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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

If You’re Addicted To Gain, Prepare For Pain
May 10, 2022

“Budgets are being squeezed now. We know that. Gasoline prices, gallon of milk, pound of ground beef, whatever it may be, it’s not that people are spending less. It just means that they are spending 100% just to get by. And that actually is the Keynesian dream. You don’t have savings. So you make adjustments. You limit where the funds flow, and it’s just the essentials that remain. All the fluff gets taken out. We’re back to the basics.” — David McAlvany

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

I brought up last week that we’re back meeting at Ken and Sue’s, back at table 30 on Monday nights, sipping on our Talisker. You came in last night, and of course you’re in training. So you ordered, what are they called, lollipop wings. And we had stickers.

David: Pot stickers.

Kevin: Yeah, pot stickers. I just always yield. When you’re in training, it’s like, why don’t you go ahead and eat? You eat more than me because you’re trying to fill that body, all those calories getting ready to go.

David: And I feel guilty, but I don’t linger.

Kevin: Yeah. I noticed you took me up on that. But what you didn’t tell me was that you had just come from a bakery and had eaten this blueberry thing that you talked about with everybody this morning. You didn’t tell me that you had already filled the palate and the stomach with—what was it? A blueberry muffin at a record store. So, it was a combination bakery, an LP vinyl record store.

David: My friend Josh is a motorcycle maniac. At least he was before he had a young daughter, and he and his wife are a really dynamic couple. And they love vinyl. They love baking. And she is a master baker. This was not a muffin. I don’t know what it was, but it had a blueberry compote on top. And it was one of the best things I ever put in my mouth. So anybody coming through Durango, look for Toast. That’s the name of the place. They’ve got a great listing of vinyls.

Kevin: Didn’t you just buy your wife Buena Vista Social Club on vinyl?

David: It is such a great listen. It’s such a great listen.

Kevin: It’s interesting. I was thinking about it, Dave. Isn’t it strange the things that we took boxes down to the thrift store 20 years ago, our vinyl albums, now we’re going back and we’re paying premiums on those? You think about how music— We’ve got a grand piano in our house. My mom has a grand piano. My grandmother had a grand piano. Because years ago, that was the only way you had music in your house. But there was a revolution that occurred back when the long play— Or actually, even before the long play, when just the album and the record player— You remember RCA Victor?

David: Oh, sure.

Kevin: Yeah. The symbol with the— I think it had the dog, and he was sitting and listening to an old Victrola. Right?

David: Mm-hmm.

Kevin: Wasn’t that RCA Victor?

David: That’s right.

Kevin: Yeah. And so you think, all things seem to come back, don’t they?

David: Well, all things do come back around. It was college 20-something years ago that we used to have on a Saturday morning, once a month, something called Waffle Fest. Me and three other guys would sit and listen to the Buena Vista Social Club and make waffles and more bacon than you can imagine. And we would just eat for four hours.

Kevin: So you’ve always associated baking and LP albums.

David: Of course, of course. 

Well, Bitcoin broke support at 35,000 this week. And it has much better support at 32,000. But it races past that number in less than 24 hours. And if a rally can’t be mustered above 32,000, then 19,000 is your next level of support. And there’s some of these Bitcoin whales who have leveraged positions in the product and their margin calls start coming in at around 21,000. So 19,000, we might find ourselves getting there pretty quickly.

Kevin: What a difference from November when you had certain funds launched where everybody could get involved.

David: Yeah. “Remember November” could be the rally cry—or it could be the lament of the crypto speculator who bought a lot closer to 66,000 per coin. We’re 50% lower than that. More than that. So often we’ve wondered what the future holds for private cryptocurrencies. And we don’t know the future and I can’t very well predict what we don’t know. But the tendency of central planners to plan, and the thoroughness of the autocrat to control as much as possible, I think that suggests that Ken Rogoff is going to be proven right. It’s been three or four years since he wrote those words in Project Syndicate. What the private sector innovates, the public sector regulates and then appropriates.

Kevin: So they let you make it and then they take it.

David: That’s right. Central bank digital currencies have the brightest future of all, if you’re talking about survival, as a currency, and I think your private tokens and coins may play a role as a smart contract, as a host of secured database uses. Thus far, you’re looking at a fairly sparse list of actual use cases in the 13 years since Satoshi introduced the world to the distributed ledger and a currency dream.

Kevin: Correlation is an interesting thing. When you see one thing and another at the same time, sometimes you correlate it, like what we were just now talking about. You listening or buying albums and eating baked goods, maybe there’s more of a correlation than we thought. Okay. So look at Bitcoin.

David: Could be a coincidence.

Kevin: Well, it could be more. There could be correlation. But there’s definitely correlation between cryptocurrencies moving up and technology stocks moving up because now there’s a correlation of moving down.

David: And I think that’s the big thing to key in on here. The correlation between technology shares and cryptocurrencies has increased in recent years. And what that suggests is that speculators in one space share something in common with speculators in the other. And that is a profit and loss statement. So winners win, losers lose. And that’s not in this case a categorical judgment of the successful versus the failures in life or a statement about popularity versus those who are forgotten by history. Winners win and losers lose. This is a momentum story. It’s a risk story. It’s an accelerator to riches story, which suggests that risk-taking works for a while. And yes, risk assets require new adopters to push the edge of success further and further out, which also explains why the edge is not being pushed out currently.

Kevin: You brought up momentum, and momentum is an interesting thing because you can fool yourself with momentum. If something’s rising, you can think there’s a reason other than just the fact that it’s rising. In other words, maybe there’s some use that we haven’t figured out yet. But momentum oftentimes just is the next person buying at a higher price for no other reason than that.

David: And that really has been the case. Success in crypto-land is a price increase. It’s not the launch of a use case. So when you see a Superbowl ad and you’re deploying Matt Damon to Mars, that is a way of saying, you aim too low. You’ve set your eyes beyond the beyond. And then you will achieve the kinds of profits that only those who are bold could achieve.

Kevin: That commercial, it almost says, “Come on, you idiot. Come on, you idiot.”

David: You will arrive in the promised land of profits and digital freedom.

Kevin: That’s right.

David: The nagging concept is correlation. And the nagging reality is that tech stocks rally, and so do cryptocurrencies. And tech stocks decline, and so do cryptocurrencies. As risk assets, they move in lockstep. Now we’re not going to talk about interest rates today, but as interest rates have been rising, that has put incredible pressure on technology shares. So this correlation with cryptocurrencies, I think, again, it ties to risk assets in general.

Kevin: And this can happen with anything. This can happen with anything. Remember with silver American Eagles, when you had the Reddit crowd going out and saying, “All right, everybody go buy silver American Eagles.”

David: Boom. The price went up.

Kevin: The premium went way up. We stopped selling them for a while because it’s like, “No, this is momentum. This doesn’t have anything to do with silver.”

David: Yeah. And so, I mean, go back to that idea of success being all about a price. Well, the legitimacy of a thing is not borne out in price alone. Look back at Bernie Madoff. Look back at Mr. Ponzi. What they did would be legitimate if the price was just continuing to rise. Now, there’s more to price. There’s more to the actual story of success than just a price. Just because something has a price that increases is not in itself a success story. I talk with startups with some frequency, and I’m always amazed that the valuation of a company is based on the last round of funds raised. So it was done at this multiple. So the last sucker that gave them money is the new benchmark for the multiple in the value of the company. So it’s not based on sales or revenue or recurring cash flows. A company that’s never sold a single thing, never generated a profit, is worth what the last round of funding came in at times that multiple. It’s intriguing, but it’s not necessarily built to last.

Kevin: We talk about built to last. I’m really looking forward to this year. Mom and dad are coming into town. We are as a family office business celebrating 50 years. 50 years ago, your mom and dad started this business. You look at the ups and downs in business. You can get fooled by things, and chase after rabbits, but like a good hunting dog, you’re trained to only go for what you really know the goal is. And I look at the family and all the ups and downs in the markets, the different changes, the things you’ve brought in, Dave, the things that your dad and mom brought in through the years. There is a legacy. In fact, that’s the name of the book that you wrote. There’s a legacy that can only stand up when you look for the long-term value versus the short-term, like we talked about, the momentum play.

David: The long-term, it seems like 50 years is a long time. And yet on the grand scheme of things, it’s not. I recall the Eltz family from Germany, the owners of a castle and estates for over 900 years. And I’ll give you a short version. There was a conversation my father and I had in Germany four years ago. We talked about this on the Commentary at that time. And it tied to the concept of legacy as we reflected on the necessary ingredients of an institution lasting through time. Here was a family that started something and maintained it through 34 generations.

Kevin: That’s unheard of.

David: As I inquired what set them up for success, three things were referenced: diplomacy, civility, and sentimentality. So as for the first, they recognized the factors, family and the forces, which were an external threat, and they skillfully engaged, because sometimes, your neighbors, the local warlords— I mean, there’s a lot of things that externally can compromise you. So they recognized their external threats and they skillfully engaged in the art of a diplomat to ensure continuity and a peaceful resolution. So diplomacy, knowing how to assess and address external threats. That was their first pillar.

Kevin: A little Christopher Blattman talked about how we don’t fight. You need to have that kind of diplomacy.

David: And most of the wealthy families that they were growing up with, so to say, in Germany, they didn’t survive. And most of the times, it was because of a direct conflict that they did not win. So they just avoided.

Kevin: Yeah.

David: They chose diplomacy as a superior engagement. Civility was the code of conduct within the family wherein they chose kindness and peace when it came to family conflict. Reality is, family life is not easy. Sometimes, family is not nice. Are there values and rules of the road that guide reconstruction and promote peace internally? So for the Eltz family, it was kindness. And then sentimentality was the last pillar, which was the choice of each generation to regard what they had as special and to preserve it for the future.

Kevin: So they were there for the long game.

David: It’s a long game, indeed. Not so fixated on the future that the present was neglected. Not so stuck in the past that the future was inadequately anticipated. Each generation took ownership of the resources they received then and there, and viewed it as an honor to steward them into the next generation. So that’s how they embraced sentimentality. Perhaps they did not imagine 1,000 years, but their values propelled them through time. And I think that’s a really critical thing. When you want to see something last, what values actually offer support for the enduring nature of an organization, a family, what have you? So getting swept up in the tide of enthusiasm and speculation, that defines a moment. That does not define a long stretch of time.

Kevin: So I wonder, when we talk about these various investments that get caught up in momentum, initially they can, and you can get very, very rich very quick. Think about 110, 130 years ago, the railroads. But the railroads still have value to this day, but railroads are no longer a get rich scheme, are they?

David: Right. Railroads are one that definitely has to come to mind. Like some of the speculative experiments of our day, the future is in all likelihood, quite bright. But the speculator is rarely the one that enjoys that bright future. So think about it. Today Berkshire Hathaway may own Burlington Northern Railroad, but it’s not the get rich quick scheme which Wall Street was promoting and every stock exchange in the world sold as the guarantor of riches. The winners were the early promoters. They took the money and ran. Then you’ve got the later investors who actually developed and owned a vital asset. It was the enthusiasts who came in at the behest of the promoters, the enthusiasts, they were the ones sacrificed on the altar of Mammon.

Kevin: So when you bring up Bitcoin or you bring up the other cryptocurrencies, they’re here to stay. You’re not saying that this is not a technology that’s going to be useful. But at this point, is it still a get rich momentum scheme?

David: Yeah. Do you think of radio as the place to make a fortune? Look. Again, not everything lasts as an idea. Some things are brilliant at a point in time, less relevant as time wears on. I do think cryptos live on, but for sobriety’s sake, just think about Spotify and iTunes. Spotify and iTunes have taken the stage from vinyl records played on the radio. But RCA in its day with radio and the playing of vinyl for a broad audience, that was revolutionary, and the adoption rate was impressive. To see them scale from 100,000 radios in 1922 to 500,000 radios in 1923 to two and a half million radios in 1924—

Kevin: That took the world by storm.

David: —and 10 years later, by 1934, they are 50% of all households. They’re in 50% of all households just 10 years later. And yet the share price, if you look at that from 1924 to 1929, was up almost 1,000%, $11 to $114, getting to a price earnings multiple of 76 to 1.

Kevin: So there’s your momentum. I mean, granted, it was a new technology. It’s exciting. But—

David: Any guess how revolutionary tech like RCA— guess how it performed in the bear market. Three years later, the shares traded at $3, not $114. That’s a 97% loss. And the share price, so it took on the dynamics of a rocket ship launched and then came back to terra firma. The similarity between RCA and the cryptocurrencies is simply that they came of age in bull markets. And I suspect that they will share this in common, too: prices fading away as the tide of liquidity recedes. We still have radio. We just don’t have RCA millionaires anymore.

Kevin: So we have these inventions that come along at the right time in the markets where the invention comes along and you have the ability in a bull market— Because everything rises in a bull market. Isn’t that the saying? Everything rises in a bull and everything falls in a bear.

David: Yeah. It’s all boats rise with the tide kind of a thing. So yet, as it turns out, some of the most fabulous inventions were born in a period of speculative frenzy. Risk was the rage. Luck favored the bold. The inventions remain, but the fortunes rarely do because, again, it’s that market tide. The market tide comes in and goes out, carrying those extra dollars with it. So bull markets may be the birthplace of millionaires back in the ’30s and billionaires these days. But bear markets simply blow them up. So cryptocurrencies will carry forward, but the speculative energy, that’s what is unique. Speculative energy that is required to propel prices to infinity and beyond, that belongs in a bull market. And that bull market has ended.

Kevin: It makes me think of where the millionaires, and these days the billionaires, what they invest in. Look 10 years later. A lot of times, they’re not invested in the same thing. Things move on. Money moves in and it moves out.

David: Well, if they move on, sometimes that’s the best thing that they can do. The notion of diversification can be very healthy.

Kevin: Was it the Bass brothers? Remember the Bass brothers story?

David: Brilliant move coming out of oil, coming out of natural resources in the ’70s and ’80s, moving to cash for a good solid two years, and then making a whole other fortune in equities. And this is Richard Rainwater giving them advice as to how to navigate the macro moves in the market. And they came into the stock market in about 1982 at a market low. So, again, the bear market went from ’66 to ’82 and the bull started in ’82 with interest rates, double-digit. You just had Volker slaying the inflation dragon. And for the first time in 15-plus years, the Dow was poking its head above 1,000 points, where it had been 15 years earlier. So the glass ceiling the Dow breaks. The Bass brothers, on Richard Rainwater’s advice, have moved in and they’ve not focused on what they once were focused on.

Kevin: They didn’t get married to their investment. They knew that someday that would change. 

David: I visited the Jekyll Island Club a few weeks ago. Was in an Amelia island, Florida and only an hour or so from the famed playground of America’s most fabulously wealthy 100 years ago, more than 100 years ago. And a fascinating story. The club was limited to 100 members, and it included folks like the Vanderbilts and the Rockefellers. I actually had a Rockefeller arrive while I was there. Kind of an interesting—

Kevin: I know. You sent me a picture of it.

David: Yeah, no, it was nice.

Kevin: I love your travels. I’m home. I get your pictures. Yeah.

David: Pierre Lorillard, JP Morgan, CEO of AT&T, International Harvester. You’re talking about the most prestigious families with the most extravagant wealth of the time marked by millions, not billions at that time. And so this club, the late 1800s was when it began. It flourished through the first decade of the new century. In 1910— I think we all know the history of the Jekyll Island, a meeting in 1910. They hosted the secret meeting that gave birth to our Federal Reserve system a few years later.

Kevin: Yeah. But even the millionaires and the billionaires don’t go there today. I mean, it’s just a historic place at this point, isn’t it?

David: Well, this is an interesting part about real estate. Sometimes it tells a story that’s quickly forgotten or walked past. When the stock market collapsed in 1929, taking prices lower by 89% just in the Dow—or in the case of the most popularly held stock at the time, RCA, down 97%. Sometimes when you have concentrated ownership in a stock, it means that there’s that many more sellers at the end of the day versus buyers pushing it to higher prices. So you get to the end of the collapse, ’29, ’30, ’31. So members are dropping out. The club has to redesign itself. It rewrites the charter. It allows for a larger list of members. They bring them in as associate members. This is an extra 150 members. They’re able to attend, but lower annual dues. And this is all because of the financial hardship of the depression and the market collapse. 

And it was not resolved quickly enough. You had too many members that were being forced to resign their membership. And I guess one thing to throw in is people do move on in terms of preferences. The Victorian architecture was fading in popularity. So what was a really cool spot, hip and happening, like a Soho house or something like that on the East or West Coast. By the time World War II came around, the club was a shadow of its former self. It actually closed in 1942. That was the last summer it was open. It never reopened after that. The property was condemned in 1947. This was like Lifestyles of the Rich And Famous. Right? You remember the show?

Kevin: Yeah.

David: The property was condemned five years later, 1947, and the entire island purchased from the remaining members by the state of Georgia for 675 grand.

Kevin: Which is interesting because really only 30 or 40 years before that, if you look at this, this was where the richest went to design the Federal Reserve System. And then it completely changed. So let’s go to today’s volatility because at this point, there are some who, like the Bass brothers, have made their money in this expansionary phase with the Federal Reserve System, but they didn’t fool themselves into thinking that it was going to last forever. And they’re saying, “Should I stay or should I go? And maybe I should go.” Now there’s others who just don’t see it.

David: You’re not going to sing that song, are you?

Kevin: Do you want me to?

David: Should I stay or should I go now?

Kevin: You go ahead this time.

David: No, that’s okay. But last week was important because it marked not the return of volatility, but the enhancement of volatility as investors try to determine whether to stay or to go. And no one likes taking losses, which is why they’re usually taken when psychology in the marketplace has reached full implosion mode. You get to the point where you just can’t take the pain anymore. And there is no light. There is no hope. It’s like existing in a financial black hole. And you finally sell at the absolute low when psychology is shattered. 

Well, that’s not happening now. I get to talk to investors every day. I talked to one gentleman this last week who, “Yeah, I’ve got an investment in technology shares and the S&P and the Dow and a very large stake in Amazon. I’m never going to sell Amazon at these prices. No way. It’s only going higher.” And I got to look at his portfolio and his QQQ position was not QQQ. It was not just the NASDAQ. It was a leveraged position in the NASDAQ, a leveraged position in the S&P, a leveraged position in the Dow.

Kevin: Well, he’s done well up to this point.

David: Well, I mean, he just took a 35% haircut actually. But he’s not going to take the loss. Psychology has not pivoted, but it’s on the back of people’s minds. What do we do here? What do we do now? And the bond market starts reacting last week in a very negative way. You have the US productivity numbers for Q1, which present a major problem for the bond market because it’s not like productivity is going to solve the inflation problem. And apparently, if you listen to Powell, he’s not going to solve the inflation problem either. So the stock market loves the fact that he’s not going to restrict credit and be the next Volker. The stock market is foolish enough on the front end, as you saw the rally play out last Wednesday, to think that this is good for us. And again, the average investor who’s got a blend of stocks and bonds— We’re talking about the 60-40. That’s the Wall Street standard, 60% stocks, 40% bonds. Maybe they’ve got a sprinkling of speculative money in the standards.

Kevin: Yeah. Like Netflix, down 70%.

David: Amazon only 30. Apple, Microsoft, maybe they’ve got a smattering of cryptocurrencies.

Kevin: Down by half. Yeah.

David: Well, even if you don’t understand the cryptocurrencies, it’s difficult to be left out of the minting of money. And there’s some natural, just very, you get it. You understand if people are minting money, how can you say no to that? So the FOMO can affect everyone. You mean we can mint our own money?

Kevin: Just like the Federal Reserve, we can do that too?

David: Yeah. So quite literally, that’s what the crypto craze has been about. Well, they’ve had a rough year. The 60/40 portfolio’s had a rough year. The cryptos have had a rough year. And it’s all been a rough year in one quarter. Do we now get a bounce? Yeah. It’s a possibility. Is the worst behind us? Maybe. Or have we just finished the first chapter of the battle for investment survival?

Kevin: Well, and you wonder, too, because Powell sounded tough right off the beginning last week. And then a little bit like a parent who first threatens a spanking, then he threatens a time out, and then he gives the markets candy instead, or gives the kids candy. That’s how it felt. But liquidity’s just not there like it was, is it?

David: That’s right. I think one of the things I want you to take note of is, 1932, Oppenheimer wrote the book, The Battle for Investment Survival. And you need to read beyond the first chapter. Read the whole thing.

Kevin: That became the classic of investment savvy.

David: It’s an important book from that era. Your point on liquidity, liquidity is drying up. Money has just begun to move to the sidelines, and a part of it is in response to central banks, whether it’s the Bank of Australia or the Bank of England, now, to a small degree, the Fed tightening credit in response to the universal experience of inflation. But here in the US, 50 basis points, it’s not a lot. It’s not a lot.

Kevin: It ain’t a spanking. It may be a time out. I don’t know.

David: So what do we do? We can blame the Russians. We can blame the Chinese for inflation and the fact that it’s universally being experienced. And there are points of truth in both, whether it’s supply chain bottlenecks or tensions that have increased the price of oil, which— Well, wait a minute. That’s only really March and April’s price of oil. Leave alone the 6 to 12 months preceding in which oil was rising, having nothing to do with the Russians. Yeah. But there are points of truth in both. I think, more clearly, the faults lie primarily with us.

Kevin: Yeah. We like growth. We like prices to rise, not fall.

David: Yeah. So the system that is addicted to growth, and dependent on systemic increases of liquidity to float asset prices higher and to promote economic activity to an even faster pace, now that system’s beginning to move in reverse, with less liquidity and now some compression of value.

Kevin: But didn’t Powell sound like he was going to become a hawk last week when he gave his initial comments?

David: It was absolutely a perfect presentation. You couldn’t have asked for more in terms of sophistication and savoir faire. He addressed everyone in the audience. He addressed the common man. He addressed Wall Street. He addressed the credit analyst. He spoke like a hawk to open the day’s remarks last Wednesday. And then he transitioned to telling the market what it actually wanted to hear, not too much restriction of liquidity, a slower runoff of the balance sheet than previously stated, 47 and a half billion monthly starting in June, not the 95 as anticipated. No possibility of 75 basis point increases. They took that off the table, which is interesting. What the market came away with is, this is how doves cry.

Kevin: No. Is that Prince. Are you going to sing?

David: No, I’m not. And the markets loved it. You love it till you realize that what you love is not good for you. It is like a drug addiction. Powell gave the market a cocaine boost on Wednesday. And by Thursday we found ourselves in an alley smelling like our own vomit.

Kevin: What a picture.

David: If you’re not solving the inflation problem—and this is what you wake up to on Thursday morning—if you’re not solving the inflation problem, the entire financial system, not just the saver or family living on a fixed income, is going to be greatly pressured to maintain current economic viability and for asset prices to maintain current levels. So consumers are already radically shifting behavior. This is a no-brainer. You look at gas at $5 to $7 at the pump.

Kevin: Well, and you drive a diesel.

David: I know. $4.32 is the AAA national average this week. Diesel here in Durango is $5.75 a gallon. I know East Coast and West Coast, you could add a couple of bucks more. And when I looked at that driving home the other day, $5.75 caused me for the first time to wonder what the F stands for in F-250. The price of everything is going up. It’s 10% here, 20% there, 50% in some cases. So if that pain does not have a predictable end, markets have to adjust. They’re beginning to.

Kevin: Yeah. But do the markets still win? That’s what I wondered as Powell talked. It’s like, he’s scared of the markets, Dave. There’s a fear factor right now because— you talked about waterfall kind of losses beyond certain points. We could have it. You said that last week where we could just have some certain things just fall off the cliff, not just Netflix losing 70%, but normal, maybe even what we would consider blue chip stocks.

David: Sure. No. So we’ve already got the hint of de-risking and de-leveraging. We’re beginning to see the cross-asset liquidations. It’s not one particular geography. It’s not one particular asset class. They’re moving in tandem. Again, the marks of panic. And perhaps we can be talked out of that, but prior strength is now recognized as dependency and addiction. And again, like the drug addict, these markets cannot operate in the manic. They want to so badly, but they cannot operate in the manic without direct artificial provision. And so there is this question of, should we experience pain, will fresh support be offered? At what level of pain or depression will the Fed and other central bankers modify the treatment plan, intervene into the spiraling of the patient?

Kevin: So this last 10 years, especially, almost 11 years since 2011 has been characterized by, especially the European Central Bank, going in and buying everything that looked like a bond. Bonds didn’t have to pay interest because they knew the central banks were going to come in and buy them. At this point, those things are sitting on their books. Aren’t they?

David: What’s interesting is when you have a massive bull market in bonds, it drives interest rates lower, and you end up with stimulus for almost every other asset class. So when you start thinking about—

Kevin: So it bleeds over.

David: —interrelated bubbles, you cheapen credit, which is the result of a bond market. The price goes higher. The yield goes lower. You end up with interrelated bubbles, which my colleague Doug Noland describes as one big, crowded trade. And we’re starting to burst at the same time. All of these various crowded trades are coming unwound with now an unknown variable in play.

Kevin: So if interest rates rise—

David: With one variable in play: To what degree will central bankers intervene to prevent financial market chaos?

Kevin: If interest rates are rising, what happens to the European banks?

David: And this is where anyone with a concentrated portfolio in sovereign debt or investment-grade debt is now asking a very, very sobering question. Do we have enough capital to survive this kind of volatility? European banks are in danger. They’re loaded with government debt. It’s losing value as rates increase in lockstep with inflation. And you have to recall that bank capital is a thin sliver compared with the leveraged assets they keep on the balance sheet.

Kevin: Just remember Jimmy Stewart when everybody wanted their money out of the bank at the same time. There’s not a lot there. He had what he had for his honeymoon.

David: He ended the day with a mama dollar and a papa dollar. That was it. So they’re dealing with Italian yields rising 104 basis points so far this year, Greek yields going from 1.32 to over 3½%, German Bunds, the 10-year from negative 50 basis points to over 1%, 100 basis points. 

And it’s not just Europe. The stresses are already global in the credit markets. And certainly if you look at the Chinese credit markets, there’s not just a little stress, there’s a lot of strain. But if you go to the more obscure spots, you find it showing up and popping up too. You could look at Romanian yields. They’re at a decade high. Peruvian yields are at a 13-year high. 

And again, if you’re raising interest rates, then the value of those bonds is going down. Who owns the bonds? And is it a leveraged portfolio such that you could be looking at margin calls or such a decline in value relative to your capital that you’re dealing with impairment, you’re dealing with insolvency? Colombia is at a 12-year high. Poland at a 7, Czech Republic at a 12-year high. And again, US, if you want to go mainstream, the US just watched the 10-year treasury streak past 3%.

Kevin: Look at mortgages. That affects us all.

David: 5.27%. We went right past 5%. That’s pressure in the credit markets, which is commensurate with accidents. Now we talked about correlation earlier. Maybe there’s no correlation here. Maybe it’s just coincidental that as interest rates begin to rise, there’s bleeding. That happens in various places throughout the financial system. But at this point, you’re talking about impairment to the financial system even more than you are impairment to the global economy. Now we could have a separate conversation about weaknesses here and there within the global economy or factors within the US economy. But this is the stuff of financial accidents.

Kevin: So I just wonder what happens. We know what happens when you have free money because that’s really what we’ve experienced this last decade, free money. What happens when it’s not free?

David: Yeah. Final thought on that. Where the trouble lies, leveraged speculation has been state-sponsored for over a decade. Some would argue three to four decades. And now you have inflation which will not easily dissipate. 

There’s a contrast between the financial markets and the economy. The economy does not necessarily have to implode along with the financial markets. So even though inflation is impacting the leveraged speculator in causing an unwind of trades within the fixed-income markets and now putting pressure on corporations and their ability to continue to perform as they have in the past decade with stellar returns for investors. The economy does not have to implode if you have major financial market stress. 

Love this period of 1966 to 1982. It’s an excellent example where you had rising inflation. You have the impact of the guns and butter policies of the Johnson administration leading through the late ’60s into the early ’70s. You began to see the inflation at 2%, becoming 4%, becoming 6%, becoming 8%, moving double-digit as you progressed through the ’70s. GDP growth averaged nearly 10% per year during that entire timeframe. Factor in inflation. So if you want a real GDP number versus the nominal, in real terms, you were at 3.2% annualized from ’66 to ’82. 

Punctuating that period is the recession of ’73 and ’74. Equities did not tank. You had no waterfall cascade like 1929 to ’32, where you had an 89% decline. In many instances, they halved. So a 50% decline. That still hurts.

Kevin: And adjusted for inflation. They were going down.

David: That’s the killer. The killer in the context of stagnant returns was inflation, flipping them even further upside-down. Throughout that timeframe, stocks largely traded sideways, ’73, ’74, that period, that recession being the exception. But the total return equation was disastrous because of the lingering effect of inflation. We can repeat many aspects of that period. And I think we are beginning to. We may even surprise with relative strength in our currency, with robust activity in our economy, when you look at budgets being squeezed.

Kevin: Yeah. Dave, during that period, the Dow during that 1966 to 1979 period, the Dow lost value from 30 ounces of gold down to 1 in 1980. So when you’re talking about relative strength, we like to measure things against gold. And the Dow went from 30 ounces of gold to 1 while everyone sat there thinking that it was holding steady.

David: You look at central bankers from Jekyll Island to the present with Jerome Powell, and there’s an inflation bias. They’ve all been inflationists to one degree or another. They know how to add money to the system. They’re not very good at taking away the punch bowl. Very few ever did that. So it’s not as if they’re afraid of inflation. They just don’t want too much of it such that it changes the behavior of people who are out there spending. 

And again, this is where budgets are being squeezed now. We know that. Gasoline prices, gallon of milk, pound of ground beef, whatever it may be, when budgets are squeezed, it’s not that people are spending less. It just means that they are spending 100% just to get by. And that actually is the Keynesian dream. The Keynesian dream, promoted by inflation of central bankers, is that you don’t have savings. The rentier class is destroyed.

Kevin: Utopian slavery.

David: Right. You spend every dollar you have. Every dollar that’s created is in the economy creating even more growth. So inflation actually promotes the reality of, you can’t save. Everything’s in the system. And if everything’s in the system, we have greater growth promised. You look at GDP. What is it? We talked to Diane Coyle about that a few years back. It’s an imperfect measure, but it’s what we have. 

They’re forced to limit where the funds flow, and that’s what households adjust to. Instead of saying, “I’m going to the movies and spending 20 bucks and buying popcorn and a Coke,” you rent a movie for three bucks. So you make adjustments. You limit where the funds flow. And it’s just the essentials that remain. All the fluff gets taken out. We’re back to the basics.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.

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

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