Podcast: Play in new window
- Bank Lending Drops 90% In Q1
- Is Taiwan In The Crosshairs By Year End?
- China Announces Big Gold Purchases As It Sells Treasuries
China Puts Its Big Listening Ear In Cuba
June 14, 2023
“There is something very compelling to cryptocurrencies in terms of their appeal to freedom of choice and privacy of transaction. And there’s nothing nefarious about wanting to have your own information be your own information. And so that notion of privacy is important. That notion of personal autonomy is important, and there is certainly a compelling case to be made with these private digital currencies. But that is not a case that any central bank wants to reinforce or enable. In fact, we’re going back to this notion of a limitation of choice being what allows for a perfect economic outcome.” — David McAlvany
David: Now here are Kevin Orrick and David McAlvany.
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
You know Dave, in these superhero movies, there’s this guy named Flash and he actually, honestly, it’s not fair, because he can go faster than everybody else and everybody looks like they’re just standing still. And I thought, wouldn’t that be something in life if you could just freeze, be the guy who stops and looks at freeze-frame and be able to make decisions from a macro basis based on the scene without it moving? And I know you do that economically.
David: Yeah, that’s important when you’re making macro calls to have good sources of data and to see things in different timeframes. And when you’re trying to make decisions as it relates to macroeconomic events and things that are impactful to the markets, you can look at things from a short-term perspective or a long-term perspective. And so some things come in real time and other data is delayed. So today, for instance, we see the British bond market back in sort of the meltdown mode. Yields are rising. They’re getting to a disruptive level, where perhaps you see intervention, and we’re actually at those kinds of thresholds where you could expect to see the Bank of England step in because things are trading in a somewhat disorderly fashion. That’s today. But on a longer timeframe, there’s a variety of things that bring the reality that you’re in, into perspective.
Kevin: Well, and I know you like to look at reports that show what’s going on internationally between the United States and international, and then of course what’s going on domestically.
David: Two government reports which serve as a basis for considerable economic and financial market insight for us are the TIC and the Z1. And the TIC stands for the Treasury International Capital, those flows of dollars coming in and dollars going out, it tracks the inflows and outflows from the US capital markets and it reveals who internationally is buying or selling US dollar assets on a monthly and on a quarterly basis. So I know to the uninitiated it may sound dry, but wouldn’t you like to know? Wouldn’t you like to know if there is a line for our Treasury paper, or one way or the other, a line of buyers or a line of sellers? In recent years, we’ve had the Chinese that have been simultaneously selling US Treasurys, 250 billion in US Treasurys, and buying 144 tons of gold. That’s just from November to the current timeframe. So a reduction of exposure to US Treasurys is meaningful, and an increase in ounces is also meaningful. I’m worried more and more that their financial commitments are indicative of a pre-war footing. But before exploring the Chinese concerns, the Z1 report is pretty fascinating.
Kevin: Yeah, before you get to Z1, it reminds me, Dave, you just now said that the Chinese were selling 250 billion in Treasurys and they bought 144 tons of gold. You talked about pre-war footing, but remember we talked about this a couple of years ago when the Russians were selling their Treasurys and buying gold, so it’s an interesting parallel.
David: Yeah. The Z1 is published by the Federal Reserve, and is a quarterly report that tallies your most critical financial market metrics, and it reveals the current condition of the assets and liabilities across the US. So the report tallies household conditions, it looks at business conditions and government conditions for a thorough look at the financial accounts across the US.
Kevin: Well, and this goes back to freeze-frame. If you can stop and not look at everything going on around you at the time, and just look at, whether it’s a report or we’ve mentioned that Greenspan, Alan Greenspan when he was in the Federal Reserve would sit in the tub two hours every morning and read things like the receipts from dry cleaners and things like that. He said that that gave him a frame of reference for what was going on in the economy that a lot of people weren’t looking for.
David: These freeze-frames are kind of a fascinating thing, an interesting experience for me. Today, we’re traveling cross country. We’re going to look at a couple of colleges for my oldest son, and we have a family reunion just around the corner. And of course, when you get together as a family, there’s opportunities to reflect on your life together thus far, what it has been in the past, what it may be in the future. And today I’m in Little Rock, Arkansas. I’m sitting in a podcast booth back behind a coffee shop, Fidel and Company, off of Clinton Avenue. This is Bill Clinton Avenue downtown, and I don’t know why they have a Fidel and Company coffee roaster on Clinton Avenue. I’m sure it’s a mere coincidence.
Kevin: Well, I’m wondering if it’s infidel and company, infidelity and company. I don’t know.
David: To me, Arkansas is this snapshot in time of what was. I lived here for a year, not in Little Rock, but in Arkansas, and I could feel, as we crossed the state line, Kevin, I could feel this sort of tightness in my chest. I told my kids that we wear our memories in our bodies, and we can rediscover those memories in very visceral, physical ways. And so to go back to being 14 years old and 15 years old, kind of dark days for me, and it was just an interesting experience crossing the line, but it’s a snapshot of what was going on at a place in time. And I’ve got these clear images in mind of what that experience was like.
Kevin: Well, and for the person who’s curious about that, actually I was at church on Sunday, Dave, talking to somebody who said they were reading your book on legacy, and yeah, those stories, the reason there’s tightness in your chest is in the book Legacy.
David: Yeah, the Z1, coming back around to the financial snapshot, there’s always interesting conversations held in our offices when these numbers come out because change is reflective of the climate you’re in. And while we’re accustomed to real time change, that’s what we face every day in the markets, things are constantly being repriced, there is an advantage to stepping further back from the daily fray of market pricing and volatility for a monthly or a quarterly view of things. It helps you gain some perspective. A wider lens helps perspective.
So the disadvantage is that it takes time to tally, and thus the recent reported Z1 is for the first quarter, so it’s already past tense by quite a bit. We’re nearly at the end of Q2. Still, I think the contrasts tell you a lot and confirm with hard data what you might have concluded on another basis. For instance, we discussed the contraction in bank lending, and that bank lending is anticipated to slow for the remainder of the year. That comes from the Federal Reserve Senior Loan Officer survey. Well, the Z1 confirms that it already happened, not just is likely to happen on the basis of survey conjecture.
Kevin: I have a client that we’ve talked about before who listens to the Commentary. He has his family listen to the commentary. He’s a gentleman farmer, but actually his specialty is banking, and he’s president of several banks, or has been, of banks that he’s turned around, and actually is currently with the banks right now. He called me yesterday and he said, I heard something about the imminent failure list on banks. He said, I just wanted to confirm this with you. And I said, “why are you calling me? You understand more than I.” He says, “well, it’s because I’m genuinely concerned, and there is a genuine concern right now in the banking industry.” Loans, we’re seeing a dramatic drop in the amount of loans that are being given out.
David: Well, that’s right. If you go to a car dealer, what do they do? They sell cars. And so the volume of cars out the front door matters. And if they’re not selling any cars, obviously you’ve got an impaired business. Loan growth is the equivalent of cars being sold by dealership. [Banks] have to put new loans into the marketplace to be generating more money, increasing their revenue. Loan growth in Q1 was only $31 billion. That was down from the fourth quarter total of $356 billion. Now just let that sink in, the quarter on quarter difference, 31 down from 356. And it’s well off the seasonal 2022 peak in lending, again during Q2 of last year, which was running at an incredibly hot pace, $549 billion in Q2 at the peak of bank lending in 2022. So for reference’s sake, the quarterly bank lending numbers have never exceeded the Q1 2020 number. Go back to Covid, go to direct interventions, go back to the government handing out money, and that money getting pushed out the door as fast as possible. That was $561 billion, that’s the first quarter of 2020. Q2 of last year, $549, just barely missed it. And then again, Q4 of last year, 356, Q1 of this year, 31. Do you see what I’m saying?
Kevin: Oh yeah.
David: By contrast, 31 billion in Q1 of this year is a veritable collapse.
Kevin: Okay, now I’m thinking of another episode of, okay, this time it’s not the flash, but it’s Star Trek. And I remember one of the early Star Treks, this is back when James T. Kirk, there was a scene where one of the characters was able to go much faster than the others, and so they would see everybody just standing in the room and they could make decisions based on these frozen figures because the speed was different. Now let me ask you a question. If you see—what is that? —a 90% drop in the amount of loans that are being given out? If you see that, and you’re freeze framing, is that a precursor to a recession?
David: So let’s take out those big numbers, 561 in 2020, 549 last year this time, Q2 2022. Take those out. Step farther back. Look at a longer timeframe. Five quarters bank lending average, about 370 billion in loan growth. If you step back even further, a 20-year average from 2000 to 2019, it’s nearly as high: 363 billion a quarter in new bank loans. So Q1 is well off the mark. You’re right, we’re talking about a 90% reduction. March’s banking crisis was certainly a factor, but that was like a crescendo. Remember March, you’ve got January and February which precede it, so like a crescendo, it’s building, and then there at the end of the period, you go from drama to high drama.
I think that puts that SLOOS report, the Senior Loan Officer [Opinion] Survey from the Federal Reserve, it puts that report in a different light. A continued reduction or maintenance of tight credit at these levels is contractionary for economic activity, and it’s consistent with a recessionary dynamic evolving and unfolding in the second half of this year. Now, I doubt very seriously, if you’re looking at future Z1 for the second and third quarter, that this 90% decline will be anywhere as dramatic. In fact, it might pick up again, but a reduction from 363 to 31, that quarterly trend is still noteworthy. We discussed last week that there is a variety of supporting data points for a hard landing recession later in 2023, all of which, if you think about how giddy the equity markets have been of late, all of those factors seem to be ignored.
Kevin: So we’re talking about bank lending dropping, but what about household debt? I mean, are people charging things still?
David: Yeah, I mean looking at household sector, the growth in household debt has been shrinking. If you go from the third quarter of last year, it was running at a 6.43% growth rate. Move on to the fourth quarter, it declined from six and change to 3.33. Still growing, but at a much reduced rate. And then from the most recent Z1, there’s an even slimmer 2.2% growth rate, and this is, again, household debt. Of course, with mortgage rates hovering around 7%—that’s on a 30-year fixed rate loan—it’s not surprising that mortgage debt drops from almost 9%, 8.79%, to the 2s.
Kevin: So you’ve got banks cutting back on lending dramatically. You’ve got consumers cutting back, but the stock market is still pretending like it’s a bull market. Are they borrowing in the financial sector still?
David: Well, and I think that is fair to say. So as goes the corporate credit markets, so goes the stock market. The big jumps came in the financial sector. You had a blistering 12.3% growth in financial sector debt. And so that’s again first quarter of this year. That compares with 10.5 in the fourth quarter. And you have to go back to 2007, actually, for a bigger number. 2007, just before the global financial crisis, we had financial sector debt growing at a 13.5% number. So Q1 of this year is just shy of the 2007 peak numbers. So again, we’re talking bond issuance, we’re talking the other Wall Street Financial Frankenstein-like creations of credit, private credit in every packageable loan that is not through the bank.
So the 10-year average in financial sector debt growth is 2.67%. So again, we step back and we say, okay, if 2.67 is the norm and 10.5 was pretty overheated in the fourth quarter of last year, 12.3 is truly blistering. We’ve only had one number in recent memory that was higher, and that was 13.5%, 2007, just before the global financial crisis. So Wall Street does get giddy, the stock market does get giddy, and as long as there is bond issuance, that gives plenty of rope for the stock market to hang themselves with. And I think that’s what we’re really talking about here, is a surprise for the financial markets, but up until that point of surprise, there’s a lot of elevated sentiment.
Kevin: In a way, you actually have real thinking going on, possibly, in the banking sector and with consumer loans. But the financial sector is sort of known to hit every high possible at the worst time. So hair on fire, borrow as much money as you can. What’s the stock market selling relative to forward earnings right now?
David: And this is what would be remarkable. Can you imagine—we were saying, tongue in cheek last week, welcome to the new bull market. This would be the first bull market of its kind—starting at 20 times forward earnings, and that’s hardly a bargain.
Kevin: Well, this week the Federal Reserve is needing to make a decision as to whether to raise rates or to skip this month. Seems like we’re getting mixed messages.
David: Well, this is a very tough situation to be in. We’ve got CPI softening just a bit, and yet we’ve got the stock market which is already going bananas. So what do they do? If they say we’re going to skip at this time, we’re not going to raise rates, or we’re done, then all of a sudden the stock market goes into melt-up mode. It’s encouraged by the fact that you may have a reduction in interest rates, and that is just fuel for the enthusiasm fires in the equity markets.
So this is a tough position for them to be in because on the one hand you’ve got inflation, which is moderating a bit and so maybe they should pause. But if they do pause, and this is going back to, I think it was Plosser from the Philadelphia Fed who said over the weekend, you got to be careful what you signal here. If you don’t continue to raise rates, the market is going to assume that that means not a skip but a reversal, and they’ll go wild. So there’s some market savvy applied to what they’re doing, but the decision this week is clearly consequential.
Kevin: This is why I think it’s so important to read the Credit Bubble Bulletin and Hard Asset Insights on our website because these are difficult times, but you’ve got people who’ve watched. Doug spends all day every day— I mean, when was the last time Doug took a vacation?
David: Well, I can count the number of days on one hand, and the number of days on one hand matches the same number of years, about five days in five years. He is a hardworking guy.
Doug provides further detail on the weekend Credit Bubble Bulletin. For me, that’s just never to be skipped. He says there that this liquidity and speculation bonanza—and this is with reference to the credit numbers and the short squeeze dynamics and derivative-induced melt-up in tech, which he covers in the report. He says, “this poses serious risk to a highly levered bond market, Fed skip notwithstanding. A problematic shift in market liquidity dynamics doesn’t seem a low-probability scenario. A spike in yields would spur another bout of liquidity-destroying de-risking and de-leveraging. Faltering bonds could spark an equity market reversal with recent powerful derivatives-related buying abruptly shifting to aggressive selling. And after months of liquidity abundance and strong markets, risk hedges have either matured or been abandoned throughout the marketplace. Sudden return of risk off would catch many poorly positioned, with a mad rush to reestablish hedges exacerbating market liquidity issues.”
Kevin: So we got a chance to see, a couple of months ago—actually almost three months ago, the dangers of long-term Treasury debt when you need liquidity. But actually there’s danger built into short-term Treasury debt as well for the overall economy. I mean, going back to the banks.
David: Well, right, so this is really critical. What Doug’s talking about is this notion that speculation is back in play, but it could reverse very quickly. What would reverse it? An increase in rates. Well, no one’s expecting an increase of rates. What might then pressure short rates to a higher level? And there’s kind of two versions here. An abrupt supply problem would do it. So version number one would be a return of existing Treasury paper to the market. We talked about the Chinese already having sold 250 billion. Well, they’re still sitting on over a trillion dollars—close to 1.2 trillion—in Treasury debt. So they could be, or the Japanese, or our best friends in the Middle East and Saudi Arabia could bring some Treasury paper to the market in short notice.
The second version would be a major capital raise by the Treasury Department, and if that capital raise was not well received, if there was not an equal number of buyers for the scrips of paper being offered, then all of a sudden you could have rates on the rise. And we do have that, do have that. JP Morgan estimates that we’ll have issuance of between 850—just sit down for this number—$850 billion to a trillion dollars in short-term Treasury paper between now and the end of September. This is a deluge of paper. You just hope that there’s enough interest to soak it up.
So number two is going to happen. Number one, no one knows until the day it does. But this is what drives interest rates, or potentially in the next 90 days, drives interest rates higher and causes an unwind, not only in the bond market but also in the stock market. Take two on 2022 as a repeat of both losses in stocks and bonds. Not supposed to happen to your 60-40 portfolio, but you may have the second shoe dropping in both venues very soon.
Kevin: Well, and you may have intended the pun or not, I would guess that you intended the pun when you said with all that debt coming to market, you just wonder if there’s going to be enough interest. Well, you can fill that sentence in several ways. If there’s not enough interest, interest has to rise. Now, if I’m a banker, and I can only offer a couple of percent to my clientele, and they can go anywhere else, like a money market or just short-term Treasurys, and get two, two and a half times that, what we’re seeing is the makings—I don’t want to say the words bank run, but we’re seeing the makings of awful lot of money coming out of banks and repositioning in money markets.
David: I think it was Jim Bianco who described it as a bank walk instead of a run, because it’s not really a panic, it’s an opportunistic shuffle, if you will. And so again, the circumstances exist for the Treasury to be making policy choices that have unintended consequences. They look at their cash balance and they say to themselves, we got to pay bills, we’ve got to raise some money. We want to refresh our cash coffers. All of these things make a lot of sense. But then if you take them outside of the context of the banking sector travails of the first quarter and the financial market structure that we have today, again, you have the potential for unintended consequences—in this case, an increase in short rates.
You can recall that this last escalator up in interest rates destabilized a number of US banks. Another round of rate increases—again, this would be rate increases not mandated by the Federal Reserve, but market determined down to that basic thing of supply and demand. And as you said, if there’s not enough interest in buying the bonds, then interest rates do rise. This is the supply and demand for Treasury paper, which, again, may reignite the traffic out of local bank deposits and into money market funds, Treasury bills, et cetera, et cetera.
This is not complex math and it’s not even complex psychology either. It’s just this basic. If you get less than 2% at the bank, and frankly I’m being generous, 2%, you’d be hard stretched to find that at most banks. I was shocked to even look at my own bank statement the other day because I thought they’d kind of played catch up. No, still less than half a percent. It made me angry. I moved some money.
But in a money market fund, you’re talking about one bump higher. If we just get a little bump higher, you will be in a range for money market funds in between 5½ and 6%. Where does your money go? Little thought experiment. Does it stay or does it go? Three month T-bills today are at 5.1%. That number could be 6% without that adequate uptake of the trillion dollars in new Treasury bill issuance. We’re talking about in the next 90 days, short-term Treasury bill is at 6%. That is a bleed out for the US banking system.
The $1 trillion—again, that’s supposed to be with less than one year maturity, so all short dated. Before Q4, we’re likely to see a non-Federal Reserve-authorized increase in rates, and therefore another chapter in bank stress, along with bond and stock market double barrel blasting to the downside. One of the things that you should consider doing is having a healthy cash position, and the best way to play that cash position is by rolling very short-dated paper. That’s still a good cash management strategy—or own ounces, frankly.
Kevin: Yeah. Well, and that’s where I was going with this. You can either just roll short term paper or you can roll out. There used to be this saying, do you want to roll over or do you want to roll out? Well, at this point, the Chinese have been rolling out and they’ve been making it pretty public. It’s unusual for the Chinese to be talking about how much Treasury paper they’re selling and gold they’re buying.
David: Yeah, we mentioned Chinese selling of Treasury paper, and in recent years it’s totaled to 250 billion in Treasury reductions. Here are a few thoughts on managing the flow of information. First of all, China kept its gold holdings private for many years.
Kevin: Very.
David: Yeah. So the fact that they report those figures today, that in itself is noteworthy. You don’t change the way that you report your data unless there’s a reason to. That they have added to those holdings and reported that information seven months in a row—including another 16 tons in May, bringing the November ’22 to present total to 144 new tons of gold—is also meaningful. They’ve long been buyers and didn’t feel compelled to share that information. They are still buyers, but would now like you to know about it.
Kevin: It reminds me of the commercial years ago: When EF Hutton talks, people listen. Yeah, and China’s talking right now, I’m wondering if people are listening.
David: Well, people should be listening, because when Xi Jinping talks, it’s very important to know what is being communicated. Sometimes you communicate by saying nothing, silence. What is between the lines is potent information. When you choose to communicate something that previously you had chosen to keep quiet about, the shift in data or information dissemination is also important.
China is not alone in its gold purchases. You’ve got many central banks who are doing the same thing. China is unique, however, in shifting from opacity to transparency in its metal purchases. So while the intent of that shift remains a matter of personal conjecture—I don’t know why they made that shift—I do think that the rally cry, the rally cry of de-dollarization, is at least indirectly amplified by publishing those PBOC gold holdings. So the implicit messaging by the Chinese is powerful. I think, the secondary question in my mind is: who is their intended audience?
Kevin: So, if China is the EF Hutton, and we’re supposed to listen—even though they’re not giving a full explanation, they’re revealing things—I guess Hungary is the one that they’re allowing to talk for themselves. And Hungary hasn’t had any problem telling people why they’re moving out of Treasurys and into gold.
David: Many years ago there was a book written by Fareed Zakaria called The Rise of the Rest, and it was kind of an echo of the Goldman Sachs guy who had coined the phrase “the BRICS nations.” You’ve got Brazil, Russia, India, China, South Africa, and these are sort of your upstart nations that are kind of a part of a new consensus, a new direction. The breaking of dollar hegemony and the old order of things was going to be replaced by a new order of things. And again, I think this was Jim O’Neill at Goldman Sachs. Zakaria catches the same energy, and that is what is on display with the Hungarian government. Halfway around the world, we find a more explicit messaging of sharing openly why they want more gold. Their head of the central bank said this last week, “we are adding gold as a risk mitigator for expected disruption during a period of transition in the international monetary system.”
Kevin: And you just wonder how much celebration is going on, even though it hasn’t happened yet. There are a lot of people who would celebrate being away from the dollar because we’ve weaponized it, Dave. Part of the way we control the world order without kinetic warfare is we use monetary warfare.
David: Well, that’s right. There’s going to be a confused or mixed message here because, on the one hand, I don’t condone the way we’ve used the dollar. On the other hand, I’m not saying that the dollar system is going to disappear overnight. So there’s some variance and nuance here that we just have to talk through. And at some point if we do another Q&A, maybe we can revisit this with the listeners of the podcast. The de-dollarization audience is growing. There is an international relations component to that, again, where countries are wanting to insulate themselves from US Treasury Department control. And this was best illustrated in Juan Zarate’s book years ago, his book called Treasury’s War. If you haven’t read it, you should. It’s very instructive coming from a Treasury Department guy as to how the Treasury Department is the new State Department. They get more done than the State Department does. State Department, what are they good for? Cocktail parties and canaps—whatever they call those things, small appetizers.
Kevin: I think it’s canapé, isn’t it?
David: Canapé. Yeah. My son was reading on the car ride over here. He was reading The Tale of Despereaux, and he’s like, “what’s up with this French thing, the Tale of Desperocks?” I’m like, “well, they pronounce things differently. Just give him some slack.” So is it canapés?
Kevin: I think so. Here’s how I know that, Dave, we were on a cruise, the only cruise we’ve ever taken as a family. And my son was young, and we paid for the upscale wine tasting. We did the regular one and it was like, yeah, we’ll pay for the upscale. So the only reason I know how to say it is because my son ate all of my wife’s canapés, everything that was supposed to be paired with the wine. He was hungry, even though there was a buffet downstairs.
David: That’s great. He’s got good taste.
Kevin: We spent a lot of money. And so I’ve learned this word canapé through the years that my wife was like, “we need to do that again, and this time I’ll pair my wine with my canapé.”
David: The State Department really isn’t that much of a threat anymore. They don’t get anything done. It’s cocktail hour. I don’t know what time they start cocktail hour, probably 9, 10 o’clock in the morning. They don’t get a lot done. The Treasury Department sure as heck does. And you get that in the Treasury’s War. But there’s a domestic policy mismatch, not unlike the late sixties—and this is another component here, the domestic policy mismatch, which in fact inspired the French to migrate to gold and move out of greenbacks, solidified resolve to completely avoid greenbacks. I think this is captured by Dennis Ippolito, he’s a public policy professor and fiscal policy guru from Southern Methodist University. He summed it up well. He’s saying, what you’ve got in place is essentially Democrat spending policy and Republican tax policy, and there’s nothing in the works that suggests any change to either of those.
So again, you go back to what the French noticed in the late sixties and early seventies, it is sort of domestic policy mismatch where you’re spending too much and you don’t have enough tax revenue coming in. If you were an outsider and you watched the debt ceiling debate over the last few months and then quietly observed that outside of a recession, outside of a depression, the US was prepared to increase its debt by $1.5 to $2 trillion simply by lazy math, spending a lot, and not bringing in enough revenue to match it. You might see de-dollarization as a form of financial insulation from relative decay, right? You don’t have to just be against US foreign policy. You could say, these guys are idiots. What are they doing? What do you mean? You can’t spend that amount of money without consequence.
So while money supply numbers are not growing today at the blistering Covid-era pace, you do have this idea of the exchange value of the dollar not necessarily able to stay on a stable footing when people begin to distrust its value. We saw that devaluation in the seventies, and we may see it again, money printing or not. If people want to sell the asset and get out, they may have, again, looking at the domestic policy dysfunction and fiscal policy dysfunction, they may have good reason to do so.
Kevin: Well, you bring up the French migration to gold in the late sixties and the first couple of years in the 1970s. We both read a book—in fact, thank you, Dave, you bought me, you paid a lot of money for me to have a used copy of Jacques Rueff’s book from the sixties, encouraging Charles de Gaulle to get out of the dollar before it’s too late. And he did. He basically converted an awful lot of dollars to gold. In fact, I’ve heard numbers where it was as much as 1500 tons an hour, back until August 15th, 1971 when Nixon closed the gold window. But that was a major currency paradigm change when Nixon closed the gold window because of what the internationals were seeing with the dollar, and they were de dollarizing. Now the question I have: Is the next currency regime change, is it the central bank digital currency?
David: We go back to Rueff just a moment, because I think what he experienced on a visceral basis, what he felt in his body, and what he tried to communicate to de Gaulle, was what he had experienced in the 1920s when he was financial at attaché to the British. And he watched the British deliberately devalue the currency. It was one of the first of a series of devaluations in the 20th century by the British. And he watched it happen, and he understood the dynamics in play. And when he watched it happen again, when he watched it happen again, a deliberate devaluation, not a gradual devaluation, but an overnight chopping of value, he was concerned and he wanted de Gaulle to take action. That was the impetus was this snapshot in time, this reflection back to the 1920s and this reality that if we don’t take action, we will pay a price too dear.
Kevin: So this goes back to freeze-frame. Freeze-frame every once in a while, stop and look and say, “what have we seen before?”
David: So, currency crisis within the decade—I think that is very likely. Will that be the necessary precondition for sort of the broad adoption of a primarily or even exclusively digital currency alternative here in the US? I think that’s what you’re talking about. A currency crisis, a crisis of any sort, allows for pliability of mind amongst the electorate. So this would be the central bank digital currency variety, which is in the testing lab today. It would not be the free market variety.
The dollar is not going to disappear overnight, but it may well appear differently than it does today as it reemerges in a digital format. Given a rapidly deteriorating confidence in institutions, I can’t see this being an entirely voluntary transition. So again, when I think of crisis dynamics, when I think of devaluation, when I think of Jacques Rueff and the policy choice to devalue one time—we saw this in ’33, a 65% devaluation overnight. Crisis opens the mind, crisis opens the social will. And I think, that brings us back to that oft-repeated Ken Rogoff quote, which at this point should be obvious to the crypto crowd, but likely it is still not. “What the private sector innovates,” and he was saying this specifically about cryptocurrencies, “what the private sector innovates, the public sector regulates and then appropriates.” He couldn’t have been clearer than that. Policy decisions against cryptocurrencies have been in lockstep with that exact progression: private sector innovation, public sector regulation, and ultimately appropriation.
Kevin: On Sunday nights, my wife and I sometimes watch America’s Funniest Home Videos, and the vision that I have— cryptocurrency is actually a pretty clever idea for freedom and for privacy. But it reminds me, this clip that I remember seeing, this little girl had raised from a caterpillar this butterfly, and it was time to finally let the butterfly go free. Now I’m thinking, the butterfly being cryptocurrency, and she does, and they’ve got the video going, and within a second a bird sweeps down and eats the butterfly. I mean, it’s so sad for the little girl, because I mean she spent so much time, and it was it beautiful moment.
David: It’s poetic.
Kevin: It was a good idea, but the problem is, the bird, in this case being the government, Rogoff is right, I’m sorry. They’re just not going to let that butterfly go free.
David: Well, yeah, I mean Binance, you’ve got 12 different cryptocurrencies that they’re being investigated as securities. Coinbase has 13. Robinhood also under SCC investigation in a lawsuit, all three of them under pressure for allegedly distributing securities on an unregulated basis. Other issues include the co-mingling of client cash with company cash. Gensler has led the charge at the SEC, arguing that many cryptocurrencies should be categorized as securities—and that’s the case that’s going to be made in a court of law—and as such are required to have formal disclosures, risk documentation before they’re distributed, and routine oversight from a regulator like the SEC. So you’ve got Binance and Coinbase, these two exchanges which account for 50% of the global trading of cryptocurrencies. You’ve got these lawsuits which are massively consequential to their survival. And if you think about 50% of volume of all cryptocurrencies trading on these two exchanges, I come back to something that’s very basic. When you own an asset, it’s easy to buy. It’s not always easy to sell. What is the liquidity for the asset? You could see liquidity vanish overnight. Now, do you have a multi-trillion dollar asset class or do you have a multi-million dollar asset class, because you can lose a lot of value very quick when there’s no place to go with it.
Do I think that this is a part of the transformation of what the private sector innovated? The public sector has regulated, now appropriated, and yes, as we move towards a currency crisis in the dollar, central bank digital currency, it makes sense conceptually for a broad base of people. And they may not be able to distinguish what a CBDC represents versus what the free market offers.
I think you’re exactly right. There is something very compelling to cryptocurrencies in terms of their appeal to freedom of choice and privacy of transaction. There’s something that is in fact appealing, and there’s nothing nefarious about wanting to have your own information be your own information. The Europeans have done a brilliant job at making this very clear, that your own information is your own information. And so that notion of privacy is important. That notion of personal autonomy is important, and is certainly a compelling case to be made with these private digital currencies. But that is not a case that any central bank wants to reinforce or enable. In fact, we’re going back to this notion, and we’ve explored this for multiple years now, of a limitation of choice being what allows for a perfect economic outcome.
Bookstaber laid this out with his book, The End of Theory. We don’t need a theory to describe economic behavior and economic choice when you’re in control of choice, when you live according to the fallacy of false alternative and you provide for the consumer option A or option B. And doing the studies that we’ve done using big data and knowing what your behaviors are, we know you’ll choose A every time, fallacy of false alternative. You become predictable and the economy becomes something that is easy to predict and manage accordingly. So the CBDC system fits that so well in terms of top-down management. There is no allowance for freedom of choice here. We’re moving towards something that most generously could be described as a digital autocracy or technocracy.
Kevin: So this is the age-old battle of top-down versus bottom-up management. So going back to Rogoff’s quote, what the private sector innovates, that’s bottom-up, the public sector regulates, that’s top-down, and then a appropriates. In other words, the bird eats the butterfly. I’m sorry, I don’t know how you fight it.
David: Well, trading cryptos in the US will change dramatically over the next 12 months. It’s hard to imagine a scenario where restrictions which lead to reduced transaction volumes doesn’t end up negatively impacting prices. Already Binance and Coinbase are having difficulty finding banking partners. Signature was taken out of the mix with their failure this year. There are, again, 12 to 13 named cryptos for each of these companies, which may not survive in the form of a regulated security. So we’re talking about an extinction event for some of the most popular crypto names, effectively wiping out billions in value and forcing the transactions, if they are not going to be allowed to operate in the United States, forcing all those transactions into international venues. In any event, the Fed coin or whatever the central bank digital currency will be called, is coming closer to reality with less competition from the private sector. Really not a surprise there. Regulation and appropriation were always in the works.
Kevin: One of the things that actually puts a monkey wrench in top down utopianism is the unpredictability of other players. You know had mentioned China and China’s wanting to de-dollarize. They have their own top-down system, but I don’t know that they’re playing ours.
David: We’re 300 years from the anniversary of the publishing of The Wealth of Nations. And I think it’s worth reflecting on this competition, because while people may say, well, it’s not fair, this dollar-based system, dollar hegemony, US hegemony, who are we? What presumptions do we have to carry some form of colonialism from the past into the present or into the future? Lest we forget the brilliance of that book, The Wealth of Nations, specialization and the ability to cooperate in free trade within a country and beyond a country’s borders has brought greater wealth in the last 500 years than any other factor, bar none. Bar none.
The brilliance of that book should be remembered. It should be remembered, particularly in a period of time where you’ve got ideas which are competing for mind space. And the newest ideas are that state run capitalism or state run economies can somehow do a better job than the market economy.
So I want to end with a few thoughts on China. We’ve got the gold purchases. That’s an interesting footnote, of course. And then there’s a long-term case to be made for changing of the economic and monetary guard. If you want to say, “okay, we’re moving towards the Asian century,” maybe we are, maybe we aren’t. But being in the precious metals business, all catalysts for volatility are important from a planning perspective. So this is very, very interesting to me. But on the headlines, moving from the footnotes to the headlines, what we should be reading is: China prepares for war. China prepares for war.
Kevin: That’s your freeze-frame. That’s your freeze-frame.
David: The time is not quite now, but it may soon arrive where the gamble on violence, where the risk versus reward metrics are compelling to the Chinese. And so we tend to think of this de-dollarization as perhaps an opportunism and upset move towards the monopoly and opportunism in unseating US hegemony to be sure. But I think the Chinese will be attempting to solve domestic issues even more than they will be seeking some sort of extraterritorial expansion. Is their vision of the world a world which is subject to Chinese rule? They’ve got bigger problems, more immediate problems, and I think that is of a domestic character. While Taiwan may seem to us to be that expression of expansionism, from the standpoint of the Chinese, there’s nothing expansionary about it. It’s merely a reclamation of their territory, following the same logic that the Russians used when they invaded Crimea in 2014 and then Ukraine. The lesson learned from the Russian debacle was that time is a luxury that no one can afford. You don’t want your enemy or the friends of your enemies to have time to organize a resistance. To win, it must be decisive and quick.
So the domestic political considerations, reducing social dissatisfaction, redirecting animus away from the state and towards a nationalist agenda, that is now a Chinese imperative. You’ve got youth unemployment at record levels. We talked about over 11 million people graduating from college, less than half of them will find jobs this year in China. You’ve got a credit boom without equal in the history of the world, and it’s on edge. We are near a credit and financial market bust in the Chinese markets. So in the midst of ratcheting up population surveillance, people controls, what Covid provided as a perfect test case for moving people, restricting movement, Chinese war preparations are not for us.
Chinese war preparations are not for the US, in my opinion, but Taiwan could fall in a week. Nothing drawn out, no resistance for the West to support. And I think that China knows it has a window of opportunity. We have a compromised White House, both from its Ukrainian and Chinese business dealings, and that kind of leadership is easier to roll over than either a reinvigorated Democratic leadership, perhaps RFK Junior, or the GOP alternative, a DeSantis or what have you.
A Taiwanese incursion is more likely to occur between now and the end of the year, particularly given the pressure that Biden is now under, with no less than three Form FD 1023s, these filings of malfeasance and concern over Biden’s business dealings in the Ukraine. But you also have a Burisma director willing to provide audio tapes documenting the Biden family payoffs. I mean, on top of that, you have the FBI complicity in covering for the Bidens. This is reminiscent of Clinton-era skullduggery, and I love this. I’m recording this off of Bill Clinton Boulevard or Avenue or whatever it is, downtown Little Rock. If the Chinese want to win in Taiwan, doing so while the Biden house is in disarray makes all the sense in the world.
Kevin: So freeze-frame, okay? Let’s freeze-frame again, but let’s apply it to investments. Dave, so often we look at seasonal trading, we look at charts, we look at price moves up and down, but there are times when you just buy the thing that freeze-frames. I mean, I’m thinking about gold right now. Gold, historically, for thousands of years, has purchased one loaf of bread per day for a year per ounce. Freeze-frame, is it time for us to not look at the charts right now and maybe freeze-frame, step aside and watch what goes on?
David: Well, as we said last week, gold trading may have seasonal aspects. It may have technical ebbs and flows, but what we are on the edge of combines financial market frailties with economic vulnerability, pre-recessionary stuff eminent. On top of that, domestic political dysfunction and perhaps even political desperation—because remember that cornered animals do crazy things, desperate things when they don’t have options. Then you have international tensions that are unmatched since the Cold War. This is a complex and fraught set of circumstances. As an investor, the no-brainer is gold.
Kevin: Yeah, you said last week, gold is stupidity insurance.
David: Well, did we forget to mention the Wall Street Journal article coverage of the Chinese setting up a listening station in Cuba in a pay-to-play funding scheme that delivers billions to a desperate Cuban government and returns a meaningful communist presence to within a hundred miles of our shore? I mean, we are talking about unmatched since the Cold War. Gold is indeed stupidity insurance. And you may look at the price today, you may not think it looks cheap today, but by tomorrow’s standards you will wish you had bought more at the current lower prices.
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.
