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China’s Digital Currency Will Track All Activity
September 14, 2021

“The issue is tracking all activity and approving or denying any desired choice according to the current measures of state-determined trustworthiness. God forbid that that kind of control would be in the hands of an animated, partisan politician in America, where again, we can determine trustworthiness on the basis of the way you vote, on the basis of the friends you keep, on the basis of the tweets that you send, right? This is very, very intriguing because we’ve already got the social construct for it.”
— David McAlvany

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

One of the things that we have valued in this company—I know you value in your family—is the ability to raise whatever issue that you have and say, “Look, I’ve looked into this. This is my opinion. What do you think?” And have a debate. You and I were talking last night, this COVID period has been an interesting period. And there are some positive things that have come from it that I’ve noticed. What I’ve found, Dave, is various family members— You can have coworkers, family members, what have you, seem to all have a little bit of a different opinion as to the vaccine and the virus. And some people are getting the vaccine, other people are not. Those who are doing their research have their reasons why they’re doing one or the other. And you and I were talking, even husbands and wives, or parents and kids are having to make their own decisions, come to their own conclusions. You’ve always loved debate as long as it was well thought out.

David: That’s right. So, thinking for yourself and the exercise that we’ve had on a collective basis over the last 12 months has been fairly fascinating. And there are some people who don’t really like debate. They like to trust the authorities and just go with it.

Kevin: That’s herd mentality, in a way, not herd immunity, but herd mentality, no matter what side you pick.

David: The contention is ultimately not about who trusts or doesn’t trust a particular authority, but how you’ve come to your conclusion. And so, you’re right. Debate, I love it. I mean, I would say enough with social coercion, enough with censoring, enough with shaming. If you have an idea, even a mistaken one, the process of discovery and change is invaluable.

Kevin: It’s not always about being right or wrong. Sometimes it’s about doing the research.

David: Yeah. So, bring on the debate. I was reminded of this in a recent month’s Foreign Affairs magazine. They ran a piece by Oriana Skylar Mastro and they were arguing. She was arguing for the likelihood of armed reunification. It’s another way of saying invasion—

Kevin: Yeah. That sounds like invasion.

David: —across patient across The Taiwan Strait.

Kevin: Okay.

David: Now, in the September/October issue of that particular rag, no less than five academics challenged her argument. And they do so along, basically, three different lines—in my view, none convincingly. So, then Mastro is given the space to respond. And I really appreciate the back and forth in an age where no one seems to listen, or, on a predisposed basis, you hear what you want to hear. A real exchange of ideas is refreshing.

Kevin: And so in a way, Foreign Affairs is almost looking like it’s an op-ed. They’re basically saying, let’s debate this a bit.

David: Yeah. And I think Foreign Affairs finds itself in the awkward position of having informed the establishment Democrat—and maybe even slightly less so, the establishment Republican— approach to foreign policy over the last two decades. Rightly so, there are times for reflection and reconsideration, and this looks like one of them. What failed and why? What part of a liberal democratic agenda goes underappreciated or undervalued in the developing world? So, here you have room for debate, and it suggests that there is also room for reappraisal on at least some issues, and there’s an allowance for experts to come to differing conclusions—

Kevin: Do you think they were actually planned—

David: —at least on some issues.

Kevin: Well, and that’s what I’m wondering. Do you think Foreign Affairs actually planned on the give and take or did they have to do that? Because what they were saying was actually probably unpopular with the establishment.

David: I think it was unpopular with the Chinese and they got an earful. So, yeah, I mean, finger-pointing abounds, but in the midst of questioning the best way forward in terms of U.S foreign policy, there is an allowance for debate. And that allowance seems limited to areas where, again, there’s self-inflicted black eyes, more or less. It’s forcing the conversation about cause and effect, and there’s little surprise here that examination at that level is really about the world out there in our foreign policy, and has not been allowed to migrate to domestic policies where you find de hate is de rigueur and de silence and deception in reporting. That’s what you get 90% of the time.

Kevin: Well, and we lost that for about four years. When Trump was in office, debate didn’t exist. Remember that? People just picked sides and that was it. There was the Never-Trumpers, just the hatred for the sides where debate actually was the casualty.

David: And a closed-mindedness on both sides to real engagement. So, whether you agree with the Foreign Affairs starting premises, or even their reason for existence—advancing a liberal democratic order globally—at least it’s not that Trump-era Foreign Affairs, where academics betrayed their visceral and emotional selves and left out any opportunity for conversation. You basically had four years of apoplectic rage, a derangement syndrome, where, again, the establishment Never-Trumper, be it a Republican or a Democrat, was not interested in conversation, not interested in debate. The truth was already known. It was definitive. Again, at least on selected topics.

Kevin: And I wonder, last week we talked about how RAND Corporation said a Taliban-run Afghanistan—we talked about the pullout—a Taliban-run Afghanistan adds to the perception that Beijing is making the decisions in that region. It’s interesting that Foreign Affairs is also responding to what you’re saying, probably a Chinese reaction. So, what we’re seeing is a change in power worldwide.

David: Well, again, the Mastro article was, I thought, very well-articulated, and pointed to the growing concerns about the Taiwan Strait issue between Mainland China and Taiwan, and whether or not there was a likelihood or growing likelihood in coming years of a conflict there. And I suspect that the master article angered the Chinese. And the best way to redirect ire, if you’re running Foreign Affairs, is to provide further critique or a venue for alternative views. On the one hand this and on the other hand that, so you’re harder to pin down. Going through the most recent issue, the critiques of Mastro’s argument were very, very generous to the Chinese.

Kevin: Well, and a person might say, “Well, okay. Why are you talking so much about the Chinese?” Well, it’s because we operate—talk about debate—we operate with the assumption in the West that we can use debate. We can have our own opinion and not be chastised for it. What we’re talking about is the rise of a system that really doesn’t put up with that. At times, they’ll shut it completely down.

David: Yeah. And I think that’s a presumption we have for now about our ability to speak freely in the West. So, again, speaking of the Chinese, the Alipay breakup is an important acceleration in China’s domestic power grab. And that happened just this week. This is a huge deal. Not only does it reinforce the idea of corporate wings being clipped in China, it’s also a big data move on the part of Beijing.

Kevin: Information.

David: Yeah.

Kevin: The commodity of the—

David: The 21st century.

Kevin: —21st century. Yeah.

David: So, the FT editorial board, Financial Times editorial board, did an admirable job framing the issues involved, starting with Jack Ma, again, being on the losing side of appropriations.

Kevin: So you’re quoting Ken Rogoff. Remember what Ken Rogoff said about, develop it first and then they’ll appropriate it?

David: That’s right. So you’ve got Jack Ma who starts Alibaba, and then you’ve got the subset companies, Ant Financial and Alipay, which are downstream from Alibaba. And you’re right, Ken Rogoff— it was about cryptocurrencies, but it seems to apply here. What the private sector innovates, the public sector will regulate and then appropriate. And that seems to fit here. 

In fact, it sounds like an explanation of what they’re now calling Xi-thought. You just see it in action. So, his playbook has been to further centralize control, scrub the marketplace of dissenting voices and eliminate then anyone or anything that could eventually erode his power as he moves towards a third, note: unprecedented, term. So, Ant Group is the financial services app, which—it has every imaginable financial product. Consumer credit products, unsecured loans. Those were forced to be spun off here recently. And now, you have the government announcing a new joint venture, partly owned by the state. 

“Absolutely marvelous,” says Jack. So, not really. His opinions are not being solicited. You’ve got Alibaba, Ant Financial, Alipay, all are in the same ecosystem, with Alipay facilitating third party mobile online payments. So we’ve got Ant Group and Alipay. They also hold the consumer data that allows for—and again, this is what the Financial Times was focusing on—a radically upgraded state—again, being able to orchestrate their Sesame Credit Scores for each Chinese citizen.

Kevin: So, are you a good citizen or are you a—

David: [Unclear.]

Kevin: Yeah. So, it would be a little bit like Google with a joint venture with the U.S government. If the government was cracking down and trying to control everything.

David: Google and Amazon, good citizen?

Kevin: Yeah.

David: Bad citizen?

Kevin: Yeah.

David: We know what you do. We know what you buy. We know where and when you travel. We know if you use diesel, you’re a dirty person. We know if you use unleaded fuel, you’re slightly better, but still a dirty person, or if you charge your electric vehicle. We can measure your carbon footprint, and we can tell who you associate with. We know if you’re a good citizen or a bad citizen. So, I mean, again, the Alipay breakup and forced joint venture is the next major step in China harnessing big data.

Kevin: And most people don’t understand what kind of control that is. We are actually making decisions, Dave, that we think were coming to ourselves that are actually manipulated using big data against ourselves. I mean, that’s this whole new political cycle as well as you mentioned Amazon. I got to admit, I think that I know if I’m being manipulated by Amazon, but I know that they’re recommending things to me that I would have never thought of before. And a lot of times, I buy them.

David: Well, we also talked at a much higher level with a guest over a year ago about this idea of the end of theory. And when we had Richard Bookstaber on the program, the idea was that big data allows policy makers to collect enough information to predictively know your natural inclinations and to provide you with alternative A or alternative B. Of course, we know that. And logic is the fallacy of false alternative. There’s always more than A or B. It may be C, D, E and F, but if you’re only given A and B, and those are reasonable choices given your past patterns and proclivities, then big data allows for determining future outcomes. It’s a guided process of getting a mass of people to do what you want when you want.

Kevin: Remember when you interviewed Polverini, and he said, “Look, when you get something for free, realize you are the product. It’s that information.

David: Yeah. So, you’ve got Xi’s politburo, it’s giving birth to a super state with access and control of the primary commodity trading in the 21st century. You said it earlier, information. It’s information on people, which is different than any other information. Because you’re talking about something that has leverage, it has the power of coercion. My biographical details are a part of a personal sphere of actions and life choices that express autonomy, that illustrate my values. They’re a part of free choice. That’s very different than, say, the biographical details of Anne Boleyn. How are you going to use the biographical details of Anne Boleyn to change the course of human action? Right? Well, I guess if you’re part of the CRT crowd, you can take and leverage any historical details towards the present tense power grab, that is critical race theory. Because they do like to take these historical facts and leverage them.

Kevin: So, do you think they’re trying to control choice? In other words, I may be thinking that I’m making a free choice, but, in reality, where I’m getting my input from, it may be manipulating my choice.

David: Yeah. So control of choice is the end game. And this is where the social planner, the central planner, the central banker, they all begin to coalesce into one personality, which is a very, call it a prideful personality. It’s very egotistical that I know better than you what is best for you. And so, yeah, it does come down to control of choice. Either a utopian end-of-theory version where, look, I’m just feeding you what you want, but within the parameters of what is good for all of us, or you’ve got the dystopian rehash of something like the Stasi in East Germany, where every detail mattered because of the power it conferred to the possessor.

Kevin: So, has there been a legal change in China? I mean, this joint venture that you’re talking about, what’s changed?

David: No, no. And that’s one of the things that the Financial Times points out. There is no legal basis here for the joint venture. Merely a decree and requisite compliance. And the Financial Times article echoes the Soros concerns we mentioned a few weeks ago: a shift in China that is net negative for investors. And I think a key takeaway for investors is regulatory risk, first and foremost. Understand the regulatory risk of investing in Chinese companies when something like this is simply announced. There is no due process, there’s no law which says, this is how it’s going to be done. It is dictated and you comply. And if you don’t like it, you may find yourself in a reeducation camp somewhere. So, a key takeaway for investors is regulatory risk, and we can leave the dystopian questions of surveillance and control for the reader to contemplate. And they do, in the Financial Times. They suggest it. It’s certainly there in the text. But we can also recognize that’s a category, at least for the imagination at this point.

Kevin: So, I got to tell you, we’ve had squirrel problems in our house over the last few years. And we actually had a squirrel move in, well, a few years ago and eat through the in-floor heating. And we had to redo the drywall in an entire room. So, squirrels, they’re cute. They’re cute. But here over the last few weeks, I’ve been live—trying, trying—to live trap the squirrels with marshmallows. I heard that marshmallows with a little bit of peanut butter on top, that’ll draw them in every time. 

And what’s interesting is, as I think about this. You brought up digital currency. Okay. And we talk a lot of times about digital currency. And one of the big selling points to crypto or digital currency when people are talking about it is anonymity. Anonymity. And what I think about that is, you were talking about how you let them develop it first and then it gets appropriated. Well, the very thing that people think is the strength of a digital currency could be the very thing that traps them. 

So, those marshmallows. I’ve taught the squirrels to like marshmallows with peanut butter on them, but now what I’ve done is, I’ve put them in a trap and it’s amazing. I’m live trapping them, I’m driving them miles away, I’m releasing them. There’s no squirrel killing going on here. But what’s interesting is the look on their face. Those marshmallows with the peanut butter on them were probably the best thing that they ever, ever ate. I mean, think about it. You’re a squirrel. You’ve been eating nuts, and now you’re in a trap and I’m driving him. Last night I drove a squirrel 10 miles away out into the woods, released the squirrel. But I think about, in a way, the things that are designed initially to help us can also be those marshmallows with peanut butter on them. And the trap closes behind. And I’m just looking at the digital RNB. Okay.

David: The critique is not with the product itself, the critique is with and for the person who is using the product in a certain way. So, in this case, a central bank digital currency takes on a very different tone and dynamic.

Kevin: Anonymity goes away.

David: Oh, of course. That’s actually antithetical to why it would be a part of a system, where again—

Kevin: The trap door shuts behind you.

David: Yeah.

Kevin: Yeah.

David: Now, I have to say, I had this text come through the other day on my phone, and it said something to the effect of, there is a squirrel under the hood of your truck.

Kevin: I sent that text to you. I saw that squirrel go up into your truck.

David: But I didn’t have context for it. So I’m like, “Okay, what does this mean?”

Kevin: Is this all coming together now?

David: Is there a code here? It’s like, what? The squirrel is under the hood.

Kevin: I guess I should have given more elaboration.

David: And I really was wondering, “All right, how am I interpreting this?” I mean, obviously there’s nothing in it that’s offensive, but I was like. Hmm, what’s the message?

Kevin: I’ve been having squirrel nightmares. I’ve been having squirrel nightmares. Two weeks, two weeks, they avoided the trap, and now I’ve gotten two of them. Yeah, two different drives to the woods.

David: Well, the launch of the digital RNB is weaved into that future tense speculation. The FT article talks about it, but the issue is tracking all activity, and approving or denying any desired choice according to the current measures of state-determined trustworthiness. Right? So, this becomes very interesting when you move from one side of the pond to the other. God forbid that that kind of control would be in the hands of an animated, partisan politician in America, where, again, we can determine trustworthiness on the basis of the way you vote, on the basis of the friends you keep, on the basis of the tweets that you send. Right? This is very, very intriguing, because we’ve already got the social construct for it. Just not the mechanisms in place to do something with it. And the CCP is doing that already.

Kevin: Okay. So, what separates us, America from China? Is it the rule of law? Is that all? Is that what protects us now?

David: That is the thin line between Chinese totalitarianism and our corporatist-sponsored American form of democracy.

Kevin: Time to dust off Bastiat’s book—

David: It is.

Kevin: The Law.

David: It’s The Law. Now, I think we find the judiciary is what appears the only substantive difference between the CCP and Washington DC. And we’ve discussed Bastiat’s Law. Even that element, as he points out, can be harnessed for abuse. The law, as good as it is, can still be wielded like a club. And so, even that element can be harnessed for abuse. I think of Alipay’s set of resources. It’s benign, or it’s malignant, but that’s determined by who wields the resource and to what effect or towards what end.

Kevin: Yeah. A few years ago I read something, why there were so many apps that you could download for free that allowed your phone to be a flashlight. Well, there were pages, and pages, and pages of disclaimers of you basically allowing all this information. You talked about big data. Download a free app, well, guess who’s the product?

David: You. You are.

Kevin: You’re the product. Now you can use your phone as a flashlight and they can use you for everything else.

David: Yeah. This morning, I read a Financial Times article highlighting an anti-fraud app launched in China just a short period of time ago. It’s been installed on more than 200 million phones, and was recently re-tasked to monitor any user’s access to overseas financial news sites. I mean, let that sink in.

Kevin: Really. So, when you look up Financial Times, if you had that app, it would trigger?

David: That’s right. You’re getting your news from a non—

Kevin: A foreign source. Yeah.

David: Yeah. This is not the dialogue that is supportive of our efforts as the CCP. Reports of police questioning immediately after viewing overseas sites have many users concerned. In fact, one person interviewed in the article told of four consecutive contacts from police after visiting what are categorized as highly dangerous sites. Guess what one of those highly dangerous sites was? Bloomberg.

Kevin: Bloomberg.

David: Bloomberg.

Kevin: Oh my gosh.

David: Right? Because apparently, there’s narratives on Bloomberg that would conflict with the official narratives. Maybe it pertains to stability of the RNB. Maybe it pertains to the debt markets in China. Maybe it pertains to anything that would shed a negative light on the Chinese economy and we’re not gonna have that. We don’t talk about—

Kevin: And this is in the name of anti-fraud.

David: It’s not that we debate the status of economic progress. No, no, no, no. We don’t talk about certain things. If it is not the right tone and tenor, if it is not complimentary to what we are doing, shut thee up now. That’s the message loud and clear. So, you dig into the permissions in this particular app, it includes live monitoring of call logs, text messages, conversations. I mean, and today, you can still turn off those permissions, right? So, you can go in and select which ones you’re allowing or not allowing. I don’t think that’ll be the case forever. Parents have been told that in order to enroll their children in school, this app has to be downloaded.

Kevin: Wow. Does that sound familiar? I hate to bring the vaccine up again, but you’re starting to see, well, no, we’re not going to demand that you do it.

David: Unless you do this—

Kevin: You just can’t.

David: Shenzhen, there’s a number of rental contracts where the ability to rent a place was contingent on the app being on the renter’s mobile device.

Kevin: Huh?

David: Right. So in the first three months of usage, you’ve had 23 million alert messages.

Kevin: That’s all fraud. That’s fraud?

David: You wonder if it’s really about fraud, right? Well, you had last year’s online fraud arrest hit 361,000 in China. That’s up from 73,000 online fraud arrests two years earlier. And the effort is officially stated as to combat fraud perpetrated by overseas operations managed by Chinese and Taiwanese nationals. That’s interesting in and of itself, but again, it’s under the guise of anything to keep us safe. Anything to keep us safe. And I think we’ve got to remember the scariest words from any public official anywhere in the world are these words, “Hi, I’m from the government and I’m here to help.”

Kevin: Okay. So, let’s come back to domestic news. Unemployment continues to drop, but not for everybody.

David: Well, and keep in mind, we can actually have this conversation, which is refreshing. There’s no one coming to knock on the door and say, “You said something with a tone and with a framing that was not appropriate.”

Kevin: That didn’t make your Sesame Credit Score go up.

David: Right. Yeah. Right. My “stock” went down because I said such and such. 

So, the unemployment numbers declined to 5.2%. That’s the good news. The bad news, as we know from the previous nonfarm payroll numbers was that a good percentage of the numbers created, which were disappointing, came from the death birth model. But there’s also another aspect which was not particularly encouraging, not surprising, in fact, that the August unemployment rate for black Americans ticked up, not down. So, decline up to 5.2% except for—

Kevin: But not for everybody.

David: Not for everybody, ticked up to 8.8%. And I say it’s not surprising because many of the gains on the employment front in recent years were small business entrepreneurs and female-owned businesses in the black community. And they came under excruciating pressure during the 2020 economic closures. So, the gap is widening again, and the best explanation that pundits can provide is that race and prejudice is impacting the hiring process.

Kevin: Versus an economic reason.

David: And versus the fact that once you’ve started a business as an entrepreneur, it’s not like you have startup capital in your hip pocket to go out and start again. So, a more reasonable conclusion might include the lingering effects from COVID-related governmental shutdowns for small businesses in black and brown communities. Restarting is not easy.

Kevin: So, that may have been an unintended consequence of a Biden policy.

David: But when Biden chose that policy course, whether it was unintended, inadvertent, there was a sacrifice made and small businesses in the black community have paid a price. Now, ironically, I won’t say Trump facilitated, but he was at least coincidentally present when we saw the smallest employment gap between black and white workers in decades. The best employment numbers within the black community going back, I don’t know, 30 years, 40 years. 

So, Biden will have to actively engage small business initiatives. This is a big deal for him. He’s going to have to actively engage small business initiatives within these communities for this gap to not become an election concern next year. My guess is that he takes the cheap shots, and that he inflames race issues rather than facilitate small business job creation. Because like most politicians, keeping power is more important than solving real problems. This is a real problem. It’s just not one that I think he’s addressing head on.

Kevin: He’s got a couple of election problems coming up that he’s going to have to deal with because inflation is a real issue. People are feeling the pinch right now. Even though they tell us CPI is falling slightly, in the producer’s side of things, it’s skyrocketing.

David: When I lived down in LA, one of the news stations that I would listen to on occasion was KTLA. And according to KTLA, there are some other election problems. This is actually having to do with Gavin Newsom’s recall election. El Camino Real Charter High School in Woodland Hills, some voters say they were told the computers showed them as already having voted even though they had not. Now, that is interesting. I didn’t realize that these computers could glitch or have software issues. But be that as it may, taking one step beyond this, yeah, the Newsom recall election is something of a telltale. You will know what the midterm elections look like. Now, if there’s chicanery involved there in the San Fernando Valley, I can’t—

Kevin: But if you didn’t vote and you’ve been told that you already did vote—

David: That is true.

Kevin: —maybe you’re not going to be a factor in that election.

David: That’s right. That’s right.

Kevin: Yeah. Unfortunately, you can’t control the election. Somebody else does. So let’s go back to the inflation rate. Yeah. They can tell you what the numbers are, but you know what you’re spending at the end of the month.

David: This is the more enduring issue politically. And I saw that Mohamed El-Erian, before the CPI was printed this week, said, “We have a growing sociopolitical issue relating to inflation.” And that’s exactly right. Last week we had notable movers, natural gas up almost 5%, copper up really big. And this is in the context of the stock market selling off. We had aluminum up, gold, silver, platinum down. So, really strange currents within the commodity markets. 

And yeah, this week, CPI for August is being presented as a bit of a relief. Maybe we’ve seen peak inflation, CPI for August came in lower than expected, in contrast to last week’s PPI, the Producer Price Index report, which was higher than expected. So, given the sensitive nature of CPI, that is sensitive to white washing, I think that PPI is a better indicator of inflation reality. The PPI print was 8.3%, with a month over month increase of 0.7 versus the 0.6 expected. CPI, Consumer Price Index, was, on a month over month basis, up 0.3 versus the 0.4 expected. So again, a lower number, maybe inflation’s behind us. It lowered the annual rate to 5.3 versus 5.4 previously.

Kevin: Yeah. But the Fed said their target is 2%. We’re already above that, aren’t we?

David: Oh, sure. And if you took the most recent number, which everyone is saying, “Well, this is encouraging,” and just annualized it to 0.3 over a 12-month period, you’re still talking 3.6, 3.7, which is well above that Fed target of 2%.

Kevin: Yeah. So, that brings into the question for the Fed. All right. You’ve met your target. Has inflation peaked? Do you taper? What happens now?

David: Such a fascinating back and forth, even in the gold market early this week, because you’ve got a weaker than expected CPI number, which would imply that the Fed is not going to be as interested in moving to taper. No pressure to begin the taper process. And all of a sudden, that means more QE is on tap and staying in line for a longer period of time, and notice gold peaked up, almost instantly from the CPI’s announcement. So, Market Watch has asked the question this week, has inflation peaked? To which I respond, have we seen fiscal spending at excessive levels come to an end? Has deficit spending in the 3 trillion mark or even the 2 trillion or 1 trillion mark, has that ended? When we talk of Central Bank tapering, and actions are what ultimately matter. And really there’s some question of whether financial markets can tolerate a higher rate structure without buckling under those costs. 

Even think of what happened earlier, reflect back to last week. And you had Christine Lagarde from the ECB talking about the PEPP program. We called it putting a little PEPP in their step. The PEPP program is their 80 billion euro per month bond-buying program, very similar to our $120 billion a month program. And she had this very non-committal comment about, “Yes, we are going to moderately lower the pace of QE.” But she gave no numbers whatsoever. And I’ve seen subsequently no numbers released from the ECB. So, it’s basically, we’re going to continue buying a lot of bonds, and maybe we’ll buy less, maybe we won’t buy less.

Kevin: It’s all talk.

David: It’s all talk.

Kevin: It’s all talk.

David: That’s right. So, we talk of Central Bank tapering, the consequences are there. If you increase the rate structure, the question is, can the financial markets actually handle it? And QE is supposedly coming to an end, and rates are expected to move higher. That is now the consensus, but the question remains, if we can deal with the consequences of that choice, will the Fed embrace uncertainty? I think the answer is no. Will the Fed tolerate an increase in asset price volatility? I think the answer is no. If volatility, by that we mean volatility on the downside. In a leveraged economy, I mean, we’re talking about a hyper-leveraged financial system. I would argue the Fed cannot allow, it cannot allow asset price declines, or they end up tempting fate with an uncontrollable asset deflation and subsequently, bank system insolvency.

Kevin: So, the question would be, can they just keep asset prices up forever as long as they sacrifice the value of the dollar?

David: And I think it’s better at this point to devalue quietly. This is not my advice, but this is how I would say they pragmatically view it. I think they would pragmatically say, behind closed doors, better at this point to devalue and quietly maintain the status quo, and thus avoid a full-blown crisis dynamic.

Kevin: I read Marc Faber’s latest newsletter last night, and it was really good. Talking about Afghanistan, his own personal, just goings and comings through Kabul, and just through the years, the various regimes. And it was worth the read, but he also is saying what you’re saying right now. And that is, they’re not going to let asset prices fall if they can help it, they’re just going to keep printing dollars, keep the QE running. And most people don’t really realize why inflation is eating them up.

David: Yeah. I would strongly recommend getting a copy of his most recent report. I would strongly recommend subscribing. Tell him we sent you, it’s an amazing report this month. Dig around for it. Subscribe. 

Again, you’re right. He covers a great historical vantage point on Afghanistan and then he talks a bit about inflation as well. He says this, “Who are the codependents of the financial sector?” Quite clearly, the Federal Reserve, Powell, the U.S Treasury, Yellen, the big banks, auditors, accountants, and lawyers. They all have a vested interest, which would reduce all of these companies’ profitability meaningfully. Therefore, with Wall Street being the paymaster of the Fed, easy monetary policies are likely to stay with us forever. Another codependent of the expansionary monetary policies is the profitability of the corporate sector.

Kevin: Yeah. And not all of them are really coming right out like 3M did. I mean, when you listen to what 3M’s talking about, you can’t hide inflation because they can’t hide inflation.

David: Well, that’s right. And the corporate sector is very aware that these are not transitory aspects, and they’re having to deal with a growing dysfunction within supply chains. It’s not as if, in the last 60 to 90 days, we’ve resolved our supply chain issues. In fact, many of them have been compounded. So, I’m grateful to my colleague, Morgan, who pointed out a recent speech from 3M’s CFO. And the point was that the company is aware that inflation is less than transitory. 

The CFO said this. “Moving over the raw materials. Again, I think the inflation is unprecedented. We’re seeing inflation in the same area as I talked about earlier, jobs, raw material, labor, logistics. Unfortunately, inflation is higher than we even thought in the third quarter. So, despite taking prices up, getting to positive, we’re seeing inflation outstrip price. So, when we come in at earnings, we had told you 50 to 100 basis points of pressure between the net of price of raw materials. Currently, we look at it somewhere between 100 and 150 basis points of pressure in Q3.”

Kevin: Well, and that’s why it’s so important to understand, you look at Producer Price Index more than you look at Consumer Price Index, because in a way, it’s already too late. By the time it gets to the consumer, Producer Price Index is telling you that, look, what we buy, the people who make it, like 3M, they’re having to pay more. So, what does that mean?

David: Well, and again, it’s not that one measure is a better measure than the other. They’re very different. But what you have with CPI, we talked about it earlier, is a whitewashed number. Owner’s equivalent rent is 40% of CPI, owner’s equivalent rent is a question that’s a random question. You got a house, how much would you charge if you rented it out for a while? That’s different than the actual rent increases that we’re seeing, 13% to 17% nationwide, and owner’s equivalent rent was only up 2% and change. 

So, it’s an understated inflation statistic, whereas there’s less gamesmanship. There’s less massaging of the numbers. There’s less control manipulation there with PPI. Nobody’s really paid attention to it. And so, in that sense, it just tells a clearer number. Is it enough? Is the PPI level inflation, which ends up getting passed on, these again, the producers—these are the folks who are making things, these are the 3Ms—is that level of inflation passed on to the end consumer? Is it enough to change our economic trajectory? 

As we discussed last week, the opinion of stagflation becoming a reality is on more minds by the day. For over a year, we’ve suggested the financial market meat grinder of the 1970s is a high probability outcome. You have inflation, which is ignored, but it’s still accruing to the detriment of consumers, to the detriment of savers, to the detriment of investors. You’ve got nominal growth—and again, we’re talking about growth in assets, not necessarily economic growth—nominal growth, which is a possibility, given all a host of things, manipulation of the news cycle by the Fed and treasury and other politicians. And of course the continuation of QE and fiscal giveaways. But in the end, in the end, a real inflation-adjusted negative number compounding for years to come. It is that ’70s show. No one thinks of the 1970s as a terror like 1929 and 1932, but it’s its own version of a nightmare.

Kevin: Well, and you had talked about how CPI is whitewashed, but even whitewashed it’s getting high.

David: Yeah. There are limits for companies before they must move prices higher. And that’s what we’re seeing as a mea culpa from the 3M CFO. Look, we move prices higher. Our earnings are still going to get hit in the third quarter because inflation was higher than we expected. So, again, he’s asking for some space. Do not punish us when we report third quarter numbers because we had no idea inflation would be this virulent, would be this persistent, and this pervasive through all of our areas, jobs, raw materials, labor logistics, right? 

So, he is doing his best to increase prices, but there are limits for consumers as well which alter their behavior. And ultimately, when the prices of goods and services reach a certain threshold, you have to make economic choices. Instead of A, B and C all going into the grocery basket, it’s A and B. Something gets left out. And that is a diminishment of economic activity. That ends up affecting the farmer, or a producer, or manufacturer whose product did not get put in the basket.

Kevin: Right. So, let’s just look at this. We are well above 2%, and you’ve even got people with the Fed that are admitting the fact that it’s going to be pretty high as we go forward.

David: Right. The New York Fed puts out their median one-year inflation expectations, which for them are now set at 5.2%. And it will be interesting, as we get to the end of this week, to see how the University of Michigan sentiment numbers reflect, number one, the economic expectations, which we had the downsize surprise last time. It’ll probably be a little bit better this time, just because it was so horrendous last time. But two, you’ve got the inflation question in that survey, which is, yes, more anecdotal, but important to keep it matched with the Fed statistics of 5.2% in terms of inflation expectations. Because again, the importance of inflation expectations is it drives consumer behavior. It drives consumer adaptation. And that’s where you begin to see some economic vulnerability emerge when behaviors change in response to this entrenched notion that inflation is here to stay.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. You can find us at or 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 your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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