Podcast: Play in new window
- Equities To GDP (Buffet Index) Screams Overvalued at 168%
- RMB + Yen Needed “Rescue” From Disaster Last Week
- Bubbling Over: Will Everything Bubble Ever Pop?
Currency markets were particularly interesting last week. The two that stood out, the yen and the RMB, the Chinese currency. We reached levels last week that required intervention in both markets by the Japanese monetary authorities and the Chinese, respectively, and nothing happened. We were up to the line. This is when you’re peering into an abyss, and you think, “Boy, we really shouldn’t cross this line.” We were on that line last week. Now, nothing happened, but it’s what nearly happened that we have to keep our eyes on. –David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
Relationships are so important, Dave. I’m talking to you now. I know that you’re down in Florida at a meeting with CEOs, and you had a meeting this morning, I think, with a pastor from Chicago that was talking just how important relationship is. Can you elaborate?
David: It’s one thing to be with men and women who are incredibly successful in their public lives. His main point was sometimes that’s not the case in their private lives. Our emphasis as we talk about legacy is we’d like to see a really well developed idea of what that is, how you succeed not just from a financial balance sheet perspective, not just in your investments, but also how you succeed in all of life. Are you continuing to grow and mature intellectually, emotionally, spiritually? This challenge was, your business is probably getting the very best of you, and everyone else is probably getting leftovers.
It was a really intriguing call because he basically said, “You have the opportunity to be just as powerful in a different domain, but you’re going to have to enter other people’s worlds in a different way. You’ve built a world. How and to what degree are you entering the worlds of the people who are in your life who may not be interested in your world?” It was a very compelling message, I think, something that everybody in the room was—shell-shocked wouldn’t be the right word, but certainly in tune with.
Kevin: One of the guests that we had in the past, she wrote a book called Signals. I think about relationship, Dave. A lot of times, relationships are built by how we listen to and look at each other. What are you paying attention to? Are there things happening with the person that you have this relationship with that you’re picking up on that may be displaying a problem, and that can be addressed just by simply intervening in that? One of the things I have always loved about working with your family is that your family has always cared about my family. That’s one of the key elements you have tried not to let happen in your business relationships, and that is to let business be before family. So, I appreciate that.
But Dave, I want to transition to this Signals thought. Do you remember the name of the lady that we interviewed, who wrote the book Signals?
David: Pippa Malmgren.
Kevin: Pippa Malmgren, that’s right. I’ve still got that book at home. But signals, there are key signals. Let’s think about the economy for a moment, because we need to talk about the economy.
David: We made it through almost the entire program last week without discussing economic statistics. I think I can remedy that today.
Kevin: Are you going to talk about— Well, and I’m trying to tie that in because actually, statistics, if they’re put in the right perspective, can be very valuable, or they can be worthless if they’re not.
David: Well, last week was interesting if you focused in on a few key details in the market. Specifically, we had currency gyrations. We had bond market yields. Of course, we had the Fed Z.1 report too, which was confirmation of the current credit cycle dynamics. I think it’s important, particularly the currency gyrations, the bond market yield, and some of the things that came from the Fed Z.1 report. Perhaps these are easy to miss. As I processed what happened and what it means, I was struck by the simple fact, as a market operator working with a team of the market operators, engrossed by the mechanics of the global financial markets, there are details. They’re very intriguing, but which most people would not have noted last week or assumed as super important.
Kevin: Well, and sometimes it’s a specialty issue. Okay, right now, you’re meeting with these CEOs and business owners. They probably are very good at what they do, but they probably also don’t have time, Dave, to watch the same things that you do in the markets.
David: It crossed my mind. I’m at this conference with CEOs and business owners Monday and Tuesday this week, and these are folks that run businesses very well. These are people in many cases that have been successful in starting from nothing, growing through several stages with their enterprises, and are making a great deal of money. Not a dumb crowd by any stretch, but the market details that we focused on internally in some of our discussions this week as a team, if I brought them up in discussion with many of the folks in this crowd, it might be lost on them, because they’re very subtle in nature.
Kevin: Dave, if you sat down and discussed corporate finance with them or operations or marketing, leadership, personnel, they might be able to give you an awful lot of advice. But talk about Z.1 or unemployment figures, trade surpluses, they probably are going to rely on you.
David: You’re right. They wouldn’t skip a beat on any of those. The financial markets have a unique signaling and nuance that even the informed business owner or entrepreneur could easily skip over. Sometimes we refer to economic indicators, things like home sales and small business optimism or trade surpluses, deficits when unemployment’s on the topic U-3, U-6, or we might be discussing financial market indicators like credit default swaps and credit spreads and sovereign bond yields and currency exchange rates. These two areas, economic indicators and financial market indicators, they’re distinct but complimentary datasets.
Kevin: Well, and you actually said them, but most of the time, they’re turned into acronyms like CDSs. So, you almost want to sing a partridge in a pear tree after you hear all these different things. It’s like, “Z.1, CDSs—credit default swaps, ♫and a partridge in a pear tree.♫
David: It reminded me of the importance of explaining not only what the stats are that we review routinely, and what they’re doing, but also the relevance as to why they matter, and how they fit into a bigger picture. Portfolio management entails significant quantities of data, and that data is constantly changing. So, the usual conversation of data being released or updated or revised, sometimes it’s revised higher. Sometimes it’s revised lower. It may seem to the casual observer quite boring, just minutiae, but it’s in the nuance that reading the market’s behavior occurs. Imagine the psychiatrist observing a patient, noting what is said and not said, trying to discern reality from any cues that are given, behavioral cues, tics and tells, which speak loudly, particularly to a trained eye.
I was reminded of the importance of our team dynamic and the process of reviewing these market tics and tells, nothing too dramatic, but everything in a composite picture is important in piecing together the truth. Markets are an expression of human behavior. They’re an expression of human bias and belief. If we started with price action, that’s perhaps the most obvious starting point for market observation, but there’s other data points that add to clarity about the present reality in a significant way. I’ll try to connect some of the dots a little today, and expand on a few of the details which spoke loudly to us as operators in the last little short stretch of time.
Kevin: I just heard a talk from a guy who does very interesting operations back in countries that are quite dangerous, for the CIA. He talks about when he puts a team together, he realizes that each person in that team is going to have a very specific specialty, but they’re also going to have a specific frame of reference so that they can actually do something that maybe the other team members couldn’t do. What he said was this, he said, “When a team is working well together, you’re going to have one that’s dominant for a short period of time, and then that dominance no longer works, and you have to be able to quickly shift to someone else.”
I think about your team, Morgan, Lewis, and Doug, and Robert, and Ted. You look at this, and Dave, yourself, as you guys discuss those things, I’m sure you rely on that same team dynamic.
David: I go back to a book that I read as a part of the program in Edinburgh, Scotland, where we looked at the history of financial markets. One of those books dealt specifically with how much credit is in the system. Asset prices are driven by either there being too much credit or not enough, and there’s never really a static point or a balanced point in the credit markets. There is either too much or too little. So, we look at certain indicators, and it gives us these inputs that we need. Part of our framework is credit. The Fed released its Z.1 report, and it does this on a quarter by quarter basis. It includes data on transactions and levels of financial assets and liabilities by sector in looking at specific financial instruments.
So, you get the full balance sheet including net worth for households and for nonprofit organizations and for non-financial corporate businesses and for financial corporate businesses, along with a decent snapshot of governmental finance as well. The Q2 report was released last week on the eighth, and gave several intriguing data points to consider. The report does not provide conclusions or recommendations. That’s where we have to look at it and say, “What does this mean?” The meaning of the report, that’s subject to interpretation, and therefore is ideally understood in a context of how it has changed through time.
It’s particularly helpful if we’re able to say, “Okay, here’s what the numbers are today. What were they in the past? How does this compare?” So, I’ll look at Richard Duncan’s analysis, and review what his thoughts are on Z.1 occasionally. I also have the privilege of interacting with Doug Noland, who reviews the Z.1 every quarter. This plays into our thesis of market stages and bubble dynamics. There are some significant insights that come from the Z.1, because it gives you some historical perspective. So, last week’s Credit Bubble Bulletin gives you a broad summary of the highlights. I want to focus in on just a few of those highlights, and if you want more, then you just go to mcalvany.com and read the weekly Credit Bubble Bulletin.
Kevin: Okay. So, what I’d like to do, Dave, because most of us don’t read the Z.1 report every quarter, I’d like you to explain—
David: That’s for a good reason.
Kevin: Yeah. Well, just if you would, this is a little bit like I’ve been to many restaurants with you where you will ask what are some of the ingredients in whatever we’ve just been served. I’m going to ask you the same thing. Okay? What are the ingredients of the Z.1 report for the person who doesn’t read it every quarter?
David: The economy is driven by three main things. It’s how individuals spend money, it’s how corporations spend money, and it’s how the government spends money. So, that’s what drives economic activity, those three segments. And then there’s also three separate balance sheets. There’s the household balance sheet, there’s the corporate balance sheet, and there’s the governmental balance sheet. And you get a picture on all of that in the Z.1. The report is fairly exhaustive on the state of households, corporations, and government. That covers most of, again, economic activity and the domestic changes in balance sheet status. I think that’s the best way of seeing the Z.1.
One way of interpreting the numbers would be this way. In all three categories, there are astounding numbers right now, nothing short of impressive, but if you look at it through a slightly different lens, rather than seeing perfection, you could also see excess. Just to illustrate this, non-financial debt increased at a 6.34% rate in Q2. Okay, well, that’s up from 3.78% in Q1. We’re now at a record. We’re far above the previous peak, which was 228% of non-financial debt to GDP. That was in the fourth quarter of 2007. And again, for perspective, we were at 186% in the cycle before that, the first quarter of 2000. So, now we’re at 266%. Reflect on that. 228 was the last bubble peak. 186 prior to that. Now it’s 266. That’s how it’s changed through time.
Now, I think it’s particularly helpful to look at both the nominal figures and the relative figures. I like the debt numbers relative to GDP even more than the nominal figures because they allow for a better comparison across time.
Kevin: Well, and the GDP is so important because that’s what we would consider our income, basically, the production and income of a household, GDP, that’s how we measure it for a country.
David: Yeah. So, financial sector borrowing, we talked about non-financial debt being up 6% or more than that. Financial sector borrowing was nearly the opposite, -6.36%.
Kevin: So, that’s the financial sector. How about the government?
David: And this is the big kahuna, really no surprise. Government debt expansion led the charge. It increased at a 12.67% pace. This is the fastest pace of government debt growth since we had the pandemic splurge back in 2020.
So, in the second quarter, household debt expansion increased at a pretty low level. Corporate borrowing was still positive, 2%, but down from 5% in the first quarter. Total system credit was higher by $795 billion. It takes us to just over 96 trillion, nearly double the levels of 2008. And history would suggest that’s problematic. There’s just a lot of debt in our system, and frankly, it’s higher levels of debt. And as we’ve said in previous weeks, we are also having higher debt servicing costs on those higher levels of debt because interest rates are higher.
Kevin: Well, one of the challenges when we’re dealing with these things is to say, “Okay, what do we compare this to?” Because we’re just human beings. The only way we can really understand something is how it relates to something else. We were talking about relationship, one of the masters of seeing relationship is this man named Warren Buffett. And Warren Buffett pays very close attention to various relationships relative to GDP.
David: Yeah. This has become more popular. Forbes magazine wrote about this back in 2002 in an interview with Buffett, and it’s what has become known as the Buffett Indicator. And it was his way in 2002 of saying, “I think stocks are still a little pricey.” Maybe it was 2001 that the Forbes article ran.
But comparing the Dow, for instance, in 1929, it was 381 points. Compare that to the Dow in its most recent peak, 2022, 36,952 points. So, if you look at those two numbers, 381 versus 36,592, what does it tell you? But if you look at the index versus GDP, it gives you a truer picture. And that’s where Buffett’s market cap-to-GDP, which is the Buffett Indicator, accounts for all of equities, not just one index like the Dow, but all equities. The ratio is in bubble territory. Right?
And I think this helps us explain why the actions taken by Berkshire Hathaway and Buffett’s management team have been what they’ve been in recent months. We’re now in a three quarter streak of selling stocks and raising on a net basis $33 billion in cash from those equity liquidations. Sure, they’ve been buying some stocks, but if you look at the buys versus the sells, over the last nine months 33 billion in cash raised, 33 billion of equity liquidated, right?
Buy when others are selling and sell when others are buying. Right? This is very consistent with Buffett’s approach to value. Buffett liquidations are consistent with this theme of the market being overvalued. So, digressing a little bit. In the year 2000, the ratio of corporate equities divided by nominal GDP, again, the Buffett ratio, it was at 160%. That’s in the year 2000. In 2007, it was 120%. It’s currently at 168.5%, right? So, we’ve already rung the bell. The bell ringing occurred at 210% in late 2021, early 2022. And this cycle to take the number down to between 60 and 70%. So, we’re talking a pretty significant haircut from the 168.5 that we have today.
Kevin: And so often we’ve talked about how you have to be willing to feel a little bit too early and a little bit like an idiot when everybody’s out making money. If you feel something is overvalued, it doesn’t make sense to go buy it. But oftentimes we’re tempted to do that because it’s like, “Well, all right, it’s been overvalued for a long time, maybe it’s going to be even more overvalued and I can make a little bit of money.” How do we know when something’s overvalued and how do we have the discipline to actually exercise that knowledge?
David: Yeah. And again, this is really difficult because we’re interpreting numbers that on the face of it are very impressive. Very impressive. If you look at real estate as an example, if I bought a house for $500,000 14 years ago at the market low, so 2009, and could sell it today for 1,200,000, I’d be happy with the result. They’re good numbers. They’re not bad numbers. How can you be negative about real estate when you’re looking at such impressive numbers?
So, on the one hand, one could argue that the growth in that house of 10% a year from then to now is fantastic. I think a sober-minded investor would say, “Yes, but that 10% annual growth from then to now is also well above the historical averages.” So, the current price would actually be excellent for the seller and not necessarily the ideal starting point or cost basis for the buyer. Is it overpriced? Yeah, you can make that case. And I think the same is true for equities, you can make that case today.
Kevin: Well, and as you factor in, assets have grown as well. So it’s not just the value of things, it’s actually how much we have in our households. Not everybody listening is going to say that that’s happening. But overall, the way they measure it, how much have assets grown just over the last few years?
David: Yeah. Again, we go back to the Z.1. Household assets were up 13.4% on an annualized basis in the last quarter. That’s to an all-time high of $174 trillion, right? So that’s household assets. The 2009 level was 73 trillion, just for perspective on where this bull run began. That’s $101 trillion increase. And of course you’re getting some of that from real estate and some of that from stocks and bonds. The previous peak in assets, this is prior to the global financial crisis, was just over 85 trillion. So from peak to peak, we’re talking about a double. Assets have doubled.
Kevin: Well, and that sounds awfully good, but any controller of a corporation or a banker or an accountant, they’re going to say, “Yeah, but tell me about the liabilities.”
David: And that’s intriguing of course, too. Liabilities increased 170 billion. This is specifically speaking of households, 170 billion in the most recent quarter. They’re also at an all-time high, $20.138 trillion.
Kevin: Wow.
David: So, just over $20 trillion. So, you take those two. Net worth is assets minus liabilities. They’ve inflated by $5.5 trillion in the last quarter. So net worth alongside assets is at a new record of $154 trillion. And did I say Buffett was selling more than he was buying over the last nine months?
Kevin: Sure. Yeah.
David: It raises the question, are you the lucky bag holder? Who gets caught holding the bag? If assets have increased a $100 trillion off the 2009 lows, is it inconceivable to see half of that given back in the next recession? I would actually guess that it’s as much as two thirds given back, closer to 60, $70 trillion lost in the next recession.
Residential real estate will be under pressure at some point with higher interest rates and higher unemployment. And I think that employment piece is what brings that demand and supply back into balance, but that’s been the anchor for household net worth. And of course, we’re just a stone’s throw away from all-time highs in the stock market.
But you can look at other valuation metrics as well. The Q ratio is something that we’ve talked about before. It’s at two standard deviations above the mean, and that number has never been three standard deviations. So, we’re in that bubble territory on the Q ratio metric. The Shiller PE, which is the 10-year rolling average of price/earnings, it’s also at a two standard deviation above the mean, and it has actually seen three. It’s been three standard deviations above the mean back in 2000 and back in 2022. Most recently in this last quarter, it did tick higher. And one thing to keep in mind when you’re looking at earnings and the price of the company is you could have sort of stubborn pricing and earnings begin to fade off, and all of a sudden you’ve got a blowout, just like you did in 2000 where we could actually see these numbers take out the 2000 peak later this year.
Kevin: So just to repeat, I’m thinking I’m saying this right, back to you, Dave, the Z.1 report is basically saying the everything bubble never popped. The everything bubble has just gotten bigger.
David: That’s right, the everything bubble has only gotten bigger. I suppose if you wanted to pick on a particular asset class that has not gotten back to or near its all time highs, now you’re talking about the cryptocurrencies, whether it’s Bitcoin or Ethereum or name all the ones that are in that list of, what, 1,200 different cryptocurrencies. The two final pieces from the Z.1 that I think are really important, one is total securities. This is debt as well as equities. That’s now at 127.9 trillion.
Kevin: Is that an all-time high?
David: It is, yeah. It’s an all-time high. It’s $31 trillion increase in less than four years, $31 trillion in increased value in both the equity and debt markets. If you want to look at it, again, compared to the economy, GDP, we’re 482% as of the most recent reading, 387% was the peak in 2007. We were 368% in 2000. So just, again, wrap your mind around this, 482% today, 387 and 368 at previous peaks. And so, now the second part of the Z.1 that I want to touch on is the hullabaloo about dollar dethroning and liquidation of US dollar assets as the rest of the world protests US dollar hegemony. That’s not what the capital flow statistics confirm. US dollar holdings in the rest of the world category in the Z.1 report, they jumped $2.154 trillion to over 45, almost $46 trillion. It’s running at a 19.8% annualized rate.
So this concept, this fear of the BRICS meeting in South Africa, the dollar’s irrelevance, well, it’s just not in the numbers, at least not today, and you could see it flow into particular areas. Equities and mutual funds had inflows from overseas of 1.13 trillion, that was the infusion into equities and mutual funds. Foreign direct investment, this could be private investments, this could be private enterprises, it could be private equity, 1.056 trillion. Debt securities, a little bit more modest, inflows of 114 billion, but again, this notion that we are being neglected or people are moving out of dollar assets, in total, the rest of the world holdings of US dollars have increased by almost 40% in the last three and a quarter years, 39.7% in the last three and a quarter years. Now tomorrow, all that money could hit the exits, but today you have to say that appetite for US dollars is still real and is still growing.
Kevin: And isn’t that the challenge for all of us? A lot of times we can see trends. It’s like here in Durango, we can hear that train, Dave, 12 to 15 miles up the valley, coming, and it will inevitably reach the station. It happens three times a day. It leaves the station three times a day, reaches the station three times a day, but when you’re managing money, you can hear that train whistle for an awful long time, but a lot of cars are passing over each one of those train crossings while they’re waiting and you have to be careful when you look too far ahead. I remember I was talking to my son and he went back and watched some of your dad’s videos and listened to some of his tapes back from the 1980s and early 1990s, and he said, “You know, dad, Don McAlvany was right about so many things,” but see, he was early.
He was early. You couldn’t have made a lot of the decisions based on what Don saw coming at that time, and you’re saying the same thing about the dollar. We get calls all the time about, “Oh my gosh, have you heard about September 23rd, the dollar’s going to collapse, or have you heard—” Give it a date, and I’ve heard those dates since 1987 when I started, and it hasn’t happened. You can’t predict a date on something like that, but you can hear the train whistle. I mean, yeah, down the road the dollar may actually leave the station or the BRICS may arrive, however you want to look at it, but for right now— And this is why the Z.1 report, it’s a snapshot, isn’t it?
David: Well, and I also say this, it’s important to gain another frame of reference. If you price assets in gold, you begin to see how those assets are changing according to something that is solid versus fiat currencies. When you’re measuring value in fiat currencies, each of these fiat currencies is strong or weak relative to each other. Earlier I said that currency markets were particularly interesting last week. The two that stood out, looking back to last week and actually into this week as well, the yen and the RMB, the Chinese currency. We reached levels last week that required intervention in both markets by the Japanese monetary authorities and the Chinese, respectively, and nothing happened.
Kevin: They both had to jump in, huh?
David: They did. We were up to the line. This is when you’re peering into an abyss and you think, “Boy, we really shouldn’t cross this line.” We were on that line last week. We reached levels last seen that required intervention in both markets and last seen like 16 years ago in the case of the RMB, 1990 in the case of the yen. Now nothing happened, but it’s what nearly happened that we have to keep our eyes on. The yen was breaking down alongside the RMB, and both reached levels that could lead to a cascade lower, so verbal intervention, threats from the PBOC literally saying, “If you’re speculating against our currency, we’ll find you.” It’s really fascinating. That supported markets at those critical levels. Speculators know where the line in the sand is, and will, I think in the future months, press and breach the line.
The yen at 147.83 last Friday and the RMB at 7.34 were in danger territory—again, the RMB’s 16-year low versus the dollar. On the verbal interventions this week, they’ve recovered some ground and the US dollar has given up a bit of ground, which relieves some pressure in other places because as the dollar gets stronger, it has a negative impact on the emerging markets. That’s what we began to see is the dollar is marching higher and these two key currencies are weakening. The increase in the value of the dollar is exerting this vice-like grip on the emerging markets. Emerging market currencies were under extreme pressure last week, and frankly, if you look at their exchange rates, that’s one thing, but we also had an increase in government bond yields in the emerging markets last week as well.
So, if the yen or the RMB break down from here, the US dollar reciprocally would rally higher, that dollar rally would be the kiss of death for the emerging markets. There’s a lot at stake in the next few weeks, and we’ve said this in past weeks, but last week we were up to the line. Watch the RMB, watch the yen for clues on macroeconomic shifts. Macroeconomic shifts that unwind the leverage which is in the financial markets. The yen’s levels, again, it’s kind of astounding. You just don’t get here every day. These are levels we haven’t seen the yen at since 1990.
Kevin: Think of a bunch of guys jumping out of an airplane and somebody is falling faster than somebody else. That’s a little bit like the fiat currencies. When you talk about a dollar rally, what we’re really talking about, you know those shots where you have these guys skydiving and somebody’s got a camera on their helmet and you can see some falling a little quicker and some spread their arms out, and that’s really what fiat currency is because when you talk about a dollar rally, you’re not talking about grandma going to be able to buy more bread with her dollar. That’s not a dollar rally in buying power.
David: Oh, that’s right.
Kevin: Everybody’s falling in buying power. It’s just who’s falling quickest.
David: I know, and this is a reminder to many of our listeners, but in a fiat money system, one currency’s weakness is another currency’s strength.
Kevin: Right.
David: Everything is a relative value. There’s no absolutes that are being measured. So, while we can make a great case for long-term dollar weakness, I am on board with that. In the present moment, it is yen and RMB weakness that defines US dollar strength.
Kevin: And so, gold is the airplane that’s not dropping, everybody jumps out. How is gold looking relative to the RMB and the yen?
David: You look at the yen, we passed a monumental level last week. Gold in yen terms, 10,000 yen per gram. In ounces, it’s over 282,500 yen per ounce. It’s a new all time high.
Kevin: Wow.
David: It really is fascinating, when you travel the world, you begin to see things that you wouldn’t see if you were sitting at home, and this is one of those things. Gold in yen terms is breaking out to new all time highs. No surprise, Japanese gold retailers can hardly keep up with the demand. The yen is under pressure, Japanese inflation is on the rise. The Japanese retail investor, in spite of record levels, wants to own more ounces. If you merely looked at this through a sociological lens, you would say that trust in the Bank of Japan is dying. That’s really what you’re seeing in this movement of people out of yen into gold. Trust in the Bank of Japan is dying. That’s what you really have from a sociological perspective when you consider gold prices moving in a particular currency. Insurance demand, if I think of gold, I often think of it as an insurance policy, financial insurance if you will. Insurance demand and the cost to insure against a financial debacle or a monetary mishap is quickly accelerating.
Kevin: And this is another reason why I think it’s good to talk about— Even though this is a lot of statistics, it’s good to look at these types of things as a snapshot in time to say, “What is really happening?” It keeps you objective. Because sometimes, when you’re talking about China, somebody might think, “Oh, you’re just China-bashing.” Or Japan, “You’re just Japan-bashing,” or what have you. But the truth of the matter is the statistics. Yes, you can lie with statistics, but the statistics don’t lie if you’re actually looking at them in relation to the right things.
David: Yeah, some comments last week questioning my motives for criticizing China. I’m pointing out statistics. Certainly, you can make the case that there is a narrative that I am adopting around those statistics. But there is something intriguing to say about statistics that say, for instance, the Chinese government is no longer willing to publish. It’s not a critique. It’s not China-bashing. It’s commentary. You can draw your own conclusions. Why did they stop publishing numbers on youth unemployment? Is it because it’s becoming uncomfortable? Is it telling too much of the story of what is happening inside their economy? Capital flight, this is not me picking on anyone. It’s an observation. Capital flight, like the psychiatrist reading the patient, this is a tell. What’s going on in China? Why does big money want out? I don’t wish to trash the Chinese people or the Chinese government. I have deep respect for both. But you can’t grow a credit market as fast as they have without significant misallocation of capital. And that, too, is a fair point, regardless of the geography.
Last week noted the closure of Norway’s sovereign wealth fund, the office that they had in Shanghai. They’re picking up stakes, they’re moving to Singapore. And you might say, “Well, okay, there’s a rationale for that. There’s a reason for that. Maybe they’re not investing in China as much.” No, they actually said, “We’re not changing our strategy in terms of investing in the mainland.” But you take that, the sovereign wealth fund leaving the mainland and going to Singapore, and the same article noted the significantly reduced footprints of Morgan Stanley and Goldman Sachs in country. And the deteriorating geopolitical climate was noted. This is the reality. We have things changing. This is not me picking sides. This is not me picking a fight. This is not me creating a narrative. This is just observational. Why would a group like Morgan Stanley or Goldman Sachs decide that they don’t want to allocate as much capital in that part of Asia? Maybe it’s because they don’t see the opportunity as it once was in their minds, as it once penciled out. Pro formas have changed.
Kevin: And one of the things that you like to do, Dave, is talk to people who are on the ground in these various places, or have that kind of experience. How many times have we interviewed Stephen Roach?
David: Yeah. Whether it’s Stephen Roach, or Victor Xi, or Minxin Pei, or Michael Pettis. Morgan Stanley’s Asia chief, now he’s at Yale, he’s been a guest on our commentary numerous times, Stephen Roach. Whether it’s in conversation with Stephen Roach, or it’s with reference to Mackinder’s maps and the likelihood of Chinese preeminence in the decades ahead, I have a healthy respect for the Chinese trajectory in the 21st century. I merely want to point out that the path to success is not a straight line. It’s not determined. It cannot be forced by government edict. And it has a variety of significant complications in the present moment, like demography and like debt. So making those observations is critical to understanding the ups and downs in the currency markets, the supply and demand dynamics for crude oil and gold and industrial commodities. And, ultimately, how that affects the periphery-to-core risk-on and risk-off dynamics within the financial markets. These are dynamics we have to be sensitive to because they have implications for every investor, regardless of their exposure to Chinese assets
Kevin: Well, and again, so that’s what this Commentary is about. The Commentary is about looking ahead. You often talk about how the economic moves to the political moves to the geopolitical. Actually, I should have started the financial does because we looked at financial markets as well. So financial to the economic, to the political, to the geopolitical. You have to look down the track using that train analogy, but you also have to look at what today is. And the snapshot for today is not the snapshot for tomorrow. But just navigating that at this point, you have to look at where the pressures are building.
David: We’ve often talked about the perspective triangle on this Commentary. And we look at the basic asset allocation between growth and income oriented investments on one side. And precious metals at the base of the triangle as a ballast insurance type asset. And savings or cash equivalents on the other side of the triangle. And there is another triangle that my dad used to put up in the beginning of every one of his presentations. And I remember this, going back to when I was age six. It too was a perspective triangle. And he talked about the monetary-economic decline, that was on one side of this triangle. And then he talked about the social and political decline on the other side of the triangle. And then he also spoke about the moral and spiritual decline at the base of the triangle.
And these ways of organizing our thinking— I was reminded in today’s comments with these CEOs that what we really need is a corrective, a corrective in each of these areas. When we think of the moral and spiritual decline, in this case, Freddy DeAnda is talking to us about how we can fix what is contributing to the decline in connection within our homes. And just being able to come home each day and flip a switch. What is my job as I walk in the door? I’m the chief servant. And that is who is about to walk in the door. It doesn’t matter if I’m tired today. It’s time to turn on this notion of, I’m here to serve. If you can do well in business, you can do well at home. There has to be a corrective in our approach. Otherwise, what we end up with is that morass of moral and spiritual decline.
But the same is true in terms of social and political decline and monetary and economic decline. For us to fixate on the RMB in the yen today, for us to look at the Z.1 and say, “This is too much debt.” We are talking about there needing to be a corrective of some sort. Will it be forced on the market through some sort of crisis dynamic? Or is it going to be determined by policy? I know, I know that we can effect change at the smallest or the lowest level. This is the bottom-up approach that I like when I think about legacy and what we can do to make a difference. I frankly don’t know, I don’t know what we do with the quantities of debt. 32, it’ll be 50 trillion by the time we get to 2032. This is amazing. These big picture issues, I’m not exactly sure what the corrective is. But at the micro level, I think there’s much that we can do.
So to return to where I started today, currency and bond fluctuations and the Z.1, they were particularly interesting. If nothing blew up last week, we still need to pay attention because pressures are nonetheless building.
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You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.
This has been the McAlvany Weekly commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.
