The Bubble: Embrace or Run Away?

McAlvany Weekly Commentary

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S&P 500: More Declines Than Advances Every Day In December China Adds 160,000 oz of Gold Send Questions To [email protected] "We're at this moment where, again, credibility gets thrown out the window for the Fed. And I think that is the final stage of a bull market in metals, where your central bank credibility is lost and investors go scrambling in an effort to survive a loss of purchasing power. And I think in this case, you're also talking about ramifications that are well outside of any central bank's control, and that is geopolitical issues." —David McAlvany Kevin: Welcome to the McAlvany Weekly Commentary. I'm Kevin Orrick, along with David McAlvany. Dave, before we start, let's just remind our listeners this is the last day to submit questions for our upcoming question and answer programs over the next two weeks. So those questions can be sent to: David: [email protected]. Kevin: Yeah, [email protected]. Well, I'll tell you what? This has been a great week. I feel like I lived a month through this week just because of your birthday. What an amazing celebration at your house, various nights. But I was very honored to be invited to meet some of the people that you knew back in college, Dave, relationships that you've kept going all these years. David: Well, actually we had friends that came into town and some of those relationships go back 50 years. So we covered every decade from when I was a wee small lad to still a truncated and underdeveloped wee small lad. I was a late bloomer, so it was about college before I actually added a little bit of height. So then the timeframe of developing college friends and then professional friends, and it was a phenomenal week. Kevin: Dave, it wouldn't surprise our listeners to know that the people who did fly in for your birthday, who you had affected earlier in life, [The Intentional] Legacy is the name of the book that you wrote about—just what we're all about. And I listened to your friends. Some of them I had heard about, but I had never met. And I listened to them each saying, "Hey, this is how you affected my life." And it was very poignant because I realized there's just been a lot to you all the way back. And at the end of the evening with these friends who had known you, well, one of them had known you since you were a child. He's a professional musician. And he pulled a guitar off the wall, very impromptu. He took the first two minutes to tune a very out-of-tune guitar—so it was very impromptu. But what he did was amazing to me. He sang the various stories that people had told throughout the night at the dinner table. He wrote a song and sang it. I could tell it truly was a gift, but talk about a poignant moment. That was completely unexpected, and I really had no idea somebody could do that. I mean, I don't think he forgot a single story. David: Yeah, it was very special. Family and friendship have played a central part in the last five decades, and I can't imagine the future much different than that. So spending time with friends from across the country, very special week. Kevin: Okay, so we're going to get into business here. This is the week of the Fed decision. And inflation hasn't gone away, Dave, and things feel awfully loose for loosening of the interest rate. What do you think? David: We are in a new world. People know who Jerome Powell is. There was a day when the Fed chief was anonymous. Nobody took the time. Nobody really cared. But this week is particularly important. The next Fed decision is here. The bond market's pricing in 97% probability of a 25 basis point cut, a quarter of a point. But the interesting trend remains that in spite of rate cuts dating back to September when this cycle started, interest rates like the 10-Year Treasury have been on the rise. So 3.63 on the 10-year was the yield then, in September, and reached a peak this week of 4.44. So 79, 81 basis points roughly, an increase in the face of a 75 basis point cumulative Fed decreed cut. So at some point you get the impression that the bond market isn't seeing what the Federal Reserve is seeing. Their data is a little bit different. My suspicions rest on the focus being debt, deficits as two main concerns, with resurgent inflation being the third threat and something that market practitioners are keenly aware of, I think particularly in the bond market, because inflation, man, it's no fun if you're a fixed income investor. So there's a keen awareness of that. The fact that this divergence has occurred and not gotten a lot of press I think is also an interesting tell. Kevin: They call these guys the bond vigilantes because the actual free market usually knows better than necessarily the people who are artificially cutting rates. David: Well, and we go back to our conversation last week, and the Adam Smith discussion of the seen hand versus the unseen hand. The seen hand says 75 basis points lower, we're going to do another 25 this week, most likely. And the unseen hand says, "Well, we were 3.63, now we're 4.44." There is not a single rate cut cycle since the '90s where this behavior to this degree has occurred. Kevin: You've brought this up, especially with guests that you've interviewed. You've read books on the history of interest rates, and that doesn't sound very exciting. But when we actually understand that the history of interest rates is actually the history of the price of time, that's a little different. David: Yeah. And interest rates are that, they're the price of time. And the US, our prices are still on the rise, and at some point the increasing cost of capital is going to have a material impact on stocks. There is a threshold out there, it's unknown until we've passed it, that will send equities down 20%, 40%, maybe even 60% from current levels. This trend of higher interest rates despite lower policy targets was seen across the eurozone last week as well. The ECB, European Central Bank, cut rates, and interest rates jumped higher. It was an undeviating trend across the European countries—Italy, Portugal, Greece, Spain, France, Germany. So again, the ECB cuts 25 basis points and rates increase from 10 to 20 basis points. Not exactly, I think, what they were hoping for. That was the fourth cut by the ECB this year. They've cut rates as many times as the French have replaced prime ministers. They're onto their fourth in 2024. Kevin: Well, and I think it's important to note that the central banks actually look like they have control of interest rates, but the truth of the matter is, they have to react to the reality of what the interest rate markets say. They can artificially do it for a short period of time where they say, "No, we're going to go down and everything else goes up." But even here, Canada, how much did Canada lower their rates? David: They weren't alone. The ECB was joined by the Bank of Canada—an even bigger week there, 50 basis points in cuts. And as a proportion of what they have yet to cut, Swiss National Bank also cut 50 basis points, from 1% to 50 basis points, half a percent. And the head of the SNB, the Swiss National Bank, declared sort of a previous success story with zero interest rates. He likes zero interest rates. He thinks a negative interest rate, that era. He stated firmly that he sees this as a way to discourage further Swiss Franc appreciation. That was the direction for the Swiss going forward. That's what he thinks is the way forward. And this is a flashback, money for nothing, without the awareness of what that low to negative interest rate environment creates in terms of asset bubbles and malinvestment all over the place. So the exception to the rule was the Bank of Brazil. They lifted interest rates one full percent to 12 and a quarter. Inflation's raging and in need of tighter financial conditions. Kevin: So when we talk about tight financial conditions, that's usually where money's not flowing, and loose conditions are when things are flowing fine. Right now it feels like we're extraordinarily loose. Is there a way that we can actually quantify that? David: Absolutely. And this is where, again, our framework is so different than the Federal Reserve's. They claim to be data dependent and they claim to be resolving a significant problem in the financial markets, which they view as tight financial conditions which need to be eased. Thus, they've been lowering rates. The Z.1 report was out last week, providing an insight into just how tight or loose the financial conditions are here in the US, at least through the end of the third quarter. And the highlights are worth a repeat as we enter the twilight zone of finance. The financial sector expanded four and a quarter trillion dollars during the third quarter to a record 144 trillion—a significant increase in a single quarter. Debt securities increased 1.235 trillion for the quarter, and for the last 12 months now debt securities have increased 3.34 trillion. That's a record. In total it's at 61.46 trillion. The previous peak expansion was going back to 2007. So again, just keep some of these numbers in mind as a relative comparison. If the last quarter was 4.25, the previous expansion for the full year in 2007 was growth in debt securities reaching 2.56 trillion. So 2.56 in a year versus four and a quarter in one single quarter. Kevin: Wow. David: So 30% beyond the previous record. So our question, why would you lower rates in this environment? Corporate credit issuance, corporate bond issuance, was 466 billion for the quarter. Not exactly [tight] financial conditions. You look at corporate credit spreads and you see that this is an incredibly accommodating environment if you're a corporate borrower. Equities inflated 5.8 trillion in Q3. Another part of the Z.1 report. One year growth of $21 trillion, just over 21.1 trillion. And for comparison, the pre-2008 expansion,

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