Your Questions Answered Part 3

Weekly Commentary • Jan 04 2022
Your Questions Answered Part 3
David McAlvany Posted on January 4, 2022


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Your Questions Answered, Part 3
January 4, 2022

“Just because you have stocks, real estate, and bitcoin going up drastically doesn’t mean that they’re a better hedge against inflation. They are trading on their own dynamics for their own reasons as an expression of speculative excess, not necessarily as a ‘hedge.’ We’re really at a fascinating crossroads. And I wouldn’t be too concerned about timing. If you see something in advance, be willing to position for it and be patient because I don’t know that anyone gets to be right in both timing and trend.” — David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. 

Well, my buttons are bursting Dave. I was just in a meeting with you and everyone at our company. And we just talked about, we’re going into the 50th year of McAlvany. And I really think, listening to the various departments giving their reports for the last year and talking about 2022, I really think we are at our best right now. And so I just, I want to thank you for allowing me in your family, allowing me to be a participant in all of this. Before we get into the question and answers, even our listeners, I feel like, are part of the family, and I want to thank them also.

David: Yeah, this is a big year for us. It is five decades now in the rear view mirror with our asset management company heading into the 15th year and the Weekly Commentary as we get closer to March, that’ll be the beginning of our 15th year of doing this every week. So we look at these Q&As, these question and answer sessions at the end of each year. And we’re amazed and pleased that we get to have such a robust conversation and interaction with some really bright people out there. And so we appreciate you engaging with us. We hope that you can take these conversations and pass them along to friends and family members so that your conversations more broadly can be informed, inspired, helped along, guided in any way possible. 

And this is a major part of what we do on a weekly basis in terms of looking at the world and figuring out what the right things to do from a financial standpoint would be. But yep, 50 years, 15 years, 15 years, these are some milestones as we head into 2022. We’re very excited about 2022. I think there’s some pretty big challenges to be faced within the financial markets, but that’s not daunting if you are adequately engaged and there’s a variety of resources that you need. Hopefully this is adding to some of the resources.

Kevin: One of the things that I love about working with your family is the diversity of the conversations that we have. Truth is truth. Whether you’re talking about the financial markets, whether you’re talking about politics, whether you’re talking spiritually, truth is truth. And what I love about our clients, too, and the people who listen to the show, is that’s what they’re pursuing. So the variability of what we talk about, some people think, oh, well, it’s a gold company, or oh, it’s a financial management company. 

Really, the only way that you can get to truth is to look at it from every angle. And we’re starting show number three of the answers to the questions. And this is a question from Mike that actually reveals that you have to look at truth from a lot of different directions. Mike says, “In your December 8th podcast, you mentioned that a judge ordered the release of Pfizer’s emergency authorization report. Is there a link or a way I can get this report? My daughter is a statistical epidemiologist, and I would like her to read it. I love your weekly shows, and I am an avid listener.” So Dave, Pfizer, the report, what do you say?

David: Well, the FDA has been willing to release 500 pages of the report per month, which suggests that the 329,000 pages of supporting documentation, which they looked at to justify the emergency use authorization for the Pfizer-BioNTech jab, that’ll be released in total by 2076.

Kevin: Wow. How old will the company be at that point, Dave?

David: 105 years, in fact. 105 years. So there are further requests to speed up the release of those documents. And the argument’s been made that the FDA, if they could get through the study and the approval process, the approval of 329,000 pages, in 108 days, then it should not be that difficult for them to do the redactions and release them in some shorter timeframe. Not 55 years, but maybe even 108 days for that disclosure. 

All that to say, we can’t send everything out, but the FDA does have some disclosures already out. I cannot link to the report. That’s the issue. The release is gradual over time. It’s not clear that what will be released is sequential. We don’t really know what we’re going to have, or that it will in any way provide context for the FDA decision. You can look at the FDA approval’s timeline for each iteration of the vaccine. And I found that to be helpful. And it highlights the approval for Comirnaty as well. 

And a particular note as I went through this, it’s only about a 20-page read, but footnote 18: although Comirnaty is approved for use, there are insufficient supplies for distribution. So you have the FDA approved vaccine, but there’s not enough for that to be distributed. So they’re still using the old stuff. What is not noted is that although it’s approved, it carries a different legal status, and that not originally under the emergency use authorization, again, with what I think is a significant variable because it was the earlier version which held indemnity for Pfizer. So the contrast is between a fully licensed vaccine and one that is approved for use under the emergency use authorization. 

You can’t mandate a vaccine under the emergency use authorization approval status. You can mandate a fully licensed vaccine. However, the fully licensed vaccine is not readily available. That very intriguing legal argument in support of this position. And I would refer you to a court docket where, if you want to look at a case against the Department of Defense, it highlights some of these contrasts, and you can see as it’s laid out in legalese what’s at stake with version one, version two, et cetera, et cetera. So in the show notes, we’re going to include two things. One is that FDA 20-page summary report. And then the second is again from a court docket Doe versus Austin. And here, we’re talking about the Department of Defense.

Kevin: Our next question, “I am a longtime listener to the McAlvany Weekly Commentary. And I recently found my parents’ old savings account passbook from the early 1970s, actually, before I was born. I attach some pictures.” Dave, he sent us pictures of this old passbook. “It is interesting that the passbook contained a section stressing the importance of saving money. When I read it the first time, it reminded me of something out of the book of Proverbs. My favorite statement is, ‘A savings account is one of the strongest defenses against misfortune.’ Do you think, Dave, that banks will ever include such language again today on their website or any of their marketing documents?”

David: I think it represents an implied position which was long held within market-oriented societies, that the individual should sufficiently reserve for business cyclicality—call it the surprise. It’s the individual, and it’s not the state, that should be the first defense against misfortune. And that older notion of independence and self-sufficiency is being replaced with ingrained dependencies on the state. I watched an interesting Financial Times presentation over the holidays arguing for universal basic income. And it really was putting forward this notion that we can improve wellbeing, we can reduce anxiety, that’s how the argument went, as long as we provide a predictable supplement to everyone’s income, not means tested, just everyone, no questions asked. A certain amount of income. It’s a fascinating twist post-COVID where here in the United States, we’ve just completed an extended experiment with universal basic income. Everyone got a government check. And do we feel a deeper sense of security knowing that Uncle Sam is our strongest defense against misfortune instead of our savings filling the gap? Now we have the federal coffers which are stepping in and filling the gap.

Kevin: And what we found, Dave, is that turned into high inflation. So now what do we do? Do we go back to the government and say, can you control the inflation that this experiment created?

David: Well, the question that was being asked is really about banks and whether or not they’ll include that language again. And what about the banking community? Unfortunately, there’s more emphasis today from the banking community on consumption, on leveraged speculation, on growth driven off of a conception of the good life, which is infinitely acquisitive. It’s become a reasonable conclusion to ask, why would you reserve against misfortune when government stands at the ready to provide resources in any unfortunate event? Why would we do it in the first place? So we’re quickly being conditioned to see interventionist measures as the best solution to calamity. And I think, look, there is a place for intervention, there is a place for safety nets, but what the past two decades have produced is the increase of moral hazard on the other side of misfortune. You have investors, you have speculators, you have savers, even banks have come to operate with the assumption that gains are for the house, losses are for the taxpayer. This was very popular post-2008, 2009 to talk about privatized gains and socialized losses.

Kevin: And think about it, Dave, back from the last depression, the banks were encouraged to keep a certain amount of reserves themselves. So not just the individual should have some savings and reserves, but it used to be that the banks were held responsible to have a certain amount of reserves. They’ve been reducing that to almost nothing, haven’t they?

David: That’s right. So it’s not only a lack of individuals adequately reserving, creating a strong defense, but banks themselves are too often testing the limits of reserve requirements as well. Do they have adequate capital available in the event that the mismatch between short-term deposits and long-term investments is revealed through unfortunate circumstances? So, yep, most bank literature I see promotes living the life you want now. It’s very consumption-focused. So, again, coming back to, will banks ultimately return to sponsoring savings as a defense against misfortune? I think today that runs against the grain of the more common marketing theme reflective of YOLO philosophy, which is an acronym. It means, “you only live once.” All that is, is the 21st century version of Epicureanism.

Kevin: It reminds me of the old American Express commercial where the couple got home from their vacation, they were in the airport and they weren’t done. So they just pulled their next card out and borrowed that way.

David: Yeah. A savings account is one of the strongest defenses against misfortune. I completely agree with that, but I would return to earlier questions in the last few weeks and suggest that in the world of fiat currencies, even a savings account has its risks because of vast interventionism, because of governmental overreach. We also have the money machines, which whirl and spin and produce an excess of fiat money and credit. This creates a challenge for the saver, as few and far between as they are today. That’s a new challenge for the saver of our day. Can you leave everything in the bank or do your reserves need a superior denomination? 

And so for me, I balance between cash, actual fiat currency in the bank, and ounces of gold or silver. That resonates with me, in part because one version of misfortune in the modern era is central bank generated, and a savings account—and again, funny that you should have to think in these terms—a savings account may be helpful in terms of insuring against misfortune, but what if your savings account isn’t adequately protected? 

 So the concept of reliable savings for all, that’s at the heart of our vaulted platform, it’s an alternative to deposits in mere paper form. And that’s what I would consider maybe a truly strong defense against misfortune.

Kevin: That leads to the next question. And we didn’t purposely time it this way, but there is the perception, Dave, before I read the question, there’s the perception that gold is not hedging against inflation like some of the other items. So let me go ahead and read this, and I’d like to hear your answer on this. This is a question from a listener: Stocks are up exponentially, real estate up unbelievably, bitcoin up drastically. What is troubling silver and gold?”

David: Well, to start with, I don’t think any of those are hedging against inflation either. They’re moving on their own dynamics. Risk-on is still alive and well. Some look at the investment trends currently in motion, and I think very appropriately categorize them as speculation. So you get the upside potential in the assets mentioned. And that is proportional to monetary supply expansion, the continued free flow of liquidity to financial operators and speculators. And you have basically this positive feedback loop where buyers positively impact price. And that draws in more buyers based on the performance results of the previous buyer. 

Does that continue forever? No, I don’t think so. But to be clear, just because you have stocks, real estate and bitcoin going up drastically doesn’t mean that they’re a better hedge against inflation. They are trading on their own dynamics for their own reasons as an expression of speculative excess, not necessarily as a “hedge.” 

And I think it was last week or the week before where we talked about gold and silver and gave an inflation scorecard, if you will. So there are economic and political costs, coming back to this notion of expanded money supply and what is driving those other asset prices, there’s economic and political costs to money supply growth. Ultimately inflation is what comes into the market as a result of that. And when those costs exceed a benefit, the flows can be turned down, the flows can be turned off. And now all of a sudden you have a different kind of traffic. 

We’re already hearing from the Federal Reserve and the ECB and other central banks that there will be a reduction of liquidity, there will be a tightening of credit. There has been no bite from that yet within the financial markets, and there has not been actually a lot of delivery if you’re talking about actions taken versus just word spoken. We’ll have to see if the ECB and Fed deliver to the degree that they’re at least talking now.

Kevin: So with the valuations as high as they are, Dave— we’re moving into 2022 right now. As an analyst and someone who actually has to look at money, even though these things are overvalued, how do you manage when you know that they may continue the flow of liquidity going into this next year?

David: Well, I suspect that 2022 will be equally challenging to last year, 2021, from an analytical perspective. We’ve got money flowing from the central banks, we’ve got the discussion about that tap being turned down, if not off. And here we are with valuations very high, real estate cap rates are at historically low levels, we’ve got bond yields too that are very historically low. They’re not at the record lows we’ve seen in recent years, but with bonds, keep in mind that central banks have been hesitant to raise rates. They’re now in this awkward reality where inflation is percolating, and German bonds and US Treasuries—although those rates are not at record lows, you start factoring in inflation, which is percolating higher. Adjust those yields for inflation, and you’ve got lower rates. You actually have more negative rates now than at any other time in multiple decades.

Kevin: Well, and I wonder, Dave, if the confidence that we’ve gotten used to with the backstop that the central banks have provided with this talk of inflation, is that confidence starting to crack?

David: Confidence is a big thing. And it’s difficult to know when a small bout of risk, when that risk-off enters the market, when that snowballs out of control. But I suspect that the disastrous call on inflation by the Fed and the ECB—it’s all transitory, right? That was the theme of early 2021. It’s all transitory. The disastrous call on inflation last year by the central bank community is a part of the undoing of confidence within the financial markets. And I think this is relevant because so much of the positivity within investor’s minds stems from central bankers maintaining legitimacy. It’s been up, up and away until the helium effect wears off and gravity takes hold. 

If you look at the metals, so much of the metals’ underperformance ties to the outperformance of the other asset classes. And this is the heart of the question, what’s troubling silver and gold? Nothing is troubling the metals, you do have opportunity costs still in play. So we’ve talked about the Summers-Barsky thesis as an underpinning for gold. And really, Larry Summers, when he put this together back in the ’80s, looked at how interest rates were a key component in the price of gold. So lower negative rates remove the opportunity cost of owning gold. But today we have, on the other hand, if equities are providing a viable venue for growth, there still is an opportunity cost and the same kind of impact, negative impact, into the metals market as you’d have implied by the Summers-Barsky thesis.

So looking at the implied risk of equity investing, looking at current levels, looking at current valuations, I think you’re already playing the greater fool strategy of investing, hoping a greater fool pays you more than you did to provide you with liquidity. But this is a perspective that we’ve seen before, sort of the grass is greener perspective. 2022 will likely see some carryover from 2021. If you lost 5% in gold, if you lost 13% in silver in 2021, and the S&P 500 was up over 25%, you might be tempted to sell your medals and buy equities, assuming that an object in motion stays in motion or that a market on the rise stays on the rise. But I think it’s worth reviewing the difference in mandates you have for different assets in a portfolio, because what I just said would suggest selling metals for equities to increase growth in a portfolio. And I think you’d be dead wrong.

Kevin: It’s a repeating pattern, Dave. When things start really going up, a lot of times people will sell the safe assets and jump into the dangerous assets, thinking that that will continue. So if growth is the only mandate for all of your assets, then there are ways to do that where you’re chasing momentum, but the gold and silver are not the mandate for growth. They are the mandate for preservation, are they not?

David: Yeah. And I think this is one of the great governors for investment psychology is having different objectives and different mandates for parts of your portfolio. If it’s all compared to what was the greatest growth opportunity, you’re going to be disappointed with yourself, looking and saying, well, I guess I should have owned only shiba inu as a cryptocurrency this last year and sold everything for that, maybe even mortgage the farm for a little bit more shiba inu. But the reality is you can’t just focus on growth. There’s more going on, and you have to govern that psychological propensity to chase what worked best last year and hope that it does the same this year. 

Again, if growth is your only mandate, and this is where I would say, actually, we covered this a little bit last week when we talked about the balance between gold and silver, we talked about the permanent portfolio and the four quadrants that is split up in Harry Browne’s old model of investing. But let’s just say for the sake of argument, growth is your only mandate. No, we’re not going to put 100% in a random fraction of a penny cryptocurrency. That’s not what I’m saying. But we covered this a few weeks ago. The annual rebalance between equities and gold is a part of that success. And quite the opposite of what I mentioned a moment ago, you would be selling stocks and adding ounces on this year-end 2021, 2022, rebalance. 

So that’s, first of all, I think looking at the mandates is important. And if you’re going to argue for a strong growth mandate, recognize that there is a role for gold alongside equities to maximize growth. But second, I think it’s fair to say that growth is not the only critical mandate. Income certainly is an important mandate for many Americans, insurance from the standpoint of looking to bona fides of precious metals, I think that’s another important mandate. We talked about reserves earlier. Reserves are critical for businesses, for households, for governments. You see the consequences of crises exaggerated when there are insufficient reserves in place. 

And so I think the survival of any entity when you put it under stress is largely determined off of its reserves, not how it’s positioned for growth, but how it can respond, if it has the resources to respond, to surprise. We have this in our relational lives as well, emotional reserves in the case of marriage or family, monetary reserves if you’re talking about the corporate entity, the governmental entity, what have you. But this again is a legitimate allocation of assets that does not have to be strictly growth-oriented.

Kevin: And so what you talk about is if we have a growth fixation, ultimately we have no money. I know because after 34, this is my 35th year coming into this business, that we do rebalance. And there will be times in the future, Dave, where the base of the triangle, the gold and the silver will have to be sold to rebalance over into stocks and cash. Right now, it’s just the stock side that needs to be rebalanced. So I really, I like that.

David: I think of Jesse Livermore, who is one of the most famous speculators on Wall Street. And he made many fortunes. He also lost many fortunes. He essentially was a stock market gambler. And when you say eventually you don’t have any money, that’s right, because as good as you are, you will lose it all. You will lose it all. If growth is your only mandate, and you’re constantly pressing a portfolio to maximize growth, you will, I’m telling you— Jesse Livermore, one of the best in the last 100 years, committed suicide after his last boom-to-bust cycle. And he lost hope because he didn’t have enough time in his life to make it back again. 

So I think what’s troubling gold and silver is the growth fixation within financial markets. The metals are excluded to some degree as being out of step with the directions of the equity and fixed income markets. And I would look at record-high pricing in the assets mentioned in Dennis’s question, and with gratitude, with gratitude, not greed, lighten your holdings in all of the overvalued assets. I think what’s troubling the metals is temporary.

Kevin: Next question. “New listener and loving it. Thank you. Just a question regarding your thoughts on how the meme stocks will play out, like AMC, GME in particular. The FTDs,” which is failure to deliver, “naked shorts, using options to hide the failures to deliver, the use of media and social media bots to manipulate, et cetera, et cetera.” What’s your thought, Dave, about this brave new world?

David: Well, I can’t say that I follow the failure to deliver issues with those meme stocks. What I can say is that excess liquidity in the system drives excess optimism and risk taking. And while the removal of that liquidity has the opposite effect, it changes behavior very quickly and can move prices lower in just as dramatic a fashion as they’ve moved higher. Today, you’ve got the day trading and retail investor enthusiasm for basically bankrupt companies, which works, and it’s working because you’re aggregating decisions, and greed is the dominant emotion in the market. If you ever run out of buyers, the market discovery process, the price discovery process, looking for some sort of a bid becomes very dramatic on the downside. I think what we forget is that fear is the more powerful emotion. We don’t see it at present. But when it’s in motion, it can impact markets in a very dramatic way. The meme stock craze, you’ve got the cryptocurrency craze, you’ve got the non-fungible token craze. They all share a backdrop of unbridled greed. And that unbridled greed has been enabled by unlimited credit at really non-existent rates of interest.

Kevin: Okay. So is there a limit to the upside? A lot of people are thinking, gosh, it’s pretty easy to get rich these days.

David: Today, the only limit to upside in the investment world is the investor’s imagination. We left reality, we left fundamentals—those limiting factors—years ago. But I think it’s worth remembering that the decline in those meme stocks to date, we’re well off the highs. We’re 60 to 70% lower than we saw in 2021. All that represents is profit taking. That’s not a shift to negative sentiment, that is not outright concentrated liquidation. They are still nine, 10, 12 times higher than where they started this process. 

You know how these meme stocks play out, that’s what Ty is asking. To the degree that the meme stocks are turning their shares into reserves, fortifying their balance sheets, whether they’re issuing new shares or raising money in the debt markets, then maybe they have the opportunity to restructure their businesses and live to fight another day. 

What we saw revealed in the 2000 and 2001 period of time with the tech stocks was that the most popular stocks—again, these were the trading sardines of that day, primarily tech stocks—they suffered the greatest declines in the context of a market liquidation event. They had been aggressively bought, and they were on the flip side being aggressively sold. And it all changed when sentiment shifted. And it shifted fast, hard, and unexpectedly. Everybody who thought they were the best trader and we’re going to get out near the top found themselves holding a significant bag. 

So we have had that. We’ve had AMC issue senior notes. They were paying as much as 15% for their bonds middle of last year. They raised over a billion dollars. We’ve had GameStop issue new shares. And I think that’s just populating shares for new suckers in the market. I don’t see these companies as reshaping the financial markets as we know it. But I think the trading dynamics on display here are worth keeping in mind. As we retire 2021 and look at 2022, there were some really important lessons learned from the meme stocks. Not that you should go out and buy what is on Reddit, but I think the trading dynamics with a short squeeze adding to the spike in price, that was very interesting. 

And to your point, Ty, social media is a new factor that creates a swarm-like effect with retail investors. And that can hit positive or negative. We had short covering combined with long call option strategies, combined with just going out and buying the shares themselves. And I think really what we got from GameStop and AMC, ironically, was very much casino-like entertainment.

Kevin: It’s interesting, Dave. Before I read the next question. If I use the word crypto, bots come on to our YouTube channel, and every YouTube channel, and give about 23 recommendations that you go buy or use a particular advisor for crypto. These are all robots. And it’s interesting. There is a program that actually just mines for these, and then it populates the comments with fake robo-controlled recommendations that you buy. 

So the social media aspect is really interesting and a lot of times it’s robot-driven. So I’ll go to the next question here. “Thank you for your intelligent and often wise considerations about the financial markets related to developments in the world. Inflation is a growing problem, and the low interest rates on savings, too. What is your opinion about institutions like Celsius Network in the crypto world that give 10% interest when storing USDC stable coin there?”

David: I’ve never participated in lending against crypto assets or using them as collateral for a loan. So I think some things that stand out to me, the price swings are so volatile. Whoever is providing those services, in this case Celsius, would have to have a hedging strategy of some sort not to get into serious trouble on a day-to-day basis just because the underlying asset is all over the place. And that suggests that Celsius has a trading system in place or they would have clients constantly blowing up. So, again, lots of trouble when you’re dealing with loans and the value of collateral jumping all over the place. 

The 10% interest component suggests to me that spreads on crypto product have to be incredibly wide, that would put a market maker in cryptos as, it sounds like an incredibly lucrative position because of how wide the transaction spreads are. Again, that’s the difference between the bid and ask, or what you buy something for and what you sell something for. But in that in itself, the wideness in bid-ask spreads, raises concerns for me as to, one, the transparency of the market, two, the actual liquidity of the market, and three, the actual float of products, that is of cryptocurrencies available at a particular point in time. 

So it seems to me that the natural constraints of the market are what allow for the attractive yields to be on offer. But with those constraints, there are also considerable risks as well. And this is— as you study markets, any market, whether it’s a bond market, currency market, stock market or sub-sector within those markets, the healthier a market, the higher the volumes and the more compressed your cost become. 

Take the flip side of that, where your costs are incredibly high, your spreads are incredibly wide, and your volumes are not particularly impressive, and the flip side is really a warning. A mature market does not have those kinds of yields, even bond yields in the junk debt markets are a fraction of that number. 

So I think another factor you’re dealing with in giving your money to a platform like that is there’s unknown credit risk. You may be getting interest on a stablecoin or crypto asset, but the interest paid to you—keep in mind just what this is exactly—the interest paid to you comes from someone else in the form of interest paid on a loan. You’re lending as a depositor, Celsius is lending at an even higher rate to a third party. It’s basically crypto banking, right?

Kevin: So you want to know who you’re loaning to, but you don’t really know, do you?

David: You don’t know. So you have no idea how to gauge that credit risk. And I have a lot of questions about the process of judging credit quality, which is really, again, just the ability of the borrower to pay off a loan with interest, particularly if it’s based on a simple anonymous online form. And clearly, I’m at a disadvantage here. I’m not familiar with this Celsius onboarding process, but they are acting as a digital bank. And they’re doing the work of a loan officer, basically converting your digital asset on deposit with them, which is now their liability, they owe it back to you. They’re turning that into a banking asset. That’s how banks see loans. An asset of the bank is something that’s been lent out. So you give it to them, they give it to somebody else. Now it’s their asset they’re earning interest on, and they’re giving you a small portion of the interest that they’re receiving in turn. Does that make sense following that?

Kevin: Mm-hmm (affirmative). Yeah.

David: So this is a classic example of shadow banking. And there’s $24 billion in assets on the Celsius Networks engaged in their program. This is collateral on loans that have a volatility profile that would make a typical banker cringe. Right?

Kevin: Well, and you wonder, Dave, when you’re loaning money to a bank and they’re loaning it to somebody else, they’re charging them interest. So you wonder what are they charging the guy who’s on the other side of that transaction?

David: Yeah, because I saw one of their teaser rates. You can receive as much as 17 to 18%. So if you’re earning that from them, what are they charging those taking out a loan? Does it seem realistic that an unregulated product offering three to four times the interest of a junk bond would carry the risks that those types of interest rates imply? So again, you’ve got the incoming and outgoing crypto assets. And there’s no doubt an opportunity for proprietary trading on the part of Celsius. Profits for them. But to me, that translates—you have to think in these terms to some degree—that’s added risk for you. We’ve seen prop trading on Wall Street blow up. Just because there are smart people on Wall Street trading stocks and bonds and currencies and commodities doesn’t mean they get it right all the time. And every once in a while, they blow up in a big way. Here you’re talking about a less regulated environment with less transparency, no oversight or accountability, and they’re doing prop trading on crypto assets? Do you think anything could possibly go wrong?

Kevin: We’ve seen this in the past when something sounds too good to be true, it usually is. And it’s usually based on cleverness, a very complex structure. Will cleverness prevail on something like this?

David: It’s also a classic case in point, Kevin, of it works until it doesn’t. And as long as you’re at the front end of that where it’s working, you’d have to say on the basis of my experience, why would you argue against this? It’s working. It works until it doesn’t. 

I think the cleverness of the structure, it’s intriguing, but the fact that multiple state securities bureaus have already issued cease and desist orders in recent months, it confirms in my mind that it may be too clever, and in the end, not very consumer-friendly. So, for the record, I’m not against owning cryptocurrencies, but like any other asset, and this one is exaggerated to some degree, but like any other asset, if you introduce leverage, if you introduce proprietary trading, if you have as a part of the asset class, extreme price volatility, if you have delicate trading volumes, you’re asking for ugly surprises at some point. And so, such is the state of the financial markets today, not just a crypto lending platform. And I think we come back to, if opportunity seems obvious, it may be because risk has been disregarded.

Kevin: Another question that ties into this a little bit, just the crypto question. Here’s the next question. It says, “In the hopefully unlikely event of a worldwide fiat money collapse, how do businesses adapt pricing to a market with multiple currencies? Will I go to the store and see the price tag for my milk listed in gold, silver, bitcoins, and a multitude of other currencies? It just seems like a daunting task to ask people to adapt like that. Won’t they revolt?”

David: I love the question because in real time, I mean, actually, the joke bantered on BBC this week was about business owners in Turkey. Their employment is on the rise because the number of people needed to raise prices on products on the shelves and their stores is going up. 36% inflation rate. There’s daily changes needing to be made to everything on the shelves. And that can be an all-day affair for any shopkeepers. So hey, don’t worry. Think positively. Employment is improving in Turkey. That was the gist of the joke. 

This is a great question about pricing and about understanding what something is worth and how you navigate changes in a period of time where you might be experiencing destabilization in your unit of account. What we know today is the incumbent role of fiat currency. And we can safely assume that if the monetary authorities maintain control, that that’s going to continue to be the case. The local market will be priced in local currency terms. Maybe there’s a digital central bank iteration of that, but for dollars, it’s going to be dollars in some form or fashion. It’ll be the same for pound sterling or wherever you go in the world, priced in local currency terms. Every once in a while, you get a snapshot of cross-border transactions in what the question implied, having multiple prices for one asset, I picked up a book the other day and in US dollar terms was priced at $28.95. And in Canadian dollars, $38.95. Canadian dollars versus US. All that is is a snapshot in time of the exchange rate when the book was published, 75 cents to the dollar, Canadian currency at that point in time was 75 cents to the US dollar.

Kevin: Is this not why you need to bring meaning into value? And what I mean by that, Dave, is we’ve often talked about an ounce of gold over time always buying about 365 loafs of bread per ounce. That adds meaning to value. Then you can say, okay, well, gold goes up and down, but for the most part, it’s worth about a year’s worth of bread at a loaf of bread a day. Why wouldn’t you just measure meaningfully all these other currencies? Isn’t that part of the conversation?

David: Yeah. And I think, really, the importance of the question is getting to the point where you know how to translate, where you know how to understand what is in front of you. What we have to do is be able to translate the current official exchange rate into something meaningful in the event that the official rate is skewed for political reasons. We’ve talked about this in Argentina before, where reality with the exchange rate diverged, with the official rate being one thing and the street rate being something completely different. The blue market or black market rate, however you want to call it. So it’s important to recognize when the official rate does not reflect reality. 

And yeah, while the local currency, if you’re talking about US dollars or Aussie dollars or euros or yen is the most important measure still, I love the idea of thinking in terms of value outside of just a local currency. In the Commentary, you’ll often hear us talk about ratios, for instance, the value of the Dow, Dow Jones Industrial Average, 30 stocks. It may be 36,500 points, or said differently if you turn that into a ratio, it may be 20 ounces of gold, 20 to one being the ratio. That’s the actual ratio today. 36,000 doesn’t tell me much, except that maybe it’s historically high in nominal terms. But translating that into ounces, you find that here we are at a record nominal high, except when you adjust for real money, gold, it’s less than half it’s all time high. 

Cutting through the market crap, you get to see that actually stocks are not doing that well vis-à-vis gold. It suggests that the elevated price levels are a function of inflation and speculative gaming, not a reflection of wealth. The old high in the ratio was 43. 43 ounces of gold exchangeable for the Dow. Today, it sits at 20. In fiat money, you may look wealthy, and prices of everything around us may infect at be eye popping, but in ounces, this is where, again, we go back to having a reliable reserve asset, it’s been a reliable reserve asset down through the ages. Costs are actually not that extreme. Gold as a reserve asset has helped you maintain your purchasing power. 

I’ll give you a couple examples. College tuition at Yale, you think, oh my gosh, you’re killing me. It’s got to be through the nose. College tuition at Yale is about where it has been for 100 years priced in gold. Even after a big rise last year in the price of coffee, a spike higher in the commodity price, it’s still less expensive in gold terms than most of the last 20 years, again, priced in gold. In US dollar terms, or any fiat currency, any fiat currency, a Big Mac is pretty expensive today. But in gold terms, a Big Mac is still cheaper than at any time since 1985. 

So again, we lose track— what does 36,000 in the Dow mean if you don’t have reference point, if you don’t know how to translate to what it means in real wealth, what it means in a stable measure of wealth? So the takeaway is that gold as a reserve asset, as a retirement ballast, as an alternative reference point for value, gets you away from the fiat rat race. Over long periods of time, you’ve got preservation of purchasing power in gold terms, which is very, very compelling. Now I think this is where one of the things that you can say, okay, well, I’m just not interested in gold. It’s an asset class that my stock broker told me I shouldn’t be paying any attention to. I’m going to give you something depressing to think about. The federal minimum wage was at 1.2 grams of gold in 1971. So you have to do the translation on that to real dollars. But now we’ve left gold behind. Bretton Woods is behind us. We’re in a perfectly fiat world. And the federal minimum wage is 0.2 grams of gold.

Kevin: So from 1.2 down to 0.2 if we’re measuring the minimum wage in gold from 1971 till now.

David: You were paid six times more in real money terms 50 years ago, six times more, or if you flipped the math, moving off the Bretton Woods system and its basis in gold, your income in fiat is down 83.3%. Of course it takes two incomes to make ends meet. Yes, it’s a mirage. The mirage that we feel better, we feel like we’re making more money. But when we’re making more money and there is more money on the table, what we’re saying is there’s less value. There’s less value. And that’s what ratios reveal. So all I’m saying is that when the measure changes, you should have a way of still determining value. And that’s the point.

Kevin: All right, Dave, this is a very short question, and maybe you’ll allow me to answer it. It says, “Hello, thanks for taking these questions. I always wondered, what is the music in the intro? You don’t need to answer in the show, an email is fine.” But I’d love to just comment on that, Dave. Being a trumpet player, the philosophy is always to try to leave them wanting more. And that’s hard with a trumpet. Okay. And I played trumpet since I was a kid. And I played Auld Lang Syne out on the patio at midnight the other night. Just want to let you know, the music is there to wake you up. There’s a lot of people— we get comments often, and they’re like, “Please change the music, turn it down in the front side.” And it’s like, no, no we’re trumpet players, or I play trumpet. Now, wake up and let’s enjoy the show. All right. 

And on the next question, Dave. “Something I’ve been wondering about is how world currency gets revalued in a Weimar Germany hyperinflationary event. In other words, if the US dollar collapses and the government brings in CBDCs or whatever’s next, how does that get tied to gold or bitcoin or whatever? Can the government even set the terms, or does it have to be the market? And a modern corollary of the question is, what happens to crypto? If there are no more dollars to measure bitcoin, bitcoin and everything else goes into infinity dollars. So if the government later ties a 100 CBDC coins to an ounce of gold, for example, how do you think the market would end up valuing bitcoin, et cetera? Thank you.”

David: All right, Randall, Mr. Tax Lawyer, I don’t know if this will be an adequate answer for you. So offline, if we need to continue the conversation, I’d love to. But I think this goes back to earlier questions, official versus unofficial exchange rates, which we covered earlier. And then in the last question, measures of actual versus, let’s call it arbitrary value. The only measure of value that has been around and been reliable for 5,000 years is gold. Frankly, the price of bitcoin may in the end be like Apple stock. Sure, it’s an investment, it’s a speculation and there’s a conversation to be had about that as a decision, as an investment, but we’re not talking about a unit of account for trade. 

I would not want to measure my wealth in bitcoins or in Apple shares, although it might have been beneficial to own them. I’m not sure what happens to those kinds of “assets” the next time we have a solar flare or a grid meltdown or a nuclear accident leaving bitcoin or maybe even Apple as anything more than a historical footnote. Gold on the other hand serves as a foundational reserve asset for central banks, wealthy individuals, and has already encountered basically every historical permutation in 5,000 years. 

So to the point, yes, the government can set prices on anything. If the prices are not realistic and they’re controlled in an unnatural way, ultimately the market finds a workaround, and you end up with a two-tier pricing system. That’s what we were talking about with the Argentinian currency. Two prices exist. One’s the official government price. The other is what everyone else operates at. Just because somebody with a PhD says that, for instance, spam should be priced at $2 per 10, that doesn’t mean that it can realistically be produced and distributed for $2 per 10. If the real price is $3.60, then what you’ll find is that every official outlet whose mandatory price is two bucks, then they’ll have no supplies. There’ll be no supplies available because the price has been set arbitrarily too low. The street price will elevate to, again, true cost, $3.60 or higher, again, where plenty of supply exists at a realistic price. 

And where you see something contrary to that in the market is if governments want to subsidize prices. That often happens. We see that where governments subsidize fuel costs all over the world, it does not change the global price of the asset in question. It just means that they are taxing another part of society to make up for what is an unrealistically low price. In Venezuela, you don’t pay $2, $3, $4 a gallon for gas. There’s other prices to pay. There’s other ways in which that gets extracted from your hide. But again, you can have prices set and the market does create workarounds.

Kevin: Okay. But his question also was, does bitcoin go to infinity in dollars if the dollar fails?

David: Well, regarding bitcoin, if no dollars exist, prices don’t go to infinity. The asset in question will be priced in whatever currency is available, whatever your reference point is. Dollars go the way of the dodo bird. We’re not pricing bitcoin at infinite dollars. We’re pricing it at zero dollars, and it has to be repriced in some other reference point. They adjust to whatever unit of account is used, and they’re reflective of the strength or weakness of that measure. That’s the real key point is that it’ll reflect the strength or weakness of that particular measure. 

If it was dollars still in use, and as the question suggests we entered into a Weimar type hyperinflation, you’re talking about a greater number of currency units being necessary for one bitcoin. That’s not positive commentary on bitcoin as much as it is negative commentary on the unit of account. Think about it in terms of like a fifth of vodka. We’ve had this conversation in the commentary because we had a friend who survived the German hyperinflation, their family did with a basement full of vodka and whiskey. So just because a fifth of vodka cost a half a billion marks in 1924, it didn’t mean that you were well-off because you had a basement full of it. It just meant that as the currency collapsed and your 400-mark bottle was repriced to a half a billion marks, at least you maintained an asset that was tradable, literally liquid, and it was repriced. So your currency unit lost value. It was being marked down. It’s a story about your currency unit being marked down, not your vodka being marked up, if that makes sense. 

There’s still a question in my mind about how cryptocurrencies respond under duress. They seem to still be trading in risk-on and risk-off dynamics. Maybe bitcoin is a popular solution in the next inflation or hyperinflation. To my mind, it hasn’t been adequately tested. Who knows how the market will value it? Maybe the perfect hyperinflationary cocktail is one part crypto, one part vodka, two parts gold, if you’re really on the rocks. In the military, they like to say no plan survives contact with the enemy. And I think if you’re talking about reserves, investments, dollars, gold, vodka, in my planning, I want a variety of resources, a lot of options. And I prefer evidence of integrity and strength from past episodes of stress.

Kevin: Now I got to admit, Dave, if your hyperinflationary cocktail is one part crypto, one part vodka, two parts gold, it’s going to take a lot of discipline if things are bad to not lose that one part vodka down in the basement while I’m waiting for the two parts gold and the one part crypto to work. So maybe there’s another reason to have a basement full of vodka. We’ll probably get responses. 

But okay, here’s the next question. “Do you know a good book on the topic of investing in gold that you would recommend for investors? I’ve previously read The Golden Constant, which I thought was very good. Thank you so much for your great podcasts. I’ve learned a lot from you and I’m grateful. May God bless you, John.”

David: I like The True Gold Standard by Lewis Lehrman, not as a guide to investing, but for context as to why and how a gold standard exists. And the subtext to me is that if you don’t have an official standard, putting yourself on a personalized gold standard has similar merits. So the Gold Standard by Lewis Lehrman. Another would be James Rickards’ The New Case for Gold. That was an interesting read. I come back to The Golden Constant by Roy Jastram, which is a deep dive into the role of gold in society. And for those of you who haven’t—John, I’m glad you already have—but for those of you who have not read Jastram’s book, it shows you where both in inflation and deflation gold serves a very valuable role. 

We’ve been helping investors with gold for 50 years, and that’s a conversation I’d love to have with you directly because there are some things that you’re not going to find in the beginning of a book laid out in outline form. What are your objectives? Are you looking for a portfolio that is dynamic or static? Are you using retirement assets? Are these non-retirement assets? Are you talking about domestic holdings or overseas holdings? Is this product that’s physically delivered or is it stored someplace else? 

So many of these things tie to individual investor preference. The few books I’ve read on gold investing tend to run a pretty hard agenda and the author is driving towards a sales goal, if you will. They don’t really entertain the unique problems that an individual investor is trying to solve. So I prefer the broader context books. And then just know that customizable advice is available, and that I’m happy to engage with or anybody on our team is willing to. 

Kevin, we got a question from Charles, who’s a mechanical engineer from Spain, and he comments that he’s a long time listener of the Weekly Commentary and a reader of Doug Noland’s Credit Bubble Bulletin. Charles says that he’s writing a book explaining economics and the flow of liquidity within the system, applying fluid mechanics and looking at hematology, hemodynamics as a human body analogy. 

There’s not so much a question here as just an observation on my part. Kevin, you and I had a lengthy conversation about what Charles is interested in, and came up with a list of books that seemed to compliment where he’s going with his own book as he continues to research ideas. And the ones that you suggested were Noise, Flow, Complexity, three books that are titled with a single word, complexity. The author of that is Melanie Mitchell. And then the last is a piece that takes you the deep into the pool, Stephen Wolfram’s A New Kind of Science. So Noise, Flow, Complexity, and A New Kind of Science. 

I would add one more to that, specific to asset markets, and it’s The Liquidity Theory of Asset Prices by Gordon Pepper. The Liquidity Theory of Asset Prices. I had Gordon as a lecturer, and there are some insights there that I think would match where you want to go with fluid mechanics and hemodynamics. So look forward to having a lengthy conversation one-on-one, let’s try to set that on the calendar for 2022. And I’d love to see how you’re progressing with your book. Thanks Charles.

Kevin: This next question makes me feel of the tropics, Dave, when we went over and did that half Ironman in Hawaii. “Aloha Kevin and David. I am grateful for all the Commentaries you’ve done. They have helped me navigate the economic times we are in since 2011. I remember the process you kept stating: the financial leading to the economic, leading to the political, leading to the geopolitical. From what I’ve been hearing from a small number of individuals, not the mainstream media, is that we are moving close to the end of the sequence. What are your thoughts to these three things? One, the fact that it looks like we are on the path toward destruction of the middle class. Two, we are getting close if we’re not already there to a geopolitical event. According to the Fourth Turning by Howe and Strauss, the cycle usually ends in war. And three, if the prior two events happen, could there be a great reset and a new monetary system using cryptocurrency. P.S., just an observation. I wonder if what we’re going through at this moment in time is similar to the events, feelings, and sentiments of the people during the end of the Roaring Twenties. If history rhymes, I would hope that people take heed and be prepared. Mahalo.” From Hawaii. Again, there we go.

David: Well, John, as for the 1920s, yes, I think there’s a lot of similarities. And there’s a fascinating read by Frederick Allen who was a Harvard grad in the nineteen-teens, maybe 1912, ’13, something like that. And then he worked for Harper’s and the Atlantic Monthly, the title of his book is Only Yesterday: An Informal History of the Nineteen Twenties. 

There is a lot of rhyming, and there are so many lessons from the Coolidge era for today. So I think that’s a book worth reading if you’re not interested in economics, but only interested in culture. And again, some of the feelings and events and sentiments, boy, what a great book. It really— as a guy who is writing as he did for so many of those magazines, writing in a very approachable way. 

So, as for the crushing of the middle class, I mentioned the 83% decline in wages from 1971 to the present as measured by gold. I think that sums it up. But now we also have current inflationary trends on the rise. We’ve got taxes in all probability on the rise, we’ve got financial repression, which is, again, just artificially low rates, pressuring retirees and those on a fixed income, further squeezing those who are in the middle class. So it’s difficult to argue that the middle class is doing better unless we are making hedonic adjustments of course. 

To John’s last point, there’s certainly the possibility of politicians redirecting animus, and in playing the blame game for some sort of domestic trouble, and that leading to conflict. It’s not inevitable, but, as mentioned by John, it’s pretty typical at the end of a cycle. And so desperate politicians not willing to take adult-like ownership of circumstances, which they may have had some play in, point the finger and pull the trigger. 

So I think an official move to cryptocurrencies, while that’s a possibility on the other side of some sort of economic reset, actually a very high possibility, central bank digital currencies particularly. That’s not an advancement in human freedom, and it’s not an advancement in autonomy. Quite the opposite. There’s a lot more to discuss there. But thank you, John, for your thoughts.

Kevin: Dave, this last question, I won’t read the whole thing because I think the basis of the question is, how long is this whole reset thing going to take? So I’ll just go ahead and read the first part of the question. “It is interesting to me, Dave, all through the years, timing seems to be very, very important in the minds of people, but actually, trend often is ignored. And it seems, of the two Ts, the one thing you can predict is the trend. The timing, that’s pretty hard, isn’t it?”

David: It is. And this is our 50th year in business. We’ve gotten to see some cycles in various asset classes, and I’ve gotten to read my dad through the years. I think one of the remarkable things about him is that he connects disparate dots that other people in particular areas of expertise would say, I don’t even know, what are you talking about? This doesn’t make sense. How are they related, connected? And lo and behold, three years later, it’s almost like a prophetic voice being echoed into the present moment. His ability to connect dots ahead of time is amazing. Now here’s one thing that’s worth noting, it doesn’t make him a good trader.

Kevin: He’s right, but he’s usually early, isn’t he?

David: He’s right, but he’s early. He’s early. And I think so many times people ask questions about timing, it’s because they want to be right and there’s something pressing the issue on timing, where they may have placed a bet in motion, and it’s particularly important for them to be right on a certain timeframe. Maybe they retired too early and they’re running out of funds, maybe they need a big score on a particular asset class, and that’s going to set them up for what they consider to be part of the good life from this point forward.

Kevin: All right. So I’ll read the first part of the question. “Will the reset be a quick transition or a long five to 10 years ordeal? Will the powers that be allow money printing, higher inflation, pain and misery to the masses in order to drive them to acceptance of a new debased currency or eventually a digital dollar?” So timing is part of this as a transition that seems to be trend-oriented, Dave. “So thank you for your podcasts. Merry Christmas and Happy New Year.”

David: Last night, I sat with my son. He wanted to watch a movie, and so we did. We watched V Is for Vendetta. And you’ve got this larger-than-life character who is taking advantage of every opportunity, every crisis, social crisis, health crisis, what have you, to drive forward change at a structural level. And so, a fascinating movie if you’ve never seen it. 

But this notion of a reset and a quick transition, I think we’ve reflected on this in years past. Kevin, there are decades where nothing happens and there are weeks where decades happen. And that idea where, again, going back to my dad, it may be a long time between connecting the dots and then all of a sudden reality hitting the newsreel. And he does a good job of connecting the dots. And the newsreel may not offer any confirming affirmation, if you will, for years to come. But there are decades where nothing happens and there are weeks where decades happen. 

Between the general enthusiasm people have for cryptocurrencies—today it’s as a speculative moneymaker—and what we already have as a payment system, which is almost entirely digital, and where we are moving away from physical currency very quickly, I think the adoption process will be an easy one. It already is in motion. So the notion that it takes five years or 10 years, it could take five days, it could take five seconds. We’re not far away from an entirely digital system. And with that, the ability to manage inflation in a different way, to hand out the cost of financial repression to select groups on a digital basis, we’re really at a fascinating crossroads. And I wouldn’t be too concerned about timing. If you see something in advance, be willing to position for it and be patient because I don’t know that anyone gets to be right in both timing and trend.

Kevin: Well, and I know I speak for both of us, we would like to thank you the listener to the McAlvany Weekly Commentary for sending these questions and for thoughtfully engaging and listening to the Commentary through the years. 

You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.

This has been the McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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