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Loose Conditions, Excess and Fed Accommodation – October 30, 2025
David: Good afternoon. Thank you for participating in our third quarter 2025 recap conference call for Tactical Short. This is October the 30th, and we’re grateful for your joining us. As always, thank you to our valued account holders. We so greatly value our client relationships.
The objective of Tactical Short is to provide a professionally managed product that reduces overall risk in a client’s total investment portfolio, while also providing downside protection in a global market backdrop with extraordinary uncertainty and extreme risk.
I just want to double-check and make sure that everybody has been let into the audience. Ted, can you confirm that? I am going to assume so unless I’ve heard otherwise.
Okay, so beginning: our Tactical Short strategy began and ended the quarter with short exposure targeted at 82%, focused on the challenging backdrop for managing short exposure. A short in the S&P 500 ETF, that is the SPY, remains the default position for high-risk environments. I’ll give you an update on performance and then pass the baton to my colleague, Doug Noland, and then we will handle Q&A together at the tail end.
So updating performance, Tactical Short accounts after fees returned a negative 6.56% during Q3. The S&P 500 returned a positive 8.11. For the quarter, Tactical Short accounts lost 81% of the inverse of the S&P 500’s positive return.
As for one-year performance, Tactical Short after fees returned negative 12.54 versus the 17.56 return for the S&P, Tactical Short losing 71.4% of the S&P’s positive return.
We regularly track Tactical Short performance versus three actively managed short fund competitors. First, the Grizzly Short Fund, which returned a negative 1.24% during Q4. Over the past year, Grizzly’s return has been a negative 5.12. Ranger Equity Bear Fund returned a negative 3.13 for the quarter and a negative 5.42 for their one-year return. Federated Prudent Bear returned a negative 6.16 during Q3 and a negative 11.64 for the one year.
Tactical Short underperformed the actively managed bear funds for the quarter on average by 305 basis points. Tactical Short underperformed over the past year by an average 515 basis points. Tactical Short has significantly outperformed the bear funds since inception. From the April 7th, 2017 inception through the end of June, Tactical Short outperformed each of the three competitors by an average of 1,654 basis points or 16.54 percentage points. Doug, over to you.
Doug: Thanks, David. Hello, and thank you everyone. It was another extremely challenging quarter—the ongoing confluence of speculative markets, highly elevated risk, and worrying developments. With market risk at what I view as extreme levels, I hesitate to reduce exposure. The wide short exposure trading band I’ve discussed in previous calls was a drag on Q3 relative performance.
A pat on the back to the competitor funds, they dodged a powerful short squeeze as the Goldman Sachs Most Short Index posted a 24% gain for the quarter. Tactical Short underperformed for the quarter and over the year, over the past year. Most of the year’s underperformance is explained by our competitor funds benefiting from an approximate 400 basis point annual return on proceeds from short sales. Loose conditions, excess, and Fed accommodation. Where do I even begin? We live in such incredible times—we’re witness to a steady drumbeat of extraordinary developments—that it’s somehow come to almost seem normal. For most, an ever-rising stock market is a normality.
This government shutdown is now one of the longest in history, the latest example of the breakdown in functional governing. It is no exaggeration to say deficits are spiraling out of control. More generally, warnings are blaring everywhere within credit markets, the economy, societal well-being, and political and geopolitical stability. Meanwhile, we’re witnessing historic manias in AI, crypto, and financial instruments more generally. As I say, things turn crazy at the end of cycles. The intensity of recent folly is consistent with a historic cycle’s dramatic concluding act.
The big picture is one of an unprecedented three decade-plus credit bubble and monetary disorder dating back to the late ’80s decade of greed excess. One of my messages today is that complacency is inherent to late-cycle dynamics.
My interest in bubbles dates back to my experience as a treasury analyst at Toyota’s US headquarters in 1986, ’87. At the time, Toyota Management was concerned that a problematic bubble had taken hold in Japan. Loose monetary policies and an investment-led economic boom were fueling extraordinary asset inflation—most conspicuously in stock market and real estate bubbles.
At the time it appeared that the 1987 stock market crash had abruptly brought bubble inflation to a conclusion. While not as dramatic as the 22.6% one-day drop in the Dow, Japan’s Nikkei 225 index was down 23% from highs to end 1987 at 20,500.
But something extraordinary unfolded that I still find absolutely fascinating. The Nikkei almost doubled in two years to end 1989 at 38,957 while already inflated real estate prices also roughly doubled. That was my first experience with what I would later label terminal phase excess—somewhat along the lines of the great Austrian economist Ludwig von Mises’ crack-up boom. The compact explanation? Years of gratifying excess lay the foundation for exuberance, risk-taking, and manic behavior to go off the rails to doom long cycles.
The 1989 year-end high in Japan’s Nikkei would not be surpassed for over 34 years—a period where deep post-bubble financial and economic structural maladjustment would see Japanese policymakers resort to decades of reckless, ultra loose monetary and fiscal policies. Inflationism’s upshot is a Japan today in a more dire predicament than in 1989.
After the 1987 stock market crash, there were fears of another U.S. economic depression. Instead, Fed accommodation and loose conditions fueled our own late ’80s terminal phase. The bursting of the late ’80s bubble would reveal massive fraud and recklessness at the savings and loans. Michael Milken, Drexel Burnham, and junk bond market crimes and shenanigans. Ivan Boesky, LBO madness, and pervasive insider trading; awful loan underwriting, fraud, and deflating real estate bubbles along both coasts.
The 18th largest US bank, Bank of New England, imploded in 1991. There were serious concerns for City Corps and other major financial institutions. Having witnessed in the US and Japan parallel cycles of bubble excess, market dislocation, monetary accommodation, late cycle bubble excess, and subsequent painful bubble collapses, it was clear that there were extremely consequential bubble dynamics that I had to understand. I’ve discussed this previously.
The fascination with bubble analysis drove my long and deep dive into understanding America’s preeminent bubble experience: the first world war inflation that evolved into historic Roaring Twenties excess, the 1929 market and financial crash, and the Great Depression. In past calls, I’ve discussed in some detail alarming parallels between that experience and today’s multi-decade bubble. In short, one cannot overstate the consequences of the interplay of phenomenal technological advancement and financial innovation and evolutionary changes in monitoring management.
For this call, I will offer context for current terminal phase excess and the general disregard for risk in the face of mounting fragilities. Years ago, I read all the contemporaneous accounts of the late ’20s period I could find, and the more I studied, the more confounding and fascinating it all became. How could everyone have been blindsided, got so exposed and unprepared in 1929?
At some point I stumbled upon writings from a journalist who had interviewed a group of Wall Street traders after the crash. He wanted to understand how they could have failed to recognize the dangers associated with speculative excess, all the margin debt, the leveraged trusts, Wall Street Chicanery, deteriorating economic prospects, and such.
I was struck by the commonality of their responses. It was not that they were unaware. Most had recognized the gravity of market excess. Concerns had intensified, especially during 1927 market and economic instability. But these Wall Street traders conveyed something quite profound and especially pertinent for bubble terminal phase analysis. They admitted that you can only worry about such things for so long, explaining that surging stock prices eventually compelled all those operating in the markets to disregard risk.
Terminal phase excess is a period of intoxicating wealth accumulation. I’m talking late night whiskey shots rather than evening wineglass tipsiness. Just look at these days at how hefty market returns continue to inflate investment accounts across the population. Just ponder the incredible amounts of money that Wall Street firms made during Q3 and over the past year. Earnings that feed huge compensation for traders, investment bankers, asset managers, structured finance specialists, corporate managers, and executives.
There are also the energized commercial bankers and loan officers, along with those working in booming FinTech and crypto, those engaged in private credit and private equity. There are tens of thousands employed across investment management that have never had it so good. The investment arms of insurance companies are printing money, and let us not miss booming professions supporting this great asset inflation, including attorneys, accountants, consultants, and real estate and insurance agents. Millions have watched their net worth inflate tremendously, especially recently. Generations ago, economists referred to this inflationary phenomenon as money illusion.
Terminal phases are dominated by loose conditions and liquidity overabundance. Importantly, liquidity will always chase inflating prices, with finance habitually flooding into booming markets. When everyone is making so damn much money, they’ll simply ignore risk until some development smacks them in the face. Reminded again of bubble insight from the great American economist Charles Kindleberger, I’ll paraphrase: Nothing causes more angst than watching your neighbor get rich.
My hope for this call is to help bridge the divide between what many of us recognize as extraordinary risk and unmistakable evidence of systemic fragility versus bullish consensus view that downplays or dismisses things we know are so important. It is not that we don’t learn from history, but, especially when it comes to bubbles and inflating market and asset prices, the learning process is of the short-horizon variety in such a confounding and uncertain world that has never been as important to adopt a historical perspective.
The seeds for today’s spectacular terminal phase were planted when the Greenspan Federal Reserve responded to the late-’80s bubble collapse with a then-dramatic loosening monetary policy—easy money that stoked fledgling bubbles and securitizations, the GSEs derivatives, repo, money market funds, hedge funds, and Wall Street securities finance.
It was the genesis of the so-called shadow banking apparatus that continues its runaway expansion despite being at the epicenter of the great financial crisis. Just a couple of weeks ago, the IMF warned of mounting bank exposure to hedge funds, private credit, and other non-bank financial institutions.
The Greenspan Fed’s extraordinary market intervention sowed the seeds for 1994 bond market and derivatives mayhem, the so-called Tequila Crisis and Mexican bailout, and later in 1998 with the collapse of the egregiously levered Long Term Capital Management run by its genius Nobel laureates. The Fed-orchestrated LTCM bailout triggered 1999’s almost doubling of NASDAQ.
Tech bubble terminal phase excess ended with spectacular bubble implosion, including collapses in technology stocks and the likes of WorldCom, Global Crossing, Mcleod, and other highly levered telecommunications operators and scores of dot-com darlings.
Loose money and Wall Street finance propagated one of the biggest US corporate swindles. The Enron fraud unraveled in 2001. [Unclear] and Superior Bank and [unclear], along with accounting heavyweight Arthur Andersen. Subsequent post-tech bubble monetary easing made Alan Greenspan’s early ’90s cuts to 3% look timid. Rates were held at 1% until June 2004, despite double-digit annual mortgage credit growth in 2001, 2002, and 2003. Moreover, rates were slashed 325 basis points in eight months after the 2007 subprime eruption, a dramatic loosening that prolonged terminal phase excess.
The 2008 bursting revealed an absolute fiasco of reckless lending, leveraged speculation, derivatives abuse, and seemingly systemic financial fraud and misconduct. Major collapses include Bear Stearns, Washington Mutual, insurer AIG, and of course Lehman Brothers with its 640 billion of assets.
I first warned of the unfolding global government finance bubble in April 2009 with outstanding Treasury debt at 6.2 trillion and a then-plump 2.1 trillion Fed balance sheet. The Federal Reserve had just unleashed an unprecedented 1 trillion of liquidity. It was clear that Washington’s desperate policies to reflate the markets and economy had crossed the Rubicon.
Having scrutinized dynamics during the ’90s and again following the burst tech bubble, all the makings were in place for a super bubble to inflate at the very heart of finance—central bank credit and government debt. And with this perceived safe money and credit, and enjoying insatiable demand, this bubble had unique potential to run longer into greater excess than all previous bubbles.
Today, Treasury debt is approaching 29 trillion, with the Fed at about 6.6 trillion. It recently took just 71 days for federal debt to grow an additional 1 trillion, the fastest pace ever. Previously unimaginable monetary inflation and resulting disorder unleashed myriad forces now completely out of control. Epic crazy has become deeply entrenched. Stock prices inflate to ever higher highs fueled by a steady flow of trillions into stocks, mutual funds, and ETFs. Equities have come to be recognized as a no-lose proposition. Millions have discovered that you trade options to really juice returns. High-risk lending has boomed like never before, exemplified by trillions of leverage loans and private credit.
To be sure, speculative excess has entered uncharted waters notably tech stock, AI, and crypto-manias. In the dark shadows, leveraged speculation has reached unprecedented heights, with tens of trillions of basis trades, carry trades, and leverage strategies propagating across virtually all markets everywhere.
Excess long ago passed the point of no return. It is when, and not if, myriad bubbles burst. Again, my love affair with macroanalysis took hold in 1987, mesmerized by the Telerate machine on Toyota’s US trading desk. I will never forget summer of 1987, market instability that culminated with that October’s Black Monday crash.
Curiously, Citadel’s Ken Griffin a couple of weeks ago reminded an audience that the ’87 crash was without a clear catalyst. There was similarly no catalyst for Black Monday, October 28, 1929. As I’ve discussed in previous calls, parallels between the two Roaring Twenties are as striking as they are frightening. Both were culminations of protracted cycles characterized by epic technological advancement and innovation intricately connected to equally phenomenal financial development. Momentous credit expansions characterized both periods. In both, the Federal Reserve was fundamental to such energized and prolonged cycles.
The Fed began its operations in 1914 at the onset of a major world war-related inflationary cycle. The perception of a central bank committed to actively backstopping system stability was essential to confidence that crystallized on Wall Street and throughout the economy. Bubble excess got out of hand in a world experiencing monumental change in stability and disorientation.
In 1927, New York Fed President Benjamin Strong’s infamous coup de whiskey injected liquidity into an already dangerously speculative marketplace, triggering a fateful two-year speculative blow-off. Caution was thrown to the wind. Faith in the Fed backstop spurred a fateful mania that saw bullish perceptions completely detached from deteriorating fundamental prospects and escalating systemic risk. The Roaring Twenties finale? Finance became deranged: precarious speculative excess—too much on leverage—that was financing a manic upsurge of new paradigm investment spending and resource misallocation.
The 1929 stock market crash and financial crisis revealed epic fraud, financial chicanery, and malinvestment. As is said, history may not repeat, but it sure rhymes. Today’s backdrop shares too many unnerving parallels to 1929. Having for more than three decades watched this historic bubble inflate to ever-greater extremes, it’s astounding how closely developments have followed the Roaring Twenties playbook.
A powerful new central bank was paramount to the twenties bubble era. While the new ultra-powerful QE reflationary tool has been fundamental to this era, the $5 trillion COVID period monetary stimulus coupled with egregious fiscal stimulus, now that’s a whiskey double shot with beer chasers.
Fundamental to bubble analysis is the maxim that given sufficient time and monetary accommodation, a cycle of credit growth, loose conditions, speculation, and risky lending will invariably run completely amok. The third quarter was replete with notable financial excess that I’ll share in some detail.
Investment grade corporate bond issuance jumped to 208 billion in September alone—a September record and the second-largest month excluding COVID. Investment grade bonds traded to the narrowest spreads to Treasuries since 1998, reflective of incredibly depressed risk premiums throughout the markets. The strongest weekly issuance in five years powered high yield junk September issuance to 58 billion, one of the busiest months ever. Q3 volume of 118 billion was the strongest since 2021. The quarter saw almost 400 billion of leveraged loan launches, an all-time high. At 161 billion, year-to-date collateralized loan obligation—CLO—issuance was 10% ahead of booming 2024. Private credit CLOs were sold at record pace.
Fueled by loose conditions and booming debt markets, M&A activity has been on fire. Global deals surpassed 1 trillion during Q3 for only the second time. At 3 trillion, year-to-date activity is up 27% from last year to the strongest pace since 2021. More than 255 billion was raised in the equities market during the first nine months of the year, also the most since COVID. The 55 billion buyout of Electronic Arts greatly exceeded the previous record set while debt markets were still dancing in 2007—the $32 billion buyout of utility TXU.
It would not be surprising if Q3 Wall Street earnings represented a high-water mark for years to come. Goldman net revenues were up 20% year over year to 15.2 billion, with earnings per share up a staggering 46%. Global banking and markets revenues were up 18%. Investment banking fees surged to 42% to 2.7 billion. Assets under management surged 159 billion to 3.34 trillion.
JPMorgan’s revenue was up 9% to 47 billion, with 14.4 billion of net income. Market trading was 25% higher, to a record 9 billion. Investment banking fees were up 16%. Client assets inflated 20% year over year to 6.8 trillion. At Bank of America, revenues were up 11%. Year-over-year investment banking fees surged 43%.
Charles Schwab Q3 revenues were 27% higher year over year to a record 6.1 billion. Net new assets were 48% higher at 134 billion, as daily average notional trading volume surged 30% to 7.4 trillion. BlackRock revenues were up 25% to 6.5 billion. The company saw 205 billion of net inflows during the quarter, a more than fourfold increase from Q3 ’24. Assets under management reached a record 13.5 trillion.
The Fed’s Q3 Z1 won’t be available until December, but Q2 data illuminate the scope of ongoing historic financial excess. The financial sector has been firing on all cylinders, the most powerful growth dynamic since peak mortgage finance bubble. Banking system loan growth surged to 316 billion during Q2, or 8.4% annualized, the quickest pace since 2022. Loans, chiefly to business, expanded 16.4% annualized, with one-year growth of 10.4%.
Meanwhile, Wall Street left notably strong bank lending in the dust. Broker dealer assets expanded 259 billion, or 18% annualized, during Q2, for a record 6 trillion. Over one year, assets surged 849 billion, or 16.4%. In 11 quarters, assets ballooned 1.6 trillion or 36%.
During Q2, the asset broker-dealer loans jumped to 75 billion, or 41% annualized. Loans were 21% higher year over year. Broker dealer security holdings surged 106 billion for the quarter, or 36% annualized. These holdings were up 316 billion, or 33% in a year, and 677 billion—more than doubling—over 11 quarters.
Wall Street has been leaning on the repo market to finance ballooning balance sheets. Repo liabilities ended Q2 at 2.71 trillion, the high since Q3 2008. Over one year, repo liabilities inflated 333 billion, or 14%, with 11-quarter ballooning of 1.1 trillion or 68%. Total system repo assets jumped 291 billion, or 15% annualized, during Q2, for a record 8.1 trillion. Repo assets inflated 1.1 trillion, or 16% year over year, and 3.3 trillion, or 68% over 22 quarters.
Rapid financial sector expansion feeds asset inflation and inflates household perceived wealth, in the process boosting spending and economic activity. While robust corporate earnings are viewed as confirmation of the bullish thesis, they are a direct consequence of financial excess. Household net worth—assets less liabilities—jumped to 7.1 trillion, or 17% annualized, during the second quarter to a record 176 trillion. Illuminating historic late-cycle bubble inflation, net worth was up a staggering 10 trillion over one year, 30 trillion over three years, and 65 trillion, or 59%, over 21 quarters.
Household net worth rose to a non-COVID record 581% of GDP, compared to previous cycle peaks of 487% in Q1 2007 and 443% for Q1 2000. American households have never enjoyed such a stock market bonanza. Household equities holdings surged 3.7 trillion during Q2 to a record 42 trillion, with three-year growth of 15 trillion, or 56%. Total equities and mutual fund holdings expanded to a record 180% of GDP compared to previous cycle peaks of 105% and 116%.
I wish there were some flaws—and deep ones—here in the analytical framework, but there is consistent and irrefutable thesis confirmation, unrelenting Washington debt growth, booming high-risk lending, conspicuous market excess, egregious amounts of leveraged speculation, demanding AI arms race, the crypto mania, and so on. It would be somewhat less concerning if markets demonstrated the capacity for orderly adjustment, but the opposite is true. Markets become only more dismissive of risk and detached from the reality of extreme uncertainty, underlying fragility, and waning prospects.
The world’s preeminent banker, JPMorgan’s Jamie Dimon, recently offered a warning, “I probably shouldn’t say this, but when you see one cockroach, there are probably more. Everyone should be forewarned on this.” He also said, “My antenna goes up when things like that happen.” Dimon was referring to the swift collapse of First Brands.
I’ll try to explain why the First Brands fiasco is a big deal. I have compared it to the June 2000 collapse of two Bear Stearns credit funds that had invested in subprime mortgage derivatives. That event basically terminated subprime mortgage excesses, marking an inflection point in the mortgage finance bubble.
The Bear Stearns subprime eruption proved so consequential because it revealed the scope of egregious excess, especially the revelation of the critical role Wall Street structured finance had played in the intermediation of risky mortgages, what I refer to as the Wall Street alchemy transforming high-risk loans into mostly perceived money-like instruments. This apparatus works miraculously until increasing precarious schemes collapse under their own weight, until the associated finance becomes too malignant.
In the case of the Bear Stearns funds, it was subprime CLOs. The blowup of these two funds shattered perceptions and effectively ended what had become the critical source of finance to the marginal home buyer. The cycle reversed when marginal borrowers lost access to mortgages. Inventory piled up and prices declined, buyers backed away. Terrible underwriting and widespread fraud were revealed, and, much belatedly, the regulatory environment shifted. The bubble was doomed.
While not huge, First Brands is a microcosm of key facets of this cycle’s excess. It encompasses banks, Wall Street firms, hedge funds, flimsy structured finance, private credit, business development companies, leverage, so-called FinTech, invoice and supply chain finance, insurance companies, credit insurance, CPA firms, rating agencies, and a complacent investor community.
The collapse revealed that, across the spectrum of players, a boom time ethos prioritized money-making above analysis and sound business practices. Loan underwriting was woefully deficient, as was the accounting and due diligence across the intermediation process.
First Brands was willing to pay high borrowing rates for billions of liabilities, affording profit opportunities for layers of enterprising operators. It worked miraculously until the scheme collapsed. Remember that it was 15 months between the subprime eruption and the October 2008 financial crisis. Credit tightening at the periphery takes time to gravitate to the core, especially during periods of loose conditions and central bank accommodation. Indeed, aggressive Fed rate cuts sustained bubble excess in 2007’s second half, with declining AAA-rated mortgage-backed security yields sustaining risky lending for prime mortgages. System credit growth remained highly elevated into 2008, with stock prices reaching record highs in October of 2007, months after the fateful subprime collapse.
We’re witnessing similar dynamics now. The drift higher in global yields ended abruptly a few weeks back with the First Brands news. 10-year Treasury yields dropped last week to a one-year low of 3.94%, despite a 3.9% Atlanta Fed GDPNow forecast and ongoing inflation risks. Markets now assume a more aggressive rate cutting cycle, and yesterday the Fed announced the end to its balance sheet drawdown.
Fed accommodation is in this call’s title for good reason. More than a year ago, in September of 2024, the Fed began cutting rates despite loose conditions and conspicuous market excess. And over the past 13 months we’ve witnessed historic bubble inflation go into high gear, notably in AI, leverage lending, and private credit. NVIDIA stock inflated almost 80%. For Oracle, 65%. The semiconductor index has returned almost 50% since the Fed’s first cut, boosting three-year gains to over 200%.
It’s important to note that money market fund assets inflated 1.09 trillion, or 17%, since that first cut, expanding another 30 billion last week to a record 7.4 trillion. Just over the past eight weeks, money funds inflated 191 billion, further extending one of history’s great monetary inflations, one I linked directly to the expansion of leveraged speculation and repo market borrowings, especially over the past year. This now-international phenomenon has stoked global liquidity overabundance. That the Fed and global central bank community are slashing rates despite historic leverage speculation is a perilous bubble dynamic.
I have previously highlighted the trillion-plus hedge fund basis trade where extremely levered Treasury positions are financed in the repo market. Interestingly, Federal Reserve researchers recently released a report where they estimate that hedge fund holdings of Treasuries domiciled in the Cayman Islands ended 2024 at 1.85 trillion, fully 1.4 trillion more than tabulated in Treasury data. This position had doubled in two years. Amazingly, this places the Cayman Islands as the largest foreign owner of US government securities, ranking ahead of China, Japan, and the UK.
From this revelation, I’ll offer a few inferences. For one, estimates that hedge funds held a massive 3.4 trillion Treasury position in 2024 likely grossly [under]estimates actual holdings. Second, Fed analysis further confirms that basis trade and other Treasury leveraged speculation ballooned starting in 2022, coinciding with the historic inflation of money market fund assets. Third, leveraged speculation has become critical to financing massive fiscal deficits and is also a primary culprit behind over-liquefied speculative market bubbles. This is such a precarious market structure.
I’ll try to tie these various analytical threads together. In its semi-annual global financial stability report, the International Monetary Fund issued strong warnings. The IMF believes the time has come for forceful oversight of non-depository financial institutions, or NDFI, the so-called shadow banking universe, which includes hedge funds, private credit, private equity, credit funds, insurance companies, and others. Quoting from the IMF, “Beneath the calm surface, the ground is shifting in several parts of the financial system, giving rise to vulnerabilities.” Banks are increasingly lending to private credit funds because these loans often deliver higher returns on equity than traditional commercial and industrial lending.
From IMF data reported by the Financial Times, banks in the US and Europe have four and a half trillion of exposure to hedge funds, private credit groups, and other non-bank financial institutions. The IMF report was released three weeks after the First Brands’ bankruptcy. A week following the IMF, Bank of England Governor Andrew Bailey issued similar but notably more urgent warnings, stressing that alarm bells were ringing. I’ll share some of his important comments:
“We certainly are beginning to see, for instance, what used to be called slicing and dicing and tranching of loan structures going on. And if you were involved before the financial crisis, then alarm bells start going off at that point. Wall Street’s practice of packaging subprime mortgages into asset backed bonds fueled the 2008 financial crisis, with years of loose lending standards leading to a crash in the value of these assets when US house prices fell.
“In the run-up to the crisis, bankers and investors had regarded many such complicated financial products as virtually riskless. The perception encouraged large institutions to borrow heavily against their holdings. If you go back to before the financial crisis, when we were having a debate about subprime mortgages in the US, people were telling us it was too small to be systemic. That was the wrong call.”
Bank of England Deputy Governor for Financial Stability Sarah Breeden added her own warning: “We can see the vulnerabilities here, the opacity, the leverage, the weak underwriting standards, the interconnections. We can see parallels with the global financial crisis. What we don’t know is how macro-significant those issues are.”
First Brands’ revelations have altered credit cycle dynamics. The quiet part is now being said out loud, and it’s being spoken at an elevated volume by top central bankers and financial regulators. Providing additional perspective, the Financial Times last week highlighted analysis from JPMorgan, noting that the First Brands and Tricolor collapses had raised bank funding costs. “High profile collapses have highlighted their complex and often opaque financial arrangements between banks and non-depository financial institutions.”
The article underscored a key development. Regulators have become increasingly concerned about the interconnectedness of banks and NDFI. I believe a consequential tightening of high-risk lending is afoot, though ongoing market exuberance is currently masking it. Banks will tighten loan underwriting, with the leveraged lending crowd forced to adopt a more cautious approach. Importantly, the opacity and leverage that provided a boom time advantage for private credit will increasingly prove a hindrance. And a tightening of subprime finance will become problematic for scores of levered and negative cash flow borrowers whose existence depends on readily available new finance. And over time, I expect revelations of widespread imprudent loan underwriting, along with historic quantities of fraud and financial shenanigans. The credit cycle has not been repealed. The old Austrian economists warned that the pain associated with the bust is proportional to the excesses of the preceding boom.
And this is what really worries me. Trillions of basis trades and speculative leverage have created seemingly unlimited liquidity—liquidity that has helped finance a historic AI arms race. Looking ahead, the AI and energy infrastructure build out world will require many trillions of additional borrowings. So far, much of the required AI finance has been from or associated with the cash-rich tech oligarchy. Going forward, much of the trillions required will have to come from the credit market and financial institutions.
Future AI arms race profits are highly uncertain, if not dubious. Trillions of borrowings will be of high-risk nature. Especially when the AI mania breaks, I doubt markets in the financial system will be willing and able to take on such colossal amounts of risky debt.
Meanwhile, there is this perilous issue of bond market and credit system leverage. The bout of de-risking/deleveraging will expose vulnerabilities to marketplace illiquidity and dislocation. We saw elements of this dynamic start to unfold during April market instability. The April [unclear] illuminated the tight correlation between deleveraging fears and aggressive selling of tech and AI related stocks.
Importantly, the AI arms race build-out is dependent on ongoing market exuberance and liquidity abundance. So long as terminal phase excess continues, the AI arms race appears miraculously feasible. Meanwhile, this bubble is uniquely vulnerable to a shift in market perceptions. A surprise market derisking/deleveraging would immediately expose the fragile high-risk nature of AI finance, history’s greatest subprime lending bubble.
I’ll wrap this up with a concise summary. AI and tech are history’s greatest mania, and throw in crypto for good measure. The leveraged lending and private credit booms are the greatest high-risk lending bubble ever. US and global sovereign debt is history’s most spectacular credit bubble. And basis trades, carry trades, and myriad levered credit market strategies comprise the most colossal leveraged speculative bubble. I often say, “I hope I’m wrong.” I’m not wrong on this. Timing remains unknown, but this will end very badly.
David, back to you.
David: Thanks, Doug. Appreciate the insights and the historical perspective. It is absolutely critical to see current events and the nature of market cycles to appreciate natural limits.
So we’ll go into Q&A, and if there’s questions that go beyond the scope of what’s been already submitted, we’re always available in coming weeks to meet with you one-on-one and to have those dialogues directly.
Don asks, “Where do you see gold going?” By the way, there’s a number of questions here that seemed more appropriate for me to answer, although we’ll try to get Doug the mic as often as possible. So gold, where do we see it going? I would say this post-correction, and I do think we have an ongoing correction in the metals price. Post-correction, this is where I’ll pick up my comments.
It’s our observation that gold moves to varying degrees for a variety of reasons, with one common theme being a breakdown in confidence, essentially an erosion of trust. That may take the form of public policy wobbles or geopolitical tensions or financial market fear and panic or erosion of faith in a currency.
The reason we always frame gold as wealth insurance is that interest picks up intangible assets, particularly gold, when something is not quite right, when confidence is shaken. It can be for a variety of reasons, individual reasons or a whole mess of reasons together. But again, it’s a reflection of a breakdown in confidence and an erosion in trust.
We had the pickup in central bank buying as the US Treasury challenged certain reserve manager assumptions about custodial autonomy and independence back in 2022. That was followed by several years of significant emerging market central bank buying, and strong Chinese buying as well.
Where we see gold going is predicated on dysfunction and it’s on dysfunction continuing at the policy level—that’s both domestic and international—and I think dysfunction in the financial markets as well. Thus far, the allocations to gold by western investors have been marginal—de minimis, believe it or not. Financial market dysfunction on par with the year 2000 or the period of the global financial crisis, 2008 and ’09 I think would increase investor demand, and that demand would then be in competition with price-insensitive central bank buying.
So to the nub of the question, I think those combined elements drive gold towards 10,000 an ounce. We speculate internally that 8,000 is the right number, but momentum has a way of creating its own energy, and there are certain circumstances where you could argue there’s really no cap. I say that because I was reminded in conversation with a colleague this week, gold is the only tangible asset that can be crowded into without an adverse economic effect. Contrast that with oil. Oil spikes, they rearrange household inflation, they squeeze corporate profit margins. Any other commodity frankly has a similar negative economic impact when it spikes. In that sense, gold is the only tangible asset that will not face political pressure to end its rise. So is it eight to 12,000? Is it 17 to 20,000? I know those numbers sound silly today, but we still don’t know the currency effects from fiscal and monetary policy choices from the G-10 intent—and this really goes beyond the U.S—the G-10 intent on managing unmanageable deficits and debts.
So if currencies move lower a little, and on the other side of that gold moves up a lot, currencies move lower a lot, and that’s when you see simply no cap on the price. I’m not in the camp that would expect a super or hyperinflation, but let me just illustrate where we have our minds blown in terms of price action in a particular commodity. And again, I don’t subscribe to a hyperinflationary future, but again, it serves to illustrate this point of removing price caps. Prior to 1914, an ounce of gold could be purchased for 87 German marks. By 1923 at the height of the hyperinflation, it was approximately 87 trillion German marks.
It’s really a function of the currency. We are in a unique environment, a post-Bretton Woods world where we no longer have global currencies anchored to the dollar and the dollar anchored to gold. There is no stability reference in the global currency markets, and we have, as I mentioned earlier, the G-10 with comparable issues to our own—too much debt and unwillingness on the fiscal side to cut deficits because of the political costs involved. And so for us, under normal circumstances, it’s eight to twelve thousand, in answer to that question.
Marcel asks, “What is the easiest way to track the gold and silver ratio? I can go look up both, but I’m sure there’s an easier way.” Actually, that’s exactly what I do. I just grab a calculator when I check my vaulted app and you take the spot price for gold, divide by the spot price of silver. Today it’s 82 to one and just get used to doing the calculation. It’s just as fast as searching the web for it.
Again, a number of these questions are gold related, so I’m going to just crank through them very quickly. Gail asks, “Please describe and explain to us how you can take a portion of your gold coin portfolio and use it to make purchases to take advantage of ‘purchasing goods on sale’ as David referenced?” I think what she’s saying is something I’ve said repeatedly in the Weekly Commentary, my podcast, and I usually think of this in terms of shares in the Dow Jones Industrial Average. So three ounces of gold for one share of the Dow or two ounces of gold for one share of the Dow or one ounce of gold for one share of the Dow. And so, I generally think of goods on sale as the assets of a company when they’re being compressed in value, but let me try to illustrate it differently with something that’s more of a consumer good.
I bought an Airstream travel trailer for my family in 2018, bought it used and I sold ounces of silver to do it. In 2018, it cost me 4,000 ounces of silver for my silver travel trailer. Today, that same trailer, if you bought comparable age and comparable use and all of that, it would cost me 1,315 ounces of silver instead of the 4,000. That is, if you do the math, a 66% discount in silver terms. So the question of purchasing goods on sale, the Airstream’s on sale if you’re saving in gold and silver ounces. If you’re saving in USD terms, the nominal price is the nominal price.
So the gold and silver owner is already getting the world on sale. I think the gold and silver investor will have an opportunity to own financial assets, coming back to the Dow, at those kinds of discounts as well. We intend to help our clients navigate that transition, reduce metals holdings to convert to, for instance, dividend paying stocks at very compressed values. I would just say stay tuned to keep in touch. That’s why we launched our asset management group in 2008 in anticipation of an amazing transition.
Again, I apologize, there’s a number of questions here on gold, so I’ll just continue on. “If and when there’s a crash in Wall Street equities, will gold go down this time to cover margin calls, and if so, how much?” Alvin, thanks for the question. The relationship you’re suggesting is a correct one. It typically does. It typically does. If the equity narrative continues to cast a delusional shadow across the minds of investors, they will prefer to keep their risky bets and jettison liquid assets to do so.
This is what we saw in 2008 and 2009. You sold the liquid asset to keep the bad bet in play because you weren’t willing to accept the fact that you were wrong about the asset which you had done pro forma math on and figured it was going to take you to infinity and beyond. Again, you could see that same thing happening in the ‘2000 period where you get rid of your cash, you use your cash to keep your margin accounts going, you keep the bets until that point where you’ve got to backtrack. So once the shadow and the delusion fades, there’s typically a scramble back towards the liquid and counterparty-free asset like gold.
That might be a tradable event in the futures market, but I wouldn’t count on it in the physical metals market. What we saw in 2008 and 2009 is that premiums on physically deliverable product for immediate delivery, premiums went up significantly, and that meant that for immediately deliverable physical gold there was no lower price. It was only in the paper contracts where you saw gold and silver compress in price.
So, how much lower gold would trade in terms of a crash and Wall Street equities, no one knows that. I think what’s different, and this is what I suggested in the earlier question relating to the G10, the audience of buyers in this current cycle is much larger. Certainly, we had a global connection in the global financial crisis, but in 2008 and 2009 you didn’t have a dozen or more central banks and government treasuries impaired to the degree that they are today.
The G10 suffers from debt and deficit problems, and I think a scramble for ounces on a global basis will reveal how thin the gold market actually is relative to all other asset classes. They estimate about $21 trillion in current value. What people don’t appreciate is, that overstates actually available gold. Of course, 21 trillion accounts for everything that central banks own as well. Well, that’s not coming to market anytime soon. So, you’re talking about an exceptionally thin market and I think the circumstances under which Wall Street equities are crashing, you’ve got a more savvy investor base and a broader geography of gold buyers.
Gary asks in the next question, “Seeking wisdom on best decision to protect current wealth at age 82.” I’m going to give you a simple version and then Doug, if you want to add to this, it’d be great. Best decision to protect current wealth at age 82. I’m going to take the most clean-cut approach. And then Doug, if you want to add something, great. Balance out between short-term T-bills and a low-cost precious metals portfolio, I think that’s the most basic approach. If you extend into the stock market, I think hard assets are a critical allocation. That is one of our specialties. But Doug, how would you address the best decision to protect current wealth?
Doug: Hey, David, we obviously think along the same lines here, it’s just a time to protect what we have, be risk averse, so the safety of shorter term Treasuries and precious metals make tremendous sense to me also.
David: One more question on gold and then I’ll pass it to you, Doug. Gail asks, “Why would companies lease or lend gold to other companies?” The easy part of the question, the easy answer is: for the money. Somebody’s got gold and it doesn’t bear income, but you can create an income stream if you encumber it.
So, if you look at both sides of a lease or loan agreement, let me give you a practical example. Say an undercapitalized jeweler. The jeweler is manufacturing product, selling product. They have to have a huge inventory, but if they don’t have enough capital, they know they can make up whatever interest costs they have because they have huge markups on their manufactured products.
So you borrow gold, let’s say you pay a 15% rate, pay interest, and you’ve got the promise to return the gold at some point in the future, and so, you’re on the other side of that. You lend your gold. You might think, this is great, I still own it. You’re no longer in control of it. There’s a wrinkle there, but I’m getting income from my hard asset. This is fantastic.
I’ll just say this, it’s a terrible idea if you own gold as an insurance asset. Now you have gold you can’t get, and imagine this: in the case of the jeweler’s insolvency, you may never get it. So if you own gold as an insurance asset, don’t play any games with lending or leasing, that’s in the category of “might not be there when you need it the most.”
Doug, this one’s for you. “82, have lived with uncertainty all my life, but uncertainty is a factor in market stability. Is uncertainty powerful enough to bring the markets down?”
Doug: Thank you for your interesting question and perspective. I’m sure I would benefit from your insight on what you’ve learned on this important subject, matter of uncertainty, but I’ll share my thoughts.
I used the word “often” in my presentation. To directly answer your question, I would have to say today that markets have become rather immune to even extreme uncertainty. It’s part of the distorted terminal phase excess backdrop I just discussed. In a more normal environment, investors would make decisions through thoughtful evaluation of potential risk, uncertainty, and reward. In periods of elevated uncertainty, they would demand lower purchase prices to compensate for extra risk. But in speculative markets, the focus—I should say fixation—is on anticipated big returns. That’s what dominates. Uncertainties, they’re disregarded. Rising market prices are viewed, they’re the virtual certainty. Sure, there could be some volatility, people believe today, and even some short-term losses, but it is viewed as a certainty that, over time, stock prices will always recover.
Uncertainty should be a major factor in market pricing instability. It’s not, and I point to decades of central bank market intervention and manipulation as the primary culprit. Markets now are dysfunctional. With an open-ended Federal Reserve liquidity backstop, ready to intervene in the markets when the markets are unstable, when the markets need help, the critical issue of uncertainty’s potential, the impact on market prices, these days it’s muted. It’s not on people’s minds.
But this dynamic, it’s problematic. Disregarding uncertainty creates vulnerability to an abrupt change in market perceptions when risks that were dismissed suddenly become a pressing issue. I’ll again use the Fed liquidity backstop as an example. When markets that are disregarding risk because of faith in the Fed suddenly question the capacity for the Fed to guarantee market stability, one-sided markets become vulnerable to panic and dislocation. All of a sudden it’s—I call it the “holy crap” moment. “Oh, we believe this. Uh-oh, maybe it’s not the case.”
Robust markets and economies— In a well-functioning market there’s a natural evaluation of uncertainty that promotes system stability. So, in that environment, it’s a much more robust environment for markets and economies, much less fragility and vulnerability.
In the current era of bubbles and manias and this inherent system fragility, I suspect the confluence of uncertainties will at some point, prove powerful enough to bring things down. Of course uncertainties matter. It’s just when, and the longer you disregard them, the more important they become when they’re recognized. So thank you, sir, for your question.
David: Doug, the next question from Fred is, “In the current fiscal and monetary climate, are quality individual corporate bonds still a wise investment for income? If yes, what changes would cause you to re-evaluate these positions? And how about individual municipal bonds?”
Doug: Well, this is not my area of expertise, but, just from the top-down macro view, my sense is that the corporate bond market today demands, if you’re going to play in that space, intensive individual company and bond analysis along with ongoing focus on market and macro developments. It’s doable, but there’s a lot of work that goes into that. A lot of work.
Risk premiums are extraordinarily low. I mentioned this. Investment grade spreads are near the lowest level since pre-Long Term Capital Management crisis, the summer of ’08 and all that exuberance, summer of ’98 and all that exuberance.
So the current market pricing, these spreads, the risk premiums don’t make sense to me. To me, it’s one aspect of market-wide irrational exuberance, so there’s just little room for air in an environment where a lot could go wrong. I know, for my family savings I prefer to accept an only somewhat lower Treasury yield and wait patiently for opportunities because I think there will be opportunities and that’s key, is to have liquidity to take advantage of those. And I would have a similar view with municipal bonds, which I know very little about, just from macro perspective. I just don’t see yields reflecting today’s extraordinary—the uncertainty in this environment. It seems to me that fixed income in general is complacent, assuming Fed rate cuts and QE ensure ongoing stability. I just believe this confidence is misplaced, so I’m guarded, I’ll put it that way. Thank you for your question.
David: The next question from Michael. “What are the implications for deterioration in the U.S. core for the Australian periphery in relation to credit and systemic financial instability in the Australian credit architecture, which has one of the largest private mortgage credit bubbles?”
Doug: Yeah. First of all, thank you, Michael for your question. And I love Australia, love Australians, so haven’t been paying as much attention as I should to Australia, but I’ll give this a shot.
As you mentioned, Australia has experienced such a long and spectacular mortgage debt and housing bubble. It’s following that. Seemingly, it’s been running in tandem with the multi-decade U.S. bubble. There’s clearly vulnerability there. There’s no doubt about that, especially in the event of a surprising spike in global yields—one scenario, surprising spike in yields. I will say fortunately, Australia’s fiscal position is significantly stronger than what we’re dealing with here in the U.S. Australia’s budget deficit is forecast. I think it’s just under 1% for the year. Debt to GDP of 76%, I see. I know elevated real estate lending remains a serious issue, and household debt, and that’s chiefly mortgages now, it’s in excess of 100% of GDP, and that, as I’m sure you know, is high and potentially—well, not even potentially—it’s problematic.
I assume there’s some carry trade speculative leverage in Australian government bonds, but I have no reason to believe it approaches the level of leverage here in the U.S. and Europe. But I do follow Australian bond yields relatively closely, and it’s a market that, at times, has been quite sensitive to upward pressure on global yields. There’s a volatility in bond yields that suggests to me a speculative component or perhaps it’s just a sensitivity to global yields related to the large systemic mortgage exposure.
I would tend to believe that Australia is not as exposed to potentially problematic debt dynamics as the U.S, but that’s a pretty low bar. My greatest fear is a global crisis scenario where no major economy escapes. With such high household mortgage debt, I would expect the major Australian banks to be vulnerable. From a top-down perspective, I tend to think of resource-rich Australia as somewhat of a port in the storm in the event of a global crisis, but there’s a lot of uncertainty in this view, geopolitical, for starters.
A major global credit crisis would create great uncertainty with commodity prices generally. A disinflationary global credit crunch on one hand or massive QE inflationary response on the other. Two potential scenarios. How the Australian dollar performs in a crisis environment will be key. How the dollar performs. I tend to think in terms of the U.S. dollar as key and in the U.S. at the epicenter of the crisis with the dollar, I would expect the dollar to be under heavy selling pressure. I would expect that to underpin commodity prices, Australian dollar and such. I overweight that scenario.
In such a scenario, a relatively stronger Australian dollar could bolster Australian finance and asset prices. But if crisis dynamics spur a flight to the U.S. dollar, the opposite, you get this flight to the dollar, the periphery, including Australia, would face major financial and economic dislocation. I’m just going to try to follow these developments closely going forward, and thank you very much for your question.
David: Patty asks a question about U.S. Treasuries, who’s buying, what happens if they turn sellers? She says, “Who is buying the United States Treasuries? Is China buying the debt of the United States? Does the United States still hold a debt to China, leaving the United States vulnerable and a slave to China? Can China call in their debt?”
Doug: Thank you for your questions, Patty. The buyers of U.S. Treasuries are somewhat of a mystery, and I don’t even know if I should use somewhat. It’s a mystery. I mentioned earlier the recent Fed analysis that suggests massive hedge fund buying, and that’s on leverage, right? Their report estimates 1.9 trillion of holdings in the Cayman Islands alone, a popular offshore hedge fund destination. I believe hedge funds and leveraged speculators have become dominant, if not the dominant players in financing the U.S. government through highly levered basis trades, carry trades, and such, and these buyers can be domiciled all over the world, funding purchases in the U.S. and foreign repo markets as well as in Japan, Switzerland, and other low-rate jurisdictions.
I mentioned earlier that the Cayman Islands today holds more Treasuries than China, Japan, and the UK do individually. China has significantly reduced their Treasury holdings. They still hold a significant position. Our reports have 730 billion. It’s not a lot of certainty with that, but that’s the number, and that gives them considerable leverage if they choose to use it. Back in April with that Post-Liberation day market instability, now, there were market concerns that Chinese Treasury liquidations were contributing to a jump in Treasury yields, which was transmitted to a jump in global yields.
China wouldn’t call in this debt, per se, but the potential for aggressive selling, it’s problematic. So far, they haven’t used Treasury sales as leverage, but they could in the future, and the situation turns more serious if the hedge funds move to begin reducing their massive holdings. More recent Chinese treasury sales—and there’s been other emerging market central banks that have sold—these sales have occurred in an environment of extraordinarily strong hedge fund buying on leverage. It’s not obvious to me where the sources of buying come from if the hedge funds and the Chinese move to sell at the same time, and I think at the end of the day, it’s going to be the Fed. I think the Fed’s going to own a lot of Treasuries, a lot more than they do now going forward. And thank you for your question.
David: Doug, let me just jump onto your last comment. The last scenario you’re laying out is a potential scenario for a spike in yields, and then the question is, what is a policy response? I think your answer was, the Fed would have to intervene, some form of yield curve control, expansion of the balance sheet to who knows what. Is there any other outcome if there’s an overhang of U.S. Treasuries and insufficient appetite for it?
Doug: Well, if the hedge funds start to deleverage their multi-trillion dollar levered Treasury bet, there’s only one buyer with the wherewithal to accommodate that liquidation, and that’s the Fed. And it’s like the 2008 scenario where you can say, “Okay, it’s a big balance sheet increase, a massive increase of liquidity, but basically it’s just liquidity to lift the hedge funds out of their trade.” And I think the scope of QE would trouble a lot of people, it might trouble the dollar. Certainly I would expect it to energize precious metals prices and just lead to a lot of confusion, a lot of fears for market stability.
David: Dave asks a question, “To the extent that bitcoin and gold both benefit in dollar value from having their float capped, what are the subliminal reasons for gold and silver? The demise of the most prominent fiat currency begs the question, when does gold have intrinsic value rather than dollar value? And does the gold-backed yuan answer that question?” I first read this and I thought to myself, “I need to sit down with Dave over a beer, ask a few clarifying questions, make sure we’re on the same page.” I’m not sure I understand this one. So again, Dave, if there’s a reason for an offline conversation, perhaps we can have a Zoom call and a happy hour at the same time.
First of all, with bitcoin, if the price— I would just ask this. There is a difference between gold and bitcoin in terms of its functional place in a portfolio. It is fair to say that they’re more or less finite in supply, so there is a commonality there, but if you asked the question to a bitcoin owner, “If the price were not appreciating, do you have a reason to own it?” I think many would say, “Yeah, probably not.” And yet with gold, you still have many reasons, wealth, insurance, a repository of wealth. Whereas, I mean, bitcoin, what that question I think reveals is that it is more of a speculation, which doesn’t mean that it can’t have a place in a portfolio, it just means that the two assets should not be confused. They share some common characteristics, but they’re not identical.
Now if you look at gold, maybe the second part of the question, if you look at gold in multiple fiat currencies, I would suggest it already has intrinsic value. What you’re witnessing is the social reappraisal of a currency’s value in gold terms. It was just a few weeks ago we had gold in yen trade over 650,000 yen, and I talked a little bit earlier about what happened between 1914 and 1923 in Germany. There is this draw to gold.
And so when you’re asking the question of intrinsic value, the currency value in gold terms, I think you already have that reappraisal occurring. The fact that gold is appreciating in all global currencies is a very significant signal.
The last part of the question about gold-backed yuan, if yuan were ever gold-backed or backed by gold, I think you’d see a similar social and global investor reappraisal of that currency with a legitimacy boost to the degree that a currency has created some connection, association, peg to gold, that’s what has given it stability and legitimacy.
And we even saw that, again, back to the 1923, ’24 time frame, you had to go back to gold ultimately to resolve the currency issues in Germany. And so I think there’s significant value to any country that backs their bonds with gold, backs their currency with gold, it’s a significant legitimacy boost as the world is giving that social reappraisal of stability.
Next question Bob asks is, “If China establishes a 24-hour trading system through gold delivery vaults in key global financial centers, what implications, if any, would this development have on gold prices?” That’s really interesting because I think we already have China doing this. They’re setting up vaults in various parts around the world. Hong Kong is a big outlet. The launch of the Shanghai Gold Exchange, my dad and I were there the year that they opened the gold exchange.
Ultimately, Shanghai—and this takes time—but they could begin to crowd out London and New York as financial hubs. Gold is one asset, but it’s a unique asset, and there’s no doubt that credit is still the linchpin of crop capital flows and where you have the deepest credit markets, there you will have financial dominance. What is possible over time is that Shanghai begins to compete with London and New York, and maybe this has to do with trade invoice settlement on a global basis. But gold trading over time introduces a certain degree of credibility, and I think would allow for an expansion of Chinese credit markets. Ultimately, to the degree that gold and trade financing are connected, you’re talking about a significant increase in demand, and I think that’s very price positive to what’s the development on gold pricing.
China is angling to remake the global monetary system, and gold is certainly a part of their strategy, and I don’t think that’s going to put pressure downward on the gold price. I think it’s highly supportive to them being able to mark their balance sheet and gold holdings to market it at much higher values. And with that comes I think an announcement to the world that the yuan or the renminbi is a currency to be taken very seriously.
Next question goes back to comments that we made in a previous call. Tom asks, “David, a couple of conference calls ago, you were asked about the Roosevelt currency devaluation during the ’30s.” He quotes my answer. I’ll give a brief summary. He said, “Could you elaborate on this further. At what price for gold were foreign dollar holders offered? Was it the $20.67 cents per ounce? Was it the $35 per ounce as an incentive for U.S. holders of gold to turn in their holdings?”
Let me take this one. U.S. Citizens were paid— I appreciate the question. I appreciate you coming back to a conversation we had previously, Tom. U.S. citizens were paid $20.67. It was after the devaluation that foreigners were paid $35 an ounce. What’s very interesting is the European markets had already anticipated the devaluation, and you had a huge flow of $20 gold pieces flowing to Europe, particularly Paris, and they were already trading, $20 gold pieces were already trading in the low 30s per ounce circa 1932. So fascinating dynamic, that the market has a certain wisdom and insight. If you pay attention to some of the nuances and signals, it may tell you exactly what you need to know. So U.S. citizens were not paid $35 by the U.S. government, but there was still a free market function prior to 1933, and those $20 gold pieces were selling at premiums in Paris because the devaluation was really considered a fait accompli.
And I think a part of that sensitivity was because you had just had the pound sterling devalued, 1931. So it was, people were on watch, people were on notice, and the idea that other currencies might also devalue in the context of financial market compression was ’31 in Britain, ’33 for us, and the French were fast to import the gold and get paid the premium.
Series of questions here. “Did the post World War Two Breton system change this foreign dollar-holding conversion rate? What was the nature of added factors the system imposed that made conversion of foreign held dollars to gold a less rigid arrangement?” So no, it stayed $35 for all official transactions. Again, the French, for whatever reason, maybe it’s because they’ve destroyed their currency so many times, they’re hypersensitive. The French were hypersensitive to our fiscal mess in the 1960s—not just the French, but across Europe.
And there was the extra sensitivity in France, in part because Jacques Rouff had been the financial attaché in London. He was the French financial attaché in London during the currency devaluation in ’31. So he’s now pounding the table with de Gaulle in the ’60s insisting that debt payments be collected in gold and not greenbacks because he’s seeing in the 1960s things that were so reminiscent of the pound sterling devaluation in the ’30s that it was just a matter of time before we devalued and broke that $35 peg. And the market, again, sensitive to these things. Gold was already trading—free market trading—in Europe at 38, 40, 42, $43 as you got into the late 1960s. In answer to your second question, it was private gold trading that after, say, 1967 drove the free market price above the official peg of $35. The London Gold Pool intervened routinely to maintain that $35 gold peg and their efforts ultimately collapsed.
I think if memory serves, March 1968, the gold pool collapsed and they couldn’t keep the peg. By 1970, you had foreign holdings of U.S. dollars exceed U.S. gold reserves five to one, right? So this is what the French are looking at. This is what the Europeans are looking at. They’re like, “Wait a minute, there’s way too many obligations to pay, and there’s not enough underlying metal.” Five times the paper currency promises to the one ounce of gold available for coverage of that debt. So I mean, these were the dynamics, the hoovering of gold reserves out of the United States. Nearly 50% of foreign central bank debts were being settled in gold instead of greenbacks. Very concerned with our deficits. And so, again, post Bretton Woods, the conversion rate didn’t hold, the free market dominated, and the free market read well what was happening in that fiscal, the impending fiscal disaster.
So I think it’s really, the only reason I wanted to spend a little bit of time getting into the details of that is, the market is already anticipating fiscal pressures on a global basis. I’ve come back to the G10 a couple times now, and Doug has covered well the financial instability within the United States and its debt and its deficits, and it’s certainly the amount of leverage and it’s the creative financing. This is a global issue. Gold is telling you something very important, just as it did in 1932 in the streets of Paris, just as it did again in Europe and in Paris again, 1967, 1968. Smart investors can do the math. When it is crazy they start battening down the hatches, right?
If you’re wondering what to do next, if you’re wondering how to allocate assets, just realize there’s some things coming that have yet to be revealed. Central banks, high net worth investors, family offices, they’re already on the move, beating down the path into the gold market.
And anyways, next part of the question, “Was the reorganization of the U.S. banking system following 1933’s bank holiday sufficient to encourage Americans to return their savings to the banking system even though they no longer had gold convertibility?” Doug, I don’t know if you remember these details, but it seems like it was the creation of the FDIC in June of ’33 that was really responsible for bringing back the deposits into the banking system. As of 1934, they were insuring up to $2,500 in deposits, and in the wake of 3,000 bank failures, they had to have some promise. Anything else that you think was bringing people back into a position of trust?
Doug: No, I think that’s it, David. Just a general shift in confidence from the New Deal policies.
David: Well, right, the boldness of the policies. It was, to some degree, like Mario Draghi’s 2011 “we’ll do whatever it takes.” So there was that, too. The general shift in sentiment moving more positive.
Okay. On a related note, “in terms of the safety of today’s banking system, what services is your firm providing clients to make them better informed? I believe it was during the 2023 fiasco, you were front and center on this. Obviously, risk in today’s banking system remains elevated. I believe most Americans would be shocked by the size of deposits that today are uninsured.”
So I would say expand your focus. Banks do still have the $250,000 per account insurance. Places that may be full of surprises in the years ahead would be in the insurance world. Private equity has discovered a $23 trillion pool of captive assets, and there— I can think of five or six different instances where private equity firms have bought insurance companies just so that they could abuse those balance sheets and stuff their private equity holdings and private credit paper into a place that has a 20, 30, 40 year timeframe. It’s not like demand deposits at a bank. And so they can pile in this garbage into the insurance company balance sheets, and nobody’s going to ask questions for a long, long time. I would say it’s not just the banking system. It’s a great question. Short list is, if you want to get in touch with us, we can provide bank ratings. What other resources do we have for you? The Credit Bubble Bulletin, Hard Asset Insights, our weekly podcasts, other online tools, something like Vaulted as a savings alternative. These are the kinds of things that we’ve done to help people stay informed and be agile.
But I would expand your focus from just the banks to insurance companies. They’re being abused by the private equity and private credit crowd. And Doug, question to you, “How do I help someone else who is beginning to become aware of the global financial situation? Let them know how to batten down the hatches for the next five to 10 years? What do I do for someone who hasn’t been tending their garden and is trying to figure out how to invest?”
Doug: Thank you, Alvin, for your most pertinent question. I definitely believe, clearly, as you wrote, it’s time to batten down the hatches, but this is tricky. These terminal phases are tricky. Every day it seems the probability for the market to continue to rise, that probability seems like a hundred percent. Stocks just keep rising, ensuring the crowd is fully exposed at the top. And you have naysayers like myself, we’ve long been discredited as one would expect in such a long cycle speculative marketplace. Arguments against the bullish narrative today, they just don’t resonate, right? They don’t resonate. So if I were trying to convince someone to take a more cautious approach, I think it’s a good time to focus on some price charts from prior bubble periods just so people can visualize. This is what happened back here in similar situations. A chart of the NASDAQ 100 index would show a March 2000 high of 4,816.
The index lost 83% of its value to trade down to 795 by October of 2002,. It then took the index 15 years to get back to that previous high. You know many dot-com stocks, they collapsed to zero, they were gone, they never recovered. And interestingly, even Amazon, okay, Amazon.com lost over 90% of its value before mounting a recovery after the tech bubble burst. Microsoft fell 64% from highs in less than a year. And from the October 2000 highs to March 2009 lows, the S&P 500 lost over half its value. Major index lost half its value in not that many months. A chart of the Japan’s Nikkei 225, and I mentioned this earlier, would show a 63% decline from record highs over two and a half years. And as I mentioned, it took 34 years to return to that high. I also mentioned that the Dow collapsed 22.6% one session during the ’87 stock market crash.
And I’ll say investors today are delusional if they don’t recognize major downside risk. And of course you could say the probabilities are the market continues to go up, but the major downside risk is out there. It’s just trying to convince people that’s difficult. Maybe the charts help.
And for those that have resources to invest and those working to build resources, for both, it’s important for— If you’re going to batten down the hatches, we all have to do our best to pay down debt, save as much as possible. That’s our best defense. And it’s never been more important to manage debt prudently and to build up some emergency reserves. And it’s a great time to have safe cash balances and an allocation to precious metals. We’ve talked about that. A traditional hedge against both inflation and instability. And I think both of those are a pretty good bet going forward. And thank you for your question.
David: Yeah, Doug, I would just echo that. I’m sure you’ve had conversations with your son the way I’ve had conversations with my kids. You put a dozen charts in front of him and we start with the idea of buy low and sell high. I don’t even have to tell you what company this is or what index it is. What does this look like to you? An opportunity to make money or an opportunity to lose money? Where are we at in the cycle? And I kid you not, you get the cleanest and most unbiased answers from a 12-year-old, a 15-year-old, a 19-year-old as they look and say, “This is not a great time to buy.”
And if you need something muscular to add to it. Okay, market cap versus GDP, 215%, only been higher once in all of history. Cyclically adjusted price earnings ratio of 41:1, only been higher once in history, and it was the dot-com peak. With some statistics but certainly I think it’s even more powerful, because most people just, their brains can blow up thinking about stats and standard deviations from the mean and those kinds of things. Just look at the picture, visualize in a price chart where we’re at, and there is a possibility we go higher, but for how long? Valuations would argue we are already past what is reasonable. So now you’re just playing for the last few percentage points gain. Is that a five percentage point gain, a 25 percentage point gain?
What you suggested, Doug, is I think really worth keeping in mind. We’re not talking about a 10% correction off of the peak when momentum shifts. And I think one of the things we maybe haven’t covered very much today, when momentum shifts, you’ve got such a high concentration in just a few names. The names which have been most popular are the names that naturally get sold off the hardest. Because as people look for liquidity, it’s the only thing that they own. It’s the predominant asset that they own. So you’ve got one stock today that is five trillion in market cap. You’ve got eight stocks today which capture 40% of the value of the entire S&P 500 and represent roughly 36% of the entire U.S. stock market, eight names.
Because the money and the capital continues to flow, and it goes disproportionately through the indexes to the larger cap names. It feeds on itself on the way up. And you talk about this a lot, Doug, but in a well-functioning market, that’s fine. In a dysfunctional market, when it works in reverse, that’s when things can be crazy. An 83% loss in the NASDAQ. I don’t think anyone today has an imagination for anything more than about a 10 or 15% correction. It takes a little historical perspective and maybe a snapshot. As you’ve suggested, a picture is worth a thousand words. It might be worth 50% or more in preserved capital.
We appreciate you joining us today for the call. Loose conditions, excess, and Fed accommodation set up an amazing market circumstance, one that’s not easy to navigate. We appreciate your interest, your curiosity, spending time on hard topics, and we wish you well as you try to navigate and make the best possible decisions. Doug, any final words?
Doug: Yes, thanks very much David, and thanks everyone for being on the call, and good luck out there. Good luck.
