Podcast: Play in new window
This week we look at Scott Bessent’s efforts to keep foreign buyers like Japan invested in U.S. Treasuries, the growing likelihood of financial repression, and why investors like Stanley Druckenmiller are pushing back on the direction of fiscal and monetary policy. If the plan is to manage the debt through inflation, suppressed rates, and a weaker dollar, what can investors actually do to protect themselves? We discuss why gold continues to play such an important role when confidence in government debt and currencies begins to erode.
“I do appreciate the perspective that Scott Bessent brings to this. He has to say something that’s positive and pretend like he’s holding a winning hand. Bessent is conveying something about this circumstance, very manageable, we’ll grow our way out. But I think what you see in the surge in commodities, the surge in gold, the surge in silver, the surge in bitcoin, it all suggests that investors are ignoring Bessent’s claims. And it’s what he actually said, ‘People have bad information. I have asymmetric information. Do we know something the market doesn’t know, what I would call a Treasury twist here in terms of the bond market? What do I know that the market doesn’t know?'” —David McAlvany
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Kevin: Welcome to The McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
David, I’ve got a question for you. Scott Bessent has basically said that he’s got secret information, things we don’t really know, and we’d be calm if we knew it. But he’s also coming out with Operation— What is it?
David: Economic Outcast.
Kevin: Economic Outcast. It sounds like he’s threatening the world with “you’d better march in step or you’re not going to get the benefit of the dollar.”
David: Oh, we just came out of a meeting, and one of our colleagues was talking about the arc of the hegemon, where there is a phase in this arc where coercion is not necessary, but as you actually don’t have the control or power, then you need to use coercion.
It’s interesting. I read the Financial Times first thing this morning and the article right on the front page was about China basically saying, “And what do you mean we can’t do business with who we want to do business with? We’ll see about that.”
So, Operation Economic Outcast might be Operation Bessent TACO 2.0 or whatever. I don’t know that he can implement all that he wants to implement.
Kevin: So, does he—
David: It’ll be fun to see him try.
Kevin: Does he control anything, and is control itself an illusion?
David: I think anybody who’s reflected on their own lives, whether it’s doing your own personal work or you’re a student of history and you look at perceptions and perception management, control is an illusion. When a family member or someone close to you has endured a health crisis, you experience that. You don’t really have control, and you know it deep down inside. You can find yourself barely hanging onto sanity, projecting confidence, hoping and praying for a particular outcome, but control is not something that you have. It is an illusion.
Kevin: But if you can maintain that illusion— Let’s think about the last few decades with the Federal Reserve. The illusion was, it was perception control, and sometimes it did have an impact. At this point, the markets perceive that there’s something terribly wrong, and Scott Bessent is actually having to say, “No, no, no. I have…” What does he call it? Asymmetrical information. Is that—
David: Yeah, it’s very interesting. I think also when the Fed is put in context here, they’re no longer using forward guidance. Well, forward guidance was something that harnessed the energy of self-interest amongst speculators and investors, and so you could create a scenario of predictability and control by teasing out, like basically hanging a carrot out there. We’re going to do this. It has implications for asset prices.
Kevin: Now you go do that.
David: Now you go do that. And it becomes self-reinforcing. We are now in an era where we’re not going to, or at least that’s been the last two meetings from Kevin Warsh. We’re not going to be giving you the updates, the anticipation. Bessent is a very interesting case. Over the last three weeks, he said that he has a more expansive insight into the current market and financial context. He knows more. The markets are misguided, and their concerns over some sort of a fiscal quagmire— Not a quagmire, he would say. We will grow our way out of $40 trillion in debt.
Kevin: How do you do that, Dave? 40 trillion in debt, what would that take in GDP growth? I mean, just to get that done.
David: The CBO ran those numbers. Congressional Budget Office ran those numbers years ago when our debt levels were closer to $10 trillion. Theoretically, growth is a way of overcoming a debt burden. It can work for corporations. Theoretically, it can work for countries as well. The conclusion then, and theoretically, it should hold today, except that debt has quadrupled over the last 15 to 20 years.
Kevin: It’s not $10 trillion anymore. It’s 40.
David: Yeah. The hard math was not theoretical when the Congressional Budget Office did this. The conclusion, 50 years of sequential, uninterrupted, double-digit GDP growth. That was the economic growth required to overcome, call it $11 trillion in debt.
Kevin: You’d have to have double-digit growth for 50 years—
David: In a row.
Kevin: —50 straight years—
David: In a row.
Kevin: —for $10 trillion.
David: Yeah.
Kevin: Now we have $40 trillion. What does that take?
David: It’s a tall order. Of course, the economy has grown too, but the last year we had double-digit real GDP growth, my father was three years old.
Kevin: Your father is 86.
David: Yeah, so 1943. Only five years out of the last 100—
Kevin: Wow.
David: —have we had real growth rates north of 10%. Five in 100. Those were 1934, 1936, ’41, ’42, ’43. Three were associated with war mobilization in a command and control economy. Two were recovery years coming out of a depression. And of course, those growth rates were also, you could say— Arguably they were so high because you were coming off of such a low base, and of course stimulated by massive government spending, which, if you recall, immediately followed a currency devaluation.
Kevin: Right.
David: ’34 and ’36, those were the years. These are real GDP growth numbers, which of course nets out inflation.
Kevin: What are the chances? Let’s just do it one in 100. How many years in 100 years would we get that kind of double-digit growth?
David: Real growth, again, net of inflation, 5%.
Kevin: That’s incredible. I’m going to just say this back to you because it just shows how ridiculous a predicament, a quagmire Bessent is in, and Kevin Warsh. When we had $10 trillion in debt, it would take 50 years of double-digit GDP growth to get out. And you’re saying that only 5% of the time we’ve had double-digit growth over the last 100.
David: Your odds improve dramatically if you include inflation, so now we shift to nominal growth rates instead of real growth rates. Nominal growth rates, you pick up 14 more years of double-digit growth, so a total of 19 out of 100 years. There were four regimes under which nominal growth was high enough to support Bessent’s grow-your-way-out-of-it, assuming you could bear with those contexts.
So you had the depression recovery, which we mentioned, wartime mobilization, we mentioned, the great inflation, which ran from 1973 to 1981, and then most recently the pandemic recovery.
Kevin: But the debt-to-GDP was nothing like what we have right now.
David: That’s the biggest limiting factor today is our starting point of a high debt-to-GDP ratio, call it 120%. You can look at it differently. Debt held by the public is just north of 100%. Gross debt is the one that takes you north of 120. 40 trillion is the gross number. That’s a lot of debt. The mechanics of managing debt, of making interest payments, of stimulating GDP growth simultaneously, it assumes an acceptance of higher inflation, and at the same time requires the suppression or the control of interest rates.
Academics call the artificial suppression of rates financial repression. You remember our conversation, gosh, that might have been 2014, 2015 with Carmen Reinhardt.
Kevin: Right.
David: She described the corralling of winners and losers, the differentiating, and policymakers deciding who wins and who loses.
Kevin: Inflation beating interest rates just enough, right?
David: Yeah. Well-
Kevin: That’s the devaluation of your currency over time.
David: —you keep inflation high and you keep rates low, and that allows you to navigate and direct the flow of capital to where you want it to go.
Kevin: And move the pain to the backs of the people.
David: Yeah. This is our state of play. For the Treasury to control interest costs on 40 trillion in debt, the artificial suppression of rates, that is a mathematical necessity. The central issue here is whether or not the Treasury has the power, or firepower, to do so. That control, in my opinion, is an illusion.
On paper you can force the math to work. Drive—or if you want to stimulate nominal GDP growth, of course you do that by allowing inflation to run hot. Cap interest rates if you can do that.
Kevin: There’s a new term that’s been floating around: fiscal dominance. Morgan Lewis has been bringing that up. It’s the idea of: the government now knows that they have to pay for their fiscal commitments over fighting inflation. Is that what we’re seeing right now?
David: Yeah. It prioritizes government financing needs over inflation, and prioritizes government financing needs over household well-being. So there is a who wins, who loses? Sorry if you’re living on a fixed income. Sorry if you’re a middle-class household, you’re the loser. And if you are government, if you’re part of the Treasury, you are the winner. The winners in the scenario would be the US Treasury government; losers, household savers, those living on a fixed income as inflation costs eat away at income stability and any rogue purchasing power. This is the state of fiscal dominance.
Kevin: When we came out of our meeting today, there was a young man who’s been working at the office now for a year, and he said he could not believe how quickly it went, and you said, “Wait till it’s a decade.”
David: And you said, “Wait till it’s four.”
Kevin: And I said, “Wait till it’s four.” But Dave, let’s look at what’s happened in that period of time. I was getting into the refrigerator yesterday, and I pulled up a fresh-baked sourdough loaf that we bought across the street from the office down, and I saw the price tag and it was 11 bucks. This is a loaf of bread. That same loaf of bread when I started back in the ’80s was 85 cents. So from 85 cents to 11 bucks, that’s what we’re talking about. This is this repression that you’re talking about.
I’m shouldering that. So, no matter how much—as a consumer or an investor, even—I’m saving, I’m still going backwards unless I’m beating this inflation rate, right?
David: Yeah. As we look at November, one of the factors that’s on people’s minds is that inflation is good for asset prices, but it’s not good for income. From your 85 cents a loaf to 11 bucks today, there’s a lot of folks who are having a harder time paying that.
By the way, we’ve got wheat up, what?, 25%. You have major hits to both the Ukrainian exports and the Russian exports, which puts a number of North African countries in the same scenario that we had coming into the Arab Spring—major political and social disruption as a result of people not being able to feed themselves. And that was 2008, right? I’m thinking Arab Spring.
Kevin: Yeah.
David: And it’s Tunisia and it’s Egypt. Those are probably the top two in terms of under threat because of wheat that is not coming out of those two countries.
Kevin: So, this boils down to people not being able to buy the loaf of bread at all. I mean, at this point when we talk inflation, they can start—
David: They can’t buy it because supplies are diminishing. For the rest of us, it’s just at a higher price because if you lose 17% to 23% of global wheat supplies, the price goes up pretty aggressively and you’re just going to pay what you’re going to pay for a loaf of bread. So, buckle up. We’ve got another version of choke points, and it’s not Hormuz, it’s the Black Sea.
Kevin: So, let’s bring up Summers-Barsky because you’ve talked about this before and actually you and Morgan had an interesting conversation about Summers-Barsky, which basically says there is a point when people move back to paper assets, given the interest rate, versus gold. And before we go there, I’ll just mention that 85-cent loaf of bread with $300 gold, I could buy a year’s worth of—an 85-cent loaf of bread a day.
David: And at 4,600, you can probably buy a comparable number of ounces.
Kevin: And at 4,600, I can buy the same amount of loaf of bread at, yeah, $11 a loaf. So, the gold did at least protect the buying power. But does Summers-Barsky make any sense when you have this kind of fiscal situation that we’re in?
David: Well, I think Summers-Barsky does make sense. Again, you mentioned, a couple months ago I was asserting—this was an in-house meeting—classic analysis laid out in the 1980s Summers-Barsky thesis. It made clear that when rates reach a certain high threshold, the opportunity cost of holding gold becomes too great.
Kevin: And so, people move from gold back into bonds or what have you.
David: Yeah. Gold is discarded for a better alternative. Its opportunity cost becomes too great to hold. And that’s when Morgan Lewis insisted that it’s true if, and only if, the system is deemed healthy. We’re in a different environment. Fighting inflation with higher interest rates has to be a viable option for the math of Summers-Barsky to work. The math of Summers-Barsky is held in check when raising rates adequately to fight inflation is not an option.
And you have to remember, interest expense rises when the yield curve moves higher, and debts being rolled over carry that increased payment burden. So, when you’re under those circumstances, higher inflation leading to higher interest rates doesn’t occur in a way that you get a positive real carry. And so, a secular trend taking gold to ever higher prices remains in play.
Kevin: Okay. So, going back when I first started, Volcker was still the Fed chairman and Reagan was the president. And I could see where Larry Summers and Barsky would come up with this concept because when Volcker came in, gold was hitting a high. We had high inflation, gold was hitting a high. Volcker came in and raised rates so much that people moved from gold back into— I mean, at one point CDs were paying like 18%.
David: Yeah, long bonds at 20% beats inflation at 15. You’ve got five points of benefit, and you got to look at your ounces and say, “I’m going to earn an extra 5%. Why not?”
Kevin: Right. But we only had a trillion in debt from George Washington to Jimmy Carter. It took us that long to get to a trillion. We didn’t have 10 trillion, and we definitely didn’t have 40, right?
David: Yeah. And now you’ve got two government or quasi-government organizations that are kind of in conflict with each other. To the degree that Warsh is forced to defend Fed credibility by raising the fed funds rate, Bessent will be forced to do what he put on display twice over the last three weeks: buy down the rates and particularly across the long end of the curve.
First, it was the yen intervention and that was in cooperation with the Bank of Japan. Support the yen so that the largest owner of Treasuries isn’t forced to liquidate those Treasuries to raise capital to hold up the yen from further declines. Second was last week’s version of Operation Twist. Issue T-bills, use the proceeds to buy 10-, 20-, 30-year bonds, capping interest rates further out on the curve. And some suggestion this week that he could just tap the government program TGA. He could use the Treasury general account and up to a trillion dollars to influence the Treasury market.
Kevin: So, basically his war chest, they were basically giving him his Warsh chest. But that’s Bessent. But a trillion going— basically buying from Japan or actually buying from them an agreement not to sell Treasuries is what we’re doing, right?
David: Right. We’re going to prop up yen so that you’re not motivated to sell Treasuries. In fact, the Japanese were selling Treasuries in June to support the yen. And I think that was a part of the necessary steps. If you’re trying to rationalize Bessent’s first move in cooperation with the Bank of Japan, he could rationalize that, saying, “We don’t want to get to a tipping point here where a trickle becomes a flood.” The numbers for June are published, 26.4 billion in Treasury liquidations, and that’s just from the Bank of Japan. The total liquidations from foreign holders, including the Japanese, tallied to 72.1 billion.
Kevin: So, it’s net selling, not net buying. Yeah?
David: That’s net liquidation. So, the July numbers have not been published yet. We do know, however, that in July, the Bank of Japan currency interventions came in two tranches, 59 billion to support the yen and then 87 billion thereafter. So, I think it’s safe to assume that there were further BOJ Treasury liquidations in July along with other foreign holders, and Bessent’s move was to stem those further liquidations. Selling bonds drives down the price and drives up the yield, and that’s a circumstance that the US Treasury can neither afford nor, it seems, will they allow. But this is something Bessent can’t actually control, I don’t think.
Kevin: So, contrary to what people were hoping when Warsh came in was that the debasement trade is over and we’re going to see actual strength in the dollar. What we’re seeing is they’re back.
David: He’s going to tame inflation. So, why do we need to be concerned about debasement? The gold market has offered its humble opinion. The debasement trade is back. Fiscal dominance is our reality at present, and financial repression is in its early stages. So, the implications are that gold has a lot further to run, a lot further. Robin Brooks from the Brookings Institute and former chief FX strategist, foreign exchange strategist at Goldman, said in a Bloomberg interview last week, “markets are primed for dollar debasement to resume.” I’m going to say that again. “Markets are primed for dollar debasement to resume. And as Japan shows, it can be next to impossible to stabilize a currency once it enters a devaluation spiral.” And then his concluding remark, “the US is playing with fire with this buyback.”
Kevin: These actions, these interventions like the one we saw last week, they’re sending a message, at least. Well, I don’t know necessarily that people are shifting their assets, but they’re shifting their opinions slowly.
David: Yeah. So, again, his reference to last week’s Treasury market intervention, the implications are clear to buy down interest rates is a costly commitment. You spend money you don’t have or money that you freshly create. And the currency in this case, the dollar is going to reflect it.
You had Bessent come out on Wednesday and say, “Here’s what we’re going to do with Treasuries. The dollar had its worst day in months.” And again, it’s an indication that if you’re doing that, you understand there’s a cost to do that. And again, if the dollar is going into debasement, you could say by extension that households and businesses are going to pay the price for that in the form of inflation.
Kevin: And puts it on their backs.
David: Currencies decline, the cost of goods and services reflect it with higher prices. It’s your loaf of bread, 11 bucks, not 85 cents. That is a reflection of currency debasement through time. It’s not that you’re getting better quality wheat. I mean, maybe it was a fancy loaf. I suspect it was, but it’s not an accident. It’s a policy choice. It’s a policy choice. Drive economic growth any way you can. That’s the conclusion, or the assumption, that Bessent’s making. Allow inflation to run hot regardless of how you talk about it, control your interest expense, cap those yields, which allows you to keep the government funded. And it’s not unlike the 1970s.
Kevin: Yeah. Well, and I was just thinking that, Dave, and actually let’s go back to the ’60s for a bit because in the 1960s there were threats to the— Sort of veiled threats, like to France, that even though they could settle their debts in gold and we had a gold backing at the time, we sent a letter. When was that, that the letter was sent to France where it said, “People who are our friends like to settle things in greenbacks, not in gold.” That was the message, but it was sometime in the ’60s.
David: Jacques Rueff included that. He cited it in The Monetary Sin of the West, which I think was published in ’68. So, the letter would’ve had to be two or three years before that. I’m guessing ’65. But even then, the US government is communicating: friends of the West will settle debts in dollars, not ounces.
Kevin: And that sent a message, though.
David: It absolutely did.
Kevin: Yeah.
David: So, you go back to the ’70s, the closing of the gold window in ’71, which was the end of dollar-gold exchange by central banks. It was a Nixon decision that came on the heels of telling our foreign creditors they didn’t need gold. US paper was just as good.
Kevin: And it would stay as good even if we weren’t on the gold standard. Bread’s not going to go up in price. That dollar’s going to buy the same amount of bread. You just wait.
David: The harder we tried to manage the outcomes, the more you found rational actors concluding that US dollars were not as safe as we were suggesting. It doesn’t take much to read between the lines. They concluded the opposite. Our efforts to control our gold reserves was an expression of desperation and internal concern. I think that echoes into last week’s actions pretty clearly. Foreign creditors acted accordingly back in the ’70s. They drained Fort Knox and precipitated the end of Bretton Woods. So, the years from ’73 to ’81 achieved nominal growth in the high digits, hoorah. I mean, what’s not to love about an increase in economic activity?
Kevin: You get that GDP is going up? Don’t worry about the inflation.
David: But if you’re a household, no one wants that again, right?
Kevin: Sure.
David: Unless you’re Treasury. I think a version of the 1970s fits the playbook Bessent is interested in using. Repression meets inflation dynamics. That achieves high nominal growth rates without the increased costs to the Treasury in terms of interest expense. Again, remember that higher nominal growth rates deliver higher nominal tax receipts as well.
So if you’re looking at the Treasury, saying, “We need more income,” and it’s politically awkward to raise taxes, well, that’s fine. Just know that as a percentage of everyone’s income, you’re talking about larger numbers in nominal terms. You have a fixed amount of debt, and yet you can expand via inflation the amount of revenue—
Kevin: And your tax receipts should look like they’re going up. Yeah.
David: Right. So maybe he can compel the math to work.
Kevin: Yeah.
David: You get a boost in revenue for the Treasury, even if your currency is decaying. So it solves the problem of debt repayment. It just creates other problems, social and political, which is really—
The biggest issue I have with inflation is not the debasement of currency, it’s the devaluation of human effort. It’s taking an individual who saves and bottles up their energy to be used at some future point, whether— You talked a few weeks ago about saving for your daughter’s wedding, or saving for retirement, or saving for college, and yet it becomes hard to keep up. From the 1970s to the present, you’ve got college expense, which is up 600%. You got 14, 15 colleges charging $100,000 a year. I mean, these are crazy numbers.
Kevin: In dollars it’s up 600%, but in gold, it still buys the same education, Dave.
David: Yeah, no. And our friend who runs the website pricedingold.com, you look at the chart of a Yale University education priced in gold, and it’s actually quite reasonable. It’s quite reasonable. If you are a gold saver. If you’re a US dollar saver—
Kevin: Well I mentioned the wedding. Yeah. A wedding was 10 ounces of gold when my daughter was born. Okay? And today, a nice wedding is 10 ounces of gold. Now she got married five years ago, and that gold was worth half [of what it is today], and it still was 10 ounces of gold. But it’s a nice amount of money to put aside for your daughter when she’s born. Isn’t it amazing how few people actually see the dynamic here of financial repression, what it does to a person if you don’t defend yourself with your own gold standard?
David: One of the worst financial mistakes I’ve ever made. It was taking my daughter to a hundred ounce wedding.
Kevin: Oh, no.
David: It framed for her what a wedding should be.
Kevin: And she’s quite a lady. I mean, she may demand that. Yeah. Yeah.
David: It was the stupidest thing I’ve ever done.
Kevin: Yeah. Oh my Gosh.
David: From a financial standpoint.
Kevin: She reminds me a little of Audrey Hepburn. So for the person who wants to imagine this wedding someday, I don’t know if she reminds you of Audrey Hepburn, but the way she carries herself, it’s like, oh, this girl’s going to demand the most. Yeah. In a good way. Very humble, sweet girl.
David: We can negotiate towards 20 maybe. 10, 20, whatever. So again, back to the debt markets. Of course, if you’re in a context of devaluation, of course your creditor is not going to be happy about taking a haircut on the money that they lent you. So saying implicitly that you’ll pay back 90 cents of a dollar owed, how does that land with a creditor? 80 cents of the dollar owed. In other contexts, that would be called a restructuring of the obligation.
Kevin: And these creditors are other countries, these creditors are hedge funds. It’s the person who’s buying the US bond.
David: Right.
Kevin: Yeah.
David: In the case of inflation, you’re not gaining the consent or approval of the creditors, the way you would in a formal debt restructuring. And so if you’re the Treasury, you’re assuming, you’re hoping the creditors stand pat and don’t liquidate those obligations in the open market.
Kevin: Okay.
David: Which again is why you see Bessent. He knows something that we don’t know.
Kevin: Really? Or he doesn’t.
David: Maybe he knows what we know and is aware that he’s got to manage the situation well. Again, project confidence or else.
Kevin: Yeah. It’s almost like when you put your finger in your shirt and try to pretend like it’s a gun. Now, is it a gun or is it my finger?
David: It depends on how you project.
Kevin: I guess Scott Bessent— We’ll have to see if it’s just a finger or if it’s a gun.
David: Yeah.
Kevin: Yeah.
David: Well, like I said earlier, control is an illusion. When you or someone close to you is enduring a health crisis, at times you’re barely hanging onto sanity. Perhaps you’re projecting confidence, perhaps you’re hoping and praying for a particular outcome. But control is an illusion.
In the case of interconnected financial markets with the freedom to not just ride out uncomfortable circumstances, which in the case of a health crisis you just have to. Market participants, when they express their agency, they can come and go as they please. So it’s different than a health crisis where the outcomes remain uncertain, you’re trapped in your body. Free markets imply agency, free markets imply choice. The choice to stay opted in or to opt out.
Kevin: Like the song, “Should I Stay Or Should I Go?” You get to choose. Okay, so the gold action that we’ve seen here just recently, it seems that an opt-out of the dollar and into gold is starting to come back.
David: When investors begin to acknowledge and realize that the debasement trade is back on, I think that’s what you do see in gold action over the last several weeks. It’s an expression of the debasement trade. Gold is telling you that the market anticipates a policy course that is abusive in nature, abusive of trust, and presumptive about participants’ willingness to stay opted in. So repeating the Brooks earlier comment, the FX strategist formerly with Goldman Sachs, the US is playing with fire with this buyback. We completely agree.
Kevin: Well, and interest rates. Okay, so what do we have the 30-year Treasury at right now? They’re rising at this point.
David: Yeah. Well, last Tuesday the peak was 5.34, 5.34%. The 10-year got as high as 4.75.
Kevin: So it’s hovering below five. Isn’t five a big deal for the 10 year?
David: Well, Bessent doubled the commitment to Treasury purchases, actually kind of a smallish number—from two to four billion—which makes again that reference to the TGA, the Treasury general account. And if we need to—
Kevin: That trillion.
David: —we can tap a trillion dollars. That’s his, like, “I’ve got plenty of chips to back this bluff.”
Kevin: Here’s my finger in my shirt.
David: But what it did Wednesday, it brought the yields down to 5.18 from 5.34, 10-year to 4.63. Without intervention, this is where you see that this is not just a US issue. The rest of the global debt abusers, yields remain elevated: France, the UK, Germany, Japan, they’re all sitting—
Kevin: Everybody’s in this boat.
David: Yeah, and they’re near 20-year highs in terms of their interest rates.
Kevin: Really?
David: The fiscal predicament we in the US find ourselves in is reflected globally by dozens of other treasuries. Their policy tools are similarly limited. Of course, Bessent is suggesting otherwise, as you’d expect him to, projecting confidence.
Kevin: Well, you’d hardly think he’s going to come out and panic.
David: Right.
Kevin: Can you imagine? I mean, any Treasury guy, if he came out and said, “Oh my gosh, we are screwed. We’re in trouble.” Right?
David: Yeah.
Kevin: So he’s acting the part. It’s like being cast for Hamlet. You’re going to actually speak Hamlet’s words, right?
David: And the role that you play is a very important role. And I wouldn’t expect him to say anything else, given the stakes. Given the stakes. I remember my brother was in Banda Aceh in 2004, one of the first people on the ground and—
Kevin: After the tsunami.
David: Yeah, after the tsunami. And he would routinely come across people who, their wounds need to be debrided. There was amputations that had to occur, their bodies would go septic. And the difference between survival and not survival was hope.
And so I do appreciate the perspective that Scott brings to this—Bessent, not Scott, my brother—but it’s similar. He has to say something that’s positive, and pretend like he’s holding a winning hand. But again, Bessent is conveying something about the circumstance. Very manageable, we’ll grow our way out. But I think what you see in the surge in commodities, the surge in gold, the surge in silver, the surge in bitcoin, it all suggests that investors are ignoring Bessent’s claims. I mean, and this is what he actually said, “People have bad information. I have asymmetric information.”
“So I think that the markets should think, ‘Well, why would we have joined the Japanese in the intervention at this time? Do we know something the market doesn’t know?’ That in terms of being willing to do what I would call a Treasury twist here in terms of the bond market, what do I know that the market doesn’t know?” That’s what he said last week.
Kevin: Yeah. You don’t know what I know.
David: Scott, perhaps the better question is, what has the market figured out that you already know but can’t speak to without having your bluff called?
Kevin: Okay. So Warsh and Scott Bessent worked for Druckenmiller, and Druckenmiller just came out with a piece basically criticizing, I mean, this whole idea that there’s secret information and the markets don’t really know what they’re doing.
David: Right. If you haven’t read the Wall Street Journal article with the op-ed from Druckenmiller, that’s a must read for this week, and it’s behind a paywall, so we can’t post it. You have to go get it yourself. But one of my favorite quotes, I’ll do my best to quote it accurately, “If 5.5% is the clearing price of the long-term bond, that’s not a crisis. It’s an invoice.”
You’ve got the market saying, “We will be compensated for the risk that we’re taking. If you’re increasing the risks by not addressing structural issues within the economy, if you’re going to leave your fiscal house in disorder, we will be compensated.” That’s not a crisis. This is an invoice. The bond market is sending you the bill.
Kevin: Here’s the bill.
David: Right. So if you don’t—
Kevin: Oh, we thought insurance covered this. No, no, no.
David: But if you don’t like the bill, then fix the problem.
Kevin: There you go.
David: The problem is there is a political price to pay in doing so.
Kevin: Yeah, but okay. So it’s not just the government that we have right now. I mean, Treasury holders also are now in the form of hedge funds, and there are some large Treasury holders that really you can’t fiscally control.
David: Yeah. Well, the Financial Times discussed the composition shift in the Treasury market last week. One of my favorite sections in the Financial Times is Alphaville. It’s some cheeky writers who, sometimes they don’t even edit their pieces. It’s kind of funny. But they said “the Treasury buyer base has changed over the last decade, with the influence of most price-agnostic central banks ebbing and the importance of price sensitive private investors increasing sharply.” Alphaville touched upon this in a big post last week which focused on the swelling hedge fund involvement in the US government bond market.
Kevin: Yeah. You talked about this months ago. Remember when you were talking about this gigantic bite that the hedge funds right now are taking into the Treasury markets, and how they’re playing really, really narrow movements. And if there was any kind of real volatility, it could shake this thing out.
David: Trillions of dollars sitting in Cayman Island bank accounts, which is your hedge fund crowd looking to optimize from a tax standpoint. Optimize.
Kevin: Until you can’t optimize.
David: Yeah. Well, so you can coordinate efforts with a central bank like Japan, and maybe that’ll work, but try corralling a bunch of hedge fund capital cowboys and getting them to sit idly by as you cap rates and inflate away the value of the IOUs they own.
Kevin: Right.
David: Good luck, Scott. You know better.
Kevin: Yeah. No, he has asymmetrical secret information. You just need to relax. That’s right.
David: Asymmetric information. Well, another Financial Times article described Bessent’s plan as a Band-Aid on a bullet hole. Until the Fed and Treasury are dealing with the real structural issues, the best that Bessent can do is attempt to bully the bond market and to bluff his way through a pending crisis of confidence. No one has ever successfully bullied the bond market. No one.
Kevin: Right. Yeah. The power of persuasion may work on a daily basis with short-term traders because they realize everybody’s going to trade on that, but they don’t believe it in the long run usually, right?
David: Well, and when you loan money for 10 years, 20 years, 30 years, rarely are you a short-term trader. You’re doing longer-term macro analysis. So you’re right. When you’re talking about moving the markets by headlines and quips and quotes, it really is the equity trader not considered to be sort of the sharpest tool in the shed. Your bond market, your FX traders, they tend to be more cognizant of how the universe is stitched together.
Kevin: They’re economists. They’re not just financial traders. They’re economists for the most part because they have to be. They have to look long term to see how the economy is doing.
So let’s look at the foreign holders of US Treasuries because they’re going to play a big role as well as the hedge funds.
David: Well, we talked about Japan earlier. They’re 1.1 trillion. That’s one central bank.
Kevin: What’s it add up to total?
David: Foreign holders of US Treasuries now stand at $9.3 trillion. So that supply is consequential. When you think about a poker table, Thursday night sometimes we play poker, the boys in our family. And so bluffing often works in poker if you can simultaneously bully the table with increased stakes. If I have more chips and I’m fully bluffing, but I start putting on a bet that is so large, you’re like—
Kevin: They have to fold. Yeah.
David: They’re not going to find out because you can basically buy the pot, right?
Kevin: Right.
David: And so a couple of things. One, Bessent doesn’t have the cards. Second, the bond market collectively is the bully. Bessent is not reading the room, or he’s forgotten what he should have remembered when he was working with Druckenmiller. So third, like Nixon in the ’70s, an attempt to bend the will of free agents and verbally convince them that you know best can produce the opposite outcome than the one that you want.
Kevin: Okay. So I’m going to ask a question that’s obvious to me. And it’s obvious to you, but why isn’t it obvious to the markets? I mean, when you see all these things stacking up, how come so few people, there’s such a small percentage of the investor base that has any gold?
David: Yeah. What did we say a few weeks ago? The average high net worth family office has two and a half percent allocated to gold, where it was something like 75% have zero and a smaller slice does have a larger allocation. But these are sophisticated high net worth family offices. They haven’t figured it out.
Kevin: Maybe they have asymmetric information, Dave. It could be they know what Scott knows.
David: Or they’re riding the wave of inflationism, and at this point don’t have to care. So it’s the lower class and middle class that actually have more of the asymmetric information relative to the high net worth family office because they’re on the ground every day gathering information every day. And whether it is a loaf of bread or a gallon of milk—
Kevin: Or a wedding.
David: Or a wedding, it’s hard to pay for, and they know how hard it is to pay for it. So they can feel, they can see the change. It’s gritty. And at a certain income level, I just don’t think they care. They don’t have to care.
And once again, I think gold is leading as an expression. It’s leading as a signal that global structural issues are not resolved, and they can’t be resolved without pain. So who feels or who will feel the pain is the question. And I think some of those high net worth family offices are front and center as a part of the investor base that is going to experience volatility—not upside volatility, downside volatility. So who feels the pain? I think it’ll be investors in the form of volatility, savers in the form of lost purchasing power. And I think to some degree we all pay the price as we see the social fabric fray.
Kevin: When we met— Before we record this program, we meet as an office, and we hear from Morgan Lewis, Robert Draper, we hear from the various people who are making decisions on money. And you read something from the Financial Times, Dave, that is sort of like, “Oh, what could possibly go wrong?” I mean, the guy was basically saying, tongue in cheek, we read that quote. Would you read that quote that you read to us at the office?
David: Robin Wigglesworth, Financial Times, “In case you were wondering, the Strait of Hormuz is still closed. The US economy is propped up on an AI buzz that is increasingly fueled by vast off balance sheet exposures. The Fed is possibly going to raise interest rates. The China economy is still slowing. Yields everywhere are climbing, and Japan is suffering a bond crisis. Private credit is stressed. Virtually every measure of leverage is engorged. Asian geopolitics is messy and getting messier. Europe is Europe, and the UK is being particularly British. So what do the world’s leading capital allocators, the bad boys and risk-takers who put it all on the line every day, make of all of this? Fund managers are currently carrying one of the lowest levels of cash in nearly three decades.”
Kevin: Unbelievable.
David: “Equity allocations are the highest they’ve been since the 2021 euphoria. Optimism on corporate earnings is also the highest it’s been since 2021.”
Kevin: So what could possibly go wrong, Dave? What could go wrong?
David: What could go wrong? I think gold is beginning to reprice the possibility that something, anything, perhaps everything goes terribly wrong.
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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.
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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.
