1. Well, That Didn’t Last Long. China Blinks When It Comes to Financial Reform

    China is on the horns of a dilemma with no good way out. On the one hand, China has driven growth for the past eight years with excessive credit, wasted infrastructure investment and Ponzi schemes like wealth management products (WMPs).

    The Chinese leadership knows this, but they had to keep the growth machine in high gear to create jobs for millions of migrants coming from the countryside to the city and to maintain jobs for the millions more already in the cities. The Communist Chinese leadership knew that a day of reckoning would come.

    The two ways to get rid of debt are deflation (which results in write-offs, bankruptcies and unemployment) or inflation (which results in theft of purchasing power, similar to a tax increase). Both alternatives are unacceptable to the Communists because they lack the political legitimacy to endure either unemployment or inflation. Either policy would cause social unrest and unleash revolutionary potential.

    The Tiananmen Square protests and massacre of 1989 did not start out as a liberty movement, although that’s how they are remembered in the West. It started out as an anti-inflation protest, and that’s how the Communists remember it. Instead of these unpalatable extremes, the Chinese leadership is trying to steer a middle course with gradual financial reform and gradual limits on shadow banking.

    In prior columns, I predicted that this gradual policy would not work because the credit situation is so extreme that even modest reform would slow the economy too fast for comfort. That’s exactly what has happened, according to this article.

    China has already flip-flopped and is easing up on financial reform. That works in the short run but just makes the credit bubble worse in the long run.

    China may soon resort to a combination of a debt cleanup and a maxi-devaluation of their currency to export the resulting deflation to the rest of the world. When that happens, possibly later this year in response to Trump’s trade war with China, the effects will not be confined to China.

    A shock yuan maxi-devaluation will be the shot heard round the world as it was in August and December 2015 (both times, U.S. stocks fell over 10% in a matter of weeks). The trade and currency wars are far from over. Get ready for more volatility and drawdowns in U.S. stocks.

  2. Another Prominent Asset Manager Says Markets Are Heading for a Fall

    There are plenty of asset managers and government officials warning that stock markets are riskier than they have been for a long time, with some even warning of a market crash. But not all of their analyses are particularly persuasive; some are just fear-mongering or an effort to say “I told you so” if markets do crash.

    Relatively few analysts can give you sound technical, historical or fundamental reasons for a potential stock market crash. This article reports on one manager, Peter Toogood of Embark Group, who actually has identified the Achilles’heel of this stock market and why a catastrophic crash could be in the cards.

    Toogood says that because this bull market is almost nine years old (with a few corrections along the way), and because the economic expansion is just as old, pretty much every investor who wants to get into stocks is already in. Put differently, there’s no money “on the sidelines” waiting to get back into the market as there was in 2009 and 2010. This means that if stocks hit an air pocket, there’s no liquidity pool of reserve buyers to cushion the fall.

    That’s exactly what happened between Feb. 2 and Feb. 8 when stocks dropped over 2,500 Dow points, or 11%. Since then, stocks have recovered somewhat and market volatility has calmed down. But Toogood’s fundamental point remains valid.Volatility and drawdowns are still in the cards, and when they hit you can expect stocks to drop even more dramatically in less time than they did in early February.

    With a mild stock market recovery the past week, this is a good time to lighten up on stocks at good levels and increase your allocation to cash. That way you can go shopping for bargains when the next air pocket hits stocks.

  3. Not So Fast on Those Higher Oil Prices. Energy Market Is Heading for a Fall


    Oil markets took off like a rocket in January 2018 and oil prices blew past the $60/barrel level and were headed much higher. Analysts were talking about oil in the $70/barrel range or higher. Suddenly, the frackers came back to life and wells were being drilled at a rapid pace in all of the major shale oil-producing areas in the U.S.

    Players in the oil patch were ready to party like it was 2012! But we warned readers that this blip was likely to be short-lived and the fundamental economics of oil were still deflationary.

    We pointed out that Russia and Saudi Arabia would support higher prices only to the point where fracking came back into play in a big way. Once that point was reached, it would be in the interests of Russia and Saudi Arabia to put a lid on prices, as they did in 2014, in order to bring the frackers to heel.

    As this article reports, the situation is more dangerous for everyone. Russia and Saudi Arabia both need as much oil revenue as they can grab. But the frackers have done a great job at lowering their costs of production.

    Frackers who produced in the $70–130/barrel range in 2014 now produce in the $30–40/barrel range. This is due in part to further improvements in hydraulic fracturing and horizontal drilling technology, but also to the fact that “new” frackers bought equipment, leases and reserves from “old” frackers for pennies on the dollar when the old frackers hit the wall in 2015.

    The result now is an oil global glut with no end in sight. The frackers are eating OPEC’s lunch. That won’t last. OPEC (really Russia and Saudi Arabia) will retaliate by opening the spigots again to take market share from the frackers. But this time the breakeven point won’t be $60/barrel; it will be more like $40/barrel.

    This new reality in the oil patch is a huge counternarrative to the increased “inflationary expectations” that have been roiling the stock and bond markets lately. Get ready for lower oil prices and more Fed ease (in the form of rate cut “pauses” and “forward guidance”) later this year.

  4. New Trade War Is Finding Support in Unexpected Places

    The new trade war is now in full swing. This comes on top of the global currency war that began in 2010.

    Countries like China have been fighting the trade war for decades with neomercantilist policies involving tariffs on imports, subsidies for exports, theft of intellectual property and accumulation of gold. It’s just that the U.S. was not fighting back until very recently.

    President Trump wanted to penalize China with U.S. tariffs and other penalties as soon as he was inaugurated in January 2017, but his national security team persuaded him to hold off because the U.S. needed China’s help with North Korea. Now that it has become clear that China will not help on the North Korean situation beyond some token commitments, the gloves are off.

    The national security team has been brushed aside when it comes to trade wars, and the White House “trade troika” of Robert Lighthizer, Wilbur Ross and Peter Navarro is now empowered. Trump has already imposed tariffs on solar panels and washing machines and is preparing to impose more harsh tariffs and other penalties in the areas of steel, aluminum and intellectual property theft.

    Most globalist elites oppose these measures. They argue that the U.S. wins from free trade even when others don’t play by the rules. That claim is false (because of the mobility of comparative advantage), but still the elites stick to it.

    This article reports a strange twist in this elites-versus-Trump debate. Normally, major company CEOs would be expected to line up with the elites and oppose Trump’s trade war. But this article shows that a majority of CEOs in the U.S. and around the world favor protectionism in various forms.

    This would come as no surprise to Alexander Hamilton and Henry Clay, who understood 200 years ago that America benefits from protectionism and gold.

  5. Republicans and Democrats Finally Agree: Let’s Spend More Money!

    Political dysfunction in the United States is at an all-time high. Republicans and Democrats are fighting pitched battles on immigration, Obamacare, tax cuts, regulation, infrastructure and just about every other major policy issue you can name.

    These fights are bitter, involve a lot of name-calling and show no signs of abating soon. The stakes could not be higher. These policy fights are a prelude to the congressional elections in November 2018 when the entire House of Representatives is up for grabs.

    Right now the Republicans are in control, but a loss of 24 seats will put the Democrats in charge and hand the gavel over to Nancy Pelosi as the speaker of the House. Once that happens, the impeachment of Donald Trump will begin within a matter of weeks.

    In this toxic environment, it seems that Republicans and Democrats cannot find common ground on anything. It turns out that’s wrong; they can agree on something. More spending!

    As this article explains, the Republicans have thrown in the towel and given up any pretense of being fiscally conservative. Republicans have joined forces with Democrats to eliminate budget caps on defense and domestic spending. Entitlements were already out of control because they’re on budget auto-pilot and don’t require new appropriations or votes. Now even the budget items that were subject to votes are out of control.

    The bad old days of $1 trillion annual government deficits of the Obama administration (2010, 2011, 2012) are back under a Republican administration. Of course, none of this spending is paid for, because the recent tax cuts already increased the deficit before the new spending spree took effect.

    Many economists try to find a silver lining by saying spending will be stimulative for the economy. Don’t believe it. We’re past the point of no return.

    With a 105% debt-to-GDP ratio, heading toward 110%, the historical evidence is clear that bigger deficits do not produce real growth — they just produce higher interest rates, slower real growth and, ultimately, inflation. Got gold?

  6. Stocks, Bonds and Gold Are All Connected. The Debt Bomb Is the Glue


    Investors are understandably confused about recent price action in stocks, bonds and gold. After a nearly nine-year bull market, stocks have just experienced their fourth 10% correction, and the first since January 2016. This correction is the most mysterious of all, since there is no easily identifiable cause such as the Chinese devaluation that triggered the stock market corrections in August 2015 and January 2016.

    At the same time, interest rates are surging and bond prices are plummeting, yet there are no signs of inflation. Finally, gold has mostly been moving in a narrow range, which is actually quite bullish considering the head winds arising from Fed rate hikes and higher interest rates generally. So what’s going on? How can we connect all of these dots?

    This link goes to my three-minute interview on Feb. 8, with Stuart Varney on the Fox Business Network. I make the point that the catalyst for the stock market correction is much higher interest rates. But higher interest rates are not due to inflation.

    In fact, there is no inflation anywhere in sight. The jobs report on Friday, Feb. 2, was much weaker than was widely reported. The reason for higher interest rates is the sudden fear of huge deficits arising from the Trump tax cuts, the congressional budget-busting deal and surging defaults on government-guaranteed student loans.

    The deficit implications of this triple-whammy are so horrendous that gold is showing strength despite higher rates, on fears that huge deficits and credit downgrades will erode confidence in the U.S. dollar itself. So there you have it. Higher deficits = higher interest rates = lost confidence in the dollar = plunging stock prices = higher gold prices. It’s all connected.