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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

February 6, 2019

“I’m surprised that you don’t have Warren, Krugman, Ocasio-Cortez, Sanders, the whole lot – why aren’t they up in arms? If they want to defend the poor, why aren’t they talking about the fact that inflation is not a progressive tax? It’s a regressive tax. It hurts those at the bottom end of the spectrum. Worse, it reinforces the trends of wealth disparity by further impoverishing the poor. “

– David McAlvany

Kevin:It’s funny, Dave, I’ve gotten to where I don’t watch much TV, but when I do my blood pressure goes way down when I can turn an old Western on. The other night I was watching a Jimmy Stewart Western called Bend of the River. I won’t go into the whole story, but it shows how quickly a town can change when there is a gold rush.

It makes me think of what is going on right now. When there is a gold rush, they come after the secret is out. Gold is found, and usually people try to keep a secret. When the secret is out, everything changes. Now, we have a gold rush going on right now, but it’s still sort of veiled, it’s in secret, and the people who are collecting the gold don’t really want us to know.

David:It’s interesting, Nixon closed the gold window in 1971. We had deficits which were ballooning, we had an economy which was shifting toward recession. 1973 and 1974 ended up being nasty in that regard. It was not surprising to see the world central banks scrambling to diversify out of dollars and into gold.

Kevin:And during that time France wanted to try to be secret about it even though they were taking just about all of it.

David:And frankly, that was in the mid to late 1960s where they were taking a lot of gold, and of course, we know it got to the critical point in 1971. Gold represented, in that era, the legitimate asset behind the U.S. dollar. As the fiscal position of the United States was being compromised, the world rightly assessed that there was a greater risk in the relationship between the dollar and gold, and that relationship being disconnected. It was a debt problem that became a currency problem.

Kevin:Isn’t that how it always happens? It’s a debt problem that turns into some form of crisis, yet, at this point there seems to be a similar type of activity by the people in the know.

David:It may be happening all over again. Do you recall That ’70s Show? (laughs) We may have that in 2019. You have central banks which bought the most gold in a single year, last year, 2018, at 651½ tons. That was a 74% increase year-over-year. That is the most gold bought by central banks in any year since the 1971 central bank gold rush.

Kevin:Isn’t it interesting that the central banks have purchased more gold in a single year since 1971, and yet the American buyer of gold is at an almost all-time low. The U.S. Mint said that gold sales last year were the lowest in over a decade.

David:Yes, go back to the 1970s. By the time the public fully understood that the U.S. Bretton Woods currency debacle was on them, the gold price had already moved 500%. And that was not the last leg. The last leg was an additional 400% on top of that. That was what was still to come. What is this? This is all reflecting a diminishment in purchasing power. It was also representing a loss of confidence in the monetary authorities, specifically, the U.S. central bank at the time.

Kevin:Isn’t it interesting, as we speak you have people still investing in these index funds just thinking that the central banks have got their back. Look at how much money and how much stimulus from the Federal Reserve it has taken just to get us to the point we are at.

David:And so here we are sitting at less than 10% from all-time peak prices in the stock market. You have fiscal deficits which are widening, you have global economic growth slowing. If you look at what the Fed has done, they have put rates at about 2¼ percent, and frankly, to the peer group that you are comparing them to, that is rather high, but it is only half of what they were prior to the global financial crisis. We cut rates from 5¼ down to just 25 basis points, and even that extreme 500 basis point cut was not enough to avoid the recession of 2007 and 2008. I don’t know, but it appears that 200 basis points to give, if we were to go back to that ¼ point, is that going to get it done the next time the Fed actively intervenes?

Kevin:Not when it took what it did in the past. Now, what is interesting is, the very people who cut all those interest rates and are telling the stock market that they have their back, and Powell basically saying things are fine, pay no attention to my latest action, these are the same entities, these central banks, that have a 74% year-on-year increase in their gold buying. They know something that they’re not saying, Dave.

David:Look at the lack of ammunition on the part of the Fed, and I think, in answer to our earlier question, no, 200 basis points is not enough, and what that really suggests is that the unconventional toolbox is closer to being opened and used again than you might think. And I think, frankly, if you are watching the actions of central bankers, this is what you may imply.

Central banks are aggressively diversifying into gold, which is a very different signal being sent by their actions than by most of what the central bank community’s words or the reassurances that they continually give to the marketplace. It is high praise that you hear for the current state of the global economy, and yet they are piling gold like it was 1971.

Kevin:Being an American in the United States, and being denominated in dollars, I think sometimes we are a little bit like that kid that is walking down the street with the ear buds on. He is not hearing anything that is going on on the outside. Look at what gold has been doing against foreign currencies, the people who don’t have their dollar ear buds in – it’s amazing.

David:Yes, priced in foreign currencies, gold is trading at, or near, all-time highs. So you may not see, as an American, or somebody who prices their assets in dollars, what the rest of the world already sees. And that is a likely problem if you continue to ignore it. But I also think it is an opportunity if you are willing to act upon it. I think, since stocks began to sell off in October, look at the exchange-traded fund. GLD has added 93 tons. It set a new total of 823 tons in that product.

This is a healthy indicator of investor demand. This is traffic that is beginning to increase. Sentiment is shifting to more positive in that investor category. We talked about the central bank community. That is a separate purchase category. The investor category is very intriguing. January saw inflows into GLD at 36 tons compared to January of 2018 which was just four tons.

In the last six months we have had everyone from Ray Dalio, manager of the largest hedge fund in the world, Jeff Gundlach who is the new bond king, and as many of you may know, Bill Gross retired this week, Mark Mobius, the real estate legend, Sam Zell – all of them have disclosed gold purchases and have been suggesting that the world already knows, and they do, too, if you look in retrospect.

But also, if you are looking forward in time, you had better save in a reliable unit of account, that when financial markets are dislocating, gold is a safe haven, and that when governments get desperate, you want a part of your wealth position outside the traditional banking system so that you can avoid repression. We’re talking about financial repression – negative interest rates, hidden inflation taxes. Those are the quiet enemies of today’s saver, but with real, ultimate deleterious effect to someone’s assets.

Kevin:I remember talking to Jim Deeds. We have Jim on the show on a regular basis. Jim was in the investment world back in the late 1960s. That was when gold was illegal to own, but he started seeing, a little bit like these other investors you are talking about – Dalio, Gundlach and Mobius – he read a book back in the late 1960s that told him the problem, and he started to see what the central banks in Europe were doing. They were accumulating massive amounts of gold. It’s this gold rush you are talking about that seems to be starting again. Jim started buying silver and when you have that type of nose for what’s going on, you can be ahead of the crowd.

David:To me, what we built into the vaulted program, giving investors the opportunity to own a liquid, accessible, transparent position in kilo bars with the Royal Canadian Mint, what we are talking about is creating an alternative for the trapped U.S. investor who may say to themselves, “Look, I’ve always been with Bank of America, I’ve always been with Wells Fargo, I’ve always been with…” Pick your bank – A, B, C. But this is a substitute for banking and savings deposits, and I think it will serve investors very well in the pressured years ahead. If you haven’t considered it, look at it. is, to me, the best alternative you can find for a cash position where you need liquidity, you need transparency, you need accessibility. It has all those things.

Kevin:Sometimes I think it is just habit that makes us keep things in a bank account, not necessarily looking at the interest or the negative side. We’re doing a little bit of home improvement right now in the kitchen and my wife said, “Why don’t I just go ahead and pull the money out for the next few things and we’ll put it in cash in an envelope and just pay it out?” The first thing I said was, “No, let’s go ahead and leave it in the account until we need it.”

And then I caught myself. Why? They’re not paying me any interest. You know what it is? It’s habit. So if we change our habits, like with Vaulted, you don’t have to keep it in an account that you’re not earning any interest if you want to put yourself on a personal gold standard.

David:It was interesting, I read an article by Bill Bonner recently. His idea was that we do what we do because we’re used to it. And that is sometimes how we get into trouble is that we never rethink why we do what we do, or how we do it. I think only when circumstances get to an extreme, or the pain threshold gets to a point where we are forced to reconsider do we then look at our activities and our habits and, perhaps, reassess and re-organize them.

Kevin:Do you think, possibly, some of the tensions internationally that are breaking globalization down are also moving the central banks into gold?

David:I think both central banks and just the international investor demand for it. Internationally, there is a breakdown of globalization, and you have the requirement in that context for local governments to become more sensitive to populist outcries, discontent, and there are reasonable reasons to look at long-term growth prospects diminishing. Again, politics begins to transform. I think the rest of the world knows only too well how governments sometimes deal with their own fiscal issues and the inflation tax is something that is used on a routine basis all over the world. It is a part of the government toolkit to redistribute assets, to choose winners and losers when they, themselves, are under duress.

Kevin:It’s funny that our Federal Reserve almost treats inflation as our friend at this point. We have this targeted inflation, yet inflation, if you really look, at Germany back in the 1920s, Venezuela today, inflation always ends in starvation.

David:Yes, certainly at the extremes it does, and getting there, the anticipation of it, is something that wreaks havoc on virtually every asset class. So I think as a complement to, as a precursor to more global political tensions, we are seeing foreign governments aggressively accumulate gold. We mentioned last year’s record-breaking 651 tons, and according to Meridian Macro, the Swiss Federal Customs Administration shows gold exports to China coming in at about 450 tons a year.

So the Bank of China doesn’t disclose these numbers and they don’t adjust their official holding figures to reflect these imports, and those numbers are also not included in the 651 tons accumulated last year by central banks. So again, keep in mind that we could actually see closer to 1,000 tons of central bank demand, if you’re talking about the PBOC, as well. Some percentage of those ounces of the 450 tons going into China, obviously, are to meet local on-the-street demand, as well.

Kevin:So if we had been listening to central banks, everything that they are saying about what they are going to do next for the market, we should also look at what they are doing, themselves. What is this saying?

David:I think, in short, we are on the cusp of a major event in the gold market. If you look at $1365, the gold price, that was the level that gold peaked at in 2016, and it represents the last meaningful resistance, in my view, in a move back to the previous highs of $1900. There are stopping points along the way, but $1365 is a significant level. The lows were established in the gold price December 2015 and the U.S. market has largely ignored this recovery story with the general equities indexes capturing most of your investor enthusiasm, capturing most of the public’s attention.

Kevin:Passive investing is what you are addressing.

David:Yes. Well, now we have the next leg higher opening in the gold market, and frankly, what the catalyst is hardly matters. But what we do know is that the context is set. The context is set, and that should be obvious. But I guess, in case it’s not obvious, if this is a new story to you, I think it’s worth looking at some of the micro, as well as some of the macro, in terms of the analysis. We had a notable profit warning from DowDupont, expecting a decline in profits.

And interesting in the notes on their announcement, DowDupont is a very significant chemical player, so they are pointing at Chinese and European economic slowdown as one of the contributing factors to their profit warning. It’s not the profit warning of that company that bothers me, it is the cause. Step back, and I think it’s worth highlighting the importance of Chinese slowing growth.

Kevin:Which has been the engine of the growth. It has allowed our Federal Reserve to do what it has done over the last ten years because China has continued to grow.

David:So the trade conflict, frankly, has not been thefeature in this earning season’s disappointments. TheFinancial Timessays, “Here in the 1stquarter earnings tipped for the first decline in three years. Analysts slash their year-on-year forecast as companies succumb to pressure on margins.” That is from today’s Financial Times. As we noticed in previous commentaries, China has driven global GDP growth for quite a few years. As their economy slows, frankly, it is probably just a fraction of the official number.

They say that 2019’s numbers are going to be 6.4% growth. They are probably going to be a fraction of that. The impact is already showing up in the earnings and the profit disappointments across a very diverse group of companies, whether it is the chemical giants, the chip makers, phone manufacturers, auto parts suppliers, it is being revealed.

Kevin:You know that the growth is being over-stated because you have a contact in China that told you so, but we can’t really name him, and we can’t talk to him because he is fearing for his life if he actually gives true economic statistics.

David:It’s true at this point that any line into and out of China is a recorded line. There is no such thing as private communications in that country at this point. China’s manufacturing index fell again in January. It is now at a three-year low. It suggests a very difficult operating environment in China for manufacturing. The eurozone, as well – their PMI, Purchasing Manager’s Index, according to Reuter’s, fell for a sixth month in a row, and they are now at a 5½ year low.

Kevin:Car sales in China have been plummeting. I saw a chart yesterday. It’s not minor, it is a major difference in car-buying.

David:From the first of the year the decline was fairly insignificant, but as we move toward December it began to open up to where December was a horrific month and it just added to what ended up being a pretty nasty year overall. Car sales declined in China last year, 2018, for the first time in 30 years. So again, there are some trends that are being broken and some things I think investors should pay attention to which are backdrop issues if you want to understand the context for why central banks are interested in greater monetary stability and creating some offsets within their own balance sheets, and why investors are doing the same.

Kevin:Well, we have to watch two things. People have to have cars, people have to have smartphones, almost, these days, and it seems that both are dropping in China.

David:The modern world – what would we be without a smartphone?


David:Chinese smart phones shipments fell by 14% year-over-year. You had imports into China, total imports, which fell by 7.6. Exports from the country for the full year down by 4.4%. Whether it is executives at Intel or ADI, Nvidia, they are all pointing out on their earnings calls that there is a weakening in consumer demand, and it is driving revenue expectations lower. This is a growing business executive concern, and we’re back to one thing. The macro economic conditions are souring, and in particular, China is impacting the bottom line for a lot of multinationals.

Kevin:Last week, or a couple of weeks ago, actually, you brought up that Germany was slowing. So the European region, because Germany we talked about being an engine of growth for Europe, the whole European region is also slowing.

David:Right. That was German manufacturing we talked about a few weeks ago, and Europe does continue to slow. Italy had its GDP figures contract in the 4thquarter, so it draws its economy into recession. Italy is officially in recession. As you can imagine, when you have a declining economic base and economic activity, it makes it more difficult to service your debt. So think about the target two obligations. You have big shifts in these cross-border liabilities that are held with, or held through, or at least marked by the ECB.

The big shifts, in terms of their liability accumulation, occurred in Italy. If we go back to 2011, that was the first major increase. And then it has gotten progressively worse with those numbers accelerating to the downside, 2014 to 2016. But think about this. Prior to the 2009 global financial crisis, the Italians were a net creditor according to their target two balances. Ten years later it is half a trillion – well 482 – close to half a trillion dollars of cross-border obligations. That’s a real issue. So again, slowing economic activity, increasing debt payments – that’s a nasty cocktail.

Kevin:We talked in October on the Commentary that Draghi was just first talking about tightening up a little bit in Europe. That didn’t last long, did it?

David:Right. Looking at ECB policy, you can see why they’re hesitant to tighten financial conditions in earnest because you do have issues within Germany, issues within Italy. The issues within France, I think, at this point are largely political, but I think we will see more indications of economic weakness in France, as well. Draghi is now in his final year at the ECB, and in recent weeks they suspended the asset purchase plan, but I think they are going to have to reconsider that as an option, again, if they continue to see Eurozone growth slowing and that being a spreading theme. It was only a few weeks ago that they stopped that.

Kevin:Yes. So the asset purchase plan, for those listeners who don’t know what that is, that is when the central bank comes in and buys everything. What he was talking about is, “We’re not going to do that anymore.” Remember, when we talked about this we said, “Well, there goes Europe.”

David:Right. They were slowing considerably in October, and then by the end of the year came to an abrupt halt. So we don’t know the precise threshold, but when the market swoons, rates will go lower here in the U.S. You have the balance sheet normalization, which has been the promise, and that was Powell’s initiative straight out of the gates, and we shrunk our balance sheet by a mere 10%. And now, if you’re listening to the dovish language from the Fed, that has been suspended already. So again, we are weeks into tightening at the ECB, we are weeks into the balance sheet normalization at the Fed, and what have we got here? Already an about face because we have considerable weakness. Yes, as soon as they start recanting, as soon as they bring out the dovish language you have a massive rally in the Dow and the S&P and the NASDAQ, and I think we need to look at that backdrop again, slowing economic activity, increasing debt burdens, rising interest rates. As I said before, this is a very nasty cocktail.

Kevin:What a difference a quarter makes. Let’s just go back before the last quarter of 2018. The stock market was hitting all-time highs, the economy was supposedly flying. We had virtually no volatility in the market. We had the Federal Reserve saying that they were going to have four interest rate increases in 2019, and that they were going to reduce the four trillion dollars that they have on their balance sheet. What a difference a quarter makes.

David:That’s right, because in just that one quarter, with a little bit of stock market volatility, we have a complete about face and the central bank presidents are reversing course. The markets are, once again, conditioned to believe that central banks will support their leverage, will support their speculation, when push comes to shove. And now the markets expect – in fact, if you’re looking at the odds of an increase or decrease in interest rates, I think it is somewhere between 28% odds that we have a decrease in interest rates here in the United States by year-end, and a zero percent chance of an increase, whereas two increases in 2019, again, that was the language that was used as recently as early in the 4thquarter – two increases with a baseline assumption, that’s gone.

But again, the swoon in the stock market in Q4? Do you remember? Powell was concerned about bubble dynamics in the stock market as we headed into October. Then we get volatility and here we are only 8½ percent below all-time market highs, and he is pandering to the market.

Kevin:And remember, Trump was concerned with bubble dynamics, too, until he got elected. And then he loved the bubble.

David:He owns the bubble.

Kevin:You gotta love the bubble.

David:This is his bubble. He doesn’t want to see it burst.

Well, the Wall Street Journaleditorial board, I think, was spot on. This was last October. This is what they had to say about before you are running your victory laps in the central bank community, consider this. I am going to quote from the Wall Street Journal, I think it was October 10th:“Ten years after the financial panic, the architects of the rescue policies are taking a victory lap. The final payments on any Fed monetary cycle aren’t merely the results when interest rates are low and policy is easy. The verdict is clear only at the end of the cycle when the Fed has to unwind its accommodation and interest rates rise. Only then can the world see clearly whether the Fed over-did the stimulus with nasty consequences on the other end.

So that’s where we are. You begin to see in quarter 4, the 4thquarter of 2018, that no, actually, this isn’t really a success story. If they have to normalize it, they pull back. As they take away the proverbial punchbowl, guess what happens? Everyone is unhappy.

Kevin:It makes me wonder if the loneliest guy in the room is the guy with the QT tee-shirt. Nobody loves him, nobody even let him go. We had QE, which was quantitative easing, and that guy gets all the credit, and that guy actually gets all the action, because they introduced QT he turned out to be a shy, lonely man, and now QT is being dismissed.

David:Right. So the experiment with QT, very short-lived exercise, the Fed observes normalization is, in fact, an impossibility. It is an impossibility in a world where asset price inflation and where economic stability have been propped up with unconventional monetary policy measures. So that is the issue. Getting back to normal would be like the addict getting back to a natural state without the externally induced euphoria from a drug. What is life like when you have to go back to boring, without the drug?

Kevin:And how often have you asked the question, “If the market goes up with QE, does it go down with QT?”

David:That was our mantra all year long last year as we headed toward the 4thquarter and said, “Look, if it benefits on the upside, there is going to be a cost on the downside. Withdrawals are difficult, sometimes even deadly, whether you are a drug addict or if you are dealing with QT and QE.

Kevin:So what you are saying is, no, in this leveraged economy you have to have QE to continue to rise.

David:The bottom line is, the over-leveraged world we live in cannot handle tighter financial conditions without a considerable adjustment to asset prices, and that is where it becomes politically controversial. Who wants their home price to go down? Who wants their 401k to diminish? Who wants their pension to be even more underfunded than it already is? So our conversation last week, I think, is particularly important because we begin to see what happens, political pressure builds by constituency groups when those constituency groups are under pressure, or are in a loss position, and they start crying for blood.

Kevin:You have the haves, and you have the have-nots, and you want to make sure that you are voting on the haves’ side, or the designated winner.

David:You lower values in fixed income, you lower values in stocks, you lower values in real estate, and that raises the political stakes. And I think that is where we are at. The bottom line is that they can’t normalize in an overleveraged world. So we go back to last week’s conversation. We ask the question, “Who is? Who is the designated winner? Who is the designated loser?”

If credit flows are two politically selected winners, then again, this is in my view a problem with the nature of democracy. It is the best form amongst the worst forms. I think that has been said better than I just said it, but maybe it was de Tocqueville. “It is the worst form of government except for all the rest,” is, I think, exactly what he said.

So the nature of democracy is to direct capital and credit to those constituency groups that put you, or keep you, in power. And the losers are typically the ones who end up being in the minority of votes. But I think this is very interesting. The last two weeks we have brought out a new sort of redistributive competition.

Kevin:It feels like socialism is knocking at the door.

David:Well, the Democrats don’t have any other hook to hang their hats on. For years they appealed to populists, and yet Trump stole the populist vote. So the only direction they could go is hard left. So you have Warren, you have Krugman, his voice piece for the New York Times. You have Ocasio-Cortez, you have Sanders. You have this march back to the already tried, the already failed 90% tax rate, and that is what is on the minds, that is what is in the hearts, that is what is now in a variety of legislative proposals, somewhere between the current number and 90 at the far edge. You have Omar from Minneapolis, who hit the 90% number. Why? Let’s fund the Green New Deal. We talked about the Green New Deal kind of tongue in cheek a few weeks ago. Is that a different version of what we knew as the red new deal? That’s on the income side. You have Warren who is proposing a 2% annual wealth tax. Sanders likes the estate tax at 77%. So again, if you can line up 51% of the public to say it’s a good idea for us to take from him, to give to him, or her, again, redistribute from the haves to the have-nots.

Kevin:You’re talking about a 2% annual wealth tax. Does Warren know that the Federal Reserve beat her to the punch?

David:I think that’s hilarious. I think it’s hilarious that legislators are capturing the headlines with these proposals of massive increases in taxation, when the monetary policy crew, the folks at the Fed, have already decreed a 2% tax. That’s what we know as the targeted inflation rate. We are not represented, of course. You remember the whole cry of no taxation with representation?

Kevin:I don’t remember voting for it, yes.

David:No, no, no. These are not elected officials. Nonetheless we have the 2% wealth tax already via the inflation target. That’s already a reality. Granted, it doesn’t apply to all wealth, it’s just to your bank deposits, it’s just to your liquid assets. But you might argue, if you’re one of those that questions the veracity of the inflation number – we’re talking about the 2% number (laughs).

Kevin:Right. I’m sure that’sreal

David:Then actually, the inflation tax is quite a bit higher than that. It could be 2%, it could be 3% or 4%. My dad and I were talking about this last week. He said, “Dave, what do you think the real-world inflation number is?” I said, “It’s probably closer to 5%.” He said, “Oh, I think it’s probably 8%.” Again, this is debatable depending on how you calculate the number and what you leave out of the number or include in the number. You can get to any number.

The reality is this. The inflation number has never mattered. It never will matter. It is when you tip over from the consumer’s experience of the world, of buying stuff, and they begin to anticipate higher levels. Anticipation of inflation is what redefines asset classes. Anticipation of inflation is what redefines the way people invest their dollars. And I think it is only fair to point out that inflation, and this tax, hurts those on the lowest economic rung the very worst.

So I am surprised that you don’t have Warren, Krugman, Ocasio-Cortez, Sanders, the whole lot – why aren’t they up in arms? If they want to defend the poor, why aren’t they talking about the fact that inflation is not a progressive tax, it is a regressive tax. It hurts those at the bottom end of the spectrum worst. It reinforces the trends of wealth disparity by further impoverishing the poor. And it only hits the wealthy at minimum.

Kevin:And you talked about it being a tax, and taxation without representation. It makes me wonder if the Federal Reserve actually has a tea that we could throw into the water, because that was what happened in Boston.

David:We’re not being represented, right. And I think one of the features of Calomiris’s book that I appreciated most was how since the 16thcentury inflation is not an accident. Inflation shows up over and over again as a choice, and it is a choice by those in power to participate in the redistribution of assets.

Kevin:It is a friend of the governments, and it is an enemy of the people.

David:It is not an accident. It has been, and always will be, a way of taxing the savings and deposit base of a society. And what we see growing as a far left consensus is that whatever the tax number is, the all-in number, inclusive of the inflation target, inclusive of the explicit wealth tax which Warren is talking about, along with your traditional income taxes, capital gains, inheritance taxes, it’s never enough. It won’t be enough until the playing field is leveled. And I need to remind you that this is not exactly compatible with free markets. This is not exactly compatible with capitalism.

And this hard swing to the redistributive left, may, in fact, be why Howard Schultz – you know, the Starbucks CEO – chose to run for president. He is going to run against Trump. And he is not doing it as a Democrat even though he has a lifelong affiliation with the Democratic party, he announced his candidacy as an independent. And I think it’s because you have this radicalization of the party. It’s been a theme, certainly, in high relief for the last few months, but they don’t really have an alternative. If they don’t swing hard left, they don’t have a clear differentiator between what Trump is doing, which in some sense is a socially progressive, in some sense is taking care of labor, in some sense is taking care of the populist voice. He is tough to nail down.

And by the way, the GOP hates him because he doesn’t align enough with the standard party GOP line. So the GOP insiders hate Trump, but he has captured the platform. He has also captured the populist platform from the Democrats. So you have this greater radicalization of the Democrats and the GOP.

Kevin:It is interesting, people loved populism when it got Trump in – there were people who loved populism – but populism can go many directions, can it not?

David:It has many faces. So again, consistent with Calomiris’s and Haber’s historical analysis, we got the swing toward populism. And there is a greater demand for redistribution. This is normal in the context of financial market turbulence, and with expectations of hard times ahead, and of those in the middle who have been lost. So why is the populist voice so loud at present globally? Well, the rich have gotten richer. There is no doubt that asset price inflation has benefitted the balance sheets of the, not 1%, but the thousandth of 1%. Again, we have this new competitive political sport – who can take the most from that fraction of 1% and hand it out in the largest numbers possible?

Kevin:It reminds me of the Peter/Paul quote that you had. “If you’re robbing from Peter to pay Paul, Paul is going to like you a little bit more.”

David:That’s right, you have a great supporter in Paul if you’re taking from Peter to redistribute to Paul. The wealthy didn’t get the signal in 2008. If they didn’t – if they did not get the signal in 2008, if they were in Europe and they didn’t get the signal in 2011 I think they should be acting now because Madame Guillotine is being dusted off, you have the sharp edge of redistribution. It is being honed as we speak. My opinion – take it for what it’s worth – wealth needs to be a lot less obvious in the years ahead. I think being not in the fraction of 1%, but even in the 1%, which means you’re making maybe $100,000 a year. Being in the 1% means that the 99% have you out-voted. They have a far louder representative voice. And as long as votes count, 51% is sufficient to become tyranny and to guarantee redistribution.

Kevin:Like we started the show, there is a gold rush going on with the central banks, not with the people yet, but with the central banks. And so you said, wealth needs to be a lot less obvious in the years ahead.

David:And frankly, I think if you can take it off balance sheet, gold is not a bad way to do that. Back to inflation for a moment, I read an interesting book on Sunday, discussing the FIRE movement. FIRE is an acronym that stands for Financial Independence Retiring Early. It is a growing movement among millennials who are dealing with this angst and malaise of lower job opportunities, high student debt, and just kind of looking at the world and saying, “Do I really want to work until I’m 65 to then enjoy the good life, or is there some way to sort of hack this and get a better outcome faster?”

Those that have chosen to scale down lifestyle expenses and scale up their savings, and their target is generally between 50% and 70% of income for savings, so that within a decade they can achieve financial independence, and even consider that early retirement. Again, early retirement not by a few years, but in your 30s, or your 40s.

Kevin:That reminds me of a conversation you told me years ago that you had with John Templeton.

David:Yes, the 50% idea was a compelling one. I adopted it after meeting, and listening to, John Templeton back in 2004. I kept on thinking that this idea of saving 50% — that was his argument. He said, “Look, if the Chinese save 50%, you should save 51%.” Obviously, it’s an arbitrary number, but the point is, wealth is accumulated only if saved. It is not on the basis of speculation. You could go out and play the lottery every day for the rest of your life and prove the poorhouse right, but that’s not the recipe for success. Saving and living beneath your means is.

But I was reading through this book and there are some basic assumptions that I think the whole group and the whole movement are missing. I kept on thinking that the weaknesses that need to be wrestled with within this “FIRE” community tie to assumptions about asset price stability and growth. So again, index investing is very popular because it is cheap. And cheap ends up defining everything. Well, I can tell you, there is a way to be penny wise and pound foolish, and that would be by buying and holding index funds and just forgetting about them.

The other thing I think is really important and many investors lose sight of this, including this group of well-intentioned, and I think well-organized people within the FIRE community, is this issue of the quiet, the often-neglected nasty – inflation. Pennywise in the way of life – that is not inherently problematic. But inadequately protecting against inflation, I think, is where the community may experience the pound foolish part of the adage. Buying gold is never cheap. It never has been. You have to store it. You have to transport it. This was why the central banks wanted to move against it.

1922, the Conference of Genoa, central banks gathered from around the world and they said, “It’s just too much hassle. Do you know the security involved to move a real asset like that? Why don’t we just exchange paper receipts instead of actually moving physical gold?” That was the first decline, if you will, in the gold standard, when we moved to the “gold exchange” standard. The point being, there is high cost to the metal and it is one of the reasons why I think the community neglects it.

At the same time, they don’t think about inflation. Their love affair with index investing has to be addressed, but this regressive inflation tax also has to be addressed, and we’re talking about a generation which has seen inflation diminish to almost nothing.

Kevin:This is a generation that doesn’t remember the 1970s because they weren’t born. They haven’t had inflation in their lifetime. The other thing, too, is they really were in college when we had our last global financial crisis – or maybe in high school. So try to hand this type of person a book, and it’s almost like it’s a bother. Or pay them back in cash, it’s almost like it’s a bother. And so we do live in an age where they don’t want to deal with having to make investment decisions, they just want stability. I understand that. Wouldn’t it be nice if you could just put money into an index fund or a passive investment and know that you can count on the growth that we have had over the last ten years?

David:If anybody wants financial stability in the years and decades ahead, they have to pay attention to what inflation does, because inflation – not only the stated rate, but the real-world rate – is something that, even if you have a positive rate of return of 3%, or 5%, or 7%, or 10%, that inflation factor may take you, in real terms, negative. So it’s the silent thief, that you may feel like doing a victory lap because look what I got, my 10%. Well, how much of that did you actually get to keep? And remember the real equation which subtracts out inflation and taxes, and it’s really what you get to keep at the end of the day after those two factors.

Kevin:It’s like having a water bucket with a hole in it. You get down to the river, you have a lot of water, by the time you get back to the house it’s gone.

David:It’s not a big hole if you’re talking about the euro inflation. The euro area inflation rate sits at an average right now, if you’re averaging all the countries, of 1.4%. Now look, if interest rates over there are still in negative territory, then you’re obviously talking about still deeply negative interest rates, in real terms. The U.S., if you’re talking about our interest rate and inflation rate, the U.S. sits, after tax and inflation, right near zero. So, as in the 1970s, when fiscal largesse and debt accumulated too quickly, inflation became the most politically viable solution, and that is becoming the most likely scenario, not only here in the U.S., but globally.

Kevin:Okay, but I can tell you, in the decades that I have been alive, I have watched our government not really have to pay back their debt, and at this point we are increasing our debt at about the most rapid pace, I think, that we’ve ever increased it.

David:This is a confidence game, and we will continue to throttle this as long as we can. We will continue to kick the can as long as we can. And that game of kicking the can down the road is still alive. We are enabled to do that via the credit markets. And it’s working around the world. The issue – and this is an issue that our guest last week highlighted, is that debt levels are reaching critical thresholds that can challenge the system’s ability to efficiently chug along. You can’t expect economic growth when you have too much debt, and to service that debt is costing the system so much.

Last year we added 1.36 trillion dollars in debt here in the United States. That’s one year’s deficit. That brings us to a total of 21.97 trillion dollars. Now, if you go back to the pre-crisis number we had 9 trillion in total debt. Use your 9 trillion number as a base year, just so you can compare, the aggressive growth in debt that we are seeing on a year-by-year basis. If you compare 1 trillion to 22 trillion, it doesn’t seem like much, but when you compare 1.36 to 9 trillion, which is the number that we had prior to the crisis, we’re increasing the national debt at a 15% annual rate.

Kevin:Okay, let’s put that in a household sense. Let’s say, Dave, over the last four to five years you have been running your household and going 15% a year further into debt. Doesn’t that imply that we’re broke?

David:That’s exactly what it implies. It implies that the U.S. Treasury is empty. It implies the government is broke. You can say, “Wait, wait, wait. No, that’s not true. We have, not only the cash flow from taxes, but we can always increase taxes, so how can you be broke when you have the far left who are going to increase taxes and take care of this fiscal mess?”

Well, I’m just telling you, the Treasury is empty, and if you’re talking about what we need to finance operations and meet outstanding obligations, what was required last year was an increase of national debt well above 1 trillion dollars just for 2018. And I don’t think the prospects for 2019 are much better. So does that compute? We had an operational deficiency of 1.37 trillion dollars.

Kevin:You just had a meeting with your dad, and I’m glad you guys get together. That’s awesome. It has been six months, I think, since you saw him last. As you discussed the business, if we were going into the red at that rate, would you guys keep the office open? Is there any reason to have a business open if you’re going into the red 15% more per year?

David:I think one of the things that you ask as a business is, “How much liquidity do we have to suffer through a period where business may be slow.” So that’s a question of reserves.

Kevin:You want to have some reserves.

David:You want to have reserves. We’re not talking about treasury reserves, we’re talking about the Treasury being empty. We’re talking about, instead of liquidity, we’re talking about credit lines. So really, a company or a country under duress has to ask the question, “How much credit do we have?” We take for granted that we have unlimited credit because we have the world’s reserve currency, and because we have had a number of arrangements, whether it was the petro dollar arrangement, or the mercantilist recycling of dollars and Chinese goods which we have had over the last 20, 30 years. In both cases we have had an audience to purchase – the Japanese, the Chinese, our friends in the Middle East. We have never had to ask the question in the post Bretton woods era, “From whence will the credit flow?”

Kevin:Okay, but you said post Bretton Woods era, and Bretton Woods, really, for all intents, ended August 15, 1971 when Nixon closed the gold window. Let’s just go back 50 years. If we were sitting here in 1969 and knew what we knew was going to happen in 1971, we would be buying gold, Dave.

David:This is Jacques Rueff – de Gaulle will not listen to him, literally, de Gaulle will not meet with him. So he goes to Le Monde and he starts writing opinion letters on what the French authorities should be doing. And after writing two or three and getting published in the big Paris paper, because now all of a sudden people are paying attention to Jacques Rueff’s opinion, now all of a sudden the politicians pay attention. And what do they do in the late 1960s, they start taking the gold.

Just like the French, if we go back to that time when the world, and particularly the French, called our bluff, as we removed the Bretton Woods gold-backed international monetary regime, the world shifted toward their own gold standard, as best they could. And frankly, I can’t think of any more reasonable thing to do. I think you would be wise to do the same.

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