By John Mauldin 

There is presently a bull market in complacency. There are very few alarm bells going off anywhere; and frankly, in reaction to my own personal complacency, I have my antenna up for whatever it is I might be missing that would indicate an approaching recession.

It was very easy to call the last two recessions well in advance because we had inverted yield curves. In the US at least, that phenomenon has a perfect track record of predicting recessions. The problem now is that, with the Federal Reserve holding the short end of the curve at the zero bound, there is no way we can get an inverted yield curve, come hell or high water. For the record, inverted yield curves do not cause recessions, they simply indicate that something is seriously out of whack with the economy. Typically, a recession shows up three to four quarters later.

I know from my correspondence and conversations that I am not the only one who is concerned with the general complacency in the markets. But then, we’ve had this “bull market in complacency” for two years and things have generally improved, albeit at a slower pace in the current quarter.

With that background in mind, the generally bullish team at GaveKal has published two short essays with a rather negative, if not ominous, tone. Given that we are entering the month of October, known for market turbulence, I thought I would make these essays this week’s Outside the Box. One is from Pierre Gave, and the other is from Charles Gave. It is not terribly surprising to me that Charles can get bearish, but Pierre is usually a rather optimistic person, as is the rest of the team.

I was in Toronto for two back-to-back speeches before rushing back home this morning. I hope you’re having a great week. So now, remove sharp objects from your vicinity and peruse this week’s Outside the Box.

Your enjoying the cooler weather analyst,

John Mauldin

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A Worrying Set Of Signals

By Pierre Gave
Regular readers will know that we keep a battery of indicators to gauge, among other things, economic activity, inflationary pressure, risk appetite and asset valuations. Most of the time this dashboard offers mixed messages, which is not hugely helpful to the investment process. Yet from time to time, the data pack points unambiguously in a single direction and experience tells us that such confluences are worth watching. We are today at such a point, and the worry is that each indicator is flashing red.

Growth: The three main indices of global growth have fallen into negative territory: (i) the Q-indicator (a diffusion index of leading indicators), (ii) our diffusion index of OECD leading indicators, and (iii) our index of economically-sensitive market prices. Also Charles’s US recession indicator is sitting right on a key threshold (see charts for all these indicators in the web version).

Inflation: Our main P-indicator is at a maximum negative with the diffusion index of US CPI components seemingly in the process of rolling over; this puts it in negative territory for the first time this year.

Risk appetite: The Gavekal velocity indicator is negative which is not surprising given weak market sentiment in recent weeks. What worries us more is the widening of interest rate spreads—at the long end of the curve, the spread between US corporate bonds rated Baa and treasuries is at its widest since 2009; at the short-end, the TED spread is back at levels seen at the height of the eurozone crisis in 2012, while the Libor-OIS spread is at a post-2008 high. Moreover, all momentum indicators for the main equity markets are at maximum negative, which has not been seen since the 2013 “taper tantrum”.

These weak readings are especially concerning, as in recent years, it has been the second half of the year when both the market and growth has picked up. We see three main explanations for these ill tidings:

1) Bottoming out: If our indicators are all near a maximum negative, surely the bottom must be in view? The contrarian in us wants to believe that a sentiment shift is around the corner. After all, most risk-assets are oversold and markets would be cheered by confirmation that the US economy remains on track, China is not hitting the wall and the renminbi devaluation was a one-off move. If this occurs, then a strong counter-trend rally should ramp up in time for Christmas.

2) Traditional indicators becoming irrelevant: Perhaps we should no longer pay much attention to fundamental indicators. After all, most are geared towards an industrial economy rather than the modern service sector, which has become the main growth driver. In the US, industrial production represents less than 10% of output, while in China, the investment slowdown is structural in nature. The funny thing is that employment numbers everywhere seem to be coming in better than expected. In this view of things, either major economies are experiencing a huge drop in labor productivity, or our indicators need a major refresh (see Long Live US Productivity!).

3) Central banks out of ammunition: The most worrying explanation for the simultaneous decline in our indicators is that air is gushing out of the monetary balloon. After more than six years of near zero interest rates, asset prices have seen huge rises, but investment in productive assets remains scarce.

Instead, leverage has run up across the globe. According to the Bank for International Settlements’ recently released quarterly review, developed economies have seen total debt (state and private) rise to 265% of GDP, compared to 229% in 2007. In emerging economies, that ratio is 167% of GDP, compared to 117% in 2007 (over the period China’s debt has risen from 153 to 235% of GDP). The problem with such big debt piles is that it is hard to raise interest rates without derailing growth.

Perhaps it is not surprising that in recent weeks the Federal Reserve has backed away from hiking rates, the European Central Bank has recommitted itself to easing and central banks in both Norway and Taiwan made surprise rate cuts. But if rates cannot be raised after six-years of rising asset prices and normalizing growth, when is a good time? And if central banks are prevented from reloading their ammunition, what will they deploy the next time the world economy hits the skids?

Hence we have two benign interpretations and one depressing one. Being optimists at heart, we want to believe that a combination of the first two options will play out. If so, then investors should be positioned for a counter-trend rally, at least in the short-term. Yet we are unsettled by the market’s muted response to the Fed’s dovish message. That would indicate that investors are leaning towards the third option. Hence, we prefer to stay protected and for now are not making a bold grab for falling knifes. At the very least, we seek more confirmation on the direction of travel.

Positioning For A US Recession

By Charles Gave
Since the end of last year I have been worried about an “unexpected” slowdown, or even recession, in the world’s developed economies (see Towards An OECD Recession In 2015). In order to monitor the situation on a daily basis, I built a new indicator of US economic activity which contains 17 components ranging from lumber prices and high-yield bond spreads to the inventory-to-sales ratio. It was necessary to construct such an indicator because six years of extreme monetary policy in the US (and other developed markets) has stripped “traditional” cyclical economic data of any real meaning (see Gauging The Chances Of A US Recession).

Understanding this diffusion index is straightforward. When the reading is positive, investors have little to worry about and should treat “dips” as a buying opportunity. When the reading is negative a US recession is a possibility. Should the reading fall below – 5 then it is time to get worried – on each occasion since 1981 that the indicator recorded such a level a US recession followed in fairly short order. At this point, my advice would generally be to buy the defensive team with a focus on long dated US bonds as a hedge. This is certainly not a time to buy equities on dips.

Today my indicator reads – 5 which points to a contraction in the US, and more generally the OECD. Such an outcome contrasts sharply with official US GDP data, which remains fairly strong. Pierre explored this discrepancy in yesterday’s Daily (see A Worrying Set Of Signals), so my point today is to offer specific portfolio construction advice in the event of a developed market contraction. My assumption in this note is simply that the US economy continues to slow. Hence, the aim is to outline an “anti-fragile” portfolio which will resist whatever brickbats are hurled at it.

During periods when the US economy has slowed, especially if it was “unexpected” by official economists, then equities have usually taken a beating while bonds have done well. For this reason, the chart below shows the S&P 500 divided by the price of a 30 year zero coupon treasury.

A few results are immediately clear:

• Equities should be owned when the indicator is positive.
   
• Bonds should be held when the indicator is negative.
   
• The ratio of equities to bonds (blue line) has since 1981 bottomed at about 50 on at least six occasions. Hence, even in periods when fundamentals were not favorable to equities (2003 and 2012) the indicator identified stock market investment as a decent bet. 
Today the ratio between the S&P 500 and long dated US zeros stands at 75. 

This suggests that shares will become a buy in the coming months if they underperform bonds by a chunky 33%. The condition could also be met if US equities remain unchanged, but 30 year treasury yields decline from their current 3% to about 2%. Alternatively, shares could fall sharply, or some combination in between. 


Notwithstanding the continued relative strength of headline US economic data, I would note that the OECD leading indicator for the US is negative on a YoY basis, while regional indicators continue to crater. The key investment conclusion from my recession indicator is that equity positions, which face risks from worsening economic fundamentals, should be hedged using bonds or upping the cash component.

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The article Outside the Box: A Worrying Set Of Signals was originally published at mauldineconomics.com.

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Balloons in Search of Needles

By John Mauldin

I love waterfalls. I’ve seen some of the world’s best, and they always have an impact. The big ones leave me awestruck at nature’s power. It was about 20 years ago that I did a boat trip on the upper Zambezi, ending at Victoria Falls. Such a placid river, full of game and hippopotamuses (and the occasional croc); and then you begin to hear the roar of the falls from miles away.

Unbelievably majestic. From there the Zambezi River turns into a whitewater rafting dream, offering numerous class 5 thrills. Of course, you wouldn’t want to run them without a serious professional at the helm. When you’re looking at an 8 foot high wall of water in front of you that you are going to have to go up (because it’s in the way); well, let’s just say it’s a rush.

If there were rapids like this in the United States, it’s doubtful professional outfits could get enough liability insurance to make a business of running them. In Zimbabwe we just signed a piece of paper. Our guides swore nobody had ever been lost – well, except for a few people who disobeyed the rules and leaped in the water in the calm sections because it was 100° out. That’s where the crocs are.

They promised we wouldn’t run into any in the rapids, which was good. More than a few of us got dumped in the water trying to run the rapids, but they had teams of kayakers who got you out quickly. The canyon below the falls is unbelievable, and below that is the even more impressive Bakota Gorge.

And yes, you then had to walk to the top of the canyon up a switchback trail to get home. I would do it all over again in a heartbeat, but I would spend at least three months training for the hike out. That was most definitely not in the full-disclosure-of-risks one-page piece of paper.

It would be hard to miss an analogy to the stock market. Everything’s peaceful and calm, you’re drinking some fabulous wine, eating some fantastic fresh game and fish, looking at all the beautiful animals as you drift easily with the current. Anybody can steer the boat in a bull market. Until the rapids hit and the bottom falls out.

As an aside, while the large waterfalls are majestic and awe-inspiring, the smaller ones are more hypnotic. I love the sound of falling water. I could listen for hours. The one place I don’t like to see waterfalls is on stock charts. Those leave me awestruck at the market’s power. They do have the power to focus the mind, however, especially when we own the shares that just went over the falls.

The US stock market is having the most turbulent year we’ve seen in a while.  It’s not terrible by historical standards, but we have a full quarter to go. And next week it’ll be October, a month in which the stock market has run into trouble before. With all that in mind, this week I want to take a look at where stocks stand and maybe offer a thought or two about the events that could bring us to the next waterfall.

Not Niagara Falls Yet
Here is how the waterfall looks so far this year. Barely a 10% move peak to trough, and it lasted for just a few days. We see a lot of jostling, followed by the harrowing plunge in August, and then a partial (less than halfway) recovery. Where do we go from here?

Let’s start with the macro view. Back in July I showed you some research that I did with Ed Easterling of Crestmont Research. This was before the China sell-off accelerated into the headlines, so it is very interesting to read again in hindsight. (See “It’s Not Over Till the Fat Lady Goes on a P/E Diet”).

Our view is that we are still in a secular bear market, and have been since the 2000 Tech Wreck. You may find that view surprising, since the benchmarks have roughly tripled since the 2009 low. Our analysis looks at price/earnings ratios to identify when bull and bear markets begin or end. P/E multiples were close to 50 in year 2000. In order for that bear market to end, they needed to drop into the very low double digit or single-digit range, which has been the signal for the end of every long term secular bear cycle for over 100 years. That hasn’t happened during the intervening 15 years.

Can a secular bear market last 15 years? Yes. Some have lasted even longer, like 1966-1981 and 1901-1920. So this one isn’t unprecedented. And please note that the long-term secular cycles can have cyclical movements inside them. Again, we see secular cycles in terms of valuation and the shorter cyclical cycles in terms of price. (Unless this time is different) long-term secular bear market cycles will always end in a period of low valuations.

Currently, P/E ratios (or any other valuation metric you want to use) are not low enough to provide the boost that typically starts a new bull market. They were closer in 2009 than today, but have never dipped into the area that would mark the end of the bear market and the onset of the new bull. We’re still riding the same bear.

What’s taking so long? Our best guess is that stocks were so richly valued at the 2000 peak that it is taking the better part of a generation to work off that excess. In order for this bear to end – and the new bull cycle to begin – valuations need to tumble. That can happen only if prices drop considerably or earnings rise without pulling prices higher.

Obviously, there can be many trading opportunities within a secular bull or bear cycle, but Ed’s research says we have three long-term options from here.

1. If P/E ratios decline toward 10 or below, we will be near the end of this secular bear. A new bull cycle should follow.
2. If P/E ratios stay near where they are, we will be in what Ed calls “secular hibernation.” This would mean a lot of sideways price movement, with dividends having to deliver the lion’s share of stock market returns.
3. If P/E/ ratios rise further, we will go back into the kind of “secular bubble” that created the Tech Wreck. I recall those years vividly, and I would rather not relive them.

Now, combine this market situation with what appears to be a global economic slowdown. China is a big factor, but not the only one. The entire developed world is in slow-growth mode. At some point it will likely dip into recession territory. Canada is already there. I don’t think they will be alone for long. Japan and Europe are weak.

I think the next true move to lower valuations will be a cyclical bear market combined with a recession. Can the stock market hold on to today’s valuations in a recession? Nothing is impossible, but I wouldn’t bet the farm on it, either. I can’t find an example of stock prices and valuations staying in place in the midst of a recession. Prices can fall slowly or they can fall fast, but I feel confident they will do one or the other.

Speaking of Bubbles
Our old friend Robert Shiller popped up last week in a Financial Times interview. Shiller is the father of CAPE, the cyclically adjusted price/earnings multiple, which looks back ten years to account for earnings cyclicality. He is also a Yale professor and a Nobel economics laureate.

Shiller’s CAPE has been saying for several years that stocks are seriously overvalued. In his FT interview, Shiller dropped the “B” word: It looks to me a bit like a bubble again, with essentially a tripling of stock prices since 2009 in just six years and at the same time people losing confidence in the valuation of the market.

When will the bubble burst? Shiller is less helpful there. He said the recent bout of volatility “shows that people are thinking something, worried thoughts. It suggests to me that many people are re-evaluating their exposure to the stock market. I’m not being very helpful about market timing, but I can easily see aftershocks coming.

Now, if you aren’t very confident about timing, it’s arguably better not to use words like bubble and aftershock. You can be sure the media and analysts will jump all over them, just as I’m doing right now.
In any case, Ed Easterling and Bob Shiller reach similar conclusions (though for different reasons). Neither sees a very bullish future, though both are unsure about timing. So when will we know the end is nigh? Sadly, we probably won’t, unless we begin to see signs that a recession is building in the United States.

Balloons in Search of Needles
As the old proverb goes, no one rings a bell at the top. The same applies at the bottom. Let’s imagine the stock market as a whole bunch of balloons. One or two can pop loudly and everyone will jump and then laugh it off. You now have deflated debris hanging from your string. Eventually, enough balloons will pop that the weight of the debris overwhelms the remaining balloons’ ability to keep the string aloft. Then your whole bunch falls down.

The last balloon to pop wasn’t any bigger or smaller than the others; it just happened to be last. In like manner, some kind of catalyst sets off every market collapse. It is usually something that would be survivable by itself. The plunge occurs because of all the previous balloons that bit the dust, but pundits and the media always like to point the finger at the most recent event.

So, if Easterling and Shiller are right, balloons are popping and making investors nervous, but there’s not enough damage yet to drag down the whole bundle. What are some candidates for the last balloon? A Chinese “hard landing” is probably the biggest, most obvious balloon right now. And actually, China is big enough for multiple balloons. Their stock market downturn produced one pop already. Beijing’s currency adjustment may have been another one.

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: Balloons in Search of Needles was originally published at mauldineconomics.com.

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The Most Important Geopolitical Trend of the Next Decade…Here’s How to Profit

By Nick Giambruno

The bloodbath was merciless. In 1842, 16,500 British soldiers and civilians withdrew from Kabul, Afghanistan. Only one would survive. It was the most humiliating military disaster in British history. The death toll sealed Afghanistan’s reputation as “the graveyard of empires.”

It was the desire for control of Central Asia that sucked the British Army into its Afghan disaster. For most of the 1800s, the UK and Russia pushed for power and influence in Central Asia in a competition known as “the Great Game.”

It wasn’t just to score points. The thought of losing India terrified the Brits more than anything else. India had huge economic resources, a plentiful supply of military-aged males, and strategic geography. London treasured India as “the jewel in the crown of the British Empire.”

To the Brits, the expansion of the Russian Empire into Central Asia was a threat to their control of India. Neighboring Afghanistan was their red line. If the Russians could draw Afghanistan into their sphere of influence, they would become an intolerable threat to British India.

So, in 1839, the British Army invaded. They installed a puppet regime in Kabul that would stand as a buffer to Russian influence. Every previous attempt to bring Afghanistan under foreign rule had ended badly. The Afghans are some of the toughest and most stubborn fighters in the world. The British knew that executing their plan wouldn’t be a cakewalk.

After a few years of trying and then failing to impose their will, the Brits threw in the towel. Early in 1842, 16,500 British soldiers and civilians packed up and left Kabul. As they fled through the mountainous trails, Afghan tribal fighters attacked repeatedly.

It added up to an epic massacre…..If the Afghan fighters didn’t kill you, disease and winter weather would.

After just seven days, only one man was still alive. William Brydon was bloody, torn, and exhausted. He was the only one to make it to the nearest British military outpost. That outpost was in Jalalabad, 90 miles away from Kabul. The Afghans let him live so there would be someone to tell the grisly story.

The garrison in Jalalabad lit signal fires to guide other British survivors to safety. After several days, they realized no one was left to see the light. Painter Elizabeth Butler captured the pain and desperation of the moment in her Remnants of an Army, below.

The debacle was a brutal lesson in geopolitics: geography constrains the destiny of nations and empires. Ignore that constraint at your peril. Despite their folly in Afghanistan, the British were generally shrewd players in geopolitics. It was a skill developed from a centuries-long career as an imperial power.

The godfather of geopolitical theory was British strategist Sir Halford Mackinder. Mackinder developed a general theory that connected geography with global power. To this day, planners in the US, Russia, and China study his teachings.

Mackinder argued that dominating the Eurasian landmass - Asia and Europe together - was the key to being the leading global power.

Zbigniew Brzezinski, the renowned American geopolitical strategist, echoes Mackinder on the importance of Eurasia in his book The Grand Chessboard: American Primacy and Its Geostrategic Imperatives: Ever since the continents started interacting politically, some five hundred years ago, Eurasia has been the center of world power.

A power that dominates “Eurasia” would control two of the world’s three most advanced and economically productive regions…rendering the Western Hemisphere and Oceania geopolitically peripheral to the world’s central continent. About 75% of the world’s people live in “Eurasia,” and most of the world’s physical wealth is there as well, both in its enterprises and underneath its soil. “Eurasia” accounts for about three-fourths of the world’s known energy resources.

A single power that controls the resources of Eurasia would be an unstoppable global superpower. If one couldn’t control all of Eurasia, the next best thing would be to dominate the world’s oceans. Control of the sea lanes means control of international trade and the flow of strategic commodities.

In 1900, the British Empire was near the peak of its strength. It was the world’s undisputed naval power. Its naval bases ringed Eurasia from the North Atlantic to the Mediterranean, from the Persian Gulf to the Indian Ocean, all the way to Hong Kong. This enabled the Brits to project event shaping military power into Eurasia.

Today, the US is far and away the world’s leading naval power. Like the British before them, the Americans have followed the geopolitical strategy of ringing Eurasia with military bases and exploiting its divisions. The aircraft carrier, with its 5,000-person crew, is the central instrument of US naval power. Putting just one of these enormous vessels into operation costs more than $25 billion.

The US Navy has 11 carriers, more than the rest of the world combined. And it’s not just ahead in quantity. The power and technological sophistication of US aircraft carriers are far beyond the capabilities of any competitor. There is simply no military force now or in the foreseeable future that could dispute US control of the high seas.....Soon, though, it may not matter.

That’s because China, Russia, and others are working on an ambitious plan. They seek to make US dominance of the seas unimportant. They’re tying Eurasia together with a web of land-based transport facilities. A constellation of supporting organizations for financial, political, and security cooperation is also in the works. If they’re successful, they’ll wipe away hundreds of years of geopolitical strategic thinking. They’ll make the current US planning paradigm obsolete. They’ll undermine the strategy that the US - and the UK before it - has relied on to dominate geopolitics. It would be the biggest shift in the global power balance since WWII.

It’s a game for the highest stakes…a real-life battle of Risk. The effort and countereffort to integrate Eurasia is the new Great Game. It’s the most important process to watch for the next 10 years. The central project to integrate Eurasia is the New Silk Road.

The World’s Most Ambitious Infrastructure Project

For over a thousand years, the Silk Road, named for the lucrative trade it carried, was the world’s most important land route. At 4,000 miles long, it passed through a chain of empires and civilizations and connected China to Europe. It was the path along which merchant Marco Polo traveled to the Orient. When he returned, he gave Europeans their first contemporary glimpse of China.

Today, China is planning to revive the Silk Road with modern transit corridors. This includes high speed rail lines, modern highways, fiber-optic cables, energy pipelines, seaports, and airports. They will link the Atlantic shores of Europe with the Pacific shores of Asia. It’s an almost unbelievable goal.

If all goes according to plan, it will be a reality by 2025. A train from Beijing would reach London in only two days.

New Silk Road Routes

The New Silk Road is history’s biggest infrastructure project. It aims to completely redraw the world economic map. And, if completed, it has the potential to be the biggest geopolitical game-changer in hundreds of years.

Tying Eurasia together with land routes frees it from dependence on maritime transport. That ends the importance of controlling the high seas. That reshapes the fundamentals of global power…and it’s exactly what the Chinese and Russians want.

In late 2013, Chinese president Xi Jinping announced the New Silk Road. The Chinese government rules by consensus. They’re careful long-term planners. When they make a strategic decision of this magnitude, you know they are totally committed. They have the political will to pull it off. They also have the financial, technological, and physical resources to do it.

The plan is still in the early stages, but important pieces are already falling into place. On November 18 of last year, a train carrying containerized goods left Yiwu, China. It arrived in Madrid, Spain, 21 days later. It was the first shipment across Eurasia on the Yiwu-Madrid route, which is now the longest train route in the world. It’s one of the first components of the New Silk Road.

As ambitious as the New Silk Road is, it’s just one aspect of the integration of Eurasia. In just the past year, a set of interlocking international organizations has emerged. These new linkages are the institutional support for a new political-economic-financial order in Eurasia.

Here are the most prominent organizations…

Asian Infrastructure Investment Bank (AIIB)
China launched the AIIB in 2014 with financing for New Silk Road projects in mind. Its initial capital base is more than $100 billion.

The AIIB would be a Eurasian alternative to the US-dominated International Monetary Fund (IMF) and World Bank. Those institutions have been standing atop the international financial system. China, Russia, and India are the main shareholders and decision makers at the AIIB.

Nearly 60 countries, mostly in Eurasia, have signed up to join the bank. Japan and the US declined to join. Then, the US government embarrassed itself by trying (and failing) to pressure allies the UK, France, and Germany into snubbing the organization.

BRICS and the New Development Bank (NDB)
The BRICS countries - Brazil, Russia, India, China, and South Africa - are all onboard for Eurasian integration. The NDB, like the AIIB, is an international financial institution headquartered in China (but headed by an Indian banker), with $100 billion in capital. Also like the AIIB, the NDB is an alternative to the IMF and World Bank. The BRICS countries established the NDB in July 2015.

The NDB and AIIB will complement, not compete with, each other in financing the integration of Eurasia. The NDB will also finance infrastructure projects in Africa and South America. The NDB will use members’ national currencies, bypassing the US dollar. It won’t depend on US controlled institutions for anything. That reduces the NDB’s exposure to US pressure. The BRICS countries are also exploring building an alternative to SWIFT, an international payments network.

SWIFT is truly integral to the current international financial system. Without it, it’s nearly impossible to transfer money from a bank in country A to a bank in country B. In 2012, the US was able to kick Iran out of SWIFT. That crippled Iran’s ability to trade internationally. It also demonstrated that SWIFT had become a US political weapon. Neutralizing that kind of power is precisely why the BRICS countries want their own international payments system.

Eurasian Economic Union (EEU)
The EEU is a Russian-led trading bloc. It opened for business in January 2015. The EEU provides free movement of goods, services, money, and people through Russia, Belarus, Kazakhstan, Kyrgyzstan, and Armenia. Other countries may join. Trade discussions have started with India, Vietnam, and Iran. The EEU is gradually expanding as countries along the New Silk Road remove barriers to trade. Egypt, Argentina, Brazil, Paraguay, Uruguay, and Venezuela are also in trade talks with the EEU.

Shanghai Cooperation Organization (SCO)
In the military and security realm, there’s the SCO. Current members include China, Kazakhstan, Kyrgyzstan, Russia, Tajikistan, and Uzbekistan. India and Pakistan will join by 2016. Iran is also likely to join in the future.

Putting the Pieces Together

Eurasian integration, and the US attempt to block it, will be the most important story for the next 10 years. This is the new Great Game. Oddly, the US media has barely made a peep about it. Maybe the story of Eurasian integration is just too big and complex to fit into sound bites.

The New Silk Road…the Asian Infrastructure Investment Bank…the BRICS New Development Bank…an alternative SWIFT system…the Eurasian Economic Union…the Shanghai Cooperation Organization…these are the building blocks for a new world. There could be huge profits for investors who position themselves correctly ahead of this monumental trend.

There is an easy way for US investors to tap into this trend. Click here to get the latest issue of Crisis Speculator for all the details.

The article was originally published at internationalman.com.

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Citizenship as a Weapon: Travel Controls and What You Can Do About It

By Nick Giambruno

It’s an extremely potent weapon, yet most are not even aware of its existence. That is, unless they have been unfortunate enough to be on the receiving end of it.

The weapon I’m referring to is travel controls, also known as people controls. It’s the power any government has to limit the ability of its citizens to travel. They do this by restricting the issuance of travel documents like passports. Any government can use this weapon can at a moment’s notice. It just needs to find a convenient pretext. Many countries in the past have notoriously turned to people controls. For example, the Soviet Union would routinely revoke the citizenship of its perceived internal enemies.

Recently, look at how the Dominican Republic stripped tens of thousands of people of their citizenship with no due process. Or how the Syrian government previously refused to renew the passports of Syrians abroad whom it suspected of being associated with the opposition. Or how the US government revoked Edward Snowden’s passport with the stroke of a pen. These are but a few of countless examples. The point here is not to pick good guys and bad guys. The point is that there are many instances throughout history and modern times that prove that you don’t own your own passport or citizenship… the government does. And they use them as a weapon.

If you hold political views that your government doesn’t like, don’t be surprised if they restrict your travel options. Unfortunately, the situation is getting worse. Over the last couple of years, there have been several attempts to pass a bill that would make it easier for the US government to cancel the passport of anyone accused of owing $50,000 or more in taxes. I suspect that sooner or later Congress will pass this bill. Fortunately, there is a way to protect yourself from these repressive measures. More on that in a bit, but first let’s look at the most common forms of travel controls.

Different Shapes and Colors

Desperate governments always seek to control money with capital controls and people with travel controls.
Here are the three most common forms of the latter:

1. Soft Travel Controls
These include arbitrary fees and burdensome bureaucratic procedures. These measures amount to unofficial travel controls. It’s similar to how FATCA works with money. FATCA doesn’t make it illegal to move capital outside of the US. But it achieves the same effect by imposing onerous regulations that can make it impractical. In the same sense, the government could achieve de facto people controls through deliberately excessive rules and regulations.

2. Migration Controls
Migration controls are official restrictions on the movement of a country’s citizens. Sometimes governments will put restrictions on certain citizens from leaving the country. This is especially true during times of crisis and for those who have accumulated some savings. Many people feel that they can simply wait till things get bad and then exit. But it’s likely the politicians will have slammed the door shut by then. For example, after Castro came to power in Cuba, the government used to make its citizens apply for an exit visa to leave the island. They did not grant it easily.

3. Revoking Citizenship and Passport
This is the most severe form of people and travel controls. Preventing people from leaving has always been the hallmark of an authoritarian regime. Unfortunately the practice is growing in so-called liberal democracies for ever more trivial offenses. In the US, for example, the government can cancel your passport if they accuse you of a felony. Many people think felonies only consist of major crimes like robbery and murder. But that isn’t true.

The ever expanding mountain of laws and regulations has criminalized even the most mundane activities. A felony is not as hard to commit as you might think. Many victimless “crimes” are felonies. A study has found that the average American inadvertently commits three felonies a day. So, if the US government really wants to cancel your US passport, it can find some technicality to do so…. for anyone.

Second Passports - An Antidote to Travel Controls

Here’s what my colleague and the always insightful Jeff Thomas has to say about travel controls:

As a country approaches an economic collapse, a crystal ball is not necessary to predict that, amongst the actions of the government, will be increased currency controls, travel controls, tariffs, and a host of other last-ditch efforts to keep the sheep penned in - to assure their presence for a final shearing.

What remains for the reader to determine, if he is a resident of one of the nations that is presently in decline, is whether he: a) believes that, in the future, his ability to travel internationally may be either restricted or prohibited; and b) whether he should take steps to assure his liberty for the future. If so, it might be wise to do so before he actually has lost his ability to travel.

If you have only one passport, you’re vulnerable to travel controls. I think it’s absolutely essential to obtain the political diversification benefits of having a second passport. You’ll protect yourself against travel controls. You’ll give yourself peace of mind knowing that you will always have options.

Among other things, having a second passport allows you to invest, bank, travel, reside, and do business in places that you could not before. More options mean more freedom and opportunity. I believe obtaining a second passport makes sense no matter what happens.

Unfortunately, getting one isn’t easy. There are no solutions that are at the same time cheap, easy, fast, and legitimate. Worse, there’s a lot of misinformation and bad advice out there that could cause you big problems. It’s essential to have a trusted resource to guide you through the process. That’s where International Man comes in.

You need to know the best countries to obtain a second passport in and exactly how to do it. We cover that in great actionable detail in our Going Global publication. Normally, this book retails for $99. But we believe this book is so important, especially right now, that we’ve arranged a way for US residents to get a free copy. Click here to secure your copy.

The article was originally published at internationalman.com.

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A Great Insight into Why Commodity Weakness Will Persist

By John Mauldin 

In today’s Outside the Box, good friend Gary Shilling gives us deeper insight into the global economic trends that have led to China’s headline making, market shaking devaluation of the renminbi. He reminds us that today’s currency moves and lagging growth are the (perhaps inevitable) outcome of China massive expansion of output for many products that started more than a decade ago. China was at the epicenter of a commodity bubble that got underway in 2002, soon after China joined the World Trade Organization.

As manufacturing shifted from North America and Europe to China –with China now consuming more than 40% of annual global output of copper, tin, lead, zinc and other nonferrous metal while stockpiling increased quantities of iron ore, petroleum and other commodities – many thought a permanent commodity boom was here.

Think again, Australia; not so fast, Brazil. Copper prices, for instance, have been cut nearly in half as world growth, and Chinese internal demand, have weakened. Coal is another commodity that is taking a huge hit: China’s imports of coking coal used in steel production are down almost 50% from a year ago, and of course coal is being hammered here in the US, too.

And the litany continues. Grain prices, sugar prices, and – the biggee – oil prices have all cratered in a world where the spectre of deflation has persistently loomed in the lingering shadow of the Great Recession. (They just released grain estimates for the US, and apparently we’re going to be inundated with corn and soybeans. The yield figures are almost staggeringly higher than the highest previous estimates. Very bearish for grain prices.)

Also, most major commodities are priced in dollars; and now, as the US dollar soars and the Fed prepares to turn off the spigot, says Gary, “raw materials are more expensive and therefore less desirable to overseas users as well as foreign investors.” As investors flee commodities in favor of the US dollar and treasuries, there is bound to be a profound shakeout among commodity producers and their markets.

See the conclusion of the article for a special offer to OTB readers for Gary Shilling’s INSIGHT. Gary’s letter really does provide exceptional value to his readers and clients. It’s packed with well-reasoned, outside-the-consensus analysis. He has consistently been one of the best investors and analysts out there.

There are times when you look at your travel schedule and realize that you just didn’t plan quite as well as you could have. On Monday morning I was in the Maine outback with my youngest son, Trey, and scheduled to return to Dallas and then leave the next morning to Vancouver and Whistler to spend a few days with Louis Gave. But I realized as Trey and I got on the plane that I no longer needed to hold his hand to escort him back from Maine. He’s a grown man now. I could’ve flown almost directly to Vancouver and cut out a lot of middlemen. By the time that became apparent, it was too late and too expensive to adjust.

Camp Kotok, as it has come to be called, was quite special this year. The fishing sucked, but the camaraderie was exceptional. I got to spend two hours one evening with former Philadelphia Fed president Charlie Plosser, as he went into full-on professor mode on one topic after another. I am in the midst of thinking about how my next book needs to be written and researched, and Charlie was interested in the topic, which is how the world will change in the next 20 years, what it means, and how to invest in it. Like a grad student proposing a thesis, I was forced by Charlie to apply outline and structure to what had been only rough thinking.

There may have been a dozen conversations like that one over the three days, some on the boat – momentarily interrupted by fish on the line – and some over dinner and well into the night. It is times like that when I realize my life is truly blessed. I get to talk with so many truly fascinating and brilliant people. And today I find myself with Louis Gave, one of the finest economic and investment thinkers in the world (as well as a first class gentleman and friend), whose research is sought after by institutions and traders everywhere. In addition to talking about family and other important stuff, we do drift into macroeconomic talk. Neither of us were surprised by the Chinese currency move and expect that this is the first of many
.
I did a few interviews while I was in Maine. Here is a short one from the Street.com. They wanted to talk about what I see happening in Europe. And below is a picture from the deck of Leen’s Lodge at sunset. Today I find myself in the splendor of the mountains of British Columbia. It’s been a good week and I hope you have a great one as well.

Oops, I’ve just been talked into going zip-trekking this afternoon with Louis and friends. Apparently they hang you on a rope and swing you over forests and canyons. Sounds interesting. Looks like we’ll do their latest and greatest, the Sasquatch. 2 km over a valley. Good gods.

Your keenly aware of what a blessing his life is analyst,

John Mauldin, Editor

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Commodity Weakness Persists

(Excerpted from the August 2015 edition of A. Gary Shilling’s INSIGHT)

The sluggish economic growth here and abroad has spawned three significant developments – falling commodity prices, looming deflation and near-universal currency devaluations against the dollar. With slowing to negative economic growth throughout the world, it’s no surprise that commodity prices have been falling since early 2011 (Chart 1). While demand growth for most commodities is muted, supply jumps as a result of a huge expansion of output for many products a decade ago. China was the focus of the commodity bubble that started in early 2002, soon after China joined the World Trade Organization at the end of 2001.

China, The Manufacturer

As manufacturing shifted from North America and Europe to China – with China now consuming more than 40% of annual global output of copper, tin, lead, zinc and other nonferrous metal while stockpiling increased quantities of iron ore, petroleum and other commodities – many thought a permanent commodity boom was here.

So much so that many commodity producers hyped their investments a decade ago to expand capacity that, in the case of minerals, often take five to 10 years to reach fruition. In classic commodity boom-bust fashion, these capacity expansions came on stream just as demand atrophied due to slowing growth in export-dependent China, driven by slow growth in developed country importers. Still, some miners maintain production because shutdowns and restarts are expensive, and debts incurred to expand still need to be serviced. Also, some mineral producers are increasing output since they believe their low costs will squeeze competitors out. Good luck, guys!

Copper, Our Favorite

Copper is our favorite industrial commodity because it's used in almost every manufactured product and because there are no cartels on the supply or demand side to offset basic economic forces. Also, copper is predominantly produced in developing economies that need the foreign exchange generated by copper exports to service their foreign debts. So the lower the price of copper, the more they must produce and export to get the same number of dollars to service their foreign debts. And the more they export, the more the downward pressure on copper prices, which forces them to produce and export even more in a self reinforcing downward spiral in copper prices. Copper prices have dropped 48% since their February 2011 peak, and recently hit a six year low as heavy inventories confront subdued demand (Chart 2).

Even in 2013, after two solid years of commodity price declines, major producers were in denial. That year, Glencore purchased Xtrata and Glencore CEO Ivan Glasenberg called it “a big play” on coal. “To really screw this up, the coal price has got to really tank,” he said at the time. Since then, it’s down 41%. But back in February 2012 when the merger was announced, coal was selling at around $100 per ton and Chinese coal demand was still robust.

Nevertheless, Chinese coal consumption fell in 2014 for the first time in 14 years and U.S. demand is down as power plants shift from coal to natural gas. Meanwhile, coal output is jumping in countries such as Australia, Colombia and Russia. China’s imports of coking coal used in steel production are down almost 50% from a year ago. Many coal miners lock in sales at fixed prices, but at current prices, over half of global coal is being mined at a loss. U.S. coal producers are also being hammered by environmentalists and natural gas producers who advocate renewable energy and natural gas vs. coal.

Losing Confidence?

Recently, major miners appear to be losing their confidence, or at least they seem to be facing reality. Anglo-American recently announced $4 billion in writedowns, largely on its Minas-Rio $8.8 billion iron ore project in Brazil, but also due to weakness in metallurgical coal prices. BHP took heavy writedowns on badly timed investments in U.S. shale gas assets. Rio Tinto’s $38 billion acquisition of aluminum producer Alcan right at the market top in 2007 has become the poster boy for problems with big writeoffs due to weak aluminum prices and cost overruns.

Glencore intends to spin off its 24% stake in Lonmin, the world’s third largest platinum producer. Iron ore-focused Vale is considering a separate entity in its base metals division to “unlock value.” Meanwhile, BHP is setting up a separate company, South 32, to house losing businesses including coal mines and aluminum refiners. That will halve its assets and number of continents in which it operates, leaving it oriented to iron ore, copper and oil.

Goldman Sachs coal mines suffered from falling prices and labor problems in Colombia. It is selling all its coal mines at a loss and has also unloaded power plants as well as aluminum warehouses. The firm’s commodity business revenues dropped from $3.4 billion in 2009 to $1.5 billion in 2013. JP Morgan Chase last year sold its physical commodity assets, including warehouses. Morgan Stanley has sold its oil shipping and pipeline businesses and wants to unload its oil trading and storage operations.

Jefferies, the investment bank piece of Leucadia National Corp., is selling its Bache commodities and financial derivatives business that it bought from Prudential Financial in 2011 for $430 million. But the buyer, Societe Generale, is only taking Bache’s top 300 clients by revenue while leaving thousands of small accounts, and paying only a nominal sum. Bache had operating losses for its four years under Jefferies ownership.

Grains and other agricultural products recently have gone through similar but shorter cycles than basic industrial commodities. Bad weather three years ago pushed up grain prices, which spawned supply increases as farmers increased plantings. Then followed, as the night the day, good weather, excess supply and price collapses. Pork and beef production and prices have similar but longer cycles due to the longer breeding cycles of animals.

Sugar prices have also nosedived in recent years (Chart 3). Cane sugar can be grown in a wide number of tropical and subtropical locations and supply can be expanded quickly. Like other Latin American countries, Brazil – the world's largest sugar producer – enjoyed the inflow of money generated from the Fed’s quantitative easing. But that ended last year and in combination with falling commodity prices, those countries’ currencies are plummeting (Chart 4). So Brazilian producers are pushing exports to make up for lower dollar revenues as prices fall, even though they receive more reals, the Brazilian currency that has fallen 33% vs. the buck in the last year since sugar is globally priced in dollars.

Oil Prices

Crude oil prices started to decline last summer, but most observers weren’t aware that petroleum and other commodity prices were falling until oil collapsed late in the year. With slow global economic growth and increasing conservation measures, energy demand growth has been weak. At the same time, output is climbing, especially due to U.S. hydraulic fracking and horizontal drilling. So the price of West Texas Intermediate crude was already down 31% from its peak, to $74 per barrel by late November.

Cartels are set up to keep prices above equilibrium. That encourages cheating as cartel members exceed their quotas and outsiders hype output. So the role of the cartel leader – in this case, the Saudis – is to accommodate the cheaters by cutting its own output to keep prices from falling. But the Saudis have seen their past cutbacks result in market share losses as other OPEC and non-OPEC producers increased their output. In the last decade, OPEC oil production has been essentially flat, with all the global growth going to non-OPEC producers, especially American frackers (Chart 5). As a result, OPEC now accounts for about a third of global production, down from 50% in 1979.

So the Saudis, backed by other Persian Gulf oil producers with sizable financial resources – Kuwait, Qatar and the United Arab Emirates – embarked on a game of chicken with the cheaters. On Nov. 27 of last year, while Americans were enjoying their Thanksgiving turkeys, OPEC announced that it would not cut output, and they have actually increased it since then. Oil prices went off the cliff and have dropped sharply before the rebound that appears to be temporary. On June 5, OPEC essentially reconfirmed its decision to let its members pump all the oil they like.

The Saudis figured they can stand low prices for longer than their financially-weaker competitors who will have to cut production first. That list includes non-friends of the Saudis such as Iran and Iraq, which they believe is controlled by Iran, as well as Russia, which opposes the Saudis in Syria. Low prices will also aid their friends, including Egypt and Pakistan, who can cut expensive domestic energy subsidies.

The Saudis and their Persian Gulf allies as well as Iraq also don’t plan to cut output if the West's agreement with Iran over its nuclear program lifts the embargo on Iranian oil. As much as another million barrels per day could then enter the market on top of the current excess supply of two million barrels a day.

The Chicken-Out Price

What is the price at which major producers chicken out and slash output? It isn’t the price needed to balance oil-producer budgets, which run from $47 per barrel in Kuwait to $215 per barrel in Libya (Chart 6). Furthermore, the chicken out price isn’t the “full cycle” or average cost of production, which for 80% of new U.S. shale oil production is around $69 per barrel.

Fracker EOG Resources believes that at $40 per barrel, it can still make a 10% profit in North Dakota as well as South and West Texas. Conoco Phillips estimates full cycle fracking costs at $40 per barrel. Long run costs in the Middle East are about $10 per barrel or less (Chart 7).

In a price war, the chicken out point is the marginal cost of production – the additional costs after the wells are drilled and the pipelines laid – it’s the price at which the cash flow for an additional barrel falls to zero. Wood Mackenzie’s survey of 2,222 oil fields globally found that at $40 per barrel, only 1.6% had negative cash flow. Saudi oil minister Ali al-Naimi said even $20 per barrel is “irrelevant.”

We understand the marginal cost for efficient U.S. shale oil producers is about $10 to $20 per barrel in the Permian Basin in Texas and about the same on average for oil produced in the Persian Gulf. Furthermore, financially troubled countries like Russia that desperately need the revenue from oil exports to service foreign debts and fund imports may well produce and export oil at prices below marginal costs – the same as we explained earlier for copper producers. And, as with copper, the lower the price, the more physical oil they need to produce and export to earn the same number of dollars.

Falling Costs

Elsewhere, oil output will no doubt rise in the next several years, adding to downward pressure on prices. U.S. crude oil output is estimated to rise over the next year from the current 9.6 million level. Sure, the drilling rig count fell until recently, but it’s the inefficient rigs – not the new horizontal rigs that are the backbone of fracking – that are being sidelined. Furthermore, the efficiency of drilling continues to leap. Texas Eagle Ford Shale now yields 719 barrels a day per well compared to 215 barrels daily in 2011. Also, Iraq’s recent deal with the Kurds means that 550,000 more barrels per day are entering the market. OPEC sees non-OPEC output rising by 3.4 million barrels a day by 2020.

Even if we’re wrong in predicting further big drops in oil prices, the upside potential is small. With all the leaping efficiency in fracking, the full-cycle cost of new wells continues to drop. Costs have already dropped 30% and are expected to fall another 20% in the next five years. Some new wells are being drilled but hydraulic fracturing is curtailed due to current prices. In effect, oil is being stored underground that can be recovered quickly later on if prices rise Closely regulated banks worry about sour energy loans, but private equity firms and other shadow banks are pouring money into energy development in hopes of higher prices later. Private equity outfits are likely to invest a record $21 billion in oil and gas start ups this year.

Earlier this year, many investors figured that the drop in oil prices to about $45 per barrel for West Texas Intermediate was the end of the selloff so they piled into new equity offerings (Chart 8), especially as oil prices rebounded to around $60. But with the subsequent price decline, the $15.87 billion investors paid for 47 follow-on offerings by U.S. and Canadian exploration and production companies this year were worth $1.41 billion less as of mid-July.

Dollar Effects

Commodity prices are dropping not only because of excess global supply but also because most major commodities are priced in dollars. So as the greenback leaps, raw materials are more expensive and therefore less desirable to overseas users as well as foreign investors. Investors worldwide rushed into commodities a decade ago as prices rose and many thought the Fed’s outpouring of QE and other money insured soaring inflation and leaping commodity prices as the classic hedge against it.

Many pension funds and other institutional investors came to view them as an investment class with prices destined to rise forever. In contrast, we continually said that commodities aren’t an investment class but a speculation, even though we continue to use them in the aggressive portfolios we manage.

We’ve written repeatedly that anyone who thinks that owning commodities is a great investment in the long run should study Chart 9, which traces the CRB broad commodity index in real terms since 1774. Notice that since the mid-1800s, it’s been steadily declining with temporary spikes caused by the Civil War, World Wars I and II and the 1970s oil crises that were soon retraced. The decline in the late 1800s is noteworthy in the face of huge commodity-consuming development then: In the U.S., the Industrial Revolution and railroad building were in full flower while forced industrialization was paramount in Japan.

At present, however, investors are fleeing commodities in favor of the dollar, Treasury bonds and other more profitable investments. Gold is among the shunned investments, and hedge funds are on balance negative on the yellow metal for the first time, according to records going back to 2006. Meanwhile, individual investors have yanked $3 billion out of precious metals funds.

Commodity Price Outlook

Commodity prices are under pressure from a number of forces that seem likely to persist for some time.

1. Sluggish global demand due to continuing slow economic growth.
2. Huge supplies of minerals and other commodities due to robust investment a decade ago.
3. Chicken games being played by major producers in the hope that pushing prices down with increasing supply will force weaker producers to scale back. This is true of the Saudis in oil and hard rock miners in iron ore.
4. Developing country commodity exporters’ needs for foreign exchange to service foreign debt. So the lower the prices, the more physical commodities they export to achieve the same dollars in revenue. This further depresses prices, leading to increased exports, etc. Copper is a prime example.
5. Increased production to offset the effects on revenues from lower prices, which further depresses prices, etc. This is the case with Brazilian sugar producers.
6. The robust dollar, which pushes up prices in foreign currency terms for the many commodities priced in dollar terms. That reduces demand, further depressing prices.

It’s obviously next to impossible to quantify the effects of all these negative effects on commodity prices. The aggregate CRB index is already down 57% from its July 2008 pinnacle and 45% since the more recent decline commenced in April 2011. To reach the February 1998 low of the last two decades, it would need to drop 43% from the late July level, but there’s nothing sacred about that 1998 number.

In any event, ongoing declines in global commodity prices will probably renew the deflation evidence and fears that were prevalent throughout the world early this year. And they might prove sufficient to deter the Fed from its plans to raise interest rates before the end of the year.

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The article Outside the Box: Commodity Weakness Persists was originally published at mauldineconomics.com.

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Closing the Sausage Factory

By John Mauldin

“Bureaucracy destroys initiative. There is little that bureaucrats hate more than innovation, especially innovation that produces better results than the old routines. Improvements always make those at the top of the heap look inept. Who enjoys appearing inept?”

– Frank Herbert, Heretics of Dune

“Economies naturally grow. People innovate as they go through life. They also look around at what others are doing and adopt better practices or tools. They invest, accumulating financial, human and physical capital.

Something is deeply wrong if an economy is not growing, because it means these natural processes are impeded. That is why around the world, since the Dark Ages, lack of growth has been a signal of political oppression or instability. Absent such sickness, growth occurs.”

– Adam Posen, “Debate: The Case for Slower Growth”

Today’s letter will be shorter than usual, because I’m at Camp Kotok in Grand Lake Stream, Maine, where the first order of business today is trying to outfish my son (not likely to happen, this year). But I’ve been looking closer at productivity barriers, and I want to give you some points to ponder.

The New Normal?

Like many of you readers, I’m old enough to remember a time when 2.3% annual GDP growth was a disappointment. We always knew America could do better. Not anymore, apparently. Some people actually cheered last week’s first estimate for 2Q real GDP growth. It was 4.4% in nominal terms, but inflation brought the figure back down. While certain segments are growing like crazy, for the most part we are muddling along in a slow growing malaise. You might even call it “stagnant.”

I for one still think the United States can do more. We have a large population of intelligent people who want to build a solid future for their children. They’re willing to work hard to do it. If that’s not happening – and clearly it isn’t – some barrier must be standing in their way. What is this barrier to productivity and growth? There are actually several, but government red tape is one of the biggest. I thought about this after reading an excellent Holman Jenkins column in the Wall Street Journal last week.

Jenkins led me to an audio recording of an interesting discussion on “The Future of Freedom, Democracy and Prosperity,” conducted at a symposium held at Stanford University’s Hoover Institution last month.
Government research & development funding has fallen off considerably from its peak in the 1970s moonshot days. This holds back worker productivity. The federal government is doing too much to slow down business and not enough to boost it.

The three economists who spoke at Stanford all pointed to important productivity barriers emanating from Washington DC.....

One of the participants, Hoover economist John Cochrane, spoke of fears that America is drifting toward a “corporatist system” with diminished political freedom. Are rules knowable in advance so businesses can avoid becoming targets of enforcement actions? Is there a meaningful appeals process? Are permissions received in a timely fashion, or can bureaucrats arbitrarily decide your case by simply sitting on it?

The answer to these questions increasingly is “no.” Whatever the merits of 1,231 individual waivers issued under ObamaCare, a law implemented largely through waivers and exemptions is not law-like. In such a system, where even hairdressers and tour guides are subjected to arbitrary licensing requirements, all the advantages accrue to established, politically connected businesses.

The resources that businesses put into complying with government regulations is staggering. I have often envied people outside the highly regulated financial industry for their freedom to operate rationally. In my business we seem to spend half our time – and an ungodly fraction of our money – just maneuvering through the regulatory morass.

Intrusive federal regulations touch every part of the economy:

• Energy and mining companies have to deal with environmental protection rules.
• Drug companies and health care providers must satisfy the FDA and Medicare.
• Cloud technology companies have to process FBI and NSA demands for user information.
• Retailers and consumer product makers are required to abide by the fine print on millions of product labels.

I could go on, but you get the point. Anything you do attracts bureaucratic oversight now. We may laugh at “helicopter parents” hovering over their children at school, but we all have a helicopter government looking over our shoulders at work.

Before anyone calls me an anarchist, I think some government regulation is perfectly appropriate. We all want clean drinking water. Everyone appreciates knowing our cars meet crash survival standards. I’m glad FAA is keeping order in the skies.

The problem arises when agencies enforce confusing, contradictory, and excessive regulations and try to micromanage the nation’s businesses. Every business owner I know is glad to play by the rules. They just want to know what the rules say, and that is frequently very hard to do.

A few weeks ago, in “Productivity and Modern-Day Horse Manure,” I explained that growth is really quite simple: if we want GDP to grow, we need some combination of population growth and productivity growth.

The US population is growing, thanks mainly to immigration, but the effectiveness of the workforce is another matter. Baby Boomer retirements are rapidly removing productive assets from the economy. To offset that trend, we need to make younger workers more productive.The red tape that constantly spews out of Foggy Bottom is not helping matters.

Regulatory Capture

The red tape hurts the economy overall, but it does help certain parties. The largest players in any niche often “capture” their regulators. Then they use their influence to tilt enforcement away from themselves and toward smaller competitors.

Put simply, new regulations can be great for your business if you are already well established and have the resources to comply with government mandates. New entrants rarely have those resources. The resulting lack of competition boosts profits for the big players but hurts consumers. The competition that would normally lead to better, less expensive goods and services never happens.

Holman Jenkins makes another great point about how over regulation affects growth.

Another participant, Lee Ohanian, a UCLA economist affiliated with Hoover, drew the connection between the regulatory state and today’s depressed growth in labor productivity. From a long-term average of 2.5% a year, the rate has dropped to 0.7% in the current recovery. Labor productivity is what allows rising incomes. A related factor is a decline in business start ups. New businesses are the ones that bring new techniques to bear and create new jobs. Big, established companies, in contrast, tend to be net job shrinkers over time.

Recall our economic growth formula: population growth plus productivity growth. The US population grew at a peak rate of 1.4% in 1992, and growth has been trending down ever since. Now it is around 0.75% per year. Add that to 0.7% productivity growth, and you see why Jeb Bush’s 4% growth target will be so hard to hit.

Blame Flows Downhill

Business leaders love to complain about the bureaucrats who run Washington’s alphabet-soup agencies. I think the problem goes deeper. With only a few exceptions, the regulators I’ve met over the years have been competent professionals. They weren’t intentionally trying to hurt my business. Often the regulations confused them as much as they confused me.

The real blame, I think, starts on Capitol Hill. Our legislative process is a sausage factory. Congress passes vague, complicated laws riddled with exceptions for this and zero tolerance for that. The result is superficially attractive but a mess inside. People in the alphabet agencies then have to remove the sausage skin and make sense of the contents. This would be a tough job for anyone. I certainly don’t envy them.

Jenkins mentions Obamacare’s convoluted waivers and exemptions. Even its advocates admit the law is a crazy mess. But how and why did it get that way?

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: Closing the Sausage Factory was originally published at mauldineconomics.com.

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The Biggest Trade Ever....No Exaggeration

By Jared Dillian

I won’t keep you in suspense. The biggest trade ever is in demographics. In particular, our rapidly increasing life expectancy.

Quick story. My Coast Guard friends are retiring now. You get to retire after 20 years of service, but some of them have been taking advantage of early retirement and are leaving the service as young as age 40.
Oh my God, what a deal: At age 40, you can bring home about $50K a year and then start a whole new career on the side!

In the old days, you could offer that deal because military folks would die at 47. Now they will live to 100.
Paying out benefits for 60 years to retired military personnel doesn’t sound like a great deal for the taxpayer.
Of course, the military pensions are just the tip of the iceberg. To receive Social Security, you can retire at age 62 (or 67 for full benefits). Again, that’s fine when most people die before 62. The blended life expectancy (for both men and women) is almost 79 years and trending higher.

Or my favorite chart on life expectancy ever, also a rebuttal to those who don’t like capitalism.

If you pay attention to Silicon Valley stuff, you know that Google and Ray Kurzweil and some other folks are working on projects that will allow us to live to 150 or even beyond. That would involve doing a couple of things, first

1. Curing cancer
2. Curing heart disease
3. Curing Alzheimer’s disease

You do these three things, it increases life expectancy by another 10 years or more. And we are actually doing those things!

Once you have a cure for all known diseases (attainable in my lifetime), then you have a different problem. Cells get old and die. The Silicon Valley folks are working on that too. Funny, if you don’t smoke, eat right, and get a little exercise, you will pretty much live to 80, no matter what. What happens beyond that is up to genetics, which we will solve one day. So what will the world look like if people live to 100, 150, or more?

It Looks Like Greece

Greece’s retirement age (to receive benefits) used to be 55 years. Again: retiring at 55, what a deal! I would only have 14 more years to go. People are pretty healthy at 55 (though maybe not the Greeks—they have the highest rate of tobacco use in the developed world).

So if people live way longer than the retirement age, the Social Security system goes kablooey. It just does. And yet people resist all attempts to reform it. We know Social Security is in trouble. George W. Bush tried to tackle it. For all his faults, it was the right thing to do. But he got laughed at.

The first thing we will do is to means-test the benefits, which will just make it more progressive but won’t solve the actual problem. You need to push back the retirement age, like, to 80.

But wait a minute. There aren’t even enough jobs for people to work until age 80.

I know…..

The World Was a Lot Simpler When People Just Died When They Were Supposed To

We’re going to look back at the 1940s-2000s as an exceptional period in economic history—with high, virtually straight line, uninterrupted economic growth. We had debt problems before, but biology has made them intractable.

In fact, the whole profession of economics is based on the very idea that there is population growth and inflation. What happens if birth rates decline? They are. Population growth rates will peak very soon. (By the way, the old Malthusian idea of overpopulation is being discredited.) What does the profession of economics look like with declining populations, people living longer, a dearth of unskilled jobs?

Is it nonstop deflation?

Many economists predict years of global deflation based on this premise. They say that you should buy bonds at any price. It’s a compelling argument. I think we’re going to learn a lot of really interesting things about money velocity in the coming years.

The Trade

Like tech in the ‘90s and energy in the 2000s, health care has been and will be the trade of the 2010s. You have the happy accident of huge technological advances and a government that seems willing, for the time being, to pay for it all. You hear some squawking about the cost of some treatments, but seriously, if you can cure cancer for $250,000, who is going to say no? Especially when that person’s chemotherapy, radiation, and hospital bills could easily exceed $2,000,000.

Lots of folks thought that Obamacare would tomahawk the health care sector. In classic market fashion, it has done the exact opposite. The insurers in particular have been the biggest beneficiary. You probably saw the recent Aetna/Humana merger.

People have tried for years to short biotech. Hasn’t been fun for them.

People have funny attitudes about death, you know. You ask someone if they’d like to live to 100, 120. “Noooooo,” they say. “I wouldn’t want to just sit in a chair.” Me, personally, I’d be okay with sitting in a chair. But the point of these treatments is that you can be active into your 100s. What then?

“I don’t know…” they say.

Are you kidding me? Forever young, my man. I’m 41, and I look a lot younger than my parents at the same age (sorry, Mom and Dad). I’m still DJing parties, for crying out loud.
Still don’t get the point of Snapchat, though.

Jared Dillian

The article The 10th Man: The Biggest Trade Ever (No Exaggeration) was originally published at mauldineconomics.com.

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A Powerful Weapon of Financial Warfare--The US Treasury's Kiss of Death

By Nick Giambruno

It’s an amazingly powerful weapon that only the US government can wield—kicking anyone it doesn’t like out of the world’s US dollar based financial system.

It’s a weapon foreign banks fear. A sound institution can be rendered insolvent at the flip of a switch that the US government controls. It would be akin to an economic kiss of death. When applied to entire countries—such as the case with Iran—it’s like a nuclear attack on the country’s financial system.

That is because, thanks to the petrodollar regime, the US dollar is still the world’s reserve currency, and that indirectly gives the US a chokehold on international trade.

For example, if a company in Italy wants to buy products made in India, the Indian seller probably will want to be paid in US dollars. So the company in Italy first needs to purchase those dollars on the foreign exchange market. But it can’t do so without involving a bank that is permitted to operate in the US. And no such bank will cooperate if it finds that the Italian company is on any of Washington’s bad-boy lists.

The US dollar may be just a facilitator for an international transaction unrelated to any product or service tied to the US, but it’s a facilitator most buyers and sellers in world markets want to use. Thus Uncle Sam’s ability to say “no dollars for you” gives it tremendous leverage to pressure other countries.

The BRICS countries have been trying to move toward a more multipolar international financial system, but it’s an arduous process. Any weakening of the US government’s ability to use the dollar as a stick to compel compliance is likely years away.

When the time comes, no country will care about losing access to the US financial system any more than it would worry today about being shut out of the peso-based Mexican financial system. But for a while yet, losing Uncle Sam’s blessing still can be an economic kiss of death, as the recent experience of Banca Privada d’Andorra shows.

Andorra, a Peculiar Country Without a Central Bank

The Principality of Andorra is a tiny jurisdiction sandwiched between Spain and France in the eastern Pyrenees mountains. It hasn’t joined the EU and thus is not burdened by every edict passed down in Brussels. However, as a matter of practice, the euro is in general use. Interestingly, the country does not have a central bank.

Andorra is a renowned offshore banking jurisdiction. Banking is the country’s second-biggest source of income, after tourism. Its five banks had made names for themselves by being particularly well capitalized, welcoming to nonresidents (even Americans), and willing to work with offshore companies and international trusts.

One Andorran bank that had been recommended prominently by others (but not by International Man) is Banca Privada d’Andorra (BPA).

Recently BPA received the financial kiss of death from FinCEN, the US Treasury Department’s financial crimes bureau. FinCEN accused BPA of laundering money for individuals in Russia, China, and Venezuela—interestingly, all geopolitical rivals of the US.

Never mind that unlike murder, robbery and rape, money laundering is a victimless, make-believe crime invented by US politicians.

But let’s set that argument aside and assume that money laundering is indeed a real crime. While FinCEN seems to enjoy pointing the money laundering finger here and there, it never mentions that New York and London are among of the busiest money laundering centers in the world, which underscores the political, not criminal, nature of their accusations.

And that’s all it takes, a mere accusation from FinCEN to shatter the reputation of a foreign bank and the confidence of its depositors.

The foreign bank has little recourse. There is no adjudication to determine whether the accusation has any merit nor is there any opportunity for the bank to make a defense to stop the damage to its reputation.
And not even the most solvent foreign banks—such as BPA—are immune.

Shortly after FinCEN made its accusation public, BPA’s global correspondent accounts—which allow it to conduct international transactions—were closed. No other bank wants to risk Washington’s ire by doing business with a blacklisted institution. BPA was effectively banned from the international financial system.

This predictably led to an evaporation of confidence by BPA’s depositors. To prevent a run on the bank, the Andorran government took BPA under its administration and imposed a €2,500 per week withdrawal limit on depositors.

However, it’s not just BPA that is feeling the results of Washington’s displeasure. FinCEN’s accusation against BPA is sending a shockwave that is shaking Andorra to its core.

The ordeal has led S&P to downgrade Andorra’s credit rating, noting that “The risk profile of Andorra’s financial sector, which is large relative to the size of the domestic economy, has increased beyond our expectations.”

For comparison, BPA’s assets amount to €3 billion, and the Andorran government’s annual budget is only €400 million. There is no way the government could bail out BPA even if it wanted to.

The last time there was a banking crisis in a European country with an oversized financial sector, many depositors were blindsided with a bail-in and lost most, or in some cases, all of their money over €100,000.
While the damage to BPA’s customers appears to be contained for the moment, it remains to be seen whether Andorra turns into the next Cyprus.

BPA is hardly the only example of a US government attack on a foreign bank. In a similar fashion in 2013, the US effectively shut down Bank Wegelin, Switzerland’s oldest bank, which, like BPA, operated without branches in the US.

To appreciate the brazen overreach that has become routine for FinCEN, it helps to examine matters from an alternative perspective.

Imagine that China was the world’s dominant financial power instead of the US and it had the power to enforce its will and trample over the sovereignty of other countries. Imagine bureaucrats in Beijing having the power to effectively shut down any bank in the world. Imagine those same bureaucrats accusing BNY Mellon (Bank of New York is the oldest bank in the US) of breaking some Chinese financial law and cutting it off from the international financial system, causing a crisis of confidence and effectively shuttering it.

In a world of fiat currencies and fractional reserve banking, that is a power—a financial weapon—that the steward of the international financial system wields.

Currently, that steward is the US. It remains to be seen whether or not the BRICS will learn to be just as overbearing once their parallel international financial system is up and running.

In any case, the new system will give the world an alternative, and that will be a good thing.

But regardless of what the international financial system is going to look like, you should take action now to protect yourself from getting caught in the crossfire when financial weapons are going off.

One way to make sure your savings don’t go poof the next time some bureaucrat at FinCEN decides a bank did something that they didn’t like is to offshore your money into safe jurisdictions. And we've put together an in-depth video presentation to help you do just that. It's called, "Internationalizing Your Assets."

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The article was originally published at internationalman.com.

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