Endgame Strategizing

By John Mauldin

We are all on a debt-filled train that is eventually going to crash, and if you are on it, it won’t stop to let you off first. Jumping at the last minute is not a good option, either. So what do you do? You take action now, while you have time.

Last week I gave you some rules to follow with your investments. They were necessarily general because I’m writing to a broad audience. Today, I will get more specific by discussing some possible strategies for high-net-worth “accredited investors.”

However, you should read this important information even if you aren’t wealthy. You might get there someday and it will help prepare you for it. “Someday” could be sooner than you think, too. The Great Reset will rearrange much of the world’s wealth and some people will see their financial condition change quickly, either for worse or better. There will be some enormously positive opportunities.

And as we will see, many strategies that are currently available only to accredited investors are slowly showing up in lower-cost, publicly accessible ETFs and other instruments around the world.

There is truly a fintech-driven revolution going on in the financial industry. For we who make our living in that world, the changes seem to intensify almost daily. As I will discuss at the end of this letter, these changes are forcing me to update my own business model. So opportunities not available to you today may very well be available next quarter or next year. You and your advisors need to stay in the loop.

The broader point: Whatever our current circumstances, we can all do things to prepare for the radically different world I think will unfold in these years. You need to make the most of what you have. I want to help by meeting you where you are. Fortunately, I have multiple ways to do that, as you’ll see below. Stick with me and we’ll get through this together.

Take a Deep Breath: It’s Going to Get Better

Now, I know I have used a train wreck metaphor for this series. That sounds pretty bad, doesn’t it?

And the portfolios of most investors truly will look like they have gone through a train wreck. But you don’t have to be one of them.

The world itself is not going to be a train wreck. The world will be much better in 20 years, and in many ways even in 10 years.

• We will still be eating—both going out and cooking in—and that means there will still be agriculture and ways to bring that food to you. Now, the way your food is grown and harvested and delivered to you may very well change. That will happen in the background. You just want your food to show up when you’re hungry, be well prepared, taste fabulous, and keep you healthy.

• We will still get together with friends. Travel will be easier, communications will be cheaper and faster and better.

• I can’t even begin to explain how much better healthcare and biotechnology will be. I’m willing to bet a considerable sum that cancer will have been reduced to a nuisance in 10 years, but I really think it’s more like five years. Other mind-boggling treatments are coming. Nobody will want to go back to the good old days of 2018.

• We will have fantastic investment opportunities in this new world. There will truly be massive fortunes made and you will have the chance to participate. And while I’ve talked about the disappearance of many jobs, most workers will adapt and survive. New jobs will appear, although some of us old dogs may have to learn a few new tricks.

In short, I am an optimist about the future but a realist about our portfolios. Business (and investment) as usual is not going to cut it. If you are holding the traditional 60/40 portfolio, thinking it will get you to the other side of The Great Reset, I think you will be disappointed.

My goal—and it is a deeply personal, almost spiritual quest—is to help my friends and readers reach that brighter future with their spending power intact in a very tumultuous economic and financial world.

Let me put it this way. Imagine I had come to you in early 1929 and told you about the Great Depression. If you believed me, you would have changed your life and your investments, preparing to protect your assets and take advantage of opportunities.

So I’m whispering now. Get prepared. We have time. Shane and I are making rather large changes ourselves, actually eating my own cooking, so to speak. This isn’t just theoretical to me.

With that said, let’s jump into the letter.

Too Much Protection

Ideally, the investment process for two otherwise similar people would be much the same whether each has a little money or a lot. The only difference would be the number of shares they own. Unfortunately, it is not that simple.

One reason: The government tries to protect small investors from making mistakes or being defrauded. That’s not entirely bad. I am actually a believer in financial regulation. Swindlers frequently prey on the uninformed and desperate. But in the US, our laws do it by making certain kinds of investments available only to “wealthy” people.

You may have heard the term, “accredited investor.” This means certain kinds of businesses, or individuals with:

• Net worth over $1 million, excluding the value of their primary residence, or

• Income over $200,000 in two of the last three years (or $300,000 with spouse) and reasonable expectation of same this year.

If you qualify by either of those standards, it is sort of like unlocking the next level in the video game your kids play. You can now enter new territory forbidden to others.

Note the assumption here: If you have this minimal amount of wealth or income, you are financially sophisticated and no longer need the kind of protection government gives the masses. This assumption is often wrong. We all know people who don’t have much capital or income but possess extensive financial expertise. There are also wealthy people who are, shall we gently say, naïve about money. Our regulatory structure gives too much protection to some and not enough to others. But it’s what we have so we must deal with it.

Behind the Door

So, what lies beyond the secret door that being accredited allows you to pass? Even those who qualify don’t always know. That’s because, in addition to forbidding banks and brokers from selling these investments publicly, the law sometimes says they can’t even talk about the investments publicly. Wealthy people often miss out on possibly great investments because they never hear about them. They, or their brokers and advisers, aren’t in the “deal flow.”

Some incredible deals (I see them all the time) actually aren’t that large, so the large “wire house” firms ignore them. They have so many brokers with so many clients, they stick with bigger offerings.
Regional brokers who can take the “smaller deals” are pretty jealous about their own deal flow. Many private deals are gobbled up by family offices and pension funds too quickly for the rest of us to get a chance.

As an aside, I’m a real fan of private credit and believe in the future it will be even bigger than private equity. Banks are being forced out of their traditional role of providing credit to businesses; and entrepreneurs are stepping in to provide it. Here again, access to deal flow is important.

The most common opportunities are in unregistered securities—shares of stock that don’t trade on exchanges and haven’t gone through the normal IPO process. An initial public offering is usually preceded by one or more private offerings in which wealthy investors can buy a company’s shares.

Sometimes you hear about them because the companies are large and well-known. Uber, for instance, is a private company whose shareholders are all large investors and funds. They don’t have to file the kind of quarterly and annual reports required of publicly traded companies. Thousands of smaller start-ups have similar status.

It is not the case that all these companies are great investments. Many are not. But you can’t get to the attractive ones unless you are an accredited investor. Many gain exposure by investing in a venture capital fund, which gives you professional management and additional diversification. And diversification is important in these types of investments, as many fail and go bankrupt. Are Uber and Airbnb worth their last valuation round? I have no idea. We will find out one day.

Private equity is a similar category but typically involves more mature companies. You sometimes hear about a public company “going private” and delisting from the stock exchange. This usually means a group of investors bought all the shares, intending to restructure the business once it is out of the spotlight. You can be one of them if you’re accredited, either directly or through a private equity fund.

You really have to know who you are working with on private equity funds. Many use leverage that makes them riskier than they should be. These are for sophisticated investors who have deep pockets and even better advisors. There are as many varieties of private equity funds as there are breeds of horses, to use an odd analogy. But just as few of us would consider ourselves knowledgeable about horses, even fewer are knowledgeable about private equity funds. Don’t let your investment pay for your college tuition in private equity.

Hedge funds are another common accredited-only investment. The term is a bit misleading because many hedge funds don’t hedge. I prefer to call them “Private Investment Funds.” They work a bit like mutual funds, in that investors pool their money together under a professional manager’s guidance.

But because the investors are all “sophisticated,” hedge fund managers have more discretion and far less oversight than mutual fund or ETF managers. That can be great if you are in the right one, but finding them is a challenge. I have spent much of my career helping investors do this and I still run across great funds I never knew about.

Full disclosure: somewhere north of 20% of my personal investments are in what is typically classified as hedge funds. I favor diversified trading funds and generally (though I’ve made exceptions) don’t invest in the classic Jones model “long/short” hedge funds today, because I think the alpha they once had has dried up for the time being.

Hedge funds (or whatever you call them) cover a bewildering range of asset classes and investment strategies. Someone out there has a fund doing anything you can imagine, in any part of the world you can imagine. Right now, it seems like everybody’s putting together new crypto currency hedge funds. Cannabis is hot (and for good reason). I have always liked “distressed” hedge funds that buy unwanted assets at ridiculously cheap (at least in hindsight) prices. A patient team of turnaround artists can unlock the real value. It is an art form and some of the most storied names on Wall Street are so-called grave dancers. But their clients are very happy.

I mentioned private credit above, but that was generally about smaller loans. Some large hedge funds are essentially banks and can do very large deals indeed. Typically, they use about two times leverage and your capital will have at least a three-year lockup period. Never invest in a private credit deal that offers deep liquidity but lends long term. The initial returns may look enticing, but if there is ever a “run” on the fund it can collapse overnight. The terms of the investment capital and the loans should be roughly equal. You don’t want there to be a recession where everybody starts trying to withdraw their capital, forcing your fund to sell loans at ridiculously low prices to those distressed debt funds.

While I can’t mention the fund’s name, a very large fund marked down their portfolio well over 20% during the last credit crisis, but not one client lost money. They were all locked up. By the time the crisis ran its course, the loans had regained their value and everybody got paid and made the returns they expected to begin with. Capital and credit were properly aligned.

This is why you need sophisticated advisors to navigate this world. It is not for rookies. While hedge funds can be rewarding, many are complete disasters. As they say on TV, don’t try this at home, boys and girls.

That being said, look for funds where management has an edge that is not correlated to the market.

There are more than you might imagine. This is what I mean when I say diversify trading strategies, not asset classes.

Real estate is another investment area increasingly dominated by accredited investors. I like income real estate that is not loaded down with leverage. I don’t personally own any, although my wife owns a few rental homes in her hometown. I watch from afar, as dealing with renters and contracts and all that is just too much trouble for me. Then again, I know people who have made serious money by patiently buying and renting homes over decades.

I don’t want to write a book about hedge funds (I did that some 15 years ago). They have a lot of drawbacks and many are just asset-gathering schemes to make money for management. Fewer than 20% of the funds out there would make it through my filters, and a fraction of those actually get my approval.

Cracks in the Wall

As you can tell, the current situation makes investment planning a lot more complicated for those with substantial assets. You have more options to consider. But those same assets also let you hire expert advice, which is definitely a good idea. I think almost all investors should have one or more investment advisors. Plus, read all you can from trusted sources.

However, in the bigger picture, investment democracy is trying to assert itself. Bankers and marketers are finding ever-more-innovative ways to make products available to a wider audience. Strategies once found only in private hedge funds now exist in mutual funds and ETFs anyone with a few thousand dollars can purchase.

We also see venture capital and private equity increasingly held within otherwise conventional mutual funds. Regulators permit it so long as these illiquid securities represent only a small portion of the fund’s assets.

I suspect we’ll see these moves continue and governments should actually encourage them, simply out of self-defense. I’ve written a lot about pension problems and people not having sufficient retirement savings. The main reason is that neither workers nor employers are contributing enough… but it doesn’t help that investment returns are miserably low, too. Locking people out of the best opportunities simply “protects” them from building the assets they need to fund a comfortable retirement. It makes little sense and needs to change.

In my own small way, I’m trying to help. At Mauldin Economics we have a crack team of editors who can show you how to take advantage of today’s best opportunities. You heard some of them in the special reports “Bull or Bust” videos we published this month. Jared Dillian, Kevin Brekke, Patrick Cox, and Robert Ross shared some ideas useful for investors at all levels.

I’ve received quite a few emails from folks who missed out on some of the special reports from last week, and this week’s presentations. We did have to be strict on the time limit for Bull or Bust. But don’t worry if you missed out on the three special reports, four presentations, and trade recommendations. On Monday, we’ll be sending a very special invitation to you. If you accept, you’ll get permanent access to Bull or Bust as a thank you. Please stay tuned.

The Best “Strategy” for The Great Reset

We all want our portfolios to perform as well as possible. But simple reality says that apart from a lucky few who find an investment that really takes off and propels our total net worth, most of us need more.

Where is net worth truly created? Small businesses, often generational, some of which become medium and large businesses. More people have made more money all over the world by starting businesses than any other way. Their businesses will go through The Great Reset, maybe not in perfect ease, but come out the other side still generating profits for their owners.

Very few places are more open to entrepreneurs than the US but this happens everywhere. The bulk of the wealth created in China? New businesses. Of course, oligarchies in many Third World countries make launching new businesses tres difficile. Starting a business isn’t easy anywhere and most new businesses fail. Do your homework, make sure you have enough capital and consider taking the leap.

And if you are not the entrepreneur type? Then link up with someone who is, make him or her successful, and be sure you get a piece for your effort. With so many new business opportunities and technologies coming, there have never been more options. Look around at what you know and think how technology can make it better. Then create it. And when we’re together, tell me your story.

Grand Lake Stream, Maine and Moving On

Next week I once again journey to Camp Kotok at Grand Lake Stream, Maine. I will visit with old friends, make some new ones, talk economics and investments and try not to let the fishing get in the way. I think this is my 13th year and it’s always a wonderful reunion. I will have a report when I get back.

I mentioned above how I was making some changes. I too want to make sure that when we get to the other side of The Great Reset, I have as much of my capital intact as possible. As part of this, I am selling my apartment in uptown Dallas and making some other lifestyle changes.

Nobody should feel sorry for me. It’s just a new part of the adventure. However… if you are interested in a fabulous high-rise apartment with 270 degree views of Dallas, click here. (By the way, selling a home is high-tech now. Soon you will be viewing homes via augmented reality sets. It is pretty cool technology.)

I mention that mostly to show I am really serious about this getting-your-life-in-order thing. I am as “all in” as anyone can be. And while you know what we’re doing at Mauldin Economics, I’m also making changes in my advisory and brokerage businesses. I want to help as many people as I possibly can, in as many ways as I possibly can. That means helping advisors and brokers help their clients. The technology to do this didn’t exist even a few years ago.

I am committed to helping you. I seriously consider my readers to be my million closest friends. It’s more than a cute phrase to me. I am optimistic we will have more fun and better lives in the future if we make the right changes today. I’m right there with you.

And with that, it is time to hit the send button. Have a great week!

Your live-long-and-prosper analyst,

John Mauldin
Chairman, Mauldin Economics

Bond markets signal early end to Fed rate rises

While the central bank hails strength of US economy, traders are not so sure

Joe Rennison in New York

Fed chair Jay Powell

Bond traders are anticipating that an end to the Federal Reserve’s cycle of monetary policy tightening could come as early as next year, facing down policymakers that expect to raise interest rates for longer.

While the Fed expects to raise rates into next year and potentially the year after — a point that could be reiterated by chair Jay Powell when he gives testimony this week to Congress — current prices in US interest rate markets suggest that the central bank will stop its hiking cycle sooner.

According to the median prediction by policymakers, the Fed policy rate will rise to 3.375 per cent in 2020. In contrast, eurodollar futures suggest rates may plateau in 2019.

The differences come as investors are factoring in the risk of a slowdown in the economy despite strong corporate earnings growth and positive economic data, .

“The markets are telling us that there is a pretty high risk of economic slowdown or recession at the end of 2019,” said Guy LeBas, chief fixed-income strategist at Janney Capital Management.

The yield on futures expiring in December 2019 stood at 2.97 per cent on Friday, and on futures expiring in March 2020 it was an almost identical 2.975 per cent. The yield falls to 2.96 per cent for December 2020 eurodollar futures.

“The market is saying that the Fed is wrong,” said John Brady, managing director at RJ O’Brien.

This is only the fifth time since 1989 that there has been an inversion in the eurodollar futures yield curve, where longer-term rates are below shorter-dated rates. Each time it has been followed by the Fed pausing its policy tightening.

The Fed has been stressing the strength of the economy in its recent communications but trade concerns have amplified fears that companies may begin to slow capital expenditure, while some analysts say that the boost from tax reform will begin to erode in 2019 as year-over-year growth comparisons will be set at a higher bar.

A second market measure of interest rate expectations, fed funds futures, which are less heavily traded than eurodollar futures, is showing a similar plateau in 2019, although it is not inverted.

The pattern can also be seen in the difference between two and 10-year Treasury yields, with the 10-year struggling to sustain levels above 3 per cent. When shorter-dated yields rise above longer-dated yields it is seen by many investors as a sign of a coming recession. The spread on Friday between the two Treasury benchmarks stood at just 24 basis points, the lowest level since 2007.

A majority of Fed policymakers expect two more rate rises this year. With further moves early next year, that would put the Fed close to its median estimate of the neutral interest rate, at which monetary policy neither stimulates nor cools the economy. Policymakers are intensely debating whether to push beyond that level or call a halt there.

Complicating deliberations is the Fed’s balance sheet, which some officials think may be artificially flattening the yield curve and making it a less useful indicator than in previous economic cycles.

The size of the balance sheet is still holding down long-term rates, they suggest, but the programme to reduce its holdings, which began in October of last year, may be contributing to an upward drift in short-term rates as investors struggle to digest the increase in supply.

Additional reporting by Sam Fleming


by Egon von Greyerz

“The winner takes it all, the loser standing small” (an Abba song) is the next phase in the world economy. Sadly there will be few real winners since the world and its people will be the loser in the coming phase of destruction of asset values, implosion of debts as well as a breakdown of the fabric of society.

I do realise that this all sounds very gloomy, and also that bearers of bad news are not popular. But the world is now facing an inevitable breakdown of the biggest debt and asset bubble in history. It is absolutely certain that this will happen, so it is in my mind not a question of if but only when.


Although we will all be losers to some extent, there are be some who are better protected than others. And the few people who understand this will be the winners in the investment world.

This week I want to make the message simple. There is one graph that tells the whole story of what will happen in the next few years. Anyone who “gets” this chart also understands what is going to happen. But there is only a minuscule percentage of maybe 0.5% of the investment population who would even look at a simple chart that could be the difference between misery and fortune. This means that over 99% of the investment world will not be prepared for what is coming next and most of these people will see a destruction of their assets to an extent that has never occurred previously in history. Their journey will end up in miseries whilst the few who take the tide that leads to fortune will have secured their financial position.

There is a tide in the affairs of men.
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves,
Or lose our Ventures.

Shakespeare – Julius Caesar


The chart I am talking about is the stock market compared to gold. I will take the US market as the example but the ratio chart gold versus stocks could be applied to most stock markets in the world.

If we first look at the Dow/Gold chart since 1997, we find that it topped in July 1999 at 45. This means that one unit of the Dow bought 45 ounces of gold. It then crashed by 87% to 6 in 2011. Since then there has been a steady recovery to the 20 level. In technical terms that means a very normal 38% correction.

So 19 years after the Dow/Gold top in 1999, the stock market is still extremely weak measured in real terms or real money which is gold. And this is in spite of a major recovery in stocks since the 2009 bottom. This bodes ill for stocks. Whether the correction goes a bit higher than the 20 level is irrelevant. The chart shows that stocks have recovered in nominal terms due to massive money printing. But in real terms, stocks are in a long term downtrend since 1999 and this downtrend will soon resume with a vengeance.

DOW GOLD – FOUR CRASHES SINCE 1837: 70%, 90%, 96%, 87%

To understand the longer trend we need to look at a long term chart since 1800. The chart below shows that stocks have been in a long term uptrend against gold for 200 years. This is the natural consequence of the real growth of the world economy fuelled by industrialisation and the discovery of oil. Between 1800 and 1913, the swings of the Gold/Dow ratio were relatively small with one exception. But with the foundation of the Fed and modern central banking the swings became much greater.

PANIC OF 1837 – 70% FALL

The biggest crisis in the 1800s was the Panic of 1837 which lasted until 1844. As with all crises, this one was preceded by a major speculative bubble with stock and land prices surging together with commodities like cotton and also slave prices. This led to a deflationary crash and a depression with high unemployment and bank failures. Out of 850 US banks, 343 closed entirely and 62 failed partially. During the 7 year crash, the Dow/Gold ratio declined by 70%.

This was by far the biggest decline of the ratio in the 19th century.

CRASH 0F 29 – 90% FALL

The next big fall was after the stock market Crash of 1929 when the ratio fell 90%. Thereafter it went up 14 fold to a top in 1966. The next big drop was 96% with Dow/Gold reaching 1 to 1 in 1980. Then the biggest surge ever in the Dow/Gold ratio started with a 45 fold increase between 1980 and 1999. Stocks boomed and gold declined. That 1999 peak is likely to stand not just for years but for decades. (see chart above)


The big Megaphone pattern in the Dow/Gold ratio since 1913 completed on the upside in 1999. Between 1999 and 2011, the ratio crashed by 87%. This is not the end of the down trend. The next big move will at least reach the bottom of the Megaphone. I would be surprised if the ratio doesn’t go well below the 1 level it reached in 1980. More likely is 1 Dow to 1/2 ounce of gold or lower. (see chart above)

A fall of that magnitude will involve a stock crash from here of 98% against gold. For the few who will anticipate this fall, it will lead to fortune. But for the 99.5% of investors who will not solve this relatively simple Gordian knot, it will mean misery and the biggest wealth destruction in history.

Seldom has an investment decision been simpler. According to the legend, Alexander the Great also had a simple solution to the Gordian knot. He used his sword and cut it in half. Although this version is disputed by some, it does show that there are very simple choices that can solve what seems complex problems. The dilemma is of course that most people cannot even see the present knot. All they see is a continuous long term uptrend of stocks that will go on forever. Little do they understand that the gyrations in the Dow/Gold ratio will continue until the megaphone pattern is completed on the downside. Whether the ratio reaches 1 to 1 like in 1980 or overshoots to 1/2 to 1 or less is irrelevant. What is important to understand is that governments and central banks have created a bubble of such proportions that when it pops, it will lead to a wealth destruction and a wealth transfer never before seen in history.

I am here taking the Dow as an example of a stock market but remember that the next crash will be a global phenomenon and no market will escape.


I am not saying that the holders of physical gold will totally avoid the misfortunes that will hit the world. Everyone will suffer. But when the panic starts, the ones who have taken protection in physical gold and some silver will feel a lot more secure than the ones who are still in the stocks or other bubble markets.

100 years of financial mismanagement has not finished the 5,000 year track record of gold as the only money which has survived in history. The next 4 to 8 years will prove that again. 

Big Builders Are Remodeling the Housing Market

The demise of many small builders has given big ones more power, one reason new-home sales have stayed low

By Justin Lahart

      A contractor hammers the frame of a D.R. Horton home in Florence, Ariz.

One of the big mysteries of the housing market since the financial crisis is why sales of new homes have remained so low despite a strong economy and real-estate market.

One explanation is a major consolidation among homebuilders, which has given surprising power to some of the big publicly traded companies. That is a big change in what has long been a heavily fragmented industry driven at the margins by small-time construction companies that built like crazy during boom years. With its historically low barriers to entry -- a bit of capital and know-how were the major requirements for breaking into the business -- this marks a major change in the industry.

Top 10 builders' market share, median for top25 markets (2004-2017)

Source: Builder magazine

The housing bust and the financial crisis destroyed many home builders. In the tally of U.S. businesses it conducts every five years, the Census Bureau found that there were 48,261 home builders operating in the U.S. in 2012, about half as many as the 98,067 it counted in 2007. In the consolidation, publicly traded home builders fared much better, with only a handful of small ones going bankrupt, and most of those ultimately remained in business.

Updated Census figures won’t be available for some time, but even as the economy has recovered and demand for homes has risen, the number of homebuilders doesn’t appear to have rebounded. Instead the industry has become more concentrated, with a few big national players dominating major markets like never before. According to data from Builder magazine, the median market share captured by the top 10 builders in each of the country’s top 25 new-home markets was 63% in 2017. That compared with 34% a decade earlier.

Top 10 home builders in Atlanta in 2017 by market share

Source: Builder magazine

Note: Lennar completed its acquisition of CalAtlantic in 2018

While homebuilding is nowhere near as consolidated as industries like airlines, the result has been similar, less supply. Last year, 1.9 new homes were sold per 1,000 people in the U.S., compared to an average of 2.6 over the past 50 years.

Big builders have benefited in other ways. They have been able to leverage lower funding costs and economies of scale in ways that smaller players, more dependent on bank lending, haven’t. Higher costs on lumber, caused by tariffs and forest fires, and on other building products have further squeezed small builders. The big players have also been better able to navigate the tight labor market by promising workers more stable jobs. Average hourly earnings for workers on new single-family homes were up 9% in June from a year ago, versus a 2.7% gain for U.S. workers overall.

Evercore ISI analyst Stephen Kim thinks that the gains the big builders have made in major markets may signal a broad shift in how new homes are built. These companies, focused on profit margins, are using their buying power to lower material costs, and are building homes that are more standardized. That makes them less labor intensive and more profitable.

That is reflected in the results of public builders themselves, he says. Profit margins at big ones such as D.R. Horton , Lennar and PulteGroup are substantially higher than smaller public players such as KB Home , M/I Homes and M.D.C. Holdings , he points out. “That suggests that the larger builders are the ones who have figured out how to be more efficient,” he says.

Wholesale price index for residential construction godos

Source: Labor Department
Note: Not seasonally adjusted. Indexed to 1986 level

While big homebuilders have benefited, the shift has been a drag on the economy. Not only is home building contributing less to gross domestic product and employment than it used to, but it isn’t as big a driver of business in other areas, like furniture and washing-machine sales.

The environment isn’t uniformly bad for small builders — away from the big markets, the business remains far more fragmented. In many of those markets, land is easier to come by, points out Chris Herbert, managing director at Harvard University’s Joint Center for Housing Studies, while lower sales volumes make them less enticing to the public builders. “The reason why you’re seeing the small builders doing OK in the smaller markets is the big builders just don’t want to go there,” he says.

Median price of single-family homes

Source: National Association of Realtors (existing homes), Commerce Department (newhomes)

Home builder George Hale says that these days it is harder for small builders like him to get a toehold in the Portland and Bend, Ore. markets where he operates. As a result of high land prices and the regulatory hoops builders need to jump through, the capital requirements to start a project are high. That makes it tough to compete with large public builders, like Portland-area leader D.R. Horton, which have readier access to funds.

Mr. Hale has been lucky since he focuses on smaller projects that don’t interest big builders. But he doesn’t see many new people getting into the business. “I’m 48, and all my peers are my age plus,” he says.


Even stockmarket bulls are more cautious than at the start of the year

Will being a bear save you money as well as make you sound clever?

BEARS sound clever; bulls make money. This piece of financial acumen, imparted by a trader to a colleague, is hard to beat for brevity. It also makes a good point. There is something about market pessimism that endows bears with an aura of wisdom that is not always deserved. The cautious sound clever because they appear to have weighed the odds. Optimists seem heedless by comparison. Yet it is only by taking on risk that investors can hope to make money.

So it is telling that even bulls are now sounding cautious. The economy and stockmarket in America have had a good run, after all. The expansion, which started in 2009, is now the second-longest on record. Unemployment is low. The Federal Reserve is hawkish. This mix tends to kill a bull market sooner rather than later. The question is how much further stocks can rise. Is there still time for bulls to make money? Or will being a bear save you money as well as make you sound clever?

In this debate, each side has a distinctive way of looking at things. Put crudely, the pessimists believe that markets drive the economy. In their view, near-zero interest rates and quantitative easing, or QE, pushed investors out of government bonds and into risky assets. Now that such policies are reversing, stocks and corporate bonds are vulnerable—and so is the economy. The optimists, by contrast, believe that markets are led by the economy. Only when it shows weakness, and profits slump, is it time to get out.

At the start of 2018 the optimists had the better case. Then, for a while, things looked more balanced, with the pattern of returns providing ammunition for both sides (see chart). Now, though the most recent data favour the optimists, they seem to be losing conviction. The strength of the bearish case suggests that, when the market turns, it will be dramatic.

Consider the pessimists’ case. If markets lead the economy, notes Matt King of Citigroup, trouble can strike suddenly. In this view, the sell-off in emerging markets and jitters in the rich world, such as the sudden drop in American stocks in February and turbulence in Italy in May, have a common cause. For David Bowers, of Absolute Strategy Research, they indicate a “rolling liquidity crisis” caused by tighter Fed policy. He sees the steep falls in the shares of big banks in Europe and China as another worrying sign.

Does the body rule the mind?

The optimists see things differently. Though the broad American stockmarket has been flattish, the Nasdaq index of technology stocks and the Russell 2000 index of small firms have done well. That is to be expected in a maturing business cycle. Bull markets tend to narrow with age, as investors double down on stocks that have served them well. Late-cycle economies also favour small, left-behind stocks. Shares in Europe and Japan have fared badly because of a temporary loss of economic momentum there. Emerging markets have suffered, but that reflects local troubles: botched reforms in Argentina; fiscal laxity in Brazil; inflation in Turkey.

Moreover, strong jobs growth in America last month was more of a spur to the labour supply than to wage inflation. Europe’s economy is perking up. Trusted signs of financial distress are absent. The yield curve has an upward slope. In the past, when the gap between short-term and long-term rates has turned negative (that is, the yield curve has “inverted”), recession has often followed. Another signal, says Ed Keon of QMA, a quantitative equity manager, is a widening spread in corporate-bond yields over Treasuries. But that light is not flashing red either.

Even so, the bulls are becoming less bullish. In part this is because they worry that Donald Trump’s trade spat could all too easily develop into a damaging trade war. (The boom in the shares of small, less globalised firms owes something to such fears.) Concerns are growing that the Fed might trip up. It has no guiding example of reversing QE and quitting a zero-interest-rate policy. Tax cuts in America complicate the Fed’s task. Higher barriers to trade will add to inflation and hurt GDP, but to an extent that is hard to fathom.

Can the optimists and pessimists be reconciled? A minor irony is that both tend to favour American assets—the bulls because they reckon a booming economy will keep delivering fast-growing profits; the bears because America is where capital goes when investors are scared. There may well be a final upward leg to the bull market in stocks. The worry is that the bears will also be proved very right, very suddenly. If such worries are borne out, it will be a lot harder to pick the bottom of the bear market than it was to pick the top of the bull market.

US Housing Bubble Enters Stage Two: Suddenly-Motivated Sellers

Housing bubbles proceed in fairly predictable stages. Stage One is long and (initially) slow, fueled by excess central bank money creation or foreign demand or some other source of liquidity that encourages large numbers of people to buy houses. At first, sellers remember the peak prices from the previous bubble and aren’t willing to sell at anything less than that (in finance-speak, they’re “anchored” at the highest price they could have gotten last time around).

So demand initially outstrips supply, causing home prices to rise, slowly at first and then explosively as increasingly-desperate buyers become willing to pay any price while mortgage lenders, seduced by fat fees and confident that they can securitize and offload any kind of dicey mortgage, lower their standards to include pretty much the whole of society.

Stage One usually ends with price spikes in the hottest markets so extreme that they generate headlines. Like these:

San Diego home prices spike

Home Prices Spike Near Murrieta, SoCal Median Hits Record Level

Orlando Home Prices Spike 10 Percent Annually in April

Another month, another record for Denver home prices

Phase Two of a typical US housing bubble begins when sellers read these headlines and note that prices are now above what they could have gotten in the last bubble. With the memory of how badly, during the subsequent bust, they’d wished they’d sold at the peak still reasonably fresh, they realize that they’ve been given a second chance to cash out, move to a cheaper, less-frenetic place, and coast on their real estate riches. So they call a realtor and list their house. As do a bunch of their neighbors. Supply, out of the blue, jumps.

That may be what’s happening now:

The housing shortage may be turning, warning of a price bubble
(CNBC) – The most competitive, tightest housing market in decades may finally be loosening its grip, and that could put pressure on overheated home prices. The supply of homes for sale in the second quarter of 2018, the all-important spring market, rose at three times the rate of the same period in 2017, according to Trulia, a real estate listing and research company. 
The inventory jump was the largest quarterly improvement in three years and could be signaling a slight thaw in today’s housing market. But it is just a start. 

“This seasonal inventory jump wasn’t enough to offset the historical year-over-year downward trend that has continued over 14 consecutive quarters,” according to Alexandra Lee, a housing data analyst for Trulia’s economics research team. 
The supply of homes for sale is still down 5.3 percent compared with a year ago. Still, all real estate is local, and some markets are seeing greater relief. Thirty of the nation’s 100 largest cities, including New York City, Miami and Los Angeles, now have more supply than a year ago. 
Of course, the increase is a double-edged sword. Supplies are increasing because sales are slowing, and sales are slowing because prices are so high. In New York City, the median household must spend 65 percent of its income to buy a home, according to Trulia. In Los Angeles, it takes 59 percent. 
“Among these unaffordable metros, San Diego posted the largest inventory growth—22 percent year-over-year,” wrote Lee. “Compare that with the same quarter last year, when that Southern California metro registered a 28 percent inventory decrease.” 
Mortgage applications to purchase a newly built home plummeted nearly 9 percent in June compared with June 2017, according to the Mortgage Bankers Association. This suggests lower new home sales going forward, despite higher Price.

Stage Two’s deluge of supply sets the table for US housing bubble Stage Three by soaking up the remaining demand and changing the tenor of the market. Deals get done at the asking price instead of way above, then at a little below, then a lot below. Instead of being snapped up the day they’re listed, houses begin to languish on the market for weeks, then months. Would-be sellers, who have already mentally cashed their monster peak-bubble-price checks, start to panic. They cut their asking prices preemptively, trying to get ahead of the decline, which causes “comps” to plunge, forcing subsequent sellers to cut even further.

Sales volumes contract, mortgage bankers and realtors get laid off. Then the last year’s (in retrospect) really crappy mortgages start defaulting, the mortgage-backed bonds that contain their paper plunge in price, et voila, we’re back in 2008.

How far away is the climax of Stage Three? It’s too soon to tell, with just one quarter of trend-reversal data on-hand. But if you’re thinking of selling (or if you own a lot of bank stocks or are thinking of shorting such stocks), now might be a good time to start paying attention and taking the appropriate steps.

Latent Fragilities

Doug Nolan

I have a rather simple Bubble definition: "A self-reinforcing but inevitably unsustainable inflation." Most Bubble discussions centers on the deflating rather than the inflating phase. A focus of my analysis is the progressively powerful dynamics that fuel Bubble excess, along with attendant distortions and maladjustment - and how they sow the seeds of their own destruction.

The ongoing "global government finance Bubble" is unique in history. Rarely has market intervention and manipulation been so widely championed. Never have governments and central banks on a concerted basis inflated government debt and central bank Credit. And almost a full decade since the crisis, the massive inflation of "money"-like government obligations runs unabated - across the continents.

The IMF calculated first quarter real global GDP growth at 3.64%, near the strongest expansion since 2011. U.S. Q2 GDP of 4.1% was the strongest since Q3 2014. There have been only eight stronger quarters of U.S. growth over the past 18 years.

Extreme and protracted policy (fiscal and monetary) stimulus has indeed stimulated real economy expansion. Given sufficient scope and duration, stimulus will invariably fuel spending and investment. Unfortunately, however, the artificial boom is not without myriad negative consequences. Is the boom sustainable? Have we today reached the point where economic growth is self-supporting? Or, instead, is the global boom vulnerable to the curtailment of aggressive stimulus? Has global government stimulus promoted a return to stability? Or has almost a decade of unprecedented measures only exacerbated Latent Fragilities?

It was yet another week that seemed to support the Acute Latent Fragility Thesis.

July 22 - Financial Times (Gabriel Wildau and James Kynge): "China's central bank injected Rmb502bn ($74bn) into its banking system on Monday to help fortify a weakening domestic economy against the impact of an escalating trade war with the US and growing friction with Washington over its falling currency. The injection was the most emphatic move in a series of recent indications that Beijing is moving to ease monetary policy… Raising the risk that the US-China trade war could turn into a currency war, Mr Trump has accused Beijing of manipulating the renminbi, which last Friday reached its lowest point for a year against the US dollar. It has fallen 5% since the start of last month."

Despite GDP growth in the neighborhood of 6.0%, booming household borrowings, an unrelenting apartment Bubble and an ongoing Credit boom, China has once again been compelled to resort to aggressive stimulus in an attempt to hold its tottering Bubble upright. The Chinese economy's vulnerability to a U.S. trade war is generally offered as the impetus behind recently announced measures. Perhaps exposure to the faltering EM Bubble is also a pressing concern in Beijing.

July 22 - Wall Street Journal (Jeremy Page and Saeed Shah): "Pakistan's first metro, the Orange Line, was meant to be an early triumph in China's quest to supplant U.S. influence here and redraw the world's geopolitical map. Financed and built by Chinese state-run companies, the soon-to-be-finished overhead railway through Lahore is among the first projects in China's $62 billion plan for Pakistan. Beijing hoped the $2 billion air-conditioned metro, sweeping past crumbling relics of Mughal and British imperial rule, would help make Pakistan a showcase for its global infrastructure-building spree. Instead, it has become emblematic of the troubles that are throwing China's modern-day Silk Road initiative off course. Three years into China's program here, Pakistan is heading for a debt crisis, caused in part by a surge in Chinese loans and imports for projects like the Orange Line, which Pakistani officials say will require public subsidies to operate."

A few decades ago it was Japanese Bubble Finance spreading its tentacles around the world. This week saw Japanese 10-year yields almost reach 11 bps, near the high going back to January 2016. It took two Bank of Japan (BOJ) interventions - offers to buy unlimited JGBs - to push yields back below 10 bps by Friday. There is considerable market focus on next week's BOJ policy meeting, along with heightened concerns in Japan for the sustainability of the BOJ's policy course. Holding "market" yields indefinitely at zero promotes distortions and imbalances. Various reports have the BOJ contemplating adjusting this policy. The BOJ may also adjust its ETF purchase program viewed as distorting the Japanese equities market.

Sharing a similar experience to central bankers around the globe, the BOJ has seen the impact of its inflationary policies much more in booming securities markets rather than from (stagnant) aggregate price levels in the real economy. Despite a massive expansion of central bank Credit, Japanese core consumer price inflation is expected this year to be about half the bank's 2.0% policy target. Increasingly, the 1% difference in CPI must seem secondary to risks mounting in the financial markets.

July 26 - Bloomberg (Masaki Kondo and Chikafumi Hodo): "For all the speculation over possible Bank of Japan policy tweaks next week, the most important change for global bond markets may already be underway. While market watchers disagree about whether the BOJ will adjust its target of keeping 10-year yields around zero percent, its steady reduction in purchases of longer-maturity debt and more expensive overseas hedging costs mean Japanese funds are already contemplating bringing more money back home. The BOJ's steps to buy fewer bonds has seen the annual increase in its debt holdings slow to 44.1 trillion yen ($398bn) versus its guidance of 80 trillion yen. Last quarter the reductions were entirely focused on so-called super-long bonds, which are the most attractive to insurers. What happens next in the world's second-largest bond market has the potential to cascade globally given Japanese investors hold $2.4 trillion of overseas debt."

It's a big number: $2.4 TN. BOJ policy has nurtured great Latent Fragilities. For one, policy measures have incentivized Japanese institutions and investors to comb the world for positive yields (fueling Bubbles, in the process). Moreover, there is surely a large yen "carry trade" component, as financial speculators essentially borrow free in yen to leverage in higher-yield global instruments. The dollar/yen bottomed in late March, not coincidently about the same time U.S. and global (developed) equities put in trading bottoms. After trading as low as 104.74, a weaker yen saw the dollar/yen rally to trade last week at 112.88. Having reversed course, the dollar/yen closed Friday at 111.05.

I would argue that the ECB has also nurtured great Latent Fragilities. The ECB Thursday confirmed that policy rates would remain near zero at least through the summer of 2019. "What are they afraid of?" German two-year yields ended the week at negative 0.61%, the French two-year at negative 0.44%, and Spanish yields at negative 0.33%. Even Portugal enjoys negative borrowing costs out to two-year maturities (-0.23%). The German government is paid to borrow out to five years (-0.17%). To be sure, European debt instruments have inflated into one of history's most distorted Bubble markets - and I'll assume Mario Draghi is not oblivious.

Italian 10-year yields jumped 15 bps this week to a four-week high 2.74%. Draghi was again questioned about Target2 balances during the ECB's post-meeting press conference. It's a critical issue that garners surprisingly little attention, perhaps because it is deftly deflected by the head of the ECB. Besides, it was a 2012 worry that proved short-lived.

Journalist: "How do you rate the risk in this [Target2] system, especially for the Bundesbank and compared to the Italy National Bank, for example?"

ECB President Mario Draghi: "First of all, let me make a general point. Target2 is a payment system, as such it doesn't generate instability. It's the way a monetary union settles its payments, and it's devised to make sure the money flows unencumbered across countries, individual sectors, companies - all economic agents. So that's the first thing we should always keep in mind.

The second thing is how to interpret recent numbers which show an increased number of Target liabilities in certain countries. Well, this is again a question that was asked several times in the past. Most of the movement in Target2 liabilities depends on our own asset purchase program - and depends on how and where - especially where - the balances of the purchases of bonds are settled. About 50% of the institutions… that sell bonds to the national central banks are not in the euro area and settle their account with one or two core countries where the financial centers reside. So, in this sense, you see that the accounting settlement of the balances do depend on where the settlement is made. It has nothing to do with capital flows from one country or another. Keep in mind that 80% of the institutions - banks namely - that sell bonds to the national central banks do not reside in the country where the purchaser's national central bank resides. A lot of inter-country payments and flows do not say anything very specific about the overall situation.

But going back to the recent movements in the liabilities in certain countries, you see that first of all they are not unprecedented - this is not the first time. We've seen movements as large and even larger in the past. Second…, they are of second order with respect to the massive movements produced by our own purchase program. So, the bottom line is the system works very well. The people who want to cap it, collateralize, limit - I mean, the truth is that they don't like the euro. They don't like the monetary union. Because the only way a monetary union can work is if they have an efficient payment system - which is what Target2 is. And I think it is just too early to understand exactly what part of the liabilities do reflect political uncertainty."

Italy's Target2 liabilities rose $16.3 billion during June to a record $481 billion, with a two-month gain of almost $55 billion. It's worth noting that Italy's liabilities surged from about zero in mid-2011 to $289 billion at the height of the European crisis back in August 2012. The ECB's "whatever it takes" stabilization program saw these liabilities shrink to $130 billion by July 2014. They've been basically heading south ever since.

Clearly, there is a lack of confidence in Italy's future position in the monetary union. And, at this point, it is not clear what might reverse the steady outflows from Italian financial institutions and assets. I don't completely disagree with Mr. Draghi's assertion that ECB policy is having a significant influence on Target2 balances. When Eurozone central banks buy Italian debt securities in the marketplace, the sellers are choosing to hold (or dispose of) these balances in other countries - thus creating a Bank of Italy liability to another euro central bank (largely the Bundesbank). Why is this not a major festering problem? Germany's Target2 assets rose $20 billion in June to a record $976 billion - having now more than doubled since December 2014.

That Germany will soon have accumulated an astounding $1.0 TN of Target2 assets implies acute Latent Fragility in the euro region. This was never supposed to happen. These balances reflect mounting imbalances plugged by freely-flowing central bank "money." ECB sovereign debt purchases have so compressed interest-rate differentials that there is today insufficient incentive to hold Italian and other "periphery" debt. But a market adjustment toward more realistic Credit spreads risks bursting Bubbles and blowing up debt markets. The entire European monetary integration experiment hangs in the balance.

So, the ECB is forced to stick with negative interest rates and "money" printing operations, and countries such as Italy accumulate liabilities that they will never service, leaving the German people to fret receivables that will never settle. Draghi's assertion that the payment system "works very well" is at best misleading. With imbalances growing bigger by the month, the semblance of a well-functioning payment system depends on monetary policy remaining extraordinarily loose. Stated differently, Acute Financial Fragilities are held at bay only so long as "money" remains free and created in abundance.

I believe we've reached the stage where a meaningful tightening of finance in Europe risks acute bond market instability and perhaps even the entire euro experiment. For those believing this is hyperbole, allow me to phrase this differently: Italy and other "periphery" nations are one financial crisis away from demanding an alternative monetary regime.

A reasonable question: Why then is the euro not under more pressure? Well, Japan is only a meaningful tightening of financial conditions away from major bond market and financial system issues. The yen is a big wildcard. China is only a meaningful tightening away from major financial and economic issues. The renminbi is a big wildcard. The emerging markets are already suffering the effects of a tightening of financial conditions. Many EM currencies are in trouble.

Why is the euro not weaker against king dollar? Because the dollar is fundamentally an unsound currency - in a world of unsound currencies.

July 24 - Wall Street Journal (Josh Zumbrun): "The U.S. remained by far the largest driver of global current-account imbalances in 2017, running the world's largest deficit and adopting policies-mainly a shift toward much larger fiscal deficits-that are likely to increase its imbalances in coming years. The U.S. ran a $466 billion current-account deficit, meaning the nation imported far more than it exported. The U.S. has become an increasingly large driver of global deficits, accounting for 43% of all global deficits last year, up from 39% in 2016, according to the International Monetary Fund's annual assessment of the state of global imbalances. Washington's shift toward major deficit spending will move the U.S. trade deficit 'further from the level justified by medium term fundamentals and desirable policies,' the IMF said."

I would argue that the U.S., as well, is only a meaningful tightening of financial conditions away from serious issues. Inflated U.S. securities markets have been on the receiving end of huge international flows, much a direct consequence of QE (i.e. ECB and BOJ) and rampant Credit growth (China and EM). It would appear that U.S. residential and commercial real estate markets are already feeling the effects of waning international flows.

In the eyes of complacent markets, vulnerabilities - China, Japan, EM, Eurozone, UK, etc. - ensure the coterie of global central bankers remain trapped in aggressive stimulus. Yet there appears increasing recognition within the central bank community that further delays in the start of "normalization" come with mounting risks. That they have all in concert far too long delayed getting the process started ensures great Latent Fragilities.

The Dow jumped 1.6% this week, the Banks 2.4% and the Transports 2.0%. The S&P500 added 0.6%, its fourth straight weekly gain. But the week saw (Crowded Long) declines of 16.7% in Facebook, 21.4% in Twitter, 9.5% in Electronic Arts and 8.2% for Intel. The broader market underperformed. Interestingly, the Goldman Sachs Most Short index dropped 3.1%. Rather abruptly, there are indications of nervousness and vulnerability below the market's surface.

The historic mistake was to believe that aggressive monetary policy would reduce systemic Fragilities. Stimulation of economies and animal spirits, no doubt, but at the cost of mounting latent instability. It's the six-year anniversary of "whatever it takes;" approaching the 10-year anniversary of the financial crisis; going on ten years since the massive Chinese stimulus. This week provided further evidence of trapped central banks.

EM rallied again this week, reducing the safe haven Treasury bid. Two-year Treasury yields jumped eight bps this week to 2.67%. The ten-year is again knocking on the door of 3.0% yields. I have no doubt that a surprising spike in Treasury yields would expose Latent Fragilities. The same question applies to Treasuries as it does to fixed-income markets around the globe: How much speculative leverage has accumulated over the past decade? Keep in mind it's the speculation and leverage that typically dooms a Bubble. Indeed, the interaction of leverage and depreciating asset values becomes a critical factor in why Bubbles are unsustainable.

First, it was the February blow-up of the "short vol" trade. Then instability engulfed the emerging currencies, debt and equities markets, followed by a destabilizing spike in Italian yields. The Chinese renminbi sinks a quick 5%. This week saw further weakness in the Chinese currency, along with hints of instability in Japanese and Italian bonds. Importantly, Beijing stimulus measures come with atypical currency vulnerability.

All in all, the Latent Fragility case is coming together. Financial conditions are tightening, and myriad Bubbles are showing the strain. And while the VIX traded below 12 this week (ending the week at 13.03), my hunch would be that liquidity in the volatility markets has quietly receded. The next VIX spike could get interesting.

Trump lays bare Britain’s ‘special relationship’ delusion

Tensions between London and Washington are nothing new

Lawrence Freedman

That Britain is a country “in turmoil” is one of US president Donald Trump’s more accurate observations. It is a turmoil to which he contributes. Instead of offering a beleaguered UK prime minister a helping hand, he has added to Theresa May’s woes by blatantly encouraging her most hardline Brexit critics. Mrs May finds herself having to cope with enormous strains in the two relationships at the heart of Britain’s foreign policy: with the US and with Europe.

This is not a wholly unique situation. In early December 1962, as Britain’s first attempt to join what was then the “common market” was about to fail, former US secretary of state Dean Acheson noted that Britain “had lost an empire but failed to find a role”. This unhelpfully set in motion a quest for that special role. Finding it became the holy grail of British foreign policy.

The search focused on Britain’s relationship with the US. The Suez crisis of 1956 had demonstrated in a humiliating manner that Britain could no longer pursue ambitious policies against American wishes. Just before Acheson’s speech, the Pentagon had decided to abandon the Skybolt missile upon which the future of Britain’s nuclear strike force depended. It took an emergency summit between prime minister Harold Macmillan and president John Kennedy for the US to substitute the much more appropriate Polaris missile. The episode underscored the extent to which Britain’s strategic independence had been compromised.

Macmillan had already decided, post-Suez, that the only way to sustain any position in the world was to stay as close as possible to the US. In this way, shared history and culture, along with the security connections forged during the second world war, could keep Britain centre stage. The country may not have found a special role, but it did have a special relationship.

Britain was clearly the junior partner, although at times London flattered itself that it could make up for a lack of raw power by using its mature wisdom to guide the brash newcomer. But there was also a solid foundation. The intense co-operation between diplomats, military staffs, intelligence agencies and nuclear establishments worked to the benefit of both. The two also had similar world views and were fully embedded in the network of multilateral institutions set up after the war to keep the international system as orderly as possible.

Most importantly, the relationship stayed so close because a series of great causes held it together. Following the joint fight against the Nazis — the greatest cause of all — this sense of shared endeavour was sustained through the cold war. Then with the collapse of the Soviet Union came more positive opportunities to spread western values and practices in eastern Europe and beyond. This was followed by the darker period of the “war on terror”.

These great causes did not prevent disagreement. Even during the 1980s, when Margaret Thatcher and Ronald Reagan were on a shared ideological campaign, they had their differences, for example over the Falkland Islands in 1982. Yet the Falklands episode also indicated the underlying strength of the relationship. While Thatcher was furious that Reagan sought a deal between the Argentine aggressor and his aggrieved ally, the Pentagon and American intelligence agencies were actively working to make sure that British forces had the support they needed.

Tony Blair declared after the al-Qaeda attacks of September 11, 2001 that the UK would stand “shoulder-to-shoulder” with the US. He set himself up as a committed strategic adviser to president George W Bush, even when this led to the invasion of Iraq. The episode illustrated the limits of the alliance. Mr Blair could exercise some influence when the White House was undecided about what to do, but he could not get it to budge once it had made up its mind up. The result was that Britain found itself part of an ill-prepared and much-criticised occupation.

This left a legacy. There was little appetite for new operations of a similar kind, other than the occasional use of air power. David Cameron’s failure to get parliament to back a military response to Syria’s use of chemical weapons in September 2013, and Barack Obama’s own reluctance to get involved in another ground war in the Middle East, marked the end of this activist stage in the special relationship.

Weariness replaced the confidence with which the 21st century had begun. The international order that had served the interests of the two countries so well was under challenge from critics at home as well as abroad. The UK’s vote to leave the EU was one symptom of this challenge; Mr Trump’s election another. There was even a theoretical possibility of a new stage in the special relationship marked by the two working together outside the multilateral institutions that they had both worked so hard to develop and sustain.

But Mrs May has never been able to bring herself to support the radical break with the past that Mr Trump represents. On every issue in which he has challenged mainstream thinking (climate change, Iran, trade), the UK has found itself on the same side as its EU partners.

Before the Brexit vote it might have been possible to compensate for Mr Trump’s unpredictability with a more active role in the EU, but that is no longer available. A country whose role in the world always depended on the quality of its partnerships with others now faces an unusually lonely future. To lose one special relationship is a misfortune; to lose two together looks like carelessness.

The writer is emeritus professor of war studies at King’s College London and author of ‘The Future of War: A History’

 Is The Interest Rate Death Spiral Finally Starting?

The yield on Italy’s 10-year bond is up by about 100 basis points from its 2018 low. Meanwhile, its government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, forcing it to borrow even more money, and so on until this “interest rate death spiral” becomes fatal.

It would already be fatal, if not for the European Central Bank’s willingness to buy Italy’s bonds at extremely favorable prices (i.e., very low interest rates). But now the ECB is promising to stop doing that, which leaves Italy in the early stages of a very negative feedback loop.

Italian 10-year bond yield intrest rate death spiral

Not our problem, you say? Italy is irrelevant to everyone including most Italians, so its imminent financial crisis is no more important than Venezuela’s.

Fair enough. Let’s move closer to home and start the story over:

The yield on US 2-year Treasury paper is up almost 100 basis points since last September.

Meanwhile, the government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, which means it has to borrow even more money at higher interest rates, and so on until this “interest rate death spiral” becomes fatal.

It would already be fatal if not for the Federal Reserve’s willingness to buy Treasury bonds at extremely favorable prices (i.e., very low interest rates). But now the Fed is promising to stop doing that, which leaves the US in the early stages of a very negative feedback loop.

US 2-year note yield interest rate death spiral

Here’s what the US government’s interest payments would be under different average interest rates:

US government interest cost interest rate death spiral

Note that the highest rate used in this table – 6% – is about average for the two decades prior to 2000.

So it only seems extreme in today’s era of monetary experimentation. We’ll get back there, one of these days.

Except that we won’t. An annual interest bill of 1+ trillion dollars would send the deficit – which is projected exceed a trillion without a meaningful rise in interest rates – above $2 trillion. And – since new interest will accrue on each year’s new borrowing – the current 21 trillion of US government debt would grow by around 10% a year in this scenario, kicking the process of higher rates producing higher deficits into overdrive. This impossible-to-hide acceleration will in turn produce extreme responses from governments and/or markets, including but not limited to spiking inflation, plunging bond prices, capital controls, martial law and a global monetary reset.

Italy will probably get there first, which allows Americans to view our future by looking across the Atlantic. So you see it does matter.

And remember, this scenario involves only central government debt, which is cumulatively dwarfed by private sector debts, state and local unfunded pension liabilities, emerging market external dollar debts, and bank derivatives. And all of these things are vulnerable, one way or another, to rising interest rates, which means the interest rate death spiral, when it kicks into high gear, will be something for the history books.