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- If It's Free To You Online, Realize That "You Are The Product"
- Banking Crises Are Actually Designed Ahead Of Time
- Dollar Recycling Being Replaced By Gold
"And it just goes to show how vulnerable a lot of this infrastructure is, particularly the internet. When you talk about the internet as we conceive of it, like going to Amazon and buying something, or your mobile phone, going to New York Times, that internet is very much a trust-based cabal of people that for the longest time have just decided there is a decorum that they're going to have about how it's run. But if that changes, then the internet is going to look very different." —Becker Polverini
Kevin: Welcome to the McAlvany Weekly Commentary. I'm Kevin Orrick, along with David McAlvany.
David, oftentimes you and I, when we go out on Monday nights, we talk about past guests, and we'll say, "Hey, I'm going to go back and listen to that." And it's great for discussion. Last week's program, Peter Zhao, I went back and listened to that. I'm going to listen several more times and I'd like to take our listeners through that process a little bit.
David: Yeah, certainly as we look at the fabric that we've created, the tapestry, if you will, of guests that we've had and content that we've created, we refer back to these things as lessons that we've learned, things that we've gained, insights that we've benefited from, and it's a part of our everyday conversation.
If a new listener is unfamiliar with some of the most important guests that we've had on the program and content that offers insight that would be outside of a normal expected analysis, it's really important to be familiar— And we're not asking them to go back through the hundreds of guests that we have, but every once in a while we will highlight a few of them for their benefit.
Kevin: Well, and the three that we've chosen for today that we wanted to go back and talk about, now think about this crypto week that people are talking about. And we've been talking about AI, all this electronic intrusion. Yes, are we trying to move forward electronically, but what is the cost to doing that?
And I go back to 2017, Dave, you interviewed Becker Polverini, and this is a man who spends his entire life in that world, cybersecurity, looking at anything from China, countries who are trying to break into each other's systems, to companies. And I think it would be worth going back to his interview back from 2017.
David: Yeah, and just to set it up a little bit more, a part of our conversations in that time frame included an interview with Nazli Choucri, who wrote a book on who controls the internet. And it's important, particularly because we're in a period of time where data is one of the most important assets that exists. And so where is it organized? Who organizes it? How is it sold? What are the means of distribution? This year, we have Nvidia trading in a market capitalization of over $4 trillion, and they're feeding the AI frenzy. And that AI frenzy is really about organizing and distributing the data that already exists.
Kevin: Well, and whose information is it? Right?
David: That's right. And that's a key point that we get to in the conversation with Becker Polverini. That data is you. You are the asset.
Kevin: You are the product.
David: What is being sold is the breadcrumbs that you've left, all over. The activity, the searches, you have this profile and you are being monetized.
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Becker, I have a whole lot of questions for you, and I wondered if you might be able to tell us a little bit about yourself and kind of what puts you in the position to speak to cybersecurity and cryptography and the many other things that you're interested in and an expert with.
Becker: Yeah, yeah, sure. So currently I'm the CEO of PKC Security. We're a cybersecurity consultancy south of Los Angeles in Southern California. My background is in really nation-state cyber warfare. So I cut my teeth on China in particular, how China does censorship and surveillance, the algorithms behind it, how it's analyzed, and publish some research in that area. Currently, I do the three pillars, classic pillars of cybersecurity consulting, risk assessments, code audits, and custom software development.
Specifically my background's in cryptography, applied cryptography. So designing ciphers and just basically creating secure channels, trying to make sure that the data between point A to point B is as it should be and hasn't been tampered with. So the kind of work we do is we work a lot with companies that have something worth protecting or sometimes that's personnel, sometimes that's intellectual property. But we take the time to understand what's happening with our clients and try to come up with a custom solution for their context, which varies a lot based on region and on industry, and we try to use our knowledge to bear on their context.
David: So a conversation I had about two years ago with a gal from MIT, Nazli Choucri, the big question on the table was who controls the internet? And I wonder how you would respond to that.
Becker: That's a great question. I'd probably say no one, but if anyone had to control it, I'd probably guess the United States. But that's probably because of the large incumbent tech powers that are right here in Silicon Valley.
The real answer, though, I would say is no one, if you really think about it. The technology that undergirds the internet really has no security model to it. So we've started to see now that cyber warfare is kind of becoming mainstream and as nations like Russia are using it in conjunction with kinetic warfare, that the internet was based on a simpler time, a happier time when everyone was an academic and kind of roughly agreed that, hey, we should all follow the rules.
And the technologies haven't really changed. It's just been now instead of academics it's internet service providers. But when your government controls the internet service providers, then they become an attack vector for everybody else. And we've already seen this happening. So a key example, I think it was maybe a year or two ago, the People's Republic of China messed with a critical part of internet infrastructure and routed a bunch of traffic from the West Coast through China.
And it just goes to show how vulnerable lot of this infrastructure is, particularly the internet. When you talk about the internet as we conceive of it, like going to Amazon and buying something, or your mobile phone, going to New York Times, that internet is very much a trust-based cabal of people that for the longest time have just decided there is a decorum that they're going to have about how it's run. But if that changes, then the internet is going to look very different.
David: The internet of things still runs on that same information highway.
Becker: Yeah, that's right. That's right. So that gets especially spooky when you start thinking about, well, I got a water filtration plant that's hooked up across the wide internet to maybe some monitoring facility or whatnot. Then you start running into all kinds of different issues. Generally, there's the internet of things, too, where you talk about maybe a security system in your home or your thermostat, it gets spooky when you start thinking about what happens when China can start spamming everybody's home security system and hot-miking their house or something.
These scenarios can get pretty apocalyptic. But the truth of the matter is, the internet is not designed for security or privacy really. It's designed for the least amount of work to keep it connected. And I think that's where information security professionals can leverage their skills is trying to make sure that data that's running over this non-secure medium can still do what it's supposed to and not what it's not supposed to.
David: So you're a cryptographer.
Becker: That's right.
David: And you know how to get into things and maybe even protect things, and maybe there's two sides of the same coin. So this is more of a sociological question, but why is there so much privacy indifference today?
Becker: That's a great question, and I think it's mostly psychological. I don't think it's technical. And I think it's highly generational. I'm a millennial. When I think of millennials, I think we've grown up in a generation where exchanging privacy for free stuff has been very much in our favor. And I think the Faustian bargain of giving up our privacy, we haven't seen what the other side of that deal is yet. We give up our privacy and we have free Facebook. We give up our privacy we've got free unlimited email with unlimited storage.
And we think, boy, these are all fantastic. I mean, it's just my privacy. But I think a generation or two, particularly when millennials are going to try to run for elected office and all of the dumb things they've done have come to the forefront, I think they're going to have a very different attitude, a very different conception of privacy. And I think you're already seeing it with Gen Z, the generation after millennials. They've grown up with social media as just totally omnipresent. So they're much more keenly aware of the fact that there is a trade-off that's being made. Whereas millennials have kind of had the life of Riley in terms of making these privacy trade-offs.
David: There's a company I'm familiar with out of Virginia who now is owned by Chase and the predictive technologies that they use kind of gather information and allow for Chase to figure out how to market what products to whom. And it's all commercial, but it's this huge information dragnet. It's very interesting, and it's for commercial purposes.
So you think, well, it's benign and maybe it's annoying and maybe it's spam and who cares. But not to go to the dark side, but it just seems to me that there's something about big data that is very good and helpful and something that is actually a little dangerous too. And I just don't hear a lot, not in the circles I run in, we don't hear a lot of conversation about the dark side of it.
Becker: So I mean, with big data, the problem is not so much in one person having all the data, but all of the different parts of our lives that are being categorized in some ways. So to make it real, for example, the same algorithm that, or it's not the same, but roughly the same algorithm that's used to detect the likelihood that you are pro-ISIS on Facebook is roughly the same algorithm for how match.com or some of these other websites actually use their machine learning to figure out whether or not somebody is likely to be a strong match.
And these algorithms are all interconnected, and these different data sources are collecting very similar data. But when you mix those different data sets together, you get tremendous power, predictive power into someone's life. If you know what they buy, what they read, what they think, who they know, eventually you start having a very concrete picture of a person. And I think for me, for big data, I'm less afraid of one person having the pool of some part of my life and all of the different people having little tiny pieces that are very well formulated. Because I wonder if there will come a time when, say a government or regime or not just here, but in really any country anywhere, is able to go to these companies and mandate that they turn it over and now all of a sudden they have a unique fingerprint that very clearly identifies the kind of person that I am.
And the question is, are we okay with that? Some people might be. They might look at the positive side and say, "Well, that's good. I want my healthcare company to know that I'm much more at risk for heart disease." Or, "Yeah, I'm totally okay with Apple recommending the New Lady Gaga album." But it's a very different question when you say, "Well, now I get screened by TSA twice as hard every time I fly because I've tripped some indicator that I'm a little bit more susceptible to ISIS propaganda than other people."
David: Francis Fukuyama wrote a book called The End of History and basically said the end of conflict, that's historical. There will be peace in our future. We will all live in a liberal democratic society where votes are respected and freedom of speech is there. And that was his idea. And short, little book, I think it was by Robert Kagan, was The Return of History and the End of Dreams, as sort of a short response to it a few years later.
Becker: Sure.
David: It turns out that we haven't entered a brave new world where governments are always generous and always kind and always have their citizens' best interest in mind. Governmental leviathans do what they've always done through the course of history, and we may have a positive view of our government today, but the reality is if Lord Acton from Cambridge University knew anything, power corrupts and absolute power corrupts absolutely.
Becker: Yeah.
David: And so if that's the case, we look and we say all this information that's out there, it's not being used against us today, but it's information that's out there. It doesn't mean that it can't be used against us tomorrow.
Becker: Absolutely. Yeah.
David: So, you trust your government today, you just hope they don't change tomorrow, but that's the problem, democracy—
Becker: Correct.
David: —sometimes goes the wrong direction. So, what are some practical things that you would suggest— I mean, I know you live in the 21st century.
Becker: Sure.
David: I'm sure that you live sort of a wired life and stay connected to clients and friends and family, but at the same time, I bet there are some cautions and precautions that you employ that are just totally common sense to you, knowing what you know about security.
Becker: Yeah. I mean, you're right in saying that we have to be worried about tomorrow. As storage costs get cheaper and cheaper for data, data is just not getting deleted. It's sticking around forever. The internet is forever. And as a result of that, the issue of how I relate to my government or how I relate to anything is a question of your entire lifetime, because something you've done today could come back to haunt you tomorrow because that data will never leave. It will always be sold. It is a very precious resource to the tech industry and to governments in general. And it's so precious they will hoard it, they'll keep it forever.
To your question of what you do, there are simple things that I believe people should be doing in order to protect themselves from the unexpected loss of their privacy. I think a lot of our privacy is going away just by virtue of the things we interact with. You can't read a newspaper without having a tracker track where you came from, where you're going. So, there's some element of what you look at that's unstoppable. But there's some things that you can prevent, I think, some good things you can do.
If you really want to take your privacy seriously, use a VPN. If the internet looks at you, what they're going to see is they're going to see that you're coming from some address that lots and lots of people are coming from. They're not going to be able to fingerprint you as well, because your traffic will be mixed in with the traffic of everyone else on the VPN.
David: So, use a virtual private network?
Becker: Yeah, use a VPN. Even if you're not at a cafe, even if you're at work, consider using a VPN. If that is a principled stance you'd like to take on your privacy that's a good way to do it.
The second thing I would say is understand your supply chain. Understand what you're procuring in terms of applications or services that you're using to improve your life. Make sure you understand their privacy policies. Sometimes they can read like stereo instructions or like legalese, but it is beneficial to at least understand what is the Faustian bargain you're making. Maybe there isn't one. If you're paying, you shouldn't give up your privacy, but if you're not paying, you should be a little suspicious because you're probably the product.
David: You are probably the product.
Becker: You are the product. You are being sold to somebody else.
David: Explore that a little bit because that's obvious to you. I don't think that's obvious to everyone.
Becker: Yeah. So, I mean, Google's not a nonprofit. Facebook's not a nonprofit. These are companies that are worth billions and billions of dollars. And the way that they do that is they curate and they manage and they expose your data in ways that advertisers or whomever can use to do their own industry. So, the more people they have, the more hooks they have into your life, the more that they understand about you as a consumer, as a voter, or as a father, the more that they can turn around and sell that data to other people.
So, for example, we use a lot of what Facebook exposes or what LinkedIn exposes to do war games. Companies will pay us to go hack them and tell them what their security is like. We don't need any tool beyond LinkedIn. We looked at LinkedIn, we get your network, we get what articles you read, who you know, who's in your organization, who are your family members. That's enough information to engineer anything.
So, that's— When I say you're the product, if we're using it for evil for a small amount of time, ultimately for good, there are companies out there that are using just strictly for evil. If let's say, you're going up against a nation state, or for gray, if you're thinking about being sold a product, for textual advertising.
So, that's what I mean when I say you're the product. They're literally turning around and selling your data. And they're selling your data for a ton of money. I mean, look at Google, look at all the stuff that Google gives for free, their operating system, search, Google+, Google Voice. I mean, they're doing video for free and video is one of the most expensive things you can transmit over the internet. They're doing it for free because if they know who you're talking to, that is totally worth it.
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Kevin: Again, that was Becker Polverini and it'd be nice to have him back on the show.
Dave, the next two people that we want to go back and listen to have to do specifically with things that are going on right now, even though these interviews took place a while back. One is how the banking system in America works in a way that actually benefits some and punishes others. And so, banking crisis and liquidity crisis, that type of thing that we think just happens out of thin air, oftentimes is really fragile by design. And our guest Charles Calomiris wrote a book by that title explaining that even this Big Beautiful Bill and some of the shadow banking that we're seeing right now, a lot of that is designed into the system for some to benefit.
David: And we tend to think of banking crises as random and unpredictable, and what Charles does is he says, "No, these are actually expressions or consequences of policy decisions, and those policy choices are made to favor a particular constituency." So, the weakness is built —not on purpose, of course—but the unintended consequence of choosing winners and losers, looking at monetary policy and fiscal policy with intended beneficiaries, it has a consequence. And those market consequences are the things that we see with a Silicon Valley Bank or various other points of crisis, and they're anything but random.
Kevin: It reminds me of when you interviewed Richard Bookstaber and he talked about A Demon Of Our Own Design. Oftentimes, the regulations that are built into a system to protect the system actually create the crisis itself.
David: One of the big features in Calomiris' work is how central the real estate markets are to the US economy, and how we have chosen to favor homeowners, but we've also built in weaknesses into the system, things that are not really market-oriented in having a constituency that is given somewhat of a free ride, and is given benefits, and that is a part of the weakness within the system, fragile by design.
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Charles: Well, first of all, thanks very much for the opportunity, and thanks for reading the book. All authors that are pleased and almost shocked sometimes when people read their book so carefully, and your description of the main theme of the book is exactly accurate. So, thanks again.
So, I think that it's a common experience I have that most people who are looking at the recent banking crisis in the US or the whole sort of plague of banking crises that we've had throughout the world for the past 30 years, which is really unprecedented, are asking themselves what is the sort of random shock that happened? What mountain lion climbed out of the rock next to them and decided to eat them on this particular moment? And just as you say, we're trying to get people to understand that when you look at banking crises and the current wave of them and why they happen in some places and not in others, it's pretty clear that banking crises are coming from risk. That is not just something that happened because there was a bad mountain lion attack, but because you were taking risks in the first place.
And then the question is, why would people in some places decide to take these kinds of risks? And in the case of the U.S., why would we decide to take them perpetually, over and over again, and never seem to learn that we are the riskiest of all the developed countries' banking systems in the world, that we keep purposely doing this? And the point, of course, is people take risks because the banking system is controlled by the government. The government charters banks, commercial banks, and it regulates them. It decides whether to protect them and how to protect them. It decides when losses happen who's going to bear those losses, whether the taxpayers will or the shareholders or the depositors.
So, it's all those government decisions about chartering, regulating, protecting banks that makes banks decide or not decide to take risks. And so, those are political decisions. And so, it's really not a very controversial thing to say, if you have a country that's deciding to take risks through its politically engineered decisions about banks, over and over and over again, that that must be a political outcome. And it's obviously a conscious political outcome.
Now, of course, politicians never like to frame it that way. They don't like to say, "We've decided to have a risky banking system." What they want to say is something different, "We've decided to make the American dream happen. We've decided to make sure that our economy grows. We've decided to make sure credit is abundant." All those positive things. But the way that they decide those, the way that they make those happen entails—and purposely it reflects—the decisions about risk. It's not that the politicians want risk, it's just that they want the things that are stapled to risk. And those things are going to happen and continue to happen in the U.S.
So, we just experienced one of the worst real estate crises in our history, but most of our banking crises are real estate crises of one kind or another. And by the way, we're probably going to have another one, maybe not quite as severe, but we are already in the middle of a very high-risk real estate situation once again. And this isn't a coincidence, it's because politicians get a lot of benefits from subsidizing the risk inherent in real estate borrowing.
I've found in some empirical work I've done since the book, people will vote for a politician or not vote for them based on their own personal mortgage credit experience. So, if you want to know who's to blame for all this crisis stuff, very unpopular when I say this, I tell people, "If you're an American voter, look in the mirror. You're the one who is rewarding politicians on both sides of the aisle. This is a bipartisan thing. You're the one who is instigating politicians to want to create a fragile banking system." They don't do it because they're pathologically drawn to risk. They do it because they're pathologically drawn to getting elected.
David: Right. And that may be a pathology.
Well, talk to us about the co-evolution of the modern state with banking, because originally you've got banking, which was there to finance trade and war, and now we've got the iteration that benefits the consumer. So maybe take us on a quick tour from the 16th to the 21st century.
Charles: I'm happy to do that. I don't usually get people to ask me to give them a quick tour of 500 years and all over the world. But actually, it's not that hard to do a quick one. So as you said correctly, the first chartered banks are the creation of government, which is really there to finance trade and war, which actually trade and war in the 16th century were really part of the same thing, which was expansion of Empire. And you had some of the most important ones in the 17th century. Early 17th century was the Dutch Wisselbank, and toward the end of the 17th century the British Bank of England. And these were extremely important. The Wisselbank was basically a trade finance clearing house. It wasn't a big risky lender. It was really trying to make sure that what was then the most important means of financing trade, which is bills of exchange, could be liquid and could be traded through a central clearing house.
And that's what the bank did, it wasn't really interested in lending. Similarly, the Bank of England wasn't very interested in lending either. The Bank of England was actually created as an equity for debt swap mechanism to create liquidity and increase the value of British sovereign debt for the government as part of the struggle between Britain and France that went for more than a century.
And those were really the purposes of those banks, and they were extremely successful for promoting trade in the case of the Wisselbank, and promoting sovereign debt restructuring and increased war finance capability for the Bank of England, and therefore for the British Crown.
And over time, let's say by the 19th century, banks started getting chartered more for financing business. And in Scotland, I guess you would say by the middle of the 18th century, all of the important inventions of banks in creating money and creating credit as what we're kind of used to as the mature modern bank, including clearing houses for exchanging notes, including letters of credit, including branch banking. All of those things that we think of as kind of the obvious credit and money functions of banks really were perfected, I would say, by the middle of the 18th century in Scotland.
And then as this became clear that this was a very important tool of state for developing further prosperity growth, countries that were more interested in jump-starting their growth, again, partly as a national priority for military or other purposes. I'm thinking now of Germany and Japan around the end of the 19th century, they saw banking as absolutely necessary for that jump-starting of their own industrialization. So what you see happening in countries like Germany and Japan is chartered banks getting more aggressively involved in longer-term industrial finance.
And that really then brings us to the final phase almost, which is banks learning to do securities markets underwriting alongside their other existing functions, which was credit and money creation.
And that's really, I would say, roughly speaking, the 20th century and where we are today. Of course, there's been a lot of changes. Banks got much more protected in the middle to the end of the 20th century. Banks didn't use to be protected by governments very much. For example, by 1960, the US was still the only country that had any deposit insurance for banks. And so that grew and became very pronounced. The notion of government bailouts and insurance deposits, that was really the final phase. And that's really the last 50 years or so, and especially the last 30 years or so, which not coincidentally is also the era of the worst banking crises in history, because if you protect banks more, guess what? They take on a lot more risks.
So that's pretty much where we are with the modern universal bank that does all those functions, and how they were taken on. And the key point is that those decisions about what banks do, why they're chartered, what their powers are, and how they're protected, were all political decisions that came about at certain times for perfectly understandable political reasons.
David: I think most people, when they think of banks, they don't think of statecraft. And yet because of these bank bargains, we've had the evolution which you just described which brings us into the modern era, preservation of political order in many instances is through using the mechanisms of finance and credit as tools. So maybe you could just expand on that a little bit, banks as a tool in statecraft.
Charles: Absolutely. Well, the way I like to start that conversation is by pointing out to people that there's some countries in the world that don't have standing armies: Costa Rica. There's some countries in the world where the government doesn't tax: Kuwait. But there are no countries in the world where the government does not charter—that is, license specifically—the creation of banks. That is, you might say, almost, in that sense, the defining function of government is to figure out how to set up a financial system. Of course, in the US, Alexander Hamilton is our great national architect of our financial system. But if you just sit for a minute and think, how could a government function without a financial system, without an ability to collect taxes, which is a financial transaction, or to spend money, which is a financial transaction, to borrow? And how can the government be prosperous if its economy isn't prosperous?
And if people can't transact and borrow at some minimum level, of course the government is going to suffer too. So a perfectly selfish government, because remember, a lot of these governments are not democracies. Historically, they weren't run necessarily for the interest of the common man, but governments have always seen the importance of making sure that their economies function and that their own public finances can be executed properly.
And so banking is just central. And the governments then have to decide what kinds of things can they achieve with banks more easily than they could achieve through other means. And this varies a little bit by country and by time. So for example, in the US, we really depend upon banking through many means to subsidize real estate credit, particularly housing credit. And you could say the government could just do that directly, but the government decided in the 1960s, when it was already full-blown with using banks for this purpose as government functions, they decided that it didn't want to have that on its own balance sheet anymore.
And that was because we were in the middle of the Great Society and the Vietnam War, and so why create housing subsidies on the government's balance sheet that requires the government to actually recognize its own costs? How about this? Let's do something different. Let's regulate to make a private entity, Fannie Mae, Freddie Mac and the commercial banks, the federal home loan banks, I could go on and on. The FHA, the Veterans Administration, all of these are banking vehicles that are part of the government apparatus. None of them is part of the government's accounts. The government achieves all of those subsidies without having to actually show the costs on its own balance sheet. Of course, every once in a while when things blow up, the government has to come in and clean up, but then that's just something that they claim as some sort of crisis cleanup.
They don't ever have to recognize the high cost of the subsidies that they're providing at the time they're actually providing them. So that's a political decision. Not all countries do it that way. Not all countries prioritize, let's say, housing finance. So the point is, the function of the banking system, the role of the government's use of the banking system, varies by country. But it always reflects a political calculation.
In the US, we've decided that we want to do a lot of risky housing subsidization through finance, but we don't want to do it through our own government's direct balance sheet. We want to do it kind of, I don't want to say non-candidly or invisibly, but we want to do it in a way that where it kind of absolves the government of direct involvement, but politicians still get to claim the credit for all the programs for housing that they actually are creating.
So it's a strange outcome in the US, and it's actually fairly unusual. But that's an example of how the government decides and always has decided that it wants to use its power to create finance, to regulate finance, to protect finance to achieve particular objectives.
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Kevin: Yeah, again, that was Fragile by Design. This final clip that we're going to listen to, Dave, of course, we get a chance to listen to every Tuesday because Morgan Lewis works here, which is— What an amazing benefit. But he has really very, very clearly stated what's occurring to the dollar, to the petrodollar, to gold recycling versus Treasury recycling, and how that's somewhat a replacement at this point for what we've seen in the past.
David: In the last segment, we looked primarily at commercial banking and the fragilities that are built into that. We're looking at a transition with central bank policy and central bank reserve strategy, and that's really what Morgan is getting at. He joined us as an equity analyst, and is now co-portfolio manager for our hard asset strategies. And it's a particularly important insight to see just how the BRICS and other countries have decided to make a significant shift. Of course, it dates back a ways, but has become much more intense at a quicker pace since 2022. He looks at Jeff Curry's idea of gold recycling, former Goldman Sachs Head of Commodity Trading, now with the Carlisle Group, and looks at how central banks are doing something very different now. It has defined the course of gold in the last several years, and is likely to continue as they pursue what is a multi asset reserve strategy.
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Morgan: The BRICS, the criticism coming out of Kazan has been that they haven't announced some alternative reserve currency. But I think that misses the point. I don't think their intention is to create a US dollar-centric reserve currency model.
David: Take me back to 2015 when we had a clear intent expressed by leaders within the People's Bank of China as to the role that they saw gold playing in the future, as they were literally just launching and developing this new thing, the Shanghai Gold Exchange.
Morgan: Yeah. We know that they are interested in an alternative to the dollar, the PBOC member in 2015 wrote a piece that was titled, "The World Needs a New Reserve Currency." In it, he referenced the intention to use the yuan for trade invoicing for commodities like oil and gas. And he said they would like to increase the uses of the yuan in trade using gold.
So this has been talked about for a long time. I think people get a little tired of the king dollar narrative is brought up frequently to belittle these claims. And the idea being that they really can't de-dollarize and there's no alternative to the reserve currency and therefore they're just talking. But this year we had Jeff Currie, the former head of Goldman Sachs Commodity Trading, very well-connected guy, very knowledgeable guy, come out and say on multiple occasions that what's happening in the world is that the BRICS primarily are changing the global system on the margin from what he called, "dollar recycling to gold recycling," in his words.
David: And the gold recycling is a stand-in. The old system of dollar recycling, whether it was the petrodollar recycling or trade dollar recycling, where trade surpluses from the Chinese or trade surpluses from OPEC countries were being recycled, literally recycled, into the purchase of Treasuries. And that's how they kept their currencies from appreciating vis-a-vis the dollar. This is substituting Treasuries, taking it out of the equation or reducing it, and instead infusing gold into the mix.
Morgan: Yeah, it's the old petrodollar system. It is, I as a foreign country need dollar reserves in order to buy commodities, primarily oil, in dollars. That's the petrodollar system. That was the arrangement made between the US and the Saudis. So if you had trade surpluses, you recycled them into Treasuries so that you had dollar reserves to then go back into your commodity markets and settle trading. What appears to be happening now, and what Jeff Currie is talking about now, is that those countries want the added leeway and the safety of not having to rely on the dollar and having to rely on trade with the US in particular or holding a reserve currency that is controlled by the US.
That's both because of the debt problems we're having, the likelihood that we are going to be dealing with secular inflation to deal with that debt problem. That's not very attractive for somebody who's trading in their valuable oil for a US Treasury Reserve note that, as Putin says, is depreciating at 8% a year. If he's saying 8% a year a couple of years ago, you can add a few percent to that, most likely, going forward. So that's not an attractive proposition. And at the same time, we weaponized the dollar following Russia's invasion of Ukraine.
David: To some degree, it's to create some insulation from the intrusive nature of Treasury Department and State Department policies, which are not necessarily in keeping with the priorities of these trade partner countries?
Morgan: Yeah, of course. And the key is that they need to find a way to trade commodities outside of the dollar. And if they can do that, then they alleviate their reliance on the dollar and the dollar system and on the US. And so obviously they've been talking about it for a long time, and it appears that now they're doing it. And it's on the margin at the moment, but they're increasingly making trade deals in local currencies.
And the idea is that basically they make agreements for their surpluses to be recycled in BRICS currencies. And then the net surpluses are settled in gold, and gold becomes the new reserve asset, at least on the margin. And like I said, Jeff Currie coming out and talking about that this year, at least to me, gave that entire narrative a whole lot more credibility. And if you go back and look at some of the comments made by officials in China, starting with the chairman of the Shanghai Gold Exchange a while ago, he said, "the Shanghai Gold Exchange will change the current gold market with its consumed in the East, but priced in the West arrangement. When China has the right to speak in the international gold market, the true price of gold will be revealed."
So I hear what Currie's talking about this year, I look and see what the chairman of the Shanghai Gold Exchange has said on the record, and I look at what's happening in the price of gold right now, and I find it to be very revealing, and frankly very confirming of what Currie's talking about. We see that gold has diverged from real US Treasury yields. That's virtually unheard of over the last 20 years at least. And gold similarly diverged from a strong dollar, also a head scratcher for any Western investor.
And at the same time, I think maybe most importantly, we're seeing that the price of gold has managed to go significantly higher, even while inventories in the gold ETFs were being liquidated. And at the same time, we're also seeing that gold is outperforming US Treasuries, we're seeing gold outperforming commodities and gold outperforming oil. And all of those would be what you would see if dollar recycling and Treasury recycling was transitioning on the margin in BRICS countries to gold recycling.
David: Yeah, it's actually not that novel of an idea, it's just a return to either the gold standard or the gold exchange standard. Prior to 1922, you actually had to move ounces from one bank vault to another to net settle your trade imbalances. And then 1922, the novel introduction was, well, let's just do this via paper credits and debits. We don't have to hassle with moving the product, but I'll give you an IOU that says, I'll hold the gold but IOU X tons in settlement for this particular quarter or year, but we're all squared up. And so it is a return or a flashback to just having something stable in the global monetary system.
Morgan: Yeah, like I said before, I think the Western debt has now become a problem. I think we've crossed the threshold or Rubicon with Western debt. And when you weaponize the dollar on top of that problem, I think the Western debt issue has become a significant problem. I think it was a problem, but one that could be ignored and now I don't think it can be ignored.
David: You mentioned in this last week's Hard Asset Insights—thanks for putting that together each week. That's a great way for folks to know what our thinking is on a weekly basis as it relates to hard assets. But you mentioned the $780 billion in annual trade surpluses from BRICS nations and $12 trillion in global dollar FX reserves, trillions of private wealth held in sovereign debt likely seeking an exit from medium- to long-term Western sovereign debt. So what you're describing as a new model, there's a lot of money to flow through that model. However, there's not a lot of gold to necessarily be involved in the system. Is there enough gold for this system to actually function?
Morgan: Well, yeah, there is—at the right price.
David: There you go.
Morgan: So the biggest way to increase the gold market is for price to go higher. So yeah, as you mentioned, right now we have the ammunition for gold, so to speak, is in the form of that $780 billion in BRICS surpluses, at least in 2023, the $12 trillion in global dollar FX reserves along with those trillions in private wealth on the margin. If debt is seeking an exit into the gold market, they're trying to squeeze into $265 billion of annual gold mine production. So the price has to go higher to make that market larger.
David: It has to go quite a bit higher.
Morgan: It has to go a lot higher.
David: So I mean, if I were to bottom line this, the conclusion would be, we can build a case from a technical standpoint—you review the COT numbers for us, the Commitment of Trader numbers, for us each week, and while we can make the case for gold correcting, there is this fundamental source of demand which is price insensitive. And so we're on the horns of a dilemma. On the one hand, we could see a gold price correction. On the other hand, we don't have to with there being $780 billion seeking to squeeze into a $265 billion market.
Morgan: Yeah. Well, that's what makes it so interesting. When the chairman of the Shanghai Gold Exchange references gold consumed in the East, but priced in the West, that underscores the dilemma we face in our analysis of the gold market. You would've traditionally thought that real Treasury yields rising would've certainly meant that gold would be falling. A strong dollar certainly would've meant that gold would be falling. And outflows from Western gold ETFs, certainly you would conclude that the price of gold would be falling. So these old relationships have all broken. And looking at the technicals right now in gold, looking at the COT report in gold, you would say the price of gold certainly should correct, but maybe it won't.
David: So this time it's consumed in the East, priced by the rest, and that is the rest the world as they're trying to resolve their trade imbalances.
Morgan: That's right. The price of gold probably will correct, but I don't think we can take that for granted the way we might've in the past.
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Kevin: What Morgan was talking about, that was a good six months ago, Dave. Today he was talking about secondary sanctions that Trump is talking about, where Russia would be not the only country penalized for selling Russian oil, it would be the countries that would be buying Russian oil. And so there's just all the more reason to move away from the petrodollar. These countries are realizing that we can control things from this side, they'd probably rather settle in gold than dollars.
David: Yet this has huge implications because it's not only reserve assets in question, but it's how invoices are settled. And we've been the dominant currency, and that is slowly being chipped away at.
Kevin: Well, you've been listening to the McAlvany Weekly Commentary. I'm Kevin Orrick, along with David McAlvany. You can find us mcalvany.com, and you can call us at 800-525-9556.
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