The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“On today’s show Trump trumps out the Paris Accord and 93% of all positive employment numbers for the last ten years have come from a single fudged birth/death model. The stock market is soaring on new results of just five stocks rising while 495 stocks fall to the downside.”
– Kevin Orrick
“The reality is, when incumbents keep a strong economy they get re-elected. And to see the Trump phenomenon where the fly-over states where there has been more economic rot and no real benefit from the asset price inflation created by the Fed, what you have is the sociological expression of the B.S. in the BLS numbers.”
– David McAlvany
Kevin: Well, we talked about this, for the first time in 12 years, your dad is coming back from the Philippines, and you guys are going to go on a whirlwind whistle-stop tour, starting with the Western United States. We ought to talk about some of those dates because we are inviting all of our listeners to these intelligence briefings.
David: Absolutely. Starting mid July and going to mid August, and then we will pick up again as we head toward the East Coast in November. So, four weeks in November, one in December, and that will cap the year for us – about nine or ten weeks of travel.
Kevin: You’re going to start in Northern California, work your way down, and then on up to Washington and Oregon.
David: So July 14th we will be in Palo Alto, California. And then we will head further south to the north side of L.A., Agoura Hills, on July 19th. We’ll head up to Bellevue, Washington July 25th. And then over to Portland, Oregon on the 28th of July. Phoenix is the 31st of July, and we have two more things to finalize there, but we’re pretty sure the 31st is going to be the date for Phoenix.
Kevin: Then you are going to end up in your home base where you grew up, actually – Denver.
David: That’s right. August 8th there in Denver. We started the company in 1972 and that is where our home base was before we moved to Durango. What I would like you to do is RSVP if you think you can make one of those events, just so that we can prepare to have enough things to nibble on and sip on and things like that for you. So for your comfort and the comfort of the other guests who are going to be there, please RSVP. Let us know which friends you are bringing, which family members you are bringing. It will be a great opportunity to meet Don.
Honestly, this is how it transpired. My dad calls and says, “Do you need some help with the client conferences this year?” I said, “No, Dad, I think we’ve got it covered.”
Kevin: He’s calling from the Philippines.
David: That’s right.
Kevin: Middle of the night.
David: Yeah. And so, another two minutes into the conversation, “Do you need some help with the client conferences this year?” And I mean, I can be thick at times, but it dawned on me, “He wants to throw his hat in the ring.” He has something on his mind. He is watching things happen in Asia, which are absolutely amazing to him and he wants to talk about it.
Kevin: He had probably been in the process of writing his letter, too, because Dave, he is always fired up when he is writing his letter each month.
David: Right. I know he sees a lot of traffic in the gold markets because he is in Asia. He is in China and India, specifically, quite a bit. And of course, now, in the southern part of the Philippines have announced martial law, and he is kind of excited to be in country where – he’s living in a country where they are implementing martial law and he’s just glad to be there, and he wants to talk about it. So if you don’t know my father, you need to know my father. When he presents, it literally is like drinking from a fire hose. It’s really fun. Of course, this is the way I grew up. Since I was three years old forward I have been traveling with him, and honestly, we haven’t been on the road in 12 years and I got to thinking, just one-on-one time that we’ve had. The last one-on-one time I’ve really had with him was Shanghai five years ago. So to me, this is going to be a great nine weeks in two tranches.
Kevin: Let me just add, it is not just the conference each night that you are giving, but you will schedule consultations the next day. So as people RSVP if they want to sit down with you and Don…
David: Absolutely. We’ll make it very fruitful that way, too.
Kevin: So, if you’re listening, and you want to come to one of these, call 800-525-9556, ask for extension 118 – Karis – she’ll take care of the RVSP. We would love to see as many people as can make it.
David: Managing tangible wealth is something that we do quite a bit of in our day to day lives. The book that I wrote this last year had to do with managing every other form of wealth. So, it’s not the only thing we focus on, but I think some people don’t consider the tangible asset – they just think about wealth management in general.
Kevin: Speaking of your dad – your dad trained you to understand tangible wealth. You and I were just sitting and talking – how you are training your kids – the same thing. You are teaching them how to think about money, how to think about growth, how to think about capital, and expansion of that capital.
David: My first training in tangible wealth, I think, was when I six years old, going down to the bank and counting Krugerrands in the safety deposit box with my dad. I said to him, very boldly, “Dad, when you die, can I have all of your gold?” As a person who is not really thinking about his death, not then, nor now – he’s 77 and strong as an ox.
Kevin: That had to take him back a little bit.
David: I think he thought it was impertinent. So, anyway, as a family, we see the importance of tangible wealth. That could be land, that could be livestock, that could be art, and certainly, it’s ounces. I want to start today with a little bit of a rabbit trail on little people, and little treasure chests.
Kevin: You’re talking about your kids – little people.
David: Exactly. And for them, the little treasure chest is typically a cigar box. Both of my older boys brought a cow to market this year.
Kevin: This isn’t the first time, is it?
David: No, no, no. They’ve done this a couple of times. The challenging question for both of them – do we invest for cash flow, or do we invest in tangible wealth in another form? So from dollars on the hoof, as their grandfather likes to say, to now, dollars in the form of ounces and will they fill up their treasure box? And that’s where the quandary begins?
Kevin: You let them make their own choices. You help them through it, but they do sit down with their money and they make choices.
David: They have, again, a deep intention of filling that treasure box. Maybe it’s a family trait to be that goal-oriented, but fill the box they will. You can see the gleam in their eyes. It is amazing to see the sense of accomplishment in filling the box just a little bit more. So, we gave them a third choice this year which involved a little bit of financing. Mom and dad would buy a lawnmower, weed whacker, leaf blower, and they can work against the total bill, which will take about 37 weeks to work off. At the end of that timeframe they own the equipment. They own it free and clear, and the future cash flow for them depends on the amount of time they want to spend building up a list of clients in the neighborhood.
Kevin: So you bought the equipment to start them out. In a way, you financed it, because they are going to be cutting the lawn now for a period of time at a given rate, and they are going to be paying off the equipment only to own it free and clear to use it however they need to afterwards.
David: That’s right. So in the meantime, there are other decisions to make, because, again, they have these dollars that they just got from the cow and they could have bought the equipment outright. And they said to themselves, “No, we would rather own the ounces today, versus worthless fiat.” Again, that’s an ingrained family bias. For their money, silver is very attractive, and they are trying to fill the box, and they don’t want anything to deter from that goal – even creating a business with cash flow. So, it’s a question of – “How can we do both?” And we gave them the means to do both.
Kevin: Dave, I think what is interesting about this, I have the conversation so often with people saying, “I just don’t want to be in debt. I never want to use debt. Is there ever a good time to use debt?” And actually, there are times that debt can be managed accordingly to help build a business, with the idea of ultimately getting it paid off as quickly as possible. You are teaching your kids, for the first time, I think, ever, about the positive aspect of debt.
David: I think there are a lot of things that, in life, can be dangerous, but aren’t necessarily so. For instance, if you drink too much wine, that can be dangerous. If that becomes a life habit, it can be debilitating, controlling, and ultimately up-end relationships. But there is a proper approach to that, too, as a part of celebration, which, I think, can be, because of the danger, completely missed and ignored. Debt is the same way.
So, for the time being, they are now debtors. They have tangible wealth sufficient to pay off the equipment at any time they want, and they are leveraging several things. They are leveraging their time because – guess what? They’re out of school now, and they have the option of entering into the neighborhood in search of other lawns to cut, which would allow for the accelerated payoff of the equipment. And they are also capitalizing – leveraging this, they are capitalizing on the silver-gold ratio. They know that at some point if they want to sell a few ounces and pay off the equipment sooner, they can do that.
Kevin: Well, they have been playing the silver side more than the gold side, based on the ratio. So you have taught them that, as well.
David: Right. Now, I want them to have a deep-seated concern with debt, and a clear priority to pay it off aggressively, and to avoid it when possible. But there are reasons to take it on, and if one has a plan and will actually pay it off on schedule or ahead of schedule – again, it’s learning to deal with things that are dangerous in a responsible, grown-up fashion. Because I don’t want them experimenting with their credit cards at the age of 18 for the first time, not knowing, really, what debt is, except that you slide this thing and magically, you can buy anything in the world you want with it, with no cognizance of – there is a payday.
Kevin: Right. And a credit card – 18%, 20%, 21%. Now, dad and mom probably didn’t go for the credit card rates.
David: (laughs) To be frank, I’m conducting my own Federal Reserve operation on a very small scale. The interest rate is nil.
David: We have a zero interest policy right now, and I’m interested in stirring economic activity with my zero interest rate policy. So again, if I can sort of borrow from Janet Yellen and Ben Bernanke – should I even be admitting this? It seems like the variable I prefer. Here is where we negotiated our own implicit interest, if you will. We negotiated a lifetime set cost on the yard work, at a reasonable rate, with no adjustment for inflation into the future.
Kevin: All right, now, wait a second Dave.
Kevin: This is where I think you maybe have gotten one over on your kids. You are teaching them about inflation, as well. You set in a lifetime rate? They’re very young.
David: I think over the course of the agreement we both win because on the front end, they’ve got the equipment, and on the longer term basis, they can grow their client list, and of course, they can adjust prices as needed to adjust for inflation. But the capped cost of service for us is a great payback in lieu of any interest cost, financing cost, and we got them set up. This is like the cost of seed capital.
Kevin: Okay. Dave, I know your two boys that you’re talking about right now, and they are negotiators, and you have taught them to negotiate. How in the world, down the road, are they not going to start renegotiating the contract when they see inflation eating up their dollars?
David: I was tucking them into bed in their bunk beds, and literally, the second-born is already attempting to renegotiate. He said, “Well, we were really just talking about the back yard, right? You did the front yard, so what we agreed to must have only been the back yard. If I do the front yard, too, then it would have to be X-plus.”
Kevin: He didn’t remember seeing that in the contract, did he?
David: (laughs) In future years I suspect there will be other attempts to renegotiate, and my guess is that it is going to hinge on the inflation piece. Because, you know, Keynes said that there is not one in a million people that understands inflation.
Kevin: John Maynard Keynes said that hardly anyone understands it, but it is a hidden tax on everyone.
David: I think they will fully understand it before they graduate from high school, and they are in the process of learning, sort of Econ 101.
Kevin: You used to cut lawns. How much did you charge, Dave? Let’s see what has inflation has done from there.
David: In the 1980s I cut lawns – this is in suburban Denver – the standard was probably ten bucks. A really big lawn might have been $12 or $15. And that seemed like a lot at the time. If I did four lawns, man, I was knee deep in clover. It was fantastic. But let’s say that between then and now the Fed has changed the picture a little bit. I think you look at real incomes and they haven’t necessarily risen with the multiples that we have seen in a variety of categories, including the cost of lawn care, which is up – I don’t know – 300-400%.
Kevin: And lest one of our listeners is possibly thinking we’re just reminiscing and talking about your family, there is a lesson here for all of us as to how to manage our funds, when to be in tangible assets, when to be actually expanding and investing in our own business. It is important that we all learn these simple lessons.
David: I had a friend ask me the other day, what ten books she should read on the topic of investing and economics. And you’re right – here’s the main point. Economic and financial education is like eating an elephant. You do it one bite at a time. Taking another bite – last night my conversation migrated with my oldest. He is eleven years old now. We looked over a number of silver-producing companies.
Kevin: You’re talking about mining companies.
David: Right. And he has a stake in these because the last time he sold a cow he put a few hundred dollars into this. It’s just a few hundred bucks, but for him it’s like, he’s a player (laughs). It’s fun to see. But he said this. He was surprised by, number one, that in any given year, there is only a third of the silver produced globally which comes from primary silver mines. The remainder comes from by-product.
Kevin: Isn’t that surprising? So, silver mines – they don’t go get silver, for the most part. Only about a third of the silver was the active goal.
David: Our primary producers.
Kevin: It’s a by-product of other metals.
David: Yes. Zinc and lead, primarily, and copper, they are after. And lastly gold. And so, this is one of the things that adds to supply constraints. When you see explosive moves in price, it is because demand is very elastic – supply is inelastic. And that is one of the dynamics you have with precious metals. The other thing that he pointed out as we were talking about this around the back table last night – I’m smoking a cigar and he’s asking me questions about what I assigned him to read. He loved the idea that a two-dollar move higher in the price of silver can represent a 50% increase in profit to the company, where costs are held relatively constant.
Kevin: That’s leverage.
David: That gives investors considerable leverage to move in silver. So with the last cow he sold, as I mentioned, he bought a collection of silver companies. Those silver companies that he bought, collectively, produce just shy of 76 million ounces of silver a year. So he learned an acronym last night that he had not known before – AISC, which stands for All In Sustainable Cost – brand new concept for him. The all-in sustainable cost, on average, for these companies that he owns is $11.50.
Kevin: And see, we have silver nearing $18 an ounce at this point.
David: Right. So every dollar increase in silver to the spot price produces an extra 76 million dollars more for these companies. Now, of course, if the price of silver drops – guess what (laughs)? They lose that amount of money, in terms of revenue, very quickly, as well. But here is what he could not wrap his mind around. He was stuck. He couldn’t wrap his mind around how companies that are increasing their profits, and are fundamentally stronger today than a year ago, are selling for less than what they were a year ago.
Kevin: Yes, the shares have been dropping.
David: We talked about this, in the first quarter, cash flows increased by 29% amongst this group of silver companies, and yet the share prices are lower than they were a year ago.
Kevin: Dave, this is the beauty of the free market. The free market is not the efficient market hypothesis, which says, everything is priced correctly based on the information that is out there. The information is saying that, just like what your son was looking at, the cash flow has been increasing on these companies as silver has risen, yet the share price has been dropping. That is an opportunity. Free markets provide opportunities for you to see something that maybe someone else did not.
David: Right. So in this process of economic and financial education, again, like eating an elephant one bite at a time, the next lesson has to center on the wonders of the efficient market hypothesis, and other zombie economic theories. Again, just one bite at a time.
Kevin: Well, let’s talk about zombie economic theories, then, because it seems that the only thing people are watching these days – it used to be you could watch interest rates and say, “Wow, okay, so risk is increasing in the market, or dropping in the market,” but they have been saddled and manipulated by the Federal Reserve, and it has gotten to be where the only thing people are really looking at financially anymore is, “When is the Fed going to raise rates? When are they going to control rates one direction or another?”
David: Well, one thing I’m fairly certain of is that the Fed does not hold the sun, moon, and stars in space. There are greater powers in the universe. But you still watch the back and forth from the Fed governors, and the consensus here, one week out before their expected rate move, is still that they will raise rates once in June. The tenor, however, is shifting toward rethinking further hikes through the end of the year. And you might ask, “Why, pray tell?” I think the jobs number on Friday certainly factors in. It raised concerns. Even with the usual massive additions from the birth/death modeling and your seasonal adjustments, and those things which kind of represent shenanigans in the world of statistics.
Kevin: Even with the fudging they came in under what they thought.
David: That’s right. The numbers came in way below the consensus – 190,000 was expected, 138,000 was less than ideal. Just like we have seen before, there is sort of a pragmatic acceptance of the Fed as a partner to the White House. This is, I think, one of the critical things that you see as sort of a changing of the chameleon’s colors. Prior to Trump taking office he was very critical of the non-farm payrolls numbers. He was the guy who was saying, “Look, this is totally fake, this is contrived, this is B.S. from the BLS. Their methodology is awful.”
Kevin: Now we hear nary a word.
David: That’s right. No methodology has changed, no heads have rolled, but he is the beneficiary of good news, and hopeful that more will be coming.
Kevin: Well, he is a pragmatist (laughs). He does try to get the deal done.
David: That’s right. And one thing we do know, with a degree of certainty, is that Trump is not one of the beltway elites. All of the elites are a little uncomfortable with him. But he is learning that politics is highly pragmatic, whether you are a beltway elite or not. Bill King, this last week, mentions that 93% of the new jobs reported since 2008 have been added through the birth/death modeling.
Kevin: That’s amazing!
David: Just since 2016, 40% of the jobs – again, since 2016 40% of the jobs have come in from that same statistical modeling. Recall, this is an assumption of how many people are born, how many people die, and in that life cycle, how many people are likely to start businesses, and thus hire people. Tell me there is not a little squishiness in that.
Kevin: Yes, that’s beyond a soft number. And you’re saying 93% of all the new jobs added since 2008 have been part of this soft, squishy, vaporous model.
David: So there are a lot of assumptions that go into the model, and it gives you pause when you think about the 4.3% unemployment statistic, the U3 statistic. I think the U6 is closer to 8, 8.5, 8.4, something like that. 93% of all new jobs since 2008 are from the birth/death model?
Kevin: This is incredible.
David: This is like some version of cognitive dissonance where the statistics fly in the face of economic reality. But again, bear in mind that the true unemployment number…
Kevin: Isn’t it interesting? If we actually had that true unemployment number down at 4.3%, the Democrats probably would be in office right now. Trump came in based on the fact that the unemployment number was not correct. It was being understated, which is the same case as overstating employment.
David: Look, I think this is a completely politically neutral conversation here because the reality is, when incumbents keep a strong economy, they get re-elected. To see the Trump phenomenon, where the fly-over states where there has been more economic rot and no real benefit from the asset price inflation created by the Fed, what you have is the sociological expression of the B.S. in the BLS numbers.
Kevin: Last week, I remember having you repeat, partially for me – we talked about how the GDP for the last ten years has matched exactly the GDP numbers, the growth numbers, for the 1930s, the Depression decade. This is a statistic that is very similar to that, Dave. Over that same period of time, if 93% of the new jobs created were just part of a modeling process, the birth/death model, this whole thing is a scam. Yet, we have the stock market hitting all-time highs.
David: This is a subtle point, but a very important one, because we are talking about the birth/death modeling, and the reality is that in the latest non-farm payrolls, even with the help of 230,000 added jobs via the birth/death model – that is what was imputed into the most recent number to get it to a positive number. 230,000 jobs were added via the birth/death model, and it still missed expectations. So what that says is, the stock market is reaching new highs. For anyone with historical recall, these were the kind of circumstances which preceded 2008-2009.
Kevin: It was reaching new highs at that time. The tech stock bubble back in 1999.
David: It’s an ebbing of economic fundamentals in the face of rising stock prices, and the disconnect is there. The question is, how many people in the market choose, or past tense chose, to ignore it. You can call it a black swan all you want, but these kinds of divergences, you say, “Okay, well look, this can continue, but not forever.”
Kevin: Let’s get in our nine or ten-year time machine, Dave, and push the button. Oops – we’re back about nine or ten years. The Fed was hesitant at that time to raise rates. Even though the stock market was hitting highs, it was like, “Oh, I don’t know if we’re going to do that.” Go back ten years before that, 1999. Tell me this is not a repeating pattern.
David: And there is a similarity. Doug Noland reminds us this last week that the Fed was similarly hesitant to tighten policy in 1999. What was the context? We were following the long-term capital management debacle. All of your MIT Ph.D.s and mathematicians were putting together a trade that could not miss, could not go wrong. And they leveraged up so much that they almost brought down the entire financial system. This was just one financial firm that no one had heard of.
Kevin: Dave, this is hardly what the Federal Reserve was intended for. They basically said, “Yes, we’ll step in, and we’ll provide a punchbowl until the party gets started, but we’re going to pull it out.” Who was that who said that? Was it William McChesney Martin?
David: That’s it.
Kevin: He said, “Remove the punchbowl just as the party is starting.” We’re well into the party, Dave.
David: Right. But you’re talking about a different era of central banking, too. You’re going back to the mid 1950s when it was understood that you need to moderate excess. You don’t want things to get crazy. But they were concerned.
Kevin: There was no Amazon or Google back then, Dave.
Kevin: “We’ve got to keep those stocks roaring.”
David: Y2K was also an issue. They wanted to remain accommodative, and so they did, while asset prices were absolutely going nuts. Now, Amazon, Google – what is hitting $1,000 mark per share right now, and close to hitting $3,000 if you’re looking at Bitcoin? There are a number of things that are going interestingly higher at a rate which some would describe as unsustainable. A rate of change, in any year’s timeframe, that is between 150 and 200% is ultimately unsustainable.
1999, if you recall, the last stretch leading into the collapse of NASDAQ, was 120% Sprint, and it literally was going parabolic. It was going straight up in too tight a timeframe. If you go up 120% over a ten-year period it’s no big deal. Over a five-year period it’s no big deal. Over a one-year period – try doing that year-in, year-out, and you run up against physics. You run up against something that is not sustainable. How many people will continue to buy it – can continue to buy it – and on what basis?
Kevin: You run out of buyers. And when that happened with the NASDAQ back in 2000, Dave, as you recall, it took us 17 years just to break even. They lost over half of their value almost instantly. And then we just got past that number that they fell from just a few months ago on the NASDAQ.
David: There is another fascinating similarity, an aspect which we see today which we saw then, as well. And that is that at the end of a bull market run, the dollars being invested get squeezed into fewer and fewer names. So it’s not the general market which is going up, your index is being dragged up by five or ten names, whereas in an index of, let’s say, the NASDAQ 100, you could have 90 that are literally circling the third level of hell, but you have ten which are going gangbusters.
Kevin: And it’s pulling the average up.
David: That’s right. The same thing is happening right now. You have five companies in the S&P 500 which, since March, have added 260 billion dollars in market cap, but this is in a note from Marc Faber this last month, 495 of those companies since March have shed almost the equivalent amount in market share. So you lose 260 billion on the left hand, you gain 260 billion on the right hand, and actually, the index has looked very healthy. But under the hood, you realize, no, it’s only five companies that are doing the heavy lifting. So again, there is this fascinating aspect where in the last push in a bull market, your interest narrows to just a few names. This is a problem with the S&P 500. This is a problem with NASDAQ. Why? Because these are cap-weighted indexes, which means the guys with the largest capitalization continue to see the largest amount of flow. And this is exaggerated by trends we’ve talked about for the last several months relating to ETF purchases. This is no accident that you’re seeing a clustering effect with just five names, because again, the indexes, themselves, are built around cap-weighting.
Kevin: Remember the old saying, “When the shoeshine boy gives you stock advice you’d better get out.” Right now, the shoeshine boy, I think, owns a lot of Amazon, owns a lot of Google, and he’s giving a lot of advice.
David: But the investors, both professional, and the passive type who are just buying the indexes and getting these, are along for the ride. They are riding a momentum wave. And that’s great. But I think what they will be surprised by is that many of these waves do crash, and that the similarities today versus 2007-2008, and 1999-2000 – there is nothing that says the NASDAQ can’t add another 1000-1500 points in some sort of a manic move higher, or that the Dow can’t surpass 22,000-23,000. We are putting in an epic top, and you have all the hallmarks of an epic top, including the inability for any professional to actually call the top. Why? Because you don’t know when the psychology turns. It goes from manic to depressive – like that.
Kevin: I’m just looking forward to looking into the rear-view mirror. I don’t want to see anybody really lose, but Dave, as we do this show, and as we did the show last week, I’m just thinking ahead – we’re going to have a rear-view mirror show, and we won’t know what trigger the press attributes to the crash but “not only did we see this coming and should have seen this coming, but here are the effects and this is how you’re going to get through this.”
I want to shift. You talked about politics just a few minutes ago. And speaking of rear-view mirror conversations, we talked about the voter cheating that was going on before the elections last year, during the fall. It was like, “Wait a second, where did those voters come from? Wait, where did those voters come from?” Now it looks to me like Virginia is cleaning the mess up, the elections are over, and now they are nullifying some of the votes – I don’t want to say they were all for Hillary, but it was an interesting trend, wasn’t it?
David: You look at the way the Dalys ran Chicago, and the way that Chicago politics – everyone knows that there is a bunch of people buried out back who are still casting votes, and it’s been 20 or 30 years since they were buried, but they’re still casting votes. And that’s called Daly politics.
Kevin: Not day-by-day, but it is Daly politics.
David: This is fascinating to me – the citizen defect. I read this in about six different places. A citizen defect is the cause for over 5500 votes and voters in Virginia – not Chicago, but Virginia – their registrations being canceled and their votes being canceled. And the issue is, they’re not American citizens. They’re foreigners. And believe it or not, that’s part of the rules of the road, if you want to vote.
Kevin: You have to be a U.S. citizen, I think.
David: You have to be a U.S. citizen.
Kevin: You’re supposed to be.
David: I am curious – this is just a point of curiosity, not a bipartisan comment, but I’m curious what percentage of them voted for Hillary or for Trump. And I’m also curious about people in the next election, what their disposition is going to be toward ID requirements because curiously, these 5500 voters were in a state that required them to show ID. So what is an ID? Everybody knows that you can buy alcohol as an under-age person if you have a fake ID. But did you know that you could also vote in a national election with a fake ID? Because there are 5500 votes that are being yanked. Really, you know what I’m most curious about. You remember ACORN, that community organizer.
Kevin: That conservative lynchpin of liberty.
David: I’m wondering if they have any workshops on who, when, where, and how to acquire IDs. So, just by extrapolation – this is not factual, but by extrapolation, if every state had an equivalent issue of 5500, you would be talking about a quarter of a million fraudulent votes across the country. Is that material?
Kevin: Well, you know, the outcome of the election was different, even though there was fraud that went on. I’ve been watching the last few days, the press just foaming at the mouth that Trump threw the ecological system under the bus by not approving the Paris Accord, and not wanting to participate in the Paris Accord. But it is amazing, the misinformation that has been coming out. You have people who really do believe that Trump’s decision was a decision to fill the air with pollution, and to ruin plant life worldwide, when really, it all turned out it was just redistribution of wealth. It was a money situation.
David: So whether it’s Pittsburgh or Paris – that’s a way of rhetorically contrasting who is in the driver’s seat and who is the favored audience, I guess you could say – it is fascinating to read in the international press – I get an Economist read and Financial Times sends me stuff, and so I wake up in the morning and I’ve got five messages waiting from a variety of news sources. And one of them was China is expected to lead the climate debate since the U.S. has pulled out of the Paris Accord.
Kevin: That’s amazing because China wasn’t even going to participate in the Paris Accord until about 2030.
David: I know, that’s what I thought was funny. The two most populous nations on the planet, accounting for 37% of all humans, hadn’t even made the Paris commitment, and yet the international press, on Trump’s faux pas, is willing to say, “Well, it looks like China is going to lead the way.” Are you kidding me? If you want to criticize Trump on that, be my guest, but to elevate China – that’s just ludicrous.
Kevin: You sent me pictures when you were in China, trying to see the building across the street, and the pollution was so bad, it was just fog.
David: I tell my children, never stare into the sun, and yet, in Shanghai, in Beijing, you can stare into the sun and you actually barely see it.
Kevin: And China was not even going to participate in the Paris commitment, yet now, the Economist magazine – I’m going to guess it was the Economist magazine that sent you your little clip that said now China is going to be the leader.
David: It is interesting how the press does spin these things. I loved reading on Elon Musk’s throw down with Trump that he quits Trump. I just instantly thought to myself, “You know, what if the federal government quits Elon Musk? Who is going to replace the 4.9…
Kevin: SpaceX and Tesla.
David: But all these projects – that’s fine if he is using his own money, but he has to replace 4.9 billion dollars of government subsidies. What is Tesla without government subsidies?
Kevin: But he crossed his arms and said, “I quit Trump.”
David: I appreciate his sense of [unclear]. I just wonder if shareholders appreciate, as the L.A. Times pointed out, that the viability of Tesla hinges on government pork. Relationships run two directions. Trump can quit Tesla, too, and that impact might, in fact, be material.
Kevin: While we’re talking about China, their debt has been spinning out of control. It has been growing massively. And now we see the debt downgrade that we have been looking for.
David: And it was fascinating to see currency speculators decide to get in there, short the currency…
Kevin: Which would have been a correct move if it weren’t manipulated, right?
David: Well, this is the interesting thing. You learn something about political will. The Chinese force their currency up to a seven-month high, and basically, scolding the rating agencies, and according to Bloomberg, this is an interesting sort of issue. We have a command and control economy, which you might recall…
Kevin: That’s another word for Communist.
David: Ours included in that, where we don’t have the free market driving interest rates or prices. But you have the will of a body of people that can, in the short run, thwart normal expected market trends. And of course, that is to the consternation of investors, that is to the consternation of speculators. Now, they can’t do that forever, but I can tell you what pain feels like. Pain is real in the moment that you are experiencing it. And currency speculators got their heads handed to them by the Chinese, who basically said, “These rating agencies don’t know anything. You think our currency is going to go down? Watch this.” Flip the switch, spend a few – however many – millions or billions of RMB, and the currency is off and running.”
Kevin: You talked about the unsustainability of rapid growth, and talk about rapid growth, let’s just look at debt in China over the last few years.
David: I always love reading Michael Pettis’s look at the economy. He has a very fair approach to what’s working and what’s not working.
Kevin: He lives right there on site.
David: That’s right. He teaches in Beijing. And to look at the estimates, going back seven years ago when we were running double-digit rates of growth, and they gradually started bringing those down to 6% and 7%, and real world, he would estimate, and other economists, too, 3-4%, not the 6% to 6.5% stated. And there have been some periods – if you recall, our conversations with Minxin Pei and a few other people with sort of direct access to the Chinese markets, probably running at zero. And they know how to paint-the-numbers like we know how to paint-the-numbers, because that is the nature of statistics. You need to figure out the narrative that is appropriate for the audience, and then just tell the story the way it needs to be told.
Kevin: But if you can’t have GDP growth, you have to grow the debt.
David: Here is where the numbers don’t lie. Chinese debt has grown, if you go back to 2010 – 2010 – we already had 200% debt-to-GDP in China, and those numbers have moved 250% since then. So current debt-to-GDP figures are 250%. The U.S. is not even 120%. That is not saying that we smell like a rose. Reinhart and Rogoff have said the wheels can, probablistically, come off, once you get above 90%. In fact, all cases of the wheels coming off, it has been with debt-to-GDP numbers of above 90%.
Kevin: And China is 2½ times that.
David: And that is not to say that getting above the 90% threshold is the trigger or the cause, but it sets the environment for a collapse in debt. And so, this is very interesting. We have the 250%. Debt levels are still rising in China in spite of the government’s efforts to control and to put a cap on them, which proves the other side of the story. By force of will, the government cannot achieve anything it wants. It can do some things for a short period of time, but it cannot achieve anything it wants. The market still speaks. It will achieve what it can, and then the question is, “At what appropriate level of cost?” Because to anything that you do there is a financial cost, a social cost, a political and economic cost, and so now we have the nearly 10 trillion-dollar shadow banking sector in China. It continues to grow. As we talked about last week, we have the yield curve inversion which tells you exactly what you can expect.
Kevin: Short-term rates are higher than long-term rates, the cost of long-term rates. That always tells you there is a crisis on the horizon.
David: Right. It doesn’t tell you when, it just tells you that it will happen. So, what is in the pipeline? Massive, massive change in Asia. This comes back to my dad looking and saying, “Yeah, but…” This is a point where my dad and I agree and disagree. He sees the rise of China in the region. He sees massive consumption in China and India of gold, and he knows, ultimately – ultimately – that’s a long-term characterization – ultimately, “He who owns the gold makes the rules.” It has always been that way. You go back through the history of time, “He who owns the gold makes the rules.” And he sees this fundamental shift in Asia, and it’s happening.
So, where will China be 20, 30, 40 years from now? No doubt, it eclipses the United States. No doubt. But between here and there, there is a long road. Keep in mind that the road to global leadership in the United States, handed off from Great Britain to the United States, included us going through a Great Depression where we lost half to two-thirds of our banks, and the financial markets were closed for a long period of time. The only way we actually recovered on the other side of it was on the other side of a world war.
So there are a lot of things that happened in the transition from 1919 and the cranking up of the financial engine in America with the first loans – those were the first years that we made mortgage loans – to 1956 when you could say, definitively, at Suez, “The British really don’t control the world anymore. The U.S. has taken their place.” So, it’s a long road, but between here and there, is there room for massive hemorrhaging in China? I think so.
Kevin: You know, we talked about the Paris Accord, and I have to admit, I was happy to see that Trump kept his campaign promise. But I think we should also be realists at this, Dave, and not just say, “Oh good, well, our team won.” Trump’s report card is not looking great on an awful lot of his campaign promises. And I think, to be fair, we need to look at some of those things.
David: And honestly, when we say, our team, I remember that our team is We The People. And what we are interested in is the Constitution. I think of what the marines look at. They look at loyalty to what? Neither political party, nor a flag, but a constitution which is represented by many other things. So they have respect for positions, office, and symbols, but it is in light of ultimate loyalty to a constitution, and to this thing that we have organized – a social contract where We The People are engaged.
Kevin: Well, and I would say, our team did win, no matter who the president was, whether it was Hillary or Trump, if we would not approve the Paris Accord, because that was just a bad deal for the United States. But Dave, he is reneging on some very clear campaign promises right now, and we need to look at that.
David: Rolling Stone had a great article back in 2009. Matt Taibbi – he loves – he loves – spitting in the eye of Goldman-Sachs. If you haven’t read any of his articles, they are really a fun read. But he made clear in 2009 that the big winner in the climate battle was Goldman-Sachs. And he connects all the dots between the deals that they have made, the people that they have invested with…
David: And the ways that they benefit, whether it is from trading carbon taxes – they are set up to win.
Kevin: Money and privilege.
David: So from that standpoint, you’re right. It is very interesting that pulling out of the Paris Accord – think of who it stunned most in the financial circles, and it was probably Goldman-Sachs. At least, according to Matt Taibbi. So, three disturbing facts from Trump in recent days. Again, this is kind of continuing what he said he was going to do, and hasn’t done, or what not. He reneged on the campaign promise to move the U.S. embassy in Israel to Jerusalem. That was just last week. That was campaign rhetoric, understand, but what that brings into question is, how do we decide what else is just rhetoric? Because he said, “We’re moving. That’s it. It’s a done deal. Planting the flag in a new spot.”
Kevin: Let’s look at immigration, because that was one of the major, major issues that he won on.
David: It is fascinating that it is actually Breitbart, and you know, there is a connection to Bannon and everything else in the White House. But Breitbart reports that you have nothing but a continuation of the Obama administration’s policy of catch-and-release at the border. It’s not precisely the same thing as building a wall.
Kevin: Not even close.
David: Listen, whether you want a wall or not, that’s not the point. Maybe this is, in fact, a good thing. But Trump is more of a windbag than a man on a mission.
Kevin: I’m still waiting for the swamp to be drained, Dave. At this point, I’m not seeing much in the way of swamp drainage.
David: This is probably the most bothersome thing to me. Swamp draining was actually intriguing rhetoric from the campaign trail. I look at the amount of corruption. I look at what gets done in Washington because there are no term limits, because politicians some and they stay, they grow old and they die there. And they act like leeches on the average taxpayer, for their professional careers. And they become the “ruling elite,” which is absolutely preposterous. That is not what leadership in D.C. was ever intended to be by our founders. You go back as a citizen statesman and you give your time and that’s it.
So to me, the rhetoric of draining the swamp – very intriguing rhetoric. Of anything he had to say on the campaign trail, that spoke to me. But now you have several top Trump officials who are being granted ethics waivers – 17 precisely. That bothers me. That bothers me. Now, Trump has not done any more than the Obama administration did. The Obama administration issued the same ethics waivers to 17 people. The difference is that Barack Hussein did that over an eight-year period, and we have that done in less than eight months in office. I don’t like it. I don’t like it. It just speaks to me of saying one thing and doing another.
I want to come full circle, because we started on the issue of managing tangible wealth, and I just want to return to a dinner table conversation with four little people, and I have some little people that don’t even understand what we’re talking about. But we often circle back around to what we know, and what we don’t know. We know that our banking system is over-leveraged. We know that it’s frail. And we know that it is paying nothing on deposits. That is the point that my kids get because they’re getting paid nothing on their deposits at the bank. And they actually have the common sense to express outrage that banks can lend out their money without giving them adequate compensation.
Kevin: The bank is still making some money when they loan.
David: Absolutely. Borrow short, lend long. That’s the nature of banking. But the benefit to the depositor just isn’t there.
Kevin: And you have taught your kids that the fiat money system – the dollar, and all paper currency, is just on a slow grind to zero.
David: All right. So we know that the banking system is not quite perfect. We know that our fiat money system is on a slow grind to zero, as you say. We know that real economic hope does, in fact, lie in economic risk-taking and individuals who are willing to engage and solve problems, who are willing to innovate, who are willing to create new opportunities and new employment venues. We know that deploying capital, opportunistically, requires that some of your capital has to be safeguarded or held in reserve.
And so, I return to something very simple, something that makes sense to a three-year-old, to some degree, because he already has a box and he loves putting stuff in it, to a six-year-old who is feverishly adding silver to her cigar box, and to an eight and eleven-year-old – simplicity of ounces in a cigar box. That is something that little people get, and it’s actually something, sometimes, big people don’t.