- Japan’s QE Is More Than All Global QT Combined
- U.S. Inflation 9.6% Calculated The “Old Way”
- Credit Card Debt At All-Time High
Could Japan Crash The World?
February 22, 2023
“If yield curve control is finally killed off or even tweaked, it will probably be a major event for markets everywhere. So that’s a big question: Will that be the straw that breaks the fixed income market’s back? Yields rising globally to levels that reflect actual balance sheet conditions, actual inflation risk, not what we’re playing with, not the numbers that get massaged lower. Just the methodology changed 30 days ago has a substantive impact on the inflation reality that we think is in front of us.” — David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
Last week we titled the program, It’s Not The Debt, Stupid. It’s The Interest Rates. Now, of course, that was a play on a famous election campaign run back 25 years ago.
David: It’s the economy, stupid.
Kevin: Yeah, but the truth of the matter is it really isn’t the debt. Dave, we could have quadrillions, not trillions, quadrillions in debt if we could live in the fairyland of printing our own money, never raising interest rates, and not having inflation.
David: If you can control interest rates, then you can control your destiny in terms of the amount of debt that you take on. It was just days after we mentioned the Congressional Budget Office projections for our national debt, and, of course, the expected interest expense, and they revised them—higher. Surprise. Surprise.
Kevin: You’re kidding, they revised them?
David: To a higher number.
Kevin: That never happens.
David: So the 2023 budget deficit is now projected to be 1.41 trillion, and the low side projection for 10 years from now is moving from 40 trillion, which we talked about last week, to 46 trillion.
Kevin: Oh, well, what’s six trillion when you’re talking trillion?
David: I think we can probably assume the high side also migrated from 50 to 56. I didn’t stop to do the math. But if 90% debt to GDP is historically a problematic threshold, and that’s what Reinhardt and Rogoff wrote about in their book This Time is Different, that 90% threshold marks the period in time or the threshold at which you begin to see countries have problems fiscally. Why would we think that flirting with 125 to 175% of GDP is not problematic?
Kevin: Well, and how could it be problematic unless interest rates have to be high?
David: The CBO knows what Congress and the White House also know. The debt ceiling’s a joke. It’s just one more opportunity to generate more political heat than light.
Kevin: Let’s tell that to the people who are pulling their credit cards out right now. We need to talk about that because credit card debt being record at this point. Retail sales, they’re just cooking along. I’m just wondering if people worry at all about ever paying it back.
David: That is a place where interest rates don’t seem to matter because people will pay whatever they have to pay to use the plastic. Retail sales rose in all 13 categories in January. The rise was well above expectations. 1.9 was what they were looking for versus the reported 3%. It should be noted, none of the categories of the 13 saw big increases. Some of them were single digit, some of them were healthy double digit. None of those categories are adjusted for inflation.
Kevin: But people are spending right now, even if it costs them debt.
David: That’s true. But the reason why it’s important to know that those categories are not adjusted for inflation is that to some degree you have a confirmation that inflation is alive and well in every nook and cranny the consumer encounters. In the last inflation reports—so this goes back to last week—we had CPI and PPI. PPI’s strongest monthly gain since June. So that was notable after we had our Commentary last week. CPI, less dramatic. It was the strongest number that we’ve seen in three months.
Kevin: Well, and of course, PPI is Producer Price Index. CPI is Consumer Price Index.
David: Yeah. And generally speaking, when you have a more aggressive Producer Price Index, these are your wholesale prices, that ends up becoming, on a lagging basis, consumer price inflation.
Kevin: PPI is the engine of the train. CPI is the caboose—
David: Caboose. Right. So there was more than expected inflation in both measures. If you’re looking at the Consumer Price Index, services inflation was noticeable. Up to this point, the Fed has confidently stated a new era of disinflation. Those were kind of the words that Powell referenced. That new era has begun. They focused on goods pricing coming down and having come off the boil of the 2022 levels.
Kevin: Well, and that was a win to a degree, right? If they’re going to try to find something slowing in increase, goods came down, but what about services?
David: Just think about this because we have to keep this in mind, Powell is arguing for a new period of disinflation, only to encounter within days of that verbiage services inflation being obnoxiously on the move higher. The former Obama economic counselor, this is Jason Furman, he’s currently a Harvard prof and does some work for the Peterson Institute of Economics, he says that, “Nothing in this number gives me comfort. This inflation issue is real. I don’t think it’s going away anytime soon. I think anyone who’s overly calm about it is making me nervous.” And of course, his comment came almost immediately after Biden’s press release that inflation’s getting beat down. We’ve had seven months in a row of declining inflation, and it’s like, “Well, no, it’s not really declining inflation.” I mean, imagine walking into an OR, an operating room, and you’ve got a patient that’s bleeding out. If you can reduce the amount that that person is bleeding out, they’re still bleeding out, they’re just not bleeding out quite as fast. That’s the kind of victory we’re talking about.
Kevin: But everybody high fives if they’ve reduced the amount of patients bleeding out while the patient—
David: It’s not actually a reduction in inflation, it’s a reduction in the rate of inflation. It’s no longer increasing aggressively, it’s just not increasing—as you were saying just a minute ago—at the same aggressive rate. It’s still increasing.
Kevin: But sometimes inflation will hit and then it’ll go away. There are times when you have spikes. Let’s look at the difference between goods and services here for a moment. Goods, you can have a spike in inflation and then have it just go away once those goods become available. Services, that sounds to me like wages. How many people have their wages lowered and raised based on inflation? Usually once the wages start going up, they stay.
David: Right. So services become very important. The reality is, when you look at goods, you’re really talking about what is behind a finished good, which is the stuff that goes into it. So the supply and demand dynamics of commodities is super important, and the solution for high prices is high prices. Because what happens is when you get high prices, the producers of that commodity say to themselves, “Well, we should make a little bit more of this stuff, sell it while we can.” And they bring more product to market. They bring more supply than demand allows for, and you have a collapse in price.
David: So it’s one of the reasons why—if you look at CPI, PPI, and PCE, personal consumption expenditure, that’s the Fed’s favorite measure of inflation—they like to take out the things that are most volatile: food and fuel. Why? Because they know that there is this boom and bust within commodities and supply and demand are constantly solving each other.
Kevin: That’s what we learn—
David: It’s a problem. It’s no longer—
David: It’s a problem, it’s no longer a problem, that’s what supply and demand does.
Kevin: That’s macroeconomics 101. That’s how you learn to play those little games on paper. The problem is, wages really muddle that up.
David: Yeah, and by contrast to goods and the commodities that go into finished goods, services have been given a nearly 60% weighting in the consumer price index, 58.2%, and they strongly correlate with wages. They’re generally considered to be a stickier contribution to inflation as you go forward. Sticky in this case means less volatile, more likely to stay elevated. Once it moves higher, it stays higher. So the more service level inflation you get, the more employment. This is the reality that no one really likes to talk about, and we haven’t had to face the music on this yet. The more service level inflation you get, the more you’re going to have to see an adjustment on employment to a much lower gear. That is less demand in the economy, potentially a higher unemployment rate. That’s the bottom line is that at this point when you see inflation become embedded, and it’s service related and it becomes wage related, you’re going to have to see unemployment increase.
Kevin: But that’s not happening right now.
David: And that—
Kevin: I mean, we see help wanted signs all over Durango right now. People cannot hire enough people.
David: What it implies is a long road, a long road to thinning out the lines of the potentially employed. The JOLTS number, that’s Job Opening Labor Turnover Survey, we’ve got 11 million jobs ready to be filled. This is just below the all-time record of 11.855 set last March.
Kevin: With signing bonuses. Have you noticed the billboards? With signing bonuses.
David: We still have an incredibly tight labor market, and would likely see far more opportunistic migration—move from one town to another to get the better paying job—but look at what’s also gone up. If you’ve got to change and move from one place to the other, it may be that you’re paying higher rent in the other place, or it may be that you’ve got to sell your house, buy another, and your mortgage rate’s going to be double what it was. So very few can afford to hit the housing reset button and accept new rent or monthly mortgage levels—higher mortgage rent rates. That supports the JOLTS number remaining where it is. In essence, stifling labor migration and that supply of workers moving to where there’s attractive demand that the jobs being offered would exist.
Kevin: What you’re talking about, though, Dave, smacks against something that I don’t think you even believe in. Remember the old discussion of the Phillips curve?
David: You’re right. I don’t think the labor market inflation correlation is consistent over long periods. I mean, you can draw a chart, and like any chart it depends on what timeframe you have in mind as to whether or not it tells you a relevant story, a true story. The Phillips Curve analysis, which in its original 1958 version has been discredited, you could look at a particular time slice and say, “Here’s the point. This is going to be the case. Labor and inflation are tied at the hip.” And yet, that was not the case in the ’70s. If you’re a market trader, then you understand the status as being discredited, this theory of the Phillips curve. But if you’re an economist, you do look at this, and this is one of your gospel truths. This is one of the reasons why we even mention the services being related to wages, and wages related to the stickier inflation, because we’re watching the watchers.
Kevin: Yeah, I was just thinking that. Who was the guest that we had, Dave, that talked about the theory actually running things, where the facts no longer matter? Once you have a model or a theory, you have to watch people believe people who watch the model.
David: That’s right. They’re watching the model. They’re making decisions. They’re making policy choices on the basis of the model they hold to be true. Even if it’s false, it doesn’t matter. It doesn’t matter.
David: This is where sometimes being right doesn’t matter because the market can still move against you. And so, we have to consider some of these relationships even though, again, when it comes to the Phillips curve, at least the ’58 version has been discredited.
Kevin: It’s like the question, who’s your audience?, in a way. Who’s managing money right now? We need to understand what they think still works, which is the Phillips curve.
David: Knowing what crosses the Fed’s mind and influences their decisions is relevant even if you disagree.
Kevin: But consumers who are not economists— I mean, yes, everybody’s an economist to a degree, because you have to make your bills, at least we do. The government doesn’t have to make their bills. But you have to be an economist to a degree, and right now, the consumer economists, you, me, the rest of the people out there, things seem to be chugging along. They say, “Well, I don’t feel a recession right now, do you?”
David: I love the old translation from Greek of economics, which just basically goes back to managing a household. It wasn’t some higher math, and you didn’t need—
Kevin: Phillip’s curves.
David: —DSGE models.
Kevin: Acronyms, all the stuff we talk about, you didn’t need back then. Just manage—
David: No, back in the day, a couple thousand years ago, to be a person who understood economics was to be a person who managed their household well. Another lens you can look through on retail sales is that of consumer health and economic strength. Because you look at it, and the activity was robust. Households are, in fact, spending. And by extension to the financial markets, when the financial markets look at this household spending robust, they look at the retail sales number as coming in above estimates, they say, “This is a good thing.” So you’ve got animal spirits, which are high—
Kevin: In the financials.
David: —in the financial markets, as a response. So retail sales figures did, in fact, inspire some animal spirits last week in equities and option trading. Not enough to close the week on a high note, but retail mania, even if it’s midweek, in the interim needs little inducement to move to the manic very quickly.
Kevin: But the question has to come, where’s the money coming from? Remember the American Express commercial where the couple comes back from the vacation, they’re standing in the airport, they’re ready to go back to work, and then they look at each other and they say, “We’ve got this.” They pull the American Express card out, and they start spending money they don’t have for a vacation that they really weren’t going to take. The question is—
David: It’s such a different mindset.
Kevin: —where’s the money coming from?
David: I mean, Kevin, it’s such a different mindset. My wife and I have got a trip coming up, and I’ve got a marathon I’m going to run in. I’d prefer to pay everything in cash because I don’t want to come home to a bill. There’s nothing to me more demoralizing than the pleasure wrought from an adventure, a trip—
Kevin: Paying for last year’s vacation.
David: I hate that. I’d much rather go—
Kevin: At 20-plus percent interest.
David: That’s right, because if you wait any time at all, the trip just costs you that much more.
David: So this gets to the point of challenging that notion of consumer health, right, because we talk about activity, we talk about households, in fact, getting out and spending, that’s economic activity that was very robust on the surface. But what of consumer health? I think challenging that notion is the record increase in consumer credit card balances and household debt. We have Q4 household debt which jumped by the largest amount, this is in nominal terms, the largest amount in two decades. In two decades. So that’s what Q4 2022 looked like. Households added $394 billion in overall debt, which for households now tallies to 16.9 trillion, just shy of $17 trillion in total debt. But the details are even more interesting. Credit card debt moved to an all-time high, knocking on the door of a trillion dollars, even as delinquencies were also accelerated.
Kevin: Now, that’s important. Because if credit card debt moved to an all-time high and everybody’s still making their bills and not delinquent, that’s not as bad a thing. But what if they’re charging and they can’t pay? It’s last year’s vacation not being paid for, you’re just delinquent.
David: Well, right, so balances on credit cards ballooned by $61 billion in Q4 to 986 billion total. Again, just shy of the trillion mark. That was the largest quarterly increase since 1999.
Kevin: It’s not getting paid back. They’re carrying that credit on.
David: So that’s just one quarter, which is a monster, but year over year, the increase was 130 billion. And just think about that. That gives you the fourth quarter scale at nearly half of the total for the year in a three-month period. We were using credit cards irrationally in the fourth quarter of last year.
Kevin: What do you think is causing that?
David: Well, this is at a time when credit card companies are charging record high rates, right? So you’re doing it with the knowledge that you’re going to pay 18, 25, as much as 30, maybe even more than 30%.
Kevin: Is it Covid fatigue? Do you think people are just sick of sitting around for three years, “Hey, let’s just go spend money,” or do you think it has to do with the inflation, the people are not making their bills and having to charge?
David: That’s a good question, because I think as we look at the New York Fed, the research on this credit numbers, noteworthy were the younger borrowers who are struggling most to make payments. And that’s going to be very consequential as we move into this year with student loan forbearance still mostly in effect. You’ve got younger borrowers who don’t even have to pay the largest chunk of their balance sheet liabilities. They’re not even making payments on that. So the fact that younger borrowers are struggling to make payments on their credit card debt, it’s going to get really interesting. It’s a dynamic worth watching closely.
So annualizing the New York Fed’s household borrowing data, Doug Noland, our colleague, reported in the Credit Bubble Bulletin this last weekend that credit card debt expanded at an annualized 26% pace and total debt at a 9.5% annualized rate, and that’s, again, over the quarter. Clearly, the credit boom is continuing, and this is in spite of higher rates. But the quality of credit is growing suspect. And sus is the way my teenagers describe it these days, “Oh, that’s so sus.”
Kevin: That’s a word, huh? That’s the new word.
David: Yeah, anything that’s suspect is sus.
Kevin: “Oh, that’s sus.” Everything’s sus these days.
David: Right. Well, using credit cards can be a convenience for some, or it can be a sign of consumer pressure, amongst others, lacking sufficient resources, credit cards fill the gap. Morgan Lewis, a colleague, writing in Hard Asset Insights over the weekend, pointed out that that gap to fill, on average in the United States, is now 7,500 bucks a year. In other words, your expenses are exceeding your income per capita $7,500. That’s kind of a big deal.
So we could see retail sales, surprising as it did, as good news, a signal of robust economic activity, or we could see a broad-based inflation reality generating more household stress as evidenced by the big bump in credit card usage. Studying over the New York Fed report, one of the things that I noticed was HELOCs, home equity lines of credit.
Kevin: That’s where you tap your home for the next little bit of cash.
David: That’s right, treating your home as an ATM. We did this a lot in 2005, 2006.
Kevin: That turned out very, very badly.
David: Oh, you mean people discovered what negative equity means?
Kevin: Oh my.
David: Well, so the HELOCs as a line item in this New York Fed report, $14 billion for the quarter. Third quarterly increase in a row, and the biggest equity extraction in over a decade. What is the state of the household?
Kevin: I want to just take a diversion here, because you’ve quoted Doug Noland, Credit Bubble Bulletin. I was talking to Jim Deeds, he’s been a guest on our program. He’s in his nineties, but he’s still so engaged, and he doesn’t miss Doug Nolan’s Credit Bubble Bulletin. He doesn’t even have a computer. Dave, he goes to a library.
David: I love him.
Kevin: He doesn’t trust it. He goes to a library, and he goes to mcalvany.com, and he reads Credit Bubble Bulletin. Now, something he mentioned to me that I’m going to mention on the program, because a lot of people like to read the weekly report on the Credit Bubble Bulletin, it is free. So is Hard Asset Insights from Morgan Lewis. Both of those are excellent reports to read, but there is a daily Credit Bubble Bulletin to a degree. Doug Noland does that as well.
David: What that is is a curated newsfeed, where if you want to save yourself hours of time in looking for the most relevant articles from across the internet—
Kevin: Let Doug filter it.
David: He’s already filtered it, so you’re looking at NBC and CBS and Reuters and the Wall Street Journal and the Financial Times and Bloomberg. You’re looking at everything.
Kevin: Yeah, it saves so much time. But I want to mention something because Jim asked me, he said, “Hey, where did the weekly go? You guys changed your website? Where’s the weekly?” If you go to mcalvany.com, it’s all right there. You can get the Credit Bubble Bulletin. You can get Hard Asset Insights. You can listen to the Weekly Commentary, Golden Rule Radio. You name, it’s all free.
David: Well, there’s an even easier way.
David: What you do when you open up that page is you have the ability to personalize. You can put on your preferences.
Kevin: You build your own cockpit basically?
David: Yeah. Do you want to see the Weekly Commentary? Yay, of course you do. Oh, yes. Or do you want to see the Credit Bubble Daily, which is, again, the curated newsfeed. If you want to see the Credit Bubble Weekly, you just check the box, and all of the things that you check are what you’re going to have in your view.
Kevin: It’s all in one place now—
David: That’s right.
Kevin: —under mcalvany.com. It is a great new site. I just wanted to mention that before we went on because you are quoting Morgan Lewis, you’re quoting Doug Noland, sometimes—
David: I read them every week. I find them to be some of the best material that I go through on a weekly basis as I think about the Commentary. Part of it is because they’re distilling so much down, so there’s been a heavy lift that’s happened there.
Kevin: This is the fly on the wall concept that I wished for the first 20 years that I was here, Dave, that we could have a fly on the wall where people could participate in the discussions we participated in, the things we read. Now they can, it’s free.
David: Yep. Another inflation metric arrives this week, as if CPI and PPI were not sufficient as inflation data points. And actually, most people would concur that they are not.
Kevin: Yeah, because they’re always adjusting them.
David: Yeah, because you’ve got the adjustments, the weighting shifts, other types of manipulation to the formulas. I mean, one commentator this week pointed out that using the Bureau of Labor Statistics’ own methodology from 30 days ago, repeat, repeat—
Kevin: Before the change? Before the change?
David: That’s right. Yeah. 30 days ago would’ve put the monthly inflation at 0.8 and increase the tally to 9.6% annualized. So here we are, again, doing victory laps about inflation because it’s coming down—
Kevin: Oh, they’re saying 6.4 now—
Kevin: —but it’s really—
David: Just using the methodology we had 30 days ago—
David: —it’s unbelievable. So like counting votes, the Bureau of Labor Statistics’ bean counters can play with the results of the game very effectively. They don’t have to change the rules as long as they control the scoreboard.
Kevin: So the patient is still bleeding out very, very quickly, and you’re celebrating that you think, based on the new way of measuring blood, that he’s bleeding out less quickly.
David: Stabilized, holding nicely.
Kevin: There we go.
David: We live in an age where fabricated realities are preferred to the real thing.
Kevin: Get your VR glasses on. Just put that virtual reality—
David: Well, exactly. Fiction’s preferred to fact. Virtual reality preferred to life in the real world. It’s like the rebirth of The Matrix.
Kevin: Blue pill, red pill, what’s it matter? Right? Okay, so what is coming out on Friday?
David: PCE, it’s the one that we mentioned earlier. PCE is out this Friday.
Kevin: Personal consumption expenditures.
David: Consumption expenditures. That comes from the Bureau of Economic Analysis, not the BLS. That’s the number the Fed looks at. And thus, it’s a number that we should pay attention to as well. If core PCE excludes food, and energy of course, if it surprises by being off that disinflationary trend—
Kevin: Which means up.
David: Right. The equity and bond markets will get flustered, and the implication being that Powell’s disinflationary dream is more of an illusion than reality, and interest rate policy will indeed have to move higher for longer.
Kevin: This is you watching those who watch what they watch, right?
David: Yeah. So disappointment to speculators, counting the days to the return of easy money and cheaper credit, you’ll have a bit of a temper tantrum. The trend for PCE looks something like this, if you go back to the fall of 2022: 5.2, 5.1, 4.7, 4.4. The Fed Reserve out of Cleveland does a real-time forecasting for core PCE, and they’ve got the next one set at 4.3. So expectations are 4.3. If they’re 4.3, markets should be happy. Fed’s going to do exactly what they said they’re going to do, nobody’s worried, and stock market will continue moving higher. But from this number, PCE, will come a market reaction worth pondering. If you think about what’s gone into the market in the last, call it, 60 to 90 days, here’s the setup, and I don’t know if this has any implication for this week necessarily, but here’s the setup that we have: retail investors have poured in—retail investors, remember—$1.51 billion a day into US equities.
Kevin: That’s 1,500 million per day, for how long?
David: Full month. Full month. That’s the last month. It’s the largest on record. And of course—
Kevin: The party’s back. The party’s back.
David: But it’s based on the narrative of a soft landing or of no recession at all—
David: —of rate hikes largely behind us, of a reduction in rates by year-end being a fait accompli, and yes, the economy remaining on an excellent footing.
Kevin: Doesn’t gambling increase at that point though, too? Those are the real assets, the financial assets, but then you have options that get purchased on both sides too.
David: Yeah, because if you’re a guaranteed winner, then why not increase your risk? We talked about options expiring within a day. We talked about that last week. Options markets are seeing, and this is according to JPMorgan’s Marko Kolanovic, daily notional volumes in short-term options around a trillion dollars a day.
Kevin: Okay, so no. That is a million million a day.
David: He references the February 2018 period, which was called Volmageddon, where volatility was so extreme in the options market that it overwhelmed and absolutely controlled the underlying assets themselves. And he sees that as a growing likelihood. So it’s an interesting setup. There’s a lot of speculation in the market as supported by options’ volumes, by volume into US equities, US financial markets over the last month.
Kevin: Have we forgotten something, Dave? We’re at about half of what we should be on interest rates if Taylor’s right. Taylor was a guest on this program, he’s quoted all the time.
David: Stanford prof.
Kevin: Are we missing something with—
David: Yeah, it’s a problem. The Taylor rule implies an appropriate fed funds rate between nine and 10%, not the sub five we have today. If rates were where they need to be to actually squash inflation, you’re talking about a whole host of nasty responses in the marketplace.
Before we completely skip over this service inflation, and I know this is probably boring to some of you listening, but I just want you to keep in mind the cyclicality of commodities. I read a great paper, about a 20-page paper, from Goldman Sachs looking at commodities entering a supercycle, what they view as 2023 supercycle material. Why would they argue for that? They would say the move higher in 2021 and 2022 had everything to do with the dollar, and commodities traded off of the dollar. They’re arguing that 2023 is very different, and actually, you see a significant rise in the price of commodities, which again goes to goods inflation, not service inflation, but goods inflation on the basis of underinvestment. And by underinvestment, I mean companies that are digging in the dirt for iron ore and copper and gold and silver, oil, natural gas, they have not been spending to make sure that they’ve got adequate supplies coming into 2023. So we’ve got some supply overhang, particularly I think of commodities like natural gas. But there’s other commodities where we’re working off a virtual deficit today: copper.
Kevin: And it’s not recognized in the price yet.
David: Not recognized in the price. So we’ve got the Chinese coming back online, they’ll take away an extra 1.2 million barrels per day from the oil market.
Kevin: And that hasn’t really hit yet.
David: It hasn’t hit. So we think we’re dealing with this inflation issue, and goods inflation is okay, and we can ignore service inflation because the Fed’s got this. Meanwhile, goods inflation, because the commodity price increases in late 2023 is going to slap us upside the head like a two by four.
Kevin: Sometimes we all, in various situations, we assume stability in supply and demand. We just always assume it’ll be there when we need it.
David: The only thing you can assume with commodities, [unclear] goods inflation, is constant volatility. It’s not stable at all.
David: So the fact that it has receded, nobody’s thinking that, “Oh, well, it’s going to come roaring back.”
Kevin: So the Goldman Sachs report is basically saying we’re going to have scarcity of things, and they’re not prepared for that.
David: That’s right.
Kevin: And the prices are going to go up—
David: That’s right.
Kevin: —and it’s going to be a big time price increase.
David: That’s right. Again, we come back to the Taylor rule, applying an appropriate fed funds rate of, say, nine to 10%, and what are the implications there? Well, a recession would be unavoidable. The economy would take a short-term painful hit.
Kevin: That’s okay sometimes, though, isn’t it? You remember the depression that just came and went—
Kevin: Yeah, Grant wrote about that. In 1921, everybody forgot about that depression because they let it happen.
David: The forgotten depression. We did an interview with him years ago, and at the end of the interview, it was probably one of the best compliments I’ve ever had, maybe I feel that way because I’ve got a lot of respect for Jim, but he said, “That’s the best interview anyone’s ever done.”
Kevin: Because he was so interested in the subject, and so were you. That’s the key to having a good interview is being interested.
David: Yeah. Forgotten depression, 1921, I’d go back to the archives. I don’t know if it was a good interview or not, but he liked it. But the book was good even if the interview wasn’t.
Kevin: But it’s a good interview.
David: Right, it’s worth reading. So the economy would take it. It’d be a rough road for a little while, but you’d have a healthy rebalancing within the financial markets. A healthy rebalancing suggests a bear market, which would bring us back to more reasonable values. Here we are standing at single digits away from all time highs in your primary equity indices. Options traders have decided that day trading at the casino beats taking a real job—
Kevin: A trillion a day.
David: Right. Because the money is just that easy to make. And we all know that speculating, gambling, it’s just—everybody wins, right?
Kevin: Draft kings, yeah, go ahead.
David: That would be a description of loose financial conditions. We have loose financial conditions. Meanwhile, over on the other side of the street, not Main Street, now we’re talking Wall Street, institutional investors remain bearish on stocks. I wonder why.
Kevin: Because their jobs are on the line on that.
David: Could it be that interest expense is a real factor for corporations? Could it be that interest expense is a real factor for commodity producers, and higher interest costs may, in fact, hit commercial real estate investors? I mean, think about it, Starwood continues to get redemption requests exceeding their monthly limits, alongside KPR and Blackstone. People understand that rising interest rates ultimately do have an impact on prices. And smart investors, starting middle of last year, decided to start pulling the plug on some of those private equity real estate investments. Could it be that earnings have been largely uninspiring? I mean, think about it, outside of energy and industrials, earnings growth has been largely negative.
So you’ve got the old economy stocks that actually make money. For at least a year now, they’ve been a better bet than new economy stocks. What do they do? They harvest social media traffic. They pretend that that audience is the same thing as having a customer. They pretend that impressions are the same thing as revenue.
Kevin: Well, and I want to go back to your saying that institutional investors are skeptical. They’re sus, right? Isn’t that the word your teenagers use, sus?
David: Yes. Institutional investors look at this as very sus.
Kevin: Okay, so let’s picture who that would be. For the person who doesn’t really know who an institutional investor is, it’s the banker father in Mary Poppins. That’s the guy who’s like, “You know what? We’re going to be conservative here. Uh-huh, we’re not playing this $1 trillion-a-day game in options. Can you picture that?
David: I love the fact that rising interest rates and the reality of capital having a cost attached to it shines a light on economic absurdities, which is how I think we can accurately describe 25% of all publicly traded stocks in the US. They’re pipe dreams. They are economic absurdities. They are the walking dead. We talked about zombie companies who don’t even have enough money coming in to make payments on their interest, the interest on their debt. It’s just crazy.
Kevin: You’re just being too practical. Let’s go fly a kite. ♬Let’s go fly a kite.♫ Okay, but let’s transition, though, to where the liquidity has really come from for the last few years. We don’t ever think about it. We think of Japan, sushi, yeah, sushi—
David: Yeah, absolutely.
Kevin: —and sake. Yeah, sake.
David: And someday—
Kevin: How about liquidity?
David: Someday it’s going to be powder skiing because they have a couple of areas that get more powder than even places like Grand Targhee.
Kevin: Like Fuji, do they get a lot of powder on Fuji?
David: I forget, it starts with an H, but it’s an area—
Kevin: And you’re going to go jet ski.
David: Well, someday.
Kevin: So we’re distracted here for a second, but how many runs did you get in on Saturday up in— Where were you? Wyoming?
David: We were in Wyoming.
Kevin: Was it 30?
David: It was absurd. 30 runs.
Kevin: 30 runs in a day?
David: 54,000 vertical feet.
Kevin: Hey, all you did was get on lifts and jump off of lifts and go straight down the hill.
David: I felt like I was 12 years old again. We actually did stop and eat lunch. At age 12, we would’ve eaten lunch on the lift. But today, then versus now, we have high-speed quads, high speed lifts that get you to the top of the mountain in two minutes.
Kevin: Aren’t you glad you’ve been training for marathons, though, to be able to have a day like that?
David: It was phenomenal.
Kevin: You couldn’t have done that without—
David: More corduroy than I’ve ever had in my life in a day. It was—
Kevin: I’m looking across the table from you, you still have that sunny glow. It looks like it was probably sunny that day.
David: All right, so transitioning to Japanese monetary policy—
Kevin: Where all the money comes from.
David: And it relates to what we were just talking about because it’s perhaps an even greater economic absurdity, and one with an even greater potential to wreak havoc in the world of economics and finance, not just in Japan, but globally. The Bank of Japan yield curve control sits like nitroglycerin within the financial variables of global finance.
Kevin: And yield curve control is artificially keeping interest rates low.
David: That’s right. You set the interest rate and then you keep on buying your own bonds to artificially keep the price capped. So it takes a tremendous amount of money to keep on buying your government bonds to keep that interest rate capped. But like that explosive substance, nitroglycerin, it degrades over time and it becomes even more unstable. So the longer Japanese monetary policy has been run in this reckless manner, the greater the risk of financial shock, not only in Japan, but also here in the United States, frankly, globally.
Kevin: Okay, so you can artificially keep interest rates low if you don’t care what the currency does, if you’re willing to just trash the currency. Because you got to print that currency to buy the bonds.
David: Well, that’s the point. That’s the point. We’ve talked about choosing either yen stability or the price cap, the yield cap in the bond market, but you can’t have both. So yield curve control has remained the autopilot option, and as a result, it’s an artificial source of liquidity within the credit markets. So to play out some of these dynamics, if you can’t buy Japanese government bonds as a Japanese saver, what do you do with your savings? Take them elsewhere. Take them elsewhere for more yield, and take them elsewhere because there’s no product available for you to buy.
Kevin: Yeah, because the government buys them all, or the bank does.
David: You end up forcing Japanese savings into the financial markets of the world. So by controlling prices and buying bonds, expanding their balance sheet as significantly as they have, they force Japanese savings into the world of finance.
Kevin: We call that hot money. We call that hot money because they’re forced out there, but that could come right back if interest rates rise.
David: Yeah. So QE from the Bank of Japan has more than offset all the global quantitative tightening from the US, the eurozone, and the Bank of England combined.
Kevin: You’re going to have to repeat that because that’s incredibly powerful. For years, we’ve talked about the QE and the buying of bonds in Europe, the Europeans just buying virtually everything. Anything that wasn’t nailed down, they bought it, right? And you’re saying that the Bank of Japan, the numbers overwhelm that?
David: Yeah, in the last, let’s call it, 90 days. Go back, let’s say, four or five months to present, you’ve had more Japanese bonds bought in aggregate than the US Fed, the ECB, and the Bank of England have brought to market in terms of bonds that they are selling out of their vast hoards.
Kevin: Little bitty Japan. I’m sorry, I’m not trying to be diminutive, but Japan’s not a big enough economy for that to have happened.
David: Right. So to manage their yield curve and maintain artificially low rates, they’ve been buying government bonds in quantities that more than offset the bonds which the aforementioned Western central banks have been selling as they’ve begun to reduce their balance sheets. We think of the past several quarters as a period of financial tightening, because that’s what we were told by Powell just a week or so ago. We’ve seen sufficient tightening. We think of the past several quarters as financial tightening because of the balance sheet shrinkage and rising rates. But the Bank of Japan has undermined global financial tightening entirely. Entirely. I quote Robin Wigglesworth from the Financial Times, this is February 15th, “Its policy of keeping Japanese government bond yields rooted near zero has acted as an anchor for the entire global fixed income complex.”
Kevin: That’s insurance policies. That’s annuities. That’s fixed income complex. That’s gigantic.
David: What it suggests is that we’ve got rates, even though they’ve come up, they’re still lower than they should be. What has kept them anchored is this artificial pricing of government bonds, specifically JGBs, Japanese government bonds.
Kevin: So what happens if yield curve control stops working?
David: Well, Robin goes on to comment, “If yield curve control is finally killed off or even tweaked…” And Kevin, I’ll tell you this, there’s a probability of that. We’ve got an incoming Bank of Japan governor in April. Remember that, in April.
Kevin: A new one?
David: Yeah. So Robin says, “If yield curve control is finally killed off or even tweaked, it will probably be a major event for markets everywhere.” That’s a big question, will that be the straw that breaks the fixed income market’s back? Yields rising globally to levels— now unanchored and rising globally to levels that reflect actual balance sheet conditions, actual inflation risk, not what we’re playing with, not the numbers that get massaged lower. I mean, can you believe it? Just the methodology change 30 days ago has a substantive impact on the inflation reality that we think is in front of us.
Kevin: This is why I like showing up for this show, Dave, because I knew nothing about this, but this is huge. I mean, it’s good that we talk.
David: So here’s one scenario. One scenario is, Japanese yen continues to weaken. Weakness in the yen, we go back to where it was last year, closer to 150, and maybe beyond if yield curve control persists. The dollar strengthens in response to that. This is one scenario. As the dollar strengthens, it puts tremendous amount of pressure on the emerging markets. So now you’ve got problems with emerging market debt because, again, a lot of their debt is in dollar terms, so their ability to repay becomes harder and harder and harder. So just keeping—
Kevin: This goes back to Doug Noland’s periphery, going from the periphery to the core.
David: Sure, but you’re talking about a destabilization daisy chain. Again, from Japanese yen weakness to dollar strength to emerging market debt weakness.
Kevin: But that’s just one scenario.
David: The other scenario would be if you give up on yield curve control in April. What you would likely see is a multi-trillion dollar repatriation, multi-trillion dollar repatriation of Japanese savings, not only to capture higher yen yields, but also to ride the yen appreciation from the current level of 135 to about 100 would be a good guess. You end up with higher yields globally. That throws on the brakes in dramatic fashion in terms of global growth, and causes what the World Bank has estimated as a significant issue. We’ve got a third of countries who are on a razor’s edge. What would throw us into full-blown economic recession globally? Again, it’s the other scenario. You give up on yield curve control, the yen appreciates, yields rise globally, the anchor is gone. The World Bank estimates that even a 1% rise in global yields from this point would take the current GDP estimate of 1.7%—they just reduced it, by the way—but if you had a 1% rise in yields globally on average, you would take your GDP growth from 1.7, the latest estimate, to less than 0.6. So GDP growth, global recession, these would be the domino effects from the end of yield curve control.
Kevin: Japan’s been on my mind here recently because I know I keep bringing it up to you, but I’m reading a great book about the attack on Clark Field, not on December 7th, 1941, but on December 8th, and how these guys expected that there would be problems from Japan, and so they had moved 35 B-17s down there. December 7th hit quicker than they thought. They knew there was going to be a problem, they were preparing for war, but December 8th at Clark Field in the Philippines, they were completely unprepared even though they had gotten news that something was happening based on something the Japanese were doing with America and the rest of the world. They were sitting ducks. They lost most of those planes because they didn’t do anything. It was like, “Oh, it sounds like the Japanese hit Hawaii.” Well, guess what? Nine hours later—
David: Are there implications for you? They didn’t connect the dots.
Kevin: And maybe this isn’t the same type of thing, but I’m thinking about the size.
David: It’s important to connect the dots. It’s sort of a high stakes damned if you do, damned if you don’t scenario with the Japanese, because you’ve got ripple effects everywhere, not just in Asia. The problem is they took this experiment with monetary policy so far that to do anything is going to be damaging. We know they can do the right thing, and ultimately it will help the Japanese, but the right thing’s going to come at a cost, too. This reminds me of the conversation we used to have with Ian McAvity.
Kevin: I miss him.
David: Doctor told him, “Don’t quit smoking, it’s killing you. But if you quit smoking, it’ll kill you that much faster.” Literally, this is like the scenario we’ve got with yield curve control in the Japanese: Don’t stop buying Japanese government bonds, it’s killing you.
David: It’s going to kill you. So if Bank of Japan policy shifts, US investors—and this brings us full center. You’ve often heard it said of US equities, “Sell in May and go away.” Well, that’s May. Just pull out your calendar here, okay? That’s May. If Bank of Japan policy shifts, this is expected as soon as April, right? US investors will wish they had sold in March, long before April made them look like fools.
Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.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.