Is Gold About To Get Whacked?




Gold has spent the past couple of weeks steamrolling technical barriers and reviving the spirits of long-suffering gold bugs.
 
But markets don’t move in a straight line. Bull runs (if that’s what this is) have stomach-churning corrections along the way – usually just as everyone concludes that the good times will roll on forever.
 
321gold’s Bob Moriarty, a consistent voice of reason in the precious metals space, explained this to his readers yesterday:
Gold bulls are coming out of hibernation with even billionaires talking about how much they like gold. That tends to happen just before a correction. The gold bulls get frothy around the mouth; speculators pour money into gold contracts just in time to get whacked once more so they can whine about how gold and silver are manipulated and no one saw it coming. 
I’ve written a number of times about the importance of understanding bullish sentiment.  
I find the DSI of Jake Bernstein the single most valuable indicator I use. On both Thursday and Friday last, the DSI for gold hit 94. That doesn’t suggest a major high marking a top for the next 200 years but it does say caution would be merited.  
Too many people turned bullish all of a sudden. 
The COTs agree. Gold sentiment is excessive.

Speaking of the COTs (which show the structure of the gold futures market), they are indeed excessive. The past few weeks have seen an epic buildup of speculator longs and commercial shorts:

Gold COT gold whacked


Here’s the same data in graphical form, with the speculators in gray and the commercials in red:


Gold COT chart gold whacked


Since the speculators are usually wrong at big turning points and the commercials are usually right, the paper market set-up is extremely bearish. As Moriarty says, this doesn’t mean an end to the bull market, but it might mean a several-week-long pause.

As for how to play this kind of squiggle, that’s easy. Keep doing what you should have been doing all along, which is dollar-cost-averaging into gold and silver bullion and well-chosen mining stocks. The fundamentals that will eventually drive precious metals and other real assets higher will continue their long march towards an era-ending financial crisis. And gold will track this evolution — with the occasional correction.


Ray Dalio Is Kinda, Sorta, Really Wrong, Part 3

By John Mauldin


Two weeks ago I started a mini-series in the form of an open letter responding to a series of essays by Ray Dalio, the founder of Bridgewater Associates. I wrote here and here that he was kinda, sorta wrong in Why and How Capitalism Needs to Be Reformed, Parts 1 and 2 but really, really wrong in It’s Time to Look More Carefully at ‘Monetary Policy 3 (MP3)’ and ‘Modern Monetary Theory,’ in which he basically endorsed MMT. Today I continue my response.

If reader feedback is any indication, you are also passionate about this conversation. Last week’s letter generated many long, thoughtful reader comments. Clearly, it is not just Ray and I who are worried about the country’s future direction. I find that encouraging. A national conversation is precisely what we need in these serious times.

As noted, Ray has done us all a service by pointing out some rarely mentioned elephants in the room (some tinged with pink). We discuss various parts but seldom the entire creature. By that, I mean the rapidly growing potential for “progressive” control of both Congress and the White House. This stems from differences between haves and have-nots, between the protected and unprotected, combined with a desire to have government solve our society’s perceived ills.

So let’s pick up where we left off last week.

Dear Ray


In Part 1 of this letter I mostly agreed with you about the significant wealth and income disparities in the US today. And then in looking for your hope of a bipartisan commission that can deal with the problems, I simply pointed out that such commissions have rarely worked in the past and would be even more unworkable given today’s partisan, ideological divide.

Now I want to review two of your suggested solutions. Since this is an open letter and others will be reading it, let me quote directly from that section:

1. Leadership from the top. I have a principle that you will not effect change unless you affect the people who have their hands on the levers of power so that they move them to change things the way you want them to change. So there need to be powerful forces from the top of the country that proclaim the income/wealth/opportunity gap to be a national emergency and take on the responsibility for reengineering the system so that it works better.

4. Redistribution of resources that will improve both the well-beings and the productivities of the vast majority of people. As an economic engineer, naturally I think about how money might be obtained from taxes, borrowing, businesses, and philanthropy, and how it would flow to affect prices and economies. For example, I think about how a change in personal tax rates might occur and how changes in them relative to corporate tax rates would affect how money would flow, and how changes in tax rates in one location relative to another location would drive flows and outcomes in them. I also think a lot about how the money raised will be spent—e.g., how much will be spent on programs that will improve both social and economic outcomes, and how much will be redistributive. Such decisions would of course be up to the people on the bipartisan commission and the leadership to decide and are way too complicated an engineering exercise for me to opine on here. I can, however, give my big picture inclinations. Above all else, I’d want to achieve good double bottom line results. To do that I’d:

b. Raise money in ways that both improve conditions and improve the economy’s productivity by taking into consideration the all-in costs for the society (e.g., I’d tax pollution and various causes of bad health that have sizable economic costs for the society).

c. Raise more from the top via taxes that would be engineered to not have disruptive effects on productivity and that would be earmarked to help those in the middle and the bottom primarily in ways that also improve the economy’s overall level of productivity, so that the spending on these programs is largely paid for by the cost savings and income improvements that they create. Having said that, I also believe that the society has to establish minimum standards of healthcare and education that are provided to those who are unable to take care of themselves.

A National Emergency?

Let me highlight in particular one sentence from the above with my own bolded emphasis.

So there need to be powerful forces from the top of the country that proclaim the income/wealth/opportunity gap to be a national emergency and take on the responsibility for reengineering the system so that it works better.

First, let’s ignore the fact that many would not agree that the income and wealth gaps rise to the level of “national emergency.” Let’s for the moment assume the levers of power you mention would pass to a majority who would in fact see it that way and want to do something about it.

Using suppositions and hypotheticals, this is not all that far-fetched. It is entirely possible next year’s elections will deliver a Democratic Congress and White House that would consider these gaps a national emergency. A recession in early 2020 would raise those odds. And if not in 2020 then by 2024 it might even be more plausible.

That said, let’s look at what your proposals to raise taxes and redistribute income might actually look like.

First, the on-budget national deficit for this year will be in the $1 trillion range and when you add in the off-budget deficits total debt could easily rise by $1.3 trillion or more. That’s just in 2019 and it won’t get much better in 2020.

Total US government debt is now $22.4 trillion. We could easily see the national debt at $25 trillion before the next inauguration. That doesn’t include the $3 trillion+ state and local governments owe, nor some $100 trillion of unfunded federal liabilities or $6.7 trillion of unfunded state and local government pensions (data from The US Debt Clock.)

Even a garden-variety recession will blow those deficit numbers out of the water. If revenue falls and expenses rise as they did in the last two recessions, a $2-trillion deficit is more than likely. The national debt would almost certainly reach $30 trillion within a few years.

Interest on the national debt is budgeted at $389 billion for fiscal 2019. Assuming similar interest rates in the future, that cost will rise to almost $550 billion on a $30-trillion national debt—almost as much as the defense budget.

Essentially, we would need to raise taxes by $1 trillion along with some considerable budget cutting just to balance the budget before we get into any redistribution of income. But let’s set aside that for the moment and talk about raising taxes enough to fund the income redistribution programs you would like to see.

In your words, you want to increase taxes “from the top” and earmark those increases to help those in the bottom and middle, somehow “engineering” those taxes to have no effect on productivity. Let’s look at some real-world numbers of what the top income earners pay in taxes, courtesy of the Tax Foundation.
 


 
Some 68% of all income tax revenue comes from the top 10% of income earners.
 
That’s fair enough, I suppose. Interestingly, the top 1/10 of 1% of income tax payers pay more than the bottom 50% combined.  


Source: Bloomberg

 
Here’s a chart from that same Bloomberg article that breaks it down by the different percentiles and the percentage of total income taxes they paid. The top 1% paid a greater share of individual income taxes (37.3%) than the bottom 90% combined (30.5%).
 


Source: Bloomberg

 
Now, let’s go back to the Tax Foundation data. This is part of a larger and more detailed analysis at the website.



 
Note the top 10% of income tax payers paid approximately $1 trillion in income taxes. When you say that you want to “raise more from the top via taxes” let’s see what that means. Giving $3,000 to each of the 70 million tax filers in the bottom half would require $210 billion. You would also need the government to have the systems and people to do this which would require at least another $20 billion or so, and that may be giving a lot of credit to government efficiency.

So, getting an additional $230 billion from the top 10% of income earners would mean giving that group a roughly 23% across-the-board tax increase. That’s before we do anything about the national deficit.

Note also, to do this you wouldn’t be taxing only millionaires and the rich. To get in the top 10% of income payers you merely need to be making ~$140,000 a year. The cut-off for the top 5% is approximately $200,000.

So, let’s say we ask only the top 5% of income earners to fund this new spending. To get that same $230 billion you would need to raise their taxes by approximately 30%, give or take.

Want to do it just from the top 1%? You would need to raise their tax rates by 50%. Again, that is before we even begin to reduce the deficit.

And when you say that you want to engineer these taxes not to affect productivity, I am scratching my head trying to figure out precisely how to do that. The marginal tax rate for incomes over $500,000 is 37%. So if you wanted to get that $230 billion from the wealthiest taxpayers, their top marginal tax rate would rise to approximately 56%. Add state income tax and the rates could easily get to 60% or more in some states.

And do we really want to raise taxes either during or just after recession? Seriously? Not exactly a prescription to boost the economy and productivity.

Adding a little more complexity, there is a difference between the top 10% of earners and the top 10% of taxpayers. To be a top-10% earner, you merely have to make $118,000. In October of 2018, the Economic Policy Institute published a study showing that the top 1% reached the highest wages ever in 2017. But when you read all those stories about the 1%—or even the top 5% or 10%—how much money do you need to pull in to be in one of those groups?


Source: Investopedia

 
We already have a system where somewhere between 40–47% of taxpayers literally pay no income tax. (They do, of course, pay Social Security and Medicare taxes on their wage incomes.) How much more progressivity do we need in order to be “fair,” whatever that is?

It is one thing to simply state that you want to engineer taxes in order to redistribute income to the lower half and doing that while not hurting productivity. But it is another thing entirely to lay out exactly how much money is needed to be able to make the system more equitable.

Is $3,000 per family enough? Do you need twice that much? Where does the money come from and how much would taxes have to be raised? It is one thing to say that we should tax pollution (if it would help bring down pollution, I might even find myself in favor of that—pollution has a social cost) but it is another thing to say what constitutes pollution and how much. Automobile emissions? Do you raise taxes on the bottom 50% for their cars? It gets complicated real quick.

Louisiana Sen. Russell Long (Senate finance committee chair from 1966 to 1981) is credited with saying, “Most people have the same philosophy about taxes. Don’t tax you, don’t tax me, tax that fellow behind the tree.” If the top 10% are the “fellow behind the tree” then you must raise their taxes substantially in order to collect any meaningful amount of money. Or else move down the scale and raise taxes on many more people.

The real emergency? Trillion-dollar deficits that will grow to $2-trillion deficits during the next recession. You could literally double taxes for the top 10% and barely balance the budget today, before any recession. That is how far out of balance our system has gotten.

And all this is before we have paid for climate change or free college or any of the progressive left’s other proposals, along with income redistribution. And to be fair, Republicans are no longer concerned about multi-trillion-dollar deficits, either. They just have different spending priorities.

You want bipartisanship, Ray? It seems to me that deficit spending pretty much gets everyone’s support. Not exactly the kind of bipartisan cooperation that I find helpful.
 
A Little Coordination, Please

Finally, you call for coordinated monetary and fiscal policies. Quoting:

5. Coordination of monetary and fiscal policies. Because money is clogged at the top and because the capacity of central banks to ease enough to reverse the next economic downturn is limited, fiscal policy will have to be more coordinated with monetary policy, which can happen while maintaining the Federal Reserve’s independence. If done well, this will both stimulate economic growth and reduce the effects that quantitative easing has on increasing the wealth gap by shifting money and credit into the hands of those who have a higher propensity to spend from those who have a higher propensity to save and from those who need it less to those who need it more.

Here and elsewhere, you acknowledge that quantitative easing did in fact make the income and wealth gap worse. So you call for fiscal policy to do the income redistribution that you feel necessary.

When I read Parts 1 and 2, I came to this section and left a little bit mystified. If you didn’t want to use quantitative easing, and the realities of our national debt and growing deficits being what they are, how much would taxes have to be raised?

And then you answered that question when you wrote It’s Time to Look More Carefully at ‘Monetary Policy 3 (MP3)’ and ‘Modern Monetary Theory’. And it is at this point that you went from being kinda, sorta wrong to being really, really, really wrong.
 
[To be continued…]
 

Next week we will look at various scenarios for the future (going out about 10 years), what their various outcomes and costs might be, and how we can deal with the massive debt and deficits, not to mention new spending programs. I am actually going to propose my own solution that I think will put us back on track.

Unfortunately, paraphrasing Winston Churchill, the US will likely try everything else before we finally do the right thing.

Boston, New York, and Puerto Rico

I am enjoying the beautiful weather here in Puerto Rico. Later this month I’ll be visiting Boston and New York, then on July 4 I fly back to Puerto Rico working on what will likely be Part 5 of this series. It may or may not be the final part. I’ll just see how far I get.

Shane has developed an interesting new hobby. One of our guest bedrooms has an open outdoor alcove. There was really nothing in it but weeds when we moved in. She has cleared it out and made a nice little garden. The interesting thing is that she planted something that to me looks like a weed but monarch butterfly caterpillars evidently consider those weeds to be ambrosia. So now Shane is growing cocoons and raising monarch butterflies. It is really pretty cool to watch them emerge from the cocoon. And theoretically, they’ll migrate back next year, since they supposedly return where they were born to start the process all over again. We’ll see how that theory works next year. But right now, it’s just a lot of fun.

And with that I will hit the send button. I feel like there’s more to be said on taxes. I know that Elizabeth Warren is talking about a wealth tax. I’m not quite certain how that would work on illiquid assets. It would certainly raise a lot of money but imagine the chaos.

On that cheerful thought, let me wish you a great week!

Your thinking about taxes in the future analyst,



John Mauldin
Chairman, Mauldin Economics

Deeper in the red

As growth slows, the spectre of local-government debt looms once more

The central government urges spending, but regions are burdened by debt




A STATUE OF a golden bull, poised to charge, stands outside the headquarters of Xiangtan Jiuhua, a government-owned company that funds much of Xiangtan’s infrastructure investment. It has seen better days: the gold paint is flaking and the torso is cracked. That makes it a fitting symbol for public finances in the sprawling prefecture of 3m people in central China, and scores of similar cities across the country, where the ambitions of local officials have collided with heavy debt loads.

Concerns about local balance-sheets in China have recurred over the past decade. Recently they have come into sharp focus again. Attempts to clean up local debts have not worked. And borrowing looks set to rise as the trade war rumbles on: China wants its provinces and cities to prop up growth by building roads and railways.

At just 38% of GDP, less than half the average in advanced economies, government debt in China might seem under control. But that misses much of what is happening. Local governments have long relied on off-balance-sheet debt to solve a perennial policy quandary.

They are responsible for about 85% of public expenditures, yet command only 50% of revenues. Moreover, central authorities make it hard for them to borrow formally, hoping to limit their profligacy. So they have created entities such as Xiangtan Jiuhua, referred to as “local-government financing vehicles” (LGFVs). These are registered as companies. But creditors know—or, rather, assume—that the state stands behind them.

At last count China had 11,566 LGFVs. According to the IMF, when they are factored in, government debt rises to about 70% of GDP. This is worrying for three reasons. The first is the trajectory, with LGFV debts more than tripling over the past decade. The second is their opacity. Banks and bond investors think they must be safe, but even government auditors struggle to get a full picture of what is owed and where the money is going. Third, it is China’s poorer inland provinces that are most reliant on LGFVs. China International Capital Corp (CICC), a big domestic brokerage, has referred to them as a “grey rhino”: a risk that, unlike a “black-swan” event, is obvious but easily ignored.

The government, to be fair, does not have its eyes closed. It has been trying to limit LGFV borrowing since 2010. Regulators have also sought to ease financial constraints on local governments, most notably through a giant debt swap in which local governments exchanged trillions of yuan in LGFV bonds for official bonds charging lower interest.

But big risks remain. LGFVs are becoming less able to pay back their debts. Their operating incomes cover only about 40% of their obligations due within one year, according to CICC. For a normal company, that would spell trouble. Moreover, local governments remain addicted to them. Stripping out the bond swap, LGFV borrowing rose at 20% annually over the past five years, far outpacing overall debt growth.

Last year China seemed to be getting serious about crimping off-balance-sheet borrowing. It wielded its most potent weapon: permitting defaults. On 15 occasions LGFVs failed to repay loans on schedule, according to Fitch, a ratings agency. That spooked markets. LGFVs’ interest rates went up, and their bond sales slowed.

The impact was palpable. Local governments had less cash to spend, and Xiangtan was one of the casualties. It was forced to halt work on a highway around the city, which now stops abruptly at hoardings plastered in yellowing propaganda posters. A dirt track takes the place of an on-ramp. Zhou Juzhen, a retiree, has planted a small garden of chili peppers and green beans at its edge. “I wish the construction would resume,” she says. “It would be much more convenient living next to a big road.”

The slowdown in building has played out on a national level. Infrastructure investment was just 1.6% higher in May than a year earlier, a big comedown from the previous double-digit norm.

Worried about slowing GDP growth, on June 10th the central government opened the door for provinces and cities to increase spending. It urged them to issue special bonds for big projects such as modernising power grids. Many think local governments will again turn to a familiar friend. “Faith in LGFVs is seemingly on the rise again!” exclaimed analysts with ICBC, a major Chinese bank.

But the government may find that last year’s stringent debt-control campaign has made provinces and cities more reluctant to open their wallets. Local officials know that once growth stabilises, they are likely to face pressure to deleverage again, says Houze Song of the Paulson Institute, a think-tank in Chicago. There is a more radical option: the central government could in effect fund LGFVs directly. China Development Bank, a giant state-owned lender, has started to offer long-term loans to LGFVs to replace their short-term debts. This is similar to the bond swap, but allows LGFVs to get cheaper funding without testing the market.

Yet there are obvious drawbacks. For one thing, it puts the central government on the hook for LGFV liabilities. And if the programme is rolled out nationwide, efforts to get them to operate more responsibly would come to naught. So far the government has reportedly tested swaps in a few places. Xiangtan is one, not least because the prefecture includes the birthplace of Mao Zedong. China’s leaders do not want to see defaults here, of all places.

At a river that bisects Xiangtan, giant pilings have been sunk to support a bridge. But the site has been abandoned, another victim of the local cash crunch. Fu Weijun, who works in a nearby steel mill, walks along its banks before his shift begins. It is just a matter of time before the bridge is completed, he says. “Western countries change too often. We can stick to the same path, no matter what.” That confidence might be shaken in the coming years.

The rich world is enjoying an unprecedented jobs boom

Capitalism’s critics are yet to notice




EVERYONE SAYS work is miserable. Today’s workers, if they are lucky enough to escape the gig economy and have a real job, have lost control over their lives. They are underpaid and exploited by unscrupulous bosses. And they face a precarious future, as machines threaten to make them unemployable.

There is just one problem with this bleak picture: it is at odds with reality. As we report this week, most of the rich world is enjoying a jobs boom of unprecedented scope. Not only is work plentiful, but it is also, on average, getting better. Capitalism is improving workers’ lot faster than it has in years, as tight labour markets enhance their bargaining power. The zeitgeist has lost touch with the data.


Just the job

In America the unemployment rate is only 3.6%, the lowest in half a century. Less appreciated is the abundance of jobs across most of the rich world. Two-thirds of the members of the OECD, a club of mostly rich countries, enjoy record-high employment among 15- to 64-year-olds. In Japan 77% of this group has a job, up six percentage points in six years. This year Britons will work a record 350bn hours a month. Germany is enjoying a bonanza of tax revenue following a surge in the size of its labour force. Even in France, Spain and Italy, where joblessness is still relatively high, working-age employment is close to or exceeds 2005 levels.

The rich-world jobs boom is partly cyclical—the result of a decade of economic stimulus and recovery since the great recession. But it also reflects structural shifts. Populations are becoming more educated. Websites are efficient at matching vacancies and qualified applicants.

And ever more women work. In fact women account for almost all the growth in the rich-world
employment rate since 2007. That has something to do with pro-family policies in Europe, but since 2015 the trend is found in America, too. Last, reforms to welfare programmes, both to make them less generous and to toughen eligibility tests, seem to have encouraged people to seek work.

Thanks to the jobs boom, unemployment, once the central issue of political economy, has all but disappeared from the political landscape in many countries. It has been replaced by a series of complaints about the quality and direction of work. These are less tangible and harder to judge than employment statistics. The most important are that automation is destroying opportunities and that work, though plentiful, is low-quality and precarious. “Our jobs market is being turned into a sea of insecurity,” says Jeremy Corbyn, leader of Britain’s Labour Party.

Again, reality begs to differ. In manufacturing, machines have replaced workers over a period of decades. This seems to have contributed to a pocket of persistent joblessness among American men. But across the OECD as a whole, a jobs apocalypse carried out by machines and algorithms, much feared in Silicon Valley, is nowhere to be seen. A greater share of people with only a secondary education or less is in work now than in 2000.

It is also true that middle-skilled jobs are becoming harder to find as the structure of the economy changes, and as the service sector—including the gig economy—expands. By 2026 America will have more at-home carers than secretaries, according to official projections. Yet as labour markets hollow out, more high-skilled jobs are being created than menial ones.

Meanwhile, low-end work is becoming better paid, in part because of higher minimum wages.

Across the rich world, wages below two-thirds of the national median are becoming rarer, not more common.

As for precariousness, in America traditional full-time jobs made up the same proportion of employment in 2017 as they did in 2005. The gig economy accounts for only around 1% of jobs there. In France, despite recent reforms to make labour markets more flexible, the share of new hires given permanent contracts recently hit an all-time high. The truly precarious work is found in southern European countries like Italy, and neither exploitative employers nor modern technology is to blame. The culprit is old-fashioned law that stitches up labour markets, locking out young workers in order to keep insiders in cushy jobs.

Elsewhere, the knock-on benefits of abundant work are becoming clear. As firms compete for workers rather than workers for jobs, average wage growth is rising, pushing up workers’ share of the pie—albeit not as fast as the extent of the boom might have suggested. Tight labour markets lead firms to fish for employees in neglected pools, including among ex-convicts, and to boost training amid skills shortages. American wonks fretted for years about how to shrink disability-benefit rolls. Now the hot labour market is doing it for them. Indeed, one attraction of the jobs boom is its potential to help solve social ills without governments having to do or spend very much.

Nonetheless, policymakers do have lessons to learn. Economists have again been humbled. They have consistently underestimated potential employment, leading to hesitant fiscal and monetary policy. Just as their sanguine outlook on finance in the 2000s contributed to the bust, so their mistaken pessimism about the potential for jobs growth in the 2010s has needlessly slowed the recovery.

The left needs to accept that many of the criticisms it levels at capitalism do not fit the facts.

Life at the bottom of the labour market is not joyous—far from it. However, the lot of workers is improving and entry-level jobs are a much better launch pad to something better than joblessness is. A failure to acknowledge this will lead to government intervention that is at best unnecessary and at worst jeopardises recent progress. The jobs boom seems to be partly down to welfare reforms that the likes of Mr Corbyn have vociferously opposed.

The right should acknowledge that jobs have boomed without the bonfire of regulations that typically forms its labour-market policy. In fact, labour-market rules are proliferating. And although the jury is out on whether rising minimum wages are harming some groups, such as the young, they are not doing damage that is large enough to show up in aggregate.

The jobs boom will not last for ever. Eventually, a recession will kill it off. Meanwhile, it deserves a little appreciation.

Technology platforms are losing control

The land grab for assets across media and food delivery shows their power is under threat

John Gapper




Everything Amazon does has an impact and by leading a $575m funding round for the British food delivery company Deliveroo, it hurt shares in the latter’s rivals. The deal gives Amazon a stake in both delivery and preparation through “dark kitchens” in which some Deliveroo meals are made.

It is an arresting move — who knew that a company that started by selling books online would end up as the part owner of kitchens? — but it is characteristic of Amazon’s roaming instinct. It has moved from online retailing to running warehouses, publishing books, and making films and television shows for its Prime streaming service.

More surprising is the degree to which other technology groups are following Amazon in becoming vertically integrated. Instead of sticking to the business of running platforms, they are creating their own content and buying assets to bolster themselves.

Netflix is close to a 10-year deal with Pinewood to lease studio facilities in the UK, while WeWork is raising $2.9bn for a property fund to buy offices that it will lease. Apple is spending hundreds of millions on video game development for its Arcade service, pushing Microsoft and Sony to form a tentative alliance to defend their games franchises.

Integration is also developing in the other direction, with brands trying to find a path to sell directly to consumers, rather than through retailers. Edgewell Personal Care, owner of the Wilkinson Sword and Schick men’s razor brands, this month acquired Harry’s, the razor subscription business, for $1.4bn. Investors took fright and Edgewell shares dropped to a 10-year low.

A sudden move to integrate by buying a supplier or distributor suggests vulnerability — why take the risk of doing it unless you fear being shut out? Controlling the supply chain from parts to production, marketing and distribution secures autonomy. But it also requires capital investment and is a challenge for any company to manage.

So far, technology companies have not been punished by shareholders for pursuing integration. Amazon is trusted to handle acquisitions, such as that of Whole Foods, the US supermarket chain, and Netflix’s huge investment in original production has not alienated investors. Their critics instead wonder whether they are acquiring too much power over markets.

Lina Khan, a fellow at Columbia Law School, has attacked Amazon for exploiting the gaps in US competition law, arguing that it has “marched toward monopoly by singing the tune of contemporary antitrust”. Ms Khan singles out its vertical integration, which is treated leniently by US authorities.

Amazon has expanded across its supply chain, into retailing and other services, and controls production and distribution assets, now including a stake in Deliveroo. This enables it to offer its own goods and services to Prime subscribers, as well as boosting its bargaining strength with other suppliers.

This contrasts with the original approach of platforms such as Google and Facebook, which focused on building networks while relying on others for content. Uber and Lyft have a similar strategy — creating ride services by linking drivers to customers, rather than by owning and operating taxis.

But as platforms mature, vertical integration is growing. The meal delivery industry is one example, moving from a traditional platform approach to one in which companies such as Deliveroo and UberEats run kitchens. Deliveroo is a pioneer with its Editions kitchen hubs, where meals are prepared by restaurants and caterers.

The threat is that someone else builds such facilities, limiting the power of any platform: Travis Kalanick, Uber’s co-founder, last year acquired a $150m controlling stake in the parent of CloudKitchens, which does so. Restaurants at its facilities in Los Angeles cook meals that are delivered by platforms including Uber Eats and GrubHub.

A similar battle is occurring in video games, with both Apple and Google setting up new streaming services. The ideal for these companies would be to have games developers flock to their platforms and pay them fees, but competition is such that they cannot rely on that. Apple is taking the same path as Netflix — investing in production to secure exclusive rights.

This makes technology companies more like media businesses that own distribution and content. Vertical integration was limited in the 1970s and 1980s by rules barring US television networks from controlling too much production but has grown. Mergers such as Comcast’s acquisition of NBC Universal have been approved by regulators.

The shift to integration by technology companies requires close scrutiny by competition authorities, as Ms Khan suggests. But it is also an expression of weakness — platforms that used to be able to dictate terms to providers of content and services now feel the need to secure assets, rather than risk being shut out by others.

If so, investors may be treating the land grab across retailing, media and other industries too complacently. They are accustomed to Amazon and others being able to dominate, but this burst of dealmaking tells a story of technology platforms losing control.

Looking Back at 100

Three themes have dominated the author's analysis of global affairs in his previous 99 Project Syndicate commentaries. All of them – Middle East turmoil, the rise of China, and the dissolution of the post-World War II and post-Cold War order – are certain to figure prominently in the next hundred.

Richard N. Haass

haass101_StudioDorosGettyImages_booksmagnifyingglass


NEW YORK – This is my 100th column for Project Syndicate. It comes nearly 20 years after my first. As is the case with most milestones, it offers a good opportunity to take stock, to look back on what I have written, and to see what it says about the world over these two decades and where we may be heading.

Three themes stand out. The first is how much the Middle East consumed the world’s attention, including mine. Think about it: This is a region that is home to around 6% of the world’s people, and, despite possessing vast amounts of oil, accounts for less than 5% of global economic output. Yet it manages to account for a large share of the world’s headlines, conflicts, terrorists, and refugees.

Some blame the Middle East’s many problems on the European colonial powers. But that era is too distant from our own to explain today’s failures. After all, many former colonies elsewhere in the world are thriving.

That said, outsiders have made things worse over the past two decades, both by what they did (the US invasion of Iraq in 2003 comes to mind, as does NATO’s intervention in Libya and Russia’s in Syria) and by what they failed to do.

Here I would list US reluctance to act in Syria even after the government there defied warnings and used chemical weapons. While the intervention in Libya was misguided, once that decision was made, it was incumbent upon the United States and its European partners to mount an effort to stabilize the country following the ouster of Muammar al-Qaddafi.

Yet the lion’s share of the responsibility for the Middle East’s terrible record lies with the region’s leaders, who have largely failed to provide economic opportunity or political rights at home and who have refused to compromise in the cause of peace. Instead, what we have seen are prolonged and costly conflicts in Syria and Yemen, stagnation in Egypt, and fading prospects for any lasting settlement between Israel and the Palestinians.

The second theme that emerges from the past two decades is Asia’s emergence as the central arena of modern international relations. If Europe was the principal venue of much of twentieth-century world history, including two hot wars and one cold war, now it is Asia’s turn. The region is where one finds the bulk of the world’s population, the majority of its economic output, and increasingly its military might. It is where the major powers of this era face one another.

The good news is that for the past 20 years – in fact, since the end of the Cold War – Asia has remained stable, underpinned by America’s steadying hand and buoyed by rapid economic growth. The question now is whether stability will continue to be the rule, given China’s rise, the near-certainty that North Korea will not just retain but possibly expand its nuclear and missile capabilities, and lingering disputes over the South and East China Seas, Taiwan, and numerous islands and borders.

The third theme that runs through many of the previous 99 columns is the demise of the world that we knew. The titles of several commentaries say it all: “Liberal World Order, R.I.P.,” “Cold War II,” “Europe in Disarray,” “The Era of Disorder.”

One reason for this downbeat assessment is the growing prominence of a China that remains illiberal at home, engages in myriad unfair practices that boost its trading position, and is mostly unwilling to assume global responsibilities commensurate with its strength. Another is President Vladimir Putin’s Russia, which seeks to violate sovereignty – the most basic norm of what international order there is – with traditional and digital armies alike. Moreover, the gap between global challenges, such as climate change, and the willingness of the world to deal with them has widened. The thesis of my 2013 commentary, “What International Community?” still holds: the phrase stands for a concept that is more aspiration than reality.

One factor stands out amidst this deterioration: the refusal of the United States to continue to play its traditional role in the world. The last two decades have made clear that no post-Cold War US foreign policy consensus exists. What exists is wariness born of costly military interventions in Iraq and Afghanistan, and a populist surge fueled by the 2008 global financial crisis, growing inequality, and reduced upward mobility.

This is the context that gave rise to the election of President Donald Trump. Over the past two-plus years, Trump has added to global turbulence through his own unique mix of hostility to multilateral institutions and alliances; sustained use of tariffs and sanctions on behalf of goals that are so ambitious as to be unrealistic; increased military spending but decreased military action; a much-reduced emphasis on promoting democracy and human rights, coupled with a penchant for strongmen; and a faith in his own personal diplomacy but not in professional diplomats.

As suggested above, all this has contributed to the fading of the post-World War II, post-Cold War world. What will take its place is unclear; Trump is much more a disrupter than he is a builder. The next 20 years thus promise to be even more disorderly than the last 20. Sad to say, there will be more than enough material for at least a hundred more commentaries.


Richard N. Haass, President of the Council on Foreign Relations, previously served as Director of Policy Planning for the US State Department (2001-2003), and was President George W. Bush's special envoy to Northern Ireland and Coordinator for the Future of Afghanistan. He is the author of A World in Disarray: American Foreign Policy and the Crisis of the Old Order.

martes, junio 25, 2019

FINALLY, FOMO ARRIVES FOR GOLD / DOLLAR COLLAPSE

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Finally, FOMO Arrives For Gold

by John Rubino
 


The past few years have been a feeding frenzy for most major asset classes. Stocks blew through previous highs, as did trophy real estate, fine art, and, most recently, Treasury bonds.

A big part of the reason for what came to be called the everything bubble was the sense that with everyone else making easy money, the worst possible fate was to be stuck on the sidelines, a sentiment known as “fear of missing out,” or FOMO.

Gold, alas, wasn’t invited to this party and has languished far below its 2011 high, while bouncing off resistance at the $1,360 level five (!) times over the past five years.

That may have changed this month. As central banks move back into easing mode – with interest rates already at historic lows, implying that future cuts will take even more of the world into negative territory – and the US blunders ever-closer to a major shooting war, safe haven assets are suddenly in vogue. And gold has popped.

Gold price FOMO


Now the emotional tone of the precious metals market borders on giddy, with dozens of recent headlines quoting analysts on their upwardly-revised gold price targets and new buy ratings on precious metals mining stocks.

In other words, where just a few weeks ago would-be gold and silver buyers thought they had plenty of time and feared being stuck in a dead-money asset, they now feel like time is running out. FOMO has become their dominant impulse.

Here’s an excerpt from a King World News interview with Michael Oliver, a technical analyst who has been predicting a sharp, quick upward move in precious metals for the past few months and was — sharply and quickly — proven right in June. Not surprisingly, he thinks the current move has very long legs:

This is a new massive gold bull leg that’s an extension of the bull market that began in the 1970s…Most price chart analysts are looking at this and are thinking ‘I have to be in this or I’m’ going to miss it.’ We’ve rapidly taken out the highs of the past five years.  
Money managers who have not been in gold are being jolted into the sense that they have to be part of this. Especially with the gold miners, which are rising at double the rate of the metals. When these folks start to move assets into this sector it can have a dramatic effect. They’ll move explosively higher.  
Most people will be shocked where the next rest stop for the gold miners. GDX was $20 recently and could be above $30 in short order. It’s a new dynamic and all the price-related technical indicators that most people look at will be shattered to the upside. Ignore those overbought signals.  
By the end of the year we should see $1,700 in gold. That’s not the end, it’s just where it will be at year-end. We’re in a major situation.  
Silver, meanwhile, is about to slingshot to catch up with gold. It will do twice as well as gold, too quickly to allow time for committee meetings to decide whether or not to buy.  
You won’t get a measured move – expect a move from the mid $15s to over $20 in a matter of weeks. But that will be just the beginning. 
If you’re not there you’re going to miss it.

martes, junio 25, 2019

VISITING CHINA / GEOPOLITICAL FUTURES

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Visiting China

By George Friedman        

I can’t explain China. I don’t know it well enough, and sometimes it seems to me that the Chinese are experts on their country, but they’re experts that don’t agree. Still, China is an American adversary, and an adversarial relationship between these two countries is dangerous even if it doesn’t lead to war. Therefore, I have to try to understand China.

I have been to Shanghai and Beijing, which I suspect are as representative of China as New York City and Washington are of the United States. In that sense, I have not been to China. Still, these are the country’s political and economic centers, so I will begin there.

I traveled to Beijing last fall as the guest of a bank that wanted me to speak to Chinese investors. It was at a time when the economic confrontation between the U.S. and China was just heating up, and the meetings were tense. Everything I said was met with suspicion. The local people I met with were filled with bravado, of how they would retaliate against the U.S. and the price they would exact. A quiet drink with one or two of them later in the evening brought out another dimension, as such late-night encounters often do. The investors were afraid of the United States and wanted to send back a message that while the U.S. was overreacting, there was nothing that couldn’t be managed. The Chinese simply wanted to know what the Americans wanted.

These were important men. They were well connected to Chinese political power; they wouldn’t be handling the funds they were handling without political blessing. They had been to many countries, including the United States. One of them, who led a particularly large fund, had been confrontational in public but admitted in private that he didn’t understand the Americans – not the government, not President Donald Trump, and not what he took to be the animosity of the American public. In his view, Trump was the prisoner of massive social forces. (In some sense, this was the old Marxist in him searching for the social basis of things.) But he couldn’t understand how American society had turned on a country that had done it no harm.

There was something profoundly strange in his understanding of the U.S. On the one hand, he felt that Trump was a prisoner of social forces. On the other hand, he asked that I deliver him a message. Why deliver a message to a trapped man? The confusion was compounded by the idea that I could deliver a message to any senior official. I tried to explain that I was not connected with the government and that officials would not give me the time of day, assuming they had any idea who I was. This was also incomprehensible to him. How could I be in Beijing, speaking of matters as sensitive as those I addressed, and not be authorized by the government? The more I protested, the more he assured me that he understood. This is a dance I have done in many countries whose citizens cannot conceive of a private citizen knowing things and not being answerable to the government. (The assumption is that I am CIA, and the more I protest that I am not, the more I get a wink and knowing look.) But this man had been to and done business with the United States. How could he not tell that I was merely watching from the bleachers and putting forth my best analysis of the situation?

The truth is that while it can be said that Americans don’t understand China, even the most sophisticated Chinese simply don’t know how to read the United States. Yes, Trump was elected by social forces, and yes, he is president. But he has to deal with Congress and the courts. His hands are free and tied in a very American way. As for me, the U.S. is filled with people who go to China and act as if they know something. Washington is a city filled with people who would claim to know important people, but mostly they don’t.

Years ago, well before today’s mutual fear, I met a Chinese businessman who wanted to sell some goods to the Department of Defense. He wanted to meet with a senior government official, at least the secretary of defense. He was told that he needed to meet with a lieutenant colonel, the project manager, based in Colorado – that was the key to the sale, not the secretary of defense. The businessman recounted this story to me with anger, because he had clearly been rebuffed without courtesy. All I could do was tell him that he better hurry before the lieutenant colonel was rotated to a new job, and his job left open for six months.

While I was in Beijing, I was given a guide who would take me around the city. One of the places she took me was a small traditional neighborhood in the midst of Beijing called a hutong. It is not a museum but a small village with people living there, shopping there and raising families there. The cottages, if they can be called that, were small and my guide told me that she had lived in one of them when she first came to Beijing. She had a room with access to a shared stove for cooking in a hallway but no plumbing. When she wanted to take a shower or use a toilet, she would have to walk down the street to a communal bathroom. She told me many people wanted to live in this neighborhood but that rooms are very expensive.
 


Earlier that day, I had had lunch with an Australian friend in a shopping center, which would be quite upscale for the United States – all the international brands were there and then some. The mall was crowded with mostly younger shoppers. I was told that there were many such malls in Beijing. In the hutong, my guide told me that there were many such villages in Beijing. I find it incomprehensible that the capital of the second-largest economy in the world would have malls that would make Beverly Hills blush, intermingled with peasant villages from a bygone era. My guide could not understand my bewilderment.

This is the point where I am supposed to say that we should all work toward better understanding each other. If we have time, we should. But the fact is that we will not, on the whole, understand each other. I have met many U.S expats who had spent years in China and confessed that while they understood China better than I did, they still had large blank spots in their knowledge. Same for the Chinese. Each of us reasons through the prism of our own societies looking for analogs from our own countries. That includes those who admire the other country as much as those who fear and distrust it. The two countries have different geographies, histories and fears rising from different places.

It is also not necessary for us to understand each other, which is just as well since we won’t. What is necessary, however, is that the citizens of each understand their own country and its needs. I couldn’t explain to the Chinese fund manager how the U.S. works, but I could tell him what it wants from China: access to the Chinese markets on the same terms as we give them, and recognition that the Pacific is under American control. It is most important that we understand what we need and leave it to the Chinese to understand what they need, and the system will take care of itself, mostly peacefully and sometimes violently. But the idea that if we understood each other better we could work things out misses two points. First, that we won’t understand each other. And second, that the vast internal pressures in each country will determine what each will do – not a think tank, not the close friends of presidents. But if we know what we want, then at least we can understand what is going on.


Rejoicing Central Banker Capitulation

Doug Nolan


June 21 - Neel Kashkari, Minneapolis Fed president: “In the Federal Open Market Committee meeting that concluded on Wednesday of this week, I advocated for a 50-basis-point rate cut to 1.75% to 2.00% and a commitment not to raise rates again until core inflation reaches our 2% target on a sustained basis. I believe an aggressive policy action such as this is required to re-anchor inflation expectations at our target.”

May 31 – Bloomberg (Matthew Boesler): “It’s too early for the Federal Reserve to begin cutting interest rates despite increasing concerns about low inflation and an escalating trade war, said Minneapolis Fed President Neel Kashkari. ‘Either of those could be cause for changing the path of monetary policy, Kashkari told Bloomberg… ‘I’m not quite there yet. I take a lot of comfort from the fact that the job market continues to be strong.’”

In three short weeks, Kashkari’s view evolved from “It’s too early” to begin cutting rates to advocating a dramatic 50 bps cut that in the past would have been in response to a market or economic shock. Yet nothing that extraordinary has occurred over recent weeks, outside of a major bond market rally that has the amount of global debt trading at negative yields jumping $2 TN to a record $13 TN (from Bloomberg). Unprecedented as well, talk is heating up for a 50 bps cut with the S&P500 at all-time highs (and corporate Credit spreads narrowing sharply and overall financial conditions loosening notably).

Markets, Rejoicing Central Banker Capitulation, have no intention of letting off the pressure.

There will be unrelenting pressure as well on Chairman Powell to fall in line - or face demotion. Crazy.

Question from Bloomberg’s Chris Condon at Chairman Powell’s Wednesday post-meeting press conference: “Mr. Chairman, if and when the committee decides to cut rates, I suspect there will be a debate over whether to move by 25 or 50 bps. Indeed, there is a pretty substantial body of academic literature arguing that a central bank close to the zero lower bound ought to act sooner and more aggressively than it otherwise would. I’m wondering what you think of that prescription, and if you could spend a couple of minutes discussing the pros and cons of a 50 bps cut and how you approach that question.”

Powell: “On the specific question of that - that’s just something we haven’t really engaged with yet. And it will depend very heavily on incoming data and the evolving risk picture as we move forward. So, nothing I can say about that is specific to the near-term question that we face. More generally, though, the research you refer to essentially notes that in a world where you are closer to the effective lower bound – it’s why research kind of shows this – it’s wise to react, for example, to prevent a weakening from turning into a prolonged weakening. In other words, sort of an ounce of prevention is worth a pound of cure. So, I think that is a valid way to think about policy in this era. I don’t know – and it’s always in the minds of policymakers during this era - because it’s well-understood to be correct. Again, I don’t know what that means in terms of the size of a particular rate cut going forward. That’s going to depend heavily upon the actual data and the evolving risk picture.”

There’s a theory that, with interest rates not much above zero (“effective lower bound”), central banks must be ready to cut aggressively – employing their limited firepower early and forcefully – to “prevent a weakening from turning into a prolonged weakening.” I say theory - as opposed to “research” - because the experimental nature of the current monetary policy framework ensures minimal empirical data to analyze and draw conclusions.

In my view, this “act sooner and more aggressively” is the latest iteration of policy activism that further distances the Fed from its primary mandate of safeguarding system stability. December’s rapid emergence of systemic fragility (i.e. faltering Bubbles) emboldened the view that central banks must provide assurances they are prepared to quickly adopt “whatever it takes” measures to bolster the markets. From the perspective of highly speculative markets, the January “U-turn” unleashed a speculative fire and this month’s rush to dovishness (Fed, Draghi, PBOC, BOE, BOJ, etc.) pours gas on a flame. Countering Powell’s “an ounce of prevention is worth a pound of cure,” I would warn of the enormous cost of stoking blow-off “Terminal Phase Excess.” An ounce of late-cycle stimulus creates a pound of destabilizing excess.

Two long-held CBB themes should especially resonate these days. First, the fundamental problem with discretionary central banking (versus rules-based) is the propensity for a policy mistake to lead to a series of ever bigger blunders. Second, aggressive expansion of central bank Credit/balance sheets (aka “QE”, “money printing”) is a slippery slope eventually leading to a multitude of unintended consequences (including speculative market Bubbles, maladjusted economic structure, and trapped central bankers). Who back in 2008 anticipated the prospect of ongoing central bank purchases would be deeply embedded into global bond and securities prices – and market expectations more generally – a full decade later?

The QE naysayers at that time focused on the risk of inflation – and even hyperinflation – in consumer prices. However, the paramount issue was instead market distortions and hyperinflation in securities (and asset) prices, where perpetual QE essentially removes any ceiling on sovereign debt prices (floor on yields). Why shouldn’t exuberant traders imagine Treasury yields at some point trading at the current Swiss bond yield of negative 52 bps?

Why not leverage 10-year Treasuries at 2.06% if the Fed will eventually become a price insensitive buyer of Trillions of these securities? Why not take levered positions in German bunds at negative 29 bps – better yet, Italian and Greek debt at 2.15% and 2.52% - appreciating it’s only a matter of (probably not much) time before the ECB fires back up the “electronic printing press.” Perhaps most consequential of all, why wouldn’t everyone speculating globally in the risk markets simultaneously leverage in sovereign debt, confident that aggressive global QE deployment devises the perfect market hedge? Why not hedge market risk with sovereign debt-related derivatives? In total, we have unearthed a recipe for history’s greatest episode of speculative leveraging (mortgage finance Bubble excess measly in comparison).

A crisis-period experiment in QE came with profound repercussions. The Fed’s 2011 “exit strategy” was supplanted the following year by Draghi’s “whatever it takes” – and there’s been no turning back. The prospect of Whatever and Whenever It Takes QE as essential to the global central banker toolkit has Changed Everything.

June 18 – Financial Times (Scott Mather): “Central banks around the world are pivoting toward easier monetary policy. In pursuit of a 2% target for inflation, major central banks seem willing to exhaust their monetary policy ammunition at a time when economic output is at — or above — potential. Unfortunately, there is little evidence to suggest that lower policy rates are successfully generating either better real growth outcomes or higher inflation. In some countries, this policy stance has the potential to reduce monetary policy effectiveness, create imbalances that may sow the seeds for the next crisis, and leave central banks powerless to respond to that crisis. It is time to ask whether the 2% inflation target has outlived its usefulness. Despite largely maintaining policy rates below their own estimated ‘neutral’ levels for more than a decade, the central banks of the US, euro zone and Australia, among others, have been guiding markets to expect lower rates for longer. This is happening even as employment rates are already above estimates of full capacity, and economic growth rates have been higher than what is deemed to be achievable in the ‘steady state’.”

There is indeed “little evidence to suggest that lower policy rates are successfully generating either better real growth outcomes or higher inflation.” Instead, there’s a strong case for the opposite: a decade of ultra-loose monetary policy has contributed to downward pressure on many consumer prices (along with deep economic maladjustment). China, India, greater Asia and the emerging economies in general have enjoyed an unprecedented period of protracted loose financial conditions, associated investment booms and resulting overcapacity across industries.

No sector has benefited from loose global finance as much as technology. How can the global proliferation of myriad high-tech products and services not enter into today’s inflation discussion? There is today essentially unlimited supply of technology devices and services capable of absorbing much of whatever purchasing power thrown into economic systems. How great is the global capacity to manufacture smart phones, computers and servers, telecommunications equipment, and the “Internet of things” - not to mention a veritable deluge of technology-related services and downloadable content? What is the capacity for global online media to absorb swelling corporate marketing budgets?

The nature of output and overall economic structure has changed profoundly over the past 25 years. Historians and analysts will look back at this period and struggle to comprehend the blind focus on an arbitrary target for aggregate consumer price inflation, when securities markets and asset prices were going completely haywire.

“Globalization” remains complex subject matter. To simplify, highly integrated global finance has fundamentally loosened financial conditions for much (if not all) of the world. China, in particular, has “enjoyed” unlimited capacity to expand cheap Credit on a protracted basis to an extent never before possible. If not for global post-crisis zero rates and QE, China’s international reserve holdings would never have inflated from about $1.5 TN (end of ’07) to a 2014 high of $4.0 TN ($3.1 TN today). And without this massive reserve horde, renminbi stability would not have survived history’s greatest Credit inflation (i.e. total bank assets $7.2 TN to $41 TN since the end of ’07).

Globalization is tightly intertwined with experimental monetary policy. The world followed the U.S.’s lead in “activist” policy intervention, along with a related move to securitizations and market-based finance. Resulting market booms fundamentally loosened finance, stimulated investment and propelled economic growth. It also worked to exacerbate wealth disparities, within and between nations. Booms and Bubbles also ensured U.S.-style policy activism enveloped the world, with each new round of instability and attendant monetary stimulus further undermining the stability of markets, finance, economies, societies and geopolitics.

Today’s prescription for unstable markets and finance: more monetary stimulus. For unstable economies: more monetary stimulus. For inequality, trade wars and geopolitical uncertainties: much more monetary stimulus.

Couple momentous advancement in various technologies with globalized finance and policy activism and one has a remarkable backdrop with momentous ramifications for global price dynamics. I would argue strongly against conventional wisdom that holds the so-called “technology revolution” (with associated productivity gains and disinflationary pressures) granted central bankers greater latitude to boost growth with accommodative monetary policies. The primary focus, instead, should have been the powerful inflationary dynamics fueling asset prices and dangerous Bubbles. If there was an overarching lesson to be learned from the 2008 fiasco, it was that distorted financial markets and resulting Bubbles pose systemic risks that completely overshadow those that might emanate from rising consumer prices.

I am not against market-based finance per-se, although market-based Credit is notable for being inherently self-reinforcing on both the upside and downside. The problem arises when “activist” policymaking incentivizes the upside – fostering Bubbles. On the downside, faltering policy-induced Bubbles then ensure even more destabilizing policy activism. And in this Age of Market-Based Finance, the longer the recurring cycle of activism incentivizing excess and greater Bubbles the greater the risk of a crisis of confidence in policymaking and financial assets more generally. This miraculous game of massive issuance of new financial claims at increasing prices is unsustainable.

We’ve reached the point in this most extraordinary cycle where it’s become pretty clear that loose monetary policies have minimal impact on aggregate consumer prices and maximum influence on highly speculative securities and derivatives markets. The Fed is poised to cut rates – perhaps even 50 bps – essentially to sustain market Bubbles. With 10-year Treasury yields nearing 2% - and in excess of $13 TN of bonds trading globally with negative yields – sovereign bond markets have become completely divorced from traditional fundamentals. This equates to governments from Rome to Washington essentially being handed blank checkbooks. And with the (“risk free” sovereign debt) foundation of global finance in market dislocation, how sound are markets for equities and corporate Credit?

Capitalism is in clear and present danger. This sounds extreme – unless you’ve followed the trajectory of developments over the years. How are capitalistic systems to operate with central banks abrogating adjustments and corrections both for market and economic systems? It takes a tremendous amount of wishful thinking to believe that today’s markets will effectively allocate real and financial resources. Sound analysis also points to only more precarious imbalances and maladjustment on a global basis. And with global fragilities increasingly conspicuous, it’s reached the perilous point where markets believe central banks will preemptively flood the global system with liquidity to forestall “risk off” in the markets and recession globally.

June 20 – Financial Times (Don Weinland): “Banks in China are facing a pinch on liquidity following the government takeover of a commercial bank that is resetting the rules for trading in the country’s interbank market. Many of China’s more than 4,000 banks face difficulty raising deposits in smaller cities and rural areas, making them more reliant on wholesale borrowing from the interbank market, where banks lend to one another. But the government takeover of Baoshang Bank in May has disrupted the willingness of larger banks to lend to smaller ones, leaving some strained for liquidity… For interbank lenders, including some of China’s largest financial institutions, the treatment of Baoshang represents a sharp shift in the rules of the market. ‘It’s not just concern on credit risk, it’s also about the resolution mechanism [for defaults on interbank borrowings],’ said Katherine Lei, co-head of Asia ex-Japan banks research at JPMorgan. ‘What is the mechanism and how long does it take?’”

June 17 – Wall Street Journal (Stella Yifan Xie and Zhou Wei): “Chinese regulators made fresh attempts to calm frayed nerves in the country’s financial sector, as bank liquidity remained tight by some measures three weeks after authorities took over a struggling city lender. On Sunday, securities regulators summoned a group of large Chinese brokerages and asset-management firms to a closed-door meeting in Beijing and asked them not to cut off trading and other dealings with smaller banks and financial institutions, according to a meeting summary… The memo said there had been some defaults in the repo—or repurchase agreement—market, where banks, brokers and other financial firms borrow cash for short periods by pledging securities against short-term loans. It said some institutions in the debt markets had placed certain trading counterparties on a ‘blacklist’ and demanded they post higher-quality collateral against their borrowings. In other instances, some firms were cut off from trading because of worries that they would not repay their obligations, it said. ‘If such mistrust is allowed to continue to spread, it will eventually become systemic financial risk,’ the memo said, adding that mutual funds and brokers need to provide liquidity support to each other.”

June 18 – Wall Street Journal (Nathaniel Taplin): “While the world has been focused on the U.S.-China trade conflict, another threat—potentially just as large—has been brewing beneath the surface of China’s financial system. On Sunday, the country’s securities regulator convened a meeting asking big brokerages and funds to support their smaller peers… The briefing cited rising risk aversion in money markets after defaults in the bond repurchase market. Some interbank lending rates have moved sharply higher in recent weeks… Nonbank borrowing through bond repos and interbank loans has skyrocketed since China’s central bank began easing monetary policy in early 2018. It hit a net 74 trillion yuan ($10.7 trillion) in the first quarter of 2019, according to Enodo Economics, up nearly 50% from a year earlier… Worryingly, problems appear to be migrating from the relatively small market for negotiable certificates of deposit (NCDs)—used primarily by small banks—into the much larger bond repo market.”

With a flock of dovish central banks, collapsing yields and record stock prices, it’s easy to disregard China. Haven’t they, after all, repeatedly overcome bouts of heightened systemic stress. Beijing always gets things under control. The PBOC can effortlessly print “money” and bail out its troubled banking system. Not so fast… “Bond repos and interbank loans” up nearly 50% over the past year to $10.7 TN. Those are two data points that should alarm the world – and surely help explain panic buying of Trillions of negative-yielding global bonds.

President Trump has officially commenced his reelection campaign. He has ample incentive to avert a trade war showdown with China. Chinese finance is nearing the precipice. President Xi has ample incentive to avert a showdown. Yet if these two historic strongmen leaders have irreconcilable differences they have irreconcilable differences. Neither can tolerate any display of weakness or lack of resolve.

If Trump and Xi don’t get negotiations back on track at next week’s G20, there’s a scenario where things could turn sour rather quickly. An unfolding crisis of confidence in China’s money market portends serious trouble ahead for China’s financial and economic Bubbles. The PBOC has been injecting enormous quantities of liquidity into China’s financial system. Much, much more will be required. If there is as much leverage in that system as I suspect, Beijing will be on the hook for Trillions of liquidity injections, bank bailouts/recapitalizations and debt monetization.

It all implies currency vulnerability. The good news for China is that currency values are relative – and the renminbi competes against a throng of structurally weak currencies. Little wonder gold has caught such a nice bid. Quite an equities run into “quadruple witch” option expiration. A decent short squeeze in EM securities markets and currencies. And wild volatility in crude and energy prices. Central Bank Capitulation seems to have unleased wild price instability throughout global markets. Things do get crazy during the late phase of Bubbles.

We’re witnessing Bubbles and Craziness in historic proportions.