Dalio Warns Of Dollar Crisis - "History Is Doomed To Repeat Itself"

- "History is due to repeat itself" warns Ray Dalio on Bloomberg

- "I think it will be more of a dollar crisis than a debt crisis" says Bridgewater Founder

- "It will be more of a political and social crisis..."
- "Balance is key" and if going to be active investor, you need to be contrarian and "buy when there is blood in the streets"
- Bridgewater continues to own gold and Dalio views gold as a currency and as money
- "It's not sensible not to own gold..." Dalio told the CFR
Watch Bloomberg Markets and Finance video via YouTube here

 

Movin’ On Up! Interest Rates Keep Rising (100% Prob of Rate Hike At Sept FOMC Meeting!)

 They're a movin' on up .. to the north side. 

The Fed Funds Target Rate, the 2 year Treasury yield, the 90 day commercial paper rate and effective Fed Funds rate all moved together prior to the first Fed rate hike in late 2015. Since then, we are seeing divergence.

And the 10-year keeps a goin' on up!

And the probability of more Fed rate hikes are forecast for the future.

And WIRP, the implied probabilty from Fed Funds Futures are pointing to a 100% chance of a rate hike in September AND November.

And the good ship Folly Pop isn't sinking. Yet.

This ‘Deflationary’ Bull Markets Ending – And Here’s What’s Coming Next For Investors

After many years of cheap money and asset bubbles – it looks like the upside is finally over.

That is – the potential upside against the amount of risk taken on – is over. 

I often write about investors needing to find asymmetric (low risk – high reward) opportunities. And lately – as I've written about earlier this month – many key indicators are now flashing potentially huge downside ahead.

As I wrote then – it's not like I'm predicting markets to tank tomorrow. Or even next week.

But what I'm getting at is that there's significantly more risk ahead than reward – at least for the general market and equities.

 

I'm not alone thinking this way. . .

 

Bank of America & Merrill Lynch (BAML) recently published a white paper with an interesting trading suggestion. . .

First, they show us that the nearly 10-year monster U.S. bull market has been highly deflationary. And in case you forgot, deflation refers to when there's an overall decline in the prices of goods and services.

The 'deflationary assets' group includes U.S. investment grade bonds, government bonds, the S&P 500, 'growth stocks', U.S. high yield credit, and U.S. consumer discretionary equities (aka non-essential goods – such as luxury goods, entertainment, automobiles, etc.) . . .

And the 'inflationary assets' group which includes commodities, developed market stocks (excluding U.S. and Canada), U.S. bank stocks, 'value stocks', cash, and treasury inflation protected securities (aka TIPS) . . .

Since the end of the 2008 crash – the Fed embarked on a 'easy money' and expansionary path via ZIRP (zero interest rate policy) and QE (quantitative easing; aka money printing).

But even after all this – deflationary assets have seriously outperformed inflationary assets. . .

 

This will cause future economic historians to scratch their heads wondering how this happened. 

 

"Wasn't all this stimulus and easy money supposed to cause inflation?"

 

BAML chalks it up to what they call the 'Three Ds' – technology disruption, ageing demographics, and excess debt.

Over the last 10 years we have seen companies advance their technology – causing production costs to be lower. And yes, the 'baby boomers' have aged and are entering retirement (if they even can).

But the main reason here – as always – has been excessive debt and underwater assets.

For this, I think BAML would do well to read the economist Richard Koo's theory on 'Balance Sheet Recessions'. . .

As a quick explanation, Koo says that a Balance Sheet Recession is when citizens and companies (the private sector in general) are bogged down by debt after an asset bubble pops. And their primary goal is to save and pay off debt instead of taking on new debt and more spending.

And as people and companies save more, that's money not fueling consumption and investment. This slows down economic growth.

Even with rates at near-zero – slightly negative – people and firms don't want to take out more debt until they pay off old debt (we see this in Japan and the EU).

The massive amount of private savings ends up flooding banks and investing institutions. And since no one's borrowing, these lenders have no where to invest it all. Thus, the only place they can invest all this excess savings is in government debt. And that's why governments can run huge deficits as rates stay so low.

For an example of a deep Balance Sheet Recession – just look at Japan since the 1991 Japanese bubble burst. Another example is the Eurozone post-2010.

Because the housing market burst in the U.S. during 2007 and 2008, many individuals have still been plagued by underwater assets and heavy debt burdens.

But finally – almost 10 years later – things are now starting to recover in the U.S. as private spending, debt, and inflation picks up.

The only problem is that it's a bit too late. . . 

 

So – what's next?

 

Unfortunately, without the excess liquidity from the Fed – expect excess portfolio returns and growth to come to an end as well.

Making matter worse, since the Fed's tightening so aggressively – via rate hikes and Quantitative Tightening (bond selling) – we're seeing liquidity dry up worldwide. (I've written extensively about the dollar shortage and evaporating liquidity problem – you can read about it here).

And as Central Banks continue tightening and draining the excess liquidity, portfolio and asset price declines won't be far behind. . .

A collapse in global asset prices will undoubtedly kick off a global recession – as it frequently has throughout history.

There's almost always a financial crisis when the Fed tightens after years of easy money. . .

 

Because of this – BAML calls for, what they call, a 'perverse' trading idea.

They call for investors to rotate from the deflationary assets and into the lagging inflationary assets. 

 

My thoughts? 

 

I believe the world's about to get hit with a much harsher Balance Sheet Recession (from years of building up student, auto, credit card, corporate, and mortgage debts). This will make the 2008 'debt disease' look like child's play.

Central Banks will then rush into negative rate territory and more money printing in attempt to reignite borrowing, push asset prices higher, and make debt re-financing easier. 

Meanwhile, governments will run massive deficits as they slash taxes and increase government spending to offset the loss of private sector demand. 

Put in simple terms – the elites will stop at nothing to try and prevent a deflationary spiral. 

So I think inflationary assets should get a boost – especially since they'll stop at nothing to get it. . .

Things Have Changed...

Today's post is sure to anger a bunch of you. My libertarian friends will probably be the most outraged, but I suspect many will misinterpret my observations about society's most likely path as my belief regarding the proper course.

So let me try to be clear. I have no interest in asserting I know what should be done, but rather I am focused on what will be done. 

If you want to debate the theoretical, then there are a myriad of websites for you to choose from. Whether you are conservative or liberal, hard-money or gasp Keynesian, there is a place for you to feel safe and share your views about society's optimal direction. But let me tell you right now - this isn't it.

So put aside your political views and try to deal with only probabilities as opposed to your desires regarding economic policy.

Although the Republicans are supposedly the party of fiscal conservatism, we all know that sort of talk is only for when they are not in power.

Again - please do not email me with your political rant. I have no dog in this hunt. When it comes to the markets, I am politically agnostic and the only religion I worship is that of the Market Gods.

There should be little surprise that under Republican stewardship, the greatest fiscal stimulus in the past decade has been instituted. Not saying if it is good or bad because my opinion is completely irrelevant.

But I would like you to step back and think about the recent bout of U.S. economic outperformance. It's probably fair to say that relative to the rest of the developed world, American fiscal policy has been easier while monetary policy tighter. This is the complete opposite of the past decade's recipe of tighter fiscal policy (as austerity and other budget balancing policies were enacted in the wake of the 2008 credit crisis) and easier monetary policy. I say easier monetary policy but that's really underselling the reality of the situation. Un-friggin-precedented easy monetary policy is probably more appropriate. Stupid bat-shit-crazy stuff like negative rates and shockingly large expansions of central bank balance sheets has become so normal that market participants have become numb to them monetizing billions of dollars against previously unheard of assets like equities. Over the past decade, governments throughout the world have tamped down their fiscal spending while central banks have desperately tried to offset the slowdown with irresponsible monetary stimulus.

Yet that's changed over the past couple of years with Americans taking the exact opposite tack. And what has been the result? Economic outperformance.

The changing environment

Now, don't worry if it is sustainable. Don't worry if it is smart. Don't worry if it is right.

All you need to ask yourself is what are consequences of this development?

Do you think it likely Europe or China will look at America's outcome and say, "you know what? We should really cut spending and push even more monetary stimulus into the system?"

Not a chance.

The entire world will look at America's success and copy them.

What will that mean? More spending. Larger deficits. Most likely, higher interest rates. And strangely enough, probably a much stronger global economy.

Think I am wrong? Then you aren't paying attention. It's easy to see the change in attitude. In the aftermath of the Great Financial Crisis even the most left-leaning politician had to keep their spendthrift opinions in check. Contrast that to today's shift in sentiment. Where are the Tea Party faithful demanding an end to Trump's deficits? Crickets… And how about U.K. Labour party's embracing of Richard Koo's balance sheet recession concept? Here is a fascinating video ad from Jeremy Corbyn and his party.

Austerity doesn't work. pic.twitter.com/LvKSMvHetI

— Jeremy Corbyn (@jeremycorbyn) August 17, 2018

Do I need to say it one more time? Probably. Don't email me spouting all sorts of terrible things about Corbyn. I don't care.

I am only concerned about the fact that there has been a sea change in the public's attitude toward spending and debt.

Maybe Corbyn will never be elected. Not disputing that one bit. But it's not only U.K. Labour party bold enough to make a stand against austerity:

From Reuters:

You would be foolish to ignore the dramatic change in the world's attitude towards economic policy. "Tight fiscal and easy monetary policy" is being replaced with "easy fiscal and (somewhat) tighter monetary policy". And ironically enough, the Republican Party under Trump's "leadership" is at the forefront of this change.

Don't worry about whether it's right or not. Don't let your political views get in the way of your portfolio construction. Just worry about whether this trend will get more or less intense from here. My bet is that this is just the start...

All Eyes Will Be On This Dot During Next Week's FOMC Meeting

With a 25bps rate hike during next Wednesday's FOMC meeting virtually assured, trader attentions will be focused on something else entirely: the median 2019 dot, shown below, as well as any changes to the "accommodative" language from the Aug. 1 statement, according to strategists and economists Bloomberg reports.

The reason for this is that, with markets having been left with a distinctly "dovish" take of Fed chair Powell's Jackson Hole speech, the Fed may "neutralize" forward guidance in the Sept. 26 statement while displaying a firm intent to hike in December, according to Morgan Stanley, while Citi's Jabaz Mathai expects the central bank to take a meeting-by-meeting approach instead.

As of today, the market's odds of an additional December hike after a September move were 80%, with two more increases priced in for next year as EDZ8/EDZ9 now implies 51 bps of hikes next year, up from just 34 bps at start of last week.

; the disconnect is the Fed's latest projections which in June showed the FOMC penciling in three more hikes for 2019. And, according to BMO's Jon Hill, "a key question for analysts is whether the FOMC will be prepared to keep hiking past the neutral level for rates; there could be "no incremental clarity" on the issue at this meeting."

Alternatively, depending on where the median 2019 dot goes, there could be.

As Hill adds, even if the Fed doesn't explicitly comment in the statement or press conference about next year, the market's focus on the end-2019 fed funds rate dot "will be pretty notable" and "if there's an upward revision, we could see a pretty sharp upward revision in pricing."

The reason for that is that with the Fed most likely two or three hikes away from breaching the neutral rate of interest, an upward revision would "cement the expectation that, as a base-case scenario, the Fed hikes through neutral."

And, as a reminder, according to Stifel, once the Fed hikes above the neutral rate, bad things usually happen to the economy.

Meanwhile, in terms of the actual statement, "the core phrase we will pay attention to in the statement is what is now described as 'accommodative' policy" according to BMO. If information from the FOMC's upcoming meeting simply reaffirms policy makers' previous expectations, "the path of least resistance should be a flatter curve." According to Morgan Stanley, "policy makers could change "accommodative" language in statement to "modestly accommodative", while "other options would be to remove the sentence altogether or to say the target rate has moved closer to estimated range of neutral."

Others chimed in on the topic of the third 2019 rate hike, with Joseph LaVorgna saying that the issue for the market is whether policy makers add an extra hike in 2019 by pulling one forward from 2020, or simply inserting a new one altogether into next year: "My fear is that they will do more. They are not going to do less."

Naturally, any new hints of additional future hikes in the statement - or a rate even higher than neutral - would be interpreted as "hawkish," causing yields to push higher, hurting stocks. To Lavorgna this is the big risk: "I see the risks as asymmetrically more hawkish"; Fed officials have "no reason to back away from the number of hikes they have."

Morgan Stanley, on the other hand, expects unchanged median dots for 2019 and 2020, which should remain unchanged at 3.1% and 3.4%, respectively.

Citi's Jabaz Mathai agrees, writing that "some on the FOMC might be influenced by strength in the labor market and asset prices, which might push the dots higher. But there's probably not much reason to go up further, in the aggregate, because the dots already assume this." Bolstering his case, he notes that the recent CPI readings have been "rather subdued," posing a deterrent to moving rate forecasts higher.

Then there are the quasi-doves, like Wells Fargo's Boris Rjavinski, who told Bloomberg that if Powell hints that most on the FOMC are leaning toward idea that couple more hikes are needed to get to neutral, including this month's, "the market may indeed start thinking about how to position for the approaching end of the cycle." That said, Wells Fargo's forecast is above the market, and sees two hikes left for this year and another three in 2019.

Source: Bloomberg

When Does This Travesty Of A Mockery Of A Sham Finally End?

Credit bubbles are not engines of sustainable employment, they are only engines of malinvestment and wealth destruction on a grand scale.

We all know the Status Quo's response to the global financial meltdown of 2008 has been a travesty of a mockery of a sham--smoke and mirrors, flimsy facades of "recovery," simulacrum "reforms," serial bubble-blowing and politically expedient can-kicking, all based on borrowing and printing trillions of dollars, yen, euros and yuan, quatloos, etc.

So when will the travesty of a mockery of a sham finally come to an end? Probably around 2022-25, with a few global crises and "saves" along the way to break up the monotony of devolution. The foundation of this forecast is this chart I prepared back in 2008 (below).

This is of course only a selection of cycles; many more may be active but these four give us a flavor of the confluence of crises ahead.

Cycles are not laws of Nature, of course; they are only records of previous periods of growth/excess/depletion/collapse, not predictions per se. Nonetheless their repetition reflects the systemic dynamic of growth, crisis and collapse, and so the study of cycles is instructive even though we stipulate they are not predictive.

What is predictable is the way systems tend to follow an S-curve of rapid growth with then tops out in excess, stagnates in depletion and then devolves or implodes. We can see all sorts of things topping out and entering depletion/collapse: financialization, the Savior State, Chinese credit expansion, oil production, student loan debt and so on.

Since each mechanism that burns out or implodes tends to be replaced with some other mechanism, this creates the recurring cycle of expansion / excess / depletion / collapse.

I plotted four long-wave cycles in the first chart:

1. The credit expansion/renunciation cycle. a.k.a. the Kondratieff cycle. Credit expands when credit is costly and invested in productive assets. Credit reaches excess when it is cheap and it's malinvested in speculation and stock buybacks, and as collateral vanishes then credit is renunciated/written off.

This is inexact, but obviously the organic postwar cycle of expansion has been extended by the central bank money-printing / credit orgy.

2. The generational cycle of four generations/80 years described in the seminal book The Fourth Turning. American history uncannily tracks an 80-year cycle of crises and profound transformation: 1860 (Civil War), 1940 (world war and global Empire) and next up to bat, 2020, the implosion of the debt-based Savior State and the financialized economy.

3. The 100-year cycle of inflation-deflation described in the masterful book The Great Wave: Price Revolutions and the Rhythm of History. The price of bread remained almost constant in Britain throughout the 19th century. In contrast, the 20th century has been characterized by inflation--the U.S. dollar has lost approximately 96% of its value since the early 20th century.

Another characteristic of this cycle is wage stagnation: people earn less even as costs of essentials rise, a dynamic that inevitably leads to political crisis and upheaval.

The end-game for inflation is destruction of fiat currencies, i.e. rising inflation or complete loss of faith in paper money. This is of course "impossible," just like World War I, the Titanic sinking, the global meltdown of 2008, etc. Impossible things happen with alarming regularity.

4. Peak oil, which does not mean the world runs out of oil, it simply means oil production no longer rises to meet demand and eventually declines even as new fields are brought online. It can also mean that the price of energy rises to the point that consumers can either buy energy or they can keep the consumer economy afloat, but they are no longer able to do both.

Many observers are confident that fracking and other technologies will enable current energy profligacy to continue unabated as the U.S. production of oil and natural gas soars.

All this surplus energy in North America sounds wonderful, but that doesn't mean the world as a whole has escaped Peak Oil. Even if fracked wells didn't deplete in a year or two (they do), that expansion of production will not replace the loss of production as supergiant fields in Mexico, the North Sea and the Mideast enter the depletion phase. Yes, technology can extract more oil, but technology is costly. The days of cheap natural gas may have arrived, but the days of cheap oil are numbered.

How all this plays out is unknown, but even raising U.S. production might not be enough to maintain current production levels. Since several billion more people desire the U.S.-type lifestyle of energy profligacy, then what are the consequences of the mismatch between global demand and supply?

What happened to crude oil production after the first peak in 2005?

We can also posit that "good-paying jobs" in developed economies are also tracking an S-curve. The post-industrial decline in labor has many causes, but the Internet is a key factor going forward as the Web, AI, Big Data and mobile telephony leverage all sorts of productivity gains without the pesky overhead, costs and trouble of employees.

This reality was masked by the initial boom in Web infrastructure that topped out in 2000, and again by the credit-fueled global malinvestment in real estate that topped out in 2007 and soon by the topping out of the social media/mobile app tech boom, the third stock market bubble and Housing Bubble #2.

Once these bubbles have popped, the reality of long-term employment stagnation can no longer be masked.

Credit bubbles are not engines of sustainable employment, they are only engines of malinvestment and wealth destruction on a grand scale.

A number of other questions arise as we ponder these dynamics. How "cheap" will all that energy be to those without full-time jobs? How will 100 million workers support 100 million retirees, welfare recipients and parasitic Elites plus Universal Basic Income as costs rise, taxes soar and wages stagnate?

The Status Quo is unsustainable on a number of fundamental fronts. How long it can maintain the facade of stability and sustainability is unknown, but the global willingness to squander additional years on artifice and propaganda suggests that another four years will fly by and the end-game will be at hand whether we approve of it or not.