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He Who Controls The Credit Makes The Rules
January 18, 2022

“The checks that are going to have to be written to smooth over a number of these issues are very large checks. So does that spell higher rates of inflation as we head into 2022? We redefined the weightings that go into CPI. Statistically, inflation is going away. But my reality, your reality, the reality of every other American who’s paying bills will be quite different. The statistics don’t matter. The reality faces them every day, at the grocery store, at the gas pump. And that’s what we have to come to terms with.” — David McAlvany

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

David, there are so many times when I wish the mic was on before we’re actually recording. And this just happened. We were just now talking and it’s like, “Wow, this should be part of the show.” I love our conversations. I just have to say how natural it is. I was even telling my son this because he’s known you all his life. And I said, “You ought to ask Dave. He always brings something new to the table.” 

We were just now talking about pragmatism versus idealism, the gold standard versus being able to print money. Let’s just go with this. Let’s just go with this. Because honestly, I think a lot of times, we think that this is all well defined, like politics and banking. Okay. Today, you and I were talking just a little bit about, it’s not necessarily who you elect that makes the rules, it’s who controls the flow of money. And I’d like to talk about that a little bit today. And some of the behind-the-scenes politics that occur. It ain’t Biden making the decisions right now. Let’s just face it.

David: No. We had January 6th come and go, and certainly another opportunity to reflect on the drama and the political rancor of our age. I was in the airport yesterday, stuck between Fox in one ear and CNN on the other, literally two big screens, 20 feet apart. And so I—

Kevin: You were in the Dallas airport.

David: Yeah, I was in the Dallas airport in the Centurion lounge. And so I’ve got these two— I kid you not. There was almost a revolution occurring in my mind as I’m getting bombarded by unqualified statements from the right, unqualified statements from the left and—

Kevin: The facts don’t matter.

David: The facts don’t matter.

Kevin: Right.

David: What matters is more heat than light. We’re not after insight, we’re after conflict, because it raises viewership.

Kevin: Wow.

David: It’s amazing to me that mainstream media is today loving the political rancor, and I think there will be more of it as we head towards November.

Kevin: Well, okay. So let’s broach a subject right now that’ll immediately get us canceled, okay, in cancel culture.

David: Go for it.

Kevin: January 6th, I was told that it was going to be like an earth shattering day by the mainstream media. They really wanted me to be upset about the annual anniversary of January 6th. Where’d that go? Gosh, I forgot what date it was until that night.

David: Yeah, I mean, I think any serious student in history would look and say, “We could consider the main inputs for an insurrection or a coup.” I guess what was there, almost nothing. What we did have is the media outlets covering and expecting a great to-do. But there was one piece from the Wall Street Journal, the editorial board, which I thought was very fascinating. They covered the January 2nd— on January 2nd, a series of maneuvers which were coordinated by Elizabeth Warren. And this really is more the marks of a coordinated overthrow. And this is, again, you look at the last few weeks of December. You get the coordinated efforts of Warren’s protégé, Rohit Chopra, who runs the Consumer Financial Protection Bureau. And he succeeded in ousting the chair of the FDIC, Jelena McWilliams. She’s gone. She personally cataloged the saga in the Wall Street Journal earlier on in December, describing the political efforts to strip her of authority before her term ended in June of 2023. 

So just a really fascinating set of machinations inside the financial bowels, if you will. Chopra only recently confirmed by the Senate, who went for the jugular with McWilliams. It’s typically the chair, and that’s McWilliams, who sets the agenda for the board. That’s plain and simple. It’s always been that way. Chopra is on the four-member board, but he’s not the chair, she is. And the efforts were to strip McWilliams of that power. And here we have McWilliams choosing to resign, December 31st, effective sometime in February.

Kevin: And you’re saying this was orchestrated or in the Wall Street Journal. This was orchestrated from the start.

David: Again, I would encourage you to read the article, “The Warren-Biden Bank Heist,” because it reminded me of the book that we read a couple years ago, Fragile by Design. And you may say, “Why is this of consequence to the markets or of concern to me as an investor?” Yeah, because this is really nothing more than internecine, technocratic squabbling. And does that really have any direct interest for the average Joe investor?

Kevin: Well, it’s the guy who can give the loans. That’s the guy who makes the rules. So, yeah, I guess it does if that’s what’s been heisted.

David: Yeah. And I suppose there’s certain areas of technocracy that are of little interest, and that would be ordinarily true. The squabbles just don’t matter. It’s politics as usual amongst bureaucrats. But this is credit. This is credit. And this is where credit flows are influenced. So to quote the Wall Street Journal, speaking of Senator Warren, “She may have lost the 2020 Democratic primaries to Mr. Biden, but she has colonized the government’s financial regulatory offices.”

Kevin: So they control the flow.

David: Exactly.

Kevin: Yeah.

David: To quote further, “What do the Warren cadres hope to accomplish? One clear goal is greater influence over the allocation of credit. Using regulation to squeeze financing for fossil fuels will be a priority. Bank mergers are a political target. Regulatory approval can be exploited as a tolling station to coerce money for local communities to used Mr. Chopra’s euphemism for progressive political groups.”

Kevin: Huh? So your dad used to have a phrase when he would talk up front. He’d say, “You want to know what the golden rule is?” He says, “He who owns the gold makes the rules,” but the truth of the matter, in a fiat economy, he who owns the credit or controls the credit makes the rules. That’s the new— At least from the top, that’s the new gold as far as politics goes, isn’t it?

David: It was an interesting insight. It was an interesting insight with Warren. Lost the 2020 Democratic primaries, but is colonizing the government’s financial regulatory offices.

Kevin: Wow.

David: She has her former staffer as the Deputy Director of the White House National Economic Council. She has another aid that’s now Deputy Treasury Secretary, yet another runs the Federal Trade Commission. And one more still that’s Assistant Treasury Secretary for Financial Institutions. 

In January of 2019, we spoke with Charles Calomiris. He’s the co-author of Fragile by Design: The Political Origins of Banking Crisis and Scarce Credit. And it was a critical look at how politics leverages banking and credit distribution for the downstream benefits it confers to the constituency groups and, in turn, of course, those who are in power. So in doing so, it often creates crises. And that’s why the title of the book Fragile by Design. It’s no accident when you have a Wall Street crash or a global financial crisis tied to some sort of a banking conundrum or banking debacle. It actually was understood to be problematic, and there was a trade-off. The trade-off was intriguing to the politician. So as the motive to move credit was along political and financial and economic lines, so we have this opportunism, one part carrot, one part stick. If you control who has access to credit, you can have help some, you can punish others. And it ends up being not just about banking but ultimately about political agendas.

Kevin: And control of the narrative. I read a quote by Voltaire, and I thought it was really accurate. He says, “You want to know who’s in control? Figure out who you can’t criticize.” And that’s really the truth. You want to know who’s in control, figure out who you can’t criticize.

David: And isn’t that the case today? If you say one negative word about Xi Jinping, good luck.

Kevin: Right.

David: You may find yourself at a re-education camp with other Uighurs. I mean, it’s fascinating to me that there is no opportunity for free speech without grave consequence.

Kevin: Well, like the American Heart Association, definitely don’t tell people that the vaccine might increase heart disease because you’ll get de-twittered, if that’s a word.

David: Or maybe lose your medical license. So “The Warren-Biden Bank Heist,” again, that’s the article from the Wall Street Journal, going back to January 2nd. And it’s lingered on my mind over the last several weeks, bringing up many of the critical issues we discussed with Calomiris. And I’ve mentioned previously that bibliographies are to me a little bit like the briar patch, feel free to just toss me in.

Kevin: Your library is a bibliography. It’s bibliography after bibliography. It’s like having children.

David: And so in the front— In that sense, I think I have enough. But when it comes to books—

Kevin: —when you go home, that’s for sure bibliographies.

David: —will be.

Kevin: Yeah.

David: So Alex Pollock was a gentleman—

Kevin: It was a good guess, too.

David: —we brought on to the commentary. And out of his bibliography came Fragile by Design. So in the front of each of my books, I have a reference as to where I found the book. So in Fragile by Design, you’ve got Alex Pollock. In Alex Pollock’s book, I’m sure there’s a reference as to where I found his book, too.

Kevin: What a great idea. That’s the thread that sort of shows you how you got there.

David: Yeah. And I think the Pollock conversation was excellent, not to be missed. But Fragile by Design, that was on my reading list. “Bank strengths and shortcomings are the predictable consequences of political bargains.” This is what Calomiris says, “Bank strengths and shortcomings are the predictable consequences of political bargains. And those bargains are constructed by society’s fundamental political institutions.” It goes on to say that, “Modern banking is best thought of as a partnership between the government and a group of bankers—a partnership that is shaped by the institutions that governed the distribution of power in the political system.”

Kevin: You remember when governments used to have to go to banks to borrow? That was the whole thing with Rothschild, right? Rothschild through the last few hundred years over in Europe. Yeah. He actually started as a coin collector, which is interesting, a numismatist, and he had gold. And so you had governments that had to come, if they’re going to fight a war, whatever, they’d go to the bank. But there was a separation. The banker was controlling, in a way, the government. What we’re saying now, it looks to me like there’s a power play, Dave. It sounds to me like the government is finding a way of controlling the banker.

David: Yeah. It’s fascinating just to think of the development of government and sort of bureaucracies as we know them today. Sovereign defaults were much more common back in the 16th, 17th, 18th century because you didn’t have a refined form of taxation. And so sovereign defaults would occur when a monarch would go to a bank, as you said, and borrow money. And then when they couldn’t pay it back, they would default. 

There was a change in the structure of finance as we moved away from monarchy and towards democracy. And the more democratized things became, actually, there was also the opportunity for an increase in taxation. We have less sovereign defaults as time goes on as we sort of develop politically, but other things that come into play. Certainly, there were issues in terms of monetary stability, and we’ll get to that in a minute. I don’t read all books cover to cover, but this one, 500 pages, Fragile by Design. I can’t put this down, really.

Kevin: I’m looking at it on the table in front of your mic. Okay. This thing is worn out.

David: Yeah. And I think the “choosing winners and losers” has been a theme on this program before.

Kevin: Remember Carmen Reinhart.

David: Certainly, that came from a candid conversation with Dr. Reinhart. But Fragile by Design illustrates how the choosing of winners and losers is a political process. And banks are merely the conduits of getting credit to the right people. And there’s some agreement that takes place. There’s some financial benefits which accrue to the bank, which is why they’re involved. 

What this particular study showed was how choosing winners and losers has a structural stability cost attached to it. And those costs are largely disregarded as a higher purpose is served. And that, again, is a political purpose, the maintenance of power. So champions of political sponsorship in the credit markets, implicitly, they do undermine democracy. They do undermine meritocracy, and they add sort of a component of plutocratic redistributional idealism.

Kevin: Okay. So let’s get nostalgic here for a second. All right. Okay. So the Commentary started in the spring of 2008. That was a really critical time in America because if we go back to 2007, we had started to see cracks in the system that were— Actually, they came from years and years of giving people loans who the government knew could never pay those loans back. Okay? They could not pay it back. 

We called it the subprime crisis. But nobody really knew how bad it was going to be in 2007. And Bear Stearns came out, and they offered $400 million worth of bad debt. What did they call it? I can’t remember what they called it. What it was was something they actually wished they never had shown through the curtain. 

So when no one came in and bought it, then they pulled it back off. But you and I talked about that in 2007. And I remember talking to a couple of clients, saying, “Hey, something’s up, all these bad loans that have been given out. The chickens are coming home to roost.” 

Well, we, in 2008, started the Commentary, and were able to walk through the global financial crisis. But wasn’t it caused by some of the same things we’re talking about right now, where money was directed to people to buy houses. It sounded like a noble enterprise, but these were people who had absolutely no income or possibility of being able to pay those mortgages over time.

David: Well, it’s fascinating that you have a parallel with China, as well, migration from the countryside to the city and the building of cities. And certainly in 2008 and 2009, it looked like they would be ghost cities. Some of them still are, some of have been filled. And in cases where the construction is now old enough and the quality was, at the time of the build, so poor, you’re now seeing some of those buildings torn down, and I’m sure they’ll be replaced just to keep the economic engine turning. But we had our subprime lending crisis, and they have their equivalent of a credit vortex right now.

Kevin: Yeah.

David: It’s happening. Yeah.

Kevin: As we speak.

David: But the exploration of the subprime lending crisis is a fascinating one, not as an expression of Wall Street greed. When we think back to that, we think of Countrywide, and we think of ninja loans, and we think of all the things that were happening that seemed so irresponsible, reckless, and driven by private corporations, the sub-story, the subtext is actually that there’s more to it than Wall Street greed because that’s rarely in question. You can count on that. But it really was a consequence of bank consolidation, bank consolidation which was supported by urban activists who would support mergers if and only if they met a good citizen criteria.

Kevin: It was a sort of colonization, like what you were talking about in the Wall Street Journal article currently.

David: Yep. So banks could only merge if they were willing to guarantee credit flows to various constituency groups. So mergers had the quid pro quo of promised lending to underserved communities. So, yeah. Again, before you start saying, “Oh well, I mean, that’s a good idea. We should do that. Everyone should own a house.” Before you jump on that sort of fairness-for-all and social-justice wagon, because it does sound nice, remember that bankers have to appraise risk, and they have to determine the degree to which depositor’s money is going to be returned with interest. It’s not their money they’re lending out. They’re lending out depositors’ money, so they have to weigh risk. And yet they’re being told that to grow it as an organization, they will be hobbled unless they start lending to unqualified borrowers. So the risk calculation gets a downgrade when the political bargain is on the table. You see what I’m talking about?

Kevin: Yeah.

David: And thus, our banking system becomes more fragile. And yes, it is by design.

Kevin: So they look right across the table and they say, “Lower your standards, lower your standards. We have a voter base here, lower your standards.”

David: Right. So we circle back around to Ms. Warren, and we circle back around to the colonization of your financial overseers. And this is, I think, what we’re getting ready for in the 2022, ’23, ’24 timeframes is the very politically directed credit, which will help some people and hurt others.

Kevin: The new golden rule. Yeah. He who controls the flow makes the rules.

David: Yeah. One of the crucial steps—going back in time to the subprime crisis—one of the crucial steps was the lowering of underwriting standards on mortgages that could be included in Fannie Mae and Freddie Mac portfolios. And that allowed for banks to jumpstart the lending and origination process. But, ultimately, they didn’t have to hold the paper on their balance sheets. They didn’t take the long-term credit risk in the portfolio of loans. They just passed them on to the government sponsored entities.

Kevin: Right. They would just sell them right away, and then they were repackaged, right? So you really couldn’t even see what was inside of it.

David: And that’s where Wall Street got creative in terms of the distribution to a broader and global audience. So it was our political bargaining within the banking industry which created the throughput for loans that ultimately went into packages which were sold all over the world and gave us not just a US banking crisis but the global financial crisis. So the fundamental bargains which underpinned the flows of credit and led to the GSE crisis, that is the government sponsored entity crisis—Fannie Mae/Friday Mac crisis—of 2007 to 2009, they were in motion actually as early as 1992.

Kevin: Wow. That was when Clinton was elected.

David: Yeah. So you’ve got the GSE Act, and really it continued to build a head of steam from ’92 to 2007. To quote again from Calomiris, “Once again, the devil’s in the details, but one cannot escape the conclusion that the decisions made by regulatory agencies were driven by the logic of politics.” And look at how HUD lending mandates expanded after the ’92 election. That’s a big part of the story because they had these categories that had to be filled. Special affordable. Special affordable meant very, very low income homes. That segment of loans within the GSEs was increased from 1% of all loans to 12%. And the “underserved communities” was raised to a target of 21%. So by the time Clinton left office, those two categories, special affordable and underserved communities, comprised over 50% of all Fannie and Freddie loans.

Kevin: Well, and those loans were considered AAA, AA, whatever. I mean, they were considered the best of loans as far as the secondary investor.

David: What you are talking about really is the implicit government guarantee, which covered them over like a white cloth over a dirty face.

Kevin: They knew they had their back.

David: Yeah.

Kevin: It’s like a lot of this stuff. The government’s got our back, don’t worry.

David: Yeah. So by 2001, two out of three loans in the Fanny and Freddie portfolio that were coming in were in these categories.

Kevin: Okay. So special affordable—

David: Special affordable and—

Kevin: —and underserved communities.

David: —underserved communities.

Kevin: Two out of three?

David: Yeah. So the FHA was equally complicit in building in subsidies, creating weaknesses within the system. When it capitulated to Clinton in his administration’s pressure to lower down payments, they specifically pressured FHA to lower down payments to 3%.

Kevin: Wow.

David: Again, so you go back to ’92. You go back to the GSE Act, which allowed for reconfiguration of the balance sheet for these GSEs, where they could have two and a half cents of capital for every dollar, or $2.50 of capital for every a hundred dollars in lending. That’s 40x leverage.

Kevin: Wow.

David: That’s 40 times leverage, which was being built into the system. You could say, “Yeah. Yeah, it was fragile by design.” 40x leverage with an implicit government guarantee. What’s not to love about the expansion of credit? And of course, we know that credit and money are almost indistinguishable today. So what’s not to love about the expansion of money in the system on a 40x basis?

Kevin: And what you’re saying is this is happening again. This Wall Street Journal article from January 2nd is saying, at this point, you’ve got political distribution, let’s call it, okay, of the banking system to the political interests that are at hand.

David: It’s a combination of things. It’s the fiscal flows, which are already highly political, and it’s the monetary—

Kevin: And then the credit flows.

David: —flows.

Kevin: Yeah.

David: And then the credit flows, which will continue to be political. So we return to the coup of ’22. The real coup of 2022 as deterioration of political momentum continues back in DC. It’s evidenced by the stalling of legislative efforts, a free fall of support for the Biden administration in the polls and now coming in into around 33% approval, some of the lowest ratings you’ve seen in presidential history at this stage in the game, and you’ve got a skilled political operative wasting no time—

Kevin: Sure.

David: —wasting no opportunity in fortifying the means of credit creation and distribution. We mentioned a few already. And then there are the new Fed nominees. You got Sarah Raskin. You’ve got Lisa Cook. You’ve got Philip Jefferson. And these are the Fed nominees to join the board. If brought onto the Fed committee, it would make the committee certainly the most diverse ever across gender and racial lines. Raskin spent time at the Fed already—the Treasury. Cook comes from the economics department at Michigan State University, Jefferson’s at Davidson College. And these are all reputable and respected economists, but yes, they’re also of a more progressive bent. So I think you can see where I’m going. I think.

Kevin: I’m just thinking about it. I’ve got this vision of all these scenes that we saw from January 6th of last year. This was a quieter January 6, but this is far more powerful, isn’t it? I mean, this is the storming of the capital and everything else, just simply by replacing certain people who won’t play ball.

David: You’re appointing the people who will determine who gets anything and who gets nothing. So again, who’s at the Treasury, who’s at the Fed, who’s at the FDIC, who’s in the presidential economic council? When you start stacking the deck in your favor in such a way, what you’re basically lining up to do is then say, what is our agenda? Is it climate change? Is it inclusion? Is it a variety of other hobbyhorses that are at the receiving end of credit in 2022? And we’re not talking about, “Oh, I need a loan for $10,000.” This will be trillions of dollars delivered, trillions of dollars delivered.

Kevin: Okay. So let me ask a question that’s on the minds of a lot of students.

David: And not just 2022, but stretch it out through the end of the Biden first term.

Kevin: Could one of the hobbyhorses be to get the vote of the student that’s deeply in debt.

David: Of course. And in that respect, you are talking about vote gathering from among students in exchange for the extinguishing of student debt. Again, it’s an application of credit. It’s a fiscal decision. Someone will pay that cost and someone will receive the benefit. Is it to small business owners that take up the torch of a green agenda? Could you have some sort of a subsidy for your business if you’re willing to have an electric charger out in front of your business to charge cars? I mean, there’s a variety of ways, again, with carrot and stick, where the new credit scheme may be for those who are explicitly anti-fossil fuel or are pro-immigrant. I mean, you name it. This is carrot and stick used to shape the political landscape. But frankly, it’s no different than what we’ve already seen in the last series of decades.

Kevin: And when we started talking, we started talking about the change over the last few hundred years, where monarchs would go and get money from banks. You were talking about sovereign defaults and that type of thing. But now that we do have a form of, call it democracy—in a way, it’s populism applied to the vote, too, isn’t it? I mean, populism in the voting side of things. So we have really changed at this point. The politician doesn’t just, in an evil way, move money where the voter base is. They have to. If they’re going to be reelected, doesn’t reelection— A monarch doesn’t have to be reelected. A politician does.

David: Well, think about what a representative form of government looked like in the early stages of America where not very many people could vote. And I’m not saying that that’s the right way to do things—

Kevin: Right.

David: —but it meant that the conversation was along very different lines. Representation for what?

Kevin: Right.

David: And at this point, it really is a question of how many tax dollars can you bring back to your constituents? So representation today is out of the tax coffers, and that really wasn’t the case 150 years ago.

Kevin: But universal suffrage. We now have—

David: So the shift towards voter sensitivity and the prerogative and the voters’ prerogatives, that was highlighted by Giulio Gallarotti, the conversation we had with him years ago on our commentary. Really after World War II and the move towards universal suffrage, the budget became politicized. I remember when he said that. It never dawned on me. It was the simple insight that has had ripple effects through so many of my views on things. But the budget became politicized to a greater degree. And with that has come tremendous currency pressures.

Kevin: You’ve got to be able to print money. That’s inflation. Inflation is a choice, isn’t it?

David: Absolutely. So chapters 11 to 13 in Calomiris that covers inflation as a part of the policy outcomes of bank bargains. And I think he does a great job of contrasting what an autocracy faces when they’re employing the inflation tax and how difficult it is actually to on a consistent year-over-year basis apply the inflation tax to democracies because people will tend to say, “Ouch, I don’t like this. Make it stop. And by the way, I don’t like the fact that someone has more than I do. Let’s tax the rich rather than subject me and us to the inflation tax.”

Kevin: No wonder we don’t have a gold standard. No wonder we don’t have a gold standard. You couldn’t do this without fiat currency.

David: Yeah. That’s important to think about. The modern banking system only exists to the degree that it does because of fiat currency. The global average inflation rate— Think of this. In the 19th century, the global average inflation rate was less than 1%. It was 0.7 of a percent for the entire century. The global average inflation rate, less than 1%. Good luck with that today. Notice we’ve changed our monetary system. We didn’t like the bondage that gold put us in. We didn’t like the limitations that it gave us. And so we have today the universalization of fiat and the encouragement of credit distribution. And now you’ve got politicians who’ve figured out how to control the credit distribution for their benefit, for political gain. Should we be surprised that inflation is more of an issue in the 20th century than in the 19th? No, we’ve got a different monetary system. It’s unhinged. And as we launch into the 21st century, can we expect it to be easily tamed when the political appetite is only seemingly bigger and more desperate by the day?

Kevin: Yes. But your modern monetary theorist or current central banker is going to say, “No, Dave. The inflation that we’re experiencing right now is transitory. It has to do with COVID.” I’ll tell you, I was walking the dog the other day and right across from us lives a general contractor. We were talking and I said, “How you doing?” And he said, “Well, it’s really interesting. I’m busier than I’ve ever been. I’ve got a line of customers who want me to do jobs.” And he does large commercial projects. He’s currently working with the car dealer and building a building there. 

And he said, “Kevin, I start a project.” And he said, “Usually, I have to order parts and trusses,” and the things that he uses, a week or two ahead. He says, “Right now, I’m having to order six months ahead, and if it’s appliances,” and you went through this, you guys personally went through this with your appliances and your kitchen remodel. He said, “It can be as much as a year and a half for what we need for appliances.” So he’s got projects that he would’ve normally finished in six to nine months that are taking two, two and a half years. That’s part of this COVID slowdown production, whatever. He said he was in the car dealership that he was working on, and he could hear the guys calling. Remember I mentioned last week, I have a client who owns a car dealership—

David: Looking for a part.

Kevin: —or just inventory. You can’t buy a used car reasonably right now. And he said he could hear these guys calling. They normally would call about a 500-mile circle area. And he says they were calling into Louisiana, out of Colorado. They’re just looking for inventory. 

So going up to a modern monetary theorist, he’d say, “Well, the inflation that we have right now is based on that. We have production disruptions. We’ve got transitory. So address that if you—

David: Yeah. Well, there’s part of it that that’s a reality. We’re dealing with that. As you mentioned, washing machine, it was ordered January 2021, and there’s still no idea of when it’s going to arrive.

Kevin: This is for you.

David: Yeah. We’ve got a gap in our kitchen, and there’s more hand washing of dishes than usual, and whatever. But we’re going over a year now as we pass the one-year mark.

Kevin: That’s incredible.

David: So post-COVID, we have increased production inefficiencies. And if you look at how globalization has over the last two, three, four decades benefited from a gain inefficiency. And prices have benefited from these efficiencies. Just-in-time inventory management has meant that nobody had to carry a huge inventory. Production was going to be quick because it was fast and easy to have everything ready to go, slap it together, ship it, deliver it, everybody’s happy.

Kevin: But it wasn’t as resilient as we thought.

David: It wasn’t as resilient. That’s for sure. But think about the efficiencies that existed. And we’ve steadily decreased those, again, all the things that were built up over a 40- to 50-year period. Now it’s in reverse. We have production inefficiencies, right? And that is, I think, transformational, if you’re talking about those production frictions. Now those inefficiencies are reemerging as global trade grinds ahead inefficiently because of COVID constraints, because of a lack of available parts, because of a slowdown in materials for those parts, because of the unpredictable nature of a labor force who’s in one day, out the next because of COVID. Because of transportation being limited, whether it’s trucking or whatever else. All these things are cost additive.

Kevin: Yeah.

David: And maybe they’re transitory, maybe they’re not. But the worst inflation call by the Fed in 109 years was tied to seeing these as the sole inflation contributors. And I think that’s really the key point used.

Kevin: Money printing does have something to do with it, doesn’t it?

David: Yeah. Yeah. So we do have things that may end up being transitory in terms of these production frictions. And maybe we say, “Yeah, but we don’t like the vulnerability we had of having a supply chain overseas.” Or perhaps if we end up with real conflict in China, we don’t like the supply chain in China at all. How do you reconfigure when most your finished goods have some piece, part, or the finished product itself coming from China. What does the world look like then? All of a sudden that form of inflation isn’t transitory.

Kevin: The dollar store becomes the hundred-dollar store.

David: That’s right. And so they’re not entirely short-term, and they are not the sole contributors. You’ve got credit creation and lax monetary expansion, which also contribute. And as we’ve highlighted repeatedly, you also have fiscal spending, and that’s very inflationary. More politically directed dollar flows. It’s already considerable. And that is not transitory as an inflation input because politicians have rediscovered it for the first time since the 1960s. This is a great way to get things done. Let’s create an agency. Let’s spend a bunch of money. Let’s hand a bunch of money out.

Kevin: Well, what you said, create an agency. Last week, you talked about Biden saying we have a severe shortage. What was that severe shortage of, Dave?

David: Government agencies to more effectively redistribute capital to—

Kevin: Yeah.

David: It’s an amazing thing. So this is the crossroads we’re at. As inflation increases and the votes roll through to tax the rich, we’re also going to see more interest in and approval for the support of social safety nets as we discussed last week. That’s the Biden administration believing there’s too few government agencies to carry out the work of public administration, aka redistribution. What we’re focused on today in this conversation is how credit flows. Those credit flows are not just about organizational structure but credit flows are a tool for redistribution. And then this is how Elizabeth Warren has been gathering resources to more effectively manage that redistribution tool.

Kevin: So, Dave, we’re in an election year, and everybody’s talking about, “Oh, is it going to be red? Is it going to be blue? Which is going to be the wave, the big wave?” Is that really just a distraction as to the people who are really pulling the purse strings right now of power?

David: I think those who are aware that the Democrats are not going to do well in this election are already positioning themselves very wisely to capitalize on areas where they can consolidate strength and power.

Kevin: Huh. Almost like they’re channeling water. Where’s it going to flow when the flood comes?

David: Yeah. We may lose power in the House and Senate it but—

Kevin: But not in the banking community.

David: We’re going to tell you how things actually work.

Kevin: Not for credit.

David: We’re going to cut you off. It’s like, “You’ll be fine, but we did take the oxygen out of the room.” You’ll be fine for a little while. I mean, that’s what they want to do is regulate the lifeblood of the financial markets and of the economy, and make sure that the people they want to win win and the people they want to lose lose. And again, that’s where—again, credit, because we’re so credit dependent within our financial system and economy—that’s a huge power move. It is the coup of 2022.

Kevin: So you don’t really need sufficient votes.

David: No, the takeaway is that even if you can’t organize sufficient votes to win the midterm, you can fortify your position in the channels that drive long-term political power at the intersection of credit flows and constituency benefits. And that’s really what Calomiris is getting at. The more you control who gets what, the more influence you have on the vote count. To quote George Bernard Shaw, “A government that robs Peter to pay Paul can always depend on the support of Paul.”

Kevin: That’s true. That’s a good one to remember. Okay. I want to go back to China though because we were seeing cracks in the system in 2006, 2007, 2008. You might recall, we sent out a CD. Remember what those are?

David: Oh yeah.

Kevin: Okay. CDs, they were the little round silver things, right? We sent out a CD to our client base in 2006. It was your dad telling people to get out of real estate because the cracks were showing up and real estate was overvalued. I’ll never forget that. I mean, it’s great timing.

David: Now that was in the US markets—

Kevin: Yeah.

David: —right?

Kevin: Yeah. But China now—

David: Yeah. China equally intriguing. You have the unfolding credit debacle in China. The preferred source of economic growth over the last several years, actually decades, has been from property development, up to one-third of GDP growth has come from that sector, property development.

Kevin: A third of the entire GDP.

David: Yep.

Kevin: Yeah.

David: And for all the centrally planned credit flows, like our own politically motivated flows, it’s fragile. It’s fragile by design. How fragile? You’re not seeing adequate coverage of the hemorrhaging that is taking place in the country. Right now, the largest developer in the country, Country Garden is the name of it, has had its debt, if you go back to September of last year, priced at 3%. So it seems like fairly low risk. January 1st, it was up to about 6.6% in terms of the yield. And just since the beginning of the year, it’s gone from six and change to 12.

Kevin: Wow.

David: So a doubling in interest costs.

Kevin: And then—

David: And they’re considered—

Kevin: They’re doubling.

David: Exactly. They’re considered the most financially stable developer in the country. You’ve got Kaisa, who’s a top-10 developer in the country, and they’ve seen their debt trade from yielding 30% just a few months ago. Now it’s yielding 75%. We’ve followed Evergrande. We’ve followed this for months now. Evergrande now trades at a 99% yield.

Kevin: Wow. So put a hundred bucks in, get 99 more.

David: Or get nothing. Yeah.

Kevin: Or get nothing.

David: Yeah.

Kevin: Yeah.

David: The creditors are, in essence, assuming there’s nothing left, equity’s wiped out. But to have creditors taken to the woodshed in this manner is shocking. I mean, you’re talking about billions in debt. I know we grow insensitive to what these numbers mean, but Evergrande has $300 billion dollars in liabilities, $300 billion in liabilities. They have more in debt than you have in terms of the market capitalization of Ford and GM. It’s just astounding, right?

Kevin: Okay. So if China goes through—

David: By the way, 10 billion of that’s coming due this year, close to 10 billion is coming due in 2022.

Kevin: So it’s not going to get any better.

David: No.

Kevin: So we’re talking about Xi. We’re talking about China. If he were to go through a global financial crisis like we did in 2008, and he had his eye on Taiwan. Okay. Because he’s losing his engine of power. What you’re saying is a third of his GDP came from this development, right? And so his engine of growth, which is critical— Of all the people we talked to, the economists who are experts on China, they say that China has to grow fast. It has to keep growing hard or else it doesn’t work. 

So let me ask you. And it was brought up in the meeting this morning, Dave, as we talked about this with the company. One of the men said, “Why wouldn’t he just consider war as a distraction?” And yesterday I had a client, you and I both know him real well. In fact, he’s been a guest on the commentary. He is a former Senator, and he is an expert mathematician, used to fly B-52s. He was part of a war game group that would play mathematical and outcome-based war games at the Pentagon. That was part of his assignment when he was with the military. And I just asked him yesterday. I said, is Taiwan the real deal, Ukraine for Putin? And he was very sober. He was very sober. He says, “Yeah, yeah. It seems very likely.” So my question would be, and we’ve been talking about politics, we’ve been talking about credit. You talked about the financial moves to the economic, which moves to the political, which moves to the—

David: Geopolitical.

Kevin: Yeah.

David: Yeah. Honestly, I think Biden is more in a desperate position than Xi Jinping is.

Kevin: Oh.

David: Biden’s—

Kevin: You think he’s eyeing Taiwan and going, “That might be my distraction.”

David: I think he’s eyeing Ukraine and creating— I mean, this is the tail that wags the dog type scenario where Russia is the problem. What was the question here? Russia is the problem for everything. And there to blame—

Kevin: My son-in-law is a captain in the Air Force. I really don’t want to hear anymore about the distractions. That doesn’t sound—

David: Yeah. Ukraine. I mean, coming into our election, I think there’s a greater sense of desperation. The reality is, Xi Jinping does not need a vote. He doesn’t need dominion. He doesn’t need anyone’s help along the way. There’s very little concern about what the outcome for him is in the—

Kevin: An election of one. Yeah. Yeah.

David: Yeah. Yeah, because this is the 20th Congress, right? This is the National Congress, 20th National Congress in China in November. He’s going after a third, unprecedented stint as leader. And it’s probably third and forever. My guess is that once he’s in, he’ll be like Putin.

Kevin: Right.

David: A permanent fixture.

Kevin: Just rename the position that you’re holding, but it’s the permanent fixture.

David: Recover the couch. It’s the same couch that’s been sitting around for a long time. But Xi’s lost his engine of growth. Xi has a GDP growth target of 5 to 6%, which is going to be pretty tough to pull off.

Kevin: Yeah.

David: And that certainly will put pressure on his reelection bid, creates an internal pressure for him, a different form of calculus. The question is, is he willing in the context of that complicated economic calculus, is he willing to consider something sort of along the lines— Will he be tempted by the art of redirection and focusing on— I mean, nationalism is definitely there. We have nationalism on the rise. Economic numbers are fading, even this nationalist sentiment is picking up. And that you look at the timing of the Olympics. They’re going to beat that drum really hard. Who shows up? Who wins? Who dominates? Who gets all the golds? Well, I mean, half the world’s athletes aren’t even going to show up. So you’re going to have record-breaking Chinese results in the Olympics, more golds, silvers, and bronzes for the Chinese than— I mean, it’s not the BLS. You’re not going to have more medals than competitors. BLS could come up with something like that, but you are going to have a lot of medals.

Kevin: The timing of the Olympics is interesting.

David: And it just ties the theme of—

Kevin: When the Ukrainian thing started becoming a problem was right after the Russian Olympics. Do you remember that? I mean, nothing happens until after the Olympics.

David: Right.

Kevin: Right.

David: But I mean, again, this issue of who’s under more pressure, Xi Jinping—

Kevin: That’s a great point.

David: —put them all on the list.

Kevin: Yeah.

David: Is Putin put under pressure today?

Kevin: No.

David: What’s the price of oil? Pressing $85 a barrel.

Kevin: Great point.

David: Revenue’s fine. He’s got the strong side of the negotiating table for Nord Stream 2. I mean, he’s in a great position with Europe. He’s in a great position in terms of his relations in the Middle East. He’s in a position of strength, right? 

Xi Jinping doesn’t really have a plan. The credit markets are blowing up in his face. He’s got the equivalent of a 2007, 2008 credit crisis on his hands. It’s happening in real time. It’s going to suck the life out of the Chinese economy. So this is a surprise, and it leaves some wild cards with the Chinese, real wild cards. But from a political perspective, geopolitical, rather, he’s not in a position of weakness. And from a nationalist perspective, he’s doing quite well. I mean, you’ve got Xi Thought, which is, again, it’s like a rebranded Maoism. There hasn’t been this much energy around communism in decades, in decades.

Kevin: And they have the Sesame Credit to watch if you have the same mindset.

David: That’s right. So he’s locked down controls on technology. You remember Deng Xiaoping used to say, “We’ll let some get rich, and then we’ll all follow.” That was the theme of opening and transfer from the ’70s forward. Deng Xiaoping was okay with that. They were okay with that. This is a model of growth that allows a version of capitalism. And if there is a sacrificial lamb in this— I’m not sure that Taiwan is the first sacrificial lamb. They’ve already played their hand in terms of the billionaire class in China. They may be eating billionaires for breakfast. I mean, the problem is with that many people to feed, there’s not that many billionaires.

Kevin: Right, not enough.

David: But to look for a thread that kind of runs through all of these things, I think you have to say that interventionism and a certain degree of desperation, in some instances a purely economic desperation; another, political; and another still, geopolitical. The theme is you haven’t seen anything yet in terms of government spending. You haven’t seen anything yet in terms of the inflationary trends. 

So I read almost as comedy some of the Fed chiefs saying, “By the end of 2022, the inflation rate will be back to 2%.” Okay. And are they accounting for all of the other factors that drive the rate of inflation, which they have no control over? They have no control over supply chains. They have no control over the fiscal spend. They have no control over whether or not we have conflict with the foreign country. They have no control over the desperation of a White House looking to solidify a second term or make sure that there’s solid gains and not losses in the House and Senate.

Kevin: Doesn’t this go to why a person is listening to the commentary right now? We have to be able to think for ourselves.

David: Yeah, the outcomes are not determined, and the checks that are going to have to be written to smooth over a number of these issues are very large checks. So does that spell higher rates of inflation as we head into 2022? We already said January is our good month. It’s our best month. We redefined the weightings that go into CPI. Statistically, inflation is going away. Statistically, maybe we do hit 2% by the end of the year. But my reality, your reality, the reality of every other American who’s paying bills will be quite different. The statistics don’t matter. The reality faces them every day, at the grocery store, the gas pump. And that’s what we have to come to terms with.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. Yeah, I’m Kevin Orrick, along with David McAlvany. You can find, 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 addition of the McAlvany Weekly Commentary.

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