The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“We are on the cusp of once-in-a-generation opportunity, a wealth transfer that occurs when assets get very, very inexpensive. And the question is, do you have liquidity in the most reliable form? And yes, that does mean devoid of counter-party risk. That’s imperative. And if you can answer those questions, I think the next three to four years are absolutely thrilling for you, instead of terrifying.”
– David McAlvany
Kevin: I remember the first time I played musical chairs. Honestly, I really do. I remember the scene, because it was such an unusual game to me. Here we were, I was in kindergarten, there were probably 12 kids, and the music starts and these 12 kids, and I was included in that, circled these chairs that were in the center of a circle, and there were 11 chairs – 12 kids, 11 chairs. Of course, we all know how the game goes, when the music stops, every kid, all 12, try to find a chair. There are only 11 chairs, so there is one kid left standing. You remove the kid, you pull a chair out, you play the game again, and you do that over and over and over. That’s how the game is played.
Dave, the reason I’m bringing this up is because for years we have talked about how the gold paper market is a lot like the game of musical chairs. At one point there were 100 players and only one chair. Earlier this year there were 300 players and only one chair. But the statistic right now is just blowing my mind. How many players, Dave?
David: 542-to-1, which puts it at an all-time high. If you’re looking at registered owners versus the physical inventory held there at COMEX. Interesting article by Byron King from the Daily Reckoning, which was reprinted in the Business Insider. I think it is just worth thinking about, the normal game of musical chairs is where there is only a minor deficiency – 11 chairs, 12 players.
This is the opposite way around. In this article they provided the updated numbers for the ounces available on COMEX. And as you said, we have always considered 100-10-1 a very big deal. In terms of musical chairs it’s really not much of a game to have one chair and 100 players unless you’re a spectator, because if you’re a spectator it’s like mixed martial arts or something. If you fancy brawling, that’s what you have with those kinds of ratios. The numbers soared in recent years, as you mentioned, to 300 claims, and that was as inventories dropped. And now we have, not only new entrants into the paper gold market, but we also have the inventories which have declined, not been increased significantly. So the ratio has exploded.
The March numbers, registered owners, those with a claim to the gold, 542, versus the ounces available in the COMEX depositories, one. And as Byron says, your child has 30 times better odds of applying and getting admitted to Harvard, Yale, and Stanford than does a COMEX contract holder of walking away with one ounce of gold.
Kevin: The key is, of course, in any musical chairs game, if you don’t want people to find out that there are fewer chairs, you have to keep the music going. That’s the key. You can’t stop the music, or lift the needle, so to speak.
David: We suggested a run on the London vaults a few weeks ago. COMEX is the same here in the states. It is not if – that’s not the question – it’s when you see the price of gold and silver move up, say, $100, not in a week, but in a day. It is going to be a new experience for most investors to see the supply and demand disparity in the physical market play itself out in an exponential move in the price.
Kevin: This has been going on for a while. Let’s face it, for the last 10-15 years they have been able to keep the music going to a degree. We haven’t seen what you are talking about. But at some point the music has to stop.
David: The dynamics are there, and I think the trust factor has been eroded for the last 10-15 years. So when confidence, which is a very critical variable – when that has shattered, then you see the mad dash for who can secure what. And it is not at the market price, it is at any price. And my suggestion is, you don’t buy when you need to, because by that time it’s too late.
We were discussing the other day, triathlon related things, and we’ve got our big race coming up in about three weeks. And the reality is, you need to fuel your body before your body tells you what you need. You fuel when you feel fine so that you continue to feel fine, and sometimes, when you are trying to meet a need, when that need is obvious it’s tougher to do that. Anticipation is the operative word here. Anticipation is key. Asia has already done that. China and India taking major stocks of gold off of the market. Interestingly enough, Texas may be doing that, as well, in terms of a work of anticipation. Be ahead of the curve, not behind it.
Kevin: I’m wondering if there are a lot of people who are already starting to see this break in confidence because ETF buying of gold, tonnage of gold, in the exchange-traded funds, usually goes down when the price of gold goes down. People get scared, they liquidate, but in this particular case, over the last few weeks, gold has dropped 1½% roughly, and the tonnage on the ETFs has increased pretty substantially.
David: The normal behavior over the last four years has been, on anything that would represent good news for gold, the price goes down, and on anything that represents bad news for gold, the price goes down. So, it didn’t matter, good news or bad news, the price was going to go down. And a lot of the negative movements, a lot of liquidations came from exchange-traded funds. So give them an excuse and they would be liquidating.
Exchange-traded funds give you the ability to buy a proxy for gold and have it in a London vault. I’m not sure that I necessarily want it in a London vault. I might rather want to have that in my hand. But the issue is this. What we are talking about is the price is now in decline, or has been over the last couple of weeks, after reaching a peak, I think it was May 5th, just above 1300. It has been in decline and yet the tonnage in the ETF has expanded every day.
Kevin: Obviously somebody is buying.
David: Yes, exactly. You said about 1.6% decline. Bloomberg covered this and the ETF in that same timeframe added about 63 tons. So the sentiment in the gold market has shifted. Institutional investors are basically saying, “Ah, well maybe, as long as there is this interesting, curious, unexplainable experimentation going on with monetary policy, whether it is Japan, Europe, the United States. Maybe, just maybe, because we don’t know the consequences, it makes sense to have a little bit of a gold exposure.
On my way to work this morning, listening to National Public Radio, which sometimes I do, I don’t know why, sometimes. Sometimes it’s interesting. I’m listening to the tale being told about George Soros having bought 20 million shares of Barrick Gold, and Paul Singer recently advising a huge amount of gold. Of course he is the manager of that 28 billion dollar hedge fund. And we talked about Druckenmiller who doesn’t manage other people’s money anymore but for his own account felt it necessary to have…
Kevin: There have been big names coming into the gold market.
David: About a third of his liquid assets are in physical gold. So it is an interesting shift amongst the bigwig crowd, and you have to wonder why. I think, for the bigwigs, it makes sense, but what you end up seeing is copycat trades, and I think you are going to see that for the next two to three years where people say, “Oh, well yes, of course, everybody’s doing it.”
When you look at the stock market, we’ve gone seven years without a major correction. Anymore, you turn on CNBC and a major correction is when it is down 1/2 % and everyone is literally crying and there is weeping and gnashing of teeth, and “Oh, my word, can you believe, we’re 4% off an all-time high? This is really tough going.”
But when you think about not having a major correction for seven years, that’s the second longest winning streak in stock market history. And then when you look at valuations being the second highest in all of stock market history, when you look at earnings, which, again, we’ve talked about GAAP versus non-GAAP earnings, positive, you’re looking at non-GAAP, down 15% if you’re looking at GAAP earnings.
Kevin: Non-GAAP is lying, and GAAP is telling the truth, affirming the government accounting procedures, right?
David: GAAP is the generally accepted accounting principles. So we see a declining trend in earnings across the S&P 500 companies. We’ve been in an industrial recession for at least six months. We have retail numbers which are coming out which suggest that we are solidly in a recession. You have the political machinations which suggest when you look at the extreme left and right, the appeal of a Sanders and the appeal of a Trump, where it really is Middle America, whether you are conservative or liberal, saying, “Something’s not adding up right now. I’m angry because the economy is no better than it was, and I don’t think it is going to be getting any better anytime soon.
And they would be very upset if you said, “No, no, no, it’s actually much better,” because their own stories suggest something different. And it doesn’t matter if the stock market is up, they weren’t participating. Look at the first quarter, look at the second quarter, and again, it is a declining trend in the earnings of companies, but there is not a huge decline in the stock market.
Earlier this year we discussed the industrial recession. That was the obvious sore thumb in the first quarter. And we asked whether it would remain contained in that sector of the economy, or if it would spread. And it appears that it has spread to retail. You have a retail recession, ironically, which is coming as official statistics are telling us that consumer spending is on the rise. We’ll talk about that in just a minute. We do know that consumer credit has expanded. That is some evidence that there has been an increase in spending. But retailers have not been on the receiving end.
This is an interesting scenario where the official statistic for retail sales is on the increase, but retailers are suffering greatly. Kohl’s disappointed on their earnings. Their CEO has said, “There seems to be some macro-economic issues given the performance of both ourselves and the competition.” On the recent conference call that is what he was saying. Dillard’s missed on their earnings. You have Kohl’s, Dillard’s – Macy’s was off, and Macy’s is sitting there scratching their heads, their management is, over how the economy, if it is recovering: How is traffic falling off at all their stores so sharply?
Kevin: They’re probably not scratching their heads, they’re probably shaking their heads, saying, “Here goes the government again on an election year, giving statistics that they are just coming up with out of thin air.”
David: They may be saying to themselves, “Look Amazon may capture market share from all of us, brick and mortar may be dead, where everything is ordered on a virtual basis.
Kevin: Or the weather. Remember how they blamed the weather.
David: That was the case last year. In the first quarter we had really ugly numbers, and it was like, “Look, you know what? It has been an extraordinarily cold winter and that explains everything. And yet, we just had the warmest winter on record – the warmest winter on record.
Kevin: So you can’t use it as an excuse this time.
David: You can’t use it as an excuse for the retailers to be suffering. Nordstrom’s – Nordstrom’s missed on their earnings. You have Macy’s, Kohl’s, Dillard’s. I’m just saying it’s not one company, it is retail. And when Nordstrom’s lowered their guidance for the next quarter their shares fell 15% on the announcement. But here is the interesting thing. You have all the bad news in retail stocks, and yet Friday retails sales were up an impressive 1.3%.
Kevin: According to whom?
David: Well, the Bureau, of course (laughs). So it’s curious, because if the number was legitimate and the news really is that good, why did we see treasuries rally on the same day of the announcement.
Kevin: I think you should explain that, because the treasuries rally, typically, on bad news, not on good news.
David: That’s right. People buy treasuries on bad news, not good news, and this is where, again, simple adages – the devil’s in the details. It appears that the seasonal adjustment number for the retail sales figure was way out of line compared to the last several years. Stephanie Pomboy of MacroMavens pointed out that had the same adjustment been made as had been made over the last several Aprils – same, same, same – in terms of the seasonal adjustment, we would have had a 9/10th of a percent decline in retail sales instead of a 1.3% positive gain. You see?
By the way, labor markets are also on the mend. Official statistics – you look at U3, that statistic is stabilized. We have unemployment at 5%, so the labor markets we can assume are pretty healthy. It has been advertised that wages are coming back and are increasing, and yet, also from last week, the Fed’s internal numbers – this is the labor market conditions index – for April, it was down 9/10th of a percent.
Kevin: So for their own private numbers they actually are showing negatives. For the public numbers they are showing positives.
David: Who is the audience?
Kevin: Who are the voters?
David: So we have the fourth consecutive negative reading on the labor markets conditions index which the Fed uses as one of their critical measures, and we haven’t had that long of a string of negative numbers since the global financial crisis. And this is the one that they trust. It is just interesting, isn’t it?
Kevin: Dave, I want to bring it back to treasuries, because U.S. treasuries are what people run to when they think they are hearing bad news. Why is that? The main reason is, the U.S. treasury, because we are a reserve currency, is the strongest paper asset that a person can buy before they actually move to gold. I want to discuss this reserve currency change that we’re hearing so much about, because some of the people that we’ve talked to on the Commentary are all for it. I think about Barry Eichengreen who wants to see a basket of currencies. But I don’t think Americans really understand what it is going to feel like when the dollar is not the reserve currency of the world, stand alone.
David: It is argued more and more that no one should want to have the world’s reserve currency, and it is suggested that in a causal chain of financial destabilization, it is the reserve currency, in this case the U.S. dollar, which can and should be taken to task. It’s our fault, essentially. So we discussed this directly with Barry Eichengreen. Claudio Borio at the Bank for International Settlements also likes this line of reasoning – he argues the same. Whether you agree or disagree, this is the new fad. It’s the new fad in Central Bank circles, it’s the new fad in academic circles, to argue for a more egalitarian system, representative of trade flows and relative contribution to global GDP.
Kevin: Let’s just look at history, because even though the dollar is the reserve currency today you would have to say the British pound was the primary reserve currency of the world for about 100 years before that. Isn’t it strange, Dave, that the countries that would be considered global superpowers are also the ones that control the reserve currency? I wonder if that gets changed when you lose your reserve currency status?
David: Which comes first, the chicken or the egg? Is it is a mere coincidence that having the world’s reserve currency occurs at the same time that a notion leads the world as a, or even the, superpower. And is it a coincidence that once that leadership is lost, from a geostrategic standpoint, so is the reserve currency status. And which happens first? Is it that you lose the reserve currency status and you lose your geostrategic advantage? These are, I think, issues worth contemplating, and the issues related to capital flows and financial stability, these are complex.
I agree that instability is ingrained in a single currency fiat system, but what I would suggest is that it is the nature of fiat currency being a mere paper promise to pay, which is more important, and it is routinely overlooked, because most of our academics and central bankers assume that that is actually something that has its own inherent virtues. I would look at it and say no, this is actually where the problem lies.
Kevin: Yes, here in America, it’s good for us, but if you’re number two, number three, number five, number ten on, let’s call it the G20 scale, the top 20 nations, is it normal to want to rise in pecking order a little bit in the reserve currency?
David: I don’t see anything wrong with that. If I were a country with an economy of lesser size than the U.S. economy, which is most countries, I would want a greater currency float, and a larger percentage share of central bank reserve deposits. In essence, I would want to step up the usage of my currency even as the U.S. dollar, to a degree, stepped down or stepped back.
Kevin: Because you can print your own, right (laughs)?
David: It decreases the likelihood of currency panic for the non-dollar currency, whatever that currency may be, hypothetically we are talking about here. By putting the float of currency into the hands of political decision-makers versus investment in capital allocators.
Kevin: You remember Frieden, who you interviewed six to seven weeks ago, said, “All currency decisions are political.”
David: Right. That’s the thing, when you look at an investment committee, or someone who is allocating capital from a fiduciary standpoint, what are they looking for? Their broadest objective is profit, and if they think that is going to be put at risk, or they’re not going to get their money back, or they’re going to take a haircut in any way, then they move in and they move out just as fast as they moved in. So you see capital flows and currency flows as very, very fickle.
But if you’re looking at a currency being adopted as a central bank reserve assent, again, it just gives you a stable float. You know that there are X number of units of your currency out there, and it’s not coming in and going out. That doesn’t create the same kind of financial disturbance as it would if it were just flowing in and just flowing out on the basis of financial opportunity or financial panic on the other side of that.
Kevin: Central banks love to say, “Do as we say, don’t watch what we do,” because actually, you and I have talked so many times about how gold brings stability to a system. Central bankers would love to tell the populace, “No, no, no, fiat currency is perfectly fine.” But if you look at their reserves, Dave, they’re buyers of gold. I remember when they used to be sellers, but they learned that that doesn’t work. It is just interesting to see the accumulation.
David: I found it very curious – Ken Rogoff in a recent Project Syndicate article began to champion the idea of central bank accumulation of gold. Again, you need to recognize it is not the normal thing for a Harvard guy, a guy who is actually one of the primary champions today of a cashless society, to be championing gold in central banks, specifically, amongst emerging market central banks. And the argument is, essentially, if you want to play a larger role in the global capital markets there needs to be an additional basis for trust.
I’m putting this in my own words, of course, but you need to have an additional basis for trust. Gold represents trust. It represents reliability amongst central banks. So hate the stuff, as many of them do, but it is still collecting dust, as you say, in most of their vaults because they know other central banks view what they possess in ounces and in tons, as a very reliable asset to have on the balance sheet.
Kevin: Dave, I remember, being here 29 years, I remember all through the 1990s, seeing on a monthly basis how much the central banks were divesting out of gold, and that was supposedly pushing the price down.
David: And that actually only changed on a net basis, buying and selling. There became a net positive number in 2009, it has been positive every year since then, and it is averaging between 400 and 600 tons per year. So accumulation has been the trend by central banks since 2009, and as globalization continues down what I would view as a rockier road in future years, I think that accumulation pattern is likely to continue. What it does is, it does support, and even justifies, foreign currency cooperation, the cross-holding of paper by central banks, maybe an expansion of exposure.
Do I really want to own Brazilian reals today? No, not really. Their currency has been in freefall for the last two to three years on a fairly precipitous basis. But what if the Brazilians said (and by the way, this is hypothetical, they have not said this), but what if they said, “We’re going on an accumulation program and our currency is going to be 30% backed by gold. And we’re going to have 250 billion dollars’ worth of gold backing our currency by the end of 2025.” Do you think that would stabilize the real? To some degree, it would.
Kevin: That’s what saved other currencies in the past. We talked about the German mark when it failed back in the 1920s. How did they re-establish it? It was with gold.
David: And so if these emerging markets want to have a greater role in the global capital markets, no one wants to have their deposits devalued. So if I take on your currency as a deposit, it is now mine, but it is denominated in your currency, do I want it valued? No. And gold goes a long way toward protecting against it, which on the one hand, increases the likelihood of continued global trade. That’s good. But on the other hand it does suggest that there is something underlying which is kind of obvious.
There is concern amongst academics and central bankers about devaluation, and the only way forward is to re-establish, to buttress and support things that will maintain confidence and allow for continued capital flows to be there and not get nasty and ugly. Why do we move to a world of tooth and claw? We move to a world of tooth and claw when we are concerned about our own survival. Things get nasty, and we get very concerned about how we preserve our own self-interest when things don’t go well.
Kevin: When you bring up Brazil, we can talk about Argentina in the past, we could talk about what is going on in Europe in the southern states, the northern countries, it all boils down to how debt is handled. In the long run too much debt is handled in two ways. You brought up devaluation – that’s one of them. Or default. You either devalue your currency, and that pays the debt off, or you default. Now, we’re in a political year right now. You have Trump talking, you have Hillary talking, you have Sanders talking. They all, in one way or another, are actually talking, whether they know it or not, about how they are going to handle this upcoming debt problem.
David: Clearly, we don’t know who is going to be the next President of the United States. If we did, we could bet a handsome sum and make a handsome sum, having a guaranteed outcome.
Kevin: Yes, but Trump says he has a solution. How do you feel about it?
David: He does have a solution. He says debt is his baby, that he can solve the debt problem, having 20 trillion dollars when Obama finishes his time in office. Trump isn’t worried about that. A billion here, a billion there, he’s scrubbed his balance sheet clean more than once. He knows how to accumulate it, he knows how to handle it, he knows how to default on it.
Kevin: He never worried about debt.
David: Think about that. He knows how to default on it. And it’s done with ease. So I like the suggestion that he is buying back debt at a discount. That is what he has proposed. It makes sense from a business standpoint. But what is good for the debtor is, of course, bad for the creditor. And this bad for the creditor scenario – that could be in two flavors.
You have to ask yourself the question – would you be open to either one of these if you were a major creditor of the United States, if you were the Japanese government, if you were the Chinese government, if you were a member of OPEC, for instance. Either interest rates go up and the market value of the debt goes down, allowing for a cheaper settlement of the obligation, essentially buying the I.O.U. back as the market price of that debt drops.
Kevin: Which is a form of default, in a way. It’s a form of deflated default, or smaller default, but it’s still taking one of those D’s. It’s not devaluation, it’s default.
David: But Trump is going to argue, and I think he has a point here – that’s market-driven. The market price goes down and you take advantage of the market price dropping. You obligated yourself at par, and it traded at a premium, now it trades at a discount, and you’re making a good business decision. I see that. I can tell you that our creditors would not be very happy with that. So what makes sense may not make many friends.
The second option is to devalue the currency and allow for a discounting of debt via the exchange rate weakness, and you just pay off your debt with cheaper fiat currency.
Kevin: Which is what we’ve tried to do for the last 40 years. That is the plan so far.
David: Surreptitiously. You do it a paper cut at a time, and ultimately you bleed out, but it’s not a big deal in the immediate. It’s one drop here, one drop there, of very precious blood. But go back for a moment, because the argument is that this unipolar monetary system centered on the dollar, is in fact destabilizing. That is the current academic argument, and it should be viewed as unattractive from an economic viewpoint because it causes global destabilization of financial markets.
And of course, from an economic viewpoint, what do you have to do? You have to set aside any geopolitical advantages which you may have. And those geopolitical advantages may, in fact, be what gives you bigger and broader long-term economic advantages, but just set that aside for a minute. The nature of fiat money, and allowing for debt discounting, as we looked at option two – that’s the real problem. The old solution for having too much debt has been perennially solved using that option.
Kevin: Over and over and over. Not just us. You can look at virtually any country out there.
David: Look at the drachma, look at the franc, look at the Italian lira – those countries, and more. Going back to the beginning of fiat currency in China, thousands and thousands of years ago, all of those countries have used the power of the printing press to alleviate the burden of debt. And yes, it cost them something. It cost them reputation. No longer were they considered reliable. There was a degree of trustworthiness. In the pre-European Monetary Union context, everyone was always suspicious of the Italians, the French, the Spanish, the Portuguese. Why? Because they were always printing. And you saw that reflected in the exchange rates as they came and were merged into the euro. You had exchange rates relative to the German mark which were 100-to-1, 300-to-1, 600-to-1, 1200-to-1, where they had already gone down the path of inflation.
Kevin: And those countries gave up the power of the printing press when they entered the European Union. When they entered the monetary system that is based on the European euro, they were giving up their ability to print their way out of a problem.
David: Right. To become a European satellite country it was basically, “We in Brussels are going to give you lots of free stuff. We’re going to be rebuilding your roads. We’re going to gentrify neighborhoods and towns that are broken down and out of date. We’re going to redo this electrical and that communications, various infrastructure projects.” And so, yes, they were willing in a process of becoming a European satellite country, to take, and at that same time, as you say, they gave up the power of the printing press. Money-printing is gone and now they have to struggle with austerity and debt negotiations. Greece is back to the negotiating table. Can you believe it? We’re a stone’s throw away from summer, 2016, and it was the summer of 2015 that we had debt negotiations in Greece. It was the summer of 2014, 2013, 2012, 2011. Why do we still have this issue with Greece?
Kevin: You can look at titles of Weekly Commentaries going back to about 2009. I’m just going to tell you, Dave, we need to stop using the name Greece in our titles, we’re going to look like a broken record.
David: Unless it’s grease (laughs). Let’s take it a different direction altogether. I’m not a champion of the current system of fiat. I’m not a champion of breaking promises. I wish to simply point out that before we demonize a monetary system centered on the U.S. dollar and change it à la a grand global currency reset…
Kevin: Like a giant euro.
David: Yes, and significant role reshuffling, it’s worth considering the benefits conferred alongside the costs that come with them. And I think what academics do today is generally look at the costs, and not really talk much about the benefit. So rather than focusing on the cost alone, I suspect that the real cost of a more “globally fair monetary system” would be to the U.S. person, someone living on a fixed income, someone heading into retirement, someone in the middle class, this becomes very relevant. I think the real cost of moving toward a more globally fair monetary system would be to increase the cost of living for that person to the tune of 30-50%.
Kevin: You’re talking about their living standards dropping by half, almost.
David: Yes, because everything is more expensive. So do that, and I think you see the revolt of the masses.
Kevin: Right.
David: Do that and I think you had the direction, honestly, I don’t think you end up with a Trump. I don’t think you end up with a Clinton-type presidency, but someone with a far nastier bent altogether. This idea of strongman politics – there is a way of satisfying angry people, and then keeping everyone in mind, let me give you one historical example – Tito. If you make the people angry enough, they’ll ask for a strongman, and then be stuck with a strongman. I think Trump is a small shadow of what we might end up getting if we end up with a massive inflationary problem.
Kevin: Dave, our country was built on states, and states had certain rights. Obviously, you and I are talking federally here, we’re talking about people revolting as masses. But I remember about three years ago you were in Austin, and there was a guy who was campaigning in Texas, a guy named Greg Abbott, and he came out and actually talked to you before your conference. He had something going on in the room next door. You guys talked about gold. He said, “I like gold.”
And what we’re seeing now, that man ultimately was elected governor of Texas, Governor Greg Abbott. And we’re starting to see legislation come through in Texas that has to do with secession. We’re talking legislation coming through and requests to the Federal Reserve to bring back a billion dollars’ worth of gold from the Federal Reserve depositories. You’re starting to see some action right now from a state level that might be similar to this revenge of the masses.
David: I’ve met a lot of politicians, and most of them practice sincerity whether they mean it or not. Most of them seem friendly, but that’s sort of in campaign mode. And Greg struck me as a genuinely interesting and good human being – far from perfect. That would describe me, you, and probably everybody else on the planet.
Kevin: But there was a relaxed way about him when you guys were talking.
David: I think he was just genuinely sincere, genuinely friendly, genuinely curious. Politicians often want to talk, and if you give them a mic, if you give them the limelight, just try to get the mic back, try to shift someone else into the limelight, or get them out of it – it doesn’t happen.
Kevin: But he asked you questions.
David: He asked me questions, which I thought was interesting. But you are right, back to this issue in Texas. It is intriguing to watch Texas be proactive. They’re discussing the resources, they are discussing controlling their resources outside the purview of the Federal government, and the proposed bullion depository – we brought this up maybe a year-and-a-half or two years ago – is firmly supported by Greg Abbott. It speaks to me to a core issue.
Beyond having a depository in Texas – I don’t even know if that makes sense – but what it speaks to me is the core issue in play for the last 10-15 years, which is an erosion of trust and a growing suspicion of the political elite. I guess you could say the political elite, I think you could say the Wall Street and banking elite, where people just say, “Look, I want a little bit more control.” And taking control is what people do when fear and distrust reign. So the idea of having liquid assets that are not in the vast system of bank liabilities and counter-party risks – when does that become a priority? It becomes a priority when those counter-parties become suspect.
Kevin: Let me ask you, bringing back Texas’s bullion from New York back down to Texas – is it a symbolic move or is it more of a practical move?
David: It may be as simple as this – maybe we don’t know all the reasoning. It could be that HSBC gets slapped with all kinds of fines from money laundering – this goes back a few years. But you just think, “Gosh, who am I working with? Who is storing my gold? Do they still have it?” And maybe you say to yourself, “We’re paying them a lot of money to store it, and we’re not sure we even like them. We certainly don’t like the way they have conducted business in other areas.”
So is it a symbolic gesture? It could be. I’ll tell you what, it’s not a sum that’s large enough to be anything more than symbolic today. You look at the revenues in the State of Texas, you look at the budget in the State of Texas, and this is miniscule compared to everything that is going on in one of the most vibrant states in the country. Of course, they are in tough times, or tougher times today, with oil and natural gas being on their backs.
But it does make you wonder about what the state leadership wants. What kind of bargaining chips are they organizing? What is down the pike where if they have to give this up it’s for something else? The discussion of secession – maybe this goes back since the beginning of the state. They kept it open, they always keep it open. Every time I see my in-laws it’s always an option, it’s written in their state constitution and they are the only state that still has that in the state constitution.
Kevin: Really? That’s the only states that still has it in?
David: They only signed on with the understanding that they could sign out and walk away any time they chose. There is secession conversations occurring again in the Texas legislature. Maybe this is just rumblings and saber-rattling and everything else. It makes me wonder, which straw is the straw that breaks the camel’s back. When you think about the impact of taking gold out of a system where so much of that gold has been leased, has been lent out, has been double-triple-quadruple counted in the case of COMEX that we were talking about earlier. It’s not a quintuple counting. 542-to-1 – that’s a very significant issue. And it comes back to that question of – when? When? Because it may be Texas asking for their 600-700 million dollars’ worth of gold to be shipped, and all of a sudden HSB says, “We’d like to comply, but we can’t.” Is that it? I don’t know.
Kevin: We’ve seen this before. We have seen Germany ask for their gold and be told that it’s going to take seven years, even for a fraction of what they supposedly have here. So yes, there are some things that threaten what you would consider the trust of the system. Another thing that is showing a threat, though, Dave, strangely enough, is Saudi Arabia, now that they are threatened with possibly being fingered for the 9/11 attacks, they have come out and said, “Look, that’s fine, we’ll just go ahead and pull our treasuries.” This is a play of a movie that we actually saw back in the late 1970s called Rollover, where if Saudi Arabia just sold all their treasuries, or didn’t roll them over, didn’t buy them again, you could see the collapse of the U.S. dollar.
David: You have to understand, the McAlvany family, under the Don McAlvany leadership, has never been fond of Jane Fonda (laughs), but very intrigued by the storyline in Rollover.
Kevin: That was the movie that the family saw at least once.
David: I think between Rollover, Red Dawn, and half a dozen Chuck Norris movies, they were sort of the staples growing up, and my dad had sort of a love/hate relationship with Rollover, one, because he loved the story, but two, he just couldn’t stand Jane Fonda.
Kevin: The story was the Saudis had a gun to our heads because they were the ones who bought the U.S. treasuries.
David: That’s right. They were not going to continue to finance our deficits, and here in recent weeks they threatened to sell 750 billion dollars’ worth of treasuries and other U.S. dollar assets if we open up a liability to the Saudis, the royal family, the government, for 9/11. We now have, this week, in a Freedom of Information Act request, the treasury releases the official Saudi holdings as if to say, “Are you threatening us? Did you say 750 billion, because at our last count, and just so you know, we have, at your request, not shared this number for 40 years, but we are today sharing it because some citizen in the United States requested that we do so – you don’t have 750 billion dollar’s worth of U.S. treasuries, you have 116 billion, and that represents roughly 20% of your reserves, well under the global average. Let me ask this question again. Were you threatening us?”
Kevin: The global average is 50% or 60% of countries holding treasuries.
David: And there is so much going on in the Middle East right now that I would love to be privy to. You have Al-Naimi, the oil minister who was canned. That just doesn’t happen. Al-Naimi has been there, he has been a force to be reckoned with, and he gets fired. Kerry is visiting this week. The FBI is keeping under wraps over 80,000 secret files on the Saudis and 9/11. And I don’t know, maybe it’s time for another Freedom of Information Act request.
But what is perfectly clear, while there is not a lot clear because I’m not in Riyadh, what is perfectly clear is that the Saudis and other foreign states have shifted from treasury accumulation to treasury distribution. And anything we do on the fiscal front here in the United States is going to be hampered by our ability to finance it. Perhaps in a zero-interest rate world – we’ll see how that works out.
This is the interesting parallel. Think about this. You have had a distribution trend for gold for four years and now it is beginning to be accumulated. A treasury accumulation trend which has now shifted in the direction of distribution. Do you see some shifts occurring in some fundamental asset classes that are supposed to both represent safety?
Kevin: Remember what we talked about last week with your dad. He talked about the double run in a banking system. That double run is the final phase, whether it is the banking system or what we are talking about right now, in the worldwide reserve system where people are going out of the reserve currency – we’re seeing this by the billion right now – and into physical metal.
David: What is curious – when you think about Mark Spitznagel’s comments this last week that markets don’t have a purpose anymore, they just reflect whatever central planners want them to.
Kevin: Right. We’ve seen the manipulation.
David: That cuts through so much garbage. “Markets don’t have a purpose anymore. They reflect whatever central banks want them to,” was his comment. And you look, and you say, “Well, this is a strange world. We live in a zero-rate world where investors look at our nearly 2% nominal yield on ten-year treasuries and you compare that to negative rates elsewhere in the world.”
Do you remember that old phrase, “In the land of the blind, the one-eyed jack is king?” Treasuries may still attract people on the basis of having a positive yield, and yet Spitznagel’s comment, but who is attracted, and who is doing the buying? Is the Fed buying from the Treasury directly? Are we doing direct monetization and maintaining a façade of the market? Because the market is gone.
Kevin: Right. And talking about interest rates, I think the United States is one of the only countries left in the world that is actually paying positive rates.
David: When you are looking at U.S. paper, that is, all debt instruments, we are 60% of all positive-yielding paper in the world. And if you include things that mature in one year or less, the U.S. represents 89% of all positively-yielding paper.
Kevin: We’re the last guys in the game.
David: We are the last guys in the game. So, it’s a bit confusing. Is this the end of the dollar or the beginning of the dollar regime, just on new terms? We had the Bretton Woods era. We’ve had the post-Bretton Woods era. We know that we have discontent among the G20 for how things are centered on the U.S. dollar. And yet, look at us. If you’re allocating assets and looking for a positive yield, we’re just about the only place that you can go. We live in very interesting times.
Kevin: Over the last couple of years we’ve seen the hedge fund managers doing what we’re talking about, which is moving away from paper, starting to re-accumulate gold. We’ve seen the central banks over the last four, five, six years decreasing their paper and increasing their gold. We’re seeing Saudi Arabia and the other countries who would normally be buying treasuries, at least not re-buying as many treasuries, but they are accumulating gold. And so, I guess this is probably an easy question to answer, Dave, but for the person who is seeing these things, what should they be doing?
David: It is interesting, when Paul Singer, when Stanley Druckenmiller – the first comments are always, “Look, stocks are really over-priced.” So what are your options? So you decide stocks are over-priced and you want to “get out.” Where do you go? If you move to U.S. dollar cash, you’re asking Janet Yellen, Evans, Fisher, Dudley, Brainard – all the crew at the Federal Reserve, to manage your assets for you. And a professional asset manager says to themselves, “I grant you, they are all Ph.D.’s but I would prefer to manage my money than give it to them.” And central banks, by the way, don’t have a very good long-term track record.
So what are your options? Druckenmiller says, “My largest cash position is in ounces today.” What is he saying? He’s saying that he has opted out of stocks for a very good reason because fundamentally they’re over-priced.
Kevin: And he’s opted out of cash for a very good reason.
David: He’s opted out of central bank management for obvious reasons. That says it all, right? That says it all. You do want to lower your risk profile in terms of equity allocations. You do want to recognize that the bond market, to some degree, is a rigged game until it quits being a rigged game. So you have low rates, not on the basis of low risk, but on the basis of heavy-handedness by the Fed. And it is this heavy-handedness, this control in the marketplace, which has many market practitioners saying, “I’m not sure I want to play because it is no longer being driven by normal cause and effect. We don’t even know what basis to make decisions on because, again, it’s the arbitrary decisions of a committee.”
Kevin: Central bank perception management.
David: So what do you do? Yes, you do need to move to cash. But to be in only cash and have Yellen, Evans, Fisher, Dudley, Brainard and the rest of them manage your money is a bad idea. So you hedge that bet, too, with a metals portfolio of gold, silver, platinum, what have you, just to say, “Look, I like cash, but I don’t like the people managing it, so I’ve hedge that bet.”
Kevin: Yes. And you call that cash, as well.
David: Right. Because ultimately, what purpose does it serve? It serves this purpose, the same as every kind of cash. At the right moment, in the right context, you look at value and you say, “I want to put this to work for me. I’m going to spend my cash on what I consider to be a reasonable value when that value proposition presents itself and it is compelling.” I can tell you, as challenging as I think the next two to four years are going to be, I am more excited now than I have been any time I’ve worked in the professional money management field. Do you know why? Because of the opportunities.
We are on the cusp of a once-in-a-generation opportunity – a wealth transfer that occurs when assets get very, very inexpensive. And the question is, do you have liquidity, and do you have liquidity in the most reliable form? And yes, that does mean devoid of counter-party risk. That is important. That is imperative. And if you can answer those questions, I think the next three to four years are absolutely thrilling for you, instead of terrifying.
