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- Only 4% of CEO’s see economy improving over next 6 months
- FED still providing up to $75 billion in overnight loans
- GE freezes pensions for 20,000 employees
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
FED’s Powell Announces Additional $60 Billion Per Month Of “NOT QE”
October 16, 2019
“I think without those reference points you might be tempted to think of your brand of politician as having the country’s best interest in mind. After reading both of those books I think you will look at all politicians the same way, as being incredibly self-interested, and not particularly interested in what is best for the country.”
– David McAlvany
Kevin: David, if you forgot when we were talking – let’s just say I said that the Federal Reserve has just promised 60 billion dollars a month addition to the market, a little bit like quantitative easing I, only larger. And corporate CEOs have the lowest confidence level, actually very, very low level, where they look ahead and say, okay 4% of us believe things are going to be better in six months, when would you think I was talking? Remember, the 60 billion, the corporate CEOs.
David: 2008, 2009, middle of the global financial crisis.
Kevin: How about October of 2019? (laughs) Those are the facts right now. We have to talk about this. Powell says that that 60 billion is not quantitative easing. Well, what is it?
David: We may think of present tense problems at Deutsche Bank, and they have had problems for the last couple of years, or if you reflect back to 2008-2009 and the role that systemically important banks played in the global financial crisis, would anyone think about or reflect on BNY, that is, Bank of New York Mellon as a very important player today? That is not the topic for October 17th Tactical Short call. We are doing our quarterly call and it is at the periphery of the topic.
We are going to be talking about managing short side beta in an extraordinary environment. But it is on topic today because you have Bank of New York Mellon who is the bottleneck of a 2.4 trillion dollar repo market, the Tri-Party repo market. Just a few years ago J.P. Morgan exited the business. They left Bank of New York Mellon the sole provider of clearing and settlement for these repos, again, 2.4 trillion dollars’ worth.
Kevin: You’re talking about just general liquidity to the short-term market. That is what these repos provide, right? And they are the bottleneck of trillions.
David: Wondering if all is well in the repo market is, by default, asking if all is well with one of the financial market’s largest custodial giants – custodial in this sense not being the cleaning crew of Wall Street (laughs).
Kevin: And speaking of CEOs, usually when the captain of the ship gets off first, the ship might be going down.
David: You are referencing the CEO leaving Bank of New York Mellon here in the last few days, they are losing their CEO, and that may an issue in months ahead as there is pressure which remains in the repo market, and you have the primary player in that market searching for new leadership.
Kevin: Yes, but we have the Federal Reserve. They can smooth out everything these days, can’t they?
David: Yes, and I think, actually, that CEO departure was for greener pastures. Fixing what is broken at Wells Fargo is, I think, where that CEO is headed. But you have this context, back to what you said of the Fed, this is a context of concentrated responsibility with BNY, and it is easy to see how the Fed has stepped in to provide liquidity, and may, in fact, remain in the role of market smoother. We used to think of the Fed as being involved as a last resort. Well, they are now the market smoother of first resort, not merely that sort of panic pinch-hitter in the last resort.
Kevin: So are they actually emergency body support, or life support, before the body ever even goes into convulsions?
David: What they are really giving portents of is a permanent overnight repo facility, and that would shift the obligations and the risks in the money market toward the Federal Reserve, away from financial institutions that they rest with today.
Kevin: What are the consequences of that?
David: In one sense this is nothing new because you have what they have done so far, change monetary policy, begin to see unintended consequences from that monetary policy, and then backfill what was a marketplace role with a centrally controlled operation, and the New York Fed headquarters is right off of maiden lane, so it is the folks off of maiden lane who would be in control of this backfilled position.
Kevin: But we’ve called these things, for years, free markets. It is no longer free markets, it is controlled markets. It seems that everything is now boiling down to more and more control.
David: I was going through the bookshelves here at the office the other day, and there were a few that needed to go, which it is very difficult for me to get rid of any books.
Kevin: It is hard for you to throw a book away.
David: I know.
Kevin: Some of them you kicked right out the door, though. You couldn’t believe they were still on the shelf.
David: I know. Some things that had five minutes of relevance back in the 1980s, published for a moment in the sun, and that moment is long past. But I brought home a copy of The Law, and I brought home a copy of The Mainspring of Human Progress. Weaver wrote The Mainspring of Human Progress. I gave it to my oldest son and he immediately started picking at the pieces, because there are aspects of it which are so pro-American as to actually ignore some historical facts. So I appreciated that he was diving in with a critical mind. But I signed both that, and The Law, to my 13-year-old and 10-year-old. The Law is a must-read.
Kevin: Even if it is just the first ten pages.
David: To me, in this context of the Fed taking over more control in the marketplace, I think it is worth dusting off Friederich Hayek’s 1944 book, The Road to Serfdom. Kind of all three are in a similar vein, but The Road to Serfdom is where Hayek convincingly argues that autocratic control awaits us whenever you have government or quasi-government organizations beginning to step in to play a role in the economy. Again, you may critique it as sort of slippery slope logic either at its best, or slippery slope logic at its worst.
Kevin: Yes, but he did get a Nobel prize, granted, 30 years later.
David: Exactly. So fast forward to the 1970s, work that he did in the 1940s was finally recognized as incredibly valuable. And I think it is required reading. As you say, a Nobel prize in Economics. He is not a slouch. But I think this is required reading for anyone who cares about the intersection of public policy and freedom. And if you haven’t read it, it’s not an option. The Road to Serfdom is a classic.
Kevin: Oh yes, no one will regret reading that. They will actually regret then looking at the news after they read it, because they realize we have really traveled a long way down that road.
David: Back in college I was the TA for U.S. History, and I took some liberties, myself, in assigning that in some of the side work.
Kevin: Pun intended – liberties. We’re talking about liberty here.
David: Yes, and I don’t know that people wanted an increased work load, but I thought, “They’re never going to get exposure to this book otherwise.”
Kevin: Okay, so another L-word. We had liberty. Now let’s talk about liquidity, because banks are at all-time highs as far as reserves that they are holding. How come we have no cash in the system. We’re talking about repos, but really, that is just a fancy word for cash, and the Fed has been having to provide up to 75 billion a day at times.
David: It is fascinating because this is an issue. Banks have a ton of reserves, but they have so little in cash. So why money is not making it through the intermediation process to those that need it is a significant issue, and regulators, I think, will shine a light on this in the months ahead. But regulators seem to be unable at this point to ask the right question, and in doing so, pin the tail on the donkey. That is not a partisan comment. But what are the long-term impacts from playing with the natural rate of interest?
Kevin: Well, Solomon said there is nothing new under the sun, but I would challenge that after 2015, because the zero bound on interest rates has been violated.
David: Yes, and is that zero bound really that hospitable to the long-term creation of value? In front of me I have Barron’s and their weekly rag, October 14th, “How to Play Upside-Down Interest Rates.” Throughout this they have “Best Income Investments in a World of Low Rates,” “Negative Rates Are Hitting Home in Europe,” “Five Quality Stocks with Decades of Dividend Growth,” and it’s all about how we cope with an unhealthy environment in the zero bound. And it’s unhealthy for the investor, not necessarily unhealthy for those who have tons of debt and are trying to finance that at low levels. But does this environment spur these extraordinarily low rates. Does it spur economic growth by stimulating investment, or does it spur malinvestment by spurring speculation outside your traditional lending channels?
Kevin: Well, money is free. Why in the world would you consider risk if you could have money any time you wanted it?
David: Banks are unhealthy in Europe in part because of this low rate stuff. Again, there is a problem with intermediation and we’re asking the question, do these repo engagements that the Fed has committed to recently suggest greater distortions and unhealthy functioning of the financial markets? Are distortions not to be expected also with the behavior of borrowers and lenders? So we find things changing. In the case of nearly free money what does it mean to measure risk? And what does the loan officer do? Is his role somehow abridged or curtailed? Again, we come back to liquidity. Perhaps liquidity has bypassed those that need it, the normal lending relationship with banks, and it has gone to those that want it, namely, the leveraged speculative community.
Kevin: Well, let’s just unpack that. If you know that the money is free, why in the world would you not leverage, and leverage on top of that – double, triple, quadruple leverage – because you really have no risk on the downside?
David: Hedge funds, private equity, grabbing cash to gin up results. I’m looking, again, through that Barron’s magazine and they are giving these cash alternatives for investors looking for fixed income returns in the 3 to 3½ percent range, and I’m telling you, there is no such thing as cash alternatives yielding 3 to 3½ percent unless you’ve brought leverage into the equation. It has become the vital component, not only for someone who is just wanting a plain vanilla cash product, but also for someone who is speculating at the level of the hedge fund.
This is a sign of the times. Capitalism was once a system where surplus income was created and that surplus income was invested. Now we have surplus capital. It’s not from savings, but this is surplus capital from the central banks, that is required now from the central banks. It’s not so carefully invested.
Back to the word that typifies the stage of the cycle that we are in now – malinvestment. Malinvestment. Non-bank financial firms have a growing share of not only the assets, but I think also of the liquid cash, as well, and they have a very different set of compulsions and requirements than commercial banks.
Kevin: Do you remember 20-25 years ago when the carry trade occurred with Japan, where what you needed to find is a country that you can borrow from very, very cheaply, and then go make more money in another country. On top of leverage, you also have currency risk, other types of risks, but there are great gains if you know that there is no risk behind the need for liquidity.
David: Yes, so what you are doing is playing this game of low-yield borrowing on the one hand, and high-yield investing on the other, and you are using someone else’s money at the low-yield, capturing the difference. That is the nature, or a rough description of, the carry trade. This is one of Doug Noland’s concerns, that the size of today’s carry trade, whether it is cross-border or across asset classes, the size of that speculation is funded, not by a singular country with low yields, but it is funded by free, or nearly free money, and it has created a bubble that makes the mortgage-backed securities bubble look like child’s play.
Kevin: I think you need to repeat that. We’re talking about the bubble that occurred eleven years ago, looking like child’s play. That almost destroyed the world economy, had the central banks not stepped in and bailed out the system. This next bail-in, Dave, is going to be huge.
David: Yes, I think the negative implications are far more grave because the risk assets have been pushed up by these artificial capital flows. The artificial capital flows are from the U.S. market – you have the Fed driving that – the Chinese markets – massive credit expansion from the PBOC, which has fueled massive asset growth – the European debt markets, the emerging debt markets, Japan – everyone is playing in a world where, let’s face it, sustainable growth is secondary.
You want the immediate pop, the immediate return, and borrowing cheap, again with sort of low-yield borrowing to the high-yield investing, that is the game that is being played on a global basis. And all your risk assets are involved, all of your fixed income markets where that funding is cheap, are involved. To see the interconnections within the financial markets is, really, actually, a harrowing process.
Kevin: And you leverage those gains because tomorrow you may die. I remember in high school learning about the philosophy of the cavaliers, and actually, it was a verse that was taken out of the book of Isaiah in the Bible. “Eat, drink, and be merry, for tomorrow we may die.” What we have going now is, “Eat, drink and be merry because we have the Fed behind us.” But it is still cavalier in its approach. It is a no-consequence mindset.
David: This weekend we came to a similar conclusion. We were watching a movie as a family, and the director was trying to make a point, and it was really that at the end of the day, we have a nihilist and an existentialist conclusion. Nothing matters, therefore eat, drink and be merry, because tomorrow we die. We’re doing that financially, even while some of our directors are making movies and telling us the same thing socially. Here we find this irony because we have cash shortages in an age of excess credit.
Kevin: But do we have cash shortages when we have Powell coming in and saying, “Let’s not call it QE, but it will be 60 billion a month, which is larger than what the first QE was.
David: That is where we find the Fed making new commitments. 60 billion a month announced last week, that is in treasury purchases, in order to ease the cash shortages in the financial system from this week, and I think they go through the end of Q1, I believe, 2020. This is a larger QE operation than QE1. But Powell was very clear in his opinion. This is not QE – even though it looks and smells like QE. Maybe we call it QE Light.
Kevin: But they’re not worried. They’re telling us, don’t worry about the economy, we’re just applying 60 billion dollars out of thin air.
David: I think for the astute investor, you say to yourself, “if the Federal Reserve is building a reserve buffer, and creating liquidity for the big banks in a very aggressive manner today, is it possible that there are concerns that are not being telegraphed to the man on the street? Issues that they see cracks in the financial system which press them toward greater proactive involvement in the markets, and ultimately, hopefully, with a positive impact for the economy. I think that is the case.
On Friday the Fed claimed that these actions were, and this is to quote them directly, “Purely technical measures in support of the effective implementation of an interest rate policy. It doesn’t represent a change in stance.”
Kevin: Yes, “Go away kid, you bother me. This is purely technical. You won’t understand.”
David: But this is following Jerome Powell’s comments that this is not QE. What is it then? Again, maybe it is QE Light, but in addition to the 60 billion they are starting with this week to create a little bit more cash for banks, the Fed is still providing up to 75 billion in overnight loans – that is for the repo market, a different deal – and an additional 140 billion in longer-term repo loans – this is the 6-15 day term repo loan. That is a different deal, an extra 140 billion.
So Friday’s comments underscored that purchasing of treasuries would … and again, he wanted to emphasize this is really not going to impact the markets – they said it is going to have little, if any, impact on the level of longer-term interest rates and broad financial conditions. I thought to myself, “Okay, so wait a minute, they’re saying this is not going to impact financial conditions, just throw in 60 billion into the markets, a little bit of cash, is not going to change financial conditions or longer-term interest rates? And oh, right, what are they buying? They’re buying bills. Bills are all short-term instruments, and yes, technically, that is right. The impact is not on longer-term rates, but what the purchases will, in essence, do is help take away any concerns in the marketplace. Remember we’ve talked about the removal of signal in the market? What does the inverted yield curve signal to most people? You see the inverted yield curve generally just prior to a recession.
Kevin: Let’s explain again, the inverted yield curve is when short rates are paying more than long rates.
David: And the purchases the Fed is talking about are going to help take away any concerns stemming from an inverted yield curve as short rates – again, this is three months to one year – they have, in fact, been higher than your two- and five- and 10-year categories. So come on, isn’t it fair to counter that claim with the observation that if you take away the concerns of operating with an inverted yield curve you are, in fact, influencing broader financial conditions? In some sense, this is like a scene from the Wizard of Oz. Pay no attention to the man behind the curtain.
Kevin: I just came from a meeting this morning before the recording, and Tony, if you are listening, I will just go ahead and share the conversation. Tony is a pilot, and we were talking about the economy. He said, “So you mean to say that the economy this last ten years hasn’t really been sustaining itself, it has been stimulated?” I said, “Tony, let me explain from a pilot’s point of view. When we get to a stall angle on a plane” – remember your stall training when you were learning to fly?
David: Yes, sure.
Kevin: You basically pull the plane up until that wing is right on the edge of not flying anymore, and stalling. But, there is a trick that you can apply. You can apply power to the engine and you can fly for a period of time on the back side of that curve where the wing is no longer actually doing the work, it is actually the engine doing the work. I’m going to apply this now to the market. When the Fed is stimulating by adding 60 billion more a month in new quantitative easing – sorry Jerome Powell, I’m going to call it what it is, 75 billion a night sometimes in repos – what we are doing is adding power from the outside that is not part of the actual power plant. This is not the economy supporting itself. We are in a stall right now. We’re flying on the engine, and that always goes wrong because ultimately the fuel runs out.
David: And note that the proactivity is right now in response to a slowing global economy. You have the newest managing director of the International Monetary Fund this week saying, “The global economy is now in a synchronized slowdown.” And the reason why we are applying power to the backside of the curve, as you described it, is not because of what we see in the U.S. economy, but because of what we see in the global economy. So all of a sudden the Fed is now defender of the global economy – the world.
Kevin: Soon the universe, by the way.
David: I don’t think anyone has made a cartoon of Jerome Powell in a cape, but that would be a fun one.
David: I think part of the pressure yet to be unleashed in the weeks and months ahead within the financial markets, specifically the stock markets, is in the tech space. And this is just kind of an overlooked thing, but the lockup periods for all of your recent IPOs are expiring. We have a couple now within the next few weeks. This is the expiration of restricted periods where post-IPO, executives, employees, early investors, cannot sell their own shares. You have Uber, Zoom, Pinterest – they all fit that bill.
Kevin: So there is a period of time when you are in that corporation that you can buy those shares for the IPO, but you cannot sell those shares for a period of time.
David: Not the day of issue, and not for, generally, three to six months. So as we mentioned in our comments – Friday we publish each week on our McAlvany Wealth Management website, hard asset insights, a one-page summary, a good read. The tech-heavy unicorn IPO space has become a disaster. And here in a matter of 30 days you have gone from loss-making companies being the wave of the future…
Kevin: Which we talked about three weeks ago. We talked about how it didn’t matter if you made money, you were going to get money flowing in from shareholders.
David: But from then to now you have this refreshed view of profits and losses where you have to show investors money that you are making before they will throw more of it at you. That has been a significant change in the last three to four weeks. To me it seems like a modern-day miracle that profits matter again (laughs).
Kevin: Wow. Do you remember when profits started to matter back in the year 2000? Back in, oh I don’t know, February before the March crash?
David: But you’re hearing CEOs from Silicon Valley reflect on the change in sentiment in the last three to four weeks and they’re saying it feels a lot like 1999. Everything was working…
Kevin: Wait a second, we have to make money?
David: And this is the deal. You had that eternally hopeful view that a company not making money would have preference because it is easier to fit it into a more imaginative pro forma – “We can go to infinity with this company. We can make more money than Midas. Granted, you can’t calculate it on the basis of what we are making today, but that’s why it is easier for imagination to capture, we can go anywhere from here.”
Kevin: Haven’t you been to our office? We have an espresso machine and Lincoln Logs and Legos. Why would we have to make money? We’re a new innovative though process.
David: Yes, and that has changed within just the last few weeks. The Financial Times reports that 30 tech companies will move past the lockup period between now and year-end. And, in our view, the lens through which these companies are analyzed has been replaced with a harsher one where a sustainable business model is required, and profitability is foundational. So again, you go back to the early private investors, the founders, the employees – they’re going to want to capture liquidity that the IPO was supposed to provide, but with the SEC limits immediately following an IPO, again, typically a three to six-month period, there is a hunger to move to the exits.
The likelihood of seeing tech unravel between now and year-end is heightened by this – call it a late cycle dynamic – where the market recently cared less about sustainability of sales and revenue, but now is expecting these attributes. You need to have some sales, you need to have some revenue, you need to – gracious – have an actual business. Those are attributes that you need, along with a business plan. Sentiment shifts with expectations, and prices often follow.
Kevin: Last week you brought up the bag-holder theory. Remember when you worked at the brokerage firm and you had to find bag-holders for the bigger investors. What does that look like now?
David: I think it would be interesting to gauge venture capital sentiment at this point. If you went to Silicon Valley, the early seed-funding and the angel-funding for these firms, I wonder what their concerns are at this point. Because as you mention, we were talking about private equity last week looking pretty late cycle, with product proliferation for smaller investors, what we described as the late cycle bag-holder theory. And I wonder if there is not a bit of a panic in the VC community, with the capital market shifting from kind of, “Who cares?” to “No, we care.” And from, “What need for profit?” to “You don’t get any more money without showing a profit.” Again, for the venture capitalist, you’re an early funder, and the IPO gives you the exit from your original investment, the exits are, to a degree, closing.
Kevin: It’s not the consumer, though. We talk about bag-holders, and a lot of times the man-on-the-street is the last to know. Consumer confidence is very, very high, even though early in the program I mentioned that CEO confidence, the people who actually see the numbers and just can’t wait to sell their shares are getting out.
David: That’s the interesting contrast. Friday’s University of Michigan consumer confidence numbers came in stronger than expected. They are at a three-month high. And the consumer is not concerned. The consumer is not negative at this point in time
Kevin: Unless they work for General Electric.
David: Oops. Sure.
Kevin: They might be a little more concerned.
David: Yes. You probably saw signaling of good times ahead there.
David: Just a little freeze on the pensions, only 20,000 employees affected. The reality is, these under-funded pensions are a big deal for your staid old companies, even with the huge run-up in stocks and the huge run-up in fixed income, with rates near record lows, you have the largest plans here in the United States still facing a 269 billion-dollar shortfall. It is just mind-boggling to me, some are over-funded, some are nearly funded, and a bunch are massive under-funded.
When you look at that and you say to yourself, “Well, we can’t keep on adding to these mountains of obligation without ultimately causing a crisis for the firm. You just wonder if at the micro-level these decisions like GE freezing pensions, if that logic doesn’t somehow flow upstream to the government, where the issue of sustainability, the issue of long-term obligations, the issue of cash flow – do any of these things matter, or is the political animal considered to be somehow different?
Kevin: I have a good friend who worked for BP, British Petroleum. He told me after the Deep Water thing, the concern that they might have that they would lose their pensions. Can you imagine? I know that this man played his cards right. He worked a good 40 years and retired, and he has a good retirement, but there was that scare at that time that possibly it wasn’t going to be there. Could you imagine working for 40 years in a job that you may or may not want, really, to call your life’s goal, so that you could get a good retirement, and it just possibly disappear?
David: And let’s be clear, not all pensions are created equally, so if you are working with a state, a municipality – God forbid you are in the state of Illinois, or Chicago – that is a different equation than some companies. And there are some companies that are hurting – GE would be an example, and other companies that are well-funded. So it gets to be critical when you are looking at this from a company-specific standpoint.
Kevin: But the shortfall is still a quarter of a trillion dollars across the board of these larger companies.
David: Right. So back to the University of Michigan number because sometimes these numbers are particularly thought-provoking when they are contrasted with a divergent number like the Conference Board’s CEO sentiment index. From that group we get the following, taken from the Conference Board’s website. “The Conference Board measure of CEO confidence, which was unchanged at 43 in the 2nd quarter of 2019, declined to a reading of 34 in the 3rd quarter. A reading of more than 50 points reflects more positive than negative responses. This is the lowest reading since the 1st quarter of 2009 when the measure was at 30.
Kevin: 2009 – where were we in 2009? That’s what we talked about at the beginning of the program.
David: Trade and tariffs certainly factor in. Where our opinion probably steps beyond the CEO stated concerns is that financial market conditions are unstable, even with a resolution in trade conflict between the U.S. and China, which admittedly would help economic growth statistics, there are still issues within the financial markets which are very significant. You can’t say that the problems in the repo market are tied to the global trade issues between the U.S. and China. Not at all. Now, there might be instability in the Chinese financial markets, and there is a knock-on effect to the U.S. financial markets which shows its ugly little head in the repo markets.
Kevin: Well, and we jump back and forth oftentimes. I think you should differentiate. You have the financial markets. That is what we talk about with Wall Street and the banks.
David: Yes, the contrast is between the financial market cancer and the economy. The former, the financial markets, capture the reckless allocation of capital throughout this era of easy money, and the latter, the economy, captures is the consumers’ circumstantial decisions and responses, and you can measure that in terms of the money that is spent in the system. You can also measure that by the CEO sentiment numbers. I think it is worth lingering on that as a harbinger of corporate capital allocations because when CEOs get nervous, what do they do?
They look at their budgets and they say, “Gosh, I just don’t have enough visibility about where we are going to be as a company, the kind of sales we are going to have in the 1st quarter or 1st half of 2020. I think we need to cut production back, or I think we are going to wait on the replacement of mainframes for the computer until…” and all of a sudden these capital allocations get put on hold. The consumer is spending with confidence, probably with less awareness, or with less interest, in global economic relationships.
Kevin: Yes, but they don’t get a chance to talk to these CEOs.
David: That’s where I think there is a difference here with the C Suite – your CEOs, and your CFOs, etc. They are going to be making spending decisions based on uncertainty, based on concerns that do tie to Trump and Xi and the broader decline in global trade. Out of this group – you mentioned it earlier – only 4% of CEOs see an improvement over the next six months. 67% expect economic conditions to worsen. Not surprisingly, a major number of these CEOs, about 64%, expect to see a decline in sales, and a decline in revenue, coming into 2020.
Kevin: Yes, but the stock market doesn’t show that. The stock market says everything is just going to keep getting better.
David: That’s right. What is priced and what is not priced into the S&P 500 or the Dow, the S&P is now near 3000, the Dow roughly 27,000 – again, you have expectations of these CEOs, declining sales, declining revenues, a tough economic environment moving forward. This is a significant divergence of opinions between the consumer, the man-on-the-street, who is just happy – happy to buy, happy to enjoy, happy to indulge, and the CEO who says, “No, I don’t like what I see.”
Kevin: You said last week, they are liquidating. The CEOs are actually liquidating their own shares. It is called insider selling. And at the same time they are borrowing money and buying up their own shares to boost the share price.
David: In some instances, borrowing to buy the share buy-backs, in some instance using cash or part of free cash flow for the buy-backs. So buy-backs utilize company cash. Those are raging ahead. Insider liquidations of company shares, those liquidations are raging ahead. And the CEOs are telling you, both by their actions and with the poll, the measure of CEO confidence, the Conference Board numbers, that trouble is coming.
Kevin: Most people don’t have a lot of savings. When you look across the board, across the nation, if a person owns their house, it is usually the largest part of their savings. So let’s look at the housing market, because that seemed to be the fly in the ointment back in 2007, 2008, 2009. Where are we at right now, and what are our interest rates telling us?
David: The wealth effect was something that the Fed targeted. They wanted to buoy, not only stock returns and what not, but also housing, because housing is a factor into the general sentiment for the consumer, probably more than the CEO. But you feel good if your home is worth more than it was last year, and you might even tap some of the equity to make some improvements, add this, add that, or take a vacation. A year ago we were at an inflection point in the mortgage market. We were at 4.9%, just peering into the 5s, for the 30-year fixed rate. That is if you had good credit. Now we are down 133 basis points. Your 30-year fixed-rate mortgage is at 3.57%. Tell me that doesn’t factor into the consumer’s feel good moment right now, captured in the University of Michigan’s sentiment measures.
Kevin: But we were at 4.9% last year, and I know that you were concerned that once we broke that 5% barrier that there may be a change.
David: I think it is. I think that number is the Rubicon for consumer borrowing and housing market stability. Cross it, and pain will be triggered. So at this point the consumer here in the U.S., feeling no pain, not a concern in the world.
Kevin: But we have talked about before that the consumer in the U.S. is definitely not where you want to get your clues as to how things are going. It is better to watch, oh I don’t know, maybe the Chinese, maybe the Russians, maybe the Turks, maybe the European central banks. Sometimes those are where we should get our clues. Do as I do, not as I say.
David: I was fascinated by that conversation I mentioned last week with the endowment partners and the consulting that we do during the month with the college here in town.
Kevin: Yes, how did that go?
David: It was good. There is some messaging that is just going to fall on deaf ears, and there is some that I think, hopefully, I add some value there. But it is interesting the level of concerns – very different. The consumer is obviously spending because there is confidence and sort of a spring in the step. In that room there was more pessimism and negativity and discussions of moving to New Zealand because the Trump administration is an abomination, just like to many in the previous administration Obama was an abomination. You go from one period to another and you have one group who is just tearing their hair out and convinced it is the end of the world, and then it is the other team’s turn to tear their hair out and think it is the end of the world. To me, I have a low opinion of politicians and of this back and forth kind of Kabuki Theater, power games without any real focus on values and getting a good job done.
Kevin: But both sides like to spend an awful lot of money, and they will tell you why it works for their side.
David: Well, they do, so where we see clues is, you see central bank activity. This is one of the things that they wanted to talk about. Central bank activity and the purchases of gold send a very different message. If all is well, the stock market says all is well and confessions of all around the table with the exception of me, that the efficient market hypothesis is alive and well, and the market knows something that we don’t. You have the Dow and the S&P at high numbers, but we are concerned about this political disaster.
Kevin: Well, forget that the People’s Bank of China is buying gold. Forget that the European central banks are buying gold – with both hands.
David: And that is, I think, worth keeping in mind. Bloomberg reported the latest inflows into gold by the People’s Bank of China – 5.9 tons. That was the most recent addition. That follows 99.8 tons over the prior nine months. So what do they see here? When they are buying gold and fortifying a reserve position, is that because they see a positive outcome in the trade conflict? Is that because they see potential for devaluation of the RMB, and the reality which all central bankers have recognized through the decades, that if you have a collapsing currency, the only way to re-establish credibility is to bring gold back into the conversation, if not the literal monetary equation. So what are the Chinese doing? I think we know where the RMB is headed over the next six, 12, 18 months. The pressure is there, and the likelihood of devaluation is pretty high.
Kevin: And we’re not speculating on price. We talked about last week that they just add to their buying any time gold goes down. We’re in a little correction right now.
David: I would like to buy 5.9 tons this month (laughs). Somehow that would bring me great satisfaction.
Kevin: Going back to politicians always spending money. Let’s take the partisanship out of this for a moment, and let’s look at what the deficit is going to be this year.
David: The partisan divide grows by the day, and I’m curious if you can tell me what Donald Trump has in common with Nancy Pelosi, with Mr. Schiff, with Schumer, even Elizabeth Warren.
Kevin: Uh-oh, we’re going to lose half our listeners. They’re going to turn over to Glenn Beck or someone else, because you can’t put him in the same camp as Warren or Schiff.
David: What does Donald Trump have in common with Elizabeth Warren, Schumer, Pelosi, the whole bag?
Kevin: This like Sesame Street. Remember that? “Three of these things belong together, three of these things are kind of the same.” Keep going.
David: Washington D.C. – I think it makes for strange bedfellows. The federal budget deficit for 2019 is projected to be 984 billion dollars, and of course, actual financing needs will exceed that by another 200-300 billion.
Kevin: Right, they break a trillion. They just call it different things.
David: Right. So maybe more. Again, we are talking about projects that no one wants to talk about, that don’t get fit into the budget. But then throw on top of that the evergreening. You have a few hundred billion dollars in debt.
Kevin: What’s a few hundred billion?
David: So the 984 billion figure is the highest since 2012, according to the Congressional Budget Office. What I am saying is that the actual deficit figure is likely 50% above that. But back to the question – What do politicians have in common when you set aside this or that coup attempt, or whatever else? What binds all politicians’ hearts together? This is from a Bloomberg story. Steve Matthews wrote this up. He says, “U.S. budget deficits and the national debt are on track to keep growing because both Donald Trump and his Democratic rivals want to use low interest rates to finance more spending,” in effect embracing some form of modern monetary theory.
Kevin: Right. Even Trump tweeted three weeks ago that he would like to see us go to negative interest rates. Well, what is that saying? That is exactly what you are talking about.
David: Truth is of secondary importance when power is on the line, and I think that is what we see if you are looking at the news media. This is probably just to clear aside partisanship, truth becomes irrelevant when power is on the line. The power of the purse has never been more important because right now you have the promise of limitless spending, which has just been theoretically rationalized. We’re talking about modern monetary theory. And so he who controls the purse controls limitless spending, and controls, in essence, limitless power.
Kevin: MMT – 60 billion dollars a month by Powell. And let’s not call it QE, because it is just simply technical. Again, “Go away, go away, you bother me.”
David: What we have talked about in recent weeks is we actually are in a transition, even though Powell holds on to quantitative easing and the expansion of the Fed balance sheet and some measure of monetary policy shenanigans, we still have the fiscal drumroll playing because we will have announcements of how money will be spent. It’s money that we don’t have, but how money will be spent.
As Americans, set aside your partisan views, we should recognize this period as one of our greatest national risks. Politicians on both sides of the aisle are destroying the fabric of society. They are reshaping the capital markets and they are creating greater political animus than we have seen since the 1860s, so that the winner – and there will only be one winner, everyone else is a loser – can take all. The body politic is being risked for the sake of collapsing political power into a single party system.
Kevin: So the phrase is, give me liquidity or give me death.
Kevin: Give me liquidity, or give me death!
David: I think Ben Franklin knew the cycle, and we’re not talking about the business cycle or the economic cycle, but the political cycle, from freedom to bondage, when he said, “Only a virtuous people are capable of freedom. As nations become more corrupt and vicious they have more need of masters.” Kevin, what has changed?
Kevin: This goes back to the three books you recommended, and actually, I’m going to reduce that to two – Hayek is absolutely necessary, and The Law, by Bastiat, is absolutely necessary. Mainstream of Human Progress is interesting, but again, it is hyperbolic in some ways.
David: It is, very much so.
Kevin: But Hayek is not. Road to Serfdom is not. And neither is The Law.
David: Your assignment, should you choose to fully engage here (laughs) is to carefully read The Road to Serfdom, by Hayek, and The Law, by Bastiat. I think without those reference points, you might be tempted to think of your brand of politician as having the country’s best interest in mind.
After reading both of those books, I think you will look at all politicians the same way, as being incredibly self-interested, and not particularly interested in what is best for the country.