The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“What are the areas of your life that you want greater control over? As control is being ripped from your grasp, and as you are being herded into the cattle chute, the question is, where do you want autonomy, where do you want freedom, how are you going to express that? And how are you going to ensure that it is maintained, not only in your lifetime, but in the next generation?”
– David McAlvany
Kevin: A few years ago, I remember you meeting with one of the great investors of the 20th century, John Templeton, and you came back with some very sound common sense types of points that I think you’ve tried to apply to your own investing career since then.
David: I look like I’m about 12 years old in the picture that was taken with John Templeton (laughs).
Kevin: You guys were in the Bahamas, weren’t you?
David: I read a brief summary on the investment career of John Templeton from Marc Faber recently, and it reminded me of the times that I met with Sir John in 2003, in 2004, you’re right, down in the Bahamas, and that was 12 years after he had formally retired from the investment business and now it’s 12 years ago.
Kevin: He was in his 80s, I think, when you were meeting with him. Wasn’t that the case?
David: It was actually his 90s. He lived for a few years longer. I think he died in 2008. But he approached the world of investment from a deep level of common sense, which might have been a part of his Tennessee upbringing, or may have been enhanced by the time he spent studying with Ben Graham, the father of value investing.
Kevin: That goes back to the stock market crash and the depression period of time in the 1930s. Ben Graham was known then as the great mouthpiece of value investing.
David: There are some notable observations about John Templeton, starting with this. He spent a good bit of his investment career investing in what others saw as worthless (laughs), and it’s the nature of value investing that it happens to be cheap, and it’s cheap because nobody wants it, nobody wants it because people don’t see value in it.
Kevin: What are you doing buying straw hats in the middle of winter when you need to be buying gloves?
David: He was a value investor, he didn’t like to overpay for stocks, and that meant that when stocks got expensive his performance also suffered because he was usually underperforming a market where valuations were getting richer and richer, prices were going higher and higher, and if he couldn’t justify a valuation he was more than happy to let someone else take the risk and move to treasury bills, move to cash, or begin the search for the next out-of-favor stock. And the advantage, of course, was that he outperformed when the market went down because he had gotten out of those risky and overpriced assets.
Kevin: If you don’t mind me making an observation here, Dave, and some of this may be painful even to you to say, but it’s the best investors, long term, that a lot of times look like the worst investors short term. Just like John Templeton. They can be mocked because you look at their annual returns and you say, why aren’t they doing what the other guys are doing? But when you look in the rear-view mirror you start to see, wait a second, these guys are buying cheap and waiting.
David: And he had years where he was down 10, 20, even 25% in a single year. And it did not take away from his 50+ year career as a successful investor, compounding growth at about 16% per year. Now, was that 16% year-in and year-out like you’re clipping a bond coupon? No, not at all. There was plenty of volatility, and that volatility came, in part, because he was buying things that were unpopular. That eliminated a lot of the risk from his portfolio, buying that which was unpopular, but it also gave him good growth in periods of an upswing.
Kevin: He also paid attention to things that you pay attention to, like the price of a share relative to its earnings.
David: Right. And he liked a 20-year rolling average, which was similar to, but even a longer-term gauge of value than what Robert Shiller at Yale has popularized as the Shiller PE, and what prior to that had been known as the cyclically adjusted price earnings multiple, which is a ten-year rolling average of a PE. Templeton looked at a 20-year and basically asked, “How out of line is the valuation of this company that I’m considering at this point in time, from a historical perspective? Is it cheap, from a historical perspective? Is it expensive from this 20-year rolling average?” That was another major emphasis for him, bringing in a historical perspective.
Kevin: And that is, of course, looking at the earnings of a company, but he also looked at replacement value. We’ve talked to Smithers and he talked about Tobin’s Q. What does it cost to replace the entire company? And a lot of times he was buying things at less than what it could be replaced for.
David: I invited Andrew Smithers back onto the program. You may recall he retired from his business, retired from writing articles for the Financial Times, and also is retired from doing public interviews, so we won’t have him to talk about the CAPE, the Cyclically Adjusted Price Earnings, or the Tobin’s Q. Those were two very, very focused and deliberate efforts in Smithers’ work to say that these are the best measures, bar none. And it’s not surprising that Templeton leaned heavily on these measures, too. Tobin’s Q – he was very interested in purchasing assets at less than their replacement cost. Of course, that goes back to the Nobel prize winner, Tobin, who had written about that in the 1950s, which was about the time when Templeton started his major career in investing.
Kevin: I remember your dad taught me early on, when I was in my early 20s and I had first started with the company, he talked about bonds, because bonds really are the telltale of the entire world’s money market because it is measurement of the cost of the risk in the market. The way he explained it was, he said, “Look, guys, if you think the stock market is something to watch, consider this cup (he had a coffee cup). This is the stock market. Now, consider a bathtub. The bond market is what you watch.” That was one of Templeton’s calling cards, wasn’t it? He watched the bond market, actually, to see how it would affect equities – stocks.
David: Right, and he was very interested in the yields on stocks relative to the yields on bonds, and looking at how that was an indication of over-valuation or under-valuation market-wide. His typical holding period was about five years. He was not a buy and sell tomorrow – it took time. And day in and day out, statement by statement, investors could look and say, “Well, that hasn’t done anything for me.” And you might hold something for three or four years without it doing something, where the payoff was, having been early and having bought it when it was cheap, before there was a catalyst for growth. It is interesting that he would look critically, after about two years, to see if anything needed to be kicked out, but there was a typical five-year hold on most of his holdings, and he took very concentrated positions.
Kevin: Let’s contrast that, though, with the other extreme which a lot of people have heard from their brokers, and that is, buy it and hold it forever. You’re bound to make some money. That was a strategy, actually, that when Templeton was doing his investing, became quite popular. The brokerage industry said, “Look at the long term stock market, just go ahead and hold everything.”
David: The first book I was given to read by a professional stock broker was by Jeremy Siegel called Stocks for the Long Run, and it argues that you just buy it, stuff it away, and don’t think about it until you need it. The problem is, your beginning point, and the point at which you do need it, may not coincide with the market being generous. There are periods of time when the stock market is up, and there are also periods of time, over 40% of the time in aggregate from about the 1870s, that the stock market is down – 40% of the time it’s down, and it may be that your need, whether it is a liquidity need for college, a wedding that you have to pay for, a retirement – it may not coincide with that 40% of the time when the market is down and your assets are suffering as a result.
Kevin: If it’s like me, it’s always the worst time when I need to sell something.
David: I introduced my oldest son to John Bogle this past autumn. He was the founder of the Vanguard group of funds, and is the leading advocate for passive investing in an index fund. We discussed his case for passive investing, the three of us did, and it’s in stark contrast to the results that Templeton had over a 50+ year career. Passive investing is cheap, that much is true. But passive investing assumes that you stay invested through thick and thin, which also means that you weather the 1987 storms, you walk through and stay through 2001, you don’t budge, and you let 2008 come and go, and the present decline, or events which may take it even further to the downside, 20-30% from here, these are events that you simply have to ignore and accept. That is what I could consider almost a blind level of acceptance (laughs). On that point, it appears to me that Bogle and Bhuddism are related, that pain is this reality that you can just try to ignore, or if you reach some sort of higher level of consciousness, pain doesn’t even matter anymore. And I’m very sure that in practice, both John Bogle and your average Bhuddist monk are still going to look both ways before crossing the street.
Kevin: So what we’ve done is we’ve looked at the two extremes that are not John Templeton. You have day traders who are trading hour-by-hour and trying to make profits that way. And then you have the extreme on the other side, passive investing, you just don’t touch it and let it grow, supposedly, and shrink and grow and shrink. Templeton seemed to have the long-term investor mindset but also very carefully watched those aspects that we were talking about before.
David: Yes, the value proposition was absolutely critical and he would prefer not to play than to just run with the bulls headlong into excessive valuations.
Kevin: And sometimes that comes with a cost. You have to sometimes sell at a loss.
David: And in the case of Templeton’s management, you were paying dearly for what ended up after a 50-year career being a very successful endeavor, and very much supported the fees paid for his acumen and his patience. And of course the value of that only became obvious once there was risk aversion in the marketplace. When that was in play and the average investor was suffering losses, then and only then could you see Templeton’s unwillingness to jump headlong into those risky assets. And that’s where it paid off. He was a bit like the tortoise. I think, judging his career in investing, I think you could judge the quality of his race a bit like you would the tortoise, the old tortoise and the hare, that old tale. You judge it on the entirety of the race, and not on a single year, or even a five-year stretch. It was time, and it was patience, that proved the value of his insistence on value investing.
Kevin: Looking at the last five-year stretch, it has been unique, Dave. We’ve seen oil jump very, very high and then come down to levels – I just took a trip down to Phoenix this weekend. I put gas in the car over and over and I didn’t even feel the effect because I was buying gas in the $1.70s. It was incredible. It’s the same type of thing when I’m buying something from overseas. The dollar is just so strong that the items that are coming in from overseas are cheap. The dollar, over this last five-year stretch, if we’re looking at that, has been unusually strong against all these other foreign currencies, and I have to wonder what effect that has on companies that are directly affected by the falling value of those foreign currencies, not the rising value of the dollar.
David: There is a two-fold effect, because as Jim Grant observes, not only has dollar-denominated debt spread around the globe, and the quantities of that debt have soared in recent years, making it, quite frankly, difficult to pay back by foreign borrowers as the dollar has risen in value relative to their currencies which have declined.
Kevin: Or impossible to pay back. You’re going to be talking to Reinhart soon – we told the listeners last week that Reinhart would be on this week and she had a family emergency come up, so we’ll have that interview coming here in the next few weeks.
David: But your major U.S. companies, as you say, 47%, almost 48% of the S&P component companies, their sales are based in those depreciating currencies, so almost half of the sales of the S&P 500 companies are based in depreciating companies and you end up losing the value of those sales when they are repatriated to dollars. So you’re talking about a hit to earnings of 10%, 20%, 30%, 40%, depending on the devaluation metrics for the local currency in question. Does this have an effect on corporate earnings? Of course it does. As long as the dollar strengthens, earnings on Wall Street will continue to suffer, raising the question of whether or not stocks are a good value.
Where do you grow from here? Where do you get your growth? Is it demographically driven? No, it doesn’t appear to be. Is it driven by central bank stimulus? It looks like we’ve exhausted those avenues in terms of increased productivity it looks like we’ve already exhausted and squeezed every last drop of blood out of that turnip, as well.
Kevin: I’ve noticed there is such a hesitance right now in the central banking community to actually say maybe we are in a recession, maybe we are actually too slow to pull ourselves out with just normal growth. They seemed to be denying it. Mario Draghi made that point last week.
David: It seems to be an issue of ego. It may be that simple. Rather than gauge the risks in the global economy as they continue to rise, rather than looking at indebtedness continuing to grow, slowing growth in the global economy, rather than focusing on these things, looking at them and giving them attention, the central bankers are still converging on the issue of how to compel the public to spend and release their savings into the system, and this is reminiscent of Keynes asking the question, “How do we get the rentier – that is, the person with excess savings who is expecting an income off of those savings – how do we get those savings into the financial system and not off on the sideline somewhere? And this is today’s version of that, a monumental fight to destroy mattress money and regain control of monetary policy effectiveness. So you have central bankers that have, in point of fact, failed in their objective to gin up economic activity and they are still self-grading themselves on a very different basis.
So, it seems to me you ignore, you turn a blind eye, to the economic facts and keep on trudging on with a strategy of, “How do you get the consumer back, how do you get the consumer back, how do you get the consumer back?” We saw the Chinese manufacturing PMI was off again, six months in a row. U.S. durable goods orders for December, the consensus was that it would be off slightly, and it cratered more than 5.1%. That’s not good. On that basis, J.P. Morgan cut their fourth quarter GDP estimates to zero. And in complement to that, you’re seeing shipping volumes globally which are sending a siren warning that the global financial crisis 2.0 is here. Meanwhile, what are central banks focused on? “We cannot be wrong. We cannot be wrong. We know what we know, and it’s just a question of freeing up velocity,” as we talked about last week. “It’s just a question of compelling the consumer to get off their duff, quit saving, releverage, get out and spend like its 1999.”
Kevin: Well, a little after 1999, it reminds me of after 2001, September 11. Bush came out and said, “It’s your patriotic duty to go spend money.” The government even gave everybody some money to go spend, so this consumptive society has been trained that the only way you can be patriotic and actually part of the system is to continually go into debt and spend. It obviously is not the central bankers’ fault.
David: It’s not the history of capital. Unfortunately, that is simply not the history of capital. But nevertheless, you have central banks implementing their monetary policies and their claim is simple. Their claim is, “It is working, it’s just not working through the channels that we expected.”
Kevin: “You people are just too stupid to know that it’s working. Please go spend.”
David: We created high-powered money, it went into assets. No, it didn’t go into private sector borrowing, no it didn’t end up exactly as we hoped, but zero interest rates which have frustrated savers in recent years – we’ve talked about the nature of having a deposit in the bank which hardly justifies a cup of Starbucks coffee on a weekly basis. There is just not enough interest income coming in. That’s frustrating to savers. And what you find as a response to that is the central bankers wanting to motivate the community, pump up the money supply, pump up the money multiplier, release liquidity through commercial banks into private lending channels. Those private lending channels have closed shut because, in part, consumers don’t want to borrow. They’re ready to unleverage, and you see that trend.
Since 2008 households have deleveraged, corporations have added to leverage, and governments have gone on a debt orgy. It’s absolutely unacceptable the levels of debt that governments have gone to around the world. But again, you have the banking system which has is also hindered here because they have risk weighting requirements applied to the assets that they have, the loans that they have, which have curtailed their ability to lend. So to regain control of the old channels, a change in consumer behavior is what is being forced.
Kevin: And is this where negative rates come in? We just got the announcement day before yesterday that Japan has now gone negative on their rates. That’s punishment for saving money.
David: It is, and negative rates are on the tongue of every progressively minded central banker around the world. What I failed to discuss last week is not just the elimination of cash in order to foist yet another tax on the economy, diverting literally trillions of dollars from the man and woman in the marketplace toward leviathan, but I forgot to mention that the motivational stick to be used is to increase the cost of cash transactions. This goes back to, actually, the 1950s when this was first explored by a guy named Gesell, they’ve actually called it the Gesell tax, as a way of saying, “Look, you can use your cash, but it’s just going to cost you a lot more money to do so. Wouldn’t you rather use something that is much more convenient? Wouldn’t you rather use an alternative that doesn’t have the same prohibitive costs involved? And this is the nature of the transition we are in the middle of right now.
Kevin, I tell you, in the last year I’ve seen a radical increase in the number of articles, whether it is academic papers or popular pieces on CNBC or Bloomberg. This last week, another one from Bloomberg View dealing with the irrelevance of cash. The opening line of the article was, “Cash has served its purpose for 4,000 years, but it’s so declass, it’s dirty, it’s dangerous. Who really needs it today? It’s analog.” And I’m thinking to myself, “Gosh, this is interesting. We, for the sake of convenience, would override our concerns, not only about outright theft, which is what I consider financial repression to be, negative interest rates and financial repression, the very same thing, but also we would override our concerns having to do with the mapping of every transaction. We are creating a profile, not just for commercial entities to market to, but we are talking about, for governments to be able to see and figure out the deep motivations of every person on the planet. That’s kind of disturbing to me. It’s beyond George Orwell in the sense that his version of Big Brother, I don’t think, could have entailed or incorporated the kind of 21st century technology that we have at our fingertips today.
Kevin: Let’s unwrap this for a moment, Dave. The central banks have been managing the economy, but you and I have had the opportunity to not participate if we don’t want to. We can pull our cash out of the banking system if we don’t like the banking system. We can pull our cash out of the stock market if we don’t like the stock market. We can spend on what we want, still, but that is liberty. That is the liberty that cash gives us, it gives me, it gives you, it gives our listeners, the ability to choose where they want to participate. Remember the song Hotel California by the Eagles? You could check in, but you could never leave.
What seems to be happening here is that there is a general movement toward closing the exits. Instead of us having the ability to exit – let’s say we smell something that smells like propane. “This doesn’t smell right and I’d like to leave,” and we find out, wait a second, they’ve locked the doors. That’s what a cashless society will do. That’s what negative interest rates will do. That’s what a Gesell tax will do. What we’re doing is we’re basically eliminating the liberty that we have been given to spend our money where we would like to spend it.
David: The vast majority of people who consider autonomous action from a financial perspective, reference cash, because they don’t realize that gold played that role for hundreds, and in fact, thousands of years. Only since 1913 in the popularization of fiat currency here in the United States have we let gold become analog and fiat currency become digital. Now we’re taking currency, itself, greenbacks, and trying to redefine that as analog, and moving on to something new and different and supposedly better. This is very interesting because this idea of a currency reset is very present in what it means to go from a physical fiat to a digital fiat currency, and the things that you can do with a digital fiat currency are very intriguing. As you just suggested, you don’t need to maintain confidence in central bankers or in a currency when everyone is captive within the system.
Kevin: If the exits have been sealed.
David: Confidence isn’t required if you’re captive.
Kevin: You brought up a good point, too, with this Gesell tax. I hadn’t thought of this. You don’t actually have to tell people they can’t have cash. You could even leave a little cash in the system. You just make the cost of doing business ridiculous. Look at people with ATMS, at this point they’re willing to pay ridiculous fees just to get a little cash out.
David: We’ve already shown that those ATM fees, let’s say the average is 1-3%, that’s acceptable and people pay it all the time. I remember being baffled by my college classmates who would routinely pull $20 or $40 out of an ATM machine and pay $2, $2.50, if it was expensive, maybe $3 or $3.75, on a $20 or $40 withdrawal. And their justification was, “Well, it’s just a couple of bucks.” But it’s equal to 5% or 10% (laughs). And quite frankly, I’m afraid that a college degree didn’t sharpen them any to this particular issue. What is the threshold where extraction of cash puts us toward using cards or other digital payment methods exclusively? Is it a 5% number? Is it a 10% number?
And our response will not be an outcry of, “Stop this nonsense! We want our own capital back. After all, it’s our deposits we put with you. Why should we be paying for just getting it back?” We’re not going to cry out, it’s instead going to be to react like a herd animal. Do you remember the Temple Grandin story where she designed her cattle chutes to take away any resistance in the hard edges? I can imagine the American consumer and the global consumer reacting like a herd animal in a Temple Grandin designed cattle chute. Take the path of least resistance, go where there is no friction, no stress. This, Kevin, is how we accept a cashless society.
Kevin: Convenience.
David: And the cashless society is how central bankers run their financial repression schemes on a universal scale. Why do I say this? Kevin, in addition to my market reading this week, I read two papers, one a special paper, “Potential Instruments for Monetary Policy” from the London School of Economics Financial Markets Group dated January 2013 by Charles Goodhart. He was a guest of ours on the program last year.
Kevin: Bank of England.
David: That’s right. He is a professor there, also spent 25 years as one of the chief monetary policy makers at the Bank of England. Another paper that I read was from the Ricks Bank, “How Far Can Repo Rates Be Cut?” This was from November 11, 2015. In both of these papers it is a given that we need negative rates, and there is the very clear observation that the single hurdle to an effective negative rate policy is cash, because people can opt out of negative rates and you can’t extract that tax. They even talk about it candidly as a tax! They’re going to increase taxes outside of the regular legislative process.
So what is this exactly? Negative interest rates are a form of financial repression. Repression of this sort is theft. Negative interest rates are thus a sophisticated form of theft. They are a tax on the flow of all money through the financial system, and it is pre-empted by the central monetary authorities and it is unapproved by any legislative body and that is one of the reasons why it gets under my skin. The reason why I can’t quit talking about it is because we are talking about a wealth tax in real time, the same kind of thing that happened to Cyprus, only it’s happening to us now. Our deposits will not be exchanged for equity in the banking system. Our deposits will simply be reduced according to the whim and fancy of whatever central banker happens to be making the decisions at that particular period. This is all in play right now.
Kevin: And it is eerie, whatever a person believes about prophecy, it is interesting that 2,000 years ago in the Book of Revelation, John wrote about a system where no man could buy or sell without a particular mark on the forehead or on the right hand. There has really never been a period of time where the central bankers or the central authorities have been able to control both the spending habits and the cash, a cashless society where something like that could happen. Isn’t it amazing at this point right now, Dave, that these academic papers coming out of reputable central bankers are saying that this is what they’re going to do?
David: Kevin, the war on gold, and now the war on cash, are wars on freedom.
Kevin: It’s liberty. They’re taking your liberty.
David: That is exactly what is in play. The only means that central bankers have of forcing a behavioral shift amongst consumers and thereby take advantage of the general public, fleecing them in the process, is by altering incentives and manipulating the context in which a transaction occurs. Technology and a drive toward e-commerce, these are the means that make facilitating this agenda a fait acompli in our lifetime. Not only in our lifetime, in the next couple of years. We have it in the Nordic countries, we have it in Europe, and coming to a theater near you. So the bank of Japan lowered their rates to a negative 10 basis points. The Swiss National Bank is already negative 75, the Swedish is already negative 35. I forget what Norway is at, I forget what Denmark is at. But you’re lowering the reward for savings. That’s one tactic.
Kevin: That’s what we saw over the last few years. We saw low interest rates, then we saw zero interest rates, now we’re seeing negative interest rates, now people will opt out unless you close the exit.
David: That’s right. The gradual process of lowering the reward, then penalizing a saver – that’s the second tactic, as you say, and it does elicit that opt-out decision by anyone who is paying attention to their bank statement. And rather than lower rates to a level where the public protests, you lower rates as far as you possibly can. And then this is the critical point – you raise the cost of cash transactions so egregiously that the negative rates imposed on deposits is small potatoes by comparison.
I’m not making this up, this policy prescription comes directly from the Swedish Riksbank, the oldest central bank in the world. This is from their economic commentaries dated November 11, 2015. Bankers around the world are watching them as they were the first to implement negative rates – 35 basis points I mentioned, Swiss at -75, Bank of Japan now -10. 25% of all government debt globally now trades at negative nominal rates. There is a lot more than trades at negative real rates when you factor in inflation, but negative nominal rates where you are paying a fee in order to save. Why continue on the issue of financial repression? Why fixate on the issue of negative rates in a cashless society? Because we are getting closer to a global currency reset.
Kevin: It’s all based on convenience, Dave. As you watch people checking out now, they can hold their phones over a sensor, and the phone at that point does the transaction, and they’re buying their Starbucks coffee, they go on their merry way. And let’s say they’re going to the airport to get on the plane, they move their phone over a sensor, it’s got their ticket on it – incredibly convenient. All you need is a phone. And so, if repression is occurring, they may not even feel it.
David: I live in this in between space where the cashless society is controversial to me, and yet I’m that guy getting on the plane and using my phone and the convenient phone apps that allow me to track my schedule, track what my next appointment is.
Kevin: Why not use it for cash, as well?
David: Absolutely brilliant, and yes, it organizes my life in a compelling way. And I’m realizing the vast majority of people really don’t care about being in a cashless society. Whatever lingering concerns I have, they’re not felt or held by the vast majority of people. It just boils down to convenience. Convenience is the critical argument for it. But just as fiat money is more convenient than gold, remember, we’ve already been here to a degree.
Kevin: Yes, and how’s that worked out for you, like Bill King would say?
David: Right, fiat money is more convenient than gold and it has precipitated the loss of 97% of the purchasing power, basically, taking wealth from private citizens and moving it to the banking industry. Does this make sense?
Kevin: Is it worth losing 97% of your buying power just to use cash instead of gold?
David: It was quite a gift, and unfortunately, you are on the giving, not the receiving end. That was popularized by the Federal Reserve during World War I, so now digital fiat, in my estimation, removes the last encumbrances on money supply manipulation, on monetary policy experimentation, and in a world of virtual money – you remember the old days where in Weimar, Germany, you picture the person wheeling in a wheelbarrow full of cash to buy a loaf of bread? In the world of virtual money, your wheelbarrow can carry any quantity, into the trillions, and you need only worry about the grid as in the electric grid, for your security, because, oh by the way, yes, you do still have some exogenous problems, things that can sink your ship (laughs), things like the lights going out.
Kevin: When we sit here and sound like we’re worrying about things that won’t happen, you can trust a central banker to tell you the truth, can’t you? Look at Japan. A couple of weeks ago Japan said, “No, no, no. We’re not going to go to negative rates.”
David: Yes, I think that’s a lesson we need to remember. You can trust a central banker to be a central banker, and that is, commitments and promises are more like suggestions and good intentions. Just January 21st of this year, Kuroda said that he had no plans to adopt negative interest rates, and then last Friday he introduced them, with the policy committee saying that they will cut the interest rate further into negative territory as necessary.
Monday, our friend Bill King responds to Kuroda’s announcement. He said, “The threat of imposing deeper negative rates if consumers don’t spend, is tantamount to asserting, ‘We’re going to continue the beatings until your morale improves.’ What are you trying to accomplish here? This is a higher wealth tax on top of a group that is already trying to absorb a higher sales tax.” The Japanese have been tortured beyond belief from a monetary perspective, and it is as if the bad policies of yesteryear are just being refashioned, retooled and intensified, and yes, you should say, “Thank you, Sir, may I have another?”
Kevin: This incredible need – like you said, it’s egotistical on the central bankers’ part because they don’t want to admit that their theory has been wrong all along. Studies have shown, and actually the last three or four years have shown, that lowering interest rates does not increase spending. It actually can lead to more savings. Look at China. The more they lower the rates, the more they save.
David: That was a point that Michael Pettis explained many years ago on our commentary, that in a low rate environment the Chinese are more likely to increase their savings in order to meet their future financial needs. The less natural compounding that is occurring in their portfolios, the more they must set aside today to meet future bills and obligations. This principle seems to me to be playing out on a more universal stage. As the central bankers lower rates past zero into negative territory it is creating financial insecurity, and for some, of course, there is a response of taking greater risks consistent with findings in the field of behavioral economics where a guaranteed loss on one side of the equation increases the propensity of risk-taking on the other side of the equation. But the Chinese response is also now in play, and it is this: I’m not going to meet my goals, so I need to save more.
So, perversely, the zero interest rate, and now the negative interest rate strategies are causing more money to seek the mattress, rather than less, and the problem, it seems, with both economists and central bankers is that their elegant mathematical equations are not consistent with human behavior and human nature. Now, in a response to their theories not working, they want to try to become Skinnerites, disciples of B.F. Skinner and his famous school of psychology where they are hoping that behavior modification is the next set of tricks that they can effect.
Kevin: The only way you can create behavior modification is to have some control of every variable. That’s really the bottom line of what you are saying right now. The freedom that a person has had in the past to spend when and where they would like to spend is being taken away.
David: Other things that are certainly on my mind as we head into the new month, we’ve gotten the U.S. durable goods orders for December, I mentioned that. There was a disappointment coming out of the Census Bureau of 5.1%. We already looked at retail sales and those were a disappointment in terms of their growth rate. And now this last week we also had Amazon, which was supposed to have captured market share from brick and mortar retailers, and that was their big explanation for why there were falling retail profits.
But they announced on Friday that they earned a dollar versus the expected $1.55, and their shares dropped, in about two seconds, by 14%, and it’s because they missed their earnings expectations at such a catastrophic level. This is the question that remains for me: Where is the Amazon brick and mortar replacement theory, or are we just looking at slower retail activity, and the same thing that central bankers are trying to stimulate in the first place, which is a return to consumer leveraging, spending every dime that you make, and certainly more than you make, made available to you by the credit markets.
Kevin: A lot of theories right now are having to be challenged. We were looking at the high-yield market over the last year-and-a-half, and we discussed if some of that could have to do with energy. This dramatic downturn in oil, would that have been what affected the junk bond market? But it doesn’t turn out that that is necessarily so.
David: That’s right. Junk bonds, aka high-yield, or the other way around. You are right, energy took the rap for that. The major disruption in junk bonds had everything to do with a disruption in the energy space, oil and gas. As you sort through the numbers, actually, distressed debt, today, according to wolfstreet.com, is, in that oil and gas space, responsible for only about 30% of the debt that is now distressed. And the total coming under pressure, the other 70%, comes from a broad cross-section of industries, whether it is telecommunications, whether it is media and entertainment.
Kevin: So this isn’t just an isolated area, we’re talking a general upturn in the yield, and a downturn in the principle value of a large, broad category of debt.
David: What it suggests is that what we had six months ago was a brewing industrial recession – we have had confirmation of that now on a global basis, and certainly here in the United States – that industrial recession is, in fact, creeping into other sectors, other sectors that are very important, and include the service sectors in our own economy.
Kevin: The owners and the key decision-makers for the various companies must see this because the insider selling right now has been very, very high. They have to report it. If you, Dave, were CEO of a public corporation, and you were selling shares of, say, McAlvany, you would have to report that. And actually, insider selling, I believe, right now is very high. These guys are seeing the handwriting on the wall.
David: And it is across a wide cross-section. If you are talking about the retailer insiders who have been selling their stock versus buying, it’s at Target, it’s at Costco, it’s at CVS, it’s at Home Depot. Of course it’s at Amazon, where there is always high selling. But also, the big surprise in the last month or so has been bank insiders, massive selling at J.P. Morgan, massive selling at City Group, massive selling, off the chart selling, at Goldman-Sachs, a little less so at Bank of America, plenty at Wells Fargo, plenty at Morgan Stanley.
Kevin: Remember, these would be the same people who would probably have been selling in 2007, 2008. This is the sector that would have gone down.
David: This is from Alan Newman. He compiles these numbers for us. It is an intriguing story when you look at one particular set of advertising which is, happy days are here again, and we are very hopeful that 2016 and 2017, everything is coming up roses. And yet, you look at the behavior of insiders and they’re selling something else. They’re selling you on one story, and they’re selling their own shares at the same time, and it is a period in time where you must watch what people do, not what they say. Kuroda reminds us of that, watch what he does, not what he says, it’s irrelevant. The lies that he weaves and the confidence that he tries to engender in talking his way through things – watch the actions, watch the follow-through.
Kevin: Dave, I want to go back to the general theme of what you were talking about, which is financial repression with a built-in control, not only of the money supply, but the type of money that is used in trying to actually control the velocity of money, or people’s spending habits. In other words, complete control. On Monday night, when you and I meet – we usually meet to talk about what we’re going to talk about on the commentary – I asked you a question. I said, “If we see this as a fait accompli, and we are moving to a cashless society, and we are moving to negative interest rates, just like the central banks are telling us they are going to do, then what do we do now if we see it coming?
David: This was the point of a conversation I had with my wife last night, and it will be an ongoing conversation, one that deals with balance sheet reappraisal. And it is to look and say, “What are the things that we would like to have that represent real wealth that aren’t necessarily a part of the financial system? And this is an oversimplification of the conversation that we had with Chris Martensen late last year, but what we said in that conversation, and what Chris had to share with us last year was, “Look. I am a wealthier man for being able to step into my back yard and harvest my own garden, wealthier in so many ways. My emotional health, my mental health, my physical health, are all a part of the equation. It is not just about being self-sufficient, it is about what goes into creating this thing that I call resilience. The same, I think, is true of so many things in life. Where do you want your resources to be? I prefer to have my resources in real things. That might be apple trees, pear trees and peach trees.
Kevin: It might be a gold coin.
David: It might be a gold coin, or a silver coin. And the emphasis on real things and real wealth, I’m reminded of its importance this last week when Marc Faber quoted this particular philosopher, and this philosopher says, “Democratic leaders will realize that they are only easily supported when there is a war that the people can rally behind, so the democratic leaders will unnecessarily become involved in violent affairs, creating wars to distract the people. To ensure their power, the leaders will create laws to bolster their positions, the rulers will impose heavy taxes against the commoners to ensure they are unable or unwilling to fight back, and any who do oppose the leaders will be labeled as an enemy and persecuted as a spy.
“Strange times are these in which we live when old and young are taught in falsehoods school, and the one man who dares to tell the truth is called at once a lunatic and a fool.” Sounds like a modern issue, except that was Plato from, oh, just several thousand years ago. And the issue is recurrent because what we’re dealing with is the common theme of individuals exercising freedom and autonomy, and a state apparatus which wants to control and determine what that autonomy is, how it will be delimited, etc.
Kevin: And this is not a Republican or Democrat issue.
David: Not at all.
Kevin: This is the Republican and Democrat issue and every other political party.
David: So here we are, in an effort to look down to where we should be five years from now and say, “What are the areas of your life that you want greater control over? As control is being ripped from your grasp, and as you are being herded into the cattle chute, the question is, where do you want autonomy? Where do you want freedom? How are you going to express that? And how are you going to ensure that it is maintained, not only in your lifetime, but in the next generation?
