Honey I Shrunk The Cereal Box – The Cost Of Shrinkflation

Weekly Commentary • Jun 15 2021
Honey I Shrunk The Cereal Box – The Cost Of Shrinkflation
David McAlvany Posted on June 15, 2021
  • Inflation of 5% “seasonally adjusted” down to 2.2%
  • Using 1970s counting methods, inflation is now double digit
  • “No more deposits please”, banks beg people to borrow or spend

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Honey I Shrunk The Cereal Box – The Cost Of Shrinkflation
June 15, 2021

“Taxes are definitely a part of the government intervention because it really is a question of redistribution. If you’re talking about grants, where does that money come from exactly? The government is not the source of wealth. They can capture someone else’s wealth and then shovel it around, reshuffle it, but it reminds me of what Vladimir Lenin said, the way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.”— David McAlvany

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

Years ago, Rick Moranis was in an entertaining movie called Honey, I shrunk The Kids. And I’ve been looking at these inflation numbers, Dave and even though I know my wife is complaining about what we’re paying extra at the grocery store, Jay Powell and these guys, the BLS, the bureau of labor statistics, have been saying, “Oh, no, don’t worry about it.” So I think there should be a new movie, Honey, I Shrunk The Box, because they’re either going to hide inflation by shrinking boxes, or they’re going to— Maybe it’s Honey, I shrunk The Inflation Statistic.

David: Well, we’re surprised when commentators look at the inflation statistics and don’t mention the various changes in measurements that have occurred throughout the years. It’s something like 30 different revisions over the last 20 years. It takes me back to philosophy, as many things often do.

Kevin: Everything takes you to philosophy. That was your major.

David: Well, so you get these various theories of truth, identity theory, correspondence theory, coherence theory, and some of them date back to ancient Greece and Rome, and some of them are more contemporary discussions on how you determine something to be true. We had this red-hot reading on inflation last week. And this is even with the unrealistically low inputs used to craft the numbers, right? So the all items index increased 5% before your seasonal adjustments, which was the largest 12-month increase since August of 2008. And so we’ve got 5% now, it was 5.4% back in August of 2008. To cap or to tame the figure, the BLS bean counters factor in a variety of numbers which bring it on down. Shelter costs and food prices, they increased 2.2%.

Kevin: So honey, I shrunk from 5.4% to 2.2%. Honey, I shrunk the inflation number.

David: Yeah. Medical commodity costs, they have as a declining by 1.9%. I don’t know if anybody’s been to the hospital recently. I’m just wondering what actually did decline in price.

Kevin: Band aids came down. Q-Tips—

David: Maybe.

Kevin: —maybe they shortened the Q-tip just a little bit.

David: That’s right, that’s right.

Kevin: Yeah.

David: A little less cotton. So rent, you’ll be heartened to know that is rent of a primary residence was only up 1.8%.

Kevin: Oh, you should tell my son that. Hey, only 1.8%.

David: Yeah, yeah. And so you end up with a 5% number because all of these smaller numbers get factored in. And again, inflation—counted the way it was counted in the 1970s for an equivalent comparison, reversing a lot of the changes in substitutions which have been brought in—we’ve got double digit inflation this year.

Kevin: Okay.

David: Counted as it was in the ’70s.

Kevin: Okay. So, let me get this right because I remember the ’70s, I remember them well, and the way they fought inflation back in the 1970s, which, it got to be very high, but they made these buttons for everybody that said WIN, big W, big I, big N, and it said, whip inflation now. Now that was Alan Greenspan. Alan Greenspan was with the Treasury back then. And that was Alan Greenspan’s idea, I believe, was to whip inflation now. And what it is is it was just a way of encouraging or persuading people to ignore the fact that things are costing more and please don’t raise prices. That would be unpatriotic.

David: Yeah. So now you’ve got the exclusions and the changes which have been made. And they’ve conveniently allowed for both the headline and the core numbers to be minimized. So we wonder if the federal reserves— When you look at them, they’ve got this sort of self-assured attitude on being able to control inflation. We wonder if it fits the old mold of perception management.

Kevin: Right, whip inflation now.

David: Yeah, statistical chicanery really, rather than true inflation fighting tools. It’s something of a different nature. If you can define a word or shift its meaning, can’t you manage perceptions and thus manage expectations? Perhaps. However, when you encounter economic realities, this is what you encounter day in and day out as you pay the bills, as you engage with the world around you. This is what brings correspondence theory to mind. Correspondence theory. Does a proposition correspond to the fact?

Kevin: Isn’t it funny that there’s even a name for that? I thought that was life. Doesn’t a proposition need to correspond to the facts?

David: Yeah. Well, this is why philosophy sometimes frustrates people because it goes beyond the obvious, right? Sometimes to the absurd. But as consumers, we can clearly say that our direct experience of rising costs is different than that of the BLS bean counter in very significant ways. We could say that the numeric facts in the world around us are consistent with higher readings of inflation. And that if you’re talking about the BLS sausage machine, again, you’re talking about very curious ingredients. What, in fact, they put into that inflation statistic. We’d have to say that even with their creative and curious ingredients, you end up with the highest readings for core CPI since 1992 if you’re looking at month over month numbers, year over year numbers. Again, those numbers, still, as low as they are, as surprisingly high as they were, 5%, nobody wanted that, but again, they don’t correspond with reality. They’re not true. They’re false claims if you’re using that idea of the correspondence theory of truth.

Kevin: Okay. So correspondence theory means that the facts have to match the proposition or the proposition the facts, right? But we live in a day and age where you can identify with something that’s really not correspondent to the fact. And I’m wondering, you were talking about BLS has some curious ingredients. I’m wondering if they’ve got ingredients that possibly identify with falling prices, even though the prices have been rising? I wonder too, Dave, in all seriousness, Social Security, there’s a lot of people on retirement Social Security. And if the BLS continues to lie—oh, I’m sorry, I mean, maybe identify with lower inflation—they don’t have to adjust the cost of living for the people who need it the most, which are the retired.

David: Yeah. Well, again, this is sausage-making. We don’t exactly know what goes in, but we know what comes out and you really don’t want to know what the process is. Now, the BLS provides the fodder necessary for the Fed to fight inflation. And the fight is really one of social reconstruction. There was an author last name of Berger wrote a book called The Social Construction of Reality back in the ’80s. Very important from a philosophical and sociological standpoint. But a social reconstruction of reality, not corresponding with the facts, the fodder postulated is false.

Kevin: So a logician like Bertrand Russell’s going to say, “This is irrelevant. This is not working?”

David: Well. And in fact, Bertrand Russell was an early champion. If you go back to the early teens, he was an early champion of the correspondence theory of truth. But yeah, he would scoff. If you were Ben Bernanke, he might be in more of a celebratory mood.

Kevin: Well, what about Jay Powell, though? That’s the current, what, perception manager?

David: I think he would hold fast to the truth that inflation is rising, but he would frame it as transitory and contextualize it with a 2020 pandemic-based comparison. And this is where they get a lot of latitude, the base effect, they would say, exaggerates the numbers, thus properly understood, in Powell’s view, the concerns over inflation. Although the number is higher, the concerns over inflation are overdone.

Kevin: Now whip inflation, just rearrange the letters, not whip inflation now, but now whip inflation. Yeah.

David: But again, you’re dealing with a social reconstruction. Alternatively, we would suggest that 2020 is not the year to use for contextualizing inflation. Since Powell and the Fed like to dismiss on the basis of base effects, I would suggest we jump on that point. It’s really dangerous, in my opinion, for them to suggest—this is the trans community, the trans inflation community, I’m sorry, the transitory inflation community—to reference base effects because it points to a more relevant timeframe. And again, these are base years even further back in time. And the reality that’s exposed when you look at the long-term impacts on purchasing power, which are largely obscured by month over month changes or year over year comparisons.

Kevin: Well, brought up in the past, okay, we’ve gone through some major changes, not only in our monetary value and how we look at money, look at the last, oh, a little over a century. I mean, 1913, the Federal Reserve Act, actually income taxes came out at the same time. 1933, the devaluation of the dollar and the confiscation of gold. 1944, that was Bretton Woods, right? 1971, they took us off— they broke the Bretton Woods agreement. They took us off the gold standard. What’s happened to the dollar through those years? What if we actually used 1913 as a base, Dave?

David: Yeah. And in fairness, they took us off, ’71, they took us off a quasi gold standard.

Kevin: Right, sure.

David: Which had already been— We don’t want to get into the details, but it had already been shifted in ’22, the conference of Genoa. 1913, 1933, 1944, 1971, very significant dates. And we’d be aghast if all the inflation numbers used any of those as a base year because then all of a sudden you would see high drama. Of course, you can see those years as the transition years from the old money system to a new money system. And of course the argument for, if you’re talking to economists, is this latent new growth potential in terms of GDP. But what I see in each of those years is also of embryonic significance for the story of inflation and the growth numbers, which do in fact correspond to facts and reality.

Kevin: Okay. So let’s look at 1913, okay? In 1913, an ounce of gold or a $20 bill were the same. Right now, that ounce of gold— The ounce of gold still buys the same amount of bread, but the $20 bill, it takes what? 90, 95, $20 bills? Back then a $20 bill and one ounce of gold were equal. Today, a $20 gold piece, one ounce of gold, it takes almost a hundred times the $20 bills to buy it.

David: Right. So your chief mandate is price stability. Roll the clock back to 1913, the creation of the Federal Reserve, the currency that you manage, again, price stability, has lost 98% of its value. You really don’t want to be tied to a correspondence theory of truth where the facts matter. You want the latitude to free yourself. In this case, free your organization from the constraints of objectivity. Yeah? And this is a current social trend. Of course we want to be free from the constraints of objectivity. Freely choose what goes into your burrito. I say burrito because Chipotle just this last week increased their prices depending on the menu items between one and a half and 4% in the week. And they’ve got expectations of more price increases to follow before year-end. The BLS says that your year over year food costs are up 2.2%.

Kevin: Okay. So let me get this right—

David: But the Chipotle burrito, up 4%.

Kevin: Up 4%. Well, not necessarily. You might be wrong. That’s just the transitory burrito. And if you order a transitory burrito at Chipotle and they say, “What is that? Say, “Well, that’s the seasonally adjusted burrito.” But we’re seasonally adjusting everything. Isn’t that how you get rid of an actual real numbers? You just say, “Oh, well, the season, ‘tis the season.”

David: Better than the Chipotle burrito is your grocery bill.

Kevin: Mm-hmm.

David: Any thoughts there? When you’re walking the aisles, does your mind register the increase of 2.2%? As you look at the things that you fill your cart with. I think, actually, we have a less sophisticated model. We might call it the shock model. What happens? We are very in tune with things that are up 15% or 30% or 50%. You look at the box and you say, “No, I’m not doing that. Are you kidding me? There’s no way. What has happened to the cost of this or that, or that?” Again, your mind does not register an increase of 2.2%. You could care less about 2.2%. And yet we all have familiarity in the last 12 to 24 months with something that we’ve looked at on the shelves and said, “I’m not buying it, no.”

Kevin: My wife. I told you last week, my wife— On Sunday nights, we have steak. She said, “Kevin, those $11 steaks went to $17.” I get to go back to her and tell her, “No, the BLS says actually—

David: 2.2%.

Kevin: Yeah. Which would mean $11 and a quarter, about $11.24. “You may have paid $17, but really that steak identifies with $11.24. It’s a seasonally adjusted transitory steak.”

David: Yeah. Well, in the last issue of Grant’s Interest Rate Observer, Jim points out that in the lead-up to the great inflation of the 1970s, two things were obvious to the Treasury Department and to the Fed. Number one, inflation had risen an average of 1.3% a year from 1952 to 1964. And number two, there had never been a serious peacetime inflation in US history. In Grant’s Interest Rate Observer, there was an attached letter from 1965. It included Paul Volcker as a signer. He was then the Deputy Undersecretary for Monetary Affairs at the Treasury Department. This is before he joined the Fed. They sometimes go back and forth, as we’ve seen.

Kevin: With Greenspan, Volcker, what have you.

David: In this letter, they downplayed any future inflation, saying that prices may creep upward further, but the rise is not likely to accelerate. It’s ironic that Volcker didn’t see it coming. But 15 years later, he’s forced to solve a problem that he failed to anticipate. And the second irony is— We’re talking 1965, right? The second irony is that dimes, quarters, and half dollars lost their 90% silver content in 1964.

Kevin: Mm-hmm.

David: Right? That was the last year of it. I think the change was made in 1965, but so anything pre ’64 has the 90%, anything post does not. So we have a significant devaluation event. Anyone with a sense of monetary history knew what taking silver out of our currency signaled, even if the Undersecretary for Monetary Affairs did not. So sometimes you’ve got the engineers of the system are just too close to the trees to see the forest.

Kevin: Talking about a forest, my birth date was 1963, and they took the silver out of the coinage in 1964. So it’s strange. There are generations alive right now that don’t even remember that we had silver in our coinage. Funny, too. They didn’t change— Talking about Honey, I Shrunk the Kids, Honey, I Shrunk the Silver Content in the Coinage, all right? Because when you take a Roosevelt dime right now and hold that up and show somebody, if you show them the face, they don’t know whether it’s silver or not if they don’t see the date. You have to turn it on the side and show the difference between the copper in the one, or zinc at this point, and the silver content of a pre-1964 dime. But isn’t it funny, they didn’t change the coin when they took the silver out?

David: Yeah. It would be fascinating to see the next round of devaluation, right? Because this is where— Think about de-carbonization as it’s occurring currently. Kevin, they want copper for other things. We have to electrify everything, right? But you also need zinc and nickel in this de-carbonization mode. And yet nickel is something that is— Our coinage is about to change again. It has to. And we think, “Oh, well, this will have to do with the environment and de-carbonization and global warming,” and are addressing those issues aggressively. Actually, it corresponds with yet another devaluation.

Kevin: So, should we go down and buy bricks of nickels before that happens? Huh, yeah?

David: Anytime I can buy a brick of nickels and the content of the nickel is worth $0.09, I will do that. I haven’t figured out how to arbitrage it and get the value out, but I’ll still do it. But there are generations, like I said, a lot of the guys here at the company weren’t alive during the time that we actually had metal content, precious metal content, in our currency. Well, I spoke with a smart young coworker yesterday. Great job in Kona. He was in the race, too. And said something like, “You were probably in the third grade during the global financial crisis.” And I was wrong. He said, “No, I was in the fourth grade.” And I thought back at that, “Okay. So the only catastrophe that occurred in my fourth grade year wasn’t a global financial crisis. The challenger blew up.” Yeah.

Kevin: I remember that, yeah.

David: So 2000 miles an hour, very high altitude, even after only 73 seconds of flight, brittle O-rings matter. The devil’s in the details, as they say. And you might say something similar about the sprites at the BLS, the devil’s in the details. Small details don’t matter until they do.

Kevin: Well, let me ask you a detail then. What would inflation be if we were measuring, like when I was a teenager in the 1970s? What would it be right now, if we just used that measuring block?

David: Well, and again, this coworker of mine recognized 1913 as too far back for hardly anyone to reference today from direct experience. Yeah, my coworkers reminded, even the 1970s stretches back to a period that to some seems pretty historic. Nevertheless, inflation measured by those 1970s models, they’re solidly double-digit today.

Kevin: Wow.

David: Solidly double-digit for another blast from the past that the US monetary base, going back to the ’70s didn’t even double for the early ’70s inflation to catch fire. Then the rate of inflation did continue to expand. Obviously, Volcker didn’t anticipate it. It continued to expand into the end of that decade, giving us the worst increase in prices since the civil war.

Kevin: Mm-hmm.

David: Have you seen what the US monetary base has done over the past decade?

Kevin: Well, you’ve talked about it. You’ve talked about what the monetary base is. It’s like water sitting behind the hoover dam waiting for velocity.

David: We’re about six-fold higher than we were 10, 12 years ago. So inflation is a bigger deal than many economists assume. And that’s a proposition that corresponds with reality. The reality of the monetary base doubling in the last two years, after previously tripling immediately following the global financial crisis, has yet to be fully factored into our direct experience of inflation. But it’s one of the reasons why hard assets make so much sense in the years ahead.

Kevin: You’re talking about hard assets, and you’re not saying put 100% into gold. When we talk to our clients, we draw a triangle, the base, the bottom third is gold and silver. Yes, that’s that $20 gold piece versus the $20 bill. The other two sides they take into account stocks, bonds, and cash. So if you just, at first, pour that foundation, you really have protected the rest of the portfolio.

David: Yeah. And our approach is to, on the asset management side, look at infrastructure, look at global natural resources, look at precious metals mining companies, and look at real estate. And it’s interesting right now we’ve got pension funds and insurance companies and private equity groups that are going after single-family houses.

Kevin: Isn’t that amazing? Yeah.

David: And competing directly with young married couples for their first time home. Prices are going higher and higher in part because you’re competing with institutional capital, right? And so you have the same trend. It’s not as if we’re the only people seeing that real things matter in the context of rising inflation. So, yes, to the most basic forms of money, gold and silver as a hard asset base in a portfolio? Absolutely. And yes to companies that find the basis of their value proposition in the ownership and production of hard assets. We’ve said it before, your standard equity portfolio, managed as it has been over the last 30 to 40 years, sort of the 60/40 split between stocks and bonds.

Kevin: Mm-hmm.

David: Do you remember when Mark Farber was on the program years ago? And he said, “We are doomed.”

Kevin: Yeah.

David: Well, the 60/40 stock bond portfolio—

Kevin: Is doomed.

David: —is doomed.

Kevin: Is doomed.

David: And if that describes you, you should check the weather report because just like the challenger and its O-rings, you may have an O-ring issue.

Kevin: Well, it’s not just David McAlvany. Okay. We’re talking Morgan Stanley, Jamie Dimon. These guys are saying, “Hey, we’ve got inflation here.”

David: Comments last week from Morgan Stanley. “This is the biggest paradigm shift in global macro in the past three years. The wage share of GDP will start to reverse its 40 year decline. The tide is turning in favor of higher inflation. Second economic cycles could run hotter, but shorter,” says Morgan Stanley. And that note on the wage share of GDP suggests a little bit of demand-pull inflation as well. An expanding economy, rising wages, discretionary fiscal spending. We talked about de-carbonization a minute ago. De-carbonization, increasing demand for particular technologies. A rapid expanding monetary base. You think we might have too much money chasing too few goods?

But again, you’re right. We’re not the only ones that see it. You’ve got Morgan Stanley, JP Morgan. CNBC was reporting Jamie Dimon’s comments discussing this large cash hoard that JP Morgan Chase has currently as he was reflecting on inflation. You think, “Well, how can you do that? Why would you want lots of cash if we’re in a period of inflation?” Jamie Diamond said, “Very good chance that inflation is here to stay.” You know what happens when the transitory theme on inflation plays out?

Kevin: That’s a scary thought because then people are like, “Wait a second. This is going to go for a while.” And that’s when it takes— That’s your velocity right there, Dave.

David: And this is also your inflationary repricing of assets.

Kevin: Mm-hmm (affirmative), right.

David: And inflation is not good for bonds. Everybody knows that.

Kevin: David, what about stocks?

David: Many people think it is good for stocks. But I’d say yes and no. There’s enough no in there to encourage you to keep your powder dry. And in spite of a loss of purchasing power on that liquid position, on your cash, you will have ample opportunity to put it to good use at much lower numbers. Implicit in Jamie Diamond’s comments, inflation up, interest rates up, asset prices down. Ergo, stockpiling cash is opportunistic in advance of discounted prices.

Kevin: But stockpiling cash, if you are stockpiling cash and you’re earning a little bit of interest, you’re still probably earning a negative rate at this point, right? We talk about the Europeans actually accepting nominal negative rates, but what about real rates right now? If we have inflation, you said double-digit inflation using the 1970s number, let’s just use the BLS numbers.

David: Right. And I think this is where, again, I come back to the Summers-Barsky thesis and say, “All right. Well, there is a point at which interest rates and inflation in the gold story, there’s a divergence and you’ve got to be cognizant of when that occurs.”

Kevin: Yeah.

David: We’re dealing with sort of the grass is greener mentality and opportunity costs, et cetera, et cetera, but the math on US rates in real terms, that’s pretty interesting and I think still a very compelling story for gold. Factor in your inflation number, the official CPI. Again, don’t ask how the sausage is made, but just accept 5% as a reality. And your six month bill is -4.97%. Your 10 year note is -3.57%. Your 30 year bond is -2.83%.

There was a lot of activity in the bond market last week. The huge amount of buying, and it was basically sovereigns around the world have been shorted, significant short selling. That short covering, they had bonds rallying last week in a pretty significant fashion. I saw the Financial Times run an article, and they were discounting inflation. Ah, the scare about inflation is over, the bond market is fine. It’s like, “Wait, wait, wait, wait. Wait a minute.” The dynamic was a huge, a massive short position, and covering it had nothing to do with the end of the inflation story, but it’s fascinating to see how the news outlets respond in real time to those kinds of things.

Kevin: You bring up Summers-Barsky. For those who haven’t actually read the Summers-Barsky thesis, it just simply says that interest rates need to exceed the inflation rate. You have to be positive. The interest rates that you’re being paid on your money have to be positive enough to move somebody away from gold, or, if they’re negative, people are going to move into gold. So Summers-Barsky is just simply saying, “Watch the interest rates, watch the inflation to see whether you’re buying bonds or gold.”

David: Yeah. And we’re talking about two academics back in the ’80s who punch these numbers together. Larry Summers, whom we also know as a participant at Harvard in the Treasury Department and Council of Economic Advisors for Clinton. This is a guy who’s been around the block, and is very concerned that inflation is going to surprise on the upside, and the odds are increasing by the day that that is the outcome, in Larry’s opinion. So that’s, again, just to kind of contextualize Summers Barsky. I think, on the basis of his equation and the rates part of that thinking, you still have a strongly bullish case for gold. Strongly bullish.

Kevin: Right.

David: And again, that deals with the, as you mentioned, the opportunity costs. The point at which you are +5% versus -5% on your six-year T-bill. You said to yourself, “Why would I sit in gold? It’s costing me a decent amount of cashflow.” At -4.97% of six month T-bill versus sitting in an ounce of gold, I’d sit on an ounce of gold. Absolutely. Are you kidding me?

Kevin: Right. But if you’re short-term trading, you’re going to still get the fluctuations. Gold could go down a little bit in here, but that’s a short term. That’s not a long term—

David: That’s right. So you look at things on a short-term basis and your daily turned down, did so two weeks ago. This is, again, just one of the technical measures we look at. 200 day moving average is currently trending lower. Those are not positive trends for gold. But they do define where gold’s likely to go in the short term. The short term, you’ve got US dollar strength, gold weakness, and, in my view, that should provide better entry points for the purchaser of gold. A return to 1800 is possible, and I think that fills your gaps. You’ve got some gaps about 5% lower. A retest of the 200-day moving average, closer to 1840. Retesting the breakout level again, 1840, that might be sufficient, but a move below 1840 puts 1800 in view. And I think a couple of the things that stand out to me here in the last week or two is that silver has been more resilient, even as gold has given up a little bit of ground, silver has been resilient. The mining shares have been very resilient. That can change rapidly. But thus far, platinum and gold have weakened, and silver and the mining shares have stubbornly resisted on the downside.

Kevin: You spoke about short covering changing the market. And one of the encouragements that I try to give to my clients, and I know you do, too, is don’t watch these shorter-term prices too closely because a lot of times it’s just gaming for month-end or what have you. And I think we have that coming up this week, don’t we?

David: Of course. Month-end and quarter-end games are certainly in play. And this week you also have the Wednesday Fed meeting, which is significant. And you also have the Friday options expiration. Some hedge fund managers have suggested that this is Powell’s most important meeting, and will be defining for how he’s remembered.

I think you’ve got at least two out of three rings at the circus that are open for entertainment when you’re watching options expiration in the Fed meeting. So I don’t know what is the third ring for this week. Maybe we’ll know by Friday.

But stock market dynamics are a bit concerning here. Sentiment indicators all suggest a top. You have the put/call ratio last week at 38, which would be 38 out of 100, looking to protect on the downside, the majority still aggressively buying call options. Again, an indication of extreme bullishness. In fact, if you looked at these other indications of extreme bullishness last week, you had options trading for AMC, the movie outlet, right?

Kevin: Right.

David: Total $11.6 billion, which was more in value trading in options on AMC, then all options traded for the S&P 500, QQQ and Tesla options combined.

Kevin: That just points out that you and I both like sushi, and, as small as Durango is, there’s always three or four sushi places competing with each other. But I don’t know if you remember, I’m not going to name it, but there was a sushi place that had really good sushi. The problem was, nobody ever went. It was low volume. One of the things with the stock market is, you can see prices rising in the stock market, but you better look at the volume. And if you’re looking around in the stock market and going, “Yeah, it’s hitting all time highs, but where is everybody?”

David: That’s right.

Kevin: That’s like, don’t eat at that sushi place.

David: That’s right.

Kevin: Dude, don’t eat that sushi.

David: Well, and that’s why I say there’s sentiment indicators that suggest a top, but that would be another indicator. Volume is a huge divergence signal. Equity prices are still very strong. But bull markets are driven off of large volume, and if you’re looking at volumes statistics, if you don’t see an increase in volume as prices are increasing, then you’d better be cautious.

Kevin: Mm-hmm.

David: And volume right now is not stellar. It’s not going through the roof with prices. It’s actually on the decline. You also have New York Stock Exchange declines versus advances. The declines are on the uptick, and the advances are trending lower. Not exactly what you want to see in terms of bull market dynamics. All that to say, stocks have short-term trading dynamics, which are barely favorable, with a medium to long-term outlook which is very bleak. And you get gold, which is on the other side of the equation. Short-term weakness, medium to longterm, very compelling.

Kevin: Okay. But I want to go ahead and look at this gigantic reservoir of, you were talking about monetary base, the liquidity that’s out there that has grown stagnant, Dave. Over the last 10 years we’ve had an incredible increase in liquidity to the point where banks don’t even want it anymore, right? They’re basically saying, “You need to do something with this money.” So is that money actually— when Napier was on, Russell Napier, he talked about, “We should look for an increase in velocity as the government becomes more command and control.” Are we going to see that? Is there going to be a direction for that cash, that stagnant huge reservoir of liquidity?

David: Yeah, a lot of liquidity is still sort of segregated and not flowing through the economy. And one of the places you can see that is the reverse repo market. That activity has been notable in that respect. Earning nothing is apparently pretty attractive. Overnight quantities in the reverse repo facility have swollen to $534 billion, up from virtually nothing. A fourth record, and this is a fourth record in about a week, a fourth record for the Fed, all of these records in excess of $400 billion, which suggests that excess liquidity has not yet found a home. That’s also supported by banks, encouraging their corporate customers to spend their cash, or in fact, take it elsewhere. And this goes back a month or two, but I highlighted from a personal conversation with our local banker this issue of having too much in the form of deposits. You wouldn’t think that that’s an issue for banks, but in fact it is.

Kevin: Well even the Wall Street Journal, they just had an article recently that said, “Banks to Companies: No More Deposits, Please.”

David: What? Again, it just highlights the lack of appetite for loans, right? Because the flip side of this is if you have a place to put those deposits, you’re going to take in as many deposits as you can. But if you’re not seeing a flow, and this is where, again, there’s been a distortion of activity in the financial markets where the Fed has stepped in and bought lots and lots of paper. QE has negative consequences, and this is where some of those negative consequences show up. When the Fed steps in, it creates distortions in terms of the flows into the financial system. A lot more financing, debt financing, is occurring outside of the banks, right? Corporations can do a bond offering. And this is a way to raise a lot of money, and it doesn’t include banks.

Banks need to be able to lend out money, right? Banks make money by borrowing short—that’s the deposit side of the equation—and then lending long, making loans that generate income above what the depositor requires. And then they do that on a leveraged basis. That’s how banks maintain fat profit margins. If you end up with too many deposits and not enough loans, then you’ve got a shrinkage of margins. Nobody really likes to see that. So you get this anomalous behavior of banks not being interested in bringing in any more deposits. But it’s really a story about loans on the other side of the equation.

Kevin: I’m so glad that we got a chance to listen to Russell Napier when you talked to him last month, because we— And you have been incredibly suspicious of a coming day when all that that huge reservoir of liquidity would start to flow. And Napier said it’s coming with the government moving that money. I’m listening to you talk about banks not wanting any more in the way of deposits. What came to mind, Dave, expiration date kind of money. When banks are saying, “You can’t keep your money here anymore.” In a way, that’s a form of expiration date. That would increase velocity just in and of itself.

David: Well, and again, you think about the dynamic of not having enough of an appetite for loans. People who would ordinarily qualify for a loan are not interested in taking a loan.

Kevin: Mm-hmm.

David: Right? So banks have this issue of excess deposits in part because they can’t find enough qualified people for loans. Then you go back to the conversation we had with Napier, and there is a governmental solution to that. And it is called redistribution. And this is where, again, whether it’s grants or loans that are guaranteed by the federal government, now all of a sudden banks don’t have to find someone who qualifies for the loan, they just have to find somebody who’s willing to take the money. And of course, there’s risk attached anytime you are lending money, but if the risk is not factored in—

Kevin: No, because the government will back you up if it’s the preferred project.

David: And that’s what we found in 2005, 2006 and 2007 in the run-up to the mortgage-backed security debacle. You didn’t even have to fog a mirror to get a loan. The money was being moved so fast nobody was checking to see if you qualified. In this case, no one cares to check. You don’t have to because the federal government’s going to pick up the losses. And I was reading a Reuters article where Biden wants to deal with and narrow what he views as the persistent racial wealth gap, dividing black, Latino, and white Americans. And what he wants to do is expand federal contracting by 50%. So $100 billion over five years specifically to “disadvantaged businesses.” Then you’ve got $10 billion of infrastructure plans, which again are going specifically to neighborhoods and places— communities that need to be, “revitalized.”

Kevin: So you have preferred projects and guaranteed loans? The banks don’t take the risk?

David: Yeah. And I just think, “Okay, so you’ve got a community which has been largely abandoned. You want to build landscaped gardens and libraries, $31 billion for minority-owned businesses, $15 billion for competitive grants, reconnecting neighborhoods that have changed dynamically because of the creation of highways.” This is like your old Radiator Springs story if you go back to your kids’ movies. I know some of you probably are past that. I’m not quite past that yet.

Kevin: Yeah, when the old super highway went past the town and nobody came anymore.

David: Right. Well, if you were Radiator Springs, you’d be in line for $15 billion in grants.

Kevin: Well.

David: Of course you have to be a minority neighborhood on the wrong side of the highway.

Kevin: What about a sushi restaurant that doesn’t have too much traffic? Maybe they would get a specialized loan.

David: Flower boxes outside of the building anyway.

Kevin: Okay.

David: What I’m saying is, is you’ve got to gin up the flow of money through banks, and you can do it through commercial banks, but banks are saying, “We can’t find anyone with the appetite for the loan that meets our loan criteria. And the only way we’re going to change our loan criteria is if you change our risk where you basically take on and subsidize the risk implicit to the loan.”

Kevin: And that was Napier’s point.

David: And that’s exactly what Biden is talking about. And that’s what this writer’s article was specifically on. Racial disparities persist over generations, so we’re going to solve that. We’re going to increase household net worth by making sure that everyone gets a home. And of course, first thing that comes to mind is, are you aware that buying a home usually is associated with debt? How many people do you want to saddle with loans? I understand the long-term benefits of home ownership are there, community stabilization. And there’s two sides to the story, I guess, is what I’m saying.

I just can’t believe that we’ve got these dynamics playing out where the banks are saying, “We have so much money, we’re just going to store it with the Fed. We can’t take any more deposits because there’s no demand for loans, and the governmental solution, the fiscal solution, is to say, “Don’t worry about it. We’ll take the first loss.”

Kevin: Okay. So reading the Reuters headline, “Biden Eyes Grants, Federal Purchasing to Narrow Racial Wealth, Home Ownership Gaps.” Gosh, this reminds me of the three steps you were talking about before that was talking about. They regulate appropriate taxes, sound like they’re coming.

David: Well, taxes are definitely a part of government intervention, because it really is a question of redistribution. If you’re talking about grants, where does that money come from exactly? The government is not the source of wealth. They can capture someone else’s wealth and then shovel it around, reshuffle it, but it reminds me of what Vladimir Lenin said, “The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.”

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.

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

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