EPISODES / WEEKLY COMMENTARY

Making BRICs Out Of Basket Case Currencies

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Aug 23 2023
Making BRICs Out Of Basket Case Currencies
David McAlvany Posted on August 23, 2023
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Making BRICs Out Of Basket Case Currencies
August 23, 2023

If we just use the old metrics that were used to construct CPI, we have, still, double-digit rates of inflation. The statisticians have gotten much more clever with what they count, what they don’t, when they count it, how they weight it. And this is just one more iteration as we come into 2024. Inflation will be a thing of the past except for that reality gap. An annual measure and re-weighting of the components allows for a closer-to-real-time erasure of problematic contributors. The CPI number will trend lower even if the consumer reality does not. —David McAlvany

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

Dave, one of my favorite trips with you, and we have had many trips, was when we went down to Argentina. It was you, myself, Pete, Rob. It was fascinating in many ways, but one of the things that we learned was that there are two values to the US dollar. There was the official value that Argentina said was the exchange rate between the Argentinian peso and the dollar. And then when we got in that van and they said, “Hey, we know where to exchange the dollar for the blue rate.” They didn’t say it that way. They said, “We know of a good leather store where you can exchange your dollars.” They don’t want to call it a black market. They call it a blue market, and they called it the blue dollar.

David: Yeah. When a shopkeeper becomes a currency speculator/banker, you know something’s gone seriously wrong with the currency. And we were there, and I remember we went to the wine store and then—

Kevin: Yeah. You bought a bottle of Malbec.

David: It was a very nice bottle for 50 US dollars. And that’s not what he was asking, but that’s what we negotiated to. And the value of US dollars was he wanted them. In fact, you could say he needed them.

Kevin: At the official rate, it would’ve been a $100 bottle because the government would’ve said no, at the official rate, it would’ve been $100 bottle. You got it for 50. What would that bottle of Malbec be today?

David: Well, in the official terms, call it 400 pesos, today it’s 16,000, roughly, at the kind of back-of-the-napkin math.

Kevin: Wow.

David: So just in nine years, there’s been a pretty significant change to the purchasing power of the peso.

Kevin: So to be clear, it was $50 that you paid for it, but it actually would’ve been a 400-peso bottle.

David: At that point.

Kevin: At that point. Now it’s how many?

David: 16,000.

Kevin: 16,000. I guess they ruined their currency even more since we’ve been there.

David: Thank God they haven’t ruined their Malbec.

Kevin: That’s right. It’s like gold in a way. You put gold aside. Now, you can’t really drink gold, so it’s good to have gold and Malbec.

David: A balanced portfolio of liquid assets. I’ve always thought that that was important.

Kevin: Sometimes, Dave, there was a phrase that I went hiking the other day and I just memorized and I continued to roll it over in my head because, at least for me, I like to think that I’ve learned something and I can keep it, but repetition is really, really important because we can touch something but we can’t hold onto it. And here’s the phrase. This was written by a theologian. I can’t remember his name, but it’s a beautiful phrase and it’s really true. He says, “The human creature, made for fellowship with God, can touch the eternal, but he can’t rest in it.” He said, “Our experience is inherently narrative, relentlessly temporal. We’re given no rest, so the story moves on.”

And I said that over and over because it’s really true. We try to touch the eternal, okay? So this is a spiritual statement. But even the things we’ve learned, we really haven’t learned them. You and I have to remind each other every day. In fact, the reason we do this program, these are discussions that we were having long before we ever recorded them, right? We would stop, we’d sit and we’d think and try to remind ourselves what’s true and what’s false.

David: Yeah, you get this sort of recurrent theme, if you go back to “The Gods of the Copybook Headings,” these are the truths which should be repeated over and over again, and you need to be reminded of them. It doesn’t matter if you’ve heard them before.

Kevin: You sound like a broken record to your kids, but maybe not.

David: Yeah. Sometimes I’ll interject in a conversation with my dad. “Dad, you’ve told me this before.” And he’s usual response is, “That’s right. And it’s important. You need to hear it again.” So I think on the program, if we’re repetitive on a particular theme, it’s for emphasis to mark the importance of that theme. And as I grow older, I’m beginning to see that covering the same ground is not a mark of forgetfulness on the part of the teller, maybe me, but a sort of thoroughness. And you think of the diamond expert, turning the stone over and over again. And as the light hits each of those facets in a different way, it reveals something new from a fresh angle, right? So details matter. They’re easily missed if the viewing is cursory, if it’s not careful, if it’s not repeated.

Kevin: Well, and this is one of the reasons why I think marginalia is so important, Dave. I mean, all of our books are really not resellable at a bookstore because when we read a book, we almost destroy the book writing in it because we have to be able to go back and remember what was the thought that came at that time.

Let’s just take that with the economy. Couple of years ago we were being told, yes, inflation’s picking up a little bit, but it’s transitory. It’s transitory. We need to go back and look at those margins right now and see, do they still apply?

David: Yeah. I can’t emphasize strongly enough the secular shift in inflation and the secular shift in interest rates. The implications of these major structural shifts have yet to be felt fully. And a generation of investors have yet to discover that a regime change is well underway and anything but transitory.

So weeks ago we referenced the BIS, the Bank of International Settlements, tally of G20 non-financial debt, $250 trillion. With the further observation that the average coupon for the Bloomberg Global Aggregate Bond Index, it has only reset by 50 basis points.

Kevin: Even though interest rates are up as much as they are.

David: Yeah, from 1% to 4%. Yet this aggregate bond index has only reset by 50 basis points, meaning that the pain from higher rates has yet to transfer through the entire fixed income universe. The Bank of International Settlement Study suggested that the hypothetical reset to current rates across the domain, the entire landscape of existing debt obligations would increase interest expenses for G20 borrowers by $8 trillion, above and beyond what they’re paying now. An interest expense burden of $8 trillion. 

We said this weeks ago. That’s right. We’re saying again because it’s important. You need to hear it again. The most significant moves in the financial markets in recent weeks have been in the bond market. And what we’re suggesting is that the possibility of a different kind of backdrop is the explanation for why risks are at present underappreciated and inadequately hedged. So “the worst is behind us.” That attitude, the worst is behind us, that sets up the market for surprise—negative surprise—and I think significant disappointment.

Kevin: So we have to replace our thinking from transitory inflation to higher rates for longer, probably higher prices for longer—a lot longer.

David: Yeah. Doug Noland describes it as a new cycle phenomenon, and other writers might think of it as a paradigm shift or a regime change, and that kind of fits for me. Higher for longer is not just a Fed policy story. There are structural shifts in trade and employment and labor costs in many other areas. And some of these areas are going to be talked about this Friday at the Jackson Hole meeting. Structural changes are beginning to be appreciated, but have not been priced in, right? So when you think about trade employment, labor costs, other areas which have been a certain way for decades, they’re now shifting.

Kevin: Okay, so this isn’t just the Federal Reserve. This isn’t just a single central bank that has to figure this out.

David: Yeah. In recent weeks, the uniformity of higher rates all over the world is very significant, that it’s not just the US Treasury, but it’s the German bund. It is the French OAT, the British gilts. I mean, anywhere you go, in Europe, the US, even parts of Asia, South America, the uniformity is very significant. This is not one central bank problem. This is the world choking on too much debt. And it’s the world markets signaling that demand for debt is no longer in line with supply. We’ve got an issue. Oversupply is impacting the price. And by its nature, price declines drive the cost of capital higher. Regardless of what the central banks want, you now have an imbalance between supply of debt and demand for that same debt, which in and of itself creates a positive pressure—that is, an upward pressure on interest rates.

So regardless of central bank policy to price rates at a particular level, you’ve got this sort of waterboarding effect of forced supplies in the debt market, which continue to choke the global fixed income market. And we can only hope that debt monetization schemes aren’t revived, with central banks returning to be the buyer of last resort, filling that function like they did with the various initiatives with QE in that whole era.

Kevin: One of the worst things that can happen is, if they raise interest rates and then decide to lower interest rates, let’s say it’s a policy decision, but interest rates keep going up and inflation keeps going up. That sounds to me like the hyperinflation nightmare that it could be.

David: Well, and certainly they’re aware of the mistake made in the ’70s, assuming that inflation was behind them, lowering rates too soon. And so there is a certain stubbornness amongst policymakers to keep rates higher for longer. And I’m not talking about that. I’m not talking about the policy choice to remain at an elevated level. I’m talking about the market’s dictation of reality. 

And so, inflation in this scenario could go from minorly annoying in a localized context to globally catastrophic. And again, it’s the uniformity of rates globally increasing which is suggesting that one central bank policy at this point does not necessarily change much of anything. The impacts are not just fiscal pressures as you might expect, but you’ve got the three spheres of the economy which are all at risk of increased pressure, the governmental, the corporate, and the household sectors, which are touched pretty significantly by the increase in interest rates.

Kevin: Well, I know how the household sector is affected when it’s got too much debt. But in the corporate sector, they really enjoyed the days when we had zero interest rates because they could just go out and borrow money and it didn’t cost them anything.

David: Yeah. Maybe the most extreme impact is for the marginal borrower. We call them high-yield or junk borrowers. These are folks that don’t have very good balance sheets and are only too happy to pay double-digit interest rates because they’re a bad bet, right? So when the pricing of money occurs and interest rates move higher, paying for junk rate companies is pretty intense. But for any company, yields go up and valuations come down, which means you have to look at how those companies are priced in the market. And if valuations are coming down as yields go up, then you can guess what happens to the value of those stocks. It’s down. And that’s just fairly well axiomatic.

Kevin: Well, and earnings drop too. I mean the earnings of the company.

David: The impact to corporate earnings from higher interest rates, that takes time to filter through, particularly since many corporates took the opportunity to refinance their debt at or near 5,000 year lows. That is arguably a long lit fuse compared to the governments of the world, particularly I think of the US, which did very little to refinance their debt on longer terms at lower rates.

I will say that as fixed rate bank debt has been displaced by private credit, those terms are not as long as you’d find in the bond market, and are commonly variable. In other words, they can be like an adjustable rate. At the end of 12 months, it’s going to mark to whatever the current rate is. So expect increased pressures and defaults to proliferate from the private credit markets. Again, this is sort of a carve-out. Not the bond market and not the bank lending market, but the private credit market. It’s our latest iteration of shadow banking, and it’s full of surprises.

Kevin: So if you’re in the government and you know there are roads that need to be fixed, there are bridges that need to be built or repaired, you either have the money or you don’t. But if you’re spending it on interest, the interest that we’re paying on our debt right now is substantially higher than we were even a couple of years ago.

David: Yeah, on track for a cool trillion dollars in interest payments this year.

Kevin: Wow.

David: So if you think about our budget deficit, the 1 trillion versus the budget deficit of 2 trillion, half of our budget deficit is coming from the interest expense, which is just ballooned. So yeah, when we discuss the governments of the world facing a more aggressive fiscal strain, it’s because the debt levels increasing more dramatically are just exaggerated that much further by the compound, or the increased, interest component. 

It’s worth keeping an eye on, and it’s worth remembering that central banks set the short-term rates, but markets determine the long end of the yield curve, which is where inflation compensation and deteriorating credit quality leave the greatest scars on investors. Rough translation: word to the wise, longer bond durations have hurt, and will likely continue to dole out lots of pain in the years ahead.

Kevin: Yeah, so I’m thinking ahead here, Dave. If the governments can no longer borrow what they need to spend, they’re probably staring at everybody who’s listening right now because they know we probably have some assets that need to be taxed.

David: Well, and isn’t that the case that if governments lack the capital to pay bills, then taxes will increase or heads will roll at the top? So we have the predictable grasp of the government hand reaching out for more taxes, and that’s just to balance the outflows with fresh inflows. They don’t make anything, but they can take lots, and they may be required to just to remain viable as an entity. And this is not money that’s used for additional government services, but just a catch-up, a repayment on already-spent money. 

So the downside to an increase in taxes, and I think this seems to make sense, the downside to an increase in taxes is that it diminishes the dollars available for investment either by households or corporations. And so, when you have a government increasing taxes, and a larger and larger percentage of that is just going to interest payments, you can see the inanity, the insanity of it all.

Households in a different situation to some degree. There’s the obvious uphill battle as rates go higher, and you haven’t seen any change in the sticker price for home values. So, unaffordability in housing is one dimension of households facing an uphill battle.

Kevin: Well, how about groceries? My wife, we were sitting the other day and she said, “Kevin, I saw just a small jar of mushrooms that would’ve normally been about two and a half bucks.” She said, “That would be about right. It was $8.” She’s seeing things that are way beyond what they’re actually reporting CPI increases.

David: I can’t figure out if I just have great taste in wine or if prices are really beginning to get annoying because I can remember when I got married almost 25 years ago, I had the best case of wine that I could buy at reasonable prices. So $15 to $20 a bottle. Most of those bottles, most of those brands are now at 75 bucks a bottle.

Kevin: Where do you draw the line?

David: Well, I don’t buy them.

Kevin: Right.

David: I’m buying Italian wine because it’s a lot cheaper. I’m buying Malbec because still in US dollar terms it’s a better value, but to see something go from say 25 to $75 in a 25-year period, to triple in price. And again, I’m talking about something that is absolutely unnecessary in contrast to the rest of the world who’s struggling with the rising price of corn, wheat, and rice.

Kevin: Yeah. If rice increases, for some people it goes from maybe having two meals a day to one.

David: So we have higher wages and consumers racing to keep pace with higher costs of goods and services. Households are exhausted by the hunt for alternatives. If you see that as sort of the backdrop for 2024 elections, you can appreciate just how similar that the rancorous nature of politics has been from 2016 through 2020 and up to the present day. It’s a backdrop of frustration. It’s a backdrop of discontent among consumers.

Kevin: You know, what they need to do is just change how they calculate it. Tell us that things are getting better when they’re not. 

David: And lo and behold, that is what’s going to happen. It’s pure brilliance. We’ll resolve inflation in 2024 by changing how we calculate the statistic to create a more favorable impression with the public. The CPI is changing yet again. Next year—

Kevin: It wouldn’t be the first time.

David: Exactly. Next year, the revisions to the weightings, the revisions to the weightings of each item in the basket, will go from a recalculation every two years to every 12 months. And that venerable basket measuring what is supposed to be a constant and unchanging lifestyle, which used to be rejiggered once a decade and then was once every two years, will now be recalculated once every 12 months. But the government has chosen to bring the micro back into management, hoping that the CPI, that measure of inflation, that print, will be a source of encouragement rather than frustration and disdain.

Kevin: It reminds me back in the ’70s, they tried that campaign called the WIN campaign. Remember that? Whip Inflation Now. What they were basically saying is, “Don’t raise your prices.” The government says, “No more. Don’t raise your prices.” It was like Argentina saying, “Oh no, you can trade seven pesos for a US dollar.” In fact, it made everybody illegal. Everybody was a criminal if they actually exchanged for the actual rate that the government said was non-official.

David: Yeah. So the CPI changes. This is veering into that same space, governmental sleight of hand. When changing the world without substantively changing the world, the market discerns ways to work around the BS.

Kevin: Right.

David: So Argentina, since 2014, we’ve recounted the US dollar to Argentine exchange rate. The fact that global currency quotes reference the Argentine peso—this is pretty funny—anytime you’re looking up a quote for the Argentine peso, it’s marked with three letters: A, R and S [ARS is the International Organization for Standardization (ISO) code for the Argentine peso].

Kevin: ARS. Hey, it reminds me of my fair lady. Remember Eliza Doolittle, when she got excited about her horse, she goes, “Come on, move your bloomin’ arse”?

David: Well, it’s unfortunate, but it’s accurate. That’s accidentally confessional in some sense.

Kevin: ARS. Yeah.

David: The ARS continues to be a direct reflection of the quality of governance and public policy viability in Argentina. And yes, there’s the two exchange rates, the official and the blue market rate. The blue is the new black in Argentina. When we traveled there in 2014, the official rate was eight to one, the blue market rate varying between 14 and 16. The official rate is a bit of a farce, which is perhaps where currency traders came up with a three-letter reference. I think everyone loves to rhyme—

Kevin: A bit of a farce rhymes with arse.

David: Arse. Of course.

Kevin: Yeah.

David: So today the official rate nine years later is 350 to one, instead of eight—

Kevin: That’s the official rate.

David: That’s right. Instead of eight to one. The blue rate still maintains the reality gap. 

When I think of disdain and frustration with CPI and our measures of inflation, everybody has the reality gap. Everybody knows the difference between what is stated and the actual, what they have to pay, and we just make the mental adjustment. But there does come a point where it’s so absurd that the people who are proffering the statistics, they just lose all credibility. And I would say that the Argentine central bank has done just that. So yeah, the official rate nine years later, 350 to one, the blue rate, maintaining the reality gap, sitting at 710 to one, I would merely wish for our statisticians to know that the market is not stupid, and can discern the difference between smoke blown up the posterior and a real-world inflation bite in the same nether region.

So Argentinians have met monetary doom. That’s their story over the last nine years. And of course, then, there’s a recurrent theme. It’s not the first time, not the first rodeo. And this is the price for popular democracy. This is the price for political corruption. While they can’t seem to elect good people, they do have the good sense to recognize a currency scam. So you have this two-tiered market, the blue market. They understand it. They get it. The central bank runs the scam, and it gets perpetuated by the commercial banks.

Someday, I think Americans may launch the blue dollar rate to reflect the real world devaluation of our own currency. Not the micromanaged, not the sanitized, not the entirely false measure which we have coming through in statistics like the CPI. Come to think of it, gold is your currency truth teller. And it’s your currency truth teller in any geography. You don’t need a blue dollar rate when you have a gold dollar rate.

Kevin: Well, that’s exactly right. I mean, we were talking about that bottle of Malbec. Malbec, you could have a standard of Malbec bottles of wine because it will maintain its value far better than the currency that bought it. But if people are watching CPI, and you know they’re going to because a lot of decisions are made on what the government says inflation is, it wouldn’t be unusual to see CPI drop substantially and then come back, and then drop substantially and then come back, because this is a manipulated number.

David: And it happens that way. Between 1940 and 1952, there were three moves in the CPI from zero to around 10%. Two of those instances it was well over 10%, the third just under 10, and then back to zero. So you’ve got this period of inflation fluctuation, and the cumulative impact was a reduction in purchasing power by 47%. So the 1940 dollar buys 53 cents worth of goods and/or services in 1952.

Kevin: So in a 12-year period?

David: It’s noteworthy CPI volatility. And so it looks like a roller coaster at an amusement park if you’re looking at a chart. It didn’t end there. CPI numbers were equally volatile, equally consequential through the ’60s and ’70s, leading to the crisis management. And frankly, the only thing that saved the reputation of the central bank was Volcker’s extreme action, taking rates as high as he did. We’ve known the moderating of that volatility since the early ’80s in large part because the inflation measuring stick has been lengthened. You think about that. If what you measure something by is changing itself— The yardstick is now actually two yards long according to the old measure, but we’re still calling it just a yard.

Kevin: Right. So if we measured—like during the days of Reagan, when Reagan came into office in that high inflationary period—if we measured the difference, what our inflation rate would be right now, it’d probably be two or three times what they’re telling us.

David: That’s precisely correct. If we just use the old measurements, if we just used the old metrics that were used to construct CPI, we have still double-digit rates of inflation. So a part of that inflation moderation has been driven by a refinement in statistical models. And this is the benefit with time and age—maybe it’s age and sagacity or treachery, I don’t know. But the statisticians have gotten much more clever with what they count, what they don’t, when they count it, how they weight it. And this is just one more iteration as we come into 2024. Inflation will be a thing of the past—except for that reality gap.

An annual measure and re-weighting of the components allows for a closer-to-real-time erasure of problematic contributors. The CPI number will trend lower even if the consumer reality does not. So look at the gold/dollar rate, the US dollar to gold exchange ratio. I mean, we just think of it as the gold price, right? But that’s what it really is, is an exchange ratio between two currencies: the US dollar/gold exchange rate. And you can do this with any currency for that matter, like the blue dollar indicating a strong southern breeze. Something stinks down there, or perhaps the official rate of BS. The gold dollar tells you everything you need to know. It tells you if policies are legitimate, trustworthy, or if they’re false.

Kevin: And that applies whether you’re in the United States or in England or in Europe, or look at Japan.

David: Today the yen in gold is near all time highs, close to 277,000 yen. The RNB in gold, too. It’s telling you that Chinese policies are not supporting public confidence. Public confidence is being lost, and it’s reflected in the depreciation of the currency. It’s reflected in capital flight from the Chinese currency. Is it a surprise that the RNB or the yuan price for gold is on the increase? Not a surprise. The gold price in a variety of currencies is your long-term tell. It’s your long-term tell. Who are the worst offenders from a fiscal and monetary policy standpoint? Their currency in gold terms, that exchange ratio tells you everything you need to know.

Kevin: I remember when we traveled to Argentina, not only did I bring dollars because I had heard that this was going on and we needed the dollar to be able to function, just like the Argentinians needed to be able to use the blue exchange rate to function, but I also brought a little bit of gold. I usually travel with some small British sovereigns or Dutch gilders or what have you. It’s interesting because if we would have actually sold somebody in Argentinian currency some gold down there, maybe exchanged for some pesos, they wouldn’t be behind at all at this point.

David: If you think you can afford to ignore the gold price any longer, “Oh, we live in the US. What’s wrong with the dollar?,” or you live in the eurozone, “What’s wrong with the euro?” This is the brightest minds, the intentionality of design. Maybe you can’t make that case. But if you think you can afford to ignore the gold price any longer, consider the plight of the average Argentine, from 16:1 when we were last in Argentina to 720:1.

Kevin: That’s in dollars, yeah.

David: Using the blue rate nine years later. Kevin, poverty has many faces and many causes, but bad policies and the lies that justify them are chief among them. Forget about the official rates. I’m interested in the truth, not a forced, fabricated reality. Not a farce.

Kevin: And this is why we have to keep repeating truths to ourselves. When John Maynard Keynes said that inflation is a tax that one in a million understand, we need to remember that he said that back in the— Was it the late ’20s, early ’30s?

David: Well, and what does it look like? Because if definitions are changing, if models and statistical calculations are being reformed, what does it look like? I agree, thoroughness may include repetition. We may not see all the important parts of a thesis or an idea the first time through. There may be implications of higher rates and inflation which is stickier which are far more complex and multifaceted, and extend beyond the present tense. There’s some danger there. As you start thinking about what the implications are, the farther you reach out into the future and try to understand it, the more it is like the proverbial limb, incrementally sketchier as you reach out to the edges.

Kevin: So let’s talk about this movement toward the BRICS currency, this unification of the BRICS, because I wonder what is it that they’re trying to solve? None of the currencies that are entering this BRICS agreement are strong in and of themselves.

David: And isn’t that funny? Because in fighting US dollar hegemony, you’re putting together not a basket of strength, but a basket-case of countries that can’t manage themselves out of a paper sack. Deglobalization and balkanization are ideas that come to mind, and they’re distinct but they’re complementary.

Deglobalization, if you’re talking about economic disintegration, if you’re talking about trade conflicts, they’re best associated with the former, deglobalization. And then you deal with political and ethnic divisions. That’s more characteristic of the latter, balkanization. They’re complementary in the sense that localized, sometimes nationalist, priorities come to the fore as competition for power, control, competition for the old slice of the economic pie, channeling of resources to a preferred group becomes a priority.

We’re getting both right now. We’re getting deglobalization. We’re getting balkanization. We’re getting a radical shift in supply chains. We’re getting the reemergence of resource nationalism, again, signs of deglobalization.

Kevin: So this BRICS meeting, I mean if you had to lean one way or the other, deglobalization or balkanization, which one’s motivating?

David: It’s more akin to balkanization as territorial sovereignty and political fragmentation are evidenced in the strain to remake the global order. They want to remake the global order. This is inherently political. It deals with sovereignty and who’s going to tell us what to do and what not to do. It is a pushback against the US Treasury involving itself in every aspect of foreigners’ lives, but to remake the global order around new institutions and new power alliances.

Both of these are intriguing trends, but each of them has distinct causes, motives, and costs—unique costs. Trade tensions, trade wars, they will continue to proliferate as deglobalization hits its stride.

Kevin: And as you have that B-R-I-C-S [Brazil, Russia, India, China, South Africa], and you look at those various currencies, look what all of those currencies are doing in gold right now.

David: Precisely. A meltdown in the ruble is a melt up in ruble gold prices. A meltdown in rupees is a melt up in gold prices, and on and on and on. So Doug Noland, from his weekend comments, says that the Chinese currency was under more pressure. The PBOC repeatedly adjusting its daily fixing, floating peg to a group of currencies higher, signaling its displeasure with the weak renminbi. And repeatedly, the currency market completely disregarded the PBOC—a noteworthy new development, he says. There was also aggressive buying support from the major Chinese banks. Intervention that had minimal impact.

Kevin: And China, the way they’ve been running for many years is they’re used to just basically making a mandate and saying it’s going to be this way. Do you think those mandates will work?

David: Yeah. And Doug’s point, a noteworthy new development was that the currency markets completely disregarded the PBOC, the PBOC’S intervention activity. So there is a disregard. There is a— What was the word we used earlier? A disdain for what is not reasonable in the current environment. So conventions of control, pretensions that come with it, can fall flat. 

The idea that the PBOC does control the economy and can make happen what they want to happen, there’s a lot of pretense in that. And it’s not happening as they hope. The blue dollar is evidence of official pretense parading around like a clown in Argentina because the reality is about 100% different. So your official currency rate is pretentious and false. China is joining the currency circus, as are the Japanese—red-nosed, goofy, like a bunch of clowns.

Kevin: So let me ask you a question because when we’ve gone through crisis, whether it’s the 1987 crash or the 2008 crash, what you’ll see is safe haven. People will run to US Treasurys as a safe haven, and rates will drop. You can actually see the market dropping the rates. That doesn’t seem to be happening right now.

David: Well, from last week’s Commentary where we pointed this out to another iteration of that in Doug Noland’s Credit Bubble Bulletin, back to his comments from the weekend, because this happened yet again all week long this last week. He says it’s extraordinary to watch an escalation of systemic China concerns coupled with global contagion and not see so-called safe-haven buying of Treasurys, German bunds, and other top-tier sovereign bonds. Instead, 10-year Treasury yields jumped 10 basis points last week and were up another nine basis points today to a 16-year high, 4.34%.

Mortgage-backed security—MBS—yields surged 17 basis points last week. Mortgage-backed security yields rose an additional nine basis points today, 6.23%, the high back to 2007.

Kevin: And that’s why we have to continue to remind ourselves and continue to repeat truths because if we are going to be higher for longer, this whole bond market rally that everyone has positioned themselves for might just be a farce.

David: Well, they’re assuming that rates are going to go lower. And Doug says especially with respect to recent market trading action, there’s a growing support for the bond market, a new cycle paradigm shift thesis. The bullish bond market narrative has been that with inflation rapidly coming down, the Fed would soon reverse course on tightening. Bond funds have attracted huge inflows this year. Most bond managers have been positioned for declining yields. But instead of anticipating the next Fed easing cycle, bonds now seem much more focused on fundamental factors such as sticky inflation and a massive supply of new debt instruments as far as the eye can see.

Kevin: So to be the broken record, okay, when I came to work here back in 1987, a loaf of bread was 85 cents a loaf. And you could eat a loaf of bread a day for a year. $300 is what it would cost. That’s what an ounce of gold cost at the time. A loaf of bread today is about $5. An ounce of gold is between 18- and 19-hundred dollars. You go do the math. And I know that’s a broken record. I’ve said this many times on this show. I’ve said it many times to my family. Any client who wants to listen, I say the same thing. Gold still seems to be the best measure of inflation.

David: Preservation of purchasing power over long periods of time. It’s a primary merit of having gold as a ballast asset in a portfolio. Yes, it can take on safe haven attributes in the context of financial panic. So there’s other reasons that you can own it in a short-term scenario or on a short-term basis. But over the long-term as a ballast asset within a portfolio, that’s it. It’s preserving your purchasing power and it’s being repriced to reflect the tomfoolery of politicians.

Kevin: And it’s wonderfully boring.

David: Yeah.

Kevin: Wonderfully boring.

David: I suggested some time ago, this goes back to— Well, it’s not that long ago, in the era of zero rates, that gold might be the only measurable sign of protest coming from the old-fashioned bond vigilantes. If they can’t vote with their feet in the bond market because the world’s central banks are going to buy all the product in the world in artificially suppressed rates, you’re never going to see any information coming from the bond market again. We’ve broken free from that. We’ve broken free from that. Interest rates are higher. The only true signal of currency reality in the farcical world of fiat currencies, which as you know are priced relative to each other, not priced relative to something stable, I would contend… And again, rates are back with a vengeance. They’re higher. And you could argue the bond vigilante is too.

Gold is a measure of confidence in the policy prescriptions of our day. If we see a breakout in the price to higher levels, it’s nothing more than a breakdown in confidence with the man in the street judging official numbers to be untrue, unsound, unworthy of acceptance. That’s what the price of gold is telling you. A breakout in price is really a breakdown in confidence.

Kevin: Dave, I was talking to a client yesterday and he said something so profound. And I have to admit, I am ashamed. I’m ashamed of what we did to the world with the US dollar. So, call me unpatriotic, but I am ashamed, because he said something that triggered this thought. He said what we’ve done to the rest of the world we’re now going to do to the American public. And he’s talking about the nation and the dollar. What we did to the rest of the world is we got them to believe in a reserve currency that really, it was an abuse of trust. It says on the currency “In God we trust.”

I got the letter out from Teddy Roosevelt this weekend, and sat and reread the letter that he wrote to a pastor up in New York saying why he wanted to have “In God we trust” taken off the currency, because he felt that that was too profound a name on the currency for the way that we behave. Not just with currency, but with what it was being spent for and the abuses. It was a very convincing letter. Now, Teddy Roosevelt, he liked to get the feathers up on Congress. So Congress came right back and said, “No, we’re going to put “In God we trust” back on the currency. But actually his reasoning for taking God’s name off of the currency probably was more accurate than why we would put it on.

David: Well, I just want to go back to that comment, ashamed of what we’ve done with the US dollar. I think we’re talking about the lifecycle of a currency. And to be fair, the US dollar is not what it used to be. And so, what we set out to do and what we’ve done are two very different things. I wouldn’t say that it’s axiomatic that being the world’s reserve currency automatically perpetuates pain, destruction, disorder, imbalance, economic or financial. They’re not inherently connected.

Kevin: Dave, it used to be a receipt for gold. And then we took the gold off. I mean, I don’t know. I am ashamed that we did that.

David: But what you’re talking about is decisions that were made that were rationalized at different points along the way. And each one of those decisions were justifiable at the time—or the attempt was made to justify them.

Kevin: Right.

David: You’ve got the Conference of Genoa in 1922. You’ve got the Trading with the Enemy Act of 1933. You’ve got Bretton Woods in 1944. You’ve got the end of Bretton Woods as we get to the breakdown of that system in the late ’60s and the closing of the gold window in ’71. It’s a series of compromises that move you from capitalism to creditism, that prioritize the creation of more money and focus on quantity over quality. 

But it’s not like we’re divorced from that reality in the rest of our lives, is it? So much in our lives is oriented to amassing things. Quality doesn’t matter, quantity does. And whether that’s the quality of construction of a home, we prefer a bigger footprint and more square feet versus smaller, condensed, and higher quality. You understand this is what happens when you fall in love with falsehood. I know—

Kevin: But when you abuse that trust—

David: I’m pushing—

Kevin: An egg [unclear] eight bucks a dozen, you know?

David: I know, but I’m pushing back on the US dollar being reprehensible in some way or us having abused a global system.

Kevin: Well then, just give me my gold. That’s all I care about. However you look at it, just give me my gold.

David: We’re talking about human delusion, which is expressed over time with compromises made all along the way. And what started out as an ideal, something that was fairly stable, moves towards something that is ultimately unsustainable, unstable, and breaks down. And you know what we’re going to do again? We’ll have a great currency system. Is it the US dollar system or some other system? I don’t know. But the next reserve currency system will be legitimate and sound because this system is failing. I’m not talking about failing today or failing tomorrow. The recurring theme is one of abuse of trust and subsequent repudiation. 

That’s happened with every reserve currency that’s ever existed: abuse of trust, subsequent repudiation. The recurring themes include how that repudiation is measured in terms of currency values and rates of interest all over the world. So when you start looking at interest rates, you think to yourself, “Who cares about the cost of money?” This is the stuff that drives wars, that causes insolvency and national bankruptcy, corporate chaos. Something as simple, mundane, seemingly as boring as an interest rate is what drives the world.

Kevin: So with this meeting this week with the BRICS, no way could they take responsibility for the demise of the dollar if that happened. I mean, it’s the abuse of trust.

David: No, they’re not responsible for the dollar’s demise. Each one of those countries is doing that to themselves.

Kevin: True. True.

David: They’re destroying themselves. It’s not like they’re holding themselves up and saying, “We are the standard-bearer. Come follow us.” Have you stopped to look at or consider the strength of the real, the strength of the ruble, the rupee, the renminbi or the rand?

Kevin: Right.

David: It’s a bad joke to think that aggregated weakness is somehow a force to displace the currency markets or the currency system that we have today centered around the US dollar. No. They are each their own version of a train wreck, and we are too. We’re not a train wreck because of them, but because we all share something in common. Bad ideas often have bad consequences. And those ideas are not accidental to our policies. They are structurally integrated into them. The new regime we’re talking about is a forced embrace of logical consequences and bills past due.

*     *     *

You’ve been listening to the McAlvany Weekly commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com. That’s 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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