Any model based on an assumed 7.5% return is doomed

Any model based on an assumed 7.5% return is doomed
Photo by stevepb (Pixabay)

Whether or not you’ve had time yet to plow your way through David Collum’s excellent 2016 Year in Review, our annual podcast with Dave always brings additional color to light — and this year’s is no exception.

Any model based on an assumed 7.5% return is doomed. As you get low returns, our pensions get in trouble. And whenever the returns shoot above the norm they say “Well, this is excess.” And they scoop it up. So every time they are above water they scoop it up. How? They stop contributing. They start using the money for other stuff. Think of a sine wave oscillating about the mean — even if you guessed the mean correctly, if every time it is on the high side you skim it you’ll never get the mean; and that’s what the pension managers have done. And companies just stop contributing to pension plans and started calling the retained funds “profits”, which causes equities to go up and makes the thing get out of whack.

We’ve got a recession coming, one of the full-blown kind. And I don’t know what will happen. My prediction is that it is going to be a bad one. But what a lot of people don’t realize is that is when things start unwinding, counter party risk kicks in and faulty business models start showing up as bad and they start collapsing. All the accounting problems that built up behind the scenes so that the people cook the books to get their bonuses up and they made these crazy assumptions — under the protective cloak of a recession, CEOs can get away with announcing anything because they say Hey, don’t look at me. It’s a recession. So they write down huge blocks of cost. This actually exacerbates the downswing because people are dumping all their cooked books and getting all the fraud off their books so they don’t have to fess up to the fact that they cooked them. In actuality, they’re getting ready to then start building up their stock options again from some bottom somewhere.

Gates Capital Returns 32.7% Tries To Do “Fewer Things Better”

Gates Capital Management's Excess Cash Flow (ECF) Value Funds have returned 14.5% net over the past 25 years, and in 2021, the fund manager continued to outperform. Due to an "absence of large mistakes" during the year, coupled with an "attractive environment for corporate events," the group's flagship ECF Value Fund, L.P returned 32.7% last Read More


This is going to unwind. It has to unwind. This is like a person who weighs 850 pounds — they’re not going to make it into their 90s, right?

Click the play button below to listen to Chris’ interview with David Collum (49m:26s).


Chris Martenson:     Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson. It is December 21, 2016, so happy Solstice everybody. It is perhaps fitting that we are recording this podcast on the shortest day of the year, because what things can only get brighter from here. At least physically brighter. Perhaps not financially or geopolitically, but that remains to be seen. Now, in order to assess where we are headed, what could be better than a gigantic romp to where we have just been? Continuing with our annual tradition we have got the best year in review in the business thanks to today’s guest, Dave Collum.

For those of you unfamiliar with Dave, he is professor of chemistry and chemical biology at Cornell University, where I got my MBA. And in addition to his academic interests, David authors an annual macroeconomic assessment titled the Year in Review. Great title and it is, hands down, listen it is the best synopsis of anything that mattered during the previous 12 months. I am super excited for today’s podcast. Dave’s latest year in review can once again be found in full and in all its glory on I’m excited to have him with us now, live in order to expand on his excellent insights. Dave, thank you for joining us again this year.

Dave Collum:            Hey. I’m glad to be here. I actually was just editing the last of the galleys for this thing for Adam so it is kind of fresh on my mind. This time of year my mind is buzzing with this annual review thing. I almost can’t speak without citing it now.

Chris Martenson:     It’s such a huge work and I have to thank you on behalf of everybody for taking the time to put pen to paper or finger to keyboard, as the case may be, and delivering this yearly review. This one- — I think there was so much material it is probably your longest ever.

Dave Collum:            Actually presented a problem for me because when I started in January I knew that by – first of all, I knew the election would overwhelm the year. I had written these things through previous elections and never had that sense, but this year was pretty clear. And then I also knew that there was a dozen players, most of them Republican, but a dozen players who by November 9th would be irrelevant. They would be footnotes. So, I somehow had to keep track of all of these different players and what was happening, and then knowing that they would be relegated to footnotes by the end and that there would be one probably highly polarizing figure left standing and, as I refer to it, for us to be chalk outlines around this person. And as we now know, it is Donald Trump.

Chris Martenson:     And that’s so amazing. You are writing this year about themes and this year’s theme that obviously deserves a lot of attention where you started is the presidential election. I want to start there; but listen, with failures and mendacity everywhere, let’s start with the easy prey. Just how badly did mainstream media screw this one up?

Dave Collum:            Well, it depends on what their goals were. They screwed it up in unimaginable ways. At the beginning of my year in reviews, I always come out and support the notion of conspiracy theories.

Chris Martenson:     That’s right, yea.

Dave Collum:            And I denounce those that use conspiracy as a pejorative, because really, men and women of wealth and power conspire and, to anyone who doesn’t think that is true, is an idiot. And this year with the election, the Wikileaks, the curtain got pulled back so anyone who can somehow get through 2016 believing that conspiracies don’t exist is just a complete buffoon, right? So, I open up with that. The press’s role in the election this year was just staggering to me. It was obvious, because as Trump got more and more powerful, the press became more and more blatant in their attempt to engineer the outcome of the election. And then by the end we also, thanks to Wikileaks — we knew in advance of that, but we got confirmation that the press was completely in cahoots with the DNC.

Chris Martenson:     Well, absolutely. They got a lot wrong, obviously. I want to get to how they missed the most obvious thing, which is what the appeal of Trump might have been. But first, I was just driving around today. I had NPR on for a second. There is a little fresh air going. I am not listening to it, because I am drawn to it. I had to turn it off, because they had the chief political correspondent from Politico on there talking all about just how bad Putin has it out for the Clintons, and how Mrs. Clinton is pretty sure, Hillary is pretty sure, that Putin did something and they are just running with this whole “Russians did something with our election” meme with zero evidence, but this is helping the people – some people on the left, feel better, because they don’t have to look in the mirror and say, what went wrong? How did the DNC not only shoot itself in one foot, but probably both feet? Instead of soul searching, they are going for who can we blame. And I find this continued demonization of Putin, which was a big theme for 2016 — I find this to be a really dangerous game and I am not really sure who is driving that ship, but it is just, I think, the people who are willingly running with that ball at this point in time as a means of preventing a good, hard look at what went wrong for their party. I find that particularly troubling at this point, because it is not dying down. Whatever mistakes were made are being continued. It is sort of a doubling down on the mistakes, as I see it.

Dave Collum:            For three years I have written, by western standards, fairly favorably about Putin. Now, I am a Reagan Republican, so this is not something I came to easily, but I think Pat Buchanan said it well. Putin is a Russian Nationalist and so – he is a hard ass, right? He is a tough guy. He is someone not to be messed with, but I think that he possibly is who Russia needs running that place. I don’t know. The demonization of Putin to me is very scary as you said. The irony for me is throughout the election I said Trump was going to [unintelligible] meanwhile the Democrats and Hillary were demonizing Putin in a way that, to me, was much riskier. To me, I think Trump has not – has very few militaristic intentions in him, which is ultimately what made me think pretty hard about voting for him, as opposed to, say, a third party. And I think picking on Putin the way we did was, as you said, pushes a little towards the brink; and if they keep doing it they could get us there. Fortunately, I think Trump has no interest in pushing around and in the end maybe we will find out that is a problem. But right now I would like to stop bombing the Middle East. I’d like to stop sticking a stick in Putin’s eye and Hillary scared the hell out of me, because she looked like she would happily do both.

Chris Martenson:     Well, she said right in the second presidential debate, which was a full deal killer for me for her, she would support a no fly zone over Syria, which, if you understand things, US has no UN mandate to oppose such a thing and Russia is flying planes around the airspace of Syria legally. She was openly saying, “oh yea, I am all for an act of war with Russia,” which I am thoroughly on record as saying bad idea. But still, that meme is running somebody somewhere; is still saying “we have to get Putin in a box” and they are trying to put Trump in a box, which, I know this is a little off year in review, it feels to me like 2016 — that theme is continuing and I am not sure to what end and nobody has been able to explain to me why we should hate Putin or Russia so much at this point. They feel like more natural allies to me at this stage of history, given where China is, than an enemy. But somebody has decided they are the worst thing since Spam in a can.

Dave Collum:            Yea. You know, we pried open the Russian archives after the Berlin Wall came down. One of the things that supposedly came out of that was the fact that much of what we were told the Russians were reactive, not proactive in terms of the West and that that that their view is that they were simply responding to our actions, and I think that is more true now than ever. I watched a couple of interviews of Putin, obviously with a translator, and I listened to what he had to say and I had the sense that he understood the risk and he understood the Middle East better than we do. Maybe our guys who have top security clearance understand the Middle East. The American’s don’t. I am a little surprised at how many people just accept at face value that Putin is the enemy. He has been demonized. I haven’t seen anything that tells me that he is actually a serious threat. The stuff going on in the Ukraine, Crimea — we triggered that. That was us. We were moving pawns around the chessboard in places that Putin had to defend.

Chris Martenson:     Yea, and to this day it still describes the annexation of Crimea when Crimea voted well over 90% in a fair, free open election to rejoin Russia, who by the way it didn’t seem odd to me, and maybe this is my difficulty, having context; but the Russian speaking people and Russian cultured people in Crimea who since 1954 had their language and their customs banned and otherwise down trodden on by the Ukrainians, that they didn’t want to join and stay with the people in Kiev who were openly saying let’s kill all the Russian speaking people. Somehow, they decided when they voted that they wanted to vote to rejoin Russia, who were saying “oh no, we would like you to survive and live and thrive.” It was such an easy choice. I don’t know how you still call that an annexation, but everybody runs with that from NPR to the National Review to the Brookings. Everybody agrees that was a horrible annexation; it was a big crime. But again, it is lacking that mirror perspective, because last I checked Russia hasn’t’ attacked anybody without trumped up evidence for instance, for example.

Dave Collum:            I’d like to know – again everything is in terms of what I wrote. Things I really care about, I wrote about. I made sort of facetiously this statement about this huge American casualties caused by Syria. I said, I am working on where those are. We have destroyed Syria. Really, Aleppo. Martha [?] asked somebody what happens if Aleppo falls and you look at Aleppo and you are like there is no Aleppo left. It has fallen. It’s gone. It’s a city that was thousands of years old and now it is just a pile of garbage. We kind of did that. If I were hoping for Trump to do something, I can imagine him standing up there and saying “look guys, you have oil over here. We want to buy it and, provided you keep selling it to us, we are good to go” and if you want to think about, you know, US national interest, you could add to it. “If you refuse to sell it to us, then we are going to come over and turn this place into a sheet of glass, but otherwise we want to be your customers,” right? And you know that notion showed up when I read about some German oil expert who was chatting about how we were fighting the Arabs. He said “I don’t know why you guys keep bombing this place. We just buy the oil.”

Chris Martenson:     Couple of different approaches, right?

Dave Collum:            Right.

Chris Martenson:     Same thing. China is all over the world with its magic checkbook; something I have been noting for awhile. That is part of it. Let’s try to connect economics to what we were just talking about. So certainly listen, the whole fake news thing, the Russia angle, all this stuff my opprobrium, I am going to heap on the mainstream media in the United States, is this – they clearly were revealed to have not been doing their jobs. They were not impartial arbiters. They were not providing, essentially, context. When confronted with that their next strategy was to say “let’s see if we can drag all of our competitors down to our level” rather than saying “how do we up our game,” right? How do we become relevant and provide stuff that people want, which would be news that is accurate in some way. With all that aside, I am still wondering how the mainstream media and many political operatives are missing the explanation for the Trump phenomenon, which I think I am going to draw from your recent piece, part one of the year in review and “the wealth for middle class households has dropped 30% since 2000. One in five kids lives in poverty. 46 million folks are on food stamps. 20% of the families have nobody employed despite the 4.9% unemployment number. And almost 50% of all 25 year olds are living with mom and dad unable to translate that self-exploration major into a job. Half of all American workers make less than $30,000 a year and 62% of Americans have less than $1000 in savings.” To me that explains a lot, and still that is not being talked about.

Dave Collum:            Yea, and you know the problem with those numbers is they are not numbers that you can – they present a dilemma. You defined two things. You said there is a predicament and a problem. What did you say?

Chris Martenson:     Problems have solutions, but predicaments just have outcomes.

Dave Collum:            And predicaments don’t.

Chris Martenson:     You have to manage the outcome.

Dave Collum:            And that’s a predicament. I remember I was struck by that when I listened to – I don’t remember whose podcast it was, but that is a predicament when you are 55 years old and you have 17,000 dollars in savings you are in a predicament. And the people listening to this who are sitting there going “wait a minute, I am 55 years old and I have $17,000 in savings.” You have my condolences. I don’t know how you are going to do it. And we are not going to be able to grow our way out of this. This reminds me of a business that has basically run out of cash. Right? It doesn’t have a mechanism to function now. And so that is where the savers are and you get these numb nut central bankers who insist our goal is to drop rates to get people to consume, and it is clear that the consumers (not I think) they really now get it. I mentioned that Larry Summers said they got too much debt. Larry Summers has totally ignored the fact that they are also looking at their retirement accounts and saying “I don’t have anything.” And therefore, how can that consumer go and buy stuff. You can drop rates to whatever number you want and they are saying I can’t spend anymore. So that is a predicament.

Chris Martenson:     Provides a lot of the fuel for the populace uprisings, which we are seeing all over the globe at this point in time. And my macro explanation for this, Dave, is that global growth is over. What we used to have; we fashioned all of our policies, fiscal policies, monetary policies, fiscal expectations, dreams, hopes, all of that was fashioned when we had 6.7% nominal GDP for 3.5 to 4% real GDP. Those days are gone and they have been gone arguably for a decade; and that should be enough time, but people haven’t gotten their heads around that yet, and so we have that predicament of dropping rates, goosing the markets, printing like crazy and still that magic growth genie won’t reappear, no matter how hard we rub; and so that, I think, is creating some of this discomfort that is showing up politically as people are going “wait a minute, you guys, the story seems to be broken. You just keep turning the crank on this machine and all that seems to happen is you guys get richer. My life gets harder. I am not sure I am down with that story anymore.”

Dave Collum:            Yea, the other – in some sense all of what you just said at some level reduces down to a demographic model, too. So we have this situation where the boomers are looking to retire and there’re too many of them and not enough highly productive people younger than them. So, there was this – while we had this huge pollus of boomers all pulling on the oars, all pulling the economy forward and not demanding freebies, right? What is a freebie? I don’t mean to say they haven’t worked for it. It is a time they weren’t drawing off the system. They were producing and they were consuming, so the economy was rolling forward. Now those boomers, they haven’t started yet, really. That is the miss – that is a misunderstanding, but they are going to start to demand that they get goods and services without pulling on the oar. And I get lost –

Chris Martenson:     It dropped.

Dave Collum:            Oh, okay. Where did it drop? I have no idea.

Chris Martenson:     We are going to have to back up a little bit. It dropped. I can’t remember.

Dave Collum:            I was on a conference call one day with a student of mine and we talked for about 20 minutes and didn’t realize no one was on the other end.

Chris Martenson:     So, let’s just rewind here. Do you remember what you were just talking about?

Dave Collum:            Well, you just give me a – restate a question. It is hard for me. I don’t know where it dropped. I saw it reappear. I don’t see a drop.

Chris Martenson:     Alright. Let me think where we just were. I was looking at that. We are talking about this predicament we are in.

Dave Collum:            Talking about consumers not being able to consume.

Chris Martenson:     Consumers not being able to consume.

Dave Collum:            Did you hear me ranting about the demographics?

Chris Martenson:     No. We didn’t quite get there, yet. You were talking into thin air at that point in time.

Dave Collum:            Yea.

Chris Martenson:     Let me think of how I am going to pick this up, then.

Dave Collum:            Want me to just start with a new question and I will pick it up?

Chris Martenson:     Yea.

Dave Collum:            Then you can edit off the tail wherever it makes sense.

Chris Martenson:     Right. You were in a great place. I was really excited for the answer and I just spaced, because I was calling you back. I should have logged it. So, it was people. Not, you know — you apologized for the person who had $17,000 in savings and was retiring. And we are talking about the consumers. You drive stuff all the way down. Alright, so we are going to start here. So Dave, you know another part of this dynamic then. For me, is that because these interest rates got driven down, and you say because the Fed wanted to spur consumption. What has really happened, though, is that they prevented interest payments. About a trillion dollars in interest payments have no longer flowed from banks, in essence, to savers and it is a savings account. So, these poor young people out there who have record amounts of student debt, who are coming into what is inarguably not an okay job market with fairly depressed wages and all of that; but also these young people are the ones who not only do household formation, but business information and many times the seed capital for that business formation as parents and grandparents who, tada, are missing about a trillion dollars in interest payments. And so, that is a trillion missing from business formations. So, you know I’m wondering all of these things are data numbers that are in your report, but if you can add to that you are a professor. You are interacting with these young people today qualitatively. Quantitatively, how are they perceiving what seems to be a situation where the deck is pretty well stacked against them?

Dave Collum:            So again, I have the advantage of working with students who, because we are at Cornell, they certainly have a better chance than most, right? Independent of what they study, on average they have a better chance than most. What we see, I think this is generally true, when the economy turns south, when things start getting dicey and people know it even if the Feds, and the Fed in the most general sense Feds, the authority figures tell us everything is rosy when it knows it is not. What you see in a college campus when that is occurring and I actually went to college during one of those times it was in the middle of the 70s. So, we had double digit inflation garbage going on — is that the kids start choosing much more practical things to study. So, they actually make the appropriate decision; and that is you find far less you know Henry Blodget went to Wall Street on an English major. None of our kids are counting on that now, right? You see a flood towards practical issues. There is a bit of a crisis going on on some of the campuses. The humanists, I think, are feeling kind of an existential risk, because I think you have a lot of kids heading off to college, and their parents are saying “no, you are not going to major in that subject. I am not spending $200,000 for you to major in,” and I won’t name one because I have colleagues who are in it. Go ahead and take a few courses in it, but you are trying to get a self-extinguishing loan here, right?

You are trying to get a career to pay off all this debt. Don’t major in something in which there will be no job and the parents are pushing it. The kids are realizing it. You tend to see an increase in medical students, for example, because that is a pretty dependable career. Why applications go way up because kids who majored in the wrong subjects do a do over through law school, because anyone can get the law school, right? From any subject, I should say not anyone can get there. You say “now I have a major in something that can’t get me a job. I will go to law school, then. I will have a job” and 10% of graduating law degrees do law and the rest do something else. No one really knows why. You see a pragmatism way up here. The social pressures that appear to be totally unpragmatic on campus.

Chris Martenson:     That sounds perfectly normal and rational, then. There is some pressures out there and people respond appropriately. So let’s turn to an organization that lacks that particular skillset — the Federal Reserve and other central banks and I guess I want to back into the discussion of these central banks because, look, regarding equities being historically and wildly overvalued, you have got a great piece in the Year in Review Part One about that. You noted in there that a 76% over valuation is regressed to the mean by a 43% correction, which “will be as pleasant as baptizing a cat.” I love that line. That is probably where we are going to get to.

My preferred version of where these markets are — you had another line, which captures what I believe to be true. You said “it is suggested that central banks in programmed investing have pushed a wall of money at the markets.” So, Mark Spiznagel from Universa investments — you have another quote that I think ties this all together. He says “markets don’t have a purpose anymore. They just reflect whatever central planners want them to. Why wouldn’t it lead to the biggest collapse? My strategy doesn’t require that I’m right about the likelihood of that scenario. Logic dictates to me that it is inevitable.” So, pull all that together and we have got these programmed investing computers that are easily shoved around, if you have a willing non economic participant like a central bank that is willing to lose a few 10s of billions by just shoving them into markets. Maybe the central bank of Switzerland, right, to get non conspiratorial around it. Here is one pushing with a balance sheet over 100% of its GDP, a good chunk of it in equities; the Bank of Japan doing the same thing. So, that sense of markets really being just now a reflection of what the central planners, AKA the central banks want, really feels to be badly out of step with reality. But there are a lot of people out there who sort of have taken the bait and said this is the new normal. This is just how it is going to be. We can trust them. What is wrong with that view?

Dave Collum:            How about a simple answer – it’s stupid.

Chris Martenson:     Put that on a t-shirt. It would sell.

Dave Collum:            I had the luxury of having dinner with Mark Spiznagel about a year and a half ago, and we talked about the 09 bottom, right? You and I, I think have talked about this before, where the markets were collapsing and to the world it felt like it was hell’s gates opening up. But the fact of the matter is, if you look at traditional valuation models as the dollar is banging around 6700 by historical measures, that was fair value. It was fair value using equity market to GDP ratios and the equity price to book value, things like that. Now, I am a big believer in thermodynamics, which I bet you are, too, being a science system – eventually you find that sort of thermodynamic minimum. Another way of putting that is markets are notoriously mean regressing, so they will get way over valued. They will stay way over valued, but eventually they will regress back to and through the  mean; and you mathematically have to spend equal time on both sides. So one of the things, we are never going to get through it and go to the other side, is dreaming and, unless you think that we are not going to regress to the mean ever again and it is an infinitely sustained prosperity, which is close to the 1929 quote of Irving Fisher, then at some point in our futures is what I call a mean regression.

Chris Martenson:     Emphasis on mean.

Dave Collum:            There is a quote. I paraphrase Hussman, someone said it so clearly and it, just to me, it captured the essence of everything you just said and that is, if you pay above the historical normal prices for assets, you will get below the historical norm returns. I cannot say it simpler than that. And so, the question then becomes are we above the historical norm? People can debate that, but according to every valuation coin that composites the short model that I use this year, we are looking at about a 50%. We are looking at the market cutting in half to get to the mean. And I don’t need to know when that is going to happen. This gets back to you and your – I read your book Prosper. You are not planning for a specific point in time. You are planning for something that feels like it is going to happen and you just gotta be ready for when it does. To the extent that markets are mean regressing, I don’t need to know when. I just need to know that if you buy way above normal prices you are going to get way below normal returns. I will sit on cash, thank you very much. And I am. And actually, in ‘09 I started buying equities at fair value. So I started buying very daintily in ‘09 and I bought some tobacco stocks that I liquidated a prudent fund that I had and I did this for about a month. And then it bounced off like a golf ball off of a car path.

I was talking Spiznagel. He said that is exactly right. We spent weeks at fair value.

Chris Martenson:     Weeks.

Dave Collum:            And, you know, we are supposed to go through fair value. We are supposed to spend a handful of years below fair value in a real correction. And we didn’t and that is the Fed. I am saying okay, it’s coming. They were able to put a cork in it, but the pressure is building again. So, I am sitting in cash. My diversification, by the way, is not assets. I am very undiversified in assets. I am diversified institutions. I have a lot of different accounts and they are spread around to different types: Charles Schwab, Vanguard, local bank, Citigroup. I am all over the place. I got about 10 different accounts.

Chris Martenson:     Yes. I do, too. And I do that because I don’t trust any one institution and you do it because…?

Dave Collum:            Collapse. That’s right. We haven’t’ even talked about bail ins. I don’t talk too much about the bail ins this year, because they were a big topic last year and I don’t want to be a broken record. Your readers know this. Bail ins are this notion that you know that instead of making the sovereign state bailout the banking system, we will let the creditors bail them out. What the average joker doesn’t know is that you as a depositor are a creditor and you are going to give up your wealth, just like the Cypriots did when their banks got emptied on a bail in. So, I don’t know if I trust the $250,000 cap or not that they say above that. You can lose your money. But since ‘09 they put a lot of legislation to position that makes bail in – see when ‘09 hit there were legal loopholes, there were legal weaknesses I think to actually solve the problem. And I think they put in a lot of legislation to make the bailins doable. And that means, therefore, that when the time comes it is going to be very easy to say “oh, by the way, you just lost half your bank account because, well, this is a crisis and you have to pay your fair share.” And I have no intention of paying my fair share. I am attempting to avoid that part.

Chris Martenson:     Yea, the bail ins could strike at any time. Certainly, something I talk about a lot and here is how I think all this, a lot of this, ties together for me. My macro analysis says that we are at the terminal stages of the grand debt super cycle. There is not a lot of choices at the end of one of those. I am a big Vonmeses[ph] fan for this one big quote, which says you either voluntarily abandon that credit cycle or you risk facing the catastrophe of the currency system involved. This explains to me why I think the central banks are so averse to allowing any sort of corrections to happen. It is why in ‘09 we spent weeks at fair value. They freaked out and either hubris jumped in and they considered themselves to be masters of the universe; we can fix this and that is our job you know superman capes and everything, or they are deeply afraid of what happens if that super cycle of debt really does draw to a close and we couldn’t face that, so here we are. And it feels increasingly desperate to me, knowing that we are now – we have a great quote in there from Grant Williams, one of my favorite commentators and analysts saying “we had a central bank intervention on average every three days since the crisis started.”

Dave Collum:            I have another quote I like even better from Grant. Grant is an adorable person, right? Grant is – I actually one time drove five hours to New York City just to spend the afternoon with Grant. I knew he was in New York City. he and Simon __-[00:34:09] and I, we just sat around for four or five hours and chatted, because it was worth that drive for me.

In any event, Grant has another quote. He says “there is a difference between hadn’t and hasn’t.” That is really important, because we keep saying “well, nothing happened.” It hadn’t happened. He says “no, it hasn’t happened” and that is a profoundly importantly linguistic distinction. It hasn’t happened, yet. But that is not to say it is not going to.

Chris Martenson:     Right. Well in that super cycle either you keep it going or you don’t. Those are basically the choices at this point. Realistically, where are we going to double and double and continue to double our debts down here? You noted that the average rate of debt accumulation in the US government is around 8% a year. Something like that, which means it is double a rule of 72 what every nine or 10 years under that rate? Nine years I guess?

Dave Collum:            Nine. Right on the money nine, right.

Chris Martenson:     Yea. So, that is astonishing. So, what are we going to do? Keep doubling our debt every nine years? I mean, eventually you would think thoughtful people would go “listen, do your emergency stuff for six months, maybe a year.” But that should probably be the extent of it, right? Here we are on our eighth year of emergency stuff, right? No end in site and obviously we are trapped at this point in time. What is your sense of having collected all of these dots that other thoughtful, maybe large money people, are starting to really understand that this – that there is an unworkable plan here? There is no exit to this box that we are in?

Dave Collum:            Well, there is necessarily an exit. There is always an exit. You know, the system will dust itself off and move forward. But the exit — sometimes you don’t want to be involved. The corrective measures can really stink. And so, I’m not as ready as you. Let me just make that clear. I was trying to remember back when we first chatted. You were only part way through your Crash Course. And I was thinking about this today, knowing we were going to be chatting. I was thinking about the fact your Crash Course was like the movie Field of Dreams, where you built it not knowing where it was going to go, right?

Chris Martenson:     Right.

Dave Collum:            And you just felt this terrible need to lay out the case and you know the drop of water in the in field that becomes two drops, becomes four, becomes eight and then eventually you fill the stadium with water. But you know, five minutes before the stage full of water is just a puddle and that is the law of the exponential, right? That Berkeley professor — what is his name? You know his name. Albert something, who talks about the law of the exponential. The blow off, right, the exponential that finally blows up. It happens so fast in the final stage that it is very unpredictable, because right up until that point you don’t even see it; and then bam, it is like an explosion. Never saw it coming. You just end up with, you know, shards of stuff in your forehead.

Chris Martenson:     Yea, you know Mr. Bartlett actually, Al Bartlett — I gave a talk in the Crash Course in 2009 so I just finished it and I’m out. And I am in Colorado at a nice auditorium. About 300 people showed up and he was one of them. He showed up, so I gave a talk on exponential to Al Bartlett. It was the most awkward moment of my career.

Dave Collum:            Probably.

Chris Martenson:     I really wasn’t comfortable with it.

Dave Collum:            Find that talk in case you haven’t seen it, because his talks on the exponential are really good, too.

Chris Martenson:     Oh, fantastic. A well-oiled machine of a talk, it is so good. And just inescapable in its conclusions. And so I feel like it is a lot of shenanigans and dancing to figure out how to avoid – look we can’t just continue to expand debt at 8% when the economy is growing at 4% or less, right? It just doesn’t pencil out and every – all well meaning people know that. And the only way you escape that over time is by dropping interest rates lower and lower and lower. And that works until you hit zero and that is where we got to, and you dance around with negative rates and that turns out to be even more soul crushing than zero. So, they backed off and we’re kind of flittering around at zero or just north of zero, but there is nowhere else to go on that particular story. And so, to me, you know, the obvious escape valve when you see that your authorities can’t figure out how to get out of the debt cycle, so they are going to just risk something more catastrophic. So gold, to me, is a clear way, historically, that has been sort of good to side step shenanigans like that. But what can I say about gold here except that the GLD tracking trust has now dumped gold for 28 straight days post the Trump election. That is a record. I can’t account for this except to use that word shenanigans. These investors, whoever they may be, are idiots because, listen, in those 28 days we have had Trump calling Taiwan and then taunting China about a stolen drone. We got Russian relations and communication channels. All time lows. We got Venezuela disintegrating. Central banks easing every three days we talked about and I can’t make sense of any of this except to say either I have this narrative completely wrong or somebody is doing something that just doesn’t make any logical sense at all.

Dave Collum:            As you know, but I will just say it again. I have been a gold bug since ‘99 and I was buying it up until around 2000 – God it gets so vague. Around 2004 or 5 I was buying it up to  around $600 an ounce. Then I said I got enough. Then we got to ‘11 and it got its butt kicked, right? And to me, you know if you look at the long wavelength circuits. I am not an Elliott waver but I believe that there might be times where it is not a crazy model. So, that really felt like just the first correction of something that was moving way up. For four years you and I had to eat a lot of buckets of stuff. You are just a gold bug and your days are done now and that game is over. So, I took the beating for those four years. It not only was painful watching it go. Now my cost basis was on average around $330 an ounce, so it wasn’t that bad because it was dropping from 19 to 11 or something right? 100 to 11. When it finally seemed to run out of gas to the downside in 2015 I started buying again. In ‘15 I was pretty aggressive. In ‘16 right at the very beginning of the year I dropped the equivalent of a half of my annual salary on gold again. And then throughout the year I actually hadn’t done the math I actually ended up buying more throughout the year than an entire annual salary of gold. So, I clearly am voting with my dollars and feet and my gold positions are pretty big.

I’m still over 50% cash and the people say “well, that is the stupidest.” No. No it’s not. The only way you are ever going to buy cheap assets at the bottom is to have cash. You’ve got to get out of the market before it heads down or you are going to have nothing, right? My dad taught me that, so cash is king. Right now the opportunity cost of sitting on cash is zero. There are no interest rates. It doesn’t matter. If you buy a bond you make nothing and if you buy equities, you are taking huge risks and so – and people say yea, but you know, you are out too early, you are an idiot you are a fool. You know, I’m going when you guys are, you know, in fetal position with the Dow sitting at 9000 or something. You are going to be rethinking that model, I think.

Chris Martenson:     Yea, well let’s talk about some people who may need to rethink that, then. In the time we have remaining, I have been on this wealth conference circuit and it has been fantastic. I get to talk with people who are – in particular, the people who aren’t working with other people’s money are highly concerned at this point. I have one set of conversations. People who have other people’s money at play are coming in a couple of flavors. In particular, I have been interacting with pension managers. So, these are like, you know, the Austin firefighters pension, or people with identifiable – and so the pension managers, they come in two flavors – delusional and panicking. The delusional ones think 7.5% returns are coming back. They have this explanation for why this has to be true, because they are hanging their hat on a different sort of mean reversion, which is we used to get returns like that. So, they must be coming back, right? The panicking ones know that they personally won’t be dead before their funds blow up, and retirees find them and have hard conversations with them. It is just astonishing to me, but no – neither of those groups I couldn’t get either of those groups to say the central banks have destroyed our model, Which is what I think clearly has happened. But they can’t go there.

Dave Collum:            Well, the other thing is we get told — this model with 7.5% — 7.5% return has never been correct. And the reason it is not correct is, first of all, they never inflation adjust it. And when they do, you find out that if you inflation adjust it and you throw in the dividends you get the 4 to 5%, but the 4 to 5% does not include still our fees and taxes. And so now you are down to like 3% and, by the way, it is not a coincidence. That is kind of the growth of the GDP over the 20th century, right?

Chris Martenson:     There it is.

Dave Collum:            And so any model based on the assumed 7.5% return is doomed. 7 to 8%. Now here is the place that makes it really doomed – as you get low returns, holy cow. We’ve got to save, our pension is in trouble. As the returns shoot above the norm, they say “well, this is excess” and they scoop it up. And so, they don’t let the excess become more excess, because by the way there is a mean reversion coming and that is not going to be excess forever. So, every time they are way above water they scoop it up. How they do it? They stop contributing. They start – they use the money for other stuff. So, if you have like a sine wave oscillating about the mean, even if you guessed the mean correctly, if every time it is on the high side you skim it, you will never get the mean; and that is what pension managers have done. They – and companies, they just stop contributing to pension plans and started calling them prophets, which makes equities go up, which makes the thing get out of whack.

The other thing I talk about (I think this is really important) — we got a recession coming. I think we have been in this kind of labor economy for a very long time. But at some point we will have one of the full-blown kind, right? The kind that is so bad that the central bankers realize that we have a recession, right? And I don’t know what will happen. My prediction is that it is going to be a bad one. But what a lot of people don’t realize is – that is when things start unwinding, so that the house of cards that is built starts crumbling. So, counter party risk kicks in and bad business models start showing up as bad and they start collapsing. And all the corporate chicanery, all the accounting problems which are built up behind the scenes so that the people cook the books to get their bonuses up and they made these crazy assumptions under the protective cloak of a recession, a CEO can get away with announcing anything because they say “hey, don’t look at me, it’s a recession” so they write down huge blocks of cost. They write down all sorts – so it actually exacerbates the downswing, because people are dumping all their cooked books and getting all the chicanery off their books. So, they don’t have to fess up to the fact that they cooked them. And so they are getting ready to then start building up their stock options again from some bottom somewhere.

Chris Martenson:     This is why I think this next recession when, but not if, but when it comes and to the point that even the central banks have to recognize it, why I think it is going to be so bad is corporate debt, right? You got this piece in there. The corporate debt, it isn’t just up a little bit. It is up a lot; huge amounts and still the shills in the mainstream media are like “oh, look at all this corporate cash,” you know. Uh, yea that’s great, but let’s look at corporate debt. And many of these companies, in whole sectors in fact, in whole indexes we find the debt is up higher than cash flows, meaning that from a net position they are cash flow negative and it is just astonishing to look at this and say well, eventually that has to be paid down, right? And in a recession you probably have a rising interest rate environment. It is possible. But anyway, corporate debt. It is amazing. It is astonishing. This era of financial engineering whether it is the non GAAP cooked books that you are talking about, or it is the pretending things are better than they are by borrowing money to buy back shares and pump up the stock price, it just, it all feels a little fake to me. Maybe I am just too cynical at this point in life, but it all just doesn’t feel right.

Dave Collum:            But you are not – this is not just a feel thing. You know that. You are much more convinced and it has to do with historical measures, right? You can say “well, what does history have to do with anything?” History has everything to do with everything, right? And so you know I don’t need to understand a correlation. If, for example, you know the price of the stock market correlates to the price of walnuts, I don’t care if there is causality. If that correlation is strong enough, I will say “look, I’m going to start watching the price of walnuts,” right? So the problem with the corporate debt is that since ‘09 it more than doubled. I think that is where I actually defined the 72 rule for the casual reader and it is up like 9% a year. And their earnings aren’t close to that. Their earnings are tiny compared to that. And so yea, that is going to unwind. It has to unwind. This is like a person who weighs 850 pounds. They are not going to make it to their 90s, right?

Chris Martenson:     Well, that is absolutely all true and we could talk, gosh we barely scratched the surface here. So, maybe we will do this again soon. So everything we have been talking about we found in part one of the year in review and of course there is a part two. Didn’t even get to that. Most of the topics there, and I would love to get to those at some point, including especially the pieces around what is really going on with this election and what we might expect from a Trump presidency. Real estate. We didn’t get into real estate, which I got a whole piece on that, which you made me think about very carefully, as well. And really, what is going on with these rigged primaries and what is happening, of course, in campus politics, which you are closer to than anybody else I ever talk to. Those would all be things I would love to talk about.

Dave Collum:            The campus politics section is the scariest section for me. Campuses are going nuts. Someday we will have to talk about it.

Chris Martenson:     There is something about – I am reminded of that scene in the Princess Bride where this word it does not mean what you think it means and that word is tolerance. I am not real clear that people understand, actually, what that word means. How it is used to intolerantly shut people down. A whole conversation we can have there. Listen, Dave, thank you so much for your time. We unfortunately have to cut this here. People listening you can, of course, find the year in review at Peak Prosperity. So, if you are listening to this on iTunes or you are finding this on YouTube or whatever, you are finding this particular podcast. We will have the year in review up there and, of course, it will be syndicated out. You might see it on Zero Hedge, as well. So come on by and check it out and fully reference one of the best year-end reviews you are going to find. You are going to laugh. I guess fair warning, if you are easily triggered, this may not be the right year in review for you. Dave Berry’s might be better. With that, Dave, thank you so much for your time today.

Dave Collum:            My pleasure always.

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