The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“So again, we come back to this context of political theater, where whether it is Republican or Democrat, they are promoting, not only certain ideas, but promoting ways to pay for their ideas. As we, an informed electorate, go to the polls, I think we have the opportunity to hold them accountable, and understand what they are doing and trying to accomplish via the exchange rate, via their monetary policies, and what have you.”
– David McAlvany
Kevin: David, my wife and I were watching Good Morning America today before I came in. Trump was on and he was saying, “Oh, no, no, my rallies are not violent, they’re love fests. They’re absolute love fests.” I’m not going to try to be political or pick candidates here, but I don’t know. I had a hard time thinking that any of these rallies are love fests.
David: Love is hate, war is peace, and my son has been recently asking about these sorts of political assaults and verbal indecencies that are too common to a campaign trail. He is wondering, and I think it’s pretty decent of him, why anyone would vote for someone so rude and obnoxious, and he’s not just thinking of Trump, he’s thinking of a number the comments and barbs that get thrown hither and yon. And I think he’s reacting to the contrast of what we expect at home, which is a basic level of decency and respect in communication.
Kevin: Right. Your son is how old at this point?
David: Nine years old, almost ten. And when you disagree on an issue in our household you can do that, and you let the issue stand on its own. Relationship is a totally different matter. The issue is the issue and it’s on the table.
Kevin: Right.
David: We don’t bring personalities into the mix.
Kevin: You don’t go name-calling.
David: No. Exactly. When you disagree on an issue, you state your case. The verbal assaults, the ad hominem attacks, that is, the attack against the character of a person that disagrees with you, is cheap, and to some people, even my son, it reveals some combination of weakness of mind, maliciousness of spirit, or even an assumption of personal infallibility.
Kevin: Dave, last night the Bachelor picked his new bride, and they say a lot of America was watching to see the Bachelor pick his bride. And then you have Survivor, as another reality program. You have the Bachelor, Survivor; you have Dancing with the Stars. You have Trump’s show before he decided to run for office. We have this reality TV mindset where you have to continually create conflict.
I’ll give you an example. The original Survivor program. If you ever study survival situations, you never pit everyone on the island against each other, because everyone ultimately would die. Teamwork is what is necessary. What we’re seeing right now is a debate, definitely a Republican debate, but we’re seeing debates every few days on TV because they are just bringing such great ratings.
David: This last year we had Oliver Sacks, the neuroscientist and author who died. In one of his case studies on aphasiacs he shows how this group of institutionalized patients that are generally catatonic, can’t help but instinctively laugh at the lies and half truths that are display in the political theater that we call an election. And it was funny because their team of doctors who was caring for them would notice this periodic uncontrollable laughter, and then it would go quiet for months and even years, and then again just this uncontrollable laughter. And it tied to the political cycle. And it turns out that aphasiacs have an instinct for lies and they think it’s absolutely ridiculous. So, I wonder what the aphasiacs’ response would be to this year’s schoolyard name-calling, the bullying in the election cycle. And I wonder if some of the self-righteousness, the braggadociousness on the campaign trail, wouldn’t be a bit denuded or stripped of its pretentions under the gaze of the mentally handicapped. I’m beginning to wonder if there is more mental handicap in the general public than that with the aphasiacs who Oliver Sacks writes about who so clearly see something that perhaps the rest of us are blinded to – the lies and subterfuge of our political class.
Kevin: When they were playing, last night, some clips from some the campaigns, I told my wife, “This is something that really looks like it was hatched in a Saturday night live skit. It didn’t seem real to me. Now, I wasn’t laughing. Maybe it’s because I don’t recognize the humor in lies.
David: (laughs) The other morning we saw your family out at a breakfast, Sunday morning, and I had just finished playing a Saturday Night Live skit for the kids, and it was Donald Trump and Ben Carson, Ben Carson holding a big steak over one eye, and Donald Trump, at least the portrayal of Donald Trump in the Saturday Night Live skit, saying, “No, no, really, I do like black people. I’m not a racist. And I’m all for peace.” And here is, again, that piece of steak over Ben Carson’s eye.
Kevin: As long as your kids see just how ridiculous this is.
David: Well, unfortunately, there are some rumblings around the dinner table, and the sense is that if the current cast of characters are the most electable people in the nation, that something is wrong with the nation. And maybe the cast of characters can’t help but be what their culture has encouraged, and in sense, created. This, unfortunately, is politics imitating life, like art imitates life, and we are now venturing into the grotesque, the uncensored reality show we call an election.
Kevin: It is probably good that your son is only ten because I think he might become revolutionary the way he feels about these things.
David: It’s a good thing he can’t vote right now, and has to wait until he is 18, because that is exactly right. And I think he would probably lead the charge with the younger set in our house. They would be pushing for revolution.
Kevin: And Dave, I think it’s important. We can talk about these things, we can be disgusted with the politics on the stand, but it is going to affect people, and we have seen the world go through periods of time where there is more cooperation. We have talked about the days of the gold standard years ago. And then there are times when nationalization sets in, World War I, World War II, and can lead to an awful lot of bloodshed. That can happen within a country, but it can also happen within a nation. And I know that we talked last week about how you arrive at new guests. One of the questions that we have had is this: If we’re really moving toward a new regime politically, if we are moving toward a new regime currency-wise – the dollar has been a standard, almost like a gold standard now, for 40-some odd years since we went off the actual gold standard. If we’re moving toward that we really need to be able to prepare ahead of time for who will benefit and who will lose.
David: Yes, I think the Commentary is a bit like an intellectual collage, where you have ideas and people, past events, and forward prognostication, that are all connected in this web that, again, they may be on opposite sides of the web, but still interconnected in some way. As you mention, we have been through periods of amazing trade cooperation and globalization. Harold James, a guest of ours a number of years ago, who has been with us a couple of times, has expressed his concerns that we have come to the end of another period of globalization.
Kevin: Which could actually be also termed cooperation. For the person who bristles against the word globalization, we’ll just talk about actual peaceful coordination.
David: Right. An increase in trade and international business. The flip side of that is the haunting possibilities of nationalization and an inward focus, which if history is a guide, increases the possibility of geopolitically conflicting priorities, one country to another, where you are focusing on your own self-interest, at the expense of your neighbor, and in the extreme, this is the stuff of war.
Kevin: It reminds me of when you interviewed Otmar Issing, who was the head of the European Central Bank for seven years, one of the backbone creators of the euro. It was very clear, when he brought out why he was motivated to do that. He had seen World War II, and he didn’t want to see that happen again in Europe.
David: After eight years as an ECB director, he would probably put it more elegantly than I can, that if Europeans don’t pull together and align their interests, they are going to pull apart and fight for more domestic economic priorities. And given the closeness, both in time and geography, in continental Europe, to the Great Wars, you can appreciate why the European Union has been championed. Geopolitical and political concerns are the back story to the monetary union. They had to settle for less than they wanted. That is all they could get, but the real story is the geopolitical and political concern.
Kevin: Politics a lot of times, we can point out, is about special interests, but when we talk about currency regime changes, you and I have talked, Dave, over the years, and said, when the dollar system, this dollar reserve system, petro-dollar, gold-backed dollar – when it ultimately is replaced, who will be the special interests that gain?
I mentioned last week, one of the ways that you come up with guests, and I love the fact that you come up with guests based on bibliographies of books from other guests, and Jeffry Frieden is a person who can answer the question about what does a regime change look like, what does a currency regime change look like, and how does it affect special interests?
David: Howard James and Otmar Issing set the stage for a broad discussion of the broad brush strokes of political and economic history. Otmar Issing, certainly, as a director at the ECB, narrows the focus to monetary policy and the designs to create economic growth via a centralized monetary policy system. But taking it one step further is Jeffry Frieden, Harvard University Professor of Government, and next week we will discuss with him his perspectives on currency politics.
I came to know Jeffry’s ideas back in 2009 as I leafed through the bibliography of Michael Pettis’s book, The Volatility Machine. Michael spoke highly of his analysis, both in person, and also in his book he referenced him several times. So I have read a bit of Frieden’s work since then, mainly on Latin American debt and currency crises, and now on the politics of currency regimes. Why is this important? The thesis that Frieden proposes is that every currency regime is driven by politics, and there are distributional benefits that each type of currency system confers to specific blocks of voters.
Kevin: Yes, I think his thesis is, the most important price in any economy is the exchange rate, and we could actually add to that, because after reading the book, the most important political tool can also be the exchange rate, but it does affect particular special interests.
David: Right. So we consider not only the past currency regimes, which we have done before, the gold standard, the gold exchange standard, the Bretton Woods system, the free-floating system that we have today, but we look at the future systems even now being debated, and we should keep in mind that a particular monetary system offers benefits to some constituencies at the expense of others.
Kevin: Let’s go back to one of our favorites, Dave. Let’s go back to the gold standard back in the 1800s up through 1914. Granted, it benefitted the majority of people, but there were still people who were calling for that to be abolished so that they could have more monetary flexibility.
David: That was an age where households didn’t have very much debt, and so what was of particular interest was the cost of goods that you needed to provide for your family. And if the cost of those goods went down, it was to your benefit. If you were a creditor, if you were part of the banking elite in New York City, or any of your money-centered capitals of the world, you were very interested in stable values so that when you loaned out money, you were paid back with money that was worth the same as when it was loaned out.
So you can see, between a creditor and debtor, debtors would prefer inflation to allow them to pay back debt with cheaper currency. Creditors prefer the opposite. So, there are beneficiaries, and people who pay a hard price, even within the context of the gold standard.
Kevin: Let’s go back to Bretton Woods, just a little further forward, isn’t it interesting that the victor of a war is the one who sets the new currency regime standard. It seems at that point to prove the point that it is a political tool.
David: In the international world, this became acute in the 1960s where Jacques Rouffe began to describe the unfairness of the Bretton Woods system which allowed for the U.S. government to run deficits and never have an adjustment to pay, what he called the deficit without tears, so we could run trade deficits indefinitely and never see a real economic adjustment. And so, you have the gold standard, we have had the fixed, but adjustable Bretton Woods system which lasted from 1944 to 1971. Now we have a generally free-floating currency system, and there is rumblings in academia and in policy circles that a new international regime is needed to balance and to coordinate international economic interests.
Kevin: One of the guests that we have had on this program, Barry Eichengreen, is calling very loudly for a new currency regime that would dethrone the dollar.
David: Right. And I can’t say that I agree with him on that, or with very many things. He probably is the voice which has bias more in academics against gold than any other voice. And what is fascinating to me is, even reading through Frieden’s book, his indictment of the gold standard is really a parroting of Eichengreen’s book Golden Fetters, in which I think Eichengreen unfairly confuses the difference between the classical gold standard and a bastardized version of that, the gold exchange standard, which was substituted in 1922 following the conference of Genoa.
Kevin: Which actually allowed them to print paper money and call it gold, so it wasn’t really the true gold standard at that point.
David: Right, so paper could stand as the reserve asset and be moved around instead of gold. So again, the adjustment, the automaticity that you had with the gold standard, was all of a sudden compromised, and yet Eichengreen blames the 1930s depression on a standard which went away in 1922, yet he says, “No, no, no, it’s the gold standard 1933 which is to blame for the chaos of the 1930s.
Kevin: We’re not talking about a basic academic discussion here, Dave, we’re talking about the future of all of our listeners, because we probably are, over the next several years, moving toward a new replacement for the dollar world reserve currency system. Can that be done? How can that be done?
David: Again, Eichengreen is an influential voice in the conversation, and so he should be engaged with. And like we said earlier, he can be engaged with respectfully. I’ve had guests on the program that I don’t agree with, but have certainly expanded my mind, in some instances changed my mind, but certainly we can explore ideas and spar about them to bring clarity to the issues. And will we have a new international monetary system within a few years? Can that be done? How has it been done in the past? Who would be, in our context, the winners and the losers?
As I’ve explored some of these ideas with Michael Pettis, and with others, it is clear that there has been, and there always will be, a massive amount of conflict over which regime should be favored, and what levels of appreciation and depreciation should be allowed. Frieden argues in his book that the reason for the conflict is, really, basic self-interest. And that self-interest pools into something that we call (laughs) a special interest group.
Kevin: And Frieden points out, when we talk about a currency regime, we’re not just talking about a particular country, what we’re talking about is a decision as to whether that currency floats up and down in value…
David: Is pegged to gold.
Kevin: Is pegged to gold, or is pegged to another currency, like we’ve seen with China.
David: Yes, two classic pegs today, the RMB is pegged to us, and the Saudi real is pegged to us. And it means that any fluctuation that we see in the dollar automatically changes the value of the real or the renminbi, and gives them vis-à-vis, or relative to, other trade competitors, an advantage in their trade with us.
Kevin: So let’s look at a Chinese manufacturer, because if we look from China’s perspective, manufacturing has really run the economy now for the last 40 years, and so they’ve had the most political gain and economic gain by having a currency that they can continually devalue with the dollar. They can provide cheaper labor, they can provide cheaper goods. But we’ve talked to Pettis, we’ve talked to Roach, we’ve talked to Minxin Pei, where there is a shift in China at this point, maybe to more stable monetary policy, maybe not a peg to a devaluing currency so that the consumer can now benefit.
David: And Stephen Roach, I think, not only in his tenure with Morgan Stanley, but now as professor of economics at Yale, does a good job in saying, “Look, they’re making great progress, they don’t have to advertise quite the way we do, keep in mind they’re political system is different than ours, and they don’t need a cent to move forward. They will make their plans and let the chips fall where they may. And they are moving to empower households and household spending, which again, would imply a stronger currency compared to the last 30-40 years of a weaker currency, and the exchange policy suggests where the government wants the culture and the economy to go, and thereby where they want the country to go in its international standing. “
Kevin: So it really boils down to what you do for a living or what your socioeconomic position is, as to what you are going to vote for as far as currency regime.
David: That’s right. There are costs and benefits to every currency system. Now, in recent months, in perhaps an even broader context, we have considered the proposals by Michael Woodford at Columbia, Ken Rogoff at Harvard, to effectively implement negative rates as a monetary policy tool. Academics would like to change the medium of exchange to what would be, essentially, a cashless society, all debits and credits.
Kevin: Yes, so we’re not only changing regime, but we would be changing the medium of exchange. The medium of exchange right now could be cash in our hand, or it could be writing a check, credit card, what have you. What we are talking about now is a medium of exchange where cash would no longer be an option.
David: Right. So what we have with currency policies and exchange rates is that they are always highly politicized because there are economic benefits that they create for particular special interest groups. In this case, there is the added bonus of monetary policy effectiveness. At least, the belief is that there is monetary policy effectiveness if you change the way we handle money. Organizing an idea like this, the idea of a cashless society, creating a social trend is never value-neutral or politically neutral. So if the trend is toward greater ease of transaction, you can recall that those same arguments have been made in the past. You go back quite a ways, but you go back to the 1860s and the proponents of greenbacks actually created a greenback political party to run for president and represent them in Congress.
Kevin: To fight against the gold standard.
David: They fought against the gold standard, they didn’t want to return to the gold standard, they wanted to promote greater flexibility and a greater supply of dollars, and the same desire for more money in the system, and in more common denominations, also defined your elections in the 1890s, again, a fight against the gold standard, but here in the United States you had parties fighting over whether the gold standard should stay, or we should replace it with a silver standard.
Silver being more available allowed for a greater degree of currency depreciation than gold did. And lo and behold, there were special interest groups that would have benefitted from that currency depreciation, as there were special interest groups that did, in fact, benefit from currency stability under the gold standard.
Kevin: Let’s go ahead and unpack that from that time period because I think it is interesting to see who would benefit. You had mentioned that the bankers who were giving loans internationally wanted to see their currency stay stable, so they liked the gold standard. The households who were enjoying, actually, the benefits of slight deflation which put more money in their pocket, they enjoyed the gold standard. But the farmer, someone who is selling wheat competitively, worldwide, would love to have seen an appreciating currency because inflation actually helped the farmer get higher prices for his grain.
David: Higher prices for his grain, and at a lower relative cost in the international market, so improved trade competitiveness. Again, you have to move beyond the rhetoric to this simple fact, and this is what Frieden argues for, and we will discuss further next week, you have direct self-interest in the choice of a monetary regime. And we continue to survey history on the Commentary, and as we survey the current landscape, looking at what is money, that discussion is alive today. The discussion was alive, and was a very blustery and boisterous discussion in the 1890s and the 1860s. It has been contentious because self-interest expresses itself with particular candidates when you come into the political cycle. This political cycle is no different.
Kevin: I’m thinking of an analogy, Dave. When you go into an arcade, like a Dave and Busters, what have you, and you play some of the games, they punch out little tickets that can be redeemed for prizes. In a way, that’s a little bit like controlling the currency regime. You know that Dave and Buster’s is not losing money every time you walk away with a Teddy bear because you are using their money and it takes a whole lot more of their tickets to buy that than you probably could go buy with the dollars that you spent playing the game.
Now, apply that to the entire world. China has been looking at America here for decades, punching out their little prize tickets called the U.S. dollar, and they have to buy their oil in these little prize tickets – they have to buy everything in these prize tickets – and at this point they are saying, “You know what? I don’t think I want to do that. I think I’ll go ahead and buy that Teddy bear, I’ll go buy that oil, I’ll go do what I need to do with my own currency.” That seems to be one of the key aspects of the new regime change, and we’ll have to see whether that is a depreciating currency or a stable currency and how they are going to validate it.
David: So whether it is the Chinese response to our monetary posturing, our expectation that they either raise or lower their currency, I know that it’s not the first question that comes to mind when people get out of bed in the morning – “What is money? What is the nature of our monetary regime?” And I’m sure that there are fewer people today who are connecting the dots between economic and political self-interest tied to the prevailing monetary system, but votes matter in a democracy, and people react according to self-interest even if they don’t understand the nature of causation between exchange rate policies and economic effects. And your average bloke can feel which circumstances are favorable, or harmful, to him.
Kevin: Even though he may not know why the pain or the gain is coming.
David: Right. But it can become a political issue, or a political problem, when the effects of those monetary systems are felt by the common man. We gave one example earlier of the farmer, but I think, just to reiterate, if you have a farmer who is growing soybeans and corn in Iowa, he sells the product and receives a price for it. The price of that product is directly impacted by the value of the currency it is priced at. And if the currency is weak or deliberately devalued, you get more currency units for that product. And it is thus priced more competitively relative to other global producers. So, if the currency strengthens, on the other hand, you get less currency units for the product, and it is as if the prices went up, eliminating competitiveness.
Does it matter? Listen to the political rancor – “We want to make America great.” What do we want to do to make America great? Do we want to bring jobs back to the United States? Sure. Do we want to bring manufacturing jobs back to the United States? Okay, let’s say we do. Let’s say we bring back a million-and-a-half, two million manufacturing jobs to the United States. Do you realize that since about 2008 we have about a million-and-a-half new jobs in the restaurant business, specifically, waiting tables?
Kevin: Right. It’s service, it’s not manufacturing.
David: Yes, and we’ve lost that amount, so we have gained a million-five, and we’ve lost a million-five. We want to bring back a million-five in terms of jobs that are specific to the manufacturing industry.
Kevin: You have to have a depreciating currency.
David: It is more favorable to have a depreciating currency so that your products are priced more cheaply in the open market. So, when someone says, “I want to bring jobs back to the United States, one of the things that they are implicitly committing to is a depreciated currency. What is the effect for the saver or the person living on a fixed income? It means that your dollar buys less, so while it is good for the general economy, it may be bad for you.
Let’s way you’re a member of the AARP and you’re already struggling to make ends meet, bringing back jobs to the United States and supporting the manufacturing base here in the United States – guess what? It implies a weak dollar, allowing for us to compete in the international markets more effectively, because I can tell you right now, 50 dollars per hour doesn’t compete in the international markets. It doesn’t. With all the benefits and everything that gets put into and packed into the U.S. worker’s pay, we are not competitive. But one of the things that can balance that out is the exchange rate.
Kevin: So let’s just clarify. If the currency depreciates, the manufacturer who produces something here in America that sells overseas, that helps him. But if the currency depreciates, the household really feels it.
David: Right. So at odds with the farm community, at odds with the tradable goods sector. You are selling products, not just in the U.S., but in the international markets. The household pays the price. So when you experience a currency depreciation, the value of the currency goes down, the household feels it via an increase in the cost of goods. The result is that a household can’t buy as much as they could otherwise on a static income. This is your inflation squeeze. On the other hand, if the currency appreciates and buys more, enables you to get more with each dollar, you get the benefit of increased purchasing power.
Kevin: A little bit like gasoline has been over the last year.
David: That’s right. You get to buy more gasoline for less money, as if your static income had been increased. And it was, in terms of purchasing power. You have an implicit pay increase with a strengthening currency. And you can recall from previous shows where, Kevin, you and I have talked about the 19th century, which was good for the average worker in terms of an increase in real wages and an increase in purchasing power. It was because of the monetary system then in use.
Kevin: The gold standard.
David: That’s right. So price deflation, which was a real state of affairs during the 19th century, was objected to by farmers and exporters, but households were a sector that were benefitting greatly from the gold standard. And this is just one example, but it illustrates the economic benefits of currency appreciation or depreciation. There are winners, there are losers. And appreciation and depreciation are affected by the type of money system chosen, and by the degree to which central bankers keep flexibility in their monetary policies. So, look at what central bankers have been doing the last several years and you have this on full parade. Think interest rates. Think quantitative easing. Think paying interest on excess reserves. Think monetization or the direct purchase of assets. These are the various forms of monetary policy which affect the exchange rate, and in the end, benefit or penalize particular political constituencies.
Kevin: That’s what Frieden’s book is about. He makes the case that every shift in monetary regime relates to these political factors – who wins, who loses?
David: This is an important insight, because as we re-analyze the current global monetary system and we consider the priorities of current and future politicians, who are they pandering to? Why? How is that expressed in terms of an exchange rate policy? A leader and their advisors – you are going to find that they have a particular vision for what will be the source of growth in the future for our country. Our political and economic policies will promote a certain direction for growth, and that is undergirded by policy preferences in the price of money, the value of money, the exchange rate – that’s what we’re talking about – and that exchange rate is inherently political.
Kevin: As we come into an election year here in America, we may also see whatever party gets in is going to have their own opinions as to how we change our exchange rate policies if we do. But let’s look at the Chinese, because there is a definite shift. The five-year plan, as they come up with these new five-year plans, this time around it’s to benefit the consumer. China is trying to establish what America did decades ago, and that is to invigorate the consumer to go consume.
David: Right. They are a perfect example in real time of how an undervalued currency promoted manufacturing and exports. They did that for years. That game is up. They recognize that it’s not sustainable and they don’t want the same dependencies on the U.S. economy and on Europe, and they can promote greater independence by generating growth internally via consumption. And they have begun to accomplish this. Their last five-year plan was promoting not only an improved value in the currency but a raise in wages, which they have begun to do. This is starting to fuel consumption. It is starting to empower household spending over exports. But they are faced with a political challenge.
Kevin: It’s the old guys who made their way by manufacturing and selling cheap.
David: That’s right. The political challenge is that you have the old vested interests that are not happy with losing the currency subsidy that they held for years with an artificially devalued currency. So, the currency served one special interest group. Now it’s going to serve another. It’s this way. Anywhere in the world, it’s this way, at any time in history. And as a saver, and an investor, it is particularly relevant to you. This is what we were talking about earlier. The most important price in any economy is the exchange rate, because every price is impacted by the currency.
Kevin: So for the listener who is wanting to have an idea of where we are going with this, Frieden will be with us next week and he will be able to explain currency politics. And then in a couple of weeks after that, I think you’d like to have Michael Pettis on so he can address directly what you are talking about with China.
David: That’s exactly right, because there are major changes in China, and I don’t think there is anyone better to discuss that with (laughs) with the exception of Stephen Roach or Minxin Pei, a couple of the other folks that speak to specific issues within the Chinese context.
Kevin: Let’s shift to the economy just briefly, Dave, before we wrap up, because we’ve talked before, one of the best ways that you can see whether an economy is booming or busting is by actually looking at the inventory on the shelves. If inventory is building and it continues to grow, things are not selling.
David: Right. We have a positive jobs number, which everyone look to, again, and says, “Look, this is irrefutable proof that the economy is improving.”
Kevin: It’s irrefutable proof that it’s an election year, Dave.
David: (laughs) Well, you say that. You say that. I know what you mean, and I think some of our listeners do, too. If you look into the details of the jobs number, we did last week, to say, “Look, there are some things that we just don’t like, particularly, retail continues to hire, which is, at this season of the year, something that is sort of preposterous. And then, let’s move over to what we have as evidence for inventories and sales. For the second month in a row, where wholesale inventories are on the rise, even as sales are falling further. And they are now at levels that you would expect to see in the context of a recession. So that ratio of inventories to sales is sending a very clear signal. And it is inconsistent with the jobs numbers, it is inconsistent with the details within the jobs numbers which say, “No hiring is going gangbusters in retail.” And you, as a listener, as an investor, have to decide which of these numbers is most easy to manipulate and control toward a political perception and outcome.
Kevin: We talked about how currency regimes and currency policies can be political, oil is one of the most political prices, as well, and I think it is worth looking at the amount of oil excess that is on the market right now, and seeing what direction the price goes.
David: We have had a great bounce off of the lows, not a bounce that I’m interested in playing or putting confidence in, in part because you look at, again, just basic supply and demand fundamentals, and the supplies are still too high. There is some suggestion that U.S. production is falling, but quite honestly, it is not falling fast enough. And we have new supplies still coming online. Cushing, Oklahoma is probably the deciding vote in the oil market. They have capacity for about 73 million barrels, they are 64 million full, and when storage capacity reaches its limits, you have a fully flooded market, and I think supply will weigh on price. We haven’t turned up yet, not in my opinion, and I wouldn’t trust this rally.
Kevin: We talked a little bit about Mario Draghi’s action last week. Draghi is doing everything he can to try to talk the euro down.
David: And this ties directly into our conversation next week on currency politics with Jeffry Frieden, because the unification theme in holding the union together, what he is attempting to do is devalue the euro and bring more economic activity into the eurozone thereby. And yet, what happened was very interesting. He didn’t get what he wanted. What did he do? He increased the purchasing limit from 60 billion to 80 billion a month, which was a big deal. He cut the deposit rate for banks.
Kevin: Negative, yes.
David: Negative 40 basis points. They’re paying 40 basis points to put money on deposit with the ECB, and then he opened the door to buying corporate bonds as a part of the quantitative easing program. What is interesting is, most of the eligible bonds are French and German bonds, the two largest economies in the eurozone, and there is somewhere between 418 and 550 billion dollars which are ready to go into that purchase program. Again, I say he didn’t get what he wanted because what happened to the euro? The euro moved up after an initial down stroke, which was not the intended course. So your currency markets and your market participants listened to what he had to say, looked at the actions taken, and because he ended his sentence with, “And we don’t expect to do more of the same,” he shut down the imagination and the possibility of extrapolation in the marketplace where your market participants would have said, “He’s done an extra 20 and he might do 20, 40, 80 more.”
Because he said, “We’ve done this, but probably no more,” that extrapolation was not allowed, and all of a sudden, the currency market, instead of depreciating, appreciated. And it did not accomplish what he wanted, so he is going to spend an extra 20 billion a month monetizing corporate loans along with government debt and bank debt (laughs) and he’s not even going to get anything for it.
Kevin: As we talk about all of these things, Dave, I think about something that I’ve tried to do for the last three decades and that is, all this currency policy stuff that affects us – Mario Draghi, the Chinese, the United States, the guys who are running for elections, all of these people can affect my bottom line, and so actually, I can choose to put my family on a gold standard, go back to the old days and basically turn all this paper garbage into gold, and then redeem it when I need to actually spend it. I think that is something that every listener could probably consider more of. Cash is many things, but probably the greatest form of cash is gold, itself.
David: Richard Russell described gold before his passing as real wealth, not as a commodity, just as a form of real wealth. And perhaps his suggestion was on the high side, for some it may be on the low side. But he said a standard fare, if you are managing intergenerational wealth, you must have at least 3,000 ounces of gold. That’s a decent stake in the gold market.
Kevin: I would say.
David: But just as you described, he viewed it as the basis for everything else, which is how gold functioned in an economy, it was the basis for everything else. It was reliable, it was stable, it was disciplined, and it forced governments to live within their means. So again, we come back to this context of political theater, where, whether it is Republican or Democrat, they are promoting, not only certain ideas, but promoting ways to pay for their ideas. And it’s important to recognize that behind every price is a story, and in this particular story we have constituency groups which will be pandered to and taken care of, and others which will be penalized. So, as we, an informed electorate, go to the polls, I think we have the opportunity to hold them accountable, and understand, perhaps more than they do, at a certain point, what they are doing and trying to accomplish, via the exchange rate, via their monetary policies, and what have you.
