This week we answer your questions that were submitted over the last few weeks regarding investing, the market movements through 2018, and what is ahead for the markets in 2019. Thanks to our listeners and subscribers for a great 2018!
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
YOUR QUESTIONS ANSWERED 2018, PART 2
December 26, 2018
“I’m just amazed. Thank you, again, to our listeners for engaging, not only in the content of commentary, but then engaging with each other in a way that is considerate, in a way that is constructive, in a way that is respectful. It speaks to the quality and character of who you are as individuals, and your pursuit of truth.”
– David McAlvany
Kevin:Well, part two of our question and answer sessions.
David:Kevin, when we go travel and do presentations for our clients, my favorite part is the Q&A. Doing formal stuff is easy.
Kevin:That’s why you go hours and hours after the presentation.
David:I ask the question, who cares about power points? I certainly don’t.
Kevin:Who cares about midnight? Yes, and the people have a two-hour drive home.
David:Well, that’s what happens when Q&A gets really engaged. But it can be really fun, really insightful, and again, we appreciate you, as listeners, throwing your hats in the ring to say, “Hey, we want to know about this, we’d love to talk about that.” Because understand, we would love to sit down over a cup of coffee or have a beer with you, something where we had this conversation with you, and it didn’t end.
Kevin:Something that strikes me, both at these presentations when you do them live, and the questions that come in on these commentaries, people are engaged, they are listening. They will say, “Back in September you said such and such,” and then they will start piecing together a question that is very well put together. So thank you very much. Now, I told the listeners last week that I was really looking forward to this first question. It made me laugh.
Kevin:(laughs) This is a question that we will be hearing an awful lot about coming up into this next political season. It is an economic theory that is being asked about. But let me back up and read the whole letter, because it is worth it. Here we go. He says:
Hello. I’ll try to make this as brief and condensed as possible. About six weeks ago, David McAlvany called me at 11:00 a.m. on a weekday while I was sitting around in my underwear watching the markets. He didn’t identify himself. All he said was, “Hello, may I speak with Bill?” “Speaking.” “Hello, this is McAlvany Wealth calling.” I was surprised to get the call, being based in Toronto, in addition to being a very loyal listener to the Weekly Commentary. As the conversation progressed for a minute or two, I had the distinct feeling, “I know this voice.” It was, actually, Dave McAlvany, himself. “Is this Dave McAlvany I’m talking with?” “Yes, it is,” Dave replied.
Well, I was standing at the time, and I had to locate my easy chair and sit down. I’m 53. If I was 27 I would have swung from the branches. For the next 45 minutes, David and I, both philosophy undergrads who regard macroeconomics as merely the philosophy of money, chewed the fat on a delightful range of topics – economy and finance, geopolitics, Trump in 2020, moral philosophy. One aspect of our conversation helped me immensely because I was embroiled in the subject. I asked David what his thoughts were regarding MMT, Modern Monetary Theory.
Dave, that’s what I’m talking about. We’re going to be hearing a lot more about that.
Dave said, “Oh, you mean chartalism.” I had to look up chartalism. I love looking things up. David went on with a robust answer. I do distinctly remember that he was not nearly as taken as I. The MMT is growing momentum such as I predict it will feature prominently for the Republicrats for the 2020 election platform. David will no doubt know that Bernie Sanders’ economic advisor, Stephanie Kelton, recently wrapped up her MMT tour in Australia. The question I put to both David and Kevin is, and I would be grateful if both voices weighed in on this one because I enjoy the insights from both, is MMT a crock, or can it supplant orthodox economic ideology, which treats the national economy as if it were a private household that could go bankrupt via over-indebtedness. Is Warren Mosler a kook, or the next U.S. Treasury Secretary? It’s a can of worms I’d love to see David and Kevin tangle with. Thank you, and goodnight. Bill.
David:Well, the main takeaway from Modern Monetary Theory is that you have no budget constraints. That’s one thing.
Kevin:No barriers, right?
David:And that economies are self-stabilizing. Now, that’s how they would describe it, and that’s a very confusing path to that conclusion. I’m not even sure what the MMT crowd means by it. I know what self-stabilizing means within the context of the gold standard, but there is a very convoluted route to get to an economy which is self-stabilizing.
I think another point on MMT is that it takes the government deficit and it borrows from an accounting formula. This is legitimate to a degree, I think it is just misapplied. Where there is a deficit, there is also a surplus. What MMT would say is that the government’s deficit is your surplus. This is, again, where you start to feel the influence and the affinity with a Bernie Sanders.
Kevin:You start smelling snake oil because what they are promising is no deficit, we can just print as much as we want and it will be fine.
David:Or infinite deficit, there are no budget constraints because we can print as much as we want. The irony is that modern – that first word in the MMT – is not. John Law was the first that I know of that designed the system in his 1705 book, Money and Trade Considered. The subtitle is, With a Proposal for Supplying the Nation with Money. This was the foundational work which got attention by the French monarchy, and, ultimately, had him put in place as the equivalent of prime minister there in France, managing, as a man from Scotland, the entire French monetary system.
So study the period, and you will see a focus on financial innovation, you will see the abandonment of monetary constraints, and you will see a great contrast between two characters of the period, John Law on the one hand, Richard Cantillon on the other. Cantillon was a contemporary of Law’s. As we began to see Law’s whole system, with the Mississippi scheme, falter and lose legitimacy, Law was begging Cantillon to come back and help fix the system because there were some significant errors embedded in this early 1700s version of MMT.
So in the next few weeks we will take a very deep dive on Richard Cantillon. I think he is an important figure to be familiar with, and I would love to have a conversation with his biographer, Antoine Murphy. Murphy wrote the definitive book, just republished in paperback by Oxford University Press, Richard Cantillon: Entrepreneur and Economist.
Kevin:The system absolutely requires a captive audience. Talk about a closed system, if you are going to have a system where the government can print freely and as much as they want, you have to close it. Carmen Reinhart told us, “You have to create a captive audience.”
David:There is a contrast, too, between Law’s system, which was one of control and a centralized influence, and you’re right, it did require a closure of the system to work, to function. Contrast that with Cantillon’s view, which was, really, the entrepreneur is central to what develops within a capitalist system, although he wouldn’t have called it a capitalist system. I don’t know that he even would have used the language of free markets. But he saw the role of the entrepreneur and freedom and individual risk-taking as central, and that is where Cantillon came in with a wicked critique of John Law.
So with Law’s system it meant that, ultimately, choices were limited and there was both a political and an economic price to pay if you were going to opt out. So the man on the street ran into the Mississippi system for all the benefits that it offered, for the wealth that you could acquire, and for the trading rights to the new world. It really was an ingenious system, but it had some significant flaws. And that person who was running into the Mississippi system abandoned gold and silver.
Meanwhile you had smart money, very wealthy and wise families in the French context, who were hoarding specie – specie is just a fancy name for gold and silver coins – and they did that in spite of the run-up in the Mississippi shares in terms of value. When the systemic cracks began to appear, they continued to maintain their hordes of gold and silver outside the money and banking system.
What is really curious about this is they had chosen an opt-out. The MMT process – again, that’s what we call it today, but Law’s system was really the early model – required closure. We mentioned that. If you owned gold you were limited to 500 livres, which was virtually pocket change. And if you were found with more than 500 livres of gold or silver you were threatened with total property confiscation. So if you were worth millions and millions in that day, finding a little bit of gold meant that you would lose everything. Again, to enforce the system they implemented exchange controls.
Modern Monetary Theory goes well beyond Keynes, and it goes beyond Keynes to the great inspiration for centrally planned monetary experiments, and that is John Law in 1720. So MMT is a new theory in name only. If you’re talking about Kelton, if you’re talking about Mosler, if you’re talking about Bernie Sanders, or the Sanderses of the world, they’ve been here before. And what is interesting to me is that the ideological failures are forgotten only because they have been given new names and we’re not making the proper associations.
So what is it, in essence? We’re playing with the nature of money. We’re playing with the definition of money and we’re trying to gain the latitude that politicians have always wanted without restraints on the definition or use of money. That is as old as dirt. That is not modern except in its most modern iteration.
Kevin:Promising free money without ever having to pay it back is a little bit like a perpetual motion machine. The patent board will no longer even look at perpetual motion machines because they look like they work, but honestly, the science hasn’t changed. The terminology to confuse has been modified. When somebody says, “Let me tell you why this one will work” – this is Modern Monetary Theory – and then they want to show you the math and show you how it works, it is still snake oil. It is still socialism. It is still promising perpetual motion.
Kevin and David, I hope you had a great year. Thank you for your episode on cryptocurrency. I teach block chain, cryptocurrency and artificial intelligence at college. I just taught a mixed audience of 50 in downtown Houston about block chain. Everyone that attended the free event left with their own python block chain code. You guys nailed it, 95%, right on the head. I was pleased. I know you’re limited on time, I have so much to add. I point out that block chain does offer economic incentive to invest in faster processors and cheaper electricity.
He is going to jump, actually, Dave, in the question to SpaceX. SpaceX has put a car into mars orbit and plans to land on mars in six years. It is only a matter of two to three decades and artificial intelligent mining equipment, they will be littering the solar system. So here is the question of the year, he says:
When all natural resources are no longer scarce, what assets will hold value?
I think he is referencing mining asteroids, mining planets, mining in space. I think we need to address that. We have gotten a question like this before.
David:I think one of the constraints today is the economics, and perhaps that changes over time, but I think before we assume that gold will be as common as dirt because of what, first of all, may or may not exist on other planets or on asteroids. Kevin, I think maybe you could explain a little bit on stars and supernovas and the variance in matter that can exist, and maybe even the concentrations that might exist as a result.
Kevin:Well, stars are very complex, but actually very simple. They start as hydrogen and they start fusing to heavier metals. They get to a point where they can’t fuse anymore when they get to iron. The theory is, and actually there is good evidence of this, that any heavier element, then, must be produced by supernova.
David:So you’re talking about any element heavier than iron has to be produced by supernova.
Kevin:What that means also is this. There is an awful lot of gold in the universe, but it is a long ways away and it is sparsely populated. So it’s like everything else. So to think that we’re not going to have need for precious metals or natural resources, what have you, even if it was free to go get it would still be difficult. But here is the problem.
David:But supernovas are not exactly the most common occurrence, are they?
Kevin:No, they’re not. That’s the thing that makes these elements rare. But here’s the problem. With the shuttle program it was $10,000 a pound to loft something chemically, chemical combustion to space. Now it has dropped to about half that. With some of the technology like our listener was talking about it could drop even more. But in our lifetimes the cost of mining in space, I doubt that we’re going to live to see the relevance of it.
David:Just to look at the economics today, and this is all back of the napkin, non-scientific, first of all, there is a lack of evidence that there are actual high-grade deposits. When you are exploring for gold, you need not only for it to be present, but you need for it to be concentrated.
Kevin:They’re speculating that it may be out there.
David:And maybe out there in the universe is different than having it in a concentrated form where you can mine it. But you’re talking about exploration and mining which is a very expensive project here on terra firma, and the theoretical production costs for gold, we’re talking hundreds of thousands, if not millions, of dollars an ounce. Again, we’ve got SpaceX, we’ve got Elon Musk’s other enterprises which are doing quite well, but only because of the willingness of politicians to bestow taxpayer dollars on those ventures, not because they are actually economical.
Nevertheless, you mentioned $10,000 a pound to launch to space. On the basis of his subsidies and those going to SpaceX, he can launch at $5,000 a pound. And so, I’m just thinking of the Caterpillar model 797. If you guys have ever seen one of those massive Caterpillar dump trucks, they weigh 1.23 million pounds, and assuming that you could alter the combustion engine and you have an operable dump truck in space, the cost to get it into space and then operate it, we’re talking about a single dump truck – drumroll for the pun – it’s astronomical (laughs). It’s 6.15 billion dollars, assuming that new number of $5,000 per pound to launch, 6.15 billion just to get one Caterpillar dump truck into space. We’re not talking about the ancillary operations or anything else that you would need for mining. I guess what I’m saying is, I’m not worried today, or really in multiple lifetimes, that gold in space is going to dilute value here – not yet.
Kevin:Well then, let’s go to the next question because it ties right in, not with space, but with gold:
Hi guys, I’ve been listening to your Weekly Commentary for at least eight or nine years.
Wow, thank you.
Knowing the short attention span of the average American, what is quick way to explain the opportunity with precious metals?
Now, pretend like you’re in an elevator, Dave, and you’re going down and you have to explain the answer to that question by the time you get to the first floor.
David:Right. Well, the first thing is to get someone’s attention. The problem is, I don’t know how to do that focusing on the most critical element of gold, because first and foremost, the opportunity is to preserve wealth, and then secondarily, to expand wealth thereafter. I think anyone who is in the elevator is going to want the story of how wealth can be gained instantly, and with ease. I think you have to step back and look at the process of why you own gold and what it is used for. If you treat it as money, if you use it as an insurance policy, then you’re getting to the heart of the matter. So again, I think you look at preservation of wealth first, expansion of wealth thereafter.
You could have nominal prices of gold increase depending on the value of the underlying currency. Let’s say, we’re talking about the Venezuelan currency or Zimbabwean currency, or how it marks in the market today in Japanese yen. Whatever it may be, the underlying currency and gold priced in that underlying currency could be five digits, could be six digits, could be seven, eight, could be nine digits. The real opportunity in gold is not in the capital appreciation, but in the capital preservation. When very few pockets of wealth have been preserved, it’s the wealth that remains that goes a long way.
Kevin:Now, you’re on the 10thfloor, you’re still descending, give us another point.
David:Getting back to insurance. Insurance and the role that gold plays is money. This is the key to understanding the real opportunity in gold. You have to follow the process through to realize it, whether you’re talking about shares, or acres, or square feet, gold buys it all. And it buys it at some exchange value. And that’s where the magic happens. So again, you own gold to preserve wealth. You use your wealth in a transformative fashion when there is opportunity to do so.
So I’m less concerned about capital appreciation and it being priced in five, six, seven, eight, nine digits, because again, that is more commentary on the value of the underlying currency. I want to know the exchange value into other real things – land, plant, infrastructure of a company, square feet for an apartment complex, acres for a productive farm. This is where you begin to see your wealth used in a transformative fashion, and I think this is where my elevator speech ends (laughs).
Kevin:Floor one. That’s good. But this next question also ties in because we have seen what looks like control, to a degree, of the gold price through the futures market. So here is a question from Kaye:
Hi. This week you talked about government control, or kill, in relation to cryptos. Now, I’m wondering if the Federal Reserve or the U.S. government doesn’t feel the same way about gold and silver. Is it a matter of, “Don’t fight the Fed,” when we set out to put 25% of our portfolio into gold and silver? If they succeed in setting the price of gold and silver, as they have done for the last five years, we will be worse off than if we had put our money into treasuries or Apple shares. After all, this is what they want us to do. Then they would have succeeded in controlling us and killing gold and silver. P.S. I’ve listened to your Commentary every week without fail for years. Well done.
Thanks Kaye. So Dave, let’s talk about this price control on gold.
David:First of all, I think in our conversation with Nazli Choucri a couple of years ago we hit on who controls the Internet, and what the jurisdictions are. And the fact of the matter is, governments all over the world do have kill switches. Anytime they want they can shut it down. So to the degree that we are talking about cryptocurrencies, they can, in fact, control and kill. When you’re talking about gold you’re talking about a diverse and dispersed market, a global market that no particular government controls.
But I think Kaye has a point here. If you’re talking about this last five-year stretch, there is no doubt, that’s a five-year timeframe in which Apple shares and treasuries were the winners and gold, on relative basis, the loser. I guess if you wanted to, you could choose other five-year Stretches, other time periods, where the opposite would have been true, where gold was the winner and Apple was the loser.
Nevertheless, for those who have listened to our Commentary through the years, and have listened to Marc Faber, very often he will conclude with a rough asset allocation model of 25% in four different categories – 25% in metals, 25% in real estate, 25% in financial assets (stocks and bonds), 25% in cash or some sort of liquid, short-term treasury bills, or what have you.
Kevin:So what about control and kill? Can they do control and kill with gold and silver long-term?
David:That’s the real part of the question, the controlling and killing of the gold market, and I don’t buy it. Look at the gold market from $275 to $1900. That was not controlled, that was not killed. What we have had since then is a simultaneous cyclical bull market in financial assets, and I think that has been driven to an exaggerated level, and frankly, the timeframes exaggerated as well by central bank monetary policy, but we’ve had a cyclical bull in financial assets.
At the same time we’ve seen a cyclical bear in the gold market. There is a psychological complement to this. You have enthusiasm for financial assets and you have no enthusiasm for real and tangible assets. We are talking about gold and silver here, but it’s worth looking and saying, “Is the establishment controlling the entire commodities complex?” Because if I take the GSCI, the Goldman-Sachs Commodities Index, and compare it to the S&P500, as one of our questioners does a little bit later, guess what you find? Commodities, the whole complex, are cheap relative to financial assets, the cheapest they’ve been, or as cheap as they have ever been in a 50-year period. So it’s not as if you are controlling one versus the other, I think there is a psychology within the market which is more in tune with the pricing of the assets, and not necessarily a command and control dynamic.
If you’re going to try to perpetuate the financial asset bubble, you will ultimately pay for that. You will pay for that with a weaker currency. You will pay for that with the exchange rate. What we have today is an open global economy, and that open global economy allows for individual actors to express their self-interests, to seek opportunistic ventures here and there in a way that is consequential to the trends, whether that is the bull market in stocks or the bear market in commodities.
But trends are never perpetual. I think this is a really key point. We look at the trend which has been in place for five years and say, “All right, well, we should have been in Apple shares and treasuries, not gold.” And we cannot infer from that that gold will forever be held back, or the entire commodities complex will be held back. Trends are never perpetual. They run in cycles, just like financial assets do. They run in cycles because of the attendant psychology of those individuals participating in the trends. That psychology also runs in cycles.
So regarding gold and silver, even the worst-case scenario, let’s that the government moves against and picks on one particular commodity, or two commodities, gold and silver, with illegality, with confiscation, or with some sort of confiscatory capital gains tax. Even when the costs are high for an individual to preserve self and to preserve their wealth, individuals will find a path.
Again, returning to Cantillon. You had, in the context of John Law, the failure of that system. What is the modern iteration of that? Modern Monetary Theory. Exchange controls were in place. They had to close the system to make it work. Anything over 500 livres in gold and silver was illegal. You still had perspicacious, wise families, not only owning the metals in large quantities, but they were able to ultimately get out of the country.
And this is how Cantillon made his second fortune, providing currency exchange out of the closed system. Was it legal? I don’t know, but those who wanted to move out of French livre into specie, which is what we call gold and silver – Dutch guilders, British sterling – there is always a way. There is always a way out, there is always a way around, there is always a way under, there is always a way through.
And this is, I think, the point. You cannot control the market. If individual actors, singly or in mass, decide that they want out, around, under or through, it will get done. That is what history shows. The markets speak, and ultimately, no plutocrat, no autocrat, no dictator, can determine the course of a particular market.
So I love the question, Kaye. I think we are finished with this particular cycle which has favored financial assets and has left it to the dustbin of history and relevance, at least that is the current meme, the entire commodities complex.
Kevin:The thing that amazes me is, every single bubble we could talk about, if you had moved to gold before the thing popped, you would make a fortune. We’ve seen this with bitcoin, we’ve seen this with other bubbles, even the Mississippi scheme 300 years ago with Cantillon. It is interesting. Where do people move when they move out of a bubble before it pops? Gold. It’s because it preserves value.
Moving on to the next question:
I’ve heard from many folks that there is a coming financial reset. Do you have any thoughts on what that would look like as it relates to bank balances, and especially, personal debt balances? I’m most concerned about mortgages. Could you see a gold-backed currency as a result of this reset? On another note, I’m thrilled with the Vaulted app. It came just as we were looking for a safe place to park some cash because we’re going to need it later. Thanks for being so forward minded.
So gold-backed currency and a reset, Dave – what are you thinking?
David:Right. Vaulted is a fit as a cash or savings alternative. Of course, you have the gold price volatility, that is implicit, but you are simply choosing between the currency that has stood the test of time, and the currencies which are being purposefully and willfully degraded. Now, this is fascinating – I’m sorry, small rant – it is no longer by a hidden factor, the hidden inflation rate. It is as if our central planners have said, put the inflation target out there for people to see. It makes it less of a bogeyman and something to be feared. Inflation desensitization is what has occurred via targeting the rate.
Kevin:But what about mortgages because that was the chief concern of this question.
David:Right. So mortgages would likely be indexed along with other debts. So you have to keep in mind the central banks’ penchant for keeping creditors intact. Can’t allow creditors to be destroyed, so debt has to be indexed. The problem with the gold-backed currency – another part of the question – is not a problem inherent to the gold standard itself, but bankers and politicians both oppose it. They oppose it because it restrains both of those groups in their activities and in the commitments that they can make.
Going back to Vaulted for just a minute, Vaulted was launched, in part, so that people could establish a savings system which is their own gold standard. So knowing the weakness of will, knowing the self-interest of 97% of the banking and political community – not all politicians or banking executives fit into this – but the majority in the community would implement policies which degrade the value of our currency. That means we have a choice to make.
Kevin:Keeping consistent with that, then, the safety of something like a Vaulted app, Bart asks this:
According to your website, the gold is stored at RCM, Royal Canadian Mint, which is a crown corporation, which means it is owned by the government of Canada. I’m interested in precious metals, not only as a way of preserving the purchasing power of my savings in the long run, but also as a way of staying outside of the system. Due to concerns of a potential bank holiday in the event of another crisis, I am against storing any precious metals in bank deposit boxes. Is McAlvany ICA not concerned that storing their clients’ gold at a government corporation such as Royal Canadian Mint is highly risky, even more so than storing it at a local bank? I believe a better option would be to store physical metal at private vaults such as Loomis or Brinks. Will Vaulted app offer this option in the near future? On the podcast where I first heard of Vaulted app, Dave mentioned that gold can be stored at RCM, Royal Canadian Mint, or Switzerland. However, I was not able to find information on the Swiss option on your website. Can you please clarify?
David:The design of Vaulted is to be a cash and banking alternative. The assumption is that that is an in-the-system choice, but a diversification in terms of currency, and maybe even geography. So the in-system versus out-of-the-system – the only out-of-the-system measure is to have physical gold in hand, and perhaps be practicing midnight gardening or something like that.
I want to reflect a little bit on the scale of risks here. There is a scale of risks, if we’re talking about credit and solvency risks. Corporations are at the lower end of that scale, much lower than sovereigns. So I think, from that viewpoint, sovereigns are a better risk than corporations. By the way, Loomis – for logistics purposes we use all the vaults that you can imagine, and transportation companies, in the world, and have relationships with them. But again, I would take the balance sheet of Canada more seriously than the balance sheet of an individual company – far more seriously. So again, you’re still in the system with a Brinks or a Loomis. That distinction, I think, has to be made up front.
Back to the scale of risks. We contrast the difference between sovereign and corporate risk – credit risk. That’s there. Then comes, in my mind, a very critical distinction – countries that practice the rule of law and appreciate property rights, and those that don’t. And I think anywhere outside the Anglosphere and you’re taking on huge risks because those sovereigns that do not practice a robust rule of law and recognize property rights are unconstrained, and you’re taking massive risks there.
Kevin:I think the listener is asking a question wanting Vaulted to be everything, but we also have multiple programs to get these things done – what he is talking about.
David:Yes, we offer a variety of programs. Each is an iteration, and Vaulted, in my opinion, is the best, specifically, for a cash and savings alternative. This is defined for me by certain qualities. It is defined by the product – kilo bars – the purity, the liquidity, of said product, accessibility to the balance via the technology, the technology’s robustness, and at the same time, the simplicity of it. One way of thinking of this is as a storage arrangement with the sovereign versus a deposit. There is a bailment here which signifies that you are the owner and are renting the space. The product is not on the balance sheet of the entity storing it, nor can that product be loaned, nor can it be leased, nor can it be otherwise encumbered. So yes, it is in the system, but it also has all the other benefits and robustness of being a separate and sole asset of the client.
Kevin:Let’s go many steps away in this next question then, because ETFs are nothing like actually having gold in storage. The question goes:
I’ve been buying mining stocks over the last few years while precious metals prices have been dipping. I own a few gold ETFs, such as GOLDX and GDXJ. In the event of an equity collapse, what would happen if the investment firm who owns the ETF is forced to liquidate? Do you think it is less risky to own individual mining company equities rather than diversified mining ETFs in the event of an equity collapse?
David:GDX and GDXJ are both owned by VanEck. My dad was the national wholesaler of the original VanEck gold fund. This goes back to the 1960s and early 1970s. The VanEck funds have weathered the early 1970s sell-off, the 1987 sell-off, the year 2000 sell-off, the 2008-2009 catastrophe, and I’m not worried about them at this point. I have a personal preference. My personal preference is for core holdings of individual shares, the highest-quality shares, with a supplement and a diversification through funds like the ones mentioned. So I would own the big boys outright, and I would own the juniors in a fund form for diversification, or as some would call it, “deworsification” (laughs). But that, I think, is a good strategy, to use those. And as you mentioned earlier, there is a difference between ETFs and gold stored.
Just one comment on that, although it wasn’t part of the question – GLD and SLV are both gold-stored. The issue is, unless you are taking delivery of, say, ten million dollars, it’s not practical. You can’t take delivery of it, FedEx is not going to deliver it to your door, you don’t have the same fungibility, which gives Vaulted that same-as-cash quality, just a choice of denomination in ounces versus greenbacks.
Kevin:Fiona is trying to look ahead at taxes on the same thing we are talking about, so I will read her question. She says:
An old adage usually attributed to Ben Franklin in a 1789 letter states, “Our new constitution is now established, and has an appearance that promises permanency. But in this world nothing can be said to be certain except death and taxes.” The investment community seems certain that you are going to pay a lower tax rate when you retire, so the majority of investment tax is deferred. Given the level of government debt, I wonder at the wisdom of this assumption. How do we plan for future investment taxation beyond our current planning assumptions? Is there a strong argument for a fiscal and economic context in which you anticipate and act differently today for tomorrow, based not only on investment growth, but tax exposure? With government and institutional control and rules on virtually all of our monetary and investment instruments, I’m not sure how we see that we can truly secure our wealth as our own anymore. Thanks for the show. Fiona.
David:Well, what a fabulous question, a series of observations, and I feel unqualified to answer it, so understand there are going to be some holes here. I think one of the ways that you act differently today for tomorrow is by, if you are able, taking traditional IRAs and utilizing the Roth conversion option. You’re settling up with Uncle Sam now. You’re not assuming that rates are going to be more favorable in the future, and frankly, I think with the current administration, this is about as good as it is going to get. If the current administration loses in 2020 and we bring in somebody of a Bernie Sanders ilk, I think you can look at a massive attack on wealth in all its forms, and so I would want to settle the score with Uncle Sam as quickly as possible. That would be one way of bringing the future into the present and acting differently today for tomorrow.
I think there are a couple of other things to keep in mind and this relates to how to plan for future investment taxation beyond our current planning assumptions, maybe taking it into the next generation. So let me make some assumptions about intergenerational planning and wealth strategies which might be apropos. One, decide on what assets you have which are tradable assets. That would be one category – tradable assets which in your time you are going to buy and sell, and there you are going to see whether it is coming out of a retirement account income tax implications, or outside of retirement account, merely capital gains tax implications. Now you have one pocket designated tradable assets. That is in contrast to the second pocket of assets which you would consider long-term or inter-generational assets.
Now, think about this. Let’s say that you own a stock portfolio, or, like last week, the gentleman in Australia. Well, that’s not a good example because it doesn’t apply to the U.S. tax code. But let’s say there is somebody just like him who owns 13 kilo bars, and they want that to be an intergenerational asset. Well, upon your demise the next generation gets a step up in basis. So rather than selling in your lifetime to simplify a portfolio and hand over only cash, keep in mind if you sell in your lifetime you are going to trigger a capital gains tax and then you have an inheritance tax thereafter. If you allow the asset to pass from one generation to the next, the step up in basis takes care of the capital gain that would have existed. You see the value there of thinking long-term?
Now, there may be an inheritance tax depending on the total size of the estate, but I think two things we have talked about, the traditional to Roth conversions, and then deciding on what is in your universe of assets which is tradable, first category, second category, intergenerational or long-term in nature, and make sure you take advantage of that step up in basis.
How protected is our money sitting in bank savings accounts right now? When the next recession hits, will depositors be required to bail banks out? What is your thought on that? Are we the bailout of last resort again?
David:Yes and no. They were a part of the bailout last time around. Just think creatively about this. What we call financial repression – we have low rates, negative rates. What is the purpose of keeping interest rates at a low level? This helps rebuild the capital within the banking system, and it is at the expense of the depositor. You can say, “Hey, what’s the bail-in? Well, that was an implicit bail-in as opposed to an explicit bail-in, and we call it financial repression. You can hide behind a bunch of words – at the end of the day we did already have in 2008-2009 one version of a bank bail-in.
Kevin:And we’re still bailing it out. The artificially low interest rates are part of that bailout.
David:That’s right. And maybe that moderates over time, but one of the things you also have to consider is that we’re also adding to, not necessarily the bank system’s health, but we are adding to the government’s health via the inflation tax. That’s 2%. Nobody really thinks about 2%, but you have to. You have to recognize the size and scale of 2% when that is more than you might get in your bank deposit.
So you earn less than 2% in your bank deposit, and you give up more than 2% in an inflation tax, you’re going to get hammered on both sides, either with low rates and what we call financial repression, or the inflation tax, which again, is not necessarily directly beneficial to the banking system but is very beneficial to government. The question – how protected is your money sitting in a bank savings account? I think we answered it.
Kevin:Okay, Mr. Bibliography. This question is on education:
What sources do you recommend to learn about our money system, including the BIS, the Federal Reserve, Treasury, Goldman-Sachs, consumer banks?
I have to throw out right off the bat, Dave, The Creature from Jekyll Islandis where you start.
David:And I think the journey never ends. The question is, how far along do you want to go? And there are both degrees of complexity and detail which at a later date may be very important and very intriguing to you, which on the front end are not seemingly relevant, so it depends on how far your curiosity takes you. But if you want the journey to never end, as a lifetime learner in every category, whether it’s psychology or market dynamics or economics or finance, in this case the question is relating to the money system, the Federal Reserve, the Treasury, banks.
I’m going to give you a variety of names. Some of these are expensive books and therefore out of reach, or too academic. But you started with a good one, The Creature from Jekyll Islandgives the back-story to the creation of the Federal Reserve, and lets you know that this is actually the third iteration of our central bank – we’ve tried it twice before. Now, it doesn’t give you the history of the Riksbank which was the first central bank in Sweden. It doesn’t give you the creation of the Bank of England in 1694. There are a number of central bank iterations which preceded the Federal Reserve. All you get in The Creature of Jekyll Islandis how the current central bank in the United States came to be.
I think The Ascent of Money, by Niall Ferguson, is an excellent book. Beyond The Ascent of Moneyhe has one that deals more with the history interest rates and borrowing, which isThe Cash Nexus, also by Niall Ferguson. The Cash Nexusis very intriguing. This Time Is Differentis a book by Carmen Reinhart, one of our Commentary guests, and Ken Rogoff, who we quote in last week’s Commentary, the Q&A, and it is eight centuries of financial folly. Lo and behold, when you are studying financial folly you get to read about banks, you get to read about central banks, you get to read about interesting corporate decisions and political decisions, etc., so that is a read that I would encourage.
The Curse of Cash, also by Ken Rogoff, is his argument for why we should be moving to a cashless society, and moving beyond just the tools that the Federal Reserve has today to even broader tools, and so I think that is a good sort of modern iteration. The Death of Money, by Jim Rickards, and The New Case for Gold, also by Jim Rickards, too, which read more like spy novels as opposed to some of the other books which I might give you which are definitely more academic.
Fragile by Design– don’t commit to this unless you are interested in 500 pages of small fine print, but a fascinating look. The subtitle is The Political Origins of Banking Crisis and Scarce Credit– a must-read. That came from a bibliography of Alex Pollock, and we had a conversation with our banker friend, Alex Pollock. Harold James, also a contributor to the Commentary here – International Monetary Cooperation Since Bretton Woods. The more boring the title sounds the more likely it is to be an academic work, and the less likely the average person is going to want to spend time either buying it or reading it.
Kevin:But the more likely it will be in your library.
David:Be forewarned. And then I think one last one, and this is one that has just made a huge impact on me is Giulio Gallarotti’s The Anatomy of an International Monetary Regime: The Classical Gold Standard 1880-1914. You have to be a hyper-geek in terms of monetary policy, and be willing to spend a couple of hundred bucks because it is not an in-print book. But that gives you a range from introduction to the Federal Reserve via The Creature From Jekyll Islandand the author on that is Edward Griffin, to something highly academic and fairly arcane.
Kevin:Can I just add, Dave, in case the person doesn’t want to read, we do have a video calledWhat Is Real Money?
David:(laughs) Yes! There you go!
Kevin:You did that yourself. I’m sorry, there are people right now thinking, “No, this ain’t gonna happen.”
David:Okay, you’re right. Actually, that’s a great point.
Kevin:Yes, just get on our website.
David:It’s 30 minutes, 40 minutes, something like that. It is a summary of the history of money, its uses, and why gold became the default currency through time. And actually, we do get to borrow some from the ideas of Gallarotti, Harold James, and others in terms of the history and the importance of gold in the monetary system from the beginning of recorded history.
With the gold-silver ratio at 80-to-1 plus, why hold any gold at all? Shouldn’t I be in silver all the way and buy back gold later when the ratio drops? Or is it really possible that the ratio can linger for the next three to five years?
David:We had that question last week, to some degree. I would just say that the ratio can go to 100-to-1. I doubt that it will, but it can. And so I guess the question you are asking here as an investor – do you own the metals for asset preservation or do you own them for growth? And to the degree that you are trying to sit the fence between those two that is how you would end up with diversification between gold and silver, because asset preservation is the prominent theme, the dominant theme of gold, growth a little bit more of the factor that you get from silver or platinum or palladium.
80-to-1 certainly argues for a higher ratio there, and I do not have more than a 50/50, if you’re talking about aggregate. I do have specific accounts which are 100% silver, but they are designated for growth, they’re designated for the gold-silver ratio, they are designated within tax-deferred structures so that I can aggressively play those ratios, and that would be the only place that I would have 100-to-1. But in aggregate, across a net worth picture and inclusive of an entire precious metals portfolio, I think the only time that is appropriate is if you, the individual investor, have made the priority growth, and have increased your risk profile – you have to acknowledge that – and have decreased the importance of asset preservation and protection.
Kevin:Next question has to do with just taxation and the future of gold:
What is the possibility of the government slapping a giant tax on the selling of gold?
David:The possibility is high. It can happen. It is not a dumb question.
Kevin:It’s one of the reasons you love IRA gold, too, right? Moving an IRA into gold and silver where you don’t have that issue is a great option.
David:I think when you look at land, and at gold, gold remains an asset of choice for wealthy families going back hundreds of years across any geography in the world, and as we talked about with the French system in the 1720s, you choose how, you choose where, you choose when to engage with the system. And in the case of the Mississippi era, if you got caught holding gold they would confiscate your entire net worth. They would take everything. So the idea that they could slap a giant tax on – yes, so they do. The question is how you, as an individual actor, choose to participate in that, and how you choose to engage with self-preservation and wealth preservation in the context of those decisions.
Only you can make those decisions. There are real ramifications for breaking a law. I’m not advising breaking a law. I just recognize that people throughout time have done what it took to preserve value for themselves and their families, and have not played to the interest of the state, even though the state has suggested it, required it, and penalized those who didn’t comply with it.
Kevin:Of course, Dave, anytime we are asked, we always recommend and tell people – pay your taxes. What you’re saying, though, is that we have no idea what the system looks like at that time. The system, itself, could be falling apart. We don’t even really know what the government entity would be in that case.
First off, I just want to thank you guys for the Commentary. I have listened to every episode you have produced throughout the last five years and it has been an incredible help to my transition from an average American millennial video-gamer to an actual adult with a focus on the future of my family. First, for some background, I originally intended on becoming an engineer, but I switched to social work in the hope of switching out monetary gain for something intrinsically rewarding. Unfortunately, all I have ended up with is an insane amount of stress and not so much in the way of income. I am currently 33 and my wife and I together make about $75,000 a year. We are currently purchasing about $150 a month in physical silver with the occasional purchase of gold if I run into a bonus here and there. We live on a small farm and we are currently very slowly building our own home without the help of banks as possible. My question is this. What direction would you guys suggest that a person in my financial position should focus? I am not so much focused on retirement as I am pretty well convinced that I am not going to have that option to retire 30 years into the future, but would instead like to focus on protecting my current meager wealth to pass down as much as possible to my children, currently two and four, when they become adults. Again, thank you guys for all you do.
So Dave, these folks are putting together a house without the banks on $75,000 a year with two kids. That’s tough. That’s admirable.
David:I love this. I would focus on exactly what you’re focusing on – wealth protection as described, what you are doing with both an acquisition of gold and silver, not getting into a huge amount of debt. I think another goal for you would be creating a duplicative income. Right now the two of you are working and creating $75,000 a year. Is there anything that, over time, could be, in this case, a third source of income?
Again, not shared here are the details of living on that farm, but is there something there that could be income generative, and in fact maybe an entrepreneurial sort of hot-house for your kids where they are learning to see things from the standpoint of creating value, whether that is selling eggs from the chickens that you have to local stores. You wouldn’t believe, $6-7 a dozen for free-range eggs at the farmer’s market here in Durango.
Kevin:Yes, we pay it, at James Ranch.
David:So there is that, in terms of the duplicative income. I would really do that. That is a part of a mindset, really. It is a mindset to say at some point we might need a substitute for one of our incomes, either because of a health issue, or because of a personal choice, or the kids are grown and gone and that duplicative income gives you the flexibility of dialing back your current workload to something that is less stressful.
Kevin:I’ll tell you what, Dave, the skills that they have gained just living the way they are living means an economic downturn isn’t nearly as devastating as it is, actually, to most of the people listening right now.
David:Right. So I would be thinking in terms of retirement, but I would not be thinking in terms of your own retirement. I think there is a healthy generational restart here and an opportunity for you. If you are saying, “Look, there’s no point. I’m 33 and there is not going to be anything for me. I’m going to have to work, I’m going to have to provide. Is there something I can do for my kids?” I would say, yes, wholeheartedly. Absolutely.
Look at Roth IRAs for your kids. You may think, “Can I have an IRA for someone who is two or four? Yes, you can start them at any age. They have to have an earned income, but there we go again. If you’re creating a duplicative income from something that you are doing on your little ranchette – great. You can assign that income to them. Yes, it means they have to have a social security number, it means that they have to file taxes and everything else, but their participation in the family business can be rewarded, and I would use those dollars to fund a Roth IRA for them.
Doing so does a couple of things for you. By the way, minors are really not allowed to own securities so you’re limiting to owning gold and silver in a precious metals IRA. I’ve done that for our four kids. Don’t tell them. I haven’t told them yet. I’m not planning on telling them until they are in their 20s. Nevertheless, I’ve funded their IRAs for two, three, four years each, and that’s it. But the math works in a fairly compelling manner. If you can set aside a modest amount, by the time they are 65, compounding at a very modest rate, you have a very, very healthy number.
And it only takes one generation to get this jump-started because you have demonstrated to them thinking intergenerationally, you have showed them in real, demonstrative terms, that money is not just about you, but it’s about the other. It’s about taking care of other people, it’s about taking care of family. And for them to adopt that as a perspective on life and raise their kids in the same way and say, “Look, my parents saved for me and my retirement, I’m saving for your retirement, I’m already taken care of.” It’s a totally different mindset and I think it’s valuable.
Kevin:I just want to add one more thing because you’re probably not going to add it, yourself, but read your book on legacy because these folks sound like they are actually intending on having a legacy for their family.
David:If you want, feel free to contact me directly and I will share the math with you on what doing the gold-silver swaps, those ratio trades, back and forth inside a tax-deferred vehicle like a Roth, how powerful that is over a 65-year period, if you assume you can go from one position, say silver, to gold, and all the way back to silver again, getting to do that about once a decade. Start doing the compounding of ounces over 65-70 years and it is unreal the number of ounces that end up being there in retirement.
Kevin:Going to the next question:
Dave, you have no interest in politics – I know that. So, if you were in Lawrence Kudlow’s job, what policies would you be recommending to the president right now? Can we prevent an economic disaster, or is it inevitable?
David:This is a question of economic idealism or political pragmatism because I could give you some ideas that I think would help the economy. The chances of them being implemented are slim to none. The chances of walking out the door with my job the same day they were recommended are slim to none. And that is the nature of politics. That is one of the reasons why I am a bit cynical about D.C. and what happens there because even if somebody came in with the greatest ideals, you will be railroaded out once people start weighing the cost of those ideals.
Kevin:Because it’s all about re-election. But Dave, let me ask you – let’s pretend like we have a president that doesn’t care about being re-elected. What would you recommend?
David:I think there are limits to spending, which make sense, and I think living within our means does make sense. I think the idea of deficit spending is a bad idea. We have adopted it because we can, we can because we have a monetary system that supports it. We can create infinite amounts of credit given the monetary system that we have. I think, ultimately, that makes for radical boom and bust cycles. On the boom side, everyone loves it. It is on the bust side that it becomes catastrophic.
And the reason, ultimately, why I’m against it philosophically, and for sound money, is because what happens in the context of a bust cycle is that greater and greater freedoms are taken away from people. This was the ratchet effect, which we talked about in our conversation with Robert Higgs a few years ago, borrowing the ideas from his book, Crisis and Leviathan. Nobody complains about the boom cycle, everyone wails – there is great weeping and gnashing of teeth – on the bust cycle, which is always bigger when you have a fiat system driving the expansion of credit. And guess what you cede, that is, transition over, a massive amount of individual freedoms to government control.
And so that, I think, from a philosophical, political perspective is why I don’t like the radical boom/bust cycle, why I really favor constraints put on government. Who wants constraints on government? Not government. Who wants constraints on credit? Not the banks. So who is the audience for this? The only reasonable way that would occur is if you had a certain brand of populist president, and that is a populist president probably more in keeping with, say, a Ron Paul – a Ron Paul who is constitutionally oriented, to a degree, but is a fairly radical libertarian.
Not an anarchist, not an anarcho-capitalist, but somewhere between a constitutionalist and a capitalist, and I think if you could blend the ideals of a constitutionalist and a capitalist – a free market capitalist, that is, not a crony capitalist – then I think you could start to design some policies which, although not popular, could have a real lasting impact.
Kevin:Next question from China, but I think it actually applies to us, as well, Dave. This is from Chris in Shenzhen, China.
Gentleman, as a nonfinancial sector professional who has been purchasing precious metals since 2009, how is it that the system has not reset given the following? We have 20 trillion dollars in debt and 20 trillion unaccounted for pentagon defense spending, trillions created for the bailout in 2008, QE1-2-3, etc., China and Russia divesting from U.S. treasuries, on and on. Why?
David:That’s a kind of U.S.-centric issue and that’s a good question. Why has confidence remained? On a broader basis we have low estimates, 216 trillion, high estimates, 280 trillion, of debt in the global arena, not just the 20 that we have here. So the issue, Chris, is one thing – confidence. Confidence remains. Just appreciate what confidence means to any market, and what it means to social order, and what confidence means to the ability to play the games that we have played in the credit markets. Confidence is a very thin thread, and it is the thread that holds the financial universe in its cosmic place today. And that doesn’t mean that it holds it there tomorrow. Confidence is a very thin thread. That’s the only thing that keeps us in motion.
Kevin:This next question, actually, Dave, deals with our reserve currency status. He says:
Before I ask, I just want to let you guys know how your show has helped me a lot in understanding the markets, especially on the fundamentals side. So thank you for that. Here is my question. By Triffin’s dilemma, we cannot have the petro dollar U.S. dollar as a world reserve currency and do that without running a net deficit in trade. If Trump keeps on insisting in reducing the deficit, what is the most likely scenario for the U.S. market? Can we expect rising treasury yields, leading to more debt burden on all the sectors of the economy – household, private, government? God bless you guys, and again, thanks for the show.
David:Our deficit is someone else’s trade surplus, and so to the degree that we are running a deficit, you see surplus dollars divided between our trade partners. Those surplus dollars have, through the years, been recycled into U.S. assets. So there is a question about how, and a concern on my part, as to what happens if those surplus dollars are not coming into the United States. Is there an insufficient flow of funds back into the U.S. to support the equities market, to support the debt markets? I guess what this implies is that in the absence of recycled trade dollars you would have, at least in the bond market, a rise in interest rates, and certainly, the rise in interest rates serves to be a restriction on the financial markets as a whole, with negative implications for the stock market.
Kevin:Sometimes we can be rough on John Maynard Keynes, but in this particular case he saw this problem right up front. He said, “When you have a reserve currency like this, it will lead to trade deficits. In fact, you have to have trade deficits. The problem is, there is a fuse – to use your own word – that lights a fuse. There is only so long you can run trade deficits and run that system before it fails.
David:The interesting thing is that Keynes appreciated something that John Law did not, and the reason Cantillon made his fortune on the Mississippi system was because he understood this bit about having a trade deficit, and Law did not.
Kevin:(laughs) Triffin’s dilemma 300 years ago.
David:And it is a very interesting historical analog. There is one other thing I would say. You also have the impact on a widening budget deficit. If you are successful in reducing our trade deficit, which is the explicit goal that Trump has stated, what are the implications into our financial markets? Well, you tell me how people start viewing our debt and our dollar with an ever-widening budget deficit. If we don’t have money coming in to support the budget deficit, to finance those recycled surplus dollars, who is financing it?
We have debt that is being issued – you have to have a buyer. Who is the buyer? Is this where we move into the next phase of quantitative easing or what the central banks have done overseas, what the ECB just ended December of 2018 – monetizing debt? Is that what we end up having to do – monetize debt? Because you can’t have it both. You can’t have the world’s reserve currency run a trade deficit and not have problems that emerge.
Kevin:Vitelt wrote this. He says:
I have a couple of questions which relate to commodities. I pose these questions within the backdrop of the GSCI, The Goldman-Sachs Commodity Index and the S&P 50 ratio, which I believe to be the lowest it has been in 50 years, if not longer. Even though platinum’s demand in the industrial processes have dropped off over the past four years, the gold-to-platinum production ratio is about 14-to-1, and production costs for both metals are not dissimilar. The price ratio between the two metals is now 0.685 and I believe that’s the lowest it has ever been. My question is, why isn’t investment demand more than making up for the industrial demand? Why aren’t investors considering platinum as good, if not better, than gold as a store of value? It seems like a no-brainer.
David:I tend to agree. I think, on this point, that first the GSCI, the Goldman-Sachs Commodity Index compared to the S&P 500 – if you look at that chart, you have the inflated asset value of the S&P 500. The deflated – these are the numerator/denominator – you put those together and you do end up with a radical chart, as cheap as it has been in 50 years. Recognize, too, GSCI is a little bit skewed toward energy, 60-70% of the index is energy-related and maybe 10% industrial commodities, 10-15% ag depending on when it is being constructed, and a very small percentage precious metals. So really energy-heavy.
Oil is cheap. It has been cheaper, but we haven’t had these levels of oil and commodities with, at the same time, the S&P500 being so high. So it is telling you a very interesting story, and if you had to put a caption on it – time to exit financial assets and move to tangibles. That would be the caption.
Kevin:I’m thinking that actually ties you right into the second part of this question because he says:
We’ve been in an everything-except-commodities bubble since 2012, until today. What is the probability that we are going to have a major bull market in the 2020s or 2030s in commodities, gold, silver, platinum, what have you?
David:Right. I think before we go there, on platinum, why isn’t industrial demand being overtaken by investment demand? Because people rarely buy bargains. People rarely do the right thing at the right time. They buy out-performing assets, they don’t buy under-performing assets, and that is why their portfolios generally under-perform because they are not willing to buy value. In the 2020s, to that last part of the question, I would say there is a 90% probability that the next major bull market is in that timeframe, the 2020s versus the 2030s, and it corresponds with financial assets being at all-time highs.
So as you see, the mean reversion in financial assets giving up some ground, I think you will see ground taken back by your tangible commodities, and that is a whole swath of tangible commodities, the most money-like of which would be gold and silver. So yes, it has been an everything bubble except commodities, and I think 2018-2019 looks to be a good transition out of the paper world and into the tangible.
Kevin:Dave, another fabulous year of questions. There were a couple of people who we did not read their question only because we answered it in someone else’s, but please, when you have questions for the show, even when we are not doing Q&A programs, feel free to send those in at [email protected] as we provide guests and bring people in, oftentimes we are trying to listen to what the listeners are saying.
David:One of the things that I love most each week after we do the Commentary and I look back at the week before, is seeing the dialogue between the listeners, whether it is on YouTube, or in various social media channels, where they are talking with each other.
David:It is amazing. It is a robust conversation. There are people there who are generous. I’m just amazed. Again, thank you to our listeners for engaging, not only in the content of the Commentary, but then engaging with each other in a way that is considerate, in a way that is constructive, in a way that is respectful. It speaks to the quality and character of who you are as an individual, and your pursuit of truth.