Podcast: Play in new window
- Every $10 In Oil Price Increase Boosts Inflation 20 Basis Points
- The War Is Costing $900 Million Per Day
- Watch Oil Futures To See Expectations Of The Duration Of The Iranian Conflict
“The markets are concerned with duration of the engagements, which ends up being a defining factor for costs. How much will this add to US debt levels? How long can the global economy endure higher costs? From the consumer standpoint, it’s cost at the pump or energy inputs into manufacturing, elevated prices slowly working their way into the supply chain and then into the real world through inflated goods. If it’s only weeks, the world economy is resilient. If it’s months, then the system strain is going to be felt with tons of different knock-on effects.” —David McAlvany
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Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
David, what we’ve been praying for in this war is that it end quickly. The one thing that we probably want to avoid is a long, drawn out affair for many reasons; the money, the ammunition, the lives, but there’s a lot hinging on the duration of this war being short, isn’t there?
David: Yeah, I think duration is the key. And that is what will move every financial market, every asset class. If it is deemed to be a long-term endeavor, you’re going to see significant repricing across the board. And if it’s a short-run event, as expected by the administration but not necessarily controlled, remains to be seen.
Kevin: Well, and it’s good to remember too, this is not a war against the Persian people, the Iranians. This is a war against a particular regime, right?
David: That’s right. The Persian culture is one of the greatest in all history. And today, the Iranian regime is not representative of that culture. It is an autocracy. It is a theocracy. And as such, it’s not as if you have a representation of the people. It’s a regime that even within the world of Shia Islam is idiosyncratic and radical. My experience of every Persian has been of a people and of a culture which is rich, dynamic, educated, and teaming with unbound potential.
Kevin: That was a powerful empire too, between 400 and 500 BC.
David: Yeah. And I think if they are freed from the narrowness of religious extremism, it’ll be very interesting to see the role that the Persian people play in the world of tomorrow.
Kevin: Yeah. Well, I wonder, too, though, it’s not just about the regime that’s in, but we haven’t necessarily always had success getting a new leadership in a country where the old regime is eliminated.
David: No, getting out the 20% that is supportive or moving them to the margins and allowing the people to have a more representative government will be a challenge. Less than 20% of the population fully supports the existing regime. I was listening to a Bloomberg interview with Princeton professor Bernard Haykel. And my first thought was, why is everybody in Near Eastern Studies—
Kevin: Named Bernard?
David: —named Bernard?
Kevin: Yeah. I remember in 2008 is when we interviewed—
David: Bernard Lewis.
Kevin: —you interviewed Bernard Lewis.
David: Yeah.
Kevin: Princeton?
David: I think he was 96 at the time.
Kevin: Yeah. That was an interesting show though because he went all the way back to the 1950s when he started writing about Islam.
David: Yeah. And he brought a lot of clarity. If you’re interested in learning about the difference between Shia and Sunni, I can’t think of a better resource. We have on our shelves The Crisis of Islam, What Went Wrong?, Islam and the West. Those are just three of dozens of titles that he’s written.
Kevin: But this is another Bernard who is now at Princeton who’s writing about the Middle East.
David: Yeah. And it’s the regime’s willingness to use violence and the threat of death that has kept the majority in Iran in a subjugated state, very much like Syria under Assad.
Kevin: Okay. But that’s a good example. So do we have a plan for stabilization after the elimination of the regime right now?
David: And that remains to be seen, too. We may shoot first and ask questions later. Fire, ready, aim—
Kevin: Are they hiding right now? I’ve wondered where they are. It could be that it’s just too dangerous for anyone to arise right now.
David: Well, interestingly, the Kurds are on the move. So you’ve got Kurdish resistance in a part of the country which is mobilizing, and that significantly upsets the Turkish government because they don’t want to see the Kurds active militarily and gaining momentum or success. So there’s all kinds of cross-currents across the Middle East.
But you’re right about our record. The West is not great at regime change. The US is not great at regime change. So, many concerning aspects of this war.
Kevin: I’ve got a friend who was a specialist in asymmetrical warfare, and you would never know he’s fighting a war because he’s doing everything but shooting at the enemy. I’m wondering if the Iranians are trying to work toward that, increase the duration of the war, take out some of the key things. Who would have thought of desalinization plants? But that is existential, isn’t it?
David: Yeah, exactly. It remains to be seen if we can create a context for regional stabilization. Are we willing to see through the objectives of this engagement? Are we going to quit as the costs reach a pain point which is considered too much to bear? And are those costs things like you just mentioned where you see cultures impacted, where it becomes an uninhabitable part of the world? You can’t exist in the desert without water.
Kevin: Right.
David: So you consider these questions and see where the Iranian regime is seeking to leverage all that it can. Yes, that is extending the duration. It is expanding the battlefield beyond its borders. That impacts the economic calculus for everyone concerned by extending the timeframe, miring the region in economic chaos. By doing that, the Iranian regime is in essence seeking to play a longer game and extend their probability—improve their probability of survival.
Kevin: You were talking about liquidity today in our meeting. And strangely enough, Dave, I was thinking about liquidity and how critical it is to survival. I started thinking of Jack London. Remember he wrote that story “To Build a Fire.” And if you think about it, maintaining body temperature is the biggest part of survival. If you die of starvation, ultimately you lose body temperature to the point where you don’t survive. If you’re in the cold, though, “To Build a Fire” is a great story. I would recommend all the listeners go back and read it.
It’s a short story, but it’s about a man who’s in the cold and he builds a fire. And through a series of just small things until finally a tree dumps snow on his fire, he ends up freezing to death. It happens so suddenly you think that the guy’s going to make it the whole time until you get to the end of the story. And I think about liquidity, you think about duration, we could run out of liquidity and ammunition. Let’s face it. In a war, you need ammunition, but you need liquidity to pay for a long war too.
David: Yeah. Time is the factor they’re seeking to leverage against Israel and the US. And Morgan Lewis highlighted that in Hard Asset Insights over the weekend. The impact of oil on the consumer price index, every $10 move in oil increases inflation by 20 basis points.
Kevin: Okay. So every $10 move in oil is a 0.2%—
David: Increase to the CPI.
Kevin: Okay, I got you.
David: So you push inflation higher and you begin to pressure the bond market in meaningful ways, but we’ll talk about that more a little bit later.
Kevin: Okay. But still, quick success is what we’re looking for in this war. And it could happen. Right now, a lot of leadership’s been taken out.
David: Yeah, except we don’t have a great record in the Mid-East. Quick success, effective cost management, these are things that we don’t have— We haven’t succeeded on those fronts yet. So Iran, decades ago when the US State Department facilitated the overthrow of Reza Pahlavi—
Kevin: The Shaw, right?
David: Iraq, Afghanistan, now Iran for a second round of regime change. Perhaps this time there’s more consensus across the Middle East that Iran’s regionally destabilizing regime must go. And I think interesting because Iran is attempting to bring everyone into this conflict, make it regional, but I think that might turn out to be disfavorable to them.
In essence, they’re helping build a coalition. You think about Donald Trump and he’s not the great unifier, and yet Iran’s poking everybody throughout the region and launching counterattacks against everyone is creating a coalition, which I think is interesting.
Kevin: When we’ve been pheasant hunting, we’ve had one guy, I love him, but he sometimes runs up ahead of the group. And that’s a dangerous thing to do when you pheasant hunt. And I think about Dick Cheney. He came around a little bit too far, but where I’m going with this is, if you’re trying to get allies, take it from Iran’s point of view, it’s sort of stupid to shoot at them, don’t you think? I mean—
David: Well, yeah, it’s pretty easy if you’re trying to say, “Hey, the great Satan is against us, and we could unify around this. Israel, the US, let’s go get ’em boys.”
Kevin: Right. And then they shoot at them.
David: But attacking regional neighbors like Bahrain and United Arab Emirates and Turkey, that’s created a unique coalition centered on regime change. These guys have got to go. Continued attacks on energy and civilian infrastructure that requires more than a defensive posture. They’re stimulating an aggressive regional response.
So to the degree that energy and civilian infrastructure is damaged, the global economy will bear greater costs. That’s precisely what Khamenei 1.0 and now Khamenei 2.0 have intended, stimulating regime change via social and economic destabilization, a mirror to what the US and Israel are seeking, but they’d like to see it across the region.
Kevin: Do you remember when you interviewed Kamran Bokhari and he talked about the void that was created when Saddam Hussein was taken out of Iraq? He said, “This void is going to be filled either by Turkey or Iran, but they’re competing for that.” Remember that?
David: Yeah, and Saudi too. Somebody wants to step into the gap and be not only the regional hegemon, but also the leader within Islam. And again, you’re talking about a faction within a faction. This is not just the difference between Shia and Sunni, but the Twelver faction, whether they’re seeking the Hidden Imam and they’re looking for this messianic return. It’s very interesting, even with the belief that they can bring about the return of the Hidden Imam through violence and destabilization.
Kevin: It’s an Armageddon-like scenario that they’re looking for anyway, right?
David: That’s right. So Iran has attempted to fill that power vacuum—again, going back to the removal of Saddam Hussein, and in competition with the Saudis. What they’ve done through time, they’ve funded the Houthis, they funded Hezbollah for years.
Kevin: Right.
David: If you look at Hezbollah— I mean, Lebanon is 50 years behind in terms of development. One of the most beautiful, magical places on earth. I will go there before I die. I’ve always wanted to visit Lebanon, but they’ve been underdeveloped for at least five decades. And of course, Iran has also kept Saudi Arabia on its toes, defending its oil infrastructure from constant Houthi rebel attacks.
Now, by moving against oil infrastructure and the desalination plants, along with other civilian targets, Iran is codifying this regional opposition, which in the case of desalinization plants is an existential threat. You simply cannot exist in the desert without water. Back to your point, on the one extreme, you’ve got cold, and you have to maintain your body temperature so that you don’t freeze.
Kevin: Right.
David: The other extreme is—
Kevin: You got to have water.
David: You have to have water.
Kevin: Right.
David: So—
Kevin: That’s part of maintaining body temperature as well. But when you’re taking out infrastructure as a strategy, okay, maybe it’s not necessarily to create an enemy, but it’s to create a crisis that would make an ally later. Is that what you’re saying?
David: I think they’d like to open the possibility for radical regime change across the Middle East, and taking out existing leaders through major discontent. There’s probably nothing more socially disturbing than not being able to survive.
Kevin: Right.
David: Again, water is more important than oil in terms of survival.
The markets are concerned with duration of the engagements, which ends up being a defining factor for costs. How much will this add to US debt levels? How long can the global economy endure higher costs? If you’re looking at that from the consumer standpoint, it’s cost at the pump or energy inputs into manufacturing, elevated prices slowly working their way into the supply chain and then into the real world through inflated goods.
Kevin: So duration, duration, duration.
David: Duration.
Kevin: That’s the key to this?
David: Yeah. So weeks— If it’s only weeks, the world economy is resilient. If it’s months, then the system strain is going to be felt with tons of different knock-on effects economically and socially. Markets are incredibly sensitive to duration. And the Iranian response to weaponize energy is with duration in mind. And it puts on the table this notion of political will. Do we have the political will? Does Europe have the political will? Does anyone have the political will to deal with the economic consequences, which multiply if crude oil and LNG stay at elevated levels for very long? Duration is the key.
Kevin: One of the ways you watch interest rates is by watching the futures market to see what the long bond is doing. And so we can do the same thing to a degree with energy right now. So what are the futures markets saying? Are they saying short war, long war? What do you think?
David: Yeah. To date, the futures markets see quick resolution.
Kevin: Okay.
David: Yeah, the front month pricing is elevated, but every other month out to December of 2026 is priced for much lower Brent Crude levels, and so you’re back to the upper 60s by the time you get to December. By mid-year 2027, it’s the lower 60s.
Kevin: And we’re in the 80s now?
David: Yeah.
Kevin: Yeah.
David: And that may change, but to date, the volatility and price up to $120 quickly back into the 80s has only been in the front month contract.
Kevin: Okay. But this goes back to asymmetrical warfare. And I don’t want to give Iran or this regime the benefit of the doubt, but they’ve got cheap drones, Dave. And they’ve got a lot of them, and it probably doesn’t take much to manufacture them.
David: Yeah. I mean, they’re outmatched with respect to technology and firepower.
Kevin: Right.
David: But in some respects, they’re hoping to fight the fight that puts the US and Israel off balance. Asymmetrical strategies include weaponizing the energy markets and using a barrage of cheap drones, which they’ve seen work very effectively in Russia and Ukraine to overwhelm the very expensive weapon systems used to neutralize that threat. So, ultimately, stimulating economic challenges that discourage further engagement seems to be the goal.
For long-time listeners, going back to 2009, 2012, in that timeframe, we read Martin van Creveld’s books The Changing Face of War and Transformation of War. I got to interview Martin at his home in Jerusalem, just outside of Jerusalem. And there was the theme of less state-on-state actions and more guerrilla style unconventional actions. And Ukraine has demonstrated to the world how drones, low cost to manufacture, how they level the playing field, offering an unconventional response to conventional forces.
Kevin: I know Trump met with some of the defense contractors, and they committed to building more. But I mean, how many Tomahawk missiles can we make relative to, say, these cheap drones that Iran is making?
David: Not enough, and Iran has been a major supplier globally for drones. They have the capacity to manufacture 10,000 drones a month and extend the conflict at much lower costs compared to US and Israeli conventional munitions. And the defensive arms used to neutralize both drones and inbound missiles, the contrast between cost is amazing. $20,000 per drone. If you’re talking about the small missiles that are used to take them down, $30,000 at a minimum, up to $4 million per missile required to neutralize them.
Kevin: Hmm, wow.
David: And so time is the factor that multiplies the expense, the duration of this engagement. The Center for Strategic and International Studies estimated that the first hundred hours of the conflict has cost $3.7 billion thus far, just under $900 million a day.
Kevin: To me, that’s a little surprising, Dave. It seems like it would have cost more. I mean, a billion is a billion, but doesn’t it seem like this war would be costing more right now?
David: Yes. And I don’t know if that fully includes the cost to keep our carrier fleets in the area.
Kevin: Right.
David: And I think there’s a number of things that could be either added or subtracted. But if you just took the $900 million a day, if this extended six months, you’re still in the neighborhood of $170 billion for an expense, which is a lot of money, except that on a voluntary basis, the Congressional Budget Office pencils out that we’ll be at $1.9 trillion in budget deficit this year.
Kevin: Right.
David: So compared to our out-of-control spending already in place, it almost looks like a rounding error.
Kevin: Right.
David: Which is crazy, because when you talk about hundreds of billions of dollars, it is real money.
Kevin: But if you think about the costs, and I’d like to talk about this today, the costs are actually going to extend to— They’re taking out refineries. Let’s talk about that at some point. And you said desalinization plants as well.
David: Yeah. The real cost is having oil and LNG offline and damaging infrastructure, that would be the fat tail. Taking supplies offline for months instead of weeks, because if you damage that infrastructure, it’s very difficult. You have to then rebuild. And it’s not as if you turned off production switch and then turn it back on. It takes a good long time to restore and get back to previous levels.
So for a domino effect into the global economy, it’s infrastructure that matters most, not even the short-term closure of Hormuz, which has a real economic impact. We talked about last week the fact that most of the oil coming through the Strait of Hormuz is headed towards Asia, with some going to Europe as well. But if you’re looking at prices of LNG, they’ve skyrocketed predominantly in the Asian markets.
And so there are places, there are particular geographies which are more impacted by even the short-term closure of Hormuz. But you’ve had refineries in Bahrain, in Kuwait and Qatar and Saudi Arabia, United Arab Emirates have been hit already. One desalinization plant in Bahrain also damaged.
Kevin: Well, the refinery thing, what’s bothersome about that, we started to see that with the Ukraine war as well, Ukraine and Russia, because when you take out a refinery, like you said, you can have as many barrels of oil as you want. Unless it’s converted to something that can be used, it’s not useful at all. It’s worth an ounce of silver.
David: Yeah. So that introduces a different economic threat. Already we’ve had jet fuel crack spreads on the rise in Europe, and they’ve passed $88 premiums over the crude price. And in Singapore, the peak price was $230 a barrel.
Kevin: So what’s a crack spread? What does that entail? I don’t know that word.
David: Yeah. And I don’t know what the premium versus Brent was on the Singapore jet fuel crack spread, but let’s say it’s north of $110 a barrel.
Kevin: Okay.
David: So what is a crack spread? The price or spread over the crude oil price, that’s what a refinery charges to work through and refine from crude to some other form of usable fuel.
Kevin: Turn it into something useful.
David: Diesel, that could be heating oil, that could be jet fuel. So obviously, if we’re thinking about the economic impacts, airlines are already under pressure. Fuel cost increases hit those companies’ earnings per share dramatically where they’re inadequately hedged in particular. So Dow Jones transportation average over the last week has been hit. It’s off 7% versus the Dow Jones Industrial Average only off 2%. So it’s something to watch. Airlines in particular, Delta is off 9% over the past week. Southwest 11%. American Airlines, 12.7, United, 12.5%. Because again, the crack spread on jet fuel is at levels that will crush them.
Kevin: Well, and how significant is fuel to the airlines as far as their operating costs?
David: Yeah. 10 to 20% increase in fuel costs can hit their earnings per share by 30 to 40%. In some cases, even 50%, because fuel is between 20 and 30% of their operating costs. It’s the largest single line item. So on the flip side, you’ve got the refiners who make that difference. It’s basically a transfer of wealth from the airlines and their profitability to the profitability of the refiners. They’re making that spread. So Valero, Marathon, Phillips 66, these guys make the spread, as we discussed last week. Unless or until these moves in oil are seen as sustainable, your operators in the oil—and in this case the refining—space, they’re barely moving, which is a bit of a surprise.
I mean, in some cases, you’ve got refiners who are actually priced lower in the same week that airlines are down between 10 and 13%. So I think liquidity exiting the markets is one factor where people are not willing to take extra risk in equities, but you’ve also got durability of the move, which is another key factor. Again, you’ll see it in the crude oil curve, if you will. The futures market will price in and reflect concerns over longer term duration. Year to date, it is important to note that oil was already up 20, 25%. I mean, I’m talking about your operators, your ENPs. Call it 15 to 25% range, and all of that predated the Mid-East conflict.
Kevin: It reminds me a lot of the miners. You’ve been talking about the gold miners and what it costs to mine an ounce of gold versus what it takes to get it into, finally, the hands of the person who’s buying it. There’s a big spread right now. And gold’s influenced by inflation, so are interest rates. I mean, how’s the bond market handling this?
David: Yeah. The global bond market has been incredibly sensitive to the possibility of higher inflation. If you’re looking at one market which is expecting more inflation, and this may go beyond— Maybe it just speaks to how sensitive they are to even a minor increase. I mean, again, if you’re talking about a $10 move or a $20 move from 69 to 89, 40 basis points doesn’t seem very much, except that you’re dealing with a world that is awash in debt, and 40 basis points, which, less than half a percent may seem like a small number, but it impacts one of the largest markets in a very dramatic fashion. So rates have been creeping higher since the initial bombings.
On top of that, and as an extension of our conversation on liquidity last week, you’ve got leveraged loan prices that are falling. You’ve got high-yield spreads in Treasuries that are rising. All your usual indicators of stress in the fixed income market, really at the periphery of the credit markets, they’re getting repriced. So it’s kind of a combination of things. I think it’s both inflation, as well as a shift in, or a reappraisal of, credit quality, where again, it’s at your marginal quality, the highest risk—high yield, which is just euphemism for junk bonds, leveraged loans, collateralized loan obligations, private credit, which we’ve talked about in the last couple of weeks, you’re seeing repricing there. And that’s less about the inflation story, more about a shift in appraising quality of that credit. But both of those things coming together at once is, I’d say unfortunate.
Kevin: Well, and the thing is, it’s less about the war, too. See, the thing is, we’ve been talking before the war ever broke out. Interest rates, the bond market was already expressing a fear of inflation. Even the inflation market before the war broke out, didn’t we have CPI on the rise again in February?
David: Yeah, I think it’s worth noting the sequence of that. Again, just showing that the impact of war is going to be seen in your March inflation statistics. But February numbers, PPI was hotter than expected. Fed leadership is aware that current CPI—PCE is a preferred measure, close to one full percent above target. Similar to PPI, last week you had the ISM prices paid. It increased 11.5% over January numbers, from 59 to 70.5. And I mentioned the ISM numbers because it was all logged prior to the Mid-East conflict. So we have a bump in inflation prior to— Now you can—
Kevin: You had a bump in oil prices, you had a bump in inflation, you had to bump in interest rates. This was happening before any of this broke out in Iran.
David: Right. March figures are going to be market moving in fixed income when you get CPI, PPI, PCE. Friday this week, we have the preliminary University of Michigan sentiment numbers and the inflation expectations. It’s a broad sampling. I think the preliminary numbers are under 500 people, or 500 entities. And my bet is that the final report, which expands that sampling out, about doubles it, it’s going to diverge. The final will diverge from the preliminary, because again, the preliminary included interviews which were done prior to military conflict. So look for UMich numbers to move higher in a meaningful way by the end of the month.
Kevin: You know, with debt, you can handle debt if you’ve got a healthy GDP, if things are growing. And you can even handle some inflation if you’ve got the same type of thing, if you’ve got a lot of growth. If we had a slowdown, I mean, there’s a word that was used years ago. It’s sort of a meaningless word if you think about it, stagflation, that’s not quite saying it, but if you have inflation and a slowdown at the same time, that’s a real problem. And it seems like right now we may not have the growth that we need for the inflation that’s coming.
David: Yeah. Stagflation combines a slowing economy, which would impact the labor markets, with inflation. You bring those two together and it’s kind of a nasty recipe.
Kevin: It was like the 1970s for a while.
David: Mohamed El-Erian commented in the Financial Times, his article, “Stagflationary Forces Are Building,” two data points he references. Nonfarm pay rolls from last week off 92,000 when positive 55,000 was expected, and that puts unemployment ticking up to 4.4%. And concerns of inflation from supply chain disruptions and rising energy costs in the wake of the Mid-East conflict. So PCE in December already hit 2.9%.
Kevin: PCE is the preferred method of measuring inflation now. Instead of CPI, they use PCE.
David: At least at the Fed. Yeah, That’s their preferred measure.
Kevin: Yeah. Okay. All right.
David: You had core PPI, producer price indexes. And that was 3.6%, well above consensus. And El-Erian’s takeaway echoes ours. He says that, “How great a shock the world faces will depend on duration and the spread of the Iran war. More disruptions to supply chains will no doubt spur a further shift away from just-in-time efficiency to the more costly yet necessary just-in-case approach—
Kevin: Right, which is inventories.
David: —to inventory management. It’s a structural evolution that bakes higher costs into the system at a time when affordability is already an economic, political, and social issue.” That’s the end of the quote. And he goes on, and he describes a challenging setup for the financial markets. And three things are center stage: private credit—no surprise there for our listeners.
Kevin: You’ve been talking about that.
David: AI impacting the workforce.
Kevin: That too.
David: Again, you’re talking about sort of a white collar ghost town. So this is revolutionary, it’s fabulous. You can have every question answered better than just searching it on Google. AI will give you more detailed explanations.
Kevin: It’ll write music for you. I had an uncle who, in his 80s, showed me that he’s writing music now with AI.
David: Hey, I’ve used it to write poetry for Mary Catherine because I’m not much of a poet without ChatGPT.
Kevin: No. She should have slapped you.
David: Well, she knew it wasn’t real because she knows me.
Kevin: It was too good.
David: Yeah. Well, we all have our skills and that’s just not one of mine. The global bond market is the third area where El-Erian focuses, and its ability to absorb record supplies of government debt.
And that I think is a really critical one. And as you’re looking at influences in interest rates, sure, inflation is a factor for the bond market. And yes, they want greater compensation if they’re going to put money in the barrel. They want to be compensated for inflation risk.
Credit risk we talked about, is certainly growing, and that’s a part of El-Erian’s concerns with private credit and what we’ve described as a periphery to core migration. But the third aspect that can influence rates higher is a supply and demand imbalance. If you have too much supply, not enough demand, then interest rates will creep higher.
Kevin: They have to go up. Yeah, and we’ve got an awful lot of debt that actually we have to renew this year. I mean, how much do we have to renew this year?
David: Yeah. Meridian Macro tabulates the US Treasuries needing to be rolled over in this 12-month cycle at 10.8 trillion.
Kevin: That’s not chump change. And you don’t have a lot of buyers right now.
David: Well, so we have the CBO estimates of 1.9 trillion in excess spending which will need to be financed, plus the 10.8 trillion in refinancing and an unknown war tab building at 900 million a day. And I think frankly, we’ll run out of ammunition before we run out of money. You’ve got fiat and the ability to just print. And then you’ve also got the credit markets, which again—
Kevin: Again, you can’t print a Tomahawk missile.
David: Yeah. It’d be nice if you could.
Kevin: Yeah.
David: But this is something that doesn’t happen in the digital world. This is the real world.
Kevin: Right.
David: So all of this in the context of stubborn inflation and credit market repricing to higher rates, which is already happening. Just repeating the insight from Hard Asset Insights, each $10 price move in crude equals 20 basis points increase in the consumer price index. We can get above 4% inflation pretty quickly. And the financial markets can’t take the strain. They can’t take a strain of 100, 200 basis points increase in rates. Again, factor in, that’s the better part of 12 and a half trillion dollars that has to be financed in 2026 between Treasuries that are coming due and new financing. That’s going to require a lot of demand.
And El-Erian’s point is pretty critical because it’s not just the US that needs to refinance. Coming through COVID, there was plenty of growth in balance sheet liabilities globally. And so we’re competing, right? We’re competing for investor interest.
Kevin: We need those loans. Dave, I can’t help myself, but to go back to Jack Londen’s story, everything seemed to be going fine and it’s amazing how quickly certain elements can catch up with you. And El-Erian, what he’s talking about, the downturn in AI, the downturn in private equity, the possibility of not being able to borrow money without raising interest rates. All of those things could fall like snow from a branch onto the fire. I’m not trying to be a doom and gloomer here, but we probably ought to realize that we are in a vulnerable position if this continues, the duration thing, right?
David: Yeah. I just want to end with a quote again from Morgan Lewis. “Any clear and public failure to achieve quick and decisive victory in Iran that exposes US military weakness could radically change the global order overnight. In any such event, hold close to gold. There’s currently no other asset that can replace US Treasuries as the global reserve asset. If the rules-based order falls, we’re in a vacuum. At least temporarily, we’re left in a world without rules. Without rules, there is no trust. And without trust, the world will need to drastically reduce dependence on credit and counterparty risk, and only gold is gold at that point.”
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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 or 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.
