April 10, 2013; Japanese Currency Attack: Welcome to the Next World War

Weekly Commentary • Apr 12 2013
April 10, 2013; Japanese Currency Attack: Welcome to the Next World War
David McAlvany Posted on April 12, 2013

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, it seems that no matter how much I study monetary history or the markets, I am having to broaden my scope. In the old days you could look at U.S. history, you could see what the Federal Reserve did, or you could look at markets in a one or two-year time frame and you could say that you had enough data to continue, but at this point you have to broaden your historic understanding, and you have to actually broaden your international understanding to have any idea what effect it will have on your assets.

David: It’s a good time for people to be asking the question, “What grasp do I have of monetary history?” For anyone paying attention to the events that are happening right now, this week, and the last ten days, we are hurtling toward a monetary disaster, and we will get to this shortly, but what is different this time than in the past? Really, it is that we don’t have the limitations, we have no machinery to be concerned about – actual printing presses involved in adding electronic zeros.

Kevin: David, most people don’t pay any attention to Japan, and in fact, Japan has gotten to be quietly out of sight, out of mind, because for the last 20 years or so they have just been in a quiet depression/recession, no real inflation. They haven’t really participated. But now it seems that they are trying to imitate the Federal Reserve and print a lot of money.

David: Three to four months ago, we looked at “Abe-nomics” and the idea that Shinzo Abe, the new leader of Japan, was going to, this month, replace the Bank of Japan chief, and we have just in the last 3-4 weeks figured out, not just what the talk will be, but what the action will be, by the bank of Japan. This is what happened last week, the increase of the Bank of Japan balance sheet by over 100% over the next two years. That’s amazing.

Kevin: They’re trying to double their balance sheet in two years.

David: We’ll get into some of the details on this, the how and why this matters to the gold investor. The world’s central banks have increased the size of their balance sheets, buying assets, and putting money into the banking system. Thereby, we have seen over the last 12-13 years, the price of gold rise in lock-step with that increase in balance sheet footprint, if you will.

You can see the trend going back to the year 2000, and we are talking here about the collective assets between Japan, the U.K., Europe, and the U.S. It started at just over 2 trillion dollars, it has risen to just over 9 trillion, more recently, and gold in that time frame has simply measured the degree to which the major world currencies have been debased.

Kevin: That is amazing. If you think about gold coming up between 4½ and 5-fold during that period of time, we’re talking almost dollar-for-dollar how much the monetary base has increased.

David: We are looking at a collective increase of the world’s central banks increasing their footprint, buying assets, and putting that money into the banking system. Every trillion-dollar increase has increased the price of gold, on average, by about $200-210. As Eric Sprott has been keen to point out, this collective increase in liquidity is not likely to change anytime soon. If you are looking at last week’s Bank of Japan commitment, you are talking about a 75 billion dollar per month asset purchase.

Kevin: Similar to the Federal Reserve. We’re saying 85 billion, they’re saying 75 billion. Put that together and that’s a lot of money.

David: You are coming up on 2 trillion dollars’ worth of an increase over the next 12 months. We are talking about an economy that is much, much smaller than ours, so while we are increasing our balance sheet by a trillion dollars this year, they are going to do the very same thing, just shy of it, and in a much smaller economy.

The price inflationary impact within Japan is something definitely to ponder. But we also have the brand new Bank of England chief, Carney, who moved over from Canada, who may do the same thing. It’s really only the European Central Bank which remains in question as to how much, or if they will, increase their balance sheet.

Kevin: This is like a race to the bottom, Dave. As far as values in currencies, they can’t continue to do this without ruining the currency of the world.

David: A number of large European banks have argued that gold is going to witness a precipitous decline, that we’ve moved into a new bear market in gold, etc., and yet what they are ignoring is, basically, the facts. We have a $400-420 price that is likely to be added to current levels which would take us to the old highs at around $1920, and as we discussed last week, the U.S. Fed has spent the last 18 months doing little, while doing a lot of talking.

Now they are doing the opposite. The latest numbers show that they are back in the expansion mode and gold will reflect the aggregate expansion, not just the Fed, but the bank of England, the Bank of Japan, the European Central Bank, as they expand or contract in unison, and for now it appears that the correction in gold is over, prices are moving higher. Over the next several months, we will see those prices get in line with the aggressive monetary polices now so common in practice.

Kevin: It is amazing to see how we are being manipulated, Dave, as far as perception goes. We are talking propaganda coming out from the top-level guys, like George Soros, these guys who are pulled out of the closet anytime they are needed to perform their Jedi mind tricks, and say “Gold is going down. We’re printing money, but gold is going down.”

David: “You will not need this asset class. As I surreptitiously buy my own ounces, you will think about other things and dream bigger dreams.”

Kevin: Here’s the thing, though, Dave. They have told us that we have no inflation, but that is changing. They are starting to say you also will like inflation. Inflation is good for you.

David: We have entered into the publicly disclosed phase of inflation. Up until now there has been some attempt at downplaying inflation. Although monetary policies have been very interventionist, the inflationary effects have been purposefully downplayed. The PR machine has basically said that there is no inflationary concern, to use Bernanke’s classic, and how often does he repeat this? “Inflation remains well anchored.”

Now the game is becoming less subtle. We will print, we will inflate, and you will change your consumption, savings, and investment behavioral patterns, or pay the price. The new message is, I think, very clear. The middle class, and those living on a fixed income had better prepare for the worst. And of course, those with assets will likewise need to, or should be, shifting their allocations. The key question is where?

Kevin: Talking about the Japanese, they have not really experienced inflation in the last 20 years, so everyone, not just in the United states, but everyone is going to have to change their investment habits, because at this point they are going to have to protect themselves from inflation.

David: And you have to subtly distinguish between what the intended destination of your assets is, versus where you should more prudently be investing your assets. This is designed to get you out of your bank deposits. This is designed to scare you out of a cash position. This is designed to stimulate velocity of money, and create a better economic engine, if you will, or to essentially jump-start the economic engine.

Kevin: David, this is what is interesting. The central banks are printing money to try to increase growth. The problem is, the Japanese companies are not buying into this at this point. They are saying, “We’re not really seeing the growth. We’re not going to actually increase.”

David: This where economic realities meet monetary ones. You have 85% of Japanese companies which plan to either keep wages flat or actually reduce them this year. You have had Japanese factory output which fell in February, with a still very sluggish Chinese economy affecting Japanese business leader sentiment. This poses a challenge for both Shinzo Abe and his central bank president, Kuroda. As inflation is intentionally being put into the system, they are expecting a rise in wages, and it’s not going to happen.

So what do you have here? The hope is that you go from deflation to a mild form of inflation, something that is very controlled. But what if, instead, you merely shift from deflation, which is not all bad when you look at savings buying more.

Kevin: You can buy more with your money, and that’s a good thing.

David: But what if you shift from deflation to stagflation, wherein you have economic activity that remains stagnant, along with wages, while the prices of things are going up. This is a very real possibility in Japan.

Kevin: David, we have talked about Federal Reserve policies always looking also toward the full employment model, trying to get everybody employed, but actually, this could increase unemployment, not decrease unemployment.

David: Sure, if there is political pressure on the business community in Japan to raise wages, what you are likely to see is a very reasonable unemployment rate, right around 4.3%. You are likely to see that rise in Japan. That is not a positive outcome, but add to that a stagnant real-wage environment, the notorious aging demographics in Japan where more and more people are dependent on their savings to make ends meet, and this could be a disaster for an aging Japanese population, unable to meet the rising costs except by radically increasing risk in their investment portfolios.

So here again, you are seeing a central bank push the issue. “If you are not going to free up those deposits, we are going to force the issue, and you will be taking greater risks just to make ends meet.” So in an attempt to revive the economy, you could very well create greater social anxiety, and even social dislocation.

In any event, it appears to us that capital is going to massively shift from the private holdings of Japanese government bonds, to the Bank of Japan balance sheet, and again, you have an exit which will either take money into fixed income markets, ex-Japan – that could be Europe, or stocks. They could literally exit Japan altogether. That is not the aim of the Bank of Japan, but you could have that happen, too.

Kevin: I think what we are seeing, similar to what Stockman has been talking about, is the end of Keynesian economics. We are seeing last-ditch efforts in which the only model they have is to print money and keep interest rates abnormally low. The problem is, they are not seeing the results that John Maynard Keynes predicted.

David: Right, so inflating a currency puts a subtle pressure on individual savers and business managers alike, to release caches of currency or cash back into the economy, rather them keeping them as a war chest.

Kevin: Which is a Keynesian goal.

David: Right. Rather than have them sidelined as a reserve, the challenge is that in a globalized world you can create the pressure and you may inadvertently stimulate capital flight. Just because you want to force something out of the bank and into the economy, it may literally leap-frog your economy and go elsewhere because if risk and reward are not in balance, the market is fairly reasonable.

So we may be looking at a three-year period where we see not only massive stimulus from the world’s central banks, but then coping with the unintended consequences, the need to raise capital controls to make sure that you don’t, on the one hand, “solve a problem,” and on the other, create a new one, which is to get rid of your deposits altogether.

Kevin: David, we are reading Stockman’s book right now, and he talks about how Keynesianism only works in a closed system, and this is exactly what you are talking about. If you had a closed system, and nobody could exit the system, what you would have is the ability to control the economy, at least to a degree, based on theory. But of course, what you are saying is that money will flee until the capital controls come in and lock it down.

David: And in the days immediately following the Bank of Japan announcement last Friday, this week on Monday, the Tokyo stock exchange had to temporarily halt trading of Japanese government bonds. But listen to this. You had yields on Japanese government bonds swing from a 32-basis point yield, up to as high as a 65-basis point yield.

You are talking about a doubling in yield, and this was not the intended consequence of the announcement of quantitative easing, this massive money-printing effort. When the government is saying, we are going to buy Japanese government bonds, what that should ordinarily do is not only cap rates, but bring them down. The fact that you are seeing yields blow out says that there is a lot of uncertainty as to the stability of the Japanese government bond market, and it may be too large an issue for the Bank of Japan to even handle.

Of course, this is just one day, and one day does not make a trend, but what that would imply is that there are enough operators in the Japanese government bond market who would say, “Listen, we are out completely, and we don’t like the smell of this. This could spell the collapse of the Japanese government bond market.” You just don’t see that kind of volatility in a market that is supposedly as liquid at the Japanese government bond.

Kevin: There are strange after-effects of these policy changes. All of a sudden it starts to affect the European bond yields, the values of European bonds. Why is that?

David: Particularly last week we saw with European government bonds, a massive influx of buying. Yields came down, prices went up. Where did the money come from? You have the exit on the Japanese government bonds, and the entrance. This is investors being forced out of positions they have been happy to hold, with the idea that if you are going to inflate away our purchasing power, then low-to-zero rates in the government bonds that we have in Japan won’t be sufficient to cover our income needs. Therefore we have to find a higher level of income.

So where do they go? Japanese government bonds to Italian, to Hungarian? This is an amazing thing. Literally, you are driving money completely out of the Japanese system. Is that really what the Bank of Japan wanted? To some degree, that is welcome, because when you exit the yen investments, you are boosting the value of the euro and the euro-area bonds, and so you are receiving a relative benefit. The yen is weakening, and of course, a weakening yen is exactly what the Bank of Japan wants as a part of its 2% inflation target gambit.

Kevin: It’s amazing. Central banks have control over printing money, but they don’t necessarily have control over the unintended consequences, which even go beyond that.

David: Really, what you are talking about is a bubble dynamic which is created. You can create liquidity, but you can’t necessarily direct its flow. What you are creating is unhealthy capital allocation. That is the real result. When prices are distorted in one arena, then you begin to see spill-over effects in other asset classes. That’s what drove European bond yields lower, as we were just talking about a minute ago, and prices higher, last week.

Kevin: So the Europeans are saying, “Thank you very much,” in Japanese.

David: “Arigatou, arigatou.” Thank you very much. We see this same issue in the current U.S. real estate market, just to switch gears here, and by analogy, with the Fed driving mortgage rates lower via the Fed purchases of mortgage-backed securities. And then, of course, you have the opportunity, once they’ve gotten the system dependent on their purchases, the mere suggestion of eliminating the market subsidy takes anyone who is sitting on the fence off the fence, and gets them into the market.

Because what happens if they stop buying mortgage-backed securities? Mortgage rates will go higher. It means you may not be able to afford the house that you have been looking at on Zillow, or on whatever your favorite real estate website is. “You may not be able to afford it, your current income won’t allow it. You’d better get off the dime and buy that house right now.” This is the ability of central bankers to manipulate crowd behavior.

Kevin: So they don’t even have to do it, they can just threaten doing it. “You know, we may let interest rates rise a little bit.” And then you’d better get your mortgage done.

David: It’s not that the Fed has to, or will quit, but they can further badger the reluctant real estate buyer into concerns over what we talked about last week, cash flow affordability. That’s really what we are talking about, affordability. Not because real estate prices can’t go lower in nominal terms, but in terms of affordability, in terms of cash flow affordability. That’s what people are afraid of missing out on.

Kevin: People are saying, if I don’t lock these low rates in now, I’m not going to ever be able to buy a home.

David: Or a condo, or whatever. In essence, the mention of ending QE is a scare tactic to get people to do something else with their money, to dis-hoard their savings. That’s a very strong Keynesian thematic in terms of how you manipulate the market, and market participants’ behavior.

Kevin: It’s amazing to me to see how governments are starting to use market psychology. That’s what this really is. The psychology of forcing people to buy a home, the psychology of getting Japanese people to actually do something now that they are printing money. But I’m thinking that the Japanese experience of investing is going to change because they now have to understand how to hedge their own buying power of their savings, and they haven’t had to do that in the last 20 years.

David: This is a radical shift. It’s not just in terms of monetary policy, but it is also investor behavior. And yes, if you now know that inflation is a threat, and it hasn’t been in your investment experience for the last 10, 20, 30 years, then yes, an era is passing. One of the largest groups of savers in the world is Japanese savers, and over the next two years they are going to be pressured with sort of a neo-Keynesian cattle prod.

Kevin: Their monetary base is going to be doubled.

David: Right, which means they are either going to spend their savings, or move onto other assets which have a greater risk profile, but do give them the income they need to meet the inflationary concerns that they now have. What they have becomes worth less and less each year. Where are those savings going to go? Only time will tell, but we know that we will see a trickle into the Nikkei. Since November the Nikkei is up 40%, and this is just with Abe’s suggestion of bringing in someone like Kuroda to do exactly what he just announced this last week.

Kevin: You pointed this out last week. A little bit of inflation is good for the equities market. A lot of inflation is devastating for the equities market.

David: But we are also seeing a trickle going into foreign government bonds, in Europe, Treasury yields have come down in the last few days. And at least a trickle will go into gold. We have had pension fund managers in Japan say, “Listen, if this is going to be an inflationary trend, we are going to have to increase our allocation to gold.” This is dealing with creating an antidote to central bank shredding of a currency, in this case, the yen.

Kevin: David, I know this week you are going to be with some top thinkers. You do this every year. You are going to be near, and talking to, David Stockman, who has been very outspoken about these incredible policies and what they are actually going to do to the little guy.

David: It is the Bank of Japan that is in our sights today, but keep in mind this is a conversation that is reflected almost in an exact mirror by the Fed’s activity, and Stockman, just this last week, said, “This is why the current monetary system is so profoundly wrong. We have this character, Rosengren, up in Boston, saying that it’s a good thing that we’re trying to induce people to go into risk assets.” Stockman says, “Who the hell is Rosengren to tell old ladies in America that they have to buy junk bonds because the Fed tells them to? If the old ladies feel safer in a CD, they ought to be able to earn something besides dog food money on it. There is going to be a revolt against these arrogant mandarins running the Fed. They will rue the day they arrogated to themselves such massive power.”

It’s not just the Fed, it’s the Bank of England, it’s the Bank of Japan, it’s the ECB, all acting in unison, and doing the same kinds of things, looking at the Fed’s activity over the last several years and saying, “Worked for them. Maybe it will work for us.”

Kevin: David, even above the central banks, we have people who are supposed to be regulating and watching out for the world – the BIS, the IMF. Lagarde – I think she’s lovin’ this inflation.

David: She is. She said of the Bank of Japan’s actions this last week, “This is a fantastic step.” She said that loose monetary policies and unconventional measures by the world central banks are, in fact, boosting global growth.

Kevin: Is that really happening, Dave?

David: Like in China? Like in Europe? The U.S.? We’ve already talked about the seasonal adjustments which improved first-quarter numbers in the U.S. Take those away, and where are we going now? I would like to see Christine Lagarde’s response to declining economic statistics as we move into the second, third, and fourth quarters of the year, and see if she still feels like money-printing is stimulating growth in the global economy. I quote her here. She says, “The reforms just announced by the Bank of Japan are a welcome step in this direction.” Again, speaking of boosting global growth.

And we mentioned this last week, U.S. figures are positive because of seasonal adjustments. They have exaggerated the stats higher and that, of course, gets sucked out for the rest of the year via negative seasonal adjustments.

Kevin: David, you were saying that you would like to hear her response. Actually, what I would to do is hear your response to her. (laughter) What would you say to her if you could talk to her right now?

David: “I guess I’m comforted to know that the key ingredient for economic growth is money printing. I was under some grand illusion that real things had to be invented, and produced, and distributed, and sold. I was under the impression that money was both a store of value, and a medium of exchange, and now, thank you Ms. Lagarde and our cohort of world central bankers. Now I see that you can do so much if you eliminate the ‘store of value’ as a definition of money, and use it instead just as a means of exchange for goods.”

Kevin: David, we’ve seen this really not work in Europe in the past, and we can go back almost 300 years to see the first incident of just complete destruction of a monetary system.

David: Sure. John Law would be proud of her, and the central bankers of our day would be, too. This is very progressive thinking. You don’t need money as a store of value. It is sufficient for it to be a medium of exchange, and thus, increasing its supply helps you, helps the business, helps the world economy, because it doesn’t have to be a store of value. That, of course, flies in the face of history, which would say that real money has to be a store of value, otherwise the vicissitudes of the market, the risk that is in the market, and what anyone has done with a fiat currency, will ultimately be destructive to an economy via the destruction of that currency.

Kevin: And we are not a closed system, so when Japan decides to double their monetary base, the Chinese have to respond in kind, or their imports all of a sudden get out of whack, so it’s a race to the bottom.

David: Lo and behold, therefore, an exchange regulator this week says, “Wait a minute, this is really going to have beggar-thy-neighbor effects. If you’re lowering the value of the yen, we either have to do the same thing, or deal with a reduction in exports because we are no longer competitive in terms of our electronics, etc.” Now you have the opportunity for intense trade disputes, and you have the possibility of yuan devaluation.

Then what do you do if you are managing the Vietnamese currency? “Okay, well, if the Chinese are devaluing because the yen is devaluing, we must devalue.”

And so, it sets across a domino effect, a competitive currency devaluation. This is where I think Lagarde and others are losing the forest for the trees on this issue. You have super quantitative easing, which carries an implicit devaluation with it, and others must respond or lose market share and exports. They are not willing to lose their political legacy by having more people unemployed because they somehow had a reduced slice of the export pie.

Kevin: This really is just a desperate move to keep this thing together. The Economist magazine, which is out of England, discusses easy money this week. It has a full special report on it, and basically what it is saying is that we have had 4 or 5 years of very substantial easy money policies. We are really not seeing the growth.

David: It hasn’t led to global economic growth. In spite of what Lagarde is suggesting, it is simply not there. The numbers don’t support it. Speaking of the numbers not supporting it, let’s come back across the pond to the U.S. Last week’s unemployment numbers were awful. Not just bad, but terrible. The irony was, of course, that U3, the most popular measure of unemployment, dropped from 7.7 to 7.6, so there is an apparent improvement in the employment numbers, meanwhile everything about it was rotten. Just stinky.

Kevin: They are changing the size of the labor force every time they do a calculation. If the number of people actually in the labor force is decreased first before you figure out what your increase is, your increase is going to look like it’s better.

David: Exactly. Your total labor market, if you have people who are leaving the labor market, the percentage how are unemployed in the labor market does improve on the basis of those who are no longer in the labor market. So you had 500,000 plus that left the labor force, unemployed as a percentage of total labor force.

Let’s just look at this. This, to me, is one of the reasons why U3 is just an absolutely worthless number. You have the unemployed, as a percentage of the total labor force. If the labor force declines, then the number improves. Ergo, if 10 million people left the labor force, we should see a dramatic improvement in the employment figure. Again, it’s an absolutely worthless statistic, so your labor force participation rate is now at a level we haven’t seen since 1979. In other words, there are less people in the economy.

Why does that ultimately matter? Well, think about some of our long-term issues – Social Security, Medicare, Medicaid. These are the issues, which, along with the defense, are unaffordable for us moving forward. We don’t have enough revenues to deal with the expenses which we anticipate. What Laurence Kotlikoff has penned up as a 220 trillion dollar funding gap, the difference between our expected revenues and the expected outflows, we have that many less people in the economy generating revenues and generating productivity by which we can then pay those bills. This is a sick inconsistency where we can see the unemployment number improve, but the economy can actually be declining at the same time.

Kevin: Let’s just use an example. Let’s say that you are using a base of 100, and you use a reference of 10 to that. That’s 10%. But if you reduce your base to 50, all of a sudden 10 represents 20%, so you are increasing the way the percentage pays off. But actually, you are not increasing workers, Dave. They are shrinking. That’s the bottom line of what you are saying here.

David: And many would argue that where you are really seeing a reduction in the labor force is with those who are retiring, that it is retirees who are simply saying, “Hey, been there, done that, time to go play golf or shuck pecans on the front porch.” But what is it that is actually happening?

Kevin: It’s discouraged workers.

David: It is discouraged workers. We can’t make sense of it being retirees, because the fastest growing demographic, in terms of jobs growth, has been in the age bracket between 55 and 70.

Kevin: They’re having to go back to work, Dave.

David: Well, they wanted to retire, and this is the sad reality. Those who would like to retire can’t afford to, or they are strategically putting it off for a few years. In the latter case, we think that is wise, but honestly, we see far too many cases where retirement occurs too early, and with too little in resources.

Kevin: A big part of that is the low interest rates that are being paid. We have talked before about people who retired 20 years ago who could expect maybe 5%, 7%, 8% on their money. They could have saved a certain amount of money and actually lived on the fixed return from that investment.

David: It’s not just the households that are seeing that distortion. The same distortion is occurring amongst CFOs and amongst the big Fortune 500 companies. You have corporate executives who are wise enough right now to finance at these ridiculously low rates, and what they are doing, in many instances, is playing the game of buying back shares with the money that they are borrowing.

Kevin: With cheap money.

David: Right. This last week we had Wal-Mart borrowing 5 billion dollars. I don’t know exactly how they are going to use it, but many corporations have taken the borrowings at historically low rates, and gone ahead and retired equity. This is a game. I say it’s a game because when you reduce the shares outstanding, it is this kind of sleight of hand to improve your earnings-per-share number. You have reduced the shares outstanding, and thus, your earnings for a given quarter, divided by a smaller number of shares, shows up as an increased, or improved, earnings-per-share number.

Kevin: We talked about that last week. The price-earnings ratio is so critical. You talked about how the price-earnings ratio in the stock market right now is getting toppy. It’s getting up to a point where possibly the stock market would come back down. But an executive can actually reduce the number of shares by borrowing money, cheap money, buying shares, reducing the amount of shares outstanding, and that makes the earnings look better per share.

David: Right. So when you get to an earnings report and you say, well, from last quarter, from last year, quarter-on-quarter, year-on-year, things are improving. What do we really have to look at? You have to look at the liability side of the balance sheet and see if they are, in fact, growing their liabilities, growing their debts at the same time their earnings per share is improving. How are they gaming the system? That’s really what we are talking about.

Kevin: David, I would like shift back to gold, because that is what we are talking about here. We are seeing gaming of the system, we are seeing quantitative easing, we are seeing printing, we are seeing artificial interest rates. We are seeing a system right now that is being manipulated by those who would try to persuade us that everything is fine. Yet we are also seeing manipulations in the gold market. I came in Monday morning this week, just like every other Monday morning, it seems. The gold market seemed to be doing fine and then, boom! Somebody came in and knocked it down again.

David: Monday morning smackdown. It’s an amazing thing to see the handoff from Europe to the U.S., and the negative bias, which we have discussed before, in the New York markets for gold. It is, at this point, axiomatic that central bankers need to cover the consequences of the liquidity they are creating. And if they can, along with the help of a George Soros, or whoever else is going to ring the bells and capture the print headlines, “No, gold is a worthless item, you don’t need it. Silver is not something that you should have. There is no defense against volatility in the equity markets or bond markets or the currency markets, except buying more Treasuries, perhaps.”

There are some really confusing themes that are coming through the new headlines, and I would say, if you cut through all of that garbage, you have central bank balance sheets which are expanding, and you have the price of gold which is moving in lockstep with it. We have had very little central bank balance sheet expansion, in aggregate, over the last 18 months. Lo and behold, the price of gold hasn’t gone anywhere. And it is back in the mode – that is, balance sheet expansion – of the central banks of the world saying, “Well, we’ve got continue to print.” The Bank of Japan, England, U.S., ECB – in aggregate, we are beginning to see that increase again.

Kevin: So for the person who owns gold, or is buying more gold, what you are saying is, that’s not going to change. As much money as they print, that’s how much gold will go up.

David: Our currency of choice, which would be gold, will reflect dollar weakness, yen weakness, euro weakness, as a result of that money printing.

Kevin: That is amazing, Dave. It’s like what we were talking about before. We can look at gold in dollar terms and say, “Gosh, what a week, it really didn’t do much.” But in yen terms…

David: It was doing just fine, and it’s moving back toward its all-time highs. The question, in terms of the U.S. equity markets, and our financial system as a whole, is that there is, in our opinion, a lot of rottenness in the system, at the core, and deterioration in terms of earnings. The quality of earnings is beginning to slip. What is the trigger that would have us replay a 2007-2008, or rather, a 2008-2009 debacle?

Kevin: That’s a question that I’ve had a lot of clients asking. They are watching and saying, “Gosh, should I go back into the equities market?” My old broker, who, granted, lost me a lot of money in 2008, is calling me and saying, “Hey, I’m making money now.”

David: And I would say, you should be reading the market. You know how you go to a theme park, and you see the sign before those big roller-coasters that say that if you have a heart condition, you should avoid this ride? It’s kind of their disclosure, a CYA, if you will, for, “You shouldn’t be on this ride if you have heart palpitations, or have just gotten out of a major surgery.” Well, that’s what I think we can expect. The ride for 2013 and 2014 in the U.S. equity markets is not for the faint of heart.

What is the trigger for lower prices? I don’t think it even matters. Living in the mountains here in Colorado, when I did my avalanche training up in Silverton, we were taught that anything can be a trigger. You dig your pit, and you figure out what the stability conditions are. What are the levels of snow? What levels create instability? And if the environment is bad, if the environment is unstable, then go home. Go home, don’t play, because you could be the trigger. A bird flying overhead could be the trigger. A pine cone falling from a tree could be a trigger, in the next valley over could be, a snowmobiler just ripping through the bottom of the valley, and you could be in the wrong place at the wrong time. That’s what it feels like to us.

Kevin: David, that’s a great analogy. Tragically, a couple of weeks ago someone my son and daughter went to school with was lost, a very big name in the community. He was a back country skier, a young guy, 22 years old. He was in the wrong place at the wrong time. The conditions were that he should not have been there in the first place, not trying to figure out what would trigger it, but just stay away from the environment.

David: Just this last week, Bloomberg reports the Bank of England saying equity prices do not reflect underlying economic situations. What are they basically saying? “Prices are too high, given the amount of economic activity we see.” That’s a subtle way of saying, “Be cautious. Be very cautious.”

Kevin: David, if you were to summarize, with this change that we are seeing, not only with Japan, but worldwide, what would you say?

David: Inflation is here, on a global basis. The new normal is nothing more, nothing less, than the extraordinary experimental policies of the Fed. They have been rationalized, and now they are being employed all over the world, and the new normal is one of radical measures which have been taken, which inadvertently have destroyed the capital allocation process, which normally, the market directs.

What are the consequences? The consequences are that you have asset bubbles. The consequences are that you have reinforced systemic frailties, even while everyone is glad-handing and patting themselves on the back, for creating what they believe to be a market normal condition.

In fact, it is abnormal. In fact, is it unhealthy. In fact, it is very dangerous. And the end of April, beginning of May, may be the transition point to a very scary time, in terms of the markets, and a recognition that the economy globally is not, in fact, in recovery.

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