Stocks In Drunken Boom As Sober Bonds Are Wary

Weekly Commentary • Apr 02 2019
Stocks In Drunken Boom As Sober Bonds Are Wary
David McAlvany Posted on April 2, 2019
  • Stock Market Darlings Uber & Lyft Have Never Made Money… Ever
  • Kudlow Demands 50 Basis Point Interest Cut But Says “Don’t Worry Everything Is Fine”
  • Two Firsts In All Of History: Negative Interest Rates & More People Over 65 Than Under Age 5


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

April 2, 2019

“This is the story of the devaluation of the U.S. dollar through time, and it doesn’t take a rocket scientist to say, ‘How do I do something about this? If I want to save for the long-term, how do I save in a reliable currency, when the whole world is dealing with a floating currency system?’ Easy. Gold has been money, and I think will be the resorted-to currency in the context of the coming currency crisis – globalcurrency crisis.”

– David McAlvany

Kevin:David, my wife and I went to the city – Denver – this weekend for a scholarship fund-raising event. It is interesting, when you go to events like this where there is alcohol served, you have two types of people. You have people who are very careful in how they partake. It can be young or old. I used to think the older ones were the wiser ones but I’ve changed my mind on that. Sometimes the older ones are just as surprised at the hangover that occurs the next day.

David:I was checking out at the grocery store this weekend and it was 1:30 in the afternoon. I was overhearing a conversation with the manager. She said, “Well, Shawn is not going to be in until two o’clock. He overslept.”

Kevin:And you knew what that meant.

David:(laughs) I thought, “Oh, my word, what a bender!”

Kevin:Well, we’ve been talking about the bond market and the stock market. When stocks get too high it reminds me of some of these people I know this weekend who overdrank at the event, who also decided to go out after the event, because it was tradition, and they over-overdrank. I think about the ins of equity markets, when they reach a high and it doesn’t make any sense, there is an after party. Almost always there is an after party. And they seem to always be surprised the next day at the hangover that comes on.

David:Over the last year we have talked about margin debt. We’ve talked about excessive valuations, and pointed to certain factors within the equity markets, it is to say, we can tell we are at the end of a cycle. It doesn’t mean that that cycle can’t go a little further.

Kevin:Isn’t the mature guy standing in the back, the bond markets, already saying, “Hey, this is not going to last?”

David:I think there is a difference in narrative if you’re talking about bonds versus stocks. So, the first quarter performance was great for stocks, and it was greatly ginned as well. Certainly you had a 13% rise in the S&P which was intriguing, but if you wanted even better returns you had the 27% rise in the Shanghai Exchange, still juicier there. Of course, the liquidity was flowing. If you look at the PBOC, we talked about that a few months ago, January setting records in terms of the amount of liquidity flowing in a single month, and sure enough, we have responsiveness for the first quarter in the Shanghai Exchange. I think the common denominator for success in this era is not corporate profit growth, it’s not a technology revolution where things are radically different.

Kevin:It’s liquidity from the central banks.

David:Yes, it’s stimulus money from the central banks. Add to that, you have your corporate treasuries which are opening up and buying back record amounts, retiring record amounts of shares. There is also a little bit of cannibalism. If you look at new technology platforms not necessarily doing new things. Lyft didn’t redefine, Uber didn’t redefine, catching a ride. But they have disrupted, or cannibalized, an industry that already existed and was quite resistant to change.

Kevin:So those are the drinkers at the party. They are the ones who are actually going to the after-party. But have you noticed the bond market? The bond market is not playing.

David:Yes, we have the talk of the yield curve inversion and the potential for recession which is out there, but I think the price action is intriguing, too. Stocks rise on that all-is-well thematic. At the same time, demand for bonds has driven prices pretty high. If you look at the 10-20 year categories on the U.S. treasury market you’re really beginning to get a mixed message. The message is, in the equities market, one of risk-on. In the bond market it is, proceed with caution. Again, fixed income is telling you something a bit different.

Kevin:There is an expectation of lower rates.

David:Yes, and you wonder if it is pricing in recession already within the bond market, so maybe the fixed income market is telling you something about recession on the horizon. That is what is implied by a yield curve inversion. But maybe it is telling you in the pricing of those fixed income instruments, the 10-20 year treasuries, that there is a struggle to hit the 2% targeted rate of inflation in spite of the trillions of fresh capital floating in the financial system.

Kevin:So let me ask, why did Kudlow basically say we need a 50 basis-point interest rate cut? You don’t do that when you are in a robust economy.

David:Right. And I honestly don’t know why he did, but as soon as he said it he came right back out and said, “But it’s not because we think there is anything wrong, we think it would prevent anything from going wrong.” Maybe the bond market is telling you that the underperformance which we have seen in the financial sector here in the first quarter did not match up to the broader indexes. Maybe that’s what it is pricing in. So there are some questions. Certainly, if you’re talking to professional economists, they are silent on the issue, which frankly is not a surprise. When you talk about professional economists being concerned about the economy, it’s few and far between.

Kevin:Well, they’re only concerned after it turns. How often do they actually predict a recession?

David:Bloomberg reminds us – they ran an article and said, “460 downturns since 1988” and the IMF predicted four…

Kevin:Out of 469.

David:By the spring of the preceding year. And then looking at recessions, 153 recessions in 63 countries between 1992 and 2014 – five were predicted. And in this Bloomberg article the conclusion was, and I quote: “Group think may pose an obstacle.” (laughs) Really? They went on to say, “Professional forecasters feel safer in a crowd rather than sticking their necks out with a recession call.” That, to me, again, Kevin, reminds us that equities is the market that gets things last. Bond market investors are already telling you that 2019 is probably not going to end like it started, to much fanfare and the elated enthusiasm that we have seen here in the first quarter.

Kevin:Okay, but the Federal Reserve and the central banks, actually, around the world have been serving free shots. They’ve been giving the free shot glasses. This is why, let’s say you are an equities investor right now. You’re paying a high price to hopefully get a higher price. But give me another one of those shot glasses because the Fed’s got my back.

David:And it is reinforced by the things that you read. A Wall Street Journalarticle yesterday was titled “Goldilocks Returns to the Markets.” They said, “Renewed strength in the economy, plus having the Fed off their backs, is a nice setup for investors. Eventually, the central bank could take away the punchbowl, but for now the drinks are on the house.” That is the quote from that article. Try to keep in mind that when you are dealing with either the error of optimism, or the error of pessimism, the source for both of those errors is trend extrapolation. When things are as good as they can get and you think, well, but they are going to still get better…

Kevin:That’s what has been happening.

David:You’re just drawing a trend line. It’s the same thing with negativity. About the time that things get really ugly, you just assume that they are going to get even uglier still. It’s the trend extrapolation – error of optimism, error of pessimism.

Kevin:No price is too low for a bear, no price is too high for a bull.


Kevin:I remember reading that proverb. So we’re coming into April, but there is the old saying, “Sell in May.” There is a repeating cycle, whether a person wants to look at it or not, where from the early summer months on it’s not necessarily a good thing for the market.

David:Right. And maybe we wait until May, and in April we do have a bit more of an updraft. We just had the 50-day cross, the 200-day moving average for the S&P 500, just like the death cross signifies the price is moving lower when the 50 below the 200, so the golden cross is when the 50 moves above the 200. We’ve got some room to move. Let’s see if the S&P 500 sets new all-time highs, and if April isn’t, in fact, the ultimate end of this bull market. We’ll have to see.

Bill King has been on the program a number of times and in recent weeks, as well. Yesterday he suggested that strong Q1 rallies tend to peak in April. After a normal spirited decline in the spring you typically have a run for the roses which tends to appear in the summertime. And then if you have, in that same context, economic ebbing, if that is still operative, then the autumn usually becomes horrible for stocks. So again, just think about his step-sequence here. A strong Q1 rally peaks in April, a spirited decline in the spring – that would be May/June/July – a run for the roses sometime in the summertime – maybe we try to see a little bit of a revival by the time we get to July/August. But then he says again, if the economy is an issue, if there is economic ebbing, then the autumn is horrible for stocks. He quotes 1929, 1937, 1966, 1967, 1971, 1981, 1990, 1992, the year 2000 and 2008. He goes on to say Powell and company put themselves in a box. This is what he said yesterday morning: “The squishy Fed CEO ignited the most dangerous equity environment known to mortal beings – a surging stock market with ebbing economic fundamentals on the notion that more central bank largesse is coming.”

Kevin:When we were in Denver we were driving out the south side where a lot of the money is right now. We had lived there, Dave, before the company moved down in 1992. That is where my wife and I grew up. We were high school sweethearts. We were driving through what used to be the neighborhoods that were the furthest southern part of Denver. They were the newest neighborhoods, and we lived in one of them called Highlands Ranch. Well, now it just goes mile after mile after mile beyond that. My wife looked around and she said, “Do you see prosperity, or do you see debt?”

David:What a great question.

Kevin:She said, “I see debt. I see debt everywhere.”

David:What we have is a perception. We have a perception of well-being. We have an understanding and appreciation for something that is actually not really sustainable. Or you could say, it is sustainable as long as you can continue to make your payments. So the good life – we have it on loan. The good life – we have it as long as we can make minimum payments. The good life – we have it as long as the banker doesn’t come to repossess or foreclose. So keep on making the minimum payments and all is well.

I think what we really have is a study in contrasts. Going back to the Wall Street Journalarticle, you have a professional financial news journalist who loves what he is seeing. “This is great! Hey, look, the punchbowl is there, drinks are on the house.” And then you have a professional trader, Bill King, who fears that the setup we have at present typically ends in tears.

Kevin:Don’t you think it is just perspective? At this point, has society really grown to get used to debt to the point where you really don’t have to earn an income anymore. Look at some of the companies like Netflix and Uber. They’ve never earned an income, yet they look like they are the cat’s meow. So people, at this point, are saying, “You know, maybe debt is wealth.” That goes to what Richard Duncan, one of our regular guests, has talked about. We have gone to creditism or debitism to the point where we don’t even recognize what earnings are or what wealth is.

David:We have skewed perspective. You’re right. When it comes to perception you can consider the contrast. And even more recently if you shift to the political debate, here is where it is fake news, right? But this is perspective. This is where perspective matters. What experience do you have? What other factors inform a perspective and cause an individual to weigh some evidence in a different light than other evidence?

Kevin:Even a person who calls something fake news is making a judgment call, saying that they know what the real news is. We talked about this last night. A conservative is going to look at the liberal media as fake news.

David:I don’t remember if it was the BBC or NPR, because somebody was speaking in a British accent, and they were from Singapore, so it could have been either one. But the discussion earlier this week was, Singapore has some rules in play, legislation that is being voted on, that journalists are afraid of because it would limit their ability to report. And the Singapore government has said, “No, no, no. We will not limit anything that you want to say that is factual.”

Kevin:So, it’s free speech as long as it’s factual, but they are the ones who figure out what is factual.

David:Who determines what is true and what is false?

Kevin:That goes back to perspective, Dave.

David:This goes back to the first century A.D. when the question, “What is truth?” is on the table. What is truth? Doesn’t it boil down to perspective? Someone saying, this is factually accurate, or this is factually inaccurate – anyone who has studied hermeneutics – if you look at the history of Christianity, how many schisms and splits do you have between people who look at the same text and come up with a different answer to the same question?

Kevin:Yes. That’s one book. Take that out into all of society.

David:That’s right.

Kevin:So what is fake news? Are liberals going to think conservatives are fake news, and vice versa? But what, even, is real money? We used to have reserve ratios, like with the dollar used to be a receipt for a certain amount of gold. At one point it was 20-to-1, and then they raised it to 35-to-1. But we are in a situation right now where the dollar is really not backed by anything, so what is real?

David:Right. Again, this comes back to a difference of perspective, because on the one hand, we have a tradition of metalism and bimetalism as a means of defining what money is. And then you have a whole different school of thought which says, no, money is not based on something backing it. The value of money is assigned by a government, and it is sustained by a government’s power to tax. So even with something as basic that we assume everybody can agree on – what is money? No, no, no. No. Factually, it depends what camp you are in as to what is money. I love that Barron’s still gives Jim Grant space here and there.

Kevin:He used to write for Barron’s, didn’t he?

David:Yes, back to his roots. He had his Barron’s column before he was printing The Interest Rate Observer. I think he has been doing that for 30 plus years now. But Barron’s has been this amazing incubator. Alan Abelson, one of the great writers of the financial period…

Kevin:Yes, he was a guest back before he passed away.

David:Yes. And I think Jim Grant is a great writer, as well. So he’s in there, he’s near the last page this week, and he comments on bank leverage. He is kind of comparing what the banking industry is doing to how fashion has changed through time. He says, “Look, you have J.P. Morgan who has leveraged ratios which stood at about 10-to-1.”

Kevin:Okay, so ten times one, as far as equity goes.

David:Pretty conservative (laughs) compared to where we were 2008, 2009. But then he says that the Federal Reserve has ten times that. Their leverage is about 100-to-1. And he asks the question, “What kind of example are they setting?” He points out that at one time it was fashionable for central banks to set the standard for risk awareness for mitigation of risk. The currency that they issued reflected how much or how little sobriety they had. So much of history, our currency was backed by gold in a ratio of 20-to-1.

Kevin:Right. Twenty bucks would buy an ounce of gold.

David:And then in the 1930s, after the devaluation of 1932/1933, it was changed to $35 equaled one ounce of gold. Banking and fashion have changed. This year is introduced the open collar, sort of a business casual approach for the first time at Goldman-Sachs. And on the same token, we have monetary casual, as the Wall Street Journal suggests. Central bankers have been basically bankrolling animal house. It’s a regular financial market frat party for the last decade. And to end that now would be to take the hangover and any other penance to heart. Maybe we shouldn’t have been drinking quite so much so frequently. That’s the issue of liquidity. Stocks, yes, they put up a stellar bounce off the 4thquarter lows. You have the 20-year treasury note which is up 15 points since November.

Kevin:Right. But that’s because interest rates are falling.

David:That’s right. So bonds are sending a message. Bonds are sending a message at the same time that stock jockeys are passing the party punch from the Fed. It is difficult to tell who is the adult in the equity room. Is there anyone in the equity space that is going to be the adult here and say, “Hey, guys, maybe you shouldn’t – just slow down a little bit, you’re getting ahead of yourselves.” If you look at what is going on, you have earnings per share growth estimates for the S&P 500 which are the worst since late 2016.

Kevin:Which means the earnings are suffering.

David:What is estimated for 2019, the next quarter and the next several quarters, has been demoted, demoted, demoted. Corporate America is not going to put up a good Q2 or good Q3, at least according to the estimates. And it doesn’t matter because the drinks are on the house.

Kevin:And that’s what I’m saying. So you’re really going to an after-party? My daughter was invited to one of these after-parties. We called her the next day and said, “How late were you out?” And she said, “15 minutes.” She realized it was going to go the wrong direction quick. But while we were there, we stayed in a hotel, we parked the car, and we used Uber. It makes me think of what is going on with Lyft and Uber. These are companies where the drivers have to work very, very hard to make a living, obviously. They are driving cars that they have to maintain, they have to pay for gas. They are able to, through tax write-offs and just really, really crafty placement – where they stay and when they drive – make a living. But Uber, itself, and Lyft, itself – they’re not making any money.

David:This is what is fascinating, because whether it is Netflix or Tesla or Uber or Lyft, these are companies that are doing something different from a technology standpoint. But what they are selling to investors is growth rates. They don’t make any money. They are selling growth rates. I think it is a fascinating thing to see investors clamor for a growth rate with a company that doesn’t make any money. To be a “going concern” has changed radically.

Kevin:You had better keep those stock investments coming.

David:The Lyft IPO – it just happened this last week – it takes off, you have a valuation of between 22 and 23 billion dollars for Lyft. The competitor is Uber. To tell you a quick story, I was in New York earlier this year, and it had me thinking that there are sometimes these overlaps between what is happening with high-frequency trading and even what an Uber driver or a Lyft driver is trying to do. I’ll connect the dots for you. I barely made it to the car before the guy pulled away. And he actually looked a little disappointed when I opened the door, like, “What are you doing here?” I had his name, and he had my name, that’s the way it works, the technology is transparent that way. So I get in the car and I’m driving around Manhattan, and I said, “Oh, I see that you’re both a Lyft and an Uber driver. You’ll take either one.” He said, “Yes, but I prefer Lyft.” I said, “Oh, that’s great. How long have you been doing this?” He said, “About three to four years.” I asked, “Can you actually make a decent living?” He said, “I make a great living.” I said, “Tell me how it works.” I got him talking, and he warmed up. The next thing you know, he’s telling me about the rebates that Lyft and Uber have when you have no-shows.

Kevin:Which is somebody who orders it, but doesn’t show up on the curb.

David:And then all of a sudden he is telling me about how he structures his no-show rebates for the day, and he will have 10-15 of these where he is waiting to the second and pulling off, screeching away, so he doesn’t have to pick up the person.

Kevin:And he gets the rebate (laughs)

David:He gets the rebate. I forget, Uber was like a $3 rebate and Lyft was like a $9 rebate. So think about that. If you are a Manhattan taxi and you’re just going three blocks, you might have made $6, but if you can stiff the guy who ordered the car, you can make 50% more, make $9 for everything that you run away from. It’s amazing that they’re gaming the system, and that’s why it reminded me of high-frequency trading because you can make a good living as a high-frequency trader extracting rebates from the exchange.

Kevin:And I think you accidentally said “a good leaving.” A good leaving, just like the Lyft driver, right?


Kevin:Pun intended. Okay, but let’s talk about this. The drivers may figure out ways of making money, but the actual company, Lyft, even though they add the IPO – remember this, IPOs were huge in 1999 and 2000, it was the biggest thing ever, and then of course, we had the biggest crash ever. So an IPO craze usually tells you that you’re near the top. But they’re not making profits. Isn’t business for profit?

David:Again, this is very old school. We don’t care about making money today, we care about growth rates. And if you can capture that, all of a sudden someday we will make money and it will be like minting money. We just have to get over the hump, whatever that hump is in the future that is making money. In the 12 months prior to the IPO with Lyft, you’re talking about a company that lost 911 million dollars.

Kevin:That’s not a profit.

David:They lost 911 million dollars and this is a success story. What they beat – they beat Groupon who went public in 2011 and only lost 687 million in the 12 months prior. And they beat out Snap, who went public in 2017. They only lost 515 million dollars in the 12 months leading to their IPO.

Kevin:Dave, I think you need to take the company public. You don’t have to make money anymore.

David:No. In fact, if you’re losing money, but can show some sort of a growth rate, then all of a sudden money comes in at you. In our brave new world, proof of concept takes a decade, and even then, at the end of a decade, profitability is not a major concern. A going concern, today, is one where you are going to go public. That is the goal, to go public. Gather in the means of financing operations from a broader base of public investors…

Kevin:Who think it’s a good idea.

David:And after you have exhausted the private capital in the VC markets, the venture capital markets, as a startup on your way to being a unicorn.

Kevin:Okay, so Lyft has gone IPO. Are we going to see that with Uber?

David:They have to. And I think Uber, when they go public, that likely will mark the top in the tech sector. Their new CEO was recently saying, “We suffer from having too much opportunity right now as a company.”

Kevin:(laughs) Oh man, does that ring in the ears of the tech stock boom – when they have too much opportunity.

David:Too much opportunity, but they’re not making any money. So they’re losing on a quarterly basis only a couple of hundred million bucks, no big deal. So far, Uber has been around for a decade, and they have burned through 20 billion dollars in private investor capital. And I think the reality is, going public for Uber, they need to go to the public markets. But ironically, they have never made any money. They have to raise more to stay alive.

Look, I’ve used Uber. I would have guessed anecdotally, that the ease of the app, the popularity of the service, both with Uber and Lyft, meant that these were businesses and not corporate charity cases. This is where I can’t wrap my mind around being in business for ten years and this is nothing but a corporate charity case. They don’t exist, from a cash burn perspective, without passing the hat to investors every month. Is that a business, where you have to pass the hat every month to investors and say, “Look, we’re just burning too much cash, but some day – someday it’s going to be great.”

Kevin:Well, if it is not shareholders that are funding these operations – look at Tesla – it is you and I. The government, itself, is subsidizing to the point where we’re like, “Wow, look at Tesla, it’s a great new idea.” But guess who is paying for it?

David:To me, you can go back to a different era where there was a craze over new innovation and change – the railroad era. You built tons of railroads, they built over-capacity. And it’s not like railroads were stupid. They weren’t a bad idea, they were just so popular, and for the wrong reasons, amongst investors, that those early investors lost their shirts. Now, those who came in on a secondary basis used the services and they ended up being very good businesses. Ask Warren Buffet about Burlington Northern – a great business – but he wasn’t speculating on the front end in the 1800s, in the 19thcentury. I think that is what we have with Uber and Lyft, is something that is great, it is innovative, they will make money someday. But the stock of investors today who are buying the dream – these are the folks who are going to get hurt.

Kevin:Well, and you were talking about too much opportunity. It really does remind me of the dot.com era. There were companies, there was a lot of red ink, and that’s what we have at this point. You have companies that are the highest valuation companies that are making the least, or losing the most, as far as profits go.

David:March 25th, the Wall Street Journal, that’s what they said. Ride hailing company Lyft is leading a parade of Silicon Valley companies to Wall Street that display an unusual quality with parallels to companies going public in the dot.com era. Lots of red ink. That’s the commonality is that you don’t have to make money. So, when you were saying earlier that IPOs are an indication, it really is the IPO craze, the idea that if you just make it to the public markets, which really means you just need a couple of guys, a laptop and a PowerPoint presentation and a really great pitch. They tried to do this with Theranos, the blood treatment, and what a story. But if you have a story, you have a story seller, and guess what? The public markets, the private – this is where valuations get really out of whack.

So without ongoing financing, the businesses are not sustaining themselves. You mentioned Tesla. Tesla has been in that boat since its inception. It’s another corporate charity, taxpayer subsidized, dependent on new rounds of capital just to keep the doors open. So when you see those Teslas running around town, recognize that someday that may be a business. But right now all it is, is a corporate charity, but it is underwritten by U.S. tax dollars and a lot of investor capital that is getting burned just so that Tesla and Elon Musk feel extra special.

Kevin:There are two other ways that a company can actually look much better than it is. We’ve talked about actual stock buy-backs where the company goes into debt, sells bonds, as long as debt is available, or liquidity is available, they can buy back their stocks. The other thing we saw, and we saw this during the dot.com bubble and we have seen it over and over before crashes, is mergers. You can go eat or merge with other companies and you can hide the fact that you are not making money. And these mergers are picking up steam, as well.

David:Right. Marc Faber frames that issue this way, looking back at the AOL/Time-Warner merger in the year 2000. What did that tell you about the market mood at the time? What did that suggest about what was already behind you, maybe that the best was, in fact, behind you, with everything that followed? How about the Blackstone IPO in 2007? What did that tell you about both the Blackstone insiders, what they hoped to get out of the IPO, and where you were at in terms of the market cycle, and the enthusiasm for structured products?

Kevin:And it’s not just securities. Look at commodities as well. You can see that in the commodities market.

David:Sure. Glencore, Marc Rich’s old company – he didn’t list that until 2011. It didn’t go public, the IPO wasn’t until 2011. Again, you’re talking about coming basically at the end of a commodity cycle, maybe even a super-cycle. So as a rule, insiders are trying to sell peaks. They are trying to get out near the top. Marc concludes that the time to worry is now. Of course, he writes the Boom, Doom and Gloom Report, so maybe he is always worrying. But he’s not always negative, and he’s not always short. But the time to worry is now.

I think one final point from Marc echoes something that we said weeks ago. If you look at the semi-conductor index – pull it up as a chart, SOX – most semi-conductor companies are reporting declining revenue and declining earnings, yet that index is near all-time highs, which in his words is insane. We agree. There is a theme amongst these companies – again, I’m conflating or confusing, bringing both, what we were talking earlier with the IPOs in with the semi-conductors – but it just seems like they are buying growth at any price. And if you can buy growth, it doesn’t matter on the merger side, it doesn’t matter on the buy-back side.

This, frankly, Kevin, is what happens when you start playing with funny money and there is too much liquidity in the system. When capital is not dear, it is not treated as such. When the cost of capital is not high it is thrown around. And to me, I don’t hear the music anymore. I would be grabbing a chair. But that’s not really what is happening in the marketplace today. You have buybacks, you have all of these things going on. We’re just coming into the blackout period for buy-backs which would be interesting to see, both with the golden cross and the potential for stocks to go higher, but with that artificial buying from corporations actually being trimmed back here for a little while.

Kevin:You had mentioned drinks on the house and I was using the analogy from this weekend. But I think when the booze is free people drink more. And going back to the bond markets, we were talking about the maturity of a bond investor or the bond markets. They seem to be signaling something different than the party that is going on for these companies that aren’t making any money but are just exploding in price.

David:The Economist had a very good article on that this week, as well, where the bond market is sounding warnings on both sides of the Atlantic. It’s just that the message is worse in Europe. So you’re getting the bond market sending a signal. Nobody is really paying attention because, again, everybody is happy with the libations being passed.

Kevin:Well, they’re negative. We have negative rates in Europe at this point and people are happy to pay it.

David:Yes. The Economist article said that for the first time in three years the yield on German ten-year bonds fell below zero. Well, we’ve been there before, right? But it means that investors are willing to pay to hold it.

Kevin:That’s amazing.

David:I remember going back to 1999, the year 2000, buying German government bonds because outside of the treasury market they were the most liquid government paper, and I based that on the presumption of euro appreciation. You actually did have an interest rate which was positive. Looking back on it I almost feel nostalgic thinking about those rates. I can’t imagine stepping in and paying to own German paper today – paying to own it – with no rate.

Kevin:No, it’s a negative rate.

David:Paying for the privilege of ownership. Again, it’s not like buying a sports car where you pay for the privilege of ownership but you also get to use it. You don’t get to use German paper whereas you might get to use a BMW.

Kevin:But German paper – it’s like when you drive the car off the lot you lose 20-30% of the value.

David:(laughs) Well, okay, you’re right.

Kevin:So German bonds are like driving them off the lot. You just drive that bond right off the lot. There you go.

David:I stand corrected. But a bet on the euro today, in the face of declining economic indicators across France, Germany and Italy, I can justify. What it really is, is a bet on the punchbowl.

Kevin:Right. Draghi. It’s a bet on the punchbowl, Draghi, what have you.

David:The ECB is going to buy paper, and it’s going to buy it in even larger quantities. They’re going to drive the price higher, the yield even lower. I know it’s more reasonable to see the case for that when you’ve got against – the balance is shifting, 10 trillion dollars in global fixed income, yielding less than zero, again. But if that’s the new normal, I have to tell you, it still doesn’t feel right.

Kevin:In the book of Ecclesiastes Solomon says, “There is nothing new under the sun.” But I’m going to take exception that that.

David:(laughs) Because in the book of Homer and Sylla, if you go to the 4thedition, they wrote, those authors – not Homer as in old school back to the days of ancient Greece – Homer and Sylla wrote A History of Interest Rates.

Kevin:It sounds interesting, but they have never seen negative rates before.

David:I own the 4thedition, which was printed in 2005, and they give a range of interest rates being at very high levels and being at very low levels. And in the 2005 edition there was no such thing as a negative interest rate in 5,000 years.

Kevin:So 14 years ago they had never seen a negative interest rate.

David:Right. So we’re growing ever more comfortable, and maybe complacent, with abnormal and aberrant behaviors. Money is what we are talking about here. Interest rates are what we are talking about here. We could expand the conversation I suppose but this is the issue. After 14 years nobody is asking any questions about whether or not this is a good idea. Because the world hasn’t blown up yet, everyone is assuming that it’s okay.

Kevin:But there are only two things you can do. You can either continue to lower rates, and continue to lower rates, there is a point where people will exit the system. Or you can start as a government spending money. A lot of times when a government needs to pull something out and lowering rates doesn’t work anymore, they just go to war, or they build a new road system or bridges everywhere.

David:The low rate environment, the negative rate environment – you and I have talked about this before – it’s like the alcoholic who is a maintainer.

Kevin:Right. The vodka alcoholic where he is drinking three to four times a day, but nobody knows.

David:May go through a fifth every day, and no one knows because it’s just kind of maintained. Again, nothing has cracked up yet. Occasionally you will see indications of behavior that just says something is not quite right. It’s like a glitch in the system.

Kevin:Right. Then there is the DUI, or the accident, or something worse.

David:And all of a sudden the system starts falling apart. But the financial system today is a lot like the maintaining alcoholic who has plenty of alcohol, plenty of liquidity flowing, and no real consequence yet. The system is supporting it to date – to date. Up until this date it’s fine. You have to say, from a systemic standpoint, it’s not exactly healthy, not what the system was designed to handle, and you may, in fact, be surprised on the downside as the system rejects, rebels, or an accident is caused because of the intake.

Kevin:So what you are saying is, we could develop cirrhosis of the debt markets. But going back to spending money, we haven’t used, worldwide, all of the options yet, have we? If they can borrow money, they can go spend money.

David:When I was in Oxford for a year, I rowed crew, and one of the boats that we rowed was called Sir Osis, in case you cared, as in cirrhosis of the river.


David:What we are dealing with is monetary policy exhaustion and the need to shift toward fiscal policy, and there is some latitude for that in Europe. There may be latitude for that in the United States. This is where some of the conversation relating to modern monetary theory comes alive because if you are going to spend more, the typical equation is then you have to tax more. You have to bring in the revenues in order to afford it, and MMT says that is not necessary.

Kevin:What if you don’t? What if you just print the money?

David:So we may have some latitude from an MMT standpoint. I want to spend some time maybe looking at that in the next few weeks. But in Europe, fiscal policy, you get to do a little bit of that. Monetary policy is unified in the ECB. There is no centralized fiscal policy so you have individual countries who can look and say, “How do we improve our lot by (fill in the blank – building infrastructure, defense spending, cutting taxes?) Otherwise, without that fiscal spending, 2019 looks like a pretty bleak year for Europe.

Kevin:You think about the big spending pushes in the past, the fiscal largesse. We had a fairly young demographic called the baby boomers, and we built a lot of things, we went to the moon, fiscal spending, Vietnam, what have you. At this point, I think we have an aging audience worldwide, though. I don’t know that the demographic is quite the same to pay for this. Actually, they have worked all their life to be paid for.

David:That’s a big picture issue and probably a slow burn issue. Most demographics issues are, but very relevant, if you are thinking about, ultimately, what is sustainable, and on what timeframe might we have an issue. Again, The Economistfocuses on this in an article called Aging is a Drag. “For the first time in history the earth has more people over the age of 65 than under the age of 5.

Kevin:That’s the first time in history.

David:In another two decades the ratio will be 2-to-1 of people who basically need support from a social structure versus those who are just coming into the structure, and the trend has economists worried with everything from soaring pension costs to secular stagnation. That’s what The Economist focuses on. I would say, imagine having a funding issue with all those long-term liabilities. Again, Lawrence Kotlikoff has been on the program with us before, he pencils it out at about 220 trillion dollars.

Kevin:And that was years ago.

David:Yes, I don’t think he has been on with us for 6-8 years. My guess is the 220 trillion unfunded liabilities, maybe you add 10-20% to that and push us toward 300 trillion. But again, we’re talking about long-term liabilities and the need for funding those, coinciding with the need to roll over lots of debt. So you have default on pensions and a social safety net. These unfunded liabilities like Social Security. If you defaulted on them, it’s politically unfeasible. You have a nightmare. How many people would vote? There are more 65-year-olds and over who are voting than under five-year-olds, so who votes their self-interest? You can’t get away with it.

Kevin:You don’t default, you devalue.

David:Well, that’s the key, isn’t it? Because if you look at what is the most reasonable outcome, default on debt in a leveraged world, an outright default on a pension, you are going to have pensioners screaming. Default on debt, and you say, “Well, let the investors just grovel and cry and it doesn’t matter.” Except that when you default on debt in the leveraged world, it is the end for the bankers and the financiers that dominate that sphere. And so, the solution is to quietly and slowly inflate the debt and the liabilities away.

Kevin:That’s the devaluation.

David:And that is what I want to explore in future weeks, about how modern monetary theory comes in at just the right time for politicians to do the unthinkable, which is print and spend to make everyone happy. And my caveat would be, happy for a while.

Kevin:We have had a friend of ours, Jim Deeds, on many times. Jim brings an almost 90-year-old perspective to the world. He is so clear in his thinking that he continues to write, he continues to speak, and it is wonderful because it helps us to use him as a mentor. He goes back and looks at the 1950s, and he says this doesn’t resemble the 1950s at all.

David:Graduating from high school in 1950. At that time you had the long bond yielding 2.71%. The national debt was 267 billion dollars.

Kevin:Think about that – 267 billion dollars.


Kevin:How long does it take us to spend 267 billion dollars of borrowed money now?

David:(laughs) We add that amount to the national debt in a timeframe of between 90 and 180 days. So from the founding fathers to when Jim Deeds graduated from high school we racked up 267 billion. Then fast forward 30 years, September of 1981 debt had dramatically grown to a trillion dollars – 1 trillion.

Kevin:So from George Washington to Jimmy Carter you got up to a trillion. Then Volcker raised the rates.

David:Volcker did. And what was he doing? He was dealing with the inflationary consequences. Here we are back on the MMT theme. Volcker was responding to the consequences of an environment which blended monetary and fiscal policies, both under Johnson and Carter. So he was raising interest rates to the level where – and this was to kill inflation, he had to. The long bond yielded over 15% – 15% on the 30-year treasury.

Kevin:My wife and I bought a house. I think our mortgage was 15% back in the early 1980s.

David:Right. October of 1981 the 30-year mortgage topped at 18.5%. Can you imagine financing the purchase of a home and doing it with a long-term debt at 18.5%?

Kevin:Okay, but you have 29-year-old future politicians who are saying, “Why don’t we just print it?”

David:29-year-old existing politicians who say that there is a big difference between lawyers and attorneys.

Kevin:That’s right, that happened yesterday.

David:But the MMT crowd might want to look into the historical instances of – again, this is where the nastiness comes from – where monetary policy machinery is harnessed for fiscal policy agendas because typically inflation of a painful nature is the consequence. I have looked at this for a three-century stretch in as much detail as possible. I’m tempted to think that if you stretched it back two or three millennia you would find the same evidence where you blend the monetary policy machinery with fiscal policy agendas and you end up with something that is horrific from an inflationary standpoint.

Kevin:As a parent, you never teach your children that money grows on trees, but really, the modern monetary theory crowd, that is the whole message. They can make it as complicated as they want with equations and this, that and the other as far as economics. It really is, just print money.

David:So here we are. The current context is bond market yields moving lower. We talked about the inversion earlier. If you are looking at the entire yield curve, a one-month treasury bill is yielding 2.42%. The 30-year is at 2.89%. That is about as flat a curve as we could see.

Kevin:Boy, that’s flat.

David:And there is some inversion in there. But no doubt, you have the reduction in rates which has allowed through a long period of time – go back to 1980 to the present – that reduction in rates has allowed for a massive expansion of debt – 2 trillion, 3 trillion, 10 trillion, 15 trillion, now 22 trillion and climbing fast.

Kevin:What used to keep that in check, going back to Jim Deeds, was the dollar was a receipt for gold. You could only print as many dollars as you had gold. We went off that standard over the last century.

David:Right. He grew up in an era where there was a penalty under the gold standard for running deficits. You could run a budget deficit or a trade deficit and you were eventually penalized in the debt markets and in the currency markets. We cheated the system under Johnson and tried to bully those who wanted to penalize us for it, and that’s when the old system broke down. The original promise at Bretton Woods was that we would issue no more than $35 for every ounce of gold that we held in reserves. So that provided a stable measure of value and a reference point for all the world’s currencies because we were, by proxy, something of a gold standard, with a fixed rate exchange of 35-to-1, $35 for one ounce of gold.

Kevin:So at one time we had enough gold to back up 35 printed dollars for every 1 ounce of gold sitting in Fort Knox. Of course, that has not been audited, so let’s just assume it’s there. I wonder what that would be right now.

David:Barron’s has the data. And if you track the data from then until, let’s take it to February of this year, February of 2019, we have expanded the amount of money in supply, and of course, we have subtracted a few ounces of gold from our reserves. And now, instead of a 35-to-1 ratio it is a 6,524-to-1 ratio. In other words, it is 6,524 issued dollars per ounce that we hold in, as you mentioned, unaudited gold reserves. That is a 186-fold increase in the quantity of money circulating. We can talk about future-tense inflation issues. Let’s not ignore the one right under our noses. There is a reason why things broke apart after the Johnson administration and we have never looked back.

Kevin:So we can count on the government never going back to the gold standard, but we can put ourselves on one. 6524 dollars issued for every ounce of gold that we have – that ratio is incredible based on the 35-to-1 that we went off of in 1971.

David:You raise a good point because there is no reason to be subject to the whims and fancies of public policy. You can redirect your savings in a way that protects them, and I think it is prudent to do so. Had you done that, looking at the writing on the wall in the late 1960s, as we were trying to bully the French – we said, “If you’re a friend of America you will not do this. You will not take gold from Fort Knox, you will take greenbacks instead.” They took gold. They took a lot of it. That’s why by 1971 we determined them to be not friends of America and we had to close the gold window, so the gold stopped flowing out of our reserves. But if someone had said, “I’ll just put myself on my own gold standard,” this devaluation – again, it was 20-to-1 ratio, then it became a 35-to-1 ratio after FDR, and now we’re at a 6524-to-1 ratio – this is the story of devaluation of the U.S. dollar through time. And it doesn’t take a rocket scientist to say, “How do I do something about this? If I want to save for the long term, how do I save in a reliable currency when the whole world is dealing with a floating currency system?” Easy. Easy. Gold has been money, and I think will be the resorted-to currency in the context of the coming currency crisis –globalcurrency crisis.

Kevin:Don’t we live in a perception-backed currency at this point? We talked about perception earlier with fake news, what have you. The perception, really, is reality with the dollar. If people lost faith in the dollar today for some reason, let’s say something happened where it scared people and they said, “I can’t hold dollars anymore,” the dollar has nothing to fall back on except for the perception of the public.

David:I think this is where the folks at PIMCO used to call the dollar the cleanest dirty shirt. What Ian McAvity used to say is, “The dollar is the best-looking horse in the glue factory.” So we compare these things on a relative basis and then for an absolute judgment of what they are worth, again, recognize the context – being at the glue factory, you’re dealing with a terminal state. We have 22 trillion dollars in debt, it’s no big thing relative to others as a percentage of GDP. This is how we get away with it. We compare ourselves to someone else. Fill in the blank. “Hey, look at the Japanese. Come one, they’re at 250-300% of debt-to-GDP. We’re nowhere close. We’re just fine.”

Kevin:Yes, but look at the world. We talk about 22 trillion here. How many trillion is it worldwide?

David:Over and over again we come back to this theme of perception and how we see things. And it matters at some point. We live in a new monetary era – yes. Constraints on the quantity of money and credit have been governed by these perceptions of what is allowable and how it compares on a relative basis, not in absolute terms. But the concrete number? Reuters quotes S&P Global as saying 2019 we will top 50 trillion dollars in sovereign debt – 50 trillion dollars in sovereign debt – that will be a new record. And that’s just the governments of the world, that’s not individuals or corporations living beyond their means, just governments. And the financing needs are projected to be 7.78 trillion dollarsin total for sovereign debt. And 5.5 trillion of that is refinancing.

Kevin:They have to refinance 5.5 trillion of the 7.78 trillion?

David:I think it is worth looking at because picture this differently. The bill is coming due on 5.5 trillion dollars. Because you don’t have the capital to pay it back you have to push off those repayments into the future and you have to refinance. So you have 5.5 trillion dollars in rollover risk, and just go back to 2007, 2008, 2009. We were concerned with a few hundred billion dollars in rollover and liquidity risk during the mortgage-backed securities bubble and what followed it. We have so much money that has to be rolled over, 2019, 2020, 2021. It just doesn’t make any sense how perception is what it is, but there really is very little concern when you go to the equities market. There is – get back to this contrast with the debt markets – there is some concern in the debt markets.

Kevin:I am ashamed to say what we are really talking about is, we have already spent my son’s and my daughter’s money, my grandkids’ money if I had grandkids, my great-grandkids’ money – this debt, this perception that we are talking about, actually, we have spent that money. We have just spent the future.

David:Kevin, I think this is one of the reasons why legacy is such an important theme to me because what we do in the world of finance and investments, precious metals and asset management, it is easy for us to look and diagnose the problems on the financial and economic side of the equation. But I will be honest, I think people forget to be careful about how they invest in the rest of their lives, too. And this is where, again, legacy is so critical.

There is a Native-American proverb that says we don’t inherit the earth from our ancestors, we borrow it from our children. And I think the perspective of seeing what future generations will experience because of the decisions we are making now, is not only something that is sobering, but it is something that brings to light a vision for the right decision that we need to be making in the present context. That, again, is something that only the legacy-minded will grab onto.

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