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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

NATIONAL DEBT 22 TIMES HIGHER THAN WHEN REAGAN TOOK OFFICE
February 20, 2019

“The political squall that is brewing here in the U.S., speaking of social response and a morbid mood leading into this next election, I think is going to look like something that blends Robespierre with what you see south of us to Venezuela, and even to Haiti. There are a lot of angry people, and I think, frankly, some of them are angry with justification.”

– David McAlvany

Kevin:I heard that you, as a family, watched Papillon, the movie, again. I remember the first time that I read the book, Papillon, it had been recommended by a man who had been in the persecuted church in Europe. He had recommended that every person should read the book, Papillon. Richard Wurmbrand had said, “Prepare for the things that you’ve never experienced before.” Papillon is a book about survival. It sounds morbid because it’s a book about one of the worst prisons in the world, and the escape from that prison. It’s really less about the escape, though, than it is how to survive on a moment-to-moment basis.

David:It reminds me of something that you do regularly, or at least growing up you used to do, reading the NTSB reports, and knowing what had gone wrong in a variety of circumstances with pilots who had flown and crashed, and many of whom did not walk away, did not survive. Not that it is something that you do for encouragement or to lift your spirits, but it is very instructional in terms of the things that you don’t want to do, and the things that you do want to do.

Kevin:We were just talking with John Loeffler, and he was talking about his first primary instructor when he got his pilot’s license. The quote that he was given was, “You will make many mistakes. If you survive, learn from them.” And really, that’s what this Commentary is about, as well.

David:I experienced something about three weeks ago which came as a surprise, and it has haunted me since then. It was swimming.

Kevin:You just showed me the scar.

David:Yes.

Kevin:It’s still there.

David:Well, I decided to go for an open water swim, I met with my dad for a couple of days, went swimming out in the ocean and got stung by a box jellyfish. I didn’t know what a box jellyfish was until after the fact, doing the research. Apparently the toxin in a box jellyfish, if you get stung by up to two meters of their tentacles, is enough to kill between 10 and 20 grown adults. I can tell you, for about 18 hours I was in excruciating pain, and for the next two weeks, just here in the last few days have I stopped itching like mad. Had I known, had I been able to read and figure out what it was that I was trying to avoid, something as simple as this – on the 8thday after the full moon, don’t go in the water, particularly on a south-facing beach.

Why? Because box jellyfish are everywhere. It doesn’t matter if you are in Australia or Puerto Rico or Hawaii. It doesn’t matter where you are at in the Bahamas. South-facing beaches on the 8thday after the full moon are full of one of the most serious predators the ocean has to offer. There are more deaths from this particular creature than there are shark attacks, let alone shark deaths. Again, it’s one of those things where, had I known, had I read, if there was such a thing as an NTSB report to give me a mindset and an awareness, there might have been a different set of decisions to be made on that day.

Kevin:And there is a book that you are reading called Last Breaththat goes through different scenarios like that – if you had read it just three or four weeks before. It strikes me, Dave, as we do the show, and just looking back in the years that I have worked with you, how quickly things can change. We go from the expected, which is our everyday life, and this is why you watch the movie Papillonbecause that is unexpected. You don’t think the way a person would think if he was on a prison island in French Guyana until maybe you are in a situation like that. But how quickly you can go from the normal, regular, average, to the abnormal, and the emergency situation.

David:I think this is one of the things that we have long taken for granted, having the dollar reserve currency status and having an acceptable range in which the dollar trades relative to other currencies. There are things that we have taken for granted since 1971. Of course, we have changed the Bretton Woods agreement. But everyone is very comfortable – very comfortable today – with the monetary system that we have. That monetary system is still loosely dollar-based, but on different terms – on very different terms. Now there is nothing backing our currency or any other currency.

So you look at the levels that we’re at and what happens, and it feels normal, but there are still abnormal things which can occur. Here in the last year or so you have had the dollar somewhat volatile. It is now moving up to a point which retraces, or recovers, 61.8% of the decline from January of 2017. We were sitting just around 104 on the dollar index, and then we hit the low in February of 2018 at 88.25. So it declined, and now we’ve moved up to the 96, 97 range. It satisfies, it completes a technical counter-trend rally.

And here we are at a very interesting juncture. We have issues with Europe, and yet the euro, in light of its recent decline, is threatening to rally. It appears the dollar has many reasons to head down from here. And it is in this context that we also have gold which is about to break above a very critical level, $1366, which we set back in January of 2018. The dollar has moved higher and is ready to roll over and move lower. Gold has actually held up very well in the face of dollar strength since at least August of last year.

Kevin:Speaking of changing things quickly, now we have gold going up and we will probably have the dollar going down. We’ve been told how great the economy is, yet Friday’s retail sales came in the worst in nine years, and actually, the people who saw those numbers and understand them are saying, there must be something wrong with the numbers. We certainly hope there is something wrong with the numbers.

David:I don’t know if you saw Larry Kudlow come out, but he was saying, “There’s gotta be a glitch. Something’s wrong here. The retail sales figure was either very inaccurate, or the alternative is it is very telling as to how close we are to recession.” These are numbers that we haven’t seen, Kevin, since 2008 and 2009. You have all but two of 13 retail categories which were down. And as you factor in the retail numbers into GDP estimates for the fourth quarter, the Atlanta Fed has already slashed their estimates from 2.7% growth to 1.5, just on the basis of these horrific retail numbers.

Kevin:To be fair, though, this is the longest we have gone without a recession, almost ever. So the time is here for that to happen. But could the numbers be wrong?

David:There could be a calculation problem. Again, that’s because the number is just that bad, that possibility does exist. As I mentioned, Kudlow was out talking about how there had to be a glitch, but then he also tried to blame the decline in sales on the government shutdown. Well, not really a likely possibility given that the start of the government shutdown was December 22ndand most of your Christmas buying had already been done.

Kevin:Yes, it’s not just the retail buyer, it actually starts further up the chain.

David:Right. Industrial production numbers also were out last week and they were equally disappointing here in the U.S. So is it a coincidence? Is it a coincidence that industrial production numbers are in decline, that retail sales figures are in decline? Is that another glitch? What Bloomberg pointed out last week is that industrial production in Europe, in addition to the U.S., was falling at the fastest pace since the financial crisis. Again, is this mere coincidence?

To us, there is a theme developing, and we discussed the trend. We discussed the trend in Europe and in China over the last several weeks. But here in the U.S. you have the tax cut stimulus which is a little bit like a candle running out of wick. The U.S. is really in no position right now to be boosting global growth. We have our own issues. We have industrial production issues in Italy, in France, and in Germany – throughout the eurozone. And in fact, we may, in the U.S, have just joined the bandwagon of peripheral weakness.

Kevin:But we were talking about the norm. The norm for the last decade, since the last real recession, has been that the Federal Reserve has the back of the stock market, and so people have gotten conditioned. In fact, I talk to clients who say, “Yes, someday it will go down,” but I really think we’re going to have a huge melt-up first. Prechter is not thinking that way is he?

David:No, no, no. Robert Prechter, of Elliott Wave, comments that stocks can turn down from here and never look back. Alternatively, they can go higher. The Dow could make a new high. In his opinion, there is nothing about that – the Dow getting to new highs – which is bullish. And I think a part of that goes back to your comment, which is, we’re a little long in the tooth to begin with. You’ve already had record optimism for a record period of time. So one point that he focuses in on, despite the strength in the economy, if you want to use as the indicator for that the jobs numbers, there are presently more auto loan delinquencies than at the worst point during the recession. Classic Prechter form, he looks at the styling of automobiles and the concentration that you are seeing right now, interest in large gas-guzzling, very muscular vehicles, the styling being an indication of social mood, all very confidently conveying largesse, sort of a hyper-positive mood.

Kevin:Depending on where you live – if you live in Phoenix, every other car is a Charger or a Mustang. If you live where we do, every truck – these things look like semi trucks, and people don’t use them, necessarily, for anything other than just muscling down the road and burning a lot of gas.

David:It’s not just about the size of the truck, it’s about the size of your pipes (laughs). People have to have bigger exhaust, and I don’t even know if that does anything mechanically, but apparently everyone likes large pipes. The styling of the automobiles shifts dramatically with mood. This is one of the things that he points out in his letter, that current nostalgia for the muscle cars – you mentioned the older cars, the Chargers, the cars of the 1960s and the 1970s – there is high demand for those. There is high demand for the bigger-is-better SUVs and trucks and that is consistent with a 5thwave positive mood. If you don’t know, or as a reminder, that wave is the end of the line.

So you have nostalgia for the older muscle cars, and really, just kind of nostalgia in general, including the Bullitt version of the Mustang GT. This came up in conversation this weekend – the Bullitt did. It is characteristic of a stock market top. The whole study is called Socionomics. It is a fascinating look at cultural and social shifts. What they do is, they look to these things as indicators, or as an expression of the current feeling in the marketplace. Mood drives not only the retail consumer, but mood also drives the retail investor, and even the institutional investor.

Kevin:And that can help with understanding the market. Remember when we interviewed Pippa Malmgren? She wrote a book called Signals. It was all about not looking at the thing you’re trying to analyze, but looking at the things around the things you’re trying to analyze, to get your signals.

David:Mary-Catherine came to visit me when we were just dating, in Boise, Idaho. She wanted to watch my family more than she wanted to watch me, to know if the way I was acting and behaving was normal, or was I doing something extraordinary. She was looking for these signals on an interpersonal basis. So, as it relates to the markets, you look at mood. It is one of the signals. As goes the mood, so goes the market. You can look at other significant contributing factors. Like Alan Newman mentioned last week, you have the incidence of terror attacks which has increased significantly since 9-11. You have liquidity flows, that is, there is credit available in the system. The ease of access to credit – a recent guest, Charles Calomiris pointed that out. This impacts the feeling in the marketplace.

Kevin:Yes, everybody could get a loan for a house. Remember that? And then all those loans went bad.

David:Right. And his most recent study shows that there is a connection between the availability of housing finance and the probability of an incumbent victory in the White House, again, suggesting that people vote how they feel, and they feel, based in part on a perception of wealth and well-being and security, and whether or not they were actually able to access the home that they wanted. These are all factors or indicators that point to mood having a causal impact on the markets. Euro auto sales, just like the U.S., softened further in January. Chinese auto sales were not only down for the full year, 2018, which we mentioned, but now we have the January numbers, and they are weak again in January. And by the way, this is a season where you would expect them to be, actually, pretty robust, given the New Year celebrations and things like that in China.

Kevin:Other than the house, you have to figure that the car is the last bill that you let go bad, because you have to have something to drive. Not just here in the United States, Prechter was saying we have the most delinquencies since the last, actually, even worse than the last recession, correct? The most delinquencies. And then you have the same thing going on with sales softening in China and in Europe.

David:Speaking of the Bullitt Mustang, Mary-Catherine is traveling this weekend with my daughter.

Kevin:It’s a mother-daughter trip then?

David:It was boys’ adventure weekend for us, and I was explaining who Steve McQueen was. And I was talking about the epic motorcycle rides he was always wanting to include in his films. We were watching the 1973 version of Papillon. There is a newer version of Papillon. I haven’t seen that one, but the 1973 version and the book, I would agree, it’s a must-read.

Kevin:Oh, it’s amazing.

David:Of course, the Bullitt was Steve’s four-wheel machine, instead of his two-wheel. We also included the Matrix in the mix of movie-watching, so we had these fascinating dystopian conversations – conversations on freedom and risk and survival under adverse circumstances and the difference between people that flourish or perish, tied to things like attitude and perspective. We had fun talking about trips that we want to take, 1,000-mile motorcycle rides and things that, as they get a little older, will come into focus.

Kevin:Dave, I know your kids, and I know how deliberate you are in raising them, but you’ve told me, on these guys’ weekends, when they watch a movie on Patton, or watch a move where they can slip a word in like bastards…

David:(laughs)

Kevin:And Patton gets that in and you’ve said that they say, “Hey, dad approved the movie so can I say bastards?” It’s not normal for the kids, but…

David:Well, and remember the Patton book, the quote was, “Rommel, you magnificent bastard. I read your book.” And in this one, you have Steve McQueen who is floating off on this life raft made of coconuts, and he is in defiance of the system saying, “I’m still here, you bastards.” And of course, my kids gravitate toward that. I’m sure that can be psychoanalyzed.

Kevin:I wonder how mom feels when she gets home?

David:Oh, I know, it’s chaos. But it was no surprise, after a weekend of snowshoeing with the four-year-old, and then skiing with the older boys, and we went out and built snow forts in the mountains, and we were discussing everything from political change in China under Xi Jinping to – this was really frustrating. We played the newest version of the game Clue. There is no library.

Kevin:No library?!

David:There is no library for Mr. Mustard or Mrs. Peacock. No, there’s no library. There’s a movie room, and there’s a spa, and the new instrument of death is a barbell. It’s like, what has happened?!

Kevin:Talk about socioeconomics – hey, that’s says more than we need to know.

David:I know. So this was a part of the conversation, too. Clue has no library. And I guess it comes as no surprise that my oldest insisted last night on sleeping outdoors in the snow.

Kevin:(laughs) That sounds like something that runs in the family, by the way.

David:It kinds of does, it kind of does. And it continued to snow all night. On the one hand, I don’t know what he’s thinking, but on the other hand, it’s exactly what I would have done – and did – at his age.

Kevin:Sure. It sounds like a great guys’ weekend.

David:We’re curating culture. I think we all are, to some degree. But their experiences of life, their experiences of literature, their experiences of film and conversations which I think trigger identity markers and I think they set us on imaginative journeys which set the stage for the rest of our lives. So I won’t know for years what is stirred in the soul of a 12-year-old as it is lying there in silence in a bivy sack and a zero-degree down bag with the snow gently falling, look at the night sky. You know the way it is at night, when it is snowing and the moon is out, everything is aglow, with the moon just sort of filtered and slightly breaking through those low-hanging clouds.

Kevin:Yes, but you still have your wife calling to see how the kids are.

David:Well sure, I’m not a completely irresponsible dad (laughs). I went outside all through the night to check on him just to make sure he wasn’t turning into a popsicle.

Kevin:Right.

David:Because Mary-Catherine was mildly nervous. The funny thing is – I know this a total tangent, we’ll get back to business in a minute – I offered to read her a chapter on hypothermia and avalanche from the book Last Breath(laughs) and she was not amused.

Kevin:You were just pouring salt in the wound.

David:Well, I thought it would be fun. It was like a walk down memory lane. In 2005 we were in Africa for a couple of weeks and sitting in a linen or cotton tent, whatever it was, we were reading Death in the Tall Grass, while literally listening to the roar of the Kilombero lions across the river. And I thought, “Well, why wouldn’t you want me to read on hypothermia? It’s only our son in the front yard.” (laughs) So anyway, at midnight I went out and he was still wide awake, and he asked if I was done reading for the Commentary.

Kevin:Right, every Monday night you read for the Commentary.

David:That’s right. And I could tell by how engaged he was in conversation that the quietness of the night was almost too much for him to bear.

Kevin:So, when you’ve got him captivated outside, and really needing conversation with his dad, what did you guys talk about?

David:(laughs) Out of the blue he says, “So, about capitalism – why does it go by that name?” So we talked about finding opportunity and contrarian approaches to the market. We talked about various things. I think, frankly, real estate seems to be more appealing to him than stocks and bonds. So we talked a little bit about interest rates and the finance mechanism if that is ever disturbed within the housing market. He knows that flourishing and opportunities are always possible, regardless of adversity. In fact, that is frequently where the greatest opportunities are.

And of course, talking about Papillonand seeing that there are ways to maintain a mindset – it doesn’t matter what your circumstances are, your perspective, your attitude, your mindset, are very critical to how you either flourish or diminish as a human being in those circumstances.

Kevin:And oftentimes, the person who doesn’t take opportunities, it is because they don’t understand the danger. The fear of the unknown is such an amazing motivator. We talked at the beginning of the program about reading aviation accident reports when you are a pilot. Well, why do you do that? You don’t do that so you sit on the ground, you do that so you can go fly. Why do you read Last Breath? So that you never go back in the water? No. You just don’t go in the water on the 8thday after a full moon.

David:(laughs) Right.

Kevin:But usually, the person who actually is taking an opportunity has eliminated the fear of the unknown, to a certain degree, just by seeing, “Okay, well, what is the worst that could happen?”

David:And you may have some scars from it. Again, what you said earlier. You’ll make mistakes, and if you survive, learn from them.

Kevin:Right.

David:Right. So opportunities are presented to everyone, but they are rarely taken by anyone. I think maybe it’s because of the compulsion to follow the crowd, or because of a scarcity of resources, or being dominated by a particular fear – fear of the unknown, fear of death. And maybe it is something as basic as resources at the moment, an inability to participate, or to be able to prepare. But again, we are back to this idea of social mood.

Kevin:How often are you asked, “How come I’ve never heard this from anybody else before? In other words, I’m not going to believe this unless everybody that I know also believes this.” It’s an amazing thing, but social mood is that. That is the herd. That’s the herd mentality.

David:Where you find opportunity within the markets, it is sometimes moving away from the first person singular. We’ve been encouraged to engage with being, and being present in the moment, and living in this moment. I’m not taking away from that from a philosophical or an experiential or an existential perspective, but we live often in the first person singular, and I think a lot of insight and opportunity comes more often from the third person perspective, stepping outside the current rush of events and standing above the madness of the crowds to see what is going on below.

Kevin:Talking about madness of crowds, you can fuel an awful lot of illusion with debt. Look at what is happening in China right now. China has just absolutely opened the floodgates. “You want money? You can have money.”

David:In the last several years, obviously, that has been an aggressive stance that the People’s Bank of China has taken. And in the last few weeks their comments fromMinxin Pei, a former guest of ours on the Commentary, Ken Rogoff, Arvind Subramanian, who was in the central banking community in India, all on China, and they are all worth discussing. But frankly, the most important details on China this last week came from our own teammate, Doug Noland, who manages our tactical short offering in the Wealth Management Group. January credit data out of China was shocking. Aggregate financing totaled 685 billion dollars for the month.

Kevin:For a month.

David:For the month.

Kevin:685 billion in a month – this isn’t a year.

David:For the month. This is credit expansion gone wild. You have fresh bank lending, which was 477 billion dollars. It’s just the normal traditional bank lending. That’s January numbers. Reuter’s was suggesting that in response to a sluggish investment and sharp slowdown in the economy, that you are seeing policymakers address this using the credit spigots to try to cancel out the economic and the market declines. This is very typical of a final phase in a credit boom where you see these parabolic increases and a mass distribution of credit. We had a question on our Q&A late last year about modern monetary theory.

Kevin:Right, which is just free money theory.

David:Right. Well, this is counter to modern monetary theory. This never works. You can’t just spread credit to the wind because the returns on each subsequent credit round diminish. You have the inherent risk which increases until you enter the default cycle, that kicks into gear.

Kevin:When does a person borrow the most? If you were measuring borrowing, they borrow the most, usually, right before bankruptcy, and look at the slowdown that is going on in China, as well.

David:Yes, the borrowing comes at the peak of confidence. I got a shirt for one of my boys here recently. It is from a ski area. It says, “Confidence – that feeling you have just before you realize what you’ve gotten yourself into.”

Kevin:(laughs)

David:The current account surpluses in China – look, they continue to shrink, which tells you something about global trade. It tells you something about the willingness or the ability of the Chinese, with a shrinking trade deficit – well, for us, a trade deficit for them, their surplus dollars – but they have taken those surplus dollars traditionally, and recycled those trade dollars into treasuries. Are they going to continue to be willing to underwrite our budget deficits? The Chinese government’s response is, “You have slowing growth.” What are they reaching for? They’re reaching for the old elixir of the market soul – credit.

Kevin:Right.

David:Credit. And I think what they are forgetting is an ancient Chinese saying. Ironically, they’re drinking poison to quench their thirst. And as Doug notes in his Credit Bubble Bulletin over the weekend, they’re drinking a lot of it.

Kevin:You know, we’ve been drinking a lot of it, too, but something we’re not doing here is what the Chinese have been doing. All the gold, virtually all the gold every year is going to China. We’ve talked about this for years on the Commentary. They must see something in the offing for the U.S. dollar.

David:Yes. Weeks ago we were discussing – we looked at the imports of gold into China, suggesting that the official reports by the PBOC are understated.

Kevin:Sure.

David:And I would hold to that. But think about this. For the sake of argument, assume that the 400+ tons of gold imports into China each year are not People’s Bank of China bound. You could conclude that the massive increase in street demand for gold – investment demand for gold in China – is reminiscent of something we have seen before.

Kevin:Yes, you know, I’m thinking about signals – socioeconomics, moods, the things you’re talking about. Wouldn’t it be wonderful if you and I could transport ourselves back to 1967-1968 and see the French and say, “Hey, Dave, look what the French are doing. They’re cashing an awful lot of dollars into gold. I wonder what is going to happen? Do you realize we would be independently wealthy at this point because the next step was the devaluation of the dollar and the closing of the gold window.

David:And there was a very muscular approach that we took in our communications to the French in 1968, which was to say, “If you are a friend of America, you will settle these debts in greenbacks.” And we made it very clear that there was now a diplomatic row in the offing if they revealed that we had a fiscal issue.

Kevin:And this is a conversation that is going on either with our military or behind the scenes right now with China.

David:So again, the 1968-1971 monetary shift – it was understood by astute investors across the pond, there in France, in anticipation of a major devaluation, the gold began to move. Only in this case, I’m wondering if it is the Chinese, not the French, who are the buyers. So again, I think the PBOC may be behind the buying of that 400 tons. An alternative explanation is that there are a lot of people and there is sophisticated money within China that sees a coming devaluation, and it is the devaluation of the RMB. It is a massive devaluation to maintain trade competitiveness, and I think this is where you have a population difference between France and China so you could be talking about very different numbers in terms of demand for gold. The numbers could get very interesting.

Kevin:Another thing we could transport ourselves back for and see ahead if we could do that would be the 1930s. Remember learning in economics class what trade conflict did back in the 1930s to force us into depression. We have trade conflict right now.

David:So devaluation anticipation is what I’m focusing on with that gold comment. And you’re right, in the event of a major devaluation in China, there is this issue – we’re talking about a trade conflict. It is far more significant – far more significant– than anything we saw in the 1930s, because if you look at merchandise exports, today they account for between 20% and 25% of global GDP here in recent years. This is according to Arvind Subramanian. They were just 8% versus today’s current 20-25%. They were 8% in 1929. So here you are on the eve of the U.S./British dollar/sterling devaluations – currency wars, the old school competitive devaluations – I think we may be getting closer to that by the day.

Kevin:We talked about delinquencies on auto payments earlier in the program. You look at the segment of society that can’t pay their car bill. This is the person who also is just making the bills.

David:Kevin, you mentioned it earlier because making this particular payment not only enables you to get to work, but in a worst case scenario you can live in your vehicle in the event that you lose your home, so it is actually one of those payments that people are pretty deliberate about making. The Washington Post reported last week that a record seven million Americans – seven million Americans – are 90 days or more behind on their auto loan payments. The report was drawing from the New York Federal Reserve, and it had this to say – again, this is seven million Americans, there are more now delinquent than in the wake of the financial crisis. You have to kind of let that sink in. The New York Fed wrote, and I think this was somewhat ironically, that the substantial and growing number of distressed borrowers suggests that not all Americans have benefitted from the strong labor market. And it went on to say, “When car loan delinquencies rise it’s a sign of significant duress among low income and working class Americans.”

Kevin:Yes, it’s the lowest rung on the economic ladder. I’m going to pay my car bill. Let’s put it this way, that’s the last thing that I’m not going to pay, because even my house, I know that I can not pay my mortgage for a period of time without losing my house.

David:I just want to repeat this. The New York Fed says, “It’s a sign of significant duress among low income and working class Americans.” If you want to understand politics of the day, if you want to understand populism, if you want to understand why Trump got elected, and what the landscape looks like as you see a greater divide between left and right, let this sink in. You have seven million more Americans today than during the financial crisis who are delinquent on their auto loans, and this is suggesting duress – duress.

This is not an inconvenience, this is not, “Oh, I can’t save as much as I used to.” Duress among low income and working class families tells you that there is a huge segment of our population who were not along for the ride in terms of the asset price appreciation, compliments of the Fed, the PBOC, the Bank of Japan, the ECB – the last ten years’ run in asset prices.

Kevin:Well, that’s what debt buys. I have to imagine that the amount of car loans that are outstanding right now is far larger than it was during the last financial crisis, as well.

David:Back in 2009, again, this goes back to Noland and his comments on the weekend in the Credit Bubble Bulletin, “Auto debt is at 1.27 trillion dollars today. That is 75% higher than it was in 2009.” So actually almost a mirror to your student loan issues. 1 trillion, 2 trillion, who cares? It’s only 3 trillion dollars between…

Kevin:A trillion here, a trillion there, what does it matter?

David:(laughs) But among the subprime borrowers in the category for autos, the delinquency rates are at 16.3%. That’s a pretty high number, and it has increased from 12% over the last three to four years. The average purchase – I think this is fascinating – the average purchase price of a new vehicle is coming in at $37,000 versus $27,000 just five years ago.

Kevin:Yes. Okay, the Federal Reserve’s Powell says he sees no inflation. There is no concern, yet what you’re telling me is 40-50% increase in car prices in five years. But there’s no inflation.

David:Again, the debt number increases, the sticker price is increasing.

Kevin:Well, except that you have to factor in also the size of the exhaust pipe.

David:(laughs)

Kevin:You’re getting more exhaust pipe at this point than you did five years ago.

David:Well, I never thought I could factor a larger exhaust pipe into my hedonics. You’re right, you’re right. Powell sees no inflation, and yet we know if you’re looking at corporate profit and the earnings reports through the first quarter, that profit margins are shrinking. Profit margins are shrinking for corporate giants, and their only exit from that dilemma is price hikes.

Kevin:Well, how do you increase your profits when you have people like Amazon coming in? They can run at a loss and just lower the price and put everybody else out of business?

David:Well, and that may be a part of the issue, but we have seen at the consumer level the parade of late 2018 price hikes as people are trying to boost their profit margins. They havebeen squeezed. How does that translate to the consumer? If you’re going to increase your prices, it does flow through the retail distributor to the consumer.

Kevin:But when Amazon purchased Whole Foods, what is the effect there?

David:They had immediate cost cuts and they were trying to increase in-store traffic quite a bit. They signed some interesting contracts with their providers and so there was some cost savings, if you will, for the consumer. But here in December that chain, Whole Foods, jumped prices on over 500 items. So they are pointing fingers back to the suppliers, the suppliers are claiming increased costs of packaging and ingredients and transportation. And then you have the Wall Street Journallast week pointing to retailers – not just Whole Foods, but across the spectrum – passing on these costs in response to what they quote as growing signs of inflation.

Again, Jerome Powell says there is no inflation. The official statistics don’t show much inflation at all, it doesn’t exist officially. So CNBC writes this last week that there is headlines which say there is no inflation, but this is what the CNBC article said. “Look what is getting more expensive. The CPI remained unchanged in January, yet rent, food, and medical care all got more expensive. So anything that matters is on the increase. Anything that is a part of your daily life is on the increase. I think this ties back to this issue of political discontent, and I think it will be a primary mover in terms of the politics of the next election.

Kevin:We saw what China did as they are at the peak of exuberance, as things are slowing down. But actually, you were talking about the possibility of our currency moving lower, and our budget deficit is dramatically widening at the same time.

David:There is a connection there. The possibility of our currency moving lower has to be kept in mind. When you look at the U.S. budget deficit, it is widening. It was 319 billion dollars most recently. Again, we have flat revenue. We have Bloomberg reporting a 42% increase between October and December. Our budget deficit goes up 42% in that pace of time based on data that the Treasury released last week, Wednesday. This is very large, the quarterly increase by 42%, and think it is a reminder that our financing needs as a country are huge. So even as we sit where the Fed is saying, “Look, we are at full employment, we have a robust economy,” think about this. We’re at full employment, we have a robust economy, and we are borrowing over a trillion dollars a year. Why? Why? Because listen, if I said to myself, “Today I woke up on the wrong side of the bed and I’m a Keynesian.”

Kevin:Well, this is supposed to be perfect Keynesian economics, right?

David:Right, because Keynesian deficit spending is to prop up aggregate demand in the case that consumers go on strike and they’re not willing to do their best to keep the economy growing. So government spending steps in and you prop up aggregate demand, even if it requires deficit spending. But what does it mean when we have, according to official statistics, a robust economic backdrop, but increasing deficits? Deficit spending isn’t supposed to be happening in this environment. What are we doing? Yes, we have less revenues. Yes, there is more spending. But what does the deficit look like during the next recession?

Kevin:I was at church on Sunday and one of the guys who listens to the Commentary came up to me and he said, “I have a question to ask you before we start. We just passed the 22 trillion mark. Does our government have any intention of ever paying that back?” He knew the answer before he asked, but he was troubled.

David:I think a part of this ties to inflation, because when any government goes too far in, when they commit too much on the deficit side, and there is too much debt to repay, they will pay it back, it’s just with cheaper and cheaper currency units. And so for the saver, for the person living on a fixed income, this is where you begin to see the roiling and the tearing of the social fabric because a social contract which has been in place, whether you are talking about Medicare, Medicaid, Social Security, things that people counted on, that they put into the system when the dollar was worth, let’s say 2X, and now they’re drawing from the system, if the dollar is in some future hypothetical state, at .5X. And it just doesn’t go the distance. You’re right.

So this week, very monumental, we passed the 22-trillion milestone. That’s our national debt. Back to this issue of the deficit. We can increase that number by 10-15% in a single year during the next recession because we’re talking about running deficits that are 15-20% of GDP. Think about this. We’re running a trillion-dollar-a-year deficit with a “robust” economy. For the deficit to exceed 2-3 trillion in one year won’t be a surprise when revenues decline and the government has to step up their deficit spending even further. You ask yourself, what does the dollar look like in that environment, because we’re really talking about what the dollar looks like in the context of the next round of QE.

Kevin:One of the things we talked about was going back and looking at what the French were doing in the late 1960s and looking at what the Chinese are doing now. What the French were doing in the late 1960s wasn’t just getting gold, they were cashing in treasuries for gold. China is doing the same thing. They’re not getting gold, they’re having to buy that on other markets. But look at what the Chinese are doing with the U.S. treasuries. They are no longer our buyer of first and last resort.

David:That’s right. Debtors are judged on their ability to pay. In this case, we’re paying with our own currency, and we’re forcing the issue and saying, “You’ll be happy to take our dollars, won’t you? To be a friend of America is to take our dollars, and you will be happy with that, won’t you?”

Kevin:By the way, did you see our carrier sitting right out in the China sea?

David:Exactly, exactly. A big week last week – the TIC reports show, yet again, that the Chinese are liquidating treasuries. For the last 20-30 years we have had implicit with our trade partners, folks who are willing to finance our budget deficits, recycling those trade dollars.

Kevin:“We’ll run deficits with you as long as you buy our treasuries.”

David:That’s right. And they get the surplus dollars and recycle them. Run the drill. You spend more than you bring in. Someone has to finance the difference. They loan you the money, yet we have one of our largest creditors, yet again, as we get through the 4thquarter of 2018, dumping tens of billions of U.S. dollars onto the market. This goes full circle to, what is the mood of the market? I think it can turn negative in a hurry, and all of a sudden the assumptions that we have about normality all go out the door.

Kevin:We talked about Amazon and some of these companies that are earning billions and billions of dollars. You don’t have to borrow money to pay for your deficits if you can just raise the revenues. How about the taxes coming in on this robust economy?

David:I think this is, again, where we are talking about a political environment that is geared toward pitchforks and torches (laughs).

Kevin:Molotov cocktails.

David:Yes, exactly. Amazon is a good example of why people are about to get really, really angry, if they’re not already angry. Amazon will pay zero dollars in federal taxes for the second year in a row.

Kevin:Wait a second! I thought that is part of our robust economy. That’s why it’s good.

David:Let’s just talk about an 800-billion dollar market cap. Let’s talk about a greater than 250 billion dollars in revenue, and 11.2 billion dollars in profits. Now, they just increased their profits year-over-year from 5.6 billion to 11.2 billion. That’s impressive. I’m glad for them. But far from paying the statutory 21% income rate, I want to introduce you to an organization, the Institute on Taxation and Economic Policy (laughs). They said, “Look, it’s not the statutory 21% tax rate that they are going to pay on that 11.2 billion dollars. It reported a 129-million dollar federal income tax rebate.”

Kevin:Oh, they’re going to get money back.

David:They’re getting money back even though they increased their profits to 11.2 billion. Their effective tax rate is negative 1%. Will someone tell me how I can do that?

Kevin:Oh man, me too. Sign me up.

David:Right. But this is the nature of socialism. If we could all do it, we’d all be happy. If we could all pay nothing and get lots of things for free, wouldn’t that be great? So you start with the 11.2 billion dollars in profit. Good for them. I’m glad they’re making a profit. That’s better than not making a profit. But I like what Bernie Sanders said in his tweet last week. I don’t think I’ve ever said I like anything Bernie Sanders has said, but he said this, and I agree with him. “If you paid the $119 annual fee to become an Amazon Prime member last year, you paid more to Amazon than it paid in taxes.”

Kevin:That’s amazing. You know, it’s funny, too, the irony here, because you have a socialist, Bernie Sanders, who is criticizing something that is not paying taxes for socialist reasons.

David:Right. My wife’s comment when I mentioned this to her was, “This is what causes people who work hard for a living to become revolutionaries.” So the political squall that is brewing here in the U.S., speaking of a social response and a morbid mood, leading into this next election, I think is going to look like something that blends Robespierre with what you see south of us to Venezuela, and even to Haiti. If you have watched what is in the news in the last few weeks, there are a lot of angry people. And I think, frankly, some of them are angry with justification.

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