Doug Nolan

February 8 – Bloomberg (Brian Chappatta): “Bond traders are dusting off their tried and true post-crisis playbook after the Federal Reserve’s pivot last month. What they don’t realize is that the game has most likely changed. In an unabashed reach for yield, investors suddenly can’t get enough of the riskiest debt, with the Bloomberg Barclays U.S. Corporate High Yield Bond Index posting a staggering 5.25% total return in the first five weeks of 2019, led by those securities rated in the CCC tier. In the largest CCC borrowing since September, Clear Channel Outdoor Holdings Inc. received orders this week of more than $5 billion for a $2.2 billion deal, allowing it to price its debt to yield 9.25%, compared with whisper talk of about 10%.”

A Friday headline from a separate Bloomberg article: “Corporate Bonds on Fire as Dovish Fed Soothes Investors,” with the opening sentence: “Fear is turning to exuberance in credit markets.” According to Lipper, corporate investment-grade funds enjoyed inflows of $2.668 billion last week, with high-yield funds receiving $3.859 billion. Bloomberg headline: “High-Yield Bond Funds See Biggest Inflow Since July 2016.” This follows the highest high-yield inflows ($3.28bn) since December 2016 from two weeks ago.

There’s support for the argument that financial conditions have loosened significantly over recent weeks. Prices of corporate bond default protection have declined. After trading as high as 95 bps on December 24th, by Tuesday an index (Markit) of investment-grade credit default swap (CDS) prices had dropped all the way back to 64 (near October levels). Risk premiums have narrowed, especially for high-risk junk bonds. U.S. high-yield spreads (Bloomberg Barclays) traded as wide as 537 bps on (tumultuous) January 3rd. By this Wednesday they were back down to 400 bps (still significantly above the 300bps from October 3rd).

Bank bond CDS prices have retreated. After spiking to 129 bps on January 3rd, Goldman Sachs CDS was back down to 82 bps on Tuesday (closed the week at 89). For perspective, GS CDS traded at 55 on the final day of July and 59 bps on October 3rd. After trading to 218 bps on January 3rd, Deutsche Bank CDS was back down to 167 bps by the end of January (ended Friday at 189bps)

February 8 – Reuter (Marc Jones): “Investors pumped record high volumes of cash into emerging markets shares and bonds in the past week, Bank of America Merrill Lynch (BAML) said on Friday amid expectations U.S. monetary policy could lead to a weaker U.S. dollar… Investors have piled into emerging market equities and bonds in recent months amid expectations that the U.S. Federal Reserve will not raise interest rates as quickly as previously expected or even no longer tighten its policy.”

February 7 – Reuter (Marc Jones): “A ‘wall of money’ is set to flood into emerging markets assets now the U.S. Federal Reserve has eased the risk of a sharp rise in global borrowing costs, the Institute of International Finance (IIF) said… The IIF, which closely tracks financing flows, said its high frequency indicators were picking up a “sharp spike” of inflows following last week’s confirmation of a change of tack from the U.S. central bank. ‘Recent events look likely to restart the ‘Wall of Money’ to Emerging Markets,’ IIF economists said in a report.”

Institute of International Finance estimates put January ETF inflows on a quarterly pace of about $50 billion, ‘already equal to strong EM inflows in 2017 and likely to go higher.’”

The MSCI Emerging Market equities index has gained 7.3% y-t-d. So far in 2019, dollar-denominated bond yields are down 828 bps in Venezuela, 36 bps in Indonesia, 34 bps in Ukraine, 33 bps in Saudi Arabia, 31 bps in Russia, 30 bps in Chile, 30 bps in Colombia, and 16 bps in Turkey. Local currency yields have sunk 91 bps in Lebanon, 77 bps in Philippines, 35 bps in Hungary, 35 bps in Mexico and 27 bps in Russia.

With “risk on” back on track, why then would “safe haven” bonds be attracting such keen interest? German 10-year bund yields sank eight bps this week to nine bps (0.09%), the low going back to October 2016. Two-year German yields were little changed at negative 0.58%. Ten-year Treasury yields declined five bps this week to 2.64%, only nine bps above the panic low yields from January 3rd. Japanese 10-year yields declined another basis point this week to negative three bps (negative 0.03%), only about a basis point above January 3rd lows. Swiss 10-year yields declined six bps this week to negative 0.33% - the low since October 2016.

So, who’s got this right – risk assets or the safe havens? Why can’t they both be “right” – or wrong? There is much discussion of a confused marketplace: extraordinary cross-currents leaving traders confounded. In search of an explanation, I’ll point to the consequences of Monetary Disorder.

It has now been a full decade of near zero interest rates globally. Trillions (estimates of around $16 TN) of new central bank “money” were injected into global securities markets. What’s more, global central banks have repeatedly intervened to buttress global markets - from 2008/09 crisis measures; to 2012’s “whatever it takes”; to 2016’s “whatever it takes to support a faltering Chinese Bubble”; to last month’s Powell U-turn. The combination of a decade of artificially low rates, an unfathomable amount of new market liquidity and an unprecedented degree of central bank market support have fostered momentous market structural maladjustment. We’re living with the consequences.

It is certainly not easy to craft an explanation for today’s aberrant market behavior. I would start by positing that a massive pool of speculative finance has accumulated over this protracted cycle. There is at the same time liquidity excess, excessive leverage and the proliferation of derivatives strategies (speculation and hedging). In short, there is trend-following and performance chasing finance like never before – keenly fixated on global monetary policies. Illiquidity lies in wait.

When this mercurial finance is flowing readily into inflating securities markets, the resulting conspicuous speculative excess pressures central bankers to move forward with “normalization” (Powell October 3rd). At the same time, this edifice of speculative finance is innately fragile.

Speculative markets reversing to the downside rather quickly unleash “Risk Off” dynamics. These days, de-risking/deleveraging abruptly alters a market’s liquidity profile. Not only is there the liquidation of holdings and the collapse of leverage, the resulting downward market pressure triggers risk aversion more generally for this imposing global pool of speculative finance. And as the ETF complex suffers outflows, the leveraged speculating community and derivatives industry move to shed risk ahead of a retail investor panic. And when a meaningful component of the marketplace seeks to hedge market risk, it’s difficult to envision who takes the other side of such a trade.

Meanwhile, major shifts in dynamic-hedging programs unfold throughout the derivative universe. When markets are running on the upside, derivative-related buying (i.e. hedging in-the-money call options written/sold) exacerbates already powerful trend-following flows. But when a speculative upside (i.e. “blow-off” or “melt-up”) market advance eventually reverses course, derivative-related buying swiftly transforms into destabilizing selling. For example, a quant model used for (dynamic) “delta hedging” exposures from derivatives previously written (i.e. call options) would halt aggressive buy programs - immediately becoming a seller into market weakness.

Meanwhile, sinking markets will see keen interest in buying downside derivative protection (i.e. puts) – both for speculation and hedging. The sellers of these derivatives will then dynamically hedge these instruments, essentially requiring selling into declining markets. Using out-of-the-money puts options as an example, the amount of selling required to protect the seller/writer of these instruments expands exponentially as market prices approach option strike prices. The point is, derivatives tend to play a significant role in promoting destabilizing upside market moves, dislocations that are then highly susceptible to reversals and destabilizing market breakdowns.

Why have risk markets rallied so strongly to begin 2019? Because the Powell U-Turn incited a reversal of short positions and the unwind of bearish hedges and speculations. Derivative-related (“dynamic”) selling – that had been rapidly gaining momentum – reversed course and became aggressive buyers. Market momentum then incited buying from the enormous trend-following/performance chasing Crowd. Who can afford to miss a rally? Certainly not the global leveraged speculating community, with many at risk of losing assets, incomes and businesses.

Why have safe haven assets performed so well in the face of surging equities and corporate debt? Because current Market Structure is inherently unstable and increasingly prone to an accident. Today’s buyers of Treasuries, bunds and JGBs are less concerned with January/Q1 equities and junk bond returns, keenly focused instead on acute global market instabilities and the inevitability of a systemic market liquidity event. I would further argue that this dysfunctional market dynamic recalls the destabilizing rally in Treasuries and agency securities in 2007 and well into 2008. This market anomaly stoked end-of-cycle speculative Bubble excess and exacerbated systemic fragilities.

When risk markets advance, news and analysis invariably focus on the positives – an expanding U.S. economy, prospects for a trade deal with China, buoyant profits, a backdrop of ongoing exciting technological advancements, perpetual low interest rates, endless loose financial conditions, etc. With markets advancing, mounting risks are easily disregarded. “Deficits don’t matter.” Debt concerns are archaic. Market Structure is a nothing burger. Best to ignore escalating social, political and geopolitical risks. The unfolding clash between the U.S. and the rising China superpower – it’s nothing. An increasingly fragmented and combative world – ditto.

As we saw in December, sinking markets direct attention to an expanding list of troubling developments. Years of inflating securities prices seemed to demonstrate that so many of the old worries were unjustified – none really mattered. The problem is that many do matter – and some tremendously. The current extraordinary backdrop has all the makings for a decisive bearish turn in market sentiment that would create a problematic feedback loop within the real economy – domestically and globally.

I’ll highlight an issue that has come to be easily dismissed - yet matters tremendously. Zero rates and QE were a policy experiment. The consensus view holds that the great success of this monetary exercise ensures that QE is now a permanent fixture in the central banking “tool kit”. The original premise of this experiment rested on the supposition that a temporary boost of liquidity would stimulate higher risk market prices and risk-taking with resulting wealth effects that would loosen financial conditions while stimulating investment, spending and income growth throughout the real economy. The expectation was that a shot of stimulus would return the real economy back to its long-term trajectory.

History teaches us that monetary inflations are rarely temporary. Travel down that road and it’s nearly impossible to get off. Dr. Bernanke, the Federal Reserve and global central bankers never contemplated what a decade of unending monetary stimulus would do to Market and Financial Structure. Most – in policy circles and the marketplace - believe beyond a doubt that monetary stimulus was hugely successful in resuscitating economic growth dynamics.

But it’s on the financial side where consequences and repercussions have been fatefully neglected. It’s in the financial world where a decade of QE, zero rates and central bank market backstops imparted momentous structural change: the colossal ETF complex, the passive “investing” craze, quantitative strategies, algorithmic and high-frequency trading, a proliferation of derivative trading, leveraging and trend-following speculation on a global basis – to list only the most obvious. Along the way, aggressive monetary stimulus had much greater inflationary effects on risk markets than upon real economies. This ensured a continuation of aggressive stimulus - and only deeper market Bubble maladjustment.

For a month now, markets have celebrated the view that Chairman Powell (and global central bankers more generally) will not be attempting to “normalize” monetary policy. No Fed-induced tightening of financial conditions, along with no fretting the new Chairman’s commitment to the “Fed put.” Lost in all of this is recognition that a decade of experimental monetary stimulus has failed. Global finance is much more fragile today than prior to the 2008 crisis – the global economy more imbalanced and vulnerable.

Never has it been so easy to speculate – equities and corporate Credit alike. Never has corporate Credit availability – and financial conditions more generally – been governed by the interplay between the ETF complex, derivatives strategies and a distressed global leveraged speculating community. The Powell U-Turn unleashed another round of speculative excess. Right in the face of faltering global growth, I would argue this bout of speculation is especially precarious. And when the current “risk on” gives way to reality, maladjusted Market Structure will ensure liquidity issues on a scale beyond December.

“This is deflation, the amazing lurch toward recession despite QE...,” read the opening sentence of a friendly email I received last week. Yet I remember all the talk of deflation after the 1987 stock market crash. It became even louder in 1990 – then again in ‘97/’98. Deflation was the big worry with the bursting of the “tech” Bubble and then with corporate debt problems in 2002. Global central bankers have been fighting deflation now for a decade since “the worst crisis since the Great Depression.”

For a long time now, I’ve argued that Bubbles are the overarching risk. The “scourge of deflation” was not the ghastly plight to vanquish with interminable “whatever it takes.” Rather, deflation is a fateful consequence of bursting Bubbles – Bubbles inflated in the process of central bankers fighting so-called “deflationary forces.” Now, after thirty years of unending global Credit growth, activist central banking and egregious financial speculation, Bubble risk has never been so great. “The amazing lurch toward recession” and financial dislocation specifically because of a failed experiment in QE and inflationist monetary management.

But I’ll conclude with Market Structure. Global markets have turned even more synchronized during this upside convulsion. This increases already highly elevated risk come the next downturn. And I wouldn’t expect much in the way of diversification benefits from Treasuries, bunds and JGBs. It’s worth mentioning that Italian 10-year yields were up 31 bps in two weeks (spreads to bunds widening 41 bps!). With Italian and European economic prospects seeming to darken by the week, European corporate debt came under some pressure this week. Germany’s DAX equities index fell 2.4%, and Japan’s Nikkei dropped 2.2%. And one could almost see fissures start to appear in EM currencies, equities and bonds. Eastern European currencies were notably weak, while the South African rand, Brazilian real and Argentine peso were all down about 2%.

The challenge of one world, two systems

Unbridled strategic competition between China and the west would be a disaster

Martin Wolf

The accelerating breakdown in relations between China and the US is the most significant current event. How is this to be managed, given today’s global interdependence?

Three recent pieces of evidence reveal alarm over the rise of China to its current status as the world’s “junior superpower”, in the words of Yan Xuetong of Tsinghua University. One is the campaign against Huawei, standard bearer for Chinese technological ambitions, which must be viewed in the context of the US trade war with China and its description of the latter as a “strategic competitor”. Another is a paper from the free trade-oriented BDI, Germany’s leading industry association, which labels China a “partner and systemic competitor”. The last is the description of Xi Jinping’s China by George Soros as “the most dangerous opponent of those who believe in the concept of open society”.

This, then, is a point on which a nationalist US administration, German free-traders and a noteworthy proponent of liberal ideas agree: China is no friend. At best, it is an uncomfortable partner; at worst, it is a hostile power.

Should we conclude that a new “cold war” has begun? The answer is: yes and no. Yes, because so many westerners think of China as a strategic, economic and ideological threat. This comes not just from Donald Trump, nor only from the security establishment, nor just from the US, nor merely from the rightwing of the political spectrum: it is increasingly becoming a unifying cause. The answer is also no, however, because the relationship with China is very different from that with the Soviet Union. China is not exporting a global ideology, but behaving as a normal great power. Again, unlike the Soviet Union, China is embedded in the world economy.

The conclusion is that across-the-board hostility towards China might be far more disruptive than the cold war. If, above all, the Chinese people were to be convinced that the west’s aim is to stop them from enjoying a better life, the hostility would be bottomless and endless. Co-operation would collapse. Yet no country can today be an island.

It is not too late to avoid such a breakdown. The right path is to manage relations that will be both competitive and co-operative and so to recognise that China can be both foe and friend. In other words, we must embrace complexity. That is the path of maturity.

In so doing, we need to recognise that the US and its allies (if the former still recognises the value of the latter) possess huge strengths. China’s rise has been stupendous. But the US and its allies, in aggregate, spend vastly more on defence, have bigger economies and account for a larger share of world imports than China. Again, China’s dependence on markets in high-income countries is far greater than US dependence on China. It is likely that these advantages will last, because China is turning away from the path of reform, as Nicholas Lardy of the Peterson Institute for International Economics argues in a new book, and so its economy could slow sharply.

Moreover, despite the global rise of authoritarianism and the post-financial crisis malaise, the high-income democracies continue to possess a more attractive ideology of freedom, democracy and the rule of law than China’s communism offers. Furthermore, it is obvious that the west’s recent failures are overwhelmingly self-inflicted: they should not be blamed on others, however attractive that option might be.

Thus, the US should view its situation with far greater equanimity than can China, provided it retains its network of alliances, especially given its geographical location and economic strengths. If it did so, it could also recognise that its interdependence with China is a stabilising force, since it strengthens both sides’ interest in peaceful relationships.

Similarly, the US would recognise that making common cause with allies, in the context of the rules-governed trading system it created, would increase pressure on China to reform. Indeed, in an interview in Davos, Shinzo Abe, Japan’s prime minister, argued that the best way to deal with China is precisely in that context. To make concessions in support of a global agreement would be far easier for China than in response to bilateral US pressure. If that required reform of the World Trade Organization’s rules, that would also be fine.

Co-operation is as essential as interdependence. We cannot manage the global environment or ensure prosperity and peace without co-operation with China. Moreover, if every country were forced to choose one side or the other, there would again be deep and costly divisions among and within countries.

None of this implies that western countries need accept whatever China wants. Takeovers of strategically important businesses could be legitimately out of bounds, on both sides. Simultaneously, if evidence of strategic danger from the presence of certain companies within our economies did exist, then action against them should be taken. But the word here is “evidence”.

Finally, and to me most significantly, it is indeed vital, as Mr Soros suggests, that we protect our freedom and those of Chinese people living in our countries from China’s new “social credit” system and other forms of extraterritorial reach, so far as we can. But this would be easier to justify if the US were not so extraterritorial, too. Indeed, the belief of the US that it is entitled to impose its priorities upon the world, willy-nilly, is highly destabilising.

A new great power has emerged, one that was never part of a western-dominated system. In response, many are trying to shift the world into an era of unbridled strategic competition. History suggests this is dangerous. What is needed instead is a combination of competition and co-operation with a rising China. The alternative will be deepening hostility and rising disorder. Nobody sensible should want that. So stop, before it is too late.

5G,China and the Race to Dominate High-Tech

How Beijing plans to dominate 5G technology, and how the West plans to stop it.

By Phillip Orchard


At an informal dinner in Nova Scotia last July, the spy chiefs from the Five Eyes intelligence alliance – the U.S., U.K., Canada, Australia and New Zealand – met to map out a systematic campaign to blunt the creeping Chinese dominance of future global communications. Since then, each of the Five Eyes, as well as Japan, has announced new measures to block Chinese tech giants like Huawei and ZTE from selling fifth-generation, or 5G, wireless technology. Several European countries are debating whether to follow suit. Authorities in Poland arrested a Chinese employee of Huawei (and a former Polish security official) on espionage charges, raided the company’s local headquarters and raised the possibility of backing out of a year-old partnership with the firm to build 5G infrastructure. Last week, U.S. lawmakers introduced a bill that would bar Chinese telecom firms from buying U.S.-made chips and components. And last month, Canada arrested Huawei executive Meng Wanzhou, the daughter of the company’s founder, at the United States’ request over her alleged role in facilitating violations of U.S. sanctions on Iran. The U.S. filed sweeping criminal charges against the company on Monday over the Iran issue and allegations of technology theft from U.S. firms.

The timing of these events is hardly coincidental. The decadelong race to build out 5G infrastructure across the globe will kick off in earnest this year. The firms that deploy most rapidly will reap the benefits, including increased market share, influence over global standards and licensing royalties, and a head start in shaping the ecosystems that sprout from the new technology. And since 5G tech will have far-reaching military and intelligence applications, the race will blur the line between the commercial and the strategic. Despite attempts to freeze them out, Chinese firms have immense advantages – ones that could help dramatically reshape the global geopolitical landscape.
Why 5G Matters
The new technology could have profound implications for consumers and militaries worldwide. It will deliver wildly faster broadband speeds – as much as 100 gigabits per second on some frequencies. The speed boost will be the first feature to be rolled out, since the technology needed for it can basically be glommed onto existing 4G/LTE network architecture. But unlike 4G/LTE tech, which was developed primarily for smartphones and traditional cellular traffic, 5G was also designed for a dramatic expansion of data-intensive applications that go far beyond smartphones. Two features are critical here: The first is ultra-reliable, low-latency communication needed for mission-critical uses (such as driverless cars) where lags in connectivity cannot be tolerated. The other is the capacity to handle the coming explosion in “machine-to-machine communications,” with interconnected devices transferring ever-deeper oceans of data between them as part of what’s known as the “internet of things.”

These features will require substantially more new infrastructure and, thus, won’t be rolled out widely until the mid-to-late 2020s. But they will have the biggest impact. Designers envision finely tuned grids powering “smart cities,” widespread adoption of industrial automation and 3D printing, artificial intelligence, augmented reality and highways packed with driverless cars, as well as massive, tightly integrated military operations involving swarms of unmanned fighter jets, submarines and surveillance planes in parallel with an equally intense cyber offensive.

Defense planners and spy chiefs are cautiously optimistic about the opportunities 5G will introduce. The Pentagon, for example, reportedly believes the F-35, the B-21 Raider stealth bomber, the P-8 Poseidon ISR planes and the Aegis Combat System won’t reach their full potential until 5G’s throughput capacity allows them to function as “data monsters.” Samsung is partnering with the U.S. military to develop a prototype mobile 5G battlefield network, using drones as antennas, for places with poor satellite coverage. Communications can be tightly encrypted without diminishing connection speeds.

On the flip side, though, there are fears that Chinese firms, at the Communist Party’s behest, could insert “backdoors” into 5G hardware, giving Chinese spooks unfettered access to sensitive communications or, at minimum, to the oceans of data being generated by the internet of things. The U.S. military, meanwhile, depends on complex logistics operations throughout the world, largely over commercial telecom networks. There’s concern that Beijing could simply turn off networks around U.S. supply lines just as the Chinese military is, say, making a move on Taiwan. Similarly, the more the U.S. economy is dependent on 5G ecosystems, the higher the risk that a cyberattack could grind the U.S. economy to a halt.

At this point, the risks are largely theoretical. Those sounding the alarm about Huawei and ZTE have not provided much hard evidence that China is already slipping malware into the systems its companies have exported. Germany and France, for example, are skeptical of the Five Eyes’ warnings about Chinese tech and are keen to determine whether technological safeguards can obviate the need to freeze out Chinese firms. (Considering their outsize influence in setting EU-wide regulations, the two will play a decisive role in determining whether Chinese telecom firms ever gain market share in the West. Beijing’s lobbying efforts are being concentrated on Paris and Berlin, accordingly.)

But to the Five Eyes, at least, proof matters less than potential. It’s clear that no Chinese firm can rebuff Beijing’s demands for cooperation on weaponizing 5G. China’s 2017 National Intelligence Law made this power explicit (as if it wasn’t already). It’s also clear that China is poised to export its technology far and wide.
China’s Strengths
Beijing has been preparing for the 5G race ever since the global rollout of 3G technology exposed the relative decrepitude of the Chinese telecom sector and its continued overdependence on foreign technology. In response, Beijing began focusing on dominating 5G intellectual property even before 4G/LTE had been widely installed, shoveling money into research and development and, notably, forcing Chinese telecom firms to collaborate as part of an industry-wide alliance with Chinese universities, arms makers and local governments. Since 2015, China has outspent the United States by some $24 billion in wireless communications infrastructure, according to Deloitte. The effort appears to be paying off; Chinese firms are expected to win as much as 40 percent of 5G patents, compared to around 7 percent of 4G ones. And the rollout of commercial standalone 5G infrastructure – what’s needed for the two features necessary to expand data-intensive applications – is expected to begin in China in 2020, five years before any other country is currently expected to follow suit, according to the Eurasia Group. The head start in field testing is likely to give China a considerable edge in development of 5G applications and exports.


This illustrates one inherent advantage for Beijing: The U.S. government has long collaborated with Silicon Valley, but it cannot force U.S. firms to cooperate with it or with each other. (In fact, ample Chinese investment in U.S. tech startups has deterred public-private cooperation altogether in some areas.) Moreover, Silicon Valley isn’t equipped to stand up a full 5G network on its own, whether in the U.S. or abroad. At present, for example, U.S. carriers will likely rely on Nokia, Ericsson and Samsung (all foreign firms, which themselves rely on other foreign companies for myriad components) for 5G radio access network hardware. By comparison, Huawei alone is competitive in network hardware, chip design and end user devices, making it the equivalent of Ericsson, Intel and Apple rolled into one.

To be clear, the relative openness of the U.S. tech sphere has been a major strength, with competition among foreign and domestic private firms spurring breathtaking innovation. It’s doubtful that China’s state-managed system can ever be as dynamic (hence Chinese firms relying on shortcuts like mergers and acquisitions, tech transfers and commercial espionage). The flaws in the Chinese system will become more acute if the U.S. succeeds in cutting off Chinese firms from Western technology. As it stands, even Huawei and ZTE will still require some outside technology even for China’s domestic 5G systems.


Still, the open U.S. system is laden with security risks and ill-suited for economic statecraft. The problem is serious enough that the U.S. government has reportedly considered nationalizing existing wireless infrastructure to develop a centralized, nationwide 5G network within three years – a program the White House is comparing to the development of the interstate highway system under President Dwight Eisenhower. A National Security Council memo leaked to Axios last January lamented that “China has achieved a dominant position in the manufacture and operation of network infrastructure” but added that the new U.S. system could eventually be exported to “help inoculate developing countries against Chinese neo-colonial behavior.” It’s hard to see the government taking on U.S. telecom firms in such a manner. But the memo illustrates the belief in Washington that, one way or another, the U.S. needs to be able to better harness its capacity for technological innovation for strategic aims.
A Bifurcated World?
The U.S. campaign against Chinese tech ambitions is still in its early stages, and it’s an open question whether Chinese firms like Huawei could remain competitive without Western intellectual property. But as it stands, Beijing is poised to export its 5G tech more quickly, more cheaply and with more diplomatic support than Western firms – particularly to strategically important but less wealthy states, where the potential for Chinese malfeasance doesn’t carry as much weight against local development needs. This could have profound geopolitical implications.

In general, peripheral states don’t want to have to pick sides in the escalating U.S.-China competition. They’d rather play the two sides off each other where possible. A strategically important country like Malaysia is happy to take aid and investment from China, the U.S. and Japan – or conduct maritime security drills with each of their navies. This reality is a major limitation on instruments of Chinese soft power like the Belt and Road Initiative; it’s too easy for participating states to keep their foreign relations in balance.

But emerging technologies like 5G could force such countries to get off the fence. If the U.S. and its allies are unwilling to run military logistics networks through countries with any Chinese technology in their 5G systems, much less to expose sensitive military interoperability or intelligence-sharing operations to Chinese eyes and ears, it could substantially weaken the U.S. ability to sustain robust defense partnerships abroad. This would open opportunities for China to fill the void and extend its own military influence in places with the tech infrastructure needed for next-generation military applications. Countries like the Philippines, Vietnam, Thailand, South Korea and India are the battlegrounds to watch here.

Of course, the 5G race may not end up being quite so zero-sum. New technological solutions may emerge that allow the U.S. and its allies to shield themselves from Chinese technology and do business abroad as usual. But at minimum, 5G will increase the odds that a world with discrete U.S. and Chinese spheres of influence takes shape. The U.S. and its friends are certainly acting like that’s what’s really at stake.

The National Debt Math Doesn't Add Up

by: Doug Eberhardt

- Presidents campaign on promises to reduce an out of control national debt yet the debt keeps marching higher during every Presidents term.

- The Budget's set by Congress always fall short.

- What supports government spending and what does the data tell us today?

- Everyone ignores the elephant in the room; interest on the national debt.

- Gold & silver maintain purchasing power over time. Dollars pay interest and held up well. One has $22 trillion of debt backing it.

When it comes to the national debt, it amazes me how the debt is such an important Presidential campaign issue to criticize the past President while running for office, but once the incumbent takes the reins, Congress and special interest groups take over and get to work spending every dime and more through the process known as legislation that the President rubber stamps their approval.
It is Congress' job to "raise and provide public money and oversee its proper expenditure." Of course the words "proper expenditure" Congress ignores. Just take a look at the budget set out by Congress for the last 11 years and the actual result.
Government Budget Revenues Deficit
Yes, revenues have increased every year. That's a good thing. But living within its means, is not what politicians on both aisles do well. Yes, both Republican and Democrats are at fault here, not just the head honcho.

Here's how past presidents have stacked up when it comes to percentage increases for the national debt.

10 Presidents With Biggest National Debt Increases 

Congressional Budgets Always Fall Short
There has been failure after failure of meeting the budget set out, and many would consider this time-frame of declining unemployment to historic lows and the best ever for the stock market hit in 2018 "roaring" for most individuals. Up until this year consumers in general have enjoyed increased income year after year and have maintained a good savings rate. That’s all changing now with the Fed raising rates and putting a damper on things. It’s not the trickle down effect that Trump was looking for with his tax cuts. Let's look at the data a bit more to see where we really are and try and conclude how this may affect your investment strategy moving forward.
Where The Money Goes
Mandatory spending by government and future obligations are one thing, but projections by the CBO never seem to keep up with Congressional spending. Budgets come out and are ignored every year, even the so called good years.
For 2019 the interest on the national debt is projected to be $363 billion. In 9 years it is supposed to have doubled to $761 billion if interest rates rise. But on what amount of debt? It’s not like Republicans are doing anything to rein in spending and reduce the national debt as Trump said he would. And if Democrats take over even more in 2020, one can speculate quite easily that social program spending will increase as most all democrats running or on the finance committee are or will go after banks and the wealthy thus freeing up more money towards a “Green New Deal” among an increase in other public services.
At a time of the uber wealthy meeting in Davos concentrating on climate change, one can expect a change for the business climate in the near future as well, and it won’t be pretty if you are an investor. At times it will be great and at other times, a hint of a bigger recession looms, if one does the math. An investor must have the ability to be able to trade both sides of the market in the years ahead.
What Supports Government Spending?
Tax receipts are what one should look at to see if the spending by Congress is getting out of control.
When the government keeps spending, in good or bad or war times, there is an eventual period of time where it catches up to them. This is what we call a recession. Judging from current tax receipts, we may be on the verge of a recession within the next year, but we need to look at the data a bit closer to see if it backs it up.
This is a good time to review GDP again which is essentially what backs the U.S. dollar because a strong dollar is a sign of a healthy economy.
GDP = C + I + NX + G
“C” is equal to all private consumption, or consumer spending, in a nation’s economy“I” is the sum of all the country’s businesses spending on capital
“NX” is the nation’s total net exports, calculated as total exports minus total imports. (NX = Exports – Imports)
“G” is the sum of government spending
Business spending has slowed for the third-quarter of 2018 and the US trade deficit with China hit a record in January 2019.
But the two most important parts of the GDP equation above are consumer and government spending. If consumers are spending, in general, the government can cut its spending to help stimulate the economy.
Today we have consumer spending slightly increasing but it is clear they are doing the spending by using more credit and doing it at a higher rate than before the last recession. This is confirmed with the fact that the Personal saving rate has also declined to just 6%, the lowest since January 2014. Part of the increase in income are the minimum wage laws that have been passed in many states the past few years and in general, more people working with record low unemployment.

But the consumer has bigger issues than meets the eye right now. Consumer credit outstanding is increasing as well as student loan and auto loan debt with higher interest rates.
Interest rates on Credit card plans and New Car Loans have moved up with the Fed raising rates from 11.91% in 2013 to 14.38% Q3 2018 for Credit cards and for New Car Loans, 4.7% in 2013 to 6.4% by Sept 2018.
We can thank the Fed for this as they clear their balance sheet.
If consumer spending is 70% of GDP, and the consumer is tapped out even with higher wages for some, the government is all that is there to pick up the spending pace and we know they have and will. It’s what they do best. But there is one glaring issue with government spending that is ignored; the Interest Payment on National Debt.
This is the outlook for the next decade for government outlays and revenue.
Not only are projections moving forward showing a huge imbalance, past predictions on each category of spending has been off by a large percentage, especially related to Net Interest. Is it any wonder that the WSJ finally came out on Friday and said that the Fed may be moving closer to ending its balance sheet reduction?

One recent article from The New York Times quotes Marc Goldwein, senior policy director at the Committee for a Responsible Federal Budget says that "by 2020, we will spend more on interest than we do on kids, including education, food stamps and aid to families." You'll see more and more talk about the interest on the national debt in the years to come. But for now it is swept under the rug as most ignore the elephant in the room.
Even the Council on Foreign Relations - CFR has weighed in on the national debt dilemma saying that "Major budget legislation signed by President Donald J. Trump, along with continued growth in entitlements and higher interest rates, will see the debt nearly double by 2028 [PDF], coming close to the size of the entire U.S. economy."
We'll find out what the Fed says this week, but they have been talking the dovish talk for a couple weeks now and the stock market has shot up without looking back. While we most likely have a pullback in the market post Fed, it should be followed by a run to the 2900 level in the S&P.
What About Gold Today?
In my last article from November, I stated that gold had one more dip after this run up. I try and time my articles with these turns the best I can, as well as in my comments. Come Monday, 1/28, we may be close to a top into the Fed meeting this week and a run lower in metals commences.
Senior Editor Gil Weinreich had a podcast where he asked the Pros And Cons Of Owning Gold.
He was correct to point out that gold's returns over time are unimpressive when comparing to stocks. But he also said that it is not the relevant comparison and I agree.
If one were to look at gold as a currency, then it is true, it has had times where it has performed well, and other times it has not versus stocks. The same can be said of the U.S. dollar though. Technically one could have a podcast titled "Pros And Cons Of Owning Dollars." The fall from 2002 to 2008 in the dollar from 120 to 74 was 38%. This means your U.S. stocks had to earn 38% just to break even during that time.
In that context, gold and the dollar each have not outperformed stocks but only one of those two has maintained purchasing power over time. That's the key. My 1964 90% silver quarter can still buy me a gallon of gas exchanged for the scrip of the day and my 1965 quarter buys me 25 cents worth of gas since that year. This scenario has proven itself over time and I'll also point out that only one of those two; gold and the dollar, has trillions of debt backing it. Thus it could be said that gold is the best hedge against the one thing that most all other assets (dollars, bonds and CD's) are priced in; dollars.
Asset allocation models tell you to dip into one over the other. Gold is over 31% below its all-time highs. The dollar is 31% above its 2008 low. Which will be a better value moving forward based on the analysis of the data above if GDP really does back the dollar? The answer is clear if you connect the dots from this article.
My recommendation is to buy physical gold and silver on any dips and if one can't do that then one of the various ETFs like (GLD), (SLV), (OUNZ) that represent ownership, even though you'll see many post reasons not to in the comment section. I view these ETFs more as trading vehicles, not long term wealth building. For sentiment on trading miners, like triple leveraged ETFs (JNUG), (NUGT), (JDST) and (DUST), please follow along in the comment section.

An Italian Warning for France

With Italy’s populist government supporting the “Yellow Vest” protests, France needs to understand how and why it has become the principal target of Italian criticism. Reckoning with this latest turn of events could help France to overcome its own internal divisions and prevent Italian-style populism from taking power in Paris.

Dominique Moisi

italy yellow vests

PARIS – The support from Italy’s populist leaders for the “Yellow Vest” protests in France is a sad first in the history of the European Union. Never before has one of the six founding countries of the European project intervened so resolutely in the domestic affairs of another. To add insult to injury, Italy is supporting a movement that contains elements who clearly reject fundamental European values of tolerance and respect for democratic institutions.

Italy has gone astray, and France needs to understand why, so that it can fight to ensure that populism does not gain further ground domestically. In doing so, France must distinguish the Italian people from some of their far less admirable political leaders.

Rising tensions between the French and Italian governments are partly the result of competition between the two populist parties in Italy’s ruling coalition, which took office in June 2018. This was recently reflected in strong anti-French rhetoric from the leader of the Five Star Movement, Luigi Di Maio, who until now has been largely eclipsed by the League party leader, Matteo Salvini. But anti-French sentiment in Italy has deeper roots, and exists among both the elites and parts of the wider population.

Franco-Italian relations have always been complex. As the heir to the Roman Empire, Renaissance and Baroque Italy felt culturally superior to France and more refined. For Italians, the demonstrative way in which France exhibited its greatness and glory from the time of the Sun King (Louis XIV) to Napoleon made it appear “nouveau riche.” Even French support for Italian unification in the second half of the nineteenth century contributed to further misunderstanding, because France “received” Savoy and Nice in exchange for its precious help.

In more recent times, there had at least been some signs of mutual admiration. Italians looked enviously at France’s well-functioning state, while the French nodded approvingly at northern Italy’s dynamic network of small and medium-size companies. Today, however, this kind of reciprocal praise seems like the stuff of nostalgia.

The view from Rome these days is that France gives lectures on budgetary rigor but no longer practices it, as when French President Emmanuel Macron canceled his planned fuel-tax increase in the face of the Yellow Vest protests. But Italy’s current negative perception of France is above all emotional. From the crisis in Libya (a country Italy knows well) to the migrant crisis (which has hit Italy disproportionally hard), Italians feel deliberately ignored, if not abandoned, by the French – who, to make matters worse, also give the impression of looking down on their neighbors.

It is tempting to compare Italy’s criticism of France to the Yellow Vests’ hostility toward French elites. Both sentiments, after all, draw their strength from a feeling of humiliation in the face of perceived arrogance and privilege. The big question now is whether Italy’s populist present will be France’s future.

Clearly, this scenario is no longer inconceivable. Defenders of liberal democracy in France and elsewhere must, therefore, adopt and adapt the Yellow Vest motto and refuse to give in.

In a short 2008 essay entitled “The Spirit of the Enlightenment,” the late French essayist of Bulgarian descent, Tzvetan Todorov, reminded us that “there would not have been a Europe without the Enlightenment and no Enlightenment without Europe.” And in the immediate aftermath of World War II, statesmen such as Robert Schuman in France and Alcide de Gasperi in Italy not only were devout Christians, but also believed in the ideas of Montesquieu and Voltaire.

This is clearly not the case with Salvini or Marine Le Pen in France. Rather than being united and moved by hope and trust, they are exploiting a culture of fear and humiliation and a common desire to destroy the existing system.

There is little to be gained simply by contrasting the spirit of the Enlightenment with the populist spirit of the Yellow Vests, or Macron’s deep and sincere desire for reforms with Salvini’s shrewd and brutal vulgarity. But there are lessons to be learned from the rise of the Italian populists and the French Yellow Vests.

For starters, one cannot ignore the emotions of others. Equality of respect is as important as equality of means. Humiliation is a powerful motor that can drive people to sheer hatred, as Macron is currently experiencing. Furthermore, representative democracy is fragile and precious. It must be defended at all costs from its authoritarian external enemies, as well as from domestic opponents intent on seeing only its shortcomings.

France, meanwhile, should maintain its moderate, reasonable, yet firm stance and not engage in a war of words with Italy. Instead, it should try to understand how – and, even more so, why – it became the principal target of its transalpine neighbor. Critical reflection here could help France to overcome its own internal divisions and prevent Italian-style populism from taking power in Paris.

Dominique Moisi is Senior Counselor at the Institut Montaigne in Paris. He is the author of La Géopolitique des Séries ou le triomphe de la peur.