David Collum: The Next Recession Will Be A Barn-Burner
For those who enjoyed his encyclopedic 2015: Year In Review, this week we spend an hour with David Collum to ask: After processing through all of that information, what do you think the future is most likely to bring?
Perhaps it comes as little surprise that he sees the global economy headed back down into recession, one that will be deeper and more damaging than the 2008 crisis:
In 2008/9, while the equity markets when down, the bond markets went up. And that buffered an awful lot of pensions and 401Ks and endowments and things like that. And so people felt pain, but they didn’t realize that there was an offsetting gain. They did not notice that part as much, but I think the next downturn is going to be concurrent bond market collapse and equity collapse and there will be no slack in that downturn.I think stocks and bonds are both at ridiculously high levels now. The bond market can only go down from here, right? I mean, it can keep going up for a while, but there is just nothing left to be squeezed out of it. Interest rates are at seven hundred-year lows, supposedly - they’re certainly at stupid lows, right. You have a third of Europe at negative rates... And so I think at some point the bond market’s got to collapse. It will start in the high yield market, and that is happening right now. Then it’ll spread, maybe treasuries will get bid to the stratosphere, but at some point you’ve got to get a real return. And so bonds have to sell off to get back to that real return -- after all, all crises are credit crises, right,? And then equities are going to go once there’s not leverage out there for share buy backs and stuff like that.That's why I think the next recession is going to be a barn-burner.
Click the play button below to listen to Chris' interview with David Collum (74m:53s)
Chris Martenson: Welcome to this Peak Prosperity podcast, I am your host, Chris Martenson. Well, if you want to know where you are headed, you have to know where you are, which means you have to know where you have been. And to that end, continuing with our annual tradition, we’ve got the best year-end review in the business today, thanks to today’s guest, Dave Collum. For those of you unfamiliar with Dave, he is a professor of chemistry and chemical biology at Cornell University, my alma mater for my MBA. And in addition to his academic interests, David authors an annual macroeconomic assessment titled: "The Year in Review." It is hands down the best synopsis of anything that mattered during the previous twelve months.
His latest "Year in Review" can once again be found in full, in all its glory, at peakprosperity.com. I am excited to have him with us now live in order to expand on his excellent insights. Dave, thanks for coming back and being with us again this year.
Dave Collum: You know, I love coming back. I like these podcasts we do, and just for you and I to chat for an hour is for me a treat. We are somewhat like-minded. A lot of confirmation bias, but once in a while that kind of helps you out, doesn’t it?
Chris Martenson: I love a big heaping of confirmation bias, so let’s get right in there. How can you not have confirmation bias today though, because you’ve got these broken markets, these wild things that all the central banks are trying, and now, if you look carefully, you know what I’m seeing? Dave, I am seeing lots and lots of big banks starting to come out with their own little tentative, "Hey, this might turn out badly," assessments—a little CYA report writing from some of the bigger investment houses. You’ve got the big giants, many of whom you collected quotes from, Paul Singer et al, saying "hey, this whole thing looks a little goofy." If you were going to give this... your "Year in Review" this year, if it had to have a title, what would it be this year, do you think?
Dave Collum: Well, it actually did have to have a title. In the intro, I actually tell a little anecdote where I sent an e-mail off to a friend of mine who your readers would all know quite well. In April, I said that I’m losing track of the theme this year. And he said, "well, this year is still young dude." But there really was a deeper angst in what I was saying, and as the year went on, it didn’t go away. I became sort of less convinced that I understood what was happening. I have never been fully convinced I knew what was going on, but for example, last year I talked about Ukraine and the Saudis and the oil crunch, and stuff like that. I thought I had a pretty good narrative on it. And this year, I have probably twenty-five pages of notes on the middle east, and I’ve pretty much punted the ball because I just couldn’t figure it out. And of course, that’s so central to where we’re heading in terms of global terrorism. So the title as you know was "Scenic Vistas from Mount Stupid." Mount Stupid is a pinnacle on a curve that says willingness to talk versus your knowledge maxes out early.
And I realized I just was losing my cred. I was losing my sense of where we are. So that’s been the theme for me this year, is disorientation.
Chris Martenson: Yeah, I was thinking of that as the subtitle, "Scenic Vistas from Mount Stupid." I don’t know, I would have put something like FUBAR up top, or I don’t know what. This has been the craziest year ever, but I said that last year. So I’ve been saying this, Dave, increasingly for six years now, because the distortions, the deformations, the dislocations, the three big Ds, that the Fed has basically... the small politburo of appointed individuals has taken it upon themselves to know what the best price is for everything by mispricing money itself. And they got a lot of help. The Bank of Japan is in the mix, the Bank of England’s in the mix, the ECB is in the mix. Everybody is doing this, there is nowhere to go, nowhere to hide, and that creates a very chaotic landscape. But how do you even analyze something like this anymore?
Dave Collum: I don’t know. And then you’ve got the war on cash, you’ve got all sorts of things going on, and they’re trying to shut us out of our sort of normal defense strategy. We talked about confirmation bias, and I put a little piece in there that said I rely on confirmation bias. I embrace it. I’m well aware that it says be careful, you might be confirming something that’s wrong, but what’s also true is when you’re feeling kind of crazy about what you’re doing, you’ve got to find some likeminded people to keep your hand on the rudder steady and to not lose sight. And so, yeah, I’ve been working on an exit strategy, an exit from the situation we’re in in terms of viewing the world ever so darkly. This is by no means time to exit, in my opinion. I think we are actually topping out in the world of absurdity. But at some point we will be in a position where there will be bargains to be purchased.
They eluded us in ’09 for the most part because it never got cheap, but someday there will be and I’ve been trying to plan for that day when I’ll be able to go back to normal investing when no one else agrees with me.
Chris Martenson: Normal investing meaning what to you? You have something where you can identify value and the price is okay? And the prospects, the story makes sense, so there’s some comprehensive story besides somebody’s going to buy this from me for more money tomorrow?
Dave Collum: Well, that last sentence I don’t like. I would rather buy a well-defined revenue stream, and if someone does not want to pay me for it, that is fine, as long as it is a well-defined revenue stream. But there are none of those that I like right now. I was pretty enthusiastic about energy, I knew that the credit markets were a risk for the energy market. I must confess that I did not fully understand that risk. I am still enthusiastic about energy, and the XLE is still up threefold with the S&P is from 2000. But, I’ve had to move the goal post back a little bit in terms of my timeline for energy, but I always want to own energy. I always want to own it, I think we need it; we will use it. but my exit strategy ultimately is going to be, hopefully, to be able to do sort of a sixty-forty kind of portfolio when bonds return, will return, and stocks can be purchased cheap and pay good dividends and the companies have a growth going forward.
Chris Martenson: Well we certainly agree on energy, no question about that. You and I both have some grounding in biology and chemistry as well, so obviously, you know all of life is just a flow of electrons and from one state to another, energy is everything. And so, as I look into this energy space, I loved what you wrote about it because it confirmed for me what I thought, which is that I really think that the initial hit to the price of oil was a political stunt first and foremost, mainly directed at Saudi Arabia and Iran. And I think it kind of got away from them once that ball got rolling. And/or, our political leaders are just so tone deaf that they don’t really care, or are unaware of the amount of damage that’s being currently inflicted upon the U.S. oil industry. But at any rate, I’d love to talk to you about that because here’s when I love to buy things like oil, is it is way below its marginal cost of extraction for a barrel. You cannot possibly get it out of the ground for thirty-eight dollars, or thirty-five. Where are we at today, thirty-four... yes, so thirty-four, forget about it, not happening. You can get existing oil that you already have a drilled well. Of course, you might lose capital because you drilled at a higher set of expectations than you are currently selling it at; that is a different story, but it can come out of the ground, obviously, it does. Surprise to me has been how slowly the shale industry has responded to this. They are still drilling pretty steeply as well, but I know that oil has to go back up to seventy, eighty, ninety dollars a barrel, or we have to admit we’re going to live without oil. That ain’t gonna happen.
Dave Collum: Well, I... so I have some... my wish list, and I intend to buy energy equities again; I don’t buy oil futures or anything like that. That is too rich for me. The one thing I do, and I think your readers ought to consider seriously, at least the ones who are amateurs like me, is that I try to invest in a way where if it goes badly, I forgive myself. So if I bought futures in the oil and started playing around in those markets, and I got busted by it, I would not forgive myself because I don’t understand that world very well. So, I will be looking for energy equities. I don’t think they’ve bottomed yet. I think they’re only slowly responding to the price of energy, and so I’m still waiting, but I’m getting restless leg syndrome a little bit, as I said, and I’m thinking about it.
I want to invest in Russia too at some point, but I am waiting for them to get their tail ends kicked a bit. Maybe I will be waiting forever, I don’t know.
Chris Martenson: You mean kicked economically a little bit more, or...?
Dave Collum: Well, you know if our markets crash theirs are not going to hold up, right? And in fact, the horrifying detail going forward, I think, is in 2008/9, while the equity markets when down, the bond markets went up. And that buffered an awful lot of pensions and 401Ks and endowments and things like that. And so people felt pain, but they didn’t realize that there was an offsetting gain. They did not notice that part as much, but I think the next downturn is going to be concurrent bond market collapse and equity collapse and there will be no slack in that downturn.
Chris Martenson: Explain why you think both turn down at the same time.
Dave Collum: I think they are both at ridiculously high levels now. I mean, the bond market can only go down, right? I mean, it can keep going up for a while, but there is just nothing left to be squeezed out of it. Interest rates are at seven hundred year lows, supposedly. I don’t know how they get those numbers, but they’re claiming... they’re certainly at stupid lows. You have a third of Europe at negative rates, so I don’t see where... and I put in a quote, there were some guys saying "you know, if you buy bonds at negative rates there’s a chance you’ll lose money." I am going, "Really? Ya think?"
So I think at some point the bond market’s got to collapse. It will start in the high-yield market, and that is happening right now. Then it will spread. Maybe treasuries will get bid to the stratosphere, but at some point you’ve got to get a real return. And so the bonds have to sell off to get back to that real return, so they’ve got to go; and all crises are credit crises, right? And then equities are going to go once there’s not leverage out there for share buy backs and stuff like that.
Chris Martenson: Well think about... you know my model for this is, remember... I am drawing a blank on the year, but Bernanke was still in charge and it was the so-called "Taper Tantrum." I remember the month, not the year, it was June, and everything sold off. Everything just got clubbed at once, everything. That is sort of my model; remember that was like two or three days of awkwardness? Bonds were down, commodities were down, and stocks were down. Everything was just getting sold all at once.
Dave Collum: It wasn’t too many years ago. You know, there is the fear of twenty-five basis points, and to me, it is... at first, I thought it was just an abstract fear in which people say "Yes, but that’s just the tip of the iceberg, and you know what icebergs do, right?" But Zero Hedge did an interesting analysis and said look, you raise twenty-five basis points, you are going to see the equivalent of a quantitative typing of eight hundred billion dollars. I can’t say I follow the line completely, but I thought it was a credible storyline. So if they start raising rates and they start unwinding these incredibly leveraged positions, there is a problem, right?
Chris Martenson: Well, there is, of course the Fed has a few other tools besides just taking liquidity out. They can raise the rate of interest they are paying on the excess reserves and that would serve as sort of a magnetic attractor to a higher rate without withdrawing any liquidity. In fact, it is actually liquidity additive because you are paying banks more for the privilege of giving them free money that they round trip back into an account that you pay interest on. So they could do that.
There is a variety of things they could do because we know the Fed is deathly afraid of this market going down, and they know they do not want to withdraw a lot of liquidity. So, I think they’ve been doing what they can, and they got, apparently, the rate hike they wanted, only withdrawing, I think, about a hundred and thirty billion so far that I’ve seen. So they got away with doing it with a lot less than that Zero Hedge estimate that came through some firm. I can’t remember who.
Looking at that, here’s the theme I see. I see all the central banks as just being really afraid of the markets they’ve created. I don’t really remember you writing about the psychology of what’s going on in the politburo, or the FOMC, or inside the halls of those power bases. But it seems to me, from everybody I’ve talked to, that the Fed is actually pretty clueless. They don’t really have a good plan. They did not really mean to end up here. They don’t really know how to get out of here. But as you wrote in your article, you summed it up, you said that the dominant narrative, the theme this time that everybody’s running with—like we had railroads as a theme once that supported a set of bubbles. We had Internet, at least that was a credible story you could hang a hat on and say "yeah, I get how the internet’s going to change everything, let’s just go crazy on a bubble." But this bubble is a bubble of faith in a bunch of people who are appointed committee members, just a small handful of them, and that seems a little dangerous.
Dave Collum: Yeah, I am not sure if they’re afraid or if they’re clueless. You used both, and so you kind of hedged your bets there.
Chris Martenson: Yeah. [Laughter]
Dave Collum: I think it is probably a combination. I know Bernanke was afraid of 1938. I actually... I sort of had an epiphany on 1938. Everyone seems to accept the notion that in ’38 the Fed tapped the brakes at the wrong time. After a discussion I had with Mark Spitznagel, which was quite a treat, he mentioned the Tobin’s Q, and I started thinking about it some more, that’s a valuation model that’s really sort of a price-to-book valuation model, and he wildly endorses it as the cleanest of all the valuation models. And I went back and looked at it that night and was staring at it, and I noticed that in 1938 according to Tobin’s Q, the Fed had blown another bubble. And I had never noticed that before, so the Fed, the Tobin’s Q had reached all time highs again, and so the Fed had to tap the brakes in ’38 because they had over juiced the markets.
Chris Martenson: So price to book, is this... how clean is the book? You know we’ve got all kinds of shenanigans going on in accounting these days, so is there a cleaned up Tobin’s Q, or are we still... has that slowly been drifting off into nebulous uselessness like a lot of statistics?
Dave Collum: Well, let’s assume it’s clean. It is at near record highs, with the exception of 2000, but it is above twenty-nine, it is above sixty-seven, it is above the obvious high points. If it’s not clean, then it is worse. So, I don’t need to know... this is like the inflation debate. I no longer need to know how wrong it is at this point, because I’m just... I am not touching it. I talked to some guys who said, "Be careful of Tobin’s Q," and I go, well, I’ll start worrying about the validity of Tobin’s Q when it’s below the mean. Then I will start worrying about whether we are getting a valid read on it. Right now it can be wrong, I don’t care. I am not buying; that is the key.
Chris Martenson: So price to book then, "book" meaning—for those who are not totally familiar with accounting—this is the book value of a company. Meaning, what we have done is we have added up all their assets that we know about and subtracted out their liabilities and say, hey there is an enterprise value here that if you just broke this company up today, what would it be worth. Of course, this is a little bit tricky to estimate sometimes, because Coca Cola... how much is the brand itself worth? There’s a way of valuating that, so I’m not familiar with exactly how all that would get wrapped into the Tobin’s Q because I’m not that familiar with it. But, the idea here is that the amount that people are paying for companies, in terms of their book value, is the second most extreme in all of history, right? It is second only to what, 2000?
Dave Collum: Yeah. What is also true is there’s a bunch of other valuation models. The one that you should be very wary of is price/earnings ratios. That is the one that is toxically wrong. But there is a bunch of others, like Buffett's is price to GDP and the problem is that GDP is now all contorted. Again, assuming it is clean, which is the best-case scenario, Buffett's indicator valuation is about forty percent above the mean. As I said in the write up, I said you not only regress to it, you’ve got to regress through it, because you’ve got to spend half your time on each side of the mean pretty much. That is my freshman math teaching me that one.
Chris Martenson: Good point. Now this has been of course a very frustrating period of time for people who use history, who use common sense, who use fundamentals, who use valuations, things like that. I am thinking of Hussman, great guy, one of the smartest and most astute and mathematically oriented market mavens I’m aware of out there, and it’s just tough sledding whenever I talk to him. And it’s been hard for a while. As you and I were talking about before we started recording, here’s my frustration with all of this, David. I do the same thing, not nearly as comprehensively as you do all at once. But what I do when I’m writing is I start collecting dots and I put them all together. And once I put them in one spot, I’m like... my first reaction is "You have got to be kidding me. How can we be tolerating this?" But we do. And my frustration is that a lot of people still don’t get just how weird and extended things are.
The Fed plays dumb or coy or both, and what I am worried about is when this finally really does break, I have the same fear I think the Fed does. Once the ball gets rolling on this, I think this does go through the mean, and I think it is much worse than 2008. I think the damage is going to be extraordinary, and I am really worried about how my country is going to respond that, because I don’t think we’re going to take it well. My personal projection is that my country will blame somebody, maybe Islamic people, or Russians, or Chinese, it does not matter. That is what I feel.
Dave Collum: Yeah, they do it every time. The good news is there’s very few countries left to bomb. We are already bombing most of them. Yeah, I... here is my fear. One of the parameters in market corrections that is grossly underestimated, is time. And I really try to eliminate time from my portfolio, so I would never buy an option with an expiration date. And if you make the right bet, you want to be able to stay there until it’s either the wrong bet or it pays. And the problem with bear markets and secular bear markets—which I argue we are still in. There’s a lot of bulls saying I’m an idiot, but I argue we’re still in a secular bear market waiting for the third leg down. I am a big fan of the three-leg down model—is time is the killer. So, if you’re a Japanese investor in the Nikkei in ’89, twenty-five years later, you’re not only down seventy percent, you also have given up half of your entire investing life waiting for something good to happen. And if you’re an investor in ’67... You know, in 1981 fourteen years later, you are even on capital gains, but you are down eighty percent on inflation. And you have burned fourteen years of your investment life again. So my fear is they are somehow going to be able to stall this so long that you and I are just going to sit there and we’re just going to—dead cold finger sitting on the mouse waiting to click. And if they don’t wash it out pretty soon, time will start to chip away on all of us.
Chris Martenson: Well it has been chipping away, and of course, I am thankful... oh my gosh, I am praying right now... I am thankful that I am not a pension fund who—those guys and gals have just been getting cleaned. Can you imagine being responsible for the retirements of millions of people potentially, and you need seven and three-quarter percent in this particular environment? I don’t even know where I would begin. I am very frustrated at my own portfolio returns, but I cannot even imagine how bad I would feel if I was responsible for thousands, maybe millions of people.
Dave Collum: Well, if you integrate your... I know what you have done through the years, and if you integrate your returns over the last fifteen years, I bet you beat the S&P.
Chris Martenson: Oh I did, yes.
Dave Collum: Right, as did I. Now, for the last five years, you and I have been getting browbeaten by the bulls, but you have to integrate over a long period. So, we had a huge lead on them in 2009. We were just rocking at that point. And we’ve given up some of that lead, but we still have a comfortable margin, a factor of two or three for me, relative to the ’09 crowd who somehow were smart enough to jump in, although I don’t think many did, actually.
Oh, I don’t know... hopefully this will eventually equilibrate and eventually cause the carnage that’s necessary. The seven and a half to eight percent return crowd, that gets back to the bond market. If the bond market returns zero—which it is priced to return zero or worse, right? It is priced to pay you nothing in dividends and hold up, or to collapse. And if that pays nothing—and I’ve got to do sort of back the envelope in my head... sixty-forty portfolio, you get nothing out of the forty, you’re going to have to get about twelve percent on the sixty. I don’t think equities from this level could possibly give you reproducibly twelve percent a year. I don’t think it’s even theoretically possible, unless of course, inflation’s above twelve percent.
Chris Martenson: Yeah, so on that front, people vary a little bit on where inflation really is, but obviously, it is... so I don’t really go by prices as much as I do looking at credit and money and watching the collapse in M2 velocity, and looking at the fact that the Fed did get some credit out the door. But boy, we must be scraping the bottom of the barrel. I think the last person who wanted to took out a tuition loan for an online university, and I think the last person who could buy an eighty-four month subprime auto loan has been found and rounded up and given a loan. It really feels like we are... I don’t know how much further we go. Can people really continue to extend the housing market in San Francisco? The signs say maybe not. We see a lot of things that look like topping signs here.
So, where is the story that says here’s where we’re going to get this inflation the Fed keeps yapping about? Where does that come from, except a war that accidentally causes oil prices to spike? Which isn’t the inflation they need. They need monetary inflation, not necessarily price inflation. One is a symptom the other is the cause.
Dave Collum: Well, I’m not... okay, so, hat tip: Several years ago, a number of years ago, there were a half a dozen deflationists on the planet, best I can tell. I happen to have realized I should have given Mish Shedlock a hat tip. He was a diehard deflationist, and I thought he was nuts, and other people thought he was nuts, and he’s looking pretty smart right now. I think we are going to have a hybrid model here where I think we are going to get the worst of both scenarios. Where we are going to get inflating prices and deflating assets. And I don’t know what to call that. For years I have been railing on the idea that something so complicated as zillions of prices moving around could possibly described in a binary language of inflation or deflation. That just strikes me as nuts. So I think we’re going to have price of veal and beef going up, and the price of your equities going down, and the price of bonds going down, and possibly the price of houses going down again. I think we are going to end up with a credit crisis because, while energy high-yield bonds continue to tank, liquidation from the funds start, you are going to start having to sell the ones that are not tanking. So, other high-yield bonds that maybe weren’t such a crazy idea will now get crushed. And then lesser risk bonds will start to get sold from portfolios, and it just cascades. I think we will have an inflation/deflation hybrid combo. All the bad things rolled into one. I know it sounds like a doomsday scenario.
But my exit strategy is I think the next recession is going to be a barnburner. At the point where everyone is talking about the recession, I intend to start averaging in. And if Tobin’s Q is at the mean, I will start there. Last time I did, but then it jumped. And I will start averaging in and hopefully I will average all the way down to stupidly low levels of Tobin’s Q and wish I had not done it. But I really would love to get to sixty-forty. I would like to get back there, but I am not doing it until it is a bargain.
Chris Martenson: Well, this is going to call for more patience, right? So a lot of patience so far. I am running out of patience, I have to admit. You say you have restless leg syndrome. I have frustrated eyebrow syndrome. I just keep squinting at my screens going "how are we still here? How is this still this dumb?"
Now what I would love to get your take on—because you and I both have the opportunity from time to time to rub e-mail elbows with, or even face to face some of the big money names out there who are in this. And I’ll tell you Dave, you know, I’ve been at a few major, sort of heavy duty wealth conferences, both presenting and attending, and when I talk to these people who are running these big giant funds, they’re nervous. They are nervous. People... I was talking with a guy who has a giant real estate portfolio, unloading it as fast as he can. It’s in New York City. I asked him why. He said, "You know, our metric is once we see around seven to ten thousand units with a minimum square foot price of three thousand dollars a square foot, we just start running away from this as fast as we can." Three thousand a square foot, right? That is like at the low end. They have apartments there that are going for four, four and a half to five thousand a square foot, and the people who are managing the assets complain that there is really nowhere to look at this point in time; not within sectors, and not across the globe. Nobody can find price, nobody can find value, and everybody is concerned that they are over paying. And here’s the fun part: Everybody thinks they are a little closer to the exit than the next guy and will be able to protect their clients in the next downdraft. What are your thoughts there?
Dave Collum: [Laughter] They are nuts. I think the reason the third leg down model works is because everyone knows when it starts. I think the fear of "not again," it gets so compelling, so overwhelming. I believe that when the secular bear market is over, people will swear off asset classes in their entirety and they will say "I am just never, ever, ever again going to buy that. That is just a piece of garbage and I am not buying it, I have been duped three times." Last night I had one of my business school colleagues tell me to buy real estate... commercial real estate... and she said "that has been a really great investment." I am going "yeah okay; I will put that on my wish list. I will buy something that has boards on the windows." The reach for yield is going to kill people. They sold hundred-year Mexican junk bonds, I mean... "Mexican junk bond" is redundant in my opinion, but they sold hundred-year bonds in Mexico. Nestle got negative interest rate bonds... a corporate bond that is a negative rate. This is certifiably nuts. And it will just drive us nuts. Then one day it will crack and the ice under our feet, you’ll hear it crack and you’ll go "that was it." I remember when it did it in ’07. I know you and I were waiting for it, and waiting for it, and then it finally did in ’07 when you heard a crack and the internal Bear-Stearns hedge funds went down, and they were supposedly little things, and you go "no, no, no... Something is going on in there." And Tonta, that woman writing from inside the system—we’ll hear that again, I think. I think we will get that.
We kind of got it in August, right? The markets started to break. They started to dysfunction in August, and then somehow they pulled off a stick save. I don’t know how they did it. Guys like Eric Hunsader said he could see the markets breaking. There was complete air pockets, malfunctions, everything was wrong and will do that. They saved it, but you can only save these things so many times before one gets by you. It is like a hockey goalie.
Chris Martenson: Yeah, so in terms of how they saved that one, now there were a couple there, in August and also an October save. What are your thoughts there?
Dave Collum: Well, I don’t know. I really have not a clue how they saved it in August. They couldn’t drop rates, I didn’t see any evidence of huge influxes, although maybe I’m forgetting that Draghi dumped some money in or something. They somehow have the psychology, they have the leveraged speculators not willing to run for the exits yet. They were able to head them off at the pass. The fact that the system is fifty percent more leveraged than it was in ’07 is just so staggering. And you’ve shown charts with the little blip and the leverage and the damage it did and how it’s just gone exponential since then.
This is one of these when Dave and Chris get together and lament how crazy the world is moments. At some point, when it finally is true and we are shown to be correct, it is not going to be satisfying. We are not going to be sitting there partying in party hats and noise makers, because it is also going to be a blood bath. There’s going to be a lot of human suffering when this finally lets go, I think.
Chris Martenson: Well, indeed there will of course, and I think that is what everybody is a little bit afraid of. So, what are you detecting in your communications with people who are talking with you, who you consider to be well connected, plugged into markets, market rhythms, all of that? Except for your colleague, who very helpfully has said "buy commercial real estate," and I think your colleague may want to check out what Sam Zell is doing right now. He has obviously been through a few cycles; he is unloading his commercial real estate as fast as he knows how.
Dave Collum: Is he doing it again? Because he called the top at the last one, right? He sold his entire empire in ’07 and that was the bell. That was ding, ding, ding, that was it when he... it seemed like people knew it too. When Sam Zell emptied his empire, you go "wow, that is a top call."
Chris Martenson: And I think if I remember right, he sold off like almost forty billion of it to BlackRock, so he really...
Dave Collum: Yeah. So who do I talk to? I chat all the time with some guys who are pretty smart and they’re getting crushed. So if you look at someone like David Einhorn, he’s down... last count I saw was twenty-one percent. I know he is frustrated... both his longs and his shorts are going against him. And when guys who are that smart are losing money, the market... What it means is the winners are the dumb guys. In the past, I was talking about the dumb money being the retail guys, and so the leveraged speculators are unloading on the dumb guys at the end and they call it distribution and they talk about shearing the sheep. I don’t think that’s going to happen this time.
The retail guys are not buying these assets up, and the leveraged speculators are just going to have to unwind them to each other, and that’s not going to happen. And so I think... you’ve got risk parity funds, that’s... oh the bond market, that’s what you want to pay attention to. Guys like Ray Dalio says the way you make money off bonds is you lever them up to the point where you can sort of lever up and get the same returns as equities, and the same risk as equities. Which, I don’t think you need to lever to get that. But what it does, three/fourfold leveraging of a bond fund, and when it starts unwinding, those risk parity bond funds are going to unwind so quickly. They are going to be margin called from desks and as I said in my "Year in Review," Ray Dalio’s Bridgewater might become a bank on some Sunday night, right?
Chris Martenson: Well this is... obviously we are seeing it is a big story... I don’t really recall seeing a lot about this lately, but I think just as recently as mid-summer, there were a lot of articles talking about the complete lack of liquidity in bond markets. And not just the treasury markets and the other ones that are completely owned by the central banks at this point like the Japanese government bond market by the Bank of Japan, but the corporate bond markets too. Very, very, very low liquidity. And so we just saw that sort of all come to a head with the gating of that junk bond fund and then the closure of another, and then another. So the junk bond’s clearly have been tip toeing out the back door since about June. They started thundering out the front door starting about a month, month and a half ago. Still, a lot of complacency, I feel. People look at that and I’ve got to tell you, that’s kind of the same warning signs that I saw in 2007 well before we started to see anything really go off the rails in 2008.
Dave Collum: Well, you know, you may be able to help me here. The word "liquidity" has multiple meanings to me, best I can tell. And some of them are intractable to me. So the simplest of all of course is the idea that an asset is liquid if you can get out of it without altering its price much, right? So, if you have a million dollars’ worth of Microsoft, you can sell it. It is a highly liquid stock. If you have a million dollars’ worth of a local bank stock, that is a penny stock, you cannot sell it. So, that one is very illiquid. I get that liquidity. And then the bond market—you can have liquidities like that where there’s just, they call it a buyers strike. Where you want to sell and people say I am not buying. And during the crisis in ‘07/08/09 I was in a conference at one of Yale’s mortgage gurus. I say that tongue in cheek, but he thinks he is. He said "I don’t know why they didn’t just reprice in the mortgage backed securities." I said because A.) no one knew what was in them, and B.) it happened too fast, so everyone just stepped to the sidelines and said "I’m not buying anything right now," and therefore they became illiquid.
Then you get the liquidity in the repo market and this notion that the whole money system relies on having collateral of a certain quality. And as the central banks are buying up that quality collateral themselves, then the banking system is missing that. Do you understand that better than me? Because it would not take much.
Chris Martenson: Well, there are those pieces, which I think you did a great job explaining, and then there is just the idea of liquidity in terms of movement. So to me an illiquid issue as I was reading about this guy who owns a bond fund and he put up a corporate issue for sale, and there was a whole bid/ask stack there apparently, but he put the issue up and a day later it was still sitting there. That means he spent twenty-four hours just trying to get rid of one CUSIP from one issue and that... it just did not go anywhere. So, when we say there’s no liquidity it means the depth and the breadth of the trades are very, very low. Then you are talking about a quality liquidity as well. Once you have this atrocious quality stuff, there might be a lot of it, and a lot of it is changing hands. But that’s the kind of stuff, when the worm turns, it often just freezes. Nobody wants to bid for it at all because nobody knows what it's worth at that point. Because the value of something at least in part is due to the fact that you still can sell it somebody. As soon as you cannot sell it to anybody easily, its value might suddenly be defined by something terrifying like its actual intrinsic value.
Dave Collum: Yeah, and then you reach a point where the funds... So they start throwing away the rule book and they start... even though the funds might not have any lockout mechanism, that basically they turn a blind eye in what you used to think of as infinitely liquid funds where you could just pull your money out whenever you want. They seize up and they stop letting you withdraw your money. And so there’s a liquidity problem there. But let’s say you have some sort of money market fund which is critically dependent on having JGBs from japan as collateral, and then the Bank of Japan buys every JGB on you. So then the question is: How does your fund function if buy law, by mandate, you need them and they don’t exist? So I think that’s another... I think that also gets the name "liquidity." It is all part of that whole repo thing. I would be a liar if I told you I understood the repo/reverse repo market. I have spent a lot of energy trying to understand it and it still baffles me. I am not stupid, right?
Chris Martenson: It is baffling of course, and nobody understands it all how the derivative market works. I am comfortable saying that. I have talked to a lot of people who write derivatives, who are intimate with them, can really explain... "derivative" isn’t a thing. It is not like I decided to sell you a flashlight and we could both agree it’s a flashlight. A derivative is a contract. It is twenty to forty to a hundred pages, depending on how dense your lawyers want to get with it. So these derivatives, they are just big giant paper contracts, and of course any contract can be a little dense, but these will refer to what the parties, the counter parties and other related derivative contracts, and if this happens then it will be priced this way and that. It is just they are very complex.
I do remember where I formed a lot of my opinions about this was when... I think it was Warren Buffett bought... I think it was General Ray and this reinsurer had fourteen thousand plus derivative contracts on the books and he started unwinding those and it took them years and they never could figure out what they were worth and this was just fourteen thousand of these contracts. There are millions of them outstanding in just an individual firm like JP Morgan. And that was where he developed his idea that they are weapons of mass destruction. Financial weapons of mass destruction.
Then we saw Greece go belly up and default back a number of years ago. And the ruling body for derivatives said "oh yeah, it’s not technically a default. We know they missed their coupon payment, and other things you would say is a default moment, but we are not going to call it a default." And it took them months to declare that a default because behind back doors they had to figure out how they were going to settle the market for what turned out to be 78 billion notional outstanding, with only 3.8 billion at risk, of which 1.8 billion ultimately ended up changing hands. It took them months to figure out how they were going to settle that 1.8 billion dollar bet... billion with a B. These things number in... potentially the value at risk in a fast moving interest rate environment could be in the trillions of dollars. Could be, right?
Dave Collum: The thing to remember also, a great example of what you are describing also is counter party risk, where you may be owed money, but if you’re owed money by some guy who’s wearing a barrel with two straps, you’re not going to get paid. Back in the mortgage crisis, the mortgage backed securities were basically insured _____ [00:42:39] credit default swaps by a bunch of leveraged hedge funds. So your insurance company had no assets. They had no collateral. They had... unlike regulated insurance companies that supposedly have big huge wads of stuff they can use to pay out when they need to... when the credit default swaps are held by leveraged hedge funds, you’re not going to get paid. And so, all of a sudden, you think your hedge... I remember when Citigroup says "don’t worry we are hedged," I am going "hedged by whom?" Who can hedge Citigroup? And so yeah, derivatives are a mess. I think Buffett got duped. And he admitted it, but he still screws around in that market. That little old man is like the mafia guy and he’s not as much of a country boy as he likes to pretend.
Chris Martenson: [Laughter] You don’t think so, huh?
Dave Collum: No, I do not think so.
Chris Martenson: I don’t know how much time you spent writing this fabulous year-end review, I’m sure it’s quite a bit. Hundreds of citations. And when you put it all in one spot, is your faith in humanity bolstered or crushed? What happens?
Dave Collum: Oh, it is an interesting... let me first make a couple of comments about the writing of it. I have people say "how do you do it?" "How do you find time?" Questions like that. Sometimes it is just sort of curiosity, sometimes it is critical, believe it or not. The way I do the thing is I collect all the information and I read with a purpose. The reason I do it is it makes me read when I am reading with an idea that at the end there has to be a narrative. So I read with the idea of finding themes. I get to around the first of November and I have about four to five hundred pages of quotes, links, comments, excerpts, in a Word file that are randomly distributed. They are not sorted at all. Then I sort them, and then I write the sections. It takes me about thirty days at night, maybe three or four hours a night writing to write the thing.
William F. Buckley used to write a book in a hundred and sixty hours first draft, so I try to be inspired by that idea. I got eighteen hours in a day, and if I put fourteen or fifteen into my full time job, and then another four into this, I am okay. I will live with that. And that’s just to my critics. At some level they can kind of take a hike for all I care, but if they want to know how I do it, that’s how I do it. That is my hobby, that’s my... they go do wine tasting, I write.
Then at the very end, I find the themes. This year, what made it so hard is the themes were elusive to me this year at some level.
Greece was a great theme. Weren’t we told all year long that Greece was going to destroy the world, and then they voted a referendum that looked like it would destroy the Euro system, and then all of a sudden, not only did it not destroy it, but the whole storyline disappeared.
Chris Martenson: Oh, I love disappearing storylines. You want to know the other big one that just disappeared and I could not believe it was the Ashley-Madison hack. There were a lot of unfortunate names on that list. Wasn’t that amazing that the media somehow forgot to troll through all of that and find all of those names from the people at State Department and elsewhere? I mean, that to me was one of the greatest disappearing acts of 2015.
Dave Collum: The other thing I try to do is I collect these little snippets through the year that are just human interest stories and you know, a lot of people don’t know this, the FBI came out and admitted that ninety-five percent of their forensic hair and particle analyses that were used to convict people for decades is wrong. Now, someone explain to me why that did not turn into a colossal... a colossal... scandal. There are guys who have been executed on FBI forensic evidence and the FBI admitted it was wrong. Ninety-five percent. And these stories go right by half, three-quarters, ninety percent of the people. So I try to grab those stories too.
I know it’s long... I don’t have time to write a short one, but if you read it... and if you really do read it, there’s an awful lot of meat on the bones in there. It is really a year of human folly all brought together and I try to stitch it. I try to stitch it together in a way that makes it a plot line. I try to be a wise ass. By the way, I hammer Hillary. I know there are Hillary fans. If you read as much about Hillary as I have, you would realize that she should be in prison and she’s a sociopath. And anyone who votes for Hillary in my opinion, if they knew what I knew and still voted for Hillary because she’s a woman, you are selling your soul in my opinion. You only get one, and you sold it if you vote for her. She... I... everyone says "all the politicians are all crooked..." No. Hillary has her own zip code in that category.
Chris Martenson: You want to know... So it doesn’t take much to... I don’t do politics at all, but she completely lost me forever when I saw her on TV, knowing she was being filmed, laughing about the execution of Muammar Gaddafi. Who, whether you like him or love him or hate him or all that, once you read about what Muammar actually did for his country, yes he was strong man, but you kind of have to be one in the region. But his people had the highest standard of living in all of Africa. Somehow, that offended us greatly and so NATO took him out. And so she got on live TV and laughed and said "we came, we saw, he died. Ha ha ha ha." Somebody who can do that loses me on the human level. I don’t care if you’re a woman or a man or whatever. She lost me as a human really badly at that point in time.
Dave Collum: Yeah, and then the other place I go pretty dark is campus life, at the very end. I had Adam read it pretty carefully and he took out a chunk, which I really liked, but he took out. But what’s going on, on campuses these days is pretty strange. The Yale-Mizzou story is only part of it. I get into it... I actually place myself some level at job risk. I don’t actually think so, I’m a tenured sixty-year old professor and department chair. It would be hard to get me, but at a pretty good record of publishing and fundraising and you name it service... but when I write that stuff in this climate, I certainly could draw fire. But I decided to step back, because I happened to mention this in it, that I know a kid that I think is rotting in prison on a false sexual misconduct conviction, and it kind of tipped me over the edge. And so I’ve been on a campaign to help him, and so I’ve got an Atlantic Monthly journalist who’s going to write about it, and she said the case is appalling and... He got convicted of political correctness in my opinion. I think this epidemic of political correctness on campuses is toxic.
Chris Martenson: Oh yeah, you know I was just at a holiday party and there is a young gentleman and he’s now eighteen at a major university. And I’ve known him his whole life, so anyway... close, very close to him. I was asking him about his freshman year and he said oh my God, one of his stories he said, the PC thing is so intense that he and his friends get together and they have these hazard stories where they’re all afraid to have any interaction with women. Nobody... none of his friends will even remotely talk to a woman who might be even slightly drunk, because they know... the hazard stories they’re passing around is that they could end up in prison if anything goes wrong and even a week later she decides to remember this thing differently, like this is a legitimate hazard story for young men now, is that they may well be charged with something that doesn’t necessarily have the same burden of proof. Or I’m sure you’re more familiar with this than all that, but that certainly wasn’t... I grew up with a different set of concerns and fears, but it was interesting that for him a dominant theme of his experience was having to watch what he said and did very carefully knowing it was being put under a lens that was a moving target, is how he described it.
Dave Collum: And by the way, this is not so... Related to police brutality. There are bazillions of policemen out there and there’s some really striking videos, but the rational person could say yes, but they were selecting spectacular cases. And as a consequence, it’s not anywhere near as rampant as we’re being told. This actually is a pretty rampant problem. If I had a son in college, I’d be very scared. Because the way it works now, is if your son has sex with a young damsel consensually, and they are somewhat intoxicated, which you know, I don’t know many people who went through college who didn’t fit that description a few times. She can turn around and charge him with sexual misconduct and that guy just got thrown into the system and he’s not coming out undamaged. And it’s that striking. He can get a signed affidavit from her saying I wanted to have sex, and she can still turn around and turn him into a wretched soul fast. And this is not because of the kids. This is because of the adults in the system who have totally lost their way. I have attempted to fix it here. I mean, I have actually expressed my concerns to our dean and provost saying "you have got to do better than this." I think our president has spoken out against the idea of this hypersensitivity, but it is very dangerous.
I will tell you, if you get charged with sexual misconduct on a campus, I don’t think the courts can possibly go there. In fact, the courts are overturning these decisions fast, but if you get kicked off a campus for sexual misconduct, good luck getting a job. You just spent two hundred thousand dollars to get a job and you are not going to get one.
Chris Martenson: Let’s go further then, that this idea of this correctness that is pervading all levels of thought. I’ve seen... I know you wrote about it, but this idea that there are ideas that are too dangerous to discuss. It is like the Lord Voldemort idea. Ideas that shall not be named, right? I thought that an important part of my college career was getting my mind expanded, and that was important to me. I had a pretty standard liberal arts education, but I was exposed to things that frankly were unusual and new to me, and I thought that was a good part of the process. Is it really to the point now in your estimation where we are... Are the minds as closed as they seem from the outside? Because I only get the news, right? I peer in from the outside, but it looks pretty atrocious to me sometimes just how virulently narrow-minded some of the arguments are.
Dave Collum: Yes and no. Here is the funny part, I think most of the campus is proceeding along, paying no attention. So for example, if you look at Yale, and you look at all the press it got, my guess is that there was a little pocket of kids who are screaming and the press was surrounding them and it looked like all of Yale was going bananas when in fact it was just a small pocket of kids who were going bananas.
So in some sense, campus life is just moving forward. On the other hand, any kid on this campus is at risk of that disaster. I was talking to a kid who is editor in chief of an online newspaper that pushes back against these things, and he actually said that there’s about ten virulent activists representing all the different causes, total, and that they all hang out together and they all support each other’s causes and they organize the campaigns. So it’s quite possible that the campuses are being disrupted by a pretty tiny minority of students. I don’t know if this... I am guessing, for example, in Missouri, I am guessing the race problems are worse than at Yale. That would be my guess just because of the region of the country. I just... it’s pretty mind boggling, but my biggest fear is the sexual misconduct. I am sure my kids can avoid being racist. I am not confident they can avoid having sex with drunk women. Fortunately, they are out of college now. I don’t know what I would tell an entering freshman male to do, besides you could be in a world of trouble. And how do you... you know, you can go abstinence I guess; probably some people think that is great, but that usually does not work, right?
Chris Martenson: It raises... You know, I have been doing this hazard story thing with my own kids too. My eldest, she’s twenty one and then I have a seventeen year old boy, fifteen year old girl, and when all of this police brutality stuff started really coming out, it’s pretty obvious to me that there’s a real problem, just a giant epidemic. And that even anything other than complete, immediate and full compliance, no matter how outrageous or how illegal, or how against your rights... I did not even bother teaching my kids their rights. There is no such thing as rights at this point in our country. Because even if your rights get violated, your only recourse is to sue the police in a civil matter. And if it’s really, really egregious, maybe the justice department will come in and whitewash the whole thing for you later. But it seems to me that this idea that we have rights... that all got really just atrociously eroded, and I’m wondering, where did that really come... Really, I have to say I think a lot of things went badly off the rails in our country’s response to 9/11 and it’s going to take a long time to work that out of our system, if ever.
Dave Collum: Yeah, certainly the Patriot Act, things happened since then. And a huge issue, which again, I talked about a little this year. A lot more, I think last year, is civil asset forfeiture. What a lot of people don’t know is that you could be driving down the road, they pull you over, if you happen to have stuff of value in your car, they can confiscate it. You say "no, that cannot happen." Yes, in fact it’s estimated that $2.5 billion has been confiscated without a charge affiliated, and the vested interest is that 80% gets to go straight to fund the police department that confiscates it. And so, there are notorious stretches of highways in places where you don’t drive down that highway with anything of value in your car. There’s video tapes of prosecutors talking about how to maximize your asset forfeiture seizure from the guy... one of these guys is sort of slobbering over the idea of getting a Mercedes from a guy and then they blew it and they missed the Mercedes and here’s what they did wrong. Stunning stuff. Bloomberg wrote about it and said... and the success rate of getting your assets back is very low.
And the problem I have is if they do it to me, my sense of vengeance would be so high that I would become blood of patriots pretty fast I think. And I don’t want to go there, but if someone stole my money, I don’t know how I would contain my anger. And by the way, I would have no... There would be no morality left in my response. The constraint would be fear of reprisal, and that’s it. I don’t know why more things like this don’t happen. You don’t have to be a medicated young teen to go nuts. And so I just pray no one seizes my assets, because I swear to God, for your sake and for the rest of society’s sake, I’m going to try to find a way to rectify that injustice.
Chris Martenson: Your dial settings include mild mannered college professor, and then there’s one more click of the dial and you go straight to vengeance.
Dave Collum: And you know, people should in my opinion. I don’t know what the appropriate response is, but I do know the appropriate response is not to rollover. That is not the appropriate response. Rolling over... I owe it... we owe it... did you ever read the Robert Dorner Manifesto? The LA cop who wrote a manifesto before declaring war on the LAPD?
Chris Martenson: Did he write on the militarization?
Dave Collum: Yeah, he wrote about the corruption in LAPD and then he ended up in a shootout in a house and died. But his manifesto was a compelling document.
Chris Martenson: I never did read that.
Dave Collum: Oh yeah, I cited it I think in last year's, or maybe the year before's "Year in Review". And he wrote about all the people in the LAPD and he said this guy is good, this guy is bad, this guy is corrupt, this guy is stealing stuff, this guy does drugs... he itemized his way through the LAPD, but what was striking... and so then he declared war and ended up dead, right? But what was striking was when you read his manifesto, he was not a loner, he was not isolated, he had friends, there was meaning in his life, and he just decided he had a calling.
Chris Martenson: That is interesting.
Dave Collum: It is an amazing story, actually.
Chris Martenson: That is interesting, yeah; I know I am sure... I did not pay enough attention; of course, the media cannot memory hole something like that fast enough. We need him to be a crazy terrorist of some kind, loner that is what we need in our stories.
And so yeah... this view from Mount Stupid, it’s been an incredible view. And I think for 2016—but I’ve been saying this every year for three—but I really think that obviously we’re closer to the day when we have to sort of deal with the consequences of our actions, and I mean that “our” broadly, the Federal Reserve's actions. I really think though that 2016, it would really surprise me if we escape without getting into some really hairy market correction territory. What do you think?
Dave Collum: I went to an investment conference in Vegas. I go to this conference each year with the Stansbury Group and give a talk. And Porter Stansbury, who I think is a genius, he’s a funny guy, and he’s got a bad rep out there. Someone hung a bad rep on him, but I think he is really smart, and he says in 2017 the emerging market debt rollover is going to max out. I saw the plots, I saw the slides and it was a compelling story. So, when the emerging market debt market goes down for the count and they start rolling over and insolvency starts showing up big time, then I think... so that could be the trigger. That could be like Fasby 157 when, I think that was the trigger for the mortgage market was the legalized... the accounting rules they put into place, all of a sudden the MBS world fell apart. I think the merging market rolling over in earnest will do it.
We are not even there yet. That is the irony. I think it is rolling over now, but we are not... we have not hit the peak rollover. Remember that iconic plot of the mortgage resets that got posted ten thousand times on the internet? There has to be an analogous one for emerging market data out there somewhere. I have not been able to find it, but it has to be out there somewhere.
Chris Martenson: Yeah, there are two things I’ve been tracking there. One is the sovereign debt loads, but also it is really the corporate debt. There is a lot of ink on that. Bloomberg has written pieces, Reuters, et cetera, so you can easily find out what the numbers are. It is really astonishing the amount of new debt that got taken on in the last five or six years, some astonishing number like four or five trillion dollars. All dollar denominated, which of course, think about it from Mexico’s standpoint with the Peso hitting brand new, all-time lows, or the Brazilian Real, or South Africa, it’s just stunning. So yes, a lot of... you know, with bubbles this big, all bubbles are in search of a pin, yes, I think that absolutely emerging market debt is a pin. Is it the longest pin out there? It might be.
Dave Collum: The other thing... someone said how bad off... I cannot even remember the asset class was going to be if there were a recession right now. It struck me that it is the very existence of that risk that probably brings in the recession at some level. So it’s the top heaviness of the credit system.
Corporate debt is not only huge, and you hear about all the corporate cash on the balance sheet, and every year I try to go into that. They got a lot of cash on the balance sheet; they got way more debt, right? That is like saying I have $100K in the bank and $500K on my credit card; I’m rich because I got $100K, right? It just does not make sense. And they’ve been using it to buy back shares and LBOs, so that the creditors are buying up the companies essentially. And corporate earning profit margins have hit all-time highs, and they’re serious mean regressing things. Profit margins don’t stay at all-time highs for long. And so all of a sudden the profit margins will shrink, the PEs will soar, and of course they stop buying back stocks when things go to hell.
And the support underneath the buy backs is going to go away, so I just don’t see how this thing doesn’t unravel in some stupendous sort of way that I hope I’m out of the splash zone.
Chris Martenson: You and me both, and I guess we’ll just have to stay in touch because I do have a buy list of things I am interested in owning. And I’m going to be as patient as I know how to be on all of this, but I haven’t found anything compelling to invest on the long side in a while, except for silver. I have bought silver in the past year, and I bought a little more gold a little while ago, but that’s just sort of nibbling and It’s only to make me feel like I have some sense of purpose in life doing something.
Dave Collum: I bought gold all year for the first time since ’05. So once I got... ’05 I said okay, I have enough gold, then I was feeling very rich in 2011, and then I got beat up, but I finally started buying again. It has not made me look terribly smart yet, although it is up fourfold. Are you buying miners?
Chris Martenson: No, not yet.
Dave Collum: I will tell you, their inability to make money is epic. I got to talk to the CEO of Seabridge Mining, and he said the entire industry is filled with disasters. He might be one too, for all I know, but I have a terrible time buying in gold minor because they had gold running at $1,900 an ounce and they couldn’t make money. And if you can’t make money at nineteen hundred an ounce, you are in the wrong business.
Chris Martenson: That is why I avoided all the shale players back when they were not making money at oil at $100. If you did not like them at $100, you are going to hate them at $35.
Dave Collum: I blew that one. [Laughter] I held on... I have been white knuckling it all the way down again. They did well for years. I bought 'em low, but...
Chris Martenson: I know. It was the negative free cash flow that bothered me. And so they were basically spending—even at the peak of it all in 2014 before things rolled—they were spending a dollar fifty in capex to get a dollar of new revenue, and I hate business models like that, particularly when your shale wells deplete eighty-five percent in three years and you’ve been at it five years. You should be hitting some sort of steady state somewhere in there where your capex out and your cash flow in are balancing out and it makes money. I did not see it. So that bothered me.
Dave Collum: A bright side to that story is about a year and a half ago I went to University of Montana/Montana State. Both schools, my colleagues in chemistry were bitching about the fact that the state was just hoarding their revenues and not spending it. They thought that was wrong and I kept saying are you sure? Because governments that don’t spend money are pretty rare and pretty special. And I bet you right about now they’re going "not spending all that money is looking pretty sound right about now." Now Alaska supposedly gets ninety percent of its revenues from oil. Wrap your brain around that one.
Chris Martenson: They are going to have an income tax for the first time this year.
Dave Collum: Yeah, and they are going to... as I said in "The Year in Review," they can see bankruptcy from their front porch.
Chris Martenson: Yeah, that is right, yeah. [Laughter]
Dave Collum: I love the front porch metaphor now; I'll put anyone on a front porch.
Chris Martenson: Think about the whiplash those poor people in Alaska have. Those guys out in their cabins with their big beards, you know, they got a Grizzly out back and they’ve been getting these checks every year, and instead of a check they get a bill. That is a big turnaround.
Dave Collum: I know, there’s a lot of rude awakenings coming and it’s going to be painful. The youngsters, the twenty-somethings in the job market are getting paid squat and now we’re about to hit a down turn. So here you are earning nothing, or unemployed, and now we are going to hit a downturn. You can say "why are we going to get a down turn?" Because we always get a downturn, right? It is just like spring follows winter. You always get downturns and the next one is coming off a meta stable upturn. The whole thing feels wrong, the narrative is wrong, the plotline is wrong, and the only thing that’s right is that they were able to pump assets. That is the only storyline this whole thing is based on.
Even that, I go at in the review where I talk about the farm. I use a farm metaphor where I point out that the Fed seems to think if they can jack up the price of the farm, they will jack up the output. And there’s not a shred of evidence that jacking up the assessed value of the farm jacks up the output. And if you don’t jack up the output, you’re still putting out bushels of wheat, you’re still putting out cows, you’re still putting out milk and if somehow you sold the farm to someone else, someone else just got a horrendous deal buying the farm. You have not increased anything; you have just increased the price.
Chris Martenson: Well that is going to be a hard sort of thing for somebody like Bernanke to understand, or Yellen, both of whom have not spent a lot of time running businesses, they have never owned a farm, so I think your metaphor is completely lost on them. That is probably not going to work out; you will have to come up with another one. Maybe using textbooks, I don’t know. But at least I know you’ve got one good read on your shelf, The Courage to Act, it’s going to be amazing. I hope you read it, because I am never going to, so I need you to tell me what is in there.
Dave Collum: I am not reading it.
Chris Martenson: [Laughter] I cannot bring myself to do it, I just can’t.
Dave Collum: I have heard it is bad too. I would read it if someone said it is a nice story, or whatever. I think he made a mistake writing it by the way. Because he had been able to keep himself shrouded in mystery and then all of a sudden he comes out and tells what he was thinking, you go "Really. Are you kidding me? That is what was going on in your skull?" So I think he put blogger porn out there on the internet for everybody and I think he should have shut his mouth and been inscrutable.
Chris Martenson: Like George W. Bush... where did he go? Nobody knows, he is out painting or something, he just disappeared, nobody wants to hear him speak, and that is fine. You know.
Dave Collum: That is right, he’s looking pretty good right about now.
Chris Martenson: Well, all right, you know obviously I could talk to you forever, and we should do this again. I don’t know if we have to wait to have a "Year in Review" to have a podcast because you and I could just go on and on and on, on any one of these areas. And of course, this is going to be a fascinating year. I am reasonably convinced there is going to be a military accident somewhere in the Middle East; I am reasonably convinced there is a financial accident coming. I think Europe’s straining and looking like it wants to burst apart for a whole host of extraordinarily good reasons. Japan, who knows, that’s a slow motion disaster going on there in all sorts of ways, so lots to talk about. And love to have you back.
Dave Collum: Yeah, hopefully by then we will be able to see the consequence of the Syrian refugee crisis, because I think that might be the story of the year, and I don’t think the consequence... you’ve got a million and a half Syrians inside Germany and it’s not cold yet.
Chris Martenson: Yeah, I was talking... I was sitting next to a woman at a dinner, her husband’s at the UN, she is a reasonably well known newscaster of a country, she is from Serbia, and she almost went to tears. This was a nice dinner, and I was like if you don’t want to talk about this, please just forget I ever asked this, but would you be willing to talk to me about what’s going on with the refugees? She immediately wanted to talk about it, almost in tears saying when she was last back in Belgrade she did not recognize it at all because her beautiful city, small, very small country, not that many people. She said every street corner had four or five twenty-something year old Syrian men on the corner who had nothing else to do, and she did not feel safe, and the culture was off... just every... just that they have been overrun in some way and she was very, very upset about it. And it was a cultural sort of an insult, it was a "what are we going to do" practically, how do these people integrate? They don’t want to. Brussels was telling us we have to take these people, Brussels was providing no money, but a lot of threats, and on, and on, and on it went. So it was obviously a very important flash point and I understood what she was talking about. I live in a town of two thousand, and there were some towns we have heard about of the same size as mine that have that many refugees housed in them now. I think that would be a little bit troubling to be honest. For me, personally.
Dave Collum: Well for you and I the equivalent might be if we had one of these horrific downturns and New York City emptied up in upstate New York, right? Upstate Connecticut. And all of a sudden you could find yourself living in a town full of people who... you know, it’s one thing when it’s an immigration where the person says "look, I wish to be in the United States" or "I wish to be in Germany." It is another thing when they just flush out of there. I have been trying to figure out what the density of young male really is, because some of it could be propaganda. But if it’s really all twenty something males, there’s nothing... there’s nothing more dangerous than a group of twenty something males. From any culture, that is a dangerous group. And if literally, if many, many millions of twenty something males from a culture that does not really agree with Western Europe had flooded in, it is... that’s not Ellis Island, that’s a very different situation.
Chris Martenson: Yeah, and not just males who flooded in, but they flooded in from the same country that maybe you bombed.
Dave Collum: That is really a very touchy little detail isn’t it?
Chris Martenson: Kind of a touchy detail there, just a little thing there, because you know, I also have a vengeance setting on my dial, but if you basically bombed my country and hurt my family, you have a problem on your hands.
Dave Collum: I would be getting even. I just stated that before. I would... you know, if I were in one of those countries, I would have "terrorist" written on my forehead I think.
Chris Martenson: It is so human, and it is understandable of course, that the West seems incapable of understanding that the people don’t appreciate our fine attempts to transform their country using Raytheon hardware. It is just such a tone-deaf moment of western journalism. It is astonishing. But here we are, and I think that’s going to be a flashpoint potential. Again, it is just one of many, many pins I see out there that could burst our current illusion of prosperity. So with that, let’s do this again sometime soon.
Dave Collum: Sounds good.