James Rickards: Trump Continues to Tighten the Screws on China

At the height of the Chinese capital outflows in 2016, China was losing $80 billion per month of hard currency to defend the yuan.

At that tempo, China would have burned through $1 trillion in one year and become insolvent. China did the only feasible thing, which was to close the capital account; (interest rate hikes and further devaluation would have caused other more serious problems).

This distress might have been temporary if China had managed to maintain good trading relations with the U.S. But that proved another chimera. The trade war, which has broken out between the U.S. and China has damaged Chinese exports and raised costs on Chinese imports at exactly the time China was counting on a larger trade surplus to help it finance its mountain of debt.

Now trade is drying up and China is stuck with debt it can’t repay or rollover easily. This marks the end of China’s Cinderella growth story, and the beginning of a period of economic slowdown and potential social unrest.

The coming Chinese crack-up is not just theoretical. The hard data supports the thesis. Here’s a real-time data summary from the Director of Floor Operations at the New York Stock Exchange, Steven “Sarge” Guilfoyle:

"The greater threat to financial markets will come, in my opinion from the slowing of global growth, at least partially due to the current state of international trade. 

This thought process is lent some credence by last night’s rather disastrous across-the-board macroeconomic numbers released by China’s National Bureau of Statistics. … For the Month of July, in China – Fixed Asset Investment.Growth slowed to the slowest pace since this data was first recorded back in 1992, printing in decline for a fifth consecutive month. Industrial Production. 

Missed expectations for a third consecutive month, while printing at a growth rate equaling the nation’s slowest since February of 2016. Retail Sales. Finally showing a dent in the armor, missed expectation while slowing from the prior month. Unemployment. This item has only been recorded since January. Headline unemployment “popped” up to 5.1% from June’s 4.8%. Oil Production. 

The NBS reported that Chinese oil production fell 2.6% in July, and now stands from a daily perspective at the lowest level since June of 2011. China will not report Q3 GDP until October 15. The National Bureau of Statistics reported annualized growth of 6.7% for the second quarter. Depending on the veracity of the data, one must start to wonder if China can indeed hang on to growth of 6.5% going forward."

This unpleasant picture Sarge paints is based on official Chinese data. Yet, China has a long history of overstating its data and painting the tape. The reality in China is always worse than the official data reveals.

This slowdown comes just months after Chinese dictator Xi Jinping was offered a dictator-for-life role by the removal of term limits and was placed on the same pedestal as Mao Zedong by the creation of “Xi Jinping Thought” as a formal branch of Chinese Communist ideology.

The Book of Proverbs says, “Pride goeth before destruction, and a haughty spirit before a fall.” Xi Jinping now finds himself in precisely this position. His political ascension inflated his pride just as he now faces the reality of a falling economy and possible destruction of any consensus around his power and the lack of accountability.

Trump continues to tighten the screws with more tariffs, more penalties, and a near complete shutdown of China’s ability to invest in U.S. markets.

Turkey, Argentina, and Venezuela are large developing economies that are in different stages of collapse and threaten the global economy with panic through contagion.

Yet, those three economies combined are not as large or important as China. Only Trump and Xi can salvage the situation with negotiation and reasonable compromise on trade and intellectual property. But, Trump won’t blink first; that’s up to Xi.

So far, a spirit of compromise is not in the air. A spirit of Chinese collapse and contagion is.

- Source, James Rickards via the Daily Reckoning

The Dollars Dominance May Soon be Coming to an End

Cutting a nation off from SWIFT is like taking away its oxygen.

The U.S. had previously banned Iran from the dollar payments system (FedWire), which it controls, but Iran turned to SWIFT to transfer euros and yen in order to maintain its receipt of hard currency for oil exports.

In 2013, the U.S. successfully kicked Iran out of SWIFT. This was a crushing blow to Iran because it could not receive payment in hard currencies for its oil.

This pushed Iran to the bargaining table, which resulted in the Iran nuclear deal with the U.S. and its allies in 2015. Now Trump has negated that U.S.-Iran deal and is putting pressure on its allies to once again refuse to do business with Iran.

And Congress is again pushing to exclude Iran from SWIFT as part of a sanctions program.

The difficulty this time is that our European allies are not on board and are seeking ways to keep the nuclear deal alive and work around U.S. sanctions.

Europe’s solution is to therefore create new nondollar payment channels.

In the short run, the U.S. is likely to enforce its sanctions rigorously. European businesses will probably go along with the U.S. because they don’t want to lose business in the U.S. itself or be banned from the U.S. dollar payments system.

But in the longer run, this is just one more development pushing the world at large away from dollars and toward alternatives of all kinds, including new payment systems and cryptocurrencies.

It’s also one more sign that dollar dominance in global finance may end sooner than most expect. We are getting dangerously close to that point right now.

- Source, James Rickards via the Daily Reckoning

The World Is Ganging up Against the Dollar

The U.S. has been highly successful at pursuing financial warfare, including sanctions. But for every action, there is an equal and opposite reaction.

As the U.S. wields the dollar weapon more frequently, the rest of the world works harder to shun the dollar completely.

I’ve been warning for years about efforts of nations like Russia and China to escape what they call “dollar hegemony” and create a new financial system that does not depend on the dollar and helps them get out from under dollar-based economic sanctions.

These efforts are only increasing.

In the past four months, Russia has reduced its ownership of U.S. Treasury securities by 84% and has acquired enough gold to surpass China on the list of major holders of gold as official reserves.

Russia has almost 2,000 tonnes of gold, having more than tripled its gold reserves in the past 10 years. This combination of fewer Treasuries and more gold puts Russia on a path to full insulation from U.S. financial sanctions.

Russia can settle its balance of payments obligations with gold shipments or gold sales and avoid U.S. asset freezes by not holding assets the U.S. can reach.

Of course, Russia is not the only country engaged in financial warfare with the United States. China and Iran are leading examples, but we can also add Turkey to the list after its latest currency crisis.

Russia is providing these and other nations a model to achieve similar distance from U.S. efforts to use the dollar to enforce its foreign policy priorities.

Take China and Iran. China is the second-largest economy in the world and the fastest-growing major emerging market. China has a voracious appetite for energy but has little oil of its own. Iran is a major oil producer, and China is Iran’s biggest customer.

But oil is priced in dollars and dollars flow through the U.S. banking system. Trump’s Iran sanctions make it impossible for China to pay Iran in dollars. If U.S. sanctions prohibit dollar payments for Iranian oil, then Iran and China may have no choice but to transact in yuan (see below for the implications).

Meanwhile, Europe has remained a faithful partner to the U.S. and has gone along with sanctions against Iran, for example.

That’s because European companies and countries that violate U.S. sanctions can be punished with denied access to U.S. dollar payment channels.

But now, Europe is also showing signs it wants to escape dollar hegemony. German Foreign Minister Heiko Maas recently called for a new EU-based payments system independent of the U.S. and SWIFT (Society for Worldwide Interbank Financial Telecommunication) that would not involve dollar payments.

- Source, James Rickards

New Reality of China’s Failing Economy Is Coming Soon

I’ve written for years that Chinese economic development is partly real and partly smoke and mirrors, and that it’s critical for investors to separate one from the other to make any sense out of China and its impact on the world.

My longest piece on this topic was Chapter Four of my second book, The Death of Money(2014), but I’ve written much else besides, including many articles for my newsletters.

There’s no denying China’s remarkable economic progress over the past thirty years. Hundreds of millions have escaped poverty and found useful employment in manufacturing or services in the major cities.

Infrastructure gains have been historic, including some of the best trains in the world, state-of-the-art transportation hubs, cutting edge telecommunications systems, and a rapidly improving military.

Yet, that’s only half the story.

The other half is pure waste, fraud and theft. About 45% of Chinese GDP is in the category of “investment.” A developed economy GDP such as the U.S. is about 70% consumption and 20% investment.

There’s nothing wrong with 45% investment in a fast-growing developing economy assuming the investment is highly productive and intelligently allocated.

That’s not the case in China. At least half of the investment there is pure waste. It takes the form of “ghost cities” that are fully-built with skyscrapers, apartments, hotels, clubs, and transportation networks – and are completely empty.

This is not just western propaganda; I’ve seen the ghost cities first hand and walked around the empty offices and hotels.

Chinese officials try to defend the ghost cities by claiming they are built for the future. That’s nonsense. Modern construction is impressive, but it’s also high maintenance. Those shiny new buildings require occupants, rents and continual maintenance to remain shiny and functional. The ghost cities will be obsolete long before they are ever occupied.

Other examples of investment waste include over-the-top white elephant public structures such as train stations with marble facades, 128 escalators (mostly empty), 100-foot ceilings, digital advertising and few passengers. The list can be extended to include airports, canals, highways, and ports, some of which are needed and many of which are pure waste.

Communist party leaders endorse these wasteful projects because they have positive effects in terms of job creation, steel fabrication, glass installation, and construction. However, those effects are purely temporary until the project is completed. The costs are paid with borrowed money that can never be repaid.

China might report 6.8% growth in GDP, but when the waste is stripped out the actual growth is closer to 4.5%. Meanwhile, China’s debts grow faster than the economy and its debt-to-GDP ratio is even worse than the U.S.

All of this would be sustainable if China had an unlimited ability to rollover and expand its debt and ample reserves to deal with a banking or liquidity crisis. It doesn’t. China’s financial fragility was revealed during the 2014-2016 partial collapse of its capital account.

China had about $4 trillion in its capital account in early 2014. That amount had fallen to about $3 trillion by late 2016. Much of that collapse was due to capital flight for fear of Chinese devaluation, (which did occur in August 2015 and again in December 2015).

China’s $3 trillion of remaining reserves is not as impressive as it sounds. $1 trillion of that amount is invested in illiquid assets (hedge funds, private equity funds, direct investments, etc.) This is real wealth, but it’s not available on short notice to defend the currency or prop up banks.

Another $1 trillion of Chinese reserves are needed as a precautionary fund to bail-out the Chinese banking system. Many observers are relaxed about the insolvency of Chinese banks because they are confident about China’s ability to rescue them. They may be right about that, but it’s not free. China needs to keep $1 trillion of dry powder to save the banks, so that money’s off the table.

- Source, James Rickards

Jim Rickards: Gold Price on the Verge of a Breakout?

In this four-part video series Jim Rickards, bestselling author and investment banker, discusses the core topics of this year´s "In Gold we Trust" report with the two authors Ronald-Peter Stöferle and Mark Valek.

- Source, In Gold We Trust

James Rickards: Russia Rising, The New Axis of Gold

Russia’s financial war against the U.S. is heating up – dumping U.S. Treasuries and buying gold to break U.S. Dollar hegemony. What’s their next move?

Jim Rickards: Predicting the Next Financial Crisis

Investors Can't See the Pending Disaster Staring Them in the Face

Investors have a tendency to dismiss these threats, either because they have persisted for a long time in many instances without catastrophic results, or because of a belief that somehow the crises will resolve themselves or be brought in for a soft landing by policymakers and politicians.

These beliefs are good examples of well-known cognitive biases such as anchoring, confirmation bias and selective perception. Analysis tells us that there is little basis for complacency. Yet the VIX is back near all-time lows as shown in Chart 1 below.

Even if the probability of any one event blowing up is low, when you have a long list of volatile events, the probability of at least one blowing up approaches 100%.

With this litany of crises in mind, each ready to erupt into market turmoil, what are my predictive analytic models saying about the prospects for an increase in measures of market volatility in the months ahead?

They’re saying that investor complacency is overdone and market volatility is set to return with a vengeance. Even with the Facebook blowup and trouble in the tech space, VIX is just above 13.

Changes in VIX and other measures of market volatility do not occur in a smooth, linear way. The dynamic is much more likely to involve extreme spikes rather than gradual increases. This tendency toward extreme spikes is the result of dynamic short-covering that feeds on itself in a recursive manner — or what is commonly known as a feedback loop.

Shorting volatility indexes has been a very popular income-producing strategy for years. Traders sell put options on volatility indexes, collect the option premium as income, wait out the option expiration and profit at the option buyer’s expense. It’s been like selling flood protection in the desert; seems like easy money.

The problem is that every now and then a flash flood does hit the desert.

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.

Investors expect that the future will resemble the past, that markets move in continuous ways and that extreme events occur rarely, if at all.

These assumptions are all false.

The future often diverges sharply from the recent past. Markets gap up or down, giving investors no opportunity to trade at intermediate prices. Extreme events occur with much greater frequency than standard models expect.

When they do strike seemingly from nowhere, like fire in a crowded theater, everybody panics and a wave of selling feeds upon itself.

The trouble is, most investors will never make it out of the theater in time.

- Source, James Rickards