Dollar Dominance Dismantled One BRIC At A Time

Weekly Commentary • Aug 09 2023
Dollar Dominance Dismantled One BRIC At A Time
David McAlvany Posted on August 9, 2023
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Dollar Dominance Dismantled One BRIC at a Time
August 9, 2023

How many acres of solar panels would it take to duplicate this nuclear power plant? 1100 megawatts translates into 6,251 acres of solar panels. Now what goes into producing one megawatt of power in solar? 70 tons of glass, 56 tons of steel, 46 tons of concrete, 19 tons of aluminum, seven tons of silicon, seven tons of copper, six tons of plastic. —David McAlvany

 Now here are Kevin Orrick and David McAlvany.

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

David, we haven’t really talked much about the new edition to the Vaulted program, the silver side of things. A few years ago, you started basically working on a program where you can buy gold with your cell phone. That’s what I tell clients, but a lot of clients who really liked that program said, “Well, when can I start doing that with silver?” And that’s functioning as of now.

David: Nothing replaces having physical ounces in your possession, but when we conceived of the Vaulted program, it was to be a savings alternative. Not only looking at the frailties of the banking system, but also the frailties of our currency system. Last week, Fitch gives the country a downgrade, for good reason. If you do a little bit of balance sheet analysis, it’s reasonable. Are we going broke tomorrow? No, but we are going broke slowly, and then perhaps—

Kevin: Very quickly, like Hemingway said. Yeah.

David: Exactly. Exactly. So the question is how do you denominate your savings? And can you do it in a form that is transparent and affordable and ethically sourced? So we did that with gold and we partnered with the Royal Canadian Mint. Now we’re dealing with the most secure vault in the world for silver, HSBC. Vaulted Silver stores and ensures the silver so you don’t have to. It cuts out 70% of the supply chain costs. And Vaulted silver thus offers what we have and what we view as the lowest fee structure in the industry for physical serial numbered silver bars.

So what’s been frustrating to me, Kevin, is in recent years, prices on small silver items have gone up to 30, 50% premiums over the physical silver price. And so I look at Vaulted Silver as an amazing way to affordably invest and be able to get the economy of scale of a thousand ounce silver bar and have it there like a silver savings account just as you may have had a Vaulted Gold account.

I think it’s the must have investment for 2023. Physical silver is a vital element in batteries and semiconductors and solar panels and medical technology. So you’ve got the industrial demand side. You’ve also got the investment demand, which today at 82, 83 to one, looking at the gold silver ratio, puts it in the value category. So few things today can be put in that category. So vaulted.com, same place you might’ve checked out to see about our gold offered through Vaulted, the savings program. I love physical gold and silver delivered to your door or put in IRAs. Those are things that we’ve done for decades. This is the newest iteration as a savings tool for anybody who wants to reduce the balance of what they have at their local bank or banks, and have sound money once again.

Kevin: Just visit vaulted.com to get more details. Last week, a lot of our listeners may have missed the Tactical Short call. That’s something that they can go back this week and listen to the recording.

David: Exactly. I would go through the whole thing, including the Q and A. And Doug does an excellent job of putting 10 pounds of mud into a five-pound sack. He covers a lot of bases. If you missed it, it’s incredibly valuable. I would also encourage you, if you are not routinely going to mcalvany.com and going to the Market News section at mcalvany.com, we’ve got incredibly valuable insights from my colleagues Doug Noland and Morgan Lewis. Doug does the Credit Bubble Bulletin, Morgan does the Hard Asset Insights, and those comments are available over the weekend.

I think they’re not only important for understanding the current economic and financial market context, but I’ll tease this out a bit more. If I was intent on preserving and growing wealth, significant wealth in the years ahead, the counsel provided in those resources would have to be a weekly staple for me. So Saturday morning, pour a cup of coffee, read them both. The buzz will delight you, the thoughtful reflections, enlighten at the same time, don’t do without. Again, easiest way to find them is at mcalvany.com, the Market News section, you’re looking for CBB and HAI, Credit Bubble Bulletin and Hard Asset Insights.

Kevin: One of the things I’ve loved about working with your family now for three and a half decades, Dave, is the meeting times. I remember the years meeting with your dad, and your dad would talk about his world travels or coming back from South Africa or flying into Angola and talking about Jonas Savimbi. And I loved those tales, and I loved his take on the economy. 

We still have those meetings. Now you’re in the meetings, but you’ve also brought in other experts. Morgan and— I love reading Doug Noland. Part of the reason this podcast exists in the first place is to fulfill this desire that the people who work with us could be flies on the wall for some of this, and they can. We record it now. It’s not just the podcast, it’s Morgan, it’s Doug.

But I’ll tell you, one of the questions that keeps coming up is what is coming up right now with the BRIC nations? You remember the popular person at the school, very, very popular for a long time, and then something happens and that person is no longer on the A list? That person is on maybe the D list, and nobody wants to be associated with them. The United States is not in that place yet, but we were the most popular country on earth with our reserve currency status and our military. And at this point we’ve got an awful lot of people saying, “You know what? I think you’re not our friend anymore.”

David: There is a change which is occurring all over the place, and a part of it is a failure to appreciate history. If you go to South Korea, for instance. Today, sit and chat with someone who’s 60, 70, 80 years old. And there’s a deep level of respect and appreciation for the role that we played in contemporary Korean history. But if you talk to somebody in their 20s and 30s and 40s, there’s great antipathy for the US having any presence on Korean soil. It’s a difference between generations. But it’s more than that.

Kevin: Your dad says that about the Philippines too.

David: The generational difference is really one of historical reference points and an appreciation for what has happened in the last 100 years. So yes, there is discontent, whether you’re looking at age demographic or a geographic arena where there’s something that wants to be shifted. The BRICS are gathering in a few weeks time in South Africa, and that’s created a buzz around the possible replacement of the US dollar as the central pillar in global trade, the primary reserve asset for central banks. 

And while all things are possible, those same things are not necessarily probable. Multipolarity is something that has gained traction as a buzzword. Multipolarity is a growing trend when considering international relations, when considering political cooperation. And clearly, there is a breakdown. There’s a breakdown in alignment reflected in the division of powers, sanctioned and unsanctioned according to their association with Russia. So if you look at just that one issue of Russia and Ukraine, you can begin to see how the world is slowly being broken into two camps.

This dissimilarity of interests is better reflected in the fracturing of a body like the UN Security Council than it is the US dollar-based system of trade and reserves. Individual nations are taking a priority to global interests and power PACs, and they’re indeed challenging Western democratic morays or ways of doing things, with a resurgence of the pull towards autocratic personalities, Russia, China, and the list goes far beyond that. But you could argue that the gathering in South Africa is more a reflection of the world divided between champions of overbearing repressive regimes on the one hand, and those who are not participating, the Western Democratic Alliance. Most interesting in my view, at this meeting anyways, requests to join the mix this year come from Algeria, Bahrain, Egypt, Iran, Saudi Arabia.

Kevin: Saudi Arabia?

David: And the United Arab Emirates.

Kevin: Yeah, wow.

David: So if you wanted to say, okay, here’s the wrinkle. Dave, you’ve just said, really, this is about an international relations breakdown, not really a monetary thematic. This is a point that I think could emphasize and may sooner than later reflect itself in dollar values and other currency values. This is the wrinkle for the West. The new entrants, if included as members in the BRICS, are responsible for roughly 18 million barrels of daily oil production. And if you want to go back to Saudi’s production, it’s been decreased here the last year. Perhaps we’re north of 20 million barrels a day combined with Russian production of 10 million barrels a day. And you’ve got approximately one third of global oil supplies flowing from countries that are not interested in kowtowing to the US. Just again, for reference, 102 million barrels per day is roughly what we run these days. So 30 million barrels is a significant chunk, but again, these are countries not interested in kowtowing to the US.

Kevin: Well, and I think that’s important to go back and see how that affects the dollar, because the dollar really was built in 1944 on three pillars. One was the reserve currency status, but that was gained because it was a receipt for gold, which we lost that in 1971. And it was a receipt for oil. Pretty much all the oil in the world was traded in US dollars. That’s called the petrodollar. So how does that affect it?

David: There’s cracks. Cracks in the US dollar system which do exist. And I think this is perhaps the biggest one. How do cracks emerge? We were just out in Southern California, and you can sit there on the beach and you think, okay, San Andreas Fault, we could just all slide in. But there is an existing crack. Nothing catastrophic has happened yet, maybe it never will. Cracks in the US dollar system do exist, and this is, I think the biggest one. The petrodollar system is under pressure in ways we’ve never seen before. 30 million barrels a day with a hostile intent, or at least a set of priorities that run away from those of the US and the West. It’s worthy of consideration.

Kevin: But we as the United States, when Trump came in, we’ve started replacing that need for international oil. We’ve increased our production. I’m wondering, can we weather this without having the petrodollar?

David: Yeah. I mean, the consolation is that there’s no immediate consequence to the end of the petrodollar system. So I think pundits will be keen to ramp this up to a level where— almost sensationalizing it. Yes, this is an issue, but consider the difference between now and the 1970s, even the ’80s, where if we had, like the oil embargo, those in OPEC or pre-OPEC days, say, “We’re not sending oil, or we’ll determine what the price is.” We were in a very vulnerable place, and our economy was incredibly vulnerable to something that we had no control of. But US oil production today is robust for the first time.

So the US Treasury is confident in its ability to distribute debt, and that’s a part of this petrodollar recycling system. Maybe we don’t have to sell as many Treasurys to Saudi Arabia and OPEC countries. US oil production is robust. The US Treasury is confident in its ability to distribute debt. I’m not saying this is ideal, but the Fed’s been a willing participant in absorbing large quantities of it, their balance sheet more than doubled and could double again. Not healthy, there’s consequences to that. But you could probably see how those quarters of consolation, the Fed and current oil production in the US, are flimsy. They’re decent today, but they’re not necessarily reliable on a longer-term basis.

Kevin: As long as you can keep printing money and monetizing deficits, right?

David: Well, so our own criticism includes recognizing you can’t monetize deficits indefinitely without impacting your currency dramatically. So the Japanese have somehow demonstrated the ability to do more of that debt monetization that anyone dreamed possible. Japanese debt-to-GDP, well north of 260% while we rest at a comparatively safe place at just over 106%, on our way to 120% in short order. That may be why there’s no immediate consequence to the end of the petrodollar system. I don’t think we need to run from the room with our hair on fire. There’s nothing here that is immediately dramatic.

Kevin: Is it because we have the Permian Basin?

David: I think that is a part of the reflection for what we have, but may not have forever, at least on that other, call it consolation. The Permian Basin is a finite resource. Our second consideration and longer-term counter to the present tense consolation, if you want to call it that, is from the Permian. And from the Permian has come the majority of crude oil volume increases over the past decade here in the US.

Kevin: Our US policy, granted we have a powerful military worldwide, but it hasn’t had to be used nearly as often as we would have had we not been able to sort of fight a lot of our wars with a strong reserve currency dollar.

David: Just one more thing on the petrodollar because I think it’s important to keep in mind. I mean, we’re not just referencing the 1970s as this strange period of time. We today produce more oil than Saudi, but we’re at 12.6 million barrels a day. They’re currently exporting nine. They could ramp that back up to 11 if they wanted to, but we’re out-producing, and that gives us some insulation. That’s what I’m talking about.

Kevin: It gives us energy insulation, but it doesn’t necessarily give us that power that we had when everybody had to use the US dollar.

David: Fair enough.

Kevin: Now, I’m talking about how we fight wars, Dave, is with the dollar. You’ve pointed that out many, many times.

David: The gathering in South Africa is going to no doubt discuss challenges to a new order and structures to promote a diversification away from US policy, both foreign policy directed by the State Department and economic policy directed by our Treasury. The most significant tone shift prior to the meeting is the change of the currency in which global trade occurs. The desire has already been stated. It’s a tall order considering that what backs and enables the global system is the US bond market, the largest bond market in the world. Liquid credit markets enable offsetting of risk and hedging of currency exposure, and that’s best done where liquidity exists.

Kevin: How big is that?

David: 25 trillion US dollars, and with a strong presence throughout the globe, trade settlement in other currencies is a greater challenge than the diversification of central bank reserves, which is frankly just a simple asset allocation shift. And we’ve already seen that in earnest since the seizure of Russian reserves. Central banks’ scramble for tons of gold has increased. It should remain steady in our view for many years as the choices for reserve diversification are few and far between. You could look at gold, you can look at euros or yen, if you don’t want to be within that western sphere of influence or with a country that is in any way connected to the US, you’re at a short list in terms of what you’re going to hold your reserves in. Do I want to hold my reserves in Iranian currency or Turkish currency just because I have an affinity for China and Russia?

No, that’s a financial suicide mission, but I might want to own gold and I might want to own other commodities. Other commodities can also be hoarded as a means of purchasing in advance what you think you as a country are going to need for development purposes. And on that point, China today is probably going to come in in the second half of this year and crush the copper markets. Current copper reserves in China are very low, and just like the US strategic petroleum reserve, if they filled it today, we’re dealing with tight supplies already in the market. So you can see this large outsized buyer ending the market just for the purpose of, either in the US case, restoring the SPR, in the case of the Chinese, just adding back to a strategic mineral reserve. That would have a very strong influence on upward pricing.

So the reason why gold ends up being an even better reserve asset is because gold has little to no effect on economic planning and development. The Chinese, the last thing they want to do is bid against themselves as they look at infrastructure projects and have the cost of their inputs go up just because they want to buy more and more and more and set that aside in advance. They’re bidding against themselves. Gold has no economic value from that standpoint, so reserves of gold bars continue to be one of the best solutions for diversification away from US dollars.

Kevin: And so as far as gold trade goes, central banks have always operated somewhat in gold. But here was it 2008 when things shifted—

David: 2009 was the first year they were net positive buyers.

Kevin: So they become net positive buyers, but the last quarter of last year was the largest central bank buying of gold in history. And I’m wondering, are we looking at a new kind of transfer system? We’ve controlled an awful lot of international politics with our SWIFT transfer system or the clearinghouse interbank payment system. Do the BRICS have an alternative? Do they have the ability to actually administer something like this?

David: Yeah. That’s a good point. And just to comment real quick on central bank gold demand, we had such a huge year in 2022. I mean, like, all time record. It’s not a surprise to see the year-over-year comparisons for 2023 at lower numbers. When you set a record and then you’re comparing this to that, last year is like looking back at the flagpole.

Kevin: But it’s still very brisk.

David: It’s still very brisk. The Chinese in the second quarter added 103 tons, not an insignificant amount. There were some central banks that sold, some that bought, but still the numbers are incredibly healthy if you’re looking at the 2-, 3-, 5-year rolling average, well above average, just not keeping pace with the all time records that were set in 2022. 

So your question about international transaction settlement, the Chinese set up the CIPS system platform for cross-border settlement, and it does compete with our system. But again, this is where I think the change in reserves is as simple as an asset allocation choice and then you just sell some stuff and you buy other stuff. It’s really not a big deal. When you’re talking about changing the plumbing for international trade, that’s a different deal. They’ve had this in motion for a number of years. Today, the CIPS service that the Chinese set up, it services 15,000 transactions a day, decent, cumulative $50 billion in trade transactions on a daily basis.

Kevin: Not to be sneezed at, but how large is ours?

David: That contrasts with our CHIP system, the clearinghouse interbank payment system, which covers 250,000 daily transactions and sums to over 1.5 trillion in daily volumes.

Kevin: So let’s do the comparison again. 15,000 transactions for CIPS, which is the Chinese platform, versus 250,000 daily transactions.

David: And in dollar values, looking at 50 billion on the Chinese side, 1.5 trillion through our system, out of 3%, you’re talking about a 3% of comparative volumes, the Chinese system, the largest global alternative, which again, 3% remains minuscule at this stage.

Kevin: Right. But I want to go back to something that you said before. When we’re talking about seeing cracks emerge, that can happen in many different ways, but geopolitically it sounds to me like the countries that are not really participating in the sanctions against Russia are the ones who are trying to find an alternative.

David: Well, that’s right. And you’ll find that it’s a ragtag group. A few numbers provided by Professor Carla Norrlöf to Project Syndicate when considering the division of the world into these two spheres, the contrasting autocratic and, call it, slightly more democratic segments. 60% of world trade and economic output are controlled by the coalition participating in sanctions against Russia. 80% of global investments are controlled by the coalition participating in sanctions against Russia.

Kevin: So the wealth is still slanted toward participating in sanctions?

David: That’s right. And 90% of global currency reserves are controlled by the coalition participating against Russia. So while you do have some countries that are interested in changing the regime, the scale of what they bring to the table is minuscule in comparison. Again, we’re creating this contrast between the democratic or liberal west and the autocratic other, if you will. There is a migration away from the west, to a degree. The 60-plus countries that operate within the US Security and Trade framework represent the vast majority of liquid resources in the world.

Kevin: Even if it’s not representing the vast majority of the population.

David: Well, right. Population is a different matter, but even there, India is a swing vote in the BRICS. You’ve got Brazil, Russia, India, China, South Africa. India is in the mix, but it’s not like India has a cozy relationship with China. They certainly do have a robust trade relationship with Russia, in part because they’re willing to buy embargoed goods. They’re willing to buy the crude which is coming out of that country. It represents a healthy discount for them. India does have issues that they share in common with the BRICS, but with the healthiest demographics of any of the BRICS countries—again, India has the largest growing population—there’s a greater alignment with Western economic ideals.

Kevin: Something that you’ve brought up before, and we’ve had guests talking about this, is there are some countries that can’t fight a war or can’t function, if they’re oil producing countries like Russia, unless oil is a certain price per barrel. I remember talking to a guy, Dave, we were down in Texas. You were doing a conference. I think your dad was there. I can’t remember which conference it was. We had an oil man who had been a friend of your dad’s for years, and he said, “You know, the real price of oil, if it wasn’t political, should be about 10 bucks, 15 bucks a barrel.” He says, “But it’s political, and it has to be.” What do the Russians need to be able to fight a war and run their country? Or the Saudi’s?

David: I remember the conversation. This guy walks in, he’s in a pair of overalls, he’s a healthy proportioned gentlemen, slow to speak, but every word he spoke was gold.

Kevin: Yeah. Black gold.

David: Yep. Yep. Well, in the US, oil production has passed 12½ million barrels per day, and with improved efficiencies and reduced costs for drilling, many US producers are making money at any price between say, 40 and $50 a barrel. Saudi Arabia requires a price north of $81 a barrel to balance its books. What I mean by that is you’ve got the cost of production, but different than the US where we have primarily private market producers, there you’ve got the state-owned Saudi Aramco. Well, they floated it on the market exchange as the most valuable company in the world, the most revenues of any company in the world, Saudi Aramco, 90% owned by the Saudi royal family.

Kevin: So the Saudi royal family gets all the dividends, virtually.

David: But they have to pay for the largess of the state. I mean, from those revenues, they pay for everything, which is why roughly 81 bucks is breakeven for them, whereas 40 to 50 is break even for us. Russia, again, in terms of their production profile, they’ve got a similar break even of 40 or $50. Then, like Saudi, the state apparatus is largely funded from oil revenue, so Russia as well, they have to have prices in the 80 to $90 range to pay for the state programs, not including the war with Ukraine.

Kevin: Not including the war? So they still have to have 80 to 90 a barrel—

David: Just to pay for the state, normal operations.

Kevin: Okay. Are these countries also that run budget deficits like we do?

David: Clearly, if the price of oil’s too low, then they’re automatically in the position that we voluntarily put ourselves in. Running budget deficits is something we share with these oil producers, again, when the price of oil is below their breakeven threshold. Our revenues come from taxes—unfortunately for 2023 off roughly 11% this year, even as the budget gets blown out. Their revenue comes from oil production. Budget deficits we do share in common, but the cause is a little bit different.

Kevin: When we’re talking about these countries that may not be quite as enthused about participating in the sanctions against Russia, some of them are actually benefiting. They’re like, “Hey, you’ve got sanctions on Russia, we’ll just buy cheap oil from them,” like India.

David: India’s front of the line. The sanctions continue, and they are importing significant quantities of Russian oil, approximately 2 million barrels a day. It’ll fluctuate between 1.9 and two and change just above that threshold, and at prices below the global Brent level. This has meant a reduction in Saudi exports to India by close to a third, and a significant increase in exports from Russia or imports into India. Why not buy the cheap stuff? I mean, that’s kind of a no-brainer for the Modi government. One significant observation here is that while China and India are power rivals in the East, there are overlapping themes in each country, which again are expressed in this way. They will pursue their own interests. This goes back to that earlier comment. There’s a resurgence of national over global priorities regardless of the Western-orchestrated sanctions regime.

Kevin: These countries also have to refine this oil. If we’re looking at all the details here worldwide, what can India refine? When they reach capacity, it doesn’t matter how much oil they bring in.

David: Yeah. That’s a bit of a bottleneck. India is at a strategic disadvantage in terms of its current refinery capacity. They’re basically at a hundred percent capacity, 98 to a hundred percent now, according to the 2023 IEA oil report. China has ample spare refining capacity, and so they can continue to bring stuff in and then redistribute to other parts of Asia. Smart on their part to do so. On that theme of refining, Kyle Bass has highlighted the shift to Chinese refining normal diesel to marine diesel. They now have the state owned enterprises moving capacity and jumping from 75 to 95% so that refining capacity is, in this category, now running full bore.

Kevin: Why do you think that is, Dave?

David: Well, think about marine diesel and think about what signal that should send to the rest of the world.

Kevin: Taiwan. South China Sea.

David: This is at the same time other refined products have dropped. If you’re looking at an increase in domestic demand for diesel because there’s increased flow of goods or factory activity, no way. This in Bass’s view fits the category of war preparation.

Kevin: Xi doesn’t want to go boating?

David: No, no, no. I mean it’s fun, but a signal of invasion or blockade of Taiwan being imminent is this issue of ramping marine diesel refining capacity. I think it’s pretty interesting. The PLA Navy is dependent on marine diesel, Chinese economy doesn’t otherwise require the current output of marine diesel. It’s worth keeping an eye on.

Kevin: Isn’t it interesting what you have to look at? When you’re thinking about world politics and you think about the world turning kinetic warfare bloody, which I hope that that doesn’t happen, but we think about currencies, we think about oil, we think about what’s being refined and what’s being refined by who. Dave, if there’s a conflict and literally we go kinetic, okay, there’s a kinetic war, all this talk about inflation, there’s no more debate.

David: Yeah. If the market’s expect to navigate a conflict scenario between Chinese and Taiwan with no inflation, they’re in for a rude awakening.

Kevin: Yeah. But not just inflation, Dave. I mean, aren’t we greening the world? When you’re greening the world, do you think we’re going to be fighting with solar power?

David: Well, particularly when so many of the vital components for the green economy come from China, or are processed through China, you realize the vast majority of polysilicon for solar panels comes from China, minerals needed for a ramping up of a vast global EV rollout. This is pretty interesting. I kind of went down a rabbit hole the other day because Southern Company launched—this has been a long time in coming—this summer the first nuclear power plant to enter the market in 20 or 30 years here in the US, in the state of Georgia. It’s an 1100 megawatt power plant. There’s another one coming on later in the year, also in Georgia. 

The rabbit hole I went down was how many acres of solar panels would it take to duplicate this nuclear power plant? It was way over budget, granted. I think this is the last water-cooled nuclear plant we’ll ever see built. That does not mean that small nuclear reactors won’t be built. You’ve got Buffet and Bill Gates who’ve privately funded the company that’s building these small nuclear reactors. So that’s in motion, very well connected, going to happen. What we see in Georgia, probably the last of its kind, but not the end of the nuclear story. 

Anyways, 1100 megawatts translates into 6,251 acres of solar panels. They last roughly 25 to 30 years, then they become less effective with time. Now, what goes into producing one megawatt of power in solar? 70 tons of glass, 56 tons of steel, 46 tons of concrete, 19 tons of aluminum, seven tons of silicon, seven tons of copper, six tons of plastic. That’s for one megawatt.

Kevin: That’s one megawatt, versus 1100 megawatts for the nuclear reactor.

David: Correct. I guess what I’m getting at is, whether it’s polysilicon for solar panels, minerals needed for a ramping up of the global EV rollout, re-militarization, and increased government spending on natural resource stockpiles in advance of conflict, there is an increasing probability of global trade encountering a dynamic that creates more division of interests, more questions of loyalty, less free trade and cooperation. This is deglobalization writ large. That spells, very simply, significant upside impact to inflation. 

Here we have the decisions that people are making, and both from a local energy policy standpoint to a geopolitical engagement, as the Chinese economy lingers in what Foreign Affairs magazine diagnoses as an economic long-Covid, they are moving into a place of greater desperation, which I think frankly makes their action list more predictable. Not necessarily predictable on a timeframe, but it’s like a cornered cat. What happens next? You’re probably going to get scratched.

Kevin: Remember the old saying; how do you come out of a depression? Go to war.

David: Yeah. This is a really important article to get your hands on. Foreign Affairs magazine, this diagnosis of economic long-Covid and the interventionist and autocratic tendencies which become more pronounced as a result. I highly recommend the article. It’s by Adam Posen. It’s titled “The End of China’s Economic Miracle.” It’s in the August issue of Foreign Affairs. Posen tracks a pattern of development that leads to stagnation, and then ultimately increased levels of control over day-to-day commerce within most autocratic regimes. China’s economic long-Covid predates the Wuhan lab and it predates the global pandemic. Posen points to a shift between the timeframe, let’s say 2013 to 2015, as Xi Jinping is moving away from the multi-decade long commitment to no politics, no problems.

Kevin: Where the government doesn’t get involved in the economy.

David: Exactly. Deng Xiaoping was really changing the mode of operation, and from then forward, business was allowed to flourish and the state kept a healthy distance from commerce and trade, and now we’re moving to this new era of arbitrary micromanagement.

Kevin: So you’ve got other countries that have done this in the past. Has it worked?

David: Posen points out that this has happened before. He says that, over varying periods, Hugo Chavez and Nicholas Madura in Venezuela, Recep Erdoğan in Turkey, Victor Orbán in Hungary, and Vladimir Putin in Russia—

Kevin: How’s that working out for you?

David: —have all turned down this well-worn road.

Kevin: Right.

David: So Posen goes on to describe why the Chinese economy is stuck, and how the consumer is making decisions. The Chinese consumer is obstinately not engaging in their pre-Covid consumption patterns.

Kevin: They can’t trust their government.

David: That’s what Posen says. When an entrenched autocratic regime violates the no politics, no problem deal, the economic ramifications are pervasive. Faced with uncertainty beyond their control, people try to self-insure. They hold onto their cash, they invest and spend less than they used to, especially on illiquid assets such as automobiles, small business equipment and facilities, and real estate. Their heightened risk aversion and greater precautionary savings act as a drag on growth, rather like what happens in the aftermath of a financial crisis.

Kevin: Well, and this guy’s no slouch. I mean, granted, he’s writing for the Council on Foreign Relations. That’s where Foreign Affairs comes from. But isn’t he with the Peterson Institute?

David: Yeah. Pete Peterson, who is one of the founders of the Blackstone Group, very influential money guy, Wall Street guy. He wrote a book criticizing fiscal largesse a number of years ago and suggesting that we’d be moving towards a debt crisis if we weren’t careful about how we managed our household. This was about the same time that he was launching the Peterson Institute. Posen is now the president of the Peterson Institute for International Economics.

And I think this is an incredibly important article because it underscores what we’ve been saying in recent weeks, that economic growth in the second-largest economy in the world is not getting done the way it used to get done. It’s now dependent on direct governmental spending. Its infrastructure and its trade subsidies—those have been the classic two, the Chinese temptation. And while economic pressures mount, so do domestic political pressures within China, and these I think play into the factors that buttress an imminent conflict between Taipei and Beijing.

Kevin: Right, which is the ultimate fiscal expense. War is the ultimate fiscal expense. I mean, you can build Hoover Dam, you can make Mount Rushmore. Those were fiscal expenses to pull us out of the depression, but war. War really doesn’t. Now, we haven’t really talked much about inflation today. I mean, we’ve hinted at it, but what are we looking at with what you’re talking about? It doesn’t sound like prices of anything are going to drop.

David: We haven’t discussed inflation this week. We’ve got CPI this week, and who knows if we’ll get a better number, worse number. But Morgan, in recent Hard Asset Insights has pointed out the possible competing outcomes of fire and ice, and he’s pointed out we could have two very different outcomes, a debt collapse or the debt doom loop or sort of the inflationary crackup boom. He’s also pointed out that the base effects of the early stage of inflation in 2022 are now setting a course for higher reported rates throughout the rest of 2023. 

And Ed Easterling—he’s been on the program before, fascinating character, written some fantastic books–if you’re interested in market history, some of the best I’ve ever read—but Ed Easterling put out a report charting the same thing. Assuming a 3% annual rate of inflation through year end, you’ve got August, September, November, and December, which should all have CPI surprises on the upside. That is an inflation rate that goes up instead of down as hoped for.

Kevin: So that’ll corner the Fed. They’re going to have to do something.

David: And it’s an outcome which the stock market is ill prepared for. It suggests that where the Fed gets stuck is higher for longer with rates at elevated levels well past 2024. So then the question becomes, if the stock market is ill-prepared for a surprise to the CPI— We’ve talked about some macro considerations which can drive prices higher and energy prices higher, but even just the base effects—just the base effects—have in order an August, September, November, and December surprise on the upside. So it’s conceivable that the bear market, the bear’s crushing down-stroke, may coincide with student loan repayment beginning again in October, where you’ve got 40 million Americans who now have to come up with an extra $500 a month, which is the opposite of the fiscal stimi checks.

Now you’ve got this forced austerity which they haven’t had for years. That hits at about the same time we start having the CPI surprises, and a fragile financial system recalibrates in light of CPI statistics creeping in the wrong direction. Is this conceivable? I think it’s probable.

Kevin: Today, for me, what’s interesting in this show, Dave, when you’re just talking through these things, is we have so many variables and we have so many wrong assumptions. It can be a little bit overwhelming. And I do realize why the central banks worldwide, it doesn’t matter what side they’re on, whether they’re on the Russian sanction side or they’re on the other side, they’re all buying gold right now. That is the one thing you do when you’re uncertain of all the different variables and how they’re going to play out.

David: Just to recap, we’ve got the BRICS meeting and it is significant, but the question is how high is the probability of an eminent impact? And I’d say slim to none, but that does not mean we shouldn’t engage with the variables and the complexity that it introduces to how we see the world and how we see inflation dynamics in the future. So we’ve talked about the BRICS, we’ve talked about some of the oil producers, which are probably the most significant aspect if you’re talking about who’s moving money.

Kevin: Well, we talked about marine diesel. That may be the most important part of the program right there.

David: Yeah. And if you’re talking broadly about the destabilizing effects within the financial markets, I think it’s worth coming back around to this notion of how have you reserved in such an instance? How have you taken risk out of the equation? You can reduce risks, as we talked about with Doug Noland last week, by having a short position on the equities market. You can reduce risk by being in a cash position. Or you can further reduce risk by having your cash denominated in something that has been sound money for thousands of years. The Vaulted program provides that in the form of gold. And a more speculative—or growth oriented—option within the Vaulted program now is silver, which we just launched this week.

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, and you can call us at 800-525-9556.

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

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