November 16, 2011; Avoiding the “Certainty of Outcome” Trap

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, you are just getting back, again, from speaking at a conference, and I know that one of the topics at this conference, a chief topic, was deflation. “What happens to gold in a deflation?” There is an awful lot of information out there that may be erroneous that says that, actually, gold goes down like a commodity in a deflation. But is that true?

David: Let’s look at that, Kevin, because one of the things that we have to take into account is the possibility of deflation in light of the vast stocks of debt that are outstanding. I think this is one of the misnomers that many people have had, and I am talking, specifically, about policy-makers, that we can continue to expand the levels of debt we have, in light of growth in the underlying economy.

In other words, to the extent that the economy continues to grow, and grow exponentially, we can support, in a parallel track, an exponentially growing debt base, as well. Not a problem. That’s where the analysis fails, however, because we do have a problem. The problem is that growth is no longer exponential. It is either stagnant or declining.

Kevin: But David if we cannot sustain that growth, if we can’t continue to borrow, if we are actually having to unwind that debt, spending is going to decrease, so shouldn’t prices drop?

David: You would expect to see that, and I think you will see that. That is certainly one of the components, one of the concerns that the deflationists would have, is a drop in prices of all assets across the board, in light of this debt and deflation, or deleveraging unwind.

Here is an issue that I think is worth looking at. We have Hungary, which was just downgraded to Triple B, so there is trouble which is now brewing in Eastern Europe. We have Western European concerns, and we have talked about that ad nauseam over the last several months. Greece has a new prime minister. Italy has a new prime minister. How many things are changing now in the political sphere? The market wants to think positively about these changes, but it doesn’t really have anything to base it on, and I hope that they don’t experience the same sort of empty promise that the United States experienced in the last three years, where the promise of change was there. But in the last election, Kevin, there was nothing articulated with real specificity. There was no plan, there were no action points, there was no “Here’s what I’m promising…”

Kevin: Just the words “hope” and “change.” How can you disagree with change, or disagree with hope?

David: I think that is really what you have, a vacuous expectation in Europe that the new guys will somehow be different and better than the old guys, although those new guys have yet to even propose anything in terms of new and actual plans to be implemented.

We have new leadership in Greece, new leadership in Italy, just like we were talking about in Hungary, there being stress and strain in their debt markets, and of course we have seen French yields moving higher, so that the French bond market is under pressure, and the Italian bond market has been under extreme pressure.

Kevin: You haven’t even mentioned Spain yet.

David: Spain is probably, in a sequence, important, but right after Italy, because the real stress and strain is in Italy today. Kevin, it was interesting, last week we watched liquidity evaporate from the bond markets, and I hope that this is not where analysts on both sides of the pond are missing the point.

Kevin: You’re talking about European bond markets.

David: Yes, but analysts on both sides of the pond can say, “You see, this is exactly what we are talking about. We have a liquidity issue, and that is why the ECB needs to step in.” Well, in fact, the ECB did step in, and specifically, the two-year Italian bond was trading at a bid/ask spread of 44 basis points.

Kevin: Almost half a percent – 44 basis points.

David: The difference between bid and ask, which is enormous in the bond market. But what that implies is that there is no liquidity. In fact, people were just stepping away from the market. So, yes, the ECB stepped in, and created that liquidity, being the backstop, being the purchaser of those bonds. But the temptation is to look at Europe, and to look at the U.S., and say, “This is what we are talking about. This illustrates the point that, truly, central bankers need to make liquidity available because these are liquidity issues.” What that neglects is that this is not a liquidity issue in the first place. As we have said before, this is a solvency issue, and it is based on the fact that governments have built up a total stock of debt which they can no longer make payments on.

Kevin: Let me ask you: Is this too big to bail out? Is there enough meat in the ECB, at this point, to bail them out?

David: Not a chance, not with Italy. We are talking about 2.6 trillion dollars in debt, and the ECB intervention is, essentially, allowing banks to exit the Italian bond market. When governments prop up the market they often forget the smart operators are taking advantage of that occasion to get liquid and get out of the market.

Kevin: See, that is the point. We keep hearing how the bailout, and we saw this in the United States, as well, “Oh, you need to have a bailout so that the public is saved,” but in reality, the banks were saved. Isn’t that happening in Europe at this point, too? The banks are the ones who are being bailed out.

David: Yes, and then bring it back home, Kevin. Operation Twist is easing long bond-holders’ concerns of moving prices lower through liquidation by, essentially, creating a support structure for prices. In other words, you are saying, “I’ll write a check for any amount of bonds on the long end of the curve. If it is a long bond, I’m a buyer.” Well, guess what? You just may have ten new people who get in queue to sell who hadn’t thought of selling before because they weren’t sure what the process was going to be. Could they drive the price lower? Could there be too much price discovery on the downside in the context of trying to liquidate a huge long bond portfolio?

Kevin: So, if you were a sophisticated investor, or a bank, or a big brokerage firm, and you needed to get out of some garbage, like we saw back in 2008-2009 here in America, that junk gets sold right there to the largest buying party, which at this point, is the ECB.

David: And garbage is one thing, Kevin, but this is changing the yield structure in the marketplace, where you are seeing long bonds, particularly here in the U.S., get shoveled onto the Fed balance sheet, and what that is allowing, is for heavily exposed investors to quietly take advantage of this, again, without price movements leading to discovery of the mass liquidations.

Our view, Kevin, is that the bond markets are growing more unstable by the day, and you see these long positions, people who own the bonds outright – they are liquidating inventories, and those inventories are building on central bank balance sheets the world over. So, the Fed is doing their part, we have the Bank of England who is doing their part to do the very same thing, you have the ECB who is doing the very same thing, with many of these investors who are now exiting the bond market, or limiting, or changing their exposure from the long end of the curve to more medium or short-term bonds. These are investors who don’t intend on returning to that market anytime soon.

Kevin: David, as you have talked about over the last couple of months, people are focusing mainly on liquidity right now. They are forgetting the solvency issue, and that is happening in Europe, as well, is it not?

David: Yes, with solvency being a consequence of illiquidity. But that is the issue, Kevin. The primary issue is, in fact, solvency. There is too much debt, that’s the problem. And the expansion of debt – it is realistic, and it is manageable, as long as growth in the economy is robust and matches it. When growth slows or goes negative, the new debt cannot be carried. We have had this underlying assumption of exponential growth, and its corollary was supported – exponential debt expansion. In theory, there are limitations to growth, and now we are experiencing that, in real time.

Kevin: On the one hand are we going to have a European Union and is it going to hold together? On the other hand, are we going to see this thing dramatically shift, or even fail? Is there a problem with the ending of the European Union? We have grown to assume that it will be there, but it is obviously not able to pay its bills.

David: It is not able to pay its bills, but they may finagle a way out, and this would be via greater fiscal integration, greater political integration. I frankly lack the imagination to see that happening. That doesn’t mean that it can’t happen, but I don’t know how that happens. In the context of crisis, usually, people are not more open-minded, they are more closed-minded, more insular, and more focused on their national interests, and don’t generally think about what it takes to integrate further.

I guess maybe I’m drawing on the period of de-globalization circa 1914 wherein there was greater conflict between countries, not greater integration, on the heels of 50-60 years of greater integration, greater cooperative trade, greater movement of goods and services cross-border, and greater currency integration. All of that came to an end in 1914.

Kevin: Until 1914 we really did have a global standard, in a way, in the gold standard. There was an equal weight and ratio type of gold standard. But by 1918, there were currencies and countries that were in debt that they knew they could not pay. World War I was just coming to a close, and there was, at that point, a fracturing of currencies, with fracturing of values. No longer were they redeemable in gold.

David: Another change happened in 1918, four years later. The Austro-Hungarian currency union fell to pieces. Following the war, the redenomination to old currencies was put in motion and essentially, they were placing a unique stamp on the old bills of the Austro-Hungarian currency, to reflect which country’s monetary system it would now be a part of.

Kevin: “Dees one ees goot, dees one ees bad.” (laughter)

David: Yeah, so if you were doing that today, maybe Greece would get a black spot. “It’s a Greek euro? Oh, it’s got a black spot on it.” But Kevin, what that caused, overnight, when they were taking apart the Austro-Hungarian currency union, was boxcar loads of paper currency that fled cross-border, to be re-stamped in the currency of the preferred countries, or the more stable countries. I think of the things that is important to remember here is, if any country, whether it is Italy, or Greece, or any other, were to leave the union, you wouldn’t need boxcars to move the money. It would take a mouse, literally the click of a mouse, to move an elephantine amount of money from one jurisdiction to another.

Depositor behavior consistently leads this charge, where they say, “Okay, I see it coming, I think if we leave, there is going to be a devaluation of the drachma, there is going to be a devaluation of the lira. That’s how we are going to pay our 2.6 trillion dollars in debt.” And guess what? Smart investors are already out of the banking system before it happens. The not-so-smart investors are the ones who end up standing in line outside the bank, and you see, essentially, a run on the banks, or a collapse in the banking system. Today, you don’t need to queue. You can, literally, with a mouse, move an elephantine amount of money.

Kevin: So if you are a smart Italian, you were out long ago. If you are a Greek, you probably were out last year.

David: Kevin, that’s exactly right. We have smart Italians who have already made that move, and Greeks, many months, or even years ago, who said, “We just aren’t going to take any chances here. If they do come out, we know that there is going to be a collapse in the banking system.” And that is one of the things that they have to come to terms with. Even though pragmatically, they can now pay their debts, what does the economy look like, and how do you function, without a healthy banking system? Now you have no trust, no trust whatsoever, in the banking system, and particularly, in the underlying currency.

Kevin: David, with some of the people that we have interviewed in the past, we have seen that protectionism and controls come in when certain types of emergencies like that happen. Boxcars moving from country to country – that may be a 1918 effect, but also, they would put any law that they needed to into place to keep those capital flows from coming in or out of the country, right?

David: That’s right, and I think capital controls are something that we have explored a bit in past years, and we have done that because we think that we will see more and more of that in the future, in order to get your arms, or any central banker’s arms, around the money system as it is, or will be, under stress and strain.

All that to say, look at Europe, look at the debt burdens there, and look at our debt burdens here in the United States, and they are unsustainable. Contrary to third-quarter GDP statistics, which show U.S. GDP growth at 2-½%, we continue to challenge the notion that GDP is growing at all, by asking this simple question: If government deficit spending is equivalent to 10% of GDP today, and it is contributing to the total GDP number by that amount, do we have positive growth, or are we actually talking about a situation where we are technically on life support and GDP is underneath the old numbers by 6-8%? Growth is irrelevant. Growth is absolutely irrelevant when you have government deficit spending propping up aggregate demand.

Kevin: David, I think we all agree that this is unpayable. It is unpayable in Europe. It is unpayable here in America. A lot of the focus has been on Europe because of what is going on there, but really, we are in worse shape than Greece, as we have talked about before. You have looked at three different avenues that could be a solution that the government may chase after. They may chase after the poor, they may chase after the rich, or the middle class. Who pays the bill?

David: That is why, four years ago, when we laid out the idea that the crisis which began as a financial crisis, impacting individual financial institutions – as that rolled over into affecting the larger economy, we would eventually see a political crisis on the heels of the economic crisis. And after a political crisis, there was a high probability of even a geopolitical crisis. Let’s fast forward, because we have already seen the financial, we have seen the economic. Now, frankly, Kevin, we are smack dab in the middle of a political crisis, even though it appears that the economic is with us. It is with us, but now it’s time for politicians to choose who the winners and losers will be, and that is exactly what is happening. The question is, will it be the poor, will it be the middle class, or will it be the rich? The poor will pay the price if we maintain high levels of unemployment, and eventually see wage competitiveness re-enter the marketplace. Somebody who is used to being paid $20 an hour has to get used to being paid $10. That is one option in terms of seeing a correction in the economy.

Kevin: David, does that really politically fly? I went down to the Occupy Wall Street movement last week before it was broken up, and I talked to a lot of the people. I asked, “Why are you here? What would you like to see happen?” There were not that many intelligent conversations, but I will say this. They were against the rich. They were against what they think capitalism is, and they are very, very proud that they finally came out with something that they could hand out called the Declaration of the Occupation of New York City. In the preface it says, “I lost my job, but I found an occupation,” a play on words with Occupy Wall Street. Can this be solved by the poor just taking lower and lower wages?

David: I don’t think it can because it creates political instability.

Kevin: Politicians can’t get re-elected.

David: Particularly when you are in a democracy. Frankly, it doesn’t matter how many people you have unemployed as long as you are in a command economy, because if you don’t like the peoples’ behavior, you just take them out back and shoot them. You get the point. If you are in Russia and you are unemployed and you are unhappy, the government doesn’t necessarily agree with you being able to express your unhappiness, so they send you to the gulag. There you are in Siberia.

Kevin: You get to occupy Siberia.

David: Yeah, you get to occupy a space where no one cares. I’m not suggesting that this is a good thing, this is a terrible thing, but that is what happens in a command economy. In a democracy, when the poor are unhappy, they do have a voice, and that creates political instability. The powers that be look and say, “Wait a minute. My legacy could be up-ended in one day, with just these people showing up at the polls.”

Kevin: And that puts the second category right in the gun-sight. This is one of the messages of Occupy Wall Street, and actually, what you are seeing in the press right now. “All we really need to do is just tax the rich.”

David: And that may be a solution, Kevin. I think it may be partially a solution. Certainly, we have room to wiggle in terms of increasing tax rates here in the United States. When you look at what the average company, particularly a multinational, pays as a percentage of their income, it is a little disturbing to see companies like General Electric actually get a tax rebate and pay nothing – nothing – on the billions and billions of dollars that they make. To that, I have to scratch my head, as a small business owner, and say, “Wait a minute. The all-in number for me is close to 50%.” They say it is 35, but by the time you add in all the ancillary taxes, I’m at 50. How can I get to zero?”

Kevin: David, that’s not capitalism, that’s cronyism. I knew General Electric, and you’re no General Electric.

David: (laughter) I think there is a reason for the folks at Occupy Wall Street to feel like fairness is not there in the marketplace. But I think the assessment that this is capitalism that has bred a lack of fairness – that is patently absurd. That is not capitalism, that is creating the disparity between rich and poor. That is a consequence of central bank policies which are creating an inflation of asset values.

Take, for one example, Kevin, the difference between the average household over the age of 65 versus the average household under the age of 35. The average household over the age of 65 now has 47 times the balance sheet that someone under the age of 35 has. And just in 2005 it was a 10-to-1 difference. Now it is a 47-to-1 difference. What I am suggesting is that debt continues to be a burden for anyone who carries it, and for anyone who has assets, those assets are being exploded to higher values on the basis of central bank policies which are inflating the money system, and to some degree, repricing assets at higher levels. So this disparity between rich and poor – is it a result of capitalism? This recent study, moving from 2005 numbers of 10-to-1, to present numbers of 47-to-1, has nothing to do with the rich getting richer.

Kevin: It has to do with debt.

David: It has to do with the debt being a burden for those who still carry it, and the average person over the age of 65 has already paid most of their debts. But, that is not to say that these people are particularly wealthy. The average net worth of a person over 65 is $170,000, and is reflective of owning a home, as well. Say the average home was $150,000, then we are talking about someone who has free cash, in the bank, or in an investment account, of not more than $20,000! Kevin, this is not the rich and the poor, we are just talking about debt continuing to be a burden, while assets, to some degree or another, get the inflation benefit from the Fed.

Kevin: So David, you are a politician at this point, and you are tapping a maple tree – the rich – do you solve the problem?

David: You can solve a PR problem by tapping the rich, and you can convince the poor that you are being aggressive, and that is one of the reasons why I think they will increase taxes to some degree, but they will lose if they say, “Okay, well, let’s just move taxes to 100% on the rich.” That will create a couple of hundred billion dollars more, which doesn’t even begin to take care of one year’s new spending deficit, let alone chip away at the interest and principle that we have to pay on the outstanding stock of debt.

Kevin: So we are not going to get the solution by the poor taking lower wages, and we are not going to get the full solution by tapping the rich. All that leaves is the middle class.

David: It leaves the middle class, Kevin. And this is the classic case of adjustment. You look over time, and the place that you adjust for imbalances on your balance sheet, if you have control of a printing press, it is via the printing press, and paying off that debt with cheaper and cheaper dollars. The reason why the middle class come into the crosshairs, is because they are the ones who are most influenced by this activity.

Kevin: The rich have assets, the poor don’t have assets. The middle class has a mix of debt and assets.

David: But the problem is, most of their assets are associated with their debt, so for the average middle class person, they have two assets: One is their home, which I would consider a liability, an albatross, not an asset, because it doesn’t create anything, other than warm fuzzies and happy memories, which is very important, but from a financial perspective, it is not an asset. It may be, for your family, an asset, but don’t misconstrue it as something that is going to either be adding cash flow, or be a growth asset over time.

The only other asset the middle class typically has is a 401k and we have looked at statistics on that, and they end up being very, very, very small. So, essentially, the middle class, what savings they have, they see their savings eroded in the context of taking this adjustment via the currency. The middle class lacks one thing: A real understanding of what inflation is. I think this is where the government that we have, as well as the government that we see in Europe, the government that we see in Great Britain, the government that we see, and just universalize this – Zimbabwe – they realize that this is a way out. This is a way that very few people will appreciate what is happening to them, as it is happening to them, and if things get out of control, you can always blame your neighbor.

This is where the crisis can morph from a political choice for the middle class to take the hit, not knowing that they have been chosen, but if things get out of control, politicians still reserve the right to blame someone else. Blame the Chinese, blame the Japanese, blame the Mexicans, blame the Canadians, blame the Europeans, blame the Spanish. In fact, you know, we might find the government, if the current administration is re-elected, blaming Israel. Why? Because if Israel does go after Iran, and we see the price of oil back at $150 a barrel, they’ll have the perfect cover, because they can inflate the holy heck out of the money system, and meanwhile, the thing which is the hallmark for inflation the world over, higher energy prices and higher oil prices, will communicate to the rest of the world that it is not monetary policy, and it is not bankers, but in fact, it is the energy market, and if Israel hadn’t done this, we wouldn’t be in this problem today.

All I am saying, Kevin, is that it doesn’t matter who you blame, but this crisis will move from the current place it is today, a political crisis where you are choosing the winners and losers, and I think it is going to be the middle class taking the adjustment via a currency devaluation, to a geopolitical crisis where someone is blamed, because ultimately, inflation gets out of control. We saw this in the 1970s, as inflation rates moved from 2% to 4%, to 8%, to 16% – it moves on an exponential basis. What begins as a very tame and controlled process, eventually explodes out of control.

Kevin: That brings up the question of interest rates. If we do, actually, have inflation, people need, at some point, a positive rate of return. I think we have looked at the numbers, and 185 billion dollars of our deficit right now is in interest payments. But if we inflate, interest rates have to rise. We have to pay people more to buy our bonds, and to take on our debt. What happens when interest rates on our debt go up?

David: Without an increase in interest rates, the Obama administration has suggested that by 2015 the interest component for our national debt here in the United States will go from 185 to 554 billion on the basis of an increased total stock of debt. So we are moving from 185 to 554.

Kevin: That’s assuming real low interest rates, where we are at now.

David: Right, yes, so it is only predicated on an expanded base of debt. With an increase in interest rates, I think we could find ourselves in the next five years with interest payments alone totaling more than a trillion dollars a year, which means, just for perspective, the tax revenues to the federal government total 2 trillion a year.

Kevin: So half of your tax dollars…

David: Would go to paying the interest only! This is a problem that over the next 3-4 years is going to be a nightmare, and it is one of the reasons why political expediency today, and going the monetary route, and trying to inflate our way out of a debt spiral, could cause major international or geopolitical conflict. Because at the end of the day, those same politicians and central banks will not own the decision that they made, they will not accept the mistakes that they have made as their own, and they will have to point the finger and say, “Listen, if the Chinese hadn’t been manipulating their currency we wouldn’t be in this position.”

Kevin: Sure, you always blame somebody.

David: It could be anyone! On any basis. Actually, I don’t know how you would blame the Canadians, (laughter) I don’t think they can do any harm. But they will find a problem, and they will find someone to point the finger at.

Kevin: David, we started this conversation with deflation, and we really didn’t fully answer that question, but now we’ve moved to inflation, and people listening to this program know that we recommend at least a third in gold. We have heard people say, “Gold goes down in a deflation, make sure that you just hold out for it.” Most people agree that gold does go up in an inflation. It is pretty obvious, when the dollar devalues, and gold holds its value, it is going to go up. But would you address, please, the deflation argument? I think there is a misinterpretation there, and I have no idea, historically, where people come up with this.

David: Let’s first define our terms. If inflation is too much money chasing too few goods, then deflation is too little money chasing too many goods. That’s probably the easiest way of contrasting them. What we are really talking about is the available money and credit in the system, and if there is more money and credit in the system than currency and credit in the system, then you are leaning in the direction of inflation. And if you really lean, it is because there has been a massive amount of printing, or credit created. It is the exact opposite with deflation, and the concern there is that you will see people selling off assets in order to raise cash.

Here is the issue. Yes, saving and hoarding replace spending in a deflation. That is very true. But people tend to save the best credits. This is a critical concept, because when you are saving the best credits, you have to take into account who stands behind the paper or the asset that you desire to own. If you are talking about the British pound, if you are talking about the U.S. dollar, if you are talking about the euro, if you are talking about the Japanese yen, you are talking about putting faith in a certain number of Ph.D.s who are “managing” the system.

Kevin: And it is all fiat, it is not backed by anything.

David: Correct, and in fact, if you price any of those currencies in gold, you see devaluation run amok. Management is too generous. Mismanagement is more like it – unless this is exactly their intended course, to bring these currencies lower. Then they may be on track for succeeding. This is the point, again. People tend to save the best credits, and that best describes gold. Gold is nobody’s liability. When liabilities are being liquidated, in the context of a deleveraging or a deflation, the importance of counter-party exposure is brought into relief, and so you have to ask yourself the question, “Who stands behind this?” Whether it is a greenback, a Treasury bill, or an Italian bond. But gold, as money – as money – gains popularity in deflations, particularly in the case of coincident monetary crisis.

I think this is what people forget, that gold has been conveniently relegated to the category of commodity, but that is a concept which is only about four decades old.

Kevin: Yes, gold was money until then.

David: Yes, 1971. Now we have central bankers the world over, money managers the world over, and the general public the world over, who tend to see the dollar, the yen, the euro, the British pound, as money. But in a real deflation, in a real deleveraging, you go to the best credit, and the beauty of gold is that it is no one’s liability, and you don’t even have to consider counter-party. That’s not even in the equation at all.

If you go back to Roy Jastram’s book, The Golden Constant, he looked at five periods of deflation between 1600 and 1971, and we aren’t talking about a three-month snap, or a six-month snap. These periods of deflation lasted anywhere from 11 to 38 years. And in every instance, the purchasing power of gold increased between 42% and 82%.

Kevin: In every instance. So in every instance of extended deflation, gold rose, not fell.

David: I could care less! I could care less about the nominal price of gold. Never have, never will. I care about what an ounce of gold translates into, in terms of some other form of value, whether that is acres of farmland, whether that is shares of Illinois Toolworks – just tell me what I am translating it into, because I don’t have confidence in the Fed, and I don’t have confidence in their fiat money, so why would I value my stuff against their fiat? I am going to value my stuff against other real stuff. Again, those were five periods of deflation where the purchasing power of gold was on the increase.

This is what is different from the modern conception of gold being an inflation hedge, because Jastram looked at seven periods of inflation in the same time span, where the purchasing power of gold went down, even as the nominal price went up double digits. Again, we are talking about purchasing power, purchasing power, purchasing power. When you are in a period of nominal inflation, low inflation, 2%, 3%, 4%, gold doesn’t do a bit of good in your portfolio. It does well during radical inflations. It does well on a major price adjustment basis when the world recognizes that a major inflation has occurred, you get a repricing, and it is a one-off event. But to assume that on a daily basis, let’s say the CPI comes out, and it’s a low number, as of tomorrow, and gold sells off because we don’t have inflation. Wrong way to look at it.

Kevin: That’s short-term perception anyway.

David: Exactly. So people don’t buy gold, frankly, to protect from inflation, as much as they do to remove certain portfolio risks, and that’s what we are talking about, being in a real rate of return environment. You are just stepping outside the market.

Kevin: David, I would like you to go through those four periods of time that Jastram looks at, but I do want to mention that there is an exception – 1920 to 1933. Gold actually did better than what you talked about in the previous periods.

David: Yes, if the average was 42% to 80%, in terms of an increase in purchasing power, the period between 1920 and 1933 stood out because there were general price declines across basically all asset classes, an average of about 69%. And gold’s increased purchasing power was closed to 250%.

Kevin: You could buy five times more things of value if you had gold, from 1920 to 1933.

David: Kevin, it is a compelling case for gold, in the context of a deflation, and I am afraid what people have forgotten, is that it is a standout amongst the commodities. It shares that moniker, but only loosely, because the longer tradition of gold is that it has been valued as a currency. I suppose it reminds me of our interview with Harold James where he suggested that we look at history from a different perspective and look for a deeper history. And maybe that is just looking further back in time, or looking at nuances within history that are often neglected, and this would certainly be one, at least in terms of contemporary, or modern history, that is overlooked. It is money, far more than it is a commodity.

Kevin: David, there is something that your dad has brought to the table so many times. He talks about inflation and deflation co-existing at the same time. I know something that drives you absolutely berserk is when people who manage money talk in absolutes, or hyperbole. They say, “I’m an inflationist, and this is why I do what I do.” Or, “I’m a deflationist, this is why I do what I do.” But there is, in a crisis, a mix of things, falling in price, and rising in price, and really, the main goal at that point is just to retain value somehow, some way, and not be shaken out of the tree.

David: Kevin, the weakness in most investors’ minds is that they want certainty, and they want clarity, and they are never going to get it. There are too many things happening, there is too much complexity, to really even aspire to having that, but it is what people want. They want an understanding, they want security, in the decisions that they are making. So it is easier to think in terms of hyperbole – either/or. It’s either inflation, or deflation. It’s very complex, and almost impossible, for most investors to see that both can co-exist. Just as you can have growth in a business cycle, and a decline in certain sectors, at the same time, investing is always nuanced.

It’s always nuanced, and what we find, Kevin, is that that is exactly what we have today. We have too much debt. In certain areas we are going to see it unwind. We are going to see the consequences of that show up in certain sectors of the economy, and there will be standouts. What will those standouts be? On a singular note, I think gold is one of those, but it is not enough to say, “Deflation – all things bad but cash. Inflation – all things bad but gold.” Unfortunately, life just isn’t that easy, and anyone striving for that kind of simplicity in investing hasn’t been around long enough.

Kevin: David, you have talked about the triangle so many times, but there are traps in all three sides of the triangle. The banker’s trap is just to be completely in cash, right? Let’s take the opposite side. The gold bug’s trap – 100% in gold. And then of course Wall Street’s trap is …

David: To be 100% in equities.

Kevin: Okay, but if you balance things out, you have basically covered your bases without having to take a side.

David: And there is this idea that you have to maximize exposures. What you really should be trying to do as a professional is identify what exactly is going on and load the boat 100% in that direction. So the equity guys on Wall Street would say, “No, we’ve identified what the trend is, and we’re 100% in equities.” And the banker will identify that same trend, but from his own unique vantage point, self-interested vantage point, mind you, as will the gold broker, or as will the gold bug, and the gold bug will say, “100% or nothing. Don’t you see? We know this is the end of the world as we know it.” If only it was that simple.

Kevin: If only it was the end of the world as we know it. (laughter)

David: Yeah, well, if you know that, then you can make certain decisions with a greater degree of certitude, and know that you will be proven right. That’s the problem, Kevin. History, as nuanced as it is, is no more so than living history in the day to day. It is not going to be what you expect it to be, 100%. Our goal as a company is to try to eliminate as many things as we can that are low probability events, and excel those things to the forefront of our minds that are higher probability events.

That doesn’t mean that there is certitude or certainty with any of these things, which is one of the reasons why I do like the perspective triangle. It gives you a balanced approach. It is not nuanced enough for any professional to say, “There’s the end-all and be-all of my investment asset allocation.” But you know what it is? It is a reminder every day, for every investor, that you don’t know everything, and unless you know everything, you can’t place 100% of your eggs in one basket.

Kevin: Just a reminder to the new listener, the investment triangle is just a simple, back-of-the-napkin concept where you can put, on the right side of the triangle your liquidity, on the base of the triangle your insurance, which is not an insurance company, but it is actually physically held precious metals, and then the left side of the triangle is your growth mandate, which can be Wall Street, it can be bonds, it can be a number of things. When you have those three mandates in place, in relative thirds, you don’t have to make sure they are complete thirds, it does give a balance that we have seen really perform through the decades.

David: We have talked about this, maybe a year ago, the difference between an equilateral and an isosceles triangle. You may, as a professional, favor one side or the other, but, again, what I like about this simple picture is that it reminds you every day to be humble as you are approaching the investment markets. If you don’t adopt an humble mindset, that is what the market will do to you: It will force you to accept an humble mindset, because you didn’t have enough information going in.