Podcast: Play in new window
- Trump Is Not In Yet & He’s Already Being Blamed
- Pre-Election October Deficit Largest Ever
- Ukraine Strikes Into Russia With U.S. Approval & Hardware
“I think without tariffs as negotiated and leveraged on other items we lose the power to encourage energy imports from the US. It’s the art of the deal. Economists may worry about the inflationary impacts of tariffs, and to the degree that we see it—see that inflation—I think it’s going to indicate that Trump didn’t get what he wanted. What he really wants is to address the balance of payments deficits via exports, not via penalizing imports.” —David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
David, I did something sort of strange this weekend. I really focused on a year, 1818, because I had heard about the second US central bank tightening credit when inflation was running away. The American economy was booming at the time. People were taking huge debts and buying land, and they were exporting produce to Europe, which was war-torn because of the Napoleonic Wars. So America was booming, but the problem was the debt was creating a lot of growth that wasn’t real, that could not be sustained, and it was creating inflation, to be honest with you.
And so the head of the second US central bank—we’ve had three tries at the Federal Reserve in one way or another—went in and just basically tightened credit, and he said, “No more loans.” And he called his debts in, and it created what I had not really paid much attention to. It created what they call the Panic of 1819, and a very, very severe depression after that. So we went from, it was called the Era of Good Feelings at the time, to actually one of the worst depressions America’s ever been through.
And I’m thinking right now, you had a call this morning with an international client who said, “You guys actually are looking like you have a pretty strong economy.” But is that being run by a basis of something that can be sustained or is it just purely debt, Dave?
David: Well, that’s the key. I think when you look at GDP growth, the Atlanta Fed puts their GDPNow number together. It’s been coming down a little bit, but it’s still, say 2.5%, and the larger figure compiled is 2.8%. So GDP growth just shy of 3%. Now the question is, what would that number look like if you sucked out $2 trillion in deficit spending? Because government spending is a factor in GDP, and there’s no distinguishing between debt spending—deficit spending—and just regular old spending. It’s economic activity. So it does look pretty good.
It reminds me of many years ago. I lived in Los Angeles, and I tell you what, at least 50% of the people who owned BMWs and Mercedes lived in really cheap apartments. They could not afford those cars, but it was what they had to impress the ladies, and they lived on a larger scale with perhaps an ulterior motive. They needed to prove something. And so you live beyond your means so that you can make an impression.
Kevin: Well, and a lot of times you can afford something you can’t afford for a little while just based on monthly payments. William McChesney Martin, who basically said it’s okay to pull the punch bowl back before the party gets out of hand, and we really have left the punch bowl out continually, haven’t we?
David: Yeah, absolutely. So you’ve got today the run-up to unsustainable valuations in the stock market. These valuations, it’s pretty easy to ignore them because mainly people are making money and they’re playing the momentum game, which packs a lot of euphoria into a little bit of time. And we share a good deal in common with the late ’20s euphoria, with the year 2000 as well, what you described—was that 1818, in the era of happy feelings?
Kevin: Oh yeah, yeah, good feelings.
David: Good feelings.
Kevin: The Era of Good Feelings, but boy, you take the punch bowl away. But this is why what you brought up last week was so good. There are a lot of people who are thinking the changes that Trump is going to bring in are going to be very positive for the economy. And that probably is true, but you talked about Bush entering office in the year 2000, the markets were overheated and they had to come down. We had that big crash, the tech stock bubble. But then you also talked about 1928, okay, Hoover. At first it looked like there was euphoria that Hoover was elected back in 1928. That changed pretty quick, didn’t it?
David: It did. I think it’s worth saying that there’s no easy analysis in today’s environment. If you looked at things through the lens of credit, that’s one way of seeing things, and there’s a lot of complexity to it. If you looked at things through the lens of international relations, now you’re talking about the motivations and the psychology of nations with various different objectives in mind. If that’s China, if that’s Russia, if that’s Israel, if that’s Iran, it gets really complex really quick. And so to pretend to understand how all of these things coalesce, it would be mistaken.
Kevin: And it’s not fair to Trump to actually pin that on him. He’s coming into something that already is overheated.
David: Yeah. So we look at the market environment today, and there is a case to be made for certain things—tariffs and negotiations that come from that, perhaps being positive, perhaps being negative. What I wanted to bring up last week, we discussed Bush entering office in 2000 and we discussed Hoover in 1928. The Dow was weakening in January of 2000. That’s the Dow industrials. The S&P was initially sympathetic to the industrials, rallied to new highs in March, in that March to May period.
NASDAQ also moving higher. It paused twice in the first quarter, like it was looking both ways before crossing the street. Then it sprints part way across the street near to the end of March. It was a big move higher in that short period of time, 45% gain from the January lows to the March peak, and then it gets hit by a truck. It doesn’t quite make it all the way across the street.
Kevin: Well, and history doesn’t repeat itself, but it definitely does rhyme. If we were to go back to Hoover— Today we’ve got NVIDIA stock, and we’ve got that type of thing. But back in Hoover’s day, it was RCA. Wasn’t that the technology giant back then?
David: Yeah, and Morgan Lewis talked about it in Hard Asset Insights, the difference between a trade and a trend, and looking at the behavior of various asset classes after the election, and being able to carefully distinguish what is a long-term and sustainable trend and what is simply a short-term trade. In both timeframes—we were just talking about the first quarter of 2000 and there in ’28, 1929—the trade looked positive, even though the trend was mature. And Hoover in particular, he took office in January of 1929. He was enjoying what investors were celebrating as the Hoover bull market, and that was all, of course, prior to October ’28.
Kevin: He had 10 months of really, really good bull market.
David: Yeah, and then October 28th of that year, beginning of an 89% sell-off. So here he is, the Hoover bull market, these are the best times that you can imagine. In fact, what does one economist of the time say about it? “We’ve reached a new and permanent plateau.” Interesting.
Kevin: There you go.
David: I mean one of the smartest guys in academia at that point, and he doesn’t anticipate a swan dive.
Kevin: I think he made that statement in September, too, right before the October crash.
David: It was very close.
Kevin: He was close.
David: So in the age of central bank interventionism, I think we’re unlikely to see anything that extreme again, an 89% sell-off. But where you do find vulnerability in each major downturn is in technology. It’s where things tend to be over-owned, partially because they’ve been over-hyped as the newest, latest, greatest thing. You mentioned RCA. RCA was the technology stock of the day.
Kevin: Hey, do you have a radio? Yeah.
David: Radio Corporation of America, moving from a peak of $505 a share to a trough level of 26 bucks.
Kevin: Wow.
David: That’s a staggering 95% loss over 24 months. And it’s not uncommon when you get into bear markets. Tech has always provided more drama on the downside and the upside that precedes it, and that’s part of the reason why there’s so much downside. It tends to get way too ahead of itself. So this week, very interesting. Let’s see if NVIDIA blows out the midweek earnings with expanded future expectations or if they have to modify those expectations a little bit. This could be peak bullishness for a stock that trades at a forward P/E of 49 and a price-to-sales multiple of 36. It’s pretty rich.
Kevin: Really rich. So 49 years of earnings is what it takes to actually buy an NVIDIA stock right now. But a lot of these companies, Dave, aren’t even earning right now.
David: And just keep in mind when you talk about forward P/E, this is what you hope to earn, not what you are earning.
Kevin: That’s right, they’re not earning right now.
David: So it’s 49 years of what we hope to be earning. It’s a much higher number if you’re talking about what we are earning. So anyways, it ends up being a fairly modest number all things considered.
Kevin: So how many companies actually are going up but don’t have any earnings?
David: Morgan Lewis directs our attention over the weekend to the Russell 2000 small-cap index, which just made a new all-time high. Within the index, 43% of the companies are losing money.
Kevin: Yeah, that’s not earning.
David: Which is an amazing fact when you consider the strength of the economy, when you think of economic activity, when you think of employment figures. It is fascinating. 43% of the companies in the Russell 2000 small-cap index are losing money. The figure in the year 2000—again, the percentage of companies that were not making money in that same index—14% versus today’s 43. And if you go back to something more recent, the global financial crisis, 17% of those companies were not making any money.
So we’re nearly 50% today, don’t make a dime, but have traded higher on momentum to record levels. Prices are higher while fundamentals are being ignored. And in some respects, Kevin, that sounds to me like the US dollar this past week. Prices go higher. There’s some fundamentals that, you can choose to ignore them, but you may be doing that at your peril. So the US, Morgan tells us, is similar to one of the Russell 2000 companies, not making any money, borrowing money just to pay the interest on our debt. Great discussion of the Trump trades versus Trump trends. I would encourage you to go to mcalvany.com and look at the news section. That’s where you’ll find Hard Asset Insights.
Kevin: So you had the elite, the people that we’ve learned to hate, to be honest with you, that, Dave, stepping out, the economists, the PhDs, stepping out and giving us what the inflation rate is as my wife complains about the price of eggs. And Trump didn’t get in because of the price of eggs. I’m sorry, there’s a lot of other reasons. But these guys have no credibility. Yet inflation statistics were out this week. How’d they do?
David: Yeah, they were out for October. CPI was in line with expectations. The Producer Price Index, the wholesale index, was mildly past the market expectations. And so what we saw is that equities traded positively on CPI, and not positively—with the disappointment just even of a 10th of a percent—for PPI.
Kevin: Do people really believe CPI and PPI?
David: Absolutely. The number of people who believe in CPI is staggeringly high. They all hang out in academic circles and on Wall Street, and not very many of them do their own shopping. That’s what the help is for.
So the two absurdities in CPI came from, number one, the housing component, which the Fed admits is a part of the reason why inflation is remaining elevated because it’s been kind of contained, but it keeps on wanting to bust out to the upside. And a part of that is because they’ve artificially contained it. What we often overlook is the component they use for real estate or for housing, it’s the rent metric, owner equivalent rent. It shows that it’s only up 23.6%. 23.6% increase since January of 2021 while the actual cost of home-ownership has about doubled in the same timeframe.
As I explained to a colleague yesterday, even in my personal situation with a fixed 30-year mortgage under 3%, my monthly expenses are higher by 50% in that same timeframe due to an increase in property taxes and insurance. Housing, however you frame it, is getting expensive. It’s getting even more expensive, and it’s not adequately accounted for in CPI. They use owner equivalent rent, up 23.6 versus in-year doubling.
And even though I’ve capped my expense in terms of a fixed rate debt, the things that I can’t control, the mill rates and the new taxes that come through each election cycle, I’m getting hammered. And of course insurance. Of course, we live in a beautiful place and people are afraid it’ll burn down, and, well, that comes at a cost too. So property taxes and insurance, those are number one.
Brings me to the second thing. Baked into the inflation report is—and again, I don’t know how people take CPI seriously, but they do—baked into the inflation report is a 29% decline in health insurance over the last two years; a 12% decline over the past five years. And that helps us get to a modest inflation statistic. We’re getting towards our target. And I don’t know if there’s anything to call it other than unmitigated balderdash.
Kevin: Well, yeah.
David: It doesn’t fit anyone I know who’s paying bills, has to go to the doctor, paying insurance. Our insurance costs as a company go up every year. We thank our lucky stars if an annual increase is less than 7%, and swallow hard because typically it’s double-digit, and it’s that way every year. A 29% decline, it’s an insult. It’s an insult to the intelligence of the average American. I think that’s a lot of what we saw show up in the election.
Kevin: Well, and you talked about baked into the inflation report, and poor Whoopi Goldberg. She thought that she wasn’t getting bakery goods because of her political stance. I don’t know if you’ve seen that, but if you owned a New York bakery that snubbed Whoopi Goldberg, you’d have a lot of business right now. It turns out their ovens were broken, and she just came up with an excuse.
David: It’s much easier just to call it racism.
Kevin: Well, do we want to really listen to this, you’ve said balderdash. That’s a good B word.
David: Unmitigated.
Kevin: Yeah, unmitigated balderdash. That’s a good B word. So let’s shift to politics just for a moment because we’re talking about inflation statistics that they really have baked into the cake, stuff that’s just— Nobody’s buying it. And you said some people do, the markets do, the academics do, but the average man on the street said no two weeks ago.
David: No. So we’ll only spend a minute on politics. Isn’t this the experience of the voter that just put Trump back into the White House? It doesn’t take a college degree to know that government statistics are a massacring effect. Trust the statistics.
What we did see, it was the college-educated, get this, college-educated, non-married women that did just that, trusted the statistics. It was the non-college-educated married male that stopped and registered a protest vote, a stop-the-insanity vote, a get-a-grip vote, and largely it was the Bud Light hell-no vote.
Kevin: Even though Peyton Manning is advertising Bud Light again, trying to get it back on the map.
David: Yeah, well, I’m sorry. When you destroy a brand, you should probably just start over because Bud Light has significant issues, and it starts with lipstick. At this point, it is the pig, and you can’t put enough lipstick on it.
Kevin: So inflation coming down means different things to different people.
David: That’s right. The people I talk to every day are stuck on the real numbers. One gentleman I spoke to this week shared that he has the same items in his online Walmart cart from prior to COVID. All items, pre-COVID: $100 in the basket. Today, the same items: $350.
Kevin: Wow, 100 to 350?
David: Yeah. The Fed gears its plans around a 2% target, and with the help of understated housing statistics and “declining medical costs,” it’s getting closer to target. Economists and central bankers all over the world don’t seem to care how the sausage is made. If they paid attention to hedonics and the various things that allow for shifting the constituent parts in CPI—there’s a bunch of tricks that go into how the sausage is made—if they did pay a little bit more attention to that recipe, they might not have the same confidence in their policymaking.
So the sense by the electorate is that the nanny state has lied to them, the nanny state has manipulated them, treats them like patsies. And because of that, Democrats get to journey in the desert for four years because—you know who they’ve lost touch with? The Walmart man.
So stocks are at all time highs and they’re feeling pretty good. Inflation’s coming down, stocks are doing well, and the concerns really are now around how Trump’s going to destroy the world. Because if you listen to NPR or MSNBC, there is a version of apoplexy I haven’t seen in a little while, but the average household could care less. The average household is not benefiting from the increase in stock prices.
Kevin: Yeah, Dave, the problem is they’re running out of money before they run out of month. Income. Income is an issue because income has not been going up as much as that cart full of goods from Walmart.
David: A gentleman who spent time with HSBC and DLJ—Donaldson, Lufkin & Jenrette—and BlackRock, an alumni of all three, Ed Dowd, he notes this is exactly the point, Kevin, the real income adjusted for inflation was minus 2% coming into this election. So you’re not getting what you need from your paycheck. The minus 2% wage growth adjusted for inflation was the exact same number at the time Bill Clinton won the landslide in 1992.
Kevin: Really?
David: And he ran on the mantra, “It’s the economy, stupid.” And it was also the same negative 2% wage growth in 1980 when Ronald Reagan came to office. Actually, going back to Clinton, it was Clinton’s campaign manager, James Carville that ran with that quote, “It’s the economy, stupid.” But academic types are focused on faux statistics. They helped create the Trump victory, and I know that’s tough for many of them to hear. But when you lie to people and people live with reality and can see the lie for what it is and begin to feel like they’ve been treated like patsies, you get the protest vote. So if you try the campaign scheme, which includes heavy doses of propaganda, don’t be surprised if people just lose trust in the propagandists.
Academic types, they have confidence in the faux statistics because there’s a rationale to their creation. And I’m not saying there’s not a rationale, I’m just saying that we should sometimes question what the rationale is. Again, so we have hedonics, we have substitutions, we have the weighting shifts. All of these things go into adjusting the CPI and creating an outcome.
Dowd further points out that government hiring, government spending have promoted economic statistics that run contrary to the average man’s experience of the economy. And so Trump’s victory was a pocketbook reality which conflicted with the academic assumptions about economic strength, and that’s where Dowd would say, “You feel like the economy’s good, but a lot of that came from government hiring. A lot of that came from government spending.” Where we started the conversation earlier today, it really does matter where the growth is coming from.
Kevin: So you’re talking about income not keeping up, but throughout this year you’ve talked about how many elections are coming up worldwide. This isn’t just a US phenomenon. I mean incumbents all around the world are having to face the fact that incomes are not going up as much as the inflation rate.
David: That was at least one defining factor in the November election, as it was in 1980, as it was in 1992. And now we’ve got major elections—we talked about this early, early on in the year—80 different elections. We still have incumbents in the next six months that’ll be facing the music in the UK, in Japan, in Canada, and Germany, many others still facing the music as the higher cost of living jeopardizes their opportunity to govern going forward. They’re being judged on the basis of that performance metric.
Kevin: Is that why we had the largest debt month right before the election in US history? I mean, it was larger than I remember debt being for an entire year back when I first started.
David: It’s easy to be cynical, and then again, these are the things that you realize, maybe there’s something to it. US national debt passed $36 trillion this week. It’s worth letting that sink in. It’s kind of monumental. Okay, it’s just another trillion. But as we march towards 40 trillion, we know the trajectory is unsustainable. We know that the interest assigned to this debt is not, well, I mean we can pay it, but it’s not easy. Then we have, first month of the fiscal new year, what you alluded to, October leading into the election. And this is where my cynicism gets riled. Our deficit for the month of October, $584.2 billion.
Kevin: Wow, that’s amazing.
David: That’s a 24.3% increase from the prior year. This is a record outlay for any October in any year in US history.
Kevin: That’s almost 20 billion bucks a day.
David: Yeah, so what are we looking at? Sure, GDP is strong, but you’re talking about a half a trillion dollars in spending with money that we didn’t have. So $584.2 billion of deficit spending, you would expect that 2.8% GDP number to look as good as it does. Might even expect it to be a little stronger. So yeah, D.C.’s painting the tape with record outlays in the lead-up to the election. That’s no accident. No accident.
But it’s also noteworthy that household debt in the third quarter increased by 147 billion. The new total, 17.94 trillion, it’s a record. So just shy of 18 trillion for household debt. Never been that high. That’s up from 12.68, and that was its peak in the year 2008. So going back a little ways, housing debt is higher by 3 trillion, non-housing debt higher by 2.27, so a total increase of five and a quarter trillion. It’s a big increase. This includes student loans, it includes auto loans, it includes credit card debt. Households have joined the US government in carrying the greatest quantity of debt ever. And unfortunately, rates are migrating higher, so the cost to maintain that debt is going to be more difficult. This is axiomatic.
Bloomberg reports this is the 10th consecutive quarter that more homeowners have borrowed against the equity in their homes. And last time we saw this, it was peak euphoria in housing and also the beginning of desperation, where, again, we had a big commodities boom leading into 2007 and ‘8, and a part of that was Chinese economic growth and demand for commodities. You remember, we had oil passing 125, got almost to $150 a barrel, and so we had an inflationary trend then. We also had people tapping their house equity like an ATM.
Kevin: Well, and that was the year that we started the Commentary, Dave. That was 2008. That was the election year for Obama, and that was also the crash year as we worked our way through 2008.
David: Yeah.
Kevin: What you’re saying is—
David: It’s a sign of financial strain when households’ borrowing in terms of home equity gets now to a total of 387 billion. That’s on top of your mortgage payments, right? This is the HELOC plus your mortgage. Q3 added to the number, 10th quarter in a row, combined with a $24 billion increase in credit card debt for the quarter. You have those two numbers. That means households are not able to pay their bills. And again, the HELOCs as ATMs in 2007, home equity as an ATM in 2008. And of course we know how that story ended, negative equity, which followed shortly thereafter.
Just bringing this into frame in terms of what we have to look forward to. As recently as 2021 adjustable rate mortgages made up just 4% of applications. That jumped to 12% in 2022, and then 18.6% in 2023. There is a great reset coming, specifically with these mortgages, and the clock is already ticking. Granted, the most popular periods for an adjustable rate mortgage are five and 10 year. So we’re talking about the front edge of this. Homeowners are good through about 2026, and that’s when you begin to see the resets. 2026, 2027, 2028, significant pressure on people who were financing using ARMs, adjustable rate mortgages.
Then—as Buffett likes to say—then you’ll get to see who’s swimming naked as the interest rate tide goes out. Higher for longer is consequential. Higher for longer is consequential for corporate profits as they deal with higher interest costs, governments as they deal with higher interest expense, households as they’re dealing with cash flow issues. Mortgage rates have climbed 72 basis points over the past six weeks. Is that not remarkable? Mortgage rates are higher by 72 basis points, even as the Fed has lowered rates by 75. Who’s in control of interest rates? Who? It’s not the Fed.
Kevin: Yeah. Well, the bond vigilantes always speak, but, talking about Trump again, Trump is inheriting, really, a very awful mix. We spent four years under the Biden administration hearing how it was Trump’s fault that things aren’t going better than they are, and now Trump’s not even in, and we’re finding out that it’s Trump’s fault that we have inflation. They’re blaming tariffs at this point.
David: They are. It’s interesting. I looked at the viewership and the ratings for mainstream media immediately following the election, and you look at any of your liberal outlets and they’re down a minimum of 40%, maximum of 65%. Ratings and viewership have tanked, and it’s as if the left feels like they’ve been lied to as well, and maybe that’s because they didn’t learn how to manage expectations at a younger age. They assumed that Kamala and—what’s the guy’s name? I forget his name. Oh yeah, Tim. Lovely fellow. They didn’t win.
Kevin: Well, I’m sorry that those outlets, that there’s no viewership, because actually where else am I going to see people taking selfies of themselves crying about the outcome of the election? I love watching that stuff, and so I hope that they at least stick around long enough for me to see snowflakes cry about outcomes.
David: We talked about last week, with the biased framing of a lift in interest rates following the presidential election—and there has been an increase in interest rates since the presidential election—but there’s been a fast indictment of the Trump administration bringing inflation back via its planned tariffs. And this is what you’re seeing reflected in the bond market. And this week, more news agencies have joined that chorus framing an inflation concern around Trump and the tariff schemes.
But two important things should be considered. Inflation is sticky, it’s understated, and nowhere near dead. That state of affairs has nothing to do with Trump. Add to that the fact that 80% of the increase in rates came after the Fed decision in September and before the election results. 80% of the increase in interest rates came after the Fed decision in September, before the election results.
That is not to say that broad tariffs could not increase inflation. It’s just to make the distinction between market concerns over tariffs, which account for 20% of the increase in interest rates, and the 80% that had more to do with the lingering inflation, having nothing to do with Trump, more concerned about monetary policy and the existing state of affairs prior to the election.
Kevin: I had a chance this weekend, Dave, to pull out The Wealth of Nations by Adam Smith. And Adam Smith wrote this book back in 1776, and it really did revolutionize the way we look at balancing an economy, free markets. And what he was writing was actually a response to the way Europe had run for many years before that, under what they call a mercantilist system. And the mercantilists believed in heavy tariffs and collecting as much wealth or gold as they could, and the way they did it was they would run tariffs—whether it’s France or England or Scotland or wherever. They would have tariffs trying to block imports, and try to export as much as they possibly could and run surpluses where they accumulated gold.
And so it was like a zero-sum game. You’re just trying to beat the nation around you, forgetting that the nation around you is also your customer. And it created a great amount of poverty, a lot of war. Europe was a mess before America had its revolution. Adam Smith wrote that poverty was a great reason why he wrote this book. He said it was not unusual for a woman to have 20 children in Europe, and only have two of the 20 survive to adulthood because of the poverty. And so what he was saying was this, he was saying, remove the tariffs or at least find a way of balancing things out where countries don’t necessarily compete to the point of destruction of the other country.
And so this is a question that I have, Dave. From a free market perspective, tariffs rub me wrong. In a way it’s like, well, wait a second, this is a return to mercantilism. But actually, I’ve lived in a country that has always run deficits. We’re not accumulating, we’re running deficits with these other countries. Is Trump just trying to balance things out, a little like Adam Smith was talking about? What is this tariff thing? Is it to beat everybody or is it just to balance?
David: It’s a subject I need to read on more deeply. I need a better understanding of the role that tariffs play in a floating currency system. I’d love to talk to Russell Napier. He’s got great historical perspective on things like that.
Kevin: And he lives in Scotland right near Adam Smith’s grave.
David: He took me to Adam Smith’s grave when we did a little scotch tasting at dinner. I have a connection with Adam Smith, and it’s not The Wealth of Nations, it’s The Theory of Moral Sentiments. It’s a book that I read, studied, and explored, translating into a modern vernacular when I worked for the Institute for Liberty and Development in Santiago, Chile.
Kevin: That was where you actually read the other Adam Smith book?
David: Yeah, and it’s the more important book. This week Gillian Tett in the Financial Times makes the appeal: will Trump recognize the value in capitalism—or really, she makes the case, the values infused into capitalism. And she makes this appeal back to The Theory of Moral Sentiments. It’s my favorite book.
Kevin: I need to pull that out.
David: You read The Wealth of Nations and it’s a cut-and-dry— It’s like, this is how you win the game. But the soul of Adam Smith is in The Theory of Moral Sentiments where he’s talking about the dynamics that create systems of trust based on shared moral values. And you get into the complexity of really what we would describe more as liberalism, where we appreciate that you have value, I have value, we have respect for each other. Yes, I want a good deal, but I expect you to get the same.
Kevin: This is liberalism in the old model, not progressivism—
David: Correct.
Kevin: —or what we have now?
David: That’s correct. That’s correct. But this would be your Benjamin Constants, your Edmund Burkes, people who championed a version of “liberality” very different than how we define it today.
Kevin: So to Trump’s tariffs, is he really using these as bargaining chips? I remember in 1987, I got The Art of the Deal.
David: I think if you see it strictly through the lens of The Art of the Deal—
Kevin: Okay.
David: —as a thought experiment, think of tariffs through the art of the deal. If you don’t have leverage, you shouldn’t show up to the negotiating table. If you can’t walk away, you’ve lost before you even arrived at the table. I see tariffs as a means of balancing our imports and exports. Most people see a rebalancing coming from a decrease in imports or steady imports at higher prices after you have the tariffs tacked on. Stay with me on the art of the deal.
Let’s say that tariffs are only a negotiating tool. They’re not actually something that are going to be added to the price. They’re just there to have real leverage. Trump has to be willing to put them on. Trump has to be willing to create that inflationary environment that economists are so concerned about, but it’s not what he wants. So this is not Kabuki theater. It’s not pretend. He will go that far, and that’s the force of negotiation. You have to be willing to do what you say you’re going to do.
But let’s say it’s really just a ploy to get more US autos in Europe and Asia, more oil and natural gas—predominantly natural gas—in Europe and Asia, and you solve the trade imbalance by boosting production in the areas that you have excess capacity.
Kevin: Right, so this balancing thing is really interesting because if Adam Smith were sitting here on this Commentary right now, I don’t think he would say he’d have a problem with tariffs just to balance things out. The problem that he had at the time was tariffs were being used to beat everybody else around you. In NASCAR, when these guys race, they have particular alliances with different guys that they’re competing with all the way through the race. Or bike racing, they’ll draft for a while, and then they’ll try to beat them.
Remember the movie Beautiful Mind, remember Nash? He talked about this theory of cooperation mathematically while you’re still competing. And unfortunately, America has run, what’d you say? We passed $36 trillion in debt. Okay, plus we run trade deficits every single year. So it’s going to take a lot of tariffs just to balance this out.
David: So for example, coming back to autos, we can crank out more vehicles. Capacity utilization in the ’60s and ’70s was nearly 90%—88, 89%. Today it’s around 77%. If you’re talking specifically vehicle production, we peaked in 1978 at 13.8 million units a year. 1978, 13.8. Today we’re averaging ten and a quarter million units a year. That is roughly 11% of total global production. We used to be 100% of global production—again, Model T. And you fast-forward a century, we’ve lost a lot of market share.
We have the ability to create more. We’ve got the capacity to create more. We can fill in those jobs if we can create a market for our vehicles, and this is just automobiles. But think about that. How many jobs would you create if you could crank out an extra three and a half million vehicles and fully utilize our productive capacity?
Kevin: Well, when Trump was in office before, we were energy independent, or we could have been, plus we could export energy. Don’t we have excess energy that we could actually send away?
David: Well, that’s another example. Nat gas, we’ve got a glut. We can frack even more. We can lead the globe in LNG exports. Certainly, you can ask the question, how long does that last? Is it a five-year trend? Is it a 25-year trend? I think a part of the long-term solution for US energy policy has to include nuclear, but this is your transition fuel. This is it. So again, nat gas, we have a glut, we can frack more. We can lead the globe in LNG exports.
Oil, it’s similar. We’re running production at 13.4 million barrels. Daniel Yergin thinks we can hit max capacity around 15 million and do that in the next year or two. Oil’s a little bit different than natural gas since we consume more than we produce. We consume over 20 million barrels a day, 20 and a half. But let’s say we produce an extra million and a half barrels. That reduces our oil imports by 20%, and that helps shrink the trade deficit as well. So you’re trying to meet in the middle.
If we can increase our exports, and you could certainly do that through natural gas, if you can decrease your imports, you can certainly do that by increasing domestic production of oil, that’s what you’re trying to get to is a more stable place where imports and exports are closer to matching.
Kevin: So tariffs may be inflationary to some degree, but you think about it, Dave, it’s a little like earnings of companies coming up instead of the stock market coming down. If we can actually provide more jobs, we don’t have to create as much debt that ultimately turns into inflation.
David: Yeah, I mean, I think without tariffs as negotiating leverage on other items, we lose the power to encourage energy imports from the US. It’s the art of the deal. Economists may worry about, as they do, the inflationary impacts of tariffs, and to the degree that we see it, see that inflation, I think it’s going to indicate that Trump didn’t get what he wanted. What he really wants is to address the balance of payments deficits via exports, not via penalizing imports. But the threat of penalty gets him what he wants, a commitment from our trade partners to import our soybeans, to import our automobiles, energy resources, and other things as well.
Furthermore, do you think—and this is just from a very different vantage point—do you think that the energy giants—now I’m talking about the capital that flowed through November to aid in Trump’s election—do you think that the energy giants that helped Trump get elected merely want to increase production as he loosens up leases and federal lands and whatever the case may be? Do they just want to drown themselves in their own product? No.
They want new markets to drive more demand, and Trump is the middleman between supply that we have in the United States and a negotiated quid pro quo elsewhere in the world, which delivers the demand side. He’s not an idiot. Now, I think there’s plenty of economists that are, but the point is not to create inflation. The point is to create— Again, we come back to the balance of payments and using Trump tariffs as a means of getting what you want on the demand side elsewhere.
Kevin: So long-term outcomes are different than short-term. You have been bringing up over the last month or so that gold has been highly overbought, that the sentiment level was very, very high on holding gold. There was a breath that was taken last week, Dave, a big breath and a big readjustment. How long do you think that’ll last?
David: Great question. That gold sentiment indicator has come down from 85 to 40, the daily sentiment indicator. Think of that as a popularity vote. When you’re edging towards 100, you have a uniform desire to be owned. You are the thing. In two weeks time, we’ve scaled back that interest, that popularity, by 50%. We went from 85 on the index to 40.
In complement to that, you’ve got the Commitment of Traders reports—the COT reports—that look a lot less overdone. I still think the price correction should take us lower. I’m looking at the math. I’m looking at the COT reports, that sentiment index. I would love to see the sentiment index get to single digits, 10, five. When it’s close to zero, no one’s interested, and I’m backing up the truck.
So we’re moving in the direction where I am interested. I would be dollar cost averaging at these prices, but I’m going to be more interested when it’s a giveaway. And it’s a giveaway when it’s a giveaway. It’s a giveaway when no one wants it. It literally gets cheap because of that. So the price correction should take us lower. However, and I think this is where charts are irrelevant in a time where geopolitical and market structures—the events around market structure—can dominate and create new fundamental demand.
So we look at a chart and we say, okay, here’s where it is. Here’s where it should go. Looking at past patterns, this is what it looks like. This is what we anticipate or hope for, but that’s not how the future unfolds. We don’t know the future, and there are enough X-factors—unknown variables—that can drive the price of gold considerably higher. I come back to market structure and geopolitics. And in real time we’ve got US missiles flying from Ukraine into Russia. Russia has redone its nuclear strategy to say anyone using conventional weapons who is a nuclear power, we just opened the door to using nuclear weapons in response.
Kevin: Yeah, talk about the art of the deal. Unfortunately, that’s a bad deal for everybody.
David: It’s a bad deal for everyone. And how that gets played out, I would not want to see how that got played out with Biden or Kamala. I think there is a certain strongman dynamic where rough personalities deal better with rough personalities because it’s easier to appreciate what’s a bluff and what’s not. Instead of looking for weakness, you’re measuring strength. And that would’ve been the Kamala administration, other world leaders looking for areas of weakness to exploit as opposed to measuring strength and figuring out where you had to match and raise.
Kevin: Well, and I’d like to go back to: why gold? Oftentimes I talk to a person who has no gold. They’re all stocks, or they’re all cash, or they’re a mixture of both, and they feel like they’re balanced. And so when we draw the triangle, my recommendation is to get to a third of the base. The base of the triangle is the physical gold. Get to a third as quickly as they can so that the rest of the triangle is balanced.
David: Yeah, the question of getting started is I think obvious on the face of it. If you don’t own any gold, you should own some today, and I don’t care what the price is. You should get started. How you get to those goals is also, I think, an opportunity to have more ounces at the end of the day. That means that you’re working in consultation with someone like yourself where you’ve got some guidance as to what the market dynamics are and when there’s ebbs and flows you can take advantage of that. We read the charts, we lean into the flows.
I think what has to be appreciated in this market environment is that central banks remain the linchpin of this bull in metals. They’ve got the lead role. Investors are the supporting actors in this drama. The story is far from over, and their activity is driving the trend. This is not a trade. This is not something that has already occurred and is now in the rearview mirror, where you could imply from the current weakness in price that somehow you missed the boat and now it’s back to 20 years of a bear market. No.
The difference, as we described earlier, between trend and trade is really well illustrated by the gold market. You have fundamental drivers of demand which are not letting up, and that means that whatever weakness in price we have, that is an opportunity for dollar cost averaging, establishing that position if you’re just getting started or adding to it opportunistically.
Kevin: Well, and a good way to do it without even thinking about it, Dave, I buy a little bit of gold every two weeks through Vault plan—the Vault plan that you’ve set up where it just automatically comes out of my paycheck. Now, I still buy physical at times and continue to have that delivered, but the Vault plan allows me to dollar cost average every two weeks.
David: My trade went in today using Vault plan. I do it every two weeks. It’s a great way to automatically dollar cost average in. And then, on occasion something comes up that’s special, we don’t see it very often. Sometimes it’s a matter of price, sometimes it’s a matter of product and its scarcity.
Kevin: Inventory is a big deal.
David: Yeah. Yeah, it is. And believe it or not, even with a weakness in price, we can’t keep anything in inventory. So as an anecdote of the product flows and supply and demand, this continues to be a strong market.
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Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, and you can call us at (800) 525-9556.
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.
