Seventh-Inning Debt Stretch

By John Mauldin

 TFTF Image


Science tells us energy can neither be created nor destroyed within a closed system. Whatever amount is there will stay the same, though it might change form. If only the same were true for debt.

Within the closed system called Earth, we are much better at creating debt than eliminating it. But when we have too much, we eventually eliminate it in painful and unpleasant ways via some kind of debt crisis. This has happened over and over again throughout history.

Today we’ll look at a new book by Ray Dalio called Principles for Navigating Big Debt Crises in which he examines those debt cycles and what we can do about them. I read it on my recent trip to Frankfurt and I highly recommend you do the same. That link is for Amazon but you can also get a free PDF copy here. I read it on my Kindle so I could highlight and save notes in the cloud for later reference. Worth every penny of the $14.99 I spent.

At a minimum, you should read the first 60 pages, which explain his principles and thoughts. The rest of the book dives deep in the weeds of 48 modern debt crises, sorting them into different types and then analyzing each type. Data wonks will love that part. Ray gives us a brilliant tour de force examination of how debt crises arise and what you can do when one strikes.

At first blush, you will think that Ray is more optimistic than I am about the next debt crisis and an eventual event which I called The Great Reset, which I’ve written about extensively this year. I see The Great Reset as a generation-scarring economic cataclysm. Debt crises, while painful, have a fundamentally different character.

Ray’s book has helped me refine what I mean by The Great Reset. We’ll explore this more in future letters but here is one very important, critical, point:

 It is possible we will have another debt crisis separate from The Great Reset I envision. Indeed, it may be quite likely.

In one sense, what we called the “Great Recession” was just another garden-variety credit cycle. Unlike the Great Depression, so far it doesn’t seem to be changing the behavior of those who went through it. The Great Depression was a soul-searing, generational-impacting event. The events around 2008, bad as they were, had nowhere near that effect.

In fact, we are now many of the things we did in 2006 and 2007—reaching for yield, etc. It is as if we did not learn that the stove was hot. We are loading up on all sorts of unrated and low-rated credit and even leveraged (!!!) loans to juice returns in a low-rate world, telling ourselves “This Time is Different.”

Really, we tell ourselves that. And it never is. Sometimes I sit in awe and amazement at the human capacity for believing Six Impossible Things Before Breakfast. And we do it time and time again, over and over, insanely expecting a different result.

But that is getting ahead of ourselves, so let’s start exploring Ray’s book.

Know Thyself

Before we get into the book, you should know a little about Ray Dalio and the company he founded, Bridgewater Associates. At $150 billion or so under management, it is one of the world’s largest and most successful hedge fund operators. It is also an extremely unusual company.

Dalio decided early in his career, after enduring some painful losses and nearly going bankrupt, to rigorously examine his mistakes. When he was wrong—as all traders sometimes are—he would review his process, identify mistakes and keep a record of them. This helped him avoid making them again.

Eventually he extended this process to his entire company. At Bridgewater, the staff use a computer system to constantly rate each other’s decisions, both small and large. The result is a giant database of who tends to be right and on which subjects they are strong and weak. This affects personnel decisions, work assignments and all sorts of other things. It’s all transparent, too. Everyone at Bridgewater knows everyone else’s business.

 Obviously, not everyone thrives in that environment. But over time, it’s made Bridgewater into what Ray calls an “idea meritocracy.” People who make good decisions get identified and rise to the top.

I tell you all that so you understand Dalio is highly empirical. He doesn’t make guesses without evidence, and you see it in this rigorous historical examination of previous debt crises. It was originally an internal Bridgewater study that informed the firm’s (very successful) trading of the 2008 crisis. The team examined 48 debt crises over the last century to develop an “archetype” or template showing how they unfold.

 Like me (and many others throughout history), Ray recognizes that debt can be good or bad, depending on how it is used. He goes further with an important insight on the way debt is cyclical. He explains it so well I will quote him at length here (emphasis mine).

To put these complicated matters into very simple terms, you create a cycle virtually anytime you borrow money. Buying something you can’t afford [out of your capital or cash—JM] means spending more than you make. You’re not just borrowing from your lender; you are borrowing from your future self. Essentially, you are creating a time in the future in which you will need to spend less than you make so you can pay it back. The pattern of borrowing, spending more than you make, and then having to spend less than you make very quickly resembles a cycle. This is as true for a national economy as it is for an individual. Borrowing money sets a mechanical, predictable series of events into motion.

If you understand the game of Monopoly®, you can pretty well understand how credit cycles work on the level of a whole economy. Early in the game, people have a lot of cash and only a few properties, so it pays to convert your cash into property. As the game progresses and players acquire more and more houses and hotels, more and more cash is needed to pay the rents that are charged when you land on a property that has a lot of them. Some players are forced to sell their property at discounted prices to raise that cash. So early in the game, “property is king” and later in the game, “cash is king.” Those who play the game best understand how to hold the right mix of property and cash as the game progresses.

Now, let’s imagine how this Monopoly® game would work if we allowed the bank to make loans and take deposits. Players would be able to borrow money to buy property, and, rather than holding their cash idly, they would deposit it at the bank to earn interest, which in turn would provide the bank with more money to lend. Let’s also imagine that players in this game could buy and sell properties from each other on credit (i.e., by promising to pay back the money with interest at a later date). If Monopoly® were played this way, it would provide an almost perfect model for the way our economy operates. The amount of debt-financed spending on hotels would quickly grow to multiples of the amount of money in existence.

Down the road, the debtors who hold those hotels will become short on the cash they need to pay their rents and service their debt. The bank will also get into trouble as their depositors’ rising need for cash will cause them to withdraw it, even as more and more debtors are falling behind on their payments. If nothing is done to intervene, both banks and debtors will go broke and the economy will contract. Over time, as these cycles of expansion and contraction occur repeatedly, the conditions are created for a big, long-term debt crisis.

In other words, debt actually creates its own cycles. Lending (especially from institutions that can create money under a fractional reserve banking system) allows spending that spawns more spending, which eventually must reverse into contraction that spawns more contraction. That may seem obvious but we often forget it. As we apparently have done even as I write.

After examining dozens of debt cycles, Ray’s team built this template to describe the six stages of the deflationary variety.

Source: Ray Dalio

Stage 1 is the “good” part. People borrow money, but not too much and they use it for productive purposes. This helps the economy grow and lifts asset prices… which is where things start going wrong.

In Stage 2, which Dalio terms the “Bubble,” people look at the recent past and decide asset prices, total demand, and consumption will keep going up. They overconfidently borrow more money and start having too much leverage, although it is never possible to actually define the moment when the right amount becomes “too much.”

Stage 3, the “Top,” occurs when central banks and regulators and sometimes even the lending institutions themselves see problems and take steps to moderate growth—always thinking they can slow down without braking too hard. They raise interest rates, tighten lending standards, and so on.

Stage 4, ominously called the “Depression,” happens when growth slows or reverses beyond the ability of monetary and political authorities to help. Yet they keep trying. This is when we see interest rates go to zero or negative. The central bankers are out of bullets at this point. Everyone just has to suffer.

Stage 5 is the deleveraging phase, when businesses and families reduce spending to pay down debt and reduce their leverage. It can last a long time, but as leverage falls people get a handle on their debt service costs and slowly start to recover. Eventually the economy reaches Stage 6, normalization, and the cycle repeats.

So that was the template for a generic debt crisis. Each one has its unique characteristics (he goes into each historical crisis separately in the last sections of his book) but they generally follow this sequence. Which raises the question, where are we now? Dalio thinks we are in the late stages and points to interest rates as evidence.

Source: Ray Dalio

Twice in this century, the US went through debt crises so severe that the Fed had to drop rates to zero and resort to unconventional policies like quantitative easing. The first time was in the 1930s and then again in 2008-2009. In both cases, it “worked” in the sense that asset prices recovered. But it also had adverse side effects because higher asset prices accrue to asset owners, which most people are not, at least to any significant degree.

The result is a wealth gap between rich and poor, which of course always exists, but in these periods it grew too obvious to deny. A small part of society prospers as its assets gain value while the majority struggles. It happened in the Great Depression and we saw it again in the post-Great Recession years. Data-driven Dalio quantifies it in this chart.

Source: Ray Dalio

If that looks familiar, it’s because I’ve showed it and similar charts to you before. Ray originally posted it in a 2017 article which I summarized in a letter called The Distribution of Pain. His main point then was that it is a serious mistake to think you can understand “the” economy because we really have two economies. The top 40% live in a different world than the bottom 60%.

Combine those conditions of wealth inequality with representative democracy and the result is populism and our currently divided politics. It may become even more so now that Democrats will control the House next year. The result will be legislative gridlock, which isn’t entirely bad but may stall policy changes that could help postpone recession.

Already-huge federal deficits will therefore keep growing just as the Federal Reserve both raises rates and reduces its balance sheet assets. So far, this combination hasn’t stopped GDP growth or even perceptibly slowed it, but at some point it will. That is the goal, after all, and Ray’s template shows it usually succeeds.

In this case, I think the trigger will be a crowding-out effect as Treasury borrowing combined with Fed tightening raises household and corporate debt service costs. Everyone has a breaking point and it is getting closer.

The “seventh-inning stretch,” if you don’t know the term, is a point near the end of a baseball game. There’s enough time left for the trailing team to catch up so no one wants to leave yet. You stand up, stretch, singing “Take Me Out to the Ballgame,” then settle back in to see what happens.

That’s kind of where we are in the debt cycle: near the end, but not yet sure of the outcome. The difference is that none of us are just spectators. We are all in the game, and we will all either win or lose.

Ray has been writing over the past few years about what he calls “A Beautiful Deleveraging,” when the central bank manages to defuse the debt-burdened economy without a major crisis. Here is what he says:

The key to handling debt crises well lies in policy makers’ knowing how to use their levers well and having the authority that they need to do so, knowing at what rate per year the burdens will have to be spread out, and who will benefit and who will suffer and in what degree, so that the political and other consequences are acceptable.

There are four types of levers that policy makers can pull to bring debt and debt service levels down relative to the income and cash flow levels that are required to service them:

1. Austerity (i.e., spending less)

2. Debt defaults/restructurings

3. The central bank “printing money” and making purchases (or providing guarantees)

4. Transfers of money and credit from those who have more than they need to those who have less.

1, 2, and 4 above require varying levels of pain for lenders and borrowers. Number 3 still has pain for all concerned, something like 2008-2014 when the Fed and other central banks around the world bought trillions in assets, but it was likely better than what would have happened absent those policies.

The Federal Reserve is late in the process of raising rates, but under Powell seems committed to reaching what many economists call “the natural rate of interest.” My personal belief is that we are close to that point now. If we go past it, then I think the Fed will tip the economy over into a recession. This will be preceded by an inverted yield curve, or the place where short-term government interest rates are higher than long-term US bond rates. Since World War II, this “inverted yield curve” has always preceded a recession by somewhere between 9 and 15 months.

This first chart from GuruFocus shows the yield curve has been “flattening” for the past few years. Below that, you see the historical yield curve spread since 1970. As they note in the chart, this preceded all of the previous seven recessions.

Source: GuruFocus

Source: GuruFocus

I want to be clear that an inverted yield curve does not cause recession. It is a symptom of imbalances in the banking and financial systems. Think of it like a fever brought on by a virus. The fever is a result, not the cause of the disease. It tells you something is wrong in your body.

Note that in the graphs above, short-term rates have risen roughly two percentage points while long-term rates rose around one point. We call this a “tightening” of the curve and it is the first step toward inversion. You can bet Fed officials are watching this, as they really don’t want the yield curve to invert. It will not surprise me if, even though they have signaled more rate increases, they actually stop short of their current targets. Another point higher at the short end would clearly invert the yield curve unless there is a similar rise in long rates, which has not been happening so far.

At that point, you are really going to wish that you had read Ray Dalio’s book. Next week we will dive deeper into the process. And just as important, why another credit crisis may happen before we have what I think of as The Great Reset. Stay tuned.

On another note, I know someone with a high six-figure income who pays no income tax at all.

No, he doesn’t need to keep things quiet to stay out of jail. His situation is straight-forward, legal, and entirely on the up-and-up. And it started with something you probably think of as bland and conventional: an IRA.

Some years ago, my acquaintance began moving his entire financial life into his Individual Retirement Account. He wanted to put everything—his investments, his business, everything—in the IRA so profits could grow tax-free.

He didn’t get the job done overnight. It took time. But he kept at it because he could see how wonderful the result would be. And he used a Roth IRA, so that eventually the money would come out to him tax-free.

Now he lives in the no-tax zone. He doesn’t even need to file tax returns.

It really is possible to do that—not overnight, but in time—if you make it a priority. If you want to learn about the strategies that make it possible, I recommend Terry Coxon’s just-published special report, Supersize Your IRA. At $19.95 it’s not expensive and it comes with two free bonuses you will appreciate. Today is the last day it’s available. Terry has asked we close the offer tonight. You can learn more about the report and bonuses here.  

I find myself tonight waiting in the Admirals Club in the “airplane lottery.” So far, I have had four flights canceled due to the planes not be able to get in or diverted from LaGuardia. In theory, a flight boards in 45 minutes. (Update: now two 3.5 hours, getting me home about 4:30 (??) am. Oh well, the glamour of travel and all.) That is the theory, we will see what happens in reality.

New York and the entire Northeast are in the middle of a serious snowstorm/blizzard. For the first time in my life, I walked out of the Liberty Tower in downtown New York to catch my Uber, and the snow was blowing from my left to my right. Not up and down or diagonally. I mean from my left to my right. I was soaked after walking 50 feet to the car.

Eventually, I will get back to Texas to start preparing for Thanksgiving with all my children and their families. Sometime in December, Shane and I will go to Puerto Rico and also visit Cleveland to see Dr. Mike Roizen for the Cleveland Clinic’s executive health program. And then the holidays come.

And with that, I will hit the send button. You have a great week. Spend some time with your friends and family, as unlike debt, you can never have too much time with friends.

Your excited-about-all-the-changes-that-are-coming-in-his-life analyst,

John Mauldin
Chairman, Mauldin Economics

We are living in an age of unprecedented risks

Business faces political upheaval while politics grapples with disruption

Henry Paulson

Over the course of my 50-year career, with the exception of the 2008 financial crisis, I have never seen the public and private sectors buffeted by so much risk. These new risks are not financial, but they are unprecedented in their character, not just their scope.

Businesses face heightened political risks. While this is not new, in the past such risks simply shaped the context in which global firms operated. Successful companies could navigate through them. Now, politics threatens to disturb the foundations of the global system.

Governments, meanwhile, confront unprecedented business risk because the private sector generates so much disruptive innovation. Even authoritarian governments can no longer expect to exercise exclusive control over their domestic economies. This is not just due to hardware innovation. Communication and data flowing through privately controlled platforms have enabled social and political mobilisation that challenges the state’s role.

This week in Singapore, the Bloomberg New Economy Forum launches an effort to foster growth and development, especially in emerging markets. It hopes to help government and business better understand the risks each generates. A strengthened and sustainable global economy requires mitigation of these risks and joint solutions.

Three risks posed by government to business stand out. The most apparent is the power of populism and nationalism in advanced democracies. For a generation, market participants presumed these were emerging markets issues. Europe and the US were viewed as stable business and investment environments with robust institutions and predictable shifts at the ballot box among established political parties.

No longer. Today, advanced economies are generating the most disruptive political risks to businesses. Washington’s shift to protectionism is one example. But it is hardly alone: Italy’s fiscal choices could yet roil the markets. The need to build coalitions in Sweden and Germany, and the weakening of traditional parties, such as the German Social Democrats, looks set to do the same, as populist entrants erode political norms.

A second risk of regulatory chaos has already begun to constrict opportunities for cross-border transactions. That is ironic, as global mergers and acquisitions have hit a record at $3.3tn in 2018.

But turbulent politics are making antitrust issues more complicated and uncertain in the US, Europe, and now China. Regulators weigh in on major transactions using different criteria, often with little transparency. In recent years, we have seen competition regulators outside of a multinational firm’s domestic market kill some transactions, delay others for many months and force divestures when there seemed to be little evidence of monopoly.

A third risk is the increasingly elastic definition of “national security”. Regulators once construed it narrowly to avoid disrupting markets. Now government competition around security issues, not least between Washington and Beijing, threatens economic integration and has blurred the line between defence and commerce.

National security reviews are disrupting trade, investment, and supply chains. More important, the threat of enhanced regulatory constraints is making it almost impossible for some multinationals to plan for the long term.

The landscape is also changing for governments, including both democracies and authoritarian regimes. Multinational business has changed in recent years and corporate executives have many more levers they can pull.

That means governments must navigate business risks, lest they find their hands tied or their objectives thwarted. “Multinational” companies are just that. They can move headquarters, diffuse operations and disperse capital.

States have some tools to prevent this, including strict capital controls and tariffs. But, as US president Donald Trump has discovered with steel tariffs, companies may respond by investing in operations overseas. This turns nations into rivals. Competition for capital investment has sharpened: businesses play countries off against each other, enticing them to offer incentives.

This risks a race to the bottom in which corporate profits determine policies.

That highlights an even bigger business risk to governments. Chief executives can mobilise employees and customers and they have the money to back campaigns. So they are driving political and social change. But they are also motivated by market forces. They will invest where political risk is manageable and they can achieve the best shareholder returns. Politicians must ask whether a laissez faire policy that lets business do this is in a nation’s interest.

Government and business have different goals, divergent incentives and answer to distinct constituencies. But they have one thing in common: they need to grapple with risk. That means they are stuck with each other.

Successful governments will protect their nations from business risk while offering an attractive home for successful multinational companies. Astute businesses will adapt to changing political landscapes. Sometimes the two sides will co-operate. More often, they will win or lose by finding opportunities as they assess, manage and navigate the risks they pose to each other.

The writer served as US Treasury secretary 2006-09

The Dollar Shortage Is Back

Scarcity of greenbacks in the global financial system is a hidden risk for emerging markets

By Jon Sindreu

The world is short of dollars again. Emerging markets could be the chief victims this time round.

Signs of a global dollar shortage abated this year, only to resurface in mid-September. Investors and companies outside of the U.S. rely on the currency as the ultimate source of liquidity. Many were hurt by bouts of dollar scarcity after the 2008 financial crash, during the euro crisis, and even in 2016. 
The shortage is usually most acute around quarter and year ends, because banks report their books to regulators and try to make their exposure look smaller relative to their capital. Banks now know they need to get their dollars well before the dreaded year-end deadline, so the potential for damage now is likely lower than in the past.

Still, the re-emergence of a shortage is a warning sign that the world’s dollar dependency is far from over. That is a bad omen for companies and countries that are especially reliant on international dollar liquidity—chiefly banks and emerging markets.
The re-emergence of a shortage of dollars is a warning sign that the world’s dependency on the currency is far from over.

The re-emergence of a shortage of dollars is a warning sign that the world’s dependency on the currency is far from over. Photo: Elise Amendola/Associated Press 

Greenback scarcity can be measured by looking at spreads on derivatives called cross-currency basis swaps, which are used by investors and companies to source dollars outside of the U.S. In theory, this spread should never stay wide for long, because arbitragers with access to U.S. borrowing can profit from it.

Since 2008, however, the gap has persisted because of the stress suffered by banks, which are now punished by regulations if they expand their balance sheets.

Against this backdrop it is surprising that spreads narrowed so much earlier this year, even as the Federal Reserve sold bonds back into the market—therefore sucking dollars out of the financial system.

One explanation is that banks are using their balance sheets more efficiently, or attracting larger numbers of dollar depositors. Another is that Japanese investors are now moving out of U.S. debt and into Europe, removing a huge source of demand for dollars. This is probably a result of U.S. short-term interest rates rising relative to long-term ones, which makes it more expensive to hedge dollar currency risk.

Yet this effect may not last, as U.S. short-term rates lead others higher. Lower demand from Japan could even have obscured the dollar crunch in emerging markets. These are highly dependent on issuing dollar debt to international investors and banks, and a shortage of greenbacks tends to hamper their economic growth, research by the Bank for International Settlements has found.

In a famous speech in 1896, back when the U.S. pegged its currency to gold, former House representative William Jennings Bryan lamented that the economy was crucified “upon a cross of gold.” Even if the nails are now less visible, the world economy is still bound to its own dollar cross.

Grappling With Globalization 4.0

The world is experiencing an economic and political upheaval that will not cease any time soon. The forces of the Fourth Industrial Revolution have ushered in a new economy and a new form of globalization, both of which demand new forms of governance to safeguard the public good.

Klaus Schwab  

global connections

GENEVA – After World War II, the international community came together to build a shared future. Now, it must do so again. Owing to the slow and uneven recovery in the decade since the global financial crisis, a substantial part of society has become disaffected and embittered, not only with politics and politicians, but also with globalization and the entire economic system it underpins. In an era of widespread insecurity and frustration, populism has become increasingly attractive as an alternative to the status quo.

But populist discourse elides – and often confounds – the substantive distinctions between two concepts: globalization and globalism. Globalization is a phenomenon driven by technology and the movement of ideas, people, and goods. Globalism is an ideology that prioritizes the neoliberal global order over national interests. Nobody can deny that we are living in a globalized world. But whether all of our policies should be “globalist” is highly debatable.

After all, this moment of crisis has raised important questions about our global-governance architecture. With more and more voters demanding to “take back control” from “global forces,” the challenge is to restore sovereignty in a world that requires cooperation. Rather than closing off economies through protectionism and nationalist politics, we must forge a new social compact between citizens and their leaders, so that everyone feels secure enough at home to remain open to the world at large. Failing that, the ongoing disintegration of our social fabric could ultimately lead to the collapse of democracy.

Moreover, the challenges associated with the Fourth Industrial Revolution (4IR) are coinciding with the rapid emergence of ecological constraints, the advent of an increasingly multipolar international order, and rising inequality. These integrated developments are ushering in a new era of globalization. Whether it will improve the human condition will depend on whether corporate, local, national, and international governance can adapt in time.

Meanwhile, a new framework for global public-private cooperation has been taking shape. Public-private cooperation is about harnessing the private sector and open markets to drive economic growth for the public good, with environmental sustainability and social inclusiveness always in mind. But to determine the public good, we first must identify the root causes of inequality.

For example, while open markets and increased competition certainly produce winners and losers in the international arena, they may be having an even more pronounced effect on inequality at the national level. Moreover, the growing divide between the precariat and the privileged is being reinforced by 4IR business models, which often derive rents from owning capital or intellectual property.

Closing that divide requires us to recognize that we are living in a new type of innovation-driven economy, and that new global norms, standards, policies, and conventions are needed to safeguard the public trust. The new economy has already disrupted and recombined countless industries, and dislocated millions of workers. It is dematerializing production, by increasing the knowledge intensity of value creation. It is heightening competition within domestic product, capital, and labor markets, as well as among countries adopting different trade and investment strategies. And it is fueling distrust, particularly of technology companies and their stewardship of our data.

The unprecedented pace of technological change means that our systems of health, transportation, communication, production, distribution, and energy – just to name a few – will be completely transformed. Managing that change will require not just new frameworks for national and multinational cooperation, but also a new model of education, complete with targeted programs for teaching workers new skills. With advances in robotics and artificial intelligence in the context of aging societies, we will have to move from a narrative of production and consumption toward one of sharing and caring.

Globalization 4.0 has only just begun, but we are already vastly underprepared for it. Clinging to an outdated mindset and tinkering with our existing processes and institutions will not do. Rather, we need to redesign them from the ground up, so that we can capitalize on the new opportunities that await us, while avoiding the kind of disruptions that we are witnessing today.

As we develop a new approach to the new economy, we must remember that we are not playing a zero-sum game. This is not a matter of free trade or protectionism, technology or jobs, immigration or protecting citizens, and growth or equality. Those are all false dichotomies, which we can avoid by developing policies that favor “and” over “or,” allowing all sets of interests to be pursued in parallel.

To be sure, pessimists will argue that political conditions are standing in the way of a productive global dialogue about Globalization 4.0 and the new economy. But realists will use the current moment to explore the gaps in the present system, and to identify the requirements for a future approach. And optimists will hold out hope that future-oriented stakeholders will create a community of shared interest and, ultimately, shared purpose.

The changes that are underway today are not isolated to a particular country, industry, or issue. They are universal, and thus require a global response. Failing to adopt a new cooperative approach would be a tragedy for humankind. To draft a blueprint for a shared global-governance architecture, we must avoid becoming mired in the current moment of crisis management.

Specifically, this task will require two things of the international community: wider engagement and heightened imagination. The engagement of all stakeholders in sustained dialogue will be crucial, as will the imagination to think systemically, and beyond one’s own short-term institutional and national considerations.

These will be the two organizing principles of the World Economic Forum’s upcoming Annual Meeting in Davos-Klosters, which will convene under the theme of “Globalization 4.0: Shaping a New Architecture in the Age of the Fourth Industrial Revolution”. Ready or not, a new world is upon us.

Klaus Schwab is Founder and Executive Chairman of the World Economic Forum.

This Myth About Gold Could Be Costing You Serious Money

By Justin Spittler, editor, Casey Daily Dispatch

Forget what you know about interest rates and gold.

…Specifically the idea that high rates hurt gold.

That’s a myth... one that could cost you serious money in the months ahead.

More on that in a second. But first, let me tell you why many investors believe high interest rates are bad for gold. It’s a simple idea really.

• Gold doesn’t yield anything…

So it supposedly becomes less attractive when rates increase because bonds and other interest-bearing instruments pay more.

Makes sense, right? But the data tell a different story…

As you’re about to see, gold has experienced some of its biggest bull markets during periods of rising rates.

I’ll show you what I mean in a second. But here’s why I wrote this essay.

• Interest rates are surging…

And the Federal Reserve is a big reason why.

If you read last Wednesday’s Dispatch, you know what I’m talking about. If not, let me bring you up to speed.

Last month, the Fed lifted its key interest rate for the third time this year… and the sixth time since the start of 2017. This benchmark is now sitting at its highest level since August 2008.

This is a huge deal.

The Fed’s key rate sets the tone for interest rates across the economy. Other interest rates tend to rise when it does.

Today is a perfect example of this. Just look at what the 10-year U.S. Treasury has done since the start of 2017. Its yield has risen to 3.2%. That’s the most it’s paid since 2011.

• There’s a good reason to think that the 10-year yield will keep climbing…

To understand why, look at this chart. It shows the yield on the 10-year U.S Treasury going back to the 1980s.


You can see that the 10-year U.S Treasury yield has been falling for decades. But notice what happened last month…

The yield jumped above 3%. In the process, it pierced a nearly four-decade-long downtrend in yields.

This reflects a major shift in sentiment. It tells us Treasury yields will likely keep rising.

You’d think that would be bad for gold. But as I mentioned, history says otherwise.

• Let’s turn back the clock to 1971…

That year, the Fed started raising rates significantly.

In turn, Treasury yields also rose significantly. The U.S. 10-year, for one, saw its yield jump from 5.4% in 1971 to 14% by 1980.

That’s an enormous move. But this huge spike in yields didn’t crush appetite for gold like you might expect.

Instead, the price of gold surged from $39 an ounce in 1971 to a peak of $850 in 1980.

The same thing happened during the mid-2000s. This time, the Fed lifted its key rate from 1% to 5.25%. Another huge move. But once again, demand for gold didn’t diminish in the face of rising rates.

No. The price of gold jumped from $396 in 2004 to $715 in 2006. That’s an 81% move in just two years.

In short, rising rates aren’t bad for gold, like many investors believe. Of course, that alone isn’t a reason to buy gold. But consider this…

• Low rates have been one of the biggest drivers behind the bull market in U.S. stocks...

Regular readers know this all too well. But let me recap.

During the last global financial crisis, the Fed launched an unprecedented stimulus program. It’s pumped $3.5 trillion into the financial system. And it held its rate near zero for seven years.

These measures made it extremely cheap to borrow money. That led everyday Americans to rack up record credit card, auto, and student loan debt.

U.S. businesses also went on a borrowing binge, thanks to cheap credit. Just look at this chart:


You can see that the amount of outstanding corporate debt as a percentage of gross domestic product (GDP) – annual economic output – is at record highs.

Now, some companies borrowed money to build factories, buy equipment, and invest in research and development (R&D). But most of this money was spent on share buybacks and paying out dividends… both of which helped push the U.S. stock market to record highs.

But as you’ve seen today, the Fed isn’t holding rates near zero anymore. It’s hiking them – aggressively.

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ManCity and Paris Saint-Germain

How Oil Money Distorts Global Football

Five years ago, UEFA introduced Financial Fair Play, a set of rules designed to level the economic playing field in European football. But during his tenure as UEFA general secretary, Gianni Infantino went out of his way to ensure that Manchester City and Paris Saint-Germain avoided harsh punishment. By DER SPIEGEL Staff

Khaldoon Al Mubarak, chairman of Manchester City

It was 10 minutes to midnight on May 2, 2014, when Gianni Infantino sent an email to the boss of Manchester City. "Sorry for my 'late-Friday-night email,'" Infantino began in his message to Khaldoon Al Mubarak, the football club's chairman.

At issue was the looming possibility that Manchester City could be suspended from participation in the Champions League due to violations of Financial Fair Play, a set of budget rules established by UEFA for all clubs that qualify for European competitions.

But in his email to Mubarak, one of the most influential businessmen in Abu Dhabi and a close confidant to the ruling family, Infantino sought to put his mind at ease. The UEFA general secretary had sketched out a few suggestions for how Manchester City could escape its predicament with as little harm done as possible - such as by way of a settlement with UEFA.

"You will see that I've sometimes chosen a wording which 'looks' more 'strong,'" Infantino wrote in a submissive tone, making it clear that he was willing to massage certain passages. "Please read the document with this spirit." Of course, Infantino continued, the message was just between us. Strictly confidential. "Finally, I would also like to thank you for your trust. You know you can trust me." Infantino closed his midnight missive with a bit of optimism: "Let's be positive!"

Those days in May 2014 were a turning point for European club football, and Gianni Infantino, who is today the president of the global soccer association FIFA, played a decisive - and rather sordid - role.

The 2013-2014 season marked the first time that clubs which had qualified for a European competition were required to allow UEFA to examine their books in accordance with Financial Fair Play (FFP). The set of rules had been established by the Frenchman Michel Platini as a prestige project defining his presidency of UEFA, the governing body of football in Europe.

There were many good reasons for FFP's introduction. One of the most persuasive was the need to protect the European club tournaments from the vast amounts of money flooding into the football market as oligarchs from Russia, billionaires from the United States and sheikhs from the Arab world invested in clubs across the continent. Tradition-rich clubs that didn't want to sell no longer stood much of a chance against the nouveau riche and their financial doping.

The rules stipulate that a club's deficit in the two seasons from 2011 to 2013 could only add up to a total of 45 million euros, and in the three seasons after that, a total of just 30 million euros. Furthermore, teams were required to subsequently verify that sponsoring contracts they signed with companies controlled by their new owners did not distort competition by being overvalued. Artificially inflated sponsoring deals can boost team revenues on the balance sheet, enabling it to afford larger expenditures.

UEFA had spent months investigating nine clubs on suspicions they had massively violated, or were continuing to violate, the new set of budgetary rules. Among them were Manchester City and Paris Saint-Germain, two top European teams who had made waves in the industry due to the immeasurable wealth of their new owners. Manchester City had been sold to the ruling family of Abu Dhabi in 2008, while the emirate of Qatar had bought Paris Saint-Germain in 2011.

UEFA President Platini and General Secretary Gianni Infantino had repeatedly insisted in interviews that clubs found in violation of the FFP rules could expect harsh penalties. The most severe punishment: suspension from the Champions League. Given the strident rhetoric, the football world was shocked when UEFA reached settlement agreements with both Manchester City and Paris Saint-Germain in mid-May 2014.

The negotiations at the time were strictly confidential. Thanks to the whistleblowing platform Football Leaks, however, the enormous pressure exerted on UEFA by Abu Dhabi and Qatar can now be reconstructed. Both Manchester and Paris met almost every step taken by UEFA with threats.

The decisive ally to both of the clubs was the man whose job should have committed him to complete neutrality: UEFA General Secretary Gianni Infantino. The Football Leaks documents show just how unconscionably the top functionary sided with the newly wealthy clubs, both of which didn't just violate the Financial Fair Play rules. They held them in contempt.

During the FFP proceedings, Infantino met with club bosses from Paris and Manchester on several occasions for secret talks, even supplying them with confidential materials. He proposed compromises that he was unauthorized to propose. In short: He betrayed his own organization.

The documents make it look as though Infantino, through his intervention, purposefully sought to thwart the so-called Club Financial Control Body (CFCB), the UEFA panel responsible for monitoring adherence to the Fair Play rules and for proposing penalties to be imposed on potential violators.

The panel has two chambers. One is the Investigatory Chamber, which can initiate proceedings against a club and propose penalties for serious violations. The other is the Adjudicatory Chamber, which hands down the final verdict and imposes penalties. The Investigatory Chamber, however, can reach an amicable agreement with a club in the form of a settlement.

It is vital, however, for the CFCB to maintain its independence: Neither the executive committee nor the UEFA president's office are allowed to exert influence on members of the Club Financial Control Body at any time.

That, though, is exactly the red line that Gianni Infantino crossed in spring 2014. The leaked documents make it look as though he was the willing executioner for two clubs that wanted to get UEFA investigators and auditors off their backs.

In the 2013-2014 season, the Investigatory Chamber of the CFCB included eight members. Its chief investigator was former Belgian Prime Minister Jean-Luc Dehaene, who fell gravely ill in early 2014. He was succeeded by Brian Quinn, an economics expert from Scotland who had held a senior position at the Bank of England before becoming chairman of Celtic Glasgow in 2000.

The Investigative Chamber required Paris Saint-Germain to open its books to the body for the first time in July 2013. One year earlier, the state-owned Qatar Tourism Authority (QTA) had signed an "Agreement for the Promotion of the Image of Qatar" with the team, which was to run for five years and generate revenues averaging 215 million euros per year for the club.

It was a ludicrous amount of money, far more than the market would bear and inconsistent with anything that might smack of economic logic for the Qatari company. By comparison, FC Bayern Munich's main sponsor at the time, Deutsche Telekom, paid the team an annual sum of 29 million euros. It looked, in other words, as though the marketing contract was merely a façade, meant to allow the Qataris to pump as much money into the club as possible.

The agreement with the Qatar Tourism Authority consisted of a mere five pages and obligated Paris Saint-Germain to advertise for Qatar and "participate annually, at the request of Qatar, in its promotion activities." Otherwise, the team had to do nothing for QTA: It didn't have to put the company's logos on its jerseys, it didn't have to put up advertising in its stadium, it didn't even have to put a link on the club home page. The real reason for the excessive payments was a different one - which is also spelled out in the five-page agreement: Money from the Qatar Tourism Authority was to be used to buy players. By doing so, Paris Saint-Germain was to help Qatar become "a major player in the sporting world."

In response to a query about the deal, PSG stated that it was not a sponsoring deal, but that it was a "nation branding" agreement -- marketing for the entire country of Qatar. "Nation branding is of another scale compared to traditional sponsoring contracts," club executives wrote.

Following its acquisition of PSG, Qatar used exactly this line in its confidential "Strategic Plan 2012-2017." The goal was for the club to "become one of the top 5 European football clubs," and, by leveraging the brilliance of the stars Paris Saint-Germain was to acquire, to improve Qatar's global image as the host country of the 2022 World Cup. And that is what ultimately happened. With the money from Qatar, the club quickly signed the superstar striker Zlatan Ibrahimovi, and followed up the move with additional spectacular transfers such as those of Ezequiel Lavezzi and Edison Cavani.

From the very beginning, UEFA's investigators apparently viewed the billion-euro deal with the Qatar Tourism Authority as a clear violation of Financial Fair Play. They were skeptical of clubs whose sponsoring revenues came almost exclusively from state-owned companies that were under the control of club owners.

The Investigatory Chamber of the Club Financial Control Body sent auditors from Deloitte to Paris Saint-Germain headquarters and they spent three days closely scrutinizing the team's books. At the conclusion of their examination, they disclosed to the team's general director, Jean-Claude Blanc, that they considered the team's marketing partner, the Qatar Tourism Authority, to be a "related party."

The term set off alarm bells at Paris Saint-Germain headquarters. It meant that the two contractual partners were too closely interlinked, both on a personnel and organizational level, and that the alleged sponsoring payments were seen as hidden cash infusions for the club.

Five independent auditors, who also analyzed the QTA contract on behalf of the Investigatory Chamber, arrived at the same conclusion, a disaster for Paris Saint-Germain. Indeed, the top international sports marketing agency Octagon assessed the "fair market value" of the contract at just 2.78 million euros, an 80th of the sum that Qatar was contractually obliged to pay to Paris Saint-Germain. "Based on any conventional wisdom or practice," the marketing experts from Octagon wrote, no "rational sponsor would pay such money for this kind of exposure." They went on: "QTA pays a rights fee that is hugely inflated within the sport."

On Feb. 21, 2014, UEFA investigators notified the club that the Investigatory Chamber was continuing to examine Paris Saint-Germain's books for violations of the Financial Fair Play rules. In early March, head investigator Quinn invited club executives to a hearing at UEFA headquarters in Nyon, Switzerland.

In April, a preliminary closing report noted that the "maximum fair value" of the QTA contract was 3 million euros. The culpable debt liability for the two seasons from 2011 to 2013 were thus calculated to be "at least 215 million euros." The chamber was considering referring the case onward to the Adjudicatory Chamber of the Club Financial Control Body.

But that never happened. Instead, high-ranking UEFA officials toned down the most severe findings of the report - and withheld the sensitive document in Nyon.

Why they did so is unclear. What is known, however, is that by this point, Paris Saint-Germain executives had already been engaged in confidential talks with UEFA General Secretary Gianni Infantino for weeks.

In February 2014, the team's General Director Jean-Claude Blanc had agreed with advisers that the club's Qatari president, Nasser Al-Khelaifi, should head to UEFA headquarters as quickly as possible for a meeting with Infantino and UEFA President Platini. Even before the investigation into PSG's finances began, Blanc had advocated for the exertion of significant legal pressure on UEFA.

A secret meeting was held in Nyon on Feb. 27, with Blanc, Khelaifi, Infantino and Platini - who PSG executives consistently referred to as the "Top Guy" in their internal communications - in attendance.

The Football Leaks documents hint at the threatening attitude adopted by the Qatari club boss. They indicate that right at the beginning of the talks, Khelaifi fired a shot across Platini's bow by saying that the UEFA president surely had no interest in launching an attack on Qatar via the football club.

The mood at the meeting remained tense. Infantino recommended his two guests work toward an amicable settlement with the analysts from the Investigatory Chamber. Both Khelaifi and Blanc rejected the idea out of hand. A settlement, they demanded, could only be negotiated "at the top levels," - in other words, with Infantino and the "Top Guy" Platini.

It was a presumptuous demand akin to requesting that the FFP Investigatory Chamber be circumvented. Instead of rejecting the demand, Platini and Infantino became involved in backroom diplomacy with the Qataris and their French representatives at Paris Saint-Germain.

Prior to publication, partners with the European Investigative Collaboration (EIC) confronted both UEFA and Paris Saint-Germain with the accusation. Both answered with an excerpt from UEFA rules in which it is noted that the association's administration may support the work of the Investigatory Chamber with personnel and infrastructure. The rules also say that the chambers must be "independent."

During the negotiations, a lawyer who worked for UEFA supplied PSG with confidential documents from the Investigatory Chamber. That same lawyer then met with representatives from Paris Saint-Germain on March 21, 2014.

The Paris-based football club had adopted an extremely inflexible position: no admission that it had violated the Financial Fair Play rules. Club owners were particularly interested in escaping the matter without any damage to their image.

According to the Football Leaks documents, the UEFA lawyer apparently backed down and requested that the club submit proposals for how to solve the issue.

In the weeks that followed, several secret discussions took place between Infantino and PSG General Director Blanc. In early April, they met in London, where Infantino apparently provided his binding acceptance of a settlement. His most important condition: PSG had to reduce the value of the contract with the Qatar Tourism Authority to 100 million euros per year - still more than 30 times higher than the "fair value" established by the analysts from Octagon on behalf of the FFP Investigatory Chamber.

On the occasion of the French League Cup final between Paris Saint-Germain and Olympique Lyon on April 19, the two sides held a secret meeting at which they agreed on the details of the agreement. They allowed the club to make up the 115-million-euro difference with new sponsors, again most of them from Qatar. That part of the agreement was to be left out of the settlement document.

In return, Infantino insisted the wording of the settlement be strict enough that UEFA didn't lose face as a result of the deal. It was a victory for PSG and proof that Infantino went behind the backs of the Financial Fair Play monitors in spring 2014.

But the collaboration with the top French club was not an isolated case. Infantino also spent weeks negotiating with the owners of Manchester City behind the backs of the independent auditors. Ultimately, it resulted in a falling out with Brian Quinn, the chief investigator of the Investigatory Chamber.

Manchester City was already aware in May 2013 that the new Financial Fair Play rules spelled deep trouble. The club had lost 451 million euros between 2009 and 2011. "We are breaching anyway," wrote Finance Director Andrew Widdowson, an admission that the club had too many losses on the books to satisfy FFP rules. We are, he continued, "just relying on mitigating factors to get us through."

In January 2014, UEFA monitors sent auditors from PricewaterhouseCoopers (PwC) to Manchester. The result was a disaster. Fully 84 percent of "other commercial income" originated from sponsors from Abu Dhabi. According to the report, the club had hidden 35 million euros in costs from UEFA in its annual statement of accounts.

Manchester City reacted reflexively to the pressure with pressure of its own. The club put its lawyers on war footing, and almost all of its responses to UEFA reflected that aggression. "The PwC Report is seriously flawed in that it contains numerous erroneous interpretations of the Regulations, false assumptions of fact, errors of law and erroneous conclusions," read the reply. The lawyers demanded that the PwC auditors revise or delete large sections of their report. PwC refused, which further enraged the Manchester City attorneys.

In mid-March, Manchester City CEO Ferran Soriano carried out negotiations with Infantino related to the Financial Fair Play rule and threatened to challenge the Financial Fair Play rules in European Union courts. In an internal memorandum, the club's attorneys noted that if a "sensible settlement" was not reached with the Investigatory Chamber, Manchester City would "have no choice but to fight U (meaning UEFA) on all legal fronts." The club, they suggested, was expecting "a warning, but no further action."

Yet the evidence did not appear to be in Manchester City's favor. The marketing experts from Octagon, who had already issued a disastrous report card on Paris Saint-Germain at the behest of the FFP monitors, found that three of the four sponsoring contracts that Manchester City had signed with companies from Abu Dhabi were "significantly overvalued." They added that the deals, which had brought in 50 million euros in revenues, were up to 80 percent higher than their actual market value. Following an additional visit to Manchester, the PwC auditors determined that two Man City sponsors were "related parties." The same situation as with Paris Saint-Germain.

But by then, Infantino was already in the process of trying to outmaneuver the Investigatory Chamber. Together with CEO Soriano, he set up a meeting in early April between two lawyers, one representing Manchester City, the other UEFA. The two attorneys reached an agreement that the club would make a proposal for an amicable solution. It was a bit like a bank robber proposing an appropriate sentence to the prosecutor.

The strategy, as one attorney suggested to Man City leadership, should be to reach a deal the club could live with, but without having to admit any misconduct. "Apply as much pressure as possible, but by always giving UEFA a way out."

On April 15, Soriano informed club president Mubarak that another meeting between the two lawyers was scheduled. "I had a good telephone call with Gianni Infantino where we agreed how to brief the lawyers ('to negotiate a settlement that is more than a warning and can be seen as effective/dissuasive but does not affect dramatically MCFC business')."

But by the end of the month, the club was apparently still not satisfied with the progress of negotiations. Club lawyer Simon Cliff wrote in an email that Mubarak had told Infantino that he rejected the idea of a possible monetary penalty. "Khaldoon said he would rather spend 30 million on the 50 best lawyers in the world to sue them for the next 10 years." The football association, according to the email, now had the possibility "to avoid the destruction of their rules and organization."

Then came May 2, 2014.

Both Paris Saint-Germain and Manchester City received letters from the Investigatory Chamber of the Club Financial Control Body. The letters were not signed by chamber head Brian Quinn. He had resigned from his post as chief investigator that same day at UEFA headquarters in Nyon - because he considered the agreements too lenient given the size of the breach. Umberto Lago of Italy took over for Quinn - and the chamber ultimately signed off on the deal.

Paris Saint-Germain had reached its goal. Club president Nasser Al-Khelaifi signed a settlement agreement. The club may have amassed a deficit of 218 million over the two preceding seasons, but the penalty was nevertheless grotesquely benign: Just 20 million euros, nothing but pocket change for the Qatari sheikhs.

The deal with Manchester City was a bit more complicated, not least for Gianni Infantino. According to UEFA, the club's deficit was at least 188 million euros, but there was still no settlement in sight. Umberto Lago wrote that an amicable settlement had to be reached by mid-May, otherwise he would refer the case to the Adjudicatory Chamber of the Club Financial Control Body. Should that have happened, the team could have found itself facing a Champions League ban.

That was the reason Gianni Infantino sent Manchester City Chairman Khaldoon Al Mubarak his deferential "Let's be positive!" email just before midnight. In Manchester, after all, the mood had shifted dramatically against UEFA leadership.

On May 9, Manchester City executives showed up in Nyon for an appearance in front of the Investigatory Chamber. One day prior, Mubarak and Soriano had attended a secret meeting with Infantino in London to prepare the details of a settlement. But the meeting at UEFA headquarters achieved no results.

Manchester City leadership was furious. The meeting in Nyon had been "a disgrace," raged the club's chief legal adviser Simon Cliff, and the deal they had hammered out with Infantino, he complained, had been disavowed by the Investigatory Chamber. He sent out a confidential memorandum with the title: "POSSIBLE LEGAL ACTIONS."

Cliff considered overwhelming UEFA with lawsuits. He felt that "UEFA doesn't respond to anything other than aggression" and he wanted to take both Platini and Infantino to court in Switzerland for abuse of office and conflicts of interest. He also had it out for the auditors of PwC. It is possible, he wrote, that a lawsuit "could destroy the entire organization within weeks." He went on: "If PWC was under threat, you could then imagine them suing UEFA for damages and, if they collapsed, all their creditors suing UEFA too."

On May 11, 2014, the last day of the season, Manchester City won the Premier League title, their second in three years. One day later, Gianni Infantino wrote to Mubarak: "Unfortunately I've been informed that the Investigatory Chamber has come to the conclusion that the positions are still too distant for them to agree on a settlement agreement." He wrote that he found the situation regrettable and closed with a statement that could hardly be more ironic: "But the Investigatory Chamber is an independent body and I have to respect their decision."

Then, the club received a confidential message from UEFA President Platini explaining that at the Europa League final in Turin, he had spoken with Patrick Vieira, a member of French side that won the 1998 World Cup and who was working on behalf of Manchester City. "Please tell your owners in Abu Dhabi they have to trust me," Platini wrote in the message. "We understand and like what they are doing with the club." And, wonder of wonders, Gianni Infantino then extended a new settlement offer to Manchester City. "I feel like Bill Murray in Groundhog Day," one high-ranking club official complained.

On May 16, Man City CEO Soriano signed the agreement. The penalty was just as mild as the one that had been levied against Paris Saint-Germain: 20 million euros. In an email to Manchester City managers, Soriano wrote that the settlement "does not materially affect us."

In the years following the settlements, PSG and Manchester City together spent more than a billion euros on new players.

The EIC investigative network contacted Manchester City to request comment about the events described in this story. In response, the club said it would not reply to the questions posed and added: "The attempt to damage the Club's reputation is organized and clear."

Just how cynically and disdainfully Manchester City viewed the Financial Fair Play monitors, which they successfully managed to evade with Infantino's help, can be read in an email written by Cliff.

One day before Soriano signed the settlement on behalf of Manchester City, Jean-Luc Dehaene, who had led the Investigatory Chamber until falling ill in early 2014, died.

"1 down, 6 to go," Cliff wrote to a Manchester City employee who had informed him of Dehaene's death.