $300 billion of Chinese imports not currently tariffed (in addition to existing tariffs on $200 billion of Chinese imports) will slow the Chinese economy even further.
China retaliated with a shock devaluation of the yuan below 7.00 to one dollar, a level that had previously been defended by the People’s Bank of China. Resorting to a currency war weapon to fight a trade war shows just how badly China is losing the trade war.
But, this currency war counterattack will not be successful because it will incite more capital outflows from China. The Chinese lost $1 trillion of hard currency reserves during the last round of capital flight (2014-2016) and will lose more now, despite tighter capital controls. The spike of bitcoin to $11,000 following the China devaluation is a symptom of Chinese people using bitcoin to avoid capital controls and get their money out of China.
The unrest in Hong Kong is another symptom of the weakening grip of the Chinese Communist Party on civil society. The unrest has spread from street demonstrations to a general strike and shutdown of the transportation system, including the cancellations of hundreds of flights.
This social unrest will grow until China is forced to invade Hong Kong with 30,000 Peoples’ Liberation Army troops now massed on the border. This will be the last nail in the coffin of the academic view of China as a good global citizen. That view was always false, but now even the academics are starting to understand what’s really going on.
International business is moving quickly to move supply chains from China to Vietnam and elsewhere in South Asia. Once those supply chains move, they will not come back to China for at least ten years if ever. These are permanent losses for the Chinese economy.
Of course, lurking behind all of this is the coming debt crisis in China. About 25% of China’s reported growth the past ten years has come from wasted infrastructure investment (think “ghost cities”) funded with unpayable debt. China’s economy is a Ponzi scheme like the Madoff Plan and that debt pyramid is set to collapse.
This cascade of negative news is taking its toll on Chinese stocks. This weakness began in late June 2019 when the summit meeting between U.S. President Trump and President Xi of China at the G20 Leaders meeting in Osaka, Japan failed to produce substantive progress on trade disputes.
Since then, the trade wars have gone from bad to worse and China’s economy has suffered accordingly. My expectation is that a trade war resolution in nowhere in sight and the trade war issues have been subsumed into a larger list of issues involving military and national security policy.
The new “Cold War” is here. Get used to it.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Why China's a Paper Tiger
BY JAMES RICKARDS
AUGUST 12, 2019
https://dailyreckoning.com/why-chinas-a-paper-tiger/
Why China's a Paper Tiger
Markets are still digesting last week’s Chinese devaluation that sent the Dow crashing over 700 points last Monday.
And as everyone knows by now, the Trump administration labelled China a currency manipulator.
The ironic part of it is that China has been manipulating its currency to strengthen it against the dollar.
Here’s the dynamic you need to understand…
The Chinese yuan is softly pegged to the dollar. To maintain the soft peg, the People’s Bank of China (PBoC) sells dollars and buys yuan.
That props up the yuan. It’s basic supply and demand economics.
One of the primary reasons China tries to strengthen the yuan is to prevent capital flight out of the country. If the yuan depreciates too rapidly, massive amounts of Chinese money would look to flee abroad where it can get much higher returns.
After all, would you want to hold a rapidly deteriorating asset that constantly loses value? Or if you were a Chinese investor, would you try to convert your money into a currency that holds its value?
That’s the question Chinese investors have been facing.
A capital drain could devastate the Chinese economy, which badly needs the capital to remain in China to support its massive Ponzi schemes, ghost cities and overinvestment.
That’s why the PBoC has been trying to support the yuan, even though a cheaper yuan helps Chinese exports.
That’s the conundrum China faces. It wants a cheap yuan — but not too cheap.
I wouldn’t call last Monday’s devaluation the sort of “max devaluation” I’ve warned my readers about before. That would have been a devaluation of 5% or more in a single day, and that’s not what happened last week. I would classify it as a “red line” devaluation.
The yuan temporarily broke through the 7.00:1 “red line” dollar peg. It has since returned to normalized levels.
It’s actually ironic that China is being labelled a currency manipulator, if manipulating your currency means cheapening it.
That’s because China was manipulating its currency to strengthen it against the dollar. And when the yuan/dollar exchange rate crossed the 7.00:1 “red line,” that meant China temporarily stopped manipulating its currency higher.
If China didn’t manipulate the yuan higher, it would depreciate even more against the dollar. And the exchange rate stabilized last week when China resumed the manipulation. In other words, when China strengthened the yuan.
Welcome to the currency wars! They take on a logic all their own. In many ways it’s a race to the bottom.
I explained it all years ago in my 2011 book Currency Wars.
As soon as one country devalues, its trading partners devalue in retaliation and nothing is gained. China’s case is complicated by its desires for both a strengthened and weakened yuan.
But the ultimate reality is that 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.
Currency wars and trade wars go hand in hand. Often they lead to actual shooting wars, as I have repeatedly pointed out.
Let’s hope the currency wars and trade wars don’t turn into shooting wars as they have in the past.
But below, I show you why China is more of a paper tiger than an actual one. Why do I say that? Read on.
Regards,
Jim Rickards
for The Daily Reckoning
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This chart says it all -
And what it says is batten down the hatches for a recession. Unfortunately the Fed is no shape to deal with a recession, and the world's other central banks are in even worse shape - already near ZIRP or even in NIRP. The Fed balance is still bloated up near $4 tril, and the US is already running trillion plus budget deficits.
So..
What tools are available to deal with a big global recession? And what if the downturn morphs into a financial crisis? You're looking at an IMF bailout of the world with their SDRs. As Rickards says, the IMF has the only clean balance sheet left in the world.
The SDR system is what the global financial elites have been building to replace the current dollar reserve system. Whether they want the change to come now or later I'm not sure, but they don't want to get the blame for the crisis required to bring in the SDRs, and in Trump they have a convenient scapegoat. Dumbass Don walked right into it, both guns blazing.
>>> The Swiss Battle to Cheapen the Franc
BY JAMES RICKARDS
AUGUST 7, 2019
https://dailyreckoning.com/the-swiss-battle-to-cheapen-the-franc/
The Swiss Battle to Cheapen the Franc
One of the crucial insights in currency trading that many investors fail to grasp is that currencies don’t go to zero, and they don’t go through the roof. That’s a generalization, but an important one. Here are the qualifications:
This observation applies to major currencies only — not to currencies of corrupt or incompetent countries like Venezuela or Zimbabwe. Those currencies do go to zero through hyperinflation.
The observation also applies only in the short-to-intermediate run. In the long run, all fiat currencies also go to zero.
Yet over a multiyear horizon, major currencies such as the dollar (USD), euro (EUR), yen (JPY), sterling (GBP) and the Swiss franc (CHF) retain value and do not go to extremes. Instead, they trade in ranges against each other. That’s the key to successful foreign exchange trading. Trading profits are the result of catching the turning points.
Stocks can go to zero when a company goes bankrupt. Enron, WorldCom and a host of dot-com stocks in the early 2000s are all good examples. Bonds can go to zero when a borrower defaults. That happened to Lehman Bros. and Bear Stearns.
But major currencies do not go to zero. They move back and forth against each other like two kids on a seesaw moving up and down and not going anywhere in relation to the seesaw.
The EUR/USD cross-rate is a good example. In the past 20 years, the value of the euro has been as low as $0.80 and as high as $1.60. There have been seven separate instances of moves of 20% or more in EUR/USD in that time period. But EUR/USD never goes to zero or to $100. The exchange rate stays in the range.
Turning points in foreign exchange rates are driven by a combination of central bank interventions, interest rate policies and capital flows. The old theories about “purchasing power parity” and trade deficits are obsolete.
Foreign exchange trading today is all about capital flows driven by policy intervention, sentiment and interest rate differentials.
Another good example is the Swiss franc (CHF). If you look at its exchange rate with the dollar, an exchange rate of 0.80 francs per dollar indicates a strong franc. An exchange rate of 1.05 francs per dollar indicates a weak franc. Right now the exchange rate is 0.97, which leans towards a weak franc relative to the dollar.
CHF has traded in a range of 0.87–1.03 for the past six years. One move that stands out is the spike on Jan. 15, 2015, when CHF surged from 1.02 to 0.86, a nearly 20% move in a matter of hours. CHF then backed off that high of 0.86 and declined to its more recent trading range of 0.91–1.03.
The spike on Jan. 15, 2015, was caused entirely by the decision of the Swiss National Bank (SNB) to remove a cap on the Swiss franc relative to the euro intended to protect Swiss exports.
The Swiss economy is heavily dependent on exports of precision equipment, luxury goods such as Swiss watches and food including cheeses and chocolates. The Swiss economy also depends on tourism, which is akin to a service export sold to foreigners. All of these exports suffer when the Swiss franc is too strong.
The SNB has been enforcing the cap by printing francs and buying euros to put downward pressure on the franc. The problem with this policy is that the world wants francs as a safe haven.
That was especially true during the European sovereign debt crisis of 2010–2015. The SNB balance sheet was becoming top-heavy with European debt purchased with printed francs at a time when the European debt itself was in distress.
Eventually, SNB threw in the towel and allowed market forces to determine the value of CHF. This produced an immediate spike in CHF against the euro and the dollar, which has since moderated into a trading range.
But the franc is currently at the 1.09 level versus the euro, on expectations of monetary easing in both the euro zone and the United States have set in.
So the SNB has been buying euros in an attempt to get out ahead of the curve. It’s trying to cheapen the franc to keep its exports and tourism industry competitive. You see evidence for this in its so-called sight accounts. Sight account can be transferred to another account or converted into cash without restriction.
There has been a recent surge in these accounts lately, which indicates the SNB has been actively intervening in the currency markets.
With rising market uncertainty and hot money in search of safe havens, what does the future hold for the Swiss franc?
The single most important factor in the analysis is that hot-money safe-harbor inflows are clashing with the SNB’s cheaper franc policy.
The demand for Swiss francs will be driven by the lack of palatable alternatives. Investors are increasingly concerned about sterling because of conditions imposed by the EU, Ireland and others in the Brexit process. Brexit is irreversible, but satisfying all of the demands of interested parties to achieve Brexit will weaken the U.K. economy and sterling.
Likewise, the dollar and yen are both the cause of investor concern because of out-of-control debts. The Japanese debt-to-GDP ratio is over 250% and the U.S. debt-to-GDP ratio will soon be 110%. Any ratio higher than 90% is considered a danger zone by economists.
Almost all Japanese government debt is owned by the Japanese people, so there’s a higher threshold for panic in Japan than in the U.S. The U.S. debt is about 17% owned by foreign investors who could choose to dump it at any moment. Still, both Japan and the U.S. are on unsustainable paths and have shown no willingness to tackle their debt problems or reduce their debt-to-GDP ratios.
The euro offers better debt-to-GDP ratios than Japan or the U.S. in the aggregate. However, the European Central Bank is getting ready to pursue more quantitative easing and near-negative interest rate policies. The euro is also plagued by lingering doubts about the individual debt situations in Greece and Italy, a legacy of the 2010–2015 European debt crisis.
Meanwhile, the Swiss debt-to-GDP ratio is about 30%. In fact, Keynesians complain that its debt levels are far too low!
Russian rubles and Chinese yuan are unattractive for major global capital allocators because their markets lack liquidity and they do not have satisfactory rule-of-law regimes behind their currencies.
With dollars, yen, sterling, the euro and emerging-market currencies all unattractive for different reasons, the primary safe havens for global investors are Swiss francs, gold, silver and some of the smaller currencies such as Australian or Canadian dollars.
Many investors won’t allocate to gold because of investment restrictions or simple bias. This leaves the Swiss franc first in line to absorb huge global capital flows looking for a home.
The SNB may keep trying to knock down the Swiss franc by buying stocks, bonds, euros and anything else that’s not nailed down, but in the end it won’t be enough. Global capital will continue buying francs for lack of a better alternative.
Eventually the SNB will once again throw in the towel as they did in 2015 and allow the franc to appreciate sharply.
Having a strong currency is desirable. But in today’s world outside of a gold standard, having too strong a currency can actually be a curse.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Free-Riding Investors Set up Markets for a Major Collapse
BY JAMES RICKARDS
JULY 19, 2019
https://dailyreckoning.com/free-riding-investors-set-up-markets-for-a-major-collapse-2/
Free-Riding Investors Set up Markets for a Major Collapse
Free riding is one of the oldest problems in economics and in society in general. Simply put, free riding describes a situation where one party takes the benefits of an economic condition without contributing anything to sustain that condition.
The best example is a parasite on an elephant. The parasite sucks the elephant’s blood to survive but contributes nothing to the elephant’s well-being.
A few parasites on an elephant are a harmless annoyance. But sooner or later the word spreads and more parasites arrive. After a while, the parasites begin to weaken the host elephant’s stamina, but the elephant carries on.
Eventually a tipping point arrives when there are so many parasites that the elephant dies. At that point, the parasites die too. It’s a question of short-run benefit versus long-run sustainability. Parasites only think about the short run.
A driver who uses a highway without paying tolls or taxes is a free rider. An investor who snaps up brokerage research without opening an account or paying advisory fees is another example.
Actually, free-riding problems appear in almost every form of human endeavor. The trick is to keep the free riders to a minimum so they do not overwhelm the service being provided and ruin that service for those paying their fair share.
The biggest free riders in the financial system are bank executives such as Jamie Dimon, the CEO of J.P. Morgan. Bank liabilities are guaranteed by the FDIC up to $250,000 per account.
Liabilities in excess of that are implicitly guaranteed by the “too big to fail” policy of the Federal Reserve. The big banks can engage in swap and other derivative contracts “off the books” without providing adequate capital for the market risk involved.
Interest rates were held near zero for years by the Fed to help the banks earn profits by not passing the benefits of low rates along to their borrowers.
Put all of this (and more) together and it’s a recipe for billions of dollars in bank profits and huge paychecks and bonuses for the top executives like Dimon. What is the executives’ contribution to the system?
Nothing. They just sit there like parasites and collect the benefits while offering nothing in return.
Given all of these federal subsidies to the banks, a trained pet could be CEO of J.P. Morgan and the profits would be the same. This is the essence of parasitic behavior.
Yet there’s another parasite problem affecting markets that is harder to see and may be even more dangerous that the bank CEO free riders. This is the problem of “active” versus “passive” investors.
An active investor is one who does original research and due diligence on her investments or who relies on an investment adviser or mutual fund that does its own research. The active investor makes bets, takes risks and is the lifeblood of price discovery in securities markets.
The active investor may make money or lose money (usually it’s a bit of both) but in all cases earns her money by thoughtful investment. The active investor contributes to markets while trying to make money in them.
A passive investor is a parasite. The passive investor simply buys an index fund, sits back and enjoys the show. Since markets mostly go up, the passive investor mostly makes money but contributes nothing to price discovery.
The benefits of passive investing have been trumpeted by the late Jack Bogle of the Vanguard Group. Bogle insisted that passive investing is superior to active investing because of lower fees and because active managers can’t “beat the market.” Bogle urged investors to buy and hold passive funds and ignore market ups and downs.
The problem with Bogle’s advice is that it’s a parasitic strategy. It works until it doesn’t.
In a world in which most mutual funds and wealth managers are active investors, the passive investor can do just fine. Passive investors pay lower fees while they get to enjoy the price discovery, liquidity and directional impetus provided by the active investors.
Passive investors are free riding on the hard work of active investors the same way a parasite lives off the strength of the elephant.
What happens when the passive investors outnumber the active investors? The elephant starts to die.
Since 2009, over $2.5 trillion of equity investment has been added to passive-strategy funds, while over $2.0 trillion has been withdrawn from active-strategy funds.
The active investors who do their homework and add to market liquidity and price discovery are shrinking in number. The passive investors who free ride on the system and add nothing to price discovery are expanding rapidly. The parasites are starting to overwhelm the elephant.
There’s much more to this analysis than mere opinion or observation. The danger of this situation lies in the fact that active investors are the ones who prop up the market when it’s under stress. If markets are declining rapidly, the active investors see value and may step up to buy.
If markets are soaring in a bubble fashion, active investors may take profits and step to the sidelines. Either way, it’s the active investors who act as a brake on runaway behavior to the upside or downside.
Active investors perform a role akin to the old New York Stock Exchange specialist who was expected to sell when the crowd wanted to buy and to buy when the crowd wanted to sell in order to maintain a balanced order book and keep markets on an even keel.
Passive investors may be enjoying the free ride for now but they’re in for a shock the next time the market breaks, as it did in 2008, 2000, 1998, 1994 and 1987.
When the market goes down, passive fund managers will be forced to sell stocks in order to track the index. This selling will force the market down further and force more selling by the passive managers. This dynamic will feed on itself and accelerate the market crash.
Passive investors will be looking for active investors to “step up” and buy. The problem is there won’t be any active investors left or at least not enough to make a difference. The market crash will be like a runaway train with no brakes.
The elephant will die.
Regards,
Jim Rickards
for TheDaily Reckoning
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>>> Robot Trading Will End in Disaster
BY JAMES RICKARDS
JULY 19, 2019
https://dailyreckoning.com/robot-trading-will-end-in-disaster/
Robot Trading Will End in Disaster
Today, stock markets and other markets such as bonds and currencies can best be described as “automated automation.” Here’s what I mean.
There are two stages in stock investing. The first is coming up with a preferred allocation among stocks, cash, bonds, etc. This stage also includes deciding how much to put in index products or exchange-traded funds (ETFs, which are a kind of mini-index) and how much active management to use.
The second stage involves the actual buy and sell decisions — when to get out, when to get in and when to go to the sidelines with safe-haven assets such as Treasury notes or gold.
What investors may not realize is the extent to which both of these decisions are now left entirely to computers. I’m not talking about automated trade matching where I’m a buyer and you’re a seller and a computer matches our orders and executes the trade. That kind of trading has been around since the 1990s.
I’m talking about computers making the portfolio allocation and buy/sell decisions in the first place, based on algorithms, with no human involvement at all. This is now the norm.
Eighty percent of stock trading is now automated in the form of either index funds (60%) or quantitative models (20%). This means that “active investing,” where you pick the allocation and the timing, is down to 20% of the market. Although even active investors receive automated execution.
In all, the amount of human “market making” in the traditional sense is down to about 5% of total trading. This trend is the result of two intellectual fallacies.
The first is the idea that “You can’t beat the market.” This drives investors to index funds that match the market. The truth is you can beat the market with good models, but it’s not easy.
The second fallacy is that the future will resemble the past over a long horizon, so “traditional” allocations of, say, 60% stocks, 30% bonds and 10% cash (with fewer stocks as you get older) will serve you well.
But Wall Street doesn’t tell you that a 50% or greater stock market crash — as happened in 1929, 2000 and 2008 — just before your retirement date will wipe you out.
But this is an even greater threat that’s rarely considered…
In a bull market, this type of passive investing amplifies the upside as indexers pile into hot stocks like, for example, Google and Apple have been. But a small sell-off can turn into a stampede as passive investors head for the exits all at once without regard to the fundamentals of a particular stock.
Index funds would stampede out of stocks. Passive investors would look for active investors to “step up” and buy. The problem is there wouldn’t be any active investors left, or at least not enough to make a difference. There would be no active investors left to risk capital by trying to catch a falling knife.
Stocks will go straight down with no bid. The market crash will be like a runaway train with no brakes.
It comes back to complexity, and the market is an example of a complex system.
One formal property of complex systems is that the size of the worst event that can happen is an exponential function of the system scale. This means that when a complex system’s scale is doubled, the systemic risk does not double; it may increase by a factor of 10 or more.
This kind of sudden, unexpected crash that seems to emerge from nowhere is entirely consistent with the predictions of complexity theory. Increasing market scale correlates with exponentially larger market collapses.
Welcome to the world of automated investing. It will end in disaster.
Regards,
Jim Rickards
for The Daily Reckoning
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