The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“I hear of Trump’s desire to spend trillions and replace our infrastructure, and spend capital to create growth. And the question that always comes to my mind is “Whose capital?” Government creates nothing. Government has never created anything. Where does the money come from? Answer that question and you get a better sense for the changeless nature of government. There are solutions, but they are solutions on your dime, and on mine.”
– David McAlvany
Kevin: Sometimes the new hits hard, and hits home, Dave. This morning I just got a call from someone who is trying to get money to an orphanage in India that this company is very directly connected to.
David: My investment in India goes way back because I had a personal assistant that went on a trip with my dad and mom to this particular orphanage in India. In essence, she never came back. She fell in love with the kids and thought, “This is what I want to do. I want to do social work and I’m going to get my Ph.D., and I’m going to…” and that’s what she has done. She has pursued her academic endeavors and is working at this orphanage in India.
Kevin: Dave, right before we came into the studio today I got a call from someone who goes over there several times a year for medical work with the children. There are a couple of hundred children. She had talked to this person who had been your assistant last night on the phone, and it’s very, very dire, because of this currency grab with Modi. They are allowed to stand for hours in line right now for 2500 rupees. Keep in mind, we’re talking 200 children that have to be fed, clothed, that type of thing. 2500 rupees is about 50 dollars a day, and when they get this 50 dollars a day out, or this 2500 rupees, there is a transaction cost.
David: Yes, the banks are enjoying this because the net number ends up being roughly 38 dollars. So, if you’ve ever been annoyed by being nickeled and dimed, this redefines the size of the nickel, and redefines the size of the dime. So you can have a maximum – your own money, of course, 50 dollars a day, net of the bank transaction fee it’s 38 dollars a day, and you’re right, on 38 dollars a day they are taking care of, or attempting to take care of, 200 orphans. And there is really no way to get money to them, because again, if you could wire funds to the bank, it’s not as if they’re going to free up that capital, and it’s not as if they could use a debit card or a credit card to do what they need to do to get groceries or what not for the folks there.
Kevin: Well, we looked into that, and actually, most of the people in that region don’t have credit yards, don’t use credit cards. Most of the people in that region don’t even have bank accounts, and so they are really in trouble. In fact, the food right now is being fronted, or loaned forward, to people who need it at this point because there is no cash. There is virtually no cash that is circulating. This is a real crisis, Dave.
David: That can only go on for so long because food vendors ultimately have to pay their purveyors. If you look at the daisy-chain of obligations, someone ultimately has to be paid, and if we’re making promises to pay you back tomorrow, next week, next month, there will be a weakness in that chain at some point, where somebody says, “No, I’m not going to do this. I need money on the barrel, or you get nothing.”
Kevin: I’d like to talk about India here in a little bit, Dave. The Italian referendum – let’s go ahead and shift back over to that right now because I’m sure that’s on everyone’s mind. We had Brexit in England that was the first shot over the bow, and people starting thinking, “Wow, this could be real deal.” We had Trump elected here in America. What’s going on in Italy is multi-faceted, but it takes on the same populist nature and anti-establishment mentality, doesn’t it?
David: Yes. Renzi, 41 years old, basically put his job on the line saying, “Look, I’ve got such good ideas, and these are the reforms that I’m suggesting. If you don’t like them, and this referendum proves that my ideas are not worth keeping, then I will resign.”
Kevin: Right. And he represented the establishment.
David: He resigned. Essentially, the referendum over the weekend was struck down. It was the idea of simplifying representational government, shrinking from 315 to about 100 people representing the interests of the people, in essence, solidifying greater power.
Kevin: Consolidation of power, wasn’t it?
David: It really was, in the hands of the Prime Minister. And so, Renzi’s out. That’s done. The real concern is not over volatile Italian politics because we have 2000 years of that already (laughs). If you’ve watched that part of the world, this is par for the course. The concern is the banks’ agreements which are in process and are sort of the last hope to restructure the leading lending institutions in Italy. And if those agreements fall apart, of course, there is concern of financial dominos beginning to topple one into another again all throughout Europe. That’s the primary concern.
Kevin: What is interesting to me, Italian politics for the last 2000 years, as you’ve said, is changing all the time. But the movement that actually has the most momentum at this point sounds more like a pizza parlor to me than it does, actually, a real political movement.
David: The five-star movement run by an ex-comedian. Maybe he is still funny but he is not taking the Italian political situation as a laughing matter.
Kevin: Beppe Grillo?
David: Beppe Grillo, the five-star movement. He’s kind of the Italian version of Trump, in a sense, because he represents a movement of populism, and he is overtly anti-euro. Call him a euro-skeptic or what not. Critics would call him nativist. I don’t know what that’s in contrast to, maybe it’s globalist or euro-ist, I don’t know. But this is a secondary issue where if this rag-tag upstart movement plays a greater role in politics, does that accelerate the fracturing of the European project? And it’s too early to know, but the theme of discontent continues to echo around the world. I think that’s one thing we need to keep in mind because the news media here in the United States has basically said, “Look, there is about 150 people in South Florida who are biased, bigoted and wearing white sheets, and they’ve just taken over the White House.” That’s how they’ve kind of cast it, that the minority of racists in America have just taken over. And I would say, no, actually, if you look at the fly-over states, we’re not talking about 150 people, and we’re not talking about racists, and we’re not talking about people in white sheets.
Kevin: This is happening worldwide.
David: We’re talking about a global movement of people who are saying, “Something’s not right.” So again, it’s a broad theme of discontent. That is the echo we’re seeing in Italy, and that, I think, is worth noting as sort of one of those pings, or important messages coming out of Europe.
Kevin: Sometimes it’s good to take a bird’s-eye view and say, what is it financially that’s different in India and what’s going on in the euro? What’s going on with the euro is this. You can have a change in Italian politics. The assumption is that if Italy can’t handle it, can’t bail out their banks, the rest of the Europeans will. This goes back to something we talked about last week. A currency, in this case the euro, is either backed by gold, which we know it’s not, or it’s backed by central bankers, which is just human agreement. Ultimately, it’s just backed by debt. There is an assumption that if something were to happen now with Italy it would be a similar situation with Greece, or whatever, these PIIGS countries, and Italy is one of the PIIGS countries.
David: Portugal, Italy, Ireland, Greece, Spain.
Kevin: Exactly. They’ve been a weight on the back of the entire European Union. But now, the people in the north are saying, “Hey, one of these things, when they fall, is actually going to create the destruction of the European Union, itself.”
David: On the one hand they’ve been a weight, but I guess another way of looking at it is that they’ve been given cheaper credit than they’ve ever had before. That’s basically a license to spend so they’ve spent more than they should have. But that cheaper credit came from northern, and core, European countries. So excess savings, if you will, if you want to put it in those terms. That’s the popular Keynesian terminology today. Excess savings has flowed into the peripheral European countries and now you have major issues in terms of there being debt levels that can’t be sustained. They took on more debt than they could afford.
The old measure of solving the problem was print to alleviate the pressure. But if you’ve given up your monetary independence, as they did when they joined the European monetary union, then the question is, who takes the pressure away? You could say, well, it’s obligatory for taxpayers to do so, but that implies a fiscal union that doesn’t exist. The only thing that exists is a monetary union, and they can’t print their way out of this mess, which is what they would have done ordinarily. And that is frankly what a lot of populist tendencies are to do, is to inflate away pressure.
We had that in the United States – the whole issue between gold and silver, and the bi-metallist argument 100 years ago. You had the inflationists who wanted silver because it was easier to use and easier to create and get and basically inflate. So you had a segment in our country, too, that wanted inflationism, and they preferred silver to gold. That’s the same tendency, if you will, of alleviating pressure via the printing presses.
Kevin: And the banking union in Europe is absolutely critical to keep this thing from falling apart. The young gal we were talking about who stayed in India, she said, “If we had gold it would have been easier.” She has gold here.
David: But it’s in the United States.
Kevin: Yes, but if they had gold there, they would at least have something that they could trade with. So let’s go back to India for a moment. Modi has taken 86% of the currency out of circulation but even though there is hope that he is going to print some and get some on the streets, it hasn’t happened yet.
David: There is no infrastructure to move to a cashless society. That’s the reality. It’s not as if everyone has a Smartphone, as you might find in a more developed part of the world. There is a small percentage that do, and for them, electronic payments are intriguing, but no more intriguing than a debit card or credit card. There is this minor oversight then. The Modi government was supposed to have replacement rupees. If you’re trying to take out one currency and clean up the system, if it’s a targeted effort to get rid of black market cash and replace it with anything, whether it’s digital or otherwise, be ready for it. And this is where it appears that, from idea to execution, there has been a major stumble.
Kevin: You wonder what he was thinking. Maybe you could get into this – is this possibly a test case for other countries, worldwide, after we see the debacle that has gone on in India?
David: It’s an interesting idea because it’s going to take five to six months for the printing presses that India has to get caught up to the demand for new rupees.
Kevin: How do you meet payroll?
David: That’s just it. You don’t have the system of payrolls that we do here in the United States. You have non-traditional farm lending, you have payrolls which happen in cash. Everything depends on cash. 98% of business transactions occur in cash because of the underdevelopment of the country.
Kevin: There are a lot of small towns in India.
David: Over 640,000 small towns, and they have a different kind of financial infrastructure, which does not include payroll services, direct deposits every other Friday into your bank account, cash that can be withdrawn via an ATM. There are ATMs, but the percentage of ATMs, in terms of coverage, the numbers compared to the population, are miniscule.
Kevin: Hasn’t cash been the main form of payment in most of the country?
David: That’s right. So absent cash – this is how you settle up with workers – absent cash there is an inability to pay. With that comes the threat of strikes. So now you have something social happening, and the unintended consequence of not having your ducks in a row with the replacement currency. It’s really quite fascinating. So even if you could write a check, rural banks don’t have the cash anyway.
Kevin: Yes, and she says ATMs are absolutely worthless.
David: Well, the best case scenario is in big cities where you’re getting about three-quarters the cash needs. That’s if you’re in the middle of a big city. But even if you get out to the suburbs that number falls to about 50% of cash needs. And then of course when you get into the small towns and rural areas, it’s a big, big issue.
Kevin: Starvation actually becomes the issue. I remember when they had the onion situation. Even when onions went up in price, people were starving.
David: It translates into a food crisis. If you can’t pay to harvest, if you can’t pay to move product, if you can’t pay to sell agricultural products, you have a real disaster on your hands.
Kevin: If you were delivering to a region, wouldn’t you hold back at this point? If you had something that you thought couldn’t be paid for, you’d say, “Hey, just hold up.”
David: Well, there is a whole chain that has to be held together. And so, if you go to the wholesale markets today, you’re not finding the product that would have been there ordinarily, let alone at retail outlets. But deliveries of rice to rural wholesale markets have dropped by 61% according to the Indira Gandhi Institute for Development Research. Soy beans are down 77%, maize is down 29% by volume. So if you want to receive any cash for your produce, vegetable vendors are cutting prices in some cases to 1/12th of prior levels. Just to get anything. You had one tea estate-owner which said, “Thanks to this so-called business-friendly government, we’re being made beggars for our own money.”
Kevin: Listen to that, Dave. That’s almost a bumper sticker – “Being made beggars for our own money.”
David: Thanks to this so-called business-friendly government – Modi was elected as the business-friendly guy, the guy who was going to get rid of all the red tape and bring 21st century capitalism to India. Well, he’s bringing a 21st century nightmare. In fact, that farmer, the tea estate-owner, said, “I feel like I’m in the middle of a Soviet era nightmare.” There is a dentist in Delhi, situated in a very posh neighborhood, who was explaining that even though his clients can pay with plastic – so they do have debit and credit cards in your big cities – they’re cutting all of their spending and retaining what resources they have. So his business, since November 8th – notice November 8 was an auspicious day for us. It was also for everyone in India. Why? His business is down 70%.
Kevin: Right. Even though he takes credit cards.
David: Right. People are just saying, “I’m not spending until this gets sorted out.” You have one local business writer and editor for a paper there who says, “What started as a surgical strike on black money is now called the dawn of a cashless society.”
Kevin: Okay, so I want to ask you – the dawn of a cashless society. This is coming back, Dave. We’ve talked about what Ken Rogoff has been recommending for the United States. We’ve also talked about what Europe did with large bills. We’ve talked about Australia. We’ve talked about Sweden. There is a worldwide move. We are moving toward the exits of cash at this point, Dave.
David: Well, one thing is certain, from our perspective, that other cashless society advocates are taking note. They’re learning from the real-time disaster unfolding in India so that implementation elsewhere is more seamless.
Kevin: Yes, they’re not being discouraged from implementation, they’re just learning how to do it.
David: Starting with the basic things like staffing up at banks to handle the inflow of new accounts. That’s a part of an issue is, people have come in and said, “Oh, I’ve got cash, but I don’t have an account. And the banks have said, “Well, we’re servicing our existing clients, we’re not opening new accounts.” What do you do? You’ve earned a legal wage, you’ve paid taxes on it, it happens to be sitting in cash, and now the banks won’t even take the relationship, they won’t take the cash. And you’re looking at a sell-by date on that currency.
So if the powers that be wanted to make this more seamless, they have to have the ability to ramp up very quickly, opening up bank accounts. There is a learning curve. Well, I guess there is also the distribution logistics – printing notes ahead of time or ensuring that people have access to, whatever – online banking – I don’t know. But there is a learning curve for all forms of statism, and I think even the very best practitioners of statism need the opportunity to fail in certain venues in order to ultimately succeed.
Kevin: So your former executive secretary, who now helps run this orphanage in India, who owns a little bit of gold here in America, was thinking ahead here but she wasn’t able to actually have it there, or didn’t have it there.
David: Honestly, this is why I, personally, like having gold in three locations. This is Ian McAvity – “You bury a bone in every yard,” because you never know what back yard you end up in.
Kevin: Triple redundancy. You have some in your hand, maybe some in a safe deposit box, some in another country.
David: …Switzerland, the bank account – this makes sense to me, because you’re right. Right now, even though she owns gold, she can’t even liquidate it and get the proceeds to her because the banking system is the bottleneck.
Kevin: Yes, but the people who already had gold, and in India there were people who had gold and they’re trading it on the streets right now.
David: Not an issue.
Kevin: Okay, but for the people who want to implement cashless systems elsewhere, are they looking at that target and saying, “Hey, wait a second. We’re also seeing a move to gold?”
David: I think there was an interesting reference in this week’s Economist on the India matter. It was an interesting framing of the targeted wealth in the black economy, and the assumption of the writer was that much of the targeted wealth in the black market economy had already been spirited away into property, and into gold, and into jewelry, and thus, even Modi’s best intentions would not clean up the system.
Kevin: A lot of people did that before this all happened.
David: I thought to myself, “This is the kind of framing which ignores the historically informed purchases of such assets.” It assumes that anyone who owns jewelry and gold and property is hiding something, which is balderdash. It’s unmitigated balderdash. Again, it ignores the historically informed purchases of such assets, not as a mechanism to escape taxation, but to be removed from imminent danger. What is that danger? You have somebody who rightfully, honestly earned money. That informed citizen recognizes the rapacious nature of all governments throughout history.
Kevin: For four thousand years.
David: And the stealthy hands of thieves, imminently – imminently—there to take from them. What are the stealthy hands? I’m talking about the host of central bankers who say, “We will, by inflation, take 2% a year, or 25%, or 100%.”
Kevin: It doesn’t have to be a cash grab. You can just devalue the cash.
David: Honestly, it doesn’t matter if it’s 2% or 100%, in terms of the definition of theft. Central bankers believe that they have a right to steal some percentage of your savings every year. And governments, via an increase in taxation, not necessarily through your normal legal channels, but as we’ve seen in recent years, through non-legal channels – we’re talking about negative rates – impose another tax. I would say that this is how, in the history of mankind, individuals and families have preserved themselves through the gauntlet of governmental greed.
Kevin: Yes, they move assets into something outside of government control.
David: Honestly, if you have not read the book Crisis and Leviathan, you have no idea what I’m talking about. You must read Crisis and Leviathan by Robert Higgs, because there is this nature within every government, and it is his historical look at not only the growth of government through time, but the infinite needs of government as government grows. And ultimately it gets to the point where individuals not only suffer, but they suffer to the point where there is government failure. It cannot go on forever. So individuals and families who have some historical perspective on the growth of government through time and the requirements to feed that leviathan – what do they do? They take their wealth, legally earned, above-board and taxed, and they put it in a place where when the game changes and the rules change against them – that is private wealth, I’m talking about moving assets, again, to something that are lower profile. So if you’re the guy that wants the mansion or the Maybach, you are a target. We’re talking about families that would, instead, prefer art, jewelry, watches, physical precious metals. And as it turns out, it is Indian people that are more experienced and less naïve than their developed world brethren that, instead, place absolute faith in the power structures that promise – what do we promise? We promise benefits, we promise safety nets, and they’re delivering to us, frankly, what was ours in the first place. And the strange irony is that we thank them for it.
Kevin: You talked about how Indians are more aware of this. When an Indian bride gets married she wears her wealth, and her husband gives her wealth in the form of jewelry, in the form of gold. So it is interesting that we’re seeing this in a country that already values precious metals and understands, to a degree, how to trade with them.
David: Right. But look, the rupee is at all-time lows.
Kevin: That’s the devaluation you were talking about. Now they’re getting it into the bank. What if they wanted to do negative interest rates, as well?
David: They can. They can. They just created a perfectly captive audience. So again, you’re defining good versus evil in a totally arbitrary way – a totally arbitrary way – in a way that is convenient for governmental purposes, frankly. I just think our complacency in the West is astounding, when we look at and trust in government of any kind. I hear of Trump’s desire to spend trillions and replace our infrastructure, and spend capital to create growth. The question that always comes to my mind is, whose capital?
Kevin: Right. Who’s going to pay for this?
David: Government creates nothing. Government has never created anything. Where does the money come from? Answer that question and you get a better sense for the changeless nature of government. There are solutions. But they’re solutions on your dime, and on mine.
Kevin: Well, we’ve talked about it here in little bitty Durango – 15,000 people, but we’ve got this gigantic, multi-million dollar bridge to nowhere. It was to spend money. It didn’t produce anything.
David: No. It reminds me of Nikita Khrushchev, who said, “Politicians are the same all over.” Think about how long ago this was said, Kevin. Khrushchev said, “Politicians are the same all over. They promise to build a bridge, even when there is no river.” And my further question is, with whose money? It has to come from somewhere, whether it is the printing press or from you and me. Again, I appreciate the Indian sensitivity to the rapacious nature of government, and to their awareness of what happens to money through time when central bankers have their way with it – and I mean have their way with it.
Kevin: You mentioned that the rupee is at an all-time low. We haven’t even talked about Turkey, Dave. The lira, in the last six weeks, has lost 11% of its value, and Erdogan right now is begging people, or telling people, to swap out all foreign currency and got into lira.
David: It smacks of desperation. He is imploring Turkish citizens to swap their foreign currency, if they have any of that hidden in their mattresses – swap it for Turkish lira or for gold. And he is interesting in his position on this because he basically says Western powers are attempting to destroy the greatness of Turkey.
Kevin: It is interesting that he incorporated gold into that, though. Get out of your dollars, get out of foreign currencies. Either buy lira, or buy gold.
David: Right. And so he’s looking at economic stability, but he’s blaming the destabilization of the Turkish lira on the Western powers that attempted a coup on him in the summer of this year, so he’s tying these themes together, and now what you have is Turkish nationalism being harnessed to survive the threat of Europe and America.
Kevin: So he’s saying, “Save the turkey” – or “Save Turkey.”
David: (laughs) Yes, exactly. It’s not a post Thanksgiving rant. I don’t think he’s even a PETA member.
Kevin: (laughs) Well, other than saving Turkey, going back to saving Greece, I read an article by a man that is very controversial, and he should be. He calls himself a Marxist Libertarian. His name is Varoufakis. He was the head of finance in Greece when they were going through all the struggles that they were a few years ago. But I though the article, itself – I don’t ever agree with his solutions because they’re always somewhat communist, but his article about America was fascinating. He called it Trump, the Minotaur and the Dragon. And he told a very interesting story about our country, Dave, and I’ll just summarize it. He said, “How is Trump going to respond to a country that has been kept alive, either as a minotaur, or being kept alive by the dragon?
I’ll go back in pre-history a little bit. Before 1971, when we were still on a gold standard, strangely enough, it was because we had surpluses, not deficits, that we were able to help Europe and Japan, so we were a surplus country. After 1971, when we went off the gold standard, we became more like the minotaur. Let me explain what he was talking about. Back in Greek history, and it was appropriate that he was using a Greek analogy because that’s where he’s from. King Minos was kept in power by keeping the minotaur happy, and human flesh was how the minotaur was fed. Most people remember that Greek history. What he likened that to was the United States. We became a deficit country and it was absolutely imperative, these surplus countries, like China and other countries, would have a surplus in dollars, but they would loan us money back. That’s a little bit like that sacrifice of human flesh. And for the next 40 years we deficit-spent and kept the minotaur alive. But he claims in 2008 that the American minotaur was slain, and there had to be another country that would now be willing to take on far more debt than they were able to pay back. And that was the dragon. His point is this. If Trump comes in and completely takes down the dragon, there is really no one to save the world economy.
David: It’s a fascinating thing because there is a certain requirement of liquidity in a debt-addicted world. I’m not championing debt addiction by any stretch, but once addicted, there is a product and need to keep the addiction fed.
Kevin: It’s hard to get off.
David: It is. And so we have two trillion dollars in central bank liquidity. If you look at the ECB, this week they are slotted to discuss if they are going to increase, continue, or what they will do with their 84 billion dollars a month in quantitative easing.
Kevin: Yes, they took the baton as well, didn’t they, when we tapered off?
David: They did. And the Japanese have, as well. And those are outright monetary transactions, those are quantitative easing maneuvers. And what China is doing is a little bit different. They are putting credit into the market. They are creating a larger stock of debt to the tune of 1.4 to 1.5 trillion dollars this year. And so they are liquefying the system in a different way, but arguably, the debt that they’re putting into the system, or the credit that they are creating there, plus the credit being infused, you have a 3½ trillion dollar infusion of credit into the system, with close to half of that coming from Varoufakis’s dragon. So yes, we can punish the dragon. What begins to happen when the minotaur is gone and the dragon is gone
Kevin: And if the quantitative easing continues, and if this liquidity continues, there is currency devaluation going on relative to the dollar. You talked last week about how that is absolutely crushing the emerging markets.
David: The world is interconnected. This week’s Economist featured on the front a mighty, muscle-bound George Washington.
Kevin: Yes, because the dollar is above 100 right now.
David: Right. So here we have, actually, reiterating our themes from last week on the strength of the dollar, and that being bad for the world economy, they discuss rising rates serving to reinforce the dollar move higher. And of course, that assumes that the Fed moves in line here in December, and follows the direction that the market has already gone. We know that more attractive yields are being offered now and from a reasonable credit risk. The U.S. is viewed as a reasonable credit risk. In this recent Economist they discuss the yield-hungry search of pension funds that have bought dollar debt, issued by emerging markets, some of them the large emerging markets, but some of them also Mozambique and Zambia.
Kevin: So, wait a second. Pension funds – this is what people are depending on when they retire – are buying debt from Mozambique and Zambia that is denominated in dollars?
David: Right. That’s what I mean by a yield-hungry search, where someone says, I have to have my 7%.
Kevin: So my retirement is based on Zambia? Mozambique? Countries that continually fail?
David: Well, but it’s dollar-denominated, which to the pension asset manager, seemed like a better bet than the local currency. The Economist is pointing out what we did last week. They face a challenge paying back the loans when the dollar strengthens. They also acknowledge there is a tightening in global credit with the rise of the dollar. And I thought the most interesting part that The Economist featured in this week’s magazine was the suggestion of the need, on the horizon, not yet, to align the interests of the international community through what they were remembering as a new pact to rival the Plaza Accord. If you go back to 1985, at the Plaza Hotel, right off the park, there was a five-country agreement to manipulate the value of the dollar lower.
Kevin: They basically had to save their own currencies by manipulating the dollar down.
David: And it is interesting, isn’t it, that today we have a situation that is leading to a 1985-style currency crisis. And we’re willing to call the Chinese currency manipulators – not such a terrible thing – and it’s always a terrible thing unless you’re the one doing it. Or let’s put it in the noble category – for the greater good.
Kevin: I talked to your dad a couple of weeks ago while he was down in the Philippines, and he was very excited about the Trump victory. He was excited that Hillary didn’t win – it was more that. But the cost of liberty is eternal vigilance, and he did bring up the point when we were talking on the phone, he said, “Kevin, we have really got to watch the appointments.” You’re talking about the greater good, currency manipulation being fine for the greater good. It’s easy to run as an anti-establishment outsider, and then when you get inside, start putting in just purely establishment insiders. And I’m just wondering if that’s possibly starting to happen under the Trump administration.
David: Well, the verdict is out. There was an interesting tone change, a shift in just the way it was presented, again, from The Economist, but what changes in a week. Boy, I’ll tell you, Trump makes a few appointments that satisfy the establishment and the slathering barkers across the pond at The Economist feel better already.
Kevin: I always get nervous when The Economist feels better.
David: I know. Well, they say, “Look, he’s ditching his campaign promises, he’s appointing conventional conservatives.” And in their own words, there is the speculation that the Washington beltway elites are now resting easier as he appears to be a non-swamp draining insider.
Kevin: Is that what they called him? A non-swamp draining insider?
David: Yes, that he’s not going to drain the swamps, that he ran as an outsider who actually is an insider. But yes, they say, “He’s like any other politician. You run as an outsider, but you come in an operate as an insider.”
Kevin: And your dad is the ultimate “let’s get the establishment guy out” guy. Have you talked to him recently?
David: I did over the weekend, and from the Philippines he said, “I just don’t know. You look at these appointments, and what have we gotten ourselves into?” Look, the verdict’s out.
Kevin: You don’t want to dash the hopes of the people. There still can be hope.
David: Hey, but let’s go back eight years and reflect on what that campaign was all about. Eight years ago we were sold hope and change. Two operative words – hope and change. And he was not sold as hope, but if anyone has sold themselves on hope, just realize the potential for not only bad salesmanship because that’s what happened with Mr. Obama. But self-delusion – you can fall into the trap of self-delusion, too. Show me what reforms he is going to actually implement, and get implemented, and then I’ll tell you if I have hope. Until then, all we have is someone who is a windbag, who has promised the sun, moon and stars. If he can deliver, then we have the verdict.
Kevin: Well, you asked whose dime it would be.
David: (laughs)
Kevin: Infrastructure spending. Because that’s the big hope right now. The big hope is that that is how we’re going to employ all these people.
David: When I was in South Africa this summer I met with one of the largest infrastructure contractors on the continent. It was interesting because the story was one of redemption and change, and he told about how the bidding process for government contracts occurs – this is doing highways and bridges and all kinds of things.
Kevin: This is something that he did on a regular basis.
David: Oh yes. And he explained the bidding process for government contracts. It’s the same the world over. In this sector, once you’ve been awarded, there is a huge opportunity for skimming, for unethical behavior, and that’s just kind of par for the course. You have this small group of people who own the companies and everybody gets a piece of the action, and you kind of create a monopoly and block everyone else out. It’s the same five companies and the same five families, or whatever, that always get the contracts. It’s kind of, who gets the baton this time?
Kevin: So it’s an old boy’s club.
David: It is. And at one point he was a participant in this. He still has one of the largest contracting companies in the country, but he went on to see the error of his ways, sort of the unethical behavior, and he changed his willingness to participate in that old boy’s club, sort of the one of greed and kleptocracy. And in the process he founded a group. It’s an international organization called Unashamedly Ethical. It’s where business-owners all over the world can join. Basically, it is a public acknowledgement of doing business a better way, in keeping with values and ethics which represent just weights and measures. My point is this. Infrastructure projects, 98% of the time, employ veteran thieves and skimmers.
Kevin: That’s how the negotiations occur.
David: And our greatest hope right now for this country is the hype related to government spending projects which have classically employed veteran thieves and skimmers. It’s a fascinating twist that what we wanted was something new, but what we are likely to get is something as old as dirt (laughs). Draining the swamp is a cute phrase. It’s a very powerful three-word allusion, but I think that he’s going to be redirecting swamp water more than he is draining the swamp. And money is going to be spent, and an older theme will perpetuate. Connectedness and relationship to power has always begat money and personal gain. And I just don’t think that’s going to change with the election of Donald Trump. I will be pleasantly surprised. I hope that is the case.
Kevin: But let’s contrast that. Had Hillary won…
David: Sure. Okay, so the consolation is that had Hillary won, the money and the power and those connections – we’re talking about foreign states in the Middle East.
Kevin: Yes, Qatar.
David: (laughs)
Kevin: It’s like, wait a second, how did these guys get it?
David: In Trump’s case, at least it’s the good old boys construction club here in the United States, so it’s marginally more acceptable.
Kevin: Okay, but Trump is talking about lowering taxes. So we’re talking about spending more money – we don’t know whose dime that’s going to come on. Maybe it will be more debt, what have you. Will the decrease in taxes – we’ve seen in the past when taxes are cut an increase in productivity, in business. Would that be enough to maybe pay for t his?
David: I’ll tell you what. Lowering of taxes to a flat 15% would be very intriguing, I’ll tell you, for a couple of reasons, because your large multi-nationals don’t pay 30-35 anyway. They get their effective tax rate down to less than 10% because it pays to have a hundred, or a thousand CPAs working on your staff to get your effective tax rate down that low.
Kevin: But what if you didn’t have to do that? What if everybody just had their taxes at 15%? That’s sounds pretty good.
David: The real benefit is not to multi-nationals who already reap the reward of [unclear] tax rates.
Kevin: They don’t pay anything.
David: Right. The real benefit is to middle class taxpayers and business owners. If you’re talking about your small to medium enterprises – huge, huge benefit.
Kevin: I am looking for a raise, by the way, if that occurs, Dave. I just…
David: All things are on the table.
Kevin: (laughs)
David: Everything’s on the table, if Trump can deliver, right?
Kevin: Yes, it’s exciting if it could happen.
David: But what? What? It’s exciting if what could happen? This is a tangible thing. This is tangible. If you bring it to 15%, the promise of a benefit to all in business and to every household, the question is, is that sufficient to offset higher interest rates?
Kevin: The stock market says it is.
David: The stock market is assuming a massive benefit, but it’s a massive benefit from a yet to be approved tax cut. We’ve mentioned this two weeks in a row – buy the rumor, sell the news. There is already built into the stock market this assumption of the benefit of a tax boon. So what happens when it is actually announced? Don’t expect anything else from the stock market because it’s already been priced in.
Kevin: Well, actually, the danger is, any essence of a disappointment. Gold is way down right now, interest rates still haven’t risen that much yet. At this point, if we have a disappointment, interest rates will spike. Gold will spike.
David: I listened to Jeremy Siegel on CNBC this last week, and I thought to myself as I was hearing him speak, there was this echo of Irving Fisher. It was just so interesting because the questions that the CNBC hosts were asking were, “Okay, well, you know, Goldman-Sachs says we’re getting a little bit over-valued in the equity market.” “No, no, no, we’re not over-valued at all. In fact, this is a great time to buy. We look at the stock market…” And I’m listening to him working himself up into an academic frenzy…
Kevin: You’re thinking 1929 Irving Fisher?
David: He was quoted as saying in 1929, just literally days before the crash, “Stock prices appear to have reached a permanently high plateau.” He goes on to say, “There is no over-valuation, the rally is justified. In all likelihood, we’re going higher.”
Kevin: There was somebody who was more like your dad, though. Babson?
David: That’s right. Babson College was named after him.
Kevin: And he said, “No, get out.”
David: Well, Babson took a lot of heat for being about a year early. He was not days before the crash saying get out, he was saying, “This doesn’t make any sense, and when it doesn’t make any sense, just walk away.” Kind of like Andrew Smithers said a few years ago. Keep in mind, Smithers has been wrong for two years, and he has missed a move from 16,000 to 19,000 on the Dow.
Kevin: And he’s happy.
David: And do you know what I don’t think he cares about?
Kevin: He sleeps like a baby.
David: He does. He said, “I’d rather be in cash if I can’t make sense of the valuations.” Again, that was 3000 points ago. “If I can’t make sense…” He’s one of the best people alive today in terms of stock market valuations.
Kevin: He wrote the book, yeah, the Q [Valuing Wall Street, which applies James Tobin’s Q ratio to the stock market]?
David: (laugh) You’re right, Babson was the contrast to Fisher in the 1920s. And he was sounding an alarm then. Goldman-Sachs is not sounding an alarm today, but they are sounding, at least, reasonable, in pointing out that stocks are now in the 98th percentile in terms of valuation.
Kevin: Which means over-valued.
David: Well, it means that there is a little bit of margin left where prices can go up, there is room to the upside, but that’s inspired by a certain craziness and insanity in the stock market. But we’re already in the 98th percentile in terms of over-valuation.
Kevin: Well, we have a problem, though, too. For the last few years, Dave, corporate profits have been dropping, and business investment has been dropping. So even though the stocks are rising, the investment in businesses and the profits that are coming from those businesses are in reduction.
David: Well, that’s why we would say, clearly, that this is a case of over-valuation. To be 98th percentile in valuation means that you are really almost as high as you can go. I looked at a chart for Marc Faber and there was this interesting gap on the chart between corporate profits and business investment, and profits have been declining since 2012. Keep that in mind. For someone looking at fundamentals in the stock market, we’ve had a decline in corporate profits for the last five years. But again, fundamentals don’t matter when funny money is flowing. That has been the theme. And fundamentals will ultimately matter again, but when they matter, it’s going to be very, very painful for those who played the game of “fundamentals don’t matter because funny money is flowing.”
Kevin: Well, and we’re looking at profits and business investment. That’s been dropping the last couple of years, too, hasn’t it?
David: Actually, business investment has been in a longer-term secular decline since about the year 2000. And it has resumed, along with profits heading lower, it has resumed in the last six months below a 2% level, heading toward a 1% of GDP level. So, just for comparison, if you go back to the 1970s and 1980s, as a percentage of GDP, business investment in the halcyon days of the 1970s and 1980s was 7% of GDP.
Kevin: And now we’re moving toward 1%.
David: Right. Under 2, moving toward 1. You move to the late 1990s – and again, this is a long-term secular shift – by the late 1990s you were moving in toward 5%. So we were 7%, we’re 5%. And it’s very interesting that the downtrend which has resumed in business investment – I think this is critical – it typically occurs in the middle of, or at the very end of, a recession. Are we in a recession today? Are we in the middle of a recession? Are we at the end of a recession? You look at business investment, and it makes sense, companies tighten their belts when business is slow.
Kevin: Yes, but we’re going all the way back to 2000, Dave. The backbone of American economy has been business investment, investing in business is down to 1% of GDP.
David: The last six to nine months have rolled over, and are moving lower again. So again, this kind of a move lower is consistent with and commensurate with a recession. Do we have a recession? Or should I say, are we going to have a recession in 2017?
Kevin: History shows you that when that happens, you do.
David: Right. We already know the answer to where the profits are going, and this is, I think, the part which is sort of ethically irksome.
Kevin: It’s share buy-back and compensation for executives, isn’t it?
David: Well, yes. In our conversation with Andrew Smithers a few years ago, he said, basically, executives are being compensated with shares, and by doing that, they are incentivized to game the share price higher.
Kevin: By buying them back, making fewer shares appear out there, and then you have corporate profits look like they’re rising.
David: It’s directly tied to their compensation packages. Since the 1970s and 1980s, one of the things that you have seen is a change in compensation for directors and executives. And when you tie it to share performance, guess what happens? You begin to game the system.
Kevin: This is what is disquieting to me, though, Dave. They’re paid in shares. Then they buy back the shares.
David: Which inflates the value of the shares, allows them to lock in their gains and sell their shares at historic highs.
Kevin: The part that bothers me, Dave, is the insiders, because if you are an executive at a corporation and you buy shares or sell shares, you have to report that. And right now, I don’t think they’re buying their own shares. They’re selling.
David: Well, if you look at the last three to four weeks, this is particularly true. The insider buying has been almost non-existent. Insider selling has been brisk. But again, we’re sitting with the Dow at all-time highs. Company executives are more than willing to say, “Look, we see nothing but blue sky from here.” And they’re willing to support analyst expectations of increased earnings for 2017 and 2018. You look at the average estimates for the S&P moving into the 130 and 140 and even 150 range. These are the analysts’ expectations for 2017 and 2018. Corporate America is like, “Yeah, sure. Yep, we’ll do that.” And all the way up, as the share prices march higher, they’re selling, they’re selling, they’re selling.
Kevin: Well, and Dave, it’s the system, itself, that is abusing us. It’s not the executives. If you were an executive, or if I were an executive, and this is how we were paid, you would want to do what was the most efficient. And it’s not ethical, and I’m saying we would necessarily do anything unethical.
David: But here’s the thing. It is ethical because we’ve said it’s ethical. We’ve set the rule for them and they’re following the rules. The question is, did we set the right rules?
Kevin: The rules are wrong.
David: That’s what I’m saying. That’s why I stumble over, is it moral, is it ethical, is it any of the above? Because they’re simply following the rules. “The rules changed,” said Andrew Smithers. And the system changed. And we’ve had 30 years of a system which has prioritized executive compensation, and quite frankly, is gutting a company’s future to do that. So when I look at the grand super-cycle themes of the folks who run Elliot-wave theories and sort of take a deflationist view, one of the arguments they make is that we’re at the end of a massive super-cycle in equities. We’re at the end of a massive super-cycle in bonds. We’re at the end of a massive super-cycle in the dollar.
And one of the things that they’re looking for is the exposure of this kind of root rot. Real change occurs and a system restart occurs in the economy and in the financial markets when executive compensation is made right. What do I mean by made right? When it goes from being 300 or 600 times the average compensated worker, to being what it was prior to the 1970s.
Kevin: Something more in keeping with – I hate to use the word fairness.
David: It’s still generous, but 29-30 times the average compensation. Now it’s multiplied times ten compared to what it was in the 1970s and yet the average compensation for the average worker has not increased. Again, the managers of the business are managing the businesses as if this is a personal piggybank, and that has to come out in the wash. There has to be a cleansing in the stock market and a reconfiguration of interests, because investors should be loathe to see their businesses gutted for the benefit of the executive suite.
Kevin: So if the stock market is too high, which is what you’re saying, in simplicity, and the bond market is too high, and we’re at the end, possibly, of a grand super-cycle, according to Prechter, for the listener who is sitting here saying, “Okay, well, Dave, I bought gold, and I’ve been sitting here waiting for this grand super-cycle to end, and I’m watching gold down squandering around in the $1170s right now,” well, okay, yes, maybe in India it’s selling for $1400 to $1700 an ounce because the streets need it, but outside of India gold is below the 65-week moving average that we talked about. What does that mean to the gold investor right now?
David: What I look at as particularly compelling is the Dow-gold ratio. We started a secular trend in gold to higher levels at a 40-to-1 ratio, comparing the value of stocks to gold.
Kevin: That was in 2000.
David: Forty ounces of gold, you could have exchanged for the Dow. And that dropped by the time we got to 2011, to 6-to-1. That’s a pretty significant shift, where it only took six ounces, instead of 40, to buy the same set of stocks.
Kevin: But it wasn’t the end of the move, Dave. It always seems to end at 2-to-1 or 1-to-1.
David: And we’ve had a counter-trend move where it’s 16 or 17-to-1, and that’s a major counter-trend move, but in keeping with every counter-trend move we’ve seen of that kind in percentage terms…
Kevin: You can lay the charts on top of each other, from the past times that it happened.
David: And where do we go from here? Price is not my object. The exchange of value is my object. And being able to take gold ounces and exchange them for real things of value, whether that is companies, or acres, or square feet, all of those things are of interest to me. And how and when that happens is unfolding in front of us. We have all the dynamics in place. We have all the dynamics in place. And whether it takes place at the end of 2016, or at the end of 2018, a move to a 1-to-1 ratio, when you look at the growth in your financial footprint, because now we’re talking about an exponential move, we’re not talking about the simple math of how much did you make last year? 2%. How much did you make the year before? 10%. How did you make the year after that? 5%. We don’t want to add up our results over the last three to five years.
Kevin: You want multiples upon multiples upon multiples of buying power.
David: I want multiples upon multiples of buying power. And that’s what history suggests is being served up right in front of us. So, the movement of gold from one day to the next, the movement of the Dow from one day to the next – we’re looking at the Dow at all-time highs, yet relative to gold it’s not even half its former value. Does that compute? Because that’s what I see. Everyone is looking at the strength of the Dow. If it’s so strong, why does it get me less than 20 ounces when in the year 2000 it got me 40 ounces? That says to me that the Dow is not as strong as you think, even though in nominal terms it is the hero.
Kevin: It also tells you that gold is stronger than you think. It’s not the amount of dollars that gold is worth, it’s the amount of everything else that gold buys.
David: It’s the amount of everything else.
Kevin: And if you were in India, and you thought ahead and you owned gold, today you’re thinking, “Oh, thank God I bought gold.”
David: The value of gold is what it buys for you, and viewing it as cash is the appropriate way of viewing gold. Seeing daily fluctuations in price takes away the perspective of the purpose that it serves as a currency. When I look at 40-to-1, and a movement to 6-to-1, that was really fun, but I knew it wasn’t over, and it has been painful going from 6 to 16-to-1, because it’s the ratio in reverse. My gold is buying less and less.
Kevin: But that always happens.
David: Look, we’ve got counter-trends all the time in any market. What I’m looking at is the secular trend here in gold, and the price – I can’t tell you where it will reach, but the ratio? 3-to-1 ratio off of 16? That’s an amazing return. 2-to-1? Even better. 1-to-1? Not historically unprecedented. In fact, that’s what we would expect in this particular era, a 1-to-1 Dow-gold ratio. Then you’ll see the perfect exchange between ounces and acres, between ounces and square feet, between ounces and shares.
