Jim Rickards Talks about the Potential for a VAT in the US

Jim Rickards latest web interview is here. Below is summary of the topics covered. Not a lot of new ground in this interview, but he does respond to a question about why Trump and Congress might turn to a VAT tax later on as they work on tax reform.

------------------------------------------------------------------------------------------------------------

Topics Include:

*Commentary on FOMC and Rate Hike
*How VAT may enable a revenue neutral solution to allow Trumps fiscal and tax cuts plan
*One of the dangers to VAT is that it is prone to a creeping rise in the tax rate
*Scenarios for consumer reactions to VAT perceived as price inflation
*How increasingly fragile markets combined with highly leveraged financial services institutions are leading to amplified risk levels for the entire financial system
*Market fragility from Jim’s view is a function of system scale – if you double the size of the system the risk increases exponentially
*The system has not deleveraged since 2008, but has increased leverage and concentrated in an even fewer number of banks
*The derivatives market is approaching one quadrillion dollars in size, approximately ten times the size of global GDP
*Nation debt levels, debt ceiling, comments on the math of servicing the increasing debt burden in consideration of the debt to GDP ratio
*The first $20T of US Government debt is treasury debt, with a debt to GDP ratio of about 105%, and it does not include contingent liabilities such as social security and Medicare
*If counting contingent liabilities, it brings the US debt number to more than $100T, and the debt to GDP ratio closer to 1000%
*The most likely path out of the current debt for the US is inflation, which means inflation is ultimately required and likely

Click here to access a text transcript of the interview

Here is an example Q&A from the interview transcript text:

Alex:  I have a follow-up question to the VAT topic. Instead of consumers looking at it and thinking it is additional tax, is there a scenario where VAT could be perceived by consumers as prices of things going up? Could this be some sort of psychological trigger that could accelerate the velocity of money or an inflationary-inducing kind of effect?

Jim:  It could be, and that’s a very good question. In fact, prices will go up. I’ll leave it to the people at the Commerce Department to sort out how they want to define inflation, but if you have something that’s $100 and you slap on 5% VAT, suddenly it’s $105.

The talking heads and people on financial television will tell you, “Oh, don’t worry about it. It’s not inflation; it’s only a tax,” but I’m not sure the average consumer would think of it that way. If they’re paying $105, that’s 5% inflation overnight.

There are other weird consequences such as we’ve seen in Japan, which is if they announce an effective date, you might actually get a short-term boost in consumption. That would be good short-term for the economy, because everyone will run out and buy stuff before the effective date. If they said “This is in the bill that’s going to pass Congress with an effective date of September 1st,” you might see everyone at the end of August shopping like crazy to beat the sales tax or value-added tax.

That did happen in Japan, but it’s only a Kool-Aid high. It’s a short-term boost, because the day the tax comes into effect, the economy falls off a cliff. All you did was bring the entire aggregate demand forward to get ahead of the deadline.

It’s still early days since this bill has to wind its way through Congress, but I know the value-added tax is getting a lot of consideration and always has.

I spoke to top people at the tax section of the American Bar Association. These people are career professionals, they’re lawyers who talk to the Treasury on a regular basis about policy. One of those top people said to me a couple of years ago during the Obama administration, “The Treasury has given up reforming the internal revenue code. It’s just too much of a mess. The only way they see that we can keep the U.S. from going broke and raise revenue is with a value-added tax, with a VAT.” That’s the default position.

With the Trump administration and Congress saying you have to be revenue neutral and Trump committed to income tax cuts, there’s no way to square that circle without a big revenue raiser, and VAT is the biggest thing out there. We have to keep an eye on it. It may be coming, but it can have these weird effects of bumping inflation.

There are offsetting forces, and that’s what makes it tricky. On the one hand, sticker shock at the counter might give you an inflationary mindset. On the other hand, if everyone is running around spending before the tax and then not spending after the tax, that can actually be deflationary if aggregate demand drops and the economy runs into a brick wall.

The problem with all this is it’s not difficult to define theoretical outcomes based on what we know, but because these things are behavioral and psychological – what I call emerging properties of complex dynamic systems – basically we’re manipulating behavior and shouldn’t be surprised if we get some very bad results.

---------------------------------------------------------------------------------------------------------

Added comment: Jim talks in some detail about topics we have covered here in depth such as the risk derivatives pose to the financial system and also the inability of the US to grow its way out of its debt problems. Trump will have exposure to all these problems over his four years so no one is going to be too shocked if one or more of them blow up during that time. The key if that does happen is what his response to the situation is. That seems up in the air at this time. 

Here is one little clue though. Notice how when the GOP health care bill failed, Trump quickly pivoted to the idea of turning to Democrats to move forward on the problem. This shows you that Trump is NOT married to ideology and will go where he thinks he can get something done. Keep that in mind if we do get a huge financial crisis during his term. Trump might be more willing to work with the IMF using the SDR than most people would suspect right now even if he also might be willing to consider pro gold advocates at a time like that. I don't think we will know until it happens what Trump would actually do.

Added notes: Links to other recent interviews with Jim Rickards

Wealth Research Group 

Dan Popescu

Wall Street for Main Street

Greg Hunter - Watchdog USA - in this interview Jim briefly mentions the Tim Geithner solution to a new crisis he tweeted about earlier. Here he describes it as the government "insuring" everything, but predicts it would not work. He also says that he is not sure if the public would accept the SDR as a US dollar replacement despite his long standing prediction this solution would be tried in a new major crisis.
-----------------------------------------------------------------------------------------------------------------

Also, here is a link to a recent blog article by Dr. Warren Coats in which he talks about his views on US tax reform and briefly mentions the VAT. In this more in depth article on taxes, he supports the idea of a VAT (but only as a full replacement of existing income taxes).

Added news note 4-9-17: AP news confirms a VAT is under consideration by the Trump Administration in this article. Here is the key quote:

"One circulating this past week would change the House Republican plan to eliminate much of the payroll tax and cut corporate tax rates. This would require a new dedicated funding source for Social Security.

The change, proposed by a GOP lobbyist with close ties to the Trump administration, would transform Brady's plan on imports into something closer to a value-added tax by also eliminating the deduction of labor expenses. This would bring it in line with WTO rules and generate an additional $1.2 trillion over 10 years, according to budget estimates. Those additional revenues could then enable the end of the 12.4 percent payroll tax, split evenly between employers and employees, that funds Social Security, while keeping the health insurance payroll tax in place."

Russia Insider: Russia, China Lay Groundwork for BRICS Transactions in Gold

A thank you to a blog reader who informed me by email about this relevant news article. It appears that some officials are now talking more openly about using gold in an effort to bypass the US dollar over time. Below are a few excerpts.

-----------------------------------------------------------------------------------------------------------

"Recent progress made in streamlining trade in local currencies has brought Moscow and Beijing closer to creating a financial architecture that could facilitate transactions in gold. "

. . . . . 

"As we reported last week, Moscow and Beijing took another step towards de-dollarization with the opening of a yuan clearing bank in Russia. And earlier this month Russia's Central Bank opened its first-ever foreign branch in Beijing to allow for better communication between Russian and Chinese financial authorities.

According to an article published yesterday by Sputnik, progress made in promoting bilateral trade in yuan is the first step towards an even more ambitions plan — using gold to make transactions:

The clearing center is one of a range of measures the People's Bank of China and the Russian Central Bank have been looking at to deepen their co-operation. 

[...]

One measure under consideration is the joint organization of trade in gold. In recent years, China and Russia have been the world's most active buyers of the precious metal.

On a visit to China last year, deputy head of the Russian Central Bank Sergey Shvetsov said that the two countries want to facilitate more transactions in gold between the two countries.

Click here to read the full article

-----------------------------------------------------------------------------------------------

Added note: Below is an excerpt from the Sputnik News article mentioned quoted above:

"In a sign of increasing ties, earlier this month Russia's Central Bank opened an office in Beijing. The branch is Russia's first in a foreign country and will exchange information with the Chinese financial authorities.

One measure under consideration is the joint organization of trade in gold. In recent years, China and Russia have been the world's most active buyers of the precious metal.

On a visit to China last year, deputy head of the Russian Central Bank Sergey Shvetsov said that the two countries want to facilitate more transactions in gold between the two countries.

"We discussed the question of trade in gold. The BRICS countries are large economies with large gold reserves and impressive volumes of production and purchase of this precious metal. In China, gold is traded in Shanghai, in Russia, Moscow. Our idea is to create a link between these sites in order to intensify trade between our marketplaces," Shvetsov said."

---------------------------------------------------------------------------------------------------

My added comments: This is the type of information we watch for here. It is additional confirmation that Russia and China are building up gold reserves as part of an overall strategic plan to lessen their reliance on the US dollar over time. The process tends to move slowly because China has a lot of US dollar based reserves. It's in their interest to first hedge those reserves with gold and then gradually reduce US dollar holdings so that they do not tank the US dollar rapidly hurting their own holdings. But it is pretty clear that the long term strategy is to move away from the US dollar and also reliance on the SWIFT system. Now we have officials stating that gold is viewed as being part of the process. At some point, this could lead into the kind of major monetary system changes we watch for here.

Added note: Another thank you to the reader in the comments below who provides this link related to this situation:

http://www.zerohedge.com/news/2017-04-01/moscow-and-beijing-join-forces-bypass-us-dollar-global-markets-shift-gold-standard

I really appreciate the help I get from readers on things like this. It is very hard to find all the news relevant to what we cover here and it is big help when they send me links to such articles. 

Also, a thank you to Dr. Judy Shelton who kindly retweeted a link to this article that I sent her. Dr. Shelton has an interest in what role gold might play in the future in the monetary system.I sent her a link to this article thinking she might have some interest in these news articles about the potential for gold use by Russia and China in the future.

Appreciate the chart and comments from Dan Popescu on this as well here.

Andy Hoffman offers additional commentary on this news from the perspective of a strong pro gold advocate. He calls the news a "bombshell". The reason this news is getting so much attention is because this is the first time I know of that we have seen credible news reports that Russian and Chinese officials are planning to include gold in their trade settlements. I have seen much internet speculation that China and Russia intended to create a gold backed currency, but could find no official endorsement of that idea. So this seems like a possible step in that direction and should be reported as significant news on that basis as I see it. Without a doubt, it needs to continue to be watched over time. 

Added note 4-4-17: Lacker (Richmond Fed) resigns and admits involvement in a leak of confidential info. This means Trump gets to fill another Fed position. Jim Rickards adds this interesting Twitter comment on it.

News note 4-6-17: The news of the US missile strike on Syria did cause a little reaction in the gold market. However, the relatively muted reaction so far is likely because this move was pretty much telegraphed ahead of time and does not really come as a big surprise to markets. It is certainly true that geopolitical conflict can be a trigger to systemic instability, but it would take a much bigger event than this to generate anything like that. If you saw Russia take some kind of action in retaliation for example, that might get the markets more upset. If you see gold shooting up by $50 to $100 very quickly, then you know something more significant is taking place that has likely taken markets by surprise. 

Crisis Watch Update - The New Gridlock?

Really nothing new to report here. As we have said, if any kind of major crisis like we watch for here does arise, it will likely revolve around the ongoing battle between the Trump Administration and the existing power structure it wants to disrupt. 

In some ways we may have a new form of gridlock. Instead of Republican vs. Democrat we now appear to have the would be Disruptors vs. the Existing Power Structure (which draws from both political parties). So far, neither side appears to have gained much ground. Hence, what I will call "the new gridlock" for now. 

Trump appears to be someone who can pivot on a dime and change teams (talked about working with Democrats as soon as the GOP bill failed) when it suits his purposes to avoid gridlock if he can. But the entrenched factions that exist in the present system may be able to frustrate him as happened with the recent GOP health care bill. More on this thought later. It may provide us a clue as to how Trump might deal with a major financial crisis if faced with one during his term.

Added note: I got the BIS email alert below advising me of new BIS guidelines for banks exposed to risk from so called "Shadow Banking."

BIS Alert - Press Releases

Proposed guidelines for the identification and management of step-in risk 15 March 2017 Press release about the Basel Committee publishing proposed guidelines for the identification and management of step-in risk, 15 March 2017. "The proposed framework will help to mitigate potential problems at shadow banks from spilling over to banks. This work is part of the G20's initiative to strengthen the oversight and regulation of the shadow banking system with the aim of mitigating systemic risks, in particular, those arising from banks' involvement with shadow banking entities." and also another email alert on rules for "globally systemically important banks" here:

BIS Alert - Press Releases

Progress report on banks' implementation of the principles for effective risk data aggregation and reporting issued by the Basel Committee 28 March 2017 Press release about the Basel Committee issuing a progress report on banks' implementation of the principles for effective risk data aggregation and reporting (28 March 2017).

Eliminating the Political "Noise"

Since the US has become politicized at a somewhat extreme level now, we will try to avoid getting sucked into the seemingly endless "political noise" we see every day now. Political noise here means politicians and media proclaiming various positions simply to score political points. This has always gone on of course, but now it seems to be the dominant theme in the daily news cycles.

To give an example, let's take all the uproar over investigating the Trump Administration for ties to Russia vs. claims that Trump made that he was improperly place under surveillance during the recent campaign. All I see here is a lot of noise with both sides making all kinds of allegations, but providing no substantial evidence to the public supporting the allegations. This is beyond worthless to the public and the average person. Until someone is actually charged with a crime (and beyond that actually convicted) this is meaningless noise that has no impact of substance on the daily life of the average person. It is just politics as usual with the goal being to gain political advantage rather than to shed any useful truthful light on the situation. It is more of a diversion form real issues of substance than anything else.

In covering the potential for real and substantial monetary system change, we will try to avoid that kind of useless information and meaningless political noise. It's pretty much a waste of time and provides no information that can actually be used to make personal decisions. When we see evidence that a change of real substance that could actually impact the daily life of the average person is on the table (like the replacement of the US dollar by the SDR or a return to some kind of hard anchor like gold to the monetary system), that will get our attention here. The rest is just noise in our view here. We will continue to watch for such real potential change that might really impact people. So far, there is nothing that indicates it is on the near horizon even though the conditions for such potential change do exist.

Why Does the Federal Reserve Dislike $1 Coins?

Since this blog is focused on the topic of potential monetary system change, I thought it might be interesting to offer some information about the money we all use every day. A significant per cent of the public probably does not really think much about the money they use every day. But it can an interesting topic.

First, for those who want to learn more about how the actual cash we use gets into the hands of the public, try this link. Below I picked out a couple of interesting questions and answers as examples. Here is thought question to get you started. What (if any) is the difference between a US $1 bill (Federal Reserve Note) and a $1 coin minted at the US mint? Most people would say nothing since both are commonly accepted at equal value wherever cash is accepted for payment. But who profits from the production of each of these forms of cash? We'll look at that further below.

----------------------------------------------------------------------------------------------------------------

First here are a few selected questions and answers from the Federal Reserve Bank Services Q&A page:

Q: What is the role of the Federal Reserve with respect to banknotes and coins?

A: Currency

Within the Federal Reserve System, there are three entities responsible for the management and distribution of currency.

The Board of Governors of the Federal Reserve System is the issuing authority for Federal Reserve notes, the currency of the United States. The Board has a wide range of responsibilities related to Federal Reserve notes, from ensuring an adequate supply to protecting and maintaining confidence in U.S. currency.

Working very closely with the Board, the Federal Reserve System’s Cash Product Office (CPO) is responsible for strategic leadership to Reserve Bank cash departments by formulating policies, operational guidance, and technology strategies for U.S. currency and coin services provided nationally and internationally. The CPO’s primary mission and responsibility is to maintain public confidence in U.S. currency.

The 12 regional Federal Reserve Banks and their branches distribute Federal Reserve notes to the public through depository institutions. Reserve Banks process notes on high-speed sorting machines that check to ensure they are genuine and fit for commerce. If the notes are deemed suspect counterfeits, Reserve Banks forward them to the local U.S. Secret Service office. If they are genuine and still in good condition, the notes are sent to depository institutions to fill orders for currency. An individual note continues moving through this cycle until it is deemed unfit, or too worn, to be kept in circulation. Unfit notes are destroyed on-site at Reserve Banks in order to maintain the quality of currency in circulation.

Coins

Unlike currency, the United States Mint is the issuing authority for coins. Reserve Banks distribute new and circulated coin to depository institutions to meet the public's demand, and take as deposits coin that exceeds the public's needs.

Q: How much does it cost to produce currency?

A: Each year, the Federal Reserve Board projects the need for new currency, which it acquires from the Department of the Treasury's Bureau of Engraving and Printing at the cost of production. The new currency budget (Off-site Link)for 2015 is $717.9 million, and reflects the following costs per denomination:

• $1 and $2 notes -- 4.9 cents per note
• $5 -- 10.9 cents per note
• $10 notes -- 10.3 cents per note
• $20 and $50 notes --10.5 cents per note
• $100 note -- 12.3 cents per note

Q: How much does it cost to produce coin?

A: The United States Mint determines annual coin production. The Federal Reserve’s Cash Product Office influences this process by providing the Mint with monthly coin orders and a twelve-month, rolling coin-order forecast. Reserve Banks purchase coin at face value from the Mint. Further details on coins can be found on the Mint's website 

Well, there is some interesting informatiion right there. The Federal Reserve notes issued by the Federal Reserve only cost them 12 cents or less to produce. So, a $100 bill only costs the Fed twelve cents. Pretty good deal.

On the other hand, did you catch that the Federal Reserve has to purchase $1 coins "at face value from the Mint". So they have to pay a full $1 for a $1 coin (which costs the US Mint around 10 cents to produce based on estimates you see out there). A decent deal for the Mint, but not nearly as attractive (for the Fed) as those Federal Reserve notes they get for 5 to 12 cents each depending on the face value as shown above.

Here's another interesting question. 

Is this situation the real reason the US does not replace $1 bills with $1 coins? After all, the Fed has quite a vested interest in people using Federal Reserve notes rather than US Mint $1 coins. It seems like former US Mint Director Phillip Diehl thought so when he testified before Congress trying to get the dollar coin to replace the dollar bill a few years ago. Here is what he had to say about it on page three in the link above:

Barriers

"For many years the dollar coin has faced another significant obstacle: the FRB's (Federal Reserve Board's) preference for the dollar note. I discovered this for myself when the Mint launched the Sacagawea dollar in 2000. The FRB is the sole channel through which the US Mint distributes coins to banks and ultimately to businesses and consumers. If the FRB doesn't order a coin, it doesn't get into the hands of the public."

Mr. Diehl goes on to say that the FRB actually placed all kinds of obstacles in the way of the US Mint in trying to get the one dollar coins into circulation. They eventually bypassed the Fed and sent the coins straight to Walmart. While the conventional wisdom has been that people wanted bills and not coins, the actual initial public demand was huge according to Mr. Diehl. So, Mr. Diehl goes on to say this in his testimony:

"This debunked another piece of conventional wisdom that Americans are opposed to eliminating the dollar note. When readily available to the public, coins are readily accepted."

Mr. Diehl did not stop there. Later on he adds these comments:

"As GAO has noted, both coins and notes make a profit termed "seigniorage", but they are accounted for differently . . . .  The Federal Reserve Board buys coins from the Mint at full face value. The Mint then records all coin seigniorage, or profit, on its books and ultimately deposits profits into the general Treasury's general fund. In contrast, the FRB buys notes from the Bureau of Engraving and Printing at cost, with the FRB reporting all note profit on its books. In 2011, the FRB's note profit was estimated at $200 billion and the FRB returned $77 billion to Treasury. I am not an expert on the Federal Reserve's finances, but the math here is pretty simple: eliminating the dollar note denies the FRB a significant source of its profits."

Is this the real reason the dollar coin never seems to "catch on" with the public? 

Many other countries have eliminated their paper bills and only have coins for their equivalent of one US dollar (see Canada for example). The US could do the same and save a lot of money (an estimated $4.4 billion over 30 years) because the coins last a lot longer than the bills do in circulation. 

But the Fed would clearly lose a huge source of profit on the $1 notes which eventually flows into the US Treasury. Perhaps this is why Congress never passed the bill to do away with the one dollar bill and replace them with one dollar coins despite the obvious cost savings over time? It clearly makes the Fed look better and show more profit returned to Treasury (at the expense of the US Mint).

IMF - Strengthening the International Monetary System

IMF Deputy Managing Director Mitsuhiro Furusawa delivers this speech recently in Tokyo. He repeats calls for a number of actions to "strengthen the international monetary system" that the IMF has made for many years. Below are some excerpts from the speech.

--------------------------------------------------------------------------------------------------------------
 "In the time I have this morning, I would like to provide an overview to some of the key issues related to the International Monetary System (IMS) that we will examine. I will focus on three in particular—all of which are of central importance to Asian policymakers:

• the reduction of
  global imbalances;
• the strengthening of the global financial safety net; and
• the internationalization of currencies.

Let’s begin with some basic facts. A well-functioning international monetary system is a public good that is essential for economic and financial stability. The IMS has helped support unprecedented economic growth and trade expansion over the past few decades. But the global economy is evolving rapidly, and the IMS needs to adapt to the new reality."

. . . . 

. . . . "Our world is becoming more and more multi polar. While greater interconnectedness allows economies to benefit from a globalized economy, it also presents new weaknesses. We face the risk of new sources of spillovers and spill backs, as we saw in 2015 with China’s financial market difficulties. All of this complicates macroeconomic management.

Global imbalances are an important part of this picture. We have witnessed sustained periods of imbalances. While they have narrowed since the crisis, they remain above desirable levels. In the absence of formal adjustment mechanisms, adjustment has largely achieved through demand compression in deficit countries.

The concentration of imbalances among a few large countries presents a risk to the global economy. It increases vulnerabilities—and even raises the risk of market disruptions."

. . . . . 

"The IMF has led the reform effort to strengthen the (global) safety net. Thanks to the support of our membership, our lending capacity was boosted to $1 trillion. We overhauled our lending framework to offer more insurance and financing instruments. We are now exploring the possibility of a new short-term liquidity facility and a non-financial policy instrument. These would provide monitoring and signaling of member countries’ policies."

. . . . .

"We are also exploring whether the SDR, in its various forms can play a greater systemic role in strengthening the IMS. This could include the official SDR, SDR-denominated assets, or the SDR as a unit of account. The IMF reached a milestone last year when the renminbi was included in the SDR basket. That enhanced the SDR as a reserve asset. Also, in the last year large SDR-denominated bonds were successfully placed in China."

. . . . 

Click here to read the full text of the speech

----------------------------------------------------------------------------------------------------

My added comments: This is the first mention of the IMF study on potential broader adoption for the SDR I have seen since they announced the formation of an Advisory Group on the subject. As far as I know the Advisory Group has not issued any public statement or report so far.

Added unrelated note 3-27-17: It appears the US dollar index may once again be sitting right on a key support level at 99 (see this chart). The last time this happened the dollar index held and rallied so the next few days/weeks may be important to watch for this index. Note that the 99 level has acted as both a support level and resistance level in the past and that the index has already dropped below its 20 day and 50 day moving averages. It sits just above the 200 day average of 98.44. If support were to fail here, the index might see a sharper drop pick up steam. Just something to keep an eye on.

I will add that one high credibility source I hear from now and then tells me they think the US dollar will likely hold here for now, but then likely fall later this year around the June or July time frame. So, we need to monitor this for sure and see how the dollar index does. The movement of the US dollar impacts a lot of markets and can impact systemic stability if it becomes too volatile.

Politico - What Trump Could Do To The Federal Reserve

Here is the best summary I have found so far on how President Trump may deal with the issues we cover here that relate to monetary system change. This Politico article offers 4 alternative ways Trump may shape the Federal Reserve. Number Three is the one they suggest is most likely which agrees with what we said here earlier in this blog article. Below are some excerpts.

----------------------------------------------------------------------------------------------------------

"What happens when President Donald Trump gets his hands on the Fed?

It’s the question gripping the economic world these days. Though not as big a headline as immigration policy or his cabinet picks, Trump has a chance to appoint a new person to nearly every top Fed job over the next two years—a power not afforded most presidents, and with very high stakes. The Fed’s decisions can ripple through the economy, making mortgages more expensive, causing mining companies to reduce investment in new machinery and preventing retail stores from hiring new workers.

Given the president’s tendency to take advice from a very close circle, experts have started casting a wary eye on just who’s in Trump’s immediate orbit—and what they think about the Federal Reserve. What they’re seeing suggests that Trump has the potential to bring more dramatic changes to the Fed than any president since at least Ronald Reagan."

. . . . .

"So, what will Fed policy look like under the Trump administration? As on so many other issues, Trump’s own views are nearly impossible to determine. 

. . . . .

Here are four possibilities:"

. . . . .  (skip to #3)

3. A rules-based approach to monetary policy.

"The most likely reform for the central bank goes by the technical term “rules-based.” This means that instead of the Fed setting its benchmark interest rate on the judgment of its policy-making committee, it would do so according to a specific rule. The most famous proposed rule comes from Stanford economist John Taylor­—it’s known as the Taylor Rule—and incorporates changes to inflation, growth and other economic indicators. "

Please click here to read the full article on Politico

-----------------------------------------------------------------------------------------------------------

My added comments: The full article talks about those around Trump who favor a gold based monetary system and takes the idea seriously. It goes on to suggest that the most likely change at the Fed would be to move to a rule based system which is consistent with what we said in our earlier blog article here. Time will tell.

Added notes: Dr. Judy Shelton offers a Twitter comment on the Politico article here and Jim Rickards offers his own Twitter comment here. Dr. Shelton also offers comments on Fed monetary policy here on Bloomberg and this interesting tweet suggesting we should "consider a modern gold standard". Jim Rickards writes his own article on how Trump can control the Fed and Dr. Shelton comments on that here.

Debt Ceiling Deadline Passes Uneventfully

The March 15th Debt Ceiling Deadline passed quietly with very little media attention or comment from either the Trump Administration or Congress. This Bloomberg article suggests the reason is that everyone is happy to put it off for several months and that no one sees it as a coming crisis. If that is correct, David Stockman missed completely on his forecast that this would lead to a major crisis by summer. Time will tell. Here are a couple of excerpts.

-------------------------------------------------------------------------------------------------------------

. . . .

"Republican leaders, who control both chambers of Congress and the White House, are insisting there won’t be a repeat of the brinkmanship of recent years, where conservatives have flirted with defaulting.

Senate Majority Leader Mitch McConnell told reporters last week that “of course” the limit will get a boost. “The government is not going to default,” he told reporters.

Even the chairman of the conservative House Freedom Caucus, which led recent standoffs over the debt limit, downplays the risk.

"I don’t see a showdown," said Representative Mark Meadows, a North Carolina Republican. "I think that all us believe that a debt ceiling increase with the appropriate amount of real balanced-budget directives is accomplishable under this president and a unified government."

. . . .

"For now, Wall Street traders and firms that rate U.S. debt don’t expect the types of fireworks that occurred in 2011, when debt-limit showdowns nearly resulted in default on obligations to bondholders. In a report released Monday morning, Moody’s Investors Service said it sees no near-term credit risks after the U.S. debt limit -- suspended after yet another budget battle -- is reinstated.

“We expect Congress to agree to raising the debt ceiling, though this legislative process is likely to take months,” the report said.

. . . . .

"The Bipartisan Policy Center, a Washington-based think tank, estimated in early March that Treasury will run out of extraordinary steps to stay under the limit in October or November.

Lawmakers in both parties say that’s just fine with them.

“We haven’t finished the 2017 budget yet, and we’re awaiting the 2018 budget,” said Senator Jack Reed, a Rhode Island Democrat. “They’ve got Affordable Care Act repeal and replace issues. At some point we anticipate some tax reform proposal. All of that makes for so many different variables. This is just one part of a much-bigger picture. When we get more clarity, we’ll be in a better position to think about the complications of the debt ceiling.”

---------------------------------------------------------------------------------------------

Added note: Here is a video by Mike Maloney that has an interesting look at the history of the US debt and debt ceiling. It's worth the time to look at. Note how all discipline in government spending seems like it was virtually abandoned after 1971 when Nixon ended the link between the US dollar and gold.This is why many people want something to control the ability to create money and government spending. 

HIstory shows us what politicians do without any real controls in place. You end up like this with every taxpayer obligated for more than $165,000 in US debt and future obligations calculated at over $875,000 per taxpayer. Please note that the cash savings per US family is less than $10,000 ( a four person family currently owes over $244,000 in US debt already accumulated -- 4 x $61,000 per citizen).

Dr. Warren Coats on the Beginnings of the 2008 Financial Crisis

We have featured Dr. Warren Coats (former IMF) quite a bit here on this blog. He has detailed expert knowledge on the main topic we cover here, is willing to share his thoughts and comments from time to time, and is also just a genuinely nice person. Whenever he posts a new article on his blog site that is relevant to our topic here, I try to feature it. 

Here is a recent article that provides some interesting perspective on the 2008 financial crisis that eventually led into the topic we cover here (the potential for major monetary system changes). Below are a few excerpts from this interesting article.

-----------------------------------------------------------------------------------------------------------

"The evening of September 16, 2008, I met Randy Kroszner for dinner at Et Voila in the Palisades just outside of Georgetown. He arrived late explaining that the Fed’s monthly monetary policy meeting had lasted longer than expected. Randy is a Governor on the Board of Governors of the Federal Reserve. The attempt to rescue Lehman Brothers over the weekend had failed and it had declared bankruptcy the day before, so we had a lot of interesting things to talk about. Randy didn’t mention that the Fed had just agreed to lend up to $85 billion to AIG to cover its expected loses on its mortgage related Credit Default Swaps, thus giving the U.S. government a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. When news of the AIG bailout was posted on my phone around 9:00pm during our meal, I asked Randy what in the world was going on." . . .  


"The government actions in 2008 can be broadly stated as: a) providing all of the liquidity the financial sector needed following the Lehman Brothers collapse and financial panic; b) bailing out large banks and other financial institutions that might have been insolvent whether they were or not; and c) leaving underwater homeowners to drown. The first of these—providing liquidity—is universally accepted as a proper function of a central bank and one that the Fed executed well. The other two—bailing out banks but not homeowners—are the subjects of this note. I will review them from both an economic and a political perspective."

. . . . . 

"From economists’ perspective, bailing out anyone creates a moral hazard. If market players profit from risky bets when successful but expect that the government will pick up the tab when they are unsuccessful, they will take greater (excessive) risks."

. . . . . 

"The political optics of bailing out mortgage lenders but not homeowners is not good. Why did politicians choose to support one but not the other? Moral hazard is a problem with both. The reality is that Washington politicians were (are) much closer to Wall Street than to Main Street and are thus more sensitive to Wall Street’s concerns. Growing recognition of this fact adds some understanding to the hostile attitudes toward Washington expressed by Trump supporters.

By far the better policy would have been, and in the future is, to stick by the existing rules for bearing losses (our bankruptcy and default laws), i.e. no government bailouts." . . . . . .

"Our government has increasingly attempted to micromanage the private sector, especially the financial sector. This is a mistake."      . . . . . 

Please click here to read the full article by Dr. Coats

US National Debt Clock As We Approach the End of the Debt Ceiling Holiday

Wednesday (3-15-17) the debt ceiling holiday ends. We have become so numb to the enormous US debt figure now that most of us just don't even think about it anymore. But just to check in on reality every now and then I have added a link to the National Debt Clock web page to the list of information links on the right hand side of this blog. 

How this problem will ever be resolved in a non disruptive way is quite the mystery. So far, the US can still borrow all the money it wants. If no one else wants US treasury bonds the Federal Reserve can just create money out of thin air and buy them as they have done by the trillions already. When something like this goes on and on for years with no apparent consequences, it eventually seems like it can go on forever. You actually ask yourself questions like:

Why can't the Fed just create the money to endlessly buy US debt forever whenever we need it if no one else will buy it?

No one seems to care how much of that they do and the US dollar seems to do continue to be just fine no matter how many dollars are conjured up out of thin air that no one did any actual work to earn. It truly is somewhat like having an officially sanctioned counterfeiting operation that no one ever questions (because they all know doing so would raise the systemic risk through the roof and everyone using the US dollar would likely lose).

But somewhere down deep inside, we know this will not continue forever. As I write this article (3-2-17) every US taxpayer already has an obligation for over $166,000 of US debt (per the debt clock stats). If we add in future unfunded entitlement liabilities that obligation jumps to over $878,000 per taxpayer. There are just barely enough "total national assets" per the debt clock to cover all that obligation. And all it will take is one good stock market correction or economic recession to drop "total national assets" below the total current and future debt obligations. Not to mention that rising interest rates will make the problem even worse (will add to the interest payable on the debt).

It is obvious by now that no one knows how much longer this will go on. It has already gone on longer than many experts and analysts ever imagined possible. President Trump says he will grow his way out of the problem, but that is far from a certainty even if his policies work as planned (and if Congress actually implements them first). Also, it is pretty clear he plans on piling up plenty more debt for as far as we can see into the future right now since even his growth projection takes time to kick in.

As we noted above, so long as no one cares if we just create whatever money we need at the Fed to buy US bonds if no else will, things can just keep right on trucking along. What fun it is to have the world reserve currency that everyone needs and has to use until and unless something changes things.

Unfortunately, when the day does arrive where that won't work any longer, we will very likely have to live through the kind of dollar crisis that Jim Rickards and others have long predicted. Will that happen this year, in ten years, or even in my remaining expected lifetime (age 61)? I don't know, but it will eventually happen. And we will very likely see major monetary system changes at that time. Whether I will be here to cover it is another question.


Added note: Want a visual aid that illustrates how much global debt is out there? Try this. Also of interest is the US dollar to gold and US dollar to silver ratios in the lower right hand corner of the debt clock web page. Note the comparison to 1913. How does the US debt to GDP ratio compare to other major nations? Go here.

Added note 3-16-17: As expected, nothing of importance happened as the debt ceiling expired. David Stockman says it will be early summer, but most observers don't expect anything different this time after some usual drama.


Reader comment on this article:

Here is a great reader comment I got on this article. The reader prefers to remain anonymous:

Hi Larry;

"Just read you most recent post, after I had finished a Robert Shiller article.  He mentioned something I hadn’t known about the 17th Century tulip mania in the Netherlands, when a rare tulip was worth as much ( albeit briefly ) as a house.  What made that well known fact even more surprising was the concurrent phenomenon of a renewed outbreak of the Plague in Holland, as well as continental Europe, so that the “demand for houses” or for that matter anything else except tombstones, was about to fall dramatically, what we would today call demand based deflation.

I think that second event makes the tulip mania seem even more strange in retrospect.  With respect to the dollar and US debt, ( a dollar is, after all, a zero coupon perpetual bond ) what matters is WHO accepts it in settlement of trade, whether for goods and services, or for financial assets.  It is my personal opinion that  we are in a transition phase in the history of dollar “backing”.  The first was the gold exchange standard, which ended officially in 1971, but which was not “replaced” until late 1974, when Treasury Secretary William Simon obtained agreement from King Faisal that all oil would be settled in dollars ( the petrodollar standard ).  Today, less and less oil is being settled in dollars, as the U.S. becomes a smaller import market, while China and Europe import more oil ( and especially nat gas ). 

As we move away from the “petro dollar standard", what replacement candidate is there for dollar backing?  I would suggest that it is the financial securities markets of the US themselves which are now carrying that load.  States accumulate wealth via “reserves” of their central banks, and via their sovereign wealth funds (SWF's).  Both of these invest in debt securities, but both also invest in stocks, though the stocks proportion is greater for the SWF’s than for the CB’s generally.  A strong dollar flatters these investments, as does a rising securities market, while at the same time, reserve currency status “generally” leads to reserve currency strength.  Taken all together, this looks like a one way street, except that it relies on “price remaining no object” , just as on the 17th century.  Just exactly WHAT event will trigger the moment when “the price seems just too dear” is one which I reserve for my paid subscription clients only ( ha ha )

Meanwhile, watchful waiting is the order of the day."