The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“The world is going to be re-made, perhaps not for the better, in the chaos that ensues. And perhaps that is not by accident. Own some gold; own some gold shares. You need to let this clear, and you don’t want to be involved in the markets that are in the process of clearing. And these are debt and equity guys saying, ‘Debt and equity – dangerous.’ You’re not listening. This is going to come down to – you chose not to listen.”
– David McAlvany
Kevin: David, it’s typical for us to have a meeting, you and I. On Monday nights we talk about things that are affecting us in our lives, conversations we’re having with people. And then, it’s typical to go into a company meeting on Tuesday mornings when we’re actually recording this program, even though it airs on Wednesdays. I have to say, coming out of this meeting just now, I want to continue the conversation because you were talking about your trip to South Africa, and I’m just going to throw out a couple of key phrases and I want you to just pick up on the one that you think you’d like to elaborate on a little bit.
There were some phrases that came up at this meeting, such as “Business as Missions.” Another phrase, “Unashamedly Ethical.” And then, “Legacy as a Form of Generational Wealth.” I’m throwing these things out because you’ve been talking about these to the guys and the gals here at the office. We’ve been trying to convey these things to our clients. You’ve written a book this year about legacy and extending things beyond just the now, and beyond just the personal ownership. Could you just pick up from where you left off?
David: Legacy is, in large part, the choices that we make that impact future generations, and it’s less something that you leave for future generations, and more the way that you live and operate in the present, and what that creates, an ethos that that creates, an identity that that creates, and ultimately the way, day in and day out, how you manage all the resources that are at your fingertips, whether that is relationship, the time that you invest in people, the time that you invest in yourself, developing emotionally and spiritually and intellectually.
These are all resources that we make decisions every day to manage or not manage. Some people don’t manage their health very well at all and that becomes evident at some point in their life. There are other people that do a better job managing that particular resource. There are some people that don’t manage their intellectual lives very well at all, and that becomes obvious, perhaps, to an outside, and it’s never really obvious to the person that hasn’t managed that part of their life (laughs).
Kevin: Do you think maybe that comes from being short-sighted or self-centered? I’m thinking about health. Short-sightedness on health. I’ll admit, okay, I just ate a donut right before I came in here (laughs). Now, I know that I can’t do that all the time, but it was something that I did today. A short-sighted person might have a donut and a cigarette every morning for breakfast. Now, that’s short-sighted, and I’m sorry if I offend anyone who is listening to the program, but please, stop doing that.
David: (laughs) Well, I think it’s kind of a question of, who are you making decisions for?
Kevin: Right.
David: As a steward of resources, you are making decisions not just for yourself. You’re making decisions that have an impact beyond yourself.
Kevin: It may be a generation or two down the road.
David: Right. So, you could argue that the decisions that you make are for others, and to be a steward of a business means that you’re really not just focused on yourself and the personal benefits of being in a business, but the other people involved, whether it’s employees, whether it’s clients and vendors, and to the degree that you are focused on others, there is a very different dynamic that takes place in the context of business.
And so, when you describe legacy as something that you’re creating that is a form of wealth, we’re not talking just about the banal side of that, which I would describe as the financial side. That’s probably the least important. We’re talking about a very comprehensive approach to managing resources and growing wealth, again, from a comprehensive perspective, which is all of the resources that you possess – your physical resources, which would be health, your intellectual resources, your spiritual resources, your emotional resources, relationships – these are all things that, to the degree that you’re intentional, will grow, and to the degree that you’re not, any growth is merely accidental.
Kevin: This conference that you were at that we mentioned last week, when you were there, actually, when we were talking, the paper that you wrote and presented had to do with the storehouse mentality. We don’t have to go over ground we covered last week, but I think it’s something that we should continue to incorporate in the conversation until I get it, and the listeners start getting it.
David: From that vantage point, we assume that when we create a storehouse that we know what it’s going to be used for. I mentioned last week when we were in South Africa that, actually, you don’t necessarily know. From a relational standpoint, you make deposits in the love bank, as I said last week, and you don’t know at what point you’re going to have a call on that capital and a reduction in the balance, but you make the deposits anyway. And I think when you’re talking about creating a storehouse, whether it is financial or otherwise, it is with the future in mind, but not necessarily with a perfect picture of the future in mind. Nobody has a crystal ball, nobody knows exactly how those resources will be put to use.
I was reminded of this conversation in South Africa. It may not be our responsibility. As stewards, we’re responsible for doing something, but we’re not responsible for doing everything. And creating a storehouse, we may not be the generation that puts those storehouses to better and more effective use. We just may be the generation that creates the storehouse. Again, it’s difficult, if you’re thinking about the person who has made decisions in a certain timeframe to orient resources in a particular way, to not also be that person who is making the next set of decisions.
But I think a steward will try to expand their timeframe from me and what is mine, and how I will use it, to how others need to be prepared to use it, and actually take on the mantle of stewardship in the next generation, to be trained, in essence, how to make decisions, and how to put those resources to work.
Kevin: And it may not just be your family as your legacy. Dave, I’ve observed your father raising you, and then I’ve observed you raising your sons and your daughter, and I’m amazed how deliberate everyone is about this concept. I’m not going to say you’re perfect, no one is perfect, but I’m amazed at how deliberate you and your wife are, and how Don and Molly were. You know, Dave, here is a company – you have this desire to create that legacy, not just with your family, however. You have a deliberate desire to create this legacy with every person who listens, every client who does business with us – you have this burning desire. That’s why I wanted to start the program this way. You have this burning desire to communicate this to a larger group of people.
David: The issue is, we are in business. We’ve sold gold for 45 years, just about, and we’ve been in the asset management business for a bunch of those years. But what we do, we do for a particular reason. We do have a mission to what we do. We do have a deeper purpose for what we are doing and what we are trying to accomplish.
Kevin: And it doesn’t have anything to do with the spot price of gold on a given day.
David: (laughs) Not on any given day, you’re right, because it is this notion that, particularly when we’re talking about physical metals, we’re talking about something that is a storehouse. Again, we are going over ground we covered last week. It’s a storehouse intended to be used for something else, and there is a difference between hoarding gold ounces and being prepared to make the next set of decisions.
And that is what I would suggest is going to be the greatest challenge for anyone who has accumulated gold over the last two years, 10 years, 20 years. We have clients that have been with us for 40 years or more. It’s this shift in mindset from, “I have created a reserve. Now, how should I effectively use that reserve?” Oh, by the way, it might not be your responsibility to do that, but it is your responsibility to train up the next generation to be making wise decisions with the resources that you stewarded in your generation, and on your watch.
Kevin: When the opportunity presents itself. Let’s look at the opposite side of the picture for a second. For opportunities to present themselves, overvalued assets have to come down at some point. We talked last week about cyclicality and how that is healthy, and yet we have a system right now, using central banking, and I’d like to explore that today, where central bankers are almost like oncologists. They’re not allowing a cancerous body to actually die. I’m not saying the whole system has to die, but there are things that are being supported right now, businesses that are being supported, that at some point, need to be replaced with something productive versus where they are now, where they’re almost like cancerous tumors.
David: And it’s a dangerous comparison on the one hand, because I think if you take the heart of a central banker, you take the heart of an oncologist, most are good people trying to do a good job, and they don’t necessarily have adequate perspective to see that there are other things that could, or perhaps should, be done.
Kevin: Right. There are times when you need an oncologist.
David: That’s right.
Kevin: There are times, though, when you say, “No, we don’t want to create any more torment.”
David: The commonality between the two – central bankers and oncologists – is that rarely are you going to find an admission of failure. There is always more that we can do, there is more that we must try, even if the ultimate cost is the death of the patient. And very curiously, you have central bankers who do not circulate a disclosure document on the possible negative outcomes, and you do find that at hospitals before protocols are begun or procedures are implemented.
Kevin: Can you imagine Ben Bernanke saying, “Sign here. You may die?”
David: But that’s essentially what is happening – a grand experiment, and someone who, in an authority position, says, “I know enough to know that this may work.” What they sometimes forget is to add the disclosure, “And I also know enough to know that it may not work.” There is that part that doesn’t convey confidence to the patient, and so, that has to be left unsaid and just left for the disclosure document and the signature. But again, central bankers don’t circulate that. Only doctors do.
Kevin: I think part of the reason they get away with it is because they say this is just a temporary emergency measure, yet this has been with us for eight years.
David: Right. And I think probably five years ago we talked about that the economy was still on life support, given a low interest rate environment and the various things that were – keep in mind, five years ago Ben Bernanke was talking about green shoots in the economy, right?
Kevin: Right.
David: And in 2011 it was Bernanke who laid out a plan – 2011 – the plan was laid out for how the Fed was going to reduce its balance sheet and we were going to get back to a normal interest rate environment. Notice the date. We’re a few years from that, and so you’re right, temporary emergency measures – they’re still with us, after now eight years, which seems not to matter to most investors. But I think the fact that they’re still doing it communicates critical information.
Kevin: The thing that has happened, though, Dave, is the temporary emergency measure, this thing that only occurs, supposedly, in an emergency room, has become the new normal. Look at what Paul Krugman is suggesting at this point.
David: Kevin, you know I have a five-year-old daughter, and she is relentless. When she begins to focus on something, it is with a laser intensity. It reminds me of a dog with a locked jaw.
Kevin: And she can outlast you, I think.
David: Oh, she cannot release until she’s dead, which means she has never lost an argument with dad.
Kevin: (laughs)
David: Mary-Catherine would say that I’m a pushover in that sense, and maybe to some degree I am – she is my only daughter.
Kevin: (laughs)
David: But it reminds me of the fixation which has occurred with this issue of deflation. Everyone has been trained to think about deflation, fear deflation. Bernanke did his Ph.D. on the dire nature of deflation and how to address it. Yellen inherited that mantle from Bernanke, to say, “This is what we’re fighting, this is the game we’re playing, this is how we’re going to win.” To me, I think, because there is so much fixation – and Krugman is no different. Krugman suggests that we can increase our debt an infinite amount, we don’t have to worry about it. What we really should be worrying about is slowing growth, and therefore we need to do everything that we can to stimulate growth, and we can do that through fiscal spending. This is why I say this issue of fixation is so dangerous. We have the transition to fiscal spending right in front of us. It doesn’t matter who wins the election. There will be a massive fiscal spend.
Kevin: How do we spend more money?
David: And I think this is going to be the transition to an inflationary, and from the deflationary driving forces in the financial markets. What does that entail? It means that bonds, all of a sudden, are going to be viewed as an asset with significant risk. It means that you have a complete rethink of the misallocated capital, which has been redirected by interest rate incentives, put in place by Ph.D. central bankers.
Kevin: Well, these are the experts, Dave. These are the guys who supposedly can manage the economy.
David: I usually don’t eat lunch, just because I’m busy, and yesterday I went with a couple of guys in the office to Jimmy Johns. It’s a national chain, and if you like sub sandwiches, it’s actually pretty good. One of the points that the founder made – he hung on the wall, he has these 50 points, or whatever – he says, “The ark was built by one amateur, the Titanic by a vast number of professionals.”
Kevin: (laughs)
David: I got a kick out of that. But again, I think we’ve got professionals who are fixating, not only on their theories, but also not willing to concede where they’ve been wrong, and it leaves them blind to only focusing on one particular thing. And truly, as we move from monetary policy to fiscal policy, and spending for infrastructure, which is, I think, inevitable in a 2017-2018 timeframe, I think you have what unlooses the monetary deluge created, the trillions of dollars which have been in the banking system, you begin, at the front end, to see positive economic activity, an increase in GDP growth rates, everything that will give the new president the ability to say, “Look at what we’ve done, it’s a success story. All we needed was the authority to move forward, and clearly, it was us, the Democrats, or alternatively, us, the Republicans, who had the courage to get it done.”
What they don’t know is that behind this little trickle of liquidity that they are going to begin to see flow into the economy with good effect, is the tsunami right behind them, which represents something that they cannot control, and I think will re-price assets in a radical way, in a very radical way, as we move into the next presidency.
Kevin: 40-50 years ago, Dave, I think almost anyone would tell you that long-term growth came from savings and investment. At this point, these are the guys who would tell you, “No, long-term growth does not come from savings. In fact, savings is a nasty, nasty thing we have to get rid of. It comes from credit.” This is where Richard Duncan talked about we’ve moved from capitalist to “creditist.”
David: Right, and to acknowledge that – one, he is right, we have. Two, this is an experiment, and it’s doomed to fail. It may be something that has been in place for the last 30-40 years, but I take the position that creditism will die and become irrelevant long before we eliminate the step sequence that you just mentioned – savings, creating the opportunity for investment leading to economic growth. It’s amazing, isn’t it, that we live in a day where savings are considered a waste, and investment has been transformed into a very impatient process, neurotically predisposed to – well, I would say it’s predisposed to failure, but it’s neurotically driven (laughs), and what does it end up looking like? Speculative ventures of a very reckless nature.
Kevin: Investment, in the classic sense – you’ve talked about this in the past – is like a chain. It starts as an idea. And then investment money goes toward that idea and it builds a business around it. If it is successful, after risking the capital, it reaps benefits for the individual, both individually, and then the collective. We’re talking about everyone else who participates in that.
David: Right. So, the problem is low-to-negative rates incentivizes the use of other people’s money, that is, borrowed capital, for speculation on short-term volatility of asset prices rather than a lengthy process of investment.
Kevin: The opposite of legacy.
David: Yes, it’s the opposite of legacy because it’s all about now, it’s all about instant gratification, it’s all about bigger numbers in the immediate, without a perspective that says, “We plant trees today that will bear fruit long after we’re gone. We’ll never see it, and we don’t have to.” The transformation of capital from a long-term to a short-term commitment is a very important social, as well as financial, transformation, as is the elimination of this key, very key, strategic risk, which is normally associated with the allocation of capital, that is, the cost of capital.
The cost of capital, itself, is a risk, but if you eliminate the cost of capital, when the cost of capital is lowered to nothing, guess what? The care taken to weigh risk, and of course the reward, in that equation, is dramatically altered. And it’s no surprise that risk and reward are so out of whack. Pricing is, today, if you’re looking at the asset markets – stocks, bonds, real estate – it is suggestive of nirvana. And maybe that’s what negative rates actually yield. Maybe that’s what we get. Maybe this is the bold new world we’ve created. This is the alchemist’s dream.
Kevin: It reminds me of, in college, I remember Chase, my son, talking about some of the trust fund kids that came into the college. They didn’t appreciate what they had, they had free money coming all the time, they were driving BMWs and Mercedes around campus. There is a different feel when money is flowing freely and you know that there is more to come.
David: Right. I think one of the things that has changed in this long-term versus short-term commitment, the transformation has also been one of attitude and disposition, investors, today, instead of looking at investing as becoming a partial owner in a well-run enterprise.
Kevin: And partial risk, as well. You’re an owner, so you’ve got risk and reward.
David: Assuming risk with that – the ebbs and flows of owning a solid business. Today, investing is more of a casino bet. It’s what number are we going to hit on the roulette, how well are we going to hit it, what’s our return? You’re forgetting that there is a process, you’re forgetting that long-term wealth is created over time with a perspective that is not so instant in its gratification.
Kevin: If you know you’re going to be getting free money, and you’re hearing that everything is going to be sunny day, good news – you used a casino as an example. When I go into a casino, they pump oxygen in the casino. I’m not much of a gambler, but we have had conferences there that we attend, and they pump oxygen into the actual casino so that people feel better. They serve free drinks to those who are gambling. Everything seems fine. In fact, the money that they are using isn’t really even money, it’s just chips.
David: That’s exactly what we have with government statistics. It is the extra oxygen in the room that makes you feel, “Oh, I can do this. I should make the bet. We’re okay.”
Kevin: Whoever owns the statistics, just like whoever owns the casino, can keep the game going.
David: You end up with better than forecast jobs in the non-farm payroll number last week, 255,000 jobs. That was after the previous month of 292, and the argument is that you have positive jobs numbers, which last week kind of eased the pain of the previous week’s growth numbers for GDP, which were awfully weak – awfully weak. So, look, details matter to us, and I tend to take one of the letters out of BLS (laughs) – you can guess which one it might be. When I’m looking at the acronym, the Bureau of Statistics suits me just fine.
But July, the Bureau of Labor Statistics did a masterful job printing up the non-farm payroll numbers. And you look and say, the stock market is positively responding to this massive beat – 255,000 jobs. Here’s what is interesting. For the month of July we lost 1.03 million jobs. That was the actual job loss if you’re leaving out seasonal adjustments. But after the seasonal adjustments we get 255,000 positive jobs, so you have a 1.285 million person adjustment. Kevin, this is oxygen being pumped into the room so that you look at those dice as if you hold the magic and they hold the key to your future wealth. (laughs)
Kevin: Dave, this is more than just what we normally see during an election year. You expect this in an election year, but this is more. They must be worried.
David: It out-paced last July’s number. Just adding to this unemployment number, our friend Bill King digs into the archives a bit, and he quotes [University of Chicago Professor of Economics, former Chairman of the Council of Economic Advisors for the Obama administration] Austan Goolsbee in the New York Times. This goes back to an article that Goolsbee wrote in 2003. Listen to this. This is Goolsbee speaking. “But the unemployment rate has been low only because government programs, especially social security disability, have effectively been buying people off the unemployment rolls and reclassifying them as not in the labor force.” Goolsbee continues, “In other words, the government has cooked the books.”
Kevin: He said this back in 2003.
David: Right. So, fast forward to 2016. Nothing has changed, except the brashness of the deceit. The U.S. economy appears to be the growth leader globally, anemic as it may be, still stronger than the rest. We prefer – if you’ve listened to the Commentary for any length of time – we prefer to second guess the official growth stats. So, whether it’s from China or the U.S. or Japan – I sat with Peter Chao outside Durban – this was ten days ago – and asked him about China’s growth numbers. Peter is a top economist in China. Up until recent months he had over 10 million Twitter followers in China (laughs). That was before the government shut down his channel.
Kevin: Oh, he must not have said something that they liked.
David: I’ve got to tell you, the conversation with him was absolutely harrowing. There are things rapidly deteriorating in China in terms of free speech, in terms of the ability to operate as a business owner. He is going to stay. My advice to him would be, “Get out of that country as fast as you can,” because they are re-engineering things for a renewal of Maoism.
Kevin: Yes, first you shut down the press, and then the rest comes.
David: So I asked him – before the government shut down his channel, he was discussing some of these things more publicly, which explains why he doesn’t have the same voice he did even a few months ago, and so, back to economic growth stats, he just shook his head side-to-side, “No, the numbers – they’re a product. They’re created for certain end consumers.” This is what I think we need to appreciate. The statistics that we’re looking at – they’re a product, and they are created for consumption, and that consumption experience is designed, and the response that you have, as the consumer of that product, is intended to be what you described as the person playing in the casino.
Kevin: It’s a Pavlovian type of thing. You basically do what it’s going to take to cause the person to respond in a Pavlovian way. But we’re not just talking about China. When you’re talking about China’s growth numbers, this affects the whole Asian block, actually the whole world, but some of the other countries in that region are vulnerable if China is vulnerable.
David: Right. Some are more vulnerable than others. We’ve spent time in Asia and witnessed some of these changes materializing firsthand. My first trips to Asia were 1991, 1992, and there is a high degree of vulnerability with some of my favorite places. There have been massive successes, if you look at the last several decades, in Taiwan, in South Korea, in Hong Kong, and Singapore. Unfortunately, some degree of the progress made in those places is attributable to business with China – not a bad thing unless future growth is dependent on that source. Now you have China, which is over-indebted, highly insecure from a social and political standpoint, and in the middle of an economic makeover.
It was interesting, the French bank Natixis analyzed the economic ties, and they would suggest you are better insulated if you are in Indonesia, if you’re in the Philippines, if you’re in India. You’re less vulnerable to economic decay because China has had less trade, less tourism, less direct investment, in those kinds of places, and more involvement in Taiwan, South Korea, Hong Kong, and Singapore, which are sort of standing in high relief, as sort of the danger spots in Asia, if you’re considering sort of the knock-on effect – weakness in China, what are the regional implications?
Kevin: China built so much excess capacity, Dave, as if they were going to continue double-digit growth themselves. You’ve pointed this out before, the rest of the world just doesn’t have the money to buy their excess capacity.
David: That was one of the key issues that Peter Chao raised while we were in South Africa, is this issue of China having excess capacity for the rest of the world, which they had hoped would be absorbed domestically. Yet, incomes are not sufficient, domestically, to enable domestic consumption to absorb all the country’s excess capacity. So, you have the struggle with pricing power, with general deflation, at least at the level of the price of goods, that should persist for a long time because we have this massive overcapacity.
Kevin: If there is anybody who would be considered the biggest and the best of this credit economy, a man who has exercised his brilliance in the bond market for many years – Bill Gross. You don’t think of gold when you think of Bill Gross, but recently Bill Gross has said that there is not a lot that he’s liking these days except for a few things. He named gold as one of his favorites.
David: Isn’t that interesting, because it wasn’t that long ago that he would have been an extreme skeptic as to the metal. And of course, it wasn’t that long ago that he would have been very bullish on bonds. So maybe it’s because he was dethroned that he is no longer as keen on bonds. He used to be called The Bond King. Now, Jeffrey Gundlach is the bond king, a new, young whippersnapper who knows everything there is to know about bonds. Oh, by the way, Jeffrey Gundlach says the two things you must own today are gold and gold stocks.
Kevin: Isn’t is amazing? Yes, he is the new Gross, and Gundlach and Gross are basically saying, let’s look at the gold market.
David: Well, three, if you want to be fair. It’s Gundlach, Gross, and Goldman-Sachs. So, you have two people who trade in credit, and then one facilitator of credit and its many devices, namely Goldman-Sachs. When I said devices, I might have meant vices – I don’t know. But guess what? All three are negative on stocks. You have Gundlach and Gross, as you just mentioned, championing gold as an alternative, Gross for the first time in his career that I’m aware of, and the twist with Gundlach is that he is also interested in gold shares as an undervalued asset, and they have performed very well since the beginning of the year.
But the twist in the story, in terms of this Bloomberg article, covering these three groups being negative on stocks – the twist in the story, and it’s fascinating to watch how these things are written – they wanted to argue that it’s completely unfeasible for the average investor to get out, and get back in to the market. So, the conclusion of the article – you’re chances of success are greater as an investor if you simply ride out any downside. Don’t sell, never sell, sit there, take it like a man – that’s the Bloomberg way – not like a Goldman, not like a Gross-man, not like a Gundlach-man. So you’re not going to have their company, but if you’re just a hoi polloi-man, grin and bear it.
Kevin: For the person who is listening to this, you have to have hit a reminiscent note when they sit and talk to their broker and they say, “You know, I think the stock market is getting a little bit too high, I think I’d like to go into something defensive.” Now, I hear this all the time from people, saying, “I’ve got a broker that just won’t listen to me. This broker has been trained that you just sit there and you take every crash, which typically is about every seven years – go ahead and take it, take it like a man. We’ll make it back, because in the long run you’ll always gain in the stock market.”
David: Yes, what if you miss those top 90 days? This is what the Bloomberg article says. “There are 90 days out of a year when any given year you get most of your return.” And you’re saying that you know that you’re going to be in when you need to be in, and you’re going to be out when you need to be out. We would take the opposite position than what Bloomberg would say – “You don’t know, therefore you always stay invested.” And yet, you have voice after voice after voice saying, “Ah, I really don’t like what I see.” You have Andrew Smithers, joining us two years ago, and then a year ago again, to say, “Look, when things get expensive, here is the cost of continuing to own it. You have to accept that you’re going to have sub-par returns for at least the next decade. That doesn’t mean that you have catastrophic loss, it just means that for ten years, if you’ve bought an over-valued asset, you can expect to see an average of 1-2%. Granted, you’re still taking full market risk, and that 1-2% may not keep up with inflation, but that’s what you’re signing on for. To me, it’s fascinating to see Bloomberg has to report the scions of finance and what they’re suggesting, what they’re saying, what they’re doing with their own money…
Kevin: And then they discount it by saying, “Just go ahead and stay in the stock market anyway.”
David: Right.
Kevin: Let’s look at the stock market for a moment – the stock market and the bond market. Typically, in the past, you bought stocks for the price to increase. Yes, you bought it for dividends, and in the long run the dividends are the better way to go, but most people buy stocks for the capital gain, and they buy bonds for the income.
David: Right.
Kevin: Now, that’s been reversed here recently.
David: It has. As an investor, just step back, and think about that. People who are buying stocks today are buying for income, and they’re buying bonds for capital gains.
Kevin: Because they think interest rates are going to drop. The only way you can get a capital gain in a bond is if interest rates drop further after you buy the bond.
David: The investment world has been turned upside-down, and if you’re not paying attention to that, you’re going to learn some very hard lessons, and honestly, this is a kind of tuition bill you don’t want to pay.
Kevin: Look at how much money is going into Vanguard. People are just income-desperate right now, Dave.
David: Dividend Growth Fund at Vanguard has doubled. The assets under management have doubled over the last three years to now 30 billion dollars, and they’re closing it to new investors. The trouble with central bank induced risk-taking is that it temporarily creates a positive return feedback loop, where, when central banks are involved – let’s say, for instance, the Bank of England – we’ll talk about this in a minute, I’d like to if we have time – they are now committing to buying corporate bonds, just like the ECB has bought corporate bonds, just like the Bank of Japan has bought corporate bonds, as well as equities.
Kevin: Right.
David: And so you create something of momentum, if you will. You create a positive return feedback loop which attracts hot money, that is, people chasing returns. They are chasing the most alluring returns, and the prices go even higher. In this case, you also have shrinking yields on stocks and bonds, and they are shrinking even further. And it seems that everyone forgets that capital flows in until it has a reason to flow out, and the prices press higher until there is nothing left to drive momentum, and in fact, momentum reverses to the downside.
Kevin: It’s like packing a theater. Dave, if you pack a theater that you know at some point is going to catch fire, there are still only maybe two exits in that entire theater. And you know it’s going to catch fire because at some point this is going to reverse and that hot money is going to flow back out, or try to.
David: Right. To me, it’s a reasonable decision. You don’t try to move when everyone around you is in the context of panic. You just don’t do that. We’re going to know in retrospect, but with the weakest months for stocks immediately ahead of us, it’s the perfect backdrop for the desperately hungry income investor. Again, as we said, “Learn a thing or two about misdirecting dollars?” I think you’re going to see people lose a lot of principle due to the price volatility that is in front of us. Step back and think about that again. Bonds are yielding far less than the rate of inflation.
You should make a mental note of it, and you should slowly move to the exits. You have moments of time when you’re not competing with others to squeeze through those exits, and isn’t that the point? Hitting the exit quietly – that has its own merits. What is panic? Panic reflects a mass re-appraisal of what was considered to be the case, and has been found not to be. So, you have an instant switch across a large number of people, and it’s from believing that the world was one way, and now seeing it as completely different.
Kevin: It’s a paradigm shift.
David: And having to make a change in light of the new information. Must you wait for a mass reappraisal to make reasonable allocation decisions today?
Kevin: That’s why, when we talk about Paul Krugman’s suggestion – and I don’t mean to be mean, but there are other people that we know who are making the same suggestion…
David: (laughs)
Kevin: And that is, “Look, we’re too far down the road, we’re just going to have to borrow as much as we can, and spend as much as we can.”
David: I think you should always do the right thing and you’ll never have regrets. Even if the right thing is costly and painful, always do the right thing. This is where I’m frustrated by the notion that Krugman is reasonable. I don’t think he’s reasonable. I think he’s highly pragmatic. I think Duncan is highly pragmatic. But I think that it’s frankly insanity masquerading as reasonable advice. I read Krugman in the New York Times and as usual, I’m pulling my hair out. I still have some, but it’s why I grew a beard so that I’ve got a little excess. Given the amount of insanity that is out there I know I’m going to continue to pull hair out, and I’m just planning ahead. It’s my own storehouse for dealing with market insanity.
This is the solution on offer – finance massive spending today at low rates and transform our world with those investment projects. Don’t worry about the cost of debt because, after all, the levels of debt we currently have are not an issue. And frankly, we should trust government to be a reliable partner in growing the economy through this massive fiscal spending spree.
Kevin: Well, of course you can trust the government to spend the money right. I mean, of course, you can trust the government to spend the money right.
David: The one part, in terms of historiography, the one part that absolutely galled me in the New York Times article – he said, “Don’t we know what made America great? It was, of course, a series of government initiatives.”
Kevin: (laughs) Wow, that’s what made America great.
David: And I’m thinking to myself, “I still have this little bit of respect for the New York Times. How do they print this crap?” What do we know? We do know that spending of any kind generates economic activity. That’s a given. So, let’s say they’re right, you borrow a couple of trillion dollars – is it going to generate economic activity? Yes, it will. Yes – it will.
Kevin: There are plenty of people who go to Mount Rushmore. Those spending initiatives from back in the 1930s. Plenty of people go to Mount Rushmore, and that little town of Keystone makes an awful lot of money with tourists coming in. So, that maybe was what made America great.
David: The value of spending, if you want to put it in present value, or if you want to view it from a long-term perspective, is based on return on capital. And if there is a positive return in excess of your borrowing costs, I think you have something that is compelling – by all means, spend. That is not categorically evil. But to be frank with you, nine out of ten times, when money is spent, it is spent and there is no return, or worse yet, there are negative returns.
Kevin: Like our bridge to nowhere.
David: (laughs)
Kevin: They finally took the sign down telling us that was part of the project to rebuild America after the 2008 crash. They took the sign down because people just mocked it as that bridge just sat there – to nowhere – right here in Durango.
David: You’re talking about the millions and millions and millions of dollars that was spent on a bridge overpass that literally doesn’t connect to anything. There is no traffic.
Kevin: But it was economic activity at the time.
David: You have infrastructure projects, and I think it is well illustrated by the scandals in Brazil. That is where you have the greatest concentration of corruption occur in any economy, anywhere in the world. Let me be very clear. I’m not comfortable with Duncan’s or Krugman’s borrowing trillions to build a better America because, number one, there is an aversion to debt and an awareness of its destabilizing effects which has been seared into my brain from a young age – thank you, Don McAlvany.
And number two, because the likelihood of waste, and the guarantee of unethical dealings in the bid process, in this process of changing our energy and transportation infrastructure, you have to look at this and say, “This is where the least amount of transparency, and the greatest amount of public theft and corruption occurs. It has always been in the construction field. So taken together, might we get a few years of stimulus and economic activity? Which is quite frankly no different than any other form of debt expansion.
You do it individually, you do it collectively, it’s the same thing. You are drawing tomorrow’s growth and productivity into the present day, and in my view, this is an unethical dealing with a generation yet to be born. You’re stripping out resources, you’re leaving an environmental disaster behind, but maybe that’s comparable (laughs). Debt-driven growth – all you’re doing is sucking tomorrow’s growth into the present. Question: For whose benefit? And at whose expense? Are we really that selfish?
Kevin: When we had Jim Deeds on, who actually was one of our favorite guests this year – Jim worked with us in the 1990s and the early 2000s – Jim has that 80-year-old person’s experience in the markets. He has actually been in the markets, I think we talked about, for about 60 years. Jim – when he calls me, Dave – often says, “You need to interview Doug Noland. Have you read Doug Noland’s work?” Jim continues to look at Doug Noland’s work and he says, “This guy really is seeing things for the way that they are.” He is very contrarian. I think we should have Doug Noland on the show.
David: I like Doug, and he’s a great guy. I’ve enjoyed reading the Credit Bubble Bulletin for many, many years. He started with Bill Fleckenstein, moved on to work with David Tice with Prudent Bear Funds, and was the asset manager for their short mutual fund. We continue – I do – every week, to read his commentary at the Credit Bubble Bulletin. It’s an invaluable blog. He made a note this last weekend. He said, “Look, U.S. unemployment rate is 4.9%. Keep in mind that that number is outdone by China’s 4.1 % unemployment rate and Japan’s 3.1% unemployment rate.”
So I ask the question – we’re dealing with three economies that have full employment, or virtually full employment, basically 5%, 4% and 3%, respectively. When we’re dealing with issues of transparency, I think what is completely transparent to me is that statistics are the tools in the hands of the politician.
Kevin: The Obama administration actually now has, in the White House – the White House has taken over the Census Bureau.
David: I’m not saying that there is not reality behind these numbers, I’m just saying that it is a crafted reality, and it is meant to create a message and communicate a message.
Kevin: No, no, no no. You are saying there isn’t reality in the numbers. You just now did what they did.
David: Okay, well, maybe that’s true (laughs). It’s just – here’s what is confusing to me. You have three economies which, economically, are on the ropes – they’re on the ropes.
Kevin: Right.
David: And yet we can brag about full employment and a healthy economy. Why aren’t we seeing any economic activity? Peter Chao would say, “You’re positive, maybe, and perhaps negative, in terms of the growth rate, so the official statistics of GDP growth rate near 7% in China – I’m going to give it balderdash. Those would be my words, not his, but it captures the essence of the numbers created by the Chinese government.
Kevin: But people sense that there is something wrong, Dave, because when I watched the little bit of the Democratic Convention that I watched, I watched Obama’s speech. He was saying, “We need to stop talking negative about what’s really positive. Things are fine, you just need to look at the numbers.”
David: That’s the problem, though, isn’t it? Because the public is being taken for patsies. And this is not just in the United States. In many parts of the world there is this expectation that people will view official statistics as representative of economic reality. No one asks, “Why then, is there such social tension and geopolitical unease?
Think about that. If those numbers are true, why aren’t people happier? Do you remember – to quote one of our favorite presidents of all time, Bill Clinton, he said, “It’s the economy, stupid.” Right? What he was driving at is, everyone knows what the reality is. And it is – it’s the economy, stupid. Why is there social tension and geopolitical unease? It’s the economy, stupid. And you can’t redirect attention to a falsely created number.
Kevin: Even if you own the Census Bureau and you’re giving the numbers out the way you want.
David: Right. So, we sometimes like to draw out certain inconsistencies. Here’s a big one. The inconsistency between the payroll numbers, and apparently, because payrolls are increasing, if you believe that there are 255,000 jobs that were created, then you have businesses who are confident about aggressively hiring. But consider how inconsistent that is with the GDP numbers which show that business investment is awful. How do you square those two things? A government statistic which says, “Everything is getting better. Look – businesses are positive and are hiring at an aggressive rate,” and a GDP statistics which says, “Business investment is tepid, at best.” Why the hiring if investment is not justified? Are we back to that point of, the hiring is one version of unmitigated balderdash?
Kevin: Watch what they do, and not what they say. Look at the Bank of England having to lower rates. If things were as good as they are saying they are, employment-wise, and we’re actually on an upswing, why are the central banks continually having to lower rates? The Bank of England is down to 25 basis points as this point.
David: Right. Lowered from 50, it’s the lowest they’ve been in 322 years. Again, if you just step back, with any of these little reflections today, and say, “Huh, that’s interesting. You mean, the Bank of England has never lowered rates this low in its 322 years? What does that imply about what they think, not only about the British economy, but the global economy, because we’re all interconnected?” The Bank of England lowers rates 25 basis points from 50, it renews its quantitative easing purchases of government bonds, it adds corporate bonds to the list for the first time, and they initiate a four-year loan program for banks to lend 130 billion dollars to individuals and businesses. And more importantly, Mark Carney says, “If that’s not enough…”
Kevin: “We’ll give you more.”
David: “We will lower rates to zero, or even past that level,” (laughs) because we now know that central banks can do that, “And if required, we will add to that list of assets, the qualified buying list.” Maybe they’ll join the Japanese and start buying stocks on the London stock exchange. This is what’s frustrating, I guess, that the evidence is already in that quantitative easing does not increase economic activity.
Kevin: It reminds me of Thomas Edison. He talked about trying many, many things as filaments for the light bulb before he got there – human hair – he tried different things. There was only one thing that worked. Quantitative easing does not work, it is not a good filament for the light bulb, it has never created growth.
David: Right. So, you’ve got that, but we have also seen the lower rates end up pushing investment dollars to particular investment categories It’s a little like starving a rat before you put them into a maze, and then you kind of scent the trail to the destination that you want to rate to go to, using scarcity as a driving force. In this case, scarcity is yield.
Kevin: You’d think the British would learn, though.
David: “I’m not going to pay you. You’re a retiree, and you’re desperate for income to meet your monthly bills, and you’re starved, and now I give you the scent of the solution.
Kevin: Just like they did in Japan. The Bank of Japan, the ECB – all of these guys are doing the same experiment. They keep putting that same filament in there and it’s not lighting anything up.
David: Right. The U.S. is on hiatus, but I truly believe that’s until the next scare, then you’ve got Yellen, who joins the parade. What does it tell you when central banks continue to pursue more extreme measures of quantitative easing and market intervention? What does that tell you? Is the financial system well? Answer that question. You may argue, if you’re sitting here in the United States, “Well, that’s them, that’s not us. There’s nothing wrong with us.” But remember that every bit of capital flow is connected. Every bit of capital flow is connected. Just to illustrate – where do you, as a Japanese investor, or as a European investor, put money when there is zero yield at home?
Kevin: They’re buying U.S. bonds.
David: So, you’re forced to buy foreign currency.
Kevin: Corporates, too.
David: Foreign currency, denominated bonds, as we mentioned earlier, even emerging market stocks for the dividend income. So, you’re perverting price. So, again, this is the interconnection of capital. Through quantitative easing and central bank monetary policy, you pervert the price of an asset. And when you do that, you end up perverting investor behavior, and it causes a shift of all capital flows. Then on the other side, you have prudent investors who see this happening, and all over the globe they’re wary of the chaos that this will create when capital flows out instead of into these misconstructed investment options. And this is why many of them are shifting in the direction of gold.
Kevin: The very guys who would normally be able to provide an income, based on their investment knowledge, like Bill Gross and Gundlach, are saying, “No, you need to be in gold at this point.” So, the very thing that is being used as bait, like you were talking about over in the European realm, or any of the central banks – the guys who were the best at it all through the years are saying, “No, stick with gold right now.”
David: I do think it’s telling that when people who are concerned about price and yield look and say that we have price controls, which we know have never worked, and we know that in the end they cause chaos, you’re going to anticipate a timeframe when, socially and politically, the tar and feathers are going to present, and the world is going to be remade, and perhaps not for the better, in the chaos that ensues. And perhaps that’s not by accident. But I think this is the kind of knock-on effect that investors who ordinarily like fixed income and prefer to invest according to math equations say, “Not this time. Step aside, own some gold, own some gold shares. You need to let this clear, and you don’t want to be involved in the markets that are in the process of clearing. Debt and equity – dangerous.” That’s what they’re saying. Debt and equity – dangerous. And these are debt and equity guys saying, “Debt and equity – dangerous. You’re not listening. This is going to come down to – you chose not to listen.”
Kevin: Another debt and equity guy I read a quote from the other day – he hit the nail right on the head. Talking about tar and feathers – we are going into a change here, because this is unsustainable, and that change could either be good or bad. If capitalism is blamed, and his concern was that capitalism would be blamed, it would be the wrong place to put the blame, which means when we come out the other side, it could be communism or socialism that is the answer, at least for a season. And we have to be careful what we blame for the chaos that is coming.
David: We talked about that three years ago on the Commentary, that what is at stake is not central bank policies being blamed, but there being a twisting of the narrative, and that narrative being, “Look, capitalism doesn’t really work. What we really need is command and control dynamic which will deliver good results. You have exhibit A in terms of failure of the markets to produce growth, and they’re going to take what we’ve had in the last eight years, which is anything but capitalism – anything but capitalism – and they’re going to call it capitalism, and blame it. What does the world look like after that? I don’t know. I don’t know. But in my view, you definitely want to keep your options open.
Kevin: It reminds me of a quote from the famous Bertrand Russell. This was made back in 1940 when Hitler and fascism, and Mussolini, were right on the front screen. He said, “The first step in a fascist movement is the combination under an energetic leader of a number of men who possess more than the average share of leisure, brutality, and stupidity. The next step is to fascinate fools and muzzle the intelligent by emotional excitement, on the one hand, and terrorism on the other.” This is the perfect platform, Dave, for fascism. You look at National Socialism under Hitler. He was solving an economic problem. In the minds of the Germans, that’s what he was doing.
David: Right. There came some complications with that, and a few nuances which they should have been paying attention to, and didn’t. I can’t help but reflect – we’re nearing the end of the corporate earnings season, we’ve come in, we’ve logged a fifth straight quarter of declines. Investors, very puzzlingly, are not struggling to make sense of valuations. It would appear that they don’t care, and that the numbers don’t matter, because easy money drives forward progress. And I don’t know that that is something that they’re conscious of, or they’re thinking, but that’s what they’re operating on the basis of, because the need for income – maybe it’s more than that, maybe it’s more than easy money as a salve, but maybe it is, in fact, the need for income which is pushing all valuation concerns to the side.
Of late, you have fixed-income investors which have begun to translate a need for income into equity purchases, and particularly, emerging market equities. You just have to look at that and think – think – think. This is a shift and risk re-appraisal. When your fixed income investor is now looking for income from emerging market stocks, think what is happening. Think about the risk reappraisal.
UBS analyst, Jeff Dennis, wrote last week about this purchase of emerging market stocks by fixed income investors. He said, “That turns on it head the traditional way investors have viewed emerging market equities. Stocks are typically seen as a bet on rising global growth prospects, and as such, are bought for capital gains rather than income.” Again, it’s like the investor is saying, “Here’s what I want, here’s what I will get, and they’re forgetting that you don’t always get what you want, and sometimes you get more than you asked for. And in this case, I think that’s exactly what you’re going to get.
You can recall Andrew Smithers’ comments on the Commentary that the greater the over-valuation in equities, the longer today’s investor will have to suffer with low or negative average returns.
Kevin: Like you were saying before, yes.
David: At the ten-year period. So, thinking strategically – is no one willing to think strategically for the benefit of future generations? We’re talking about fiscal issues, as well as personal allocation. So, from the macro, to the micro, we’re suffering from the same short-termism. Are we the most narcissistic and selfish generation in modern history? Because that is what it looks like. I guess if you want to end on a positive note (laughs), it’s raining here in Durango, and we’re grateful for it.
Kevin: We love it. It’s dry, normally, here in Durango.
David: The building flooded last week, which was less than ideal, but at least we’re getting rain, and ordinarily we’re concerned about wildfires this time of the year. It’s also raining in India, which for the gold investor is even more important than what is happening here in Durango.
Kevin: Isn’t it strange? I think this is an interesting tie. Go ahead and explain why it’s good for the price of gold that it rains in India.
David: Because rains being at 100% – actually, closer to 106% of average or normal, so above average – means that larger rains equal greater crops at harvest, means more need for savings vehicles once that harvest is sold, and the traditional savings in India in the form of physical gold. I grant you, there is a tax on the imports still in place, but you look at the gray and black market activity, and you look at what is flying out of the United Arab Emirates, what is flying out of Dubai – gold is coming into India at a record pace. Yes, it’s depriving the Indian government of its desired increase in tax revenues, but I think you look at this period, seasonally, I would say 19 out of 20 years in a row, you have a seasonal upswing for gold September and October. Why? The Indian wedding season. Why is it the Indian wedding season?
Kevin: The dowry.
David: Because, the families actually have money to pay for weddings, and the dowry is in the form of gold.
Kevin: So, basically what you’re saying is, “Bumper crop, bumper savings, bumper marriage dowries, bumper gold buying.”
David: (laughs) That’s right. And so, we have that to look forward to as we head into the next couple of months.
