The New Fed Chair

By Doug Casey, founder, Casey Research

A few words are in order about the likely new Chairman of the Federal Reserve, Jerome Powell.

I don’t know the man personally. Not that it would make any difference; denizens of the swamp within the Beltway usually present well, and a brief meeting rarely allows you to penetrate someone’s social veneer. But I’m pretty confident that if we dined together it would be tense and unpleasant. We’d have no common ground, after the obligatory two minutes on the weather and the state of the roads.

He’s a lawyer, has been a Fed Governor for five years, and appears to be a “steady as she goes” so-called moderate Republican. He’s a lifelong Deep State player. But let’s not waste time psychoanalyzing this bureaucrat; he’s just a cog in the machine. And the machine, at this stage, has a life of its own.

Many of my friends in the alternative press deplore Trump’s appointment of yet another conventional money printer. They were hoping for a “hawk,” who would start liquidating the Fed’s $4.5 trillion balance sheet, and raising interest rates. And they’re right. That $4.5 trillion of super money has driven stock, bond, and real estate prices to insane levels. And today’s artificially low interest rates are discouraging saving, and encouraging people to live above their means.

In an ideal world there would be some radical changes. The best thing for the US in the (famous) long run is to go “cold turkey.” To abolish the Federal Reserve, fire its thousands of employees with their worthless PhDs. Return to 100% reserve banking with a strict separation of demand and time deposits. Depoliticize money by using gold, not Federal Reserve Notes. And default on the national debt, which is rewarding crony capitalists, and will turn future generations of Americans into serfs. And massively deregulate. And abolish the income tax, while cutting spending 90%. Etc. Etc.

The chances of that happening are exactly zero. So let’s talk, instead, about what is going to happen.

We’re going to have much higher levels of inflation. The new Fed Chair will open a monetary hydrant, at least if he doesn’t want to be hung from a lamppost by his heels. But I’m quite pleased Trump has appointed the guy. That may sound shocking. Let me explain why.

A sound economist would work to stop money printing and let interest rates find a market level. But that would precipitate a deflationary collapse after decades of monetary debasement. And the powers of darkness would again be able to paint sound policies and the free market as the cause for the problem, when actually it’s the only cure for economic problems.

From an economic point of view an inflationist like Powell is a disaster. It’s too bad he’s nominally a Republican, since for some reason they’re associated with the free market. As is Trump. Wearing our speculator hats, we’d likely be better off under Hillary—even more inflation, even more distortions to capitalize on. Even wearing our economist hats we might be better off under her, because if the whole rotten structure collapsed on her watch, it might discredit her ideas for at least a few years. But, as ever, I suspect I’m being too optimistic.

For decades—at least since I started following these things in the early ‘70s—free market economists have argued whether the Fed’s ever-increasing money printing would result in a deflationary depression, or a hyperinflationary depression.

As to why a catastrophic depression is inevitable—despite the fact most people try to produce more than they consume, and despite the fact science and technology are advancing exponentially—is beyond the scope of this brief article. I refer you to these pieces (here and here) I’ve done in the past on that topic.

It will be a deflationary collapse if the Fed doesn’t continue buying debt and creating new dollars. And a hyperinflation if they do.

If they stop printing, the banks would fail, and the public would lose a good portion of their deposits. The economy would slow down considerably, causing indebted corporations to default, unemploying their workers. Tax revenues would fall off, and governments wouldn’t be able to fund welfare programs. The stock, bond and real estate markets would collapse, wiping out the asset base of rich people.

It would be a huge social upset. But most of the real wealth in the world would still exist, it’s just that a lot of it would change ownership. And the dollar would still exist—there’d just be many fewer of them. Production and commerce could continue. At least until the cries go out for the government to “do something.”

But hyperinflation will be an even bigger disaster. And that’s what we’re going to get. Money will drop radically in value, making production and consumption much, much harder.

Foreigners will dump trillions of them, sending them back to the US in exchange for real wealth. There’ll be even more unemployment than with deflation. But the profligate—those who’d borrowed a lot to live above their means—will be rewarded, while prudent savers will be punished. Shaky, overindebted corporations might survive, while productive ones with fat balance sheets will lose. Worse, governments will have their debts erased, and therefore might even grow in power. They’ll definitely “do something,” they always do in time of chaos. Stocks and real estate could first crash, then soar as people try to get out of dollars and into assets.

This will benefit the rich, at least in relative terms.

At this late stage either type of depression will result in not just financial and economic, but in social and political chaos. It won’t be fun. In a depression everybody loses. The winners are just those who lose least. And a few speculators that get lucky. Hopefully we’ll be among them.
Given a choice—and they have a choice, based on whether they keep printing or not—the government and the Fed will definitely veer towards more inflation. Everyone in office just hopes to kick the can down the road for at least one more cycle.

Frankly, I was surprised that things didn’t go over a cliff in 2008 when we entered this most recent hurricane. And I’ve been surprised that things have held together as well as they have during the long “eye of the storm.” But governments and central banks around the world have already printed up scores of trillions of new currency units, and reduced interest rates to zero and below. What can they do when we go into the trailing edge of the hurricane?

My guess is that they’ll repeat their actions so far. Print more money and try to take interest rates even lower. The result will be hyperinflation, or close to it. And lots of new government controls of all types.

Why is this—strictly relatively speaking—good news for us? Because more money printing means more bubbles will be created. And while bubbles are the enemies of a sound economy, they’re the friend of the speculator. The current mania in Bitcoin and other cryptocurrencies is an example.

In particular, I’m looking forward to a bubble in commodities in general (most are down 50% from the previous peak in 2011), and precious metals in particular. And not just a bubble, but a hyper bubble in mining stocks.

So, if I’m right, in the next few years we could stand to make a fortune while the world is falling apart. I know—that sounds harsh to be eating caviar while the masses are forced to grub for roots and berries. But, as Ayn Rand said when asked what you should do about the poor: “Just make sure you’re not one of them.”

Inconvenient Truths About Migration


Celebrating Eid in London

LONDON – Sociology, anthropology, and history have been making large inroads into the debate on immigration. It seems that Homo economicus, who lives for bread alone, has given way to someone for whom a sense of belonging is at least as important as eating.

This makes one doubt that hostility to mass immigration is simply a protest against job losses, depressed wages, and growing inequality. Economics has certainly played a part in the upsurge of identity politics, but the crisis of identity will not be expunged by economic reforms alone. Economic welfare is not the same as social wellbeing.

Let’s start, though, with the economics, using the United Kingdom – now heading out of the EU – as a case in point. Between 1991 and 2013 there was a net inflow of 4.9 million foreign-born migrants into Britain.

Standard economic theory tells us that net inward migration, like free trade, benefits the native population only after a lag. The argument here is that if you increase the quantity of labor, its price (wages) falls. This will increase profits. The increase in profits leads to more investment, which will increase demand for labor, thereby reversing the initial fall in wages. Immigration thus enables a larger population to enjoy the same standard of living as the smaller population did before – a clear improvement in total welfare.

A recent study by Cambridge University economist Robert Rowthorn, however, has shown that this argument is full of holes. The so-called temporary effects in terms of displaced native workers and lower wages may last five or ten years, while the beneficial effects assume an absence of recession. And, even with no recession, if there is a continuing inflow of migrants, rather than a one-off increase in the size of the labor force, demand for labor may constantly lag behind growth in supply. The “claim that immigrants take jobs from local workers and push down their wages,” Rowthorn argues, “may be exaggerated, but it is not always false.”

A second economic argument is that immigration will rejuvenate the labor force and stabilize public finances, because young, imported workers will generate the taxes required to support a rising number of pensioners. The UK population is projected to surpass 70 million before the end of the next decade, an increase of 3.6 million, or 5.5%, owing to net immigration and a surplus of births over deaths among the newcomers.

Rowthorn dismisses this argument. “Rejuvenation through immigration is an endless treadmill,” he says. “To maintain a once-and-for-all reduction in the dependency ratio requires a never-ending stream of immigrants. Once the inflow stops, the age structure will revert to its original trajectory.” A lower inflow and a higher retirement age would be a much better solution to population aging.

Thus, even with optimal outcomes, like the avoidance of recession, the economic arguments for large-scale immigration are hardly conclusive. So the crux of the matter is really its social impact.

Here, the familiar benefit of diversity confronts the downside risk of a loss of social cohesion.

David Goodhart, former editor of the journal Prospect, has argued the case for restriction from a social democratic perspective. Goodhart takes no position on whether cultural diversity is intrinsically or morally good or bad. He simply takes it for granted that most people prefer to live with their own kind, and that policymakers must attend to this preference. A laissez-faire attitude to the composition of a country’s population is as untenable as indifference to its size.

For Goodhart, the taproot of liberals’ hostility to migration controls is their individualist view of society. Failing to comprehend people’s attachment to settled communities, they label hostility to immigration irrational or racist.

Liberal over-optimism about the ease of integrating migrants stems from the same source: if society is no more than a collection of individuals, integration is a non-issue. Of course, says Goodhart, immigrants do not have to abandon their traditions completely, but “there is such a thing as society,” and if they make no effort to join it, native citizens will find it hard to consider them part of the “imagined community.”

A too-rapid inflow of immigrants weakens bonds of solidarity, and, in the long run, erodes the affective ties required to sustain the welfare state. “People will always favor their own families and communities,” Goodhart argues, and “it is the task of a realistic liberalism to strive for a definition of community that is wide enough to include people from many different backgrounds, without being so wide as to become meaningless.”

Economic and political liberals are bedfellows in championing unrestricted immigration.

Economic liberals view national frontiers as irrational obstacles to the global integration of markets. Many political liberals regard nation-states and the loyalties they inspire as obstacles to the wider political integration of humanity. Both appeal to moral obligations that stretch far beyond nations’ cultural and physical boundaries.

At issue is the oldest debate in the social sciences. Can communities be created by politics and markets, or do they presuppose a prior sense of belonging?

It seems to me that anyone who thinks about such matters is bound to agree with Goodhart that citizenship, for most people, is something they are born into. Values are grown from a specific history and geography. If the make-up of a community is changed too fast, it cuts people adrift from their own history, rendering them rootless. Liberals’ anxiety not to appear racist hides these truths from them. An explosion of what is now called populism is the inevitable result.

The policy conclusion to be drawn is banal, but worth restating. A people’s tolerance for change and adaptation should not be strained beyond its limits, different though these will be in different countries. Specifically, immigration should not be pressed too far, because it will be sure to ignite hostility. Politicians who fail to “control the borders” do not deserve their people’s trust.

Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy in history and economics, is a member of the British House of Lords. The author of a three-volume biography of John Maynard Keynes, he began his political career in the Labour party, became the Conservative Party’s spokesman for Treasury affairs in the House of Lords, and was eventually forced out of the Conservative Party for his opposition to NATO’s intervention in Kosovo in 1999.

A wobbly Merkel means a weaker Europe

Problems on the continent remain, and the chancellor’s travails will exacerbate them

Gideon Rachman

When Angela Merkel hosted the G20 summit in Hamburg last July, she was the most experienced western leader in the room. The German chancellor took office in 2005 — when Emmanuel Macron was just a year out of college, and Donald Trump was still a reality TV star and real estate guy.

The only G20 leader who has been in office longer than Ms Merkel is Vladimir Putin of Russia, and the two leaders’ records make an instructive contrast. Under President Putin, Russia has lost friends, was sucked into wars and been hit with economic sanctions. But, in the Merkel era, Germany has grown steadily in prosperity and political influence. On a range of crucial issues — Russia, refugees, the euro — Germany has become Europe’s “indispensable nation”, with decisions taken in the chancellery in Berlin critical to how events unfold.

So the current political crisis in Germany has global implications. If, as now seems distinctly possible, the end of the Merkel era is within sight, Europe will be in a new and dangerous situation.

The EU-optimists in Brussels and Paris will hope that a new German leader might inject some dynamism into the European project, ditching the cautious, incremental approach that Ms Merkel has displayed over the euro.

But, in fact, the opposite is more likely to happen. The current tenor of German politics suggests that a new chancellor in Berlin is far less likely than Ms Merkel to take bold risks for Europe. The spoilers in the current coalition negotiations are the Free Democrats, who are strongly opposed to visionary ideas for deeper European fiscal integration.

For that reason, the collapse of the coalition talks in Berlin is bad news for Mr Macron. In a recent speech on Europe at the Sorbonne, the French president laid out a series of ambitious ideas for the EU, including the creation of a European finance ministry, EU-wide taxes and a joint military force for overseas interventions. Yet for these ideas to have any chance of adoption, France needs a positive response from Germany. The failure to form a new German government means the response will now be indefinitely delayed, and will be more likely to be negative when it finally comes.

Some conservatives hope that a post-Merkel Germany could be better for European unity when it comes to the sensitive issue of dealing with refugees. The chancellor was bitterly criticised in Hungary and Poland for unilaterally deciding to accept more than 1m would-be refugees from Syria and elsewhere, and then seeking a burden-sharing agreement with the rest of the EU.

The current coalition talks have already demonstrated that Germany is moving towards a much more restrictive view of refugee rights — including setting an overall limit to the number of asylum-seekers the country will accept each year. But even if the next German government is closer to the EU mainstream on migration, that is unlikely to lead to EU unity.

There are still many potential migrants who might attempt the journey to Europe. With a disproportionate number arriving in southern European countries such as Greece and Italy, there is a clear need for some sort of EU-wide response. If even Germany retreats into a nationalistic crouch, attempts to find a workable EU approach would collapse, and migration policy would become even more chaotic and divisive.

Ms Merkel’s response to the refugee crisis helped to turn her into a global symbol. During the US election, Mr Trump lambasted the German chancellor’s policies as “insane”, and regularly predicted a surge in terrorism across Europe. More broadly, after Brexit, the election of Mr Trump and the rise of quasi-authoritarian governments in Poland and Hungary, Ms Merkel was widely hailed as the most powerful defender of an international liberal order that was suddenly under unprecedented pressure.

No currently conceivable replacement for Ms Merkel is likely to embrace the populist agenda of Mr Trump, or the Euroscepticism of the Brexiters. But it is clear that a large part of the German chancellor’s current difficulties stem from the rise of the far-right and the far-left in Germany, who collectively achieved more than 20 per cent of the vote in September’s election. If the chancellor now loses office — or staggers on, in a hobbled state — her fate will be perceived across the world as a big setback for the liberal and internationalist ideas that she has championed.

The fact that Ms Merkel will end the year fighting for her political life will damp some of the optimism that has been building steadily among EU elites in the past year. The twin blows of Trump and Brexit meant that the EU began 2017 in a state of shock and fear. But Mr Macron’s victory, a modest revival of economic growth and the shambles of the Brexit process had restored the confidence of professional pro-Europeans.

Set against these positive trends, however, there have also been warning signs. These include separatism in Spain, populism in central Europe and continuing worries about the Italian banks. Amid all these problems, Ms Merkel’s Germany was the rock of political and economic stability on which the EU hoped to build. If even Germany no longer looks solid and predictable, the whole of the European project will be back in trouble.

The Fed Gets It Right, for Now

The central bank raised rates as much as promised in 2017; the risk is it needs to raise them more than expected in 2018

By Justin Lahart

Federal Reserve Chairwoman Janet Yellen at a news conference following a Federal Open Market Committee meeting on Wednesday. Photo: Andrew Harrer/Bloomberg News

The biggest shock about the Federal Reserve this year is it got its prediction of interest-rate increases right. The danger for investors in 2018 is the Fed will get it wrong and rates will end up higher than expected.

Fed policy makers on Wednesday raised their target range for overnight rates for a third time this year. This was the first year it met its promise on rates since it started to plan for increases in 2015.

Another thing that stood out is that policy makers met their promise even though the economy didn’t perform the way they thought it would. They thought that the unemployment rate would fall less than it has, and that the economy would be weaker, but that inflation would be stronger. Put it another way: They thought they would be raising rates because inflation was moving toward their 2% target, but they raised them because of a stronger economy and job market.

Federal Reserve economic projections for 2017

Next year the Fed is reckoning on another three rate increases and the market is expecting two.

But both are hard to square with the bank’s economic projections. They show gross domestic product up 2.5% on the year in the fourth quarter of 2018, matching 2017’s pace. In September, the projections called for 2.1% growth in the last quarter of 2018. That probably reflects an expectation that the Republican tax plan will give the economy a boost. Policy makers also foresee a lower unemployment rate, now projecting it will slide to 3.9% versus the 4.1% they had penciled in in September.

Yet the inflation forecast didn’t change, with the projection for the Fed’s preferred measure of core prices, which excludes food and energy items, pegged to increase 1.9% next year from 1.5% this year. Given how poorly economists’ inflation forecasts have done lately, the unchanged projection makes some sense. But it is hard to imagine that an economy that grows faster and an unemployment rate that sinks lower wouldn’t throw off more heat.

Moreover, the projection for unemployment sliding to 3.9% from the current 4.1% would represent a much slimmer drop than the 0.6 percentage point decline that the unemployment rate registered through November this year. The further it goes below 4%, the more likely Fed policy makers will raise rates further.

The Fed didn’t offer up any real surprises this year. Next year will be another matter.

 Finally, Gold Speculators Start To Bail, Setting Up A Big Q1 2018

It took a lot longer than it should have, but gold futures traders have finally started behaving “normally.” The speculators who were extremely, stubbornly long – and who are usually wrong when they’re this excited — had maintained their over-optimistic bets when they should have been stampeding for the exits, making the last few months both boring and depressing for gold bugs and related investors.

This departure from the familiar script raised questions about whether the action in futures (aka paper gold) was still relevant in the age of Chinese physical gold exchanges and cryptocurrency. The jury’s still out on that one, but for now the numbers are reassuring.

The following table (courtesy of GoldSeek) shows speculators cutting way back on long bets and adding to short bets, while the “commercials” – who tend to be right at sharp turns — did the opposite, going a lot less short.

Same thing only more so in silver, where another week like the last one will bring net positions into balance for both groups, which has historically been extremely bullish.

Here’s the same data depicted graphically for gold: Note how both the speculators (silver columns) and the commercials (red columns) held their positions from spring into fall, producing the previously-mentioned boredom and depression. Also note the sharp drop in the most recent reporting week.

The numbers we’re seeing here are as of Tuesday the 5th, and the final three days of last week were a bloodbath for precious metals, so it’s highly likely that the next COT numbers – due out on Friday the 15th – will show absolute panic among speculators, leading to an even bigger swing in the right direction.

If history is still reliable, January will be a great month to own precious metals and mining stocks.

BlackRock’s Factor Guru Favors Momentum Stocks

By John Kimelman

    BlackRock’s Factor Guru Favors Momentum Stocks Photo: Getty Images 

For decades, the most important F word in investing was “fundamentals.” But as the industry transitions away from active stock-picking by humans to more mechanized approaches, a new F word has emerged: “factors.”

In factor investing, securities are chosen by computer systems based on attributes, or factors, that are associated with higher returns. Value and quality are factors, but so are momentum and low volatility.

As Barron’s pointed out in an article this summer, about a third of all exchange-traded funds now are based on factors, and nearly two-thirds of these ETFs have been launched in the past five years alone.

A variety of financial-services firms—including BlackRock, Pimco, Goldman Sachs, and Invesco—offer factor funds to their clients. recently interviewed Andrew Ang, 45, head of factor-investing strategies at BlackRock, about this style of investing and his favorite factors. The term “factor investing” sounds like it was dreamed up by a mathematician or a statistician rather than someone marketing these things to the average retail investor. How would you explain it to a nonprofessional?

Ang: We describe factors as broad and persistent sources of returns. With each factor, you can see the same return patterns across thousands of different stocks, and in different asset classes like equities, fixed income, and beyond. They include very intuitive investment styles that have long been used by active managers, such as value investing, which is finding cheap securities; momentum investing, which seems to identify and participate in trends; quality investing, which is finding stocks with more-stable earnings; low volatility, which gravitates to safety; and small size, where you find smaller or more-nimble companies.

All of these have long been used by traditional active managers, and I think they are familiar to many. What’s changed today is the ability to focus directly on those sources of return and efficiently execute them across thousands of stocks and place them in very efficient, tax-efficient, and transparent low-cost vehicles like ETFs.

Q: I understand you don’t believe in market-timing in and out of factors, but you do believe in tilting toward and away from various factors. What factors at BlackRock are you overweighting, and which ones are you underweighting, right now?

A: You start with a well-diversified, multifactor combination and then rotate among those factors as you go through the economic cycle. Our biggest theme is that we are overweight momentum. Momentum has momentum itself now. It has high relative strength. We are neutral with respect to quality, value, and minimum volatility, and then we are underweight small size, which is due to our lower expectations for economic growth.

Q: What are some stocks that are helping lift momentum right now?

A: Looking at momentum’s performance year to date, the FAANG internet leaders have fueled the rally most recently. The financial sector makes up around one-quarter of the momentum index, and the recent performance of diversified banks such as Bank of America (ticker: BAC) and JPMorgan Chase (JPM) has also boosted results.

Q: Is it normal that momentum would be a good place to be at this point in the economic cycle? How long has BlackRock overweighted momentum?

A: Factors tend to perform differently in each phase of the economic cycle, so diversified exposure across factors is key over the long term. Over shorter periods of time, investors may tilt toward particular factors. The global economy is in expansion mode now, when growth is accelerating and trends persist, so we expect momentum and other risk-seeking factors to perform well. BlackRock has been tilted toward momentum since March.

Q: You say you are underweight small size because you have lower expectations for economic growth. What factors will get in the way of economic growth, and what gross-domestic-product growth rate are you forecasting?

A: While we see the level of growth as strong globally, and G-7 growth in particular at above-trend levels, the pace of growth appears to be moderating in the U.S. Small-size stocks tend to perform best in expansions, when investors are risk-seeking. So, relative to other style factors, we are underweight the small-size factor in the U.S. but moderately overweight small-size globally. BlackRock’s macro model currently implies future GDP growth of around 2% for the G-7 and 2.5% for the U.S.

Q: How does a retail investor partake of these factor tilts?

A: We publish a model portfolio, which we send out to various investors.

Q: Is there a multifactor fund I could buy that would basically embody those tilts?

A: Right now, they are just for institutions. They haven’t been rolled out for retail investors.

Q: I assume that you are eating some of your own cooking. What kind of factor funds are you personally invested in?

A: My personal ones are iShares Edge MSCI USA Momentum Factor ETF [MTUM) and the iShares Edge MSCI Minimum Volatility USA ETF (USMV), as well as the iShares Edge MSCI Minimum Volatility Emerging Markets ETF (EEMV).

Q: What’s a good way for investors to hold a mix of factors without tilting?

A: I would recommend the iShares Edge MSCI Multifactor USA ETF (LRGF), which represents a diversified combination of factors for equity investing. To be clear, it doesn’t do any active tilting.

Q: I see that you hold an emerging markets fund in your personal portfolio. Investors as diverse as Rob Arnott at Research Affiliates and Jeremy Grantham at GMO are bullish on emerging markets going forward, principally on valuation grounds. Do you agree with them, and how would you best use factor investing to play emerging markets?

A: Factors are very important in emerging markets, and we see the same patterns at work. Buying cheap, finding trends and high-quality names: These same patterns work in emerging markets.

Q: Thanks for your time.