European Disaster Sets the Tone for Early 2011

Weekly Commentary • Jan 12 2011
European Disaster Sets the Tone for Early 2011
David McAlvany Posted on January 12, 2011

A Look At This Weeks Show:

  • Gold Market: Linear behavior now, exponential behavior later
  • Euro Crisis: Issing’s misgivings and the ECB’s bond market intervention
  • Social Change: Can you adapt and thrive?

The McAlvany Weekly Commentary
January 12, 2011
European Disaster Sets the Tone for Early 2011

Kevin: David, the difference between now and 2008:  Let’s face it, 2008 was a tumultuous year, there was a currency crisis.  But a lot of people right now are starting to wonder if this thing has been solved, or if it has at least been delayed.

David: I think of the marketing and PR campaigns that J.P. Morgan, and Goldman Sachs, and Citi Group, and other institutions have put out there, that we do not have to be concerned about what PIMCO has called the “new normal,” that we are back to the old normal, if you look at the new jobs numbers, 9.8 to 9.4.

Kevin: Hold on, David, just a second.  Explain what you are talking about on those 9.8 to 9.4 numbers.

David: We can look at this in greater depth later in the conversation today, Kevin, but there are these data points that Wall Street Firms are looking to, and heralding as the turn in the market, that, in fact, things are getting better.

What is interesting is if you look beneath the surface you can see that the money is flowing and there is a benefit to Quantitative Easing I and likely to be with Quantitative Easing II.

Kevin: It is amazing what 2 or 3 or 4 trillion will buy.

David: But it stays sort of locked in a certain tier, and this is not meant to be a classist comment, but there is a reason why Tiffany’s and Saks Fifth Avenue are doing quite well.

Kevin: And Louis Vuitton.

David: And Louis Vuitton, as well, but at the same time Wal-Mart and Best Buy and Target are struggling.

Kevin: So, the store for the common man, right now, is still feeling recession, but not the upper crust.

David: Exactly, and as I travel around the country, you get this sense, going to money centers versus any other sort of center, for instance, if you go to Seattle, or if you go to Portland.  These are obviously cities of significant size and importance in the country, but they are not money centers – not San Francisco, not New York, maybe to a lesser degree Chicago, but these are cities where you can still feel and smell recession or depression.  It is interesting, because it really is the same difference as the Tiffany’s, Saks Fifth Avenue, Louis Vuitton set that buys, and buys heavily, in Manhattan, but you do not see as much traffic through those kinds of stores in a place like Portland, Oregon.

Kevin: So, if we think of the haves and the have-nots, the haves right now are the people who are near the money centers, and the have-nots are the ones who are maybe near manufacturing or shipping.

David: Exactly.  There is a growing sense of tension, of discontent, of anger, even, across these social strata, and we will talk a little bit about Europe in a minute, but that is probably one of the most important things to be aware of as an investor, coming into 2011 – the changes in social sentiment, and the changes in the way people are calculating things, not intellectually, but in their emotions and the way they express those emotions, whether it is the polls, the voting booth, or what have you.

Kevin: You and I have talked before about the danger of unmet expectations, when they would like to buy something, but they see that they cannot, they do not have the money in their wallet, maybe they cannot take on any more debt, and they are seeing somebody right next to them, continuing to live the life that they did yesterday.  There is an expectation change and doesn’t that bring resentment and a lot of frustration?

David: I think so.  I think a part of the frustration is in not being able to maintain the same lifestyle that you have known in the past, to continue that on into the present or future, because there are variables that have changed, whether that is access to credit, or whether that is pulling money out of your home as a makeshift ATM.

There are a variety of ways in which we have funded our private largesse, and not to speak of our public largesse, and the borrowing that occurs from the treasury, but this private largesse has been funded by a credit boom.  That credit boom is, in large part, behind us.  Now what are the social ramifications as people have gone through a large part of their savings and have no access anymore to the equity, what little there may be, in their homes?  It requires a recalibration, and with that comes an upset in expectations, as you are mentioning.

Kevin: If you think about it, those expectations came with tomorrow’s money, yesterday.  The way we have lived as a nation for decades now, has really been taking tomorrow’s money, pulling it into today, and actually calling it normal.  There is a point when it has to be paid for.

David: The perfect case in point is what you or I may do every day with a credit card.  We spend money that is not ours, with the intention of paying it back at the end of the month, or in some reasonable time period if you do not pay that off as a regular bill.  But what happens?  You are spending someone else’s money, enjoying the fruits thereof, and sorting out how it gets paid off at some future date.

Kevin: That is something that we are seeing right now coming to real fruition in Europe.

David: It is interesting.  We are going to spend some time today talking about currencies, particularly, talking about gold, and also talking about silver.  Before we do I think it is important to look at some of the shifts that have taken place, even in the last few weeks, in Europe, which are very, very significant.

Kevin: Is it political?  Is it coming down as changed rules in the system, or is it economic?  Is it just a basic vote against the euro, at this point?

David: We like to think in terms of clear categories, and this is a good example of how things overlap when we are talking about economic or financial, political, geopolitical – how they actually do weave in, and are interconnected.  They are not stand-alone categories.

If you look at the elections which happened in Germany this last year, in Westphalia, a group that had been in power there for 20-30 years…

Kevin: That was a shock to Merkel, wasn’t it?

David: It was.  But it happened in conjunction with a support by the European Central Bank of further bailout measures.  The folks in Westphalia basically said, “By the way, we are the ones who are going to end up paying for this.  We don’t like it.  Your participation in this ECB project, we are not happy with, and it is not going to work for us.”

So you begin to see this sort of repartee between political constituency groups and decisions that are being made by central planners, whether it is central bankers or politicians, and their participation in a larger social or political structure.  This is what we see happening in Europe today, and it is in tatters.

What happened this last week is fascinating, because you have the European Central Bank intervening in propping up the debt markets.  They are buying Irish debt, they are buying Greek debt, they are buying Portuguese debt, and they are actually being complemented by purchases by China and Japan.  I do not know what the calculus is behind the Chinese and Japanese purchases except, perhaps, goodwill for the benefit of future trade.  That could be, we will have to see what their reasoning is as it unfolds.

Kevin: David, answer this for me, if you would.  It seems that, so far, with all the European problems, and actually, even here in America, the American problems, the people who actually have given the loans, the people who are the bond-holders, are still intact.  They are still fully paid, even though you have default across the board in a lot of these places.

David: That is exactly why there is pressure in the bond market here in recent weeks in Europe, because there is a proposal – and this may be like the FASB rules, which were proposed in 2008 and never came to fruition, but certainly sent jitters through the banking community, and may have even precipitated a part of the collapse.  These proposals are simply this – that bond-holders participate in losses.  Up to this point, bond-holders have walked away virtually unscathed.  Bond-holders have been able to pass the buck, and the taxpayer has picked up the bill.

Kevin: So it is coming from the masses, and they are paying, basically, for the people who are supposedly taking the risk to loan the money.

David: Exactly.  You know, and I know this, too – stockholders have the most to lose, and the most to gain, in most investment scenarios.  Preferred stockholders have a little bit less risk, and they are compensated a bit more in terms of the income component of that investment, so it is somewhere between, in terms of a balance sheet item, being a fixed income investment, and being an equity investment.

Kevin: But the bondholder is the last guy to lose.

David: He is the last guy to lose, and in this case, has lost little to nothing, while the gap has been filled by the taxpayer.  This is what is considered intolerable by, who other than the taxpayer, and the taxpayer says, “This is all well and good that we want financial stability, and this is all well and good that we want a banking system that can accommodate our needs in terms of checking and savings and things of this nature, but you are changing my life.  You are expecting me to work longer, for less, and I do not even get my 5, 6, 7, 8, 10 weeks of vacation,” whatever it is in Europe.  Guess what?  They are going to the polls and they are voting differently than they have in the past.

Kevin: Do you think it is because they are starting to feel pain?  Here is where I am going with this.  Back in the mid 1990s Americans bailed out Mexico.  79% of the public was against it at the time, yet you still had the usual list of suspects:  Geithner was involved with that, Summers was involved with that, Greenspan was involved with that.  They did it anyway.  But face it, in the mid 1990s, were we really feeling pain?  We may have disagreed, but we were not feeling pain.

David: No, we were not feeling pain, and so there were protests, but it did not really matter.  The question is:  Who is in control anymore?  The world is largely run by financial institutions, in terms of the influence, and the capital flows, whether flows increase or decrease – we are talking about making and breaking situations.  If you looked at the most important people today on the planet, I would say that they are bankers, and I am not saying this from a conspiratorial standpoint, because if you just look at the components within the S&P or the Dow, and at a recent peak, the financials were the largest component part of the total mix.

Whether it is the capital markets, or actual influence in the economy, finance is huge in the developed world.  I think this is where we are beginning to run into conflict, and we have been working through a book by Ian Bremmer which challenges the notion that capitalism has been, and will always be, in control, and actually the rise of the state is more of the issue, present and future tense.

Kevin: So command economy is coming back in, just like what Napier talked about last year.  We are starting to see command economy, which is a form of socialist economy.

David: And if not the extreme of a command economy, you certainly have the state saying, “Hey wait a minute.  We need a little bit more control here, and we are going to be taking the reins from you.”  That is what we have, exactly, with this European proposal.  It is the politicians looking out at the crowd and saying, “Do you hear that sound of discontent?  We were hoping for applause, and instead we are getting booed.  I think we need to change our cue cards, and perhaps address the crowd slightly differently.  What do they need to hear?  What do they want to hear?  What do they need to see in terms of actions which prove that we are for the people and not for the bankers?”

This is the point.  There is a change amongst the state apparatus that says, “We have got to at least posture as if we care about the people and the populace.  So what does that look like?  Okay, here is our proposal.” All of a sudden, what are they forcing the ECB to do?  They are forcing the ECB to intervene in the debt markets because even the suggestion that bondholders should pay a part of the losses does not go over well in the marketplace, and it forces the ECB’s hand.

Kevin: What is the cost of that?  The cost of that is inflation, ultimately, or devaluation of the currency.  If you look at gold, in euros, right now, we have seen a little bit of a discount in dollars with gold, but actually, in euros, aren’t we close to an all-time high?

David: That is right, and just to put in perspective where gold is, and where it is going, whether it is on the upside or downside, it has been virtually unscathed, untouched, uncorrected at all.  In euros it has been a much stronger market than the dollar market, which is very significant.

To put this in context, one of our guests this last year was Otmar Issing, the Chief Economist at the European Central Bank.  He was one of the architects, and spent more years working on the project, and largely in control of the project, an 8-year stretch, which was the longest stretch allowed for any of the ECB participants or bankers.

I want to quote something from this morning’s New York Times.  This is Otmar Issing:  “‘With the failure to make sovereign states’ fiscal policies consistent with the conditions for the single currency area,’ Mr. Otmar Issing wrote in an article to be published this week, ‘policy makers not only have weakened the functioning of monetary union, but have also called into question its very survival.’”

Kevin: This is a man who had more emotional skin in the game, as far as this European Union, than anyone.

David: Our conversation with him this last year was essentially, “We have faith that this will work out.  It has to work out.”  And what you are beginning to see are questions or doubts amongst the faithful, the central bankers even, looking at the ECB, looking at the EMU, and saying, “There really are significant issues here, and I do not know that they are going to be solved.”

Kevin, elsewhere in the report he said, “The present seemingly unstoppable process toward further financial transfers, will generate tensions of an economic, and especially political, kind.  The longer this process is characterized by unsound conduct of individual member countries, the more these tensions will endanger the existence of the EMU.”

Kevin: Which he always knew was the major weakness – the political disagreements – not the financial disagreements, but the political disagreements.

David: And that is specifically what he is getting at – a basic design flaw of the Monetary Union.

Kevin: So, is this currency story more of a currency tragedy?

David: That is the point.  It is not just a tragedy in English – it is a tragedy in German, it is a tragedy in French, it is a tragedy in almost every language around the world, because it is a story that is being told, not only in English, but in every country around the globe. It is not just the Fed, it is not just the ECB – it is the educational patterns which are consistent globally, which have our central bankers, globally, thinking and acting in lock-step.

Kevin: Is this realization of what is going on, especially possibly the breakup of the euro, what would turn gold exponential, versus the linear move that we have experienced up to this point?

David: I think the great concern, by central bankers, and bankers, and financial gurus around the world, is simply this:  We do not know what the consequences would be of the dominos falling in the banking community.  We tasted just a bit of that in 2008.  What was essentially a market for insurance, where you could say, I do not want to lose in this particular investment so I am going to buy a credit default swap on that particular asset and cover my downside, essentially going neutral in the market, has become a gambit for speculation, and has become a casino, without rules.

And it is all based on a single written document.  These are contracts that are written, and in order to see who pays, and to see who the counter-parties are, and to enforce them, is done, not by the marketplace in nanoseconds the way that most assets are handled, but in courtrooms, over months or years.  The idea that we could have the financial markets embroiled and entangled in uncertainty, with no end in site, leaves a very bitter taste in most bankers’ mouths.  What do they do instead?  They would say, “We defend the market.”

Kevin: We have talked about no transparency in the past, but part of that transparency would come from standardization.  We have had guests on that talk about that.  There is no real standardization to those insurance contracts, is there?

David: No there is not, and it has been proposed, in Senate hearings.  Another guest on the program in recent years, Richard Bookstaber, has sat in front of our “best and brightest” in Washington, and they have listened to him.  He said, “I was there, I have seen it, I have done it.  Here is what you need.  You need standardization.  You need exchange-traded credit default swaps, and CDOs, and CLOs.”

If it is going to be a derivative, you have to bring it out of opacity, and into the light.  People have to see what it is, know what it is, and know how to value it, on a minute-by-minute basis.  This is the biggest issue – we do not know what we have got, and that is really what people do not want to know, they cannot know, because of the potential unintended consequences, into the financial and banking communities.

Kevin: It could literally crash the market just as soon as the realization came about, so it is a double-edged sword.  If we really knew what these things were insuring and how they would pay, it may very well just put the light on the fact that this whole thing is bankrupt.

David: Which was the point of the FASB rules a few years ago – 161, and I think it was 158 or 168, I do not remember now – those rules were intended to bring transparency to bank balance sheets, which, in theory is a great idea.  At least we know what is sitting there, and banks cannot play the same kinds of games that Enron did, for instance, with their off-balance sheet entities sitting down in the Caymans.  But listen!  That would be tragic.

Kevin: It would be like asking Medusa to take her makeup off.  It would be like, “Oh, my gosh, this is worse than I thought.” (laughter)

David: (laughter) Yes, I think that is the issue in Europe, the reason why there is a penchant to bailout.  Let me go back to one thing, because it is not like this proposal for bondholders sharing and participating in losses will actually happen.  It is a proposal.  If it is implemented, it is not until 2012 that it becomes live.  These are things that are talked about and send jitters through the marketplace, but the reality is, they will defend the markets at any cost, and because of the European, the U.S., the global bias, toward opacity, and not transparency, guess what we have over the next 2-3-4 years?  Inflation!  Inflation, because they will print money to make the problem go away, to cover over the fact that there are real structural and economic issues.

This is what brings us to the point in conversation where we say, “Is it different than 2008 and 2009?  Have we entered into recovery?  When we look at statistics that are now flowing to us that imply that things are getting better, are they, in fact, getting better, or do we need to dig a little deeper?

Kevin: Let’s look at retail sales then.  If you are going to talk about if things are getting better, we saw that retail sales improved this last quarter.

David: The biggest component of growth in the retail sales figure was gas stations, and as we pointed out a few weeks ago, that is not the purchase of Snickers bars on the increase, that is not the purchase of Kit Kat bars and Pepsi.

Kevin: That is the cost of a necessity.  That is not the cost of some sort of luxury.

David: People are spending more on gasoline because the price is going up, and they are forced to spend more out of their budget.  Are retail sales returning to their normal levels because the consumer is coming back en force, because he has newfound confidence in the economy?

Kevin: Or are they just paying more for gas?

David: Are they just paying more for gas?

Kevin: How does that affect corporate profits?  It is not just the individual that has to buy gas – corporations do, too, to make their widgets.

David: Alcoa is a great case in point.  They are one of the first to issue quarterly earnings, and this year they came out with a better than expected number.  That is great – 21 cents per share is roughly where they came in, on 5-6 billion dollars in revenues.  The interesting thing is that their revenues were virtually the same a few years ago, 5-6 billion per quarter.  But guess what was better?  Their earnings per share were 35-36 cents, instead of 21 cents.

Kevin: What brought about the difference?

David: What is bringing about the difference is the rise in commodity costs.  Their input costs are on the rise, and their margins are getting squeezed, their profitability is getting squeezed, their earnings per share are getting squeezed, and yet, they can still run numbers so that Wall Street shills say, “This is impressive.  We are glad that Alcoa is back to normal.”

21 cents will never be 36 cents.  No matter how you slice and dice it, that is obtuse math.  You cannot think that things are getting better at Alcoa.  Things were much better a few years ago, and they have not returned to what people consider to be a stable footing.

Kevin: Alcoa is at least still making a profit.  We just heard a story this morning about a poultry business that had not factored in the cost of corn, and actually, even though they would have been a profitable business, the inflation on the corn prices actually put them out of business.

David: And they sold for pennies on the dollar.  This is a huge poultry company, and this is what happens in the context of inflation being created, monetization occurring, there being a flow of capital from the central bank, into the financial system, and it is going to go where it wants to.  Liquidity can be created, but it cannot be directed, so where do we see it?  We do see it show up in stocks.  Where do we see it?  We do see it show up in commodity prices.  Where do we see it?  We do see it in bankers’ bonuses.  Certainly, December was a good period of time if you were a Goldman-Sachs employee.

Kevin: It is like you said before, “There is no recession for the banker.”

David: The new normal is the old normal at Goldman.  “Thank you very much, another great year.”

Kevin: David, I am going to narrow our focus, since we are talking about commodities, let’s focus on silver for just a little bit, because silver is a metal that has just all of a sudden come alive.  What are your thoughts right now about silver?

David: It gets a little bit of both plays, in terms of a gold alternative, as a crisis metal, or an insurance item to own, but it also, in this environment, where the general public is assuming a return to vibrancy in the economy, they also say, “Hey, but it has the industrial component.”  If we are not in a deflationary recession, then maybe silver has some upside that gold does not.  In fact, we have seen a contraction over the last 3-4 months in the gold-silver ratio, a very short period of time, from 65 to 47.

Kevin: In other words, 65 ounces of silver for 1 ounce of gold, down to 47 ounces of silver.

David: Yes, on a relative basis, silver has far outperformed gold.  I think a part of it is that, on a performance hype, yes, it will come alongside a recovering economy, as an industrial metal.

Again, that is just one opinion, in one snapshot.  I think there are better reasons to own it, and long-term, a much more fundamental character to it.  I would not own it on the basis of an economic recovery, but it certainly is getting a tremendous amount of play here in the last 90 days.

UCUBS, who, even in September, said this:  “Price strength is not on firm ground.”  They said this, further:  “We expect industrial demand to show some weakness and advise investors to avoid the metal.”  That was in September.  So after a major move, again, we are talking 90 days, and a major correction to the upside, UBS has this to say:  “Silver prices remain well-supported, and have been able to trade repeatedly above $30 an ounce.”  Then they said, further, in one of their recent reports:  “Temporarily, prices could even hit $35 an ounce on physical interest in the metal due to firm economic activity.  The bottom line:  Investors should make use of silver volatility for yield-enhancement strategies.  At levels close to $25 an ounce we will be willing to pick up the metal.”  How do you go from trading at $17.50, saying I’m negative, to above $30, saying I’m positive?  This is classic, classic, Wall Street maneuvering.

Kevin: It reminds me of financial news on T.V.  These guys do not have a memory for what they said the hour before.  If the stock market is up, they told you so.  If the stock market is down, they told you so.

David: Right, and whatever they said can be reinterpreted to mean the exact opposite.  Just give them 30 seconds, and an opportunity to explore rhetorically what exactly they meant.

I think the bottom line of what we see developing in the commodities complex, but specifically, with gold and silver, is that we have active currency intervention and monetization on a scale that we have never seen, in any one country, let alone multiple countries, where it is being done hand over fist.  If you look at the dollar, if you look at the yen, if you look at the pound, if you look at the euro, you are going to see the best gold price performance in those countries where the central bankers are just going bonkers to try to maintain normalcy.

Kevin: That has, in the past, characterized phase two of a bull market.  Phase one is when it is rising in a single currency, or maybe intermittently, but phase two of a three-phase bull market, is it not rising in all currencies?

David: It is rising in all currencies, but it is still doing so in a linear fashion.  I think if our listeners want to prepare themselves intellectually and emotionally for what the tail end of the bull market looks like, the tail end lasts 3-5 years.  You are talking about a transition from linear moves, two steps forward to one step back, to exponential moves.

Kevin: Where the tail goes straight up.

David: Right, and that is what I think we have yet to see in the bull market in metals.  I had several calls this weekend from folks who are heavily invested in real estate, and they said, “Dave, we are concerned about the utter collapse in the gold market that we have witnessed over the last few days.”  I kind of scratched my head, and thought, “What perspective do they have that has them thinking that this is an utter collapse in the gold market?”  We were at above $1400, and now we have slipped below $1400.  We have given up not more than 5% off a peak.  We have seen a 30% gain in 2010 in gold.  Is this an utter collapse?

I do not know who they are listening to on CNBC, but my guess is we have another 7% downside.  It does not matter if it is 7 or 10, to me, you are still looking at giving up half of the gains that you had in 2010 before you put on that much more by the end of 2011.  This is a normal, linear, two steps forward, one step back.  What follows after the one step back?

Kevin: Yes, rising again.  In fact, it is very, very welcome to the person who understands the market.  They want to see these two steps forward, one step back, because really, when it goes exponential, it goes exponential, and then it craters back down, though it will still come down to a higher than it is now.

I was thinking about it, David, as you were talking.  We have been in the gold business for a long, long time.  I have been here for about 23-24 years, and most of that time, throughout the ’80s and the ’90s, gold just maintained around $300-400.  A 20-dollar move down, or a 15-dollar move down, was nothing when gold was $300.  But now, when you start to see these moves, they sound like a lot more, because it is more dollars, but percentage-wise, it is no different than a 15-dollar drop in gold back in the old days.

David: It is just not a big deal.  It is interesting that we attach more emotion to the dollar figure than we do the percentage figure, but for us in the investment community, that is just not the way you translate it.  A 100-dollar move up or down at these prices is not defining the trend.  The trend is defined by much bigger picture issues, and those things remain firmly intact.  As we have been talking about, the issues in Europe are catastrophic.  These are things that we hoped we would never see, but thought that we might, given how unstructured the political side of the EMU was.

Kevin: This generation has really not gone through an epic paradigm shift, but a collapse of the euro, or a collapse of the European Union, would be epic, and that would be a paradigm shift very similar to a World War I or a World War II.

David: We have also had a number of decades where there has been very little social change.  If you go back to the United States, specifically, you are talking about the 1960s, maybe epitomized by 1968.  What of a dramatic social nature has really changed since the 1960s?

Kevin: Since 1968 really.

David: That is, I think, what we are looking at.  Coming back to what we were talking about earlier – Portugal, just as one example of instability.  We have the presidential election coming up on the 23rd, and that will be very telling.  We have seen credit default swap spreads on Portuguese debt rise significantly, and this is a very pressured and tensioned part of the world.

Kevin: Let me ask you, the guy’s name is Jose Socrates.  Are we going to see some similarities, or some parallels, between Jose and the other Socrates?

David: Well, it is interesting.  You have the presidential election set next to a prime minister who has a little bit more tenure.  But depending on how the presidential election goes on the 23rd of this month, and depending on whether or not the Portuguese need a bailout within the next 30-60 days, Socrates may be forced into his own version of hemlock, which is just to retire – not retire, as in, you’re dead, because he is not corrupting the youth, although we have to ask the question:  There are two reasons why Socrates was forced to drink hemlock in ancient Greece, about  the year 399.  One reason was for corrupting the youth.  The other reason was for refusing to recognize the gods recognized by the state.

Kevin: Boy, that sounds familiar – refusing to recognize the gods recognized by the state.

David: You wonder if there are not parallels to those who are accepted in social society and social circles today.  Who are the gods of the marketplace today?

Kevin: What are the signs of the rising tensions in Portugal?

David: If there is a potential loss in an investment, you would expect people to start insuring against that loss, and one of the ways that you can do that is using derivative contracts called credit default swaps, so what you see is that the cost to insure rises where people begin to perceive that the risk is also on the rise.

Kevin: So that is a good indicator, or a good meter of rising tension?

David: Correct.  The CDS spreads, the percentage above the standard treasury yield, they are on the rise in Portugal, dramatically, in the last week or two.  What does that spell for political decisions that are made?  I am talking about the man-on-the-street going to a voting booth and saying, “We approve, or disapprove, of these austerity measures.  We approve, or disapprove, of the way that you are going to, by force, meet our expectations.”

It is interesting, and this is where, I think, this year, if you look at 2011, and 2012, it is important to even look beyond the political and realize that the social fabric is being torn to pieces in Europe, and in many other places around the world.

So Kevin, just as an exercise, our listeners can tie into the International Herald Tribune, or the Financial Times, and follow that election on the 23rd, and I would encourage you to watch, and in addition to watching, I would encourage you to learn, and to remember what this looks like, because the interplay between the political and the social is very important.

Politics, though not quite as volatile the world over, as perhaps they would be in Spain or Portugal, will look and feel more impassioned anywhere in the world, in the years ahead, and it is not as the left-leaning press would cast it.  People across the political spectrum have very little emotional capacity to deal with financial pressures, and what comes out of that is blame.  That is the common outcome, whether it is from the left, or from the right.

Kevin: David, it is human nature.  Even if you bump your head on something, the first person you look at after that, you don’t like for a minute or two, because it is as if you say, “Doggone it, my head hurts, and you are in front of me!”  So, in this particular case, and we talked about it before, if you have unmet expectations – somebody is going to be a have, somebody is going to be a have-not, and the resentment, when it builds, turns into social tension, and it is caused by extreme differentials.

David: Specifically, wealth differentials, like we were talking about last week – social tensions in the U.S.  On the one hand you have bank balance sheets recovering – earnings, to a certain degree, recovering, in areas, particularly, where the financial system has captured the bailout dollars.  What you have on the other extreme is the marginally employed, or the unemployed, who are having a hard time even buying what they need at Wal-Mart.

Meanwhile, you have the other end of the social caste which is not having a problem buying Louis Vuitton – a 3000-dollar handbag, when everyone else is worrying about how they are going to pay off their credit card bills which are bigger in January because of – what?  Because they wanted to buy Johnnie and Susie Christmas presents.

Kevin: David, I am going to shift gears here again.  Harry Schultz, somebody who has been in the industry for many years, a very prominent voice in the free press, I would say, as far as independent thinking, has retired.  He had some comments on retirement that I think are probably worth sharing with the listeners.

David: He is a fascinating man.  I have known him since I was probably ten years old.  My dad and I would often go and visit him, either in Geneva, or in Monaco where he lived.  Depending on where we were traveling, sometimes he would come up and see us, or we would go down and see him.  I remember sitting in many cafes on busy European streets, having a cup of coffee with him, and listening to the conversations between him and my dad.

Kevin: He really is a permanent tourist, isn’t he?  He used to say, and I think this is true, that he was in the Guinness Book of World Records, as the highest paid per hour consultant ever.  What was it?  $2000, $3000, $5000 an hour, back when that was a lot of money.

David: Oh yes, you would have to go back to the 1960s or 1970s when that record was put in, and yes, a 45-year legacy of writing the Harry Schultz Letter.  I think of him as someone who is conceptually avant-garde.  He was willing to, as a thought leader, not be afraid of putting out his own interpretation of events and it was almost like he built his own Rosetta Stone, and said, “This is what is happening in the world, and no one is going to say it quite like I am going to say it, but there it is.”

Even if it required a change in language – he was the person who coined the phrase stagflation in the 1970s.  There are a number of things that, linguistically, if the concept did not exist, he was willing to bend language to make it happen.  I just wanted to say something about him on the program today, because there are a number of things that we will retain as a company, having benefited from his legacy, in our own tutelage and education.

Kevin: To the credit of Harry Schultz, he was very, very careful who he let inherit that letter, and the Aden sisters, who were guests of ours just a few months ago, are now going to be taking over for that letter.

David: That is right.  It will be good to see him next time we are in Europe.  He is 87 years old, retired, full of vim and vigor, and just wanting to focus on a few other things than writing the letter, with all its deadlines and computer glitches.

I wanted to bring that up for one particular reason.  The question is often asked, and after we did our three-week series on the Q and A from listeners, a number of people still continue to write in and say, “We have thought about spending more time outside the United States.  Is there any one place that we should go?  Any one place that we should spend time?  Even if we wanted to be an ex-patriot living somewhere else in the world, what would that look like, where would that be?”

My answer has always been, and it pointed back to, Harry Schultz.  Being a permanent tourist means that you may have diversified assets outside the United States, but where you live is very secondary.  You can operate in, and live in, and enjoy any part of the world, whether it is South America, Central America, Southern Europe, Eastern Europe, Western Europe, Asia – it really matters less where you are, than what your mindset is.  Harry Schultz, to me, represents more of a mindset than anything else, and a very healthy one – someone who was able to thrive, and still is thriving – not just surviving the tyranny of the urgent, surviving getting old, surviving any of these things which are externalities.  He has just always thrived.

Kevin: He really has, and David, we talked about this just the other day, how some people have a survival mindset, and that is what they are thinking.  How do I survive?  How do I get my next meal?  How do I get my next breath?  How do I support my family?  There is nothing wrong with that, but there is a better way.  There is a thriving mentality which says, yes, conditions have changed, but I am adaptable.  My family is adaptable.  I am going to thrive.

If you think about a person who is a “permanent tourist,” that person is also probably somebody who can adapt very well to changing economic conditions.  This is one of the things that made Harry Schultz so fascinating, in reading him, because he was an adaptor to a situation.  We are losing a lot of these people, unfortunately, to old age, but there are still people alive who remember the Great Depression of the 1930s, and they did not just survive.  Many of them, with very little money, thrived, and look at that as maybe one of the best decades of their life.

David: I think thriving is definitely something that has to be redefined, because in our culture it has to do with how much stuff you have, and what your balance sheet is, and how many vacations you have taken, and where to, and how extravagant they were, and what your bragging rights are with the friends at the country club, if you still have a country club membership.  These are all things that emphasis is placed on.

Kevin: And is my life getting better this year, based on those things, than last year?

David: Right.  But thriving has very little to do with that, because what you are talking about is a mindset.  What you are talking about is a perspective.  I guess that is what I get from Harry Schultz – not specifically that he lived in Monaco, but that it could have been anywhere.  It just happened to be a good place to live – actually, it is a great place to live (laughter).  I can only say that from the vantage point of visiting, but there is a flexibility, as you said, of mindset, which is far more important.

We are in a period in time where we do not have certitude, and certainty, about what outcomes will be, whether that is economic, financial, or political.  And yet, we maintain an attitude and a disposition which is one of deep curiosity, so that our minds are naturally left flexible.  When we quit asking questions on this program, we have walked away from flexibility, and we have walked away from our ability to adapt to whatever circumstances may be in front of us.  I think that is where thriving comes, is in the context of adjusting your expectations, and recognizing that this is it, this is what you have – enjoy it, whatever that is.

I think that is something that can, even though we my grieve some future state of political tyranny, as we have seen in the past, we will see in the future, and it will get better, these things do cycle in and out.  But as things change, to the degree that we remain flexible, and can focus on those things which truly should be priorities – family, friends, community – guess what?  That moves us in the direction of thriving, and not being held captive by our circumstances.

We are not in control of tomorrow.  We are not in control of what happens socially.  We are not in control of what happens politically.  We are not in control of what happens economically and financially.  That is the fight that we see at the Fed – to maintain control of a financial system that has already spun out of control.  The wheels are off, and yet we are trying to posture and pretend, and if we can paper over the problem long enough, perhaps we will enter a period of self-healing, and the economy will be what it once was.

Kevin: But the better thing to do would be to face the reality.

David: And adapt.

Kevin: And Adapt.

David: And adapt.  That is the beauty of a pure capitalism, is that the system, market-driven, will adapt.  Why?  Because that system is driven by the same dynamism that the human soul is driven by, as well.  We have the ability as individuals to thrive under any circumstances, whether it is slavery, or freedom – we can thrive.  We are not held captive by a world of cause and effect and determinism, which means that there is no way out, this is the end, this is what it looks like, when the municipal bonds fail, when this collapses, when this no longer recovers, when Portugal has riots in the streets.

There is a sense in which that has to be stripped away, and you have to look at the individual.  This is what Ludwig von Mises explored in his big, thick book, Human Action, where he is talking about praxeology.  He ties into the ancient Greek concept of praxis – action – and Aristotle’s idea that human flourishing is found in action.  That action – guess what?  Circumstances may change constantly around us, and we still must choose, we still must act, and in that, we find our thriving.

Kevin: And right action actually comes from that curiosity, answering those questions.  That is the wish for our listeners and ourselves – that we may ever stay curious.

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