Gold as the Monetary Sun

by Jeff Thomas



For millennia, people believed that the sun revolved around the earth, appearing, as it did, on the eastern horizon in the morning and setting on the western horizon in the evening.

Greek astronomer Aristarchus of Samos is generally credited with the concept that the universe is heliocentric, with all the planets revolving around the sun. Yet it took a further eighteen centuries before Nicolaus Copernicus came along and convinced people that this was the case.

So, we can be forgiven if we educated modern-day people sometimes have difficulty in understanding that gold is the monetary sun.

Even those of us who have been tracking gold’s progress for decades frequently give in to the ease of quoting gold’s value in terms of fiat currency—most commonly in US dollars.

And yet, we have it the wrong way round. Gold is in fact the centre of the economic universe, and all the fiat currencies (including cryptocurrencies) revolve around gold.


But, isn’t this an exercise in hair-splitting? After all, does it really matter whether we acknowledge “orocentricity”? Doesn’t it amount to the same thing?

Well, no, it doesn’t. For those of us who deal frequently (or entirely) in US dollars, there would be an inclination to say that, for more than four years, gold has been essentially stagnant, varying no more than $200 an ounce. But, during that time, the US dollar has risen against major currencies. Although the price of gold has risen in this period, the US dollar has risen more.

More to the point, this has been no accident. A major effort has existed to repeatedly knock down the value of gold in relation to the dollar. This is only possible in an environment in which public faith in the banking system and the stock market remain high. As soon as those two confidence bubbles burst, the dollar will decline rapidly in relation to gold, and gold will once more return to its intrinsic value, just as it has done time and time again for over 5,000 years.

It’s interesting to note that, throughout history, banks and governments have fiddled with the value of currencies, from the devaluation of the denarius in ancient Rome, through the increased mixture of copper in the coins, to the successful introduction of paper currency in China in the seventh century. (The practice later took off in Europe in the seventeenth century and continues today.)

Over the millennia, mankind has used cattle, tobacco, seashells, even tulips as currency, yet each of these has failed at some point. More importantly, all paper currencies that have ever existed, except the current ones, have not only failed, but have gone to zero in worth.

Which brings us around to gold once more. The “barbarous relic,” as John Maynard Keynes called it, has easily outlived his opinion of it. But then, according to his contemporary, Friedrich Hayek, Mister Keynes was an exceptionally intelligent man who was so convinced of his superiority that he based all his economic theory on what he learned at Cambridge and never even bothered to attain a full education of Austrian economics, or even classical economics. Yet all world banks and governments today operate on the principles set down by the misinformed Mister Keynes.

Readers of this publication will be aware that the world is nearing an economic collapse of historic proportions. In attempting to understand the price of gold in the future, such notables as Eric Sprott, Peter Schiff, Jim Rickards, James Turk, Jim Sinclair, and many others have all predicted that gold would have risen to at least $5,000 by now. Conversely, deflationist Harry Dent predicted that gold would drop below $750 by 2015.

Are all of these men fools? Far from it. They’ve merely been premature. As Eric Sprott has repeatedly stated, “I tend to confuse inevitable with imminent.” Even Harry Dent could conceivably still prove to be correct. A crash in the markets is almost certain to create an immediate downward spike in the price of gold, prior to the creation of currency by the central banks that would immediately follow, sending gold, eventually, to an unprecedented high price. Such a crash would predictably cause a gold mania. $5,000 is in no way an unrealistic number.

Will it stop there? Well, in spite of the fact that virtually no one is even considering the possibility now, gold could conceivably go to $50,000, $500,000, $5,000,000, or beyond. Whilst this would appear to be an absolute absurdity to us at present, if hyperinflation kicks in, in the US, as it has in so many previous cases of currency collapses, there is literally no limit to how high the price can go. (I keep on my desk a $100,000,000,000,000 Zimbabwean bank note from 2008 as a reminder.)

If that’s the case, would it also be true that gold can’t be overpriced? In a word, no. Manias have a way of overshooting—creating prices that go far beyond common sense. In a mania, those who are knowledgeable keep their heads, whilst those who don’t understand the dramatic price rise tend to assume that there’s no limit as to how high it can go. They’re the creators of bubbles, and a bubble can exist in gold, as in any other investment.
 
But a gold bubble, like any other bubble, would be temporary. Eventually, gold would return to its intrinsic value. It’s been said that 2,000 years ago an ounce of gold could buy a good toga and a pair of sandals. Today, an ounce of gold will still buy a good suit and a pair of shoes. If gold were to go to, say, $10,000 soon, it would be in a bubble. But, if, with inflation, the price of a good suit with shoes were to rise to $10,000, then gold would be quite comfortable at that level.

If gold rises well beyond the price of a suit and shoes as a result of a mania, those who know precious metals well will be seen to sell, and move the proceeds into something that’s underpriced at the moment. Gold will once again settle at a natural level.

Long after fiat currencies like the dollar, the euro, the SDR, bitcoin, etc. have gone the way of the dodo, gold will still be around and will remain the centre of the economic universe.

Although gold will outlive us all, we can, by understanding “orocentricity,” provide ourselves with an insurance policy against the ravages of currency failure.


Why Volatility Simply Cannot Rise

The Heisenberg


Summary


• Transparency, generally seen as a defining feature of post-crisis policy, has a dark side.

• It blinds investors to long-term risks by removing the incentive to consider them.

• Caught in the information exchange loop, markets become numb.


For the past decade, traders have been conditioned to expect central banks to both telegraph policy tweaks ahead of time and offer a thorough rationalization of those shifts at the time of implementation.

Canada’s central bank provided neither when hiking its benchmark rate to 1 percent on Sept. 6. Monetary policy makers hadn’t spoken publicly since July 12, when they delivered their first increase in almost seven years, nor was the latest decision followed by a press conference.

That's from Bloomberg's Luke Kawa and the suggestion is that Stephen Poloz is attempting to change the prevailing dynamic.

Years ago, central banks instituted a running dialogue with markets, in the process creating a deeply reflexive relationship. There was always a tacit acknowledgement from policymakers that their reaction functions included a careful consideration of how risk assets like stocks (SPY) have recently behaved. But this is no longer tacit. It is all but explicit.

The idea behind forward guidance or, more colloquially, "transparency" is to ensure that markets are prepared for potentially meaningful policy shifts. It's assumed that telegraphing these shifts is critical in the post-crisis world because this is an environment where markets have become accustomed to excessive and persistent accommodation. Aware of the conditioning, central banks (rightly) assume that the removal of accommodation could be destabilizing. Thus, it's necessary to be as transparent as possible even to the point of "telegraphing the telegraphing." That is, policymakers are not only keen on warning markets about policy shifts, they are now predisposed to warning markets about when those warnings are coming. That's an endless regression.

More than a few commentators have suggested that this isn't desirable - that incessant central bank jawboning is creating perverse incentives. Rarely does a week pass when we don't hear from an influential central banker in the form of a speech, a media appearance, etc. In many cases, the Fed, the ECB, and other developed market central banks find themselves having to talk back things they just said. One official makes a speech, the market "misreads" it, and another official has to be trotted out the next day to explain why traders misinterpreted things. Again, this happens almost every single week.

Deutsche Bank’s Aleksandar Kocic has variously described this in the theatre context - it is, as Kocic famously wrote in 2015, "the removal of the fourth wall." You have ceased to be a passive spectator in the central bank drama. You are not merely an observer of a play unfolding on the policy stage. You are, to quote Kocic, “an alterable observer who is able to alter.” That is, you are helping to write the script.

By including you in the play, the Fed is effectively long an option to act on your behalf. That option was financed by selling an out-of-the-money option on policymaker credibility.

The problem with this regime is that it renders everything outside of the communication channel between you (markets) and the Fed irrelevant. As Kocic writes in a new note out Friday evening, "without a rigid reference point, like well a specified reaction function, objectives, and triggers, policy risks deteriorating into a matter of referendum." Here's how I described it early Saturday morning:

This is just a kind of rolling plebiscite. Clearly, that creates substantial risks in terms of encouraging mass myopia. Thanks to near-daily speeches and media appearances by Fed officials, this is quite literally a real-time information exchange between markets and policymakers. No one can see outside of this information exchange and if you’re a trader, there’s really no utility in trying.

Note the bit about "mass myopia." If no one can see outside of the daily information exchange between the Fed and markets, then no one can form any kind of long-term view. Here's Kocic again:

In the environment of abundant information, everything becomes short term. A long-term vision becomes progressively more difficult to construct and things that take more time to mature receive less and less attention.

The communication loop between the Fed and the markets has become a way of controlling the residual risks associated with their exit. Excessive transparency has been perceived as the most effective way to stabilize the system. When used in this context, it confirms and optimizes only what already exists. The markets remain blind to what lies outside of the context of informational exchange.


In this situation, volatility simply cannot sustain a spike. And I mean that less as a subjective assessment and more as an objective statement. Unless the Fed decides or is forced (both of those are unlikely) to stop being transparent, volatility (VXX) cannot sustain a bid.

It's worth noting, given all of this, that in the week through Tuesday, the net spec VIX short hit another new record:


 (Bloomberg)


Those interested can read more from Kocic on all of this here, but for our purposes, just note that the dynamic outlined above has the perverse effect of amplifying whatever risks lie outside of the market-central bank information exchange channel by eliminating the incentive for investors to consider them.

The risks are out there, but why would you look?


The World Turned Upside Down


John Mauldin
 
Strange things did happen here
No stranger would it be
If we met at midnight
In the hanging tree.
 

– Lyrics from the theme song of The Hunger Games
 
 
If buttercups buzz’d after the bee,
If boats were on land, churches on sea,
If ponies rode men and if grass ate the cows,
And cats should be chased into holes by the mouse,
If the mamas sold their babies
To the gypsies for half a crown;
If summer were spring and the other way round,
Then all the world would be upside down.
 

– Lyrics from a 17th-century English folk song entitled “The World Turned Upside Down”
  

A bull market is like sex. It feels best just before it ends. 

– Warren Buffett
 
 
Longtime readers know that I read a wide range of newsletters, articles, and websites every day. There are times when I see patterns in the information flow that are like puzzle pieces begging to be put together. I have been struck in the past few days by the amount of analysis and number of data sets that are all pointing to the same conclusion: There is a bull market in complacency.
 

Strange things are happening out there. One formerly successful billionaire hedge fund manager after another throws in the towel, sending the money in their funds back to the clients, confessing that they don’t know how to handle these markets. I am reminded of the surrender of Cornwallis to Washington at Yorktown in 1781.
 
Tradition has it that, as the British surrendered, their band played the old English folk tune “The World Turned Upside Down.”
 
 
 
The inability of so many active funds to find that “edge” that formerly allowed them to produce alpha is quite remarkable. I have written about this phenomenon before, so I won’t go into detail here; but it is the massive move from active to passive funds that is the core of the problem. Passive investing simply allocates among a number of index funds that indiscriminately buy or sell the stocks that are in their indexes.
 

That means if you buy an index fund for the Russell 2000 (small-cap stocks), not only are you getting the stocks of well-run companies, you are also buying the 30% of the small-caps that have less than zero earnings. And since we’re seeing literally hundreds of billions of dollars moving to passive investing and away from active managers every year, that is a lot of indiscriminate buying. Barron’s estimates that passive investments could make up half of all US equity retail flows in 2018 and 2019, and this calendar year will see the largest ever dollar shift in assets under management from active to passive. Part of the reason is a general move to lower fees, and part is simply that active management has failed to outperform.
 

Here’s the problem: It is extremely difficult for an active manager to buy the best companies and/or short the worst companies and show much outperformance relative to the passive index funds. No matter how much research you do, no matter how well you know those companies, your research is not giving you an edge over the massive movement to passive investing.
 

And if you have no edge, you have no alpha. It is just that simple. Personally, I don’t think this is the end of active investing, but the game is going to have to change.
 
Where Has the Volatility Gone?
 
I was talking with Ed Easterling of Crestmont Research about the markets, and he asked me if I knew that there have been 39 times since 1990 when the VIX has closed below 10, and that 30 of those times have happened this year. And since the VIX has closed below 10 for the last two days since Ed and I talked, it is now 32 of 41 closes below 10. And 15 of those have been in the last 30 days!
 

Ed sent me an updated chart last night of the VIX Index through the close of the markets on Friday. Notice that the all-time low of 9.19 was put in on October 5, 2017.
 
 
 
All the previous sub-10 closes occurred in only two periods: Four of them were in the winter of 1993–1994 (around Christmas, which is traditionally a light trading period), and the others were in the winter of 2006–2007, another period of great complacency.
 

You can’t really draw any conclusions about the next move of the markets, because the VIX could spike to 50 or stay in this low range for a very long time. Essentially, we have trained investors to “buy the dips,” and that mentality removes a lot of volatility. Here is a chart of the VIX since the beginning of the year (from Yahoo Finance):
 
 
 
I got a blitz email tutorial this week from my friend Doug Kass, of Seabreeze Capital, a writer for the Street.com and Real Money Pro. He generally puts out two to three short pieces a day with his observations on the markets, and he discusses what stocks he is trading.
 

I was particularly struck with his observation about the massive – and it truly is massive – short position in the VIX and VIX futures. Look at this chart:
 
 
 
Now, as my friend and fellow Mauldin Economics writer Jared Dillian notes, prior to 2006 it was not possible for retail investors to trade the VIX. Then an ETF was created, and options and futures became available. Prior to that time it was just professionals who could create the effect of the VIX with futures and options trade positioning on the S&P. You almost had to be a pit trader to be able to do it.
 

Understand, the VIX is a totally artificial construct. It is a derivative of a derivative. In the beginning, around 1993, the VIX basically measured the implied volatility of eight S&P 100 at-the-money put and call options. Let’s go to Investopedia for a quick tutorial:
 
What is the VIX - CBOE Volatility Index?
 

VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking, is calculated from both calls and puts, and is a widely used measure of market risk, often referred to as the “investor fear gauge.”

Breaking down the VIX - CBOE Volatility Index
 

The CBOE designed the VIX to create various volatility products. Following the CBOE’s lead, two other variations of volatility indexes have since been created: the VXN, which tracks the NASDAQ 100; and the VXD, which tracks the Dow Jones Industrial Average (DJIA).
 

The VIX, however, was the first successful attempt at creating and implementing a volatility index. Introduced in 1993, it was originally a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, in 2004, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors’ expectations on future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.
 

How the VIX’s value is established
 

The VIX is a computed index, much like the S&P 500 itself, although it is not derived based on stock prices. Instead, it uses the price of options on the S&P 500, and then estimates how volatile those options will be between the current date and the option’s expiration date. The CBOE combines the price of multiple options and derives an aggregate value of volatility, which the index tracks.
 

While there is not a way to directly trade the VIX, the CBOE does offer VIX options, which have a value based on VIX futures and not the VIX itself.
 
Additionally, there are 24 other volatility exchange-traded products (ETPs) for the VIX, bringing the total number to 25.
 

An example of the VIX
 

Movements of the VIX are largely dependent on market reactions. For example, on June 13, 2016, the VIX surged by more than 23%, closing at a high of 20.97, which represented its highest level in over three months. The spike in the VIX came about due to a global sell-off of U.S. equities. This means global investors saw uncertainty in the market and decided to take gains or realize losses, which caused a higher aggregate equity supply and lower demand, increasing market volatility.
 
So there you have it. The VIX is simply a way to measure the future expectations of investors regarding the volatility of market prices. And lately, investors have been rewarded for shorting the VIX. It is almost like the experiments you see where rats learn that if they punch a button that they get a grape. Investors have learned that if they short the VIX they make a profit.
 

Except that now there are so many people on that side of the boat that when the boat starts to turn over, the rush to get the other side is going to rock that boat hard, possibly to the point of swamping it. Doug warns that a 2% or 3% move down in the markets could cause short covering in the VIX that could quickly spiral out of control. Not unlike the “portfolio protection” trade that brought about the 1987 crash.
 
A Bull Market in Complacency
 
Peter Boockvar sent me a screen capture from his Bloomberg. The University of Michigan’s Surveys of Consumers have been tracking consumers and their expectations about the direction of the stock market over the next year. We are now at an all-time high in the expectation that the stock market will go up.
 
 
 
It is simply mind-boggling to couple that chart with the chart of the VIX shorts. Writes Peter:
 
Bullish stock market sentiment has gotten extreme again, according to Investors Intelligence. Bulls rose 2.9 pts to 60.4 after being below 50 one month ago. Bears sunk to just 15.1 from 17 last week. That’s the least amount since May 2015. The spread between the two is the most since March, and II said, “The bull count reenters the ‘danger zone’ at 60% and higher. That calls for defensive measures.” What we’ve seen this year the last few times bulls got to 60+ was a period of stall and consolidation. When the bull/bear spread last peaked in March, stocks chopped around for 2 months. Stocks then resumed its rally when bulls got back around 50. Expect another repeat.
 
Only a few weeks ago the CNN Fear & Greed Index topped out at 98. It has since retreated from such extreme greed levels to merely high measures of greed.
 
Understand, the CNN index is not a sentiment index; it uses seven market indicators that show how investors are actually investing. I actually find it quite useful to look at every now and then.
 

The chart below, which Doug Kass found on Zero Hedge, pretty much says it all. Economic policy uncertainty is at an all-time high, yet uncertainty about the future of the markets is at an all-time low.
 
 
 
At the end of his email blitz, which had loaded me up on data, Dougie sent me this summary:
 

At the root of my concern is that the Bull Market in Complacency has been stimulated by:
 

* the excess liquidity provided by the world’s central bankers,
 

* serving up a virtuous cycle of fund inflows into ever more popular ETFs (passive investors) that buy not when stocks are cheap but when inflows are readily flowing,
 

* the dominance of risk parity and volatility trending, who worship at the altar of price momentum brought on by those ETFs (and are also agnostic to “value,” balance sheets,” income statements),
 

* the reduced role of active investors like hedge funds – the slack is picked up by ETFs and Quant strategies,
 

* creating an almost systemic “buy on the dip” mentality and conditioning.  

when coupled with precarious positioning by speculators and market participants:
 

* who have profited from shorting volatility and have gotten so one-sided (by shorting VIX and VXX futures) that any quick market sell off will likely be exacerbated, much like portfolio insurance’s role in a previous large drawdown,
 

* which in turn will force leveraged risk parity portfolios to de-risk (and reducing the chance of fast turn back up in the markets),
 

* and could lead to an end of the virtuous cycle – if ETFs start to sell, who is left to buy?
 
The chart above, which shows the growing uncertainty over the future direction of monetary policy, is both terrifying and enlightening. The Federal Reserve, and indeed the ECB and the Bank of Japan, went to great lengths to assure us that the massive amounts of QE that they pushed into the market would help turn the markets and the economy around.
 

Now they are telling us that as they take that money back off the table, they will have no effect on the markets. And all the data that I just presented above tells us that investors are simply shrugging their shoulders at what is roughly called “quantitative tightening,” or QT. I can understand the felt need by central bankers to “reload the gun” by raising rates so they will have a few bullets left to fire during the next downturn. Though frankly, I think that if they simply left the market to itself, very short-term rates wouldn’t be all that high. I mean, if 30-year Treasuries are still below 3%, what does that tell you about inflation expectations, and what does that tell you about expectations for short-term money market instruments?
 

Admittedly, the amount of QT this year is rather de minimis. But then it begins to rise quickly. At least two of those on the short list for Fed chair, in their recent speeches, have been critical of the Fed for not raising rates more forcibly; and while they haven’t explicitly commented on the balance sheet, they presumably would be inclined to continue with its reduction.
 

I simply don’t buy the notion that QE could have had such an effect on the markets and housing prices while QT will have no impact at all. In the 1930s, the Federal Reserve grew its balance sheet significantly. Then they simply left it alone, the economy grew, and the balance sheet became a nonfactor in the following decades.
 

I don’t know why today’s Fed couldn’t do the same thing. There is really no inflation to speak of, except asset price inflation, and nobody really worries about that. We all want our stocks and home prices to go up, so there’s no real reason for the central bank to lean against inflationary fears; and raising rates and doing QT at the same time seems to me to be taking a little more risk than necessary. And they’re doing it in the midst of the greatest bull market in complacency to emerge in my lifetime.
 

Do they think that taking literally trillions of dollars off their balance sheet over the next few years is not going to have a reverse effect on asset prices? Or at least some effect? Is it really worth the risk?
 

Remember the TV show Hill Street Blues? Sergeant Phil Esterhaus would end his daily briefing, as he sent the policemen out on their patrols, with the words, “Let’s be careful out there.”
 
 
 
San Francisco, Denver, Lugano, and Hong Kong
 

I will be going this week to San Francisco (technically, to Marin County) to visit the Buck Institute, which is the premier aging research center in the world. I have been invited join their Buck Ambassadors Council, which will afford me the privilege of receiving once or twice yearly updates on where antiaging research is going. I will give you a report when I return. Then on November 7 I will be speaking to the Denver CFA Society. A week later I will fly to Lugano, Switzerland, for a presentation to a conference – and I’ll try not to push myself quite so hard on this next trip across the Pond. I will also be in Hong Kong for the Bank of America Merrill Lynch conference in early January.
 

I will admit to being pretty pumped about the next two days of meetings at the Buck Institute. My host, Lou Gerken (famous local venture capitalist), decided to throw a small pre-meeting dinner for me on Sunday night. We thought eight people would be about the right number. Turns out we are now up to 21, and counting. I’m particularly excited about meeting Aubrey de Grey, whom I have talked with over the years but never met. He is probably the first person I read and then listened to who really began to make me understand the potential for solving the riddles of aging – in what may now be my own lifetime.
 

I remember talking with Dr. Mike West, CEO of BioTime, about 15 years ago. Like Aubrey, he is aggressively focused on figuring out how to turn back the clock on aging. Fifteen years ago he thought we would be able to do it within 40 years – so sometime in the mid-2040s. Now? He thinks the early 2030s is a given and maybe we’ll get there in the late-2020s. The speed at which the research is piling up and accelerating is simply staggering. Part of that gathering momentum is simply faster computers and artificial intelligence, and part of it is some remarkably good fortune and amazing discoveries.
 

Eric Verdin and his team at the Buck are literally at the center of the spiderweb of antiaging research in the world. If memory serves, the institute has some 250+ scientists across many disciplines doing research on a wide variety of topics. They freely share their findings with scientists all over the world. Since the institute opened in 1999, they have published over 660 papers. They are working on every aspect of aging, working to find ways not only to prevent some of aging’s effects but maybe also to cure them.
 

The two-day program I’ll attend is literally packed with researchers who will do TED-type talks on what they’re finding. Your humble analyst will be talking about some of the sociological and economic issues surrounding aging. And serendipitously, my great friend and doctor, Dr. Mike Roizen, will be presenting on how the Cleveland Clinic is helping its staff to get younger – until, as he says, the Buck can take over and do the rest. And with the glaring exception of myself, the presenters are all a who’s who of aging research. As you can tell, I am pumped, because this is one of those topics that I find myself really intrigued by and immersed in.
 

It is time to hit the send button. The gym is calling, and there are weights that need to be pushed, pulled, shrugged, and lifted. I’ve been training with The Beast for over two years now. We do a lot of work on my shoulders and around the neck area. My neck is literally 1.5 inches bigger now than it was 15 years ago, when I hardly ever did anything in the gym that focused on that part of the body. One of the things I’m going to have to do when I’m in Hong Kong is go to a local tailor and get a bunch of new dress shirts so that I can actually comfortably wear a shirt and tie. Not a bad problem to have, all in all. Have a great week!
 

Your wondering what will end the complacency analyst,


Turkey and the West Clash, Pleasing Russia and Iran

Ankara’s ties with the U.S. and other NATO allies are badly frayed

By Yaroslav Trofimov
.
Russian President Vladimir Putin, left, and Turkish President Recep Tayyip Erdogan at a September news conference.
Russian President Vladimir Putin, left, and Turkish President Recep Tayyip Erdogan at a September news conference. Photo: MIKHAIL METZEL/TASS/ZUMA PRESS


ISTANBUL—Here’s one measure of where Turkey stands in today’s world.

Russian and Iranian citizens are free to enter the country without a visa. Americans, following the recent spat over the detention of a U.S. consulate employee, are essentially barred from traveling to their fellow North Atlantic Treaty Organization ally.


The unfolding breakup between Turkey and the U.S. goes far beyond that dispute. It is fueled by increasing frustration on both sides—and is encouraged by countries most interested in such a separation, especially Russia and Iran. Even in the Syrian war, Turkey now has found itself in a new convergence of aims with Moscow and Tehran—and opposing American goals.

“This is the worst it’s been since the independence of the Turkish republic,” in 1923, said Asli Aydintasbas, an Istanbul-based fellow at the European Council on Foreign Relations. “The institutional bond [with the U.S.] is really weakening and the distrust is spilling into business ties, into investment decisions, and even into the NATO framework.”

The freeze isn’t just between Washington and Ankara: Turkey’s relations with key European nations, most notably Germany, have frayed just as badly.

Turkey’s traditional alliance with the U.S. already came under strain during President Barack Obama’s administration. At the time, the U.S. chafed at Turkish President Recep Tayyip Erdogan’s systematic assault on democratic freedoms and civil rights. Turkey, meanwhile, viewed as an existential threat America’s support for Kurdish militias that combat Islamic State in northern Syria.

Following a failed military coup against Mr. Erdogan last year, many senior Turkish officials have also concluded that elements of the U.S. establishment were sympathetic to the plotters’ aims or even actively colluding with the putsch, a claim firmly denied by Washington.

Mr. Erdogan, however, entertained high hopes for a reset under President Donald Trump, who refused to criticize Turkey’s deteriorating human-rights record. These expectations seemed to be validated as recently as Sept. 21, when Mr. Trump proclaimed at a meeting in New York that Turkey and the U.S. are “as close as we have ever been” and Mr. Erdogan reciprocated by praising “my dear friend Donald.”


President Donald Trump shook hands with Turkish President Recep Tayyip Erdogan in New York in September.
President Donald Trump shook hands with Turkish President Recep Tayyip Erdogan in New York in September. Photo: SHEELAH CRAIGHEAD/PLANET PIX/ZUMA PRESS


Such optimism, however, belied the accumulating poison in the relationship. In Syria, instead of reversing course as Ankara had expected, the Trump administration essentially doubled down on the Obama policy of arming and backing the YPG Kurdish militia that Turkey considers a front for the Kurdistan Workers’ Party, or PKK, a group that seeks to carve out a Kurdish state in southeastern Turkey and that is considered terrorist by Washington and Ankara alike.

Ankara was also upset with the detention of Reza Zarrab, a Turkish-Iranian businessman with ties to Mr. Erdogan who has been charged in New York with violating sanctions against Iran, and with the continuing presence in Pennsylvania of Fethullah Gulen, the Islamist preacher whom Turkey wants extradited for allegedly masterminding last year’s coup attempt. Both men have denied wrongdoing.

American officials, meanwhile, were frustrated by the yearlong detention of Andrew Brunson, an American Christian pastor whom Turkish officials have accused of links to the coup. Mr. Brunson has denied the charges. The U.S. officials were particularly horrified by recent Turkish suggestions of swapping Mr. Brunson for Mr. Gulen or Mr. Zarrab.





All of this, combined with uproar over the allegedly violent behavior of Mr. Erdogan’s bodyguards during his visit to Washington in May, has cemented a growing perception inside the administration—and Congress—that attempts to mollify Turkey have become increasingly pointless.

“Ankara has few, if any, friends in Washington now,” said Steven Cook, a Turkey expert at the Council on Foreign Relations in Washington.

The detention of the U.S. consulate employee helped ignite the latest conflagration.

“The arrest has raised questions about whether the goal of some officials is to disrupt the longstanding cooperation between Turkey and the United States,” said the U.S. ambassador to Ankara, John Bass. The tit-for-tat visa issuance suspension means that only a small number of Americans with pre-existing Turkish visas can enter the country. U.S. citizens were until now able to get Turkish visas on arrival.

Ever since last year’s coup attempt, Turkish officials favorable to continuing cooperation with the West have been warning about the rise of the ultranationalist “Eurasianist” faction, particularly inside Turkey’s security and military establishment. This current, expounded by its main ideologue Dogu Perincek, a Turkish politician, seeks to reposition Turkey into a new “Eurasian” civilizational alliance with Russia, China and Iran—and to break off traditional bonds with West.

That breakoff intensified as Mr. Erdogan declared that the U.S. consulate in Istanbul was “infiltrated by spies,” and, in a fiery speech Thursday, warned the U.S. that if America doesn’t respect Turkey, “then we don’t need you.”

In a separate case this week, a Turkish court declared a Wall Street Journal reporter guilty of engaging in terrorist propaganda through one of her Journal articles. The Journal condemned the move and the reporter plans to appeal the decision.

“This was an unfounded criminal charge and wildly inappropriate conviction that wrongly singled out a balanced Wall Street Journal report,” said Wall Street Journal Editor in Chief Gerard Baker. “The sole purpose of the article was to provide objective and independent reporting on events in Turkey, and it succeeded.”

It is hard to see what avenues still exist for defusing the tensions between Washington and Ankara. The fates of Mr. Zarrab and Mr. Gulen are “judicial issues the U.S. government has no say in,” said James Jeffrey, a former American ambassador in Turkey. “President Erdogan’s advisers are misleading him if they think otherwise.”

Things are likely to get even worse in the foreseeable future, added Sinan Ulgen, head of the Edam think tank in Istanbul and a former Turkish diplomat. “There is no clear path to de-escalation,” he cautioned, “and therefore we will likely find ourselves on the path to escalation.”


The Global Stock Market’s Hidden Juice

Rising margin lending from Swiss and U.S. wealth managers can make a downturn far more painful

By Paul J. Davies


MARGING MAKERS
Loans secured against marketable securities




One common sign of trouble ahead is people borrowing heavily to buy equities.

Investors should be worried then that stocks are being supported by record amounts of margin debt, according to research released last week from the Bank for International Settlements, the Switzerland-based central bank for central banks.

These kinds of loans secured against stocks have often proved dangerous in a downturn because when share prices fall borrowers are forced to sell.

In the U.S., margin debt is more than three-times the level ahead of the 2008 crisis and is greater even than its peak in 2000 before the dot-com crash, according to the B.I.S.

However, lending volume alone isn’t a clear indicator of risk because equity values have increased, too. In the U.S. at least, lending as a share of market capitalization has been relatively steady for the past four years, most recently at 2.12%. But that level is much higher than the period before 2007 and above even the dotcom-era peak of 2.05%.

Swiss private banks, which have among the biggest and most international margin lending operations, have grown this business significantly. Credit Suisse has doubled its volume since 2006 to about $42 billion, while Julius Baer’s has grown by five-times to $24 billion, although it got a big boost from its takeover of Bank of America-Merrill Lynch’s international wealth business in 2013.



UBS with about $92 billion, has also seen strong growth, but an accounting change in 2012 makes it hard to say exactly how strong.

While overall growth appears to have slowed, that is partly due to a decline among Asian investors in 2015 and 2016, which is masking continued strength elsewhere.


RISK MARGIN
Total in U.S. stocks trading accounts, a negative number means they are in debt (2000-2017)



The Chinese market crash in 2015 shattered investor confidence across Asia, according to bankers. But while Asian lending went backward, U.S. loans continued to grow, including at Morgan Stanley , Bank of America Merrill Lynch and UBS’s American wealth arm.

Rich clients’ desire to borrow against stocks has been stoked by the low interest rates and rising stock markets. It is attractive for banks, too. Lending against shares is seen as less risky than mortgages because stocks can be sold more quickly than a house, so banks can hold less capital against margin loans. Also, if the borrowed money is invested with the bank, rather than spent on yachts or cars, that boosts assets under management.

STOCK IN HOCK
Margin lending at the New York Sock Excahnge as a share of market capitalization (1992-2017)



The banks themselves all say that while lending looks high, their own approach is conservative and the general competition for clients is less aggressive than in the past. But neither the banks nor their investors have a full view of leverage across the system and the risk that may pose.

Equities have to fall 20% to 30% before margin loans are underwater. That protects the banks, but doesn’t stop a wave of selling to repay debt when a downturn comes. That could spell real pain for everyone else.