Rickards: Fed Continues Tightening into Weakness

As tensions rise in the stock market and geopolitics are flaring up with North Korea, Jim Rickards joined Michael Pento on The Pentonomics Channel to discuss his latest analysis.

During the discussion Rickards’ highlights what he believes the next financial panic will look like and details specifically what he believes will cause stock markets to unravel.

To begin the program the economist was asked on how the financial system got to this point. Rickards offered, “Financial crisis and the threats we face can be seen very clearly. What people don’t seem to realize is just how close we came to having a complete collapse in financial markets.”

“It has happened twice in the last twenty years. First was September 1998 and the bailout of Long Term Capital Management (LTCM), I was there and did that bailout, we did the deal and had a soft landing. Had we not, if it had fallen apart, every exchange in the world would’ve closed sequentially. Ten years later in 2008, Fannie and Freddie failed and then Lehman had failed in September 2008. We then faced the possible failure in Morgan Stanley, etc. The Federal Reserve then intervened and truncated the process. In those experiences we saw strike one, strike two and now I am looking for strike three. The pressure is building.”

Jim Rickards is a New York Times best-selling author of The Road to Ruin and has experience both on Wall Street and in advising the U.S government and the intelligence community. As a currency war expert Rickards’ has played a critical role in analyzing financial crisis and what the global impacts on markets and security are.

The economist points out, “In the past we were able to look for bubbles in specific places. Financial bubbles had been found in subprime markets, or as we saw in 1989 we hit a bubble in junk bonds, then 2008 we had a bubble in subprime mortgages. It goes back to the theory of the everything bubble which is looming, and I think that’s where we are in now.”

When asked by Michael Pento about the current state of the financial system Rickards stayed true to form. The economist rang out, “None of this is normal. Several weeks ago in a public forum the Chair of the Federal Reserve, Janet Yellen stated that we would not have another financial crisis in our lifetime.”

“As soon as I heard that, my reaction was that we are going to have a financial crisis. The point is, I can think of no better leading indicator than the Fed Chairman saying we are not going to have one. The Fed really does not get it.”

When speaking on balance sheet normalization and whether the Fed would be able to prevent a recession they are trying to put off Rickards notes, “The problem is, their models tell them they can and that conditions are good. They are using the Phillips Curve, which is like a unicorn – it can be described and pictured but does not actually exist. What I expect is that the Fed could go right over the cliff and not even realize it.”

“As we saw in 1998, Wall Street bailed out a hedge fund. In 2008, the central bank bailed out Wall Street. Sooner than later, likely 2018, who is going to bail out the central banks? Each crisis gets bigger than the one before. Each bailout gets bigger than the one before.”

“If you use complexity theory one of the things you learn is that the worst thing that can happen in a system (collapse, meltdown) is an exponential function of scale. What that means is that if you double the system, don’t double the risk.”

“We have grossly increased the scales of our economic system. When looking at the complexity and size of the derivatives markets, the concentration of assets in the five largest banks, the size of the five largest banks… These are all markers of increased scale and leverage. It means the risk is considerably higher than it was in 2008.”

“Where will the next bailout come from? The Federal Reserve’s balance sheet is leveraged 13 to 1 right now and looks like a really bad hedge fund. They’re not going to be able to pull this off again. What the Fed is doing is tightening into weakness. Why are they tightening into weakness?”

“They are not following the business cycle the way they usually do. They are trying to make up for the fact that they should’ve tightened policy in 2010 and are trying to make up for lost time. The leadership at the Fed is desperate to get rates up to 3-3.5 percent and to get the balance sheets down to $2 trillion before the next recession. The Fed can either go to a QE 4 policy or cut interest rates. On the way to hit those goals, the question is can they do that without causing a recession they’re trying to prevent? The answer is no.”

“The ultimate QE headed toward the economy is the IMF’s special drawing right (SDR). The Fed has a printing press and can print dollars but it is worth being aware that the IMF has its own printing press and the capacity to print by the trillions. Liquidity will have to come from somewhere.”

The conversation then completely switched gears to discuss the issues dividing the United States government and Asia. Michael Pento, hitting on specifics, asked what Rickards saw in terms to currency war games going forward. Rickards, “I would say the chance of a currency and trade war is 100%. It is already here.”

“If we go back to June 2015 when Trump announced he was running for president he identified China as the greatest currency manipulator in history. Then candidate Trump leveled that China takes American intellectual property and unfairly operates in the steel markets.”

“However, not one single thing was done once Trump took office. Why was that? Because when Trump met with Chinese president Xi at Mar a Lago in April 2017, he asked for Xi’s help on North Korea. It is believed that Trump offered to give China a break if he would be willing to help with North Korea. Trump agreed to offer 100 days for China to take action.”

“The bottom line is that it is very clear China will not do anything toward North Korean aggression. The trade hawks that Trump has kept off the Chinese trail are not going to be let loose. I expect announcements to be sent worldwide on steel, aluminum subsidies and retaliation for intellectual property theft.”

“The U.S Congress just dropped the gauntlet on Russia by enacting sanctions against Russia. By sending economic sanctions that would hit its oil natural gas market, we’ve now entered a trade and currency war with both China and Russia at the same time.”

“I would expect the United States to be in an actual shooting war with North Korea by early to mid 2018.  This is reminiscent of the 1920’s and 1930’s that started with a currency war, turned into a trade war and ended up as a shooting war in Manchuria, Poland and Pearl Harbor. We seem to be going down that road again which could all be a considerable catalyst to waking the markets.”

To catch the full interview with Jim Rickards and Michael Pento click here.

Thanks for reading,

The Daily Reckoning