Podcast: Play in new window
- Start saving now for the high cost of the “Save Our Future Act”
- Corporate Pollution Punishment…stocks could drop 20%-60%
- Harold James: “We no longer live in a NICE world” (Non-Inflationary Continuing Expansion)
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
The Carbon Tax – Inflation Correlation
July 6, 2021
“With higher carbon taxes and a broader scope of application again, scope one, two, and three, you pay for someone else’s misdeeds, you pressure equity prices lower to levels of say 40% to 60% less than they are today. And in case you’re wondering about unintended consequences, you’ve got the baby boomer generation looking at 201k’s instead of 401k’s in that case, and what is the response? They vote for more governmental supplements and a bigger retirement safety net.” – David McAlvany
Kevin: Welcome to The McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
Well, David, I’m just back from California, my son got married.
David: Unbelievable. This is, all of your kids now married. Congratulations.
Kevin: Yeah. He was born two years after I started working here with your family. And now he actively works here.
Something really struck me, I was talking to my wife as I was flying home. And all through Northern California, we went up to Sonoma, we went out on a boat for whale-watching. One of the things that I noticed this time around is, even though restaurants are having a hard time getting enough help, there were many, many Orientals, people who obviously weren’t born here, that were really working hard.
There was a particular Uber driver, my daughter and I had just gone out to eat and got an Uber. And this man was from China, originally. And we asked about his kids, we got talking. He was a hard-working man. He had like 22,000, 23,000 Uber rides. And he said, “Well this is my first son, and he’s a Harvard Medical School graduate.” And then he showed us the other two pictures, and both of the other kids were doctors, and I was so impressed with the hard-working ethic of people who’ve come in and recognized— maybe they’ve recognized American exceptionalism. But it comes from people who are willing to come in from the outside and work those extra hours.
David: I spent the weekend reading Francis Fukuyama’s book The Demand for Dignity and the Politics of Resentment. And there was a couple of things that complement what you’re saying both in terms of the expansion that we’ve seen in terms of global output between 1970 and 2008. The world’s output of goods and services quadrupled. A lot of that happened in the developing world. What Fukuyama is getting at is that a lot of the growth that we’ve seen in recent centuries has happened in the developing, not the developed world, which is, I think, one of the reasons why he sees some resentments brewing.
But one of the things he also points out, as I got a little later into the book section on nationalism, he looks at one particular academic, Ferdinand Tony is in this shift from the village community to urban society, where you see this mass migration within a country. And it sets up for a very interesting nationalistic expression.
I couldn’t help but think about a 21st-century iteration of this, like a 21st century time bomb of Chinese nationalism, where, again, we had it in Europe, where Europeans during the 19th century, due to rapid industrialization and migration, had this similar type thing. And you’ve got the same thing happening now, both within China and Vietnam, the move from the village to the urban setting. And again, they’re moving for opportunity. And as you describe this gentleman, even moving across the world for opportunity, and the second generation already stepping into that opportunity in a massive way, in a way that frankly, I wonder if your average American realizes how much opportunity they have. And sometimes you have to see a first-generation American working their tail off to appreciate all that is on offer here in the US.
Kevin: Well, I think we all have to admit, Dave, that 40 years ago China itself was considered almost a third world country, and over the last 40 or 50 years, what we’ve seen is China become very strong nationalistically, as far as there’s a national identity that we’re seeing emerge in China, as well as an economy that at this point competes with the United States.
David: Yeah. So there is an opportunity, what Fukuyama would describe as a psychological dislocation which occurs inside a country, you have to absorb the growth, you have to get used to a new identity, not just being the country mouse but now being the city mouse. My words, not his. But it sets up for a very interesting period of politics and even geopolitics, where conflict is possible. And again, this searching for a new identity comes out in nationalist terms. And I wonder if Xi Jinping here, celebrating the 100th year anniversary of the Chinese Communist Party, isn’t tempted to harness that, I guess time will tell.
Kevin: It’s interesting that they’re celebrating the 100-year anniversary of the Communist Party in China, at the same time that we’re just about to celebrate the 50th anniversary of taking the dollar off the gold standard. China factors very much into that. We have the inflation that had built up to the point where we had to drop the gold standard.
Dave, I’d like to talk about that a little bit today because being in California, I realized just how much the cost of socialism has affected the price, even of gas. We were paying four and a half bucks a gallon for gas in California. And you could just tell just about everything was higher based on taxes that had to do with either environment or what have you. But there’s definite redistribution, looking like it was happening in the form of inflation in California. The cost of carbon is really coming forward right now, as these bills are coming forward, where we’re supposed to be cleaning the environment by raising prices pretty dramatically on anything that supposedly pollutes.
David: The California dream is perfect weather. And this constant T-shirt or golf shirt type weather where you get to enjoy 365 days of near perfection. And you do pay a price for that. Not only higher income taxes, but the newest form of tax comes in the form of carbon, the cost of carbon. This is a national effort, actually, to segue from California, but Senators Whitehouse and Schatz have proposed in the Save Our Future Act a foundation for carbon tax implementation on a much broader scale. You already have this in California, which is one of the reasons why things are a little bit more expensive, including kilowatt-hours and gasoline. But this Save Our Future Act is the bridge between the social cost of carbon, which dates back to 2009. Michael Greenstone and Cass Sunstein essentially invented the idea. They were working in the Obama administration. One is on the Council of Economic Advisers and the other, Cass Sunstein, who is working as the White House Office of Information Regulatory Affairs.
Looking over the proposal, as presented by Schatz and Whitehouse on their official websites, I found a lot of capital redistribution, actually very little progress made in climate change policy. But it goes back to this California dream or California nightmare. The idea of perfection is there. But the nightmare is in implementation. And we’re seeing some of that pass through to the consumer. Your cost of fuel in California was easily 40% to 50% more expensive than it is here in Colorado, selectively, the states where they’ve already implemented this carbon tax. And again, it’s typically your East Coast, and, no surprise, West Coast that have already done this. There is a high cost.
Kevin: Yeah, Dave, I’m all for keeping things beautiful out there in California and in Colorado and everywhere else. But I worry when it’s politicians who are saying that we have to pay more for carbon to clean things up and to keep it beautiful.
David: And this is I think one of the ways in which the emotions related to climate concerns are leverage, and become the social impetus for the legislation. The proposal is not merely about a cleaner and greener tomorrow. Certainly, there’s a bill coming due for polluters, and you can see that on the horizon, the majority of revenue as this particular act is described, the revenue generated goes predominantly to a dividend to lower and middle-class income families. 75% of the total revenue from this particular proposed bill is, again, a dividend check to low and middle-income families. 25% goes to environmental justice communities, and you have to forgive my ignorance—
Kevin: Wow, what’s that? What in the world is that?
David: I don’t know what that means. And then smaller amounts to fossil fuel workers losing their jobs, needing retraining, and recapturing, replenishing, renewing the places where they’ve lived and worked. And then there is a smaller portion which is state handouts to defray state and tribal costs as a consequence of climate change.
Kevin: So, Dave, you brought out in the past that crisis usually means more control if the government can turn that crisis into some sort of control mechanism. Does the climate crisis actually meet a climate solution in this case, or do you think this is just more rhetoric?
David: Not really. In this case, as I generally expect, crisis equals political opportunity. And in this time, the punitive tax is to hit corporations on the one hand and help families and communities bear the cost of that tax as it gets passed along to them in the form of inflated prices for goods and services. And to me, that’s government at its best. Tamper with one side of the equation, and they have to go to the other side of the equation to fix what they tampered with.
Kevin: For the record, we, last week, we’re talking about COVID-19 quite a bit. And I asked the question, how does this affect the markets? And you said, “Kevin, volatility. Brings volatility into the markets.” This week, we’re talking about political moves to tax carbon. And the question that I would ask is why is a financial program talking about that? Well, inflation. So you’ve got volatility with COVID-19, you’ve got inflation directly tied to tax and carbon. How is this going to affect the corporations, which ultimately pass the cost down to us?
David: And I think that pass-through is critical to keep in mind because it’s not as if the big bad corporation is paying the bill, they absorb it, and make sure that their margins maintain a fat enough position. And the way they primarily do that is by passing along cost. So, imagine a list of global fortune 500 companies with a new calculation for EBITDA. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Only the new EBITDA has the T squared. So twice the tax. Cost increases are rarely just absorbed by corporations. As often as possible, those costs are passed through to consumers in the form of a higher sticker price.
So the short version summary of the tax proposal by Whitehouse and Schatz, these senators, on the one hand, you’ve got gathering tax revenues from the few, call it the fortune 500, to give to the many several 100 million people across the country, which corresponds to political franchise-building and more of a, I think of it as save the future for progressives, than save the future of the planet. There’s a lot of emotion tied to climate concerns. And in on this point, I would encourage some critical thinking to complement policy approval. I’m very doubtful that something like this, this particular act, will get passed without the elimination of the filibuster.
Kevin: What would it accomplish other than raising costs of goods and services for every man, woman, and child on the planet? That’s probably the effect of a carbon tax.
David: I think you’re talking the net effect of a carbon tax, exactly, is just an increase in cost. So, I’m not sure what else it accomplishes. You think that penalizing a corporation for its carbon footprint is an effective motivator. But the reality is different. To protect margins, you increase the prices for goods and services, and you absorb the new cost, really, you’re just passing it along. So the biggest transition is from this idea of a social cost to carbon. Again, social cost of carbon being popularized in 2009, and was gyrating around $37 per ton. And then, of course, Trump came in and was like, “No, no, no, we’re going to change the inputs, the cost of carbon is going to be $1.” So it goes from $37 to $1. So clearly, the pricing is driven off of the inputs that are variable by administrative application, and whatever policy prerogatives are in play. Now, new administration, it jumps from $1 to $51, and soon to be $53. And if this legislation did come into play, it’d be $53 out of the gates with a 6% annual increase on top of the inflation rate as proposed.
Kevin: We’re not the first country to come up with this idea. There are other countries that are implementing this type of thing right now.
David: Yeah, 27 countries have implemented carbon taxes. You’re right. We’re not one of them at this point, but I think we soon will be. There are a number of states rolling it out, as they say, it’s almost like sushi, we started with a California roll and now all of a sudden, everybody across the country eats sushi. But it’s no surprise that it’s California. And it’s a number of East Coast states that have implemented a carbon tax. And it’s also no surprise that the cost per kilowatt-hour is between 40% and 100% higher in each of those states. I think two exceptions are going to be Hawaii and Alaska. Those are the notable standouts, perhaps for obvious reasons.
Kevin: Yeah, I certainly felt it in California. When you’re talking about the 40% to 100% higher, you can barely eat a meal for less than $100 if you have two people, and driving, of course, I mentioned the gas.
David: Well, I think we forgot to mention California needing to contract for power produced outside of the state. Apparently, they don’t have sufficient quantities to cover evening usage. And so, solar is constrained by the elements, as are other forms of alternative energy. And I was reading about that contract negotiation the same week I was reading about the decommissioning of California’s last nuclear plant up near San Luis Obispo, the Diablo Canyon nuclear power plant.
Kevin: Well, and that hardly makes sense. If we’re talking about clean energy, to deconstruct the nuclear, you’ve got mixed messages there.
David: And I understand the move away from coal, as cheap as it is. It still seems like there are technologies that could adequately extract the pollutants. And, of course, that’s what the cost of carbon, that’s what they’re trying to assess is not just what the input cost is. But the social cost of carbon brings coal into a different mathematical equation by saying, “Well, what are the long-term ill effects?” And that’s what you’ve got to pay upfront. But again, so that that makes the case for natural gas, which is logical, where you move away from nuclear, I think there’s a blindness in that move and an ignorance to the compelling math from both an energy standpoint, but also the long-term environmental concerns.
Kevin: So is this just a redistribution scheme? If it’s not really about environment at all?
David: And that’s what it seems like. The Whitehouse and Schatz proposal, plethora of redistribution schemes included to counterbalance the extreme, regressive nature of the carbon tax system. Because again, once implemented, the reality of higher energy costs, it’s funny, Washington doesn’t seem to be able to note that that is a part of the inflation equation, I’m not sure they can even spell inflation. But the reality of higher energy costs being passed through to society as a regressive tax, who does it hit most? Lower-income families. Hits them hardest on a relative basis. So the answer in a command and control system in this proposed legislation, when there is a negative implication coming from policy A, then it necessitates that you create policy B and C and D to counterbalance it. Handouts, that dividend check, 75% of the revenue that goes into the dividend check, it’s a part of the revenue redistribution to counteract the inflationary cost of energy and rising prices more generally.
Kevin: Well, I have to wonder, Dave, too, if you’re raising the taxes on these corporations, that’s got to factor into the value of the actual price per share. So, do you see this affecting the stock market, the equity markets?
David: Yeah, some speculation on that where in the Financial Times last week, where they’re trying to estimate the reduction in equity prices, when you have a full implementation of carbon taxation or carbon pricing. So the estimation in the Financial Times article was that global equity markets should be priced 20% lower if you’ve got tonnage at $75 per tonne, and then they add this twist. Because again, what are we starting at? We’re starting between 51 and 53, you’ve got your 6% annual increase on top of the inflation rate as proposed. So we can get to $75 pretty quick. The interesting twist, what if you are charged not only for the direct cost of carbon emission, but could be taxed indirectly for your business associations, for who you do business with? Again, the other companies which may be polluting. The indirect category is known as scope three, and that gets you a boost in tax for anyone in your supply chain.
Kevin: Doesn’t that remind you of a sesame credit in a way in China? Now, the way they basically reward or punish a company is based on how they’re measuring your pollutants and your associations with others who do that too.
David: It also creates a structure of what you’re looking at everyone you do business with, with a different kind of critical line. I understand the incentive factor, but it feels very Eastern European in a very uncomfortable way, where your associations and your businesses are done with and only with the people who meet a particular criteria. It’s a sanctions discrimination based on a current set of social values.
So on that basis, you take another 20% off global equity prices for indirect emissions, or it’s essentially a social penalty for having the wrong business associates and you’re bearing responsibility for their climate sense. It’s kind of a form of corporate shaming. It’s a fascinating cultural expression.
So go back to scope one and scope two, where you just pay for what you pollute directly. The Financial Times article says look, at $150 a ton, you can strip out 41% from current equity prices, which is the equivalent of taking the Dow from 34,000 down to 20,000. So all in, with higher carbon taxes and a broader scope of application, again, scope one, two, and three, you pay for someone else’s misdeeds, you pressure equity prices lower to levels of, say, 40% to 60% less than they are today. And in case you’re wondering about unintended consequences, you’ve got the baby boomer generation looking at 201k’s instead of 401k’s in that case, and what is the response? Well, I think the response is, they vote for more governmental supplements and a bigger retirement safety net.
Kevin: It’s important, I think, for the listener to understand that you’re not against clean environment, this is just a ridiculous way to go about it.
David: Yeah, I’m not against clean air, water. Living in Southern California for a number of years, up against the mountains, there were, at one time, safety warnings announced every morning as to whether or not you could go outside and play ball. The air quality was that bad. Today, California is a very different place. Today, we live in Colorado. I live in and I love beauty. When you consider personal responsibility in the environment, there is a healthy way to live our lives, and we do as a family to the best of our ability. The issue here is how data is factoring into broader policy choices, and how some of these things are being proposed, and what they’re leveraging, and are they actually solving global climate issues? Or are they just an excuse to redistribute wealth? And this is where, again, I think you’ve got very squirrelly data that you have to look at critically.
Kevin: Do you remember Diane Coyle? She talked about GDP, but really what her whole method was, was to show that the methods themselves of calculating GDP are very variable and political, and you have to watch what you’re doing. So, when you’re talking about data, how in the world do you calculate data on pollutants?
David: So she has a variety of concerns about big data. And we know her from her work done on calculating GDP, but the complexity of data collection and analysis, it goes broader than just GDP. We could look at environmental issues, that’s what’s on the table in our conversation right now. But going back through her concerns with the calculation of GDP and the growing concerns with data being misused in other applications as well, I found some recent comments from Diane, very interesting.
She says the data we use shape our view of a complex changing world. But data represent reality from a particular perspective. And she describes how various assumptions in the calculations of data “mask profound distributional conflicts.” Again, she’s talking about GDP. But I can’t help but think the way that data is collected and the way that data is analyzed is absolutely critical. And she concludes that the current hunger for database certainty is becoming dangerous, as we increasingly rely on technocratic decision procedures, including machine learning systems for policymaking in areas such as criminal justice, policing, and welfare. Claims to database authority minimize or eliminate the scope of ambiguity with potentially significant consequences.
Kevin: With what she said technocratic decision procedures, let’s just go ahead and translate that. What that is, is that’s machines making decisions based on data. And it reminds me, you talked last week about an article in Foreign Affairs. Well, Foreign Affairs had a great article, oh, I don’t know, five years ago on big data and the dangers of big data and how it would be used.
But one thing that I’ll never forget is it said you have to understand the difference between correlation of data. In other words, trying to find things that correlate that happened at the same time, with actual common-sense judgment. Now, as humans, what we do is we see certain things and we associate the things that we believe are tied to consequences of actions. A machine can’t do that. A machine can’t use common-sense judgment. It just has to look at correlation. That can lead to an awful lot of problems. Can you imagine, Dave, if we get AI starting to calculate what our carbon tax is?
David: And I think a part of what Diane’s commentary is here is that there is a need for us to be in the equation. And that scope of ambiguity which she describes is the point where debate and dialogue must occur. And it can’t just boil down to machine learning systems. I would expand the use of technocracy or technocratic decision procedures to be that set of decision-makers with very specific skill sets or knowledge bases making decisions which have broad implications.
So, again, her expertise is, and this is coming from our conversation at the commentary a couple years back, is on GDP. GDP is an imperfect measure of economic activity. But that’s my point. At best, data provides the means for imperfect measures. And those imperfect measures are based on critical assumptions which serve to interpret that data and translate it into a quasi reflection of reality. And perhaps then, we even take those data points and extend them into public policy actions. But I place particular emphasis on technocratic decision procedures because what we’re talking about is regulations and tax policies, which in that environment are no longer up for discussion. Once implemented, you’re talking about data which is driving a freight train to have huge implications may or may not be justified. But at that point, we’re just forced to live with it.
Kevin: I think of various actions of the government in the past and how they name things. I think about after 9/11, back 20 years ago, the Patriot Act came out. Well, who doesn’t want to be a patriot, of course? So you’re going to be behind that. But this one, this one’s called the Save Our Future Act. Well, gosh, what criminal would not get behind the save the future act?
David: I think this is where there’s a danger in simplification and I appreciate our conversation a few weeks ago, Kevin, about simplifying things to back of the napkin. But you can’t treat these kinds of things as if they are clear on the face of them. How the social carbon cost is calculated is not simple. How a carbon tax is assessed is not simple. How the redistributional aspects of legislation play out, not simple. And it’s too simple to say that we want a better environment therefore give the legislators carte blanche to decide what our future looks like. And well, comments on this concerning evidence-based policymaking. The degree of false certainty tends to increase with proximity to policy and political decision-making.
Kevin: So she’s talking about it being political.
David: Yeah, the quote might come to mind, there are three kinds of lies, lies, damned lies, and statistics.
Kevin: Sure. And we’ve got to be careful that we don’t mistake data with science because the use of data and true science, they could be miles apart.
David: What does the data say? Is it scientific? We often think of data in a similar category as science and forget that there’s more complexity involved. Complexity that political decision-making often sets aside in favor of expedient policy implementation. So to illustrate, whether the topic is GDP or carbon pricing, when it comes to data analysis, you can proceed in a variety of ways. And each of those leads you to potentially different conclusions. So when we’re talking about the data, have we put it through qualitative analysis? Quantitative analysis? Have we used the Delphi method? Have we used the phenomenological analysis, phenomenal graphical analysis, hermeneutic analysis, narrative analysis, discourse analysis, network analysis, typification, thematic analysis, descriptive statistical analysis, correlation analysis, causal analysis, time series analysis?
Kevin: Well, wait. No, I just use the magic eight ball. The magic eight ball has always worked well for me. I don’t know what you were saying about any of the other types of analysis.
David: Each of these kinds of analysis are part of the methodologies used to determine what the data is saying. Each of these has its own sets of assumptions, and may provide alternative conclusions. And all of them fall under the broad category of research methods and data analysis. What does the data say? That’s too simple a question. It’s easy to forget that data collection has its own set of means and methods. And then there’s data analysis that takes place in the context of those methodologies. To choose a methodology is to not choose many alternative methodologies. And it suggests that the project is in fact predisposed philosophically.
And this goes back to the philosophy of science. First-order questions in science are concrete and specific questions like, what am I measuring in a beaker, and what is the equation? If I do this and this and this, what does it equal at the end of it? Second-order questions, which seems backwards, but second-order questions in science are quite different. They are the abstract questions, the philosophical questions, the questions that underlie the first-order questions of science. One precedes the other, and frames the relevance and meaning of the latter. So you’ve got conclusions on data or science, which are defined according to philosophies.
Kevin: Right. And so we could call that, who benefits? Okay. Philosophies, oftentimes, especially in politics, are, who benefits? How do we use the data to benefit what we’re trying to do?
David: Yeah. This is where I go back to conversations with Richard Duncan, and although it’s somewhat galling to think about spending $10 trillion on building a perfect tomorrow. Some of the things that he lines out are in fact building a better structure, whether it’s a scientific research structure. They’re putting money to work in real and tangible ways. I look at this, again, Save Our Future Act and 75% of the revenue coming from it goes to a dividend check to a means-tested group of Americans, middle and lower-income. This isn’t solving a climate problem. To your point, this is a work of redistribution, and it is a political opportunity under the guise of carbon tax and climate change.
Kevin: Well, it’s socialism under the guise of carbon tax because that’s what socialism does. It redistributes the wealth.
David: Listen, to quote from the Financial Times article, the kind of risks that you are exposed to over the next coming years are very different to risks from the past. And I think that’s worth thinking about from the standpoint of portfolio management, from the standpoint of political risk, portfolio risk and general investor engagement has to take into account this kind of political nonsense. And I categorize climate concerns as political risk because the rationale and the implementation for a variety of policies have a political calculus as much or even more than they do an environmental calculus.
It’s important to bear in mind that policy choices of the 1960s delivered in the years that followed the stagflationary 1970s. Again, so, too, in this environment, I think you’ve got the political will for a variety of what is today palatable or, in the current context, justifiable reasons, policymakers are, again, putting things in motion that will deliver an economic environment that not unlike the ’70s may, in fact, be moribund with prices escalating as an unintended consequence to those climate policy preferences. So again, what they want to do is save the world, what they’re actually doing is not saving the world and creating a bigger inflationary problem.
Kevin: One of the things that I learned when I came to work for the company, Dave, from Howard Onstott, actually, is we would talk about, well, is there inflation or not? And he’d say, “Well, how much money are they printing?” Because that’s how you actually measure whether there’s inflation. He says, “The prices rising is just an after-effect of the printing of money.”
And so, being a child of the 1970s, growing up, I was a teenager at the time, the inflation that we had, the high, double-digit inflation that we had, a lot of that was blamed on the oil shock, the Middle East oil shock, and most people didn’t realize that it was the monetary policies of the ’60s in the ’70s that had caused that. So, could that happen again? We’ve created an incredible amount of inflation the way Howard Onstott would have explained it, which is the printing of money, and it’s showing up in higher prices. But could the blame ultimately be enhanced with these carbon taxes?
David: Yeah, I think so many people look at trigger events, and assume that instability is based on, or the destabilization was based upon, the trigger event, and not the instability and the contextual elements which were part of it. And this is where I think you look at the financial markets today, there is incredible frailty within the financial markets that already exists. And that is ignored. People still looking for the singular batting of the butterfly wings as the cause of a great catastrophe. And people are so fixated on the trigger that they forget so many of the more important elements already exist.
Many people argue that we could not experience an inflationary period like the 1970s today. An oil price shock is not reasonable in this era. And I agree that there are different dynamics in the oil market today. But what that kind of commentary neglects is a critical timeline in which inflationary trends were already in place. They had been in place for seven years, leading up to the oil price shock. So again, it was a trigger to bring it into the public consciousness, but it was already there and growing statistically in a very significant fashion.
So, again, you talk about causal analysis and an improper causal analysis. Here’s your PhD economists saying, not possible. And really, what caused the inflation of the ’70s was the oil price spike. That’s not true. That’s simply not true. You haven’t done your history. You don’t have enough data, in that case, to come to that conclusion. But that event captures the attention, and, oh, it also conveniently deflects the blame from bad policymaking in the years that preceded the inflationary 1970s. Academics are loath to admit that monetary policy was a factor in the economic maladies of the past where the fiscal policies, again, a contributor to malaise, lest policymakers and academics who helped sponsor those policies or promote them be accused for something that they could much more easily point to a singular event like an oil shock.
Kevin: Proof of the inflation that was already built into the system because of monetary policy was the very thing that we’re about to celebrate our 50th anniversary of, which is the dollar going off of the gold standard. Nixon couldn’t maintain that gold redeem ability because we had already printed too much money. That was long before the so-called oil shock.
David: A routine part of our conversation is looking at the financial attaché in Britain in the 1930s, who grew up, was a young man in the 30s, there to watch the sterling devaluation.
Kevin: Jacques Rueff.
David: And Jacques Rueff was pounding the table in the 1960s, saying the Americans are doing the exact same thing that the British did. They’re devaluing their currency in front of us, we must take delivery of gold. Do not touch those greenback dollars.
So we’re approaching the 50th anniversary of that radical shift in our monetary system, and as you say, somebody saw it, somebody understood the reality was long before 1971. The gold window was closed on August 15th, 1971. But inflation was rampant and had been building since the mid-60s. And that was not lost on Jacques Rueff. That was not lost on our Treasury Department, who sent out a warning to the French, “Friends of America will take greenbacks in settlement of debt.”
We sent out veiled threats as early as 1968, but our hand was ultimately forced in 1971. The connection to gold, which defined the Bretton Woods era, and was a centerpiece for the global monetary system came to an end. Again, we’re coming up on the 50th anniversary.
So, treasury secretary John Connally, Richard Nixon, Paul Volcker, George Shultz, and it was Arthur Burns who was federal chair at the time, they were debating the restructuring of money and credit in a system in which currency values would, post-August 15th, 1971, float with no backing. And Nixon made that call, August, 1971. What’s interesting is we had no alternatives to the dollar waiting in the wings. So, we did not lose reserve currency status. And miraculously, we remain the dominant international currency, even to this day.
Kevin: And now we’re 50 years later, and China has become an economic force, a tour de force, basically. So, if we were to have high inflation at this point, or some devaluation of the dollar, could we see an alternative currency this time around?
David: Oh, that’s a question, whether the contenders are there because I think one of the graces of 50 years ago was there was no one to substitute for us.
Kevin: Right.
David: One of the things that we learned from the structure of scientific revolutions is that for a system which is failing to go away, there has to be a new system waiting in the wings to replace it. And in 1971, even though our monetary system was failing, there was no ready-made replacement. So, are there any contenders today, the external threat, if you will, to dollar stability? That would be a question. I don’t see it.
Having passed the 100-year anniversary of the Chinese Communist Party, that was July 1st, and having listened to the ambitions of Xi Jinping—fascinating watching him dressed in Mao attire—I’m not sure if we have a dollar substitute waiting in the wings quite yet. Ten years ago, just before Xi Jinping was elected, I would have said yes, it’s just a matter of time for the Chinese to take the lead.
But today, with the reinstatement of political purges, with censorship at its highest level in the post-Mao era, that was according to Minxin Pei, you’ve got still the maintenance of currency controls and now a context of combativeness. Japanese and American militaries are now a year into their joint military exercises due to the growing temperature and contention over Taiwan. Is there any threat to dollar stability and our global ranking from the exogenous source? Could we be ousted? Could we be replaced? It doesn’t appear that that’s the case. It appears that the problems with the dollar are endogenous, it’s our debt. It’s our inflation. It’s our financial market stability. It’s the required QE inputs that put the dollar in further jeopardy when there is any small bit of financial market instability that the Fed feels they must solve.
Kevin: Well, let’s look at the differences, too, from the 1970s. Because one of the ways that we kept, we were able to print unlimited amount of dollars once we went off the gold standard. And actually, it didn’t turn into extraordinary inflation. And the question would be, well, why? Well, how did we finance those deficits without printing and buying our own bonds like we’re doing now? Well, of course, we had China, and we would run $400 to $500 billion deficits here in the United States, the Chinese would have surpluses because they were making goods. We’re talking about trade. And we were able to transfer a lot of what that inflation would have been over to China and it was actually deflationary because we were paying communist wages for goods and services that were shipped back over here. Are we in that same environment now? It seems to me like that’s ending.
David: Exactly. Labor arbitrage and the ability for corporations to take that particular input and lower their total costs of production fattened margins and gave firms tremendous amount of growth potential. And you’re right, something did change in the ’70s. We had not only petrodollar recycling, but then, as China began to open up and we sent more of our labor overseas and increased our imports into the US, we had not only the benefit of petrodollar recycling, we also had the benefit of trade dollar recycling, where our trade partner, whether it was for oil or for goods, tradable goods, they were taking their surpluses and reinvesting them in Treasuries, stabilizing would have been an otherwise untenable situation.
So, Harold James says that we are no longer in a NICE world. And NICE is an acronym. It’s an acronym that the Bank of England governor Mervyn King used to use when he described this era of the ’80s and ’90s, in particular, to describe a benign environment of, and here’s the acronym, non-inflationary continuing expansion. And James says, “We no longer live in a NICE world.”
Now, it’s not that we don’t have continued economic expansion. The point is, we’re out of the woods in terms of inflation. That’s what we’ve got. Inflation is here. The fascinating aspect of climate policy and how this factors in is that it may very well exaggerate the inflation trends, which are already in motion.
You tend not to think of an oil price shock as an event for the 2020s. But try this on for size. Punitive policies meet with underinvestment in exploration and production in the oil patch. And you’re seeing this, you’ve seen it. We’re at 15-year lows in terms of upstream investment, and you’re seeing production come down not only Russia, Saudi Arabia, United States, but you’ve got this layered in punitive policies, which say, “We’re decarbonizing. We’re moving away from fossil fuels.” You may get an actual oil price shock in the years ahead. Again, J.P. Morgan, I think, is somewhat sensitive to this, although I’m not sure they’re tying climate change into this, but J.P. Morgan has speculated that prices on a crude could touch $190 a barrel.
Kevin: Wow. Remember when it went between $30 and $50 negative last year? Now we’re talking $190 a barrel by 2025. And that’s mainly because people are shifting away, they think, from the use of oil and so you don’t have the same amount of exploration and development.
David: Exactly, you’ve got in effect a decarbonization push. And now upstream investment, again, recently hit a 15-year low, which suggests that we may very well have a supply deficit over the next few years. And that’s an environment where you actually could have a price shock.
Kevin: Isn’t that something, Dave? Okay. So that would be ironic. I’m not looking forward to another oil price shock like we had in the 1970s. But this time around, what if it was actually brought about because people thought that we were going off of oil completely?
David: And trying to save the planet, we end up damaging ourselves. It’d be ironic if an oil shock served as the icing on the cake for what has been an era of inflation gradually working its way through the system from asset prices to consumer prices. Again, the icing on the cake coming from a climate-inspired fossil fuel price spike. Although history doesn’t repeat, it often rhymes.
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, M-C-A-L-V-A-N-Y.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.
