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Fed Pays Banks 3.9% To Not Loan Money!
December 7, 2022

“And that’s been the story of this year. Uniformity was the surprise for the 60/40 portfolio because you thought you had a balance between stocks and bonds, and that balance was supposed to keep you from losing money, and yet you lost on both sides. Instead of losing on one and gaining on the other, now you’re the double loser. Uniformity is telling you that policy matters, rates matter. We have a very leveraged system which is hypersensitive to small changes.” — David McAlvany.

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

We’re coming into that time of the year where we’re going to do our question and answer program. If you would send those questions to, three to five sentences long, please, but we’ll try to get to all of those questions at I-N-F-O at 

Well, the famous Table 30, Dave. Table 30. You left me. You left me and you went down to Cancun. You have a friend who is a musician professionally, and he invited you down for a couple of days. And you had texted me—and thank you, by the way, for communicating that you weren’t going to be there for the Monday meeting, that was helpful. But when you texted me and said, “Hey, can you cancel Table 30?” I thought, “You know what? We both have a doctor who’s a friend who listened to the Commentary back when he lived in New Zealand.” He moved to Durango and I called him up and I said, “Hey, remember Table 30?” He goes, “Oh, yeah, I’ve heard all about Table 30.” “Well, would you join me for Table 30 on Monday night because Dave is out of town?” 

So, I hate to sound like I was a traitor, Dave, but for the first time in over a decade of the meetings on Table 30, you weren’t there. I still enjoyed the Talisker and Dennis did, too.

David: Well, it sounds like an official launch for the rebranding of the McAlvany Weekly Commentary. We’ll just call it Table 30 from now on.

Kevin: You know what? That’s been suggested, that’s been suggested.

David: Table 30 it is, it’s where the good stuff happens. It is a little bit like jazz, you don’t necessarily know what happens next, but it’s always good.

Kevin: Well, and speaking of that, I think you’re just about to head to Europe for a couple of weeks as well. So, I think we’re probably going to desert Table 30 a bit but, hopefully, we’re going to have some really good interviews. I know you’re looking at interviewing someone just strictly on this history of Russia and Ukraine. How do you say his name? Is it Figes?

David: Sure—I don’t know.

Kevin: But I’m looking forward to hearing that.

David: Well, I’ll be back in town sometime around the 14th or 15th of the month and that’s going to be immediately after Powell’s comments and the determination of the next move by our central bank. So, there’s some things that may or may not deliver this year for Christmas. We like to think of the Santa Claus rally, and maybe it’s not quite as generous as it’s been in past years. 

Last week, the big moves in the markets came after the Powell address at the Brookings Institute. This was not an official Fed announcement with Q&A, but these days a central bank talking about anything—about the weather—it changes the mood of investing, and it is a part of that exaggerated focus on Fed-speak and the market dynamics that tie to a very sensitive structuring of assets. 

Doug and I were talking the other day and he said there was a point in time, not that many years ago, where there were no Fed announcements. You had Fed watchers, and they had to determine what was going on by the actions taken. But this radical transparency, which is supposed to keep people from thinking about the Fed as the wizard behind the screen—à la the Wizard of Oz—and instead these are human beings with PhDs who are making solid scientific decisions. The problem is, you’ve got leveraged markets and people who want to trade on the information. So, the more transparency there is, the more there is this hypersensitivity. Again, you talk about the weather, or a central banker does, and somehow there’s either a storm or a rainbow or whatever.

Kevin: Don’t you think they’ve created, possibly, their own little Frankenstein though? They’ve learned that talking the markets actually worked for a while. You could just talk and get the market to do whatever you want. Now the problem is you have to talk, and everybody hangs on every word and it creates short-term decision making, maybe not long-term progress.

David: That’s right because it’s devoid of a view which places events in prices and prices in a broader context. So, short-term trading, they’re just happy to look for the momentary movement and maybe get a little momentum and then move on. So—

Kevin: You know what it reminds—

David: —it’s a world of pragmatics.

Kevin: Yeah, it reminds me of mountain biking. When you learn to mountain bike in Durango, you learn over time that you’d better be looking a long ways down the trail. We’ve talked about this as an analogy. If you’re looking at your front wheel, you’re going to have a problem at some point.

David: I think the same is true if you’re working a farm and laying in the furrows or mowing a lawn. If you’re watching the front of the mower, you’re going to end up with a really jagged and— But you have to watch the far side of the lawn, and on that basis you can keep a straight line.

Kevin: And, with investing, same type of thing.

David: Yeah.

Kevin: Rather than listening to every little line that the Fed produces.

David: You’re right on mountain biking. Your eyes get glued to the front tire, and, all of a sudden, every rock and root is interesting. It’s all the small stuff that matters, and sure, they’re each a potential hazard, but that immediate fixation on the front wheel, it actually increases the odds of an accident from overreaction. So, look farther ahead and the present tense obstacles are handled effortlessly and with lower risk of a spill. 

So, yeah, market obstacles I don’t think are that much different. The future is more important than the short term. What is in the present, it’s not that it’s irrelevant, but what you end up seeing in the marketplace is this popularity with short term trading. Think of it, the imminently, with an I. Imminently, not eminently, imminently expiring options, and this is to trade a small movement hoping for a large payout, that’s a part of the story developing in the financial markets today, a bad accident. Why? Because there’s insufficient context for a grounding of judgment, and it’s just going to Wall Street and operating as a casino, not as a capital allocator.

Kevin: So, if you’re looking across the lawn—I like the mowing analogy—if you’re looking across the lawn to get the right straight line, do you think the markets at all right now are taking Powell serious as far as looking all the way across the lawn? If he’s talking about interest rates continuing to rise, and let’s say you have to get 2% or so above the inflation rate, we’ve got a long ways to go.

David: Yeah, I think they’re pretty optimistic and less cautious, more optimistic. Yeah, I focused on Powell’s comments that the ultimate level of rates will be somewhat higher than 4.75. And, if I were to guess, that’s five and a quarter, it’s five and a half, and of course maybe it goes higher than that. We don’t know the dynamics that unfold, but the question I have now is how high the new inflation target will be in relation to the policy rate. We go back to the Taylor Rule. If the rule of thumb is that the policy rate should be north of the inflation rate by roughly two points, then the inflation target, currently set at 2%, that could be adjusted to 3% or 4%. I’ll come back to that in a minute.

A gentleman from the Peterson Institute has a case for higher inflation targeting, and, suffice it to say, this takes us back to one of your favorite movies. Just because you can do it doesn’t mean you should.

Kevin: I remember Malcolm saying that, but who gives him the right? I don’t understand who gets the right to steal 2% of my buying power per year, and now they’re saying, “Well, it could be 3 or 4%.” Economics proves that we can steal more of your buying power every year. Tell a retired person that who’s trying to just make ends meet on a fixed income.

David: Yeah. So, I was first introduced to subliminal messaging in the context of music. There’s a message underneath the message. Well, liminal just means the level at which you can perceive something. So, subliminal is below the level of perception. And so this argument—this goes back to a paper written in 2010—and the argument, I could be wrong on the name, I think it’s Claudio Borio, was chief economist at the IMF and then moved to the Peterson Institute. I’ll double check that. But the paper from 2010 argues that you can move rates higher, you just cannot offend with the rates and essentially it’s—

Kevin: Subliminal.

David: Keep it below the level that someone can perceive it. And so, there’s a fresh paper out, covers this, not the one from 2010, and it argues that 4% is a number that consumers really don’t understand. So, you want to “maximize the benefits”—benefits from state planning with a higher inflation target—but you can’t get to a point where you lose credibility as a central banker. You can’t get to the point where there’s angst related to the inflation rate. So, Financial Times covered this last week, and, splitting the difference, 3% is the magic number for the US. The 2010 argument was four. We think we can actually get to four and not offend. Two percent is too low.

Kevin: It reminds me of the dentist. I go to a really good dentist. He says, “Look, if you need painkiller, let me know.” But as he’s working, he’s like, “Please let me know when it hurts.” Well, I will tell you, there are times when I’m like, “You know what? I’m going to man up,” because it does hurt and I’m not going to say anything. But in a way, isn’t that what this is? The dentist is going, “We’re going to do this,” but the problem is the government’s going to do it until it does hurt. That’s the biggie.

David: So, we come back to looking at the direction of rates. If you take the target to 3%, then your Taylor Rule would put you at five. If it’s four, you’re closer to six. And not that they’ve strictly followed the Taylor Rule, what they’ve done is ad hoc, not follow rules at all.

Kevin: Well, there’ve been a number of good interviews. The Taylor Rule, that was interesting when you interviewed Taylor, but I also remember, who was it that you interviewed that wrote the book on GDP, gross domestic product, and how variable that actually can be? Because we just got the 2.9% GDP announcement and they were like, “Yay.”

David: Diane Coyle.

Kevin: Diane Coyle.

David: C-O-Y-L-E.

Kevin: That was an interesting book because it made me distrust GDP. I hate to say it, she was an expert on GDP, and, after reading it, it was like, “Gosh, GDP could be calculated almost any way.”

David: Well, and she made the case that this is an imperfect number, it just happens to be the best number that we have for the time being. So, third quarter economic growth, referencing her book, imperfectly measured by GDP, it came in last week at 2.9% versus 2.8. Not a spectacular data point, honestly. But the Atlanta GDPNow, their forecasting tool, had the fourth quarter economic growth anticipated at 4.3%.

Kevin: That’s quite a bounce.

David: It abruptly dropped last week towards 2.8. So, we’ve had some volatility there. GDP did get a small boost here recently from two curious things, the exports of our reserve oil and the emergency reserve oil, and the Ukrainian weapon sales. So, the strategic petroleum reserves— these are one-off benefits to GDP. You sell off strategic petroleum reserves to dampen price. Clearly that had a pre-election motivation, but why export those barrels? Selling them would be one thing, but exporting those barrels when the administration is flogging US oil producers to bring more product to market for the benefit of US consumers, that’s questionable in my mind.

Kevin: So, the government doing something that makes no sense but is political? Huh, that’s unusual.

David: Questionable, but not surprising. That, I think, more than anything, reveals the politicized nature of the sales. And I think it also assumed that voters would not see the disingenuous nature of exporting a part of our economic safety net. So, let’s go back to GDP in retail consumption. Of course, coming through Thanksgiving and Black Friday, Cyber Monday, clearly consumers are comfortable spending money. It’s coming into the holiday season, we’re seeing a little bit of this out of money that they have, but also balances on credit cards are creeping higher. And so we’ll be very interested to see how we get through this period of time and see how credit is changing. We expect a lot of insight from the Z1 report to be released this week. That’ll be credit at all levels, consumer bank, governmental, et cetera, et cetera, and it provides a good look at credit flows, allows for insight on valuations of all kinds—including some of your benchmarks for things like Tobin’s Q. So, look for the Credit Bubble Bulletin to cover it in detail over the weekend.

Kevin: So, Doug will talk about credit but you’ve also got to look at purchasing managers. How are they looking forward? You talk about that line, we’re mowing and now we’re looking across the lawn to next year. The purchasing managers, they’re seeing recession.

David: Yeah, it’s very curious. So, in the US we’re starting to see some recessionary suggestions even while global PMIs are not as bad as they could have been. So, Chicago PMI was expected to come in at 47 last week, Purchasing Managers Index, and it was expected to be up from 45.2, again to that 47 number, but instead it reversed to 37.2.

Kevin: That sounds like quite a reversal to me.

David: Yeah, like we mentioned last week, when you have those two fixed-income references, the three-month Treasury and the 10-year Treasury and the yield spread between them serving as a reliable indicator of recession to come when you get the kind of inversion we’ve had for as long as we’ve had. Well, the Chicago PMI has a history of breaching a threshold under 40 and then invariably being followed by recession.

Kevin: If it drops below 40, recession follows?

David: Yeah. So, there’s a growing case that what we have had as a global recessionary pressure may resolve itself. So elsewhere may be coming out of the dark end of things and we’re just entering into it. What degree of pain will the Fed deem acceptable in curbing excess demand? Because, keep in mind, they’ve been open to the idea of a recession. They’ve been open to the idea of bringing economic activity down so that they could bring inflation down. How fast will they act, though, in response to a market decline?

Kevin: This is the dentist. This is the dentist. Just speak up if it starts to hurt. We live in a day and age— All right. Now, I got to admit, I’ve only done it once, but I did do that nitrous oxide stuff. Well, you and I are both divers, and I remember when I learned to dive—

David: Nitrogen narcosis.

Kevin: Yeah. And the person who taught us, Zane, maybe you learned elsewhere, but Zane Bilgraff was the guy who taught us to dive, and he said, “If you get a chance, sometime at the dentist, ask for it, for painkiller, so that you understand how to recognize it when you’re 50 or 70 feet underwater.” I got to admit, bad news was good news when I went to the dentist because he gave it to me. And, quite honestly, not only does it kill pain, but it makes me think that I’m funnier than I really am. I was cracking jokes that would— Cracking myself up, but the truth of the matter was I wanted a little bit of pain so that I could justify asking for nitrous oxide.

David: Yeah, nitrogen narcosis is, I think, what you get when you’re diving.

Kevin: Right, right. When you start doing things that don’t make any sense.

David: Well, and that’s the similarity is it’s almost like being punch-drunk a hundred feet below water, which can be dangerous because you think you’re going to be the funny guy blowing bubbles at fish and take your regulator out of your mouth. That’s not a good idea.

Kevin: That is an unnatural environment if you don’t do everything right.

David: That’s correct.

Kevin: Yeah, yeah. So, bad news is good news.

David: I was paranoid when I had— I only had that laughing gas once, but, for the next half hour I thought there were these people standing above me and they’re joking about how they never even went to dental school and this isn’t even the right tooth, but, who cares, this guy’s never going to know the difference, but we’ll bill him anyways.

Kevin: That’s hilarious. Do you know what else happens? It makes your hearing really acute. The dentist used to be across the street from the supermarket up north here in Durango, I could hear people talking across the way. It was like, “This is incredible. I’m funny”

David: And a superhero.

Kevin: “I’m not feeling any pain and I can hear miles away.” Okay, so back to good news being— Okay—

David: Yeah, well, that’s the way the market—

Kevin: Bad news being good news.

David: That’s the way the market responds. Bad news is good news if you’re a financial market speculator because—

Kevin: Give me some painkiller.

David: —rough patch in the economy, recession 2023, might just remind the central bank to tread lightly with QT, and even maybe have them reconsidering a return to accommodation—

Kevin: —which is painkiller. 

David: Lowering rates.

Kevin: Painkiller.

David: Even, again, expanding the balance sheet. So, reflecting on the Powell speech, there’s a strong fixation with how the central bank is handling rates. And each time we hear from another regional chief, it’s the same. It’s about rates, and it’s about rates, and here’s what we’re going to do with rates. 

At a certain point, it feels like a magic show where the practice of misdirection includes elevating attention towards something that doesn’t matter, or, frankly, matters less than something else. Rates are an important factor here, but liquidity in the financial system, liquidity in the financial system has driven us to historic excesses. And so, one indication of excess liquidity in the financial system, reserve balances at the Fed, they’re still between three and three and a half trillion dollars, and those are numbers up from virtually zero—

Kevin: They said they were going to trim those back.

David: —in 2007.

Kevin: Yeah, they said they were going to trim those back, I don’t think much.

David: Yeah, and you’ve got a couple of different things we’re talking about. They are trimming back central bank holdings of mortgage backed securities and Treasurys. These are excess reserves at depository institutions. So look at your banks, look at the deposits that they have that are not being put into a securities portfolio or being loaned out, and they just basically say, “Oh, we can just put these right back with the Fed.” That’s where you get the “excess reserves of depository institutions.”

Kevin: And the Fed pays them interest. We need to talk about that.

David: Yeah, the peak in reserve balances was in August of 2021 at 4.168 trillion. This is, again, commercial banks putting money back with the Fed. And that peak was about the same time as the everything bubble peak. So, again, keep in mind, liquidity, when it’s there, has an impact, maybe with a few months delay in terms of the August 2021 bubble and the peak in assets. Liquidity is abundance on this measure, that’s what I’m getting at. 

So, you combine fiscal policy spending, which we certainly had, COVID and post COVID, with its own unique multiplier, and you combine that with a liquidity backdrop that’s very positive for financial assets, and you have at least two policy driven supports for inflation. Isn’t liquidity in the system as or more important than interest rates? I think the answer is yes. But then, why the fixation on rates and not on liquidity?

Kevin: So, I’m a banker, all right? Just pretend like I’m a banker, and I can either take a risk loaning money out to the hinterland, to Main Street, people who want to build houses and businesses or what have you, or I can just put it with the Fed. They’re paying me interest. Until the financial crisis, I don’t think we ever heard of anything like that, did we? Did they pay interest on these reserves that were absolutely going unspent before the global financial crisis?

David: Yeah, think about what a bank does. They bring in deposits and then they have to put that money to work, and they capture the difference. What they pay the depositor—let’s say it’s 1%. That’s probably generous in this environment. But 1% to the depositor, then you’ve got to go put that money to work—loan it out or invest it—and you make the difference. It’s called net interest margin.

Kevin: Because you’re taking a risk. You’re having to actually make a business judgment call unless—

David: Well, the 2008 decision was to initiate paying interest on excess reserves held at the Federal Reserve. And this was to do them a solid, help them out. They eliminated the opportunity cost for banks when reserve requirements were high by saying, “Hey, well, you can just keep them here and then we’ll pay you some.”

Kevin: How much do they pay now?

David: Today’s interest rate paid on excess reserves of institutions is 3.9%.

Kevin: I would like to get that. Can I do that even if I’m not a bank?

David: Yeah, depositors require half a percent or 1% to keep them happy and you can— Think about this. Banks have an overnight facility, how short term is it? Overnight is pretty short term. You have an overnight facility that gives you a great rate, 3.9%, zero credit risk, zero duration risk, over $3 trillion in bank deposits are sitting there.

Kevin: Yeah, of course.

David: No surprise. Why wouldn’t they be sitting there? So, prior to the interest payments on excess reserves, which were not on offer until 2008, the numbers in that excess reserve category, just chump change for the entire banking system, never above $50 billion, maybe it stretched to 60, 80 but—

Kevin: This was before? Before they paid interest, it’d be 50 to a hundred billion?

David: Yeah.

Kevin: And now, there’s three trillion there, why isn’t there more? It’s one of those things where it’s like, 3.9%, Dave, who’s getting 3.9% safely from the Fed right now?

David: Well, I guess the point is, where that money goes is consequential. Think about, first of all, the economic stimulus coming from the return of those funds to Main Street. You’ve got $3 trillion that’s sitting there as a liquidity overhang. Deposits—what if they were deployed? What if they were spent? And then you get the multiplier on the spending. 

The second thing is there’s the inflationary impact of those reserves doing the same thing that COVID money did for household demand of goods and services. Talk about another round of supply chain bottlenecks. Like a second round of COVID stimulus, you’re going to drive demand, you’re going to pressure prices higher. So, we don’t get to say goodbye to inflation until we’ve resolved the excess reserves of depositories sitting there at the Fed.

Kevin: So, you’re trying to manage the economy from the Federal Reserve’s point of view. Do you really want a recession? You’ve brought this up before. Are they purposely paying high interest to not deploy that money?

David: Yes, they do want a recession. They just don’t want a severe one. It has to be painful enough to curb demand.

Kevin: Soft landing, yeah.

David: Yup, and that’s the current Washington Wall Street consensus is short, shallow, that’s the nature of this recession. And I loved Mohamed El-Erian’s comments this last week, basically saying, look, we had a framework for thinking about inflation, and that framework led us to believe that this was going to be transitory, and thus, we could be dismissive. We’re using the same framework when we think in terms of short and shallow recession. Maybe it will be, but maybe it won’t be.

Kevin: So, he was thinking transitory recession—maybe not.

David: Exactly. He wanted to caution consensus thinking, consensus conclusions. And, if we look at this pocket of liquidity—again, excess reserves held at depository institutions—get that out in the economy, bank lending is far more directly impactful to the economy and to inflation than Wall Street credit expansion. One stays on Wall Street, the other flows more readily onto Main Street. So, expansion of bank credit would drive one of the inflationary inputs, might actually forestall recession. Contraction of bank credit, you have a reprieve from some of the inflationary pressure, but a high likelihood of a Main Street becoming pain street.

Kevin: Just a reminder, we’re about to do our question and answer programs coming up toward the end of the year, and you can send those questions to Try to keep the questions three to five sentences long if you would, and that’s spelled I-N-F-O at 

It’s so remarkable, actually, looking at how liquidity drives an economy. We’ve talked before, a financial crisis is almost always a lack of liquidity, that’s what it is. And so, what the Fed is doing is they’ve been releasing these floodgates, but it seems, as they reduce their balance sheet, that gums up the system some, doesn’t it?

David: At least as it relates to asset prices. For the Fed to continue on its current course of reducing its balance sheet— And, so far, if you’re looking back from April to this point, they’ve reduced their balance sheet by about four and a quarter percent. Not a tremendous amount. They still have a lot to reduce if they’re going to do that. It’s already upsetting fixed income markets. So, you’ve got market makers negatively impacted. 

We’re talking about “liquidity” —this is a different kind of liquidity, a different sense than what we were talking about a minute ago. What we’re talking about is the normal buying and selling of fixed income instruments. Can you sell? That would be a form of liquidity. Yeah, somebody will pay you immediately for that. 

Trading of mortgage backed securities and Treasury securities is just not as seamless as it once was. In the period from the global financial crisis till now, more than a few structural changes have been made where the old buyers are not at the scale they once were, and this includes the commercial banks. Like we just said, one of the structural things that’s changed, they can sit in overnight facilities with Fed—

Kevin: They’re going to get interest anyway, why? Yeah.

David: Not to be forced to buy Treasurys or mortgage backed securities, they’re not taking interest rate risk on that portion of their “portfolio.” And so, driven by COVID crisis responses, the central bank purchases these Treasurys and mortgage backed securities for a period of time. That has a displacement function in the market. And so we’ve covered over the shifts in what would’ve been normal market purchases. We don’t really notice that there’s been a lot of things changed in that market because the Fed has literally papered over the issues. 

As a consequence, and the bottom line here, is there is now less depth in the Treasury and mortgage backed securities market. So, we’re talking about another form of liquidity, not the excess bank deposits held with the Fed, not the kind we were just referencing a moment ago, lower liquidity makes for higher volatility.

Kevin: Thin markets.

David: Thin markets.

Kevin: Thin markets make for higher volatility. We know that from other thin types of markets, but Treasurys, mortgage backed securities, those shouldn’t be thin.

David: Well, and that’s why I think some of the changes we can anticipate coming into 2023 is that there’s new cycle dynamics and one of those new cycle dynamics is that the markets that we think are liquid simply are not as liquid as we thought they would be. So, we’ve had volatility in spades this year with fixed income investors, generally not the kind of people who are looking for a lot of change in price, they just like collecting their income. And they landed in the rates rodeo ring. And so, they’ve been very much discombobulated, fighting for sanity, dreaming of the bucolic days of being boring again. Fixed income used to be boring. It’s not boring anymore. Rates are rising. I don’t think there’s any reason for volatility to diminish in 2023.

Kevin: So, it’s not just the fixed income investors. There are a lot of people right now that are looking at real estate and saying I can’t buy. The mortgage rates got all the way up to 7%. Now, those mortgage rates have come back just a little bit, but what’s your thought? Okay, again, you’re mowing the lawn, you’re looking across the lawn to the other side. What are we looking at for real estate, which is a huge part of this market?

David: Yeah, certainly the variable for residential real estate is the 30-year mortgage. And so, getting above 7% last month, being at 6.39 presently, it’s another example of volatility. We are still up 328 basis points from a year ago.

Kevin: That’s double.

David: But off peak levels by almost 1%, that’s a lot of volatility. Sales volume, not positive. Home builders, phew. Home builders are feeling so gloomy, at this point it’s like they’re stockpiling medicine cabinets for Prozac and Paxil and Zoloft.

Kevin: There’s your painkiller right there, yeah.

David: A different kind—emotional painkiller.

Kevin: Yeah.

David: They’re not very happy these days, which is really intriguing. Really intriguing when you look at the non-farm payroll numbers. They’re in the process of major contractions, and you can see it reflected in home-building stocks. The trend this year has been very painful. Look through the non-farm payroll numbers last year. Real estate and rental leasing added 13,000 jobs. Not a chance. Construction supposedly added 20,000 jobs in the most recent number, hogwash. 

So, the unemployment rate stays at 3.7%, labor participation falls to 62.1, just under expectations. And we have this really interesting divergence between the non-farm payroll numbers, which has a huge number of seasonal adjustments and statistical creativity which helps skew it. Compare the NFP, the non-farm payroll number, to the household survey. Non-farm payroll, most recent, plus 263,000; 200,000 was expected. So, okay, positive 263. Household survey: negative 138. They should be moving in lockstep. Household survey declined by 138,000, non-farm payrolls is up 263. That means that, since March, the difference between the two employment measures stands at 2.7 million jobs. So, the BLS says these jobs exist, the household survey says they don’t.

Kevin: So, you just take the L out of the BLS is what you’re saying. These numbers—

David: Solid BS.

Kevin: Well, so, the University of Michigan, they measure consumer sentiment, and you’ve been talking about how low it is. These numbers that you’re talking about with non-farm payroll, it is BS, what are people thinking right now? Are they thinking recession next year, or— Their assets. Let’s face it, people are upset about their stock portfolios being down, but they’re not that upset. There still is hope. That’s why they’re hanging on everything that Powell says because they’re thinking this may have just been transitory. Maybe we can actually continue the everything bubble. Could we?

David: Last week, I met with a group of local CEOs, and we looked at a variety of charts. I was interested in the contrast between the University of Michigan consumer sentiment numbers, which hover near 50-year lows, and the US household net worth figures, which are just a few trillion off of all-time highs. I think they sit around 135 trillion versus 141 trillion at their peak, and it really is a curious contrast. At one time, I could have imagined, I would’ve guessed that the difference between household sentiment negative and household net worth positive was really a tale of the asset haves—again, haves versus have-nots—being quite happy with the results from the everything bubble in contrast to the asset have-nots. There’s a bunch of people who—

Kevin: They don’t have a big stock portfolio.

David: No, no, they’ve been unable to save. Life is hard. Getting ahead is not easy.

Kevin: Month to month, yeah.

David: And they’re gritting their teeth as the cost of living exceeds income growth. And one of our colleagues reminded us that we’re now into our 19th straight month of negative real wages. So, that’s impactful. What do they anticipate? I think that’s what you end up seeing in those consumer sentiment numbers. They anticipate more of the same, and that’s frustrating. 

Very fascinating, Walmart and Aldi—it’s a European grocer. They’re not all across the United States, but in selective locations. They’re considered discount grocers, Walmart, at least if you’re talking about the grocery part of their business, and Aldi is exclusively food, both in that discount category. The largest growth segment in new shoppers is in the 100,000 plus annual income bracket.

Kevin: What’s that telling you?

David: Consumption patterns are shifting in the face of inflating prices, and you’re seeing more and more people under pressure. You don’t have to be making $30,000 to be up against the wall, or 40 or 50 or 60 or 70.

Kevin: Maybe it’s 100,000 plus.

David: 100,000 plus.

Kevin: Honey, we’re not going to be shopping at Whole Foods or whole paycheck anymore—

David: It’s going to be Walmart.

Kevin: It’s going to be Walmart.

David: A little bit of a contrast. So, back to asset values. The contention is that, as borrowing weight rates remain elevated, mortgages, which, again, we mentioned still nearly 100% higher from a year ago, there has to be a price correction in real estate.

Kevin: Sure.

David: Similar to what we’ve seen in stocks and bonds, yeah, 20%, 30%. It won’t be all at once, and of course it’ll be varied across geographies, and maybe there won’t be any correction in some places and there’ll be 40% in others.

Kevin: Well, think of people working at home these days, too. What are commercial office spaces going to do? There’s an awful lot of hollow buildings right now. Even here in Durango, you’ve got some of the bigger corporations that have just moved out completely and said we’re not going to do it, we’re not going to refill these commercial spaces.

David: Yeah, and residential, of course, is ultimately driven off of mortgage rates, but it’s not as if borrowing is unimportant in commercial real estate. So, interest rates do have an impact, and commercial office space is already under acute pressure, and it’s getting repriced. New York City business district is turning into a ghost town. First canary may have died some time ago in commercial real estate, but there’s another canary croaking as of this week. Blackstone runs a massive real estate investment trust, $69 billion in assets, real estate assets, they’ve had so many redemption requests that they had to halt new requests.

Kevin: Wow, really? Blackstone—

David: No, can’t have your money.

Kevin: —halting liquidation requests.

David: And don’t equate that with FTX. This is BX is their ticker symbol, different than FTX. Just because you have a halting of crypto redemptions, not really an equivalent here, I think it’s just a noteworthy signal, a noteworthy signal within the real estate complex.

Kevin: Yeah, because Blackstone actually has the assets people are trying to sell.

David: Yeah, yeah, you can—

Kevin: It’s a little different, yeah.

David: Yeah, it’s Madison Avenue, it’s Park, these are prime—

Kevin: Which FTX did not.

David: Well, they tried to. I think they spent 300 million on personal properties in the Bahamas, but that’s another story. Can’t find the money. Oh, it’s in the real estate. Can’t find money.

Kevin: So, Blackstone’s, okay—

David: Oh, it’s in our—

Kevin: —but you just can’t get your money out.

David: —political action committees.

Kevin: Right now. Redemption requests were halted, they were frozen. That can’t be a sign of health in real estate. 

David: We talked about banking earlier. This is similar, and we talked about liquidity or illiquidity and whether or not you can get your money when you want it. I think Blackstone’s fine. The thing to remember is that a huge fund that owns exclusively illiquid assets and traditionally allows for redemptions, those allowances imply a greater liquidity than actually exists. So, when people ask for their money back en masse, it’s a little bit like a bank run. Got to close the doors and say, “Not today, we’ll be back tomorrow.”

Kevin: Here’s Jimmy Stewart again.

David: Yeah.

Kevin: It’s in Martha’s house. It’s in Mary’s house, right?

David: Funds not available. Re-watch that. We do every year. This is a Christmas tradition—

Kevin: It’s a Wonderful Life, yeah.

David: It’s a Wonderful Life. You’ve got Bedford Falls, you’ve got the Bailey Bros. Building & Loan, you’ve got Old Man Potter. Banking is a business of mismatched assets and liabilities. There are thresholds where you can no longer accommodate demands for repayment without collapsing the structure, and Blackstone has automatic gating triggers built in. So, between last week and today, you’ve seen the gating triggers initiated. Blackstone stock has traded lower by 12%. 

It’s just a signal. Again, this is a canary. This is not to slam Blackstone at all. Commercial real estate maybe be a different animal than residential, but the correction is already there in commercial, discounting on prime properties. And a part of that, look, China had to pull the plug. They’ve got their own domestic issues, and China was the last big spender in New York City in looking at trophy properties, et cetera. So, they’re exiting and there’s no one there to take their place. Plus rates are rising. Correction’s coming. Correction is coming in residential too. 

So, if we go across the pond, we have had a radical recovery, bounces in all asset classes. Bank of America charts major moves higher in 35 out of 38 asset classes underway, and I think that’s worth remembering. We’ve talked about this in the past, Kevin, were uniformity, uniformity is not necessarily healthy, it just tells you that things are being driven off of the same basis. So, either we fixed the problems of the world and we’re all moving off in the right direction at the right time and almost every asset class is improving its position by the day because something has shifted fundamentally in favor of growth, global growth, world peace, et cetera, or uniformity is telling us something else.

Kevin: Well, when uniformity causes something to go up, it can also uniformly go down, right?

David: And that’s been the story of this year. Uniformity was the surprise for the 60/40 portfolio because you thought you had a balance between stocks and bonds, and that balance was supposed to keep you from losing money, and yet you lost on both sides instead of losing on one and gaining on the other. Now you’re the double loser. Uniformity is telling you that policy matters, rates matter. We have a very leveraged system which is hypersensitive to small changes.

Kevin: Talking about uniformity, I go back to when we were talking about mountain biking and you’re looking at your front wheel. There seems to be things that are happening right now where everybody’s looking at the front wheel and they’re going, “Hey, maybe it’s not as bad as we thought it was going to be.” Look at the yuan, the bounce in the yuan.

David: The volatility is impressive, and I don’t know that anything has changed contextually, but the yen rebounds off a 35-year low and erases a good portion of its annual losses in the same context as the Chinese RMB retaking the seven to one level to the US dollar, and Chinese developer bonds erase large parts of their losses. The guys that were paying 250% interest are now paying 100%. The yields on their bonds have improved considerably. Whatever they were, they were cut in half. Huge rallies in Chinese bonds. Huge rallies in the Chinese currency. Huge rallies in the yen currency.

Kevin: Yeah, it looks like Xi is finding stability with tanks like we talked about last week, right?

David: Right, right. Well, in some instances, literal in other instances, just through social media, we’ve got our own social media manipulations and things to consider as we look at Xi trying to control the local narrative and using his sesame credits to accomplish something.

Kevin: How about Twitter here?

David: Oh, it’s unbelievable. My two favorite left-leaning news reporters are Glenn Greenwald and Matt Taibbi. He was with Rolling Stone magazine for years, and was just given all of the internal documents from Twitter on how to handle and manage the news flow, and basically suppress the news flow through the 2020 election cycle.

Kevin: Effective altruism in another form, right? This is effective altruism. Just guide things the way you want them guided.

David: Right, right. That’s probably a very different topic, and one we don’t have time for. But the uniformity factor across markets is fascinating, and it leaves us in one particular place. Not much is changing. Not much is changing at all. We’ve got Wall Street continuing to hope for the best, which is more easy money, and they’re trading that way. They’re going to get it, the yield curve suggests it. High rates today, low rates tomorrow. Why are we going to have low rates tomorrow? In anticipation of the recession that’s coming. The bond market gets it. We’ll have a recession, the Fed will intervene, all will be well, assets will continue to go to infinity and beyond. And it’s just this fabulous world of fiction, Kevin, where ultimately you’ve got to decide if that interpretation is real, is real, and what the implications are if it’s not, if it’s wrong.

Kevin: Yeah. So, Dave, as we talk through these things, because, honestly, none of us have all the information, but one of the things that I’ve found during this age of continually controlled media is I still get to talk on the phone all day long to people who are intelligent. They’re asking intelligent questions, they’re experiencing certain things, whether it had to do with the virus or the vaccine or it had to do with economics, and we’re talking. It’s good old-fashioned information gathering back in the day when you didn’t have Twitter, okay? That’s the way we should be working. 

That’s why I really like the question and answer series that we do. We do a couple of programs every year where we just take questions from our listeners, so that’s what we would solicit right now. Keep the questions three to five sentences long, please, not full pages, but send those to us. And, over the next few weeks we’ll look them over, and you can maybe formulate some of the answers and maybe come up with some other questions.

David: Or maybe have to schedule more conversations with experts who do have the answers because that’s not us.

Kevin: Yeah. Well, that’s where the interviews come in, right?

David: Exactly. There’s questions that we just can’t answer, but we appreciate curiosity unending and continuing education unending. So, thank you for contributing to that as we head into the year-end programs with Q&A.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. Please send those questions for our question and answer program to I-N-F-O at McAlvany, and we’ll try to get to all of those questions.

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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