In Transcripts

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, we have entered a new year, and of course, with the inauguration we have entered another four years. The stock market is over 13,000. Could things get any better?

David: With the recent release of our DVD, An American Reckoning, we would take the opposite view. Even though the Dow is at 13,000, and with four more years of the incumbent, what we see is truly an American reckoning. When we described the fuse being lit, we were talking about the dollar, we were talking about the debt markets, and the concern we have in those particular markets. The idea is that sometime in the next 2-4 years we have major, major concerns, and major issues which we will address, more than just speed bumps in the U.S.

Kevin: So, even though the Dow is above 13,000, which, for reminder’s sake, we were there about 10 or 12 years ago, but we are there now again, and it seems to be rising. What you are saying is, that is not something to party about at this point.

David: In communication with Alan Newman here recently, he said that the undeniable fact is that the entirety of the U.S. stock market is worth less now than at the end of 1999. I think the point that he is making there is that indexes don’t necessarily tell the whole story. You have the S&P, you have the Dow, you have the NASDAQ. You also have a number of companies which have either gone by the wayside altogether, or have traded themselves to levels where they have been removed from the indexes completely, and what you see in these indexes appears to be good news.

And truly, it is, let’s not minimize that. But, again, the undeniable fact is that the entirety of U.S. stocks is worth less today than it was in 1999. That’s powerful. At the same time, Alan has suggested that margin levels, comparable to the stock market capitalization, are the highest we have seen since 1929. I don’t need to tell you what happened in 1929, but I think there is the issue of animal spirits, or the issue of speculation running rampant on the street today.

Kevin: Well, if you only have enough money to buy one, why don’t you take money and buy 3, 4, 5, 10, and just take your risk. That’s what you are saying about margin levels. Something else, though. It’s not just margin that is in the market, the stock market has become more like a hot potato game than an actual buy and hold game. That’s changing.

David: In our conversation many months ago with Alan Newman, this was a part of the topics covered. The high frequency trading and what we have seen as the norm today on Wall Street, essentially a reduction of the holding period, where someone used to buy a stock, let’s say circa 1991, and they held it for an average, which means some investors held it far longer than this, but an average of 21.2 months.

Kevin: So almost two years was the average holding time.

David: And then by the end of that decade, 1999, we have folks who are only holding stocks 10.4 months, so you see this declining trend and then a year after that, just the year 2000, it was 5.9 months, by 2008 it was 2.6 months. Today, holding periods are almost nothing, as computers buy and sell and try to pick up a penny here, and pick up a penny there.

Really, what has occurred over the last decade, most intensely, and we are talking about two decades in scope here, really, it has intensified over the last ten years. The exchanges have done a huge disservice to the investing public by catering to high-frequency traders, and that is at the expense of a core of retail investors. So, it really is no surprise when we talk about the Dow at 13.5, 13.6. Levitation in the stock market is at least partially explained by this automatic bidding process.

Again, we are not talking about people who are buying stocks, we are not talking about an investing class that is buying stocks, we are talking about a group of technical traders who are using algorithms and computer models, and basically, you could take your double martini at 9:00 in the morning because frankly you don’t have to show up for work. Why? Because the computer is doing all the work for you. Your brain can be absent once you have written the code.

Kevin: It’s like it’s running a scan except that it’s running a buy.

David: And again, from 2010 lows, the Dow is up 35%. That is in the face of 402 billion dollars in net sales from domestic equity funds. Step it back a little bit, as we have before, and I appreciate Newman putting these numbers together, 585 billion, if you go back to 2007, 585 billion of net sales of domestic equity funds, there has been, in the last week, the recent 8 billion-dollar surge in equity mutual funds, that is, money coming into the market.

This is the first major surge of investor activity into mutual funds, and then of course, you strip away revisions of that number which took out 5 billion, and you strip away the ETF liquidations in the same time frame, and actually, you only about 268 million dollars going into equities, so we have not seen a reversal of the trend. That’s my point. You continue to see the general public exit the market.

Kevin: Dave, something that I know you watch and has caused huge problems in the past, is mutual funds, when their cash levels get too low, let’s say something does happen where people become a little nervous. Any time somebody is a little nervous and they want to sell that mutual fund, that mutual fund, if it has no cash, is going to have to go out and sell shares, and that can compound on itself. We saw that in 1987. We’ve seen that in 2008, 2007. These cash levels, well, you have to keep a little bit in the bank so that you can pay out to people without having to sell shares.

David: If you go back to an earlier decade, you could usually find 5, 10, even 12% sitting in cash, and that was prudent management. In the last 10-15 years, fast forward a bit, and you have seen a more common trend of 5% or less, where if you are almost fully invested, you are sort of in that 1-2% range in terms of cash levels, and we are today, in terms of mutual fund cash levels, resting at 2007 numbers.

Kevin: Well, let’s back up for a second. 2007 was right before our last crash.

David: Yes, I mean, who needs reminding? Again, we talked about 1929 earlier. Maybe no one needs a reminder of what the 2007 and 2008 period looked like, but those were the highs for the decade. Risk management and caution were set aside. Cash levels in mutual funds are an indication of money manager’s concerns, and they are lower today than they were in 2000, and as we said, on par with that 2007, 2008 period.

Kevin: David, obviously the guys who are managing these mutual funds know a whole lot more than the CEOs of the corporations that they are buying because the CEOs seem to be selling more shares than buying right now.

David: We’ve talked about the insider selling issue before, but I think that issue of industry competition amongst hedge funds, amongst mutual funds, amongst asset managers, when a trend is in place, everyone wants to jump on board because no one likes to be outperformed or outgunned, because they run the risk of seeing assets move. This is really what you have in the case of impatient investors. That is what fund managers understand and that is why they will all move in one herd at one time. You have to be all in. It’s almost like the professional version of keeping up with the Joneses.

Kevin: The Joneses don’t necessarily run the corporation, though, Dave. The Joneses are the guys who are buying in the mutual funds. But the guys who are running the corporations, what we call the insiders, have to show when they are buying and selling. They are selling a whole lot more than they are buying right now.

David: The disproportionate insider selling, particularly in the retail space, has been something we have discussed, or maybe it was that I discussed that on Bloomberg last year, but perhaps investors don’t appreciate what a forward PE is, a Price Earnings multiple. If you look at a company like Amazon, its forward PE is estimated to be at 157. That is, you are paying, in today’s price, for 157 years worth of future earnings.

Kevin: Let’s just stop for a second and re-explain. Sometimes we just have to look at the simplicity of the concept. Let’s say you went out and bought a company for a million dollars, and you knew that company was going to earn you $100,000 a year, that would have a PE of 10-to-1. In other words, it would take ten years at $100,000 a year, to pay for that million dollar investment in the company.

David: What we are saying is 157 years is how long it would take. This is future earnings to pay for the current share price of Amazon.

Kevin: You’d better be taking your vitamins, Dave. (laughter)

David: Well, if that doesn’t raise the hair on the back of your neck, the price compared to reported earnings is a wee bit higher. Reported earnings is different than future earnings, because frankly, we don’t know what any company is going to earn in the future, but there is the forward projection, and when you back away and say, “What is their current PE versus their forward PE?” It is a little bit higher. What are we making, versus what we believe some day we will make. You are paying for 3,252 years’ worth of earnings. This is one of the most popular stocks on the planet today and you are paying for 3,252 years worth of earnings.

Kevin: Dave, I was talking about a company that was making $100,000 a year at 10-to-1 if you bought it for a million dollars. What you are saying is they weren’t making 100,000 dollars a year, they were making a few dollars a year, and it takes about 3200 years to actually pay the company off.

David: Just as a thought experiment, if you are counting back the years, and of course, you are paying for future performance, but this is just as a reference, 3,252 years ago Moses had been dead for about 34 years, (laughter) Joshua had recently passed away. In other words, investors are packing a lot of future hope into a company with razor-thin margins.

I have to be honest. I love ordering things on Amazon. Why? Because I can have my books in two days, or less – the next day. It’s absolutely fantastic, and I love to order books, so there is this healthy relationship. I love Amazon, I buy from Amazon. I understand why people love Amazon, too, but what I don’t understand is 3,250 years worth of earnings is packed into the current PE. Who are you?

Kevin: What I want to know then, is what’s packed into the rest of the stock market, because Amazon, actually, is a relatively healthy company compared to a lot of the companies out there right now in the stock market. Where are we going as a whole? What is the index looking like?

David: This is, I think, where Alan Newman’s most recent comments, a suggestion of a 20% reversal to the downside, and the time frame that he gives for that is … imminent. The issue here is that we don’t have a firm foundation for growth globally. We don’t. And I know that there are many pundits who like to argue, although, listen, we saw great numbers from China in the first quarter, and we have addressed that to some degree, there are reasons and explanations for why we have positive numbers. We will talk about Brazil in a few minutes, here, because we see the same thing.

Again, massage a few numbers here, massage a few numbers there, and you end up with positive performance, but the real issue here is we have root rot. We don’t have an expansion of credit, we have a reversal of globalization, to some degree, and we don’t have growth in the global economy. So there is an overestimation in the Dow, and yes, there could be a significant correction. Is Newman right? I don’t know. We’ll see. But a 20% reversal …

Kevin: That’s 2600-2700 points.

David: Oh sure. Yeah, that takes us down close to 11,500, 10,500, potentially, on the Dow, and maybe 1,050 on the S&P. These are numbers which are a little bit more compelling from a values standpoint, but ultimately, we think, if you are going back to – again, a former guest of ours that has been on, the cyclically adjusted PE or the Q ratio, you actually have 40-60% downside when all is said and done. Is that this year? I doubt it. But it could very seriously occur during this next four years. When we talk about an American reckoning, this is not just a political and social issue, this is very much a financial and economic issue, and they are all combined in one bad stew.

Kevin: The United States is not in a vacuum. We are not an island any more. It is the world, and right now, the guys that you are acquainted with across the pond, who pay real close attention to Europe, and the Latin American countries, and Asia, what are they saying from that side of the pond?

David: Through the years we have gotten to know the folks that publish the global European anticipation bulletin and they see major headwinds for the U.S., for the U.K., for Japan, for Brazil. Their list doesn’t end here, but there are several countries which are at a crossroads, politically and fiscally, and they look at that kind of combination and say, “Essentially, we have divided the major power players into two groups.” In that first category you are talking about the U.S., the U.K., Japan, Israel. Those are the top picks.

Kevin: Those are the ones that haven’t really changed much since the crisis.

David: Right, operating on the same basis. And there are those countries that have changed institutional structures and processes following the crisis, and in their view, are better prepared for a new and different social and geopolitical construct in future years, and that is something that we will discuss on another occasion. That is not our topic today.

But two years ago, their founder joined us on The Commentary from Paris, and we discussed Europe, we discussed other issues. Unfortunately, Franck Biancheri passed away this last October, he had been ill for a number of years, but they continue to publish fantastic stuff through LEAP 20/20 and the GEAB, the Global European Anticipation Bulletin. What was unique to me was in that list of the U.S., the U.K, Japan, and Brazil, Brazil is not a usual country on the list of least prepared, or most at jeopardy in the world after the crisis and it stands out, and in their view Brazil is just at a tipping point.

Kevin: It is amazing, too, Brazil has been looked at almost as a model here recently. As far as growth, it represented this new emerging market out there, and what they are saying at this point, is that it may be the one that is most in danger.

David: This week in The Economist, this was underscored, looking at the numbers from Brazil, 2012 economic growth was penciled out at about 1% GDP growth, except that the headline number underestimates inflation, and of course, we do the same thing here. We use an exceptionally friendly deflator. I think everyone knows what a deflator is by now, the factor in the GDP calculations that account for inflation.

Last year, the government, in addition to using faulty inflation numbers, this is the Brazilian government, not ours, in this case. Last year the government also capped gasoline prices, and they froze municipal transport costs in order to contain inflation even further, but there is even more to that. To get a positive GDP figure, they also brought forward dividends from state-owned enterprises, bringing future income into 2012 revenues.

And last, but not least, they also raided the sovereign wealth fund that they set up in 2008. So, when you look at 1% GDP growth, is it really 1% GDP growth? This is the issue. The B in BRIC is slipping, and the challenge for them in the future is going to be managing inflation.

Kevin: That is the thing that we have brought out so many times, Dave. You can have as much growth as you want, but if inflation is outpacing the growth, you are still going backward.

David: This is also a conundrum for them, because there is a presidential election in 2014, and while they may want to stimulate the economy using monetary policy, the problem is they already have inflation at 6 to 6½%, and that is at the upper end of their acceptable range. So that is going to be the challenge in that part of the world, specifically Brazil – managing inflation. Presidential election, again, stimulus leading up to that timeframe is set against a rising inflationary trend. The Brazilian Central Bank has a number of challenges.

Lastly, you have the employment figures from Brazil which have been very strong. They come in at about 4.9%. But as an interesting note from an investment banker from a Brazilian bank, Itau, Ilian Goldfund, he was noting that the employment figures don’t reflect the overhang of workers. Essentially, you still have tons of employment because people have been kept on. The extremely high cost of firing them…

Kevin: Sounds a little like France to me.

David: Exactly. So you see a better number in France than you do in Spain, but your ability to fire someone is very, very difficult in a space like that. And that is what he was noting, that essentially, as you come into 2013 and 2014, we may very well see the employment numbers slip from 4.9 and start to rise from there to 5, 6, 7, 8%. The Brazilian government won’t want to see mass layoffs, of course, in 2013 or early 2014, but this is the challenge with growth essentially going negative, it is going to be a struggle.

And last of all, remember that the Brazilian economic growth has run on a parallel track with the Chinese. You have resource exports to China, which in the past years have accelerated growth in Brazil, and I think it is a very telling story, Kevin, really a footnote on the Chinese, if you will, that Brazilian growth is waning. Again, follow the money. But if you don’t need the resources, if you are seeing a significant slowdown in the Brazilian economy, is it because there is slowing trade with one of your primary trade partners? I would say that is a good question to be asking.

Kevin: David, you talked about following the money, and you can do that with the financial, you can do that with the economic, but sometimes you have to do it with the strategic, and when countries have grown and gotten stronger, and then are starting to wane, they start looking around strategically and asking, “What is it that we own that somebody else wants?”

David: Well, it is thought that the islands in question in the South China Sea are laden with oil and gas reserves. There are a few islands that sit between Taiwan and Japan, and they are actually closer to Taiwan and Japan than they are to mainland China, but you see this tension now between Japan and mainland China, to the extent that over the weekend we actually had fighter planes in the air on both sides.

Kevin: These are F15s, at least on Japan’s side.

David: Exactly, and the Chinese, in a very understated tone, have said that if the Japanese should fire shots of any kind, “China will respond without courtesy.” That’s the opinion of one person, the General of the Chinese Academy of Military Sciences. The official responses have been, frankly, less diplomatic.

Kevin: I have read that the Chinese have already said,
”Prepare for the worst,” and what they meant by that wasn’t necessarily a war with Japan, it was a war with the United States, because the United States has already made a commitment, and I believe Hilary Clinton is the one who made the commitment, that we would stand by Japan.

David: Here are a couple of interesting things to keep in mind, just as the back story. The Japanese are in an awful mess, economically. You had, this last week in a CNBC interview, hedge fund manager Kyle Bass saying that the Japanese government bond market has 18-24 months of a lifeline before implosion. We talk about the fuse being lit here in the United States, and we talk about the U.S. government bond market, and U.S. dollar market …

Kevin: But they have their own fuse.

David: They do, and it is interesting because our end game is linked to theirs, with interest rates being a critically determinate factor in our solvency and theirs. So you have the Japanese, who are in an awful mess economically, and all of a sudden you have a damaged relationship with the Chinese. This is their number two trade partner.

Kevin: Right, they need them.

David: This is a relationship that is worth 340 billion dollars, so the fact that they are on the rocks, or on the islands as it were, with the Chinese, is really a bit of an issue, because they are already in an economic tough spot. There are layers of problems here, because in the backdrop you have 20 years of deflationary malaise. On top of that you have Fukushima, and now you have one of your primary trade partners that you may go to war with.

Kevin: Something else about war, Dave, is the unpredictability of the other side. You have new leadership right now. Abe is not necessarily new, but he is certainly talking like a new leader.

David: But you have to keep that in mind, because with new leadership on both sides, you have Abe who came to power on a strongly nationalist platform, and then you have Xi Jinping, who, without a strong military background, may want to look tough. He may need to flex some muscle. So there is that issue, as well.

Kevin: And Abe has been traveling a little bit. He has been visiting countries that seem to be surrounding China.

David: And this is a major concern, when you are looking at the regional stability, when you are looking at regional relationships, and who is going to lead in this next decade. Abe’s trip in recent weeks – yes, he went to Vietnam, he went to India, he went to the Philippines, and you might think that is really no big deal. All those places you could go on vacation, all those places you could do business with.

But for the Chinese, you may also feel encirclement. You may feel a greater sense of insecurity in your regional positioning and feel like Japan was exercising a move, or trying to gain an advantage, so there is a lot at play in this Japanese/Chinese relationship, including the islands.

Kevin: David, you know, encirclement was always a concern for Russia, as well. When we were in the Cold War that was one of the key issues. They were continually watching who we were befriending.

David: We see that today. Clinton has communicated very clearly, and to the chagrin of the Chinese, that we acknowledge the Japanese claim, and implicitly, by treaty, support the Japanese. In other words, not only are there the F15s with Japanese markings, but there are a lot more behind them. That is, I think, in play, and the Chinese have a reason to feel uncomfortable. I don’t know that our foreign policy, in this regard, is the smartest foreign policy.

Our notion of encirclement in the area is playing on the fears of the Chinese, and you don’t want to poke a tiger too many times, let’s put it that way. In all likelihood, the issues will be resolved through diplomatic channels, but sometimes people miscalculate. Sometimes people misread. Sometimes people play the wrong strategy, and sometimes there are enduring consequences.

Kevin: And you know, it is interesting who your partners are. If your partners, like the United States, are deeply in debt, and could somehow use a little bit of the money that Japan might have, there might be a friendship there that is not about tanks and F15s and battleships.

David: I think that is something else to keep in mind. As we discussed last week, the Japanese, and the Abe government, will receive even stronger support from the U.S. if the bank of Japan becomes a doubled-down partner on U.S. Treasuries so that over the next 12-18 months the Japanese central bank, the Bank of Japan, brings 500 billion U.S. dollars, brings a trillion in U.S. dollars, to the table, and buys Treasuries. This is very critical, because what they are doing is that they are propping up the dollar, they are propping up the Treasury market, they are slaughtering the value of the yen in order to improve competitiveness.

Kevin: You know what is interesting, Dave? We have talked about globalization on a good side, where people are actually cooperating for business reasons. When you see the breakdown of globalization, cooperation between axis and allies, there seems to be divisional cooperation right now instead of unified cooperation.

David: That is the theme of currency wars which we started talking about a few months ago, a thematic that is in play. That is what the Japanese are doing right now. They have destroyed 12% of the value of their currency to give themselves an improved trade advantage, and they will continue to do that through the purchase of U.S. Treasuries. That layers in the currency war thematic, into a real, even if only potential, military conflict.

But you are right, this is one more layer into the complexity of globalization. Globalization is, to some degree, being undone. Another issue which we saw explored in this week’s Economist, and I would encourage everyone to get it, the issue on on-shoring versus off-shoring seems a little dry. You are going to have to read between the lines to see what value it has, because really, it is the bigger picture that has an importance. Who cares if this company or that company is moving 200 employees here or there?

But actually, there is a major theme here. On-shoring is the notion of the return of service sector and manufacturing jobs, and there is a response here. For decades now we have seen the opposite occurring, off-shoring, where a company wants to improve profitability, and they assume that because of lower labor costs, they can send jobs overseas, and basically capture that labor margin in terms of profitability for the company.

Kevin: And let’s face it, that is really what the revolution in China was all about.

David: Interestingly, this is a theme that the GEAB group, that LEAP 20/20 group, has focused on, as a major development in 2013, the idea of neo-protectionism. 2013 is likely to see more and more emphasis on domestic political and economic priorities. We see that with the Japanese, we see that with the U.S.

Protecting the local economy will continue to eclipse the international cooperation and the trend of global free trade. This is underscored by this week’s Economist special report on out-sourcing and off-shoring, in which they explore a growing number of companies who are moving in reverse. They are on-shoring, or bringing jobs back to the United States.

Kevin: Which does not sound bad on the surface. As a citizen of the United States, I would like to see jobs come back.

David: Yes, that is a good news story. Are we always bearish? No, that is a good news story. But quite interesting is the comparison of labor costs, which, in most instances, were the initial reason for companies to move offshore with certain operations. There are other reasons, still, to keep operations abroad, and we can talk about that later, but with the increase in shipping costs over the last decade, along with customs fees, and the delays in the supply chain, there are a lot of companies now that are looking at a negligible higher all-in cost, even with a higher labor line-item here in the United States.

Does that make sense? I guess one of the things that we are seeing is that with a rise in the price of oil over the last decade, this advantage of labor being just one production cost, has now become less significant, so you may gain 5, 10, 15%, in terms of profitability by being overseas, but it is not 30, 50, 60, 70, 80%, which it could have been a decade or two ago.

Kevin: This, again, is where inflation factors into things that you have to count, because if you have cheap labor, but you have inflation and all the transportation costs, storage costs, what have you, it really does change the whole dynamic.

David: And this is something we talked about 2-3 months ago when we were discussing Mexico and the fact that this is a good news story for Mexico, as well, in terms of their labor market now being as competitive as China’s. But guess what? Their products don’t have to spend five weeks on a boat getting here.

Kevin: There is no ocean between Mexico and the United States.

David: Frankly, I’m also suspicious that there are tax incentives here in the U.S. which may also be a part of the reason to return. I don’t have any hard numbers on that except that we did see the secret deals cut and 73 billion dollars through tax credits given to behemoths like GE, so that may be a part of the story. But the long-term positive here is that we do see employment rates, or, at a minimum, economic growth being reoriented to a U.S. marketplace.

Jobs, to some degree, will be back in the United States, and this is what BCG, the Boston Consulting Group, sees as a very significant directional shift. We are moving toward a balance between the jobs that are still being outsourced or moved off-shore and the jobs that are now coming back, to where, basically, it is neutral. It is, on balance, net neutral.

Kevin: So you have just as many jobs now leaving as coming back. That’s an amazing balance, Dave. That’s revealing, compared to what we have been trained to think, or what we have thought, over the last two or three decades.

David: Part of this is to be expected. As we discussed in Part II, in this year’s film, The Fuse is Lit, Asian Ascendance?, we talked about China, we talked about the necessary transitions for China, and the need for them to raise their incomes, and they are, in fact, doing that. So pay in Asia is rising, particularly in China. With that, though, comes an increased cost for manufacturing in that country. So it means that those jobs may go elsewhere.

Kevin: Dave, when I call a call center, let’s say I call American Airlines, or I call Amazon, or whoever, I may actually be talking to an American again?

David: You may actually be talking to an American again. There are a number of countries which are an exception to this, where there is no reason for jobs to come back to the United States. They may go to Myanmar, they may go to Cambodia, they may go to Vietnam. Those stand out as exceptions.

The other issue, too, is that the jobs that come back to the United States are going to be in competition with automation, and that really is a critical negative, as much as there is a positive in this idea of re-shoring, or on-shoring, bringing jobs back to the U.S. You have automation, which is a critical negative. Robotics are being introduced on a mass level, and they can be operated anywhere. They don’t have to be in South China, they don’t have to be in North China, they can be in Kansas City, they can be in Alabama.

With the same base cost up front for the plants and the material, but then you are operating something and it is close to your research and development team, it is close to your end-user, the person who is going to buy the product directly from you, so you cut out the transportation cost. There are many things changing in the labor market, both in Asia, and in the United States.

Kevin: David, as in the late 1800s, and over the last 30-40 years, we saw the rise of globalization. In the late 1800s it was fueled by industrialization and the gold standard. And of course, since the 1970s, we have seen globalization occur because of the end of World War II and the restructuring of currencies, and a lot of this outsourcing. That did add to a major GDP growth expansion. So yes, we are bringing jobs back, but what does that do to GDP?

David: This brings us back to a very critical issue, and it’s one that we are going to discuss at length several weeks from now with Michael Pettis. He will join us again on the program from Beijing, if he can breathe the air in Beijing (laughter), I understand it’s been a little rough lately.

Kevin: Oh, I’ve seen some pictures. I showed my daughter the pictures.

David: Did you see anything in the pictures?

Kevin: It looked like fog.

David: Exactly. Globalization has added to GDP significantly. Globalization has allowed for labor arbitrage. Multinationals could pick and choose where to establish operations in light of lower labor costs, but credit was also a primary driver of globalization, and it is not expanding. It is not in that 30-40 year expansion mode. The labor playing field is being leveled by an increase in wages along with other factors like we have mentioned, transport costs, the cost of slack in the supply chain. You just think in terms of labor being a smaller part of the total cost to make and deliver goods.

So we find ourselves moving back to a form of neo-protectionism. Is it reindustrialization here in the United States? That might be going a step too far, but at least the limited re-shoring that we have seen to date begins a healthy process on the one hand, and on the other hand it underscores that we have domestic economic priorities. That is sort of the opposite of globalization. That’s the opposite of free trade. I don’t know if conflict is the right word, but it is certainly not as compatible.

Kevin: So David, this is an inflationary theme. I know you are just about to go see Richard Duncan in the next couple of weeks, and he is focused, primarily, on what you are talking about right now.

David: Yes, he is in the U.S., touring, discussing his book, and we are going to have dinner here in the next couple of weeks. What we discussed last year with Richard was that low wages and globalization covered over years of government printing, and offset inflationary trends with a strongly deflationary component.

If you step away from that idea and look at what we have been talking about today, rising wages and a pendulum swing away from globalization, what you are really arguing for is a period of higher inflation rates, and if you have higher inflation rates, let’s circle back around to what we were talking about in relation to Brazil, you also have contracting GDP figures – again, should you use an appropriate deflator, if that appropriate inflation rate is recognized. The reason companies will continue to keep operations in other jurisdictions will be to access the emerging market that they think they can sell product into, not necessarily for labor arbitrage.

So again, if we are losing the labor subsidy, we can expect to see, over the next 3, to 5, to 7 years, a major reversion from what has been a disinflationary, or even deflationary environment. Disinflationary for 20-30 years, deflationary environment in the last 4 to 5, given the contraction in credit, and the crisis mode that we have been in since 2008.

Kevin: So when we talk about out-sourcing, or we talk about bringing jobs back, or on-shoring, we are not only talking about people, we are not only talking, necessarily, about physical, hard, tangible products, what we are also talking about is intellectual property.

David: This is, I think, at the core of the technological revolution, and evolution, that we continue to see unfold in front of us. Corporations are more and more suspicious, skeptical, concerned, protective of their proprietary processes and intellectual property rights, and so it is going to be natural, in a period of global economic consolidation, to see firms pull back a bit, because they are just not extending trust any more.

In a microcosm of that, the Mckenzie Global Institute in Seoul, South Korea, points out that outsourcing, or going offshore, carries a number of disadvantages, including the revelation of proprietary processes, including sharing intellectual property. It is interesting, we were talking about Seoul, South Korea, and it reminds us of Samsung. It is a profound reminder because they once were a very small firm used for outsourcing by a number of Japanese firms, and now they dwarf all of their previous customers. (laughter) And note that South Korean firms almost never outsource, and I wonder why.

Kevin: Yes, I guess it is the same reason why you don’t pick up a wasp from the ground.

David: But this is, I think, this growing trend of domestic concerns, domestic considerations, protection of property rights, protection of intellectual property rights, in particular. So how are you lining things up in an age where there is greater conflict? As we talked about several months ago, this is not just the conflict that we might see between the Japanese and Chinese, this is an economic, financial conflict, and it includes things like using your currency as your primary weapon.

Kevin: David, that is what this year’s theme has been. The three videos that we have made, that you have actually gone all over the world to make, started out with Europe, and the complexities there. There is complexity, but once you understand it, there is actual simplicity. When you get to Asia, the same thing. Complexity. That was the second DVD, the Fuse Is Lit, Part II. The Fuse Is Lit, Part III, really ties everything together and that, of course, was just released this last weekend.

David: It’s titled An American Reckoning. If somebody wants to go to Youtube, they can put it into the search function as The Fuse Is Lit, Part III. If you want a hard copy, you can call our office, or go online to and get a hard copy. I would suggest getting a hard copy because it is something that I think you are going to want to pass on to your kids, pass on to your friends, pass on to your co-workers, something just to say, “Hey, I don’t want this to get stuck in your inbox and you might not have seen it otherwise, but if you have 20 minutes when you get home, because that’s about how short it is, take a look at it, I’d love to discuss it with you.”

Get a hard copy, you can order it at We pick up the shipping. We cover all the costs of production, and just hope that you learn something from it, and take very seriously some of the conclusions which tie directly to the U.S. bond and dollar markets. Again, this is An American Reckoning, the conclusion of a three-part series, The Fuse Is Lit. For us, it really is the dominant theme as we look forward to 2013, 2014, 2015, and 2016, the next four years. As we have just gotten past the inauguration, and look forward to what the next four years may hold, these are some financial, economic, and even a few political considerations, as well.

Kevin: So, for the person who has a computer and wants to just immediately look at it, they can go to Youtube, and they can search The Fuse Is Lit, Part III, or they can go online and type, right?

David:, and again, we cover all the costs to get it to you.

Kevin: A lot of people who listen to the show don’t turn their computer on that often, so they can call us at 800-525-9556, and we will be happy to send you a hard copy, a good old-fashioned DVD.

David: It’s going to take about two weeks to produce it. You can create things digitally a lot faster than you can in real, hard form. So, believe it or not, there will be copies coming direct to you from China. (laughter).

Kevin: They are on the boat, let’s just put it that way.

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