30-Year Money Experiment Ending Badly

Weekly Commentary • Mar 22 2023
30-Year Money Experiment Ending Badly
David McAlvany Posted on March 22, 2023
  • Doug Noland’s Latest Words On The Current Crisis
  • Unprecedented Deposits Turn Into Unprecedented Withdrawals
  • Instability Of All Systems Moving Forward

30-Year Money Experiment Ending Badly
March 22, 2023

“It has been a three-decade experiment. It’s been an experiment in this unfettered, market-based finance. It’s been an experiment in monetary policy. It’s also been an experiment in economic structure. The US economy, we can run huge perpetual trade and current account deficits. We can be a service sector economy. We can fund uneconomic companies, it doesn’t really matter if they’re profitable because as long as money’s loose, they can continue to borrow. And part of this has also been an experiment with globalization, the rise of China. But in the previous cycle you had an enormous credit growth, but the dominant inflation was in asset prices. And what I’m seeing now is the cycle is turning, it has turned. We’re starting a new cycle where a lot of these previous cycle dynamics have shifted.” — Doug Noland

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

One of the things I love, Dave, about working here the last 36 years is we have resources and we actually feel like we can help sometimes when there’s a crisis. And I’ll tell you, about a week and a half ago when we started seeing the bank failures, the first thing I wanted to do was get into the office. But the second thing was I wanted to see what Doug Noland had to say about it. Because for the last 20 years, that’s really where we would go. I mean, Doug really knows how to consolidate information.

David: When it comes to complexity, there’s no better place to turn. A robust conversation rooted in historical perspective, but not just arcane details. It’s the stuff that is happening in live, real time. What decisions need to be taken in light of the market behaviors and actions of the day? Doug’s an invaluable resource for the team, and if you’re curious about what we do as a team and what he does in the team for our Tactical Short product, go to McAlvany.com and you can find more details on Tactical Short, and of course, his regular contributions through the Credit Bubble Bulletin.

Kevin: Well, and I’m looking forward to hearing what you guys are going to be talking about today. I know you’re on the road right now, so thank you for taking the time.

David: It seems appropriate to open to our listeners a small part of the weekly conversations we have on the asset management team. Given the extraordinary backdrop in the financial markets in recent weeks, I thought it would be helpful to explore some of the dynamics we discuss as a team, and perhaps a few considerations on how best to navigate the current market environment. We started the podcast 16 years ago in the early stages of what would become known as the global financial crisis. Then, as now, I was referring to the Credit Bubble Bulletin for perspective at the end of each week. And then, as now, I referred to Doug’s curated newsfeed every day. So I’m grateful to be working shoulder to shoulder with a guy who’s infinitely curious, incredibly disciplined, and tireless in his work effort. Doug, thanks for joining us today.

Doug: Thanks for having me back, David, and as always, thank you for the very generous, kind comments. Thank you.

David: Well, you’ve been on the team since 2017. You’ve spent your life studying credit cycles and the dynamics that occasionally swing to excess, into bubble territory, before resolving at a high cost. You’re not just a student of markets, Doug, you’re also a practitioner as well. So from short strategies to long strategies, from commodities to currencies to equities and fixed income, you’ve successfully managed money and managed teams managing money for many decades. It’s good to work with you on the asset management team. 

Here we are midweek, we’ve already discussed a host of real-time concerns related to the banks, related to financial market liquidity, and to this week’s monetary policy choices. Maybe you can just give us two minutes, your reaction to the banking sector pressures, failures, and the forced mergers here in March, 2023.

Doug: Sure David, and maybe I’ll go back a ways. My keen focus on money and credit, the markets, it goes back to the early 1990s. I think back to the bank crisis, we had the S&L crisis and then we had fears of Citibank failing and major bank failures back in 1991. And Alan Greenspan created a steep yield curve to bail out the banking system. And I’ve been keenly focused on developments ever since.

I was convinced by the late 1990s that we were in a major credit bubble. We had this new type of market-based, unfettered credit that was taking over the system: asset backed securities, mortgage backed securities, derivatives, Wall Street finance. I watched that bubble unfold through the late 1990s. The tech bubble burst in 2000, 2001, and then I chronicled in the Credit Bubble Bulletin on a weekly basis the unfolding mortgage finance bubble where we doubled mortgage credit in just about six years. I knew that was not going to resolve any problems. That only created a bigger crisis. Then, I think in, what was it? April of 2009, I began warning about the unfolding global government finance bubble. And I’ve called it the granddaddy of all bubbles. It’s central bank credit government debt on the biggest bubble in history, just the expansion of debt. 

Then, you know, what we’ve seen more recently, we saw the Fed restart QE in September of 2019 in a non-crisis environment with 3.6% unemployment. We saw an unprecedented response to Covid: $5 trillion QE program, massive government debt. So from that perspective, I do believe we’re in this very precarious state where all we’re going to see now is just more government intervention. It can be deposit guarantees, it can be more Fed balance sheet growth, more government debt growth. And unfortunately, I just see this as all kind of predictable. 

And David, this is more than a couple of minutes, but I’ll start off by making a point that I think is very important. We’re seeing an acute banking crisis here with unemployment at 3.6%. We’ll have decent GDP growth the first quarter. We haven’t even entered into a recession yet, and we’re already seeing acute fragility. So to me, that’s a lot of confirmation of the thesis here of this historic bubble and how we’re now entering a period of what will be instability in finance, banking, and, unfortunately, I think the economy also.

David: It was in the Financial Times article here in recent days, Sheila Bair who’s the retired head of the FDIC, she was running the show during the global financial crisis, came out swinging. She had some very critical thoughts on the FDIC bailout for Signature and for Silicon Valley Bank, basically saying, look, we’ve got a couple hundred billion dollars in assets that are questionable here, in a $30 trillion market. We can’t and should not send the message that we will bail out anyone at any time under any circumstances. This is a mistake. What are your thoughts on this most recent bailout? And of course we’ve had it in the past where it’s insured depositors, but in this case it was the uninsured depositors. What are your thoughts on Sheila’s criticism of ‘throw money at anything and everything at any time’?

Doug: Yeah, I sympathize with that. There’s the moral hazard issue, but my sense is that the system is more fragile than she might appreciate. And I think that probably became abundantly clear to the FDIC and the Treasury and Janet Yellen over the last week or two when they saw unprecedented depositor flight. And keep in mind, this is a little different now. People can get a little panicked and they just open up their computers and get on the internet and hit a button and transfer their deposit. They don’t have to go to the bank. It’s not the old bank-run scenario where it takes a while to unfold. People go out and start getting their deposits and people start to get nervous. Here it travels at lightning speed on the internet, and people click buttons and banks lose tens of billions of dollars of deposits overnight. 

In Sheila Bair’s article, she also made the point criticizing the Fed for unwinding their lax monetary policy too rapidly. I don’t really think that’s the case. The Fed had to normalize rates because of inflation, and unfortunately this instability is what happens when— I can throw out just a few numbers here. In three years, we’ve had just an unprecedented growth in deposits, bank deposits because of the Covid crisis measures, we had about $5 trillion worth of QE. Not coincidentally, you had about $5 trillion growth in three years of bank deposits, unprecedented growth in bank deposits. 

So if you’re just throwing $5 trillion into the system and you have a bank like Silicon Valley Bank where they basically triple deposits in three years and quadruple their securities holdings— Think in terms of: the Fed throws this money in it, in the system. The banks get these deposits, they go out and they loan too aggressively in the late cycle, or they buy securities that are mispriced—interest rates are too low, yields are too low—in the market. And then when the system starts to normalize, then you have a huge problem. The banks have lent too much. They sit on huge security portfolios that are losing money. Depositors get nervous, and you have these bank runs. So that’s the dynamic. It’s terrible that we have to go to these extreme measures and insure or back uninsured deposits, but that’s the world we live in with this acute fragility.

David: Well, and clearly derivatives are the market behind the market. Wall Street has figured out how to take one product and slice it, dice it into 10, and then sell off and collect fees on all 10 pieces. The global derivatives market, some estimate in terms of scale between one and two quadrillion—that’d be between 1,000 and 2,000 trillion in terms of size—in US banks. Goldman is said to have 53 trillion in derivative exposure. JP Morgan, 50-plus trillion. Citi, 47-plus trillion. And these are instruments that are— You hope they’re stable, but they’re not always stable. 

So, to your point, maybe Sheila’s not looking at just how acutely fragile the banking system is as a reflection of the larger financial system—which is not just the financial system, but it’s the derivatives which have creatively been introduced into your plain vanilla stocks and bonds. That seems to be where the mystery lies. We don’t know who owns what and what kind of exposures individual balance sheets have. So when things begin to shift at the margins, the ramifications are very significant.

Doug: Right, David, I think it makes a lot of sense to focus on derivatives, and this is part of this issue that I’ve been following now for three decades. I’ve been worried about derivatives for a long time, and we’ve seen the damage that they’ve caused—certainly in 2008. And I think you have this issue where you have this market that’s developed that’s kind of an insurance market. So if the market’s concerned about equities going down, they can buy insurance to protect themselves against the decline in equities. If they’re worried about interest rates, market yields going up, they can buy insurance to protect against rising yields. 

Well, the weakness in this is that if you have a large amount of the marketplace that is worried about a risk and goes out and hedges against that risk, for example, interest rates, what happens when all of a sudden interest rates really start to go up and whoever wrote that insurance, they have to go out and short securities, in this case Treasurys, to hedge this exposure? So it just leads to this self-feeding melt up in yields, and the derivative players are all selling and markets turn illiquid. But then when you have an event like this unfolding banking crisis, then all of a sudden there’s a big reversal and you have enormous buying to unwind the selling that took place the previous week or two weeks or a month. 

So you get this wildly unstable market where you have trillions of dollars worth of derivatives driving the spike in yields and in the reversal—like we saw last week—the reversal in 2-year yields. We haven’t seen anything like that in decades. Why? Because of all the derivatives, and it just creates this instability, and it’s very difficult for people to operate in a market where you have interest rates, 2-year yields, moving a hundred basis points in not that many sessions. 

So I think it’s a problem. At some point, these derivatives just lead to illiquidity and potentially a crash if all of a sudden equities start to come under a lot of pressure and there’s a lot of derivatives out there. It’s like the 1987 portfolio insurance issue, just so much—so much—larger, where whoever sold those derivatives, they have to sell in the stock market and it just leads to a cascading market decline. 

I’m very concerned with the way these derivatives are operating. And to throw out one last comment, let’s keep in mind, also since 2007, Treasury securities—the outstanding Treasury securities—have grown from six trillion to almost 27 trillion. So this is just more interest rate risk to hedge. More derivatives. I think at the end of the day it’s not sustainable for the system to manage risk this way. The market can’t hedge itself. There’s no one big enough to take that kind of market risk. So it ends up in the hands of the derivative sellers. They have to short. It just leads to market dysfunction.

David: You mentioned the big increase in Treasury paper, and it seems like there’s been a big increase in everything paper. Federal home loan bank issues 304 billion in one week to help bolster bank liquidity. The amount of expansion that we saw last year by the Federal Home Loan Bank, a lot of that towards the tail of the year, a good number, I think it was $15 billion went into Silicon Valley Bank. It’s as if we can create credit in a lot of different areas—and this proliferation of credit gets to the heart of your thesis. And yeah, with the creation of credit comes the improvement of the increase in asset prices, but it’s not on a firm foundation. And it’s when that foundation begins to crumble that you begin to see the price paid. On the front end, everything looks to be grand. It looks to be fantastic. Asset prices increase, household net worth increases, corporations get to manage their businesses in that slightly lax way, with easy access to credit. And then there’s a shift. What does it look like to operate in an environment of tighter credit conditions when, in recent years and even decades, all we know is loose financial conditions?

Doug: Exactly. I like to throw these numbers out and I know sometimes they’re a little numbing. The reason I throw them out is, we go out in our daily lives, we go out and we’ll go to shop, we’ll go to work, whatever, and everything seems just like business as usual, right? It doesn’t seem like there’s anything extreme going on out there. If you look at the numbers, though, that tells you how extraordinary this environment is, and these numbers should make us keen to extraordinary developments in risks. 

You mentioned the FHLB, Federal Home Loan Banking System, and I’ve been on the GSE case going back to 1994, where Fannie and Freddie basically bailed out the hedge funds in that bond crisis in ‘94, which led to only a bigger hedge fund industry, et cetera. So the Federal Home Loan Bank system expanded assets huge last year. It was not necessary. People need to be aware: last year was a historic year of bank lending. And then you mentioned last week, just in one week, the Federal Home Loan Bank System increased their balance sheet, increased lending to the banks, by $304 billion. 

So just one institution, the Federal Home Loan Bank System, that government sponsored enterprise, they ended 2021 with assets of 344 billion. That was the end of ’21. They’re up now to 1.1 trillion. And as you said, it creates this liquidity between the FHLB at 300 billion and the Fed’s balance sheet last week added over 300 billion. We’re at 600 billion of new finance that these government entities created. 

And sure, that, I guess, prolongs the lending cycle. But from my framework, it delays what is a necessary adjustment. Because, as you mentioned, we have a shift coming. We’re now in a banking crisis. The regulators are going to be tightening—regulations will be tightening. Bank executives now will be much more cautious. They know there’s now risk with aggressive strategies. There’s risk to their balance sheets. There’s risk with the regulators. So bank lending will slow markedly. At the same time we’re seeing a tightening of market conditions with less debt issuance. 

So credit conditions are going to tighten, and there’s no way around this, David. There has to be a huge adjustment. There has to be huge adjustment in the markets, a huge adjustment in the economy because our credit growth was on an unsustainable path. And the problem is, when you have all this credit growth, especially the Fed’s balance sheet and Treasury and government related entities, you’re really risking a crisis of confidence in that credit. 

And that’s what makes this really dangerous right now. We need to adjust, and we need these entities not to continue with reckless growth because, at some point, the markets—will they trust Treasury debt? Will they trust central bank credit? And that’s what trajectory we’re on. It’s very worrying in that realm of systemic confidence. So a lot of ramifications for this change in the cycle now that I think has started.

David: Well the new federal lending program backing up the cash strapped banks, none of these banks are eager to take losses in their bond portfolios. But that program’s already put back $300 billion onto the Federal Reserve balance sheet. That was last week, 300 billion, that’s half of quantitative tightening year to date. Again, we hope that they shrink their balance sheet. We hope they do normalized rates. But here they are, 300 billion to the bank balance sheet and another 300 billion from the Federal Home Loan Bank, 600 billion in liquidity into the system in one week. Dollar doesn’t really like that. Where are your biggest concerns, specifically as they relate to the Fed balance sheet? Do we just take it to 15 trillion, 20 trillion? I mean, what are the limits in terms of balance sheet expansion without challenging that notion of credibility?

Doug: Exactly. Yeah, it’s a credibility issue. I think there’s also an issue of injecting liquidity into a system that’s unstable, with unpredictable consequences. And we saw last week the strong gain in gold. Well, of course you’re going to see a big gain in gold price because we think of gold prices as the inverse of confidence in central banking, the capacity of central banking to maintain financial stability. So gold is signaling a real concern with financial stability. 

To me, it’s the worst-case scenario to see the Fed’s balance sheet grow like this because it’s going to have to grow aggressively to accommodate illiquidity at some point. And we haven’t even reached that. We’re still early in this. We haven’t even reached bank charge offs, and bad loans haven’t become an issue yet. Why? Because we haven’t even entered the downturn yet. So there will be a time where the central bank has to expand its balance sheet to keep the system liquid. But to expand at this point that aggressively, if nothing else, it’s just kind of a signal of what we’re going to be facing going forward, a troubling development.

David: So let’s talk about the new cycle dynamic. On the most recent Tactical Short quarterly conference call and numerous weekly calls with the asset management team, you couched your comments with, ‘there is this new cycle dynamic or that new cycle dynamic.’ What kind of a cycle do you see that we’ve entered? Just explore that a little bit.

Doug: Sure. And again, I’m going to go back a ways here. When I talk about the new cycle, the previous cycle was a multi-decade cycle. You can pinpoint it maybe after the ’87 stock market crash and Greenspan promising liquidity, where I mentioned the early 1990s with the bank crisis. From my perspective, it’s been a three-decade experiment. It’s been an experiment in this unfettered, market-based finance, and I mentioned it: asset backed securities—mortgage backed, Wall Street finance, the GSEs, all of this. It’s been an experiment in monetary policy inflationism, zero rates, QE, manipulating yield curves, intervening in markets aggressively. 

It’s also been an experiment in economic structure. The US economy, we can run huge perpetual trade and current account deficits. We can be a service sector economy. We can fund uneconomic companies. It doesn’t really matter if they’re profitable because as long as money’s loose, they can continue to borrow and everything works fine. Part of this has also been, I’ll say an experiment with globalization. The rise of China, the massive increase in manufacturing in China and the emerging markets, which led to downward pressure on goods prices for sure. 

But in this cycle, the previous cycle, you had an enormous credit growth, but the dominant inflation was in asset prices because of unusual dynamics. And what I’m saying now is the cycle is turning; it has turned. We’re starting a new cycle where a lot of these previous cycle dynamics have shifted, importantly. Inflation’s a problem. Consumer, producer price inflation is an issue. So central banks can’t just focus on maintaining strong asset prices. You also have globalization—we’ll call it de-globalization now. You have price structures in China have shifted dramatically. The days of cheap goods out of China and the emerging markets are over. You have these fragilities in the credit systems and economies and global relationships strengthened over decades, now they’re weakening. 

So it’s just a big shift, and the biggest shift is, the central banks are going to have to deal with structural inflation now. And asset prices are going to have to respond to these new realities. And importantly, credit growth has to slow because it’s the credit growth that’s driving the inflation, and it’s unsustainable to continue to grow credit the way we’ve been growing it. And I think the new cycle is unfortunately a period of instability, and that’s financial instability, economic, geopolitical, a lot of things that we took for granted during the previous cycle, we’re not going to be able to take for granted going forward.

David: You’ve got a spreadsheet which we refer to on our Monday meetings and our Wednesday meetings that, maybe it’s got 120 or 150 different indicators. What in your indicators are behaving uncharacteristically right now?

Doug: Uncharacteristically? Well, I’ll just state that some of the key indicators are flashing heightened systemic stress, and we talk about these at our meetings, David, and I send this out to the group at least a couple of times a day because we follow these things basically real time. Last week in particular we saw a significant increase in credit default swap prices for bank debt. And why is that important? That’s the cost of buying insurance against a bank failure, basically. Well, those CDS prices are a very good indicator of concerns about banking system stability, and we’ve seen a major increase in that area. Last week in the European banking area—it was the largest weekly increases we’ve seen in bank CDS prices at least since the Covid panic in March of 2020, in some cases going back even further. 

We also follow CDS prices. There was a significant increase in CDS prices for the Chinese banking system. That’s a potential flashpoint. And one thing I’ll mention, David. In the media they’re talking about: why all of a sudden was there a panic on Silicon Valley Bank, and why was there a panic on Credit Suisse? Well, these institutions are well known in the marketplace as aggressive players. Silicon Valley Bank’s balance sheet is not a surprise to anyone. Credit Suisse has had issues, but what changed is, all of a sudden—uh oh, a problem I didn’t think I would have to worry about, now I have to worry about. 

These kinds of dynamics lead to these panics, and what I’m seeing in the CDS market is areas where I think the market understands there’s a lot of risk. The banks—and that’s global banks—all of a sudden now they’re more attentive to that risk. They’re certainly more attentive to risk in high-yield debt. Why high-yield debt? Well, if you have a tightening of bank credit, then the small and mid-size banks are aggressive major lenders to commercial real estate and real estate generally. And all of a sudden, if that credit tightens, then that puts a lot of high-risk, high-yield bonds in jeopardy. 

So my framework, I often look at the periphery and core, and right now we’re seeing stress at the periphery, but also at the core of the banking system. So for me, it’s always a mosaic of indicators that we’re following. And certainly the key indicators right now are flashing systemic stress. I’ll say a little bit of relief this week, the latest talk in Washington, they’re trying to figure out a way to guarantee all US bank deposits, even after Yellen last week said that’s not what they intend to do. And that kind of talk allays some fears of an impending bank crisis. But overall, the indicators are something we were watching closely, and confirming the fragility thesis.

David: Last year, there was a big shift in asset values on the basis of interest rates. They’ve risen significantly over the last 12 months. In fact, you’ve looked at the performance in the Treasury market, and that’s where there was a real bludgeoning, even relative to high yield or junk bonds. We actually had junk bonds outperform Treasurys last year, at least longer-dated Treasurys, and now that’s changing. So to your point, the high yield market is showing that there’s a little bit more of a credit concern. This is not just about interest rates, but there’s credit concerns that are sort of a 2023 unfolding story as opposed to the 2022 hyperized move in interest rates. But the ECB continued to raise rates recently, up another 50 basis points. This week we hear from the Fed. Let’s explore this catch-22 between inflation not being tamed—still need to raise rates to fight inflation—but now also being concerned with financial market stability if they do continue to raise rates.

Doug: Yeah, and this was a problem that was inevitable. This is part of this new cycle dynamic that I referred to earlier, and there’s no escaping it. There’s acute fragility, but there’s structural inflation, and how does the Fed handle that? And they don’t know how to handle it. The ECB doesn’t know how to handle it. The ECB got off to such a late start tightening monetary policy, raising the rates, and they were committed to that 50-basis-point increase, and they moved forward, which I think made sense. The Fed, I’m not so convinced. I know the market right now expects them to go 25 basis points, and they could, but I think this will be the last move by the Fed unless the markets get a strong risk-on and the markets make the Fed’s job more difficult. But I think the focus of the Fed now shifts to fragility and away from monetary tightening.

David: So last week there was de-risking/de-leveraging very much in play. You got to see a lot of chaos in the rates market, currencies were bouncing, plenty of chaos just about everywhere. If that de-leveraging continues, what’s the net effect, looking at corporate borrowing? Corporations typically have a pretty easy time going to the market and raising new money, issuing new bonds, and of course it’s been unfortunate for them that they’ve had to do it at higher and higher rates here recently. But in the context of de-risking and de-leveraging, what is the net effect for your corporate borrower?

Doug: Sure, and I think it’s important for listeners to appreciate that there’s two key dynamics going on right now. You have the US domestic bank crisis, this run on deposits and what will be a tightening of bank lending with significant ramifications. Globally now, especially after Credit Suisse and that bailout, you have the unfolding global crisis of confidence, which leads to a lot of de-risking/de-leveraging—and we’re talking about hedge funds, and they call them family offices, and all these players out there in the world that borrow cheap, short money and lend and make a lot of money playing leverage and interest rate differentials. 

We don’t know how large what I call the leveraged speculating community is, but we’re talking trillions of dollars of leverage out there. The Bank of International Settlements has actually warned of between 65 and 85 trillion of hidden leverage that they talk about. And we also know from how quickly things unraveled in March of 2020, there’s a huge amount of leverage out there. And why this is a problem is when you get de-risking/de-leveraging, you get players that bought things on margin. They borrowed money to buy things, and when they start to lose money, they have to de-risk. They have to sell some of their assets. So that takes liquidity out of the system. You need to find new buyers as they unwind their speculative credit. Markets quickly can become illiquid. 

We saw hints of this last year in 2022, especially in September when you had the gilt crisis in the United Kingdom, and you had a acute de-risking/de-leveraging in the UK and contagion in other markets, which was getting serious until the Bank of England kind of resolved the situation. But importantly, that was while US bank loans were growing at a record pace last year. So bank lending offset part of this global dynamic of de-risking/de-leveraging. 

Why it’s dangerous now is that you could have both issues unfolding concurrently. A tightening—significant tightening—in bank lending, slower bank loan growth, while you have global de-risking/de-leveraging. That is a major problem. That is what we started to see unfold last week. That is why we saw Credit Suisse get bailed out in Switzerland. That’s why the Fed, the Bank of Canada, the Bank of Japan, the Swiss National Bank, the ECB, they came out and strengthened their dollar swap liquidity agreements because they see these liquidity issues developing. And all of a sudden things turn very tenuous. 

A lot of times these kinds of rescues or bailouts, whatever you want to call them, that 600 billion that you referred to from last week, that’s a signal to the market to go risk-on again. So all of a sudden you can have an unwind of bearish hedges and you can have the market strong, but it’s not a sign of stability. It’s certainly not a sound system, it’s a financial volatility. But it all sets up for this potential risk-off illiquidity crisis that I unfortunately think is almost unavoidable at this point.

David: When we started our conversation earlier, I mentioned the daily routine that I’ve had going back 16 years or probably closer to 20 years, to the curated newsfeed that you put together. It’s an amazing service, and I think all of our listeners should make that a part of their daily habit. And that is a part of our website and a great resource if you want to save yourself hours in a day. One of the articles that you linked to last week, a Bloomberg article, discussed the market being moved by as little as $2 million. Of course this was equity futures. You’ve got a little leverage there, but $2 million in equity futures. Typically it’s five to 10 times that amount to begin to see the market move on the basis of actions taken. And I thought at the time, wow, that could be a sign that liquidity is drying up, taking less and less money to move a market—suggest that. At least that was my impression. What’s your impression?

Doug: Yeah and I think that’s—well it’s not even a secret in the marketplace. And there’s a lot of concern that the markets are just illiquid. You can have buyers panics and you can have sellers panics, and that illiquidity certainly was an issue of 2-year yields. Again, they were at 5.08% on March 8th, and then at one point yesterday, yeah, they traded down to 3.62%. You get these enormous moves that are very destabilizing, that all signal that these are not healthy markets. These are not liquid markets. The Treasury market—2-year Treasurys should not move in gaps of 40, 50—they were down 75 basis points last week. That’s not the way a healthy market would work, and it’s part of the concern at some point you’re going to see those dynamics where the sellers completely overwhelm the buyers.

David: So rates drop, sometimes you can look at interest rates dropping as sort of a safe haven bid. Investors fleeing to Treasurys on that basis. Isn’t there also a scenario where interest rates go considerably higher? We were at the 5% number on the 2%, you mentioned just days ago. It’s not an era—

Doug: Eight days ago.

David: Yeah, it’s not a bygone era. Have we already found the threshold for pain tolerance in regard to higher rates, where fragilities are revealed and things start to break because the financial system just simply can’t take those higher rates? But again, isn’t there a scenario where rates go considerably higher still?

Doug: Yeah, and I mentioned earlier, David, the alarming aspect of this is we’re having a bank crisis and we haven’t even entered the down part of the cycle yet. The economy’s still expanding. Well, and we’ve had serious issues in marketable security portfolios, and today the 10-year yield, we’re at 3.6%. From a historical basis these yields are extremely low. Could that 10-year yield go higher? Absolutely. Could it go significantly higher? Why? I don’t see why not. 

Because I think we’re moving in the direction and this will unfold over months and quarters where I think the Treasury’s going to be on the hook for a huge bank bailout. Could it be a trillion dollars? Easily. Could we see $2, $3 trillion deficits if all of a sudden you go into a recession and a lot of costs go up and tax receipts dwindle? Absolutely. So we can get into a situation where the market looks at this and says, wait a minute, there’s a structural inflation issue. Even when the economy’s weakening, we still have upward price pressures and we have massive, frightening deficits as far as the eye can see, and the market might go back to the way it used to trade and discipline Washington. The bond vigilantes come out, and they kind of did this in the UK, and said, hey, you got to rein in these deficits. I don’t think we’re going to fund them. 

Another issue, and this is probably unfolding, if the Fed is out lending to the banks to finance the runoff of these deposits, it’s kind of like QE, but they’re not actually buying Treasurys. They’re funneling money into the banks. Well, the Treasury holder right now has looked and said, okay, if there’s a crisis, I’ve always got the Fed to buy my bonds in a QE. They might say, uh oh, maybe the Fed’s not going to buy my bonds. Maybe the Fed’s just going to directly finance the banking system. 

So there’s a lot of shifting dynamics. I can see this setting up where you see some upward pressure—surprising upward pressure—further out the yield curve. That story will unfold, but everyone’s so used to: any crisis, buy the 10-year because the Fed’s going to buy the 10-year and yields are going to collapse and we’re going to make a lot of money. This time it may be a different dynamic, but we’ll watch this and see what unfolds.

David: Going back a few years, we had the Trump budgets, which were— Well let’s just say he’s never met a dollar he didn’t enjoy spending—or maybe 10, even if he didn’t have them to spend. Leverage is the way he’s rolled. The Biden budget now is monstrous. Debt levels are already too big. Interest payments are estimated to exceed—interest payments, mind you—exceed 1.2 trillion annually by 2032. There’s times, Doug, when I look at inflation and I think, is this a game? They need to pretend to fight it? Because it seems to me that inflation may be the only part of the bailout strategy that makes sense. How else do you deal with the amount of debt that we have and continue to accrue if you’re not willing to sacrifice something on the currency side? For them to be as sanguine as they are about debt levels, and for the bond vigilantes to be absent the market—there’s some things that maybe I just don’t get anymore.

Doug: Well, in the old days, there would be a dollar panic with this kind of crazy stuff going on, but I guess the dollar has very weak competitors right now. The yen; Japan has very serious issues, structural issues. Obviously Europe; the euro has serious structural issues. The Chinese currency. So we’re in a world of fundamentally unsound currencies, and currencies are all relative. So the good news is it’s not a dollar panic. The bad news is, all of global finance is suspect at this point, which comes with its own alarming analysis there. 

So I think the dollar is extremely vulnerable here, not only because of the banking crisis, what the Fed’s doing, what Washington’s doing generally, the current account deficits, that could be a big unfolding surprise, dollar weakness. And dollar weakness would certainly only exacerbate the inflation issues with— We import so much. That’s another one, though. We just come in every day and watch developments to see which currency is the weakest. But certainly that crisis of confidence in the dollar is not outside the realm of possibility here.

David: Currencies are really tricky, and when you talk about the yen showing safe haven strength, the dollar showing safe haven strength, although fundamentally they’re both basket cases. It’s like, that’s how they trade on a given day. They’re really complicated dynamics there. To me, it seemed like one of the clearest signals that we had in the markets through the last week or so has been the gold surge of $121, suggesting that there are market practitioners who understand that there are system-wide fragilities, and you own gold as a way to have a stake in the financial sphere, but that’s just outside of the financial sphere. It’s not complicated by counterparty exposure. It’s no one else’s liability. It’s considered money anywhere in the world. The dynamic we were just talking—where you have sort of a global rethink of debt sustainability and a global rethink in terms of the confidence put into a variety of currencies, yen, euro, dollar—makes a pretty strong case for owning gold. And clearly, if your new cycle is one that’s inflation biased, maybe that’s the place you just kind of hang out for a couple of years.

Doug: Back when I worked in the mutual fund industry, for 16 years I managed an international, safe haven, top tier, short-term bond fund with a commodities component, kind of a safe haven vehicle to protect against a decline in the dollar. And anytime I saw heightened systemic risk like I’ve been seeing, I would immediately, in the fund, I would increase my allocation to yen. I would increase my allocation to Swiss debt and to gold. And that strategy today, I don’t feel so comfortable about adding Swiss francs, and I don’t feel so comfortable about adding yen, but I certainly still feel comfortable adding a store of value that you don’t have to worry about someone else paying you that money back. You don’t have to worry about counterparty derivatives. All the things that I worry about, I think, make the precious metals one of the best risk rewards available in a very, very uncertain environment. No doubt about that, from my perspective.

David: There’s a couple of things that I think our listeners should consider. One is hedging out specific risk in their portfolio. And you do this in Tactical Short, a product that we’ve offered for a number of years. And maybe you can speak to the role of Tactical Short in a total portfolio. Also where you would put your own money in an environment where there’s shifts, there’s changing expectations, there’s relationships that used to hold, some of which still do and some of which don’t anymore. What would you do with your own money in today’s environment?

Doug: Sure, I’ll start with Tactical Short and to my own, my family’s resources. Tactical Short, what we’re trying to do is provide a hedging vehicle that can post returns, solid returns in a down market environment. We just want to be a small part of a bigger portfolio. We don’t want people to go out and make these big bear market bets. We want people to think through how much risk they have, how exposed are they to this environment, how exposed would they be to weakening securities markets. Have an allocation to Tactical Short to try to take some of that risk out of your portfolio. 

This is not an easy environment to run a short portfolio because it’s chaotic. You have these huge short squeezes and everything else. So what we’re trying to do with Tactical Short is run a lower-risk short portfolio compared to the way a lot of other people run short portfolios. It can be highly, highly volatile. So we’re taking a measured amount of risk to try to protect an overall portfolio. 

As far as my family’s resources, we’re in risk adverse mode. We’re hard asset people, certainly the precious metals and real estate, our financial assets, we want them safe. I guess I don’t have to worry about uninsured deposits anymore if all the deposits are insured, but we do have money in the banking system. We do own some Treasurys, but the focus really is things of real value, the hard assets that we think will weather this storm much better than financial assets. I don’t own any stocks, I don’t own any corporate bonds. I don’t own any mortgage backed securities derivatives. I just don’t like the risk reward of those securities in this environment.

David: Credit Bubble Bulletin is the weekly report that you’ve been writing for decades, and I would encourage our listeners to be looking at that on a weekly basis, on a daily basis. What you post is invaluable. Thanks for being as disciplined and as hardworking as you are. I don’t know anybody with the work ethic that you have, Doug. Honestly, it’s astounding and I know maybe something that you take for granted, but it’s a rare thing. 

The net result is that every day our listeners have the opportunity to have a distilled and curated newsfeed with what’s going on with financial markets, that is most relevant to the decisions that they need to make in real time. Being strategic, being tactical, and to pass on that, it would be a mistake. I would plug into that on a daily basis and make sure you’re reading Doug Noland’s Credit Bubble Bulletin each Saturday morning. Stiff cup of coffee, first thing in the morning, sit on the back porch and start reading maybe—

Doug: Maybe decaf, I don’t know.

David: Tums may be in order depending on the week. But Doug, thanks for joining us for the conversation today. There’s so much going on and so many details. Kind of connecting dots is really important, to appreciate and understand what’s happening, and we appreciate the clarity you bring to that for our team on a daily and a weekly basis and for our listeners here periodically. So appreciate you taking the time.

Doug: Well David, thanks for having me, and it’s awesome to work with you. I mean, it’s like a gift. I can’t believe I was so fortunate. The team you’ve put together, the quality of the professionals. I have never been as satisfied in a working environment and excited. Maybe I work hard, but to me, every day’s kind of a gift and I love it. It’s a great opportunity to follow the markets and share with the team and work together. So thanks so much for the opportunity.

Kevin: Well, Dave, so many things to think about. Doug was talking about the 30-year experiment now seeming to come to an end. And the last three years, unprecedented deposits in the banks, followed by unprecedented depositor flight. A lot of things that people have to keep in touch with, but to find what Doug says on the Credit Bubble Bulletin and on his daily posts, as well as to learn more about the Tactical Short, our listeners just simply have to go to McAlvany.com.

David: Absolutely, very easy to navigate from what we’ve offered for 50 years on the metal side of things to our asset management offerings, both the hard assets strategy and the Tactical Short strategy as well. Both are there on the website, very easy to navigate. And if you’re looking for market information, that’s where you’ll find Hard Asset Insights as well as the daily and weekly Credit Bubble Bulletin.

Kevin: You have been listening to the McAlvany Weekly Commentary with our guest today, Doug Noland. You can find us 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 advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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