Podcast: Play in new window
- Iranian Oil Toll System Accelerates Petroyuan
- We Are Handing Monetary Transition To Chinese On A Silver Platter
- U.S. Is Having A Hard Time Selling Enough U.S. Treasuries
“We’re handing this monetary transition to the Chinese on a silver platter. And Trump may have had a plan in Iran when he started, but I doubt he was considering the unintended consequences of increasing the Chinese currency profile in the process. Crisis indeed compresses time. In this case, we’re taking years or decades off the gradual increase in trade invoice market share. So everyone needs oil and gas. At present, it’s 11%, which is off the market and available only if you pay on the new terms, which again includes buying it in yuan.” —David McAlvany
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Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
Liquidity, David. We talk a lot about liquidity, and the sale of gold has been a theme that we’ve talked about over the last several weeks, but Treasuries, US Treasuries are also in the picture, aren’t they?
David: Yeah. And certainly it’s relevant in the gold market to see central banks selling gold, filling a liquidity gap. Gold is not a loan. And I think more consequential than the sale of gold is the liquidation of US Treasuries.
Kevin: And that’s really happening right now. There’s the need to raise liquidity, not just for central banks, but I mean, even private equity, private debt. Right now, there’s a scramble for liquidity.
David: Right. And it was the Financial Times that highlighted that foreign central banks have slashed their holdings of Treasuries at the New York Federal Reserve to the lowest level since 2012. And that is, as they describe, as countries are selling US government bonds to prop up their economies and currencies in the wake of the Iran war. So this particular liquidity drive is: how do we pay the bills? And certainly gold got caught up in that.
The most recent liquidations from Turkey have a lot more to do with just stabilizing the currency and propping up the lira. But the value of Treasuries held in custody at the New York Fed by official institutions—which is a group that’s largely made up of central banks, but also includes some governments and international institutions—has dropped 82 billion, and that’s since February 25th. Still a large number, 2.7 trillion in holdings, but 82 billion is still a real number.
Kevin: Which leads to monetization, which leads to more inflation. I mean, isn’t that really the outcome of monetizing our own debt?
David: Yeah. And I think that’s what we’ll talk about in a moment is that with poor Treasury auctions in recent weeks, the government has just kind of cleaned up what was remaining. So while it would be easy, or an easy read-through, to see higher oil feeding higher inflation, and that being a source of pressure on US Treasuries with rates going higher, there is far more to the story. I think, again, those auctions in March reveal a lack of demand in the face of rising supply.
So you not only have fresh Treasuries on offer in the market to finance their deficits, but an outright sale of outstanding bonds, which adds stress to the interest rate market. And as we’ve talked about in recent weeks, over $10 trillion in US Treasuries have to be refinanced. So again, supply problem, the only way to resolve that is either shrinking it or increasing demand. And this is the point where US Treasuries are being sold by central banks on a net basis.
Kevin: And not a lot of people buying right now. We’re having to buy our own for the most part, aren’t we?
David: Yeah. I think the worst auction last month had a roughly 12% interest, with the remainder being bought by the government.
Kevin: Well, and what’s compounding it right now is there is a reduction in oil revenue, and so there is a need for liquidity.
David: Well, exactly. So a reduction in oil revenue reduces the flow of capital available to be recycled in the old petrodollar system. On top of that, previously purchased Treasuries are being liquidated to fill the Mideast fiscal gaps at the most, I would say, inopportune times.
Kevin: Well, when you have $39 trillion in debt, you have to have buyers of that debt. You can’t just buy it all yourself as a government.
David: It’s more consequential than the gold sales because we are at a tipping point in supply/demand terms already, for US debt. Too much supply, not enough demand. And the auctions in late March were for two year, five year and seven year Treasuries. And the primary dealer absorption for those maturities was 24% for the two years, 16% for the five, and 12% for the seven-year debt, for seven-year debt.
Kevin: So the government had to buy the rest back themselves.
David: Yeah. So you never have to worry about a failed auction because the government can just step in and buy the remainder. But as we witnessed in the 1970s, monetization of debt is not a healthy dynamic if you dislike inflation and dislike a general loss of credibility in your fiscal policy tightening.
Kevin: When you bring up the 1970s, again, because we were monetizing debt at that time but we also had higher oil prices. So it’s a one, two punch. And then we had war toward the end of the ’70s with Afghanistan. So at this point, it seems, again, like a rhyme. Maybe it’s not a repeat, but a rhyme of the 1970s inflation.
David: Add to that the easy read-through or the obvious knock-on effects from higher oil prices, leading to higher inflation, leading to negative real rates, and you have a recipe for higher gold prices.
Kevin: Right. So gold’s not overpriced at this point, in your opinion?
David: Well, I think you have a catalyst for growth in the context of negative rates. And so whatever the price is, it can go higher in the context of negative real rates. Gold responds positively to negative real yields as your opportunity cost diminishes with each negative tick in the interest you receive. Of course, the flip side of that is that positive real yields add pressure to the rationale for investors holding gold, as you’ve got opportunity cost increasing under the circumstances.
Kevin: You’ve brought up the Summers-Barsky thesis, and that basically says if interest rates get a certain level above inflation, at that point people will divest out of gold and back into interest-bearing products.
David: Yeah. It was a great paper written back in the ’80s, and what it mapped out was that you need multiple percentage points of positive yield to change the calculus for gold investors.
Kevin: But there are other reasons the central banks own gold, too. I mean, it’s not just for positive returns or being ahead of inflation. You’ve got geopolitical reasons to own it. Control reasons, actually, with the weaponization of the dollar in the rear view mirror.
David: Yeah. I think that the calculus is very different for central banks than it is for the investment community. There’s a little bit of a difference here. To start with, central bank rationale for buying and holding gold is not strictly economic. It’s not about return on capital. There are the political and geopolitical concerns which “trump” the purely economic ones. It’s not a moneymaking motivation among central banks. It’s a combination of liquidity and having control of the assets in question. So direct control of the asset and the ability to use reserves freely away from the pressures of the US State and Treasury departments have become paramount in the context of dollar weaponization.
Kevin: You brought up Turkey. Okay. Turkey sold gold—what was it, two or three years ago—and then they replaced it, didn’t they? Didn’t they turn right back around and buy it back?
David: Right. And that’s why I’m not particularly concerned about the Turkish liquidations. The penchant to own gold by central banks really has to do with those control factors and liquidity factors. Certainly Treasuries are a form of liquidity, but when you own them in a digital form, as the Russians found out in 2022—
Kevin: You might lose them.
David: The flows of liquidity can be sucked the other direction. And you might find that what was on deposit is no longer on deposit. So it’s liquidity and control. And the recent Turkish sales of gold, they do mimic what happened in 2023. Gold sold then and now to prop up the Lira. In 2023, it was 150 to 160 tons versus March liquidations of 58 to 60 tons. And in 2024 and 2025, subsequently, they replaced every ounce and more.
The Russian Central Bank also sold gold this January and February out of dire fiscal need. And things have changed since the end of February. With a near doubling in the price of oil and a suspension of sanctions on Russian oil, monthly revenue is on track to double from 12 billion to 24 billion dollars. So the government share of oil revenue will, at this rate, add about a hundred billion-dollar windfall to Russian coffers this year.
Kevin: Wow. Wow. So what they don’t spend on war with Ukraine, they might turn right back around and put back into gold. I saw today that China—
David: Certainly the pressure is off in terms of being motivated to pay bills. They’ve got plenty of money coming in.
Kevin: Right, because of the tariffs coming off—or the restrictions coming off. Okay. So China, I just saw this today that China was a net buyer of gold again. So even in this period of time that they’re raising liquidity, it was only five tons, but the pendulum swung back a little bit. But as far as this dedollarization of the petrodollar, China’s really the winner in this, aren’t they? I mean, at this point, we’re starting to see a shift of oil being purchased in yuan.
David: Yeah. Last week we suggested that China was the biggest winner in this conflict. That is, in geopolitical terms. In economic terms, it would appear that Russia is now very much in the running. And we expect the central bank acquisitions to continue at a pace, if you’re talking collectively among central banks, well above the last 10-year trend. Of course, you had a doubling in that trend starting in 2022, but to be in the six to eight hundred ton per year range, I think, is a reasonable estimate. And maybe we get back to the thousand ton per year run rate that we had over the last three, four years.
Kevin: Okay. So, one of the things we haven’t seen until now with the Strait of Hormuz thing, it depends on what currency you’re selling your oil in. There’s a tiered— Those who are selling their oil or who are allies with Iran or selling oil in other currencies, they’re more inclined to let them through than if it’s dollar-denominated or if they’re enemies of Iran.
David: As I do my reading each week, I’m always pleasantly surprised to find some of the best reading that I do is generated in house. And from this week’s Hard Asset Insights, there’s a connection between the Iranian toll system, which at present breaks those oil flows into those three categories. Alliances with Iran pay nothing. Neutral parties pay dearly for transit, and enemies are not allowed to pass at all.
Kevin: Yeah. Just blocked.
David: Right. So, as long as Iran controls the flows of oil through Hormuz, and their proxies in Yemen can bring pressure on the rerouted oil through the Red Sea—because that east-west pipeline can avoid Hormuz and take it to another exit route, again, through the Red Sea. But if you look at the map, the Houthis have easy access there at a critical choke point as well. As long as those pressures remain, I think oil prices will remain elevated globally. Add to these the new common payment methods for oil. And in this mix, you’ve got cryptocurrencies, which is bizarre to me, and yuan.
You’re more deeply entrenching the Chinese currency in the global system, gradually displacing the petrodollar with what we could now call the petroyuan.
Kevin: The last two years of meetings at Mcalvany Wealth Management, Morgan Lewis has talked about this movement since 2015 of the absolute deliberate replacement of the dollar in oil purchases. And it involves the Shanghai exchange. It involves gold. This dedollarization, it’s not something new, but do you think maybe the war is accelerating things at this point?
David: Yeah, you’re right. It goes back a couple years. And the first note of a new regime coming into play was from Jeff Currie. He was head of commodity trading at Goldman Sachs. He now works for the Carlyle Group. And back in 2024, he was making this case that we were moving away from the petrodollar recycling system towards a gold recycling system.
Kevin: Gold is critical in the whole transaction, isn’t it?
David: In particular, net settlement of trade, and I don’t think he was focusing on oil at that point. I think he was talking about an entire trading system where today we invoice in dollars and tomorrow, whatever we invoice, it may be between countries using their own currencies.
Kevin: Rupee, rubles, yuan.
David: But the settlement, the ultimate settlement being on a net basis in gold. And so, I mean, what we find is that war and crisis compress time. We know that to be true. And in this case, we’re talking about an acceleration of dedollarization and an acceleration of market share capture by the Chinese, both in terms of global influence and in capital flows. So, Bloomberg highlighted this in an article titled “Secret codes and yuan fees get ships through Iran’s Hormuz toll booth.”
Kevin: And secret codes would be referring to cryptocurrency.
David: No, I think secret codes as in you need to know where to go to not hit the mines.
Kevin: Oh. Oh, those secret codes. I’d want to know that. Yeah.
David: You kind of want to know how to navigate. We’ll get you through step by step. But Lloyd’s of London is quoted in that article saying that Tehran’s toll system is now controlling Hormuz traffic with payment settled in yuan. In a separate article from Bloomberg titled “The Iran War could be the making of the petroyuan,” there was a Deutsche Bank analyst that suggested the conflict could be the catalyst for erosion in the petrodollar dominance and the beginning of the petroyuan. China is Iran’s largest oil customer.
Kevin: Are they?
David: And so, we’re talking about a small percentage of oil being settled in yuan relative to what has settled in the dollar. Maybe it’s not even worth the mention. But again, as long as we keep this choke point around Hormuz or there’s tension and thus higher pressure on the oil price, I think you see China getting to write their own script here.
So, the plan, as you mentioned, for this dates back to 2015, where this objective was laid out at a Shanghai Gold Exchange International Conference. And the presenter noted that the gold market and Shanghai Gold Exchange International are vital to the internationalization of the yuan: The key function of an international currency is trade invoicing for commodities like oil and gas. We would like to increase usage of yuan in trade invoicing by gold.
This is not a new conversation, but it’s something that is, I think, gaining some traction. And when we describe crisis compressing time, what might have taken five or 10 years maybe now only takes place in a matter of a few years instead.
Kevin: Isn’t it interesting because when we were on a gold standard, the US Treasury would convert dollars to gold. That was the known way of going about things. At this point, you’ve got almost the same type of system, don’t you? You’ve got the Chinese yuan being traded—or even rupees or rubles—in gold in Shanghai at the Shanghai exchange. It’s almost like a pseudo treasury, isn’t it? And a pseudo gold standard.
David: Yeah. I mean, we’re handing this monetary transition to the Chinese on a silver platter, and Trump may have had a plan in Iran when he started, but I doubt he was considering the unintended consequences of increasing the Chinese currency profile in the process. And crisis indeed compresses time. In this case, we’re taking years or decades off the gradual increase in trade invoice market share. So, everyone needs oil and gas. At present, it’s 11% which is off the market and available only if you pay on the new terms, which again includes buying it in yuan.
Kevin: Buying it in yuan.
David: So, duration to the conflict, we’ve said that that’s critical, not only for the conflict, but for control of Hormuz and for this sort of acceleration, the new terms of trade that are flowing from the Chinese.
Kevin: Okay. But, question for you, because we have talked about the Trump administration, that Scott Bessent talking about not wanting to have a strong reserve currency dollar, petrodollar, that that actually becomes a burden over time. Does Beijing actually want a strong yuan, a petroyuan? How do they stay competitive?
David: Yeah. I think when we reflect on Bessent’s commentary, when we go back to before the election, when there’s some white papers written on the need to re-industrialize and focus on US industrial policy as a critical part of our security apparatus, I think what they had in mind was a devaluation of the dollar on a very gradual basis. And so, there’s some advantages to being the world’s reserve currency. The way that we’ve set up our system, we have strong support for the currency through this recycling of oil revenues. I don’t know that we at this point want a very strong dollar. We just want to control the decline.
And for the Chinese to aspire to a greater role in the world monetary system, that doesn’t necessarily mean that they want a strong yuan. In fact, that is at odds with what makes them successful.
Kevin: Because they want to compete.
David: As a mercantilist empire, I mean, they are the giant in terms of exports. We are the giant in terms of imports. But to increase the value of their currency unnecessarily or too far, they lose trade competitiveness.
Kevin: They make, we consume, and we still have to be able to afford what we consume.
David: Yeah. What Morgan was talking about in Hard Asset Insights is really this question of, is a yuan-for-oil exchange, is that what it is? Or, as was suggested 11 years ago in Shanghai, are we setting up for a gold-for-oil exchange?
Kevin: It’s a new gold standard.
David: And as you suggest, Beijing has no desire for an increase in the yuan exchange rate as a net effect of increased demand for its currency, effectively pricing them out of the export-dominant position they have. So, where do currency units from trade ultimately flow? For us in the US, the recycling of dollars into US Treasuries was vital for financing our deficits, but what about surplus countries? It doesn’t work exactly the same way. And there is a plausible scenario where Shanghai continues to grow its market share, marginalize at the edges the role of London and New York in the gold market, as net settlement for an increasing share of trade happens in gold.
In what form do central banks hold their reserves? It’s a mix of currencies. It’s a mix of fixed income instruments, and of course it includes gold as well. So, to some degree, that will remain the case as long as the US remains the world’s reserve currency, but a marginal shift away from dollars and a marginal shift away from being the global import giant in that desire to re-industrialize, gin up new manufacturing in the United States, and to some degree go toe to toe with the manufacturing world, that changes the calculus.
Kevin: And so, gold recycling in place of dollar recycling is the theme that you’re talking about, but you’re also talking about the compression of time. This conflict may be at a hinge point.
David: Yeah. And I think Trump creating a conflict or taking an existing conflict and bringing it to a boil, it may be recorded by historians as the tipping point away from dollar dominance and towards a world that is more evenly balanced in terms of reserve allocations.
Central banks lead, and I think investors in this case will follow. Investors faced with the option of choosing some random sovereign currency to hold their reserves in or opting for the most reliable currency throughout all history, namely gold, I think they’re likely to see gold less as a speculative commodity—which is how it’s often branded by Wall Street—and more in keeping with its historical identity. It is a reliable store of value. It is a means of exchange.
Kevin: You brought up Wall Street. Okay, used to be we didn’t really depend on foreigners for Wall Street investment. You said that Wall Street pooh-poohs gold, but Wall Street really needs the dollar to be a prestigious and stable currency, don’t they? Because there’s a lot of foreign investment right now in the financial markets.
David: Yeah. I think our industrial policy is at odds with what Wall Street would desire. And I say that because the erosion of dollar prestige, while it’s significant to US consumers in terms of paying more for things, if the dollar is losing value, the cost of goods and service is going higher for the consumer. And so that’s an inconvenient reality for—
Kevin: But if you’re a foreign investor investing in a US stock market.
David: It’s even more critical for the rest of the world. And an asset allocator is looking for a combination of growth and stability and liquidity. And we’ve provided all three. If you look at the best ways to invest in tech today, outside of Taiwan semiconductors, I think probably the biggest names, certainly represented by global market share, it would be US tech.
Kevin: The FAANG stocks. Yeah.
David: So if you’re looking for growth, the US markets are a great place to be. If you’re looking for stability, again, from the standpoint of policy, politics, property rights, all of these things suggest stability. And of course, liquidity is a part of that too. And I would also add that stability, we’ve gotten used to there being some sort of a put in the market where markets won’t decline too much without there being some form of an intervention. So catastrophic losses are not something that most investors really consider and foreign investors really have to worry about. So we have growth, stability, and liquidity. Our markets cannot afford to discourage foreign capital from US investment. And from the Z.1 reports, which are just out, the rest-of-world holdings of US financial assets, they inflated last year by $8.3 trillion. That’s a fresh record. In total, it’s now 65, call it 65 and a half trillion dollars in total.
Kevin: When we started this Commentary in 2008, we were in the midst of a global financial crisis. How much did we have in foreign investment at that time in our markets compared to today?
David: Well, this is a mix of both fixed income and equity. So foreign ownership of equities now tallies to 22 trillion. And so the remainder is in fixed income. The total, 65 and a half, in foreign holdings of US assets.
Kevin: 65 and a half trillion.
David: Yeah. That compares with 15 trillion in 2008.
Kevin: 15 trillion in 2008.
David: Yeah. So we’ve had a—
Kevin: 65 trillion now?
David: Correct, a 322% increase—
Kevin: Wow.
David: —in foreign investment in US markets. It is common to see our debt dependency and fiscal reliance on foreign capital. We know that. The Chinese have financed our debt. The petro states have financed our debt. Back in the day, the Chinese used to finance our debt, but it is in our equity markets, which we are now equally dependent on fresh foreign capital to maintain current market values. So if you have pressure on your currency, that raises the performance bar in the equity markets and in the bond markets. What I’m saying is that without currency stability, you’ve got a new risk profile that gets attached to US assets.
Kevin: Well, and you’ve recently said that Asia is probably on the cusp of a recession. That’s going to probably be another reason to pull money out. The raising of liquidity, going back to the beginning of the show today.
David: Yeah. We are close to recession in Asia. It’s on a delayed basis, on a lag basis, coming soon to Europe. And it’s still, I think, far off on the horizon here in the US. What could ratchet forward the US time frame to recession is a bear market in equities and bonds. And I say that because we’ve talked about the K-shaped economy, which essentially divides US households into the asset heavy, which are on the top part of the K, and the asset light category, those who really don’t have assets, lower tier in the socioeconomic strata. And it’s that top tier, the top part of the K, which has benefited greatly from the wealth effect, where basically the wealthy are propping up consumption to a large degree.
Kevin: The wealthy get wealthier. Yeah.
David: So when you look at household assets, which are inflating, last year by 15 trillion dollars just in the US, this is US households, that’s now to a record 205 trillion. Subtract out the increase in liabilities, household net worth, which is your net from assets and liabilities, household net worth increased 14.48 trillion last year to a record 184 trillion. Net worth versus GDP is now 585%. We look at that as a measure of assets versus the economic engine. Those assets are an expression of the strength of that economic engine.
Kevin: How does that compare to previous peaks? Because that’s usually a signal of a peak in a market.
David: Yeah. So 2025, we now have net worth, again, 184 trillion compared to our GDP. That’s 589%. That’s 2025. In 2007, it was 483, and in 1999, it was 449.
Kevin: Wow.
David: So again, it’s one thing to look at the Dow at 50,000 or the S&P at whatever number, the NASDAQ 100 at whatever number. It’s really important to anchor it to what is driving that growth, the economic engine, which is what we’re referring to as GDP. And so we are far in excess of what we’ve been in previous bubble eras.
And so on that K shape, the lower classes are already pinched by inflation, the inflation of recent years, and they’re in dire straits. If we get a further bump in the cost of living, the wealthy are in great shape. With net worth—you’re talking about real estate, fixed income, equity, whether it’s public or privately owned businesses—it’s at all-time highs.
They’re fine, but that’s where, again, if you see a correction in stocks and bonds, what’s holding consumption together is those upper tiers where they comprise a huge percentage of the 68%. 68% of our economy is driven by consumption, and the vast majority of that is that top tier.
Kevin: Yeah, and what you’re talking about is we’re at a higher peak than we’ve been at both in 1999 and in 2007 before the last two peaks. I’d like to talk later about the Buffett Ratio, Shiller PE. All these things are peaking out at this point. So is the market worth it right now? Is it worth the risk? If you’re out there and you’re buying stocks, is this the right time to be buying?
David: Well, one of the reasons why late last year we had some conversations around the idea of the crack-up boom, is that you can get into an inflationary cycle where you really don’t have pockets of deflation. You don’t have deflation of any sort. You don’t have mean reversion. It’s just up, up and away, and it really is dependent on how much devaluation of currency you have, where people look and say, “I’d rather be in stocks than in cash, because at least I’m owning a productive company.”
Kevin: Something real, yeah.
David: And they can reprice their products, and their revenues are going to increase in line with the increase in the price of the products. Like, “I’ve got some inflation insulation or protection from inflation if I’m owning stocks.” There are potential scenarios where the stock market doesn’t have to correct. And I read a great Substack article from a group called Behind the Balance Sheet, and I’m falling in love with Substack these days. There’s some great writers, and they’re finding a voice there, which is fabulous. And it makes the case that a combination of valuations, concentration of investment—so you’re talking about crowding into particular names—and CapEx spending, those three things, they don’t just add up to elevated risks in the US financial markets. They are, in combination, a compounding of risk. They look at a series of cycles where CapEx spending has reached peaks. They looked at the 1880s railroad boom. They looked at the telecom era. They looked at the oil boom.
Kevin: So what you’re talking about are concentrated trades, basically, where it’s all concentrated in one place, whether it’s a railroad or some other—radio, TV boom, what have you.
David: Yeah. When you’re looking at these three things, valuations, concentration of investment, and CapEx spending, there’s only one period which registered a combined score of greater overvaluation than present, in all of US history. And what was skewed there was the CapEx boom in the 1880s when they were building out rails, and the rail boom was just flat insane. CapEx to GDP ratio was 6% and that was what it was then. Now, if you’re looking at AI, you’re talking about one to one and a half percent at max.
Kevin: Okay.
David: We’ve seen CapEx booms that make this look really conservative.
Kevin: So AI may not be overvalued compared to the rails.
David: Compared to the rails.
Kevin: Yeah, but what happened to the rails?
David: Yeah.
Kevin: Right.
David: Well, the bust in rails was not merely the market falling of its own weight. Looking back to the recession of 1873, there was also a massive locust swarm. I’ve seen it written up very frequently that the railroad boom, it was really a credit-driven thing, and certainly there was a lot of debt issued by the railroad companies, but there was this exogenous event that happened, right?
Kevin: When things are overvalued, there’s always a trigger, and this time it was locusts. That almost sounds like the Book of Exodus.
David: Yeah.
Kevin: Yeah.
David: An infestation estimated to cover 198,000 square miles. I mean, if you think of a swarm in size greater than the state of California-
Kevin: Wow. What’d it do to the crops?
David: You devastate the mid-east, right? And this was following several very hot, dry years. That ended up changing the narrative of westward expansion. It ended up changing the crop and livestock productivity in the West, and it was enough to force dozens of banks to the wall. I think 69, 70 banks went to the wall in that crisis, and it was a complete collapse in the railroad shares.
So liquidity was a dynamic, crop failure was a dynamic, overcapacity was a dynamic where, basically, return on investment was negative for decades thereafter, and because there was so much overcapacity, investors started realizing, “Wait a minute, we’ve invested a lot. We’re not going to get a lot back out, are we? Or not on the time frame that’s relevant to us.” That does have an echo of AI, where you’re pumping in 600 billion this year, 800 billion the following year.
Kevin: Very concentrated trade again.
David: Yep.
Kevin: Yeah.
David: And that over capacity. But I guess what I’m getting at is there were a cluster of factors that led to the recession, and looking back at the rails, this is a radically different time. In terms of stock market capitalization, the railroads peaked at 85%. If you’re looking at the stock market—
Kevin: 85% was rail.
David: 85% of stock market capitalization was railroads.
Kevin: Wow.
David: That dropped to 45% by 1900. It was 1850, by 1900, it’s 45%. By 1950, it’s 10%. Today, we’re at six-tenths of a percent, and they were revolutionary. It was a technology which was going to transform the country, and in fact, it did. It just wasn’t accretive to the early stage. I guess the early, early stage investors benefit, but then the early-ish stage investors ended up being bag holders.
Kevin: Sure. It’s like a multi-level, right? It’s like multi-level. You want to be in early and you’re going to do just fine.
David: If you start the multi-level.
Kevin: Okay, so it was locusts back in the 1800s, but there’s always a trigger, so let’s go back to the Buffet ratio, let’s go back to the Schiller PE. All these peaks right now, Dave, as long as we don’t see any locusts, I guess we’re fine.
David: Well, and again, what we’re getting at here is we are fairly insulated from a recession driven by an energy shock, mainly because we’re energy-independent. The difference between now and the 1970s is we’re a net exporter of oil. We were entirely dependent on the Middle East, so with the embargo in ’73, we just got a hammered. I mean, it was a deep crisis. But that’s in essence what they’re experiencing in South Korea and Indonesia and Bangladesh and India, in Taiwan, and Japan.
Kevin: Japan.
David: But that’s their reality today, is an energy shock on par with what we had in the ’70s.
Kevin: You were talking about natural gas being three bucks here and 25 to 30 bucks in Europe, right?
David: Right. Well, in Asia. In Asia. It’s 18 to 20 in Europe.
Kevin: Okay. Huge.
David: Yeah.
Kevin: Big differential.
David: We use the Buffet ratio, recently over 225. The Schiller PE, recently north of 40. Again, you’re paying for 40 years worth of earnings, not exactly cheap.
Kevin: Well, that’s beyond peaks.
David: And then I also like looking at that statistic we looked at earlier, net worth to GDP. Are these indications of sustainability or unsustainability? Are we growing closer to what would be a normal mean reversion? You get to peak levels and they simply can’t be supported by the underlying economy. What follows is typically a bear market. Recession.
Kevin: What are the triggers for that, though, usually? What are the most common triggers when we look back? They’re not always locusts.
David: Yeah. There’s usually a confluence of factors. The two most common triggers for any recession, if you’re looking at a 200-year period, and if you want to look at not only the US but the UK as well, war and energy shocks. If you’re looking at the two most common factors, these things happen, recession happens.
Kevin: We got our Durango Herald, and I’m thinking there’s war and there’s energy shocks in the Durango Herald today. We’re not talking about past.
David: Yeah, so we have both, and unless we can end the war immediately, return oil prices to sub-70 levels, even in the US, we’re tempting fates with financial market chaos, economic recession. From an asset standpoint, if there’s a reason for stocks to move lower, bond yields to move higher, value of bonds to move lower, you’re talking about taking out the top of the K-shape in that K-shaped economy, and the rich join the poor in having to make tougher daily decisions.
Kevin: Let’s go back to the Treasury markets before we finish up here because, in a way, that is the fuel that keeps the craft afloat. I had a good friend who— He was flying a Cessna 152 and he landed in a field just outside of Durango, and he swore he didn’t run out of gas, but he ran out of gas. To this day, he still says, “No, I didn’t run out of gas,” but they checked. The US Treasuries are a little bit like fuel in the tank. Remember when you used to put that dipstick in when you would check the Cessna to see how much fuel you had? I’m wondering if the stick is coming out dry. If we’re having to buy— What’d you say the last auction was? 16%? We sold 16% of our Treasuries.
David: Yeah, that was for the five-year. Yeah. 12% for the—
Kevin: And we bought back. The government bought back 84%.
David: It was a very successful auction.
Kevin: That doesn’t sound like it.
David: I mean, 100% got bought.
Kevin: It’s like a garage sale where you put everything back in the garage, right?
David: You look at the Treasury market, and it was once considered the benchmark for the risk-free rate. No radical moves in rates. You’ve got a stable currency. Again, going back to these things that are enticing for foreign investment capital. The Treasury was the gold standard for global capital.
Kevin: That was the great experiment. Looks like it’s failing.
David: I mean, how do we want to say this? Bloom is off the rose, or all that glitters is not gold? There is a gradual, there is an informal, re-monetization of gold occurring. At the same time, the old system, the post-Bretton Woods system, is being dismantled. The dismantling is picking up pace, and so when we look at what’s happening in the Middle East, that’s really what we’re focused on, is you let this go on and people change behavior patterns, people create trade agreements, and there’s just a new way of doing business. We, in fact, are accelerating this new way of doing business, which includes trade settlement in something other than dollars.
Kevin: Right.
David: Again, this dismantling is picking up pace, and considering your options, kind of backing your own personal finances, central banks are doing this with gold reserves. They’ve been doing this aggressively since 2022 at 1,000 ton-per-year pace. Prior to that, 500 tons, and I think you’d have to go pre-2012 for it to be in the three, four hundred ton-per-year pace, but they’ve been gradually increasing their allocations. Would it make sense, in terms of personal finance, for gold reserves to play a larger role? From my perspective, we can only hope for further weakness in the metals prices to accommodate more ounces for the same greenbacks.
Kevin: Right.
David: That’s the exchange that I’m interested in. I wouldn’t bet on the greenback, I wouldn’t bet on Treasury viability or strength over the next one, three, five years. Quite the opposite. The world will be betting against them, and the flows involved, I think, will ultimately overwhelm the Fed and the Treasury’s ability as the buyer of last resort.
Kevin: Well, and you said that it’s accelerating, and it reminds me of the quote, “Years of boredom punctuated by moments of sheer terror.” Is that maybe what we’re having right now, is this acceleration?
David: Exactly. As crisis compresses time, I think the timeline to a new monetary order is picking up speed.
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You’ve been listening to The McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. You can find us at mcalvany.com and you can call us at 800-525-9556.
This has been The McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of The McAlvany Weekly Commentary.
