The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“On today’s show, with interest rates at 5,000-year lows, the world economies are seeing that there is really no chance of an interruption in prosperity. Is this time really different from any other time in history? Will perpetual prosperity and growth be achieved, or could this just be a well-managed charade that has an ugly, ugly end? Stay tuned.”
– Kevin Orrick
“George Bernard Shaw: ‘The most important thing about money is to maintain its stability.’ He goes on to say, ‘You have to choose between trusting the natural stability of gold and the honesty and intelligence of members of government.’ And he says, ‘With due respect to these gentleman, I advise you, for as long as the capitalist system lasts, to vote for gold.’”
– David McAlvany
Kevin: I’ve been thinking a lot, Dave, about stress, because we were talking last night before we recorded the program, that you are reading a book about the positive aspects of stress. There has been a trend for the last 30-40 years of denouncing stress, saying that it’s the worst thing that can possibly happen to a person. But actually, in a balanced life there are some stresses that are unavoidable.
David: The case that this book makes, actually, is that stress is something that actually drives you to many good things. And depending on how you frame events in your life, there can be a very positive outcome. For instance, at a biochemical level, when you are experiencing stress and there is a natural release of cortisol there is a counter-balancing release of chemicals when you are motivated to do in that context something through altruism, or for the purpose of altruism. So there is this counter-balancing chemical that, actually, is physically reparative to the heart. It is this magical answer antidote.
Kevin: That’s the cortisol.
David: That’s right.
Kevin: But we were also talking about stresses that we bring into our lives that we don’t necessarily need. I’ve been thinking about some of the issues that are coming up right now between gun control, immigration, tax reform – you name it. There is a lot of pressure here in America to have a clear and concise opinion on every one of those issues. I think back, and I even look back at the biblical model. Leaders are there to take care of certain issues, and I don’t know that we necessarily have to have the nitty gritty on everything.
I’ll give you an example. When the news is on in the background and I hear about bombing and it has killed tens of people somewhere in the Middle East, I grieve, but I can’t grieve for every single news story that is occurring all the time, 24/7. I’m not built that way, Dave. It creates a stress that is unnatural and I don’t have an altruistic answer for it.
David: I don’t think the body or the soul were made for the news feed that we have on any given day. There are critical moments in life where there are stresses that we have to embrace. Maybe it is starting a new business. Maybe it is solving a problem alongside a family member. Maybe it is bringing someone out of grief, and to really move into that empathetically with them can be stressful. There are very many positive aspects, but when you think of the barrage of micro-stresses that are layered on us from the outside, and from the news feeds, it becomes so overwhelming that the response, typically, is just to block it all out, try to forget it all, not care, just say, “You know what? I need to go on a vacation. I’m going to turn off the television and just quit caring about anything.”
Kevin: This weekend you were asked to give a talk on finishing well for a group of people. Something I have also been thinking about is, there is a stress, Dave, that I think is unnatural that we build into our systems, especially as we get into our 50s and 60s, which is this stress of, “Oh, my gosh, am I going to be able to retire? Can I go golf three times a week, or fish three times a week, or this or that?” But if you really go back and look at finishing well, retirement isn’t necessarily one of the things that we are supposed to – you were talking about altruism, it’s not necessarily a goal that is laid out for everybody. And there is this amazing amount of stress, especially during this period of time where a person can’t earn interest on their money. You can’t just put it into the bank and then get rid of a job. I think we put unnatural stresses for goals that aren’t necessarily even right.
David: If you are thinking about retiring, I think one of the things you have to come to terms with is, what is the purpose, and what are you going to be intentional about doing in the context of that second half of life? So rather than seeing it as moving to the sidelines altogether, how are you engaging in a different way? Retirement may not be the right description – retooling, retreading, etc. I see that with my parents living in Asia.
It was interesting, one of the comments made at the conference I was at over the weekend – they asked me to talk on one aspect of stewardship, which was finishing well, and one of the other speakers mentioned that the average duration of a man’s life after he retires is three years. There is something shocking about that. Of course it is an average. There are many people who live 20-30 years, and some people who live a lot less. But there is in the back of my mind this question of, “What are they doing with purpose?”
Kevin: What are we here for?
David: Yes, I think we’re hard-wired for making a difference, we’re hard-wired for caring, we’re hard-wired for impact, and that does mean embracing some stress which means retirement says, “No, no, no. Just kick back, enjoy, relax.”
Kevin: Dave, you told me a story about a man who got up after your talk, and it really was very life-changing for him. He knew he needed to redirect.
David: The commentary was brief, but he said, “Look, I’ve been enjoying three days a week fishing, and I just assumed that this was the good life. After listening to you talk about finishing well, I realize I’ve got to rethink my life completely. Yes, I’ll enjoy fishing, but I have a better context, a bigger and broader context for it, and I’ve really got to do some thinking on this.”
Kevin: Something I love about the listeners to this show, Dave, the people who read your dad’s newsletter, and the clients who call us – most of the people that we talk to, if not almost all of them, are very, very engaged. They have a reason for living. They’re not just trying to figure out a way that they can maintain some sort of minimum comfort level until they die. I know that there are an awful lot of people out there that try to do that.
Speaking of comfort, I’m going to have to shift to what is going on in the markets because society will pay almost anything. They will give up almost every freedom for comfort, or for convenience. I’m looking at the markets right now. Yesterday we were talking about a chart that overlaid three potential crash years, three March through October periods of time in the stock market. The first one was 1929. And of course we saw jagged line rising, and it rose until it fell, and we know that the crash occurred in 1929. Then overlaid on that was the crash of 1987 that we talked so much about last week because we are in our 30-year anniversary of that crash. There was normal market volatility. There were the zig-zaggy lines of buyers and sellers all the way up to the crash.
But this year’s market, Dave – it was just a smooth, steady, almost non-moving line. There was no saw tooth in that line. We have a market right now that has pretty much decided that their comfort will be paid for central banks and by debt, and that the markets will not be allowed to fall. The markets right now are ignoring a possible nuclear confrontation in North Korea. They are ignoring everything that would cause it to go down.
David: I don’t know if you have ever seen a wait staff glide across the room carrying martinis…
Kevin: (laughs) Filled to the brim.
David: And there is this smooth step, and it’s just amazing to watch because everything is perfectly laid out. That’s what that chart looks like.
Kevin: Yes, no doubt.
David: The markets completely ignore the possibility of nuclear confrontation. The markets are completely ignoring any possibility of geopolitical events. And that is the investment community at large. We had some very significant things happen this last week. Xi Xinping had his conference – nothing that would necessarily impact the markets immediately, but you have Xi Xinping now included in the Chinese constitution along with only two other people. He has basically put himself in there and written himself into Chinese history as the equivalent of Mao and Deng Xiaoping. So he now is sort of this person who has basically said, “Here is what we are going to do over the next 50 years. This is the shaping of the modern Chinese society.”
Kevin: What are they looking at? Are they looking at trying to be a superpower?
David: A socialist super state with Chinese characteristics with a military buildup through the middle of the century to be one of the, if not the, most significant military powers in the world. And the emphasis, of course, as it has been since 2012, was on a massive crackdown in corruption. They recognize that weakness cannot be tolerated.
Kevin: Let’s call it what it is. In a communist country a crackdown on corruption can look very, very different than what we think of it as.
David: They have had, in the last year, I think, 1.3 million party members who have been under investigation. So there really is a purge, if you will, to figure out who is a party loyalist and who is just in it for themselves for the money.
Kevin: A tightening of the fist, is what it is.
David: It really is, and it is interesting, because we have some friends that live in China, and communication is getting more sparse. What can be spoken of is less and less with each day, week and month that pass. And there is a very different tone set now than, say, roll the clock back five years ago to the last five-year plan that was laid out. There has been a lot happen in the last five years. We could have said, and I think my dad and I might have argued this point, they might have been the growing example of capitalism in the 21st century, and here, now, with five years passed since the last congress, I would say decidedly not.
Kevin: Command and control. I’m wondering if they are also sensing that they need to fill the vacuum. A vacuum will be filled, and the petrodollar which was so strong that it allowed the United States to be the superpower that it has been since World War II, is slipping away very quickly. And so there will be a power void if we can’t control power economically.
David: Over the weekend I had a fascinating conversation with a guy from the Treasury Department, an ex-Treasury guy – about eight years with them – a fascinating background with the Heritage Foundation and then a move over to Treasury. Part of the discussion centered on the petrodollar. What we have done, in terms of foreign policy, and as an attaché overseas for Treasury, he was able to witness some of the things that we are doing, from an international relations perspective, driving new relationships.
You and I have talked about the fact that Israel has been pushed into the arms of Russia over the last four or five years, and now you have the same thing happening with Saudi Arabia. So you have this strange group of countries that used to be more in alliance with us – at least, the Saudis and Israel – and now they are gravitating toward Russia and China. And it’s happening at the same time that we are reaching an independence level, or moving toward petro-independence – 9.3 million barrels a day is pretty decent production. Don’t know how long that will last, and don’t care, because the significant implication, at least for this conversation, is that we are remaking old relationships and we are damaging old relationships.
What we don’t realize is that the petrodollar is going away – with it, the power that came with having these mass reserves held in dollars all over the world. What happens when – and this is not a hypothetical risk, this is happening as we speak – through the One Belt, One Road project, through the new alliances between Saudi Arabia and Russia, Saudi Arabia and China, Israel and Russia, Russia and China – there is a gravitation of geopolitical power and influence that is moving East. My dad has always said, “You watch where the gold is going and that is where the power will follow.” And there is this step-sequence of the gold moving toward Russia and toward China.
And sure enough, there are re-engagements, disengagements from our standpoint. We have never had a more dysfunctional Secretary of State, and I’m not saying anything about Tillerson, but we have not had a cohesive foreign policy in probably 20 years, and it’s only getting worse.
Kevin: Follow the Secretary of State, as well. When you talk about following the gold, that is true, you can see where the power is, but follow our former Secretary of State because you can also see where her power is. We try to stay away from some of the banal political commentary that we see on all the news services because it is just exhausting. But what we are seeing right now, Dave, being revealed with Mueller and Trump, and Hillary and Obama, and some of the things that are coming out, the Russian connection actually turns out to be a Clinton connection. So I’m wondering, you talked about a corruption crackdown in China, do you think we will ever have a corruption crackdown here in the United States where it needs to happen?
David: I think this has been an amazing irony that as the media has pushed to skewer Trump and try to put his head on a Russian pike and say, “Look, you’ve colluded, there have been all these things that have happened,” the more they are uncovering things, then they have to recover, and say, “Uh-oh, what did we do? What did we get ourselves into?” You have Rosenstein, you have Mueller, you have Comey, McCabe, Weissman – you have all these people who were at the periphery of a massive cover-up between Obama and Clinton, and this uranium deal.
If you go back in time to the uranium One deal which was done a couple of years ago, Obama brushed off all evidence of corruption and money-laundering and bribery that the Russian company that the U.S. did this deal with, they had a subsidiary here in the United States that was already under investigation for all these things – again, felony extortion, fraud, money-laundering. And it was interesting because the Department of Justice, the FBI – all of these things were known, and the deal was being done, and it was covered up.
It is interesting, I just want to read something to you from the National Review. “The Obama administration also knew that congressional Republicans were trying to stop the transfer” – this is of 20% of the U.S. uranium reserves to Russia. Can you believe this (laughs)?
Kevin: That’s amazing.
Kevin: Who then gives it to, possibly, Korea or Iran, or you name it.
David: “Congressional Republicans were trying to stop the transfer. Consequently, the Justice Department concealed what it knew. Interestingly, as the plea agreement shows, the Obama Department of Justice Fraud Section was then run by Andrew Weissman who is now one of the top prosecutors in Robert Mueller’s ongoing Special Counsel investigation into suspected Trump collusion with Russia.”
David: And they conclude, “This stinks.” We have internal issues, which, quite frankly, is one of the reasons why we don’t have a coherent foreign policy, because we have folks going to the very top of the State Department – not Tillerson, again, I’m talking about ex-State head, Hillary Clinton – who have basically said, “We can do anything we want. Nobody is going to ask any questions.” Now, with these reveals going on, we just have to start counting body bags, because again, as National Review says, the Clintons were just doing what the Clintons do – cashing in on their public service. You had millions of dollars flow from this deal with Uranium One straight into the Clinton Foundation.
Kevin: So you’re not insinuating, though – when you were talking body bags I got a little uncomfortable, Dave. Are you implying that witnesses to some of these goings-on might not live to the next year?
David: The Clintons are one of the most ferocious political organizations – dynasties – to exist, ever, in American history. So this is either going to be quickly brushed under the carpet and become nothing, or it becomes something, and then you will find all of the people who knew anything about it start disappearing.
Kevin: It’s a modern day game of thrones. Now, speaking of modern day gold, I was at the coffee shop the other day and somebody who enjoys talking to me about gold, who I see sometimes down there, said to me, “Kevin, Bitcoin is the new gold. I hate to tell you, but you’ve been replaced. Bitcoin is going to be the new 21st century gold.”
David: The problem is, that market is no longer run by greed. We’re coming up on $6,000 on the price, and it is actually fear that is driving that market.
Kevin: Now, what kind of fear are you talking about?
David: You know exactly where you are in a cycle when fear takes hold, because it begins to reveal what people really are about, why they are doing what they are doing. In this case, it is the fear of missing out. It is the other kind of capitulation that you will see in markets where – I talk to Wealth Management clients all the time and they look at the stock market continuing to rise, and they are like, “You know, look, I understand it’s not based on fundamentals. I understand that earnings are this, or earnings are that. I understand that ratios are stretched. I understand that asset values are expensive. But – but – but…”
And they are moving ever closer to the point of capitulation. What kind of capitulation? The capitulation that says, “I fear missing out.” And that is now driving the Bitcoin market. Paul Isaacs – brilliant asset manager – his advice to Millennials on Bitcoin is to listen carefully, and sell when your parents ask you how to invest in it. That makes sense to me.
Kevin: (laughs) That makes sense. But let’s face it. Even though gold has had a pretty good year this year, 10-12% up, the stock market has done – some of the indexes more than that, it’s really nothing compared to Bitcoin. But look at the junk bond market. You cannot get return. But let’s go to the European junk bond market. We may as well call it the guaranteed default market.
David: Bitcoin doesn’t get under my skin. It’s an anomaly, it’s a fad, it’s technology and everybody loves technology.
Kevin: Right. Block chain has a future somewhere, we just don’t know where.
David: Sure. Again, it’s the flavor of the month. We don’t know which currency will last. We know that Bitcoin…
Kevin: Okay, but European junk bonds gained 2%, Dave.
David: That gets under my skin. Bitcoin doesn’t get under my skin. European junk bonds yielding 2% – yeah, that’s a great measure of risk. We’re talking junk bonds, folks – 2% yield on junk bonds? Just as the name implies, this is not the U.S. treasury market. Yet, it’s cheaper for a moribund company in Europe to borrow and finance their operation than it is for the U.S. government? Well, what could go wrong there?
Kevin: And Dave, for it to be considered a junk bond you have to figure the possibility of default on that bond is probably 15-25% before maturity. I don’t know what the exact number is, but when you go out and buy junk bonds you say, “Okay, I’m going to probably be out of this bond before they default.” But the likelihood is that there is a high probability of default on those bonds. Now, explain, if you would, the pricing of bonds and interest rates a little bit, because I think sometimes people forget that interest is merely a price. It’s the price for something.
David: That’s right. Quick review then. Interest rates are a price.
David: That is, they price what the market believes to be the implicit risk of nonpayment on a loan. Does that make sense?
David: So, the higher the rate, the higher the implied risk in the instrument.
Kevin: Thus the name junk bond would be a high probability of default.
David: Yes, so there is information in the number. There is supposed to be information in the number anyway. And it conveys market pricing of risk, which is why it is normal to see credit card rates much, much, much higher than something like mortgage rates. Number one, you have higher defaults on those kinds of loans. Number two, there is a lot lower scrutiny of a credit card borrower on the front end. So there is information in the price. And I know this is a review, but we too quickly accept that the current state of affairs, this world of suppressed interest rates, is normal and is sustainable. And what are we working off of? We’re working off a recent history, and I think even direct experience should warn us otherwise.
David: Again, go back to 2007, 2008 and 2009. What do you know about interest rates and the mispricing of risk when things get squirrely? Dangers existed in 2004, 2005 and 2006.
Kevin: Yes, before the last crash. In fact, I’m thinking about bubbles here as you are talking about it, because this is a bond bubble. Greenspan just this last week said, “I don’t know if the stocks are necessarily a bubble, but the bonds are definitely a bubble.” I think about my dog. I’ve got a dog that loves soccer balls, and you can kick that soccer ball, and we can go weeks without him popping one. But he always ends up popping one, so our garage has two extra soccer balls sitting in the box waiting to go for when the ball gets popped, because it’s a toy that he absolutely loves.
I’m thinking about the bubbles that we have had just since I’ve worked for your family. We had a stock bubble that popped in 1987. We had a savings and loan bubble that popped back in the mid 1990s. We had a tech stock bubble that was the largest I think any of us had ever seen that popped in the year 2000. Then it got transferred, and Greenspan was involved in most of these, I hate to say it, but Greenspan knew that he had to inflate another bubble. He had to go get another soccer ball out of the garage to placate the dog, and that was the mortgage bubble.
There were dangers back in 2004, 2005 and 2006, and we talked about it, Dave. We sent CDs to people so that they could hear that there was a real estate risk. I remember 2005, 2006, sending that to all of our clients. The bubble did pop, but we have thrown it now into a bond bubble.
David: Greenspan, you’re right, was involved in more bubbles than any other standing Fed president. Part of that was that he was the second longest standing member of the Federal Reserve next to William McChesney Martin. But he was reflating the economy via the mortgage-backed securities market – Fannie Mae and Freddie Mac. What that looked like – by driving down borrowing costs lower and lower through artificial means, and repricing the cost to borrow in the housing market, Greenspan was inviting a whole host of buyers into the market that could not have participated otherwise. And what that amounted to was artificial buying.
The long-term consequence of that – there is a cost to it, and it is usually future market volatility and destabilization. And history bears that out. They created a bubble, then it ran out of steam, and we paid the collective cost. The costs would, under normal conditions, have been too high for those new participants. If you are talking about houses that they would have been able to buy, or financing costs that they would have paid, but when the Fed drove rates down, they opened the gates for nonqualified buyers to come in.
Kevin: Thus reinflating a bubble that everyone knew had to be reinflated. In fact, it is amazing, Dave, sometimes we think that history just occurs off the cuff and at random, but actually, Paul Krugman called for the reflation of the bubble after the tech stocks popped.
David: It was a response to the dot.com bust, and to quote him from 2002, “To fight this recession,” Krugman said, “the Fed needs more than a snapback. It needs soaring household spending to offset moribund business investment. “And to do that,” as Paul McCulley of PIMCO put it, “Alan Greenspan needs to create a housing bubble to replace the NASDAQ bubble.” This is, literally, 2002.
Kevin: He said that ahead of time.
David: Paul Krugman is saying, “You gotta have a soccer ball on the shelf because the dog will pop one, and then you gotta have another to roll out. Let’s roll out housing. We don’t have tech stocks, let’s roll out housing.” And the challenge is, when the biggest bubble that you’re facing now is a government bond bubble, what soccer ball replaces that? Which do you take out of the garage and throw out for the dog to play with?
Kevin: I hate to say it, Dave, but it sounds like a bail-in for the next one – a cashless system and a bail-in for the next one. That’s you and me.
David: This is exactly what they decided to do. They lowered rates, which in essence, was lowering the hurdle to get over to access borrowed funds. And in essence, you have a grand scale distortion of risk in the marketplace resulting from artificially low rates. The pricing was off. The list of qualifying participants swelled due to the accommodative lending terms, and you had a new cycle of bubble dynamics emerge to replace the dead NASDAQ market. Once everybody was through the door and flows needed to be maintained, that’s when you began to see things really get creative.
Kevin: The fancy math, the amortization loans.
David: Negative amortization loans, your adjustable rate mortgages. Oh no, you can’t afford a 15-year – oh no, you can’t afford a 30-year – but you could afford interest only adjustable rate. And again, you’re kind of moving down the food chain in terms of who even qualifies and we’re still stuffing people through the system. But that kind of creativity was sending a clear message to the observant investor at the time. Be cautious. The last buyer in is nearly past the threshold.
Kevin: It sounds to me like the movie The Big Short. Remember? The big short. There were people who actually saw it coming ahead of time. In fact, you’ve been to James Grant’s conferences a number of times, and James just had his most recent conference. In that movie, it was Grant’s Interest Rate Observer that was one of the documents that I saw on the desk that he was using to see it coming.
David: (laughs) Of course.
Kevin: And the same thing is coming now. James Grant is saying, “It’s time again.”
David: Yes. The last time I was at Jim Grant’s conference I took my son with me. We met and had a conversation with the founder of Vanguard funds – the head of indexing. And the big debate at the conference was, to index or not to index.
Kevin: Right, which is passive or not.
David: That’s right. But fast forward to the present. Not even a decade later after the collapse in the housing bubble, which Paul Krugman said must happen to replace the NASDAQ bubble – not even a decade later, we have asset bubble dynamics, we have rate manipulation à la the 2003, 2004, 2005, 2006 vintages. And we think, today, it is perfectly acceptable. And we think that this is going to produce a new and sustainable market dynamic.
It’s fascinating to see the reinforcing dynamics of a bubble. As the group of participants swells, the new dollars within the asset class, they whip through and get into a frenzy. And it gives the impression, on the basis of new capital flows, of a very fresh and potentially enduring trend. But there are limitations. And there are also only so many participants.
Kevin: That is where that last man in comes in, Dave. Again, using the analogy with my dog and the ball, that ball looks like a normal soccer ball until the moment it pops. And it is amazing, it scares him. He thinks he’s killed it and so he runs away from it. But it just immediately deflates.
Kevin: It’s not one of those things that, gradually, we just sort of replace one bubble to the next, or one ball to the next. It really is always pretty devastating.
Dave: When you start to run out of new bodies to file through the system and take on debt, the end is near. But the last stage of it would seem that governments step in and perpetuate the trends by becoming a part of the throng of buyers, the artificial buyers though they may be, but they are a part of the throng of buyers, and they leave the impression that there are, yet, more participants in line at current prices, and the trend in place is thereby going to be viable. That is the impression created by their presence in the marketplace, even though they have no place there in the first place.
In this case, you know where the money is coming from, not from the excess savings or capital that is derived from a free enterprise system, because that is how capitalism works – it depends on savings, it depends on excess profits, for further expansion. But instead, you have money coming from the creation of debt instruments, which substitute for hard-won assets. What is different this time is that interest rates the world over are at, say, 5,000-year lows – 5,000-year lows.
Kevin: And going lower. That’s the thing that is just crazy. We talked about normalizing rates, but you talked about the last man in, and that there are only so many possible participants. What has seemed to change recently is that we really don’t have a limit of participants because it is the central banks that just print more money. You’re talking about that debt creation. Is this time different?
David: Right, so you see some capitulation amongst some big name investors. The migration is thought, again, from some of these big names, that we don’t have precedent for these kinds of activities. Again, if interest rates are at a 5,000-year low, and potentially going even lower, you’re right. We don’t have precedent. Not the scale, not the scope, and so we really, in their opinion, can’t determine how far the charade can go.
Kevin: So let me ask you, if you can’t beat ’em, join ’em?
David: That’s basically the spirit of the day – rather than attempt to hold your breath and wait, join in the fray. Again, this capitulation tells you something.
Kevin: You talked about the fear of being left out. It’s the same type of thing here. There a fear of being left out. It’s like, “Yeah, I understand it shouldn’t be going up, and we don’t really have a true business expansion, but hey, everybody around me is making money. Why shouldn’t I?”
David: Yes, it’s kind of like, “Well, after all, the bubbling up of assets is tied to Ponzi finance, and those dynamics are now becoming normalized. The general public rather enjoys the feeling of success, regardless of the Ponzi foundation it rests on, right? They just enjoy the price movement and the reward, they don’t care how they got it. So, if it’s going to go on for some time, “Let’s do this thing.”
And in essence, the smart money, in this category, is betting on the dumbness of the dumb money, assuming that they are always smart enough to catch the turn in the markets and get out. The smart thinks that they are so smart that they can’t get hurt, and they are assuming that dumb money will continue to be dumb and not figure out just how Ponzi-esque this whole shootin’ match is.
Kevin: Isn’t that called momentum?
David: Well, momentum – yeah. The government, via the Fed, is engineering a reality which it never imagined. Because look back. In the 100 years of its existence, it always assumed that its presence in the market was to be temporary. So it’s a game changer in their view if they can play a permanent role in the marketplace. So who is learning from whom? Did the Chinese learn from us, or did we learn from the Chinese? As we looked at their capitalism with communist characteristics, what are we learning? We are actually adopting the command and control dynamics, importing them here, and saying, “No, actually, we will play a permanent role in the market.”
Kevin: As our guest, Tomas Sedlacek said, “It really is a new religion. It’s a religion of perpetual growth, and the high priests of the perpetual growth are the central bankers.” But it really is a new religion, because what do false religions promise? They promise prosperity from a false source. That’s really what a false religion is.
David: So how long does this virtuous cycle of growth last? We have synchronized global growth which everyone is talking about. How long does that “virtuous” cycle of growth last? We could ask Krugman, we could ask Janet Yellen. She says, at least for her lifetime. And here’s the irony. The certainty of continuance of any particular trend, Kevin, is itself an indicator of where you are in the cycle. There is always greater certainty near the end, in part, because things are always best near the end. In a few minutes I want to share quotes with you from 1927 to 1929, that timeframe.
Kevin: Right before the crash. Everybody thought it was going to go forever.
David: And I think Yellen is maybe some sort of reincarnation of Irving Fisher, to listen to her confidence as to what the future holds. So, to me, the fascinating part of this trend – and I’m talking about the stock market and the growth trend off of the lows 2008 and 2009 – it did not begin at a market low. And you may think, 2009, that was low. Not really. Low compared to the highs of 2007 and 2008, yes, I grant that. But it’s not low, and it was not low, compared to the lows of any other period in 200 years. Where you see a major market correction, it gets to a certain standard deviation below the mean in terms of normal market functioning.
Kevin: And that’s where the purging occurs. You purge the bad debts, you purge the bad businesses. You’ve been making this point for years and years, Dave, that the 2008/2009 correction – that really was not what needed to happen, fully. And I think we see that also with the Dow-gold ratio. The Dow-gold ratio really did not get to the normal 1-to-1 or 2-to-1. I think we got to 5-to-1 or 6-to-1. And then it picked back up.
David: Yes. Look, I’m not complaining about the stock market reaching new highs, and I’m not complaining about the economy showing signs of improvement. That’s not a complaint at all. But the basis of these moves, which is entirely debt-driven, and this is what Doug Noland gets to in his credit analysis. We had a great meeting, by the way, this last week, and it was interesting listening to the comments.
Kevin: You recorded that, didn’t you?
David: We did. It’s on the Wealth Management website if you want to listen to the quarterly call. I would highly recommend it. But this move has been debt-driven. It’s inherently unstable. Deutsche Bank said this this week: “We’re in a period of very elevated global asset prices, possibly the most elevated in history.” This is going to work, it’s going to be a success story, and it will be a success story for some unknowable period of time. It’s unknowable to me, it’s unknowable to you, and yes, it’s unknowable to the great and mighty Oz.
Kevin: But it’s perception. The mighty Oz is the Fed, and really, what they are – they’re not as much monetary economic geniuses as they are perception managers. It’s perception, Dave, that they’re managing.
David: Speaking of perception, because this gets to the heart of liquidity – Robert Rubin, back in 1987, correctly noted that liquidity is more of a psychological phenomenon than a monetary phenomenon. We think of liquidity as the Fed creating all this liquidity and it being in the market. No, liquidity is, first and foremost, a psychological phenomenon. The Fed thinks it knows, but I think they have forgotten Rubin’s insight. It’s the mass mind that drives asset prices. It’s the mass mind and the feelings within the marketplace that ultimately trump everything that the Fed or any other central bank can do.
The market is, ultimately, in control. And yes, that psychology can be manipulated. That’s where you say “perceptions,” and oh baby, that’s just hitting the nail on the head. Why? Because perception management is how you manipulate psychology. And that’s how you get price action follow-through on the upside. That’s what makes all of this so very interesting to watch.
Kevin: In a normal world, Dave, we would mention the word counterfeiting and say that that’s a crime. I can’t print money, you can’t print money. We can’t coin money that would be in competition with the U.S. dollar. In fact, you said you met someone who had been a treasury employee for eight years. Our treasury, on a regular basis, will, with an enemy country, counterfeit their currency to try to drive them – we did this with Iran. Why have we validated the process of counterfeiting and called it the Federal Reserve?
David: That’s interesting. You’re right, if you change the frame, change the context for a minute, change the names and characters for a moment, say that Kin Jung Un was the entity creating currency and credit in the trillions, classically, this would be viewed as an assault on U.S. financial stability.
Kevin: Right. It would be war.
David: By contrast, we get infinite credit and currency from the only entity that won’t go to jail for counterfeiting currency. That’s our central banks, both domestic and foreign, in the current paradigm. And we’re praising them for what would otherwise be, categorically, an assault on the financial stability of our country. It’s very fascinating.
Kevin: Call it illegal. It should be illegal.
David: Right, so North Korea, and other rogue states, routinely try to do this – counterfeit dollars, in part, in an effort to destabilize and attack another country via their currency. Yet, if our own central bank does the same thing, it is a virtue – back to this virtuous cycle. Well, maybe we should ask the question: What is virtue? This is the basis for the current virtuous cycle. How long does the perception of stability and success remain? I think this boils down to the faith that the public maintains. As long as the public has faith. Then you go back to Sedlacek’s comments. If you were a central banker in the modern era, you truly would, like a priesthood, seek for a deeper level of belief, faith, trust, conviction, and you might even pray fervently for the flock, even knowing their future – a complete fleecing!
Kevin: What they are doing is, they are sacrificing on the altar of perpetual growth. I just went to Israel last month, and there are still regions in Israel, especially in the northern part by Caesarea Philippi, where there was the false god, or Pan worship, and a lot of the other false altars. But what did that offer the people at the time? Well, I won’t go into detail, but it was comfort, especially. They felt like fertility came from sacrificing to these false gods. Well, what is fertility? Fertility in the spring is the same thing we’re talking about in the economy. We’re looking for perpetual spring.
David: Just to add to that, I think there is in every age and race a desire for autonomy from the rules. “I’ll make my own rules, thank you. I will make a rule and a law unto myself.” And it’s like the temptation of Babel in every generation.
Kevin: Psalms 2 – it says “The kings have set themselves, and the rulers have taken counsel with each other, to cast off the bands and throw the cords asunder.” So, they don’t want to have the rules. They want to be autonomous, that’s great.
David: So Deutsche Bank – this is just going back to the market for a moment, because they note that since 2012 the S&P 500 companies, in aggregate, have spent about two-thirds of their earnings on dividends and buy-backs.
Kevin: Say that again – two-thirds of their earnings are going back into buying back their own shares.
David: And dividends. But on top of that, as Dave Burgess in our office looks at, add another third to the leveraging process where these same companies have gone ahead and borrowed money in addition. They’ve leveraged their balance sheet to do the same thing – borrowed money to pay dividends and fund share buy-backs. Just think about that behavior, because one of the things that is driving the stock market bonkers today is the idea that tax cuts are going to be stupendous for the business cycle, great for business investment, etc.
But if you look at the current behavior and consider the probability that those firms will increase business investment as a result of tax cuts, I think you are existing in a very naïve place. The White House has assumed that corporate tax cuts will stir investment, but the current pattern suggests that it is going to trigger a large amount of capital, a larger, even, amount of capital exiting corporate America, and in that case, perhaps the markets, too.
It’s not going to increase investment. That’s what Trump believes, that’s what is being priced into the market. At this phase in the market dynamic, they’re looking for any excuse to push prices higher into the year end, and it is not as if the trend is changing. You look at last year’s numbers – not just 2012 to the present, but as a percentage of S&P earnings for 2016, last year 99% went to share buy-backs.
David: And shrinking the pool of outstanding shares. What does that do? It magnifies the earnings, themselves, on a per share basis. This is being treated like a virtuous cycle. Return of the shareholder value – that’s the whitewash description of it. Return of shareholder value – that’s what we’re doing through dividends. But really, they’re prettying up the pig. When the market figures out that insiders and large shareholders have, in essence, been giving themselves a special opportunity to pull capital out of the companies – (laughs) I guess it won’t matter because the trend is toward unmanaged – that’s a better description for your passive investing – ETFs. The trend has been toward unmanaged investing anyway, so who is really there to care anyway?
Kevin: You were talking about quotes, going back to the 1920, right before the crash, and I think we should get to those. But I had a conversation with Dave Burgess just before we walked into the studio, and he basically said the tax cuts have already been discounted into the stock market. What he means by that is, you buy the rumor, sell the news. Everyone knows that saying. The rumor right now is that there is going to be tax cuts and it’s going to be good for America. So the buying is happening right now.
David: It has happened since November. Do you know how much is already baked into the cake? At this point people are trying to rationalize what is nothing but a speculative frenzy. And you can’t put your mind around this. This is Newton saying, “I can understand the movement of the stars, but I cannot understand the madness of crowds.” So when I listen to CNBC I think it’s laughable that every tick higher in the stock market they have an explanation and a justification for. They don’t know anything.
Kevin: No, but hindsight is 20/20, so let’s go back to the 1920s. Let’s look at some of the quotes, because these were very, very intelligent people making these quotes. These were not idiots.
David: This sounds like CNBC. October 1929 – R.W. McNeal who was a financial analyst at the time said, “Some pretty intelligent people are now buying stocks. Unless we are to have a panic, which no one seriously believes, stocks have hit bottom.” This was right after the first leg of the crash, so you’re only down a small amount, on your way to losing 89%. You’re probably down 10-15% off the top. And he says, “Look, there are some smart people that think this is a deal. I think stocks have hit bottom.”
Kevin: Yes, and they continued to fall until 1932, if I remember right.
David: Oh, oh, that’s what they call catching a falling knife. I see. Or how about this from Goodbody and Company. This is from the New York Times, Friday, October 25, 1929. Just tell me if this sounds like the 1920s version of Jim Cramer. “We feel that, fundamentally, Wall Street is sound, and that for people who can afford to pay for them outright, good stocks are cheap at these prices.” It’s fascinating, you have the chairman of Continental Illinois, which is a bank that went away. October 24, 1929, he says, “This crash is not going to have much effect on business.” Really?
Kevin: And we know that we went into about a 14-year depression after that. But you had mentioned Irving Fisher. You compared Janet Yellen with Irving Fisher. You ought to give the quote from Irving Fisher.
David: By the way, I don’t believe in reincarnation, but if Irving Fisher were to be, actually, in that sort of reincarnation karmic deal, moving up the chain maybe he would be a woman, and maybe he would be Janet Yellen. So this is not a hit to Janet Yellen, this is just that there is a similarity and a thread that goes throughout the cosmic theme of things, it seems.
Kevin: He said this – what? A day or two before the first crash?
David: Yes, this is October 17th – “Stock prices have reached what looks like a permanently high plateau.” I love this quote. You’ve heard me say it before. “I do not feel there will be soon, if ever, a 50 or 60-point break from present levels, such as bears have predicted. I expect to see the stock market a good deal higher within a few months.” For perspective, this is a Ph.D. in economics who was considered one of the brightest minds at the time. He also said, September 5th, a month-and-a-half before that – “There may be a recession in stock prices, but not anything in the nature of a crash.” That was from the New York Times September 5th.
John Maynard Keynes, arguably one of the smartest minds of his time, maybe one of the most confused minds of his time, as well, in many categories – “We will not have any more crashes in our time.” Wait a minute. Was that Yellen, or Keynes? “We will not have any more crashes in our time.” That is a quote from 1927. Myron Forbes, who in 1928 was President of Pierce-Arrow Motorcar Company, was so confident he said, “There will be no interruption of our permanent prosperity.”
The presumption of control – I think that is one of the big themes we have hit on over the last three to four years. We believe that we are in control of more than we actually are. And I think, with any wisdom, with any life experience, we reflect and say, “What do we really know? And what are we really in control of?” It’s just interesting that you and I, in an honest conversation, can come to that conclusion, but is it egoistic blindness – what is it that has leadership unable to say that? Maybe it is the consequences of revealing that they are actually in control. I don’t know what they are afraid of, but we know on a common-sense basis that the Fed has never, nor will they ever, hold the sun, moon and stars in place.
Kevin: In all fairness, if we are going give quotes, there is a famous quote by George Bernard Shaw about paper money. I think it would be worth listening to that quote, because some of these quotes actually have proven out to be correct.
David: Yes, I just get back to this idea of control, and you see that this is why interest rates have to stay low. If you don’t keep interest rates low, the reality of bankruptcy emerges. The reality of bankruptcy, which already exists, if rates normalize, with the existing stock of obligations that are there. Central banks should be able to do the math, I think they have done the math, I think they realize that at this point the best thing they have going for them is perception management, manipulation of sentiment, control of people’s understanding of the facts. Again, this is a work of hermeneutics. What are the facts? Well, let me tell you what the facts mean. That interpretive piece right there – “Let me tell you what they mean, what is the significance.” That is how they are controlling outcomes and driving prices higher.
Kevin: All perception.
David: Yes. George Benard Shaw – “The most important thing about money is to maintain its stability.” He goes on to say, “You have to choose between trusting the natural stability of gold and the honesty and intelligence of members of government.” And he says, “With due respect to these gentlemen, I advise you, for as long as the capitalist system lasts, to vote for gold.”
Kevin: Yes, Dave, that’s what I’ve been doing. I’ve been voting gold for at least the last three decades and I’m not going to change anytime soon.
Dave, let’s just remind our listeners that we have these conferences coming up. You have eight conferences coming up here over the next six weeks.
David: Would love to spend some time in person with you. I think the novelty factor is getting to spend some time with my dad and myself at the same time – a bit of yin and yang. We begin in Kansas City, then head to the Twin Cities up in Minnesota. After that we’ll head to the East Coast – Philadelphia, Charlotte, then Austin. And then we finish off with two locations – Naples and Orlando in Florida. And I hope that you can either fly to see us, or come if we’re close to your area. In about half of those briefings, our consultations are already booked. So, if there is any desire at all to spend some one-on-one time, ask personal questions, personal financial questions, what have you, then you want to act fast on that.
Kevin: Give us a call so we can RSVP it, or you can also visit mcalvanyica.com/briefing. But you can also give us a call at 800-525-9556.