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  • Mohamed A. El-Erian “Lower yields are no longer good news for stocks”
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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

FED Power: “One Ring To Rule Them All”
July 20, 2021

“Market participants today are running up against the best offers of peace and tranquility. You get central bankers who’ve offered to smooth the historical timeline, provide a world of reduced volatility where everyone wins. No one loses. They’ve offered to get rid of the chaos, but control must be maintained. Who wants mischief when you can have order? Who wants war when you can have peace? You only need to relinquish freedom and a better world can be crafted for you.” — David McAlvany

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

I’m reading an interesting book, Dave, on the history of the ring myths, the Ring of Power myths. We see Tolkien with the Lord of the Rings, and he talks about the One Ring and Sauron and the misuse of having unlimited power. But actually, if you go back, you can look in the Norse mythology. You’ve got ring myths in the Carolingian, which was the Charlemagne throne. Those myths, even though it was based on a real person, there were myths around it, and it had to do with the Ring of Power or the serpent’s ring. We were talking, when a central bank has the ability to print unlimited amounts of money. In a way, isn’t it wielding a ring of power?

David: Power and what people will do with it. These are themes that go way back. I mean, not just to the Carolingian period, but even back to ancient Greece and Rome, where you can see the same kinds of conflicts, the same kinds of ideas wrestled with. And so, when you have a group of people who are given a tremendous amount of influence and a mandate, which, unfortunately, has gone from fairly narrow to quite broad—you have the ability to save the world, they are told, and that’s what they’re attempting to do is, in a grand fashion, in a top down manner, save the world.

Kevin: Do you think maybe that’s why this whole transitory inflation thing has been, in a way— the markets have been seeming like they’ve been believing that inflation is transitory until now?

David: They believe it’s transitory because those with authority and those with the prestige of a PhD following their names have told them that it is transitory. And here we have Biden, President of the United States, leader of the free world, who says this week, no serious economist is worried about inflation. And I thought it was pretty interesting because he actually called Larry Summers into the White House a couple of times in the last week, I think to remind him that he’s currently singing out of tune. There is a way that he should be singing this particular chorus—not to worry, no inflation, simply transitory.

Kevin: I wonder if Monday of this week they started wondering if they were believing the wrong people.

David: I would also note that it’s Otmar Issing’s turn, who spent eight years at the European Central Bank as the chief economist—probably not a serious economist in Biden’s view either—but his whole message in a recent Project Syndicate article had everything to do with inflation being a real concern.

Kevin: Well, talk to us about Monday because Monday scared a lot of people, and of course, somebody came in and maybe it was just normal buyers came in and kept the market from being a full-on collapse. But it got scary there for a while. It was almost a thousand-point drop for a bit.

David: It started in overnight trading on Sunday, and actually markets noticed even before the weekend that for weeks something was shifting. So if you’re looking at the equity markets, they’re usually the last to wake up to anything. But the bond markets have been telling something very unique. So Bloomberg and CNBC have supported the equity narrative that everything’s okay. The bond market has been the anomaly. It’s assumed up till recently that treasury yields moving lower was on the basis of a correct inflation assessment that yes, in fact, that’s transitory, and that the monetary wizards had proven in real time that they were correct. Just look at the drop in rates.

Kevin: One of the things that’s nice about being able to do this for decades, Dave, is you can go back and say, “Okay, well, what did we learn last time?” In the Global Financial Crisis, we saw indicators like this where the thought was, “Oh, well, things are fine.” And then of course, we had the collapse in 2008.

David: Bond managers are largely paid to worry, and stock managers are largely paid to run around with pom poms and get people whipped up into enthusiastic supportive of spending money and speculating on a better tomorrow. But again, bond managers are naturally a little bit more risk aware, and so we would say, not so fast. We mentioned this. The assessment of yields dropping had nothing to do with inflation, or was not solely having to do with inflation, being on the decline and being transitory. But in fact, these are the dynamics which were mirroring the treasury market prior to the Global Financial Crisis. Bond managers and sophisticated investors saw that things were not healthy. They didn’t like what they saw on the horizon in terms of economic activity, and the frailties within the financial system. And they began to hedge their positions, they began to position more conservatively, and yields were telling you something.

We have the 10-year treasury below 1.2%. Today, in fact, it’s traded as low as 1.14. German bonds, or bunds as they call them, to a negative 0.44, and the bond market participants don’t like what’s on the horizon. Once again, you’ve got equity bulls, who are eternally sanguine, and very fascinating, particularly to watch the behavior of depressed Mondays, manic Monday where nobody liked what they saw. There’s more COVID cases. What does this mean? And then Tuesday, it comes roaring back, right? But bonds, and this is what was really key for Tuesday, bonds continued to move lower, below the 1.2 to 1.14, reinforcing a very important signal from the bond market. Again, the sanguine nature of the equity investors is going to get them in big trouble.

Kevin: Yeah, a lot of times when you see those rates going down, it means that people are piling into bonds because they’re afraid. It was interesting watching gold on Monday as well, Dave, because everything seemed to be selling off, and gold was holding its own. And I had told my wife, my wife, she looked at the stock market first when I got up in the morning, and she said, “Wow, have you seen that it’s down about 600 points?” And I told her, I said, “Well, that probably means gold will be down,” because a lot of times there’s a need for liquidity right off the bat. But that wasn’t the case. Gold was down three or four bucks, but I mean, everything else was down quite a bit. So I’m going to bring up last week’s program because we had talked about how it was a herd of bulls, everybody thinking the market was going to go up. I mean, second highest in history, and nary a bear in the herd. We started to see the fear of bears on Monday.

David: Yeah, I mean, the safe haven bit on Monday was fascinating because not only were people moving to Treasuries as they have for a number of weeks, but you’re right. Ordinarily, if people are looking to raise liquidity, cover margin, debt balances, they will go to gold and liquidate it as a very liquid asset to fill gaps elsewhere. In this case, gold moved down a dollar or two, but very disproportionately strong. You might say, “Oh, it was down for the day.” It actually was showing amazing resilience and showing just the huge difference that gold is as a protective asset, even as opposed to silver or platinum, which have more industrial uses. They’re more intertwined in terms of economic activity, and thus some vulnerability there, too. So, we mentioned the disparity between bulls and bears last week, this is back to equities, a 45 to one differential being a sentiment indicator akin to an air raid siren. And not a surprise, really, that this week, we have some volatility as so many people crowded onto one side of the boat to try to figure out how to keep things a little bit more in balance.

Kevin: Oftentimes, when people are trying to look at a scenario and you’re either a bull or a bear. I mean, down deep inside, nobody’s really objective. And the bulls are going to say low yields are actually good for equities. Now, is this always the case?

David: Well, it’s typically the case. But I think Mohamed El-Erian tried his best to separate his opinions from the frothy bulls in the Financial Times piece not long ago noting that lower yields were no longer good for stocks. And so, it’s really a phase shift, if you will. It’s a transition from what was once positive and propelling speculation. Now, all of a sudden, there is something very different in the messaging. If rates are going lower, why exactly are they going lower? And the previous explanatory power that was, again, pushed by Bloomberg and CNBC doesn’t appear to capture all of the facts, not enough to give comfort to the equity bull. So his point was, we’ve had too much of a good thing. And I think, frankly, that could have been said a long, long, long time ago. The question he left on the table was, is there still the possibility of an orderly exit from what has been a remarkably long period of uber-loose monetary policy?

Kevin: Now I like that thought of orderly exit. When we get into a theater, of course, we can’t say fire because there’s too many people in one small space and too few doors. Has the stock market become that over the last few years?

David: Well, and this is really the question of whether or not the Fed is trapped. Whether their policies at this point are in play because they have to remain in play. And we would answer that question in the affirmative. To normalize rates, to end quantitative easing, the asset purchases which they’re still doing on a monthly basis. To return to market-driven pricing, all this comes at a cost the Fed is frankly unwilling to allow to come into play. So you get public and private debt levels that have reached heights that require a controlled interest rate structure. And that’s what Powell and his crew are doing. There is the risk of debt deflation, and of asset implosion, like 2008 and 2009, which becomes too real as a theoretical Boogeyman for Powell and company to entertain. So in that sense, yes, the Fed is trapped.

Kevin: Which makes me wonder, if there was a fire in this metaphorical theater that we’re talking about, could they give the warning?

David: Well, you’ve got unemployment rates sitting at acceptable levels today. You’ve got economic growth which is humming, although that is not a given going forward. And the idea that there’s a necessity attached to $120 billion in monthly asset purchases. This is, again, $80 billion in treasuries, $40 billion in mortgage backed securities. Even right now, that strikes some, including us, as unnecessary, and others, it is striking them as completely necessary. And I think it’s unnecessary if the economic growth and recovery story is well founded. And if it’s grounded upon improved employment, and on the pillars of business investment, and consumer spending, and reasonable capital allocation. It’s unnecessary if you’re okay with normal price discovery.

It’s completely necessary, on the other hand, if the primary measures of success are really just a proxy for central bank and government stimulus. If people know that this is very much a Potemkin village, and that you have measures of gratuitous liquidity hitting the system and finding a home, but that, actually, real health is elusive. Completely necessary, I think, for those, too, who are scared of consequence, for those who are afraid of actual market dynamics. We go back to this idea of price discovery. What if price discovery told us that not everyone is special? I know the markets are not exactly like kindergarten. But it seems that positive affirmation is important even for asset classes these days.

I mean, think about this, it’s not normal for junk bonds to yield less than the rate of inflation. Price discovery tells us all manner of truths, and some of those truths are inconvenient for the speculator hoping for a very perfect and manicured world. It’s just not that tidy.

Kevin: Press discovery is dangerous if you’re trying to control the narrative.

David: Over the weekend, we finished the first season of a Marvel Comics miniseries called Loki. My kids love Marvel, and from Norse mythology—

Kevin: There’s that Norse mythology right there. I brought it up earlier.

David: So the Loki character is this creator of mischief in chaos. He’s like a flame that is constantly threatening or disturbing the peace. And the series ends with a debate on the chaos associated with choice versus the peace and relative tranquility of control. There’s actually a point at the tail end, and I am giving this away. I’m sorry. But there’s a dictator who basically says, “Can you really afford to have unknown outcomes?” And so, I mean this— what do you want? A world of violence or a world of peace? Can we really afford to have everyone making choices that disturb an otherwise perfect timeline?

Kevin: Isn’t it interesting that Disney is asking this question, Dave?

David: It’s probably a coincidence. But this is the second week in a row where some healthy philosophical questions, low level of social critique, are flowing from Disney. And it’s providing some interesting conversation around the dinner table. Again, it’s probably a coincidence, but the notions of free will and determinism, these are ideas that go back a long time. What is the value of an individual choice? And is it more important that that individual choice be elevated? Or should you look to collective benefits as you organize and prioritize outcomes?

So the debate about chaos versus order? It’s real today, and it’s as real today as it was thousands of years ago. Control is tempting. Peace is tempting. A better world, I mean, who doesn’t want a better world? And of course, it’s important to define what you mean by better. That should be understood early on, because you can think of lots of examples. Say for instance, Nancy Pelosi and Gavin Newsome. They’re creating a better world in California. It’s just that better looks different depending on your vantage point.

Kevin: Yeah, I can feel a little bit of discomfort siding with Loki. But in this particular case, what you’re talking about is Loki is offering individual freedom. So the questions being asked, Do you want free market? Yeah, you’re talking about price discovery. When we talk about true price discovery, what we’re talking about our free market prices.

David: Yeah, he’s the man of mischief in the story. And it’s the man who wants to undo a perfect order, and actually allow history to write itself rather than see controls put on human action, a fallacy of false alternative over and over and over in an endless loop, in line with a presumptive vision of superiority. Again, do you want chaos or do you want order? And so the drama emerges in each episode as character after character realize that they have been pawns in a controlled and artificial existence. Every outcome could have been different, but the central planner’s idea of this loftier historical trajectory was all ready in motion. And so, you’re either on board or you’re not. And to diverge from this perfect model is to become the unnecessary branch off the tree. The system is designed to prune it quickly so that the primary energy is not sapped from the more important thrust of events being orchestrated.

Kevin: Yeah. And that’s the illusion of control. The illusion of control, if we look at the last century, Dave, and the 100 million plus people who have died to the dictator regimes that believed that control was better than individual liberty. At that pruning— we think that it brings peace. On the surface that’s what we’re told. But actually, it brings death, and blood, and destruction.

David: I spoke to our friend Jim Deeds last week. And in a very frank conversation, he said, “Dave, I just don’t believe in the markets anymore. It’s 100% rigged. It’s 100% controlled, and there’s nothing that we can do.” Monday is one small reminder that that just ain’t so. That in fact, there is volatility that emerges when a different narrative is considered. So, you’ve got the official narrative, which is very consistent with the polished nature of things. And in a very calm and nonvolatile world, controlled where peace is the destination, and a better place is on promise. And then we have Monday, which is absolutely chaotic, and the markets are down, and everything’s moving the wrong direction. It doesn’t matter the asset class, it’s all moving down. It’s worth noting that, no, I mean, and with all deference to our friend who’s 89 years old, and spent a lot of time in the financial markets, there is an attempt to control, there is an attempt to rig, there’s an attempt to polish the narrative, but it doesn’t always work.

Kevin: I love talking to Jim because he says those things because he doesn’t believe them. You and I both know that. Okay, he really does not believe them, but he gets frustrated. And I get that whole market bipolar type of thing. When you really believe that the markets are telling you the truth, and then you have somebody who can come in and print unlimited amounts of money. There really is this belief that this management will go on forever.

David: I understand that to a hammer, everything looks like a nail, but the orchestration of price, and the fear of allowing markets to play out cause and effect apart from a managed process seems to be where our central planners, where our central bankers are stuck. Control is one option, and they prefer it, or tempt fate with chaos. Command or the option of being subject to market directions, which may run away from a preferable utopian outcome. There’s the temptation to print money. There’s the temptation that over and over again as you look at all of those mythologies and all of those stories, the individual is inserted to say you have the power to make a difference. Will you do something that benefits all of us, right? The temptation to print is well intentioned. The temptation of Gyges in the second book of Plato’s Republic. Again, make the world a better place, except for, in the midst of gaining extreme power comes temptation. So what does Gyges do? He murders the king and takes the queen as his wife. The temptation of the Ring of Power, which is retold in Norse mythology. Jerome Powell is, you just have to say, he’s not in new territory. There’s not a new territory. The idea to dream a bigger dream, a better world of less volatility and greater control. This is all too common throughout history.

Kevin: Well, and so often we’re told that, well, we’re going to use this for good. I remember the face of Gandalf in the Lord of the Rings series. When he touches that ring and he holds that ring, he has to get rid of it. He will not keep it because he understands, no matter what the good intentions are, there are unintended consequences at the time.

David: Don’t tempt me. Yeah, there are unintended consequences. Charles Hughes Smith published a chart titled Financial Aristocracy Wins, Everyone Else Loses, which shows that the change in percent in real annual earnings here in the United States from 1979 to within a few years of the present, and so the bottom 90% have seen a cumulative gain in their real earnings of 22.2% since 1979 to the present. The top 1%, a gain of 157.3%, and the top 1/10th of 1%, 343% gain. Jen Psaki, this is Biden’s press secretary, was very excited because last week we had wages along with CPI and PPI. Wages, the report on wages, and they’re up. But when you factor in inflation, so you’re talking real terms, oh, unfortunately, they decreased by 1.7% from the previous year.

Kevin: Well, and unfortunately, those who would seek control, those who would control the Ring of Power would say, “Well, look at those numbers. By golly, we need to use this to control people and redistribute the wealth.” Is that what you’re saying? Would you use the numbers for that? I think I know the answer.

David: Well, I’m the last to even reference numbers like those as a measure of fairness or as a justification for redistribution. I think where it’s helpful is to appreciate what animus is driving popular angst and frustration, and what segments of society are in the most vulnerable positions as inflation and other policy-related consequences are meted out. The fault lines of social conflict are in fact exaggerated, not only by the differences in wealth and income, but more acutely by the continual squeeze of inflating prices. And again, inflating prices, as long as wages are staying ahead of that, that’s fine. But you telling me that we can afford all that we could afford back in 1979. Unfortunately, it’s not the case. We’ve had to move from a one-income family to a two income family just to make ends meet. I think into the void comes government check after government check.

Kevin: Yeah, and we talked about the carbon tax, probably not solving environmental problems, but certainly trying to redistribute the wealth. And now, of course, you’ve got the tax credit for children.

David: I opened my check last night. It’s an advance payment, it says, for the child tax credit. This is the July installment, $1,000. And it’s like manna from heaven. And what I felt—of course, tongue in cheek—but my gratitude to the state grows with each visit to the mailbox.

Kevin: Well, and my gratitude grows too because my kids are grown. I didn’t get that, but thank you for having kids young enough to get that credit. I’m being tongue in cheek, too. I don’t appreciate that Biden’s doing that to you.

David: To be frank, I feel uncomfortable accepting money from the big guy. In part, because nothing is ever free, and in part, because it seems like a grand manipulative effort to redesign the way we engage the state. Again, never free is a real issue. But you’ve got to back-to-back budget deficits over $3 trillion. And we know not yet what 2020 financial outlook will be. It leaves me wondering, are we now in this perfect place where money grows on trees?

Kevin: Well, and that money, if it does grow on trees, it grows less and less potent every time it grows.

David: You’ve got the future impact of both trade and budget deficits on the value of the US dollar, and that’s nothing to sneeze at. But when you combine that with growth in the monetary aggregates, and the economic consequences of the twin deficits, you start to realize that these gifts, again manna from heaven, or sense of gratitude every time you visit your mailbox, it’s actually a very expensive gift program.

Kevin: I know you give your kids money, but I know that you demand a matching program. So for the parent who’s trying to say, “All right, well, our government’s not a good example of how to teach people how to either save money or spend money.” Explain, Dave, to the listener, a little bit of how you and your wife handle that.

David: Well, for a long time, I’ve tried to incentivize saving and investment by having some sort of a matching program. So, if they’ve done a project here at the office, or if they’ve done the lawn over and over and have some accumulated savings and want to put them into some sort of investment. Whether it’s gold and silver, or even an investment account of some sort, I’ll match their dollars. And so, this check comes in the mail, and it was a surprise. I live on a reasonable budget and know what financial responsibilities I have to maintain month in and month out and it’s a $1,000 I wasn’t counting on. So, we offered our four kids, I’ll match your investments up to $250 each, and my view is we’re offsetting the effects of reckless fiscal policy by owning more ounces. That has some appeal to me. And again, it’s a little odd receiving gifts from the big guy. But, unlike Hunter, these gifts are not being recycled off books expanding inner city employment one pimp at a time.

Kevin: Well, no, I don’t think that’s how it’s being used. But lest we sound partisan, the Republicans have benefited by the Federal Reserve and their actions as well. But now they want to keep up with the Democrats. So, I don’t know that we can be partisan on this.

David: Yeah, the market’s volatility this last week raises a critical question about how the Federal Reserve has operated, and how they will be going forward in the midst of market sell offs and general pandemonium if it continues beyond even a day or two, there they are to announce this intervention or that help. And so, what happens when the GOP has decided that the Fed actually has too much of a leash, and are in the process of increasing political pressure. So, they’re simultaneously rediscovering a version of fiscal conservatism—this is the GOP—that they haven’t lived by— we haven’t seen for years. These are just small things. But I loathe political duplicity and double standards. And this is the same GOP that would spend equal or greater sums on their own wish lists of pork.

So back to the market volatility, the pressure point, and potentially destabilizing point of tension, is where politicized force meets crisis dynamics, and interventions which the market has come to expect are not immediately available. What if the Fed pauses before increasing an interventionist QE? I don’t mean to suggest that Jerome Powell would or could come under the sway of GOP legislators, but note that the system is already dependent on QE. And a really dodgy stock market, if it’s not immediately supported, could quickly become a cascading market. And the X Factor that frankly is rarely modeled by Wall Street firms is the political factor.

Kevin: You talk about dependence on quantitative easing. And I have to go back to Monday, Dave, and look at gold’s response to a major sell off. And again, usually when there’s a major sell off in equities, I think people misunderstand, but back in 2008, gold lost quite a bit quickly, and then it recovered quite a bit more. And that goes back to 1987, goes back to the year 2000. When you have stock market crashes, or major sell offs, gold is so liquid that oftentimes it goes down for a few days. It was so resilient on Monday, and again, maybe we’re overstating on Monday, but gold is starting to show that its resiliency has to do with people being worried about either inflation or quantitative easing causing this weakness in the dollar. So let’s talk about that. And then let’s talk about the seasonal movements on gold because a lot of times gold, through the years, you can count on it hitting a low at a certain time, typically or going up.

David: I love the way that Dow theorists used to describe—and some of them still do, but this is particularly Richard Russell back in the day when he was writing Dow Theory Letters. He would contrast secular trends with cyclical trends. That is long-term trends with shorter-term trends, and he equated it to, as you might expect from someone living near the San Diego beaches. He compared them to tides and sets where the tide comes in and tide goes out. And within those longer trends, there’s the individual actions. The day today still occurs in the context of the tide coming in or the tide going out.

As we suggested last week, we’re just coming into a phase where gold gets a lot of attention, and stocks are likely under pressure. But again, I think it’s worth keeping in mind that you can lose your mind trying to divine and discern what the major trend is if you’re only looking at the micro factors and the micro daily activity. We have a larger context for gold and I think it’s set up very well for months and perhaps even years ahead of us. And what happens in a day may not matter.

What I thought was interesting about gold’s action on Monday, on a particular day, is the way it behaved in relation to everything else. A date is not a trend to make. But notable amongst the market carnage on Monday was gold’s relative stability. Silver and platinum suffered with the broader indexes. We saw the gold silver ratio jumped to 72 and a half. And gold gave up almost no ground trading just above or just below the previous day’s levels. It’s seasonality for gold. Seasonality for gold typically finds the price putting in lows sometime around June, occasionally as late as July. But then you have stronger pricing dynamics as you move through August, even as far as October.

Kevin: Do you think that that will be affected by the increased spending, these budgets that are coming out that are in the multiple trillions?

David: I think there’s no doubt as we start to factor in the twin deficits. The seasonal peak in gold in the autumn has an interesting mirror in the equities market where it’s not uncommon to see stocks at their lows for the year, even as gold is showing its strength there in the third quarter. Now, as we get clarity on the 2022 government spending, we will also get clarity on gold’s 2021 trajectory because there has been a strong correlation between the trade and budget deficit duo and the trajectory of the metal. So trillion here, trillion there, and you’re eventually talking about real money. As we formalize 2022’s spending, I think, again, we’ll be able to back into if gold is breaking to new highs or not before the end of the year.

Kevin: Well, and I wonder if the announcement of the fire in the theater might actually have something to do with inflation surprises.

David: Yeah. And again, this goes back to the President’s comments, which is— I mean, the things that I find humorous, not everyone does. But no serious economist is worried about inflation. His words, literally, there’s nobody suggesting there’s unchecked inflation is on the way, no serious economist. That’s what he said on Monday.

Again, the metals market take on a heightened sensitivity with the last three months of inflation surprises. You have to think about this. Inflation— if we get more traction over the next couple of months, and the numbers are not, in fact, transitory, as they are commonly believed, what happens next, right? The transitory inflation projections— these are coming from the same cohort of economists, PhDs, that have now underestimated the last three months’ surprises.

And again, if I say, “Okay, PPI I’m going to say is at six tenths of a percent month-over-month, and it comes out to be 1%. Or CPI say is going to be 0.5 and ends up being 0.9. We’re talking about an underestimation by between 60 and 100%. My calculations are not just a little off, they’re catastrophically off. I should be wearing the dunce cap. I should be excused from class. I mean, this is not acceptable if we’re talking about PhDs in economics. But this is where they factor in certain things that, gosh, to listen to Powell. Kevin, you listened to him last week. Apparently, the only thing we have to be worried about is the price of used cars. As you look at a component of CPI, that’s about a 3% component in CPI, and yet that is supposed to be what we’re concerned about and the reason why inflation is transitory, right?

Kevin: Yeah, Dave, I read on Project Syndicate Otmar Issing’s article on his concerns about inflation, and I think we have to go back. I remember the 1990s. I know you do, too. The concern talking to Germans. I remember talking to Klaus Buecher, who was a money manager up in New York. He had come out of Germany and his family had experienced, through that century, through the last century, huge inflations where they lost their house and had to re-buy it three times. Otmar Issing, same thing. So as the European Union was coming together, the European currency was coming together, there was a fear that there would be inflation again. These people have scars that were so deep, they never wanted to see it again. I sense that— when I read Otmar Issing’s article, I think he’s warning people of hubris.

David: Yeah, and there’s the practical side of economics, as well as the theoretical side of economics. And oftentimes, the PhDs in economics with their models of human behavior enter in again, theoretically, with the boldness of demigods, and they’ve been telling us about how management of the macro economy is their real gift and talent and their stock-in-trade. And they say they have the tools to both create inflation, which is contrary to the fact over the past decade, and they have the tools to tame inflation, which at least in past periods, central bankers have been proven to be somewhat neutered or inept. Maybe really, it’s just the predictive part that is harder for them.

You’re right, coming back to Otmar Issing’s comments. Of course, he was a Weekly Commentary guest a number of years ago. And far more important, he was former chief economist of the European Central Bank, longest standing member of the European Central Bank’s board. And in that article, he took a very cautious tone, referencing the not-so-temporary inflationary inputs. This is similar to the themes that we’ve been hanging onto, Kevin, in recent weeks—the longer-term factors, whether it’s rapid monetary growth. Additionally, he focuses in on what he views as a regime change. Something that happens on a generational basis. Factors like demography and globalization, which have held inflation at a lower level, and are giving way to a new era of what he describes as exogenous price pressures. So, ignore the rapid growth in money, and that’s a mistake, in his opinion. And again, the factors that he’s concerned with are to him reminiscent of the 1960s and 1970s.

Kevin: Just like you said last week, and those who abide by modern monetary theory, which really is just a theory that you can create as much money as you want. And we can look at that and talk about money growing on trees and saying, “Well, this time it actually works.” But what’s interesting is the models, Dave, since the 1970s. You brought up the 1970s. But we’ve been living in a model that probably is unsustainable. And as I read that article by Otmar Issing, I imagined an old wise man in the room amongst a number of PhD economists that are using models that are questionable.

David: Yeah, I can’t help but remember Michael Pettis’s most recent comments as well on modern monetary theory, where he says from a purely monetary point of view, from a real economy point of view, the growth in debt is ultimately limited by the growth in real debt servicing capacity. What he’s getting at is that there is a naive version of modern monetary theory, which says you don’t have to worry about debt. And he basically points and says, “If you’re just thinking about numbers, you’re right. Theoretically, you can print as much to pay for as much debt as you want.” But where you come across the problems is in real terms. He says, “This simply isn’t true. While the government can indeed print as much money that likes to service the debt nominally, the story in real terms is very different.”

Kevin: Don’t you think that Otmar Issing is making the same point?

David: Absolutely. Because forecasting by central bank PhDs, you look at the new theories which inform their ability to say, “Look, we can do it different this time.” And the old man in the room says central banks seem to be relying largely on models that lost much of their forecasting capacity years ago. Issing says, “Owing to the lack of viable theoretical explanations for what determines financial flows, risk premia, and asset prices more than a decade after the 2008 financial crisis, the main general equilibrium models used by central banks hardly even consider the large heterogeneity between households in terms of wealth, outstanding long-term debt positions, uninsured risks, and expectation formation.”

Kevin: I think if a listener wants to read that, I think all you have to do is google “Otmar Issing inflation,” and that current article will come up.

David: It’s a classic reading where you’ve got an experienced central banker offering an insider’s critique of the community he hails from, pulling back the veil that we talked about last week, and revealing the wizard’s pretense.

Kevin: We’ve talked so often about controlling the narrative. We’ve created already the inflation. Now it’s the perception of inflation or the expectation of inflation. But not everybody admits that. A lot of people say, “No, expectations have nothing to do with it.”

David: Well, those were his last words. Expectation formation, and this is something that we take for granted. A few weeks ago I read the words of a Dallas bond fund manager claiming that expectations have no impact on inflation. Again, you’ve got the old man in the room. Otmar takes the other side of the argument, and says expectations play the key role in forecasting future inflation. He says, “What if those expectations, after so many years of very low inflation, are now more backward than forward looking?” And then he follows that with an observation, “What credibility will central banks have if inflation expectations have already lost their anchor?”

Kevin: He wasn’t just talking about central banks. One of his concerns in that article was actually private debts and public debt, this increase in debt unlimited in amount.

David: Now the context is very interesting. His point of contention with the ECB and the Fed is in the accommodation of higher levels of private and public debt by keeping rates lower than they should be. They’re already at dangerously high levels. But he looks at the purchase of government bonds with more than a little concern. And again, you could go back, as you mentioned, Klaus Buecher, the similarity between these two men is a history of money, decision making, and the hubris that comes with thinking that you are the smartest guy in the room making the most important decisions that are going to create the best of possible outcomes and a beautiful and pristine world. And into that comes the oops factor, right? And so, the old man in the room says this. His last words in the Project Syndicate article. “The only certainty is that neither a financial collapse, nor an inflationary surge can be ruled out.”

Kevin: This goes back to the Ring of Power, Dave, and I can’t help but go back to just the masterpiece that Tolkien wrote. You look at the heroes in the story, whether it’s Gandalf, or Bilbo, or Frodo, or Sam, each one had a confrontation with the ring. The heroes were the ones who realized that they could not control the power. It was the Gollum, ultimately, that bit Frodo’s finger off. So, the Ring of Power, even Frodo at that moment of decision of giving up the power, even though his entire journey was realizing and trying to destroy the ring, realizing the destructiveness of the ring and trying to destroy it. In that last moment, he failed. It took Gollum, the bad guy, basically, to bite off his finger and ultimately fall into the abyss.

David: Yep, market participants today are running up against the best offers of peace and tranquility. You get central bankers who’ve offered to smooth the historical timeline, provide a world of reduced volatility where everyone wins, no one loses. They’ve offered to get rid of the chaos, but control must be maintained. Who wants mischief when you can have order? Who wants war when you can have peace? You only need to relinquish freedom, and a better world can be crafted for you. Perhaps it is in fact a fantasy. It sounds perfect, Kevin, doesn’t it? All we have to sign on for is inflation, financial repression, wage suppression, taxes, wealth appropriation, default, restructuring.

Kevin: Sounds like peace to me.

David: A nearly— a nearly perfect world.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick long with David McAlvany. You can find us at,, and you can call us at 800-525-9556.

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

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