In this interview Jim Rickards explains that China is getting ready for a post dollar world by on going accumulation of gold.
During this 30+ minute interview, Jason starts off by asking Jim about his recent trip to mainland China and if he learned on his trip if physical gold demand in China is still strong?
Jason also asks Jim if China is worried about President Trump starting a trade war by putting a very high tariff on Chinese goods, why Keynesian predictive models with extremely poor long term track records are still given any credibility and whether Janet Yellen and the Federal Reserve will raise interest rates anymore in 2017?
I was surprised this week that the stock market reached new highs — despite the fact that expectations of a March rate hike by the Fed moved from 40% to 60% in three days. Today those expectations are about 75%.
But I’ve been calling a March rate hike since late December. I was almost alone in that view. Wall Street analysts were paying lip service to the idea that the Fed might raise rates twice before the end of the year, but said the process might begin in June, not March. Market indicators were giving only a 25% chance of a rate hike within the past couple weeks.
Is it because I’m smarter than all these other analysts?
No, I certainly don’t claim to be smarter than any of them. It’s just that I use better analytical techniques based on complexity theory, behavioral psychology and other sciences that account for the ways actual markets behave. Meanwhile, most analysts are using outdated, static models that don’t apply to the real world.
Speculation began after Janet Yellen’s testimony to House and Senate committees last month. She said a solid job market and an overall improving economy suggested the Fed would likely resume raising rates soon. But, Yellen did not say anything she hadn’t said in December.
But suddenly this week everything heated up. Now the markets agree that a rate hike is coming, thanks to an orchestrated campaign of speeches and leaks from senior Fed officials. Several Fed members have been talking about the need to tighten, including Fed Governor and uber-dove Lael Brainard. When she starts sounding like a hawk, it’s time to pay attention.
As I said, markets are now pricing in nearly a 75% chance of a March rate hike (my estimate is now 90%).
But there’s a big difference between the dynamics behind my view of a rate increase and the market’s view. In effect, markets are saying, “The Fed is hiking rates, therefore, the economy must be strong.”
What I’m saying is “The Fed is tightening into weakness (because they don’t see it), so they will stall the economy and will flip to ease by May.”
My view is the economy is fundamentally weak, the Fed is tightening into weakness. By later this year, the Fed will have to flip-flop to ease (via forward guidance) for the ninth time since 2013. Stocks will fall, while bonds and precious metals will rally.
Both theses start with a rate hike, but they rest on totally different assumptions and analyses.
Under my scenario, the stock market is headed for a brick wall in April or May, when weak first-quarter data roll in. But for now, it’s still up, up and away.
My take is that the Fed is desperate to raise rates before the next recession (so they can cut them again), and will take every opportunity to do so. I believe the Fed will raise rates 0.25% every other meeting (March, June, September and December) until 2019 unless one of three events happens — a stock market crash, job losses, or deflation.
Right now the stock market is booming, job creation is strong, and inflation is emerging. So, none of the speed bumps are in place. The coast is clear for the March rate hike.
There is a great deal of happy talk surrounding the market right now. But with so much bullishness around, it’s time to take a close look at the bear case for stocks. It’s actually straightforward.
Growth is being financed with debt, which has now reached epic proportions. The debt bubble can be seen at the personal, corporate and sovereign level. Sure, a lot of money has been printed since 2007, but debt has expanded much faster.
In a liquidity crisis, investors who think they have “money” (in the form of stocks, bonds, real estate, etc.) suddenly realize that those investments are not money at all — they’re just assets.
When investors all sell their assets at once to get their money back, markets crash and the panic feeds on itself. What would it take to set off this kind of panic? In a super-highly leveraged system, the answer is: “Not much.”
There’s a long list of potential catalysts, including delays and disappointments with Trump’s economic plans, aggressive rate hikes by the Fed, a stronger dollar, and economic turmoil due to China’s vanishing reserves or the new Greek bailout.
It could also be anything from a high-profile bankruptcy, a failed deal, a bad headline, a natural disaster, and so on.
This issue is not the catalyst; the issue is the leverage and instability of the system. The bulls are ignoring the risks.
My view is we’re well into bubble territory, and stocks will reverse sooner than later. Stocks are a bubble that will certainly crash. But you must realize that the timing is uncertain. Recall that Greenspan gave his “irrational exuberance” speech in 1996, but stocks did not crash until 2000. That’s a long time to be on the sidelines.
Conversely, bonds are not in a bubble, despite the large number of analysts who make that claim. These analysts are looking at nominal rates. You need to look at real rates, which are still fairly high.
Nominal and real yields on the 10-year Treasury note were much higher at the end of 2013 than they are today. Wall Street yelled “bubble” then and shorted the bond market when the 10-year note yield-to-maturity was 3% in 2013.
Those who shorted Treasury notes got crushed when yields fell to 1.4% by early 2016 (they have reversed since). I expect another bond market rally (bonds up, rates down) to play out between now and this summer.
One source of investor confusion is that the White House and Congress are moving toward fiscal stimulus, while the Fed is moving toward monetary tightening. That’s a highly unstable dynamic. Markets could tip either way.
Investors have to be prepared for countertrends and reversals while waiting for this picture to unfold. The Trump administration is perfectly capable of shouting “strong dollar” on Monday and “weak dollar” on Tuesday. That’s one reason I recommend a cash allocation — it allows you to be nimble.
Something else to remember going forward is that Trump will have a minimum of three, and perhaps as many as four or five, chances to appoint members of the Fed board of governors, including a new chairman in the next 10 months. I expect these new governors will be dovish based on Trump’s publicly expressed preference for a weaker dollar.
The Senate will definitely confirm Trump’s choices. So get ready for an extreme makeover at the Fed, with the likelihood of easy money, more inflation, higher gold prices and a weaker dollar right around the corner.
That combination of Fed ease (due to slowing) and Fed doves flying into the boardroom on Constitution Avenue in Washington will give gold prices in particular a major lift in the second half of the year.
I’ve been warning my readers since last December that the Fed was on track to raise interest rates on March 15.
I was almost alone in that view. Market indicators were giving only a 25% chance of a rate hike. Wall Street analysts were paying lip service to the idea that the Fed might raise rates twice before the end of the year but said the process might begin in June, not March.
Wall Street expectations and market indicators did not catch up with Fed reality until last week, when expectations moved from 30% to 90% in four trading days before converging on 100%.
So expectations of a Fed rate hike March 15 are now near 100% based on surveys of economists and fed funds futures contracts.
Markets are looking at things like business cycle indicators, but that’s not what the Fed is watching these days. The Fed is desperate to raise rates before the next recession (so they can cut them again) and will take every opportunity to do so.
But as I’ve said before, the Fed is getting ready to raise into weakness. It may soon have to reverse course.
My view is that the Fed will raise rates 0.25% every other meeting (March, June, September and December) until 2019 unless one of three events happens — a stock market crash, job losses or deflation.
But right now the stock market is booming, job creation is strong and inflation is emerging. So none of the usual speed bumps is in place. The coast is clear for a rate hike this Wednesday.
But growth is being financed with debt, which has now reached epic proportions. A lot of money has been printed since 2007, but debt has expanded much faster. The debt bubble can be seen at the personal, corporate and sovereign levels.
If the debt bubble bursts, things can get very messy.
In a liquidity crisis, investors who think they have “money” (in the form of stocks, bonds, real estate, etc.) suddenly realize that those investments are not money at all — they’re just assets.
When investors all sell their assets at once to get their money back, markets crash and the panic feeds on itself.
What would it take to set off this kind of panic?
In a super-highly leveraged system, the answer is: Not much. It could be anything: a high-profile bankruptcy, a failed deal, a bad headline, a geopolitical crisis, a natural disaster and so on.
This issue is not the catalyst; the issue is the leverage and instability of the system.
This looks like a good time to get out of stocks, increase cash and buy some gold if you are not fully allocated. Gold faces some head winds in the short run, but today’s prices offer an excellent entry point. Gold is a great safe-haven asset.
Trump advisors believe they can avoid a debt crisis through higher than average growth. This is mathematically possible but extremely unlikely.
A debt-to-GDP ratio is the product of two parts — a numerator consisting of nominal debt and a denominator consisting of nominal GDP. In this issue, we have focused on the numerator in the form of massively expanding government debt. Yet, mathematically it is true that if the denominator grows faster than the numerator, the debt ratio will decline.
The Trump team hopes for nominal deficits of about 3% of gross domestic product (GDP) and nominal GDP growth of about 6% consisting of 4% real growth and 2% inflation. If that happens, the debt-to-GDP ratio will decline and a crisis might be averted.
This outcome is extremely unlikely. As shown in the chart below, deficits are already over 3% of GDP and are projected by CBO to go higher. We are past the demographic sweet spot that Obama used to his budget advantage in 2012–2016.
The Congressional Budget Office, CBO, estimates that inflation and real GDP will each grow at about 2% per year in the coming ten years. This means that nominal GDP, which is the sum of real GDP plus inflation, will grow at about 4% per year. Since debt is incurred and paid in nominal terms, nominal GDP growth is the critical measure of the sustainability of U.S. debt.
The Fiscal Budget
The Congressional Budget Office, CBO, estimates that inflation and real GDP will each grow at about 2% per year in the coming ten years. This means that nominal GDP, which is the sum of real GDP plus inflation, will grow at about 4% per year. Since debt is incurred and paid in nominal terms, nominal GDP growth is the critical measure of the sustainability of U.S. debt.
From now on, retiring Baby Boomers will make demands on social security, Medicare, Medicaid, Disability payments, Veterans benefits and other programs that will drive deficits higher.
The CBO projections show that deficits will increase to 5% of GDP in the years ahead, substantially higher than the hoped for 3% in the Trump team formula.
As for growth, we are now in the eighth year of an expansion — quite long by historical standards. This does not mean a recession occurs tomorrow, but no one should be surprised if it does.
Official CBO projections, shown in the chart below, expect approximately 2% growth and 2% inflation for the next ten years. That would yield 4% nominal growth, not enough to match the deficit projections. The debt-to-GDP ratio is projected to soar even under these rosy scenarios.
There are numerous problems with the CBO projections. They make no allowance for a recession in the next ten years. That is highly unrealistic considering that the current expansion is already one of the longest in history. A recession will demolish the growth projections and blow-up the deficits at the same time.
CBO also makes no allowance for substantially higher interest rates. With $20 trillion in debt, most of it short-term, a 2% increase in interest rates would quickly add $400 billion per year to the deficit in the form of increased interest expense in addition to any currently project spending
The Impact Signal of Debt on Growth
Finally, CBO fails to consider the ground-breaking research of Kenneth Rogoff and Carmen Reinhart on the impact of debt on growth. We have discussed the 60% debt ratio danger threshold in this article. But there is an even more dangerous threshold of 90% debt-to-GDP revealed in the Rogoff-Reinhart research. At that 90% level, debt itself causes reduced confidence in growth prospects — partly due to fear of higher taxes or inflation — which results in a material decline in growth relative to long-term trends.
These headwinds practically insure that the Trump growth projections are wholly unrealistic. With higher than expected deficits, and lower than projected real growth, there is one and only one way for the Trump administration to reduce the debt ratio — inflation.
If inflation is allowed to rip to 4% and Fed financial repression can keep a lid on interest rates at around 2.5%, then it is possible to achieve 6% nominal growth with 5% deficits, which would be just enough to keep the debt ratio under control and even reduce it slightly.
Can Trump pull-off this finesse? Are his advisors even analyzing the problem along these lines?
We will know soon. As we’ll discuss in upcoming issues, Trump will have the chance to make an unprecedented five appointments to the Fed board of governors in the next 16 months, including a new chair and two vice chairs.
If he appoints doves, that will be the signal that inflation in the form of helicopter money and financial repression is on the way. That will also be the signal to move out of cash and increase our allocation to gold beyond the current 10% level.
If Trump appoints hawks to the board, that will be a signal that his team does not understand the problem and is relying on overoptimistic growth assumptions. In that case, we could expect a recession, possible debt crisis and strong deflation. That is a signal to keep our 10% gold allocation as a safe haven, but also buy Treasury notes in expectation of lower nominal rates.
We are watching for a signal on Trump’s nominations to the Fed board. The first three should be announced soon. Once the names and their views are known, the die will be cast.
"In 1998, he helped save the financial system from the collapse of LTCM… In 2006, he warned Washington officials of the coming $12.6 trillion mortgage meltdown…
Now CIA financial-threat analyst Jim Rickards warns of a looming $326 trillion crisis poised to freeze the world financial system indefinitely… in just 48 hours…"
Yes, war with China could break out in the South China Sea...
HISTORY shows that many wars begin not by design but by accident, writes Jim Rickards in The Daily Reckoning.
World War One is the classic case study.
No one really wanted a world war. And 16 million people died as a result. The Ottoman, Russian, German and Austro-Hungarian empires all collapsed in the aftermath. Still, the war happened anyway – through miscalculation and misreading the intentions of the other side.
Today the US and China are confronting each other in the South China Sea the way Germany and Russia confronted each other just before World War One. Could another world war happen by accident?
The answer is yes, it could.
The shoving matches between China and Japan in the East China Sea, and between China and the Philippines in the South China Sea are getting worse. It's just a matter of time before some incident or accident at sea sparks a war.
The problem is that the US has treaty obligations to Japan and the Philippines, as well as to Taiwan. So a Chinese war with them can quickly become a Chinese war with America.
The maritime regions off China's east and southeast coasts are vital to Chinese interests...
The South China Sea is rich in natural resources. It has rich fishing grounds and as much as $5 trillion in oil and gas.
But apart from its fisheries and vast energy resources, the South China Sea is home to some of the most important sea routes in the world. A third of all the world's seagoing trade, and roughly $5 trillion worth of goods transit through South China Sea each year.
The Malacca Strait links the Indian Ocean to the South China Sea. The amount of oil transported from the Indian Ocean through the Malacca Strait and into the South China Sea is three times the amount that passes through the Suez Canal every year. And fifteen times the amount that passes through the Panama Canal. The Malacca Strait is therefore one of the great choke points in global shipping.
Without access to the strait, China's access to oil and other raw materials from the Middle East and Africa would become greatly reduced. In wargames, American ships and bombers have rehearsed blockading the Malacca Strait. Chinese leaders are well aware of the implications and have watched these wargames with alarm.
China has now essentially claimed the entire South China Sea for itself (except for small zones immediately adjacent to the surrounding nations). But its control is disputed by six countries – China, Vietnam, Philippines, Malaysia, Brunei and Taiwan, all of which lay claim to some portion of it.
Of course, Chinese assertiveness in the South China Sea is nothing new. China has claimed territorial rights to almost the entire South China Sea in defiance of international arbitration and the competing claims of the other nations.
China has been backing up its claims by dredging the ocean floor to create artificial "islands" on existing rocks and atolls. Then it's built military bases on those islands and threatened to interdict any fishing or commerce which it does not approve.
Control of the South China Sea would be a sensitive subject at the best of times, but now it is more of a tinderbox than ever.
Lately, the seriousness of the confrontation has been dialed up.
The US has conducted freedom of navigation patrols in the area by sea and air. Numerous incidents have occurred between China and other claimants involving fishing and coast guard vessels in accidental collisions and intentional boardings.
China also seized a US underwater surveillance drone and has been conducting strategic bomber overflights in the area.
Some of this is in response to comments by President-elect Trump about China's currency manipulation and unfair trade practices and the suggestion that the US acceptance of Beijing's "One China" policy may be up for review.
Soon after his election, Trump received a congratulatory phone call from the president of Taiwan.
That might seem like a routine courtesy.
But from the Chinese perspective, the Taiwan issue is nonnegotiable. Beijing insists Taiwan is a "breakaway province" and not a separate country. US politicians usually tiptoe around this issue, but not Trump.
Not only did Trump chat with Taiwan's president, but he questioned the US "One China" policy in a tweet.
Trump's actions set off alarms in Beijing. The Communist leadership decided to send Trump a message by stealing the underwater drone operating in Philippine waters, nowhere near the disputed South China Sea waters claimed by China.
The drone was later returned, (after Trump tweeted that the Chinese should "keep it"), but the point was made. In short, geopolitical tensions between China and the US are definitely on the rise.
What about the future?
The indications for that are not good. In his confirmation hearing for secretary of state, Trump's nominee, Rex Tillerson, said that China should be denied access to the artificial islands they created in the South China Sea.
Attempting to deny China access by a blockade or other means would be tantamount to an act of war. China fired back immediately. A leading Communist Chinese publication said, "Unless Washington plans to wage a large-scale war in the South China Sea, any other approaches to prevent China access to the islands will be foolish."
President Xi of China is on the world stage at the Davos World Economic Forum this week even as Donald Trump is about to be sworn in as 45th president of the United States. We are certain to hear more on this topic soon from both leaders.
But Trump's not even president yet. That won't happen for a few more days. Imagine how much worse this could get once Trump takes office and his policy suggestions become reality.
The prospects for peaceful resolution are not good. This volatile mix of disputed claims, natural resources and complex treaty networks has the ingredients needed to escalate into a Third World War.
All it would take to start a war is some spark such as a collision at sea or an attack based on mistaken identity or misunderstood intentions. For example, an accidental collision at night between a Philippines' naval vessel and a Chinese fishing boat resulting in Chinese casualties has the potential to start the next world war. Now, I'm not saying it necessarily would, but the potential exists.
So in addition to trade wars and currency wars, China and the US could soon find themselves in a shooting war in the South China Sea.
Of course, the implications of this for markets are nothing short of catastrophic. But the serious potential for a shooting war in the South China Sea has largely being ignored by markets.
World Wars often emerge in unexpected places or on thin pretexts. The same could happen here. In fact, a war there is probably just a matter of time.
The entire situation is a tinderbox waiting to explode.
Six years ago in my first book, Currency Wars, I wrote, “There is nothing today that suggests the currency wars will end anytime soon.” Today, those words seem as true as ever.
A currency war is a battle, but it’s primarily economic. It’s about economic policy. The basic idea is that countries want to cheapen their currency. Now, they say they want to cheapen their currency to promote exports. Maybe it makes a Boeing more competitive internationally with Airbus.
But the real reason, the one that’s less talked about, is that countries actually want to import inflation. Take the United States for example. We have a trade deficit, not a surplus. If the dollar’s cheaper it may make our exports slightly more attractive.
It’s going to increase the price of the goods we buy — whether it’s manufactured good, textiles, electronics, etc. — and that inflation then feeds into the supply chain in the U.S. So, currency wars are actually a way of creating monetary ease and importing inflation.
How many times have you heard the Fed say they want 2% inflation? They analyze it over and over and over. They’re desperate to get there.
The problem is, once one country tries to cheapen their currency, another country cheapens its currency, and so on causing a race to the bottom.
Currency wars are like real wars in more ways than one. They can last longer than the combatants expect, and produce unexpected victories and losses. Real wars do not involve all fighting, all the time. There are quiet periods, punctuated by major battles, followed by new quiet periods as the armies rest and regroup.
There are critical turning points where a long-term directional trend is set to reverse. Today’s “winners” (the strong currencies) suddenly become “losers” (the weak currencies), contrary to most expectations and Wall Street forecasts. Today we could be at one of those turning points, which we’ll explore in a moment. But first, let’s see how we got here.
The currency wars of the early 1930s are potentially instructive for what we could be experiencing today. The U.K. devalued the pound sterling in 1931. Soon after, the U.S. devalued the dollar in 1933. Then France, which devalued the franc in the ‘20s, and the U.K. devalued again in 1936.
You had a period of successive currency devaluations and so-called “beggar-thy-neighbor” policies.
The result was, of course, one of the worst depressions in world history. There was skyrocketing unemployment and crushed industrial production that created a long period of very weak to negative growth. This currency war was not resolved until World War II and then, finally, at the Bretton Woods conference. That’s when the world was put on a new monetary standard.
The next currency war raged from 1967 to 1987. The seminal event in the middle of this war was Nixon’s taking the U.S., and ultimately the world, off the gold standard on August 15, 1971.
He did this to create jobs and promote exports to help the U.S. economy. What actually happened instead?
We had three recessions back to back, in 1974, 1979 and 1980.
Our stock market crashed in 1974. Unemployment skyrocketed, inflation flew out of control between 1977 and 1981 (U.S. inflation in that five-year period was 50%) and the value of the dollar was cut in half.
The real lesson of currency wars is that they don’t produce the results you expect which are increased exports and jobs and some growth. What they generally produce is extreme deflation, extreme inflation, recession, depression or economic catastrophe.
But they’re very, very appealing to politicians because they can stand up say, “Hey, it’s good to have a cheap dollar because we promote jobs.” But the reality is, it doesn’t promote jobs. It just promotes inflation.
You’re actually better off with a strong currency because that attracts capital from overseas. People want to invest in the strong currency area, and it’s that investment and those capital inflows that actually creates the jobs. So as usual, the politicians and the central bankers have it completely wrong. But they’re not listening to me or necessarily reading my newsletters.
The period between 1985 and 2010 was the age of what we call “King dollar” or the “strong dollar” policy. It was a period of very good growth, very good price stability and good economic performance around the world.
The United States agreed to maintain the purchasing power of the dollar and our trading partners could link to the dollar or plan their economies around some peg to the dollar. That gave us a generally stable system. It worked up until 2010 when the U.S. tore up the deal and basically declared another currency war to boost U.S. exports. President Obama did this in his State of the Union address in January 2010.
The currency wars have been ongoing ever since, with varying intensity. But with the election of Donald Trump, they look set to enter a new major battle.
Today, the currency wars have brought the U.S. to the cusp of a trade war. President Trump and several of his top advisers in recent days have complained that not only is China a currency manipulator, but so are Japan and Germany. It seems the U.S. is tired of the new “king dollar” phase it’s been in lately, and is willing to take action to cheapen the dollar.
But how can the administration actually do this?
The Fed will not lower rates because it is in a tightening cycle. The Fed will probably be raising rates in March and possibly later this year. That makes the dollar stronger.
China is trying to prop up the yuan but is running out of dollar reserves to do so and will have to devalue before they go broke. Germany might like a stronger euro to fight inflation, but the decision is not entirely in their hands — it’s up to the European Central Bank, and the ECB is still engaged in QE for the time being.
Japan cannot afford a stronger yen, because they have the highest debt-to-GDP ratio of any major economy and are desperate to get inflation. Japan needs inflation to lower the real value of that debt.
If China, Germany and Japan cannot give Trump what he wants in the foreign exchange markets, what options does the U.S. have?
The main option is tariffs, exactly what Richard Nixon did on Aug. 15, 1971.
You may remember that date as the day Nixon ended the convertibility of dollars for gold. But he also imposed a 10% across-the-board tariff on all imported goods as part of his New Economic Plan. Nixon combined the currency wars and trade wars in one policy by hoarding gold and imposing tariffs.
Historically, currency wars do lead to trade wars and, ultimately, to some form of systemic collapse. That seems to be happening again. I’ll be analyzing each side of this coin in the coming weeks.
Cognitive dissonance is a psychological term to describe a situation where perception and reality are out of sync.
It’s similar to what most people refer to as “denial.” The patient sees things one way, but the reality is different. Of course, it’s just a matter of time before reality prevails and the patient is jolted back to reality. This process can be fast or slow, easy or painful, but the important thing to bear in mind is reality always wins.
Something like cognitive dissonance is going on in markets right now. Markets have been temporarily euphoric over Trump’s tax, regulatory and spending policies. Those policies are important to business and credit cycles and economic growth.
The perception is that happy days are here again. The new Trump administration is expected to pour trillions of dollars of stimulus spending and tax cuts into the economy. Immediately after the Nov. 8 election, investors took a quick look at Trump’s policies and decided they liked what they saw.
Trump wants lower taxes, less regulation and higher infrastructure spending. Corporate profits and consumer spending benefit from lower taxes. Banks and pharmaceutical companies benefit from less regulation. Construction firms and defense contractors benefit from infrastructure spending. There seemed to be something for everyone, and the stock market took off like a Roman candle.
And indeed, the major stock indexes hit one record closing after another. The Dow topped 20,000 this week before pulling back. The dollar has been trading near a 14-year high, although it’s slipped in recent days. Gold was moving mostly sideways until it broke out again over the past few days.
Bank stocks went vertical in expectations of wider net interest margins (from Fed rate hikes) and less regulation (from Dodd-Frank reform). Happy days, indeed.
Reality is another matter. I’ve been warning my readers lately that the Trump trade is levitating in thin air and is ready for a fall. Now that reality could be beginning to sink in.
It’s far from clear how much of the Trump economic agenda will see the light of day. Congress wants to offset tax cuts in one area with tax increases in another so they are “revenue neutral.” That takes away the stimulus. Less regulation for banks won’t help the economy if bankers lead us into another financial meltdown like 2008.
Infrastructure spending will increase the debt-to-GDP ratio past the already high level of 105%, putting the U.S. closer to a sovereign debt crisis like Greece. As I wrote Tuesday, many believe a 60% debt-to-GDP ratio retards growth. That’s the standard the ECB uses for members of the Eurozone. Scholars Ken Rogoff and Carmen Reinhart put the figure at 90%.
Again, the U.S. debt-to-GDP ratio is currently at 105%, as stated, and heading higher. Under any standard, the U.S. is at the point where more debt produces less growth rather than more. This is one more reason why the Trump infrastructure spending plan will not produce the hoped for growth. And if infrastructure is funded privately, you’ll need tools and user fees to pay the bondholders, which is just another form of tax increase.
There’s almost no way Trump’s policies can supply the stimulus the market is pricing in. The Dow Jones index peaked on Jan. 26, 2017, one day after cracking the mythical 20,000 mark. It’s now trading around 19,900. The downhill trend may continue and get steeper soon.
Productivity has stalled out in recent months. Economists are not sure why. It could be due to lack of investment by business, or that workers are not being trained in useful skills, or that everyone is spending too much time on social media. Whatever the cause, productivity is flat.
Fourth-quarter GDP came in at 1.9%, below expectations — the final chapter on the worst year of U.S. growth since 2011 when the economy was still healing from the global financial crisis. The strong dollar is a major headwind to growth, along with flat labor force participation and weak productivity growth.
Growth in a major economy is simply the sum of increases in the labor force plus increases in productivity. Think about it. How many people are working and what is the output per worker? That’s it; that’s all there is. The reality is that the workforce is not growing.
Labor force participation is near 40-year lows and is expected to decline further for demographic reasons. Birthrates have never been this low since the Great Depression. The U.S. used to get a labor force lift from immigration, but that might dry up because of Trump’s policies. We’ll have to wait and see.
A flat labor force plus flat productivity equals a flat economy, or almost zero nominal growth. That’s reality.
How will this situation be resolved?
Either growth will rebound based on “animal spirits” and the Trump stimulus working better than expected or markets will collapse once they realize the growth is not coming. By “collapse,” I mean a violent stock market correction, a falling dollar and major rallies in bonds and gold. We expect the latter.
Financial crises are not mainly about the business cycle. They’re about investor psychology, sudden shocks and the instability of the financial system. Right now investors are skittish, numerous shocks are waiting to happen and the system is highly unstable due to overleverage and nontransparency.
Despite Trump’s best efforts and positive policies, a collapse could happen any day unless radical steps are taken to prevent it — such as breaking up big banks and banning derivatives. I’ve been warning about this for a while, but now mainstream economists see the danger too. Nobel Prize winner Robert Shiller, for example, sees a stock market crash coming that could be worse than 1929 or 2000. I hope he’s wrong.
The problem with a financial panic is that panicked investors don’t care if the president is a Democrat or a Republican; they just want their money back. The same dynamic applies to natural disasters like tsunamis and earthquakes.
Once the disaster starts, the dynamics have a life of their own and don’t care if the victims are liberals or conservatives. Everyone gets hurt just the same. I’m not hoping for it, but this is a lesson Trump may learn the hard way.
Above I said collapse means a violent stock market correction, a falling dollar and major rallies in bonds and gold. I expect the latter. The long-term trends favor gold if U.S. growth continues disappoint.
The strong dollar story can’t last, so it won’t. The Trump administration has clearly signaled that the day of the strong dollar is over. When you see a coordinated attack on the dollar from the White House, the Treasury and the Fed, you can bet the dollar will weaken. That means a higher dollar price for gold.
The dollar may get one last boost from a Fed rate hike in March, but after that, even the Fed will acknowledge that they got it wrong again and start another easing cycle with happy talk and forward guidance.
For now, investors should not stand in front of a moving train. Keep cash ready and be prepared to move into gold, bonds and the euro. In fact, it’s not too soon to leg into those positions now.
Instead of watching the tape or short-term trends, my advice is to stay focused on the long-term trends. That’s how you’ll make the most money and preserve wealth in adversity.
The Dow fell back below 20,000 today. Many in the media are blaming it in part on Trump’s Friday executive order temporarily banning travel from seven Muslim countries.
It’s amusing and a bit discouraging to watch the mainstream media react to the initial wave of executive orders coming from the White House. Headlines blare, “Trump’s Building a Wall With Mexico,” “Trump’s Stopping Syrian Immigrants” “Trump Pulls out of Trans-Pacific Partnership!”
Really? Why are the mainstream media so shocked? After all, didn’t Trump say he was going to build a wall, stop some immigration and pull out of the TPP? Isn’t that exactly what Trump campaigned on? Of course it is.
What has the media baffled is that Trump is the first politician in living memory who actually does what he said he was going to do. Media and most voters are so accustomed to politicians who say one thing to get elected and do another once in office that they literally can’t process a politician who does what he says.
Hence the hysterical headlines about policies you could see coming a mile away.
My point is not to debate these policies. We all have our own opinions on each one; that’s fine.
Among those policies is a huge boost in defense spending, upgrades to the nuclear arsenal, expanded operations in space and reviving something like Ronald Reagan’s “600-ship Navy.”
You can see this defense spending bonanza coming not only because Trump promised it (and he means what he says), but because Trump will have to go down this road to lend credibility to his other statements about the South China Sea, North Korea, Taiwan and NATO.
Trump has suggested confrontational or unilateral actions in all of those areas. You can’t act confrontationally or unilaterally without a strong defense and intelligence capability. That’s exactly what Trump is out to create.
And on Friday, he issued a presidential memorandum pledging to rebuild the military, reading in part: “To pursue peace through strength, it shall be the policy of the United States to rebuild the U.S. armed forces.”
But defense technology is not something you can create by executive order. It takes a year or longer to conduct feasibility studies and make it through the appropriations process. That’s good news for investors prepared to take advantage of the spending boom because it means they have time to get in on the most promising defense tech startups and medium-sized players before the big orders and the big buyouts start to roll in.
This is a once-in-20-years opportunity, and with Trump in the Oval Office, smart investors who understand the implications will have the wind at their backs for a decade.
