Monday, August 6, 2018

"Signs Point to a Global Slowdown"

"Welcome to 'New Age' Fiscal Policy"
by Brian Maher

"The United States government, alas, is embarrassed for funds. More money is going out the back door than is coming in the front. So today Uncle Samuel holds his hat before the bond market... requesting to borrow $329 billion through September… and $440 billion by December.  Sixty-three percent higher, these numbers are, than the Treasury’s borrowings for the same period last year. And this year’s debt spree promises to be the greatest since the depths of the financial crisis.

Thus we pause today to acknowledge the nation’s deliverance from the final vestiges of fiscal sobriety…We are told the economy has good steam behind it. Official second-quarter growth nicked 4.1% — its grandest quarter in four years. Unemployment is all but licked, we are further told. In a season of plenty, even the Keynesian prayer book preaches a gospel of fiscal restraint. It is the time to gather acorns… to save against a time of lean time… to lay up against the rainy day. When recession inevitably arrives, the government can then meet the emergency with a full strongbox. 

“Countercyclical” policy, academic men term it.  But even the old Keynesian religion has gone behind a cloud...  In its place we find “New Age” fiscal policy - the religion of perpetual deficit. Analyst John Rubino on the new catechism: "Even Keynesianism, generally the most debt-friendly school of economic thought, views deficit spending as a cyclical stabilizer. That is, in bad times governments should borrow and spend to keep the economy growing while in good times governments should scale back borrowing - and ideally run surpluses - to keep things from overheating."

But now we seem to have turned that logic on its head, with fiscal stimulus ramping up in the best of times, when unemployment is low, stock prices high and inflation stirring. New Age fiscal policy seems to call for continuous and growing deficits pretty much forever.

America’s debt-to-GDP ratio rises to 105%. “Never in modern times,” warns analyst Sven Henrich, “have we seen tax cuts being implemented and spending increased with debt to GDP north of 100%.” The reasons for the new deficit spending come in two inseparable parts: One, $300 billion of new federal spending under last year’s bipartisan budget agreement. Two, the Trump tax cuts that limit the government’s wherewithal to fund it. 

Hence, the Treasury’s recent bond auctions to make the shortage good. The Office of Management and Budget projects trillion-dollar deficits for the next four years - at least. Meantime, the Congressional Budget Office projects nearly 4% economic growth as far as eyes can see: But CBO’s forecast has a fatal hole in it… It fails to account for possible recession. At 108 months, the current “expansion” is the second longest in U.S. history. By next July it will become the longest ever — if the gods are kind.
Can the economy peg along another four years without a recession? Or even half so long? We are unconvinced. In the likely event of recession - depend on it - the spending floodgates will be thrown open.
“We get a recession,” affirms the aforesaid Henrich, “and you are looking at $2–3 trillion [annual] deficits.” “A deficit explosion,” he styles it.

Here is our prediction: Recession will likely fall within a year or two.  Deficit spending of the kind described will come issuing forth in full spate. This deficit spending will exert vast upward pressure on interest rates.  Why? Because only substantially greater rates will be able to lure investors at that point.

As analyst Michael Lebowitz explains: "If $2, 3 or 4 trillion of additional debt needs to find a home, it is quite likely that interest rates would rise sharply to attract new investors. Plus, there is one other small problem. As interest rates rise, the interest expense on the debt increases and drives funding needs even higher. "

Here he knifes to the heart of the dilemma - rising interest expense on existing debt. Rising debt service will likely lower the curtain on the entire show, as rising borrowing costs overwhelm the economic machinery. Financial analyst Daniel R. Amerman: "Given its sheer size, if the interest rate on that debt were to rise by even 1%, the annual federal deficit rises by $200 billion. A 2% increase in interest rate levels would up the federal deficit by $400 billion, and if rates were 5% higher, the annual federal deficit rises by a full $1 trillion per year."

Could interest on the debt alone total $1 trillion per year? The math is the math. And we would remind that 5% interest rates are well within historical norms.  At that point the New Age fiscal policy would come crashing upon the rocks of actuarial fact. A 40% plunge in the stock market - or more - cannot be excluded. “The divine wrath is slow indeed in vengeance,” said Roman historian Valerius Maximus nearly 2,000 years ago. “But it makes up for its tardiness by the severity of the punishment.”

Meantime, the recovery is eight years old… and counting… Below, Jim Rickards shows you why “all signs” point to a global slowdown. Is the Fed prepared? Read on."
"Signs Point to a Global Slowdown"
By Jim Rickards

"As gold has struggled through 2018, (down over 10% from $1,363/oz. on January 25 to $1,215/oz. today), my forecast for a strong year-end for gold has remained unchanged.  This forecast is based on a better-late-than-never realization by the Fed that they are overtightening into fundamental economic weakness, followed quickly by a full-reversal flip to easing in the form of pauses on rate hikes in September and December.

Those pauses will be an admission the Fed sees no way out of its multiple rounds of QE and extended zero interest rate policy from 2008 to 2013 without causing a new recession. Once that occurs, inflation is just a matter of time. Gold will respond accordingly. Gold above $1,400/oz. by year-end is a distinct probability in my view. Even if gold rallies to the January 2018 high of $1,363/oz. by year-end, that’s an 11.5% gain in just a few month’s time. 

Let’s drill down a bit. Let’s start with the Fed. The reality of Fed tightening is beyond dispute. The Fed is raising interest rates 1% per year in four separate 0.25% hikes each March, June, September and December. (The exception is if the Fed “pauses” based on weak stock markets, employment, or disinflationary data, a subject to which we’ll return). The Fed is also slashing its balance sheet about $600 billion per year at its current tempo.

The equivalent rate hike impact of this balance sheet reduction is uncertain because this kind of shrinkage has never been done before in the 105-year history of the Fed. However, the best estimates are that the impact is roughly equivalent to another 1% rate hike per year. Combining the actual rate hikes with the implied rate hikes of balance sheet reduction means the Fed is raising nominal rates about 2% per year starting from a zero rate level in late 2015. Actual inflation has risen slightly, but not more than about 0.50% per year over the past six months. The bottom line is that real rates (net of inflation) are going up about 1.5% per year under current policy. From a zero base line, that’s a huge increase.

Those rate hikes would be fine if the economy were fundamentally strong, but it’s not. Real growth in Q2 2018 was 4.1%, but over 4.7% of that real growth was consumption, fixed investment (mostly commercial) and higher exports (getting ahead of tariffs). The other components were either small (government consumption was +0.4%) or negative (private inventories were -1.1%). Q2 growth looks temporary and artificially bunched in a single quarter. Lower growth and a leveling out seem likely in the quarters ahead.

The Fed seems oblivious to these in-your-face negatives. The Fed is extending its growth forecasts to yield 2.27% for Q3 and Q4, and expects 2.71% for 2018 as a whole. That’s a significant boost from the 2.19% average real growth since the end of the last recession in June 2009. By itself, that forecast offers no opening for a pause in planned Fed rate hikes or balance sheet reduction. The Fed is completely on track for more rate hikes, a reduced balance sheet, and no turning away from its current plans.

The Fed’s plan assumes all goes well with the economy over the rest of this year. That may be wishful thinking. Agricultural exports definitely surged in Q2 in an effort by Asian importers to take delivery of soybeans before tariffs were imposed.  The same can be said of specialized U.S. manufacturing exports. U.S. consumers went on a binge, but much of that was funded with credit cards where losses are already skyrocketing and a return to higher savings and less consumption has resulted.

A lot of the standout components in Q2 have already gone into reverse. Real annualized U.S. GDP growth exceeded 4% four times in the past nine years only to head for near-zero or even negative real growth in the months that followed. There’s no compelling reason to conclude that Q2 2018 will be any different. Data indicating performance close to recession levels will emerge in the next few months.
With Fed tightening and a weak economy on a collision course, the result might be a recession. 

What’s my outlook for Fed policy, the U.S. dollar, and other major currencies including gold? I use the most advanced analytical tools to assess the influence of global economic and political conditions on currency and capital markets. I created these tools along with colleagues while working in capital markets intelligence at the CIA. My associates and I used information from capital markets as a predictive analytic tool to uncover threats from terrorists and other U.S. adversaries in advance. I use the same disciplines of complexity theory, applied mathematics, and dynamic systems analysis we used at CIA to spot hidden trends in markets that affect both exchange rates and asset valuations. 

The single most important factor in the current analysis is that the U.S. does not exist in a vacuum. The Q2 real growth quarterly rise in Eurozone GDP was a disappointment and further evidence that the ECB is still distant from its ultimate goal of normalizing rates and its balance sheet as the Fed started in 2015.
Likewise, China’s PMI and related reports that arrived July 31 revealed a distinct slowdown in China, the world’s second-largest economy. The global impact of these conjoined European and Chinese slowdowns over the year ahead is shown clearly in Chart 1 below:
This mash-up of divergent critical paths among the world’s major economic blocks is best summarized in this downbeat July 31, 2018 synopsis from Capital Economics, a traditionally bullish voice: “While global economic growth rebounded in Q2, it will probably slow again in the second half of this year and in 2019. The US will not be able to sustain annualized GDP growth of 4%, China’s economy is slowing steadily, and any pick-up in the euro-zone from a lackluster first half is likely to be modest.”

Meanwhile, policy organs of the U.S. other than the Fed are already joining forces to box-in the Chinese trading threat. A new announcement by the U.S., Australia, and Japan is clearly meant as a robust source of capital to counter the Chinese Belt and Road Initiative (BNR). This counter-BNR investment vehicle is of great geopolitical significance, but it will be financed by more government debt, which is already producing headwinds for indigenous growth in those three leading economies.

The Fed may be the last major body to see this data for what it is, but their realization won’t take forever. Toward the end of the third calendar quarter, the full extent of a global slowdown will be apparent even to the U.S. central bank. The Fed’s response will be to pause their rate hike path either in September (if the data becomes clear by then) or certainly December.

The Fed has the worst economic forecasting record of any major institution, with the IMF running a close second. The Fed’s latest forecast, issued last week, is that the U.S. economy is “strong” and that the Fed is on track for another rate hike in September as planned.  But the Fed ignores the negative impact of trade wars, currency wars, stagnant wages and a host of other important data. Leave aside the fact that the Fed has never forecast a recession in its 105-year institutional history. What’s unfolding is a slow-motion train-wreck in which weak forecasting and over tightening by the Fed are about to collide with a weak U.S. economy and lead to a recession.”

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