Credit Bubble Bulletin

Presented by Doug Noland since 2012

Credit Bubble Daily
Wednesday, February 1, 2023
[Yahoo/Bloomberg] US Stocks Waver With Fed Rate Decision on Horizon: Markets Wrap [Yahoo/Bloomberg] Adani Stock Slump Worsens as Key Share Sale Fails to Lift Mood [Yahoo/Bloomberg] Oil Steadies Before Fed Meeting and OPEC+ Guidance [AP] Powell likely to stress Fed’s inflation fight far from over [Yahoo/Bloomberg] Fed Expected to Slow Rate Hikes in Signal Work’s Not Over [CNBC] Private payroll growth slowed to 106,000 in January as weather hit hiring, ADP says [CNBC] Mortgage demand took a big step back last week, even after interest rates fell further [CNBC] Gold demand surged to an 11-year high in 2022 on ‘colossal’ central bank buying [Reuters] End of easy-cash era is going to hurt [Yahoo/Bloomberg] Housing Slump Deepens From US to China in Risk to Global Growth [Reuters] U.S. states struggle to share dwindling waters of Colorado River [Yahoo/Bloomberg] Adani Stock Meltdown Hits $92 Billion as Collateral Worries Grow [Reuters] Adani loses Asia's richest crown as stock wipeout reaches $86 billion [Reuters] Asia's factory activity contracts despite China's COVID reopening [Yahoo/Bloomberg] Euro-Zone Inflation Eases as ECB Debate Over Rates Heats Up [Yahoo/Bloomberg] Global Dealmakers Suffer Worst January for M&A in Two Decades [Yahoo/Bloomberg] Gundlach Suspects Fed Will Push Back Against Pivot Narrative [Yahoo Finance] Hackers lifted $3.8 billion from crypto investors in 2022 [WSJ] Ukraine Braces for Major Russian Offensive [FT] Fed poised to move down to quarter-point rate rise as inflation eases [FT] Liquidity loses top slot as investors’ biggest concern after six years [FT] Bernstein: End the Fed ‘put’ [FT] ‘Extreme leverage’? Adani’s debt-driven expansion under scrutiny [FT] Does it matter that central banks are losing squillions?
  • Volcker Pivot: 17% to 9%… Back Up To 19%
  • Party Till You Die! Markets Premature/Post-Inflation Celebration
  • Give Me My Money - Large Real Estate Funds Have “Gated” Liquidation Requests

Do You Remember The Volcker Pivot? February 1, 2023

“Rates remain low relative to inflation. We still have interest rates that are less than the CPI. Credibility is in the crosshairs. Alex Pollock recently noted that the Fed is leveraged 200 to one, reporting operating losses of $2 billion a week, showing unrealized mark-to-market losses on its securities portfolio of $1.1 trillion, and is even considering a further debauching of the idea of price stability by changing the inflation target to three percent from two. Credibility in the crosshairs means that if Powell loses control of inflation, the viability of our Central Bank is on the table.”—David McAlvany

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

Well, last night when we were at Table 23—not table 30, but the new Table 23—we were talking, and I was trying to remember an actor in a movie. We were talking about a book that I had just read that I knew a movie had been made, and I could not remember the name of the actor. It turned out it was Geoffrey Rush that I was trying to remember, but you gave me no help. You said, “Kevin, I may have seen the movie, but I cannot remember the name of actors.”

David McAlvany: No, no, no. I’m more of a book than a movie guy. Don’t get me wrong. I enjoy movies, but I engage them with purely entertainment value in mind. My retention and remembrance of actors, details, what have you, pretty pathetic. So to forget having seen something before, given enough time, that’s not uncommon in our house.

Kevin: Well, funny too, you’re watching more movies right now because of your long time training. Didn’t you tell me that you went through two Bond films the other night while you were on the treadmill?

David: I did watch Skyfall on Sunday morning, and that was followed by The Darkest Hour, so I got two movies in. And it was a longer run.

Kevin: Hey, it’s cold outside, isn’t it? 

David: Well yeah, so I preferred the treadmill for that one. Yeah, the current episode of inflation is, in a similar way, only vaguely familiar. The details of the past episode have long been forgotten. And it’s almost as if we’ve watched this episode before, but because it’s been so long, it’s barely in there. It’s barely in there. So I’ll quote a famous central banker, and you can tell me who you think it is. “The momentum of inflation has clearly been checked.” Said by which valiant knight, out to slay the wily beast of inflation?

Kevin: Well, it starts with a V. It has to be Paul Volcker.

David: V is for victory, or V is for Volcker?

Kevin: Well, V is for Volcker. I can’t think of another Fed Chairman that actually defeated inflation.

David: Yes, except that this was prior to his placement as head of the Fed, and it was while he was Undersecretary of the Treasury for Monetary Affairs. So Paul Volcker indeed, but it was January 14th, 1971 when he said this phrase.

Kevin: Really, not 1981?

David: Nope, 1971. Jim Grant comments, “The great Volcker spoke 10 years too soon.”

Kevin: Let’s stop and think about that for a second. Because 1971, Nixon was in office and we—Think about the gold market, Dave. The gold market probably had seen this coming long before. We read Jacques Rueff’s book named—Jacques Rueff told de Gaulle, “Start cashing your dollars in,” in the late ’60s.

David: The Monetary Sin of the West was written in the ’60s, and so we have the peak of inflation in 1981, but we’ve got the early concerns of inflation and the initial encounters actually in the ‘60s. So the trend towards monetary chaos was sniffed out in the gold market a full decade earlier. It was in the streets of London and Paris that you could have a $20 gold piece, one ounce of gold less the seigniorage, and it had jumped from the statutory $35 an ounce to $40. This is 1960, ’61.

Kevin: So that was on the street in Paris and London, and anywhere where you could trade gold for dollars.

David: Yeah, that’s right. I mean, the first down stroke for the US dollar was, as you recall, recorded in 1933, announced by law, moved from $20 to $35, which was a significant devaluation of the purchasing power of the paper equivalent. So in 1960 you could fetch $40 an ounce on the streets of those cosmopolitan cities. And the market was doing its job. It was sniffing things out.

Kevin: They started to wonder if one of the three pillars of the dollar was about to fall. The three pillars being the gold standard, and then of course the agreement with the OPEC nations, and then the reserve currency status. Gold was about to fall.

David: Well, OPEC was started in 1960, and the ’60s were a pretty active period. You had the Johnson administration—came in and replaced Kennedy in ’63, and by ’64 the guns part of the guns and butter policies were ramping up. You had the Gulf of Tonkin incident, which brought our “police presence” into full military escalation mode in Vietnam that year. Then by January 1965, the Great Society programs had been put to the Democratic Congress for passage.

Kevin: Don’t you love the name, Great Society? Was it really great?

David: Well, it reminds me in some ways of the ironically named Inflation Reduction Act of 2022. I mean, in some respects it’s the Great Society 2.0, just with more of a focus on climate change, but still with the echoes of the war on poverty. Fiscal largesse was then, and is now, a reality. And this is truly a reality now and going forward. 1.3 trillion is the annual estimated budget deficit—annual estimated budget deficit—from now until 2033. Some things never change.

Kevin: Well, and you talk about sniffing things out. The sniffing out that the dollar was possibly going to go off the gold standard, you could almost see it coming, couldn’t you? Because silver had been in our coinage, but we took silver out of the coinage even before we went off the gold standard.

David: Yeah, the 1965 Coinage Act. Again—very busy administration, the Johnson administration—the 1965 Coinage Act removed all silver from dimes and quarters, and reduced silver content from 90% to 40% in the half dollars. So, as always, the money tells a fascinating story, a story of political priorities, and in many cases the policy choices that designate the winners and losers. So devaluation has and always will hit the middle class and the lower classes the hardest. And so now we are in the situation where we get to see who wins in the Powell era, and that may very well be cataloged by historians this week.

Kevin: And you think about the separation between the Fed and politics, and the Fed acts like they’re working against inflation. Paul Volcker ultimately did. He had to fight the politicians—remember when Reagan was in office. But you think about what things cost before this Johnson-era change. Let’s equate things to silver. You normally equate things to gold, but let’s look at what things are valued at in silver back in the ’60s.

David: Yeah, I mean this is only a snapshot in time. The 1965 Coinage Act was a very interesting piece of legislation. And so, there in 1964, the year before, silver was about $1.30 an ounce. The average home cost $19,000, and the average take-home pay was $6,000 a year. Today, the silver price is near 18 times higher at $23 an ounce. The average home is right close to 18 times higher at a cost of $348,000, but the average wage is only nine times higher at $54,000 a year.

Kevin: So let’s look at that again. Okay, so the average silver price is 18 times higher than it was in 1964. The average home price is 18 times higher, but wages are only nine times higher. Sounds like we’ve lost half of our buying power with wages.

David: Yeah. Yeah, just said differently, homes ran at three times the average income. Now homes are at six and a half times the average income.

Kevin: There you go.

David: Households make less, and they’re carrying more debt compared to previous generations. So the house in the ’60s ran, again in silver terms, at roughly 15,000 ounces of silver, and it still does. 15,000 ounces translates to roughly 340, $350,000 for that single family home. Small example of asset price inflation running higher than wage increases. Wages up nine-fold, prices up 18-fold. The reality is, inflation favors asset holders. Hard assets serve to protect purchasing power over time, sound money is now a personal choice. But you go back to that issue of the middle class and the lower classes suffering because they don’t have that same buoying effect—assets keeping track of, maybe even staying ahead of inflation.

Kevin: Shouldn’t we feel a little betrayed, just like the rest of the world, with the dollar? Because those three pillars, okay, we had the gold standard in 1944 when they talked about Bretton Woods. We had an agreement with the oil producing nations that oil would be sold in dollars. And then we had the reserve currency status, which basically, the bank said, “Yes, we will support and hold the dollar because of those first two pillars.” We lost the gold pillar in 1971 under Nixon. We’re definitely losing—we talked about this last week—we’re losing the oil pillar right now. Why in the world would we keep the reserve currency status pillar if we can’t keep to our word?

David: Yeah. I mean, a part of it is there’s no better alternative. And in a world of thieves and knaves—oh, and politicians—nice little trifecta there—there’s no better place to go. So also recall that the dollar relied on the 1944 Bretton Woods’s agreement for its stature.

Kevin: Yeah.

David: And only by the end of the ’60s was that agreement fraying. What a Democrat-led Congress and White House assumed there in the mid to late ’60s was that King Dollar could not be deposed. And with the policy objectives of the Johnson era, there was no price too high for greatness—great society, et cetera, et cetera. But they were wrong.

Kevin: I read in August of 1971 that there was as much as 1,500 tons of gold leaving Fort Knox a day before Nixon closed that gold window.

David: Yeah. The street-level grumblings were already being expressed in the exchange for gold at elevated prices, starting in the early ’60s. By 1968 the revolt of the masses was in full swing. And you’re right. Gold deposits were flying out of Fort Knox. They were being drained, predominantly by the French.

Kevin: Right.

David: 1968 to ’69, if you recall, not only is this a period of monetary chaos and fiscal strain, but it’s also a period of intense political and social unrest.

Kevin: This is when the French— The joke is that they say, “Run away.” This is when French running away benefited the French, not the Americans.

David: But I like this tie to the financial markets and the monetary policy angst showing itself in terms of social and political unrest. More street-level chaos in ’68, I think the famous summer of ’68 and ’69, some of your post-modern thinkers were very much active and engaged in their writing and publishing in that same timeframe. So a dramatic shift in the pillars of thought as well. But by ’71—that’s the year that Volcker’s comment on inflation— Again, he’s taking the premature victory lap that’s—

Kevin: “We’ve got this under control.” Yeah.

David: Then you’ve got Nixon closing the gold window. And in fairness, how could he have known? Volcker saw inflation being tamed in January. Well, he was wrong, but Nixon ended the Bretton Woods Agreement, which was an indication of, and also an accelerant of, inflation, in August, August 15th of that same year. So January Volcker’s comment on, “We got inflation. It’s done.” August 15th of the same year Nixon closes the gold window.

Kevin: Yeah, but Nixon also had Henry Kissinger, and if you’re going to go off a gold standard, you better have a monopoly on oil. And Henry Kissinger secured that, didn’t he?

David: Yeah. That decade was a bear in many ways, for consumers, for investors. And only in 1979, after some very fancy maneuvering directed by Mr. Henry Kissinger, and then it was the implementation of the United States-Saudi Arabian Joint Commission on Economic Cooperation.

Kevin: We’ll scratch your back if you scratch ours.

David: Yeah. That agreement was what propped the dollar up on the throne. It contained the promise to recycle oil revenues back into US dollar debt instruments, specifically Treasurys. That was a big year. Volcker stepped in, also in ’79, stepped into the Federal Reserve Chairman role, August of ’79, and he was facing nine to 10% inflation rates. And if he was looking back on his ’71 comments, we probably all try to forget the mistakes that we’ve made, but he’s eating a rather indigestible hat, having been so wrong there on inflation years-plus earlier.

Kevin: What a decade. What a decade that was, because we had the Iran hostage crisis, we had Afghanistan being invaded by the Soviet Union. So I guess it doesn’t all just take place. There’s a lot of things going on.

David: Yeah, yeah. In fairness, I mean, this is a truncated history. It leaves out many of the contributing factors. You did have the mid ’70s oil embargo, so OPEC’s upset with our involvement in Israel. It fits with recession throughout the decade of the ’70s, just to name two of them. But in broad brushstrokes, the victory over inflation was declared in ’71.

Kevin: Isn’t that interesting?

David: Again, it was sussed out by the market in the early ’60s. Victory was declared in ’71, and it was Volcker a decade later facing inflation at 11%, and by 1981 a fed funds rate boosted to 19%.

Kevin: So the news of the death of inflation was premature?

David: Well, one more small detail from 1980 that matters a great deal. 1979 and 1980, you had auto dealers mailing in keys from their cars that they had on their lots in small coffins to the Federal Reserve headquarters. “You’re killing our business. You’re killing us.” Farmers at one point blockaded the National Mall in DC with their tractors. And Volcker is remembered as being [unmoved] by political pressure, when in fact he capitulated and lowered the fed fund rate from 17% to 9%. Inflation was not gone, but the political pressure to alleviate economic pain was increasing, and he caved.

Kevin: Yes, but he regretted that decision.

David: Yeah, only to reverse course and try to save Fed credibility, then boost rates to the record 19 to 20% in the January to June period of 1981. With inflation, it’s not over till it’s over.

Kevin: Sniffing things out then, if I’m trying to figure out where you’re going with this, Dave, are we maybe in that 1971 period right now, where Powell may be looking like he— Well, he may not pivot, but the markets certainly think he’s going to.

David: We’re a year into inflation. Maybe it’s ’71, maybe it’s further on in the life cycle of this inflation thing. The market is already taking a victory lap. That is for sure. And so the market’s taking a victory lap in this crazy game of chicken. Consider this, we have no real economic pain yet, measured in the economy. We have seen no impact on employment, boosting it to higher levels. The worst-case scenario imagined by Wall Street consensus is now considered a soft landing, which is the mildest form of recession. Meanwhile, the S&P earnings growth is being penciled in at 4.2% to the positive for 2023. Now, that’s one hell of a slowdown. Let me just say one comment on the most recent GDP numbers, because even though they were positive, you factor in a realistic inflation number. And just use CPI as an example, because the number that they use for the GDP statistic is in the threes, not in the sixes. So they’re pretty happy with a 2.9% number, GDP growth coming into the end of the year. When in fact they understated their own inflation numbers by 100%.

Kevin: So your bottom line is, inflation is understated.

David: And GDP is overstated. I mean, and this is one more reason people are excited: “Well, GDP wasn’t as bad as we thought. The economy’s not really going into much of a recession.” Yeah, but if you look at the contribution of the inventory component, which was massive—so inventory builds and an understated inflation, and you end up with an overstated GDP growth figure.

Kevin: And understated inflation. It’s going to be good for all of us.

David: Right. Bottom line, inflation is underestimated, and the movement in fed funds has thus far been overestimated in its total shock on inflation. I think people are wanting the worst to be behind us, and yet we haven’t even really taken a significant step in that direction.

Kevin: Do you think Powell will have to pull a Volcker in the future?

David: Powell’s not even close to the Volcker-style ’79 to ’80 tactic. I mean, remember, that was just before he lowered rates, and then regretted it as inflation blew up in his face. We still have bank reserves which are ample. Ultimately, Volcker had to clamp down on that, and that was probably the most effective way of treating inflation, not the rates gambit. Rates remain low relative to inflation. We still have interest rates that are less than the CPI. That’s not going to get it done. 

Credibility is in the crosshairs. It was our Commentary guest from a few years ago, I think maybe 2019, Alex Pollock recently noted that the Fed is leveraged 200 to one, reporting operating losses of $2 billion a week, showing unrealized mark-to-market losses on its securities portfolio of $1.1 trillion as of September 30th, and, as we discussed last week, is even considering a further debauching of the idea of price stability by changing the inflation target to three percent from two. Credibility in the crosshairs means that if Powell loses control of inflation, the viability of our central bank is on the table.

Kevin: Yeah, but we could still rely on Saudi Arabia. Tongue in cheek.

David: There’s no United States-Saudi Arabian Joint Commission on Economic Cooperation lined up for 2023. This is not 1979. The Saudis are more in bed with Russia and China than they are with us because of how poorly we played the shale revolution. So we get a temporary spike in US domestic production to 13 million barrels, this does not have to end poorly. But it more and more is feeling like the George Washington rapping in act one of that hit musical Hamilton. We’re outgunned, outmanned, outnumbered, out-planned. Powell, is that who’s the right-hand man?

Kevin: Yeah. You wonder how much politics and the Fed actually have to hold hands in this particular case. But, Dave, why are you such a negative guy? Okay, because I would’ve just purchased Tesla over the last week or two. Or, well, you name it, all these companies that went down last year, I could be making it all back.

David: Now, this is the challenge. And when you think about Powell and the realities that he faces, the very tough decisions that he’s got to make—and his whole committee, Powell marches into Wednesday with Tesla surging 33% last week. Lucid 65% last week. Rivian, 22% in a week. GameStop, 16% in a week. Footlocker, 16% in a week. Airbnb, 14.5% in a week, which brings year-to-date gains— I mean, we’re talking about four weeks total. Tesla’s up 44. Lucid is up 88. Warner Brothers up 57%. Carvana, 64% year-to-date. Now it’s still down 90% from its peak.

Kevin: Right, right.

David: That’s a Dodo bird story. Wayfair is up 94%. Beyond Meats, for those of you who don’t like red meat but still want to pretend you’re eating meat, it’s up 50%. There’s hope for you too. LendingTree, up 79%. Expedia, 32%. Airline stocks, pick ’em. There’s at least a couple that are up almost 30%, 29%. Disney is up 26%. Salesforce, 24%.

Kevin: Okay, what is causing that? What are the things that are going into that, other than just insanity as far as I’m concerned?

David: The way we framed it previously is, this kind of manic behavior is a combination of things. It’s one part Fed pivot—a bet on the pivot. One part FOMO, fear of missing out. Investors clamoring, jumping over themselves to get involved again. And it’s two parts short covering.

Kevin: Yeah, explain that one. That’s important, because there were a lot of people who thought it was going down that now have to cover those shorts. They have to go back in and buy those stocks.

David: Right. When you see a healthy market sort of marching ahead, it’s the cream of the crop that are tending to do very well. When you can second-guess—and this is just where reality has to be recognized—when you see the cream of the crap rising to the top—and again, here we’re talking about Carvana and your most favorite shorts from 2022—when they’re the ones that are rising, what you see in terms of the energy is folks who’ve been short who now have to buy back those shares to cover their short positions. And it creates a little extra energy, extra positivity. It’s not true organic buying. It’s just a shortcut.

Kevin: Well, does it create a little drunkenness as well? I mean, the proof of— Like a Long Island iced tea is very smooth going down, but when you look at the ingredients, somehow, some way, they’re all drinks that you probably would not want to mix.

David: That’s what we’ve got. If it’s one part pivot, one part FOMO, two parts short covering. It’s like the Long Island iced tea. It’s a vodka, it’s a tequila, it’s a gin, it’s a rum.

Kevin: It’s maybe even absinthe.

David: Right.

Kevin: You introduced me to that a few years ago, but don’t ever do that again.

David: That’s not in the classic Long Island iced tea.

Kevin: Yeah.

David: Even Sam Bankman-Fried’s FTT tokens, crypto tokens, they’re up 160% in January, and they’re known in some circles as Sam Coins. I think the better descriptor, post FTX, is probably Son of Sam Coins.

Kevin: Hopefully you could put that in your IRA and really count on it for retirement.

David: Well, what you’re talking about is a serial destruction of wealth, which is far from over. And again, you’re seeing the biggest moves in those pockets, those areas. The most extreme expressions of speculation are in the lowest quality. It just has the makings of, well, let me say it, a bear market rally.

Kevin: So we record this on a Tuesday, Powell talks on a Wednesday. If we were to look into Powell’s microscope, does he see this?

David: I don’t know how he ignores it. Doug Noland comments over the weekend in his Credit Bubble Bulletin, “I think he knows what he needs to do. If you fight the Fed while the Fed’s trying to fight inflation, you’re apt to lose. But that’s Volcker and not one Fed Chair since Volcker, it’s such a different era now. The Fed doesn’t dole out punishment. They just play Mr. Nice guy to the markets and extend monetary rewards.” I think Doug’s right. I think Powell knows what he needs to do, but he doesn’t necessarily want to upset the market. This is a game of chicken between market speculators and Fed Chairman Powell, with domestic investors already—if you look at how this is priced in—domestic investors are pricing in a maximum for the fed funds rate at 4.9%.

Kevin: When you’re talking about the—This is called discounting of a market, where you’re pricing in what you think it’s going to be long-term.

David: Yeah. So if you look at how investors are pricing in what the Fed’s going to do, they estimate they’ll stop shy of 5%, 4.9 as the peak fed funds rate, and then that’ll recede to 4.47% by the December Fed meeting. That’s the market’s bet. That’s their version of chicken. You’ve had a host of Fed participants who’ve already said, “We need to stay north of 5% for an extended period of time.” So there’s already a divergence in views the market, but the market—

Kevin: But the market’s saying, “No, I don’t believe it.”

David: Right. And in this context, global financial conditions have loosened. Global equity markets have posted healthy annual gains of between eight to 15%. I mean, think about that, annual gains of eight to 15% in four weeks. Speculation is back in full force on Wall Street. Again, to quote Doug, “Markets have expropriated the Fed’s tightening cycle, and it’s unclear whether the Chair or his committee fully appreciates this reality or the ramifications. Market control of financial conditions guarantees wild risk-on, risk-off instability. Prevailing risk on looseness seems to ensure ongoing strong lending and credit growth, which is sustenance for price inflation.” Again, you’ve got the makings of greater price inflation, and the market is driving towards greater price inflation. How does the Fed not respond to this?

Kevin: Okay, so from a political point of view, it’s amazing to me, every few years we have this discussion of, “Oh, do you think the government’s going to shut down, or do you think they’ll raise the debt ceiling? Are they going to shut down and—”

David: Yes.

Kevin: We’ll even get calls and it’s like, “Have you not seen this show, this theater, all of your life?” It’s a theater.

David: Exactly.

Kevin: It’s a theater. We’re always going to spend more than we make.

David: Even if you’re not good on movie retention, you kind of know who the parts are and the people and the players and how the script is read. This is a second game of chicken, and it’s barely worth mentioning the debt ceiling of 31.4 million. That’s been breached. Oh, horror. Who saw this coming?

Kevin: Yeah.

David: Total farce. In this case, it’s a farce between a set of mentally deficient chickens. We already know the debt accumulation expected over the next decade is at a $1.3 trillion annual clip. The spending deficit which our legislators have signed onto, they can see it. They know it’s there. 10 years from now, the debt levels will be at least $44.5 trillion based on what both parties want to “invest in,” if you want to call it that. So how can any serious-minded—should I instead say honest?—politician not call it out as an utter farce? Deficient chickens belong in the fryer.

Kevin: Isn’t it strange, though, if you’ve got financial conditions loosening, you’ve got the markets rising, why is it so hard, why, Dave, is it so hard? You talk about exit strategy. One of the key questions in investing, whether you’re buying gold or stocks or real estate or real estate trust, the question is not how easy is it to get in, the question is how easy is it to get out?

David: Well, guess whose bird is getting plucked? Janet Yellen activated an extraordinary cash management measure so as not to breach the debt limit. And this is like a free course available online, taught by Janet herself. Call it a master class, Raiding the Piggy Bank 101. She notified Congress that she would be accessing the Government Securities Investment Fund. This is the G Fund. And for those of you that don’t work for the federal government, this is one of the pension schemes that government employees can opt for, and it’s the go-to for filling the gap until the debt ceiling is lifted. So government pensioners, you got to love this. In one hand—

Kevin: She’s just borrowing the money.

David: Yeah, you’ve got a plate full of cookies from Grandma Yellen. In the other hand, she’s wielding a hammer for breaking the piggy bank. Probably a hammer she borrowed from Paul last time she visited San Francisco.

Kevin: Okay, but what I was talking about is Blackstone and some of these private equities that you can’t liquidate right now. What’s going on there? If things are loose, why can’t I get my money back if I was invested in one of those private trusts?

David: Right. Powell and the Fed and the US Treasury are not the only entities worth discussing. You’ve got Blackstone, and this is a development over multiple months, but it’s coming to a head. Blackstone, KKR, Starwood Capital Group, these are your private equity and/or real estate giants, have each gated real estate funds as requests for redemptions are increasing.

Kevin: You can’t have your money.

David: They’re already dealing with a backlog of requests from November and December, where they were not fully met. They’ve parceled out a little bit here and a little bit there, and they’ve instituted further limits as requests keep on flooding in. Here’s an interesting contrast, one that suggests there is a devil lurking in the details. Publicly traded REITs, real estate investment trusts, were down 25.96% last year as of the end of December. Yet, these private equity groups with the real estate portfolios in question are using mark-to-make-believe metrics for valuing their real estate portfolios. And they show a positive return of 8.4, 6.3, and 8.32%, according to Reuters, on January 24th. There’s something hidden behind the gates, and it’s called the reality of mark-to-market.

Kevin: So you can tell people you’re making money, and they say, “Okay. Well, great. Then give me mine.” And they’re like, “Oh, no.”

David: “Oh, no, no.”

Kevin: “No, no, no, you can’t have it, but we are making money.”

David: Yeah, yeah. No, and as long as you’re happy with that answer, it’s just fine.

Kevin: How do they meet the redemptions, if they’re going to pay it out at all?

David: Well, two ways. One, redemptions are met either with new liquidity infusions, as was the case with a University of California cash infusion of $4.5 billion into one Blackstone fund. So now they’ve got the money to pay out to people who are asking for money. Kind of sounds Ponzi-esque, but it’s not really.

Kevin: Wow.

David: Or else assets have to be sold, and guess what? When you sell assets, now you have a mark. 

Kevin: We’re not making money anymore. 

David: Mark-to-market imposes itself on a group of squirming private equity CPAs, and those fictional positive returns of 2022 might in fact give up even more than the 25.96%. Because with the time lag and the further increase in commercial real estate borrowing costs, you’ve got cap rates which are readjusting higher, and thus prices on the assets in question moving significantly lower. 

Let’s leave it with this. Details are overlooked. Downside risks are being underestimated, and we’ve miscategorized this year altogether. This is the year of the chicken, not the rabbit.

Kevin: You’ve been listening to The McAlvany Weekly Commentary. Now I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com, or 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.

Tuesday, January 31, 2023
[Yahoo/Bloomberg] US Stocks Waver as Earnings Roll In; Dollar Rises: Markets Wrap [Yahoo/Bloomberg] Adani Stock Rout Continues Despite Support From Key Investor [Reuters] Fed officials see lots of room to shed bonds from balance sheet [Reuters] Veterans of 2011 U.S. debt-ceiling fight see tougher battle ahead [Yahoo/Bloomberg] Global Inflation Fight Far From Over, IMF Chief Economist Say [Reuters] Western allies differ over jets for Ukraine as Russia claims gain [Reuters] Crypto lender Celsius propped up its token, benefiting insiders - U.S. bankruptcy examiner [Yahoo/Bloomberg] The World’s Next Big Inflation Surprise Is Looming In China [Reuters] China economic activity swings back to growth in January - official PMI [Yahoo/Bloomberg] China’s Economic Activity Rebounds Sharply After Reopening [Reuters] U.S. stops granting export licenses for China's Huawei - sources [AP] China accuses Washington of wanting ‘technological hegemony’ [Reuters] Disillusioned at home, super-rich Chinese set their sights on Singapore [Reuters] China foreign minister seeks stronger economic ties with Saudi Arabia [Reuters] Euro zone economy unexpectedly grows in Q4 but weak 2023 looms [Reuters] NATO, Japan pledge to strengthen ties in face of 'historic' security threat [Reuters] Turkey's push into Iraq risks deeper conflict [Bloomberg] Fed Points Toward a Pause in May Once Hikes Have Time to Sink In [Bloomberg] Gold as Inflationary Hedge Makes Turkey World’s Biggest Buyer [NYT] Wall St. Is Counting on a Debt Limit Trick That Could Entail Trouble [NYT] The Pandemic Used-Car Boom Is Coming to an Abrupt End [WSJ] U.S. Pushes for Military Sites in Philippines to Counter China [FT] ‘Colossal’ central bank buying drives gold demand to decade high [FT] Washington halts licences for US companies to export to Huawei  
When Economic Jokes Are Not Funny Inflation certainly distorts reality. In the future, investors might look back on this time as the era when they considered eggs some of their most valuable assets. In contrast, real estate and the dollar are currently taking a ride in the down elevator. If the Weimar Republic saw thieves dumping out wheelbarrows of cash and stealing the wheelbarrows, the US might soon see thieves bypass a grocer’s cash registers and raid the egg section. Or perhaps high schoolers will deface the neighborhood curmudgeon’s car by throwing wads of cash at it. On a more serious note, the situation is becoming more difficult by the day. Though inflation has recently abated, it is historically still very high. And given the government’s proclivity for changing the way inflation is measured, shoppers might know the true state of the economy better than economists do. And shoppers are not amused—or at least they’re not amused by inflation. As gallows humor appears in deadly times, egg humor has abounded in current America—witness our crude attempt at the same in the first paragraph. To get some idea of what humorists could be joking about tomorrow, take a look at or listen to one or more of the reports below. And to reduce the need for you to joke about what was once your pension or 401(K), be sure to make these communications part of your weekly reading or listening. Key Takeaways:
  • Inflation is a thief
  • The money supply today remains much too loose to quash inflationary dynamics
  • This week’s FOMC meeting will give a strong indication of who tomorrow’s winners and losers will be
  • Gold is on a tear—but not all gold assets are faring equally well
The McAlvany Weekly Commentary: Readers unfortunate enough to have studied economics in college likely suffered through the vagaries and valuations of Keynesianism. As a method of balancing supply with demand, that “discipline” leaves a lot to be desired, but as a soporific, it is virtually unexcelled. The same is true of Marxism. If you’re having difficulty sleeping at night, just pull out an English-language copy of Das Kapital, read a few pages, and start sawing logs. The same would likely be true for fascism, but how-to texts are understandably (and thankfully) in short supply. In short, economics, as commonly presented, deserves its “dismal science” moniker. That’s unfortunate. Few disciplines affect people’s lives as deeply or broadly. Yet because of the resulting lack of public understanding, bankers, business magnates, legislators, and leaders can easily steal a march on the people, and in so doing steal their wealth as well. David and Kevin discuss how the poorly understood concept of inflation steals the wealth of hard-working people just as surely as a thief in the night, though far more effectively. Credit Bubble Bulletin: Given the policy ramifications and personal tragedies inherent in the hot war in Ukraine, one might be forgiven for not paying attention to the war of influence over the economy raging in the US. On one side stands the Fed, raising rates on behalf of Main Street to tame inflation. On the other side stands Wall Street, thinking and acting like rate increases are about to abate and easy money return. The situation is pregnant with immense ramifications, and neither side’s victory will come without extreme difficulty for the opposing side. Doug tallies the facts and analysis from both sides and offers his own highly informed breakdown for those who have a stake in the outcome—in other words, everyone. This week’s FOMC meeting could give a strong indication of which side is winning. Hard Asset Insights: Morgan also points to this week’s FOMC meeting as a pivotal event—pivotal in respect to its overall importance, not necessarily in respect to the Fed’s stance on quantitative tightening. As a prelude to the meeting, he rounds up the thoughts and assessments of his A-list economic surveys, indices, and analysts. “HAI has pointed out a notable deterioration in economic data since December. First it was the December ISM Purchasing Managers Index (PMI). Then it was the NFIB small business outlook cratering along with a notable drop in profit trends. Last week’s Empire State manufacturing data spoke the same recessionary language. This week it’s the Conference Board’s Leading Economic Index (LEI) banging the recession gong in convincing fashion.” Those are neither subjective nor minor indications of trouble. Whatever his decision, Chairman Powell must know that his decision will pick winners and losers on a very large scale. Golden Rule Radio: With gains over the past five consecutive weeks and 11 of the last 13 weeks, gold is off to a roaring start in 2023. Will it continue? Will it take a breather or back off? Tory and Miles ponder such important questions this week. They note that gold is significantly overbought at this point, and that it will likely trigger some standing sell orders at its current price or soon. They also note that not all gold-related assets have fared equally well. While gold is up around $340 since late November, ETFs are sitting at a two-year low. The reason for this difference is important for investors to consider.
Credit Bubble Weekly
Wednesday, February 1, 2023
[Yahoo/Bloomberg] US Stocks Waver With Fed Rate Decision on Horizon: Markets Wrap [Yahoo/Bloomberg] Adani Stock Slump Worsens as Key Share Sale Fails to Lift Mood [Yahoo/Bloomberg] Oil Steadies Before Fed Meeting and OPEC+ Guidance [AP] Powell likely to stress Fed’s inflation fight far from over [Yahoo/Bloomberg] Fed Expected to Slow Rate Hikes in Signal Work’s Not Over [CNBC] Private payroll growth slowed to 106,000 in January as weather hit hiring, ADP says [CNBC] Mortgage demand took a big step back last week, even after interest rates fell further [CNBC] Gold demand surged to an 11-year high in 2022 on ‘colossal’ central bank buying [Reuters] End of easy-cash era is going to hurt [Yahoo/Bloomberg] Housing Slump Deepens From US to China in Risk to Global Growth [Reuters] U.S. states struggle to share dwindling waters of Colorado River [Yahoo/Bloomberg] Adani Stock Meltdown Hits $92 Billion as Collateral Worries Grow [Reuters] Adani loses Asia's richest crown as stock wipeout reaches $86 billion [Reuters] Asia's factory activity contracts despite China's COVID reopening [Yahoo/Bloomberg] Euro-Zone Inflation Eases as ECB Debate Over Rates Heats Up [Yahoo/Bloomberg] Global Dealmakers Suffer Worst January for M&A in Two Decades [Yahoo/Bloomberg] Gundlach Suspects Fed Will Push Back Against Pivot Narrative [Yahoo Finance] Hackers lifted $3.8 billion from crypto investors in 2022 [WSJ] Ukraine Braces for Major Russian Offensive [FT] Fed poised to move down to quarter-point rate rise as inflation eases [FT] Liquidity loses top slot as investors’ biggest concern after six years [FT] Bernstein: End the Fed ‘put’ [FT] ‘Extreme leverage’? Adani’s debt-driven expansion under scrutiny [FT] Does it matter that central banks are losing squillions?
  • Volcker Pivot: 17% to 9%… Back Up To 19%
  • Party Till You Die! Markets Premature/Post-Inflation Celebration
  • Give Me My Money - Large Real Estate Funds Have “Gated” Liquidation Requests

Do You Remember The Volcker Pivot? February 1, 2023

“Rates remain low relative to inflation. We still have interest rates that are less than the CPI. Credibility is in the crosshairs. Alex Pollock recently noted that the Fed is leveraged 200 to one, reporting operating losses of $2 billion a week, showing unrealized mark-to-market losses on its securities portfolio of $1.1 trillion, and is even considering a further debauching of the idea of price stability by changing the inflation target to three percent from two. Credibility in the crosshairs means that if Powell loses control of inflation, the viability of our Central Bank is on the table.”—David McAlvany

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

Well, last night when we were at Table 23—not table 30, but the new Table 23—we were talking, and I was trying to remember an actor in a movie. We were talking about a book that I had just read that I knew a movie had been made, and I could not remember the name of the actor. It turned out it was Geoffrey Rush that I was trying to remember, but you gave me no help. You said, “Kevin, I may have seen the movie, but I cannot remember the name of actors.”

David McAlvany: No, no, no. I’m more of a book than a movie guy. Don’t get me wrong. I enjoy movies, but I engage them with purely entertainment value in mind. My retention and remembrance of actors, details, what have you, pretty pathetic. So to forget having seen something before, given enough time, that’s not uncommon in our house.

Kevin: Well, funny too, you’re watching more movies right now because of your long time training. Didn’t you tell me that you went through two Bond films the other night while you were on the treadmill?

David: I did watch Skyfall on Sunday morning, and that was followed by The Darkest Hour, so I got two movies in. And it was a longer run.

Kevin: Hey, it’s cold outside, isn’t it? 

David: Well yeah, so I preferred the treadmill for that one. Yeah, the current episode of inflation is, in a similar way, only vaguely familiar. The details of the past episode have long been forgotten. And it’s almost as if we’ve watched this episode before, but because it’s been so long, it’s barely in there. It’s barely in there. So I’ll quote a famous central banker, and you can tell me who you think it is. “The momentum of inflation has clearly been checked.” Said by which valiant knight, out to slay the wily beast of inflation?

Kevin: Well, it starts with a V. It has to be Paul Volcker.

David: V is for victory, or V is for Volcker?

Kevin: Well, V is for Volcker. I can’t think of another Fed Chairman that actually defeated inflation.

David: Yes, except that this was prior to his placement as head of the Fed, and it was while he was Undersecretary of the Treasury for Monetary Affairs. So Paul Volcker indeed, but it was January 14th, 1971 when he said this phrase.

Kevin: Really, not 1981?

David: Nope, 1971. Jim Grant comments, “The great Volcker spoke 10 years too soon.”

Kevin: Let’s stop and think about that for a second. Because 1971, Nixon was in office and we—Think about the gold market, Dave. The gold market probably had seen this coming long before. We read Jacques Rueff’s book named—Jacques Rueff told de Gaulle, “Start cashing your dollars in,” in the late ’60s.

David: The Monetary Sin of the West was written in the ’60s, and so we have the peak of inflation in 1981, but we’ve got the early concerns of inflation and the initial encounters actually in the ‘60s. So the trend towards monetary chaos was sniffed out in the gold market a full decade earlier. It was in the streets of London and Paris that you could have a $20 gold piece, one ounce of gold less the seigniorage, and it had jumped from the statutory $35 an ounce to $40. This is 1960, ’61.

Kevin: So that was on the street in Paris and London, and anywhere where you could trade gold for dollars.

David: Yeah, that’s right. I mean, the first down stroke for the US dollar was, as you recall, recorded in 1933, announced by law, moved from $20 to $35, which was a significant devaluation of the purchasing power of the paper equivalent. So in 1960 you could fetch $40 an ounce on the streets of those cosmopolitan cities. And the market was doing its job. It was sniffing things out.

Kevin: They started to wonder if one of the three pillars of the dollar was about to fall. The three pillars being the gold standard, and then of course the agreement with the OPEC nations, and then the reserve currency status. Gold was about to fall.

David: Well, OPEC was started in 1960, and the ’60s were a pretty active period. You had the Johnson administration—came in and replaced Kennedy in ’63, and by ’64 the guns part of the guns and butter policies were ramping up. You had the Gulf of Tonkin incident, which brought our “police presence” into full military escalation mode in Vietnam that year. Then by January 1965, the Great Society programs had been put to the Democratic Congress for passage.

Kevin: Don’t you love the name, Great Society? Was it really great?

David: Well, it reminds me in some ways of the ironically named Inflation Reduction Act of 2022. I mean, in some respects it’s the Great Society 2.0, just with more of a focus on climate change, but still with the echoes of the war on poverty. Fiscal largesse was then, and is now, a reality. And this is truly a reality now and going forward. 1.3 trillion is the annual estimated budget deficit—annual estimated budget deficit—from now until 2033. Some things never change.

Kevin: Well, and you talk about sniffing things out. The sniffing out that the dollar was possibly going to go off the gold standard, you could almost see it coming, couldn’t you? Because silver had been in our coinage, but we took silver out of the coinage even before we went off the gold standard.

David: Yeah, the 1965 Coinage Act. Again—very busy administration, the Johnson administration—the 1965 Coinage Act removed all silver from dimes and quarters, and reduced silver content from 90% to 40% in the half dollars. So, as always, the money tells a fascinating story, a story of political priorities, and in many cases the policy choices that designate the winners and losers. So devaluation has and always will hit the middle class and the lower classes the hardest. And so now we are in the situation where we get to see who wins in the Powell era, and that may very well be cataloged by historians this week.

Kevin: And you think about the separation between the Fed and politics, and the Fed acts like they’re working against inflation. Paul Volcker ultimately did. He had to fight the politicians—remember when Reagan was in office. But you think about what things cost before this Johnson-era change. Let’s equate things to silver. You normally equate things to gold, but let’s look at what things are valued at in silver back in the ’60s.

David: Yeah, I mean this is only a snapshot in time. The 1965 Coinage Act was a very interesting piece of legislation. And so, there in 1964, the year before, silver was about $1.30 an ounce. The average home cost $19,000, and the average take-home pay was $6,000 a year. Today, the silver price is near 18 times higher at $23 an ounce. The average home is right close to 18 times higher at a cost of $348,000, but the average wage is only nine times higher at $54,000 a year.

Kevin: So let’s look at that again. Okay, so the average silver price is 18 times higher than it was in 1964. The average home price is 18 times higher, but wages are only nine times higher. Sounds like we’ve lost half of our buying power with wages.

David: Yeah. Yeah, just said differently, homes ran at three times the average income. Now homes are at six and a half times the average income.

Kevin: There you go.

David: Households make less, and they’re carrying more debt compared to previous generations. So the house in the ’60s ran, again in silver terms, at roughly 15,000 ounces of silver, and it still does. 15,000 ounces translates to roughly 340, $350,000 for that single family home. Small example of asset price inflation running higher than wage increases. Wages up nine-fold, prices up 18-fold. The reality is, inflation favors asset holders. Hard assets serve to protect purchasing power over time, sound money is now a personal choice. But you go back to that issue of the middle class and the lower classes suffering because they don’t have that same buoying effect—assets keeping track of, maybe even staying ahead of inflation.

Kevin: Shouldn’t we feel a little betrayed, just like the rest of the world, with the dollar? Because those three pillars, okay, we had the gold standard in 1944 when they talked about Bretton Woods. We had an agreement with the oil producing nations that oil would be sold in dollars. And then we had the reserve currency status, which basically, the bank said, “Yes, we will support and hold the dollar because of those first two pillars.” We lost the gold pillar in 1971 under Nixon. We’re definitely losing—we talked about this last week—we’re losing the oil pillar right now. Why in the world would we keep the reserve currency status pillar if we can’t keep to our word?

David: Yeah. I mean, a part of it is there’s no better alternative. And in a world of thieves and knaves—oh, and politicians—nice little trifecta there—there’s no better place to go. So also recall that the dollar relied on the 1944 Bretton Woods’s agreement for its stature.

Kevin: Yeah.

David: And only by the end of the ’60s was that agreement fraying. What a Democrat-led Congress and White House assumed there in the mid to late ’60s was that King Dollar could not be deposed. And with the policy objectives of the Johnson era, there was no price too high for greatness—great society, et cetera, et cetera. But they were wrong.

Kevin: I read in August of 1971 that there was as much as 1,500 tons of gold leaving Fort Knox a day before Nixon closed that gold window.

David: Yeah. The street-level grumblings were already being expressed in the exchange for gold at elevated prices, starting in the early ’60s. By 1968 the revolt of the masses was in full swing. And you’re right. Gold deposits were flying out of Fort Knox. They were being drained, predominantly by the French.

Kevin: Right.

David: 1968 to ’69, if you recall, not only is this a period of monetary chaos and fiscal strain, but it’s also a period of intense political and social unrest.

Kevin: This is when the French— The joke is that they say, “Run away.” This is when French running away benefited the French, not the Americans.

David: But I like this tie to the financial markets and the monetary policy angst showing itself in terms of social and political unrest. More street-level chaos in ’68, I think the famous summer of ’68 and ’69, some of your post-modern thinkers were very much active and engaged in their writing and publishing in that same timeframe. So a dramatic shift in the pillars of thought as well. But by ’71—that’s the year that Volcker’s comment on inflation— Again, he’s taking the premature victory lap that’s—

Kevin: “We’ve got this under control.” Yeah.

David: Then you’ve got Nixon closing the gold window. And in fairness, how could he have known? Volcker saw inflation being tamed in January. Well, he was wrong, but Nixon ended the Bretton Woods Agreement, which was an indication of, and also an accelerant of, inflation, in August, August 15th of that same year. So January Volcker’s comment on, “We got inflation. It’s done.” August 15th of the same year Nixon closes the gold window.

Kevin: Yeah, but Nixon also had Henry Kissinger, and if you’re going to go off a gold standard, you better have a monopoly on oil. And Henry Kissinger secured that, didn’t he?

David: Yeah. That decade was a bear in many ways, for consumers, for investors. And only in 1979, after some very fancy maneuvering directed by Mr. Henry Kissinger, and then it was the implementation of the United States-Saudi Arabian Joint Commission on Economic Cooperation.

Kevin: We’ll scratch your back if you scratch ours.

David: Yeah. That agreement was what propped the dollar up on the throne. It contained the promise to recycle oil revenues back into US dollar debt instruments, specifically Treasurys. That was a big year. Volcker stepped in, also in ’79, stepped into the Federal Reserve Chairman role, August of ’79, and he was facing nine to 10% inflation rates. And if he was looking back on his ’71 comments, we probably all try to forget the mistakes that we’ve made, but he’s eating a rather indigestible hat, having been so wrong there on inflation years-plus earlier.

Kevin: What a decade. What a decade that was, because we had the Iran hostage crisis, we had Afghanistan being invaded by the Soviet Union. So I guess it doesn’t all just take place. There’s a lot of things going on.

David: Yeah, yeah. In fairness, I mean, this is a truncated history. It leaves out many of the contributing factors. You did have the mid ’70s oil embargo, so OPEC’s upset with our involvement in Israel. It fits with recession throughout the decade of the ’70s, just to name two of them. But in broad brushstrokes, the victory over inflation was declared in ’71.

Kevin: Isn’t that interesting?

David: Again, it was sussed out by the market in the early ’60s. Victory was declared in ’71, and it was Volcker a decade later facing inflation at 11%, and by 1981 a fed funds rate boosted to 19%.

Kevin: So the news of the death of inflation was premature?

David: Well, one more small detail from 1980 that matters a great deal. 1979 and 1980, you had auto dealers mailing in keys from their cars that they had on their lots in small coffins to the Federal Reserve headquarters. “You’re killing our business. You’re killing us.” Farmers at one point blockaded the National Mall in DC with their tractors. And Volcker is remembered as being [unmoved] by political pressure, when in fact he capitulated and lowered the fed fund rate from 17% to 9%. Inflation was not gone, but the political pressure to alleviate economic pain was increasing, and he caved.

Kevin: Yes, but he regretted that decision.

David: Yeah, only to reverse course and try to save Fed credibility, then boost rates to the record 19 to 20% in the January to June period of 1981. With inflation, it’s not over till it’s over.

Kevin: Sniffing things out then, if I’m trying to figure out where you’re going with this, Dave, are we maybe in that 1971 period right now, where Powell may be looking like he— Well, he may not pivot, but the markets certainly think he’s going to.

David: We’re a year into inflation. Maybe it’s ’71, maybe it’s further on in the life cycle of this inflation thing. The market is already taking a victory lap. That is for sure. And so the market’s taking a victory lap in this crazy game of chicken. Consider this, we have no real economic pain yet, measured in the economy. We have seen no impact on employment, boosting it to higher levels. The worst-case scenario imagined by Wall Street consensus is now considered a soft landing, which is the mildest form of recession. Meanwhile, the S&P earnings growth is being penciled in at 4.2% to the positive for 2023. Now, that’s one hell of a slowdown. Let me just say one comment on the most recent GDP numbers, because even though they were positive, you factor in a realistic inflation number. And just use CPI as an example, because the number that they use for the GDP statistic is in the threes, not in the sixes. So they’re pretty happy with a 2.9% number, GDP growth coming into the end of the year. When in fact they understated their own inflation numbers by 100%.

Kevin: So your bottom line is, inflation is understated.

David: And GDP is overstated. I mean, and this is one more reason people are excited: “Well, GDP wasn’t as bad as we thought. The economy’s not really going into much of a recession.” Yeah, but if you look at the contribution of the inventory component, which was massive—so inventory builds and an understated inflation, and you end up with an overstated GDP growth figure.

Kevin: And understated inflation. It’s going to be good for all of us.

David: Right. Bottom line, inflation is underestimated, and the movement in fed funds has thus far been overestimated in its total shock on inflation. I think people are wanting the worst to be behind us, and yet we haven’t even really taken a significant step in that direction.

Kevin: Do you think Powell will have to pull a Volcker in the future?

David: Powell’s not even close to the Volcker-style ’79 to ’80 tactic. I mean, remember, that was just before he lowered rates, and then regretted it as inflation blew up in his face. We still have bank reserves which are ample. Ultimately, Volcker had to clamp down on that, and that was probably the most effective way of treating inflation, not the rates gambit. Rates remain low relative to inflation. We still have interest rates that are less than the CPI. That’s not going to get it done. 

Credibility is in the crosshairs. It was our Commentary guest from a few years ago, I think maybe 2019, Alex Pollock recently noted that the Fed is leveraged 200 to one, reporting operating losses of $2 billion a week, showing unrealized mark-to-market losses on its securities portfolio of $1.1 trillion as of September 30th, and, as we discussed last week, is even considering a further debauching of the idea of price stability by changing the inflation target to three percent from two. Credibility in the crosshairs means that if Powell loses control of inflation, the viability of our central bank is on the table.

Kevin: Yeah, but we could still rely on Saudi Arabia. Tongue in cheek.

David: There’s no United States-Saudi Arabian Joint Commission on Economic Cooperation lined up for 2023. This is not 1979. The Saudis are more in bed with Russia and China than they are with us because of how poorly we played the shale revolution. So we get a temporary spike in US domestic production to 13 million barrels, this does not have to end poorly. But it more and more is feeling like the George Washington rapping in act one of that hit musical Hamilton. We’re outgunned, outmanned, outnumbered, out-planned. Powell, is that who’s the right-hand man?

Kevin: Yeah. You wonder how much politics and the Fed actually have to hold hands in this particular case. But, Dave, why are you such a negative guy? Okay, because I would’ve just purchased Tesla over the last week or two. Or, well, you name it, all these companies that went down last year, I could be making it all back.

David: Now, this is the challenge. And when you think about Powell and the realities that he faces, the very tough decisions that he’s got to make—and his whole committee, Powell marches into Wednesday with Tesla surging 33% last week. Lucid 65% last week. Rivian, 22% in a week. GameStop, 16% in a week. Footlocker, 16% in a week. Airbnb, 14.5% in a week, which brings year-to-date gains— I mean, we’re talking about four weeks total. Tesla’s up 44. Lucid is up 88. Warner Brothers up 57%. Carvana, 64% year-to-date. Now it’s still down 90% from its peak.

Kevin: Right, right.

David: That’s a Dodo bird story. Wayfair is up 94%. Beyond Meats, for those of you who don’t like red meat but still want to pretend you’re eating meat, it’s up 50%. There’s hope for you too. LendingTree, up 79%. Expedia, 32%. Airline stocks, pick ’em. There’s at least a couple that are up almost 30%, 29%. Disney is up 26%. Salesforce, 24%.

Kevin: Okay, what is causing that? What are the things that are going into that, other than just insanity as far as I’m concerned?

David: The way we framed it previously is, this kind of manic behavior is a combination of things. It’s one part Fed pivot—a bet on the pivot. One part FOMO, fear of missing out. Investors clamoring, jumping over themselves to get involved again. And it’s two parts short covering.

Kevin: Yeah, explain that one. That’s important, because there were a lot of people who thought it was going down that now have to cover those shorts. They have to go back in and buy those stocks.

David: Right. When you see a healthy market sort of marching ahead, it’s the cream of the crop that are tending to do very well. When you can second-guess—and this is just where reality has to be recognized—when you see the cream of the crap rising to the top—and again, here we’re talking about Carvana and your most favorite shorts from 2022—when they’re the ones that are rising, what you see in terms of the energy is folks who’ve been short who now have to buy back those shares to cover their short positions. And it creates a little extra energy, extra positivity. It’s not true organic buying. It’s just a shortcut.

Kevin: Well, does it create a little drunkenness as well? I mean, the proof of— Like a Long Island iced tea is very smooth going down, but when you look at the ingredients, somehow, some way, they’re all drinks that you probably would not want to mix.

David: That’s what we’ve got. If it’s one part pivot, one part FOMO, two parts short covering. It’s like the Long Island iced tea. It’s a vodka, it’s a tequila, it’s a gin, it’s a rum.

Kevin: It’s maybe even absinthe.

David: Right.

Kevin: You introduced me to that a few years ago, but don’t ever do that again.

David: That’s not in the classic Long Island iced tea.

Kevin: Yeah.

David: Even Sam Bankman-Fried’s FTT tokens, crypto tokens, they’re up 160% in January, and they’re known in some circles as Sam Coins. I think the better descriptor, post FTX, is probably Son of Sam Coins.

Kevin: Hopefully you could put that in your IRA and really count on it for retirement.

David: Well, what you’re talking about is a serial destruction of wealth, which is far from over. And again, you’re seeing the biggest moves in those pockets, those areas. The most extreme expressions of speculation are in the lowest quality. It just has the makings of, well, let me say it, a bear market rally.

Kevin: So we record this on a Tuesday, Powell talks on a Wednesday. If we were to look into Powell’s microscope, does he see this?

David: I don’t know how he ignores it. Doug Noland comments over the weekend in his Credit Bubble Bulletin, “I think he knows what he needs to do. If you fight the Fed while the Fed’s trying to fight inflation, you’re apt to lose. But that’s Volcker and not one Fed Chair since Volcker, it’s such a different era now. The Fed doesn’t dole out punishment. They just play Mr. Nice guy to the markets and extend monetary rewards.” I think Doug’s right. I think Powell knows what he needs to do, but he doesn’t necessarily want to upset the market. This is a game of chicken between market speculators and Fed Chairman Powell, with domestic investors already—if you look at how this is priced in—domestic investors are pricing in a maximum for the fed funds rate at 4.9%.

Kevin: When you’re talking about the—This is called discounting of a market, where you’re pricing in what you think it’s going to be long-term.

David: Yeah. So if you look at how investors are pricing in what the Fed’s going to do, they estimate they’ll stop shy of 5%, 4.9 as the peak fed funds rate, and then that’ll recede to 4.47% by the December Fed meeting. That’s the market’s bet. That’s their version of chicken. You’ve had a host of Fed participants who’ve already said, “We need to stay north of 5% for an extended period of time.” So there’s already a divergence in views the market, but the market—

Kevin: But the market’s saying, “No, I don’t believe it.”

David: Right. And in this context, global financial conditions have loosened. Global equity markets have posted healthy annual gains of between eight to 15%. I mean, think about that, annual gains of eight to 15% in four weeks. Speculation is back in full force on Wall Street. Again, to quote Doug, “Markets have expropriated the Fed’s tightening cycle, and it’s unclear whether the Chair or his committee fully appreciates this reality or the ramifications. Market control of financial conditions guarantees wild risk-on, risk-off instability. Prevailing risk on looseness seems to ensure ongoing strong lending and credit growth, which is sustenance for price inflation.” Again, you’ve got the makings of greater price inflation, and the market is driving towards greater price inflation. How does the Fed not respond to this?

Kevin: Okay, so from a political point of view, it’s amazing to me, every few years we have this discussion of, “Oh, do you think the government’s going to shut down, or do you think they’ll raise the debt ceiling? Are they going to shut down and—”

David: Yes.

Kevin: We’ll even get calls and it’s like, “Have you not seen this show, this theater, all of your life?” It’s a theater.

David: Exactly.

Kevin: It’s a theater. We’re always going to spend more than we make.

David: Even if you’re not good on movie retention, you kind of know who the parts are and the people and the players and how the script is read. This is a second game of chicken, and it’s barely worth mentioning the debt ceiling of 31.4 million. That’s been breached. Oh, horror. Who saw this coming?

Kevin: Yeah.

David: Total farce. In this case, it’s a farce between a set of mentally deficient chickens. We already know the debt accumulation expected over the next decade is at a $1.3 trillion annual clip. The spending deficit which our legislators have signed onto, they can see it. They know it’s there. 10 years from now, the debt levels will be at least $44.5 trillion based on what both parties want to “invest in,” if you want to call it that. So how can any serious-minded—should I instead say honest?—politician not call it out as an utter farce? Deficient chickens belong in the fryer.

Kevin: Isn’t it strange, though, if you’ve got financial conditions loosening, you’ve got the markets rising, why is it so hard, why, Dave, is it so hard? You talk about exit strategy. One of the key questions in investing, whether you’re buying gold or stocks or real estate or real estate trust, the question is not how easy is it to get in, the question is how easy is it to get out?

David: Well, guess whose bird is getting plucked? Janet Yellen activated an extraordinary cash management measure so as not to breach the debt limit. And this is like a free course available online, taught by Janet herself. Call it a master class, Raiding the Piggy Bank 101. She notified Congress that she would be accessing the Government Securities Investment Fund. This is the G Fund. And for those of you that don’t work for the federal government, this is one of the pension schemes that government employees can opt for, and it’s the go-to for filling the gap until the debt ceiling is lifted. So government pensioners, you got to love this. In one hand—

Kevin: She’s just borrowing the money.

David: Yeah, you’ve got a plate full of cookies from Grandma Yellen. In the other hand, she’s wielding a hammer for breaking the piggy bank. Probably a hammer she borrowed from Paul last time she visited San Francisco.

Kevin: Okay, but what I was talking about is Blackstone and some of these private equities that you can’t liquidate right now. What’s going on there? If things are loose, why can’t I get my money back if I was invested in one of those private trusts?

David: Right. Powell and the Fed and the US Treasury are not the only entities worth discussing. You’ve got Blackstone, and this is a development over multiple months, but it’s coming to a head. Blackstone, KKR, Starwood Capital Group, these are your private equity and/or real estate giants, have each gated real estate funds as requests for redemptions are increasing.

Kevin: You can’t have your money.

David: They’re already dealing with a backlog of requests from November and December, where they were not fully met. They’ve parceled out a little bit here and a little bit there, and they’ve instituted further limits as requests keep on flooding in. Here’s an interesting contrast, one that suggests there is a devil lurking in the details. Publicly traded REITs, real estate investment trusts, were down 25.96% last year as of the end of December. Yet, these private equity groups with the real estate portfolios in question are using mark-to-make-believe metrics for valuing their real estate portfolios. And they show a positive return of 8.4, 6.3, and 8.32%, according to Reuters, on January 24th. There’s something hidden behind the gates, and it’s called the reality of mark-to-market.

Kevin: So you can tell people you’re making money, and they say, “Okay. Well, great. Then give me mine.” And they’re like, “Oh, no.”

David: “Oh, no, no.”

Kevin: “No, no, no, you can’t have it, but we are making money.”

David: Yeah, yeah. No, and as long as you’re happy with that answer, it’s just fine.

Kevin: How do they meet the redemptions, if they’re going to pay it out at all?

David: Well, two ways. One, redemptions are met either with new liquidity infusions, as was the case with a University of California cash infusion of $4.5 billion into one Blackstone fund. So now they’ve got the money to pay out to people who are asking for money. Kind of sounds Ponzi-esque, but it’s not really.

Kevin: Wow.

David: Or else assets have to be sold, and guess what? When you sell assets, now you have a mark. 

Kevin: We’re not making money anymore. 

David: Mark-to-market imposes itself on a group of squirming private equity CPAs, and those fictional positive returns of 2022 might in fact give up even more than the 25.96%. Because with the time lag and the further increase in commercial real estate borrowing costs, you’ve got cap rates which are readjusting higher, and thus prices on the assets in question moving significantly lower. 

Let’s leave it with this. Details are overlooked. Downside risks are being underestimated, and we’ve miscategorized this year altogether. This is the year of the chicken, not the rabbit.

Kevin: You’ve been listening to The McAlvany Weekly Commentary. Now I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com, or 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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