EPISODES / WEEKLY COMMENTARY

Almost Half of My Taxes go to Pay Interest!

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Nov 29 2023
Almost Half of My Taxes go to Pay Interest!
David McAlvany Posted on November 29, 2023
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  • 40% of personal income taxes are sucked up to pay interest on US Debt
  • Seven US Banks closed 42 branches in one week
  • 50 Billion a month is fleeing China in the form of gold and other creative alternatives.

“You’ve got to know that our Chinese counterparts, they laugh, knowing that they are the winners. They win. Who advances in rocketry? Who advances in AI? Who advances in the life sciences and is solving problems that cure disease? When you consider the fluid nature of the global economy, the fluid nature of a global workforce, where do you think innovation? Where do you think technological progress and economic growth come from? I would argue it comes from the best and the brightest. I would argue that it does not come from the most easily triggered.” –David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. 

Somehow, when you’re desperate, Dave, you find ways of doing what you need to do, and I’m thinking of China right now. For three years, they were shut down, and now that things are loosening up a little bit, there’s an awful lot of money leaving China, the mainland China, and it’s coming out in forms that we’re very familiar with.

David: New York Times reports that 50 billion a month is being taken out of China. That’s Chinese households and the private sector companies as well, and that’s gold in suitcases, and it’s wire transfers to accounts in Hong Kong. The title of the article, if you’re interested in reading it, “Gold Bars and Tokyo Apartments: How Money Is Flowing Out of China.”

Kevin: You had said Tokyo apartments, it’s not new for Chinese people to buy Tokyo apartments, but they were used to spending about $300,000.

David: Exactly, and then turning around and renting them. Now, they dominate the apartment market $3 million and over. It’s real money that’s moving, and it wants to be positioned in real things. And you have to ask, what do they know that may not be in the press today, may not be front headlines news today?, and I think it’s always telling. Capital flight is always telling, never ignore it.

Kevin: Capital flight and then also consolidation of business. If you looked at what’s happening to the banks right now, if you own a regional bank or you work at a regional bank, you may not be there tomorrow.

David: Yeah. Shrinking of the retail footprint, that may be what this is about. Seven US banks closing 42 branches in a week. Cost savings may be the motivation, digital bank prioritization, allowing for increased scale, reducing overhead as the hard costs of personnel are minimized. All of those things may factor in.

You’ve got PNC that closed 19, and then the rest were split between US Bank, JPMorgan, Bank of America. And to be honest, I don’t see this as a retreat, but perhaps as house cleaning the ineffective and non-profitable branches, house cleaning prior to further big bank advance and increase of market share.

Kevin: Do you think this plays at all into this bailout that we know is coming in March? The banks who purchased all these long-term securities, these Treasurys that are underwater, they’re hoping for a bailout.

David: Well, whatever shape it takes, we move towards the March 2024 anniversary, and it’s the anniversary of the Bank Term Funding Program. That was when the Fed swapped assets that were underwater and exchanged them at par, used them as collateral for one-year loans. The relevance is, it’s one year. So, by the time we get to March, the year is up, and it’s worth considering how the Fed’s choices to either amend, or extend, or wind down that program prioritize particular players in the banking industries. You’re talking about 100, 120 billion in the program, and so perhaps the list of borrowers reads more like a menu to the big banks.

If you’re looking at what’s for dinner, if for any reason pressures increase on those lenders who are part of the bank term funding program, their larger brethren do stand to benefit. So, how will the Federal Reserve sort of serve up dinner to these larger bank players?

Kevin: Well, and just to refresh people’s memories, I know it’s common knowledge as to why Silicon Valley Bank failed and a number of others. They purchased long-term, very safe US securities, and then interest rates rose, and those long-term securities, if they need to sell them before maturity date, there’s quite a loss.

David: Yeah. This year, the pressure centered on securities portfolios. You’re right, lost value as interest rates rose swiftly, and that pressure could certainly be a factor in 2024, but commercial real estate certainly will be a factor as banks reflect those losses on their loan books, and they take on inventory from owners that simply opt to walk away.

Kevin: I’ve never really liked Black Friday. For me, Thanksgiving holiday isn’t really about going shopping, and Black Friday, but it has become a tradition. If you drove around on Friday, Dave, here in Durango, there were lines nowhere. Nowhere. You remember how it used to be? People would get in line a lot of times when it was still dark before the sun came up so that they could get their Black Friday deal. So, just by visual perception, it would be, well, this Black Friday is a doomed Black Friday, but that really wasn’t the case, was it? People right now are using their keyboards and their monitors.

David: No, that’s right. A lot more purchases being done online and the online sales increase of 7.5% from last year probably reflects that dramatic shift from in-store to online purchases. It’s difficult to say how robust the sales weekend was when you’re sort of blending these two things. The early bird lines inside the big box stores, they seem to be a past or historical social phenomenon. And retailers, interestingly, they were discounting items months ago with discounts just increasing as we came closer and closer to Black Friday.

Kevin: It was black third quarter is really what it was.

David: Exactly. So, with that in mind, there’s speculation that Q4 sales somewhat pulled into Q3, and so that may leave total retail numbers a little flat when viewing December alone or when looking at the final quarter.

Kevin, just moving away from the Black Friday sales and things like that. Back to the debt markets for just a minute. The pressure because of interest rates that we saw in 2023, the rise in interest rates, and we have yet to see recession. It doesn’t mean we won’t see recession, it just means we haven’t seen it yet.

When you see higher rates reflected for other reasons, I think that’s when things become very interesting within the financial markets. Because to date, you’ve got credit spreads which are very, very tight. In other words, the premium that you get for taking more risk above just Treasury investment is really thin. You’re not getting compensated very much, and that would be true for investment grade paper, that would be true for high yield paper.

Kevin: What you would call junk?

David: Yeah. So, this notion of getting a recession this next year, you get a recession and now you’ve got interest rates increasing for other reasons. It’s credit related. It was not credit related in 2023, and that might seem—

Kevin: So, worrying about payback is what you’re talking—

David: Again, it might not seem important, but this distinction between what moved rates in 2023 and what’s likely to move rates in 2024, they’re not the same thing. When the Fed raises rates, that’s one thing. When there’s stress in the economy and bonds are getting repriced according to a food chain or a pecking order of quality, now all of a sudden, instead of junk being the top performing, which in fact it is this year in the fixed income market, instead of it being the top performing, it becomes the worst performing.

So, everything has been sort of radically flipped upside down. The worst place to be in 2023, US Treasurys. The worst place in 2024, you might be fine hanging out in Treasurys, but watch out across the corporate credit markets, because now you’re talking about a totally different dynamic. Totally different dynamic. And here’s I think what’s important to keep in mind: When credit spreads change and corporate debt becomes a pressured asset class, the next shoe to drop is corporate equity. So, the stock market follows the bond market. Particularly with the bond market, you’re talking about corporate credit.

Kevin: I like going back to what you were talking about, when the Fed raises rates, it’s very different than when the market raises rates, because that’s what you’re talking about, Dave. There’s free market forces that you cannot manipulate for forever. So, the Fed can be the manipulative part of, “well, we’re going to raise rates this time,” or “we’re not going to raise rates.” They can make that almost as an arbitrary decision. But when the market actually starts to say, “Wait a second, I’m actually requiring higher interest because there’s a higher likelihood that I might not get paid back when it comes time for maturity.” That’s what you’re talking about, right?

David: Yeah. Well, the markets are aware all the time and making judgments, opportunistic judgments, risk mitigation judgments. Take for instance data from the University of Michigan. Immigrants are clustering in states that provide the greatest welfare benefits. This is just a market phenomenon. The article from the University of Chicago on this, income maximizing behavior implies that foreign born welfare recipients, unlike their native counterparts, may be clustering in states that offer the higher benefits.

Kevin: That’s sort of a, “Well, duh,” right?

David: Yeah.

Kevin: That’s what the market does, it’s, “Well, duh,” right?

David: But the empirical data confirms that. People behave in ways that sort of maximize pleasure, minimize pain. In this case, it’s maximize benefit with exposure to the subsidy or this opportunity, through welfare benefits. And if you’re just getting settled, you don’t have roots, of course, you’re going to move where the best opportunity is.

You could see investors doing the same thing, where today it makes sense. You’re buying junk bonds because there’s higher yields, and there’s no more risk that you’re taking there. At least that’s the modern mindset is, “I’m getting paid more. Why wouldn’t I go there?” “Well, you might be taking more risk.” “No, I’m not.”

That’s the conclusion that the market has come to, is there’s no more risk, but there is more compensation. They have to be convinced that there is more risk, and you get that in a recession. One of the things we talked about in our meeting today is that we’re currently running a deficit to GDP of 8%. That’s our deficit compared to GDP, 8%.

You get into a mild recession, you add 6% to that. You get into a worse recession, and it’s 8% or 12% that you add to the— We could be as high in 2024 with a deficit to GDP of 20% total. That’s enough to scare the whiskers off a cat, and it’s enough to force the Treasury to issue another 1, 2, or even $3 trillion in added debt. So, you could actually have both things happen. You could have the increase in interest rates in the corporate sector because credit is now a concern in the context of recession. You can also have, in the context of recession, deficit spending increase further, going past the current 8% number to a 14, to a 16 to a 20% level. And that would require mass issuance of Treasurys. And that in itself would also, just based on supply and demand, drive interest rates higher as well. So we’ve got a couple of things that, coming into 2024, are going to be really interesting in the coming months.

Kevin: Well, and if that doesn’t take your breath away, if the debt to GDP or the deficits to GDP doesn’t take your breath away, this would. Okay? I want everybody who’s listening to picture the carrier groups that are floating out all around the world, the jets that are flying for the US military, the troops. Okay? Picture all of that and the cost of all of that. Well, those deficits, Dave, have to be paid, and there’s interest on those deficits. Right now, the interest that we pay on those deficits—

David: Well, the interest on the debt.

Kevin: On the overall debt, but I mean those deficits add to it, do they not?

David: Sure.

Kevin: And so the interest that’s being paid on that debt is greater than what we pay for the military.

David: Total defense spending. Interest is now more than total defense spending.

Kevin: That’s crazy. That’s crazy. So I guess the question we would ask— Okay, you were talking about subsidies. Last night, you and I had actually sort of a colorful discussion about where does regulation come in, subsidy? Where does remarket take over? And there is this balance. You can’t be all one or all the other, but you better be careful what you subsidize. You were talking about the immigrants clustering in states that provide the greatest welfare benefits. What about the subsidies for political correctness and wokeness right now? It’s almost as if we’re subsidizing things that absolutely lead to no kind of productivity whatsoever.

David: Yeah, it’s a social subsidy instead of an economic one. But over the Thanksgiving holiday, a friend shared a Wall Street Journal article on the current hiring practices at Ohio State University.

Kevin: The Ohio State, by the way. Yeah, that’s what they say.

David: Yeah. Well, so this is interesting. This is 800 pages of data that was collected on the interviews, committee determinations, etc., etc. The author, one John Saylor, director of university policy at the National Association of Scholars. He details the priority that the university—in other research that he’s done, he also looks at the University of Tennessee and University of Texas, Austin as well. But these universities, the emphasis and priority they place on DEI, diversity, equity, and inclusion, that criteria for hiring. And if you ever wanted to get a sense for lunatics running the asylum, look no further than OSU. November 20th is the article date, Wall Street Journal, and it’s just evidence of the absurd. In some instances, you find applications by science professors in biology, in astrophysics, and the weighting— They come up with this metric for if they qualify to move on to the next round in the interview process. And professors who have applied in biology and astrophysics, the weighting, a third to half of their total value proposition is on their diversity statements.

Kevin: Really? So what they say about the diversity?

David: Yeah, compared to the research that they’ve written in their field of study, or their teaching statements, kind of what they view as the priority, the best way to engage students and help them grow. This has become a more complex issue. No longer are your race and gender sufficient for university affirmative action, DEI hiring protocols. To understand the current state of intellectual suicide, you look into the university DEI hiring protocols, and it’s wild. Merit is out. Merit is not the first thing that they look for. You’ve got race, you’ve got sex. Believe it or not, you have size, gender, and then how these things mix, what they call intersectionality. And then not only do your inclusion and diversity statements need to be clear that you’re on the “right side of history,” but you need to prove that you have some activist mindset. It’s not sufficient to point out the need for DEI. There’s now a requirement for this vociferous voice, this activist voice for advancement in the academy. Welcome. Welcome to the modern zeitgeist. Welcome to the modern zeitgeist where bias, where bias is being institutionalized.

And to me, the correlation between university policies that diminish the role of research, that diminish the role of academic excellence, the correlation to a diminished value of a college degree, it is far more than one-to-one.

Kevin: And you think about what these degrees cost these days, Dave. I have a friend who was 60 years old before he finally paid off his college tuition. He had several doctorates, a number of master’s degrees. He was a professor all of his life, but he only paid it off in February of this year.

David: With inflation and tuition far outpacing inflation in other categories, I think individuals are already faced with paying more.

Kevin: Yeah.

David: And asking whether there is a real value provided in a four-year degree—

Kevin: And spending a lifetime to pay it back.

David: —sufficient to justify indentured servitude. Because think about that. If you get a degree, the average payback on student loans spans 20 years, and that comes from a sample size of 60,000 graduates. So maybe you know somebody who paid it off in 10, and clearly someone who took more than 20 years to pay it off.

Kevin: Right.

David: But the average payback on student loans spans 20 years. That is a period of indentured servitude. What are you getting for the education? Now, I realize this is not a new trend. The current DEI trends, again, this is diversity, equity, and inclusion trends— And I’ve seen it in my work with the college here in town. This is not a surprise to me. I think what is a surprise to me is how absurd it’s becoming. If you want to be an astrophysicist, again, your identity has to be so complex as to be almost un-understandable to the average person on the street. It’s like, what? I thought you were just a human being. “No, I’m a this and this and this and this and this and this and that, and that’s how you need to respect me.”

Kevin: Well, and it’s not just you. It’s what you say about everyone else. It’s your statements that you make. Actually, not just about yourself, but others as well.

David: Right. Well, so the current DEI trends, I think they may just flip the switch. They may fully convince the public that, in fact, indoctrination does not prepare you for success in life. Indoctrination does not prepare you for a successful career. What does is education. Education does. Critical thinking does. Education is quickly becoming like Flannery O’Connor’s lament for good men, hard to find. 

Where do you get a good education? If I’m studying STEM [science, technology, engineering, and math], can you tell me how my skill sets are improved by any form of classroom bias, let alone a form of racism that is now being sponsored? And that’s what it is. It’s just a reverse form of racism. Anytime you’re prioritizing one person over another, it’s inappropriate. It’s inappropriate. You’re not looking at the person on a blind basis. You’re showing preference. And showing preference, I think, is problematic. Can you explain how soft science social experiments—that’s all this is, a soft science social experiment—serve as a foundation for hard science research, hard science progress, competition in the global economy?

If you think about what happens at OSU, you’ve got to know that our Chinese counterparts, they laugh, knowing that they are the winners. They win. They win. Who advances in rocketry? Who advances in AI? Who advances in the life sciences and is solving problems that cure disease. When you consider the fluid nature of the global economy, the fluid nature of the global workforce, where do you think innovation, where do you think technological progress and economic growth come from? I would argue it comes from the best and the brightest. I would argue that it does not come from the most easily triggered. 

We are quickly confusing sociology and a much-degraded psychology with the hard sciences and the laws of nature, astrophysics. Do I really need to prioritize a hire on the basis of body size, sexual identity, and race? Think about this. Richard Feynman was on that basis simply too white, too skinny, and too straight to be of any use in the modern science departments at OSU, at UT Austin, and a growing number of not hallowed institutions, but hollowed-out institutions.

Kevin: And it’s interesting you bring up Feynman because a number of the people who worked on the bomb back in the 1940s would not have been admitted based on what you’re talking about right now. So I guess we wouldn’t have needed that weapon. It was more important that we were woke while we did it.

David: Well, here’s a marketplace solution to these educational dumpster fires. If you graduate from an institution that prioritizes intersectionality over academic rigor, you actually have an extra hurdle in life because now you have to prove that you can do the job, that you actually learned something and weren’t merely indoctrinated. Don’t expect to be hired on anything but merit. You may have wasted your money and entered this sort of indentured servitude for no reason at all.

Kevin: Yeah. So you’re talking to the person who thinks that that’s important. What do you value, Dave, if you’re hiring someone?

David: I value common sense. I value problem solving. I value work ethic. I value integrity. I value critical thinking. If you do have a degree, which is not always a criteria, but if you do have a degree, I value the depth of knowledge in the field of study. I want to know that you have the ability to integrate, to be an integrationist in your thinking, to look across fields and make connections. Can you find cross applications for multiple fields? How well do you work with others? This is where— This is so funny. There’s been— Goldman Sachs went on a hiring spree a number of years ago, and they wanted to hire only the best and the brightest, and they didn’t stop to think that sometimes the best and the brightest also have egos about how bright they are, and they didn’t work well together. They were pain in the bazoo, right?

So do you have humility? Do you have gratitude? Do you know what gratitude is? What are your life experiences that demonstrate grit and determination? Do you have the capacity to recognize your mistakes and quickly move to fix them? Do you have enough ego strength to be able to say, “Yep, didn’t do well on that one? I’ll make it right. No problem. I’ll fix it.” If you’ve been trained to see the world through the eyes of a victim, you’re going to find that you keep on walking around with a cloud that follows you forever, wherever you go.

Kevin: Well, and I think about the terrible discrimination that we have had in this country through the years. Is this not another form of discrimination? I mean, at this point, the color of your skin or your gender or what have you all of a sudden is your determining factor again.

David: That’s all that matters, which is I think what we were told was not supposed to matter.

Kevin: Right? I thought we were working away from that.

David: Somehow the script has been flipped. It used to be that the color of your skin should not be a determining factor in hiring, should not be a factor in advancement. It used to be that gender was not supposed to be a limiting factor in hiring or advancement. It used to be argued that what happens in my bedroom— Remember that there was this liberal defense here, argued that what happens in my bedroom is none of your business.

Kevin: Right.

David: But today, not only is it your business, along with race and gender and a dozen other peculiarities of identity, these are the basis of hiring and advancement. You will pat me on the back for what I do in my bedroom and approve of it, or I will sue you.

Kevin: And it adds to the points of your score.

David: Equity, diversity and inclusion are important, don’t get me wrong, but they should not be addressed through the discriminatory practices of affirmative action on college campuses. And the Supreme Court agrees. The Supreme Court blew this apart in June. Was it June or July of this year? I think a better solution to solving disparity of opportunity is to revamp K through 12 education. Forgive me for the rabbit trail, we will get back to the economy in a moment. A better solution to solving the disparity of opportunity is to revamp K-12 education and allow for school choice. When underrepresented people are provided the skills they need to compete, and they do so on merit, the world does embrace diversity.

But diversity should not be the prequalification for access, nor should it be the creed that limits advancement. If you provided every student in America with the opportunity to attend a private or parochial school and upscale their academic achievement, no one would be surprised by underrepresented groups filling in their per capita share of professional and leadership roles across the economy. So as basic as school choice seems on the surface, it is an immense opportunity to remove the real obstacles, the real obstacles to social and economic mobility. Educational institutions bear some things in common with businesses, like subsidizing a broken business model. The costs end up extending beyond a single organization on the receiving end of a subsidy because it creates systemic disincentives, that that preferential treatment confuses the whole ecosystem.

Any business subsidy is a negative block to a better market environment because in essence it reduces competition and takes better business ideas and makes them harder to succeed. Affirmative action is merely a social versus an economic subsidy. But it’s still a subsidy, and it neither promotes the best, even though they may be promoted coincidentally. You can have that laundry list of identifiers and be the person with merit, but I think you’re talking about a coincidence, nor does it incentivize the best to continue to be all that they can be.

So the latest form of contest in this world of social subsidy in academia is to create an identity as complex as possible. Then and only then can you be considered truly unique. How about this? Everybody is unique. You don’t need to fabricate complexity to be treated with dignity or be given opportunity. Everybody is unique. That’s the way you were created. This simple phrase in scripture, train up a child in the way they will go. When they’re old, they’ll not depart from it. That is our obligation as parents, to help discover who the individual is. Value the individual, empower the individual, get behind the individual. Get out of their way. Let them be what they were created to be. We don’t need a zombie academic model even more than we do a zombie company model. Sometimes these institutions need to be allowed to fail, and I think maybe the next great recession will separate the institutional wheat from the chaff.

Kevin: Well, and you wonder, if we do, this next great recession may separate actually a zombie country and its currency. You look at the economics and the fiscal policy of some of these currencies. Dave, look at Argentina. You can print money for only so long, but talk about supporting a zombie bad idea. It ultimately does die.

David: Yeah, let’s bring it back around to economics and fiscal policy because when governments run out of money after making too many financial commitments, several things can occur. We witnessed, yes, in Argentina in recent decades the first option, a doubling down on the absurd which, as we’ve seen, has a negative compounding effect, both in terms of the economic growth or lack thereof that follows, and in terms of currency stability, where you go from inflation to super-inflation to tempting fate with hyperinflation. 

There are of course, as the government is run and making promises to various constituency groups, there’s limitless projects and programs that we can spend money on. The question is, do any of them generate a positive return? And if they don’t, how can they be justified? The commitments we make, which are not self-sustaining, are in essence a drag on the system overall. And only when system survival is in question, as we see in Argentina today, are those commitments reevaluated. Only in duress can someone say, “I’m going to take a chainsaw to fiscal spending, to government spending.”

Kevin: Which is happening in Argentina right now.

David: We’ll see. I think it’s going to happen, at least that’s what was promised. But as we know, politicians don’t always follow through. So if unsustainable fiscal commitments remain and are not cut, what are your secondary options? Borrow, print, redistribute from other resources. That’s it. That’s it. So far, the borrowing gambit has put us in a precarious place.

Kevin: Is that why we’re being downgraded as we speak? Our debt quality?

David: Fitch, Moody’s, S&P, they agree on this. Not only do we have political unhealth, but we have no real vision for what the road ahead looks like. We could increase taxes, we could decrease spending. There’s a number of things that we could do, but there’s a lot of political discord on those points. And so, yes, currently 8%, this is deficit-to-GDP, on track to a 14 or a 16 or an 18, 20% number next year, should we find recession the reality. 

This is complicated. It seems to me that redistribution, what system do we have? Worst system in the world, except for all the rest, as de Tocqueville would like to say. That’s democracy. And it seems to me that redistribution is most compatible with democracy when democracy is at its worst. And that is where we find ourselves, a voting base that cares more about social justice than basic math, and cares more about climate change as a dogma. As a dogma. And hasn’t stopped to consider the logistics involved to pull off a true energy transition.

I’m not opposed to an energy transition. I’m not opposed to fixing climate change. But you need to get the mathematicians involved and the accountants involved to see if it’s something beyond idealism, because idealism everywhere is not helpful when we truly need critical thinking and creative problem solving, and that’s not what students are being given today. That’s not how they’re being trained. They’re trained to be barking seals.

Kevin: Well, and you were talking about other countries looking at us. You said a voting base that cares more about social justice than basic math. It’s not just a voting base, it’s also a country that has to run on debt that has to be sold to overseas investors. Overseas investors are seeing this.

David: Well, that’s right. So when you see dysfunction, when you see a system that is not functioning in a way that you can really bet on, your behavior changes. Today, for the first time in decades, overseas investors are asking whether the US debt markets are viable. Now ironically, domestic US investors are pouring in billions each week with blissful abandon, chasing that very slim yield bonus above the Treasury rate. We talked about spreads earlier, people love investment-grade debt. People love junk bonds. You’re talking about a bonanza. Investors are pouring in. So that’s the domestic side.

Kevin: That’s like bailing water in and out of our own boat, but we need somebody to actually pump it out from overseas. We have a deficit that, we’re paying a trillion dollars plus on interest, Dave, or debt.

David: Yeah, the overseas perspective is different, removed from the insanity of constituent-driven fiscal commitments, none of which seem up for negotiation for cuts. The overseas investor has already begun to limit their exposure to US debt, specifically Treasurys. A further market corrective, I think, is still needed. But you see this, overseas investors have reduced holdings from US Treasurys. It was 50% of the total, now it’s 30%.

Kevin: And that’s substantial. 

David: Any market that sees a major buyer reduce purchases by 40%, from 50 to 30—that’s a 40% decline—is going to be impacted. Supply and demand in the Treasury markets has been the main show in the credit markets to this point.

Yahoo Finance framed the interest component on our national debt in a novel way. 40%. 40% of personal income taxes are siphoned off for that one line item, interest. 40% of income. 40% of income taxes go into that one line item. You and I, Kevin, we’ve talked about total government revenue. That was a 6% number, graduated to 9, 15. Now it’s close to 19%. Projections in the years ahead, we could see 25 to 30% of all government revenue going to interest. But if you’re just talking about income taxes, now 40% of income taxes go into pay interest.

Kevin: Wow.

David: The outside creditor could see that as concerning, and probably does.

Kevin: So that’s how the country’s run. But corporate debt has actually been pretty resilient, and I’m wondering if that’s because we haven’t had a recession. What does corporate debt look like when we actually do have this recession we’ve been talking about for 20 months?

David: That’s the key I think as we look ahead. We can look back. We can live in the present moment. We need to look ahead and anticipate with some imagination, try to see what happens next. The credit markets on the corporate side have been very resilient. While higher rates are an issue, broadly speaking, without recession there’s very little stress in the corporate bond market. So is part two of the bond bear coming after this fourth quarter intermission? And is that second act, if you will, going to draw corporate debt into the spotlight? It’s likely, and when it does, the equity markets are toast. As goes corporate credit, so goes corporate equity.

Kevin: So we see bonds affected by interest rates, and you talked about how, in corporate debt and corporate equity, as one goes, so goes the other. My question would be, we have talked about the FAANG stocks in the past, and now naming them different things, but it’s only between five and seven stocks that are really performing right now. Everything else is lackluster.

David: Kevin, I just can’t get over this, that the equity markets are so convinced that because the Fed is done raising rates—so maybe July was the last hike—because they’re done raising rates, now rates go lower. No. This is still a supply demand issue, and, just as we were describing a moment ago, if supply of Treasurys overwhelms the demand for them, prices go down, bond yields go up. So now you’re talking about that market dynamic, which doesn’t matter what the edict is. It doesn’t matter what the Fed wants.

Kevin: That’s the market. Well, duh.

David: What the Fed gets, what the Treasury gets in the context of oversupply will drive rates higher. But, again, you mentioned equities. So the concentrated focus, the energy in the markets has really become fascinating. While we’ve talked about the equal weighted S&P providing a better perspective on true index performance and where the market is at versus the cap weighted version, what really highlights where all the action has been this year is the S&P Seven, and this is highlighted by John Authors in his Bloomberg column. This tells you something about averages, year-to-date performance, in those seven names. In those seven names, up 80%.

Kevin: Good year.

David: Yep. John says the S&P 493, so, again, the remaining balance of the 500 stocks in the S&P, everything else is basically flat. So as we look at this concentrated performance in equities, it actually doesn’t take much to turn the whole market lower. We’ve seen benefits on the upside from seven names, you can see benefit on the downside across the spectrum within the index, and thus a new weight. Just as there’s been this elevation, this lifting of all boats by the seven, you can also see a depression, a pressure coming from just those seven. 

But, Kevin, I come back to the gold markets and I think about this last week to 10 days. So much has been shifting. We looked at the Treasurys. We know the Treasury market has reputational damage that has been done, and this has to do with reckless spending on the fiscal level. We’ve seen the cost not only in terms of higher rates, the inability to now finance what we need. And so there’s reputational damage in this alternative to stocks.

Kevin: We’ve played that card.

David: Yeah.

Kevin: We’ve played that card.

David: We also see growing reputational damage in the context of the other alternative to stocks and to bonds, only popular in the last decade, but cryptocurrencies. You’ve got only two big ones, only two big ones. FTX is gone through fraud and now Binance settles with the Department of Justice, $4.3 billion settlement, because of what we have known and what many people recognize is a compliance issue. You’re talking about exchanges which are handling not only money laundered by tough groups. If you’re talking about Islamic Jihad, if you’re talking about Hamas, if you’re talking about Al-Qaeda, if you’re talking about funds that have financed child abuse and drugs and actual terrorist organizations, we’re talking about the evidence which was put out on behalf of this case against Binance and forced its founder to personally pay $50 million pleading guilty to protect against money laundering, and the organization pays 4.3 billion because it’s facilitated a lot of nefarious activity.

Kevin: Well, so what we’re talking about is something that can be regulated completely out of existence value-wise. When you look at cryptocurrency, it sounds like a great idea unless somebody can just say, “Hey, you just broke a law.”

David: And this is not me being critical of cryptocurrencies, this is illustrating the sequence which Ken Rogoff laid out so clearly. You and the private sector innovate, we in the public sector will regulate, and then we ultimately will—

Kevin: Appropriate.

David: —appropriate. So where we go with digital currencies, it’s so clear. Use a little imagination. We no longer have Treasurys as the viable option as an opt-out from stocks. Cryptocurrencies, which are the 21st century version of the new shiny object, an amazing vehicle for speculation, but not something that is going to be allowed to exist. Think about it, if you’ve got scrutiny on Binance and FTX and everybody else in the space, a lot of the volumes through those exchanges is nefarious and it just goes away. It finds a dark hole. And, again, regulation scares away the bad actors. And now you’ve got the appropriation phase.

Kevin: Right.

David: I don’t know what the cryptocurrency world looks like on the other side of the appropriation phase. This, to me, highlights where gold, this really basic anachronistic relic of the past, which has been written off as a pet rock by some within the financial community, re-emerges as one of the most important assets. 

I guess because I don’t have a lot of experience buying Tokyo apartments, gold makes a little bit more sense to me. But if I was trying to exit the system, if I didn’t want to participate in something that I thought was corrupted, unsustainable, likely to collapse, where do I go? If I’m in China, I go to Tokyo. Or I go to gold bars.

Kevin: Right.

David: If I’m in another part of the world, gold is this thing, this asset, which is off-grid, and you think, well, why do I want that? On a good day, you don’t need it. On a bad day, it’s the only thing you want. And that to me is where we find ourselves launching into 2024. We’re bumping up against resistance again between 2000, 2100. One of these days, we break out, and when we do, if you hope to get on board at that point, it may be too late.

*     *     *

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Oreck along with David McAlvany. You can find us at mcalvany.com. And you can call us at (800) 525-9556.

This has been the McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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