January 16, 2013; Signs of Failed Leadership

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, there is a particular mountain bike ride here in Durango that is particularly difficult, a lot of climbing, but you have these peaks that you get to, and they are always false summits. It drives you nuts, because you’re tired, you look at the summit, you think you’re just about done, you come up over the top, and you’ve got another false summit.

That is reminding me of Washington, D.C. right now. Fiscal cliff, all the nervousness, “It’s been averted.” I think that was a false summit.

David: Kevin, I thought for sure you were going to mention Star Wars [another local mountain biking trail]. It’s the ride that I always go over the handle bars on, and I think that’s a lot like Washington D.C. right now, too. There’s a point in the road where if you don’t get off and walk your bike, or perhaps if you are a skilled rider you don’t have to, but I typically do go over my handlebars on that one particular section.

Yes, false peak, after false peak, after false peak. I don’t usually stop and listen to the news on Fox news, or Bloomberg, or CNBC, but I thought listening to the final press conference of Obama’s first term might be worth a couple of minutes. Of course, folks in the office said, “You might just want to move along, your blood pressure is probably going to rise,” as theirs was already.

It did start out with a very bipartisan tone. The press corps, unfortunately, very quickly got under his skin, and the “conversation” that he was willing to have with the Republicans starting to sound like it entailed sitting down with an inmate to discuss reforming bad behavior.

Kevin: David, I hate to say this, but we have a president right now who does not like to be questioned on anything that he hasn’t already told you that you can ask him.

David: (laughter) Well, in the interview, compromise was sounding like a dictation of supreme will. He would not compromise, there was no compromise, there was no discussion. It was final. Either you get on board, or else. It is ironic that, as the president, he feels so adamantly about raising the debt ceiling, when Mr. Obama, as a junior senator, voted against raising the debt ceiling, and in fact, went so far as to say this. I quote from 2006: “The fact that we are here today to debate raising the debt limit is a sign of leadership failure.” I guess, if the shoe fits… back to the quote: “It is a sign that the U.S. government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our government’s reckless fiscal policies.”

Kevin: David, I remember that, and that was definitely a grandstand moment, because if you will recall, when he was a senator, he wasn’t there very often, but when he had the camera, that was one of those situations where he knew that he could go on record just slapping the Republicans around. Now he is in the same situation.

David: It was an impressive lecture. But I would ask the president, “Which fiscal policies did you have in mind which are categorically reckless?” We have the largest fiscal commitments, which are, in fact, noncompulsory. When we discuss paying our debt obligations, that is, specifically, making payments on, or servicing, roughly 10 trillion dollars in actual IOUs, it is a defined universe.

Defense is not a debt or interest payment. Social Security is not a debt or interest payment. Medicare is not a debt or interest payment. The increased salaries of Congress approved in recent weeks are not a debt or interest payment. In fact, you have to go down to the 4th line item, it’s the 4th largest item, but it is 4th on the list, that is an actual debt, that is, interest on the national debt, which comes in at about 30 billion dollars a month – 30 billion dollars a month – which is important.

Kevin: David, what you are saying is, we can make payments on the debt. If they are going to call it the debt, we can still make the interest payments because the revenue is coming in, at least, to pay the interest with these rates where they are now.

David: Sure, with 200 billion in tax revenue each month, and 30 billion dollars a month in interest payments, pay some principle on top of that, and we have what we need to make payments on our debt and avoid default. The argument that the Republicans are holding America hostage and bringing us to a default scenario is entirely inaccurate. That theme of default is an utter red herring.

Kevin: So this is just basically misuse of a term. They are calling it debt and saying that it is unpayable, we have to raise it, but actually, they are doing that. They are tying their horse right now to entitlement programs and other bills that are not part of the debt.

David: These are political obligations, but there is a difference between a political obligation and what is, in fact, debt. The White House has very disingenuously tied the budget into our debt obligations, conflating the issue over whether or not we will face a debt downgrade or go through a default scenario, including things in the debt category which are not debts.

If you look at Friday’s Wall Street Journal, they had a superb discussion on this, pointing out, “The obligations protected as debts by the 14th Amendment do not include entitlement programs such as Medicare and Social Security. These programs are not a part of the “public debt.”

Kevin: They are bills.

David: Again, the actual debt consists of loans made to the federal government through bonds and similar financial instruments. This is just political rhetoric, and frankly, it’s political rhetoric at its worst. It is confusing the populace, and misplacing blame for a non-issue.

Kevin: Let’s talk about legality here, Dave, because, in reality, the government has to follow the law. I know sometimes they would like to tell us that they are above that, but there is a law that says we have to pay our “debts,” using that word, and that is what is being addressed right now, but you are saying that it is also being mixed with all these other commitments.

David: Exactly, and there is no legal obligation to borrow money to pay for entitlements, or even defense spending. To do so neglects the vastly overlooked moral obligation. I think this is really what should drive us mad as a society – a moral obligation to future generations.

Kevin: You are talking about our kids.

David: Yes, because debt is a deferral of tax, one which will be paid by future generations. It is a bill being accrued in the present, for which we, in the present, are not held responsible. It is our children and our grandchildren who are saddled with the task of payment, saddled with larger and larger debts. We are essentially eviscerating the quality of life that they will lead.

If you think of it this way, we are limiting their opportunities and hobbling their efforts at achieving something that we have had access to, namely the American Dream. In essence, we are passing the tab to them, while prioritizing our own consumptive habits, the benefits that we receive in the here and now, because we think, frankly, we are more important.

Kevin: Put yourself in their shoes, Dave. Let’s say that when we were in our teens and in our 20s and we were first getting jobs, that we actually weren’t paying for our own debts, but we were paying for debts from our grandparents that had perhaps taken place back in the 1920s, 1930s, 1940s. How inspiring would that be?

David: I like that thought experiment, particularly if you go back to the 1920s, the lifestyle which was extravagant, champagne every night, you name it, you could have it. Now, it didn’t mean that you were paying for it in the here and now, you might be paying for it next week, next month, next year. But then, you don’t have the money to pay for all of the extravagance, and you just pass that on to your grandchildren.

Your grandchildren look back and say, “What did we pay for? Was it a better America, or was it for extravagance that was unnecessary?” And to some degree, that is what we have done. We have made political commitments, not debt obligations, but political commitments, which they are trying to stay true to, but for political reasons, not because we are actually on the verge of a debt default.

Kevin: Just in case somebody is wondering, we are not talking about a Democrat versus Republican issue. This is Democrats and Republicans. This is a Republicrat issue. The Republicans are responsible too.

David: Yes, the Republicans have, on more than one occasion, done the same thing, and raised the generational burden to pass on to our heirs. What makes politics, frankly, a disgusting human endeavor, is that people pretend to be on the side of truth, but are all too willing to flip-flop conveniently to posture with the party, both parties here, and win points in the short-run. Unfortunately, we have a very misinformed electorate.

Kevin: Not just misinformed. In many ways, it is out of our control. You cast your vote and then you have to go about your day and earn the money that they are going to take.

David: It is both parties which are complicit in the current level of debt, and both parties that have all too gladly raised the ceiling. Do you know how many times they have raised the debt ceiling thus far?

Kevin: No.

David: 107 times. This is not new. We have done this over and over again. It is not a Republican issue, it is not a Democrat issue. Anyone who is trying to grandstand and say, “Here, on principle, we must draw a line in the sand,” or “Here, on principle, we must not hobble ourselves, destroy the economy, we must raise the debt ceiling.”

Understand that it is utterly convenient for both parties, whatever they are arguing today, they argued the exact opposite just 6 months, 6 years ago. This is the insanity of politics. People who are unprincipled beyond belief. It is on both sides of the aisle that we see a concentration of disingenuous cowards.

Kevin: It reminds me of when my wife and I first got married, yes, we used credit cards, too often, and we got to the point where when we finally paid them off, when something new would show up on the house, we would look at the other one and say, “Did you charge that?” Of course, over time, we started saying, no, we didn’t charge it, and we actually paid for things. But to do that 107 times, in a way, it’s like, “Did you charge that, again?”

David: But then to wash your hands of it and say, “Well, it’s not us, it’s the other party. We’re being held hostage.” Who is holding whom hostage? It is the political class which is holding the American public hostage, and not paying attention to the large structural issues. We have made too many obligations, too many promises, and there is no way to get in front of the debt levels that we have already, let alone adding to them.

We are forgetting the primary point of the conversation which needs to be held, which is that we are moving toward a debt debacle here in the United States, if not addressed immediately, and that may be precipitated by something as simple as the debt ceiling, and a downgrade to our national credit, which could precipitate higher interest rates.

And that one thing, which, if you recall Alan Greenspan’s comment going back 5-10 years ago, “It is interest payments which are the uncontrollable budget item.” Interest payments. Remember, that is the 4th biggest line item in the budget. In terms of our national debt, if interest rates rise for any reason, we have the 4th largest budget item which will eclipse all others. And now you have the issue of the Department of Debt, which appears to be in control today.

Kevin: So what you are saying is that it is a redefinition of what used to be called a Treasury, because there was something in it.

David: I think this is Jim Grant’s brilliance, just in its simplicity, that the Department of Debt is what it should be called. It’s not the Treasury. There is no treasure in the Treasury. There is no treasure! If there is no treasure in the Treasury, a rebranding is in order. I think Jim is right. The Treasury is anything but a treasury, it is the Department of Debt, but the Department of Debt is in control, until it’s not.

Kevin: And interest rates are a big factor in that. As the dollar starts to lose credibility worldwide, we have to pay more interest to those who are going to loan us money. That hasn’t happened yet. We have had this zero interest rate policy. But David, you talk about it being the 4th item down, as far as the interest that we pay on our debt, and that could go from 4th, to 3rd, to 2nd, to 1st very quickly. We are talking only a few points of interest rise to do that.

David: This is something we highlight in our most recent DVD, which will be out in a matter of days, certainly before the inauguration, and it is this issue of, if we return to the average level of interest payments that we have had over the last 20-30 years, we aren’t talking about 30 billion dollars as an interest payment, we are talking about 90 billion dollars as an interest payment, which would be the equivalent of 42% of all of our revenues going to one line item, namely, the interest compounded. We aren’t paying down our debt. That’s just to keep our creditors from forcing default, from putting us into the awkward position of calling the loans.

Kevin: It’s just purely interest. It’s like a credit card, going back to that analogy where you pay $500-600 a month, and realize you aren’t paying down your debt by more than a few dollars. It’s all interest.

David: That 30 billion dollar number today is likely going to be 90 over the next 3 to 5 years.

Kevin: It’s amazing, we have been printing money, we have had zero interest rate policies, yet our GDP still stinks. If we go across the ocean, I know there is a lot of hope that is tied to the emerging markets, to China. Are we going to get GDP from the other side? When it’s dark here, it’s light there. I’m wondering if that is the case with GDP in China.

David: China is amongst a group of emerging markets over the last three years, which, due to their size, have shown fantastic growth rates relative to the developed world, and specifically Europe and the United States. With every dollar of artificial stimulus in those countries, there has been fantastic growth, but you have to realize that the growth is actually constrained without government spending initiatives.

China, right now, is rebounding, but not on core economic growth. It is, specifically, artificial stimulus measures which have been put in place over the last several months. Other emerging markets face the challenge of growth in the context of consumer retrenchment in Europe and the United States, and China has not yet made the transition away from the artificial stimulus and investment toward being a consumption-oriented economy.

That may be the long-term goal, they may achieve that objective, but we are seeing things move the opposite direction. Right now we have power consumption growth, which is in steep decline. It is at about 5.5% now below the GDP growth rate, which will be, for 2012, right around 7.4%.

Kevin: So what you are saying, David, is that a good way to measure growth is how much power is being consumed. If you have GDP growing at 7.4%, you should also have growth in the demand for energy. It is just sort of a side way of looking at whether the growth is real or not.

David: The precedent of the last ten years has been increasing GDP growth rates, and a power consumption rate which far exceeded the GDP growth rate, and now it’s lagging. Essentially, we are in a transition phase, and one that doesn’t have any guarantees. GDP is likely going to bump higher following the last quarter’s government investment splurge, and we may, in fact, see those power consumption numbers grow again on a temporary basis, but these are all going to be first-half events.

Our expectation is that in the second half of the year, 2013, China will leave investors largely out in the cold, as we begin to see a decline. Remember, the declining trend in GDP growth means that they will be contributing less on a global scale to global GDP, but they are actually moving in a healthy direction toward a more normal growth level, not the double digits they had earlier this decade, and not even the high single digits, but toward a very sustainable long-term 3-4%, and that, I think, they will move toward as they head toward 2014.

Kevin: David, leaving China and going back to Europe, we have, for the last 2-3 years, really focused a lot of our energy, from the press point of view, even from this program’s point of view, on the problems in Europe. As you have said before, it is probably not going to end in demise, completely, but it is still on the table.

David: They are not out of the woods, and as we reflect on these Basel-III liquidity requirements we discussed last week, we did watch, subsequently, the large French and Italian banks respond very positively to the news of the changed LCR metrics.

Kevin: Well, of course, why wouldn’t they? They were told that they could value anything as an asset, virtually.

David: Yes, so with changed LCR metrics, they, after all, have the largest capital gaps to fill. They would have needed to raise the most capital, or, at a minimum, trade up in quality to pay for the old credit standards. We saw shares rise in response to those lower standards and the easier capital hurdle. So we have European banks that had well over a trillion dollars in new capital to raise, and that number has now shrunk significantly, basically, a new lease on life for the financial institutions. But the irony is, the new lease on life for those financial institutions is that they get to remain as they were, which is unstable and highly leveraged.

Kevin: It is amazing, Dave, just like we saw here in America, the banks were bailed out, yet the economy really didn’t feel it. The banks got their pockets full again so that they wouldn’t have to fail. We’re seeing the same thing with Europe. I saw a story yesterday about the deforestation of Greece. People cannot afford to heat their homes, and so they are going out and cutting down what little forest Greece has. They are going out and cutting it down, illegally, and trying to stay warm this winter. We haven’t seen employment improve at all in Greece, Spain, or Italy. We are not seeing improvements there.

David: No, and Spain is worth mentioning, I think just one last thing, which is that there are exceptions to this rule. As the LCR metrics were coming through, that is the Liquid Capital Ratio, the Swedish banks were already out in front of this and had raised enough capital and had put enough quality capital onto their balance sheets to be in excess of the old, and what was going to be expected, the very high hurdle, by 30%, which puts the Swedish banks in a category of their own in terms of stable institutions in the European context.

Kevin: Wouldn’t that be nice to see with other banks, where they are not forced to do something, that they actually did it above and beyond what they were asked to?

David: Now, in all fairness, the U.S. and our major banks, would be second in line behind the Swedish, followed by the continental banks and the banks in the U.K., which are the most exposed, you could say.

Kevin: David, I had mentioned Greece, but you said Spain, as well. There are problems there that are starting to show up on the underside of things that are going to have to be dealt with socially.

David: When we talk about China, and we talk about any country and what they face in terms of political problems, employment is so very, very important. The fact that the Fed has just changed the mandate here in the United States to focus on the employment figure, I think, speaks to where we are, and the risk that they would like to avoid, from the standpoint of political destabilization.

Why is that an important point? Because unemployment drives political instability. Another way of saying that is that unemployment drives people mad, and oftentimes it is mad people that hit the streets and let you know what level of discontent they are experiencing, and what they are discontent with. Is it the status quo? Is it the elites having a different deal than they are cut? What is the difference between the hoi-polloi and everyone else?

Kevin: The danger for the government at that time isn’t just the individual who is unemployed, but it is when they start uniting and banding together, when you start to see union types of movements back toward the government.

David: You certainly see that new sense of solidarity emerging amongst trade groups, and it is perceived that banks and the elites are taking something from the working class. This is what happened in Spain here in recent weeks. Locksmiths in Spain have turned down work, refusing to change locks on foreclosed houses. This is from Michael Pettis who lives in Beijing, but his family has a house in southern Spain, and he notes this because he was there through the holidays, that there is this sense in which social unrest will remain a theme in 2013, and there is this discontent, and a growing discontent, particularly in the countries where unemployment is very high.

So in Europe, and in many other places, perhaps in the U.S., we will see this as a theme that sort of continues on. We will have to see what executive orders are issued here in the United States that may serve to polarize the public and define, not necessarily debate, the conflict in coming years. Policy is really a critical point here. Policy is the central theme for 2013, and moving past the point of financial market demise, the implementation of policy will take center stage and either gradually help things get better, or cause even more damage. And that is really where the verdict is out.

Kevin: David, one of the things that is the most fragile within a country, of course, is the social stability of the government and the people. But there is a fragility, also, that extends worldwide, what we call globalization. It is the cooperation between countries, and that really does break down when you have unemployment within various countries and the poor are blaming the rich, or blaming the government.

You also then have governments who take cover and start penalizing anyone who does business outside of their own borders. It is not appropriate at this point to say that the global crisis is finished, but we could say that stage I of the global crisis is complete, and now we are at that stage where policies make all the difference. Now things will be policy-driven for better or for worse.

And this is the juncture that we suggested five years ago would represent the danger zone for international geopolitical or geo-economic conflict. You have domestic policy priorities, which often ruffle the feathers of trade partners, leading to reactions and potentially, a breakdown in international cooperation. Globalization is pressured as you have these domestic politicians fighting for power retention, and they essentially take off the gloves.

Partisan politics becomes more aggressive, finger-pointing, scapegoating, which can take domestic concerns into the international sphere very quickly, not that that is some sort of a deterministic outcome, that we will end up in some sort of international conflict.

Kevin: No, but this is a historic repetition. This is something that happens over and over.

David: Well, when we do see repetition, it is not exactly the same, but it is very similar, because the nature of man is more or less constant, and thus, is to some degree, predictable.

Kevin: Actually, one of the ways that international cooperation breaks down also is in the form of currency wars. We have talked about it before. If one country is devaluing its currency, another country is going to devalue its currency even more, so that they can stay competitive in the market. Japan has been an exception to the rule until now.

David: Right, so those are reflationary or inflationary policies. Japan is going big, or that is, at least, what they are suggesting, and I think they have learned a lot from the Fed. Talking big is the first, and most important, resource to utilize as a central bank. So “developing a communication strategy,” which the Fed has been trying to practice and utilize over the last year or so, in the name of transparency, is really just a way of talking your policy agenda into reality.

Kevin: It is manipulating perception.

David: Creating self-fulfilling prophecies. You have central bankers who know full well that monetary policy is one of the many determinants for asset allocators and investors the world over. So to manipulate the capital markets via suggesting actions or anticipated actions, that has proven more effective, frankly, than the actions themselves. So now you have the bank of Japan with a new head soon to be appointed, which may play that role in Asia. Will currency devaluation be the cure for Japan, or will the cure of one disease be the cause of another, perhaps even more dangerous?

Kevin: Again, David, we are not talking about evil people trying to create evil in the world. They actually think they are trying to do good. The policies that they are putting into effect, they think will work.

David: Yes, bad policies are never enacted because people believe they will fail, or believe they are bad. Inflation, or reflation, as some like to call it, is the policy tool which has increased global central bank balance sheets over the last 3-4 years to roughly 14 trillion dollars in aggregate. That is all the world’s central bank balance sheets combined. Of course, the two largest of those are the ECB, European Central Bank, and the Fed.

This growth in central bank balance sheets was in response to consumer retrenchment. If consumers are not willing to come out of their shells, even with this vote of confidence sustained by the world’s central banks, then central banks can then begin to trickle out some of that liquidity and threaten inflation, which creates an urgency. When you threaten inflation and you create a sense of urgency, consumers want to buy today…

Kevin: Right, because it’s going up tomorrow.

David: Exactly. They are thinking that prices will be higher tomorrow for the same goods and services. So, let’s just hope that those trillions, 14 trillion to be precise, don’t radically re-price real assets and cause the same sort of social and political upheaval which past inflations have caused. As we know, a trickle has been known to become a flood. But again, perhaps this time is different.

Kevin: It reminds me of the book Reinhart and Rogoff wrote by the same title, This Time Is Different.

David: The irony is, we started out by talking about Congress, and the White House, and Mr. Obama, who has appointed Jack Lew to be the new Treasury chief, again, the head of the Department of Debt, and he is every bit the socialist we find in Obama. In a second term, Obama is essentially surrounding himself with the party’s left-wing loyalists, and it promises to be a very interesting four years. The best thing I think we can hope for, or pray for, is gridlock.

But when you look at Jack Lew and the fact that he is coming into the Treasury Department, the Bank of Japan may, in fact, be his best friend there at the Department of Debt. The bank of Japan is discussing, particularly Abe, tearing down the walls of separation between politics and central banks. He is saying, basically, that they will be buying 500 billion dollars worth of U.S. Treasuries.

Some estimates by Wall Street firms put the number as high as 1 trillion dollars in Treasury buying schemes, again, the Japanese stepping in and buying U.S. Treasuries. They already have 1.13 trillion dollars. To double that would be a great benefit to us. Obviously that would take the 10-year Treasury here in the United States to probably 1%, down off of its current 1.83%, and to levels that we have never seen before.

Kevin: This reminds me, going back to the Reagan years, I’m thinking 30 years ago, back in 1983. We were just coming out of a recession and Reagan was looking at another election year. We had had, from George Washington to Jimmy Carter, a buildup of 1 trillion dollars in debt. It took that many years to get there. But in 1983 I remember they sat down and said, “Where are we going to get the money that we need to continue, and get this election done?”

Reagan wanted to continue to work on the Cold War politics that he was trying to work through. The point is, Japan was who we went to. We went from a 1 trillion dollar debt to a 3 trillion dollar debt in just a matter of a couple of years based on this cooperation with Japan. And this goes back to what we were saying earlier. We have raised the debt ceiling so many times, 107 times. This would only be the 108th time. Who is fretting about one move higher when we have done this over and over, and over and over, and over and over, and over again.

Kevin: Well, I will tell you, though, Dave, there are some people who are starting to see the handwriting on the wall, because Bundesbank is repatriating their gold. We have China buying a whole lot of gold that they are not telling us about. Guys are starting to say, “You know what? You can’t do this forever with the dollar.”

David: And all that is to say that the fuse is lit, and that is why we titled this year’s DVD The Fuse Is Lit. Ultimately, it is not a fuse that is tied to an incendiary device in Europe, or in China, but in fact, to the U.S. dollar and debt markets. The long-term concern is focused on those two issues, the U.S. dollar and debt markets.

Kevin: How desperate are we, really, when we are talking about a trillion-dollar platinum coin? Now Dave, we sell coins, right? We have clients who have owned them for years. A trillion-dollar platinum coin – that just sounded like a devisive scheme.

David: What you are talking about, and this is a good reason why folks around the world are losing confidence in the U.S. political class. When you suggest taking a $1695 coin and calling it a trillion-dollar coin, a 1-ounce platinum coin, and calling it a trillion-dollar coin, and making that available for payments of your debt, no wonder Germany wants control of its physical gold assets! The Bundesbank is talking about repatriating gold in the face of the insanity that they see here in the United States. This is the circus-like behavior here in the U.S. which has created, not confidence, but actually, quite the opposite.

Kevin: David, they are not bringing back a little bit of gold. We aren’t talking about 1000 ounces, 5000 ounces. We are talking tons.

David: Yes, and they may leave some here, but the suggestion is that they may take most of their 45% allocation. They have close to 3400 tons. 45%, or close to it, would be right around 1500 tons, moved to Frankfurt from the New York Fed. They are also emphatic about bringing back the 370 tons which they have sitting at the Bank of France. Again, they are bringing that back to Germany.

We have Hollande’s government, that is, Francois Hollande’s government in Paris, which appears to be on an equal footing with Monsieur Obama. This is a really interesting turn of events. Germany, as recently as November, reiterated their comfort level with maintaining gold reserves with the Fed in the United States. What has changed since the election? We ask the question. Did the election change something?

Kevin: Somebody must have smelled a rat.

David: Well, that’s right. What do central bankers need as a motivator in order to make a shift such as this when the metals have been there in varying quantities since the 1950s? Consider this. Is it the full faith, or is it the credit, of the United States, which is quickly coming into question?

Kevin: David, there is a lack of credibility in our government when they try to come up with the craziness of a trillion-dollar platinum coin, but we also still have relatively free markets. People can go out and buy stock if they want to buy stock, and the stock market has been holding up so far. What are your thoughts about the voting of the public with their money?

David: About six months ago Allen Newman joined us on the program. He does a lot of technical analysis, looks at statistics, and his assumption is that we are moving toward at least a 1000-point drop in the Dow, a decline predicated on bear funds. These are funds that bet short on the market, being the lowest they have been in a decade, and investor sentiment approaching levels that preceded the last 7-10% decline going back to September of last year, so there is that issue of over-confidence.

You have the VIX, which is the volatility index, at record lows, and you have a number of things in the chart which are very concerning as far as we are concerned here in the early part of earnings season. The Wells Fargo numbers tell us a story which we will get to in just a minute.

Alcoa, while they have met their number of 6 cents, gave us no real forward guidance that was positive. They are expecting to see a little bit of growth in China, which was the positive note, but in fact, if you compare where their sales, where their revenues, are today versus where they were four years ago, it is still an ugly picture.

There is a little bit of an improvement, but again, they didn’t beat expectations, and that tends to set the tone for the entire earnings season. If they beat expectations, there is an upbeat tone throughout the earnings season. If they completely miss, it is a negative tone. And all we got was neutral.

What makes Wells Fargo so interesting is that they are being squeezed and the financials are being squeezed. I think this is very, very important, because as go the financials, so goes the market. Your net interest margin, that gap between what a bank borrows at, and lends at, again, they captured the margin in between. That’s at its lowest level in 50 years.

So again, you have the financials which are being squeezed and pressured, and this is in spite of the regulatory changes which we talked about, relating to Basel-III, here in the United States, because the Fed policy has flattened the yield curve.

Kevin: David, mortgage rates are just as low as they have ever been, and there has been a refinancing boom because of the yield curve being low. You have people who are the losers, who are not earning interest on their money – that’s the saver, the retired saver. But you also have the person who still owes on a mortgage who has refinanced, maybe two or three times. Does that seem to be waning at this point?

David: It does seem to be waning, and we may see a continual fade in terms of that refinance boom. We have a couple of things. When you look at the financials, not particularly healthy. We have retail sales figures which are coming in as expected, low, and showing that discounting was what was driving volumes through the holiday season. So less than spectacular retail sales, a refinance boom that is fading, Wells Fargo numbers which are lackluster because their net interest margin is shrinking and is now at 50-year lows, and Alcoa, which is just flat.

This is an environment where you need to be blowing out numbers to bring enthusiasm back to the street, and there is no enthusiasm because they aren’t blowing out numbers. By blowing out numbers, I mean beating expectations. We’re not doing that, which means, really, we are in a very fragile and frail situation.

Anything can cause a slippage in price in the Dow, and it may be what we started talking about today, which is this reflection on failed leadership and the debt ceiling. The debt ceiling may be that precipitating event, but you should know, it is not because of the debt ceiling. There is an entire background that is not supportive to higher equity prices.

Kevin: And David, as we talk about the stock market possibly losing 1000 points, as we talk about the bond market not really being a place to be long-term because interest rates can only do one thing at some point, and that is to rise. Gold: We have talked over and over about the consolidations in the gold market and the new highs that are hit after the consolidation. Over the last ten years, this is the 4th consolidation. The consolidations tend to be about 12 to 17 months long. We are right now entering, I believe, month 16 of the consolidation since the last high in August of 2011. What are your thoughts on gold as we near the end of this consolidation?

David: Just as sentiment in the stock market is incredibly bullish, so sentiment in the gold market is incredibly bearish. It’s not that gold bulls have turned around and said, “Okay, the world is a happier and better place, and therefore I should go put my assets to work for me in more productive places.” In fact, they don’t feel that way at all. But because of the length of time this consolidation has taken, they are feeling rather boorish, or rather discouraged.

What they should realize is that after every period of consolidation in the last 12 years, we have seen a minimum of 50% improvement in price – a minimum – with the largest gains being the most recent run higher of probably 90%. So, these periods of consolidation do occur, and following those periods of consolidation, you have major moves higher. We think we will see a challenge at $1800. We think we will see a challenge at $2000. But it is almost without question that we pass the $2000 barrier in the year 2013.

There will be a pretty big fight at the $2000 mark, being a round number, but I think you will begin to see a recalibration of people’s expectations, and really, of investors’ imaginations of where gold can go, breaking through that round number. When we get through $2000 it wouldn’t surprise us to see $2300 or $2400 in very short order, again, as investors flock to what seems to be a successful momentum trade.

At that point, we think the price will drop back to $2000, not on a permanent basis, but again, the same kind of consolidation we have just seen, we will see another period of consolidation. But I don’t think you will ever get the chance to buy at these prices again. I think, really, we are at the end of a consolidation. You have seen $1500, you have seen $1600, we are getting ready to break the $1700 barrier, on our way to $1800. The consolidation, in terms of time frame, is done. Now the question is the technical support, and is there something fundamental that drives more buyers and the price higher from this point forward.

Kevin: So for those who are still waiting to move dollars into gold…

David: Get off the dime, get off the fence, you’ve waited too long, don’t wait a day longer.