Welcome to 2018. So far it looks the same as 2017. The President of the United States ended the old year and began the one with a barrage of tweets, including one threatening nuclear annihilation with the “Little Rocket Man” of North Korea. The world can only hope they keep it to each other and not involve the rest of us. Markets did well in 2017 as they have for the past eight years. Bitcoin did exceptionally well, gaining over 1,300% even as it was down 20% from its high. Most people should have seen their portfolios rise. It is not difficult making money in a rising market. The real test comes in a down market.

In our last missive of 2017 (December 18, 2017), we outlined a series of risks that could upend global markets. It was not surprising to see other analysts note many of the same risks. Political analysts in their predictions for 2018 managed to note more than a few that could upend global markets even though their focus was political, not economical or financial. One of the more interesting ones was given to us by Tony Burman, a former head of Al Jazeera English and CBC News writing for the Toronto Star who outlined “Ten international headlines you’ll read in 2018” (Toronto Star, December 30, 2017).

No, not all of Mr. Burman’s predictions pertained to markets but 5 of them stood out. Mr. Burman noted that of his 10 predictions for 2017 he got 9 of them right, more or less. So maybe he is on to something. We don’t predict but instead lay out the risks that investors should be paying attention to. The five that we noted (using Burman’s headlines) were as follows:

–America’s constitutional crisis—Robert Mueller’s investigation into what is known as RussiaGate could lead to an investigation into Trump’s political and business empire. That in turn could trigger a constitutional crisis if Trump were to conduct a Nixonian “Saturday Night Massacre.” Trump and GOP representatives have been attacking the Mueller investigation as they have been taking cues from news organizations such as Fox News that has been calling it “a coup in America.” Trump and others have also been attacking the U.S. Justice Department. Add into this mix the release of an insider book on the Trump administration where attempts are being made to prevent its release. We have noted that if the Mueller investigation were to break wide open it could shake the confidence of markets globally.

– The Democrats roar back—Burman has noted all signs point to the likelihood of a Democratic “wave” in the November mid-terms. Democrats are well positioned to win the House of Representatives and possibly even the Senate. We noted how a turnover of the U.S. Congress and Senate could bring considerable pressure on the Trump administration including a drawn-out impeachment process. Market confidence would be shaken.

–Conflict with North Korea—for the past year President Trump of the U.S. and Kim Jong Un, the Supreme Leader of North Korea have waged a war of words involving mutual nuclear annihilation. North Korea could, if they feel threatened, once again resume nuclear testing. Many believe that the U.S. could conduct a pre-emptive strike on North Korea. But any strike against North Korea could quickly draw in Russia and China, both of whom border North Korea and have made it clear that a strike against North Korea would be unacceptable. The result could be the world is drawn into something they don’t even want to think about. Any time North Korea has hit the headlines global markets have reacted negatively even as the threat seems to quickly dissipate.

–China makes it move—Burman has noted that by Trump making “America First” he is inadvertently causing a boomerang effect, making “China First.” China, the world’s most populous country, will soon become the world’s largest economy. China has been making moves globally to strengthen its presence and by extension its power. China is calling for the end of the US$ as the world’s reserve currency and has been pushing trade to be denominated in Yuan when dealing with China and even elsewhere in Asia. This has brought China into conflict with the U.S. both economically and militarily. What Burman didn’t note and we did is its increasingly shaky banking system. A banking collapse in China would have global implications given the massive amount of global debt (current estimate $230 trillion) and a global banking system that still has some hangover from the 2008 financial crisis. The good news on that front is the Peoples Bank of China (PBOC) is in a much better position to bail out the financial system than are the western central banks (U.S., EU, and Japan).

–Countdown to war in Iran—the countdown to war with Iran seems to be marching ahead unabated. The urging for war is constant from two American allies—Saudi Arabia and Israel—who are both arch rivals of Iran. Everywhere we turn Iran is being demonized and a case against it is being constructed. There are accusations of Iranian agents operating in the West Bank even as it was noted the U.S. gave the green light to Israel for the assassination of a top ranking Iranian General. Iran is in Syria where they assisted the Assad government in defeating ISIS as well as taking on US-backed rebels. Syria borders Israel. Protests have been going on in Iran where the Iranian government accuses its enemies (read U.S., Saudi Arabia, Israel) of inciting the protests. While the attacks against Iran are not dissimilar to the attacks against Iraq leading up to the 2003 invasion, Iran is not Iraq. An attack on Iran could also quickly draw in global players such as China and Russia, both of who stood aside when the U.S. (and allies) invaded Iraq. An attack against Iran would shake global markets. 

Mr. Burman’s other predictions could have a market impact in 2018 as well. We just do not see them in the same heightened risk that could negatively impact global markets as the above. Burman’s other predictions are:

–British Government collapses

–Europe is back on its feet

–Assault on free expression

–No hope for Kushner peace plan in the Mid-East

–A resurgent Palestinian cause

Politics, economics, and finance are all intertwined. All wars (political) are ultimately about economics and that in turn is about finance. The world is engulfed in debt—as we note, an estimated $230 trillion. The U.S. leads the way with $20.5 trillion and the U.S. as a whole (governments, corporations, and individuals) stands at $69.1 trillion. And that is what is officially reported. No wonder the U.S. is referred to as “the Empire of debt.” It is estimated that since the 2008 financial crisis the balance sheets of the major central banks (U.S., EU, and Japan) have grown by $8.3 trillion (the Fed went from $800 billion to $4.4 trillion). Meanwhile, global GDP grew by only $2.1 trillion. It is also estimated that some $6.2 trillion went not into the “real economy” but into assets—stocks, bonds, real estate, and emerging market debt (as reported by Agora Financial, 5-minute forecast, January 3, 2018). And we wonder why we have a bubble in global stock markets and elsewhere.

Against this backdrop of a potential looming debt crisis, we have the global economy enjoying a good period of growth together—in the U.S., Europe, China, Japan, and other markets both developed and emerging. Corporation profits are at record highs. The U.S. economy has unemployment at a 17-year low. Inflation is low. Manufacturing is registering strong economic readings both in the U.S. and the EU. Technological innovation continues apace and new medical wonders continue to emerge. The U.S. administration just delivered what may be the biggest tax cut in U.S. history.

We have had 8 years of good news. But against this backdrop is too much debt and the central banks trying to take away the “punch bowl.” We had quantitative easing (QE) and now we have quantitative tightening (QT?). The Fed is slowly selling off its asset portfolio of Treasury debt and mortgage-backed securities (MBS). As well they are raising interest rates and have signaled that this should continue in 2018 on a quarterly basis. The EU has hinted strongly that QE will be ending as well. The world is leveraged and debt could come tumbling down. The most vulnerable are emerging market debt and the aforementioned mountain of debt in China but there are also problems with shaky Italian banks and in the US student and automobile loans.

While praises are being heaped on the Trump administration for its tax bill one tends to overlook, even by the GOP’s own estimates, indications that it could add $1.5 to $2 trillion to U.S. debt over the next decade. It’s probably no surprise the U.S. still needs to deal with the debt ceiling and ongoing funding, a reckoning that keeps getting pushed out. But they are running out of time with the next deadline looming this month and, once again, Trump threatening to play a game of chicken with Congress to get what he wants.

Debt is the Achilles heel. Since the 1970s, starting with the energy crisis and the Watergate crisis that triggered a banking crisis and a 45% to 55% collapse in global markets, the world has been through a series of debt and economic crises. The Latin America debt crisis, the Japanese asset bubble, the “crash” of 1987, the savings and loan crisis, the banking crisis of the early 1990s, the breaking of the Bank of England in 1992, the 1994 Mexican debt crisis, the 1997 Asian financial crisis, the 1998 Russian debt crisis, the Argentine debt crisis of 1999–2002, the busting of the dot.com/High Tech bubble resulting in an 80% collapse of the NASDAQ 2000–2002, the 2007–2009 financial crisis that followed the bursting of the housing bubble, the EU sovereign debt crisis of 2011, the Russian economic collapse of 2014, and the Chinese stock market bubble bursting in 2015.

The world has been through a series of economic, financial, and political crises over the past 40 years. But one thing was constant following each crisis. Each time, governments bought their way out of the crisis by sharply lowering interest rates and flooding the financial system with money. Following the 2008 financial collapse flooding the financial system with money became more or less permanent through quantitative easing (QE). Corporations obliged by also buying their way to higher stock prices through mergers and acquisitions and stock buybacks, usually by issuing more debt. And households kept buying more and pushed a consumer and real estate debt bubble.

Total U.S. debt has increased $19.2 trillion since 2008 or almost 39% vs. an increase of $6 trillion for GDP or 44%. That implies it took $3.20 of new debt to obtain $1 of GDP. Since 2000, U.S. GDP has grown by $10.3 trillion or 111% while total debt has grown $43.7 trillion or 172%. That implies it took $4.20 to purchase every $1 of GDP. Hard to believe the growth rate has actually subsided. If debt growth were to slow further it would have negative implications for GDP growth. The question is: what are the limits to debt? We may soon find out.

Nothing lasts forever and the next financial crisis could already be forming. Economics, finance, and politics—each feeds on the other, and all are intertwined.

Gold in 2018

Following 5 years of what can only be called a bear market, gold, and by extension silver, platinum and the gold stocks could be poised for a major move. One of the prime reasons we may be ready for a major move is cycles. Since gold became free trading in the 1970s, after the end of the Bretton Woods gold standard by former President Richard Nixon in August 1971, gold has followed what appears to be regular patterns.

Raymond Merriman of Merriman Cycles has outlined one long-term cycle of what he believes is a 23.5-year cycle. Making it difficult for gold cycles is the lack of free trading history when compared to the U.S. stock markets. Merriman cites the major low seen in 1976 and again in 2001 as examples of the 23.5-year cycle (range could easily be 22 to 25 years). Cycles can break down into halves or thirds. Merriman has cited a possible 7.83 cycle (range 7–9 years) a figure that divides the 23.5-year cycle by 3. Significant lows were seen in August 1976, February 1985, March 1993, April 2001, October 2008, and December 2015. Since the December 2015 low, we have seen gold slowly rise with higher lows being made in both December 2016 and December 2017.