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[Music] the McIlvain ii weekly commentary covering monetary economic and geopolitical news events start reading the credit bubble bulletin every week Doug made money our tactical short made money in the first quarter if you need a hedge for an existing or a legacy equity portfolio you should be talking to him right now not in the context of chaos but this is a bear market rally if you're not taking advantage of that lightning equity positions raising cash adding to gold and silver if you don't understand gold in a portfolio you don't understand history you don't understand economics now here are Kevin auric and David McIlvain II welcome to the michael vanie weekly commentary I'm Jevon Oracle Ong with David McIlvain II every week the night before we record Dave you and I sit down and have a talisker I think you had a soda water last night but I had a Talisker and you had a cigar and you asked me you said so what are the people you're talking to saying and I had been on calls all day long and you know I had to think just for a second I thought you know I'm talking to a lot of people I've never talked to this last couple of weeks because a lot of people are coming into the vaulted program and they're finding us out on the internet they've never heard the commentary necessarily so I'm getting a chance to talk to the fresh voices that I've not talked to before and here's what I'm finding I'm finding there's a consistency people who've never purchased gold before who maybe find something on the internet and they say well okay I want a little bit of gold but I definitely want to buy even if I have very little money I was talking to a number of people who you know less than a thousand dollars but they wanted silver somehow they intuitively understood that something's changing in the money I just thought it was interesting because I normally talked to commentary listeners I talked to clients that I've had maybe for decades in this case I'm talking to in a lot of cases the uninitiated that are now starting to look at metals when you think of trillions it doesn't really compute and that's whether you're an economist or the average guy or gal in the street right it's just a really big number at a certain point it's just a really big number and so I think that intuitive understanding that something's not going to end well for the global currency system it comes from this idea that wait a minute everybody's just playing around with trillions and this can't work out right so we're not talking about high math we're not talking about an uber sophisticated approach it just in frankly you don't need it you know you know as we've gone through the March period in April period is what we anticipate significant generations in the financial markets ahead of us you know one of the things that I've done is reviewed a book I read years ago it's a very very valuable book probably the most valuable book in terms of looking at the Great Depression I generally don't recommend it because it's like five six hundred pages long and it's too detailed to matter to most people but the crash and it's aftermath by Barry Wigmore is fascinating he finished at Goldman and decided this was how he was going to spend his retirement was documenting what happened and so it's a very in-depth look at it and anyone who is operating on the basis of instinct prior to the crash was served well by that instinct and there was lessons to be learned after the crash as well Barry didn't live through it so this is sort of a post-mortem decades later but a guy who did live through it and another book I do strongly recommend if you can find an out of print copy is the battle for investment survival was written in 1935 this is one of my favorite books this is a book that I read 30 years ago that was Loeb right yeah Gerald Loeb yeah and the battle for investment survival I think you know what you said reminds me of what he says about gold and silver he says in the history of the world we find the record of savings really saved through buying gold hoarding precious stones and other forms of hard wealth privately secretive in the future history of America most of us will in my opinion learn this lesson too late currently this is a personal matter for each individual to decide and execute for himself without consultation that's the end of the quote but it's fascinating because here is two years into a depression 1930 what four five is that when he wrote that so here he is writing a book and he's in the midst of the Great Depression actually a few years since gold was made illegal right so I think that's why he brings in the precious stones there's a there's an aspect of if you can't own gold what can you own and it was illegal starting in 1933 after the what they called the trading with the enemy act an interesting way of framing that isn't it where there's we're gonna control the domestic money supply inflate the crud out of it and we're gonna get away with it by calling it the trading with the enemy Act if you don't like it your objection will be duly noted and what he's basically saying is what we've been saying you know you better own something physical Andrey when you're going through a financial crisis and this is back in the 1930s a brilliant book it's worth looking at from a variety perspectives if you want to understand the value of diversification if you understand what someone who walked through the Great Depression experienced in terms of a market crunch it's a personal look it's it's also a professional look because he was actively trading the market all through the Depression and the roaring 20s leading into it so I think it's worth looking at that and saying yeah the man on the street today is if they're interested in silver they're interested in gold if they just want to buy what they can buy whether it's you know ten dollars through vaulted or you know in the form of gold or you know $150 with the silver here and there they're responding in a way that for someone who's really sophisticated they might say well why are you doing that why are you bothering instinct okay a lot of times the more professional an investor becomes the less they have instinct you know the more informed they are they can actually start looking at charts more than listening to their gut well and the more they assume the future will be exactly like the past they're they start making certain assumptions about continuity of themes and maybe even the constancy of progress okay so let's say that we're looking forward you know we had a GDP of what twenty one trillion dollars that's and so we're seeing debt skyrocket and our debt is skyrocketing relative to what our GDP used to be but there's going to be a dramatic slowdown I would imagine in GDP so the debt to GDP ratio which we're looking at right now is only probably going to get worse as we start measuring the slowdown right yeah it's a fascinating me because when you think about sort of this idea of Perpetual progress we're assuming that we'll just go back to normal and normal is twenty one trillion dollars in economic activity well that also was the peak of all-time in US history right so yet what is we define normal by our high-water mark and that's what we're trying to get back to so we have all of our debt to GDP figures they're based on that GDP of 21 trillion and what is that in relation to the debt okay so our GDP 21 trillion what's the percentage of the debt relative to that yeah we're moving from a hundred and seven percent debt to GDP and obviously that number as a percentage is going to grow and it's growing right now because we have massive deficit spending the debt expansion that's occurring at present so we're on track for at least three point six trillion dollars for this year in terms of deficit spending you remember when we were appalled about eight weeks ago on the show we said it's gonna be one point two trillion boys and girls the deficits gonna be one point two trillion dollars I guess it's changed who allit keeps on increasing because the need keeps on increasing so it's not a surprise to see the debt to GDP figures on the increase and you know just for reference when we talked with Carmen Reinhart you know other reasons I wanted to visit with her years ago in the commentary was because she co-authored a book with Ken Rogoff called this time it's different was a study of debt and the dynamics relating to financial crisis when you got to a point where debt levels were unsustainable and and so they did all the statistical research and basically said you begin to encounter financial crisis when your debt to GDP figures exceed 90% right we're at 107 it's going higher very quickly on the basis of debt increasing right so let's play a mental experiment though data let's pretend let's say the government comes in with huge spending projects or what have you and we actually don't have a slowdown let's say we can hit that 21 trillion is that a possibility sure but I guess what we're assuming is that we can get back to a 21 trillion dollar economy and the question of whether we can or can't I mean that remains to be seen we're in limbo in that regard so the answer would be maybe but not right away so if you look at debt to GDP as an equation it's a little bit like price earnings and that multiple again this is one number divided by another number and the price earnings multiple just like debt to GDP can blow out in the case of the price earnings multiple if your earnings drop more than your price again the numbers can blow very quickly and this is what we are gonna see here in the US economy our debt to GDP figures should be soaring and as soon as we get official numbers all documented I think this is where people are going to be surprised because the economy is slower than our assumption our assumption is we went from a hundred and seven and it's moving higher on the basis of an increase in debt but you're also changing the denominator and this is a really critical point you're changing the denominator and it'll cause a spike in your debt to GDP figures so what we're looking at though is let's say we have potential so what can be produced versus what is being produced or what will be produced how do they measure that that's that's what economists call an output gap so if the difference between twenty one trillion the old number and the new number let's say it's eighteen or something else the difference is a gap right and the standard Keynesian theory is you fill that gap with fiscal spending even build bridges in this case it could be spending on the order of three trillion dollars to make up the difference and the object to do that is to keep people employed and avoid sort of a negative feedback loop transitioning from a recession to something more severe like a depression there's where we got hoover dam that's where we got Mount Rushmore right I mean in the 1930s that's how they respond a big spending program so yeah we have seen the filling of a gap but to be frank we still don't know how long the current state of affairs will last and so we're talking about a gap of unknown proportion does that make sense yeah it sounds like Princess Bride yeah rodents of unusual size it was like gap of unknown proportion right right to just come up with an acronym for the that's a goop a gap of unknown proportion I so unemployment hit fifteen point three million before rolling the clock back to 2008-2009 the global financial crisis unemployment hit about 15-round down to fifteen million we have thirty million already filed at this point so our unemployment let me repeat that okay so unemployment which was a real problem back in 2008-2009 we have double the unemployment at this point it was fifteen million and now it's thirty and we know it's more than that product and how long this goes on will be the difference between recession and depression so depression if we allow this to go on we'll have sort of a consequence that is sort of reshaping the social fabric of the country and so really we mentioned this how long ago maybe January when we first talked about kovat 19 duration is the key duration is the key if this is over and done very quickly it's no big deal but if you leave 30 million people unemployed for very long you're talking about the loss of businesses diminishment of tax revenue it recycles negatively into a number of spheres because now you're talking about municipalities which are compromised I was reading an interesting point on Detroit who five years ago were you know in the midst of the biggest municipal bankruptcy in US history and today seventeen percent of their revenue comes from gaming well how how many people are going to the casinos in Detroit to fill the Detroit coffers at which is to say the longer this lasts the closer you get to recycling a bankruptcy event for Detroit all over again and how many other cities and states municipalities face the same music well I saw you just came up with the solution all we need is lottery tickets and casino more casinos you know we live on reservation area down here there's a lot of casinos maybe we should do what Detroit did and just increase the games again we go back to the gap of unknown proportion we should not be surprised by further funds being needed the question will be how much of our previous economic capacity will return are we gonna get back to 21 trillion is that what's going to be in place six months from now a year from now three years from now if the new normal for the US economy is reduced let's say by ten to fifteen percent for instance then then GDP is going to be in that 18 to 19 trillion dollar range and again we're talking about a growing debt level on top of a shrinking GDP figure which makes again measured off a smaller base or it makes the percentage debt to GDP a little bit scary so when you change the denominator there's a significant impact on the math which if you are Fitch if you are Moody's if you're S&P the rating agencies which look at corporate debt and sovereign debt they didn't do a very good job of looking at mortgage backs Quixote's debt back in the day but hopefully they've learned their lesson you know this is where it begins to matter you look at the math and you say oh this is gonna be a bit of an issue Fitch this last week assigned Italy a negative triple B rating and this is sort of like hanging on by your fingernails it's like oh you think I mean they should have done this years ago now they're finally saying well in the and it wasn't a complete downgrade to junk but I mean it's like a half downgrade and just barely keeps them hanging on so you know an S&P was like well as we mentioned last week S&P said no problem here as long as the ECB's got the Italians back side we are back rather if any won't worry about it but what impact is Cova having on the country and the globe in terms of consumption only spending habits okay so I want to bring that up because I was thinking about this the other day in the 1930s we were a producing nation we produced things we made things right now I mean what percentage of that our economy is me just going down to Starbucks or going to a movie consumption isn't that the major driver of our economy at this point yeah so as we've transitioned to more of a service oriented economy and we're not the world's greatest producer you see the economy driven by consumers you and me you go back to 9/11 and what did George Bush say I think in his first interview after 9/11 we need to get out there and do our patriotic duty we need to spend something yeah right because he's basically saying look the reality is if we all freeze up and are afraid of terrorism we're not gonna spend and we're gonna collapse the economy do your patriotic duty and get out there and spend well that's because the US economy is based 70% on consumption so again if there's a reduction in consumer spending even if it's at the margins 10 15 percent reduction in consumer spending you're talking about 70 percent of the total economy being reduced by all of a sudden really is a big number and it's not unreasonable to think that the new normal is more like 18 trillion instead of 21 trillion reduce economic tivity today if you do that and you reduce economic activity you're talking about something that has major implications for the corporate sector why because if you're not spending they're not making money and so as long as we remain in this limbo state you know we have a reduction in economic activity that flows through to corporate earnings they're gonna remain under pressure and this goes back to that equation the numerator denominator the e earnings is also a denominator yeah reduce e earnings and your PE looks even more overvalued so you can see your p/e ratio again we've got stock market in recovery that's so you've got a bounce here since the March lows and so prices are increasing earnings are actually decreasing we should see a blowout not only in terms of the p/e ratio but also in terms of the debt to GDP ratio because the denominator shifting and as we talk about that I mean when the stock market was close to 30 thousand points I think the Shiller tenure adjusted p/e got up to about 34 if I'm right on that and now the p/e can change not even if the stock market rises what you're saying is if earnings fall which it seems to me like earnings have to fall okay if earnings are falling you could have a higher p/e with a lower stock market number that's right that's right so everyone sees you know the all-time high in the Dow of 29 and changed and says well gosh we're buying 24 are we buying a value right not on that metric you're not so take a look at last Friday and the action that we saw in the stock market Friday was the most recent 90 percent down day for the S&P 500 is that that's 90 percent of the stocks were down versus 10 percent up that's right actually I think was more like 94 it was it was a high in the 90s so very small percentage of companies actually traded higher over 90 percent of the stocks listed on the index traded lower for the day and it was close to drawing other indices into the same dynamic so if you're talking about these small caps and mid caps 80 percent down for the small and mid caps not quite to the 90 percent level but I would watch for that as a confirmation of the bear market rally being complete and that's the position that we would take is this is not a new bull market and in the first uptrend or a v-shaped recovery in an uptrend that that was a what we've seen in recent weeks was a bear market rally so that would be one of the confirmations but you've been talking about declining volumes okay and a lot of times in a bear market you can have rising stock prices for a period of time but the volume is decreasing and that's something that most people don't see because they're just looking at the points on the stock market yeah the whole rise since March has been on declining volume so less and less people buying and that's really not a defining characteristic of a bull market that is more characteristic of a bear market rally than the beginning of a new bull market so you combine that with a 90 percent down days again where you're counting the stocks that advance in price versus those that decline and you begin to see maybe this is not the time to be putting a lot of hope or money into the market okay so for the generation that's just used to the stock market just really rising since 2008 let's call them the v-shaped recovery group people who are saying well you know I'm in a bet on America okay I'm gonna bet on this coming back what do you think about a v-shaped recovery well I think one of the things that you would need is a confirmation is commodities moving along with the price of stocks because again if you think about what is happening not just in a service economy but more broadly in an everything economy where people are buying stuff it makes sense for you to see the price of the raw materials that go into that stuff moving higher along with the stock prices denominator of this product sovereign lumber oil the things that it takes to build things yeah raw materials are needed for the production of goods being created and sold so commodity is you know and we noted this last week they're not matching the pace of the equities markets recently you had a couple of your commodities indexes obviously oil as a significant component and the index as a whole even with oil rebounding off of those lows is still sort of in the 70s malaise early 70s type pricing in the commodities market and I think that divergence between commodities and your major stock indexes is very meaningful if you're trying to discern whether or not this is a new uptrend in stock or just a bear market rally I think that divergence tells you what you need to know one of the beauties of having this show go for you know a dozen years is we were able to talk through the 2008-2009 crisis you know 2011 what we found out I mean there was real worry about the banks in 2008 and 2009 I guess we also found out there was no reason to worry about the banks at all because the government would do absolutely anything to save the banking system in fact what we saw was the bonuses of the bankers who supposedly caused the problems those bonuses went up ya know and I did an interesting study of this this goes back to one of Lex riffles books on restructuring sovereign debt and he had a couple of charts that I've kind of fallen in love with which showed how when you had a banking crisis prior to 1913 that is the the creation of the Federal Reserve System prior to that there really was no connection between a banking crisis and a currency crisis but from 1913 forward in a period of time where you know you can create as much money as you want now of a sudden there's more of a trend towards banking crisis proceeding currency crisis and and part of this is because you can now abuse the currency to save the banks so save the bank destroy the currency right but but that never was the case prior to the creation of the Federal Reserve which in large part as you suggested is really about protecting the banking sector so I thought it was interesting Richard Duncan who's been a guest many times in the program who was discussing the practical purposes served you know by the consumer in business loans you know this is where govern our government in the last few weeks and months has basically extended a lot of money where they're telling us they're helping us out yeah we're helping small businesses and we're helping consumers and I guess the implicit argument is no actually you're just helping the banks and so he focuses on JP Morgan he could have picked any bank but he chooses JP Morgan because they're a big one the biggest of the big ones which by the way before you go on we filmed for almost three days at wall street and right across from Wall Street where the stocks are traded was the bank that JP Morgan's that in the original JPMorgan the man okay and saw to it that Wall Street took care of him I was talking about kids last night about somebody who had influenced my life again in Dallas Willard and I said you know he also influenced a guy named JP Morgan and I said wait wait wait no no JP Moreland and your trip it was it was a philosophy professor that I had in college anyways yeah so JP Morgan right wall and broad but the new bank that is JP Morgan in its current iteration they have about forty seven trillion dollars in derivatives on their book that's the notional value of derivatives they are the largest bank in North America among the largest in the world and they generally trade at the lowest risk premiums if you're looking at credit default swaps and so you know you could say that this is kind of a conservative estimate if you're looking at JP Morgan this is not it to pick on them at by any stretch its just illustrate a point and his point is that you can look at complete bank system insolvency very very quickly if the Fed does not intervene in the fixed income asset markets because of the leverage and that's exactly right so so Duncan's arguing that the Fed intervention in the fixed income asset markets as well as sort of directing benefits to the consumer and the small business community in order to keep loans to us out there in the general space the general public this is really about keeping banks solvent so because anytime someone's leveraged in an investment if it goes down or if it goes up they actually make money on that leverage if it goes down it actually has a compounding effect yeah so what Duncan did is he went through the quarterly results of JP Morgan and he concluded that at ten percent decline in the value of its consumer and wholesale lending portfolios again this is really key because you've got the Fed trying to keep the consumer and small businesses alive correct so so if you see a 10% decline of the value of the consumer or wholesale lending portfolios that is sufficient to wipe out one hundred percent of bank capital that's that's quite a margin call yeah so so when the capital is depleted you're talking about bankruptcy so JPMorgan the strongest Bank arguably in the country at least measured by their credit default swaps you would say not likely to happen they can't possibly go down well what you see in terms of the Fed behavior is actually a defense of that balance you if there is a a downgrade to the balance sheet and you've got a number of assets there right you've got loans to the consumer you've got loans they have actually very diversified loan portfolio but if you saw a 10% hit to their loan portfolio it's a very big deal the Fed can't allow that in active their own minds yeah if you're looking at other parts of their assets where you know it's the securities side this is where you've got stocks and corporate bonds and government-sponsored entities you know Ginnie Mae is Freddy this is the paper where it would take probably a 20% loss in that portfolio but that too could wipe out a hundred percent of bank capital and then again they can't let it happen that's right so you have support in the fixed income markets support indirectly into the equity markets support for small loans consumer loans and what-have-you and really we're talking about bank solvency because if there's much of a correction at all these guys are very leveraged this is what you're saying is this goes back to when you have a banking crisis which you'd have to look at this as a banking crisis the currency is going to be sacrificed the problem is that just means that you and I and the prices at the store is what pays for the bailing out of the bank yeah and remember the assets held at the bank can represent a far larger number than Bank Capital Bank capitals going to be smaller than the assets that they actually controlled because of leverage and so you know ten times balance sheet leverage is not an excessive figure industry-wide and many bankers post global financial crisis would see a ten times leverage balance sheet as a conservative number that you and I would say that means they've got a skinny dime on the table that's not a lot of skin in the game because obviously a small percentage fluctuation and asset prices can wipe out that die pretty darn quick and when they're looking at this okay capital adequacy is adequate as long as the normal is the normal that you know yeah if if we were still at a twenty one trillion dollar GDP and we were pre kovat nineteen it makes sense so that's exactly right so they run these quarterly capital adequacy ratios they have to maintain them and those numbers are based on an analysis of risk and probability in terms of loan losses under a variety of circumstances very good case scenarios very worst-case scenarios what would you bet that the capital adequacy ratios that were made at the end of the year coming into 2020 had adequate risk parameters do you think anyone had the conversation about the global economy being shut down four weeks or four months or four who knows some indefinite period of time let's do that ourselves okay we talked about the future and economic history all the time that's sort of what we do around here and take yourself back to Christmas time just imagine back to Christmas 2019 could you have imagined that the world this is the first time in my lifetime that the world has been affected by something to this degree in it I think everybody's life time so none of us could have you know we may be talking about kovat ninth team within within weeks of that no but we weren't talking about a global shutdown no the gist of our conversation at that time was look at QE 4 it's already been launched the repo markets are telling you something is not healthy within the banking system is already a liquidity crisis yeah and this is September October this has nothing to do with Cova this predates right so sorry Kove it again is it provides cover for the central bank community to do whatever they want and for politicians to spend whatever they want and that is our new reality but you know we've got six to eight weeks which we've logged now maybe if you're talking about Asia a little bit longer and we've basically exchanged suicide for death by plague then this is something I'm not really sure how it's going to be recorded by the historians and we're talking about economic suicide quinces or the benefits from quarantine they're gonna have to be weighed by social and economic commentators and you know looked at for decades to come it's too soon to tell what the ultimate costs are going to be in terms of human life in terms of economic destruction which ie about revenue losses which are earlier about municipalities and the pressure that they can come under shrinkage of the tax base reconfiguration of employment these are things that haven't yet been figured out right so we have no idea what else we're going to see initiated to fill the gaps coming back to that output gap well and when you talk about output gap I mean how do you fill the gap you either print money you raise taxes which you've got productivity going down raising taxes isn't the greatest thing to do so I guess you print money in some form right or you spend you print and you spend you know we're talking about filling the gaps you brought up Keynesian economics early on in the show Keynes would say well you got to go build a bridge got to go build a dam you need to go carve president faces onto a mountain you got to go do something you'd print the money to do it yeah I mean last time we moved into a period of uncertainty the Fed balance sheet expanded fivefold and that's what got us to about four and a half trillion dollars and so then if you look at the pre Korona levels we were back into the threes three 6:37 so off the pre coronal levels a five-fold increase this time would be you know again 20 21 trillion you we're talking about better than 16 trillion dollars in new resources sitting there on the Federal Reserve balance sheet well you've been playing 21 on a lot of things here today we talked about 21 trillion being or GDP our entire GDP now what you're talking about is if we had that increase in the Fed balance sheet you could literally have the entire GDP amount before pre kovat 19 GDP on the Fed balance sheet when it's hard to fathom in fact 21 trillion dollars on a Fed balance sheet sounds absurd but stability the financial sector is the priority of the Federal Reserve and they're not going to compromise on that before things got really nasty we had rose and grin again you wonder what is seen in advance and what is not you've got rose and grin from the Boston Fed on March 6th who is talking about amending the Federal Reserve Act for the fifth time which means to expand their role yeah so starting in 1913 that's when the Federal Reserve Act came into play if you know the history was written a few years before that they couldn't get it passed finally it was passed whenever one is on Christmas vacation correct correct so very few people meeting the roll call anyway the Federal Reserve Act has been amended in 1930 to 1945 1965 1968 and think about the context for each of those 30 to 45 65 68 they're all dates that resulted in major changes to our currency system thereafter right so almost always negative for the saver 3233 devaluation 45 again a year after the the Bretton Woods Agreement 65 to 68 this is a period of time where Jacques Ruth was talking about the eminent demise the dollar the breaking of the Bretton Woods system advocating with the French that they take gold instead of greenbacks this is the 65 was remember that changed the silver content and coins we are devaluing our actual coinage and these were signals and signs that the man on the street could see could pay attention to it didn't take a PhD to know that if you have a coin with silver that's 90% of its content and you start reducing it that means you're being screwed you're not being taken care of you're being taken advantage of so if you're thinking you're gonna trust the system okay let's look at the people who trusted during that period of time 1968 the dollars lost what 95 percent of its value since 1968 as of the pattern of gaining greater flexibility and gaining more tools for the Fed that may mean they can create greater stability for the financial system and specifically for the banks but that does not mean they're creating currency stability going forward so the guys in the black suits we're the Federal Reserve we're here to help his proposal is for a list of assets that the Fed can buy okay it's kind of like the Bank of Japan thus coming back to rosengren he's suggesting that they might be a buyer of last resort for all assets no limits so far there has been no amendments to the Federal Reserve Act what they've done instead to skirt the legal limitations is they've just set up a shell company to make purchases of junk debt because remember junk debt is not according to their mandate allowable they cannot buy it and yet they are buying it it's called a special purpose vehicle so they're not buying it another entity that their funding is buying it as mafia it sounds like a drug ring or the Mafia or something like that do no no we don't own the business that's doing this but in a way they do own the business this it sounds like if I ask my kids a question I'm like did you do this they're like they have some technicality that they figured out no I didn't do it what do you mean you didn't do it why I didn't touch it no you just poked him with a pencil you didn't touch him the pencil touched him yeah I mean really have little kids and so this kind of logic exists are sub teenage children are doing the same thing in terms of their behavior right it creating special-purpose vehicles to remove guilt and and and absolve themselves of any responsibility it's crazy but Rosen grinning while he's promoting it March 6th by the end of the month they're already doing it actually I take that back by the early part of April they're doing that with junk bonds ok so as we talk through these things yeah I was talking to a man in Denver the other day and we were talking about the progression of what we've seen coming over the last few years you know you talked to Carmen Reinhart on the show a few years ago we just replayed that show in the last year because it was so amazingly prophetic but what she was saying was they're ultimately going to have to close the system first you go to negative rates and then everybody wants to get out of the bank and then you basically go cashless or you close the system the gentlemen I was talking to in Denver went to a Whole Foods and they won't accept cash well why won't they accept cash well it's a kovat danger and he then went to take money out of an ATM through his Schwab account and they were discouraging it because the cash is now dangerous I don't know if people are sneezing into $100 bills or what the heck's going on I blew my nose on I was actually but what an amazing excuse for what Rogoff already wrote the book about last year which is the curse of cash okay so if you're listening this and you don't read Doug Nolan's comments on a routine basis you should it should be a part of your weekly routine call it a Saturday morning ritual grab a cup of coffee you probably need it he usually is packing a lot of information into it and you want to pay attention but read Nolan's comments from this last weekend he covers a bunch of quotes from former Minneapolis Fed cockerel Dakota and Koch lakotas talking about negative rates he's talking about a praise for moving towards a cashless society he's talking about the need for greater flexibility with the Fed tools in order to create this perpetual growth and never have a serious correction financial markets and he references rogoff's book of the curse of cash as a brilliant addition to the conversation and I couldn't help but think yeah this is really what he's talking about is gaining the flexibility gaining the power to do what Carmen Reinhart described on our commentary a while back that investors ultimately have to be corralled once cash is gone and the financial system is closed then you can begin to extract value from an existing asset base if you're gonna see a diminishment in GDP economic activity and you can't as you suggested increase taxes on a diminishing resource what you do is you go to the savings pool and you start surreptitiously extracting value to feed the system and make sure the banking system stays home you keep them from being able to escape I remember when I was a kid financial repression that's what it Friday nights my mom and dad would go out and we had a babysitter and we were allowed to stay up okay and so Twilight Zone would come on oh no no no it was Outer Limits and I'm sure we'll get comments here because I'm gonna get one of the shows wrong but Twilight Zone Outer Limits those were the black-and-white shows where they really sort of played with your mind a little bit and there was the was one where aliens had come to earth and everyone thought that they were there to help and people would continually get on the flying saucer to go away and they were they were very excited to go to this new planet but there was this book that they had not translated the title of until the very end of the show you know a typical twilight zone or Outer Limits finish and they finally the guy comes running with the line of people who were getting on this flying saucer to say know the name of the book is how to cook and eat humans wait so what you're basically saying is our version of outer limits today the central banking version of outer limits is we're not here to help we're here to harvest we're gonna close the system we're gonna have negative rates and it's gonna be good for you and you are a part of the harvest okay so go back to revisit the March lows you know the Dow is getting to 18,000 18 and change and as we get to those lows again because I think we are heading there over the next couple of months start reading the credit bubble bulletin every week Doug made money our tactical short made money in the first quarter there's no surprise there it's a short product if you need a hedge for an existing or a legacy equity portfolio you should be talking to him right now not in the context of chaos but this is a bear market rally if you're not taking advantage of that lightning equity positions raising cash adding to gold and silver if you're not getting defensive you don't get it this is like Ray Dalio I like to quote him we did last week if you don't understand gold in a portfolio you don't understand history you don't understand economics the same gentleman that I was talking to you know who tried to spend money at the Whole Foods we were talking about the Buffett call because Warren Buffett of course had a shareholder call nobody was in the group but we started talking about making sure that when you listen to Buffett talk you also make sure to watch what Buffett does because talk and does does not they don't always man yeah exactly I think we actually have two Buffett indicators right the first one we've talked about in the commentary pretty regularly it's stocks versus GDP that's the ratio between total stock market capitalization and the total scale of the economy you're comparing the financial assets and the prices there versus the engine that's generating profits Kay that's the ratio and that's the first expression okay the second expression is watching the activities as you say of Buffett Munger the Berkshire Hathaway crow and there's a very interesting nonverbal communication there the shareholder meeting took place this weekend in an empty auditorium usually there's 40,000 shareholders and attendance but obviously with Kovac concerns not the case this year show must go on so Buffett was there and he handled it very well but the numbers in their quarterly release and the tone in the call I think are worth commenting on okay so what was the buffett indicator it's got to be high well what it is today a hundred and thirty-four point nine percent the ratio is unambiguously overvalued when the ratio is above 115 it's considered significantly overvalued so the first buffett indicator says yep you think you're buying a value today good luck with that you are overvalued 134 point nine the threshold for not just overvalued but significantly overvalued is 115 we're well beyond the pale on that as for the call you get Munger is 96 years old he didn't travel in for the call but the highlights that stood out to me is as we mentioned maybe three four months ago 137 billion in cash which is a large cash position for Berkshire Hathaway largest ever no big acquisitions and this is based according to Buffett on current valuations being high so it's interesting he says if you're the general public you should step out and bet on America don't bet against America okay and so invest in equities invest in your market index and yet he's got a hundred and thirty seven billion dollars in cash and views acquisitions as being too pricey to step in okay that's interesting keep buying stocks cuz I own some he had also of interest is he had two mark-to-market losses of fifty billion dollars that's on a two hundred billion dollar portfolio which was a result of a change in disclosures where you now have to report your unrealized gains and losses for the quarter and so yeah fifty out of 250 you know it's back of the napkin math close to twenty five percent loss for Berkshire that the quality the company's this is a tough environment to be in those are unrealized losses right so next quarter he could put 50 billion back on the table no problem so let me get this right okay Buffett's got a large amount in cash okay what is 137 billion in cash but he still owns almost twice that in equities yeah 200 billion and you know essentially if you're looking at Berkshire Hathaway it's like a mutual fund that controls most of the businesses they're invested in whereas mutual funds own a small portion of a business very rarely if ever a controlling interest so even if he's heavy cash he's gonna do what the general market does yeah and these are not companies that he buys and sells they buys them and holds them forever but the market still prices Bircher a shares and B shares according to what they view the intrinsic value those companies the earnings power of those companies to be the underlying companies to be so the companies that he controls showed operating profits for the quarter of 5.8 billion dollars and that's not that down obviously from the prior quarter but what's interesting this was very interesting to me he is writing selling put options which is a bet that the market would go down he's selling the bet that the market would go down he has to pay that bet if the market goes down right well exactly so he's collecting a premium on the belief that the market will not go down you know think of it as he's selling flood insurance right because he thinks we're in a drought right so it's great you just collect the insurance premiums you're in a drought we've got global warming don't borrow against America whatever talking about a one in a hundred year flood and floods don't happen rains not happening right you know sell insurance and that's what he's been doing selling put options so he's selling put options he's collected a total of two and a half billion dollars in premiums oops but in the first quarter he lost close to 1.4 billion of that and derivative losses and this is again on his puts so you for the first quarter it's two and a half billion in premiums collected minus one point four which they gave back to mr. market it's just interesting because derivative exposure I wasn't aware that that was something that he was real keen on and do the math one point four versus five point in terms of operating profits he basically threw his derivative losses gave up twenty four percent of his operating profits from all of his set right and he wouldn't necessarily come out and tell you he was playing in the derivatives market this is where we're going don't necessarily listen to what buffett says watch what they do and it's a very interesting period of time to be selling flood insurance don't you think could those derivative losses you know this was q1 2020 could those derivative losses wipe out an entire quarter profit or a year's worth because remember puts are asymmetrical in nature you know if somebody is buying a put they may put in a dollar and expect to make a hundred but that's not perfect math but I'm just demonstrating a cemetry Berkshire is saying it's not gonna happen it's not not not gonna happen so you know he's willing to take the other side of that bet the problem is if he's wrong he may have collected premiums of $1 but all of a sudden he has a liability which has grown to a hundred it's negative asymmetry if you're the person who has to make good on those derivative obligations so you have a double wrong actually because if you do own two thirds of your portfolio in general equities then they're gonna go down when the stock market goes down if you've sold and you're taking responsibility to pay off those puts you're also losing in that area so this was not a great call no no I in fact I mean it's not like he he was buying the puts to hedge his equity position he's selling the puts and it makes him even more procyclical in terms of his performance it sounds a little greedy it sounds like just sort of adding frosting to a cake that's fairly dangerous yeah maybe poison King I think everyone at a certain point in a market cycle has a hard time resisting the casino aspects of the market and so also from the call no buybacks no acquisitions liquidation of six billion in publicly traded shares that doesn't sound like a bowl at bow you know as far as bullish on the market if there's no buybacks no acquisitions and most of the liquidations were Airlines he thinks it's going to be years before they recover so all in all you listening looking at a few of the numbers it was not an indication that Berkshire thinks the worst is behind us so again looking at what they do looking at what they say you know look six billion dollars in liquidations there's only 3% of the equity portfolio so it's not a mass liquidation but they are hoarding cash they are cautious with their buybacks they are cautious with any major acquisitions maybe I'm wrong here but I would say that the concern was palpable listening to the call let's go ahead and go back to the people that we were talking about initially who aren't necessarily Warren Buffett and they don't spend their day looking at economics and numbers just the guy in the street who says you know what something's really really wrong I want to buy my intuition says I want to buy some silver and some gold and I want it to be small and I want to be able to barter with it Knight you know I mean on and on and on but that's that intuition thing we talked about it's intuition something's going to change with the currency and this is domestically but it also applies to the global system it's it's not rocket science it's not a partisan judgment to surmise that trillions in government programs here and overseas it we're talking about fiscal and monetary initiatives ultimately has a dilute of effect on the currency there's a price to pay for preventing a depression maybe the financial markets can make it through you know this is where doug's concerned we voiced this last week it's about financial markets not always being liquid and continuous well trillions are being brought into the market in an effort to keep them to ensure that they are liquid and continuous what can be deceptive and I've had a couple of conversations this way where I'm talking to someone and they're saying well well Kevin the dollar actually is getting stronger not weaker well that's pretty deceptive because other countries are doing the same things that we're doing and their currencies are just falling at a quicker pace but you can only really measure a currency by what it buys not necessarily by what other currencies it buys yeah I think this is where if you don't know a little bit of monetary history you don't have to be a geek to appreciate the impact that policy shifts have had on you the consumer 1971 is a key year but weaker global currencies when as you say there's other currencies that are also weak that ends up shining a favor light on the dollar we're talking about relative not absolute strengthen it since 1971 that is the end of the Bretton Woods system we have a hundred percent fiat currency system as isn't all paper promises nothing real backing those paper promises it's just the phd managed system and the trust in the phd managed system and and the the expected trust from the hoi polloi in the system but again we come back to relative strength versus absolute strength this is like running from a bear if you want to think of absolute versus relative the absolute speed of a bear is 25 miles an hour that's about what they top out at right so if you are Usain Bolt you can run 28 miles an hour and you're just fine your absolute speed beats their absolute speed you're okay absolute speed versus a grizzly you stay alive if you're the fastest runner in the world run for a long long ways yeah I'm gonna guess the bear can run 25 miles an hour longer than bolt can run 28 look true that's a hundred meters or whatever but in relative terms you only have to run ten miles an hour hmm as long as your companion in the woods is running nine right right it's a relative speed like relative strength makes you circumstantially viable does that make sense but in the domain of currency is it doesn't prevent the destruction of value in terms of purchasing power right it's a peer group measurement that allows you to set the curve that's the relative strength right you look like a winner walking away from your mauled currency alternatively you what you could have been you remember our guest before he passed away over and over and over family friend in macavity I remember what he would say about that yeah he loved turning anything into an acronym right BL HGF was his it was acronym you go what scratched the head but BL HGF was best looking horse in the glue factory and that's the way he viewed the dollar he's like okay so you're thinking it's strong strong relative to what let's look at the other currencies then relative to gold okay because the other currencies are falling relative to the dollar but what are the other currencies doing right now that's relative to gold that's how you can gauge the currency death march in absolute terms you can look at real things and have an idea of what is happening with the yen what is happening with the rupee what is happening with the ruble what is happening with the British Pound what is happening with the euro and instead of comparing one against another what's your plumb line what is something that is constant through 5000 years has never been through a currency meat-grinder like every other paper currency has through time by the time we have new highs and US dollar terms you will have a complete picture here because gold is at oh it's already at all-time highs in euros it's already at all-time highs in yen it's already at all-time highs in British pounds and it's a few hundred dollars away from all-time highs and US dollar terms but the global audience for gold is seeing the same thing new highs in their currency terms does that make sense when you compare for instance the euro weakness relative to US dollar strength you're missing something critical and that is that they're both falling in buying power yeah so measured one against the other you're talking of both running less than 25 miles an hour and that isn't a range if you like that analogy that is a range that currency Mullings occur you've been listening to the McIlvain ii weekly commentary i'm kevin Orica long with david McIlvain ii you can find us at McIlvain e.com MC al V a NY dot-com and you can always call us at 855 955 six this has been the McIlvain e 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 McElhaney weekly commentary [Music]