James Rickards: Investors Have Fallen Into a False Sense of Security

In January 2018, two significant market events occurred nearly simultaneously. Major U.S. stock market indexes peaked and volatility indexes extended one of their longest streaks of low volatility in history. Investors were happy, complacency ruled the day and all was right with the world.

Then markets were turned upside down in a matter of days. Major stock market indexes fell over 11%, a technical correction, from Feb. 2–8, 2018, just five trading days. The CBOE Volatility Index, commonly known as the “VIX,” surged from 14.51 to 49.21 in an even shorter period from Feb. 2–6.

The last time the VIX has been at those levels was late August 2015 in the aftermath of the Chinese shock devaluation of the yuan when U.S. stocks also fell 11% in two weeks.

Investors were suddenly frightened and there was nowhere to hide from the storm.

Analysts blamed a monthly employment report released by the Labor Department on Feb. 2 for the debacle. The report showed that wage gains were accelerating. This led investors to increase the odds that the Federal Reserve would raise rates in March and June (they did) to fend off inflation that might arise from the wage gains.

The rising interest rates were said to be bad for stocks because of rising corporate interest expense and because fixed-income instruments compete with stocks for investor dollars.

Wall Street loves a good story, and the “rising wages” story seemed to fit the facts and explain that downturn. Yet the story was mostly nonsense.

Wages did rise somewhat, but the move was not extreme and should not have been unexpected. The Fed was already on track to raise interest rates several times in 2018 with or without that particular wage increase. Subsequent wage increases have been moderate.

The employment report story was popular at the time, but it had very little explanatory power as to why stocks suddenly tanked and volatility surged.

The fact is that stocks and volatility had both reached extreme levels and were already primed for sudden reversals. The specific catalyst almost doesn’t matter. What matters is the array of traders, all leaning over one side of the boat, suddenly running to the other side of the boat before the vessel capsizes.

The technical name for this kind of spontaneous crowd behavior is hypersynchronicity, but it’s just as helpful to think of it as a herd of wildebeest that suddenly stampede as one at the first scent of an approaching lion. The last one to run is mostly likely to be eaten alive.

Markets are once again primed for this kind of spontaneous crowd reaction. Except now there are far more catalysts than a random wage report, despite last week’s optimistic GDP report.

We all know what’s happened to Facebook since last Friday. But look at the potential trouble from geopolitical sources alone…

The U.S. has ended its nuclear deal with Iran and has implemented extreme sanctions designed to sink the Iranian economy and force regime change through a popular uprising. Iran has threatened to resume its nuclear weapons development program in response. Both Israel and the U.S. have warned that any resumption of Iran’s nuclear weapons program could lead to a military attack.

Venezuela, lsed by the corrupt dictator Nicolás Maduro, has already collapsed economically and is now approaching the level of a failed state. Inflation exceeds 40,000% and the people have no food. Its inflation rate has now exceeded the hyperinflation of Weimar Germany.

Social unrest, civil war or a revolution are all possible outcomes. If infrastructure and political dysfunction reach the point that oil exports cannot continue, the U.S. may have to intervene militarily on both humanitarian and economic grounds.

North Korea and the U.S. have pursued on-again, off-again negotiations aimed at denuclearizing the Korean Peninsula. While there have been encouraging signs, the most likely outcome continues to be that North Korean leader Kim Jong Un is playing for time and dealing in bad faith. The U.S. may yet have to resort to military force there to negate an existential threat.

This litany of flash points goes on to include Iranian-backed attacks on Saudi Arabia and Israel, a civil war in Syria, confrontation in the South China Sea and Russian intervention in eastern Ukraine. These traditional geopolitical fault lines are in addition to cyber threats, critical infrastructure collapses and natural disasters from Kilauea to the Congo.

- Source, The Daily Reckoning

War With China is Just a Shot Away

China dredged sand surrounding useless rocks and atolls in the South China Sea and converted them into artificial islands and then built out the islands to include naval ports, air force landing strips, anti-aircraft weapons and other defensive and offensive weapons systems.

Not only are the Chinese militarizing rocks, but they are trampling on competing claims by the Philippines, Vietnam, Brunei, Malaysia and other countries surrounding the sea.

China is claiming control based on ancient imperial arrangements and argues that the West and its South Asian allies “stole” the territory from them. The answer is that both the ancient claims and the theft narrative are open to dispute.

More to the point, the world has developed rules-based platforms for resolving these issues without military force. The U.S. is guaranteeing freedom of passage, freedom of the seas and the territorial rights of allies such as the Philippines.

Incidentally, I was at Norfolk naval base last week delivering a lecture on financial warfare with China. There was a “hurry up” feel to it, a definite sense of urgency. I got the impression that something must be up.

So far, the U.S.-Chinese confrontation has been about naval vessels passing in close quarters and surveillance aircraft being harassed by fighter jets. The risk of such tactics is an accidental collision, a rogue shot fired or a command misunderstood.

Any such incident could lead to retaliation, and there’s no telling where it might stop. Trump is not someone to back down, and Chinese leadership does not want to appear weak before the U.S.

That’s especially true at a time of great economic uncertainty. Communist Party leadership is desperate to maintain the support of the people, or else it risks losing the “mandate of heaven.”

China does not want war at this time. But diverting the people’s attention away from domestic problems toward a foreign foe is an old trick leaders use to unite the people in times of uncertainty. Rallying the people around the flag is a tried and true method to garner support.

If China’s leadership decides that the risk of losing legitimacy at home outweighs the risk of conflict with the United States, the likelihood of war rises dramatically.

I’m not predicting it, but wars have started over less.

As Mick Jagger sang, a U.S.-China war is “just a shot away.”

- Source, Jim Rickards

Jim Rickards: Shooting War With China More Likely Than You Think

The mainstream media narrative about the U.S.-China trade war implies that Trump is on a highly damaging ego trip and China holds all the cards.

The exact opposite is true.

Trump has ample financial warfare weapons including tariffs, penalties, bans on direct investment, improved cybersecurity, forced divestiture and freezing of assets.

Meanwhile, China has almost run out of room to impose tariffs. Further, they will invite retribution if they try to devalue their currency further.

China’s vulnerabilities run deeper than that.

The U.S.-China trade war comes in the aftermath of a Chinese Communist Party conference that made Xi Jinping dictator for life and enshrined his doctrines on the same level as Mao Zedong.

Once Xi got these powers, he proceeded on a disastrous policy course that has resulted in a slowdown of the Chinese economy, higher debt defaults, lost investment opportunities in the U.S. and declining hard currency reserves.

The knives are now out in Beijing.

Reports are circulating that Xi’s opponents are questioning his judgment and the wisdom of expanding his powers at such a critical time. Many are starting to blame Xi for the trade war almost as much as they blame Trump.

Xi still has torture, firing squads and concentration camps at his disposal, but the notion of a unified, coherent leadership structure in Beijing is now seen to be a myth.

Trump will keep up the pressure; he never backs off and always doubles down. It will be up to Xi to blink and acquiesce in many U.S. demands.

The U.S. will win this trade war because Xi does not want to lose his throne. Yet there will still be material damage to the global economy and lasting animosity between Xi and Trump.

But there’s more to the U.S.-China dispute than trade.

Yes, headlines and TV interviews are dominated by talk of the trade war. That escalating confrontation is a big deal, but it’s not the only flash point in U.S.-China relations, and not even the most important.

China is as much concerned about a military confrontation in the South China Sea as it is about the economic confrontation in the trade wars...

- Source, Jim Rickards via the Daily Reckoning

Rickards: We Are in a New Currency War

The problem from an investor’s perspective is they are “slow burn” crises and can linger for a long time before producing anything dramatic such as a shooting war or market collapse. They are not date-driven or date-specific in the short run.

One story that’s under the radar and could blow up soon is Chinese currency devaluation.

If Trump puts a 25% tariff on Chinese imports but China then devalues its currency 25%, then the net effect is zero. The impact of the devaluation offsets the impact of the tariff and then you’re back where you started.

This new currency war seems to be happening.

Once Trump focuses on this, he’s likely to be infuriated and retaliate against China in the currency war and take steps to penalize China for currency manipulation over and above the existing tariffs and penalties for theft of intellectual property. This has a hard date of Oct. 15, 2018.

That’s the date of the U.S. Treasury’s semiannual report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States.

That report is the formal mechanism for labeling a trading partner such as China a “currency manipulator” with severe consequences. Oct. 15, 2018, is just three weeks before the midterm elections, so it could be a highly popular political move in addition to being economically important.

All of this and more is on Trump’s policy plate right now. Just don’t expect him to handle it the way politicos usually do. Investors should expect dramatic policy shifts and extreme threats. But don’t overreact like the Washington pundits.

Remember, it’s all the art of the deal.

- Source, James Rickards via the Daily Reckoning

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Jim Rickards: Trump Haters Don’t Get the “Art of the Deal”

I’m continually amazed at the legions of politicos, pundits and so-called “experts” who don’t understand President Trump or how he conducts policy.

These elites have a mental model of how a president is supposed to behave and how the policymaking process is supposed to be carried out. Obviously, Trump does not fit their model.

Instead of trying to grasp the model that Trump does use, they continually berate and disparage Trump for not living up to their expectations. A more thoughtful group would say, “Well, he’s different, so why don’t we try to understand the differences and analyze the new model?”

Really, these people need to get out of Washington, New York and Hollywood more and get away from their screens. If they knew more everyday Americans, they would come a lot closer to understanding how Trump gets things done.

It’s not chaos; it’s just a little different and more down to earth.

This is because of Trump’s “art of the deal” style described in his best-selling book by that name. Bush 43 and Obama were totally process-driven. You could see events coming a mile away as they wound their way through the West Wing and Capitol Hill deliberative processes.

All you had to do was understand the process and you could forecast big developments in a relatively straightforward way.

With Trump, there is a process, but it does not adhere to a timeline or existing template. Trump seems to be the only process participant most of the time.

Here’s the Trump process:

• Identify a big goal (tax cuts, balanced trade, the wall, etc.).

• Identify your leverage points versus anyone who stands in your way (elections, tariffs, jobs, etc.).

• Announce some extreme threat against your opponent that uses your leverage.

• If the opponent backs down, mitigate the threat, declare victory and go home with a win.

• If the opponent fires back, double down. If Trump declares tariffs on $50 billion of good from China,and China shoots back with tariffs on $50 billion of goods from the U.S., Trump doubles down with tariffs on $100 billion of goods, etc. Trump will keep escalating until he wins.

Eventually, the escalation process can lead to negotiations with at least the perception of a victory for Trump (North Korea) — even if the victory is more visual than real.

No one else in Washington thinks this way. Washington insiders try to avoid confrontation, avoid escalation, compromise from the beginning and finesse their way through any policy process.

Trump is in a league of his own. What amazes me is that the media still do not understand his style and keep taking the bait when he announces something crazy, as in Step 3 above...

- Source, Jim Rickards

Trump: The Art of the Deal

Jim Rickards: When the Financial Flood Hits, It's Too Late to Buy Insurance

"When we consider recent financial catastrophes affecting U.S. investors only, without regard to other types of disaster, we have had major stock market crashes or global liquidity crises in 1987, 1994, 1998, 2000 and 2008.

That’s five major drawdowns in 31 years, or an average of about once every six years. The last such event was 10 years ago. So the world is overdue for another crisis based on market history.

Does any of this mean you should go to your fortified bunker and curl up in a ball? Of course not. We all wake up every morning and face the day, come what may. I’m not paralyzed by fear and neither should you be.

But it does mean that we need to overcome any cognitive bias about the future being like the past or about recent calm being a good forecast for the future (called “recency bias” by behavioral psychologists).

When the 100-year flood does hit, it’s too late to buy flood insurance. Likewise, when the next financial crisis hits, it will be too late to buy gold at today’s relatively attractive prices. The best time to buy flood insurance is when the sun is shining."

- Source, Jim Rickards via the Daily Reckoning

Jim Rickards: Get Ready for the “100-Year Flood”

One of the long-standing reasons to own physical gold or invest in gold mining shares is to hedge geopolitical risk or the risk of natural disaster.

From the Black Death in the 14th century to the Thirty Years’ War in the 17th century to the world wars of the 20th century, gold has been a reliable store of wealth. There is no reason to believe that such existential events are no longer a danger.

I don’t think you need any reminder of the litany of risks present today.

The United States is determined to prevent Iran from obtaining nuclear weapons. Iran is equally determined to develop them. Iran’s neighbors, such as Saudi Arabia, have said that if Iran obtains nuclear weapons, they will quickly do the same.

In that case, Turkey and Egypt would follow suit. The choices boil down to a conventional war with Iran or a wider nuclear arms race in a highly volatile region.

North Korea already has an arsenal of nuclear warheads with a yield approximately the size of the Hiroshima atomic bomb, about 15 kilotons of TNT, but it has tested much larger weapons. It has also developed intermediate-range ballistic missiles (IRBMs) and has tested intercontinental ballistic missiles (ICBMs).

Denuclearization discussions are ongoing between the U.S. and North Korea, but President Trump has made it clear that he will attack North Korea if it advances further toward its stated goal of having a deliverable nuclear weapon that can reach the U.S.

If talks fail and the U.S. does attack North Korea, it is likely that North Korea will unleash devastating force on South Korea and possibly launch a nuclear weapon aimed at Japan.

Venezuela is a political and humanitarian catastrophe and is approaching the level of a failed state, which could result in civil war, riots, mass refugees and a cut off of its oil exports, about 3% of the world total today.

Its inflation rate is now running at over 40,000%. That means its hyperinflation has officially exceeded Weimar Germany’s, where the highest recorded monthly inflation rate was “only” 29,500%. The IMF now forecasts Venezuela’s hyperinflation will reach 1,000,000% by the end of the year.

Other hot spots around the world include Syria, Ukraine, Israel and its confrontation with Hamas and Hezbollah, the Saudi war with Iranian-backed Houthi rebels in Yemen and conflicting claims in the South China Sea.

That’s just scratching the surface. Natural disasters abound from the extreme flooding of Hurricane Harvey to the lava flows of Kilauea on Hawaii. The Ebola virus has reemerged in the Congo, four years after a prior epidemic in West Africa caused 10,000 deaths. Other threats are ubiquitous.

New threats are also emerging that are not traditionally geopolitical or natural. These include power grid collapses, cyberwarfare, hacking, data theft and misuse of big data including examples such as Russian interference in recent U.S. elections. Killer robots, swarm attack drones and rogue artificial intelligence applications are coming soon.

An investor would not be blamed for saying, “So what?” Many of the threats mentioned have been festering for years. Going back further in time would produce a different list of threats, most of which never came to fruition.

Americans, in particular, seem safe from the worst of these threats except for the temporary effects of a bad storm or wildfire in a specific area. To most Americans, these threats are just background noise. Complacency rules the day.

But here’s an interesting bit of math, somewhat simplified, that might break investors out of their complacency. Don’t worry about the details, but I strongly urge you to focus the implications.

Let’s consider a “100-year flood,” which can literally be a 100-year flood like Hurricane Harvey or a metaphorical rare event, a so-called “Black Swan.”

Let’s call “P” the probability of a 100-year flood in a known flood zone and consider the odds of the flood happening or not happening each year in a succession of years...

- Source, James Rickards

1 oz Sunshine Mint Morgan Silver Round

Jim Rickards: The Weaponized Dollar Will Soon be a Victim of its Own Success

This will not involve dead-end cryptocurrencies like bitcoin but entirely new utility tokens and cryptos. Imagine something like a putincoin and you’ll be on the right track.

China is pushing its trade counterparties to accept Chinese yuan as payment for goods and services. The yuan is a small part of global payments today (about 2%) but the yuan may get a boost as the U.S. sanctions on Iran kick in.

China is Iran’s biggest customer for oil, and if U.S. sanctions prohibit dollar payments for Iranian oil, then Iran and China may have no choice but to transact in yuan.

The International Monetary Fund, IMF, has already announced efforts to put its world money, the special drawing right, SDR, on a distributed ledger. This would make the SDR a global cryptocurrency for settling balance of payments transactions among China, Russia and other IMF members, also without reliance on the dollar payments system.

Alongside the new money in cryptocurrencies, there is the oldest form of money, which is gold. The use of gold is the ideal way to avoid U.S. financial warfare.

Gold is physical so it cannot be hacked. It is completely fungible (an element, atomic number 79) so it cannot be traced. Gold can be transported in sealed containers on airplanes so movements cannot be identified through wire transfer message traffic or satellite surveillance.

There is good evidence that Iran currently pays for North Korean weapons technology with gold, and good reason to expect that future Chinese payments for Iranian oil will be made at least partly in gold.

Imagine a three-way trade in which North Korea sells weapons to Iran, Iran sells oil to China and China sells food to North Korea. All of these transactions can be recorded on a blockchain and netted out on a quarterly basis with the net settlement payment made in gold shipped to the party with the net balance due. That’s a glimpse of what a future nondollar payments system looks like.

Finally, look at the evidence presented in Chart 1 below. This shows Russia’s reserve position from 2013–18. The reserve position collapsed from $540 billion to $350 billion as a result of the oil price crash beginning in late 2014. (And query whether the oil price collapse itself was engineered by the U.S. in retaliation for Russia’s annexation of Crimea).

Since early 2015, Russia has rebuilt its reserve position under the patient stewardship of Russian Central Bank head Elvira Nabiullina. Russian reserves are now back up to $460 billion and rising steadily.

Yet there’s one huge difference between Russian reserves in 2014 and those reserves today. That difference is gold. During the reserve collapse in 2014, Russia sold U.S. dollar assets as needed to maintain liquidity, but it never stopped buying gold.

Russian gold reserves rose from 1,275 tons in mid-2015 (near the reserve low) to 1,909 tons at the end of April 2018. That’s a 50% increase in gold reserves in less than three years. Using current market prices, the Russia gold hoard is worth about $90 billion, or 20% of Russia’s global reserve position.

Why would a country put 20% of its reserves into gold unless it expected gold to be a major part of the international monetary system in the future? It wouldn’t. Russia not only expects gold to be part of the system, it is in strong position to make that happen by working with China, Turkey and Iran in what I call the new “Axis of Gold.”

The bottom line is that the weaponized dollar will soon be a victim of its own success. While the U.S. was bullying the world with dollars, the world was quietly preparing a new nondollar system. The U.S. wanted diplomatic and military clout and it got it with the dollar.

But as the saying goes, “Be careful what you wish for.”

Wise investors will prepare now for a new nondollar payments system. You may not be able to buy crypto SDRs (yet), but you can certainly own gold, and you should.

- Source, Jim Rickards

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The US Dollar: A Victim of Its Own Success

America’s most powerful weapon of war does not shoot, fly or explode. It’s not a submarine, plane, tank or laser. America’s most powerful strategic weapon today is the dollar.

The U.S. uses the dollar strategically to reward friends and punish enemies. The use of the dollar as a weapon is not limited to trade wars and currency wars, although the dollar is used tactically in those disputes. The dollar is much more powerful than that.

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

Before turning to specific tactics, consider the following. The dollar constitutes about 60% of global reserves, 80% of global payments and almost 100% of global oil transactions. European banks that make dollar-denominated loans to customers have to borrow dollars to fund those liabilities.

Those banks do their borrowing in the eurodollar deposit market, or with dollar-denominated commercial paper or notes. Being based in Switzerland or Germany does not allow you to escape from the dollar’s dominance.

The U.S. not only controls the dollar itself. It controls the dollar payments system. This consists of the Treasury’s digital ledger of holders of U.S. debt, the Fedwire payments system among U.S. Fed member banks and the Clearing House Association (successor to the New York Clearing House and proprietor of CHIPS, the Clearing House Interbank Payments System) composed of the largest U.S. banks.

A dollar payment going from a bank in Shanghai to another bank in Sydney runs through one of these U.S.-controlled payments systems.

In short, the dollar is the oxygen supply for world commerce and the U.S. can cut off your oxygen whenever it wants.

The list of ways in which the dollar can be weaponized is extensive. The International Emergency Economic Powers Act of 1977, IEEPA, gives the president of the United States dictatorial power to freeze and seize assets and block payments.

The Treasury’s Office of Foreign Assets Control, OFAC, maintains a blacklist of individuals and companies with whom financial intermediaries, such as banks and credit card companies, are forbidden to transact. Individuals on the OFAC list are like dead men walking when it comes to travel and business.

The Committee on Foreign Investment in the United States, CFIUS, can block any foreign acquisition of a U.S. company on national security grounds.

This list of financial weapons goes on, but you get the idea. The U.S. uses the dollar to force its enemies into fronts, crude barter or the black market if they want to do business.

Examples of the U.S. employing these financial weapons are ubiquitous. The U.S. slapped sanctions on Russia after the 2014 annexation of Crimea and invasion of Eastern Ukraine. The U.S. waged a full-scale financial war with Iran from 2011–13 that resulted in bank runs, hyperinflation, local currency devaluation and social unrest.

The U.S. was pushing Iran to the brink of regime change in 2013 when President Obama declared a truce to pursue what became the Joint Comprehensive Plan of Action, JCPOA, or the Iran nuclear deal. President Trump has now ended that deal and the financial war with Iran has resumed where it left off in 2013, but tougher than ever.

The U.S. is slapping stiff Section 301 penalties on China for theft of intellectual property. Other obvious victims of U.S. financial weapons are North Korea, Syria, Cuba and Venezuela.

The actions described above did not arise in the normal course of trade and finance. The Russian, Iranian and other sanctions noted are explicitly geopolitical, while the Chinese sanctions are geostrategic to the extent the U.S. and China are vying for technological supremacy in the 21st century.

None of these sanctions would be effective or even possible without the use of the dollar and the dollar payments system.

Yet for every action there is a reaction. America’s adversaries realize how vulnerable they are to dollar-based sanctions. In the short run, they have to grin and bear it. They’re fully invested in the dollar both in their reserves and in the desire of their largest companies like Gazprom (Russia) and Huawei (China) to become major global players.

Transacting on the world stage means transacting in dollars.

And dollar-based sanctions are a powerful financial weapon for the U.S. But our adversaries and so-called allies are not standing still. They are already envisioning a world where the dollar is not the major reserve and trade currency.

In the longer run, Russia, China, Iran, Turkey and others are working flat-out to invent and implement nondollar transactional currencies and independent payments systems.

Russia has begun a major research and development effort in the area of distributed ledger technology (also known as “blockchain”) so that financial transactions can be processed and verified without reliance on Western-controlled banks...

- Source, James Rickards via the Daily Reckoning

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Jim Rickards: Once the Tsunami Hits, No One Will be Spared

The problem is that regulators are like generals fighting the last war. In 2008, the global financial crisis started in the U.S. mortgage market and spread quickly to the over-leveraged banking sector.

Since then, mortgage lending standards have been tightened considerably and bank capital requirements have been raised steeply. Banks and mortgage lenders may be safer today, but the system is not.

Meanwhile the Fed is raising interest. It’s undertaking QE in reverse by reducing its balance sheet and contracting the base money supply. This is called quantitative tightening, or QT.

Credit conditions are already starting to affect the real economy. New cracks are appearing in emerging markets, as I mentioned. I also mentioned that student loan losses are skyrocketing. That stands in the way of household formation and geographic mobility for recent graduates.

Losses are also soaring on subprime auto loans, which has put a lid on new car sales. As these losses ripple through the economy, mortgages and credit cards will be the next to feel the pinch.

It doesn’t matter where the crisis begins. Once the tsunami hits, no one will be spared.

The stock market is going to correct in the face of rising credit losses and tightening credit conditions.

No one knows exactly when it’ll happen, but the time to prepare is now. Once the market corrects, it’ll be too late to act.

That’s why the time to buy gold is now, while it’s cheap. When you need it most, once the crisis hits, it’ll cost a fortune.

- Source, James Rickards via the Daily Reckoning

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