Podcast: Play in new window
- Cayman Island Hedge Funds Hold Most Of U.S. Treasuries
- Precious Metals Move Another Late Cycle Signal
- Risk Taking Can Turn To Panic Within Hours
“What makes me worried today is I don’t know where the next bubble is because when this bubble bursts, you’re going to have government debt and central bank credit discredited, I believe. You’re going to have markets questioning if policymakers can reflate anymore, and if you have that type of dynamic unfold, I think that’s the ending of this long super-cycle that’s been unfolding over thirty-some years. That’s my concern today.” — Doug Noland
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Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany and our guest today, Doug Noland.
I was just thinking, what if we actually listened to Doug Noland toward the end of the tech bubble back in the ’90s, and then maybe listened to Doug Noland about 2006, 2007 during the mortgage bubble where that bubble had shifted. And then maybe listened to Doug Noland—oh, I don’t know—when the government bubble replaced it. And that’s where we’re at right now. And Doug has repeatedly said he really doesn’t know where the next bubble can go because the government bubble may be the biggest in history. What are your thoughts?
David: Well, I think of finance, I think of asset management, as a domain that is so pragmatic, and it is absolutely imperative to have different narratives than the one that you’re currently on just to bring balance. And there’s a point where you can agree, you can disagree. Pragmatically, people may choose to continue to take risk and set aside cautionary words against scenarios which may not play out as well as you want them to or hope them to. This is, again, I think, where it’s important from a pragmatic standpoint that people do fully engage and don’t fall in love with their assets and the way they have things allocated at a particular point in time because things do change, and change is slow until it happens very quickly.
Kevin: Yeah. And we have encouraged our listeners for years to read the Credit Bubble Bulletin. Doug has put that out for decades, and it’s a no-miss kind of publication.
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David: Doug Noland, you’ve spent many decades analyzing the markets, chronicling bubble dynamics, trading these markets on a daily basis. For folks that aren’t familiar with you, what makes you tick?
Doug: Oh, dear, where do I begin? As far as the markets, I fell in love with the markets and macro analysis sitting on the Treasury desk at the Toyota US headquarters back in 1986, ’87. I just was hooked. Not only was it the wild market instability in the summer of ’87, and it crashed in October, you had this bubble inflating that they were very concerned about at Toyota, and Japan. So I just was fascinated with it all. And I guess, David, I’m just a geek and I’m the type of person, when I get focused on something, I’m happy to come in and work on it every day and I’ll work on it every day for, how many?, thirty-some years, since ’87. So I followed these dynamics so closely, and I’ll also throw out what makes me tick. I got my lucky break back in 1990. I was asked if I wanted to join Gordy Ringon’s hedge fund out in San Francisco.
I was a treasury analyst at B.F Goodrich in Ohio after my MBA school. And I just jumped at the opportunity to be involved with the markets. It was just a great opportunity. And I went out, and Gordy had been a very successful hedge fund manager focused on the short side. My first year with him, we were up 63% back in 1990, and I would sit at my desk and I would think, “I’m just a small town working class kid. What’s it going to be like to be rich? What’s it going to be like to be rich?”
Well, it didn’t turn out that way. Greenspan came in, started reflating the system after the bursting of the late ’80s bubble, and I spent the ’90s— A lot of people spent the ’90s making money. I spent in the ’90s just obsessed, trying to understand how a system that was so fragile and in such trouble in the early ’90s morphed into this incredible bull market.
So I just became very, very focused on non-bank finance, Wall Street finance, derivatives, hedge funds. And to me, it’s the most fascinating analysis imaginable, and I believe that as much today as I did 30 years ago. So I’m just kind of living my dream here. It is not fun having the markets go against me when I’m trying to manage money for folks and provide a hedge. But it sure is fascinating, and it almost gets more fascinating every week.
David: Anybody who has managed their own money or done so professionally for others, nothing focuses the attention like a loss. And what I’ve noticed in the years that we’ve worked together is that your focus on system dynamics, on nuanced changes with particular aspects in the financial markets, the various indicators that you look at every day and all throughout the day, they inform this view, but it’s driven by something. It’s a problem-solving curiosity that just doesn’t seem to have an end, and I appreciate that about you. The details matter, all the details matter because there’s a signal in them. And taken together, the mosaic, as you often refer to it, the mosaic of indicators, one detail is important. Altogether, they’re telling you something, and you’ve got to listen.
Doug: My thought on this is, I’ve watched, monitored, closely monitored multiple major bubbles. That’s going back to the late ’80s and then the ’90s tech bubble. I referred to the global government finance bubble, monitored that daily, daily, and wrote about it weekly. Each of these bubbles, when they burst, you have this reflationary response from the government. And basically what I’ve missed, it just makes the next bubble bigger. I’ve never seen policymakers resolve any problem. They just reflate their way out of it, and that’s going to lead to the next bigger bubble of the next bigger problem. And so I kind of anticipate what’s going to unfold at some point from a top-down, really macro, perspective. And then I get down to the nitty-gritty, the little indicators saying: Are financial conditions tightening or loosening? Is the marketplace embracing risk? Is it turning more risk-averse?
And I’ve always looked—and this goes back to 1990 working in the hedge fund industry, the hedge fund leveraged speculation. They’re kind of the marginal buyers or sellers, the marginal source of liquidity for the markets. They’re the marginal players that either make financial conditions looser or tighter, depending. Are they adding leverage? Are they risk embracing or are they turning against risk? Are they de-risking/de-leveraging? And that has a profound impact on financial conditions.
So I am monitoring every day just to get a sense for that dynamic, and I know it’s so important. So it’s habit-forming to come in every day to do the micro, really detailed analysis of financial conditions, knowing that you’ve got this big issue out there of these bubbles that only get bigger and only more problematic, if that helps clarify my thinking.
David: I have dozens of questions for you, but let’s dive in right there. Speaking of hedge funds and what is a crazy position in US Treasuries? Talk to us about the largest holder of Treasuries today, bigger than Japan, bigger than China, and I think it’ll surprise our listeners.
Doug: Yeah, David. And you’re referencing a Federal Reserve report that just came out a couple of weeks ago, and what their economists, they dug into the detail to try to figure out the size of hedge fund holdings in the Cayman Islands. And that’s a place, an offshore domicile where the hedge funds like to operate. They can do a lot of things there that you can’t do when you’re here in the US. Well, what the Fed Report said was that there were $1.9 trillion worth of hedge fund holdings now in the Cayman Islands. Well, actually that was at the end of 2024. I’m sure it’s much larger even today. They also said that that position had doubled in size just from 2022. So now the Cayman Islands, they are the largest holder of US Treasuries. They own more Treasuries than China or Japan or the UK, and it’s clearly hedge funds.
And we know what the hedge funds do when they buy these Treasuries. They borrow in the repo market, the repurchase agreement market, which is just the money markets. It’s this pool of liquidity, and they just borrow in the money markets to take these highly leveraged positions in these Treasuries that they hold in the Cayman Islands and elsewhere. And in some cases they’re leveraged 75 times or even more. It’s really probably the biggest leveraged speculation in history.
It’s egregious, but what they do is they own Treasuries, and then to hedge themselves they also short futures contracts, and that’s why it’s called a basis trade. It gets kind of complicated, but they think they can have this huge amount of leverage, and then they make just a few basis points on that difference between a yield on a cash bond and the rate on a futures contract. And it’s basically free money as long as it doesn’t blow up.
Well, it almost blew up. It was blowing up back in March of 2020, and that was one of the reasons that the Federal Reserve had to come in and add trillions of dollars worth of liquidity to reverse what was going to be a deleveraging that could have brought—was bringing the financial system to its knees. And it’s kind of like the best kept secret out there that the hedge funds have this trade on.
David: So you borrow in the repo market. We had some dysfunction in the repo market in the fall of 2019. There’s some growing concerns with the repo market today. Is that a warning, if you will, the repo market telling you that something’s not quite so functional?
Doug: Yes, absolutely. The repo market is seeing something’s not right. There’s a lot of pressure, especially at month end, at quarter end, and even just normal days, the rates are rising when they shouldn’t be. There’s just more demand for borrowing than there is liquidity. Conventional analysis says this is because the Fed has withdrawn so much liquidity from the system that there’s now a shortage of so-called reserves in the system. So the Fed needs to stop reducing the size of its balance sheet. It needs to stop pulling liquidity out of the market, and that’s what they announced yesterday. They were going to end this process.
Well, there’s another angle on this, and the angle back in 2019 was, you started to have these highly leveraged traders start to unwind a little bit of leverage, and when the hedge funds are putting on leverage, when they’re borrowing in the repo market to own Treasuries, that creates liquidity. It’s self-reinforcing and it creates liquidity. The problem is, it doesn’t work in reverse. If you start to unwind that leverage, then your liquidity disappears. It starts to evaporate, and the system tightens, and then people get a little nervous that the system’s tightening, and that leads them to be more risk averse, and they start to deleverage. So it can feed on itself.
One other element here I’m going to add that’s interesting because we’re seeing this instability in the repo market. Just a few weeks ago we had the blow up, the bankruptcy of First Brands that revealed a lot of issues. So I think in certain parts of the market right now there already is some risk aversion, some marginal de-risking. We’ve seen, it’s been reported, there’s been some significant losses in some of the quant hedge funds, especially the long-short funds. So there’s evidence here that there’s incipient de-leveraging that’s probably also playing a role in the tightness in the repo market.
David: First Brands, Tricolor, those two failures, they definitely raise the possibility that private credit, leveraged loans, and less transparent markets are coming under a bit of pressure. At least people are beginning to ask, “Hey, what do we actually own and what kind of risk profile do we have? And are we going to be implicated if there’s another First Brands or another Tricolor out there just waiting to slip on the banana peel, so to say?” Talk to us about the periphery-to-core movement, because private credit is basically a non-publicly traded junk bond. I mean, it’s low quality, it’s high yield, and you can get in, but getting out is a very different matter altogether. Wouldn’t it make sense to begin to see some problems at the periphery of the credit markets?
Doug: Absolutely. And David, I’m afraid you just put a quarter in me, so I try not to ramble on this too long. Just stop me at any point.
Okay. So, the big picture here is—this is not hyperbole—we’ve seen the greatest growth—I call it a bubble—in high risk lending—I’ll call it subprime—that we’ve ever seen. All the leverage loans, the private credit, we’ve got high-risk credit that makes the old subprime mortgage issue look pretty small. And it is worth reminding people that when subprime blew up back in June of 2007, it was dismissed. Everyone was saying it’s inconsequential. The numbers are so small. Credit’s sound except for a few issues here at the periphery, at the fringe.
Well, the problem is, when you have these types of bubbles, if you start to have tightening at the fringe, if you start to see—and I’ll use Jamie Diamond’s language—if you start to see a cockroach and you know, especially if you’ve been around the markets for a while, you know if you see one cockroach there’s going to be a lot of other ones out there. You start to tighten up your credit underwriting, right? You start to tighten your credit.
So, right now, the banks are going to have to start tightening their credit. Leverage lenders are going to have to start, private credit’s going to have to start because First Brands, it’s not that big, but it revealed a lot. It revealed how egregious everybody involved— You have structured finance, you have private equity, you have the hedge funds, you have the banks, you have the auditors, you have credit insurers. It revealed that everybody’s so focused on making money that they kind of just pushed away normal judicious analysis and business practices. They just threw it away. You don’t even need it when things are blooming.
Well, what happens when the first cockroach comes out, then people start to tighten. And that means other people that need to borrow all of a sudden maybe they’re not going to be able to borrow anymore.
And you’ve got so many leveraged companies out there, negative cash flow companies that have been out there borrowing money for years in loose conditions, and all of a sudden, if financial conditions tighten, if credit tightens, they can’t access more money, they go broke, and they go broke quickly, and that’s the downside of the credit cycle. And I think we’re starting to see that. We’re seeing it at the periphery, and in credit, it takes a while. And I talk about the 15 months it took from the subprime eruption in June of ’07 to the financial crisis later on in 2008.
It takes a while for that tightening for the marginal borrower. In ’07 it was subprime mortgages. Today it’s subprime business. It takes a while, but it does start to gravitate towards the core because when liquidity starts to tighten you start to have deleveraging, and you have more risk aversion.
And I will say right now nobody cares because they look at the markets, there’s exuberance, there’s seemingly overabundant liquidity for stocks. Similarly, we saw that dynamic— The markets went to all-time highs after the subprime blew up in the fall of 2007. So, yeah, it started at the periphery.
David: What’s the difference between subprime being in the mortgage market and subprime now being in the corporate bond market? This is corporate lending. This is not your marginal home buyer who can barely fog a mirror but they still get a loan and that gets papered and packaged and sold on to some investment, whether it’s in a mutual fund or in an ETF or what have you. What are the implications of it being in corporate credit this time, and how would you see the dominos falling either similarly or differently from subprime mortgage debt?
Doug: Yeah, the subprime was different, of course, because the marginal buyer, the subprime borrower lost access to new mortgages. They couldn’t buy their starter home in Phoenix. So, the inventory piles up, prices start to come down, buyers start to back away, the banks get nervous, and then you start to see a tightening throughout the chain of mortgages with a big impact on declining home prices, which panicked a lot of people, including the regulators. This is different in that the excesses are more in corporate finance, although private credit and all the FinTech and everything else, they’re the ones financing buy now, pay later loans. And for businesses like First Brands, they borrowed against invoices and they borrowed, it appears, multiple times on the same invoice. So, it’s a different dynamic, but when you have these blowups, it reveals the fraud and it reveals just the poor quality of a lot of the lending.
So, then you see nervousness and a tightening of financial conditions. And I would argue we’ve never had so many negative cash-flow, levered companies out there, and that’s private equity and just in the private sector and public companies also that are very vulnerable to a tightening of financial conditions where all of a sudden they can’t borrow new money. And it’s like the household, as long as you can continue to borrow on your credit card, you can stay current. You can borrow on one credit card to make the minimum payment on another. All of a sudden, if you can’t borrow new money, all your balances are a problem.
What makes this really interesting, David, and what I’m really concerned about is I look at AI finance as likely the unfolding greatest subprime bubble in human history. It’s going to take trillions of dollars for this build out, for this AI arms race, right?
Trillions of dollars for all the data centers and all the energy. We’re going to need enormous amounts of energy generation here to make this thing work. So, it’s going to take many trillions of dollars, and nobody’s worried about that today. It’s a mania. It’s a mania. Plus what’s interesting: here at the late cycle, you’ve got these cash-rich big tech companies, the Microsofts and Amazons and Googles, Meta, they have all this cash that they can deploy to this arms race, and that’s fine, but that’s not going to cut it. They’re getting closer to the point where they’re not going to be the big sources of finance for this build out. It’s going to be the public markets and banks. And this build out here is on a dream of what profits are going to be down the road. Nobody knows, but somehow it’s supposed to be enough profits to pay on seven, eight, nine, 10 trillion dollars’ worth of spending investment.
So, this is really risky finance that, if the markets tighten, if you start to have derisking/deleveraging, then this finance is suspect. And we saw hints of this, David, and we talked about this at the time. Back in April, with the Liberation Day market instability, all of a sudden you had fears of deleveraging and the AI tech stocks tanked. They were getting hammered. So, there was a tight correlation. The market recognizes this vulnerability. Well, since April, you’ve had just enormous liquidity excess. So, there’s not a worry in the world. You can dream about whatever AI investment you want because there’s ample unlimited liquidity. Well, that liquidity dynamic can change quickly, and I expect it to change.
David: I don’t think there’s an argument to be made against AI in the sense that it is revolutionary like the internet was revolutionary. You come to the dot-com era and the world is radically different in the aughts than it is in the ’90s. What you ended up with in 2000 and 2001 was the great culling and the distinction between those who survived to move forward and become a part of the actual internet revolution. And it seems like you could have that same dynamic with AI. The separation of winners and losers has yet to be determined. There’s so much money flowing. I mean, the 10 big AI names today, which have a combined market cap of a trillion dollars, not a single one of them has positive cash flow. They have no profits. So, in this environment, no one cares and the money’s flowing to them. Going through a market compression, maybe two out of 10 survive.
And the attitude today is, well, own them all and you’ll be glad you own the two that survive. I don’t think people have an imagination or we’ve forgotten what that culling looks like. Take us back to the early 2000s and the correction in NASDAQ, the correction in Microsoft, the correction in Amazon, because I don’t think many people keep those kinds of dynamics in mind. It’s all well and good when you’re making money, but on the other side of change in liquidity and a compression in price, there will be winners. There’ll also be losers.
Doug: Yeah. And David, what I would say, too, and when we think about the tech bubble or we think about AI, the focus of course is on the stocks. That’s what gets everybody’s attention. That’s where people are making the money. The issue, the serious issue, the problems for systemic stability, that’ll be on the credit side. That’ll be on the credit side. And back in the early 2000s, the tech stocks got creamed, but a lot of debt turned sour, a lot of telecom debt turned sour. WorldCom, Cloud, Global Crossing, there were a bunch of them. And what people forget today is that debt crisis that started with tech and telecom, by the time it got to 2002, there were serious concerns about liquidity at Ford. There was a corporate debt crisis that basically engulfed major US companies that were levered. The issue going forward here is we’re going to have trillions of dollars of tech-related borrowing.
Right now, you’ve got Oracle out to borrow 38 billion. You’ve got Meta is going to borrow another 30 billion. And to keep this arms race going— and that’s what this is, this is an arms race. To keep this going, you’re going to have just borrowing after borrowing after borrowing, and the numbers are going to add up. And again, it’s suspect credit because we don’t know how future profits are going to play out, but since it’s an arms race, there’s going to be a bunch of losers here, and there’s going to be enormous amounts of debt that’s going to lose, that’s going to be a systemic issue.
David: But for now, the music’s playing, so you’ve got to get up and dance. At market peaks, there’s typically a narrative which supports setting aside the conventional wisdom, whether it’s valuations or what you would describe as bubble dynamics, really any measure of excess. What do you think shifts the AI narrative?
Doug: An indicator that I now watch— My indicators kind of shift around, and my core indicators that I’m always looking for, the new ones, I’m watching Oracle credit default swaps. So, that is the amount the market is charging to buy insurance against a future default of Oracle. Nobody’s worried about Oracle defaulting. They’re going to borrow $38 billion, they’re in the thick of the greatest thing in the world, AI. Well, the market right now is saying they’re increasingly worried—worried is too strong—increasingly watching debt dynamics at Oracle. And I think post-First Brands, there’s much more focus now on credit dynamics generally because we’re starting to see a tightening of credit. So, now there’s going to be a lot more analysis that’s going to go into buying AI-related debt, I think, because the credit dynamics generally are starting to change at the periphery.
You’ve had the IMF come out, and they’ve warned about the bank exposure to non-deposit financial institutions. You had the governor of the Bank of England, Andrew Bailey, come out—very strong words—saying, the alarm bells are going off. The alarm bells are going off. We need to watch all of these dynamics. And Bailey at the Bank of England saying it reminds him too much of right before the great financial crisis when everybody was telling him things were fine.
So, I just think the environment is changing right now. And equities, they’re always slower to get onto these things than the credit markets are, but it is time now to really watch the credit dynamics.
I can tell you also, I watch every day the number of leveraged loans issued. We had 400 billion in the third quarter. Enormous number. That number, the issuance has slowed dramatically. High yield issuance has slowed dramatically. So, we’re seeing a lot of the things I would expect to see in a changing credit environment. I think the credit cycle has turned.
David: Talk to us about the concurrence of excess money and credit with technology innovation late in the credit cycle. The boldness of experimentation, the grandness of the narrative. It was RCA in 1929 and then the tech Wunderkinds in 2000. This is actually kind of a classic setup.
Doug: It is classic. And I’ve said that the parallels to the roaring ’20s are, to me, fascinating, but also frightening. In these long cycles, you don’t have these kinds of bull moves. You don’t have this type of market inflation unless you have these phenomenal new technologies. They go hand in hand. It’s the reason that these bubbles can last so long.
But the problem is, the longer the bubbles last and the more innovation you have, the more technology adoption, investment, you similarly have finance turning more and more aggressive, I would say reckless. And you get this late cycle dynamic where everything looks incredible if you look at what has unfolded during the boom in technology and investment. It’s hard not to look into the future and just feel like the future is really bright. It’s difficult not to see a permanent plateau of prosperity, as Irving Fisher did weeks before the crash in 1929.
It’s the same dynamic today. You look at the technology and you say, wow, this is unbelievable. Well, that’s why finance has done what it’s done, and finance is now late cycle deranged, where it creates its own demise with just this parabolic rise in systemic risk. You have all of this, you have huge growth in credit of deteriorating quality. So, you get this exponential rise in systemic risk that goes right along with the perception of endless prosperity and that’s late cycle, and it creates a lot of fragility that nobody sees coming.
David: Yeah. The complacency is amazing. And maybe there’s a correlation between positivity and complacency, whether it’s the markets or even you look at our debt and deficits, you can hear harrowing diagnoses and prognostications. You hear them long enough, and you just discount them. You’re like, “yeah, but it’s different this time.” We go from 37 trillion in debt in August to 38 trillion in October. And it’s like, “yeah, well, I guess we took it in stride.” This numbness to debt and deficits, this numbness to the deteriorating quality of credit being issued, what do you think snaps the complacency?
Doug: David, I would argue that the complacency we’re seeing today, it’s almost like textbook late supercycle type stuff because the system has gone through so many hiccups, so many financial crises. You could even argue it’s worsening crises at times, and we’ve always bounced back. The Fed’s always reflated, stocks always go to new highs, tech always comes with some new fantastic innovation. At the end of the cycle, if you’re not a risk-taker, you’re a loser. The risk-takers are in charge. They’re in charge of Wall Street. They’re in charge of corporate America. They’re in charge everywhere. In households, the husband and wife, who’s been the most aggressive risk-taker? They’re in charge now. That’s just the way it works at the end of the cycle. And to make money like people are making now—and these are lenders, financiers, borrowers, everybody’s making all this money—you have to disregard risk. You have to, or you’re going to miss opportunities.
That’s conditioned repeatedly over the long cycle to the point where you get where you are today, as you were in 1929, where nothing matters. I just know stocks are going up. They always go up and I’m playing it hard and I’m a genius because I’ve been right. And that’s where we are. And it just creates all this fragility because perceptions can change so quickly. Marketplace liquidity can change so quickly. Aggressive risk embracement can, within hours, turn into panic, risk aversion, market dislocation. So, it’s a fragility, it’s very tenuous, but it sure is powerful on the upside. These blow-off dynamics, my fascination never ends with them.
David: Many of your insights have been distilled through the ’87 crash, the chaos in ’94, ’98, 2000, 2008, more recently, 2022. Is there something that’s different in terms— You just referred to textbook late supercycle. Supercycle means something to you that might need to be explored a little bit. Is the difference between ’87, ’94, ’98, 2000, 2008 that we actually have a ginormous bubble in government bonds and it’s not a U.S. exclusive issue, it’s the G10. Is that the limiting factor this time? Why can’t we kick the can down the road?
Doug: I followed the ’90s bubble daily, intensively. When that bubble burst in 2000, 2001, I thought that was the big bubble. In 2002, I could see that they had reflated. It was now going to be mortgage credit. And I started warning of the mortgage finance bubble in early 2002. And that bubble was much more dangerous than the tech bubble because all of a sudden, you had the GSEs and AAA mortgage backed securities. You had these quasi-government backed instruments that had insatiable demand in the marketplace. That bubble could really grow, really inflate. If it’s high-risk debt driving your bubble, it can’t get too far because people will say, wait, wait, wait, no more junk. If it’s money-like stuff, that bubble has legs. Well, in 2008, of course, I thought the bubble burst again. Well, I’m out in April of 2009 warning against the unfolding global government finance bubble, potentially the greatest bubble in history.
And why was I saying that? Because we crossed the Rubicon. All of a sudden, it was clear that Washington was willing to open the floodgates with unlimited central bank liquidity, unlimited central bank balance sheet growth, QE, and unlimited deficit spending. So, for me, bubble dynamics had shifted from mortgage credit to the heart, the core, of finance, sovereign debt, and central bank credit. With insatiable demand there, that bubble had potential to go beyond any bubble in length and scope because of the nature of the bubble.
And here we are. It has done more than I ever would’ve imagined. What makes me worry today is I don’t know where the next bubble is because when this bubble bursts, you’re going to have government debt and central bank credit discredited, I believe. You’re going to have markets questioning if policymakers can reflate anymore. And if you have that type of dynamic unfold, I think that’s the ending of this long supercycle that’s been unfolding over 30-some years. That’s my concern today.
David: With those dates in mind and the shift from mortgage credit to sovereign debt, how does the next crisis of confidence unfold?
Doug: Well, what worries me right now is— I really don’t want people to think this is hyperbole, but I look at AI, crypto, financial instruments. This is the greatest mania in history. I look at government debt and central bank credit, the greatest credit bubble in history. I look at basis trades, leveraged speculation, all the leverage and credit system as the greatest leveraged speculative bubble in history. This is a confluence of really unprecedented things altogether.
So, where’s the catalyst? What goes first? Right now, we’re seeing credit go first. I thought it might be leveraged speculation that would go first. Right now, we’re seeing the issue is developing credit. Where it gets serious is if you have de-risking/deleveraging all of a sudden, the hedge funds start to deleverage. Then you could have an issue with liquidity in the Treasury market, which would be a huge issue.
You could have a stock market crash. It could be a huge issue. You could have unfolding problems that get very serious in private credit, leverage lending. You could have international currency instability because a lot of these dynamics that I’m discussing are turned into a global phenomenon. That’s why I don’t call it the government finance bubble. I call it the global government finance bubble.
You can look at China, you can look at Europe, you can look at Japan. You have accidents waiting to happen across markets and across the globe. So, I don’t know which goes first. I just know there’s fragility everywhere, basically. Everything looks fine as long as you continue to have leveraged speculation, you continue to have all this liquidity. It doesn’t work well in reverse. The credit cycle doesn’t work in reverse. The leveraged speculation doesn’t work well in reverse.
David: If 2008 and 2009 revealed that DC is willing to open up the floodgates, I think we can assume that London, Paris, Beijing, this is sort of a uniform belief, it just is going to take more money and credit to get us through a tight spot. What does that look like? In essence, is that perhaps what gold and the central banks have been front running? The reality that you have not just the U.S. dollar under pressure, because it has to come under abuse. If D.C. is willing to open up the floodgates of credit and money, and it’s global in nature this time, London, Paris, Beijing, and the rest, doesn’t that argue for more currency pressures, chaos, and volatility in currency markets than maybe—could be a stretch to say—we’ve ever seen?
Doug: Yeah. And David, I look at gold, silver, platinum, precious metals. I see that as powerful confirmation of the thesis. This is end game stuff here, and a lot of sophisticated players, they don’t know when it ends, but they know they want protection because we’re getting close.
So, I take the movement and the metals as evidence that we’re really, really late in the game. I look at China created— For their 5% GDP growth, it took them $5 trillion worth of credit last year. Over this cycle, this 15, 17 years, Chinese bank assets are up tenfold to 60 trillion. I look at what Japan has done. They’re 250% of GDP for just government debt, and I think the Bank of Japan owns about half of it.
There’s things that we’ve never seen in history all around the world right now, and that’s what makes this very difficult to play out. You don’t know if the problem starts globally, if it starts here domestically, but I don’t see any way around just a lot of instability in currency markets and bond markets and financial markets generally. I don’t see how we wouldn’t have that.
It’s just difficult to know that, I’ll say the sequencing of bubble collapses, which ones start to falter first because as we see, if you have problems at the periphery, what happened three weeks ago when you started to see credit issues with First Brands. Tricolor, and such? The bond market rallies. Why does it rally? Because it’s expecting now the Fed to be more aggressive with rate cuts. It’s expecting the Fed to get ready to do QE.
We saw this dynamic after subprime blew up in June of ’07, you had a huge rally in AAA-rated mortgage-backed securities that prolonged the boom. It prolonged credit growth, credit excess at the core. So you have a lot of different dynamics. I try not to think too far ahead because I’ve got to follow what might unfold on a daily basis.
David: So gold’s typically non-correlated with equities, and you would, or have in the past, seen markets move lower, equity markets move lower, and gold performs pretty well in those cycles. In this case, you’ve got equities moving higher and gold moving higher. What do you think’s behind that correlation? Do you think that stays that way or do we move back to sort of the non-correlated relationship?
Doug: Oh, I think it’s going to be non-correlated. Where it could be correlated—and we talk about this a lot, David. We talk about different scenarios, and one of the scenarios is that on a short-term basis you could have the precious metals caught up in a hedge fund deleveraging. That’s a possibility, and we’ve seen this dynamic before.
So you could see stocks get hammered and some pressure on the precious metals, but at the end of the day, I think one will prove a very good store of value over time and one will not.
So there will be a decoupling, but I see gold, the precious metals, this significant rise we’ve seen recently that’s correlated with the speculative blow-off in stocks, as just this dynamic that we’re late in the game. Systemic risk is rising exponentially now. So a lot of players are saying, “It’s time to get my metals positioning and hunker down.”
David: Interesting conversation with an executive in an S&P 500 company, CEO, just a few weeks ago. Private money, he basically said, “I want to own the best hedge funds on the planet, and I want to own gold, and I think gold’s expensive here and I don’t care because I know what it does at the end of a cycle. And it does some crazy things on the upside.”
And I think he’s going back to the most recent playbook of verticality in the precious metals market where gold’s at 200 and then at 300 and then at 400, and then at 500 and 600 and at six weeks it goes actually from 400 to 800, doubles in value as chaos unfolds.
The difference between the ’70s— Let’s talk that a little bit. What are the differences in this kind of a gold market versus the last gold market, which was resolved with Volcker setting rates to 18% and clamping down on inflation and solving some problems, which obviously had a negative economic impact. He helped precipitate a recession. What stops gold if the central banks aren’t able to ratchet rates higher as they did in the ’70s?
Doug: Well, this is such a different environment from the ’70s, and when it comes to the gold market, David, you obviously can speak much more eloquently on this subject than me, but from just a top-down perspective, the ’70s didn’t have QE. Central bankers weren’t trapped. Volcker was not trapped. He did what he needed to do to get inflation down. He put the screws to the economy, the financial system, credit, to get inflation down.
Central bankers today, they do not have that luxury. They’ve created this themselves, but we say they’re trapped. They are trapped. There’s no putting the screws to anything today to get inflation down, right? It’s not going to happen. And everybody knows with all this leverage, the hedge funds barely existed in the ’70s. You didn’t have all this leveraged speculation. You didn’t have the central banks as the only buyer of last resort for a multi-multi-trillion-dollar hedge fund community if they need to come out of their leverage, right?
So I don’t really see many similarities between now and the ’70s. The bull case for gold to me was much different. One was back in the ’70s it was a hedge against inflation. Today it’s a hedge against a lot of things, including the potential for a serious financial dislocation, and I’ll call it a crash. I mean, that scenario is not a low probability event, knowing how much leverage and speculation and excess we’ve seen over this long cycle. So I think gold protects against a lot of scenarios right now.
David: Do you see a first-mover advantage to either China bringing gold into its currency structure or into its debt markets in some way? I mean, Judy Shelton’s talked about backing long-term Treasuries with gold. Do you see a first-mover advantage to China announcing something or the US announcing something in terms of adding a degree of legitimacy to either their debt markets or their currency?
Doug: David, you again could speak to this better than me, but I have my own, maybe nuanced, view. I don’t think it’s possible today to have a gold-backed currency. What does that mean in China? Does that mean backing their $60 trillion worth of bank deposits? What does it mean? I mean, they clearly, they have a lot of gold, but that gold could disappear in a hurry if they start backing deposits and everything else. So I’m kind of skeptical of having all of a sudden this currency that somehow gives us the benefit of bullion. I’ll believe it when I see it, and I certainly would never trust the Chinese to create something that I would put my hard-earned savings in, as opposed to gold. But that’s just the way I look at it.
David: Yeah, I think maybe the Treasury market or, it’s not really the dim sum bonds, but if you had an assurance that your long bonds weren’t going to be inflated away, it may have nothing to do with the currency and everything to do with long-dated paper.
Doug: Yeah, I would just have to see the structure. I’m just skeptical because these are electronic journal entries, right? We talked about money and credit. These are debits and credits, this global general ledger of all these entries, and are you going to start saying, “Well, okay, these entries over here, we’re going to back with gold.” Well, then those entries are going to say, “Fine, let me have the gold.”
So I don’t know. But again, you studied these dynamics much better than I do. I’ve just over the years been a little skeptical that anyone would actually have the discipline to have a microcosm of a gold standard, because the gold standard worked not only because there was gold backing, but people believed in the system and they knew to protect the system they had to guard against credit excess, speculative excess, and all these other things. So people were very devoted to the stability of the system, and that’s what made the gold system work. The gold, plus people believed in it and acted appropriately to create a stable system where the financial obligations were tied to something of real value.
David: Today’s economists are a part of a cult of growth, and the idea of limiting that growth by having it bound by a hard asset, I think you’re right, it’s pretty low probability. But we see in the past where Bretton Woods broke down because there were too many paper obligations compared to the gold that was in the system. And you’re right, people didn’t ask for the paper anymore, they just wanted the gold. So in the end, don’t give me the synthetic, give me the real. That’s been the trend among central banks. Give me the real, I can’t be in an electronic journal entry anymore.
The Russians lost 330 billion with faith in electronic journal entries, which the US Treasury said, “Thank you very much. They’re now ours,” which electronically was very easy to accomplish. I wonder when the investor, the generalist, looks at gold the same way and says, “I just don’t know. Any version of paper promises to pay, whether it’s in the debt markets, whether it’s in the equity markets. Give me something real.” It seems like a focus on hard assets is a critical part of navigating what could be some very challenging, call it the narrows on the river where the water’s a little rougher.
Doug: Well, right now, if they want something real, I think Nvidia is really appealing to them. So I think a lot changes when this mania breaks and the old notion of store of value all of a sudden is important to people.
David: Yeah, for a long time I’ve benefited from reading the Credit Bubble Bulletin. You put more than 10 pounds of mud into a 5-pound sack, and it’s a significant effort. I look back at your CV, your resume, and it’s market veteran, it’s analyst, it’s chronicler of one of the greatest bubbles of all time, and I’m appreciative of the work you’ve done in-house for us, and which you continue to do with the Credit Bubble Bulletin is almost like a general— It seems almost like an act of goodwill. If people were paying attention, I think they will come to appreciate the detailed analysis that you’ve been doing for many decades now. So we appreciate your insights and appreciate your wisdom. Appreciate your guidance. Appreciate your mentorship. You’re greatly appreciated.
Doug: Thanks so much for the kind words, having me on, and I so deeply treasure our relationship, and just thanks for everything. Thank you very much.
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You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany and our guest today, Doug Noland. 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.
