I’m a big critic of the Fed models, but that’s because they’re obsolete and they don’t record with reality. You need the right ones.
In a typical business cycle, the economy starts from a low base, then gradually business starts expanding, hiring picks up, more people spend money, and businesses expand.
Eventually, industrial capacity is used up, labor markets tighten, resources are stretched. Prices rise, inflation picks up and the Fed comes along and says “Aha! There’s some inflation. We’d better snuff it.”
So it raises rates, usually for a full cycle.
Eventually it has to lower rates when the process goes into reverse. That’s the normal business cycle. It’s what everyone on Wall Street looks at. And historically, they’re right. That process has been happening 40 times since the end of World War II.
The problem is, that’s not what’s happening now. We’re in a new reality.
This is a result of nine years of unconventional monetary policy — QE1, QE2, QE3, Operation Twist and ZIRP. This has never happened before. It was a giant science experiment by Ben Bernanke.
And that’s the key…
You have to have models that accord to the new reality, not the old. Wall Street is still going by the old model.
The new reality is that the Fed basically missed a whole cycle. They should have raised in 2009, 2010 and 2011. Economic growth was not powerful. In fact it was fairly weak. But it was still the early stage of a growth cycle. If they had raised rates, many would have grumbled, the stock market would have hit a speed bump, but it wouldn’t have been the end of the world.
We’d just had a crash. But by the end of 2009, the panic was basically over. There was no liquidity crisis. There was plenty of money in the system. There was no shortage of money and interest rates were zero. They could have tried an initial 25-point rise but they didn’t.
This isn’t Monday morning quarterbacking, either. I was on CNBC’s “Squawk Box” in August ’09. The host turned to me and asked, “Jim, what do you think the Fed should do?”
My response was, “They should raise rates a little bit, just to say they were going to get back to normal.” Of course, that never happened.
Now we’re at a very delicate point, because the Fed missed the opportunity to raise rates five years ago. They’re trying to play catch-up, and yesterday’s was the third rate hike in six months.
Economic research shows that in a recession, they have to cut interest rates 300 basis points or more, or 3%, to lift the economy out of recession. I’m not saying we are in a recession now, although we’re probably close.
But if a recession arrives a few months or even a year from now, how is the Fed going to cut rates 3% if they’re only at 1.25%?
The answer is, they can’t.
So the Fed’s desperately trying to raise interest rates up to 300 basis points, or 3%, before the next recession, so they have room to start cutting again. In other words, they are raising rates so they can cut them.
And that’s what Wall Street doesn’t understand. It’s still operating from its old assumptions about the business cycle.
Wall Street thinks the Fed’s raising rates because official unemployment is low and the economy’s strengthening. But as I just explained, that’s not the reason at all. The reality’s quite different.
The Fed is hiking rates not because economy is strong, but because it’s desperate to catch up with the fact that Bernanke skipped a whole cycle in 2009, 2010 and 2011. So as usual, Wall Street is reading the signals exactly backwards.
The Fed’s actually tightening into weakness.
So now what?
After yesterday’s hike, the Fed still has a long way to get to 3%. That means seven more hikes of 25 basis points each, every other meeting, or four hikes a year. That means the mission won’t be accomplished until June 2019.
What would cause the Fed to back off? Any of three conditions…
Number one is a market meltdown. If the stock market sells off 5%, which would be over 1,000 points on the Dow, that would not be enough to throw them off. But if it goes down 15%, that’s a different story. Ben Bernanke actually told me that not long ago.
Now, if the stock market falls 10%, the Fed will pause. It won’t raise. But it won’t cut either at that point.
Now, markets are complacent right now and are not expecting any sudden moves to the downside. But it’s when markets are most complacent that sudden drops are most likely. August 2015 and January 2016 are good examples. Another drop could be right around the corner.
The second condition is if job creation dries up. Now, job creation does not have to be 200,000 jobs a month, or even 150,000 jobs a month. Their baseline is around 75,000, which is a very low base. If you see jobs go below 75,000, the Fed may pause.
The third condition is disinflation. Now, I’m not talking about outright deflation. I mean inflation falling substantially short of the Fed’s target under a metric called PCE, or the Personal Consumption Expenditure Price Deflator Core.
You may be skeptical of how the Fed measures inflation, and rightly so. But you have to look at what the Fed looks at to know what they’re up to, right or wrong. And they look at the PCE, year over year.
The Fed wants 2% inflation. Lately it’s been getting close. But if that figure drops to, say, 1.4, that’s another reason to hit the pause button. That seems unlikely at this point.
Unless any of these three conditions materialize, the Fed intends to raise rates four times a year, every other meeting, until the middle of 2019. If any one of those three things happen along the way, the Fed will probably hit the pause button. If all three happen, it will definitely pause.
Gold is down today after yesterday’s hike, but I expect it to start heading higher again. Too many powerful forces are driving it behind the scenes. Dwindling physical supply is a major one.
On a recent visit to Switzerland, I was informed that secure logistics operators could not build new vaults fast enough and were taking over nuclear-bomb proof mountain bunkers from the Swiss Army to handle the demand for private storage.
Geopolitical fear is another. The crises in North Korea, Syria, Iran, the South China Sea, and Venezuela are not getting better. The headlines may fade in any given week, but geopolitical shocks will return when least expected and send gold soaring in a flight to safety.
Fed policy tightening is normally a headwind for gold. But, the last two times the Fed raised rates — December 14, 2016 and March 15, 2017 — gold rallied as if on cue.
Gold is the most forward-looking of any major market. It may be the case that the gold market sees the Fed is tightening into weakness and will eventually over-tighten and cause a recession.
At that point, the Fed will pivot back to easing through forward guidance. That will result in more inflation and a weaker dollar, which is the perfect environment for gold.
In short, all signs point to higher gold prices in the months ahead based on Fed ease, geopolitical tensions, and a weaker dollar.
John Maynard Keynes once wrote, “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
Truer words were never spoken, although if you updated Keynes today, the quote would begin with “practical women” to take account of Fed Chair Janet Yellen. The “defunct economist” in question would be William Phillips, inventor of the Phillips curve, who died in 1975.
In its simplest form, the Phillips curve is a single-equation model that describes an inverse relationship between inflation and unemployment. As unemployment declines, inflation goes up, and vice versa. The equation was put forward in an academic paper in 1958 and was considered a useful guide to policy in the 1960s and early 1970s.
By the mid-1970s the Phillips curve broke down. The U.S. had high unemployment and high inflation at the same time, something called “stagflation.” Milton Friedman advanced the idea that the Phillips curve could only be valid in the short run because inflation in the long run is always determined by money supply.
Economists began to tweak the original equation to add factors — some of which were not empirical at all but model-based. It became a mess of models based on models, none of which bore any particular relationship to reality. By the early 1980s, the Phillips curve was no longer taken seriously even by academics and seemed buried once and for all. RIP.
But like a zombie from The Walking Dead, the Phillips curve is baaaack!
And the person who has done the most to revive it is none other than Janet Yellen, the 70-year-old liberal labor economist who also happens to be chair of the Federal Reserve.
Unemployment in the U.S. today is 4.3%, the lowest rate since the early 2000s. Yellen assumes this must result in inflation as scarce labor demands a pay raise and the economy pushes up against the limits of real growth. Yellen also agrees with Friedman that monetary policy works with a lag.
If you believe that inflation is coming soon and that policy works with a lag, you better raise interest rates now to keep the inflation from getting out of control. That’s exactly what Yellen and her colleagues have been doing.
Meanwhile, back in the real world, all signs point not to inflation but to deflation. Oil prices are declining, intermediate-term interest rates are falling, labor force participation is falling, demographics favor saving over spending and logistics and supply-chain giants like Wal-Mart and Amazon are relentlessly squashing price increases wherever they appear.
Even traditional high-price sectors like college tuition and health care have been cooling off lately.
Yellen and a small group of Fed insiders, including Bill Dudley and Stan Fischer, are keeping up the drumbeat for more rate hikes later this year. Opposition to more rate hikes among Fed officials is growing, including from Neel Kashkari, Lael Brainard and Charles Evans.
This intellectual tug of war is coming to a head.
First, bonds are rallying because the bond market expects a recession or slowdown due to unnecessary tightening by the Fed. Which brings me to Bill Gross…
Practically every investor has heard of Bill Gross. For decades he was the head of PIMCO and ran the world’s largest bond fund. His specialty was U.S. Treasury debt..
PIMCO was always a “bigfoot” in the bond marketplace. In the 1980s and 1990s, I was chief credit officer at a major U.S. Treasury bond dealer, one of the so-called “primary dealers” who get to trade directly with the Federal Reserve open market operations trading desk.
PIMCO had dedicated lines and a dedicated sales team at our firm. When they called to buy or sell, it would move markets. Every primary dealer wanted to be the first firm to get the call.
Gross is famous for outperforming major bond indices by a wide margin. The way to do that is market timing. If you sell bonds just ahead of a rising rate environment, and buy them back when the Fed is ready to reverse course you not only capture most of the coupon and par value at maturity, you can book huge capital gains besides.
Now Gross has issued one of his most stark warnings yet. He says that market risk levels today are higher than any time since just before the 2008 panic. We all know what happened then. Gross says it could happen again, and soon.
No one reads the market better than Bill Gross. So, when he issues a warning, investors are wise to pay attention.
The stock market is giving a different signal. Stocks are rallying because markets interpret Fed rate hikes as a signal that the economy is getting stronger.
Both markets cannot be right. Either stocks or bonds will crash in the weeks ahead.
Gold is watching and waiting, moving down on deflation fears and then up again on the view that the Fed will have to reverse course once the economy cools down.
My models show that bonds, Bill Gross and gold have it right and that stocks are heading for a fall.
The stock market correction won’t come right away, because the Fed is still in a mode to talk up rate hikes and strong growth and to dismiss disinflation as “transitory.”
Yet even Janet Yellen can’t ignore reality forever. The Atlanta Fed GDP growth forecast for the second quarter has gone from 4.3% on May 1, to 3.4% on June 2, to 2.9% on June 15.
Today it released its latest growth forecast, which remains unchanged from its June 15 reading — 2.9%.
Something is slowing down the economy, and that something is Fed rate hikes.
By August, even the Fed will get the message. But by then it may be too late. If Q2 growth comes in at 2.5% combined with Q1 growth of 1.2%, that would put 2017 first-half growth at about 1.85%.
That’s even weaker than the historically weak 2.0% growth of the current expansion since June 2009. This is not the stuff of which inflation is made.
The Fed’s bungling should come as no surprise.
The Federal Reserve has done almost nothing right for at least the past twenty years, if not longer. The Fed organized a bailout of Long-Term Capital Management in 1998, which arguably should have been allowed to fail (with a Lehman failure right behind) as a cautionary tale for Wall Street.
Instead the bubbles got bigger, leading to a more catastrophic collapse in 2008. Greenspan kept rates too low for too long from 2002-2006, which led to the housing bubble and collapse.
Bernanke conducted an “experiment” (his word) in quantitative easing from 2008-2013, which did not produce expected growth, but did produce new asset bubbles in stocks and emerging markets debt.
Yellen is now raising rates in a weak economy, which should produce the same recessionary reaction as 1937, the last time the Fed raised into weakness.
Why this trail of blunders?
The answer is that the Fed is using obsolete and defective models such as the Phillips Curve and the so-called “wealth effect” to guide policy. None of this is new; I’ve been saying it for years in books, interviews and speeches.
What is new is that even the mainstream media is beginning to see things the same way. Fed leaders have been exposed as charlatans, like the Professor in the Wizard of Oz.
The Fed’s latest failure will cause policy to shift to ease before September in the form of forward guidance on no further rate hikes this year. Just one more failure in a long list.
It’s time to load up on Treasury notes, gold and cash and lighten up on stocks. The Fed may be the last to learn about deflation, but when they do, the policy response could be instantaneous and markets could suffer whiplash.
That’s what happens when zombies are on the loose.
It’s been an interesting day. Cryptocurrency Ethereum hits a record high as OPEC oil production increases thanks to Iraq and Libya. Jim Rickards joins us live to talk about what’s going on tomorrow at the Federal Reserve while Beijing scores a major win as Panama establishes ties with China, leaving Taiwan out in the cold. Rounding us out, Manuel Rapalo takes a look at a malware that reportedly cause a major power outage. All that and more on today’s Boom Bust!
Jim Rickards joined The Street and Kitco’s Gold Report to discuss bitcoin, gold and the future economy with Daniela Cambone-Taub. The conversation covered a leader in virtual currency, bitcoin, which continues to make headlines in financial media coverage. Jim Rickards’ interview takes on investor confidence, liquidity preferences and what it might mean for the U.S dollar and gold.
To begin the conversation the host asked how Rickards’ saw the cryptocurrency and the craze unfolding. Rickards’ pressed, “It is interesting. I looked at it last night and it was nearing $3,000 for one bitcoin. It could be closing $4,000 by tonight.”
“Bitcoin is a form of money. I have no quarrel with that. When people say the price is $2,000 or $3,000 it is still not an investment and has no yield. When you buy stock in a company you can analyze the company, the management, the assets, etc. When you buy a bond you can see the interest rate, who is the issuer, creditworthiness, inflation. There are ways to analyze all of these things.”
“There are ways to analyze these things. When you buy a bitcoin and give dollars, euro, yuan to get bitcoin all you are doing is exchanging one form of money for another. It has no yield. There are no bitcoin investable assets. There are no bitcoin bonds. You are just swapping money. When you see the price going to $2,000-$3,000 you can say that bitcoin is going up, but you can also say that the dollar is going down.”
Jim Rickards is a currency expert and economist who examines the complex dynamics of geopolitics and global capital. Rickards’ has worked as a portfolio manager, lawyer and held various senior positions on Wall Street. His most recent New York Times best seller, The Road to Ruin offers his critical analysis of financial crises and what he believes is ahead for the global economy.
When speaking on the trend and value of the cryptocurrency Rickards’ noted, “People are expressing a liquidity preference for bitcoin as a form of money over dollars. That’s one theory of valuation. What’s the evidence for that? None. Because, if that were true, if you were losing confidence of the dollar then gold would be going up and it’s not. So it looks like a bubble.”
The host then pressed on the restriction on “printing” of the virtual money and its reproduction Rickards’ responded that it, “is capped to some level but we’re not there yet. Where does bitcoin come from? Yes, bitcoin can be purchased on a secondary market. But they are created by “miners” which is a bit of a misnomer. They’re basically people with a lot of computing power and developing expertise that solve very hard math problems and give a bitcoin as a reward. When bitcoin reaches levels similar to today, two or three thousand dollars, that is a pretty big incentive.”
“While the cost of [digital] “mining” is not zero, but it is pretty low relatively to the cost. To me it looks a bit more like the Fed. How much does it cost the Fed to create a dollar? The answer is zero. It doesn’t cost them anything to create a dollar.”
“What does it cost to create bitcoin? Sure, you have some investment in computing but it is nowhere near the market price. [So that’s why] it looks a bit like the Fed where you keep cranking them out, they are money, and when you buy bitcoin for dollars you are just swapping money.”
Every five, six, seven years, financial crises happen. It’s been eight years since the last one. How long do you think we’re going to go? So that is a catalyst for much higher gold prices.
But I don’t worry much about manipulation. I know it goes on, and I know why it goes on, as I spoke to the statistician’s expert witnesses in some of the pending litigation on gold manipulation.
On June 6th, for example, gold got whacked 2 percent because somebody sold $4 billion’s worth of future contracts on the COMEX. Gold was getting close to $1,300 an ounce.
The impact on the markets is like selling $4 billion in gold. But it wasn’t gold. It was paper gold.
Four billion dollars’ worth of gold is 90 tons. Do you think you could sell 90 tons of physical? You can’t source 90 tons of real gold. You are lucky if you can get a couple of tons of gold. All the mines in the world produce a little over 3,000 tons a year. Those 90 tons are close to 3 percent of all the output of all the gold in the world, with one phone call.
But the point is, all manipulations fail. Jim Fisk and Jay Gould ran a gold corner in 1869, and it failed. The London Gold Pool in the late 1960s failed.
So just get your gold allocation—I recommend 10 percent of investable assets—and put it in a safe place, keep out of the banking system, and sit tight.
James Rickards, author of “The Road to Ruin,” has successfully predicted Federal Reserve (Fed) policy in the past. In this interview with The Epoch Times, he explains why the recent tightening could lead to a recession and why he recommends gold as a “crisis hedge.” He also explains why he thinks bitoin is in a bubble.
The Epoch Times: Why did the Federal Reserve (Fed) hike rates last week, and what will its policy look like in the future?
James Rickards: They’re trying to prepare for the next recession. They’re not predicting a recession, they never do, but they know a recession will come sooner rather than later. This expansion is 96 months old. It’s one of the longest expansions in U.S. history. It’s also the weakest expansion in U.S. history. A lot of people say, “What expansion? Feels like a depression to me.”
I think it is a depression defined as depressed growth, but we’re not in a technical recession and haven’t been since June 2009. So it’s been an eight-year expansion at this point, but it won’t fare well, and the Fed knows that. When the U.S. economy goes into recession, you have to cut interest rates about 3 percent to get the United States out of that recession.
Well, how do you cut interest rates by 3 percent when you’re only at 1 percent? The answer is, you can’t. You’ve got to get them up to 3 percent to cut them back down, maybe to zero, to get out of the next recession. So that explains why the Fed is raising interest rates. That’s the fourth rate hike getting them up to 1 percent. They would like to keep going; they would like to get them up to 3, 3.5 percent by 2019.
My estimate is that they’re not going to get there. The recession will come first. In fact, they will probably cause the recession that they’re preparing to cure. So let’s just say we get interest rates to 1 percent and now you go into recession. We can cut them back down to zero. Well, now what do you do? You do a new round of quantitative easing (QE).
The problem is that the Fed’s balance sheet is so bloated at $4.5 trillion. How much more can you do—$5 trillion, $5.5 trillion, $6 trillion—before you cause a loss of confidence in the dollar?
There are a lot of smart people who think that there’s no limit on how much money you can print. “Just print money. What’s the problem?” I disagree. I think there’s an invisible boundary. The Fed won’t talk about it. No one knows what it is. But you don’t want to find out the hard way.
The Epoch Times: What about balance sheet reduction, reversing the QE that you are talking about?
James Rickards thinks bitcoin is a bubble, he prefers gold as a crisis hedge.
Mr. Rickards: You probably want to get from $4.5 trillion, down to $2.5 trillion. Well, you can’t sell any treasury bonds. You destroy the market. Rates would go up, putting us in recession, and the housing market would collapse. They’re not going to do that. What they’re going to do is just let them mature.
When these securities mature, they won’t buy new ones. They won’t roll it over, and they actually will reduce the balance sheet and make money disappear. They’re going to do it in tiny increments, maybe $10 billion a month or $20 billion a month.
They want to run this quantitative tightening in small increments and pretend nothing’s happening. But that’s nonsense. It’s just one more way of tightening money in a weak economy; it will probably cause a recession.
Welcome to this week's Market Wrap Podcast, I'm Mike Gleason.
Coming up, we'll hear part one of an amazing two-part interview with Jim Rickards, author of Currency Wars, The New Case for Gold and The Road to Ruin. Jim shares his insights on the Fed's supposed plan to unwind its balance sheet and what it will mean for the economy and for gold prices. He'll discuss some potential fireworks involving the U.S. dollar as it continues losing its reserve currency status. Don't miss a must-hear interview with Jim Rickards, coming up after this week's market update.
Beaten down gold and silver markets showed signs of recovering late this week as prices have risen above recent lows. Mining stocks are rallying strongly, pointing to upside potential for metals in the days ahead.
As of this Friday recording, gold prices come in at $1,256 an ounce, unchanged since last Friday's close. The silver market is also flat on the week with spot prices currently coming in at $16.74. Platinum is off very slightly at $932 an ounce. While palladium, which was outperforming again through Thursday close when it posted a new high for the year, is off 2.5% so far today and is now down 0.5% overall this week to trade at $869.
All of the precious metals are outperforming crude oil this year. Oil prices took another dip earlier this week on concerns about over-supply. The glut has persisted despite OPEC's vows to cut production.
The longer prices persist below $50 a barrel, the more non-OPEC producers will also have to hunker down. Many shale and offshore drilling projects that came online a few years ago are simply uneconomic at today's prices.
By next year, things could look quite different in the market for crude and other commodities. Despite a surge in sales of electric vehicles, global demand for oil will continue to rise. The U.S. Energy Information Administration projects the world will use 100 million barrels of oil per day in 2018, up from 98.5 million this year.
Demand for industrial and precious metals will also rise. But the beleaguered mining industry will have difficulty meeting it. In 2018, we could be facing record supply deficits in copper, silver, and other metals...
Is Bitcoin now in bubble territory? Will it scream higher before it comes crashing down? Or could it possibly be the next big thing, the replacement for the flawed fiat currency system that we now find ourselves under? Jim Rickards discusses.
