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The Equity-Gold Price Conundrum, Part 2: The Great Inflation

The Equity-Gold Price Conundrum, Part 2: The Great Inflation

Via GoldMoney Insights,

Equity markets have relentlessly rallied over the past 12 months, pushing valuations to extreme levels based on traditional metrics. In this report, we…

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The Equity-Gold Price Conundrum, Part 2: The Great Inflation

Via GoldMoney Insights,

Equity markets have relentlessly rallied over the past 12 months, pushing valuations to extreme levels based on traditional metrics. In this report, we analyze the two common arguments by equity bulls why this time is different and current valuations are justified. We find that markets are either currently mispricing gold or equities, as either of these arguments would imply that gold should outperform stocks.

This is a two-part report in which we analyze the dichotomy between current equity prices – which by conventional valuation metrics look extremely overvalued - and gold. In the first part of this report (see The equity-gold price conundrum – Part IMarch 08, 2021), we identified the two common arguments put forward by the equity bulls why these valuations are justified:

  1. The great Gatsby: The pandemic, as negative as it was for economic activity near term, will be followed by a period of unprecedented economic expansion. Hence, the GDP will rapidly rise and close the gap to equity prices.

  2. The great inflation: Stock simply price in future inflation that eventually will come on the back of decades of ultra-low rates and central bank balance sheet expansion

We then took a closer look at the first argument: Proponents of the great Gatsby scenario argue that, once the COVID19 pandemic is behind us, as enough people are vaccinated and normality returns, economic activity will explode. However, we found that in order to close the gap between GDP and equity prices, the US would have to undergo a prolonged period of very high real economic expansion. Given the extent of this expansionary period, there is only one precedent since the end of WWII, and when that started, the US economy was in a significantly better starting position. Therefore, for the great Gatsby scenario to play out, substantial monetary and economic stimulus (infrastructure programs and potentially UBI) would be necessary[1]. However, these programs would have to be entirely debt financed.

Thus, the equity-gold conundrum doesn’t disappear in the great Gatsby scenario. In fact, we think that if we see strong economic growth over the coming years, it will entirely be debt-financed and, as a consequence, gold should outperform stocks, not the other way around.

In this second part of the report, we look at the other possible justification for current stock prices – the great inflation scenario – and explore the viability of stocks outperforming gold in such an environment.

Scenario 2. The Great Inflation

The great inflation scenario assumes that current equity valuations simply price in strong future inflation. In an inflationary environment, a company’s costs and revenues in nominal terms increase. All else equal, profits and thus stock prices should increase in line with inflation. The same happens to GDP. As equity markets are to some extent forward looking, equity prices are anticipating the inflationary impact on stocks before it happens in the real economy. Hence, if the market expects strong forward inflations, stock prices could temporarily detach from the current economic reality and equity valuation metrics such as total market cap to GDP begin to look very inflated. However, once inflation kicks in, nominal GDP increases, bringing stock prices, earnings and GDP back in line.

This scenario seems intuitive at first sight. As we have highlighted before, prior to the outbreak of the COVID pandemic, the US economy, and by proxy the world economy, began to stutter and heavy intervention from the FED was needed to get the repo market under control. The Fed had slashed rates from 2.5% in July 2019 to 1.75% by December, before COVID19 ever hit the news. 10-year treasury rates dropped from over 3% to 1.5% over the same period (see exhibit 2).

Back then, we concluded that the hike cycle had ended and that we would probably soon see new lows in real-interest rate expectations and a new high in the Feds balance sheet. What followed was truly unprecedented. The global COVID19 pandemic and the ensuing lockdowns sent asset prices spiraling and economic output contracted at its fastest pace in history. The Fed did not hesitate and slashed rates to zero. More importantly, it aggressively increased its balance sheet.

From the end of February to the end of May 2020, the Fed added $3tn in assets to its balance sheet. Other central banks followed. The ECB for example added EUR2.4tn to its balance sheet since March 2020.

This pushed real-interest rate expectations sharply lower, with 10-years TIPs yields falling below -1% for the first time. While inflation expectations took an initial hit when the pandemic unfolded, dropping to almost 0.5% (10y breakeven), they soon climbed back and are currently at 2.2% (see exhibit below).

One of the main differences between the great Gatsby scenario and the great inflation scenario is time. Real economic growth in one year is limited, but nominal growth due to inflation is not. In the first part of this report, we asked:

Even with a staggering 5% annual GDP growth and 2% inflation, it would still take more than seven years to get there. Are stocks really pricing in the year 2028 with 0% discount rate?

As we have demonstrated, there has hardly been any prolonged period with real growth at over 5%. However, in the 1970s, there were several years in the US with double-digit nominal GDP growth due to high inflation. Outside the US, there are plenty of examples where nominal GDP grew much faster than 5% as the currency rapidly devalued. Thus, in our view the great inflation scenario is better suited to explain current equity prices than the great Gatsby scenario. But does it solve the equity-gold price conundrum? In other words, should equities outperform gold on the cusp of a major inflationary period?

First of all, it’s important to get an idea on how much inflation would be needed to bring current equity prices back in line with historical valuations. One way to estimate this is to look at what level of nominal GDP is needed to bring total market cap to GDP back to reasonable levels. As a reminder, in part one of this report, we showed that total market cap to GDP stands at a staggering 193%. Historically, the average “sustainable” total market cap to GDP was around 100% (it was 120% over the past 10 years).

Arguably, current GDP is heavily impacted by the lockdowns. So for the sake of the argument, let’s assume that the US nominal GDP returns back to pre-covid levels once the economy reopens[2]. In that case, the US GDP would start at $21.4tn. Hence, nominal GDP would have to increase by 86% to bring the total market cap to GDP ratio back to 100% ($40tn), or by 63% to bring it to 120% ($35tn). Let us also assume that the US economy grows by 2% in real terms over the long run once it has returned to pre-covid levels. Over a period of 5 years, that would bring the nominal GDP to just $23.6tn. That means, it is up for inflation to fill the gap. Thus, inflation would have to be averaging at 10% to bring equity prices in line with GDP in 5 years. And that would require equity prices to stay flat for the next 5 years. Are equity markets that forward-looking? How much inflation is needed to get stock prices back in line over a shorter period of time? The table below gives an answer.

Table 1: Inflation needed to bring equities back in line with US GDP

As a result, in order for equity valuation to make sense even over the long run, VERY high inflation has to occur. However, when we look back at previous episodes of high inflation, we find that equities did not protect investors from inflation that well. After President Nixon temporarily suspended the convertibility of the USD to gold in 1971, de facto ending the gold standard, the US entered a prolonged period of very high inflation that only ended in the early 1980s. Corporate revenues rose with inflation, but stock prices lagged. In fact, it took stock prices 17 years to catch up with inflation (see Exhibit 2)

Thus, investing in stocks has historically not been a great way to protect against very high forward inflation. Gold on the other hand is leading inflation. As for the equities to gold ratio in high inflationary periods, It took the S&P500 27 years from 1971 to pick up with gold (see exhibit 4)

Arguably, stocks also pay dividends, so it would be unfair to just compare prices. But even when we take dividends into account, the SP500 massively underperformed gold both in the run up to and during the double digit inflation year (see exhibit 5). When inflation peaked in the early 1980s, gold had outperformed dividend reinvested stocks by a staggering 1500%. It would take equities with reinvested dividends a full 14 years to fully catch up with gold, despite gold prices declining sharply form their peaks as Fed chairman Volker aggressively raised rates to over 20% to combat inflation.

Arguably, even though inflation and inflation expectations picked up recently, until now we actually have not seen the unprecedented monetary policy of the past 12 months to translate into an equal move in consumer price inflation. Instead, it led almost exclusively to asset price inflation. This is very different from the 1970s, which saw staggering price inflation in all goods and services. Should gold still outperform stocks in such a scenario?

We do have a historical example of a monetary environment that primarily led to asset price inflation with relatively benign consumer price inflation as measured by the CPI. That is the period of extreme monetary policy since the great financial crisis. The Fed began cutting the its funds rate in September 2007 as the subprime mortgage crisis unfolded. From September 2008 onwards, it was aggressively expanding its balance sheet. By December 2008, it had slashed rates to zero.

We find that gold outperformed stocks from any of these starting points for at least 4 years (see Exhibit 5). In fact, when measured from the first time the Fed cut rates in 2007, gold outperformed stocks for 11 years.

To summarize:

  1. We find the great Gatsby scenario of an explosion in real economic growth over the coming years implausible, unless it is on the back of huge infrastructure spending, entirely financed through an unprecedented expansion in debt. However, such a debt expansion would favor gold over stocks.

  2. We find the great inflation scenario is plausible, but in this scenario too, we expect gold to outperform stocks.

  3. Should neither scenario occur, then stocks are due for a significant correction. This would ultimately again force the Fed to intervene, which would also favor gold (however, the initial correction in equities may also negatively affect gold prices, but much less so, and only for a brief period).

Thus, in our view, while timing remains challenging, we expect gold to outperform stocks over the next few years.

Tyler Durden Sat, 03/20/2021 - 07:00

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Veterans Affairs Kept COVID-19 Vaccine Mandate In Place Without Evidence

Veterans Affairs Kept COVID-19 Vaccine Mandate In Place Without Evidence

Authored by Zachary Stieber via The Epoch Times (emphasis ours),

The…

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Veterans Affairs Kept COVID-19 Vaccine Mandate In Place Without Evidence

Authored by Zachary Stieber via The Epoch Times (emphasis ours),

The U.S. Department of Veterans Affairs (VA) reviewed no data when deciding in 2023 to keep its COVID-19 vaccine mandate in place.

Doses of a COVID-19 vaccine in Washington in a file image. (Jacquelyn Martin/Pool/AFP via Getty Images)

VA Secretary Denis McDonough said on May 1, 2023, that the end of many other federal mandates “will not impact current policies at the Department of Veterans Affairs.”

He said the mandate was remaining for VA health care personnel “to ensure the safety of veterans and our colleagues.”

Mr. McDonough did not cite any studies or other data. A VA spokesperson declined to provide any data that was reviewed when deciding not to rescind the mandate. The Epoch Times submitted a Freedom of Information Act for “all documents outlining which data was relied upon when establishing the mandate when deciding to keep the mandate in place.”

The agency searched for such data and did not find any.

The VA does not even attempt to justify its policies with science, because it can’t,” Leslie Manookian, president and founder of the Health Freedom Defense Fund, told The Epoch Times.

“The VA just trusts that the process and cost of challenging its unfounded policies is so onerous, most people are dissuaded from even trying,” she added.

The VA’s mandate remains in place to this day.

The VA’s website claims that vaccines “help protect you from getting severe illness” and “offer good protection against most COVID-19 variants,” pointing in part to observational data from the U.S. Centers for Disease Control and Prevention (CDC) that estimate the vaccines provide poor protection against symptomatic infection and transient shielding against hospitalization.

There have also been increasing concerns among outside scientists about confirmed side effects like heart inflammation—the VA hid a safety signal it detected for the inflammation—and possible side effects such as tinnitus, which shift the benefit-risk calculus.

President Joe Biden imposed a slate of COVID-19 vaccine mandates in 2021. The VA was the first federal agency to implement a mandate.

President Biden rescinded the mandates in May 2023, citing a drop in COVID-19 cases and hospitalizations. His administration maintains the choice to require vaccines was the right one and saved lives.

“Our administration’s vaccination requirements helped ensure the safety of workers in critical workforces including those in the healthcare and education sectors, protecting themselves and the populations they serve, and strengthening their ability to provide services without disruptions to operations,” the White House said.

Some experts said requiring vaccination meant many younger people were forced to get a vaccine despite the risks potentially outweighing the benefits, leaving fewer doses for older adults.

By mandating the vaccines to younger people and those with natural immunity from having had COVID, older people in the U.S. and other countries did not have access to them, and many people might have died because of that,” Martin Kulldorff, a professor of medicine on leave from Harvard Medical School, told The Epoch Times previously.

The VA was one of just a handful of agencies to keep its mandate in place following the removal of many federal mandates.

“At this time, the vaccine requirement will remain in effect for VA health care personnel, including VA psychologists, pharmacists, social workers, nursing assistants, physical therapists, respiratory therapists, peer specialists, medical support assistants, engineers, housekeepers, and other clinical, administrative, and infrastructure support employees,” Mr. McDonough wrote to VA employees at the time.

This also includes VA volunteers and contractors. Effectively, this means that any Veterans Health Administration (VHA) employee, volunteer, or contractor who works in VHA facilities, visits VHA facilities, or provides direct care to those we serve will still be subject to the vaccine requirement at this time,” he said. “We continue to monitor and discuss this requirement, and we will provide more information about the vaccination requirements for VA health care employees soon. As always, we will process requests for vaccination exceptions in accordance with applicable laws, regulations, and policies.”

The version of the shots cleared in the fall of 2022, and available through the fall of 2023, did not have any clinical trial data supporting them.

A new version was approved in the fall of 2023 because there were indications that the shots not only offered temporary protection but also that the level of protection was lower than what was observed during earlier stages of the pandemic.

Ms. Manookian, whose group has challenged several of the federal mandates, said that the mandate “illustrates the dangers of the administrative state and how these federal agencies have become a law unto themselves.”

Tyler Durden Sat, 03/09/2024 - 22:10

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Are Voters Recoiling Against Disorder?

Are Voters Recoiling Against Disorder?

Authored by Michael Barone via The Epoch Times (emphasis ours),

The headlines coming out of the Super…

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Are Voters Recoiling Against Disorder?

Authored by Michael Barone via The Epoch Times (emphasis ours),

The headlines coming out of the Super Tuesday primaries have got it right. Barring cataclysmic changes, Donald Trump and Joe Biden will be the Republican and Democratic nominees for president in 2024.

(Left) President Joe Biden delivers remarks on canceling student debt at Culver City Julian Dixon Library in Culver City, Calif., on Feb. 21, 2024. (Right) Republican presidential candidate and former U.S. President Donald Trump stands on stage during a campaign event at Big League Dreams Las Vegas in Las Vegas, Nev., on Jan. 27, 2024. (Mario Tama/Getty Images; David Becker/Getty Images)

With Nikki Haley’s withdrawal, there will be no more significantly contested primaries or caucuses—the earliest both parties’ races have been over since something like the current primary-dominated system was put in place in 1972.

The primary results have spotlighted some of both nominees’ weaknesses.

Donald Trump lost high-income, high-educated constituencies, including the entire metro area—aka the Swamp. Many but by no means all Haley votes there were cast by Biden Democrats. Mr. Trump can’t afford to lose too many of the others in target states like Pennsylvania and Michigan.

Majorities and large minorities of voters in overwhelmingly Latino counties in Texas’s Rio Grande Valley and some in Houston voted against Joe Biden, and even more against Senate nominee Rep. Colin Allred (D-Texas).

Returns from Hispanic precincts in New Hampshire and Massachusetts show the same thing. Mr. Biden can’t afford to lose too many Latino votes in target states like Arizona and Georgia.

When Mr. Trump rode down that escalator in 2015, commentators assumed he’d repel Latinos. Instead, Latino voters nationally, and especially the closest eyewitnesses of Biden’s open-border policy, have been trending heavily Republican.

High-income liberal Democrats may sport lawn signs proclaiming, “In this house, we believe ... no human is illegal.” The logical consequence of that belief is an open border. But modest-income folks in border counties know that flows of illegal immigrants result in disorder, disease, and crime.

There is plenty of impatience with increased disorder in election returns below the presidential level. Consider Los Angeles County, America’s largest county, with nearly 10 million people, more people than 40 of the 50 states. It voted 71 percent for Mr. Biden in 2020.

Current returns show county District Attorney George Gascon winning only 21 percent of the vote in the nonpartisan primary. He’ll apparently face Republican Nathan Hochman, a critic of his liberal policies, in November.

Gascon, elected after the May 2020 death of counterfeit-passing suspect George Floyd in Minneapolis, is one of many county prosecutors supported by billionaire George Soros. His policies include not charging juveniles as adults, not seeking higher penalties for gang membership or use of firearms, and bringing fewer misdemeanor cases.

The predictable result has been increased car thefts, burglaries, and personal robberies. Some 120 assistant district attorneys have left the office, and there’s a backlog of 10,000 unprosecuted cases.

More than a dozen other Soros-backed and similarly liberal prosecutors have faced strong opposition or have left office.

St. Louis prosecutor Kim Gardner resigned last May amid lawsuits seeking her removal, Milwaukee’s John Chisholm retired in January, and Baltimore’s Marilyn Mosby was defeated in July 2022 and convicted of perjury in September 2023. Last November, Loudoun County, Virginia, voters (62 percent Biden) ousted liberal Buta Biberaj, who declined to prosecute a transgender student for assault, and in June 2022 voters in San Francisco (85 percent Biden) recalled famed radical Chesa Boudin.

Similarly, this Tuesday, voters in San Francisco passed ballot measures strengthening police powers and requiring treatment of drug-addicted welfare recipients.

In retrospect, it appears the Floyd video, appearing after three months of COVID-19 confinement, sparked a frenzied, even crazed reaction, especially among the highly educated and articulate. One fatal incident was seen as proof that America’s “systemic racism” was worse than ever and that police forces should be defunded and perhaps abolished.

2020 was “the year America went crazy,” I wrote in January 2021, a year in which police funding was actually cut by Democrats in New York, Los Angeles, San Francisco, Seattle, and Denver. A year in which young New York Times (NYT) staffers claimed they were endangered by the publication of Sen. Tom Cotton’s (R-Ark.) opinion article advocating calling in military forces if necessary to stop rioting, as had been done in Detroit in 1967 and Los Angeles in 1992. A craven NYT publisher even fired the editorial page editor for running the article.

Evidence of visible and tangible discontent with increasing violence and its consequences—barren and locked shelves in Manhattan chain drugstores, skyrocketing carjackings in Washington, D.C.—is as unmistakable in polls and election results as it is in daily life in large metropolitan areas. Maybe 2024 will turn out to be the year even liberal America stopped acting crazy.

Chaos and disorder work against incumbents, as they did in 1968 when Democrats saw their party’s popular vote fall from 61 percent to 43 percent.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times or ZeroHedge.

Tyler Durden Sat, 03/09/2024 - 23:20

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The Coming Of The Police State In America

The Coming Of The Police State In America

Authored by Jeffrey Tucker via The Epoch Times,

The National Guard and the State Police are now…

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The Coming Of The Police State In America

Authored by Jeffrey Tucker via The Epoch Times,

The National Guard and the State Police are now patrolling the New York City subway system in an attempt to do something about the explosion of crime. As part of this, there are bag checks and new surveillance of all passengers. No legislation, no debate, just an edict from the mayor.

Many citizens who rely on this system for transportation might welcome this. It’s a city of strict gun control, and no one knows for sure if they have the right to defend themselves. Merchants have been harassed and even arrested for trying to stop looting and pillaging in their own shops.

The message has been sent: Only the police can do this job. Whether they do it or not is another matter.

Things on the subway system have gotten crazy. If you know it well, you can manage to travel safely, but visitors to the city who take the wrong train at the wrong time are taking grave risks.

In actual fact, it’s guaranteed that this will only end in confiscating knives and other things that people carry in order to protect themselves while leaving the actual criminals even more free to prey on citizens.

The law-abiding will suffer and the criminals will grow more numerous. It will not end well.

When you step back from the details, what we have is the dawning of a genuine police state in the United States. It only starts in New York City. Where is the Guard going to be deployed next? Anywhere is possible.

If the crime is bad enough, citizens will welcome it. It must have been this way in most times and places that when the police state arrives, the people cheer.

We will all have our own stories of how this came to be. Some might begin with the passage of the Patriot Act and the establishment of the Department of Homeland Security in 2001. Some will focus on gun control and the taking away of citizens’ rights to defend themselves.

My own version of events is closer in time. It began four years ago this month with lockdowns. That’s what shattered the capacity of civil society to function in the United States. Everything that has happened since follows like one domino tumbling after another.

It goes like this:

1) lockdown,

2) loss of moral compass and spreading of loneliness and nihilism,

3) rioting resulting from citizen frustration, 4) police absent because of ideological hectoring,

5) a rise in uncontrolled immigration/refugees,

6) an epidemic of ill health from substance abuse and otherwise,

7) businesses flee the city

8) cities fall into decay, and that results in

9) more surveillance and police state.

The 10th stage is the sacking of liberty and civilization itself.

It doesn’t fall out this way at every point in history, but this seems like a solid outline of what happened in this case. Four years is a very short period of time to see all of this unfold. But it is a fact that New York City was more-or-less civilized only four years ago. No one could have predicted that it would come to this so quickly.

But once the lockdowns happened, all bets were off. Here we had a policy that most directly trampled on all freedoms that we had taken for granted. Schools, businesses, and churches were slammed shut, with various levels of enforcement. The entire workforce was divided between essential and nonessential, and there was widespread confusion about who precisely was in charge of designating and enforcing this.

It felt like martial law at the time, as if all normal civilian law had been displaced by something else. That something had to do with public health, but there was clearly more going on, because suddenly our social media posts were censored and we were being asked to do things that made no sense, such as mask up for a virus that evaded mask protection and walk in only one direction in grocery aisles.

Vast amounts of the white-collar workforce stayed home—and their kids, too—until it became too much to bear. The city became a ghost town. Most U.S. cities were the same.

As the months of disaster rolled on, the captives were let out of their houses for the summer in order to protest racism but no other reason. As a way of excusing this, the same public health authorities said that racism was a virus as bad as COVID-19, so therefore it was permitted.

The protests had turned to riots in many cities, and the police were being defunded and discouraged to do anything about the problem. Citizens watched in horror as downtowns burned and drug-crazed freaks took over whole sections of cities. It was like every standard of decency had been zapped out of an entire swath of the population.

Meanwhile, large checks were arriving in people’s bank accounts, defying every normal economic expectation. How could people not be working and get their bank accounts more flush with cash than ever? There was a new law that didn’t even require that people pay rent. How weird was that? Even student loans didn’t need to be paid.

By the fall, recess from lockdown was over and everyone was told to go home again. But this time they had a job to do: They were supposed to vote. Not at the polling places, because going there would only spread germs, or so the media said. When the voting results finally came in, it was the absentee ballots that swung the election in favor of the opposition party that actually wanted more lockdowns and eventually pushed vaccine mandates on the whole population.

The new party in control took note of the large population movements out of cities and states that they controlled. This would have a large effect on voting patterns in the future. But they had a plan. They would open the borders to millions of people in the guise of caring for refugees. These new warm bodies would become voters in time and certainly count on the census when it came time to reapportion political power.

Meanwhile, the native population had begun to swim in ill health from substance abuse, widespread depression, and demoralization, plus vaccine injury. This increased dependency on the very institutions that had caused the problem in the first place: the medical/scientific establishment.

The rise of crime drove the small businesses out of the city. They had barely survived the lockdowns, but they certainly could not survive the crime epidemic. This undermined the tax base of the city and allowed the criminals to take further control.

The same cities became sanctuaries for the waves of migrants sacking the country, and partisan mayors actually used tax dollars to house these invaders in high-end hotels in the name of having compassion for the stranger. Citizens were pushed out to make way for rampaging migrant hordes, as incredible as this seems.

But with that, of course, crime rose ever further, inciting citizen anger and providing a pretext to bring in the police state in the form of the National Guard, now tasked with cracking down on crime in the transportation system.

What’s the next step? It’s probably already here: mass surveillance and censorship, plus ever-expanding police power. This will be accompanied by further population movements, as those with the means to do so flee the city and even the country and leave it for everyone else to suffer.

As I tell the story, all of this seems inevitable. It is not. It could have been stopped at any point. A wise and prudent political leadership could have admitted the error from the beginning and called on the country to rediscover freedom, decency, and the difference between right and wrong. But ego and pride stopped that from happening, and we are left with the consequences.

The government grows ever bigger and civil society ever less capable of managing itself in large urban centers. Disaster is unfolding in real time, mitigated only by a rising stock market and a financial system that has yet to fall apart completely.

Are we at the middle stages of total collapse, or at the point where the population and people in leadership positions wise up and decide to put an end to the downward slide? It’s hard to know. But this much we do know: There is a growing pocket of resistance out there that is fed up and refuses to sit by and watch this great country be sacked and taken over by everything it was set up to prevent.

Tyler Durden Sat, 03/09/2024 - 16:20

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