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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
The Future Of Crypto? “Innovate, Regulate, Appropriate”
May 25, 2021
“Post-COVID we’ve seen a radical shift in control. The world is getting smaller and smaller. Governments around the world are presuming more control, again, which translates to less personal freedom and opportunity. It’s a fascinating world we live in, one that we shouldn’t be surprised by as we look at governments. Look at what has worked in the private sector, look at brilliant innovation for centuries. Is it a surprise that the best that they can come up with is regulation and appropriation?” — David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
Strange thing happened, David, about six weeks after the global financial crisis in 2008. An interesting algorithm came onto the scene and it was put out there by someone with a pseudonym, not a real name, and it became a thing.
That thing has since innovated and tested itself, grown, turned into other things. And I can’t help of thinking of complexity math and emergent behavior, and how now in the days of stochastic math and how it can be captured on computer that if you put something out to the public, it will start innovating in ways that are completely unpredictable. And it becomes something more than it started with.
I’m just throwing this out, Dave, because we’ve watched the digital currency world grow in innovation and it’s been sold to the people as if it’s the perfect way to have privacy and maintain your own autonomy of control. Yet last week, and we’ve seen this before, we’re starting to see radical volatility and it’s coming from the second step of what Rogoff said happens. Firstly, innovation happens. Then the regulation happens. Is that what happened last week?
David: Well, I mean, veterans of the 2017 crypto bear market would say, here we go again. We had bitcoin move from 19,000 to 3,200, over an 80% decline. And we’ve returned to volatile times again. Bitcoin was $64,863 per coin a matter of weeks ago, and declined to $30,000 and that’s where some stability returned with a bounce to the upper 30s. So now, it’s only down 40% in 40-odd days.
The volatility is intriguing between Musk tweets and government scrutiny. Cryptocurrencies are testing the volatility tolerances of particularly the people who came in late. Your late entrance, they were eager buyers, fear of missing out. Maybe this is the thing that we just can’t say no to, and even Wall Street has gotten onboard. Whether it’s Ray Dalio or every financial firm who basically asks themselves the question, “Can we afford to miss out if this is the next big thing?” Not quantifying or qualifying that it is, but if it is, can we be left out?
So a lot of people come in, between 30,000 and 60,000. And again, they’re now called hodlers, not holders of bitcoin. Hodlers, it’s an acronym for holding on for dear life. The hodlers of cryptocurrency, what I would encourage them to bear in mind is that capitulation is a sentiment. It’s not a price. You’re talking about market psychology being turned inside out, like a stomach with food poisoning. Again, capitulation is a sentiment. It’s not a price. You don’t get to a certain price and say, “Oh, good. We’re done.” If we have an actual bear market in cryptocurrencies, it’s likely to last longer than a nanosecond.
Kevin: If you were looking at things long term and you knew you were going to have a command and control, let’s say command and control farming, the first thing you’d want to do is give everyone autonomy and freedom to produce the farm in a free market way. And these farms would all grow. I think of Germany when I went there after the Berlin Wall fell. Driving up from Munich to Dresden, we could see West Germany on one side, and the beautiful furrows and how well things were being taken care of as far as the crops. And then we saw, this was five years after the wall fell, but we looked to the right on that same road, and that had been East Germany, and it was just gray. It was unkempt. The people had not really learned how to innovate. And I think about this with cryptocurrency, Dave. I can’t help but wonder if we haven’t seen this interesting technology grow with people thinking, “This is the next new thing.” And it is. But it’s the next new thing for the government, not the next new thing for free markets.
David: And that might be the fatal flaw in there. You see, in the digital asset crystal ball, the soothsayers are looking and saying, “Okay, look, we’ve had this correction. It’s all well in hand. It’s a normal 50% Fibonacci—” What? Soothsayers would like to say 307 is the next destination.
Kevin: 307 what?
David: Oh, $307,000 is the October price target, longer term targets. If you’re talking about Cathie Wood, up $500,000 is the easy estimate. And we’ve got estimates out there as high as $31 million per bitcoin.
Kevin: What am I doing? Why am in the bank? Why am I even in gold?
David: Shouldn’t we all be speculating? If this is where we’re going, if this is inevitable, that’s $31 million per bitcoin. And admittedly, the $31 million number is supposed to represent an inflation adjusted $1 million. So you are talking about an absolute disaster for the US dollar. This is really not what you benefit from as if the currency were stable. $31 million in bitcoin represents basically a collapse in the US dollar.
It’s a little bit like saying, “I’ve got German marks in my pocket, and I’m a billionaire.” Well, whoop-de-doo. It really depends on what currency. So the crypto crowd has at least a few inflation concern participants even as their asset of choice, I mean, in the current moment, is deflating. Coinbase, the recently IPO’ed crypto exchange, number two behind Binance, has seen a similar fate. It’s off 47% since its April debut. Kind of a tough slog there in the early days. Still trades with the market cap of two times that of Nasdaq. So even though it’s lost half its value, it’s still trading at two times that of the Nasdaq exchange. Very interesting.
Kevin: The enticing thing about the digital currency is the so-called utility of it as far as it being a ledger system that can capture data, and it’s very hard to alter that data. I just wonder, though, if the person who is buying cryptocurrency right now is looking at the utility or are they just really buying because it’s been going up?
David: Yeah. So volatility aside, utility remains promising but it’s also elusive. And I think we could look at utility in two senses, utility for whom, ultimately an unchangeable ledger documenting everything that’s been done and immutable. That’s kind of a curious feature of the blockchain, and in certain countries it’s been important to move official files and documentation onto the blockchain so that you don’t have history shifting through time. I can appreciate that. But the utility that investors are interested in is really about use cases, and what this becomes, not what it is today but what it becomes after sort of its nascent form when it’s in full bloom. Regulation remains an unknown variable for future price estimates. And again, whether they’re very high or very low, regulation is a major contributor to the current market generation.
Kevin: Well, we can look at China as taking the lead there.
David: Yeah, China has been back at it, discussing bans and control measures on mining cryptocurrencies. I wasn’t aware that they had a real strong carbon neutrality goal, but at least the amount of energy consumed for creating digital currencies, that’s one of the things that’s being discussed. And total control or displacement as a digital currency, this is what the Chinese government has already rolled out, something that will supplant private currencies like Ethereum or like Ripple or Bitcoin or what have you, and all the altcoins.
And the Chinese government has rolled out their own digital bank currencies as we talked about many weeks ago. Now, you get the US bank fast tracking its research to do the same. Monday of this week brought the Federal Reserve Governor, Lael Brainard and Jerome Powell, both, to the podium separately to pronounce a step up in research towards developing a digital US dollar. And of course, the discussion is around the consumer shifting towards digital payments, and of course, other countries developing official digital currency, central bank digital currencies versus the privately owned currencies as well.
Kevin: It’s important to look at who’s talking about this now. A couple of years ago, the people who were talking about currencies that were denominated in digits, basically, a lot of them were talking about Bitcoin or Ethereum or what have you. Now, we’re seeing the players in the central banking community, like you said, in China, but right here. Right here in America as well.
David: Yeah, I mean, it’s a question of adoption. In the early stages, the cryptocurrency crowd wanted to see adoption, and it was kind of a major deal to see a bank signed on, or at various Wall Street firms. But it’s a different deal when the central bank start to sign on. The adoption process takes on a very different tone because you realize, “Oh, yeah, the big problem originally was, at scale, we would stepping on the toes of those who already have the money monopoly.”
Kevin: You’re stepping on the toes of the greatest monopoly in the world, and this is the only way the governments function, and that is to be able to create and inflate their money, and also make sure that you’re just using theirs.
David: Yeah, printing money, it’s not a bad gig if you can get it. The discussion on digital payments, that stands out. This is a part of what the Chinese have talked about. It’s also what Lael Brainard and Jerome Powell were talking about. When we spoke of the Chinese central bank digital currency a while back, it was with reference to Alipay, stretching too far in the digital payments.
Kevin: And they were stepping on toes.
David: Yeah, becoming a de facto currency for the Chinese consumer. It was a bridge too far for the People’s Bank of China, and Jack Ma has since been leveled by the Politburo. I mean, the trajectory of his company dramatically shifted, and I think there’s a valuable lesson there. Michael Pettis in his most recent penned piece has something to say about, and I’ll come around to that because there’s a bit of poetry, something poetic about it.
Kevin: Yes, but don’t they need to save a stave? I mean, just look at this last year how manipulative things can be when it comes to providing safety for the masses. Now, I’m not going to go down the whether a person wears a mask or gets the vaccine road, but you look at what’s going on, and everything is about safety. You do it for each other, make sure that you maintain safety. What about making safe digital currency? That’s what it sounds like Brainard is talking about.
David: Yeah, safety is a fascinating concept, and I’ve just invited—I have no idea what his response will be—but British playwright who’s doing a short film for the Financial Times. And he wrote The Crown, which you might be familiar with in Netflix.
Kevin: My wife and I, that’s our show. We watch it.
David: He’s been very interested about privacy, and one of his key concerns at the moment is what he just witnessed societally in terms of the degree of safety which people have demanded and been open to, the provision of safety by government in the context of pandemic, and what that means for human freedom—
Kevin: Really, how to give up liberty for safety, basically?
David: That’s right. Again, who knows if he’ll say yes, but I’d love to have him on the Weekly Commentary to get the artist’s perspective and the cultural critique, because we can certainly see issues involved from a sociological or political or even economic perspective. And I’d like to see his take on not only those fears, but also culturally and from the arts.
Kevin: Yeah, Dave, as we watched The Crown, one of the things— I know, with any kind of history, it’s never going to be completely accurate, but the story that they tell goes much deeper. And that’s the thing that we enjoy about watching The Crown. But actually though, Dave, when we hear Federal Reserve governors talking about providing safety in digital currency or safe money, it does catch your attention. There’s a deeper meaning there too.
David: Yeah, almost like when you hear from the government: We are from the government and we’re here to help. Well, you think you understand those words, but experience is a helpful interpreter of those words. Yeah, Brainard once saved central bank money, which implies that other digital assets are not safe. And we wonder if there’s any recently seated central bank governor who’s considered even whether their existing product line is safe.
To what degree would you define today’s suite of modern fiat currencies as safe? But nevertheless, Brainard describes that the payment space is fragmented, and so there’s room to sort of bring in the payment system. Again, we go back to this digital payments that stood out with the PBOC and Jack Ma and Alipay, and Brainard is basically echoing that. You got payment spaces fragmented and I think this is where you begin to see that “appropriation.”
Kevin: Innovation, regulation, and now, appropriation.
David: That’s the appropriation opportunity in terms of the payment space. We never miss the opportunity to bring in Ken Rogoff: innovate, regulate, appropriate. Not only is it good writing, but it’s what’s happening.
Kevin: We talked about the utility. I remember buying a little bit of a cryptocurrency that was mainly purchased for the utility side of it. And I can’t remember exactly how it was sold, but it had to do with regulating everything from refrigerated trucks carrying meat, to commerce and technology that would have to do with communication. But it was a cryptocurrency-based— It was mainly sold for its utility. I won’t name it. It dropped dramatically after I bought it. Yeah, they don’t all go up. But the utility of cryptocurrency, has it really delivered what exactly it says that it has? I mean, this ledger system, the utility, it seems to me like it’s been a disappointment up to this point.
David: Kevin, are you telling me you’re not still a hodler of that cryptocurrency?
Kevin: I’ll have to ask my son. He’s the one who helped me do it.
David: I mean, the utility of the cryptocurrencies has been more of a hopeful promise than what has been delivered to date. Again, it’s helpful. The potential use cases, what they have served as sort of a pro forma enticement for investors to imagine a transformed digital world. And it’s those ideas and it’s the narrative that feeds the mind and helps speculators feel more rational about their decisions to gamble. Because up to this point, it is speculation on price which has dominated the space. Again, it just contrasts the speculation on price and the massive benefits that have been seen there versus the actual utility function and use cases which have been rolled out. On one, you can put it on a post-it note, and on the other, the gains require at least a couple of post-it notes that take on the commas and commas—
Kevin: Well, I’m going to go back to the safety thing, and who’s talking about it. We’re talking about policy concerns from people who, they’re going to have to be able to see fairly deeply, have some sort of means of regulating and controlling if they’re going to be providing safety. Am I right on that?
David: Well, I mean, there’s a couple of things from a policy concerns— Brainard says, “Okay, the policy concerns and technology requirements are still being explored.” The policy concerns, well, that means something to him that doesn’t necessarily mean to you and me, including what currency or currencies are at the root of the global monetary system, and the transmission vehicles for global consumption. He’s talking about inflation, which is, again, a policy concern, a much needed extractive policy to alleviate the pressures from extreme levels of debt throughout the financial system, but your official debt to GDP figures are certainly relevant there.
You’re talking about policy concerns that relate to financial repression and the means of assigning winners and losers in the economy. So yes, they are looking at the digital currencies and saying, “Okay, we have our policy concerns. We have technology requirements still being explored.” And then he goes on and says, “We promise an inclusive and safe currency.”
Kevin: Those words, inclusive and safe, boy, they keep coming up everywhere, don’t they?
David: I don’t know who he’s selling to, or what he’s selling, but I didn’t realize that a currency had to be inclusive. Maybe we’re just in a unique period in history where everything has to be green, everything has to be inclusive. This goes back to comments we had weeks ago on, really, nothing matters unless you’ve cross-pollinated and the intersectionality of your life is what really demonstrates your value. So if you’re one thing, that’s not good enough. If you’re five things, now we’re talking.
Kevin: One, if you’re bitcoin, but you really identify as Ethereum, then you get to be Ethereum.
David: What if I identify as Bitcoin Lite or Bitcoin Classic or Bitcoin— What’s the next nomenclature? I don’t know.
David: No, Brainard says it will be inclusive and safe, and he goes on to say, “We’ll offer household privacy while preventing illicit activities. Now, think about that, and this goes back to your comment—
Kevin: You still have your privacy but we’re going to be able to monitor everything.
David: Yes, so we’ll take care of the illicit activities but you’ll still have your privacy. That’s the great surprise of the digital asset multiverse, is that what was heralded as private and decentralized has become the proof of concept for the centralized and not private government version. So call it private, not private. It’s very private, not private. You’ll be fine and safe, but not safe.
Kevin: Yeah, but you said think that through. You’re right. Those can’t be held together, but look what they’re also talking about. Remember last week, you talked about good billionaires and bad billionaires, dividing who’s good and who’s bad. What we’re talking about right now is currency transactions that, you get your privacy if you’re a good guy, and we’re going to prevent your illicit activity if you’re a bad guy. Well, who’s the good? Who’s the bad?
David: What algorithm is reading who is the good and who’s the bad? I mean, you’re safe. The bad guys are not safe. And big government, big data, and a big enough algorithm is there to sort the wheat from the chaff, the sheep from the goats, the good citizens from the bad citizens. Very reassuring, isn’t it?
Kevin: You know what it reminds me of is Sesame credits in China.
David: Well, the Chinese have taken video game construction to this sphere of social credits. That basically all you’re talking about is social policy gamified. And now, we’re fast-tracking digital currency usage, they are, anyways. Perhaps we’ll also follow them up, central bank digital currency in China. For them, there’s this potential for development into a dystopian offering of gamified behavioral control. But what is the difference between them and us? When you look at social trends, cultural trends, or political trends, it seems that everybody wants the currency. I’m not sure that anyone can say no to a world where, again, behaviors can be modified with carrots and sticks, and you’re going to enjoy it.
Kevin: It brings to mind panopticon. And Dave, you read the book on panopticon. That was middle 1800s, right, was when Bentham came up with this concept of a prison where all the behaviors of the prisoners would be changed because they could be— It was circular, wasn’t it? And they could continually be observed at all the times by the guards on the outside.
David: Yeah, the reason we went through the book The Panoptic Sort, and looked at Bentham’s ideas were for this very application. When you think about not only digital currencies, but every transaction you have that is digitized and recorded forever. There is a certain power that comes with the knowledge of what you have done, not only today, but yesterday and five days ago, and because it really begins to create a picture of what you will do every day and every second for the rest of your life. And it makes you not only imminently saleable in the retail market, which is where commercial interests have taken their stake, and said, “If we have a perfect profile of a person, we know how to market to them very effectively.”
So that’s one thing. But then you move it to the public sector and now, all of a sudden— And again, Bentham would love this. The digital panopticon is not a distant dystopian dream or nightmare from my perspective. It’s an offering coming to a marketplace near you to eliminate payment system frictions. That’s what Lael Brainard is talking about—
Kevin: There’s your inclusiveness right there.
David: Yeah, we’re going to maintain inclusiveness, we’re going to eliminate payment system frictions. It will keep us safe from bad actors. Safety is our first priority, and honestly, I don’t know if that’s in the back of my mind as a jingle from American Airlines, or if that’s a part of some sort of nightmarish 1984 dream sequence.
Kevin: So every Federal Reserve chairman that we’ve known in our adult lives, their main job is to maintain confidence. Confidence is everything. The perception of your confidence or safety in a currency is really one of the only jobs of a Federal Reserve chairman, including Powell.
David: Yeah, Powell says they’re going to publish a paper this summer to stimulate broad conversation and get public feedback on the central bank digital currency to be controlled by the US Central Bank. And they made that very clear, to be controlled by the US Central Bank. So let’s again refresh our minds. What is happening is innovation, regulation, appropriation. There’s no intention of any central banks around the world to compete with private sector offerings. Not going to happen if we’re talking about money. Now, if you’re talking about other functions, other uses for digital assets, fine, you’re not competing with one of the most fierce monopolies on the planet.
So what they want to do is capture the benefits but avoid the pitfalls. Powell noted, he did a little video clip on this, “The effective functioning of our economy,” he says, “requires that people have faith and confidence not only in the dollar but also in the payment networks, banks, and other payment service providers that allow money to flow on a daily basis.” Now, if I were just— Again, this sounds crazy. Forgive me if this is too crazy. But if I was putting together my own central bank digital currency, I’m Jerome Powell, it would be super convenient sometime between now and the end of the year to have some sort of an event that related to the cryptocurrency world that proved just how unfeasible it is to have a payment system, some aspect of banking, or a payment service provider where money is flowing on a daily basis. And it’s either a data compromise. It’s something that relates to the Chinese grabbing this or doing that, or the Russians doing this or doing that.
Kevin: Similar to the pipeline experience this last few weeks.
David: Exactly. Where all of a sudden they say, “This is why. We told you before. We told you before, the effective functioning of our economy requires people to have faith and confidence not only in the dollar but in the payment networks, banks and other payments. We have the resources to make the money flow on a daily basis in a way that you can trust.
Kevin: Let’s just take the silver.
David: Exhibit A, we’re trustworthy. Exhibit B, it was so tragic that this happened over here.
Kevin: It reminds me of 2011 when we heard that, “we will do whatever it takes.” And the entire central banking community took over the bond market. They just started buying all the bonds. That’s why we have interest rates so low. So, Carmen Reinhart, when we had Carmen Reinhart on here, one of the writing partners that she has is Ken Rogoff. Remember, they wrote the book, This Time is Different. But Rogoff, if we were to echo what he has to say, he’s the one who said what the private sector innovates, the public sector regulates and then appropriates.
David: All is fair in love and war.
Kevin: I think we should memorize that because—
David: All is fair in love and war. You’re talking about war and the Fed will not let go of the monopoly in currency creation without a fight, and probably not a fair fight. This is what we were referencing a couple of months ago with realpolitic.
Kevin: Well, then so I’ll bring bonds up again because bonds were taken over about a decade ago. Bonds are proving no longer to be a place of safety when stocks or equities or cryptocurrencies or what have you go into turmoil.
David: Well, that’s because inflation is becoming a catalyst for volatility. Bloomberg comments last week on the ineffectiveness of bonds as a safe haven. You’ve got stocks, cryptocurrencies, commodities all falling, and Treasuries barely budged. The article looked back to 1999. They said, look, the S&P and the 10-year Treasury haven’t been so positively correlated since 1999. Long bonds as your hedge worked in a Goldilocks era of stable growth and inflation.
Kevin: You could have either one, stocks or bonds, you’re going to make money.
David: And to the degree that you’re losing in stocks, the bonds are picking up the slack for you. So, as the article was saying, your hedge worked in the Goldilocks era of stable growth and low inflation. But now, due to the pandemic response, that old dynamic no longer applies. And this was Charlie McElligott of Nomura Securities said, “Inflation is a volatility catalyst,” and that’s exactly right.
Kevin: Well, one of the things we’ve seen over the last few years, Dave, is with the confidence in interest rates staying low and the central banks being in control, people started moving to the higher yields in junk bonds, corporate bonds, what have you. Is that still happening? I mean, is that confidence still there?
David: The confidence is there. You see it measured by the spreads on corporate credit versus Treasuries. And those spreads are the lowest since the last few months leading into global financial crisis. Indicators of financial market stress are eerily quiet, and there’s nothing really going on in terms of alarm bells. Maybe with the exception of junk bonds last week, it had outflows of 1.7 billion, almost the same inflows for investment grade debt, which frankly, 1.6, 1.7 in inflows for investment grade is a slowing because it’s been four to five pretty consistent every week. But in a separate Bloomberg article last week, commentators were noting that President Joe Biden’s top advisers detected growing political challenge from the spike in inflation.
Kevin: They remember the Carter years maybe? I don’t know.
David: Yeah. And I guess I moved that direction because the bond market still is relatively stable, even with inflation picking up a bit. And no one worries about what the Treasury and Fed have declared to be transitory because, again, inflation is not going to be much of an issue. That’s what Powell said, and that’s what the Treasury Secretary Janet Yellen has said as well. If prices are not tamed, there is going to be a different category of concern, and it’s political concern because consequences in the midterm elections will show up. And that’s really where Biden’s advisers are paying attention to anything that looks like more than transitory inflation, because it will impact politics.
Kevin: So, Larry Summers is not doing Biden any favors right now.
David: Well, in some respects, he may be doing him favors. I mean Larry is a dyed-in-the-wool Democrat, but he’s also a Democrat who’s highly critical of the current administration’s policies. He’s out almost every week with strong criticism on the current mix of monetary and fiscal policy largesse. And in the last few days, was at a conference hosted by the Federal Reserve of Atlanta. Yeah, I wonder if they regretted the decision as soon as he started speaking because he was accusing the Federal Reserve of creating a dangerous complacency, his words, in financial markets and misreading the economy. The policy suite that they have, in his view, he says, underestimated the risks very substantially both to financial stability as well as conventional inflation at protracted low rates. Again, it’s this idea that all is well, but there’s consequences that are in a pending category, both for the bond market and if things linger much at all also consequences pending for your politicians.
Kevin: If you don’t like the consequences, though, and you have enough control, like China, let’s say the consequence of inflation. The consequence of inflation is rising commodity prices. Well, if you don’t like the consequence, you just make commodity prices fall.
David: Right. And I would say the other voice there with Larry Summers is Mohamed El-Erian, who was at PIMCO for years. And he’s been probably the second loudest voice of protest in recent months on monetary and fiscal policy. While he’s allowed voice, what you get in China is the loud pronouncements. And they meet direct action, which is what you’re speaking of. The politburo and the PBOC may not be able to tame credit growth, but they can scare the whiskers off a commodity trader in Shanghai. All they have to do is say, “We’re coming to get you.” And in China, that may mean a reeducation camp. That may mean, this was your turkey day, the best day, the very last day, recognize that this was your turkey day.
Kevin: The best day, the most fed is the day that you’re about to be, yeah.
David: So, inflation is a threat anywhere. But Chinese central planners are aware of the implications of inflation for social stability in unique ways, given a history that includes not only nasty bouts of inflation in the past, but also mass starvation.
Kevin: Right. The two go hand in hand.
David: Yeah. And a lot of that has to do with demographics. In lower wage countries, countries with large populations, commodity inflation can become a catalyzing issue for social and political destabilization.
Kevin: You know what it reminds me of, though, Dave? When you’re trying to control the consequences. You can do that— I remember the Whip Inflation Now campaign back in the 1970s. Just don’t raise your prices. The other thing, though, in these countries that have control, you start hearing the word “hoarder.” If you’re trying to protect yourself from, let’s say, currency devaluation, the consequences of what a government is doing, you could be called a hoarder.
David: Yeah. And part of this is, you look at the current bottlenecks for a number of manufactured goods including semiconductors. And if you can’t get access to the raw materials that you need, then you can’t deliver products that have been ordered over what you intend to put into inventory. Semiconductor companies are doing it. They’re beginning to hoard. And the more pressure they feel, both in terms of price and in limited supply, the more that hoarding trend continues. So, no surprise, the Chinese government stepping into the commodities market this week to scrutinize hoarding, rebuff speculative trading and try to bring down commodity prices.
Lo and behold, copper, iron ore, aluminum, and several other industrial commodities have peaked for the time being with efforts to control prices proving pretty effective. Now, I think one of the fascinating things that I’ve found even in the last 48 hours of news is articles saying, “See, we told you. There is no such thing as a commodity super cycle. There is no such thing as inflation. Commodity prices are already coming down.” Well, what that neglects is the significant changes to credit that we discussed with Russell Napier a few weeks ago, which is, we figured out through credit guarantees and direct cash payments to consumers how to get money into the pockets of constituents, which becomes inflation even if you’re trying to put a lid on the price of commodities. So, as you said, the harder to try to whip inflation now, the more you’re probably whipping up inflation inadvertently.
Kevin: In a weird way, there’s a Tourette Syndrome that goes on through all of these because you’re maintaining perception. And with Tourette’s, you say one thing and then you say another involuntarily. But in this particular case, it’s like, well, we have inflation. We don’t have inflation. We’ve got a great economy. We don’t have a great economy. You’ve got privacy. You don’t have privacy. If you’re a bad guy, you don’t privacy. And so in a weird way, there’s this— Which is it, Dave? Are we getting both all the time?
David: Well, I think that’s what we’re getting from the Fed right now, is the kind of giving us the idea that change is coming and then walking that back and saying, “No, we’re quite comfortable with what we have now.” They actually called this forward guidance, so the US pronouncements, if you want to call it forward guidance, fine. Call it forward guidance. But it’s either more nuanced or just flat confusing than indications of where we’re going next. So, you listen to the Fed chatter and I think it’s worth noting the chatter on QE. No inflation actions to take because it’s transitory, but they’ve spoken, not spoken, on ending the $120 billion in monthly purchases. They’re ready, not ready, to end bond purchases. The economy has made substantial progress, not made, and needs to make more substantial progress prior to tapering. Again, it’s basically the Fed walking out the idea and then walking it back the same day with a different governor—
Kevin: Right. It’s not the same guy saying it. They just let the governors just talk in their own way about managing, hour by hour, the perception of the people.
David: That’s right. And it leaves the market forewarned and yet expecting nothing to change. So you have, I call them ambiguous Bostic—ambiguous [Atlanta Fed President Raphael] Bostic from Atlanta. Maybe we will, maybe we won’t. The information is good, not good enough. Then you have the cut-the-QE [President Robert] Kaplan from Dallas: We’re ready, and we need to move sooner than later. You’ve got [President Patrick] Harker from the Philly Fed: you need to start a conversation sooner rather than later. Last, but not least, you have, clearly we’re not there yet [Fed Vice President Richard] Clarida. This is a guy who, as an academic, loves the DSGE models, probably using his favorite dynamic stochastic general equilibrium modeling to be convinced that we’ve got the trifecta. We got the strong economy. We got jobs growth. We got stable inflation. The model says, it must be so. Modeltov to you, Mr. Clarida, modeltov to you. The models give us everything we need.
Kevin: And the dollar has been strange over the last year because a year ago, the dollar had fallen quite a bit and then we saw the rally in the dollar. Now we’re back to about where we started a year ago.
David: That’s right. 12 months pass. We go from 99 at the high to roughly 89. We’ve had the double whammy of commodity demand pushing up prices. The currency declined, shifting a negative focus to the US dollar in the foreign currency markets. Here at home, we’ve got lumber shortages and land scarcity. And again, lots of land but development land already through the process of building approval. Those two scarcities, no surprise, home prices are jumping. But they’re jumping so much. They’re jumping so much that the likes of DR Horton and Lennar and some of your large home builders, they’re moving from pre-selling—which you’d think, “Well, gosh, that makes a great bit of sense,” pre-sell and now you’re using someone else’s money to build the home—they’re reluctant to sign contracts until construction is complete because commodity prices are increasing at a pace that wipes out their profits. And again, they’re actually moving towards an auction system, away from set pricing, auction pricing versus fixed pricing. So, the surprise for April, we’re seeing housing starts decline by 9.5% from the previous month, and in all likelihood it has to do with land development bottlenecks. But is it an anomaly? Is it a trend? Time will tell. Time clarifies most things.
Kevin: Yeah, Dave, which you were talking about on contractors being hesitant to pre-sell. We both have a mutual friend who built a house down in Texas, and the contractor was so sorry that he had purchased that house before construction, because by the time construction was done, that house, he probably lost several hundred thousand dollars.
And so I want to shift gears, though, because you and I were talking before we came in here and we were talking about there’s talk of global minimum corporate taxes. And I ask you. You were standing there drinking your espresso and just slamming down your toes because you’re training for this triathlon. You’re eating all the time, by the way, Dave. That is nothing to do with what we’re talking about. But I asked you the question. I said, “Okay, so global corporate taxes at minimum, who’s going to monitor that? How would that be maintained?” I really was confused, and you said, “Well, that hasn’t been mentioned yet.” But isn’t that where we would have to go?
David: It’s not mentioned. It’s just implied. So far, the response to the global minimum corporate tax has been positive. Many in the EU like the idea. Ireland is a little squeamish to see the tax migration end. For those of you who don’t know, they’ve got one of the lowest corporate tax rates in the world, and it comes in around 12.5%. 15% is the minimum, has appealed to Europe, particularly when you’re talking about big tech and the masterful tax avoidance from your digital giants.
Kevin: So, Ireland has the lowest corporate tax rate. I didn’t realize that. You’ve brought up Switzerland before, how you negotiate your tax rate, canton by canton.
David: That’s right. I mean we started our business in Switzerland years ago, we went to the Canton of Zug because they had a competitive tax rate. And basically, you can let each of the tax administrations know that you’re considering this canton or that, and actually create something of a bidding war. But they’re like, “No, no, no, 5? We’ll do 4.” But I mean, not that low, but it’s interesting the way that happens. And I think the tech giants have really raised the ire in Europe. And the rate here, the 15% minimum would apply to all sales in a particular country regardless of corporate jurisdiction, regardless of the domicile.
Kevin: Well, I don’t think you want to see some sort of worldwide control. But wouldn’t you, even before— the small guy only having to pay about what the big guy pays?
David: Well, that’s the interesting thing between profit shifting and tax arbitrage, which come to an end, there is an aspect of that which I like. Like you say, seeing Fortune 500 companies or multinationals pay comparable rates to small and medium sized enterprises, novel idea, doesn’t happen today. I don’t think most people recognize or understand that somebody who owns a business and employs less than 500 people pays far more in terms of a percentage of the company’s revenues than a multinational because, again, profit shifting, tax arbitrage, transfer pricing. And these are all issues that you’ve got to be— They’re games that multinationals play that the little guy doesn’t get to.
It’s an idea that’s legitimate in my mind, but it doesn’t make sense that via profit shifting, transfer pricing, or tax arbitrage games, that they pay effective rates well below businesses with a smaller footprint. I’d say no, it doesn’t make sense. What I don’t like is the idea that governments globally then coordinate and report more stringently between themselves. This is what becomes uncomfortable for me as a— I think I was born a libertarian. I don’t know if that was on my birth certificate, but the world is getting smaller and smaller and governments around the world are presuming more control, post-COVID, which translates to less personal freedom and opportunity.
Kevin: So, Higgs, Crisis and Leviathan, but this time it’s a worldwide leviathan.
David: Well, that’s what I don’t like. Post-COVID, you empower a global leviathan to build a global infrastructure for transaction and tax tracking, that’s less heartwarming. That’s just not really heartwarming at all, in fact. So, we come back to digital currency. We come back to digital currency as a bridge between jurisdictional worlds. Data is data. And if you can put it into the digital, now it is just data, and it’s a lot easier to manage, if you put that in quotes. Manage? Yeah, again, it’s not something that’s particularly heartwarming being on the receiving end of a management program.
Kevin: So, what we’re going back to. We’ve talked about currencies and being appropriated; innovate, regulate, appropriate. But now what we’re talking about is an appropriation of basically monitoring and tracking worldwide tax payment.
David: Yeah, the EU, the UK, the US, China, the Treasury proposal of a global tax implies a system to track it. You have to have an infrastructure. This not just sort of cooperative treaty that’s signed, like when you need something, call us, we’ll help you. No, this is an infrastructure that allows for data to flow and for all accounts to balance, a created digital matrix for transactions. And this gets kind of interesting. Whoever controls the internet ends up controlling the world.
Kevin: It’s like ransomware, except for it’s the government that’s doing it.
David: Well, in a worst case scenario, it is. I mean you can look at it from two perspectives. Whoever controls on a daily operational basis is very important, but then, like Colonial Pipeline a few weeks ago, the flows of oil were hostage to a group of hackers. You move digital and now you have certain vulnerabilities. What does the world look like when digital flows for transactions and tax settlement in the cooperative nature of a global minimum tax, all of those flows, financial flows are held hostage? And you can look at it and say, “Yeah, but hackers like that, I mean you’d have the ire of the world come down on you.” Maybe.
Just a thought experiment. Does China’s fast-tracking of a central bank digital currency create urgency on the part of the US and the EU to do the same? You don’t want to be left out. And we’ve seen this in the arms race. We’ve seen it in a variety of different versions where, if somebody starts something, you stay to yourself, “We’ll, I don’t know if we like the idea or not. But we can’t be left behind,“ because, I mean, if it is something, man, you hate to be losing the race and losing your role, your position of importance in the world. Does China’s fast-tracking of the central bank digital currency create urgency on the part of the US and the EU to do the same?
Now, what comes with that? What latent vulnerabilities are there in that system? Maybe those latent vulnerabilities are understood by the Chinese? Maybe they’re understood by the Russians? Maybe there is an intent to destabilize? Again, that moves into the purely speculative because you’re talking about state actors. One of the things that we know when it comes to the internet is far more important. And as it relates to international relations today, your non-state actors are as important if not more important. So basically, you move to a position where the world’s capital flows could be hostage. What do you control or not control in the internet? Who controls what? Now we go back to the conversation we had with Nazli Choucri years ago, in December of I don’t know what year .
Kevin: Yeah, borders. Geographic borders don’t make any difference anymore.
David: That’s right. So, the jurisdictional issues, those lines get blurred, and now it is a question of who’s in control of what. It’s very important because as we move towards digital currencies, you are talking about a further blurring of the lines. And we are talking about political lines. We are talking about not just the lines that establish the nationality of a country but how we operate internationally, cooperatively.
Kevin: And the blurring of freedom of speech— our country has enjoyed, for hundreds of years, freedom of speech. But you look at the worldwide effort right now to control the flow of information. Look at China. A simple poem posted on the internet costs a company and possibly future lives of people, a simple poem for just a short period of time.
David: Right. So, we’ve talked about non-fungible tokens, the digital tokens. They could cost you a thousand dollars. They could cost you for collage of pictures, 60 million, whatever it was.
David: What about a thousand year old poem published for a day digitally and then erased? What is the cost of that poem? $40 billion. Now, what are we talking about? Michael Pettis wrote this in his GlobalSource Partners paper here in the last few days. You’ve got the CEO of Meituan, I probably did not pronounce that correctly, my apologies. This is a huge transportation and delivery company, transportation, travel, shopping, entertainment. They handle food. The value of the company, the market value of that company declined by $40 billion with the printing and retraction of a poem.
Kevin: The Chinese government didn’t like the poem?
David: I think the Chinese people understood the implications of the Chinese government not liking the poem. “The ashes of burnt books had not yet faded away, but the Qin dynasty was already weak. The natural military forts did not protect the Qin dynasty. The bonfire of burning books was not yet cold when the riot in Shandong started. It turns out Liu Bang and Xiang Yu did not read books at all.” That’s all that was printed.
Kevin: That was the poem?
David: It was retracted, and you have something of a throwdown between a corporate scion, not unlike Jack Ma, who’s flexing a little bit of muscle, making a public statement about the security of Xi Jinping and the current politburo in the context of rising prices and the context of global destabilization—
Kevin: And the share price lost $40 billion in capitalization, which means the people— See, the thing that’s fascinating is this is not a government manipulation.
Kevin: This is the fear of the people of their own government.
David: That’s right. No, that’s exactly right. And you realize the cost of freedom of speech, the cost of freedom of speech is far greater elsewhere. Post-COVID, we’ve seen a radical shift in control. The world is getting smaller and smaller. Governments around the world are presuming more control, again, which translates to less personal freedom and opportunity. We’re talking about information freedom. We’re talking about perceptions of reality and being able to come to our own conclusions. The control of data and commentary, the control of commerce via digital currencies, the control of health thematics and narratives, what is good for you, what you will do, what you must do, what is appropriate and what we will do to shame you into obedience. It’s a fascinating world we live in, one that we shouldn’t be surprised by as we look at governments, look at what has worked in the private sector, look at brilliant innovation through years, through centuries. Is it a surprise that the best that they can come up with is regulation and appropriation?
Kevin: You’ve been listening to the McAlvany Weekly Commentary. Now, I’m Kevin Orrick along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com. And 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 adviser to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.