Markets, Manias and Cranks, Part II

In yesterday’s reckoning, we brought you the first part of our interview with Chuck Butler. Chuck’s the writer of the indispensable Daily Pfennig newsletter andthe managing director of EverBank’s Global Markets Group.

We discussed how the U.S. economy is flirting with recession despite all the happy talk by the mainstream press… Britain leaving the European Union… the “Shanghai Accord”… and more.

Chuck mentioned yesterday that he didn’t foresee the Fed raising interest rates anytime soon, despite what seem to be good unemployment numbers. He added these comments in this morning’s Daily Pfennig:

Yellen is a dove at heart, and much of her academic studies prior to her appointment as the Fed chairwoman were centered on the labor markets. I continue to believe the FOMC will wait for a move higher in wages prior to pushing rates up; Yellen and company would rather error on the side of higher inflation than being blamed for killing the nascent recovery and fragile wage growth which has accompanied it.

Despite some hawkish talk by some Fed members this week based on unemployment numbers, Fed fund futures data still only indicate a 30% chance that Yellen will raise rates in June.

Today, we bring you Part II of our interview with Chuck. You’ll see what he thinks is driving the price of gold higher… if we’re really heading for a cashless society… if the Chinese economy is in for a major crash… and if the petrodollar is in serious trouble.

Answers below


Markets, Manias and Cranks, Part II

A conversation between Chuck Butler and Brian Maher

Brian Maher: We’ve covered a lot of ground yesterday, from Brexit to China to the dollar. Now let’s turn to gold, Chuck. Gold, as you know, has had a great year so far, the best year in 30 years. It’s up something like 20% so far this year. What’s your take on gold? Where’s it going, and what do you think is pushing it higher?

Chuck Butler: I think the driving force in gold right now is all these countries going with negative interest rates. And there’s even talk of it happening here in the U.S. I’m not sure it’ll happen here, but important people are seriously discussing it. And just talking about negative interest rates here in the U.S. gets people concerned about their cash. If they’re not going to earn any money on their cash, or they’re going to have to pay banks to store their cash, they might as well put it in gold.

So I think all this talk about negative interests rates is what’s driving gold right now. And then, you’ve always got the geopolitical stuff going on around the world. There’s just a lot of uncertainty in the world.

Brian Maher: We saw how the Japanese reacted to negative rates. Instead of going out and spending like the government expected, the only thing they bought were safes to hoard their cash. Many also bought gold.

Chuck Butler: Yup, and the talk of a ban on cash is also another thing. That just scares the bejesus out of me, it really does. There are so many other things that could happen if they started banning cash. Ever since I started writing about this issue, people have been sending me emails telling me, for example, that they were in Italy and tried to pay for their hotel room in cash and were told they couldn’t.

And this ban on cash is going to really drive the price of gold higher, I think. Right now you’ve got Mario Draghi fighting with the Bundesbank, the German Central Bank, about stopping printing of the 500 euro note.

I was surprised that the Bundesbank was against him on that, but still, the point is that he’s trying to get rid of cash and doing it under the guise of stopping money launderers, criminals and terrorists. But it won’t.

Brian Maher: Isn’t that always the excuse, though?

Chuck Butler: Yup, it’s very similar to some other arguments that have been used over the years to get rid of something. So anytime you see talk about banning cash, negative rates or even interest rate cuts, it should drive the price of gold higher.

Brian Maher: It seems like things are inexorably headed in that direction, that they’re going to succeed ultimately. I don’t know how long it’s going to take, but it seems like we’re heading for the cashless society, the banning of physical cash. It’s going to be the new barbarous relic, like gold was called. I don’t know how long it will take, but once these things start they just don’t stop. Agree?

Chuck Butler: Oh yeah, absolutely. And to me it’s like a government program that’s put in temporarily, it never goes away.

Brian Maher: Nothing’s so permanent as a temporary government program, right?

Chuck Butler: Right. And when Nixon removed the gold backing from the dollar, it was only supposed to be a temporary move. Most people don’t realize that.

Brian Maher: I’m sure those who orchestrated it knew otherwise, but it’s the old frog in the pot scenario. The elimination of cash is already well advanced in places like the Scandinavian countries, there are hardly any transactions conducted these days in cash.

So once a whole economic area goes cashless, ultimately it has to be coordinated on a larger scale. For practical reasons, you can’t have one area using cash and the other doesn’t. So eventually there’s going to have to be a convergence.

Chuck Butler: Exactly, and that was my point in one of my recent issues. You may not think that’s going to happen here in the U.S. But if all the other countries in the world are getting rid of cash, how’s it going to work for the U.S. to have cash? It’s not. So we’ll have to go along with everyone else.

Brian Maher: Scary. But do you think the Japanese experience has frightened some of these bankers out of negative rates, because the Japanese people’s reaction was the complete opposite of what was expected? So do you think that gave Janet Yellen and the rest of these people pause going forward?

Chuck Butler: No, in fact, I think what it tells them is that they probably need to do more of it. It’s sort of like the Krugman argument that when we were doing quantitative easing. We just didn’t do enough of it, that’s why it didn’t work.

Brian Maher: When theory confronts reality, they go with theory every time. They all attend the same schools, they have the same theories, and they just will not adjust their theories to reality.

Chuck Butler: Well, I truly don’t believe that the economists and everybody else at the Federal Reserve, are stupid. I really believe that they realize that all their Keynesian economic theory and everything else that they’ve done hasn’t worked for decades. However, I just don’t think that they have the courage to take a different course.

Brian Maher: God forbid the market is free to decide.

Chuck Butler: That’s always been my take, that we don’t need a central bank. We just need markets to set the interest rates.

Brian Maher: I read an interesting quote yesterday from an ECB official dismissing the idea that central banks have run out of powder as it were, or ammunition. He said, I think the quote was, we are magic people, we can, we have far more tools at our disposal than people realize, or we can do much more. It’s amazing.

Chuck Butler: Yeah, the whole thing has gotten out of control as far as I’m concerned.

Brian Maher: Jim Rickards, unlike that ECB official, warns that when the next crisis strikes, the banks won’t have anything left to handle it. Then it’s on to the IMF and special drawing rights to the rescue.

Chuck Butler: Yeah, I’ve read that, too. I can’t argue with him, but at the same time I’d like to think that it’s not going to happen.

Brian Maher: So what about China, do you think it’s got more air in the tire or do you think it’s going down?

Chuck Butler: I think China’s fine. They grew way too fast for too long and they have to go back and clean out those excesses. They have to take some lumps now and endure a period where they simply clean out the excesses. But they’ll work it out. I really do believe that they will and they’ve got a huge treasure chest of reserves, which I always remind people.

It has $3.4 trillion worth of reserves. It has decreased from over $4 trillion. But it’s still $3.4 trillion. And they can do a lot of things with that amount of money to correct problems in their economy.

Brian Maher: Interesting. China has a very long history cycling back between fragmentation and centralization. So they have a whole different view of history than we do. So their main concern is having these millions of single unemployed men in these cities, and the civil unrest that can cause. So you have to figure they’re going to pull out every stop to ensure some kind of soft landing.

Chuck Butler: Exactly, exactly. But at the same time, I think they really do want to try to stay out of it and let the markets go where they’re going to go. That’s towards more of a market-driven, domestic demand-driven type economy.

I think that they realize now that their export driven economy worked great for a while, but if all the other countries they export to slow down, it’s not a reliable model. So they need to increase their domestic demand, and they’re really working towards that.

Brian Maher: It’s really a major transition from an export-based, mercantilist model to a domestic consumption type model. Obviously there’s going to be some rough patches along the way, it’s not going to happen overnight. But you’re confident they will get it right ultimately?

Chuck Butler: Yes, I am very confident that they will.

Brian Maher: OK, what about emerging markets? What about emerging market currencies in the near future?

Chuck Butler: Well, they just have so much dollar-denominated debt that they scare me right now. But when things are good, they’re responsible for the majority of the economic growth in the world. But I don’t think right now is a good time for them. I’m talking about emerging markets as a whole, not individual countries.

But they’re working towards having better balance sheets and that will help them get through this dollar-denominated debt that they’ve got. That reminds me of this book I read by a paid assassin if you will, that would go in and show these emerging market countries how they needed to run up debt. When they couldn’t pay them, these people would go in and gobble up their assets like vultures. I believe it was called, Confessions of an Economic Hit Man.

It just boggles my mind that so many countries fell for that type of talk. Greece did it, they were shown by the Goldman Sachs of the world that they could have all this debt. Why not?

But getting back to the emerging markets, they’re still working out their problems, and so it’s probably not a really good time to look at them. But when they do get their problems worked out, they will be responsible for the majority of the growth in the world, like they were before.

And that’s when you’ll want to look to countries like India, Brazil, South Korea, and some of these other countries that have such great potential for growth.

Brian Maher: Makes sense. Chuck, I wanted to ask you about the petrodollar. It’s an important source of dollar strength since the world is forced to buy so much of its oil in dollars. Does the petrodollar have a future?

Chuck Butler: No, I don’t think the petrodollar has a future. I think that Russia’s going to start pricing their oil in rubles and I don’t think we’re going to send any missiles through Putin’s tent like we did Gaddafi’s when he decided to price his oil in his currency.

I think Saudi Arabia probably is going to, at some point, it could be this year, maybe next year, reach a point where it just doesn’t make any sense for them to price their oil in dollars any longer.

Brian Maher: Well, especially now that the U.S. is much less dependent on Saudi oil than it used to, and we’re making deals with Iran. Iran’s their sworn enemy. And the Saudis see China as a more important customer than the U.S. going forward, so the old system is showing cracks.

Anyway, as Jim Rickards has explained, currency systems last 30 or 40 years on average, so the petrodollar system could be near the end of the line, if you go by history.

Chuck Butler: Yes, I agree. I just don’t see it lasting that much longer. I’ve historically been notoriously early in when I see this type of thing. And so then I talk about them and then six months to a year later it happens. By that point, most people forget about what I said. Oh well. But I believe it will happen soon enough.

Brian Maher: Thanks Chuck. Now let’s quickly turn to how our readers can can profit from the market conditions we’ve discussed. As the managing director of EverBank’s Global Markets Group, I know you offer some great products for investors they won’t find anywhere else. I believe you’re offering a special commodities CD that you’re really excited about. Please tell our readers why you like it so much.

Chuck Butler: Well, since 2005, we’ve issued what we call MarketSafe CD’s. And they have 100% principal protection and an underlying asset, or group of assets, with substantial potential for gain.

That means if they don’t gain over the period of the CD, which is usually three to five years long, you get 100% of your principal back. That’s why it’s called a MarketSafe. So over the years we’ve picked different categories, or underlying assets for them, and they have a theme if you will. Our first ones were a gold CD and a silver CD, and those saw unbelievable returns. But we’ve issues them on Japanese REITs and on interest rate increases, for example.

So, I was sitting around in January looking at commodities, and thought man, they’ve had a tough four or five years. And I’ve always told people, and I have to remind myself of it all the time, is that you buy on weakness. But you’ve got to have a reason why that weakness is not going to last. And to me, commodities just looked like they were the most hated things on earth, and that is always an indication to me that it’s time for them to turn around.

And when commodities move, their trends last quite a long time. So having them in a MarketSafe, five year CD actually works out pretty well because if commodities were going to go on a long run, this would be the type of vehicle you would want. So we put together eight commodities in an indexed CD.

We have a west Texas crude, gold, silver, soybeans, corn, sugar, copper and nickel, all in this one CD.

And basically how it works is every year you reach the annual anniversary of the CD’s issuance, we check the prices of those commodities versus where they were when we issued it.

Then in the second year, we check all those prices again. So at maturity, you have five interim performance measures, capped at 70% each, and you average them up. The CD is capped at a 70% return, for the record.

Brian Maher: I think anyone can live with a 70% return.

Chuck Butler: I think so, yes. And if the commodities didn’t gain a nickel over those five years, then you get 100% of your principal back. And EverBank is a member FDIC.

Brian Maher: So you can’t really lose. You have 70% potential upside, and your principal is guaranteed. And with practically zero inflation, even if you don’t gain much, you still maintain your principal. That’s not so bad.

Chuck Butler: Exactly. If you don’t earn anything during the five years, you still get all your principal back. You do have to pay an original issue discount (OID) tax every year that you can potentially get back at the end of the five years.

But these are good for IRA’s or individual accounts, they’re a very interesting way to go about looking at commodities without having to take a position and face a loss on it if it doesn’t work out.

Brian Maher: That sounds like a great deal, Chuck. You’re guaranteed the principal back, no matter what. How often do you get the opportunity for enormous gains while guaranteeing your principal? If commodities go in your favor, you can really come out far ahead.. You don’t find that too many places these days, that is for sure.

Chuck Butler: Yup, so that’s the CD. Now, it technically had a funding deadline of yesterday, May 19th. But if you contact us and mention that you learned about it in The Daily Reckoning, we’ll extend the offer a few days for you. So don’t be discouraged that the official cutoff was the 19th. But yes, you have to hurry to take advantage.

Brian Maher: Well Chuck, it’s been a pleasure speaking with you. Thanks a lot for taking the time to share your insights today with Daily Reckoning readers. I think we all learned some things today. I really appreciate it.

Chuck Butler: No problem. I always enjoy talking with you guys.


Brian Maher

Managing editor, The Daily Reckoning

P.S. As Chuck described, EverBank is offering you a chance for serious capital gains if commodities rise over the next five years… and zero risk to your deposited principal if they don’t.

If there’s a net gain at maturity, you’ll get your money back plus the upside payment. And if there’s a loss, you’ll just get 100% of your principal back. That’s right — there’s virtually zero risk to your principal! And, EverBank is a member FDIC, which means your deposit is even insured up to $250,000 by the FDIC.

Technically, the offer’s closed. But the folks at EverBank have extended the MarketSafe CD offer a few days for Daily Reckoning readers. So be sure to tell them you read about it here.

Click here now to learn more.


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