Podcast: Play in new window
- Tesla profits? – They lose on car sales but gain from carbon credits
- S&P 500 – Six stocks only account for 100% of the gains, the rest lose
- $20 gold piece goes from $20 to $2000 since the Fed started in 1913
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Zombification & The Free Money Apocalypse
September 16, 2020
“In one sense, we’re destroying capitalism and don’t know what system will replace it. And that’s what you see with the orchestrated fiscal policy initiatives, monetary policy initiatives. We want a world where there is no more business cycle. We want a world where there is no more pain. We want a world that is utopian in nature and goes beyond the vagaries of the market and the cruelties of capitalism.”
– David McAlvany
Kevin: David, sometimes you think about some of these companies as the living dead. But before we get to that, you said that your daughter, who didn’t know what we were going to talk about today, got up singing a song with zombies in it.
David: (laughs) It’s song from the nineties by the Cranberries, and over and over again they have the word zombie. I have no idea why she actually thinks of herself as the eighties girl. That’s kind of the era of music that she likes.
Kevin: She stands about 4’5”?
David: That’s right. So, yes, I woke up to, as I’m finishing my thoughts and notes for the commentary today, I hear in the background, “Zombie, zombie.”
Kevin: You’ve been talking zombies because you’ve been talking about some of these companies. Look at Tesla. That zombie phrase, by the way, before we jump in here, was used back during the last tech stock bubble – zombie companies. What that represents is companies that actually are running almost purely on debt, virtually no profit, yet their stock is skyrocketing,
David: Yes, it’s old world to think that you need earnings and profits, New World to think about leverage and the potential of what gets unpacked from sort of the pro forma bliss. Tesla is probably squarely in that camp. And it’s weird because, how do you consider it a zombie with a recent market cap of $450 billion?
Kevin: Isn’t that amazing? Almost half a trillion dollars? That’s more than almost all the other automakers combined.
David: The company loses money on car production, but shows earnings exclusively from its sale of carbon credits. Let that sink in.
Kevin: What the heck is a carbon credit anyway?
David: It’s a different kind of zombie. True, their production is about 360,000 to 370,000 vehicles. And in a bizarre twist of financial market fate, this is like a casino. When you look at the behavior relating to investors in Tesla, the company is worth more than nine of its competitors combined. Those nine competitors produce 50 million cars per year.
Kevin: Let’s compare that again. Tesla sells 367,000 vehicles. They’re worth almost half a trillion dollars, and that is more than all these other nine competitors that sell 50 million cars per year?
David: We used to say when you’re talking about McDonald’s you make it up on volume. Today you make it up on carbon credits. Why bother with cars when you can sell carbon credits? It’s the wave of the future. Just for the record, we are not short Tesla, we are not long Tesla. We are neutral in our opinion. Well, we’re not neutral in our opinions, but at least we are in our positions.
Kevin: I’m thinking that’s probably good, because how long can you print free money? Granted, you get something for free, but it will ultimately cost you everything. But just to show that you’re not picking just on Tesla, let’s look at the NASDAQ because if you really look at advancing shares versus declining shares, it is signaling something much different than the price.
David: Yes. By the way, I’m not skeptic when it comes to the electric vehicle revolution, it’s just a question of who wins, because usually the early adopters of new technology are not the ones who end up winning. And my guess is the production prowess of those nine other Tesla competitors, the ones who are already producing and selling 50 million cars – it’s actually not that difficult to pivot toward a different kind of offering if the market demands it.
So, yes, you have Rivian. You have a whole host of other companies out there that will produce electric vehicles, and 20 years from now, 30 years from now, the landscape will look very different. But you mentioned NASDAQ. Stephen Hochberg. I often read him on the Elliott Wave, and we’ve had him as a guest on the commentary before. He has noted that NASDAQ breadth continues to deteriorate. We talked about breath versus breadth and this is bad breadth, as in advancing shares minus declining shares.
Kevin: So it’s a simple calculation. You’re just basically saying how much is advancing versus how much is declining?
David: Exactly. How many companies are moving up, how many companies are moving lower? The advance minus decline is the lowest since March and places a downside target, as Stephen does, NASDAQ about 9350 to 10,000, a fairly wide range. That would be like the opening act. I think the headliner is still to come, a lot more downside in NASDAQ, but a first destination of, say, 9350.
Kevin: So it’s not just the NASDAQ. Anytime you look at a group, Dave, it’s good to look at who are the winners, who are the losers, and does that outweigh? You were talking about subtracting declining shares from advancing shares on the NASDAQ, but if you look at the S&P 500, you’ve mentioned this before, the gains are coming from just a very, very small group. It’s not the 80/20 rule. It’s, what would you say, about 494 decliners to six gainers?
David: Right. Bill King has been on the program a number of times. We love to have him as a guest, and he hails from the Windy City. So does Jim Bianco. They are both rigorous in their thinking, have a strong research and trading background. And it was Jim Bianco in his Bianco Research that pointed that out. Six stocks account for the entirety of the S&P 500 gains year-to-date. So 494 are kind of a drag on performance, dragging the numbers lower. Meanwhile, you have Facebook, Apple, Amazon, Netflix, Microsoft and Alphabet, which everyone refers to as Google. Those six stocks contributed 100% of this year’s gain.
Again, we’re talking about breadth. Breadth is an issue for all the indices, NASDAQ and S&P 500 included. But when you have these kinds of breadth readings, what you can say is not necessarily to the day, but in the near future, watch out below.
Kevin: Last week we talked about how Powell is probably not going to be remembered well when we look back at inflation because he’s adding fuel to a fire that’s actually hitting new highs. It’s just so different, Dave, than when I was coming out of high school and Paul Volcker was doing just the opposite.
David: It reminds me of Greenspan because in some senses Greenspan came in with a certain idealism and then was converted to central bank pragmatism fairly quickly. What he had understood in terms of sort of an Ayn Randian perfect world all of a sudden got scrubbed, washed, disinfected, and he became a different man in the context of working at the Fed. I thought Powell, coming in, was taking a different approach and in fact, his first moves were to tighten credit, appropriately, given sort of loose credit that had been abundant since the global financial crisis.
Kevin: And then he had a change of heart.
David: And I think that’s market driven. It’s definitely pragmatic in nature. But thanks to Jim Grants’ team for pointing out sort of the book-ends. What began as one book-end October 6th, 1979, that was the launch of the Volcker action Plan. The impetus was to destroy inflation, to cut off growth in bank reserves.
And Powell offers the other book-end, the opposite action plan 41 years later. Our goal now, according to the more pragmatic Powell, is to stoke inflation and to use all tools at the Fed’s disposal to improve employment and higher wages. So we go back to the old mandate. The mandate for our central bank is, I quote, “To promote maximum employment, stable prices and moderate long-term interest rates.” That’s the goal of the Fed. Of course, where we would perhaps want to linger is the open interpretation of price stability and the loose understanding of moderate long-term rates. Those two things, in case you thought you knew what they meant, check your dictionary. There are multiple definitions.
Kevin: We’ve got to remind ourselves over and over how it is that you beat inflation in that world. Interest rates have to rise. We had Taylor on, and he was basically saying that the Taylor rule says you must have this much more in interest than inflation for the system to work. Now we have the opposite. We have repression. So what we’re really being told isn’t that the Fed needs to stoke inflation, we’re really being told that we’re not going to be able to keep up as savers.
David: I guess the main point for the Fed and for others who are looking at our total quantity of debt, which we talked about a little bit last week in terms of gross debt, Bloomberg notes that the debt pile is getting cheaper as it grows. What they’re looking at is the interest payments have declined by 10% in the first 11 months of the fiscal year.
David: And that is the Fed. That’s not the market that’s doing that. The Fed is doing that.
David: Pushing interest rates lower. So the Congressional Budget Office is confident that the cost to finance our debt is going to get cheaper from here. And my guess is that they are talking, that is, the Congressional Budget Office is talking to the central bank community. And they are confident that the guiding of rates lower, as you say, they’re responsible for pushing these rates lower.
The guiding of those rates lower by the seen administrative hand of the Fed – we like to think of capitalism and the unseen hand – well, this is the seen administrative hand of the Fed. There is a belief that they will succeed. And the evidence is with the market effect, the average yield on U.S. debt since last December has declined from 2.4% to 1.7%.
Kevin: Well, of course we can afford more. If you can continue to pay less and less for that debt, why not borrow?
David: And that’s precisely what happened here in the last 12 months, even with home mortgages. If you look at the new record set at 2.86% on the 30-year mortgage, you can now buy 9.3% more house for the same money involved. So you lower rates, and it lets you buy more.
Now, the flip side of that is you’ve got consumers who are buying and have more exposure from a balance sheet standpoint to a liability. They think they’re buying an asset, but when you’re attaching debt to it, there is this liability component. And we all forget about what a liability does in aggregate, what it does as a single item on a balance sheet, and, of course, if you don’t have a fixed rate or if you have to roll over your debt, then all of a sudden you’ve got real issues.
So this is the official argument, and so goes the market’s blasé reaction to our increased deficit. This year it is three times what it was last year. It’s estimated at 3.7 trillion and would be more but you’ve stalled out in terms of fiscal spending. Nobody wants to agree to additional fiscal spending prior to the election. You might be seen as helping or hurting someone, and nobody wants to take those risks.
Kevin: I think we have to stop for a moment and ask what has changed in our lifetime and what has actually changed just over the last 10 years, and especially the last six months, we’d have to say that we’ve eliminated, to a degree, the market forces. It used to be called the bond vigilante. The bond vigilante was you and I basically saying, “No, I’m not going to put my money here. I demand higher rates.” At this point, we’re being displaced by what you might call the anti-bond vigilante, which is somebody who can print money for free, the Federal Reserve. So when money is free, it’s free, but ultimately, it costs us everything, doesn’t it?
David: Yes, and my memory is a little fuzzy, but I think Ed Yardeni was with Merrill Lynch years ago, and in the 1980s he is said to have coined the phrase, bond vigilante. There is a new market presence, and it’s the anti-vigilante. The anti-vigilante is the Federal Reserve. Investors appear to exert, let’s call it insufficient power, over governments. In other words, the old bond vigilante would come in and sell their bonds, force rates higher as a penalty for running large deficits and as an expression of risk quantification.
Kevin: And interest rates rose.
David: That’s right. Bond prices dropped. As they sold, interest rates rose and there was a certain discipline applied to the fixed income world as a result of that. The anti-vigilante basically steps in and neutralizes any of that. So today we have investors without sufficient power to override the government’s edicts and wishes. What are we talking about? Fed purchases of government debt this year have totaled about $1.8 trillion. I take that back. That is since March.
Kevin: How do you compete with that? If you’re the general market, how do you compete with the Fed that can just throw 1.8 trillion into keeping interest rates low?
David: Yes, and then they’re averaging 80 billion a month in treasury purchases, not to mention the mortgage-backed securities and corporates. So your all-in number is closer to 120 billion a month. So we can shoulder an even larger debt burden. Again, going back to this mountain of debt that grows that seems to be getting cheaper as time goes on, at least according to that Bloomberg article. We can shoulder an even larger debt burden if – and this is the key – if rates can be brought down to ever lower levels.
Kevin: So are they caught between a rock and a hard place, or have they just basically said at this point, “We don’t need the markets, we’re just going to print money.”
David: Well, the math works, and that’s what they’re doing is they’re making the math work. It is a tenuous situation. It’s one that requires a willingness to be on the hook for unlimited sums of money. Again, that’s as the role of anti- vigilante. And of course, my contention for years has been that you can have some smart Ph.D. that makes the math work, and that person, as good as they are with the equations, can be oblivious to the X factors, which can make a perfect equation on paper turn into a real-world absurdity, and ultimately a market disaster.
Kevin: I had asked you what has changed. Another thing that’s changed over my lifetime is a millionaire used to be a millionaire. I remember when people would retire they’d say, if we have a million dollars in the bank and can earn 5% on that million, that was a sweet $50,000 a year just from the interest on that money. Those days are gone.
David: Yes, the cost for growth in the economy and in the markets, and this current modern version of market stability, in large measure comes from the value extraction from the class of savers and investors that would otherwise have seen passive income on their savings. So you talk about a million dollars, and that used to be the magic 5% you could generate on.
Grant lays it out this way. He says, “When the 100-year treasury fetched 5%, a $1 million nest egg annually threw off $50,000. At a yield of 2.5% a saver needed $2 million to generate the same $50,000. Today, at 75 basis points, that’s ¾ of 1% yield, that saver, or public pension fund, or insurance company, would need $6.7 million. And if the bond bulls, or, Kevin, you and I could say, if the Congressional Budget Office or the anti-vigilante, otherwise known as the Fed, got their wish and the 10-year yield tumbled to ¼ of 1%, seekers of $50,000 a year from the 10-year point on the treasury curve would have to front $20 million.
Are yields going to zero, is the question that Jim asks. If instead, they stopped at a single basis point, our thrifty retiree would need $500 million in savings for that same $50,000 in income.
Kevin: We’ve had a couple of guests in the past say, well, at this point, the winners and the losers are being chosen, and I think what we’re talking about right now is that we’re probably not the chosen winner.
David: Exactly. I think that fairly well illustrates who wins and who loses in the game of low-to-negative interest rates, because on the one hand you’re subsidizing a higher debt load, as Bloomberg points out in the article that was titled, “Debt Pile Gets Cheaper As It Grows.” And that’s at the expense of anyone who sought to save and maintain a modicum of independence from the state.
Because, remember, we have this social safety net we refer to as Social Security. But for anyone who does want that extra layer of protection to take ownership of the fact that your future needs to be secured by you, then the savings which you have painstakingly set aside through the years, well, guess what? Unfortunately, you are a part of the fodder necessary to keep this kind of game going.
Kevin: So the magic 5% is not impossible, but it forces increased risk-taking. You had mentioned Treasuries paying 5%. What we’re now talking about is, somebody can go out and actually get that 5%. But what are they giving up?
David: Yes, and it’s the increase in risk-taking, it’s the yield-chasing when the magic 5% yield is going through its own version of an ice age. And that’s what we have. We have a fixed income ice age where we’re going toward lower and lower temperatures.
Kevin: Does anybody understand? I mean, really, like John Maynard Keynes said, one in a million really understand this
David: Because they don’t understand, the Fed will never be required to take responsibility, and they’re not going to step up and volunteer to take responsibility for a negative outcome where volatility, if and when it does emerge, ends up testing the value and the solvency of those entities with bloated debt levels. Again, where added risk and risk-taking has a disproportional cost to the insignificant rewards on offer. High-yield debt is a classic case in point. If you look at the J&K ETF, it’s a high-yield ETF, delivers approximately 5% in income, but the volatility is not the same as Grants’ illustrated 10-year treasury.
Kevin: Again, we’re talking about retirement paper. This is the money that you saved all your life. You don’t want to lose it in the last few years of your life.
David: Junk bonds, the most likely to default of any paper. Again, this is pro-cyclical, works great in an up-market, terrible in a down-market, occasionally very painful. Last week we talked about the triple B paper. This is the stuff that creates, ultimately, as you look onto the horizon, a major supply problem for the junk market. And I’m talking about an over-supply problem, where the junk bond market is flooded with triple B paper. This is the focal point. This is where you see the Fed is going to have to intervene.
In March they averted a major market rout, and that was with J&K being off 21%. Roll the clock back to 2008 and 2009, that downturn, and you had this same product down 45%. So this is a speculative fixed income product. March 2020 was headed there, and then the Fed pulled the anti-vigilante moves and started buying corporate credit, unclogged the ETF products that were in full liquidation mode. And so the losses were only 21%. Amazingly, far less downside in junk bonds.
And think about this – less downside in junk bonds than in Tesla stock, really a volatile asset and probably why the S&P 500 did not include Tesla in the mix because in today, out tomorrow, is the most likely outcome there.
Kevin: The thing that’s tough about this, too, is this anti-vigilante move. If we look at it from another perspective, it’s actually very calming because volatility is what actually works us up. When we see ups and downs, the anti-vigilantes, the guys who can come in and replace the market with free printed paper, they do smooth things out. They destroy volatility, but in a way it also removes your emotions. It’s like touching a stove, Dave, that’s burning your fingers, but you don’t know, you don’t feel it.
David: We’ve talked about it in terms of cold death. The anti-vigilante role is really an anti-volatility role. And the problem is, volatility is what you have when the price of an asset is changing constantly – that back and forth of, “It should be priced at this. No, at that. No, at this. No at that.” That is the market function, figuring out where value exists and when something is appropriately priced. The anti-vigilante role eliminates the volatility. You’ve got smoothing. You eliminate risk of loss. Is there a cost for that stability?
And I think, yes, this is where it’s very clear. You’ve got pension funds, insurance companies and retirees all facing the same sort of desperation. You’ve got a ratcheting up of risk as the anti-volatility central bank playbook reduces all assets to lower and lower return propositions, with implicitly higher and higher risks. You don’t see those risks on the front edge, because again it looks safer because you don’t see any movement.
Kevin: You don’t feel it. You don’t feel the volatility. But we’re also talking about Grandma and Grandpa. These are people who saved all their lives, and they’re seeing Triple B and junk paper and Tesla stock as smooth as what 10-year treasuries used to be. This has to work.
David: Maybe not Tesla as a smooth line. That one has been particularly volatile. But I think the trend continues until everyone, including Grandma, is forced to be a gambler. And that was our casino reference last week. But again, the Fed will in no way take responsibility for negative outcomes induced by the behavioral shifts their policies created. Is their a choice in this? Does the individual investor have to play? Can they say no to becoming sort of the gambling granny?
Kevin: Isn’t that what’s happening with the gold price? The gold price may not be spectacular right now, but isn’t gold signaling right now that some of the people are saying you can have your purchase with free money, low volatility and false stability. I’m going to step outside of the system and go back onto a personal gold standard.
David: Yes, and on that same note of taking responsibility for negative outcomes, the Fed has never seen that their money printing gambit and easy credit schemes are contributors to wealth disparity. Somehow that happens in the marketplace, but their actions are not connected. Don’t connect those dots. At least they don’t connect those dots. And so we’ve had this radical asset price inflation as a result of monetary policies. And with that comes the haves having more and the have-nots having less on a relative basis. Is it any surprise that we have a tearing of the social fabric? I wouldn’t put it to envy as much as I would this issue of desperation, because on the one hand, you’ve got easy money and an easy life as long as you have assets to appreciate in that environment. But if you didn’t have assets to appreciate, and you’ve got the growing consequences of inflation showing up elsewhere, yours is a pressured life. Yours is a life that requires dual incomes. Yours is a life that if you get a pink slip, is incredibly stressful because it’s not as if you had enough to save. You were living paycheck to paycheck in the first place.
Kevin: And if you are retired, you’re forced to gamble. Even if you are a grandpa or grandma, you’re forced to gamble, and you may not want to.
David: So the opt-out, you mentioned, is gold. And so is this self-serving? Sure. The first and best opt-out is gold, but remember this. Gold represents a very valuable positioning in a transition, and all you need is a modicum of stability in market transitions that have historically basically been a move to cash.
So when you want to get out of the stock market, the bond market, the real estate market, you sell the asset and you move to what? Historically, that was cash. Cash was gold. A little bit more on that in a minute. But think about it in these terms. Think lifeboat, for lack of a better word picture. You’re uncomfortable temporarily above the water, but that’s a significantly better position to be in than being irreparably below the water line.
Kevin: The question that I have for myself and the listeners and you is, can we transition to a new paradigm, though? I have been raised in a capitalist system, or what I thought was a capitalist system. Richard Duncan came along and said, “No, no, it hasn’t been capitalist for a long time. It’s creditism. We have Doug Noland, who talks about the moneyness of credit. They’re saying similar things, but capitalism, which means you profit at a business, you save, and you benefit from the savings. Those days are over.
David: Yes, in one sense, we’re destroying capitalism and don’t know what system will replace it. And there’s a significant transition afoot. The market economy of the past has given way, as our guest Russell Napier said years ago, to command and control dynamics. And that’s what you see with the orchestrated fiscal policy initiatives, monetary policy initiatives. We want a world where there is no more business cycle. We want a world where there is no more pain. We want a world that is utopian in nature and goes beyond the vagaries of the market and the cruelties of capitalism.
Kevin: But if no business dies, part of capitalism is creative destruction. If nothing dies, don’t we go back to this zombie that your daughter was singing about, and actually you told me about a dream she had recently.
David: That’s right.
Kevin: She’s thinking too much about zombies right now, Dave, but we are talking about zombie companies. If you let nothing die in business, all you have is a bunch of zombies.
David: And it’s okay for that to happen. What happens to the capitalists when capitalism is no more? What happens to his or her capital when a free enterprise system is replaced by the financial equivalent of the zombie apocalypse? I mentioned this dream that my daughter had. She came into my bedroom this weekend as she woke, and said that her dreams were the worst she’d ever had. Zombies everywhere. The living dead. And I responded compassionately – this was Sunday morning – “Honey, it’s more real than you think. And I happened to be on my phone looking at Sunday’s Financial Times, and there was an article there. The number of U.S. zombie companies is nearing peak levels we haven’t seen since the year 2000.
Kevin: But only in the McAlvany household is your daughter going to come out and tell you that she’s had a dream of zombies and you say, “It’s worse than you think,” and then you tie it into what we’re talking about today.
David: The headline read, “Pandemic Debt Creates a New Generation of Zombie Companies,” and the issue then, back in the 2000, as it is now, is that you get to a point where your operating profits are less than the interest owed on your debt.
Kevin: Say that one more time, when operating profits are less…
David: When operating profits below the interest owed on your debt. That’s a bit of a problem. But you can continue to play this game if there’s easy money. I thought the conversation was seamless. I think what she wanted me to do was empathize with the fear of being chased down by an army of life-filled corpses who would either eat her or pass along their dead/undead status.
Kevin: But, Dad, is that too much to ask? I remember I didn’t dream of zombies, but I’ll never forget my first skeleton dream when I was three or four years old. Same thing.
David: If you’re listening to this and you are a psychologist, cut me a break. Parenting is an imperfect process on the best of days, and I’m sure that you’d be critical of World War Z. Maybe it was a little strong for family night, but that was a long time ago.
Kevin: Come on, come on. You didn’t do World War Z for family night. But zombies don’t exist. The bottom line is, the zombies we see in movies don’t exist, or if they do, I haven’t seen one. But the companies you’re talking about.
David: We create the conditions for corporate and banking zombies routinely. More routinely, it would seem, since we left the gold standard and stable currency value. So the zombification of corporations is roughly in line with central bank accommodation in the markets. Because, in essence, accommodation is the removal of consequence for poor capital allocation decisions in the life of a business, and an allowance to just keep on going long past the point at which you should have been dead.
Kevin: You remember when the tech stock bubble was getting at its peak in February of 2000? How many zombie companies did we have in relation to the other companies at that time, the year 2000?
David: The last time we hit peak Z was that year, year 2000, 2001, around 15% of the Russell 3000. So looking at smaller cap companies, peak Z, it took the global financial crisis and mass bankruptcies to bring us from 15% of the Russell 3000 in that category to under 7%, so finally, kind of a cleansing and a washout. Now we’re back to peak Z again, 15% again.
Kevin: Again, that is a company that actually is paying more interest than their earnings, their profits. Is that correct?
David: Yes. Jun Zhu of the Leuthold Group asks, “What happens if all of a sudden capital markets dry up and they can’t refinance or pay down their debt? How will they roll it over or even afford the interest expense?” That’s a good question. Ask the anti-vigilante if a domino effect of tightening credit is acceptable. Of course, the answer is no.
Kevin: No, they can’t.
David: How many trillions is the Fed willing to purchase? And how long before the benign, again, what we consider today low levels of inflation, shift to levels that impact consumer behavior and create a new set of variables for, oh, these are scary words, inflation expectations? Those are the inputs which the anti-vigilante cannot control.
Kevin: And that’s my question. Can they control that? Because in the 1970s – you brought up Greenspan. I have to admit, I was about 11 years old when this happened, but when Alan Greenspan was put in charge of the Treasury – this was before the Fed – he was tasked with controlling inflation expectations. And so they had these buttons that they handed out to people called WIN – Whip Inflation Now. It had zero effect, because these guys can print as much money as they want, and they can control volatility for a while. They can control market stability. Maybe they can even add to employment. These are some of the things they’ve talked about. But they can’t control inflation expectations except for through perception, in other words, telling people that there’s no inflation.
David: Right. Go back to the Greenspan era. This is a fascinating shift because Greenspan, they used to say, spoke Greenspeak, and it was a language that only Greenspan understood. And so, basically, you could control the market by baffling them with BS. And that was the reality. You didn’t understand what he said, but he must have understood what he said, and he meant it. He said it with conviction. Therefore you had to believe it. So you were being directed and you were being controlled through a language that was not clear.
Now fast forward to the age of Powell and Bernanke, and what do you have? You have forward guidance. And forward guidance gives you the impression that these folks are sitting there like the oracle of Delphi, some sort of a seer, knowing the future and saying, “This is where we’re going, this is where we’re guiding it, this is what we have under control.” It’s the same thing. You’re managing perceptions, but one was literally baffling with BS, and the other is now telling you exactly so clearly where we are going that you cannot doubt the certainty and the certitude with which it was spoken.
Kevin: Again, it’s managing perceptions. It’s pay no attention to the man behind the curtain because what we’re seeing is the things that everybody looks at, which are the indexes on the stocks, the value of bonds, the interest that’s paid. All of that can be seen. But strangely enough, inflation seems to be the invisible element behind the zombies, and it’s sucking the value out of everyone’s buying ….
David: Yet, the anti-vvigilante cannot control inflation expectations because inflation expectations tie to a mental construct and an emotional response. It’s the gray matter of the mind, which is beyond a price that you can pay for purchasing. You can buy a bond. You can buy some other asset class and influence pricing. But the gray matter you can only influence to a certain point. Perhaps you can coerce it for a time, but it really is theoretically not for sale.
Kevin: You had talked about an opt-out. If we’ve got this invisible monster that’s sucking, it is zombifying companies and it’s sucking the value out of your currency. I came to work for your dad and your family back when I was 24 years old, and I was introduced to the old $20 gold piece. At that time it was about $500. Just a few years before that it was $35, when the company started. And I have, over the last 33 years, recommended people by this $20 gold piece. 100 years ago it was worth 20 bucks. It was worth 35 in the early 1970s when your dad started this business. It was worth about 500 when I came in 1987. Isn’t it amazing that that almost perfectly matches what we’re talking about, the zombification of companies and the destroying of the life of the currency?
David: Yes, you could look at it as a long-term bull market in gold, or a long term bear market in our money. The Federal Reserve was launched in 1913. An ounce of gold was equal to $20.67. So your $20 gold piece, coin of the realm here in the United States, was cash in that day. And today we believe in currency and price stability because we have no reason not to. That’s it. We believe what the Fed says because we have no reason not to. And after all, with 600 PhDs, who are we to question them? A vast appeal to authority, which is very effective.
But let’s go back to the Fed’s mandate, particularly on the two points subject to interpretation. On the one hand, you have price stability. On the other hand you have moderate bond yields – “moderate.” Full employment we’re going to leave alone because it’s not a challenging subject. The smaller the number gets, the better we all are. But as for price stability, your $20 gold price is now $,2000 per coin versus the original 20 bucks. That implies a 99% loss of purchasing power in the paper which the Fed is supposed to be managing. And again, the first and primary mandate is price stability. So how do you grade it? A 99% loss of purchasing power is their demonstration over 100-plus years of what price stability looks like. And it’s a very gradual decay, which has not set the investment community on edge. But is there a point where, if you are either historically aware or even just budget constrained and asking if the system that we have today…
Kevin: Creditism.
David: Correct.
Kevin: Not capitalism. Creditism.
David: Is it working? And if inflation is a factor driving monthly frustrations over your costs as they increase, and income constraints as they stay relatively flat, can we ignore these things? Can we ignore the fact that M2 growth is, year-over-year, up 29%? Can we ignore the month-to-month increase in CPI, the Consumer Price Index, which in July had the biggest jump in three decades, ex-energy. So at 0.6 of a percent, the average investor still looks at it as a rounding error, though it puts us at or above that target of 2% for the full year. You tell me, and this is where I do think we begin to have this reality check, a 99% loss of purchasing power?
Kevin: It’s well-meaning, but it sounds like hypocrisy to me because the monetary policy makers are basically saying we want to give you stability. But you just now talked about losing 99% of the purchasing power of the currency that we save in, not just spend in, we save in.
David: Hypocrisy would be one thing. I would call it well-intentioned duplicity. Monetary policy makers for decades have silently accepted the duplicity of creating inflation while claiming to want price stability. And it’s for a greater good, and there’s a way to rationalize it from an ethical standpoint, depending on how you structure ethics.
January 2012, Ben Bernanke told us that the best definition of price stability was a 2% inflation target. Historically, again, this goes back to, which dictionary are you using? What’s your reference point? Because 0% up to that point, at least to the common person, was the acceptable level of inflation.
Kevin: Right, because it’s theft. If someone says, “Yes, I can steal 2% from you every year, that’s stability,” that’s not stability. That’s theft.
David: Zero was the expectation up to that point. Now 2% is the target and the expectation. Now, current tense, to achieve the 2% we have to tolerate – this is as of Jackson Hole a few weeks ago – we have to tolerate higher levels of inflation for longer periods of time, above the 2% target originally put in place in 2012.
Kevin: So let’s think that through. What they’re basically saying is, now it’s not 2% but it’s more than 2% because we hadn’t quite gotten to 2% before.
David: And I think as an investor you have to also translate it this way. We’re going to deal with longer periods of negative real returns. That’s how you should read it, if they’re increasing interest rates. And yet, look at Richard Clarida making it clear that interest rate caps are around the corner. Negative real rates are a clear, present, and future reality. So this is where I do think you go back to the Summers-Barsky thesis, which argues the gold price will move inverse to real returns – real meaning your inflation-adjusted returns. So if you have a positive real rate of return you have a clear reason to go buy something else. If stocks are going to give you a 5% rate of return above inflation, why wouldn’t you choose that as opposed to sitting in gold, right? Same with bonds. If you go back to that magic 5%, great. But now, if inflation is eating your lunch and interest rates have been capped, where do you go?
Kevin: Have you noticed the Wall Street giants like Goldman-Sachs, Credit Suisse? They’re coming in and they’re actually – I don’t know if they’re trying to save face or … because they know the direction of gold is higher … but they’ve even raised their expectations for next year.
David: Gradually, for some and more radically for others, Goldman lifted its price target to $2300 for next year, Credit Suisse to $2500 for next year. Bank of America, with the largest number from any of the big banks, $3000 an ounce. That’s a better than 50% gain from here. And I think this is what it comes down to. You have debasement. That is a global currency phenomenon, not just where Biden likes to hang out.
Kevin: (laughs)
David: And it’s happening everywhere, so your investor demand is also global. Demand for the medals is global in nature, and we have an official pronouncement from the Fed of higher rates of inflation coming, provided, by the way, under the cover of Covid-related demand slack. So we’ve got disinflation, we’re going to have to run inflation a little bit hot. They actually have the perfect cover for shifting their policy even as we’re moving into a naturally higher inflation environment.
Kevin: Deflation is the wrong bogeyman is what you’re telling us, where the invisible inflation bogeyman is the one that’s been sucking us dry.
David: Well, you know, I don’t have a great amount of love for Jeffrey Currie over at Goldman-Sachs, mainly because sometimes I don’t like hearing what people have to say. In 2013 he called the market top, and I should have paid more attention to him.
Kevin: In gold, you’re talking about.
David: That’s correct. And he had some good facts that I should have paid attention to, and I did not. But yes, as head of Global Commodity Research at Goldman-Sachs, he said here in recent days – and frankly, this is what we’ve been harping on for years, Kevin. He says, “Ironically, the greater the deflationary concerns that policymakers must fight today, the greater the debt buildup and the higher the inflationary risks are in the future. The deflationary shock caused by the pandemic drives the need to expand balance sheets to support demand today. The resulting expanded balance sheets and the vast money creation spur the debasement fears, which in turn create greater likelihood that at some point in the future, after economic activity is normalized, there will be incentives for central banks and governments to allow inflation to drift higher to reduce the accumulated debt burden.”
Now that’s the end of the quote, but what are we talking about? At some point in the future? We’ve just had a monumental shift. We went from 0% to 2%. That shift, it took us basically 100 years, assuming that 0% was the right inflation target. And then in 2012 we moved it to 2%. Now we move it to some number above 2% that gives us an average that’s appropriate to whatever we think it should be, maybe at or above 2%.
Kevin: So are you saying in short order that free money isn’t free forever? It will ultimately cost you everything.
David: It comes in a very high cost, a very high cost. So we come back to this issue of what is the cost of stability? What is the cost of this smoothing effect within the markets? And there are political reasons for the smoothing. There are pragmatic reasons, and we got into that with Richard Duncan a number of weeks ago. Call it survival and just not wanting to deal with negative outcomes, so let’s just paper our way through this. That is the M.O. That is what’s happening in the current context.
So yes, any surprise to see Goldman shift its price target to $2300, Credit Suisse $2500, Bank of America $3000? I think that as time goes on and we continue to see balance sheet expansion, the revisions that they make will not be down, but will be up, yet again.
