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This week and next we answer your questions that were submitted. Thank you for listening to the McAlvany Weekly Commentary.
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Your Questions Answered, Part 1
December 30, 2020
“There is an opportunity to expand your financial footprint or to go beyond just maintaining purchasing power if you happen to be the only buyer. And frankly, with a gold and silver asset you put yourself in a pretty good position to do that because liquidity is not an issue. So, again, if you’re the only buyer, the only person with liquidity, you can more easily name your price.”
– David McAlvany
Kevin: Well, we hope everyone had a very merry Christmas last week. Actually, Dave, you were with quite a bit of your family. You got a chance to talk to your dad and mom in the Philippines, but your sister was here, your brother was here, the kids. One of the things that I love about working for your family is that’s exactly what it is. It’s a family. And you include a lot of people outside of the circle of just the bloodline.
David: Yes, it’s funny getting together. You’re not often reminded of how many oddballs can come from one particular gene pool. But it’s a lot of fun. We had a great time.
Last night we were gathered for a family dinner, and it was kind of an interesting experience. I was talking to one of the kids and I backed my seat up and I bumped one of our bookshelves. And on this particular bookshelf, we have every decanter, every plate. We’ve probably got, I don’t know, 200 pounds’ worth of porcelain and glass. Four out of five shelves came tumbling down. I barely bumped it and one collapsed on the other, collapsed on the next, and we were so grateful that no one got hurt because looking at the carnage on the floor, it was unreal. It was absolutely unreal.
So when families gather, we thought to ourselves, this could have been a Greek wedding, except we aren’t Greek. But they have the tradition of taking the porcelain or whatever and just throwing it away, breaking it. It was an expensive evening, but a great family gathering, and we just laughed and laughed and laughed, thinking this is going to be one of the great tragedies that we will never forget but one of the funniest things that’s happened in a long, long time.
Kevin: Dave, one of the things about family, you know, as we read through the questions, we’ve done this question and answer program now for 13 years. The company itself is going on almost 50 years old. It’s the 49th year we are coming into. But what I what I love about our listeners to this broadcast is they get the family vibe. And so even in the questions as we read through the questions, there are little personal things where people are saying, “Well, hey, on Wednesday nights, this is what we do. We turn on the McAlvany Weekly Commentary as a family.” But that’s what I really love and would encourage for our listeners, is just enjoy the real things in life. The financial is fine. It’s fine to talk about ups and downs in the monetary markets, and all of that’s interesting. But really, your intentional legacy is the true backbone of this show, and actually of what we’re trying to do here.
David: And certainly the big picture matters to us, and that ties into macroeconomics. But the bigger picture for all of us is the relationships that we’re engaged with and the values that we bring into those relationships, the skills that we develop to better be able to navigate those relationships. So having skills, being able to navigate, there is some cross application, and we’re grateful to participate in a larger conversation and thought process with our listeners.
So the Q and A each year is really fun for us to be able to see not only the points of connection that we’ve made through the year or through the years with those listeners, but also the things that are on their minds. So we’ll just dive right in.
Kevin: Okay, so we’ll just go to that, and thank you for the engaging questions that were sent. The first question is from Preston. He says:
Hello. I work at a precious metals dealer in the Bay area. We were expecting the price to spike during Diwali, but it practically did the opposite of that. Monday morning on November 8th of that week it dropped from $1950 an ounce to $1850 an ounce. That whole week the price recovered slightly, making its way back up to about $1880 per ounce. Would you be able to talk about this and what factors you think were at play? Is it possible, and this is a speculation, that we could see this repeat during the Lunar New Year of 2021?
So it’s sort of a seasonal question, Dave. Can you answer that?
David: What we watched that week was the largest hedged event in US financial history. The U.S. presidential election was being unwound, and the dynamics within the market overwhelmed any normal seasonality in gold. Nevertheless, if you look at the gold price and its trend through the year from up to that point, and even to this point, it’s been a good year. We’re up about 24%. That week was the combination of an almost insignificant bounce in the dollar, a very small move higher in the dollar that particular week, and the massive theme was the hedge reduction, which could be viewed from a slightly different vantage point as risk-on post election.
But again, primarily, the dynamic was an unwind of hedges. That’s been a key post-election trend. It has added to a risk-on, almost melt-up dynamic. It has included gold taking a breather for a little while. Again, we’ve seen the melt-up dynamics across the board. This is NASDAQ, this is small cap stocks, this is mid cap stocks. In fact, I don’t think there’s an index that has had a trading session lower than the numbers that we saw that week after the election.
So the market’s risk-on mode at present is largely on the view that even if Biden wins the White House, the Senate would remain controlled by the GOP. Of course, we have here in the next few days the Georgia runoff which will determine the final outcome for the Senate. But betting markets have the GOP maintaining control of the Senate, and the markets like that. The markets like the idea of divided government.
So the unwind of risk is there. You could see certainly a major consternation in the market. The opposite would be the case if we saw the outcome in Georgia go to the Democrats. Then you’ve got markets which are fairly well unhedged at this point, and I think that could cause considerable damage in equities, likely increase safe haven buying of gold. But there are other factors driving the gold trend at present.
Kevin: I think it’s important to remember – oftentimes we’ll get calls, Dave, where someone will say, “Well, the exact opposite happened in the market than you would expect.” Oftentimes it’s hedges that are being unwound one direction or another because you buy the rumor and you sell the news. And so oftentimes those hedges can send a completely opposite signal to what you would think the news event brought.
The next question is from Akira, who says:
Hi, guys. I’m a five-year lurker, originally referred by Chuck Missler and have been listening ever since. First off, thank you for your podcast. I enjoy your non-shouty, matter-of-fact way of discussing topics. Even though I’m from Asia, I listen to matters about the United States, and the dollar directly affects a lot of policies here. That leads to my question. For us non-American listeners, how do you see the American dollar collapse/reset impacting markets in the East in Asia, and more specifically, should the dollar collapse do you foresee a rise in demand for Chinese currency, for goods, for services, securities, because East Asia in general has a stronger manufacturing base and it will ride out the coming reset a bit better? Or is the dollar more or less king, and when it goes everything else goes with it, and the entire world will sink into more or less a depression. I apologize for my newbie question. I’m just trying to wrap my head around the situation because, frankly, I’m nervous about the whole state of affairs. Thank you, Akira.
David: It’s a great question. There are a couple of factors that I think are important to keep in mind. There’s a credit crisis brewing in China, which may radically impact the Chinese RMB. We are today considering the possibility of dollar weakness, and so perhaps in light of the question, relative strength in the RMB or other Asian currencies, and it really matters what happens in China as much as it matters in the United States and with the U.S. dollars.
Serious decline in the U.S. dollar, if you just wanted to focus on that aspect, would impact global trade. It would force a rethink of dollar holdings used to facilitate transactions. I think one of the things we have to keep in mind that is sort of a counterpoint to that is that it’s much easier, and it’s much less costly to conduct foreign currency transactions today than it was 20, 30 or 40 years ago.
So to see a new trade regime with inclusion of many more currencies, circumventing the use, and thus further diminishing demand for dollars, I think that would play out in the context of a weaker dollar. That would seem to be beneficial to Asian currencies, beneficial to Asian debt markets. The big caveat is with China. With a significant financial storm brewing in China, it’s difficult to imagine the RMB, the renminbi, as a replacement for the dollar.
So what I think you might see is marginal gains amongst a variety of Asian currencies. That’s not difficult to imagine. I would consider how the Bank of International Settlements responds to growing pressure on the U.S. dollar, and we’re talking about real out-of-control declines within the U.S. dollar, coordination of your central bank community through the Bank of international settlements in Basel, Switzerland, creative adaptation. I think whatever you see coming out of the Bank of International Settlements is likely to set the tone for a new global monetary regime if there was going to be something to pressure the old dollar hegemony.
One last comment on U.S. dollar collapse. You have to assume that an orderly depreciation of the dollar by 20-40% may in fact be a policy choice. That would be [consistent with] many instances of sterling devaluation throughout the 20th century, where you could see anywhere from a 30-50% orchestrated decline. In that case, the non-policymaker, you or me, the investor, might see that happening, not know that it’s been devised and planned, and might extrapolate the trend and assume that we’re witness to the death of the currency, the demise of the dollar, which is not necessarily the case. It would, of course, be a cause for re-pricing of hard assets to higher levels, and may, in fact, move prices of hard assets into sort of a parabolic price dynamic where you see demand for savings alternatives increase.
What is bad for the currency, in this case the U.S dollar, may be good for shifting trade advantages back to the United States. And that’s where we did see with the Trump administration certainly an open mind to a weak dollar policy with the idea of on-shoring and bringing jobs back to the United States. Whether the incoming administration has a will for a weak dollar policy and that kind of on-shoring remains to be seen.
Trump was certainly no fan of a strong dollar. I suspect Biden will not be either. But coordinating a currency decline is a part of a larger policy suite that runs in parallel with who is being chosen within the marketplace to sit in the category of winner or loser. It’s a way of re balancing the whole economic pie, and we’ll know a lot more about that six months from now, post election transition.
Kevin: That would be a policy choice, but what about the alternative scenario? What if there’s a disorderly, non-coordinated currency decline? Some people would call that a collapse.
David: Yes, and I think that’s more of what people expect to see, not realizing that sometimes it can be coordinated and deliberate. So you’re right, if there’s a disorderly, non-coordinated currency decline, this is where the markets may get nervous with massive quantities of debt and with loss of confidence, where confidence in the dollar evaporates.
A disorderly decline, that will be fought by the Treasury and the Fed. So you might think, okay, if the dollar goes into a freefall, boy, what happens next? Well, what happens next is, it’s like triage. The Fed and the Treasury get involved and will use all means necessary to maintain stability and bring order through whatever means they can employ.
Interventions and controls – that’s what you would expect to see. That scenario is where you could see the reintroduction of capital controls, the limitation of electronic movements of money, disorderly devaluation. The second category, quite frankly, that’s the more dangerous scenario to the global economy.
Kevin: So let me ask, who benefits if we have a devaluation? There are always winners or losers. Who would be the beneficiary of that?
David: I think there’s a long list of potential winners and losers, either with a strong dollar policy or with a weak dollar policy, deliberately weaker. If a major devaluation is a policy choice, then the benefit goes to the debtor and not the creditor. And so you have to think about the political context for choosing to sort of gang up on the bankers or the financial community. Try to imagine who’s in the political crosshairs. Try to imagine, I guess, alternatively, who politicians hope to solidify as a voting base for 2022 and 2024, solidify as a voting base or vilify for the same reasons. So with that in mind, there’s a case to be made for choosing winners and losers. Let’s say it’s a shift in manufacturing back to the West from the East, on-shoring of jobs. If policy-makers want to recapture the loyalties of the working middle class, then you could see an orderly devaluation coordinated by Janet Yellen and Jerome Powell, both helping with that.
What makes this tricky is we’ve seen political alliances shift, and the working middle class is not as reliably democratic as it was before. This last year is a great case in point. Social experiments throughout the year of Covid, and you’ve got policymakers at least talking about, if not thinking in terms of, a universal basic income, a basic wage for all working age Americans. And maybe that’s what they would pursue instead of a weak dollar policy and potential ramifications for international relations, negative ramifications.
What do you do with a universal basic income? You have increased taxes on corporations, increased taxes on the wealthy. So there are other aspects there. You don’t have to necessarily focus on bringing the jobs back, or whatever. But I think the big lesson from the year of Covid is not that the global economy is so robust that it can withstand these kinds of shocks, thinking about the demand shocks like we’ve seen in 2020, but rather that policymakers are more than willing to spend unlimited quantities of money, money that they don’t have by the way, to keep the system on a stable footing.
So to the degree that policymakers intervene, I think that wherever you are in the world you should expect the price of gold to increase in terms of your particular country’s currency. In other words, if your treasury department and monetary policy-makers are actively engaged in intervening to save the system or to keep things on an even keel, then the price of market stability will continue to be reflected in terms of gold, wherever you happen to live, whatever currency you use.
Kevin: Yes, Dave, we all remember 2008. The printing really started after 2008, but of course, this last year with Covid it has just been incredible.
That takes us to the next question from John. He says:
I just rewatched the movie, The Big Short, and the quote, “History does not repeat, but it rhymes.” Would you comment on the similarity of the crash of 2008 and the current stock market, maybe even the real estate market? There’s a scene when Steve Carell is speaking with an executive of the rating agency Standard and Poor’s, where in not-so-obvious talk, they admitted to fraud. Is that happening in today’s market?
Dave, before you go on to that answer, I remember we talked about on the Commentary how the rating agencies were changing their standards and playing games. The movie captured that after the fact. So what’s the answer? What’s happening in today’s market, and how similar is it, as John asks, to the 2008-2009 scenario?
David: Yes, we did back in 2008 and 2009 talk about grade inflation and how the rating agencies were sort of putting lipstick on the pig, so to say. I think, in answer to the question, it’s different when you’re dealing directly with the government. Think back to the crash of 2008-2009, it reflected the excesses in the credit market, which came from a deliberate reflation of assets following the 2000-2001 market crash.
Using the mortgage market, policy-makers facilitated the extension of credit and infused a massive artificial boost to household net worth. That was supposed to drive economic activity and economic growth. Well, bad behavior emerged and reckless lending occurred, and of course, there were grave consequences stemming from what ultimately was, as noted in the question, fraudulent.
But banks are just finishing up, in the current context, paying for those mistakes. Over the past decade U.S. banks have been hit with about $200 billion in fines and penalties. Of course, no one presses that one step further and asks for accountability with the central bank, which is largely, if you’re thinking about the causal sequence of things, causally responsible for setting the stage of the credit excesses that, again, were paid for in the private markets, ultimately passed on to the taxpayer.
But fast forward to the present. Like he said in the question, there is rhyme, but not exactly a repeat. There is a rhyme, we have the same loose financial conditions that invite excess credit expansion. We have a decline in lending standards. Now there is less abuse in the asset-backed securities market and the mortgage-backed securities market today. There is more abuse in the types of loans being extended to corporations. So you’ve got covenant light loans, you’ve got non-secured debt. You’ve got all kinds of things that are being fabricated by Wall Street and distributed. But the real issue this time is that it’s not commercial banks at the risk of stepping over the line as much as it is the government itself. This is why I say it’s different when you’re dealing directly with the government. It’s like running a printing press. You and I run a printing press, we get thrown in jail for – what do they call that?
Kevin: Counterfeiting. Now, of course, the Federal Reserve can’t counterfeit. But I think it’s the same thing, isn’t it?
David: Liquidity provisions versus counterfeiting. So again, it’s a little bit different, blurring the ethical lines and continuing to facilitate credit expansion. What we have now is they’ve gone beyond the normal cycle peaks by using their balance sheet to continue to buy up all forms of assets. Buying billions in assets, what that ends up doing is it does promote reckless lending. This time, again, it’s not through banking channels, but it’s through Wall Street. It’s not loan origination this time, it’s financial instrument creation.
Shadow lending is what we called it in the last cycle, where Wall Street was already creating workarounds for credit expansion beyond your normal bank lending channels, and they were using structured financial products to do that. That’s the primary source of credit expansion today. It’s not bank lending. And there’s even less scrutiny of quality now than there was in the 2006-2007 period leading into the debacle in 2008 and 2009.
What you have today are legal teams and complex documents that are the governing elements of this round of risk creation and risk distribution. And ultimately, I think the complexities inherent to this round of credit expansion will require massive intervention by the Fed, coordinated with the Treasury, so as to avoid an extinction event for a combination of entities – Wall Street trading houses, insurance companies, pension funds.
Keep in mind where all these complex instruments are ending up. They are ending up being owned by folks that are just counting on a little bit more income and a little less risk and they’re figuring out maybe the way that you can do that is to creatively structure product. Well, what is the cost, ultimately, of stability?
This is where I think when we anticipate not only the poor production quality of the financial instruments being put into the market today, and the ultimate implication of having to bail out those instruments and the entities that own them – again, go back to insurance companies, pension funds, Wall Street trading houses – this is a game that I’d rather watch from the bleachers. So as we watch this unfold, I’d rather sit in the gold and silver seats, if you will, those particular bleachers, and just watch this one play out.
Kevin: I only read half the question so I’ll read the last part because it plays right into what you’re talking about. He is still referencing the movie The Big Short and what it was highlighting of the 2008 crisis. He says:
That being said, it seems that it’s not if, but when the bubble will burst and we see another crash. But in the movie, the when took a long time until the fraud was “too big to hide.” Now, when that snowflake that catalyzes the crash, or like you and I talk about the sand pile effect, when that happens to the market, will it be able to survive? Specifically, will there be companies that survive?
David: Yes, specifically, will there be companies that survive? This is a really critical point because I think it’s worth recognizing that assets survive even when companies do not. So when you’re buying a company, knowing the quality of the asset really does matter. Assets survive even when companies do not. Think about capital structure and where you want to be in that capital structure.
If you’re going to own publicly traded companies as an equity owner, with the right assets, that company better have a balance sheet that allows them to walk through hell and back. Otherwise, the assets will exchange hands, and you will lose exposure to them. Today’s equity owner or stockholder may not have control of the assets at the end of the day.
I think what we’ve seen is the last 10 years have skewed the value of fundamental analysis. There’s been little value given to it. Monetary policy excess has covered over balance sheet weakness. And this is where I think, on the horizon, in a major market sell-off, not everyone is going to get a credit lifeline. The companies that survive – and this is a huge emphasis for our portfolio and asset management – the companies that survive are going to have not only high quality assets, but the ability to keep them, which brings us back to fundamental analysis and the quality of a balance sheet.
So, yes, I think there are companies that will survive, but it’s worth moving in the opposite direction from the current market trend, which is to ignore fundamentals because it’s only in a careful study of those fundamentals that you would be able to figure out if the assets are going to change hands in this next round of sell-off, or if you as an equity owner get to keep the assets, in part or in whole.
Kevin: You would say this time is different then. There may be a big short, too, but it’s going to be a little bit different kind of fraud. If they make another movie after this next one, it’s going to be a little bit different flavor, you would say?
David: Well, yes, because the fraud being revealed, hopefully doesn’t have a different source, but it’s being played out differently. It’s the asset-backed securities market, the mortgage backed security market, that include private markets and commercial banks. That’s where the bad behavior and fraud that was occurring that was revealed in 2008 and 2009.
What happens when bad behavior, maybe even, well, let’s not call it fraud, but a Ponzi dynamic, at least, what happens when it’s directly maintained by monetary policy excess, and the perpetrators, the facilitators, are the policymakers? So asking what kind of snowflake is needed to catalyze a crash or to trigger an avalanche? You’ve got low rates which have been moved to negative rates. The discussion is there to even move to deeply negative rates. And corporate credit, financial wizardry, is moving already to the deep end of the debauchery pool.
And the longer these excesses and abuses build up within the credit markets, the more resources that will be required to stem the tide, prevent a crash, maintain order. And this is the danger attached to a disorderly devaluation, to efforts to sort of save the financial universe. It may carry with it the unintentional death of the dollar. So when the fraud moves to the heart of money and credit, you have to have an adequate insurance base, and I think that’s where metals provide that more reliably than any other asset.
Kevin: Dave, this next question reminds me of when our family used to go boating at Lake Powell. They had these tour boats that would come by and they cut a really deep wake. And the wave at first was manageable, even in our little 18-ft boat. But you had to really be careful because that wake would go hit the walls of Lake Powell, those straight up flat walls, and the wake would come back and it would hit you from different directions. And I think about Covid. This last year there has been an awful lot of money printed. There have been the PPP loans that have gone out. We have the ramifications that are still coming. So let me go ahead and read the next question. It’s short, but I think it’s very, very important. He says:
Do you think there will be a wave of insolvencies when the tax ramifications of EIDL and PPP money become known in 2021?
What are the ramifications of the things we’ve seen over the last 10 months, Dave?
David: The short answer to the question is yes. The loans are not automatically forgiven. There’s a separate application for forgiveness that has to be submitted. So only then is the income nontaxable and forgiven. So without the right forgiveness applications run through the system, you do have the potential for an income issue. And it appears the expenses paid for with loans can, in fact, be written off. That was not originally a part of it, but they came back in in June and passed some measures that would allow for them to be written off as expenses in addition. That is, at least, according to the U.S. Chamber of Commerce.
The other surprise, I think, will come for those that deferred payroll taxes. You can do that, but 50% of the deferred tax is due December 31st, 2021. Then you’ve got the other half of the deferred payroll tax which is due the same time the following year, 2022. It’s these kinds of accumulated liabilities that are the potential trigger for insolvencies. So you’ve got a horizon. If you assume that we’re not back to business as usual by then, then you’ve got these liabilities that someone will say, “Well, I guess I can’t make the payments. Time to hang up the cleats.”
Kevin: Thank you, Mr. Esslinger, for that question.
Dave, this next question reminds me, about a month ago we talked at length about your feelings on cryptocurrency, bitcoin, some of the things to keep in mind when investing in that. This next question pertains to that, so let me read the question from Taha. It says:
I truly enjoy listening to your weekly commentary and would like to submit a question. They are calling bitcoin the digital gold. Just like gold, it has to be mined and there’s a finite amount. Why wouldn’t you choose that over gold, and you wouldn’t then have to pay for storage either.
Thank you, Taha. So Dave, bitcoin back on front center stage? Let’s talk about it.
David: I think the burden of proof lies on the crypto speculator to redefine the known universe to accommodate and legitimize a digital token on a par with gold. That’s not our burden to prove. Gold already has the legitimacy that cryptos at this point only aspire to. Just to be clear, bitcoin is neither a coin in any real sense, nor is it mined. As you might imagine, gold is mined. I’ve been in mines deep in the earth, and it’s a very different process.
When you’re looking at bitcoin, it requires roughly 6,000 kilowatt hours of electricity to run computers that solve a complex math problem. At the end of that energy expense, you have a new crypto token which exists as a digital number. Mining is really a term that’s borrowed. It’s just cranking through numbers on a supercomputer or massive computer banks. So again, mining is a borrowed term, as is the reference to a coin. There is no actual coin. All you have is a numeric key, which represents proof that you just spent through 6,000 kilowatt hours. You’ve used that up. So you have proof of work, or proof, some might argue, proof of waste instead of proof of work, 6,000 kilowatt hours for what?
I think of it like the old Dewey decimal system. There is a number that represents something, except that in the case of the crypto token, you have no book associated at the other end. Proof of work is the numeric code. You own the proof of work. You have a number sequence in a database that shows that a math problem has been solved. And for that proof of work, you get to pay $27,000, whatever the price of bitcoin happens to be. So that’s all somewhat clear in my mind.
But I would choose gold ounces as a tangible expression of proof of work over numeric code for any number of reasons. Call me a luddite, but that’s my personal preference. As for storage costs, I think you have to look at all-in costs when you consider a comparison between the two. Transaction costs with cryptocurrencies are very high. It’s almost like doing foreign currency exchange 30 years ago, where you could expect to pay 10-15% to buy or to sell. So you’ve got the transaction costs.
If you own cryptocurrencies through something like Grayscale, a trust that allows you to buy and sell your ownership in the cryptos in the form of a trust unit, almost like an ETF, you’re paying 2% in an annual fee. So to compare a storage cost of less than half a percent, with 2% management fees or transaction costs in the 10-15% range, I’m not sure what the problem is with paying storage to own gold and silver.
Also, what you’re getting for that is not just a roof and protection, its insurance. I know the insurance carriers and I know the limits of liability, I know the carve-outs. I don’t think that anyone has ever created an insurance product for theft against cryptos. And frankly, in an age of digital insecurity, I would think that the tangible nature of gold speaks for itself as an advantage, compared to the insecurity that you have with a digital token. And forgive me if I’m speaking out of ignorance there and just fear of what I do not know.
But should you own cryptos? I think we’ve talked about this in past commentaries. Like any form of speculation, you’re best served with a speculation by limiting the size of a position. That is just a requirement for mitigating risk. So should that be 1% of a portfolio? It should certainly be a marginal “token” amount.
So is bitcoin the new gold? No. Bitcoin is maybe the new gimmick which may, in the fullness of time, serve a purpose. So far gold has served the purpose as real money for thousands of years. So far it has been the only reliable basis for a monetary system. Again, I go back to that idea that the burden of proof lies on the crypto-currency speculator to redefine the known universe.
And if you’re going to legitimize a digital token, and put it on a par with gold, you’re going to have to prove it. Gold already has that legitimacy. You can’t just lay claim to it or make a vague association like, “Oh, it’s a coin.” No, it’s not. It’s a digital sequence of numbers. And is it mined? No, it’s not. You’re just burning kilowatt hours to create a digital sequence of numbers.
Again, I’m going to come across as the skeptic here. But is bitcoin the new gold? No. It doesn’t mean that it’s not legitimate. It doesn’t mean that it doesn’t have a place. But to argue its legitimacy as the replacement for something, again, that’s where the burden of proof lies, on the crypto speculator. If you want to argue it as a legitimate asset class, that’s fine. Just don’t have it in direct competition with gold, because I think it’s a pretty tough case to make.
Kevin: It is like what we talked about last night when we were going through this. We just have to be careful what we call something. If you call it a coin, and it’s not, just realize that. If you call it mining, and it’s not, just realize that. That doesn’t change the legitimacy, at all, of the investment, but don’t call it something that it’s not and fool yourself.
David: And just before you move on, you pointed out in our conversation last night that the average household consumption of energy is roughly 10,000 kilowatt hours a year to keep the lights on, run the air conditioning, the heater, keep the refrigerator and freezer going. Your full year’s consumption of energy is more than one bitcoin’s worth of energy consumption. What do you have, a life lived and all the things that facilitates for 10,000 kilowatt hours? What do you have with bitcoin? Again, it’s a digital series of numbers that stands for a proof of work. In other words, the computer did a complex math problem, and you have proof that they solved the math problem.
Kevin: It reminds me, Dave, of grade school. If we were all given a problem that looked like it was going to take a long time to solve, the first person to solve it probably would be able to sell that answer to everybody else. And in a way, that sort of is what bitcoin does. But it doesn’t make your car run faster, and like you said, it takes about half a year of energy usage of a normal middle income house.
Moving on to the next question. Kevin Muir:
The Macro Tourist, is well known for analogizing the debt to GDP of Japan as nominally representing the well-known figure of 250%. However, he goes on to say the Bank of Japan owns half of that debt issuance, and the government of Japan owns the other half. So who’s to say the bank can’t just flatten their half of the debt to zero, leaving only 125% debt-to-GDP. My question is, how different is the present debt-to-GDP in the United States than that of Japan, in that much of the issuance of the debt stems from the Federal Reserve, and thus leaves them open to simply monetizing outstanding debt and canceling much, if not all, of it to decrease the overall present U.S. net debt-to-GDP ratio? And what would happen to the markets and the global trade if they did that?
What we’re talking about, Dave, is a monetization question. Can you just paper over it with money?
David: This goes back to being a very easy to solve math problem. In theory, there’s no reason you can’t do that. Where math begins to fail, and theory all of a sudden is less relevant, is that you’ve got the reality of market commitments. I think we agree that a debt is a contract to repay a certain amount at a certain time, a certain dollar quantity in a certain timeframe.
And so, in theory, debts can be canceled, but we generally think of that in terms of a default. Let’s say it’s not a default, and when the debt owed is like an obligation from my right hand to my left hand, then cancelation is of no real consequence. Again, in theory that works. But the larger issue is how contracts are viewed, and when that happens, you start canceling debts, how those contracts being viewed, what stands out?
If contracts are a matter of convenience and not obligation, then all of a sudden you see the person who is putting money out there. Again, you have a creditor and a debtor on both sides of a debt instrument. The creditor is going to want more surety, more collateral for any contract. If it’s becoming the norm that you can treat it as something of convenience rather than what we view contracts to be, having some heft to them.
And I think it’s telling that Japan has never canceled out its debt. So if in theory it works so elegantly, if that’s such an elegant solution, why have they not done it? And I think the answer is in how consequential the impact would be to all future contract obligations. Is there an implicit obligation, or is there an implied risk of default?
Kevin: I think that’s a great point. Carmen Reinhart and Ken Rogoff wrote the book This time Is Different. It went back and talked about hundreds of years, 500-600 years of records of defaults, of countries that continue to float debt and then default. And you really do ruin your reputation and you ruin your customer base. Who’s going to buy it the second time around?
David: It would go back to the divide. If you’re going to default, it’s either explicit, with some embarrassment, or implicit, under the cover of various policies that are hard to understand, and the general public never gets. I’m not sure we have to speculate on a theoretical form of jubilee, cutting the debt in half to improve your debt-to-GDP figures, when the policy tools already exist to control any amount of debt. Any amount of debt.
It’s specifically what we talked about in the commentary before, using inflation and financial repression. Why create unknown market dynamics or concerns in wiping out, canceling or erasing debt, when you can effectively do the same thing with no fanfare through those two tools, inflation and financial repression?
The general public is clueless on those two policy tools. If you operate in the context of relative obscurity, that seems to have advantages compared to operations that are far more transparent. Wiping out the debt, defaulting on it, however you want to view it, it’s more transparent and it’s subject to scrutiny and criticism. I think as many public policymakers as can operate in the context of relative obscurity – there are some advantages to that. So my view is that inflation and financial repression are here to stay, and those are all the tools they need to deal with debt and a rising debt-to-GDP figure.
Kevin: In a continuation of the same question, he says:
As a follow-up to that, assuming rates stay at or near zero, at what point does a debt-to-GDP ratio become not only unsustainable but so large that it causes total national bankruptcy or insolvency to the point of a loss of faith, globally, in the U.S. dollar? Is there a ratio figure, or is it simply an eventual decline in recognition to the insanity of the situation?
So that brings default back into it, Dave, the second part of the question.
David: Yes, there is no number. Quite to the contrary, if you think about lower rates, zero rates, negative rates, those are the factors. We’re talking about repression again, that allows for significantly higher levels of debt compared to GDP. There’s no risk of insolvency or loss of faith if yield curve control can be maintained indefinitely.
What is theoretically possible does not seem realistic to me, at least. So can you do that indefinitely? That’s the question. How long can interest rates be controlled at lower or negative levels? Which gets to this person’s last part of the question. Is it just a point where you recognize insanity and all of a sudden there’s a loss of faith?
That, I think, is where you ultimately go. There’s no debt-to-GDP figure which is unsustainable. It could be the Japanese 250%, our 120%, it could be 500%. There’s no debt-to-GDP figure which is unsustainable if rates can forever be kept at abnormally low levels, because it’s cash flow required to maintain those debt obligations, that’s the key variable. And it is the variable that you’re manipulating to your advantage with lower rates. If there’s an impact reflected in the currency from financing the purchases of the debt needed to control the rates of interest, that’s a totally different scenario. And I suspect that monetization is thus a very temporary fix.
So you can buy the assets needed to maintain yield curve control. We just don’t know how long you can do that. We haven’t played with the outer time boundaries yet. We’re obviously playing with the upper dollar limits, but we don’t know how long we can play this game with confidence.
Kevin: So what’s the impact on the currency from doing that?
David: Well, again, it is a question of how long we can play the game. Can we do it for years? Can we do it for decades? Can we do it forever? We’re playing with time and the market appraisal of cost or consequence, and that market appraisal is the unknown. In every other era of monetary experimentation and direct debt monetization, when you had endless quantities of money, ultimately that affected the quality of that money. Again, endless quantities affected the quality. Free money became worthless money, and the journey from where we are today to our currency being viewed as worthless, I think that’s just a journey of the mind. It’s tied to perceptions of value and security, and that’s one of the things that factors into it, again, the appraisal of cost and consequence.
Kevin: The third part of Edward’s question, and thank you for the question, it was a good question, Edward. He says:
Assuming that inflation actually has any real world effect in the unit accounting of precious metals to reflect the numerical values on the debt clock, were silver and gold to reach, let’s say, $33,000 gold and $4,000 silver, respective figures for such, what would those metals increase in purchasing power, or would they increase in purchasing power if…
He says normalized. I’m not sure what he’s meaning by that, Dave, but maybe you do. Would the purchasing power increase “if they were normalized to the numbers, or would they simply maintain the equivalent purchasing power they have today?” This is a purchasing power question. You and I have talked before, you could go back any time in history, and an ounce of gold is worth about a year of bread, 365 loaves of bread per ounce, whether it was 100 years ago or 1,000. What’s your thought on that?
David: First of all, the figures of 33 and 4, I think, are fairly unrealistic, in part because if you do the math, it’s an 8-to-1 ratio, and even the in-ground measure of silver to gold is 15 or 16 to 1. There is no basis for an 8-to-1 gold-silver ratio. There’s barely an argument for 15-to-1 ratios being maintained in the current context. We’ll get to that a little bit later.
There’s a question on using the gold-silver ratio in real estate later on, but straight out of the gates, I’m not sure where those values come from, except to say that if there’s lots of inflation, then we’re just talking about higher prices. And if we’re talking about higher prices, did we get any benefit from those prices in terms of increased purchasing power, or did we at those higher prices, theoretically, whatever they are, just keep up with the devaluation of the currency? And I think that’s the reality, that you’ve maintained your purchasing power.
The value of having gold and silver is, in part, their ability to help you maintain purchasing power. The other value of having gold and silver is of having liquid assets, and this is really key, when other people do not have liquidity. So you’ve maintained purchasing power when others have not been able to, and you’ve maintained liquidity when others have zero liquidity.
That means you are only able to improve your financial position by moving from that asset into other assets, and doing so when perhaps you’re the only buyer and you can more easily name your price. Does that make sense? So I think it is keeping up with the inflation.
There is an opportunity to expand your financial footprint or to improve, to go beyond just maintaining purchasing power, if you happen to be the only buyer. And, frankly, with a gold and silver asset, you put yourself in a pretty good position to do that, because liquidity is not an issue. So again, if you’re the only buyer, the only person with liquidity, you can more easily name your price.
Kevin: When you talk about maintaining buying power, honestly, Dave, for the last 33 years, why I get out of bed and do what I do is because I believe that gold will maintain buying power. It’s not about out-producing some other asset as far as growth goes. But compounding ounces you talk about often, and that is, if you buy your silver low and swap it for gold when silver’s high, you can definitely do a lot better in platinum, palladium as well.
Next question. This is from Richardson, Texas. Mr. Stacy says:
Dear McAlvany Weekly Commentary, I’ve been a regular listener for many years. Thanks for the show. My question regards inflation and pensions. Is there a reasonable way to hedge against long-term price inflation other than the obvious overweighting the other investments toward gold and silver mining shares when a fixed pension makes up a disproportionately large portion of your net worth?
He says he’s got substantially more than one-third in stocks, bonds and annuities. And he’s using the investment triangle for the question. He says:
Back in my day, my dad’s pension lost about two-thirds of its value to inflation prior to my mom’s passing, and I’m worried about deja vu all over again. Best regards.
Thanks, Ed. So Dave, when someone is stuck in a pension with a lot of stocks and bonds and annuities, is there a way to hedge against inflation?
David: Yes, if your pension overexposes you to financial market or currency devaluation risks, then increasing an allocation in the metals in other areas of your portfolio would make sense. The other approach is the approach we’ve taken in our asset management company, which is just to own a broader cross section of real intangible assets that provide income and can adjust, both in terms of the price of those assets as well as the cash flow can adjust higher as well, so your dividend income can increase as well. Those the only means that I know of.
This takes us back to an old problem. This is a problem that my dad was trying to solve in the 1960s when he worked for Boettcher and Company in Denver, Colorado. They were the underwriters of a ton of Colorado state municipal bonds and, no surprise, a lot of their clients were interested in tax-free income. The problem was, in the late 1960s and early 1970s, if you had income, whether a fixed pension or income coming from tax-free municipal bonds, there really was no way to hedge that risk. It was a totally different scenario then, and you might recall that you could not own gold in the late 1960s and early 1970s.
So the consternation by the fixed income investor or pension fund recipient was, “What do I do? Do I speculate in gold stocks to hedge my risk? Do I own a couple of big oil companies to hedge my risk? What do I do?” It was not as simple, it was not as elegant, as owning gold and silver, the physical metals. That came later, and I’m proud to say that my dad and two other gentlemen were involved in the lobbying process to get gold legalized again, and we had sort of a first mover advantage in the gold business. But, being in business in 1972, legalization was January 1st, 1975, it’s a fun story, another story for another time.
But the problem being solved then, is the same problem that Ed is talking about, which is, how do you hedge that sort of loss of purchasing power? Two-thirds of the value of his dad’s pension was lost to inflation. I would venture to say that had his dad owned a significant position in physical tangible assets, that would have been largely mitigated. So you’re losing on one part of your portfolio, gaining on the other, and it’s not helping you get ahead, it’s helping you stay even and avoid something of a catastrophic loss.
That’s a lot easier to do today. It’s legal to own gold today, so he answers his own question in some respects. Do you overweight your other investments toward gold and silver? Certainly, that’s more reliable. The mining shares are kind of a different animal altogether in terms of a growth vehicle – appropriate, but also need to be appropriately sized. But yes, what he offers as an answer is, I think, the simplest.
Kevin: One of the things that I think is just a shock to people when we’re talking to clients who are maybe stuck in a 401k. When you reach the age of 60 you can roll that over into an IRA. And so we have many clients who are over-weighted in stocks, bonds, annuities that want to hedge against inflation that have reached that age of 60 but they still want to work another 5, 10, 15 years.
Well, legally, that 401k can be rolled into an IRA. And, of course, that IRA, we can put into gold and silver. So that’s one possibility for a hedge, as well, Dave, just as a reminder to the listener. If you’ve reached age 60 and you’re stuck in a 401k and you love your job and you just want to keep working, it doesn’t mean you have to be stuck in the 401k. You can roll some of that into gold.
David: I had a great conversation last week with a young man in Redondo Beach, California. His wife is a teacher, and there is this reality of, what is her pension going to be worth as and when they can draw on it? And the operating assumption is, not much. And I think you know the impetus for aggressively approaching investments, both growth and a substitute for that pension income, it takes on a real urgency.
I think that a millennial generation of anyone under the age of 50 should be considering the fact that, on a go-forward basis, what you consider, whether it’s a state pension, a teachers pension, very few companies today offer a pension. They’ve shifted things to the 401k model.
But if you have that coming, you may want to consider how you hedge the risks associated with the fixed income. Again, this is primarily an inflation concern. What are the obligations paid out? Will they be paid out? Will there be modifications as time goes on? Will inflation be the great modifier?
And I thought it was a very realistic assumption that, yes, if we have it, we have it. But we’re not counting on it at all, and we’re organizing our finances as if it is not going to be there at all. It just speaks to a future resilience, which I thought made a lot of sense.
Kevin: We have more questions coming next week, Dave. I’m looking forward to it. I love it when our listeners are thinking these thoughts and asking us these questions. I know that you were challenged through these answers. As we talked about it, you said, “You know, this is a fascinating time for introspection.”
David: As always, the conversation continues offline, so if there is anything that we can help you with, or you want to continue to talk about something that’s on your mind, give us a call and we’ll pick up where you left off with your questions.
