Janet Yellen: The Best Pick Pocket in the USA

By Tony Sagami

“Some of the experiences [in Europe] suggest maybe we can use negative interest rates.”
—William Dudley, President of the New York Federal Reserve Bank

“We see now in the past few years that it [negative interest rates] has been made to work in some European countries. So I would think that in a future episode that the Fed would consider it.”
—Ben Bernanke

“Indeed, I would be open to the possibility of reducing the fed funds target funds range even further, as a way of producing better labor market outcomes.”
—Narayana Kocherlakota, President of the Minneapolis Federal Reserve Bank

If you are planning to travel to any major European city, you better watch your wallet because there are thousands of very skilled pickpockets looking to separate you from your valuables. Those pickpockets, however, will only get away with however much money you have in your wallet. Sure, a pickpocket can throw a major monkey wrench into your vacation, but the amount these European thieves take from you is peanuts compared to what Fed head Janet Yellen wants to steal from your bank account.

While Wall Street experts and CNBC talking heads regularly debate the "will they or won’t they" interest rate liftoff, a more important question is whether or not the Federal Reserve will follow the European model of negative interest rates. Negative interest rates are nothing unusual in Europe as several central banks lowered key interest rates below 0%.

Yup, that means investors essentially pay a fee to park their money.

That parking fee just got higher last week when the European Central Bank cut its already negative deposit rate from minus 0.2% to minus 0.3%. The ECB also expanded is current quantitative easing program. The European Central Bank, the Swiss National Bank, and the Danish National Bank all have interest rates below zero. In fact, the Danes have held their overnight rates at negative 0.75% since 2012.

The Swiss, however, are the undisputed leaders of the negative interest rate experiment. The SNB first moved to negative rates in December 2014 and then dropped rates to negative 0.75% in January of this year. The Swiss National Bank, by the way, meets in a couple of days, on December 10, and is widely expected to cut rates again.

The question, of course, is how negative can interest rates go? Before the end of December, I expect deposit rates in Switzerland to be between -100bps and -125bps. Remember, we’re not talking about some backwater, third world countries here. Switzerland and Germany are two of the wealthiest countries in the world, as well as the home of major financial and political centers.

And I’m not just talking about short term paper either. Finland, Germany, France, Switzerland, and Japan are all selling five year debt with negative yields. In fact, Switzerland became the first country in history to sell benchmark 10 year debt at a negative interest rate in April.

Don’t think that negative interest rates can happen in the US? Wrong!

You may have missed it, but the United States is now also a member of the “0% club”—most recently in October, when it sold $21 billion worth of 3 month bills at 0% interest.

However, that is not the first time. Since 2008, the US government has held 46 Treasury bill auctions where yields have been zero. The next step after zero is negative… and it’s becoming a real possibility. Welcome to the European model of starving savers to death!

The implications for investors are monumental.

Ask yourself, what would you do with your money if your bank started to charge you to deposit it there? Would you pay hundreds, perhaps thousands of dollars a year just to keep your money in a bank?

Option #1: Hold your nose and pay the fees.
Option #2: Move those dollars into the stock market; perhaps into dividend paying stocks.
Option #3: Buy real estate; perhaps income generating real estate.
Option #4: Invest in collectibles, like art or classic cars.
Option #5: Stuff your money under a mattress.

The point I am trying to make is, the rules for successful income investing have completely changed. If you are living (or plan on living) off the earnings of your savings, you better adapt your strategy to the new world of negative interest rates…..or plan on working as a Walmart greeter during your golden years.

Even if you think I’m nuts about negative interest rates coming to the US, there is no doubt that interest rates are not climbing anytime soon.

According to the Federal Reserve.....
"The Committee anticipates that inflation will remain quite low in the coming months.”
“The stance of monetary policy will likely remain highly accommodative for quite some time after the initial increase in the federal funds rate.”

With the US national debt approaching $19 trillion, our government doesn’t have any choice but to keep interest rates low. Sadly, our politicians are paying for their spendthrift ways by starving responsible savers.
But you can (and should) fight back by changing the way you think about investing for income. You can start by giving my high yield income letter, Yield Shark, a risk free try with 90 day money back guarantee.


Tony Sagami

30 year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here.

To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

The article Connecting the Dots: Janet Yellen: The Best Pick Pocket in the USA was originally published at mauldineconomics.com

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Marin Katusa: 199 Days of Hell

By Marin Katusa, Chief Energy Investment Strategist

Just after I signed the publishing agreement for my first book, The Colder War, I realized how much research I was going to end up doing, specifically in areas that I never thought would be so integral to my subject area: energy and mining. Along the way, I came across some fascinating events that were completely out of my area of expertise but gave me a better sense for the unintended consequences in an historical perspective of the events that led to where we are today.

One epic event that really stood out for me, which I will discuss today, is the bloodiest battle of all time, to my knowledge. Over 2 million soldiers and civilians died in this one battle that lasted 199 days from start to finish. (If you know of one particular battle—not a war—that had more deaths, I would love to hear about it)

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What was the catalyst for the bloodiest and most horrible battle of all time? Oil. Before I get into why it was, I want to present the events that led up to this epic battle.

In 1939, Hitler and Stalin signed the German-Soviet Nonaggression Pact. Hitler focused on Western Europe and on defeating France by the mid 1940s, he became rattled by Soviet expansion in the East, which by this time included the occupation of the Baltic states (now Estonia, Latvia, and Lithuania) by the Soviets.

The Day That Changed the World

A critical, often forgotten event (especially by the French) occurred on June 22, 1940. That was the day the French surrendered to the Nazis and signed the armistice. Four days later, the Soviet Union made a decision that ended up becoming one of the critical turning points of WW II.

Initially, the Soviets planned on annexing parts of Romania via full-scale invasion. Sound familiar? I’ll touch on Crimea later in my missive, but for now, stick with me—this gets very interesting.

However, the military masters of the Soviet Union recognized that with the fall of France, out went the French guarantee of security at Romania’s borders.

So rather than actually invading Romania, the Soviets sent an ultimatum to Romania: withdraw from our territories of interest—which were Northern Bukovina and Northern and Southern Bessarabia—and avoid military conflict with the Soviet Union. If not, the Red Army will invade.

Germany via the 1939 German-Soviet Nonaggression Pact recognized the Soviet Union’s interest in Bessarabia; thus Hitler became paranoid about the Soviet Union’s expansion from the east to Central Europe. But more specifically, Hitler feared the proximity of the Russians to the Romanian oil fields, which the Nazis depended on.

By early August 1940, these territories that Romania withdrew from made up the Moldavian Soviet Socialist Republic, and they were quickly folded into the Soviet Union.

By late 1940, Hitler made the decision that I believe was a critical turning point of WW II. Initially, Hitler planned on invading the Soviet Union in May 1941, but Yugoslavia and Greece got in his way, and his plans were delayed by five weeks until the Nazis defeated those armies in the Balkans.

The Russian winter came early in 1941, but Hitler believed that the Nazi Germany army was much superior to the Red Army (and they were more superior at the time) and that the Soviets would be defeated before November 1941.

The Nazis sent 3 million soldiers. Stalin met the Nazi offensive with over 5 million Soviet soldiers. I don’t know of a larger invasion in the history of mankind.

To put this battle in perspective, it’s the equivalent of battle lines spanning from Florida to New York (over 1,100 miles). Also, over 90% of all Nazi casualties in WW II were due to their invasion of the Soviet Union.
By late July 1941, the Nazis fought their way within 200 miles of Moscow; by this time, they had progressed over 400 miles into the Soviet Union in less than a month.

Initially, the Germans made incredible progress. However, heavy rains in early July hampered their speed as the terrain became a mud bath, and by this point, Stalin ordered a scorched earth policy, where the Soviet troops destroyed all infrastructure, burned all crops, and dismantled and evacuated all factories and equipment via rail to the east upon the Nazi advance.

As winter set in, the progress of the Nazis came to a standstill. On December 7, 1941, Japan bombed Pearl Harbor and subsequently, the United States joined the Allies and entered WW II.

Hitler was well aware that the biggest priority of the Americans upon entering WW II was to defeat the Nazis. He knew he had to bring a quick defeat to the Soviet Union and drastic measures had to be taken.
Hitler believed that rather than attacking Moscow (the heavily fortified capital of the Soviet Union), Germany should go after the Soviet oil fields in the Caucasus. For Hitler, the victory would result in a triple positive for Germany:

1. Cut off the flow of oil to the Soviet resistance;

2. Divert the oil produced from the oil fields in Caucasus for the Nazi cause and for future battles against the Americans; and

3. Cut off Soviet access to the breadbasket areas of Ukraine.

To execute Hitler’s plan, the Nazis would have to control a key industrial city, which happened to be named after Soviet leader Joseph Stalin: Stalingrad (today known as Volgograd). The Nazis invaded, and Stalin threw everything the Red Army had at this battle, even refusing to allow the civilian population to be evacuated. He believed the soldiers would fight to their death if civilians were in the city.

He was right. Stalin’s ruthless orders worked. The Red Army, including civilians who worked in factories made up of men and women of all ages, put up a ferocious resistance doing whatever possible. The Germans had superior weapons, training, and land and air support. To put things in perspective, the average Soviet soldier, upon arriving to Stalingrad, had less than one day’s life expectancy.

The battle eventually evolved into concrete guerilla warfare within the city ruins. The Nazis captured 90% of the city by September 1942 and by this time, they took over 3 million Soviet prisoners of war, most of which never returned alive.

The Soviets’ luck changed on November 19, 1942, when they decided to launch Operation Uranus, which many at the time within the Red Army believed would be their last chance to defeat the Nazis. With 90% of Stalingrad under Nazi command, the Soviet plan was to swing multiple army troops around the Nazis and surround them. It worked.

Up to this point, Hitler publicly made announcements that the Germans would never leave Stalingrad. For most of the German soldiers, this proved to be true. Rather than having the German troops attempt a breakout (and going against Hitler’s promise of Germany never leaving Stalingrad), they were ordered to fight, even though they were running low on ammunition and starvation had set in within the German camp.

On January 31, 1943, German Field Marshal Friedrich Paulus surrendered to the Soviets. After the Nazi defeat in Stalingrad by the Soviets, it was only a matter of time before Germany lost the war. Hitler never got access to the oil fields, and over 2 million soldiers died.

Déjà Vu and the Butterfly Effect

Let’s reflect back to the events that followed. Hitler became paranoid about the Soviet expansion after the signed 1939 German-Soviet Nonaggression Pact.

Remind you of anything?

We see NATO today supplying military troops and land and air force in the Baltics for similar fears about Russian expansion. NATO sees Crimea today as a reminder of the Baltics’ situation in 1940. Ukraine is not in a civil war—let’s make that very clear. A civil war is defined as two or more groups fighting for control of the government. What’s going on in eastern Ukraine is not a civil war, but rather a war of secession; the two breakaway provinces don’t want to go to Kiev. Furthermore, NATO will not stand for a secession.

Putin is facing sanctions from the West and military force by NATO… not to mention that oil has dropped in half from over $100/bbl to under $50 a barrel in the last 12 months. Hitler’s decision, based on actions that essentially involved a small territory (now known as Moldova) sandwiched between Romania and Ukraine, resulted in the bloodiest battle of all time.

But behind the scenes there is always tension and momentum building and waiting for a catalyst to release the pressure that has built up. We have seen this many times in the past where an insignificant event on the global stage puts in motion events with shocking results. But there is always more behind the story than a “simple” catalyst or unconnected events.

The Arab Spring eventually brought to the global front a built-up dissatisfaction of many youths and lower-income people of human rights violations, dictatorships, absolute monarchy, extreme poverty, and many other factors. The catalyst for the protests in Tunisia was the self-immolation of Mohamed Bouazizi in 2010.
I recall a specific event I experienced in Kuwait in December 2010, where a Pakistani taxi driver shared with me his story of anger and contempt with the government of Kuwait. I asked him to be my driver for the week, mainly because he spoke English and had been in Kuwait for 10 years and knew his way around, but I also enjoyed his company.

But I got much more than I expected. He took me around Kuwait, where I saw the good, the bad, and the ugly. Every city in the world has those areas you will never see advertised in the travel guidebooks.

Kuwait—a “dry country,” meaning you cannot buy alcohol—wasn’t that difficult to find alcohol in if you really wanted it. Yet at what seemed to me to be every hour on the hour, I heard prayers blasting through the air. My taxi driver wasn’t an extremist; he was Muslim—and no different than any Catholic, Jew, or atheist—working his cab 12-15 hours a day, wanting a better life for his family. He was a good guy, caught up in the momentum that was building, which led to the Arab Spring.

The spread of the Arab Spring was muted by high oil prices. That is fact, though not a popular one. How did Saudi Arabia prevent protests in its kingdom? The House of Saud promised tens of billions of dollars in social programs.

How will the oil producing nations, such as members of OPEC, Russia, Canada, and Mexico, fare at $45 oil in 2015? How will the African petro-states function? How will the investors, who are exposed to billions of dollars of debt in the US energy sector (below is the payment schedule of all public companies’ debt payments due over the next 11 years), going to fare if oil stays below $50 in 2015?

History doesn’t repeat, but human nature has a repeatable pattern. The growth for energy will only increase in the future, even with energy efficiency improvements.

The fact is, the world will consume more oil in five years than it does today… even though I get many emails a day from uninformed individuals telling me why fossil fuels are awful (and yes, to the 100+ people who have emailed stating that Tesla cars will kill the need for oil—keep on dreaming. And by the way, your Tesla is on average powered over 50% by coal and natural gas—so you all are absolute hypocrites).

The world still needs uranium to power its nuclear base-load power, such as the US, which is currently the world’s largest consumer of uranium, using about 25% of the world’s uranium. China won’t be far behind, and it’s catching up quickly.

You Need to Be Brave When Everyone Is Fearful

Investing isn’t easy. If you want to do well in cyclical sectors, such as energy or mining, you must be able to buy when the sector is unloved and beaten down. Unfortunately, from a psychology standpoint, it’s easier to buy when it feels good.

Here is a list of rules of speculation I like to follow:

1. Never put more than 10% of your speculative portfolio into any one stock. True success in speculation is only achieved with risk mitigation and letting your winners ride. While putting all your eggs in one basket theoretically can pay off in a big way, it rarely does so in reality. If your speculative portfolio is worth $50,000, don’t put more than $5,000 into any one junior.

2. If, for whatever reason, an investment causes you stress to the point that you cannot sleep or are overly distracted from your daily life, sell enough stock to alleviate the situation. Life is too short. Have fun. If your stress level becomes intolerable, you’re either overinvested or speculating just isn’t for you. That’s okay; you’ve found out more about yourself. Speculation is a journey where the reward is money and the experience, but it’s not for everyone. If your wife, husband, family, or partner is hating you because you lost the family’s vacation money, look back to Rule 1.

3. Know what you own and why you own it. The Casey Energy Report posts all relevant news about the companies in our portfolio every Monday and Thursday after market close.

4. Use trailing stops and stop losses. For liquid stocks, they’re important, in my opinion. We work to create for you a balanced portfolio of high-risk speculations along with mid risk and lower risk yield plays, and we lock in gains along the way.
   
   The current market is exciting but carries a significant level of volatility. We want to be able to capture the upside and hold on to it, which is best accomplished by locking in gains with trailing stops (we did this very well earlier in 2014). Then we can sit patiently on the sidelines and await a general correction that allows us to get back into our favorite stocks, which we are currently doing.
   
   There’s a big difference between a trailing stop and stop loss. A stop loss limits losses. It’s the price you set to sell your stock in case the trade goes south on you. A standard stop loss is a sell order that’s automatically triggered if the security falls 20% (or whatever you put in for your stop-loss percentage) below your purchase price. For example, if you bought a stock for $10 and you put in a 20% stop loss, it would be $8, at which point you would lose $2. Unfortunately, stop losses (and trailing stops) don’t work for illiquid juniors, so be careful. That’s why Rule 3 above is so important.
   
   A trailing stop locks in your gains. Let’s say you paid $10 for a stock, and it goes to $14. If you’d be happy to sell at $13 and pocket $3 per share in profit, then that’s where you set your trailing stop, in case the price retreats to that level. Of course, if the stock continues to push higher, you can always move your stop along with it, to capture even more profit.
   
   Many of our trailing stops were hit in early to mid-2014, a good indicator that we’ve been right to be careful amid this market’s volatility.

5. Give your speculation some time to play out, as with trends like the European Energy Renaissance. Such speculations demand that the investor wait for the market to catch on to the potential. This one specific rule—be patient—is probably the most difficult of all to stick to. A speculator is his or her own worst enemy.

6. Risk mitigation. Reduce your risk while preserving profit by using the Casey Free Ride formula when the opportunity arises. It’s prudent speculation.

Getting Your Casey Free Ride

Number of shares to sell =	Purchase price of stock	x Number of shares bought
	Stock price when you want to sell

7. Know that you’ll make mistakes, and that will result in losing money on that trade. Not every trade will be a winner. But if one or two of the junior high-risk speculations work out, they will make the whole journey more than worthwhile. I’m speaking from personal experience.

This is just a short list of many of the rules to speculation.

With oil at $45 per barrel, could there be massive changes that many aren’t expecting?

Definitely.

If you’ve been a subscriber of mine, you know how cautious I’ve been since early to mid-2014 on the price of oil.

What’s Next in the Energy Sector?

In the past four months, I’ve personally invested more cash than I have in the last four years. Could I be wrong? You bet I could, but this is not my first downturn.

I also believe in not owning too many positions, as I don’t have many positions either personally nor in the Casey Energy Report. I follow a very disciplined approach, and my style isn’t for everyone. I’ll be the first to acknowledge that fact.

If you’re looking for a newsletter that recommends a stock every month on the month and has 50 stocks in its portfolio, I’m not your guy.

But if you’re looking for in-depth research, experience, and exposure to my vast network in the resource sector, then you may want to pay attention to what I’m doing.

There’s blood in the streets in the energy sector—and I love that!

Now if you believe that to be successful in the resource sector one must be a contrarian to be rich, as I do, now is the time to become engaged.

Come see what I am doing with my own money. You’ll get access to every Casey Energy Report newsletter I’ve written in the last decade, and my current recommendations with specific price and timing guidance. It’s all available right here.

I can’t make the trade for you, but I can help you help yourself. I’m making big bets—are you ready to step up and join me?

The article 199 Days of Hell was originally published at caseyresearch.com.

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How Global Interest Rates Deceive Markets

By John Mauldin

 “You keep on using that word. I do not think it means what you think it means.”

– Inigo Montoya, The Princess Bride

“In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

“Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.”

– From an 1850 essay by Frédéric Bastiat, “That Which Is Seen and That Which Is Unseen”

All right class, it’s time for an open book test. I’m going to give you a list of yields on various 10 year bonds, and I want to you to tell me what it means.

United States: 1.80%

Germany: 0.36%

France: 0.54%

Italy: 1.56%

UK: 1.48%

Canada: 1.365%

Australia: 2.63%

Japan: 0.22%

I see that hand up in the back. Yes, the list does appear to tell us what interest rates the market is willing to take in order to hold money in a particular country’s currency for 10 years. It may or may not tell us about the creditworthiness of the country, but it does tell us something about the expectations that investors have about potential returns on other possible investments. The more astute among you will notice that French bonds have dropped from 2.38% exactly one year ago to today’s rather astonishing low of 0.54%.

Likewise, Germany has seen its 10-year Bund rates drop from 1.66% to a shockingly low 0.36%. What does it mean that European interest rates simply fell out of bed this week? Has the opportunity set in Europe diminished? Are the French really that much better a credit risk than the United States is? If not, what is that number, 0.54%, telling us? What in the wide, wide world of fixed-income investing is going on?

Quick segue – but hopefully a little fun. One of the pleasures of having children is that you get to watch the classic movie The Princess Bride over and over. (If you haven’t appreciated it, go borrow a few kids for the weekend and watch it.) There is a classic line in the movie that is indelibly imprinted on my mind.
In the middle of the film, a villainous but supposedly genius Sicilian named Vizzini keeps using the word “inconceivable” to describe certain events. A mysterious ship is following the group at sea? “Inconceivable!”

The ship’s captain starts climbing the bad guys’ rope up the Cliffs of Insanity and even starts to gain on them? “Inconceivable!” The villain doesn’t fall from said cliff after Vizzini cuts the rope that all of them were climbing? “Inconceivable!” Finally, master swordsman – and my favorite character in the movie – Inigo, famous for this and other awesome catchphrases, comments on Vizzini’s use of this word inconceivable:

“You keep on using that word. I do not think it means what you think it means.”

(You can see all the uses of Vizzini’s use of the word inconceivable and hear Inigo’s classic retort here.)
When it comes to interpreting what current interest rates are telling us about the markets in various countries, I have to say that I do not think they mean what the market seems to think they mean. In fact, buried in that list of bond yields is “false information” – information so distorted and yet so readily misunderstood that it leads to wrong conclusions and decisions – and to bad investments. In today’s letter we are going to look at what interest rates actually mean in the modern-day context of currency wars and interest-rate manipulation by central banks. I think you will come to agree with me that an interest rate may not mean what the market thinks it means.

Let me begin by briefly summarizing what I want to demonstrate in this letter. First, I think Japanese interest rates not only contain no information but also that markets are misreading this non-information as meaningful because they are interpreting the data as if it were normal market information in a familiar market environment, when the truth is that we sailed beyond the boundaries of the known economic world some time ago. The old maps are no longer reliable. Secondly, Europe is making the decision to go down the same path as the Japanese have done; and contrary to the expectations of European central bankers, the potential to end up with the same results as Japan is rather high.

The false information paradox is highlighted by the recent Swiss National Bank decision. Couple that with the surprise decisions by Canada and Denmark to cut rates, the complete retracement of the euro against the yen over the past few weeks, and Bank of Japan Governor Kuroda’s telling the World Economic Forum in Davos that he is prepared to do more (shades of “whatever it takes”) to create inflation, and you have the opening salvos of the next skirmish in the ongoing currency wars I predicted a few years ago in Code Red. All of this means that capital is going to be misallocated and that the current efforts to create jobs and growth and inflation are insufficient. Indeed, I think those efforts might very well produce a net negative effect.

But before we go any farther, a quick note. We will start taking registrations for the 12^th annual Strategic Investment Conference next week. There will be an early bird rate for those of you who go ahead to register quickly. The conference will run from April 29 through May 2 at the Manchester Grand Hyatt in San Diego.

For those of you familiar with the conference, there will be the “usual” lineup of brilliant speakers and thought leaders trying to help us understand investing in a world of divergence. For those not familiar, this conference is unlike the vast majority of other investment conferences, in that speakers representing various sponsors do not pay to address the audience. Instead, we bring in only “A list” speakers from around the world, people you really want to meet and talk with. This year we’re going to have a particularly large and diverse group of presenters, and we structure the conference so that attendees can mingle with the speakers and with each other.

I am often told by attendees that this is the best economic and investment conference they attend in any given year. I think it is a measure of the quality of the conference that many of the speakers seek us out. Not only do they want to speak, they want to attend the conference to hear and interact with the other speakers and conference guests. This conference is full of speakers that other speakers (especially including myself) want to hear. And you will, too. Save the date and look for registration and other information shortly in your mail.
Now let’s consider what today’s interest rates do and do not mean as we navigate uncharted waters.

Are We All Turning Japanese?

Japan is an interesting case study. It’s a highly developed nation with a very sophisticated culture, increasingly productive in dollar terms (although in yen terms nominal GDP has not moved all that much), and carrying an unbelievable 250% debt to GDP burden, but with a 10 year bond rate of 0.22%, which in theory could eventually mean that the total interest expenses of Japan would be less than those of the US on 5 - 6 times the amount of debt. Japan has an aging population and a savings rate that has plunged in recent years.

The country has been saddled with either low inflation or deflation for most of the past 25 years. At the same time, it is an export power, with some of the world’s most competitive companies in automobiles, electronics, robotics, automation, machine tools, etc. The Japanese have a large national balance sheet from decades of running trade surpluses. If nothing else, they have given the world sushi, for which I will always hold them in high regard.

We talk about Japan’s “lost decades” during which growth has been muted at best. They are just coming out of a triple dip recession after a disastrous downturn during the Great Recession. And through it all, for decades, there is been a widening government deficit. The chart below shows the yawning gap between Japanese government expenditures and revenues.



This next chart, from a Societe Generale report, seems to show that the Japanese are financing 40% of their budget. I say “seems” because there is a quirk in the way the Japanese do their fiscal accounting. Pay attention, class. This is important to understand. If you do not grasp this, you will not understand Japanese budgets and how they deal with their debt.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best selling author, and Chairman of Mauldin Economics – please click here.

The article Thoughts from the Frontline: How Global Interest Rates Deceive Markets was originally published at mauldineconomics.com

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German Chancellor Merkel Won’t Let Ukraine Get in the Way of Business

By Marin Katusa, Chief Energy Investment Strategist

The Ukraine crisis has moderated for now, but it should have awakened the world to the new “great game” being played in Eastern Europe. Vladimir Putin is positioning Russia to control the global energy trade, knowing that he holds the trump card: Europe’s dependence on Russian oil and gas.

This epic struggle between the US and Russia could change the very nature of the Euro-American trans Atlantic alliance, because Europe is going to have to choose sides.

The numbers in Putin’s OIL = POWER equation are only going to keep getting bigger as Russia’s control and output of energy continues to grow and as Europe’s supply from other sources dwindles—as I outline in my new book, The Colder War. Finland and Hungary get almost all their oil from Russia; Poland more than 75%; Sweden, the Czech Republic, and Belgium about 50%; Germany and the Netherlands, upward of 40%.

Cutting back on energy imports from Russia as a means of pressuring Moscow is hardly in the EU’s best interest.

Germany, the union’s de facto leader, has simply invested too much in its relationship with Putin to sever ties—which is why Chancellor Angela Merkel has blocked any serious sanctions against Russia, or NATO bases in Eastern Europe.

In fact, Germany is moving to normalize its relations with Russia, which means marginalizing the Ukrainian showdown. Ukraine is but a very small part of Moscow’s and Berlin’s plans for the 21^st century. Though the U.S. desperately wants Germany to lean Westward, it has instead been pivoting East. It’s constructing an alliance that will ultimately elbow the US out of Eastern and Central Europe and consign it to the status of peripheral player. (The concept of the “pivot “ in geopolitics was advanced by the celebrated early 20^th century English geographer Halford Mackinder with regard to Russia’s potential to dominate Europe and Asia because it forms a geographical bridge between the two.

Mackinder’s “Heartland Theory” argued that whoever controlled Eurasia would control the world. Such a far flung empire might come into being if Germany were to ally itself with Russia. It’s a doctrine that influenced geopolitical strategists through both World Wars and the Cold War. It was even embraced by the Nazis before Russia became an enemy. And it may still be relevant today—despite the historical animosities between the two countries. After all, the mutually beneficial alliance of a resource-hungry Germany with a resource-rich Russia is a logical one.)

Considering the deepening ties between Russia and Germany in recent years, the real motive for the US’s stoking of unrest in Ukraine may not have been to pull Ukraine out of Russia’s sphere of influence and into the West’s orbit—it may have been primarily intended to drive a wedge between Germany and Russia.

The US almost certainly views the growing trade between them—3,000 German companies have invested heavily in Russia—as a major geopolitical threat to NATO’s health. The much-publicized spying on German politicians by the US and the British—and Germany’s reciprocal surveillance—shows the level of mutual distrust that exists.

If sowing discord between Russia and Germany was America’s goal, the implementation of sanctions might look like mission accomplished. Appearances can be deceptive, though.

Behind the scenes, Germany and Russia maintain a cordial dialogue, made all the easier because Vladimir Putin and Angela Merkel get along well on a personal level. They’re so fluent in each other’s languages that they correct their interpreters. They often confer about the possibility of creating a stable, prosperous and secure Eurasian supercontinent.

Despite the sanctions, German and Russian businessmen are still busy forging closer ties. At a shindig in September for German businesses in the North-East and Russian companies from St. Petersburg, Gerhard Schröder—former German prime minister and president, and friend of Putin—urged his audience to continue to build their energy and raw-material partnership.

Schröder’s close personal relationship with Putin is no secret. He considers the Russian president to be a man of utmost trustworthiness, and his Social Democratic Party has always been wedded to Ostpolitik (German for “new Eastern policy”), which asserts that his country’s strategic interest is to bind Russia into an energy alliance with the EU.

Schröder would have us believe that they never talk politics. Yet in his capacity as chair of the shareholders’ committee of Gazprom’s Nord Stream—the pipeline laid on the Baltic seabed which links Germany directly to Russian gas—he continues to advocate for a German-Russian “agreement.”

That’s a viewpoint Merkel shares. In spite of her public criticism of Putin’s policy toward Ukraine, Merkel has gone out of her way to play down any thought of a new Cold War. She’s on the record as wanting Germany’s “close partnership” with Russia to continue—and she’s convinced it will in the not-so-distant future.

Though Merkel has rejected lifting sanctions against Russia and continues to publicly call on Putin to exert a moderating influence on pro-Russian Ukrainian separatists, it looks like Germany is seeking a reasonable way out. That makes sense, given the disproportionate economic price Germany is paying to keep up appearances of being a loyal US ally.

Politicians in Germany are alert to the potential damage an alienated Russia could inflict on German interests. Corporate Germany is getting the jitters as well, and there are a growing number of dissenting voices in that sector. And anti-American sentiment in Germany—which is reflected in the polls—is putting added pressure on Berlin to pursue a softer line rather than slavishly following Washington’s lead in this geopolitical conflict.
With the eurozone threatened by a triple dip recession, expect Germany and the EU to act in their own interests. Germany has too much invested in Russia to let Ukraine spoil its plans.

As you can see, there’s no greater force controlling the global energy trade today than Russia and Vladimir Putin. But if you understand his role in geopolitics as Marin Katusa does, you’ll know how he’s influencing the flow of the capital in the energy sector—and which companies and projects will benefit and which will lose out.

Of course, the situation is fluid, which is why Marin launched a brand new advisory dedicated to helping investors get out in front of the latest chess moves in this struggle and make a bundle in the process.
It’s called The Colder War Letter. And it’s the perfect complement to Marin’s New York Times best-seller, The Colder War, and the best way to navigate and profit in the fast changing new reality of the energy sector. When you sign up now, you’ll also receive a FREE copy of Marin’s book. Click here for all the details.

The article German Chancellor Merkel Won’t Let Ukraine Get in the Way of Business was originally published at casey research

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Paper Gold and Its Effect on the Gold Price

By Bud Conrad, Chief Economist

Gold dropped to new lows of $1,130 per ounce last week. This is surprising because it doesn’t square with the fundamentals. China and India continue to exert strong demand on gold, and interest in bullion coins remains high.

I explained in my October article in The Casey Report that the Comex futures market structure allows a few big banks to supply gold to keep its price contained. I call the gold futures market the “paper gold” market because very little gold actually changes hands. $360 billion of paper gold is traded per month, but only $279 million of physical gold is delivered. That’s a 1,000-to-1 ratio:

Market Statistics for the 100-oz Gold Futures Contract on Comex
	Value ($M)
Monthly volume (Paper Trade)	$360,000
Open Interest All Contracts	$45,600
Warehouse-Registered Gold (oz)	$1,140
Physical Delivery per Month	$279
House Account Net Delivery, monthly	$41

We know that huge orders for paper gold can move the price by $20 in a second. These orders often exceed the CME stated limit of 6,000 contracts. Here’s a close view from October 31, when the sale of 2,365 contracts caused the gold price to plummet and forced the exchange to close for 20 seconds:

Many argue that the net long term effect of such orders is neutral, because every position taken must be removed before expiration. But that’s actually not true. The big players can hold hundreds of contracts into expiration and deliver the gold instead of unwinding the trade. Net, big banks can drive down the price by delivering relatively small amounts of gold.

A few large banks dominate the delivery process. I grouped the seven biggest players below to show that all the other sources are very small. Those seven banks have the opportunity to manage the gold price:

After gold’s big drop in October, I analyzed the October delivery numbers. The concentration was even more severe than I expected:

This chart shows that an amazing 98.5% of the gold delivered to the Comex in October came from just three banks: Barclays; Bank of Nova Scotia; and HSBC. They delivered this gold from their in house trading accounts.

The concentration was even worse on the other side of the trade—the side taking delivery. Barclays took 98% of all deliveries for customers. It could be all one customer, but it’s more likely that several customers used Barclays to clear their trades. Either way, notice that Barclays delivered 455 of those contracts from its house account to its own customers.

The opportunity for distorting the price of gold in an environment with so few players is obvious. Barclays knows 98% of the buyers and is supplying 35% of the gold. That’s highly concentrated, to say the least. And the amounts of gold we’re talking about are small—a bank could tip the supply by 10% by adding just 100 contracts. That amounts to only 10,000 ounces, which is worth a little over $11 million—a rounding error to any of these banks. These numbers are trivial.

Note that the big banks were delivering gold from their house accounts, meaning they were selling their own gold outright. In other words, they were not acting neutrally. These banks accounted for all but 19 of the contracts sold. That’s a position of complete dominance. Actually, it’s beyond dominance. These banks are the market.

My point is that this market is much too easily rigged , and that the warnings about manipulation are valid. At some point, too many customers will demand physical delivery and there will be a big crash. Long contracts will be liquidated with cash payouts because there won’t be enough gold to deliver. I saw a few squeezes in my 20 years trading futures, including gold. In my opinion, the futures market is not safe.

The tougher question is: for how long will big banks’ dominance continue to pressure gold down?

Unfortunately, I don’t know the answer. Vigilant regulators would help, but “futures market regulators” is almost an oxymoron. The actions of the CFTC and the Comex, not to mention how MF Global was handled, suggest that there has been little pressure on regulators to fix this obvious problem.

This quote from a recent Financial Times article does give some reason for optimism, however:

UBS is expected to strike a settlement over alleged trader misbehaviour at its precious metals desks with at least one authority as part of a group deal over forex with multiple regulators this week, two people close to the situation said. … The head of UBS’s gold desk in Zurich, André Flotron, has been on leave since January for reasons unspecified by the lender…..

The FCA fined Barclays £26m in May after an options trader was found to have manipulated the London gold fix.

Germany’s financial regulator BaFin has launched a formal investigation into the gold market and is probing Deutsche Bank, one of the former members of a tarnished gold fix panel that will soon be replaced by an electronic fixing.

The latter two banks are involved with the Comex.

Eventually, the physical gold market could overwhelm the smaller but more closely watched U.S. futures delivery market. Traders are already moving to other markets like Shanghai, which could accelerate that process. You might recall that I wrote about JP Morgan (JPM) exiting the commodities business, which I thought might help bring some normalcy back to the gold futures markets. Unfortunately, other banks moved right in to pick up JPM’s slack.

Banks can’t suppress gold forever. They need physical gold bullion to continue the scheme, and there’s just not as much gold around as there used to be. Some big sources, like the Fed’s stash and the London Bullion Market, are not available. The GLD inventory is declining.

If a big player like a central bank started to use the Comex to expand its gold holdings, it could overwhelm the Comex’s relatively small inventories. Warehouse stocks registered for delivery on the Comex exchange have declined to only 870,000 ounces (8,700 contracts). Almost that much can be demanded in one month: 6,281 contracts were delivered in August.

The big banks aren’t stupid. They will see these problems coming and can probably induce some holders to add to the supplies, so I’m not predicting a crisis from too many speculators taking delivery. But a short squeeze could definitely lead to huge price spikes. It could even lead to a collapse in the confidence in the futures system, which would drive gold much higher.

Signs of high physical demand from China, India, and small investors buying coins from the mint indicate that gold prices should be rising. The GOFO rate (London Gold Forward Offered rate) went negative, indicating tightness in the gold market. Concerns about China’s central bank wanting to de-dollarize its holdings should be adding to the interest in gold.

In other words, it doesn’t add up. I fully expect currency debasement to drive gold higher, and I continue to own gold. I’m very confident that the fundamentals will drive gold much higher in the long term. But for now, I don’t know when big banks will lose their ability to manage the futures market.

Oddities in the gold market have been alleged by many for quite some time, but few know where to start looking, and even fewer have the patience to dig out the meaningful bits from the mountain of market data available. Casey Research Chief Economist Bud Conrad is one of those few—and he turns his keen eye to every sector in order to find the smart way to play it.

This is the kind of analysis that’s especially important in this period of uncertainty and volatility… and you can put Bud’s expertise—along with the other skilled analysts’ talents—to work for you by taking a risk-free test-drive of The Casey Report right now.

The article Paper Gold and Its Effect on the Gold Price was originally published at casey research

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The Madness of the EU’s Energy Policy

By Marin Katusa, Chief Energy Investment Strategist

The stakes couldn’t be higher. Vladimir Putin has launched a devastating plan to turn Russia into an energy powerhouse. And Europe, dependent on Russian natural gas and oil for a third of its fuel needs, has fallen right into his hands: Putin can bend the EU to his will simply by twisting the valve shut.

Considering how precarious Europe’s economic security is, one would have thought that now would be a good time for the EU to reassess its energy policy and address the effect crippling energy costs are having on its struggling economy. But the EU is never going to agree to a rational reappraisal of its policies, because eco-loons like its new energy commissioner, Violetta Bulc, have taken over the asylum.

A practicing fire walker and a shaman, she’s the sort of airy fairy Goddard College type who only believes in the power of “positive energy.” What will guide us in this frightening new era is, according to her blog, the spirit of the White Lions:

The Legend says that White Lions are star beings, uniting star energy within earth form of Lions. The native ancestors were convinced that they are children of the Sun God, thus embodying Solar Logos and legends say that they came down to Earth to help save humanity at a time of crisis. There is no doubt that this time is right now.

With the European Commission stuffed with green anti capitalist zealots, it’s not surprising that the EU’s response to the challenges of a resurgent Russia is a complete break with reality.

The EU has come up with an aggressive climate plan—just like Obama’s. In defiance of all logic—if not Putin—it’s agreed to cut greenhouse gas emissions by 40% and make clean energy, like wind and solar, 27% of overall energy use by 2030. Instead of guaranteeing the “survival of mankind,” this would cause the extinction of Europe’s industry—unless there’s a secret plan to massively expand nuclear power.

Fortunately for Europe, its leaders haven’t yet lost all their marbles.

These climate goals are just a bargaining chip in the runup to next year’s UN climate summit in Paris. They’re not legally binding. Unless the whole world commits to an equally radical policy of deindustrialization—which seems rather unlikely to say the least—the EU will “review” its climate targets.

This is just as well. In trying to meet the so-called 20:20 target—a 20% reduction in emissions by 2020—Germany and the UK have already discovered that renewable energy is too costly to maintain a competitive industry. As electricity prices skyrocket, Germany’s industrial giants are either having their power costs subsidized or are relocating to the US.

Both countries are struggling with the inability of wind and solar energy to provide reliable baseload power, which is threatening to cause blackouts.

The UK is putting its faith in fracking—and has managed to head off any EU legislation to ban shale-gas. But Germany and its fellow travelers, who have no qualms about reverting to coal, are simply overriding the EU Commission and its zero emissions utopia.

Knowing that EU climate policy would destroy international competitiveness and crush their economies, Poland, which depends on coal for 90% of its energy needs, and other low-income countries have taken a different approach. They've forced the Commission to give them special exemptions from any emissions reduction plan.

Unlike in the U.S.—where Obama is taking executive action to wipe out the coal industry—lignite, or brown coal, is set to become an increasingly important part of Europe’s energy supply, as it is in much of the rest of the world. There are 19 new lignite power stations in various stages of approval and construction in Bulgaria, Czech Republic, Greece, Germany, Poland, Romania, and Slovenia. When completed, these will emit nearly as much CO₂ as the UK.

Which is ironic. The UK is the only member of the EU to have been insane enough to impose a legally binding carbon dioxide reduction target intended to take it to 80 percent of 1990 levels by 2050. It’s also the only modern industrial nation where there’s serious talk of World War II style energy rationing.

As you’ll discover in my new book, The Colder War, Europe and America need to wake up. They’ve never been so economically vulnerable. The time for indulging environmental fantasies and putting one’s faith in White Lions is over—unless, that is, you want to see Putin controlling the world.

Click here to get your copy of my new book. Inside, you’ll discover exactly how Putin is orchestrating a takeover of the global energy trade, what it means for the future of America, and how it will directly affect you and your personal savings.

The article The Madness of the EU’s Energy Policy was originally published at casey research

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Gold: Time to Prepare for Big Gains?

By Casey Research

Years of a severe downturn in the gold market have left very few bulls to speak out in favor of the yellow metal. Here are some positive opinions on the future of the precious metal, from the recently concluded Casey Research Fall Summit.

David Tice, founder of the Prudent Bear Fund, believes we are heading for a “global currency reset” that will reduce the role of the dollar in global trade. Central banks, he says, don’t possess all the gold they claim to, and the unwinding of the paper gold market probably isn’t far down the road—it could even ignite the next major crisis.

The paper gold market (for example, exchange-traded funds like GLD) has massive leverage, with a ratio of 90:1 or 100:1 of paper claims on gold bullion. If only a small fraction of owners convert their paper to physical gold, says Tice, it will create a “no bid” price environment and cause the price of gold to explode.
He believes that once the paper gold market collapses, gold will be priced on the basis of supply/demand for the physical metal—which means it could be headed for $3,000 to $8,000 per ounce.

Ed Steer, editor of Casey Research’s popular e-letter Gold and Silver Daily, is equally bullish on gold… in the long term, because right now, he believes the gold market to be rigged: “Central banks intervene; that’s what they do.”

They control not only gold, but also silver, platinum, palladium, copper, and oil. He says there are two possible reasons that Germany hasn’t gotten its gold back that it had stored in the U.S. — either the gold doesn’t exist or there’s so much paper written against it that it can’t be moved for collateral reasons.

While there’s not much an investor can do about gold manipulation, Steer believes that the manipulators’ schemes will blow up in their faces sooner than later.

Summit regular Rick Rule, chairman of Sprott US Holdings, isn’t worried about the bear market in gold.
“What matters is your response to the bear market,” he says. “If you have the wits, courage, knowledge, and cash to take advantage of them, bear markets are great.”

He’s keeping his eyes peeled on junior gold mining stocks, which, he says, are hugely attractive right now.
“Our market has fallen by 75% in three years. That means it’s 75% more attractive than in 2010, when we were all in love with it. Within a few years, we’ll look back on today’s low prices as the good old days.”
Louis James, chief investment strategist of Casey’s Metals & Mining division, also welcomes the opportunities to buy low that the current slump in gold prices provides.

He personally owns stock of three of the junior miners present in the Map Room at the Casey Fall Summit. All three of them have exceptionally high-grade projects that are delivering what they promised.

To get all of Louis James’ stock picks (and those of the other speakers), as well as every single presentation of the Summit, order your 26+-hour Summit Audio Collection now. It’s available in CD and/or MP3 format. Learn more here.

The article Gold: Time to Prepare for Big Gains? was originally published at casey research

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The Finest Worksong

By John Mauldin

“In theory there is no difference between theory and practice. In practice there is” – Yogi Berra, as cited by Ben Hunt in today’s Outside the Box. Or, to put it in macroeconomic terms, “Why is global growth so disappointing?” In the aftermath of the Great Recession, fearing a deflationary equilibrium (which, as Ben notes, is macroeconomic-speak for falling into a well, breaking your leg, at night, alone), the Fed bought trillions of dollars in assets … and saved the world. Sort of. If you don’t count the reckoning yet to come. The theory was that with all that monetary-policy injections, global growth would spring back to “normal.”

But what did practice show? The global economic engine never fired back up. The central banks’ answer? Do more. So the Fed gave us QE 2 and QE 3, and then we got Abenomics, and now it’s Draghinomics.

Still no real growth. What’s missing? asks Ben. He has a surprising answer. Read on.
Ben works for Salient Partners and writes the fascinating letter called Epsilon Theory. You can subscribe to it for free here, or by emailing bhunt@salientpartners.com.

I had dinner last night with my good friend Richard Howard, who, besides being a charming young Australian lad, is also the wickedly brilliant chief economist of Hayman Advisors, the hedge fund outfit run by my friend Kyle Bass. We try to get together every few months at one of the local eateries and hash out the world. And yes, for those interested, the recent action in Japan has both of us smiling a “we told you so” sort of smile. But also thinking that the magic will last for Abe-sama a little while longer. Actually, we talked about why this trade could take a lot longer than most yen bears expect.

(Side note: As longtime readers know, I had just hedged a good portion of my newly acquired mortgage this year by shorting the yen using 10-year put options. Just for grins, I called my broker [a.k.a. The Plumber – Eric Keubler of JPMorgan] and asked how much my position was up. I know, I bought 10-year options and shouldn’t check more than once a year at most, but I was just curious – so sue me. Anyway, with a 5-yen move in my favor I expected to see a rather nice profit. It turned out the profit was about 3% of what I was expecting [not a typo]. That seems odd, I said. No, he told me, all the volatility in the option price has collapsed. The complacency in the currency market and especially in the yen-dollar market is simply massive. This made me glad that I bought 10-year options, as I fully expect that the volatility will have to reappear in the future – unless human nature has somehow changed without sending me a memo. But it goes to show you, gentle reader, that you can be right on the trade and lose money, perhaps a lot of it, if your timing sucks. Ironically, I can get roughly the same trade today for only a few dollars more than I paid five or six months ago, with the 5-yen advantage to the home team. Go figure. I plan to add to this trade, so if you are watching and know when I’m going to do it, you will know that volatility is exceedingly high when my personal situation allows me to execute.)

Richard and I then went on to talk about the interesting decision by CalPERS to completely exit hedge funds. I think the consensus as we left the table was that it is both an odd decision and a perfectly reasonable one, depending on your perspective. Please note that in their press release CalPERS used 5 years and 20 years as their retrospective time horizons. The intervals between 1994 and 2009 and the present just happen to be very convenient time periods to compare overall portfolio returns for CalPERS and for equity markets in general versus hedge funds. If you used 2000 or 2006, your internal rate of return would suck, and your portfolio performance would be less than flattering. Still, hedge funds in general have not performed as well for the last five years as they did in the past, and in general they didn’t offer the downside protection in 2008 that they did in the prior correction of 2000-2001.

In my opinion, CalPERS was not very good at choosing hedge funds, and their timing in entering and exiting a number of their funds wasn’t any better. You can go to any number of pension funds and find far better results than CalPERS achieved. To be fair, I would suggest that the majority of hedge funds are not worth the fees they charge, as they simply provide leveraged beta. Choosing hedge funds is as much an art form as it is a science. Kind of like choosing stocks.

I mean, every asset class has its own particular rhythm. As we all know, over the very long run stocks generally do well. But there are some periods of time when the performance numbers don’t live up to the promise. Those are called secular bear markets, and we had one beginning in 2000. I don’t think we have come to the end of it, and so we still live in a world where we have to look for absolute returns. That’s just the way I see the data.

All that said, I can totally understand CalPERS’ decision to exit the hedge fund world. First, their entire hedge fund investment portfolio was less than 2% of their total portfolio. Even if their hedge fund portfolio was crushing it, that wouldn’t move their overall needle. They were paying $135 million in fees for the privilege of being continually second-guessed by their critics. Frankly, if they had asked me, I would have said, either go large or go home.

And there’s the problem. They really can’t go large. Let’s say they put 10% of their fund into hedge funds. That means at least $30 billion. I don’t think you can allocate $30 billion appropriately from the standpoint of public pension fund responsibility. I wouldn’t even begin to know how to do it. Two or three billion? Absolutely. It would be difficult, but it could be done.

The problem is, you don’t want to become too big a portion of any one fund. Seriously, there are not that many good large funds. Most hedge funds are way too small to be considered as potential investments by CalPERS. So if you are CalPERS you are size-constrained and limited to a small universe of very large hedge funds. Which is not typically where you find hedge fund alpha. And you don’t want to have 100 different funds, as the complexity of tracking all that is enormous.

So you either end up with a portfolio that is ridiculously spread out and is going to regress to the mean, that is, to general market performance; or you going to be over-allocated to some fund that will prove to be a time bomb just when your public relations team is being overwhelmed with something else. I’m not sure who in the universe is in charge of the rules on timing, but it does seem that things are structured so as to cause the greatest possible embarrassment.

So I can certainly understand extremely large public funds leaving hedge funds. I do think that they should consider what other forms of alternative investing might make sense. Pension funds have one commodity that very few other investors have: they have time and lots of it. Most of them sell their time for ridiculously cheap premiums in the fixed-income market. Perhaps figuring out how to increase the return on your patient cash would be the way to go. And that’s not a bad strategy for individual investors as well. Just saying…
That’s the news from beautiful, sunny Dallas. It is time to go ahead and hit the send button as The Beast is lurking in the gym, waiting for me. Have a great week, and enjoy Ben Hunt’s essay.

Your ready to get on a plane again analyst,

John Mauldin, Editor
Outside the Box

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Scottish Independence Would Shake Up the Global System

“Finest Worksong”

Take your instinct by the reins
You'd better best to rearrange
What we want and what we need
Has been confused, been confused
– REM, “Finest Worksong” (1987)
The politics of dancing

The politics of oooh feeling good
– Re-flex, “The Politics of Dancing” (1983)
The fault, dear Brutus, is not in our stars, but in ourselves.
– William Shakespeare, “Julius Caesar” (1599)
In theory there is no difference between theory and practice. In practice there is.
– Yogi Berra, (b. 1925)



Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back. ...
Indeed, the IMF's expectation for long-run global growth is now a full percentage point below what it was immediately before the Global Financial Crisis. ...
But it is also possible that the underperformance reflects a more structural, longer-term, shift in the global economy, with less growth in underlying supply factors.

– Fed Vice Chairman Stanley Fischer, “The Great Recession: Moving Ahead,” August 11, 2014

There is one great mystery in the high falutin’ circles of the Fed, ECB, and IMF today. Why is global growth so disappointing? There are different variations on this theme – why aren’t businesses investing more? why aren’t banks lending more? – but it’s all one basic question. First the Fed, then the BOJ, and now the ECB have taken superheroic efforts to inflate financial asset prices in order to bridge the gap between the output shock of 2008 and a resumption of normal economic growth. They’ve done their part. Why hasn’t the rest of the world joined the party?

The thinking was that leaving capital markets to their own devices in the aftermath of the Great Recession could result in a deflationary equilibrium, which is macroeconomic-speak for falling into a well, breaking your leg, at night, alone. It’s the worst possible outcome. So the decision was made to buy trillions of dollars in assets, forcing all of us to take on more risk with our money than we would otherwise prefer, and to jawbone the markets (excuse me ... “employ communication policy”) to leverage those trillions still further. All this in order to buy time for the global economic engine to rev back up and allow private investment activity to take over for temporary government investment activity.

It was a brilliant plan, and as emergency intervention it worked like a charm. QE1 (and even more importantly TLGP) saved the world. The intended behavioral effect on markets and market participants succeeded beyond Bernanke et al’s wildest dreams, such that now the Fed finds itself in the odd position of trying to talk down the dominant Narrative of Central Bank Omnipotence. But for some reason the global economic engine never kicked back in.
The answer? We must do more. We must try harder. And so we got QE2. And QE3. And Abenomics. And now Draghinomics. We got what we always get in the aftermath of a global economic crisis – a temporary government policy intervention transformed into a permanent government social insurance program.

But the engine still hasn’t kicked in.

So now villains must be found. Now we must root out the counter-revolutionaries and Trotskyites and Lin Biao-ists and assorted enemies of progress. Because if the plan is brilliant but it’s not working, then obviously someone is blocking the plan. The structural villains per Stanley Fischer (who is rapidly becoming a more powerful Narrative voice and Missionary than Janet Yellen): housing, fiscal policy, and the European economic slow-down. Or if you’ll allow me to translate the Fed-speak: consumers, Republicans, and Germany. These are the counter-revolutionaries per the central bank apparatchiks. If only everyone would just spend more, why then our theories would succeed grandly.

Hmm. Maybe. Or maybe what we want and what we need has been confused. Maybe the thin veneer of ebullient hollow markets has been confused for the real activity of real companies. Maybe the theatre of a Wise Man with an Answer has been confused for intellectually honest leadership. Maybe theoretical certainty has been confused for practical humility. Maybe the fault, dear Brutus, is not in external forces like Republicans or Germans (or Democrats or Central Bankers), but in ourselves.



Let me suggest a different answer to the mystery of missing global growth, a political answer, an answer that puts hyper-accommodative monetary policy in its proper place: a nice-to-have for vibrant global growth rather than a must-have. The problem with sparking renewed economic growth in the West is that domestic politics in the West do not depend on economic growth. What we have in the US today, and even more so in Europe (ex-Germany), are not the politics of growth but rather the politics of identity. At the turn of the 20th century the meaning of being a Democrat or a Republican was all about specific economic policies ... monetary policies, believe it or not. You could vote for Republican McKinley and ride on a golden coin to Prosperity for all, or you could vote for Democrat Bryan and support silver coinage to avoid being “crucified on a cross of gold.”



 Today's elections almost never hinge on any specific policy, much less anything to do with something as arcane as monetary policy. No, today’s elections are all about social identification with like- minded citizens around amorphous concepts like “justice” or “freedom” ... words that communicate aspirational values and speak in code about a wide range of social issues. Don’t get me wrong. There’s nothing inherently bad or underhanded about all this. I think Shepard Fairey’s “HOPE” poster is absolute genius, rivaled only by the Obama campaign’s genius in recognizing its power. Nor am I saying that economic issues are unimportant in elections. On the contrary, James Carville is mostly right when he says, “It’s the economy, stupid.” What I am saying is that modern political communications use neither the language nor the substance of economic policy in any meaningful way. Words like “taxes” and “jobs” are bandied about, but only as totems, as signifiers useful in assuming or accusing an identity. Candidates seek to be identified as a “job creator” or a “tax cutter” (or accuse their opponent of being a “job destroyer” or a “tax raiser”) because these are powerful linguistic themes that connect on an emotional level with well-defined subsets of voters on a range of dimensions, not because they want to actually campaign on issues of economic growth. Candidates have learned that while voters certainly care about the economy and their economic situation, the only time they make a voting decision based primarily on specific economic policy rather than shared identity is when the decision is explicitly framed as a binary policy outcome – a referendum. Even there, if you look at the ballot referendums over the past several decades (Howard Jarvis and Proposition 13 happened almost 40 years ago! how’s that for making you feel old?), the shift from economic to social issues is obvious.

Both the Republican and the Democratic Party have entirely embraced identity politics, because it works. It works to maintain two status quo political parties that have gerrymandered their respective identity bases into a wonderfully stable equilibrium. The last thing either party wants is a defining economic policy question that would cut across identity lines. But until the terms of debate change such that an electoral mandate emerges around macroeconomic policy ... until voters care enough about Growth Policy A vs. Growth Policy B to vote the pertinent rascals in or out, despite the inertia of value affinity ... we’re going to be stuck in a low-growth economy despite all the Fed’s yeoman work. I know, I know ... what blasphemy to suggest that monetary policy is not the end-all and be-all for creating economic growth! But there you go. At the very moment that elections hinge on the question of economic growth, we will get it. But until that moment, we won’t, no matter what the Fed does or doesn’t do.

What reshapes the electoral landscape such that an over-riding policy issue takes over? Historically speaking, it’s a huge external shock, like a war or a natural disaster, accompanied by a huge political shock, like the emergence of a new political party or charismatic leader that triggers an electoral realignment. In the US I think that the emerging appeal of national Libertarian candidates (all of whom, so far anyway, have the last name Paul) is pretty interesting. The 2016 election has the potential to be a watershed event and set up a realignment, if not in 2016 then in 2020, which hasn’t happened in the US since Ronald Reagan transformed the US electoral map in 1980. And yes, I know that the conventional wisdom is that a viable Libertarian candidate is wonderful news for the Democratic party, and maybe that will be the case, but both status quo parties today are so dynastic, so ossified, that I think everyone could be in for a rude awakening. It’s a long shot, to be sure, mainly because the US economy isn’t doing so poorly as to plant the seeds for a reshuffling of the electoral deck, but definitely interesting to watch.

What’s not a long shot – and why I think Draghi’s recently announced ABS purchase is a bridge too far – is a realigning election in Italy.

I like to look at aggregate GDP when I’m thinking about the strategic interactions of international politics, but for questions of domestic politics I think per capita GDP gives more insight into what’s going on. Per capita GDP gives a sense of what the economy “feels like” to the average citizen. It addresses Reagan’s famous question in the 1980 campaign with Jimmy Carter: are you better off today than you were four years ago? It’s a very blunt indicator to be sure, as it completely ignores the distribution of economic goodies (something I’m going to write a lot about in future notes), but it’s a good first cut at the data all the same. Here’s a chart of per capita GDP levels for the three big Western economies: the US, Europe, and Japan.



Source: World Bank. For illustrative purposes only.
The Great Recession hit everyone like a ton of bricks, creating an output shock roughly equal to the impact of losing a medium-sized war, but the US and Japan have rebounded to set new highs. Europe ... not so much.

Let’s look at Europe more closely. Here’s a chart of the big three continental European economies: Germany, France, and Italy.



Source: World Bank. For illustrative purposes only.
Germany off to the races, France moribund, and Italy looking like it just lost World War III. I mean ... wow. More than any other chart, this one shows why I think the Euro is structurally challenged.

First, why in the world would Germany change anything about the current Euro system? The system works for Germany, and how. Alone among major Western powers, the politics of growth are alive and well in Germany. “But Germany, unless you lighten up and embrace your common European identity, maybe this sweet deal for you evaporates.” Ummm ... yeah, right. The history books are just chock-full of self-interested creditors with sweet deals that unilaterally made large concessions before the very last second (and often not even then).

Second, why in the world would Italy accept anything about the current Euro system? The system fails Italy, and how. The system fails other countries, too, like Spain, Portugal, and Greece, but these countries are in the Euro by necessity. Their economies are far too small to go it alone. Italy, on the other hand, is in the Euro by choice. Its economy is plenty big enough to stand on its own, and with a vibrant export potential, an independent and devalued lira is just what the doctor ordered to get the economic growth engine revved up. Short term pain, long term gain.



Why doesn’t Italy bolt? Lots of reasons, most of them identity related. Also, let’s not underestimate the power of cheap money to keep the puppet-masters of the Italian State in a Germany-centric system. The system may fail Italy as a whole, but if you’re pulling the strings of the State and can borrow 10-year money at 2.5% to keep your vita nice and dolce ... well, let’s keep dancing.

Still, nothing focuses the electoral mind like the economic equivalent of losing a major war. At some point in the not so distant future there will be an anti-Euro realigning election in Italy. And that will wake the Red King.

In the meantime, Draghi will go forward with his ABS purchase scheme, a brilliant theory that will deliver frustratingly slim results quarter after quarter after quarter. Until the politics of growth are embraced outside of Germany, European banks will remain reticent to lend growth capital to small and medium enterprises. Until the politics of growth are embraced outside of Germany, large enterprises with plenty of cash and access to cheap loans will remain reticent to invest growth capital. Maybe a little M&A, sure, but no new factories, no organic expansion, no grand hiring plans. The thing is, Draghi knows that he’s pushing on a string with the ABS program and that growth won’t return until the fundamental political dynamic changes in France in Italy, which is why he is calling both countries out by name to institute “structural reforms”. But in typical European fashion this entire debate is Mandarin vs. Mandarin, with almost all of the proposals focused on regulatory reform rather than something that must be hashed out through popular legislation. So long as economic policy reform is imposed from above ... so long as we are engaged in modern-day analogs of Soviet Five-Year Plans ... I believe we will remain stuck in what I call the Entropic Ending – a long gray slog of disappointing but not catastrophic aggregate economic growth. That’s not a terrible environment for stocks, certainly not for bonds, and the alternative – economic reform based on the hurly-burly of popular politics, is almost certain to be a wild ride that markets hate. But to get back to what we need (real growth) rather than what we want (higher stock prices) this is what it’s going to take. Elections always matter, but in the Golden Age of the Central Banker they matter even more.

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The article Outside the Box: “Finest Worksong” was originally published at mauldineconomics.com.

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