Podcast: Play in new window
- Who’s The Target For The Democrat Tax Increase?
- 400 oz Gold Bar Was $14,000 In 1971
- S&P 500 & Gold Increase The Same Since 1971
“The reality of a democracy is that politicians compete for votes primarily through promises to pay. Sure, you’ve got other tactics. You can inflame the electorate with a particular issue. But the real traction is gained and the real constituents built through the public purse. Cuts are discussed but rarely made. New spending is introduced and often approved. It’s an ugly imbalance we’ve grown accustomed to. Meanwhile, revenue, if not matched to new spending, just further drives up the national debt. That is, if you look at our debt and deficits, these two are our Achilles heels moving forward.” —David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
Dave, my wife and I were watching Ike and Alan Barinholtz win a million dollars on “Who Wants to Be a Millionaire” this week. It was actually very entertaining. But I started thinking about this. John Carpenter, in 1999—Regis Philbin was the host back then, that’s when “Who Wants to Be a Millionaire” started—and John Carpenter was the first million dollar winner. At that time, Dave, gold was about 250 bucks an ounce, 252. So he won the equivalent of, if you can imagine, ten 400-ounce bars of gold. He won the equivalent of ten 400-ounce bars of gold.
David: And as of today—
Kevin: As of today—
David: He wins one 400-ounce bar—
Kevin: Think of that. Think of the difference between a stack— Okay. So for those who are listening who’ve never seen a 400-ounce bar of gold, you see it sometimes on the movies like “Ocean’s Eleven,” things like that. But what they look like, they look like the size of a spice cake. Wouldn’t you say it’s sort of a spice cake?
David: Yeah. That’s about right.
Kevin: Imagine ten of those, solid gold, in 1999, being handed to the first “Who Wants to Be a Millionaire” winner. Last week, Ike and his father, Alan, winning one of those little tens, basically, the size of a spice cake. What have they done to our money, Dave?
David: I know. John Authers was noting in The Financial Times that if you go back to the 1971 period where gold was unhinged from the dollar—this is the Nixon era, the closing of the gold window—the S&P performance from then to now and gold performance from then to now, they’re on top of each other. Indistinguishable.
Kevin: Really?
David: Yep. And—
Kevin: Really? After taking all that risk in the stock market and companies coming and going, you could have just owned gold?
David: Adjusted for gold, you’ve not made any progress. It’s a really fascinating thing.
Kevin: Wow.
David: So yeah, we went from a million dollars buying ten of those bars to a million dollars buying one of those bars. This is the first time in history that we’ve had, in US dollar terms, a 400-ounce Good Delivery bar at a million bucks—
Kevin: At a million bucks, it’s finally happened. So your thesis on tangible assets, this brings into light why.
David: Well, as you know, our interest in hard assets ties to a thesis where the very factors that delivered decades of success for financial assets become impediments, and in turn spur on growth in tangibles. Of course, not all tangibles are equal, and we’ll discuss iron ore a little bit later. A lump of iron ore or steel is very different than a lump of gold.
We had virtually no inflation, very low inflation. And we have the opposite now. Yes, the inflation growth numbers have come down, but you were talking about growth of the inflation factor. We’re not talking about a diminishment or an elimination of inflation. The middle class and lower class household, they’re still compounding inflation off of a low base. And a 3% higher number on top of already high levels means that lower inflation numbers are not at all consoling. It’s a little bit like the reduction of that pulsing, excruciating pain, if you’ve slammed your finger in a door or something, shifting to a dull and constant throb. It’s gotten better. Sure. That’s progress, but it’s not painless. And to pretend otherwise is to ignore an issue that has high political stakes attached to it.
So we would need deflationary pricing to reverse the sprint to high levels. And the monetary policy experts, frankly, are dead set against that. Deflation is a plague to be avoided at all costs. I mean, at all costs.
Kevin: And so, when they tell us that, when they say, “You don’t want deflation,” what they’re telling us is you want those ten 400-ounce bars to reduce down to one. Because inflation takes the real stuff away from you, but the truth of the matter is, it’s because we’re going into debt, Dave. The interest rates are so high at this point. Granted, we’re coming into the week where Jackson Hole, that’s usually where the central bankers give the gifts to Wall Street or what have you. I mean, are you seeing lower rates with this Jackson Hole meeting?
David: Well, and so that’s the point I’m trying to make, is that our thesis ties to inflation. It ties to interest rates, which have adjusted higher with consequence, and those consequences remain. Consequences for government, corporate, household borrowers. The Jackson Hole meeting this week is an expression of hope from the indebted among us. And the hope is that there’s sufficient justification to lower rates and ease the pain of rising rates, which we’ve had over the last 24 to 36 months.
The inflation numbers, other than the core, which actually marked a little bit higher, they gave Powell, I think, what he needs to signal a September cut in interest rates. The economy weakening might add more impetus to cuts if he’s going to guard the employment mandate. But frankly, last week’s economic figures were not that bad, so he doesn’t have that leg to stand on. Leaning on Doug Noland, “The US economy,” he said in Credit Bubble Bulletin over the weekend, “is neither weak nor robust. It is, as bubble economies invariably become, maladjusted and unbalanced.”
Kevin: Well, and there are ways to finance things that you can hide inflation. I mean, are you looking toward different types of versions of quantitative easing? I mean, that’s what we found during the global financial crisis was there’s other ways to print money.
David: Yeah. We continue to anticipate versions of QE, inflationary fiscal stimulus. As an Exhibit A, last month’s deficit is not so small a piece of evidence. It’s the second largest month of deficit spending in US history. Kind of amazing when you think about it. We have higher rates. That’s translated through to much higher interest costs. July’s deficit number was 244 billion.
Kevin: Wow. Quarter of a trillion dollars.
David: Yeah. What most people would’ve considered a big number as an annual number is now a monthly number. Round up to a quarter of a trillion. A large part of that was the 89 billion in interest expense on our outstanding debt. So it’s higher by 21%. It’s on a path to over $1 trillion for the year, higher if there is insufficient relief from Powell. This is now where math has become excruciatingly painful.
Kevin: And so, this debt rolls at different rates at different times. What would you say the weighted average of our interest is right now? On the overall, what is it? 36 trillion roughly?
David: So it’s crept higher by 49 basis points. It now sits at 3.33%. That’s the weighted average interest cost, 3.33. The rollovers from the low-debt era, they continue, and the weighted average interest cost rises each month. Think of it as the rollover ratchet. And it’s going to continue moving higher unless or until the Fed lowers rates aggressively. I mean, less than 2%. Unlikely in my view. That would put you in a position where if interest rates were 2% and inflation’s hanging between 2 and 3, you’re running negative real rates. That would upset the bond market. It would compromise the Fed’s reputation. Yes, they generally are seen as credible still. Obviously, not in all circles. But that could change.
Kevin: Just to put it in perspective, most people listening probably have purchased a house at some point in their past. Sometimes, it’s offered an adjustable rate mortgage. Hardly ever is that a good deal, but it’s a dangerous task. What you’re seeing here is you’re talking about three—What is that? 35, $36 trillion ratcheting up in interest. That’s like an adjustable rate mortgage on trillions and trillions of dollars.
David: 2024 has 12% of all of our debt rolling over, much lower than last year. 2023, 30%. This is according to the St. Louis Federal Reserve. So 12% this year, 30% last year, and it’s followed by 9% of all of our debt rolling over in 2025. Another 7% rolling over in 2026. To think that this is a passing inconvenience, higher interest costs, misses the math. 30 plus 12 plus 9 plus 7, 58. Nearly 60% of our debt will have experienced a ratcheting higher of rates. That’s a big chunk that will have doubled or tripled off of the low rates we had pre-pandemic.
Kevin: So let’s say that a bone is thrown in September, where rates go down. What does that look like for longer term rates?
David: We’re still moving that number higher. Again, we’re talking about the weighted average interest cost. Even if they lower rates, you’re talking about financing things at 2, 3, 4, 5-year, 10-year increments. And all those numbers would still be higher than the 3.33. So you’re still going to see a ratchet from the low levels pre-pandemic to the current.
So talking about lower rates as a reminder of this year as the Fed reverses course. So in our conversation, Kevin, while we’re talking about lower rates being a reality, the remainder of this year as the Fed reverses course, I don’t think that’s incompatible with holding the view of higher rates thereafter for a variety of reasons.
First of all, I think it’s always important to distinguish between short-term intermediate and long-term time frames. So in the short run, we’re lowering rates. In the intermediate or long-term, we can definitely see higher rates. The reasons to expect higher rates for longer have less to do with monetary policy and what the Fed wants, and more to do with bond market dynamics: pricing and risk, pricing in a return of inflation—it’s not dead yet—and pricing in fiscal pressure, and monetary stability having been compromised.
Kevin: I can’t help but think political right now. We’ve got the Democratic National Convention going on. Oh, by the way, you don’t look like you’ve got dark circles under your eyes. You know those times when you go to bed and you can’t sleep so you get up and maybe read at midnight or 1:00? You had to be up at midnight or 1:00 to hear Joe Biden speak last night. Because apparently, they hid him away until— Oh, no. They didn’t hide him away. He just had something else to do for the first 90 minutes when he was supposed to be talking.
David: The DNC has taken over Chicago for the week. Frankly, I wish they’d move in. They can keep it. They can keep all of Illinois—
Kevin: Keep Chicago.
David: —and then maybe they could secede. That would be helpful, maybe. It remains to be seen if the convention is like the one in 1968 where the city was turned inside out. Downtown shops this year, they have boarded up, and so far the attendance at the convention has been slimmed by an inability to get to the venue through the protesters.
Kevin: Right.
David: And these are Democrats largely protesting against one particular issue. It’s: you’ve shown way too much support for Israel, and it’s not clear that you’re supporting Hamas. That’s a lot of protesters. It’s really interesting.
Kevin: It’s amazing how things don’t make rational sense anymore. I was talking to my wife. I don’t know necessarily, when we talk about Kamala or when we talk about Joe, I don’t know that the nation is actually being run by the people who are the figureheads out front. Let’s talk about the policies and forget the people for a moment. What’s being brought up right now at the Democratic National Convention? Are there things to look at?
David: Yeah, I thought yesterday’s discussion, the tax policy certainly has captured a few headlines. The move from 21%, which frankly very few multinationals pay anyways, but moving that to 28%, and I actually think that’s a good idea with some caveats.
Kevin: Take the personalities out of it. Let’s just talk policy.
David: No surprise that Kamala—she’ll need to see more revenue to pay for more promises. Where I differ strongly from Kamala and Trump is that spending must be reined in, and corporate taxes must increase as well, and I’ll get to that in a minute, but we’re running the largest deficits in US history outside of wartime and apart from full-blown crisis.
Kamala has new spending initiatives to add to the old. The new ones could actually be accommodated by higher corporate rates, but that doesn’t move us any closer to a balanced budget. That doesn’t do anything to eliminate the—call it 90 on its way to 100 billion dollar monthly interest tab, or what last month was 244 billion in deficit spending. Leaving all the older promises to pay and not reducing our deficit is a very, very big deal. Where do we get the money if you’re going to spend even more than has already been committed?
Kevin: There was something really strange that happened in the 1990s, and I think that was the last time it happened. The budget was balanced. Do you remember the Clinton years when— People can say, “Well, it was because of the Reagan tax cuts and things like that.” The truth of the matter is, in the ’90s we had a balanced budget for a while.
David: Clinton was the last president to balance the budget, and that was nearly a quarter century ago. I know it’s a mortal sin in some circles to suggest higher taxes, but there is a reality to higher spending already committed. No politician wants to take it away. If cuts are not coming, then where can tax revenue be increased meaningfully?
And again, the cost to cut means that somebody you’ve already made a promise to is now being eliminated from your constituency base. That’s why politicians are loath to cut because there are strings attached. With the gift came the promise to return the favor at the voting booth. The 1% are not an infinite resource from which all needs can be met. Small businesses, again, we go back to this corporate tax increase. Small businesses I would carve out, leave at 21%. Inflation has hit them hard, labor costs have hit them hard. Just draw a line in the sand, 500 employees or less, leave them alone, they need all the help they can get.
Kevin: You have brought up in the past, though, that some of the large corporations, I think it was General Electric that you used as an example, maintained hundreds and hundreds of accountants so that they could work out all the little angles so that they didn’t pay any tax at all.
David: GE in a number of years— I know that their tax consortium, the group that in-house works to eliminate their taxes, they’ve got about 1,000 CPAs.
Kevin: Wow.
David: Think about this.
Kevin: And it works.
David: It works because you’re talking about one of the largest corporations in the world—at different points. They’re one of the only constituents that through 100 years has been an enduring presence in the Dow—that is, the Dow Jones Industrial Average. They in certain years don’t pay any taxes, or in other years reduce their effective tax rate to the 5–10% range.
We talk 21, that’s fiction. That’s fiction. Larger companies, mega multinationals, have perfected the art of tax arbitrage. Very few pay the current 21%. None would pay 28% if the number were raised. That tax arb should be looked at. Arbitrage between countries and domiciles where they have offices should be looked at by the Treasury.
Kevin: What are the other ramifications? Maybe the unintended consequences—like a multinational corporation—how are they going to deal with something like that if the taxes go up?
David: Well, I think the multinationals would welcome the increase knowing that they have the resources to avoid it anyway, whether it’s transfer pricing or 1,000 other schemes to retain earnings offshore, defray taxes, and in aggregate keep their taxes well below the statutory numbers.
Over time, the increased pressure on small businesses would help consolidate monopoly power. They might whine about an increase in taxes from 21 to 28, and that’s an obligatory basis, but they won’t pay any more than they already do with the help of their accounting teams working hard to avoid them.
Kevin: And so let me make sure that our listeners hear what you said earlier. You’re not talking about raising taxes without cutting spending. That’s what you’re saying. If they cut spending and raise taxes and work more toward a balanced budget, higher corporate taxes applied to those who’ve not paid as much in taxes for decades actually does make sense. But small businesses, Dave, you own and run a small business.
David: What I’m saying is that the political reality is that spending cuts are not on the table. What I want versus the reality, these are two different things.
Kevin: I’m going to vote for you, though. I’d actually like to see spending cuts. Are you running?
David: But I’m managing expectations, and it is that you can talk about spending cuts, and the GOP will certainly do that, but the reality is, delivery on those promises, very, very slim. Very, very rarely does that happen.
Kevin: Well, and our deficit increased as much under Trump as it did under Biden, so that’s going to make people mad. Just go look at the numbers.
David: No, but that’s the math. That is the math. Those are numeric. You can data check, fact check that. Yes, we had a deficit which increased as much or more under Trump than it has under the current Democratic administration, higher corporate taxes applied to those that have not paid much in taxes for decades.
Kevin: Makes sense.
David: Makes sense to me. Small businesses are precariously perched on a knife’s edge. To live or die, this is a constant struggle. Will they make it? Distinguish between who in the business community would bear those costs, and I think you have a winning fiscal strategy.
Kevin: Well, and I want to go back around because talking to clients, I think they really believe the Republicans are more fiscally responsible. And granted, we’re all going to pick one side or another as far as other policies, but don’t fool yourself on fiscal responsibility.
David: No, if that was a question, let’s talk about the fiscally responsible, the reasonable Republicans. Send me a list. I don’t think they exist because the reality of a democracy is that politicians compete for votes primarily through promises to pay. Sure, you’ve got other tactics. You can inflame the electorate with a particular issue. It’s the abortion debate, it’s some other hot button issue, it’s the wall, it’s immigration. But the real traction is gained and the real constituents built through the public purse. Cuts are discussed but rarely made. New spending is introduced and often approved. It’s an ugly imbalance we’ve grown accustomed to. Meanwhile, revenue, if not matched to new spending, just further drives up the national debt. That is, if you look at our debt and deficits, these two are our Achilles heels moving forward.
Kevin: This just brings us back to the concept of a balanced budget. 100 years ago when we were on a gold standard, or 120 years ago when we were on a gold standard, you had something called the balance of payments, and the gold—We’ve talked about those 400-ounce bars of gold, but you can imagine if you owed a 400-ounce bar or what have you, that bar moved from one side to the other and you balanced that budget. That’s a balance of payments. What we have here is an unbalanced national income statement. We don’t pay our bills.
David: That’s right. The long-term cost of an unbalanced national income statement. I wonder if it would help politicians to face a hanging clause. This is not grammatical, we’re not talking about dangling participles. Just imagine this: if you detrimentally impact future generations of Americans, leaving them as serfs to pay off your fiscal largesse from your purchased votes, you can be hanged.
Look, I know that completely overstates what I’m getting at, but think about the consequences. There are none. No, I’m not actually suggesting death to the political class. What I am suggesting, on the other hand, is accountability for irresponsibility.
Kevin: When we travel up to Montrose, Colorado, there’s that gas station over on the right side of the road just before you get into Montrose, and they still have a tree from 100 years ago. The station is called The Hanging Tree. They still have the tree where some guy unfortunately lost his life. Well, unfortunate for him. There was accountability for whatever it was that he did.
David: Are we surprised that people in DC live irresponsibly, like children? When we joke, when we say things like, “when will the adults show up?”, we say that tongue in cheek. But the reality is, a world without consequences is a world where children just go haywire. You have to have logical consequences, and there are none. You can spend any amount you want, you can promise any amount. And a part of that is an allowance that comes with our form of government, democracy, and with a fiat currency.
You combine those two things together and it is a free for all. Ultimately, it’s something that is not sustainable. This is where you begin to see the math of debt and deficits play into the gold market. We talk about 25 years ago a million dollars buying 10 400-ounce gold bars. Today it buys one 400-ounce gold bar. That’s a story of the US dollar more than it is a story about gold. It’s a story of the market adjusting to irresponsible politicians and an unhinged monetary system.
Kevin: So let’s just look at this accountability thing using the bars. Our deficit spending this year, just this year, is the equivalent of almost two million of those 400-ounce bars. Look at the math there.
David: Yeah, 1.9 trillion is our deficit spending.
Kevin: I think it’s 2 million of those 400-ounce bars. That’s just what we’re going to deficit spend this year.
David: Yeah, those are political promises already made. They have to be delivered on.
Kevin: This is incredible.
David: 1.9 trillion deficit spending, a trillion in interest costs, and call it a trillion in overspending. We—or we could say our politicians—we are doing it to ourselves. There is no accountability. There is a generally accepted recklessness which no one has questioned.
Kevin: The interest on that debt is a million of those 400-ounce bars. Dave, I’m still processing.
David: A million millions.
Kevin: Just the interest. A million of those 400-ounce bars.
David: In the era of declining rates and zero inflation, you didn’t have to care. The revenge of the old math is upon us. Stupid levels of spending only work under unique circumstances. That is the period of zero inflation. That is the period of zero rates or declining rates. But rates in inflation, being cyclical and not controllable by policy dictate, bring us to the dark side of those many decades of over-commitments. We’re back to the old math.
Kevin: So the question is, what do you do now? Okay, we’re going back to policies now. If we’re talking politics, what do you do?
David: And again, I recognize that somebody’s going to object strongly to the notion of raising corporate taxes, but where do you raise the most revenue without detrimentally impacting growth? One of the first things that comes to mind, look at share buybacks as an expression of not being in a survival situation.
Kevin: Right. They were taking their extra cash and just buying their own stocks back. That ran the market the last decade.
David: And a part of that is gaming the system so that corporate execs can get their big payoffs. That is a known dysfunctional attribute of the current financial market system. Corporations have excess. There’s latitude for corporate rates to increase tax rates.
Households, no latitude. The wealthy, not enough in resources to move the needle on a recurring basis. If you go after it once as a wealth tax, that’s fine, it’s one and done, but we have a problem, and that is habitual overspending. And now half of it is interest payments.
The only reason politicians roll out the tax-the-rich themes is that in a democracy the rich can’t protect themselves from being outvoted, right? It’s an easy target for the rapacious politician, and you can pound the table and be the social justice hero and not seriously look at solving the larger issue of debt and deficits.
Kevin: So let’s just assume we don’t know the candidates. We just put a bag over their head. You’re basically saying, if you have to raise taxes, this is where to do it because they’re not going to cut spending. Okay, so again, bags over their head, we don’t know who’s saying what, let’s just pretend that for a second. When somebody starts talking about price controls, they start thinking communism.
David: If we’re talking about cutting spending, you’re right, that is something that I prefer. The only reason we’re not going there is because it’s political suicide. In a democracy, cutting spending is political suicide. In a democracy. Now there’s other forms of government, which I do not favor, where you can do whatever you want whenever you want. In a democracy, cutting spending is political suicide. That’s why I am assuming that that’s not on the table and that the best we can do is raise revenue and hope for economic growth.
Kevin: So let’s take the bag back off the head, and now we’re looking at Kamala, and she’s talking about price controls too, Dave.
David: Slippage in the polls from her broader economic plans, price controls, people saying to themselves, “Wait a minute, prices have gone up, but it’s not because grocery stores are gouging.” I think it was Kroger’s—
Kevin: Yeah, 1.4% is their takeaway.
David: Yeah, 1.43, let’s be generous.
Kevin: Oh yeah, there you go.
David: 1.43% profit margins. Now, if it was 143%, if it was 1,400%, now we’re talking drug maker type margins.
Kevin: So you can’t use price controls. I remember when I started in retail, Dave, I was 18 years old and they showed us a video because I was a retail manager in a hardware store before later being a retail manager in a toy store. But they showed us a video called “Four Pennies,” and they showed what our markup was. It was 30-some odd percent that we marked up lumber and hardware and things like that. But then they showed where all the expenses went, and it left four pennies. And as a manager, you are being judged throughout the year as to if you’re going to lose those four pennies. As you controlled inventory, there was slippage, there’s things like that. But what you’re talking about with Kroger’s, a major grocery chain, it’s not four pennies, it’s 1.43 pennies. There’s no margin for error.
David: That’s right. And this is where it’s one thing to get on a high horse and brandish things that inflame the masses, get them excited, “We’re going to solve the injustices.” We need to keep in focus that fiscally we’re not able to hand out more money we don’t have. It seems basic, but it’s lost on both parties. We’re not able to hand out more money we don’t have. The differences between the two parties is merely whose friends get bankrolled. And if you look towards retirement, whose Rolodex becomes more monetizable after retirement. I’m wondering if anybody in our audience remembers what a Rolodex is.
Kevin: I remember your dad’s Rolodex. I remember hearing that Reagan had 5,000 people in his Rolodex that he regularly called and kept in touch with.
David: This weekend, we dropped our oldest son off at Belmont University. He’s in Nashville. So they had this parents and student handoff and this big gathering, like 3,000 people in the auditorium, and they did a quiz. They had an incoming student and her father on the stage, and they showed a picture of a fax machine, and they asked, “Do you know what this is?” And she looked befuddled. They showed a floppy disk, “Do you know what this is?”
Kevin: Oh, my gosh.
David: And she looked befuddled. And of course, they had an equal number of cultural references in the modern era and her father was like, “Who’s that?” Some current famous musician or whatever.
Kevin: So things have changed. Okay, let me ask you a question—
David: Flip-phones, fax machines, Rolodexes, okay, they’ve gone the way of the dodo bird.
Kevin: But let me ask you, because has the stock market priced in at all the possibility of a rise in corporate taxes?
David: No. If that’s potentially on the table—and it wouldn’t be if Trump were coming into play. There you’re talking about tariffs, and with tariffs, I think anybody who wants to look at the knock-on effect from tariffs just needs to reread the era of Smoot-Hawley and see what tariffs can create in the global economy. But today, if you’re talking about raising corporate taxes, nothing’s priced into equities. Your publicly traded shares would revolt from that notion.
A Kamala victory would introduce a new pressure in the equity markets not there today. So keep that in mind as we look forward to November. Don’t know who’s going to win. Is it 50/50? I don’t know if it’s a toss up, but there’d be bad news for the equity player in the event of a Kamala win, at least based on the things that she’s trying to do from a revenue generation standpoint.
Kevin: So let’s talk about impacts of tariffs because you had brought up in our meeting the impact of the tariff on meat internationally and what it’s done to the farmers and ranchers.
David: Yeah, we’ve raised tariffs on China, Trump did on a number of things, and then China raised tariffs on, I think it was soybeans and beef and pork and a couple of things we do export quite a bit of to China. 25% tariff is, I think, where it stands. It’s been devastating for US farmers. That notion of tit-for-tat, you’re going to hurt us, we’re going to hurt you back, or we got to keep things balanced. If it’s going to cost us more, it’s going to have to cost you more. That’s what happened in the 1930s with the Smoot-Hawley protective tariffs.
Kevin: Yeah. See, and I’ve heard and just read, historically, if you go back and look at the world wars, tariffs played a preliminary role in ultimate kinetic action later.
David: Yeah. Now, you talk about steel and the current market for steel, China has overproduced and they’ve under-consumed from what they used to consume. So you’ve got a significant backup with steel. Europe is concerned—
Kevin: Is that why iron prices are falling right now?
David: Yeah. Well, that’s a part of it, but you’ve got the tariff factor in play where Europe is concerned that China is going to dump their steel into the European markets. That’s going to hurt their steel fabricators. So we’re at this interesting place where they can’t keep the machines rolling. They can’t keep on refining. They can’t keep doing what they were doing over the last 10, 15, 20 years. What’s in a price? I think iron ore tells us a lot about the Chinese economy.
Iron ore is more than 50% lower from its peak. And that peak was set in 2021 at almost $250, sitting right at around a 20-year average. Javier Blas discusses in a recent Bloomberg piece how iron ore more than any other commodity has benefited from the boom in China over the last 25 years, up tenfold from the mid-’90s pricing. And it’s on the front line of declines in the new era of real estate development implosion. He suggests that the shift to services within China and away from investment in housing is responsible for that. I see it differently. You’ve got the malinvestment of the past decade which has led to a crazy excess supply of housing in China, north of 100 million units.
Kevin: Wow.
David: And on top of that 100 million, you’ve got 48 million units which were pre-sold but haven’t been constructed. So again, 48 million units on top of 100 million units already built, and the units which have been pre-sold, these are folks all across China who’ve put money down, those units haven’t been built. Developers don’t have the resources to complete them, and they don’t have the resources to return the deposits. We’re talking about something that represented the lion’s share of Chinese economic activity and growth over the last decade, and it’s just been flipped upside down.
Kevin: Dave, sometimes I’ll walk in on you guys, either on a Monday or a Wednesday, and it’s other times as well, when you’re meeting with the McAlvany Wealth guys. And I think it’s important to understand, your attitude isn’t just to go buy stuff and hold it because sometimes the supply and demand aspect of it says—Look at iron, you don’t want to own iron when it loses half of its value.
David: Well, and this is an interesting parallel because we have both commodities— If you call the iron ore move one of the best in the commodity space, up tenfold in that period of time, now it’s given up half, and yet gold’s up tenfold over the last 25 years. Is there a reason for it to give up half?
I think the answer to that question ties to the amount of imbalance within the financial markets and within the global economy. $310 trillion in debt. When we talk about our deficits and debts, we’re not alone. We might be one of the offenders, but we’re only one of the offenders. I mean, not all commodities in the hard asset space have a compelling supply demand profile. With iron ore, at the same time you’ve got too much supply and demand is dropping rapidly. And China, frankly, just before—if you go back two, three years ago—they were responsible for 54% of all iron ore consumption.
Now, you’ve got Africa and Australia, low cost mines in Africa and Australia, which are coming online even while demand from China is coming under intense pressure.
Kevin: So a bad timing.
David: Terrible timing. Australian bank Macquarie, they do some amazing commodity research and analysis, in part because they lend to a lot of Australian commodity producers and they want to know what risks they’re taking. Macquarie sees the commodity—this is iron ore—remaining in surplus through 2028, and the only hopeful aspect of that is that if iron ore prices dip another 20%, your third tier, second tier producers will go broke, and that production will come offline.
Our focus in the space has been with producers who, even after this 55% decline in the commodities, maintain a 40 to 50% profit margin. This is what makes hard assets and managing in this space a real challenge. Supply and demand profiles are unique to each commodity. A broad thesis that supports owning things that you can stub your toe on and that pay you to own them while you await healthy dividend streams. The thesis has differentiated dynamics that have to be tended to.
Kevin: Yeah. And you’re not just all industrial. You have monetary metals.
David: Far and away our largest positions remain in the monetary metals, not the industrials, but demand for gold and silver have a number of drivers, and we’ve seen central bank demand pick up. We’ve seen investor demand pick up on a very regional basis. We’ve seen a really interesting cohort within the investment segment surprise. The 18 to 24 year olds in China, a younger set that’s looking and saying, “Real estate is not an option. Don’t want to go there.” Stock market is now entering its fourth year of declines in China. Where can you make money? It’s not compelling.
The risk is there and they know— I don’t know how many 18 to 24 year olds know this, but the reality is, there is enough—if you look at the entire amount of bad loans within China—there’s enough to scare whiskers off a cat. And you could very quickly move to a radical devaluation of the yuan, a breaking of the peg and a devaluation. I think smart money knows that we’re in this very interesting place.
The fascinating aspects to me two weeks ago, looking at the yen debacle and looking at the yen carry trade unwind, it was a signal to the world that there are these gross imbalances. Again, what Doug described I think very well, a bubble economy invariably becomes maladjusted and unbalanced, and it doesn’t take much for that maladjustment, the imbalances, to be revealed. We had that two weeks ago. Friendly shot across the bow. Smart money from this point forward would say, “While I don’t like paying all time highs for gold, what we have to conclude is we’re really not looking at the price trajectory of gold as much as we are the value associated with any individual currency.” You’re making a bet to be out of a system, not to be in a gold position. You don’t want exposure to the dollar because you see the mismanagement of the system and it’s been priced. It’s been priced in real— You can see the evidence of it in a tenfold increase in the price of gold. Another way of saying that is, the dollar has been shellacked over the last 25 years.
Kevin: Dave, I just did a little bit of math while you were talking there, and when your dad started this company back in 1972, one of those 400-ounce bars of gold was $14,000. Now, when “Who Wants to Be a Millionaire”— That bar would be a hundred thousand dollars at that time, back in 1999 when Millionaire started. That bar is now a million dollars. So we went from $14,000 for a 400-ounce bar when the company started to a million dollar bar. The sad thing is, what does the dollar buy anymore?
David: Jim Deeds sent me a letter the other day, and he’s been a guest on the program before. He worked with us for a number of years. He’s 93 years old.
Kevin: And sharp as a tack.
David: 70 years of experience as an investor, and he was reminding me that he bought his first home. It was a home that care was taken in its construction. He hired an architect. This was a custom-built home. And he built it for between 20 and $30,000. I think 28,000 was what he paid for it, all in. That home sold for about 700,000 in recent months. The value of the home is a reflection of the devaluation of the currency as much as it is appreciation in real estate.
I think it’s difficult for investors to conceptualize that $2,500 is not a high price. It is reflective of a low value in our currency. And we in essence have been deceived. I mentioned John Authers saying, “Look, 1971 to the present, the S&P and gold, they’re a dead match.”
In other words, you took all that risk and all you’ve done is basically stay flat, and I would say the same. I’m not impressed by a tenfold increase in the price of gold. All that means is that the investor who, like my dad, could have bought and did buy a lot of ounces at $35—400-ounce Good Delivery bar, $14,000. It’s a million dollars today. Is that a gain, or have you seen that kind of a loss in purchasing power? Are we on the cusp of seeing massive devaluations, not only in the US but globally because debt and deficits matter?
Kevin: So I wonder if who wants to be a millionaire needs to be rephrased. Someday, people will go, “Who really wants to be a millionaire if it’s in dollars?”
David: Who cares about being a millionaire? We’ve just moved the goalpost. For it to be impressive anymore, it would have to be who wants to be a billionaire?
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You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.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.
