The Greeks: Is it a Game of Chicken or a Forfeit?

About this week’s show:

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“Which is the higher of costs? To print, or not to print? That is the question. Today, for the patient investor, this is a period of epic instability, and epic opportunity, if cautiously positioned ahead of time. We are going deeper and deeper into our addiction to credit and credit expansion. How does this end? I don’t know, but we do know it does not end well.”

– David McAlvany

Kevin: You told me a story, Dave, which shows that Strike Anywhere matches aren’t necessarily strike anywhere matches. Sometimes you have to be prepared with a backup plan, don’t you?

David: This weekend, I took the boys on their first overnight winter camping trip. That started for me when I was 16. They’re starting at a fraction of that age, 6 and 8. We dug into a snow fort, set a fire, which actually took quite some time, dealing with wet tender…

Kevin: And matches that wouldn’t work.

David: Strike Anywhere, which would not strike anywhere. Moving to flint and steel – we used everything – and finally did get a fire started, and they were very happy about that.

Kevin: But the emotional rise was, you were a dad, and started to realize that maybe you needed a fire worse than you thought when you started.

David: Yes, reminiscent of Jack London’s story, we know the consequences of not starting a fire. And there is this extra pressure as a dad, taking your kids into an environment that is very uncomfortable, not an environment that I’m uncomfortable with, because since the time I was 16 I’ve been building snow forts and enjoying the back country in the middle of winter. But I’ve never done that with my boys and it was very unnerving. I kept on thinking about the emergency room, and I kept on thinking about how we would very quickly get out and leave if something happened.

Kevin: And you were a ways in, too. You told me last night why you feel it is important to take your sons to do this, and I think it is worth explaining, that you are building in them an independent spirit, you are teaching them not to panic, and you are teaching them to live with some discomfort.

David: Yes, and I think that that idea of knowing what you are able to do, what you are capable of, and pressing the outward bounds of what you believe is possible, physically, psychologically, and emotionally – there is no doubt, there were points where I was under a lot of stress and strain, and the boys knew it, and they, too. In the middle of the night, with very cold feet, “Dad, Dad, what do I do?”

Well, there’s a problem, and there is also a solution. Let’s think it through. Let’s talk about what else we can do. What do we need to change? Developing in them the ability to solve problems, the ability to keep their heads in the midst of an uncomfortable situation. And on the other side of it, it doesn’t remain uncomfortable. The next day, we were reminiscing, now off the mountain, and the boys loved it. They said, “Can we do this next weekend?” They so enjoyed this heightened sense of awareness that yes, it was stressful on the one hand, but on the other hand, they felt very much alive. And I do think that, as young men, they were being empowered to walk into a difficult circumstance and keep their heads.

Kevin: And you know, Dave, you could have given them an artificial comfort. There could have been an artificial out, and you didn’t. But let’s say you had a car there. You could have started the car up, heated the thing up, but they really learn, when there are consequences to actions, how to deal with those consequences.

David: In fact, I sent a text to my wife just telling her where exactly we were, so that she knew precisely where we were if something should happen. And she was very surprised. She thought we would be right off the road, with easy access to the car. And on snowshoes, we hiked in an hour and a half away from the road, and it did heighten that sense of, if it doesn’t go well, it may not end well. But that, in itself, was a part of the experience for them, to know what it is like to be, in the winter, in 3-5 feet of snow and making the best of it.

Kevin: And in this society of easy money, easy entertainment, pretty much easy anything, how often do you see people actually going out and experiencing those types of things? Now, I’m going to shift to the economy here because we have consequences that we are seeing being completely avoided in Europe. I want to talk about Greece today, sometimes we move that direction. We have consequences here, though, Dave. It is interesting, as I was coming to work today, I watched several cars drive by going to an office building where I know what they pay, they don’t pay much. These guys were driving very nice cars. I was thinking, how much of that person’s paycheck is going to the car? But then there are stories right now coming out, Dave, that there are people who aren’t even bringing in a paycheck that are driving very nice new cars. Is this the next new bubble? We saw the subprime lending on housing. How about cars?

David: That’s a good question because I think it is spreading beyond the normal neighborhoods where you would expect this as sort of normal behavior. I know when I lived in Los Angeles, one thing that was very common was low-rent neighborhoods. And I mean low rent, no one owned. These were basically slums and where slum lords had pretty interesting income coming in from these renters. What you would see is, in every parking spot, a BMW or a Mercedes, and there was a statement that needed to be made. You needed to prove yourself. You needed to advertise well. And of course, this is L.A. culture in large part, I think, and that is why I say I think it has spread beyond that. You have auto activity and this is kind of the good, the bad, and the ugly right now. There is a bright spot, there is a surprise, if you will, in the retail sales numbers, and it is in the auto sector. You know last week there was disappointment in retail sales. The January numbers dropped more than twice what they were expecting.

Kevin: But non-auto retail sales.

David: Right. And the trend in auto sales has been up. That is the one bright spot in the retail sales figures. It still wasn’t enough to keep that number positive. It dropped by 0.8 of a percent. The trend in auto sales has been to finance more, and that is, down payments are shrinking. You basically have people with less skin in the game. And then at the same time, extend the payment terms over a longer period of time.

Kevin: And that is how these car-makers are actually making a lot of their money, isn’t it? It’s just the loan side of it.

David: If you stop and think back to the not-too-distant past, you realize there is a ring of familiarity to this. You have the normal buying volumes which are now past tense, and it is financing wizardry which is responsible for increasing the size of the buyer list. The loans are increasingly – I don’t think they called them subprime, but that’s exactly what they are.

Kevin: Just like the housing.

David: Exactly. And so, it is reminiscent of that last episode of reckless risk appraisal in the housing market. There are differences. There is no Fannie Mae, there is no Freddie Mac jamming the financial system with the volumes of securitized paper, which in the 2005-2007 period, allowed household debt to increase by 4½ trillion dollars in about a five-year period.

Kevin: And that’s the question. How does this compare to, say, the housing? How large is the subprime auto market right now?

David: Yes. Growth in lending in the auto sector has been about 240 billion over the last several years, and a lot of that is questionable. Again, hundreds of billions – it is nothing to sneeze at. We live in an age where you can print that over the weekend. So is it a big deal? It’s not a big deal relative to the 4½ trillion dollars that went into household debt as a result of subprime lending and housing – it is small potatoes. 240 billion, that’s a number that is just under what we are dealing with in terms of the Greek problem, which is about 280 billion. Of course, that’s the largest debt debacle in recorded history.

Kevin: But these are small numbers when you print money.

David: These are small numbers when you print money.

Kevin: Okay, but the question that I asked, “Is this a bubble?” Bloomberg even asked that same question, “Is there a bubble in the auto sector?”

David: Right. Over the weekend they were very transparent in pointing to the weakness inherent, and that is, that the biggest rise in auto lending has been in the same zip codes that saw the highest mortgage default rates.

Kevin: That is exactly what we were talking about.

David: And you had two economists in the context of this article quoted that the lending trends at present that are boosting the auto industry are equivalent to the 2005-2007 lending trends which boosted home demand, and home improvement, just before we had a catastrophe in the housing sector. It is really not a surprise that there are default rates on the rise in those zip codes again, and you have a large number of loans which are instantly in negative equity.

Kevin: Immediately as they drive off the lot.

David: Exactly. Because you know what happens when a car gets driven off the lot. There is an immediate drive-off-the-lot discount, and if you have a skinny down payment, guess what? You are already under water. You owe more than the car is worth. So right now, as a percentage of the retail sales figures, autos are about 20.5%, with the all-time high being about 23% of the retail sales number. This is where we wonder – the quality of the buyer is going down. What happens over the next 12 months in terms of the increase in pressure on that retail sales figure. We’ve been told that the lower the price of oil goes, the greater we are going to see consumer spending, and it’s not following through at this point. In fact, retail sales are dropping in spite of the aggressive, aggressive financing maneuvers being done for now, what is considered subprime auto lending.

Kevin: Well, let’s go ahead and shift into the retail sales number, taking the autos out of it. The L.A. Times last week talked about retail sales really dropping right now. Are we not in a growing economy? Isn’t that what we are being told from the administration?

David: The headline from the L.A. Times read that retail sales are suffering as shoppers continue to be cautious. And of course, the glaring question is, why are shoppers cautious if, in fact, job growth is, as we are told, the strongest since 1997 and consumer sentiment is nearing the 2007 highs? So, do you see the disconnect? You have lower gasoline prices, and what some would describe as a consumer bonus, starting when gasoline reached its peak in June and has been in steady decline since June of last year.

But there is no follow-through in the retail sales numbers. The consumer is supposed to be showing up, and the consumer is saying, “I feel happier,” and the consumer is reflecting and saying, “Look, those numbers are the best since 1997,” and yet the retail sales figures are not. Do you remember many years ago we talked about the fact that growth in China, the numbers were not telling the truth, and if you looked at the decline in electricity usage, it was diverging. It was in a downtrend compared to the official growth stats which were still in an aggressive uptrend. And we said, “You know, something’s got to give here.” This is what we are saying – these kinds of numbers, when they are not consistent, that glaring inconsistency should tell you something about the reality of the economy, strength or lack thereof.

Kevin: Okay, but let’s face it. Gas prices are lower, people are probably still driving as much, if not more. But probably, even if they were driving more, they’ve got a little bit more in their pocket right now, Dave. Where is that money going? This Keynesian economy, you’re not allowed to save anymore, so where is the money going?

David: Well, they’re either bucking the Keynesian trend, and saving in spite of no rates at their bank… Keep this in mind. We’ve got early March. We’ve got the Commerce Department’s Income and Personal Spending Report that will be out and that will be a look-back for January, and that includes services. So retail sales, we’re talking about products being sold, we’re not talking about services. So, the January figures which are out March 2^nd, I believe, will give you your services, as well, and it includes things like health care, and that’s a big part of it.

I think what most politicos are loathe to admit is that the gas savings is being redirected toward, number one, a paying off of debt, which is not what they want. They want it to go to an increase in consumer debt, an increase in consumer spending, not paying down debt. So, paying off of debt is one thing. And then I think you also have an increase in Obamacare, healthcare-related expenses, and again, that should be shown a little bit more and the personal spending specifically for services, as that is shown here in the next few weeks, and no one wants to talk about it because Obamacare was sold as tax neutral. It was not supposed to be a tax hike.

Kevin: I think they called it whatever they needed to call it so that it would go through, didn’t they? It was a tax and then it wasn’t a tax, I agree. Okay, let’s look at the stock market, though. If retail sales are suffering, why are retail stocks skyrocketing? Who is buying retail stocks when you are looking at the numbers of the consumer spending?

David: Well, that’s what funny money does for the investor community. It’s like beer goggles. Ugly becomes beautiful. Bad becomes good. Essentially, we have a market that is on drugs and thinks that what they are experiencing is normal. So yes, you’re right, you should watch that divergence. This is critical. The retail sales number is in decline and you just said something very, very critical. The retail stock index continues to move higher. That kind of a disconnect, again, should be disconcerting for investors, but again, they’ve got their Fed-issued beer goggles on. The only fact that seems relevant to the speculative community is how much money is being pumped into the system by the Fed or any other central bank from around the globe. And so this is their investment thesis. Surely it will suffice to have easy money coming into the system. Supply and demand – that is irrelevant in this day and age of easy money and cheap credit. Full speed ahead!

Kevin: And when we are talking full speed ahead, Dave, when you look at the world, you have Russia, you have Ukraine, you have the situation with Greece. You have all this stuff going on that really should cause alarm, but actually, like you said, these guys are seeing this through glasses that are making everything look bullish.

David: Yes, I love it. Fed-issued beer goggles. It is what you get to put on when you look at the Ukrainian/Russian ceasefire. I mean, come on – how many have they already had?

Kevin: (laughs) They have one every four days.

David: Yes, so they’ve had three, four – is this the fifth now? You begin to lose count. And I realize a ceasefire is not a treaty, but what did Lenin say? Treaties are like pie crust – made to be broken. Ceasefires aren’t even as deep a commitment as a treaty, so it’s a convenient time out. This is literally like a time out in the middle of play. We will resume play shortly.

Kevin: Well, how about the Greeks, then?

David: Right. Well, they’re sitting at the table discussing restructuring of the two earlier bailouts which have totaled roughly 280 billion dollars and the market is considering it good news because they are sitting at the table. They are just sitting at the table. Making progress – that’s a very different issue. Investors are confident. They know which way the ball is going to bounce, and so what are they doing? They are rushing in the direction of what they anticipate to be the place where the ball will be.

Kevin: But the question is, what are they missing?

David: (laughs) What are they missing? Come on, real wages are still in decline. The housing market remains well below levels you would expect if we were in a full-blown economic growth phase or a healthy recovery. Industrial production and orders, both are weaker due to a strong dollar. Here we are at the end of the first month, heading into the second month; 2015 layoff announcements have been sizeable. In January, alone, you had 53,000 layoffs and that does not include IBM’s massive 110,000 layoff announcement. These are real numbers. You have oil and gas, CAPEX cuts which have already been announced at 24 billion, and that number will rise. And you have analysts which are now, in anticipation of diminished revenue and earnings growth, slashing their earnings estimates for 2015, and they are doing it dramatically. You should see some of the numbers.

Kevin: I know that some people are writing about this. What are some of the numbers right now?

David: If you look at what they were, the estimates in 2014 for 2015 consumer staples, 10.5 now estimated to come in at 2.7. In the financials, very little slippage there, from 13 downgraded to about 11.5. Telecom, 8.6 downgraded to about 1.6 – that’s the current estimate. For the material sector, from 23 down to 0.6. Technology, 15 down to 6.2. Albert Edwards of Société Générale points out – and these are his numbers – corporate profits and sales are crumbling. And so, he looks at a chart going back to 2010, and he shows U.S. S&P profits, that is Standard and Poor’s 500 profits and sales growth in steep decline, that is, percentage growth, is in steep decline.

So, this year’s pressure, now, is coming from a strong dollar, which diminishes the value, even for these big, multinational Fortune 500 companies, of their overseas product sales. Again, you are looking at at least half of their sales being generated elsewhere, not in North America, and so they face the music on the conversion back to dollars. They take a major hit if the currency is increasing, and guess what? It has been increasing.

Kevin: And it reminds me of what you were talking about with Giulio Gallarotti. Are people being more innovative, finding more ways of creating sales, or are they using currency wars to make things happen?

David: I have to tell you a funny story. This last week, Mary Catherine, my wife, called me, and she said, “You’ll never guess what Tess is making (that’s my little girl) in the back seat of the car. She’s baking cakes. Guess what she’s making? She’s making Gallarotti cakes.” (laughs) You never know what a three-year-old is going to pick up in family dinner table conversation. I don’t know that she learned anything about our conversation with Gallarotti, per se, but the name, at least, stuck. So, there is now a thing known as a Gallorotti cake.

Kevin: So, speaking, then, of the Gallorotti cake. There is a cost. The Swiss know this now. Americans are starting to find this out. There is a cost to a stronger, or rising, currency, isn’t there?

David: Yes, and that’s just the point. The dollar is on the rise and it’s putting pressure on your earnings for the fourth quarter, and will for the first quarter this year, as well, as the dollar remains relatively high. Does anybody read the Washington Times? I guess everybody in the beltway does. But, there was a recent discussion, just a few days ago, in the Washington Times, of President Obama’s – this is a total change in tack – temporary deportation amnesty, and the issuance of Social Security numbers for the illegals which are being given amnesty, and this was in a Congressional hearing, the IRS Commissioner, John Koskinen. He told Congress last week that illegal immigrants who didn’t pay taxes will be able to claim back refunds with their newly issued social security numbers, and all they have to do is prove that they worked off the books for those years, and the checks will be in the mail.

Kevin: That doesn’t make any sense, Dave. To be an illegal immigrant and still get a tax refund? I don’t know that I’m going to get one this year.

David: If anybody wonders why we have fiscal and budgetary issues, look no further. Washington is the source of virtually all of our problems. Let’s look at this pragmatically. Maybe this is how you fund a Democratic campaign in 2016.

Kevin: I wonder how the vote will go. You know, we’ve been talking about America. I think we should go on and look at the Greek situation, because we’ve talked about game theory, Dave.

David: (laughs) On that theme of fiscal and budgetary mess, absolutely.

Kevin: Well, game theory in Greece – there are a lot of Europeans criticizing the way Greece is playing this game right now, but they might be misjudging something, don’t you think?

David: Sure. I mean, what game are we playing, exactly? Harold James has been on our program a couple of times, and on project syndicate; that’s an interesting site. He mentioned this last week sort of this game of chicken between the eurozone and Greece, and it may not, in fact, be a game of chicken. This new party contends that the promises of the last administration don’t have to be kept by the new administration. “That was then, and that was them. This is now, and this is us.” And so who is the “us” in this equation?

Last week we mentioned that we thought the most critical detail in the debate was that the new finance minister is a student and teacher of game theory, which suggests to us that, yes, it may be a high stakes game of chicken which is being played, and he may be playing it with a very interesting, interesting approach, but again, who knows what the Brussels technocrats and the E. C. Bailout boys are thinking, themselves. Chances are they are thinking, like technocrats, that this is the greatest thing since sliced bread. “The opportunity to participate in the EMU – this is the greatest opportunity of Greek history, and of your lives, and of course you will want to stay.” Is it possible that the Greeks have a very different perspective on that?

Kevin: And you know, Greeks do think a little bit differently. They were burned back in World War II, let’s face it, by the Germans, involving debt. And there is still a chip on their shoulders about that.

David: That is true. That is a very interesting point. It is the Greeks who were kind of forced to loan to the Germans and they did. They loaned a large amount of money to the Germans. That massive debt to Greece, from Germany, was never paid back, and they are still waiting for it to be paid. Now, the Germans consider it sort of a historical footnote. They have no intention of paying it. So, this is where you maybe have sort of a canceling out of the moral obligation to pay back the present tense debt. The Greeks are saying, “Hey, you owe us, we owe you. Let’s just call it even.” But roll the clock back, not quite that far, but to 1999-2001, when the countries which make up the 19 members of the monetary union were joining.

Kevin: All things were not equal at that time. That was why the Germans were nervous.

David: That’s right. They left the old currencies and joined the new one, the euro. So, when the peseta, when the lira, when the drachma – when these currencies were being dropped, you had the old exchange rate to a new currency, and really, the anchor, truth be told, to the whole project, was the deutschmark. But those rates, the exchange rates to the original euro, I think, tell a lot. You had the German mark, which exchanged to the euro at less than 2-to-1. And then you went to the Spanish peseta…

Kevin: It was over 100, wasn’t it?

David: 166-to-1. And the Portuguese escudo at 200-to-1, the Greek drachma at 340 drachmas to 1, and they joined in 2001. And then you had the Italian lira at 1,936 lira to 1. My point is that among the southern countries there has always been a bias toward inflation, and that’s what you see here, that they solved a lot of their fiscal problems by having the monetary machinery in place, and it’s evidenced by the exchange rates upon conversion into the European Union’s unit of measure, the euro.

Kevin: And I think we should quantify this, because there are three ways to grow if you need to grow. There is actual normal growth where you sell more products, that type of thing, but the other is debt. You can raise money with debt, or you can just print it. And what you are saying is, of the three, the southern countries really prefer to just print money, and forget the consequences.

David: The bias toward inflation, and this is a guess, sheer conjecture on my part, but debt leaves tracks which you can tie to a politician’s decision to spend. Inflation leaves no such evidence. So, for the Greek Finance Minister, here in the last few days, to suggest that the problem is too much debt, and that it should be forgiven or written off, in large part, is really a return to the pre-EMU, European Monetary Union, strategy of Greece printing what they needed rather than merely issuing new IOUs and then burying themselves under this mountain of debt.

Kevin: I think about inflation in the way that I think about painkillers. I remember when I had an operation on my eye a couple of years ago. I’ve never really been into painkillers, but I sort of liked the painkiller.

David: (laughs)

Kevin: In fact, I remember talking to the doctor when he was tapering me off, and I said, “You know, I just might need a few more.” And he just smiled at me and he said, “No, don’t go that direction.” Inflation is like a painkiller, isn’t it? It always feels good at the time.

David: Yes, and for the general public, it’s a slippery idea to get a hold of. And it has the political advantage of selling well amongst the common man, amongst the hoi polloi.

Kevin: And I’m talking about when inflation is created, not actually the pain of inflation later.

David: That’s exactly right, because more money is a good thing, right? You want a pay raise, don’t you? You deserve it. Your pension should give you more, shouldn’t it? That’s where you have sort of the populist promises which are so easily offered and paid for from the printing press without the evidence pointing back to political malfeasance or fiscal irresponsibility. Does that make sense?

Kevin: Yes.

David: So the longer-term consequence being that, yes, it takes more escudos, pesetas, liras, drachmas, to buy the same goods, and you saw that in 1999-2001, that changed this habit of print to pay when all of Europe went to the EMU and gave up monetary sovereignty.

Kevin: This thing is, too, Dave, everyone got to be treated like a German. Germans earned, through a lot of pain in the past, an attitude and a work ethic that kept them out of inflation, and they were adding Italians, they were adding Spaniards, Greeks – these people, all they really knew was inflation, yet they were treated, from a credit standpoint, as if they were German.

David: And that has major implications, because Europe, all of Europe, was basically given the credit status of the Germans, and the rates that they were charged in terms of interest rates, therefore, began to drop like a stone across Europe, mirroring the German credit quality. Now, if you go from having a 6, 8, 10, 12% mortgage, to now having a 3% mortgage, what do you do?

Kevin: You go borrow more.

David: You not only refinance, but for the same money that you used to be paying on a mortgage, you buy an extra house by the sea. And this is why you had a property boom, and ultimately, a bust in a lot of these countries, because the addiction to easy money was now being serviced by cheap credit. And now, of course, we have a mountain of debt, as evidence of this change in strategy, if you will. But there was a fiscal irresponsibility built into the whole EMU project. When we talked to Otmar Issing a number of years ago, he knew full well, and he got together with the central banker in Spain and said, “This is going to be a problem. It’s not my problem to solve, it’s your problem to solve.” They knew going in that they were going to end up with a major debt problem if the domestic central bankers were not aggressively fighting it, but they did nothing. And so now we have a Greek debt problem. We have not only a second refinancing, but now, ultimately, what is likely to be a wiping out of some of that debt.

Kevin: And this new head of Greek finance, we’ve talked about his game theory, but actually, what in the heck is a Libertarian Marxist? He describes himself as a Libertarian Marxist. Now, doesn’t that sound like a conflict there?

David: Yes, well, I don’t know, it doesn’t sound stable to me – Libertarian Marxist who studies game theory. Last week we played the music for Zorba the Greek. This is a totally different version of Zorba. This is not the hedonist. Libertarian Marxist? He describes austerity measures, like spending cuts, just as one example? He describes that as fiscal waterboarding. Fiscal waterboarding!

Kevin: Well, I know my wife says, “A budget? A budget? That’s fiscal waterboarding!” No, not really.

David: It makes me wonder. You have the ECB which believes that they have leverage over the Greeks – so much debt is owed. And the Greeks believe no such leverage exists; they can simply walk away. The two parties don’t want the same thing. In point of fact, it’s not a game of chicken, after all.

Kevin: No.

David: This last weekend was supposed to deliver an agreement, and the Greeks stormed out defiantly. So, to date, at this point, there is no agreement. In the background, going back to February 8^th, you have Greenspan saying the best strategy is dissolution.

Kevin: To walk away.

David: His quote: “It’s just a matter of time before everyone recognizes that parting is the best strategy.” And you can see a Greece re-adopting of the drachma and going through a three- to five-year period of high inflation. This would be a political coup for the Syriza party. You know why? Because they would be able to deliver on every political promise made with control of the printing presses once again. And so, it’s sort of back to the good old days of buying votes with freshly printed money. Well, I guess, or tax refunds. We do that here in the U.S., as we mentioned a minute ago. Politicians are the same the world over. Buying votes is the soup of the day.

Kevin: And you know, the United States stepped in and actually was the backup plan when Europe was going through their problems a few years ago. They are still going through it, but the U.S. is probably going to have some opinion and some play on this, are they not?

David: Well, this is interesting, yes, because if you bring the U.S. into the mix – if it was just left to the Europeans and the Greeks, I think the Greeks exit. But I think the U.S. has an interest here. We used the airfields in Greece to launch our Libyan air strike in 2011. And the U.S. is probably the best hope of a solution with the European technocrats. I say that because we are likely to pressure the Europeans just to take a haircut on the loans. Cut them by 20%, cut them 40%. That’s probably going to be Washington pressure because we still want Greece as a player in NATO.

So, the X factor for me, here, is a geostrategic X factor. You can look at the money, you can look at domestic politics in Greece, but I think, ultimately, Brussels is going to get pressure from Washington, because if Greece gets pushed out of the EMU or it gets pushed to the point where they choose to exit, they will swing toward Russia. They will get a few handouts from the neo-Marxist bears in Russia, getting some political support, getting some global support, even getting some monetary support, and I think we will lose a NATO member, ultimately, and the U.S. does not want to sacrifice that NATO member.

Kevin: So, this plays into the geostrategic chess game, as well, positionally.

David: Yes. It could go any way. And so many things to talk about. We could talk about Puerto Rico. We don’t have a whole lot of time. S&P downgraded them three points. I think the bigger thematic here is still the dependence the world has on central bankers. And it doesn’t matter what sphere you are in. We spend a lot of time on Japan, on Europe, on the United States. We’ve covered U.S. economic issues today, retail sales being sort of a tell, if you will, of something that doesn’t match what is supposed to be a healthy recovery. You have the Chinese, which from their Head of International payments, the group SAFE, the acronym SAFE – that’s the group that manages their exchange control peg, and their Head of International Payments this week is basically saying, “There is not much more we can do. We would like to ease, but we can’t, because if we do ease any further, we could jeopardize 1.1 trillion dollars’ worth of currency-sensitive debt on corporate balance sheets.”

Kevin: Well, and isn’t there a lot of money coming out of China right now, fleeing, with the thought that the renminbi is going to drop?

David: That was his point, as well, that there is enough fragility, given the corporate balance sheets in China, that they don’t want, as a central bank, to do anything to create a 1997-1998 style financial crisis where you have massive flight capital. The thing is, you already have massive flight capital, so this is a little bit like the horse already being out of the barn. The Chinese are moving out, on a monthly basis – think about this – 50 billion dollars a month in anticipation of financial and currency turmoil. Obviously, this is not in anticipation of that only, we also have a major strategy change in China, which is to move against graft, to move against corruption, what used to be called the 59^th year.

Remember we talked with a gentleman from China, an analyst here in the United States from China, who said, “Well, of course, in your 59^th year, just before you retire, that’s when you start bringing home the paperclips from the office. That’s when you start stealing everything that isn’t nailed down, because in the 59^th year you know there’s nothing that you have for an encore because you have forced retirement when you are 60.” So yes, there is a huge amount of flight capital that is being encouraged because of the breakdown on graft and corruption, but also, in anticipation of a 1997-1998 Asian-style financial crisis is in the air.

Kevin: And they have to keep borrowing. China has been running on debt for quite a while, have they not?

David: Well they have, and I think this is critical. You have Bloomberg, which records the increase in credit in China from 2007 to 2014, a total of about 20 trillion dollars, and can they afford not to continue the credit expansion? This is the same sort of hamster wheel that Richard Duncan suggested we are on in the West. We are addicted to credit expansion. To keep the façade of growth going, we are going to have to continue to expand the base of credit, but at the same time, there is also a very high cost.

So, you have central banks around the world who are in this Catch-22, and having to make a political decision. Which is the higher of costs? To print, or not to print? That is the question. I think, very pertinent today, for the patient investor, this is a period of epic change in the financial system. This is a period of epic instability and epic opportunity, if cautiously positioned ahead of time. You look at the radical measures that central banks and politicians are making all over the world. Yes, they want to put a smiley face on it. In our opinion, a smiley face is nothing more than lipstick on the pig. They have yet to fix any of the structural problems. And we are going deeper and deeper into our addiction to credit, and credit expansion.

How does this end? When does it end? I don’t know, but we do know it does not end well. And that is why I think, again, for the patient investor, being cautiously positioned ahead of time, this is the time when you want a certain percentage of assets in cash, a certain percentage of assets in gold, (laughs) and just enjoy your life – maybe take your kids camping.