Economy with a Fever


Getting a fever is no fun. You likely get chills, you sweat, and you’re just generally uncomfortable. You get tired easily and need to rest. But here’s the weird part:
Fever isn’t the real problem. It’s a symptom of something else. You must treat whatever that is to relieve the fever.
Economic indicators are similar. Lately I see a lot of talk about the flattening yield curve and speculation it might invert as the economy enters recession. If that happens, the inverted yield curve won’t be the culprit. It will point to another culprit, or combination of them.
This is something I watch carefully because a recession is long overdue, if history means anything. Some argue this time is different. Maybe so, but I’m not inclined to bet on it. Today we’ll explore some reasons why.
First, a little business nostalgia. If you read Outside the Box this week, you saw that Wednesday’s issue was the last one ever. I must say, I felt more than a twinge of sadness when hitting the “send” button. It’s not easy to end anything after fourteen years.
Still, it was a necessary change. As you know, there’s a lot more going on in my life than there was five or ten years ago, and I need to do an ever-increasing amount of research to stay on top of my game. Plus, I need to start penciling in some downtime, too!
I’ve gotten plenty of emails in the last few weeks about these changes. This one from Tom sums them up nicely:
John—Don’t leave us hanging by our fingernails, let us know what you’re planning. I’ve been very impressed by your network and the information that you pack into these two newsletters. I hope we will be able to continue to have access to you and yours.
Well, Tom, I can tell you (and everyone else reading this letter) that Monday, April 30, will bring the Great Unveiling. My editor Patrick Watson and I think of it as The Big Reveal. Think the final moment in a magic act. Maybe I don’t qualify as an economic magician, but I have had a few surprising “reveals” in this letter.
And more to the point, not only will you still have access to me and my friends and associates, we’re giving you more valuable access, in a way that fits neatly into your schedule. I better stop before I say too much, but please watch your inbox for an email from me on Monday.
Now, on with our fever treatment, which of course, brings up a story.

In late 2006, when the yield curve was last in the process of inverting, I put in a call to then New York Fed’s Dr. Fred Mishkin, who co-authored a seminal report reviewing 20 different indicators as recession forecasting tools. They found only the inverted yield curve had any true significance, and then it was generally a year early.
I had first used that signal back in 2000 to forecast a recession, using their research but just as important, what I learned from one of my earliest economic mentors, Dr. Gary North. Back in the early 1980s, Gary pounded into me the inverted yield curve’s importance in forecasting recessions.

Later, Professor Campbell Harvey of Duke came along with his groundbreaking work, and then Mishkin and his New York Fed colleagues—which if I remember right was in 1996.
Anyway, Mishkin returned my call, and I asked his thoughts on the then-current inverted yield curve. Did this mean a recession? He was actually quite reserved and told me an unqualified “maybe, but not necessarily. This time could be different.” I pressed, but he stuck with that answer.
There weren’t that many of us in late 2006 ready to make the recession call.

The market promptly rose another 20% after I said it was time to begin to move out of stocks. Two years later, I looked like a genius, but only after months of being mocked as another perma-bear gloom and doomer… along with Nouriel Roubini and a few others. Now everyone claims to have predicted the Great Recession. Memories are a funny thing…
Last week brought a little (at least short-term) good news if you’re worried about the yield curve inverting, i.e. short-term rates rising above long-term rates. The ten-year US Treasury yield rose above 3% for the first time in four years. This will be the opposite of inversion, if it persists. It makes the curve steeper unless short-term rates rise even more. 

Nonetheless, the yield curve is still abnormally flat. The gap between two-year and ten-year Treasury yields hasn’t been this low since before the last recession.
Note in the graph how this gap dropped below zero—i.e. inverted—shortly before the last three recessions. We haven’t seen it yet in this cycle. But we certainly could see inversion within the next year or so if it keeps dropping at the current rate. That’s quite possible if the Fed keeps hiking because they have hit their inflation and employment targets.

The Fed is now walking a very tight rope. They know, deep down and viscerally, that they have to get rates back up so that they will have a few “bullets” for the next recession. It is likely they will keep hiking rates until we get to an inverted yield curve. Are they aware of all the literature and what they’re doing?
Absolutely. Candidly, I can’t imagine accepting a Fed appointment knowing that we are this late in the cycle. 

Does an inverted yield curve guarantee a recession? No, but inversions are strong evidence one is forming. Last month, yet another new San Francisco Fed study found an inverted yield curve, which predicted all nine US recessions since 1955, is still valid even in today’s low-rate environment. 

However, yield curve inversion is a far-leading indicator, which is why my previous recession and bear market calls were early. Those nine recessions all began 6–24 months after the yield curve inverted. And, in the ones I’m old enough to remember, many experts spent those months telling us that this time was different. (Spoiler: It wasn’t.) And I expect the same again. 

Look around at all the great economic news. I’m aware of it. But the economy was hitting on all cylinders in early 2000 and late 2006, too. The numbers always look great right before a recession. Then it all rolls over at once. 

Like that fever I mentioned, an inverted yield curve doesn’t immediately damage the economy. It points to damage that’s already happening—an underlying infection. It means bond investors have lost short-term confidence in the economy and want to lock in longer-term interest rates.

You don’t want to buy, say, one-year bills if you think rates will be lower when it’s time to reinvest them. That will be the case if, for instance, you expect the Fed to be lowering rates to stave off recession. 

One point about that economic fever. I said that fevers don’t kill you, they are a symptom of something being wrong. Well, that’s not actually true. If a fever gets high enough or lasts long enough, it will kill you. Which is why hospitals work so hard to keep your fever down. A steeply inverted yield curve that goes on long enough is like having 108° fever. Both banks and shadow lenders go upside down on their “book” and stop making loans.

That can freeze the economy and makes a garden-variety recession even worse. Which is why any central bank facing that scenario lowers rates and fights the yield curve. 

The London Interbank Offering Rate (LIBOR) has for most of my adult life been the world’s most important private interest rate. By now you know that it is going away, and new substitutes are coming. But LIBOR is still out there for a short time, so let’s look at it. 

(By the way, Dennis Gartman and I had an argument/discussion yesterday about whether the two-year Treasury yield is artificially depressing the Fed funds rate. I suspect that it is. I hope he can get to dinner with Art Cashin and friends in New York next Tuesday night and argue that to the table.) 

But in any case, there’s now less than a 60-basis point spread on the Treasury 2/10 and half that if you’re using LIBOR, which I think of as more free market. If you go out the LIBOR swap market, you find a 20-year swap is not much different than a 10-year. The further out the curve you go, the flatter it gets. This is what happens at the end of an economic cycle and right before the yield curve inverts.

Source: Mortgage Equicap, LLC
The next-to-last Outside the Box that we sent you on April 18 featured Lacy Hunt’s quarterly review. Among other things, Lacy talked about falling growth in M2 money supply. Here’s an updated version of his chart:
In that article, Lacy described how M2 growth decelerated ahead of 17 of the 21 recessions since the early 1900s. He then dug into the four exceptions (marked A, B, C, and D on the chart) to see if they disproved the rule and found they did not. 

What is M2? It is a broad measure of the money supply, including cash, checking, and savings accounts, time deposits, and money market mutual funds. In a healthy economy, M2 should be growing. Diminution of that growth suggests recession is coming—but like the inverted yield curve, not necessarily soon. As he told me, broad measures of monetary growth can begin to decline two years or more before you have an actual recession. 

Again, this symptom results from an underlying disorder. M2 money supply grows with bank credit growth. It falls when banks reduce lending growth. They do that when finding credit-worthy borrowers gets harder, as it does in a recession. So here again, we see a condition that isn’t itself problematic but points to one. 

Lacy explained in his quarterly why this is a concern now. In the first quarter of 2018, M2 growth decelerated to just above a 2% annual rate. Year-over-year, M2 growth slowed to just 3.9% versus the 6.6% long-term average growth.
Additionally, bank credit growth declined 0.6% at an annual rate. Loans continued to inch upward but only because the banks’ securities portfolios fell. Loan volume does not typically fall until an economy is in a recession because firms borrow to finance an unintended rise in inventories. 

Note that credit growth doesn’t have to go negative. It rarely does, the main historical exception being the Great Depression. The key is its direction and distance below that 6.6% long-term average. The present 3.9% rate is the lowest since 2009. This again points to recession on the horizon. Not next month or even this year, but likely within 2–3 years. 

My friend Richard Duncan from Singapore sent me a note on credit growth this week. The emphasis below is his:
When credit growth is weak, the United States falls into recession. Between 1952 and 2008, there were only nine years when total credit (adjusted for inflation) grew by less than 2%. Each time, there was a recession. In 2017, total credit grew by just 1.9%. This was the first time credit growth has fallen below the 2% recession threshold since 2013. 

Total credit in the United States reached $68.5 trillion at the end of 2017. Given such an enormous base, it is difficult for credit to expand by 2% after adjusting for inflation. For instance, if the inflation rate is 2%, then total credit must grow by 4%, or by $2.7 trillion, just to reach the 2% recession threshold. If inflation increases to 3%, then total credit must grow by 5%, or by $3.4 trillion, to get there. Credit growth on that scale is not easy to achieve, especially given stagnant wages, the already high level of private-sector debt and, now, increasing interest rates. 

The latest Macro Watch video forecasts US credit growth out for the next three years by considering the outlook for borrowing by each of the major sectors of the US economy. With inflation trending higher, it looks as though credit will expand by only 1.7% a year during 2018, 2019, and 2020. If those forecasts prove to be correct, the chances are high that the United States will soon fall back into recession.

Cycle Studies
According to central banks and some on Wall Street, the US and global economies are right on the cusp of breaking from the post-recession doldrums. They think their aggressive monetary policies are finally bearing fruit, helped by tax cuts and other factors. Hence, the Fed is now tightening policy lest this inevitable growth spark too much inflation. 

My friend Lakshman Achuthan of the Economic Cycles Research Institute is not convinced. He recently sent some slides I want to share with you. (He will be at the dinner on Tuesday, and he was gracious enough to talk me through these this week.) This first one shows that the present, low-grade expansion phase is the latest in a series. By the way, the ECRI is as close as we have to “official” economic cycle watch service in the country.

Source: Economic Cycles Research Institute

 Note, this is growth during times when the economy is not in recession, which should be considerably higher than the full-cycle averages. It has been falling steadily since the 1970s and is now below 2%. If the best we can do is 2% not counting recessions, it’s hardly time to proclaim victory. 

The next chart looks at the ECRI U.S. Coincident Index, which is their alternative growth measure. The shaded areas are cyclical downturns, the three most recent of which did not reach recession status.

Source: Economic Cycles Research Institute
The important point here is we see little or no improvement in the growth rate. Since 2010, it has moved sideways in a tight range. In the last two years, it moved up to about the middle of the range, which is positive but doesn’t mean the US economy is off to the races. 

Finally, and most ominously, Lakshman shows this chart of quarterly GDP growth in the three largest developed market economies.

Source: Economic Cycles Research Institute
We see in all three places that quarterly growth peaked in mid-2017 and then fell in the last quarter. Yet the experts tell us a synchronized global recovery is forming. Really? What I see here is a synchronized downturn.
Granted, it’s just a couple of quarters but early data makes Q1 2018 look lower still. 

If a recession is coming, GDP growth will decline from its present level to 0% or below. That process will likely unfold over a few quarters—and may already be beginning.
On top of all this, we have a fast-growing federal debt. I realize some readers are of the “debt doesn’t matter” persuasion. With all due respect, the debt does matter for reasons I will explain below. Yes, we owe this money to ourselves and maybe it will all balance out eventually. But we must get there first, and the road is not necessarily smooth. 

Let’s look at some data from my friend Luke Gromen, who runs a unique advisory service called Forest for the Trees. His informative letters are typically short, and I’m becoming quite fond of them. The most recent one had some fascinating points on the debt. 

First, Luke says one of the least-noticed recent developments is that foreign central banks stopped net purchases of US government debt about five years ago.

Source: Forest for the Trees, LLC
This is important because someone has to fund our deficit spending, and the job is not getting easier. It’s getting harder, in fact, as Luke’s next chart shows.

Source: Forest for the Trees, LLC
By the way, this gap is conservative. It assumes the US will have no recession by 2021 and that foreign central banks will hold their Treasury portfolios to maturity. The recent trend line suggests they won’t. It also assumes China will keep running a $600B yearly current account surplus with the US and buy US Treasury securities with all of it. Those aren’t guaranteed either—and will certainly change if the Trump administration succeeds in reducing the US-China trade déficit. 

To this point, the Fed and Treasury have filled the gap with assorted contrivances, such as forcing banks and money market funds to buy more Treasury bonds. These have run their course and no replacement tools are obvious. 

That leaves one option: higher interest rates. People will loan their money to the government if it gives them enough incentive, and higher yields will do it. How much higher? We don’t know, but it won’t take much to further reduce bank lending activity, which will reduce M2 and push the economy closer to recession. Investors will further extend their maturities, inverting the yield curve. 

That, my friends, is a fever that won’t feel good at all.
By now, everybody knows we are in the slowest recovery on record. Lacy Hunt blames ever-increasing debt, which is a drag on growth. He has tons of academic literature to support his position, and I agree with him. That the next recovery will be even slower. 

Go back to what Richard Duncan said earlier. When credit growth drops below 2%, a recession almost always follows. Lacy tells us that bank credit growth is down to 0.6% since the beginning of the year. That is ugly.

I now have to officially put my recession watch antenna firmly in place. The models that my four ETF trading strategists follow (using their significantly different quant models) are all beginning to de-risk their portfolios. Given the volatility of the market, that has been a good decision. Have they pulled all their chips off the table? No, not even close. But they are closer than they were one year ago. 

In short, there is not enough data to have me predict a recession and the consequent bear market. But there’s enough data bubbling up all around me that it makes me very nervous, and I am paying close attention. You should be, too.
First, please join David Rosenberg and many of my friends in giving to the Richard A. Yamarone Memorial Scholarship in Economics at Brooklyn College. For those of us who knew Rich personally, we have all been devastated by his sudden passing away from a massive heart attack while he was playing his beloved game of hockey. Not watching, mind you, but playing. That was the way Rich was, even at 55. I will miss one of my best friends and the economic Darth Vader in my life. He was the chief economist for Bloomberg and deeply loved by everyone he knew, simply because he was the nicest guy in any room he entered. We need to produce more like him, so please follow the link above if you are so inclined. To those of you who have answered my call, a huge debt of gratitude. 

I am writing this from Florida. After my speech here, I fly back to Dallas where I will shower, change bags, kiss Shane, and then fly to Iceland overnight. Next week, I have several meetings in New York and the dinner I mentioned above with Art Cashin and friends. I’m also seeing Ian Bremmer, where we will talk about his latest book that was in my last Outside the Box. I should have it read by the time we get together. 

It is time to hit the send button. I make a speech in 19 minutes somewhere in this hotel, so I better get on my pony and ride. You have a great weekend!

Your worried about future economic growth analyst,

John Mauldin
Chairman, Mauldin Economics

Can Baby Boomers Succeed in a Millennial World?

Everybody book

You’re in a staff meeting with the new boss. As you sit there thinking she must be about the same age as your daughter, she welcomes two new apple-cheeked team members whom, you have heard, the company hired at half of your salary and the salary of the workers they are replacing. You are asked to mentor one of them on a “new” initiative — an idea, it turns out, that is a lot like a project you led a decade ago. You feign enthusiasm.

The plight of the baby boomer in an increasingly millennial-focused workplace is playing out with greater regularity. Next year, 20-to-35-year-olds are poised to overtake 52-to-70-year-olds as a percentage of the U.S. population, according to the Pew Research Center. Many baby boomers today find themselves reporting to supervisors younger than themselves. Working at a time of great pressure for higher corporate profits and increasingly sophisticated technical skills, boomers, after spending years as the most coveted generation, often now feel as if they’re getting pushed aside and out.

“Cutting ‘Old Heads’ at IBM” is the headline on a recent ProPublica report that found IBM had targeted older employees for layoffs even when they were rated as high performers. The story further alleges that money saved from the layoffs was used to hire younger replacements; that IBM encouraged workers targeted for layoffs to apply for other jobs within the company even as it advised managers not to hire them; and that after telling some older workers they were being laid off because their skills were out of date, the company brought them back as contract workers, often for the same work at lower pay.

IBM responded to the story by saying it was “proud of our company and our employees’ ability to reinvent themselves era after era, while always complying with the law.”

ProPublica pointed out that IBM has nearly 400,000 employees worldwide, and “how it handles the shift from its veteran baby-boom workforce to younger generations will likely influence what other employers do.”

But companies eager to move baby boomers along should be careful what they wish for. For one thing, millennials are less likely to stay in jobs than others, and turnover often carries high hidden costs. For another, few workplaces have mastered a system for transferring knowledge from one generation to the next.

There are other compelling reasons for organizations to not give baby boomers the bum’s rush.

“When we talk about gender and ethnic diversity, a powerful argument for diversity is that you want to look something like your customers,” says Wharton management professor Matthew Bidwell. “If everybody you employ is a white male, that will come back and bite you, because you are not in a good position to understand your customers. There has to be an equivalent argument about age.”

He notes that if everybody in an organization is middle age and older and a large part of its customer base is younger people, then there is logic in hiring some employees who can relate to those customers. “Does that mean a wholesale clearing out of baby boomers? Absolutely not,” he adds.

Energizing at least some of the push for generational turnover are stereotypes that have developed around baby boomers, millennials and others – for example, that millennials are apathetic, and that boomers are intransigent and tech-adverse.

But are there really intrinsic, permanent differences among the generations? No, says Wharton management professor Peter Cappelli, director of the school’s Center for Human Resources.

“Young people do behave differently than older people,” he says. “It’s just that a few decades from now, they may be different workers with essentially the same kinds of frictions.”

The bias of fundamental attribution error, Cappelli says, means that when we see behavior, we attribute it to our assumptions about the character or disposition of the person rather than thinking about the circumstances that make them behave that way. “If someone is racing down the highway, we assume it is because they are a jerk and don’t consider the possibility that they have an emergency,” he points out. “When we see young people in our office focused on things other than work, we assume it is because of their character rather than the fact that at this point in life, socializing is always a central activity, and we forget that we were like that once as well. Of course, it has also become an industry of consultants selling solutions to this alleged problem.”

The real force impelling companies to lay off the old and hire the young is less complicated than all that, says Cappelli: “To save money.”

False Stereotypes

This doesn’t necessarily mean that today’s 21-to-36-year-olds are the same in every way as 21-to-36-year-olds a half-century ago. For one thing, workers from each succeeding generation since the so-called “greatest” are less likely to be white. In the U.S., the generation that is 72 or older is 79% white and boomers are 72% white, while whites makes up just 56% of millennials.

More LGBTQ workers today are likely to be out. This more diverse workforce brings different experiences to bear on decisions.

But “meaningful differences among generations probably do not exist on the work-related variables we examined and the differences that appear to exist are likely attributable to factors other than generational membership,” found the authors of “Generational Differences in Work-Related Attitudes: A Meta-analysis,” published in 2012 in the Journal of Business and Psychology. The analysis looked at 20 studies covering nearly 20,000 individuals from various generations and concluded that “targeted organizational interventions addressing generational differences may not be effective.”

Still, the tendency to stereotype workers according to age is “really quite profound,” says Wharton management professor Stephanie Creary. “The reality is, we use labels and categories as a way of simplifying complex information; we refer to men and women and we assign attributes and characteristics to those groups of people to make it easier to understand the patterns of their actions.” The problem comes when that information is full of negative connotations — such as baby boomers aren’t into tech, they don’t want to get with the times, or millennials aren’t committed at all. “I think it’s a fine line between how we understand some of the things that influence workers in our workforce without using those categories to create harmful stereotypes,” Creary notes.
Much of the friction around the boomers-versus-millennials question stems from the fact that the pace of change in many industries is currently so rapid that employers themselves are struggling with their workforce needs, says Wharton professor of operations, information and decisions Prasanna Tambe. “The pace at which technological change is disrupting industries is as fast as it has ever been within the last century,” he says. “… That is the moment we are in, where organizations are struggling to respond to new and difficult questions about their workforce needs that are being raised by the disruption of their traditional business models or by technologies like new internal communication tools or artificial intelligence systems. It’s not surprising if this uncertainty further exacerbates the tensions that already arise naturally when employees of different ages are together in the workplace.”
For years, it was understood that people take a job, and as they got older they would get promoted, says Creary. “There were tighter links between age and tenure and promotions.

With millennials came new ways of working as a society. We have the internet and other ways of working that are non-traditional that allow people to circumvent a lot of the hoops. I think we are reacting to the very changing nature of work.”

Another layer of uncertainty comes from the fact that in some sectors and at many companies, it’s not yet clear which revenue center will be generating the lion’s share of profits. Says Tambe: “The industry-level disruption is part of the story, and it may be the case that older workers hold more of those industry-specific skills that are now being endangered when employers don’t know where their revenue will come from in the next 10 years.”

In the meantime, many baby boomers feel their options are limited. Some may not have enough squirreled away for retirement to end their careers, while others whose careers have been ended unjustly by their employers find themselves stymied by limited legal remedies.

“Age discrimination litigation has stalled,” says Janice Bellace, Wharton professor of legal studies and business ethics. “Every survey of working persons over 50 shows that a large majority feels that there is age discrimination. Yet, there are few lawsuits.”

One reason for the paucity of lawsuits, she says, is the Supreme Court’s view of what the plaintiff must prove. “It is much more difficult to prove age discrimination than race or sex discrimination. This relates to a somewhat technical point. Both Title VII and the Age Discrimination in Employment Act of 1967 (ADEA) have similar language; namely, that an employer cannot take an unfavorable action ‘because of’ an employee’s protected characteristic,” she notes. “In a 1989 sex discrimination case, the Supreme Court considered an adverse employment action which was based on both permissible and impermissible factors, a so-called ‘mixed motives’ case, and held that where an impermissible factor was a motivating factor, the burden of persuasion shifted to the employer to show that it would have taken the same [adverse] action even absent the impermissible factor.”
In 1991, Congress amended Title VII to incorporate the mixed motive model for Title VII discrimination claims. However, Congress never amended the ADEA. In 2009, in an age discrimination case involving the demotion of an employee with 32 years’ service, the Supreme Court focused on the language of the ADEA, “because of age,” and held that the plaintiff must prove that age was the determinative factor for the adverse employment action.
Says Bellace: “In other words, the plaintiff had to show that ‘but for’ his age, he would not have been demoted. It was not sufficient that age was one factor, even a substantial factor, if there were other factors.” As a result, in an ADEA case the plaintiff must prove that other reasons the employer offers for the adverse employment action are mere pretext.

“That’s a very heavy burden of proof,” Bellace notes. “In real life, if an employer would like to push out an older worker, the employer’s [managers] would have to be idiots not to lay down some paper trail that suggests that there were some other reasons for dismissing the person. It’s even more difficult in a hiring case, because the plaintiff must prove that there was no other reason, except for age, that the employer preferred another candidate.”

Strategies for Boomer Longevity

For all of the challenges, though, baby boomers should hardly think of themselves as helpless.

Comportment matters. The stereotype of the “older worker not willing to learn new stuff, I think it’s fairly unfair,” says Bidwell. Still, he says, “it probably behooves older workers to go out of our way to demonstrate that we are keeping up, learning new things and so on. Obviously if you are seen as inflexible, unwilling to keep up, that is not going to be great for your longevity in the organization. You have to be prepared to leap on bandwagons.”

Mentoring and reverse-mentoring — older workers learning from younger ones — are highly valuable tools, says Julie Kantor, president and CEO of Bethesda, Md.-based mentoring consulting firm Twomentor. “Everything goes back to a company having a good culture, and part of a good culture is creating respectful systems with four or five generations in the workplace,” she notes. “If I were a baby boomer, I would want to learn what I can from millennials.”

Kantor thinks of these relationships as reciprocal. “I’ve yet to meet someone who has mentored who hasn’t gotten as much out of it as the person being mentored. If people are talking about what a great mentor, leader or adviser you are, it will increase your recognition in the company. That will increase your visibility. And you will learn by mentoring other generations about culture and diversity and about other perspectives.”

But there is a vast difference between asking an older employee to train a new one, and a culture that promotes mentoring on an ongoing basis. “If I am a baby boomer being replaced by a cheaper millennial, why would I want to give them my institutional knowledge?” says Bidwell. “On the other hand, it’s going to be very hard to transfer that knowledge. We talk about tacit and explicit knowledge, there are things you don’t know you know, and no matter how much you know you know you can’t really write it all down.” Traditionally the way employees have passed down knowledge is through apprenticeships and mentorships, having younger people work alongside older people for a fairly substantial period of time. That doesn’t happen much now, he says.

Creary urges keeping up with business peers and trends, which can be valuable as “non-formal, non-graded face-to-face delivery models that build community and build relationships. Who knows, it might give people who are baby boomers an opportunity to think about next steps. Never stop networking, even when you are senior vice president of marketing at a Fortune 500 company. It becomes really important to keep on doing the things that got you to where you are.”

Anything that adds value to a worker is a hedge when HR is sent out to meet a number by making cuts. Says Creary: “It’s very easy to attribute value to a salary because those numbers are hard and fast — a new entrant is making $60,000 a year and we are paying baby boomers two or three times that. So, the reality is, if we hire a younger person we are going to save on labor costs. But knowledge, institutional memory and efficiency also have a price attached to them, and it’s not so easy for every HR officer to realize the value of that. Organizations are, for better or worse, quantitatively oriented. And so, the larger question is, how do we attach value of that older person to the institution? I think that math needs to be done.”

On the Korean Peninsula, Toasts Give Way to the Problem

By George Friedman

The leaders of North and South Korea held talks last week, and that in itself is significant. But the talks should not be confused with a solution to the problem on the Korean Peninsula. There are five players involved in these negotiations: North Korea, South Korea, the United States, China and Japan. Each has very different imperatives forcing its hand, and each has varying amounts of influence over the situation. Some can be excluded from the deal but not all, and finding a common basis for an agreement among even three or four players is difficult to imagine. It can be done, but only with concessions that would undermine crucial interests for at least some. Let’s review what each country seems to need.

North Korea wants to secure its regime from outside forces. The outside force that most directly threatens North Korea is the United States. The presence of significant American forces in South Korea and the region is seen as a threat to the regime. They might not be a threat at the moment, but the future is uncertain, and if North Korea is weakened internally, it can’t trust the United States not to take advantage of the opening. North Korea must assume the worst. It therefore wants all or most U.S. forces to withdraw from South Korea, and possibly limitations on U.S. naval forces in the Sea of Japan. In addition, North Korea wants access to South Korean economic capabilities, without allowing the introduction of corrosive ideology into the North, which will be difficult to pull off.

South Korea wants to make certain that nothing threatens its economic well-being, especially not a war on the Korean Peninsula. At the same time, it wants to be certain that North Korea is not in a position to assert military power that South Korea cannot check by itself. South Korea does not want to become subordinate to the North and, therefore, wants to maintain a basic defense relationship with the United States, including some U.S. presence in South Korea, perhaps lightening the U.S. footprint but not removing it altogether.

The United States’ primary imperative is to keep North Korea from having the ability to launch an intercontinental ballistic missile at the continental United States. How North Korea will evolve politically is unknown, and the risks associated with that uncertainty are unacceptable for the U.S. At the same time, the United States also wants to maintain its military presence in the region as a counter to Chinese military power. South Korea is a base from which to project power into the Yellow Sea. A complete American withdrawal is impossible because it would shift the military balance in the región.

China’s core imperative is to see that its coastal seas come under its control. An equally important imperative is for China not to rupture relations with the United States, with whom it has a crucial but currently delicate economic relationship. The Chinese would support any agreement that reduces the U.S. presence in the region and likely would try to manipulate the situation to achieve this, but they would do so with as little visibility as possible, complicating any negotiation.

Finally, Japan has an enormous interest in the Korean Peninsula, as it has historically been a buffer between Japan and China and a base from which Japan could project power. A united Korea that would remove the United States from the equation would be an existential threat to Japan, forcing it to increase its already substantial military force. Given Korean hostility toward Japan, this could firm up South Korean insistence on retaining U.S. forces, or perhaps force an accommodation with the North. These are contradictory but both plausible and, for Japan, risky results.

The question of North Korea’s nuclear capability has opened the door to these negotiations, but this issue is not the real heart of the matter – except from the United States’ perspective. At the heart of the matter is that there is a contradiction between what North Korea needs to ensure its security and what South Korea needs. It is quite possible that they can overcome this problem on their own, but they cannot disregard the strategic interests of the two major powers, the United States and China, both of which could override any agreement that is not in their interest. Meanwhile, Japan, the world’s third-largest economy and a major regional power, also faces a threat from the Korean Peninsula, particularly if it falls under Chinese influence.

I am not arguing that a settlement is unlikely, but merely that reaching a settlement will require major concessions over matters that are at the core of every player’s national strategy, and making those concessions will be extremely difficult. I am reminded of the U.S.-Chinese entente in the 1970s. That situation was relatively simple. There were three powers involved: the United States, China and the Soviet Union. The first two had adversarial relations with the Soviets and, therefore, an interest in collaboration. The issue was relatively clear and the level of trust required was minimal. But today, there is neither simplicity nor clarity. North Korea might well give up its nuclear weapons, but what it would demand in exchange would not only be hard for the other players to concede but would trigger a significant degree of regional unease and instability. It is too early to think of Nobel Prizes.

Smart Money Is Moving into Gold as Volatility Returns

We are in a dangerous period of economic transition.

The Fed is shrinking its balance sheet and raising rates after a decade of stimulus. The dollar is losing its ground. Bonds are at risk after a 30-year rally.

Not to mention record-high valuations in the stock market and the return of volatility.

Bottom line: risk is everywhere, and there seems to be no place to hide.

But as you’ll learn below, there’s one asset class that top money managers turn to as the ultimate hedge.

It’s gold.

Below are highlights from SIC 2018 with quotes from some of the best investors in the world about gold and its role in your portfolio.

Even if you are not into gold, don’t let it put you off. This update will give you a lot of valuable insights into the current state of our economy and the markets from people who know it best.

Your Purchasing Power Is Being Destroyed

Mark Yusko

At the SIC, Mark Yusko, CIO and CEO of Morgan Creek Capital Management, gave an emotional speech comparing the Fed to a dictator that robs the nation.

He pointed out that despite $20 trillion being injected into the US economy through quantitative easing since 2008, the results haven’t matched the effort... 
Everybody's all excited about QE. Everybody's all excited about the Fed, but you realize that in the last 10 years, we had the worst growth in the history of America. Let that sink in for a second... 1.4% real growth for the last 10 years. And we have indebted our future to the tune of $20 trillion for nothing.
This increased money supply, he said, resulted in currency devaluation. “This is what dictators do. They systematically acquire the assets, and then they devalue the currency and boost the price of assets.”

He showed a chart that plots the S&P 500 price in nominal terms (blue line) and in gold (pink line).


“Gold is money,” he commented. “It's real money. For 5,000 years, an ounce of gold has bought a fine man's suit. So you can see in 2007, we had the housing bubble in nominal terms, but... the value [of the S&P 500] in gold fell. Today, we don't have a bubble. We have a bubble in nominal prices, so this is what dictators do.”

Put simply, he said, record-high valuations in equity markets are the result of a devalued currency and monetary measures that the Fed pursues: “The purchasing power of the currency is being destroyed right before your eyes, and you're just not paying attention.”

Gold Will Break Out in a Big Way

Jeff Gundlach

Jeff Gundlach, CEO of Doubleline Capital, provided a more technical forecast for gold. Given the situation in the markets, he thinks it’s only a matter of time before the price of gold breaks out:

We're at a juncture in gold, not surprisingly, because it is negatively correlated with the dollar...

Now we see a massive base building in gold. Massive. It's a four-year, five-year base in gold. If we break above this resistance line, one can expect gold to go up by, like, a thousand dollars.

Gundlach was reluctant to predict the probability and timing of this massive gold rally, but he thinks that investing in gold at this price is a no-brainer: “It’s a great time to be buying gold... because one way or the other, this baby’s got to break in a big way.”

Gold Will Shine in the Coming Inflationary Boom

Louis Gave

Louis Gave is the co-founder and CEO of Gavekal Research. The main theme in his keynote speech this year was a once-in-a-generation shift from a deflationary boom to the inflationary boom that we see today.

Below is a four-quadrant framework that Gave uses to determine where we are in the cycle:


According to Gave, these shifts occur every 30–40 years, usually as a result of policy errors.

As a method to determine where we are in the cycle, Gave suggested using the gold/bond ratio: “My starting point is always that... over a four-year period, bonds should always outperform gold... When they don't, when bonds underperform gold, that's the market giving you a very important signal.”

He pointed out that gold has been outperforming bonds for the past four years now. “This, to me... means we are moving to an inflationary boom and bust period.”


If that’s the case, Gave told the SIC attendees, the investing environment will radically change.

He suggested that investors reconstruct their portfolios and get out of bonds as a diversification tool because they are not a good diversifier in periods of inflationary booms.

To prove his point, Gave showed a chart of the performance of gold, cash, and US Treasuries as hedges during inflationary booms (see below).


In the last inflationary boom, from 1966 to 1980, Treasuries were a horrible choice for your portfolio.

Meanwhile, gold and cash shined.

Another positive trend for gold that Louis Gave sees is the growth of emerging markets (EM).

That’s because higher purchasing power in EMs tends to translate into higher gold demand: “...for me [gold] is a good proxy for emerging market growth. When people get rich in an emerging market, they buy gold. And the reality is today people are getting rich in emerging markets at an accelerating pace.”

He said that growth in emerging markets combined with rising inflation and a weak dollar creates a perfect setup for a gold rally in the coming years: “I think the time indeed has come for having gold in your portfolios.”

A Shift in US Monetary Policy Spells Trouble for Equities

Grant Williams

Grant Williams, author of Things That Make You Go Hmmm..., warned investors about the dangerous implications of a shift in US monetary policy—another good reason to invest in gold now.

According to Williams, for the last 40 years, US monetary policy has been built on constant injections of stimulus. Since Paul Volcker’s tenure in the early 1980s, every Fed chair has pushed interest rates lower.


Now QE is officially over and is to be reversed. Williams thinks that this marks a monetary shift, which spells trouble for equities.

He gave a brief rundown on the effects that the Fed’s three rounds of QE had: “Stocks soared.

The S&P doubled under the Fed's various QE programs. Gold fared really well because of fears of inflationary effects of money printing. The dollar eventually eked out a small gain. And the yield on the [10-Year] Treasury fell 1.6%.”

The key message for investors is, Williams said, that after nine years of one long, pleasant, ride in equities, we've reached the point where the main driver of equity prices is about to reverse.

In the best case scenario, he thinks quantitative tightening will reverse the effect of the Fed’s stimulus measures on the stock market. However, he doesn’t rule out a much bigger sell-off.

Asked what investors should do, Williams joked, “Long the Zambian kwacha versus the US dollar. Ah, who the hell am I kidding—it's gold! Of course, it's gold!”

The reason is that all the trends are pointing to rising inflation, he said. “Gold performs best in a rising inflationary environment, not a high inflation environment. So, we're kind of moving into that sweet spot.”

Williams likens today’s situation to the period leading up to the 1970’s recession where a shift from equities and cash to gold could happen unexpectedly fast.

What happened with that late-cycle stimulus that Johnson put in, and what happened to equity markets, bond yields, wage prices, CPI, and gold, going into the late ‘60s into the early ‘70s, we saw these things take off. And these things are cyclical. So to me, if this inflation story gets some traction, then I think you're going to see money move to gold reasonably quickly.

Further, Williams suggested, in periods of quantitative tightening, equities eventually crash.

Since gold is inversely correlated to the stock market, this is another reason gold should rise in the coming years.

In fact, history shows that gold has rallied in the last five out of seven recessions.


There’s No Better Hedge Against a Weak Dollar Than Gold

David Rosenberg

Yet another speaker who praised gold was David Rosenberg of Gluskin Sheff. The biggest reason for Rosenberg’s bullishness on gold is the United States’ protectionism, which he thinks will inevitably push the dollar down: “We'll get a countertrend rally in the US dollar, maybe three to four percent, and then it's going to go right back down again. Because you have a protectionist government, and part of that protectionism, what is a better tariff than just depreciate your currency?”

Rosenberg suggested buying gold as hedge against a weak dollar: “Gold is perfectly inversely correlated with the US dollar. If you want to hedge against the US dollar as opposed to inflation... you have to have some gold in your portfolio.”

Mauldin Economics on Gold

Now that you’ve heard from our notable SIC speakers, we’ll share the Mauldin Economics perspective on gold.

Physical gold is not for speculation. You don’t buy gold to get rich quickly. It’s a long-term investment. More importantly, gold is an ideal hedge against currency devaluation, a financial crisis, or a black swan event.

Most investors are underweight gold and won’t move to correct their mistake until it’s too late. In some ways, we are lucky today—gold ’s price is a relative value compared to where it will be in the coming years. You still have time to hedge your portfolio against the financial headwinds that are already looming on the horizon.

But perhaps not much time. Tech stocks like Facebook and Amazon have led the market’s gains over the past several years. Today, they no longer look invincible.

In this increasingly volatile environment, allocating some of your liquid assets to gold is a prudent move.

Still, most investors stumble when it comes to acting on the recommendation. How do I buy gold? Should I buy gold bullion or collectibles? Is it better to get coins or bars? Where do I store it? And why even bother with physical gold when there is an ETF for everything?

Automation and American Leadership

Robert Skidelsky

The mostly automated facility

LONDON – Not so long ago, there were two competing explanations of unemployment. The first was the Keynesian theory of deficient demand, which holds that workers become unemployed “involuntarily” when their community lacks the money to buy the goods and services they produce. The second was the view often associated with the Chicago School, according to which unemployment is a voluntary choice of leisure over work at whatever the offered wage.

Now, a third explanation is gaining traction: declines in full-time work opportunities and real wages are both due to automation. To be sure, the idea that robots are gobbling up human jobs is a new slant on the very old problem of technological unemployment. But it is a slant that merits attention, because the problem cannot be solved with the conventional policy responses.

The “official” narrative about technology treats accelerating change as inevitable. According to acronymically named institutions, think tanks, task forces, et hoc genus omne, automation and artificial intelligence (AI) will soon eliminate or alter a large but unpredictable number of human jobs.

At the same time, embracing new technology is considered necessary for a country’s geopolitical and competitive success. Thus, disruptions to existing work patterns should be welcomed and “mitigated,” by adapting education and social-security systems to the needs of an automation-driven job market.

So says The Work Ahead: Machines, Skills, and US Leadership in the Twenty-First Century, a new report published by the Council on Foreign Relations. Like many other recent reports on the topic, this one starts from unargued – and largely unwarranted – assumptions and arrives at anodyne conclusions.

For example, we are told that technological possibilities will determine job outcomes. Because most jobs will be automated in whole or in part, resistance is futile, and adaptation (“mitigation”) is the only option. Moreover, technological innovation must be enthusiastically embraced, or the “best and brightest” workers will flock to foreign competitors.

We are also told that if the United States were to slow the pace of automation unilaterally, it would forfeit its dominant position on the world stage. On the assumption that China is a strategic enemy of the US, it is imperative that the American people embrace technological innovation to win the race for world leadership.

Lastly, we are told that work is the source of one’s identity. So, rather than delinking economic security from employment, the challenge is to salvage traditional but more flexible forms of paid employment. Thus, a universal basic income must be rejected, owing to its “enormous cost and the potential disincentives to work.”

If one abides by these ground rules, then the only answer to the march of the robots must be an active labor-market policy geared toward preparing workers to race with machines. The challenge of a more precarious job market is to be met by making people more precarious.

To its credit, the CFR report does come close to making an important point about the relationship between cyclical unemployment and the longer-term problem of technological unemployment. The authors are correct to view a policy of “full employment” as necessary (though not sufficient) to win the public’s acceptance of automation. And they even note that the US economy has been at full employment for just 30% of the period since 1980, compared to 70% of the period between the late 1940s and 1980. “At any given time,” the authors write, “millions of people are likely to be out of jobs involuntarily and looking for work, and in times of recession and economic slowdown, those numbers will spike.”

And yet, to “mitigate” this problem, the report proposes more of the same policies that brought us to where we are. Accordingly, monetary policy should be used to expand employment – even though it has consistently failed to do so. And, “Congress and the Trump administration should also use fiscal policy prudently to maintain strong growth and employment” – even though “the worsening federal budget deficit … will unfortunately further handcuff” efforts in this direction.

So much for using macroeconomic policies to confront the “jobs challenge.” Instead, we are left with the usual microeconomic measures to prepare people for algorithmic employment – that is, the use of big data to match people with the jobs they will need to remain consumers. Again, we are told that future labor-market participants should be equipped with job-targeted education and portable social-security pots to help them jump from one automated workplace to another.

In the case of education, the report calls on employers and colleges to work together to develop talent “pipelines.” For example, it highlights Miami Dade College’s “programs in animation and game development, working with companies such as Pixar Animation Studios and Google.” Likewise, Toyota “has built its own advanced manufacturing technician program to provide a pathway for students seeking careers at the company.”

And to ensure labor mobility, the report gives pride of place to “flexicurity,” in the form of portable benefits (“transition assistance for workers”). In typical fashion, it does not attempt to delink benefits from work itself, but rather from “single employers and full-time work.”

In the end, the report never makes up its mind about whether flexible forms of work in the “gig economy” represent Keynesian demand deficiency, voluntary choices for part-time work and self-employment, or the involuntary encroachment of automation. And while the authors admit that globalization and technological dynamism have left a large part of the US population and territory behind in terms of wealth, income, and self-esteem, their own remedy is to redouble ongoing efforts to bring the “left behinds” up to speed.

For my part, I would draw a different conclusion from the same facts. If the goal is to lift all boats as far as possible, then some slowdown of globalization and automation is inescapable. Every citizen has a right not to be left too far behind. Upholding that right should not be sacrificed in the name of largely bogus calculations about the effects of slowing down automation on US global leadership.

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.