Podcast: Play in new window
- Quantum Computing makes giant leap – good or bad?
- Does quantum decryption impact cryptocurrency?
- Repo Market: Fed provides $50-75 billion per day in emergency liquidity
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Google & NASA Solves 10,000 Year Problem In 400 Seconds
September 25, 2019
“You’ve had debt issuance which has gone crazy, you have central banks moving back to QE mode, you have sovereigns that are looking to expand fiscal spending, and the bond market vigilantes seem to have taken a long vacation. The gold market may very well be sending you the same message – you’ve gone too far, this has been too much, this is not sustainable. I think the gold market is suggesting that it is time for insurance.”
– David McAlvany
Kevin:You know, I’m sort of a nerd, Dave, in many ways. Back in the 1990s I bought a book by Richard Feynman, the physicist, which talked about the concept that he was toying with called quantum computing. The name of the book was The Feynman Processor. What he was toying with was something that would actually give a form of knowledge power that would overwhelm any kind of processing that we had ever known in the past using quantum science.
David:In the last week to ten days we have had the announcement that cooperation between NASA and Google has used quantum processing in a very effective way.
Kevin:One of the problems with quantum processing, without getting too technical, is that it requires very, very low temperatures, and so refrigerators had to be made to actually cool things lower than any place in the universe that we know of. They have to keep these quantum particles in what they call super position – they are very finicky, very sensitive – for interaction. But up to this point, as far as I have studied this, they were able to keep eight quantum bits in super position.
Well, last Thursday it was announced, for a short period of time, on the NASA website, and then of course they pulled the report off, that they were able to process something with 53 qubits – quantum bits. They kept them in super position and they actually ran a program past them that would have taken 10,000 years on, actually, the fastest linear super computer that we have at this time.
David:That’s amazing.
Kevin:But before we talk about that, Dave, there are geopolitical events that are going on. We have the makings of what looks like war in the Middle East, possibly.
David:We had quite a week last week, and as we head into this week, as well. Between the Fed and their moving of rates, between what was happening in the oil market earlier in the week, obviously, there is a lot going on. Last week started out with a noticeable rise in oil, so, depending on who you talk to, attributable to the Houthi rebels, or to Iran. I guess there is motive involved if you are trying to go to war with Iran.
Kevin:It involved a fair amount of oil, didn’t it? We’re talking millions of barrels.
David:That’s right, 5% of the world’s total production. Saudi oil infrastructure lost 5.7 million barrels of production a day. That’s better than half of everything that comes out of Saudi Arabia. By the end of the week what you saw was that concerns of that supply being offline for long – they had faded. So there will be a number of months – originally they had thought a few weeks – to make those repairs. But the lingering impact on the oil market is this – it is the realization that asymmetric warfare makes a lot of infrastructure, whether it is oil infrastructure in the Middle East or infrastructure elsewhere, very vulnerable.
Kevin:This is a little different than states shooting at each other. The old Cold War – remember, it was real easy when you watched a James Bond film because you knew who the bad guys were. They were the Russians. And you knew who the good guys were – they were the Brits and the Americans.
David:That’s right. The CIA and MI6, you could always count on those guys, they were the good guys. It’s been a long time since I met with Martin van Creveld at his home outside of Jerusalem, but for those interested in knowing why the Saudi attacks are not a one-time event, I think you should read his book, The Transformation of War. It is a very critical look at this move from state-to-state warfare becoming something that is more asymmetric and non-state in nature.
If you want to take it a step beyond that, you could look at his more economic work, The Rise and Decline of the State. It is more of a slog, but the conclusion there, too, is that conflicts in the future are not primarily between two nation states, but you have non-state actors, you have asymmetric warfare, and indeed, that has been a prescient prediction. These are 20-30-year-old books and they have become the issue of the last few decades.
Kevin:Who would have thought that the technology that we are talking about, like quantum computing – if you can compute something in three minutes and 20 seconds that would have normally taken 10,000 years to compute, if you have non-state actors that want to use that for something other than the good of mankind, it seems like there is a tie-in here.
David:Well, it could be for the good of mankind. We rationalize and justify anything we want to do as the good for mankind, even if it is self-interested in nature. So it may seem an odd segue to talk about Google, but one thing that van Creveld did not address in those books that were written back in the early 1990s was these transnational corporate giants.
Kevin:Right. Google is bigger than most countries if you think of the information that they control.
David:And Google, although it was founded in the U.S., maintains headquarters in the U.S., its data collection and storage and its processing are obviously farther reaching. And it is relevant because of what we started talking about. This last week’s accomplishment was really something expected far into the future. Three minutes and 20 seconds, Google solves a P factor problem that linearly, using the world’s best super computer, would take 10,000 years. This is believed to be the first computation that can only be performed on a quantum processor.
Kevin:Just looking at that, there are two ways to solve a problem. There is an equation that tightens things up. We use equations all day long, Dave, when we are calculating ratios, or what have you. It really doesn’t matter what numbers you plug in, as long as you use the right formula you come up with an answer very quickly. You don’t have to test every possible way to accomplish it.
The quantum computer works on something called brute force problems. You had mentioned the P type of problem. That is a problem that you cannot solve without testing every possible outcome. I one time read it is analogous to trying to find the lowest point on one of those raised topographical maps if you had a program that was just going linearly across and up and down a map to find the lowest point. What a quantum computer would do is, it would see the whole map all at once. In other words, you don’t have an equation, it is actually accomplishing a huge, brute force problem all at once.
David:So quantum computing provides an edge to that classical computing.
Kevin:Exactly – linear.
David:So certainly there is room for exploration and creation of new materials and solving complex biological concerns, if you are looking at biomedical breakthroughs. Quantum computing could be very intriguing in the future, don’t you think?
Kevin:Well, as long as everybody has it.
David:Well, and I guess that is the point. As with any tool, it is not the tool which is an issue, but the user of the tool. Just a few weeks ago, with 9/11 passing around and the New York Timesjust off-handedly talking about the 9/11 attacks and these deadly planes which rammed into Tower I and Tower II, I had to pause and think, generally speaking, planes are not deadly, but in that case they were weaponized by particular people with a particular motive.
Kevin:So you would call these assault planes. You would have to re-categorize these as assault planes.
David:High capacity assault planes. Seriously, what do you do with an informational advantage – back to super-computing. Who is able to control and limit the possibilities of shrinking time, if you have an algorithm and you can fill all of the informational gaps that take away arbitrage between two informational points? If you have an informational advantage, what do you do with it?
Kevin:I think about it. Okay, they say that there are more moves on a chessboard than there are particles in the universe. I have never tested that, it would take a little bit of time. But what if you were playing chess with a quantum computer? The quantum computer could work out every possibility before you could even start to make the first move of the first pawn.
David:It’s not a game.
Kevin:Exactly. But when you have one entity who has that control, and you have the rest of the world who still has to do things in real time, again, the questions come up. It becomes more philosophical, Dave, than it is technical.
David:And I think to the person observing and who doesn’t understand the quantum aspect, it looks almost spiritual in nature. You and I have talked about quantum computing before, and this information advantage, it is as if you are working with magic.
Kevin:Arthur C. Clark, I think, said that technology can be mistaken for magic if it is advanced enough.
David:Yes, so is there a point at which – I want to go back to a conversation that we had with Richard Bookstaber a year or so ago. He wrote his book The End of Theory, and is there a point at which computational power is sufficient to judge the probabilities of choices that you and I might make, and essentially guide those choices?
Kevin:Let me ask you a question. This might be more simplistic, but how does this affect cryptocurrency? The value of a cryptocurrency comes from its inability to be decoded quickly.
David:When you think crypto, it is the first part of the word cryptography, and so if you can solve any problem by brute force, theoretically, there is a consequence to cryptography. Really, it is kaput. So Google’s quantum supremacy, developed, matured, broadly applied – the nature of cryptography and computer security is changed forever.
Kevin:That’s not just finance, that’s military, you name it, cryptography is used for just about everything.
David:Now, this is years in the future, so I think it is worth looking on the horizon and seeing what may be. And certainly you could say, Kevin and Dave, this is a work of imagination here. Yes, but it was also a work of imagination to go from eight bits in super position to 54 bits. One of them failed, so they ended up with 53 bits in super position in this case, but that was not supposed to happen for years and years to come.
So again, this idea of it being so far ahead – well, maybe not. So the P factor problem that Google solved using these 53 or 54 cubits, it was a specific problem. So maybe the questions that you and I are asking are philosophical and maybe even alarmist. But on the other hand, I see IBM aggressively seeking to make quantum computing more applicable to a broad range of questions and uses.
Kevin:For the people who watch Jeopardy at about dinnertime across the nation, the questions are asked in a way that you wouldn’t think a computer could actually answer. But if you watched a few years ago, IBM had a computer – granted, it took the size of a warehouse to play a man who was standing there, a human being. But it won. And you look at some of the ways the questions are asked, and it requires sideways thinking, or lateral thinking. I could see where you could use quantum computing if IBM applied the algorithms right, wrote the programs right. I guess it is all, in life, about asking the right question.
David:As we talked about a couple of these things around the dinner table last night, we went back to the classic story that Plato tells in his book, The Republic.
Kevin:About the ring?
David:Exactly, book two of The Republic. It, too, in my opinion, is about informational advantage, and what we, as people, do with that information advantage. The discussion is on justice and what a man chooses – to be just, or does he choose to be unjust? What does the character do, in this case, Gyges, in the story, when he is given an informational advantage, giving him impunity from wrongdoing? And, in brief, he uses it. He takes an informational advantage, and he abuses it. He usurps the king, and he sets himself up as a dictator. Nothing holds him back. And the Gyges ring story is repeated in other literary narratives. There is a ring of familiarity to it in Tolkien’s series, The Lord of the Rings. The message is clear. Again, it is not the tool – there is nothing implicit to a ring which makes it good or evil, or to a technology which makes it good or evil. But we should fear that the tendency toward injustice in the human wielding the tool.
I am fascinated – it was my ten-year-old last night who said, “Do you remember when Gandalf said, ‘I won’t touch the ring, because I know that I will use it for good, at first.’” I think there is this idea that what we create we have grand ideals in mind for. We don’t know the successors. We don’t know the character of the men or women that follow us and how they use the tools, even if it was originally created for good.
Kevin:A guest that we had just a few weeks ago said something that was sort of chilling at the end. It surprised me a little. He said, “I believe in illumined leadership by an illumined few.” You mentioned just or unjust. Very few people in power believe they are being unjust. They believe, actually, that they have a better solution than the average man.
David:With the perspective, of course, that you are always coming from the illumined point of view.
Kevin:Yes, as long as you are the illumined one.
David:Exactly.
Kevin:Let’s go back to state and non-state. Remember a few years ago we had Nazli Choucri on. She was from MIT, had studied the Internet, and she said, “You know, the Internet is sort of interesting because it doesn’t follow state boundaries and national boundaries. It transcends that.
David:That’s right. That was a part of the issue – who controls it? This is kind of strange in the context of states and borders and TSA and things like that – this is an unbounded and jurisdiction-less world of data that we navigate on the Internet every day. So how do states deal with non-state actors? And what if those non-state actors have informational advantages that the state does not have? Where is the confluence of interests between, say, the world of Google and their corporate objectives, and the world of established and entrenched power? Again, I think we are at a very fascinating point where I don’t know if I am encouraged or terrified by NASA being a part of Google’s findings. Maybe there are some sort of checks and balances. I think I would rather have them working with Google than a different country around the world. But if you are listening to this and you live in Norway, or you live in – again, this is sort of an informational disadvantage and you would hope that there is more free play here, right?
Kevin:Well, and I hate to say this because it will probably launch a whole flurry of defensive comments on our site, but any time we say there might be a vulnerability in cryptocurrency, there is a loyal few who see cryptocurrency as the new gold. But there are vulnerabilities. If you can break the key, it is no longer crypto.
David:Yes, and this is my chief objection to putting real money into cryptocurrencies. It is this issue of cryptography and quantum computing, because cryptocurrency scarcity, and therefore the value implicit to the cryptocurrencies, are dependent upon that laborious computational processing that they call mining. Google is introducing the realty of de-crypto. Do you understand? If scarcity of these digital currencies is important, what does scarcity look like for these digital currencies when quantum computing eliminates the cost to mine them?
Kevin:Speaking of that cost, I was reading that it is an average of 5,000-6,000 kilowatt hours for a single bitcoin, which is about half the usage of power of a house for a year. That is really an amazing amount of labor. Of course, it is translated all over the world because you have computers that are doing that algorithmic search coming up with the next bitcoin, but somebody is going to have to find a corner that continues to keep things in cryptographic form.
David:Yes, so we’ve looked at cryptocurrencies and said, “From a state standpoint, will there be any existing state that allows for the displacement of their currency monopoly?” And so we have this theoretical derailment on the table. And then there is a challenge to that. I think, obviously, the more concerning issues when it comes to quantum computing deal with privacy, deal with national security, deal with the abuse of big data.
But I would say this. For those who have chosen to speculate the cryptocurrency space, you should consider the utility, you should consider the disruption potential from the utility, rather than the mere speculation on price, because quantum computing, at least in theory, and maybe this is years ahead so no real concern today, but quantum computing is the death knell for radical appreciation in cryptocurrencies.
Kevin:Yes, so just to be clear, block chain technology is an amazing technology, but probably it will be regulated by the people who also create the currency.
David:So look to its utility, look to the ways that it disrupts particular industries, and I think in that you can find a thousand speculations, all profitable. But again, if it is just price appreciation you are running up against two things – state power and the complication of regulation, as well as quantum computing, which, again, makes mining something that is actually quite effortless and costless.
Kevin:We sound like we are talking about dystopian types of things, and your son, you had mentioned a few commentaries ago, that your son has been reading dystopian novels.
David:Right. It’s just par for the course at this point in his education. As a young teenager he is asking questions anyway, so why not read some of the great dystopian novels? I think he is working through Marx as we speak. I think he is intrigued by our conversation, probably a little bit scarred by the conversations. He doesn’t like the idea – if you remember the movie Minority Reportwith Tom Cruz – he doesn’t like the idea of living in that sort of dystopian world. By the way, we do watch light-hearted movies, as well.
Kevin:So you do get Princess Bride in every once in a while?
David:Oh, of course, it’s one of their favorites. But there is good and evil – as Plato lays it out, justice and injustice. That is at the heart of Plato’s discussion from thousands of years ago, as much as it is in the heart of our discussion today because the technologies that we create can promote either of these outcomes – good or evil, justice or injustice. And I don’t care what you are talking about, whether it is guns or cars or super computers or cameras. I was looking at Atlanta. Atlanta has several thousand cameras monitoring the people. The largest per capita surveillance in the United States is in Atlanta, and that doesn’t hold a candle to what they have in Great Britain, which is hundreds of thousands. And if you go to Chongqing in China, now you’re talking about – I think it is 2½ to 3 million cameras – in one city. I think of a camera as something that takes pictures and records fond memories of family, right? That’s one use, isn’t it? The other use, or abuse, may be monitoring to control.
Again, all of these things are neutral. It depends on how they are used. The issues through time, whether it is Plato or today, are the same. We have agency, we have responsibility, we have limits of human action such that one person’s choice may, in fact, negatively impact someone else. So the tools are neutral. The use or abuse of those tools – that is what lies in the domain of policy choice. That is why moral critique and social consequence and our discussion have to come around them.
Kevin:And don’t you think that this actually applies to the concept of liberty? Privacy is a portion of that, as well as even just private property ownership. Life, liberty, and, actually, it originally was supposed to be the ownership of private property – life, liberty, and the ownership of private property, because the pursuit of happiness is pretty vague.
David:It is pretty vague, and I agree with you. So we have Saudi oil on the one hand, we have Google quantum supremacy, and both deal with the deteriorating role of the state, and the rise of non-state actors. And factor in here, I can hardly imagine bureaucrats of any stripe sitting idly to see if they, whether with pencils or paper clips, remain relevant in the years ahead.
Kevin:Lest we think the state no longer exists, though, front and center right now is China and the United States, so we still have to look at state actors as they fade away.
David:But if we think that the power struggle in the 21stcentury is primarily about that kind of trade conflict – China and the U.S. – obviously, we have the old ideas of state power, the classical struggles between super powers, on display. But we have seen that kind of struggle over and over again since the Treaty of Westphalia, 1648, and that has defined the world according to non-religious groups.
Kevin:And that is a great point because before 1648 it wasn’t really the state that we would have thought of. It would have been a religious entity.
David:Right. So now we go back to something that, again, I don’t know that you can say that it is drive by ideology, but the non-state actor, however you define that, the non-state actor empowered by technology, and I guess occasionally inspired by religious ideology. But again, with an informational advantage, in the case of Google and maybe a technological advantage, even as basic as something as drones might have been for the Houthi rebels, they might be able to undermine a nation state. That is fascinating to me. Isn’t it?
Kevin:You know, if I were an investor listening to this and I wasn’t really interested in the things we have been talking about, I would say, what does this have to do, Dave, really, with my investment today, whether it is going to go up or down?
David:Well, on the one hand nothing, but on the other hand everything, because who determines the outcomes in the market today? This is a macro and a micro question. At the macro level you have central planners, you have bureaucrats, you have central bankers, and at the micro level you have people who want an informational advantage, as well. Think of the trading operations that want to be located as close to an exchange as possible because they are still using the traditional computing.
But powerful algorithmic trading gains an advantage by proximity in so far as speed is enhanced and the information can be reacted to faster for these high-speed, high-frequency trading platforms if you are located closer to the source from which those ideas and the source of information is emanating and to which the trades can be placed.
Kevin:You think about light speed being 186,000 miles per second. You would think that is just too fast to matter, but you are exactly right. Real estate near these trading organizations or operations gets higher and higher priced as you get closer to it because that little fraction of meters that you can pick up is enough to actually get a trading advantage.
David:Right, so arbitrate is just filling an information gap. You have two parties and they think they know something, and there is something that both of them are missing. If you can fill that gap, there is profit. And this is the nature of most markets where prices are determined and people make decisions and money flows according to some sort of informational arbitrage. Informational advantage is the key to profiting in the markets. What if you take away, or eliminate, all information advantage?
This is why, theoretically, this is very important because you could get to the point where there is no such thing as a market. We’re not there, but I’m just saying, test this out. If the nature of a market is that arbitrage gap fill, and you can get rid of it through the superimposition of 54 qubits, or 256 qubits, or however many go into the process of quantum computing, what does the world look like that we live in, the world tomorrow?
I was asked by a journalist earlier this week, and this is one of the reasons why I think this is very apropos, about the Powell rate cut, a 25 basis point cut this last week, and his question was, is the market in control or is the Fed? That was the question. The question is multi-layered because you have controlling the narrative and the data to support the narrative, and ultimately, the desire to influence belief at such a deep level that choices by the common investor, the hoy-polloi, can be influenced.
And so yes, you saw Bernanke and Yellen and the desired wealth effect – does gold stimulate economic activity? And lo and behold, the second part of that equation did not materialize – the economic activity part. But they were still going after the influence of the crowd. And now what are they going after? They want to influence the all-is-well litmus that everyone in the market uses. This is an imperative for the Federal Reserve and the powers that be. Managing the direction of the stock indexes is key because that is the litmus test for “How are we doing? Am I making money? Everything is fine. I’m losing money? Something is wrong.”
Kevin:And I have to think back to May when our good friend, Howard Onstatt passed away. I had asked him about a month before he passed away what was his thought? I didn’t know it was going to be our last conversation, but I said, “Howard, can you leave me with a thought?” He said, “Yes, the cycle prevails.” The cycle prevails. Which is answering the question. The market will be in control at some point.
David:Right. So we look at last week as an important one with a number of very subtle things occurring, which suggests to me that in spite of the presumption of control by the central bank community, the standing bureaucrats in D.C. and around the world, the markets are alive and well. The cycle prevails, and the consequences of financial market success are on the ooze. The Fed can’t quite keep them contained. They are beginning to ooze out a bit.
Kevin:But I thought when we had low unemployment that we don’t cut rates. Tell me about that, Dave.
David:The first observation from last week, a 25 basis point cut, along with a decrease of interest on excess reserves. They cut that from 2.1% down to 1.8%.
Kevin:That’s where they pay banks not to loan money.
David:That’s right. I reflect on the IOER, Interest on Excess Reserves, number as a motivation for banks to not lend. You get to collect interest without taking any credit risk. What are the consequences? If you shrink the benefit to banks to not lend, you may, in fact, be encouraging some of those excess reserves off the sidelines and into the economy.
Kevin:That would be good, I would think, wouldn’t it?
David:You should see a pickup in velocity. Yes, good perhaps, but potentially inflationary, as well, so you have to keep that in mind when the IOER comes down, or goes to zero, which is what it used to be. They never paid interest on excess reserves.
Also from last week, Fed Funds, again a 25 basis point cut, you mentioned kind of an oddity given that unemployment is where it is. Fed Funds was first targeted in 1982, and no time since then has the Fed cut rates with unemployment below 4%. The closest we came was 4.2% back in 2001, and they did cut rates at that point, but that is the closest we have come. Now you have Bullard from the St. Louis Fed, who is angling for the next Fed presidency when Powell moves on. He says, “No. No, we should not do 25 basis points. It has to be 50.” (laughs)
Kevin:Oh, he just wants more and more. But with all this money available to flow, how come last week, Dave, most people didn’t even see this because they don’t understand how much liquidity is necessary in the 24-hour markets, but the Fed had to just pour billions and billions and billions of emergency money into the market because there was a lack of liquidity. In fact, I think that liquidity, which normally runs about 2% to borrow, jumped to 10% at one point, there was such a lack of cash.
David:Yes, you’re talking about the repo markets and the overnight lending markets. The repo market last week showed some very interesting signs of stress, and you haven’t seen those on display, or the Fed’s involvement in that market since the global financial crisis.
Kevin:So for 11 years.
David:To keep overnight lending rates at a normal level, the Federal Reserve entered the repo market and provided between 50 and 75 billion dollars a day in liquidity. That’s interesting. Now, supposedly there was 35 billion dollars in outflows from money markets to meet the September 15thquarterly corporate tax payments that were due.
Kevin:Thirty-five billion dollars is hardly 75 billion dollars a day.
David:Right. So the Fed’s activity was to kind of smooth that out – that was the narrative – smooth that out. But as the Credit Bubble Bulletin, Doug Noland’s piece, pointed out over the weekend, this activity comes on the heels of some very interesting things. You have instability in other markets, which again, the news media did not point to any of this. But the week previous, we had an extraordinary bond reversal. You had ten-year treasury yields which moved up – up– 34 basis points. Mortgage-backed securities spiked almost half a percent in one week, from 2.37 to 2.83 percent.
Kevin:That had to be a shock because most people are just shorting that. They’re basically saying that interest rates are going to fall forever.
David:Right. So you have the clobbering in the bond market. You have a recent clobbering of long/short hedge funds. You have a very powerful short squeeze. You have the quant funds, which are just getting rocked. And all of these things precede the repo disruption. But nobody is talking about that, right? And by the way, before all the hedge fund chaos and chaos in the bond market, the reversal the week previous. You have Chinese money markets which are in turmoil, and you have QE, also the week before, restarted by Draghi.
Kevin:That was in Europe.
David:It might be a coincidence, but I think the 35 billion one-time quarterly tax payment doesn’t seem like enough of a catalyst to require a daily commitment of 75 billion dollars from the Fed all the way through October 10th. Just so we are clear, the number 75 is not added cumulatively. This is not an aggregate number. The loans in these repo agreements are for less than a day. So last week they were oversubscribed, this week they are undersubscribed, suggesting calm again. The markets are calm, the overnight lending markets are back to normal. But that made for some interesting, interesting dynamics in the market last week.
Kevin:Do you think if you were in the Federal Reserve you would be nervous, or would you just realize you have unlimited control?
David:The things that would make me nervous are where I believe I have control – having that slip from my grasp. So fascinating to see the Fed Funds rate move above its target on Tuesday of last week, and the Fed didn’t like everyone seeing that market move, because this is their number. This is the Feds “keep this within determined parameters.” So who is in control in the end? The all-powerful Fed is supposed to be able to control this number and yet it is slipping from their grasp. So to me, last Tuesday, Fed Funds moving out of their grasp was a little bit like the all-powerful Wizard of Oz. “Just pay no attention to the mortals behind those curtains.”
Kevin:Yes, but does it still not seem like life support in a way? Even if the body economic looks like it is healthy, it somehow is connected to a bunch of machines.
David:Our frequent guest, Bill King, suggested that anyone paying attention should realize that the global financial markets cannot function smoothly without constant central interventions. Markets are addicted to central bank support. King also suggested last week that Mr. Bond – the bond market – may be revolting at long last. You have debt issuance, which has gone crazy. You have central banks moving back to QE mode – quantitative easing. You have sovereigns that are looking to expand fiscal spending.
Kevin, you and I have said this over and over again – the bond market and the bond market vigilantes seem to have taken a long vacation. The gold market may very well be sending you the same message – you have gone too far, this has been too much, this is not sustainable. I think the gold market is suggesting that it is time for insurance.
Kevin:The fascinating thing about gold, though, versus bonds or currency, unlike the Fed being able to just come up with money out of thin air, 75 billion here, 50 billion there, we know that the gold market – we’ve seen this before, Dave – when people start running to gold they start realizing there is nothing there. I was telling a client this the other day, you would think October/November of 2008 we would have been doing gangbuster business because we had a line out the door, basically. But we couldn’t get product.
David:And just for that flashback, it took me about 90 days to say, “We’ve got to fix this problem, and fast. This will never happen to us again as a company.”
Kevin:You had to go to Europe to do it.
David:That’s right. So I created a company in Switzerland that allowed for the purchase of gold direct from a number of refineries there in Europe, and it opened up our supply lines to where we weren’t constrained by whatever supply might come from a Johnson Matthey or today, Asahi. Believe it or not, the Japanese beer company bought Johnson Matthey here in recent years. I don’t know why.
Kevin:Beer and gold. Beer and gold (laughs).
David:Also this last week, lest we forget, you have three from J.P. Morgan who are being prosecuted under racketeering for manipulation of the gold market.
Kevin:Do you think that’s a hand slap, or do you think it’s the real deal.
David:When they throw out racketeering, it’s a bigger deal. And I think one of the things that this sets is a tone for the next six, 12, 18 months, where the shenanigans maybe you got away with in terms of manipulation of the gold and silver markets past tense…
Kevin:You might think twice?
David:If there are consequences, yes. And if it is more than a hand slap, certainly. You have career risk always, but that is one of the reasons they take the risk.
Kevin:But racketeering is a prison sentence, right?
David:Exactly. Go back to the market. On the bright side, in spite of all the repo stuff, there was little to no follow-through in other markets last week, in terms of weakness. I think Friday was the exception. Friday, not only did the stock market weaken a bit, but you also had credit default swaps. They started to have some activity. Bank credit default swaps moved pretty significantly, and then stayed at those elevated levels through Monday of this week. Again, you listen to the pundits and they say the Chinese were disinvited from a farm tour and that is why the markets were off.
Kevin:(laughs) I saw that.
David:Yes, so you’re telling me the credit default swaps didn’t move one bit all week long with all the chaos in the repo markets, and then a tour of – I don’t know, it sounded like total hogwash to me.
Kevin:Unintended, yes.
David:You can’t look at our soybeans and pigsties and that sends the market into a tizzy? No.
Kevin:I don’t think so.
David:I guess the point is there are some underpinnings which are unhealthy. The rockiness in market movements actually started before that Chinese announcement. They started in the overseas markets well before the farm cancellation. The media is just always looking for easy causal connections.
Kevin:You talk about the Federal Reserve being in control, and when a person knows that the Fed has their back, they start layering leverage on. It’s like, “You know what? If I’m going to make a little bit of money, I’m going to borrow some and make a lot more. And I’ll borrow more and make a lot more.” You get these layers and layers of leverage so that even a small amount of volatility can kick that thing out.
David:But the speculative community, today, does believe that they have enough money in play, with enough counterparties in the mix, that if they don’t get their way and you start to see a significant market selloff, that is exactly what the Fed is going to do. They are going to back up the truck, and just like they did for the repo market, they will provide any quantity of liquidity. The reality is, the leveraged speculative community is on edge, and when we talked about some of the things that they have encountered earlier, whether it is losses from Argentina, emerging market currencies, emerging market bonds, the quant quake we discussed earlier, these have been small instances of hemorrhaging within the hedge fund community, and I’d like to see some of those losses marked-to-market here in the 4thquarter. I think it is likely to impact financial conditions, tighten them considerably.
As we talked through our weekly meeting Monday this week – Doug’s opinion – we should remember this repo deal this last week is marking the Fed’s smallest balance sheet for years to come, perhaps even for my lifetime and yours
Kevin:So he says the Fed balance sheet is going to expand from here?
David:Absolutely. And I think he has support for that. Listening to Powell’s comments after the statement of what was being done in the Q&A he started responding to a question on negative interest rates. Powell’s comments after the Fed meeting basically said that negative interest rates are less interesting to him than large scale assets purchases, meaning massive QE is the next tool for the next downturn. So mark this on your calendar, this is about the lowest, 3.74 trillion, that you will ever see the Fed balance sheet – 5 trillion, 10 trillion – as Buzz Lightyear liked to say, to infinity and beyond.
Kevin:I think it is important for us as the people who are on the other side, remember we talked about the illumined few making illumined decisions. If you are not part of the illumined few, it actually ends up costing you quite a bit of money. We talked about negative interest rates being a confiscation of your deposits, but actually, QE is a confiscation of the buying power of your cash, and so either way, whether Powell is less interested in negative interest rates, and more interested in QE, or vice-versa, the result is the same. It is a loss of your savings, the buying power of your savings.
David:One of the things that I think makes gold an intriguing purchase in the next few years, an asset to own, is that we are seeing the same kinds of tendencies among all the world’s central bankers, as if Europe wasn’t in enough of a sinkhole. You have the European PMIs, the Purchasing Managers Index, numbers not good. German manufacturing was the worst of all, the low 40s, and Draghi comes out and says, “We need to start exploring the merits of Modern Monetary Theory.”
Kevin:Yes, print that money with no restriction.
David:Exactly. So you can print and fund any fiscal issue. You have probably heard this said before, that it could get worse before it gets better. I think it could get crazybefore it gets any better.
