EPISODES / WEEKLY COMMENTARY

Not The Debt Stupid, It’s The Interest

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Feb 15 2023
Not The Debt Stupid, It’s The Interest
David McAlvany Posted on February 15, 2023
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  • At What Point Does Interest On The National Debt Bury US?
  • The Fantasy Of Modern Monetary Theory In The Age Of Inflation
  • The Fantasy Of Renewable Energy In The Age Of De-Globalization

Not The Debt Stupid, It’s The Interest
February 15, 2023

“I think for the retiree, it’s really a question of seeing these issues, the mountain of debt, the necessity of inflation, the requirement of suppressed interest rates at a more reasonable, controllable level so that the fiscal picture doesn’t blow up. Knowing that you are the designated loser, how do you choose to allocate assets in your battle for economic and financial market survival?”—David McAlvany

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

David, the older I get, the more I realize that there are certain repeating themes that you no longer build any tension towards, like raising the debt ceiling. How many times have we noticed the politicians arguing about raising it, and, “No, we’re not going to raise it.” “Yes, we are,” and, “We’ve got to do this.” What happens every time? In a way, it reminds you of like a dance. They all know the steps, they’re just going to get through it from start to finish.

David: We talked about it a few weeks ago as a game of chicken, and I think that game goes beyond the $31.4 trillion debt ceiling. The real issue is existing in a system that, despite these periodic theatrics, it’s a system that has bipartisan sponsorship. They both spend beyond their means, and it doesn’t matter if it’s in crisis or outside of one. The nature of politics in recent times is like an exotic bird dance. You’ve probably seen this on National Geographic, the Amazon Bird.

Kevin: Yeah, with the plumage—

David: That’s right.

Kevin: —just dancing around getting the mate.

David: Yeah. Only these are the politicians seeking votes. The politicians dance and show off their plumage to gain attention, and that increases their odds of perpetuating their legacy into the future. Just like the bird, right?

Kevin: Mm-hmm.

David: Promise more money for what the constituents are most concerned about, and get lucky with another term in office. Whether it’s the Trumpian orange feathers, how orange are your feathers? How crazy are your dance moves? It doesn’t matter—the party, again. It’s fair game in terms of the bird-like dance.

Kevin: We’ve got that on the news right now. But I’ve got a question for you. Okay, going to inflation. If high inflation slowing in its rise is called disinflation, is high inflation that’s slowed in its rise, that’s now being revised up again, is that dis-disinflation? Is it de-disinflation? What do you call it when inflation gets revised back up, or when it hits a higher number actually like we saw today?

David: Right, two negatives equal a positive, like in math. This week’s CPI, and in another day PPI, gets the headlines for good reason. Inflation at 6.4% is a far cry from 2%, and it’s over what was estimated. The month-over-month change was right on the number. And it just means that the higher-for-longer—we’re talking about the interest rates, and Powell keeping rates higher for longer—that is the reality. Powell, I think, will have his resolve at some point give way when there’s sufficient pressure on the jobs market. But thus far he’s felt no heat on that front. 

Stocks may retrench if investors have to wait for easy money. Precious metals, I think, should continue their necessary corrective move on dollar strength—and that’s consistent with higher rates and dollar strength, and thus a lower price for gold and silver. February, I think, is a month, with that in mind, to take measured bites in the metals because you’ve got the ebb and flow of monetary policy constraint. And I think what we have today in real time is going to look very different by year-end. The mega bull market in precious metals should be added to on temporary weakness. And likewise, when you look at the fledgling bear in equities, it should be sold on counter-trend strength. But this is something we’ve said before.

Kevin: We can raise the debt ceiling as much as we want, as long as we don’t have high inflation that leads to high interest rates. The real issue is not the debt ceiling, is it? It’s what we pay on the debt.

David: That’s right. The CBO, Congressional Budget Office, base line estimate for the national debt by 2032, so stretch out about 10 years, is $40.2 trillion. Then the high side estimate comes in, obviously higher than that, 50.4 trillion.

Kevin: But if you’re not paying interest on it, who cares?

David: Exactly. As I’ve often said, it’s not the debt itself that is unsustainable, it’s the rates that you pay on it. We’ve mentioned this in the past, in this sort of neo-Wicksellian world of interest rate suppression, a zero or negative rate allows for fiscal authorities to increase debt to massive levels. And this is consistent with Michael Woodford’s theorizing on rates. This is the significant book on interest and prices Michael Woodford put together that, again, borrows from Knut Wicksell, the Swedish economist, so you’ve got him theorizing on rates. You’ve got the Bank of Japan’s real-time experiments with price controls and fiscal fantasy planning. Think about this. You don’t hear as much about Modern Monetary Theory right now. Rates are rising, and without suppressing interest rates it is what we knew it to be: Modern Monetary Fiction.

Kevin: Well, you and I were talking last night, too. We watched the Super Bowl, and there was a significant disappearance of crypto ads. Last year there were a number of companies telling you that you were an idiot—you were not like Magellan, the explorer, or the Wright brothers or the astronauts that landed on the moon because you don’t own cryptocurrency. And sure enough, there was an absence of those commercials.

David: Not a single one.

Kevin: Not a single one, but you brought up that Modern Monetary Theory, that’s all that was being talked about, about a year ago. And now we have this inflation here. I think about the old show Fantasy Island. “De plane! De plane!” It’s modern monetary fantasy island.

David: Right. And fantasy is a fair descriptor because the ability to control prices is temporary. The results are only maintainable if the impossible is kept in play, or for as long as the impossible is kept in play. And of course the financial risks that proliferate because of artificially suppressing rates are nothing shy of ruinous. Of course, when normalcy returns and the market starts repricing risks—and these are the classic risks that you find in the fixed income markets. Credit knows how to suss out and smell out default risk, credit risk, duration risk. These are things that get set aside in this world of fantasy where rates are suppressed.

Kevin: Well, and just like in Fantasy Island, people got back on the plane after living out the fantasy, and they had to go back to real life. Real life in this particular case, let me ask you the question, when does interest on the debt actually overwhelm?

David: Pete Peterson is a very interesting guy, if you’re looking at the history of Wall Street. He’s a big name—a big name that not many people know—but the Peterson Institute does some really good economic work. The Peter G. Peterson Foundation did some work, and they’ve been focusing on debt and its implications for a long time. But 2052, while that’s a long time from now, the foundation pencils out that by then 40% of all tax revenue will go to paying interest on the national debt.

Kevin: Wow.

David: Just let that sink in.

Kevin: That’s like having a high credit card debt.

David: Well, and it wasn’t that many years ago, it was 5%. 5% of tax revenue went to paying interest on that.

Kevin: And this is 2052? That still does seem like a ways away that you’re talking about almost half.

David: And that doesn’t leave as much room—of course, if you’re paying 40% of all tax revenue just on the interest component for your debt—that doesn’t leave much room for the $95 trillion in unfunded liabilities of Social Security and Medicare. And that unfunded estimate, I believe, is conservative, and it reflects a present value of future liabilities. But the Peterson research shines a light on other Congressional Budget Office, CBO, calculations, bringing them from that far-distant place into the bill coming due right now in the present. 2022 interest expense was $399 billion. $399 billion. 2023 bumps to $442 billion according to the CBO estimate. And by 2032, the number scales to $1.2 trillion. Again, this is interest only, but recall the possibility that we could be talking about 50.4 versus 40.2 trillion in government obligations. Your 1.2 bumps to an annual 1.5 trillion if we come closer to 50.4.

Kevin: And this is just interest?

David: Yeah. We run the math on that. It assumes that the average interest expense across all maturities sits at less than 3%. 2.9%.

Kevin: How is that realistic? 2.9%, 3%, whatever you want to call it. How do you assume 2.9%? It’s got to be higher. I mean, inflation alone is going to keep it at a higher rate.

David: I think this is where we as thoughtful individuals need to listen carefully, whether it’s to the White House Press Corps or we’re reading the daily paper and someone presents something, what does that assume? Here’s one of those key assumptions. We’re going to be at 442 billion or 1.2 trillion, and this is still done on a straight line at 2.9% as an average interest expense. Now, I have no crystal ball, but there is at least a possibility that rates move in long cycles, as they have throughout history, and perhaps—perhaps, just maybe—the Congressional Budget Office has forgotten that longer arc of history in which those rates could— and listen, I mean, you don’t have to go back that far in US history or world history. Maybe they could be more like 4% or 5%. Those numbers get interesting, right? Because if you assume the 40 trillion, the 50 trillion as a mountain of debt, then you start coming in at 1.6 to 2 trillion in interest expense, or, at a 5% number, 2 to 2½ trillion as an annual interest expense. 

Again, just reeling that back in. All of that is out there in the future, and maybe inflation, these things will solve themselves like the snake eating its tail. Inflation will eradicate the burden of debt. But here’s what we have in the short term. The Wall Street Journal, February 10th, highlighted that in the first four months of the fiscal year, interest payments are up 33%. They were $196 billion during the same timeframe last year. They’re now at $261 billion. Again, for the first four months of the fiscal year, 261. You don’t have to annualize the number, but if you did annualize the number, you look at the CBO’s estimates of 442, it’s a little bigger than that. 2023 interest costs may end up being way too low. We’re talking about the CBO estimates, which means that we’re going to blow past 10% of total revenue going just for the interest expense. We’ve gone from five to 10, where do we go from here, to 15 to 20? Again, it depends on the debt, and it depends on the interest paid on the debt. And clearly we’re in less control of that today than we were a year ago.

Kevin: It just makes me think how overwhelming life is right now. There’s so much noise in the news. We hear about the reopening of China and the reintroduction of their economy. Who would’ve known that the reopening of China would’ve been announced by a huge release of balloons? I mean, but think about this—

David: 99 of them, right?

Kevin: We sang that last week.

David: 99 balloons.

Kevin: But yeah, so there is this noise. It comes from propaganda, fake news. That’s the new word. A lot of it’s even generated narrative from artificial intelligence. You’ve got AI actually feeding you the things when you’re looking them up. My question, Dave, would be this, and we ask this every Monday, but I’d like to go through this again. If you had to look at the things that are the most important right now, what are you thinking of? What are the things that the team is thinking of? Because what we have to do is eliminate certain things so that we can put other things on the front burner.

David: Well, on that last comment, the cover of Barron’s magazine has three quotes from Zuckerberg, from Satya Nadella from Microsoft, and the current Alphabet CEO. From Alphabet you have, “AI is the most profound technology we’re working on today.” From Zuckerberg, “AI is the foundation of our discovery engine and our ads business.” They’re watching you and determining what you want to see so that you can be more effectively sold to. And Nadella from Microsoft, “AI will fundamentally change every software category starting with the largest category of all, search.” When you are searching for something, you will be fed what you are searching for. This gets to the heart of the conversation we had with Dr. McBrayer about how you have these curated news feeds, which really only exaggerate your lack of objectivity. You will see the world more and more and more and more and more exactly like you want to see the world. You may say, “What’s wrong with that?” Well, because you could be wrong.

Kevin: Well, it’s a self-reinforcing navigational error is what it is, Dave. When I go out and I take the sextant out, and I mark a fix, look at the sun, the moon, a star. This morning I looked at Spica and the moon. My house doesn’t move, but I do it for practice. But the reason a sailor takes a fix is because he’s doing something called DR, dead reckoning, beforehand. When you’re a sailor and you don’t actually see anything, you’re basing your estimate on forward progress, possibly currents, how long you’ve been going. But when you take the fix, you get to reconnect. 

Now, where I’m going with this is this. Artificial intelligence, if it’s actually feeding you a feedback loop of what it knows you like, you’re actually not getting a fix. You’re just continually dead reckoning, and that’s the reconfirmation. You’re not actually seeing where the star is or where the sun is. Now, I bring that up with you, Dave, because you have a team that you meet with that does not always agree, just like navigational charts. Your dead reckoning will not always agree with where your fix is, and then you have to readjust your fix. You went to a conference recently. People are asking questions. Your team, you meet every Monday and Wednesday. What are the important things to look at and what should we disregard right now?

David: I was preparing for that conference in Texas, and the question was asked, what are we paying attention to? Why? There was sort of an immediate shortlist that came to mind because it is what we reflect on as a team quite frequently, and the gathering brought folks from the heartland, South Dakota and Michigan and farther afield, New Jersey, Hawaii. I learned a lot from them, and my daughter and I enjoyed the level of engagement, the curiosity, the forward thinking. 

To that shortlist, the first thing is market structure. And this is something that Doug Noland hits a lot, in not only the Credit Bubble Bulletin, but as we’ve done our quarterly calls with Tactical Short clients. Market structure includes things like leverage, the degree of speculation, the ETF products, and the kinds of things, the constituent parts in those products, dynamic delta hedging. This is just one point of analysis. And with more and more day traders moving to the options market to sort of buy their daily lotto tickets—

Kevin: Oh, gambling. Yeah.

David: Yeah. They’re not just buying options that sort of allow them to be right within a six-month period, but we’re talking about this massive surge, a tsunami of speculation into options with zero days to expiration, right? And it’s a fascinating setup because—

Kevin: It’s a flip of a coin.

David: —it really is buying lotto tickets on a daily basis. Since Q4, we’ve had hedge fund de-grossing, that is cutting both their long and short positions, and that’s been accompanied by retail investor speculation on a par with any extreme environment of greed and manic risk taking that we’ve seen in history. I think the market structure is more frail than the price action would suggest. 

The second thing is central bank credibility. You look at price stability, and they’ve lost it. They want to gain it back. You look at mandate creep, which is where you might have two, you might have three, you might have 10 mandates, and depending on which central bank you’re talking about, some are legitimizing the fight of all things. Not just price stability and employment as two core mandates, but a much broader, longer list, which brings them into the realm of sociology and politics and everything else. 

The last part of central bank credibility, I think, ties to political independence. To what degree can they stay in their lane, do their job? These are always on the line, these issues of central bank credibility. But in an era of rising inflation and delayed effects of policy implementation, there are credibility risks aplenty. Not only the Fed, but the Bank of Japan and the ECB in particular. I really don’t think about the People’s Bank of China dealing with credibility because it’s not like you get to vote with your feet, necessarily. The markets are controlled, the currency’s controlled. To some degree you’ve got a net thrown over the country, where capital controls are in place to a degree. 

The Bank of Japan, on the other hand, they’re playing with fire. Not only QE fire, but their balance sheet, which was once similar in scale, in terms of the balance sheet to the economy, similar in scale to the US central bank or the ECB’s balance sheet. Again, relative to their respective economies. Bank balance sheet is over a hundred percent of Japanese GDP. That’s not a good idea, not a good idea. Not only is the Bank of Japan’s credibility on the line, but this points us back to the first point. Japan has been the marginal source of cheap credit for leveraged speculators for nearly two decades. When we think about market structure and leverage and speculation and what’s driving it, a lot of the leverage bet comes from money that is not yours. Japan has been that marginal source of cheap credit for a long time. 

Just imagine, if you will, a bond-vigilante moment in Japan where all of a sudden you’ve got shockwaves throughout the entire global financial system. The potential for a crash just related to a shift in monetary policy in Japan, or a forced exposure, if you will. Again, this is sort of the peek behind the kimono, a very embarrassing moment where the Fed loses credibility and loses control of the currency and loses control of the Japanese government bond market. The implications are pretty significant. 

The third thing that comes to mind as I was just going through—and believe it or not, we didn’t get to talk about any of these things down in Texas. We had a different conversation, which was great, but the inflation ebb and flow, this is something I think you and I have talked about quite a bit that we’ll see the push and then the receding back of the inflation issue.

Kevin: The dis, and the dis, and the dis. Disinflation, inflation, dis-disinflation.

David: Yeah, it’ll go back and forth. We have a top, back in the middle part of last year, versus the top, and that remains to be seen if we have put in the top. The history of great inflationary periods is for inflation to spike and fall back, only to spike again, unfolding over extended periods of time. There were multiple years in the ’60s and ’70s where rates, this is interest rates, would triple and then decline by half—not a small little drop. It significantly declined, only to do it again and again. With each move—at least for the investor community and for those who are looking at the economy—each move raising hopes before delivering disappointment all over again. 

The move to June levels and the subsequent moves lower were just the first in a series of inflation gyrations. January numbers capture the increase in gasoline prices and a few other volatile inputs, which can just as easily recede into February. I think if we just are looking for an analogy, there is a war, but there are also battles, and we can’t mistake a battlefield victory as the equivalent of the war being won. The war on inflation has many years ahead of it, and in no small measure due to a factor I’ll mention in a moment.

Kevin: Don’t be distracted at this point by these little battles that are being won. Don’t be distracted by disinflation, the “disinflation,” because that may not be the case.

David: The fourth thing that comes to mind is liquidity management, and I think this has more to do with risk mitigation and portfolio construction, but I think really critical to any investor today needs to be what they have in gold, what they have in Treasurys.

Kevin: Those are the factors of liquidity, right? Gold and Treasurys.

David: Very, very short term Treasurys. Three months, six month, 12 month, at most two months. But understand that the farther you go out, the more interest rate risk you’re taking, and it’s not something that you want to be playing with.

Kevin: Cash and gold.

David: Yeah. When we have advocated a blend of liquidity tools, it’s been to mitigate downside volatility, number one, and also to prepare for opportunistic allocations. If you preserve value, then you have the opportunity for opportunistic allocations and a significant or compelling growth proposition there in the future. Avoid major losses, and with patience, allocate into compressed value. That’s what we do for investors in the equity space. 

We’re closer today than we were in late 2021, but more compression is coming. Would we be surprised by an additional 35 to 40% decline in US equities? No. Does that improve long-term returns, starting with a better cost basis? Of course. Of course. If you’ve bought and are holding stocks for the long run, I had a great time— Great time. I say great time because certain things that really get my blood pressure going I sometimes consider to be a great thing. The review of the random walk down Wall Street— Again, Barron’s this week, and we have the 50th anniversary of the random walk. Well, I look at that, and most Wall Street investors say, “Yeah, this is what we know to be true. The random walk is just that. You can’t predict the future. You just need to stay invested all the time.” And I would say, “So you’re willing to go through the compression, you’re willing to watch your 401(k) become a 201(k) because the random walk tells you that it’s just the averages and you can’t do any better?”

Kevin: What would Smithers say?

David: Well, and that’s the key point here is that his book, Valuing Wall Street: Protecting Wealth in Turbulent Markets, looking at the Q ratio, it implies that there are times that you should be fully invested, and there are times that you should be very aware of risk, very careful, and part of risk is knowing how something is fairly valued or if it’s overvalued.

Kevin: Dave, he’s kept his wealth. He’ll tell you he’s missed some gains by being out of the market when it continued to go up, when the Q ratios said to be out, but look at him over the long haul.

David: Right, and if you have, on a periodic basis, once every several decades, an opportunity to establish positions in quality companies at a very low cost basis, does that help you with your long-term returns? Avoid losses, and start positions with a superior cost basis. I think you’re doing yourself a favor, and what that points back to is liquidity management. Not only risk, but liquidity management. 

The fifth thing, and I think this is something that gets us really close to the newsfeed even today, you’ve got the US Embassy in Moscow saying that US citizens residing or traveling in Russia should depart immediately. Because they’re seeing citizens detained, harassed, denied fair and transparent treatment, being convicted in secret trials without having credible evidence presented. This is a communiqué direct from the embassy.

Kevin: Wow.

David: Why mention that? Well, because we’re dealing with geopolitical tensions, whether it’s Europe or Asia, whether it’s balloons or it’s just weather balloons, or UFOs, the tensions are rising regardless of how you frame it.

Kevin: Is China preparing for war? That’s what we’re wondering.

David: All we have is questions. All we have is probabilities. Whether China is preparing for war or China is planning to come to Russia’s aid, escalating existing tensions with the West. What we do see as we ask those questions about where we’re at and where we’re going, we do see a growing number of wealthy Chinese opting for Singapore.

Kevin: Not the United States.

David: It’s the Switzerland of Asia, and they’re opting for Singapore for their money and a new domicile. Is that with an instinct or an inference from what they see on the mainland? Again, all I have is questions, but the flight capital is real, and the flight path is shifting from the US, Canada, and Western Europe to Singapore. There may be an important signal in that.

Kevin: We talked about this earlier, but at Christmastime, one of my favorite movies ever, ever, ever is Casablanca. Just love everything about that movie. Made in 1942. But it was about that period of time when France was overtaken by Germany, and people were getting out of Germany. They were getting out of France, they were moving across Europe, and they were having to move through Casablanca to the United States. Of course, if they had gold, if they had diamonds, if they had cash, they would be able to move. 

Now, what I’m asking you here, Dave, that movie captures a preparation for a much larger war, and it captures sort of the movement of people and the fear, and where do you go for safety? You’ve got balloons coming over America right now from someone who probably will be a future enemy. You’ve got our embassy in Moscow saying, “Americans get out of Moscow.” You’ve got drones coming from Iran, fighting in Ukraine right now. You’ve got currency blocks that are being reorganized away from the dollar, possibly into an alternative way to buy energy, what have you.

David: Most recently between China and Brazil just last week.

Kevin: Is this the makings of a Casablanca moment? Are we in that preparation?

David: Nothing is guaranteed. Nothing is set in stone. I don’t want to pretend that there’s some sort of determinism in play, but the probabilities of World War III are increasing. And I’m reminded of just how smart some folks are and how history is kept alive by the smartest people. The conversation I had with one of our largest clients out of India, taking advantage of gold storage in other parts of the world, and I asked them, curiously, why they would never put gold in Singapore or Hong Kong. And they said, “Well, Hong Kong is obvious. Just look at where the politics go back to.” He said, “Singapore is obvious, too. The Malaysian peninsula lacks the Swiss mountains. It lacks the Swiss military. You’ve got those strategic disadvantages,” and interestingly enough, you’ve got people leaving China, and again, East/West tensions are affecting the flow of capital and people from China, and Singapore is a hub for them. But there are some people who would say, “And that too is shortsighted. That too is shortsighted” because something as basic as geography is really critical to having a buffer, an adequate land buffer to keep you safe, to keep your resources safe. 

At this meeting in Texas, I had a conversation with this doctor who was there, and he asked very good questions, lots of them. And I have to be honest, I think a part of the impression that I had was this is sort of a version of organizing logical cells within an Excel spreadsheet, and everything needs to fit together. But then, as we walked away from breakfast one morning, he basically said, “Our family fled Europe, and what you could carry is what you could keep,” and that’s my—

Kevin: You leave everything else behind except for what you can have on your body.

David: I’ve focused on real estate. I love real estate. I think it’s one of the best investments that you can make, but it’s not something that I can take with me, and my family history suggests that this is something to pay attention to. 

Going back to Casablanca, no, I don’t think this is the end of the world. I’m hoping that we’re not talking about World War III, but the probabilities are skewing that direction if we can’t have reasonable conversations. What we do have, and it is in motion, and this is not a probability, this is an actuality, and this is the sort of sixth thing. I mentioned five, maybe there’s six that I would’ve shared. Here’s your enduring inflation input. You remember I mentioned that I thought that there’d be an ebb and flow with inflation? And one of the reasons why I thought it would exist on a longer basis, it’s not just the volatility of crude or natural gas. Here is your enduring inflation input. Globalization in reverse is related to the last point made, but on a strictly economic front. Supply chain reconsideration, on-shoring, other domestic security priorities, and they all carry a cost with them, which will ultimately be born by the consumer.

Kevin: What does a chip cost when you can’t get it from Asia?

David: This is of course one of the enduring pillars of inflation, but it’s also a part of a world where national interests and heightened fiscal pressures—back to our earlier point—they take precedence over a global identity.

Kevin: What does that mean for the guys at the World Economic Forum over in Davos?

David: Yeah. In this sense, the Davos man, the agendas promoted by Klaus Schwab and the others likely to fall on deaf ears. Keep in mind that the fever pitch of those Davos agenda items, they seem to correlate to the lack of unity on those issues. Because again, we’re coming down to not everybody’s doing better, so everyone will pay their fair share. Now, it’s who pays and how much. And when it comes to implementation, you’ve got fiscal choices and the direct political fallout from the people who are making those political choices, those fiscal choices.

Kevin: One of the things that we’ve gotten away with, in a way we’ve gotten away with murder since the 1970s when we went off the gold standard, because prices, even though we’ve had inflation, prices have not inflated to the point that they would’ve if we actually didn’t have globalization. But what we were doing was we were outsourcing to places that made things cheaper than we could make them ourselves. That is what you’re saying is falling apart. The reason I paid over a hundred dollars for a dozen roses for Valentine’s Day, and the reason a greeting card, I mean, a Valentine’s card now, Dave, as you know, probably, nine bucks. Nine bucks for a nice card. Roses, nine bucks. Shari’s Berries are getting there late, okay? Because delivery services are starting to fall apart. All the things that seem to be working, I’m likening that to globalization.

David: If I’m not aware of these price changes, is that an indication of the state of play in my romantic life?

Kevin: Well, I’m going to just tell you that I know that that’s not true because you took your wife out for Valentine’s Day.

David: Well, consider the numbers previously discussed. You start to multiply those fiscal burdens in the reshaping of the global economy. Say, for instance, in the electrification of the market landscape. This is one of those big themes. We’re going to electrify everything, right? Forget the dependencies that come with that. Forget the grid dependencies and the fragilities that we’re just walking towards in the name of moving away from fossil fuels. We’re willing to increase all kinds of systemic risks. But again, I’m digressing. 

The cost benefit analysis has been distorted. If you take away the government role in these numbers, it’s an utter disaster. Renewables are an utter disaster, but they’re portrayed as sort of Mary Poppins perfect, practically perfect in every way, she said of herself, right? Let me illustrate the delusion. We have real numbers from Duke and Dominion Energy. They both are registering losses, impairment charges of 1.3 billion for Duke, 1.5 billion for Dominion Energy on a combined 6,000 megawatts of power. This is across their solar, wind, and battery projects. They’re a disaster even with the government’s 30% tax credit.

Kevin: They’re still losing, even after the 30%?

David: Yeah, but wait for Dominion’s Virginia Beach $10 billion offshore wind project. They can’t raise prices on energy. They’re not allowed to, and yet their costs are already blowing out.

Kevin: We were talking about Fantasy Island. The whole renewables thing right now is Fantasy Island.

David: This is a microcosm of cost blowouts and economic inefficiencies. The greener the agenda—outside of nuclear. Let me just say, I am not against a green agenda. I just think you need to be reasonable about the math, and you cannot assume that somebody else is going to pay the bill. If you can’t pay your way, you’re not viable. Outside of nuclear, you’re talking about disastrous math—which is not to say that we won’t continue down this path of renewables development. The political die is cast because the argument has been, “ditch fossil fuels or die.” But it’s important to note that the benefit side of the cost/benefit analysis assumes ongoing massive federal subsidies. We’re told that the math is more compelling than ever, that renewables beat out every form of fossil fuel. You got to check with the British again. I don’t know that Mary Poppins would say this, but it’s bollocks. It’s just not true. What it equates to is greater fiscal strain going forward, and this is where the rubber meets the road. In case you forgot what a subsidy is, it is a rob Peter to pay Paul—

Kevin: Somebody always pays—

David: —transaction.

Kevin: —for the subsidy.

David: Yeah. It’s ultimately an allocation of a scarce resource. Either tax dollars are being redistributed or a reduced tax burden has to be picked up elsewhere. There’s no such thing as a free lunch.

Kevin: Dave, those are some of the things that are on your mind and on the team’s mind. But I’d like you to give us a behind the curtain look at what you guys disagree on. I mean, you agree on things, you disagree on things, and a lot of times on the Commentary we don’t necessarily talk about that, but what does it sound like when you guys meet on Mondays and Wednesdays?

David: Well, not everybody on the team sees things precisely the same way, whether it’s climate change or changes in interest rates. We’re going back and forth on the meaning of the yield curve inversion, and this happens pretty routinely. Is it recession that’s in the pipeline?

Kevin: Jim Grant says so.

David: Yeah. Grant suggests in his most recent missives that eight of the last eight three-month, 10-year yield curve inversions portended recession. Why think this is any different? This will be nine for nine, he would argue. Or the argument could be seen through a financial market lens that this yield curve inversion, a financial market debacle, is being priced in by the bond buyer looking out onto the horizon and predicting Fed rate cuts in response to a market disaster. Do we know what the disaster is? Is it triggered by geopolitics? Is it triggered by the Bank of Japan and a change in market structure given leveraged speculative players having to close out bets and unwind at losses? What is it that could be priced into the far end of the curve? Market disaster or recession?

Kevin: And I have an idea—

David: One’s economic, one’s financial market.

Kevin: I have an idea of who the guy on the team is who is thinking that way, and he’s fascinating to talk to because what he does is he looks at interest rates going out, and watches the wave pattern, basically, and says, “Wait a second. The market sometimes is very, very smart. The market itself is seeing a cut in interest rates, or not a recession,” and he can see that looking out on what the expectation is in the long rate, right?

David: Yeah.

Kevin: The long and medium and the short rate.

David: Well, I mean, either way, avoiding groupthink is a challenging but important dynamic to maintain. Let’s come back to the fiscal issues and tie in the central bank losses from the Fed. We have seen in recent years the Federal Reserve remit its profits back to the Treasury. That’s what it does by mandate. But it’s been to the tune of 50 to a hundred billion dollars in excess income, and they give that back to the Treasury.

Kevin: It’s a positive rate of return. It’s almost like a business.

David: Well, it’s income that helps with the Treasury’s ability to pay bills, but that income is not coming in this year. The Fed is taking a loss for the first time in several years, and it’ll simply defer that into the future. And it’s fascinating to me. It’s the language used, it’s called a deferred asset.

Kevin: Do you get to do that with your business, Dave, if you lose?

David: Call a loss a deferred asset?

Kevin: Yeah. I don’t think so.

David: Amazing. Amazing. It’s almost like absence making the heart grow fonder or something. I don’t know. At least from a Fed bean counter’s perspective maybe it’s that way. The net effect is that the Treasury will be short an additional 50 to a hundred billion dollars. We come back to running deficits and thinking that it’s okay. The excess of spending over receipts totaled $459 billion in the first four months of the fiscal year. Again, we’re not using the calendar year. That’s not the way the government counts things, but we’ve already run, in four months, $459 billion in deficits.

Kevin: And how does that compare, then?

David: Well, that’s up 200 billion over the same period last year.

Kevin: Wow.

David: With deficits adding to the total quantity of debt, there may be talk of an inflation fight or even a war on inflation. But the reality is that the US is moving towards a full-blown crisis of confidence if inflation is not allowed to dismantle and diminish the burden of debt. We’re way past being able to solve the debt crisis any other way except via inflation. We can pretend like the monetary policy is there to defeat inflation.

Kevin: It’s been our monetary tool.

David: If there’s anything that represents Kabuki theater, it is this game. It’s this dance. It’s this show of, “Oh, we got to get rid of inflation.” Inflation is one of the only ways that they can get rid of the debt. The part of the equation that they’ve lost control of, and they’d like to get control of, again, is control of the interest rates.

Kevin: But a subsidy always comes at a cost, and inflation is a subsidy.

David: Right. But if you can maintain control of interest rates and allow inflation to bump up, then you can have all the dials, your economic dials.

Kevin: The cake and the eating.

David: Yeah, the saver. It’s the saver. It’s the person on a fixed income that in this saga is the designated loser. I think for the retiree, it’s really a question of seeing these issues—the mountain of debt, the necessity of inflation, the requirement of suppressed interest rates at a more reasonable, controllable level so that the fiscal picture doesn’t blow up. Knowing that you are the designated loser, how do you choose to allocate assets in your battle for economic and financial market survival?

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

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

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