EPISODES / WEEKLY COMMENTARY

The Early Bird Gets The Gold

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Apr 26 2023
The Early Bird Gets The Gold
David McAlvany Posted on April 26, 2023
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The Early Bird Gets The Gold
April 26, 2023

“If you look at the steeply inverted yield curve today, defined in part by the Fed’s earnest fight against inflation—they’ve raised rates this high, and of course, you consider the proximate cause of liquidity leaving the commercial bank sector, you look at Fed funds, overnight lending, if you look at the structure of short rates, these are engineered by the Fed, with the market driving longer term rates, and they are in fact priced lower. But you have an intriguing bet on the future prospects of the economy at the long end of the curve. Yield curve inversion, along with bleeding economic indicators, suggests that June, July, August is our timeframe for recession. Now the question is, soft or hard landing? That’s the only question.” — David McAlvany

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

And David, we just got out of our meeting that we have each week. We were talking as a group about, do as the central bankers do, not as they say. There’s a chart that was in the Financial Times a couple of days ago that you were remarking about. I’d like to talk about that right now because when the central bankers are buying gold, usually nothing’s happening, but they’re buying a lot of gold before something big is about to happen.

David: Yeah, central bankers have not existed forever. We go back to the 1600s, and it’s the Swedish first, then the British following the Swedish example, and the problem they were trying to solve is how do you keep the currency from decay? They had a special guild that was responsible for the creation of currency, and lo and behold, the folks at the guild were cheating the public and they were clipping coins. So, imagine, you put people in charge of managing money, and somehow there’s decay. So they bring in the central bankers so that there’s no longer this managed decay. Central bankers are supposed to be the custodians of this sacred reserve, the keepers of gold. And so, we have this thing which brings stability to society. Now, all of a sudden, instead of managing our reserves and the keepers of gold, all they’re doing is managing the process of decay.

Kevin: But when they’re buying gold, and they bought gold all through the 1960s when the dollar was still under the gold standard, and then they just stopped buying in ’71.

David: And it’s worth watching what they do, when they do it, and asking the question why they do it.

Kevin: Right. And they’ve been doing that for the last 12 or 13 years, again, buying a lot of gold. What do they know?

David: Right. Charles Goodhart, who’s previous Commentary guest and veteran British central banker, he takes aim at US monetary policy as the driver, as the first cause of the recent banking market chaos. So we go back—

Kevin: That’s the printing of a lot of money.

David: Yeah. It was last month in the US, we had, of course, those bank failures, and now he anticipates a ramp up in regulation and an increase in bank capital requirements, which he says, Look, this is great. It’ll bring a short-term solution, and that brings calm to the immediate context, but it also promotes recessionary trends. If you’re going to increase the bank capital requirements, if you’re going to increase regulation, again, all of that may be reasonable, but it also increased the cost of financial intermediation and it reduces lending, which ultimately increases systemic risk and promotes recessionary trends.

How did we get here? Well, Goodhart says that “lax monetary policy,” this is where he starts, “lax monetary policy designed to help the economy grow made the financial system dependent on low interest rates. Banks adapted their operations to the low interest rate environment, was not seen as a problem because they would only face difficulty if rates were to rise. Consequently, a necessary condition for the monetary policy to be sensible is that inflation would never rise. It was a bet on low inflation and low interest rates lasting forever, akin to riding a deep out-of-the-money and decades-long-maturity put option on inflation.”

Kevin: Well, it’s akin to just saying that money grows on trees and you’re never going to have inflation. And so, let me summarize. Here’s all this money from the central bankers. “Here you go. We’re going to print it. We’re just give you a bunch of money. Oh, now we’re going to take it back because we have inflation.” That causes problems.

David: And it lacks monetary policy. There to do what? Promote economic growth. And then all of a sudden we find that there is a cost. There is ultimately a cost to a boom cycle.

Kevin: Let me ask you, though, because we’ve got inflation, but we also had robust economic growth. That seems to be changing pretty rapidly right now.

David: As oil and copper give up ground, their price action is suggesting that either the Chinese recovery is not what it’s hoped for, it’s not delivering, or potentially that the global economy is growth deficient, moving into a contraction as the year progresses. Those two commodities are incredibly important when you’re thinking about global GDP, and particularly when you’re thinking about Chinese GDP growth in recent years, because Chinese GDP growth has been the source of marginal global GDP growth. That’s where most of the global growth has come from, their contribution.

Kevin: So when you’re seeing copper and oil falling at the same time, is that a lack of demand?

David: It just suggests that there’s something lacking within the global economy. Two very important tells in the world of economists, and for traders, these twin commodities portend weak demand. That’s what they’re telling you. It’s there now. You don’t have enough demand to drive the price, even as their supply profiles improve. And I think this is really important to keep in mind because with demand and supply, sometimes you can be in a case where you’ve just overproduced. So the demand side, you don’t know if it’s too strong or too weak because you’re oversupplied. 

With oil, you’ve got OPEC cuts, you’ve got long-term underinvestment in production expansion. And in the case of copper, a reaffirmation that mine supplies from the largest producers are now unable to be ramped up for even a marginal increase in demand. Supplies are just tough to come by. Let alone what the world is now expecting with this notion of energy transitions. A quintupling of demand would be required from current copper productions in order to move forward with this green energy transition. 

This is a very bullish setup for copper. Copper stockpiles are the lowest they’ve been in 18 years, so demand side is—at least on paper—set to blossom, and supplies—lowest stocks in 18 years. And if they go digging in the dirt, that’s a problem too. There’s a real-time shadow cast over consumption and price action that I think at this point can’t be ignored if you’re looking at these two commodities. 

As an aside, the supply pressures in the copper market are in part due to Chile’s underinvestment. They’re responsible for about 25% of the global copper supply. Chile has underinvested for many years, even decades. These are state-run firms that have failed for years to expand their resource base.

Kevin: Funny you’d bring up Chile because that’s been in the news here recently. Last week we talked about how you can’t always assume something’s going to go parabolic. We’ve been talking about this going green, which means a lot of electric cars. Problem is, you need a lot of lithium to have batteries for those electric cars. In Chile, we’ve had a Chile cook-off, I think, here over the last week, along with the other countries that are nationalizing.

David: Well, again, you look at what is there on paper for an energy transition, and it’s easy to chart the trajectory for lithium. It went from 10,000 a ton to 90,000 a ton. Whoops, the parabolic curve broke, and is back at 25,000 a ton and declining. Why? Well, Chile vaulted itself into the leader role this week as a threat to market-based dynamism. And a potential problem, again, for any country that has ambitions to move away from fossil fuels. What did they do? Well, nationalizing all lithium assets in the country, moving into a forced partnership with existing producers, that was their major accomplishment for the week.

Kevin: This would be mine. This would be mine, right?

David: Three for me, one for you. Three for me, one for you. So lithium companies with exposure to Chile are in freefall. In fact, if you look at the chart of some of these lithium companies, they look like US regional bank stocks. Funny, isn’t it?

Kevin: It’s dropping.

David: We’re on the edge of a nationalized commercial banking system here, and there you’ve got nationalized assets. What is it about control these days? It seems the least competent people in the world are the ones vying for the most control they can get.

Kevin: We talk about free markets, and then we see these socialized economies. Socialism, that’s a terrible worldview for business, isn’t it?

David: Yeah. The state that brings you a failure to plan in the copper mines is now accelerating a delusional socialist gambit. They believe they can provide lithium to the world—a move, frankly, that for all resource investors needs to focus your attention on the frailty of resource claims. Be wary of where you invest and who is in office there.

Kevin: So worldview matters.

David: Who is in office there. Yeah, absolutely. Yeah, I mean ideas have consequences, and worldview does matter. You want to know how much it matters? Ask the folks that were lithium-exposed in Chile. In a world of rapacious and backwards idealism, we’re afforded the opportunity to see in Chile the snake eat its own tail.

Kevin: Wow. 

David: How’s this going to work out? 

Kevin: Oh, but China produces more lithium than anybody, don’t they?

David: Well, so let’s transition from the snake eating its tail to the dragon. China doesn’t produce a lot of lithium, but they refine most of the world’s lithium. China has 60% of lithium refining capacity, and above 90%—if you want to look at a broader list of rare earth metals—above 90% processing capacity for rare earth elements. The production bottleneck for the basic substances that we need for modern technology—that frankly keeps the world in a close relationship with the Chinese whether they like it or not. 

Think of Europe, Europe relies on China for 98% of its rare earth minerals. So you’ve got Christine Lagarde’s comments last week, captured by the Associated Press. She says, “Economic data dating to 1900 shows that geopolitical risks led invariably to higher inflation.” And that’s worth talking about, Kevin, on its own, but she also pointed out that severing ties with China would be difficult. And so this is back to that rare earth comment. She says, “Used in cell phones and computer hard drives, among other products, if world supply chains were to split along geopolitical lines, consumer prices could rise 5% in the near term and 1% in the long term.”

Kevin: And you think that’s realistic, or do you think it’d be more?

David: I think that’s the understated case of an economist who’s now a politician. Try 25 to 50% in the near term and five to 10% in the long term. Geopolitics has a radical impact on scarcity and pricing. Lagarde was speaking at a Council on Foreign Relations meeting in New York City. She was saying, “We are witnessing a fragmentation of the global economy into competing blocks, with each block trying to pull as much of the rest of the world closer to its respective strategic interests and shared values.” 

It’s fascinating because now, all of a sudden, we’ve been told that we don’t want a unipolar world. This world centered on the United States is garbage. It’s all about abuse, and this is such a terrible thing. Suddenly, in the comments of Christine Lagarde, multipolarity is a contributor to global instability and higher costs. Multipolarity is a contributor to the problem. Fewer people appreciate the US- and Western-led system, as imperfect as it is. But the alternative: be careful of the chaos that comes from competing interests and contrived scarcity.

Kevin: Yeah. I’m going to go back to what I was mentioning before about growth and inflation versus recession. There are signals right now, especially in the leading economic indicators, that we are moving very rapidly into recession, even if we’re not feeling that right now. Chinese growth is critical to the world. You were bringing up China, but haven’t they been counting just the debt, the money that they’re actually using for stimulus, as part of their growth?

David: Well, when you create liquidity or credit and you pump it into the system, it’s going to go someplace. Does it go to the consumer? Does it go to real estate projects? Does it go to government infrastructure projects? Does it go to defense spending? When you create that liquidity, it flows someplace. We saw that in a period of time where lots of liquidity went into asset price inflation. And then a few years later, here in the US, lots of liquidity’s created, and it goes into consumer price inflation. So Chinese growth, GDP, it seems one thing at the 4½% we discussed last week—decent number, but it seems one thing and is quite different. The credit created by the Chinese government in the first quarter was equal to 53% of GDP during the period. We’re talking about $2 trillion in credit growth—

Kevin: That’s incredible.

David: —in a three month timeframe. Astounding. So while the first quarter is traditionally the period of strongest credit growth in China—it’s not uncommon to see Q1 be a larger number than two, three, and four—but this is the only time that this quantity of credit, relative to GDP, has been created. On par with Q1 2020 in the middle of the pandemic.

Kevin: Yeah. And that was their excuse, was COVID at the time, but what’s the excuse now?

David: Yeah, exactly. What are the authorities addressing as an acute need or crisis in China that would encourage them to inject record quantities of stimulus now?

Kevin: Yeah, but we talked about central bankers preparing by buying gold, what are they doing with the money right now?

David: Well, there’s no pandemic. There’s no global financial crisis yet. Michael Pettis, our Commentary guest who who’s still living in China, suggests that they’re taking out growth insurance in the form of aggressive local government borrowing and major infrastructure projects. So if they give you the projection 5%, this is where the abuse of statistics comes into play. When you don’t have the rule of law, you can abuse anything and everyone you want to make the statistics sing. In this case it’s just a credit. They’re going to abuse the credit markets to get their growth statistic. And that’s what Pettis is saying, is they will channel the flow of that liquidity to infrastructure projects. And this time, as the economy is to some degree coming off the rails, that’s actually where they’re putting their money, is into the rails. Literally, massive railway spending near the sparsely populated and poor western border.

Kevin: When countries build railways all the way out to their borders, what are they preparing for?

David: When they did the One Belt, One Road project, they were moving trade, facilitating services. They were an open mind to spending a trillion dollars to tie in Western opportunities for economic growth. What are they doing now, moving things to remote borders? This is not the rails of the One Belt, One Road project, and it’s not moving trade or facilitating services. You could almost think of it as defense spending, at least in this iteration. Pettis points out a slightly different theme. “The objective,” he says, “is to use railway construction to meet politically determined GDP growth targets.”

Kevin: So go put some tracks right here because it’s going to help the economy.

David: They are going to achieve their 5% goal. They’ll have something to pat themselves on the back for, and as they sort of march around creating a coalition of people who are interested in Chinese growth, you might be able to point out the US failure of growth in 2023 as we head into recession, and the Chinese success story. Now granted, quality may be suspect in terms of that 5% number, but this is what they have done traditionally, is find an infrastructure project to build out, and gin up economic activity.

Kevin: In a way, this is their Mount Rushmore. Instead, they’re going to lay tracks. “Lay those tracks out to the border. We don’t care what direction you go, just lay the tracks out to the border. These are our four presidents. This is a mountain that we’ve carved. Here are four presidents.”

David: The second way that they sort of gin up economic growth and activity is by subsidizing their manufacturers. Exports were off the chart, along with credit growth. We talked about the 2 trillion in credit growth in the first quarter. Again, only seen one other time in Chinese history, Q1 2020 in the middle of the pandemic. Exports are off the charts alongside credit growth. This is the fifth largest trade surplus in Chinese history, last month, $88.2 billion in US dollar terms, and in addition to the infrastructure investment there’s an emphasis on subsidized production and export-led growth, which is typical of the Chinese. When they’re targeting numbers, they rely on the old ways. You create a subsidy, you make sure that the production costs are lower, they can compete in the open market, and you just start pumping your products into the world. 

Really fascinating, though, because the Chinese numbers were in stark contrast to South Korea’s export numbers, which fell 13.6%. So you’ve got strong exports in China and very weak exports in South Korea, suggesting that the export numbers in China were in fact promoted by government mandate. Consider it like a supply push and not a market-driven demand pull function.

Kevin: But you mentioned that the money’s flowing down to the people because retail sales were up. You mentioned that last week.

David: Yeah, 10.6%. If that’s sustained, that could be constructive. Again, where Michael Pettis has been playing with the idea for the better part of 10 or 15 years: if they can rebalance, when they rebalance, when the quality of growth shifts from infrastructure and exports to consumption and services. And yet, failure after failure, as a percentage of GDP, that has not been a real source of change. The evidence is not there that they’re making this critical economic transition out of what economists call the middle-income trap. 

And so you get a number like 10.6%, and it is an anomaly. We mentioned that last week. Going back to 2018, it’s an anomaly. Will it be just an anomaly? We need April numbers, we need May numbers to further buttress the case and extend the trend beyond what, frankly, may have just been latent, pent-up demand from the lockdowns. But again, you tie it all together, commodity declines, copper, oil, iron ore, they suggest China, apart from that $2 trillion in credit growth, is in real trouble.

Kevin: So for the person who is saying, “Well, yeah, but I don’t live in China, what difference does that make to me?” we really need to take a broader approach and say, “You know what? What happens in China is very important to what happens in the rest of the world.” Because if this doesn’t turn into continued expansion, they have to go to plan B, don’t they?

David: Yeah. I’ll just add one more market data point before moving on from China, and this dovetails with Doug’s comments from our Tactical Short call last week. By all means, get ahold of the transcript. The audio is available if you prefer to listen to it. At mcalvany.com, you can go to the wealth management section and you’ll find the Tactical Short recording and transcript. 

The Chinese are in a financial panic mode, and the more disturbing aspect of their planning—this is, again, reflective of Doug’s concerns here—is Plan B. If financed growth doesn’t work, direct military conflict with the West is Plan B.

Kevin: That’s where it matters.

David: And as for that data point, I was going to mention the data point, this is from CNBC, “the global rice shortage in 2023 is set to be the biggest in 20 years.” So factor in food instability to your geopolitical calculator. This is going to get hot. This is going to be very bothered—volatile, to say the least.

Kevin: When we look at the dollar staying a strong reserve currency worldwide, we really, in the back of our minds, or actually in the front of our minds, in the front of our windshield, we should see the carrier groups and the military of the US. If there was a shock to the military in the US, that has to be a shock to the dollar.

David: I was following Kyle Bass’s Twitter account. He runs Hayman Capital, is a pretty decent hedge fund manager, and lives on a big ranch in Texas. He posts things that are sometimes very interesting. He’s been short China for a long time. I don’t know if he still is. But I like to see his comments, and he details the military-age male Chinese nationals flooding across our southern border. They’re currently coming through, an average of 530 per week. 

As I mentioned last week, US dollar hegemony is a pillar which, at this point, can only be toppled—toppled quickly—via military failure. It’s time to focus on national security and not on woke madness. There are real concerns which could change our way of life, our standing in the world, our ability to be a significant contributor to anything positive. I’m not saying everything we contribute is positive, but anything that we do contribute globally that is positive, that is at jeopardy when we begin to think about the challenges that we face of a geopolitical nature. That we have porous borders to the south of us— 

I’m in the middle of writing a paper right now for an economic forum on immigration. I am pro-immigration. Great. I’ll get some wonderful comments in the notes on that one. But there is a complicated story. But when you look at our demographics, when you look at future economic growth, when you look at our ability to facilitate the best and the brightest in the world coming here to have a place to land and have opportunity and make a significant contribution to making the world a better place, I think immigration is a very intriguing idea. It has to be handled well. 

So don’t get me wrong, this is not a rant against immigration, but with a porous southern border—they are now tracking 530 military age males, Chinese nationals, coming across the border on a weekly basis. This is a bit of an issue. I took flack from listeners last week for being US-centric, and I would ask the question, what world would you like to live in? I’m sorry, global peace is US-centric. 

I think the other side to that is you could say global war is also US-centric. Again, I am not excusing bad decisions by our State and Treasury Departments. We make a mess of most things, but we don’t make a mess of all things. When and if that changes—us being a source of global peace—when and if that changes, I think you’ll find Madame Lagarde’s comments to the CFR, the Council on Foreign Relations, even more abiding, because you’re talking about competing interests and multipolarity raising economic costs, impacting inflation—a factor that’s not going to go away anytime soon and begins to reshape cultures everywhere.

Kevin: Don’t you think a lot of this, though, we politically stereotype each other and then we go at war with each other, and it’s like, “Oh, well, you’re just a Republican or you’re just a Democrat, you’re a NeoCon. You’re this or that.” You’re talking about multipolarity of nations, but there’s multipolarity right now within our own country.

David: Look, I’m not a NeoCon, I’m not a Republican. Sure as hell, I’m not a Democrat. But we will lose our country to madness and what Bill Maher described recently as the gerbil mind—this is if you don’t identify real problems and solve those real problems and quit being led astray by, again, what Maher described as nothing burgers. He introduced the Cojones Awards, which I thought was fascinating, for those who were fighting back against the ridiculousness of cancel culture. He said, “And the lesson is, if you stand up to the mob for just a day or two, their shallow, impatient, immature, smartphone-driven gerbil minds will forget about it and go on to the next nothing burger, and you still will have your cojones.” I appreciate common sense, and I think Bill has a good bit of it.

Kevin: So let’s go to objective reality then. Because the only way you can do that, if you’re operating in subjectivity, in opinion, all the time, you’re not going to be able to get that award.

David: Maher is no C. S. Lewis, okay. But a populist without cojones does recall for me Lewis’s book The Abolition of Man. If you haven’t read it, it’s worth looking at. Chapter one is titled “Men Without Chests”, and it envisions a dystopia where people can no longer discern objective truth. He says, “We make men without chests and expect from them virtue and enterprise. We laugh at honor and are shocked to find traitors in our midst.” 

Kevin, there’s nothing new under the sun. If you deny objective reality, you align yourself ultimately with the madness of crowds. The results are chronicled already, and most often these episodes end in some version of violence. That’s what The Fourth Turning suggests is— And again, they’re not tying together Lewis’s men without chests or Maher’s populace without cojones. There’s nothing new under the sun. 

Anyway, all I wanted to say is that rice is a 2023 catalyst for chaos on its current price trajectory, particularly if you’re looking at Chinese plan A and the volatility that would envelop the world in the event of a Chinese plan B.

Kevin: Isn’t it interesting, though, the measure of volatility right now? With all these things that you’re mentioning—these various tensions between recession, inflation, Chinese plan A, Chinese plan B—the volatility index, the VIX, is nice and calm. It’s fallen asleep again.

David: Totally ironic. The VIX has simmered down, and if that’s taken as a signal of concern for the equities market here in the US, it suggests there’s no concern at all. We’re not quite to single digits, but 16 as of last week, and it’s finally peaking up a little bit this week. That 16 number leading up to options expiration, it felt flat. It was extremely quiet, leaving options traders with no volatility to milk. If you’re trading short-term options, you have to have volatility. You can buy a put or a call and bet on a directional move in the markets, or you can be on the other side of those transactions. You can sell those calls and puts to speculators for income generation. Last week, the prize went to the writer of options, the sellers. Collecting income with no directional volatility in equities, puts expired worthless, calls expired worthless. Morgan, my colleague in the asset management group, described it as the calm before the storm. There is a financial market storm brewing that is inescapably linked to an economic storm. Now, the geopolitical color we just added suggests that if you’re not paying attention, losses this year within a portfolio could set your financial goals back, not a year or two, one or two decades. Pay attention and stay informed.

Kevin: I look at the last six weeks, Dave, the calls that we’ve been receiving, and before that period of time, people were starting to chase higher and higher rates at various banks. Well, what did that cause? That caused a liquidity problem at Silicon Valley Bank and several others. Then everybody’s focus changed. “Oh my gosh, we need to check to see the bank’s safety rating of whatever we’re in.” And so money was moving from bank to bank based on fear of failure. That’s changed again. Now people are back chasing rates. It’s amazing to see how that flow, just in the last six to eight weeks, has gone from chasing higher rates to, “Oh my gosh, we may lose our money in the bank that we’re in,” to chasing higher rates again. So you’ve got almost a dual personality schizophrenia in the market right now.

David: Bank deposits continue to move to greener income pastures and they’re seeking the high grass, you could say, of short-term Treasurys and short-term rates in Treasury and money market funds. And so deposits are migrating, and so lending from banks is being further pressured because their deposit base is more volatile than it once was. That is a market pressure which has yet to be exacerbated by increased regulation. 

So a couple of things: I read an NBER paper last night, and in some sense it was helpful. In other ways it wasn’t at all. They’re out to prove what percentage of the commercial bank interest rate exposure is hedged. And so, they go through and tabulate all the numbers. 

There’s well over $120 trillion in notional value, so these are gross figures in terms of derivatives. You’re talking about swaps and various derivative products that are there to specifically hedge interest rate risk for commercial banks. And yet, by the time you net it out, it’s just under 800 billion on a net basis. They conclude that with all the hedging that’s done there, there really is no effective protection from a rise in interest rates. 

My takeaway from the NBER paper was that really all [the banks have] done is they’ve created 10 different ways to collect commissions and pretend like protection exists from interest rate volatility. But really, the only thing that protects a bank from interest rate volatility is having sufficient cash to meet depositor demands when cash is called, so that you don’t have to reveal the part of your portfolio which is underwater. For the largest banks, what we basically saw was, they’ve got sufficient cash. If depositors want to move money, they didn’t have to dig deep enough into the flesh of the bank before revealing this particular malady, this particular weakness.

Kevin: And of course, the investment platforms change too. It’s not just the banks that people are getting interest from right now. I mean, you can go to Apple and get higher interest than your bank is paying.

David: Yeah, I just was looking in that NBER paper, National Bureau of Economic Research paper, for some support that the large banks were well hedged. The conclusion was, there’s a lot of activity, but effectively no hedge, and yet there was not any sort of insinuation that there would be a problem with that. I think the problem is insinuated by the fact that we know the nature of the depositor. 

Who can blame the depositor? Self-interest has been and always will be the governor of the unseen hand in markets. If you look at Apple and Goldman, they just combined forces to further disrupt the traditional commercial bank brick-and-mortar business. They’re offering a digital Apple product that provides interest income north of 4%. As they’ve promoted their product, they’ve said, “We’re promoting this at 4.15%. That’s 10 times the income of the average bank savings rate. Come move your money to us.” So Apple and Goldman are willing to exacerbate this problem of deposit flight, taking advantage of what is natural self-interest on the part of the depositor. Do you want to be locked in at 0.4%? If given the choice to stay with four-tenths of a percent or go across the street—in this case it’s not across the street, it’s just swipe of a finger to your Apple Pay, whatever—

Kevin: It’s just one more reason you don’t want to be a banker right now.

David: 4%.

Kevin: Yeah. It’s hard to compete.

David: Do you stay or do you go? 76.2 billion left last week again. So just as Goodhart defined the original cause of banking market chaos as Federal Reserve monetary policy, so, too, if you look at the steeply inverted yield curve today, defined in part by the Fed’s earnest fight against inflation— They’ve raised rates this high, and of course you consider the proximate cause of liquidity leaving the commercial bank sector—you look at fed funds, overnight lending. If you look at the structure of short rates, these are engineered by the Fed—with the market driving longer-term rates, and they are in fact priced lower. 

But you have an intriguing bet on the future prospects of the economy at the long end of the curve. Yield curve inversion projects recession. Yield curve inversion, along with what you mentioned earlier, Kevin, leading economic indicators, suggests that June, July, August is our timeframe for recession. Now the question is, soft or hard landing? That’s the only question. 

We’ve got the high water mark, the three-month T-bill rate, which is sucking deposits from banks at a destabilizing rate. There is no question that, as deposits continue to flee—again, not because of panic from the next SVB, but to feed the appetite for income—the next SVB will appear, Silicon Valley Bank. It will appear for the same reasons that SVB did.

Kevin: Don’t you think, though, it’s because we had no income for so long? I mean, when you put money in the bank, it was just a joke.

David: Yeah, so 13 years of below reasonable rates. Quick math, 13, 12 months, 156 months—that’s a fast from income, and you’ve got an appetite which is raging. John Hussman recounts in the Financial Times this weekend, “Too much liquidity from central banks was the wave that drove rates below zero.” Again, we’re back to that starving the fixed income investor. “And now you’ve got the wave of liquidity moving off of bank balance sheets, and it is destabilizing.” So like Goodhart, Hussman makes the case that the cause of chaos originated at the Fed, and 13 years of financial repression, that’s what’s to blame.

Kevin: It wasn’t a lack of money, it was too much money.

David: Too much liquidity was the issue, not the assumed too little liquidity. Hussman says, “While SVB did not have an adequate liquidity to tolerate a bank run, and did not have adequate solvency to meet its liabilities, emphatically however, the failure did not occur because there was too little liquidity in the banking system as a whole. It occurred because there was too much.” Those destabilizing excess deposits are there because of a decade of quantitative easing. “The Federal Reserve,” Hussman says, “took $8 trillion of bonds out of the hands of the public and replaced them with bank reserves.”

Kevin: So it’s not a lack of money, but really what used to be money was gold, Dave, and I think what still is money is gold. And so, even though the central bankers may have caused this problem, the central bankers have been buying more gold than any time in history.

David: What’s fascinating, when they manage your money, they’re managing your fiat. When they’re managing their reserves, ironically, they are adding to gold.

Kevin: Give me the gold.

David: So finally to gold, HSBC, the Reserve Management Trends survey— Reserve Management Trends survey. Sounds fascinating, doesn’t it? It sounds like a cure for insomnia.

Kevin: Yeah, yeah.

David: But it’s fascinating because it captures everything we’ve spoken about today in a nutshell. Financial Times on the 22nd of April says, “Central bankers who manage trillions in foreign exchange reserves are loading up on gold as geopolitical tensions, including the war in Ukraine, force them to rethink their investment strategies.”

Kevin: Now, it’s interesting, though, they’ve been doing this for 13 years. The war in Ukraine just started last year, so there are other reasons.

David: You’re talking about the central bank accumulation of gold.

Kevin: Exactly.

David: Yeah, it’s been aggressive since 2009. The annual poll of 83 central banks in this HSBC survey found that two-thirds of them thought that their peers would increase gold holdings in 2023. Number one concern: geopolitical risk. Second concern: high inflation.

Kevin: Sure.

David: With 70% of those polled agreeing that this is an ongoing issue of concern. 70%. Inflation’s not going away. 23% thought these were issues that we should be aware of a year ago. Now 40% would agree, “Yeah, these are the issues.” 

Reserve managers were also taking note. Again, these are the guys and gals that are making the decisions about where currency reserves for central banks go. These reserve managers noted that it was the sanctions led by the Western Alliance of the US, UK and the EU, including the freezing of $300 billion in Russian assets. How many times have we mentioned this?

Kevin: They can do it to the Russians, they know that they can do it to somebody else.

David: They can do it to anybody, right?

Kevin: Yeah.

David: So it has these central bankers thinking differently about what and about where their reserves are.

Kevin: Yeah.

David: Now it’s funny, our family’s been asking those questions and helping others answer those questions for 50-plus years, “What do you have your reserves in? Where do you have them?”

Kevin: Well, and let’s talk about that family history because it’s interesting. You talked about this Financial Times article when we were in our meeting, but your dad and mom started this firm in 1972. The central banks had been buying massive amounts of gold up through 1971. And then the public came in, and over the next 10 years, I mean, gold skyrocketed.

David: From the point the public came in, gold went up 25X. This is the heart of the central bank diversification into gold. I found the chart in that article— Again, this is April 22nd. Go look at it, it’s absolutely worth reading. Financial Times, April 22nd, central banks on reserve management. I found the chart in that article revealed a fascinating sequence, from central bank concern leading to aggressive purchases of gold, all of which preceded chaotic years.

Kevin: And they were early.

David: Chaotic in terms of geopolitical conflict, chaotic in terms of domestic social upheaval and violence, chaotic in terms of financial market and currency devaluation. Central banks bought through the ’60s and into the early ’70s and then stopped.

Kevin: Yeah, $35 an ounce. I mean, look what happened by the end of the decade in the ’70s.

David: Investors drove the price of gold and silver up 25- to 26-fold on a base set by central bank acquisitions in the preceding decade. The investor decade was the mid ’70s to mid ’80s. Supply was tight because the connected and astute central bank community bought in advance of the crowds.

Kevin: So let’s talk about today.

David: Fast forward, the base of buying has been more than a decade long, starting with the net positive purchases by central banks in 2009. They were liquidating and getting rid of ounces up through 2008. That changed for the first time in decades in 2009. Central banks have been acquisitive since 2009, relentlessly so. 2022 broke all records, going back to when records were started in the ’50s, and the pace in 2023 hasn’t slowed. What I ask you to consider is the VIX.

Kevin: The volatility.

David: A measure of investor indifference to risk, indifference to risk. Our conversation today—perhaps it hasn’t been, on a number of notes, that bright, but the equity investor says, “Eh, who cares?” “Eh.” I hear this a lot from my teenagers, “Eh.”

Kevin: Yeah. Well, what was noticeably absent from that survey in the Financial Times, that HSBC thing, they talked about geopolitical risk, they talked about inflation, they didn’t talk about internal risk. I mean, the culture wars and the cultural clashes that are going on in various cities around the world right now, you almost have to hedge for the internal side too.

David: Listen, it’s not uncommon for inflation, violence, and crime to go hand in hand. You think of the statistics coming out of Chicago or out of Maryland, Baltimore. This is absolutely insane. So look at the VIX and look at that as an investor. There’s indifference to risk here, a total indifference to risk. Everything’s going to be fine, and the equity investor knows it. 

What I ask you to consider also is the cultural clash here. It’s Paris. It’s London. It’s parts of those cities on fire, riots that get run, and they’re unchecked. And we’re told to be sensitive to lives under pressure, to be understanding of people with no opportunity or people who are in transition. We’re asked to ignore recognizable and diagnosable madness. What’s provided for us is excuses and no accountability. That’s what we get. 

So inflation, violence, and crime go hand in hand. Our friend Bill King, I think unfortunately, lives in Chicago, he reminds us that that’s been true for thousands of years. And now a fresh iteration of geopolitical competition, up to and including conflict, that also drives uncertainty. That also drives the cost. It drives economic frictions and higher costs for everything.

Kevin: So the question for the listener who’s taken the time to listen to this program is, what are you doing with your reserves? I mean, the central banks, we know what they’re doing with their reserves.

David: You’re still in the smartest phase of reserve allocation. That is gold and silver acquisition. You’re in good company with reserve managers that see risk. Perhaps they can’t speak of it without being politically incorrect, but they are allocating their $7 trillion in reserves accordingly. What of your reserves and the risk that you see? How are your reserves being allocated? I know how mine are already.

Kevin: Well, and you have to be able to grasp and be able to rationalize objective truth. You have to figure out what you’re going to do with a truth. It’s not relative truth, it’s objective truth.

David: Now, if something insane is in front of you, you have a choice to respond. There’s this combination of rationality and instinct, and they have to be combined. We were talking about Lewis and The Abolition of Man earlier. C. S. Lewis’s diagnosis was of social decay. That decay started as a choice made by educators to remove objective truth from the educational system and thereby rip the hearts out of mankind, leaving them with a disconnect between what Lewis describes as the visceral human capacity and the intellectual. 

Are we surprised to be surrounded now by intelligent, trained minds whose behavior is no better than that of beasts? I think of the indecency and disrespect in the halls of Ivy League universities where students are shouting down their professors. These are privileged white kids who are up in arms about what? They know nothing about respect for someone who’s going to open the world of knowledge to them. I mean, it’s absolutely insane. I think of the violence in Baltimore. It’s the missing middle. It’s a social reserve. It’s a social reserve, like gold. 

Lewis’s description is elemental, it’s a version of gold. As core as gold is to the monetary system, so you have this thing which is objective and immutable, another reserve asset, right? But it’s now in the heart of man, not in the heart of money. 

I’ll conclude with a quote from The Abolition of Man: “In a battle, it is not syllogisms (logical arguments) that will keep the reluctant nerves and muscles to their post in the third hour of the bombardment. The crudest sentimentalism about a flag or a country or a regiment will be of more use. We were told it long ago by Plato. As the king governs by his executive, so reason in man must rule the mere appetites by means of the ‘spirited element.’ The head rules the belly through the chest—the seat, as Alanus tells us, of Magnanimity, of emotions organized by trained habit into stable sentiments. The Chest, Magnanimity, Sentiment—these are the indispensable liaison officers between cerebral man and visceral man.

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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