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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“Is there a possibility for surprise in 2018? A military surprise? A market surprise? A surprise in the Middle East? A surprise from the Chinese? A surprise from the North Koreans? Some sort of surprise – unexpected? It’s not priced in. What’s priced in? What is priced in is a perfect tomorrow. Unfortunately, in my opinion, that’s not wise expectation management.”

– David McAlvany

Kevin: Last night, Dave, when we met as we normally do before we do a weekly Commentary, we talked about the conferences that we went to, and was there a word that we came up with? You brought something up and I totally related with it. The word was grateful – how grateful we were for our clients. But it was amazing to see how many people who had either read your dad’s newsletter for the last two or three decades or listened to the Commentary. They were grateful that we were there. It’s amazing, gratefulness is contagious – both sides.

David: It is. Just like laughter and yawning, gratefulness is one of those things that spreads. I think in some respects we forget how much an elixir to the soul appreciation is. But it is something that, as we gather with family around the holidays, is really important to remember. It’s important to appreciate the people that you are with, and dig deep into the memory banks and recall the things that are most significant to you about your life experiences together, because there is something that happens which is really dynamic when you dig into appreciation. And we were on the receiving end of that.

I have to tell you, it was incredibly life-giving, and it was incredibly encouraging, for people to say, “We’ve been listening to the Commentary for seven years.” Or, “We’ve been listening to the Commentary for almost ten years since you guys have been doing this.” Or, “We’ve been listening to the Commentary for a year.” “We’ve been reading your dad’s newsletter for 35-40 years, and it has been giving us these insights that we have needed to do this and that.” It reminds us that there are people out there (laughs) and that’s helpful to know. We can count the views and we can count the listeners, and we know that there are thousands and thousands and thousands of people listening, but it is actually very meaningful to us to get to interact one on one, and in a face-to-face environment.

So, my hope is that in 2018 when we hit the road again we are able to spend more time with our Commentary listeners when we travel from place to place. That was incredibly rewarding to us, and we are equally as grateful and appreciative of you, the listener, for taking the time out of your schedule to engage and learn.

Kevin: It’s just that – it’s the time. I think, probably more than anything, as I get older, Dave, the thing I wish that I had more of is time. So it is incredibly humbling that people not only take the time to listen, but people are also listening and making comments. And sometimes they are even talking amongst themselves in the comments section.

I think next week it might be worth showing our gratefulness to the listeners on YouTube who have posted comments on there, maybe wondering if we’re reading those comments. We don’t have time to answer the comments, but how about we just take the show next week and take those comments on the YouTube channel and just maybe address some of the things that are brought up?

David: Specifically, the questions that are posed, because over the course of time there are things that are asked about either guests that we have on, or particular topics, and we would love to engage with you in the Commentary, even if your questions aren’t answered immediately through that particular venue. So yes, for the YouTube channel listeners, we will look forward to doing that.

Kevin: That will be the show a couple of days after Christmas, for you who are listening. I do want to bring up something, too. Last week’s program, the Alan Newman program just really was reposted all over the Internet. We probably had a quadrupling of normal listenership on the show because we contract that. So for any of the listeners that are listening right now that might have accidentally missed that show last week, that can be found on our site,, or if you’re listening on YouTube you can click the link and the description below. But I would highly recommend it. I sent that to about 1700 people, clients of mine, and I have been getting great comments.

Alan talked about the over-valuation of the stock market, he talked about trends that he can see in the charts. Let’s talk about the stock market because as we roar into the last week of December, things are doing what they normally do in the stock market. Isn’t there normal gaming going on?

David: Yes, and some of it is positioning into year-end. You can see performance gaming. Sometimes that happens at the end of every quarter, not just the end of the year. But you have equity markets which are on the rise into year-end, and that is fueled by some degree of performance gaming end of quarter, end of year, but also a lot of forced short covering. You’re seeing specific names jumping 3%, 5%, 10% in a very short period of time, suggesting that the moves are really driven by forced short covering.

So when we look at a long-term chart and look at the relative strength indicator and the MACD 2 technical indicators in the charts – I’m thinking specifically of the S&P 500, the weekly chart – you have those indicators are the highest levels in ten years. And what that suggests is that we are at the end of a growth cycle in the NASDAQ, the S&P and the Dow, and the current moves higher in the equity markets are on an unstable footing. We have talked about this, perhaps ad nauseam this year, on unstable footing of borrowed capital, and of course, what I just mentioned exaggerated by short covering. And when that reverses, it tends to reverse hard, and I think that will happen at some point.

Kevin: And the fear of missing out – you talked about the fear that is in the market right now. It is definitely not the fear of losing any money. The fear of missing out can create a madness. We call it momentum investing sometimes when momentum just takes over, and people are really only buying because their neighbor is making money and they don’t want to miss that.

David: The madness in the markets is not a new phenomenon because people are the same yesterday, today and tomorrow. And it is also not a new phenomenon to see boom and bust cycles, and our central bank community will be there to do the best they can to shift blame. They surely had nothing to do with the inflation of asset prices. On that note, not just here in the United States, but in a number of other geographies, we are starting to see consumer price inflation move higher. So yes, we’ve had asset price inflation, now consumer price inflation is beginning to follow through as well. I think you have central bank group think which is becoming more and more obvious, and I don’t think it is hyperbole to say that bankers everywhere – everywhere – are focused on the same thing, which is that inflation target.

Kevin: Let’s talk about the inflation target. You and I have both read the book, Magic and Showmanship. You bring it up in the Commentary often. It talks about how to successfully pull off a magic trick or a magic show using distraction. In other words, if your left hand is doing something you don’t want the audience to see, you get them to focus on the right hand. In a way, this inflation targeting, making everyone think that the central banks are working their hardest to give you the inflation that you deserve – actually, that’s the distraction. And there are central bankers right now, what I would consider more honest central bankers like William White, who are saying, “Wait a second. That’s not a good goal. That’s a distraction.”

David: If you’ve ever noticed, a very effective magic show always has a pretty girl at the front of the stage, and there is that part of the distraction, as well. In this case, what you really have is inflation targeting as both a dangerous and delusional tool. It presumes that past periods where you have had mild inflation are going to be predictors of future growth. So it’s believed that if you have low levels of inflation, and again, we’re talking about the targets that central bankers are currently aiming for, if you can hit those targets of low levels of inflation using monetary policy tools, you are going to be creating growth.

So what do they want you to look at? They want you to look at growth, because what you want is growth, and what everyone agrees is growth. So growth is the pretty girl on the stage. Growth is when everyone says, “Aha,” while they are actually accomplishing a lot more.

Kevin: But enter a central banker that we have interviewed in the past, William White, and he is throwing up the red flag right now and saying, “Don’t pay attention to that right hand.”

David: He has been with us in years past. He is now full time with the OECD in Paris. A low level of inflation is believed by central bankers to be both a necessary and a sufficient condition for sustained economic growth. And that is precisely what today’s central banker community is operating on the basis of. And if it is a sufficient condition – low rates of inflation – if that is a sufficient condition, then you target it for guaranteed sustainable growth. So goes the established line of thinking.

White stands out as a very interesting critic of central bank policies, having spent his entire professional career as a central banker, first in Canada with the central bank there, and then in Basel, Switzerland with the BIS, the Bank of International Settlements, which is sort of the bank of all central banks (laughs). I routinely read his ideas and he is keen to point out that the current policy framework, broadly accepted as a success, is entirely experimental, and it has yet to be in place long enough to be considered a true success.

What you have along with it is bubble dynamics which are a result from the current framework, and which have a set of costs which have not yet been accounted for, and which, quite frankly, could be devastating. Because again, you’re talking about what comes on the other side of a boom or bubble dynamic.

Kevin: Just to clarify, when we’re talking about the target of a low rate of inflation, they’re not talking about targeting no inflation. What they’re saying is, a low rate of inflation is good for everyone, a couple of percent being a target.

David: There is one thing on William White that is important. It is not a sufficient condition. If you want economic growth, it’s not just a matter of getting inflation to the perfect number, and therefore you have uninterrupted sustainable growth, as if you can control the business cycle just by targeting that one particular number. It is not a sufficient condition, and that is the behavior and that is the position the central banks have taken. It is the necessary and the sufficient condition – and it’s not.

Kevin: Another guest of ours, Stephen Roach, says that they are making the same mistake now that they did back in 2003 through 2007 before the last crash, which is that same targeting mindset, is it not?

David: Yes, routinely, he was on our Commentary back when he was traveling a million miles a year – literally, a million miles a year as an economist with Morgan Stanley. And he is still focusing in with laser precision on lots of issues, this one in particular in recent commentaries. He is at Yale now as a professor, a little easier (laughs).

Kevin: He doesn’t travel as much.

David: No, he doesn’t. But he says, “Afflicted by a profound sense of amnesia, central banks have repeated the same mistake that they made in the pre-crisis froth of 2003-2007 – overstaying excessively accommodative monetary policies, misguided by inflation targeting in an inflationless world. So you have monetary authorities who have deferred policy normalization for far too long.”

The issue for White, and the issue for Stephen Roach – they are both sharing, in my opinion, what is a realistic perspective on cause and effect. That is, we already have the makings of the next crisis, and it has actually been set in motion, yet again, by central bank monetary policy which they believe in their heart of hearts is here to help us and to fix the problems, but is, in fact, the causal factor in the next crisis that is already there.

Kevin: And the scary thing is, this time around is a little bit different because the bloating of the balance sheets of the central banks has already occurred to keep us from going through the last crash. Alan Newman talked about this last week. He said we never were really allowed to have the crash that we should have had back in 2008. They came in, central banks bought up a lot of assets – trillions and trillions of dollars’ worth of assets, to keep us from actually having the cleansing that we needed in 2008.

David: I looked at some fundamental factors. We shared this with our clients when they visited us at these client conferences across the country here in November. What I showed is a long-term short going back to the year 1900, and you have these peaks and troughs where the market is getting really excessively high, and then it corrects really hard. And looking at a valuation metric which includes the cyclically-adjusted price earnings multiple and Tobin’s Q and a couple of other things thrown into the blender so you have one solid valuation metric, you have at market peaks – you’ll see the market be at 60%, 70%, even 100% over the mean. And when it corrects it will drop 50-60% below the mean. So here we were in 2008 and 2009, we got to about 17% — 17% below the mean – which was an extraordinarily small decline relative to every other decline in stock market history.

Kevin: It reminds me: when you’re serving what you don’t like, like a medicine, a spoonful of sugar helps the medicine go down. In a way, with debt, we sort of created a Mary Poppins kind of spoonful of sugar, did we not?

David: (laughs) Mary-Catherine was in the play Mary Poppins not long ago, and so the words, I know them, “practically perfect in every way.” And that is the world. To borrow from Mary Poppins: It’s practically perfect in every way. That’s what globally synchronized growth is supposed to mean, that it’s practically perfect in every way. Well, in point of fact, no, it’s not. Central banks have been willing to buy – literally buy – the conditions that they deem both necessary and sufficient to economic growth. And guess what they are doing to do that? They’re using their balance sheets. So Roach points out that balance sheet expansion, in just the largest central banks, not all the world’s central banks but just the largest, totals about 8.3 trillion dollars.

Kevin: That’s that bloating of the balance sheet – 8.3 trillion.

David: Between 2008 and 2017. That gave us an increase in nominal GDP of 2.1 trillion.

Kevin: So you take 8 trillion to try to create 2 trillion in growth? That’s not good.

David: Think about the levels of commitment required to deliver growth and low inflation. You have the hangover, or quite literally, the overhang, rather, which is 6.2 trillion dollars of excess liquidity in the financial system which has spurred a massive asset price bubble. Herein lies the risk. While the central bank community is taking its victory laps, you have saner minds that will reflect on the nature of busts. They are always preceded by booms. And that’s exactly what we have (laughs). This one is induced, not by a natural economic course, not by a demographic issue, but massive central bank liquidity. This about the ratio of intervention to positive GDP growth – a 4-to-1 ratio?

Kevin: Wow. 8 trillion to get 2 trillion. That’s incredible. But, what you are saying is, we’re seeing the 6.2 trillion dollars that is in excess – it’s trying to find a home. Weird things like bitcoin – things that you’ve never seen before. But let’s look at the central banking community and go back in history when they think their successful model actually worked. There were some historic things occurring that are not repeatable at this point. And I’d like to talk about this because we don’t have the advantages we had in the 1980s and 1990s.

David: Yes, the so-called great moderation, that period through the 1980s and 1990s where you had high growth and low inflation, and when we got through the 1980s and 1990s, that has become the model and the precedent for current monetary policy. And it has fed this belief that low inflation equals high growth, again, as if that is both a necessary and sufficient condition.

Kevin: Let’s just do it again. It worked last time, they thought.

David: But the elephants in the room which are neglected in that are that, number one, in the 1980s and 1990s, we saw high growth and low inflation due to a demographically-driven demand search. We have come to know it as the baby boomer era, and this was a massive segment of the population maturing and spending more, all at one time. So you have that factor.

The second factor, and perhaps more importantly as a one-off event, and in complement to that boomer demand, was that when the fall of the Berlin Wall occurred, and we saw the end of the Cold War, that brought in an inclusion into the global economy, a half-dozen to a dozen countries which not only added to demand, but simultaneously delivered a low-wage component to global manufacturing, spurring benefits of increased economic activity, but without a wage-driven increase in inflation. So again, you’re talking about two factors that cannot be duplicated.

Kevin: So when you’re talking about coming without wage-driven increase in inflation, what you are talking about is a lot of extra workers that came on board. It’s something called disinflationary, right? When actually, we should have all benefitted from much lower prices because of the fall of the Berlin Wall. Now, strangely enough, that also gave the central bankers latitude to inflate the currency without experiencing price increases.

David: What we have is a misinterpretation of what happened. If you want to talk about the real inflation here, the real inflation here is the way that central banks perceive their role in impacting history. That’s what is inflated. They think that monetary policy tools got us to where we are. There were a number of historically unprecedented events which occurred which gave us high growth, low inflation.

Kevin: So it gave them false confidence.

David: It has given them false confidence. And again, I don’t think these are repeatable factors. Essentially, the disinflationary effects of mass inclusion into the global economy was an adequate offset for any excess inflation which might have entered the system due to increased productivity, or what you would have expected from increased productivity – ultimately, a healthy increase in wage growth. Where was wage growth? Economists have asked this question. Why didn’t we see more wage growth? Why didn’t we see inflation as a result of wage growth? If the economy was that strong, why didn’t we see more wage growth? We really haven’t seen a big increase in wages since the 1970s.

Kevin: Right. The standard of living is actually dropping.

David: So now we have the idea in play that monetary policy, if it can achieve that positive but modest inflation number, that’s going to deliver an economic Eden – some sort of a garden which is perfect in balance and harmony. No lie (laughs). This is the framework in place today.

Kevin: I want to talk about this later, but there are two groups of people. There are the haves and the have-nots. The have-nots, I’m going to say, are the man-in-the-street. The man-in-the-street has to be convinced that inflation is a good target, and that it is actually good. Talk to anybody who has been to college, and they say, “Well, a little bit of inflation is good. That’s what I learned in my Macro-Economics class.” Well, that is a ruse. That’s a deception.

David: This goes back to the whole magic and showmanship. What is that lady at the front of the stage actually doing? The magician is doing whatever the magician is doing, and you’re not paying attention to what he is doing because you’re paying attention to her (laughs). This is the reality – growth is the gal. The historical record, if you take in more than just the late 20th century and look at the benefits of mild deflation, you’re going to see that there are far more benefits from a mild deflation than a mild inflation. So again, you go back to looking at the 19th century and it’s a very different story. The targeting of inflation, as you say, that’s a ruse. Implicit in the inflation targeting deception is the fear narrative which references the deflationary collapse of the 1930s.

Kevin: Right, you never want to have that happen again. Ben Bernanke – that’s what he wrote his thesis on when he was at Princeton.

David: That’s right. He specialized in this particular fear narrative, and with it, has contributed greatly to the current belief in the markets. And make no bones about it, this is a belief that inflation beats deflation for its economic advantages (laughs). This is simply not true. You have consumers and savers which reap the rewards of an economic backdrop, which brings prices down.

Kevin: What in the world is wrong with that. Every time prices drop, is that not a benefit to the man-in-the-street?

David: Right. So a mild deflation is that. It is a reduction in prices. That, in effect, is like getting a boost to your income when it buys more for less. No consumer complains about Amazon’s price structures. Why is Amazon so popular? We had the benefits in the 19th century of Amazon-like pricing due to low levels of deflation, not low levels of inflation. Again, this was prior to two world wars, a double obsession with debt, and the fiat currency required to propel it forward. But you are following a massive expansion in national debt. And what we have had since then, which is really, if you think of it sociologically, a social normalization of leverage. Everyone should have debt, and there’s nothing wrong with it.

Kevin: Right. That’s the only way you can operate.

David: Right. So we have the social normalization of leverage, and now we have a monetary framework which by necessity favors inflation.

Kevin: That’s why they teach you in economics class that you need to favor inflation. They have to continue that, Dave, because the debt is unpayable at this point.

David: Yes, the reality under the surface is that huge levels of debt, unsustainable levels of debt, are managed better by inflationary policy goals. What does it do? It removes the burden of debt through time.

Kevin: Well, let’s face it. If you’re a politician, what are you going to want to do? Tighten things up, or loosen things up?

David: They’re rarely going to protest the current construct, because when you have easy money policies, not only does it tend to improve asset prices in the short run, for which they can claim credit, but easy money policies also allow for – what have we seen on display for decades and decades? Profligate congressional spending (laughs). I haven’t met a Republican or a Democrat who knows how to keep his hands in his pockets. Collecting taxes and spending, and spending even money that they haven’t collected in tax revenue – they are all in.

The real issue is, in fact, papering over debt. So when we talk about monetary policy tools, what are we targeting in terms of 2% rate of inflation? The real issue is just that – papering over debt, supporting the banking system. Trust me, banks don’t mind having an ever-expanding base of assets from which to collect interest. That should be a given. So the benefits essentially accrue to the few.

Kevin: Okay, that’s what I’m talking about – the haves versus the have-nots. Now, see, if the haves can convince the have-nots that what they are doing is good for them, it’s amazing how far they can go.

David: But it’s funny that it’s the exact opposite, because the inflationary bias in the system is good for politicians, it’s good for financial market operators, specifically banks. It’s good for the wealthy through asset price appreciation. But by contrast, you have the deflationary environment of the 19th century, which, broadly speaking, had far more benefits to the man-on-the-street.

That system was not hyper-controlled, that system was not hyper-planned, and that is, frankly, one more reason why it is unpopular today amongst the central planning elites, because they want to be involved. Of course the preference is for control. They believe that having their hands on the levers – that is actually what is going to deliver growth. Again, what has been inflated is the view among central bankers that they actually determine the course of the economy, that their rules and decision-making are going to guide our future.

Kevin: One of the things that I noticed about William White when you have interviewed him, Dave, is there is a dose of humility with him. This is a man who – it sort of made me laugh when you were interviewing him. He said, “I really haven’t seen central bank policies really work. In the decades that I’ve been in this business, I haven’t really seen anything that in the long run was successful.” I was thinking, “How does that feel to be in a particular field where you’re admitting this science maybe isn’t a science, and it doesn’t really work?”

David: Right. Sometimes I listen to 1980s rock music, and I think to myself, “These guys thought they were really good. They thought they were rock stars.”

Kevin: Oh, now, you’re going to hurt some people’s feelings.

David: You listen to the quality of the music and some of it is absolute garbage.

Kevin: Are you sure you’re not talking about the 1990s? Are you sure you’re not talking about the 1990s?

David: (laughs) You’ve got a community of central bankers that have already positioned themselves as rock stars, and for someone like William White to come along with that humility…

Kevin: As a central banker.

David: And say, “Uh, look, you know, I recognize that pulling the levers and pushing the buttons, we believe that determines the course of the economy.” No, he would say, “It rarely works the way you think it will, and often,” he would say, “it has grave consequences due to overestimation.” This is like deflating the ego of the central banking community, one of the largest egos, collectively, that you can find on the planet today. He is bringing sobriety to central planning revelry.

Kevin: This last weekend we went to the latest Star Wars, and it reminds me, we continue to tell the same story, over and over. Fairy tales, the Bible, the movies – they’re always talking about this empire that wants to defeat the good guys, and it gets bigger and bigger and bigger. And there is always some form of death star. I think we’re built for this story, honestly. That’s why I brought up the Bible. But the central bankers have built this death star that they believe can control the universe. And I don’t think I’m the only one who thinks that way

David: No, no, no. I want to tie in the comments of Stanley Druckenmiller from last week where he was in an interview with CNBC. He said, “Central bankers are the world’s Darth Vader.” (laughs) That’s what he said.

Kevin: That’s not pulling any punches there.

David: No, no, no. He said, they are the world’s Darth Vader. They are the Darth Vader creating exploding asset bubbles. He says, to quote him, “Every serious deflation I’ve looked at is preceded by an asset bubble, and then it bursts.” That’s the end of the quote. The way you create deflation is to create an asset bubble. We are talking about a more radical form of deflation. The kind of deflation earlier we mentioned is largely beneficial. We saw that witnessed throughout the 19th century.

What he is talking about is a sudden stop in the financial system where all of a sudden there is a drop in price, catastrophically, and something that was selling for a dollar is now selling for ten cents. And it wipes people out. It wipes the banking system out. You see massive rupturing within the financial system with deflation. That is what we are setting ourselves up for. So essentially, we have to think a little bit more carefully about inflation and deflation because there is a low level of deflation when it comes to consumer prices, which is absolutely healthy, and actually quite normal in the context of the gold standard. And then you have these deflationary collapses which everyone is fearful of. That’s the theme that has been popularized by Bernanke.

Kevin: It strikes me, as you talk about these various people, Dave, you’re talking about true historians. These are people who look at history before they look at mathematical magic. The economics of the current central banker, the Ph.D. central banker, is a relatively new economics, and it is based on selling the public on inflation, selling them on unpayable debt. I think of a historian that we have on our program, and also a market practitioner – this is a guy who has to make it work – Bill King. He also points the same thing out. “Inflation? Come on guys.” I can just hear him saying it.

David: Oh yeah, with his Chicago brogue. “In the latter years of the 19th century, the U.S. had years of deflation.”

Kevin: You’re quoting him.

David: Absolutely. “The latter years of the 19th century the U.S had years of deflation with rapid real growth.” So again, years of deflation with rapid real growth. Progress used to mean lower prices and higher production. Now central bankers are trying to convince us that inflation is good for us. Most people realize this is B.S., and it is all about unserviceable sovereign debt and big bank solvency.

Kevin: That’s the truth.

David: That’s the deal. That’s the sum total of why our monetary policy framework is what it is. It relates to two things – unserviceable sovereign debt and big bank solvency. What King is re-iterating is that our system is adjusting to a malady. Think of debt as the malady. Debt is the key to our current system of malinvestment. Think of – have you ever thrown your back out? Now you have a new structural defect.

Kevin: You have to do a work-around. Everything you do now is based on your back being thrown out.

David: You can take an aspirin, and that makes the pain go away, or it hides the symptoms of that defective alignment, but ultimately, the whole body begins to adapt to the structural defect, and your posture shifts. You accommodate to avoid pain. Maybe you walk with a limp, maybe you drag your foot, maybe you drop a shoulder to avoid the point of pain, but you’re accommodating and you’re adapting. And while pragmatically that is useful and fascinating, it is not the optimal solution.

Kevin: Right. So are you saying that easy money is the aspirin and it takes away what we really should be paying attention to in other ways?

David: That’s exactly right. Easy money is the aspirin. It takes away the discomfort, allows for us to normalize. But you’re talking about a misaligned financial or credit structure. And it’s not good, it’s not healthy, it’s not normal. You’re having to contort, to pretend like you’re okay. And it’s only easy money that is allowing for this system of credit to continue to grow. Again, going back to inflate – why do they care to target inflation? Because they are addicted to debt, because they believe that growth and perpetual growth is possible.

Kevin: Okay, but I’m going to sit here, and oh, this feels horrible, but I’m going to pretend like I’m Janet Yellen or Powell right now. Either way, it feels wrong. But I’m going to say, “Dave, you’re wrong. Have you not seen that we’re raising interest rates? We’re normalizing. We just raised rates a quarter of a point.”

David: (laughs) I have to tell you, it was really weird right there, seeing you in a wig and skirt (laughs). So yes, the FOMC meeting – they raised rates this last week another 25 basis points to between 1.25 and 1.5 percent. You have the jobless rate that sits at 4.1 percent. You have other economic indicators that continue to improve, supporting the rate hike and giving them carte blanche to raise them another three times in 2018.

Fascinating when you look at Yellen’s final speech in her role as head of the Fed before she hands it off to Powell in February. She reflects on stocks and says, “They’re not excessively valued.” Repeat – not excessively valued. No concerns there. But has real concerns with the levels of debt in the system. As I listened to that, I thought, “Is this her mea culpa?”

Kevin: Oh, that sounds like – remember when Greenspan left? He started warning people. But wait a second, you told us everything was fine. Wait, wait, that’s not fair. You’re leaving and now you’re telling us, “Maybe there is a problem?”

David: “You cooked the omelet. Are you telling us now that you should be careful of what is being served?” (laughs) Come on, what is this? So Jerome Powell, he is set to take over, and I think you’re going to see more of the same. If you diminish the easy money in any way, including tightening via a series of rate hikes, and the structural defects present themselves for what they are, what is that? It’s a painful structural misalignment, and to realign is also equally painful.

So you have a J.P. Morgan strategist who was very soberly surmising this last week through CNBC, “Inflation is not the enemy,” again, referencing the targets and the Fed objectives. He said, “The gauge that they have to watch here is asset prices.” And again, nobody wants to call it a bubble, but you realize that we now have the largest household ownership of stocks since 2000. We have almost the equivalent household ownership in equities as we had at the market peak in 2000.

So there is this idea that everybody is still on the sidelines and is going to drive prices even higher. This is the way bear markets begin. You run out of buyers. Bull markets end with the last buyer in, and thus begins a bear market where all you have is liquidators and sellers.

Kevin: Isn’t there another saying about three rises of interest rates? Now, the goal for this next year, and we know we can’t take these goals seriously, but let’s go ahead and say that they go with the three rate-hike goal that they are talking about for 2018. What are we looking at?

David: I don’t know what the threshold is. We’re starting at zero, and it’s not like we’ve been here for a long time. It’s the lowest rate structure we’ve had in 5000 years. So the traditional three steps and then a stumble – maybe it’s six steps and then a stumble. There is a threshold. If you think about the adjustment, you have 350 trillion dollars in debt instruments which are sensitive to LIBOR – 350 trillion dollars which are sensitive to LIBOR – you start playing around with rates, raise them up three more times, there is a threshold where you will experience pain in the bond market.

Kevin: Explain LIBOR.

David: London Inter-Bank Offer Rate, which is basically a benchmark rate upon which lots of other debt instruments are gauged. So if LIBOR goes up, then you have a reset for 350 trillion dollars in debt instruments.

Kevin: Trillion – that’s with a T. That’s a third of a quadrillion, for those who want to just keep adding zeroes.

David: It’s not insignificant. So we have the three hikes expected in 2018, you have Morgan Stanley and a host of other firms that are in agreement on that. They’ll take it three steps higher. Fed funds would then be at between 2 and 2.25. And likely, that further flattens the yield curve. We talked about that a few weeks ago. A flattening yield curve usually precedes a recession. But again, it’s not surprising, as we get to the latter stages of this business cycle, we’re hearing the discussions of how this business cycle is different, and this time around, flattening of the yield curve is not, and will not, signal a recession, as if recession cannot happen, will not happen – it’s an impossibility, rather than just around the corner.

Kevin: Dave, it makes me think that maybe the one indicator that we should use, rather than the Shiller PE being high, or margin debt being high, or the three rate hikes, what have you. Maybe we can throw all those indicators out and just measure the amount of words out there that say, “It’s different this time.” If we just saw how many times, “It’s different this time” is used in a sentence…

David: Or, “It’s not a bubble.”

Kevin: Or, “It’s not a bubble. It’s not a bubble.”

David: (laughs)

Kevin: I think back to 1987. That’s what they were saying, I think, before the 2000 crash, before the 2008 crash. Those are words that we always hear right before a crash.

David: What is entirely predictable is that as growth in any asset persists, the thinking shifts from being cautiously optimistic, climbing that proverbial wall of worry, to what Newman discussed last week as a more rare event, where greed dominates the thinking, and it allows for a complete re-interpretation of the world, as seen through a 100% bullish lens.

One of the other indicators that we gave at our client conferences was the MAIM, the Measure of Active Investment Managers, that gauge their exposure to stocks. These are money managers. And when we were traveling it was 102% allocated to equities.

Kevin: Which is mind-blowing.

David: So you’re talking about zero cash allocation and using leverage to gain more exposure. And just since we’ve finished the conferences it has gone from 102 to 109. So you’re leveraging a momentum trade, and this is absolutely a late cycle phenomenon. I’m just saying, it usually ends poorly.

Back to inflation for a minute. It is well established that inflation is a central bank tool. It is less well understood by the general public that financial repression in the form of negative rates is also a monetary policy tool.

Kevin: Think of Carmen Reinhart.

David: That’s right.

Kevin: She is an expert on financial repression.

David: And this is one that is coming more in vogue, so even as we are seeing rates move higher, understand that there is an infrastructure shift which will allow for a more constant employment of negative interest rates. So what was experimented with over the last few years, with some success in Sweden and in Europe. I say success – it has convinced the powers that be that this is the way that they should go.

Kevin: So call it a cashless society, call it a captive audience, like Carmen Reinhart repeated several times in the program a year ago. They have to create a captive audience, because who is going to stay for negative rates?

David: Right. So the monetary policy tools – we talked a lot about inflation today – this tool of financial repression or negative rates, I mention it because in future weeks I want to return to the idea of the cashless society. I just finished reading another paper this week from the International Monetary Fund which lays out clearly why de-cashing – and the words that they use are not cashless, and the words that they use are not all digital credit and debit – they prefer de-cashing and transferrable deposits.

Kevin: Euphemisms.

David: So you have transferrable deposits, and I think it is important to understand the language. But I want to come back to this because we are headed this way. The IMF lays out very clearly why de-cashing, and why moving toward digital transferrable deposits is critical to monetary policy operations tomorrow. More on that later.

Kevin: Just looking at inflation, if, indeed, it is a true tool, and maybe it’s not a deception. Maybe a lot of central bankers think that they can control inflation and that it is a good target. One of the things we’ve seen throughout history, and we saw this, of course, in Germany in the early 1920s, is that inflation is a little bit like piecing together a person that you think is going to be a nice person like Frankenstein, and ultimately it kills the maker. Inflation can get out of control very, very quickly.

I remember back to the early 1920s, Barton Bigg’s book, Wealth, War and Wisdom. He shows the chart where inflation in Germany in the early 1920s was a manageable 2%, it went to 2.5%, then it went to 3%. It started climbing a little quicker than they thought. And then it was a matter of months before they were actually in the billions, and even trillions of percent inflation – a total collapse. So it was the monster that got out of the cage and it killed the maker.

David: You have this idea that inflation is an always and everywhere monetary phenomenon. Yes, but it’s different when it becomes a hyperinflation because it’s a monetary phenomenon until it’s a psychological and sociological phenomenon.

Kevin: Until it’s a panic phenomenon.

David: Yes, exactly, where you basically see a real, live repudiation of the currency, and what it looks like for people to try to hot potato out of their currency in pocket and get rid of it as fast as they can. So you see a massive spike in velocity of money. The turnover goes haywire because people want to get rid of it, and as soon as they get it they have to get rid of it because they know it’s not going to be worth anything tomorrow – even later today.

Kevin: But it starts with a creep, and aren’t we seeing some areas in Europe right now where we are seeing that creep getting a little higher than they thought?

David: I don’t think it’s anything that would lead us to super- or hyper-inflation – not at this point. But you’re seeing a monetary authority surprise on the upside. Take the Swedish as an example. They’re ones that have been playing with negative rates. They have been playing with an entirely cashless society, Less than 2% of their retail transactions occur with cash – 98% are now cashless. It’s a remarkable experiment over there. But the Swedish saw a pick-up in inflation. They were expecting 1.7%, and it came in at 2%. So they’re targeting a number, and this came in a little bit higher.

You say, “Well, that’s 30 basis points. Who cares, Dave? Really? You’re worrying about 30 basis points?” No, what I’m worried about is, if you’re a bond-holder with a ten-year promise to receive payments, there is nothing in real terms to be receiving. The yield on that paper is 0.68. Subtract 2% for inflation, and that gives you an upside-down return, or a negative real rate of 1.3%.

Kevin: So they’re negative, and they’re cashless – virtually.

David: Yes, exactly. So you’ve got low orchestrated rates, and rising inflation. And I’m just asking the question. It’s going to provide a very curious show. How do you think investors are going to act? What are the thresholds that determine a change in investor allocation and behavior? Is it moving out of bonds? I don’t know what the threshold is. Did we put in the top last June in what has been an epic global bond bull market?

Kevin: It’s not just Sweden. We’re looking at it in Britain, as well. We’re starting to see that negative interest rate creep coming in there, too.

David: Again, we’re talking real terms here. U.K. ten-year paper – same mess with inflation surprising on the high side by a full 1%. You had inflation come in at 3.1%, 1% higher than it was supposed to. So 3.1% was the actual number. Let’s put that in real terms. The U.K. ten-year gilt – that’s the equivalent of our treasury note – it’s paying you 1.22%. But after inflation, it offers you the insulting negative rate – negative rate – of 1.9%. How do you like that ride? So you have low rates and rising inflation. These are the elements which will remind the investing public of an earlier description of sovereign paper. Do you remember what we used to call U.S. treasuries at an earlier period in U.S. history?

Kevin: Certificates of confiscation, I think.

David: That’s exactly right, because when you have low rates and rising inflation, it is a guaranteed loss. And what you can’t project is how quickly those inflation rates get out of control.

Kevin: It reminds me of what Alan Newman said last week. “Gold is still the currency of last resort.” No, it’s probably not bitcoin. Sorry to pop people’s – oops, I’m not allowed to use the word bubble yet – but it’s not bitcoin, and it’s probably not another currency. Gold, historically, for thousands of years, has always ended up as the currency of last resort, but you have to watch these things play out.

David: Central banks, in the end, are forced to practice gold being the currency of last resort. Investors with perspective already know that. And even though the majority of people in the world have forgotten the role of gold in the monetary system, circumstances in 2018 are likely to not only underscore, but remind them in real time of its importance as an asset preservation tool. And I think that’s really what people need to focus in on. It is an asset preservation tool. It is a means of value storage. It is a means of conveyance of value through time. Liquid, portable, private – these are things that don’t seem sexy in the world today, but in a world where those characteristics are becoming more and more scarce, I think you’re going to find its value appreciated in a new way.

Look at 2018 as a continuation of 2017 – disintegration on a global scale. Is that going to bring us trials and hurdles that are not presently accounted for in the high levels that we see in stocks? Are we going to see something shift in the low levels that we see in the options market tallied in the VIX? The Volatility Index – when it is single-digit, it’s telling you you’re at the end of a cycle, not the beginning. Investors have chosen to ignore the fact that we have more disintegration – we’re talking about post World War II structures, whether it’s money or power – (laughs) this is all happening all happening in the first year of the Trump administration.

But investors are ignoring the complete disintegration of these post World War II power structures. And none of this is factored into the market. Is there a possibility for surprise in 2018? A military surprise? A market surprise? A surprise in the Middle East? A surprise from the Chinese? A surprise from the North Koreans? Some sort of surprise, unexpected. It’s not priced in. What’s priced in? What’s priced in is a perfect tomorrow. Unfortunately, in my opinion, that’s not wise expectation management.

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