Podcast: Play in new window
- China part 1 – Did we get the deal or does it just “look amazing,”.
- Boris Johnson win in England should give U.S. Democratic candidates the shivers
- $1 Trillion annual deficit for the next decade? What could go wrong?
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Let’s Make A China Deal! What’s Really Behind Door #1?
December 18, 2019
“In a period of rapid-fire credit creation, of massive deficit spending, gold is likely to have a very fresh day in the sun. Think about this. The correlation between massive deficits and the gold price is a very strong one. So let’s just take it from the CDO that gold is going higher, as deficits are going higher. And this is regardless of who wins in 2020.”
– David McAlvany
Kevin: David, finally, we have been talking about this, it sounds like maybe there was a deal. But I have to tell you, when I was growing up I never missed Let’s Make a Deal with Monty Hall, Carol Merrill, and the three doors. Door #1 sometimes had a car behind it, door #2 sometimes had a vacation behind it, door #3 might have had – oh, I don’t know, a pig with some soybeans. I’m wondering how this Chinese deal – which door do we have?
David: (laughs) Here is the deal. In principle, we have one. In some ways, I think that relieves us of having to come in every day in the morning to some surprised headline or tweet on trade. And that’s how we’ve buoyed the stock market. “Look, we’ve got a positive new movement toward a trade deal.” Well, now we have one. Here, the problem with the deal is obvious, because after two years the Chinese – what are they going to do? They’re going to buy some pork, they’re going to buy some soybeans. But, well, they have yet to say how much, or when.
Kevin: So it doesn’t sound like the new car, it doesn’t sound like the vacation, it may very well be the pig and the soybeans.
David: The pig right behind door #3. Details are either not determined at this point or they have not been disclosed. We had one of the Chinese negotiators from Beijing, Mr. Wang, who said that it still needs to go through the legal procedures, and that has to happen in both countries before it is signed. In other words, the deal that we have is really just a verbal nod, which last time I checked, if you’re talking about Trump and the deals that he has done in the past, that is not the kind of deal Trump would ever consider to be solid or committed, as in signed, sealed and delivered. A verbal agreement is one of those things that you can – again, we come back to, in principle, we understand where we’re going. (laughs) What has been finalized?
Kevin: And that’s the thing. Trump does know how to make a deal, and so what is the deal Trump is really making versus the one that actually is being put before us? And I think that probably is that he wants to convince the people that there has been a deal. I mean, look at the market. It has been soaring, they have been fueling it with just huge amounts of printed liquidity, but also, great news in perfect timing.
David: It’s just such a contrast between the NAFTA deconstruction and then restructuring, where, if you want, you can get clear answers to it, whereas in this case you are left with a lot of questions. So you have Trump who is estimating 50 billion dollars in agricultural purchases. That is Trump who is estimating, that is not the Chinese committing, and actually, the Chinese were completely silent on that point. The Chinese did not answer the question on the size of agricultural purchases at all. So you do have sort of a verbal agreement that they are going to try to increase trade above the 2017 levels by 200 billion dollars. But I think even more scarce were the details on the real substantive issues of intellectual property, forced technology transfers, what Trump has been pounding on since day one, currency manipulation.
Kevin: Those are the important issues, not the pork and soybeans, right?
David: Exactly, so what the Chinese want is to bring technology to the world, because frankly, they can buy soybeans other places. They can go to Brazil, and there is a wider market for some of the agricultural products that they need.
Kevin: The other thing, too, is he has delayed phase two now until after the election. So what do you think the play will be on that?
David: Honestly, until the ink is dried, I don’t even really have confidence in phase one. But you’re right, at least from his mouth, phase two is now after the election. Again, bear in mind, there are no written details on phase one. The Chinese can walk away from this. Or even better yet, because there is nothing in writing, Trump can say that they walked away from it. And that is either in the midst of, or immediately after, the impeachment trial. Again, he will go back to his tweets and his headlines if it is useful in the election cycle.
Kevin: Also, we have to look at the actual presumptive close, if you think about it. Well, we’ll do phase two after the election. In other words, the presumptive close is, after I get re-elected.
David: (laughs) I wonder what the news stories will be. You have seen the importance of how this issue has been used to create positive energy in the stock market. You have Kudlow who will come out and say something, or Trump will come out and say something, or Mnuchin will come out and say something, kind of cheerleading the stock market enthusiasts. If phase one actually does stick, what do these guys come into the marketplace with to kind of continue that cheerleading from now until November?
Kevin: Was the actual deal to be able to delay tariffs until after the first of the year? Going into the end of the year, with the stock market posting great grains, people right now are looking at unemployment and they are saying, “Wow, this is really, really low.” Why would you want to change the music before the end of the year?
David: Actually, it is that we’re not adding more tariffs as of December 15th, so he really got what he needed which was just an excuse to delay the added tariffs. But again, it’s not like we’ve changed the tariffs that we had in place before. They are existing modifications, minor modifications.
Kevin: And he billed this as an amazing deal for all. Now, I’m wondering how long you can use hyperbole if this really is just the pig with the soybeans.
David: Yes, it is amazingly skinny. It is amazingly scant on detail. It is amazing to me that stock investors, this group of all wise, all knowing, equity market enthusiasts – what exactly did they see in this? Maybe I’m missing something, but perhaps it is what we said earlier. It’s like a sigh of relief, some reprieve from the tweets and the headlines that have created some volatility, in some instances positive volatility for the stock market. Maybe it is just that, a curbing of uncertainty, to a degree.
Kevin: Well, you still sound uncertain, but I’ll tell you what, this whole Brexit thing in England – the uncertainty there just got washed away. At this point people have a pretty good idea that Brexit is a real deal.
David: We still don’t know what the long-term implications, if any, are to Brexit. But I think you are right, this is one of the significant events of the week. The curbing of uncertainty, with Boris Johnson destroying the labor party candidate, Jeremy Corbyn. This was the worst electoral loss in Britain since 1935.
Kevin: For what would be considered the progressives in England.
David: Yes, and I think there are similarities to the Democratic defeat in 2016. Look at the pollsters. The pollsters missed this in London by a massive margin. And the defectors, which I think, frankly, the Labor party would have described as “defective” voters – not my opinion, of course – but they have been reliable Labor voters from working class families in Northern England and Wales. And remember that these were families and communities that were, from an employment standpoint, brutalized by Margaret Thatcher in the 1980s, and had a lot of issues to overcome to shift to the conservative from the Labor party.
So now the uncertainty of stay or go Brexit – that is settled. Again, the implications of Brexit not necessarily settled, but the uncertainty factor of “will this actually happen?,” Johnson has a mandate to leave, and leave he will. So thus far, Britain has avoided what was expected to be the Brexit apocalypse.
Kevin: Would you say this is a little bit like Trump winning the election here in America? It’s the same type of thing. You feel this populism coming up. And the intellectuals, the ones that really consider the populists idiots, are like, “Don’t they see? Are they uneducated? Don’t they understand?”
David: I think there is a certain cosmopolitan blindness, whether it is New York, Los Angeles, San Francisco, Chicago – London, in this case – where you’re right, it is just inconceivable that people would do something so stupid as to move toward Brexit. Or as you said, in 2016, “How could he possibly win?” That would be like national suicide, the suicide of the West on display by bringing Trump into office. But some have said that in the case of what happened this week in London and across the U.K. that it was just personality. You had the unlikeable Johnson who won over the unelectable Corbyn. I think the issues run deeper than that.
Kevin: Do you think it is the distribution of wealth, or the redistribution, the gap in the middle?
David: I think that has a lot to do with it, and just as declining interest rates have set off income and wealth inequality, and a less than equitable distribution of wealth in the periods both preceding and following the global financial crisis.
Kevin: We had Paul Tucker on last week, central banker from the Bank of England, and other banks, as well. He also talks about central planning and central banking actually tipping off some of these inequalities.
David: And I think that’s what we have is a central planning and central banking miscalculation. What we are beginning to see is that these economic miscalculations have political consequences. So we find, not just populism – I think it is actually more than that because sometimes if you linger on that word, populism, you can dismiss the heart of the issue. But what you are having as a consequence is a restructuring of political loyalties and mandates.
Kevin: It’s not just here, it’s around the world.
David: And if you look around the world, you would have to say, okay, this is cities versus heartland, this is white collar versus blue. And yes, there is popular discontent, but oftentimes, again, populism has some baggage with it that suggests unemployed or disadvantaged people want to get rid of the old social contract and tear the system apart, restart with some sort of working man’s new deal or whatever.
And that’s not accurate. I think unemployment is not the issue. Maybe if you look at certain places – India, China, the BRICs, if we were to pick on those – Brazil. You have higher levels of unemployment, but we’re not talking about that being the driving issue in the U.S. and Europe. Obama left office and unemployment was not terrible. In fact, it was improving. And it has only continued to improve. So we’re not dealing with populism as an expression of, “We can’t make ends meet.”
Kevin: Would you say it is being ill-informed? That’s really what the elite would tell you. “Maybe they just didn’t understand.” We saw that when Trump was elected.
David: Right. Or disadvantaged, not having access to the right information, ill-informed. I don’t think that’s the issue, either. I think that serves as a rationalization for those who would defend the status quo, and it allows them to simply ignore objections or concerns with the status quo, on the basis that opposition, or whatever opposing ideas come into the conversation, lack legitimate intellectual grounds.
Kevin: Which is not true. There is an assumed ignorance that is not there.
David: Well, you could say it’s not necessarily the case.
Kevin: Right.
David: So you look at the gig economy and there is a disconnect between the types of education needed today versus what was offered 20 years ago. You have specific job skills, professional recalibration. These are real issues. And I think the intellectual elites have, whether it is London or New York, again we come back to that sort of cosmopolitan centers around the world – they are missing a recurrent theme. And the recurrent theme wherever you go in the world is these widening gaps in wealth and income directly attributable to central bank monetary policy. And no one wants to pin the tail on that donkey.
Kevin: Speaking of Paul Tucker, we were talking last week to Paul, and I thought that was an excellent interview. We got great comments on it. But what he said was important. What he didn’t say may be more important.
David: And I think that will take some time to unpack, because I think you are right, that was a very valuable conversation. I appreciated his candor, reflecting on what the limits are of central banks. I would say that one of the parts that was missing in our conversation with – I should have called him Sir Tucker. I didn’t realize he had been knighted, but yes, 2014, a year after he retired from the Bank of England he became Sir Paul Tucker. What bubbles? Was that a part of our conversation? Not at all. So do we have asset bubbles today? Is that a part of the monetary policy framework and the consequences of it? Did you hear any of that in our conversation? I’m glad we didn’t press the issue, but I think the absence spoke for itself, and I guess he was willing to acknowledge that there is “distributional effects” from central bank policies and that those are not even.
Kevin: And he may not have mentioned bubbles, and there may be, actually, a lot of reasons why, because they are so obvious right now, the bubbles are huge, and they have been fueled by central banks. But one of the things that I really did like was that he was calling for politicians to limit the power of central bankers. That is an interesting call from a central banker.
David: Yes, and I think one of the reasons why it is difficult for the conversation to go toward bubbles is that the largest today are not to be found in the equities markets. They are to be found at the heart of central banking money and credit. If you look at government debt, if you look at who is monetizing government debt, and pushing prices to extremes never seen before in the history of finance, this is where it gets really interesting. We are enabling a system that really can’t afford itself, and yet, we kind of extend and pretend on the basis of monetary policy.
I did appreciate his insistence that central banks should stay in their lane, and if you’re going to craft polities, keep them narrow, keep them explicit. I love the idea of a sunset clause with various mandates.
Kevin: Yes, the five-year thing.
David: I like to do a job, but it’s not a forever job.
Kevin: Right.
David: And so, I think most in the central bank community might agree with him in principle (laughs), but not really in practice. You see that even this week. We saw at the European Central Bank, you have Christine Lagarde – this is her first report as President of the European Central Bank, and what does she include in her sweeping – I don’t care if it’s fair to call it a shift in mandates, but now climate change is on her ECG agenda. Climate change.
Kevin: Well, if central banks can manage money, and they can manage employment, and they can manage inflation in the markets, why can’t they affect climate change, Dave?
David: If it’s the issue of our day, why can’t we manage it as central planners? Again, this is where you begin to feel almost the laughability, the hubris connected to – “Do you have any idea what you’re actually doing?”
Kevin: Remember Jurassic Park? Malcolm is my favorite character in Jurassic Park. Malcolm is a chaos guy, and they bring him in for his expert opinion on whether they could bring dinosaurs back and actually control these large – we’ll call them leviathans. What he was saying was, “No, there are always unintended consequences.” I would think over-managing or getting the hubris to think that you can also not only affect everything else on earth, including climate change from a central banker’s position, there are unintended consequences.
David: Again, I’m not really sure how this cosmopolitan blindness stays front and center, but here you have, again, widening wealth and income gaps attributable to central bank monetary policy, and nobody sees it, nobody wants to connect the dots, and we have the unintended consequences. The 2016 election, I think, is an expression of that. The Corbyn/Johnson debacle, if you want to call it that – certainly if you were on the Corbyn side of things this was a total debacle. The unintended consequences of trying to over-manage financial market outcomes is that we are shifting the political and social structures.
And now a gruff and very unlikeable personality – and by the way, again, this is not just 2016 U.S. politics, this is Bolsonaro in Brazil, this is Duterte in the Philippines, this is Trump, now Johnson in the U.K. You can be an unlikeable person and it’s not a deal-killer. Meanwhile, you have the grand promises of redistribution, and they are too often heard, and they are typically lacking a clearly articulated strategy. And with the intended audience, they ring more and more as empty promises, as political rhetoric. They have been heard so many times, and they have never been delivered on.
Kevin: I wonder, though, what the Democratic Party right now is thinking, because they saw in England something that they don’t want to see this next election. Corbyn was modeled as a progressive, basically. He took his modeling, didn’t he say, from Bernie Sanders?
David: According to the Washington Post, that is exactly right. Jeremy Corbyn, loser in the U.K. election, referenced in the Washington Post in June of 2017 as a model of success for American progressives. And then again in July of 2017, again in the Washington Post, Corbyn is quoted as saying, “I got my ideas from Bernie Sanders.”
Kevin: And he’s gone. Corbyn is gone.
David: There are differences between our political systems, differences in constituencies, differences in political candidates. The blindness of the pollsters, the deafness of the political elite – this is what is consistent from one side of the pond to the other. Politicians have abused their currency, which is just promises and commitments, as much as central banks have abused our system of fiat money. We’ll get back to that in a minute.
Kevin: Dave, years ago you had us, as a company, go back and read When Money Dies, by Adam Fergusson. It is a book about the hyperinflation in Germany from 1920 to 1922. One of the things that really struck me as shocking was, as they looked back in the rear-view mirror after the market completely collapsed and they had to restart the financial system, very few people understood that it was monetary policy that caused the hyperinflation in the first place. They were blaming everything else, but they still didn’t learn the lesson as a country. And I’m just wondering, because of the liquidity that is being thrown into the system, all of this lunacy that is going on to push these markets right now, when we look back in the rear-view mirror, will we blame it on monetary policy?
David: That is the irony because we got into the series of crises that we have had over the last 20-30 years because of monetary policy, and yet, because we have moved toward specialization, and there are vast degrees of ignorance, both in the political class and on Main Street and Wall Street, who better than an expert to fix the problem? And this is why we were talking to Paul Tucker last week because we’ve seen this massive migration of power to unelected people. And he was right in saying, “This is a problem, it never should have happened. We should stay in our lane, and we’re not.”
So the irony is, the cause of the crisis, and yet the general perception is that they are the only ones to deliver the cure, and missing or ignoring the impact of monetary policy. This is also what is consistent from east to west, from north to south, central bankers won’t own it. And I think politicians – we have talked about blindness and deafness here – are too dumb to connect the dots. Maybe it is this. Maybe I should be more generous. They can’t find any political advantage to connecting the dots and saying, “Yep, it is central bank monetary policy.”
Kevin: So what they will do is blame the free markets. This next time we have a major crisis, they will basically say, “Look, it was market forces, it was a black swan, we couldn’t see it coming. By golly, we need to come in and save you again.”
David: And you already have that with a Warren, with a Buttigieg, with a Sanders, with an Ocasio-Cortez. With Corbyn this is what you have, not an assessment of cause in a careful way, but in a way that fits sort of a political rhetorical narrative. So in addition to what is branded as market failure – and again, this is the progressive left – “Inequality must be blamed on market failure. It’s not central planning, obviously. We’re advocates of having more central planning” – having a hard time connecting those dots, or wanting to.
Kevin: It sounds like something that somebody would write in the red book 100 years ago.
David: And I think that’s the deal, where Uncle Joe is being resurrected for the 21st century. And I’m not talking about creepy Uncle Joe, Joe Biden. We’re talking about old Joe Stalin, resurrected in the form of Corbyn, Ocasio-Cortez, Warren, Sanders. And we come back to this issue in 2020, in our elections, which is going to come down to unlikeable versus unelectable. And it seems like the 2020 election, really, on that basis, is Trump’s to lose.
Kevin: So if you’re a Democrat right now and you are paying close attention to what occurred in England, and around the world, how do you even approach the next election?
David: You might say, “Why is it Trump’s to lose, with impeachment already in the wind?” And I think the Democrats know the election odds are low. Why? This is a democracy, it’s a question of counting votes, and they’ve lost the working class vote. And they can’t make the Clintonesque appeal – you remember? “It’s the economy, stupid.” You can’t do that, can you? So what are you left with?
Kevin: You just have to insult the character who is in office right now.
David: That’s right. So character assassination is the only path to victory. And they have to get back the working man’s vote. This is the thing. It’s not on the merits of what they offer, because that’s the classic “Who gives the most free stuff?” In this case, 2020, it’s on the demerits of the incumbent. That’s, of course, how it is being framed by media, by Schiff, Nadler, Pelosi and company.
Kevin: Yes, I think they feel so disoriented because they’ve lost the class of people they thought would vote for them. The Democrats have lost the working class folks, at least for right now.
David: Exactly, so if they can migrate the working class family (laughs) sort of back onto the farm, because that is where the working class was supposed to stay. The Democrats have always known – free handouts, extra promises, a few programs, and you have that vote locked up. But that didn’t happen in 2016. And it didn’t happen in the case of Wales and Northern England this week. In the modern era, people are less enthralled by the broken record messages of both parties.
And Trump is not well received by the Republicans. He doesn’t represent the Republican Party, he is a man on his own, and he certainly is not a welcome participant on the Democratic side either. So you see people dumping the damaged goods, again those scratched records, over and over again, and they’re jumping on what has more visceral appeal.
Kevin: Okay, so I’m going to bring up impeachment now, because everyone is already tired of the whole impeachment message. I don’t care what side you’re on, I can hear it already in people’s voices. But is it a real deal? Is it something that could actually affect the election? Or is it something that is just wearing people out and actually hurting the Democratic vote in the end?
David: I’ve been thinking about this the last week or so, and it is not always the answers you have to the questions, but the questions that get asked. And I’ve thought to myself, “How can this possibly go off the rails for Trump? He’ll have plenty of witnesses there.” And then all of a sudden we start hearing about the Republicans saying, “No, no, we’re just going to whip through this very quickly, no witnesses required.” I’m thinking, “What is going on?” I don’t know if I understand the process or the rationalization for not bringing in new witnesses. But for me, it is game-changing to think that there wouldn’t be people called and questions asked in that environment.
Kevin: Do you think they’re trying to hurry it along just to get it over with?
David: I think there are a couple of things that are in play there because the trial would be swift. I think attention span is a social issue and you have 11 months to go until the election. And if attention span remains an issue that is a political concern for the Democrats. So that is one thing.
But I think one of the reasons why so much emphasis has to be put on the impeachment here is because it is difficult to vote the man out. Whether you like Trump or hate him, you have unemployment at 3.5%, you have incomes on the rise and a very tight job market. So back to Clinton, it’s a no-brainer if you can reference the pocketbook and the savings account and “It’s the economy, stupid.” But this is why the impeachment circus is in town.
And given that impeachment has been on the Democratic lips since before Trump’s inauguration, I guess the question would be if there is not so much desperation in this process of getting rid of Trump, that middle-class Americans, or Middle America, if you will, don’t see the Democrats as more of the clowns at the circus, rather than as the lion tamers.
Kevin: So you’re thinking that maybe the trial would be swift, but people have very, very short attention spans. So I’m just wondering, we’re 11 months from the election.
David: That’s right. So just as we have crisis fatigue in the context of military conflict, how many weeks did it take after the Gulf War many years ago for people to just tune it out? Or whether it is market disruption – mainstream media is reporting on a topic until frankly no one cares anymore, and the audience begins to tune out the news. I think impeachment fatigue is already a reality.
Like I said, impeachment calls have been there, not just in recent weeks or months, but go back and have been lingering in the air since late 2015, pre-inauguration, and really, it was just kind of on whatever grounds could be found. “We’ve got to do this on whatever grounds can be found.” So how do we frame a particular set of circumstances to make this happen? That has been an agenda item for the DNC since 2015.
Kevin: It is shocking to me sometimes, Dave, I will talk to people on the phone and I will realize that they have the news on all the time. They have picked their station, whatever it is, and they have the news on all the time. I can’t imagine hearing these same stories, this noise, over and over and over again. You were talking about fatigue. I’m news fatigued just hearing their stories that they’re watching all day long with bated breath.
David: I know there are some people who love to go to Vegas and love the ding, ding, ding, ding, ding, ding, ding in the background as they go through casinos, as they sit in the casinos, they live in a casino for hours or days, or however long. It takes me about 30 seconds to go just about crazy and want to crawl out of my skin hearing the monotonous ding, ding, ding, ding, ding, ding. And I have the same kind of internal response to the news when it is on and it is in a repeating cycle. I have to tell you, I was stuck on a treadmill for three hours on Sunday and I had Fox News right in front of me, and on one of the other televisions right next to it was CNN, both in front of me.
Kevin: Wow! Double pain. Double pain.
David: I now thoroughly detest them equally. These are three hours – I’ve got news fatigue, I’ve got impeachment fatigue, I’ve got breaking news fatigue, because everything is breaking news. Everything is breaking news, including like, saving a kitten from a – I mean, it’s just crazy.
Kevin: Yes, but news is a form of entertainment.
David: How many times can you repeat, repeat, repeat yourself? That’s what the news cycle feels like.
Kevin: You tell them it’s breaking – it’s breaking – it’s breaking – it’s the same type of thing.
David: No, it’s broken, is the whole messaging. But I agree, it’s entertainment, it’s selling ad placement to particular demographics. But the longer I was ambling on, on that treadmill, and they lingered on the same topics, I started hearing lyrics of Rage Against the Machine running through my mind.
Kevin: Uh-oh, your youth is coming out.
David: Maybe unfortunately, but most of you are probably better off never having heard of that 1990s L.A. rock group.
Kevin: Rage Against the Machine.
David: But I hadn’t planned on hearing the echoes of an old angst-filled teenage chapter of my life being drummed up by these pundits, and of course they are on opposing sides of the issues. But it was a reminder to me of just how quickly you can wear something out.
Kevin: Well, speaking of wearing something out, how long can we just pull money out of thin air and throw it into the repo markets, the quantitative easing? How in the world could anything go wrong if this free printed money continues to do the job it’s doing?
David: Maybe it feels like we’re wearing out that topic. I hesitate to bring up repo, but you have the Fed, that since September has bought 90% of all treasuries issued. And so, I get it.
Kevin: Is that MMT? Are we actually functioning with Modern Monetary Theory at this point?
David: In essence, we are. It’s like, okay, bring out the idea, debunk it, tell us it’s not real, it doesn’t work. And then just do it. Don’t think about it, just do it. So yes, we do have a form of MMT in motion now. Again, the Fed has bought 90% of all treasury issuance since September.
Kevin: Yes, but the stock market is hitting all-time highs, Dave.
David: That’s what people want to celebrate. You have new highs in the stock market, and there is an assumption that we are in a normal context of growth, in a healthy economic expansion, and it is just a continuation of the trend. And for those who are fans of Trump, this is just one more reason to look at what makes America exceptional. You can’t bet against America – this is a Trump brand of American exceptionalism. But what is it that is actually exceptional? This is where I look and say, there is a dependence on intervention, and the scale of management required to maintain the perceptions of health and economic well-being – well, we’re creating a new scale altogether.
Kevin: It reminds me of someone who you see driving the hottest new car and taking the longest, most exotic vacations, and you think, “Wow, what’s that guy doing?” And the closer you get to him, the more you realize – “Wait, this is a trust fund kid.” He’s not doing anything for this success. He’s getting this success handed to him.
David: Or another way of looking at that may be, his wallet is so thick but it’s not full of money, it’s full of credit cards (laughs).
Kevin: There you go, there’s another way to look at it. That’s a different type of trust fund, but isn’t it amazing?
David: Well, you just don’t have to pay the piper, and you don’t have to really be connected with reality.
Kevin: Yes, but the stock market’s up. I’m going to say it again.
David: How do we argue with it? The S&P is up 28% this year. Semiconductors, they’re up 55%. Just when you think you can make a fundamental case against a sector – I could give you a dozen reasons why semiconductors are on the edge of an abyss. Doesn’t matter. Stocks are up 55%.
Kevin: How about Apple?
David: 75%.
Kevin: 75%.
David: So our assessment is, and this is Doug Noland suggesting that when you have extraordinary asset inflation, that’s only possible with some underlying monetary disorder.
Kevin: Right. How about 2007, the year before the major crisis? We saw this accommodation. There was money from everywhere just going straight into – it was pre-crisis.
David: So here we are, 3rd quarter reports, Z1 reports are in, and we have total credit expansion of almost 1.1, 1.075 trillion dollars – one quarter. That’s the largest credit expansion since the 4th quarter of 2007. Before we abandon the repo conversation as a topic, I think last week’s Bank of International Settlement study was revealing. I didn’t want to distract the Paul Tucker conversation with what was out in the news from the BIS that week, but the Bank of International Settlements was looking at the repo issues back in September, and they were saying, “Well, one trouble factor is that it’s not just banks who are getting liquidity via the Fed’s repo facility. We have hedge funds which have found a fresh source of cheap financing for their leveraged speculations.
Kevin: In a way, it’s like handing a gambler free cash that the government is providing.
David: What could possibly go wrong? As we reach the final weeks of the year, this is the last couple of weeks of December 2019, the Fed is ramping up. They have plans between now and year end to offer 490 billion dollars – that is half a trillion dollars – to the repo market to ensure that between now and year end the repo market doesn’t see any hiccups.
Kevin: Boys and girls, there will be no lack of liquidity. Come to the door.
David: And if there are hiccups, the reason they are trying to avoid that is because, of course, there would be ripple effects into the banking community and the money market funds, etc. And that strikes to the heart of confidence in terms of your average investor. If you see a money market fund break the buck as we did back in 2008 and 2009, all of a sudden people say, “Something has gone amok.”
Kevin: What happened to quantitative tightening? Remember the QT thing, where we were going to try to slowly normalize rates now that the economy supposedly has recovered?
David: Quantitative tightening – in two months we have reversed all of what happened in the first nine months of the year, and we have re-expanded the Fed balance sheet, and we’re doing that at the fastest pace in Federal Reserve history. But as long as stocks are up no one cares.
Kevin: So we’re talking Modern Monetary Theory. This is monetary policy, central banking, that we’re talking about. But the government can also run on deficit. They can either balance the budget, like Paul Volcker, you have to hand it to him. I’m not a fan of central bankers in general, necessarily. Just like what Paul Tucker was saying, I wish that they were more limited. But Paul Volcker really believed in a balanced budget. That’s what he was raised with. And that is no longer a question.
David: So what happens if you walk away from those kinds of strictures and limitations on what you can spend? The national debt today is over 23 trillion dollars. You look at our line items and, beyond defense, Medicare, Medicaid, the 4th largest line item on the budget is interest on the national debt, and we have not normalized interest rates, so you tell me what kind of issues we have, from a fiscal standpoint, from a deficit standpoint, if we ever actually do normalize rates?
Kevin: So does the piper ever get paid? That’s a question.
David: So if we leave the monetary policy insanity aside for a minute and head over to the fiscal policy side, the Congressional Budget Office forecasts for 2020 that we will have just a trillion-dollar annual deficit, not only for 2020, but they actually say a trillion dollars a year for the next decade is what they are expecting.
Kevin: Good thing there is no interest.
David: And that’s the point, that interest is the 4th largest line item in the budget now with non-normalized interest rates. Imagine if we were paying back 5%, which we have been a lot closer to that in years past. So of course we ran deficits, a trillion dollars and more during the 2009-2012 period, because, why? It’s crisis management. And so you have an explanation.
Even if you’re not a Keynesian, there is still a rationalization. You may disagree with it, but there is a rationalization for filling in and propping up aggregate demand. And you’re supposed to be able to, at least on the old Keynesian doctrine, step in, do it, and then step out. This is the point. We’ve never stepped out. We are here. We have “recovered” from that crisis period, and yet we still need the treasury to finance our budget, and we need the Fed to monetize the debt.
Kevin: We’ve never come off of life support, and we’ve called it a recovery.
David: So this is where, again, people look at the price of stocks and say, “We’re just fine. We are in peacetime. Recession is not a present problem. Unemployment is at a 50-year low, and yet it is still a requirement that we run a trillion-dollar a year annual deficit?”
Kevin: So what could go wrong, Dave?
David: (laughs)
Kevin: Actually, let’s change this for a second. What could go right? So that we don’t sound like Negative Nellies all the time, what could go right?
David: I’ll tell you what could go right. In a period of rapid-fire credit creation, of massive deficit spending, gold is likely to have a very fresh day in the sun. Think about this. The correlation between massive deficits and the gold price is a very strong one. So let’s just take it from the Congressional Budget office, who says, “Yep, deficits – here, now, 2020.”
Kevin: Over a trillion.
David: A year for the next decade. So take it from the CDO that gold is going higher, as deficits are going higher. And this is regardless of who wins in 2020.
