About this week’s show:
- How is gold valued/used in a currency crises?
- Is the world economy in a “Coffin Corner”?
- Deflation, inflation or both and?
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“This is the beauty of what we do in the process of trying to figure out up and down, left and right, in the financial world, in the world in which we live. When we have a question that we think needs to be answered by a particular person, the rolodex does include enough people to say, ‘Hey, will you join us on this part of the Commentary and share your insights with us?’”
– David McAlvany
Kevin: We have asked our listeners, Dave, to send in questions that they have had – so much volatility. You brought this out in last week’s show, and we are seeing it again today. There is so much volatility; I think we need to address that before going to the questions.
David: Well, certainly, we have two weeks, actually, to go through these questions, because not only did we have so many of them, but the quality of them was yet again astounding. I don’t know why I’m surprised each year, but I am. The quality, the insightfulness; we really appreciate the time taken to send those to us. So, it will take us a couple of weeks to get through all of them.
The markets in the last couple of weeks have been fascinating, to say the least. As we talked about last week, we looked at the price of oil, and the impact the price of oil is having, potentially positive for the economy. So far that has not shown up in improved sales, but that is certainly the theory, and in practice, so far it has failed. We also have the migration of gold, a number of European Central Banks requesting repatriation of gold, with Belgium this week adding itself to the list.
These things are very fascinating, and I think it is worth recognizing the amount of volatility that we have in the stock market. The VIX still stays relatively low, that is, the volatility index, the measure of puts and calls. While you have had oil crash, you have had gold which has frankly remained quite stable in the context of the dollar reaching to six and seven-year highs, silver, incredibly volatile. Just ten days ago we reached an overnight low, Sunday night before it opened in trading here in the United States, of 77-to-1 on the ratio, and today, we are at 71-to-1. And that has happened in less than ten days, the kind of volatility that you could expect, actually, over a year or two, in a very calm environment.
What is this speaking? It is speaking very loud and clear that there are things that are subcutaneous, substructural, within the world economy, and in various financial markets, which are unstable. We saw the Shanghai Exchange crack yesterday and drop 5%. The same day we saw the Greek stock market down, over 12.7% in one day. These are things that warrant discussion, but frankly, you could skip over them and sum it up to say, ”I told you so,” in this one sense, in the sense that there are Band-Aids that have been put on structural problems, and structural reform, which has needed to take place for the last five years, and has not taken place, is the root cause and reason for doubts that are emerging, not only in the commodities markets, but in the world financial markets, as well.
You go back to the oil market, you have 16% of junk bonds, which today, stuffed into various junk bond funds, are made up of oil-related shares. These are your explorers, your producers at the low end, who have a hard time financing themselves, except at 8%, 10%, and 12%, which those yields are very attractive to a junk bond fund manager, and they buy them hand-over-fist. Well, guess what? With oil crashing, the viability of those bonds is also put into question, and may be the pin that pops the junk bond bubble that we have talked about in recent months.
Kevin: It is amazing to see how things are inter-related, Dave. You talk about oil dropping, and that relates to the junk bond market. The Chinese recognizing certain debt as collateral, and then changing their mind, debt is no longer collateral. Isn’t that what happened to Shanghai yesterday?
David: It is the nature of policy and politics impacting the financial markets. When they decided to look at low-grade debt, that is, very risky debt, and no longer accepted it as collateral, it changes the structure of the financial markets, and it changes expectations, and all of a sudden debt takes on very equity-like characteristics, in terms of its volatility. And that, of course, has a ripple effect into the equity markets, and we saw that throughout the Asian stock markets with the Shanghai Exchange being the most volatile, off, as we mentioned, well over 5% in one day.
Kevin: Dave, that brings us to the first question. Like you said, we have a lot of great questions from listeners. This question is from Phil, and he says:
“There is a phrase in the aviation world – coffin corner – which describes what I believe we are into. High-flying pilots, U2, SR71s, are especially concerned with these conditions. Essentially, the plane is going into a stall condition, but it is not a stall that can be flown out of. It is a stall that will lead to the plane coming apart due to a complete loss of control. The pilot can’t power out of the condition, he cannot descend out of the condition, and he is literally flying into a box canyon at high altitude.”
Phil is asking, Dave, if we are in a position that we can’t get out of.
David: And his first question is, “How long can the U.S. Fed, or for that matter, the global central banks, continue with monetizing debt, and what action will stop them?” And I think this is really the credibility narrative which is in play. They are trying to weave a credibility narrative, and they will continue to have success with monetizing debt, with very little impact until that narrative is challenged.
Kevin, as we described earlier, there can be an action taken which has a ripple effect into other markets, and that is what we saw this week with the Chinese changing what they expect in terms of quality of collateral. That is an action-oriented shift. And we may have events, we may have specific actions that take place. It, frankly, is like the question of what triggers an avalanche in an unstable environment. That answer to that is – anything. And it doesn’t even have to be something that is rationally connected when the environment is unstable, as Phil mentions, the coffin corner, or the box canyon, so to say, you are already in a real pickle, right?
So, what event is going to cause a collapse in that environment? Frankly, you could say that it has already been set in motion. It is just now a question of counting time until an eventuality occurs. You fly into a box canyon and your options are very limited, if you have any at all. And he is describing an environment where you have no options at all – the demise is inevitable. And so that, I think, is really why I would circle back around to the credibility narrative. You have extended the time frame in which central banks are trying to stimulate growth in the world economy, and they have failed to do so thus far.
When does their credibility get called into question? Is it when Europe, officially, is in their third triple-dip recession? Is it when China does something to intervene in the markets because out of desperation they are trying to keep a declining growth rate from being discouraging the world over? Is it when the U.S. has to recalculate a figure, and it is less than favorable? I think we are really talking about something that changes the mind of the market, but the backdrop of weakness is already there.
Kevin: It is a little bit like what Phil was saying. The plane is already flying in a stalled position. It can’t actually be recovered from. Being a pilot, I don’t fly U2s and I don’t fly SR71s, but Dave, you and I both have flown Cessnas. The beauty of a Cessna is, if you stall a Cessna, as long as you have a little bit of altitude between you and the ground, that plane is going to fly out of the stall, but what he is talking about is a highly sophisticated configuration at high altitudes that cannot be flown out of, and really, if you think about the economic conditions we are in right now, it is the same type of thing.
David: Well, right, except that some would argue that we can grow our way out. You look at the assets that we have relative to the liabilities that we have, and we should be able to grow our way out. If you recall, it was David Walker whose study showed that we could, in fact, grow our way out of too much debt, but it would require double-digit rates of growth for decades to come. The fact that we haven’t had one single year of double-digit rates of growth for several decades is the problem. How do you fabricate that kind of growth when the mountain of debt is as large as it already is?
We have also talked about, in our conversation with Richard Duncan, the fact that we have moved to a system of what he describes as debtism, where the economy functions only on the basis of this additive. It is not on the normal basis of growth going back 50-100 years, but the new additive to growth is debt, and so we actually have to have a significant increase in debt each year, just in order to avoid recession. Well, as we know, the long-term impact of that is the same as this coffin corner. It is just a question of whether or not it happens right now, or five minutes from now – not literally five minutes, but maybe it is five years, or as Duncan would say, 25 years from now. Do we really want to see it happen on our watch?
Kevin: Dave, this whole concept of debtism where we are having to create more and more seems to relate to this next question from a listener named Todd. Here is what he says:
“Mathematically, does a fiat-based currency system have to keep expanding in order to survive, or can it stay even without imploding? I think,” he continues, “it must continue to expand to cover the debt payments and interest. Is this why all fiat currencies are eventually doomed, because of math?”
David: Theoretically, it does not have to expand, but because it does, obviously, debt tends to move along in lockstep with it, expanding as well. Theoretically, it doesn’t have to expand, but practically, it does, mainly because it is an easier political choice. What I mean by that is, and this is sort of the dark side of democracy, it is easier to promise future constituency groups from the government trough, even though you may not have the money, knowing full well that you can simply print it. So, as a political expedient, the theoretical “you don’t have to” becomes the practical “of course you are going to.”
This was always the justification for the gold standard amongst those who wanted, not only a sound currency, but also a sound political system, because gold limits political excess by increasing the cost to create and acquire more money. If there is no real cost to acquiring or creating money, you create it in an infinite quantity. So, the value of gold is not just as a stable money anchor, but also as something that stabilizes politics and reins in political excess, as well.
Kevin: And it forces countries to balance the books. David, you run a business. I have run businesses before, too, where at the end of the day you balance the books. You have to have a balance. Between countries it is called the balance of payments. Gold forced the balance of payments. Now that we are on a fiat system, and we are a reserve currency, and because we are running trade deficits, never really balancing out, are we not forced through this debtism, like Duncan talked about, to continue to expand and print money just so that we can keep up with the debt we have already created?
David: Right. This gets to a distinction which I think is helpful for Todd, in that you have two different worlds. The U.S. is in a unique world in that we are reserve currency, and as such, we have been able to run trade deficits for years, without any real consequence. Under a gold standard there would have been an immediate consequence to running a trade deficit or surplus. When you are out of balance, the gold standard brought that back in line. In a fiat system, yes, when you are the reserve currency and you are running trade deficits, then it does require money-printing and credit creation, which is basically the same thing, on an ongoing, uninterrupted basis.
So, again, back to that theoretical distinction. If you weren’t the United States, if you didn’t have the reserve currency, if you weren’t running trade deficits, could you actually have a fiat currency and not have it expand? Theoretically, it is possible. Again, it goes back to the unlikely outcome of that, because of what mankind does. The permanency in history here is that man does the same thing, looking for expedience, looking to economize choices, looking to buy opportunity, if at all possible, without any real cost. That is where I think the U.S. is perfectly described by Todd’s question, wherein we must continue to print. As world reserve currency, you have a greater need for dollars. We continue to disseminate those dollars via our trade deficit as we pump out the actual currency itself, and credit. So yes, it is, because of the math, because of those conditions.
Kevin: Next question. This was from a listener named Colleen. She says:
“I’ve been listening on and off to the Weekly Commentary for a few years now, and have so appreciated the insight and perspective presented. I am still very new to the concept of investing in gold or silver as a type of insurance, but see that there is a practical wisdom in it. I also view the perspective triangle as a very valuable, practical way of approaching investing. I must mention, as well, that I highly cherish the theme and message of legacy, inheritance, and intergenerational wealth transfer. It is rare to find such a take on wealth-building and investing, but I see the long-term approach as a very solid and invaluable way to build one’s life, family, and home. Thank you for that. Question number one: How has gold and silver, as well, for that matter, held its value and why. How does it function as a liquid asset?”
That is a pretty basic question, isn’t it Dave?
David: Let’s start with the second part of that. How does it function as a liquid asset? There is more volume of gold traded around the world on any given day, than there is money trading through the S&P 500, the largest 500 companies in the U.S, and arguably, some of the largest in the world. So, when you are defining liquidity, one of the things you have to say is how easy is it for me to buy and sell? If you are talking about a Picasso, it may be beautiful, you may like hanging it on the wall, and there may be three other people in the world who want to own it. It is not a very liquid market. If two of those people don’t show up, you don’t have much of a pricing gambit, so to say, if you were wanting to liquidate it. But in a market that trades globally, almost 24 hours a day, to buy and sell gold and silver, it is incredibly liquid.
As you know, Kevin, we were recently in South America, between Argentina and Uruguay. I have a small little street test, if you will, in every country that I ever visit, and it is, how easy can I buy or sell an ounce of gold or an ounce of silver, and I will take a part of the time off when we are not working, and I will go and try to find a venue where it can be bought and sold, and to date, I have not been in a country anywhere in the world where it was impossible to buy or sell. If you look, and you know where to look, there is always a place to buy and sell gold, and this is, I think, outside of the futures exchanges, outside of your banks shifting tons of gold around on a given day, week, month, or year, there is a street-level trade for gold, and it is, in part, because during difficult times, people resort to it over, and over, and over again, as a form of wealth security and source of asset protection.
So, back to the first part of the question, how has it held value and why? Clearly, like any asset, you can see volatility. It goes up and it goes down. Smoothing out some of the volatility by looking at, say, a three, five, seven-year rolling average, you begin to see that it is on a gradual increase. Maybe that is because we continue to see the world economy grow, in aggregate, the world population grow, in aggregate, and demand grow, in aggregate, with a finite supply of metals. It may be that simple. Where you tend to see price spikes is where confidence is lost in a given paper regime. And so, that is where some of the volatility comes in, and of course, price declines where confidence, for whatever reason, returns. So, we have seen over the last two to three years, more confidence in the U.S. dollar than we did in the previous 10-12 years, where the dollar was in decline, and had declined close to 40% relative to the euro index, and gold moved from $252 to $1900 dollars.
So again, you have this give and take, and I think if you smooth out some of those volatile moments, and look at a rolling average, it gives you a clearer picture of its value as a resource preservation tool. And quite frankly, those on Wall Street do the same thing with stocks. Jeremy Siegel, to say, well, that’s unfair, maybe you are just picking and choosing a particular time, Jeremy Siegel, when he wrote his book, Stocks for the Long Run, basically said this: “On average, stocks should be up 7% per year.” Do you know how long his timeframe was? His rolling average was about 50 years. He basically said, over a 50-100 year period, you can expect a 7% return. That may be, in one year, a 30% increase, and in the next year, a 40% decline in equities to get to that average, so it is not to say it is a smooth line.
What we have confidence in when we talk about gold being a source of asset preservation and protection, is that you cannot go out and willy-nilly create more of it ex nihilo – out of nothing. With stock shares, guess what I can do? I can issue more shares in any quantity I want tomorrow morning if the board approves it. With currency, our world central banks are, in an effort, in fact, to support their export trade, and are willing to print an infinite amount of currency units in order to devalue their currency and prop up their economies, so we have less confidence in what can be controlled and manipulated by a few men and women with Ph.D.s hither and yon, that we do something that actually takes hard work to go and get.
Kevin: That actually takes me to the second part of Colleen’s question, which is right down the line of what you are talking about. She says:
“If a fiat currency is completely debased, and one is left with the gold or silver they have purchased, how is it used in transactions in a society that, I feel, doesn’t completely grasp its value? Also, with that, what tools are used in such a case to verify fair exchange when using gold or silver?”
It is a great question, Dave, because we have not been, in this country, in a barter economy, let’s say, or with a failing dollar, but many countries have, and people have gold, they have other things that they trade. They have to know when they are getting a fair value. Do you have a meter for that? Do you have a tool that she can look at and say, “This is a good way of knowing what my gold would be worth if the dollar were not here any more?”
David: First of all, markets are a quick study, and when people are put under pressure, and all of a sudden expectations change, the environment they once were in is now radically different from one day to the next. There is a moment of chaos and panic, of misunderstanding, and then, there are moments of clarity where you begin to sort through, and as the dust settles you understand the new, and can see the difference between the new and the old, so I think markets, which are made up of people, are highly adaptable on a very quick basis.
And going back to Uruguay, as an example, the coins that I bought when I was in Uruguay, it is interesting, they all have different dates on them, and the only ones that were immediately available at the outlets that I went to, the dates of the coins corresponded to currency crisis in Uruguay. So, what I am saying is, there became a quick and immediate popularity and demand for gold and silver when there was a period of currency crisis. Now, this is not a period of currency crisis in Uruguay. It is in Argentina. I mean, literally, you are only an hour’s distance, and the difference is night and day.
Argentina is in currency chaos, and people want dollars and gold. What do they want in Uruguay? They are perfectly content owning the local domestic currency because it has been stable, but I love the fact that you can see this narrative of people moving to the metals en masse. Again, markets are a quick study. People figure out what they want when they need it. And when they don’t think that they need it, they move away from it. That is the case in Uruguay today, it may not be the case tomorrow, but I have full confidence that they would figure things out and demand would increase substantially in what followed.
Kevin: And David, I think it is important to point out, when a currency is failing, even in a complete collapse, people still eat, they still have jobs, they still do things. It is not like we just go back to a caveman scenario. People are trading back and forth, they have to know about how much to trade for various items.
David: Yes, so this is a great back-of-the-napkin calculation. You could share this with your kids or grandkids. An ounce of gold has been, always will be, worth roughly 350 loaves of bread.
Kevin: A loaf of bread for a family, almost a loaf of bread a day, it is about an ounce of gold. So whatever happens to the currency, you can sit down and say, “Hey, is this a fair exchange value?”
David: Yes, am I getting the equivalent of, on a per-ounce basis, 350 loaves of bread a year. The importance of that is, and I can’t overstate it, you go to a place like Weimar, Germany, and all of sudden, an ounce of gold is selling for trillions of marks, and you have lost any real bearings, because the nominal value has gone up so high. Are you a trillionaire, are you a billionaire, are you a millionaire? What does that exactly mean?
Kevin: Maybe you are a 350 loaves-of-bread-aire, if you have an ounce of gold.
David: And that is the important thing. On a constant basis, gold has always been roughly 350 loaves of bread. Now, is there some volatility in that, where one year it will buy you 400, and one year it will buy you 300? Yes, for those of you who are nit-picky on the details, yes, by all means, there is some volatility in that. But again, going back to what I said earlier about smoothing out some of that volatility, if you said on a five-year basis, on a ten-year basis, gold is roughly 350 loaves of bread, and that is a good average to keep in the back of your mind. The last thing I would say, in terms of verifying fair exchange when using gold and silver is that when you are dealing with coins that are officially minted by governments of the world, there is official acknowledgement of how much gold is in that particular coin.
Kevin: It is a great verification, versus, say, a bar from an unknown refiner.
David: Or, for instance, we had, in the 1970s, a family that came in and actually brought what they call gold tails. They had some from Vietnam, and they had hidden these gold, essentially tiles, small, thin bars, in their shoes, leaving Vietnam in a chaotic period of time, and they started a business here in the United States. I can be quite honest with you, I don’t know what that gold is worth, because I have to weigh it, I have to do a market calculation.
The beauty and the simplicity of owning gold that has been officially minted by a government is that you know exactly what the gold is. So, a one-ounce gold eagle, you know that it is one ounce of gold, and you can do that math, that times one ounce times the gold price. A Canadian maple leaf, fairly straightforward. The same with the British sovereign, Dutch guilder, they all have a specific gold weight, and you do the calculation, gold weight times the current spot price, and voilà – you have your market price.
Kevin: Yes, that’s a good rule of thumb, the 350 loaves of bread. You know, Dave, a lot of our listeners from the past, as I have been reading through the questions, really like some of the guests we have had in the past, and want to see them come back, and this was from Vince, a very short question. He said:
“I loved your past interview with Felix Zulauf. What are the chances he will be on your list for the future?”
David: Any of the guests that we have had on the program, assuming that they are still alive, are a phone call away. This is the beauty of what we do in the process of trying to figure out up and down, left and right, in the financial world, in the world in which we live, when we have a question that we think needs to be answered by a particular person, the rolodex does include enough people to say, “Hey, will you join us on this part of the Commentary and share your insights with us?” So, yes, I think inviting Felix back this next year is a given, that is not a problem.
But I would suggest that for anyone listening, if there is someone who stood out, that is very helpful for us to know what was resonating with you. So, feel free to send us comments and feedback if there is something that you really like. That’s great. Let me say this, on the flip side, if there is something that you really don’t like, you can send that, too. If we don’t change things, don’t be offended, because there is a process and a reason for even having people on the program that we don’t even agree with.
So, please, if it is just a desire to create a chorus of support for something that you have done, or believe, or think, we may not provide that for you every week on the Weekly Commentary. Our process is really to sort out all facts and figures from a variety of perspectives and then in that process synthesize toward something that we think is coherent, maybe finding a gem, a diamond in the rough, so to say, and throwing out a lot of the excess or scrap rock.
Kevin: That takes us to Andrew’s question, because he says something very similar. I will give you the opening, and then give you the question, Dave. He says:
“Greetings to you all, and thank you for asking the listeners for questions.” First off, he said, “I anticipate David and Kevin’s Commentary and guests more than any other YouTube subscription I have.” That is nice of you to say, Andrew. “I can’t go a week without it,” he says. “Terrific wealth of insights and information.” Here is his question. He says, “Can you think of one particular guest and/or past archive that really had you both blown away with thinking about the global economy in a different way. If so, please repost.”
David: Oh yeah, to me, there have been a number of things which have been helpful, and this is part of what defines our commentary as our commentary.
Kevin: James. Harold James.
David: Harold James, absolutely. Richard Duncan. Otmar Issing. Russell Napier. Those guys come to mind right away.
Kevin: You even brought up David Walker.
David: Michael Pettis. There are guys that have a theoretical construct that I don’t necessarily agree with, and yet, they have done some excellent thinking, and have some observations that, if ignored, you do ignore at your peril.
Kevin: Dave, when we were talking about this yesterday, when we read the question, we thought about who the people are who come to mind? Almost all of them were people who brought something to the table that we didn’t necessarily agree with.
David: That we were a little bit uncomfortable with.
David: And I think, frankly, if you are looking at intellectual growth and understanding, in every area of life, if there is something that takes you just slightly out of your comfort zone, it has you thinking about something a little bit differently. I would suggest to you that that is a possibility for growth. I don’t want to say it is a precondition, that may be too strong, but there is an opportunity for growth intellectually when you are having previous thoughts, things that you had held to be true, challenged or seen in a different light. And I think, again, Harold James has brought tremendous insight, we will repost. Richard Duncan has been with us probably once a year for the last six to seven years.
Kevin: And he is always uncomfortable to listen to.
David: Otmar Issing, again, just a tremendous insight in terms of the creation of the European Central Bank. He was one of the founding members, and the longest-standing head of the European Central Bank. To see, not only the nuts and bolts of how it was created, but then the existential and personal commitments of the men behind the European Central Bank. As he shared, his father was working at one of the German camps during the war, and he sat down for lunch on the first day of his work there at the ECB with a gentleman whose father was in one of those camps.
What they are attempting to do, in terms of unifying Germany, and unifying Germany to the rest of Europe, and unifying Europe in such a way that war is no longer possible – listen, I don’t know that that is even possible. That may be pie in the sky. But you can see two sons now sharing a profession, and there is an existential draw toward a particular commitment. I think there are things that, for me, are something of a game-changer in terms of adding nuance, and adding some personal color, beyond just charts and facts and figures.
Kevin: And actually, one of the things I appreciate about you, Dave, when you pick the guests, you are not just trying to pick somebody who agrees with you. I know there are other podcasts. I know there are other programs out there where when you listen you are really just listening to reinforce what you already believe. It is more of a cheerleader kind of podcast. This is different. I really do believe that this is a podcast that if you hear something that bothers your past predictions, you look forward to it.
David: Before Russell Napier and I had dinner in Edinburgh earlier this year, we walked up and down the streets of Edinburgh and went to a small church. In that church courtyard was Adam Smith’s grave. Time spent with other thinkers, reflecting on the past, considering present variables, and trying to anticipate the future as best we can, not knowing exactly what outcomes will be, but doing our very best, these would be a few people, and frankly, I could put another ten on the list, but Andrew, those would be starting places as you are going through our archives, and we will be happy to repost them for you.
Kevin: Going on to the next question:
“I have heard your last several guests leaning toward an outcome of deflation as opposed to inflation. Do you agree with that summation? Also, can you please clarify how this is possible with what seems to be decades of consumable goods increasing in costs and U.S. dollars that may come back to our shores if the dollar loses more strength globally?”
The question, and this ties right into the guests that you have talked to, Dave, deflationists, inflationists – where do you stand?
David: How is it possible to have both? On the one hand you have a mountain of debt, and it requires a continual increase of income to service that debt, and so if you don’t have an increase in income, or an increase in economic growth, there is no means of paying back that mountain of debt. So, you can get behind the eight ball in terms of having too much debt in the system. The argument for the deflationists is very clear. There is simply too much debt in the system, and good degree of it has to be unwound.
On the other side of the equation, you have a central bank community, and it is now a universal central bank community, that sees market intervention as a means of smoothing market volatility, and they have taken on a very different role in the last five to ten years than they even had 50, 60, 70 years ago, and that has been to inflate asset prices and to inflate the currency, create more credit and more currency to keep growth trends in place. In that regard, you have to argue that the world central banks, in spite of arguing that they have political autonomy, really don’t. Because what is at stake here is not just market volatility, but also political and social volatility. If you lose market pricing, and begin to see, for instance, what we had in the 1930s here in the United States, it opens up all kinds of possibilities for social and political volatility. Politicians don’t like it, and they like to do anything they can to avoid social volatility.
You see the way the Chinese organize their society and markets to avoid extremes of volatility which could lead to street demonstrations which they could not control. The party is one demonstration away from being out. How large a demonstration? It would have to be a fairly large demonstration. With a million-man army you can quell just about any revolution, at least that you can imagine. Again, a million-man army, and over a billion people in China, ultimately, the numbers don’t work, but what I am suggesting to you is that you have both at one time. You have a consequence of the money-printing that has gone on for years, which is consumer price inflation, and for anyone who would like to argue with the notion of consumer price inflation, talk to your wife, or talk to the person in your family who does most of the grocery shopping.
Kevin: Dave, I have. I have asked, “Is there a single year since we have been married that groceries have gone down in price?” And, they have not.
David: And is that because the price of corn is always going up, is that because the price of rice is always going up, or are we talking about something slightly more subtle, and certainly nefarious, which is, it takes more currency units to buy the same stuff because the value, the purchasing power has been diminished by the creation of too much of those currency units. So, you have that, you have the stock of debt, and your question gets right at the heart of this. It is why we have a both/and scenario, and not an either/or scenario. We do have the threats of deflation and inflation, potentially even leading to hyperinflation as an outside possibility, in play at once.
Kevin: We have had numerous guests, including Charles Nenner, who was on just a couple of weeks ago, who have said, “Gold is good, in inflation or deflation.”
I am going to move to the next question:
“If one were to invest in more silver or gold, which has more value in, say, 30 years. It seems that silver has much more industrial and medicinal purposes than gold, and as far as silver goes, what would you do? Numismatic or bullion?”
So, this one includes multiple questions: Silver or gold, and then numismatic or bullion?
David: Let me start with the gold and silver ratio, because this is a ratio, basically taking the price of gold today, and dividing by the price of silver today, it tells you how many ounces of silver have the same monetary value as one ounce of gold. Today, 71 ounces of silver are the equivalent of one ounce of gold. That ratio is inherently volatile. So, you have it trending as high as 100-to-1, and as low at 15-to-1. Either timeframe, either 100 years, or 200 years, the average is closer to 30-to-1, so we are at 70-to-1, well above the average. It argues for that ratio moving lower, but on what timeframe, I don’t know.
By saying 30 years, the difficulty is, we may have seen a tremendous amount of volatility in that ratio in the next 30 years, so what I would suggest is, neither a silver bug nor a gold bug be, but allow the ratio to speak, whether you should be an owner of gold or silver in a particular timeframe. Of course, silver has more inherent volatility. Because of the size, it is like a micro-cap stock, relative to a small-cap or large-cap stock, there is less volatility in a larger market, and more volatility in a smaller market. But that gold and silver ratio should tell you, yes, you should own some silver today. And, if we get to a 30-to-1 ratio, a 20-to-1 ratio, a 15-to-1 ratio, you should be moving to gold instead. That could happen multiple times over a 30-year period, so if one were to invest in more gold or silver, as the question says, which has more value in, say, 30 years?
One is going to have more or less value multiple times in the next 30 years, and one of the ways that we like to dynamically manage a portfolio, even in bear markets where gold and silver may not be going up in price, is by taking advantage of this ratio volatility, and it allows for compounding of ounces along the way. A bull market is where prices go up, a bear market, prices go down or sideways, and guess what? You can still make money in precious metals if you know how to manage those ratios. We have done that effectively through the years, and that would be the value-added service of being a part of our client deck.
Kevin: And that turns out to be maybe three or four times in a decade, Dave. This isn’t day-trading. But it does compound ounces dramatically.
David: And I agree, the long-term prospects for silver, if you look at the industrial and medical uses, they are astounding, and you are constantly depleting the supply of silver versus increasing the total stock of gold. So there is an argument, long-term, for significantly higher prices of silver. One of the things you will never see with silver, that you will with gold, is massive tonnage accumulation by central banks, so there is sort of a to-have-and-to-hold relationship with certain investors and/or central banks, that silver doesn’t have. It tends to be either dissipated through use, or acquired and sold on a more speculative basis.
The last part of that question: As far as silver goes, numismatic or bullion? I think, frankly, the bullion is the place to put most of your emphasis on. There are a lot of changes in the industry which are creating new numismatic coins out of new coins, and I am not exactly sure that works, but I don’t think it is going to turn out very well. I think you should focus on bullion silver when you are looking at silver in a portfolio, stretching out to something like circulated silver dollars as the most collectable coin you would probably want to own in that space.
Kevin: The next question, Dave, and the last one for this week’s program:
“What has been fixed since the crash of 2008, and what is the biggest bubble threat in your eyes? Is it bonds, student loans, or derivatives?”
David: What has been fixed? Certainly, we have repaired sentiment, and that is the main thing that has been repaired and I would say that is a very effective PR campaign that has gone on between the Fed and Wall Street and of course, your government statisticians. So, repairing sentiment isn’t actually repairing the economic underpinnings for future growth. So, to the second part of the question, what is the biggest bubble threat in your eyes, bonds, student loans or derivatives? Well, derivatives are the biggest threat, but they are not a first concern, and the reason I say they are not a first concern is because there is no problem in the derivatives market unless there is a problem with the market they are a derivative of. So, that would mean something in the bond world has to be called into question.
Kevin: Or stock.
David: Or stock market. These things have to come under pressure before you see the knock-on effect in the derivatives market. And so, while the derivatives market is the thousand-pound gorilla in the room, it is actually other areas which represent triggers for vulnerability. It is almost like when you look at an explosive, you need not only the explosive, itself, but you need a charge. So, what is it that sets off the big explosion? I am very concerned about what it is that sets off that big explosion. Derivatives are the big explosion.
Kevin: What about student loans, then?
David: Student loans – there is really no pin chasing the student loan bubble. It is a big problem, but it is not a problem that has an immediate catastrophic effect, and I say that because one person says, “ I can’t pay my student loans,” but that doesn’t cause the whole system of student loans to unravel. You have students who have been going to school and accumulating this debt. Really, over the last ten years it has grown to 1.2 trillion dollars, and that is a huge part of the growth in consumer debt, there in that student loan category. But you are not looking at something that has the same vulnerability as, say, what we were talking about at the beginning of the show, which was the oil patch.
The price of oil is dropping. 16% of the junk bond market is attached to companies which have financed things at a very high rate in the segment. You begin to look at the knock-on effects of a lower oil price into, not only the junk bond market, but ultimately, the entire fixed income space, and it is a very, very big deal. You can’t have the same sort of domino effect in the student loan market, and quite frankly, that is an area where the government may just step in with a political opportunity. Look for the next mid-term election or major election. What a great way to buy a generation’s worth of votes.
Kevin: Oh, sure.
David: We talked about the dark side of democracy already today. It is a question of whose money you are spending to buy what votes, and that is what you have as an opportunity with student loans. Somebody is going to come along and say, “We’re going to forgive a certain amount of these loans, and we are going to set it up on terms that are almost the equivalent of forgiveness, and you are going to see a mass of students, a new generation, say, “This is good stuff.”
Kevin: “You have my vote.”
David: “You have my vote.”
Kevin: Okay, the bond market. You talked about how oil prices had triggered a bond market correction, but how about the overall bond market? Is there a single trigger that would create an interest rate spike?
David: This is such an interesting thing, and this is one of the reasons why I like having conversations with the Napiers and the Duncans, and what have you. As we have explored even some of our commentaries with folks who grew up in China, and are familiar firsthand with a command economy, what we see today in the bond market is something where prices are controlled, and they are controlled very deliberately, the Fed will continue to write big checks and control those prices because they simply can’t allow for rates to go higher. And the day rates do go higher, and they lose control. You were talking about the end of the bond market, you were talking about the end of an entire segment of bond investors who assumed that bonds were safer than stocks.
Kevin: So, is that a potential bubble pop?
David: It is. There is just political calculus involved. It is one part market calculus, one part political calculus, and which trumps which first is tough to say.