November 1, 2017; Getting Locked In: The Forced Banking System Of The Near Future

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“Folks, that’s the game. All you have to do is beat on the earnings-per-share announcement, and as soon as you have a headline print from Bloomberg, you have trading algorithms which grab the stock and push it up 7-8%. So what you’re really saying is, ‘We can’t get the job done. But you’re too stupid to recognize it. And there is a bunch of patsies who will buy this stock if we can generate a positive headline and get the algorithms trading off the positive headline.’ Isn’t that wild?”

– David McAlvany

Kevin: We just landed last night, Dave, from the Charles Missler Strategic Perspectives Conference. You spoke a couple of time there. I thought it was fascinating – a lot of the people who were there, hundreds of people wanted to just talk about what it would be like to be in a system that is closing in around them. Closure of the system, or creating a captive audience – that’s the next step.

David: Chuck has routinely asked me to come to the conferences for a unique reason, and that is not because I’m in his area of expertise, or many of the other speakers who attend the conference, but because we have an emphasis on economics, current events, and are interested in the interplay between public policy and how that impacts the financial markets. That’s what he wants me to talk about.

Kevin: That’s what you talked about on Friday, but now on Saturday you brought it into the home and said, “How do you finish well? What is the legacy? Because really, is money that important if it ruins your family?”

David: In the final analysis, I think we all care about something more than just dollars and cents. Even though that fits into one category of stewardship, there are many other things that we do steward. And that’s a large part of what I talk about in the book. Only one chapter in the book, The Intentional Legacy, deals with money and hard structures, the things that you would consider when you are thinking about an estate plan or a will, things of that nature, all very important, but the majority of the book is dedicated to the soft structures, the things that allow families to thrive, regardless of the extent of their financial resources.

Kevin: Yes, from God, to family, to what legacy you leave generationally.

David: Yes, but really, the emphasis is on what you are creating in your day-to-day lives, so that family identity and the ways that you live, the choices that you make, day in and day out.

Kevin: Deliberate.

David: Those end up becoming what you leave at the end of your life. And that is why it is not an accident, if you want to leave a great legacy you have to include some degree of intentionality. It was interesting because we went from the macro level to the micro, and to me it is a very appropriate thing to do because quite frankly, when we look at the big problems that we have today at the macro level, none of them, really, are solvable at the macro level.

If you are waiting, if you are holding your breath for the next election cycle and getting the right people in, I think what you have to ignore is the fact that getting the right people in over the last decade – 2, 3, 4, 5, 6 however many decades it is you may have been holding your breath (laughs) – you get the right people in, and what they discover back in the D.C. beltway is that the only way to get anything done is by compromise.

Compromise, basically, means that we do the same thing that we have been doing and pretend that it is a little bit different, a little bit different enough to sort of assuage our guilt for, yes, we could have done a little bit more, but here we have to settle.

Kevin: One of the things we did at the conference was that we just gave everybody a silver dime from before 1964. It was interesting, as you hand someone, especially younger people who don’t remember the pre-1964 dimes – they were 90% silver – you hand that to them and you say, “Do not get this mixed up with the new money, because this dime, even though it looks exactly like the dime that you have in your pocket, this dime is worth 13 of today’s dimes.”

So we had a chance to talk about the devaluation of money and how we have ruined it.

David: Even that fact doesn’t really work for people because it is math, and people don’t think in terms of math.

Kevin: That’s right.

David: If you go to this dime bought you a Snicker’s bar, and this dime still buys you a Snicker’s bar, it is because real money has retained its value through time (laughs) and what we have done to our monetary system in the intervening period has actually – again, it’s only 2-3% per year, and if you look at John Williams’ numbers maybe it is 7-8% per year, which I think is pretty realistic – that is where you get nicked, and nicked, and nicked, and all of a sudden you feel the squeeze. You feel the squeeze of not being able to pay for the things that you used to be able to afford.

Kevin: Think about it, Dave. If we were to go back to the days of Kennedy, Johnson, Nixon, going on up even to the Reagan years, we as a nation could borrow money because we were still that close to when we were on the gold standard. We didn’t have that much debt. In fact, your dad was known for saying, “Hey, listen, it took from George Washington all the way to Jimmy Carter to get to 1 trillion in debt.” Now, it was tripled under Reagan, but that was still just 3 trillion dollars in debt. Dave, are we now ending that cycle? Are we getting to the point where it’s all debt and no equity? And what happens when it is all debt and no equity?

David: The brave new world is a world of all debt and no equity, and the contention is that if we control rates we can do that. And so, you have these curious themes that are developing, and this is really the core content of my first presentation this weekend, is that the financial system is closing.

Kevin: Right. Like Carmen Reinhart said, “We’re going to create a captive audience. You have to be closed into the system.”

David: It’s necessary to close the financial system if you’re moving to an all debt footing, where capital becomes less important than debt within the financial system, and to maintain control of the system you have to maintain control of interest rates. So theoretically, you could drive interest rates negative and create an infinite amount of debt, and not have a cash flow problem. As most people live their lives and manage their household affairs, it is not in light of assets and liabilities, to the balance sheet side of things, it is actually in light of a cash flow statement. How much money do I have, and what can I afford from the standpoint of cash flow? Can I afford that $200 payment? Can I afford that $300 payment? That’s the basis upon which people buy a car. Can I afford the $1500 or $1700 monthly payment on a house? It is not how much debt am I taking on and how long will it take me to pay it off, and in the end, how much will I have paid in debt service? Nobody is thinking in those terms anymore, it’s all about cash flow and what can I afford with my current income? So the government has done the very same thing, saying, “We can control the cash flow side of this equation if we control interest rates.” But to do that, it is by necessity the case that they have to control the financial system, and in essence, close it. That is the financial repression which we have talked about for years now, what the academics call financial repression, running rates at a zero to negative interest rate.

Kevin: What people don’t realize is that the rift between the rich and the poor is increasing dramatically. It is interesting to me, Dave, as you watch the rich, who probably made their wealth on buying something and becoming productive with it, there seems to be a level of wealth, though, where a person goes from capitalist where you buy something and become productive, to a socialist for everybody else. I’m thinking about Soros. I’m thinking about Buffet. I’m thinking about Gates. I’m thinking about these guys who are billions strong, and yet they think, at this point, that the rest of the world needs to be socialized for their own good.

David: And maybe there was a political persuasion going into that, but there is an interesting conversation, and this came up over the weekend, an observation that Silicon Valley elites are truly capitalists. My response was, “Yes, and no.” And I thought of a quote from Investor’s Business Daily, which summed it up well, if I can kind of borrow and cross-apply. They recently said – this is their quote: “Like many hypocritical liberals, Warren Buffet is a capitalist with his own money, and a socialist with yours.”

Kevin: There you go.

David: (laughs) If you’re talking Silicon Valley, that pretty well describes it. The contrast between personal interest and the social good. More than willing to use your capital for the social good, but in terms of personal interest, they are still, at their hearts, capitalists.

Kevin: As a government, we are borrowing a tremendous amount of money. Japan is borrowing a tremendous amount of money. Europe is borrowing a tremendous amount of money. But what we are seeing in China is dwarfing all of those combined. China is looking ahead. Their 50-year plan, their 5-year plan, whatever you want to call it, it looks to me like they are going to plan on just selling the farm.

David: And it’s fascinating because you have different currents. You have Chinese money supply growth, which is at 9.2%, and that sounds big, but it is actually a shrinking number. It was bigger. So that the growth trend, even though it is a large number, is a declining growth trend. What is not declining, what is not shrinking, is Chinese debt. They have added more debt in the first three quarters of this year than the U.S., Japan, and the European Union combined. And that is no small task.

Kevin: Say that again – U.S., Japan, and the EU. That’s pretty much the rest of the world. They’re borrowing faster than the rest of the world.

David: That’s right. And you look at what we added just this last month, nearly 200 billion to our liability side. And that was with a pretty healthy tax take for the month of October. That’s in the U.S. The ingredients for 21st century success is just simply add more debt.

Kevin: More debt.

David: And are you prepared to add more debt? It is interesting, the IMF estimates that credit expansion, far from being curtailed in China, is going to expand to twice the current level by 2022.

Kevin: That’s five years away. That’s less than five years away.

David: And this is from Article IV of their consultations, if you are interested in looking at the country by country diagnostics.

Kevin: Well, they already have 27 trillion bucks in debt now, do they not?

David: That’s right. You have to stop and think about that because if they are currently at 27 trillion, you add another 27 trillion in credit expansion over the next five years, actually, a little less than five years – let the good times roll. At what point does debt become unsustainable? I don’t know if the IMF nails this one or not, because like most economists, the group has a batting average that would make little leaguers look like professionals. They actually get it more wrong than right so I’m not suggesting that the IMF has this down to a science and we will, in fact, see 27 trillion dollars in credit expansion in China. But that is their estimate. And you have to, as a market practitioner, wonder what it looks like, because at the same time they add 27 trillion for the Chinese, they add in 18 for ours when you look at our section of the Article IV consultations. That’s 45 trillion dollars in credit expansion over less than a five-year period!

Kevin: We’ve had a multiple of bubbles and they seem to all be called a credit crisis of some form. It almost always hedges on leverage and debt. Can you think of a single credit crisis that was caused by too little credit, Dave?

David: It is interesting because obviously there are nuances in the context of a credit crisis, but you get to the point of crisis by having too much of it, and having a system that then becomes dependent on it. And then that system, if it doesn’t get what it needs or wants, it really is like a drug addiction. You say, well, how do we get to this point of crisis? Well, it’s a lack of drugs. No, no, no. It’s starts with the addiction, itself. That’s the prevenient. That’s the earlier causal deal.

So you set the context by having an addition in the first place, and we have an addiction to credit. Then you can have things like what happened in 2008 and 2009 where there was no availability of credit when it was needed, and that liquidity crisis then ultimately morphed into a solvency crisis. But if you look at the context, yes, we ran out of credit for a short period of time, but these are with institutions which were assuming the guaranteed flow of credit.

Kevin: Let me go ahead and play like I’m Janet Yellen. Ben Bernanke, Jim Cramer, Paul Krugman, all these guys who would say, “Dave, Dave, don’t you understand? You can have debt if you have GDP, if you have GDP growth. Didn’t you see the latest GDP numbers? Didn’t you see that we have 3%? We were only estimating 2.6. Why can’t we go into debt?”

David: It’s a good question. You’re really talking about what are the natural limits? Are there any natural limits? This is where, what I’ve argued for the last 18 months is that when you blend Keynesianism with neo-Wicksellianism – this is Knut Wicksell from the 1860s combined with neo-Keynesianism and say, “This may be unnatural to take on this amount of debt, but if we control what is the “natural interest rate” and define it however we want, then actually, you can make the math work. From a cash flow standpoint, you can make the math work and you can add an infinite amount of debt. I’m overstating, but more credit than you can imagine – hundreds of trillions.

Kevin: So, it’s a little bit like a reverse mortgage. When someone calls and says, “Hey, I own my house at this point, I can live until I die on my reverse mortgage.” And I know there are people listening who probably have these. But actually, what is happening is the equity that a lifetime built is being extracted for daily living. That seems to be what we’re doing in this economy. So when we say it can go on forever, you’re tongue-in-cheek to a degree, because all debt gets paid somehow, but it sounds like it is progressively a form of bondage.

David: I would differ on the point of the reverse mortgage in that, at the end of it, with the reverse mortgage, you are leaving nothing.

Kevin: Right.

David: Right. And so you are basically eating through equity.

Kevin: But you’re not going backwards beyond that. Is that what you’re saying?

David: Yes, in this case you’re not just leaving nothing at the end of the day, you’re creating a deficit that has to be paid back.

Kevin: By your kids or your grandkids.

David: To your point, exactly, and that’s where you look at the moral component of debt and interest rates may fluctuate, and this is the dangerous notion of that neo-Wicksellian meets Keynesian solution of lowering interest rates to zero or negative, because interest rates fluctuate, but debt is permanent. Just like asset prices fluctuate, but debt is permanent.

Kevin: You know what? That’s a bumper sticker. Everybody stop for a minute and memorize what Dave just said. Please. I need to do that, too.

David: So what works right now, interest rates being at a low level and having this amount of debt – it works right now, but interest rates fluctuate, just like prices fluctuate.

Kevin: But debt is permanent.

David: But debt is permanent. You still have to pay it back. And if your payments on that debt – now you’re talking about a cash flow crisis, because what we are predicating is something that, in the history of the world, has never been done, which is to say, “We can, and we will, control the price of interest rates.”

Kevin: Right. But answer my question, Dave. I’m also being a little sarcastic here because GDP is nothing compared to the amount of debt that we’re taking on. That would be the argument. Krugman would look at you and say, “Hey, listen, we have GDP in this economy and we can handle the debt.”

David: The GDP numbers were good third quarter, second consecutive quarter of positive growth. We beat the estimates of 2.6% – that’s what was expected – and came in at 3%. What we seen in response to that is economic statistical encouragement. You have investors, you have institutional asset allocators – they’re diving headlong into risk. Again, let the good times roll. Investor caution, barely a factor in the markets post 2012, now encouraged by the central bank community. It’s fascinating, because you get these supporting aspects, economic – call it confirmations – and what I don’t like is the lack of respect for risk in the marketplace that you see on display. It has disappeared completely.

Kevin: GDP can be also doctored up a little bit. GDP does not necessarily say that you’re selling more hot dogs at the hot dog stand. It can come from inventory. GDP can come from taking more debt on. We have had experts on GDP on this program explaining that you really can’t trust that number anyway.

David: The two big components, GDP figures positive this quarter, third quarter, the biggest contribution came from an inventory buildup. So if you think about that, these are not finished goods that have been sold yet, but corporations have gone ahead and said, “We’re going to go ahead on the expectations that we will see continued growth. We are going to go ahead and stack inventories so that we have plenty to sell as soon as there is follow-through from the consumer, and from other businesses who need our goods, and that is what we see as an inventory build. The other component was foreign trade.

Kevin: Okay, but when you have an increase in GDP you shouldn’t have an increase in the deficit at the same time.

David: You can. It’s a question of are you living beyond your means, and we believe in that. That has been sort of a right of the American consumer, to live beyond their means, because they have learned from Uncle Sam, their good uncle, who has given them the greatest tutelage, or mentorship, in that. If the government lives beyond its means, surely the individual can live beyond their means. And when it comes to the end of the line and you can’t make payments, you just restructure the debt in some way. Change the terms, talk to a specialist, and have them negotiate a better price, what have you.

It’s discouraging to me that if we do, in fact, see some economic increase in economic activity, that we feel that we must continue to spend more than we are making. GDP – yes, positive, but we’re on track for a trillion dollars in terms of the budget deficit. Now, Goldman-Sachs says we’re not going to hit that number consistently until 2020, but the reality is we will pass 700, 750 this year. Next year maybe it’s 750 to 850, but we’re marching back toward trillion-dollar-a-year deficits.

The thing is, you have to watch not only the deficit figure, but the actual expansion of treasury debt as well, because even though the deficit figure would suggest we’re only adding a trillion, in the last two to three years, we have been adding between a trillion two and a trillion three per year in new debt to our system. So there is actually a bit of a skew where the deficit figure and our total debt figures are not matching up. We’re actually going into debt more than our budget deficit figure would suggest.

Kevin: I’m looking over at Europe. Draghi had sort of taken the baton. When we stopped our quantitative easing back in 2012, 2013, right in that area, Draghi took the baton and turned it into 300 billion dollars a month of quantitative easing of some sort, buying up assets. Now he is talking about tapering, Dave. He is talking about normalizing. It’s a different form of normalizing, but backing away from some of those purchases. Is it that he is just running out of things to buy, or do you think it’s really happening?

David: That 300 billion is inclusive of what the Japanese have done, too, so if you’re looking at the global liquidity flowing into the markets, that is total central bank liquidity being provided. And they have been 60-80, even 90 billion of that on a monthly basis. And he is talking about reducing the monthly purchases to 35 billion U.S. dollars. They handled it very diplomatically. They basically said, “Look, we’re going to reduce, but we’re not really reducing because we’re extending the timeframe that we’re going to continue those purchases well past next September.

Kevin: So September 2018? And then you know what happens when we get there.

David: Yes, and of course, he made the promise, “We’re available to increase them if needs be, so if you have any gyrations in the stock market or bond market, or prices begin to move…” Oh, by the way, interest rates – this was an interesting component of what he spoke about – by the way, rates will not be allowed to rise prior to 2019. Again, it’s just a fascinating commentary, for anyone who understands what markets do.

Markets price risk. Markets price the current value of an asset in light of risk and reward, in light of a number of macroeconomic factors, including inflation and credit. What he just said is, “None of that matters because the only thing that really matters in the marketplace today, at least in terms of interest rates, which would imply all fixed income instruments in Europe, is my footprint. I will tell you what interest rates are going to do, and I just told you that they’re not moving until 2019.”

Kevin: So is he not repeating exactly what he did in 2011? September 2011 he said that they would do anything that was necessary – anything. And what that meant was buying up anything for any amount of money, controlling interest rates. And he has. Dave, here we are in 2017.

David: It’s language games. It’s language games, on a hawkish basis, to come out and say, “We’re limiting what we’re going to buy, we’re shrinking it back, but by the way, you won’t see the needle move at all because we have our ways. We have the means to control interest rates, and they will not rise until 2019.” If anyone is concerned that he is backing away, he reiterates that we have, and will maintain, a strong presence in the marketplace.

Kevin: But I have a question for you, because when you’re buying that much of the marketplace, you’re going to have to run out at some point. Think of the Japanese. The Japanese Central Bank owning 70% of their markets – the European Central Bank is starting to run out of things to buy with all this money that they are printing every month.

David: Right, the BOJ owns 70% of the ETF market there in Japan, and the ECB bought everything under the sun that they could in terms of government bonds, and then as they ran out of instruments to buy they simply said, “We can buy corporates, as well.” So they extended the list to corporate bonds and they have been buying corporate bonds in Europe. I think if they run out, maybe that is why they are reducing the total amount that they are buying on a monthly basis, running out of government bonds to move the needle, now they are migrating to corporates. They’ll just extend the list. They can do that.

Kevin: End up buying everything. Okay, well, the little guy, and I’m talking about everybody who is not a central banker or a WalMart, Amazon, Google – you name it. There are companies that are so large that they don’t have to have a profit. What we would call profit in the government would be GDP, some sort of productivity. Look at Amazon. How many of us order – I even order my oatmeal from Amazon, Dave, because it’s just easier, I press the button and I get my next three boxes for the next three weeks. But Amazon doesn’t have to have a profit. They have cash flow. They have money that they are not creating necessarily out of thin air, but the stock price is.

David: Yes, and GDP would be activity, profit would be surplus. And we just talked about running a deficit.

Kevin: Yes, that’s a good point.

David: So the Amazon shares, it’s interesting because Amazon goes soaring this last week because their cloud profits surprised by 42%. So again, they’re operating in the cloud and this is kind of new way of storing data.

Kevin: Yes, selling storage.

David: Fred Hickey tweeted something I love. He said, “Wait a minute. Amazon lost 824 million dollars in their retail business in the third quarter.”

Kevin: Almost a billion in quarter three.

David: (laughs) They’re losing money and gutting the American retail sector, right? They had estimated earnings per share growth 90 days ago, so this is for the third quarter. They had estimated them at $1.09.

Kevin: And didn’t they lower that estimate so they would look like they beat the estimate when it came in?

David: Right. During that 90-day period, they lower their earnings-per-share estimate to 52 cents, and then they beat the low-ball estimate. And Wall Street goes wild. They praise the results and they’re ecstatic. Why? Because they came in above their estimates. But again, it’s like saying, “I’m going to be a schmuck that never brings flowers home – ever, ever, ever, ever – and then once in ten years I bring them home, and it’s like, “Look at me, I’m a hero!” Now, in the grand scheme of things, if I bring home flowers once in ten years, categorically, I’m a schmuck. I think everybody gets that. But if you lower expectations to zero and then deliver anything, somehow you’re a hero? That’s the way Wall Street is playing this. Lower your expectations to nothing. And what it ignores is that Amazon has seen a 40% decline in profits before taxes on a year-over-year basis. Their operating income is down 36% year-over-year.

Kevin: It’s almost like Netflix. They’re not making a profit but it continues to go up.

David: Earnings-per-share growth is zero percent for Amazon. Folks, that’s the game. All you have to do is beat on the earnings-per-share announcement, get a positive headline, and as soon as you have a headline print from Bloomberg you have trading algorithms which grab the stock and push it up 7-8%. It’s like a magic show. It’s the art of misdirection. Nobody cares about the decline in profits before tax, nobody cares about the operating income being down 36%, nobody cares about the fact that what you delivered was about half of what you thought you were going to deliver at the beginning of the quarter, so what you are really saying is, between the lines, “We can’t get the job done. But you’re too stupid to recognize it, and there is a bunch of patsies who will buy this stock if we can generate a positive headline and get the algorithms trading off the positive headline.” Isn’t that wild?

Kevin: It is wild, but it is amazing, people are looking for a reason to buy something. They need the reason to buy something. I remember in 1992, you might remember when Bill Clinton was first running, he had a terrible pre-election summer right before he won the election, before he beat George Bush. I remember reading an article – it was in Worth magazine – it was a brilliant article. In the summer of 1992 it said that Bill Clinton will probably win. And it didn’t matter what the news was because he said, “This Bill Clinton campaign has the elements of a bull market. People want a reason to vote for him, and even if they find reasons that they shouldn’t, like the Gennifer Flowers incident and all the things that were going on…

David: All you need is a reason.

Kevin: You just need a reason. And right now the market doesn’t need a real reason to go up, it’s just needs a reason to go up.

David: And that’s why I look at this earnings-per-share beat. If you beat by a penny, for the lemmings that are coming into the market, the earnings-per-share beat is a little bit like catnip for lemmings. They just go, “Oh, this is great! Fantastic! I feel so good! Let’s do this.”

Kevin: High-yield bonds – same type of thing. Any kind of interest return in this zero interest rate environment right now is like catnip.

David: The Wall Street Journal this last week on the 22nd, pointed out that you are seeing greater and greater allocations toward risky assets and it’s focused on yield, and it’s getting what they want immediately.

Kevin: High yield.

David: And in fact, we have exceeded the appetite for risky fixed income assets that we have ever seen before, that the collateralized loan obligations which were a part of the blow-up – we saw this growth in exotic constructs back in 2006 and 2007 and then they are blew up. A good percentage of them blew up in 2008 and 2009. Collateralized loan obligations grew in 2006 to a peak of 136 billion dollars. And here in 2017, just in the first nine months of the year, we’re not at 136, we’re not at 236, we are at an all-time high of 247 billion dollars. We haven’t even finished the year!

This is for, again, stuff that pensions and insurance companies are willing to gobble up because they and a host of other institutional investors are looking at positive returns in the space and they are basically just jumping on board. They’re pouring money in on the basis of positive returns. And they say, “Look, we can make money, we can have our needs met in terms of cash flow requirements. Look at what just happened last year, look at what happened the year before. It’s just unfortunate that we waited this long.” This is the kind of risk ignorance that happens at the end of a market, when people just say, “Hey, you know, it’s working. Let’s do what’s working.”

Kevin: We’ve talked over and over about momentum – the greater fool theory – basically saying, “I’m going to buy something hoping that someone else will come in and pay a little bit more.” That’s really what pushes prices up. It reminds me of the old chain letter Ponzi schemes where you get a letter and say, send this to 20 of your friends and have them send you a buck, and then you tell them the same thing. Well, everybody, especially near the top – I hate to say it but a lot of the multi-level businesses are built this way, too, where the guys at the top are the ones who are flying in on jets. They are called the diamonds. They come and talk to the little people and say, “Hey, get into this so you could have a jet, too.”

David: You could have a bitcoin, too.

Kevin: It’s true, you could, but what always happens on any of those schemes is you run out of new people. And if you don’t have a new person does the price continue to go up?

David: That’s what drives anything higher – new money. And that is the cycle we are in now. Anything with a positive return is seeing hot money flows into it.

Kevin: Okay, stop for a second. Define hot money, because we talk about it when we do bank ratings, but hot money is different than other types of investment or loyalty type of money.

David: Yes, it’s just chasing a rate of return, and that is the only reason it is there. So, risk is not a significant factor for asset allocators who are just trying to keep their jobs by meeting or beating a benchmark. The understanding, or the complacency, which has set in, is again – volatility is toned down, and because of that we can now take more risk without there, really, technically, being more risk taken. Is that possible? No, it’s not. To actually not take on risk generally associated with a risk asset, that is kind of the feel is that volatility is coming down, therefore there is less risk and we can therefore add more leverage, buy more of the same asset. What we’re talking about is belief and behavior which are not consistent with more prudent ways of hedging out risk.

Kevin: Well, it’s insanity, but it is in the form of some sort of – it’s being paid off right now, Dave.

David: Yes. But risk doesn’t exist in this time slice. That’s the way people are behaving. It doesn’t exist. And therefore, with managed volatility, we can enter into something that, in retrospect, I think we’re going to look at as central bank intoxicated revelry. But until it is in retrospect, what we have is just kind of the running of the bulls. The basics are still the basics. We may feel different at present because prices are being pushed higher, and that is more satisfying as an investor.

But buying begets higher prices, selling begets lower prices, which suggests that the limits to appreciation are still tied to the quantities of dollars into an asset, or the quantities of dollars coming out. It goes back to your question about hot money. Hot money is only there as long as it thinks it can get a better rate of return. And it will gladly move to something else if it finds a place to go that offers more. So slow the flow, or increase the flow, and prices are going to fluctuate one way or the other.

Kevin: I brought up Reagan earlier, Dave. Reagan was able to pull off something that a lot of guys are not able to pull off, and that is, a somewhat effective use of debt, because we did have, as a country, a tremendous amount of equity. We didn’t have much debt. He was working with a country that only had 1/20th of the debt that we have right now. And he was able to take that trillion, turn it into three trillion dollars’ worth of debt, and I’m not going to say that was the right thing to do, but we had some things going on with Russia – the Soviet Union – those types of things where they literally met and they discussed, is it worth doing? And they also changed the tax code, they changed the economic plan, and in a way, were able to pull this off without destroying the country.

David: I think the other thing that worked in that timeframe is that they had the latitude to lower rates.

Kevin: We were in a high-rate environment, that’s right.

David: That’s right, so whatever the consequences might have been, if there were any, of a negative nature, as a consequence of lowering taxes, think of what latitude you gained, both in 1981, and then again in 2001, when you’re lowering interest rates by 5 to 9 percent, depending on which case you’re talking about.

I go back to this time having a different backdrop. In this cycle of money chasing yields we are ignoring risks, and it is important to recognize that positive returns are never enough – the little positive increases, the risk appetite – it increases the boldness of the investor. Greed dictates that if a positive return is possible, then leveraging that positive return and capitalizing on margin or some other form of leverage, that even makes sense. That is what people are doing today. That artificially increases the buying volumes. We have that. Lower volatility brings in borrowing and the speculating masses out of the woodwork.

But you had a different kind of caution back in the 1980s. Why? Because you had been in a bear market. Stocks had been going through the meat grinder for the better part of a decade. The last significant bull ended in 1968, so there were various cyclical, short-term cycles through there, that really, you didn’t begin a secular bull market until 1982.

Kevin: You brought up a great point, Dave, and I should have brought that up when I was asking the question. We had double-digit interest rates at one point. That’s hard to believe, but we had double-digit interest rates. You could not go anywhere but down on interest, which would have created growth at the same time that you were going into debt because you were able to borrow at lower rates.

David: What we see today is a voluntary disconnect of both the private sector investor, the private investor level, at the institutional asset allocator level, and even among domestic central banks. So if you’re talking about the Bank of Japan, the European Central Bank, the Fed, the Bank of England, you have debt-driven growth which is a curious phenomenon. It has a well-documented history. It starts well, it works excellently, until it fails miserably. We have the early stages of that, which are very alluring, and now we’re continuing well beyond that. Economic growth is now one possible outcome of debt expansion.

That’s what was argued back in the Gipper’s day. “Look, we’re going to increase debt, we can do that, and we’re going to see economic growth.” And we’ve mentioned this in different presentations we have given before. You were getting four dollars of economic growth for every dollar that you were increasing in debt. We have gone past that. You don’t get a dollar’s worth of economic growth for a dollar in debt, so if we go a trillion dollars in debt, you didn’t get a trillion dollars in growth. It’s a fraction of that. So we’re actually working in negative territory now, but everyone seems to want to ignore that.

Kevin: It reminds me of base-jumping. That is one of those skills that you don’t learn what not to do from history because you never live through the next bad jump. The way debt works is, it starts well, it works excellently, until it fails miserably. And that is like a base jump. It starts well, you’re not hurting in any way, shape or form as you are falling, the parachute opens and you’re great as long as that works. But if it doesn’t open, or that one time when things go wrong, it fails miserably, and you’re not there to remember the lesson.

David: That’s very interesting, the base-jumping analogy. If you think about it, you have the Gipper pulling off what he did when our debt-to-GDP figures were less than 50%, I think something closer to 35% of GDP. Now we’re at 110%.

Kevin: So he had a big chute. It was like, “Hey, look what Ronald Reagan did.”

David: Huge chute, but he also was starting at a different altitude. So you base jump from 100 feet, is there even enough time for the chute to open? We’re at 1% interest rates today. You were starting at historically high interest rates in the early 1980s, and with very low levels of debt. If someone is reflecting back on that, you should say to yourself, “What can you afford at higher rates?” And as it turns out, you can’t afford – you cannot afford – 110% debt-to-GDP at higher rates. You can afford somewhere between 35-50% because we’ve done that. We can afford it, but it comes at a very high cost in terms of that cash flow component. You see the same kind of usefulness of debt, just like the Gipper harnessed it. Corporate expansions, if well-timed, if well-executed, can be done with positive effects. But it is a tool. If it is used all the time and any time, that’s when it becomes dangerous.

Kevin: Right. And it has to be something that you can pay off. Dave, today we’re out of time, but something that I really liked about the conference that you had this weekend is that you quickly ran through – I think it was about 30 items that I think were almost impossible to argue with that would say, “You should not be in these markets, and you should be vigilant.”

What I would like to do is remind people that you are going to be all over the country starting this weekend. You’re starting in Kansas City this weekend, moving to Minnesota right after that, Pennsylvania after that, North Carolina, Austin, Texas, a couple of places in Florida – Orlando and Naples. I would really recommend to anyone listening to the show, like we have said over the last several weeks, if you can get to one of these conferences, and actually, I’m talking to the listener now, talk to Dave, talk to Don. It’s well worth it. We’re just coming off of the conference in Coeur d’Alene, Idaho, and it was very valuable for a lot of people.

David: We’re over-booked by almost a dozen people in terms of our consultations in Kansas City. I don’t know if that means we will stay an extra day, or how we will manage that, but the response has been very strong. I think the combination of Don’s perspectives from Asia, my perspectives here, operating our businesses in the United States, it’s time well spent getting some one-on-one time with either of us or both of us. Also, a decent commitment if you are looking to the spaces that we do have available at the latter conferences. Would love to see you, love to spend time with you, look forward to that.

Kevin: Yes, give us a call at 800-525-9556 to RSVP to one of those conferences.