Bond Markets Revolt against Central Banks

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• PHD Central Bankers slapped with “NO Confidence” vote by Bond Markets
• The FED is 700 basis points behind the curve
• Trade settlement in Rubles and Yuan up 1067% in 100 days

Bond Markets Revolt against Central Banks
June 7, 2022

“This notion of no confidence, this notion of fear, I think it has to do with being unmoored, being undone, and there being no one to help in that situation. My view, and yours as well, is that education has so much to do with the re-mooring, it has so much to do with the anchoring, it has so much to do with confidence that remains, even when you’re in a circumstance of no confidence.” — David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary, I’m Kevin Orrick, along with David McAlvany. 

Dave, your dad and mom were in town from the Philippines a couple of weeks ago, and he told a funny story. He was in the Air Force back in the sixties and he was a medic, but there was a reason he was a medic. They actually wanted him to be an aircraft mechanic until he took the test, and I think he got, what, 4% on the test for aircraft mechanics? And so they made him a medic. Now, I’m just wondering, I heard the story this weekend about what happened to you with the diesel engine. Did you inherit your dad’s mechanical skills?

David: Well, I think if it’s the mechanics of interest rates and currencies, maybe we’ve got that down a little bit more than the actual physical world of nuts and bolts and gears and things of that nature. I will say my dad’s first day on the job as a medic, he was given a needle and there’s a guy who needs a shot in his butt and he managed to bend his first needle. I don’t know that the 4% grade on the mechanic immediately slotted him towards 100 hundred percent success rate as a medic. He did enjoy serving, I’m sure it beat the alternative of washing dishes.

Kevin: If you can just tell, in short order, what happened with you and your family this weekend? It actually was pretty heartwarming, but it started out sort of scary. You had gone up to Denver for a school conference for your kids, and on your way back, you were pulling the Airstream trailer and you started smelling diesel. Tell the story from there?

David: What a weekend, getting to see friends and our kids’ friends, and then going to see Dear Evan Hansen, a play that many have probably seen. Then driving back, and our engine breaking down on Wolf Creek Pass. I thought I overfilled the gas tank, so there was a little smell of diesel. But then it starts to smell worse, and we think, well, maybe we should just turn off the AC and open the windows. Then it’s even worse, we get down to Pagosa [Springs, CO], pull over, and we’ve got a small geyser under the hood and diesel’s going everywhere. I go and search for a little J-B Weld, because, I mean, that’ll fix anything, won’t it?

Kevin: That’s sort of scary, Dave, the very thought that you thought that would fix it.

David: Yeah, well, I mean, there’s a hole. How do you plug a hole? A little J-B Weld will do the job. 

Anyways, I meet this young guy, and he’s from North Carolina. It’s his first day in Colorado, and he has it. The convenience store that I went to didn’t. There were very few places open at that point of the day. I could not get over to the auto parts store, which was about five miles away, and so he bails us out. Calls me 10 minutes later and says, “Why don’t I just haul you back to Durango?” So, AAA took the truck into the dealership and he came with his truck, and an hour later, hauled us to Durango. It was just a remarkable bit of kindness, not something that I’m accustomed to seeing, but something I’m incredibly grateful for. 

I think if you reflect on the upside down nature of the world we live in, and the degrees and illustrations of unkindness, an occasional reminder of someone stepping outside of their own personal priorities and time schedules, and being willing to give. It’s a reminder that we all could do that, and probably do it a little bit more than we do currently.

Kevin: Yeah, that was quite a sacrifice. I think you said it took about five hours out of his day to pull the Airstream back and take care. I think he even called you back later to check that you guys were okay, right?

David: Yep, that’s right.

Kevin: I look at the markets right now, and I’ll be honest, I don’t understand English politics very much, but apparently Boris Johnson’s out of the woods in one way, but the Tories have said that they don’t really have confidence in him. What is it? Is Boris Johnson going to continue to be the Prime Minister or is the vote of no confidence, is that something that’s going to affect him?

David: Well, it will affect him because he’ll lead with a lot less power, but he was nearly cannibalized by his own party in a vote of no confidence this week. Survived that onslaught. He does get to move forward. And the central bank communities in various countries face no such threat of annihilation or removal. If people don’t like you or the job that you’re doing, it’s not like you were elected in the first place, so you can’t be tossed out of office. Unelected, they serve a term at the whim of a presidential appointment, at least here in the United States. That’s our process is presidential appointment, confirmation by Senate. No confidence does not have a bearing on the office they hold once they’re in, but you can still see no confidence felt in the public sphere. As individuals reflect on their pocketbooks, that’s where no confidence begins to stem from. They’re important market signals, whether it’s from the stock market or the bond market, the currency markets, which collectively indicate where the people stand in relation to the central bankers’ best plans, and intentions, and confidence or lack thereof.

Kevin: When the markets lose confidence in central banks, or when the currency loses confidence in the central banks, it can create an enormous amount of extended pain. Yet, since these guys, these central bankers, are not elected, they can continue that pain, because people don’t really know where the pain is coming from, the source of the pain. Think of the 1970s, how long did the stock market just sort of stay at the same level while inflation ate it completely alive?

David: Yeah, and I mean, that’s again where you get some of these ridiculous tropes about it’s the oil companies that are sticking it to us. I mean, that’d be like saying farmers are out to pick our pockets, because corn is more expensive. The reality is the reality. Prices go up, and it’s not gouging, it’s just the nature of things. Not that there aren’t instances of gouging, but that’s not generally what’s happening. 

You look at the ’70s, backdrop, we’ve referred to that countless times. If you’re talking about the gold market, if you’re talking about the stock market, gold was already in a long-term structural bull market. As the US dollar came under pressure, that’s where the cause of higher prices was going to be coming from for over a decade, devaluation of the currency. The gold bull market was just the inverse of that. Prices moved in fits and starts from $35 to over $800—25-, 26-fold move between 1968 and January of 1980. 

The inverse of that, the equities inversely were in a long-term bear market, capped at a thousand points. Getting to that level in ’66, retesting that level in ’68. Then the Dow just a few years later hits a low about 50% from that, 500 and change is where we got to in the bear market of 1973, ’74. Then by the time inflation gets factored in, that 1980 to 1982 period, where you’ve kind of had the worst behind you, the Dow’s down for the count and has lost the better part of 80%, 75%, and your most popular stocks of the 1970s were down 80 to 90%. So to see those backdrop dynamics and say, “Well, this is clearly the fault of big oil, or the farmers are really sticking it to us.” No, there’s actually other causes, and that’s one of the reasons why inflation can be used as a political tool, because so few people will actually pin the tail on the donkey.

Kevin: One of the problems, though, is that when you manage money, and everyone has to try to figure out what they’re going to do with their savings, if they have savings, even if they see what’s going on, it’s hard to position, isn’t it? Because you had talked about how gold moved in fits and starts. Well, if you buy gold and forget about it, over time it maintains buying power. But if you’re managing a large portfolio, you sort of wonder how do you position even if you see through the veneer of what we’re being told?

David: Yeah, I mean, you’re exactly right. Gold would hit pockets of decline that were matching the cyclical upswings in sentiment, so, or recovery in the general markets. That would happen as the equity markets rallied, and then all of a sudden those equity market rallies would lose steam, and gold and silver would then take the lead again. It’s almost like a jockeying of horses in a race. One market was stair-stepping up. If you’re stepping back and looking at what was happening, gold is taking a step or two up and then flat-lining or even going down, and then taking another step or two up. Then you’ve got the other, which is stair-stepping down—the stock market was stair-stepping down. Markets never do you the service of making decisions and taking positions, they don’t make it easy.

Kevin: Well, and even inflation will give mixed signals at different times, won’t it? Sometimes inflation can look deflationary in the short run, and in the long run still continue the— Well, I guess you would call it the secular trend. Secular is the long-term trend, cyclical is the short-term trend, and the secular trend for inflation in the ’70s was higher and higher and higher inflation, until it was broken, really, by Paul Volcker, wasn’t it?

David: That’s true, but the move was not smooth. It was not on a smooth curve from one to two, to three, to four, to five, to six, to 10 to 12%. It was also moving in fits and starts, so you had relief in inflation that appeared every so often. As you had relief on the inflation side, bonds would rally, then inflation would percolate up again, bonds would sell off again, and they would go to even lower levels. Finding escape in a diversified portfolio was nearly impossible then, and it’s nearly impossible now. Bonds faced in the 1960s and ’70s, early ’80s, the worst possible conditions. You had rising inflation, slowing of the economy, what we call stagflation. We’ve got some of that today as well.

Kevin: In a way, the central bankers at some point are running around— We talked about J-B Weld, but in a way, they’ve got a bottle of J-B Weld and now they’re filling holes. But look at the European bond market over the last 10 days. There is a definite loss of confidence, and do you think J-B Weld will hold this time?

David: Growing up one, of my favorite shows was MacGyver, and figuring out how to fix things— My dad might not have been super mechanical, and I might not be either on a textbook basis, but give me a little bit of J-B Weld or some duct tape, a Swiss Army knife, I can make my way around. Now, it’s probably not going to be clean and pretty. Any engineer would look at it and say, “I don’t know if it’ll hold.” 

I think to some degree, you have ugliness appearing in the European bond markets. I don’t think the measures that they’ve put in place will hold. In the last 10 days, the European bond market has been in the grip of a major selloff. The question is, is it the first bond market to send a no confidence vote on central bank management of inflation? Is that what we’re getting from the European Central Bank’s lack of willingness to step in, dragging their feet, not doing anything? Is the European bond market saying, “If you won’t, we will. That’s just the way it’s got to be.”?

Kevin: Well, I think of our guest Paul Tucker, who said that these are unelected people who actually rule the world. It’s interesting, too. You’ve got hawks and doves—a little bit like we have Democrats and Republicans. In a way, the fact that you have those two, they almost seem to validate that they should be there in the first place. Hawks, doves, Democrats, Republicans, it’s like you have two options, but actually, should we be looking at a third, and maybe not have central bank control?

David: Well, I mean, the last few years you’ve had the control factors put into the interest rate market. Controlling rates, propping up prices, that’s been the case for a few years. A part of the question about whether or not the bond markets in Europe are the first to indicate a significant concern about endemic inflation is this issue of there being a revolt against the PhDs. Has that begun? 

From a distance, yeah, the hawks and doves, they’re birds of a feather. They could be mistaken for one another, at least by the concerned investor. The larger question was what Paul Tucker was getting at, one of sustaining legitimacy for unelected technocrats. His stern admonition to every unelected official was to just focus on a narrow scope of work and do that well. Don’t use your platform to expand your scope of work. Don’t use monetary policy to address social justice issues. Don’t use interest rate policies to resolve global warming, cooling, change, what have you. Step outside your lane, and you may end up losing all of your influence.

Kevin: But there doesn’t seem to be any mechanism to oust those central bankers, like we have with government. I once heard that the US Constitution was written with the worst possible president or leadership in mind. In other words, okay, so let’s take the very worst thing that could happen. What mechanisms do we have to get rid of that government? Now, we don’t have that with central banking, do we?

David: No, but when we talk about there being no confidence, you do see it show up in the market, so while there’s no procedure for ousting a leader, like British parliament has, you can look at prices and you can look at the same signal which is being sent. Credibility, once it’s lost, it will reveal itself in a mad scramble for security guarantees. You may have screams from the street for an easing of the pain, but in a world of inflated financial assets, where no real guarantees can be made, you’ve got these issues of solvency and liquidity crisis which can emerge quickly. Control can be lost completely. 

And again, you start looking at stocks, bonds, and currencies, they’re signaling not only that the markets are moving into an unstable period, but potentially, into a period of panic. When you get to that period of panic, that’s, again, when you have sort of a reformation—a recall, if you will. The no confidence vote is there in real time. Loss of confidence is a very big deal, particularly when people who are in the markets look around and say to themselves, “There’s no adults in the room to make things better.”

Kevin: I look at some of the central banking responses, and it’s incredibly slow right now, it reminds me of, let’s say you’re on the Titanic. They’re handing out life vests very, very slowly to control the flow, when really the ship’s not going to be there in two hours.

David: There was a bit of a discussion, debate, argument, what have you, on words in the last wealth management meeting we had, Monday this week. There was the word apathetic, which was used to describe the central bank community, and particularly those at the European Central Bank. I said, “Why? Why use apathetic when pathetic is just as good a description, maybe even better?” You get Italy’s current governor at their central bank. This is Ignazio Visco, he says that, “The ECB must proceed in an orderly manner to avoid potential bond market turbulence.” These are words of caution to Madame Lagarde, Madam Inflation, to not raise rates too aggressively or pain in the bond market will be felt. But these words of caution, they’re completely out of step with the activity of the bond market, which is happening in real time. I mean, you’ve got a decimation within the European bond market in the last 10 days. For him to say, “We just need to move very cautiously,” the market is moving, and all you’re doing is standing there looking like an idiot. 

The Italian 10-year treasury saw rates rise half a percent last week, and 131 basis points, 1.31%, over the last 10 trading sessions—nine trading sessions. Portuguese 10-year debt, up 40 basis points last week, 110 in nine sessions; 40 for Spain, 97 basis points, or almost a 1% move in nine sessions. Closer to the European core—again, for those of you don’t know European rates, this doesn’t sound like much—but 34 basis points higher for German bunds, and 75 basis points higher in a short timeframe. We’re talking about still under 1½%, but that means they’ve moved up almost 50%—or over 50% off of a low base.

Kevin: Well, they’re seeing European inflation. I mean, the inflation rate in Europe is what now?

David: That’s right, it’s over 8%. So whether it’s Greece or Spain or France or Italy, negative rates are a reality all over Europe. We spoke about pan-European inflation being north of 8% last week. The bond market is closing the gap. They’re saying, “Look, we can see clearly, if you’re having a problem seeing this, what’s right in front of us, let me just show you what we’re going to do,” and they close the gap. 

The central bank’s dragging its feet, it’s still holding out. I don’t know, is it holding out for inflation being transitory? Or maybe it is that central bankers are looking and saying, “This is going to get dicey. Maybe we need to be looking for our next gig, maybe we don’t want to be the ones who are pinned with the responsibility for causing collapse.” 

You had Draghi who jumped from Goldman to the ECB, and now he’s Italian prime minister. Maybe there’s a bunch of central bankers in Europe who are saying, “We’ve got to look to our political future. We don’t want to muck anything up, so don’t be blamed for market carnage and pushing the levers that rupture asset prices.” So, do nothing? This is really interesting to me because it’s almost as if, if you ignore it will go away, right?

Kevin: Well, that’s what my wife says that I do with jury duty. Last week, I completely forgot about jury duty, and she’s like, “How is it that you get away with this stuff?” We called the next day, and sure enough they had canceled it, so ignoring-it-and-it-went-away worked for me that one time, but I’ll bet it catches up.

David: Well, look on a broader social basis, and this is a global issue, but with a variety of church abuse cases emerging in recent decades, you’d think that the idea of doing nothing would now be recognized as being connected to culpability. Ignore it, and it’ll go away? The bond market is issuing its own verdict, and guilt and complicity are heralded in the pages of the International Tribune, the Financial Times, the Wall Street Journal, because the numbers are the numbers. If doing nothing is the default choice of the planning community, then the markets are going to enforce the necessary discipline. That’s what we’re beginning to see happen, at least in Europe here recently, and simultaneously you’ve got the PhDs credibility which is being cannibalized.

Kevin: Yeah, so those interest rate increases that you talked about in Europe, those radical interest rate increases over the last 10 days or so, those are being enforced by a market that sees inflation, and it’s not paying attention to the central bankers. Think about the last few years, Dave, as we’ve done this program, how much control, compliance and control over the markets, the central bankers have wielded. All they had to do was speak and they could make the market do what they wanted. It was because they could print money and buy things. Now, printing money is biting them in the butt.

David: Yeah. In a period of low inflation, you don’t have something that is sort of standing out and causing you to look a little bit foolish, and there’s no motivation for the bond market to revolt. In a low interest rate environment, you’ve got central banks that can kind of do whatever they want. Bond markets are alive now and aware of the fact that inflation is real, and the bond market is also aware of the stupor, the inertia in the central bank community. I think there’s exceptions. We mentioned New Zealand last week. But between the US and Europe, and most of Asia, central bankers are cautious in aggressively addressing an issue which maybe they failed to see as both a secular and structural issue in nature.

Kevin: Let’s talk about secular, because secular means that the issue is a long-term issue. I’m going to go back to this weekend with your family. At first you smelled diesel and you thought you just overfilled the tank. Then as time went on, you lowered the windows and you realized that it was getting worse. There’s a point that you made a decision to stop the truck, get out, and look to see what was happening. It turned out it is a longer-term issue. You would not have made it back to Durango without you making the decision to stop. Now, the question that I have is, are the decision makers right now seeing this as a secular long-term problem, or are they seeing this as cyclical, which is just it’ll go away, like you said, ignore it?

David: Yeah, I mean, I love looking at Dow Theory, which kind of— If you go back to Charles Dow, one of the original authors of the Wall Street Journal— editors of the Wall Street Journal— he created the Dow Industrial Average, he created the Dow Transportation Average, the Utilities Average, and was commenting on the behavior of the markets a long, long time ago. He made the distinction between sort of tides and waves. The tides are these longer-term trends, if you’re thinking about, again, sort of the movement of the moon and its impact on water and the shoreline. There’s big trends, and then there’s little trends in the context of bigger trends. The tide comes in and goes out, and there’s sets of waves that keep on lapping up against the shore in either case, whether the tide is coming in or going out. 

A trend shift that is secular may have the shorter-term ebbs and flows in the interim. When there is, it looks like there is a temporary receding of that trend. There’s some intellectual comfort. For the investor who may have just taken a loss, and now all of a sudden there’s a few points put back on, and losses aren’t so bad, and maybe the trend is up again, and we should be hopeful. Well, look, if the tide is going out and all you’re seeing is sort of a shorter-term wave crashing on the beach, just beware. Beware. I think that’s— again, the slow-moving central banker and investor who gets relief, if they don’t recognize— if the structural shift is unrecognized for too long, then comes the catastrophic cost, both to the investor’s balance sheet, but also I think to the central banker’s believability.

Kevin: The central bankers are behind the curve. I mean, Powell, at least, is raising the rates, but is he doing what he needs to do to normalize?

David: If you compare where interest rates are at today versus 10-year Treasury, the US Fed is either 200 basis points behind the curve—again, relative to 10-year Treasury—or, if you just look at CPI, and we’ll have a fresh number this week, but just looking at last month’s number, they could be 700 basis points behind the curve, and that’s not using sort of a Taylor Rule comparison. But again, just looking at the range of either CPI or the 10-year Treasury, somewhere between 200 and 700 basis points, we’d have to move that much to get to neutral. 

But as you said, at least Powell is raising rates. And this week—credit where credit is due—the first round of balance sheet shrinkage, reducing mortgage backed securities and Treasurys, and stepping away from being the market’s marginal support. What have they been doing for a couple years? Creating artificial pricing, keeping rates unnaturally low. Now, they’re going to be shrinking the balance sheet, and I think it’s inevitable that rates rise as a result of that. They should rise if you’re taking 47½ billion dollars monthly off the balance sheet—up until September, in which case it’ll probably double—17½ from mortgage backed securities, 30 billion a month from Treasurys.

Kevin: Dave, I watched an interview of J.P. Morgan’s president Jamie Dimon, I mean, a name that comes up often. I had clients who also had seen it, so I think this had made the news. But Jamie Dimon says he really doesn’t see any way out of ultimately normalizing, but you had mentioned the word catastrophic. It was interesting to see a man who really, I mean, he could almost be accused of panicking the markets. He’s got that kind of power. He just had this look on his face, he said, “It’s going to be a hurricane, it’s unprecedented.” He said, “It’s so difficult to position assets when you’re facing something that you possibly have never faced before.” The normalization of rates, what does that look like if it happens slow or happens fast? Is Jamie Dimon right? Is it going to be what he called a hurricane?

David: Well, if nothing else, he’s trying to cover his backside, because he doesn’t want to be like Moynihan at BofA, who said, coming into the 2008-2009 financial catastrophe, “while the music’s still playing, so we got to get up and dance.” There’s this turning a blind eye to what you see, but just knowing that, hey, everybody’s going to keep on playing the game, and we lose if we just drop out, so keep on playing the game. Music’s still playing, get up and dance. 

Dimon, I think, is a little bit more circumspect. In looking at quantitative tightening on this scale—47½ billion monthly, and then moving to 90 billion—we’ve never had this kind of quantitative tightening or shrinkage within the credit markets in history. Not knowing what markets are going to do, how they’re going to react to a much restricted or constrained financial environment, I think that’s where the concern lies. 

As rates normalize, asset prices—it’s almost axiomatic—should sell off. I mean, the inertia I spoke of earlier, it’s tied to the costs of returning to a natural level. The reason why I think you’ve got some feet dragging is because it is consequential. When you start raising rates, there is an impact on asset prices. Bonds, of course, because of an inverse and axiomatic relationship to rates. Stocks sell off as the cost of capital rises and accessibility to capital shrinks. You’ve got corporate America and global corporates who’ve been borrowing and borrowing and borrowing and borrowing and borrowing and borrowing. For the terms of those borrowings to change and go up, it really does impact them. There’s some balance sheet impairment. 

Last week, we saw something interesting: relief in the junk market. It had been shut for a number of weeks. Very little financing happening. New deals that were slotted were canceled. Then finally, last week, the junk markets lightened up a little bit. $7 billion in new issuance gave a little sign of life for the corporate credit markets. I think this is a really critical thing to keep in mind. When and if the corporate debt markets freeze up—as they have, again, to a degree in recent weeks within the high yield or junk market, but specifically in the investment grade side of the market—fireworks begin in earnest at that point because that’s like economic engine seizure.

Kevin: Yeah, talk about the vote of no confidence, we were talking about the central bankers and how there really is not a mechanism to get rid of them if they’re not doing well, but the markets will get rid of them, ultimately. Okay, so maybe that is the mechanism. Politics, we’re in an election year, Dave. Biden’s got to be thinking about this, Xi Jinping has got to be thinking about this, because economics can certainly affect the outcome of elections as well.

David: Yeah. In honor of an old friend, Ian McAvity, poly and tics stands for many blood sucking creatures. 

There are parallel pressures on Biden and Xi Jinping as they eye the remainder of 2022 and as they look at an election cycle. Xi has an election that affects him directly, Biden, only indirectly with the midterms. But it’s important for economic growth and a positive story to be on the airwaves, so you got to do everything that you can to manage that. How do you whip up positivity? Well, I mean, spending from the government coffers is an easy way to go, and sure enough, this is what we’re seeing this week from Xi Jinping, the People’s Bank of China, a number of government functionaries, who are basically opening up the cash coffers. 120 billion in fresh funding for infrastructure projects, that’s the first Chinese announcement driving growth via public investment. 

If you just look at the last 10, 20 years of Chinese GDP growth—growth via public investment—it’s like a bad addiction. Every time they try to move towards growth driven off of consumption or some other model, they can’t quite get there, and they go back to the habit. Public investment. 120 billion, that’s for infrastructure, there’s going to be a lot of other projects, I think 33 other projects announced. I don’t know if they’re going to push trillions in spending, whether that’s through easing credit conditions to promote Chinese household borrowing.

It’s going to be interesting to see how the Chinese navigate this because they’re still coming out of lockdown, and it’s not clear that they want to take on a new load of debt. In that respect, if the Chinese government wants the Chinese household to increase consumption, they can only do that via an increase in credit. Well, it takes two to tango, and the people are going to have to decide if they want to do that—or will we just see the People’s Bank of China open up the liquidity floodgates? 

I think we saw a little bit of a note of the floodgates opening, in watching the industrial commodities in the last week. We know that the Chinese are trying to maintain that 5.5% growth target, that’s what’s at jeopardy. I think that’s why these promises in the last few days are being made. Industrial commodities perked up with the infrastructure announcement, PBOC’s monetary policy stimulus talk was also very stimulative. I mean, if you’re talking about zinc, copper, nickel, platinum, so far 33 measures announced to promote growth and recovery post lockdown.

Kevin: If worse comes to worse, you can just do the helicopter option? Remember the helicopter option, Ben Bernanke? Just hand out free money, I mean, just from the helicopters. I heard, and correct me if I’m wrong, but isn’t China just giving away digital currency right now?

David: Well, that’s one of— There’s a couple of different cities that are experimenting with it. You’ve got the city of Shenzhen, which is handing out digital yuan, an interesting way to get e-currency adoption, just give it away, get people hooked on it. Then the goal is to improve consumption, revive small business activity. They call them red packets, so they’re giving you red packets, digital packets. What if I prefer the blue packet, instead?

Kevin: You’re thinking matrix right now, but I think a little backwards.

David: Yeah, my boys will tell you that Shenzhen was the place they had one of the best meals of their life—duck, five ways. We visited a factory there on our way to seeing my parents in the Philippines.

Kevin: Even if they had recovery, with Covid and the way they’re handling Covid, I mean, even if they just stopped everything, recovery would be slow. But wouldn’t just this policy toward Covid halt recovery or make it— You talked about fits and starts, boy, that’ll fit it and start it, won’t it?

David: Yeah, I mean, recovery of economic activity after a full shutdown, it’s not going to be like a light switch. It was off and now it’s on. There’ll be no rocket launch, there’s going to be no aggressive growth straight away. To even get out and use public transportation, you’ve got to have a fresh Covid test every 48 hours, a new one every 48 hours. They’re open, but they’re still highly restrictive, and that’s sort of the current state of play. Things are going to be better than they were, but on a very gradual basis.

Kevin: We talk about unprecedented, but one of the things in our life that’s unprecedented is trades—whether it’s oil or other types of trades, internationally—being settled in something other than the dollar. I mean, you and I, our entire lifetime, we’ve experienced only one reserve currency, and that’s the US dollar. We’ve wondered if we’re going to see a different currency used, and now what we’re starting to see, whether it’s US policy, whether it has to do with the war, whether it has to do with just a distrust of the US monetary policy, we’re starting to see a shift. Trades are being settled in yuan and even rubles.

David: The currency uncertainty that we had in the 1970s is what necessitated what ended up being a stroke of genius on the part of Kissinger, arranging for petrodollars to even exist, to trade, and settle contracts in US dollars. As we got further into the ’90s and the 2000s, it was the tradable goods sector that largely complemented, maybe even substituted for, the petrodollar. But where you see these huge reserves of dollars held by the Chinese, how did they end up with $3 trillion in dollar assets? Well, they were running trade surpluses while we were running trade deficits, and they accumulated all of these dollar assets as a result. 

That was magic in the 1970s, saving us from a currency abyss. Without that, the dollar would long ago have lost its reserve status. Bloomberg reports that trade settlement in the ruble and yuan pair has surged to $4 billion over the last hundred days. This is basically since the Russian incursion into Ukraine, surged 1,067%, so they are beginning to move away from US dollar trade settlement. That’s in motion. We’ll have to follow how that takes shape, if it continues to grow. Certainly, you can’t expand it a thousand percent every a hundred days. But there is a lot of billions, even trillions, in global trade, and that can be shifted away from the dollar to great consequence. We weaponized the financial markets, have done so for a number of years. And now we’re beginning to see something of a counterpunch.

Kevin: I just wonder how we’re going to see the geopolitics of maneuvering the dollar change, too, because war is fought in many ways. Sometimes it’s kinetic, sometimes it’s people actually shooting. But the actual quiet war, the one that goes on continually, is when you have a reserve currency, like the US dollar, you can place your Treasury assets in various countries to coerce or to get that country to comply with whatever your politics are. Where we’re at right now, the dollar is losing strength in tradability, but is it also losing its strength in manipulating international policy?

David: Money is a tool, and assets are often useful policy levers, if we look at things from that perspective, leverage, coercion, to some degree. They’re not just things that revolve around a gain and loss calculus. Our Treasury Department has made that perfectly clear. 

I forget who it was, but I recall a conversation, it was either Minxin Pei or Victor Shih, where this point was brought home. US Treasury holdings in China are not an asset that are held for income or with the hopes of monetary gain. I mean, it’s difficult for a US investor to say, “Well, then why do you own anything, if you don’t think it’s going to go up in value?” Those allocations have always had a geopolitical rationale different than you might expect if you think only in terms of profit and loss. Terms of trade, capital flows, and some very critical financial relationships will be critical to watch going forward. 

Additionally, we’ve got the yen continuing to sink to new lows, and I think it’ll be important to watch how the Chinese respond to that, and whether or not the Chinese currency will move from that vantage point. Devaluations to improve exports and pump up labor markets, that’s not at all uncommon, if you’re looking at economic history or trade history.

Kevin: When you have the reserve currency, and when you have that power, you also can define terms. For the last few hundred years, the United States has defined the terms of what republic is, or democracy. When you start to lose that reserve currency power, your influence goes down, and other people can start defining their own terms. I’ve noticed that China has started to talk about their own democracy, I mean, what is that?

David: Yeah, I mean, look, it’s not as if we don’t have our own version of intellectual—how should we say?—tyranny here in the United States, where power struggles occur and definitions are seized. I mean, and that’s happening in the ivory tower all the time, where you just claim it, you rename it, you own it, and now you redefine reality accordingly. 

I think, to some degree, you’ve got that same trend happening overseas. Bloomberg comments that China and Russia are working together to promote “real democracy,” based on a nation’s own conditions. They had some Chinese officials say that the US no longer has a monopoly on the definition of democracy and human rights. I mean, fair enough, we can critique US policy, and clear definitions are definitely needed. But I recall that, just over the last few years, capitalism in China was described uniquely. “Capitalism with Chinese characteristics,” which was kind of a soft way of saying “command and control capitalism.” Central planning is not capitalism, by definition. Now, we get democracy with Maoist or Stalinist characteristics. 

So you can try to put new words to a definition, but, to be frank, for China and Russia to talk about democracy seems a bit of an oxymoron. At some point, we’re going to have to reconcile words with reality. That needs to happen here in the US, as well. For now, we live with words we all know, we have reference points, but sometimes the definitions are what we can’t agree on.

Kevin: Well, and definitions are very important to you. You’ve recognized that for years. I remember when you made the call and you said, “Kevin, guess what I just bought?” You had purchased the entire Oxford English Dictionary, and there aren’t many people who will just sit and read definitions. But it’s been of value to you, because the— How many volumes is that?

David: I forget if it’s 12 or 13 vol— But I went to the Strand Bookstore, and I’m always looking for curiosities like that. One of the gentlemen who worked there, he said, “You need to go upstairs to the rare book collection. We have— not the cloth bound version of the Oxford English Dictionary, the two-volume set, where everything’s crunched in and you use a magnifying glass to look at things. We’ve got the blue leather copies upstairs, and this was the president of the Oxford University Press. He had a home here in the US. When he moved back to Britain, he sold this set. This was his set.” I went upstairs and looked at it, and the Oxford English Dictionary is just absolutely phenomenal. So something like this, democracy comes to play, yes, I grab the Oxford English Dictionary, and they say, “Government by the people. That form of government in which the sovereign power resides in the people as a whole, and is exercised either directly by them, or by officers elected by them. In modern use, it often more vaguely denotes a social state in which all have equal rights without hereditary or arbitrary differences of rank or privilege.”

Kevin: We all have equal rights.

David: And that’s not the case today, if you take a quick look at the Department of Justice and the FBI. There are definitely two applications of the law, two applications of privilege here in the United States, two citizenries in this country, two sets of rules. 

Just a quick quote from Victor Davis Hanson, he’s at the Hoover Institute, he says, 

The law is no longer blind and disinterested, but adjudicates on the ideology of the accused.” Eric Holder is held in contempt of Congress and smiles. Peter Navarro was held in contempt of Congress and is hauled off in cuffs and leg irons. James Clapper and John Brennan lied under oath to Congress and were rewarded with television contracts. Roger Stone did the same, and a SWAT team showed up at his home. Andrew McCabe made false statements to federal investigators and was exempt. A set-up George Papadopoulos went to prison for similar charges. So goes the new American commissariat…

The common denominator in Joe Biden’s two years of colossal failures is Soviet-like edicts… Playing the role of Pravda, Biden and his team simply denied things were bad, relabeled failures as successes, and attacked his predecessor and critics as various sorts of counterrevolutionaries.

Biden rejected common sense, bipartisan policies, superimposed leftist dogma on every decision whose ideological purity, not real life consequences for millions, was considered the measure of success. 

We are an imperfect democracy—we already know that we’re a dead republic—but an imperfect democracy. But, again, going back to China and Russia, to assume that the Russian and Chinese governments are improving on the idea, that’s suspect in my mind.

Kevin: Well, see, and that I think the acceptance that there is middle ground— I had to laugh, you remember the economist in Greece who called himself a communist libertarian?

David: Yanis Varoufakis, yeah.

Kevin: There we go. Yeah, a communist libertarian. Well, you can say anything you want, but what exactly is a communist libertarian? We’re talking about democracy and communism. Is there a middle ground? I mean, I already know the answer to that, but how do you live with that? And is that what we’re starting to see here?

David: Right. Well, I mean, just one other quote from Lord Acton. For those of you who don’t know Acton, he was head of the history department at Cambridge University and wrote a seven volume series on the history of liberty. He says, “The one pervading evil of democracy is the tyranny of the majority, or rather of that party not always the majority, that succeeds by force or fraud in carrying elections.” Again, this is a liberal thinker, this is according to the old definition of liberal, but quite a thinker at that. 

We’re moving towards a shared middle ground. Our democracy degrades, if you’re looking at it in the US, and we see the half-life of freedom and conscientious citizenry measured in decades, and that already has seen some decay. Then we look at what the Chinese and Russian governments have proposed as a real democracy, and as champions of human rights. I’m not exactly sure how the China and Russia can consider themselves champions of human rights. But again, maybe we just don’t understand what they mean by human rights. They move towards us, borrowing the trappings and language of democracy, while maintaining brutality for nonconformists. It seems that we are moving towards each other. Sure, you’re free to think, and free to speak, and free to act, as long as it’s in keeping with a homogenous party line. Here in the US, if you don’t keep that homogenous party line, you’re canceled for not conforming. There, you get your teeth kicked in and are sent to a reeducation camp, so there are degrees of consequence. There is still that distinction.

Kevin: Wouldn’t you say that’s why a guest of ours, Harold James, took the time to very carefully write out a book of definitions that he had felt changed. That was quite an enterprise. Definitions are important aren’t they?

David: Absolutely, just below the definition of democracy in the Oxford English Dictionary is democrat. It’s “an adherent or advocate of democracy, originally one of the republicans of the French Revolution of 1790. Opposed to aristocrats.” That’s an interesting way of thinking of a democrat, and politics, and power, according to head count.

Kevin: Literally, rolling head count.

David: That’s right. Kevin, coming back to the conversation you and I had last night, and we typically have before our Commentaries each week, there’s fear amongst the people we are talking to. It’s fear of change, it’s fear of unemployment, it’s fear of inflation, it’s anxiety over a variety of things. It’s a fascinating thing, just to get a sense of what people are thinking, what they are feeling, perhaps feeling more than thinking. The anxiety is tied to things that are outside of their control. 

We come back to Jamie Dimon’s quote, and when he references the hurricane, again, these are the things that you realize—how small you are in the grand scheme of things. You realize how little you can actually do to change an outcome when a force of nature as great as a hurricane is upon you. Whether it’s a Ray Dalio or half a dozen of the other big hedge fund guys looking at the current environment we’re in now— I think of Jeremy Grantham and Ray Dalio, they come to mind first. They look at this as unprecedented. They look at it as dangerous. They look at it as a timeframe where financial assets are going to be impaired, and real assets are treated differently because of what they are, real assets. Whether it is gold and silver, whether it’s oil— I mean, going back to the ’70s, it was oil and gold which were the two greatest performing assets in the inflationary 1970s. Stocks performed terribly, bonds performed terribly, and those hard assets did not perform terribly. There was a differentiation because of the quality and kind of assets in play.

So I see the shift occurring. Your Wall Street elites are beginning to say, “No, we can’t play the game the way we have in years past. Quantitative tightening is a very, very big deal, and we’re going to have to approach things more nimbly with a greater cash position, with more liquidity, with a greater emphasis on hard assets.” That’s, I think, the reality that we see, whether it’s the people you’re talking to or even the people we read and listen to in the leveraged hedge fund community. There is concern about change, and the change is along many lines. There is political change, there is geopolitical anxieties which are on the world stage and they haven’t been present since the end of the Cold War. All of these things add up to increase in caution, decrease in risk taking. All of that, again, comes back to this notion of secular and structural change.

Kevin: Dave, for those people who we’re talking to that are fearful, and maybe it’s not fear, maybe it’s just highly concerned, and there’s a reason to be, what are just some simple steps that they can take?

David: Well, Kevin, I’m not going to give you a list of things to go buy to make yourself feel better. If we are looking at a tremendous amount of change, I think one of the most helpful things you could do is recalibrate your expectations. Richard Russell used to say, “In a bear market, the person who wins is the person who loses the least.” It’s not to say that you’re not going to lose something, but the person who loses the least. Maybe that’s losing less sleep, maybe that’s gaining back more time. 

The disastrous race which I had in Hawaii last year, disastrous because the time was terrible, it taught me something very valuable. I’ve got the wrong expectations. I needed to have a particular result and a particular outcome. The whole experience of being there and doing what I was doing with 10, 12, 15 colleagues who went with us on that trip, it was soiled by the fact that I had to have a particular result. That caused a recalibration for me. So different was, say, the ride this last weekend, going through Rocky Mountain National Park with no expectations. Just an embrace of beauty, and a challenge, but with results not being a factor. 

There is an anxiety that I think most retirees face and it’s will I have enough? What is enough? Does anybody have an answer to that? What is enough? Is a million dollars enough? Is $10 million enough? Is a hundred million dollars enough? What is enough? The anxiety that we create by not achieving all that we want fast enough, and now having market constraints which pressure and take away our ability to move the ball further down the field, that, too, creates its own version of anxiety. I think there’s things that you can own that make more sense in this environment, certainly, but I think one of the best things that investors can do is begin to recalibrate their expectations.

Kevin: We talk about fear. You said you’ve talked to some people, and I have too, that are fearful or very concerned. I think a big part of that is they are losing confidence— The vote of no confidence is also affecting them because they’re losing confidence in the thought that anyone can solve the problem. You had mentioned that right now there’s this feeling that there’s no adults in the room. 

It’s important for us to realize the things that are important, and in a bear market people lose money. We all lose money. Was it Richard Russell who said that? We probably need to expect a little bit of financial loss, but that doesn’t mean all is lost. It is a good time not to be leveraged. It’s a good time not to take risks that would be based on things working the way they did in the past. Probably a good time to just stop, take note, and listen to what the environment is telling us. What are your thoughts?

David: Kevin, so much of what we’re striving for in this Commentary is to engage with ideas, and to have a conversation ongoing with people that we agree with and some people we don’t agree with. But the nature of no confidence is from depending on people who know more than you do, perhaps it is the politician of Boris Johnson’s ilk, classics from Oxford. Perhaps it is the PhDs who are running our central banks, perhaps it is the medical establishment. Whoever it is that you have depended on to this point, can’t you be your own problem solver? Can’t you be a researcher? Can’t you be the person who is seeking and searching out the truth, from the very basic definition of words to the composition of an argument, to the reality of a worldview that is cohesive and sound? 

This notion of no confidence, this notion of fear, I think it has to do with being unmoored, being undone, and there being no one to help in that situation. My view, and yours as well, is that education has so much to do with the re-mooring, it has so much to do with the anchoring, it has so much to do with confidence that remains, even when you’re in a circumstance of no confidence.

Kevin: You’ve been listening to the McAlvany Weekly Commentary, I’m Kevin Orrick along with David McAlvany. You can find us at mcalvany.com. That’s M-C-A-L-V-A-N-Y.com, and you can call us at (800) 525-9556.

This has been the McAlvany Weekly Commentary, the views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.