In PodCasts
  • CDS Credit Default Swaps signal acute stress in Chinese bond markets
  • Harry Figgie “Bankruptcy 1995” was early but not wrong
  • Ultra-high inflation will be the result of big, bad debt defaults worldwide

Evergrande wants to pay YOU 75% interest!
October 13, 2021

“The prop comes at a price, and the price to pay for stability and control of market dynamics is going to be reflected in the currencies, whether we’re ultimately talking about the US dollar, the renminbi, the yen, the euro. Frankly, if you’re not seriously invested in hard assets, you are in trouble. And again, I can’t get over the silence, the silence on the Chinese bond market issues. We’re watching an implosion in real time. The silence is ominous.” — David McAlvany

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

Well, David, I’ve been asked several times to not sing on the program, but you and I were talking about memories, and one of the things that I feel very blessed about is I’ve known you since you were a teenager. I’ve watched you go to college. You didn’t have any interest in the stuff that you have interest in now at the time, but I’ve watched that. So just, if you would indulge me, there’s a song called Memories. I’ll just sing the first line. (singing). Sorry, I did that for those who’ve asked me not to sing. Please don’t do that. But let’s go back to your college days, Dave, because your dad had a gold and silver firm going back all the way to 1972. And, granted, you had interest in politics, you had interest in economics, but honest to goodness, you probably didn’t have that much interest as you went to college in the stuff that your dad had raised you with.

David: Yeah. Interesting dynamics. We are good friends and love to travel and vacation with them. And if he said, “What do you think about basketball?” I would say, “Soccer is preferred.” “So what do you think about baseball?” I’d say, “Lacrosse, please.” And so, when it came to studying, he would say, “What do you think about finance and business?” And I said, “Philosophy sounds about right.”

Kevin: I remember when he called me in and he said, “Kev, David’s going to study philosophy. Can you believe that?” I remember that.

David: I can understand the degrees of disappointment. It would be like someone coming in, one of my kids saying, “Dad, I really have dreamed of studying for four years underwater basket weaving.” I’d say, “Well, okay.” How do you muster enthusiasm? But I started my bachelor’s degree in 1993, and the economy was of little interest to me then. It seemed to me a boring string of numbers and prognostications by people that could barely tie their own shoes. And some of that I still think is true, at least on the shoe-tying side of things. As I would soon discover, I did like questions and puzzles and musings on human behavior and what people found meaningful and how they chose to organize their lives. I guess, compared to the average student, I was more interested in international politics and public policy, having traveled with my dad to a dozen different countries as a boy. And so when things happened there in the early nineties, there was lots to pay attention to. Mandela was released from prison in 1990, elected president in 1994. I paid attention. Just like I remember the year previously, 1989, a business trip to Southern California, sitting in the hotel near [unclear] fairgrounds and the Berlin Wall came down. I didn’t realize the interconnections there in ‘93. I didn’t realize the interconnections between choice and freedom and philosophy and how those things are actually at the heart of economics.

Kevin: I think that’s what sort of lit the fire under you, Dave, because you started to see the human side, the philosophical side of economics. And one of the things that everyone knows about the McAlvany family is freedom. The freedom is probably one of the number one goals as far as economics goes. So in 1993, there were already people who were declaring that America is going to go bankrupt if it continued down that road. We’re almost 30 years past that. What we’ve done is we’ve really moved money from the future into the present over and over and over, and it hasn’t caught up with us. What’s your thought on that?

David: Yeah, and this comes back to a process of discovery, where I didn’t appreciate that within business and finance, within something as simple as an interest rate, there is quite a story. What I didn’t appreciate or I didn’t care about is the way that people and politicians prioritize today’s agenda and preferences without considering the long-term costs borne by those who are experiencing the consequences tomorrow. It may not feel like economics, but there is an element of cost that weaves its way through each choice we make, an actual cost, monetary in some instances or an opportunity cost in others.

Kevin: And it can show up in the strangest ways. Look at the lockdown. Have you noticed the childhood obesity figures based on just the unintended consequence of the lockdown this last year and a half or so?

David: I go back to a year ago when we were talking about blue waves and anticipating the election outcomes, and that was our conversation a year ago at this time. Also about the same time, there was a group of epidemiologists and scientists from around the world who put something together called the Barrington Agreement. Agreement, accord, I forget what it was exactly. It’s been a long time since I looked at it. But it made an impact on me. I thought, here’s a group of scientists whose approach is both practical, in terms of getting to herd immunity, as well as clearly based in science. And from the best schools, from Stanford and Oxford and Harvard. If you haven’t read it, I would go back to it. But one of the things that they address are the consequences of lockdowns for various age groups, and taking an intelligent approach, not a one-size-fits-all approach, so that we don’t have unintended consequences. These are scientists, not economists, but I appreciated the fact that they were stretching into the future and taking account of the consequence of choice. 

Today we can read about the unanticipated costs of our national lockdown. Childhood obesity figures are soaring. They’re reaching new heights. And it’s a combination of things. It’s eating processed foods, it’s sitting in front of screens for more time, it’s limited access to activities outdoors. But we now have the greatest number of 400-pound 17-year-olds in US history. That’s something to be proud of, I suppose, or not. But with that comes type 2 diabetes and hypertension and a host of other adult health considerations that are increasingly plaguing children. Alongside physical health, we have a deterioration in mental health. This group of scientists anticipated that as well, which I thought was very thoughtful in their part, stretching into the psychological, out of the epidemiological. The issue is, our choices today are accruing increased costs to be paid tomorrow. Not all of those costs are monetary. We’re racking up debts that stress the system, whether it’s the financial system, it may in fact crash the system, but we’re also talking about the health system and the money system, maybe even the political system.

Kevin: Okay. But Dave, I remember reading Harry Figgie’s book Bankruptcy 1995, and he was right. America is on the track to bankruptcy. Jim Deeds, he sends us packets with information, and he sent us both the Harry Figgie book from 1995, and he said, “He may be early, but he’s not wrong.” So what’s your thought on that? Because people are going to say, “Yeah, yeah, yeah, yeah, yeah, debt. We’ve never experienced the pain of debt.”

David: Yeah. Harry Figgie figured we’d be bankrupt by now. That story goes back to what he laid out in his book, New York Times bestseller, Bankruptcy 1995: The Coming Collapse of America and How To Stop It. Well, he was working with the Grace Commission to study government waste in places where potentially you could tighten the budget, save money, and instead of just sort of steamrolling towards higher levels of debt, do something to control the outcomes. The conclusion was that debt was accumulating at an accelerating pace, and that had him concerned. It’s not just that it was growing, but it was growing faster and faster with time. His conclusion was, ultimately that would bankrupt the country and perhaps, he suggested, also lead to the kind of bankruptcy witnessed in your overextended and over-leveraged banana republics, coupled with out of control inflation.

Kevin: This is not a partisan issue. Both sides seem to blame the other as far as spending too much money, but between Republicans and Democrats, they all spend money.

David: Yeah. And again, in 1993, I was interested in weekend trips to Joshua Tree for climbing escapades, not the ascension of debt levels to unsustainable heights—not my area of interest. I think my freshman year I was majoring in bird watching, and so trips to the beach for sand volleyball and bonfires, that was more critical to my research at the time. Bonfires, not bond fires.

Kevin: Your interests have changed. Yes, I get it.

David: Yeah. The run rate in 1993 was for a half trillion-dollar deficit, and it was scary at the time. That’s now a mere 17% of our current annual number, about the same the year previously, too. So we’ve got 2021 and 2020 at $3 trillion deficits. What we look back in time at and what people were afraid of then, now all of a sudden we’ve scaled up. 

1994, there was a significant hiccup in the bond market. Going to school in Southern California, Orange County, again, what am I paying attention to? Not what’s happening in the municipal bond market, I can tell you that much. Orange County declares Chapter 9 bankruptcy. They take a $1.5 billion loss on investment positions, specifically a leveraged bet that interest rates would stay low or decline. And again, you think, well, what could go wrong? Could the market actually take rates higher? The market did take rates higher, and the rest is history. The largest municipal bankruptcy in US history at that time, again, which I was happily oblivious to.

Kevin: Do you remember the days where a president would actually talk about balanced budgets? I remember Clinton saying it and thinking, this is going to be a disaster. He’s going to raise taxes. But we had a balanced budget, didn’t we?

David: Yeah. He was promising new spending programs, so on the one hand you think, okay, this is just more of the same. We’ve seen this. Doesn’t matter Republicans, doesn’t matter Democrats. He was on tap for roughly 160 billion in handouts. It’s great. That’s how you solidify your base, make sure that they’re happy and get what they voted for. But he wanted to increase taxes and come closer to a balanced budget, and that, too, is something that you’ll hear a lot about from Republicans. Very little follow-through. Just look at the history of the deficit and what each president and what each Congress has done on their watch to bring us that direction. You realize it’s just rhetoric, just rhetoric. Everything else is bollocks. To the surprise of many, you’ve got Clinton, he actually pulls it off.

Kevin: Isn’t that amazing? Because the Republicans would say, well, we’re the fiscal conservatives, but Figgie said something different.

David: Yeah. Figgie looks at studies from the National Taxpayers Union on returning members of Congress, which concluded that Democrats returning to the Senate were twice as likely to endorse money spending bills than those who had left. And Republicans were five and a half times more likely, again, to endorse spending bills than those who had left. So we come into the 102nd Congress. 102nd Congress, you’ve got Dan Quayle as the Senate president, that’s Quail with an “I”. I’m just kidding. And Newt Gingrich, the minority whip. $5 trillion in money spending bills are being proposed, $5 trillion. This is five trillion ways that we can spend tax dollars, and there’s $488 billion in savings bills which are being proposed. So yeah, you can tell, given their druthers, they will drive us into bankruptcy, any one of them, as fast as possible. And it’s just a game of who controls the power and how do we pay for gain of control? The odds of Clinton coming in and balancing the budget were incredibly low, but at least he had a stated intention was there, and he did it. He did it.

Kevin: Yeah, but they had not discovered modern monetary theory. We found the money tree, which means you no longer ever have to pay a debt off. I hope you’ve taught your children that they no longer have to pay debt.

David: Yeah. Well, it’s odd, but yes, true. Today, balancing the budget is an anachronism. It’s not something we even need to consider. I say this tongue in cheek. Why would you do that? Why would you consider balancing the budget with the bright idea of monetizing your debts and being completely freed from the constraints of a budget altogether? You’ve basically opened up limitless spending, which gives you access to the power. One party or the other, it gives you access to the power. MMT, modern monetary theory, it is the rationalization which might well bring Figgie’s deeper fear to life, that is, a rapid expansion of debt culminating in an inflationary debacle. Only time will tell. There’s always hope that our politicians will do the right thing. I will have to say, I think hope sometimes hangs by a very slender thread.

Kevin: When you said MMT, it just hit me. I think we should start calling it money money tree, the money money tree, because that’s the only purpose that MMT serves until you have your collapse. But it’s strange, politics still continue. They’re talking about raising the debt ceiling. You’ve got one side acting like they’re more conservative than the other. Political sides, talk to me about that.

David: Mo money tree, I think that’s what we call it. The mo money tree.

Kevin: Mo money tree. That’s better than—

David: I need the mo money tree. Not the no money tree, I need the mo money tree. We watch the political wranglings over the debt ceiling, and you’ve got Biden protesting the GOP obstruction. He said this just last week, “Not only are Republicans refusing to do their job, but they’re threatening to use their power to prevent us from doing our job, saving the economy from a catastrophic event. I think, quite frankly, it’s hypocritical, dangerous, and disgraceful.”

Kevin: Yeah, but didn’t he vote against it when the Republicans were in?

David: This is the pot calling the kettle black. Biden voted twice. He voted against raising the debt ceiling two times under the Bush administration. You have to understand, the way votes are cast, it is along party lines 99.9% of the time. It’s almost the same mirror of the survival rate of COVID, but that’s another issue. While he was in the Senate, again, he votes against raising the debt ceiling two times. That’s politics. What is risible is public anger that ignorantly believes anything a politician says. So again, hope is there, but it also hangs by a slender thread.

Kevin: Okay. But let’s talk to somebody who goes, “Yes, but David, Ronald Reagan,” and I’m being tongue in cheek on this, but Ronald Reagan is seen as a fiscal conservative. He was anything but.

David: Yeah. In some sense, this is why principles in politics get set aside. The war against the Soviets, the Cold War and the domination game, played on a grand global theater. It meant that he felt compelled to outspend the Russians, and in fact, bankrupted them thereby. Reagan borrowed and spent more than Johnson, Nixon, Ford, and Carter combined by a factor of three, by a factor of three in his eight years. Actually, he spent more than the 39 presidents that preceded him combined. So the increase or the rate of change was notable then, and it’s notable now. And you can say, all right, well, that’s one of the reasons why we don’t have to worry. It was no big deal then. We’re still around. Who cares? What we’ve said in recent weeks in our conversation on excess aggregate demand, I think shines a light on what kind of spending is important to consider and how it’s likely to dial up our inflation problems.

Kevin: Let’s talk about what kind of spending, because a person would defend, and I would be one of them in the past, I would say, well, the Soviet Union. Reagan had the Soviets to beat, and frankly, he beat them economically with borrowed money. That was the excuse. That was the type of aggregate demand that was created at the time.

David: That’s right, but it wasn’t aggregate demand that created a tremendous amount of inflation. He was in the race with the Soviets. Military spending was the target. As we’ve said before, that may put money in the pockets of the military industrial complex, but those privileged members of the 1%, coincidentally in the military industrial complex, don’t spend. They don’t spend enough of their savings to move the economic needle. Where the money goes indeed does matter. Going into the hands of families living paycheck to paycheck is a direct infusion into the economy. This form of demand stimulus is more inflationary than Reaganesque military spending, or even Obamaesque financial bailouts following the Global Financial Crisis.

Kevin: And that’s an important note, because when I mockingly say, “Dave, we’ve never really experienced the effects of all the debt that we’ve created,” the truth of the matter is, that debt gets paid with high inflation at some point.

David: Well, I think it also neglects the fact that we’ve been in a long cycle of interest rates and the cost of capital being in decline. At least a few times a year, we talk about the US interest rate cycle and the fact that in either direction, either up where interest rates are increasing, or down where interest rates are coming down and the cost of capital is decreasing, those cycles, the shortest in 200 years of interest rate history, thanks to Louise Yamada and the studies that she did with Solomon Smith Barney years ago, 22 years is the shortest interest rate cycle in US history. The average is about 36. We’re pressing 40 right now. We’re beyond long in the tooth in terms of this interest rate cycle, so we’ve been able to accommodate an increase in debt as the cost of capital has been in decline. That is a circumstance which is not duplicatable, nor, if we’re talking about sustainability, if we’re talking— that favorite buzzword of the day, all of the projects that we’ve put in motion that have taken for granted— cheap debt may not work, may not work in an environment where the cost of capital is increasing.

Kevin: That kid who was just going into college in 1993, who loved beach volleyball and bonfires, that kid at this point is interested in economics.

David: And I’m very interested in bond fires as much as I am bonfires. As it turns out, 30 years later, the economy is fascinating because it’s the centerpiece of choice, decisions, coercion, freedom. And you see in real time the actions of individuals played out in the pricing of asset prices and risk markets. 

Yeah, 1993, living in the moment was pretty exciting. Anticipating the future would have to wait. I wasn’t sure even what I was going to major in halfway through my second year. The future is now, and debts are no longer in the Bankruptcy 1995 range, where Figgie would have said, “Look, $10, $13, $14 trillion and we’re doomed.” We’re at $28.8 trillion and rising. We’re going to exceed $30 trillion next year. And off of these levels, with the economy that we have today, I’m horrified to think what tax increases would be necessary to balance the budget. 

I recognize that nobody cares about that anymore. We’ve got a new theme going on, which is print and pay as you go. Monetize all pieces of paper and every obligation. Keep in mind that budget cuts are a form of political suicide. So if we are going to see anything reasonable come into the equation, it’s not going to be in the budget cutting side, it will have to be on the tax side. And you can see it already. Redistribution is a priority, social justice is a priority. Counting the costs of each and all policy commitments, that’s not really a priority.

Kevin: It seems that everyone is counting, everyone in the market is counting on interest rates staying perpetually low. You talked about the interest rate cycle. It goes up for 20 to now 40, 20 to 40 years, and then it comes down, and then it goes up 20. So the interest rates do cycle, unless there’s some game playing in the economy. And if you’re printing money and just buying all the bonds, you can keep interest rates down a little, but do you remember? Okay, you’re bringing up 1993, and California played a role in your life. Do you remember Orange County? They were counting on low interest rates too during their bankruptcy.

David: That’s right. On our bet on a national level, and you could actually extrapolate this to Europe and China as well, it’s not unlike Orange County, late 1993. Interest rates will stay low and are likely to go down. That’s an operative assumption. Now, we might have to raise rates a little bit because of inflation, but we’re still talking about very, very low levels relative to a longer-term picture on the cost of capital. The business community has bet on low rates. Municipalities have bet on low rates. The federal government has bet on that. Speculators, risk parity traders, they’ve bet on low rates. Some actually depend on that as a way of hedging equity risk.

Kevin: Can’t you guarantee gain? There have been people in the past that have guaranteed gain based on the thought process that they can control it.

David: There was a very simplistic set of assumptions that went into the Orange County debacle. Not a particularly sophisticated guy running the show, Robert Citron. Very few people remember Robert Citron, municipal employee who was fired and disgraced for popularizing a portfolio position that in his view couldn’t lose, until it did. And frankly, Wall Street was only too happy to feed this idea. Merrill Lynch fed billions of dollars into that portfolio, profited handsomely. There is not one Robert Citron today, but tens of thousands. You’ve got political party functionaries, you’ve got municipal flunkies, you’ve got Treasury market makers, you’ve got congressional baboons. They all seem to share in common Citron’s portfolio positioning: rates are going to stay low and likely head lower, and we’ll all continue to make a lot of money. Isn’t that nice? That’s nice.

Kevin: Okay, I’m going to ask you a question. Was Harry Figgie right? Are we bankrupt at this point? Are we just masking it?

David: Yeah. Technically yes, practically speaking no. The game goes on till some event occurs and a vast reappraisal comes into play. A minor bump in interest rates quickly annihilated one of the wealthiest municipalities in America, and we’re talking about a bump. 1994 was not resetting the trajectory of the cycle. We were coming down from 1982. We’ve continued lower and lower and lower still. We’re talking about, in the scheme of things, a fairly insignificant bump in interest rates in this longer-term secular down cycle. A minor bump in interest rates annihilates one of the wealthiest municipalities in America. And of course, excessive debt played a leading role, long before interest rates did. 

Minor bumps in the cost of capital don’t sound like the stuff of bankruptcy, but perhaps we should discuss how minor sometimes turns to major. Discussing China, it’s not an exploration in financial hyperbole, it is a real-time exposé on excessive leverage and a massive, let’s call it Citronian bet, not for a few million people, but for a large swath of the global population. Sadly, the Chinese story is our story, too, and Europe’s. Debt proliferation and saturation is a global phenomenon accumulating at record low interest rates and dependent on rates staying near 4,000-year lows in order for the wheels to not come off.

Kevin: And that’s what makes us so different right now than 1993 as well, because the average American doesn’t even think about the Chinese bond trader. But right now with China, the size of their debt, that’s going to affect us.

David: Yeah. The Chinese, like the American bond trader and the European central banker, have believed that rates were a matter of edict and not market vote. Perhaps there is a shade of Citron there too, that somehow it’s all going to be controlled and it’ll all turn out just the way we’ve planned it to be. Remember talking to Richard Siler, and we explored, this is also about a year ago, exploring his tome on the history of interest rates? It was co-authored by Sidney Homer. Homer said sooner or later, every generation is shocked by the behavior of interest rates.

Kevin: And I’m wondering when that happens. One of the shocks that we’ve had already, Dave, is for the first time in 4,000 years, we have nominal interest rates negative.

David: Yeah, we should be shocked by how low interest rates have gone, but oddly, we’re now conditioned to believe, and this is sort of a Neo-Keynesian, Neo-Wicksellian reshuffling of the natural rate of interest, but we’ve been conditioned to believe that what our generation should be shocked by, again, this is negative nominal rates, deeply negative real or inflation-adjusted rates, that that’s normal. And not only is it normal, but we can extrapolate that into the future. This is the state of play. Whether we look at things from the viewpoint of business finance or balance sheet construction, at both the corporate and now national levels, we’re talking about a dependency, a precarious dependency on the ability to roll over trillions in debt on favorable terms.

Kevin: I’m thinking out loud, Dave, but an interesting study, if a person wants to go back and look at history, is the finding of the Rosetta Stone. It’s fascinating, because it was literally— Before that, Egyptian writing was just hieroglyphs. And they had no idea really how to translate them. There were various interpretations. Are these pictures that represent something? Are they sentences? Are they phrases? And then the Rosetta Stone was found, and it had multiple languages interpreting one of the messages on one of the sides. There were two other languages interpreting it. It was an amazing find. For the person who’s listening to this commentary and saying, “How in the world can I keep up with all this stuff, and how do I interpret it?” don’t you think the Credit Bubble Bulletin with Doug Noland and these people who’ve spent their entire life trying to translate the hieroglyphs, that seems to me like an obvious.

David: Absolutely. It was 1996 that I was in London at the London Museum. They’ve got the treasures of the world there, and behind a red cord is the Rosetta Stone. Today it’s behind glass. I think I know why it’s behind glass, because when it was just behind a red cord, the temptation to touch said stone was too great for some people. Some people, I don’t know who that would be, but—

Kevin: For some people. For some people.

David: Yes. Yeah, last week we talked about the Credit Bubble Bulletin. You should be reading Noland every week. Why does that tie to the Rosetta Stone? Because to me, the Credit Bubble Bulletin is a very important chronicle of this chapter of financial history, and reading it provides a real time look at the equivalent of a financial Rosetta Stone, an interpretation of the data so we understand what is actually going on. There’s a lot of data, and it is important, but it needs context. Doug has made another transition in his career here recently. He’s witnessed the shift from theoretical risk buildup to collapse, and he’s seen this numerous times. And it would appear by the continued move in sovereign credit default swaps, the pricing of insurance on Chinese sovereign bonds and a variety of now other sovereign debt as well, it’s showing up in sovereign bond yields, it’s showing up in bank credit default swaps, that the acute stress within the Chinese bond markets today has carried us through from the theoretical to an actual crisis dynamic.

Kevin: And for the person who’s nodded off in this program, Dave, you are saying, this is something new. Doug is actually seeing crisis in the credit default swap, related to China, related to debt. So stop, listen again, because we are in a crisis. It’s showing up in a way that most people don’t watch.

David: Our asset management clients had the benefit of our annual call last week, and that call is available, unfortunately, just exclusively to those clients. But in the Credit Bubble Bulletin, you have the benefit of distilled data, interpreted data, and I would avail yourselves of it. On our weekly call, starting Monday, Doug started out by saying, “1998, I remember it like it was yesterday. I remember when the credit default swap market started to price in Russian default. This was 1998. As soon as CDS prices started to move, I said, ‘This is it. It’s done. We’re done.’” And it was only a matter of weeks before things began to unfold, and the Russians did default. Of course, that that led to a whole series of issues within the US financial markets, with Long-Term Capital Management having taken a leveraged bet and coming close to sinking the entire global financial system.

Kevin: So is Evergrande the new LTCM?

David: I don’t know that they’re the next LTCM, but there are concerns within the credit default swap market which are becoming more apparent. We’re not in a crisis mode, but we’ve also seen moves here in the US within the investment grade bond market and high yield, and specifically with credit default swaps. Now also with US Bank CDs, which are beginning to move. Again, they’re suggestive that sophisticated money doesn’t like what they see. It’s not panicked, but it’s very concerned. Evergrande is one company where “panicked” is 100% accurate, and it’s only one company. We understand that.

Kevin: It’s huge.

David: It has 300 billion in liabilities, so that is massive. But on its own, if containable as a credit calamity, is manageable by the PBOC. The issue becomes contagion. Contagion is a factor which raises the stakes, raises the cost, raises the odds of systemic failure, because again, it’s spread beyond a small localized issue. This is no longer theoretical risk, either, and we’ll talk about this more in just a minute.

Kevin: Okay. Maybe I overstated. Maybe we’re not in the crisis, we’re seeing signs of a potential crisis. But Ray Dalio, he’s trying to paint over this and say, “No, the de-leveraging out of Evergrande, it’ll be calm.”

David: I think when he was writing up those comments, he must’ve been listening to the Grateful Dead or something. It just didn’t even sound— The concept of beautiful de-leveraging when talking about the Evergrande sell-off and it not being a concern at all, I found to be somewhat preposterous. It’s a little like Smokey the Bear suggesting that an untended fire is fine. Granted, the wind is picking up, but it’s not a concern. Not yet. So you’ve got Evergrande debt, which now trades at 19 cents on the dollar, at a yield of over 75%. I can now give you a list of a dozen other Chinese developers with billions of dollars in debt due this year and next year as well, and they’re trading between 20 cents and 83 cents on the dollar, with yields from the teens to the 60 to 70% range. Again, this is no longer an issue which has been contained. There’s nothing beautiful about this de-leveraging.

Kevin: Oh, but if they could save Evergrande and if you could consistently get 75% yield, that’s almost too good to be true. We talk about these things, and when you’ve got a company like Evergrande that’s paying 75% on their yield, that’s a bankrupt yield. How come we don’t hear it from Wall Street?

David: Yeah, that is amazing. The most amazing aspect in the last 48 to 72 hours has been the news flow. Wall Street firms are saying nothing, Main Street media has been virtually silent, and we’re on the edge of what may be the next global financial crisis. Silence, silence. Kaiser Group, it’s another property developer, on the 1st of October, it traded at a yield of 20%, clearly under stress. Last Friday, 36%. Today, 43%. That is a yield. When all this is done, when all this is done, Kevin, I hope that you remember, that our listeners remember, the collusion of Wall Street and the media, which were blacking out the newsfeed so as to paint a prettier picture, whether for their own political objectives or while doubling down on speculative bets. But supposed sophisticates are replaying the Citron stupidity. It starts with debt, it starts with the promise of easy gains, and it ends in tears.

Kevin: One of the things you said earlier that Homer had said was the interest rate shock. Are we right on the precipice of an interest rate shock? You’re talking about 75% rates with Evergrande and other Chinese firms. Does this spread like a contagion?

David: Yeah. The rise in rates within the developer bond universe is consequential for an industry that has relied on borrowing for growth and requires the rollover of that debt on reasonable terms—again, we said reasonable terms—in order for the game to continue. These are game-over terms, not reasonable terms. Higher rates at this rarefied air, not reasonable at all. So no, this isn’t Lehman, but it’s potentially bigger. You have a destabilized backdrop. You have a destabilized backdrop for global trade. That’s in play, which we’ve spoken of in terms of the supply chain issues not going away quickly. You’ve got inflation which is already rising everywhere around the globe. And the folks who are most concerned about it are the folks who’ve paid that price dearly in the past and seen a social unraveling as a consequence of inflation. Again, economics used to be of no interest to me. I didn’t understand that it gets to the heart of not only money and credit, but also individual lives. And so when you see the ravages of inflation and how it can tear apart not just an economy, but an entire culture, yeah, it begins to matter. Now we have credit risk infused into this backdrop. Again, global trade, already challenged. Inflation, already present. Now credit risk infused into the mix of trade interruption inflation concerns, this is epic. This is epic. I hope you’re prepared.

Kevin: Something that’s so hard to get our head around is the size of leverage. I’ll bring it home to a conversation I had with a doctor client of mine, really sharp guy. We were talking about the Global Financial Crisis 13 years ago, and he’s a doctor. He doesn’t know anything about stocks and bonds, or he doesn’t claim to. And he said, “Kevin, I had 30,000 bucks at the time.” He was just building, he’s a young doctor. He’s done well for himself since then. But he said, “I had $30,000, and when the stock market came down, I checked to see if I had lost anything.” And he said, “I lost everything, all $30,000.” He said, “That was all I had saved at the time.” He says, “Then I realized when I called my broker that the cost of margin is very high.” How do we get our heads around the size of the leverage we’re talking about?

David: Yeah, because if you go back to the Global Financial Crisis, you’re talking about initial hiccups with a couple of funds totaling about $400 million, million with an “M.” That’s still in the vernacular. We know what “million” is, even though it’s paltry, but $400 million in issues and concerns impacting hundreds of billions of dollars globally. Now we have one company which is hundreds of billions of dollars in play. And yes, it has implications into trillions. Nomura Securities’ most recent estimate suggests that we have all failed to appreciate the scale of the leverage involved in the Chinese property markets. They suggest the number is $5.2 trillion of debt, $5.2 trillion of debt tied to property developers in China, $5.2 trillion in a failing sector. $300 billion is absorbable by a government that has over $3 trillion in exchange reserves, specifically the Chinese government, the PBOC, but the scale of the bubble bursting at present is sufficient to overwhelm the resources of the PBOC and trigger something worse than the Global Financial Crisis. We’re talking about scale unimaginable. We’ve never done this before, not in human history. But to look and say the Global Financial Crisis of 2008 and 2009 was really no big deal, we’ll only be able to say that with time passage and reflection back. But here we have, again, hundreds of billions in play on trillions of dollars in assets, which are potentially compromised, versus 400 million with hundreds of billions at risk in the last cycle.

Kevin: A couple of weeks ago, we had Bill King on, which is always a favorite, but the cost of paying for stability and control, because Bill King, with his experience, he can watch, and he’s like, “Yeah, every time the stock market wants to correct down, which it really does, somebody comes in, whoever that somebody is, comes in and makes sure that that doesn’t happen.” But Dave, there’s a price. Over time, you can pay for stability for a short period of time. You can print money. You can buy bonds with that printed money. But there’s a price, isn’t there?

David: Yeah, the prop comes at a price, and the price to pay for stability and control of market dynamics is going to be reflected in the currencies, whether we’re ultimately talking about the US dollar, the renminbi, the yen, the euro. Frankly, if you’re not seriously invested in hard assets, you are in trouble. And again, I can’t get over the silence, the silence on the Chinese bond market issues. We’re watching an implosion in real time. The silence is ominous. The art of redirection is in play. The bazookas, both monetary and fiscal, sit at the ready. And again, if you want the best evidence for when things are coming unraveled, watch the currencies. The RMB, blowing up. The yen, continuing its already 9% decline for the year. The euro, the dollar, coming under pressure because the only way to solve these problems, the scale of these concerns in the credit markets, is with a massive inflation. 1993 was a long time ago. 1995, that bankruptcy never happened. Maybe it never will. Again, of critical importance is to watch the currencies and watch the inflation in each locale.

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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