September 5, 2012; Bernanke in the Land of Oz

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, one of the things that I know you watch on a pretty consistent basis is the psychology in the market based on volatility. They measure something called the VIX which is volatility in the S&P 500, or the overall stock market.

David: For us, I think, the market is generally very optimistic, or cautiously optimistic, I guess you could say, coming into a number of the things that we expect to be announced, whether it is the ECB or the Fed here in the next 2-3 weeks, how proactive they are going to be. So there is that sort of cautious optimism. But the bet has already been placed, and that is why we see the Dow at $13,000. They are hoping that they were right in terms of assuming the Fed’s role in the marketplace. We would define ourselves as cautiously pessimistic. It could be worse, but we certainly see room for deterioration, and rapid deterioration, if expectations don’t go according to plan.

Kevin: We interviewed Bill King last week. He says that the stock market right now is in the most dangerous territory of the year. It is above 13,000, it is going up on bad news because they are waiting for a little bit more QE candy, and then it goes down on good economic news. How is that sustainable?

David: Yes, and your point on the volatility index is simply that it dipped to below 14 in mid-August, and now it is back to about 18.

Kevin: So 14 would show complacency.

David: It really would. Any time you are below 15, you are at record levels of complacency, so there are a few more people who aren’t quite as sure of their bets over the last two weeks, but sort of mid August, we saw the most ridiculous levels in terms of complacency, for the summer.

Kevin: To look at where that money comes from, to go into the equities market, the stock market, we have had incredibly low rates, artificially low interest rates for years now, so a person can’t just go out and put money in a bank and earn interest. It almost forces them, even old people who should not necessarily be speculating with their money, to take risks and go into that equity market. How long can those rates stay as low as they are?

David: That is a question that was asked this last weekend at our McAlvany Wealth Management briefing here in Durango, the second of the year. It fell on the same day as the Jackson Hole meeting, and we had our own views of what needed to be done, and one of the questions was, “How long can rates be held at these levels?”

There are really two ways of looking at it: Number one, we are looking at an artificially low rate. Arguably, the activities of the Fed in the marketplace, creating those artificially low rates, could go on for a long time.

Kevin: As long as they can maintain control. Treasury bills have returned negative rates, related to inflation, for years now.

David: The second element of that is that the market can reassert itself and supersede any activity that the Fed has in the marketplace. Those two things are the real challenge, anticipating which is in control. If you look at the TIPS, the Treasury Inflation-Protected Securities, you have negative returns on 1-year paper, 2-year paper, 5-year paper, all the way out to 15-year paper.

Kevin: So people are willing to give up buying power in the future just to have – what – the safety of Treasuries. Is that it?

David: TIPS is an indication of a place where people would take money if they are concerned about inflation, if they are assuming that the CPI is going to move higher with inflation, of course, and they are going to be compensated. TIPS are structured in such a way that you are compensated, commensurately, to an adjustment higher with the CPI. Of course, we have our own argumentation as to how legitimate CPI is, because it is sort of massaged, if you will, with components coming in and going out, which are fairly relevant to real world inflation. That is another issue. What we see there is that people are really saying that they don’t anticipate any inflation and everyone the world over is betting on deflation. Everyone the world over is betting on some sort of a collapse in the financial system.

This is what is interesting. When everyone is betting one direction, you can usually bet that everyone is wrong. You don’t want to be an iconoclast just for the sake of being an iconoclast, or a contrarian just to be cantankerous and against the trend. We are not artists trying to prove our identities as something other than the norm. But the point is, when you have this many people betting in the Treasury market that some sort of demise is occurring, they are either dead right or they are dead wrong.

Kevin: Can’t you figure, though, that the Chinese contraction and the contraction in euroland, the danger over there, is forcing people to the only thing they can actually own in paper that they feel safety with? Wouldn’t you say that is a big part of the purchasing of Treasuries right now?

David: Sure, and as you see that sort of panic capital into the Treasury market, rates have gotten squeezed to record low levels. What is interesting, again, is that over the last 2-4 weeks we have seen some easing up there, and rates have been rising, not only in the Treasury market, but in the German bund market, and even in the sterling market, the 10-year British paper, as well.

Kevin: Aren’t the central bankers right now playing things awfully dangerous, as well? I think they are assuming that they know just how long they can control rates and continue to print money. Inflation is always the danger. All throughout history, these are the beginning signs of inflation – low interest rates, the printing of money, and the thought that there is going to be deflation. In fact, correct me if I am wrong, but deflation almost always precedes a hyperinflation.

David: We will talk about the faith that the investment community has in central bank activity in a few minutes, but I think one of the things that you have to take stock of here, is that the central bankers who are being entrusted with taking away monetary stimulus and loose monetary policy, at just the right time so that there are no inflationary consequences to their loose monetary policies, these are the same central bankers who did not see a problem emerging in 2000, 2001, and 2002, or following, in 2005, 2006, and 2007, that period of recovery following the stimulus just 3-5 years earlier than that.

They didn’t see a problem coming into 2007 and 2008. They didn’t see the problem, but they now have the solution, and we are assuming that these folks who have a hard time anticipating the future, and are largely involved in a rearview mirror policy-making measure type of formulation are going to anticipate? It’s a disconnect for investors, because they are largely looking in the rearview mirror, and yet, we are assuming they are looking way out on the horizon, and they are going to be able to anticipate and pull back these loose monetary policies.

Kevin: But in this case, the Sword of Damocles that they are standing directly under, and they assume they can dodge just in time, has gotten to be so gigantic that if it did fall, and they didn’t dodge in time, is devastating.

David: Certainly, we still have the fears of a European collapse. We have the easing of those fears, which I think would go a long way toward reversing the flows of capital into the U.S. Treasury market, it takes rates much higher as demand diminishes, and the challenge with analyzing yields is that new data, surprises, frankly, of any kind, can radically and very quickly reverse the present course.

Kevin: That’s the sword that’s falling – any new data.

David: Yes, so you are in the strange position of seeing 1-1¼% in the U.S. 10-year as a high likelihood, given a collapse in the eurozone. On the other hand, we are already at suppressed and artificially low rates. Arguably, any news data that has a return to normalcy in the U.S. economy, we can see those 10-year yields reverse course and move in the opposite direction very quickly.

Kevin: We have talked about the negative effects of these artificial low interest rates. We have talked about retirees having to risk money that normally they would have earned interest on. They would have been able to just put it into the bank, put it into Treasuries, earn the interest, and maybe enhance their Social Security checks. But low rates do benefit some, and I think it is worth pointing out that for every crisis there is an opportunity, for every negative there can be a positive to those who are adept and understand what is going on. Can you explain some of the advantages of artificially low rates for the individual investor?

David: This is the confusing part because, on the one hand we are saying that low rates, which generally are an indication of low risk, if you are just looking at where you are going in your yield…

Kevin: Low risk of default.

David: Exactly, and actually, it indicates nothing of the sort when they are artificially constructed. But there are people who are opportunistically taking advantage of that. Namely, there are big companies whose earnings are improving, as we see both stock buy-backs and refinancing at record levels. We’ll talk about August in just a minute. Some big companies are taking advantage of refinancing debt at these low levels. And then there are holders of large mortgages, households, and I say holders of large mortgages because, generally speaking, the folks who are refinancing at this juncture have plenty of equity to give up. If you bought at an inopportune moment, 2004, 2005, 2006, you are likely negative in your equity, and you can’t refinance, so you may be stuck at a 5-6% mortgage rate, without any ability, unless you are willing to write a check for $50,000-100,000 just for the privilege of refinancing.

Kevin: But for someone who has owned for more than a decade, who purchased back before all that happened, they could actually refinance at sub-4% right now.

David: Exactly, and that is what we are seeing. We have big governments, we have holders of large mortgages, and the last area that is benefiting from this low rate environment, which we have talked about before, of course, is government, and that is very clear. When we look at the corporate landscape, there are about a hundred cash-rich companies which, not only are their earnings improving and they are building this war chest, so to say, but they are also refinancing aggressively. They stand in stark contrast to small and medium-sized businesses, which still have very little access to credit. So again, what is the difference? If you are running a company and you have 100-500 employees, maybe even 1000-2000 employees, you are still a small to medium enterprise, and your access to credit through the banking system is very, very difficult. Meanwhile, take somebody like an Illinois Tool Works, as just one example, 30-year paper, with a coupon of 3.9%. That was 1.1 billion dollars in borrowing just for ITW. August was a classic case in point. If you are looking at corporate credit expansion the world over, it was close to 250 billion dollars in one month, the largest August on record. Corporations are taking advantage of these low rates, and it is giving a short-term boost to earnings.

Kevin: That brings up another point. We get the question all the time, “What can the Fed do?” The Federal Reserve has kept rates low, and you have talked about some of the people who have benefited from that. It is actually not the little guy, necessarily, who has benefited from the low rates, but quantitative easing is the second thing the Fed can do. They can print money. They can monetize the debt. They can do those types of things.

Here is my question, though. Why, after two rounds of quantitative easing, with little-to-no economic growth filtering down to the little guy, would we see this QE-III as a valid course of action?

David: And frankly, there is no improvement in employment, so QE-I and QE-II…

Kevin: And unemployment kept getting higher and higher.

David: Right. There was a temporary reprieve, really, in the equity market. In the financial centers there was a reprieve because of QE-I and QE-II. That, I think, is where we should consider the cost in terms of both dollar volatility and increased interest rates in light of QE-III. Only the balance sheet neutral Operation Twist was of benefit to the Treasury market, lowering borrowing costs, allowing the dollar to creep marginally higher. What assets might they purchase in a QE-III? We keep on talking about QE-III, but they are going to have to get creative, because out of the box, if they do exactly what they did with Quantitative Easing I or Quantitative Easing II, there is a net benefit to the stock market on a very temporary basis. Beyond that, what was the benefit? To the employment numbers? No benefit. To the overall economy?

It was interesting because Ben, this last week, went so far as to say, we can’t really prove where there has been an economic benefit, but our models do show improvement.

Kevin: “We have computer models up here in New York that we run, and you know what? Forget the facts. Forget, actually, that unemployment rose, and that it never filtered back down. We do have a couple of algorithms in a computer program that say it’s working for us in some sort of virtual paradigm.”

David: We mentioned this years ago. Do you remember the Wizard of Oz, what his former occupation was before he was pulling the strings, and all the levers and cords behind the screen, and making Oz this brilliant, beautiful, and magical place?

Kevin: You mean, he wasn’t really the wizard?

David: No, he worked at a county fair and he was a hot air balloon man. Lest we never forget, the men who are behind the screen, pulling the levers, with their beautiful models – who are they really? What were they before they are the Wizards of Oz? Hot air men.

Kevin: Most of them got published, though, by academic institutions, Dave. You need to understand, they have been published.

David: That’s true. Credentialing is everything.

Kevin: I have a question for you. Is the banking system, which did benefit from quantitative easing and low interest rates, and the U.S. Treasury did also – are they now dependent, like a drug addict, on low rates? What happens to them if rates rise?

David: There are a couple of things. One, we have to ask the question, if they did move toward QE-III, why would they? Toward what end? Because there was no palpable benefit to the man in the middle – the middle class, if you will – is there a large institution that is quietly bleeding, necessitating the vigilant stance of the Fed? Are the banking system and the U.S. Treasury, as you said, dependent now on lower rates? And if so, an improvement in economic statistics, like we had last week in the beige book, frankly, is awkward, if only because the conditions for low rates are being held constant, artificially, by bond purchases from the Fed.

Again, if the economy is improving, then the case for artificial manipulation of the yield curve weakens, and the likelihood of higher rates set by market forces comes into focus.

Kevin: It’s almost as if they are disappointed when things start getting better. It reminds me of a person who goes through a surgery and they are given Vicodin, or morphine, or what have you, and it starts to become worse and worse news the more they get better, because they are going to have to back their drug away, and they would rather have the Vicodin than actually have the outcome that they came in for in the first place.

David: So perhaps Ben needs things to remain on edge, not in crisis mode, just on the edge, to facilitate what has been happening now for several years – the redistribution of income from the household sector to big banks, number one, and government, number two, via subsidized borrowing costs. We would like to think that someone is looking for resolution and wants to see an improvement in the economy, but at what cost? In the game that is being played now, the Treasury has to have low rates in order to finance themselves.

The Obama administration, last year, suggested that we could see a doubling of interest costs by 2015. Well, that’s a bit of an awkward moment, because we can’t afford 500-600 billion dollars in interest costs…

Kevin: On between 2 and 2½ trillion of tax revenue, that’s what we bring in.

David: So that’s 500 billion, moving up from less than 200 billion, in terms of the interest component on our national debt. They can’t afford the rise in interest costs. So there is this awkward juxtaposition, the battle between the Beige Book and Ben Bernanke, where Bernanke does want to see an improvement in the economy on the one hand, but on the other hand, he knows what the cost will be to the U.S. Treasury, and to the Ponzi scheme being played in the context of rebuilding bank balance sheets. Are we done yet? Is there stability in the banking system yet that would justify a move toward a more conservative monetary policy?

Kevin: Concerning this economic weakness, I want to make sure that we are not too myopic here on this show. You travel to Asia, and you travel to Europe. This economic weakness is widespread. This decoupling that has been preached by some of the pundits out there, where emerging countries, or China, or Europe, are all disconnected now and can do their own thing. If interest rates rise, or if we continue the economic slowdown, they get taken down even further, do they not?

David: Oh sure, and if you are looking at the contribution of global growth, and growth in global GDP, it was the emerging markets, the BRICS, and those types of countries that over the last 10 years have contributed most. Roughly a third of the growth component in GDP is coming from the BRICS – Brazil, Russia, India, China, those sorts of countries – with the U.S. coming in at close to 16%, and Europe coming in closer to 6%. That’s where the growth trend has come from. The question is: Is that ultimately sustainable? And what we are seeing is that developing countries have not decoupled from the West. They merely follow the engine around the bend on a delayed basis.

Kevin: They are following the engine, but the engine right now is running purely on faith in central banks, David. When economic news is bad, the stock market goes up because they are thinking…

David: Now the ECB will act, now the PBOC will act.

Kevin: How much faith is sufficient? We are talking about, not just the United States, but if we are the engine, and the other cars of the train are everyone else, it is all attached to faith on Ben Bernanke.

David: Yes, and again, in this case we are talking about faith of investors in the capacity of central banks and bankers around the world to stimulate growth and stir recovery. We have Germany, Japan, Brazil, China all slowing, or with anemic growth. Brazil, and other Latin American countries are now being hit by the slowing demand for commodities from China. Does this come as a surprise? No, not really, I think we have been addressing this, but the issue is that it is global in nature. The developing countries and the developed world are both experiencing the malaise. Japanese exports to the EU…

Kevin: I saw that in The Economist – down 25%…

David: In total value from last year at the end of June until this year. We have weak Chinese PMI numbers last week, 49.2 versus the 50 expected. Well, guess what? This is good news!

Kevin: Because they are going to intervene, just like Ben Bernanke does here.

David: Exactly, bad news is good news. The media spins it and says, yes, the PBOC is close to intervention. Is the PBOC, the People’s Bank of China, talking about intervention? Have they laid out a strategy? No, it is just implied – worse is better. Not in the Lenin sense, but the worse things get, the more likely we are to see central bank intervention. That is really not the definition of a healthy economy or a healthy market, which, I think, goes full circle to our talk with Bill King last week, when he said, “This is a very dangerous period for equity market investors because this is not a reality built on facts, this is not a market that reflects current economic realities.”

Kevin: Bill King definitely pointed out last week, and not everyone out there is completely ignorant to this fact, that things are broken, they are not getting better. Everyone is assuming someone has a wild card they can put on the table that is going to cure things, but nobody really knows what it is, so they keep playing the game, hoping that they have the wild card.

David: And not everyone has one, but everyone is pretending as if they do. We have the ECB September 6th meeting with Draghi. Obviously it is important. It was important enough for him to skip the Jackson Hole meeting. He did not come over because he was preparing for that meeting. So, what can we expect? Again, this is what everyone is anticipating. We have the equity markets in Europe, which are 20-25% higher, off of their lows, and we are talking about 90-95% off of their peaks, and now recovering off of rock bottom lows. Is that an indication of strength in the economy in Europe, or will the ECB offer to buy unlimited amounts of paper under that 3-year threshold?

Kevin: Are you betting that they are going to have to come out with something a little like Ben Bernanke hinted at for the United States?

David: The ECB may surprise. They may exceed expectations. Draghi is moving closer to a blend of monetary and fiscal policy, and it is sort of a subtle coup. It is a coup, of sorts, in the sense that the ECB is moving in to fund specific government needs via bond purchases. No, fiscal policies, and those responsibilities, are not being relinquished by various governments.

Kevin: Not officially.

David: Right. No one is arguing about the free lunch via the EBC, so as long as it is constitutionally appropriate, which, of course, when you are looking at any document, hermeneutics is very important. What are you reading? What are you gleaning from the document? How do you interpret it? That is what is being twisted and manipulated sufficiently. This legal contortionism is happening in Europe today so that they can read the constitution such that the ECB now has the freedom that it did not have two years ago to do the very same thing.

Kevin: It reminds me of our interview with Otmar Issing, who was one of the founders of the ECB. In fact, he served with them for seven years. He knew that there were crises coming with Spain, Portugal and Italy, and he understood that all countries have monetary policies and fiscal policies. The monetary policy is how you control the money. The fiscal policy is how you control the taxation and the spending. There was a definite separation, when the euro and the ECB were accepted, that these countries would keep their own fiscal decisions, and what you are talking about at this point is that the ECB is creeping into that without officially being granted that power. They have to. Otherwise this thing falls apart. No monetary union in history has ever succeeded without having some sort of fiscal unification, as well.

David: And one of the major leaps forward is through the banking system, so following the June meeting, the euroland is really moving full steam toward the ECB being in a control position over all euroland banks. There are about 6,000 banks. While they can’t get to fiscal union today, bank instability is serving as justification for the ECB to creep into an ultimate oversight position superseding the national central banks. Of course, they may hand off and delegate certain banks to the national level, but they are in that ultimate oversight position. They are moving toward a position where, frankly, whether we like it or not, if you have the grand socialist dream of Europe or not, it doesn’t matter.

If they can resolve the crisis, we are going to see some radical shifts, one of which we were just talking about, in the Treasury market, where the panic buying into Treasuries, on the assumption that we are going to see an implosion of the eurozone and everything euro-ish, that concern goes away, and the buying that pressed Treasury yields so low and Treasury prices so high becomes selling, with prices dropping, and yields returning to more normalized levels, at higher levels. It comes at a very inconvenient time because the U.S. Treasury, as we pointed out many times, is in the process of needing to finance the large stock of that 16 trillion dollars in debt.

Kevin: We need them to need us.

David: Over the next four years. Anything that we can do to keep rates lower helps us, and if Europe gets fixed, that actually doesn’t help us. There is this strange irony. We don’t hope the best for our neighbors because that means tougher financing for us.

Kevin: Isn’t it amazing how we are hoping for more and more bad news, either for our neighbors or for our own economy, so that quantitative easing comes in. We interviewed Bill King last week and there is an option outside of the currencies. We have the euro, we have the renminbi, and we have the dollar. There are places that one can hold liquidity. Bill King pointed out last week, and this is a quote also from something he wrote again today, “Gold is the preferred vehicle when economies are receding globally and most central banks are in easy-money or quantitative-easing mode.” That is what we are talking about. We have receding economies and we have the potential of a surprise out of Europe, which is going to be easing. We have a potential out of the FOMC of more easing, or Quantitative Easing-III, so gold is the preferred vehicle. We have seen gold become fairly active over the last week or two.

David: Sure, it has been creeping higher, at about $1700. There is support on the downside at $1650, and $1550 below that. Our view is that after breaking out of the pennant formation, in which an initial move higher is positive, we would not be surprised by temporary retracement to the level it broke out from. $1650 is a pretty normal expectation if you want to see a run to maybe $1725, $1750, retrace to $1650.

Kevin: But then what would be the next target?

David: We are talking about very, very short-term, over the next 2-4 weeks, this kind of gyration between $1750 and $1650.

Kevin: On the way to…

David: I would suggest year-end, $1950 to $2100, followed by a consolidation, and the next major move after $2100 being $2500.

Kevin: So we could have a very interesting 2013 in the gold market.

David: Yes, and maybe we stretch those dates to 2014. There is going to be an adjustment period to either a new president or the old president, as the world figures out what is next. I would say this. Seeing $2500 in the gold price is probably a 2014-2015 event on a Romney presidency, and it could be mid-year 2013 if Obama is re-elected.

Kevin: And we are not just looking at gold here. We like to look at ratios. We have always said that if you can buy 50-60 ounces of silver for an ounce of gold, the silver is a good deal. But if you can only get 30 ounces of silver for an ounce of gold, then silver may need to be sold and rolled into gold. We are seeing that ratio tighten. We were at about 58-to-1, 58 ounces of silver to one ounce of gold, just a few weeks ago. We have seen that come down to 52-53 at this point.

David: Right, and the ratio’s next move is likely to 45-to-1, dividing the price of gold by the price of silver. That would be following gold strength. And we might even, as we get to the 2014-2015 time frame, break the recent lows on the ratio of 31-to-1.

Kevin: And that was last year.

David: And going into the 20s would the first time we have seen that in decades – quite exciting for the silver owner – and likely, very likely. Is it one year out? Is it two years out? Again, it does argue for a healthy silver position, but with the idea of, as you just mentioned, Kevin, going back to gold at a lower ratio, which do you love more, gold or silver? Actually, it is a more compelling basis on relative value. Where you should be, or what allocation you should have, and when you should lighten up, is really determined by the math, not by personal preference.

Kevin: For those unfamiliar with these ratios, you simply take the price of gold today, and you divide it by the price of silver, you see what that ratio is, and silver becomes very attractive in the 50s to 60s. It becomes a little bit high relative to gold, in the 20s or 30s. It is almost that simple, but actually, it is best to have professionals watching it with you.

David: We generally scale in and scale out at some critical level, so it is always best to do that and consult with someone on that. I think if there are actions to take I would just suggest this. We are finishing up the summer months. September and November tend to be the strongest for the metals of any months out of the year.

I would just say that if anyone has been sitting the fence, you did miss the opportunity to buy at $1530, $1550, $1600, and I would suggest that anywhere between $1650 and $1700, you have to get off the fence, because what is ahead immediately, both in terms of the fiscal cliff this year, and a transition to a new administration, or the same administration trying to solve the same problems, much of it is simply baked into the cake.

It doesn’t matter which person it is at the helm. Someone will take the hit in 2013, 2014, 2015, and 2016 as the economy rolls over and the finger is pointed at the person in the oval office. “You did this to us, you didn’t do anything to improve our lot.”

I think, really, the unwind, both of the stock market, the bond market, and the next major and final leg higher of gold, is immediately in front of us, 2013-2016 being the largest moves higher for the precious metals. My question is, in terms of actions to take, have you done enough? Do you own enough ounces in light of where we are and where we are going over the next several years?

Kevin: I might point out that in the last 25 years of working in the precious metals industry, when you are in a bull market, you have these periods of consolidation that last a little more than a year, and we have had three. We are now finishing one of those periods of consolidation. It is one of the most difficult times, actually, to roust yourself out of a slumber, because it has been quiet. We went to a little above $1900, and then settled back down and went sideways in the mid $1600s, and this is the time, each time there is a consolidation, to do something.

I know that this is something you have pointed out. You had a private meeting with some of the people who use the Wealth management platform, David, and you finished out the week last week with some very special people. Our clients are amazingly special. They flew in to meet with the management team. I would like for you to share with the listeners, some of the people who are also on the platform, who didn’t get out there. What are some of the impressions that you had from the Thursday, Friday, and early Saturday meetings?

David: The challenge, I think, is for any investor in a period like this, the last 12 months, particularly, to go through a consolidation in which your primary trends are in place, but very unrewarding. The challenge is just simply to remain patient. As you re-analyze, and analyze over, and over, and over again, the facts, to make sure you are on the right side of the trend, and to make sure that things haven’t changed to your detriment, then the question becomes, if you are not immediately rewarded, can you sit tight? Can you wait?

Kevin: If you’ve done the right thing in the first place. We talked about this yesterday. You can either act, or you can do nothing, or you can do the right thing and then set it up and be patient. And doing nothing isn’t the right action. If you haven’t done what you needed to do ahead of time, patience doesn’t reward anything, it is just doing nothing. But patience, after setting up the correct foundation, the correct management, and realizing that you are correct in the trend, and you just wait for the next move, that is actually a very difficult action. You have to watch, without reward, for a period of time.

David: As I mentioned last week, I think the Bill King interview was one of the most important of the year, if for no other reason, the one point that he made that the market no longer reflects economic realities. As you are looking at the Dow and the S&P – 13,000, 1400, roughly – that does not represent economic reality. There are people investing in those markets today, wholeheartedly believing that they do represent reality, and that the Fed is there to support that reality.

What we have tried to point out earlier is this: When you are looking at the interest rate structure, when you are looking at the Treasury market, and the impact of the Treasury market across all asset classes, including equities, what you have is something that is false. You have a false pretense set of manipulated numbers put in motion by the Fed’s activity in the marketplace. When you manipulate those rates lower, you are destroying price discovery and you are destroying what prices really mean, which is an indication of value across the board.

With equities, you don’t have real price discovery today. With bonds, you don’t have real price discovery today. It is important for an investor to step back and say, “After looking at all of the true economic realities, why would I be tempted by something that is false?” And what we are seeing is a massive influx of people who have been tempted, and have fallen prey to that. We have seen over a trillion dollars in the last year move into high-yield bond funds and the bond market via mutual funds, but specifically, the bond market.

Kevin: David, I know you are very careful to look at the financial, and then look at the economic, and look at the political, and then look at the geopolitical, and continue that cycle. Next week, David, you are going to be talking to a man who is part of that bureaucratic society. We cannot discount the fact that these days the markets are being moved by Federal Reserve announcements, by things that the World Bank does, by things that the ECB does. We are talking about command economy types of dynamics, so not only looking at the Austrian economic ups and downs, and what the market is doing, and what the market is saying, we also have to see what the establishment is saying, and what their angle is, and we are going to have Dr. Ocampo on next week.

David: Yes, a ten-year time with the United Nations, and this last year a nomination for President of the World Bank. What we are dealing with is on two fronts – false realities, on the one hand, and excessive faith in the wrong things, and maybe even the wrong structures and people, on the other. That is what we are trying to unpack here. Who are these people? What are the ideas that are dominating the marketplace? Do we necessarily agree with them? No, but we had better well understand what everyone else is putting their faith and confidence in, because when confidence fails, and economic realities reassert themselves, there is going to be a handful of people with answers, and we hope those people are both our listeners and our clients.

Kevin: I will be looking forward to that conversation next week. I know you will be, too.

By | 2012-09-07T06:36:28+00:00 September 7th, 2012|Transcripts|