The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“Everything in life is nuanced. And everything on a political platform becomes very bifurcated, and good or evil, and that’s not nuanced at all. So now that we’re past the election we need to start getting into the fine brush-strokes and figuring out what are the things that we need to hold onto and what are the costs of letting them go?”
– David McAlvany
Kevin: Last week we did two shows, obviously, because of the election. Dave, I just want to take the time right now to thank our listeners. We had a great viewership of both shows. There was no drop in viewership or listenership even though it cost twice the time last week. So just thank the listeners for the time, for the comments. Actually, there is substantive dialogue that goes on in the sections that we see on YouTube with some of our listeners that actually seems to be lacking in what is going on in the mainline media right now.
David: You and I have noted many times that there is this impressive commentary which occurs after the Commentary from the listeners, and the insights and the questions and the dialogue between themselves. To me, it is a remarkable thing. And then at the end of the year when we do our question and answer period we are equally floored by the challenging nature of the questions posed, and just how engaged our listeners are with current events and how invested they are in particular outcomes, whether it is political, social or what not. But it is marked by civility, and it is marked by a real care and concern for not only the country, but our economy, and of course, their families, and their individual balance sheets, of course, too.
Kevin: That is what has been disappointing to me in the nation right now. What is going on generally across the nation is not civil dialogue. The people who considered themselves the most tolerant, at this point are looking to be the most intolerant.
Kevin: Talking about substantive dialogue, there really isn’t any. If you talk to someone who considers themselves a loser from last week’s election, some of them won’t even admit that they’ve lost. They just won’t accept the outcome. But for the people who are upset about the loss, I haven’t had, really, an honest-to-goodness intelligent conversation with any of them. It’s mainly just name-calling rather than actually talking about any of the issues.
David: In the news this week, I think it’s the best evidence of a generation of bubble children. I was describing the importance of college to my kids at the breakfast table the other morning, and really, why I thought both undergraduate and graduate studies were often of value. And here was my caveat. There was the qualifying, when at University, try to avoid indoctrination, which is like a simultaneous parasitic invasion of the temporal lobe. The temporal lobe helps you think deeply and process information. And at the same time, getting over-stimulus of the limbic system, which is that emotional and visceral reaction part of you. I would just hate to see my kids converted, on the basis of indoctrination, from otherwise thoughtful individuals, into emotional basket cases.
Kevin: People are just ranting right now. Even here in little Durango there are protests right now, and if you read the signs or talk to the people at the protest, it reminds me, honestly, Dave, of going to Occupy Wall Street when I was down in New York a couple of years ago. I went there hoping for good economic discussion as to why they were occupying. They had none. These people were just mad and they couldn’t explain why.
David: I came home the other night after the rally here in Durango. My kids were at the park where this rally was occurring. I wasn’t, but they were there playing at the park, saying, “I thought Trump won. Why are they saying he’s not president?” So we had an interesting conversation that night. But half of the placards that people were holding up dealt with decolonization, and native lives matter, and I was just thinking, “It really is an excuse for people to just sort of rant.” So here we have, the bubble has burst, and you have the need for some combination of a rant room, a safe space on campus, or just a day off from school, again, because the bubble has burst. So if there are any challenges to their preconceptions of the world, that popping of the bubble, there are these sorts of behavioral outbursts.
I see a similarity to what eminent sociologist Peter Berger calls a plausibility structure, which is just a set of ideas believed to be uniformly held by everyone within a society. These structures form the basis for feeling like everyone around you is like you, and holds the same ideas about reality. But then when someone discovers you are outside the belief structure and not a part of the homogeneous group, it’s like a tearing of the social fabric, and it can elicit this feeling of betrayal, of danger, and it can even evoke violent reactions and protests to what was considered inconceivable.
Kevin: You’re talking about the limbic system, right? It’s an emotional response from people who pride themselves, oftentimes, on thinking a little bit higher than the average Joe.
David: Right. And then they feel no longer safe. This appears to have occurred in the election with The Donald. Trump blew up the liberal media’s plausibility structure, and the left is now scrambling for explanations, for justifications, which identify the threat, which sort of cordon off, if you could call it, a disease of difference, people who were, in fact, different from them, and they didn’t realize they were there, and they’re not comfortable with them being there. So they still see themselves as the reasonable ones, as the gentle souls.
And as I do every week, read for this commentary, and to keep apprised of the markets, I’ll sample The Economist, and Project Syndicate, and read different national newspapers and listen to CNN and MSNBC and Bloomberg and CNBC. And it’s interesting because most of these news sources have gone full blown into their apoplexy. And they’re angry, and they’re frustrated. This is the foreign press corps, too. I think there is a temptation, if you read The Economist this last week, to cancel a subscription because it’s insulting.
Kevin: Yes, Dave, that’s was what I considered, going ahead and cancelling my long-term subscription to The Economist because it’s trying to direct the way people think instead of actually listening to the way people think. I think of ABC, NBC and CBS. They were already fading into the twilight anyway because we have people going to the Internet for their information these days. But I listen to George Stephanopoulos, and we talk about some of the people who consider themselves as objective analysts just really falling apart. The New York Times, however, is coming at it a different way. They don’t want to be thrown to the dustbin of irrelevance, so they have come out and apologized and they said they’re going to change their ways.
David: You’re right. They seem to be one of the few sort of standing in stark contrast. The majority are basically presenting the president-elect as a misogynist at best, a molester quite possibly, and then they’re adding to the compliment every blast from the past that could scare your socks off. So here’s kind of how they’ve painted the picture. Imagine Donald Trump taking the oval office, and he is gathered, in white sheets, with all of his fellow advisors, conducting séances to get in touch with the lead advisor, back from the dead, none other than Hitler, himself.
Kevin: Right. That’s how it’s being portrayed.
David: Right. And that’s why I think there is that refreshing note from the New York Times, which basically claimed its failure in the face of a declining subscription rate, and maybe that is why they’re out there. But they’ve “rededicated themselves to truth in journalism.” Again, for the New York Times to come out with something like that is an indication of just how much they must be hemorrhaging from ad revenue and subscription cancellations. But the rest of the media group, if they don’t humble themselves a little bit, they will find themselves, as you said, in the dustbin of irrelevancy.
Kevin: The thing that is enlightening to me this last week is, the people who consider themselves the most tolerant are being intolerant, like we talked about before. It reminded me, you might remember a couple of years ago, someone made a comment how Muslims really don’t have a sense of perspective, or humor. They were threatened, basically, with death by the Muslims, saying, “What do you mean we don’t have a sense of humor? We’re going to kill you for saying that.” There is a lack of understanding of the irony of the situation.
David: Well, S.D. Gaede wrote a book, When Tolerance Is No Virtue, and there was another book by D. A. Carson – I don’t remember the title exactly, but it was a similar title and similar theme. Both of them suggested, years ago, that there is this deep thread of intolerance in the tolerance movement, and that is, the movement of stridently politically correct people. They would say something like this: “We’re open to all ideas, unless they conflict with ours.” That would kind of be the gist of it.
And if you haven’t fought hard to hold the moral high ground, and if you look at the current university environment, it operates more out of intellectual intimidation than it does free thinking, but if you haven’t fought hard for that moral high ground, but have instead, over the last 20-30 years, benefitted from bullying tactics, and then you lose the high ground, it’s kind of difficult to regain it. And so, the first appeal seems to be violence, threat, an increase in volume, shouting. Intellectually, the left is more empty-minded than it is open-minded. This reminds me of something Chesterton said: “We keep an open mind like we keep an open mouth, to close on something solid.”
And in this case, the empty mind assumed that its plausibility structure would never be challenged, and that if you were occasionally reading a New York Times article, or an Atlantic Monthly article, that was sufficient to be informed, and to appear to be thoughtfully engaged with ideas and cultural trends, and long gone are the days of the hard work that went into developing a coherent argumentation. The hard work of argumentation – I’m talking about civil argumentation, a debate where ideas are worked out rigorously, again, with a certain degree of generosity – that has been out of practice for a very long time. We had the presidential debates being just one example of that.
But the news media’s preference for shaming into compliance is just one other example. They’re not engaged with ideas or issues, it is sort of a social corralling, and if you don’t agree with the latest liberal agenda item, you are the person who can be subjected to any manner of dehumanization. So after all, we’ve found someone who is different, with different views, and the easiest explanation, or the knee-jerk explanation, when you’re dealing with the destruction of a plausibility structure, is to assume that that person is evil, or dangerous, or insane, or all of the above.
Kevin: That can happen on either side of the equation.
David: Of course.
Kevin: The left, at this point, has been left behind, and they don’t know exactly what to do. But the other side of it still needs to debate. So if the left has lost their ability to debate, possibly because they’ve been in power for so long, we talked about on Friday, Dave, that it has been since 1928 that the GOP has controlled the House, the Senate, the presidency, and what probably will be weighting heavily, the Judiciary.
David: I think with that lack of power, my hope is that the left actually does engage rigorously in debate, and it raises the bar for both left and right in terms of why we’re doing what we’re doing and what the justifications are for it, because they’re not operating with ease anymore. They’re going to have to fight against whatever the Republican majority wants, and they’re going to have to fight for everything that they want to defend and not cede to the Republicans. And I hope, again, that is not done on the basis of fear tactics, but that they look at, and reflect on, the better approach, which is, how do we educate people toward a proper conclusion? In some instances, they will find they can’t, in some instances they will find they can, but it will be harder work than they are used to.
Kevin: You have talked about how your family handles things, that the relationship is not broken just because you disagree. I think sometimes we can get a bad name for tolerance. I’m sick of this whole intolerance argument, but I also want to be a tolerant person. I want to be a person that doesn’t break the relationship just because I don’t agree. So I think we should look at what is good tolerance versus what is this misnomer that we’ve been taught is political correctness.
David: Yes. D.A. Carson quoted from the United Nations Declaration of Principles of Tolerance – this dates back to 1995 – where it asserts that “tolerance involves the rejection of dogmatism and absolutism.” Also from Carson’s book, he quotes Thomas Helmbock, who is Executive Vice President of the National Lambda Chi Alpha Fraternity, who wrote, “The definition of the new tolerance is that every individual’s beliefs, values, lifestyle, and perception of truth claims are equal. There is no hierarchy of truth. Your beliefs and my beliefs are equal, and all truth is relative.”
Kevin: That’s very, very post-modern thinking, isn’t it?
David: I read Gaede and a bit of Carson in college, and this past week had to brush it off again because it hits the nail on the head. This is what Gaede says: “In the past, political correctness generally centered on issues that were quite substantive. The Victorians were prudish about sex because they were enthusiastic about bourgeois morality. In the ’50s many Americans were intolerant of any notion that seemed remotely pink – socialistic – because they assumed communism to be a major threat in their economic and political freedom. Today’s PC, however, is intolerant, not of substance, but of intolerance, itself. Thus, although the politically correct world would have a great deal of difficulty agreeing on what constitutes goodness and truth, they have no trouble at all agreeing that intolerance, itself, is wrong. Why? Because no one deserves to be offended.”
David: So, when someone is offended, as we have witnessed in the aftermath of the election, they not only cry foul, but it would appear they intolerantly cry for vengeance, justice, a return to sanity. Again, their plausibility structure has been challenged and they’re now in a crisis of sorts, and people often don’t behave rationally when in a crisis. They should, perhaps, but I think what happens is they broaden their emotional response spectrum.
Kevin: Does D.A. Carson go back and talk about what old tolerance is versus this new tolerance?
David: Yes. “The old tolerance,” he says, “draws its limits on the basis of substantive arguments about truth, goodness, doing harm, protecting society and its victims, while the new tolerance draws its limits on the basis of what it judges to be intolerant, which has become the supreme vice. Advocates of the new tolerance often find no more scalding epithet to hurl at those with whom they disagree than intolerance.”
Kevin: Yes, it’s the worst. To be named intolerant, at that point you’re written out of the argument.
David: And then he says, “there are the related categories of being bigoted, narrow-minded, ignorant,” and so forth. Carson didn’t know who was going to win the election, but he has grasped the current social trend and accurately predicted how, for instance, NPR’s Steve Inskeep, or MSNBC’s Rachel Maddow have added more heat to this current discussion, and not very much light and insight to the conversation.
Kevin: It sounds to me like that would be a book that would be worth reading then, the book by Gaede.
David: It was just an interesting look. Again, this dates back to 1993 when I read it for the first time, When Tolerance Is No Virtue: Political Correctness, Multiculturalism, and the Future of Truth and Justice. It’s an engaging little book.
Kevin: All of us have had to learn to adapt to this new paradigm over the last week, Dave. Look at the markets, how they behaved, the night of the election, the swings, we talked about it on Friday, they were huge. They were large, over 1000-point market swings based on people just changing their positions and reworking their own paradigm.
David: Markets are, to some degree, a picture of entrepreneurship. When they’re not controlled or nationalized they are, anyway. And so, in general, I’m not surprised when a market adapts. But in this case, it appears more than adaptation. It appears to be a rationalization. When Comey cleared Clinton, and then reiterated the FBI’s conclusions from the summer that nothing nefarious had occurred with her emails, the stock market moved up over 400 points.
The Hillary rally was on track indicating a Hillary win. Then it was surpassed by the Donald rally, claiming the same reasons for future growth. Of course, that was on Wednesday, following through after the election, because we had a 1000-point drop, as you mentioned, and then actually the rally brings it back to a total of a 480-point gain, which is, from the low to the high, a nearly 1200-point swings from lows to highs. And that to me, again, is a market schizophrenia.
Kevin: But the one market that wasn’t schizophrenic, and again, you brought this out on Friday, was the bond market. It was quite consistent. Interest rates rose. A trillion dollars was lost in two days.
David: Right. It was the largest one-day sell-off in the bond market in four years. I think there are two ways that you can read the bond market. The stock market bulls would read it this way: Higher rates reflect the belief that economic growth is on the horizon, and we’re going to see that as a result of massive government spending.
Kevin: Right. Well, let me stop you then, because that’s what people saw when Reagan first took office, as well. When Reagan first took office we had a rally almost exactly like the one we’ve had so far.
David: Right. About 5%. And then we spent the next year-and-a-half with the stock market declining pretty significantly. So, to see a parallel, I think there is more a parallel in the market than there is in Reagonomics being relived. We do have a very different economic backdrop – 20 trillion, relative to the size of our GDP, is significant compared to the 1 trillion which Reagan took on when he took office.
Kevin: I don’t want to pour any water on this, but this particular rise, this rally that we are seeing post Trump, is not unusual, and it can continue into the ongoing bear market that the stock market has been in now for years.
David: Yes, and I think that is more likely the outcome. That doesn’t mean that you won’t see some pockets that are benefitting from a major investment spend by the government, but we’re talking about two different things. Sectors within the stock market which benefit from liquidity flows and the general economy which is growing or not growing on the basis of investments. I’m talking about corporate investments, private investments, growth of businesses, spending by individuals. Basically, what you will likely see is a reduction in corporate and private investment, and that being replaced by government spending, which means, on balance, you are not necessarily moving the needle.
So there is the second interpretation, a reading of the bond market, which would be that rising rates reflect a market concern over too many obligations already in the system. Ray Dalio, who I mentioned last week, with Bridgewater, has suggested that with total IOUs, well over ten times the size of the economy – that is, we’ve looked at debt-to-GDP before and we’ve said that’s about 330%. What he does is, he takes and adds to private, corporate and governmental debt, Social Security and Medicare, and not the 10-year or 20-year timeframes that Larry Kotlikoff was.
Kevin: He’s just looking currently.
David: He’s saying current liabilities for Medicare and Medicaid added to current debts gives you your IOUs or obligations, which are 1000% compared to GDP, so ten times the size of the economy – 1000% obligations to GDP. That is not an amount which the economy can handle with higher rates.
Kevin: You’ve talked about this before. You can handle an awful lot of debt if you’re paying 0% interest, or 1% interest. But if interest rates actually begin – to use the word that economists use – to normalize, normalization is in the 4-5% range.
David: Right. We’ve been talking all year long about the game plan of the Democrats and how Treasury Department and a fairly dovish Fed may keep rates low, or even move them negative. And the person that we forgot to mention, who lost in this election, when we talked about this on Friday, is Ken Rogoff, dreaming of a Treasury position, and now he is stuck being an academic at Harvard. I can think of worse places to teach, but if you have governmental aspirations and want to be a decision-maker at the highest levels of government, then maybe he is disappointed by the loss because Hillary probably would have put him in place.
So there was one story, a fork in the road, where negative rates were the more probable outcome. And they still could be if we see a rollover in the stock market and the Fed becomes desperate to instigate something like quantitative easing and basically buy down the whole yield curve. If they want to buy down the whole yield curve we will see a blowout with the central bank balance sheet from 4-10 trillion dollars, and that is still a possibility. But what do we have now? Until now, the market has refused to go higher, that is, interest rates have refused to go higher. And thus, the Fed has remained pat.
Kevin: But you do have the longer bonds. We’re starting to see interest rates rise out on the long end of the curve at this point.
David: That’s right. Rates are rising at the long end of the curve. That’s where market operators cast their vote. And this second interpretation suggests a concern over high levels of indebtedness, and an awareness that moving to fiscal policy initiatives, after being so accommodative with monetary policy, we are likely to have an inflationary surprise on the upside. So bonds start to factor in a different set of expectations in terms of inflation and the total quantity or stock of debt. In future commentaries I want to explore the link between deficit spending and inflation, and explore, also, the connection between balance of trade deficits and their relationship with higher, and in some instances, hyper, inflation.
Kevin: Let’s look at some of the signs that people are thinking inflation other than bonds. Bonds have always been, up until this managed economy stuff that we’ve had over the last couple of years, a great indicator of risk of future inflation. What is the risk of holding currency long term? That’s what a bond tells you. But copper – we’ve talked about Dr. Copper in the past – Dr. Copper tells us what people expect as far as infrastructure building, but ultimately, inflation. Cooper is one of the key components in most future infrastructure.
David: If we say that copper has a Ph.D. in Economics, the movement of copper is very important to figure out what is next.
Kevin: Didn’t it go up double digits last week?
David: That’s right. Nickel and copper were both up double digits last week, and this is based on the idea that infrastructure spending will positively impact the sector, which I think is reasonable in the short run. We said that on Friday. The market is, however, raising expectations, outside of those sectors, it is raising expectations for broad-based 3-4% economic growth.
Kevin: We’ve been lucky to get 2% or less up to this point.
David: That’s right. So we’re currently at sub 2% levels. I think a significant question I would like to keep in focus is, are we willing to buy a few years of economic growth at the expense of the next generation’s opportunities, and at the expense of creating even greater burdens. We had Obama, who massively increase the scale of debt, and we have Trump who is likely to be even more aggressive at increasing our debt.
Kevin: Let’s look at that for a second, because Carmen Reinhart pointed something out when you interviewed her six weeks ago, Dave, that really was stunning. She said the Fed doesn’t have a mandate to deal with debt. I thought about this later, and I thought, the president really doesn’t seem to have a mandate to deal with debt either, because when Reagan came in office he had brand new ideas. It was a paradigm shift. He had defeated what everyone thought was the shoo-in candidate, the incumbent, Jimmy Carter. All of a sudden the paradigm had to shift, and Reagan was then facing a recession. He sat down with his cabinet members and they said, “There is only one way out of this and that is to triple the debt.”
So they went from one trillion dollars, which it took America 200 years to get to, and during the Reagan administration went to three trillion. A lot of people who were with Reagan at the time would argue that it was worthwhile because we had the Russian threat to defeat. The wall fell and a lot of people say it was worth the debt. But if you look at Trump, there are an awful lot of things he says he is going to do. He probably can’t fund it with revenues, right?
David: I think, like everything in life, sometimes you’re stretched thin. Have you ever had one of those days when you are just tired and worn out, and you don’t have a lot of margin, and somebody cuts you off in traffic, and boy, you holler instantly? And it’s almost without control, a knee-jerk response, and maybe ten seconds later you think, “Well, that was a little un-called for.”
Kevin: Right. But at the time you felt like it was warranted. You didn’t even think whether it was warranted.
David: But the question is, how much margin do you have?
David: And the same is true if you are looking at an equity portfolio, or a net worth statement. How much margin do you have? For some people, taking a 10% loss is catastrophic. For some people, taking a 10% loss absolutely does not matter one iota. How much margin do you have? The greater our burden of debt, we’re decreasing our margin, so it means that any hiccups along the way, there is a much more catastrophic set of consequences that comes with it. And I think in the 1980s when Reagan came into office, we had lots of margin, so increasing debt, we had a certain economic allowance for it that we don’t have today. So even if we were to increase our debt by 50% or 100% from here, to 27, or 30, or 40 trillion dollars, we don’t have the margin. And Trump is likely, as I said, he is going to be more aggressive at increasing debt. He has indicated that on the campaign trail, and he has already begun to detail that in his economic plans with one of his advisors, David Malpass.
Kevin: Isn’t David Malpass the guy who was with Bear Stearns back before the crisis last time?
David: Absolutely. He was the chief economist at Bear, and he was all too happy to recommend an increase of Bear Stearns debt exposure in the spring of 2008 before they imploded, even as they were imploding, on the belief that the worst was behind them. Such was the advice given while he was the chief economist at Bear.
Kevin: Right. And I think we should remind the listeners that Bear Stearns did not make it through the financial crisis.
David: That’s right. So I would say don’t be surprised if debt-to-GDP figures reach 150% on Trump’s watch, getting to 27 or 30 trillion, maybe even 40 trillion, but that would be an outside figure, doubling the national debt. I think this is less of an economic growth story, coming full circle to that second point, and I kind of favor the second argument, what the increase in interest rates signifies.
Kevin: Right. And you said that second reason is because of the concern for the debt burden.
David: I think it’s less of an economic growth story, and more a story of a government-financed spending spree. And I think there are some consequences to a government-financed spending spree.
Kevin: I think, for the person who really is happy that the establishment was defeated, people can ruminate on that a little bit. I know I’ve enjoyed that this last week. But I think we should also engage in exactly what we were asking the left to do, and that is, some dialogue. What do we agree with Trump on? What do we disagree with Trump on? I think that needs to be an actively engaged discussion this entire time. We can’t just fall into lockstep and say that everything that he’s doing is right on target.
David: That’s right. I mentioned this on Friday, as I looked through his Contract With the American Voter, I like 22 of his 28 proposals. That’s a majority. Four I think are dangerous, economically, and those are actually four of the pillars that he was running on the basis of.
Kevin: I think they’re all related to trade, though. That’s always been your concern.
David: Yes. And there are two that I’m neutral on, but the dangerous ones center on trade. We’ve had 30-35 years of a bull market, which were complemented and aided by globalization. I don’t care what you think of globalization, just know that most of the economic success that we’ve had in the last 30 years is related to change in capital flows.
Kevin: Let’s define terms quickly so that the listener can stay on board with you. Globalism is one thing. Globalism is maybe looking toward one-world leadership – that type of thing. That’s a negative in my mind. I think it’s a negative in your mind, and in our listeners’. Globalization is different. Globalization is just not putting tariff and taxes on trade so that you can have free flow of currency.
David: For instance, at the end of the Cold War you began to see all of your former Iron Curtain countries and European countries – France, Italy, Germany, England – they all had capital controls, so there was no free flow of trade, there was no free flow of immigration, there was no free flow of capital. So you had these massive costs of doing business.
Kevin: It strangles business.
David: If you were familiar with traveling from one country to the next, it is not uncommon, when you are exchanging from one currency to the next, to have it cost you 3, 5, even 10%, in a currency translation. Think about what that does to stymie trade, transaction, travel, and general economic activity. So to me, curtailing trade is like suggesting that you can maintain the same level of stability as you saw off one of the legs of the stool. And that, to me, is why items 7, 8, 9 and 10 on his list of 28, I have significant issues with. On each one of those things, not to paint with a broad brush stroke, there are specific issues that have to be addressed. For instance, 8 deals with the TransPacific Partnership.
I am not for the TransPacific Partnership, but you have to look at the things that were going to be accomplished with the TPP. There are three positives for every ten negatives attached to it. If you could go back through and scoop up the three positives and reject the ten negatives, now you’re making some progress. So again, everything in life is nuanced, and everything on a political platform becomes very bifurcated, and good or evil, and that’s not nuanced at all. So now that we’re past the election, we need to start getting into the fine brush-strokes and figuring out what are the things that we need to hold onto, and what are the costs of letting them go?
Kevin: We want to differentiate between immigration problems and capital flow problems. You can continue to do business worldwide and still have a solid immigration policy, and I think sometimes people blur those lines.
David: Kevin, it’s funny, one of our clients said this to us, and I’m not sure if this is just sort of a spoof, but I got a laugh out of it. As the election results came through there was an Internet collapse, a website that couldn’t make it under the strain of pressure, and it was the Canadian immigration website.
Kevin: Everybody wanted to leave.
David: So one of our clients sent us this this week. I thought it was hilarious. It said, “Boy, oh boy, are all those Americans wanting to flood my country of Canada going to be shocked when they find out we have actual immigration laws. You have to have money in the bank, marketable skills, sponsors, monthly checkups with Immigration, and a multi-tier application process that takes about ten years. You know, all those things Donald Trump wants for your immigration policy, but you hate so? You want to move here, but you can’t.”
David: So there is this idea of there being a benefit to the free flow of people, capital, ideas, and this globalization, free trade, open borders – this was a part of the growth story through the 1980s, 1990s, and the 2000s. And the problem is, as Jim Bianco points out this last week, is that 2008 and 2009, that recession, what happened was, it was not equally unfair to all. In other words, if everyone suffers equally, there is a sense of solidarity by the losses taken, but if it’s unequal, then people are bitter about it.
Kevin: The haves remain the haves. The have-nots became even more so.
David: Right. So the bailouts of the banks left the silent majority feeling like it was an episode that was unequally difficult, and so we have this re-emergence of populism. There was no Arthur Anderson. There was no Enron, as there was in the earlier recession, 2000-2001, where at least in that recession, those entities were destroyed, and in essence, they paid for the sins of the marketplace. In this era, the status quo, and anyone with establishment connections, became much more vulnerable in the election, because again, nobody had paid the price, and now there was going to be hell to pay.
Kevin: Just look at the map. The election map tells you who were the haves through this entire crisis, and who were the have-nots.
David: A disproportionate number of people that benefitted from Fed policy and government largesse basically centered in ten major population centers.
Kevin: The blue.
David: And that is basically all Clinton won was the ten major population centers. The rest of the country went Trump, and they were wanting a leveling of the playing field. There is, again, this message that leveling the playing field means rearranging trade. That’s true to a degree, but only a small degree, which is, again, why I have some concern over 7, 8, 9, and 10 of his proposals, if they are not dealt with carefully. Listen, I think we can always return to the days of Smoot and Hawley, and find ourselves smack dab in the middle of a global depression, if we’re not careful, cutting off our nose to spite our face.
Kevin: There are opportunities when the elite, or this particular fix in the political system that’s been broken for a while. I guess the question I would have is, how long are the elites out?
David: Along with the elites, how long are the experts going to be held suspect? Because after all, it was the experts, and it was the elites, that said, “This is what you’re going to do, this is what you must do, this is what’s reasonable.” As you said earlier, “This is how you must think about it.” And the experts and the media got it wrong. Are the media still going to solicit expert opinions from people proven clueless time and time again, whether it is the pollsters or economists?
The transition that we talked about on Friday is a pretty significant one. The old media is one of the losers in this election, and it’s circling the drain. The new media is still taking shape. Clearly, the bear market tumble last week continued in one particular sector. We saw it in bonds, but we also saw it in media credibility, and there was no bounce in terms of the bear market impact for media credibility, and quite frankly, establishment political control.
Kevin: Yes, so it is sort of a new world for us. But I have to go back and look at bubbles that we’ve seen pop in the past, Dave, because we’ve seen them spread from – we can go back and we can go to the tech stock bubble of the late 1990s. We saw that thing blow up, and as it started to pop, of course, Alan Greenspan was in at that time and we saw the real estate market become unusually large. So that bubble transferred to the real estate market until about 2006-2007. That bubble popped and it became a debt bubble. The bailout came from the very top and this large debt bubble – you’re talking about the bond market, I’m talking about the debt bubble, it’s the same thing – could the next bear market, this next bubble that pops, be the biggie? Could it be that the debt market outweighs everything else?
David: Right. I had an interesting conversation with Robert Prechter over dinner just a few weeks ago. Of course, he is significantly bearish and looks at credit and these long-term trends, and thinks this is actually the end of a major super cycle, going back to growth that we saw off the lows of 1932. Of course, that was after an 89% implosion in the stock market. We’ve seen growth in sort of a two steps forward, one step back. Some of those one steps back have been catastrophic along the way, but from 1932 to present, a growth trend. And he is suggesting that this is a super cycle top. I think the next bear market may well be the grand imperial one. That’s the debt markets. After a move like we saw last week, I think, on a shorter-term basis, you could expect the bond markets to calm down a bit, for yields to drop. I mean, it moved fast and hard. But the big, big question is the interest rate question. And this summer is likely the peak in bond prices and the low in yields for a generation.
Kevin: Now, you mean this last summer? This last summer was the peak?
David: That’s right. It’s unclear whether the Fed will, in the future, move to a negative nominal yield in the context of financial panic. That is entirely possible. But barring a massive shift toward another QE program, and buying the yield curve down, for the time being the markets are moving yields higher, and prices lower. And I’ll tell you, being cavalier about a rise in rates is a dangerous disposition to adopt. And unfortunately, we’re seeing that across the marketplace, as if, again, this is an indicator of economic growth instead of something that represents a generational tipping point.
Kevin: It’s not just governments. We’re talking about the government bond market here, but corporations over the last few years have taken advantage of these low interest rates, as well. They can’t handle interest rate rises either, can they?
David: No. Corporations have re-leveraged, significantly, since 2012. Recently, City Group analysts looked at the rise in debt for corporations compared to a drop in EBITDA, Earnings Before Interest, Tax, Depreciation and Amortization, showing that net leverage in corporate America has never been higher.
Kevin: So we are at a high. When you’re saying leverage, you’re talking about just pure debt.
David: Right, but they were specifically in the corporate sector. Massive buy-backs in the U.S., of course, have buoyed U.S. equity prices, and it’s interesting to watch these dynamics. Emerging markets haven’t fared so well, but emerging markets have been more restrained in their financed purchases of stocks and of dividend payments. So U.S. companies have borrowed massively to buy – let’s look at it this way. They’ve borrowed to buy the loyalty of existing share-holders and keep as many in their seats as possible. Rising rates are an economic headwind. We know that from a broad basis, but they’re disastrous for a highly leveraged corporate sector.
Kevin: Or the highest-leveraged corporate sector in history.
David: That’s right. So you look at interest, you look at debt service costs, and you look at corporations over the next year or two years, whatever it may be in terms of rising rates, having to allocate a greater percentage of revenue in that direction. Anything can happen here. We don’t know what Trump or his administration is actually going to propose, but what if they were to do something like eliminate the interest deduction for corporations? Because what was suggested by Carmen Reinhart is that fiscal policy and the corralling of interest is going to be a priority.
Monetary policy, using legislation, new fiscal policy initiative which is tax, spend – we are directing audiences, and to motivate corporations to spend and invest, maybe they create deductions over here, and tax credits over there, and remove deductions from there, and increase or decrease taxes – there are all kinds of games that are going to be played. And I just think we assume a lot about the safety about the debt side of the corporate balance sheet. And again, I think it’s dangerous to be cavalier about that.
Kevin: I want to go back to something that we’ve discussed over the last few months as far as just getting rid of cash. Ken Rogoff, you had mentioned, probably lost his hope for gaining the Treasury position, but he did write the book about removing, at least, large denomination bills from our economy. That may have slowed down a little bit with Trump’s winning, but look at India right now. India has taken the large denomination bills out. Australia is being urged to get rid of their large denomination bills. So is this still a trend that we can expect will continue even here in America.
David: Yes, I think there is antipathy for paper, and a desire for control. And to the degree that government, Treasury, Fed, these groups needs to corral investors and corporations and encourage spending of a certain sort, and dishoarding of another sort, they’re going to play with the gloves off, and that may include moving toward a cashless society.
Kevin: So even in a Trump administration we may still see the same trends going on as far as capital control, and people control, as far as the cash?
David: Rogoff suggested the first step toward moving toward a cashless society is removing high denomination bills and that is exactly, like you mentioned, what they did in India this week. So now they have a problem. Anyone who had money in 500 and 1000-rupee notes – guess what they have to do? They have to get rid of them and get something else. So what happened is, you have a massive influx of cash into the banking system that was outside the banking system because it is no longer going to be considered worth anything if it doesn’t get into the banking system.
So they changed a rule and what happened? It caused a movement of money into the banking system. Was that the desired effect? Could you say that the Indian people were corralled, like Reinhart suggested on our commentary? Absolutely. And now Australia, as it has been suggested by UBS, Australia is the next likely candidate to begin moving cashless and eliminating large denomination bills.
So it is happening gradually, and I think it will grow to become a global consensus that cash is dangerous, and that will be, like we’ve often heard – tell a lie, tell it often enough, and people will believe it. There will become this sense that, yes, we’re just at risk if we have cash. The reality is, most people do their transactions with debit card and credit card anyway. So there is no real threat, but it allows them to create captive audiences. And that, in order to throw fiscal policy into the mix, is going to be the thing.
Russell Napier, who you know is a long-term contributor to the Commentary, we read him consistently, I’ve spent time with him at the Library of Mistakes in Edinborough, Scotland. A wonderful guy. His most recent comments related to that very thing. Not only the concerns about an inflationary outcome from fiscal policy, but also, just how nasty financial repression is in the context of fiscal policy. And in fact, this is where you can see the meat-grinder effect, for investors and for savers. Monetary policy has its own mechanisms and machinations for the investor and the saver when it comes to financial repression.
But his argument is that now we’re entering into the end game, and the end game is a fiscal policy blitz which brings financial repression that you have never seen or imagined in your lifetime, but is all too common in financial history.