Podcast: Play in new window
- Would A Fed Pivot Cause Stagflation?
- Are Things Worsening In The World, Or Are We Just Getting Old?
- The 15 Minutes City & Who Wants You There
Your Questions Answered, Part 2
December 28, 2022
“High inflation is preferred to the unknowns of the next leg down in the markets. So what’s preferred there? Some pain, yes, but if you’re talking about asset price implosion, collateral destruction, that’s the kind of thing that moves Powell to move the opposite direction and start accommodating.” — David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
Well, today we return back to the question and answer program. I really enjoyed, though, the break last week with your interview with Orlando Figes.
David: One of the things I think about when I think Christmas and Russia is, oddly enough, that conflict in World War I, where for a moment the allies and the Germans who jumped out of their trenches and on Christmas Day played a game of football. And this notion that actually there’s a lot of decisions that are made by leaders which are not really representative of the people themselves. And if left to themselves, you know what you find?
Kevin: They might get up and play soccer and sing some carols.
David: You find some harmonies. Certainly last week and coming through Christmas and the interview on Russia, I hope it was insightful and brought some clarity to what should be incorporated into an appraisal of the modern day, with a little bit more of historical reference. But in the end, I think one of the big contrasts is that leaders have a way of directing history and oftentimes it’s out of step with what the people actually want and what really represents their interests.
Kevin: Well, let’s just get back into the rest of the questions that we’re asked. Dave. We do appreciate our listeners sending these in. And our first question that we’re going to go into is, “A Fed pivot assumes a capitulation of monetary tightening and a return to either easy cheap debt or quantitative easing, or both, likely both. Apparent common Keynesian perspective seems to interpret this as a win for stocks and bonds, providing them with the fuel needed to scream higher. Given that the stock market started turning down prior to the first rate hike at the end of 2021 and prior to acknowledgement that the Fed was thinking about thinking—”
David: Thinking about thinking.
Kevin: “—thinking about thinking of raising interest rates on transitory inflation, shouldn’t a pivot instead mean a return to much higher inflation combined with a recession, equating to stagflation and thus a much lower stock market and a much lower bond market?”
David: That very well could be. Maybe we avoid the recession, maybe we don’t. The yield curve implies that a recession is going to happen, we just don’t know how deep. So more inflation is a reasonable assumption on a pivot, and stocks would indeed love that. Quality bonds could see some relief as well, driven by catalyzed inflows, investors trying to call a peak in rates with the idea that we’re headed back to the zero bound. Now that outcome I think is pretty unlikely. I think we’ve put in the low potentially for many, many decades.
But the question of what kind of a recession we end up with, would determine if lesser quality credit—so going back to the fixed income markets—if lesser quality credit is impacted. So I think maybe Doug Nolan would be the better person to answer this question, and I’m sure if he disagrees, I’ll give you the update in coming weeks. But think of your marginal investment grade and think of your junk debt. They could both rally off of a loosening that’s perceived or financial conditions, with the real sorting function coming three to six months later. If business revenues are declining in the context of recession is sufficient to impact your marginal credit, that’s where you would see it show up. Ultimately, company valuations could turn ugly, forcing stocks lower as well. So a bounce in beaten-down tech land would, in my opinion, only be a bounce.
Kevin: Well, and the question continues, “Why does the standard narrative persist that rate cuts equal higher stocks and bonds? Isn’t this a liquidity trap?”
David: Rate cuts embolden speculation in stocks particularly, so theoretically they drive debt and refinancing activity, and so there’s that positive aspect, cheaper money. Under looser financial conditions, public companies would get more aggressive there, in terms of the refinancing.
I’m not convinced Powell is quickly moving to cuts unless we’re looking into the jaws of a very severe recession, really severe, then anything’s on the table. High inflation is preferred to the unknowns of the next leg down in the markets. So what’s preferred there? Some pain, yes, but if you’re talking about asset price implosion, collateral destruction, that’s the kind of thing that moves Powell to move the opposite direction and start accommodating.
So I think the sequence for Powell looks something like this, a pause after projecting a slower pace of increases, that for sure I think is what we’ve got in motion. But to cut rates, I don’t know, I think inflation is embedded. Think about wages, they’re not an inflation component that jumps up and down like commodity prices, not quite as volatile. They move up and they stay up.
So I think you can make the case that we’re in a new era of higher inflation, and so I think there’s going to be a hesitancy on the part of Powell to really accommodate. Now the economist I mentioned in the previous Q and A session from the IMF, now at the Peterson Institute, is arguing for a higher target, inflation target, for a number of reasons. But the gap between target and actual today is embarrassingly wide—the actual inflation rate versus the target rate. Commodity price declines have certainly helped take off the edge. But the longer-term factors where you’re talking about reconfiguration of supply chains, on-shoring, sticky wages, global conflict, those are new cycle inputs in their infancy. And so a 4 to 6% range, I think that’s a reasonable new average inflation rate. And 3 to 4% is a reasonable new target for inflation. And I say reasonable not because I think that idea is even defensible. I don’t think an inflation target is appropriate for any central bank. I think its bad policy. I think it flies in the face of their primary mandate, price stability, but the fact is they’re moving from 2 to some higher number. And so I think one of the reasons they want to do that is because it’s a lot easier to talk about your success when you are mere basis points away versus many percentage points away from your target.
Kevin: Darren writes, “I appreciate your weekly podcast, and have tuned in for several years. I admit to having a bias against gold and precious metals when I started listening, and thought you guys were crazy. So now I’m at the point of understanding where it does not seem crazy to have $50,000 worth of gold under my bed, but not because of financial apocalypse. Any practical advice for owning physical gold?”
David: Well, I own some ounces that are earmarked for transfer, transfer to financial assets. Think of the Dow/gold ratio that is sort of a trade of a lifetime. So I own some ounces for that reason. I own other ounces as a pure hedge, which will go to my kids someday. In these ounces are occasionally traded from gold to silver and back again using that ratio. And I like the idea of growing those ounces because at the end of my generation you’re talking about a division by four, and hopefully the value of hard assets won’t be lost on my kids. Hopefully the dinner table conversations will have sunk in on that. And hopefully they can compound those ounces in their generation in sidestep, the terminal math of division.
So again, I own ounces to be transferred into shares someday. I own ounces that will be transferred to the next generation, and I need to be effective in compounding those ounces, because again, from an intergenerational standpoint, I don’t want to see a hundred ounces divided by four and then however many kids they have divided again and divided again until you’re basically dividing into nothing.
I also own a few ounces if I’m honest, not too much, but I own a few rarities, a few high grade coins, and these I want to keep. Maybe I part with them at the right price and the right auction if the numbers were too tempting. I own these because of their artistry. I own them because of their scarcity. I own them because of the story they tell. To look at hammered coins versus pressed coins. You see the history of money in gold, and I love the fact that I can go back a thousand years and tell that story in real terms with something of substance on the table with my kids and grandkids. And again, this is not a huge investment for me, but it’s just enough to tell the story from one century to the next.
I also own ounces in our Vaulted program, and I own them as a cash alternative. I don’t own them as a gold substitute. I own them as a cash alternative. I will use those ounces like I use a bank deposit. I prefer to denominate in gold, silver by mid-year next year is our goal. But as long as real rates are insulting and the cost to carry those Vaulted ounces are better than a bank yield, net of inflation, then I’m interested in that as a banking alternative. I like those ounces as a pure liquidity position. Those ounces are going to get spent. They’re going to get spent on a remodel, they’re going to get spent on college education, a new car if I need it. I consider it cash, just a superior form of cash. So the practical advice I have for owning gold is, categorize what you own and why you own it, because it can have different functions, as I have just demonstrated there.
Kevin: From British Columbia, Allen writes, “If central banksters bought 400 tons of gold last quarter, and China has publicly stated that it will increase its gold holdings this quarter, why has the market remained flat? Inquiring minds would like to know. Is it global warming?” he says.
David: Well, of course, everything’s attributed to global warming these days. No, those were big numbers. Largest aggregate central bank purchases in a three quarter period versus any comparison to a full year total, going back to 1956. China’s been increasing ounces for a long time, and we don’t have an exact figure of their current holdings. I think we’ll find out what they are. They’ll tell us when there is an advantage to the world knowing what they have.
So central bank accumulation, as I mentioned earlier, it’s another form of a hedge. In the last Q and A session we talked about gold as a hedge and central banks using it as a hedge. A hedge against us foreign policy—that’s become an issue, a hedge risk, a hedge against US Treasury policy. The gold market has remained flat, to answer your question directly, because on the other side of central bank purchases were hedge fund and investor liquidations. In those categories there’s no patience, no perspective. Momentum is not up, so sell or sell short and ride momentum the other direction. I think what you have with that particular community, the investor community, sometimes the hedge fund community, is pure momentary opportunism. And I think there was also a fair bit of liquidating in the face of severe losses in stock and bond portfolios. So kind of truing up a portfolio in terms of percentage allocations. So some pressure on the investor side, even while we had gigantic purchases from central banks.
Kevin: Greg from Australia asks a question I think of we often ask ourselves, “Is it different this time? Are things different?” He says, “It feels lots of things are worsening in recent years, and that’s accelerating. Multiple crises, corruption, environmental problems, general civilizational decline. Do you agree? And if so, is it because we’re a certain age—you kids, get off my lawn—or is it maybe exacerbated by the internet, or do you think things really are unraveling quickly?” Is it different this generation?
David: I agree with Greg, but I don’t know to what degree my then-versus-now comparisons are tainted. As you learn more, there is a certain burden that comes with it. And as you discover areas of ignorance in your education and your awareness, whether it’s of current events or markets, what have you, you also discover the previous bliss that went with not knowing. So for people that are more in tune with what’s going on around them, there is a sense in which things may feel progressively worse, but I think that may be a part of your educational process. So take for example the level of crime in our small town. I’m not faced with it on a daily basis, and I say this, my truck did get stolen out of my driveway last year.
Kevin: You got to take the keys out of it sometimes Dave.
David: I know. It was on my birthday so I went outside and I thought one of my friends was playing a practical joke on me and it’s like, “No actually—” But if I went and had a cup of coffee with the local sheriff or someone in law enforcement, they could inform my view more thoroughly of incidents of crime I wouldn’t otherwise know about, and my view could very well shift. So if I don’t know what’s going on, there’s sort of this blissful ignorance, and if I do know what’s going on, there’s an extra burden of information and maybe even fear factor that comes with it. As it turns out, petty crimes and drug related crimes are going through the roof in our town. Not knowing and then knowing can give me a sense of things worsening. Does that make sense?
Kevin: Uh huh, sure.
David: I think we can find historical contexts when crises were as numerous or more numerous, maybe even more grave. But if you borrow from the Strauss and Howe playbook, we are now in a fourth turning. And again for those of you who are unfamiliar with Strauss and Howe’s book, it’s by that title, The Fourth Turning. You’ll find a lot that repeats that is worse and worsening before improvements are chosen and hard choices made.
We’re in a timeframe cyclically. If you’re comfortable seeing history run in cycles where an intensification of chaos is normal—it’s not inevitable, but it is normal. So that cyclical view of history does have things sort of accelerating towards the tail end. You see the same thing in credit cycles as well. Things seem to get wildest at the tail end.
To your point, Greg, the internet and the endless repetition of bad news presented for dramatic effect from your news outlets does accentuate the bad. And that has changed over the last several decades. I think if you engaged with the news and current events on a disciplined basis, let’s say once a week or once a month or even quarterly, you would still see the same events, but from a less dramatized perspective. So let’s say you got on a sailboat for six months, disconnected from media and social media, you wouldn’t change events as they were occurring. But I think the anxiety that you might feel about those events as they were occurring might moderate.
Today we live glued to our devices, and part of this we discussed with Dr. McBrayer earlier this year as we explored the reality of fake news. Big tech in fact curates our news feeds to our specific interests. So they create a feedback loop that reinforces our sense of things, thereby giving us an unbalanced view to any issue. This of course creates greater polarization as some people want to see some things and some people want to see other things, so that polarization in politics results and people can’t understand why someone can’t objectively understand the facts as they are. Well the reality is you’ve got two different people who wanted two different curated newsfeeds looking at two different sets of facts. A world that is more easily divided between us and them is the result.
Kevin: And that affects the culture.
David: ;Yeah. Culturally are things deteriorating on a global basis? On a global basis, I don’t know. I don’t have the data or the insight. I can speak directly to American culture. Yes, from sex slavery to addictions to cultural conversation that is loath to include an awareness of virtue, loath to anchor education in a set of values—not religious, but cultures have referenced, if you’re looking at the western tradition dating to Ancient Greece and Rome, yes, values like courage and virtue and prudence and piety and justice, just to name a few. When those are cast today as monolithic patriarchal symbols of oppression, then guess what, you do end up with a very different kind of culture, a very different kind of culture.
Kevin: But could it be our age? I mean, you kids get off my lawn was his example and I thought that was pretty funny.
David: Yeah, well events speed up as you age, there’s another explanation of that, likely ties to our internal mortality clock. As 12-year-olds, everything seems to take an eternity. At 40 or 50 or 60, you may experience a midlife crisis driven off, at least in part, this sense of time running out and a weighing of the value of your life up to that point. I do think that time speeds up, or the perception of time speeds up, as you age. There’s no doubt about that.
But there is the chaos of our age, and I think this is fair. We are at the end of a credit cycle. We are at the end of a globalization cycle, and the consequences you face as relationships change, these are objectively intensifying. Take the 30,000 foot view. Back away. We’ve seen credit cycles end and begin again. We’ve seen globalization cycles end and begin again. And as Strauss and Howe pencil it out, it’s at roughly a hundred, a hundred and twenty years for their super cycles from a cultural, social, and political standpoint.
We’ve grown accustomed to a form of peace. We’ve grown accustomed to ways of doing business in light of credit dynamics, and we now have to adapt and change ourselves, which can be very uncomfortable. So that’s that sense of not liking what is changing around us. I think it’s time to go through the end of this cycle. There’s no avoidance of natural consequences. But I do think, on the other side, there are lessons that we glean and resolve that we can apply based on those experiences that will end up shaping, in a positive sense, the next up cycle.
Kevin: Jeff is writing to bring clarity to a very recent event the FTX collapsed. So here’s what he said. He said, “Was the FTX collapse a failure of the custodial cryptocurrency asset itself, or simply the mismanagement of the said asset? Would FTX have collapsed if instead of owning cryptocurrencies as assets it had owned some other valuable asset like Maple Leafs, T-bills, or tulip bulbs? I have yet to read an explanation of the failure of cryptocurrency itself to be used to justify the regulation of it.”
David: I think the parallel is best with the Mississippi Bubble and John Law. Look at our Commentary guests’ observations on that. In Project Syndicate, Harold James wrote in his article “Faking It, Making It, Losing It” how the two are similar in many of their Ponzi dynamics.
Kevin: That was a great article.
David: The linchpin is the currency they both created and then used to boost the value of other assets. I don’t think a crypto exchange or a particular token is Ponzi-esque, per se. But the use of FTT, this is the FTX token that Sam Bankman-Fried created, sort of backing the exchange. FTT, that token is where the abuse ends up looking very similar to the 1720s use of a token equivalent in John Law’s sort of creation of value out of nothing. A great inflation of value and collapse were a part of the beginning, of the middle, and the end of both of those schemes. So go back and read “Faking It, Making It and Losing It,” I think Harold James brings a really keen historical perspective to it.
Would this saga have ended differently with gold backing? Very differently, but it’s where it begins with something solid that cannot be produced out of nothing. That is a part of why central bank monetary authorities and Ponzi bandits alike don’t do gold. It’s a limiting factor. There’s less to ramp to higher values. Can you create gold out of nothing? No, you have scarcity. You have true scarcity as a limiting factor.
And modern fiat systems and Ponzi scheme dynamics like FTT—that’s how there is this vast difference. How many FTT tokens can be created? It’s an interesting question. How many ounces of gold can be created? Well at the snap of your fingers it’s not easy to pull off.
So to the last part of that question in terms of what justifies regulation, I think broad-based adoption by a less literate investor base who end up deploying the asset into retirement accounts. All of that raises questions about the creation and the distribution of the crypto asset, and what disclosures are appropriate for something that is sort of retirement account ready.
Look at the who’s who list of FTX investors. I’m not suggesting that there’s only the underdog investor who didn’t know better. You’ve got hedge funds and family offices that simply couldn’t say no to exponential growth. This was an example of the fear of missing out. And you realize this is not merely a Ponzi scheme that took advantage of old ladies and retirees, but it’s the less sophisticated investors that lost money, that end up driving the consumer protection side of regulations. At this point it has to happen because too much money was lost by the little guy. Any idea that crypto would remain unregulated is now pipe dream. You’ve got crypto derivatives, which are already under the watch fly of the CFTC, Commodity Future Trading Commission, but you now also will have under the watchful eye, the remainder of the SCC. The SCC will be watching it. I think that in itself will cull hundreds of existing cryptos that can’t reach the various regulatory bars raised. Comes back to our quote, also from Project Syndicate, an article by a different author, Innovation, Regulation, Appropriation.
Kevin: This next question actually is referencing a book, Dave, that you’ve recommended, that I’ve read, the office read, by Barton Biggs called Wealth, War and Wisdom. Here’s the question from Wes. “My own context comes from Wealth, War and Wisdom, thanks to you guys. What do you think would happen to gold and other assets in the event of a sharp population decrease like nuclear war or mass starvation? And if one happens to own stocks like Gazprom, what are the possible ways that plays out? I find the concept of ounces-to-living-human ratio or barrels-of-oil-to-living-humans ratio something that I never hear about.” It’s something I never want to even think about Dave, to be honest with you.
David: Well, it’s fascinating. It’s a great book. Great question. You can definitely make the case for the repricing of commodities with significant shifts in population. A significant increase in population does drive that higher. Particularly like fossil fuels, the ones that see massive production and total consumption of what was produced each year, where there’s nothing left at the end of the year. Gold may get consumed but it’s not destroyed. So I think a few variables there factor in and make it a bit different.
You’re suggesting that demand dynamics are important. They are, but you’d have to know something about supply dynamics as well. Now I’m thinking really specifically about commodities, specifically, not the commodity producers, because the question references Gazprom. Stocks that are dealing commodities absolutely are driven off of demand, not just supply. Whereas the commodity itself can be driven off of both, because at the end of the day a company, let’s say Chevron Texaco or ExxonMobil, they have to sell X number of barrels of oil. If you’re talking about a Rio or BHP, they have to sell a certain number of tons of copper and iron ore in order to generate revenue. It doesn’t matter that the price of the commodity goes up, if they’re selling 5/8ths less in terms of previous supply to the market. That will impact them. The throughput of supply matters for the company.
And this is, I think, the difference where if we’re just talking about the supply and demand dynamics of the commodity versus the commodity producer. If you’re talking about the commodity, you have to know something about the supply dynamics as well. Take silver as an example. A part of a very bullish thesis on silver today has to do with a weakness in demand for industrial metals. Global recession, constrained Chinese consumption, and with silver predominantly mined in conjunction with industrial metals as a byproduct, when there’s a diminution of industrial metal production, then you all of a sudden see silver supplies hit as well. So you can make a case for the price of silver moving higher on the basis of diminishing supplies. Very dynamic environment for silver pricing now, and it just remains to be seen how investors will behave. Investors like we talked about gold investors in the previous question, silver investors, how will they respond in 2023? But supplies could very well be tighter, and if demand stays constant, you have a recipe for appreciation.
Kevin: Yeah, Dave, we don’t often think of a severe population decrease, but on that side of things, do less people also translate to less commodity production?
David: So you’ve got less people, for whatever reason, could translate to less commodity consumption. There is the supply side to consider where less people may also translate into less commodity production.
David: What is available? Nuclear war might shrink the global population, but it can also shrink economic activity. If that war were to impact either the US, Saudi Arabia and Russia or all of them, then even diminished demand may be in balance with diminished and available supply.
Kevin: Well how about barrels to living humans? Let’s translate it to oil.
David: I want to think more about the barrels-to-living-humans’ ratio. I think I just have to reflect on that some more that that’s going to be stuck in my head for a long time. Thanks, Wes. Barrels of oil are still at the heart of economic activity and development. It’s a required staple. Gold is a little different. It’s peripheral from daily life and less essential than, say, oil for business activity, the movement of goods and services. And certainly if you want to factor in things like food and water, all of a sudden you can see that there are commodities which are absolutely vital. We can’t do without. You can make a theoretical case for increased gold demand with an increasing population, but you still have to have a catalyst for interest. Why do they want it? You need no catalyst for interest in soft commodities or energy resources. You simply can’t do without them.
One of the things that I kind of reflect on, if you look at the Rogers International Commodity Index, it’s 38 commodities. They trade on 10 global exchanges. You have a good picture of global commodity prices tied broadly to global demand dynamics. Past periods of conflict and extreme loss of life, supply was equally important to commodity pricing as was demand. So major conflicts with loss of life oftentimes were more dramatically impacted by visibility of a future surprise. Will we have what we need in the future? And you see the price of those commodities increase with that uncertainty. Anyways, Wes, I’ll keep on thinking about it.
Kevin: This next question is from Brenda, who obviously is very plugged in and listening to not just the Commentary, Dave, but I think the calls with Doug and the team. Here’s what she says. She says, “Putin has floated the idea of Western economies depositing gold with Russia to buy rubles with which oil and gas can be purchased. Also, indications that India, Brazil, and South Africa have supported BRICS statements on altering the global financial system for their own interests—example: a new global reserve currency as an alternative to the IMF SDR and to the petrodollar. How likely is it for this or similar actions to occur soon, especially under our ‘woke’ administration and impotent Congress. What economic changes might reasonably be expected to happen here in the United States should this occur?”
David: While I doubt Russia and payment for oil and gold will be a significant trend going forward, in part because you’ve seen deterioration in trust levels with Putin, he’s not the most reliable counterparty. There is no doubt that the BRICS mentioned in the question—and many smaller nations beyond Brazil, Russia, India, China, South Africa—they want a differently imagined global economic and monetary order. The case is made that based on global GDP and GDP contribution, the US can remain a significant stakeholder, but that others should have a more pronounced voice in the conversation, tied to their economic contribution. So far that case has not become consensus, and frankly the US is not willing to concede its dominant role.
A new reserve currency, it’s been there as a theoretical possibility. I certainly have had fairly intense conversations about that dating back over 20 years. In part, as the euro became very popular as a monetary alternative, and even as central banks started to acquire euros and diminish their central bank holdings of US dollars, it seemed that there would be ultimately a displacement of the US dollar. And that’s the point, is a new reserve currency is really a displacement of existing power—US power for someone else. And the system really, other than that, wouldn’t be much different. The system would still be fiat. The tendency to abuse that new system for certain advantages would not go away—the benefits flowing to a more diverse list of nations, maybe that’s the only change.
In the interest of fairness, in the interest of justice, these are the kinds of terms that you find bandied around with somewhat liberal economic thinkers here in the US, particularly in the ivory tower, US academic halls. And some policymakers who are sympathetic to a “more multi-polar world.” But at the end of the day, the US remains a hegemon. Our currency maintains its dominant role in global trade, and it remains that way until a superior alternative comes along. A superior alternative that has sufficient military backing to convince us—that is, the USA—to adopt an inferior role going forward. So think about the dynamics, it’s not just a question of economic or monetary strength or weakness. It also has to do with military prowess. Our system is imperfect. But again, coming back to this idea of displacement, as imperfect as the US dollar system is, it has no realistic challengers to undo it. So until that time comes, we’ll continue to benefit from inertia.
Kevin: All right, Dave, so this next question, before he gets to his economic question, Eric asks, “So what is the intro and outro music for the McAlvany weekly Commentary. Where can I get it?”
David: And then he links to his question from the year before. I was wondering what the intro, I guess we didn’t answer that one last year.
Kevin: Yeah, I guess we must have skipped over it. Well, the title of the music is called “Moving on Up.” It doesn’t have anything to do with the old TV program the Jeffersons, but apparently that’s what the studio musicians who played that piece wanted to title it. And Dave, just a side note, I wanted to be a studio musician back when I was 18, 19 years old, because I’m a trumpet player. So I went to a school literally where you learn to just sit and play down the music. They just bring chart after chart, after chart. And my guess is that this is probably from a stock of studio musicians, some of the best out there. And boy do I love that music. How about you?
David: It hits you like an espresso first thing in the morning. Woo, here it is.
Kevin: Yeah, we try to wake you up just as soon as we turn it on.
All right, so here’s Eric’s economic question. He says, “I’ve got a serious question for David and Kevin. Can they please comment on the Bank of International Settlements’ warning of FX derivatives time bomb? What’s your thought on this?” He says, “If the time bomb is indeed a real concern, then it renders futile the subtle art of economical prediction, and that just leaves those who are prepared and those who aren’t.”
David: A lot of publicity on those numbers followed the December 5th press release from the Bank of International Settlements, and one of the highlights in the review was the foreign exchange market derivatives—that 80 trillion number which is largely off the radar for central banks. A host of news outlets ran with it. It was a big number, and certainly gets the juices flowing.
What is known is the FX or foreign exchange market volumes and how counterparties behave under normal circumstances. What is unknown are the behaviors under market stress. So if there’s a time bomb, it’s really a time bomb that is circumstance-driven. You can exist with rot within the system or something that it doesn’t belong or is dangerous for a long time, it still needs something to surface it.
So under stress, there’s a lot of leverage, mostly accounted for. But think of this, this is also from same paper, 39 trillion in debt obligations amongst non-bank financial entities. Again, so think about this, 39 trillion in debt obligations among non-bank financial entities. Only 15 trillion of that shows up on those entities’ balance sheets. The point is, whether it’s the 80 trillion or the 39 versus 15, there’s a lot of hidden debt that isn’t accounted for on company balance sheets.
I did like the paper, in part because it shows an awareness of the gravity of our debt picture globally. But awareness does not necessarily eliminate risk. It just lowers the risk of surprise. It’s I think maybe like taking an afternoon stroll on a set of train tracks. You’re safe, just stay aware of where you’re at and what’s coming either in front of you or behind you.
So the context of crisis, central banks can extend lines of credit to ease rollover stress. That’s what you generally see. But it becomes more difficult to do that when you’re talking about non-bank institutions, which is one of the reasons why they were highlighting the 15 trillion which shows up on balance sheets versus the 39 trillion in debt obligations because those are non-bank financial entities. How do we help you if we can’t throw the lifeline? You’ve got visibility, which is a factor. You’ve got non-bank institutions, that’s a factor. Knowing what precisely the debt rollover needs are, and of course, non-bank are multiple steps away from central bank credit. These are all the complicating factors that come out in that BIS paper.
Another insight from the paper reinforced the US dollar’s dominant position in the market. Going back to the earlier question where we were talking about the US dollar, dollar hegemony, et cetera, et cetera. Daily foreign currency turnover reached a peak this year of 7.5 trillion dollars. Again, that’s seven and a half trillion dollars on a daily basis.
Kevin: That’s daily. Wow.
David: I think that was back in April. That is 30 times daily global GDP. So if you look at how that breaks out, close to 90% of that volume was in US dollars on one side of the transaction or the other. There is no competition in terms of foreign currency exchange. We are necessary for the invoicing of trade, and to date we are a long way off from that displacement.
The euro as a percentage of global trade and foreign currency volumes tied to global trade—that number peaked back in 2010, and has steadily given background to the US dollar. Furthermore, looking at it through the lens of, again, that trade invoicing, close to half of all global trade—half of all global trade—is invoiced in US dollars, even though we represent only 10% of actual global trade. So half of invoicing versus 10% which is directly tied to our markets. US dollar’s still very much king.
Central bank reserves, that’s another aspect of the currency picture. Central bank reserves have declined over the last 20 years from 72½% US dollar holdings to under 60%. That seems to be sort of the biggest place where preference has shown itself for something else. Anything else, including gold—
Kevin: Including 400 tons in a quarter.
David: Yeah, but back to the hidden debt quote, I’ll go to page 76 from the paper and read directly. “FX swaps forwards and currency swaps create forward dollar payment obligations that do not appear on balance sheets, and are missing in standard debt statistics. Non-banks outside the United States owe as much as $25 trillion in such missing debt, up from $17 trillion in 2016. Non US banks owe upwards of $35 trillion. Much of this debt is very short term, and the resulting rollover needs make for dollar funding squeezes. Policy responses to such squeezes include central bank swap lines that are ‘set in a fog,’ with little information about the geographic distribution of the missing debt.”
So really what the BIS paper is pointing out is that we have an overleveraged system, and we’ve got huge transaction flows, and we don’t have visibility necessarily on where the transactions are coming from. Again, I want to go back to the daily foreign currency turnover. This is just the exchange of currency, up to $2.2 trillion in foreign currency trades are at risk of not settling between counterparties. And so—
Kevin: Wow, 2.2 trillion, it may not settle?
David: Well, that’s a third of daily transactions may not settle. That’s the risk we have in the market every day. Now, before you panic and run from the room saying, “Oh my gosh, I can’t believe we’re on the brink of catastrophe.” Three years ago the number was 1.9 trillion. So the numbers have increased, but we haven’t blown up—yet.
Perhaps the most disturbing finding is the shift from multilateral trade platforms to less visible trade venues. And again, this is where the Bank of International Settlements and other central banks just don’t know who’s doing what, when, or why. There is less and less transparency.
Again, if we go back to that idea of the train tracks, you’re walking down, your afternoon stroll and the train tracks, it’s really no big deal as long as you’re cognizant of what’s going on around you. What happens, Kevin, if you throw in your earbuds while you’re walking the tracks, lowering your perception of what is going on increases your risk of a bad outcome. When you combine the quantity of money traded with the visibility diminishing, you can understand why the BIS is a bit concerned. In a crisis you’ve got to know as much as you can in order for the highest quality planning and execution of those interventions to be effected.
If you just wanted to sum it up, you could count this as a significant structural blind spot, sensitive to foreign exchange and interest rate volatility. The paper’s actually not one paper, it’s a series of papers for the curious amongst you. You can wade through the BIS website. It’s the December quarterly review, and it makes me reflect: like other aspects of structural weakness in our financial system, I think it underscores the importance of financial insurance—financial insurance in the form of gold ounces. And the question implies that there are those who are prepared and those who aren’t. And when markets seize—and we’re talking about something the Bank of International Settlement said—it is probability, not necessarily a high probability, but a probability.
When markets seize, big money moves to metals for security. And a part of that is counterparty risk mitigation. So if you said, “Well, the big money does that in a pinch, perhaps the smartest of the smart money can view gold as a reasonable allocation prior to the seizing of the FX markets or the interest rates markets.” Again, if some fraction of the 2.2 trillion dollars in daily volumes that may not settle does not settle. You’re talking about liquidity and solvency crises that resemble a firestorm.
Kevin: You sort of have to have the gold before it happens, don’t you? That leads to this next question from Jack. Jack says, “I’m expecting some future waterfall declines in the stock market, as were you a couple of months ago. During these waterfall declines, everything generally goes down, including precious metals. Will metals go down with the market as in the past, or will the next time be different? I ask because I can’t decide whether to buy silver at 23 bucks or wait until it’s back to 18, if it ever gets back to 18.” That’s a good question, Dave, because sometimes the stock market will crash, the metals will go down initially, first few days, first few weeks.
David: Well, Jack, I have a core position in the metals that are not particularly price sensitive. I own them, some ounces I own at a cheaper price, some ounces I own at more expensive prices. I would say if you have large amounts of cash, you can be opportunistic on a price break, but I wouldn’t count on it. I wouldn’t be waiting to buy your first ounce on a price dip.
How the Treasury market behaves in a series of equity market selloffs is unknown. Traditionally, you could count on a rotation to short dated fixed income as sort of a safety bid. In an environment today where future inflation expectations are less anchored. It’s not as certain an outcome that we see the flow from equities in a market decline into Treasurys. Gold may in fact see sizable inflows. So in the past we’ve expected, in a “deflationary environment” and in an environment where rates are coming down—again, 40 years of rates being in decline, that was the context for a selloff in equities, represents risk off across all asset classes, perhaps with the exception of Treasurys, where you see the inflow and they benefit.
So on the other hand, a financial entity caught in the midst of de-leveraging might well sell off quality assets to keep other bets in motion. We don’t know. We don’t know. I would just say this, own ounces at 23, own ounces at 18 with gratitude for a lowering of cost basis and an improvement in total ounce positioning. Looking at the context that we have today, again, end of credit market dynamics, end of globalization cycle dynamics, the stakes are too high to bargain hunt on a core position. Only do that if you’re adequately allocated already.
Kevin: And sometimes it’s hard to get the product when that happens.
David: Go back to 2008 and 2009. There was in the spot price a drop of 30% in gold and silver.
Kevin: It was a big one, yeah.
David: However, when you went to buy product, you found that it had barely moved in price because there was no supply available.
Kevin: If you could get it.
David: So the divergence was in the futures market, where you saw a discount in price, versus the physicals market where, in the context of crisis, you could not get those cheap ounces. So you’re at 23 and the spot price now says 18 on the market selloff. But what if you go to the market and you can only buy your silver at 23? You waited for what? You took the risk of not being in the market. I would just say that if you have access to product, then add to your position. And if you have the opportunity to do so opportunistically, great, but you’re only in that position—it’s a luxury position—if you’ve allocated to the metals and have an adequate insurance position already.
Kevin: So don’t count on waterfall declines, and don’t count on huge population decreases either. I keep going back to that question. It’s like, “I’m not going to play that market timing.” But okay, so next question, “Is GDP measured in dollars? If so, wouldn’t it be overstated by the percentage of inflation possibly turning a GDP decrease into an apparent increase? Even if GDP is corrected for inflation, would the official (fake) 8% inflation rate be used rather than the real 17% inflation reported by Shadow Stats? That difference could still turn negative real GDP into a fake positive GDP.” Can we trust the GDP numbers?
David: I know Dave. He’s a good guy and he’s a thoughtful scientist. Dave, this is spot on. To understate inflation via what is known as the price deflator, which is how they account for inflation in the GDP statistics, you indeed overstate GDP. So to understate inflation is to overstate GDP. That is in principle the case. I think GDP is still useful as long as you factor in a more realistic inflation input. So whatever you land on for an inflation number, make sure that that is substituted instead for a more realistic view of GDP, of where you’re at in a business cycle, recession, depression, et cetera. Look at Q3 as an example. The Bureau of Economic Analysis uses 4.4% inflation as the deflator. Okay, now that’s below the official number of 6, 7% and it’s down from the BEA’s—Bureau of Economic Analysis—Q2 number of 9.1. Both of those are available at the BEA website if you want to check it out on moving forward basis. So just take a blended rate for the year or any individual quarter you find that yes, GDP is in fact overstated because inflation is understated via the “deflator.”
Kevin: And Dave is a senior scientist, retired. Is that why they call economics the dismal science? Because he wants to actually see what the facts are.
Dave, my mother-in-law just left this morning, and she told me last night, she says, “I’m about a third of the way through Dave’s legacy book and it’s really, really good.” And so this next question, a lot of people know that you apply these things that you talk about here on the Commentary and the things you do to your family. So this next question is family oriented. It says, “David, how do you approach financial education with your children?”
David: Yeah, this is actually a series of questions. So let’s see, 1, 2, 3, 4, 5 questions in a row. I’ll give you a brief answer to each and then we can move on. Talk about everything. I think a large part of financial literacy is vocabulary, and only on a secondary basis familiarity. So work on both. And I think dinner table conversations are the place for that. And this is not just about financial education, but even what’s going on in the world. My 16-year-old asks me every other week, what’s new with Ukraine? And he wants the update. He wants the update on Russia, Ukraine, who’s doing what, when, why? And it’s because there’s been enough of dinner table banter about these things. It’s stirred his interest, and that’s the one that he circles back around to. There’s other things that our other kids circle back around to. Why would they be curious if you hadn’t created points of curiosity? So this is I think the opportunity we have at the dinner table.
Kevin: The next part of the question is, “How does it differ for the various ages you have?” And I think sometimes, Dave, we would be surprised at how much our younger kids actually understand.
David: Well, and I think, so to answer the question, not much changes. Speak with a child like they’re an adult and the learning curve is impressive. Speak with them like they’re a child, and you’ll be surprised how flat the curve is. Yes, they need definitions. Yes, they need examples. Yes, they need stories. And that’s where you find different contexts or age sensitive, different things make sense to different age groups. But—
Kevin: Well, and having heard that you were visiting colleges, the next part of the question, “Sounds like college is in the picture. How does that factor in your overall financial education approach, Dave?”
David: Well, I think, on the financial education side, I assume, like many other categories of education, that I’m responsible, Mary Catherine and I, we’re responsible. It’s not the role of a curriculum or an institution, whether it’s the church or the school or any other institution to do my job. And so there is, to some degree the base of education which starts at home. You don’t have to homeschool for that to be the case, but you’re responsible for a perspective on the world as you help your kids move towards navigating what’s in the world and understanding through some lens what the world represents and how they can personally engage with it effectively with their gifts and talents.
To this question in terms of college, college is not necessary if you have kids that show business savvy and an entrepreneurial bent early on. But if that’s the case, you better make sure they’re really good at written and verbal communication along with math skills. So we come back to sort of the basics of education. They may not have to go to college, but you still better prepare them to be competent and professional without a college degree. And I’ve met plenty of people who have a college degree that are not competent with math, not competent verbal communicators, not competent written communicators. So I’m not saying that this is a solution.
In our family, I assume college and a master’s degree for all my kids. But frankly, I’d take a hardworking problem solver with communication skills over a degree any day of the week. Now I’m talking about in the workplace. They’re not mutually exclusive. But again, show me a high schooler who’s a problem solver, has a great attitude, and communicates well. And what I’d probably do is hire the person, train them, and then encourage them to go to college. And in fact, we would sponsor their college degree.
College should be like a finishing school. It’s not the core of an education. It adds some breadth, ties various fields together, particularly if you’re talking about what I am biased towards, which is a liberal arts education. And it improves communication and critical thinking skills. I’m very much a fan, but exceptions are out there. So my kids are today in a variety of educational venues. Frankly, where I see the biggest benefit is the couple of classes that they still take at a classical school. It has them doing better work. I would say better. What I mean by that is more rigorous work than I was doing through my sophomore year in college.
Kevin: I can attest to that. I love talking to all of your kids. The next part of the question was, “How do you handle the idea of “trading time for money” with your children, basically getting a nine to five type of job?”
David: I could take that question a couple of different ways, and David, I would love to have that conversation maybe with you offline and explore a couple different directions. One conversation we’ve had is on the range of hourly compensation you can expect in a variety of professions, a plumber making $90 an hour doesn’t necessarily have a college degree, and maybe making more money than the person with a college degree. An electrician or journeyman making more than a hundred dollars an hour—that’s five times the minimum wage. So you can look and say, on balance, there’s a variety of outcomes, given whether or not you’re inclined to trades or some more white collar expression. You’ve got lawyers and doctors that could make 200 to $1,200 an hour, but frankly, not all kids are suited for those professions.
So a great trade or skill or an educational specialization, it allows for a more effective trading of time for money the rest of their lives. And both oftentimes provide a set of skills that are portable. And again, by both I mean a trade skill or unique specialized education, JD, MD, PA, whatever it is, there’s a flexibility that I’d love for them to have, both in terms of the portability of skills and employability because of their ability to move. But also when you look at a higher income, it may mean that you can navigate on a four-hour work week because you can manage 80% of the pay at a higher rate. There’s different ways that you can configure not even a nine to five job five days a week, but sort of navigate that depending on where you’re at on that pay scale.
Kevin: And David concludes the letter, just saying, “Arguably lots of facets to these questions. We have six children, they may be all younger than yours.” I doubt that, Dave McAlvany’s got a spread of ages, but what would you say, Dave, for those six children?
David: Talk about everything, give them context for living. The reality is, as you’re raising kids, you realize that they’re totally unique and individualized. Six kids represents six different approaches. Just when you think you’ve sort of mastered the code on one, you realize the next one breaks the code and you’ve got to start all over again. There’s an implicit humility to raising kids when you realize that just when you figured things out it’s meaningless.
Kevin: It’s fun to talk to your kids too. Just ask them what they’re learning and they’re enthused with learning it. I have to credit you and Mary Catherine for that.
Dave, you were just in Belgium, and here’s what Walter says. He says, “This is Walter from Belgium. I have been listening to you for about a decade now. I was happy to hear you were in my country on the train while answering this week. Thanks for answering my questions so extensively last year. I learned a lot.” Here’s his question, “As philosophers, I’d like to hear your take on how the ’15-minute’ cities are going to evolve. I see it being sold for its advantages, but there’s a dark side: increased government control and power. I’d like to hear your take on its potential versus the moral hazard.”
David: It’s a great question. So Paris is noted as one of the examples of a 15-minute city, and I think there’s a lot of European cities that fit the build because public transportation links everything together, and you have access to everything, whether it’s by walking or by bike or public transportation, within 15 minutes, and that’s the concept. I enjoy walking Paris and London. I enjoy the public transportation. I enjoy the fact that parking lots are not a dominant public eyesore.
I think I understand the rationale for the 15-minute city. To the degree that there is an aesthetic value that you encounter in some of these older cities, they’re bound to have it. And that of course appeals to me too. But let me give you two examples, I can get from Mayfair to Borough Market in less than 15 minutes. Including the walk time between the tube stations. In Paris, if I stay in either the 11th or the Sixth Arrondissement, the neighborhoods, I can be at the Algerian market, best produce in Paris in about 12 minutes. When I travel I still like to cook. So getting to a great butcher or a cheese monger or picking up fresh vegetables and fruits, I love that. There’s an advantage to having access to a lot in a condensed space.
But to be honest, city dwelling is still very different than living in a town. And I have yet to experience a cityscape that was not anonymous and limited in its relational touch-points. Even when I’m romantically inclined towards, the walking into the baker, walking into the butcher, the relationships that you can enjoy connecting with the sole proprietor. I enjoy that when I’m in a city. But that’s dying because people today prefer the quick sandwich. They prefer the branded coffee, they prefer the supermarket. And not mom and pop specialty shop.
So in the end, I think the 15-minute city is really about efficiency and control over environmental impact. And however it’s sold, with sort of the romantic ideals, you have to strip it out and certainly reflect back on past experiments of public planning that had to do with efficiency. And frankly, you can look towards Eastern Europe and see what some of the architecture becomes and looks like in the environment of— and in fact they call it brutalism. Brutalism is the description of an era in Eastern Europe. But it was incredibly efficient and it epitomized the 15-minute city with no frills because no one needs frills. When you’re finally talking about efficiencies, when you finally prioritize in light of climate change priorities or whatever else, what has to be sacrificed? I think we should keep in mind that what starts as beautiful Paris ends as ugly brutalism in Eastern block.
Kevin: So what would you say would be the ideal, Dave? Or if you had to come up with something, what would be better?
David: My alternative would be to prioritize the small town, 20 to 50,000. That’s not just because I live in a small town, but the studies on the 15-minute cities idealize 400,000 to four million in population. I prefer something that gives you a little bit more access to the wildlands out the back door. Where I can get to my office in less than 15 minutes and I can get everywhere in town on a bike or a very short drive, literally within minutes. Here’s my biases: an outdoor lifestyle is what I like, what our family lives by. Slightly less cultured, Why? Because we don’t go to a play every other weekend. We don’t hear opera once a month. An outdoor lifestyle suffers in the city. Cities provide plenty of culture and sophistication, but lack the amenities that cater to things that I see develop amongst our culture here in Durango, in a small town. Independence, a sense of adventure, an indomitable spirit set against daily physical struggles that you encounter as you’re riding a mountain bike or climbing or doing whatever. But again, I reflect on my own idiosyncrasies here.
Kevin: Well, and you have to look at who came up with these ideas. Is this the company that you want to keep?
David: This idea is being popularized by the World Economic Forum. That crowd loves the idea of the 15-minute city as well. And I think maybe for different reasons. In a discussion on the 15-minute city from the WEF website, there’s a reference to dystopias, there’s a reference to utopias with a U, and then sort of a new coined phrase, borrowing from a guy named Geddes. Again, a public space planner eutopia with an E-U. Right? And the EU, you’re borrowing from the Greek where U means good, as in Eudaimonia, or good spirit, roughly translated as happiness in Greek. So eutopia, E-U-T-O-P-I-A-
Kevin: Is a good topia.
David: It’s a good topia. It’s a good topia. And so the quote is this, “To better quantify and plan utopias,” that is, good topias, “Geddes developed the concept of a ‘vital budget.’ He argued that ‘society must transition from “money wages”—which tend to dissipate energies toward individual gains at the expense of both natural and cultural qualities—to a “vital budget” which facilitates “conserving energies and organizing [the] environment towards the maintenance and evolution of life – social, individual, civic.”’”
Now I have to be honest, just straight out of the box, the idea of evolution of life being a controlled process and evolution of social and individual and civic being a top-down managed process gives me the willies. So back to the question, increased government control and power, is there a sense in which I’m not totally comfortable? Yeah. I read that quote from the WEF website as an expression of cost analysis that shifts the many into a higher position of priority than the one.
Kevin: Right. He even said he wants to get rid of individual gains, the—
David: Individuals wages in light of the vital budget, which is a collective budget. The individual prerogatives need to conform to the greater good. The individual oriented to his or her own money wages makes choices according to personal preference that may be in conflict with the “vital budget” encompassing the collective needs of society. Very big philosophical question. How do you prioritize the one over the many? How are you organizing your society? Do you subjugate the preference of the one to the preference of the many?
Kevin: I think that’s been tried here over the last a hundred years, several times.
David: Sustainable living is argued in this concept. Sustainable living is argued to only exist within cities.
Kevin: Takes a village.
David: And by sustainable we have to then move away from the agrarian life, which that word might bring to mind. I think of sustainable in terms of reproducible, cost effective, healthy, actually I do conjure up pictures of the agrarian life. But now we have to substitute sustainable for climate change compliant.
And Hélène Chartier, writing for C40 Cities—this is a group sponsored by Mike Bloomberg, the mayor of London, a bunch of other big wigs. They make the case that climate sustainability is not viable outside of cities. In other words, you are going to be moving out of your towns and suburbs into these sustainable clusters, these 15-minute cities because it’s the only thing that is climate sustainable.
I do see climate change as a leverage point for social and political change. Crisis is the only thing that unifies us in a secular world. Fears are no longer of the spiritual realm, giving rise to what in past centuries would’ve been animism or even millennia. But now we have natural catastrophe. And actually if you look at how people responded to natural catastrophe in the past, yet in this iteration of history, instead of setting up altars to thousands of gods to resolve our coming to terms with the vagaries of nature, the unpredictability of the rain and storms, we’ve erected chairs of science which give us the same kind of emotional peace.
It’s interesting, it’s still a form of religion that the history of mankind includes these regular attempts to try to control the uncontrollable. Only now, with the advent of modern science, we think that our skills can and will directly shape future outcomes. And our new faith indeed is quite bold. I think a resource that’s useful on the 15-minute cities is the CNU, Congress for New Urbanism. They’ve got a great series of journal articles which explore the benefits of the 15-minute city, and it’s a really helpful resource for understanding the planning aspect of the ideal. It’s not going to get you into what you have to give up to get this. Kind of is laying out the appealing elements.
There is the reality though that legal mandates and limitations are implicit to the planned outcomes. And this again is sort of an echo from history, whether it’s the history of religious ideas and the development of religious ideas across the world. This is not the first time we’ve talked about the value of the city versus the value of the country.
Kevin: You might go back to one of the most ancient stories that we have in cuneiform writing.
David: The Epic of Gilgamesh, because it concerns the city dweller versus the country dweller. There are some aspects that we should keep in mind in terms of what is being prioritized and at what expense. Because this is not a new conversation. Just because the WEF is now sponsoring the idea of 15-minute cities and gathering together through this group of leaders, the C40 cities, as sort of champions of the new ideal. It’s not a new ideal, and the old sacrifices that have to be made for greater efficiency should be considered. To get that done, you have the crisis mindset and the fear mandate, finding an opportunity for leverage to bring about this cultural redesign.
I just wonder what the limits are. Efficiencies gained for the sake of climate control end up interfering in personal choices. I saw this in Paris, the place that we rented. This guy is a chef, and we rented the apartment right next to his apartment, and he comes in and he says, “I’m sorry, a friend of mine convinced me to put in an induction stove, and I’ve never been able to cook in here the way I used to because it’s not that classic blue flame.” And he is right. There’s a difference. You can’t switch to electricity and an induction stove and have the same outcome as cooking on a blue flame. But we will be told in a 15-minute city that we’re no longer engineering for fossil fuels. We’re no longer building for fossil fuels, and therefore you will use electric whether you like it or not. And you will live in a multi-family dwelling versus a single family home. Who knows what the mandates are.
But this is again where there has to be a conversation about where personal choices end and where public preferences begin. Where are those lines? And maybe it’s petty to talk about induction stoves versus the classic blue flame, multi-family dwellings versus single-family homes. That begins to become a little bit closer to home.
But I was reminded again, I recently rented a flat in London, was reminded of life on the other side of paper thin walls, some things that you don’t need to be a part of. And you’re right in the middle of. The big question which precedes planning: What role is government supposed to have in determining or limiting our choices? What limits central planning should be the centrality of individual choice. That’s a personal belief, but public debate rests on an appeal to the greater good as a justification for this or for that. That’s where public debate is heading. I think we would do better to discuss the limits of individual choice and those edges where personal preference, yours, interferes with personal preference. Mine, and personal preference, ours—there has to be a pretty robust conversation there. Before we just say, carte blanche, yes, let’s go for the 15-minute city.
Kevin: Our next question. “Would the ruble risk another depreciating event in the future with China partnering with the Saudis?” So would the ruble depreciate with China partnering with the Saudis?
David: I don’t think we’re going to see a voluntary devaluation with the ruble. It’s too costly to the Russian population and they’ve got enough to manage with their incursion into Ukraine. If you saw a collapse in energy prices or a total blocking of Russian energy flows, you might see a further depreciation.
This overlap between Saudi Arabia and China and Russia, very interesting. I’d love a foreign policy expert to explain our engagement and our strategy with the trade partners that have determined the success of the US dollar throughout the end of the 20th century. Because you’ll recall the first thing that gave us a boost in the context of more or less terminal decline was the petrodollar dynamics being driven in large measure by the friendly terms we had with the Saudis. And then it’s been supplemented over the last 20 to 30 years, the trade dollar recycling dynamics, again over the past two to three decades. That was reinforced by the Tradable goods exported from China to the US.
Russia’s relationship with China is intriguing as an energy supplier to the really only critical economic challenger the US has. The closer China gets to both Russia and Saudi Arabia, the more our energy security is at risk. And you can’t just slap a renewable sticker on that one. It’s way too complex, and it’s just, you can’t. There are experts out there with a clearer view on the topic. But it seems we’re taking things for granted. We’re taking for granted availability of energy, taking for granted availability of finished goods, and taking for granted the benefits that we have been used to, accustomed to, the recycling of trade surpluses back into the US Treasury market.
Kevin: And last week’s program, Orlando Figes does feel that China and Russia will grow closer, and we have to look forward to that.
This question is from Ward, he’s from the Pacific Northwest. He says, “The CO2 and emissions climate doom story that is currently dominant in Western civilization seems to be based on faulty and incomplete models. The sun is not fully accounted, nor is volcanism and geoengineering. Also, renewable energy has serious flaws that are rarely talked about. Is the climate change narrative being used to control the masses rather than acknowledging peak oil and a massive energy crisis? The push also to do more geoengineering as a response to the so-called urgency of that doom narrative is more concerning to me than the CO2 emissions. Thanks for any thoughts you can share and Merry Christmas.” A little after Christmas.
David: Orlando Figes, in one of my questions to him last week, began his answer with “that’s politically fraught.” And I think this question is both politically and socially fraught. I agree that renewables have yet to resolve the intermittency concerns, and costs have yet to become realistic or comparable to what we have with fossil fuels. Any energy strategy, frankly, if we just back away from renewables versus fossil fuels, any energy strategy that does not include nuclear seems to me to be ideologically driven and blind to the most compelling math that an energy solution should have in, again, we’re dealing with something that’s proven already. That nuclear has largely been sidelined suggests to me that social change more than climate change is what the current agenda is aimed at.
And we come back to this notion that crisis moves the political needle, that this is a given. Crisis moves the political needle. Without crisis and fear, nothing gets done. With crisis, anything is possible, and with fear, any price is willing to be paid.
So yesterday’s crises, we’ve had these before, whether it’s the war on drugs or the AIDS crisis, just to name a few. If you can get those elevated to a national or a global crisis, first people pay attention and then politicians pay attention to people to maintain their jobs. So I understand that any opinion on the issue of climate change not in alignment with the crisis narrative is considered a dangerous one. And that in itself suggests to me, if you look at that, that the sociological impact of the narrative has moved beyond reason to a place where discussion is devalued. And when were questions, again, we’re like, “Here with the answer, what was the question?” Questions are secondary, not the other way around. They should precede. Having a somewhat philosophical bent, that’s troublesome to me. But again, you look at it, it’s also revelatory as to what’s going on. Are we talking about science? Are we talking about sociology?
I listened to Dr. John Christy’s testimony to the House Natural Resource Committee. I listened to it recently, it was from a few years ago. And I was interested in his distinction between the data that he collects, the data sets constructed from his research. The University of Huntsville hires reasonably gifted scientists, and that’s what he focuses on is atmospheric research. He’s saying that his research and the models used to extrapolate and project ahead to climate disaster tell a bit of a different story. The difference he claims are between what we actually observe and measure, versus what modeling creates, which is a suggested outcome and on a truly worrying scale. So if the models are correct, then we should be very worried, but the models don’t exactly jibe with the data.
Knowing that in our own sphere of interest, Kevin, where finance and financial modeling and all these things can tell a very interesting story. Knowing that modeling and finance allows for a variety of fictions to exist and be legitimized regardless of their connection to reality. Again, we’re talking about mark to model, mark to make believe, versus a mark to market reality. I think there’s a conversation to be had here. Let’s look at the data. What is the data saying? Yes, we should be interested in models, but those models have to be tested. And Christy says, “Yes, climate change is an issue. It’s real, but that the crisis is manmade, by compressing the timeframes, the modeling, to something that does not match the data.”
And you might think of this in a different way. Imagine a hundred years of aging in a human body, but it happens in 10 years and that’s dramatic. If you had to observe it, it would even be scary, it’s a lot of change in a short period of time. Something similar to that is what the models capture and may in fact exaggerate.
So very interesting to me was his observation on back testing the models and theories of climate change against the existing data. The models used to signal climate catastrophe, he notes, they’re inconsistent, they’re inconsistent with the back tested data. They don’t work at all with the back tested data. And that too is a critical point in my view because I’m not a climate guy and I’m not an environmental guy. But consider that climate crisis models are inconsistent with historical patterns before you assess their relevance for future prediction. That’s Christy’s view, if I’ve understood him correctly.
Kevin: Well, and think about it. It applies to what you do for a daily living.
Kevin: You have to look at history. You do not know the future.
David: But if I’m going to use a model— In the world of finance, if I propose a serious strategy for making money in the future and yet can’t support it with back tested data or the historical record of that strategy working under actual real world conditions, I wouldn’t be taken seriously.
The markets are a cruel judge of relevance and accuracy. Daily trading activity is sort of a real-time proving ground for ideas. Was it a good idea or a bad idea? And you can’t just mark to make believe. Where we get into trouble is when market practitioners, again, thinking of financial market practitioners, when they get creative with their storytelling, when they’ve got hyperbole, when they’re working off of pro-formas that are really idealized, exaggeration allowed to be supported by a model.
This is typical in finance, where, if you’re looking for quantification of risk or trying to lay out rewards being modeled, very commonly you don’t have sufficient timeframes involved. It’s one of the reasons why 2008, 2009 happened. All of your risk metrics were off of timeframes that were sort of our lifetime, but not all lifetimes. When you input the all lifetimes into the equation, all of a sudden there’s risks that we think of as 500 year floods, 100 year floods, highly improbable events that actually do happen on a routine basis. You just have to look at a long enough time slice to realize how routine they are. The variables assumed to be relevant may be true, but are not sufficient to tell the whole story. It’s just a part of the story. So bring one part of a story into high relief, I think that is in fact detrimental to the whole story and may suggest some political opportunism.
I do think there is a large degree of policy opportunism attached to the climate crisis. And that’s not to say that there isn’t climate change, but again, the crisis dynamic, that’s really what I’m getting at. Perhaps it’s justified, but I’d be more comfortable if academics were invited to discuss, invited to question, invited to debate findings rather than merely get in line with the current consensus. Anytime you’re forced to believe something and there’s no robust discussion around it, to at all be skeptical of catastrophic climate change, as a non-tenured professor its professional suicide, and that’s the state of the academy today. You get on board or you’re out. Bless your heart if you happen to be tenured because then you can actually say what you want to say.
Kevin: Bet you won’t get your paper published.
David: That’s true. But it seems there are many issues in the academy which blur the lines between science and sociology. So from my perspective, Kevin, stewardship of our resources is a discussion and a practice that I’m deeply committed to. We’re never off the hook in considering how our choices influence future generations. And how care of our natural resources is a critical component of how we engage the world that we’re surrounded by. I’m simply adding to that, that crises are occasionally fabricated. And crises are occasionally leveraged by politicians and policy advocates to get stuff done. We need to be mindful of how fear is used to leverage democratic power. Mobs are moved by it, with any doubts. Look at our darkest and most embarrassing moments in history, both in the US and around the world. You can see how politicians have leveraged xenophobic fear to rally an electorate to a particular policy resolve, fear policy moving the needle. Fear is an easy emotion to tap into and then manipulate for policy purposes. I have a problem with that. I like problem solving. I don’t like political manipulation. So where we can have a clear conversation about facts, I find that very productive in the context of stewarding the earth resources.
Kevin: Well, Dave, again, this year has been a great year for questions from our clients. It just seems like they become more engaged every year, doesn’t it?
David: Absolutely. And I don’t think we set any questions aside, particularly the one on music. We got back around to, what is our opening music. But I’m humbled by the level of engagement, by the sophistication, the thoughtfulness, and just the willingness, the time people are willing to give up to engage with the questions. Listen—
Kevin: There’s a real loyalty there, Dave. People have been listening for years.
David: No, I thank you. We’re in our 15th year as we move towards March. We’ll head into our 16th year of doing this every week. It’s been an amazing discipline for us, but the engagement with you, the listener. You know what I hope is that there’s opportunities in the future for us to gather as a community and enjoy the breaking of bread, enjoy a glass of wine, enjoy robust discussion, not just in a removed fashion—us in the studio, you in some other part of the world—but where we can benefit from relationship with you. Because I think, frankly, where I have significant errors in the answers that I’ve provided, many of those errors would be resolved in a conversation with the person asking the question.
Kevin: Open dialogue.
David: And that’s what we want to invite through the Commentary, through the Q and A. Please don’t presume that we presume to have all the answers, and where I have significantly stepped my foot in it, forgive me, I look forward to the conversation as it continues.
Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany, and you can find us at McAlvany.com, M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.
This has been the McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.