Reality Returns To Wall Street, Rickards Warns "This Will Not Be A Soft Landing"

Authored by James Rickards via The Daily Reckoning,

Barely a week after it set another record high, the Dow just suffered its worst one-day point loss in its entire history.

While the latest turmoil hasn’t reached the crisis level by any means, I’ve been warning about a correction for months.

Warnings about an imminent collapse of developed economy stock markets, especially the U.S. markets, have been everywhere.

Whether you use Shiller’s CAPE ratio, Warren Buffett’s preferred market-cap-to-GDP ratio, or traditional P/E ratios, markets were overpriced and ready to fall. Of course, that did not mean they would fall anytime soon, or on anyone’s timetable.

As we saw in the dot.com bubble of 1996-2000, and the housing bubble of 2002-2007, so-called “irrational exuberance” can last longer than the skeptics believe. However, some warnings perhaps deserve more attention than others.

Anyone can sound warnings about doom and gloom or stock market crashes. But those Cassandras are not worth listening to unless they offer facts and analysis to support their views. Opinions without something solid to back them up are just that — opinions. The warnings I pay most attention to are those from establishment insiders.

These are the kinds of individuals who attend Davos and routinely discuss market conditions with central bank heads, finance ministers and people like Christine Lagarde, head of the IMF.

The credibility of such insiders is enhanced ever further when they come with serious academic credentials such as an economics Ph.D. from a top university in the field.

William White is such an individual. He was former head of the OECD review board and former chief-economist for the BIS, the “central bankers central bank” based in Basel, Switzerland.

In a recent interview, White flatly declared, “All the market indicators right now look very similar to what we saw before the Lehman crisis, but the lesson has somehow been forgotten.”

You can’t get much more of a blinking red light than that.

Heading into this year, I called 2018 “The Year of Living Dangerously.”

That description seemed odd to lot of observers. Major U.S. stock indexes kept hitting new all-time highs, which continued through the end of January.

Even in strong bull market years there are usually one or two down months as stocks take a breather on the way higher. Not last year. There was no rest for the bull; it was up, up and away.

The unemployment rate has been at a 17-year low. U.S. growth was over 3% in the second and third quarters of 2017. It underwhelmed in the fourth quarter at 2.6%, but it was still above the tepid 2% growth we’ve seen since the end of the last recession in June 2009.

The U.S. hasn’t been alone. For the first time since 2007, we were seeing strong synchronized growth in the U.S., Europe, China, Japan (the “big four”) as well as other developed and emerging markets.

In short, all has been right with the world.

Or not.

To understand why I said 2018 may unfold catastrophically, we can begin with a simple metaphor. Imagine a magnificent mansion built with the finest materials and craftsmanship and furnished with the most expensive couches and carpets and decorated with fine art.

Now imagine this mansion is built on quicksand. It will have a brief shining moment and then sink slowly before finally collapsing under its own weight.

That’s a metaphor. How about hard analysis? Here it is:

Start with debt. Much of the good news described above was achieved not with real productivity but with mountains of debt including central bank liabilities.

In a recent article, Yale scholar Stephen Roach points out that between 2008 and 2017 the combined balance sheets of the central banks of the U.S., Japan and the eurozone expanded by $8.3 trillion, while nominal GDP in those same economies expanded $2.1 trillion.

What happens when you print $8.3 trillion in money and only get $2.1 trillion of growth? What happened to the extra $6.2 trillion of printed money?

The answer is that it went into assets. Stocks, bonds, emerging-market debt and real estate have all been pumped up by central bank money printing.

What makes 2018 different from the prior 10 years? The answer is that this is the year the central banks stop printing and take away the punch bowl.

The Fed is already destroying money (they do this by not rolling over maturing bonds). Last week, the Fed reduced its balance sheet by $22 billion. While that doesn’t seem like much when you’re talking about a $4 trillion balance sheet, it was the Fed’s largest cut to date.

Funny how the market hit the skids just after this happened. But you haven’t heard the mainstream media mention that.

By the end of 2018, the annual pace of money destruction will be $600 billion — if the Fed under new chairman Jerome Powell stays on course.

The European Central Bank and Bank of Japan are not yet at the point of reducing money supply, but they have stopped expanding it and plan to reduce money supply later this year.

In economics everything happens at the margin. When something is expanding and then stops expanding, the marginal impact is the same as shrinking.

Apart from money supply, all of the major central banks are planning rate hikes, and some, such as those in the U.S. and U.K., are actually implementing them.

Reducing money supply and raising interest rates might be the right policy if price inflation were out of control. But despite a recent uptick in some inflation measures, prices have mostly been falling.

The “inflation” hasn’t been in consumer prices; it’s in asset prices. The impact of money supply reduction and higher rates will be falling asset prices in stocks, bonds and real estate — the asset bubble in reverse.

And as the past few days show, the problem with asset prices is that they do not move in a smooth, linear way. Asset prices are prone to bubbles on the upside and panics on the downside. Small moves can cascade out of control (the technical name for this is “hypersynchronous”) and lead to a global liquidity crisis worse than 2008.

This will not be a soft landing. The central banks — especially the U.S. Fed, first under Ben Bernanke and later under Janet Yellen — repeated Alan Greenspan’s blunder from 2005–06. Greenspan left rates too low for too long and got a monstrous bubble in residential real estate that led the financial world to the brink of total collapse in 2008.

Bernanke and Yellen also left rates too low for too long. They should have started rate and balance sheet normalization in 2010 at the early stages of the current expansion when the economy could have borne it. They didn’t.

Bernanke and Yellen did not get a residential real estate bubble. Instead, they got an “everything bubble.” In the fullness of time, this will be viewed as the greatest blunder in the history of central banking.

Not only that, but Greenspan left Bernanke some dry powder in 2007 because the Fed’s balance sheet was only $800 billion. The Fed had policy space to respond to the panic of 2008 with rate cuts and QE1.

Today the Fed’s balance sheet is over $4 trillion. If the current rout becomes a full-blown panic, or even if it is delayed until later, the Fed’s capacity to cut rates is only 1.5%. And its capacity to expand the balance sheet is basically nil, because the Fed would be pushing the outer limits of an invisible confidence boundary.

This conundrum of how central banks unwind easy money without causing a recession (or worse) is just one small part of a risky mosaic.

For now, think of 2018 as the year of living dangerously.

Smart investors should prepare now with reduced exposure to stocks and increased allocations to cash and gold.

Comments

Laowei Gweilo lloll Wed, 02/07/2018 - 23:47 Permalink

>>> re: "“All the market indicators right now look very similar to what we saw before the Lehman crisis, but the lesson has somehow been forgotten.” <<<

 

this is a ridiculous comparison

it blows my mind that within days we can have articles that can say this is similar to 2008 and similar to 1987

 

they were complete opposites in terms of private institutional debt exposure AND consumer debt that had interest rate risk

2018 could easily be as bad as either, so don't misunderstand

but if you look at institutional debt exposure, 2018 is nothing like 2008; and, if you look at consumer debt, student/subprime consumer debt is fundamentally different than mortgages because both consumer exposure to their [default] and the debt holders exposure to default (notably how they keep the debt on the books) is absolutely nothing like 2008. 

there's a bad consumer debt situation but it's nothing like 2008, and a lot more like the economic/inflation situation of 1987, and the economy itself cannot be like both 1987 or 2008, nor can the institutional debt/interest rate risk.

what next, it's similar to 1929? i mean, gd... pick one, lol (pro-tip: it's 1987)

In reply to by lloll

ktown skbull44 Thu, 02/08/2018 - 04:05 Permalink

It is different! The Fed remitted 50 billion dollars  from main street to wall and broad streets to make sure excess reserves stay in waiting and continues to say interest on excess reserves are temporary? Until the Fed eliminates payments to banks for excess reserves we fall faster than advertised? The Fed needs jumpers! (To replace missing drama) crickets can't be good?

In reply to by skbull44

BlindMonkey Wed, 02/07/2018 - 20:48 Permalink

"The credibility of such insiders is enhanced ever further when they come with serious academic credentials such as an economics Ph.D. from a top university in the field."

 

Yeah, the crash is going to happen.  Check.  We got it but appeals to authority don't help your sell among anyone that can think for themselves.  

TeethVillage88s Wed, 02/07/2018 - 20:52 Permalink

Rickards has like 4-5 books to explain this complex topic... he does disservice in an short article.  But his books are well documented with notes and are really historical and reveal trade agreements, treaties, and economics.

- Spoiler Alert: he reveals dire picture

 

Apeon Wed, 02/07/2018 - 20:54 Permalink

Do not sign up for Rickards stuff, he sends dozens of emails immediately after you sign up, one of them has an opt out provision, and if you do not read it, you get stuck!

Rusty Shorts Wed, 02/07/2018 - 20:54 Permalink

BULLSHIT. Trump is making America Great Again. We will see great times in the next 7 years, a time of plenty of coke and whores, plenty of money, plenty of food and drink.

 

You will be entertained.

hoist the bs flag Wed, 02/07/2018 - 20:58 Permalink

please be a currency crash, please be a currency crash....PLEASE be a currency CRASH! domino the planet!!!

can't WAIT for that 2018 NWO currency!! whoo hoo!

hail the Lord of Light!

MozartIII Wed, 02/07/2018 - 21:01 Permalink

Zero hedge, your shit is broken. Benzinga has no real link. Your links to follow people are shit. your whole board is shit. That is another story. Don't think that you care anymore. Die. Natural progression in a fight club. Your fat and happy then you die!

Yen Cross Wed, 02/07/2018 - 21:05 Permalink

   This might be O/T, but Tucker Carlson just spent about [2]minutes interviewing some kid, Re; infrastructure financing.

  This kid has only been involved in politics for about [3]years, but suddenly understands public infrastructure funding.

  FWIW, WE as taxpayers pay for infrastructure improvements. [the kid] suggested more "toll roads".  Apparently the kid has limited understanding of " national security"? 

  Bringing in 'private' investment for large scale infrastructure projects is prohibited, for obvious reasons. [not to mention OUR tax dollars] are supposed to provide for those expenses.

  I wonder where all those tax dollars went? 

 

Paul John Smith Wed, 02/07/2018 - 21:07 Permalink

Jim Rickards is the unofficial "warning agent" for the deep state ... it seems to me he is used to warn people, in a captain obvious way, that some great doom has arrived. He is also quite good at nearly crashing the economy (LTCM 1998), and other such follies. He is CIA.

Phillyguy Wed, 02/07/2018 - 21:34 Permalink

The US is confronted with very severe structural economic problems, largely of our own making and a direct consequence of government and corporate policies. These include decades of tax cuts for the wealthy, job outsourcing, financial deregulation, spending $ trillions on the Pentagon and very costly wars in Afghanistan (longest running war in US history), Iraq, Libya, Syria. The US deficit is circa $20 trillion and only going to increase with Trump’s tax cut, which according to David Stockman will result in $400 billion in lost revenue for the US treasury, while the 2019 Pentagon appropriation will be circa $100 billion higher than 2016.

Since 2008, Wall St. has been supported by $ trillions of ultra-cheap money from the FED for stock buybacks and MA deals. The problem will all this is that companies that paid inflated prices for these shares, effectively using borrowed money (albeit at low interest). See- www.rt.com/shows/keiser-report/417979-episode-max-keiser-1185/

Two facts reveal the true state of economic relations in the US- 
1) The 3 wealthiest people in the US have as much wealth as the bottom 50% of the US population (~ 160 million; Link: www.scmp.com/news/world/united-states-canada/article/2119052/three-rich…)
2) The majority of Americans have little or no savings and thus, are one expensive car repair or medical emergency away from financial disaster- not being able to afford rent, buy food for their family, etc. (See: www.usatoday.com/story/money/personalfinance/2016/10/09/savings-study/9…).

Bottom line- this will not end well.

ktown Phillyguy Thu, 02/08/2018 - 04:23 Permalink

Bottom line; the Federal Reserve needs you and your fellow compatriots  to fore go the use of 3trillion dollars for a period to extend until such time as the board can comfortably raise Federal Funds rate for the purpose of removing the punchbowl? Any hardships experienced during said period should be used to educate yourself on the dangers of excess!

In reply to by Phillyguy

JailBanksters Wed, 02/07/2018 - 23:35 Permalink

Only if the Government of the Day is NOT willing to give the Banksters more free money from Tax Payers and

the CLUB Fed is NOT willing to give their Bankster Buddies more free money and the Banksters are unable to steal your money from your bank account. But one of those things is going to happen, so it will be a lot softer than if you can't repay your Mortgage. If it sounds familiar ....

 

ktown JailBanksters Thu, 02/08/2018 - 04:33 Permalink

The Federal reserve is the banksters co-op. The Banks don't trust each other and pool assets on the Fed Balance sheet? Which begs the question, if the Fed can't sell the mortgages back to the original processor's (banks) which after a decade they haven't been willing and/or able?  Perhaps  the rolloff is a scam and the proceeds are being stolen!  The Fed needs to   hide the 1.8 trillion dollars of mortgages panic bought during 2008?  Its another flimflam to socialize massive losses by the Federal reserve  any way you tranche it?

In reply to by JailBanksters

2rigged2fail Thu, 02/08/2018 - 07:27 Permalink

If Rickards says down then prob up.  The guys track record is horrible.  Gold has gone no where, his big claim to fame trump win and brexit.  He bashed crypto for over a year then puts out a rec that in 2 weeks loses over 50%, and you got to pay prob thousands for that pick lol.  He said buy 100 of these coins and if it goes to the same price of BTC you will become a millionaire.  He fails to mention the float on this crypto is going to be 100B hundreds of times more than BTC so $10 would be pushing it.  What a fraud

 

He wants to sell books and doom