David M Glassman, President

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Email: Stockmarketdoc@comcast.net

July 11, 2018

The Great Reset

by Monetary Metals

Mon, 07/09/2018 - 10:30

Before it collapsed, the city of Rome had a population greater than 1,000,000 people. That was an extraordinary accomplishment in the ancient world, made possible by many innovative technologies and the organization of the greatest civilization that the world had ever seen. Such an incredible urban population depended on capital accumulated over centuries. But the Roman Empire squandered this capital, until it was no longer sufficient to sustain the city (we are aware the story is more complicated than this).

After the collapse, the population fell to about 8,000 people. Some fled and arrived at safe places, but surely most perished.

Monetary Reset

This is what we think of when we hear someone say, “There will be a reset”.

A reset is not a good thing. No one should look forward to it, and you certainly cannot profit from it. Not even from owning gold. Sure, those who don’t own gold may be worse off than those who do, but no one does well in a catastrophe like that.

Keith saw a museum exhibit, displaying gold hoards dating from the time of the fall of Rome. It had been the gold of several very wealthy men (each hoard had hundreds or thousands of ounces of gold!) Yet it did not avail them. Those people either fled or died, and their gold was lost for 1,500 years. And rediscovered by workers who were excavating foundations for big buildings in the late 20th century.

The monetary system is indeed headed towards this reset. We shouldn’t just wait passively for it, we should change course if possible. It is possible, but first, let’s look at what we can’t do.

Price Fixing Scheme

We can’t fix the right gold price. When you hear this proposed, don’t you get the picture of a central planner, a gnome with his tables and magic formulas? Lobbyists would line up in the greatest battle of special interest groups that Washington has ever seen. And a counterintuitive one, at that. We assume that most gold bugs are not debtors, and have savings (i.e. they are creditors). A low gold price benefits creditors. And a high price benefits debtors.

For example, suppose someone owes you $100,000. If the gold price is $1,000, he would need to give you 100 ounces. But if you owed that same amount, then a price of $100,000 lets you pay off your debt by handing over one gold Eagle.

Of course in any market, buyers always want a low price, and sellers always want a high price. There is no conflict of interest, unless the government fixes the price. Which is the essence of this approach.

That’s one fatal flaw. Another is that there is no way to set the price of gold. Look at all the banana republics which have tried to fix the exchange rate of their currency to the dollar. In the end, this scheme always fails. The problem is that Banco de Banana has to take the other side of the trade. So when market participants sell the baneso, Banco has to buy banesos and sell dollars. Since Banco only has so many dollars, it is overrun sooner or later.

The Swiss National Bank tried to fix the price of the franc in the other direction—they wanted to keep it down against the euro. Everyone believed they could do it, because obviously they couldn’t run out of francs when they have the power to print to infinity and beyond. Except it’s not printing, it’s borrowing. The SNB was borrowing francs to buy euro denominated assets. The market was pushing up the franc which is the liability of the SNB, and pushing down the euro which is the asset of the SNB. They could only take so much increase in their liability and so much decrease in their asset, before crying “uncle!” Keith wrote about this at the time, at Forbes.

Money Supply Targeting

Advocates of a gold standard based on a fixed price of gold don’t usually propose buying and selling gold in order to maintain the peg. Instead, they say the Fed should print dollars if the price of gold drops below the target and unprint (our word, not theirs) dollars if the price of gold goes too high. There’s just one problem. Can you spot it, in this graph?

Money supply has an almost perfect record of increasing, with the barest of downward blips during the worst crisis in nearly a century. At the same time, the price of gold is up and down. Suppose the Fed were trying to get the price of gold up to $1050 from 1996 through 2008. It was increasing the quantity of dollars at a good clip. But from 1997 through 2001, the price of gold was going down. What was the Fed supposed to do, borrow more dollars into existence even faster?

Then the price of gold begins to rise, accelerating after 2005. By 2011, it overshoots by almost 100%. What should the Fed have done at that point? Pull mass quantities of dollars out of the economy from 2009 through 2013? Would any Fed Chairman have the guts to do that, given what was going on in the economy at the time? Would any president allow such a Chairman to remain in office? Would the people keep their pitchforks unsharpened, their torches unlit if so?

At best, the connection between quantity of dollars and the price of gold is tenuous, and it isn’t realistic to think that the Fed could ever really reduce the quantity of dollars under any circumstances, much less do it in a crisis.

Gold Backed Currency

Another approach to the gold standard is to declare gold backing. Like many political slogans, this term is vague and ambiguous. What does backing mean, exactly? What could it possibly mean? We can think of two meanings. One is, “trust us, we have gold in the vault corresponding to X% of the dollars in circulation.” Uh, thanks guys, but our cup of trust is a little drained right now.

This is not a mechanism anyways. This leads us to choice two. Backing could mean, “we will buy gold below $X and sell gold above $X.” OK, that is at least a mechanism. And it would work—until the central bank runs out of gold. Just ask Banco de Banana about running out of dollars. And it would run out of gold when the market gets serious about buying gold. Which it will do, because the quality of the dollar keeps falling, regardless of its quantity.

Unlike during the classical gold standard, today the dollar is a completely different animal from gold. It is not a gold-redeemable promise—it is an irredeemable promise. There is no way to retroactively tie it to gold. That train left the station in 1971.

High Gold Price

One popular idea is that gold will begin to circulate as a medium of exchange, once the price gets high enough. The attraction of this idea is not so much economic theory, as relishing the thought that everyone will need gold when the dollar fails. Those who were foresighted enough to lay in a stock of gold will sell it to the masses. And thereby get very rich. One question arises, which is what does price mean when the dollar is going to zero?

This could never work. The collapse of our currency will be a calamity in the best case, even if it’s not 476AD. Those with capital will not be eager to consume it, by spending on consumer goods. Nor will they be buying businesses or real estate. Collapse will be a time of widespread defaults and bankruptcies. In a collapse, the gold will remain hidden. A rising price, much less a collapse, is not a mechanism to make gold begin circulating in the market.

Interest is the only force that can pull gold out of private hoards and into circulation. We have said many times, that interest is the regulator of flow in the gold standard. A lower rate will tend to push gold out of the market and into hoards. A higher rate will tend to draw it into the market.

This is the end of part I. We will include part II in next week’s Report.

Supply and Demand Fundamentals

The price of gold rose two bucks this week, though the price of silver fell 10 cents.

We have seen several analyses recently predicting big price drops, in one case by at least $500 in gold by the end of the year. Is this what capitulation looks like? It’s said they don’t ring a bell at the top, but they don’t ring a bell at the bottom either.

We have also seen technical analysis arguing that silver is about to break out and that gold is bouncing off its support (which is said to be $1,250).

What could drive the prices of the metals higher? Whenever we ask this question, we mean durably. Of course, speculators in the futures markets could begin to buy long positions with leverage. But then what? Such buying inevitably turns to selling, unless there is real buying of the metal.

Right now, so far as we can see, there’s weak demand for retail coins and bars. The Indian rupee has been falling all year. The average Indian is about 7% less able to buy gold than he was at the end of December. The Russian ruble peaked at the end of January, and is now down 11.65. The Chinese yuan is down about 6% since its peak in early February.

And the reason for these big currency moves is simple. All around the world, governments and corporations have previously borrowed US dollars. Their revenues are in their local currencies. This mismatch creates a risk. It’s great when everyone from currency traders to yield-starved fund managers are borrowing dollars, to sell them short and buy other currencies. Then the local currency, which is their asset, is rising against the dollar which is their liability.

Eventually, the tide turns. It becomes a bit harder to generate local currency revenue. Perhaps because the world seems to be headed towards a repeat of the tariff policies that exacerbated the last great depression. Perhaps because it’s time for the cycle to turn. Perhaps because QE has become QT. It could even be that market participants lower their estimate of the quality of the debt backing these currencies.

Whatever the reason, market selling begins pushing these currencies down. This compounds the problems of dollar-debtors around the world. This makes their local currency bonds even less attractive, and hence their local currency too. What was a lot of fun on the way up, turns into a lot of pain on the way down.

Add to this the fact that interest rates in the dollar have risen. The cost of funding such “carry trades” is much higher, and the attractiveness of other higher-rate currencies is less compared to the dollar, than it was a few years ago.

This, by the way, is what it means that the dollar is the world’s reserve currency. The reserve currency is not whatever oil is priced in—oil is priced in dollars because it’s the reserve. It is that the dollar is an asset on every major balance sheet in the world. The other currencies are dollar-derivatives. It is appropriate to describe their motion up and down with reference to the dollar from which they derive.

We are painting a picture of credit stress. The first phase of such stress is a general impoverishment, reduction in profits, wages, and savings. This is not an environment for accumulating gold or silver. The question is will the second phase come, a.k.a. fear. This is when investors (those who are still solvent) rush to trade some of their paper for metal. When they don’t like the risk of the counterparties who issue that paper.

We are not embedded in the culture in India or Russia or China. We can speak only to America, and right now, there is a general optimism that GDP is doing great, the stock market is going great, employment is doing great, and even policies that harm the economy like tariffs are great. This won’t last, as these purported signs of greatness show accelerated capital consumption (along with the rise in debt levels). Not even counting the impact of tariffs which has not been felt yet.

So what would the reason be for someone to stack more gold and silver today? We don’t refer to someone who owns no metal (we always advise people to own some, and not worry about price for their first purchase). We mean someone who owns a few tubes of gold Eagles and a few monster boxes of silver. What is the reason for adding more?

Is it the greed to get rich when the price will suddenly skyrocket, that no more metal will be for sale soon? Seriously, after all this time, and all these gold-to-$50,000-stories not to mention deadlines for monetary doomsday (according to that sales squeeze page we’ve been mentioning, the one that had been urging action before July 1… the end of the world has now been rescheduled for December 31).

Is it the fear that the banks are failing? We see no backwardation in gold or silver. Nor any reports of major US banks about to fail. It’s a different story in Europe, and that will make Europeans want to sell their euros to buy dollars and deposit them in US banks. Gold will always be the distant second to the dollar in such trades.

We do see something that could precipitate a sustained buying trend and drive the price higher. The issuance of a gold bond by an AA-rated government: Nevada. If you live in this state, please call your legislators and tell them you support this historic measure.

Keith is going to be at the Sprott Natural Resources Symposium next week in Vancouver. Please contact us if you want to meet. Sprott gave us a discount code for $100 off registration: MDA2018.

So whither the price of gold next? We will provide a picture of the changing gold and silver fundamentals. But first, here is the chart of the prices of gold and silver.

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). It went up this week.

Here is the gold graph showing gold basis, cobasis and the price of the dollar in terms of gold price.

Look at that scarcity (i.e. cobasis) rising. However, this week the price did not fall.

The Monetary Metals Gold Fundamental Price went up $2 this week to $1,300.

Now let’s look at silver.

The same thing in silver, rising cobasis, though against a drop in price.

Hedge Fund CIO: What Does It Mean When Stocks Rally On The Day Trade War Begins

“What does it mean when stocks rally into the first shot of a trade war?” asked Yoda, high in the Rockies.

The S&P 500 finished Thursday +0.9%, the deadline looming. And certain his question did not require an answer, I waited quietly. “When that same market closes sharply higher on the day the trade war begins, what is it telling you?” asked Yoda.

In the distance, peaks everywhere, each unique in shape, though formed by identical forces. “The market never likes to be told what to do. It moves on its own terms, none other. And it was too short.”

“There’s plenty of anxiety in markets,” said Roadrunner, surveying the landscape. “Risk premiums aren’t cheap. The selling of volatility into rallies is no longer massive,” continued the market’s biggest equity volatility trader. “On the slightest fear in the world, the VIX jumps to 18 almost immediately.” Since mid-April the VIX index has oscillated between 11 and 20. “This is a healthier market than when the VIX gets stuck between 10-12. And it just trades like the market believes Trump will be more talk than action. I guess we’ll see.”

“There’s one market where the volatility selling is relentless,” said Roadrunner, his army of market makers filling the void left by investment banks. “There is almost constant selling of 5yr, 10yr and 30yr interest rate volatility. We keep getting buried.” Having pushed through 3.00% in May, 10yr bond yields are back to 2.83%, stuck amidst the 2.71% - 3.10% range since February. “Feels like it’s one of these big structural sellers, though hard to say for sure. All I know is that at these levels, I’d rather be long it than short.”

* * *

“The resiliency of Bitcoin is impressive,” continued Roadrunner, building a presence in crypto trading. “It’s held up despite talk of bursting bubbles and exchange hacks.” Bitcoin is down 67% from its highs, which takes it back to last October’s price. “Down the road, everyone will hold some percentage of their wealth in digital assets. The winner may not be Bitcoin, but right now it feels like the one.” Bitcoin market cap is $112bln, Ethereum is #2 at $46bln, followed by Ripple at $18bln, Bitcoin Cash $12bln, EOS $6bln, and Litecoin $5bln.

“2017’s rally was total euphoria,” explained Roadrunner. “People anticipated a Bitcoin ETF at the end of the year.” It never happened and the price tanked. “People then were either unaware or underestimated their capital gains tax liabilities into April, and that cut prices in half.” Ever since it’s been in a $9,900 - $5,900 range (last price $6,500). “The futures market trades in light volume but it’s a start, a success. Coinbase (the dominant exchange) will go public at some point with a crazy valuation. And when the Bitcoin ETF arrives, the price will double.”

* * *

And a bonus anecdote from Peters:

His passion for it was fading. He knew that much. “But what to do?” whispered the Economist, mostly to himself. For decades he’d examined every word, placing it into context, comparing the endless stream of Fed statements to their predecessors. He took great pride in not missing a single interview by all twelve voting members. While he couldn’t recite Fed Chair press conferences verbatim, he got close. And that impressed his employer’s biggest clients who considered him Rain Man. He loved it, even if more recently it felt narrow, hollow. In his early years, Greenspan had been exciting in a nerdy kind of way. Alan knew that in a fiat system it is vital that the central bank exude confidence, wisdom. But deep down the Maestro understood how little we know. So he hid that truth in obfuscation, erudite nonsense, saying much and nothing, all at once. Bernanke was an authority on the Great Depression’s monetary mistakes. And this assured that his zealous commitment to prevent a repeat blinded him to the far-reaching unintended consequences of his policies.  Every major central bank followed Bernanke’s lead.

Politicians ceded control, central banks ruled supreme. As global interest rates fell to zero and below, debts soared while interest payments sank. This increasingly fragile construction proved stable provided nothing changed. Yellen inherited the bizarre legacy in 2013. She had previously invented the Dot Plot, an experiment in communicating expectations for the future by an economics team that consistently misjudged it.

The goal was to abolish policy uncertainty. But uncertainty is immutable, and escaping the central bank’s grasp, manifested in an anti-establishment political wave.

“What use am I now?” sighed the Economist, having devoted his career to Fed watching, still hanging on to every inconsequential word, as the age of the central banker passed, and power returned to politicians.

The Economic History Of The World In One Minute

"...and America's pre-eminence is over"

Remember, nothing lasts forever...

As we noted previously, history did not end with the Cold War and, as Mark Twain put it, whilst history doesn’t repeat it often rhymes. As Alexander, Rome and Britain fell from their positions of absolute global dominance, so too has the US begun to slip. America’s global economic dominance has been declining since 1998, well before the Global Financial Crisis. A large part of this decline has actually had little to do with the actions of the US but rather with the unraveling of a century’s long economic anomaly. China has begun to return to the position in the global economy it occupied for millenia before the industrial revolution. Just as the dollar emerged to global reserve currency status as its economic might grew, so the chart below suggests the increasing push for de-dollarization across the 'rest of the isolated world' may be a smart bet...

The World Bank's former chief economist wants to replace the US dollar with a single global super-currency, saying it will create a more stable global financial system.

"The dominance of the greenback is the root cause of global financial and economic crises," Justin Yifu Lin told Bruegel, a Brussels-based policy-research think tank. "The solution to this is to replace the national currency with a global currency."

Here’s why stock investors should rejoice over Trump’s second year in office

Published: July 6, 2018 3:01 p.m. ET

Second years of presidential terms typically favor stock investors


President Donald Trump






There’s a 67% chance the U.S. stock market will be higher at the end of 2018. Yet these odds have nothing to do with anything you’ve been reading about in the financial press. In fact, these odds would be the same even if there weren’t an imminent trade war, easing tensions on the Korean peninsula, or pending U.S. mid-term elections. The odds of an up six-month period would be the same in almost every scenario.

That’s because the stock market is forward-looking; it has already discounted all available information. Given the risks inherent in stocks, the market’s price on any given day will rise or fall to whatever level produces a two-out-of-three chance of the market rising over the subsequent six months.

Consider: Since its creation in 1896, the Dow Jones Industrial Average DJIA, +0.41%  has risen 66.7% of the time, on average — or two out of every three years. In contrast, here are the odds of the Dow rising from July to December in other situations, as illustrated in the accompanying chart:

• Second years of presidential terms: 66.7%

• When the stock market during the first half of the year rises less than 2%, as the S&P 500 SPX, +0.85%  did this year: 66.7%

To be sure, I haven’t searched for all possible correlations between first- and second-half performance. But I did look for a number of obvious ones, and came up empty.

Bull markets don’t die of old age. The same could be said of bear markets.

For example, it makes no statistically significant difference to these odds whether there’s a bear market, a young bull market, or an aging bull market. This is why, as many have noted before, that bull markets don’t die of old age. The same could be said of bear markets.

This finding is something we should actually celebrate, according to Lawrence G. Tint, chairman of Quantal International, a firm that conducts risk modeling for institutional investors. In an interview, he said that the market would be “subject to unnecessary and unhealthy turmoil” if the market’s return in one period were correlated with its return in the previous period. “We can be comforted by the fact that reasonably efficient markets always base their level on anticipated future returns, and do not include history in the calculation,” he added.

How ETFs could soon become 'Blockchain-traded funds'

Note carefully that I am not saying the market won’t fall between now and the end of this year. The odds of a decline are one-in-three, after all.

My point is, simply, that those odds have nothing to do with what’s dominating the news headlines, the age of the bull market, or how the market has behaved so far this year. As you place your second-half bets, you need to ignore the past and focus instead on what you think is going to happen that is not already reflected in stock prices.

Inflation Rearing Its Ugly Head

The world of finance and investment, as always, faces many uncertainties.

The US economy is booming, say some, and others warn that money supply growth has slowed, raising fears of impending deflation. We fret about the banks, with a well-known systemically-important European name in difficulties. We worry about the disintegration of the Eurozone, with record imbalances and a significant member, Italy, digging in its heels. China’s stock market, we are told, is now officially in bear market territory. Will others follow?

But there is one thing that’s so far been widely ignored and that’s inflation.

More correctly, it is the officially recorded rate of increase in prices that’s been ignored. Inflation proper has already occurred through the expansion of the quantity of money and credit following the Lehman crisis ten years ago. The rate of expansion of money and credit has now slowed and that is what now causes concern to the monetarists. But it is what happens to prices that should concern us, because an increase in price inflation violates the stated targets of the Fed. An increase in the general level of prices is confirmation that the purchasing power of a currency is sliding.

According to the official inflation rate, the US’s CPI-U, it is already running significantly above target at 2.8% as of May. Oil prices are rising. Brent (which my colleague Stefan Wieler tells me sets gasoline and diesel prices) is now nearly $80 a barrel. That has risen 62% since last June. If the US economy continues to grow the Fed will have to put up interest rates to slow things down. If it doesn’t, as money-supply followers fear, the Fed may still be forced to put up interest rates to contain price inflation.

It is too simplistic to argue that a slowing of money supply growth removes the inflation threat. In this article, I explain why, and postulate that the next credit crisis will be the beginning of the end for unbacked fiat currencies.

The fictions behind price inflation

The CPI-U statistic is an attempt to measure changes in the general price level, defined as the price of a basket of goods and services purchased by urban consumers. The concept is flawed from the outset, because it is trying to measure the unmeasurable. Its mythical Mr or Mrs Average doesn’t exist. Not only is the general price level different for each individual and household, but you cannot ignore different classes, professions, locations, cultural and personal preferences, and assume they can be averaged into something meaningful. We can talk vaguely about the general level of prices, but that does not mean it can or should be measured. Averaging is simply an inappropriate construction abused by mathematical economists.

There is also a fundamental and important dynamic issue, ignored by economic statisticians. You cannot capture economic progress with statistics, let alone averages. The ever-present change in the human condition is the result of an unquantifiable interaction between consumers and producers. What a consumer bought several months ago, which is the basis for statistical information, can be no more than an historical curiosity. It does not tell us what he or she is buying today or will buy tomorrow. Nor can the statisticians possibly make the value judgements that lead consumers to switch brands or buy different things altogether. In short, even if there was a theoretically justifiable price index, it measures the wrong thing.

The statisticians are simply peddling a myth, which leaves it wide open to abuse. The myth-makers, so long as the myths are believed, control the narrative. It is in the interests of the statisticians’ paymasters, the state, to see price inflation under-recorded, so it should be no surprise that independent attempts to record price inflation put it far higher.

Independent estimates suggest that a price inflation rate of around 10%, depending on the urban location, is a more truthful assessment. If this was officially admitted, the continuing impoverishment of the ordinary American would be exposed, because the GDP deflator would be large enough to record an economy continually contracting in real terms. And this appears to have been the situation since the Lehman crisis, as well as in many of the years preceding it.

You cannot, year in year out, take wealth away from consumers without crippling the economy. A continual economic contraction, which is the inevitable result of monetary debasement. It can never be officially admitted, least of all by the Fed, which has total responsibility for the currency and the banking system. The Fed does not produce official price inflation estimates, which is the responsibility of the Bureau of Economic Affairs, so the Fed conveniently hides behind another government department.

But if the Fed did admit to this statistical cover-up, what could it do? The whole concept of monetary stimulation would quickly unravel, and the debate would almost certainly move away from policies that rely on monetary smoke and mirrors towards the reintroduction of sound money. The Fed would be out of a job.

However, the government now depends on inflationary financing to cover persistent budget deficits, if not directly, then indirectly through the expansion of bank credit to finance the acquisition of government bonds. In the short term, President Trump has made things worse by raising the budget deficit even further, which will be financed through more monetary inflation. And in the long term the obligations of increasing welfare costs will ensure accelerating monetary inflation ad infinitum is required to pay the government’s excess spending.

So, we can say with confidence that the purpose of monetary policy has quietly changed from what is commonly stated, that is to foster the health of the US economy. Instead it is to ensure government spending can proceed without interruption and without asking the people’s representatives permission to raise taxes.

Supply-side and time factors

The conventional neo-Keynesian view of price inflation is that rising prices are driven by excess demand. In other words, an economy that grows too fast leads to increasing demand for the factors of production.

This approach wrongly plays down the role of money. If the quantity of money is fixed, the increased demand for some factors of production can only be met by reduced demand for other factors of production. If the quantity of money and credit is increased the redistribution of factors of production is impaired, and common factors are bid up to the extent the extra money is available. The source of higher prices is clearly the extra money.

When a central bank, like the Fed, creates money and encourages the expansion of credit, it takes time for this extra money to work through the system. It is deployed initially in the financial, as opposed to the productive side of the economy. This is because monetary inflation is initially directed at the banks to stabilise their balance sheets. And once the immediate crisis is passed, the banks continue to extend credit to the government at suppressed interest rates by buying its bonds. Suppressed interest rates and therefore bond yields lead to a bull market in equities, encouraging credit-backed speculation. Bank credit is then increasingly extended to businesses and also to consumers through credit card and mortgage debt. At this point, price inflation then begins to be a problem.

The eighteenth-century banker and economist Richard Cantillon was the first to describe how the new money gradually disperses through the economy, raising prices in its wake. To his analysis we must in modern times add the course it takes through financial markets to impact the non-financial economy.

The time taken for new money and credit to be absorbed into the economy governs the length of the period that separates successive credit crises. Cantillon also made the central point that the gainers are those that get the new money to spend first, while the losers are those who find prices have risen before they get their hands on the new money. In effect, wealth is transferred from the latter to the former.

This wealth transfer benefits the government, the banks, and the banks’ favoured customers through the transfer of wealth from mostly blue-collar workers, the unemployed, retirees and those on fixed wages. The self-serving nature of the Cantillon effect is bound to influence monetary policy-makers in their understanding of the effects of their monetary policies. Blinded by self-interest and the interests of those near to them, they fail to understand exactly how the creation of extra money actually creates widespread poverty.

Monetary creation manifestly benefits the parties that control and advise the Fed, giving it and its epigones the rosy glow of institutional comfort and superiority. Everyone around it parties on the new money. And the licences to create it out of thin air given to the commercial banks are exploited by them to the full. They are temperamentally opposed to withdrawing the stimulus. It is hardly surprising the neo-Keynesians, with their flexible economic beliefs, no longer believe in only stimulating the economy to bring it out of recession. Instead they continue to stimulate it into the next credit crisis, as the ECB and the Bank of Japan currently illustrate, because everyone in the monetary establish wants the party to continue.

The link between monetary inflation and prices

There is no mathematical formula for the link between monetary inflation and prices. For modern economists, it comes down to their fluid mainstream opinion. Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon”, but not everyone shares his conclusion. Central bankers note Friedman’s dictum but ignore it in favour of their ad hoc interpretation of the effects of monetary policy. The result is that in the absence of a sound understanding of the relationship between money, prices and asset prices, they always end up shutting stable doors after a new financial crisis overwhelms them.

It is a policy that always fails. Central bankers think the difficulty arises in the private sector, so they address what they see as evolving market-related risks. They fail fully to understand it emanates from their own monetary policies. Besides going against the grain of their own vested interests, convincing central bankers otherwise is made doubly difficult because there is no empirical proof that links the quantity of money in circulation with prices.

Logically, Friedman was correct. If you have more money chasing the same quantity of goods, its purchasing power will fall. That was the lesson of sound money, when it was beyond the reach of government creation and interference. The purchasing power of both sound and unsound money also vary due to changes in the general level of liquidity desired by consumers.

However, widespread use of sound money, gold or silver, also ensured that the price effect of changes in a localised desire for monetary liquidity were minimised through price arbitrage, so in those circumstances, the relationship between the quantity of money and the general price level was plain to see and unarguable. Unbacked national currencies do not share this characteristic, and their purchasing power is dependent only partly on changes in their quantity, being hostage to consumers’ collective desire to hold their own state’s legal tender. In other words, if consumers collectively reject their government’s currency, it loses all value as a medium of exchange.

In effect, there are two vectors at work, changes in the quantity and changes in the desire to hold currency. They can work in opposition, or together. Given the quantities of new currency and credit issued since the Lehman crisis, there appears to be a degree of cancelling out between the two forces, with the effects of a dramatic increase in the quantity of money being partially offset by a willingness to hold larger balances. The result is the dollar’s purchasing power has not fallen as much as might be expected, though as was discussed earlier in this article, the fall in the dollar’s purchasing power has been significantly greater than official inflation figures admit.

It is very likely that people and businesses in the US have been persuaded to hold onto cash balances and deposits at the banks by misleading official inflation figures. If the authorities had admitted to rates of price inflation are closer to the figures from Shadowstats and the Chapwood index, consumer behaviour would probably have been markedly different, with consumers reducing their exposure to a more obviously declining dollar.

In that event, both the effect of a massively increased supply of broad money combined with falling public confidence in the currency would almost certainly have worked together to rapidly undermine the dollar’s purchasing power. All experience tells us that unless a loss of confidence in the currency is nipped in the bud by a pre-emptive and significant increase in interest rates, a currency’s descent towards destruction can rapidly escalate. Doing it too late or not enough merely undermines confidence even more.

The issue of confidence poses yet another problem for the Fed. The extent to which currency values depend on misleading statistics represents a great and growing danger for future monetary policy, when statistical manipulation by the state is finally revealed to the disgust of the general public.

The dollar has nowhere to hide in the next credit crisis

The history of successive credit cycles shows that the general level of prices rises as a result of earlier monetary expansion. Inevitably, a central bank is belatedly forced to raise its interest rates, because the market demands it does so by no longer accepting the suppression of time-preference values.

Higher interest rates expose the miscalculations of the business community as a whole in their individual assessments for allocating capital. A slump in business activity ensues, and the banks, which are highly-geared intermediaries between lenders and borrowers, rapidly become insolvent. A credit crisis then swiftly develops into a systemic crisis for the banking system.

In the past, the encashment of bank deposits has been the way in which individuals tried to protect themselves from a bank’s insolvency. This created a demand for physical cash, which helped support the currency’s value through the systemic crisis. However, this prop for confidence in the currency in a crisis has now been effectively removed.

Central banks regard the right of the general public to encash their deposits as a hinderance to their attempts to stop banks failing.Since the 1990s, governments have gradually restricted public ownership of cash, accusing cash hoarders of criminal activities and tax evasion. More recently, they have moved towards banning cash altogether, assisted by the spread of contactless cards and other forms of electronic transfer.

The removal of the physical cash alternative forces a worried depositor to redeposit money from his bank into another bank he deems safer. The central bank can compensate for the loss of deposits in a bank which has lost its depositors’ confidence by recycling the surplus deposits accumulating in the other banks. It allows the central bank to rescue ailing banks behind closed doors, instead of having to deal with the contagious loss of public confidence that goes with an old-fashioned run on a bank. That is probably the overriding reason why central banks want to do away with cash.

Now let us make the reasonable assumption that the next credit crisis is worse than the last: that is, after all, the established trend. An ordinary saver is locked into the system and unable to demand cash to escape the risk of being a creditor to his bank and the banking system generally. His only remedy is to reduce his exposure to bank deposits by buying something, thereby giving the systemic and currency headaches to someone else. It is easy to envisage a situation where the marginal sellers of a currency held in bank deposits drive its purchasing power rapidly lower. All that is needed is an absence of buyers, or put another way, a reluctance to sell assets seen as preferred to owning the currency.

But what is safe to buy? Failing business models mean that non-financial assets fall in value and residential property prices, which are set by the interest cost and availability of mortgages, are likely to be in a state of collapse, at least initially. Equities will reflect these collapsing values as well. Government bonds are a traditional safe-haven asset, but government finances are certain to face a crisis with budget deficits rocketing out of control.

Prescient investors and savers are likely to anticipate these dangers in advance of the credit crisis itself and take avoiding action. That is how markets function. Now that the cash alternative has been effectively closed down, the only assets for which deposits are likely to be encashed in advance of the crisis are precious metals and cryptocurrencies. Therefore, it seems likely that safe-haven demand escaping falling currencies will initially benefit these asset classes. They will be, as the cliché has it, the canary in the coal mine.

Are we heading for the last conventional credit crisis?

This article has highlighted the deceitfulness of official US price statistics, and the way they have been used to fool both markets and consumers. The Fed’s monetary policies are founded on quicksand and could face a different set of challenges from the last credit crisis: a general loss of public confidence in the Fed itself.

In the Lehman crisis, we looked to the Fed to rescue us from a complete systemic collapse. It succeeded by doubling base money in a year from September 2008, eventually increasing it nearly five times over the following five years. The fiat money quantity (FMQ), which includes all dollar fiat money and credit (both in circulation and reserves), increased threefold from $5.4 trillion to $15.6 trillion. These are measures of the massive monetary expansion, whose price effects have been successfully concealed by official statistics. The whole process of rescuing the economy from the last banking crisis and making it appear to recover has been a truly extraordinary deception.

When one stops admiring the undoubted skill the monetary authorities have displayed in managing all our expectations, there are bound to be doubts. The Fed appears to be normalising its balance sheet, presumably so it can do it all over again. But the ratio of FMQ to GDP was 33% in 2007 before the Lehman crisis, and is at a staggering 80% today. On any measure, we are moving towards the next credit crisis with far too many dollars in issue relative to the size of the US economy.

When the next credit crisis hits us, the Fed is likely to find it impossible to expand its balance sheet and support both the banks and the government’s finances through QE in the way it did last time, without undermining the purchasing power of the dollar. A crisis that is demonstrably caused by an unbearable burden of debt cannot continually be resolved by offering yet more credit. Last time it worked without undermining the currency, next time we cannot be so sure. But the Fed has no other remedy.

The next credit crisis could therefore be the last faced by today’s fiat currency and banking system, if the debasement of currency required to prevent a debt meltdown brings forward the destruction of the dollar and all other currencies that are linked to it. The credit cycle will therefore cease. We should shed no tears for its ending, but our rejoicing must be ameliorated by the political and economic consequences that follow.

The end of fiat money may not happen immediately, because the general public can be expected to hang on to the fond illusion their dollars will always be valid as a medium of exchange before finally abandoning all hope for it. That has been the experience of documented inflations in the fiat currency age, from the European hyperinflations in the early 1920s onwards. And since all currencies are in the same unbacked fiat-currency boat, the purchasing power for them is likely to collapse as well, unless individual central banks introduce credible gold convertibility.

We have well-documented individual monetary collapses, even regional ones such as those that followed after the First World War in Europe. In Austria it ended four years after the war, in Germany five. But a transcontinental monetary crisis leading to the end of the global fiat currency regime takes us all into unknown territory, whose timing and progression, if it occurs, is hard to estimate.

My best guess for the timing of the next credit crisis remains later this year, perhaps the first half of 2019 at the latest. The short time that is left is the consequence of the enormous monetary debasement throughout the credit cycle not just in the US but globally as well. And the small amount of headroom for interest rates before the crisis is triggered, due to the accumulation of unproductive debt since the last crisis.

Total fiat currency destruction should take at least a further year or two, perhaps three from there. But first things first: the current phase of the credit cycle must evolve into a credit crisis before we can feel our way through its developing consequences.

China Threatened By "Vicious Circle Of Panic Selling" From Marketwide Margin Call

Two weeks ago, when commenting on the PBOC's latest required reserve ratio cut, we pointed out that one of the more prominent risks facing the Chinese stock market, and potentially explaining why the Shanghai Composite simply can't catch a bid during the recent rout, is the risk of a wave of margin calls resulting in forced selling of stocks pledged as collateral for loans.

The pledging of shares as loan collateral - a practice that has gotten increasingly more popular over the years - has been especially prevalent among smaller companies as we observed in February and initially, last June. Unlike in the U.S., where institutional shareholders are a big market presence, private Chinese firms are often controlled by a major shareholders, who often own more than half of company. These big stakes are the most convenient tool for such big shareholders to raise their own funds.

Here, the risk for other shareholders is that when major investors take out such share-backed loans is that stocks can plunge sharply when the borrowers run into trouble, and are forced to liquidate stocks to repay the loan. Hong Kong-listed China Huishan Dairy fell 85% in one day in March 2017: It is unclear what triggered the selloff in the first place, but the fact that Huishan’s chairman had pledged almost all of his majority shareholding in the company to creditors was likely a key factor.

Small caps aside, the marketwide numbers are staggering: about $1 trillion worth of stocks listed in China's two main markets, Shanghai or Shenzhen, are being pledged as collateral for loans, according to data from the China Securities Depository and ChinaClear. More ominously, this trends has exploded in the past three years, and according to Bank of America, some 23% of all market positions were leveraged in some way by the end of last year in China, double from the start of 2015.

Source: WSJ

As a result of the recent market rout which sent the Shanghai Composite into bear market territory, in June UBS warned that it sees a growing risk in China's stock pledges; the bank calculated that the market cap of pledged stocks that have fallen below levels triggering liquidation amounts to 440 billion yuan with some 500 billion yuan below warning line, which translates to ~1% and 1.1% of China’s entire market value of $6.8 trillion. A separate analysis by TF Securities, as of Jun 19th, stock prices of 619 companies were close to levels where margin calls will be triggered. Since then, that number has increased.

Now, a new analysis by Morgan Stanley looks at the threat rolling margin calls pose to China's brokers, who are the intermediaries most exposed to stock pledged financing and over-pledging.

According to the bank's own analysis, shares pledged account for ~10% of total A-share market cap, with 123 companies over 50% pledged, amounting to a combined pledged market cap of RMB1.0 trn, or 2% of total A-share market cap.

Furthermore, so far in 2018, there have been ~50 A-shares that have suffered price declines over 60%, with an average pledge ratio of 28%, thus likely falling below margin closeout level. According to the Securities Association of China, stocks below margin closeout level amounted to <1% of total A-share market cap as of June 26.

So what does this mean for brokers?

Morgan Stanley estimates that the total stock pledged financing balance at ~RMB2.7trn, of which RMB1.6trn is by brokers. The good news, is that following the introduction of new asset management rules in China, and ongoing financial cleanup, banks' participation has been notably less, since this falls under non-standard credit assets.

The not so good news is that even with regulatory changes, as of end-2017, brokers' stock pledged repo exposure was equivalent to more than all of the brokers' net capital, or 103%, up from 16% in 2013.

Putting these numbers together, Morgan Stanley calculates that it would take ~11% of brokers' net capital to absorb 50% of their exposure to stock pledged financing below margin closeout level.

But how great will the pain for brokers get if the market continues to slide?

That is the question Chinese regulators tried to answer earlier in the year when the awoke to the threat of China's stock-pledged financing, additionally realizing that compared to margin financing or OTC leverage, stocks used for stock pledged financing are less liquid, as major shareholders' stock holdings could be locked up or subject to shareholding reduction restrictions.

Which brings us to the new rule on stock pledged repo business implemented on March 12, 2018 which enforced stricter standards on concentration and collateral, and the Notice on June 1, 2018 essentially suspended OTC stock pledged financing for brokers.

Meanwhile, to ease concerns about margin calls, regulators set the guarantee coverage ratio as 181% for SHEX and 223% for SZEX, still relatively sufficient, if well below the initial levels of ~300%. And, as Morgan Stanley adds, in an attempt to avoid a feedback loop, regulators advised brokers to avoid margin closeout and provide liquidity support by extending contract periods or negotiating for more collateral.

In short, as prices drop ever lower, Chinese regulators are stretching the rules hoping that the current wave of selling ebbs and prices rebound from levels that would have already triggered forced liquidations. Or, as Morgan Stanley writes, China is doing everything in its power "to maintain stability of capital markets and avoid a vicious circle of default and panic selling, causing markets to spiral down further."

What is perhaps most concerning for Beijing regulators, is that despite all its efforts to prevent self-reinforcing liquidations, the Shanghai Composite has continued to sell off despite all its best efforts, and worse, the trade war with the US which has emerged as a major risk for Chinese companies comes at a time when the Composite is on the verge of taking out a critical support level: the lows hit after the bursting of the 2015 Chinese stock bubble.

Which may also be the line in the sand for China, and should the Composite slide another 100 or so points, taking out the critical support at 2,655, then regulators may finally be forced to tap banks and brokers on the shoulder, and demand companies repay loans. The resulting stock mass liquidation could also be the trigger Trump needs to demand capitulation from Beijing as part of the escalating trade war. The big question is, if indeed this is the endgame, whether China will allow this to happen without retaliation, or if Beijing - having little to lose - will sell a few hundred billion Treasurys to punish US capital markets as its own stock market crashes and burns.

The Yield Curve Is The Economy's Canary In A Coal Mine

The economy has hit a wall and is now sliding down it. I don’t care what bullish propaganda may or may not be bubbling up in the headlines from the financial media and Wall Street, the hard numbers I look at everyday show accelerating economic weakness. The fact that my view is contrary to mainstream consensus and political propaganda reinforces my conviction that my view about the economy is correct.

As an example of the ongoing underlying systemic decay and collapse conveyed by this week’s title, it was announced that General Electric would be removed from the Dow Jones Industrial Average index and replaced by Walgreen’s. GE was an original member of the index starting in 1896 and was a continuous member since  1907.

GE is an original equipment manufacturer and industrial product innovator. It’s products are used in broad array of applications at all levels of the economy globally.  It is considered a “GDP company.” GE was iconic of American innovation and economic dominance. Walgreen’s is a consumer products reseller that sells pharmaceuticals and junk. Emblematic of the entire system, GE has suffocated itself with poor management which guided the company into a cess-pool of financial leverage and hidden derivatives.

As expressed in past issues (the Short Seller’s Journal), I don’t put a lot of stock in the regional Fed economic surveys, which are heavily shaded by “hope” and “expectation” metrics that are used to inflate the overall index level. These are so-called “soft” data reports. But now even the “outlook” and “expectations” measurements are falling quickly (see last week’s Philly Fed report). The Trump “hope premium” that inflated the stock market starting in November 2016 has left the building.

Something wicked this way comes:  Notwithstanding mainstream media rationalizations to the contrary, a flattening of the yield curve always always always precedes a contraction in economic activity (aka “a recession”). Always. Don’t let anyone try to convince you otherwise. An “inverted” yield curve occurs when short term yields exceed long term yields. When the yield curve inverts, it means something wicked is going to hit the financial and economic system.

Prior to the financial crisis in 2008, the yield curve was inverted for short periods of time during 2007. The most simple explanation for why inversion occurs is that performance-driven capital flows from riskier investments into the the longer end of the Treasury curve, driving the yield on the long end below the short end. The expectation is that the Fed will be forced to cut short term rates drastically – thereby driving the short-end lower, which in turn pulls the entire yield curve lower (the yield curve “shifts” down). This gives investors in the long-end a better rate-of-return performance on their capital than holding short term Treasuries for safety. The Fed’s dilemma will be complicated by the fact that it does not have much room to cut rates in order to combat a deep recession.

Studies have shown that curve inversions precede a recession anywhere from 6 months to 2 years. I would argue that, stripping away the affects of inflation and data manipulation, real economic activity has been somewhat recessionary for several years.

The massive intervention in the Treasury market by the Fed, ECB and Bank of Japan has muted the true price discovery mechanism of the Treasury curve. The curve has been barely upward sloping for quite some time relative to history.  This could indeed be history’s equivalent of an inverted curve. That being the case, if an inversion occurs despite the Fed’s attempts to prevent it, it means that whatever is going to hit the U.S. and global financial and economic system is going to be worse than what occurred in 2008.

A note on gold and silver: The massive take-down in the price of gold and silver, which is occurring primarily during the trading hours of the LBMA and the Comex – both of which are paper derivative markets – is quite similar to the take-down that occurred in the metals preceding the collapse of Bear and Lehman in 2008. It is imperative that the price of gold’s function as a warning signal is de-fused in order to keep the public wallowing in ignorance – just like in 2008. 

But keep an eye on the stock prices of Deutsche Bank, Goldman and Morgan Stanley – as well as the Treasury yield curve...

Why The Coming Oil Crunch Will Shock The World

My years working in corporate strategy taught me that every strategic framework, no matter how complex (some I worked on were hundreds of pages long), boils down to just two things:

  1. 1Where do you want to go? (Vision)

  2. 2How are you going to get there? (Resources)

Vision is the easier one by far. You just dream up a grand idea about where you want the company to be at some target future date, Yes, there’s work in assuring that everybody on the management team truly shares and believes in the vision, but that’s a pretty stratightforward sales job for the CEO.

By the way, this same process applies at the individual level, too, for anyone who wants to achieve a major goal by some point in the future. The easy part of the strategy is deciding you want to be thinner, healthier, richer, or more famous.

But the much harder part, for companies and individuals alike, is figuring out 'How to get there'. There are always fewer resources than one would prefer.

Corporate strategists always wish for more employees to implement the vision, with better training with better skills. Budgets and useful data are always scarcer than desired, as well.

Similar constraints apply to us individuals. Who couldn't use more motivation, time and money to pursue their goals?

Put together, the right Vision coupled to a reasonably mapped set of Resources can deliver amazing results. Think of the Apollo Moon missions. You have to know where you're going and how you're going to get there to succeed. That’s pretty straightforward, right?

So, it should be little surprise that the opposite, a lack of Vision and/or Resources, leads to underperformance -- and, eventually, decline. Think Kodak or Xerox. Or third-generation family wealth that has dwindled away to nothing. In a changing world, refusing to change with it is a losing strategy.

A great strategy aligns people’s interests and motivations with the available resources. More importantly, it provides a meaningful framework for action, one that gives a sense of purpose that will motivate everyone through difficult or trying times.

The grand goal of defeating the Nazis provided sufficient motivation for people to buy war bonds, scrimp on consumption, plant victory gardens, and go without nylon. A large part of our national resources were dedicated to the larger strategy of winning the war. Because of the strategy everyone shared, practically nobody complained of this repurposing as a 'time of sacrifice’ or as an imposed burden.

Given the right framework and the means to achieve it, people will literally crawl through mud in freezing temperatures -- and find it deeply satisfying. But given zero context or insufficient resources, people quickly become demoralized or rebellious (just observe how quickly most folks get royally pissed off at having to sit on the tarmac for a few extra minutes before their airplane takes off.)

Strategy matters. A lot.

A Nation Adrift, A World In Denial

Here's why I'm harping so much on strategy: the US is operating without a viable one.

We neither have a compelling Vision of where we want to go, nor any sense of the Resources required to change with the many transitions underway around us.

The current ‘strategy' (if we can be so generous as to call it that), is nothing more than "business-as-usual" (BAU).

The US is assuming it is always going to have more cars and trucks on the road this year than last year, more goods sold, a larger economy, more jobs, and the world’s most powerful military. That’s the BAU model. And it has largely worked for the past century.

But it can't work going forward. And the longer we pursue it, the more of our future prosperity we ruin.

Why? Because the future of everything is dependent on energy. More specifically: net energy.

Having a powerful military consumes a tremendous annual quantity of energy. The US military eats up 100 million barrels of oil each year. By itself, America's Department of Defense is the 34th largest consumer of oil in the world.

In total, the US consumes over 7 billion barrels of oil each year. And that represents only 37% of the nearly 100 quadrillion of BTUs of America's annual energy consumption (the rest coming from natural gas, coal, and other sources). For comparisons sake, the rest of the world consumes another 450 quadrillion BTUs.

And world energy demand just keeps on insatiably growing year over year. The (notoriously conservative) EIA predicts it will jump by 28% over the next two decades.

Will our energy production be able to keep up? As I've been warning for years, it will be very challenged to do so -- or, to do so at prices anywhere near as low as today's.

Putting Our Plight Into Concrete Terms

Putting those staggering figures aside for a moment, let's focus on one -- just one! -- of the crises ahead of us when it comes to our future energy needs.

The nations of the world have made the truly regrettable decision to build so much of their infrastructure using concrete reinforced with steel (re-bar, mesh, etc.). As I've explained in detail in previous articles, because the steel rusts over time, the concrete is busy being destroyed from the inside out -- something we can detect easily enough by the cracks and spalling (sheets flaking off) so readily apparent on every bridge that’s more than a couple of decades old.

This has created a ticking time bomb. The world's crumbling concrete buildings, bridges and roadways will have to be entirely replaced in just 40 to 100 years of their original construction dates. Where will all of the energy come from for that?

Also, note that China has poured more steel-reinforced concrete over just the past few years than the US did in the entire 20th century(!). All of this, too, will need to be replaced later this century.

Given that the sand required for all of the world's *current* concrete projects is now in very short supply, where all the sand will come from for all that future concrete and cement work? Who ever thought we could run out of sand?

But such are the unpleasant surprises that crop up during the late stages when running an exponential economic paradigm (i.e., "Growth forever!").

Fooling Ourselves

And it certainly doesn't help that we're remaining willfully blind to our situation.

It’s probably safe to say that the majority of the population in the US is confident that the "shale revolution" has assured America's energy security for a long time to come. Heck, the governor of Texas recently tweeted this to the world:

This is wrong on so many levels.

Yes, Texas produces oil and natural gas. But the US is still a net oil importer to the tune of about 3 million barrels per day. The US is not independent with respect to oil. And it won’t be until it produces another 3 million barrels per day (and that's making the generous assumption that consumption remains flat).

Further, to claim that the US will NEVER AGAIN depend on foreign oil is beyond bizarre. As I've been explaining for years, shale fields deplete and decline ferociously. Even the hyper-bullish EIA thinks that the shale fields will peak out in 2025 (I think earlier) and then go into permanent decline.

In my world, NEVER AGAIN is a lot farther out into the future than 2025. But Mr. Abbott has apparently ingested one too many petroleum sales pitches and received a terribly inaccurate impression about the true state of the US' energy predicament.

Much more likely is that US shale production does not EVER exceed US consumption before peaking out. So it would be more accurate to tweet the US is now and will ALWAYS AND FOREVER be dependent on foreign oil.

Finally, even if the US were a net oil exporter (highly unlikely), we’d still be tied to the world price for oil. Should foreign cartels decided to limit production and spike the price, that would still effect the US. So we still wouldn't be "independent" of their influence.

But sadly, Mr. Abbott speaks for the nation in that tweet. We're "swimming in energy" and need not have any worries. The drum of our chest-thumping will scare them away.

In other word:, there’s no strategy beyond BAU.

There's no acknowledgement of the challenges we face in the coming decades, of declining net energy per capita. Of greater competition between the developed and developing nations for the remaining BTUs.

There's no compelling Vision to marshall the public towards that fits the realities of the future. We could, and should, be working on solutions for entering a "post-growth" era with grace. Or at a minimum, aggressively using today's Resources to create a new energy infrastructure that plans for the inevitable decline of fossil fuels.

We could be doing so much better than this.

Getting Our Priorities Straight

What if we started by embracing these three facts?

  1. 1Fossil fuels have provided a supernova of surplus energy. One that has enabled literally everything and everyone you see around you to spring into existence.

  2. 2Fossil fuels are a very recent discovery for humans (barely 150-years-old). Half of our consumption of them has happened in just the last 25 years alone (due to exponentially increasing use).

  3. 3Fossil fuels will not last forever. They are finite and will someday peak and then decline, representing a once-in-a-species bonanza never to be repeated.

It's beyond dispute that fossil fuels are 4/5ths of the current total global energy mix, that our use and dependence on them has grown exponentially over time, and that they are a non-rewable resource.

Among the fossil fuels, oil is, by far, the most critically-important to sustaining both our current level of technology and the human population. It's how we move virtually everything from point A to point B and it’s a critical element for food production and distribution. It also remains absolutely essential to the manufacture and installation of alt-energy systems, like wind and solar.

Given the three facts above, it only makes sense that a responsible global society should have a credible and very publicly-stated energy strategy providing a road map for weaning itself from fossil fuels before they become prohibitively expensive/scarce.

But since we don't have one, the alternative path we're taking is to sleepwalk into the future with no plan for feeding 9 billion people or re-building a crumbled global infrastructure -- let alone facing the additional challenges of running out of critical minerals, dealing with destroyed ecosystems, and being unable to field the necessary fuel and economic complexity to install a brand-new energy infrastructure measuring in the hundreds of quadrillions of BTUs. This BAU path will be marked by the three D’s: despair, demoralization, and death. (Is it any wonder that young people aren't as inspired by BAU as their parents' generation?)

So if instead we want a future that’s prosperous, regenerative and abundant, then we have to begin doing things very differently from BAU. And fast. (The best time to have started on this was decades ago.)

For example, if we decide we want electric transportation powered by wind and solar to be anything more than a meaningless tiny percentage of the total BTU mix, then we’re going to have to use a lot of fossil fuels to make that happen. It takes an enormous amount of fossil fuels to manufacture, install, maintain and repair/replace every single alt-energy component.

The question then becomes: Where do we want to be when that future arrives? If we want to have livable cities and towns with nearby greenbelts and an alt-energy infrastructure delivering clean energy sustainably forever into the future, then an enormous amount of planning and building is going to be required to get anywhere near close to that.

It all comes back to strategy. We need a compelling Vision of this future to inspire society, and then dedicate the appropriate Resources to make it happen.

With an appropriate energy strategy that matches reality, we can engineer a reasonably bright future. Without one, we’ll just pursue BAU until it literally destroys us as well as the ecosystems we depend on.

An New Energy Strategy

So here’s one way to go about doing that.

First, identify all the energy demands that absolutely have to happen just to maintain systemic integrity. The DoD has needs, the current fleets of emergency vehicles and school busses have needs, as does maintaining the existing stock of bridges, roads, and buildings. This exercise will reveal to all that simply maintaining 'the way things are' is extraordinarily energy-expensive. But it has to be done if we want to avoid economic collapse and massive joblessness. It also bears mentioning that the energy required to keep things going is energy that cannot be dedicated to building the new future. It’s a sunk-cost of prior decisions.

Second, make a credible list of energy needs for building the future we want. How many solar panels will that be? How many wind farms? How many miles of electrified train track? How many fully-electric vehicles will have to be built? How many charging stations with the nationwide road system need? What sorts of improvements and modifications to existing cities and towns will have to be made? This is the Vision. It answers the question Where are we going?

Of course, these sorts of new activities and building projects will be very energy expensive. If we want them to happen, then we have to consciously budget an appropriate amount of energy to accomplish the Vision.

Next, develop the very best possible estimate of total economically recoverable fossil fuels. Do this by finally measuring the full-cycle energy returned on energy invested (EROEI) for the remaining deposits. After all, we’re going to build out the future with the surplus energy extraced, not the gross (surplus = Total BTUs extracted - BTUs expended during extraction). This estimate will represent the total principal balance of our national energy bank account.

Last, calculate if there will be any energy left over. If so, save it for future generations. They'll have their own sets of needs and desires that we can't possible know today. (Sadly, I'm willing to wager that there won’t be any excess fossil energy to pass along).

A Sample Scenario

By way of example, suppose that the US undergoes a thorough, exhaustive, peer-reviewed and thoroughly debated examination of all known remaining fossil fuel resources – coal, natural gas and oil – using the very best and well-funded EROEI methodologies (yet to be developed, by the way). If we arbitrarily say that there are “100 units” of net energy left, we might discover this:

  1. 25 units will be required to simply maintain the economic system so it doesn’t crash and can support the build-out of the new Vision for the future.

  2. 60 units will be required to build that future out.

  3. 15 units are not yet assigned. We might decide to leave those to future generations because that would be conscientious and prudent. Or perhaps we discover that they shouldn’t be burned because of the environmental impact.

Results such as these yield important insights.

First, we’d understand that if we accidentally burned through, say, 45 units blindly pursuing BAU, that would steal 25 units from building out the future we want.

Next, we'd realize better that our chances of manifesting the Vision are improved by limiting the amount we spend on maintenance. That insight would help to spur better decisions around conservation and efficiencies -- such as not driving 6,000 pound private SUV/Truck vehicles to transport a single passenger to a desk job, or building homes with inadequate insulation to save a few thousand dollars on the front end of a 100-year capital investment.

Finally, we’d appreciate how our energy resources are finite and limited, and that how we choose to utilize them is quite possibly the single most important decision society can possibly make. Leaving the fate of our precious energy resources to the short-term interests of the markets and politicians would suddenly look too risky and nonsensical. We'd agitate for greater stewardship of them.

Were I in charge, the most well-funded institution in the land would be the Energy Institute. Our very best and brightest minds would be heavily incentivized to work there, applying their considerable gifts at science and mathematics towards matching our energy resources with our shared national goals. Gone would be the days of our top talent working for Wall Street and private money funds to move electronic abstractions of wealth hither and yon, skimming money while creating absolutely nothing of lasting value for their country or the world.

The Coming Oil Crunch Will Shock The World

However, we both know that no such strategic energy plan is forthcoming. There’s no strategy in the US (or Japan or Europe or China, or anywhere) that aligns finite resources with a well-defined, sustainable vision of the future.

BAU rules the roost.

It’s so powerfully embedded that Ford Motor Company recently decided to scrap selling sedans and small cars in America. It will only manufacture SUVs, trucks and commercial vehicles. You know when Ford will no longer make cars, you’ve got to have really chugged the shale oil Kool-Aid to make that decision.

Concrete is still poured with steel rebar every day. New homes and commercial buildings are built with expected lifetimes of only several decades and little attention to insulation. And the Federal Reserve focuses with manic precision on assuring that the credit markets continue to grow exponentially.

Each of these and a million other activities consumes finite, irreplaceable energy at the expense of a sustainable future. At some point, perhaps already passed us, that goal becomes no longer possible.

My point is we don’t know where that line in the sand is. We haven’t done the work, made the plans, and performed the necessary visioning to know one way or the other.

But what we can be sure of is that BAU is headed in the wrong direction and it has no long term future. One way or the other, endless growth on a finite planet will run its course and end. The only remaining question left to answer is: How painful will the reckoning be?

None of us know what will finally break the largest and most destructive credit cycle ever unleashed on the world (thanks central banks!) but we all know that The Everything Bubble has a bitter end. All self-destructive delusions do.

Our analysis concludes that the hard-stop for this credit bubble is resource-based. And I predict it will be a sudden spike in the price of oil that will be the pin that the central bank enabled bubbles absolutely cannot grow beyond.

They will encounter this pin and burst.

There will be plenty of time for tears and regrets then. But right now? You need to get ready.

In Part 2: How The Coming Oil Shock Will Impact Absolutely Everything we go deep into the data showing why a global oil supply shortfall is unavoidable by or before 2020. That's less than two years away.

If gas prices at today's $70/barrel price bother you, you ain't seen nothing yet. The spike in oil's price that will result from the coming crunch will shock the world.

As an increase in the price of oil feeds into the cost of everything, it acts like an interest rate increase in terms of depressing economic growth. If we haven't already entered one yet, this coming shock will absolutely throw the global economy into recession. And if we're already in one when it hits, heaven help us.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

Jim Rickards Warns "Volatility Is On The Way Back"

When geopolitical events create crises in the world, volatility usually follows in world markets. The results of this volatility is important to note and I will discuss this below.

In January 2018, two significant market events occurred nearly simultaneously. Major U.S. stock market indexes peaked and volatility indexes extended one of their longest streaks of low volatility in history.

Investors were happy, complacency ruled the day and all was right with the world.

Then markets were turned upside down in a matter of days. Major stock market indexes fell over 11%, a technical correction, from Feb. 2–8, 2018, just five trading days.

The CBOE Volatility Index, commonly known as the “VIX,” surged from 14.51 to 49.21 in an even shorter period from Feb. 2–6. The last time the VIX has been at those levels was late August 2015 in the aftermath of the Chinese shock devaluation of the yuan when U.S. stocks also fell 11% in two weeks.

Investors were suddenly frightened and there was nowhere to hide from the storm.

Analysts blamed a monthly employment report released by the Labor Department on Feb. 2 for the debacle. The report showed that wage gains were accelerating. This led investors to increase the odds that the Federal Reserve would raise rates in March and June (they did) to fend off inflation that might arise from the wage gains.

The rising interest rates were said to be bad for stocks because of rising corporate interest expense and because fixed-income instruments compete with stocks for investor dollars.

Wall Street loves a good story, and the “rising wages” story seemed to fit the facts and explain that downturn. Yet the story was mostly nonsense. Wages did rise somewhat, but the move was not extreme and should not have been unexpected.

The Fed was already on track to raise interest rates several times in 2018 with or without that particular wage increase. Subsequent wage increases in the February, March, April and May employment reports have been moderate.

The employment report story was popular at the time, but it had very little explanatory power as to why stocks suddenly tanked and volatility surged.

The fact is that stocks and volatility had both reached extreme levels and were already primed for sudden reversals. The specific catalyst almost doesn’t matter. What matters is the array of traders, all leaning over one side of the boat, suddenly running to the other side of the boat before the vessel capsizes.

The technical name for this kind of spontaneous crowd behavior is hypersynchronicity, but it’s just as helpful to think of it as a herd of wildebeest that suddenly stampede as one at the first scent of an approaching lion. The last one to run is mostly likely to be eaten alive.

Markets are once again primed for this kind of spontaneous crowd reaction.

Except now there are far more catalysts than a random wage report.

The U.S. has ended its nuclear deal with Iran and has implemented extreme sanctions designed to sink the Iranian economy and force regime change through a popular uprising. Iran has threatened to resume its nuclear weapons development program in response. Both Israel and the U.S. have warned that any resumption of Iran’s nuclear weapons program could lead to a military attack.

Three faces of volatility, from left to right: Ayatollah Ali Khamenei, the spiritual and de facto political leader of Iran; Nicolás Maduro, the president of Venezuela; and Kim Jong Un, the supreme leader of North Korea. Iran and North Korea may soon be at war with the U.S. depending on the outcome of negotiations. Venezuela is approaching the status of a failed state and may necessitate U.S. military intervention.

Venezuela, led by the corrupt dictator Nicolás Maduro, has already collapsed economically and is now approaching the level of a failed state. Inflation exceeds 14,000% and the people have no food. Social unrest, civil war or a revolution are all possible outcomes.

If infrastructure and political dysfunction reach the point that oil exports cannot continue, the U.S. may have to intervene militarily on both humanitarian and economic grounds.

North Korea and the U.S. have pursued on-again, off-again negotiations aimed at denuclearizing the Korean Peninsula. While there have been encouraging signs, the most likely outcome continues to be that North Korean leader Kim Jong Un is playing for time and dealing in bad faith.

The U.S. may yet have to resort to military force there to negate an existential threat.

This litany of flash points goes on to include Iranian-backed attacks on Saudi Arabia and Israel, a civil war in Syria, confrontation in the South China Sea and Russian intervention in eastern Ukraine.

These traditional geopolitical fault lines are in addition to cyber threats, critical infrastructure collapses and natural disasters from Kilauea to the Congo.

Investors have a tendency to dismiss these threats, either because they have persisted for a long time in many instances without catastrophic results, or because of a belief that somehow the crises will resolve themselves or be brought in for a soft landing by policymakers and politicians.

These beliefs are good examples of well-known cognitive biases such as anchoring, confirmation bias and selective perception. Analysis tells us that there is little basis for complacency. Yet the VIX is back near all-time lows as shown in Chart 1 below.

Chart 1

Even if the probability of any one event blowing up is low, when you have a long list of volatile events, the probability of at least one blowing up approaches 100%.

With this litany of crises in mind, each ready to erupt into market turmoil, what are my predictive analytic models telling us about the prospects for an increase in measures of market volatility in the months ahead?

Right now they’re telling us that investor complacency is overdone and market volatility is set to return with a vengeance.

Changes in VIX and other measures of market volatility do not occur in a smooth, linear way. The dynamic is much more likely to involve extreme spikes rather than gradual increases. This tendency toward extreme spikes is the result of dynamic short-covering that feeds on itself in a recursive manner — or what is commonly known as a feedback loop.

Shorting volatility indexes has been a very popular income-producing strategy for years. It’s been like selling flood protection in the desert; seems like easy money. The problem is that every now and then a flash flood does hit the desert.

The future often diverges sharply from the recent past. Markets gap up or down, giving investors no opportunity to trade at intermediate prices. Extreme events occur with much greater frequency than standard models such as value-at-risk expect.

When the threat emerges, traders who are short volatility have to buy the index in options or futures form to hedge their short positions. This buying drives the price up higher and causes more traders to hit pre-programmed stop loss limits. This generates even more buying and so on.

Now the buying and short covering feeds on itself and the feedback loop dynamic drives the index to extreme levels before the panic buying is satisfied.

This is what happens when the flash flood hits the desert. The storm clouds are gathering now, and the rain is coming.

Myth: Gold Makes Boom-Bust Cycles Worse

According to some commentators on the gold standard, an increase in the supply of gold generates similar distortions as money out of “thin air” does.

Let us start with a barter economy.

John the miner produces ten ounces of gold. The reason why he mines gold is because he believes there is a market for it. Gold contributes to the well-being of individuals.

He exchanges his ten ounces of gold for various goods such as potatoes and tomatoes.

Now people have discovered that gold apart from being useful in making jewelry is also useful for some other applications.

They now assign a much greater exchange value to gold than before. As a result, John the miner could exchange his ten ounces of gold for more potatoes and tomatoes.

Should we condemn this as bad news because John is now diverting more resources to himself? This however, is just what is happening all the time in the market.

As time goes by people assign greater importance to some goods and diminish the importance of some other goods. Some goods now then considered as more important than other goods in supporting people’s life and well-being.

Now people have discovered that gold is useful for another use, such as the medium of the exchange. Consequently, they lift further the price of gold in terms of tomatoes and potatoes. Gold is now predominantly demanded as a medium of exchange — the demand for the other uses of gold, such as for ornaments is now much lower than before.

Let us see what is going to happen if John were to increase the production of gold. The benefit that gold now supplies people is by providing the services of the medium of the exchange. In this sense, it is a part of the pool of real wealth and promotes people’s life and well-being.

One of the attributes for selecting gold as the medium of exchange is that it is relatively scarce. This means that a producer of a good who has exchanged this good for gold expects the purchasing power of his effort to be preserved over time by holding gold.

If for some reason there is a large increase in the production of gold and this trend were to persist, the exchange value of the gold would be subject to a persistent decline versus other goods, all other things being equal. Within such conditions, people are likely to abandon gold as the medium of the exchange and look for another commodity to fulfill this role.

As the supply of gold starts to increase its role as the medium of exchange diminishes while the demand for it for some other usages is likely to be retained or increase.

Therefore, in this sense the increase in the production of gold is not a waste and adds to the pool of real wealth. When John the miner exchanges gold for goods, he is engaged in an exchange of something for something.

He is exchanging wealth for wealth.

Contrast all this with the printing of gold receipts, i.e., receipts that are not backed 100% by gold.

This is an act of fraud, which is what inflation is all about, it sets a platform for consumption without contributing to the pool of real wealth. Empty certificates set in motion an exchange of nothing for something, which in turn leads to boom-bust cycles.

The printing of unbacked gold certificates divert real savings from wealth generating activities to the holders of unbacked certificates. This leads to the so-called economic boom.

The diversion of real savings is done by means of unbacked certificates, i.e., unbacked money.

Once the printing of unbacked money slows down or stops all together this stops the flow of real savings to various activities that emerged on the back of unbacked money.

As a result, these activities fall apart - an economic bust emerges. (Note that these activities do not produce real wealth, they only consume. Obviously then without the unbacked money, which diverts real savings to them, they are in trouble. These activities did not produce any wealth hence without money given to them they cannot secure the goods they want.)

In the case of the increase in the supply of gold, no fraud is committed here. The supplier of gold - the gold mine - has increased the production of a useful commodity. Therefore, in this sense we do not have here an exchange of nothing for something. Consequently, we also do not have an emergence of bubble activities. Again, the wealth producer, because of the fact that he has produced something useful, can exchange it for other goods. He does not require empty money to divert real wealth to him.

Note that a major factor for the emergence of a boom is the injections into the economy of money out of "thin air.” The disappearance of money out of “thin air” is the major cause of an economic bust. The injection of money out of “thin air” generates bubble activities while the disappearance of money out of “thin air” destroys these bubble activities.

On the gold standard, this cannot take place. On a pure gold standard without a central bank, money is gold. Consequently, on the gold standard money cannot disappear since gold cannot disappear.

We can thus conclude that the gold standard, if not abused, is not conducive to boom-bust cycles.

Ray Dalio: "Today Is The First Day Of The War With China"

One month ago, Bridgewater's Ray Dalio, the founder of the of the world's largest hedge fund, advised his clients that he had turned bearish as a result of the economy's late cycle stage, liquidity drainage by central banks and the lack of a coherent plan for what happens in 2020 once the Trump fiscal stimulus fizzles:

"We are bearish on financial assets as the US economy progresses toward the late cycle, liquidity has been removed, and the markets are pricing in a continuation of recent conditions despite the changing backdrop."

It wasn't just the "late cycle" transition that worried Dalio:, however in early May, Dalio warned that "a US-China trade war would be a tragedy" envisioning the following scenario:

If tariffs are imposed as indicated, I would hope and expect the Chinese response to be small and symbolic so that both sides will have rattled their sabers without actually inflicting much harm. What will come after that will be more important. I wouldn’t expect it to amount to much anytime soon. If on the other hand we see an escalating series of tit for tats, then we should worry.

Well, "tragedy" it is then, because moments ago, Dalio - who on America's independence day won a license to sell investment products in China - just summarized where we stand in one terse tweet: "Today is the first day of the war with China", note not just trade war, but "war", period.

What happens next? Here is Dalio's LinkedIn post from early May, explaining why a trade war with China would be a tragedy:

A US-China Trade War Would Be a Tragedy

The markets’ reactions to newly imposed tariffs and, more importantly, the possibility of a US-China trade war convey appropriate tip-of-the-iceberg concerns of what a trade war would mean for the US, China, and world economies and markets. To me, these concerns are reminiscent of the markets’ first reactions to the possibility of a military war with North Korea—i.e., the seemingly aggressive posture of Donald Trump conjures up pictures of war that are very scary, so the markets react, but that doesn’t mean that such a war is likely (at least in the near term).

While I’m not a geopolitical analyst, here’s my thinking based on the time I’ve spent in both the US and China. Take it with a grain of salt.

The Chinese way of negotiating is more through harmony than through confrontation, until they are pushed to have a confrontation, at which time they become fierce enemies. They are more long-term and strategic than Americans, who are more short-term and confrontational, so how they approach their conflicts is different. The Chinese approach to conflict is more like playing Go without direct attack and the American approach is more like playing chess with direct attack. The Chinese prefer to negotiate by finding those things that the people they are negotiating with really want and that the Chinese are comfortable giving up, in exchange for those people they are negotiating with doing the same. Because there are now many such things that can be exchanged to help both parties (e.g., opening the financial sector in China, Chinese investment in the US, agricultural product imports to China, etc.), there is plenty of room for there to be big win-wins.

For these reasons, it’s in the Trump administration’s interests to make clear what it wants most and, if they can’t do that, to not be aggressive until they figure out what beneficial exchanges are. Of course, trade is extremely complex because there are all sorts of interconnections globally, so being clear without adequate time and exchanges of thinking isn’t easy.

However, as important as the real trade issues is politics, which is especially important at this very political moment in both countries (i.e., ahead of “elections”). Politics can make politicians act tougher than they should be if they were operating solely in their country’s best interests because looking tough with a foreign enemy builds domestic support. Politically for Donald Trump, two of his three biggest strongman promises were 1) to build the wall with Mexico and 2) to reduce the trade deficit with China, by getting tough with them both. Xi Jinping has similarly made commitments to be strong in dealing with adversaries, including the US.

For these reasons, it seems to me that good deals are to be had for both countries, while a trade war has the risk of tit-for-tat escalations that could have very harmful trade and capital flow implications for both countries and for the world. At the same time, I think and hope that both sides know this, and I believe that what is happening now is more for political show than for real threatening. The actual impacts of the tariffs that have been announced on the US-China trade balance will be very small. If tariffs are imposed as indicated, I would hope and expect the Chinese response to be small and symbolic so that both sides will have rattled their sabers without actually inflicting much harm. What will come after that will be more important. I wouldn’t expect it to amount to much anytime soon. If on the other hand we see an escalating series of tit for tats, then we should worry.

This Websight is only for Educational and Teaching. No recommendations to Buy or to Sell Securities or Assets in any form.

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