1. In the Gold Versus Bitcoin Debate, Goldman Goes for the Gold!

    I write and speak a lot on gold. In contrast, bitcoin is my least favorite topic. I’m made my views known many times. Bitcoin is a bubble and will crash and burn, probably to the $200 level sooner than later. It’s worse than a bubble because it’s shot through with bad actors, criminals, market manipulators, fraudulent intermediaries and every species of scam even invented.

    But, I continually get dragged into discussing bitcoin in interviews, on TV, radio and the internet. So, I discuss it whether I want to or not.

    By the way, I’m not a technophobe. I use advanced technology every day. Some of my best performing personal investments are fintech start-ups. I’m working with IBM and the Watson super-computer on a third-wave AI project to bring new paradigm predictive analytics to capital markets. I’ve read many bitcoin and blockchain technical papers. I “get it” when it comes to the technology.

    But, unlike my technologist friends, I also “get it” when it comes to market behavior. I know a bubble or a scam when I see one. Still, interviewers love to get into the “gold v. bitcoin” debate. From my perspective, you might as well discuss gold v. watermelons on bicycles v. bitcoin. In other words, it’s a phony debate.

    I agree that gold and bitcoin are both forms of money, but they go their own ways. There’s no natural relationship between the two, (what traders call a “basis.”) The gold/bitcoin basis trade does not exist. But, people love to discuss and I guess Goldman Sachs is no different. This article describes a new research report issued by Goldman Sachs that comes down squarely on the side of gold as a reliable store of wealth rather than bitcoin, which is untested in market turndowns.

    Goldman’s research department has not been notable as a friend to gold, so the fact that they favor gold over bitcoin is highly revealing in more ways than one.

  2. Bankers Hope for the Best. They Shouldn’t Hold their Breath.

    Banks stocks have been on a tear lately, as reported in this article. The reason is not difficult to discern. The Fed is on a path to raise interest rates.

    This is generally good news for bank earnings. Banks make money on the “spread” or difference between their own cost of funds and the interest they charge customers. These days a lot of the spread trading comes in derivative form rather than traditional deposits and loans. But either way, fatter spreads mean higher earnings for banks.

    In an environment of rising rates, banks will raise the cost to customers faster than their own costs go up. No surprise there. Eventually the rising cost of funds can catch up with the banks. In a declining rate environment, banks can find themselves on the wrong side of the trade with costly debt outstanding and getting lower yields from customers. But in the early stages of a rate hike cycle, fatter spreads are pure gravy for the banks.

    There’s only one problem with this rosy scenario. Past Fed rate hikes are catching up with the real economy. Disinflation is gathering momentum, velocity is declining, and the economy is slowing down. This means that the Fed will not hike rates in December and may not hike them next March either — regardless of who the new Fed Chairman is.

    When the markets expect a rate hike and it doesn’t happen, that’s a form of “ease” relative to expectations. This pause in rate hikes is bad news for the banks. It throws the bank stock rally into reverse.

    A pause in December could be good news for gold, the euro, and the stock market in general, but it’s nothing but bad news for the banks.

  3. The South China Sea War Drums are Just as Threatening as North Korea’s

    We hear in the news every day about threats to peace coming from North Korea. Kim Jong Un seems determined to complete his plan to build an arsenal of nuclear-armed ICBMs that can threaten the United States. The U.S. is just as determined to prevent Kim from obtaining that capability.

    Diplomacy is being pursued, and we cannot rule out regime change or the untimely death of Kim. But, absent that, war between the U.S. and North Korea seems inevitable before the end of March 2018; (that’s the deadline Mike Pompeo, Director of the CIA, told me at a private meeting in Washington DC last week, hosted by a think tank where I am a board member).

    But, North Korea is not the only clear and present danger to peace. This article shows that the situation is not stable in the South China Sea either. Confrontations between the U.S. and China are occurring routinely around islands that China claims in the South China Sea. The U.S. regards these Chinese claims as excessive and has conducted maneuvers in order to assert freedom of navigation around the islands.

    Neither China nor the U.S. wants a war over these islands especially at a time when both parties are trying to cooperate to contain the North Korean threat. But sometimes wars happen not because the two sides want a war but because of accidents and miscalculations about the intentions and capabilities of the other side. Such an accidental shooting incident or collision cannot be ruled out. Escalation from there is a genuine danger.

    It would be ironic if — with all of the attention being paid today to North Korea — the actual spark that set off a war happened thousands of miles away in the South China Sea.

  4. How Can There Be a “Dollar Shortage” When the Fed Printed $4 Trillion?

    One source of the next financial crisis may be the one you least expect — a global dollar shortage. How is that possible? The Federal Reserve printed over $3.6 trillion of new money beginning in 2008 to deal with the last financial crisis. That’s not even counting tens of trillions of dollars of “swaps” with foreign central banks such as the ECB, plus guarantees of trillions of dollars more of money market funds and bank deposits.

    With so many dollars floating around or backed-up by the Fed, how could there possibly be a dollar shortage? The answer is debt.

    While the Fed has printed trillions of dollars of money, governments and the private sector have created hundreds of trillions of dollars of new debt. In other words, for every dollar the Fed printed, borrowers have created twenty-five dollars of new debt. As long as the debt is performing or lenders are willing to roll it over for new debt, all is well. But, in a liquidity crisis, suddenly borrowers cannot afford to pay and lenders are unwilling to roll over maturing debt. Everybody wants his money back!

    Debtors who cannot afford to pay start selling other assets to raise cash. This is how contagion spreads from one market to another and around the world. There are usually early warning signs that liquidity is starting to dry up and borrowers are feeling the squeeze. This article describes how cross-currency swap spreads are starting to widen. Foreign borrowers who borrow in dollars like to swap the dollars for other currencies they can use in their local economies, a kind of carry trade.

    The spreads widen when demand for dollar borrowings is high. Something similar happened in the summer of 1998 just before the global financial panic that hit in late August of that year. This situation is causing concern but has not yet reached the level of full-scale panic. But this definitely bears watching.

    When swap spreads widen, it’s like an early warning that the system is about to have the financial equivalent of a heart attack.

  5. China Will Hit Stall Speed in 2018. The World is Not Ready

    This may be the most important article you read this year. It’s written by Lee Miller, a good friend of mine, and his colleague Derek Scissors. Lee is the founder and proprietor of an economic research service called “China Beige Book.”

    The name “beige book” was borrowed from the surveys conducted by regional Federal Reserve Banks of economic conditions in their regions. (In the days before internet, the Fed issued hard copy booklets with different colored covers based on subject matter. The economic conditions booklet has a beige-colored cover, hence the name). Lee does in China what the Fed does in its regions, except he covers the entire country.

    He has a diverse network of over 3,000 companies and entrepreneurs in all business sectors. He gets his information straight from the source and bypasses government channels. It’s like a private intelligence service. In fact, Lee’s network is better than the CIA’s when it comes to economic data. The CIA actually turns to Lee for advice.

    The detailed research service costs about $100,000 per year for one subscription. But, Lee publishes summaries on a quarterly basis, which are freely available. This article is his latest summary and it’s not a pretty picture.

    China Beige Book, CBB, says that China has been covering up and smoothing over problems related to weak growth and excessive debt in order to provide a calm face to the world in advance of the National Congress of the Communist Party of China, which began last week. CBB also makes it clear that the much-touted “rebalancing” of the Chinese economy away from investment and manufacturing toward consumption and spending has not occurred. Instead China has doubled down on excess capacity in coal, steel, and manufacturing and has continued its policy of wasteful investment fueled with unpayable debt.

    CBB forecasts that either China will experience a significant slowdown in 2018, which will have ripple effects on world growth, or else it will face an even bigger debacle down the road. Both outcomes are bad news for the global economy.