The US Fed’s hidden rate hike (and its effect on us)

The US Fed’s hidden rate hike (and its effect on us)

Each week for our paid subscribers of Strategic Intelligence Australia, Jim publishes five significant news stories that help inform our strategic global analysis.

This week in The Daily Reckoning Australia, I thought I’d share the latest ‘five links’.

They are quite long, so I’ll deliver them in two parts.

But they are insightful.

They show you that some people are sheep and others are wolves.

The trouble is, it can be hard to know which is which.

Is the United States a sheep or a wolf?

It certainly looks like a wolf at first.

But I’m not so sure you’ll think that after reading on…

Is the most powerful financial institution in the world saving us from financial ruin?

Or dragging us into another financial crisis?

I’m not sure those in charge know themselves.

Are cryptocurrencies a scam by nature, have they been abused by scammers, or was it all just a bubble?

Are contactless payment cards, mobile phones and a cashless society a convenience? Something that empowers consumers to buy coffee even faster and easier? Or are consumers turning themselves into the coffee itself?

The product being sold to advertising companies and the surveillance state… You have to take a stand on these seemingly obscure issues if you want the best possible chance of protecting your wealth. Not to mention being in control of your everyday life.

On the one hand, Bitcoin offered you an anti-government payment mechanism that can circumvent even capital controls.

On the other hand, many Bitcoin service providers turned out to be worse than the government…

Are you willing to insert a computer chip into your hand to make contactless payments? If not, why not? And doesn’t your phone already put you in pretty much the same position?

Should you stay in the stock market when it’s dependent on central bank funny money?

Below, Jim helps you with the upcoming choices you’ll have to make.

The sheep and wolf choice I gave you is, of course, a false dichotomy.

You don’t have to choose one.

You can do what makes us human — change your position, find the middle ground and remain flexible.

For example, the contactless payment and smartphone revolution makes a great deal of sense, up to a point.

And you can choose for yourself what that point is.

Below, Jim takes you through the battles that are playing out in the real world so you can sort the sheep from the wolves and decide how you want to react…

Until next time,

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Nick Hubble,
For The Daily Reckoning Australia

Jim Rickards

I. This Trend in Foreign Holdings of US Treasury Notes Is Ominous

When critics point to Japan’s debt-to-GDP ratio of over 200%, Japan’s defenders are quick to say that most of the Japanese debt is owned by the Japanese themselves.

Usually in insurance companies, banks, pension plans and personal portfolios, not to mention the Bank of Japan.

There’s truth in this. Japan has a highly homogenous culture.

The Japanese are all in the same lifeboat, rowing in the same direction.

As long as no one rocks the boat, the debts can keep piling up.

That’s not true for the US.

In the US Treasury market, foreign ownership has remained constant as a dollar amount, but has dropped as a percentage as the market itself has grown.

As this article reports, foreign ownership of US Treasuries has dropped from almost 50% to just over 40% in the past six years.

Foreign participation in Treasury note auctions has also dropped, leaving the US Treasury to rely more on buying by US banks than end-user demand.

These trends are made worse by the fact that overall Treasury note issuance is expanding in line with higher US deficits, and Fed-buying has moved in reverse as part of the Fed’s ‘quantitative tightening’ program, which involves burning money instead of printing it.

Treasuries will always find a buyer — the Fed can force US banks to buy them if necessary.

But if these ‘hands-off’ policies of foreign buyers continue, interest rates will rise and liquidity will dry up.

This opens the door for slower economic growth and possible flash crashes in the Treasury market.

Conditions could get even worse if China uses the Treasury market as a weapon in the ongoing currency and trade wars.

The Treasury may end up as its own worst enemy for failure to get deficits under control.

II. As Usual, the Fed Doesn’t Know What It’s Doing. Here’s Why…

Over the past five years, we’ve pointed to many examples of the US Federal Reserve’s lack of knowledge as to how the US economy actually works:

  1. The Fed has never accurately predicted a recession.
  2. The Fed has never seen a financial panic in advance.
  3. Fed growth forecasts are incorrect by orders of magnitude year after year.
  4. The Fed missed the chance to raise rates in 2010 and is now raising rates into weakness in 2018.

The list goes on (back to 1913, in fact).

Yet, the Fed’s latest blunder may be the most dangerous of all.

The Fed printed $3.7 trillion of new money from 2008-2014 under the banner of ‘quantitative easing’, or QE.

There is no evidence that this ocean of new money did anything to increase growth.

In fact, the 2009-2018 recovery has been the weakest recovery in US history, despite a few good quarters here and there.

Now the Fed is trying to ‘normalise’ interest rates and its balance sheet with rate hikes and ‘quantitative tightening’ (QT) — not rolling over maturing positions in US Treasuries.

The first process is transparent.

The Fed has raised rates from 0% to 2.25% in the past three years and is ready to raise rates again on 19 December.

But, behind the curtain, the Fed is also reducing the base money supply with QT to get its balance sheet down from $4 trillion to $2.5 trillion by the end of 2020.

As this article shows, the impact of QT is roughly equivalent to another 1% per year of rate hikes.

This means that the combination of nominal rate hikes and QT is equal to 2% of rate hikes per year off an extremely low base.

The Fed is tightening more than it realises and will probably cause a recession or worse by the time it realises its mistake.

If this happens, the Fed will cut rates back to zero. But it won’t be enough.

Then, it’ll have to abandon QT and go back to QE4.

The more things change, the more they stay the same.

Look out for Part 2 on Thursday…


Jim Rickards Signature

Jim Rickards,
For The Daily Reckoning Australia