The Cult of Central Banking

By John Mauldin

In today’s Outside the Box, good friend Ben Hunt informs us that we have entered the cult phase of the Golden Age of the Central Banker:

We pray for extraordinary monetary policy accommodation as a sign of our Central Bankers’ love, not because we think the policy will do much of anything to solve our real world economic problems, but because their favor gives us confidence to stay in the market. I mean, does anyone really think that the problem with the Italian economy is that interest rates aren’t low enough? Gosh, if only ECB intervention could get the Italian 10 yr bond down to 1.75% from the current 1.85%, why then we’d be off to the races! 

Really? But God forbid that Mario Draghi doesn’t (finally) put his money where his mouth is and announce a trillion euro sovereign debt purchase plan. That would be a disaster, says Mr. Market. Why? Not because the absence of a debt purchase plan would be terrible for the real economy. That’s not a big deal one way or another. It would be a disaster because it would mean that the Central Bank gods are no longer responding to our prayers.

But, he points out, the cult phase of any human society is a stable phase in the sense that, while change may happen, it will not happen from within:

There is such an unwavering faith in Central Bank control over market outcomes, such a universal assumption of god-  omnipotence within this realm, that any internal market shock is going to be willed away.

However, there is a minor catch: external market risk factors are all screaming red.

I’ve been doing this for a long time, and I can’t remember a time when there was such a gulf between the environmental or exogenous risks to the market and the internal or behavioral dynamics of the market. The market today is Wile E. Coyote wearing his latest purchase from the Acme Company – a miraculous bat-wing costume that prevents the usual plunge into the canyon below by sheer dint of will.

Ben identifies the three most pressing exogenous risks as the “supply shock” of collapsing oil prices, a realigning Greek election, and the realpolitik dynamics of the West vs. Islam and the West vs. Russia. (You or I might want to expand Ben’s list with one or two of our own favorites; but the point is, it’s a big, bad, volatile world out there right now.) Ben admits that it feels a bit weird to have written on all three of his chosen topics a few weeks before each of them appeared on investors’ radar screens. “Call me Cassandra,” says Ben. (Naw, I’ll stay with Ben.)

I wouldn’t want to steal too much of Ben’s thunder here, but I just can’t help sharing with you the punch line to his piece: “The gods always end up disappointing us mere mortals.”  This is one of Ben’s better pieces, and I really commend it to you as something you need to think about.

Before we examine our collective religious delusions (or at least our central banking delusions), let’s have a little fun. My friend Dennis Gartman (who could be the hardest working writer in the business) found this gem and shared it with his readers this morning. It is about the supposed lack of environmental concern of the Boomer generation has. And some of you will read it that way.

But I want those of you who are of a certain age (ahem) to realize just how much your world has changed in the last 50 years. If you are young, yes, we really did all the stuff listed below. I personally experienced every one of the rather long list of activities mentioned by the “little old lady.” Major changes in lifestyle since then? No, not really. But I’ll grand you that things are a good deal more convenient and time-saving today. Now sit back and enjoy.

Checking out at the store, the young cashier suggested to the much older lady that she should bring her own grocery bags, because plastic bags are not good for the environment. The woman apologized to the young girl and explained, "We didn't have this 'green thing' back in my earlier days." The young clerk responded, "That's our problem today. Your generation did not care enough to save our environment for future generations." The older lady said that she was right – her generation didn't have the "green thing" in its day. 

The older lady went on to explain: “Back then, we returned milk bottles, soda bottles and beer bottles to the store. The store sent them back to the plant to be washed and sterilized and refilled, so it could use the same bottles over and over. So they really were recycled. But we didn't have the ‘green thing’ back in our day. 

Grocery stores bagged our groceries in brown paper bags that we reused for numerous things. Most memorable besides household garbage bags was the use of brown paper bags as book covers for our school books. This was to ensure that public property (the books provided for our use by the school) was not defaced by our scribblings. Then we were able to personalize our books on the brown paper bags. But, too bad we didn't do the ‘green thing’ back then. We walked up stairs because we didn't have an escalator in every store and office building. We walked to the grocery store and didn't climb into a 300 horsepower machine every time we had to go two blocks. But you’re right, we didn't have the ‘green thing’ in our day. 

Back then we washed the baby's diapers because we didn't have the throwaway kind. We dried clothes on a line, not in an energy gobbling machine burning up 220 volts. Wind and solar power really did dry our clothes back in the early days. Kids got hand me down clothes from their brothers or sisters (and cousins), not always brand-new clothing. But you’re right, young lady; we didn't have the ‘green thing’ back in our day. Back then we had one TV, or radio, in the house – not a TV in every room. And the TV had a screen the size of a handkerchief [remember them?], not a screen the size of the state of Montana. In the kitchen we blended and stirred by hand because we didn't have electric machines to do everything for us. When we packaged a fragile item to send in the mail, we used wadded up old newspapers to cushion it, not Styrofoam or plastic bubble wrap. Back then, we didn't fire up an engine and burn gasoline just to cut the lawn. We used a push mower that ran on human power. 

We exercised by working, so we didn't need to go to a health club to run on treadmills that operate on electricity.” But you’re right; we didn't have the ‘green thing’ back then. We drank from a fountain when we were thirsty instead of using a cup or a plastic bottle every time we had a drink of water. We refilled writing pens with ink instead of buying a new pen, and we replaced the razor blade in a razor instead of throwing away the whole razor just because the blade got dull. But we didn't have the ‘green thing back then. 

Back then, people took the streetcar or the bus, and kids rode their bikes to school or walked instead of turning their moms into a 24 hour taxi service in the family's $45,000 SUV or van, which cost what a whole house did before the ‘green thing.’ We had one electrical outlet in a room, not an entire bank of sockets to power a dozen appliances. And we didn't need a computerized gadget to receive a signal beamed from satellites 23,000 miles out in space in order to find the nearest burger joint. But, isn't it sad, how the current generation laments how wasteful we old folks were just because we didn't have the ‘green thing’ back then?”

I wonder what our grandchildren will be telling their grandchildren in 50 years… “I remember a time when we actually used combustion engines to drive our cars that belched out dirty gases. We actually had massive electricity generating power plants and wires everywhere to deliver the electricity, rather than the small, efficient home units that produce free electricity for us now. We used something called glasses to help us see. People actually had to carry their communications devices around, and computers were measured in pounds not ounces. We had to do something called “typing” to write; and while we didn’t have to actually go to places called libraries like our grandparents did, we could and did spend all day searching through a disorganized Internet for what we needed. You weren’t connected biologically to your computer, so getting information in and out of it was a drag.

“People actually got sick and died; and though the situation was getting better, billions of people didn’t have enough food at night. People went to big stores to buy what was needed rather than just ordering it or producing it on the spot. We actually threw garbage away in huge resource-consuming “dumps” rather than completely recycling it into new products at the back of the house. It took like forever to get from one point to another. People actually had to “drive” their car rather than just getting in it and telling it where to go. And people died all the time in those cars – they were so dangerous and uncomfortable. In those days you couldn’t even instantly communicate with anybody by just thinking. You had to push buttons on that clumsy communication device you hauled around, and then talk into it; and if you lost it you were out of touch and out of luck. We didn’t even have intelligent personal robots in those days. It was so Stone Age.”

I could go on and on, but you get the drift. The changes in the last 50 years are simply a down payment on the change we’ll see and live in the next 50.

When I think about central banks and markets and try to figure out how to get preserve and grow assets from where we are today to where we will be in 10 years, it can be a rather daunting and sometimes even a depressing task. But then I think about what the world will be like and how much fun my grand kids are going to have, and I get all optimistic and smiling again.

Have a great week. The future is going to turn out just fine.
Your wondering if we will have flying cars analyst,

John Mauldin, Editor
Outside the Boxsubscribers@mauldineconomics.com

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“Catch-22”

By Ben Hunt, Salient Partners
Epsilon Theory, Jan. 12, 2015

Four times during the first six days they were assembled and briefed and then sent back. Once, they took off and were flying in formation when the control tower summoned them down. The more it rained, the worse they suffered. The worse they suffered, the more they prayed that it would continue raining. All through the night, men looked at the sky and were saddened by the stars. All through the day, they looked at the bomb line on the big, wobbling easel map of Italy that blew over in the wind and was dragged in under the awning of the intelligence tent every time the rain began. The bomb line was a scarlet band of narrow satin ribbon that delineated the forward most position of the Allied ground forces in every sector of the Italian mainland.

For hours they stared relentlessly at the scarlet ribbon on the map and hated it because it would not move up high enough to encompass the city.

When night fell, they congregated in the darkness with flashlights, continuing their macabre vigil at the bomb line in brooding entreaty as though hoping to move the ribbon up by the collective weight of their sullen prayers. "I really can't believe it," Clevinger exclaimed to Yossarian in a voice rising and falling in protest and wonder. "It's a complete reversion to primitive superstition. They're confusing cause and effect. It makes as much sense as knocking on wood or crossing your fingers. They really believe that we wouldn't have to fly that mission tomorrow if someone would only tiptoe up to the map in the middle of the night and move the bomb line over Bologna. Can you imagine? You and I must be the only rational ones left."

In the middle of the night Yossarian knocked on wood, crossed his fingers, and tiptoed out of his tent to move the bomb line up over Bologna.

― Joseph Heller, “Catch-22” (1961)

A visitor to Niels Bohr's country cottage, noticing a horseshoe hanging on the wall, teased the eminent scientist about this ancient superstition. “Can it be true that you, of all people, believe it will bring you luck?”

“Of course not,” replied Bohr, “but I understand it brings you luck whether you believe it or not.”

― Niels Bohr (1885 – 1962)

Here's an easy way to figure out if you're in a cult: If you're wondering whether you're in a cult, the answer is yes.

― Stephen Colbert, “I Am America (And So Can You!)” (2007)

I won't insult your intelligence by suggesting that you really believe what you just said.

― William F. Buckley Jr. (1925 – 2008)

A new type of superstition has got hold of people's minds, the worship of the state.

― Ludwig von Mises (1881 – 1973)

The cult is not merely a system of signs by which the faith is outwardly expressed; it is the sum total of means by which that faith is created and recreated periodically. Whether the cult consists of physical operations or mental ones, it is always the cult that is efficacious.

― Emile Durkheim, “The Elementary Forms of Religious Life” (1912)

At its best our age is an age of searchers and discoverers, and at its worst, an age that has domesticated despair and learned to live with it happily.

― Flannery O’Connor (1925 – 1964)

Man is certainly stark mad; he cannot make a worm, and yet he will be making gods by dozens.

― Michel de Montaigne (1533 – 1592)

Since man cannot live without miracles, he will provide himself with miracles of his own making. He will believe in witchcraft and sorcery, even though he may otherwise be a heretic, an atheist, and a rebel.

― Fyodor Dostoyevsky, “The Brothers Karamazov” (1880)

One Ring to rule them all; one Ring to find them.
One Ring to bring them all and in the darkness bind them.

― J.R.R. Tolkien, “The Lord of the Rings” (1954)

Nothing’s changed.
I still love you, oh, I still love you. Only slightly, only slightly less Than I used to.

― The Smiths, “Stop Me If You’ve Heard This One Before” (1987)

So much of education, I think, relies on reading the right book at the right time. My first attempt at Catch-22 was in high school, and I was way too young to get much out of it. But fortunately I picked it up again in my late 20’s, after a few experiences with The World As It is, and it’s stuck with me ever since. The power of the novel is first in the recognition of how often we are stymied by Catch-22’s – problems that can’t be solved because the answer violates a condition of the problem. The Army will grant your release request if you’re insane, but to ask for your release proves that you’re not insane. If X and Y, then Z. But X implies not-Y. That’s a Catch-22.

Here’s the Fed’s Catch-22. If the Fed can use extraordinary monetary policy measures to force market risk-taking (the avowed intention of both Zero Interest Rate Policy and Large Scale Asset Purchases) AND the real economy engages in productive risk-taking (small business loan demand, wage increases, business investment for growth, etc.), THEN we have a self-sustaining and robust economic recovery underway. But the Fed’s extraordinary efforts to force market risk-taking and inflate financial assets discourage productive risk-taking in the real economy, both because the Fed’s easy money is used by corporations for non-productive uses (stock buy-backs, anyone?) and because no one is willing to invest ahead of global growth when no one believes that the leading indicator of that growth – the stock market – means what it used to mean.

If X and Y, then Z. But X denies Y. Catch-22.

There’s a Catch-22 for pretty much everyone in the Golden Age of the Central Banker. Are you a Keynesian? Your Y to go along with the Central Bank X is expansionary fiscal policy and deficit spending. Good luck getting that through your polarized Congress or Parliament or whatever if your Central Bank is carrying the anti deflation water and providing enough accommodation to keep your economy from tanking.

Are you a structural reformer? Your Y to go along with the Central Bank X is elimination of bureaucratic red tape and a shrinking of the public sector. Again, good luck with that as extraordinary monetary policy prevents the economic trauma that might give you a chance of passing those reforms through your legislative process.

Here’s the thing. A Catch-22 world is a frustrating, absurd world, a world where we domesticate despair and learn to live with it happily. It’s also a very stable world. And that’s the real message of Heller’s book, as Yossarian gradually recognizes what Catch-22 really IS. There is no Catch-22. It doesn’t exist, at least not in the sense of the bureaucratic regulation that it purports to be. But because everyone believes that it exists, then an entire world of self-regulated pseudo-religious behavior exists around Catch-22. Sound familiar?

We’ve entered a new phase in the Golden Age of the Central Banker – the cult phase, to use the anthropological lingo. We pray for extraordinary monetary policy accommodation as a sign of our Central Bankers’ love, not because we think the policy will do much of anything to solve our real-world economic problems, but because their favor gives us confidence to stay in the market. I mean ... does anyone really think that the problem with the Italian economy is that interest rates aren’t low enough? Gosh, if only ECB intervention could get the Italian 10-yr bond down to 1.75% from the current 1.85%, why then we’d be off to the races! Really? But God forbid that Mario Draghi doesn’t (finally) put his money where his mouth is and announce a trillion euro sovereign debt purchase plan. That would be a disaster, says Mr. Market.

Why? Not because the absence of a debt purchase plan would be terrible for the real economy. That’s not a big deal one way or another. It would be a disaster because it would mean that the Central Bank gods are no longer responding to our prayers. The faith based system that underpins current financial asset price levels would take a body blow. And that would indeed be a disaster.

Monetary policy has become a pure signifier – a totem. It’s useful only in so far as it indicates that the entire edifice of Central Bank faith, both its mental and physical constructs, remains “efficacious”, to use Emile Durkheim’s path breaking sociological analysis of a cult. All of us are Yossarian today, far too rational to think that the totem of a red line on a map actually makes a difference in whether we have to fly a dangerous mission. And yet here we are sneaking out at night to move that line on the map. All of us are Niels Bohr today, way too smart to believe that the totem of a horseshoe actually bring us good luck. And yet here we are keeping that horseshoe up on our wall, because ... well ... you know.

The notion of saying our little market prayers and bowing to our little market talismans is nothing new. “Hey, is that a reverse pennant pattern I see in this stock chart?” “You know, the third year of a Presidential Administration is really good for stocks.” “I thought the CFO’s
body language at the investor conference was very encouraging.” “Well, with the stock trading at less than 10 times cash flow I’m getting paid to wait.” Please. I recognize aspects of myself in all four of these cult statements, and if you’re being honest with yourself I bet you do, too.

 

No, what’s new today is that all of our little faiths have now converged on the Narrative of Central Bank Omnipotence. It’s the One Ring that binds us all.

I loved this headline article in last Wednesday’s Wall Street Journal – “Eurozone Consumer Prices Fall for First Time in Five Years” – a typically breathless piece trumpeting the “specter of deflation” racing across Europe as ... oh-my-god ... December consumer prices were 0.2% lower than they were last December. Buried at the end of paragraph six, though, was this jewel: “Excluding food, energy, and other volatile items, core inflation rose to 0.8%, up a notch from November.” Say what? You mean that if you measure inflation as the US measures inflation, then European consumer prices aren’t going down at all, but are increasing at an accelerating pace?

You mean that the dreadful “specter of deflation” that is “cementing” expectations of massive ECB action is entirely caused by the decline in oil prices, something that from the consumer’s perspective acts like an inflationary tax cut? Ummm ... yep. That’s exactly what I mean. The entire article is an exercise in Narrative creation, facts be damned. The entire article is a wail from a minaret, a paean to the ECB gods, a calling of the faithful to prayer. An entirely successful calling, I might add, as both European and US markets turned after the article appeared, followed by Thursday’s huge move up in both markets.

When I say that a Catch-22 world is a stable world, or that the cult phase of a human society is a stable phase, here’s what I mean: change can happen, but it will not happen from within. For everyone out there waiting for some Minsky Moment, where a debt bubble of some sort ultimately pops from some unexpected internal cause like a massive corporate default, leading to systemic fear and pain in capital markets ... I think you’re going to be waiting for a loooong time. Are there debt bubbles to be popped?

Absolutely. The energy sector, particularly its high yield debt, is Exhibit #1, and I think this could be a monster trade. But is this something that can take down the market? I don’t see it. There is such an unwavering faith in Central Bank control over market outcomes, such a universal assumption of god-like omnipotence within this realm, that any internal market shock is going to be willed away.

So is that it? Is this a brave new world of BTFD market stability? Should we double down on our whack- a-mole volatility strategies? For internal market risks like leverage and debt bubble scares ... yes, I think so. But while the internal market risk factors that I monitor are quite benign, mostly green lights with a little yellow/caution peeking through, the external market risk factors that I monitor are all screaming red. 

These are Epsilon Theory risk factors – political shocks, trade/forex shocks, supply shocks, etc. – and they’ve got my risk antennae quivering like crazy. I’ve been doing this for a long time, and I can’t remember a time when there was such a gulf between the environmental or exogenous risks to the market and the internal or behavioral dynamics of the market. The market today is Wile E. Coyote wearing his latest purchase from the Acme Company – a miraculous bat-wing costume that prevents the usual plunge into the canyon below by sheer dint of will. There’s absolutely nothing internal to Coyote or his bat suit that prevents him from flying around happily forever. It’s only that rock wall that’s about to come into the frame that will change Coyote’s world.

My last three big Epsilon Theory notes – “The Unbearable Over-Determination of Oil”, “Now There’s Something You Don’t See Every Day, Chauncey”, and “The Clash of Civilizations” – have delved into what I think are the most pressing of these environmental or exogenous risks to the market: the “supply shock” of collapsing oil prices, a realigning Greek election, and the realpolitik dynamics of the West vs. Islam and the West vs. Russia. I gotta say, it’s been weird to write about these topics a few weeks before ALL of them come to pass. Call me Cassandra. I stand by everything I wrote in those notes, so no need to repeat all that here, but a short update paragraph on each.

First, Greece. And I’ll keep it very short. Greece is on. This will not be pretty and this will not be easy. Existential Euro doubt will raise its ugly head once again, particularly when Italy imports the Greek political experience.

Second, oil. I get a lot of questions about why oil can’t catch a break, about why it’s stuck down here with a 40 handle as the absurd media Narrative of “global supply glut forever and ever, amen” whacks it on the head day after day after day. And it is an absurd Narrative ... very Heller-esque, in fact ... about as realistic as “Peak Oil” has been over the past decade or two. Here’s the answer: oil is trapped in a positive Narrative feedback loop. Not positive in the sense of it being “good”, whatever that means, but positive in the sense of the dominant oil Narrative amplifying the uber-dominant Central Bank Narrative, and vice versa.

The most common prayer to the Central Banking gods is to save us from deflation, and if oil prices were not falling there would be no deflation anywhere in the world, making the prayer moot. God forbid that oil prices go up and, among other things, push European consumer prices higher. Can’t have that! Otherwise we’d need to find another prayer for the ECB to answer. By finding a role in service to the One Ring of Central Bank Omnipotence, the dominant supply glut oil Narrative has a new lease on life, and until the One Ring is destroyed I don’t see what makes the oil Narrative shift.

Third, the Islamist attack in Paris. Look ... I’ve got a LOT to say about “je suis Charlie”, both the stupefying hypocrisy of how that slogan is being used by a lot of people who should really know better, as well as the central truth of what that slogan says about the Us vs. Them nature of The World As It Is, but both are topics for another day. What I’ll mention here are the direct political repercussions in France.

The National Front, which promotes a policy platform that would make Benito Mussolini beam with pride, would probably have gotten the most votes of any political party in France before the attack. Today I think they’re a shoo-in to have first crack at forming a government whenever new Parliamentary elections are held, and if you don’t recognize that this is 100 times more threatening to the entire European project than the prospects of Syriza forming a government in Greece ... well, I just don’t know what to say.

There’s another thing to keep in mind here in 2015, another reason why selling volatility whenever it spikes up and buying the dip are now, to my way of thinking, picking up pennies in front of a steam roller: the gods always end up disappointing us mere mortals. The cult phase is a stable system on its own terms (a social equilibrium, in the parlance), but it’s rarely what an outsider would consider to be a particularly happy or vibrant system. There’s no way that Draghi can possibly announce a bond buying program that lives up to the hype, not with peripheral sovereign debt trading inside US debt.

There’s no way that the Fed can reverse course and start loosening again, not if forward guidance is to have any meaning (and even the gods have rules they must obey). Yes, I expect our prayers will still be answered, but each time I expect we will ask in louder and louder voices, “Is that all there is?” Yes, we will still love our gods, even as they disappoint us, but we will love them a little less each time they do.

And that’s when the rock wall enters the cartoon frame.

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The article Outside the Box: The Cult of Central Banking was originally published at mauldineconomics.com.

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A Five Year Forecast: Is this a Tsunami Warning?

By John Mauldin

It is the time of the year for forecasts; but rather than do an annual forecast, which is as much a guessing game as anything else (and I am bad at guessing games), I’m going to do a five year forecast to take us to the end of the decade, which I think may be useful for longer term investors. We will focus on events and trends that I think have a high probability, and I’ll state what I think the probabilities are for my forecasts to actually happen. While I could provide several dozen items, I think there are seven major trends that are going to sweep over the globe and that as an investor you need to have on your radar screen. You will need to approach these trends with caution, but they will also provide significant opportunities.

There is a book in here somewhere, but I do not intend to write one today. In fact, my New Year’s resolution is to write shorter letters in 2015. Over the last decade and a half, the letter has tended to get longer. A little more here, a little more there, and pretty soon it just gets to be a bit too much to read in one sitting. That means I need to either be more concise, break up my topics into two sessions or, if further writing is necessary, post the additional work on the website for those interested.

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So I’m writing today’s letter in that spirit. Each of the major topics we’ll be covering will show up in other letters over the next few months. I would appreciate your feedback and any links to articles and/or data points that you think I should know about regarding these topics.

But first, this is generally the most downloaded letter of the year. I want to invite new readers to become one of my 1 million closest friends by simply entering your email address here. You can follow my work throughout the year, absolutely free (and see how my prognostications are turning out). And if you’re a regular reader, why not send this to a few of your friends and suggest they join you? At the very least, Thoughts from the Frontline should make for some interesting conversations this year. Thanks. Now let’s get on with the forecasting.

Seven Significant Changes for the Next Five Years

Let’s look at what I think are six inexorable trends or waves that will each have a major impact in its own right but that when taken together will amount to a tsunami of change for the global economy.

1. Japan will continue its experiment with the most radical quantitative easing attempted by a major country in the history of the world… and the experiment is getting dangerous. The Bank of Japan is effectively exporting the island nation’s deflation to its trade competitors like Germany, China, and South Korea and inviting a currency war that could shake the world. I’ve been saying this for years now, but the story took a nasty turn on Halloween Day, when the Bank of Japan announced it was greatly expanding and changing the mix of its asset purchases. The results have been downright scary, and a major slide in the JPY/USD exchange rate is almost certain over the next five years. I give it a 90% probability. All this while the population of Japan shrinks before our very eyes.

2. Europe is headed for a crisis at least as severe as the Grexit scare was in 2012 – and for the resulting run-up in interest rates and a sovereign debt scare in the peripheral countries. After all these years of struggle, the structural flaws in the EMU’s design remain; and now major economies like Italy and France are headed for trouble. In the very near future we will finally know the answer to the question, “Is the euro a currency or an experiment?” The changes required to answer that question will be wrenching and horrifically expensive. There are no good answers, only difficult choices about who pays how much and to whom. Again, I see the deepening of the Eurozone crisis as a 90% probability.

3. China is approaching its day of reckoning as it tries to reduce its dependency on debt in its bid for growth, while creating a consumer society. The world is simply not prepared for China to experience an outright “hard landing” or recession, but I think there is a 70% probability that it will do so within the next five years.

And the probability that China will suffer either a hard landing OR a long period of Japanese style stagnation (in the event that the Chinese government is forced to absorb nonperforming loans to prevent a debt crisis) is over 95%. To be sure, it is still quite possible that the Chinese economy will be significantly larger in 2025 (ten years from now) than it is today, but realizing that potential largely depends on President Xi Jinping’s ability to accomplish an extremely difficult task: deleveraging the debt overhang that threatens the country’s MASSIVE financial system while rebalancing the national economy to a more sustainable growth model (either through either a vast expansion of China’s export market or the rapid development of “new economy” sectors like technology, services, and consumption; or both).

This will not be the end of China, which I’m quite bullish on over the very long term, but such transitions are never easy. Even given this rather stark forecast, it is still likely (in my opinion) that the Chinese economy will be 20 to 25% bigger as 2020 opens than it is today; and every other major economy in the world (including the US) would be thrilled to have such growth. At the very least, though, China’s slowdown and rebalancing is going to put pressure on commodity exporters, which are generally emerging markets plus Australia, Canada, and Norway.

4. All of the above will tend to be bullish for the dollar, which will make dollar-denominated debt in emerging market countries more difficult to pay back. And given the amount of debt that has been created in the last few years, it is likely that we’ll see a series of crises in emerging-market countries, along with an uncomfortably high level of risk of setting off an LTCM-style global financial shock.

My colleague Worth Wray spoke about this new era of volatile FX flows and growing risk of capital flight from emerging markets at my Strategic Investor Conference last May, and he has continued to remind us of those risks in recent months (“A Scary Story for Emerging Markets” and “Why the World Needs the US Economy to Struggle”).

Now that Russia has tumbled into a full-fledged currency crisis with serious signs of contagion, Worth’s prediction is already playing out, and I would assign an 80 to 90% probability that it will continue to do so, as a function of (1) the rising US dollar and a reversal in cross border capital flows, (2) falling commodity prices, or (3) both. This massive wave is going to create a lot of opportunities for courageous investors who are ready to surf when countries are cheap.

5. I do not believe that the secular bear market in the United States that I began to describe in 1999 has ended. Secular bull markets simply do not begin from valuations like those we have today. Either we began a secular bull market in 2009, or we have one more major correction in front of us.

Obviously, I think it is the latter. It has been some time since I’ve discussed the difference between secular bull and bear markets and cyclical bull and bear markets, and I will briefly touch on the topic today and go into much more detail in later letters. For US focused investors, this is of major importance. The secular bear is not something to be scared of but simply something to be played. It also offers a great deal of opportunity.

If I am right, then the next major leg down will bring on the end of the secular bear and the beginning of a very long term secular bull. We will all get to be geniuses in the 2020s and perhaps even before the last half of this decade runs out. Won’t that be fun? Let’s call the end of the secular bear a 90% probability in five years and move on.

6. Finally, the voters of the United States are going to have to make a decision about the direction they want to take the country. We can either opt for growth, which will mean a new tax and regulatory regime, or we can double down on the current direction and become Europe and Japan. I’ve traveled to both Europe and Japan, and they’re both pleasant enough places to live, but I wouldn’t want to be a citizen of either Japan or the Eurozone for the rest of this decade. (I particularly love Italy, but it is beginning to resemble a basket case, with last year’s optimistic drive for reforms seemingly stalled.)

However, I would rather live and work and invest in a high-growth country, with opportunities all around me, a country where we reduce income inequality by increasing wealth and opportunities at the lower end of the income scale instead of trying to legislate parity by increasing taxes and imposing government mandated wealth redistribution, which slows growth and squelches opportunity for everyone.

A restructuring of the US tax and regulatory regime does not mean a capitulation to the wealthy, big banks, or big business. Properly conceived and constructed, it will allow the renewal of the middle class and result in higher income for all. Sadly, it is not clear to me that either the Republican or Democratic parties are up to the task of making the difficult political decisions necessary. They each have constituencies that tend to opt for the status quo. But I see hope on both sides of the political spectrum that change is possible. The course they set will give us an idea where we will want to focus our portfolios in the decade of the ’20s. It is a 100% probability that we will have to make a decision. It is less than 50% that we will make the right one – or at least the one that I think is the right one.

7.  We have entered the Age of Transformation. We’re going to see the development of new technologies that will simply astound us – from increasingly capable robots and other applications of AI to huge breakthroughs in biotechnology.

The winners are going to be those who identified the truly transformational technologies early on in their development and invested wisely. While riskier (potentially far riskier) than most of your investments should be, a basket of new-technology stocks should be considered for the growth part of your portfolio. I see the Age of Transformation as a 100% probability.

Just for the record, I also see a continuation of the global deflationary environment and a slowing of the velocity of money until we have some type of resolution concerning sovereign debt. Central banks will continue to try to solve the “crises” I mentioned above with monetary policy, but monetary policy will simply not be enough to stem the tide. Central banks can paddle as hard as they like into the waves of change, but they cannot reverse their powerful flow.

Now, let’s look further at each of the waves that are forming into a potential tsunami.

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: A Five-Year Global Financial Forecast: Tsunami Warning was originally published at mauldineconomics.com.

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Why the World Needs the US Economy to Struggle

By John Mauldin

The headlines this morning talk about the US dollar hitting an 11-year high. I have been saying for years that the dollar is going to go higher than anyone can imagine. This trade is just in the early innings. And the repercussions will be dramatic, not only for emerging markets that have financed projects in dollars, but also for commodities and energy, gold, and a variety of other investments. The world is at the doorstep of a new era of volatility and currency wars.

In this week’s letter, my associate Worth Wray explores what a rising dollar means for emerging markets and what central banks are likely to do in response. Can they smooth the ride, or will it be the world’s scariest roller coaster? This letter will print long because of the number of fabulous charts Worth provides. I might make a brief comment or two at the end. Here’s Worth.

On the Verge of a Disaster… or a Miracle

By Worth Wray
Twenty years after the first divergence induced currency crisis of the 1990s, commodity prices are tumbling, the US dollar is rallying, and externally fragile emerging markets are reliving the horrors of their not so distant past. Except, this time, major economies like the United States, the United Kingdom, the Eurozone, Japan, and the People’s Republic of China may not be able to side step the ensuing contagion.

With 2014 now behind us, I want to focus this week's letter on what may prove to be the most important global macro pressure points in the coming year(s):

• The growing divergence among the world’s most important central banks
• The ongoing collapse in oil and other commodity prices as a function of excess supply and/or weakening global demand
• The rise of the US dollar, driven by divergence and risk aversion… and the squeeze it’s putting on the multi-trillion-dollar carry trade into emerging markets
• The vicious slide in emerging-market currencies
• The rising risk of 1990s style contagion and financial shocks
• And what, if anything, can avert the next global financial crisis

But first, let me tell you a story.

As some of you already know, I was born and raised in Baton Rouge, Louisiana – an old Southern city built on a bluff above the Mississippi River. It’s about an hour northwest of New Orleans – you can see it circled on the map below.

Given its inland position, Baton Rouge is fairly insulated from the fiercest impact of coastal storms; but hurricane season still tends to be the most stressful time of year. Our oak-covered neighborhoods and low-lying swamplands are vulnerable to the high winds and flood rains that can accompany a direct hit – not to mention the violent tornadoes that occasionally occur in the unpredictable northeastern quadrant of the tropical cyclone zone.

These storms don’t hit us often, but locals recall a handful of hurricanes that dealt heavy blows to the area over the years. And it goes without saying that the damage from any storm gets dramatically worse the closer you get to the Gulf of Mexico. Entire towns along the Gulf Coast have been swallowed up and swept away over the years by catastrophic storms like Camille (1969), Andrew (1994), and more recently Katrina (2005).

Twelve years ago, my father and I found ourselves in the path of such a storm.

According to the National Hurricane Center, Hurricane Lili was “supposed” to make landfall as a relatively weak storm. Just another named hurricane for the record books that would soon fade from our collective memory… or so we thought.

At 10:00 PM on Tuesday, October 1, 2002, Lili was a Category 2 hurricane with maximum sustained winds of 105 mph. Routine hurricane season stuff.



I went to sleep that night expecting a little rain and few uneventful days home from school; but when I woke up on Wednesday, October 2, I was shocked to see Lili develop an incredibly well articulated eye wall and grow more powerful by the hour – from 110 mph at 7:00 AM that morning to 135 mph at 1:00 PM and finally to 145 mph at 10 PM that night.

I remember the nervous look on my dad’s face that night as the two of us boarded up our doors and windows. A little earlier that evening, one of his local government contacts shared that, behind closed doors, state and local officials were expecting “mass casualties” from Morgan City (on the coast) to Baton Rouge… but it was already too late to order an evacuation so far inland. Given the mild forecasts, few were prepared for a major hurricane; and at that point in the day, making a public announcement would do little more than spark a panic. The best we could do was hunker down and pray.

This was the last advisory I saw before my head hit the pillow that night: Lili had strengthened to a strong Category 4 hurricane with maximum sustained winds around 145 mph, reported gusts above 210 mph, and the very real possibility of making landfall as a merciless Category 5. If you look at the Saffir Simpson hurricane scale, there’s a reason the first word you see next to Category 4 and 5 storms is catastrophic.

These storms are real killers.



Expecting to wake up early the next morning to sounds of thunder, pounding rain, and the eerie whistle of gale-force winds – or worse, I went to sleep Wednesday night with this image swirling through my mind:



But when I woke, I was shocked once more to learn that Lili – for reasons no one had anticipated – had all but died in the night and made landfall that morning as a small Category 1 hurricane with maximum sustained winds of only 90 miles per hour. In less than twelve hours, it had sharply decelerated from what could easily have been one of the most catastrophic storms on record to an inconvenience for most inland communities. Sure, it inflicted some damage along the coast – tearing up marshlands, knocking down power lines, blowing over trees, and flooding homes – but a Category 4 or 5 storm would have swallowed those areas whole.

As far as I know, there was no precedent in the Gulf of Mexico – or anywhere in the world – for Lili’s sudden death. It baffled even the most experienced meteorologists and left us all scratching our heads. Some people talked of miracles; others insisted there had to be a logical explanation. I imagine there’s some truth to both ideas.

While the press coverage surrounding Lili’s remarkable weakening has largely faded into obscurity, I was able to find one surviving article from USA Today that captures the confusion in the storm’s aftermath:

“Scientists Don’t Know Yet Why Lili Suddenly Collapsed.”

Hurricane Lili showed forecasters there is still a lot they don't know about hurricane intensity. Lili weakened in the hours before landfall Thursday as rapidly as it had strengthened into a ferocious storm the day before. Forecasters with the National Hurricane Center in Miami had hinted as early as Monday that Lili could rev up into a dangerous hurricane over the extraordinarily warm Gulf of Mexico, though they were surprised to see it grow so strong so quickly. But Lili's quick demise … had them admitting they didn't know what had happened…. National Hurricane Center Director Max Mayfield agrees. At a loss to explain Lili's fluctuations, he says, “A lot of Ph.D.s will be written about this.”

We still don’t have a definitive answer, but three theories emerged in the immediate aftermath:

1) Dry air was pulled into the storm and ate away at its moisture sucking core;

2) Winds aloft increased across the storm, creating wind shear and tipping the delicate balance that keeps intense storms going;

3) Water cooler than the 80° necessary to sustain a hurricane sapped Lili's strength when it moved over the same part of the north central Gulf of Mexico that had been churned up by a smaller hurricane, Isadore, a week earlier.

Regardless of why it happened, I learned something that day that will stay with me for the rest of my life: Even when a disastrous course of events is set in motion, disaster does not always strike. Surprises happen. Even miracles. Forecasts are often wrong – but it always pays to prepare.

Let me explain…..

Boom & Gloom

Just before Halloween, I wrote a letter (“A Scary Story for Emerging Markets”) explaining that the widening gap in economic activity among the United States, Japan, and the Eurozone was starting to demand a dangerous divergence in monetary policy.

Within a matter of days, the FOMC announced the end of its QE3 program... and then the Bank of Japan shocked the world, announcing a massive expansion in its own asset purchases timed to coincide with the government pension fund’s announcement that it was getting out of JGBs and into global equities.



Just as I had feared, the US dollar and Japanese yen were breaking out in opposite directions on real policy action, as Mario Draghi meanwhile continued to talk the euro down with the threat of future action. This may seem like a trivial shift in global FX markets, but it may have been the most important development we have seen since the global crisis peaked in 2008.



Since then, global economics has been a story of boom, gloom, and doom, as Marc Faber likes to say. We’re seeing a boom in US economic activity (or as much of a boom as you can expect with a massive debt overhang); a gloomy slowdown and slide toward deflation across Europe and China, along with the still-likely failure of Abenomics in Japan and renewed signs of FX contagion in emerging markets; and doom in commodities markets, particularly oil.

I’ve shared this next chart before, but it’s worth an update. Those of us who watch the US dollar were not surprised by the collapse in oil prices, because the dollar’s surge was already telling us something about global demand.



What did surprise a lot of economists (myself included) was the breakdown within OPEC, particularly Saudi Arabia’s willingness to accept whatever price the market offered in order to protect its market share.

Conspiracy theories aside as to whether OPEC’s move constitutes an anti-American trade war against US shale producers or a pro-American squeeze on Russia, Iran, and Venezuela, it’s already putting a serious squeeze on Texas oil men, Russian “oiligarchs,” and oilexporting emerging markets.

We’ll revisit the oil shock in a bit, but for now let’s get back to the US dollar.

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 Why the World Needs the US Economy to Struggle was originally published at mauldin economics

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America is Going to Have to Learn to Play Nicely......Where Have All the Statesmen Gone?

By Marin Katusa, Chief Energy Investment Strategist

One of the most striking things about the Colder War—as I explore in my new book of the same name—has been the contrast between the peevish tone of the West’s leaders compared to the more grown-up and statesmanlike approach that Putin is taking in international affairs.

Western leaders and their unquestioning media propagandists appear to believe that diplomatic relations are some kind of reward for good behavior. But it’s actually more important to establish a constructive dialogue with your enemies or rivals than your friends, because that’s where you need to find common ground. Indeed, it’s been the basis for diplomacy since time immemorial.

Reassuringly, despite having been the target of the Ukraine crisis rather than the instigator, Putin still sees the West as a potential partner, not an enemy. Nor does, he says, Russia have any interest in building an empire of its own. In theory, if Putin is sincere, there should be plenty of room for cooperation, especially in the fight against terrorism.

As Putin said in his speech at the Valdai International Discussion Club in Sochi in October—whose theme was “The World Order: New Rules or a Game without Rules”—he hasn’t given up on working with the West on shared risks and common goals, provided it’s based on mutual respect and an agreement not to interfere in one another’s domestic affairs.

Putin has, of course, already shown that he can rise above the fray. By negotiating the destruction of Assad’s chemical weapons arsenal under international supervision, he did Obama a big favor and got him off the hook in Syria. But his collaboration with Obama went further than that. Putin had helped persuade Iran to consider making concessions on its nuclear program and was working behind the scenes on North Korean issues.

But as we’re discovering, this was precisely the sort of statesmanship that the neoconservative holdouts in Washington could simply not abide, because it would wreck the plan they’d been hatching for decades to bring about US military strikes against Assad and to move beyond sanctions and more aggressively confront Iran.

Determined to drive a wedge between Obama and Putin and punish Putin for interfering with their goal of regime change in the Middle East, these masters of chaos—like National Endowment for Democracy President Carl Gershman, the US Assistant Secretary of State for European and Eurasian Affairs Victoria Nuland, and Senator John McCain—sprang into action.

These crazies first started fantasizing openly about regime change in Russia, and demonizing the “ideology of Russian imperialism that Putin represents,” before helping to topple Ukraine’s constitutionally elected government.

This is hardly the sort of behavior, to put it mildly, that would lead the Russians to trust American motives—especially after two rounds of NATO expansion in Central and Eastern Europe.

And the Russians also really don’t know what to make of the fact that one second Obama is including them on the list of the top global threats, and the next they’re being asked—yet again—to help secure a truly historical rapprochement with Iran. “It’s unseemly for a major and great power to take such a flippant approach toward its partners. When we need you, please help us, and when I want to punish you, obey me,” Russia’s foreign minister Sergei Lavrov said last week.

The West has squandered the opportunity, after its victory in the Cold War, to establish a new stable system of international relations, with checks and balances, said Putin in Sochi. Instead, the US trashed the system to serve its own selfish ends and made the world a more dangerous place.

A particularly disturbing accusation Putin made is that the U.S. has been using “outright blackmail” against a number of world leaders. “It is not for nothing,” he added, “that ‘big brother’ is spending billions of dollars keeping the whole world, including its own allies, under surveillance.” If true, it would put the US beyond the pale of the civilized global diplomatic community.

Last year Putin reminded Americans, in a New York Times op-ed, that the UN was founded on the basis that decisions affecting war and peace should happen only by consensus, and that it’s this profound wisdom that has underpinned the stability of international relations for decades. The UN risked suffering the same fate as the League of Nations, he said, if America continued to bypass it and take military action without Security Council authorization.

What really amazes Putin—and most right-minded people—is that even after 9/11, when the US finally woke up to the common threat of Islamic terrorism and suffered the most epic blowback of all time, it continued to use various jihadist organizations as an instrument, even after getting its fingers burnt every time.
What did toppling Gaddafi achieve? Nothing, except to turn Libya into a total mess and fill it with al-Qaeda training camps. And what is Obama’s present strategy of funding “moderate” rebels in Syria going to achieve, if not more of the same mayhem, as one US-backed group after another joins forces with the Islamic State?

It’s hard to disagree with Putin that America’s neoconservatives have sown geopolitical chaos, by almost routinely meddling in others’ domestic affairs. He lists the many follies the US has committed, from the mountains of Afghanistan, where al-Qaeda had its roots in CIA-funded operations against the Russians, to Iraq and Saddam’s phantom weapons of mass destruction, to modern-day Syria, where the Islamic State appears to have benefited at least indirectly from some serious funding—and weapons smuggled out of Libya by the CIA.

Instead of searching for global solutions, the Russians think the US has started believing its own propaganda: that its policies and views represent the entire international community, even as the world becomes a multipolar one. It would appear that Putin is in good company. No less a statesman than former US Secretary of State Henry Kissinger agrees with him.

Sanctions against Russia are a huge mistake, says Kissinger: “We have to remember that Russia is an important part of the international system, and therefore useful in solving all sorts of other crises, for example in the agreement on nuclear proliferation with Iran or over Syria.”

Like Putin, Kissinger argues that a new world order is urgently needed. In an interview in Der Spiegel, he adds that the West has to recognize that it should have made the negotiations about Ukraine’s economic relations with the EU a subject of a dialogue with Russia. After all, he says, Ukraine is a special case, because it was once part of Russia and its east has a large Russian population.

So how has the current generation of American leaders responded to Putin’s accusation—shared by his allies Argentina, Brazil, China, India, and South Africa—that the U.S. is riding roughshod over the interests of other nations?

By mocking him with the sort of childishness that was on display at the G20 summit, where Canadian Prime Minister Stephen Harper grabbed headlines when he told Putin: “Well, I guess I’ll shake your hand, but I only have one thing to say to you: you need to get out of Ukraine.” While Putin is obviously no saint, his presence at the G20 summit shows that far from being isolated, he continues to be treated as respectable company, despite his actions over Ukraine.

At least Germany and the EU now appear to understand that diplomacy, not military action, is going to resolve differences between Russia and the West—even though Russia expelled one of Germany’s diplomats in Moscow last week. Following up on the four-hour meeting Merkel had with Putin in Melbourne and the call for intensified diplomacy by the EU’s new foreign policy chief, Federica Mogherini, German Foreign Minister Frank-Walter Steinmeier is now engaged in intensive shuttle diplomacy with Moscow.

The world will be better off if we all stop using the language of force and return to the path of civilized diplomatic and political settlement, as Putin says. That’s what real statesmen would do, rather than trying to provoke Russia into a new Colder War. America is going to have to learn to play nicely. Otherwise, as Putin says, “today’s turmoil will simply serve as a prelude to the collapse of the world order.”

As you can see, there’s no greater force in geopolitics today than Vladimir Putin. But if you understand his role and how it influences the energy sector as Marin Katusa does, you’ll know how to get out in front of the latest moves and profit along the way. Of course, the situation is fluid, which is why Marin launched a brand new advisory dedicated to helping investors avoid energy companies that are being left behind and move into ones that will benefit from the tremendous shifts in capital being created by Putin. (In fact, Marin has the very best plays for taking advantage of cheap oil.)

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 today’s fast-changing 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 Where Have All the Statesmen Gone? was originally published at casey research

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Make No Mistake, the Oil Slump Is Going to Hurt the US Too

By Marin Katusa, Chief Energy Investment Strategist

If you only paid attention to the mainstream media, you’d be forgiven for thinking that the US is going to get away from the collapse in oil prices scott free. According to popular belief, America is even going to be a net winner from cheaper oil prices, because they will act like a tax cut for US consumers. Or so we are told. In reality, though, many of the jobs the U.S. energy boom has created in the last few years are now at risk, and their loss could drag the economy into a recession.

The view that cheaper oil automatically boosts U.S. GDP is overly simplistic. It assumes that US consumers will spend the money they save at the pump on U.S. made goods rather than imports. And it assumes consumers won’t save some of this windfall rather than spending it. Those are shaky enough. But the story that cheap fuel for our cars is good for us is also based on an even more dangerous assumption: that the price of oil won’t fall far enough to wipe out the US shale sector, or at least seriously impact the volume of US oil production.

The nightmare for the US oil industry is that the only way that the market mechanism can eliminate the global oil glut—without a formal agreement between OPEC, Russia, and other producers to cut production—is if the price of oil falls below the “cash cost” of production, i.e., it reaches the price at which oil companies lose money on every single barrel they produce.

If oil doesn’t sink below the cash cost of production, then we’ll have more of what we’re seeing now. US shale producers, like oil companies the world over, are only going to continue to add to the global oil glut—now running at 2-4 million barrels per day—by keeping their existing wells going full tilt.

True, oil would have to fall even further if it’s going to rebalance the oil market by bankrupting the world’s most marginal producers. But that’s what’s bound to happen if the oversupply continues. And because North American shale producers have relatively high cash costs (in the $30 range), the Saudis could very well succeed in making a big portion of US and Canadian oil production disappear, if they are determined to.

In this scenario, the US is clearly headed for a recession, because the US owes nearly all the jobs that have been created in the last few years to the shale boom. All those related jobs in equipment, manufacturing, and transportation are also at stake. It’s no accident that all new jobs created since June 2009 have been in the five shale states, with Texas home to 40% of them.

Even if oil were to recover to $70, $1 trillion of global oil sector capital expenditure—in fields representing up to 7.5 million bbl/d of production—would be at risk, according to Goldman Sachs. And that doesn’t even include the US shale sector! Unless the price of oil miraculously recovers, tens of billions of dollars worth of oil and gas related capital expenditure in the U.S. is going to dry up next year. While US oil and gas capex only represents about 1% of GDP, it still amounts to 10% of total US capex.

We’re not lost quite yet. Producers can hang on for a while, since there has been a lot of forward hedging at higher prices. But eventually hedges run out—and if the price of oil stays down sufficiently long, then the US is facing a massive amount of capital destruction in the energy industry.

There will be spillover into the financial arena, as well. Energy junk bonds may only account for 15% of the US junk bond market, or $200 billion, but the banks are also exposed to $300 billion in leveraged loans to the energy sector. Some of these lenders are local and regional banks, like Oklahoma based BOK Financial, which has to be nervously eyeing the 19% of its portfolio that’s made up of energy loans.

If oil prices stay at $55 a barrel, a third of companies rated B or CCC may be unable to meet their obligations, according to Deutsche Bank. But that looks like a conservative estimate, considering that many North American shale oil fields don’t make money below $55. And fully 50% are uneconomic at $50.

So if oil falls to $40 a barrel, a cascading 2008-style financial collapse, at least in the junk bond market, is in the cards. No wonder the "too big to fail banks" slipped a measure into the recently passed budget bill that put the US taxpayer back on the hook to insure any ill advised derivatives trades!

We know what happened the last time a bubble in financial assets popped in the US. There was a banking crisis, a serious recession, and a big spike in unemployment. It’s hard to see why it should be different this time. It’s a crying shame. The US has come so close to becoming energy independent. But it’s going to have to get its head around the idea that it could become a big oil importer again. In the end, the US energy boom may add up to nothing more than an illusion dependent upon the artificially cheap debt environment created by the Federal Reserve’s easy money policy.

However, there are a handful of domestic producers with high operating margins that are positioned to profit right through this slump in oil prices. To find out their names, sign up for Marin Katusa’s just launched advisory, The Colder War Letter.

You’ll also receive monthly updates on the latest geopolitical moves in this struggle to control the world’s oil pricing and the energy sector at large and what it means for your personal wealth. Plus, you’ll get a free hardback copy of Marin’s New York Times bestselling book, The Colder War, just for signing up today. Click here for all the details.

The article Make No Mistake, the Oil Slump Is Going to Hurt the US Too was originally published at casey research

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Why Russia Will Halt the Ruble’s Slide and Keep Pumping Crude Oil

By Marin Katusa, Chief Energy Investment Strategist

The harsh reality is that U.S. shale fields have much more to fear from plummeting oil prices than the Russians, since their costs of production are much higher, says Marin Katusa, author of The Colder War: How the Global Energy Trade Slipped from America’s Grasp.

Russia’s ruble may have strengthened sharply Wednesday, but it’s plunge in recent days has encouraged plenty of talk about the country’s catastrophe, with some even proclaiming that the new Russia is about to go the way of the old USSR.

Don’t believe it. Russia is not the United States, and the effects of a rapidly declining currency over there are much less dramatic than they would be in the U.S.

One important thing to remember is that the fall of the ruble has accompanied a precipitous decline in the per barrel price of oil. But the two are not as intimately connected as might be supposed. Yes, Russia has a resource based economy that is hurt by oil weakness. However, oil is traded nearly everywhere in U.S. dollars, which are presently enjoying considerable strength.

This means that Russian oil producers can sell their product in these strong dollars but pay their expenses in devalued rubles. Thus, they can make capital improvements, invest in new capacity, or do further explorations for less than it would have cost before the ruble’s value was halved against the dollar. The sector remains healthy, and able to continue contributing the lion’s share of governmental tax revenues.

Nor is ruble volatility going to affect the ability of most Russian companies to service their debt. Most of the dollar-denominated corporate debt that has to be rolled over in the coming months was borrowed by state companies, which have a steady stream of foreign currency revenues from oil and gas exports.

Russian consumers will be hurt, of course, due to the higher costs of imported goods, as well as the squeeze inflation puts on their incomes. But, by the same token, exports become much more attractive to foreign buyers. A cheaper ruble boosts the profit outlook for all Russian companies involved in international trade. Additionally, when the present currency weakness is added to the ban on food imports from the European Union, the two could eventually lead to an import substitution boom in Russia.

In any event, don’t expect any deprivations to inspire riots in the streets of Moscow. Russian President Vladimir Putin’s popularity has soared since the beginning of the Ukraine crisis. The people trust him. They’ll tighten their belts and there will be no widespread revolt against his policies.

Further, the high price of oil during the commodity super cycle, coupled with a high real exchange rate, led to a serious decline in the Russia’s manufacturing and agricultural sectors over the past 15 years. This correlation — termed by economists “Dutch disease”— lowered the Russian manufacturing sector’s share of its economy to 8% from 21% in 2000.

The longer the ruble remains weak, however, the less Dutch disease will rule the day. A lower currency means investment in Russian manufacturing and agriculture will make good economic sense again. Both should be given a real fillip.

Low oil prices are also good for Russia’s big customers, especially China, with which Putin has been forging ever stronger ties. If, as expected, Russia and China agree to transactions in rubles and/or yuan, that will push them even closer together and further undermine the dollar’s worldwide hegemony. Putin always thinks decades ahead, and any short term loss of energy revenues will be far offset by the long term gains of his economic alliances.

In the most recent development, the Russian central bank has reacted by raising interest rates to 17%. On the one hand, this is meant to curb inflation. On the other, it’s an direct response to the short selling speculators who’ve been attacking the ruble. They now have to pay additional premiums, so the risk/reward ratio has gone up. Speculators are going to be much warier going forward.

The rise in interest rates mirrors how former U.S. Fed Chair Paul Volcker fought inflation in the U.S. in the early ‘80s. It worked for Volcker, as the U.S. stock market embarked on a historic bull run. The Russians — whose market has been beaten down during the oil/currency crisis — are expecting a similar result.

Not that the Russian market is anywhere near as important to that country’s economy as the US’s is to its. Russians don’t play the market like Americans do. There is no Jim Kramerovsky’s Mad Money in Russia.

Russia is not some Zimbabwe-to-be. It’s sitting on a surplus of foreign assets and very healthy foreign exchange reserves of around $375 billion. Moreover, it has a strong debt-to-GDP ratio of just 13% and a large (and steadily growing) stockpile of gold. Why Russia will arrest the ruble’s slide and keep pumping oil
And there is Russia’s energy relationship with the EU, particularly Germany. Putin showed his clout when he axed the South Stream pipeline and announced that he would run a pipeline through Turkey instead.

The cancellation barely lasted long enough to speak it before the EU caved and offered Putin what he needed to get South Stream back on line. Germany is never going to let Turkey be a gatekeeper of European energy security. With winter arriving, the EU’s dependence on Russian oil and gas will take center stage, and the union will become a stabilizing influence on Russia once again.

In short, while the current situation is not working in Russia’s favor, the country is far from down for the count. It will arrest the ruble’s slide and keep pumping oil. Its economy will contract but not crumble. The harsh reality is that American shale fields have much more to fear from plummeting oil prices than the Russians (or the Saudis), since their costs of production are much higher. Many US shale wells will become uneconomic if oil falls much further. And it they start shutting down, it’ll be disastrous for the American economy, since the growth of the shale industry has underpinned 100% of US economic growth for the past several years.

Those waving their arms about the ruble might do better to look at countries facing real currency crises, like oil dependent Venezuela and Nigeria, as well as Ukraine. That’s where the serious trouble is going to come.
The collapse in oil prices is just the opening salvo in a decades long conflict to control the world’s energy trade. To find out what the future holds, specifically how Vladimir Putin has positioned Russia to come roaring back by leveraging its immense natural resource wealth, click here to get your copy of Marin Katusa’s smash hit New York Times bestseller, The Colder War. Inside, you’ll discover how underestimating Putin will have dire consequences.

And you’ll also discover how dangerous the deepening alliance between China, Russia and the emerging markets is to the future of American prosperity. Click here to get your copy.

The article Why Russia Will Halt the Ruble’s Slide and Keep Pumping Oil was originally published at casey research

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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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Breakfast with a Lord of War

By David Galland, Partner, Casey Research

For reasons that will become apparent as you read the following article, I was quite reluctant to write it.
Yet, in the end, I decided to do so for a couple of reasons.

The first is that it ties into Marin Katusa’s best selling new book, The Colder War, which I read cover to cover over two days and can recommend warmly and without hesitation. I know that Casey Research has been promoting the book aggressively (in my view, a bit too aggressively), but I exaggerate not at all when I tell you that the book sucked me in from the very beginning and kept me reading right to the end.

The second reason, however, is that I have a story to tell. It’s a true story and one, I believe, which needs to be told. It has to do with a breakfast I had four years ago with a Lord of War.

With that introduction, we begin.

Breakfast with a Lord of War

In late 2010, I was invited to a private breakfast meeting with an individual near the apex of the U.S. military’s strategic planning pyramid. Specifically, the individual we were to breakfast with sits at the side of the long serving head of the department in the Pentagon responsible for identifying and assessing potential threats to national security and devising long term strategies to counter those threats.

The ground rules for the discussion—that certain topics were off limits—were set right up front. Yet, as we warmed up to each other over the course of our meal, the conversation went into directions even I couldn’t have anticipated.

In an earlier mention of this meeting in a Casey Daily Dispatch, I steered clear of much of what was discussed because frankly, it made me nervous. With the passage of time and upon reflection that it was up to my breakfast companion, who spends long days cloaked in secrecy, to know what is allowed in daylight, I have decided to share the entire story.

During our discussion, there were four key revelations, each a bit scarier than the last.

Four Key Revelations

Once we had bonded a bit, the military officer, dressed in his civvies for the meeting, began opening up. As I didn’t record the discussion, the dialogue that follows can only be an approximation. That said, I assure you it is accurate in all the important aspects.

“Which country or countries most concern you?” I asked, not sure if I would get an answer. “China?”
“Well, I’m not going to say too much, but it’s not China. Our analysis tells us the country is too fractured to be a threat. Too many different ethnic and religious groups and competing political factions. So no, it’s not China. Russia, on the other hand…” He left it at that, though Russia would come up again in our conversation on several occasions.

As breakfast was served, the conversation meandered here and there before he volunteered, “There are a couple of things I can discuss that we are working on, one of which won’t surprise you, and one that will.”
“The first is precision guided weaponry.” Simply, the airplane and drone launched weaponry that is deployed so frequently today, four years after our breakfast conversation, that it now barely rates a back-page mention.

“The second,” he continued,” will surprise you. It’s nuclear armaments.”

“Really? I can’t imagine the US would ever consider using nuclear weapons again. Seriously?”

“Yes, there could be instances when using nukes might be advisable,” he answered. “For example, no one would argue that dropping atomic bombs on Japan had been a bad thing.” (I, for one, could have made that argument, but in the interest of harmony didn’t.)

“Even so, I can’t imagine a scenario that would warrant using nukes,” I persisted. “Are there any other countries doing the same sort of research?”

“Absolutely. For example, the Russians would love to drop a bomb that wiped out the people of Chechnya but left the infrastructure intact.”

“So, neutron bombs?”

“Yeah, stuff like that,” he added before turning back to his coffee.

“Okay, well,” I continued, “you at least have to admit that, unlike last century when hundreds of millions of people died directly or indirectly in world wars, pogroms, and so forth—most related to governments—the human race has evolved to the point where death on that scale is a thing of the past. Right?”

I kid you not in the slightest, but at this question the handsome, friendly countenance I had been sitting across from morphed as if literally a mask had been lifted away and was replaced with the emotionless face of a Lord of War.

“That would be a very poor assumption,” he answered coldly before the mask went back on.

I recall a number of thoughts and emotions coursing through my brain at his reply, most prevalently relief that I had moved with my family to La Estancia de Cafayate in a remote corner of Argentina. We didn’t move there to escape war, but after this conversation, I added that to my short list of reasons why the move had been a good idea.

Recapping the conversation later, my associate and I concurred that Russia was in the crosshairs and that if push came to shove, the US was fully prepared to use the new nuclear weapons being worked on.

Four Years Later

As I write, four years after that conversation, it’s worth revisiting just what has transpired.

First, as mentioned, the use of precision-guided weaponry has now firmly entered the vernacular of US warmaking. Point of fact: there are now more pilots being trained to fly drones than airplanes. And the technology has reached the point where there is literally no corner on earth where a strategic hit couldn’t be made. Even more concerning, the political and legal framework that previously caused hesitation before striking against citizens of other countries (outside of an active war zone) has largely been erased. Today Pakistan, tomorrow the world?

Second, instead of winding back the US nuclear program—a firm plank in President Obama’s campaign platform—the Nobel Prize winner and his team have indeed been ramping up and modernizing the US nuclear arsenal. The following is an excerpt from a September 21, 2014 article in the New York Times, titled “U.S. Ramping Up Major Renewal in Nuclear Arms”…,,

KANSAS CITY, Mo. — A sprawling new plant here in a former soybean field makes the mechanical guts of America’s atomic warheads. Bigger than the Pentagon, full of futuristic gear and thousands of workers, the plant, dedicated last month, modernizes the aging weapons that the United States can fire from missiles, bombers and submarines.

It is part of a nationwide wave of atomic revitalization that includes plans for a new generation of weapon carriers. A recent federal study put the collective price tag, over the next three decades, at up to a trillion dollars.

Third, the events unfolding in Ukraine, where the US was caught red handed engineering the regime change that destabilized the country and forced Russia to act, show a clear intent to set the world against Putin’s Russia and in time, neutralize Russia as a strategic threat.

So the only revelation from my breakfast four years ago remaining to be confirmed is for the next big war to envelope the world. Per the events in Ukraine, the foundations of that war have likely already been set. Before I get to that, however, a quick but relevant detour is required.

The Nature of Complex Systems

Last week the semiannual Owner’s & Guests event took place here at La Estancia de Cafayate. As part of the weeklong gathering, a conference was held featuring residents speaking on topics they are experts on.
Among those residents is a nuclear-energy engineer who spoke on the fragility of the US power grid, the most complex energy transmission system in the world.
He went into great detail about the “defense-in-depth” controls, backups, and overrides built into the system to ensure the grid won’t—in fact, can’t—fail. Yet periodically, it still does.

How? First and foremost, the engineer explained, there is a fundamental principle that holds that the more complex a system is, the more likely it is to fail. As a consequence, despite thousands of very bright people armed with massive budgets and a clear mandate to keep the transmission lines humming, there is essentially nothing they can do to actually prevent some unforeseen, and unforeseeable, event from taking the whole complex system down.

Case in point: in 2003 one of the largest power outages in history occurred. 508 large power generators were knocked out, leaving 55 million people in North America without power for upward of 24 hours. The cause? A software defect in an alarm system in an Ohio control center.

I mention this in the context of this article because, as complex as the U.S. power grid is, it is nothing compared to the complexities involved with long-term military strategic planning. This complexity is the result of many factors, including:

• The challenges of identifying potential adversaries and threats many years, even a decade or more, into the future.

• New and evolving technologies. It is a truism that the military is always fighting the last war: by the time the military machine spins up to build and deploy a new technology, it is often already obsolete.

• The entrenched bureaucracies, headed by mere mortals with strong biases. Today’s friend is tomorrow’s enemy and vice versa.

• The unsteady influences of a political class always quick to react with policy shifts to the latest dire news or purported outrage.

• The media, a constant source of hysteria making headlines masquerading as news. And let’s not overlook the media’s role as active agents of the entrenched bureaucratic interests. In one now largely forgotten case, Operation Mockingbird, the CIA actually infiltrated the major US media outlets, specifically to influence public opinion.
  
  All you need to do to understand the bureaucratic agenda is to take a casual glance at the “news” about current events such as those transpiring in the Ukraine.

• And, most important, human nature. We humans are the ultimate complex system, prone to a literally infinite number of strong opinions, exaggerated fears, mental illnesses, passions, vices, self-destructive tendencies, and stupidity on a biblical scale.

The point is that the average person assumes the powers-that-be actually know what they are doing and would never lead us into disaster, but quoting my breakfast companion, that would be a very poor assumption.

Simply, while mass war on the level of the wholesale slaughter commonplace in the last century is unimaginable to most in the modern context, it is never more than the equivalent of a faulty alarm system away from occurring.

Those history buffs among you will confirm that up until about a week before World War I began, virtually no one in the public, the press, the political class, or even the military had any idea the shooting was about to start. And 99.9% of the people then living had no idea the war was about to begin until after the first shot was fired.

Back to the Present

It is a rare moment in one’s life when the bureaucratic curtain falls away long enough to reveal something approximating The Truth. In my opinion, that’s what I observed over breakfast four years ago. That, right or wrong, the proactive military strategy of the US had been turned toward Russia.
Knowing that and no more, one can only guess what actual measures have been planned and set into motion to defang the Russian bear.

Based on the evidence, however, the events in Ukraine appear to be a bold chess move on the bigger board… and to be fair, a pretty damn effective move at that. The problem for the US and its allies is that on the other side of the table is one Vladimir Putin, self made man, black belt judo master, and former KGB spy master.

And that’s just scratching the surface of this complicated and determined individual. One thing is for sure: if you had to pick your adversary in a global geopolitical contest, you’d probably pick him dead last.
Which brings me to a quick mention of The Colder War, Marin’s book, which was released yesterday.
I mentioned earlier that the book had sucked me in and kept me in pretty much straight through until I finished. One reason is that while you can tell Marin has a great deal of respect for Putin’s capabilities and strategic thinking, he doesn’t shy away from revealing the judo master’s dark side. As you will read (and find quoting to your friends, as I have), it is a very dark side.

But the story is so much bigger than that, and Marin does a very good job of explaining the increasingly hostile competition between the US and Russia and the seismic economic consequences that will affect us all as the “Colder War” heats up.

Before signing off for now, I want to add that it is not Marin’s contention that the Colder War will devolve into an actual shooting war. In my view, however, due to the complexities discussed above, you can’t dismiss a military confrontation, even one involving nukes. Every complex system ultimately fails, and the more the US pushes in on Putin’s Russia, the more likely such a failure is to occur.

I recommend Marin’s book, The Colder War; here is the link.

We’ll leave the lights on down here in Cafayate.

Casey Research partner David Galland lives in La Estancia de Cafayate (www.LaEst.com).

The article Breakfast with a Lord of War was originally published at casey research.com.

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