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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

August 29, 2018

“We’re looking at it wrong. We shouldn’t be thinking about how we get to live larger lives because we have cheaper imported goods. If we made more money and had a stronger dollar we could buy more goods from the rest of the world, and we could get it a different way. It would be through the wealth of the nation and not through impoverishing the nation and creating a long-term structure of debt and slavery.”

– David McAlvany

Kevin:Well, for those who read the Wall Street Journalor the New York Times, many of our listeners may have already seen something that you have been working on now, Dave, for the better part of a year and a half. Why don’t you discuss that a little bit – the program up in Canada involving gold.

David:Our existing clients know that we have had a variety of programs overseas, both in places like Switzerland and Toronto. What we have tried to do with this new program called Vaulted is create a digital interface that allows you to manage a gold position, but do it digitally. I think what this allows for an investor to do is reconsider how they view their savings. Is it in dollars with a local bank? Is it in dollars with a big bank like B of A or Wells Fargo? Or is it in ounces, and just seconds away from being in cash if they need it?

So, from cash to gold in seconds, with one touch you can get to gold or back to cash, and that ease of transfer is what we have been striving for. Vaulted is better savings in the 21stcentury. That is what we have tried to do, and through working with the Royal Canadian Mint have cracked that, and we are very excited about it. Good things, I think, take a little bit longer to get all the details hammered out, and I think, particularly when you are working with a government, they can take a little longer, too, but we’ve finally settled in, and Vaulted is a fantastic offering.

Kevin:One of the things, Dave, through the years, I love taking delivery of my gold, I love having gold in hand, but I also look at my bank account, and I think, “Okay, do I really want it sitting in U.S. dollars that are just based on debt, or can I use some sort of gold program as the savings part of my assets? Let’s say, a year from now, I’m going to need to put a roof on my house. Do I really want that money sitting in dollars, or can I put it into something like a savings account that is backed by gold where it is actual physical gold that I have a right to?

David:In recent weeks that has been obvious. If you were sitting in the Turkish lira or the Venezuelan bolivar, if you didn’t have a cryptocurrency or some other way of getting out of those currencies post haste using a digital interface, you absolutely went through the meat grinder financially. So we saw a need in the market for an even more transparent, straightforward way to approaching in gold, both for the U.S. and the international investor. This is geared for, admittedly, a younger generation who may be newer to the market, may be newer to gold, but certainly understand how to use that digital interface and are not opposed to owning gold. But frankly, if you were told, “Hey, we’re going to send you a package, now go store it someplace,” that younger generation might say, “What am I supposed to do with this exactly?”

Kevin:Even an older generation – I have a client who sold real estate, and is selling real estate right now with the idea that he wants to go back and buy back in. We’ve talked about him on the Commentary. He wants to go back and buy back in after the real estate market settles back again. He did the same thing back in the 2005-2008 time period. But he had to move into the banking system. He said, “Kevin, is there a place that I could go where I could easily quickly get back out and go into real estate when this thing comes down?” Well, this is the perfect means for doing that.

David:Yes. Using an ACH function you can toggle back and forth from your existing bank to the Vaulted program. We developed Vaulted, which is an easy-to-use web-based application to really reinvent the way people invest in gold as a savings alternative.

Kevin:One of the problems that we have seen in the markets – we saw this with the derivatives back in the early 2000s – was opacity. In other words, everything was opaque. You really didn’t know the value. Sometimes you can see that in these online gold programs, as well. It’s like, what do I really own? Transparency is key.

David:Even in pricing – we mentioned this last week where the difference between the paper markets, driven by futures contracts, and the physical market, where supply and demand has an impact on pricing, it can create some confusion. There is a key value that we embraced through the development process of the Vaulted program, and that was that transparency piece. Gold investment opportunities have been criticized because of that confusion or opacity, as you describe. Vaulted addresses all of those issues by providing transparency throughout the investment process. Again, it is all there on that web-based application.

Kevin:You want to make sure, if you are moving cash in and out, that the fees are low, and I think these are some of the lowest fees in the industry.

David:Every time I have consulted with an individual who wanted a cash alternative, there are lots of way to invest in the precious metals market, and some of them have significant advantages when you are talking about ratios and premium trades and things like that. But when someone says, “I’m just looking for a cash alternative and I want it in gold ounces,” I’ve always recommended kilo bars. You know why? Because kilo bars are the cheapest way to come and go from the gold market.

Kevin:They are about the size of a candy bar.

David:That’s right, or one of the large iPhones. But we have some of the lowest fees in the industry and it is all shared with you up front. And yes, guess what gold is backing, and is a part of the Vaulted program? It is kilo bars from the Royal Canadian Mint.

Kevin:And it’s not just gold that you’re looking at on your screen on your computer. If you own the kilo bar you can have it sent to you any time. It is a physical product that you own.

David:Yes. So, a product like GLD, which is an exchange-traded fund – there are massive limitations and you need to have millions and millions and millions of dollars in the vault to take delivery. So, unlike other gold investing platforms, with Vaulted you can buy and sell real gold, stored at the Royal Canadian Mint. If you choose, you can request your gold bars at any time and they will be shipped to you securely via FedEx.

Sometimes we have people ask, “Where does the gold come from? Because I’m not really interested in supporting some third world dictator.” The Royal Canadian Mint has this in place. All of the gold is certified conflict-free. So you know that provenance is legitimate. And frankly, what the Royal Canadian Mint really provides a lot of is through-put for Canadian companies that are mining there in Canada, whether it is Ontario, or B.C., or what have you.

Kevin:Last week you talked about your kids running to the other room and buying silver when it came down because you were matching them. But oftentimes people will call and say, “I would love my kids and grandkids, who understand things a little bit different in the computer world, to be able to continue to buy gold, or teach them how to buy gold. But they really don’t know how to do the physical side of things.” This is sort of a bridge that way. You can give a gift card to someone and have them set up an account on the Internet and then they can start moving money directly from their account into gold with as little as $10.

David:Right. Vaulted is a convenient, accessible application, and allows users to build stability for themselves, to build stability for their families, starting with an investment as little as $10. What we have tried to do is take away the barriers, bring a 19thcentury asset, or arguably, something that goes back through the millennia, into the 21stcentury.

The last thing I will mention is that we did create gift cards, and a part of this deals with the legacy thematic. I wrote a book on legacy a year-and-a-half ago called The Intentional Legacy. What we would love to see is the older generation, who already trust gold as a hedge against various aspects of the market, to be able to introduce kids and grandkids to the idea of owning gold. So you can fund those gift cards – they are very easy to use, gold accounts – whether it is a loved one or a faithful employee and you want to create a reward program, and within your own culture begin to have a broader conversation about sound money and some of those pillars of savings and investing that you are already familiar with. This is one of those ways that allows you to instantly create the conversation and go deep with them.

Kevin:In this online world oftentimes we can buy and sell things without having to talk to anybody. But I have run into many occasions when I would have liked to have been able to talk to somebody, especially when it is an advisor of some kind. Vaulted does have connected with it an advisor to talk to at any time.

David:That’s right. If that’s what you want, that’s what you can have. This is a program where all your ounces are allocated and titled directly to the client. They are not pooled. I love that aspect of being able to do a little bit because in conversation with my kids I know they want to own more gold but the smallest increment they really have access to is a 10thounce Gold Eagle or Maple Leaf.

Kevin:Yes, they’ve been buying silver because it is smaller.

David:That’s right. So, to be able to buy gold for $10 and have real-time visibility on their investment, these are kids that are pretty savvy when it comes to using today’s technology (laughs). They can get on my phone faster than I can. But being able to sell gold just as easily, and move funds from one account the other, again, these are aspects that encourage ownership. And I think everyone can own investment gold when it is accessible, when it is convenient.

Kevin:It is really sort of a gas, too, to be able to do it on your phone. It’s fun for me to open up the app and transfer money from my bank account, or transfer it back in. That is such an unusual thing, Dave, because I am used to taking delivery.

David:(laughs) I’ve enjoyed watching you get used to the crypto-currency world, and buy a little of this, and sell a little of that, just to understand the functionality and how it works. Vaulted has some similar aspects in terms of its digital nature.

Kevin:But I can check the account on the phone at any time, it has real-time visibility. So even if I’m not near a computer I can check it on the phone.

David:Right. I think as we see more currencies fluctuate, as we head into an era where nationalism and trade conflict are more of a daily concern, devaluation becomes something that is on everyone’s mind. And this means you want something with a greater stability, and maybe even a greater return than the paper currency that you might have sitting there at the bank. But this makes gold ownership accessible, it gives it to you when you need it, and comparing low interest rates and rising inflation rates, and those issues in combination, it answers the question, how do you want to hold your savings?

Kevin:Having kids that are now adults, they do everything on their computer, they do everything on their phone, and there is almost a real world in this digital universe. I sometimes wonder, I know we get comments when we talk about cryptocurrencies, and sure, there is a reality to cryptocurrencies, and there is a future to block chain technology. But if we go back and look at 4,000 years of history of gold holding its value, we’re not really speculating on gold holding its value like we would be with cryptocurrencies. We actually have history that can prove that.

So for my kids – I have a 30-year-old daughter and a 27-year-old son – they do own gold and silver, but as far as their savings, I don’t know that they necessarily have an option that they feel comfortable with. But this Vaulted program – a gift card, what have you – I think I am probably going to be using that to encourage the cash part of their savings to go into gold, the portion that they don’t need immediately.

David:Kevin, your daughter is an exception. She studied theater and is familiar with Shakespearean language. Sometimes we get lost in the translation from the old to the new. To me, this is one of those bridge-building opportunities between generations to take the truths of the past and make them relevant in the present, to take the verity of gold, something that has been relevant for 5,000 years, and make it even more relevant to a younger audience that says, “Yeah, but why? Why that? Why now?” Again, that conversation for a parent to have, to have a tool to say, “Look, I want you to try this. Get used to it. This is a better way to save.” I think it is a phenomenal tool. Getting an account open with Vaulted is super simple. Just go to VaultedApp.comand it will walk you through each step.

Kevin:Moving to this week’s news, we’re seeing in the news that NAFTA no longer exists, but in a way, it’s really just an amendment to NAFTA, is it not?

David:(laughs) Yes, there is no end to NAFTA. Once you get sucked into the leviathan it never really goes away. I think there are something like 48 different government entities that now exist after the creation of NAFTA. This is the problem – when you create an excuse for government to grow, it does it, and it does it so well.

Kevin:And it never shrinks – nevershrinks.

David:No, so I think we have an amendment, not an ending, to NAFTA, as you say. But as a result of labor arbitrage, if you go back in time we have seen some significant things happen, and as a result of labor arbitrage stemming from both NAFTA back in 1994, and then China’s entrance into the World Trade Organization, we now get to buy goods a lot cheaper, and we have for over two decades. In many ways this sort of deflation and consumer goods pricing has helped us. It has helped offset the inflation targeting of the Fed. And as the Fed is increasing inflation by 1%, 2%, 3% a year – and those are the stated rates, maybe it is even higher inflation rate in reality – this has created an interesting offset – deflation in the price of goods, again, because we have outsourced the production of those goods and can buy them cheaper from overseas sources, and inflation via the Fed.

Kevin:Let’s talk about that deflation a little bit. I was thinking about this because my daughter is visiting us right now and we’re talking about how it’s time for a new iPhone. In the old days we used to have a phone on the wall. Granted, it didn’t do all of the things that it does now. But that phone might have lasted us 15-20 years. You didn’t have to buy a new phone every year or two. So granted, we have a deflation, we have an awful lot of use in these trinkets that we’re getting from China, these “useful items” but we’re having to replace them every couple of years because of technology. In fact, you can’t use some of the old technology. So, I’ve thought about this. Yes, we have deflation, things are cheaper, but I’m finding I’m spending just as much money buying cheaper goods.

David:Right. On the one hand you have the Fed inflation targeting, you have the American middle class on the other hand who has been able to continue to consume far more than they save, and it doesn’t really leave that much left to invest. And it has not necessarily given them any other net worth advancement or improvement. You haven’t had wage improvement or advancement in real terms in decades. So the advantages for working class Americans have been limited.

You have to consider, this is really by design. It is one of the Keynesian priorities, that of spending every dollar that you receive in income and leaving no passive capital waiting on the sidelines, waiting in the wings for investment. That is a Keynesian goal, to maximize the churn of every currency unit working within the economy. And that has been the case for the U.S. middle class. Again, you’re stuck between the rising cost of everything else with the deflating cost of these things that we have had, actually, in large part, or in some part, because of NAFTA and what we attribute to globalization.

Kevin:I think a lot of people have missed that about John Maynard Keynes. I remember in economics class I was taught that Keynesianism was really just fiscal policy applied to monetary policy, those two in tandem. Actually, though, there is a deeper philosophy, which is, don’t let people have independence. In other words, keep them spending all the dollars that they are making, and make sure that they don’t save enough to be independent. I think it is important to keep that in mind when we talk about Keynesianism.

David:This certainly came up in our conversation with Tomas Sedlacek where maybe in a healthy environment it is not critical that we are always maximizing growth. Maybe a healthy economy is not the economy that is growing at a break-neck speed, year-in, year-out, without pause. And he asks those questions. If you haven’t read his book, The Economics of Good and Evil, I think it is a must.

Kevin:It is a masterpiece.

David:It really is. But what benefitted the consumer by way of cheap consumer goods also benefitted the central bank, as they were busy creating what became the largest stretch of growth and economic activity in U.S. history.

Kevin:That was the decade from 1990 to 2000.

David:Exactly. Now we have an echo from the past right now, 2008 to the present, where we are competing for the second largest, or now, actually, in recent days, the longest stretch of economic activity on record.

Kevin:Do you think NAFTA played a role in that?

David:I don’t think it was single-handedly responsible for that earlier period of growth. Remember the background. You had Greenspan who was blowing bubbles and providing market support whenever there was a natural swoon which was in the offing, or beginning to occur, in the stock or bond market. He was always providing artificial support to the financial markets.

Kevin:Isn’t it amazing, though, as he did that toward the end he would call it irrational exuberance? He was using the terms to make you think that he was fighting that mentality, yet he was blowing the largest bubble in history.

David:Right. 1996 was when he described the market as irrationally exuberant. And he didn’t really change his policy stance, he continued to support those markets up until the very end. What that really illustrated was an extension of the typical business cycle, well beyond a normal historical basis of 3-5 years. We more than doubled it to ten.

Kevin:Why don’t we go back and look at this growth machine that we built and the parts that are played because this growth machine actually creates deficits for the United States and surpluses for the people who are making the goods. As long as you can run a deficit and continue to borrow money back, it works. Once you can’t do that anymore, once you can’t borrow any money, that whole machine breaks down.

David:Right, in part dealing with how we handle trade and fiscal responsibility, you look at the massive trade deficit that we have. We are not exporters of capital. We’re not. We don’t have an excess of savings flowing from the United States, an amazing economic abundance, to invest in the world all around us. We are, in fact, importers of capital, and we are, in fact, the largest debtor nation in the world. Again, that is, in part, due to how we handle trade, and how we mishandle fiscal responsibility. So the difference is clear. There is a difference between the budget deficit and the trade deficit, and there is a significant difference there.

Kevin:But they go hand in hand. We’re continuing to just build more and more debt. Just recently, we were amazed that we were getting into the 18-19 trillion dollar mark, and now we’ve passed 20.

David:Yes, they ultimately complement each other because first you have fiscal profligacy and overspending, bringing us close to the 22 trillion that we have in debt today, but that is subsidized by the excess savings from overseas which is seeking a return and becomes the recycled currency units returning to the United States soil to invest in assets and debt instruments. It is a symbiosis, but it is a parasitic symbiosis and I think it has been intentionally orchestrated.

Kevin:Going back to talking about having to replace things now, these things that are made overseas, you really have to see that what would have been savings is actually turning into consumerism.

David:Right. So follow the flow. Potential U.S. savings are spent instead of saved, and they disappear from our shores. So they are gone, and they show up as a trade surplus elsewhere in the world, and that is after we have bought some trinket, and that is what gets imported to us. Then those savings return and they return to our country not as our savings, but they return as the investment dollars of overseas persons. And they are being loaned to us to help our government fund the gap between income and expenditure. So again, intentionally orchestrated. We kind of create our captive audience for who is going to fund the budget deficit by running a trade deficit.

Kevin:It’s not just the consumerism. We have lost an awful lot of labor jobs here in America so that we can have those cheaper goods.

David:Right. Vital that that labor arbitrage occurred in the first place, and it provides the cheap goods that consumers want at cheap prices to allow for the recycling of trade surplus dollars from overseas into the U.S., to then subsidize the spending proclivities of government and the deficits that they willingly run. Now, I can hear our guest, Bill King, saying, “Yes, but David, you wouldn’t need cheaper goods if you had people making more money.”

So the fact that people are making less in terms of an hourly wage, a living wage, having a real, legitimate job that they can from excess savings be able to pay for college and all these other things – we’re looking at it wrong. We shouldn’t be thinking about, we get to live larger lives because we have cheaper imported goods. If we made more money and had a stronger dollar we could buy more goods from the rest of the world and we could get it a different way. It would be through the wealth of the nation and not through impoverishing the nation and creating a long-term structure of debt and slavery.

Kevin:And it really creates a dilemma. Your 12-year-old son was in working with you a couple of days ago, and I think of his generation. He is coming into debt that we would have never, ever, even imagined. I remember coming into the work force back in the early 1980s when we had 1 trillion in debt. It’s 22 times that. How does he feel about that?

David:(laughs) He was here in the office and, of course, when I finish the Commentary I have all of my reading and research that I’ve done, and he was looking at this picture of the debt clock. Look, my office is sometimes not the cleanest in the world, and there was a stack of papers dating back to 2016, and this picture of the debt clock showed the national debt coming up on 19 trillion dollars.

Kevin:This was in 2016, two years ago.

David:Yes. Now it is closing in on 22. He said something like this. He said, “That makes me want to punch someone!”

Kevin:No kidding.

David:“Who would do that?!” That was his question. “Who would do that?!” And I said, “Well, we would. We have. We did.” And there was a justification for it, this didn’t happen by accident. Someone was thinking it through and thought it made sense. But we have also benefitted corporate coffers. As you go back to this idea of NAFTA and what has happened, by increasing margins – again, we go back to this labor arbitrage idea where you can lower the labor costs for a corporation. Your margins increase. Labor costs have come down considerably. And yes, this is at the expense of the wage earners here in the United States. Which is to say, if you rolled a clock back to George Bush, Sr. and Clinton, they were, in fact, choosing winners and losers as they were approving NAFTA, and the benefits have accrued nicely since. And basically, capital won and middle class America lost because even though the price of consumer goods has come down, as we have been advised by an astute politician, as we now understand, you can’t eat all them apples.

Kevin:Your talking about the iPhone, the iPad…

David:(laughs) That’s right. So you get asset price inflation, which has also been a huge benefit over the last three decades. You have improved profit margins for corporate America, and these benefits have narrowly accrued. They have accrued to a minority. And yes, these have, coincidentally, been the donors and corporate scions that up until recently determined political outcomes.

Kevin:I’ll tell you a little story back from the early 1990s. I was talking to a client of mine who is a major bike manufacturer, but he was a custom bike builder and he put his name on every bike. He had great pride in that. I remember talking to him, and I won’t name him, but he was distressed because he realized all of his competition was outsourcing labor to China and producing an inferior product, and they wanted him to do the same thing and put his name on it.

So he finally came to the conclusion the only way he could do that is to dominate the accessories business because he could control the quality of an accessory what went on a bike but there was no way the bike frame that would have his name on it could actually come from China. So it’s not that these corporations don’t necessarily always come from the standpoint that they are just going to benefit themselves.

David:It can be a survival aspect.

Kevin:Yes, there really was a hesitancy with some, and it was – it was pure survival.

David:1994, when NAFTA was approved, I was taking my first business class. Honestly, it was the most boring class I ever took (laughs). I was also taking my first philosophy class, and that kind of stuck. That ended up being my course work from that point forward. But NAFTA was being approved after a number of years in the making. George H. W. Bush was on the scene to kind of get things kicked off. And it was a win for corporate profits. And you might translate that to political donors. It was a win for capital, which flowed more freely across borders. And it was a win for our trade partners in many respects. I think have some attributed the flourishing of the Mexican middle class with NAFTA, which, granted, is a positive if you live in Mexico City or wherever else.

Kevin:How many jobs did we lose here in the United States, however?

David:I think some of the research has shown we have improved GDP by half a point, which is nothing to shake a stick at. It’s neither that big of a deal or too little of a deal, either. Low side estimates of job loss is 500,000 manufacturing jobs, maybe as many as a million manufacturing jobs, and they were just moved to cheaper jurisdictions. They moved to China, they moved to Mexico, they moved to Malaysia, they moved to Taiwan, they moved to Bangalore. The emerging markets have benefitted in this period since 1990 and there has an improvement in global wealth, but not necessarily an improvement in wealth in the United States.

Let me be clear in that because we have the highest net worth numbers in history here in the United States, so that might seem to be untrue. But if you add it up, household net worth is largely skewed by the top 5%. There is a huge percentage of Americans who have not benefitted either from an increase in income or an increase in asset appreciation. So this huge appreciation has been in the emerging markets, and if you are in the 1%, 2%, 3% of U.S. culture, then you have seen massive income and asset appreciation.

Kevin:We talk about this deflation that actually occurred by outsourcing, but in reality, prices that I pay have gone up this entire time. So things that deflate don’t necessarily create more money in my wallet.

David:No, and we’ve talked, I think, before about the idea of hedonics where the folks that manage the inflation number, the CPI, are able to take the price of an asset and reduce it and show that it did not increase in price even though in nominal terms it did, if there has been some improvement, qualitatively, to the product. So let’s say your air conditioning in the car goes to 62 degrees instead of just 70. Well, maybe that is worth a $500 reduction in the value of that car. Even though you may be paying $500 more, they’re not going to count that into the inflation adjustment higher because of this “hedonic” adjustment. You’re enjoying cooler weather inside the car.

Kevin:So it’s like the amplifier in Spinal Tap. This one goes to 11 (laughs).

David:(laughs) So from an inflation standpoint here in the U.S., the cost of virtually everything has gone up. This week we had Arabica coffee beans – they hit a 12-year low. So here is the opposite. The cost of everything is going up, right? Well, not all of your commodities are going up. Arabica coffee beans are at a 12-year low, and I’ll have you know that Starbucks didn’t follow by lowering their prices. A cuppa Joe is still two to three times what it costs them for a pound of beans. It’s amazing.

Kevin:I mentioned the age of my kids – they’re now out of college, but they’re still paying for some of that college. I think about what it costs to send a child to college these days.

David:Right. Well, back to my college days, 1993 to 1997, tuition and room and board came in, if memory serves correct, maybe $27,000 a year, and that was near NAFTA being signed. Now the same school is $52,000 a year. NAFTA is obviously not responsible for that. But here is the thing. Middle class wages have stagnated from then to now, and they forced an increase in debt to maintain the status quo.

So if I could barely afford $27,000 and wages have not increased significantly from then to now, what does $52,000 look like? It looks like an opportunity to go into debt, which is why we have 1.5 trillion dollars in student loans, it’s why we have had a significant increase here in the last 10-12 years in those student loans, because as the prices go up and people can’t afford them, it’s not like people are stopping their spending habits. They’re living into their expectations of what life should be whether it is buying a house, or going to school, or buying a car, or what have you. They just do it using the credit markets.

Kevin:So the cost of a few goods have gone down, but on balance life has gotten more costly. And speaking of school, I hate to bring this up, Dave, but you do have four kids. None of them yet have gone through college.


Kevin:I’m through my college years with my kids. You have four kids. What is that going to cost you?

David:When you are doing financial planning you think about all of these one-off expenses and to the degree that you have daughters you might be thinking about funding weddings, as well as college, as well as – and you start adding up the laundry list of big ticket payments.

Kevin:It can be overwhelming (laughs).

David:Right. Well, $52,000 – if that were the number – four years, four kids. Well, if I assumed that I could freeze tuition right now and it did not go up between now and the time they were ready…

Kevin:Uh-oh, we’re breaking the calculator here.

David:And maybe even pay in advance for all four kids – that bill is going to come to over $830,000.

Kevin:To send four kids to college for four years.

David:And that’s not an Ivy League education – $830,000.

Kevin:That’s at today’s cost. You’re years away.

David:That’s right. Well, thank you for that, I appreciate it.


David:In this environment, what that means is that debt is necessary for almost everyone.

Kevin:Keynesian debt is necessary.

David:And again, I don’t think that is an accident.


David:I remember my second year with Morgan Stanley. My manager, Fred Martin, looked at my early success and encouraged me to buy a Porsche. He gave me a great office. I was out of the cubicle structure – he gave me a private office. A Porsche was a little spendy, but he said to me, “Look, you can borrow the money.” You deserve it.”


David:And Fred, if he is still living – last thing I knew he had moved to New Zealand – he knew that an obligated person is a more consistently predictable person.

Kevin:Socially, you’re much more predictable.

David:Right. A debt-laden person is a more reliable cog in the wheel. So, “I owe, I owe, it’s off to work I go.” (laughs) No, I did not buy the sports car. And I think that’s because I prefer a less obligated world, and I’m generally averse to debt. There are times when it is appropriate, but I think debt has become one of those key components in social planning, and it allows for a tremendous amount of leaverage, using leverage as leaverage, in the lives of individuals to make them consistent economic contributors.

Kevin:The last 40 years have been based on debt. We talked about the two great growth periods that we have had from 1990 to 2000, and then of course the last ten years. But I think we are about to surpass a record on stock market bull markets, as well.

David:Yes, this week – longest bull market in U.S equity history – we’re here. Greenspan fed the beast, going back to that 1990-2000 period, as have his protégées since he left his central bank post. Prices are high, have remained elevated now longer than any other period in U.S. experience. Let that sink in. As you consider the duration, as you consider the length this bull market in stocks has gone, it has remained elevated longer than any other period in U.S. experience.

Kevin:Do you think zero interest rates have had something to do with that, Dave?

David:It has definitely had something to do with it. Just as Greenspan fed the beast then, zero interest rates have fed the beast more recently. Some practitioners in the markets may say, “Well, it’s different this time. We’ve figured out how to manage risk, and volatility has decreased.” You began to hear the language of “it’s different this time” between January and February of 2000, and it was March 2000 which was the ebullient peak. It marked the 3452 days, that period of bullish market expansion beginning in 1990 and ending there in the year 2000. And we just, in the last week, passed a decade of growth – 3452 – we’re now past that. And coincidentally, for those of you who like chart patterns, we are also looking, if you’re looking at the S&P, at a rising wedge.

Kevin:Well, what does that mean? (laughs) Give us a clue as to what that means.

David:A rising wedge formation means that within a very short period of time the stock market needs to go up rapidly and stay rising or it will collapse.

Kevin:I remember 1987, too, you talk about this time it’s different – I’ve mentioned this on the Commentary – I bought a Fortunemagazine in either July or August of 1987 – and that’s exactly what it said. It said, “Are stocks too high?” And it said, “New methods of valuation show that we’re not anywhere near a crash.” Well, that October we had the largest crash since 1929.


Kevin:Yeah, you’re right. Any time they say this time is different, run for the exits.

David:And new methods of valuation – when the old ones are no longer legitimate, it’s because they have had to rationalize how they can go to work every day with the same stock and trade sales pitch – “It’s up, up, up, and away from here.”

I want to return to 2017 because I think it was a massive year of transition. There were more days with the Volatility Index, the VIX, below 10 in 2017 than in the 26 years previous combined.

Kevin:Let’s unpack that. What that is basically saying is you have complete consistency, and virtually no volatility in the market.

David:Right. So between influence in the futures market and buying prices in the indexes where the stock markets of the world were being manipulated, and then the obvious manipulation of rates with ECB and the Bank of Japan buying everything, including the kitchen sink, there we had in 2017 one of the lowest volatility periods in market history. But low volatility was resulting from massive market manipulation and I think what we have here is a year that is very different.

The market environment this year returned to volatility starting in January and the manipulation game beginning to come to an end, rates will play a very significant role at some point. You have already seen some corporate borrowers at the margins beginning to squeal, and I think this is why Trump is increasing pressure on Powell to stop it – to stop raising rates, to stand firm and do nothing else, because he is already getting feedback. There is already some chatter from the corporate sector that rates are getting to an uncomfortable level.

Kevin:You mentioned that the Fed can sometimes be influenced politically even though they try to look like they’re not. Now, Bullard has been a hawk against inflation in the past and now he is becoming a dove. Is there any political background to that, do you think?

David:Well, at least dovish in his monetary policy recommendations he has basically said we are not accommodative any more the way rates are structured today, we are at a neutral rate, that’s already been found, we don’t need any more.

Kevin:(laughs) Even though rates are still below inflation, right? We’re not accommodative.

David:Well isn’t that funny? Seven hikes starting in 2015, but we still have the Fed Funds rate below inflation. Yeah. And we’ve got a balance sheet which is totally bloated, and he says this is not accommodative at all. Right. Okay. That’s a point of view. Almost everyone else at the Fed says that we have two, three, even four hikes coming. And I think Powell is getting pressure from Trump to leave rates alone and suggests that if Powell wants Trump as a friend he is going to have to acquiesce and just leave things alone.

Kevin:But how about political independence, which we were talking about?

David:And that’s the real deal. The Fed always flies that flag and says, “Look, we are politically independent, we’re separate from the process, blah, blah, blah, blah.” And if he wants to prove political independence, then he is going to have to raise rates before the end of the year, and that may complicate the November election insofar as it may complicate the financial markets and their trends.

So what is the threshold number in the fixed income markets where prices adjust in earnest? I don’t know, but I think closing in on 5% on the 30-year mortgage, that certainly is a threshold for consumers making first-time home purchases. You’re certainly beginning to see that show up in some of, not only the new, but used homes, volumes declining there.

Kevin:We’ve talked about the Bank of Japan. They’ll come in and intervene on their market even if it drops 0.2 of 1%, I think I read, which is incredible as far as market intervention. But the European Union – I’ll never forget 2011, and neither will you. It was either August or September of 2011 when Mario Draghi came out and said, “We will do whatever is necessary.” They have. They have been buying all their paper. What happens now as they are backing away?

David:Fascinatingly, there were some similar words that came from Powell this last week in Jackson Hole, that we will do whatever is necessary whether it is on the inflationary side or the deflationary side, we intend to be very flexible and very interventionist. That was not his word, precisely, but we’ll do whatever is necessary was almost a direct quote from Draghi, echoing again from 2011 into 2018 here in August.

But yes, spreads are widening in Europe. You have the European Central Bank buying less paper. It really should not be a surprise to us that all of a sudden Spanish credit and Portuguese credit and Italian credit don’t look like German credit, because they never were to begin with. But they took on the appearance of that as long as the ECB was buying them lock, stock and barrel.

Last week we watched the Greek government’s third bailout come to an end, kind of a monumental event. Well, I guess we have seen this happen two other times in the last ten years, too, so not allthat monumental. But it makes me wonder who takes the baton from the Greeks? You have rates that are beginning to rise, budgets beginning to get squeezed. Is the next round of bailouts, maybe bailout number four for Greece, in the making? But it could be Spain. It could be Italy. It could be Portugal. Italy is certainly under a lot of pressure, as is Spain. And we have talked about both of those in the context of Turkey and the exposure that they have to cross-border loans there in recent weeks.

Kevin:We mentioned last week that we can never really predict what the trigger will be. We have talked about a lot of potential triggers. You mentioned Spain, Italy, Portugal, the Greeks, the European Central Bank stepping aside. Will a stock market turn cause a reappraisal in the markets? In a way it is a waiting game, isn’t it?

David:Right. Because you could be looking at fundamental values and say, “Well, things have been over-valued for some time.” You could look at technical dynamics and say, “Hey, you know, the S&P just broke out, and so did the NASDAQ, to new highs. What does this mean? We’re going higher.” But technical dynamics can determine direction of the market up or down. Do we, as an alternative, have traders re-engage after their summer breaks and begin to look at risk differently given a very rancorous political backdrop? Let’s get past the Labor Day celebration and see how we transition toward the political free-for-all, and is that disturbing or unsettling to the investment markets?

Kevin:As we talk about markets being overvalued, sometimes it can sound incredibly complex, like there are many, many inputs. But in reality, there are two or three things that you can watch and almost count on a market being either overvalued or undervalued. One of them is the price-to-earnings ratio you have mentioned many times. If a company can be sold for, let’s say, ten years’ worth of earnings, then that would be a 10-to-1 price earnings ratio. If it gets above 20 it typically will come back into the 14 or 13 range. Price earnings ratio is over 30. It’s at 32 – the Shiller adjusted index.

But there is another index that a person can look at, and that is, anybody who has run a business knows that there is a certain amount of cash – hopefully (laughs) – there is a certain amount of cash that is left over after you’ve paid all your expenses. That’s part of running a business – a little bit of cash. And that is actually an index that a person can look at to see where the market is at. And the free cash flow ratio right now is way out of whack.

David:The S&P, if you’re looking at that index, in particular, because it is tougher to gauge with some of your technology companies, some of which don’t make any money at all, and don’t know how to spell free cash flow.

Kevin:Don’t say Tesla, Netflix – go ahead.

David:What is free cash flow? That would be an interesting post card, just send it to Do You Know What Free Cash Flow Is? Oh, that’s right. You’ve never encountered that as a business manager, Mr. Musk.

The S&P 500 median price to free cash flow is at 34.6. Investors are buying U.S. stocks at the current price level, and they are valuing your typical large cap company at almost 35 years’ worth of free cash flow. That’s what it means. Yes, PEs are great, but as we have talked about before, you can manipulate earnings, and you can manipulate expenses.

Think about some of your technology giants who basically say, “We don’t have any labor costs,” because they don’t expense their stock options. One of the largest components of compensation doesn’t get factored in. So you have ways of manipulating the earnings of a company and the expenses of a company. But with free cash flow it gets to that, “Do you have anything left over?”

It’s one of the things I like about dividends, too. When you look at a company that can pay dividends, typically, they are paying dividends because they are making enough money, and they have something left over at the end of the day and can pay you (laughs). Now granted, that has begun to change in a world of zero interest rates where companies have begun to pay dividends and just accrue more debt so that they can pay dividends. And that’s weird. That is totally weird and has only begun to happen in the last five to seven years.

Kevin:Just prior to the great market crash of 1987, the crash of 2008, each time, we’ve said before that people will say, “Well, this time is different.” I can also remember those periods of time where you can’t imagine why anything would change. We just set a record on the bull market. Can we expect maybe another nine years of no interruption, just continued growth? Tell me about that.

David:Well, that’s what you would consider a normalcy bias. This is what we have come to accept as the new normal – the stock market goes higher, or the economy is a consistent performer. And should we expect another nine years with no interruptions to financial market progress? I think at some point investors say, “I’m paying way too much for way too little.”

It has been interesting to note, as you look at the markets here in the last couple of weeks, you’ve had the issues with Manafort, you’ve had the issues with Cohen and the investigations.

Kevin:The impeachment talk, even.

David:And the markets have not skipped a beat. It is not as if they say, “Oh, this could be devastating.” What it has really said is, “This is not a possibility at this point. We don’t see something as disruptive as an impeachment occurring.” The markets are basically giving you a signal that there is information out there that this is not a real consideration.

Kevin:It’s a non-event.

David:Yes. So we’ve had impeachment threats flying around for the last two years, and equities don’t indicate any real possibility of that occurring, at least with the information that is already disclosed. In fact, and I know this is diverging from the markets a little bit, but Grassley and Graham last week both gave the green light for removal of Jeff Sessions.

Kevin:Do you think that sent a message over to Mueller?

David:Oh, absolutely, because if Sessions is gone, Mueller is under a lot of pressure, and the investigation is under a lot of pressure. Mueller is now on thin ice. The investigation, barring any significant bombshells, will be wrapped in 60 days. So there is a significant shift in the winds. And I grant you, markets can continue to do outrageous things.

But what did we watch the dollar do this last week? An about face, and moving lower. We have watched the bond market for over a month as the bond market has strengthened over the last 30 days, but then begun to reverse here in the last five to seven days with yields rising in that shorter term.

Kevin:Look at gold. It dropped down to $1160 briefly. It hit a level that a lot of people were expecting, but it has really bounced.

David:Quickly, above $1200. In the past week there is at least a suggestion that reversals in all those categories are coming, and we’re talking about a significant trend shift. So I think the stock market and stock investors are the ones who tend to get things last. They look at the memo with a bit of dismissiveness. They don’t really see the risk side of the equation. The reward is too much in front of them.

And I just want to caution anyone who is in that camp, enjoy it while you can, but don’t let complacency or over-confidence convince you that you are capable of being that guy, or that gal, who gets out of the market at the 11thhour and 59thminute. Just don’t wait until that last minute.

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