The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“I’ve said that I’m not for conspiracy theories. But when I see this sort of insanity – this is either a terrible idea on the part of central planners, or this is a perfect plan, according to central planners, where you create chaos and you create market turmoil, and then you step in with such a Draconian solution that it could have only been justified by the circumstance. Oh – lo and behold, you were the creator.”
– David McAlvany
Kevin: David, you know, sometimes I smell a rat when I’m watching the news, and what we saw this last weekend reminded me a little bit of a coup that was staged in Russia back in the early 1990s. We had investors with large deutsche mark positions at the time, and Germany was directly affected. Anytime there was a fear that Russia was on the rise, or there was a problem with Russia, deutsche marks would fall in value.
David: Well, so the iconic picture in front of everyone was Yeltsin standing on a tank…
Kevin: Oh, I remember that, yeah.
David: And it was this bold, grand change that was going to forever transform the Soviet Union.
Kevin: But if it was a true coup attempt you would have probably seen Gorbachev’s body being displayed. Real coup attempts usually are characterized by getting rid of the old leader.
David: That’s right. So, I think what you had this last week over the weekend was the same kind of political theater that we had back in the Yeltsin/Gorbachev days.
Kevin: Well, Gorbachev was at his vacation home. Isn’t there a similarity there?
David: That’s right. If you’re starting a legitimate coup (laughs) – this is not like the anarchist cookbook – we’re not laying out the things that you need to do, but just noting from history…
Kevin: Right.
David: If you are putting in motion a legitimate coup, there are two vital ingredients to success, and one is the immediate control of mass communications.
Kevin: Right.
David: And in this case, the news media was freewheeling all the way until Saturday morning, so from when the coup began on Friday, the news media could say what they wanted to. Now, very curiously, they did gain control of the ISPs, and so Facebook and Twitter, your ability to communicate using alternative media – that was shut down, which again, suggests to me that it was really control of a narrative which was in play, but that’s the first point – immediate control of communications. The second is the immediate capture or killing of the political leadership you’re overthrowing.
Kevin: Well, and you know, I made a call to New York, to the man who managed the accounts that had the deutsche marks in it back in the early 1990s, and he basically said, “We’re not going to sell anything. Understand, this is probably going to pass in about 48 hours.” The coup – many people who are listening may not even know this, but the coup bringing Yeltsin in and ousting Gorbachev very definitely had a background planning that was just part of a narrative that Gorbachev probably knew about because I think he’s retired in the Presidio in San Francisco right now, living a very healthy, happy live.
David: (laughs) So, one or two indicators that an overthrow is a farce – just simply is, again, political theater. Number one, leave the news media alone for 12-18 hours and allow the narrative to sort of take shape. Yes, you want to raise concern. Yes, you want to raise a particular kind of awareness. Yes, you want to galvanize public opinion. And yes, you want to guide perception of the events that are unfolding. But secondly, you want to check to see if the person who is being overthrown is on vacation. And that’s the point. Gorbachev is at his vacation home and Erdogan happens to be out of town, on vacation, during the coup. So, what were you actually grabbing control of? It’s actually not that big a deal to take control of a governmental office. You control the space, and now they’ve had to give it up. But, if on vacation – think about this. It was either very poorly planned, or it was perfectly planned.
Kevin: Well, didn’t some of the guys in the military even say, “Gosh, we didn’t even know we were having a military coup. We thought we were on normal military exercises.
David: Yeah. And as we said, there are similar events that unfolded with Yeltsin and Gorbachev. And so, exhibit A in today’s lesson on political theater – is the guy in town?
Kevin: So, if Erdogan is behind this, or at least benefits from this, what do you think is going on?
David: Well, back to this issue of it either being poorly planned or perfectly planned, in this case I would say the coup in Turkey was perfectly planned. It was intended, I think, on Erdogan’s part, to consolidate power, to move away from a parliamentary system in favor of his version of religious dictatorship. And he now has what’s needed as a justification for radical change and a brutal response. In the hours that have followed, and the few days that have followed, returning from his vacation to re-establish control and power, 6,000 arrests have occurred. Curiously, almost half of those, 2700 of them, are not rabble rousers who are on the streets, or military leaders, but judges.
Kevin: 2700 judges arrested.
David: Basically, you’re saying, “Look, we had a system of government which was parliamentarian in nature. We’re changing that. There will be no one who can look at the new laws that I’m putting in place with criticism, because there is no one who can criticize. The judges are gone.”
Kevin: One of the great changes in history, we talked to Bernard Lewis many year ago, Dave, was the secularization of Turkey. Turkey was the seat of the Ottoman Empire and it was a caliphate. It was the Muslim caliphate. It was under Sharia law, basically. Now you have a secularized Turkey that is a different kind of system. It looks like that’s changing.
David: Right. Usually when we’re thinking about Turkey, as we have for the last six or seven years when different things have come under the radar with that country, really critical in the Islamic and Middle Eastern world, it’s Kamran Bokhari, for STRATFOR, who covers Turkish issues, and we’ll sometimes talk with George Friedman, as well, but their conclusion is that what we see is massive instability on a regional basis, which is deepening. And this is in the context of Erdogan saying, “Look, the secular state created by Mustafa Kemal Ataturk is gone. It was an abomination. It was terrible.” And he has long promised that he would bring about a generation of pious Islamists.
And so, what has stood in the way is a system of law and a system of government which has been in place since the secularist reign, again, following World War I, the fall of the Ottoman Empire, and the imposition of a secular state in Turkey. This was the seat of the Islamic Caliphate. When you think of Turkey, it was the center of the Islamic world. For Erdogan to have aspirations of re-establishing Turkey as the center of the Islamic world, the only thing we’re not clear on is, is Erdogan sort of an ISIS stooge? They’ve already said, “We’re the Caliphate.” Is he going to now contradict them, or does he kind of fold into them and say, “Well, of course, I mean, we’re in support of them?” I don’t know if he has designs of his own, but before Ataturk and the secularization of Turkey, this was the Caliphate.
Kevin: It was the seat of the Caliphate for hundreds of years. You know, Dave, this brings back – I know we’ve talked so often about other people we’ve had on as guests, but do you remember when the United States pulled out of Iraq? It was the STRATFOR organization – it was Bokhari, I think – who said that what they did was it created a vacuum. Iran, as you look on a map, is to the right of Iraq. Turkey is to the left of Iraq. That there would be a competition, not only for Iraq, which is in the middle, but there would be a competition for the Caliphate. You have the Shi’a law over on the Persian side, which is the Iranians, or you would have the more Sunni law over on the Turkish side. The only thing that kept that from really happening over the last few years is the secular Turkey. It seems that might be changing.
David: Erdogan, in a Bloomberg article was quoted as saying that this coup was a gift from God, and I couldn’t help but sort of chuckle and say, “Yeah, okay, it’s helping him usher in a new Turkey, and it looks to me like a gift to himself from himself.” (laughs) It was fascinating, Monday morning Financial Times came out and suggested something similar – the possibility that the coup, was in fact, staged. And again, you mentioned a few minutes ago that the military, many of them involved, thought they were on a routine military exercise. They were just out in a military personnel carrier, or on top of a tank, and you know, smiles and waves to all the kids on the street. But, as the news was carrying it, again, the official messaging and the narrative by the media which had not been shut down – (laughs) normal operation during a coup – was carrying this message that there was a major coup, and this was happening, and Erdogan was trying to reassert control, and he was getting out to his people. Well, it’s all very fascinating, but in the theme of global instability, and with the idea that the Middle East is still a tinderbox for change, geopolitically, and even economically, this is a very curious issue to occur. Do we have greater Islamization in the Middle East, and ultimately, in Europe? Well, look. This is a NATO member. They were jockeying to entry into the EU, and believe it or not, it was Angela Merkel who said, “No, that’s not going to happen.” And it was sort of one of those “over my dead body” statements where, “Yeah, good luck with that.”
Kevin: I think it’s interesting, the timing, Dave, because after Brexit we saw Turkey move away from Europe. At that point they start to say, “Oh, this ally that looked like they were probably going to be very much an enhancement to our power is now crumbling. They started moving to the East. We talked about that right after Brexit.
David: Well, and just a few weeks after Brexit, look, everyone’s moved on, there is no more discussion of it because, what do we have now? We have Trump and the RNC, and all we need is a do-flop (laughs). If the wind catches his hair the wrong direction, that’s going make the news more than either anything in the Middle East, or relating to Britain. But it was interesting, the Brits had the opportunity – this is Mark Carney, who came over from the Bank of Canada and now runs the Bank of England. I think he had the good sense of reflecting on their current interest rate structure, saying, “Look, we’re at 50 basis points as our base rate, and we can’t afford to do anything here.”
Kevin: Yeah. So, he didn’t act in panic. People thought he would act in panic and lower it 50 basis points.
David: Well, Brexit was heralded for several weeks before and after, as the equivalent of Armageddon. Now, the problem is, the stock market started moving up because on the one hand, if you have Armaggedon, you’ll have central banks who are willing to do anything, and if central banks are willing to do anything, then investors are willing to bet anything that everything will be just fine (laughs).
Kevin: They’re sort of the fifth horseman, aren’t they? You have the four horsemen of the apocalypse, but the fifth horseman is the central banker who comes in and saves everything (laughs).
David: Right. So, now that there is no crisis, because it was almost self-solved, what’s the Bank of England going to do? Well, they’re going to do the smart thing and realize that they have so little ammunition left, 50 basis points doesn’t give them much wiggle room. So, in the Brexit world, or post-Brexit crisis which no longer exists, they made a good decision.
Kevin: Wouldn’t it be interesting, Dave, if Britain was a positive place to get a positive return, when you look at Europe on the other side that is virtually all negative rates at this point.
David: Well, I think one of the fascinating things is that you still have a massive central bank footprint in the markets, and whether it is the ECB buying bonds in Europe, driving rates negative, or the Bank of England injecting, or being willing to inject, 375 billion pounds – that is, let’s call it a half-trillion dollars – into the financial markets to just sort of paper over things.
Kevin: That’s an infusion that Bernanke would have come up with.
David: When you see volatility, like a wave – up and down, up and down, up and down – if you can just take a massive amount of paper and fill those little valleys between the peaks, all those little troughs – just fill them up. That’s essentially what the Bank of England is willing to do, to say, we will see no volatility in the financial markets because peaks and troughs will be filled. We have ample liquidity, and what we don’t have we can arrange from the Fed or other central banks around the world. And it is this sort of go-to solution that has the markets taking even riskier steps. You see this in Japan, you see this with Bernanke, going over to the Japanese and suggesting last week that they implement even more creative policy.
Kevin: Right.
David: Monetary policy, that is.
Kevin: Perpetual debt, Dave. What was perpetual debt called in the past, when people ended up finding out the reality of perpetual debt?
David: Yeah, right. Look, we’re at a zero rate environment now – that’s become all too common. We have negative rates, which are now the hot trend in central banking. And it was Bloomberg who reported that [Bernanke] is not actually the U.S. ambassador of money and finance, but he might as well be.
Kevin: Right.
David: Retired head of the Fed traveling to Japan. He does sort of represent the ambassador of money and finance.
Kevin: He’s not there for the sushi.
David: I wish he was.
Kevin: (laughs).
David: (laughs) I wish him only good fish. But what he is suggesting is this idea of perpetual debt, where you issue debt, you issue loans that have no payback. They don’t have a maturity date. They just go on forever.
Kevin: You just get interest. That’s it.
David: And we’ve done that here in the United States before. And there’ve been some interesting experiments that, in the rear-view mirror, if you look in terms of our history, history of the bond market, history of the U.S. stock market, you think (laughs) okay, heights of insanity – we’ve done this before. Why didn’t we learn anything? Government bonds at one time were called certificates of confiscation. And we were not a benchmark for risk-free paper. We were not the reference point, the plumb line, if you will, for what a risk-free investment was. We were considered the riskiest bet. A U.S. government bond was called a certificate of confiscation.
Kevin: Right.
David: It’s interesting, this idea of perpetual debt is just a loan that lingers forever, and the response from Morgan Stanley, I thought, was pretty spot-on. One of their analysts was quoted in the Financial Times, suggesting – and of course this was tongue-in-cheek – that for good measure, you might as well make the perpetual bonds zero coupon bonds, as well. So, we’ll sell them at a discount, we’ll never pay interest on them, and they will never mature. But one thing that you might include in that mix is the phantom taxes that you sometimes pay on the accrual of interest, again.
Kevin: That you never get.
David: You’re never going to get it. But what the Morgan Stanley analysts were saying is that this is insane. We are now in an environment where Ph.D.s are marching around the world like rock stars, talking amongst themselves about the best ways to handle a really screwed up system. And their ideas are going from bad to worse. A market practitioner will tell you, this simply doesn’t work. That does not matter to an academic, and the Bank of Japan is already doing more than what they promised. They’ve exceeded their 80 trillion yen, the official numbers. They’re increasing beyond that.
And it’s not just the Bank of Japan, but it’s on the advice of a Ben Bernanke and others that we’re moving toward that sort of Haverstein insanity, believing that the academics are the only adults in the room, and that they are, in fact, making brilliant decisions. I think, in the light of history, we’re going to look back and say, “Brilliant? No, that was certifiably insane.”
Kevin: Yes, but do you want to know who’s not thinking it’s insane? The stock market – we’re at 18,500 points and climbing, Dave.
David: (laughs)
Kevin: It’s not really supported by any kind of economic growth or new profits, but it definitely is supported by the thought that the central bankers are going to just continue to do this.
David: It’s been the primary support for the global equities market for about seven years. Take away your radical monetary policies, and of course, your routine manipulation of stocks, when they’re trading sort of in the wee hours of the morning…
Kevin: Isn’t that strange that in the wee hours of the morning the most important things that happen on the stock market are when nobody’s up except for the people who are manipulating? The early bird truly does get the worm, or the early bird is the manipulator, in this case.
David: Right. Fascinating is that institutions have been moving out of equities for some time now, and prices are not dropping. The general public has been moving out of equities for some time, in the form of mutual fund liquidations, and the stock market is not dropping. The driver of the stock market today is the Fed’s operations, and they’re painting the tape, and it’s essentially buying futures contracts on the S&P 500 to boost stocks when no one else is around, and it doesn’t take much money to do it, because you can do it with very cheaply borrowed money. Oh – oh – in fact, the folks who are doing it are the same folks who set the price of money at zero. Isn’t that interesting?
Kevin: You know, the sad thing is, these low interest rates, or these zero interest rates, are supposed to be on paper, creating more growth, but actually, it’s just creating slow suffocation. I remember talking to a man with emphysema one time and he was telling me that it’s like slowly suffocating and he said, you know, put your hand over your mouth and breathe. He said, that’s what every breath feels like to me. This man ultimately died of emphysema.
David: That’s how the economist is describing the effect of low rates on the financial system. The financial system is not designed to cope with lower negative rates, is their case. And the words they use to describe it in this week’s Economist? Negative rates represents slow suffocation for the financial system.
Kevin: Well, and you could also put it as saturation of the market with debt.
David: Look at the irony. Look at the irony of the guys who are saying, we are fixing the financial system. They’re actually killing it – killing it.
Kevin: Suffocating it.
David: Right. Now, Richard Koo, we mentioned him last week.
Kevin: Right. Talking about saturating the economy with too much debt to where it can’t grow.
David: He’s a character you need to know. In 2001, his concept of the balance sheet recession was critical, and more recently, the suggestion that macro-economics has operated under a series of false assumptions, the idea that there was always some productive, some very attractive investment for corporations or for individuals to make money in, and this was the underlying assumption. If you just made money cheap enough, then you underpinned the demand for, you encouraged and promoted more lending. And with more lending, you had greater economic activity.
So, from World War II forward, this monetary policy tool, underpinning macro-economics – just lower rates enough and it will get into the system – and it’s not working. Koo said, “No, it can’t work in this environment.” The problem is, there are times where the cost of money – low, negative, it doesn’t matter – you have something else as the driving force behind the loan market. And it is that it wants to shrink. So the consumers desire to de-leverage, that is what takes this negative rate environment and says, “You’re not doing anything to help here. In fact, you’re hurting us.”
Richard Duncan is going to be joining us in the next couple of weeks to talk about, again, what could very well be the beginning of a global recession/depression because the system is debt-dependent, and because rates of credit growth need to be X, or 2X, in order to avoid recession, and the total stock of debt is now so big that that percentage growth that has to be there to avoid recession is almost a mathematical impossibility.
Kevin: Right. So, do you know what that directly affects? What do almost all of us go into debt for? We go into debt for real estate. Real estate is that one purchase in most people’s lives, especially if they get married young – I got married young – I couldn’t have afforded real estate on my own. I had to go buy a house on mortgage. Commercial real estate is a lot like that, too. It requires people to be able to go out and borrow money. It’s rarely done on a cash basis.
Now, Dave, I have a friend who has a relatively recognizable name, so I won’t say it, but they, as a family, owned a pretty large commercial real estate interest, and they looked at this interest rate market, and they looked at the markets that they’ve pretty much endured through for decades as a family, and they said, “You know what? No. This is the time. We’re getting out of commercial real estate because the debt that it takes to buy a property like they have right now, that they’re getting good prices on, is not going to be able to support that kind of price later.
David: Well, right. And of course, just like a see-saw, on one end you have interest rates, and the lower they go, the higher the value of the property gets. But it means that with any reversion to normal rates, those prices – you’re going to see not only a loss of capital, but a real issue – think about this. Commercial loans are timed in five, seven, ten-year chunks.
Kevin: Right. It’s shorter than a mortgage.
David: That’s right. So, at some point, you’re going to have to refinance or just pay it off completely. But what if rates rise in that five, to seven, to ten-year period, and the rise in rates causes the value of the property to diminish? How do you refinance something that has a current market value well below what you need to refinance? All of a sudden you see a major adjustment in price, and you also see a number of people who simply can’t refinance.
Kevin: That’s called upside-down on the loan. That happened back in 2007 with normal housing real estate, Dave.
David: Right. Well, these are much bigger properties we’re talking about. 2017 ends up being a very interesting year for commercial real estate. We spent a great deal of time this last week talking with a 30-year veteran of the commercial real estate market in Southern California – knows the market well. And I thought it was very interesting, just some of the nuances. He says the dynamics in the market today are feeling more and more like 2007 all the time.
Kevin: Well, there you go.
David: And he said, “Look. Prime properties – they’re easy to finance, not a problem at all. But when you get to sort of peripheral quality, things that aren’t prime, as in, the best locations, you’re already finding the standards a bit harsh, and the money and its availability tightening up.” So, he’s seen in the last month or two numerous deals where million-plus deposits have been walked away from due to the terms being so onerous. Contrast that with two years ago where money was flowing easily, and it was on the easiest of terms. So – news flash – news flash – 2017. You have 400 billion dollars in U.S. commercial real estate loans which have to be refinanced. So, if you’re a commercial real estate investor, get down on your knees – get down on your knees – and pray to the gods of finance, that interest rates stay low, or go even lower, because your needs to refinance may end up putting you in very desperate financial straits.
Kevin: Well, how would you like to be the president that comes in – okay this is the first year of the new administration – whoever it is – Hilary, Trump, or somebody we’ve never even thought of – there is a day of come-uppance coming in that first – starting probably in January of 2017.
David: So, whether it is the commercial real estate market or the stock market, or, clearly, the bond market, this massive disconnect between economic reality and prices – stock prices, real estate prices, and all of these prices are a function of the cost of capital. So, the lower rates go, the higher prices go, but not on the basis of economic metrics, simply on the basis of the flow of funny money. So, what are you doing as a financial engineer, whether you’re at the European Central Bank, the Bank of Japan, the People’s Bank of China – you are escalating financial market risks. And you’re increasing the odds of future massive bail-ins, or other extraordinary measures. Again, it’s almost as if (laughs) they’re anticipating a faux coup…
Kevin: A fake coup, yeah.
David: A fake coup in the financial markets where they’ve got to step in, they’ve got to intervene. They’re creating the problem and they’re going to pretend like they’ve got the solution to the problem, and I don’t know what we, as consumers, will give up in the exchange, but usually crisis and governmental solutions to it – in the exchange there is a value lost, and it’s a very simple and beautiful value. It’s the value of freedom.
Kevin: And you know, the excuses that they use – they seem to contradict themselves, because we’ve been told that the reason the central banks are intervening and lowering rates is because we are fearing deflation.
David: Right. The producer price index is up this last week.
Kevin: It’s above the 2%.
David: Core CPI is – well core CPI is 2.3%, above the 2% Fed target, and there is no action from the Fed. In fact, more accommodation is there. So, what are they aiming at? Again, I’ve said that I’m not much for conspiracy theories, but when I see this sort of insanity, I think to myself, “Are they stupid?” I’m going back to Turkey (laughs). It was either terribly planned or it was perfectly planned.
Kevin: Right.
David: This is either a terrible idea on the part of central planners, or this is a perfect plan, according to central planners, where you create chaos and you create market turmoil, and then you step in with such a Draconian solution that it could have only been justified by the circumstance. Oh – lo and behold, you were the creator.
Kevin: Well, and don’t forget you can increase your own personal wealth. You create a crisis, you gain personal wealth during the crisis, and then you come in, riding again on that fifth horse, and you solve the crisis, strangely enough. Now, I’m thinking about…
David: Hillary Clinton (laughs)?
Kevin: Oh, I’m sorry, I’m sorry. How did you know?
David: (laughs) Well, because some of the problems that we have with the casino-like operations on Wall Street are because of what happened under Bill. We have oil traders who are, today, holding massive North Sea oil in the form of floating storage tanks, VLCCs, Very Large Crude Carriers, and you have fleets full of oil, not only in the North sea, but out of Singapore, and other places around the world. What is going on? Well, thanks to the Clintons, who eliminated position limits, we have banks who have been converted into literal casino operations, trading commodities, trading derivatives, with unlimited positions at their fingertips.
Kevin: Dave, I remember when they did this. 1999, they threw Glass-Steagall out the window.
David: That was the most important consumer protection legislation ever written, and now we have Wall Street greed, which was unleashed by Bill, fortunes have been made in the interim. I don’t think anyone who has made a fortune is complaining. But again, Hillary is going to do one of two things. She’s either going to be reminding the beneficiaries that they have payback now and you can send your checks to the Clinton for Presidency, with a particular address in Brooklyn, or whatever, or Vinnie is going to be by on Saturday for a little physical therapy (laughs) – that’s one possible outcome. Or maybe she comes in and cleans up the Wall Street mess. But again, if you create the problem, and then solve the problem, and then get lauded as the hero, do you see anything that looks like theater? I don’t care if it’s Turkey and Erdogan, or the Clintons, post RNC and the ruckus that is there this week – I don’t know who is going to win the race.
Kevin: We’ve got to clean up Wall Street. And it’s true, Wall Street does need to be cleaned up. You could see it back in 1999 when Bill was still in office.
David: Well, all we have to do is re-implement Glass-Steagall. But I think Clinton’s version is more of an omelet/egg story where, “Look, there’s a lot of things that are broken, and I’m going to fix it. I’m going to make something work out of this, turn the scramble into something savory.” It just – it smacks, to me, as I look around, whether it’s central banking or Turkey (laughs), or even the Clintons, should she come to power, there is a lot that seems very faux about it, very false, very disingenuous in terms of crisis dynamics, things that didn’t need to be, things that aren’t really, and things that are being perpetuated unnecessarily.
Kevin: Dave, we see all these weaknesses in the system and we’re saying, “All right, well, fear is supposed to be growing, yet the daily sentiment index exceeds 87. Now, a quote from your dad. “The majority is always wrong.” When everybody thinks things are going to go up, that’s the first indication that things are just about to go down.
David: Right. Well, we’ve said this for a couple of months now, that margin debt has already begun to contract. So, you have the tide already going out. You have institutions which are liquidating pretty significant positions in equities, and that’s requiring and ever-larger central bank footprint. At the same time, you have, as you say, the investor sentiment index exceeding 87. That’s the highest it’s been in two years. It will probably go a few points higher before we see a significant reversal, but the tide is already pulling at your feet. Again, when margin debt rolls over, that represents a transition in the trend for equities. This is axiomatic. When margin debt has to be paid back, that’s borrowed dollars that have to be paid back. You have to liquidate stocks, and there is half a trillion dollars in liquidations pending.
Kevin: Right.
David: And that has already begun to occur. At the same time people are saying, “Look, central banks have got our backs, we’re happy. Don’t worry.”
Kevin: Right. Well, look at the Volatility Index, Dave. The Volatility Index is a good indicator for us to see whether there is fear in the market. But that, itself, is manipulated.
David: What we’re talking about is three distinct categories where market perceptions have been manipulated. So, VIX manipulation, that is, the Volatility Index, the put-call ratio. That sends broad market signals that traders are not concerned about future volatility.
Kevin: Right.
David: And when you get down to the low teens, even close to ten, you are at an extreme where a market practitioner like I would say, “That represents complacency. That represents a dangerous level.” And yes, I think they’re pushing the VIX lower, specifically, to send the message that future volatility is not going to be an issue.
Number two, you have rate manipulation. Well, that’s very straightforward. The first one – hammering the VIX Index, that’s a financial market black ops, if you will (laughs). You’re calling in retired market traders, or 20-somethings who know something about math and not context, and just saying, “Hey, we need this price lower. Here’s your resources, and here’s your tools, go too it. We’ll see you at five o’clock tomorrow morning.”
Kevin: You talked about erasing peaks and troughs. That’s the ultimate – erasing of peaks and troughs.
David: Right. Well, rate manipulation – that again is the straightforward, publicly disclosed easy money. That’s not black ops, in my opinion.
But the third, stock market manipulation, which we talked about earlier, compliments of our friend Bill King – he points out that 49% of the gains in your e-mini contracts – these are your smaller S&P futures contracts which trade around-the-clock with very low margin requirements. Since 2005, 49% of those gains have accrued between 2:00 and 3:00 a.m. Eastern Time.
Kevin: Isn’t that strange? I’m asleep at that time, Dave. I’m wondering – are you out buying and selling?
David: Most people are asleep at that time.
Kevin: Yeah.
David: Bill King may not be asleep at that time (laughs). I don’t think he ever sleeps.
Kevin: (laughs). Right.
David: But the point is, in a thinly traded market, you’re getting a good percentage of your total growth and movement higher in the futures contracts, again, driving S&P futures higher – when everyone is asleep? That just doesn’t make sense.
Kevin: Yes, but Dave, the retail sales – they were able to squeeze out a positive figure. Now, it reminds me a little bit of what you read when you buy sausage where it says, “all beef” and then it says, “for further ingredients, see the back,” and it takes the entire back of the package for the rest of the ingredients.
David: (laughs)
Kevin: So, you can squeeze out a positive number on retail sales…
David: Yeah.
Kevin: But by golly, they may be all beef, but they certainly include an awful lot of other things that I can’t pronounce.
David: You’re right. No, I think you had a positive number – 6/10th of a percent positive – and it is in the category of sausage-making. You should want to know the other ingredients, in this case. And so, this one’s very straightforward. If you revise the previous month lower, then the comparison between last month and this month automatically improves. So, you lower last month’s number by 3/10th of a percent, from 0.5 to 0.2, and then you come out with a number like 6/10th of a percent, and what you don’t realize is that with that positive number, 6/10th of a percent gain in retail sales, half of it came…
Kevin: From a revision.
David: From the previous month’s revision.
Kevin: Yeah.
David: Does that make sense? So just to review, from 0.5 to 0.2 on the revision, to +6 for the month of June, 3/10th of the revision lower, and 3/10th from the month’s activity, half the month’s improvement comes from the previous month’s revision lower.
Kevin: Okay, so Dave, since I work for you, let’s just think this through.
David: (laughs)
Kevin: Let’s say that you revised down what I made last year. You say, “Oh, okay, so your income – I’m going to go ahead and revise that down.” And I’m like, “Well, why are you revising it down?” And it’s like, “Well, because we need to show an increase this year by giving you less of a raise than probably what you’re going to get.” So, you give me a little bit back, and you go, “See, you’re making more.”
David: You’re doing so much better.
Kevin: But the only way that I’m doing better is because you revised a figure down from before. I know this gets very confusing for the listener, but let’s just face it, this is also a manipulated number, and this is a package with an awful lot of un-understandable ingredients.
David: Yeah, political seasoning, we could say, something like MSG. It makes everything taste a little bit better.
Kevin: Yeah. But you know, one thing we can go back and look at, we can just look at actual pricing. Credit-Suisse came out here this last week, and these analysts are looking at things and saying, “You know the standard deviation of prices, just equity prices, are way out in the hinterland. They’re starting to look like 2007, as well.
David: You take a 30-year average for where equity markets should be, and they’d say, we’ve got some concern. We’re now 1.57 standard deviations above this 30-year average. Now, let’s say you can go to 2 or 2.5. It’s not to say that we are defining an extreme. We can become even more extreme in terms of evaluation metrics.
Kevin: But it’s extreme, nonetheless.
David: Well, it certainly does not define reasonable value, right? So, for the person entering the market, you cannot make the case that we’re on the cusp of a new bull market. Where’s your growth coming from, if that’s the case? Are we talking about a demographic boom? Really? Really? That’s what we see? I see job applications at Walmart increasing amongst people who are over the age of 65, but that, to me, is not a demographic boom story, that’s a demographic coping with a tough situation story, where they don’t have enough money coming in from their savings and retirees are saying, “Well, I’d like to be living my golden years on the golf course or shucking pecans, but guess where I’m going to be instead? Saying hello, and putting a friendly smile to corporate America.”
Kevin: Yeah, but you know, the argument, Dave, is that stocks are still cheap relative to debt, relative to the bond market.
David: Right. Well, to me there’s nothing more risible or embarrassing or stupid than someone comparing any asset to bonds. Everything in the universe is cheaper compared to bonds. Chewing tobacco is cheaper compared to bonds.
Kevin: We’ve had 30+ years of dropping interest rates, of course bonds are high.
David: Slurpies prices in bonds are cheaper. When something is selling at a record high, everything in the universe is, on a relative basis, cheaper. If that’s the best that you can do is say, “Stocks are cheap relative to bonds” – relative to bonds? Are you kidding me? Is no one paying attention to low-to-negative yields, and the inverse, which is the highest prices ever paid for bonds? Really? That, to me – again, I understand Credit-Suisse’s suggestion that stocks are getting out of control on the upside. I understand, according to the Buffet indicator, that we’re 60-70% above what is a reasonable price. I understand, according to a ten-year rolling average of the price earnings multiple that we are now in an over-stretched market. Are we at the most extreme? No, but we’re at the second or third most overpriced market in all of U.S. stock market history. And that’s just the math. That’s not the Kool-Aid speaking here, that’s just the math.
I like Smithers. I mentioned Smithers last week. Smithers, I think, very intelligently, said, “If your expectation over the next decade, based on the numbers, is that you’re going to take all the risk of equities and get no better than an average of 1-2%, that’s a pretty poor risk-reward offer. I’m just going to take my money and put it in cash.”
Kevin: Yeah, and that’s what he did. He put it in cash, and he retired.
David: Yeah. He was no fan of gold – no fan of gold. But my question to him was, and remains, “So, the only thing we disagree about is how you denominate your cash position. We agree that we need cash, and need more of it today than we have in past years, or even decades, but how are you denominating your cash, which is obviously my preference for the metals.”
Kevin: Well, and you know, Smithers being form the U.K., I would certainly hope that the cash wasn’t in British pounds over the last month or so.
David: Ouch.
Kevin: But speaking of politics a little bit before we go on, the budget deficit, strangely enough, has ballooned this year. Obama can’t come out and say, “You know, I’ve been cutting the budget deficit,” because I think it’s up about 162 billion from last year.
David: So, this is either normal election year stuff, again, if you’re talking about the kinds of things that get put in motion when you’re in the final stretch of your administration, election year spending to gin the election results – that may be one of the reasons why we’re coming up short, about 162 billion more than expected. So, 600 billion is the budget deficit. That’s more than expected by 162 billion. Was that a falling tax receipt issue, or was it election year spending. I think it’s one of the two. And if it is falling tax receipts, I think you’re dealing with what we’ve thought we are dealing with, which is a weaker economy. But you can’t rule out Democrats handing out Democratic favors to potentially incoming Democratic oval office.
Kevin: That’s what Bill King calls the election year fix. But you know, Dave, it’s just hard for me to get my head around, because we’ve been doing this show now, from the end of the Bush administration through the entire Obama administration. We are now going to exceed 20 trillion in debt. I think our debt was 8 or 9 trillion when we started the show back in 2008.
David: Isn’t that funny? The purpose of the show is really not to talk about Obama.
Kevin: But that was the administration.
David: But the majority of the time that we have done this show it’s been under one administration. That’s fascinating.
Kevin: Yeah.
David: Well, we’ll exceed 20 trillion, and after eight years, what do we have? Promise of hope and change. What do we have? We have, for those who are wanting to learn something, sort of, Getting Elected 101 – Empty slogans? Big promises? Delivery on which material promises? Again, maybe there are just so many important initiatives that have been completed under Obama that I just can’t recall them off the top of my head. Well, he did get the Nobel Peace Prize.
Kevin: I hope Trump or Hilary get the Nobel Peace Prize, then, when they first come into office.
David: They should. They represent a lot of hope and change, too (laughs).
Kevin: Yeah (laughs).
David: Change, anyways – what’s left of it. Do remember a few years ago – I just want to make sure that we’re not absent a little bit more data on the real state of the economy. Do you remember a few years ago we compared the decline in electricity usage to the official growth statistics, which at that time, the official growth statistics in China were still near double-digit.
Kevin: Yeah, and I think we should explain this, because in the past, a good economist is going to sit down and he’s going to look at – I heard that Greenspan, back in his early days, used to sit in the tub every morning – the hot tub – and he would read strange things to see where the economy was going, like dry cleaning receipts – how many people are getting their clothes dry-cleaned, and is the economy rising or falling? You brought up – and you’re right, this was a couple of years ago – you brought up that the electricity usage in China was decreasing as the growth numbers were increasing.
David: On top of that, rail freight was in steep decline, as well, so you have these things the indicate economic activity, the movement of stuff, the processing and creation of stuff, which requires the use of electricity in plants and in manufacturing facilities.
Kevin: And you see it dropping while the economy is supposedly growing.
David: Right. So in the Wall Street Journal this week we have something similar. On the one hand, you have officialdom which is championing the idea of a return to growth, that we have had improved consumption numbers, yet you have container volumes into Los Angeles, you have container volumes into the Long Beach port facilities, down 8.5% for imports, down 10.8% for exports. So this goes both ways. We’re sending less out, we’re receiving less in. Draw your own conclusions, but the news media’s conclusion is that the stock market’s higher, therefore the economy must be improving.
Kevin: Everything must be fine. It reminds me of the interview with Pippa Malmgren, who was part of the Plunge Protection Team under President Bush. She talked about looking at signals. Signals are things that you don’t normally look at, but it’s just little indicators to see what’s going to happen next. This, clearly, would be a signal.
David: That’s right. So, the significance of data points, and what they mean, what clarity they bring to a bigger picture – this next week I head to South Africa, and when we used to travel down there, my father and I, the exchange rate was 4-to-1. Now the exchange rate is 14-to-1. What does that tell you about the financial management of the country?
Kevin: So, 14 rand to one dollar? Is that what you’re saying?
David: That’s right. There has been a massive devaluation of the currency, and it’s not this year, it’s not last year. Over about a 20-year period, things have continued to decline. I haven’t been there since the early 1990s. What has changed? One of the things that has changed is a change in the standard of living for every South African – for every South African. So, one of the things that I’m intrigued by with economics – it touches everyone’s life. You may not think that it does, but if you are a wage-earner, if you are a saver, if you are an investor, you’re touched by economics. And these little things that signal what is or is not happening, from a birds-eye perspective I think to myself, “Gosh, it was really interesting traveling to South Africa when the exchange rate was 4-to-1. Now at 14-to-1 it’s like going to a third-world country, in terms of the exchange rate.”
This next week we’re going to get to spend some time with a very renowned Chinese economist, Peter Chow. It will be fun, I’m taking my son with me, and he’s going to challenge his son to a game of chess. Apparently Peter’s son is a chess prodigy, which means that my son’s going to get his tail kicked, I’m sure.
Kevin: (laughs)
David: But nevertheless, we’ll have a meeting of economic minds to talk about what’s happening, not only in the developing world, but in China. Peter is very, very concerned about China. He is assuming that there is a debt bubble which is ready to implode, and that it has global economic implications, and that this is a now issue. This is not a pending issue over the next 10-15 years, but that, in fact, the political change which is occurring in China is a reflection of the insecurity within that market. And so I’ll be fascinated to see what else is learned from a group of businessmen and economists from all over the world, gathering in South Africa to compare ideas, and to move some chess pieces.
But the indicators, whether it is a currency exchange, or a container volume, or electricity usage, these are ways that you can work around official statistics. One of my favorite authors – you introduced me to him years ago – was Mark Helprin, and I’m re-reading A Soldier of the Great War right now. It’s really fun. I’m reading it out loud, so this is nighttime reading – a fun story. He wrote another book called Memoir from Antproof Case. In Memoir from Antproof Case, you have this Wall Street economist who is a unique economist, he is an on-the-ground economist. He is not an economist who is in love with math, as much as he is music in the public spheres. He wants to know who’s playing what, and why. And who’s sitting and lingering over a cup of coffee, and for how long? It’s a little bit of what Alan Greenspan used to do, wondering how many people are having their shirts dry-cleaned these days, and is that an increase or a decrease?
Kevin: Right. Sort of a Jim Rogers, too. That’s sort of that same type of thing.
David: That’s right. It’s economics at the ground level. In the story, this is what he was paid to do, travel around the world and make notes, and figure out how far off the official economic statistics were from the economic reality which he witnessed in real time. I think we can all do that. I think we can all look back, and in the context of taking a taxi to the airport, or from the airport, or talking to your dry-cleaner, or looking around and seeing which shops are closing or opening up? Is there a real buzz in terms of economic activity? Sales receipts here in Durango, which would be an indication of business activity, right here in our little town – they’re down, and this is one of the best months, and yet we’re missing expectations. What is happening, officially and at the level of theater, political and economic, and what his happening in reality? I would trust your judgment and common sense to an official statistic any day of the week.
Kevin: You know, Dave, just before we wrap up, something hit me when you were talking about the rand going from 4-to-1 down to 14-to-1. If you had held, instead of rands, or instead of dollars, even, if you just held a krugerrand, which is a one-ounce gold coin, you would have lost nothing in the exchange, because if the rand has fallen, of course, gold has risen relative to the rand. So as far as capturing value while you’re watching who’s drinking coffee, and who’s getting their dry-cleaning done, if you just simply sit in gold while you’re waiting to make a decision on other opportunities, it seems to me like you’ve beaten the system.
David: And again, I go back to Smithers’ conversation. He chose cash. I chose cash – a long time ago. I just chose a different denomination. Not rand, not yen, not euros, not the British pound – but gold.
