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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
RUSSIA HOARDING 661,500 LBS OF U.S. $100 BILLS (31.5 BN)
March 13, 2019
“We have to be cognizant of the dollar losing its incumbency. It has a major impact in terms of U.S. foreign policy hegemony. So whether you like U.S. foreign policy hegemony or not, lose one or both of those things, even marginally, and here is where you begin to see a major upset for the everyman. A major upset for the everyman is that everything is more expensive. The cost of everything goes up.”
– David McAlvany
Kevin:Last night we were sitting and talking about the show and you said, “You know, I had a dream the other night.” You told me about your dream and honestly, Dave, I know people who dream about a lot of things, but you’re the first person I have talked to that literally dreamed of books in a library and acquiring a particular library. You want to tell the listeners what your dream was about the other night?
David:(laughs) Yes, there are lots of sets of books that I really like and I think we’ve talked about the Oxford University Press Dictionary Set. That is one heck of a set of books, as a reference. You have F.C. Copleston’s books on the history of philosophy, a nine-volume set. For anyone interested in the history of ideas it’s a must. But I had a dream the other night and in it I found a treasure trove of books. I found a used set of the Everyman Library.
Kevin:Which is a literal set of books.
David:That’s right. It’s called the Everyman Library. It is 100 volumes. It was constructed in 1906 by Joseph Malaby Dent and then I think the collection was taken on by Alfred Knopf later on to be the publisher, and expanded the list to about 500 books, but the original set was around 100. So 1906 – Malaby, and less than 20 years later, you have Columbia University launching classes relating to the great literature of the Western world, and they still, as university, have a core curriculum based on the classics.
Out of the original class there at Columbia University came Mortimer Adler and he compiled a 500-book Anthology, The Great Books. He did that in partnership with the Encyclopedia Britannica. This is also a classic set. I have it, you have it.
Kevin:And I have it because of you. I think you were either in your teens or your early 20s and you said, “Kevin, guess what I have access to?” And it’s still on my shelf here at the office.
David:The most important part of that particular series, The Great Books, is the two-volume introduction called The Syntopicon. There are 102 essays which deal with the recurrent themes throughout world history. This would be the history of liberty in ten pages, the history of beauty in ten pages, the history of art in ten pages. It is basically the dialogue which has taken place through all of the classic works of literature, and the commentary that you get from each of those writers. So I find it interesting that there have been multiple movements here in the United States toward a well-read and well-rounded, call them an “everyman.”
Kevin:That was in history. We don’t see that nearly as much now.
David:The controversy emerged in the 1920s, 1930s and 1940s around what our education system would be based on, and pragmatism took hold. The argument was that there was really no cross-over in subject matter. And this was championed by John Dewey. He argued that to be able to look on an interdisciplinary basis was superfluous. It was unnecessary to think and to learn in those terms. So that is where a well-read or broadly read person, according to the pragmatist school, was just unnecessary. Dewey won the day, and he defined public education in the United States for nearly half a century. He is our primary educational architect.
Kevin:Isn’t is a sad thing that we’ve lost, though, because I remember reading a book, and you’ve read it, too, An Education of a Wandering Manby Louis L’Amour. He lived here in Durango for a while. To make a living, he became a hobo, he served on a merchant ship, he was a cowboy for a while. He was even a boxer. So this guy did a lot of things but when he wasn’t doing the things that it took to earn a living, he was home buying these little nickel classic books that were available back in the 1920s. I have a couple at home, old antique versions of these things. I have one written by Byron. It was a whole series of books. You talked about everyman. Every man really could afford these books. They were either a nickel or a dime, but I know that that is where he got the education it took for him to write the volumes of books that he has written.
David:The design of the series of books, whether it was the 100 which went into the Everyman series, Harvard Classics had 50 books in their series, the Adler series 500 – they all assumed that there are ideas and recurrent themes that every student, whether you were learning formally or more informally on your own, as you mentioned, Louis L’Amour, there was a necessary background information.
Kevin:To think well. There was an assumption that you had a context as you read another author because that author also had read those same books.
David:Yes, providing a deeper understanding before you start processing information. There are about a 100 colleges in the U.S. that still lean on a core curriculum tied to the classics. That is 100 out of about 5,300, the total number of colleges and universities in the U.S. I think one of the net results is that we have a voter base today which has very specialized education, specialized interests, and they have ears which are incapable of hearing and minds that are incapable of engaging ideas that are, today, in the present tense, determining the course of history.
And frankly, when you think about the issue or problem of fake news, without having a broader context, without having a depth of insight into things, how do you judge things? Because really, most of everything you read in the newspaper is outside of your particular field of expertise.
Kevin:We see the same thing with music. I know a lot of people found music that they liked, not looking for it, but because it was part of the context of the broader conversation. It was what was playing on the radio. These days, you can listen to exactly the style that you want to listen to and forget everything else. Well, it’s the same thing with – you had mentioned fake news. If a person wants to have news that is filtered in a certain way, something that speaks to them, they’re just going to go to that. So there is really very little discovery left in the arts, in music, and honestly, in acquiring the news.
David:Last year we spent some time talking about how social media tends to curate what they believe you’re interested in, so that the news you are looking for is always confirming a bias based on previous searches that you have made on a search engine. So you are being fed what they think you want.
Kevin:Your focus is being narrowed.
David:It is. The Education of a Wandering Man– everyone knows him, Louis L’Amour, from the sundry Western novels that he wrote, and he wrote a lot of those here in Durango. The Strater Hotel is just down the street from us.
Kevin:That was the first place that ICA met when your dad was going to move us down to Durango in 1992. It was the Strater. Yes, Louis L’Amour spent a lot of time there.
David:Early on in my life I was inspired by that book. You referred me to that book. I wasn’t more than 15 years old at the time, so we’re talking 30 years ago. The Education of a Wandering Man, the booklist at the back of the booked forced me to think differently about education. He was a person who, as you mentioned earlier, was sort of a vagabond moving all over the world. He was always reading, always engaged in questions with people, always trying to figure out, on the basis of what he was learning, and the context that he was in, which was changing constantly.
Kevin:And he was always out of his comfort zone. He was always discovering something new.
David:Really, I don’t know why I was dreaming of the Everyman series a week or so ago (laughs).
Kevin:I’m glad you dream of books, Dave. You dream of bibliographies.
David:When I think of the everyman today, and think about politics, and think about populism, the everyman we talk to every day is experiencing a huge disconnect between the news media’s presentation of where the financial markets are at, the position that they are in, and their own personal economic reality, which doesn’t seem to match the perfect world that is depicted in the news media.
Kevin:I think people are afraid of missing out. They see that everybody else is successful – this is what is portrayed, and they, themselves, are not.
David:This disconnect, to me, is intriguing, and we have suggested that the political backdrop in Europe, the political backdrop here in the U.S. circa 2016 tells a different story than that of the main stock indexes where everything is higher, everyone is happier, and we are moving nearer and nearer toward perfection. The political angst that we see in Europe and the United States – we talked about the Yellow Vest movement last week – is symptomatic of economic angst. Political angst is symptomatic of economic angst.
I noted an invitation from Russell Napier. He coordinates the Library of Mistakes in Edinborough, Scotland, and Barry Eichengreen is coming over to speak.
Kevin:He was a guest of ours at one time.
David:That’s right – on the Commentary. He is speaking at the Edinborough School of Business. I took a class there several years ago. He is addressing the students on the issue of populism. He wrote a book last year on populism. He writes that the historical occurrences of populism take place in the context of economic crisis or in its aftermath. We have had this rising interest in populism now and I wonder why it is happening now, assuming that the economy, both here and globally, has recovered. This week marks the ten-year anniversary of the end of the market decline in the markets.
Kevin:Can you believe that?
David:In the context of the global financial crisis, and yet, ten years on, we should be in this beautiful place. People should be very happy. Look at what has happened to the recovery in asset prices. And yet, there is this lingering angst in the political which suggests that there is something not right in the economic, as well.
Kevin:So what we hear from the central bankers is not, necessarily, what everybody is experiencing?
David:Exactly. I haven’t read the book in its entirety. I would guess that Eichengreen will make the case that 2016, which for him was a nightmare election, represented the worst of the worst. Now that is behind us and we can look and say, “All right, we know where we are in the continuum because we saw the craziest reaction from the craziest people in America, just like we’ve seen the craziest people in Europe do the craziest things in politics, and now that is behind us.” Again, I haven’t read his book in its entirety, but I think I’ve got the gist of it.
The unemployment rate, if you go back to 2016 – and this is a bone of contention I have – was 4.7. Today it is 3-something, a slight improvement here with the non-farm payroll numbers on Friday. So it continues to improve – 3.8, I think, is where we are now. We haven’t moved the needle that much in two years – 4.7 is not an abysmal number, hardly a period of angst, at least if you are a student of those statistics. Perhaps if you are comparing notes with John Williams he might say it’s much higher.
Kevin:He puts it north of 20%.
David:Right. And I truly believe it is somewhere in between. There is a reason for the remodeling of the number. And maybe it is closer to U6 versus U3. But again, this is the critical issue here. If we have populism, it is on display here in the United States, it is on display in Europe, it speaks to an economic reality which does not match the financial market reality, and maybe we have multiple versions of an economic reality.
If you live in Los Angeles, if you live in Manhattan, if you live in San Francisco, all is well. All is well. If you live in Detroit, things are better than they were coming off the very lowest you could go in terms of bankruptcy and the chapter liquidation that we saw there for the city. But there is a lot of the country that is a little bit more like Detroit than like the big cities on the coast, east or west.
Kevin:Dave, I have a lot of conversations with baby boomers that are now looking at whether they can retire or not. You look at interest rates right now at nearly zero, so obviously, you can’t retire on interest rates with your money unless you have many millions of dollars. They are also looking at the stock market and saying, “Well, gosh, I keep seeing that it is hitting new highs. How come my stock portfolio didn’t do that for me?”
David:I had a great conversation with a friend this weekend which was very similar. He said, “Dave, I know the stock market has been going up for a couple of years, and I just left things with the broker I’ve been with for a long time. But to be honest with you, it hasn’t hardly budged. I can’t remember the last time I looked at my statement and there was a big surprise, frankly, either up or down. So I don’t understand why I’m invested in the stock market and yet I don’t seem to be participating in the upside.”
Kevin:That’s what I’m saying. There is this feeling that people are missing out on what we are being told, what the narrative is. We’re being told that everything is better, yet people are still wondering why they are not part of that process. So let’s look at the baby boomers.
David:Yes, and I think to do that, you put them in context and ask who they follow. They follow the greatest generation. If you have angst amongst the baby boomers it is because they are thinking of a future which has some unknown variables to it. The greatest generation is passing away. That is the generation that fixated on ideals, on the possibility of structural change, positive change, if we just did the right thing. The baby boomer generation, I think, is a bit more skeptical, and they are moving very quickly into their “golden years” and I think there is a very small segment of them which will have very golden years. I think for the majority, they won’t be so golden.
PricewaterhouseCoopers did a study a few years ago showing that a third of baby boomers have less than $50,000 in retirement, one-third of the demographic which happens to be one of the largest demographics in the country. Again, this speaks to an underlying angst, and perhaps they don’t just see the present value of assets, but even anticipating future growth, it’s not going to be enough. $50,000 in retirement for one-third of the generation that is now headed into retirement – only 15%, according to the PWC study, had over $500,000 in assets, and the remainder was somewhere in between.
So the greatest generation sits on pensions, and they have supplements from Social Security. Boomers, by contrast, have no pensions, they have 401ks which are subject to market volatility, and they have an awareness that social security runs out in their lifetimes. There is this growing sense of insecurity, and in some families I would say a growing sense of desperation to have what they want, but without the necessary resources to get it. So the trend, and I know you have had conversations with folks like this, speculation becomes a hallmark for those that need to, or hope to, compress time to make as much as they can out of the little that they have.
Kevin:I think it is important that you brought up speculation, because there is a difference between speculation and long-term investing. Speculation means you have to continue to win. You put money down – it’s at risk. You have to win to make money.
You talked about desperation. I talked to someone yesterday and she was just throwing her hands up. She was so frustrated because she is only 57 years old but in her mind she feels that she has to be able to have enough to retire in the next three to four years. She doesn’t have a lot, and really what she is saying is, “I don’t really care where I put this money, I just want to make money.” Well, as we spoke, we looked at the stock market to see whether it was overvalued.
We looked at bonds, we looked at cash, we looked at gold, we looked at real estate. She didn’t care. She just now wants to make the money that everybody else is, because her only goal was to retire, it wasn’t necessarily managing money, and she was willing to speculate to do it. This is a strange period of time that I believe has been fueled and made confusing by artificial low interest rates and money that has been created out of thin air.
David:It is difficult to contain enthusiasm when you see markets rise higher, and markets rising at a rate which, frankly, is unsustainable. The Shanghai Exchange has had a very good push since January 1stafter getting obliterated last year, along with many of the other stock market indices, both overseas and here in the United States. The 4thquarter was a rough road. It was tough last week in Shanghai. This week it is recovering somewhat. But you had officials in Shanghai which were trying to contain those bubble dynamics in the financial markets. At the same time you have a meeting in late March where Trump and Xi Jinping were meeting at Mara Lago that was cancelled, so the trade details are not easy to swallow for those participating. Nothing has been finalized.
There have been reasons for the markets to move higher in speculative fashion. The question is, can they sustain these levels? Can they move higher? I know that when and if there is a finalized deal between the U.S. and China you may have the markets jump considerably. We have certainly taken a more cautious position. The stance we have taken is in light of market fundamentals. We tend to put on and take off those trades in a disciplined fashion, so if the markets move considerably higher we will react accordingly and reduce risk accordingly.
Kevin:But the question is, so it moves higher based on the news. Is that sustainable?
David:No, I think the likelihood of a move higher being sustainable is very questionable. A spike is a real possibility and that is generated by algorithms which can run the markets higher, based on what is put into the news, and literally, they are just reading positive news and buying in light of it. But I think saner market angels will likely sell the news. You have heard the old adage, buy the rumor, sell the news. When it is announced I think you could have a spike, but into that spike I think you are talking about short-term strength representing an opportunity to liquidate large positions.
So what is it? It’s a propaganda bid. It’s a propaganda bid for the Chinese, it’s a propaganda bid for the U.S. government, and it’s the perfect opportunity to pass the bag. The man-on-the-street, the everyman, believes the propaganda on occasion, particularly without the educational backdrop to step back and say, “I’ve got the context here, and I know what’s going on.” We live in a world of experts where expertise has been delegated, deferred, and you rely on people who have “greater insight than you do.” So the man-in-the-street today believes on the propaganda, acts on the propaganda, and is typically the bag-holder. So I think that is the sequence we have. We will get an announcement sometime in the next couple of months, a spike, big money sells into it, the man-in-the-street is encouraged by the move higher, finally capitulates, comes into the market, and gets caught holding the bag.
In the backdrop there is all this stuff that is happening that suggests we have already shifted gears lower. You have the Bloomberg GDP tracker, lowest growth rates since the 2009 crisis. This is from Bloomberg this week: “Global growth is at its weakest since the great financial crisis,” quoting from Bloomberg Economics new GDP Tracker. Growth in the first quarter, they say, is running at just 2.1%, sharply down from around 4% in mid-2018. Barclays reduced their 1stquarter GDP estimate to 2% from 2.5%. The Atlanta Fed took their Q1 1stquarter forecast to 0.2% from 0.5%.
And you look at other indicators, whether it is the earnings which are expected to be in decline in the 1stquarter, the Baltic Dry Index near all-times lows, measuring the cost of moving commodities and the demand for moving dry goods across borders using these massive, massive ships. What it suggests is that global economic growth has already turned down.
Kevin:And the thing is, signals. We’ve talked about signals before. Oftentimes you can’t recognize a recession until you are well into it because the signals showed you that it was happening but recessionary numbers actually only become recessionary numbers after the recession has been going six months, or a year.
David:The Bureau of Economic Analysis has never announced a recession in advance. They back-date a recession. You’re right, whether it is one month, three months, or six months into it, they will back-date it to a particular point and say, “This is where the recession began.” So you can be in a recession and no one has acknowledged it publicly. Moody’s downgraded the auto industry this week, from stable outlook to negative, on falling demand. This is from CNBC. Has there ever been a time when the economy was robust and strong and the auto sector as a whole was being downgraded? I don’t think so. I don’t think there is historical evidence for that. You have the non-farm payroll numbers for February which were very unimpressive. In fact, without the seasonal adjustments and the birth-death modeling, you had 41,000 from the seasonal adjustments, 12,000 for the birth/death modeling, the numbers for NFP would have been very negative.
Here’s the good news. The good news is U3, the broadest measure of unemployment, was at 3.8%. U6 finally came down significantly, and this is where I think somebody must have been playing with the numbers because this was the largest single drop in this series, the under-employment rate, U6, the largest single drop in that series in history. It moved from 8.1 down to 7.3 in one fell swoop. So again, that kind of volatility is interesting. It raises a few questions for me. But in spite of the good numbers, 3.8 is better than it was, I’m just looking at the non-farm payroll numbers and it is very unimpressive.
Kevin:Dave, you and I are both fans of Austrian economics, or free-market economics, let the markets do what they will. One of the weaknesses, though, that I have always found exists in free-market economics, is the clustering effect that turns into a monopoly. Look at some of these tech giants like Amazon and say, “Does it really do good to the overall economy to have one company controlling so much?” Here is the confusing thing, though. You would think free-market people would necessarily be the conservatives, but Elizabeth Warren is the one right now who is coming out and saying, “If I get in, I’m breaking up the tech giants.”
David:I think there is, actually, an implicit contradiction within the Austrian school. We have talked about this before. One of their big problems is that when you have an entirely free market, what it allows for is monopolies. And what do you do with monopolies? Theoretically, is that acceptable? So I wonder if we haven’t gotten to that stage where politicians are beginning to ask the question. Elizabeth Warren has given a voice to it, but other politicians in other ages and eras have done the same thing. When corporate power reaches a point where it challenges political power, then you find how legislation comes against and basically eviscerates corporate power.
Kevin:We have talked about the fascist society that is corporatism. That’s what fascism is. It is corporations getting to be so large that they become almost like the government. And what we have seen here over at least the last 20 years, but especially the last ten years, Dave, is that some of these companies and the government are working so closely in tandem that you can’t really tell the difference.
David:It is fascinating because if you look at mutual fund holdings and hedge fund holdings, there is such a concentration in just a few names, and it is kind of following on the momentum themes. If Amazon is up, if Google is up, if Apple is up, then everybody wants to own them.
Kevin:That’s a bull market.
David:And so people have piled in and that has funded the expansion of these companies giving them the capital to go out and buy up lots of small businesses and become a huge conglomerate. So Elizabeth Warren is talking about breaking up the tech giants. She is focusing on Amazon. (laughs) I have a little Cherokee blood in me, and it was something that kind of resonated with me because I thought I heard the whoop of a war cry.
I think her view is not the same as mine on probably any front, but if you were to apply the trust-busting politics of an earlier generation, where would you go? The only conglomerates that own it all and control it all are your big tech giants, those who are coming up on a trillion dollars in market cap and control the flow of data and are, in fact, right now redefining the nature of politics. You look at what the Russians are doing at present to change the data flow and try to control the Internet, what the Chinese have already done to control the Internet, and they recognized a long time ago the threat to monopoly power within television and propaganda that something like YouTube gives anyone a voice and it can be a voice that is very different than the state’s.
Well, Elizabeth Warren and Ms. Ocasio-Cortez can blast capitalism and they can blast big businesses, but really, what we are talking about is a timeframe in which monopoly power and status have been created and it is now in that part of the cycle where you can expect to see politicians move against some of these big business interests. So I think it is interesting to look at the convergence of “capitalism is a bad idea,” “break up the big businesses.” This week we also had the House vote in favor of illegal immigrant voting. I don’t know how that works. I mean, I guess it does work if you’re in a democracy. It’s a problem with democracy, and probably the reason why our founders established us as a constitutional republic.
Kevin:We’re not really a democracy, are we? We’re not supposed to be a democracy.
David:Right. Again, these are backdrop issues. I think they speak to political discontent and political angst and people looking for solutions to problems which tie, actually, to economics.
Kevin:We talked about bubble dynamics and how it can send a confusing signal to people. People are wondering if we are really in a bubble and everything is going as well as it is, how come I’m not doing as well as I should be. But look at what Europe did. They said that they were going to tighten up things. They have been very, very loose for a long time. They said they were going to tighten up things in the last quarter of 2018. They put their toe in the water and then they pulled right back. At this point they are thinking, “We’re not going to tighten anytime soon.”
David:Yes, so Draghi’s reputation will be held intact from the time he came into office, leading the European Central Bank, to the time he leaves this next November, there will be the first period of time in European history, that I am aware of, that interest rates only went down, never went up, in an eight-year period. So the ECB, the European Central Bank, has finally announced the next round of LTRO, which is actually the TLTRO, the Targeted Long-Term Refinancing Operations. This is round three. They are going to start in September of this year, go through March of 2012, and they have also promised to keep the assets that they have purchased already. They are going to retain them, they are going to take the interest that they have from those instruments and re-invest, so that their balance sheet stays large and they don’t put any pressure on the fixed income markets or asset markets.
This raises a question for me. Here we are this week at the ten-year anniversary of the end of the global financial crisis, and I’m so glad to know we have seen a healthy economic recovery, whether you tie that to the ECB’s activities or what not, what they said back in 2011 – “We’ll do whatever it takes.” Draghi tweets this lengthy kind of kumbaya and he ends on this note. This is what he says. “Negative rates have been quite successful.” And I think to myself, “Who have they been successful for? Toward what end? He is saying this even as the organization for economic cooperation and development cuts the eurozone GDP estimate from 1.8% down to 1%, with the biggest declines, if you are looking at individual countries, occurring in Germany, in the U.K., and Italy, and France.
And they’re making excuses. The OECD is saying it is because of the U.S./China trade deal. Look at their numbers. The OECD has carved out the Eurozone and said they are suffering because of a lack of cohesion in the bilateral trade agreement between China and the U.S. and yet their same estimates for China and the U.S. GDP numbers have barely budged. So we are eviscerating each other, only we’re not. Our numbers don’t show that anything poor is happening with us – very minor adjustments to the downside for the U.S. and for China.
Again, I think to myself, “How is this possible?” We’re going back into round three for the TLTRO, the Targeted Long-Term Refinancing Operations. We’re trying to pretend like the economy, globally, in Europe, and the United States, is very healthy. And yet, you have a lowering of GDP estimates, you have a downgrading of autos here in the United States. I don’t know. To me, it’s like the context is being completely ignored.
Kevin:I just got back from visiting a friend in the hospital this morning before we came into the studio. He was in great pain, so the nurse came in several times and gave him pain pills. Well, those pain pills are a temporary solution. He can’t live on that pain medicine for very long, and he understands that. The nurse was there and she said, “It will be the next three days that you are on this.” But that really is what this bailout was ten years ago this week. In 2008, when we got to the bottom of that market, they started saying, “We’ve got to give pain pills to this economy. We won’t do it forever.”
What you’re saying is, Draghi, at this point, is saying negative rates have been quite successful. You’re right. We haven’t seen anything really recover. And I’m wondering about pension funds, Dave. I’m wondering about the people who, in the long run, have to be able to earn money with money so that they can pay those pensioners.
David:This is where we continue to see a decline here in the U.S. Again, it is a category of economic angst which, I think, feeds the political angst. The Flow of Funds Report for the end of last year, Q4, was out late this last week and we have unfunded pension liabilities which swelled. Yet again, they are at 6.93 trillion, so almost 7 trillion dollars in unfunded pension liabilities.
Kevin:That’s not pension liabilities, that’s unfunded.
David:That’s the unfunded portion. The unfunded portion increased in the 4thquarter by 678 billion dollars. (laughs) This is no joke. Doug Noland was studying the Z1 reports. Again, that’s the Flow of Funds reports. He was noting that the nonfinancial debt figures finished 2018 at an all-time high, 253% of GDP. Again, for comparison, as if history doesn’t matter, but in fact it does, we’re at 253% of GDP – this is for nonfinancial debt. At a record, we surpassed what we had at the end of 2007 which was at 230% of GDP, we surpassed what we had in the late 1990s – 1999 – 189% for nonfinancial debt.
Just think about that. We have more nonfinancial debt today than we had at any of the previous peaks, and yet we would hear the argument from CNBC and from politicians that it has never been better. From here, it’s only going to go higher. The stock market is only going to go higher, real estate is only going to go higher. Bonds? Well, I guess they can only go higher if, in fact, we are headed toward another round of zero or negative rates in Europe.
Kevin:Haven’t central bankers, though, put themselves into a corner? You have Draghi, who is tweeting out how successful negative rates have been. If they were that successful he wouldn’t have to tweet it.
David:And it has been successful even while they are initiating another bailout program. I don’t understand. Does anyone pay attention to the dissonance, the disconnect, between what is actually happening and what is being said? It is as if it is adequate to tweet whatever you want and the people will believe it. This goes back to what my dad raised me with, quoting Lenin: “Tell a lie, tell it often enough, and the people will believe it.” This is what I see in Europe. “Oh, things are just fine here. Oh well, of course, we’re going to issue another refinancing operation and extend the equivalent of our version of QE, another round of QE in Europe. But everything’s fine here.”
Kevin:Aren’t we seeing the same thing here, though? The New York Fed President Williams is already talking about the quantitative easing that they are going to use in the near interest rate policies for the next crisis. He is already pre-loading for this just to let you know that, just like Draghi, “We’re good, we’re good. We’re going to do this now forever.”
David:Again, I think this is where saner angels within the stock market get it. They know where we are at. When household net worth – again, going back to the Z1 report – when it reaches a record high in the 3rdquarter, 523% of GDP, yes, we had 4thquarter volatility in the stock market, so it got a minor haircut. Now we’re down to 512% of GDP. Where are we in the cycle? You mentioned Fed President Williams. The worst sequence of events last week was when the New York Fed President was talking about QE and negative interest rates, policies that they would use, theoretically, during the next recession.
Kevin:You would think the stock market would have gone up.
David:And stocks sell off instead. You would expect them to be encouraged by the commitment to support the markets with unconventional measures. But I think no one likes to think that recessions are even possible anymore. Everyone would prefer to believe that, like we stated last week, the 4thquarter of 2018, that wasthe big hit, that wasthe market selloff. The worst isbehind us.
Kevin:Let’s go back to the backs in the corner, though. They have lowered interest rates and created a speculative environment, and now they are saying they cannot raise interest rates. Corporations couldn’t handle it because there is so much debt.
David:(laughs) And now it’s the Dallas Fed, Mr. Kaplan, commenting on the elevated levels of corporate debt. The market did not like him talking about how much corporate debt there was. His comment was, “It would be difficult to raise rates because of the quantity of corporate debt.” I was reading a tweet from Fred Hickey later that day, and I could tell he was ticked. He said, “Are these Fed people brain dead? Can’t raise rates because of too much corporate debt? The reason there is too much debt is because the Fed has suppressed rates to such low levels. It encouraged taking on debt of all kinds. Want to reduce debt? Raise rates.”
Kevin:Right. And see, that’s the dichotomy here, because if you lower the rates for long enough, people are going to go further into debt. That’s what they are going to do. But the problem is, when those rates go back up, they can’t afford the interest. That has happened already to our government. We have 22 trillion in debt. We can’t see interest rates go up substantially because the revenues won’t pay for it, but now corporations are in that same situation.
We have gone more than ten years without a recession, Dave. At this point we have gone about as long as we have ever gone without a recession. We talked about this week being the ten-year anniversary of the bottom of the market of the global financial crisis. Let’s go back and look at the recession that we were in back in 2007-2008. We were in the recession before we could identify it.
David:So with history, you have a frame of reference. You have, not exactly the model for how things will occur, because nothing happens the same way exactly twice. But context is key. History is helpful to recall. If you go back to December of 2007 the recession was becoming fairly obvious. Just back-date that a few months and you had corporate profits which peaked in the 3rdquarter of 2006. And as profits were peaking, no one believed that was the beginning of the end.
So sentiment tends to, and the way people appraise the present and future, it tends to track those peak figures. You had peak optimism in the stock market, along with peak profits, until recently of course. Now we have had almost the same thing, peak profits and peak optimism. You had loan growth, going back to 2006 before the global financial crisis loan growth accelerated from 2006 through the end of 2007, and actually loan growth peaked in April of 2008.
Kevin:It sounds familiar.
David:The recession had already started, but financial institutions hadn’t gotten the memo, so to say, and they kept on pushing money out the door, offering loans. I think this is very instructive for us today. Was there anything, any little indication, caution, slowing in the expansion of credit? Or was it just too late? You lent and you lent and you lent until it all unraveled.
Kevin:You have to, to keep your job. Let’s face it. If everybody thinks things are going fine, and you’re managing a fund, or you’re trying to manage people’s money, you have to take risk. You’re not going to start planning for a recession before the recession starts because you will lose your job.
David:That’s business risk and employment risk. So your peer comparison, if you’re in a publicly traded financial company, does encourage excess risk-taking beyond the threshold at which it is safe or prudent to do so. And you are right, to do otherwise would be to lose your opportunity in the marketplace and to risk market share to other companies who are going to be “more aggressive.” There is a hint already within the banking community that recession has already begun. It is not every day that J.P. Morgan gets cautious in its lending. It’s just not the nature of any banker.
Jim Grant, monitoring their Investor’s Day last week, was listening to the content, and he said, “The words recession, recessionary, and downturn were used in their Investor Day presentation no less than 30 times from beginning to end. So you have J.P. Morgan, which is expecting, for their loan book, a slowing of growth and a focus here in the near future increasing the quality of loans, positioning, in their words, to have less negative impact on us when the market turns.
Kevin:That’s a quote – “when the market turns.” They’re already saying whenthe market turns.
David:Right. So there is some anticipation and yet there is very little positioning by those in the marketplace for that, really positioning for it. The Bureau of Economic Analysis has yet to confirm a recession, but the behavior, at least of one significant lender, J.P. Morgan, implies that the wave has already crested.
Kevin:You’ve been talking about the bank holdings of not only cash, but gold, going up worldwide. The central banks are increasing their level of gold ownership.
David:I think that is significant because it signifies risk-off, where gold is a safe haven like treasuries are a safe haven, or German bunds are a safe haven. But it also represents a different kind of hedging, and this is a political and geopolitical hedging. When you are talking about the central banks, and we have often mentioned the increase in gold holdings by the central bank community, Russia is firmly in the middle of that repositioning, but they are also shifting massive holdings into physical cash – 31½ billion dollars, up from 1.3 billion U.S. dollars a few years ago.
Kevin:Dave, that is worth repeating. I read that same statistic. I could not believe it – from 1.3 billion to 31 billion. And then, I think we both read the same thing. It talked about how much that weighed.
David:This is not cash in the bank.
Kevin:These are 100-dollar bills.
David:(laughs) That’s right. And I’m sure there are some euros and other currencies, as well, but of course, sanctions are a function of this move. The source of most of that cash is from the liquidation of U.S. treasury bills and bonds. So I think you have SWIFT, which if you recall, is the mechanism by which we send funds digitally from one place to another.
Kevin:It is also a way that we punish our enemies. They can’t use SWIFT if we don’t like what they are doing.
David:Exactly. I think SWIFT is a motivating factor for getting physical. Digital cash has easy-to-control bottlenecks. Physical cash, just like physical gold, is not subject to the same vulnerability. We’ve mentioned Juan Zarate’s book, Treasury’s War– a great book. He was in the Treasury Department, and basically describes how the Treasury Department has basically replaced the State Department as the primary vehicle for statecraft in the late 20thand early 21stcentury. I urge you to get a copy. I would love to have Zarate on the program. Maybe someday we will.
He puts in context the concerns of various countries about the dependency that the world has, not only in the U.S. dollar, but the U.S. dollar system, and the controls that can be used to block the flows of funds ordinarily directed through the financial system. Evan Lorenz, who is one of the writers for Jim Grant, was talking about this in the Interest Rate Observer, where the stash of cash, if it was comprised exclusively of 100-dollar bills, would weigh 661,500 pounds.
Kevin:I read that article. It said that is the maximum takeoff weight of a Boeing 777.
David:Why would you take on the inconvenience of that amount of cash unless you were trying to address another concern? This goes back, again, to not just gold being of interest, and cash being of interest, from a risk-off perspective within the financial markets, but there is a political and geopolitical risk brewing. The bottleneck, the chokepoint, is this Society for Worldwide Inter-bank Financial Telecommunications. That’s what SWIFT stands for. If you are Iran, if you are Venezuela, if you are Russia, you either have been cut off, or can be cut off.
Kevin:There is always the threat with everyone.
David:And money all of a sudden becomes hard to move. In the ordinary process of trade settlement, business is no longer as usual. So when the Trump administration breaks off the Iranian agreement – and this is really what is interesting to me – we break off the Iranian agreement and one of the unintended consequences that we inspire is that you get a governmental consortium – German, French, British – and they launch a new payment channel as a work-around to the SWIFT.
Kevin:It’s an alternative, just like the Asian block is coming up with alternatives to trade, as well.
David:Yes. So we’re just over a month old. INSTEX was launched January 1stof this year as a work-around to shutting out SWIFT and dealing with the governmental controls, the sanctions, put in place. I can’t help but think of Thomas Kuhn. He made the case in The Structure of Scientific Revolutionsthat radical shifts are rare, in part because alternative systems are rare. So you have the status quo and to replace the status quo you have to have a whole new system to replace it. Those alternative systems are rare, so the status quo generally stays.
What he referred to as a textbook bias is where a group of people really can’t think outside the box, to put it in the language of paradigms. That paradigm, or a paradigm, is promoted by the established thinkers in a certain field, and only when A, the problems with a certain paradigm begin to proliferate, and B, you have a replacement paradigm for that viewpoint or practice that has maintained an incumbent benefit, only then when you have A and B do you see a radical shift, what he called a paradigm shift.
Kevin:He talked about how it can take over 100 years in scientific revolution to have that paradigm shift. I’m thinking things may speed up a little bit now that information has sped up. It’s not just currency and gold anymore. We have new technology, Dave, that I wonder about, that has to do with block chain.
David:We use a system, SWIFT, that is so mid-20thcentury. It is a sort of technological embarrassment. When you talked about these changes taking place over long periods of time, what it doesn’t take into account is how technology can radically shift that. You are right, in the last few years we have had Ripple which has emerged in the digital coin space as a replacement for SWIFT, as a replacement for moving money from one financial institution to another, much quicker, so banks lose their 2-5 days of float, and much cheaper. We’re talking about fractions of a penny, fractions of a dollar, depending on the size of money that you are moving around. That may represent the way forward.
But then you also have our foreign policy, which could be the complementary will to get it done. So we have the way, the will – again, you know the old phrase, “where there is a will there is a way” – I think the foreign policy catalyst may be the will for the international community to get this shift in motion. Of course, at risk is the financial system which is geared in a way that benefits dollar incumbency.
Kevin:I think that is what we are assuming. We are assuming that the dollar is just always going to be the reserve currency. That is that whole State Department effect. But the dollar is losing reserve currency status as we speak, as well as the petro dollar status.
David:We have to be cognizant of the dollar losing its incumbency. It has a major impact in terms of U.S. foreign policy hegemony. So whether you like U.S. foreign policy hegemony or not, just recognize that if you lose dollar incumbency, you also lose U.S. foreign policy hegemony. Lose one, or both, of those things, even marginally, and here is where you begin to see a major upset for the everyman. The major upset for the everyman is that everything is more expensive. The cost of everything goes up.
Kevin:You’re talking about prices going up. There are two ways to look at inflation. You have brought this up many times. One is the systematic printing of money and prices going up at a somewhat predictable pace. But there is a point when velocity, how many times a dollar bill changes hands, rapidly increases, and that creates hyperinflation. We haven’t had much velocity here recently, but this same article talked about 80% of the printed currency is actually overseas. It is not even here in America.
David:Right. That is actual physical currency. We know that money is much more broadly defined as currency and credit today. But if you look at the supply of dollars, far larger than domestic demand, far larger than what we need, and the supply is predominantly, as you said, 70-80% outside the United States, and I think those numbers would carry over, not only from currency but into the credit markets, as well, most of that demand lies outside the U.S.
Kevin:What if they want to get out of the dollar quickly?
David:The demand being outside the United States helps maintain the value of the U.S. dollar because you have a large and generally happy audience. But if you change the demand internationally, for digital or for physical cash, or expand that to even dollar-denominated credit, now the U.S. dollar, the supply, all of a sudden is too great. It is too great for what we need, and there are implications, too many dollars chasing too few goods. You remember that being basically the operative definition of inflation – too many dollars chasing too few goods.
Implicit here is the nature of inflation driven, not just by the printing press, but as you were talking about earlier, by a market exchange dynamic whereby once-happy holders of the U.S. dollar want to move on. They want to move on to other assets. They want to move on to other currencies. They get rid of their dollars and dollar assets. Those dollars need to find a new home. The problem is, an increase in the turnover of dollars, that velocity number, can be an indicator of a shrinking, a diminishment of satisfaction, amongst the holders of that currency. It can accelerate your price increases for goods and services as the desire to hold that currency ends up impacting the quantity which is in circulation. And we go back to that simple phrase – you have too many dollars chasing too few goods.
Kevin:It brings me back to Barry Eichengreen. We read his book, Exorbitant Privilege, before he came on the show before. Barry is the one who is going to be lecturing on populism over at the school in Scotland. Barry Eichengreen was arguing that the reserve currency status was actually a burden. The problem is, how can the United States continue its State Department type activities with the Treasury unless we are the reserve currency.
David:I think that is where we lose a lot of leverage. And of course, the benefits have also accrued to consumers in the form of an offset. If you have stagnant wage growth here in the United States, but your tradable goods sector, your inports, are cheaper and cheaper as the years go by, the fact that you’re making about the same as you were, or less, in inflation terms, as you were 20 years ago, you feel wealthier because you’re buying cheaper stuff. Cell phones, instead of costing $1500 cost $150, or $300. Now, iPhones are a lot more expensive, but you’ve seen a diminishment in cost because of technology and imports of that technology from other places like South Korea, Taiwan and China, etc.
Trade, consumption – again, we have had this on very good terms because the dollar is king. We have been in a very privileged position because the U.S. financial markets have been king. We have been able to finance a lot of extra spending as a government because the U.S. bond market is king. In the same context, rates have been declining for 30-plus years. So if you look and say, the holder of bonds over this 20-30 year period has been pretty happy, at least through the mid-year of 2016.
Again, we come back to INSTEX and to Ripple. They are a reminder that change rarely occurs, but when it does…
Kevin:It’s a paradigm shift.
David:It’s because a whole new system has been birthed to address the frailties or the vulnerabilities of the old system. In this case, it is not dollar strength or weakness that is the cause of there being a will to change, “where there is a will there is a way.” Again, we think, well, maybe the government prints too much money, maybe they issue to much debt – that destabilizes the financial system.
Shift gears. Shift your focus. It could just as easily be U.S. foreign policy which risks disaffecting our political partners and the old arrangements we have maintained to this point. You think in terms of debt, you think in terms of the printing press, as the reason for a dollar crisis. What if the motivating factor in the repudiation of dollar reserve currency status is not those things, but instead, it is a change in the pipes?
Kevin:It is a dissatisfaction with foreign policy, or a change because there is an alternative.
David:A change in the pipes allows for a change in the flow, the elimination of a chokehold, the bottleneck which SWIFT represents. And capital may flow differently. If capital flows freely, would it, in fact, flow differently?
Kevin:It’s like changing the pipes, or what we have with the Durango narrow-gauge train. When they shift the tracks, all of a sudden the train is on a different track. “Oh, it’s not coming by on this track anymore.”
David:(laughs) Right. So if you allow for a change in flow, and you eliminate the chokehold, the bottleneck, which SWIFT represents in a world of moving money from one place to the other, then capital may flow differently.
So here is the question. If capital flows freely, would it flow differently, and have we made ourselves anachronistic?