In Transcripts


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick


“On today’s program, thinking of Amazon, Netflix, etc., seems to represent a new business model that says, ‘Yeah, we lose money on every transaction but we make it up on volume.’ Is that sustainable, and when does actual profitability and personal relationship matter?”

– Kevin Orrick


“In every generation you have a choice to pull yourself up by your own bootstraps. It doesn’t matter what you inherited from the previous generation – physical, tangible assets, or complete social and emotional emptiness and bankruptcy, because those kinds of things can be translated from one generation to the next. But the question is, what will you do with what you receive? You may not like it, and frankly, it’s up to you to change it.”

– David McAlvany


Kevin: David, you’re traveling all the time. In fact, you are in your travel clothes. You literally stepped off the plane this morning before we recorded, and you are just about to get back on the plane for these conferences that you and your dad are planning on doing. I think before we get into the Commentary we ought to review the dates and the places that you guys are going to be.

David: Yes. We’re going to be in California. That is where our whistle-stop tour begins. The first date is always when we’re having our meetings, and the second date is when we are actually doing private consultations. So July 14th and 15th we are in Palo Alto, California. July 19th and 20th we are in Agoura Hills, California. Then we are heading north to Bellevue, Washington July 25th and 26th. Portland Oregon – we will be there July 28th and 29th. And in Scottsdale, Arizona August 1st and 2nd. We end this little segment of the tour August 8th and 9th in Denver where we started our company in 1972.

Kevin: We would just ask anyone who would like to come to the conference, or have the private consultation the next day, to please give us a call at 800-525-9556. You can ask for ext. 118. Karis will put you down as an RSVP.

Dave, we just came through Father’s Day. Something really hit me. I was with my son. Both my kids are millennials. We were just eating the other day and I made an offhand comment. I felt bad about it because just offhand I made a comment about the millennial generation. My son paused for a moment and thought, and then he said, “You know, you’re right. The millennials this, the millennials that – he was talking about some of the deficiencies that we see in the millennial generation. But it really ruminated with me, Dave – my generation was no better than the millennial generation. In fact, my generation is up to their eyeballs in debt. Our parent’s generation, even though maybe they would be called the greatest generation, not all of them were great.

Dave: The reality is, in any generation you have great strengths and great weaknesses, and we tend to kind of focus on one aspect, whether it is over-fixation on the weaknesses of a generation, or over-fixation on the strengths of the generation. We’re people. That means we’re messy. That means that there is a lot more to the story.

Kevin: Well, millennials – I have to give it to them – they’re not as materialistic as my generation. They don’t feel that they need the 3,000 square foot house. I was just talking to somebody who is down-sizing to a 38-foot trailer, and they have a family of four. But you know what? They’re excited. It’s an adventure to them. And being millennials, to them, they want to own what they own.

David: Who says we need stuff? That is one of the operating questions. I’m interested in revisiting a conversation we have had twice with Neil Howe, and if you recall, a book that we have discussed in the office, read as an office read, was The Fourth Turning. It looks at 600 years of British and American History and the changes that occur about every 100 years. It subdivides those 100-year periods into generations. And he looks at how these generations interact, and what we learn, what we fail to learn, from one generation to the next. And what the social and political ramifications are. He also has sort of an economic and financial overlay to that.

Later this month I would love to invite Neil back onto the program and kind of look at where we are in this seasonal change, if you will, and 100-year period – where we are and what we can anticipate next – because what you are talking about – generational change – absolutely critical to understand.

Kevin: I’m hoping that this generation that is coming in after us will value relationship. We have moved to sort of an internet age where Amazon is providing everything, and there is a disconnect between people. But I am also noticing that the millennials and the generations after them are starting to crave relationship. Father’s Day is a good example. When people are thinking of their fathers they get together. Most people, hopefully, who are listening to this program, had a good Father’s Day.

David: I’m grateful for relationships. Celebrating Father’s Day for us was up at the lake. We had BBQ and I think the kids loved finishing with a movie and ice cream. I think, along with just about every father, there is sort of the value of family, the priority of time spent, the imperative to deliver on your commitments to your kids. Kids are interesting. They don’t have written contracts with their parents. At least I don’t know anybody that does (laughs), but when commitments are not kept, there is the equivalent of sort of breaking of a contract. And so it is an unspoken social contract.

The opportunity that we have, Kevin, is to cultivate a respect for commitment and loyalty and relational connectedness. And that is a daily opportunity. When I speak of managing intangible resources, that is sort of in a parallel track with what we do for a living – managing tangible or financial resources, this is kind of what comes to mind – the family stuff.

Kevin: I was thinking about this today, Dave. We tell people we have a podcast radio program. But you know what? Everybody has a podcast radio program these days. And we tell people that we deliver news that we try to filter through and give good information. Everybody is doing that and they’re calling it fake news. You just have all this spam – spam this, spam that – coming into the internet. But actually, agreements, in the long run, break down unless there is truth in the arrangement. We have agreements – not just with our clients – we have agreements with institutions – some of the largest brokerage firms in the country, that we have to maintain. We can’t be giving them fake news. We can’t be variable in our relationship with them.

David: You’re right. This is the tenth year of our weekly commentary. We’ve been doing this every week for ten years. Can you believe that? I was out in the Midwest this week visiting one of our institutional clients.

Kevin: It’s a very large institutional client.

David: The original agreement that we made with them goes back 33 years. And as you might guess, it came off of an old school word processor. It’s kind of the electric typewriter style that you had in the 1970s, 1980s, even into the early 1990s. And the agreement was simple, it was short, and it remains the same today. There was no need for a legal dictionary, and there was no attorney to draft it, and it is still in effect. I look back and I think, times change, and sometimes time changes people and organizations, but for us, the better part of wisdom is to always value and elevate relationships above whatever else may have shifted in the interim.

Kevin: What is interesting to me is, 30 years ago when I first started here, I was talking to people from this particular institution – we won’t name it – most of those guys have gone on to retire and there are new guys that have come in to replace them. Yet our relationship, and the agreement, still stands.

David: Yes, we have done what we said we would do for 33 years, and they have done what they said they would do for 33 years. There has never been a complaint either way. Now we are in our fourth decade and the markets continue their shifting. We have regulatory requirements which continue to morph and match. Is there a sort of market evolution?

Kevin: Right. But the relationship doesn’t change.

David: No, there are relationships which do, I think, stand the test of time. Honestly, there is very little that offers greater intrinsic reward than to carry forward a business relationship that began when I was in grade school, and today, to keep it in healthy repair. In an agreement there is honor, there is obligation, there is intention to do right for both parties.

Kevin: And these weren’t agreements that you put together. This is an inheritance from another generation.

David: That’s right. What I have is an agreement that I need to honor, in the daily activities of our business, and I am reminded that in a family run firm there is greater latitude to live and operate with something equal in value, or even greater in value, than profit. Now mind you, if you neglect profitability, you do seal the fate of an enterprise. But having a venue where intangibles can be prioritized – that is incredibly rewarding.

Kevin: We’re living in a day where relationships and agreements are as simple as a click of a mouse, and as easy to break as just returning the product. There is very little relationship in some of this new market that we are starting to see. But when you start talking to people who are having to deal with larger projects – you just got back from a trip where you had spent some time talking to a man who is head of a very large project. Relationship in agreement is of utmost importance.

David: I think one of the striking things that he said to me – I was on my way to the Midwest and I had this intriguing conversation with the gentleman you are speaking of. He was long on common sense, he was worldly wise, and that came from decades of operating in a highly competitive business environment. He was born and raised on a ranch, and his perspective on the world came from, as you mentioned, the various leadership roles he has had in international companies.

And he said this to me. He said, “It took me over 50 years to learn this, that there is more to life than money.” He described many of the conversations that he has with friends and colleagues where they haven’t learned that lesson yet, and they are still in pursuit of the next, the greatest, the infinite goal, where the goalpost that he had, the infinite aspiration, the desire for more wealth that really is an appetite that can never be satisfied. He just flat out said, “It took me 50 years to learn that there is more to life than money.”

Kevin: And we were talking about generations. Money, to us, is debt. So we should rephrase that. There is more to life than just debt, and the more debt we pile on, in a way, we feel like we can’t feel it. I have talked to clients that have said, “You know, you guys have talked about having to pay the piper on our debt for decades, yet I don’t really feel it. But the effect is still there. It is sucking away from the growth, or the capital accumulation that could have occurred had we not been paying debt payments.

David: His observations, I think, were helpful, they were hopeful, one that Trump might actually bring something other than the same old sort of motionless political quagmire. But they were also very realistically limiting. His comments reminded me of a Financial Times article I read this week. The Financial Times article was on inflation, and it was suggesting that we are still struggling to raise the level of inflation to that which central banks consider acceptable. Evans, this week, from Chicago – that is, Fed President Evans – has basically said, “Look, we’re not there yet. Our goal is 2%. We still need to get that. We are missing on one of our serious policy objectives, and they are still trying to drive that rate of inflation higher.

So the central bank community is struggling to resurrect inflation, and you have the burden of debt, at least according to this Financial Times article, which remains an obstacle. So, you have too much debt, and you have the resources in the financial system which would ordinarily be recycled through the economy over and over again. And what is happening is, those resources are being siphoned off to pay claims to the creditor class.

Kevin: I would have to take exception, Dave – we don’t need inflation. We don’t need 2% inflation, we don’t need 1%, we don’t need 5%. That is not growth. To a central banker that may be growth, but what he is pointing out is, they can’t restart the economy. That’s just another way of saying, “We have not been able to restart the economy.” Why? Because they have built debt on debt, on debt, on debt. And we all know from our personal lives, Dave, you get into too much debt and like the encyclopedia salesman who says, “Look, if all you do is give up a Coke a day, you can own this encyclopedia.” The problem is, we don’t have 50 or 60 or 80 Cokes a day to give up.

David: The big theme from that Financial Times article was the siphoning off of wealth. Those are maybe the words that I would use to describe it. But it echoed this rancher’s opinion that there are different versions of siphoning off wealth, and it is why the system is broken. He would point to actual corruption in the political system here in the United States, but also – and I was reminded of this going back to Richard Duncan’s book, The Corruption of Capitalism, where he basically outlines this morphing of capitalism as we knew it, free market capitalism 100 years ago, to what he describes today as debtism, which is a complete replacement of what we knew as capitalism.

Kevin: And Dave, we would have velocity in money right now if we had any growth, whatsoever. Remember Milton Freedman – he just assumed that velocity, the turnover of a dollar, every year would be at least 1.7. But that has turned out to not be the case. As we have gone further and further into debt, the velocity has fallen through the floor.

David: That’s exactly right. Recall that velocity is simply the number of times a dollar circulates through the economy. And Freedman was wrong. Velocity is not a constant, it is variable. And you’re right, velocity has collapsed over the last 12-15 years. And a robust economy generally sees higher velocity.

Kevin: That means people are spending money, and accumulating money.

David: That’s right. And those dollars, when they are put into the banking system, get re-lent, and re-spent, and re-lent, and re-spent, over and over and over again. So again, there is this idea that a robust economy, generally sees higher velocity, and with higher velocity, you also tend to see higher rates of inflation. Now, there is a threshold moment where velocity can go absolutely bonkers and it quits telling you about the health and heartbeat of the economy. That’s when it starts to tell you about panic, because people want out of the currency, and all of a sudden you see a massive uptick in velocity where it actually is a repudiation of the value of that currency.

Now, I’m not talking about that. I’m talking about just a low level of inflation and the era of low inflation that we have had, say, since 2008 and 2009 has coincided with incredibly low levels of monetary turnover. There are multiple reasons for this. As I just mentioned, as debt levels have risen, a greater percentage of capital is required for debt service. That leaves less to circulate for consumer spending, less to circulate and become savings, which would be future capital for investments. So, financial institutions have essentially siphoned off resources that would otherwise circulate in the economy.

Kevin: Let me just throw this out, though, because this is the mindset that we have, and that is, “Who cares about velocity. We’ll just print more money. We’ll just create more money out of thin air. If it’s not turning over in the hands of the people, we’ll just flood the market with helicopter cash.” Remember Ben Bernanke?

David: This is one of the key distinctions that Duncan makes in his book, The Corruption of Capitalism, where he basically says, “We’ve changed the definition of money from fiat that you print on an actual printing press to something that we can do digitally now, and do infinitely – just ones and zeroes – we can create credit out of nothing. The difference between creating credit and creating what we know as Federal Reserve notes, or dollars, is that credit has two sides to the equation. There is a debtor and a creditor. So you might argue this point and say that, essentially, creation of credit is like creating money out of nothing. It is creating new money, our modern day money, out of nothing.

But here is what it requires. It requires that the limited amount of income, whether it is household income, or corporate income, that is, corporate profit, that is, government income, via – I don’t know if you want to call it a tax heist, we’re talking about tax revenue – more and more of that income in any form has to be utilized for debt service. So yes, there is additional capital created when we create debt, but that doesn’t necessarily translate into an increased means of paying for the obligatory portion of that capital, and that is the interest component.

Kevin: We have been to Detroit multiple times. I haven’t been to Puerto Rico, but I know you have. Those are two examples of when the debt gets to be too much. If you have been to Detroit recently, I’m sorry for the people who are listening, but it has changed.

David: You’re right. Detroit, a few years back, Puerto Rico, just a few months ago, and we are witnessing across the state of Illinois, at present, frankly, a slow motion train wreck. It’s occurring right now.

Kevin: Are you thinking they are going to go bankrupt, as well?

David: Anything is possible. As of last week, they have 14.7 billion dollars in a backlog of bills to be paid, that is owed by the state to private individuals.

Kevin: Now, they can’t print their own like the Federal Reserve can do for the national debt.

David: That was the same problem in Detroit. That was the same problem in Puerto Rico. It is illegal to run your own printing press. So you have population flight in Illinois. You have a business exodus which is exaggerating this trend, reducing the income that the state needs to pay for its bills, and they’re not reducing the number of bills. That’s guaranteeing the next round of extreme measures by the state and local authorities. What does that look like? I don’t know. Maybe it is an increase in tax revenue via real estate taxes. Maybe it is an increase in sale taxes. Is Illinois the first state to introduce a VAT? The reality is, there are too many obligations and not enough income to keep up with them.

Kevin: Well, let me talk about a phenomenon that this causes, Dave, because not everybody loses when there is a lot of debt. Let’s use an example right now. We’re seeing brick and mortar stores close. It is an amazing phenomenon to live through over the last couple of years, where the Amazons of the world are just replacing the mom and pop stores. Now, that’s not all bad if it’s competition, but these large organizations that are running, they’re losing money on every transaction, but they don’t need to make money.

How does a mom and pop store compete against an Amazon who knows that the money is going to keep flowing from two directions? One is unlimited amounts of debt if they need it. The second is all of these indexed funds and the funds that are focusing on these FANG stocks going in and just buying stock and so it raises the capitalization of the company. I’m going to throw this out, Dave. What if the business that you run here, the company that we work for, really didn’t have to make money as long as you could get more debt and get the stock price continuing to rise?

David: Right, and then use the stock as it rises as a form of cash.

Kevin: It’s like the financialization of the economy.

David: That started to happen in the 1990s, and arguably, the late 1980s. But really began to catch fire after Glass-Steagall was done away with in 1999.

Kevin: So it concentrates the wealth in a very small region of owners of companies, and that’s it.

David: It is no accident that you had an explosion of growth in the derivatives market, and massive leveraging within the financial system, but specifically banks and financial entities, up through about 2007-2008. Of course, that came unglued, but very interestingly, we have seen that same leveraging up within corporate America. So this idea of financialization of the economy – we’re talking about a shift from making stuff to making money on the stuff that people theoretically sell or buy, or what have you.

We mentioned this a few weeks ago, where retail businesses are making a huge percentage of their profit from financing, that is, the credit cards that they offer. Take Macy’s, as an example. They make a huge amount of money off of the Macy’s credit card, not just the merchandise they are selling. We are talking 30-50%, depending on the quarter. That is a massive contribution. So what is Macy’s? Are they are retailer, or are they some version of a bank or financial entity?

Kevin: There is a balance there, Dave. They don’t want the debt paid off. This is how they are actually making money. They don’t want you out of debt. They want you in debt just enough to where you can make your monthly payments.

David: But this is the concept of siphoning off resources that would have otherwise gone toward more productive things. As the financialization of the economy has occurred, there has been an increased amount of debt, but not a proportional increase in incomes for individuals, needed to pay for that debt.

Here are a couple of other ways that assets have been siphoned off from various economies. I got to thinking about this after the conversation with this gentleman on the plane, because it really is an interesting phenomenon, and it is happening at the macro level and at the micro level as well, where resources are being siphoned off, and it is no surprise that the Fed is having a hard time increasing inflation, and that velocity is absolutely on its keister.

Kevin: We have talked about what you look at on the dashboard to see what is going on. Strangely, velocity is the thing that is showing us.

David: Right. Think about the myriad ways in which velocity drops at both the macro-economic and micro-economic levels. Start with Amazon. They siphon off money from local communities by taking dollars that would otherwise be spent in a local economy and recirculated in that local economy, and instead, it reallocates those dollars to a corporate nexus in some other part of the country.

So we are talking about the death of mom and pop proprietorships, and I think it is very unhealthy. It’s very unhealthy for small towns, it’s very unhealthy for dynamics within a community. And it reminds me – I know you have experienced this – you drive through places all across the country, and they had their heyday decades before. It could have been from an oil boom, an industrial boom, some sort of agricultural boom. But the dollars were there, and then the dollars quit flowing locally.

Kevin: Dave, they become ghost towns. I remember growing up, there is a town in the panhandle of Texas that I grew up going to every summer, my brother and I. We would spend the whole summer just in cutoff shorts and we would never put shoes on. It was a wonderful town. But there were two highways. There was a north/south highway and an east/west highway that ran right through town. I remember my grandmother telling me this story. She said, “Kevin, they’re building something called Interstate 40 and it’s going to bypass the town.” It’s a horrible thing to think about when you’re a little kid but she said, “Someday this town won’t be what it is today.”

And it’s true, the town has turned into a literal ghost town. There are just a little over 1,000 people living there now. I’m not saying the interstate was a bad thing, but the effects of an Amazon, nationally, reminds me of the effect of the interstate on the small town on route 66 that used to be booming, and is no longer booming.

David: What you’re talking about is a technological rechanneling. In the case of this town in the panhandle, it was the flow of traffic. But what we are talking about is a flow of dollars. And either way – you create a technological bypass, or you create an actual I-40 bypass – it has the same effect, which is that dollars quit flowing locally. The economy shrinks to the point of forcing people to relocate. You can go across the country and you see empty cinemas – all over the country – and it is a reminder that at one time there was enough people and money flowing in that place to sustain a small town movie hall. But that time has passed.

Kevin: So is Amazon the next interstate?

David: I think Amazon represents a 21st century threat to small town businesses, and it represents the monopolization of retail. And I agree that the Internet opens the door for small enterprise to move in, to relocate to more desirable communities. But old school brick and mortar businesses are being hollowed out by companies like Amazon. The main point being, when the money leaves a local economy – this is not a rant on Amazon, this is looking at cause and effect – when money leaves a local economy, small town velocity falls.

And so the burden of debt for those small towns grows disproportionately compared to the incomes that still remain. What does that do? That leaves authorities to either voluntarily shrink the scope and scale of local government – good luck with that, never seen it happen before. What they usually do is just slowly bleed a community dry because they would rather choose willful blindness to a financial crisis as it is unrolling in front of them.

Kevin: Again, some of this is just the nature of creative destruction, what we have talked about, and creating competition. The competition, when it is unfairly siphoned one direction – we were talking about Amazon. They don’t need to make a profit. Tesla doesn’t need to make a profit. Netflix is losing over $100 a customer. They’re not needing to make a profit because of the stock market and because of their ability to take in debt. So there is no way to compete when one of the companies that you are competing with doesn’t have to profit.

David: It is interesting, because it is as if markets are driven by capital, and that in some ways redefines what we understand as free in that equation of free markets, because it really is who controls the capital, who has access to the cheapest capital, and how can you monetize your share price to be able to grow a business. And to be honest with you, if you operate in the private markets, as opposed to the public markets, you have limitations in terms of your access to capital.

I look at national firms, and this would be another example of a siphoning off of resources from local firms, where scale matters and where if you’re looking at cost structures, for a larger firm you can deal with certain efficiencies because of an economy of scale. And there is a little twist of irony. Here in Durango, we have a local bridge, what we all know locally as the bridge to nowhere, which was built under one of the Obama era economic recovery spending sprees.

Kevin: Huge. Millions of dollars. It looks like the mousetrap in Denver.

David: The construction company that built it was not from Durango. Not a single Durango local was hired to build this 10 million dollar bridge. I know because I spoke to somebody who was a consultant on the project, and there was not a single Durango person building the bridge. So, other than the temporary influx of hotels and meals from workers who were brought in from Denver and other large cities, the income, the wealth, was siphoned off, and ultimately circulated elsewhere.

So, there was an appearance of economic activity, but it had no lasting boost to our little town economy, as most of the 10 million dollars went into houses, retirement accounts, long-term savings, paying bills elsewhere in another part of the state, in another part of the country. This is my point again. Velocity is the number of times a dollar circulates through an economy. Small town velocity is just as important as state or national velocity, and these are the kinds of things that explain why we are seeing such a limp economic recovery.

Kevin: Let me, then, ask about the global, because you have talked about small economies, you have talked about national companies siphoning from the locals, but we have a global situation, too, where a lot of the workers that are here in America right now, Dave, are brought in. Go to Seattle. Try to find somebody who is not from India in the tech business.

David: This goes back to the conversation I had with the gentleman on the plane as I headed to the Midwest. When I described his comments earlier as realistically limiting, this is really where the conversation went because we are all thinking that Trump is going to spend – whatever he is going to spend – a trillion, two trillion, five trillion. Who knows, if he has four or eight years, how many trillions of dollars he will spend to improve U.S. infrastructure? But here is the reality, and this was the point of our conversation on the plane. Global firms siphon off cash from domestic ones.

I’m not trying to sound protectionist here. This is just a simple observation that in a market economy businesses seek opportunity anywhere they can. If there are going to be U.S. dollars spent, everybody is going to throw their hat in the ring. In 2010, when infrastructure spending was grinding to a halt in Europe – keep in mind, the decade preceding that, probably the two to two-and-a-half decades preceding that, where infrastructure was being built in Europe, and bringing it to a level that is probably ten times better than that of what we have in the United States.

And I say that from firsthand experience. I have spent a lot of time in Europe. Guess what? That infrastructure spending ground to a halt just prior to the pinnacle of the crisis in 2011. So 2010, infrastructure spending stops, and those European firms had to start seeking revenue in fresh geographies. Guess where they landed? Texas toll-ways, California high-speed rails – just about any other major infrastructure project is an attractive revenue target, and they’re here.

Kevin: Yes, but, isn’t there hope that Trump is going to try to go American, or go United States, when he is doing these infrastructure projects?

David: Right. Again, I’m not doubting that there is going to be money spent on the infrastructure projects. What I’m talking about is the siphoning off of cash, and it not being recirculated here in the United States. The real impact of spending a trillion is if it recirculates in the economy – once, twice, three times, five times – over a year where it is aggressively saved, spent, saved, spent, saved, spent. Again, this is the nature of a fractional reserve banking system. I’m not here to comment on the validity of a banking system like that, but just to say, you can deposit funds, it is re-lent, spent, re-lent, spent, and that is what gives you a bigger economic footprint from the dollars that go in when the government spends like that.

Kevin: Well, just a reminder to the listener, this is not a political talk, because you are sounding protectionist, Dave, and you’re not trying to. You are saying, “Look, we have to observe this objectively so that we know how to react to the changing system.

David: If Trump and his administration were able to stir economic activity by placing a few trillion dollars into the U.S. economy, for it to then roll around and recirculate, leaving a very impressive footprint, a considerable increase in GDP growth – that would be great.

Kevin: So, do you think that can happen?

David: That fact is, today, it can’t happen. At least, it won’t happen as desired. It can’t happen because civil engineering and contracting firms, the ones that have the capital to bid on multi-billion dollar deals – this is where the rubber meets the road – these companies not only handle design and construction phases and carry them from start to finish, but often provide maintenance via service contracts which are maintained over long periods of time. The reality is, we have four main U.S. firms that have the capability of doing this. There are 25 European firms that do, and are already here, and are bidding on the contracts and winning them. The sad reality is that as we begin to spend on U.S. infrastructure, there will be a massive flow of dollars to Spain, to Italy, and to other European countries that have access to – let’s go back to this whole idea of corruption of capitalism and how credit plays such a role – when you lower the cost of capital to nothing, guess what happens? You have companies that have cozied up to the state and they now have access, basically, to free credit for financing. Financing what? Oh, financing the deals that we are talking about here in the U.S. So, again, instead of dollars being spent in the U.S., recycled in the U.S…

Kevin: It’s the European Central Bank that is financing it.

David: Again, the nature, the dynamic of these deals, is fascinating. These companies will often bid a job and take a loss on it, so long as they add to current revenue.

Kevin: I want you to explain something, Dave, because I think a lot of people don’t know the difference between current revenue and profits. You have to profit to stay in business long-term. You are seeking current revenue if you are actually in trouble, right? Usually, if you’re just seeking current revenue and you’re doing that at a loss, that’s only going to last so long.

David: You don’t necessarily have to be in trouble. It can be a business model that says, “Hey, we’re growing our revenue, and as we grow our revenue, we are rewarded by an increase in share price, and we translate that increase in share price by going out and buying a new business, and buying that new business adds to revenue, and that increases our share price. It is a bit of a pyramid scheme. The way you work a pyramid scheme is it builds and builds and builds, and then it collapses instantly.

Kevin: Have you ever had work done on your house by a guy who is three houses behind in paying for what has happened? I have. That is a horrible thing. That is chasing revenue when you’re not profiting.

David: That is when economics finally catches up with you. But what I’m saying is, there is this deep subsidy in the marketplace today which is free capital, and it is allowing for a massive distortion, a massive ignoring of risk. And we’re talking about balance sheet risk for these companies, we are talking about a means of growth that, ultimately, is not sustainable. So then, when contracts, being the most affordable, and then often turn the costs of the project into long-term interest streams. For instance, let’s say I want to bid, and I know the cost of a project is two billion dollars – the cost – and I bid at 1.8. The local authority says, “Well, let’s do 1.8. That makes sense. They’re going to deliver under what our budget was, and I think the costs are going to be about that. That’s great. But then the company turns around and finances the deal and says, “Look, you don’t even have to spend the 1.8 billion. We’ll finance it for you. And we’ll finance it over a 50-70 year period. And so now, all of a sudden, the state is thinking, “Hey, this is great. It’s not going to cost us any money out of pocket.”

Kevin: They’re not just building a bridge, they’re giving you the loan to do it.

David: Right. Of course, when you structure those kinds of financial deals, you are often doubling or tripling the final cost of the project. And this is the danger of interest. We know this from a home purchase. I remember when I was 16 years old and I watched the folks who were buying my parents’ house in Parker, Colorado. We were there for the loan document signing, and there are all the disclosures and everything else, and here is what you pay for the house, and here is what you pay at the end of 30 years with interest. And it was more than double the price. And they looked at each other like, “How is this possible? That’s not what we agreed to pay for the house.” But what they hadn’t thought of was the cost when you include interest over time. So, you have these companies that are willing to take the loss up front, they have big enough balance sheets and big enough financial backers in Europe to be able to do this.

Kevin: Well then, let’s just bring this home to the point. The point is, we’re really counting on several trillion dollars being spent in our economy because of Trump, but we don’t even know that those dollars are going to be in the economy.

David: And that is the point again, because we are talking about a siphoning off of resources at a micro level, the siphoning off of resources at a macro level. And so, the main point is that resources that are likely to be spent by the Trump administration are not going to remain in the U.S. They are not going to recirculate through our economy. The end result will be far less substantial than anticipated because of the siphoning off of resources.

This, I think, is one of the things that contributes to the trend in lowering GDP growth expectations. This last week the New York Fed lowered their second quarter GDP numbers from 2.3% down to 1.9%. As we mentioned a few weeks ago, GDP statistics have been stagnant. They have been way below a natural and normal level, certainly below a level that you would consider to be healthy and robust for economic growth and recovery, and they have been there for over a decade.

Kevin: So, Dave, let’s talk about the model. The model of running a business where you are chasing revenue growth, and you are doing it with debt…

David: And you’re ignoring profit and loss.

Kevin: And you’re ignoring profit and loss. Now, this is a model that the government has given us for many years. We were talking about generations. I can tell you, my generation, the last 40-50 years, has left the millennial generation with a whole lot of debt, and very, very low growth – low GDP.

David: Well, the model of growth so popular among European civil engineering and construction firms today borrows from a playbook that we saw with Tyco and with General Electric, a playbook which in past periods provided hyper-growth for companies, and depended on constant acquisition and accumulation of revenue stream. So management of the acquired firms was less critical. Again, you could mismanage the business, but there was this up-front financial improvement which marked an immediate increase in revenue for the year, in the year of that acquisition, and Wall Street was just happy as a clam to do that. So GE ends up managing a debt book of 500 billion dollars, and they end up being more of a financial institution than – this is, again, the financialization that we were talking about earlier – GE by 2007 was as much a bank as they were a manufacturing giant

Kevin: There is something different about this, though, Dave. It requires forward momentum, and it requires more and more forward momentum. It reminds me of the scene in Top Gun when the two jets were fighting each other and the one flies through the jet stream of the other and it shuts the engine down. Why? Because there was no airflow coming into that jet engine. It’s really hard to restart anything that requires that much momentum.

David: You’re right. Debt if often the tool used to make acquisitions. It is what gives the artificial airflow. So yes, there is a significant increase in long-term balance sheet instability. But everyone today seems to be comfortable with leveraging up. And now it’s not just the pre-2007 banks and financials anymore. You have corporate leverage which has never been higher.

Kevin: So we’re at all-time highs on corporate leverage right now.

David: Yes. And not that this is a tangent, but I think it’s worth noting that if you go back to the 1990s levels of corporate leverage, which was 25% lower than they currently are, we have increased our leverage. If you just went back to where we were before, take off 25% of what we have today – leverage in the corporate sector.

Kevin: What would that do to profits?

David: Your profit margins would drop by 80%.

Kevin: Wow!

David: 80%. So yes, corporate America has fallen in love with what brought us amazing bank profitability prior to 2008 and 2009. But this is the point. Greece did this, Cyprus did this. Corporations in those geographies that use this model of growth hit a brick wall when finance capital was no longer available on reasonable terms. It was like not getting air in your engine. What happens? The engine shuts down? What happens next? The aerodynamics of a jet become really interesting when you have nothing to propel it.

Kevin: Do you remember back in the late 1990s when we had the tech stock boom? I read article after article – you probably did, too, because you were in the brokerage industry at that time – about how companies no longer needed profit. The PE ratio was something that was completely ignored by companies because what they were really doing was, they were thinking ahead and working toward the future. Tesla – Elon Musk uses this same kind of mentality. But it’s unsustainable. Those companies back from the late 1990s that were telling us that they didn’t need profit don’t exist anymore.

David: Yes, so returning to that, the unsustainable aspects of this model, when you ignore profit and loss, with a preference for focusing on revenue growth, of course, the grease in the gears for this kind of growth by acquisition model is low rates. That’s right, low capital rates, low borrowing rates. And that is the basis of financing deals.

Kevin: It’s critical.

David: What does this recall? It recalls Tomas Sedlacek’s warning that you have this sort of cult membership in a false religion of perpetual growth. There are limits, and it is easier to recognize what the limits of growth are, what the limits are of leveraging up and of borrowing to grow. It is easier to recognize them in retrospect than by anticipation. You know the limit when you reach it. You know the limit when you are in freefall. You know the limit when it is game over.

And quite frankly, we don’t know how far is too far in terms of corporate leveraging, we just know that we are now farther than we have ever gone before in terms of corporate leveraging, and it is beginning to reflect the same kind of risk-taking that the corporate level financial management is taking on the same kind of risk dynamics that you saw with Lehman, with Bear Stearns, with AIG, where there are risks that are being taken, and everyone assumes that it is going to continue working, and it does – until it doesn’t.

Kevin: So, let’s reflect on last week’s promise from the Federal Reserve because you said low rates are critical to this. Now, they have already told us that they are going to have four rate increases in the United States by the end of next year. How long can they raise rates where this formula still works?

David: I think that is the question that has to be asked. So four rate increases in the U.S. by the end of next year – the promise to reduce Central Bank balance sheet assets, which means they are selling off and allowing certain debts to mature, not repurchasing, to allow a natural flow off of their balance sheet.

Kevin: And the ECB is talking about tightening, as well.

David: It is not a promise, but they are suggesting it. So, when you look at a tightening of global monetary policy, is it possible that corporate culture learned something, but learned the wrong lessons from the global financial crisis? Is it possible that they learned that reward can be pocketed, that financial crisis, when it comes, is not a concern because risk can be socialized across a broad class – not of shareholders, but ultimately, of taxpayers? Because it sure looks like the way they are leveraging up, that is what they took away from the global financial crisis.

Kevin: Not one of those banking executives that caused the financial crisis back in 2008 – not one – went to jail or was prosecuted. This is an amazing thing, Dave. That was brought out at the end of the movie, The Big Short. You got to see the criminal activity, but really, what they are basically saying, and this is the mindset today, “Operating without regard for tomorrow.” We talked about generations. That is what we have done, but tomorrow is the next generation.

David: And it seems to me, Kevin, that there is this possibility that perhaps they weren’t breaking the law but that we changed the laws such that we moved into a crazy world that allowed them to do crazy things without any consequence for that craziness.

Kevin: And you’re just saying that they are probably thinking the same thing today.

David: Right. Glass-Steagall was eliminated, and all of a sudden we opened Pandora’s box for the financialization of the whole world and whole universe. Is it possible that that one thing changed our economy forever? I don’t think so, because again, when you are matching up liabilities and the income that it takes to keep payments current on those liabilities, there are natural limits.

Kevin: But sustainable economic activity takes a back seat to leveraged growth when you have that mindset.

David: Yes, so it seems to me that the mindset today is operating today without regard for tomorrow. And you’re right. If you’re going to have sustainable economic activity, you have to look and say, “How much leverage should we have in the system? Is there any way that we should put a governor on that, or are we just going to operate without regard for generational or future consequences?” And I think what we have today is a sort of generational indifference which seems to reflect a degree of selfishness that I think will be remembered and reacted to by millennials for decades to come.

I would like to explore this concept with Neil Howe, but how does one generation react to the generation or generations which preceded it? Every generation has its strengths. This is where we began our conversation. Every generation has its weaknesses. And I would suggest that one of the greatest weaknesses of the demographic, 50-70-year-olds today, is a heightened focus on self-service rather than self-sacrifice. There are notable exceptions – absolutely – notable exceptions to this, but the generation likes to focus on money.

And I go back to the conversation I had with the gentleman on the plane. It took him 50 years to learn that there was more to life than money. And yet, I think his generation pretty much would say no. And I think there a lot of things that you sacrifice – relationships included – for self-interest. Again, what’s in it for me, how many more dollars can I accumulate before my game is over?

Politics reflects the same level of self-interest. Politics has become a polite excuse for why nothing gets done by bureaucrats. And politics, if you wanted to use the word politics as a euphemism, it really is a euphemism for corruption, because nothing ever gets done without interested parties being taken care of first. This may be Brazil, this may be China, and they are obviously trying to break down on this and crack down on corruption there. We haven’t even begun to do this here in the United States.

But the last thing I would add to the list of things that siphon off wealth from the economy is just that – corruption in the political process. This, too, diminishes the economy’s ability to recirculate money through the economy, and it probably, in my opinion, gets worse before it gets better.

Kevin: Well, lest we sound too dark, there are independent decisions and individual decisions that you have encouraged our listeners to make, those who work with us to make, and that is, if you don’t like the debt economy the way it is running, don’t participate. Put yourself on a gold standard, doggone it, and makes sure that some of your assets are outside of a system that is so corrupt.

David: If you don’t like the siphoning off of wealth from small businesses in your community, maybe you should order, every other time you would normally order from Amazon, maybe you should go down locally and buy a book from a local bookstore, or buy this or that from a local pet store, rather than buy everything online.

Kevin: And develop a relationship with people and actually, maybe spend a little bit extra to buy a book at a local bookstore. There is one here in Durango, Dave. It is a great one. It is called Maria’s Bookstore. Yes, you’re going to pay more than Amazon, but there are relationships there. I can walk in and they can tell me what books they recommend. So is it worth the extra three, five, seven dollars? Yes, most of the time it is, if I just take the time to go down and continue that relationship.

David: Prioritize relationship. I think one of the things that rings in the back of my mind is a comment that Mark Faber made to us maybe two or three years ago. We were having a conversation, and it was about as gloomy a conversation as you could have. I asked him, I think, “So what does this mean? Is this the end of everything?” And he said, “Yeah, we’re all doomed.” (laughs)

Kevin: (laughs)

David: And I thought, “Okay, well…” But for me, the pivot point is discovered in the conversation with Neil Howe, where you say, “No, it is always darkest before the dawn.” And when you look at this 600-year history of cyclical change and cultural and political and social change, the evolution, or the devolution, that occurs every 100 years, the nice thing is that it happens about every 100 years, and we have some idea of how the millennials will be reacting, and what their disappointment looks like, and what their priorities and their values are, and how they take shape in reaction to the crisis that we are creating for them.

The hope is not that we get to avoid a financial crisis. The hope is that we have reasonable minds, and that we have soft and tender hearts, and that we have some awareness of a greater set of values and intangibles than have been cultivated in the current generation. And you look at that, as it is applied in the economy, as it is applied in our households, our daily lives, in our small businesses, the way we operate, the way we respect contracts, the way we invest in relationships – I don’t think it’s hopeless. It’s just the beginning.

The reason why we focus, and have for a long time, on precious metals is that it is a currency which allows for wealth translation through difficulty. It allows you to basically take something and put it in a time capsule and say, “Tomorrow, when I need it, I have it.”

Kevin: And it’s not based on debt, it’s based on reality.

David: And I don’t necessarily know what tomorrow looks like. That will play itself out as it will play itself out. But what I have is something that for 5,000 years has enabled free action and free thought. And that is what I am looking forward to. You look at what Neil Howe describes as a first turning, which follows the fourth turning. It is the spring that follows the winter. It is the new life that comes after death. And what is it exactly? What resources do you need?

We explored this with Chris Martenson a number of years ago. Basically, the resources are not just financial. Yes, we have an emphasis on tangible assets. But as I wrote the book The Intentional Legacy, that really was the focus, to say, “Hey, listen, in every generation, you have a choice to pull yourself up by your own bootstraps. It doesn’t matter what you inherited from the previous generation, it’s on your shoulders to set the trajectory for now and moving forward.”

And I think that is what we have on a broad scale, not just what you inherit – physical, tangible assets, or complete social and emotional emptiness and bankruptcy, because those kinds of things can be translated from one generation to the next. But the question is, what will you do with what you receive? What will you do with what you are receiving? You may not like it, and frankly, it’s up to you to change it.

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