The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, before we go to our guest today, let’s just give our listeners a little bit a background on Bert Dohmen.
David: Kevin, Bert Dohmen and my dad are good friends and have known each other for decades. We have been in the financial business for four decades, ourselves, and Dohmen goes back to the 1960s and 1970s, as well. We have read his reports, The Wellington Letter, for years, and have gleaned a lot of things in terms of technical analysis, from his reports. We do encourage our listeners to look at The Wellington Letter at their first opportunity.
Kevin: One of the ways that your dad and Bert Dohmen are very similar is that they just put what they think in writing. They put it out there. They say, “This is what I think is going to happen,” and they live with the results. But what is interesting, both with Don McAlvany, who for four decades has been writing a newsletter, and Bert Dohmen, who has been writing just about as long, is that you can go back and check their work, and in fact, there are ways to do that. They currently publish these things.
David: I think, Kevin, looking at his Prelude to Meltdown, a book that he wrote in 2007, and most recently, Financial Apocalypse, it is an interesting retrospective on what has happened that has led us to this point. The sense we get in his most recent book is that we actually have the second and bigger shoe yet to drop, and it is imminent.
We will discuss some of those things with Bert today. It is with great fondness that we have these conversations, because usually in between the times that we have him on the program, I will get to share a great meal with him, whether it is in the Bahamas, or California, or Las Vegas, or someplace on the planet, our families get to interact and compare notes, both personally and professionally, and that is a great joy.
Kevin: David, I have been fortunate enough to actually be part of a couple of those meals, and they are always enjoyable because we get to hear about the grand scheme of world economics and politics, and then it comes right back down to very personal issues.
David: Without further ado… We have the current Treasury and Fed regimes having adopted a decidedly Keynesian view of the crisis, and its solution. They have attempted to prop up aggregate demand through deficit spending, through cheap capital, through ample liquidity, between 1 and 1.65 trillion of the new debts which are now being added to old each year – that is the deficit spending – and we are treating issues today if there is not a structural part to them at all.
That is what they seem to be missing, that what we have in play are major structural issues. Additional debts are being used to solve a debt problem, which is kind of a gross irony, and Fed measures have not yet been exhausted. In that regard, we look at the creativity which will be used, the creativity which will be exemplified in the months and years ahead, as we have new degrees of market pressure and we look at the Fed and Treasury scramble to try to keep things together.
What might we expect? That is the question we want to discuss with Bert Dohmen today. What might we expect from the Fed and Treasury? As the fight, both to preserve the dollar system, along with the modern system of Ponzi finance, begins to intensify. What does it look like when the gloves come off? Do we see market manipulations? Do we see a change in trading rules? Do we see mandated investment choices, something like we are watching right now in real-time in Europe, like the forced rollovers being agreed to in Greece, as we speak? It is not a default, but there is also not a return of capital, either. (laughter) You get to participate, whether you wanted to or not.
Bert, thanks for joining us. We would love to get the big picture, and then home in on some of the specific asset classes which you follow so studiously.
Bert: It is nice to be with you, David. What you just outlined is absolutely terrific, because those are really the very important questions that the world is facing now, and it is interesting, when you listen to most economists and most analysts, you don’t hear these topics being discussed in that way, but this is really the important way to look at it. It is Ponzi finance, as you called it.
David: The battle in Europe, this is what is in play at the moment. We have credit default swaps, which are something of a tidal wave. Will they prevent that tidal wave, and at what cost? Will that cost even be political stability? We have had upset elections in Germany, Italy, Spain, and now over the weekend, Portugal, where the socialists apparently didn’t look out for the people’s interests enough (laughter) and there is a battle in terms of the credit default swap market. That is a symptom of what is happening in the larger credit markets, themselves, credit default swaps being an insurance against default.
Maybe you want to shed some light on what is happening in the credit markets. Looking back at 2006 and 2007, you were predicting an imminent demise in the credit markets and in the equity markets. You have written again, most recently, in your book, Financial Apocalypse: Predicting the “Unpredictable,” that a lot of these things do boil back to major credit issues, whether you are talking about the big picture credit issues of 30-40 years of rampant credit, or the more intense, and frankly, almost on steroids, credit boom of 2003-2007. We haven’t really seen a complete credit unwind. We saw something of that in 2008, but is that just a foreshadowing?
Bert: First let me address what you said about credit default swaps. This is a very important point and I think you are probably the only person I have heard so far even mentioning that topic in connection with Europe. Credit defaults, for your listeners, are a kind of insurance instrument against default of the debt instruments. In this case, with Europe, it would be sovereign debt of Greece, Portugal, etc. You can buy these, and they go up in value when the credit instruments that underlie them become more risky.
Now, what we have, in the case of Greece, because of, basically, rescheduling of debt, and so on, some of these credit default swaps, if not all of them, have reset clauses in them. I haven’t read all of these, they are complicated instruments, but it is very likely that these credit default swaps are going to come into question and people who think, “Well, the debt of Greece was downgraded, therefore I have made a lot of money on my CDSs,” but they may not be able to collect because of some of the clauses, or it may be deemed to be a total default, for the purpose of these CDSs.
This is going to be a big legal battle in the courts, in my opinion, and it is going to be in the courts for some time. In the end, it really destroys the confidence that people have in the financial system. How much confidence can you have, when suddenly, things that you thought had value, don’t have any value? It is very similar to when Chrysler was taken over by the government. The lenders to Chrysler thought that they had priority one position amongst the creditors, but no, they were put way down the list by Washington, even below the demands of the union.
So we are seeing, really, a destruction of confidence in the financial system, and you can tell that the retail customer, the retail investor, is gone. When you take a look at the charts of mutual fund in-flows, they hit the peak in the year 2000. Since 2000, less and less money has been going into mutual funds. That was the real long-term top in the markets. The actual retail investor is fleeing the markets, he has no more confidence in the markets, and I think that is very, very important.
What we have now is a situation where 70-80% of the daily volume in the U.S. stock market is just these high-frequency trading programs, and their positions are measured in seconds or minutes, not in days, weeks, or years. In fact, they put in bids and asks at lightning speed – 10,000, 20,000 prices in a second’s time – and they are canceled in less than a second. In fact, the SEC is considering a rule, which means that these high-frequency operations would have to leave their bid, or their ask, in the market for a minimum of one second. Can you believe that?
David: The high-frequency trading, black box trading, whatever you would like to call it – it is interesting that it really has covered over the fact that the New York stock exchange, the MX, NASDAQ, has become a ghost town. As you say, there are no retail investors to speak of. They have been replaced by computer trading models. You have mentioned on a couple of occasions, and you reiterate this in your book Financial Apocalypse, that for long-term investing, you have said that you cannot return to a broad value investing thesis where a buy and hold strategy works, until about 2017. I would like to discuss the course we are likely to be on between now and then. Coming back to that, 2017, what has to take place to sort of clean up this town?
Bert: Yes, in my book, Prelude to Meltdown, which was written in late 2007, I said that we were going to go into something similar to 1929, or maybe worse, and the first chance of a sustainable bottom, the first chance, is 2017, and that is just going by cycles. After a major credit bubble burst, it usually takes 17 years to get the system back to basics. But I think when you consider what is happening right now in Washington, I think the actual bottom will take much longer to form. Everything that can be done wrong, is being done, in Washington, and I don’t see any chance of that major trend to reverse to the more positive side.
David: I mentioned earlier that we could see the gloves come off, with D.C. treating New York as the scapegoat for many of the misdirected policies that they, actually, have put in play. We did see a change of rules, as you mentioned, right in the middle of the Chrysler unwind, wherein creditors got the short end of the stick. I am reminded of what governments can do when put under extreme duress. It is not something we have seen since perhaps the 1990s, with any great frequency. But capital controls – used to prevent hot money from entering and abruptly leaving a market, or to prevent flight capital in the event of a banking or currency crisis. Sage advice, if you will? What are the probabilities, and are there other, more reasonable means of the government taking the gloves off, so to say?
Bert: The thing right now is, people have to really consider that the impossible is possible. I was just at a hedge fund conference a few weeks ago. Over 1700 hedge fund guys were there. On the panel was Senator Chris Dodd, and he said that, in 2008, during the crisis, the country was within ten minutes of the government shutting down the banking system. Within ten minutes. I thought that was an incredible statement. These idiots that caused the crisis were ready to shut down and create a real global crisis, by shutting down the banking system. What use would that have been? They would have really compounded their original stupidity by not having recognized what I, and other people, did recognize, one year ahead of time, namely, that we were heading into a major financial crisis.
So, with that kind of thinking, where they would just shut down the entire banking system, good banks and bad banks alike, it means that there is absolutely no limit to what they will do, and that is what I warn people in the futures markets about. They can close down the futures markets in an instant, and they will. My prediction is that sometime over the next five years, they will close down the futures market. Especially people who are invested in gold futures and silver futures, metals futures, they should be aware of this.
This happened one other time, but it wasn’t done by the government, it was done by the exchange, itself. Do you remember Bunker Hunt, the Hunt brother that tried to corner the silver market in 1980? The exchange just said, “Okay, effective tomorrow morning, no new buying will be allowed, only selling will be allowed. If anybody would have said that they would do that one week ahead of that, they would have probably put him away because they would have thought him insane. But the exchange did it, and the exchange got away with it, and of course, that is when silver really plunged. So anything is possible right now. There is absolutely nothing in Washington that is no longer possible. As investors, I think we have to take that into consideration.
David: It is interesting that such a small amount of actual silver is traded through Chicago, roughly 5% of the silver market, and yet a change in rules there has major ripple effects. We saw the margin increases five times sequentially just a month or so ago, causing a precipitous fall. Arguably, silver was well ahead of itself at nearly $50 an ounce, but here you have, really, a two-bit player, a minority player, if you will, controlling 5% of the market, and yet, they do have a very loud voice.
It was interesting, we spoke with some folks that work directly with the exchange, and the deliveries of physical metals are coming from CTAs and hedge funds in numbers for 2010 and early 2011 that have not been seen, ever. CTAs and hedge funds typically like the liquidity of futures contracts, and I think they are realizing what you just said, Bert, which is, you don’t want to play a game where the rules can be changed right in the middle of play. So, yes, I think they are wising up to the fact that somewhere between D.C. and NYMEX/COMEX, there is a set of rules that they are not privy to, and maybe they should just play in the physical market.
Bert: I think the precious metals story is far from being over and you have to have physical, and you have to have it in a safe place. That is the only good long-term investment for the average person that I would consider, really. I cannot think of anything else.
That was the point about Japan, about low interest rates, and then high inflation, a loss of confidence in the currency. Take a look at Japan. For 20 years they have been grinding down, and the economy goes from maybe 2% growth to 2% negative, then 2% growth again – just bouncing around the zero level. They have the highest debt level in the world. I think it is about twice as bad as the United States. Interest rates are very, very low. They are near zero, because the government is keeping them there.
So you have a situation there where the government has been pumping so much artificial money into the system to pay the bills, and yet the interest rates are staying low. Granted, they financed a lot of their debt with internal savings, which we don’t have. So, eventually, the people who are financing our debt, namely foreigners, are going to get tired of this, and they are probably going to withdraw some of their financing and that will make our interest rates rise. There are so many complications in this thing, I don’t know if even a super-computer could figure it out.
David: About interest rate suppression, it is something that can be done, as you point out with Japan, for many, many years, even multiple decades. Is the circumstance different for us? Certainly, it is changing in Japan because the demographic is changing. They are running out of a saving class as people are dying off. So, the demographic end game is on the horizon for them, and being able to finance it internally, that’s a game over. For us, it is on the kindness of strangers, 47% held in foreign hands, and with an appetite that is waning. Recent TIC flows were showing five months in a row of declining interest by foreign central banks and treasuries, at this point, not to a very large degree – we are talking about 40 million dollars, no big shakes in a multi-trillion dollar market.
Bert: But the Federal Reserve will buy whatever is not bought by anyone else, so is there a limit to how much it can buy? What if they have to buy 100% of what the Treasury offers? Will that affect our interest rates?
David: They will just have to quit publishing the balance sheet numbers.
Bert: (laughter) Yes, but people don’t seem to care. They have a balance sheet now to what – three trillion dollars? And what really amazes me, they have bought everything except the kitchen sink, and I remember when it was always said that the Federal Reserve is not allowed to buy anything except triple-A rated debt. Whatever happened to that?
David: Yes, universal market backstop. A couple of questions for you: We had, in 2008, an unwind of debt. We had, in 2008, a reflation effort. There wasn’t enough reflation to keep there from being an unwind in the equities market and the bond market and virtually every market. We saw correlations go to 1, in virtually all markets.
It will be interesting to see, and we are interested in your opinion: What about this time? They had some disclosure and transparency, which was allowed in the initial stages, 2007, coming into 2008, and then, of course, the FASB rescinded certain disclosure and categorization requirements, and rather than a crisis and collapse in the debt markets today, couldn’t we see the same sorts of games played as in Europe? Combine austerity with nondisclosure, hide things off balance sheet, (laughter) as Goldman-Sachs did with great wizardry for Greece, but where we somehow keep the inevitable from happening, and an unwind in debts just through sort of chicanery and deceit in the marketplace.
Bert: Yes, exactly, and it is happening right now, with Greece. Greece is, basically, in default. But they can’t let it officially be a default, because the big European banks, and primarily the big German banks, are on the hook. They are loaded up to the gills with this kind of debt. In fact, it is estimated that the European banks hold about 1 trillion dollars worth of the sovereign debt, and who knows what it is worth – maybe 50 cents on the dollar. If they would have to write that off, they would all be in violation of their capital requirements. And these banks would never be able to raise that kind of money. If you take a trillion dollars’ worth of debt, you take a 50% haircut of that at 500 billion dollars – there is no way that these banks can raise 500 billion dollars in the capital markets today. This is the problem.
So, when Germany, and France, and these countries give more aid to Greece, it is not because they want to be nice to Greece. No, they want to save their own banking system. That’s how bad it is. And the U.S. banking system is still so loaded up with unrecognized losses on their holdings of mortgage-connected debt, it is incredible. Bank of America alone has said that it is over 200 billion dollars. Well, if that is what they say, you can maybe increase that by 50-100% for what the real number is. This is why our financial sector, or the banking stocks, are acting so very poorly, because this kind of stuff is starting to surface, and the smart, knowledgeable investment pools are getting out of the banking stocks, at the same time that they are telling the public, “Oh, these are great bargains. Look how cheap they are.” Yes, well, they are cheap for a reason.
David: Bert, when you watch Angela Merkel basically commit political suicide, approving a second bailout for Greece, with the ramifications of the first bailout having still to be fully felt, she has watched her party lose state election after state election after state election, and yet she still votes for it. You are right. How bad is it? That question gets to be answered in Merkel’s actions, to say, basically, “I don’t have a political future, by maybe I can save the banking system.” That’s what I’m reading, perhaps, between the lines, but isn’t that what is being communicated?
Bert: Yes, exactly. But there is one big problem, David, that very few people are talking about, and I think this is where the next tsunami in the financial world will come from, and that is China. China, in my opinion, right now, has, on an inflation-adjusted basis, almost no growth. I know that seems like an outlandish statement, but they are advertising about 9% GDP growth. If you consider that their actual rate of inflation is not the 5.4% that they advertise, but that it is probably closer to 10-15%, then basically, the adjusted, real GDP is barely above zero right now.
David: Well, you are preaching to the choir here. (laughter)
Bert: And we have the same distortion in the U.S. If you adjust our nominal GDP for the actual rate of inflation, not the 2.7% inflation that they said we had last year, then actually, our economy, right now, this very moment, as we speak, is already contracting. We are in a recession right now, and the economists don’t tell us that. They don’t you that on financial TV. We are already in a recession. Whether it is the same recession that we had before, whether we ever came out of it – that is a different debate. But right now our economy is contracting.
David: Yes, you are exactly right. The economists of our day are forgetting that to be speaking of a return to a double-dip ignores the fact that we are on life support, as it is, with government deficit spending on the one hand, and as you just pointed out, GDP being measured with an inaccurate deflator, an inaccurate inflation gauge, to where it is utterly overstated, we are in negative territory.
Let’s look at something you love. You eat, sleep, drink, and live technical analysis. In terms of the big picture and the primary trends, just in brief, let’s look at the equity markets, emerging markets versus developed markets – bonds, precious metals, and maybe start with the equity markets. They appear to be putting in a top, but does this correspond to a short-term correction, or does it relate to a major downtrend in equities?
Bert: Until about a month ago, 99% of all economists said, “Oh, it’s strong, there is no chance of renewed recession.” Now they are starting to change their tune, very much like in 2007-2008. Now they are starting to talk about a soft patch. “Oh, wonderful, isn’t that nice? Just a little soft patch.” And the economists from Wall Street have already reduced their GDP growth estimate for this year by 50%. Suddenly, they came out and they reduced their estimate by 50%. That’s a heck of a big adjustment, 50%.
What they haven’t done yet is reduce their profit forecast for corporations by an equivalent amount. Doesn’t it stand to reason that if the economy is growing half as fast, maybe profits are going to come down from their euphoric forecast level? So that is the next adjustment process, when finally Wall Street is nicely short all the stocks that the people like, and then Wall Street starts with their downgrades. Then the average investor loses a lot of money because he is still long, and Wall Street makes a lot of money because they are nicely short. That’s how the game is played. The game is not there for the average investor, but if you can figure out what the game is, you can make money alongside them. All you have to do is turn off your TV.
David: That’s a good call.
Bert: But in regard to whether this is short-term or long-term, I see major tops right now, in all of what I call the overcrowded trades. The overcrowded trades are what everyone loved over the last 6 months or 12 months, which is commodities. It is oil, it is the stock market, it is being short the dollar. I think the dollar is going to have a very nice ride over the next 6 months, and who knows, maybe even longer.
This is what our technicals do. We have broken major trend lines. In the stock market, all you have to do is look at the NASDAQ composite. The NASDAQ composite is still down substantially at about 2700, it is still down substantially from the 5000 high in the year 2000, but it got back to exactly the 2007 bull market peak. There is a rule in technical analysis that, as you know, the further back the prior top is, the heavier the resistance is, because there is a lot of pent-up selling at that level. We are there now, so in my opinion, there is no way that the NASDAQ is going to go through that and make a higher high. But chances are very high it is going to have a substantial down-move from here.
So, a lot of technical rules come into play, and because most hedge funds don’t use technical analysis because they don’t understand it. It is not a crowded trade to be short, and I love trades that are not crowded, where you are the only one, where people start laughing at you for even having the trade. Those are the trades that usually make you a lot of money, and you have to be so careful. I think your customers are really very lucky to have you, because you really know this stuff, and you know technical analysis.
David: Bert, the Saudi oil minister has certainly confirmed that he thinks oil belongs closer to 80, and 100 is overdone, and you are right, there is a lot of vulnerability in a number of commodities. A rise in the dollar would take a lot of people by surprise, and I think that’s what Mister Market likes to do with great frequency.
Bert: We have been saying that for a long time now, that the oil price has been manipulated and now there have actually been charges filed against the controlling share-holder, an individual from Europe, of a major tanker company, Frontline. They, and some other traders, have allegedly been manipulating the price between futures and spot. The charges, which I think have been filed by the SEC, outline exactly how it was done. It is very, very interesting. They have all this oil stored in these tankers, and the tankers are at anchor, loaded up with oil. There is no oil shortage.
David: This is an interesting thing, and maybe we can get to it if we have time today, but you mentioned this manipulation in the commodities price. Just this week we have a UN report which says this specifically: “Prices can move far from levels justified by the fundamentals for extended periods, leading to an increased risk of price bubbles. Due to these distortions, commodity prices do not always provide correct signals about the relative scarcity of commodities.” What the UN is suggesting is that the government intervene and basically control the prices of critical commodities. Is there a historical precedent in which price controls within the commodities space, or price controls (laughter) on any asset class, by a governmental authority, actually worked?
Bert: (laughter). Well, I think, David, you know the answer. I don’t know, I’m not an expert on the history, but I have never heard of one, read about one, or seen one example, where price controls by government have worked. But what you can do is reduce the speculative influence. I used to trade futures markets quite heavily in my younger days, and we had position limits. You couldn’t hold more than “x” number of contracts for a specific commodity. This prevented large trading operations from controlling the price of a commodity. That is one way to handle it.
How do you handle over-speculation in the stock market? It is not by preventing people from selling short. No, you do it by raising the margin requirement. That’s what Greenspan should have done in 2006 and 2007. Instead of 50% margin, he should have set an 80% margin, or 100% margin, which is what the Federal Reserve used to do 30 years ago. When I first started trading, they would move those margin requirements up and down, depending on the amount of speculation in the market, and it really worked. It cooled things down. The speculators had to put up 80% or 100% of the value of the stock. It reduced the speculation, and it also made the system much stronger.
What we saw in 2007 and 2008 was, really, a margin liquidation crisis. That’s what it was. That was the first part of the financial crisis. Then we had the typical rebound, the bear market rally over the last two years, and now we are going into the really painful part. The margin call crisis didn’t affect the average person as much, although they lost 40-50% of their portfolio. The next part is the slow, grinding down process, where just nothing goes up. Everything just continues to grind down. People don’t have any reserves anymore, don’t have any savings anymore, and so in the end, people are losing their jobs, they are losing their houses, and they get more and more government in their lives, and we get more efforts of government to control small business, which means small businesses don’t hire.
Right now I have run into so many small business people who say, “Hire anybody? My business is doing okay, yes, I could use a couple of people, but no way. Under current regulations, who needs the paperwork headaches?” This is what happens when government gets too intrusive. People say, “I don’t need the headache, so I’m not going to hire.” When you don’t have job creation, you have an economy that contracts.
David: On a second issue, emerging markets versus developed markets, it has become very popular to argue for the replacement of the Western European and American consumer, and in their place, the indigenous peoples of India, of China, of Brazil, of Russia, wherein they are becoming this new class of consumers, with savings and resources, and the largesse of the years where we were running deficits and they were running trade surpluses. Now they get to turn that internal. Can we regard the emerging markets as the growth play they are described as, or should we view them as, really, higher beta investments that have better returns on the way up, and actually, (laughter) are far worse on the downside? In 2008, 30% here in the U.S. was 60-90% anywhere else in the world.
Bert: Exactly, and that is when you know it’s a top, when everyone is in the emerging market. It has happened every time over probably the last 20 years. I can remember so many cases when people were starting to be careful about the U.S. market, and then they said, “No, no, but the emerging markets are so good. Look at all of these people, and they have so much to make up for, and they are starting to buy motorcycles, and they are starting to buy cars,” and you have all these beautiful stories. And then suddenly, as in Thailand in the late 1990s, suddenly the market is down 90%. 90%! In spite of all these beautiful bullish stories. We have to recognize that the speculation in the emerging markets has been much greater, especially over the last two years, than in the U.S. markets. These markets have gotten so expensive, and there is so much financial fraud. Take a look at the Chinese stock market, take a look at the Russian stock market, take a look at India, etc. All of that stuff is going to hit the fan. Warren Buffet said one time, “When the tide goes out, you can see who has been swimming naked.” And we are going to see a lot of companies that have been swimming naked over the past two years. And it is going to hit the fan. And those markets are going to go down twice as much as the U.S.
David: When it comes to bonds, I assume that if you are looking for a dollar rally and a move out of equities or a major turn in the equities market, we may see pretty decent rotation into bonds. The 30-year, if you look at the yield, its low in 2008/2009 was about 2.65. We have seen higher lows, sequentially, since then, 2.65 being the low, 3.5% since then, and we are currently at about 4%. Can we get to 3.75? Can we get back to the old lows of 2.65? It seems that, to some degree, investors have to voluntarily accept negative real rates to be moving into treasuries. We have talked about the almost fraudulent Bureau of Labor statistics and BEA numbers coming out with both GDP and inflation. If an investor class starts factoring in inflation, how do you accept a 3½% yield, knowing that you are losing 7%, in terms of a real rate?
Bert: David, once again, that is a very important topic. What has been the crowded trade on the bond side? It is being short, or out of, U.S. Treasury bonds, over at least the past 3-4 months. It has gotten to be a very crowded trade – over-believed. We gave a buy signal on bonds a couple of months ago and said, “U.S. T-bonds are going to be the safe haven investment again.” I believe the yields on the U.S. Treasuries will go back down to the lows that we saw in late 2008. In fact, if you take a look at the shorter term, like the 6-month T-bill, right now it has a yield of just slightly above zero. Can you imagine that hundreds of billions of dollars are going into these 6-month T-bills at virtually no yield? You have to ask yourself, “Why? Why is all this money – it can’t be stupid money, it can’t be money from people who don’t know what they are doing, this has to be very informed money – so why are they willing to park their money in T-bills earning them almost no interest?
There is only one answer to that, in my opinion, and that is, safety. There is no other place you can put your money for safety. You can’t put that much money into a safe deposit box. This shows you that there is something very serious ahead. The U.S. dollar is going to have a good up-move this year. Why would it, when everybody is talking about the U.S. eventually defaulting on its debt, which will never happen, but everybody talks about it? Moody’s, the rating agency, has talked about potentially downgrading U.S. debt, but the dollar is going up. So when you see these kinds of moves, there is only one answer, and that is: safe haven. It is a safe haven for big money. That is really a warning signal.
This is just like 2008. I remember in January of 2008, when people were still denying that there would be a recession, although we were already in a recession at that time. I said, in The Wellington Letter, “We are going to see the yield on short-term T-bills go below zero,” which means that if you buy a T-bill you actually have to pay money, and people thought that was crazy. Well, it happened. In October of 2008, it happened. T-bill yields went below zero. And why was it? Because it was a safe haven, and it is going to happen again.
David: The one quandary I have with the bond thesis is that, looking at our balance sheet, and looking at the Greek balance sheet, they are virtually identical. We are a bankrupt institution as a country, as is the Greek system. The difference is, we have world reserve currency status, so we have quite a bit of privilege to abuse, and as you say, default is not necessarily going to be a part of our vocabulary, as long as we can print, and pay back with cheaper dollars. The quandary is, how do investors, on a voluntary basis, even with the priority of liquidity, look at a balance sheet which, since 2008, has gotten even worse than it was then, and look at that as a safe haven? Is it just a relative comparison?
Bert: It is relative to everyone else out there.
David: (laughter) So, an absolute loser becomes the relative winner?
David: That tells you just how frail the whole world system is, when your absolute winner is not even something that we are calling into question. You can’t look for that, because it doesn’t exist anymore.
Bert: That’s exactly right. Europe is in much more dire shape, and I think Asia will be, as well. The U.S., once again, interestingly, will become a safe haven, in spite of all of the problems that we have over here.
David: Something that you have looked at on a number of occasions, and I think you have been more positive on the precious metals than I have, as to the duration of the present bull market. I guess while I have assumed that 2015-2017 would mark the final blow-off in prices, you have suggested in times past that it could be a 25-30 year bull market, which would imply a continued bull run, not finally exhausting itself until about 2025 or 2030, which actually is an interesting overlap with one of our past guests, Neil Howe, who wrote the book The Fourth Turning, with his idea of there being a final political and cultural capitulation inside the same decade, sometime between 2020 and 2025. Put that in perspective for us. While you do, is there something in the mix that will surprise those interested in gold and silver? How do we get to 2025 or 2030 in terms of an enduring bull market?
Bert: It is going to be a very, very volatile ride. I advise everyone to read a book on the German hyperinflation, many years ago, in the early 1900s, about how inflation just bounced around between deflation and hyperinflation, and back down again, and back up again. It was so volatile, you couldn’t just take a position and hold it, unless you paid absolutely no attention to the markets, just put your money in gold and said, “Okay, I’m not even going to look at it,” and then, of course, you would have really made out. But if you were trying to trade those moves, you would have ended up bankrupt. They were just too volatile.
We are going to go through various stages here. The next phase is going to be a stronger dollar, a rush to safety, and fears of another financial crisis, especially something starting in China, and then enveloping the whole world. That means that the precious metals are going to be in trouble during that time period. We saw it in 2008 when these big, over-leveraged trading institutions, especially hedge funds, have to sell, they will sell anything that is liquid, to meet margin calls. Some of these hedge funds are still working with 10-to-1 leverage, which is insane in this type of environment. So they will sell gold, not because they don’t think gold has intrinsic value, but they will sell it just to get cash so that they can meet their margin call. So that is the next phase, in my opinion. That is going to be very tough for the long-term holders of gold, but if you have physical, you don’t look at the markets, and you can say, “Okay, fine, I’m willing to ride it out, even if it goes down 50%.”
That’s a decision you have to make for yourself right now. After that, you have to look at what the response will be. The response of the central banks of the world will be just to step on the accelerator as hard as they can, print as much money as they can. Trillions and trillions of dollars of computer money are going to be fabricated in order to stop the deflation, in order to stop the crashes. That, then, will give you the next bull market, and we saw this coming out of 2008. We saw this big bull market in gold and silver continuing.
In 1981 we had done a study on the long-term cycles in gold, and we concluded at that point, when gold broke down through $694 to the downside, we said, “That’s it, it’s going to be a long-term bear market, and gold will go down for the next 20 years,” according to the cycles. Lo and behold, it was exactly 20 years. The bottom was in 2001. Most of the time cycles are not that accurate. This one was.
But we also said in 1981 that that would be followed by a 30-year bull market in gold, and we had no explanation of what would cause a 30-year bull market in gold. Now we know. It is the central banks responding the way I said to the next financial crisis by fabricating trillions and trillions of new artificial money, then you have the case for all of the money in the world. Everyone will look around and say, “Gotta buy gold.” In China, the government is encouraging Chinese people to buy gold. They know how important it is going to be over the long-term, for China to be a big holder of gold, whether it is the Chinese government, or the Chinese people. So, it is going to be a very volatile ride.
David: We have combined the short-term and long-term into our conversation, the big picture moves, and some of the vicissitudes in between. Getting from point A to point B, there are some things that do happen, and we can expect them to. Your book Financial Apocalypse – when I look at the word apocalypse, it is a word used either by extreme people, or in extreme circumstances. We know you are not the former, but in what ways do we have the latter? A set of circumstances at hand that warrant being described as apocalyptic. Is there no way forward? Or simply, no way forward under the current political, economic, monetary leadership?
It seems, as I have read the book, I think our listeners should look at it. It is a great review of everything that has brought us to this point over the last 2-3 years, and, like the captain of the Titanic, who was ignoring the small chunks of ice on the surface, maybe a different pilot would steer a different course. As it is, it doesn’t look like that is going to be in our political future for some time, or at least a few years. Tell us a little bit about the book, the thesis, and why you think it is just that bad.
Bert: The problem that I foresaw in 2007 was the huge, excessive leverage existing in the system, and by some estimates at that time, it was about 1.2 quadrillion dollars in derivatives outstanding. Quadrillion. That is bigger than a trillion! (laughter) It’s such a fantastic amount of leverage in the system. Granted, many of these derivatives are offset, but when things start tumbling, and you can’t found the counter-party, or the counter-party to your derivative has gone bankrupt, then it becomes very serious.
Interestingly, if you take a look at the charts of credit, during every financial crisis we have had over the last 30-40 years, we have had a downward move the following year or two in the amount of leverage in the system, and the amount of debt in the system. Amazingly, after the 2008 crash we didn’t have it. Leverage and credit just continues to pile up, and continues to pile up in the system. We are doing, right now, the same things on Wall Street that they were doing in 2007. Once again, they are issuing junk bonds, with payment in kind, which, instead of paying you interest, they have the option, when they don’t have the money to pay you the interest, to pay you in kind, meaning with more junk bonds, which are worthless. They have no debt covenants at all in these bonds, so they are just pieces of confetti. And there are people lining up to buy this stuff. So nothing was learned in the last crisis.
And there is something else. Every big financial crisis that I have looked at over the last 80 years, worldwide, we have had a major stock index going down at least 80%. This time we didn’t have it in the U.S., the S&P was down about 50%. So everyone says, and everyone agrees, that this was the worst that we saw since 1929. So, to me, that suggests that the other shoe is about to drop, that we are still going to have another leg down. It will take longer, it won’t be a sudden shock like 2008, but eventually, we will probably end up where one of the major indices will be down 80% from – and here is where it becomes important – the 2007 peak or the year 2000 peak? I think it will probably be the NASDAQ from the year 2000 peak. That shows you that there is quite a bit of danger ahead. But people won’t believe this stuff. In 2007 I wrote, “Real estate prices are going to go back down to their 2001 levels.” People thought that was crazy. Well, we are there in some parts of the country. And other parts of the country are following. So, never think that anything is impossible in this kind of an environment now.
Over the years, I have always been the optimist, at investment conferences. I remember in the late 1970s, many of my colleagues were very negative. They were advising to buy survival food, and all of this stuff. I said, “It’s not going to happen. You are not going to have hyperinflation right now.” And it turned out that was correct. This time around, I am probably the great pessimist.
David: Expect the unexpected. Now there is some truth to that. I think we want to see, and we want to create a world that is easy to live in. Wall Street certainly helps cater to that, with providing ample good news. If it’s not a severe correction, like the free-fall of 2008, maybe the second installment is more like the 1966-1982 bear market, where we just ground sideways, and if you factored in the cost of inflation, you were so upside down it would make your head spin. 1966-1988 was a terrible time to be invested in equities, but in nominal terms you didn’t lose much. In absolute terms, you absolutely got slaughtered.
So, that is where we would encourage our clients and our listeners to continue to think outside the box and price things in relative terms. The equity markets are already down 80%, in gold terms, certainly, and could see the same kinds of lows that we saw even in 1932, an 89% haircut, when all was said and done, leaving 11 cents of previous purchasing power on the table, not a whole lot.
Bert, we look forward to seeing you in Las Vegas in just a few weeks. I am hoping that you have set aside either the evening of the 13th or the 14th and we can again enjoy a meal together and have another conversation.
Bert: That would be fantastic. I am looking forward to Freedom Fest and seeing you again. That is always a great conference. I think this year they are looking for about 2000 people, all paid, so it is a good quality audience, people who very much think alike, that we need smaller government, not bigger government.
David: I think you will find many more of the answers in the free market system than in the statist response to the crisis that we are in currently. It is a great place to compare notes with like-minded people, I agree, and both Bert and I would look forward to seeing you there, if you can clear your calendars for July 14th through the 15th in Las Vegas.
Thank you, Bert, for joining us on the program.
Bert: Thank you, David.