Dollar Euphoria and Gold

By: Adam Hamilton

The US dollar has rocketed higher since early November's US presidential election, rivaling the massive gains seen in the stock markets. With the world's reserve currency catapulted to extreme secular highs, dollar euphoria has naturally exploded. Traders are overwhelmingly betting the dollar's strong upside will continue. But this greed-drenched currency looks very toppy and ready to fall, which is very bullish for gold.

The US dollar's recent stampede higher has been amazing, as evidenced by the venerable US Dollar Index. Launched way back in 1973, the USDX is the dominant and most-popular market gauge of how the US dollar is faring. Since Election Day 2016 alone, the USDX has soared 5.1% higher in merely six weeks! That isn't much behind the flagship S&P 500 broad-market stock index's 5.9% post-election rally.

But the post-election USDX surge is still far more extreme. The world's handful of reserve currencies are decisively commanded by the US dollar. Because of the vast amounts of dollars flooding the globe, it has great inertia. Thus like an oil supertanker, the dollar's moves tend to be gradual and unfold over a long time. The USDX usually moves with all the sound and fury of a tortoise, leisurely meandering around.

The dollar's normal lack of volatility helps explain why leverage on currency trading can be so epic, over 100x in some cases! To translate USDX moves into stock-market equivalents, they probably need to be multiplied by at least 3x or so. The dollar's post-election surge is every bit as extreme as a 15%+ rally in the S&P 500 over six weeks would be! Such a colossal move has major implications for many markets.

Trump's surprise victory unleashed staggering US-dollar buying on Fed-rate-hike expectations.

Like all traders, the currency guys assume Trump's proposed slashing of tax rates and regulations will help fuel a much-stronger US economy.

That not only gives the Fed cover to hike rates faster, but could spark surging inflation that forces the Fed's hand on rate normalization. It all boils down to Fed hawkishness.

This was reinforced at last week's FOMC meeting, where the Fed met market expectations to hike its federal-funds rate for the first time in a year and just the second time in 10.5 years.

Accompanying every other FOMC meeting, the Fed releases a Summary of Economic Projections. Currency, stock, bond, and commodity traders eagerly look to part of that report known as the "dot plot" to divine where rates are heading.

This dot plot is a graphical summary of where each individual FOMC member and regional-Fed president expects the federal-funds rate to be in each of the following few years. Since these are the guys who actually set monetary policy, traders heavily weight their collective outlook.

Last week the newest dot plot pegged the number of rate hikes expected in 2017 at three, well above the two forecast a quarter earlier.

So the USDX took off like a rocket on higher expected US interest rates, soaring 1.0% on that Fed Day and another 1.0% the next! That monster 2.0% USDX gain made for its biggest two-day rally by far since late June in the immediate wake of that surprise Brexit vote. And it vaulted already-major dollar euphoria up to nosebleed extremes. Currency traders are totally convinced the dollar's gains are only beginning.

Their premise is simple and logical. Higher prevailing US interest rates courtesy of Fed rate hikes will make US investments including cash, stocks, and bonds relatively more attractive to foreign investors in this low-yielding world. So they will increasingly sell their local currencies and migrate that capital into the US dollar to buy US investments. Currency traders think they are front running a massive coming shift.

This idea that higher US interest rates built on the foundation of the federal-funds rate lead to major US dollar buying seems unassailable. But why not see what history shows, how the USDX fared in the last Fed-rate-hike cycle? This first chart superimposes the US Dollar Index over the Fed's federal-funds-rate target over the past 17 years or so. Surely Fed rate hikes fuel major bull markets in the US dollar, right?

Fed Funds Rate and US Dollar Index 2000-2016

Our current young Fed-rate-hike cycle is tiny, and technically not even a rate-hike cycle yet since there haven't been three consecutive hikes. Nevertheless let's take the Fed at its word and assume more rate hikes are coming before any cuts. So far we've seen two hikes totaling 50 basis points in the 12.2 months since last December. Indeed the USDX has rallied 4.9% over this new rate-hike-cycle span, a big move.

But that's fairly misleading. From the day before the Fed's first rate hike in nearly a decade a year ago to Election Day, the USDX actually slipped 0.2% lower! The dollar hadn't strengthened one bit in this new rate-hike cycle until Trump's surprise win convinced currency traders the Fed would have to start hiking faster. And the dollar picture before that US-election surprise was considerably more bearish than that.

Back in mid-2014 the USDX started skyrocketing in an epic rally on mounting expectations of Fed rate hikes coming. Remember the Bernanke Fed had forced rates to zero, or technically a target range from zero to 25 basis points, back in mid-December 2008. That's where they lingered for exactly seven years until mid-December 2015. Provocatively the USDX didn't collapse during that zero-interest-rate-policy era.

If higher US interest rates are bullish for the dollar, doesn't the corollary imply lower interest rates are bearish for the dollar? Yet while US rates were first bludgeoned down to and then held underwater at record lows by blatant Fed manipulations, the USDX simply ground sideways on balance for years on end despite ZIRP. If ZIRP wasn't bearish for the dollar, why should normalizing rates be exceptionally bullish?

But as the Fed increasingly hinted about ending ZIRP back in mid-2014, currency traders flooded into the US dollar and drove a monster rally in anticipation of Fed rate hikes coming.

The USDX skyrocketed an incredible 25.6% higher in just 8.4 months, its second biggest and fastest rally in history! All of this frenzied dollar buying finally climaxed in March 2015 in extreme euphoria, as I warned about at the time.

If you weren't closely watching the dollar then, the euphoria was just breathtaking. It eclipsed today's in many ways, with traders universally convinced the USDX was due to soar much higher in the years to come. Yet with all the potential buyers already sucked in by the extreme greed, that proved the very top. Over the next 1.7 years leading into 2016's Election Day, the USDX actually defied sentiment to drift 2.3% lower.

So without that extreme post-election surge on all the Trumphoria, the USDX has been drifting sideways for almost two years. That's despite endless hawkish Fedspeak from elite FOMC officials implying more rate hikes are coming son. The hawkish dot plot at the FOMC's latest meeting was nothing new. This Yellen Fed has cried hawk so many times in recent years that its forecasts should have zero credibility.

The USDX's epic rate-hike-anticipation surge was born in May 2014. The Fed's dot plot in June 2014 showed expectations for four rate hikes in 2015 taking the federal-funds-rate up to a target between 100 and 125 basis points. Yet how many rate hikes did the FOMC actually execute over the next year and a half? A single one in December 2015! The dot plot is always far more hawkish than what the Fed actually does.

A year ago after the Fed's first rate hike in 9.5 years in mid-December 2015, the USDX surged because the accompanying dot plot forecast four rates hikes in 2016. But once again after talking tough, all the timid Yellen Fed could actually muster in 2016 was another single hike this December. Literally for years now, the FOMC has been forecasting far more rate hikes through its dot plot than ever come to pass.

So when the latest dot plot this month projected three rate hikes in 2017, up from two a quarter earlier, it is shocking currency traders still take the Fed seriously. What's almost certain to happen again is the stock markets will suffer a material selloff sometime early next year.

Nothing concerns the FOMC more than stock-market levels, as the Fed suffers withering criticism if it doesn't act immediately to arrest major selloffs.

The Fed also constantly fears the negative wealth effect from falling stock markets will retard consumer spending and therefore weaken the entire US economy. So once the stock markets inevitably drop into 10%+ correction territory again in the coming months, this tough-talking hawkish Fed will lapse back into dovish mode so fast traders' heads will spin. The US dollar will be lucky to see one rate hike again in 2017!

But let's be as gullible as the constantly-Fed-fooled currency traders and assume three rates hikes are indeed coming in 2017. Surely that would indeed be very bullish for the US dollar, right? Let's look to the last Fed-rate-hike cycle for clues. From June 2004 to June 2006 the FOMC hiked its federal-funds rate 17 consecutive times over 24.0 months for a massive 425 basis points total, more than quintupling the FFR!

If currency traders are right that Fed rate hikes are bullish, surely the US dollar rocketed heavenward as the federal-funds rate was relentlessly catapulted from 1.00% to 5.25%. That enormous increase in US yields must have made the dollar wildly more attractive for foreign investors. Yet what really happened? The USDX actually fell 3.8% over that exact Fed-rate-hike-cycle span! The reality doesn't support the theory.

After that, the FOMC held the federal-funds rate at that lofty 5.25% level for another 14.7 months until late 2007, when the global financial crisis leading into late 2008's stock panic started brewing.

With an FFR so high that it would literally bankrupt the US government today, foreign capital should've deluged into the high-yielding US dollar. Yet during that very 5.25%-FFR span, the USDX actually slid 8.0% lower!

Clearly something is dreadfully wrong with the notion undergirding today's USDX euphoria, that higher US interest rates fuel major dollar rallies. The opposite has actually proven true in the past! So currency traders who understand history make the argument that higher rates now are different in a low-yielding world. If the Fed pushes the FFR higher with the rest of the world yielding nothing, dollar buying will come.

The US dollar's main world-reserve-currency competitor is of course the euro, which accounts for 57.6% of the USDX's weight. Between June 2006 and September 2007 when the FFR target ran way up at 5.25%, the equivalent rate for the European Central Bank ran between 3.75% to 5.00%. That early 150bp positive yield differential between the dollar and euro dwarfed the 38bp today. But the dollar still fell!

The hard truth is the US dollar is wildly-overbought today, with extreme greed and euphoria rampant.

At a lofty 14.0-year secular high thanks to the dazzling post-election Trumphoria rally, any dollar buying on more Fed rate hikes has already been pulled forward. Regardless of what the FOMC does, the red-hot USDX is overdue for a sharp decline as extreme long positions are unwound. That reversal is imminent.

Provocatively the US dollar has a history of running in 7-year cycles, 7-year bull markets are followed by 7-year bear markets. Between its July 2001 peak and April 2008 all-time low, the USDX dropped 41.0% over 6.8 years despite a massive Fed-rate-hike cycle. And from there up until that extreme March 2015 peak following that epic rate-hike-anticipation surge, the USDX powered 40.4% higher over 6.9 years.

That really should've been the end of the dollar's bull run, as the sideways USDX action between then and the election strongly argued. The only thing that pushed the USDX higher still was the stunning post-election Trumphoria, which extended the USDX's secular bull to a 44.7% gain over 8.7 years.

That is far too long for a dollar bull market to last, greatly increasing the odds that a new bear market is looming.

The most-likely potential catalyst igniting serious dollar selling is the Fed going dovish. In early 2017 it's highly likely these wildly-overvalued euphoric stock markets will roll over into a correction-grade selloff. That will terrify the FOMC, which will soon start talking dovish. Rate-hike expectations will crater, and the federal-funds rate will remain at today's stock-panic levels just above ZIRP. Fierce dollar selling will ensue.

Interestingly the primary beneficiary of US-dollar weakness will be gold. Gold prices are dominated by gold-futures speculators and gold-ETF investors. The futures guys often base their collective trading decisions on the fortunes of the US dollar. They tend to aggressively sell gold futures when the USDX is surging, and aggressively buy gold when the dollar is falling.

That's readily evident in this gold-and-USDX chart.

Gold and US Dollar Index 2008-2016

Every major USDX move since its all-time low in early 2008 is noted here, with this chart divided at the resulting major USDX highs and lows. Note that gold has a strong negative correlation with the US dollar. That makes sense since gold has been the ultimate currency all throughout world history.  The gold-futures speculators flee gold when the dollar strengthens and then return as the dollar weakens.

Along with the stunning post-election stock-market rally that sucked capital out of gold, the even-more-incredible post-election USDX rally is a major reason gold plunged 11.4% since Election Day.

There is no doubt that once this blistering dollar surge reverses, gold futures will catch a serious bid again. Traders' gold-futures selling has been so extreme since the election that they are now positioned to buy heavily.

Before Trump's surprise win on election night, gold surged as high as $1337! It easily has the potential to return there in short order as this post-election dollar surge is inevitably unwound.

Gold's gains as this wildly-overbought US dollar reverses are likely to be inversely proportional. The bigger and faster the dollar's overdue drop, the bigger and faster gold's rebound rally will be. The likely igniting catalyst is ironic.

The Fed will once again start talking dovish and quickly ratchet down rate-hike expectations when the stock markets sell off materially. That will crush the rate-hike-expectation-driven dollar surge.

But the lofty dollar itself is the thing most likely to spark that serious stock-market selloff! The dollar blasting to 14-year secular highs after the election is very bearish for the US corporate earnings undergirding stock markets.

Something like half the revenues of the elite S&P 500 companies come from abroad. The surging dollar makes the goods and services they are selling to foreigners more expensive in local terms, naturally retarding demand.  On top of lower sales, any profits earned in foreign countries have to be translated back into dollar terms at very-unfavorable exchange rates. This slams corporate profits, spawning stock selloffs.

In Q4'15, the USDX climbed 2.4% on Fed-rate-hike expectations. This was a major factor helping force overall S&P 500 companies' profits 6.0% lower year-over-year in that quarter. Gold dropped 4.9% during that span on major dollar euphoria. Yet in Q1'16 as the negative earnings impact of that strong dollar came home to roost, the USDX fell hard with a 4.0% loss while gold rocketed 16.1% higher in a major new bull.

Quarter-to-date in this year's Q4, the USDX has rocketed an astounding 7.8% higher! That contributed big to the brutal 14.2% QTD gold plunge, one of gold's worst quarters in history. After such an extreme quarterly rally, the USDX is likely to reverse hard and fall proportionally in Q1'17.

That gives gold a high probability of seeing Q1'17 gains in line with Q1'16's big ones, and symmetrical with this quarter's big losses.

So the anomalously-strong US dollar itself is likely to blast corporate profits so seriously in the imminent Q4 earnings season that it unleashes the overdue major stock-market selloff. That will once again get the cowardly FOMC to shift on a dime from hawkish to dovish. And the resulting major reversal of the excessive US-dollar long positions in this wildly-overcrowded trade will cause it to plunge. Thus gold will surge.

There are a couple ways to play this coming sharp US-dollar selloff. Stock traders can short or buy put options on the US Dollar Index ETFs including the leading UUP PowerShares DB US Dollar Index Bullish Fund. They can also buy outright or buy call options on the mighty GLD SPDR Gold Shares gold ETF that dominates its peers. Being short the euphoric dollar and long gold should prove one of early 2017's best trades!

Cultivating excellent contrarian intelligence sources is essential for thriving in these markets. That's our specialty at Zeal. After decades studying the markets and trading, we really walk the contrarian walk. We buy low when few others will so we can later sell high when few others can. While Wall Street will deny the dollar's coming bear market all the way down, we will help you both understand it and prosper during it.

The bottom line is the US dollar's post-election surge to major secular highs has spawned truly extreme euphoria. Traders have aggressively crowded into this popular long-dollar trade, totally convinced Fed rate hikes will drive the dollar much higher. Yet recent history showed the opposite, that the dollar didn't rally during either Fed-rate-hike cycles or the resulting peak rates before the FOMC reverted to cutting again.

As soon as these lofty stock markets inevitably roll over again, the hawkish Fed will quickly turn dovish just like in recent years. And the red-hot US dollar will plunge as traders rush to unwind their excessive dollar longs. The dollar's sharp reversal lower will ignite massive buying in gold futures, propelling this beleaguered metal sharply higher. Extreme dollar greed never lasts, and warns of a major topping underway.

In American Towns, Private Profits From Public Works

Desperate towns have turned to private equity firms to manage their waterworks. The deals bring much-needed upgrades, but can carry hefty price tags.


BAYONNE, N.J. — Nicole Adamczyk’s drinking water used to slosh through a snarl of pipes dating from the Coolidge administration — a rusty, rickety symbol of the nation’s failing infrastructure.

So, in 2012, this blue-collar port city cut a deal with a Wall Street investment firm to manage its municipal waterworks.

Four years later, many of those crusty brown pipes have been replaced by shiny cobalt-blue ones, reflecting a broader infrastructure overhaul in Bayonne. But Ms. Adamczyk’s water and sewer bill has jumped so much that she is thinking about moving out of town.

“My reaction was, ‘Oh, so I guess I’m screwed now?’” said Ms. Adamczyk, an accountant and mother of two who received a quarterly bill for almost $500 this year. She’s not alone: Another resident’s bill jumped 5 percent, despite the household’s having used 11 percent less water.

Even as Wall Street deals like the one with Bayonne help financially desperate municipalities to make much-needed repairs, they can come with a hefty price tag — not just to pay for new pipes, but also to help the investors earn a nice return, a New York Times analysis has found. Often, these contracts guarantee a specific amount of revenue, The Times found, which can send water bills soaring.

Water rates in Bayonne have risen nearly 28 percent since Kohlberg Kravis Roberts — one of Wall Street’s most storied private equity firms — teamed up with another company to manage the city’s water system, the Times analysis shows. City officials also promised residents a four-year rate freeze that never materialized.

In one measure of residents’ distress, people are falling so far behind on their bills that the city is placing more liens against their homes, which can eventually lead to foreclosures.

In the typical private equity water deal, higher rates help the firms earn returns of anywhere from 8 to 18 percent, more than what a regular for-profit water company may expect. And to accelerate their returns, two of the firms have applied a common strategy from the private equity playbook: quickly flipping their investment to another firm. This includes K.K.R., which is said to be shopping its 90 percent stake in the Bayonne venture, a partnership with the water company Suez.

Rich Henning, a Suez spokesman, said that “Bayonne had chronically underinvested in their water and sewer infrastructure, which has certainly contributed to rate increases during the past few years.” He added, “We understand that these increases create stresses for ratepayers.”

A wind turbine that powers the Oak Street Pumping Station in Bayonne, N.J. Water rates in Bayonne have risen nearly 28 percent since the city struck a deal with a private equity firm and a private water company to manage its system. Credit Bryan Anselm for The New York Times 

President-elect Donald J. Trump has made the privatization of public works a centerpiece of his strategy to rebuild America’s airports, bridges, tunnels and roads. Members of his inner circle have sketched out a vision, including billions of dollars of tax credits for private investors willing to tackle big infrastructure projects. And Mr. Trump himself promised in his victory speech “to rebuild our infrastructure, which will become, by the way, second to none.”

Private equity firms like K.K.R. have already presented themselves as a willing partner, and Bayonne provides an important case study. Its arrangement is one of a handful of deals across the country in the last few years in which private equity firms have managed public water systems. While these deals are a small corner of private equity’s sprawling interests, they represent the leading edge of the industry’s profound expansion into public services.

For residents, the financial trade-offs from these water deals can be painful.

The Times analyzed three deals in which private equity firms have recently run a community’s water or sewer services through a long-term contract. In all three places — Bayonne, and two cities in California, Rialto and Santa Paula — rates rose more quickly than in comparable towns, which included both publicly and privately run water systems. In Santa Paula, where Alinda Capital Partners controlled the sewer plant, the city more than doubled the rates. A fourth municipality, Middletown, Pa., raised its rates before striking a deal.

Now, some of these cities are trying to take back their water. Missoula, Mont., wrested away its water system, which had been owned by the Carlyle Group. Apple Valley, Calif., whose waterworks were also owned by Carlyle, has filed a similar lawsuit. Santa Paula bought its sewer plant from Alinda last year.

Of course, there’s a reason many communities look for private partners to begin with: Their water systems are in poor shape. Budget shortfalls and political mismanagement can represent a real threat to both infrastructure and citizens. For evidence, look no further than the crisis in Flint, Mich., where the drinking water became tainted with lead.

“Keeping rates down may sound like the ultimate righteous good for ratepayers, but the truth is, not if you’re failing to provide basic care and maintenance,” said Megan Matson, a partner at Table Rock Capital, the boutique private equity firm that invested in Rialto’s water and sewer system. She added that it helps for deals to “provide more obvious public benefits,” noting that her firm partnered with Ullico, the nation’s only labor-owned insurance and investment Company.

Proponents of the public-private partnerships, citing recent studies in Canada and Europe, argue that private businesses operate more efficiently than governments do and that this translates into cost savings for citizens. And private equity firms, lacking technical expertise in how to manage infrastructure, often team up with private water companies.

Supporters also say that the deals require private equity to spend millions of dollars a year to fix things (money that towns may not spend on their own), and that the firms sometimes pay towns millions more up front. Bayonne, for instance, got $150 million up front from K.K.R.’s team, which the city used to pay off a pile of debt.

In a statement, a K.K.R. spokeswoman said, “Our partnership has provided Bayonne residents with better service, modernized technology to detect leaks and conserve water, improved infrastructure and safer conditions for workers — all without a tax increase or public expenditure.”

Desperate Measures

In Bayonne, a city of about 65,000 on a peninsula in the shadow of the fallen twin towers, a crucial test for its private equity deal came in July 2012. By then, Bayonne had already spent nearly a year haggling with some of K.K.R.’s top negotiators.

A technician monitors the pumps at the Oak Street Pumping Station in Bayonne. Credit Bryan Anselm for The New York Times

Next, city officials presented the deal to a more skeptical crowd: their own residents.

Bayonne’s sales pitch to its citizens illustrates the bold steps town officials can take — including making promises that are at odds with the actual terms of the deal — to attract private equity money. Private equity, in turn, can earn significant returns.

At a public meeting in city hall, a lawyer for the city promised that, after an initial rate bump, there would be “a rate freeze for four years,” according to a meeting transcript. Bayonne’s mayor, Mark Smith, later reiterated the four-year freeze in a magazine article.

That promise turned out to be fleeting.

The contract allowed additional rate increases after only two years. There was no four-year freeze.

In fact, rates rose even more than the Bayonne contract predicted — in part because K.K.R’s team had to make unexpected infrastructure upgrades, but also because residents were using less water than expected. The contract guarantees revenue to the team — more than half a billion dollars over 40 years — so water rates have jumped, in part, to make up the difference.

The city said it saw the revenue requirement as a way for K.K.R.’s team to earn steady returns, but not a windfall.

But the Times analysis showed that Bayonne’s water rates grew almost 28 percent under the deal, growth that far exceeded that of three other municipalities to which Bayonne has compared itself.

(Daniel Van Abs, an associate professor at Rutgers University who specializes in water management, said that a true apples-to-apples comparison of water rates in different towns was “extremely difficult” because of the different factors that can influence rates, including the size of the utility, the municipality’s population, droughts and infrastructure investment — or lack thereof. The Times analysis for Bayonne did not include sewer rates.)

Former Bayonne officials who had promised the four-year rate freeze said in interviews that they had not meant to mislead residents. They said they had earmarked some of the K.K.R. team’s $150 million up-front payment to offset rate increases in the contract’s early years.

But then voters ousted Mayor Smith. And once he left office, the new administration put that money elsewhere.

“I think we could have accomplished that four-year minimum,” the former mayor said in an interview. The town’s water rates, he said, are now “exorbitant.”

“We gave away too much,” said Gary La Pelusa Sr., a Bayonne city councilman and a former commissioner of the town’s utilities authority. Credit Bryan Anselm for The New York Times

Tim Boyle, who took over Bayonne’s utilities authority after Mr. Smith was voted out of office, said that various regulations required the city to use that money for property tax relief rather than to stabilize rates. He also blamed the previous administration for guaranteeing too much revenue to K.K.R.’s team in the early part of the deal, calling those figures “wildly optimistic.”

Bayonne officials also stress the deal’s benefits, including the up-front payment that let Bayonne pay off more than $100 million in old debts. Within three months, Moody’s Investor Service revised the city’s debt outlook from “negative” to “stable” for the first time in five years, and it has since upgraded the city’s credit rating.

K.K.R.’s team contributes about $2.5 million annually to pay for repairs to water infrastructure, plus $500,000 to the city itself. K.K.R. and Suez said they have upgraded their safety equipment and replaced inoperable hydrants around town.

They also installed sophisticated water meters that can detect leaks in people’s homes, and sent nearly 2,000 letters to customers warning when such leaks occurred. As such, use has declined, according to Mr. Henning, who said Suez had received “many notes of thanks” for the warnings.

But more-sensitive meters could lead to higher bills for some residents whose water use wasn’t fully captured in the past. When negotiating the deal, K.K.R. called this process “meter uplift,” according to emails obtained through records requests.

“We gave away too much,” said Gary La Pelusa Sr., a city councilman and former commissioner of Bayonne’s utilities authority, which approved the deal over his objections.

Bayonne originally promised residents that the city’s utilities authority would oversee K.K.R. and Suez. But the City Council recently decided to shutter the agency and handle the oversight itself.

Stephen Gallo, who headed that authority when the deal was struck, still believes that it benefits Bayonne. “But you’ve got to watch them, you’ve got to keep an eye on things,” he said. “I don’t know who’s doing that now.”

In interviews with The Times, more than a dozen Bayonne residents, including Ms. Adamczyk, expressed dismay over the rate increases. One reason is that people who fall behind on payments face long-term risks: Unpaid water and sewer bills can be sold to investors who try to collect on that debt, a common practice across the country. Failure to pay can ultimately lead to foreclosure.

In 2012, the year Bayonne struck its deal, water bill delinquencies led to 200 government liens against local properties, tax records show. That figure more than tripled the next year, the first full year under K.K.R.’s team. In 2015, the most recent year with data available, the number remained elevated, at 465.

Megan Matson and Peter Luchetti of Table Rock Capital, a private equity firm that has invested in a public water system in Rialto, Calif. Credit Anthony Cruz for The New York Times

The city publishes its lien notices in the local newspaper and residents receive mailed delinquency letters.

Still, when a reporter asked one Bayonne resident, Carlos Jimenez, about a water and sewer bill lien that had been listed against his property, he expressed surprise, saying he wasn’t aware of it. “I didn’t know this could happen,” Mr. Jimenez said. “It’s a different ballgame.”

‘There Is No “Free” Money’

One of the few things Republicans and Democrats can agree on is that the nation faces an infrastructure crisis.

In water infrastructure alone, the nation needs about $600 billion over the next 20 years, according to federal estimates. And yet federal spending on water utilities has declined, prompting state and federal officials to try to play matchmaker, courting private investors to fix what needs fixing.

For years, the Obama administration has been cheerleading public-private partnerships. In a statement, the White House said it backed them “when they are well structured, include strong labor standards, and when there is confidence that taxpayers are getting a good deal.”

During the presidential campaign, Mr. Trump’s team outlined a new plan to incentivize private investors to take on large infrastructure projects.

Wall Street has responded to the call to action. There are now 84 active financial infrastructure funds, according to Pitchbook, a private financial data platform, up 25 percent in just three years. Some belong to big banks like Goldman Sachs, but many are run by private equity firms.

“Across our country, we need solutions for infrastructure deficiencies,” said James Maloney, a spokesman for the American Investment Council, the private equity trade group. “Private equity serves as one of these solutions.”

Some critics are wary of expanding private investment in public infrastructure. Although cities may get cash up front in these deals, “there is no ‘free’ money” in public-private partnerships, says a 2008 Government Accountability Office report. Using roads as an example, the report observed “it is likely” that tolls will increase more on a privately operated highway than one run by the government.

Ms. Matson, of Table Rock, who has attended White House meetings on infrastructure, has tried to dispel concerns about these deals. Table Rock is part of a team that finances and manages the water system in Rialto, Calif., a deal that provided the city about $41 million to improve the water and wastewater infrastructure, she said.

The icy Clark Fork River flows through downtown Missoula, Mont. The city sued and won the right to buy the local water system, but not before its private equity owner sold it to another company. Credit Lido Vizzutti for The New York Times

Rialto residents have seen their water rates increase about 68 percent since the deal, according to the Times analysis, more than any other comparable city. But Table Rock said rates were artificially low after the city had declined to raise them for about a decade, giving it the lowest rates among those towns. And unlike in most other deals, Rialto residents had a say in the increases and ultimately approved them in a public vote, as required under state law. This year’s rate increase was delayed.

When the deal closed in 2012, all the public water utility employees kept their jobs. Everyone has since received raises. And Table Rock, like its partner Ullico, has committed to all 30 years of the arrangement.

“We don’t do flips, we invest for life,” Ms. Matson said, meaning that Table Rock doesn’t seek quick profits by unloading its investments. She also said that Table Rock declined to make deals that provided big up-front payments to towns without a sufficient commitment to infrastructure repairs. “Those deals give the rest of us a bad name,” she said.

Gaining Control, but Then What?

In an upscale Washington, D.C., restaurant in 2012, an executive from the Carlyle Group, one of the world’s largest private equity firms, put his arm around the mayor of Missoula, Mont.

“Mayor,” the executive said, “are you ready to buy a water system?”

Three years later, the comments by the executive, Robert Dove, were recounted from a witness stand in the Missoula County Courthouse. The city was suing Carlyle, which ultimately refused to sell to Missoula, to gain control of its water system.

Missoula is one of several places in recent years that have tried getting back their water systems from a private company. But after waging costly battles, the towns cannot always guarantee the same services at lower rates.

At the time of that dinner in Washington, Missoula was the only city in Montana that did not own its water system — and John Engen, Missoula’s mayor, wanted to change that. So, months before, he had supported Carlyle’s purchase of the regional water company (Park Water) that owned Missoula’s local system (Mountain Water), believing that Carlyle would then sell Mountain Water back to his town.

But the mayor’s plans derailed.

In October 2013, Missoula made an informal offer to buy its local system. Carlyle declined. Missoula made a formal offer. Carlyle declined again.

Missoula then sued, and it won. But the court decided the system was worth $88.6 million, substantially more than what the city had offered. On top of that, the city must spend millions of dollars on legal and other fees and must also pay some of its opponents’ costs, according to court records.

Those costs included lawyers’ fees, limo services and dinners at some of Missoula’s finest restaurants. They also included at least one order of boneless chicken wings at Hooters, and one bottle of Metamucil.

John Engen, the mayor of Missoula. Credit Lido Vizzutti for The New York Times

In a statement, a Carlyle spokesman said that the firm had considered the city’s offers in good faith. “The city offered many millions less than the company was worth, and an independent panel agreed,” the spokesman said.

He also said that under Carlyle’s watch, “capital expenditures more than doubled, leakage was reduced by 19 percent, water quality was excellent and employment was stable.”

And under Missoula’s watch, water rates may rise anyway. Further costly repairs are still needed, for one thing.

For Carlyle, the deal was a financial success. The firm sold Park Water in January to another private company for $327 million, more than double what Carlyle had paid.

Missoula is not the only city seeking control over its infrastructure. Last year, Santa Paula bought its wastewater recycling plant for about $70 million from Alinda Capital Partners.

Alinda, which specializes in infrastructure investing, had teamed up with a private water recycling company to finance, design, build and operate the plant after the city awarded them the contract in 2008. The new facility, Alinda noted, replaced an old plant owned by Santa Paula that had been violating state environmental regulations, saving the city from paying fines.

But after years of raising sewer rates, partly to pay “service fees” to Alinda, Santa Paula’s thinking changed: It would be better for Santa Paula to issue its own debt to purchase the plant than to saddle citizens with annual rate increases. Now the town — at the urging of its city manager, Jaime Fontes, and several council members, including Ginger Gherardi — has started issuing rebates to citizens.

Still, there will be bumps along the road. After all, cities like Missoula and Santa Paula are now responsible for running an important, and occasionally messy, public service.

Soon after Santa Paula regained control of its sewer plant, an equipment failure let partly treated wastewater pour from the plant. The discharge turned a pond green and flowed onto a nearby organic farm.

And wastewater, Mr. Fontes said, is “not the kind of organic you want.”

Rachel Abrams contributed reporting from Los Angeles. Kitty Bennett, Susan Beachy and Alain Delaquérière contributed research.

The Crisis of Market Fundamentalism

Anatole Kaletsky


LONDON – The biggest political surprise of 2016 was that everyone was so surprised. I certainly had no excuse to be caught unawares: soon after the 2008 crisis, I wrote a book suggesting that a collapse of confidence in political institutions would follow the economic collapse, with a lag of five years or so.
We’ve seen this sequence before. The first breakdown of globalization, described by Karl Marx and Friedrich Engels in their 1848 The Communist Manifesto, was followed by reform laws creating unprecedented rights for the working class. The breakdown of British imperialism after World War I was followed by the New Deal and the welfare state. And the breakdown of Keynesian economics after 1968 was followed by the Thatcher-Reagan revolution. In my book Capitalism 4.0, I argued that comparable political upheavals would follow the fourth systemic breakdown of global capitalism heralded by the 2008 crisis.
When a particular model of capitalism is working successfully, material progress relieves political pressures. But when the economy fails – and the failure is not just a transient phase but a symptom of deep contradictions – capitalism’s disruptive social side effects can turn politically toxic.
That is what happened after 2008. Once the failure of free trade, deregulation, and monetarism came to be seen as leading to a “new normal” of permanent austerity and diminished expectations, rather than just to a temporary banking crisis, the inequalities, job losses, and cultural dislocations of the pre-crisis period could no longer be legitimized – just as the extortionate taxes of the 1950s and 1960s lost their legitimacy in the stagflation of the 1970s.
If we are witnessing this kind of transformation, then piecemeal reformers who try to address specific grievances about immigration, trade, or income inequality will lose out to radical politicians who challenge the entire system. And, in some ways, the radicals will be right.
The disappearance of “good” manufacturing jobs cannot be blamed on immigration, trade, or technology. But whereas these vectors of economic competition increase total national income, they do not necessarily distribute income gains in a socially acceptable way. To do that requires deliberate political intervention on at least two fronts.
First, macroeconomic management must ensure that demand always grows as strongly as the supply potential created by technology and globalization. This is the fundamental Keynesian insight that was temporarily rejected in the heyday of monetarism during the early 1980s, successfully reinstated in the 1990s (at least in the US and Britain), but then forgotten again in the deficit panic after 2009.
A return to Keynesian demand management could be the main economic benefit of Donald Trump’s incoming US administration, as expansionary fiscal policies replace much less efficient efforts at monetary stimulus. The US may now be ready to abandon the monetarist dogmas of central-bank independence and inflation targeting, and to restore full employment as the top priority of demand management. For Europe, however, this revolution in macroeconomic thinking is still years away.
At the same time, a second, more momentous, intellectual revolution will be needed regarding government intervention in social outcomes and economic structures. Market fundamentalism conceals a profound contradiction. Free trade, technological progress, and other forces that promote economic “efficiency” are presented as beneficial to society, even if they harm individual workers or businesses, because growing national incomes allow winners to compensate losers, ensuring that nobody is left worse off.
This principle of so-called Pareto optimality underlies all moral claims for free-market economics.
Liberalizing policies are justified in theory only by the assumption that political decisions will redistribute some of the gains from winners to losers in socially acceptable ways. But what happens if politicians do the opposite in practice?
By deregulating finance and trade, intensifying competition, and weakening unions, governments created the theoretical conditions that demanded redistribution from winners to losers. But advocates of market fundamentalism did not just forget redistribution; they forbade it.
The pretext was that taxes, welfare payments, and other government interventions impair incentives and distort competition, reducing economic growth for society as a whole. But, as Margaret Thatcher famously said, “[…] there’s no such thing as society. There are individual men and women and there are families.” By focusing on the social benefits of competition while ignoring the costs to specific people, the market fundamentalists disregarded the principle of individualism at the heart of their own ideology.
After this year’s political upheavals, the fatal contradiction between social benefits and individual losses can no longer be ignored. If trade, competition, and technological progress are to power the next phase of capitalism, they will have to be paired with government interventions to redistribute the gains from growth in ways that Thatcher and Reagan declared taboo.
Breaking these taboos need not mean returning to the high tax rates, inflation, and dependency culture of the 1970s. Just as fiscal and monetary policy can be calibrated to minimize both unemployment and inflation, redistribution can be designed not merely to recycle taxes into welfare, but to help more directly when workers and communities suffer from globalization and technological change.
Instead of providing cash handouts that push people from work into long-term unemployment or retirement, governments can redistribute the benefits of growth by supporting employment and incomes with regional and industrial subsidies and minimum-wage laws. Among the most effective interventions of this type, demonstrated in Germany and Scandinavia, is to spend money on high-quality vocational education and re-training for workers and students outside universities, creating non-academic routes to a middle-class standard of living.
These may all sound like obvious nostrums, but governments have mostly done the opposite.
They have made tax systems less progressive and slashed spending on education, industrial policies and regional subsidies, pouring money instead into health care, pensions, and cash hand-outs that encourage early retirement and disability. The redistribution has been away from low-paid young workers, whose jobs and wages are genuinely threatened by trade and immigration, and toward the managerial and financial elites, who have gained the most from globalization, and elderly retirees, whose guaranteed pensions protect them from economic disruptions.
Yet this year’s political upheavals have been driven by elderly voters, while young voters mostly supported the status quo. This paradox shows the post-crisis confusion and disillusionment is not yet over. But the search for new economic models that I called “Capitalism 4.1” has clearly started – for better or worse.

Trump Trade Causes Pain in Spain

Spanish banks may suffer from emerging-market woes following Donald Trump’s U.S. election victory, particularly those exposed to Mexico

By Paul J. Davies

     The Santander Group logo. Photo: Zuma Press

Donald Trump’s U.S. election victory has hurt some European banks: Spanish banks in particular have underperformed due to worries about the president-elect’s attitude to trade and the pain that will cause Mexico and South America.

Shares in Santander Group and BBVA have recovered ground they lost right after the election, but have lagged behind the Stoxx 600 Banks index and are way behind investment banks, such as Barclays, Credit Suisse and Deutsche Bank, which have rallied on deregulation hopes.

For BBVA, President Trump poses real potential problems. The lender gets its biggest chunk of earnings from Mexico, about 40% in the first nine months of 2016, which is the market most threatened by the president-elect’s stance against globalization and immigration.

The peso has slid, making Mexican earnings worth less, while investment and loan growth is expected to suffer immediately. If Mexico loses industry and exports, really weakening the economy, bad loans will rise too.

Santander relies less on Mexico. Its big South American market is Brazil, which contributes about one-fifth of earnings. The country could really suffer if trade with the U.S. declines, but it has been recovering strongly and the currency has been strengthening all year.

BBVA has another problem: Its other major market outside Spain is Turkey, where a coup attempt and political crackdown have spooked investors, leading to a weak currency and higher interest rates.

Pessimism about trade under President Trump might prove overdone—as might optimism about investment bank freedoms to come. But Santander looks like a safer bet than BBVA. Fears alone will hurt Mexico for now.

Weekend Edition: Doug Casey on the Next Industrial Revolution

This weekend, to kick things off, we're featuring an eye-opening two-parter from Casey Research founder Doug Casey on the next industrial revolution. In short, Doug believes we're only 10–30 years away from the biggest change in human history…


What you’re going to read in the next few minutes will be shocking and unbelievable. But it’s also factual and logical. That will make it upsetting and disturbing. Most people are at least vaguely aware of what’s happening. But very, very few are aware of its degree or the implications.

As you probably know, I believe times are about to get quite rough economically and politically. But, at the same time, I’m very optimistic about what’s happening in science and technology. So let me hazard some predictions. And break the old rule about how, if you predict an event will occur, to make sure you don’t predict its timing.


I was born just after the end of WW2. It was an idyllic era to be an American. The U.S. had more wealth than the rest of the world combined. Things were mellow at home as “Leave It to Beaver” in the ’50s transitioned into “California Girls” in the early ’60s.

True, there were at least a couple of times (the 1962 Cuban Missile Crisis and a while in the early ’80s) when it looked like there might be a global thermonuclear war. We not only dodged those bullets, but things kept improving. The average American accumulated so much stuff that he had to rent a storage unit, after filling up his two-car garage.

The USSR collapsed, and the U.S. government went on to become the world’s only superpower.

Things have been pretty good within the living memory. No matter that the last couple of generations of prosperity were financed mostly with borrowed money.

Although everybody (including me) tends to focus on political events, it’s a mistake to pay too much attention to them. Governments, and even countries, come and go, rise and fall. Political events should be viewed as flavoring to the stew, painting on a house, or trim tabs on a flight.

They’re worth noting, but—unless they’re really bad—only marginally important over the long run.

What is important? From a long-term point of view, there are really just three things: science, technology, and capital. Science lets you understand how and why things work. Technology lets you put the theory into practice. And capital gives you the time and material to make use of science and technology.

Let’s look at civilization from that long-term point of view. Since the appearance of Homo sapiens about 200,000 years ago, things improved at only a glacial pace until the end of the last ice age about 12,000 years ago. Then, with the start of the Neolithic era and the Agricultural Revolution, things started getting better every millennium. Then, since the start of the Bronze Age about 5,000 years ago, they started getting better by the century. Then, with the Renaissance and the Enlightenment, by the decade.

Since the Industrial Revolution, about 200 years ago, they’ve been getting better every year.

And it’s been an accelerating trend. Exponentially accelerating. Most people don’t keep up with these things, but important advances are now being made weekly.

Why are these things accelerating at an exponential rate? There are several reasons, I think.

One is that, since all the past advances in science and technology still exist, we don’t have to constantly reinvent the wheel. Another is that, in earlier eras, there was very little surplus left over after covering basic food, shelter, and clothing; now there’s a lot. That’s capital, and it’s compounding. But, very important, there are more scientists and engineers alive today than have lived in all previous human history put together.

Not only that, but radically new technologies are coming into existence—not gradually at an arithmetic rate, but at a geometric rate. So things are on the verge of becoming much, much better, and very, very quickly. Not only better than you imagine, but better than you can imagine.

Moore’s Law was formulated in 1965; it states that computational power will double, and costs will halve, about every 18 months. But it appears to apply to several areas besides computing.

As a result, it’s highly probable that Timothy Leary was not just right, but conservative, when he anticipated SMIILE—Space Migration, Intelligence Increase, and Life Extension. Those things are just part of the picture.

So here’s the good news. It’s likely the very nature of life is going to change for the better, almost unrecognizably, over the next 20 years or so.

I’ve very arbitrarily divided the areas of progress into 10 areas. There’s a lot of overlap between them because all the areas of science and technology are an increasingly integrated whole.

I’m sure you’re familiar with all these trends. But the chances are low that you’ve adequately considered how quickly they’re advancing and where that advance is going to lead—very soon.

I only want to broach the subjects; libraries can be written on all of this. The takeaway is that the very components of reality itself—Matter, Energy, Space, and Time—will soon be manipulated on a cosmic scale.


Some of these things, like energy and space exploration, are just extensions of current technologies.
Others, especially nanotech, are game changers.

Energy—With the exception of nuclear, all power comes from the sun. In the past, solar, wind, and similar power sources existed mainly in the dreams of economically illiterate hippies. But now, combined with rapidly advancing battery technology, they finally make sense. Better yet, oncoming generations of modular nuclear reactors will be tiny, extremely safe, simple, and cheap. Maybe fusion power will finally become practical—although that would just be a bonus.

Oil and gas? They’re important as feedstocks, but mainly because they provide very dense energy.

They are, however, essentially compounds of hydrogen and carbon, two of the most common and simplest elements. With adequate (and sufficiently cheap—this is the key) power, they can be created in unlimited quantity; the chemistry is quite basic and well understood. Among other things, algae can be programmed to manufacture them in quantity.

Space—One of the good things about most governments being bankrupt is that they’re being forced to cede the conquest of space to entrepreneurs, who will colonize the moon, the asteroids, and the planets. I love Elon Musk’s quip: “I hope to die on Mars. Just not on impact.” Of course, if he’s lucky, he may live to be several hundred years old because of other developments.

You need “stuff” to make what you need. A lack of raw materials has always been a major reason for conflict. But digging things out of the Earth, using big yellow trucks, will no longer be humanity’s only option. The asteroids are full of dense elements. They’ll soon become available in massive quantity, cheaply.

Life extension—It’s clear we’re on the edge of solving the problem of aging; it should be addressed as a degenerative disease. All other diseases are simply footnotes to aging. If you live long enough, you can be, do, and have everything that you can imagine. It’s likely to be possible soon.

Biological engineering—The creation of not just new body parts, but new bodies, made to order, is in the works. And new species. And much more. Who really knows what can be done with DNA? But the answer is probably: Almost anything, in lots of ways.

Distributed manufacturing—A.E. van Vogt’s The Weapon Shops of Isher predicted machines that would create advanced weapons for you, in the privacy of your own home. Now that’s possible with 3-D printing. Soon, if you can design something, or get the design, you can create it. At home.

Robotics—Not just smart machines in factories. In fact, factories themselves may be on their way out. Humanoid beings—products of bioengineering and AI—could replace them. They’ll perhaps be almost indistinguishable from normal people.

This alone, the creation of intelligent machines, will overturn the nature of society, family, warfare, work—everything.

Artificial intelligence—I believe that a difference that makes no difference is no difference.

That’s the concept behind the Turing test. At some point, very soon, machines will be smarter than their creators and will in turn create other machines smarter than they are. And continue doing so at a geometric rate.

Nanotech—I did a chapter on this in Crisis Investing for the Rest of the ’90s. At the time, not one person in 100 had a clue what it was. In its ultimate form, nanotech—the use of molecular-sized assemblers and supercomputers—will change the character of reality itself. Totally and unrecognizably. It amounts to pixie dust, making it possible to manipulate the 92 naturally occurring elements into useful compounds cheaply and easily. It’s becoming possible to fabricate totally new materials, like carbon nanotubes, vastly more capable than any “natural” material.

Computer science—Electromechanical switches, then vacuum tubes, then transistors, now silicon chips, and soon quantum computing are taking place on a molecular level. All the knowledge in the world, contained in a cube. Or perhaps in the head of a biologically enhanced robot. Or perhaps in an interface to your own brain.

Virtual reality—You’ll be able to immerse yourself in a world of your own creation, activating all of your senses, in a veritable Star Trek holodeck that will be almost indistinguishable from real reality. Perhaps you will prefer to live in unreality. All in the privacy of your own home.