Month: December 2018

Authored by Alasdair Macleod via GoldMoney.com,

This article is an overview of the principal factors likely to drive the gold price in 2019. It looks at the global factors that have developed in 2018 for both gold and the dollar, how geopolitics are likely to evolve, the economic outlook and how it is worsened for the dollar by President Trump’s tariff war against China, the availability and likely demand for bullion, and the technical position in paper markets. Taken together, the outlook is bullish for gold.

2018 reprise

For gold bulls, 2018 was disappointing. From 11 December 2017, when gold made a significant bottom against the dollar at $1243, it has ended virtually unchanged today, after being 4.2% up. Gold had to struggle against a rising dollar, whose trade-weighted index rose a net 3.7% over the same period, and as much as 9.4% from its mid-February low.

Dollar strength has been driven less by trade imbalances and more by interest rate differentials. A speculating bank for its own book or for a hedge fund client can borrow 3-month Euro Libor at minus0.354% and invest it in 3-month US Treasury bills at 2.36%, for a round trip of over 2.7%. Gear this up ten times or more, either on a bank’s capital, or through reverse repos for annualised returns of over 27%. To this can be added the currency gain, which at times has added enough to overall returns for an unhedged geared position to double the investment.

Not that these forex returns have been guaranteed, but you get the picture. The ECB and the Bank of Japan have been frozen into inactivity, reluctant to raise rates to correct this imbalance, and the punters have known it.

Financial commentators have routinely misunderstood the fundamental reason for the dollar’s strength, attributing it to foreigners’ desperate need for dollars. In fact, non-US holders of dollars hold it in record amounts, with over $4 trillion in deposits in correspondent bank accounts alone, and a further $930 billion in short-term debt. This $5 trillion of total liquidity was the last reported position, as at end-June 2017. Speculative dollar demand since then, driven by interest rate differentials, will have added significantly to these figures. The continuing US trade deficit, currently running at close to a trillion dollars annually, is both an associated and additional source of dollar accumulation in foreign hands.

Meanwhile, the same US Government data source reveals that US residents’ holdings of foreign securities was $6.75 trillion less than the foreign ownership of US securities, and the US Treasury reports that major US market participants (i.e. the US banks and financial entities operating in the spot, forwards and futures contracts) sold a net €2.447 trillion in the first nine months of 2018. Assuming these sales were not absorbed by official intervention on the foreign exchanges or by contracting bank credit, they can only have added to foreign-owned dollar liquidity.

To summarise the point; far from there being a dollar shortage, as market participants believe, the world is awash with dollars to an extraordinary degree.

The great dollar unwind is now overhanging markets, which will remove the principal depressant on the gold price. And when it begins, as a source of supply these hot-money dollars will be seen as the continuation of escalating supply, with the prospect of future US trade and budget deficits to be discounted. These dynamics are a duplication of those that led to the failure of the London gold pool in the late-sixties, which led to the abandonment of the Bretton Woods gold-dollar relationship in 1971. And as I argue later in this article, the supply of physical liquidity in bullion markets to satisfy demand arising from dollar liquidation is extremely tight.

Geopolitics and gold in 2018

It is likely that at a future date we will look back on 2018 as a pivotal year for both geopolitics and gold. Russia has moved to a position whereby it has substantially replaced its dollar reserves with physical gold. It is now able, if it should care to, to do away with the dollar entirely for its energy exports payments. It is even possible for it to link the rouble to gold.

China took the seemingly innocuous step of launching an oil contract denominated in yuan. It had prevaricated since at least 2014 before making this move, presumably conscious that it was an in-your-face threat to the monopoly of the dollar in pricing energy.

There was expectation that the oil-yuan futures contract would be a segway into a yuan-gold futures contract either in Hong Kong or Dubai, allowing countries such as Iran to avoid receiving dollars entirely. And indeed, a number of gold exchanges and interests in Asia have banded together to open a 1500-tonne vault in Qianhai to facilitate gold storage resulting from pan-Asian trade flows.

These include the China Gold and Silver Exchange Society, the Hong Kong Gold Exchange, and gold market interests in Singapore, Myanmar and Dubai. The objective is to give Hong Kong the opportunity to coordinate Asian gold markets and develop a “gold corridor” for the countries along China’s Belt and Road initiative. Therefore, both private and public sectors will be able to accumulate the oldest form of money as a backstop to local currencies, as an alternative to accumulating those of their trading partners.

Geopolitics evolved from fighting proxy wars in the Middle East and Ukraine, which were effectively won by Russia, to the less obvious war of trade tariffs. President Trump has styled himself as “A Tariff Man”. We have presumed that he is ignorant of economics, but that is no longer the point. Tariffs have evolved from a policy to make America great again to bankrupting China. China is seen as the greatest economic threat to America, and in this duel, tariffs are Trump’s weapon of choice.

The objective is to impede China’s technological development. It was tolerated when China, to steal a line from Masefield’s Cargoes, was the world’s supplier “…of firewood, iron-ware and cheap tin trays”. But China is moving on, creating a sophisticated economy with a technological capability that is arguably overtaking that of America. The battle for technological supremacy came out into the open with the detention on 1 December in Vancouver of Meng Wanzhou, the CFO of Huawei. Huawei is China’s leading developer of 5G mobile technology, installing sophisticated equipment around the world. 5G’s capability will make internet broadband redundant and will become widely available from next year.

Ms Meng’s arrest represents such an escalation of deteriorating relations between China and America that many assume it was ordered by rogue elements in America’s deep state. Maybe. But these things are difficult to reverse: does America tell the Canadian authorities to just let her go? It would uncharacteristic for America to admit a mistake, and it would probably need President Trump to personally intervene. This is difficult for him because application of the law is not in his hands.

If Ms Meng is not released, we will enter 2019 with the Chinese publicly insulted. They will realise, if they haven’t already, that ultimately there can be no accommodation with America. Fighting tariffs with more tariffs is a policy that will achieve nothing and damage China’s own economy.

It therefore becomes a matter of time when, and not if, China deploys financial weapons of its own. These will be targeted at the US’s obvious weaknesses, including her dependency on China for maintaining and increasing holdings in US Government debt. The increasingly compelling use of physical gold to both protect the yuan from attack in the foreign exchanges and limit the rise of yuan interest rates would serve to insulate China from the fall-out of a collapsing dollar.

The economic outlook, and the effect on the dollar

For market historians, the economic situation rhymes strongly with 1929, when the Smoot-Hawley Tariff Act was being debated. Eighty-nine years ago, the first round of votes in Congress was passed on 30 October, and Wall Street fell heavily that month in anticipation of the result. Following the G20 meeting two weeks ago, where it was vainly hoped there would be progress in the tariff negotiations between the US and China, markets fell heavily, reminding market historians of the 1929 precedent.

When President Hoover stated his intention to sign Smoot-Hawley into law on 16 June 1930, Wall Street crashed again. The lesson for today is that equity markets are likely to crash again if Trump continues with his tariff policies. Smoot-Hawley raised import tariffs on over 20,000 imported raw materials and goods, increasing the average tariff rate from 38% to over 60%. The difference today is that instead of tariffs being used only for protectionism, they are being targeted specifically against China.

There will be two likely consequences. The first is the the undermining of financial markets, which in the 1930s led to the virtual collapse of the US banking system and the global depression. And secondly, there is the escalation of a wider financial war raging between China and the US. These two factors are potentially very serious, with stock markets already on shaky ground.

This is not the uppermost reason for market weakness in investors’ minds, who worry about the economic outlook more generally. The conventional credit cycle features rising interest rates as a consequence of earlier monetary expansion, and the exposure of malinvestments. Markets discount the phases of the credit cycle when they become apparent to far-sighted investors, and only indirectly contribute to the collapse itself. But when valuations have become wildly optimistic, the fall in markets becomes a crisis on its own, contributing to the collapse in business that follows. This was the point taken up by Irving Fisher in the wake of the 1929-32 bear market.

In any event, the global economy appears to be at or close to the end of its expansionary phase, and is heading for recession, or worse. As well as the potential impact from an unanchored reserve currency, price inflation in the US will be boosted by Trump’s tariffs, which amount to additional consumer taxes. Price inflation pressures will then call for further rises in interest rates, while economic prospects will point to easing monetary conditions.

We have yet to see how this will be resolved. A further problem is that an economic downturn will increase government welfare commitments and therefore borrowing requirements. Bond yields will tend to rise and therefore borrowing costs, driving spendthrift governments into a debt-trap, just when price inflation is likely to demand higher interest rates. The most likely outcome will be further losses of fiat currencies’ purchasing power.

The 1930s depression saw a rising purchasing power for the dollar, with all commodity and consumer prices declining. The dollar was on a gold standard, and prices were effectively measured in gold, the dollar acting as a gold substitute. This is no longer true, and the purchasing power of the dollar, along with all other fiat currencies will at best remain stable measured against consumer products, or more likely will decline. In other words, a severe recession which looks increasingly likely on cyclical grounds, will lead to higher gold prices, irrespective of fiat currency interest rates.

The gold-fiat relationship and monetary inflation.

According to the World Gold Council, central bank gold reserves total 33,757 tonnes, worth $1.357 trillion at current prices. Global fiat money is estimated to total about $90 trillion, which suggests there’s 66 times as much in global cash and bank deposits as there is gold to back it.[iii] Admittedly, issuers have different gold-to-currency ratios, but overall this suggests the gold price would be far higher if a sustainable level of currency convertibility is to return.

The reason we must consider this relationship is that in the light of all the foregoing, the gulf between the two quantities is set to accelerate from the currency side.

In the early 1930s, dollar prices of raw materials and commodities fell heavily, bankrupting farmers and miners world-wide. The purchasing power of the dollar rose, because it acted as a gold substitute. Today there is no convertibility between the dollar and gold at all, so the effect of a global economic depression is bound to see the gulf between the dollar and gold widen, as central banks expand the quantity of money in an attempt to fight recession and keep their governments solvent. There can be no doubt the policy response from the Fed and all the other welfare-state central banks will be neo-Keynesian, exploiting all the freedoms of unsound money.

In fact, the increase in the money quantity is not new, dating from the Lehman crisis. This is shown in the chart below, of the fiat money quantity, compared with its long-term pre-Lehman growth path.

FMQ is basically the sum of true (Austrian) money supply and commercial bank reserves held at the Fed. Even though its growth has recently stalled, the gap between the pre-Lehman crisis growth path still stands at $5.55 trillion.

Now imagine what will happen when the global economy stalls. The Fed, along with other central banks, will be forced to make yet more currency available to support the banks, finance government spending and encourage consumption. The injection in the US last time was roughly $10 trillion, or 55% of GDP. Next time, with interest rates needing to be maintained in order to support the currency, it will almost certainly require more aggressive quantitative easing, with central banks substantially increasing their purchases of government bonds.

Gold is already close to all-time lows, relative to the money quantity. This is shown in the next chart.

It was from similar indexed levels that gold bottomed in the late sixties. A return to the level set by President Roosevelt in January 1934 implies a price of $53,250 today. This is not a forecast, and its only relevance is to illustrate the potential for an upward adjustment in the gold price, based on the degradation of the dollar since 1934.

Physical factors

Demand for physical gold consistently exceeds mine supply. Central banks are accumulating bullion, adding 425 tonnes in the year to September 2018. Chinese private sector demand continues at a steady pace, which measured by withdrawals from the Shanghai Gold Exchange, is running at a 1,900-tonne annualised rate. India’s total gold imports were 919 tonnes in the year to end-September (according to the World Gold Council), so adding identified central bank demand to private sector demand from India and China, these three sources account for 3,344 tonnes annually, which is the same as global mine supply.

The supply/demand balance is more complicated than these figures suggest. Some of the mine supply is not available to markets. For example, China, which is the largest mine supplier by far, severely restricts gold exports. Official reserves at central banks are only what are declared and includes gold out on lease or swapped, and therefore not in possession of the central bank. They are therefore short of actual possession, exposing them to potential counterparty and price risk.

Net demand from the rest of the world and from unrecorded categories is satisfied from the existing above-ground stock of bullion, which we estimate to be about 175,000 tonnes. Only an unknowable fraction of this is available for market liquidity. The most identifiable swing-factor is ETF demand, which saw outflows of 103 tonnes in the three months to September[iv]. Looking back over recent years, another substantial ETF outflow was in 2016 Q4, when the gold price bottomed, and in 2015 Q2 to Q4 saw net outflows every quarter. It appears that ETF demand is acting as a contrary indicator of future price trends.

This fits in with market theory, which based on investor psychology predicts investors are at best trend-chasers, investing most heavily at market tops and liquidating positions at price lows. The peak of net ETF liquidation in 2018 was in June and August. In June the gold price breeched the psychologically important $1300 level, and in August the market turned higher at $1160. ETF net selling tells us therefore the gold price may have recently indicated a turning point.

Supply from ETFs at market lows satisfies demand from those that have a continuing demand. We have seen the pattern of central banks increasing their buying on lower prices, but there is also some evidence commercial banks are accumulating bullion for their own books, possibly for risk purposes.

Under the new Basel III standard, physical gold held on an allocated basis is now classified as cash and has the advantage of zero risk weighting, compared with a 15% haircut under Basel II. Besides physical cash notes (which in practice banks try to minimise in their branches), the only other alternative to cash is balances held on the bank’s account at a central bank. The ECB and the Bank of Japan charge negative interest rates on these balances, which for commercial banks in the EU and Japan leaves only physical gold as an alternative.

For the thinking banker, it makes sense to hedge fiat currency exposure (which is the entirety of his business) with some physical bullion. The opportunity cost in the form of lost interest is not a factor, with overnight money-market rates in euros and yen negative. And the regulatory cost of holding gold is being removed.

A brief analysis of the availability of physical supply points to acute shortages on any expansion of demand. Seasonal factors can have a significant impact, with the Diwali festival in India a month ago, and the Chinese New Year in early February leading to an accumulation of bullion inventories.

The absorption of available liquidity from mine supply and scrap recycling tells us the physical market has become extremely tight. Instability in fiat currencies, particularly weakness developing in the dollar’s trade-weighted index, could therefore have a disproportionate effect on the gold price as a wide range of investing institutions and commercial banks try to correct their almost zero asset allocation to gold.

Paper markets for gold

As the chart below shows, gold bottomed in December 2015, since when it has been in a narrowing consolidation. Within this pattern, there is a seasonal effect, whereby gold sells off in early December and subsequently rallies. This is shown by the three black arrows on the chart.

There are reasons why this is so. The December contract is the last active contract to expire before the year end, when many hedge funds and bullion banks make up their accounts. Hedge fund managers want to present a balance sheet with less risk exposure than they normally run, and banks will wish to present shareholders and regulators with a sanitised version of their risk exposure as well.

This exposure cycle has had an extra twist this time, because market speculators in futures markets have shorted a wide range of futures in order to capture a strong dollar. In the case of the Comex gold future, this has led to an unprecedented technical position, shown in the next chart.

Over the last twelve years, hedge funds (which are represented in this category of speculator) have only been net short of Comex gold contracts twice. The first time was in late-2015, which marked the end of the 2011-15 bear market, and the second was recently, marking the sell-off to $1160. The only reason it has partially corrected is due to the expiry of the December contract.

Market sentiment is still markedly pro-dollar and anti-everything else, including gold. The underlying assumption appears to be that foreigners require dollars and the dollar has the highest interest rates of the major currencies. This being the case, the first supposition is an error. There is a growing expectation that the US economic growth will slow next year, and the Fed is under pressure not to raise rates any further.

When these changing factors are taken into account, the dollar is likely to be sold, and hedge fund speculators will take the other tack. The market-makers, traditionally the bullion banks, are bound to be aware of this possibility and will therefore try to maintain an even book.

Conclusion

All factors examined in this article point to higher gold prices in 2019. They can be summarised as follows:

• The world is awash with dollars at a time when markets act as if there is a shortage. When the truth emerges, the dollar has the potential to fall substantially against other currencies, leading to a rise in the price of gold.

• The move towards gold and against the dollar in Asia accelerated in 2018, with Russia having replaced the dollar with gold as its principal reserve currency. China has laid the foundation with an oil-yuan futures contract, which can be a bridge to yuan-gold contracts in both Hong Kong and Dubai. This is a direct challenge to the dollar as a reserve currency, and likely to be attractive to oil suppliers, such as Iran, seeking to circumvent use of the dollar and accumulate gold instead.

• America’s trade war against China appears to be less about unfair trade practices and more about stopping China from evolving into a serious technological competitor against the US. In 2019, there is a strong possibility the tariff war will escalate into a wider conflict, with China selling down its exposure to the dollar and US Treasury debt. That would create significant difficulties for the US Government and the dollar itself.

• With the credit cycle turning and the addition of American tariffs, markets are at a growing risk of replicating the 1929-32 crash and the economic depression that followed. This time, instead of commodities and consumer products effectively priced in gold through a gold standard, they will be priced in fiat currency. Monetary policies will ensure liquidity is freely available to support the commercial banks, government spending and economic activity. This is a recipe for higher gold prices.

• Demand for physical gold continues to outstrip mine supply. In 2019, risk-weighting rules in Basel III open up the opportunity for commercial banks to augment their liquidity with allocated bullion, attractive to euro- and yen-based banks who face negative interest rates on short-term cash alternatives.

• The technical position in the paper markets looks favourable, with close to record levels of bearishness, and an established pattern of December rallies in the gold price.

via RSS https://ift.tt/2zYVavU Tyler Durden

Lies, #resistance, nationalism, hate speech, racism, #metoo, white supremacy, socialism, nazis… and Russians!?

This is the America spewed in to Americans’ brains 24/7 by the mainstream media as “the middle” has been lost.

But every now and again, something happens that allows ‘average joe’ Americans to reflect proudly on their nation, be patriotic, and share empathy with those who honorably do Washington’s bidding without question.

In a video taken at Nashville International Airport in Tennessee, Jen Tringale caught the following faith-restoring moment on her phone and posted to Facebook:

“I witnessed an international airport come to a complete stop today…

At the Nashville airport I walked out into the concourse to this scene @americanairlines was flying a plane full of children who had lost a parent in combat to Disneyworld [sic] on an all-expenses-paid trip and they threw a party for them at the gate.

But when they announced them over the loud speaker and they lined up to board the plane, the whole airport literally stopped and sang the national anthem with military present in salute.

Most every person standing around, myself included, was bawling at the sight of these kids and spouses who have paid so great a price for our country. To see all of this at Christmas time was so humbling. Seeing the general public in an airport stand still to honor these kids was simply beautiful.”

If you can watch the following clip without a tear in your eye, you’re dead inside…

The kids appeared to enjoy themselves and perhaps for a moment forgot about the hardships they face…

Over 1000 Gold Star Children travel w/ surviving parent, 1,750 in all, via @americanair to Disney World today as part of our @GarySiniseFound Snowball Express program. This charter left LAX this morning. I’ll join up in a few days. Have fun kids! We love you! pic.twitter.com/OfMEpVF1er

— Gary Sinise (@GarySinise) December 8, 2018

via RSS https://ift.tt/2PBUOAi Tyler Durden

BTFD has transformed into STFR – maybe it’s better not to play…

China was well bid overnight (extraordinarily so)…but faded in the afternoon session…

 

European stocks gapped up at the open but faded

“Constructive” was the word of the day in Europe as everyone read from the same script on Italy…

 

US futures rallied into the European Open and rallied into the US Open, but were dumped after each…

Trannies tanked on the day (see Airlines below), but all major indices gave up early gains as Secretary Ross warned that China’s current actions are not enough… By the close The Dow managed to get back green and S&P unchanged…

Short interest on SPY, the world’s largest exchange-traded fund with more than $250 billion in assets, has jumped to 5.3 percent or shares outstanding, according to data compiled by Markit.

This is the 5th “sell the f**king rip” day in a row…

Airline stocks crashed after Delta’s 2019 profit view missed analysts’ estimates, prompting concerns about weakening pricing power

 

Bank stocks resumed their downtrend after a brief respite yesterday…

 

GE soared pre-market as JPMorgan’s analyst took his foot off its throat…but faded from the open…

 

FANG stocks sold off…

 

Treasuries were mixed today with the long-end underperforming and the belly and short-end bid (but all very modestly)…

 

10Y Yields bounced off the 2.80% support once again…

 

The Bill curve is getting more perturbed through the potential shutdown date as liquidity preferences have bid the shortest-dated bills…

 

 

The Dollar managed gains on the day retracing yesterday’s losses…

 

Draghi is losing his touch as EUR ended the day unchanged…

 

Yuan faded after China closed…

 

Cable held on to yesterday’s May confidence vote gains…

 

Cryptos crashed late in the day amid headlines of a Bitcoin Bomb-Scare scam…

 

Crude soared back to the early week high, copper, gold and silver lagged…

 

WTI was well bid after Saudi export cut headlines…WTI tagged $53 high stops

 

Gold in Yuan also fell into the red on the week…

 

Finally, we note that The Fed is back in the position of being more hawkish than The ECB… just barely…

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Authored by Lance Roberts via RealInvestmentAdvice.com,

Nathan Vardi recently penned an article for Forbes entitled “Surprise! The Late-Year Bond Rally.”

“In August, Jamie Dimon, CEO of JPMorgan Chase & Co. and the nation’s most prominent banker, predicted the yield on the benchmark 10-year Treasury note could reach 4% in 2018. He cautioned investors to prepare for 5% or higher.

Dimon’s call was not a contrarian one. It had become conventional wisdom on Wall Street that rates were headed higher and that the Federal Reserve would be tightening monetary policy for the foreseeable future.”

Jamie Dimon wasn’t alone. There were many venerable Wall Street veterans from Bill Gross, Paul Tudor Jones, Ray Dalio, and Jeff Gundlach were also calling for higher rates. But, these calls for higher rates and the “End Of The Great Bond Bull Market” have been flowing through the media since 2013.

• Bill Gross Says Bond Bear Market Confirmed

• Have We Entered The Bond Bear Market

• Has The Bond Bear Market Finally Started

• The Bond Bear Is Here

• The 3-Decade Bond Bull Market Is In Danger

And that was just from January.

Of course, those headlines are not the first time we have seen such calls made. One of the biggest problems with predictions of rising 10-year bond yields, since “bond bears” came out in earnest in 2013, is they have been consistently wrong. For a bit of history, you can read some of my previous posts on why rates can’t rise in the current environment.

• Bond Bears & Why Rates Won’t Rise

• Why Bonds Aren’t Overvalued

• People Buy Payments

• Rates Continue To Defy Logic

• Rates, GDP & Challenges

• Why Interest Rates Are Going To Zero

• People Buy Payments & Why Rates Can’t Rise

You get the idea.

But what is it the mainstream analysis continues to miss?

Rates Are Low, So They Must Go Up

The general view as to why rates must rise is simply because they are so low. Looking at the chart below, such would certainly make sense.

However, it is important to note that interest rates can remain low for a very long time. The two previous occasions where rates fell below the long-term median they remained there for more than 35-years. We are currently about 8-years into the current evolution.

But here is the important point.

Higher interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time. There have been two previous periods in history that have had the necessary ingredients to support a rising trend of interest rates over a long period of time. The first was during the turn of the previous century as the country became more accessible via railroads and automobiles, production ramped up for World War I and America began the shift from an agricultural to industrial economy.

The second period occurred post-World War II as America became the “last man standing” as France, England, Russia, Germany, Poland, Japan and others were left devastated. It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding the countries that they had just destroyed.

It is important to note that interest rates are also a function of inflation. Inflation is a byproduct of money supply. This is the subject of an upcoming article forRIA PRO subscribersbut currently it doesn’t appear the Federal Reserve is quite willing, at least not yet, to generate inflation via the printing presses. 

The U.S. is no longer the manufacturing powerhouse it once was, and globalization has sent jobs to the cheapest sources of labor. Technological advances continue to reduce the need for human labor and suppress wages as productivity increases. Today, the number of workers between the ages of 16 and 54 participating in the labor force is near the lowest level relative to that age group since the late 70’s. This is a structural and demographic problem that continues to drag on economic growth as nearly 1/4th of the American population is now dependent on some form of governmental assistance.

These are issues are only going to become worse due to long-term demographic trends not only in the U.S., but globally.

As shown below, the is a correlation between the three major components of the economy (inflation, GDP and wage growth) and the level of interest rates. Interest rates are not just a function of the investment market, but rather the level of “demand” for capital in the economy. When the economy is expanding organically, the demand for capital rises as businesses expand production to meet rising demand. Increased production leads to higher wages which in turn fosters more aggregate demand. As consumption increases, so does the ability for producers to charge higher prices (inflation) and for lenders to increase borrowing costs. (Currently, we do not have the type of inflation that leads to stronger economic growth, just inflation in the costs of living that saps consumer spending – Rent, Insurance, Health Care)

The chart above is a bit busy, but I wanted you to see the trends in the individual subcomponents of the composite index. The chart below shows only the composite index and the 10-year Treasury rate.

Let’s go back to Jamie Dimon for a moment. He stated that interest rates should be 4% which would align with economic growth rates earlier this year. However, that growth was not driven by organic factors of rising wages but rather a confluence of natural disasters. Furthermore, the increase in deficit spending also helped boost economic growth.

The issue is that the surge in deficit spending, combined with the pick up in short-term demand for construction and manufacturing processes, gave the appearance of economic growth which got both the Federal Reserve and the “bond bears” on the wrong side of the trade.

As I have stated previously, the impacts of these “one-off” inputs into the economy will continue to fade as we move into 2019.

While it is certainly hoped that the current economic expansion can last for years to come, a simple look at the last 40 years of fiscal and monetary policy suggests it won’t.

Why?

Because you can’t create economic growth when it is financed by deficit spending, credit, and a reduction in savings.

You can create the “illusion” of growth in the short-term, but the surge in debt reduces both productive investments into, and the output from, the economy. As the economy slows, wages fall, and the consumer is forced to take on more leverage and decrease their savings rate. As a result, of the increased leverage, more of their income is needed to service the debt, which requires them to take on more debt.

Which is exactly what has happened.

(The chart below shows the shortfall between the inflation-adjusted cost of living and what wages and savings will cover. The deficit is the difference that has to be made up with debt every year.)

Given that nearly 70% of current economy is driven by consumption, it only requires small moves higher in interest rates before the negative impact to economic growth is realized as capital flows are reduced. (Since interest rates affect payments, higher rates quickly impact consumption, housing, and investment which ultimately deters economic growth.) 

The problem with most of the forecasts for the end of the “bond bull” is the assumption we are only talking about the isolated case of a shifting of asset classes between stocks and bonds. However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy.

Interest rates, however, are an entirely different matter.

The Next Crisis

Just recently, Janet Yellen discussed the issue of leverage in the economy stating that companies are taking on too much debt and could be in trouble should some unexpected trouble hit the economy or markets.

“Corporate indebtedness is now quite high and I think it’s a danger that if there’s something else that causes a downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector.”

Yellen also warned that the debt is being held in instruments similar to ones used to bundle subprime mortgages that led to the financial crisis a decade ago. Importantly, the investment-grade part of the bond market was $3.8 trillion at the end of October which was 6% higher than a year ago, and BBB-rated bonds accounted for 58% of the total,

In other words, with rates rising, economic growth slowing (debt is serviced from revenues), and the health of balance sheets deteriorating (BBB is one notch above “junk”) the risk of an “event-driven” crisis is real. All it will take is a significant decline in asset prices to spark a cascade of events that even monetary interventions may be unable to stem. As stock prices decline:

• Consumer confidence falls further eroding economic growth

• The $4 Trillion pension problem is rapidly exposed which will require significant government bailouts.

• When prices decline enough, margin calls are triggered which creates a liquidation cascade.

• As prices fall, investors and consumers both contract further pushing the economy further into recession.

• Aging baby-boomers, which are vastly under-saved will become primarily dependent on social welfare which erodes long-term economic growth rates.

With the Fed tightening monetary policy, and an errant Administration fighting a battle it can’t win, the timing of the next recession has likely been advanced by several months.

The real crisis comes when there is a “run on pensions.” With a large number of pensioners already eligible for their pension, the next decline in the markets will likely spur the “fear” that benefits will be lost entirely. The combined run on the system, which is grossly underfunded, at a time when asset prices are dropping  will cause a debacle of mass proportions. It will require a massive government bailout to resolve it.

But it doesn’t end there. Consumers are once again heavily leveraged with sub-prime auto loans, mortgages, and student debt. When the recession hits, the reduction in employment will further damage what remains of personal savings and consumption ability. The downturn will increase the strain on an already burdened government welfare system as an insufficient number of individuals paying into the scheme is being absorbed by a swelling pool of aging baby-boomers now forced to draw on it. Yes, more Government funding will be required to solve that problem as well. 

As debts and deficits swell in the coming years, the negative impact to economic growth will continue. At some point, there will be a realization of the real crisis. It isn’t a crash in the financial markets that is the real problem, but the ongoing structural shift in the economy that is depressing the living standards of the average American family.There has indeed been a redistribution of wealth in America since the turn of the century. Unfortunately, it has been in the wrong direction as the U.S. has created its own class of royalty and serfdom.

But most importantly, that is how interest rates remain low for a very long-time.

While there is little left for interest rates to fall in the current environment, there is no ability for rates to rise before you push the economy back into recession. Of course, you don’t have to look much further than Japan for a clear example of what I mean.

The “bond rally” was no surprise.

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The US Senate approved a resolution to end U.S. support for the Saudi-led war in Yemen, dealing a stinging rebuke to President Trump amid heightened tensions over the death of U.S.-based Saudi journalist Jamal Khashoggi. Senators voted 56-41 on the resolution, which would require the president to withdraw any troops in or “affecting” Yemen within 30 days unless they are fighting al Qaeda; in doing so the Senate defied a veto threat from the White House which has vowed it would block the legislation.

However, beyond sending a symbolic message, the vote is largely moot as on Wednesday, as part of the Farm Bill passage, the House voted to block members from forcing a war powers vote this year. Still, the Senate vote Thursday underscored the depth of frustration with Saudi Arabia on Capitol Hill, as well as the escalating gap between the White House and Congress on the relationship between the U.S. and the kingdom.

Senators said passage sends a strong message to the Saudi crown prince because it targets his most important foreign policy priority. And just to make sure the Senate was heard loud and clear, the Senate also passed a measure which said that the Saudi Crown Prince was behind Khashoggi’s death.

“I hope … we send a loud and powerful message by passing this resolution. That we’re going to bring peace to that country and that the United States Congress is going to reassert its constitutional authority to make the body that makes war not the president,” Sen. Bernie Sanders (I-Vt.), one of the sponsors of the resolution, told reporters.

“A strong denouncing of a crown prince and holding them responsible for the murder of a journalist. It’s a pretty strong statement for the United States Senate to be making, assuming we can get a vote on it,” Senator Bob Corker told reporters this week.

It’s a dramatic U-turn from less than nine months ago when the chamber pigeonholed the exact same resolution, refusing to vote it out of committee and onto full Senate. At the time, 10 Democrats joined 45 Republicans in opposing it.

The resolution’s passage comes less than a day after Trump maintained that he would stand by the Saudi government and specifically Crown Prince Mohammed Bin Salman, whom U.S. intelligence officials reportedly believe ordered Khashoggi’s killing inside the Saudi consulate in Istanbul in early October.

Trump told Reuters on Tuesday that Riyadh has been “a very good ally” and “at this moment” sticking with Saudi Arabia means standing by the crown prince.

The Trump administration had led a lobbying effort to try to squash the Senate resolution. In addition to a veto threat, they sent Defense Secretary James Mattis and Secretary of State Mike Pompeo to brief senators and privately urge them to oppose the resolution.

Foreign Relations Committee Chairman Bob Corker (R-Tenn.) said Wednesday that he couldn’t support the resolution but “I know that Lee-Sanders has the votes.”

According to The Hill, Majority Leader Mitch McConnell (R-Ky.) urged opposition to the measure hours ahead of the vote, while acknowledging members have “legitimate concerns” about Yemen and share “grave concerns” about Khashoggi’s death. “[But] we also want to preserve the 70-year partnership between the United States and Saudi Arabia and we want to ensure it continues to serve American interests and stabilizes a dangerous and critical region,” McConnell said.

The House is expected to get the same briefing on Thursday.

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Violence exploded outside the Hungarian Parliament in Budapest on Wednesday, prompting police to make 34 arrests as five officers were injured, as demonstrators stormed the building to protest a series of laws passed by Prime Minister Viktor Orban’s ruling Fidesz Party – one of which put the country’s Minister of Justice in charge of picking judges for newly created federal courts, per Bloomberg.

Hungarian police arrested 34 people when protesters tried to storm the parliament building late on Tuesday after Prime Minister Viktor Orban’s lawmakers passed a series of bills that strengthen his grip on power.

Five law enforcement officials were injured during scuffles as police used tear gas to repel demonstrators, Gergely Gulyas, the minister in charge of the prime minister’s office, told a briefing on Wednesday.

According to Local News 8, hundreds of protesters marched through Budapest and gathered at the parliament building Wednesday night after Orban’s party passed a law allowing employers to ask their workers to take on up to 400 hours’ overtime per year – something its critics have dubbed “the slave law.” But the final straw for demonstrators was the passage of another law allowing the Justice Minister to appoint judges to new courts designed to handle cases concerning “government business” like tax and elections.

Opposition lawmakers decried the law as an authoritarian power grab. After it was passed, pandemonium broke out in parliament. 

Hungary’s parliament was thrown into scenes of turmoil following the vote on the new legislation, with opposition lawmakers sounding air horns and angrily confronting the Prime Minister.

One member of parliament, Tordai Bence, filmed himself demanding answers from an awkward-looking Orban over the new overtime laws.

Shortly after the vote, around 2,000 people marched through Budapest – some waving EU flags – and converged on the steps of the parliament. Some protesters hurled objects at police, who responded with pepper spray, Reuters reported.

Notably, the demonstrations followed the retreat of billionaire George Soros and his “Open Society” foundation, which left Hungary earlier this year under scrutiny from lawmakers. More recently, the Soros-backed University of Central Europe was forced out of the country under laws intended to curb foreign influence in Hungarian politics. Soros has played a major role in organizing the opposition to Orban’s Fidesz party, which won a sweeping landslide victory during Parliamentary elections earlier this year and enjoys overwhelming popular support (particularly in the countryside) largely thanks to its immigration policies.

Soros isn’t the only antagonist trying to punish Orban and his government. The European Parliament earlier this year authorized an unprecedented Article 7 proceeding to punish Orban’s government for not caving to pressure to institute “open door” policies like those that have been rejected by voters in Germany and Italy. 

But as the billionaire investor continues to pursue his vendetta against his former protege (Soros financed Orban’s education and was an early benefactor) expect more unrest in the streets of the capital.

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Via SputninkNews.com,

Google CEO Sundar Pichai revealed that the “full extent” of so-called Russian meddling activity that took place on the platform during all of 2016 was $4,700 spent on some digital advertisements.

“Does Google now know the full extent to which its online platforms were exploited by Russian actors in the election two years ago?” Rep. Jerry Nadler, a Democrat from New York and ranking member of the House Judiciary Committee, asked the search engine’s chief executive during Tuesday’s hearing.

​”We have – we undertook a very thorough investigation, and, in 2016, we now know that there were two main ad accounts linked to Russia which advertised on Google for about $4,700 in advertising,” Pichai responded.

“A total of $4,700?” Nadler asked to confirm.

“That’s right,” the Google executive replied.

Whenever Russiagate peddlers are confronted w/ the actual facts, it doesn’t go so well. Here’s @RepJerryNadler asking Google CEO Sundar Pichai about “the full extent” of Russian meddling activity on its platforms in 2016. The answer: Russian-linked accounts spent $4,700 on ads. pic.twitter.com/MiZaq8HBvS

— Aaron Maté (@aaronjmate) December 11, 2018

Google employees and executives contributed $1.6 million to 2016 Democratic presidential candidate Hillary Clinton, according to data compiled by the Center for Responsive Politics.

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Two months after the US Treasury reported the widest annual deficit in six years for fiscal 2018, moments ago the US posted the biggest November budget deficit on record as total government spending came in twice as much as revenue.

November outlays surged 18.4% to $411 billion last month from $347 billion a year ago, while receipts actually declined 1% to $206 billion from $208 billion in 2017, the Treasury Department said in a monthly report on Thursday. The biggest spending categories were Social Security ($84BN), Medicare ($77BN), National Defense ($62BN), Income security ($46BN) and Health ($42BN). Net interest on the US debt of nearly $22 trillion came in at a hefty $33BN. Meanwhile, Individual Income Taxes and Social Security Taxes both generated $93BN in income each.

The result was a November deficit of $205 billion, a 48% increase from the $139 billion shortfall a year earlier, and the biggest November deficit on record.

For the first two months of the fiscal year which began Oct. 1, the deficit widened to $305.4 billion, up 50% compared with $201.8 billion the same period a year earlier.

On a LTM basis, the US deficit has more than doubled from the $405BN it hit in February 2016 to $883BN as of the 12 months ended November. It was the second highest LTM number since early 2013.

In Fiscal 2018, the first full year of Donald Trump’s presidency in which he enacted a tax-cut package and enacted a $1+ trillion stimulus, the U.S. ran the largest deficit in six years. The various spending programs and tax cuts have added to the growing federal deficit, which is expected to hit $1 trillion some time in fiscal 2019, one year sooner than disclosed in the CBO’s most recent forecast ; in April the agency didn’t expect the deficit to reach $1 trillion until 2020.

Then again, over the long run none of this matters…

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