All The King’s Horses & All The King’s Men Can’t Put $253 Trillion Together Again

Weekly Commentary • Mar 17 2020
All The King’s Horses & All The King’s Men Can’t Put $253 Trillion Together Again
David McAlvany Posted on March 17, 2020
  • The crisis isn’t c-19 it’s c-253 (trillion)
  • The $253 trillion debt ponzi scheme began unraveling 7 months ago
  • Physical gold will run out immediately when people “run out” of the bond market


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

All The King’s Horses & All The King’s Men Can’t Put $253 Trillion Together Again
March 18, 2020

“There are implications, not only from monetary policy, but also from helicopter money. What do I want to own? I want to own infrastructure. I want to own specialty real estate. I want to own natural resources. I want to own precious metals. And a part of the implication is that on the one hand monetary measures will continue in an effort to desperately prove relevance, even at the cost of monetary stability, right? QE5 is already here.”

– David McAlvany

Kevin: David, as we were talking last night about the program, there is so much that seems to have happened over the last week, but in reality, this takes us back to September of 2019. Something was going terribly wrong in the liquidity markets, and we were alerting clients right off the bat. September we saw the repo markets just explode, and then in October of 2019, just about six months ago, quantitative easing four, QE4 started, and yet they told us things were just fine.

David: In a world of things that can go terribly wrong, it is important to find things that have gone terribly right. I have to say, last night one of the highlights was sitting down and having a Talisker and the two of us discussing things. Talisker makes a ten-year which we are very keen on, but they also make one called Dark Storm. And it seems pretty appropriate to begin our conversation with a clinking of glasses and jumping into the nitty gritty of what is happening in the markets today.

Kevin: One of the things that really amazed me was that we really didn’t have to change the narrative at all even though the news seems like things are changing continually, what we were talking about economically, really sounded like a continuation over the last few months.

David: The real story is not C-19, but C-253. Yes, there is the virus in the shape of a crown, and that has certainly influenced behavior. It has influenced risk-taking in the modern world, but there is the credit virus, and we’re talking about the total number globally, which exceeds 253 trillion dollars. That’s where we get the C-253. It’s about 350% of global GDP. And I think the significance of an economic slowdown, whether it is trigged by C-19, or trigged by anything else, is that it reveals the unsustainable nature of the global economy. It is dependent on expansion of credit, but expansion in this case has outpaced the economies that underlie it and prop it up. We have debt, which has driven a form of growth for decades, and it has driven growth at higher levels than we would have had otherwise. And so this is where you begin to see, when asset prices fluctuate, in this case on the downside, it reveals the debt edifice, which is permanent. So stocks sell off, and all of a sudden when you are looking at balance sheets, debt-to-equity gets real ugly, real fast. And this is all because of a marginal shift in consumer behavior. Again, marginal shift in consumer behavior triggers a recession, and then you have deeper-level concerns which are not C-19 transmission. They are no Covid-19 transmission. The issue is, really, how credit market vulnerability is revealed when growth is taken off of its trend line.

Kevin: Oftentimes we talk about Tomas Sedlacek and he talked about this new religion of perpetual growth. Corporate risk-taking went up as well. I was just reading a story yesterday that said that Boeing, which had borrowed a lot of money and turned around and purchased their own stock, has now been downgraded to Triple B.

David: Right. The repurchase program began 2013. I think the number is 43 billion dollars from then to now in terms of stock buy-backs.

Kevin: It’s an amazing phenomenon when you start to see a downturn. Asset prices fluctuate, but debt is permanent, isn’t it Dave?

David: That’s right. It’s the same for American Airlines. They are in talks to borrow billions amid the pandemic and yet over the last six years they have bought back 15 billion dollars of their stock. So the story is the same the world over. I think one of the classic statements that I saw, as we are talking about a near 50-billion dollar bailout for airlines, according to the Washington Post, a kind of snarky comment from one commentator saying, “There should be no bailout for the airlines unless they add six inches of leg-room to every economy seat, and double the size of every bathroom. Let’s get something for our money.” Okay, that’s a healthy perspective, for anyone who flies, I have some sympathy for that.

But you’re right, corporate risk-taking in the form of increased debt – that is rationalized by growth prospects, is rationalized by intense competition. We have individual risk-taking in the form of buying things on credit, and that is rationalized by improvement in quality of life. And everyone, according to the credit markets, can be king or queen for the day, with access to debt. So we wear the crown proudly, but we pay for it for a long time to come. And that is the nature of the debt markets.

As we have talked about many times, credit allows for us to draw tomorrow’s consumption into today. On top of the corporate, and the private, or individual risk-taking, we also have government risk-taking, and that is perennial in the form of debt to guarantee, or to attempt to maintain continuity and stability and political control. When you look at what a government does to spend money, that is basically why they are spending money. They want continuity, they want stability, and they ultimately are reinforcing their own brand of political control.

Kevin: A good friend of mine in New York I was just speaking with before we went into the studio said, “Kevin, this problem – you know, you’re right. The problem was here the whole time. I liken it to a hemophiliac, and Covid-19 was just me coming up and slapping their back. It still triggered a problem, but the problem existed before I slapped them on the back.”

David: Yes, the panic is over C-19, but the underlying issue, and the reason that the stock markets, globally, are going to remain under pressure, is that you are talking about credit market excess. The vulnerability has been revealed. So C-253, and by the way it’s going to be 257 by the end of the first quarter, 257 trillion in global debt, that is a burden too great to bear. And the markets are only just waking to the fact that our growth scheme is more like a Ponzi scheme.

Kevin: We were talking last night about the last quarter of 2018, going back about a year-and-a-half ago. Powell was trying to “normalize” the markets. That went terribly wrong. It was a little bit like he revealed something that he didn’t want people to see, and he did an about-face in January of 2019.

David: Well, he looked like someone who might, in the footsteps or shoes of Volcker, bring some sanity back to central banking. And so, to normalize the balance sheet, and to increase interest rates, and to be in a place where for the next recession you have a little bit more “ammo,” the issues, as you are saying, were in the market and they predate the first case of Covid-19. You had pre-shocks in the 4th quarter of 2018, and that led the Fed to halt raising rates and to reverse course. So we have accommodation and we have loosening of credit. And it was a pivotal moment because the Fed’s demeanor changed there in the first week of January 2019 in response to deteriorating credit conditions there in the 4thquarter that just preceded it.

Then came the September 2019 intervention in the repo markets, and of course they had a fancy way of saying, “Oh look, it’s corporations, it’s banking, it’s the month end, quarter end, stinginess.” People are holding onto cash, that’s why corporations are not lending between each other.” Unmitigated balderdash. By mid-week last week, fast forward, we’re talking about September of 2019, we still have the Fed providing overnight support to banks. By mid-week last week, the repo market provisions, that is, the Fed’s backstop for overnight bank lending, was boosted from 100 billion to 150 billion, and then again to 175 billion. And it’s not coronavirus that has the central banks in a panic. We may be talking about the straw that breaks the camel’s back.

So it’s worth considering the real burden, as dramatic as the straw may be. But I think when you’re looking at the most important factor here, you have banks and institutions in Europe which are, I think, at the center of this, again, troubled banks and institutions which we have never talked about in terms of the funding crisis dating back to September. And they have not been identified. We don’t know who else is connected to them in sort of a daisy chain of obligations. Now we’re talking about counterparty risk. And so we can talk all we want about coronavirus, but that’s just the straw that breaks the camel’s back. Let’s make sure we don’t forget the real burden here that is crushing the dromedary.

Kevin: Something we haven’t seen until this last week, when the Fed would lower rates or throw a bone to the markets, the markets always said, “Yeah, let’s just keep doing this.” This time when they threw the bone, when they lowered the rates at the G7 meeting, once that happened, that hail Mary didn’t work.

David: This is some of the most important between the lines commentary that you can draw from the last few weeks of activity. Late Tuesday we had that hail Mary, we had the rate cut which followed the G7 meeting, and it was a disaster. There was no follow-through on the upside in stocks, which suggested that market participants were just realizing, had just realized, the Fed might be looking at a real issue of concern. What does the Fed see? This is basically what the market is asking as they respond and react to the reduction in rates. What does the Fed see that would inspire them to drop rates and then start moving more aggressively into the overnight repo market and doing more and more?

This was really a critical moment. Thursday’s harsh liquidation was of every asset. It didn’t matter where you were at in the quality stack, you could have the most pristine credit, you could have your dividends well-defended, you could have everything going for you in terms of balance sheet strength, but you saw complete liquidation. Gold was out the window. Everything was out the window. Everything of quality went on sale, along with the garbage. And that was my first day of real concern, the first day, because it was the first day of panic selling.

Then of course we had Friday’s rally in stark contrast to the declines earlier in the week. We had the Monday significant decline, open on Monday, significant decline on Thursday, which was of course shocking to the mainstream media. And of course the rally on Friday was pushed up even higher by the Fed announcing that it was going to monetize 37 billion dollars through its POMO operations, the Permanent Open Market Operations. And at the same time they were committing going forward to 80 billion dollars in monthly debt monetization all across the yield curve. So the big punch forward on Friday had a little jet fuel – is this a new trend, have we recovered, did we put in the lows, are we going to see a V-shaped recovery? Maybe not.

Kevin: For a few years we talked about what happens on a Sunday at the Federal Reserve. When we were in the financial crisis back in 2008-2009, a lot of times the most important announcement of the week occurred Sunday afternoon before the markets opened. This last Sunday’s surprise with the rate cut to zero, you would have thought that the markets would have loved that. Instead, they panicked.

David: Yes, it’s really critical how they close the market on Fridays because it sets the tone for people thinking and churning over in their minds what is at risk coming into Monday. So if you have a rough market close on Friday, you have people chewing all weekend – should I be out, should I be in, what should I do? And it makes the Fed’s pronouncements that much more important. So we ended up with a strong finish to the week last week, and then all of a sudden the surprise – Sunday surprise – a rate cut to zero and an announcement of 700 billion more in quantitative easing? That should have inspired the markets, and it did, but it inspired them in the wrong direction.

Now we’re seeing momentum on the downside, close to 3,000 points. So along with this announcement was the opening of swap lines, and you know what that means. It means that when you start extending credit to the banking system, not just within the United States through the repo market, but now you’re providing liquidity to banking and financial institutions all over the world, back to our original thesis – something was going wrong in September, and it has continued to become a bigger and bigger issue. It has required the Fed to stay put and provide liquidity through the repo markets, and now we have the swap lines open. Someone in Europe is circling the drain.

Of course, you have Europe which has the highest concentration of systematically important banks, so when you are looking at why they would be involved, why would they be so activist to solve someone else’s problems, the Fed’s assistance there is, I think, to us, providing a key signal. Providing liquidity to Europe is providing a very key signal. This is a global pandemic, but it is more of a credit issue than it is a corona issue, in terms of this pandemic.

Kevin: One of the things that worries me is people are rushing to cash right now, which ultimately will be destroyed by all this printing. That’s the only ammo of the Fed, isn’t it? Are they out of ammo at this point, where it is zero interest rates, you’ve talked about the zero bound, or the zero bound not necessarily stopping us? Has the Fed run out of tools, or are there more?

David: I think cash makes sense today, but as we migrate through this crisis – there are stages within a crisis, and as we progress you will see greater and greater desperation. We’ll talk about that a little bit in a few minutes as we look at fiscal options that they have, but cash makes sense today. You just have to keep an open mind, it doesn’t always makes sense, and as we migrate to further stages of decline, I think that is where all of a sudden it won’t necessarily provide the same value.

So is the Fed out of ammo? If you look in recent weeks, judging by the market’s response to the Fed’s actions taken, they were either shooting rubber bullets, or worse, they were just shooting blanks. And yes, now you are at zero. They effectively moved the ELB, the Effective Lower Bound. We’re sitting at zero, and they don’t have a lot of flexibility. Yes, they can quantitatively ease, they can get out there and buy more assets, expand the balance sheet. And I think the policy course of last resort has been started – monetize everything. The Fed balance sheet is now on a moonshot to 10 trillion dollars. And I think other central banks will follow suit.

Kevin: Last week we talked about the various stock market declines that we have had in the past – 1987, the year 2000 when the tech stock bubble popped, 2008. This 30% decline happened awfully quick.

David: 18 sessions, 30% decline. But I think it is way too early to buy this market. A recession will give you, typically, a 30-40% decline, and that is just standard fare. A very minor cyclical correction in the context of a bull market is usually capped at 20, maybe 25%. So you can definitely argue the market’s pricing in recession, 30-40% declines in equities. But if this is a recession that lingers, if this is an economic malaise that we have for any amount of time, again, duration being a critical point here in terms of the changed behavior as a consequence of Covid-19, then we are talking about something that opens up a possibility of 50-60% decline.

Kevin: Wow.

David: So the dead cat bounce crowd is going to feel really good about themselves. We had the market move higher on Friday, we’ll get some more rebounds this week. But listen, when you get a 9% rally, as we had last week, you have to keep this in mind. After significant declines, big rallies are normal. 1929 the market recovered almost 19% in two days. So big move higher, big dead cat bounce in 1929.

And then in 1987 you saw the same thing, a 19.9% bounce was packed into a two-day period following the 1987 decline. When the correction was a correction, 1987 was really just a correction in the context of an ongoing bull market. But if we’re talking about a long-term bear market, this is totally different. And even in 1987 you put in a double bottom in December. Original decline September/October of 1987, and then it was still months later that you retested the lows. So even if you were excited about that dead cat bounce, you retested the lows in December.

I also recall the smart money which moved into the oil patch in the 1980s. They thought they were buying a value. There had been chaos because of the decline in oil prices. And they were backing up the truck. And they were immediately rewarded. Prices were moving higher, oil stabilized for a time, but they were embarrassed to discover that all they bought was a dead cat bounce, which ultimately led into a regional banking crisis, and they got their heads handed to them. So you can be too early.

Kevin: I’ll never forget when I first got to ICA back in the 1980s, your dad talked about the stock market just being a minor player. If you really looked at the size of the stock markets worldwide relative to the size of the credit markets, which you were pointing out at the beginning of the program, and Doug Noland points out as well. A lot of times people move from stocks to bonds thinking that the bond is the safe place to go. We haven’t even begun to see the bond market capitulate, have we?

David: No, and that’s why I say the real story is not C-19, but it’s C-253, because 253 trillion dollars is the elephant in the room. It is the mother of all bubbles. The bond market has yet to start correcting. And so, again, here is the mother all bubbles. Money clamors today into bonds perceived to be liquid and stable, as it exits the stock market. And there is the assumption that you are going to be able to maintain purchasing power. And there is the assumption that credit quality is not going to shift.

Well, even in the last week we have seen a shift in terms of corporate credit, and some of your municipal paper, where literally, one week ago we were on a moonshot higher in terms of price. And not so much the case anymore. So something of a reappraisal may have begun in the credit markets, but I think you start fiscal stimulus, and now you are counting down the clock to complete reappraisal of risk in the fixed income market.

So if we’re saying that the monetary policy machine gun is shooting blanks or rubber bullets, and we’re moving closer to a period where fiscal stimulus is absolutely required according to the policymakers, then guess what? That countdown is also beginning, a reappraisal of risk within fixed income. A wholesale reappraisal of risk is already in motion in equities. You can see it, you can smell the fear. But it has yet to begin in the fixed income market.

So when we think about the precious metals, when we think about gold and silver, I think it is worth remembering that the metals markets can only accommodate a minor shift, a small trickle, from one asset class to the other because we are talking about a finite amount of ounces that is available to be purchased. And so, when that trickle becomes a flood, the only way to accommodate the traffic is through an exponential increase in price.

My strong suggestion is you own what you want to own for the next decade right now, because I don’t think these prices stay where they are at, and I do think, as we look at the bond market unwind, which has yet to begin, then you’re talking about the real issues within the world of finance. C-253 is a much bigger deal than C-19 in terms of the global economy and where we go from here.

Kevin: A lot of times when you see the price of gold drop, I think people will think, “Well, people must be selling gold.” But actually, if we look at our trading over the last couple of days, Dave, here at ICA, I’m proud of the people that we serve, and the people who listen to the program, because we had virtually no liquidations, so even as gold was falling, they were picking up what was left, and things were running out, which I think we’re going to find with gold dealers across the country. So like you said, own what you want to own. Don’t watch the price right now.

David: Yes, I think 2008-2009 was a fascinating story about how these things unfold. The price can be knocked around in the futures market by paper contract players. These are folks that have 5-to-1 leverage in their portfolios and any significant moves, which really are insignificant in the grand scheme of things, but when you are playing leverage can become very significant, they are forced to unwind. So you see price volatility, and it can be very different than the reality in the physical market. So we have seen premiums on one-ounce product, on junk bags, on a whole variety of things begin to march higher.

Why are the premiums marching higher as the price is dropping? Because demand for physical metals is very strong, even in the context of a paper sell-off. So I think this is a replay and we’re just at the front edge of that. We saw, again, a whole host of silver products which were very accessible ten days ago which are almost inaccessible today, and premiums which were basically nonexistent ten days ago are now double-digit today. I’m not talking about commissions, I’m talking about our wholesale cost to acquire and then place with a client. So we like to position folks in advance of this, but I’m telling you, if you’re not positioned adequately in the metals, you are just getting started.

Because, again, this is a minor reallocation from equities, and given the volatility in equities, into metals, we have seen nothing of a reallocation of fixed income, 253 trillion dollars’ worth of credit instruments. As those come under pressure we’re talking about, again, a very, very different financial landscape, and that is a landscape where all of a sudden it matters who you’re banking with, who your financial institution is.

And this is why I wish people would go back and reappraise, why are the financial markets in such a tizzy right now, and why is the Fed and the various central banks around the world doing what they’re doing? I think they are doing it under the cover of the coronavirus, but I think what we’re talking about is a black hole, an abyss, that they have looked into, and they’re doing everything that they can because they know that 253 trillion dollars in debt is unsupportable if we’re talking about a slowdown in the economy.

The Wall Street Journal in the last day or two said, “The U.S. economy slides into the monetary black hole. The Federal Reserve is now officially spent. Saving the U.S. economy from this point forward is now up to someone else.” That’s the reality. We have to depend on fiscal policy. I think there are massive implications for fiscal policy in terms of the inputs – inflationary inputs and credit quality, and again, that reappraisal for fixed income.

Kevin: So what you would say is at this point global recession is already a given. It may be global depression.

David: Global recession is a given. We were headed there prior to the transportation closures in Europe and the U.S. and now if you have multiple quarters of declining growth you string those together and continue with retail closures. If that persists more than for a few weeks, you have unemployment numbers which globally are going to be an issue. Already are an issue, but domestically, might be as well. So you see unemployment numbers, obviously they will shift higher. Just New York, as a classic case in point, 50,000 restaurants are closed on the order of the governor of New York. And guess what? That is 800,000 people who, for an undetermined period of time, are not getting tips or pay. And that ends up being a real issue.

Again, duration being a key. This last week – no big deal, everybody can survive a week. If it is much longer than that, I’m sorry, this becomes a real issue. Bankruptcies will occur. I think initially Amazon captures even more market share as retail businesses retrench and nobody goes out, but you can still order online. But imagine this. Imagine if, or when, Amazon employees at one or more of your fulfillment hubs catch the coronavirus. And now you’re ordering, and boxes and boxes are landing at your door, and you’re bringing what inside your house? Could even mighty Amazon be vulnerable?

Kevin: You’ve been saying for weeks, and actually years, that how long something lasts is the most important thing – duration. We all have limited resources, whether it is in our body, our bank account, even spiritual resources. So duration, duration, duration. That’s what you’ve been preaching. And at this point, like you said, most people can get through a week, but do they have the savings to get through two? Or a month? Or six months?

David: So many times on Tuesday nights my wife and I head out for a date night. We’ll have to modify that to some degree because all the restaurants in Durango are closing, too. So what we are doing is we are making deposits to the love bank, and we’re making sure that our relationship is healthy and on solid ground, because we know that life is full of stress, and sometimes that is stress relating to things that happen with our kids. Sometimes it is things that happen within our own relationship, and we want to make sure that we have sufficient reserves emotionally to be able to handle those things. And so on a weekly basis we are making sure that we are over-reserving.

Margin is like that. Let me be clear, I’m not saying margin as in borrowing to buy something else. Not margin borrowing. What we have often referenced in terms of margin is just a reference to reserves. It is the extra resources you need to fill the gaps. And that can be a whole host of things. That can be savings. That can be energy. It can be maintaining a strong neurochemical balance. There is not a lot of surplus. If you look around, in the form of savings, the majority of Americans are unable to deal with a one-time unexpected expense of $400, and not a lot of monetary or financial reserves.

It may come in the form of food in the pantry. You have a weekend’s worth of food in there, a week’s worth of food. It may be in the form of a healthy immunity, or a strong body, or even meaningful friendship. These are all things that add to our reserves. Because when we think of reserves, extra space, we’re talking about financial reserves, we’re talking about spiritual reserves, we’re talking about emotional reserves, we’re talking about intellectual reserves. So that when crisis occurs, not if, but when crisis occurs, you are adequately resourced and can take it more or less in stride.

Kevin: One of the things I have been recommending to my clients for years, but actually, just the last couple of weeks is, sit down with your family, write out a one-week plan. What do we need for the week? Write out a one-month plan. What do we need for the month? Then a quarterly plan, then six months, and then a year. Because if the duration goes on there will be changed behaviors, and we have to prepare ahead of time for that.

David: One of the practical things that my wife did just yesterday was post about 20 things that the kids can do. So dance was canceled. My son was going to be in a play here in a couple of months – Matilda – that was canceled. There is a whole group of things that they can’t do anymore. They are not going to ju-jitsu. All of their extracurriculars are done. So here is a list of 20 things that any time they are feeling bored they can go and say, “Oh, I can go up the hill and play in the fort. Oh, I can go outside and play basketball. Oh, I can…” It’s a quick reminder that things are different, but they’re not tragically different. We just have to change, and be willing to be flexible in our thinking.

Kevin: But we also have to recognize that there will be a changed set of behaviors for everyone else, too, and plan ahead. So when you’re looking, you may be changing your own behavior, but you’re preparing for the possibility of others changing behavior in a way that you have to know about ahead of time.

David: That’s where we see the economic impact of coronavirus, Covid-19. The economic impact is because of a changed set of behaviors, and some of those are voluntary, and some of those are mandated, like the retail establishment closures in both Los Angeles and New York City, and we’re going to see more and more of those in various cities and states across the country. And it comes back to that word that we have repeatedly used in recent months – duration.

A day is fine. A week is a mere inconvenience. Multiple weeks or months – now all of a sudden you begin to see the weaknesses in the system and you begin to see that there is a lack of reserves. That is on display. That is what is revealed. So duration of a crisis has a massive impact on how it is handled, and who it affects, and what lingering impact there is from it.

So listen, the C-19 versus C-253, the credit 253 problem, I’m not minimizing the C-19 problem, but it really has to do with duration more than anything else, and the change of behaviors, rather than this being the equivalent of the Spanish flu. I would suggest that listeners dust off the copy of Strauss and Howe’s Fourth Turning. I think reflecting on a larger picture is really helpful. We’re talking about a larger picture of social change. They are very keen to suggest in their book that there are periods of dislocation which are not uncommon, and they occur, say, every 80-100 years, and it’s really where excess has been built up and it has to be resolved.

But that is just on the financial side where we think of excess. There are patterns of social amnesia and cultural progress which erase the hard-learned lessons of earlier generations, and it opens up vulnerabilities in what is roughly a fourth generation away from the previous crisis. So here we are talking about, maybe it is a short recession, or maybe it is a stock market correction. If it is, then these are meaningless, frankly, in the grand scheme of things.

Kevin: What is amazing about the Fourth Turning book is that it was written decades ago. Neil Howe has been one of our favorite guests on the Commentary because, really, you could have had him on 100 years ago and he would have said the same thing, or 200 years ago. There is a cycle, and what you have is this cooperation – we call it globalization – and then you have a breakdown, and sometimes there is a fork in the road. You can either go to more control or more freedom. We have seen both. We saw more control in France back a few hundred years ago. We saw more freedom occur here in America.

David: We’re talking about a demographic study that is run by sociologists, and they saw enough of a pattern over 600 years of British and American history that they said, “This is very curious.” Actually, some of the inputs, from a sociological perspective, from a cultural perspective, they relate. There seems to be, as they say, a rhyme as you go through history – not an exact replication, but perhaps what we have seen over the last 80-100 years, and has intensified over the last 20-40 years, a period of globalization, is now moving in the opposite direction, with the currents taking us in the opposite direction.

A period of globalization leads to a period of de-globalization. A period of mutual cooperation and peace becomes, in the context of what they describe as a fourth turning, a period of breaking down – a breaking down of international relations, of increased strife, of increased nationalism, of very highly contentious domestic politics.

What I have liked about The Fourth Turning, as sort of an organizational grid – not that it perfectly predicts the future, or even determines anything that comes ahead, but it reminds me of the cycles of history which relate deeply to who we are and how we behave at a very basic level. This is who we are and how we behave in good times, and in bad times, under periods of time when we are pressured, which is what you brought up a moment ago. One of the big takeaways from the book is that during fourth turnings you accelerate trends toward either greater freedom or greater control. It is very binary.

So as we unpack the C-19 concerns, there is the social and political aspect, which is utterly fascinating to me. When pressure is applied, how do people respond? How do different people respond the way they do because of personality, because of upbringing, because of social milieu? Again, because of degrees of margin, what we were saying earlier. When fear is in the mix, and you have unsolvable challenges, those are represented to people and stress is created, it impacts decision-making, and it impacts it in fascinating ways.

Kevin: You bring up emotions. You brought up fear. The markets oftentimes are either ruled by the emotion of greed or the emotion of fear. When we study market history, rarely ever is it neutral. There is usually some degree of one of the two emotions. And so when that shifts dramatically from greed to fear, we call that panic.

David: When we look at the markets, you can look at that greed and fear continuum and short-term trends are defined by volatility, which is either daily, weekly, monthly, and it is on again, off again – risk-on, risk-off, risk-on, risk-off, risk-on, risk-off. Imagine a squiggly line. It’s up and down, and up and down, and up and down. But that can be in a larger context of either growth or decline, where the up-down, up-down, up-down volatility defines short-term trends.

The question is, is there a spirit that pervades a particular period of time such that, again, you have manic behavior on the upside, a growth period where you have these little squiggles of up-down, up-down, up-down, but the general trend is all up. Or vice-versa, where you have the same up-down, up-down, up-down volatility but the general trend driven by fear ends up being all down for a certain period of time.

Studying market history, you have the idea that markets run in cycles from extreme greed to extreme fear. Decisions are made on a continuum of emotion. People are not always conscious of that, but the tide rolls in, and bull markets occur, and people feel great. And the tides of sentiment roll out, and bear markets eat away at resources, and people experience panic and despair, and an instinct for self-preservation.

One of the more interesting aspects of the last few weeks and the market’s declines that we have seen, is that very few investors appreciate the degree to which central bank activism has manipulated sentiment and kept it elevated for longer than usual. It’s kind of like a frat party.

Kevin: Very artificial. It has been very artificial from the get-go.

David: Yes, so the punchbowl has been refilled, it has been spiked for over a decade, but the interventionist trends extend well beyond March 2009. When the Federal Reserve takes action, ordinarily the market responds with, “Thank you, sir. Yes, I’ll have another.” It’s almost as if cocktails are being passed out, and the party presses on. And it goes later and later into the night. But when the Fed takes action, and you have party participants there, and they move outside to the bushes because they’re already feeling sick, and the Fed is surprised, the Fed doesn’t get any response, nobody is saying, “Thank you, sir, may I have another?” Again, everyone has been betting on the eternal nature of the party, and they are surprised. I’m telling you, something in the last two weeks has shifted, and you see it in the response to the Fed’s impotence.

Kevin: That’s probably when panic actually occurred, when people saw that the Fed was scared.

David: We have said for months that monetary policy advocacy was in the rear-view mirror. We said that for months. And the big transition point had to be – had to be – to fiscal stimulus. I’m not a proponent of it, necessarily, but this awkwardly falls in an election year. Yet, what are you going to find bipartisan consensus on in terms of a spending package? There are implications. If Democrats sign off on something that is too generous in terms of helicopter money, does that promote re-election? So you’re really in this awkward space of the baton needing to pass to avoid outright panic, from the monetary policymakers to the fiscal policymakers. But finding consensus in a very contentious political environment – wow, that is interesting. Very relevant here, how we manage money in the context of real assets, because there are implications, not only from monetary policy, but also from helicopter money, more the fiscal policy side of things. What do I want to own? I want to own infrastructure, I want to own specialty real estate, I want to own natural resources. I want to own precious metals. And a part of the implication is that, on the one hand, monetary measures will continue in an effort to desperately prove relevance, even at the cost of monetary stability. QE-5 is already here.

Kevin: So we had QE-1, we had QE-2, we had QE-3. QE-4, which they said was not QE, started in September. Are we going to have QE-5?

David: We already have it. That’s what we just announced this week. We had 700 billion in purchases and they were starting to move that direction last week with a 37-billion dollar offer through the POMO facility, and QE-5 is already here, even while the fiscal deficit monster is being awoken and put to work. What are the implications when the fiscal deficit monster is alive and well and we’re smack dab in the middle of QE-4 and QE-5? You start to say, wait a minute. A 2-trillion dollar deficit for 2020? That’s not going to be a surprise. That might be a conservative number. In fact, multiple years of that kind of spending would not surprise us.

So, real easy here. You connect the dots between currency pressure devaluation coming from your quantitative easing, your credit market deterioration as you see massive fiscal spending. And yes, that implies that at some point the bond market rejects the Fed’s interest rate edicts, and interest rates march to higher levels, reflecting those concerns over credit quality and deterioration of credit quality and an increase in inflation risk. Reappraisal of bonds is coming, and I think this is where, again, we are way too early to be jumping into the stock market with both feet. You might be buying the dip, and you might be, in fact, what we would say, catching the falling knife.

Kevin: We are a consumer society. I just wonder, other than the purchases of toilet paper and Purel – that’s probably on the increase – but there is an absence of consumer and corporate spending at this point because we literally have a worldwide shutdown.

David: That’s right. And this is where, again, government is assigned according to the sort of neo-Keynesian model, and this is what is an aberration. In the absence of consumer and corporate spending, you have gaps. And obviously, the Covid-19 brings that into full display. Consumption behaviors have shifted dramatically. The government has to voluntarily stand in the gaps, aggregate demand fill that gap, and through fiscal spending initiatives, deficit spending initiatives, do what they have to do to ensure that a recession doesn’t become a depression.

Recall how frustrated we have been with a trillion in deficit spending in recent times because we have zero war and we have had no recession. 2019 – were we in a recession? No. Were we at war, a world war? No. And yet, we were running a trillion-dollar deficit. Then the CBO, the Congressional Budget Office, said we’re on pace for 1.3 trillion each year ahead for the next decade, and that is before we see a significant change in consumer behavior, consumption pattern shift, and we see destruction both at the corporate and private level in terms of spending.

Kevin: Let’s go ahead and talk about that, because how do we fund the state of emergency other than borrowing that money? One of the things, as you talk about fiscal spending, we’re not spending money we have, we’re spending money that we’re borrowing. So when a state of emergency is declared and handouts start coming out, that still is borrowed money.

David: I think this was a key point for this week. Declaring a state of emergency allows the president to go ahead and get the fiscal spend started. He gets to pull the first 50-billion dollar olive out of the jar, and he can intervene carte blanche with that amount. Obviously, getting a larger fiscal package together is sort of to be determined. We have the Japanese doing the same thing, you have folks all over the world – again, the IMF is talking about mobilizing a trillion dollars in lending capacity to fight coronavirus. There is going to be a world awash in liquidity to try to get people to spend. And the question is, can they? How do you get that done in the context of being on lockdown?

But there are also at least 100 special provisions, going back to the state of emergency. Those special provisions open up to Donald Trump in the wake of that declaration. Very key. You think, “Oh, he declared a state of emergency. He must think this is a big deal.” No, that is a technical choice, and it opens up legal opportunities for the administration. It removes many of the constraints that you ordinarily have under a tripartite balance of power. So not all the powers are bad. But that’s true of any tool. How you use it or abuse it is a question of who is wielding it. It depends on who has it in their hands and how they are using it.

Kevin: And the question comes, and you talked to everyone in the office about this, what are you willing to give up for security? I think back to Roosevelt in 1933. Everyone remembers his speech, “There is nothing to fear but fear itself.” Of course, that is a great thing to say, but it was within 30 days that he declared a four-day bank holiday and put an enormous amount of social controls in place. I’m wondering if we are going to see the same type of thing with our current government.

David: I had a fabulous time reading through about a 57-page paper last night put out by the Bank of England, and they are talking about creating their own digital currency. It is fascinating. The way they played financial inclusion, it was very, very coy about the merits of financial inclusion, but it essentially is shutting down the financial system as we know it, and resurrecting it on terms that are favorable to “long-term system stability.” You might say, “What’s wrong with that?” Well, somebody has to pay for that system stability, and typically, this is at the cost of the depositor.

We had FDR, we had the use, or you could say, depending on the color of your skin at the time, the abuse – FDR interned U.S. citizens using those state of emergency powers. Prior to that you had Lincoln, also using the declaration of a state of emergency to suspend habeas corpus. You had the 9/11 torture program. Thank you, Mr. Bush. Those are some of the big uglies in terms of a declaration of the state of emergency which allows you to operate around the law. But you have to consider that America, 2020, under threat of Covid-19, could look a lot more like Xi-Jinping’s China if Trump wants to go there. Under a state of emergency you can deploy troops, you can use the Internet kill switch to flip and manage the narrative. There is a whole host of things that can be done under a state of emergency.

Kevin: One of my favorite guests, and we have talked about her many times, we even replayed her interview from a couple of years ago, was Carmen Reinhart. She said that as the system starts to close they will have to create a captive audience. I couldn’t helping thinking, Dave, that we have mandatory quarantine coming. We are already seeing there is a man in Kentucky under 24-hour guard because he doesn’t want to keep quarantine. Well, that is an interesting preview of quarantining.

But let me ask you, creating a captive audience, what you are talking about with the Bank of England paper – could that possibly be a cashless system, a way of quarantining your money by mandate within the banking system as they help you to help them pay for the system?

David: That’s exactly right. Those are the dots that I would connect, and it is a quarantining of the financial system. When we talked to Carmen, we talked about captive audiences and how in a financial crisis you have to create captive audiences, and then you start assigning who pays the price. You choose winners and you choose losers, and that is the nature of financial repression. Negative interest rates, which we now have real negative interest rates with the nominal level set at zero, and inflation running at 2%, your real rate of return is negative, across the entire spectrum of U.S. debt, and that financial repression is a strategy. This is not an accident, this is an outcome of choice where policymakers are saying, “Someone will pay the price.” And you’re expected to stay in the system.

This is one of those things where, on the basis of fear, people move from stocks to bonds, and it appears to me to be a move out of the frying pan and into the fire. But again, we have fear and behavior management on display, we have social conditioning which is a fascinating aspect of this whole Covid-19 experience, where, whether this was created and intentional, or merely state planners looking and saying, “My goodness, look at how well this works. If the temperature is increased, and if there is a real frenzy about a particular issue, look at what you can do. People will bend over backward to comply.”

So there are control issues, there are social conditioning issues, there are a whole host of things that I think are fascinating that lead us right into where we go next. If you have decay in the value of the dollar, if you have credit deterioration, if you have the mother of all bubbles in the credit markets, C-253 blowing up in your face, and you have to try to maintain control, do you need new tools in the toolbox? Absolutely. And what are those?

The Bank of England talking about digital paper, and managing it and controlling it, not as – they’re not jumping on board with Bitcoin or Ethereum or Ripple, they’re talking about doing something that replaces all of those things and just basically replaces all of physical cash.

But it gives them power. It gives them the ability to maintain the captive audience and do as they wish with the Effective Lower Bound, do as they wish with setting rates at deeply negative levels. This is where we are. The big issue is not C-19. The big issue is C-253.

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