China Beige Book Warns Economic Slowdown Has Begun

When it comes to the global economy, few things matter as much as China, the trajectory of its economy and especially the pace and impulse of its credit creation, which is ironic because virtually all data coming out of China is fabricated and manipulated, and thoroughly untrustworthy, either on purpose or "by accident."

The latest example of the former was highlighted over the weekend, when we discussed that a nationwide Chinese audit found some local governments inflated revenue levels and raised debt illegally, once again making a mockery of China"s credibility on the global stage. As Bloomberg reported ten cities, counties or districts in the Yunnan, Hunan and Jilin provinces, as well as the southwestern city of Chongqing, inflated fiscal revenues by 1.55 billion yuan, the National Audit Office said in a statement on its website dated Dec. 8.

An even more blatant example of the former was highlighted in October ahead of China"s Communist Party Congress, when the local securities watchdog literally "advised" some loss-making companies to avoid publishing quarterly results ahead of the Congress as authorities sought to ensure stock-market stability during the critical gathering of China"s political elite.  As a result, at least 17 Shenzhen-listed companies announced delays to their earnings reports from Oct. 20 to Oct. 24, up from three during the same period last year.

However, now that the Party Congress is long over, China"s recent economic data offer a "warning for 2018" now that Beijing"s leaders are less motivated to prop up fake "growth" for purely optical purposes. That is the opinion of China Beige Book, and its president Leland Miller who said that "Incentives to ensure the economy was growing smartly at the time of the Communist Party Congress do not apply as next year wears on," CBB president Leland Miller and chief economist Derek Scissors said in a report released on Wednesday.

According to a private survey by CBB International, which collects anecdotal accounts similar to those in the Federal Reserve’s Beige Book, Q4 results already show some signs of a transition to slower growth,  The most recent sampling of 3,300 Chinese businesses showed:

• Hiring stopped accelerating due to a strong base of comparison


• Manufacturing orders also stopped accelerating 


• Inventory accumulation "is too fast for comfort"


• Sales-price inflation is weaker than in the second quarter


• Wage gains have stopped accelerating

Come to think of it, the CBB data is not that different from the official Chinese data which showed continued slowdown across most economic verticals:

 

"None of these is genuinely alarming yet, and none would be out of place in a typical quarter," the CBB"s Miller wrote. "But the first results after a CPC are not a typical quarter. If you expect a noticeable slowdown in 2018, the first post-Congress returns support those expectations."

To be sure, even here there is confusion: while at the 19th Party Congress, which marked the start of President Xi Jinping’s second five-year term, top leaders signaled less emphasis on pursuing economic growth at all costs, and greater dedication to deleveraging, during the main economic planning conclave in December which set priorities for 2018, they pledged to focus on "critical battles" against financial risk, pollution and poverty in coming years. Meanwhile, deleveraging - Xi Jinping"s endless crusade - was strangely forgotten. Indeed, as Goldman observed last week, "there was no explicit mention of deleveraging" as "recent policy statements increasingly use the phrase "control of leverage", in our view likely a reflection of increasing realism in policy making." This significant policy reversal prompted the WSJ last week to report that Beijing has effectively given up on its deleveraging pledge.

Leverage or not, the table below - courtesy of Bloomberg - shows CBB’s breakdown of how support for the expansion may erode:

Furthermore, evidence from the retail sector doesn’t support the government’s claims of a consumption boom, CBB said. While some large firms have strong sales and profitability improved this quarter, retail revenue growth finished last among major sectors, Miller and Scissors wrote.

"Retail’s performance is decidedly uninspiring. Revenue, capex, and hiring are inferior to manufacturing, while inventory growth is much higher."

The good news: overall hiring has held up and was generally in line with the prior quarter, with 48% of firms staffing up and 3% cutting workers. "Job growth remained stronger at state firms than private, regardless of company size," CBB’s survey found, although as we will show in a subsequent post, while hiring may remain strong, wages are tumbling in a troubling indication that China"s middle class is set for imminent disappointment and anger.

Meanwhile, inflation in wages, prices, and input costs were also roughly the same as in the prior quarter, and were moderately faster than last year, the report said. Profit growth improved.

That said, despite predictions of gloom as we enter 2018, the world’s second-largest economy proved bears fully wrong this year, exceeding analyst estimates in the first and second quarters, and is now on pace for the first full-year acceleration in growth since 2010, with GDP seen growing at 6.8% this year and 6.5% in 2018. There is a problem: this growth was on the back of a near record credit impulse since the February 2016 Shanghai accord, an impulse which is now over.

Which means that all else equal, and absent another gargantuan credit injection in the coming months, China"s bears are about to have their day in the sun all over again.

The Ghost Of W.D.Gann: Another Crash Is Coming

Authored by Philip Soos & Lindsay David via RenegadeInc.com,

The original wizard of Wall Street, W.D Gann was a finance trader and wealthy speculator that spent decades investigating cyclical trends in equity market patterns and found that prices could be predicted long in advance. He successfully predicted the crashes in the 1929 and Dot-Com stock market bubbles.  And according to his analysis, the US stock market is due for another crash in 2020.

Every movement in the market is the result of a natural law and of a Cause which exists long before the Effect takes place and can be determined years in advance. The future is but a repetition of the past, as the Bible plainly states…

After suffering through the worst economic and financial crisis since the 1930s depression when the real estate and stock markets crashed in 2007, the United States’ bubble economy is back into full swing. Residential and commercial real estate prices are growing strongly, along with equities.

The US stock market, as defined by the S&P500 index, has boomed after collapsing to a trough in 2009. The market ‘recovered’ more quickly than anyone thought it would, and has continued surging from thereon in.

This has led to a lot of commentary and media coverage that the S&P500 is in the thrall of yet another bubble that will burst. Despite the many predictions of collapse, the bubble has powered on unhindered.

Like all asset bubbles, the primary cause is speculators taking on debt to bid up prices to ever-higher levels, generating a stream of greater fools willing to purchase at inflated valuations. In the case of equities, the type of debt used is margin debt.

The trends in the S&P500 index and margin debt are obvious. The name of the game is capital gains; income is increasingly sidelined as yields become compressed to record lows.

The annual change in margin debt (the first derivative) closely tracks that of the S&P500 index. In Australia, this was true of our largest equities bubble on record, which peaked in 2007 and then burst, declining by 55% from peak to trough.

Margin debt all too coincidently rose rapidly during the boom.

In the case of the S&P500 bubbles which peaked in 2000 and 2007, margin debt also peaked a few months beforehand in terms of absolute values, annual growth and acceleration (the second derivative).

It is therefore worth closely tracking the trends in margin debt to understand where equity prices are heading.

Another metric to watch out for is private non-financial business debt because the very low interest rates on business bank loans makes it easy for corporate executives to drive up stock prices by loading up on debt to engage in stock buybacks.

As prices are often linked to executive remuneration, they have every incentive to engage in this unproductive strategy.

The peaks in the annual change of non-financial business debt correspond with those of the equities market. It should be noted that non-financial business debt is also used to speculate on commercial land, which is why land prices cycle in tandem with debt.

The yield curve is one of the best leading indicators of recession and equity market downturns. The yield curve inverted a few months before both peaks in 2000 and 2007. Currently, the yield curve is 108 basis points above zero, and could take a while before it inverts.

While the metrics noted above can accurately indicate the peak of an equities bubbles several months in advance, they cannot tell us anything years ahead of time. For this, we must turn to the research of the original wizard of Wall Street, W.D. Gann. He was a finance trader who developed technical analysis tools and forecasting methods based on geometry, astronomy, astrology and ancient mathematics.

He was a successful and wealthy speculator, spending decades investigating patterns in equities markets. He concluded that equities exhibited a cyclical trend over decades and thus prices could be predicted long in advance.

In 1908, Gann constructed his financial timetable, which tabulated the booms and busts, peaks and troughs of the US equities market. Just like the Geoist land market cycle, there is a repeating 18-year average between every major cycle.

Gann managed to predict the crash of 1929 years in advance. He realised that the timetable would have to be recalibrated on the 25th December 1989.

The updated timetable is amazingly accurate from that date onward, predicting the Dot-Com bubble peak in 2000 and its collapse. The GFC peak was off by one year; 2007 instead of one year earlier in 2006. The trough was in 2009, followed by a minor panic in 2015, when the S&P500 dipped but has since boomed.

According to the timetable, 2020 will be the peak of the equities bubble, followed by a major crash similar to that of the Dot-Com bubble.

To the economists we’ve spoken to, the peak could range between 2019M09 to 2020M03. Given how large the S&P500 bubble has become, it is worth treading very carefully during this period for those exposed to US equities.

Gann is famous for saying: “Every movement in the market is the result of a natural law and of a Cause which exists long before the effect takes place and can be determined years in advance. The future is but a repetition of the past, as the Bible plainly states…”

Due to the ETF revolution, it is a straightforward matter to gain exposure to the S&P500, including leveraged and inverse instruments. It would be even better if the government would enact policies to prevent speculation and subsequent bubbles in the first place. This can be done by banning margin debt and other securities-based loans, and heavily taxing capital gains based on the length of time they were held for (the longer, the less tax).

While the equities market boom has added a great deal of wealth to the balance sheet of US households, it is merely the latest instance in a long line of asset bubbles. No doubt many speculators believe that ‘this time is different’ but the ghost of Gann would argue otherwise.

Warren Buffett"s Favorite Indicator Just Flashed a Major Warning

It is clear stocks are in a massive bubble based on their Price to Sale (P/S valuation).

What about the economy?

Warren Buffett once famously stated that his favorite means of valuing stock was the stock market capitalization to GDP ratio.

Below is a chart for this metric. As you can see, the stock market today is as overvalued relative to the economy as it was at the peak of the 1999 Tech Mania.

So stocks are overvalued based on the most reliable corporate data point (revenues) and they are also overvalued relative to the economy. Scratch that, they’re not overvalued… they’re trading at 1999-Tech Bubble insanity levels.

We all remember what came after that...

What"s coming will take time for this to unfold, but as I recently told clients of my Private Wealth Advisory report, we"re currently in "late 2007" for the coming crisis. However, there is one main difference between 1999 and today...

Namely, that the Fed has been INTENTIONALLY creating bubbles for nearly 20 years today... and it"s out of more senior asset classes to use!

Let me explain...

The late ‘90s was the Tech Bubble.

When that burst in the mid-‘00s, the Fed created a bubble in housing.

When that burst in ’08 the Fed created a bubble in US sovereign bonds or Treasuries.

And because these bonds are the bedrock of the US financial system, the “risk-free rate” of return against which ALL risk assets are valued, when the Fed did this it created a bubble in EVERYTHING (hence our coining of the term “The Everything Bubble” and our bestselling book by the same name).

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Is the Bond Market About to Call the Fed"s Inflationary Bluff?

Perhaps the single biggest development this year, as far as the markets were concerned, was the Fed admitting on the record that it has no idea what is going on with inflation.

This represents a kind of endgame for the Fed. Since the early ‘80s, the Fed has been actively understating inflation via a variety of gimmicks.

It first removed home prices and replaced them with “owner’s equivalent rent.” Doing that removed any sharp rise in home prices from affecting inflation data, thereby downplaying the official inflation rate.

Then in 1998, the Fed started playing around with “hedonics” (think food and energy prices). The Fed claimed that the goal was to somehow balance the deflationary forces of technology vs. the inflationary forces of hedonics items… but the reality was that this was just another gimmick to understate inflation.

Then, finally in 1999, the Fed introduced the idea of “substitutions.” Here again the Fed claimed it was trying to get an accurate read on inflation (the Fed argues here that if a consumer cannot afford steak anymore, the fact he or she can substitute hamburger indicates his or her quality of life is roughly the same as before).

And once again the goal was to understate inflation.

I realize this is getting a bit complicated, so let’s put this in simple terms…

1)   Since the early ‘80s, the Fed has been employing various gimmicks to hide the real rate of inflation.

2)   Doing this allowed the Fed to overstate GDP growth while understating the true decline in incomes/ quality of life for most Americans.

This game worked for a while, but this year the whole scheme crashed into a wall when the various gimmicks resulted in data that made no sense what-so-ever.

At a time when the NY Fed’s UIG inflation measure and the Atlanta Fed’s “sticky inflation” measure, showed inflation at 2.8% and 2.1% respectively, the Fed’s official inflation measures (CPI and trimmed PCE) were clocking in at 1.7% and 1.4%,

The Fed’s Board of Governors had a choice here:

1)   Admit the official inflation numbers were garbage

Or…

2)   Act surprised by the official rate being so low and claim it’s an anomaly.

The Fed went with #2 in what was one of the most insane Fed statements ever. According to the Fed’s July FOMC statement…

• Most participants expect inflation to pick up over the next couple years.


• Many Fed participants think inflation will remain below 2% longer than expected.


• Many Fed participants believe that inflation measures dropped recently due to “idiosyncratic factors.”


• A few Fed participants believe the Fed’s framework for forecasting inflation is no longer valid.


• Some Fed participants noted their increase uncertainty about the outlook for inflation.

Put simply: the Fed admitted that it no longer had a clue what was going on with inflation. It has since maintained this “who knows!” shtick (I note that Fed Chair Janet Yellen, in last week’s conference stated that the Fed’s understanding of inflation is “imperfect.”)

Why does this matter?

As I explain in my bestselling book The Everything Bubble: the Endgame For Central Bank Policy, US sovereign bonds (also called Treasuries) trade based on inflation expectations.

Put simply, when inflation spikes higher, so do Treasury bond yields.

When bond yields rise, bond prices fall.

When bond prices fall, the Bond Bubble bursts.

When the Bond Bubble bursts, the EVERYTHING bubble follows.

Well, guess what? The yield on 10-Year US Treasuries is spiking, having broken above its 20-year trendline.

What"s coming will take time for this to unfold, but as I recently told clients, we"re currently in "late 2007" for the coming crisis. The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Venezuela"s Grim Reaper: A Current Inflation Measurement - Current Annual Rate 4651%

Authored by Steve H. Hanke of the Johns Hopkins University. Follow him on Twitter @Steve_Hanke.

The Grim Reaper has taken his scythe to the Venezuelan bolivar. The death of the bolivar is depicted in the following chart. A bolivar is worth less, and with its collapse, Venezuela is witnessing today the world’s worst inflation. 

As the bolivar collapsed and inflation accelerated, the Banco Central de Venezuela (BCV) became an unreliable source of inflation data. Indeed, from December 2014 until January 2016, the BCV did not report inflation statistics. Then, the BCV pulled a rabbit out of its hat in January 2016 and reported a phony annual inflation rate for the third quarter of 2015. So, the last official inflation data reported by the BCV is almost two years old. To remedy this problem, the Johns Hopkins – Cato Institute Troubled Currencies Project, which I direct, began to measure Venezuela’s inflation in 2013. We measure the monthly and annual inflation rates on a daily basis. We measure. We do not forecast. 

The most important price in an economy is the exchange rate between the local currency and the world’s reserve currency — the U.S. dollar. As long as there is an active black market (read: free market) for currency and the black market data are available, changes in the black market exchange rate can be reliably transformed into accurate estimates of countrywide inflation rates. The economic principle of Purchasing Power Parity (PPP) allows for this transformation.

We compute the implied annual inflation rate on a daily basis by using PPP to translate changes in the VEF/USD exchange rate into an annual inflation rate. The chart below shows the course of that annual rate. Today, a new high of 4651%/yr has been reached (see the chart below).

Three Charts That SCREAM "Inflation" In 2018

The financial system is preparing for an inflationary shock.

The single best means of measuring inflation vs deflationary forces in the US financial system is the TIP to Long-Treasury (TLT) ratio. When this ratio rallies the system is predicting inflation. When it falls, the system is fearing deflation.

Running back to 2010, we’ve been in a long-term deflationary downtrend on this ratio.

This deflationary pull has dragged down the entire commodity complex over the same time period.

But this is about to end. In the short- term, the TIP:TLT ratio has MASSIVE support at current levels. And given the clear descending wedge pattern it’s formed, the odds are favoring a sharp breakout to the upside sometime in early 2018.

This is going to ignite a HUGE rally in commodities and other inflation hedges. Our big theme for 2018 is INFLATION. And we"re already producing numerous winners from this trend.

We just published a Special Investment Report concerning FIVE secret investments you can use to make inflation pay you as it rips through the financial system in the months ahead

The report is titled Survive the Inflationary Storm

We are making just 100 copies available to the public.

To pick up yours, swing by:

https://www.phoenixcapitalmarketing.com/inflationstorm.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Bubble Watch: Warning Signs That The Everything Bubble Will Burst in 2018

I believe 2018 will be the year inflation arrives.

The reason, as I’ve noted throughout mid-2017, is that multiple Central Banks, particularly the European Central Bank (ECB), Bank of Japan (BoJ) and Swiss National Bank (SNB) have maintained emergency levels of QE and money printing, despite the fact that globally the economy is performing relatively well.

All told, in 2017 alone, these Central Banks will printed over a $1.5 trillion in new money and funneled it into the financial system. This is an all-time record, representing even more money printing than what took place in 2008 when the whole world was in the grips of the worst crisis in 80 years!

And it has finally unleashed the much sought after inflation. Around the world, inflationary data are breaking out to the upside. Producer prices are soaring in the EU, Japan, China and the US.

H/T Jeroen Blokland

Why does this matter?

Because the $199 TRILLION Bond Bubble trades based on inflation.

When inflation rises, so do bond yields to compensate.

When bond yields rise, bond prices FALL..

And when bond prices fall, this massive bubble, which I call The Everything Bubble bursts.

This process has already begun. Around the world, bond yields are spiking to the upside as the bond market adjusts to the threat of future inflation.

The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

2 Charts That Might Define The Fed"s Jerome Powell Era

Authored by Daniel Nevins via FFWiley.com,

In September, we proposed a theory of the Fed and suggested that the FOMC will soon worry mostly about financial imbalances without much concern for recession risks. We reached that conclusion by simply weighing the reputational pitfalls faced by the economists on the committee, but now we’ll add more meat to our argument, using financial flows data released last week.

We’ve created two charts, beginning with a look at cumulative, inflation-adjusted asset gains during the last seven business cycles:

According to the way that the Fed defines its policy approach, our first chart stamps a giant “Mission Accomplished” on the unconventional policies of recent years. Recall that policy makers explained their actions with reference to the portfolio balance channel, meaning they were deliberately enticing investors to buy riskier assets than they would otherwise hold. Policy makers hoped to push asset prices higher, and they seem to have succeeded, notwithstanding the usual debates about how much of the price gains should be attributed to central bankers. (See one of our contributions here and a couple of other papers here and here.) But whatever the impetus for assets to rise, it’s obvious that they responded. In fact, judging by the data shown in the chart, policy makers could have checked the higher-asset-prices box long ago, and with a King Size Sharpie.

Consider the measure on the vertical axis, percent of personal income. From the risky asset trough in Q1 2009 through Q3 2017, households accumulated asset gains, in real terms, equivalent to 139% of personal income. (Nominal gains were much greater, but we used the CPI to deduct the amount of purchasing power that households lost on their asset holdings. Also, we defined asset holdings as the four biggest categories that the Fed computes gains for—equities, mutual funds, real estate, and pensions.)

In other words, households are enjoying an investment windfall that amounts to nearly sixteen months of personal income, which is larger than the windfalls accrued in any other business cycle since the Fed began tracking asset gains in 1947. Not only that but the gap continues to widen—as of this writing, we’re likely approaching 145% of personal income and well clear of the previous peak of 128% from the 1991–2001 expansion.

Getting back to policy priorities, the chart seems to tell us that asset prices no longer need boosting. The Fed’s pooh-bahs proved they could boss the investment markets, and they’ve almost certainly moved on to new endeavors.

Bull, bear, or donkey?

But record asset gains are just one of the reasons the Fed’s priorities are likely to be changing. To describe another reason, we’ll first show that policy makers may wield a King Size Sharpie but that it’s not a Permanent Marker:

As you can see, our second chart looks like the first, except that we pinned the tails on the asset price donkeys.

We tacked on the down halves of each cycle, showing that the portfolio balance channel has a reverse mode.

So what should we make of the result that asset price cycles, adjusted for inflation, have ended with busts that reverse a large portion and often the entirety of the prior booms?

According to our beliefs about how investment markets work, the up and down phases of asset cycles are closely connected. Also, monetary stimulus influences both phases at the same time. It helped fuel the giant gains of recent expansions, but it also helped create the imbalances that led to giant losses. And after the accelerated advances of 2016-17, it’s fair to wonder if today’s imbalances are approaching the extremes of 2000 and 2007. Even some FOMC members are gently acknowledging that risk.

But we think the committee members are even more concerned than you would know by just reading their meeting minutes. We expect financial imbalances to become their biggest worry, bigger than the risk of recession, which should matter less and less to the central bankers’ reputations as the business cycle expansion continues to lengthen. In fact, a garden variety recession would barely affect their legacies at all by mid-2019, when the expansion, if still intact, would become the longest ever. By that time, the FOMC’s greatest reputational threat would be another financial market debacle, which would suggest that manipulating asset prices maybe wasn’t such a good idea, after all. In other words, the committee’s reputational calculus will change significantly during Jerome Powell’s first few years as chairperson.

All that said, Powell probably wants a recession-free economy in, say, his first year or two in the position. Moreover, he’ll certainly stress continuity with his predecessors’ policies. But once he becomes comfortable in the job, the Fed’s priorities will look nothing like they did under Janet Yellen and Ben Bernanke. Instead of fueling asset gains, Powell’s biggest challenge will be containing imbalances connected to prior gains. He and his peers will aim to avoid pinning another oversized tail on the donkey—or at least to manage the fallout from said tail—and that’s a challenge that could very well define his regime.

Asset Prices Are "Prices" Too...

Authored by Thorstein Polleit via The Mises Institute,

We live in inflationary times.

Some people might consider this statement controversial. This is because these days inflation is widely understood as a rise in the consumer price index (CPI) of more than 2 percent per year. However, there are convincing reasons to question this viewpoint. On the one hand, the CPI does not include “assets” such as, for instance, stocks, housing, real estate, etc. As a result, the price developments of these goods are not accounted for by the changes in the CPI.

On the other hand, and even more essential, price changes of goods and services are associated with changes in the quantity of money. This is why economists used to understand a rise in the quantity of money as inflationary (and a decline in the quantity of money as deflationary): Without money sloshing around, there could not be a phenomenon like inflation — that is an ongoing upward trend in all prices of goods and services over time. The truth is that rising prices across the board is inextricably linked to money.

Asset Prices Are Prices

One indicator of an inflationary monetary development is the link between the US money stock M2 and nominal GDP. This ratio can be referred to as a measure of "excess liquidity." Since the outbreak of the crisis 2008/2009, excess liquidity has been growing strongly — as GDP growth lagged behind the increase in the quantity of money. Why? Well, a great deal of the monetary expansion has been driving asset prices upwards — most notably in the stock and housing market.

The Federal Reserve (Fed) has created yet another “inflationary boom." The US economy is fueled by extremely low interest rates, accompanied by additional credit and money growth created out of thin air. The monetary expansion leads to an artificial rise in consumption and investment spending, resulting in production and employment gains. Furthermore, the newly created liquidity finds its way into financial (asset) markets, driving up asset prices and even valuation levels.

How To Keep the Boom Going: More Inflation

To keep the inflationary boom going - and prevent the “bust,” - the Fed has to make sure that credit and money supply keep increasing and that, by no means less important, borrowing and capital costs remain at fairly low levels. That said, the ongoing inflationary policy must - and for political reasons most likely will - go on. Higher interest rates and a slowdown of credit and money creation would take away the punch bowl - and the party would come to a shrieking halt. The economic boom would turn into bust.

Inflation only works if it comes unnoticed, if there is “surprise inflation.” However, as soon as people find out that the purchasing power of money goes down more than they had expected, the chickens come home to roost: People factor in higher inflation into their contracts for wages, leases and credit. If this happens, there is no longer surprise inflation, and inflation loses its power to stimulate the economy (through misleading price signals, that is).

A central bank that wants to keep the boom going and prevent the bust is left with just one option: it has to create a higher dose of surprise inflation. The reader may already know what such an “inflation game” is leading to. It puts the economy on a high-inflation road or, in the extreme case, a super-inflation road or even a hyper-inflation road that will ultimately destroy the purchasing power of the currency.

Why There Is No Perceived Crisis

So far, financial markets have remained fairly relaxed. Inflation is not seen as a major problem as proven by, for instance, inflation expectations. How come? There might be two reasons for this. First, the majority of people derive their inflation expectations from experienced CPI inflation (we can speak of “adaptive inflation expectations”). As the latter has been relatively low for many years, people do not expect inflation to edge up in the years to come.

Second, many people still do not seem to realize that “asset price inflation” ruins the purchasing power of money in the same way as CPI inflation does: If you want to buy stocks, houses or land with your money, you will get less for your money if prices for these goods go up. However, as long as asset price inflation is not understood as a form of "true inflation," inflation expectations are tamed, and central banks can continue their inflationary scheme. 

Against this backdrop we can draw two conclusions. First, inflation is alive and kicking, it is currently raging in asset price increases. Second, an inflationary boom runs the risk of turning into a bust at some point — a scenario which would hit the economy, the financial system, and asset prices hard. Unfortunately, one cannot forecast (with any scientific precision) when the boom will turn into bust; it really depends on certain conditions.

That said, the current boom may go on for quite a while — with the economies keeping expanding and asset prices rushing from one record level to the next. However, we do know from sound economics that the current inflationary boom — which is presumably welcomed by many as it provides more jobs and additional incomes — is actually sowing the seeds of a bust.

The investor should keep in mind that central banks do not only set into motion an inflationary boom in the first place (which will end in tears), but that they will fight an approaching bust with even more inflation (by increasing the quantity of money even further). That said, investors are well-advised to live up to a rather uncomfortable truth: We"ve had inflation, and there will be more of it. Money will continue to lose its purchasing power.

Bank of America: "We"ve Seen This Movie Before: It Ends With A Recession"

In a merciful transition from Wall Street"s endless daily discussions and more often than not- monologues - of why vol is record low, and why a financial cataclysm will ensue once vol finally surges, lately the main topic preoccupying financial strategists has been the yield curve"s ongoing collapse - with the 2s10s sliding and trading at levels last seen in April 2015, and with curve inversion predicted by BMO to take place as soon as March 2018. And, according to at least one other metric, the yield curve should already be some -25bps inverted. This is shown in the following chart from Bank of America which lays out the correlation between the US unemployment rate and the 2s10s curve, and which suggests that the latter should be 80 bps lower, or some 25 basis points in negative territory.

Here is some additional context from BofA"s head of securitization Chris Flanagan, who views "the recent sharp flattening of the yield curve, which has seen the 2y10y spread go from 80 bps to almost 50 bps since late October, as the natural course of events at this stage of the economic cycle. Unemployment is low, and probably headed lower, and the Fed is intent on raising rates to stave off future inflation; we"ve seen this movie before and it typically ends with a flat or inverted yield curve. Based on history (and gravity), we think the most likely path forward is that the 2y10y spread reaches zero or inverts sometime over the next year or so and that recession of some kind follows in 2020 or 2021. (Given that the curve has flattened 30 bps in just over a month, projecting an additional 50 bps flattening over the next year is not really too bold.) Of course, much can happen along the way to change that outcome, but for now that seems to us to be the most likely course of events to us."

Here Flanagan openly disagrees with the BofA"s "house call" of a steepening yield curve, and explains why:

We note that flattening is not the house call: BofAML rates strategists believe the curve will steepen due to easier fiscal policy, higher deficits, and a higher inflation expectation and the Fed will require higher 5y-10y yields as a precondition to flattening or inverting the curve. We recognize that the flattening process has already taken longer than we expected a few years back, due to multiple dovish Fed hikes, and we acknowledge the potential for what we think would be steepening detours along the way. In our Year Ahead Outlook, we tried to be especially mindful of the fact that a year is a long time and a lot can happen along the way. This would be a good example. Nonetheless, the Fed"s recent intentness on tightening in the face of low inflation readings makes us believe the last 50 bps of flattening likely will be achieved over the course of 2018.

Flanagan asks if a flattening curve is "a serious (grave) present day problem?" While it is true that a yield curve flattening and inversion always precedes a recession, the timing remains in flux. As a result, BofA notes that based on the history of the late 1990s and the 2005-2007 period, when the curve previously flattened into the 50 bps area, "we think it could be as long as 2+ years from now before spreads begin to meaningfully widen, which means 2020. In the meantime, again with history as a guide, we think securitized products spreads can continue to grind tighter. In other words, we are unlikely to see meaningful spread widening until recession actually arrives or is imminent. The recent sharp curve flattening is certainly noteworthy, but, in our view, it is way too early to start positioning for meaningful spread widening. The bull run in credit spreads has not yet ended and probably will last longer than many might expect."

Finally, for some timing context, BofA shows the following chart of GDP growth vs the yield curve: the curve hit zero by the end of 2005 and inverted in 2006; economic growth steadily slowed in 2006 and 2007 but it wasn"t until 2008 that the downturn accelerated. Credit spreads widened and began anticipating the downturn in mid-2007, after the curve had been flat for over a year.

David Stockman Lashes Out At Mainstream Media"s "Peak Fantasy Time"

Authored by David Stockman via Contra Corner blog,

If you want to know why both Wall Street and Washington are so delusional about America"s baleful economic predicament, just consider this morsel from yesterday"s Wall Street Journal on the purportedly awesome November jobs report.

Wages rose just 2.5% from a year earlier in November - near the same lackluster pace maintained since late 2015, despite a much lower unemployment rate. But in a positive sign for Americans’ incomes, the average work week increased by about 6 minutes to 34.5 hours in November.... November marked the 86th straight month employers added to payrolls.

Whoopee!

Six whole minutes added to a work week that has been shrinking for decades owing to the relentlessly deteriorating quality mix of the "jobs" counted by the BLS establishment survey. In fact, even by that dubious measure, the work week is still shorter than it was at the December 2007 pre-crisis peak (33.8) and well below its 2000 peak level.

The reason isn"t hard to figure: The US economy is generating fewer and fewer goods producing jobs where the work week averages 40.5 hours and weekly pay equates to $58,400 annually and far more bar, hotel and restaurant jobs, where the work week averages just 26.1 hours and weekly pay equates to only $21,000 annually.

In other words, the ballyhooed headline averages are essentially meaningless noise because the BLS counts all jobs equal----that is, a 10-hour per week gig at the minimum wage at McDonald"s weighs the same as a 45 hour per week (with overtime) job at the Caterpillar plant in Peoria that pays $80,000 annually in wages and benefits.

When the line is trending inexorably from the upper left to the lower right, of course, it means there are more of the former and fewer of the latter. Six more minutes of continuing worse----is still bad.

 

As a matter of fact, the November report showed 20.199 million goods-producing jobs in manufacturing, construction and energy/mining, which did represent about a 2% improvement from prior year.

The real story, however is not about the short-term monthly or annual deltas being generating by an economy barely crawling forward. Rather, at 102 months, the current business cycle is exceedingly long in the tooth by historic standards (the longest expansion was just 118 months under the far more propitious circumstances of the 1990s).

In fact, what has been the weakest expansion in history by far may now be finally running out of gas.

During the last several weeks the pace of US treasury payroll tax collections has actually dropped sharply---and it is ultimately Uncle Sam"s collection box which gives the most accurate, concurrent reading on the state of the US economy. Some 20 million employers do not tend to send in withholding receipts for the kind of phantom seasonally maladjusted, imputed and trend-modeled jobs which populate the BLS reports.

Yet we we are not close to having recovered the 4.3 million goods producing jobs lost in the Great Recession; 40% of them are still AWOL---meaning they are not likely to be recovered before the next recession hits.

Stated differently, the US economy has been shedding high paying goods producing jobs ever since they peaked at 25 million way back in 1980. Indeed,  we are still not even close to the  24.6 million figure which was posted  at the turn of the century.

By contrast, the count of leisure and hospitality jobs( bars, hotels and restaurants), or what we have dubbed the "Bread and Circuses Economy" keeps growing steadily, thereby filling up the empty space where good jobs have vacated the BLS headline total.

Thus, when goods-producing jobs peaked at 25 million back in 1980, there were only 6.7 million jobs in leisure and hospitality. Today that sector employs 16.0 million part-time, low-pay workers or 2.4X the four decade ago level.

Yes, there is nothing wrong with these jobs or the workers who hold them, but the fact that they constitute a rapidly increasing share of the mix is powerful proof that the job market is not nearly as awesome as it is cracked up to be; and that the monthly BLS report is surely no measure at all of a rising standard of living in Flyover America.

The larger point is that the monthly jobs report is really neither a report on true labor market conditions or a proxy for genuine economic growth. The fact is, without sustained growth of  full-time, full-pay "breadwinner" jobs there is no real economic recovery or progress.

And we literally mean, no progress. With an update for November"s results, the chart below would show 72.8 million "breadwinner jobs" in goods production, the white collar professions, business management and support, transportation and distribution, FIRE (finance insurance and real estate) and full-time government jobs outside of schools.

As it happens, that is virtually the same number posted by the BLS back in January 2001 when Bill Clinton was packing his bags to vacate the Oval office. In short, three presidents later---all of whom have claimed undying devotion to good jobs and rising living standards---and there is hardly a single new breadwinner job.

The above chart does not bring the concept of awesome to mind. In fact, it reminds of the same kind of stagnation that is evident in all the key metrics for real economic progress. For instance, an economy flat-out can not grow without steady gains in industrial production, which includes energy extraction and all facets of goods manufacturing from automobiles to furniture clothes, shoes and canned soup.

But like in the case of "breadwinner jobs", this so-called recovery has generated none of it. The index of industrial production stands at exactly the level of the pre-crisis peak a full decade ago.

There is a whole raft of these statistics,  but the following graph leaves little to the imagination.

Notwithstanding the Fed"s whacko claim that it hasn"t generated enough inflation in recent years, the truth is that even by the BLS" faulty measuring stick every single dollar of median household income gain has been eaten up by CPI inflation. Accordingly, there has been zero gain in real median household income for the entirety of this century!

What does our latest Oval Office occupant plan to do about this? Why nothing less than borrow $1.8 trillion from future taxpayers in order to enable corporations and other business to crank-out even bigger financial engineering distributions to shareholders in the form of dividends, stock buybacks and M&A deals.

This isn"t even "disruption" as per the Donald"s real job. It"s just dumb and fiscally irresponsible beyond measure - a message we have once again taken to the mainstream media in recent days.

Mugabe Out, Mnangagwa In, Inflation Down - Current Annual Rate 32%

Authored by Steve H. Hanke of the Johns Hopkins University. Follow him on Twitter @Steve_Hanke.

Robert Mugabe’s 27-year reign of lawlessness, corruption, and incompetence came to an end late November 2017, after a “soft coup” engineered by Emmerson Mnangagwa (aka “the Crocodile”) successfully unseated the aged dictator. Since then, inflation expectations in Zimbabwe have fallen sharply. In consequence, inflation has fallen like a stone. Indeed, before Mugabe’s resignation, Zimbabwe’s implied annual inflation soared to peak rate of 356% (10/26/17). But, following Mnangagwa’s assumption of power, the implied annual inflation rate has fallen to today’s rate of 32%.  

In 2008, Zimbabwe suffered the second most severe episode of hyperinflation in recorded history. The annual inflation rate peaked in November 2008, reaching 89.7 sextillion (10^23) percent (see table below).

At the peak of Zimbabwe’s hyperinflation episode in November 2008, Zimbabweans refused to use the Zimbabwe dollar. With that, the economy was spontaneously, and unofficially, dollarized. Eventually, the government faced this fait accompli in early 2009, when they dollarized the economy by accepting the dollar as the unit of account for government finances.

This year, Zimbabwe once again experienced a bout of hyperinflation, not due to dollarization, but because the Zimbabwean government is issuing, in effect, a new currency that is circulating parallel to the U.S. dollar. Currently (12/8/17), the annual inflation rate is at 32% (see chart below).

During Zimbabwe’s hyperinflation episode from 2007-2008, the Reserve Bank of Zimbabwe failed to report an accurate measure of inflation rates. When episodes of hyperinflation occur, the only feasible and reliable way to measure the inflation rate is via the application of Purchasing Power Parity (PPP). To do so, data on the exchange rate between the domestic currency and a stable international currency are required. This was not feasible in Zimbabwe. The Zimbabwe dollar was not traded on an organized exchange that reported exchange rates, and the use of black-market exchange rates was not feasible either.

However, the organized stock market in Harare did provide prices that allowed for the calculation of implied Zimbabwe dollar exchange rates. One stock, Old Mutual, was, and still is, listed on both the London Stock Exchange and the Zimbabwe Stock Exchange. Each share of Old Mutual commands the same claim on the company’s earnings and assets, irrespective of the market it is traded on. Therefore, given arbitrage and PPP, the ratio of the Old Mutual share price in Harare to that in London equaled the Zimbabwe dollar/sterling exchange rate.

To convert the resulting Zimbabwe dollar/sterling exchange rate to a Zimbabwe dollar/U.S. dollar rate, I multiplied the Zimbabwe dollar/sterling rate by the sterling/U.S. dollar rate, creating what is known as the Old Mutual Implied Rate (OMIR). By using the OMIR as an exchange rate between Zimbabwe dollars and USD, PPP was then applied as the final link necessary for calculating inflation rates.

When President Robert Mugabe’s party, ZANU-PF, regained control in Zimbabwe in 2013, government spending and public debt surged, resulting in economic instability. To finance its deficits, the government created a “New Zim dollar.” The New Zim dollar is issued at par to the U.S. dollar, but trades at a significant discount to the U.S. dollar. As a result of the issuance of the New Zim dollar, the money supply has exploded in Zimbabwe, and so has inflation.

Employing the same theory and method of measurement that was used to calculate Zimbabwe’s 2007-2008 hyperinflation episode, I was once again able to measure an accurate inflation rate, explained here in a detailed study. After doing so, I found that Zimbabwe experienced hyperinflation for the second time in less than ten years between September 2017 and early November 2017. 

Hyperinflation occurs when the monthly inflation rate reaches 50% per month and remains above that rate for at least 30 consecutive days. This initial threshold was breached on September 14, 2017, and the monthly inflation rate stayed above this rate until November 2, 2017. Currently, the monthly rate of inflation is -68% (see chart below).