Thursday, December 27, 2018

James Turk: The Start Of Something Big In Silver

"Are price trends the only thing to rely on? No, when it comes to markets there is no perfect formula. It is possible that silver may remain in the trading range marked by the two horizontal lines. It is even possible the price may drift lower. But today may be the start of something big, and if so, spotting trends can help.

Silver Finally Turning Higher

Who could have predicted that crude oil would collapse from $70 to $50 during October and November? A lot of money was made there by the shorts. As the saying goes, “the trend is your friend.” So if following the trend is helpful, so is watching for any clues that a trend reversal may be at hand. And right now this break of the downtrend line could be saying that the trend in silver is finally turning higher. If so, maybe a lot of money is about to be made by the longs in the precious metals.”

- Source, King World News, Read More Here

Sunday, December 23, 2018

James Turk: The Start Of Something Big In Silver, Plus the Collapse In Gold Open Interest

Everyone who understands the precious metals, Eric, knows that they are undervalued. So they also intuitively know that the downtrend in the price of the precious metals over the past several months will eventually turn higher…

Do This And You Won’t Have To Worry About A 2008 Scenario

Of course no one can predict when that turn will come, so I continue to recommend the same strategy that precious metals should continue to be accumulated for the simple fact that you are buying undervalued assets. View these purchases as saving money that is outside the banking system, and therefore immune to those types of risks that we saw in 2007 and 2008.

The same logic applies to the shares of mining companies. If you are prepared to invest in them and accept the risks, accumulate those you have concluded are good value. The good ones will turn higher when the precious metals themselves turn higher.

Collapse In Gold Open Interest

While we wait for the precious metals to reverse their downtrend and turn higher, I’ve been watching for clues that might indicate the turning point is near. And there have been a couple of important ones recently. One of those clues was the collapse in Comex gold and silver open interest over the past several days as the December contract approached first notice day. I didn’t check the historical records, but the collapse in open interest is the largest I can ever recall. I take it as an indication that the market is sold out, which itself might be saying that a turn is at hand.

Another clue is today’s action, which I see as very important. Is it telling us something we need to know? You bet it does, particularly given how undervalued the precious metals are at the moment. One thing I have learned from my five decades of experience in trading and investing is to let the market tell its story, and then listen to what it is saying. I do this by watching price trends, so take a look at this chart of the spot silver price, Eric.

Silver Breaks Out Of Downtrend!

Today the price of silver closed in both London and New York above a long downtrend line that goes back all the way to June. This event over time may prove to be a big deal.

- Source, King World News, Read More Here

Tuesday, December 18, 2018

Brexit: Where to From Here?

The deal has been agreed, subject to Parliament. Mrs May now has the uphill task of selling the deal to MPs. The overwhelming majority who have expressed an opinion including both Remainers and Brexiteers have condemned it. As has President Trump. She will be praying for no further asides from him at the G20 in Buenos Aires.

The vote is scheduled for 11 December, after a five-day debate. The Government’s tactic is to rely on Mrs May’s deal being the only one on offer, the alternative being the supposed abyss of a no-deal. The risk to this strategy is that Brexiteers expose the choice as being false and that Mrs May should go back to Brussels and renegotiate. The EU stands ready to reaffirm they will not accept any other deal to cut off this option.

The Treasury and the Bank of England have cranked up their economic and financial models again to forecast maximum disruption in the event Parliament fails to support Mrs May’s deal. However, in the Commons, the Treasury backed off from its responsibility for its post-Brexit forecasts, saying it was based on analysis involving a wide range of government departments. One is left wondering why the Treasury Secretary felt unable to give it his wholehearted support.

The Bank of England has been less delicate in its approach, by claiming we are all doomed. The result after only one day of airing its forecast is a loss of public credibility for the Bank and particularly for Mark Carney, its Governor.

The frighteners extend to a hodgepodge of claims of many things vital to life and employment, put together by government quangos[i]. Shortages of medicines, transport disruption, chemicals for water purification and many more are all documented in eighty different official papers. The deceit is to assume these supplies are provided at an inter-governmental level, and not by profit-seeking businesses, which would surely do everything in their power to secure continuing sales. The Port of Calais is expected to cut off its nose despite its face and turn away traffic.

This line of propaganda seems to be an irresistible line of attack for the Government, accustomed to frightening the populous into a preferred course of action. This is despite the failure of this tactic ahead of the Brexit referendum, when the public decided it was a stinking rat.

What is the deal, and why the fuss?

Britain leaves the EU on 29 March next year and under Mrs May’s plan enters an implementation period when there is no change in current trade arrangements, until at least 1 January 2020. After that, if the trade agreement is not in place (highly unlikely – it takes years to get the EU to agree to trade deals), Britain can either extend the implementation period for a time, or the backstop on the Irish border will be implemented.

The backstop ensures the Irish border would remain open to EU trade, as it is today, until a trade agreement is finally agreed and implemented. Until then, either the whole of the UK continues to be in the customs union, or Northern Ireland alone remains in it, effectively putting a border down the Irish Sea. The backstop, if it is implemented, can only be turned off “when we have fulfilled our commitments on the Irish Border.”[ii]

The agreement states that both the EU and the UK will use best endeavours to reach a trade agreement. But given it can be blocked by EU member countries which are not a party to the agreement, this reassurance must be worthless. Even before the ink was dry, Spain forced concessions on Gibraltar, and President Macron of France made it clear France would withhold its consent to a trade agreement if French fishing vessels were denied fishing rights in British waters.

The problem with the agreement is that by not agreeing, EU member states can ensure, in the words of Boris Johnson, Britain remains a vassal state. Worse than that, with this agreement it is a zombie state, a walking-dead captive of the customs union.

Even the Remainers don’t like it, because it is as plain as a pikestaff that Britain is in a far worse position with this agreement than it would be remaining in the EU. It is chained to the customs union with no influence over the regulations imposed upon it. Accordingly, Remainers of all parties are united in the call for a second referendum, which they hope will reverse the first, allowing Britain to remain as a full member of the EU. But to concede a second referendum would be unprecedented, and also an admission of failure by the government. Furthermore, it would take months to go through Parliament, time which it does not have. With no practical alternative, many prominent Remainers are expected to vote against the agreement.

For the Brexiteers, it is already an admission of failure, particularly since the Prime Minister always refused to consider a Plan B. Britain has agreed unconditionally to pay the EU £39bn as the divorce settlement and will continue to pay into Brussels the annual tribute of roughly £9bn until the new trade terms are agreed and implemented (which could be never). While the agreement generally limits the European Court of Justice’s powers to adjudicate on trade and related matters, it means Britain does not have control over future trade arrangements during implementation and backstop periods, and it will be impossible for Britain to strike her own trade deals until that time has passed. Hence President Trump’s remarks.

We have confirmation it is Hotel California: you can check out but never leave. The deal is so unpopular that already the media are saying it will never get through Parliament. The Daily Telegraphhas aggregated various sources of information to estimate 221 MPs will vote for it and 418 against.[iii]But much can change in a short fortnight.

Let us look at it from Downing Street’s point of view, to try to understand the Government’s strategy. 96 Conservative MPs have said they will vote against, out of a parliamentary party of 314 (excluding Speaker Bercow). The Democratic Unionist Party, with ten MPs who provide the Conservatives with their slim Commons majority, have also vowed to vote against it. The Labour Party with 257 MPs have said they will vote against it, but there are perhaps 60 Labour rebels. The Scottish National Party has 35 MPs, who will also vote against it. Liberal Democrats, with 12 are probably against it, but may not be united on the threat of no deal.

That leaves 216 Conservatives likely to support the Government (including 94 Ministers), perhaps 240 after the whips have done their work. 74 MPs from the other parties are then required, at least 60 of which must be Labour MPs. It is worth recalling that 64 Labour MPs defied the Labour whip over an amendment tabled to remain in the customs union last December, close to the number of Labour MPs required to rebel this time for Mrs May to win the vote. And that’s assuming Labour isn’t persuaded to abstain, which would guarantee Mrs May gets it passed by a comfortable margin.

Clearly, the key to success is Labour’s intentions, which is why Downing Street is wooing their MPs. However, two weeks ahead of the vote, talk of a heavy defeat for the government looks, on Downing Street’s likely assessment, wide of the mark.

All this assumes Labour will resist the temptation to topple Mrs May and create havoc for the Tories. That is a big assumption, because it is definitely in Labour’s interest to defeat the government to see what opportunities might arise. Consequently, while the Downing Street assessment may turn out to be too optimistic, the Brexit camp cannot afford to be complacent.
Brexiteer tactics

The Brexiteers will concentrate on mustering as much support as possible to reject the proposed agreement. They already have the ten DUP members on side, and 96 Conservatives who have said they will vote against. They need to work on the other 218 Conservative MPs, of which 94 are ministers, leaving a pool of 124 possible votes.

It would help their case enormously if more Brexit-supporting ministers resigned from the government ahead of the vote, so they are likely to be privately encouraged to do so. This would benefit the Brexit cause by fatally undermining the Government’s claim that the agreement is in the spirit of Brexit.

Brexiteers will also have to build cross-party alliances. Above all, they must come up with an alternative strategy acceptable to both Brexiteers and Remainers to force the Government to return to Brussels for better terms, despite Brussels saying the only alternative is no deal.

To achieve the necessary parliamentary support, Brexiteers are likely to focus on the least contentious issue, being the failure to achieve total parliamentary sovereignty in the draft agreement. Even Jeremy Corbin and others on the far left of the Labour Party can agree on this, because they want to be free from all Brussels regulations so that they can nationalise and subsidise unionised industries.

Sovereignty is the one issue the Government cannot argue convincingly, which is why it deflects the issue into one of taking control of immigration. The economic effects, which are a transitional problem, are less important to the bigger picture, but are more immediate to the electorate. For these reasons the Government is focusing on the economic effects, promoting hypothetical problems that grab the headlines and divert attention from the sovereignty issue.

The scope for half-truths and downright deception is enormous and is being exploited by both the Government and allegedly independent analysts. In the last few days, we have been told that stockpiling food has left Amazon short of warehouse space. This follows earlier assertions from Barclays Bank research that extra tariffs on food and drink imports could cost £9.3bn per annum, leading to higher food prices.[iv]

This must assume the Chancellor imposes, Trump-like, yet higher import tariffs on food than the ones being dropped on a no-deal Brexit. It might assume sterling will crash (we’ve heard that one before) but ignores the possibility the euro will fall even more. These scare stories are easy to counter and should be given no credence, but the media is always more likely to take as gospel truth the information spoon-fed to it by background government briefings, while questioning reasoned argument from Brexiteers with relative scepticism.
Mrs May’s future

Press reports suggest that Downing Street believes that if the vote is not passed, Mrs May could probably survive if it is rejected by less than a hundred votes. Any more than that, and she is toast.

This is probably too simplistic, and ignores the fact that David Cameron immediately resigned when he lost the Brexit referendum, irrespective of margins. It also relies on the ten DUP MPs continuing to give her a majority, which they have already withdrawn. If she relies on Labour votes, having failed to get sufficient support from her own party (which Downing Street is already doing), she will be ejected whatever the outcome. For the moment, everyone is being very polite, saying she has admirable qualities of perseverance and determination against all odds. And don’t we all love a fighter. This can rapidly elide into being pig-headed, domineering and deliberately misleading.

Act too early, and MPs who wish to ditch her will be accused of disloyalty and naked ambition. Furthermore, Brexiteers do not have control of the agenda. For these reasons, rival candidates for the leadership remain in the shadows. But they will be watching for that change of emphasis, which is likely to come in the wake of the Commons vote, if not before.

The only way Mrs May can save herself and the integrity of the Conservative Party is to cancel the debate and tell Brussels it simply won’t wash. She must remind them of the consequences of their rejection of David Cameron’s demands, and tell them they will have to come up with better terms, otherwise it is no deal.

Will she do it? We shall see. She has some leverage, if she can understand it. Brussels is bust and needs money urgently. The knock-on effects of a no deal might be unpredictable for the UK, but, and this is the point few have taken on board, it would be catastrophic for the EU.

- Source, Alasdair Macleod via James Turk's Goldmoney

Tuesday, December 11, 2018

Why Interest Rates Are Rising Long Term

Since 1981, interest rates have been in a secular decline, falling from 20% to zero in US dollars. They are now on the rise, but the general assumption is the current low interest rate environment will broadly continue. This view is complacent and likely to be expensively wrong, being founded on the erroneous view that significant levels of price inflation have been banished.

For the last forty years or so, monetary expansion has taken over from savings as the means of funding business expansion. This accords with the wish expressed by Keynes in his General Theoryfor the euthanasia of the rentier (or saver) and for entrepreneurial capital to be provided through the agency of the state.[i] Not only have declining interest rates deterred personal savings and encouraged the proliferation of consumer debt, but pension funds, seen as a personal savings backstop, have been undermined by the reduction of compounding interest. Therefore, we can say that during the time of our headline chart, the state has taken over the role from free markets of setting interest rates and distributing capital.

The chart above of the 10-year US Treasury bond tells us that there is now a break in this trend (shown by the dotted line). It appears there is a significant reversal of falling bond yields, threatening the state’s control of interest rates and capital allocation. Lines on charts are notoriously misleading at times, but they also indicate a very low interest rate level is enough to create a credit crisis. That is one issue, another is the general assumption that interest rates can remain permanently low.

The origin of the hope that interest rates will remain low is in large part psychological. For millennia, high interest rates have been seen as usury, or unfair charges imposed by greedy money-lenders on defenceless borrowers. This was certainly Keynes’s view, and it persists with his followers today.[ii]Instead, low interest rates are seen as both an inducement to spend rather than save, and to favour the entrepreneur investing in production over the saver.

Keynes’s view appeared to be that savers, or rentiers as he called them, were the idle rich, not employed but living off usury. To him it was morally wrong that “functionless investors” should benefit from the scarcity of capital, hence his desire for the euthanasia of the rentier. To take this line of argument, he had to navigate round the sheet-anchor of classical economics, Say’s law. He did this by describing it in such a way that it was open to question. These were his words:

“Thus, Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output is the equivalent to the proposition that there is no obstacle to full employment.”[iii]

That is nearly all he had to say on the principle which previously had been the greatest obstacle in economic theory to government intervention. He does not define it, but interprets Say’s law sympathetically to his intentions, and misdirects the reader by alleging that Say’s law was a denial of the high levels of unemployment that persisted in the decade when he wrote these words. And if the greatest living English economist at the time implies that the evidence of mass unemployment shows Say’s law cannot be true, it from that moment dies like Monty Python’s parrot, becoming an ex-law.

Say did not write down a precise definition of what subsequently was associated with him as an iron rule, but he set out very clearly his understanding of how human exchange operated. He demonstrated that we work in order buy the things we need, and our savings are the source of finance for production. This means that all consumer demand is the consequence of and follows the production of supply. Says was describing the division of labour, which is the way humanity maximises relevant output and improves its lot. Say also made it clear that the role of money is only temporary to facilitate the process.

It is a system born from the market, where people freely negotiate their business. It particularly benefited Britain during the industrial revolution, improving the lives of ordinary people, creating wealth and economic progress. There was never any need to replace savers with the state as the provider of capital as Keynes described. Nor for that matter, to replace the peoples’ money, which was gold and silver, with the state’s money. If there was disruption of production, it always came from the government and its licenced banks, which created credit out of thin air through fractional reserve banking. Diluting money by expanding both it and associated credit is a fraud on existing owners of money.

This is Keynes’s inflationary financing, relying on the fact that no one can tell the difference between existing currency and the introduction into circulation of yet more. Obviously, if you expand the quantity of money, other things being equal you have more money chasing the same quantity of goods, so prices will rise. That is the message from Say. The Keynesians answer to this is the demonstrably false proposition, that higher prices encourage consumer demand. However, there is one circumstance where this is true, and that is when the average person shifts his ownership preferences away from money towards goods and services. But this is playing with fire, because such a move can undermine a currency’s purchasing power with surprising rapidity, building into an unstoppable momentum.

There are therefore two variables that alter a currency’s purchasing power: the quantity in circulation and the public’s judgement of its future value. Central banks tend to pay attention to the quantity. The qualitative element cannot be calculated by a mathematical approach, so is generally ignored. Furthermore, mathematical economists tend to overlook sectoral shifts, whereby currency and credit flow between financial and non-financial applications. It is the non-financial economy, the part that produces goods and services that they monitor, assuming financial activities and the asset inflation they stimulate are merely a by-product.

There is a further dimension we cannot ignore. Since the interest rate spike in the early-1980s, savings have migrated from earning interest to seeking equity participation. The simplistic economic model of consumers saving and businesses borrowing has disintegrated, with consumers increasingly taking entrepreneurial risk and funding their personal consumption with credit. Companies with low credit ratings have been happy to print equity rather than go to the bond markets, encouraged further by the freedom from having to pay any dividends.

The result of these changes has been to skew the economy in favour of asset inflation, which has replaced interest on bank deposits and bonds held to redemption as wealth-creator for the ordinary saver. Asset inflation is excluded from inflation statistics, which means it can be increased at will. But asset inflation reflects the passage of expanded money and credit into the financial sector, from whence it always leaks into the real world of production.
The CPI badly underestimates price inflation

The expansion of credit taken up by consumers should have an immediate effect on consumer prices. Yet, if official CPI statistics are to be believed, there has been little price impact from the expansion of consumer credit since the Lehman crisis. And here Say’s law partly explains why.

We specialise in our production to buy the goods and services we do not provide for ourselves. Therefore, when new unearned money is put in our pockets to spend, we bid up prices, reducing the purchasing power of the currency. Alternatively, we can buy goods and services from abroad because they are available at the old prices. This is why the expansion of credit leads to trade deficits. Our ability to import to spend reduces the immediate price impact of extra money and credit, and is a temporary safety-valve for the CPI.

When monetary inflation leads to a trade deficit, the adjustment to the currency’s purchasing power takes place in the foreign exchanges. However, in the case of the dollar, this is often delayed by demand for it as a reserve currency, allowing US price inflation to remain at a lower rate than otherwise. Inevitably, this contribution to price inflation will reverse at some point in the future, probably leading to a substantial adjustment.

There can be no doubt that lower import prices is one reason price inflation has been subdued. But there is another factor at play, phony statistics. You can talk of the general price level, but that doesn’t mean you can measure it. My experience of price inflation is not the same as yours, and yours is not the same as your neighbour’s. A concept is not the same as a statistic.

The CPI statistic is therefore inherently meaningless, which allows statisticians to take views on its composition. Bearing in mind that inflation-linking means a range of welfare payments becomes more expensive to the government if the CPI is rising, you can appreciate that adjustments in this slippery concept will incrementally favour its suppression.

By comparison, the Chapwood index[iv] makes this point by coming up with far higher rates of price inflation than official statistics. Chapwood is comprised of a fixed basket of 500 goods and services, typically bought by the average middle-class American in 50 major cities. It is calculated twice a year with these 2,500 inputs, and for the last five years the average annual price increase of these inputs has been 9.8% That means a dollar today has a buying power of only 62.8 2013 cents. But the government’s version of price inflation says it has averaged 1.53%, and that the dollar buys 92.7 2013 cents. It is an enormous difference.

The CPI’s constituents are continually updated and adjusted, with assumptions made about product substitution replacing rising prices, effectively deflating the index. Parts of the CPI index are adjusted for hedonics, which deflates prices for product improvements. Each adjustment may be small, but they add up. The Chapwood index is simply a fixed basket, with no adjustments at all, and therefore indicates the degree of corruption in the CPI.

Whichever way you cut it, the CPI dramatically understates price inflation. Incredibly, financial analysts think the CPI is not only authoritative, but they even get agitated by CPI calculations that differ from their forecasts by as little as 0.1%. Perhaps it’s the threat of rising price inflation to the long-term trend of asset inflation that subconsciously motivates their wilful blindness. Perhaps it is the unquestioned acceptance of government statistics. Perhaps it’s the inability of analysts to think independently (we certainly see a herd instinct when it comes to forecasting). The three wise monkeys’ syndrome is a combination of all three probabilities.

It amounts to intellectual complacency. Complacency thrives on trends, and so long as there is no disruption to them, there is no pressure for a rethink. But when the trend changes, then even the most supine analyst can no longer ignore reality. That is the worrying thing about the chart of the 10-year US Treasury bond. Not only have we the evidence that the post-1980s trend of lower interest rates may be over, but we can begin to see the inflation dynamics that are already wreaking havoc with consumer prices.

It is not just the US Government’s statisticians in the Bureau of Labor Statistics. CPI calculations are harmonised worldwide and must be producing similarly supressed results. It is obviously wrong to believe in a statistic that is used to manage public expectations and reduce government costs everywhere in the hope that inflation will not be noticed.

When the established order is threatened by a break in trend, doubts over official estimates of price inflation commence with anecdotal evidence. More people will begin to think Chapwood has a point. But has the purchasing power of the dollar really fallen to 62.8 cents in only five years? What does that mean for the GDP deflator: have we been assuming the presence of economic growth, when a properly defined deflator tells us the economy has been in recession ever since Lehman? Does that mean interest rates will have to rise far more than we earlier thought to control the inflation monster?

These questions are not yet being asked. Instead, markets are assuming the Fed is raising interest rates before there is firm evidence of price inflation. Indeed, anticipation is the Fed’s stated policy. The Fed is not even looking at the message from Chapwood. Instead, it sees President Trump’s budget deficit accelerating growth late in the cycle, expecting inflationary consequences. It may also be anticipating the price impact of new and future trade tariffs, which will drive up consumer prices on imported goods, and therefore on goods domestically produced as well.

These are inflation pressures, yet to develop, which are in addition to the existing price erosion hidden from us by the CPI.
The market effects

It is obvious that mainstream economists and analysts are wilfully ignorant of the extent of current price inflation, and only recognise the future pressures on prices that guide monetary policy. They have noticed that rising interest rates have a habit of tripping up the economy, sending it into recession, and that the Fed has a track record of not being able to judge interest rate neutrality. This next chart is what particularly worries them.

The rise in the Fed Funds Rate has taken it through a danger zone (between the two pecked lines), which in previous credit cycles triggered an asset deflation, followed by recession, financial crisis or both. The view gaining ground is that an economic downturn is becoming more likely, as well as the possibility of a systemic event, such as a banking crisis in the Eurozone.

For these reasons, a fall in equity markets is causing a shift of investment funds within the financial sector from equities to bonds, from high-risk to lower-risk, while the narrative is moving from growth to risk of recession. Wall Street is jumping to conclusions about Main Street, when the cause of financial markets instability is, so far, mostly bottled up in Wall Street itself.

The common view is that if a recession comes to pass, inflationary pressures will ease. This expectation is incorrect, as all past inflation episodes involving fiat money have proved. Inflation of fiat currencies continues in a recession because central banks are always ready to compensate for any contraction of bank credit. Stabilisation of consumer prices is only ever temporary, usually imagined rather than real. Instead, monetary inflation only conceals declining economic activity, particularly when the deflator is under-recorded. The simplistic view that price inflation only increases with expanding activity will almost certainly turn out to be a costly mistake for investors fleeing equity risk into bonds.

And here we are, entering the next credit crisis with the inflationary excesses of the previous one unresolved. From August 2008, the month Lehman went under, the total of checking accounts, cash and bank deposits, collectively the public’s dollar exposure, increased from $5.4 trillion to $12.9 trillion today. While this dollar exposure has increased by 140%, the increase in GDP has been only 37%. Clearly, the US economy is still awash with underemployed surplus dollars. Unless higher interest rates begin to properly compensate deposit holders for loss of purchasing power, their relative preferences in favour of holding deposit money will almost certainly begin to decline.

A central bank faced with that prospect risks losing control over interest rates and therefore over the cost of its government’s borrowing. The forthcoming credit crisis is unlikely to replicate Lehman, when a potential collapse of the entire financial system led to a temporary increased preference for holding deposit money in systemically important banks, and a corresponding decrease in preference for goods. That led to a short-term slump in some prices (such as for autos), which quickly passed following the introduction of zero interest rates and money-printing. Zero interest rates will not apply this time, because the problem will be accelerating price inflation that already exceeds interest rates by a substantial margin, coupled with an exceptionally high level of bank deposits relative to the size of the economy.

When financial markets wake up to these inflationary dangers and the consequences for interest rates, there is bound to be a sizeable reappraisal of investment values. At the time in the cycle when Keynesians expect fiscal and monetary policies to soften the recession, they will be forced in the opposite direction. The US Government, as well as other spendthrifts, will find rising borrowing costs have pushed it firmly into a debt trap.

The choice will be stark. Either the US Government and the Fed will have to abandon Keynesian policies and allow a cathartic slump to take hold, or they will have to sacrifice the currency. They lack the collective intellectual capacity to understand the starkness of the choice, so will probably fudge it, leading to the destruction of the currency anyway.
The only solution

For all governments, there is an escape route from this increasingly certain mess. It requires a government to do two things: call a halt to all inflationary financing, and switch from a welfare-driven to a wealth-creation model of fiscal and economic policy. The welfare-driven economies have consistently rejected this direction of travel and will find it especially difficult to change tack, given the totality of vested interests. The two nations that can do it are Russia and China. Russia is aggressively building her gold reserves so as to be independent from the influence and decline of fiat currencies. China will have to modify her economic policy, having supped at the table of bank credit, but her government finances are sound enough to contemplate it.

Historians will look back to current times and note the credit crisis of 2018-2019 marked the end of an era that started with monetary cooperation between two central banks, the Fed and the Bank of England following the First World War. It evolved from there. It took the free world progressively into inflationism and the destruction of the wealth upon which economic progress previously depended. The final credit crisis fuelled by fiat currencies was the end of the Anglo-Saxon empire that had dominated world affairs.

Asia under communism had been a sleeping giant who awoke when socialism collapsed under its contradictions. Without the West’s accumulation of costly welfare systems, the Asian continent with nearly half the global population broadly escaped the calamity of the ending of fiat money by embracing sound money – gold. With it, China and Russia turned their backs on a Western currency collapse and built their own industrial revolution, embracing the whole continent.

For America, the Europeans and Japan, the end of the fiat money era was swift. The end of government policies of intervention allowed their peoples to take control over their own lives again, by embracing what for millennia had been central to Say’s law: their own choice of money to facilitate peaceful coexistence under free markets.

We can only hope the last bit turns out to be true. The rest appears increasingly certain.

- Source, Alasdair Macleod via James Turk's Goldmoney

Tuesday, December 4, 2018

G20 and the Financial War

President Trump initiated the trade war with China. There is a widespread assumption he is pursuing his “art of the deal”, coming into negotiations aggressively to get a satisfactory compromise. Therefore, the script goes, China will be forced to climb down on its restrictive practices, technology and patent theft, and modify its Made in China 2025 (MiC2025) initiative to open it to American corporations. Trade negotiators from both sides have been working in the background to achieve some sort of progress before Presidents Trump and Xi meet at the G20 this weekend, which buoys up hopes of a positive outcome.

If so, it will be the start of a more public process, perhaps with threatened trade tariffs deferred. Meanwhile, the rhetoric on tariffs has escalated in recent weeks, as is often the case in negotiations when President Trump is involved, and particularly when deadlines loom. But there are concerns the situation is more serious than this optimistic version of events would have us believe.

This article briefs readers about the bigger picture behind this trade spat, which is just one battle in an ongoing financial conflict between China and America. Worryingly, it takes place against a deteriorating economic outlook for the world’s largest trading bloc, the EU.

The trade tariff position

American sources have been upping the rhetoric against China’s trade ahead of the G20 both generally and specifically. For example, the US has accused China’s Huawei of planting spyware in electronic equipment. Huawei is a major global telecoms manufacturer and a leader in the development of 5G mobile technology, set to become more important to data transfer technology than broadband, and the Americans obviously want to shut them out of this market.

It was widely believed the Trump administration pursued a tough stance against China’s unfair trade practices to maximise the Republican’s success in the mid-term elections. If so, it was a policy that failed, with the Democrats gaining 38 seats in Congress. In any event, the mid-terms are no longer relevant to American trade policy, if they ever were.

The wider trade concerns expressed by America are over access to China’s markets for American corporations, the protection of intellectual property, and exclusion from MiC2025. But with MiC2025, it is a case of the American pot calling the Chinese kettle black, because America is also increasingly protectionist. However, there are small adjustments China can make to seek a trade resolution, for example modifying or dropping clauses limiting foreign involvement in key industries. Furthermore, there are pressures on the American side to seek an accommodation with China from both American-based multinationals with cost-effective supply chains in China, and from financial markets which have nose-dived in recent weeks. Add to that the soya farmers in the US, and resolving trade disputes should be a no-brainer.

Assuming a positive outcome, we can then expect that China’s economy, which has become a material driver for global economic growth, will have significant negative pressures lifted from it. The yuan will then rally, and with it a decent recovery in US stockmarkets will surely follow. US stockmarkets are important to Trump, having hitched his wagon to them. Surely, he would like to see higher stock prices. China would also welcome a trade deal. In China, the uncertainty is affecting the availability of bank finance for private sector manufacturers and undermining consumer sentiment.

With MiC2025, China wants to catch up with the West when it comes to manufacturing technologically-advanced products. Its objective is reasonable. MiC2025 has singled out ten sectors for government support, from robotics to transport, to new-generation IT, to bio-pharma. By encouraging development in industrial sectors, China is doing what all other governments do, including the US, and the US surely knows it.

Therefore, if trade is the genuine concern, all reason suggests a positive outcome from this weekend’s G20 will occur, the yuan will rally as will Wall Street. And President Trump will be praised by American industry and financial markets for his successful negotiating strategy.

There is a deep problem with this analysis, which was exposed at the Asia-Pacific Economic Cooperation summit in Port Moresby, capital of Papua New Guinea two weeks ago. For the first time ever, APEC broke up without a joint communiqué. It was also reported that the police were called after Chinese diplomats tried to force their way into PNG’s foreign ministry.[i] Geopolitics overshadowed trade issues with tensions boiling to the surface. US Vice-President Mike Pence accused China of debt diplomacy, whereby China was creating debt slaves of the smaller nations.

It was in short, a diplomatic disaster. It was also a timely reminder that there is a bigger picture, with America determined to limit Chinese expansion. The politics included criticism of China’s annexation of reefs in the South China Sea as well as the “debt slave” issue. The US, in conjunction with Australia, promised to develop a naval base at Lombrum on Manus Island, about 350 km north of PNG. Furthermore, the US has agreed with Australia and Japan to spend some $2bn improving PNG’s infrastructure, including electricity.

Doubtless, the US feels it has now bought PNG’s cooperation in its cold war against China and prevented China’s exploitation of PNG’s resource potential. It hopes to have called a halt to China’s economic expansion into the South Pacific. Australia will also have greater security from her largest customer, if it is needed in future.

Another delicate issue is Taiwan, with America sending two warships through the Taiwan Strait in a move seemingly designed to provoke China. So those hoping for a positive outcome from the G20 might like to note that it is at odds with the way America is moving on the Pacific chessboard.
The world is changing

In any attempt to divine the economic future, it is a mistake to think only in terms of China and America. The largest economic bloc by GDP is the EU, and it has also been cast into a trade and political never-never land by President Trump. The EU is losing its security blanket, which has always been provided by the US through NATO. It is now planning its own army, which will almost certainly take over from NATO in the longer term. Trade differences with the US have been put on ice but are still there.

The EU’s approach to trade is deeply protectionist, having imposed over 12,500 tariffs on imports into the EU. Additionally, Brussels regulates to the micro level what products can be sold within the EU. So, in the case of Huawei’s 5G technology referred to above, the battle in Europe is less about security issues (though they are always there) but more about influencing or responding to the regulatory regime, which is effectively controlled by its European competitors based in the EU.

In this context, Britain losing all her power to restrain protectionist instincts in the EU is crucial. The UK has been the driving force in supporting liberal trade policies against protectionist France and Germany, and following Brexit that is now no longer the case. The EU is bound to become increasingly inward-looking as a consequence of Brexit, increasing both tariffs and regulations. Add to this a developing euro crisis, with interest rates stuck below the zero bound, and it is hard to see how the EU will not resort to increasing state control of both money and trade.

From China’s point of view, the time when her export business drove her economy must be in its sunset phase. Even if a trade agreement with the US is achieved in the coming months, there’s no guarantee Trump will not renege on a deal. China’s leadership had planned for this some time ago, with a state-induced shift of economic emphasis away from export dependency. Instead, there is a strategic move towards a more service-oriented economy, with better infrastructure and improved living standards for a rapidly growing middle class. But the pace of this strategic change is being swiftly overtaken by events. Therefore, China’s leadership needs to accelerate its plans in the light of both President Trump’s trade and security policies, and the knock-on effects of Brexit on EU trade policy.

The implications for global growth are undoubtedly negative, even dire. If China accelerates her plans towards a service and technologically driven economy, it is bound to lead to a temporary rise in unemployment from its redundant export industries before labour is transitioned to the new. The social consequences could become destabilising.

In the US, the problem is a potentially stagnating economy coupled with rising prices, fuelled in part by tariffs on imported goods. Only this week, Trump made it clear not only is he prepared to increase tariffs from 10% to 25% on $200bn of Chinese imports from 1 January but is prepared to extend tariffs to all Chinese imports. The walking shadows of Smoot and Hawley once more strut and fret upon the global stage.

It may be the art of the deal, and President Trump displays the bravado of someone who has his opponent on the run. If so, he risks the enjoyment of the chase while ignoring the collateral damage. But the threat of tariff-inflated prices cannot be ignored by the Fed. If President Trump refuses to find a means whereby China can save face, which is rapidly becoming the single most important issue this coming weekend, the prospects for not only China’s economy, but that of the US and the EU as well, will rapidly deteriorate.

- Source, via James Turk's Goldmoney