In Transcripts

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: Dave, we’re on the road right now. We started in Costa Mesa, we’re in Orlando. We’ve invited our clients to these consultations and conferences, the dinner that comes before it. It’s a great time to meet our clients, but I know that there were some who could not make it.

David: What we hear oftentimes is, “If you only recorded it, we’d love to listen in. We couldn’t travel cross country this time. We’d love to know what you were talking about, what the conversation was, the questions that were asked, because we just wanted to be there.” So this is our attempt to do that. We’d like to replay for you one of the recordings from our recent conference.

Kevin: I think we might want to mention, Dave, one of the things that I love about going to these conferences, we’re based out of Durango, Colorado, but we have clients all over the nation, actually some all over the world. I think one of the things that I like to see is how clients light up when they realize that there is a group of like-minded people that they can actually have a discussion with when they come. And they also get a chance to ask you questions, personally, and so, what we will be doing is splitting these recordings into two weeks. This will be the first week’s recording. It’s you and the radio talk show host Mike Gallagher. You might say something about Mike to those who have not heard him.

David: Mike and I have been doing radio together for about the last nine months. He has a daily program, syndicated on about 180 different stations.

Kevin: He has about three million listeners, doesn’t he?

David: Yes, and it is, I think, for him, curious, because his audience is maybe not so personal in the sense that the folks that we invite to these conferences are clients that we’ve had maybe two years, in many instances 20, 30, and even 40 years, and so, I think he is always taken aback by the years that we have logged, the places we have been, literally, whether it is to South Africa or to Asia, traveling with our clients, having dinner with our clients, knowing them through all the seasons of their lives, and I think that is impressive to him because it is a little bit more one-dimensional when you’re on the radio.

Kevin: And David, Mike Gallagher has a very loyal following all of his own, and the fact that you two merged about a year ago has really been helpful for both sides. He brings the economic conversation to his listeners that maybe had not heard that before, and of course, he brings a sort of political national look to our clients. But going into this recording, everyone should understand that this was recorded at the conference last week, and we’ll be playing the first half this week, and then the next half next week, and there will be questions and answers taken care of on that week.

David: Love the questions and answers. Always, in my mind, the best period of time for these kinds of venues, these kind of explorations. We get right to what is at the heart of people’s intentions. Why did you show up? What are you curious about? What do you think is the most pressing issue? Of course we have views on those things, but to hear directly from our clients is wonderful.

Kevin: Here we go to that recording:

Mike: My name is Mike Gallagher. I’m a syndicated radio talk show host and a Fox News Channel contributor, and living in New York. Yesterday, I had to do an appearance on Gretchen Carlson’s show in the afternoon. The weather, of course, in New York is miserable, it’s cold, and rainy, and ugly, and dreary, and I have to go out to the Newark airport after my 2 o’clock hit on Gretchen’s show. Martha MacCallum was filling in and I had argued with Alan Colmes, like I do just about every Friday. He yells at me, and I yell at him, and we shake hands and we go home.

But I knew I was coming out here for this event, and as I’m heading in the car out to the Newark airport on this foggy, miserable, nasty day, and I’m asking myself in the car, “Just why do I live here, again? Why do I live in the New York area?” And I started getting the text alerts from United Airlines, “Oh, your flight’s an hour late. Oh, your flight’s two hours late. Ah, your flight’s three hours late. So, long story short, as I pull in here this morning at about 3:00 or 4:00 a.m. New York time, and I see this beautiful community that you all get to live in and experience, I hope from a New Yorker’s perspective, you know just how blessed you are to live in a place like this that is so beautiful and so clean and so lush. I can tell you all about the water towers of Newark and the miserable, horrible weather, but that’s the price you have to pay, I guess, to work as a broadcaster.

Every week on my radio show I visit with Dave McAlvany, and we have this wonderful segment, and this is how I was first drawn to the McAlvany Financial story, because for my listeners, and I’m a pretty mainstream news-talk, talk-radio host guy. We talk about politics and issues and social issues and the direction of the country, and the economy. We talk a lot about money. And over and over again, I keep hearing callers and listeners from all over the country, and I’m proud that we have about 180 stations around the country, and some four million listeners, and a lot of my listeners say, “What about my future? What about my pension, my 401K? Gold? What about my retirement?”

And along comes Dave McAlvany from McAlvany Financial, and this partnership that has been on my radio show now for the better part of a year, I guess almost a year, six months to a year, and I have just been so enamored with the McAlvany story. In my business, in the talk radio world, there are a lot of screamers and arm-twisters and people who hype gold and a back-door way to get to gold and all that. There is a glut of companies that do that, and I’ve never wanted to do business with them. But after I learned about the McAlvany Financial story and their reputation, and I got to know Dave, I have just become so impressed and enamored with the benefits that McAlvany has been offering clients for many, many years, the philosophy that Dave and his team have about gold, which is very unique and different from some of the screamers and what I call the used car salesman out there when it comes to gold.

And so I’m real, real privileged to be here with you to spend some time talking about the economy, about your investments, about gold, about jobs, about growth. I try never to drag Dave into politics because, as you might suspect, I’m not a real big fan of the direction of our country right now, and some of our leaders in Washington, but this poor guy is like, “No, no, no, I’m not political. I’m not going to start ranting and raving like you do, Gallagher.” Dave is very low key, he’s like a solid, solid rock. But we are very, very pleased and honored that you could spend some time.

I, first of all, would like to have you join me in giving a nice Orange County welcome to Dave McAlvany. (applause) That is a little nerve-wracking for you, right? Every time you do a hit with me and you hear me go on my latest rant about how the president has ruined the country, and a caller will call in and say he’s from Kenya, and you get a little nervous, don’t you, a little flop sweat before you do one of our segments.

David: On the other hand, politics and policy is a part of the economy, it’s a part of the financial system, and so the way that all these things interweave is fascinating. I think most people feel that they have to take a side and it has to be very, very determined. Here’s what I believe. It has to be this way. We certainly have our own beliefs, and they are very strong and stark. But I think one of the things that we realize is that the market and the economy function is a certain way, and you have these various inputs, and you have to understand the inputs from a somewhat dispassionate perspective, so while I have personal political views, there is this thing called the bogey-machine, the marketplace, which is trying to take in information, some of it is political, some of it is policy-related, and make sense of it, and figure out the impact.

It’s one thing to come at politics and policy from the “I believe” standpoint, and it’s another, as you have to do in asset management, from the more or less unemotional, “What’s the cause and effect, here?” It’s a challenge sometimes to figure out which hat to wear, the personal “I believe, or the “What is the consequence going to be,” and how well the general public perceive these events, these policies.

Mike: And the truth of the matter is, most of these issues should be apolitical. I’m in a kind of political arena with a talk radio show, but everybody is impacted by policy, everybody is impacted by the economy, everybody is impacted by, as I said, the private sector, the public sector, the role of government. And so, it is kind of interesting to me to watch an evolution of people, over an issue, for example, like the affordable health care. That’s become a real lightning rod, and of course, a lot of people were very excited about the idea of the promise of what has now been termed, “Obamacare,” but then as people started seeing their premiums skyrocket, and employers had to start laying people off, and companies realized they could not afford to maintain the coverage that their employees had, the tide has turned, and it is fascinating for me to hear people who are loyal, liberal democrats, for example, who said, “Wait a minute, this is not working for me. Economically, this is killing me.” And all of a sudden it becomes a non-issue politically. It’s not really right or left, or Republicans or Democrats, it’s sort of like we’re all in this together financially, and how do we plow through this.

So, this morning we’re going to spend some time talking about a lot of these issues and these components. Obviously, the microphone there in the middle of the room is for your questions, and as I’ve normally done these seminars before, we take all the time you need or want when you have questions for Dave McAlvany. There are a few slots left for consultations tomorrow. Dave will be in town all day tomorrow, here. But we’re here for you, to answer your questions, and give you as much information as we can, and tell you all about ways that you can protect and preserve your assets, and what you can do with them in the future.

I want to start, if we can, Dave, talking a little bit about jobs, and these are the kinds of things, again, that I hear from my listeners from all over the country all the time. Unemployment levels, on the surface, we’ve got some good news. We got a story, in fact, yesterday when I was doing my hit with Mark on Fox, they had a Fox News alert, and they talked about jobs numbers and on the surface they seemed to be heading in the right direction. But I also know that the labor participation rate is awful, it’s dismal. This can’t be a sign that things are good, yet stocks keep going higher. Can you talk about why job creation is so bad right now, and why the market seems impervious to it?

David: On average, we need roughly 2% job growth each year, and that is to keep up with demographic growth, folks coming into the economy, and we’ve had a total of 5% in a cumulative number since the year 2000. We’re not keeping up with that 2% annual, and have things improved since the lows of 2008-2009? Arguably, they have, but some of it is sort of creative math, if you will, and we’ll talk about that today, some of the models that are used, who is counted, who is not counted.

But Mike, as you mentioned, the labor participation rate, 62.8% is the lowest it has been since 1978. There are things that you don’t get in the U3 number. The U3 number improved just ten days ago, or thereabouts. U3 improved from 6.7 to 6.3%. Well, that is an improvement, clearly. There are less people unemployed, more people working, but when you dig into the details a little bit, you find that, again, it’s not that we’re looking for bad news, it’s just that you have to look at the numbers behind the numbers.

So 288,000 jobs were the jobs created. As you look at all of the inputs, job losses and job creations, coincident with the job creations were 234,000 jobs created by the birth/death modeling. Birth/death modeling is where the Bureau of Labor Statistics takes all the people who are born, all of the people who are supposed to die, and just put them on a rolling average and say, okay, well, this time of the year we think there are going to be X number of people coming into the job market. This is not actually counting jobs. This is, literally, a statistical aberration. So 234,000 jobs were “created” through the birth/death model.

You can look at 288,000 and say, well this is great, we’re on our way to recovery. In the total mass of additions and subtractions you have an addition there of 234,000, which, I think, for the man in the street would be a subterfuge. It just doesn’t make any sense, those are not real jobs, and so to have the impression that things are improving considerably, you have to, basically, ignore a couple of very significant factors.

The labor participation rate, again, went to a bad place in most recent memory. You had 806,000 people leave the labor force; 806,000 left the labor force. These are folks that have either decided, okay, I’m not going to find a job, I might as well retire, and maybe they’re in a position to retire. Or they’ve been looking for work and they are just sick and tired of it and they’re hanging up the cleats. They are beyond the discouraged worker category. So 806,000 leave the labor force. It’s difficult to see, from a quantitative standpoint, or frankly, from a qualitative standpoint, how the job numbers support the idea of there being a robust recovery.

On the qualitative side, in the last year we created a million jobs. Again, I’m not sneezing at a million jobs, unfortunately, three-quarters of those, 750,000, were part-time. Again, I’m not saying that it’s not good to have a part-time job if you don’t have a job. That’s certainly better than no job at all. There are both qualitative and quantitative issues with the employment numbers, and it leaves us with some concerns.

Mike: There was a big headline this week about Governor Romney suggesting that there should be a pretty dramatic increase in the minimum wage. The minimum wage debate is one of those ongoing debates we seem to have in this country. I think it speaks to the role of government. I think even the conversation speaks to what we expect the government to be able to do for entry level or low-skilled level jobs. Do you want to weigh in a little bit on this whole minimum wage controversy and maybe your take on Mitt Romney surprisingly advocating for an increase in the minimum wage?

David: Yes, I think there are certainly good intentions, and sometimes you look at one policy, where there is an argument that takes on a more moral tone, and you could say we need a living wage, and this is just a question of fairness. That is one way of looking at it. What we have seen over the last 20-25 years is a major labor arbitrage, and what I mean by that is, we had wages here, the rest of the world had wages here, and in order for corporations to meet their earnings per share numbers, a lot of what they would do is shift where there workers were. Geographically, you could close down a plant in Dayton and open up a plant anywhere else in the world, and a lot of those jobs have moved to Asia. That was labor arbitrage.

So you have to be sensitive, following the moral argument, or an emotional argument, if you will, for a living wage, that you don’t end up destroying more jobs than you are intending to create, and you are not hurting more people than you were trying to originally help, I think this is just where economics and free markets end up weighing in and saying, you have to be very cautious here.

Mike: I’m always struck when I meet McAlvany clients, or people who come to a seminar like this, how different the mindset is of the people who are here, from the mindset that we seem to hear a lot right now in today’s vernacular, about the role of government. In other words, it seems to me that the people who are interested in how to protect their assets, people who want to know about gold, want to know about their 401ks, their pensions, it’s kind of a different mindset from the cradle-to-grave, government-will-provide ideology that I think a lot of Americans have right now. Again, I’m always trying to be mindful, not trying to be too opinionated with all these economic issues, but we do seem to be drowning in a sea of entitlement, aren’t we?

David: I think it’s the contrast between makers and takers, and a mindset that comes with it, even when it comes to asset management and protecting what you’ve earned, have you created wealth throughout your professional career and do you want to keep what you’ve made? If you’re on the other side of the spectrum, the takers, it’s just a question of who is going to write the check? Is it going to be the state? The Fed? And how quickly can we get it?

Mike: I want to go back, if I can, for a minute to this makers/takers equation, and this belief that the government has to provide. Do your customers, your clients, historically, say this isn’t the role of the government, I’ve got to look out for myself. The so-called death tax. We talk a lot about the estate tax, and I talk about the radio show a lot and on Fox. There is this sort of double jeopardy, where what you have achieved in your life, you get penalized, in effect, double-taxed, when you try to leave your assets to your heirs, your loved ones. That is a great example, I think, of the government saying, we’re going to take. The government becomes the taker, and we become the victims in this.

David: Mike, most often when we’re talking with clients we find that we share a personal philosophy which is based on personal responsibility, and individual accountability. There are some things about that that tie directly to the dignity of the individual, the human being, for us, created in the image of God. That would be our personal perspective, that the value of each individual, the value of each individual choice, stems from that Imago Dei. Now, we’re not here for theology this morning, but there is sort of, I think, a shared philosophy, and some people get there a different way and still believe in personal responsibility. But as a core philosophy, that leaves them, I think, wondering sometimes, why are the solutions always top-down instead of bottom-up? I think, in terms of clients, our core clients see the role that they play, and I always want to encourage them to look at the resources that they have and realize that in the future those resources will go a long way in helping re-establish that basic common sense approach to money markets and the political system that we have, based on personal responsibility.

Mike: I got an email from a listener in Austin, Texas about a month ago, just a scathing email after one of my segments with Dave. And the guy was like, “I can’t believe you spend Wednesdays with this Dave McAlvany guy talking about retirement and what to do, because you’re wrong. You don’t get it. You don’t understand that this is really what the government is supposed to do.” And I called the guy. It was amazing, he had a 512 area code on his email, and hated me, hated my politics.

David: I believe it was Austin.

Mike: It was Austin, Texas, that’s exactly where it was from.

David: Not surprising.

Mike: Oh, you knew? He was from Austin, Texas. So I called the guy, and we had a half-hour conversation, and I’m not kidding you, he said, “You shouldn’t have to partner with a place like McAlvany Financial because people shouldn’t be worried about their pensions or their retirement funds. That’s what the government is supposed to do. Do you not realize that if we were in France, you wouldn’t have to worry about your retirement? That the government provides for seniors in their retirement? Don’t you understand, dummy?” (He kept calling me dummy). But he said, “Don’t you get it, dummy, that’s what the government…?” And so there really is this disconnect between people who say, “I’ve got to be personally responsible for what I’m going to do in my retirement, I need to look out for my kids,” and people who say, “No, no, no, no, no, you just need to spend….” And he was willing, by the way, to be taxed through the nose.” He said, “I would pay, like they do in France, 60% taxes.” That’s when I slumped over and I grabbed my chest, but he was very happy with that as long as he didn’t have to worry about his retirement. Dave, it was amazing.

David: Well, to roll the clock back even further, you look at the idea of retirement, and it’s a fairly modern concept. It wasn’t brought about, the idea of having a date at which you walk away, hang up the cleats, professionally. That wasn’t established until Otto von Bismarck. Bismarck came along, and politically, he couldn’t roll out some of his opposition. There were some old guard who were there, and apparently they had found the fountain of youth, because they were not going away. And so he created an arbitrary age and said, everybody, rather than pick a fight personally, he said, everybody, at age 65, done, you’re gone.

And so from that point forward, you’re talking late 19th century, I’m saying this is a very modern conception, up to that point, you realize, everyone worked, until about 2-3 years before they passed away, and guess who took care of them? Their family. Retirement was built in, in terms of a family unit, but there was no, sort of, the golden years. The golden years were enjoying your family, and sharing your wisdom, and offering tremendous value. I think people have lost sight of that. So, by the time you fast-forward to what the French have, what the Europeans offer, and what the high cost of that is, I think we’ve lost sight of something altogether. I’m not even sure that retirement is good for us. I realize that may be a controversial statement, but it certainly is a new concept.

Mike: I love, at these seminars, seeing the demographics of people who come, younger people, people my age, maybe people in their golden years. I’m 54 and I’m at that mindset now, and I’ve had a pretty good run over the last 25 years as a broadcaster. Wait a minute? What am I going to do? I’m starting to see that time when I’m not going to be working full time and I want to retire, and I want to make sure I can still have a decent quality of life. It’s nice for me to see younger people at these kinds of seminars who are anticipating it because, man, if we can just shake people in their 20s and 30s. I’ve got four sons in their 20s and early 30s. I could just shake them and say, “Now’s the time, guys. Now is when you have to start planning.”

David: As a family, what we try to do is look and think in terms of the next generation, instead of focusing, even Mary Catherine and I, instead of focusing on our retirement, we would say, “How can we teach our kids to be thinking in those terms?” Now, granted, we have an 8-year-old, a 5-year-old – Dashel  is somewhere in the back there – and then we have a 3-year-old and a 1-year-old. To have them thinking about when they’re 40, 50, and 60, taking care of their children, and we’ve already done that in some regards. The value of compound interest is having 60 years working for you. So for me to be setting aside what amounts to peanuts for the first five years of our kids’ lives, and to see that grow for 60 years, you have time on your side, which is one of the things that you have to have. And when Einstein was suggesting that the power of compound interest is one of the most powerful forces in the universe, as a scientist, he was looking at the exponential function and it doesn’t matter if it’s bacteria in a Petrie dish and the number of time it doubles until the Petrie dish is very colorful and growing everywhere, or money in terms of growth of assets. You have to have time on your side. And I think, if anyone in this room takes that approach and says, “Well, maybe that wasn’t the forethought that was imputed into the family, but I can begin that now.”

Mike: Start right now.

David: Yes, and again, it takes next to nothing, if you do your time value money calculations, saving virtually nothing for your kids, or for your grandkids, for that matter, ear-marking it for, if it is retirement, and then begin to teach them how to manage resources with other people in mind, where you teach the ethos of, it’s really not yourself your thinking about, it’s the next generation, or the next generation after that. It does something very interesting psychologically, I think, in a healthy way, it disconnects us from our last dollar, where we’re not so focused on, “Will I run out?” Because the reality is, you teach your kids to think in terms of the next generation and the generation after that, and how to manage resources on that basis, and guess what is sort of subsumed in the conversation? When your son needs to take care of you, he will.

Mike: Right. I want to go back, if I can, just for a moment, to talking about the economy and growth, and the market, because one of the things I love about the time I spend with you is how much I learn, because I don’t get this formula. We talked a little bit about the growth and the lack thereof. Our paychecks seem to be shrinking, the government keeps getting bigger, as we said. The stock market keeps going up. Can you, in laymen’s terms, explain how the stock market keeps going up despite all that is happening? Because this can’t be.

David: Right. Well, you go back to November 5, 2010, and Ben Bernanke wrote an essay, you can find this on the Fed’s website if you want to read it, and he basically said about quantitative easing II, the purpose of quantitative easing is to increase asset prices, and we want to see an increase in home values, we want to see an increase in the stock market, we want to see a decrease in the cost of capital, that is, bring interest rates down, and we think that if we can goose asset prices, we are going to bolster sentiment, consumers are going to be much more confident, they are going to spend more money, and they are going to be spending out of their great excess. That was the notion of quantitative easing.

They’ve gone through the third cycle of quantitative easing and what they have found is that half of the equation was accurate, it did create asset price inflation, so real estate has responded well, the stock market has responded well, but it hasn’t trickled down into the general economy, and the man in the street certainly hasn’t seen the benefit of that. If you are looking at our demographics, unfortunately, the vast majority of assets are held by, let’s say, 1% to 10% of the country. 90% don’t have hardly any assets to speak of. And so, when you are goosing asset prices, it’s good for a certain segment of society, but that’s not what drives the economy.

What drives the economy is everybody, and everybody’s consumption habits, and everybody’s saving habits, in aggregate. So you have the majority of the country which has not benefitted from asset price inflation, and in fact, is beginning to be troubled by the other thing that sometimes runs in a parallel track with asset price inflation, which is consumer price inflation. Granted, we’ll talk about that a little bit later, because apparently there is no consumer price inflation, and yet, the Kaiser Family Foundation, just in the last ten days, has said from 1999 until today, we’ve had 196% increase in insurance premiums. And this is, now, what they expect small businesses to pay, is anywhere from 25-50% increases next year, as small businesses take on responsibility circa 2015.

That’s just one area of inflation. Of course, when you look at the CPI, they don’t include the volatiles like food and fuel. So, you have sort of the stripped-down version which says there is no inflation, and the reality is, people are dealing with the higher costs of goods and services all the time, and it doesn’t matter what the statistic is, the reality is, paychecks are not going as far. You are running out of money before you get to the end of month. And so, that’s the issue, you’ve got the vast majority who are wondering where they are going to, and how they are going to, make ends meet. Then you’ve got the minority, which are, in fact, doing quite well as a result of an increase in balance sheet size and scale. So maybe you’re worth a million dollars more this year than you were last year, or a billion dollars more this year than you were last year. Does that mean you’re going to buy more from Harry Winston and Tiffany’s? Sure. But again, Tiffany’s is not the core of our economy. So that’s the disconnect. You’ve got folks that were modeling this and saying, if we do this, and create more wealth, that wealth effect will translate into a growing economy. And to this day, Yellen would say, well, we’re almost there, we’re seeing positive signs, but we still need to keep rates incredibly low. Lakshman Achuthan is a guy that runs the Economic Cycles Research Institute. He has asked the question a number of times, and I think it’s worth pondering, “If the economy has recovered, why do we have rates at zero?”

Mike: Right.

David: Essentially, we have had more stimulus in the economy than at any point in U.S. history, and if we were, in fact, in the context of a recovery, why is it necessary to still be on, essentially, economic or financial life support?

Mike: You mentioned the Fed. Let’s talk a little bit about the overview. You have some very strong views and you’ve shared them with us on the radio show over the last year. Talk about your worldview, the role of the Fed, the pros and cons. Give us an overview, a little bit about the role the Fed plays in our daily lives.

David: At this point, they have a self-appointed role as economic engineers, and they believe that they can create a better tomorrow. I think, again, whether you are conservative or liberal, from a fiscal standpoint, and from an economic standpoint, you have to appreciate the history that goes into the creation of the Fed to appreciate the sort of self-appointed role as economic engineer. Number one, the idea of being an economic engineer, basically says that our policies are powerful enough, and more important than, the voting that takes place every day as consumers decide what they want to buy, what they want to own, what they want to invest in.

And this is how we end up with price discovery. What is the price? What is the value? What is the value of a gallon of milk? Is it $3, is it $8. What is the market willing to bear, etc., etc. With the Fed acting as economic engineer, essentially, what you are destroying is that price discovery process. So what is anything worth? Well, and this is where, in fact, you end up with inflated values. With as much money as they are creating, you could argue that everything is worth a lot more. There’s a lot more money chasing a set of goods, so this is the third central bank the U.S. has had. The Fed is not the first central bank, it’s the third. The first and the second were allowed to go the way of the dodo bird, in large part because it was deemed by the general public to be the source of corruption, both in politics and on Wall Street. They saw insider deals cut all the time. They saw the choosing of winners and losers in the financial marketplace, and they saw, then, that it just wasn’t in the interest of our country to have that.

What really accelerated the popularity of the Fed were the ideas of John Maynard Keynes, and there were two gentlemen around the First World War who were writing prolifically. One was Friedrich Hayek, and the other was John Maynard Keynes. They knew each other, they sparred, and ultimately it was Keynes’s idea that became popular in the 1920s and 1930s. If you want to know the history of the Fed, kind of the dirty details, if you will, an interesting book called The Creature from Jekyll Island goes into the crisis of 1907, what happened in terms of credit contraction following that crisis, and the bankers in that day saying to themselves, “You know what we need? We need the ability to print again. And we don’t have that ability. We’re tied to gold. We have a limited money supply, the crisis of 1907, credit contraction. We need to be able to ramp this thing up.”

But they knew the political opposition they would face. So, that book goes through the history of the creation, 1911 being a significant date, 1913 being the actual creation date, and it doesn’t go into the history as much on the first and second central banks, but it does tell you about the Fed today.

The bottom line, for me, is that in this era, we believe that the markets are not as important as, basically, a command and control economy, and the Fed has become the director, the central planner, if you will, for the economy. That’s a problem, in my opinion, because I think we do have, in the last 30 years, a number of examples of failed experiments of central planning, and we’re doing it from an economic perspective on this particular go-round, instead of a political perspective, but I think we should remember the lessons of failed economies and failed political systems, in the Soviet Union, in particular.

Mike: But advocates of the Fed would argue with you that this central planning philosophy is essential. Wouldn’t they advocate for that, too?

David: They would argue that it is essential. I would say, yes, it’s essential, if what you want is sort of a uniform body politic, and no political volatility. Because you see, as often as you have major down cycles in terms of the economy, or the business cycle, you are going to have political volatility. And essentially, what the Fed has been able to do, in sort of a hand-in-glove relationship, is smooth out the business cycle. You go back to the 19th century, the 20th century, and the further back you go, the more you find sort of a 3-5 year boom-to-bust cycle.

Now, we’re talking about very shallow busts, and not-so-impressive booms. But you had, essentially, 1860-1914, if you want to take that particular period, a period of deflation, and relative business stability, and we, today, believe that deflation is destabilizing and dangerous. Deflation is essentially where your dollars buy more and more, instead of less and less. In an inflationary environment, it takes more and more dollars to buy less and less in terms of goods and services, but a mild deflation is actually ideal for economic growth. Here’s the problem: From a political standpoint, and all of this came into being when we developed the progressive tax system in 1913, the same year we created the Fed.

The progressive tax system, again, we know that is where you penalize the highest income earners, and then it is graduated on down. The issue with taxes is, I think, fairly straightforward. If you have an economy which is biased toward inflation, then the tax take is always on the increase. The problem with deflation for central planners is that you can, in fact, see no real way to grow your tax base. Imagine making $100,000 and only being able to buy $50,000 worth of goods. That’s inflation. Imagine making $100,000 and being able to buy $200,000 worth of goods. That would be okay with you, I would assume.

Mike: I would approve.

David: And the world’s at a discount. The problem is, that increase in purchasing power, that net benefit to you, the consumer, isn’t taxable. So when you create a central bank and you have a progressive tax system, it’s always going to have an inflationary bias, and I think that the deflation that they fear is a bit of a bogeyman. It really is something that they’ve said, “Okay, you look at the 1930s, and this is absolutely terrifying – what can happen. Let’s never let that happen again.”

Well, in the 1930s there were a number of very interesting inputs that occurred in that period of time that were unique to the 1930s, and if historians were honest, intellectually, what they would look back and do is say, we had periods of deflation through British and American history going back to the 1600s when deflation was not bad. It was not bad at all. Now, it is tough on political legacy, and I think that is, again, where once we got past World War II, this is where a lot of these things were codified. In 1944 we had the Bretton Woods agreement, and that created a global money system centered on the U.S. dollar.

Mike: I mentioned the Commentary, and I’m sure many of you already hear it, but I hear every week, it seems, from listeners who are thrilled with your Weekly Commentary. It is very valuable, and it’s been a big tool for you, hasn’t it, as far as connecting with people all over the world. It’s If you go to you can access all of Dave’s Weekly Commentaries, but that model, I don’t want to take away anything from your weekly appearances on the Mike Gallagher Radio Show, but the Weekly Commentary has been very fruitful for you, hasn’t it?

David: It’s been very fruitful. I think if we had an audience of one person, we’d still do it, and the reason is, the discipline that it brings to our studies and the questions we continue to ask. It fosters a sense of curiosity in everything that we do, and keeps us working hard to continue to understand an every changing world. So, curiosity takes us into some very strange places, and conversations with some very intriguing people. And the Commentary is that venue where we can talk to academics, we can talk to central bankers, we can talk to business managers, bank executives, politicians, or just have the conversation, again, sort of asking questions, not necessarily having answers.

But yes, it’s been a great venue, and I think for our clients, and maybe some of you listen to the Commentary, as well, it is also a place where you can come alongside us as we continue our education, and you can sort of get your continuing education credits, if you will. The world is very complex. I don’t think anyone has it completely figured out. Anyone who says they do, it may be an issue of integrity, it may be an issue of just pride, or overestimation. Nobody has it figured out, and so continuing to ask questions is really important. This is something that adds a discipline to our life, and maybe it’s a weekly supplement for you. Every Wednesday, wake up, have a cup of coffee, listen to the Commentary. I know a couple down in Mexico City, it’s the way they spend their Friday evenings. Yep, they pop popcorn, have a nice glass of wine, and listen to the Commentary, and they’ve been doing that for five years. They don’t listen to it on Wednesday, but that’s how they like to spend Friday, and they have a discussion about it, and the kids come over on Sunday and it feeds into the conversation.

Mike: Well, it’s kind of eerie. You have like religious, devoted, fanatical followers of this commentary. I’m not kidding you, every Wednesday it’s a big deal, because people glean so much information and so much knowledge from it, so I urge you, if you haven’t done it, go to and get the Wednesday commentary.

Let’s talk about debt. Debt is a very, very crucial part of this conversation today, Dave. It cannot be good when it keeps going up. More and more of our Federal budget is committed to paying the debt. People are worried that when interest rates spike, the interest on the debt payments will rise, as well. Isn’t that true?

David: Yes, and I guess the real question is, will interest rates spike? Apparently, the Fed is in a position today to buy interest rates down, and that’s what they’ve done through quantitative easing. Last year they were the 100% buyer of mortgage-backed securities, and at one point they were 75-80% of all new issued treasuries. The Fed CEO, Mr. Fisher from Dallas, has said that by the time they are done with QE-III, they will be roughly 40% of the total of all mortgage-backed securities, and roughly 25% of all the treasury market. The benefit that they are getting from that is, rates are lower than they would be otherwise, and there are some benefits to that. Not arguing against the benefits, but it is worth noting how artificial the circumstances are that we are in, because when you buy interest rates down, you are basically recalibrating everyone’s perception of risk, and so your risk-free rate is very low, everything else comes down with it, and people begin to underestimate risk. So there are some unintended consequences.

The total stock of debt is now in a place, again, as we mentioned earlier, where you have to have a growth in the economy in lock-step with growth in debt, and that is what has been the problem over the last five years. For the previous 25 years, we had both of them marching along at the same time and it didn’t matter. As long as there is growth in the economy, and there is growth in debt, that’s okay, they’re kind of moving along in a complimentary nature. Then the economy started to stall out, and debt is continuing to grow. Now economists would suggest that you have to have roughly 2.2 trillion dollars in additional debt added to the equation just to keep the game going, and this is where it begins to sort of feel like a Ponzi scheme. If we don’t keep on spending money that we don’t have, then we end up in a real bind.

Mike: You know, I’m struck by the artificiality of it all. This is really a huge part of the problem with the nation’s economy, because there really are factors that are artificial. We talk a lot about what is real money. There isn’t a realness to these equations, is there?

David: No, and I think people are generally happy accepting sort of life at face value.

Mike: And the outcome, of the artificiality.

David: Well, and that’s one of the problems we have today is that we have deferred a lot of responsibility to other people, and as long as they have a Ph.D., or come from the right schools, or what not, we are accepting of their opinions, their models, their views, and assume that our lives are busy enough, as is, to let the professionals handle it. And I think that’s where we’ve missed it.

You mentioned in the first part of the question about the interest component, and 2013, I think, is a very critical year for you to remember, because I think it’s a perfect illustration of what we have ahead for us. The White House estimated 2013 interest payments on the national debt to be around 250 billion dollars. Things got a little squirrely in the May to June period. Interest rates moved up considerably from a relatively low level. It was a major percentage move higher. But in terms of absolute numbers, you were still at a very, very low level, even with that kind of a move. The estimates ended up being off by about 60%. 250 was the estimated interest component on the national debt. We ended up at closer to 415 billion.

So, again, you toggle the interest rate a little bit and what’s the effect? That, in terms of, if you look at it as a percentage of our total revenue, we had 2.6, 2.7 trillion dollars in revenue last year. It went from 9% of total revenue, the interest component, to 15%. The wheels didn’t come off, but you have to ask the question, what is the mark at which total tax revenue, servicing just the interest component, this isn’t principle or even funding the government debt – oh, because by the way, keep in mind what we also have in terms of the mandatory payment category, the mandatory payment of Social Security, Medicare, Medicaid, the interest component, if you add all those together, that’s 81% of our total revenues.

Mike: When do the wheels come off?

David: Well, I think that ends up being a very critical variable, and I think what we have seen, certainly, in the Latin American experience, is that rates come down, and down, and down, and the governments manipulate them down further because they can’t afford to keep them down, and then ultimately something snaps in the market, and what tends to snap is confidence. Something acts as an epiphany, and people say, “Actually, this isn’t sustainable. This doesn’t make sense.” And I don’t know if that’s a psychological threshold where we cross from 17 trillion in the national debt, to 20 trillion, or if it is related to a statistic based on the interest component. Is it half a trillion dollars? It all works, as long as we believe that it is going to work. And again, going back to your notion that this is an artificial thing, it really is. And as long as we are all happy and don’t ask any questions everything goes along just fine.

Mike: Ignorance is bliss.

David: Right, but this is where, I don’t think you have to view our posture or position in the marketplace as particularly negative. All we would say is, sometimes the unexpected occurs, and sometimes you then have mean reversion in terms of market pricing, and if you have been cognizant of how markets fluctuate, swinging from extremes of greed to fear over about a 30-40 year cycle, you may be able to find yourself buying assets very inexpensively, and instead of playing games in your financial life, picking up pennies in front of a steam roller, just hoping that you eke out a couple of percent more, in terms of gain, you can expand your footprint in the marketplace 3, 4, 5, 10-fold, essentially buying the world for 10-20 cents on the dollar.

So our view is anything but negative. It’s just, with some awareness of how history works, of how people work, of how the markets function, and how dysfunctional our markets are today – apparently healthy, utterly dysfunctional – there is opportunity in that. Now, is that opportunity tomorrow, is it six months from now, is it 36 months from now. For anyone who is keeping their powder dry, and not being overly committed to the equity market today, guess what you have? The world is your oyster.

Mike: We’re going to spend some considerable time on gold. That’s a big issue for people, and McAlvany Financial Group has a very unique story to tell, and some exciting news that is happening right now with gold and with precious metals. I want to talk about the war on savings for a moment. I mentioned the estate tax, or the so-called death tax. A lot of people are frustrated because the Fed’s low interest policies have really punished people who’ve saved their money. Can you talk a little bit about that formula and how people are being penalized when they have done the right thing?

David: Sure. In a low interest rate environment, what financial experts would call that is financial repression. That is an actual term, financial repression. When you take interest rates to the zero bound, essentially, you are determining the winners and losers. You are determining where the capital is going to flow. On an annual basis, there are about 400 billion dollars that should have gone to households in the form of savings income, but in a low interest rate environment, it’s gone to the banking sector instead. So you have, basically, the recapitalization of the banking sector on the backs of households. This was done in the 1990s when there was a collapse in the banking system in China. It’s in the playbook. If you are an estate manager, a financial manager, not as in what we do, but at the state level, running the People’s Bank of China, running the Fed, this is the strategy.

So financial repression basically takes your income, whatever you have sitting in the bank. You should be able to buy more than a pack of Wrigley’s Spearmint gum, or a Starbucks coffee, with your annual interest. And it’s not because there is nothing in the bank account, it’s just there is nothing coming into the bank in terms of income. That income has been foregone, it acts as a subsidy to the national debt, and again, 400 billion each year over the last five years has gone to the banking sector in terms of recapitalization. So, it is something that affects households. It is something that affects anyone living on a fixed income.

If you assumed that you could save half a million to a million dollars before your retirement and supplement Social Security with income, the awkward position that this has put you in, is that in order to get the income that you were counting on, past tense, you would have said $100,000 is going to contribute 5 grand in income each year. How does that work? Well, 5% interest. So a million bucks is going to supplement your income $50,000 on top of Social Security. You’ve paid down your debts already, and living on $70,000, $80,000, $100,000 a year, a comfortable existence.

Except that, that 5% is not even 1% anymore, so you’ve seen an 80-90% reduction in your supplementary income. And so what does that force you to do? It forces you to go shopping for higher rates of income. But the only place that you can get higher rates of income is in areas where there are greater degrees of risk, whether that is credit risk, liquidity risk, or what have you. So you’ve seen a major push into high yield, what they euphemistically call high-yield bonds today. We used to call them junk bonds, for a reason, and there is that kind of a trend. There is also a trend into high dividend paying stocks.

Why? Well, the argument has gone, bond market, stock market, if you want to compare the two, it looks like the stock market is a better value, plus you have an income kicker. You’re going to get 2-3% in high dividend paying stock, plus you have growth in the equity markets, and so that relative comparison, actually we’ll do a program on this sometime on the Weekly Commentary, talking about how the comparison between bonds and equities is totally specious. But, nevertheless, Wall Street loves it, and they say that’s why you should be buying high-yield dividend pairs. And these are blue chip companies, by the way, so it’s not extraordinarily high-risk, in terms of your equity profile.

The bottom line is this: You thought you were going to be sitting in a bank account where you were collecting interest, and doing it very safely, and what’s happening instead? You’re taking higher and higher risk to meet your income needs so that you can live the life that you wanted to in retirement, increasing your risk profile as time goes on. That is dangerous. That is dangerous, because essentially, if anything goes wrong, you have an entire class in this country, living on fixed income, or dependent on supplementary income, that now has assets in jeopardy.

Mike: You mentioned junk bonds. I have to ask you, have you seen “The Wolf of Wall Street”?

David: I saw about a third of it flying over to Edinburgh a few weeks ago.

Mike: I was just surprised that it set the record on the number of times the “F” word was ever said in a movie before. I didn’t learn anything about the guy and the way he did his business with the junk trading and all that, but man, Hollywood loves that movie.

David: Well, what’s interesting is, the man in the street came to the conclusion that those kinds of activities were only possible when there was too much funny money floating around the system. Again, that goes back to why the first central bank was put to pasture, and why the second central bank was put to pasture, because they thought that ethics, morality, were basically thrown out the window. Wall Street and Washington. Washington will spend any amount of money that you give them, and more, and we know the and more part, that’s 17 trillion, and more, and more, and more. Wall Street, if you throw money at them, what will they do? OPM, other people’s money, is something that is really fun to play with, according to Wall Street, and you see an example of that in “The Wolf of Wall Street.” I don’t think all of Wall Street is like that. But I do think that Wall Street’s behaviors are altered by too much liquidity, not to the extreme that you have in that movie, but you do have altered behavior nonetheless, and none of it is particularly prudent in the context of too much money floating around the system.

Mike: If you’re looking for a movie that explores ethics and morality, that is not the movie to see. I’m telling you, avoid it, at all costs. It’s bizarre.

I want to talk about the stock market, and bubble levels, before we go on, and I want to spend some time on gold and your philosophy about gold, but a lot of people are worried about the stock market reaching bubble levels, but there is a dilemma. There’s a real conundrum, here. People think that putting more money into the market just because it’s so high might be stupid because it’s, as we talked about, that artificiality. But they are worried that they are just as dumb or dopey taking their money when the market seems to keep rising. So talk about that dilemma that a lot of Americans face.

David: Part of the dilemma goes back to not having very many good, safe alternatives. So there’s a part of the calculus which is, “Why would I sit in cash? I’m not being compensated to sit in cash.” So it forces the issue of doing something. And I generally think that’s a bad operational model as an investor, to say, well, I’ve got to do something, because there’s a whole list of things that you should be analyzing, and “I’ve got to do something” is not at the top of the list, in terms of why you should be doing anything. When you look at equities today, they are overvalued. Why do we say they’re overvalued? Wall Street likes to bring out two versions of the price earnings multiple, sort of the backward-looking and then the forward-looking. The forward-looking is patently absurd, because we have no idea what tomorrow’s earnings are going to be. So you can have your estimated earnings, and it’s a bunch of hokum, nobody knows, right?

On the other hand, backward-looking earnings, we find to be somewhat irrelevant, because we’ve had a tremendous amount of manipulations with short-term earnings, and it has everything to do with the compensation that executives receive. They are compensated on the basis of, basically, an improvement in earnings. To be able to bring them down in one quarter, revive them in the next, they’re paid handsomely on the revival. And to be able to, you could look back over the last 20-30 years and see that, as compensation went toward stock options, as compensation started favoring your C-suite, your chief financial officers, your CEOs, your COOs, your CIOs, with handsome compensation, earnings became much more volatile, and their compensation is certainly a part of that. If you want to see a real critique on that, Andrew Smithers has done, I think, the best work in terms of exploring executive compensation and its role in distorting earnings.

Mike: Is it overstated, though, because obviously, a lot of people say that is solely the problem here, the executive compensation factor.

David: It’s not the only thing, because when you are looking at earnings, they are also not factoring in inflation, so you could basically take your earnings and subtract by 30%, 40%, 50%, and you’re closer to a real number in terms of earnings. And so what Shiller did is he basically said, “We’re going to take what they used to call the CAPE, an acronym for cyclically-adjusted price earnings multiple. You’re adjusting it for a cycle, and you can either do it for 5 years or 10 years, and then you bring it into real terms, factoring in inflation. So, Robert Shiller’s PE, what is now called the Shiller PE, is a 10-year rolling average, in real terms, of the price earnings multiple. That number, today, comes out at about 25.4, as compared to something that you can basically shave off 10 points to get to what people usually consider the PE to be.

Shiller would say we’re 65-70% overvalued at this point. The stock market is overvalued by 65-70%. In the same vein, Andrew Smithers, who was one of the guys we went to meet with in Edinburgh a few weeks ago, same thing. He would say 70-80% overvalued, only because he looks at both the Shiller PE and Tobin’s Q. James Tobin was the Nobel prize-winning economist who popularized something called Tobin’s Q. Essentially, it uses one of the Fed’s reports, Z.1 Section 103B, and it looks at, basically, the value of companies in the country, and you are just looking at the stripped down land, plant, and infrastructure, essentially. If you had to go out today and replace the company, what’s it going to cost you to replace the land, plant and infrastructure?

And so, what Tobin’s Q does is basically give you an over-under. If you’re looking at replacement value, if the equity market is trading here, it would make more sense to go out and restart those companies and just buy the assets outright. You shouldn’t be buying the equities, you should start the companies yourselves. Or if it’s underneath, and basically, the equity market is selling at a 30%, 40%, 50% discount to the replacement value, then the capital market, the equity market, looks brilliant. It looks beautiful, you should be buying it, right?

So, what are those kinds of time frames? We are, today, looking at Tobin’s Q and Shiller PE, at the same places we were in terms of overvaluation in 1929 and 1937. Then the equity markets dipped, and they revised by 1937, overvalued in 1937, overvalued in the year 2000, overvalued in 2007. And today’s numbers are, if you’re looking at Tobin’s Q, second only to the year 2000 in terms of overvaluation, because the year 2000 actually saw greater overvaluation, even, than in 1929.

So, again, you may say, we don’t like Tobin’s Q, or we don’t like the cyclically-adjusted price earning multiple. The question is, why don’t you like it? Most of Wall Street is looking for a way to sell something, and it’s easier to sell stocks looking at your traditional PE. And when that fails, you know how it’s really easy to sell stocks? Using the forward PE. Why? Because it’s just a guess, and it’s always a positive guess. I think the overestimation, on average, looking at forward PE’s, is low side 12%, high side 17%. The bias is always positive by 12-17% in terms of forward estimates on earnings.

So, yes, we look at these two because they do have some historical basis. They do shed some light on periods of overvaluation in the past, and what it tells us is that this is a time that you don’t want to be in stocks. That’s not to say that you can’t go from overvaluation to even greater overvaluation, and this gets to your point. This is really difficult. As an investor you say, well, what if you sat out last year’s 30% increase in equities? Smithers was pounding the table last year, saying that stocks were overvalued, but he was saying they were 65% overvalued. Now they’re, according to him, more like 75-80% overvalued. And you missed a 30% growth rate.

It’s ultimately the concern of what it takes to earn your capital back, and Will Rogers’ famous saying, “I’m more concerned about the return of my capital, than the return on my capital.” And it’s very difficult for investors to control themselves and set the return on capital aside when you’re in a high-risk environment. And it’s way too alluring to just jump in. Could you jump in today? Sure you could, and you might have growth for the next 2-3 years. One thing that CAPE, or Shiller PE, and Tobin’s Q don’t tell you, is when things come unwound. Doesn’t tell you when. It just tells you that you’re overvalued, and that your confidence in the market is misplaced. That’s all it says. It doesn’t say that you can’t make money in the market next year. It just says that when there’s a comeuppance, it’s going to be very unpleasant.

Mike: Not going to be good.

David: No.

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