In Transcripts

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“Just get very defensive, and let this game play out. Let the opportunities come to you. And don’t try to be a genius here. The smartest people in the world are still trying to figure out how to play this. And again, after five or six years they’ve come to that realization – just get very defensive, have a nice cash reserve, and be ready to move when you need to move because things could happen very quickly.”

– Bill King

Kevin: Our upcoming guest here, Bill King, is one of my favorite guests. I love the way Bill ties history together as if he is as fluent in it as his own family history.

David: 40+ years in the financial markets on a daily basis, including weekends, because I don’t think he ever sleeps, or takes a break. It begins to pay off in terms of the accumulation of insight and understanding in the marketplace. Every day he puts together the King report through M. Ramsey King Securities, and it is something that, as an office, we wouldn’t do without. It is an invaluable tool for us as we aggregate information and try to anticipate what the markets hold for us, the gyrations which can be very positive, or very negative.

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David: Bill, great to have you back on the program. Since the start of July we have had 24 separate policy measures in China in an attempt to prop up the stock market. And of course, we had overseas shipments which fell 8.3 percent, that is, Chinese exports were considerably lower, and in response to that you have the Chinese devaluing their currency. This is a pretty big deal. Maybe you can unpack this for us a little bit.

Bill: Well, you are absolutely correct. It is a very big deal, and I think just your introduction has articulated how serious this is because China has taken so many drastic steps, including the [unclear] of their stock market and this record devaluation. It underscores the seriousness of what is going on economically in China. And the reason they are alarmed, and this is what should scare everybody, you saw China for a number of years try to slow their economy, and now that it is tumbling they are alarmed. You have to say, well, why are they alarmed when in the past they were hoping it would cool down some measures?

And it keeps coming down to the one fact that is hanging over the whole world – debt, too much debt. So, everybody – and this has been going on since 2008, 2009 – is scared to death. All your central banks, all your major sovereign nations, are scared to death of debt deflation, and they are doing whatever they can to slow it down. So, we had China, a couple of years ago, trying to slow down. They were afraid of over-heating, they were afraid of all the debt. Several months ago they decided, “My gosh, we might have a debt deflation,” so they go to this hyper-stimulation, they created a stock bubble, they were pretty open that they wanted to drive stock prices higher so their indebted corporations could do like U.S. corporations here – issue stock and pay down their debt, and get some of the investors and banks and others more liquid.

Instead, just like what has happened here in the U.S., and in Europe, the higher prices created more leverage, created people buying and levering up, taking on more debt to do the stocks. So it exacerbated the problem, and then you get a bubble, you get the margin debt going, it starts coming apart, you get the liquidation, and you get the debt deflation. So, whether it is Greece, China, U.S., Europe, you can run through the list – this is a problem. This is a big problem in the world – too much debt, unserviceable, which is why we had the crisis of 2008 and 2009. The solution was for sovereigns and banks and others to take on even more debt, and those chickens are coming home to roost now.

David: I think of the City of Chicago. Explain to me the rationale of investors who are more than happy to over-subscribe a billion-dollar issue in City of Chicago debt. Obviously, Chicago is in a bit of a vortex. You probably know this better than most. You know the area, you know the geography. But indebted already? Yes. Up to their eyeballs in debt? Yes. In need of an extra billion dollars? Yes. But who are the investors who line up and are able to actually disconnect credit risk with the income offer of – what was it? – 5.5 or 7.5, depending on whether it was tax-free or taxable? I don’t get it.

Bill: Well, there are two things there in response. First – is the debt going to be paid back? Probably not. It is unserviceable. But, we are in an era of investors in treasuries playing Old Maid. Even in the U.S. – is there any chance the U.S. is ever going to pay off its debt? No, especially with the demographics and the baby boomers. But you have bonds here, U.S. bonds, trading at ridiculous levels. Why? Well, because people think that is a place to be and that they are going to be nimble enough to get out before the ship hits the waterfall, or the end of the earth.

And the same thing with the City of Chicago. You have people in here chasing yield, you have a nice yield, and there are probably some under the delusion that they can keep playing this game for eternity. And you see that. You see how debt doesn’t matter. Some renowned economist said it doesn’t matter how much debt, we can just play this silly game. But others just are in this feeling that they are going to be nimble enough to jump out before an accident happens. And then there is also the other thing – you don’t know the politics, the arm-twisting, who is being told you had better buy this, the people that want to do business with the city. You can have people here buying these things because they are beholden to the city, or the politics, or whatever.

And they could buy on the issue, but you don’t know if they are selling out to some bond fund, or whatever, to get out, but they are making public that we are in this, but you don’t know how soon they come out. Just like an IPO. How many people are buying it just to dump it quickly? So, there are several working parts here, but you have outlined this situation – why would you do this? And there are a number of reasons why, and I think two things are the political arm-twisting, and people that think they are going to be nimble enough to jump off before the shipwreck occurs.

David: We are already seeing widening credit spreads in junk starting to be treated a little bit more like junk rather than some prized possession. Is there enough stress in the credit markets to say, “Actually, we’re not changing course, this is going to be problematic?” Or could we see treasury rates back around 2% on the long bond – 2.25, 2.5, and junk bonds back at 5, 5.5?

Bill: That’s a great question. The problem that we are all operating under is, there is unprecedented intervention by sovereigns and central banks, on a global basis. In the past we may have had Weimar, Germany or isolated cases of a country or two doing something. But on a global basis because of this debt problem everybody has, there is unprecedented intervention. And the problem you have, if we look historically, if there are wage and price controls and you peg commodity prices like Nixon did, and they sit there, and you are pegged and you are pegged and you are pegged, and nothing is happening. Then all of a sudden the dam breaks loose, and you have this horrible adjustment. That is the major risk for everybody out there.

And that is what the Fed understands. And the Fed is talking about hiking rates, and they are not that stupid that they don’t see what is going on in the world, and in the U.S. economy. There are a number economic metrics that are screaming recession here. The Fed knows that, and they know the employment games are hokey and low-paying gigs. But they understand that they have got to start moving to normalize or the adjustment is going to be that much more vicious, and we don’t know – nobody knows when this thing is going to show up, this adjustment.

We all understand that this thing can happen very quickly because it is a confidence game, literally and figuratively, a confidence game here, and when it goes, it’s the same thing that happened in 2008. We had trouble the whole year, stocks, everything hung in, the Fed is going to do this, the Fed’s going to do TIF, they’re going to do the TSLF. They did all these different measures and people held in, including hedge funds. Then all of a sudden, Lehman goes down – boom, boom, boom – the whole economic and financial system was in collapse, and they had to do what they had to do over a number of months to save it.

Enough professional investors have not learned what happened in 2008 and 2009, that this thing happened very, very quickly. They denied it, they denied it, they kept throwing measures up there to keep the market from collapsing, and then finally it just got overwhelmed and it collapsed. So, you are right, that is the risk, because you sit here, you sit here, you look at it, and then you have people here that just say, “Oh, no big deal, the Fed is going to intervene, the government is going to intervene, it is not a problem,” and all of a sudden, boom, ba-boom, ba-boom – and it happens too quickly. And that is the risk here.

David: So, we’ve got several things in play. We have equities that are reflecting massive amounts of market intervention, also bank speculation and the re-leveraging that you were talking about earlier. You have central bank activism, which is really the lynchpin, and you have a fundamental mispricing of risk. And at the same time, very few people are appreciating the amount of risk that is in the system today.

I’ll give you an example. A city manager from a big city out in California was in town this last week, and he basically said, “You know, the economy is rocking and rolling.” And we looked around, and “What’s this? The economy is rocking and rolling? What do you mean?” And his response then was, “Well, the Dow is at 18,000, of course.” And it’s like, if you can push that number higher, the common belief is that the economy is just fine. And it is as if a massive PR campaign has succeeded in convincing the vast number of people that there actually is very little risk in the system, that the central bank’s efforts have succeeded, and that we have already passed the all clear, which is why we are moving toward a September rate hike and no one is questioning that the economy is in full-blown recovery. Look, unemployment is at 5.3%, and we’re on schedule for September. Does this seem strange?

Bill: Well, only a handful of people believe that the stock market reflects the economy. The average guy gave that up in about 2006 and 2007 and the idiots on Wall Street were screaming at people, “Can’t you see how great your economy is? The stocks are telling us.” We had one ersatz economist telling everybody on CNBC, “You don’t get it, the stock market is telling you things are good.” Well, no, he didn’t get it, that it wasn’t that good, the economy was not that good for the average guy. It was just Wall Street and the money changers and the money printers that were making the money here and the same thing is going on now.

The difference now is that people in the Fed recognize this. The academics – over the last six months you have seen an increasing number of academics, especially those that lean left, Keynesians, even some monetarists, saying, “Yeah, we’ve got this concentration of wealth problem, and it’s because we’re taking money from savers and retirees and passbook accounts and CDs, and giving it to Wall Street to speculate.” They understand that. The Fed knows that. That is why you see the extreme doves like Williams in San Francisco, Dudley in New York – the financial center people – starting to back away from their dovish talk. They have been talking more hawkish. They have been trying to talk hawkish to talk the market down.

That’s the mistake the Fed made because they’re academics. They’re not traders, they’re not bankers. You can talk a market up easily. It’s hard to talk it down, and history has shown that. This is Edson Gould’s old three steps and a tumble, and it took the Fed at least three rate hikes before stocks would react and roll over. And it’s the same thing that is going to happen here. They’re trying to talk the market down, but the market’s not buying it, and it’s going to take some action here from the Fed to stop this, or it’s going to be like 2008, where everybody was bullish. For crying out loud, we had the all-time high in the Dow transportations in July 2008, at the same time oil made an all-time high, and we were at least two quarters into recession, so what the heck was the stock market forecasting then? It totally missed it, and as you stated, it is totally missing what is going on now.

And people understand that. And all week they might have been scratching their heads, but people understand right now, and Bernanke said, and other central bankers have said, China and Japan and the government leaders said, “We’re going to push stock prices up and try to create a wealth effect so we get our economy going.” And it’s not working. What it has done is, yes, New York City has done well, Silicon Valley has done well because of the stock speculation, asset speculation, prime property speculation, but the rest of the country is not doing well. In fact, it is receding.

And that is happening in Japan, it is happening wherever these policies have been going on. Happening in China the same way. So, that’s their problem. They played this card – it’s not working. But what they also understand is, we pushed these asset prices up and it has not really helped the economy, but history tells us if this stuff starts crashing we have a real problem because then the confidence goes out the window, then all these credit spreads and things you have talked about blow up, because then, as Warren Buffet said, “When the tide goes out, you see who’s naked.” Once the tide washes out here and people get concerned, there’s a lot of ugliness here that is going to be exposed, and more than being exposed, it is going to force people to reckon with that ugliness that they have been ignoring. And debt is the real issue here, because you take the opiate of the high stock prices away and then you see people start scrambling.

David: It is interesting, there is a bit of a conversation in the U.K., a guy who is rising in the ranks in the Labor Party by the last name of Corbin. He is suggesting that we need less QE for the banks, more QE for the people. And rather than say there is a problem with QE and a failure in the monetary transmission mechanism he is saying, actually, we just need to get rid of the middle man. And I think to myself, is that the way you cope with a mistake?

Bill: The problem is, the QE for the public has been done for decades, which is the entitlement programs. And all the QE that we have been doing since 2009 is entitlements for the one-tenth of one percent. It’s not the one percent, it is one-tenth of one percent – that’s their QE. But where are the people getting the most pressure? The middle class, the merchant class, because they’re not getting the QE. The entitlement spending and everything has gone high. That’s the reason why the U.K. is having a conservative revolution. That’s the reason why Donald Trump is soaring here, because the middle class is getting killed, because you are getting QE for the top end, and you’re getting QE in the form of entitlements for the bottom end. And in between, the people getting squeezed are the middle class and the merchant class.

And that is the problem. That’s why the Tea Party rose up after the 2009 debacle. Nothing has changed for the lower class. They’re still getting their entitlements. In fact, it has increased. And the upper class is getting the QE benefit of the equities. And of course, the QE also benefits the lower, the entitlement class, because it doesn’t put pressure on the government to reform the entitlement. As you said, it is in Chicago, it is in the state of Illinois, in Cook County, the rest of the country. Nobody is doing any entitlement reform. They are screaming about Greece and the same thing is going on here.

But the people who are getting killed are the middle class, the merchant class, the independent business people. They are the ones that are taking the hits here, so you can support the flat ends of the L curve here in society. But that is why you see Bernie Sanders getting these big crowds and enthusiasm – same thing with Donald Trump – because anti-establishment sentiment is just soaring. And that happened in the U.K. with their election last May, where unexpectedly, the conservatives came in. That’s why you are seeing this revolt against immigration, because the people that are getting clubbed by immigration and have tough economic times understand how immigration is hurting them. And you saw that in France with Le Pen, a conservative, a year or so ago with her election. So, this is not just the U.S., this is a global trend here. And there are going to be ramifications between now and 2016.

David: Let’s circle back around to the Chinese because it is something that has implications outside of China, clearly, regionally, even overnight, so you see a 2% devaluation in the Chinese currency and a number of commodity currencies, including the Aussie dollar down 1%, at least, and it is kind of a knock-on effect. Is this the equivalent of a currency war? You could argue we have already been in it for enough time, but are we moving into the next phase.

Bill: Yes, it is not the equivalent of a currency war, it is a currency war. And this is the next escalation. For those of us old enough to remember Vietnam, they talked about an escalation in the war. You bombed harder, you did something, you sent more troops. You got it right. It is an escalation in the currency war that has been going on for years. Beggar thy neighbor, export your way. That’s what Japan did. This was the point of Abe-nomics. They said, “We’re going to crush the yen, and this will do two things. It will boost our exports, and it will boost the stock market and we’re going to get the economy going.”

And it didn’t. It did not. And it is killing the Japanese middle class the same way – the savers, the retirees, and they can’t get their economy going. The people haven’t figured out that QE is deflationary, because it reduces your interest income. It helps a few. It helps the people that own stocks. But by and large, it crushes your predictable income stream. If anybody took portfolio management 101, they understand that all your decisions, your spending, whether it is a consumer or a business, as far as capital spending, or your pensions, are all based on your fixed income portfolio, your predictable income stream – your passbook savings, your CDs, your money markets, your bond holdings. Then you go up to stocks or whatever.

And that’s what these idiot academics at the Fed didn’t understand. Part of it is because of their lack of real world experience in banking and industry, part of it is because they ignored even academic research because it didn’t fit their theory. But that is how it works – predictable income stream first, and if you sit down with anybody, with your wealth managers, which is basically stock brokers now, the first thing you have to have is a predictable income and earnings stream, then you build your stock portfolio, and then from there you can move out to your gold, your silver, your farmland, your commodities, whatever you want.

But first and foremost, you have to set up your fixed income stream, and that’s what these guys have destroyed on a global basis, and that’s why it’s deflationary to the average person – not just in actuality, but mentally. When you, as a retiree, are used to getting 5-6% and all of a sudden you crush it down to 0.5, you cut your predictable income stream by 90%, what do you think you’re going to do? You’re going to go back to work at Walmart, if you’re retired, you take on a second job, your spending goes to hell. That’s the problem.

And these idiots in the central banks [unclear], well, I think some of them figure it out, but they see no recourse. In fact, that’s what Draghi said a couple of months ago to retirees. He said, “Yeah, I know we’re killing you, but you’re going to thank me later because higher asset prices are going to be good for you eventually.” What kind of B.S. is that? He’s telling you, “Yeah, you’ll get eviscerated, but eventually, the one-tenth of one percent will be doing so well, they’ll get the economy going”. That’s garbage, and that’s why you’re getting this political revolvement here, worldwide.

David: Yes, it seems like you’re setting up something that is ripe for social disjunction. We had 1968, historically, which is sort of the summer of chaos and a trend-setting for a lot of change thereafter. We are talking about the summer of 2015, the summer of 2016, where it’s a little bit different than the Arab Spring, but it is an expression of social frustration, the middle class being eviscerated, it not being a U.S. issue, but a global issue. Something I have raised as an issue in the office is that the stakes may not be financial in nature, but in past periods of de-globalization it was tanks and bombs and guns. Financial issues led to much bigger issues, and we sacrificed entire generations of young men to solve problems that came out of those financial crises.

Bill: Well, that’s a possibility, and the people [unclear] say, “Well, we’ve been in a state of war since 2001 with the September 11th attack.” And there is a lot of merit to that. The problem is, World War II took about three years or so to win. We have been now, going on 15 years here, 14 going on 15. What have we done? What have we done? The old story is you have taken half measures. At least in World War II the objective was clear, to defeat Japan, the defeat Germany.

Now, there is no stomach for it, there is no objective for it, it is all Chamberlain-isms. “Well, we’re going to negotiate this, we’re going to ignore that, we don’t want to get our hands dirty, we don’t want to be involved, blah, blah, blah.” You had that conflict, you got it over with relatively quickly. When you think about it, D-Day was June, 1944. By May, 1945, you were done with your war in Europe, and then in August you were finished with Japan. So as far as the actual conflict, there was planning and there were things going on – there were excursions in 1943 in Africa, and some of the other areas, Italy, whatever, after that, but the big assault was relatively quickly.

What are we doing now? How long are we going to pitty-pat around? This is worse than Vietnam, what we are doing now, but still we are going the same thing – half measures. What are politically acceptable measures? What are the least-we-can-do measures, instead of going in like Eisenhower did in Europe, or actually, like Patton was doing, which would be probably the better thing? Instead of doing a Patton on this stuff and getting it over with, we’re not.

David: So, we’ve got fundamental mispricing of risk in the market, we’ve got central bank activism on a scale, as you said, that is unprecedented, the amount of intervention that we have. Do we just play this game for another 20 years and watch the central banks manage their rabbit-beating program?

Bill: No, you can’t, because we see the market forces and what is going on. It’s starting to revolt against that. But the other thing is, you have lack of political will.

David: We have clients all the time who say, “Listen, they’ve taken us a lot further than we thought they could. Who is to say they can’t take this another 20 years?” And I don’t know that I have the perfect answer (laughs).

Bill: Well, you can’t, because the numbers tell you, the mathematics tell you, that it is collapsing on top of you. Greece tells you that, China is telling you that. If nobody was doing anything and we were just sitting around, that’s one thing. The global conflicts are telling you. It’s the lack of political leadership in the United States, the will to address serious problems, as well as Europe, the leading nations, the world leaders, they don’t have the political will to do what is necessary. That is the problem. They don’t have the will to go in there and do this stuff, whether it is in the Middle East, whether it is with the economy.

And besides the lack of will there is the corruption – there is the rampant corruption of the political process, worldwide, that is people just saying, “Let’s hold on, let’s just hope this doesn’t get any worse.” And this is basically what Europe did when Hitler was on the move. “Well, he hasn’t hit us yet – he’s just fooling around with Czechoslovakia, the Sudetenland. He just did the Anschluss with Austria. He hasn’t hit us yet. Everything has been really okay, so let’s just hope we can hang on for another 20 years and then Hitler will die or something.” Come on, we’re past that stage here.

David: So, classically, if you have too much debt, you can default on it – that’s one solution. You can have the soft default via a slower process, what we know as inflation. You kind of work around it a little bit through financial repression, but it’s not the best solution. How do you think we solve a world that is too much in debt – corporate debt, government debt, private debt – swimming in it?

Bill: You default it or you hyper-inflate it. In the 1970s, even in the 1960s, they tried a slow, partial default via inflation. Everybody with half a brain understood it. But you saw when the revolt happened, Volcker had to come in and administer the medicine because it just got too severe. The problem is, everybody is trying to inflate. The average person sits there and listens to these idiots from the Fed and these idiot economists on Wall Street saying, “Oh, we have a problem, there’s not enough inflation.”

And people are sitting there with their incomes stagnant or receding and they are saying, “Are you kidding me that we need more inflation?” No, they’re talking from a government, from an indebted standpoint. The indebted need inflation. In human history, progress is marked by lower prices. That’s why you built canals in the 1800s here. That’s why you built railroads, and you had reapers and harvesters – to lower prices. That’s why you have the Intels to make less costly and more powerful computer chips, to lower the cost. That’s what human progress, standard of living, comes from – not higher prices, from lower prices – the Model T, the assembly line. These idiot economists say, “Oh, well, the problem is that we don’t have enough inflation.”

And the average guy is saying, “Are you kidding me? Not only is the government accounting for inflation ridiculous, and everybody understands it doesn’t really tell you what inflation is, but the average guy is saying, “Are you kidding me? I need more inflation?” No, that is people that are big government, people that are indebted, that are screaming, “We need the inflation.” That is so ridiculous. And again, that is where people lose it. They are saying, “What are you talking about? That inflation is good?” And historically, it has not been good. It has been horrible. Also with inflation is marked lower living standards and lower progress. But it is a way to get rid of debt. That is the only reason people are saying we need the inflation here. Again, it is idiot academics and central bankers who are talking from what favors them, not from what favors the average person.

David: What happens if you default?

Bill: Well, then you start over. The first thing is you have the chain reaction of wiping out wealth and capital. And then you see where it settles. That is what they are all afraid of. They don’t know where it’s going to stop. They don’t think they can stop it once it starts, because it is so vast, and we don’t know. We don’t know – we just don’t know how far it goes. But we know the longer they wait, the worse it will be – the worse the adjustment is, and they’ve been doing this for at least 20 years now, trying to keep the day of reckoning at bay.

The U.S. has been doing this for a while, as has Europe. Europe has been in decline since World War I, actually. And you go through this whole process, but it really took, in the 1990s, when you had – first you had the Mexican default, the Mexican problem in 1994. And you could just see, we had the 1991-1992 with City Bank, and the Bank of Boston, Bank of New England, the different money center banks that all disappeared – Banker’s Trust, Chemical Bank. You had Chase going with J.P. Morgan – all these – Manufacturers Hanover. These were money center faces that all just disappeared. And that was the first, when Greenspan just started really printing the money, the carry trade, and then Japan – we went through these series of crises in the 1990s. 1997 – Asian Contagion. 1998 – you had Long-term Capital Management, you had the Russian default, you had Monica Lewinsky. So what did you do? You created a bubble here, a stock bubble so everybody would not see this and forget about it.

Of course, then that all blew up and you had 9/11. Was it Brazil in 2003 that defaulted, or [unclear], whatever? That’s when they bring Bernanke in in late 2002 because Greenspan is worried about debt deflation and Ben is giving the helicopter speech that we’re going to print off all the money we can to keep the deflation at bay. Then you create the housing bubble – that pops, that blows over in 2006 and you just see this series of crises. And even though the U.S. after 2009 started moving up, Europe has been in a series of crises from 2011 when you went through that whole with the PIIGS, saving all those countries, saving the banks, and it is every nine months to a year, another European crisis shows up, but very little has been solved.

The only one that really solved their problem was Iceland, because they did default, they did stop all the nonsense, they didn’t take all these loans and all this other stuff from the ECB and the IMF and whatever, and they kind of got out of it. But they were smart, they got out of it. Just like a bad trade. You get out of it, that first loss is your best loss, before it keeps piling on, but that is where we are here, and the world has been in search of a safe haven for six years now, and everything is overpriced because interest rates are so low. It’s not that you just have a bond bubble. Greenspan alluded to this just the other day that we have this bond bubble sitting here. It’s beyond a bubble. It’s a corner.

There is a difference between a bubble and a corner. The central banks and the sovereigns have cornered the bond markets of the world, because it helps them service their debt. That is what should be on everybody’s mind. Yes, the stock market, it’s important, and China, this whole thing. The real issue is when the bond corner breaks, when people just say, “Nope, that’s it.”

And it will show up first in the currency, because that’s what you would do, you would get currency exposure first. And that’s the issue here that could a real problem for China. Once you start down this road of pushing currencies downhill, and the market believes it is a one-way trade, or they get concerned, the only way you are going to stop that is really draconian interest rate hikes – that is the only way. Or you have to change your national policy, which is very hard to do. That is why currencies trend better than any vehicle, because it is very hard, very tedious, to change your national policy.

David: Even in the way I set up the question originally, yes, it’s a one-way trade in the sense that 1.9% devaluation doesn’t get you anywhere. That is not enough to give you trade advantage. It is maybe the first olive out of the jar but it certainly is not sufficient if you are trying to achieve a trade advantage. Maybe there are other things in play, but my presumption is that it is the first of many. It would be difficult, I would think, for many to see it otherwise.

Back to the U.S. markets. We are dealing with the Fed, who is not willing to deal with their fear of the unknown. That is really what deflation represents is fear of the unknown. And on the other side of the equation they are willing to throttle things with a certain presumption of control. How do you disconnect a poor record with presumption of control and positive outcomes? Because if the Fed is reflective at all, if any central bank is reflective, this is more art than science. You don’t always get it right. In fact, a lot of times you get it dead wrong. And yet, there is this, “We’re just going to throttle this a little bit, a little bit more inflation here, and then everything is going to be fine, we’ll begin to raise rates. We’ve got it under control.”

Bill: Part of it is arrogance – only the arrogance that academics can have because they don’t have real world experience. Their experience is brow-beating teenagers or young adults into their beliefs to get the grade they need to pass a course or to get into graduate school. We’ve all had that experience. It’s a different matter to brow-beat somebody when you hold a big axe over their head and they can tell you junk, and push junk on you, and have you believe junk, and write up in junk so you can get an A or B in the course, but in the real world it doesn’t work.

That is the biggest transformation that I’ve seen in the Fed is when you went to Volcker he was the last guy that had real banking experience, coming out of Chase bank. He was a banker. Greenspan had zero. Greenspan was – I hate to call him an academic because his whole academic record is an issue as to what he really did to get his Ph.D. He was a horrible forecaster on Wall Street. Townsend-Greenspan – it was actually kind of a joke on the street. People couldn’t understand why they put him in at the Fed except that George Bush wanted to be president, and Jim Baker and these guys wanted Greenspan in in 1987 – he came in in August of 1987 because they didn’t want Volcker to do a Volcker right ahead of George H. W. Bush’s election in 1988.

And that is why Greenspan was brought in, because he was compliant. As we have found out he has done throughout his history, whether he was sitting up there with Hillary Clinton, next to her at the State of the Union, Bill’s first State of the Union, pumping the money when the Lewinsky scandal broke in January of 1988 to keep Clinton from being convicted in the Senate. That’s what Greenspan did and that’s why he was brought in, not because of his record. He wasn’t a banker, he wasn’t a good forecaster, and Bernanke was brought in because he appropriated Milton Freeman’s life work, and that’s why he was called a deflation and depression specialist because he would just say, “Oh, we’ll just print everything we need to print.” Really? That’s a sign of being smart and being a genius, is that, “Oh yeah, if we have deflation we’ll just print everything we can to stop it.” And that’s why they brought him in.

David: Well, it sounds like that is what is being paraded now.

Bill: Yes.

David: You mentioned a minute ago that for six years the world has been looking for a safe haven. In a world of competitive devaluations with this instinct for a safe haven, but with asset prices pretty high pretty much everywhere you look and go, what is a safe haven? What is a safe haven, in general? Where do you go, bringing this down to brass tacks?

Bill: There is nowhere now, because as you were alluding to before, this game has been played now for many years. There is so much money, everything is overpriced. Everything is overpriced, and that is what you just don’t know. What you don’t know is where the next liquidity preference comes from. That’s what – decades ago that’s the – in the 1970s, the money ran into real assets. In the 1980s, when Volcker cut loose in July of 1982, the money ran into financial assets. And that’s kind of a normal cycle. They were grossly underpriced, and that’s why you saw these LBO guys, the KKRs and these people just pop up and do very well. And then, the same thing in the 1990s.

Then when you got the great U.S. stock bubble, the most underpriced vehicle was commodities. That’s why you saw the – some people say the super cycle began – gold, oil, and just go through the list – copper – all this stuff was really bottoming around the late 1990s, and then just took off. That’s where you needed to be up until, you could say, 2011 when gold and silver peaked, but oil peaked in 2008 – there were signs there that things were happening, but that’s where you should have been. Now, they pushed everybody, again, they cornered the bonds. They pushed stocks higher – you’ve got central banks buying stocks, whether it is Swiss National Bank, go through the whole list – China, Japan – they’re buying stocks, which is mind-boggling. Ten years ago nobody would have thought that this would have happened.

So, once you start over-pricing bonds, then it goes into stocks, it goes into farmland, it goes into prime real estate, etc. What people that have means and brains are doing now is trying to figure out what is going to decline the least. Where is your store of wealth? At this point you don’t know, so the best avenue is to have a broad portfolio, with liquidity. That is all you can do at this point. Have a little real estate, some previous metals, and liquidity.

Maybe if you have farmland, maybe different types of real estate – you have to be very careful with the type of real estate you want to own, but you get some industries that have great balance sheets, with little debt, but you want a nice cash hoard so that you can move. If we start inflating, the market picks up the inflation, the liquidity preference of the critical mass of investors is to go for real assets – you can run to that very quickly.

If you are going to have deflation you have an ample cash reserve that you can wait and pick up bargains very carefully over a long-term basis. This isn’t something where you run in one day and CNBC says, “Oh, this is the bottom in oil. Buy it.” Which they did in June – this is the bottom in oil, 70-some percent of the people said, yeah, okay, and it kept going down. That’s what is going to happen. People did not lose a ton of money in the 1929 break. Not one firm on Wall Street went bust. Where they all went bust was in 1931, 1932 when it just kept going, and that’s when Jessie Livermore went broke. He made a fortune but he bought all the way down. That’s when people lose money, when you get into a protracted bear market, let alone a deflation. You keep buying all the way down. People just can’t believe how low these things can go. That will be the risk on the way down, the people that were bears for years, if not decades, quickly start buying on the way down. That will be the issue. Again, it always is.

David: One of the things we never saw in 2009 was a real capitulation, psychologically in the stock market. We got to values, if you are looking at the Q ratio and in the cyclically adjusted price earnings ratio – it got to discounted levels, but nothing like what we saw in previous recessions or depressions – nowhere close. What you are talking about is a broken sentiment, somebody who doesn’t want to look at stocks probably the rest of their life, or whatever the asset class is in question. Are we moving closer to that? When you say that people of means are just looking for assets to be able to lose less than they would otherwise, but the assumption is, you’re going to, you have to. At this point everything is overpriced, there’s really no getting out of it. I’m looking for the pot of gold at the end of the rainbow (laughs).

Bill: Well, everybody is. They’ve been looking for five years, six years, and it has been this rotation, first you had oil and gold and silver went up in 2011 when they started doing the QEs, then that thing broke. You had the real estate people run the real estate, especially prime properties in certain areas, but if you look around the country, that game has ended in the last few months. You’re doing the biotechs. On a global basis, you can see that everybody is running, trying to say, “Where do we hide out?”

The average guy, though, is not doing that because he doesn’t have the means to do it, and the time, and the mental energy to do all that stuff. But the very wealthy people have been running on this treadmill and now they’re just slowing down and they’re just sitting there, they’re getting liquid, they have what they consider a balanced, diversified portfolio, with a lot of cash, and they’re just waiting now to see where they should go. They’re not getting ahead of themselves, they’re not getting ahead of the market, they’re not getting too far over their skis – whatever cliché you want to use – letting the game come to them, etc.

I guess that would be the best – don’t get out there, just get very defensive, let this game play out, let the opportunities come to you. And right now that is the best advice that anybody can give, and the best advice somebody should adhere to. Don’t try to be a genius here. This is really, really tricky. The smartest people in the world are still trying to figure out how to play this. And again, after five or six years they’ve come to that realization – just get very defensive, have a nice cash reserve, and be ready to move when you need to move, because things could happen very quickly.

David: The tone of our conversation today captures what is deep in my gut. There is very little that you can do that is – “Well, here’s the answer, here is the solution,” one that you feel really good about (laughs).

Bill: Yeah.

David: It seems to me, Bill, that part of the safe haven solution is cash, part of the safe haven solution is precious metals, and help me wrap my mind around this because there is the two-tiered market between the physical market and the paper market, and most recently, the paper gold market is upwards of 124 times the scale of the physical market in terms of what is deliverable.

Bill: Yes.

David: Talking to some of the exchanges, we have a delay of two weeks on kilo bar delivery, we have anywhere from 12-20% premiums on your smaller silver items. 1000-ounce silver bars are still plentiful, with no premiums. But you are beginning to see stress and strain in terms of supply and demand, and yet, in the paper world it is still just getting beat to snot – absolutely beat to snot.

Bill: And this is the thing we don’t know – how long? Again, every billionaire I know has a big stash of cash, and they’ve got a good chunk of gold – 10%, or thereabout, of their net worth, some as much at 15-20%, not just gold but in real assets. But there is no question, there is a reason why gold ran to the moon in 2011. There were some little guys, but by and large, this was the billionaires of the world getting their insurance policy. And once it got too high they backed away. And then it has come down, and now they are playing it very slow, methodically – these are real buyers, this isn’t HFP guys.

If you are a real buyer, you want to buy as low as possible, and that’s what they are doing. That’s why they have the cash. They’re going to sit here, and they have their insurance policy, they’ll slowly add, very cautiously, very methodically. And by that I mean, if you are an industrialist, or you are a wealthy person, you set your portfolio up, and then you have an income stream. And at the end of the year you look and see – your income stream has added this much to your cash position, then you rebalance your portfolio again. You buy a little more gold, you buy – whatever it is you are hedging –a little real estate, whatever businesses, you do your rebalancing.

And if you are going to do that, you don’t run out there and buy gold and chase it, you just very carefully give a guy an order, and he buys you some coins or borrows it, or whatever, and you’re happy to just slowly build this position. If you’re going to pay insurance, do you want to pay high premium or low premium? That’s how these guys are looking at it. They want to keep buying at a low price. My insurance – that’s what gold represents to these guys. This is insurance of their net worth and political turmoil, and they want to buy it as cheap as possible. And what the idiot hedge funds and these other HFT guys do – they race in, they race out, etc.

But it seems to me that there will be an incredible, mind-boggling gold rally at some point. But the issue, and again, most of the smart, wealthy people understand this, you might see gold get hammered in the initial stages of the debt deflation. That was the lesson of 2008, that gold went down below $700 or whatever – it got into that area – and then it took off to $1900. That’s what they are playing for again. That is probably how this thing is going to play again, but there will be a hammering of gold, and this is what we have been experiencing here. But the reason it hasn’t totally collapsed is there is this slow, methodical buying.

When you look at the chart of gold and what is going on with the dollar, you would think that they would just absolutely crater gold, and they have – they go out there and they do these raids. It is very interesting, the raid lasts a few minutes and then it stabilizes and moves on. And I’ve seen that in stocks. My 40-some years in the stock market – when you see stocks get busted, and it’s a stock that has good fundamental value, and something happens, like some accident, or a stock just gets hammered for some reason, you see the real buyers will show up, not immediately, but you would get it hammered, they would let it fall, and then all of a sudden the real buyers show up. And then the traders figure out real quickly that there are bids here and these are real people, and then it would go the other way, which is what you see in gold. They will go on this raid and whack it down, and then all of sudden you will see it stabilize and then all of sudden you see the traders cover it short or go the other way.

And that’s what the smart traders see, is that real orders show up. And part of that is that the brokers see who the orders are coming from. They see that it’s somebody of means, and they are in there and they think, “We’d better cover our shorts, too.” And it gets around, they call their traders and they say, “Hey, we’ve got real buyers here. Go.” “Okay, let’s cover.” And that’s why the gold hasn’t just absolutely gotten floored yet.

David: Yet is an ominous word.

Bill: Yes.

David: It is great to be able to buy it cheaper.

Bill: And that’s the other thing, when you have real buyers – and I’ve seen the same thing in stocks, when you have real buyers, and they are buying at a certain level, certain values, and then you get October of ’79, or even the [unclear] of 1978, let alone in 1987, you get these events, you just pull your orders, and the reason you do that is, you want to see where it settles. And then you pull your orders – and that’s what will happen in a debt deflation. People are going to pull their orders and wait to see what happens.

I understand – I think I understand perfectly well what is going on in gold there and who has been buying, who has bought it, why it ran where it did, why it backed off, because the people of means got their gold positions from 2009 through 2011. They bought their insurance, they weren’t going to chase it anymore, and they’re not going to pay that. You saw that in 2009, 2010, and 2011 – the storage in Europe, Singapore – they were running out of storage. The Swiss banks went from an omnibus holding cell, or whatever they called it – a vault – you’d get a personal – if you had ten million or more in gold, you had your own vault.

I remember that – UBS. If you had more than ten million we’d give you your own vault, you wouldn’t be in our omnibus vault with all the other guys. This was huge, this was enormous. I knew plenty of guys that did this, that bought it, that stored it, put safes in. And then even mutual fund guys – the high up, CIOs – were buying gold and putting vaults in their houses and storing it after 2008 and 2009. And they got their positions and then they said, “Okay, now we’re going to sit and wait.” That’s where we’re at. That’s where we’re at. That’s exactly what the gold price told people. That’s what happened.

David: Yet oil is the same deal. You have a paper trade, which is more significant in terms of volumes in the physical market. Who calls the shots, and for how long? When we got up to 140 we’re not talking about real supply and demand. We can’t be. There is trading fluff in there.

Bill: Yeah, but the difference with oil is, with the exception of money, it is the most utilized commodity. Gold is not. You don’t settle trade with gold, banks do not settle their accounts with gold anymore, so they can do this for a long time. The problem is, the traders can take control of a market, whether it is grains or any of these commodities. But if they are industrial commodities they can only last so long before they have a problem. And that is, with oil, you have a problem. People can store it. Goldman-Sachs, J.P. Morgan – they can buy tankers, they can store it, they can do all this stuff, but at some point they have to let go because the market will force them. The commercial market will force them. The big commercials, the Standard Oils, the Exxons, the Totals, the Russians, whatever, will say, “Oh, you guys – either way. Are you guys pushing it this low? Well fine, we’ll buy it.” And then they have a problem. Or if you push it too high, they say, “Okay, here, we’ll load you up with it.”

That’s not the case with gold, because you don’t have the commercials in the factor right now. But, by the same token, when it comes time for a big run in gold, you can’t count on the commercials there to feed the market, to temper the rally also. That is the other side of that gold issue and why it can get really crazy on the way. On the way up in commodities, you can have commercials feeding the market, for a number of reasons, one of which is government regulation and mining, and how long it takes to get a gold mine to produce, and into production, etc.

You get a runaway gold market, and there is not a lot the commercials are going to be – yeah, they’ll feed it, there will be some guys hedging, but it’s not going to make that much difference as it would oil or the grains or copper. Gold is actually outperforming the industrials metals. I’ve tried to allude to this in the letter. And there is a reason for this, again, because the commercials have to feed, they have to do something, it costs them, with the inventory, where gold is starting to take on a safe haven effect, a little bit. Really, the best play here is cash or some form of cash, being – I hate to say, U.S. treasuries – and gold. That is kind of the trade here that you should have. Then wait to see what happens. The problem with buying the miners is you don’t know how this is going to shake out, who is going to go under.

David: Are there plenty that go under?

Bill: Yes, there are. Ultimately it is more bullish for gold, but in the interim here you just have to be very careful. I still think, when the market turns, obviously, you want to be in, probably with the big producers first and the juniors second, would be the rotation, but right now, the physical gold makes far more sense to me, than it does in the miners, at this point. I think that’s what the market is telling them. And again, that’s because the big private wealth is not buying miners, they’re buying the physical. They’re buying it carefully.

And when people start saying, “Oh, look at this ratio, it’s never been…” Well, you know why? There is a reason why you have that ratio, but any old way, it’s going to be real interesting and very tough over the foreseeable future here. You can see the rhythm of the markets in the problems, the things showing up, in the people – the pace is increasing. This isn’t 2010-11 where people just kind of snoozed and were hoping, whatever. There is stuff happening now.

David: Well, we wish you well. Chicago has its issues, but of course, you get out of there enough for it to not be always a bother. Appreciate your thoughts, appreciate your insights. On a weekly basis, on a daily basis, we benefit from seeing your reports, and compiling data the way that you do. You are very good at that.

Bill: Thank you very much.

David: It is something that, as an office, I would say, we depend on. So, we do appreciate the worth that you put into that each week, and each day.

Bill: Well, thank you for the kind words. I appreciate it.

David: We look forward to seeing you again when we are up in your neighborhood, and thanks for joining us.

Bill: Oh, any time. Thank you very much.

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