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  • When “Con”-fidence reigns, credit flows freely for years
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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Remember LTCM, Bear Stearns, Lehman? You’d Better
March 30, 2021

“Ultimately, a financial asset that is not on someone else’s list of assets and liabilities? It’s a rare thing. It’s a beautiful thing. Gold has long been that kind of asset, where the ownership merits— they speak for themselves, right? And they’re not the kind of merits that other financial products have. As chaos increases in the months ahead, I think these are simple qualities that will be back in high demand.” — David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. 

David, before we came into the studio, I literally got off the phone with the son of a client that I’ve had for over 30 years. He called and he was just looking— he’s owned gold. He’s looking at Bitcoin and he’s looking at other things that are rising quicker right now. He was saying, “Hey, should I be selling my gold and maybe going into the stock market right now or Bitcoin?” 

Since I knew his dad, and since I understood the legacy mindset that his dad had, I knew he had it too. We just had to talk again. So we drew the triangle. We talked about the place that gold has had, how you can pass, generationally, wealth from son to grandson to great grandson, and where speculation actually should be held in a portfolio. By the time we got done, he was so thankful to realign his thought process to what his dad had already taught him, which was legacy, looking for the future generations. 

Now, Dave, I set that up for this reason. We have so much leverage right now. We’re all, as a country and worldwide, running on massive debt. Isn’t debt taking the wealth from our kids, our grandkids, and our great-grandkids and moving it into today and using it today? Isn’t that the opposite of legacy?

David: I think you’re right. I sat with a gentleman who is in the leadership at one of the local tribes. It was a fascinating conversation because he recounted how, in his family, he knows seven generations that came before him, their names, their stories. What a storyteller he is, an absolutely fabulous storyteller. His stories were about the past, but every decision that he makes is about the stories that will be told about him, about his generation in the next seven generations.

Kevin: What an amazing thought process.

David: It’s the seven that preceded and it’s the seven that come next. It’s a different way of managing the decisions that you have. It certainly takes focus off of self and personal needs and gratification. It positions you, in some respects, as we did in the book The Intentional Legacy, as a steward of resources in a particular timeline. You’re just one point in a longer timeline. And to manage those resources from the generations that came before for the generations that come next, that’s how we think, but that’s not how politicians think. It really is extraction for today, maximizing benefits for the immediate, with the priority being on political survival.

Kevin: Well, I wonder if sometimes you get so far into debt that there’s no way out. We talked last week about Turkey and Erdogan and how the central banker that was brought in actually was stabilizing things. Erdogan obviously didn’t like that and fired him. Fortunately, he didn’t assassinate him like we’ve seen in the past, but he did fire him.

David: Yeah. Not in Turkey’s past, but in other countries past, where—

Kevin: Czechoslovakia?

David: Exactly. Alois Rašín. Well, it’s a tough job when you know what you have to do, but doing it is going to be unpopular. Again, this comes back to: What’s the context for your decisions, and how do you value the role that you play in a larger context?

Kevin: It reminds me of Paul Volcker. When he came in, he was thinking legacy. He was thinking of setting things up again in order, because we had the high inflation of the ’70s before him.

David: And there was an aspect, particularly with Volcker, that tied to his personality. He could blow off any political pressure that increased as a result of hiking rates.

Kevin: He blew cigar smoke in their face.

David: Yeah, exactly. In the process of raising rates as he did, he did tame inflation. It did temporarily exaggerate recessionary pressures and pain, but he quite literally stood tall and went through the process of raising the prime rate, imagine this, to 21.5%.

Kevin: Can you imagine? I remember that.

David: William Poole from the St. Louis Fed says this, recounting Volcker’s legacy on that particular point, “By reversing the misguided policies of his predecessors, Volcker set the table for the long economic expansions of the 1980s and 1990s.” And that’s the end of the quote. But first, there was pain.

Kevin: And it always is painful to try to calm down inflation. Now, Turkey was experiencing inflation a lot like we had back in the 1970s before—

David: Almost identical, at least where it was last year, 15% per year. I think our max was about 14% in terms of the official rate. So Naci Ağbal inherited a similar inflationary mess in a more complicated backdrop, changing course from— He basically took over where the president’s son-in-law left off. The president’s son-in-law was set up as the finance minister. The finance minister has oversight over the central banker. And so, he did not have a lot of flexibility. Ağbal had to fight central bank policy bias and fight extreme political pressure.

Kevin: Well. What happened to the lira right after he came in?

David: He was there for four months. The lira stabilized in that four-month period of time where his policies were in play. But about 10 days ago, Ağbal added another 200 basis points to the Turkish base rate. He’s raised it a total of 8.75% since November to 19% total. So, it’s at 19%. He has moved it up 875 basis points since he took office. The lira in that four months has gone from circling the drain to being stabilized.

Kevin: Okay. But he couldn’t blow cigar smoke in Erdogan’s face, could he?

David: No, maybe it’s— what do they call those? Shishas? The shisha’s smoke. But Erdogan was not one who could take the pain. 

This is conjecture on my part, but I think part of the pain for Erdogan is in being different. Europe is financing the bejesus out of everything with negative rates, while Turkey is blowing past the teens, now at 19%. Huge debts to refinance this year. Somewhere in Erdogan’s mind is the desire to, “Why not us? Why can’t we finance at low to negative rates? What good could we do? What kind of social programs could we finance? Yes, it would be on the backs of tomorrow’s citizens,” like we do here in the U.S. and Europe, “but what could we finance at a low rate? What programs could we start if we just had rates lower?” He doesn’t realize that actually what Naci Ağbal was doing is a part of the success story. It’s just not an easy one to embrace on the front end.

Kevin: Well, and I also wonder the debt that he has. How many billion is it right now that Erdogan has to refinance this year?

David: Somewhere between 350 and 400 billion is the debt that they’ve got. 180 billion of that is due this year. That’s according to the Financial Times. Reuters counts it a little bit differently. It comes up with 140 billion on average.

Kevin: He has to pay back in other currencies too, doesn’t he? I mean, that debt isn’t just in his own printable currency.

David: About 45% of Turkish debts are obligated to be paid back in foreign currencies. So, the refinancing needs are pretty close to that this year. 44% of what’s going to be refinanced this year is in foreign currency terms. So the weaker the domestic currency, the harder it is to pay back foreign-denominated debt.

Kevin: You remember Barings Bank? The original sin in Barings Bank was to have debt denominated in other currencies.

David: Yeah, that’s right. Economists call it the original sin, and that is choosing to denominate your debt in someone else’s currency. When debt is in your own currency, you can inflate away the burden. That’s not a very well kept secret, but it’s often forgotten at least in today’s economic circles as we talk about inflation targeting, because, after all, if inflating away burden of debt is what gentlemen do, I mean, you’re really talking about a gentleman’s default. It’s not a real default.

Kevin: So, Erdogan did not have the gentleman’s default option because he owes a little less than half of his debt in other currencies. So what we’re talking about is, if you borrow in a currency that gets stronger and your currency gets weaker, you have to come up with more of your own currency to pay that off.

David: That’s exactly right. Debt denominated in somebody else’s currency changes everything. The inflationary devaluation increases the gap from the original obligation you took on to that priced in real time with a diminished value. It takes more currency units to meet the original obligation. So it’s like this, the 180 billion we mentioned, 44, 45% is in dollars. That would be about 79 billion in non-lira obligations. Ağbal inherited an inflation rate of about 15%. You apply that inflation rate to the foreign-denominated portion of the debts, and you’re talking about an additional $12 billion in additional financing needs for 2021. Increase the inflation rate or the valuation gap, increase the devaluation gap, really, and it’s a harder and harder issue.

Kevin: On a sailboat, you have the telltale where you can see what the wind is doing up at the top of the mast. One of the telltales that you watch is the CDS market, the credit default swap market, because that can signal—that’s how the markets insure against volatility—that can signal that something’s going on. A few weeks ago, Dave, you’ll recall, you said, “Hey, it’s looking nervous. It’s starting to go up.” Do you think they were smelling Turkey?

David: Yeah, I think there was a combination of things going on. A few weeks back, the CDS market, particularly for European banks, was getting anxious. Again, the credit default swaps or the insurance costs, you pay a premium to have some insurance against the event of default. And so the cost to insure against default was rising, specifically for European banks. And it’s because you have a lot of European banks that have made those cross-border, cross-currency loans to Turkish companies and the Turkish government. So, when Ağbal was canned, when they fired him, the risk of default on those loans was immediately adjusted upwards. Yeah, Turkey has been a disaster in the making for several years. We broached the subject with our friend, Irish friend, Russell Napier. Thank you to careful listener reminding us that Russell is Irish, living in Scotland.

Kevin: There is a difference. Yeah.

David: Russell analyzed the Turkish books years ago and concluded that there was an accident in the making. I think the inevitability of that has been there, but forestalled by the massive European Central Bank at combinations from that timeframe till now. Again, 350, $400 billion in debt. If you’re looking at the financial sector debt, 79% of it is foreign denominated. If you’re looking at government debt, 56% is non-lira. And then there’s other forms of debt, which average down to about 45%. But yeah, 79% of financial sector debt is non-lira. This is a disaster.

Kevin: If I remember right, and I don’t mean to be too crude, but I remember that Turkey is a place that sometimes people who are out of favor go and get cut into tiny pieces and disappear. It’s much nicer to have been asked to step down than— We were talking about Rašín in Czechoslovakia. He was a central banker that was out of favor. He was doing things to stabilize that currency. I don’t think he was chopped into little tiny pieces.

David: No, no, no, but shot anyways. He pulled a Volcker. Dealing with inflation, he pulled a Volcker, raised rates—or maybe pulled an Ağbal, as it were—and he was assassinated.

Kevin: You would think that that would be something that your mother would say, “That’s a safe profession to go into.”

David: Well, his policies worked, but you could say that he ultimately succumbed to political pressure. In this case, it’s six feet worth of dirt, which is showing up as some form of political pressure. Alois Rašín, not around to celebrate his success. So in that regard, Naci Ağbal has much to be grateful for at this point.

Kevin: Okay. So in the emerging markets, we have other countries right now that are also raising rates.

David: Yeah, they’re doing the same thing in Russia. They’re doing the same thing in Brazil, Turkey. You’ve got many of the countries in the emerging markets, which have inflation problems, and this is sort of a textbook way of dealing with those inflation problems. Brazil and Russia have been raising rates to curb inflation. That puts a break on economic growth. Of course, it’s not politically popular. It’s not popular-popular. What you’re doing is you’re increasing financing costs at the same time. So, that’s a tightening of financial conditions, so to say. The equity markets thesis has been where investors are clamoring to buy emerging market equities. The thesis has been that, relative to the European markets, relative to the U.S. markets and value metrics in those places, emerging markets are just cheap. They’re very cheap, but the growth story confounder is the context of tightening financial conditions, which rate increases surely are.

Kevin: It’s hard to believe that it’s been 23 years since the Long-Term Capital Management debacle, but didn’t that start similar in— Wasn’t there Russian exposure and a change that they were not able to handle because of margin?

David: Yes. So, you’ve got external factors which didn’t go into the modeling of risk and a variety of heavily leveraged bets by Long-Term Capital Management. I mean, heavily leveraged, you can imagine, astounding levels of leverage. They’re just looking to make a few pennies. One of the trades was the differential on an oil company listed in the U.S. versus the London Stock Exchange and the price differential they were playing in arbitrage. It was just a few pennies here and a few pennies there, but on billions and billions and billions and billions of invested and leveraged capital, pennies equal dollars, and dollars equals fortune.

Kevin: They were brilliant equations that were driven by quants, guys that are called quants, and there really was no margin for error. It had to work.

David: And Russia was, in many respects, the catalyst. No one had anticipated the sovereign default by the Russians. So, it’ll be interesting to see if there are disruptions in the emerging markets with Turkey—further disruptions in the emerging markets, with Turkey being a catalyst—because I think what we have seen with Turkey is that it begins to set in motion a broader financial market deleveraging. We had that with Long-Term Capital Management, again, it started with Russia, 1998, led to Long-Term Capital Management’s deleveraging of bets, requiring a coordinated bailout by just about all of your Wall Street firms.

Kevin: Speaking of 23 years ago, we had a boat 23 years ago, and we would go out with the family. Yeah, I recall that when I would step off the dock and step onto the boat, it better have been tied up, because if not, what happens is that boat pushes away from the dock. I don’t know if you’ve ever had that happen to you, but you get to the point where you can’t get onto the boat and you can’t get back to the dock. And so, there’s only one way to go and that’s to fall in. I’m wondering if we’re getting to that point right now in the debt markets, with the financial stimulus as sort of an added equation, speaking of equations, it’s sort of an added element to this. Are we getting to the point where they can’t step backward and they can’t step forward, so they’re just going to fall into the water?

David: Yeah. In this context, we already have a massive effort to invigorate the global economy via the monetary, via the fiscal, sort of that two-pronged approach, and stimulus from those two areas. And so, what’s interesting to me is even without a crisis in play or a bailout on order, we’ve got the European Central Bank, the Bank of Japan, the People’s Bank of China, the Fed, they’ve already ramped up stimulus to records never seen outside of a wartime effort and the upshot is that we’ve thinned out our resources. To my view, in a grave position, should we need to engage with a crisis in real time, a Long-Term Capital Management in real time, an Asian Contagion in real time, a Russian default? Maybe it’s a Turkish default this time around.

Kevin: Like I said, we’re so extended. It reminds me of when I was so extended just before I fell into the water. But the speculative community, anytime you have this kind of stimulus and the potential that the central banks are going to come in and just bail everything out, if you’re running a hedge fund, Dave, you’re going to have to use as much margin as you can. Aren’t we at record levels right now?

David: Yeah. I mean, confidence is to some degree procyclical. You’re most confident when you should be getting less and less confident, but that’s just not the way it works. Confidence tends to be procyclical. The last six months have introduced a variety of pressures into the leveraged speculative community, and hedge funds that are both long and short, the quant strategies you mentioned like Long-Term Capital Management, the newer iterations today which previously were unbeatable, your risk parity strategies, they’ve all suffered unexpected losses in the last three to six months relating to what they would consider aberrant or unexpected market behavior. There is this fraying in the financial markets and an acute fragility emerging amongst particular players, some of the biggest out there. It’s wise for us to remember how interconnected the financial world is. Remember that, while liquidity has and continues to lift all boats, when it reverses, the impacts are on all markets, just as you have the positive impact of liquidity lifting all boats. So when it dissipates, it impacts all markets negatively. That last comment reminds me of Richard Russell’s reflections before he passed away. “In a bear market, everybody loses. The winner loses the least.” Grant you, no one wants to lose, but in some contexts, it’s inevitable.

Kevin: 13 years ago, we were talking about 23 years ago being LTCM, but 13 years ago, we started seeing certain firms jockeying to get the collateral that was behind some of their investments because they started to see the Bear Stearns— Remember Bear Stearns started it out. It came out and it looked like, “Oh, there might be a problem.” Then, of course, it led ultimately to the Lehman failure, but there are underlying assets. If you see a bankruptcy coming, it’s like a gift certificate to a restaurant that you know may go out of business. You better use it quick.

David: It’s fascinating to watch a social dynamic. I actually can’t remember if it was Bear Stearns or Lehman Brothers. But going back to the Long-Term Capital Management story, when LTCM imploded, it required major financial contributions from all of your Wall Street firms to keep the financial system from imploding. This was a coordinated effort. It included the Fed. It included the Treasury. This was a very, very significant—

Kevin: Well, there was some pressure too. It was, “You will help out or it’s going to cost you later.”

David: That’s right. Again, I don’t remember if it was Bear or Lehman said, “We didn’t create this problem. We don’t have to be a part of the solution.” Lo and behold, it circled back around to the global financial crisis. When they started having balance sheet issues, it was one or the other of them, all of your Wall Street firms just stepped back away and said, “Hmm, all for one, one for all. This elephant doesn’t forget.”

Kevin: Wow. And there were brown boxes with office supplies that were being carried out by sad workers.

David: This last week was reminiscent of that. You’ve got Goldman Sachs, Morgan Stanley, those two firms, the first response to pressure from Archegos, which some have called a hedge fund, which is actually functioning as a family office, so without the same reporting requirements and under the cover of a family office. What you had with Goldman Sachs and Morgan Stanley was a grab for collateral.

Kevin: They knew something.

David: They did know something, and they pressed the issue. They got paid. So knowing who has the rights, who has access, who has control of an asset from a counterparty standpoint is critical. It takes you back to Buffett’s comment on poker: Sitting around the table, if you can’t figure out who’s the patsy, it’s probably you.

Kevin: A lot of times these things happen behind the scenes, but they definitely show that they’ve lost their composure when they’re doing large block trades before the market opens.

David: So the question in the Financial Times on Friday is, essentially, who’s dying? Somebody is under extreme pressure.

Kevin: Yeah, and they have lost their composure.

David: And no one knows who’s being put to the wall. On Friday, the question was, who’s selling the block trades? Why are the firms involved trading at an accumulative loss of over $33 billion? Who just blew up? And so, halfway through the weekend, the news outlets had figured it out. It was Archegos. It was the family office. They got a margin call. 

What’s the significance? Well, the forced liquidation of up to $50 billion in assets as the financial firms that had structured many of the over-the-counter derivatives for this investment group, those financial firms decided to swoop in, capture as much collateral as they could late in the week. 

So $10 billion in assets, $50 to $60 billion in market exposure. Believe it or not, that’s not huge leverage. It is huge leverage today, but it’s not the leverage extremes we saw with Long-Term Capital Management in 1998. 

What’s reminiscent is the collateral grabbing, the risk aversion, the instantaneously hitting the market with a bid on billions of one particular stock or that particular— There’s five, six, seven different companies that were pressured on that basis. Five prime brokerage relationships, Goldman, Morgan Stanley, UBS, Credit Suisse, and Nomura, they all start selling huge block trades last week. Credit Suisse and Nomura, a little flat-footed. They were reportedly slower in the foot race, didn’t dump exposure fast enough. And so, as a counterparty, ended up taking a loss. Credit Suisse shares were down 14%, and are expected to register between a $3 and $4 billion corporate loss. Nomura shares were down 16%. They’re expected register about a $2 billion loss.

Kevin: Imagine being a fly on the wall in those offices in Goldman Sachs and Morgan Stanley, where the analyst comes in and he says, “You know what, something’s about to happen. You’d better get your collateral out.”

David: Sell first, ask questions later. First to sell, least likely to lose. And that’s Goldman Sachs and Morgan Stanley dumping multi-billion dollar block trades on Friday. They may have sidestepped the losses, which their competitors weren’t able to. Nomura, the loss of that $2 billion. This is equivalent of pre-tax profits for about six months. So for a half year, they basically lost in the day what it takes them a half year to make. When you’re looking at the leverage products in use, derivatives, of course, financial firms will now pull back leverage available to other clients. Here’s one of the consequences going forward of what happened this last week, is everybody who has something at risk, a leveraged portfolio of assets, however it’s leveraged, to whatever degree it’s leveraged, has to look at the Archegos step sequence here, and know that if you’re banking with Goldman, if you’re banking with Morgan Stanley, whoever you’re banking with, everyone is jittery about collateral and about their exposure. If there’s any margin problems at all, you’re going to be cut down to size very quickly, for selling is de rigueur. 

So, I’m fascinated because this is one small, you could describe it in quotes, as a “small” hiccup in the financial markets, but it causes a recalibration. And the recalibration is significant because the previously fast and loose financial market conditions have to tighten somewhat. If you are offering five times leverage to a family office, there’s hedge funds out there that have got 25 times leverage. Now, as someone who’s on the other side of those trades, you’re thinking to yourself, “How do I trim this back? How do I limit my risk? How do I make sure that I’m first in line and fast on the grab versus last in the line with only holding the bag?”

Kevin: You talked about step sequence and we often hear about the Lehman moment. Okay. The Lehman moment was a big moment, but it was pretty late. If you’re waiting for the Lehman moment to figure out something was wrong, you are way late to the party. I know there’s one of my clients listening to this program today because he listens every week. I remember calling him when the Bear Stearns moment actually occurred about a year earlier.

David: And that was a 400 million. We’re not talking about—

Kevin: It was small.

David: —a 10 to $50 billion portfolio. We’re talking about two separate funds. I think in aggregate, they were $400 million.

Kevin: It wasn’t much, but we smelled a rat. I remember talking about it and saying, “Something is up.” It’s a little like what’s going on now.

David: And that’s what I was saying, that there’s fractures within the structure of finance and I think the edifice is too large at this point to support itself. What it certainly indicated to the market is that leverage can have negative consequences, not only for those using it, but also for those financial firms who are structuring financial products and embed the leverage into those products. It’s their risk as well, which on scale, if you’re thinking about all of these big financial firms doing the same thing, leveraging up, it makes it our risk on scale. Remember, privatized gains, socialized losses, that’s—

Kevin: Unfortunately, I do remember that.

David: Probably coming to a theater near you. You have to know that an event like this shifts the market structure.

Kevin: Okay. So a default on a margin call is a big deal.

David: Well, it’s a wake-up call if nothing else, because if you look at current FINRA numbers, margin debt is at a record $816 billion according to FINRA’s most recent numbers.

Kevin: Almost a trillion bucks.

David: They may, in fact, these defaults on a margin call, maybe the wave of the future.

Kevin: One of the things that you watch also, Dave, we talked about CDSs, the credit default swaps, you also watch volatility to see if something’s going on and the emerging markets are volatile right now.

David: Yeah. I mean, it’s not a surprise that we have wild moves or had wild moves in the emerging markets last week, and then followed on by an ex-hedge fund manager working his own money through Archegos blowing up. I don’t think that’s coincidental. I don’t know what the direct tie is, but again, it may have just been a shift in market structure where Turkey sets the stage for a de-calming event, if you will. Financial conditions for emerging market trades already shifting, Monday to Wednesday. The common theme in the hedge fund mishaps of the last year or so has been leverage, leverage, leverage. You had the relative value interest rate swaps last year. You had Melvin Capital, January of this year, Archegos in March.

Kevin: So it goes to show you, we don’t ever learn from the past, because remember MF Global?

David: Well, I think what happens is you’ve got these instances, and people want to ignore them, and they only stop ignoring them and taking action when they see a trend developing and they feel like evasive action is necessary. 

Hersh Shefrin is one of my favorite writers on behavioral finance. Back in 2017, he wrote an article for Forbes recounting the MF Global blow up. Jon Corzine left as the head of Goldman Sachs. He moved into New Jersey politics, ultimately migrated to being the head of the small commodities trading firm MF Global. In the MF Global hierarchy, there was a risk manager that didn’t like the scale of bets that Corzine was making, which went well beyond what the board had allowed for risk management purposes. Michael Roseman—he’d been hired two years prior to Corzine. When Roseman pointed out that the risk limits were being ignored by Corzine, Corzine pushed the board to fire Roseman. They did it. 

In some respects, the rest is history. He was betting on European bonds with leverage, actually ultimately with customer cash, an interesting form of leverage, as it turns out, re-hypothecated. And how’d that work out? Kind of a disaster. MF Global collapsed and was bankrupt in 2014, one of the largest corporate bankruptcies to that point. Corzine would have ultimately been right on his bets on European paper, because ultimately the ECB came in and did what he thought they were going to do. Oh, by the way, Mario Draghi, an old Goldman alum, maybe that’s why Corzine was putting on huge leverage bets on European paper, knowing that, “We’ll do whatever it takes,” was about to be a news headline, not that there’s any sort of inside chatter.

Kevin: No, he gave the nod. He gave the nod from Europe.

David: Right. But Corzine, he would have been right on that particular bet with deep enough pockets and with a long enough time horizon, and that was the issue. The clock ran out, and so did the money. MF Global, as a firm, caved to a larger-than-life personality. The board did. They caved to his resume. And now you’ve got the company, which, like the caveman, is gone. It’s a historical footnote.

Kevin: Right. Just think about this confidence game that you and I have been talking about for years. As long as confidence exists, people are going to do things that will risk everything. Have you ever had an experience, Dave, where maybe you’ve stepped onto a wooden bridge or maybe you’ve eaten sushi at a place for years and years and you get one bad piece? Once your confidence changes, you either move off that bridge or you never eat sushi at that place again. But I just wonder what this looks like when confidence changes.

David: Yeah, the difference is that moment. Confidence exists one moment, credit is extended, all is well. And in a split second, confidence is gone and a mad scramble is on for collateral. That’s what ensues. The Archegos episode illustrates not only how quickly fortunes can change, but how viciously Wall Street firms will move to protect themselves at the expense of clients. I think that’s a fascinating narrative. 

There are more big bets in play today than ever before. There’s greater confidence in the financial structures, which our financial geniuses have put together. Not suggesting they’re not brilliantly constructed, but even with Long-Term Capital Management, I mean, you’re talking about the best bond traders that Salomon Brothers ever graduated, matched with MIT math professors. I think one or two of whom were Nobel prize winners. These are not intellectual slouches, and yet they came one step away from blowing up the global financial system in 1998.

Kevin: With a single company.

David: Right. There are bigger bets today. Leverage applies, built into the bets that are there. I mean, it’s all embedded. You’ve got Goldman Sachs, you got Morgan Stanley scrambling to not be the last. I think we’re going to see more of that word. Financial firms are fighting for scraps. The biggest takeaway for me is that when any liability structure is added to an investment, you’ve got to assume trouble. It’s just a question of when, not if. 

So the credit default swap market last week was sending a very clear signal. Problems are dead ahead. So the credit markets were signaling something. Again, think of the sequence, credit markets are sending a signal. The equity markets are putting in new all-time highs. They could give a rip. The equity markets are full of idiots, largely. What they care about is what they feel. And the credit markets, it boils down to the math: What’s the math looking like now? And credit default swap markets were sending the signal. Equity markets ended up feeling the blunt force of that signal couple days later.

Kevin: I just can’t help but think right now what we do for a living. Okay. None of this would make any difference. I mean, if we’re talking about liabilities that can’t be paid, what about an asset that is no one else’s liability, that carries the value with it everywhere you go, even if you never meet the broker again that sold it to you? And I’m talking about gold. I tell my clients, “You don’t need me once you buy this. You’re welcome to continue to buy and sell from me, but you don’t need me. I’m not a counterparty to this transaction.”

David: Fascinating story: A good friend of mine worked for a hedge fund in Manhattan at the time of Lehman and Bear Stearns. It was working for a hedge fund. His boss told him, I mean, literally looking out the window, looking at the Morgan Stanley building, and he says, “Buy me $600 million worth of gold right now.”

Kevin: Really? I’ve never heard this story.

David: And he says, “Well, why?” And he says, “Because I don’t know if my money is actually across the street or not.”

Kevin: Wow.

David: He wanted nothing but pure physical gold. The takeaway from MF Global, from last week’s collateral grab, and even from Lehman, is that there are very few assets that are no one else’s liability. So many critics today look at precious metals as an unnecessary allocation. It doesn’t have a dividend. It’s not like a bond. It doesn’t pay coupon, but they’re forgetting that market dynamics are not always generous. They’re not always kind, and the Wall Street sponsors of speculation are typically very well lawyered and have built in for themselves layers of protection, contracts protecting their interests. Ultimately, a financial asset that is not on someone else’s list of assets and liabilities, it’s a rare thing. It’s a beautiful thing. Gold has long been that kind of asset, where the ownership merits— they speak for themselves, right? And they’re not the kind of merits that other financial products have. As chaos increases in the months ahead, I think these are simple qualities that will be back in high demand.

Kevin: Well, and for the people who are larger than the small investor, you look at hundreds of years of reputation of the central banks, the big government central banks, how much do they keep in reserve in gold? When war starts or when things start to get tense, it’s exactly like this man that was in Manhattan, “Get me the gold.”

David: “Get me the gold. I don’t know if the money I have across the street is actually there anymore.” It’s ironic that Erdogan knows Turkish investors have long identified his policy missteps. They’ve read it. They understand it. They see the lira in decline and they keep their savings in U.S. dollars, in euros and in physical gold. Gold consumption in Turkey is huge. They’re one of the largest consumers outside of India and China. In his implication, looking through a Financial Times article, his implication, Erdogan’s implication this week as he implored the Turkish people to engage their patriotic duty—

Kevin: Oh, I hate those words.

David: —was to bring the gold and the paper currencies back into the system.

Kevin: Patriotic duty.

David: Intelligent investors have been anticipating all of this. And regardless of the price gyrations of the commodity, they’ve been out of Erdogan’s rigged game for a long time. Will he end up going digital to close the system? Will he initiate a confiscation of hard assets? I mean, frankly, nothing would be surprising given the rising level of desperation. He may see resources— those gold and dollars and euros as national resources, just like Corzine saw client deposits as house money. We should never forget the merits of assets which are outside of the system, whether that be the financial markets directly or beyond the grasp of any despot or digital system of control.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at,, or you can call us at 800-525-9556.

This has been the McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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