"Periphery to Core Crisis Dynamics"

Doug Nolan

The renminbi traded at 6.8935 in early-Friday trading, with intensified selling pushing the Chinese currency to its lowest level (vs. the $) since May 26, 2017. The People's Bank of China (PBOC) was compelled to support their currency, with the imposition of a 20% reserve requirement on foreign-exchange forward contracts (raising the cost of shorting the renminbi). The PBOC previously adopted this measure back during 2015's tumult, before removing it this past September.

The re-imposition of currency trading reserve requirements indicates heightened concern in Beijing. Officials likely viewed modest devaluation as a constructive counter to U.S. trade pressures. In no way, however, do they want to face disorderly trading and the risk of a full-fledged currency crisis.

The renminbi rallied 1% on the PBOC move, ending slightly positive for the day (but down for the eighth straight week). Trading strongly prior to the PBOC move, the dollar index reversed into negative territory. Many EM currencies moved sharply on the renminbi rally. The South African rand reversed course and posted a 1.2% gain. The Brazilian real also jumped 1%. Curiously, the Japanese yen gained about 0.5%.

Overnight S&P500 futures, having traded slightly negative, popped higher on the renminbi rally. But EM equities were the bigger beneficiary. Brazil Ibovespa index gained 2.3% Friday. It increasingly appears the fortunes of the renminbi and EM markets are tightly intertwined.

The unfolding trade war is turning more serious. Beyond Friday's currency move, China's Finance Ministry - in measures to "guard its interests" - announced plans for significantly broader retaliation tariffs on U.S. goods.

August 3 - CNBC (Michael Sheetz): "China is preparing to retaliate in the escalating trade war with tariffs on about $60 billion worth of U.S. goods. The import taxes would range in rates from 5% to 25%, China's Ministry of Commerce said… There are four lists of goods, one for each of the rates proposed. Many of the goods are agricultural-related, with others on various metals and chemicals. 'The implementation date of the taxation measures will be subject to the actions of the US, and China reserves the right to continue to introduce other countermeasures,' China's release said… 'Any unilateral threat or blackmail will only lead to intensification of conflicts and damage to the interests of all parties.'"

President Trump had already threatened to place tariffs on $200 billion of Chinese goods if Beijing moved to retaliate on earlier U.S. measures. Shortly after the Chinese retaliatory tariff announcement (and post-U.S. payrolls data), Larry Kudlow, Director of the National Economic Council, appeared on Bloomberg Television.

Bloomberg's Jonathan Ferro: "You've sat across the table with the Chinese many, many times. What is your opinion - your insight - into what is happening to the Chinese economy currently?"

Kudlow: "Well, I'm not an expert. I do try to follow it and it looks to me - you all may disagree - it looks to me like the China economy is declining in growth - it's weakening - almost across the board. And it looks like the People's Bank of China is trying to pump it up by adding high-powered money and new credit and so forth. The currency fall is partly [because] they've stopped defending the yuan. They think it's going to help offset the U.S. efforts to get rid of their unfair trading. Some of the currency fall, though, I think is just money leaving China because it's a lousy investment. And if that continues that will really damage the Chinese economy. If money leaves China - and the currency could be a leading indicator - they're going to be in a heap of trouble. And so I'm going to make the case that they are in a weak economic position - that's not a good place for them to be vis-à-vis the trade negotiations - first point. Second point, they better not underestimate President Trump's determination to follow through on our asks - IP theft is a no-go. Forced transfer of technology - no go. Non-reciprocal trading, on tariffs and non-tariff barriers. The President, he's a trade reformer. We've said many times: "no tariffs, no tariff barriers, no subsidies. We want to see trade reforms." China is not delivering. Their economy is weak; their currency is weak; people leaving the country. Don't underestimate President Trump's determination to follow through. I'm just telling you. I can't speak for the Communist Party in China. I can speak for our President. Do not underestimate his determination to change trading practices on a fair, reciprocal plane."

Ferro: "One thing you can definitely speak to, Larry, is the strategy of the President. It just seems to me the strategy of the administration at the moment is to exert maximum pain on the Chinese economy. Is that the direction of travel for you guys, Larry?"

Kudlow: "I would maybe rephrase it a bit. I think what we're saying is we are serious. And in trade, as you well know, your guests know, negotiations often include the use of tariffs. And the President has said time and time again that targeted tariffs are going to be part of the game plan with China - unless and until they begin to meet our requests, which so far they have not. In fact, in the recent month or so we've had hardly any conversations with them at all. There is some hint now that they may wish to talk, although I can't say that with certainty."

The Shanghai Composite sank another 4.6% this week, increasing y-t-d losses to 17.1%. Meanwhile, the S&P500 gained 0.6%, boosting the S&P500's 2018 return to 7.4%. As a large net importer, the U.S. is seemingly less economically sensitive to a trade war than the Chinese economy. U.S. equities have become immune to trade threats. Announcements that would have previously rattled stocks no longer carry much of a punch. As the market sees it, the administration may bluster, but they surely won't risk jeopardizing the great bull market - especially leading up to the midterms.

As Mr. Kudlow stated rather unequivocally, the administration believes it has a very strong hand to play, while China's hand is feeble - and turning only feebler. They have somewhat of a point. The U.S. economy is booming, and our securities markets remain resilient. Meanwhile, cracks in the Chinese Bubble seem to widen by the week. Beijing is feeling the heat. Yet I see important shortcomings in the administration's analysis.

First, I'll be surprised if hardball tactics work on Beijing. For one, the Chinese recognize Trump administration issues go way beyond unfair trade. Negotiations on trade are but the first salvo - so Beijing must be tough and show unflappable resolve. As they see it, give in now and they'll face an unrelenting Washington power play. Display weakness on trade and the Americans would be emboldened to confront Beijing on the South China Sea or Taiwan. Chinese leadership sees the U.S. as trying to contain China's ascent to their rightful place of global power, influence and prestige.

I also believe the Trump administration is overstating the strength of the hand it's playing. The U.S. economic boom has attained significant momentum. Animal spirits are running hot and there remains a potent inflationary bias throughout the asset markets. But I would argue that the U.S. is today much more exposed to a shift in the global financial backdrop than is appreciated in Washington or by the markets. In my view, the unfolding trade war with China poses a clear and present threat to global finance.

The U.S. boom is built on a foundation of loose finance. Finance has meaningfully tightened globally. I'll reiterate my view that the global Bubble has been pierced at the "periphery" - more specifically, within the emerging markets. There are now serious fissures in China's Bubble, a circumstance exacerbated both by EM fragilities and rising U.S. trade tensions.

In this incipient faltering global Bubble phase, instability at the "periphery" has so far engendered somewhat looser financial conditions in "core" markets. U.S. Treasury yields turned sharply lower following the May EM eruption, reversing what had the potential to evolve into tightened financial conditions. Lower market yields, along with looser conditions more generally, incited a rally and powerful short squeeze in U.S. equities.

A critical question going forward: How will evolving conditions at the global Bubble's "periphery" impact the "core"? Recently, some stabilization at the "periphery" has seen waning safe haven Treasury demand. Treasury yields were back above 3.0% this week, before Friday's rally saw yields decline to 2.95%.

Markets remain at this point comfortable that stress at the "periphery" will continue to bolster the "core." This has been, after all, the case in recent years. After beginning 2016 at 2.27%, China and EM instabilities were behind a drop in Treasury yields through mid-year (as low as 1.36%). After a relatively brief pullback early in the year, U.S. equities disregarded global issues as they rallied for much of 2016. Importantly, loose U.S. financial conditions only loosened further, as global Bubble vulnerabilities had the FOMC sitting on its hands for a year between their initial and second "baby step" rate increases.

There remains a prevalent market view that unfolding global instability will have the Fed winding down "normalization" long before rate increases turn restrictive for the booming U.S. economy and securities markets. Besides, any unfolding bout of global risk aversion would ensure booming international flows into U.S. dollar securities markets.

Extended periods of loose finance deeply alter market perceptions, dynamics and structure. Years of QE market liquidity backstops fundamentally changed the way market participants view risk. There is today little concern for trouble at the "periphery" gravitating to the "core." After all, the U.S. has been the primary beneficiary during repeated episodes of risk aversion and outflows from China, EM or even periphery Europe, for that matter.

Indeed, markets have been conditioned to view instability at the "periphery" as an opportunity. It's now been a decade since tumult afflicted the "core." Long forgotten is the traditional dynamic where risk aversion at the "periphery" commences a process of de-risking and de-leveraging - with expanding market illiquidity and contagion. This old market problem was seemingly nullified by activist central bankers.

Well, I believe the current backdrop creates extraordinary risk for a (surprising) reemergence of "Periphery to Core Crisis Dynamics". It's my view that massive global QE measures have for years been responsible for nipping de-risking/de-leveraging dynamics in the bud. The overabundance of cheap global finance ensured a surfeit of market liquidity that would readily accommodate incipient de-risking/de-leveraging at the "periphery." In short, a global "system" awash in "money" ensured de-leveraging dynamics never attained momentum. Contagion risk stopped being an issue - quite a boon for global leveraged speculation. Moreover, even the mildest "risk off" dynamic at the "periphery" would ensure waves of inbound liquidity for the "core." Latent fragilities at the "periphery" were kept under wraps, as global central bankers dragged their heels when contemplating the start of policy normalization.

An analyst on Bloomberg Television made the important point that global QE is today in the neighborhood of $25 billion monthly, down from $125 billion one year ago. Global QE will likely turn negative by year-end. This, I believe, significantly increases the likelihood of an unanticipated return of a destabilizing global contagion dynamic. Rather than instability at the "periphery" doing its usual handiwork to buoy Bubbles at the "core," de-risking/de-leveraging dynamics increasingly have the potential to attain sufficient momentum to negatively impact the "core."

The global liquidity backdrop is in the process of profound - if not yet obviously discernable - change. EM is increasingly vulnerable to a destabilizing bout of de-leveraging in a world of waning liquidity. Thus far, the faltering EM Bubble has incited flows to U.S. Bubble markets.

However, an escalation of the unfolding EM crisis is at heightened risk of inciting a very problematic global de-leveraging - a "risk off" backdrop that would risk piercing vulnerable Bubbles even at the "core." The consensus bullish view - holding EM as a buying opportunity and the U.S. as the mighty pillar of growth and stability - could prove dangerously complacent.

I believe there are great latent fragilities associated with the "Periphery to Core Crisis Dynamic." Distorted markets have over years been conditioned to disregard such risk. I'll presume the administration is simply oblivious, believing it's deftly playing a hand of robust U.S. financial and economic systems. With such a competitive advantage, in their minds there's never been a better opportunity to play hardball and put Beijing in its place.

It's worth noting that 10-year Treasury yields declined four bps Friday. The Japanese yen (up 0.37%) also enjoyed a safe haven bid. Treasuries and the yen seemed to take a different view of developments than U.S. equities.

Friday afternoon Bloomberg headline: "Tit-For-Tat Becomes the Norm as U.S., China Dig In for Trade War." The odds are not small that this Game of Chicken goes unresolved for a while. Clearly, it would be uncharacteristic of President Trump to back down. At the same time, President Xi has shown zero tolerance for any sign of weakness. Increasingly, Beijing is being very publicly backed into a corner (Bloomberg headline: "U.S.'s Kudlow Trash Talks China Calling It 'Lousy Investment'"). Difficult to see China responding cordially.

"Trash Talking" China a few hours after the PBOC is compelled to intervene to bolster the flagging renminbi leaves me uncomfortable. There's a problematic scenario that doesn't seem all that improbable at this point: China faces increased financial instability, including capital flight and de-risking/de-leveraging. The PBOC becomes trapped in the dreadful EM dynamic of bolstering system liquidity in the face of mounting risk of a full-fledged currency crisis. Global markets fret the imposition of Chinese capital controls.

Meanwhile, China instability and trade fears see EM markets take another leg lower, with particular market concern for the highly levered Asian economies. De-risking/de-leveraging dynamics attain self-reinforcing momentum, as contagion effects engulf the global "periphery." Fears of global financial fragility and economic vulnerability see risk aversion begin to gravitate toward the "core." Fears of EM central bank and Chinese selling of U.S. Treasuries overwhelm safe haven buying, as de-risking/de-leveraging dynamics see a widening of Credit spreads and illiquidity begin to impact "core" fixed-income markets.

In such a problematic global scenario, I ponder whether Beijing might perceive it's playing with a relatively stronger hand than their U.S. adversary. Meanwhile, contagion effects would set their sights on the "periphery of the core." It just doesn't seem all that far-fetched.

It's worth noting that Italian yields jumped another 18 bps points this week to 2.93% (Greek yields up 25 bps). And while the Bank of Japan sought to comfort markets with "easy forever," the badly-distorted Japanese bond market is indicating instability. Mainly, it's a problematic market and geopolitical backdrop pointing increasingly to "Periphery to Core Crisis Dynamics." China, EM and the world are now just a disorderly collapse of the renminbi away from, in the words of Mr. Kudlow, "a heap of trouble."


Japan still has great influence on global financial markets

Though its economic heft has declined, its surplus savings are felt around the world

IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

European banks still have post-crisis repairs to do

Former US policymakers say their counterparts did not do enough to stop the rot

Gillian Tett

Ben Bernanke, Timothy Geithner and Henry Paulson © Getty

It is not easy to make a financial crisis sound boring. This week Ben Bernanke, Henry Paulson and Timothy Geithner almost did that. With the 10-year anniversary of the Lehman Brothers collapse approaching, the three luminaries — who were respectively US Federal Reserve chairman, Treasury secretary and New York Federal Reserve president in 2008 — have been talking to the media about the crisis. And their verdict is sanguine — if not a little smug.

More notably, a decade on, the trio believe that US finance has rebounded so well that it is in rude health. And they think that this happy outcome largely vindicates their policy response after the crisis, including their decisions to recapitalise aggressively the banks with government funds, reveal bad loans, impose tougher oversight — and implement quantitative easing quickly.

To be sure, the three men admit that policy has not been perfect. They fret that Congress has undercut the statutory powers used to quell the 2008 shock. “The defences are better but you have a weaker set of tools for dealing with an extreme crisis,” observed Mr Geithner. They also worry about the rising American government debt, and what might happen if there is a rollback of post-crisis reforms.

American banks now seem healthy. The US has enjoyed nine years of growth — and its government recouped the money used to support banks, with a profit, they say. The post-crisis policy performance probably does not merit an A+, but an A or thereabouts.

Not all Americans would agree. Leftwing observers are understandably angry that so few financiers were ever punished. Critics on the right complain that markets have been hopelessly distorted by government meddling. Meanwhile bodies such as the Bank for International Settlements fear that higher rates will create problems in the corporate leverage sector, and note that derivatives sector remains too opaque. All these points need more debate.

But the most interesting (and urgent) debate that needs to take place in response to what Mr Bernanke and the others have to say does not concern the US at all. The trio also revealed this week that they are surprised and dismayed by the degree to which Europe’s financial system remains troubled a decade on.

That is not because they predict an imminent crisis — they refused to comment on current flashpoints, such as small Italian lenders or the giant Deutsche Bank. But they worry that the system remains rather weak and think they know why: unlike their American counterparts, continental European leaders did not proactively use government funds to recapitalise their banks, insist on proper transparency about bad loans or close down insolvent lenders.

Accounting systems were partly to blame. “In the early days of the crisis the European banks were in worse shape than the US banks and they hid it because . . . the US bank accounting is much more rigorous,” Mr Paulson observed. The trio also argue that European politicians and voters were so keen to punish banks that it was hard to use government money.

But the biggest problem was political structure. In 2008 Messrs Bernanke, Paulson and Geithner had enough power as a unified team to explore policy trade-offs and implement unpopular decisions. But because the eurozone political system is so fragmented, policymakers never took the swift and aggressive collective action that was needed to stop the rot.

“We were very lucky,” Mr Geithner observed. “Some of those options [we used] were not available to Europeans because running a strategy among [so many] national sovereigns is hard.” Mr Paulson added: “[The Europeans] kidded themselves about how well capitalised their banks were for a long time. I do believe that they have been slower to do the things they need to do.”

This stinging, slightly smug, verdict might irritate many Europeans, given the American origins of the 2008 disaster. But that should not distract attention from the key point: the criticism is entirely correct. Just look at European bank share prices. Or consider how the BIS describes in its latest annual report the way that European banks are using the dollar repurchase market to engage in “window dressing” to flatter their accounts.

Ask yourself a simple question: if Europe was fielding a 10-year anniversary policy debate, what trio or team would it put up? European Central Bank president Mario Draghi , for sure.

But then who? Therein lies the tragedy of Europe’s political economy, and why investors need to keep worrying about European banks a decade later.

Can Anything Stop Cyber Attacks?

The recent indictment of 12 Russian intelligence officers by the Justice Department for interfering in the 2016 U.S. presidential election underscores the severity and immense reach of cyber attacks, like no other in history. To influence the election’s outcome, authorities said these agents hacked into the computer networks of the Democratic Party to get information, and strategically released it on the internet. In the private sector, companies have to step up their game against cyber attacks that are becoming all too common.

Against that backdrop, fighting cyber threats has never been more important. It is the “greatest terror on the economy, bar none,” but policy makers’ response to it has been moving at a snail’s pace, according to high-ranking cyber-security and risk management experts who spoke at a panel discussion on cyber risks at the Penn Wharton Budget Model’s first Spring Policy Forum, which was held last month in Washington. Experts called for greater awareness of cyber threats at all levels, an inclusive approach to protect all parties affected, and steps to “harden our defenses to make the cost too high for the payoff to carry out these cyber attacks.”

Russia is at the top of the list of sophisticated cyber adversaries faced by the U.S., a group that also includes Iran, China and North Korea, according to Matthew Olsen, co-founder and president of IronNet Cybersecurity and former director of The National Counterterrorism Center. “Russia has made information conflict a critical and central pillar of its national security strategy,” he said. “Cyber is a means of carrying out their geopolitical strategy.” And Olsen believes such political meddling will continue. There is “every reason” for Russia to interfere in the 2018 and 2020 elections as well, he warned, and “with even more fervor and more effort.” 
A Frictionless Weapons System

Any complacency over cyber attacks is dangerous, warned Ira (Gus) Hunt, managing director and cyber strategy lead at Accenture Federal Services and former chief technology officer at the CIA. “Despite the increasing of pace of attacks, we actually have, through technology, [ways of] stopping more and more of these attacks,” he said, pointing to recent studies by Accenture and by Verizon and others. In terms of cyber losses, “it has actually been a pretty steady state in the last two to three years across the board,” Hunt added. “But I look at this with great suspicion.”

In fact, “we are exhibiting the classic signs of insanity,” added Hunt. “We are like the little boy with his finger in the dike,” referring to the folk tale of a Dutch boy who stayed up all night to plug a leak and save his country, until the adults woke up the next morning and got it repaired. “Things are about to get much, much, much worse, and it’s going to happen very, very quickly, and very, very suddenly.” This is driven by the proliferation of devices that people use, and because of that, “the threat surface is going to expand by some three to five orders of magnitude,” he added.
According to Hunt, “cyber is the most difficult threat environment the world has ever seen … and as a weapons system, it is unlike anything previous[ly] in history.” He said “the velocity of innovation around cyber itself is unparalleled,” pointing to one study that found that more malware is released in a month than all the legitimate code in a year. “It’s highly asymmetric,” he continued. “We’re at the point now with cyber that not just nation-states but single individuals can wreak massive havoc by marshaling all of the available resources they can find on the dark web and pointing it at something, and turning it loose to attack things.”

The “scariest” aspect of cyber threats is that they are “frictionless,” said Hunt. “Cyber is the world’s first frictionless weapons system. The moment [they are] released and discovered in the wild, everybody’s knowledge is suddenly elevated and [they] turn around and come back at us in different ways.” For example, he said, days after German magazine Der Spiegel revealed the use of the Stuxnet computer worm in attacking Iran’s nuclear program, variants of it developed and spread — and then were used to attack U.S.-based systems like SCADA, a data tool for critical infrastructure and automated factories. “It’s the tip of the iceberg, not the bottom of it,” Hunt warned.

Tim Murphy, president of Thomson Reuters Special Services and former FBI deputy director, shared his own encounter, in 2008. “I’m sitting at my desk in the FBI, and I’m the number three in the FBI and I am attacked by a state sponsor — in the building — on my unclassified network,” he said. “If that doesn’t cause you to be scared and take action, not only in the organization, but give you a greater outlook on how big the problem was and is, [nothing will]. That was 10 years ago so you can understand the scope of it today.”

More Vigilant Americans

Even as those scary scenarios loom, one reason for optimism is that “we are slowly but surely seeing an awakening of vigilance by the American people about this threat,” said Daniel Kroese, senior advisor, National Protection and Programs Directorate in the U.S. Department of Homeland Security. The first major wakeup call for ordinary Americans was the data breach at health insurer Anthem in 2015 involving some 80,000 medical records, he said. Around that time, another massive breach was underway at the U.S. Office of Personnel Management, showing that “even some of the most sensitive government records were not immune to these threats,” he added. Subsequent major attacks include WannaCry and NotPetya ransom ware, the Uber breach that hit 57 million accounts in 2016, and the 2017 Equifax breach of nearly 150 million.
Murphy said people don’t take cyber threats as seriously as they should. “I want people to be scared, I want the government to be scared, and I want the private sector to be scared, because I don’t think we are scared enough,” he said. “And by scared I don’t mean fearful; I mean scared into taking some action.” He added that the response to these threats must be improved. “This works at network speed, at code speed, and we’re working at human speed to solve this problem,” he said, noting that the FBI didn’t have a cyber division until 2003, two years after 9/11.

Olsen saw the U.S. response to Russian attacks as underwhelming, and also raising troubling questions. “How seriously have we taken that threat? What has Congress done? What has the administration done? What have companies done to defend ourselves better? What pain did we inflict on Russia for the attack on our election? How do we even think about an attack on the fundamental pillar of our democracy when it’s carried out by a nation state? How do we think about it from a doctrinal standpoint?”
“We need a holistic view and we need it now,” said former FBI deputy director Murphy. The U.S. needs “that holistic view on what is happening with intrusions into anything that touches the supply chain of our electoral process, and on what is happening with the influence, which also plays a major role in our next election.”

Securing the Digital Borders

David Lawrence, founder and chief collaborative officer of the Risk Assistance Network + Exchange (RANE) and former Goldman Sachs associate general counsel, said the “overarching theme” of the 9/11 Commission and the findings from the 2008 financial crisis are helpful pointers in tackling cyber threats. “Those events were less a failure of intelligence and of information than of imagination, connecting the dots in advance,” he said.
Lawrence said that “because cyber is about technology, it becomes an overly complex puzzle” and intimidates people with its language and science. “The [cyber] crimes we are witnessing are of biblical proportions. They are theft and fraud and espionage and various [means] of sabotage and extortion and blackmail. The actors are precisely the same people who always meant us harm. Criminals and organized crime groups, terrorists, various hostile states and state sponsored groups.” Paraphrasing President Trump’s remark that “Without borders there is no country,” he said that “without digital borders there is no financial security or protection for our national economy.”

Those that have sufficient resources, such as large and wealthy organizations, do a good job of making the requisite investments to protect themselves from cyber threats, said Accenture’s Hunt. But firms or groups with fewer resources will continue to struggle. “We have this new digital divide, and I call it cyber haves or have-nots, and other people have spoken about a cyber poverty line,” he said. What makes matters worse is a “critical shortage” of cyber personnel, which in turn drives up costs further, he added.

Even with large organizations, Hunt said cyber attacks could creep into their systems through a vendor that may be small and without the security infrastructure to deal with these nefarious actions. For example, the massive breach of Target four years ago was traced to its heating and air conditioning services contractor. “When we have this massively interconnected world, we’ve got to think of an approach that can lift all boats,” he said. Hunt noted that the Defense Logistics Agency (DLA) does business with 60,000 small firms. “Each one of these potentially puts us at risk from a national security perspective, just from that DLA engagement alone.”
The seriousness of the situation is made clearer when one considers how little it costs hackers to unleash such massive disruptions. “You have actors who can spend very little money, scale their resources very effectively, and have an asymmetrical destructive impact while using our own technology,” said Lawrence. “This is the greatest tax on the national economy bar none, and it’s the greatest terror on our economy, bar none.” Olsen said that while there are various estimates of the cost of a data breach, a Verizon study puts the average cost of a breach at between $5 million and $15.6 million in “a mammoth breach.” But that doesn’t include litigation costs and the hit to a company’s reputation. Hunt said cyber crimes have cost the U.S. 0.7% or 0.8% of GDP for the last three or four years.

But some costs are just so high it is impossible to put a price on them. “What’s the cost of undermining your democracy, or stealing your intellectual property in the billions?” Murphy asked. “The cost is much bigger. It’s the way of life here in the U.S.”

A Leadership Vacuum?

Lawrence wanted to know what might provide the crucial trigger for legislative action. “Is it going to take a crisis?” he asked. “Or can we begin to apply what has worked in the past to deter enemies of the country, criminals, organized crime groups in these activities, and begin to have a unified response that will protect all?”

An effective, national response to cyber threats has to take shape in public policy. Murphy wondered as to what might provide the impetus to achieve that goal. “Maybe it takes one of those major events,” he said. “What we’re advocating is, let’s get ahead of it.” He referenced a Knowledge@Wharton opinion piece by Lawrence and SEC chairman Jay Clayton, where they call for the creation of a “9-11-type Cyber Threat Commission.” Murphy pointed out that the public policy response to cyber threats has been slow. “[Cyber crime] is at net speed and we’re moving at policy speed and debate speed. We have to move faster, that is the call.”

Lawrence added that “it is not about the people and resources that are now focused, but it is about our approaches to risk management.” Further, “we’re at the pre-9/11 moment, or the pre-financial crisis moment, where many people are looking and seeing things, and watching with increasing concern, but the centralized leadership is yet to be there,” he said. “Something more is owed to the American people. We have yet to have ownership of this issue, and we have yet to have fully [transparent reporting]. It is episodic to episodic.”
One issue is that members of Congress might not be knowledgeable enough about cyber issues. Homeland Security’s Kroese said while more work needs to be done, “there is very good coordination and cooperation between the executive branch and between the legislative branches on things that happen underneath the surface.” Members of Congress attend more briefings on the subject these days, and visit DHS offices to get more acquainted with the cyber issues, he added. In some cases, cyber issues also get bipartisan support, he noted. In sum, he saw a “reinforcement and redoubling [of their efforts in] understanding the nuance of these issues.”

Lessons from Counterterrorism

The response to the terrorism threat in the U.S., especially after the 9/11 attacks, hold useful lessons in how the country could prepare for cyber threats. “One is that it’s a team effort,” said Olsen, recalling his previous role as the director of The National Counterterrorism Center. “We learned that the hard way. [9/11 showed that] we weren’t, as a government, well-coordinated in sharing information. We need to do better to share information and work the private sector with the public sector … more effectively.”

Second, “we need to address the lack of people, the lack of expertise,” said Olsen. “We did that with expertise around counterterrorism. But there are hundreds of thousands of unfilled cyber security jobs in this country. [Third], we need to harden our defenses. We’ve hardened our terrorism defenses. We’ve all experienced what it’s like to get on an airplane — that’s the way in which we’ve hardened the aviation sector from a terrorist attack. But we haven’t done enough to harden our networks and our data.” While technological resources exist, the problem is bigger as it involves people, processes, and the policies that need to be modified. “We need to harden our defenses to make the cost too high for the payoff to carry out these cyber attacks,” he said.

But Olsen also pointed to one critical difference between counterterrorism and cyber security that make security in the latter harder to achieve: Much of what is need to be done in cyber security lies in the hands of the private sector, and 98% of the critical infrastructure of this country is in the hands of the private sector, leaving a smaller role for the government, he said.

Meanwhile, lawmakers are taking cyber security more seriously than ever before. The number of hearings on cyber-related issues has risen from one a month to six or seven a week, Kroese said. “Almost every authorizing and appropriating committee now wants to find a way to engage in cyber, really understanding and making sure that we are engaging with a nuanced view of what those lanes are to ensure that the legislation that comes out is smarter.”

Michael Pento: How The Trade War Will Hurt The US — And The World

Excerpted from Michael Pento’s Pento Portfolio Strategies 

China appears to have more to lose from a trade war with the US simply because the math behind surpluses and deficits renders the Bubble Blowers in Beijing at a big disadvantage. When you get right down to the nuclear option in a trade war, Trump could impose tariffs on all the $505 billion worth of Chinese goods exports while Premier Xi can only impose a duty on $129 billion of US goods. However, this doesn’t mean China completely runs out of ammunition. 
The Chinese could seek to devalue the yuan once again, as the nation did during August of 2015. 
Chinese yuan trade war
This would partially offset the effect from the 25% tariffs placed on its exports; however, it would exacerbate the distress on Emerging Market (EM) dollar loans, which total over $11 trillion. After all, if EM countries allowed their currencies to appreciate greatly against the yuan, their exports would become uncompetitive.  
Therefore, in order to maintain a healthy trade balance with China, these nations would have to devalue alongside the yuan. 
China could also dump $1.2 trillion of US Treasury holdings. The timing for this would hurt the US particularly hard because deficits in the US are already over $1 trillion in fiscal 2019 that begins in October. When you add in the Fed’s reverse Quantitative Easing (QE) plan of selling $600 billion worth of Mortgage Backed Securities (MBS) and Treasures, and you have a condition that could overwhelm the private sector’s demand for debt. Of course, a trade war with China also means there will be less of a trade surplus to recycle back into US debt. And if the incipient trade war caused a recession in the US, deficits would soar much further than the already daunting $1 trillion level. 
When you combine the baseline fiscal 2019 deficit of $1 trillion and $600 billion of Quantitative Tightening (QT) with a potential Chinese dumping of $1.2 trillion worth of Treasury reserves, and hundreds of billions of increased deficits arising from the reduced revenue from a recession, the potential for an annual deluge of debt that needs to be absorbed by the public in the next fiscal year could approach $4 trillion dollars! 

If you’re looking for the pony behind the dung pile you could say the yield curve perhaps would not invert in this scenario as quickly as it is now-maybe-but the spread between the 2-10 Year Note has collapsed from 265 (basis points) bps in 2014 to just 27 bps today. Hence, the next 25bp rate hike from the Fed in September could be enough to flatten out the curve completely. Nevertheless, the resulting yield shock would be much worse than your typical inversion because runaway long-term bond yields are the last thing the massively overvalued equity market, which sits on top of record debt levels, can endure. 
In other words, this upcoming tsunami of debt issuance would equate to a giant black hole that would suck all available investment capital from the private sector and send it towards the wasteful arms of government. This would virtually guarantee a sharp slowdown in productivity and GDP growth. In truth, a productivity slowdown is something the US economy cannot afford because Non-farm Productivity increased by a paltry 0.4% annual rate in Q1.  
Since GDP is the sum of labor force + productivity growth, a further slowdown in productivity from here would be extremely recessionary, especially given the slowdown in US immigration and fecundity rates.    
The major takeaway here is that China has more bullets in the chamber other than just putting a tariff on all US exports. And even though China has more to lose on face value, an all-out trade war is an extremely negative sum game for all parties involved.  
The resulting global recession, which is already approaching due to the impending removal of central banks’ bid for inflated asset prices on a net basis, is becoming expedited and exacerbated by the Trade war. Debt-fueled Tax cuts have greatly boosted earnings growth on a one-time basis. And this has been completely priced in by the Wall Street carnival barkers. However, global trade war and the bursting of the bond bubble–with its effect on record debt and asset prices–will more than offset tax cuts in the coming quarters. All that is left now is the panicked hunt for bids as the greatest financial bubble in history unwinds.

Iranians Hoard Gold Ahead of U.S. Sanctions

Gold prices in the country soar as precious metal becomes protection against a weakening currency and the impact of sanctions

By Asa Fitch in Dubai and Aresu Eqbali in Tehran 

Iranians are hoarding gold as a safeguard against a collapsing local currency and soaring cost of living as the U.S. is poised to impose economic sanctions on Iran, pushing the metal’s price to record highs in Tehran.

On Monday at midnight U.S. Eastern time, the Trump administration is set to bring back a first wave of restrictions that had been waived under the Iran nuclear deal, an Obama-era agreement that gave Iran sanctions relief in exchange for curbs on its nuclear program.

President Trump exited that multilateral deal in May, saying it didn’t address Iran’s military posture in Syria, Lebanon and other Middle Eastern countries. The new sanctions limit dealings in Iran’s currency and with its automotive industry. They also threaten U.S. penalties for banks that finance the precious-metals trade with Iran and against anyone who sells precious metals to the Iranian government.

Worried about a shaky economy and enticed by government sales of gold coins, Iranians have converted savings into gold recently even as prices skyrocketed. Demand for gold bars and coins in Iran tripled year-over-year in the second quarter to about 15 metric tons, according to a World Gold Council report on Thursday. Iran’s central bank has minted hundreds of thousands of new coins—more than 60 tons of gold in total—to feed the demand. The move has had little impact beyond stoking more demand for the metal.

“People are changing their money into gold because it’s a reliable investment commodity,” said Mohammad Kashtiaray, the head of gold and jewelry committee under Iran’s Chamber of Guilds, a coalition of merchants.

Inflation and unemployment are both in double digits this year, and the economy is expected to shrink next year as sanctions bite. More alarmingly, Iran’s currency, the rial, has seen a record weakening this year—currently trading at roughly 101,000 per U.S. dollar compared with about 43,000 in January, according to Bonbast, a site that tracks unofficial exchange rates.

A second round of U.S. sanctions in November is expected to target Iran’s oil and shipping industries. American pressure on Asian customers has already led to a reduction of crude sales that account for a large chunk of Iran’s economy. 
The economic malaise has stirred popular discontent with Iran’s leadership. In December, the widest demonstrations in almost a decade broke out. More angry crowds have taken to the streets in the past week in the largest spate of unrest since January, sometimes clashing with security forces and chanting for the downfall of the regime as sanctions go back in place. One person was killed and 20 people were arrested Friday during protests in Karaj west of Tehran, according to the semiofficial Fars news agency. 

For Iranians, giving gold coins as gifts during holidays and New Year’s celebrations and buying gold jewelry—the more elaborate the better—during weddings is part of tradition. But the recent surge in prices far outruns inherent demand.

People have lined up outside banks this year to place advance orders for Emami coins in central bank auctions, where they are often priced at lower-than-market rates.

The price of an Emami, a central bank-minted gold coin weighing 8.13 grams, stood at around 36 million rials on Sunday, more than double its price in January. It had hit a record of more than 45 million rials a week ago. The demand for gold in Iran is also bucking a shaky picture globally; spot gold prices have fallen by about 6% this year to about $1,200 an ounce.

Tehran’s gold sellers, however, haven’t benefited much from the demand, which has been primarily for coins, shop owners said.

Amir Dehghan, a gold-shop owner in Tehran, said he wasn’t seeing many buyers, and he was reluctant to sell, because high prices would make restocking that much more expensive.

“If I sell a good amount today—40 grams—I’m worried about how I’ll replace it because of prices, not because of a shortage,” he said.

Demand for jewelry in Iran fell 36% year-over-year in the second quarter to the lowest level the World Gold Council has ever measured, partly due to a 9% value-added tax but also because of the priority Iranians were placing on investment over adornment.

With prices near record highs, many people said they were buying only because they had to. A computer engineer who identified himself as Mr. Bani, said he was shopping for a set of bridal jewelry. 

“It’s what you have to do,” he said. “I’m buying now because I should, but otherwise it’s not a good time.” 
A paucity of other safe investment options in a relatively isolated economy with an underdeveloped financial system gave gold a further boost when fear reigned, according to Alistair Hewitt, the World Gold Council’s head of market intelligence.

“The access to dollars isn’t there to the same extent [as elsewhere],” Mr. Hewitt said. “So gold is one of the only alternatives they can get exposure to.”

In recent months, Iranian authorities have tried to put the brakes on gold prices, part of a package of moves they hoped would also stem the weakness of the currency—so far with little success. This week, the central bank is expected to unveil new measures to right the economy, although it isn’t clear what they are.

Late last year, the central bank restarted auctions of Emami coins in an effort to keep prices steady and to divert Iranians’ cash away from foreign-currency investments that were weakening the rial.

Demand for gold has been so resilient that prices are outpacing even the rial’s historic depreciation against the dollar. After factoring out fluctuations in the rial, the price of an Emami coin went from $346 in January to $379 today, a 9.5% rise.

In recent months, authorities are turning their focus to prosecuting people who allegedly are hoarding coins in an effort to keep prices high. In July, police arrested a 58-year-old man, dubbed the “King of Coin” in local media, who allegedly obtained about two tons of central bank coins with the help of numerous accomplices, intending to make money by selling the coins slowly as prices went up.

Marin Katusa On The Coming Junior Gold Miner “Buying Binge”

Resource stock analyst and money manager Marin Katusa just sent out a blast email that explains — via some extraordinary charts — why large miners will soon start snapping up the best junior gold miners for big premiums over current prices. Here’s the whole thing:
The Most Important Charts for Your Gold Stocks Right Now
This past week I was invited to be a keynote speaker at Rick Rule’s Sprott Natural Resource Symposium. 
And every year, gold is a key topic on everyone’s mind. 
Let me remind you of a very old saying… 
Gold is the Currency of Kings 
Silver is the Currency of Gentlemen 
Barter is the Currency of Peasants 
Debt is the Currency of Slaves 
In the long run, I’m very bullish on gold. But like all commodities, gold is very cyclical. 
I’ve written big checks and made big buy orders on assets that I believe are very cheap and well-priced in today’s currency commodity markets. 
These are the types of companies I want to own. Why? Because I believe a major will want it in its portfolio in a few years. And all for reasons, I’ll explain further down in this missive. 
Is the Commodity Bear Market Over? 
It’s no secret that we’ve been in a commodities bear market for the better part of this decade. But just because the commodity bear has gone on for a long period of time, doesn’t mean that it’s over. 
Far from it. 
These bear markets can last for much longer than a speculator can remain solvent. As you’ll see in the table below, the current loss is right near the average loss for recorded bear markets. 
gold bear market junior gold miners
But when the market turns around (and it will) as shown in the next table, the average gains across commodities become astonishing. 
gold bull markets junior gold miners
And any investor or speculator that’s been around the resource markets for a couple of years knows the famous line – but wait, there’s more. The share price of individual commodity stocks are highly leveraged to the price of the underlying commodity. And this causes the share price of the commodity stocks to soar many times higher. It’s where you see spectacular gains of 500%, 1000% and even 10,000%. 
To ride out any long downturn, I put all the companies that I hold through extensive stress tests. I do this to determine which will survive in a worst-case scenario. You need to do the same. 
But you can make a tidy fortune in a Bust and even the Echo that follows. This is the period of time where stock and commodity prices are flatlining and only the best stories can make you multiples on your investment. 
In the chart below, you could say that the gold price has been in an Echo phase since 2016… 
gold price echo junior gold miners
This is How You Make Money in Today’s Stage of the Commodity Cycle 
At this point, there isn’t crazy interest in commodities. But this is good because it allows you to pick up great assets for even greater prices. 
When there is interest in commodities, it’s speculators and investors that will bid up stock prices to crazy valuations (like blockchain, cobalt and marijuana booms that happened more recently). 
But when there’s little buying interest from the crowd, there will always be interest from another buyer – a larger company looking to increase their portfolio of projects. 
What’s bad for gold miners could be very good for gold stock investors for the next few years. Simply, gold miners are running out of gold and they need to replenish their reserves. 
They’ll do this by looking for gold in the markets. They’ll go on a buying binge to take out junior gold miners with proven reserves. 
Why? In the chart below, you’ll see that it’s expensive for some large gold companies to replace their gold production. 
gold reserves replacement cost junior gold miners
One of the things any business needs to know is its cost of acquisition. 
How much does it cost a restaurant to get someone in the door? How much does it cost an accountant to gain a new client?
In the chart below, you’ll see what the real cost is for majors to buy gold. 
gold reserves acquisition cost junior gold miners
On average, it takes $113 for these majors to secure an ounce of gold. 
Gold majors also need to know what is the exploration cost per ounce discovered. In the chart below you’ll see what this cost is for many of the large gold companies. 
gold exploration cost junior gold miners
And in 2018, it’s estimated nearly $4 billion is being spent on exploring for gold… 
gold miner exploration budgets junior gold miners
You can see that more money is spent on exploration near the peak of gold bull markets (like the recent one around 2011). But exploration budgets are proving steady in this Echo phase. 
Gold Companies Raised Billions – Where are the Dollars Going? 
Almost $10 Billion dollars of exploration has been spent in the last 24 months without a new major gold discovery. Compare this to 1990 when almost 100 Million ounces of gold was discovered with less than $2B in exploration. 
So, have geologists and exploration teams become more useless over the last 30 years, or perhaps is the “easy” gold found? 
There are no two ways about it. The chart below paints a bleak picture. It shows that annual gold discoveries are decreasing… 
major gold discoveries junior gold miners
Now, we can overlap the charts to really see the effects of the money spent and how much gold has been discovered… 
gold exploration vs discovery junior gold miners
It’s no wonder shareholders of many gold stocks are pissed off. Management teams are not finding new deposits. Is it that their luck is just off? Or are the geologists terrible at their jobs? I don’t think that’s true for most companies (but definitely for some). 
In the chart below, you’ll see that gold discoveries greater than 2 million ounces (i.e. enough to make a big splash) are becoming increasingly rare… 
major gold discoveries junior gold miners
The Gold Price and Effect on the Bottom Line of Gold Majors 
The decline in the price of gold (now hovering around $1225) means less revenue for gold companies. 
It also means they’ll have less money to spend on project development and exploration. 
Since 2012, we have seen the exploration budget for the major gold companies decrease from nearly $4 billion down to $2.2 billion currently. The chart of annual exploration budgets for the majors is shown below. 
gold exploration budgets junior gold miners
Major gold companies need to beef up their reserves by purchasing the best projects owned by smaller gold companies. But those projects need to move the needle for a major. 
Small projects need not apply. Shareholders will demand growth and they need to listen or they’ll start to see their investors look for the nearest exit. 
However, the elephant in the room is the Reserve Life Index. The Reserve Life Index is the expected number of years a company can continue to produce gold given its current gold reserves. It’s a back of the napkin calculation but it’s a reasonable indicator. The average major gold producer’s Reserve Life Index has declined should have at least 8 to 10 years of reserve life. 
The chart below shows the major producers’ reserve life index. The average Major Reserve Life Index has decreased by 40% over the last decade. That is not a good thing. 
gold mine reserve life junior gold miners
At current levels, the average reserve life is 16 years. This may seem like a long time, but it’s not. Consider that it takes on average about 10 years to bring a new mine into production. 
What keeps the majors up at night is the next chart. It shows that the average grade of production of the gold mines has decreased by 31% over the last decade. As you’ll see, both total production and average reserve grade have decreased.
gold production vs reserve grade junior gold miners

This to me is a bigger issue for the majors than the Reserve Life Index. 
Since 2007, the average grade has decreased from 1.97 grams per ton to 1.35 grams per ton. This is a drop of 31%. 
It’s a simple fact that if you have two identical gold mines, one with high-grade ore and one with low-grade ore, the high-grade mine is going to produce more cash Flow. 
As companies run out of high-grade operations, they are forced into building lower grade projects. This makes junior gold miners with high-grade projects that much more valuable.