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  • Less than 10 people get $565 billion richer since March lows
  • While 40 million less fortunate file for unemployment
  • “Fair to say you simply flooded the system with money?” Powell said “yes we did”


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

V Recovery? Hope That V Is Not Velocity
June 10, 2020

We’ve had Powell and company basically create this idea for us that a 27-day bear market is sufficient to resolve a decade’s worth of financial excess. We would suggest that you’ve had a 27-day warm up and your V shaped recovery, but we had the down, the catastrophic sell-off, we’ve had a nice bounce. But what happens next? Of course it’s anyone’s guess.
  – David McAlvany

Kevin: You told me something, David, that’s hard to believe, and I think it has a whole lot to do with the tensions that we’re seeing nationwide. You know, we hear about the prospect of a V shaped recovery, and I was just joking with you last night. I said, boy, I hope that’s not a velocity shaped recovery because when velocity increases we are gonna have inflation. But here’s what you told me, and it’s hard to get my head around this. Okay, $565 billion has been added to the net worth of less than 10 people, and at the same time, 40 million Americans are filing for unemployment. Do we have a disparity in who is making the money right now?

David: Well, there’s a massive difference between the V shaped recovery in the stock market and the V shaped recovery or lack thereof in the economy. And ultimately the stock market has to have this correspondence to what is happening in the actual economy.

Kevin: One of the things that Richard Duncan has brought up in our commentary in the past is, we can’t blame capitalism for this because we’re not in a capitalist society anymore. He calls it creditism, and what that really means is you have a wealthy few who can print as much money as they want, and then you have the rest of us who can’t.

David: Yeah, something that is in our conversation on a fairly routine basis on the wealth management side of our business, Doug Noland will often mention, you know, this tendency towards inflationism and that our central bank monetary policies have been very inflationist going back decades. The primary problem with inflation is that it is the factor that eviscerates the middle class. Middle class can grow out of a free-market economy, but you can also destroy the middle class through inflationism, and I think that’s what we are seeing as many people in the middle who are getting squeezed. And those who are not and never would be in the middle, they are squeezed even more.

Kevin: The way you can pull that off with the people is you say, “hey, we are just trying to give you comfort.” Look at this quantitative easing. Inflationism, let’s call it what they call it now: quantitative easing, which is a fancy word for just printing money.

David: That’s precisely what you’ve had in terms of driving the rally off the March lows. It’s a quantitative easing-driven, QEdriven, rally off the March lows. And, you know, are we underestimating where we go from here? Is the move in the market maybe, at this point, overhyped? Well, I think time will sort through all of those things. But what the last two weeks have sorted out visually for us is that there are a lot of unhappy people in the system…

Kevin: Right, and they’re not blaming the markets right now, they’re blaming race or they’re blaming social differences.

David: That’s right, so, and I think quite a few in the mix have demonstrated a lack of social decorum. But very clearly you look at QE, and you look at debt monetization and the drive in the stock market and you’ve got speculators, stock market speculators, in ecstasy. And that’s even while the social fabric of the country is being torn apart at the very same time. So politicians have done very little to address core systemic problems. Some would say that the core systemic problem is racism, which has permeated every nook and cranny of society. Maybe it is, I’m not an expert in many things, but I do see it differently. I see decades of a system that functions best, a system that functions best for the educated, a system that functions best for the employed, and to the degree that that group has built an asset base, those assets have exploded to record levels, leaving the undereducated and underemployed in the dust. If you think about the kinds of comments that you would get from a typical parent, I really want you to go to college, I want you to go to the best college possible. Why is that? Because we know that there is greater opportunity, depending on how you measure against everyone else in society. How educated are you? What doors open for you from an Ivy League education versus blah blah blah. So we’re all kind of aware that there is an improved lot in life and an improved increased income and ultimately asset base if you get the best possible education.

Kevin: Well and the difficulty is, if you’re on the back side of that curve… I was talking to a wonderful client yesterday. This man has been putting together carefully, actually an educated family. And he’s just finished graduating his fourth daughter from college and paying for it. Now he’s in his sixties, and he’s like, all right, Kevin, now I need to be looking at my nest egg. Well, you know, I look at the self-sacrifice of his life, and it really cost him a lot to do that with his daughters. But think about the person who’s saying I’ve been unable to build a nest egg. They’re on the back side of the curve Dave, what do you do then?

David: Well, if you’ve been unable to save and build that nest egg, you’ve also been unable to ride one of the greatest market expansions in history. From the 1980s, not the last 10 years, but from the 1980s to the present is a period of time that has seen the stock market expand 33 fold from Dow 875, that’s when the Dow gold ratio was 1:1, to Dow 29,000. And you can try and build an argument for race relations being terrible, but my view, and again, there’s a lot of things that I don’t know, but I tend to see politicians as the primary beneficiary of that meme because you have a divided and angry people, which is a form of potential energy. That’s an energy source waiting to be tapped by political interest for the purpose of generating more heat, not necessarily more light. And that is in the context of a territorial or constituency capture.

Kevin: Yeah, last week we talked about the broken window economic fallacy, but actually, two wrongs don’t make a right.

David: And it’s something that I highlighted in my book The Intentional Legacy, where, if you look at legacy, it’s typically broken hearts, not broken bank accounts that make for the undoing. The legacy wounds don’t heal by inflicting more wounds on someone else. That is a pain perpetuation cycle that only ends when someone boldly steps forward to forgive.

Kevin: Right, and in your own family, you’re continually trying to employ tactics and techniques to teach your family, for their future generations, how to handle those types of tensions…

David: …and what unconditional love and unconditional forgiveness looks like. I’m married to a Sicilian. You have to understand, like I’m seeking forgiveness routinely because there’s an alternative. If there is no olive branch extended, you may find that cousin Vinnie is visiting and he’s there to massage the knees. It’s fascinating to watch because, you know, I’ll just do something in play, in jest with Mary-Catharine. You know, maybe a friendly elbow nudge or whatever, and she comes back with, like, you know, ten powerful fist slams to my arm, and I’m like, wow, it doesn’t seem proportional. This is definitely Sicilian. So again, it’s an issue of perpetuating a cycle or embracing forgiveness, and I think that’s something that we’re really not well geared for as a society. It’s a concept that we haven’t necessarily embraced. And so, frankly, it’s not a surprise that there is more heat than light generated.

Kevin: One of the great aspects of the system that we’ve had over the last few hundred years is that we have had more of a middle class than probably any time in history, but the social tension that is now there…when I started this when we were first talking, $565 billion richer for less than 10 people at the same time that 40 million people are signing up for unemployment, there’s a disparity here. Where’s the middle?

David: Yeah, well, I would say, again, the system functions best for the educated and the income or asset rich. So again, high asset prices and income abundance are…this is not the source of poverty in America. The capitalist free markets are not what perpetuate poverty. They are the only thing in 5,000 years of financial history, or any other kind of history if you want to look at it from a different vantage point, that has allowed for a middle class to emerge. Think about that. For almost all of history, there has been a very clear cut extreme of rich and poor. Only in the last 500 to 600 years of capital market development do you have a middle class. That never existed before, never! So less than 10% of recorded history has anything we can describe as equal opportunity. And I think now we’re in a context where, again, retribution, pain perpetuation, in my opinion, a lack of forgiveness…we’re willing to tear it all down. Perfect system? Absolutely not. And no, not everyone participates equally. So the contrast between haves and have nots is there. If you’re there for sort of a Marxist critique or you’re there as a politician looking to exploit, I think this is really key. Misdiagnosis is always unhelpful if you want an actual cure, so getting clear on what the issues of the day are, it’s very important if you want a mend the broken and fix the frailties within the system.

Kevin: Yes, but if you don’t want to mend the broken fence, ok, but what you really want to do is perpetuate whatever your own agenda is, whatever side you’re talking about, then we have to say, all right, the temperatures are running a little too high for constructive criticism or dialogue, because constructive dialogue is to try to fix something. There are people out there right now not trying to fix things. It’s working just fine for them.

David: Right, and there was a book maybe two decades ago, written about having a certain number of cups of tea. I don’t remember if it was two cups of tea or three cups of tea, but the basic idea of the book was, if you sit down with someone and share not one or two, but maybe it’s three cups of tea, and you listen to them, and you dialogue with them, and you understand who they are, what their story is, it’s very difficult to hold prejudice. It’s very difficult. It is very, very difficult.

Kevin: What if there was third person in the room though, Dave, and they were testing your political correctness? What I’m finding is, I have a hard time being able to—other than in my own family and even in my own family—I have a hard time being able to have constructive dialogue because there’s this new language of political correctness. I mean, when the temperatures are high like this, people don’t want to hear that.

David: Yeah, and I think they are running a little too hot for constructive dialogue to occur at the moment. You have accusations, you have blame, you have anger. I mean, look, if you’ve ever tried to resolve conflict, there tends to be elements that escalate a situation, not de-escalate it. And this is a conversation we have, those are two words that trip off our tongue every week at our house.

Kevin: Are you escalating or de-escalating? 

David: So, I mean, there are six of us. We are in close quarters and there’s room for conflict and misunderstanding…

Kevin: Especially when you’re living in the airstream (laughs).

David: Yeah, that’s true too. So I mean, we’re imperfect people and we’re living in an imperfect world, but we operate like we know what’s really going on, and usually we either don’t know what’s really going on, or we only know in part, and it’s always more complex when you take into account someone else’s point of view, which, frankly, selfish people sometimes forget to do. But that sense of understanding, which gives us a certain degree of certitude, it’s really misunderstanding. It’s a false or incomplete belief, it doesn’t matter how sincerely you hold it, but it leads to pride, it leads to defensiveness. It leads to personal injury, taking offense, anger and even the desire for retributive justice. And I watch this play out almost daily. Okay, you can turn on the news and see it, but I see it in our living room because we have human nature on display. We’ve got kids who, this is what happens, and it’s no different seeing it extended on a larger stage. So maybe your kids are perfect. Or maybe you’re the perfect adult, but it’s just not the case in our house.

Kevin: Okay, so you use the word stage, and I think when we talk about the media, the media says that they are just objectively reporting what’s going on. It’s a stage. It’s entertainment. They have to have ad dollars coming in all the time. How do you do that? Well, you have to create tension and chaos all the time.

David: Okay, so how many interviews have I done with Bloomberg, with Fox, with CNBC…

Kevin: Right, we’re sitting in the studio where you do them, right here.

David: Dozens and dozens of interviews, either here from our studio or live in London, in New York, wherever it may be. It’s been fascinating to see how they like to have multiple guests on to create conflict. At one point, there was a Trish Regan show that I used to do with some regularity, and it was like after the close, and they actually had like all the visuals of boxing gloves and bells ringing to start the next round.

Kevin: This is going to be a fight!

David: And they’re actually trying to do that. So how do you de-escalate? I mean, Kevin I’m watching politicians intentionally escalate a very tragic circumstance with George Floyd. It’s the same with the media. The mainstream media is not in the healing business. They’re not even in the understanding business. And I can tell you that from looking at what they want to report and how they report it…

Kevin: They’re in show business, Dave, it’s show business!

David: That’s right, it’s the entertainment business, where worse is better because it’s better for ratings. It’s better for viewership. It’s better for advertising revenue. They have no intention of bringing light into the situation. The heat is absolutely what they require.

Kevin: Do you remember that book Audition that you and I both read by [Michael], I think, Shurtleff was his name, but he really brings that out. He talks about good theater. Good theater has to have tension all the time. You have tension release, tension release. It doesn’t have to be true, it just has to have tension.

David: Well, so we’re back to incentives and incentive alignment. Media loves chaos. Politicians, frankly, politicians love chaos. Then there’s real people. Real people, when they identify a problem, if they have the skills to do it…

Kevin: Let’s just fix the fence, please.

David: Yeah, yeah, They want a real solution. Frankly, real solutions very rarely exist in the context of chaos. We want to be understood. We want to be heard, and if remedies are possible, we want those too. Media producers? Professional politicians? In that sense, they’re not real people looking for remedies, they’re praying off the fears and anxieties and prejudices of others, whipping them up, keeping them going so that their version of success can be realized. And that is the routine cycle we see every two to four years in our political coliseum because all of a sudden you feel like the neighbor that you had a glass of wine with last week, last month, last year you don’t even want to talk to because they’ve got the wrong sign in their yard, you know. And it’s funny, I was in Denver this last weekend, and on one block I’ve got a sign that’s talking about Trump derangement syndrome, you know, obviously a pro-Trump person, and they’re wondering why. And then you’ve got another sign which just a few houses down says stop the virus STD, which I guess stands for Stop the Donald, but put in the language of a venereal disease. I mean, like, this is what happens every two to four years and media loves it. Politicians love it. They love to prey on our fears and anxieties and prejudices. I don’t like politics. I don’t like being trapped in silence by the framing of issues where powerful entities, again media and politicians, are basically coercively constructing things for their own benefit. I don’t like it.

Kevin: You know, Dave, anybody in the healing arts, medicine, what have you, knows that the patient has to want to be healed. Okay, if you don’t want to be healed, you can take as much medicine as you want, you’re not going to be healed. And so this is a root problem that we’re talking about because you’ve got various factions that actually gain and continue to gain through chaos and not healing.

David: Yeah, I prefer a different perspective altogether. If you go back 100 years, G. K. Chesterton wrote in his book, What’s Wrong With the World? That was the title of the book. In the opening lines, he has the forthrightness to answer his question with “I am. Yours truly, G. K. Chesterton.”

Kevin: (laughs) Only the way Chesterton could have said it.

David: Yeah, own your contribution of the chaos. If you want to make the world right, blaming others is only gonna take you so far. And I noticed that most people’s baggage, I wrote a whole chapter on baggage, as a family we’ve got a little bit of it so I felt like I had something to say on the topic. So I noticed that most people’s baggage is a burden, and they choose to carry that baggage. They refuse to ditch that baggage. It’s almost a weird sort of baggage dependency. If you think of a hypochondriac with an illness, you have to have it to be who you believe you are.

Kevin: In the past, we’ve had Neil Howe on. And he wrote a wonderful book called The Fourth Turning, and he talks about how things look when a cycle is ending. You know, the fourth turning was about hundred year cycles, but we’re toward the end or going through at this point what he believes is the fourth turning.

David: Yeah, and then again, from that perspective, I think there’s reason to not only see hope or light at the end of the tunnel, if you will, because these kinds of social tensions emerge at the end of cycles, and generally they resolve themselves with reforms and change and equalization. And I just hope that we’re addressing the right issues. So there is a point to all this, and it seems obvious to me, I’m going to get to it here in a minute. Maybe it’s not that obvious, but I hope we’re addressing the right issues. I hope we’re not dealing with intentionally cast shadows designed to inform our beliefs about reality and ultimately to determine our behavioral course. Beliefs can be sincerely held and can be severely wrong. If we’re going to discuss diabetes and you leave diet out of the conversation, that’d just be insane, right? So when we start talking about excesses in the financial markets, how can you not look at central banks and their contribution to money and credit creation? It’s like the diabetic. We now require external inputs to balance our sugar and energy levels.

Kevin: Okay, so that goes back to this disparity that we started talking about. Okay, when you have less than 10 people making $565 billion in a system that also, at the same time, 40 million people signed up for unemployment at the same time, that’s not capitalism, Dave. That is this disparity. It has to do with central banking and artificial stimulation.

David: So they’re prime beneficiaries of the QE to infinity theme. And it’s so funny to me because Powell last week said that the Fed’s policy absolutely, those were his words, absolutely did not add to inequality.

Kevin: That’s insanity.

David: Now. I like Powell, but that has to be the dumbest thing he’s tried to defend. There’s no greater contributor to wealth inequality than the market maneuvering of the world’s central banks led by Powell and company and then copied by the ECB, BOJ, PBoC. The whole laundry list of central banks. Easy money. Cheap credit has always boosted asset prices and created a financial market bonanza, and that does not require a direct connection to the underlying economy.

Kevin: Yeah, you’re either measuring vapor or you’re measuring reality.

David: Well that’s why Buffett’s favorite valuation indicator compares the aggregate pricing of financial assets to the actual economy to see if one is getting too far ahead of the other. It’s the Buffett ratio.

Kevin: You know, we’ve talked about price earnings ratios, we have for years and years, and even before we went into this COVID lockdown. We talked about the price earnings ratio being second only to the time that we have the tech stock bubble. And what’s happened, even when the stock market had fallen thousands of points before this recovery, the price earnings ratio, the price of those stocks relative to the earnings of the company actually continue to rise. So what we’re seeing with all this quantitative easing is actually just pushing prices up of the valuation of assets, not necessarily earnings. Or, like you said, the Buffett ratio, economic benefit.

David: Andrew Smithers joined us a couple times years ago before he retired, and definitely worth going to the archives for as we discuss the value of the price earnings ratio, specifically CAPE, the cyclically adjusted price earnings ratio, and Tobin’s Q measures of market valuation. And you know these are very helpful for knowing where you’re at in time and what your expected rates of return will be over the next 5 to 10 years. 

Think of the Buffett ratio. There’s a similar result. If you look at price earnings, particularly towards the end of a credit cycle, price is being driven off of an abundance of liquidity or credit. And so central banks are generating more and more of the price aspect of it. Earnings, if you’re talking about something that relates specifically to economic activity, that’s what begins to fade. So price can travel far and high while earnings decline due to lack of demand, this is a numerator denominator issue, and again you’ve got a measure of the goods and services demand for that in the economy.

Kevin: Okay, but stocks aren’t the only thing that rise when you print money. Ultimately, it’s what we eat. You know, you’ve talked, remember it was a decade ago when inflation was an issue over in India and rice itself was the issue. You had starvation. So when you have inflation, it’s not just that it costs more going to the store. Some people actually starve.

David: Yeah, the tortilla crisis. I mean, this is something that, you know is the idea that if tortillas are getting more expensive in Mexico, people aren’t happy, again because something as basic as corn does matter. Something as basic is rice does matter. I talked to my dad the other day, and I asked him what he was doing. And he’s out, you know, drying 8,000 lbs. of rice.

Kevin: For the orphanage.

David: Yeah, well for the whole community. They have become sort of a business hub for being able to offset the cost of maintenance of the orphanage. He’s just kind of an entrepreneurial guy that way, but the cost of food absolutely matters. So couple the dynamics we’re talking about where you have gross wealth and equality with rising food prices. And guess what? It’s not uncommon for frustrations to boil over. Stability and price for your main staple foods is a good anecdotal marker or a predictor for social and political stability or instability. And this is a theme we’ll develop over the next few months.

Kevin: Modern monetary theory says that you don’t have to have a budget anymore, that if you’re a country that can print its own money, loan itself its own money, and then pay back with its own printed money, it works just perfectly fine. So MMT, modern monetary theory. Does it bother you, Dave, that our federal budget, because we’re supposedly not on MMT yet, does it bother you that it’s four trillion bucks?

David: Well, effectively, we are practicing modern monetary theory. And, yes, we’re not heartened by the federal budget deficit being on track for four trillion. The national debt has already surpassed 25.7. 25.7 [trillion dollars].

Kevin: Doesn’t matter, we’ll print the money, don’t worry about it!

David: So the acceleration of debt accumulation, you had that during the Obama days, and then there’s a failure both in in his tenure and in Trump’s to rein that in to pay it down, in large part because of the way the Fed and the Treasury gains comfort from lower interest rates. Cheap credit, cheap debt encourages loading on more debt because the cash flow costs to accumulating more debt are minimal. So as long as rates are coming down, you can stack on more and more of the debt, and you just don’t have to worry about it.

Kevin: But if I’m one of these people who gains from the mentality of MMT or just the mentality that it’s okay to continually go into further and further debt, what am I going to do for the public perception? Well, Dave, what I’m going to do is I’m going to build a scarecrow. You brought up shadows earlier, and I think you’re referring to Plato’s work. The shadow is on the wall. That shadow is just a shadow, but if you can make someone feel like it’s a real threat, and the real threat for the inflationist is if inflation actually kicks in. So they have to use misdirection that the shadow on the wall, they had to make everyone afraid of deflation, and then they have to tell everybody, hey, we’re not quite making our inflation goal. We’ve got to print more money.

David: The deflation boogeyman. Is it real or is it just a shadow? And so you’re right, probably more like Plato’s cave allegory, where you’re chained in a cave of ignorance. You watch the shadows cast by the fire and they dance on the wall around you, and you come to believe that that’s real. And without a point of comparison, without daylight to challenge the shadows and reveal something else as truth, that’s how you form your beliefs.

Kevin: Well, then you have an academic to explain the shadow and say, hey, listen, that shadow truly is the looming danger of deflation.

David: Exactly. So we see the shadow dancing on the wall of our mind, filled with horror. Perhaps memories of the 1930s, and in that fear we are captive. We’re captive to particular policy courses. Let me explain a little bit more. The cave allegory is about education, and it’s how we believe what we believe. To me, inflationism is endemic to our financial system. It’s geared off of monetary policy accommodation, but the power, the power of the deflationist argument, as sponsored by the world central banks, you know, again interpreting history through a certain lens, is that from their vantage point, one that sees debt as assets…

Kevin: Can you imagine that, Dave? What if you taught your kids that as they, you know, increase in their debt load, they’re actually increasing in their assets.

David: Yeah, well, for a bank it is, because you’re issuing these IOUs and those become something that has a value with an income attached to it, right? So for the banker, it’s debt as assets, any shrinkage in the value of debts owed to the banking system, and again you’re talking about a highly leveraged system which can’t afford very much of a shrinkage at all, that’s a trigger for financial instability, financial system instability, or, in a worst case, failure. So deflating their assets, deflating debt instruments is intolerable. The other side of the coin is actually quite tolerable. Inflating the asset values, which is what central banks have been prime sponsors of as they’ve expanded liquidity in the system. It pays, it pays to keep people in the dark, dancing with the shadows of deflation. It provides an allowance for your monetary policy makers to sort of engage in freewheeling inflationism, keeping the boogeyman alive.

Kevin: You know, whenever you look at a crime scene, you say, okay, who benefits? Who benefits? Because there’s someone who is benefiting in any kind of crime. We talked about the bank benefiting from making people believe that deflation is a danger. Now we move to Wall Street, okay, because there’s an awful lot of money made on Wall Street. But where does the benefit come on Wall Street? Well, they’re wanting to see volume of trades, right? I mean, they’re getting a little bit off of every volume of trade, so they want to see it rise from there.

David: And let me be clear, because deflation can be an issue. And it’s not a boogeyman in the sense that it’s merely imaginary. But using the art of misdirection, deflation allows the inflationist to go hog wild…

Kevin: And print money.

David: And print money without the consequence of a failure of confidence in the system. So deflation is a useful tool, a trope or meme that you can point people to. You’re right, Wall Street, what do they do? They supply custody for assets, they sit on your savings and investments, and they provide trade facilitation. So whether it’s the custodial aspect of the trade facilitation, volumes matter. Volumes matter. Wall Street loves velocity, talking about velocity of transactions in the universe of stocks and bonds because they capture energy off the volumes, whether it’s a penny at a time or basis point at a time. So here you combine all these things together. You combine the banker’s defense of asset prices, central banker’s buttressing of the universe of IOUs. And there’s a bunch of them whether you’re talking about corporate IOUs or Treasury IOUs or whatnot. And then you’ve got Wall Street’s encouragement, encouragement of increasing flows of funds where money is made off of proximity to the flow. And you have interests that are then, these are the interests we’re talking about, which sponsor, they are encouraging access credit creation, regardless of the social or political consequences down the road.

Kevin: Well, and who benefits on the politics, too? I mean, as a politician, this is working for you, too.

David: Money is power to some degree. Yes. Richard Duncan pointed out years ago, again check the archives. Great interviews with Richard. Capitalism was long ago replaced by creditism. The new face of the markets has nothing to do with capitalism and free markets, and everything to do with credit reigning Supreme.

Kevin: Something that’s interesting to me is that the Federal Reserve doesn’t even have to act like they’re not doing it anymore. In fact, they’ll just bold faced come out and say, You know what? Yeah, we’re printing money. We’re printing a lot of money, and it’s really where, it’s coming from nowhere. I mean, Powell’s interview.

David: That’s exactly what happened in CBS 60 Minutes, just a few weeks ago. Not ashamed to describe it for us, the exchange went something like this, the interviewer says. Fair to say you simply flooded the system with money? Powell says “yeah, we did. That’s another way to think about it. We did.” And then he was asked again, where does it come from? Do you just print it? And Powell’s response was “we print it digitally. So as a central bank, we have the ability to create money digitally, and we do that by buying Treasury bills and bonds or other government guaranteed securities, and that actually increases the money supply.”

Kevin: (laughs) How can you fault him if he’s basically saying, yeah, this is what we’re doing. Don’t try to stop me. Why would you?

David: That’s what we do. That’s what we’re designed to do because actually the central bank is the backstop for the bank as a system, the financial system and so yeah, they’re doing what they were designed to do.

Kevin: So money supply, this is why money supply is just skyrocketing right now.

David: Right, so in Powell’s comment from 60 Minutes a few weeks ago, you have it in a nutshell. The modern day printing press, without the ink and paper limitations of Weimar, Germany or modern day Venezuela. You’ve got M2 money supply, which is now at $17.2 trillion. That’s up 22% in less than a year. M2 has expanded by 22%.

Kevin: Do you remember when they used to compare the amount of new gold coming out of the ground with the expansion of money supply? And new gold coming out of the ground would be 1.5, maybe 2% added to the money supply because gold was money, and they would say, okay, well, money supply is actually increasing at 3%. There’s a concern here for inflation. At this point, 22% up, no big deal, no big deal.

David: Isn’t it interesting that they’ve chosen an inflation target? This is an aside, maybe distraction. But they’ve chosen an inflation target of 2%, which is roughly the natural rate of increase if you’re mining gold and have that as a part of the money system.

Kevin: That was part of the formula years ago.

David: So you can have an increase in the money supply on the gold standard. What you can’t have is an infinite increase in the amount of credit in the system, because there has to be real money backing it. That was the limitation of the gold standard, which was intolerable to the banking community. And frankly, they feel like they have been freed from the shackles of monetary conservatism to do exactly what they want to do and paint a perfect picture for us. Create a better world for us through infinite credit creation. So back to Powell. Powell, he’s honest. He talks on 60 Minutes, he highlights how the modern day printing press works, and his message is echoed by Alan Blinder, a man who does truly see it like it is, when he’s describing the past month’s Fed activity. Straight up monetization. This is the former Vice Federal Reserve Chairman, he says in round numbers, the Treasury issued about $1.5 trillion in new debt securities during March and April, and the Fed purchased in almost equal amount on the open market.

Kevin: Let’s look at history, though. Okay, for the person who’s listening to this commentary, good for you, because you’re probably someone who studies economic history. It doesn’t take a rocket scientist. Okay, I’m not in any way trying to undercut you, Dave, but it does not take a rocket scientist to understand this stuff. You might be a rocket scientist in many ways, but this is pretty simple. Most people in the past who understood even the slightest bit of history would say that printing money creates inflation.

David: Yeah, in any other period of history, this would have been a cause for concern. If you’re a bond investor, if you’re a currency trader, I mean, I will say, you know, the dollar index, you know, coming off of highs at 102 is at 96. It’s breaking some key support levels, and I don’t know if that’s the beginning of a trend or of a dollar bear market. But when you are printing and going out and buying securities, again, this is what exactly what Blinder said, $1.5 trillion in new debt securities the Fed purchased an almost equal amount on the open market. Yep, that’s monetization. And experienced investors understand monetization is inflationary. Monetization is inflationary.

Kevin: Okay, but how do you keep people from seeing that?

David: Yeah, I think the key is keeping inflationary expectations off the boil. So if you can imagine this kettle on the hot blue flames, how do you keep it from sending a signal? How do you keep it from whistling and blasting a tune that gets everyone’s attention?

Kevin: What about the shadow on the wall? What about deflation?

David: Exactly. Redirection because the deflation shadow dancing on the side of the cave, it keeps the public chained in ignorance and out of the light. And on that basis you can then govern their beliefs and ultimately their behavior.

Kevin: Okay, but do you remember when we were talking before, last night we were just joking around and we talked about this V shaped recovery, and actually we’re sort of seeing that in the stock market. Definitely not in the economy, but the V shaped recovery in the stock market, maybe it’ll be a W. Maybe it’ll be some other letter, I don’t know. But when we were talking about a V shaped recovery, we said, boy, it hopefully will not be velocity that fills in the V. What we have with a 22% increase in monetary supply is we have a huge amount of money that is, you’ve used this analogy before, it’s like sitting behind a dam. If it starts to flow, or if the dam breaks, or what have you, we’re going to see velocity increase. That’s not good inflation, that’s hyperinflation or the potential of it.

David: Yeah, thus far there has been a control of the flow, right? So, I mean, velocity of money is… more than anything it’s just measuring volume, measuring volume of the supply created and then how…

Kevin: How many times it changes hands…

David: Exactly, circulating. How quickly is it circulating?

Kevin: Right, it is very low right now. Velocity is extraordinarily low right now.

David: Of the supply created, how much is circulating? How fast? The supplies have been created, the flow is largely directed to the asset markets, stock and bond markets, and that has left velocity very low, which is actually quite convenient if you don’t want to see inflation and it supports the deflation spheres of the central bank community. Again, where is inflation? Well we can tell you where it is: it’s in asset prices. Happy investors, that’s what you have today in the marketplace. Happy investors. Near all time highs, stocks, bonds. You know, they may be chained, but they see a picture on the wall and the central banks have said, yep, you should be afraid of deflation. That’s why we do what we do, to keep you happy. And these are not people who are gonna protest, not protest loudly.

Kevin: You know, bubbles move. They don’t just pop. Oftentimes, bubbles move. Through the years that I worked here with the company, I’ve had a chance to see the tech stock bubble that was huge, and as that was deflating then what you had was the real estate bubble, and, of course, we saw that bubble collapse, and we had this debt bubble that’s occurred over this last 10-12 years. So it’s a little like when you squeeze a balloon on one end, you know all the air goes to the other side. These bubbles are moving. Asset prices, that’s a bubble. That’s a bubble. Where does it move? Does it move to food prices? Is that just the front edge? Is asset price expansion, the very front edge of an inflation that we all would be terrified of?

David: Well, you’re right, and if you go back to Paul Krugman’s comments back in 2002, he was pretty clear when he specifically requested, and this is in the dot-com bust era, he said: “You know what we need to do is create a bubble in real estate.” And so, using monetary policy machinery to kind of move direction, move energy, move enthusiasm, and keep people engaged. Bubbles, do they migrate? Do they recreate themselves? What we’ve seen, I think, over the last 20 years, is this one bubble sets the stage for the next and bigger bubble, sets the stage for the next and even bigger bubble to come, and so yeah, we’ve had asset prices inflate. That’s been on the front edge of what I think will be consumer price inflation as well. So the story of cave shadows has to be constantly whipped up. The fear of deflation, fixating on creating a healthy amount of inflation, which they defined as 2%, contemplating four but currently at two.

It’s been impossible to get to their target, which is why we’re creating the new conversation around a new number. But if asset deflation is an elevated concern, then monetary inflation can fade to the backdrop. And that’s an intended consequence. Of course, it’s harder and harder to ignore the other consequence of monetary expansion, which is an asset price bubble.

Kevin: Yeah, but you give them higher stock prices. My wife, she was talking to a friend, and this friend was very, very concerned about the economy. But she brought it up last week. She says, yes, but look at the stock market, stock market is going up. I think things are gonna be just fine. We’re going back to normal.

David: Yeah, this is not a normal economy. I mean, we don’t know if we see a second round of COVID in the fall. We don’t know how successful the attempts at reopening are. We don’t know yet in terms of even the consequences of businesses that have shut already. You know, constant attention in recent years has been given to the potential for deflation. Deflation of asset prices in particular, and investors have bought it.

Kevin: Right.

David: So the cave shadow keeps your rapt attention.

Kevin: Yes, but that’s what the economists tell you. They know more than we do, don’t they?

David: Yep, the purpose is served by retelling the deflation shadow narrative so that money printing, so that digital credit creation, can go on a long time, with inflation expectations being anchored to something that’s not real. So what we consider to be real is what is in our minds as a belief. And deflation stands large as a shadow cast on the fire-lit wall, but which is in fact only a shadow. Anchoring inflation expectations at low levels, what does that encourage? It encourages a stable currency, it encourages lower than normal interest rates, which aid in perpetuating the increase in system-wide debt.

Kevin: Okay, so let’s look at that. Let’s look at that because the debt has exploded but the rates are almost zero. So the real problem, the real challenge right now…inflation isn’t just the challenge. Inflation also pushes interest rates up. So if you have expanded your debt and you have this large sea of debt like you had talked about water behind a dam, if we’re paying interest on all that water and that interest is rising, that sinks the ship.

David: Well, and this is why, again, inflation…we want it. We tell you we want it. But actually we’re not going to give it to you straight. We’re not going to tell you what the real number is. And so whether it’s CPI chained, unchained, PCE chained, unchained, there’s about 10 different measures for inflation. All of which, if I report them, will prove my point that there is either inflation or not inflation, and this is where again you look at the amount of debt that’s in the system today. We cannot afford to see interest rates rise, and if we cannot afford to see interest rates rise, then we cannot afford to see inflation, even though that’s the stated objective of one of the parts of our monetary policy. We know from past conversations that the economy has developed a very unhealthy independence on credit growth for any sort of economic growth, we now have to see credit expand, and that’s back to that idea that capitalism has been dead for decades.

Kevin: Right, Richard Duncan calls it creditism.

David: Creditism is the operative system that we have. If you want to criticize the current financial markets and the Wall Street, you know, games that are played, look at creditism. Don’t look at capitalism as the primary culprit here. And what keeps credit growing when you’ve passed the point of sustainability? The ability to pay back all that debt? Cheap rates. Cheap rates. The Fed has to keep the game going and a big part of that is defining reality in ways that impact investor and consumer behavior. Chain in a cave: You organize the shadows to inform beliefs, you inform beliefs to determine choices and those choices, both investment and consumption choices, are the affirmation that you did the right thing.

Kevin: Let’s play an imaginary game, then. Let’s say that we do know that we have 5% inflation, 10% inflation, maybe 15% inflation. We’ve had that before. We had that back in the 1970s. What would keep me in the bank with cheap rates? You talk about cheap rates, why in the world would I stick in the bank if interest isn’t keeping up with inflation?

David: Do you remember when we were in Argentina a few years ago? The man that we stayed with, he put all of his money into the next apartment or the next apartment. And that’s what we saw in Argentina is that people would rather bank themselves in the form of a second apartment rather than trust their savings to a financial system.

Kevin: Something real, yeah.

David: Well the financial system in Argentina was, and arguably still is, explicitly and grossly extractive, right? Lest we forget to mention, Argentina entered its ninth debt default here in the last week or so.

Kevin: Isn’t it amazing? I mean, they come out with bonds and the bonds pay very little interest and people are like, well, it’ll never happen again. And then how many times do they default? I mean, Argentina, Venezuela, you name it. Virtually every country that goes into debt.

David: I’m going to say that the problems in Argentina are not unlike what we were talking about earlier in our conversation. When you have a wound, it’s like a scratch on a record. You can move away from it, but ultimately it rotates around. The cycle comes back around and you find the scratch in that record again, it reveals itself again. Ninth time we’ve seen a default. If they don’t deal with their systemic issues, if they don’t deal with the core problems, will there be a tenth? I mean, come on, is that not the easiest bet in the world?

Kevin: Well, okay, so let’s take Argentina. We can even look at—Venezuela’s an extreme. If you were in those countries, If you were captive in those countries, there was a degree of captivity with the currency there, even in Argentina, Dave, because we were told what the official exchange rate from the Argentinean peso was to the dollar…

David: …versus the blue…

Kevin: …versus the blue rate. And of course, everybody had to operate on the blue rate, which you actually got twice as many pesos as you would if you were operating on the official.

David: By the way, blue is a fancy way or friendly way of saying the black market.

Kevin: That was a black market. It was a black market, but those people who were losing value in their money that rapidly and I think it was about 40 to 45% per year at the time we were there, they could have, and they would have loved to have had, an option where they could have put that into gold instead of actually a savings account that didn’t pay enough interest.

David: Well, that’s the whole point. When we set up vaulted, it was our alternative to a grossly extractive banking system geared towards low interest returns and higher and higher rates of inflation. This is where, you know, forget the blue market. Forget the black market. I’d rather be in the gold market. That’s where, again, essentially, you are a captive audience. What is a captive audience? The captive audience is an audience who is stuck with a particular set of beliefs, unwilling to crawl out of the cave into the daylight. And you find that when push comes to shove, plenty of people do, in fact say wait a minute, the system is not working for me, I have got to do something different. I have some sympathies with seeing the system as it is and wanting it to be different, you know, creating a constructive outcome, that’s what I’m interested in. So we’ve had Powell and company basically create this idea for us that a 27-day bear market is sufficient to resolve a decade’s worth of financial excess.

Kevin: That’s never happened. A true bear market is going to be years.

David: (laughs) Right, so we would suggest that you have had a 27-day warm up, right? And your V-shaped recovery, we don’t know how this chart finishes, but we had the down, the catastrophic sell off, we’ve had a nice bounce. But what happens next? Of course it’s anyone’s guess. But would you believe that 10 years, or if you’re looking at the credit markets and the gross expansion, we’ve seen more over a 40 or 50 year period that all those excesses are corrected in a matter of days? I think not.

Kevin: I think there’s time when you just exit the system. You know, you talked about gold. As far as I’m concerned, if inflation is going to take my paper, I’m going to move to gold. If the stock market, if this isn’t truly the shortest bear market in world history, or at least US history, 27 days. I don’t know. I’m not going to bet on that.

David: It reminds me of that period in the 1929-31 period where the stock market did sell off precipitously, and then it recovered significantly. And then all of a sudden you had folks in the investment community who said, I thought I was on solid ground and then the ground gave way.

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competitive currency devaluation