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By: Tenzin Lekphell

FRA: Welcome to FRA”s Roundtable Insight ..  Today we have Bill Laggner and Yra Harris. Bill is principal and co-founder of Bering Asset Management. He and his managing partner, Kevin Duffey, managed the Bering fund using an approach based on identifying boom bust cycles, value in the marketplace, bubbles, and distortions created by both fiscal and monetary authorities. Yra is an independent trader, a successful hedge fund manager, a global macro consultant trading foreign currencies, bonds, commodities, and equities for over 40 years. He was also CME director from 1997 to 2003. Welcome gentlemen!

Bill: Hi Richard!

Yra: Hey Richard! Great to be here.

FRA: Great! I thought we’d do a focus today on what we see happening for the coming year, 2019, and the economy and the financial markets. What distortions and imbalances can be identified for potential investments and/or trading opportunities? Maybe we begin in China with the China slow down. Did you see a potential unfolding of a severe credit crisis in China and and could this be a catalyst for other effects globally such as in Europe for the European bond market? Bill do you wanna begin?

Bill: Sure I sound like a broken record on China. I’ve been talking publicly for over 6 years now. The Chinese miracle, the Chinese situation is I think late innings we’re seeing more signs of that now. The Hong Kong property market falling out, the amount of capital that has fled the country over the last 4 to 5 years. I think that China’s trying to deal with multitude problems and a lot of that stems from central planning. The illusion works great when asset prices are going up and people have this perceived better standard of living but the reality is that it’s all built on debt.

If it’s not built on debt, it’s built on a series of other government policies that, lets face it, all of us have seen in history only buy so much time. There are costs to these interventions and I think we’re in the early stages of seeing what those costs are.I think the economy slowing down, I think they’ll break the peg to the dollar and I think the global slowdown is China, let’s face, is a major player in manufacturing world. So the continuing slowdown in Europe, the stagnating economy here in the US, I think wreaks havoc on the Chinese and I can see that there is even more in last 18 months of so, more disagreement within the Chinese party and I think that’s yet another reflection of an economy going in reverse. There turning on one another. They’re very similar to what’s happening in US and even in Europe. The political classes are turning on one another and those are all indications of late stage behaviour of the cycle.

FRA: Just a quick follow up question on that for China you mention that you see the potential for the break of the peg, would that be a devaluation on the currency and if that were to happen, could that affect the European bond market and the euro?

Bill: Yeah I think they have to break the peg. Years ago they did a devaluation for a short period of time which was 40/50%. Will it be as severe this time around? Maybe not but I do think they need to weaken the currency and in their mind, they’ll try to buy them more time and they can continue to try and export products and keep the illusion going.

But the problem with China is, and of course they’re also trying to attract foreign investments, but what are the rules in China?

The rules seem to change weekly so I don’t’ see long term capital making its way into China.

I think they end up having a devaluation of the currency, they may do it in stages, most smart macro people I know think they do it in stages and they’d probably agree with that.

They’ve got massive debt issue and so when countries have massive debt issues they resort to devaluing the currency and they do it in ways we’re witnessing today.

FRA: And Yra your thoughts on that?

Yra: ( inaudible 5:17-5:20) sitting here dazed and confused in some ways because I go back to the comments that come out of the White House Administration, from the Chinese which is well if we can work through this trade situation; we can take your trade deficit and basically balance of payment problems and we can take it away because we can buy so much stuff.

When I heard that, it was an interesting comment that of course S&P rallied dramatically off of it. Couple other things didn’t happen; at that time, the Yuan didn’t rally and when I read people analysis they said well that’s because in order to do that, they have to weaken the currency and number 2, the most extensible reaction should have been the Mexican peso should have soared. If China were to actually embark on a massive consumption program which that statement to me (inaudible 6:31) and that’s what Michael Pettis, who I have a lot of respect for, he’s been arguing for 10 years or as long as I’ve been reading his work which is (inaudible 6:39) professor he knows China really well. Because if you embark on a massive consumption program, that Yuan has to go higher because otherwise you would crushing your middle class or trying to aide because a weaker currency would mean you’re paying more for imports and that would be exactly what you’re trying not to do.

I’m perplexed wherever we’re at here, with all that discussion that takes place and again because of global supply lines, if China were to massively import massive consumer goods,

Mexico would benefit more than any other that’s because the peso on a relative basis is probably of the mainstream emerging (inaudible 7:30) is weakest of anything in the world.

We can probably argue the Rubble but Mexico and Russia serve different purposes in the global arena. So I understand people talking about depreciating the Yuan but since that announcement came out, the Yuan has dropped about 6.87 down to today about 6.72 so i’m not sure and then I’m gonna add in what happened on Monday; the Chinese actually invited S&P to come in and start rating some of its bonds.

When I saw the headlines which didn’t get much play than anything else but I thought it was interesting because it tells me the Chinese don’t proceed willy nilly.

I happen to agree with Mike. I don’t trust a thing that comes out of China statistically and I’ve vlogged about that for 10 years and thought about it for 20 years because my sense of that whenever I would speak on panels, it’s really a simple rule. If you don’t allow google to operate freely, I can’t trust any information that you’re willing to either put out because you don’t let a free flow of information in.

If you’re controlling what comes in, by definition, you’ve already controlled what comes out.

I don’t give China much credence to that but that doesn’t mean China doesn’t have a concept here. They always have a concept.

How they get there is what we’ll discuss and argue about but think one of the main thrust of China is could they know how important this is? They like to establish a true competitor to the US dollar as a reserve currency. I believe that because they don’t trust the US and there’s a lot to not trust about the US. One of the things we’ll get into I’m sure and going forward this year and what staggers me and makes me less bullish on the United States in that regard is we’re operating at full employment and yet have a trillion dollar a year deficit. That is a problem to me.

Last time we had a full employment economy in 97, 98, 99, we were running budget surpluses. We’re in a whole different atmosphere here and then you follow the arguments that are actually building and I love that they’re making it out to the mainstream thought on the MMP, the Modern Monetary Theorists and how you don’t have to worry about deficits just print out more money.

In that regard, I think the Chinese hold a lot of dollar assets as to others. Any type of reaction from a monetary authority to just print more money should make everybody nervous about holding that asset and because the dollar is the reserved currency of the world, we’re all forced to hold that asset. So I’m not sure about the long answer, I’m not sure about the depreciating of the yuan so I’m gonna hold my powder on that and I need to see other things here and me I’m more concerned right now; yes the Chinese have a massive amount of debt but relative to other things, they’re debt is not great to the US and the US is hemorrhaging debt at a time when they ought not to be. If you’re really a Keynesian, you should accept that premise because Richard, we have a lot of Austrian discussion on these podcasts and I’ve been very proud to do many of them and the Keynesian views, is hey, Economic times are good; you’re supposed to run surpluses at least not massive deficits.

The deficits come from demand stimulus and we certainly don’t need that so I’ll stop there.

Bill: Can I just add one more thing to what Yra said? I read Michael Pettis’s work too and I like a lot of his work. I think the most difficult thing you hit on it is we really don’t know the extent of the debt situation in China and because Google and other groups are not really allowed to get data whether it’s on Chinese banks etc.

I just think there’s such a black hole that is very difficult to analyze this properly. We realize that it’s a lot of debt, we realize the global economy is slowing, yes they wanna get into consumption based economy but what are they trying to build their “economy” on? If it’s layers and layers of agency debt or debt in various industries etc.

The banking system, many people think they need to recapitalize the banking system. I’m in agreement there.

The world is in debt and they’re all playing the same game so it’s gonna be fascinating watch it all unfold.

FRA: And on Europe specifically, Bill what are your thoughts in terms of the evolving central bank policy, trends there, and potential for the financial crisis phase two, if you will, to start out of Europe?

Bill: So I remember going back to the Greek situation which was 2011. I was convinced that Greece would leave and you would start to see the breakup of the European union of course the decisions that they make to essentially keep Greece within the EU and start this process of bail out and more taxes and more (inaudible) on the future livelihood there. Deutsche Bank Company, that we’ve been sure for quite a while now, Deutsche Bank is telling you there are problems, I think, 2 years ago there was a French junk bond issuer that was refinancing debt for 3 years that are negative interest rates all thanks to the ECB, you know, I think they are what 50% of GDP now the size of their balance sheet.

So you know Draghi was listening to himself speak the other day. I just think that they’re going continue to intervene. I don’t see them, you know, tightening policy there and it’ll just be whatever the interventions look like in the future they’re all going to equate to the same things which is loose monetary policy and trying to keep nominal asset prices from declining too much.

FRA: And Yra you’re thoughts on Europe and the potential for financial crisis to begin from there?

Yra: Well Bill, we find great commonality in Europe because the most nefarious man in the world is Mario Draghi. People really don’t understand what he’s done here but building that massive balance sheet has trapped everybody in Europe. I mean i’m in a 100% agreement with you. Europe is a mess and they’re walking down this road of perfidy and it is perfidy because Mario really has no plan. The most honest thing he ever said was you should do whatever it takes to (inaudible) to preserve the euro and in that regard he has really saddled them in a terrible, terrible situation.Of course Merkle was his guardian angel. There is nowhere for them to go.Nowhere! What was last week’s blog about Richard? Mario Draghi’s circus, which this circus was in town. Nothing he said had a bit of honesty to it. He tried to control the narrative and now the narrative is his two words; persistence of conditions that they can control and makes the assessment difficult.Of course it’s difficult. They’ve destroyed the German favours because i’m on the financial repression authority so if you want to see the master of financial repression, take a look at Europe at what they’ve done to German favours because if you’re running inflation in a country, of 1.6/1.7, you got a GDP of over 2% and you have negative interest rate on a 2 year note of 60 basis points, you got a serious problem. While they’re sweeping it all under the rug, the problem is just building, and building, and building. I think that’s the real (inaudible) block to where we’re going here.China is interesting and Trump really his disdain for Merkel and Macron, and here’s a man who doesn’t take those (inaudible) lightly so I would watch his response. The German auto sector is definitely afraid with a 25% tariff and while we’re concentrating on China, we don’t hear much about Europe.I’m very cautious here and the European central bank again has put the world into a very difficult situation and it’s all based on debt and somebody calls it the doom loop because you have the European commercial banks buying sovereign debt. Why? Because its zero risk waiting so i can buy all the Italian bonds i want no matter what you think about them and I get to carry about them in my books with no reserves. Yeah it’s a pretty good game.

Bill: Can I just add one more thing about Europe? I got great points about Germany by the way.I look at what happened in Greece, and you know people forget about Greece. You look at what happened in that country since lot of corruption in the country and of course you know how the euro was created what they did to the Greek economy. Thank you Goldman Sachs. The fact that these new taxes and other regulations were then brought into the Greek economy. It’s throwing in another wet blanket on the fire and I see the same things happening. Look what’s happening in France for example, or look at all the different taxes and so on, they got people protesting and essentially these systems that they’ve created are unwinding in slow motion. It just doesn’t work anymore.

Yra: That’s absolutely right and you know it. (inaudible) they slapped him pretty good.

Give me (inaudible) because I’d rather listen to him. I think he talks more of the truth. Again, it’s not their narratives but it’s the narrative of what’s really going on and they applaud Spain is still 14.5% unemployment. So they’ve got massive problems and a lot of them start with the monetary policy because Mario Draghi did follow Ben Bernanke down the rabbit hole.

You know, one pill makes you smaller, and one pill makes you tall. He took the one that made him tall and he just can’t get out of from that rabbit hole. You will not sit back through it.

FRA: Bill for 2019, what do you see as the biggest risk factors? Market risk, credit risk, geopolitical risk, where do you see those?

Bill: That’s a great question. It’s pretty clear the economy is slowing globally. Many of the (inaudible) figures show that. I think the fed is done raising interest rates. I don’t think the Feds can continue to tighten interest rates. I do agree with Yra that the US and the rest of the world will run these deficits, will have more interventions, fiscal and monetary interventions, probably later this year, and of course credit spreads widen, we already see the beginning of credit spreads widening, the leveraged loan market pretty much shut down the end of last year and commodity prices look rather weak so you could see an interesting contraction unfold this year.

Their not gonna sit idle. Their gonna try to fight it is my guess and so I could see the stock crisis could go down at least 20 % or 30% from here.

I think earnings are gonna be a major disappointment and credit spreads will continue to widen.

So again they are not gonna sit idle, they will immediately intervene, they will basically threaten to go to negative interest rates.

I’ve been saying this for several years, the central banks want to tighten interest rates because they can. The economy is too weak. The economy is weak for all the reason we were discussing earlier; intervention, debt, the size of government, vis-a-vis the real economy, regulation, so I think they’re gonna intervene, I think they will threaten to go to negative interest rates and I wouldn’t be surprised if the deficits go north of a trillion dollars a year here in the US. I could see where the deficits go to $1.5 trillion very easily.

FRA: And Yra your thoughts on the biggest risk factors?

Yra: To me there’s so many of them. I come back to it and Bill was nice enough to give me the push of the edge which is the debt levels and I agree with him. I think that there’s no way that earnings could sustain themselves here with higher interest rate costs and on top of that,

if you get higher wages, it has to eat into profitability so these people who put forth the growth and profit numbers, which you’re not coming off of low profits historically, you’re at basically historically all time high of sustained level profitability which can’t sustain itself if labour is to get a bigger piece of the pie and interest rates take a bigger hit. I just don’t see. Now does that result in geopolitical problems? Not sure. We’re seeing some of it but on a global basis where i see the greatest threat is of course from the prime minister of Turkey, Erdogan who continues to get favourable play and I certainly don’t understand how because he always takes the other side of the United States. The don of Venezuela, Putin, Erdogan, the Chinese, the lineup almost looks like the scene of blazing saddles where all the bad guys are lined up waiting to get signed up. They cant get out from themselves. I make the mid east with Erdogan and whatever he’s really trying to do there, potentially a major, major global risk. There’s so many. I can’t even innumerate which one would be the most because I been to economics. This debt issue is really bothersome to me so i’m gonna go (inaudible) with that.

FRA: Given all this backdrop Bill, where do you see trading opportunities, investment opportunities, in particular, what are your thoughts on the gold euro and gold yen cross rates as well as yield curve steepening or flattening?

Bill: I don’t see again because I believe we don’t have bond markets anymore. I think central banks have distorted the, Jim Grant likes to say there are no more traffic signals right? They’re all flashing the same colours so central banks intervene, they distort the prices, create these false signals that enter the market place. I’ve been bullish on gold since 2002. I (inaudible) they were gonna print a lot of money and they have and they’ll continue to print money.

So gold looks like it’s finally breaking out of a, I’m not a hard core technical analyst but it looks like it’s breaking out of a falling wedge since 2011 which we were up around 1750. So i’m bullish on gold and i’m bullish on gold not just against dollars but against yen and euro.

Whether or not the yield curve stays inverted, it’s hard to say. I think what we’re really betting on is how quickly will the central bank here in the US will cut interest rates.

Yra brings up a good point. You got wages rising so maybe they don’t have the room that they had at this juncture that they had in 08,09, or 2010. Bullish on gold and the other thing that is interesting is watching the FAANG stocks decline. A lot of the movement coming out of 2015 the NASDAQ was just a handful of companies and it looks like the FAANG bubble has burst and so I think that’s gonna be real problem for the broad market as well.

FRA: And you say interest rates falling as you’ve mentioned earlier.

Bill: I think the central bank they talk a good game, you know, Powell has already flip flopped 3 or 4 times from Christmas eve when things were melting down. My guess is that they will try to lower interest rates and/or the government will run a greater deficit if the economy slows drastically in the 2nd half of the year. I’ll add the following. I do, without getting too much off topic, think that the technology wave of decentralization is a something that is very positive catalyst for the global economy but its a tiny tiny piece of the economy today but I do see how that could be a very positive outcome for the global economy. That doesn’t mean we’re gonna dodge the debt bubble or dodge the recession. I just think in the longer term, it’s something to keep an eye on.

FRA: By that do you mean block chains, robotics process automation?

Bill: Yeah I mean internet things, block chains, i sent a lot of time in the space last 5 years. When I look at all of the inefficiencies like just in supply chain for example, you’re talking about a couple of trillions of dollars (inaudible) in inefficiencies and so the movement of money, you know, why is the foreign exchange market 25 times the size of the global economy? The disintermediation of finance is something that I think will change the world but that’s a longer intermediate longer term phenomenon.

FRA: And Yra your thoughts on trading opportunities, investments, and in particular for the gold euro, gold yen, cross rates and the yield curve?

Yra: Well Bill and I never talked but those have been my favourite trades and in fact my biggest trade I took it off this morning with long gold and short the Swiss which has been good because the Swiss was a little unnerving but, you know Richard, I always give the alchemist, it used to be a year, now it’s a decade, now it’s probably a millennium and I’m going back to zero. The Swiss national bank is of course the alchemist of Europe because they get to print Swiss Francs that don’t seem to go down in value anyway and buy global equities. What better is that?! That’s the dream of the MMP (inaudible). Let me go print a billion Swiss francs and go buy a billion dollars worth of Apple stocks. Thank you very much! And that’s what they do and then they’re trying to figure out how they can get out of this hole. The rest of the world will start to mimic them but I believe in all of the gold currencies. The gold dollar has not been great but US rates have been going up and two things and I have this discussion constantly because my phone rings off the hook all the time talking about gold, don’t buy into the inflation nonsense. By that time, gold is too late. Gold is a protection against central banks absolutely realizing that they’ve gone down a path that they have no way out of and that the effects of what they’ve done. That’s what you wanna go for. The inflation will be the ultimate ugly effect but it feels it must have been a bad investment. Oh really? How has the dollar done? Would you rather own gold for the last 50 years or to be in dollars if you’re a foreigner? I would say you’ve been much better off in gold. So the gold has done what it’s supposed to, be a store value. Now my attitude is that, and I’ve done a lot of work on yield curves for 35 years, 40 years already, this is gonna get interesting this year and i’m looking for steepeners because my attitude is with this debt overhang, and yes debt does matter regardless of what Larry Summers, and Jason Furman Monday recent articles in foreign affairs, it does matter and then they have a cost and I say that any money manager who would put their clients in anything longer than a 5 year duration of US debt ought to have reexamined because there not operating as a fiduciary because there’s just too much uncertainty with the US debt situation. I’m not even getting into the entitlement argument. Again, we’re running a trillion dollar deficit at full employment. That’s heresy if you’re a Keynesian. Heresy. So I see those as worthwhile investment. I’m looking at Germany though as we come back to Germany because my question to any German is where do you go to invest? What are you doing with your money? Are you buying 2 year German debt? Is that doing it for you? I don’t think so. The shots yield at negative 60 basis points. You’re better off putting it into your mattresses of course because it will do you better. So real estate in Germany has already reached almost a bubble proportion which is highly unusual for Germans because they don’t leverage themselves. So i’m gonna watch the Dax closely. To me the German assets (inaudible) to them of course is that Trump gets aggressive and really starts pushing for tariffs on the German auto sector. I’m not invested there yet but I’m watching because my attitude is where do I go if i’m a German? I also like Mexico because as I say If the Chinese are serious in what they’ve presented on the issue, they’re really gonna ramp up their imports, Mexico has to be a beneficiary of that so I’m gonna watch closely and again on a relative basis, the pesos cheap and they also pays you an eighth and a quarter at overnight interest rates. I’m not involved yet. I’m waiting for the 200 week moving average and I like Bill, I’m not that good of a technician. I used it to establish my losses and potentially if I see momentum but its not the first place I go to do my work and that covers me in the short term here but again, I look at it with a trader’s eye more than I do with a long term investors eye.

FRA: Wow great insight as always gentlemen!

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Download the Podcast Here in MP3

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Download the Podcast in MP3

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

podcast to be posted shortly ..

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Download the Podcast in MP3

FRA Roundtable Interview: Nov 20th

By: Tenzin Lekphell

FRA: Hi! Welcome to FRA’s Roundtable Insight! … Today we have David Rosenberg, Yra Harris, and Peter Boockvar. David is Chief Economist and strategist at Gluskin Sheff. He has a focus on providing a top down perspective to the firm’s investment process and asset mix committee. Prior to joining Gluskin Sheff, David was Chief North American Economist at Merrill Lynch in New York for 7 years during which he was consistently ranked Institutional Investor All Star Analyst Rankings. Prior there too, he was Chief Economist and strategist for a Merrill Lynch Canada based out of Toronto. David is also the author of Breakfast with Dave and Espresso with Dave (publications of his economic and financial market insights). Yra is a hedge fund manager and global trader in foreign currencies, bonds, commodities, and equities for over 40 years. He was also CME director from 1997 to 2003. And Peter is Chief Investment Officer for the Bleakley Financial Group and Advisory. He has a newsletter product called BoockReport.com which has great macroeconomic insight and perspective with lots of updates on economic indicators.

Welcome gentlemen!

Peter: Thanks Rich!

David: Great to be here!

Yra: Thanks Richard! It’s a great pleasure to be here.

FRA: Great, awesome! I thought we’d begin and look at the Central Bank policy. David you recently feel that the Bank of Canada should pause on its interest rate hikes but the Fed reserve does not have to. Can you elaborate?

David: Well firstly, I think that the US economy for the time being is already, not just at full employment but at 3.7% unemployment, is already through full employment and the FED is below it’s own an estimate of neutral so I always felt comfortable with the view that in the United States and the fully employed stable price environment, you don’t have a 2% Fed funds rate, you have a 3% Fed funds rate. We’ll see if the Fed ends up getting there this cycle. There’s more skepticism on their view than there was just a few weeks ago. Look, the Bank of Canada, the level of capacity in the economy is far different. Canada is not nearly as late in the cycle as the US is point number 1. The Bank of Canada never stimulated the economy in Canada by expanding its balance sheet and never had a present balance sheet to provide stimulus. That’s point number 2. And we don’t have fiscal stimulus in Canada so that may change with next year’s budget but that’s a long ways off but the reality is that if you look at capacity levels, unemployment, fiscal stimulus, there’s far more reason for the Fed to be more hawkish than the Bank of Canada. And so that’s been my premise here that the Bank does not have to follow in the same footsteps as the US’s on those basis.

FRA: Yra do you feel likewise?

Yra: (inaudible 3:11-3:13) I think Canada is really well taken. It’s been one of those things that when you have to look at if the Canadian economy could really muster some continued growth. I mean it has to move back but they won’t have to overcome a balance sheet situation because I think they, well first off they weren’t in the same situation because of the banking laws and regulations in Canada and the dominance of the (inaudible 3:40-3:41) and the way they do their business so they didn’t have that situation but outside of that, yes I agree.

(inaudible 3:46- 3:48) a good point and I scratch my head for quite a while why the Canadian dollar hadn’t been stronger through this period? Yes I know that it’s tied heavily of course to the energy markets, some would say commodity markets. Canadian oil has blown a price of discount for quite a long time first of all because of the nature of a lot of it (inaudible 4:17-4:18). But I agree. I agree with that very much.

David: (inaudible 4:22-4:23) that Yra just said, the Canadian benchmark gold prices are down to $14. Now we know that every benchmark comes down but (inaudible 4:32) to say that if WTI got down to $14, we’d be talking about recessed in the US and the Fed easing policy. Well that’s where the Canadian benchmark is right now is $14. On top of that, household credit demand numbers in Canada have really slowed down remarkable. I mean maybe I’m old school but normally when you have decelerating credit demands, interest rates aren’t going up, they tend to go down. So, I think the Bank of Canada is offside if they continue to raise interest rates in this environment.

FRA: And your thoughts Peter?

Peter: Well I was gonna add to what David just said about that last point about Bank of Canada having to manage high debt levels of moderating housing market in certain markets and you know creating some sort of, I don’t want to say deleveraging because it’s not really deleveraging, it’s more of a slow credit growth type situation.

FRA: And let’s move to a discussion on trade challenges, given local and global trade challenges, what are the trends that you see on economic activity resulting? David your thoughts?

David: Well look, if your an investor right now, not just an investor but a business, you’re fighting a war here, I guess Jamie Dimon called it a squirmish, he was being polite but its truely multifaceted. For one thing, we’re all waiting with (inaudible 5:54) whether or not there’ll be some sort of agreement at the G20 summit at the end of the month and that’s an on again off again situation. But I was telling everybody that even if we managed to cobble together some sort of agreement with China, which I think is going to be very difficult when you think about what Xi Jinping actually put down in the constitution on what they can actually do to the appease the U.S. How this ends up, I just say that I don’t think there’s going to be some some big deal that causes a lot of euphoria and then we’re going to be left on January 21st where the tariffs on China are going to escalate dramatically from where they are right now. Remember that’s January 1st. That’s what’s hanging in the balance.

But let’s even assume that we have a trade agreement with China that reduces the pensions. Then the next phase is the trade war with the EU. The next phase is trade war with Japan and now all of a sudden, we got the House of Representatives, which are now controlled by the Democrats, who don’t seem as a group to thrilled about the USMCA and there’s no more for negotiating a new North American trade deal because Donald Trump signed that with the with the outgoing Mexican government and will not be able to cobble the same deal with the new Mexican government. So we can a situation where we’re back even if you assume that things with China go great, we’re back to uncertainty over NAFTA because if Trump doesn’t get this deal through with Congress, and I think that actually doesn’t get discussed but that’s gonna make the front pages for the next couple of months.Then we’re back to first principles with the President when he said, during the campaign and after, that his preference is to walk away from NAFTA. So that’s actually the dark (inaudible 7:46-7:47) that people aren’t talking about right now is that this North American deal is not a done deal at all.

FRA: Yra your thoughts? Do you agree?

Yra: You know there’s so many moving parts here that I can’t even disagree with. There are great many moving parts. But the overhang to this entire market of course is the fact of the global supply chain and we don’t know what the effect is going to be, about how much disruption is going to take place through all of this.There are so many unknowns and when they get to the G20, as long as we’re going down that road, (inaudible 8:22-8:24) come away with some type of positive outcome especially the Trump Administration is so attuned to the equity market that they’ve tied themselves to the mass of a positive equity market as being the velometer of their success. So they’re gonna have to figure out something (inaudible 8:47-8:48) equities market under (inaudible 8:50) you wait for (inaudible 8:53-854) Mnuchin to show up with some kind of statement, oh we’re doing this, we’re doing that.That’s kinda getting old. Unlike the last G20 meetings, I probably wouldn’t say last, 5,6,7,8 G20 meetings where they really accomplished nothing except maybe climate change and I’m not minimizing that as nothing. We can disagree about the science but the outcomes maybe we can’t get away from.They need something here and China, you know Peter and I were going back and forth this morning because Peter wrote a really good piece this morning and Pence’s speech, you know these people all have short memory. Pence says, we don’t load our friends up with debt. Oh really?! I studied American economic history for quite a while let alone American history and we do load our friends up on debt and in fact, we use to collect it like the Brits did with (inaudible 9:53) diplomacy. So the better go back and redo their analysis. Of course we did! Whether one is (inaudible 10:00) and the other is (inaudible 10:01) financed (inaudible 10:03).

So they have a long road to hold and they have to be careful because the Chinese have a different memories about the colonial nature of the western world and that come to play in this. So I’m not disagreeing with David. I agree with him and I think (inaudible 10:25 -10:26) harder to get to.

FRA: Just a quick question on that, Yra do you see challenges as being negative upon the US agricultural commodities market?

Yra: Well I think that they’ve explained that already and you and I,Richard, we talked about that long time ago. They couldn’t have time that worse for the agricultural sector because (inaudible 10:51-10:52) right when the Brazilian crop was being harvested, the Brazilian, Argentinian, South American crops were being harvested, and they’re offering discounts because there was so much product, so much Supply.

So the Chinese could afford to play this game and all it’s done is just like it did in the seventies with the Russian wheat deal, you start losing markets. More than the low prices in the short run, the farmers are really upset that markets are trying to build a route in diminished because of this tariff.

Yes, I always laugh when you put on tariffs and through the backdoor, you start offering subsidies to the businesses. You have to scratch you head. It’s a stupid policy, it was mis-timed, they came out with guns blazing because they wanted to make a point and the rural sectors of the United States economy held strong in supporting Trump. But you couldn’t have timed that worse. I would have waited until now but they were in a hurry because of the election cycle and the election cycles are more important than anything else. It’s a terrible, terrible policy in that regard.

FRA: And Peter your thoughts?

Peter: So I breakdown of the goals of the administration in 3 lanes.

1) One is economic ignorance and that’s their desire to lower trade deficits which is nonsense

2) Then its the technology threat by Chinese companies stealing. Well there are ways of dealing with that and right now the U.S government has essentially cut off a Chinese company that was accused of threatening technology for Micron. Not only is that company being cut off from doing business with American companies but they’re also getting tossed into some international courts. That’s the way of handle the theft of technology.

3) And then you have forced into joint ventures where you have to transfer technology. Well no one is forcing an American company to do a joint venture in China and if they do, then hand over their technology. US companies don’t have to agree to that. They voluntarily do it. I’m not saying that’s the right thing for China to be doing, to force the transfer of technology, but no one is forcing US companies to do business in China. They honestly want to do it for growth but its not being forced. So my point is that throwing tariffs to address these 3 things is like throwing a football at a catcher at a baseball game. It just doesn’t apply. The problem now is that your literally freezing global economic activity, (inaudible 13:49 the CEO and CFO of multinational business, you’ve clouded up all visibility, we’re seeing trade numbers from China, to Japan, to Germany, to the US all slowing across the board. So what’s happening is that the administration is taking for granted what was a decent economic start to the year and throwing it in the winds and hoping that t can somehow withstand these tariffs. The problem is, and I talk to and listen to alot of conference calls, 10% tariffs is not good and not fun but companies can handle it. You go to 25% and all bets are off! In terms of what Yra mentioned earlier about supply chains, well many companies that do business in China aren’t going to just pick up and go to Bangladesh, or Vietnam. They’re well entrenched there. They’re happy doing business in China (inaudible 14:41) products and their just going to have to eat this or their customers will eat this because when you throw tariffs to somebody else, it’s your own people that ends up paying for it.

FRA: Great insight! I guess the big question now is, given these trade challenges and transit economic activity, will there be a massive infrastructure fiscal stimulus? And if we can look at that question from the perspective of will there be a massive infrastructure fiscal stimulus in Canada, in the US, and in China where there has been a lot for the new silk route initiatives and also in Europe? As you mentioned Yra, the key to European infrastructure program will be the issuance of a Eurobond, which will begin the process of unifying the European financial markets. Maybe we begin with Yra your thoughts on that, for the massive infrastructure stimulus, will that happen? Yes or no in those jurisdictions?

Yra: When I listen to President Macron, he would like to get there yesterday and then when the Dutch Finance Minister came out today and said he was opposed to what Macron and Merkel had reached on the budget agreement, but that’s really not the issue.

(inaudible 16:02-16:03) George Soros and many others (inaudible 16:05-16:09) I can probably go back to (inaudible 16:11), and if you gonna do this, you needed a real Eurobond not individual sovereign bonds. (inaudible 16:19-16:25) including the French. The French never wanted to relinquish their sovereignty by surrendering their budget. (inaudible 16:33-16:36) but to give up your fiscal policy, that was a step beyond.

Now they realize that Soros and the others were right. You have to create a Eurobond. Now a good way, economically, (inaudible 16:51-16:52) Rahm Emanuel, the Mayor of Chicago, Chief of Staff to Obama would say, never let a crisis go wasted.

Well the Italians, I think are much more flexible in those demands, if they knew they were getting a massive infrastructure spending financed by the capital level (inaudible 17:20-17:21) in Europe and

you could do that! You could do this. You could do this at the G20 and say, hey, we need the infrastructure spending. Let’s do 500, it’s just a number, but what difference does a number mean anyways? They’ve already bought 3.5 trillion of debt that Dragi (inaudible 17:41-17:45).

But if you went a very long way to (inaudible 17:48-17:50) whatever it takes to sustain the Euro. Why go half way?

I think the infrastructure for Europe is easy and you get that Eurobond and to make it all a bigger joke, you have the ECB buy the debt anyways. So go to the German court or European Court of Justice but it would be a needed step that they need to undertake. Is it the best step? No. But they’ve already gone this deep so why stop now?

Which is really the (inaudible 18:31) and it will buy off (inaudible 18:32-18:40) you’ll get the optics of the Italians saying, ok, we’ll back off and everybody becomes a winner and you’ll do it with German money. What better way is that?!

FRA: David your thoughts on potential for massive infrastructure spending in Canada, US, China, and Europe?

David: Well, I’ll just give my thoughts quickly on Europe. The bottom line is that the only country that has the fiscal capacity to fund something like that will be Germany and their infrastructure is top-notch. It’s one of the best in the world so I really don’t know how that’s going to be facilitated.

I look to the US and infrastructure for election is just a classic motherhood. 14 letter word for motherhood, infrastructure, we hear it all the time. It gets people excited all the time. I remember we had an infrastructure package with Obama in 2010 and I don’t remember (inaudible 19:46-19:47), people will talk about how the money never really got spent although I continue to hear things were (inaudible 19:52) already. You can use Canada as a poster child. I mean there’s no plan to boost infrastructure in Canada. There’s other issues here that have to be addressed but the Trudeau government, who got elected at 2015, the first thing they did was embark on motherhood and infrastructure was part of their key campaign plank.

Canada has already started to see that money flow into the economy and at the same time, the Canadian economy is slowing down after never really doing a heck of a lot. I don’t see a infrastructure was a big antidote at what happened at the energy sector and now residential investment is gonna be going into a bear market because of its over capacity.

So I know that infrastructure makes for a nice headline, you know if you’re long on bonds in the United States, you really want to hear about how the federal government will fund infrastructure for the local governments. I’m not convinced that’s gonna happen but if it does happen, you have to remember that the (inaudible 20:52) period for infrastructure is in years.

This is no magic bullet. I’m not gonna say that we can’t use infrastructure to upgrade roads and highways. I’ve been hearing infrastructure for 30 years. We always need infrastructure but as a tool to boost the economy, it’s not very effective. As a tool, to say, upgrade the capital stock on a long term basis, I’m all for that. I’m not so sure given the level of acrimony between the House Democrats and the Administration, I’m not very hopeful we’re gonna get something done on that.

Even if they do, it’s not changing my overall investment philosophy which is extremely defensive at the moment.

FRA: And Peter your thoughts?

Peter: Public infrastructure spending it’s tough to get more inefficient than that and all you have to do is look at, I live in New Jersey, look at New York airports, the New Jersey transit system, the New York City subways, that’s not for lack of money, that’s for a complete waste of existing money and existing resources. So to think that okay we’re going to build some bridges and roads, well that’s being done all the time at the state level. So to see that we’re going to throw some more money at it and to think that’s gonna be efficient use of spend is complete nonsense.

Then it gets to the point where, okay let’s just say we passed something, we allocate money to these different jurisdiction, who’s gonna actually work on these roads? Where’s the skilled labour that’s gonna be tightening bolts on a bridge? I’m not sure if there are plentiful right now so I don’t even know if something was passed that anything would actually get done.

This laundry list of wasteful spending projects that has ended up costing billions and billions more than what was forecasted and for what?

So I would argue that the multiplier is less than 1 and yes overtime, you want a train system that works and you want a bridge that doesn’t collapse, I get that. But the multiplier is typically less than 1 when your dealing with public infrastructure spending.

FRA: Peter moving on to your forecast, what are your thoughts for the U.S Dollar and US interest rates for the next 6 to 12 months?

Peter: What the US dollar faces is a Fed that’s gonna either blink and pause, which is a growing possibility at the December meeting and I would argue that if they pause, they won’t have the either the guts or the data or the markets to end up hiking. Now granted that they can hike every meeting next year because everyone’s alive meeting. I’m more worried about European bonds and what the ECB has done and I do think that we’ve entered a longer term bear market in bonds generally but that could take awhile to play out.

With the dollar, the challenge the dollar then faces is if the Fed blinks, the dollar is going to be in trouble and interestingly the dollar has two different phases this year.

In the first half of the year, it was strong against emerging markets and traded actually relatively poorly against more developed currencies.

Then the second half, or at least the last couple of months, you’ve seen a rally in emerging market currencies and you’ve seen dollar strength against the Pound, the Euros more related to Italy. But I see these currency movements and the strength of the dollar is not because of something great is going on here, even thought someone could say rates are going up and the economy is better here than elsewhere, but a lot of it is I think shot in the foot type behaviour in overseas economies

But the second the Fed blinks the dollar’s gonna be in trouble, that could be the end of the dollar rally because the US government is still facing massive debts and deficits, which overtime is gonna be very dollar negative and just as the years go on, there’s gonna be less dollar transactions taking place. That’s a very long term story. I know it gets a lot of press now but I see lot of secular headwinds for the US dollar notwithstanding current (inaudible 25:08) against certain currencies.

FRA: And David your forecast for the US dollar, and US interest rate for the next 6 to 12 months?

David: Well I think that, well firstly on the US dollar, its been very tempting to be bullish on the US dollar because the FED, you know textbook economics, easy fiscal policy, tight monetary policy will always and everywhere, give you a bull market in your currency. But I think that story has largely played its course. I’m getting a little nervous over the bull market in the US dollar and I’ll tell you why. Firstly, the chart today looks absolutely ugly of the DXY but I’m looking at latest (inaudible 25:52) in the traders report and I’m looking that on the intercontinental exchange the trade weighted US dollar has a net speculative long position of over 40,000 contracts. I mean we haven’t seen this in about a year and a half. So there’s a huge overhang of speculative naked longs right now that could easily exit this over crowded trade and set the condition for this pretty big reversal in the US dollar going down as opposed to up.

I agree with Peter that the most important determinant in a currency is the relative interest rate differentials and one of the reasons why the US dollar is succumbing right now isn’t just that the naked longs are starting to exit the markets but the reason why and that’s because of the Fed, in a matter of about 6 weeks, has gone from hawkish, and I wouldn’t say dovish, but certainly less hawkish enough that you’ve had already just the matter of weeks of full wage hike priced in for next year come out of the marketplace.

We were supposedly at (inaudible 26:56-26:57) Oct 3rd, a long way from neutral, we may have to beyond neutral and now everyone’s talking about, no neutrals enough and by the way, maybe one or two rate hikes away. So that’s undercutting the US dollar at the current time.

(inaudible 27:13) interest rates, a lot could happen in a year. Probably at this stage, maybe less bearish on treasuries than Peter is, I think we may look back and say that when we approached the 3 and a quarter percent of the 10 year, maybe that was the peak and I think that there’s a lot of cross currents.
You have the cost push inflations forces from extremely tight labour market and from these tariffs but at the same time that’s battling the cyclicality of a decelerating global economy and US economy. So I think that we should just take our (inaudible 27:54) from the market itself. Here we have taken out a full rate cut for next year, here we got a lot of slowing growth, another turn down in the stock market and the best we can do is 3.05 on the 10 year note. You know the 10 year note in this mix of widening credit spread, deteriorating stock market, less bearish view or hawkish views on the Fed and the best you get is 20 basis points off the 10 year note.

I mean normally in the past when you had this sort of condition, especially in the stock market, the 10 year note yield was down 80 basis points not 20. So the market’s telling us something here and maybe it’s over beyond just talking about tariffs, cost push inflation, wages, the cost push inflation, but the fact that we’re really choking on supply. I mean Peter Boockvar comments all the time on what’s happening with these treasury options and the reality is that this time last year, the deficit was supposed to be $600 billion dollars this year. Well it’s gonna be worth more than a trillion dollars. So we were choking on treasuries supply that we weren’t supposed to get except the bright lights in Congress and the White House saw that cutting taxes at a time of full employment was a really great idea. Newton’s 3rd law of motion, every action has an equal opposite reaction is that bond yields are not falling when they should be falling and that ends up being another problem for the stock market because stock markets put in the lows. When you get to a certain relationship between the bond yield and the earnings yield on the stock market, the problem for the stock market and maybe for those people uber long treasuries is that you’re not getting a normal response here.

The reason is that there is too much supply. The streets left with too much product after these auctions and the dealers have to dump this product and this is putting (inaudible 29:42-29:43) on bond yields right now. To me that’s the big story. So I think we’re stuck in a range for the foreseeable future as far as the treasuries markets are concerned.

FRA: And Yra your views?

Yra: Well I’m gonna be very sympatico with this but let me pick up where Peter Boockvar was just talking about on CNBC, which is of course a huge amount of corporate investment debt to throw onto this and how much of it actually is LIBOR based which makes it even more telling. As we’ve talked about, Richard and Peter, and David a little bit, debt, debt, debt, is to financial markets is what location, location, location is to real estate. That’s the way I knew it, and I hold true to that and I think that David’s warnings are very, very important and Peter’s been there too cause we turned bearish a dollar i think at the same time at February of 2017 when we saw the move come, Peter and I. This movement of dollar, the dollar is going up grudgingly and I like David am old enough to know that when you have these interest rate differentials and with negative nominals, forget real, but nominals wage being negative in certain parts of the world, yet those currencies are not really weakening as they ought to and couple that with David’s comments about why aren’t these bonds a lot higher, that poses the question that United States is really drowning in debt and the world sees it. It’s like you hold your nose when you buy dollar assets today because there’s very little else to buy. You buy it cautiously and I think some of it is right because it’s to expensive right now to hedge it away. So a lot of people buy it and go, if I pay for the hedge, I’m basically breaking even so what’s the sense of doing that? So some people stay away from it. With David’s point is absolutely well taken on.I’m watching these curves. Right now, the 530 curve, which I call the speculative curve, is getting interesting because it’s moved while the 210 has kinda stayed stagnant. But I would say that’s because people have more duration matches that they have to put on. But as I tell people, if you buy a US bond of longer than 5 year duration, you need your head examined and ought to go looking for another profession because you’re an idiot. You’re an idiot! Unless you have duration that you have to cover because it makes zero sense cause as David talks about, this budget/ deficit this year is over a trillion. And this is, I’m not an anti-Trump, you know again, I’m from the school of Deng Xiaoping. I don’t care whether the cat is black or white, as long as the cat catches mice.

This is a president who’s never met a debt he doesn’t wanted to take on. So if he really gets into trouble, and that has been my point and that’s why I agree about the structural basis of infrastructure spending, this is somebody who’s looking to spend, spend, spend.

And If he finds sympatico voices from the Democratic party in the house, he will get his way cause he’s already said, he doesn’t care about debt. You know what, the freedom caucus, who was the voice of fiscal austerity and soundness and responsibility, their on their heels right now.

I would not buy a piece of US paper over 5 years. I think you’re out of your mind.

The equity market, that David points out, is telling you that because as we look at this board, (inaudible 33:52-33:55) 3.05? Really? That’s all you got after a 15% drop from the high to the recent low in the equity market.

That’s all you got? To me that’s a warning sign.

Peter: In the month of October, the stock market and bond market went down. Yields rose across the curve in October when equities fell as much as they did.

FRA: And finally lets look at what investors can do for investing or protecting themselves going into 2019. David, you’ve referenced 4 letters, Q.L.D.S, Quality, Liquidity, Defensiveness, and Selectiveness. Can you elaborate?

David: Sure. I think that when your talking about a step up in quality both across the capital structure, equity and debt. If your mandate is equity, I think you have to be very mindful of the degree of cyclicality that you have in your portfolio and focus on earnings visibility, and limit as much as you can your overall GDP sensitivity.

I think classically late cycle, I think we’re in the top of the 9th, and I think when we get to the top of the 9th, historically its the rare period where value outperforms growth and I think that will continue to be a theme, maybe a theme that works for relative terms and absolute terms but it will work in relative terms.

I think as Yra has said and Peter would agree that being very mindful of your duration in the fixed income portfolio is very important. Really until you see the (inaudible 35:44) eyes of the recession, which I think at some point will come next year, is like an odorless gas you know everybody likes to say that, oh I don’t see recession coming. Well most people don’t see recession coming when it’s already hit. So you want to be mindful of that up until a certain point when things start turning around (inaudible 36:03) keeping in mind that inflation is gonna be a problem but at the same time, a bit of a lagging indicator as we saw in 2008. So that’s the quality part. Liquidity, I think it’s pretty obvious, you want to have cash on hand for optionality or maybe more than that.(inaudible 36:24) at the beginning of the next cycle in other words, transitioning out of this long bull market. So you wanna use cash and look at this time last year, cash paid you 1%.Today cash, looking at the 4 year treasury bills are trading, you’re getting well over 2%. You’re getting better than they get in the debit and yield in the stock market. So you’re getting paid to be in cash today and I think that was a very prudent thing to do.

You wanna end up being, when all said and done, a lender in this market not a borrower.

You know LQDS, D for defensiveness, that goes back at the quality, basically perhaps, subsets that again be mindful. The OECD leading indicator is down 10 months in a row so you haven’t seen anything yet. This is a financial wedge. The global economy is gonna be weakening even more next year than it has from the previous year. So that means you have to be defensive and of course I would go back to fixed income markets especially in corporate when you can consider that next year is the first of the next 4 years for you’re gonna have a tsunami of debt refinancing in the corporate sector at a time where 50% of the investment grade universe is rated BBB. There’s gonna be a lot of volatility. Defensive also means very mindful in your fixed income portfolio and credit as to what the maturity schedule of the debt looks like and the companies that you own. Selectivity just means style investing, no different than late cycle value over growth. Late cycle means you wanna own as few stocks and few securities as possible. You wanna cull the portfolio. If early in the cycle, you own 60 stocks and mid cycle you own 40 stocks, you wanna have 20 late cycle. You wanna get down to your most blue chip, liquid, relatively safe names. So that’s what selectivity really means to really just have best idea portfolio and nothing else.

FRA: Peter your thoughts?

Peter: Yeah and to add to that, if you’re going to be in equities, at least for many listening possibly US and Canadian equities, boring is good. Boring businesses, peak valuations, not exciting that’s what people should be focus on. And I think in this downturn overseas, particularly Asian emerging markets that includes China, I think there’s a lot of value being created. The Chinese stock market has been as inefficient as it is. It’s been through a bear market down 60%, well now probably about 50 from its 07 peak let alone where it’s all from its 2015 high. And to add again, short duration, I’d be in gold and silver as part of my weak dollar belief next year when the Fed blinks. I think gold and silver are gonna be up a lot when that happens. I think it’s simple as that and having cash. There’s time to play offense and time to play defense. This is one of those times to play defense. There’s time to own gold and silver. There’s times not to own it. Now’s one of the times to own it.. So boring is good and I would stick to that.

FRA: And finally Yra?

Yra: There’s so much that I agree with here. The medals, I think they’ll have their day. People have been a little bit unnerved because of rising interest rates in the United states. You know its more than just rising interest rates cause we see 8% in Mexico and I would argue that Mexico is a probably a far better investment right now than a lot of other places. Yes I know that (inaudible 40:10) is coming on and there are some uncertainties of course that exist there but US is its own inconsistency. Part of it is who’s running this show. I don’t think we’ve had a high quality secretary of treasury probably since, and we can argue about that, the Rubin Summers years. I was not a Hank Paulson fan. I was certainly not a Jack Lew fan. I was certainly not a Tim Geithner fan. I’m less of a fan Mnuchin and yet all of this is taking place.

So when I buy a country’s sovereign bonds, I’m buying not only what their balance sheet looks like and what their financial statements, I’m also buying the credibility of the people in charge.

So again, you gotta be very careful here. I think that David and Peter are both making really great points about where yields have gotten to this in the face of all this and the inability of the dollar to really have a sizable rally cause David hit this right on the head.

I know I traded my way through Volcker and Reagan so we have the classic case of fiscal stimulus with tight monetary policy and the dollar boomed so the dollar strengthened till much of

the course they had to undo it through the (inaudible 41:36) accord.

We’ve got nothing out of this! Really, when you look at it, if you put up a long term chart or last year’s, okay, you know I can say the Euro was born 1,17,85 in January 1st 1999.

We’re not that far. We’re 1,14,50 and Europe is saddled with nothing but problems and still the dollar doesn’t rally. Now that doesn’t mean today it can’t rally, tomorrow it can’t rally, next week, but when you look at it’s overall performance, I would be very weary. There’s movement afoot here. There’s things underneath the surface, that are bubbling that you have to be attentive to and it’s what ought to be happening that isn’t happening and that should be a warning sign to everyone!

FRA: Great insight gentlemen! How can our listeners learn more about your work? David?

David: Well you could either call me directly at 416-681-8919 or email me at rosenberg@gluskinsheff.com and I’d be happy to get anybody on a trial for me two morning publications at Espresso With Dave and Breakfast With Dave and the best way to reach me once again either phone or email.

FRA: Great, and Peter?

Peter: You can reach me at peter.boockvar@bleakleyadvisory.com and I have a “C” after the double “Os” is my last name. For wealth management advice or macro market advice where you can go to the website boockreport.com.

FRA: Great, and Yra?

Yra: Just notesfromunderground or you can go to yraharris.com and register for there and if you write to notesfromunderground and it’s not low quality trolling but high quality, you’ll get an answer because a lot of people will respond to you tonight, give and take on the blog. Again, it’s not a tout sheet, we’re not a tout. We try to create ideas and you’ll do the work, we’ll just try to point you in a direction to see if there is any possible investment reward. To me is a great place for two way communication and for dialogue which so much in this business is. It’s about dialoguing with people who we respect and nothing does it better than this podcast that we’re sitting on right now.

FRA: Great! Thank you very much and we’ll end it there. Thank you very much gentlemen!

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

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FRA: Hi Welcome to FRA’s Roundtable Insight .. Today we have Charles Hugh Smith, author, leading global finance blogger, and philosopher, America’s philosopher we call him. He’s the author of nine books on our economy and society, including A Radically Beneficial World: Automation, Technology, and Creating Jobs for All, Resistance Revolution Liberation A Model for Positive Change, and The Nearly Free University & The Emerging Economy. His blog oftwominds.com has logged over 55 million page views and is number 7 on CNBC’s top alternative finance sites. Welcome Charles!

Charles: Thank you Richard. It’s always a pleasure!

FRA: Great and today’s topic is socialism. What is driving the majority of millennial’s to that? So we want to explore, you know, what’s behind that trend (Especially in the US and in Canada)? You know what is socialism? Misconceptions on socialism? We’ll get different models like the Nordic model and how does that look, positives and negatives. And just in general also how this could lead to increasing levels of political instability and even political violence in the coming months.

Charles: Right and it’s a great topic Richard because we all know that the younger generation, the millennials in particular, are publicly attracted to socialism as a more just system than what they see is unbridled capitalism, which in its current iteration has created extremes of inequality and opportunity.

So I thought we’d just start out by laying 3 different flavours of socialism or what’s commonly called socialism. In classical socialism, that means that the state or the government, owns the means of production and in other words, factories and the resources are owned by the democratically-controlled or structure government so that the benefits from the means of production are then distributed relatively equally amongst the population. In today’s world, most young people according to polls understand socialism not by the classical ownership of the means of production but by social welfare. In other words, the government collects taxes and it distributes it in some sort of fair fashion to the entire populous and so I call that the social welfare version of socialism. And the Nordic model, the Scandinavian countries which are often called socialist but as you’ll explain in a moment, is not technically not really true. But what they do have is a model of deep cooperation between unions, you know labour, big corporations and the government and so there’s a there’s sort of a cultural social contract there that creates a more equal society because the wealthy pay very high taxes and there’s a lot of social welfare programs and also programs to create jobs.

FRA: And I think the millennials are coming to this from the social justice perspective so they sort of focus on that first and then they branch out into economics areas in terms of like socialism. Would you agree?

Charles: Right! Exactly! How do you achieve economic justice and they’re looking to socialism as the answer. But you know that start with the Nordic model because it’s widely understood to be successful in these is relatively small countries. I think Denmark has less than 6 million people which makes it smaller than the inter counties of the San Francisco Bay Area and considerably less than the county of LA and I think Sweden is around 13 million people something like that which puts it on par with the County of Los Angeles. So these are really small nations in terms of their population and so it’s a lot easier to have a unifying culture than it is to have a very large multicultural nation like Brazil or the United States but having said that, you mentioned a quote from the prime minister of Denmark which I thought was really insightful about the Nordic model of socialism.

FRA: Yes, exactly! The Prime Minister of Denmark recently said, “Denmark is far from a socialist planned economy. Denmark is a market economy”. And yeah just to further elaborate on that, the Nordic countries do not generally interfere with free markets so they are promoting free markets, they are promoting free trade, global trade, globalization, and generally do not nationalize industries, and do not subsidize favourite Industries which is a common misconception.

Charles: Right and I think the another common misconception is that they just give away a lot of free money to everybody but in actual fact, they have very strong work ethic. In other words, a lot of their social welfare programs are aimed at retraining people and helping small businesses emerge and hire people. So they’re really focused more on creating jobs than giving free money away and so that’s why universal basic income, which a lot of people feel is the source socialist solution. In the Nordic countries, they’re not really big fans of just giving away free money with no strings attached. They want to help people gain livelihoods. That’s really their culture focus. We were having a conversation about the culture aspects of the Nordic modelling and before we started recording, it’d be great if you could elaborate on that that topic.

FRA: Yeah the first question I usually ask when people make reference to that is have they been there before and then I mention I’ve been to Sweden, I’ve been to Norway, and what I have observed in the nature of the people generally, that in the culture, is a very strong sense of fiscal responsibility and a high level of education. Making very efficient use of government resources and even in the buildings they stay generally not looking to build brand new government offices but working in very frugally, meager type of facilities, government offices or old buildings perhaps and making the funds of the government go much farther in terms of very efficiently. That I think would be very difficult in North America given a lot of politicians are more concerned on getting themselves more lavish pensions.

Charles: Right. I think you are absolutely right and I had a chart that flabbergasted me actually that in the state of California, where I live part-time, that the taxpayers contribution to the public union pension plans there was less than a billion dollars in the early 2000’s and now it’s something like 45 billion.

So the people kind of promoting social welfare versions of socialism, they’re not a tuned to the fact that socialism limbs itself, if you have the wrong cultural traits, to cronyism and exploitation of the state rather than as you say of a fiscally prudent use of state funds to help everyone. So that leads us to, I think, Venezuela which pursued as policy both a classical form of socialism meaning that they nationalized a lot of the industries in that country, the oil industry, and so on. And they also instituted a very broad social welfare programs. And so, as we all know, the Venezuelan policies of the government have led to a complete collapse of their currency, trading at something like 300,000 or to $1. Might even be 3 million to one now. I’m not sure but they’ve impoverished of literally everyone in the country except those high officials and cronies who escaped and then it took their money to Miami before the currency collapsed. So that socialism is one version of it and we really have to ask, what did Venezuela do wrong because they pursued socialism as most people understand it

FRA: Exactly and that contrasts between them and the Nordic countries, in terms of their approach, what has resulted?

Charles: Right and the government ownership of means of production doesn’t guarantee you any efficiency and if the enterprise, where its owned by the government or owned by private parties, it’s still has to create a profit, it still has to use the efficient otherwise it just becomes a source of losses and it’ll take or who ever owns it. So Venezuela, I’ve never been there but I have sources there, I have contacts there, and it seems pretty apparent that the government owned infrastructure and resources are very poorly managed. They were undercapitalized, under investment, and cronyism has run wild there. So that raises the question for millennials, how do you make sure the socialist model that you find attractive is more like the Nordic model and less like the Venezuelan model because socialism as an ideology or as a way of organizing the resources and the means of production of society. It’s not one-size-fits-all and you have catastrophic failure right beside so called success. So socialism as a system is not the answer if it goes the path of Venezuela.

FRA: Just to point out a few more facts on the Nordic countries, their countries economic successive before they built their welfare states. A lot of people don’t realize that it was the actual wealth that allowed the luxury of the generous programs that followed so that’s one fact. Another one is a lot of people don’t realize is they don’t have minimum wage laws in the Nordic countries. None of the Nordic countries have a minimum wage law. Another fact is in Sweden, they have complete school choice so whereas your property taxes may go towards government schools only in North America, there’s a choice in Sweden. You could actually apply those funds instead to even go to a private school to attend private run school if you think that’s better for your children so a lot of people don’t realize that but yeah the result though, I mean is it all bliss, not necessarily. If you look at what’s happening now in the Nordic countries, there are problems, maybe not as bad as Venezuela but in terms of the increasing racial tension, ethnic tension, especially from a lot of new recent migrants that are looking to capitalize on that welfare system that they have in place. They’ve also suffered recently from the oil revenues that go in mainly to Norway and Denmark so that hasn’t been as good. A lot of people don’t realize that in many of those areas, there’s actually the highest consumption of antidepressants in the world. So that’s a fact. That is quite amazing as well. And then even recently what they’ve done is moved to a to do a certain activities which a lot of people are not aware of in terms of strong movements now to cut taxes, limit public benefits, reduce welfare spending, pension savings have been partially privatized, for-profit forces have been allowed in the welfare sector, state monopolies have been opened up, so that there’s a lot of change happening even in the Nordic countries.

Charles: Right those are excellent points and it goes to show that what we’re talking about is not a purely economic system that socialism, in whatever flavour we’re speaking of, is a social system and a cultural system. It’s not simply a financial arrangement. So just to kind of speak of change gears a little bit and go through some slides, I have about the social welfare model of a spending on infrastructure and public spending as sort of like a way of distributing the wealth of the nation right (inaudible) and so I have a slide here of infrastructure. Everybody loves infrastructure and it’s a very politically popular way of creating jobs and distributing resources and so we see that globally, China of course has spent huge amount of their capital on infrastructure, you know, and we all know that they have High-Speed Rail and and Subways and they’ve gotten a lot of public benefit as well as jobs from their infrastructure. But at some point, you’ve already built out all the subways you need and all the high-speed rail and then then you wonder what do you spend the money on next if that’s your social welfare program, you know building infrastructure. And here in the US, its well known that in the US infrastructure’s ageing in many ways. The water, electrical systems, roads, and so on all need more investment and that can be seen as a productive useful of public money. In other words, the public is getting some broad based value and jobs are being created as opposed to just giving money away without any strings attached like universal basic income. And then to show another failed way of distributing funds, I have a chart here of higher education student loans in the US and of course, we all know that there were no such things prior to like the 1990’s and now there’s about 1.3 trillion dollars of student loan debt which is guaranteed by the federal government. So it’s a form of socialism that ends up turning students into debts surfs and a lot of people are saying what we need to forgive all that debt. But that debt was issued by for-profit firms and so we have to be really careful when we talk about socialism like who’s skimming profits from these government programs. Then my last slide here is showing the state and local government expenditures, which tend to be the most boots on the ground or the the most visible forms of social welfare spending, tend to be state and local in other words, infrastructure on local roads, local welfare, local school districts, and so on and we can see that all in the US, the state and local government expenditure has soared the rate of expansion far beyond the actual GDP that the domestic economy. And so then we start wondering how are they spending so much money than the economy is creating and then the answer is of course we’re going very deeply into debt. I mean local governments are selling bonds and globally you can see the tremendous expansion of government debt as well as corporate and household debt. So if we’re if we’re funding all of our social welfare and infrastructure with debt, then we’re creating another issue that doesn’t have anything to do with socialism or capitalism. It doesn’t matter! The debt is creating a lot of imbalances and could bring down the entire economy. People always love infrastructure and they love social welfare, they like the government spending more money but where’s the money coming from and what are the consequences of using debt to fund social welfare.

FRA: Yeah essentially putting the burden on future Generations increasingly with the increase in debt as the result. And then some would say maybe we should just say tax income on millionaires but there’s actually a fact that if you even put a 100% tax on income from every millionaire in the US, that would only fund that US government for 4 months. So that’s quite amazing fact. Another one is that even if you confiscated the entire wealth of America’s 537 billionaires, that would not be enough to fund the nation’s budget for even one year. So there’s simply just not enough money out there but there’s a perception that there is.

Charles: Yeah that’s a very good point Richard. I believe the federal budget is pushing for a trillion a year right. I think it was 3.7 trillion and so that’s a big chunk of money and I guess we’re coming back to the question of what’s the downside or the risks of pursuing a socialism and I think if you’re going to follow the classical socialism of the government taking ownership of the means of production, then you risk gross inefficiencies and cronyism, mainly insiders basically pillaging those assets to their own benefit and then impoverishing the nation by under investing or mal investing the state money.

That’s that’s one danger. And in the Nordic model you’ve described it may not be affordable, you know, it as revenues decline even prudent governments end up starting to borrow money and living off of asset bubbles as a way of generating their revenue so that’s the danger. And the US model of just borrowing trillions to pay for infrastructure and social welfare programs. That creates of a really great risk of a currency collapse or a loss of of faith in the entire Financial system.

FRA: And now we go further to that if you look at the history of of socialism and the evolution of it. In particular countries, generally there is a very strong decrease in the standard of living that ultimately results in brain drain and wealth-trained so you get to a point at some point where it nonlinear. A lot of people begin leaving, looking for opportunities elsewhere if they’re educated. Wealthy people don’t sit there as sitting ducks. They’re likely to move at some point together with their wealth somewhere else so that’s also the potential for that to happen, brain drain and wealth drain.

Charles: Yeah and my last point Richard would be that you know socialism like capitalism itself, however you want to define it, it tends to work much better when things are decentralized. When powers decentralized, ownership of assets are distributed, and people have a say both as consumers and owners. My example here is water systems. In very localized places like a city or a county, public ownership of water has been very successful because the agency localized their only specific assets in the community and the community is democratically organized so they have a say about how that resource and asset is managed and they can vote out the board if the board is corrupt or incompetent. And so socialism, on a very small decentralized scale, can work very effectively in protecting public assets in the same way that capitalism really only works if competition is allowed to thrive. So we’re talking about when things are in very large scales like centralized power, then you get rid of competition and you usually get rid of the benefits of public ownership of assets.

FRA: And I think overall the majority of millennials have not been able to understand how and why there was a financial crisis back in 2008, 2009 and what the role of the Federal Reserve and Central Banks in general has been in causing that as well as in causing a wealth and income inequality from various Central Bank activities and Central Bank policies, we’ve covered that a lot in prior podcasts how and why that happens. So I think that’s been also a major driver for the millennials to misinterpret/ misunderstand what’s happened and therefore, go to maybe bad conclusions if you will.

Charles: No I think you’re absolutely right Richard. The financial repression of zero interest rates and quantitative easing for the the banks and so on. Yeah that’s what disrupted the opportunities and created the inequality the millennials want to resolve and we understand their desire the justice of resolving those inequalities but it’s how do we do that? And if we’re going to pursue the Nordic model, then what we’re really talking about is, then you need a market economy and a cooperative government and a culture milieu that supports fiscal prudence and wise investment of resources and not just throwing money away and giving it away.

FRA: Yeah exactly. There was also a recent study I saw where it was pointed out that the minority of radical leftist are actually dominating the Democratic party agenda. So this is interesting because between Democratic Socialist Party of America and the traditional democratic party, which is now having their agenda control or dominated by radical leftist, is quite disconcerting you know in terms of what could happen to the potential for extreme socialism in America.

Charles: Right and again what we’re trying to elucidate here is that there are models of like private or public ownership of assets on a small scale like I said that they have a long history of functioning like public ownership of the water works but what’s being proposed is not really classical socialism. It limbs itself to free money for everybody and if we have to borrow the money, then fine. So that’s not really socialism and it’s not on classical socialism nor is it the Nordic model that so many people look too as a successful model.

FRA: Yeah exactly, and we’re essentially in general agreement to conclude as some final words in terms of what could make sense so we don’t take sides on any parties but generally, we see a more limited government approach that is decentralized with minimal special interest group lobbyist, if any at all that lends itself from a centralized form of government that has been optimal. Would you not agree in terms of that approach?

Charles: Yeah absolutely that a planned economy is a failed economy. That’s really what we’re talking about. A planned economy mean insiders benefit and it’s lost all of its adaptability, flexibility, and efficiency.

FRA: Exactly. What do you see as potentially evolving as a final question to consider in a coming years in terms of the evolution of where America’s going?

Charles: Well that’s a big question Richard. I think people are struggling to find some sort of answer to rising inequality and the concentration of wealth and power and they haven’t really come up with anything and so a lot of millennials view socialism as the answer. Other people view like reforming the government so that there’s less cronyism and so on but I don’t think that they’re going to get the results they want from those kinds of policies. I think we need a radical decentralization of power and a radical redistribution of opportunity and that’s going to be breaking up all the cartels that are, you know, basically state managed cartels, which controls most of the US economy, and get rid of the financial repression that we have described. It’s totally centralized and it benefits centralized wealth and power

FRA: Great insight Charles and we’ll end it on those words of wisdom. How can our listeners learn more about your work?

Charles: Please visit me at oftwominds.com and you can read the first couple chapters for free of my new book, “Money and Work Unchained”.

FRA: Excellent, we’ll end it there. Thank you very much Charles!

Charles: Thank You Richard.

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

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OCT 24th Podcast: Yra Harris and Peter Boockvar

By: Tenzin Lekphell

FRA: Hi welcome to FRA’s Roundtable Insight!  .. Today we have Yra Harris and Peter Boockvar. Yra’s a hedge fund manager, global trader in foreign currencies, bonds, commodities, and equities for over 40 years. He was also CME director from 1997 to 2003 and Peter is Chief investment officer for the Bleakley Financial Group in advisory. He has a newsletter product called boockreport.com which has great macroeconomic insight and perspective with lots of updates on economic indicators. Welcome gentlemen!

Peter: Hey Rich, hi Yra!.

Yra: Hey Rich!

FRA: Great! I thought today we’d focus on a number of aspects for the global economy and financial markets, Central Bank policy. You recently made some observations that the Federal Reserve could be hiking the US into a recession. Can you elaborate on that on your thoughts?

Peter: Well it’s what they typically do. Most rate hiking cycles end that way and not sure why this would be any different. We have to understand that not only are they raising rates but they’re also letting their balance sheet roll down so there is a double tightening going on that only recently markets have began to appreciate it.

FRA: And how do you see that playing out currently in the financial markets globally with all the volatility?

Peter: Well from a market perspective, we’ve already seen a bunch of different potholes this year, I think driven by the rising rate so the 10-year yield of beginning of the year one from 240 to 270 and you blew up the short fixed rate. Then turkey was exposed for the debts and deficits and rising inflation that they have, which is no mystery they have political issues for years but in a rising-rate environment, vulnerabilities get exposed and it started in Turkey then went to Argentina and of course you had a blow up in the Italian bond market just as the ECB is wrapping up there own Q.E program. From an economic standpoint, the rising rates is already slowing down the pace of transactions in the housing market and in the auto sector. And also we have to pay even now closer attention to corporate balance sheets where a lot of the excess has been created in the cycle. You look at small cap stocks particularly those in the Russell 2000. 40% of debt on Russell 2000 balance sheets is floating rate, which is obviously now very susceptible to the rising LIBOR and the question is whether cash flows can then deal with that rising cost of capital. Also from a leverage standpoint, small companies in the Russell 2000 have a debt/equity ratio twice of those in the S&P 500. So this rising rates, this rise in the cost of capital is beginning to have an economic impact and as I mentioned before, a market impact.

FRA: Do you see this being bearish on credit sensitive cyclical sectors ?

Peter: Well so far because you’ve thrown into the mixes, of course the slow down in the global economy, particularly in China and in Europe, so a lot of industrial are obviously cyclical, they have high fixed costs, and very sensitive to changes in economic activity. So a lot of confluence of events are combining for what is obviously a much different market this year compared to what investors are used to over the past couple years.

FRA: And is this all creating an emerging market crisis as well as emerging crisis in the European bond market?

Peter: Well I don’t want to speak broadly when you mention crisis. Certainly in Turkey there has been one. Certainly one in Argentina there has been one with with short rates north of 60%. That’s a crisis. We have to see how it plays out in China but China has a long road to hoe in terms of the enormous amount of debt that they have, the weakening in currency, the capital flows for current account deficit and so on.

So the crisis, I don’t want to say that just yet, but certainly this rise in rates, this drain in global liquidity creates a lot of potholes as I said and if you look at just the ECB, the Fed, and the B.O.J this year or this quarter, beginning October on a monthly basis, there is a net-zero of liquidity injection if you add in the behaviour of those three central banks so that creates also a drain and I think also is responsible for a lot of the fragility that were seeing now in markets.

FRA: Will this all create strengthening of the US dollar?

Peter: Well it has against certain currencies. It has against the Yuan of course, it has against the Turkish lira and Argentinian peso but if you look at the Euro heavy dollar Index, the average level of the dollar index over the past two years is 95 and say we’re a little bit over 95. So for all the talk about Fed rate hikes and how our Central Bank is far ahead of the curve relative to others and US growth is so quick compared to everybody else, the dollar index is basically in line with its average over the past two years. So it’s been strong against certain currencies and it’s done nothing against others.

FRA: And what about in China? You have observed that off balance sheet, government liabilities and the regions of China has amounted to $6 Trillion US dollars. Do you see that as a gigantic credit risk?

Peter: Yeah that on top of the amount of assets in their banking system relative to the GDP so we’re about to see how they handle this enormous debt load. Is it something they can paper over? Is it something that can grow their way out of? Is it something that’s gonna be like Japan that’s just gonna linger for 30 years? We’ll just have to see but there’s some serious challenges in the short-term. I mean long-term, I’m pretty bullish on China. I think that they’re the economy of the 21st century but I certainly don’t discount and don’t take for granted that in the next couple years can be a tough road for them.

FRA: What do you make of the standoff between Italy and the European Union, Brussels? Yra you’ve observed that Rome knows that the higher Italian yields are forced by the rhetoric of Brussels bureaucrats. The greater the losses for institutions forced to sell in any type of panic you have observed in your blog, what do you make at the standoff?

Yra: Well the standoff is real. Unfortunately, I think there are a lot of people who talk in Europe who really fail to understand or they don’t want to understand cause (Inaudible 7:20-7:21). The Italians… they understand perfectly what’s going on here. And I think that, if I were to (Inaudible 7:29-7:36), they know what they have. The problem for the Europeans is of course, and we saw (inaudible 7:46-7:54) it’s a compounding problem for Europe. They have the Italians, who understand whats going on here, they have the Brexit situation, and they have Trump, that they have to worry about. One thing we know about the president is he doesn’t forget flight. We know that. That doesn’t mean he actively pursues a vendetta but he does not do well with flight. In the G7 meeting, Merkel and Macron and two others really (inaudible 8:31) him, you know the famous picture. It wasn’t pretty. So there was an article in the (inaudible 8:41-8:42) last week titled: Donald Trump Looks To Start (inaudible 8:45) US-UK trade talk. There’s three things to look here;

1. You have the Italians who understand the pressure because there’s really nothing Brussels can do because the whole QE program has tied them up. I know we talked about this quite a bit over a couple of years that Draghi piling up all that debt.

The bigger problem is the zero risk waiting under the (inaudible 9:20-9:21) rule. They’re carry all this Italian debt, all these banks carry these debts Including the ECB and there’s no risk to it according to the rule of (inaudible 9:31). That presides a potential problem.

1. You have Trump who will throw a lifeline to the Brits. Unlike Obama who made a categorical mistake (inaudible 946) in real time that to say, you’re going to the back of the Que, and Donald Trump says, U.K you’re going to the front of the que and we may even create a free trade zone with you involved in it, which would be death for the Germans cause of all the auto capacity, manufacturing capacity that was built by the Germans and the Japanese in Britain. You have that and this really locks up Europe. They don’t have any leverage. But I hear people talking about what leverage they have. What leverage? The Italians say, what are you going to do to me? Our rates are gonna go up. We saw rates in Greece go up by 40%. And you know what? Greece is still here and they’re talking. We need growth. I think there are actually more people in Europe who support the Italians position than we hear reported. So I mean we have the (inaudible 10:48-10:50) really into Salvini and De Mayo’s hands. It gives them a lot of strength. I don’t think Brussels has any strength in this negotiation.

FRA: And Peter your thoughts?

Peter: It’s interesting because one of the proposals from Salvini in this proposed budget, which I only really read about is lowering taxes and having a flat tax. That’s growth encouraging and huge growth incentive. The spending side, that’s not really long lasting in terms of generating growth so you get stuck with more debt, higher deficits, and you don’t really get the growth. So I think that’s what the concern is. The Keynesian side of this budget, that I think is the concern, and the assumption that it’s going to magically improve the long-term competitive and economic growth rate of Italy, which it wont. Only lowering taxes and the massive regulatory state will. Paying people universal income and getting rid of the extension of retirement age and pensions, that’s not growth enhancing and so that’s what I’m worried about that they’re not going to get the growth they’re hoping for. And bigger picture, I keep arguing that the behaviour in the Italian bond market and response to what’s going on is the canary and when now the European Central Bank is 2 months away from stepping away from its purchases, who’s going to buy these bonds? I mean they were really the only buyer. Even Germany, which has a budget surplus which has a grade A fiscal situation, who’s going to buy German bundits 40 basis point when inflation is running 2%? Or PPI today which printed 3.2% for September? Who’s going to buy these French OAT for less than 1%? Who’s going to buy these things? I think that’s a big question and I think that has broader implications for the entire region and that Italy is really the poster boy initially because of the enormous amount of debt that they have and so little growth that they have to the point where their financing cost are now running above the rate of nominal GDP growth which means that their debt to GDP ratio begins to spiral upwards.

FRA: So do you see Italy changing their budget per the request by the EU Brussels?

Peter: I mean I’m sure, Yra has been saying this, there’s some agreement because Italy is really carrying the leverage here. There’s only so much the EU can do but I do think that everyone realizes it’s in their best interest and I think that the end of the day, it’ll be the EU that folds and gives into what Italy wants to do. I don’t think what Italy trying to accomplish, as I mentioned, is going to work but I think the EU has no choice but to at least give them a try. And you know the ultimate decision-maker a year of how this is gonna go is going to be the market. If the market sees that Italy can’t generate the 1.5% GDP growth that they’ve budgeted for next year, and it’s going to be less than that, then the bond markets going to speak up and you’re going to see a much higher rise in interest rates because even at a 3.5 or 3.6% 10 year yield relative to the fiscal situation in Italy, that’s still a historical low yield.

FRA: Yra, did you see that same rise in interest rates?

Yra: I think Peter is right about that but I’m looking more in the short term. What the effects are going to be? Europe needs an infrastructure program bad. Even the Germans seems to be admitting to that. So with that, there is going to be some deal. I truly believe that. If they think this through because if we look at this through those eyes you know of what George Soros and others have been recommending for several years, and not wrong but they’ve just dragged their feet for so long and that’s what they should have done to begin with. They could create a European almost like what Obama did with those infrastructure bonds, build an America Bond.

So you could do a build Europe, and I’m not saying that it’s gonna be responsible in any ways.

You could put together a package, lets say, 500 billion euros to build infrastructure projects all over Europe and use the capital key for those ratios and get this done. If you did it with the European wide bond, you would actually start doing what people have suggested as long as you see this project all the way through to its conclusion so your gonna need a European bond. So you could do this and get the Italians. From everything that I read, the Italians would buy into something like that because that’s what they’re really pushing for anyways. So if they did it across the European wide situation, I think that’s doable. I don’t know if they have the political strength to do it, and again I think Merkel has really dragged her feet here and Macron would have pursue this. He’s been dreaming about this. So I think you could see it and they can sell it in the short term. That way it eases the pressure on the Italians and everybody gets a little something. We’re probably (Inaudible 16:57) equity markets. Any sense of discussion is (inaudible 17:01) of equity markets that are looking for anything in the short term to give them some support. I think we’re gonna see something out of this group cause it’s bad. The election was 2 weeks ago and (inaudible 1750) the results were terrible. There’s an election this week in (inaudible 17:20) so everybody will be watching for this and they’re losing the middle ground so badly. I mean the worst part of the German election, a week and a half ago was that the Social Democrats, who have always been a mainstream, middle of the road policy they polled below the alternative for Germany. So there’s real problems going on and they need something and I think that’s what you’re gonna get out of this cause its a way to placate a lot of people in the short term. I agree. Peters right, who’s going to be buying these bonds? Let’s be serious, it’s a terrible flawed policy that is now coming home to roost. We’re not quite there yet. We still got 15 billion to be bought of fresh money every month so there’s still work in it. Peter’s a hundred percent right. It will come to no good. I just don’t know what the timeline is.

FRA: And what about the effect of any political movements in Europe? How could that affect all of this like the recent elections in Bavaria, trends towards populism, and the movement away from the Merkel government power?

Peter: I’ll leave that to you Yra.

Yra: The populists are trying to make this into a global phenomenon. There are a lot of people that feel like they’ve been disenfranchised by the what I refer to as the (inaudible 18:50) elite, people who sat there and made their policy or projected a sense of making policy with little regard for basically middle classes of the world. Let’s face it, globalization has benefited capital far more than labour put it into Marxist term.

I saw the interview that Alan Greenspan had in (inaudible 19:18) this weekend. It was interesting because he actually gave a Marx high grades for certain things that I thought from him was interesting, because I think that’s right.

And that’s what the world has had to answer was the shift and the reward for global capital vs. labour and its what we’ve dealt with which is why I believe that it’s a major flaw in the modelling of the Phillips curve but that’s a different discussion for another time.

So I think these are real and you have to find someway to placate those voters who really have been….and wages have not kept up and that’s by design.

You know the whole (inaudible 20:07) Germany was to free wages to sustain jobs in Germany rather than moving them to Eastern Europe.

NAFTA, when you go back and look at the beginning of NAFTA, it was meant for the North American region to take advantage of the Canadian natural resource base, combined with US capital and combined with Mexican wage rates. I mean it simplifies it but that’s a big part of it. So wages has been the real drag here and which is why we’ve seen the stock markets to get to levels that are…..we could argue historically where they’re at but they’ve been rewarded vs labour. It’s now starting to change and how everybody adjusts to it, I don’t know.

There’s a movement afoot but we shall see. But to diminish it and to pretend that it doesn’t exist is a major mistake which is why we got Donald Trump.

FRA: You’ve recently observed, Yra, a quote by last vice chairman of the Fed, Stanley Fischer, who said, “we the central Bankers cut interest rates severely to encourage growth and to support equity prices”. That adjustment hasn’t been fully made yet and then you point out a dilemma that Nehru vs Nehru. Can you elaborate?

Yra: Well, we come back to the wage thing. They all admit that they don’t understand why there is no wage inflation. I’m not saying that’s the answer but the Nehru model, I think is flawed I believe it’s flawed for many years and when you have the mobility of capital, and not the mobility of labour, you wind up with a lot of downward pressure on wages. When you’re given the alternative, Do I want my job or do I want a wage increase? Well Peter’s younger than I am Richard and I’m not sure how old you are but in the 60’s and 70’s, when I was a teenager starting to get in the work world, unions had a lot of power because we’re still in the post World War 2 situation capital wasn’t that mobile yet, breakdown Bretton Woods but when capital becomes so mobile that can go in search of lower wages and you have the transportation mechanism, you know ships, and containers today, we can move products today so you have the ability and therefore, labour comes up in the short end. And that’s what we see and so it’s not a surprise and now you have a billion Indians coming up in the global labour markets just like you had over a billion Chinese, of course those aren’t exact numbers. And to the global labour force, you had Eastern Europe unleashed into the global labour force. These have kept wages flat even if profits grew. So we built up this whole Q.E mechanism searching to push inflation higher but if its a phenomenon that has a lot to do with the global capacity, which is vast, the Chinese have a vast amounts of capacity labour force and it keeps prices down. But they built Q.E to push us out but if it’s not happening because the models are flawed, we’re in a serious dilemma. How we resolve it is going to be the big question.

FRA: And your thoughts Peter?

Peter: Well just to quantify a couple years ago the wage for the labour portion of the profit pie, that percent is low since World War 2 and that has now shifted and labour is gaining more leverage. And I do expect and I do think the wage data has been understated, especially over the last 6 months because most of the entrance into the labour force are young people and those with just a high-school degree. So when you measure the average hourly earnings for example, that’s most of the entrance, well that’s lower than the average. For those that are already working, I think wage pressures are pretty persistent and I think that’s being seen and in many different places because if companies are in search of labour and they cant find it, well they just have only a few choice in order to get it and raising wages is a key way of doing it.

And today’s Richmond Fed survey, not really saying anything we don’t already know but highlighting again, they said quote, “firms were unable to find workers with skills they needed as the skills index drops to an all time low”. That’s also a problem as well that there may be some workers out there but there’s a mismatch of between what’s demanded in the labour force and what’s supplied. I mean we know the demand side, there’s a record amount of job openings

But the inability to fill that is a problem and for those that can fill it, at least now has leverage and are gonna be paid a higher wage. And you throw in Amazon, which is raising their minimum wage which then forces and puts pressure on a lot of other companies to respond and sort of raises the lower end of the wage band.

So how that filters into consumer prices is obviously the main question. If productivity picks up, then it would not be a big deal but if companies find the need to pass it on in to higher prices, than you know then you got that wage price spiral that was similar to the 1970’s, not that this it’s gonna be repeated this time around but it gets to a broader picture here.

When you look at, and it combines with my comments on interest rates, the two biggest drivers of profit margin expansion in this recovery was

1. Lower interest expense, which allowed companies to dramatically reduce that with low interest rates.
2. Low wage costs.

And now both of those are turning upwards. So can revenue growth be quick enough to deal with that? Well likely not if 40% of S&P revenues are sourced overseas and see what’s going on overseas. So you have profit margins that in my opinion have peaked out or going to regress to what portion to the long-term mean we don’t know because technology is so dominant factors nowadays but I think that profit margins have peaked out in this cycle.

FRA: And finally what everybody is wondering about the last few weeks is where are global equity and bond markets heading and what events and risk factors should we be looking out for in that regard starting with Yra?

Yra: Well I think, Peter and I would agree on this. First, I think bond rates are going higher. I was not looking for curve inversion. I was interested in watching to see where they were gonna hold here so it’s interesting that 530 as we talk is breaking out above its 200 day moving average for those who are technically oriented for the first time since I think in 2 years. So I find that interesting.

You have Greenspan again and his interview (inaudible 18:23) but of course he raises the issues of entitlements and the pressure it puts on, well he thinks productivity and bond values. I mean Europe is an abomination and those bonds value, we know, some of the populous fever in especially in Northern Europe, you know, people forget that this populism is taking place in a very healthy environment. Yes it’s starting to slow a little bit but you measure this stuff by historical perspective, this is not when you get populism. You don’t get populism when unemployment rates are as low as they are. This is supposed to be the feel good era but yet something is broken.

This mechanism is broken economically and politically and you can’t divorce one from the other. You certainly can’t divorce politics from the economics. It’ll be healthy if bond rates would actually go up because I believe that interest rates are a very important signalling mechanism for the entire global financial system and its been broken for so long that its trying to reassert itself. Peter is the one is the who really first one to coin the phrase quantitative tightening. Its impact? Well we don’t know the impact was but I think we’re starting to see it.

It’s amazing to me, even the Fed admits it, that they don’t pay enough heed to the fact that they’re raising rates while the balance sheet is beginning to shrink. That’s a dual edged sword. Then of course you have the Europeans cutting back dramatically. And yet you are dealing with lax fiscal conditions especially in the United States, you have the deficits growing regardless of what Larry Kudlow has to say. I’m looking for bond prices especially to be moving higher and we’ll get a good picture in Europe after January 1st because then the ECB will be replenishing rather than increasing the balance sheet.

While there won’t be quantitative tightening, there won’t be the act of participation by the ECB and the Japanese we don’t know what they’re doing. It’s too hard to tell. They own so much of the market so we’re trying to get a sense of it.

The Chinese, the book is still out. Everybody who’s talking about the Chinese…I think what they failed to understand is that China borrowed a lot going forward when they began a lot of stimulus in 2015 and 2016 so I think the stock market in China is more a story about, hey they borrowed a lot from the future and the future is here. They got some issues about how to deal with what they borrowed from the future. So it doesn’t surprise me that the Chinese capital markets are as weak as they are.

FRA: And finally your thoughts up here on the transfer equity and bond markets?

Peter: I definitely agree with Yra on the interest rates and its a variety of reasons why rates are rising and I expect them to continue and it’s very easy for people to take out their historical playbook and say, okay, inflation and growth are the two drivers and whatever that plays out that’s where rates will go but unfortunately, we have to throw in the normalization and reversals of the central bank balance sheets on top of Fed rate hikes. We have to deal with foreign appetite for US treasuries which has been dramatically reduced partly due to the cost of the hedging but certainly also related to the dramatic reduction in reserve buildups that we’ve seen in China. Then you can throw in some other reasons that I think combine for a rising rates which will continue and I think the big question going at the 2019 is how do European bond yields respond to the ECB not adding more to their balance sheet? I probably said this on your show before but just to quantify the extent which ECB was buying European bonds at the peak when they were printing 80 billion Euros a month, they were buying 7 times net issuance. 7 times! An extraordinary ratio! For the Fed was never buying really more than 25% of Net Insurance.

That all changes as of January 1st, granted they’ll be reinvesting but on that basis, they will not be expanding their balance sheets and again who’s going to buy the stuff? So if you get a rise in German Bund yields, you have to believe that you’re going to see a coincident rise in US treasury. With respect to US stocks, it’s been a party for 10 years and what typically ends the party is Fed tightening and I think it would be hard to think that this is not going to happen again. Valuations are very expensive in the US. If you look at metrics other than P multiple(inaudible 33:55-33:56), If you look at variety of other (inaudible 33:58) prices cell ratios and are very expensive. Also, the rising rates are having an economic impact which has potential hurting earnings so I’m pretty defensive when it comes to US equities.

I am becoming more intrigued with the values being created overseas market that have got hammered. You look at China for example and China’s gonna have a couple of years of serious challenges no question but the markets gone pretty cheap and its down almost 60% from its highs in 2007. And even Japan, the Nikkei is down almost 50% where it was from 1989. I know that it’s been the case for a long time now but your looking for value so it’s unlikely going to find much on the US but you’re the potential finding a lot of it overseas.

And then lastly, I remain bullish for gold and silver because I think it’s respite in this crazy environment. The dollar has been strong against some emerging market currencies particularly the Yuan and then the troubled ones like the lira and the Argentinian peso and certainly the British pound related the Brexit but the dollar index over the past two years has done nothing. It’s gone up and gone down. It’s pretty much at the same level it’s been. I think that it points to major headwinds for the dollar and then maybe it’s the twin deficits that people are beginning to focus on.

FRA: Well great insight as always gentlemen. How can our listeners…

Yra: Richard can we come back to one thing?

FRA: Oh yeah sure.

Yra: In regards to China? You know unfortunately the airwaves get filled with ludicrous assessments, I mean it’s really ludicrous. I had to listen to some of these tirades yesterday what the United States, with Trump and Navarro especially, were trying to do is force regime change in China. That’s such a ridiculous concept. If that was the case, then you’d be verge of not a cold war but a hot war because if you think the Chinese would cave to US pressure for regime change… I had to listen it to 10 mins! Its ludicrous! People need to be, this is just a warning, be careful of about what you hear and what you listen to. There are a lot of people out there with ridiculous narratives. Ridiculous narratives! That one was mind boggling because that has not happened. That shows no understanding of how China works of the politics of China. China, we want to think in terms of a western style democratic capitalists model. It’s just not appropriate. You may wish that for the end result for China and they may get there but the present situation is far so from that and any discussion of what the Trump administration is really pushing for and what they think they are able to get because why would you pursue a ridiculous policy if you had no chance of ever attaining it? Let’s just be cautious. You need a filter, that’s what I’m advising. You need a filter and you have to understand what the entire global perspective is rather than somebody who may be selling something so be very careful!

FRA: Great and we’ll end it on those words of wisdom. Thank you very much gentlemen! How can our listeners learn more about your work? Yra?

Yra: By blog at notesfromunderground. It’s a pleasure and of course doing podcasts like these, it makes for important discussion. I advise you, you need to read! You need to subscribe to people like Peter’s work because you can’t do this alone because this is an endeavour. To be a trader and investor takes a lot of effort. It takes a lot of discourse between people. I remember when I was a floor trader, one of the great things on being on the floor was you had opportunities to discuss things with people. Now that we get more isolated, anatomized by computers, we lose that ability. So anytime you can involve yourself in any of these discussions and to read as much as possible. There’s quality work out there. Peter’s work is quality. Avail yourselves of these opportunities and listen to these podcasts.

FRA: Yes exactly and Peter?

Peter: Thank you Yra for that. You can read my daily work by subscribing to boockreport.com. If you’re interested in assistance with wealth management, you can reach out to me at bleakley.com

FRA: Thank you very much gentlemen! We’ll do it again.

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

FRA Roundtable Insight: Yra and Peter Podcast

By: Tenzin Lekphell

FRA: Hi welcome to FRA’s Roundtable Insight! … Today we have Yra Harris and Peter Boochwar. Yra’s a hedge fund manager, global trader in foreign currencies, bonds, commodities and equities for over 40 years. He was also a CME director from 1997 to 2003, and Peter is Chief investment Officer for the Bleakley Financial Group and advisory. He has a newsletter product called boockreport.com which has great macroeconomic insight and perspective with lots of updates on economic indicators. Welcome gentleman!

Peter: Hey Rich. Hey Yra.

Yra: Hi Rich. Hi Peter.

FRA: Just thought we’d begin. Today is Wednesday September 26th around noon eastern time and we have the Fed statements coming up shortly, even though this program will be published slightly after, but just wondering your thoughts on what could be said that this afternoon? Yra?

Yra: Well I think we’re all baked in at 25 basis points. I just put something out, a little note on the blog, I don’t know what Peter will say to it. I think the one of more interesting aspect is people are looking to remove the line that policy is not (inaudible 1:23-1:26) anymore. I’m not sure about that but I will be watching the way this vote goes because I want to see, there’s some discussion out there, I don’t know who it is out there of course they never put name’s to it, that there are some who are looking for 50 basis points. I know Peter and I have talked about this in meetings previous. We would of liked to see 50 basis points. I don’t think this one is doable because of the closeness to the November elections but, I want to see the Brainard and Williams will because of their recent hawkishness. I don’t know if Charlie Evans is a voting member but he’s been hawkish of lately. So I want to see some of these Hawks vote in favour of 50 basis points increase. That’d be the most interesting thing to me because that would put up much more hawkish tone to the Fed regardless and we’ll wait for the press conference. Outside of that, I’m not looking for anything else.

Fra: And Peter?

Peter: Evan’s actually is an alternate number so he won’t be voting but we will have some new voters. (Inaudible 2:33) will be voting for the first time and then some relatively new members. (inaudible 2:38), I’ll be voting, and (inaudible 2:41-2:42). It’s a newer complexion and I think that because of it, they’ll be raising 25 basis points and leaning towards a December hike as the market is pricing that in. The Market, or at least the Fad, I think follow up on what Yra said on Brainerd and Williams, they want to keep on hiking and you might as well just do it in December because next year you’re wide open in terms of meetings because every meeting has a press conference. Where is before, the next press conference meeting would have been March and if they did not hike in December, they would have to wait till March.

Now there’s a lot more flexibility next year and then went to hike. You might as well move closer to where they want to go, ultimately that’s 3% or more, and get there sooner rather than later because I think a lot of these Fed people they do speak to a lot of contacts and everyone is telling them wages, wages, wages are going to higher and you can’t find any any workers and these academics still focus on the Phillips curve. They still believe that inflation will likely be triggered by that and then you throw in the tariffs. Hiking today they’re only going to get 2 to 2 ¼ and which tells me that maybe they will keep in that wording that being accommodative because to think that 2 to 2 ¼ is not accommodate is quite comical and Yra can probably speak to this better than I can because he’s seen a long-term level of interest rates much higher and it’s laughable that 2 to 2 ¼ would not be considered accommodative at Fed funds level.

I don’t think Powell wants to be that exciting with the statement. I think the statement will be not much different than the prior one so we’re going to have to wait till the press conference in order to gauge some more details in which way he is leaning but again, whether he raises in December, or January, whatever, they want to get to 3 % plus fed funds rate all else equal and based on what they’re saying right now.

FRA: Any thoughts on that Yra?

Yra: I think that’s absolutely right. Powell and, I think the new voice of (inaudible 5:03), well we don’t have Nelly Ling, that’s her name right?

Peter: Yeah.

Yra: Who seemed to be at least beyond academics and aware of the financial ramifications that emanate from the Fed policy and long held Fed policy, which I find interesting. I think Vince Reinhart was on with (inaudible 5:36) today and I thought that was an interesting discussion because I think Vince Reinhart made a good point which is that these later appointments by Trump, who been pretty responsible Fed appointments, which I’m very surprised, because I wouldn’t put them as easy money people whatsoever. While he’s spoken about easy money, who ever is advising him, who’s ever council he’s taking on, maybe is directly from Powell, these have been responsible Fed appointees and I think these are good thing cause as Peter discussed. We need to get away from the academics. Not that academics don’t have a place, but they dominated the Fed. Greenspan certainly relied on (inaudible 6:19) although he had a gut feeling. Powell said in his (inaudible 6:23) hall of speech he applauded that Greenspan had, what I think Powell would say he has which is, some risk management tools so he’s not knee jerk. Although I would certainly argue that Greenspan, with the start of every meeting raising a quarter like he did at a certain period, really set the Fed at a bad course and the world because every other Central Bank has followed that same policy. For the life of me, I really don’t get it. Your willing to cut 1% which will on only raise ¼ point increments.

Peter: Measure and Pace right? That’s what Greenspan said every meeting in the mid 2000s. Measure and Pace.

Yra: Which I think it’s terrible because you’re not listening to the markets. (inaudible 7:14-7:16) I think a set course is a terrible public (Inaudible 7:18). You can have mandated goals but why should you have set course to reach it. I know that Peter agrees to that. They should have raised half a point long ago. This quarter point is nonsense then they could have stepped back and let the market digest. I’m gonna agree with Peter. It’s a long answer to a short question.

Peter: Here we are in the 10th year of this expansion and today’s hike is only going to bring real rates to zero. For them to call zero real rate not accommodative, if they take that wording out, is laughable. So I’d lean to them leaving it in but we’ll see.

FRA: Let’s go to a macro view on a financial markets. Peter you’ve recently mentioned or observed on the disconnect that you see between the US markets and the Emerging Markets. Can you elaborate on that? Like what and what is behind that?

Peter: Yeah it’s been pretty glaring. The out performance of the U.S versus everybody else.  In fact everybody else is down on the year and we know that S&P 500, in particular, has had a great year, even though 40% of S&P 500 revenues are sourced overseas.   

Certainly worries about slowing growth in Europe, certainly in China, and by default the rest of Asia and that’s being reflected in their equity markets and we know same problems with emerging markets. I think to believe that the US is immune to that is silly. But right now at least, US growth is well outperforming most other areas. Earnings growth in the first half of the year are very good, still should be fine in Q3, but I do think you’re going to start to see some issues with earnings related to tariffs, related to higher labour costs, that is the largest input for companies and I don’t see how much longer that discrepancy can last. Either overseas is going to catch up or on the upside, we’re going to catch up to them to some extent on the downside. The differential is pretty glaring.

FRA: Right now, has it been due to international capital flows going into the US from emerging market issues, concerns, challenges, and this global slow down looking to the U.S as a safe haven also considering the U.S dollar getting stronger?

Peter: That can be part of it but I think it’s U.S investors are dominated by machines. They don’t respond to speculation about the possibility of a slowdown driven by what’s going on overseas. They only do it when they actually see evidence of it. Whether that’s in earning season over the next couple weeks, if we begin to see some signs of it, or it’s actually in the economic data. So I think that’s why the US market has sort of shrugged off not only the growth story that’s changing overseas but the rates over here where they continue to rise and we have a over levered global economy. We have a very highly levered, over levered U.S corporate balance sheet outside of (inaudible 10:51) and rising rates is usually not a good set up with that. So I think that there’s this belief that somehow the Fed’s can engineer a soft landing. Historically that’s rarely the case. But until they begin to see evidence of weaker data here or (inaudible 11:11) in earnings, they’re not going to respond. So my point is don’t look at the US equity market as a discounting mechanism. I think it’s mostly reactive instead.

FRA: And your thoughts Yra on this?

Yra: I’m going to take a little bit different tactic here. I mean I agree with him but I see things that are going on. The other day, (inaudible 11:35) comments were a 180 degree from his press conference. (inaudible 11:45) sees vigorous pickup in underlying inflation. (inaudible 11:48-11:50) but the dollar didn’t sell off. Thinking that the European are gonna be, as (inaudible 11:54-11:55) says, vigorous. Well this is totally (inaudible 12:00) of what we heard him at the press conference. It’s really raising my (inaudible 12:07) there’s something going on here.

Are the Europeans now all of a sudden are getting a sense that Trump, that if they don’t do something to raise the level of the Euro, that they’re gonna feel the sting of Trump’s tweet or whatever. That really boggled my mind. I just don’t see it. Everything has been the other way from all the other conversation. Then of course (inaudible 12:37-12:39) walked it back even though Watney from Austria was still adamant (inaudible 12:46) by pulling back.

Yesterday, there was a tweet out by, I don’t know who she is, Dr.Julia (inaudible 12:57) that said, “Hawkish Yellen, Unemployment rate is half the full point below the natural rate (inaudible 13:04-13:05) stabilize it and they need to nudge it higher”. It’s almost a hawkish comment but yet 2 weeks ago on the 14th of September, we had Yellen speaking at bookings in that group meeting. In her speech, it’s been lower for longer, lower for longer, lower for longer!

Peter: (inaudible 13:33-13:34) that don’t work and keep on doing things that doesn’t work is what she’s saying.

Yra: Its sending mixed messages. That’s a great point and it’s all making it to the headlines. I think it’s really confusing for markets even though Yellen carries no weight whatsoever. None. But the way people throws these things out, I don’t see (inaudible 14:02-14:03) that Peter’s talking about. Where’s Europe going? Europe’s going nowhere. As I’ve maintained and I know we’ve discussed this for more than a few years already. (inaudible 14:13) locked himself in this terrible trap here and it gets (inaudible 14:16) more and more. I know Peter talked about it this morning with the Italians and what happens and now the French are really caught in this similar trap because they need Macron’s poll ratings are dropping dramatically and even as Peter pointed out, the (inaudible 14:32) strongest of the majors European stock markets. His poll numbers are dropping and he gonna need to placate some on the left with greater spending but their not going to be able to do it and Germany is really in dire (inaudible 14:49) politically. Merkel is having the legs cut under her all over the place and October brings the election in Bavaria in which the S.C.U (inaudible 15:00) is under dire threat and it’ll be interesting to see if they even hold to be the most popular party because that would really bring pressure on Merkel in many other ways.

Europe is a difficult (inaudible 15:14) and I don’t see them, yes they’re going to end QE at the end of December but even (inaudible 15:20) said, ending QE their not shrinking the balance sheet. He was explicit about that and that made the capital key such a dangerous situation for him because he’s got to abide by definition and buy 18% of the assets ECP buys which are German Bunds or German instruments. Well with German surpluses growing, I don’t know where their going to find that much to buy without pushing German rates, even on the long end, further down. So there’s here’s all these things confronting us.  

FRA: Could that issue, in terms of the amount of German debt being used as diminishing, prompt the emergence of a Eurobond for the ECP?

Yra: Well there are certainly those who won’t (inaudible 16:07) cause I think that’s what the end game is.

Peter: Germans (inaudible 16:12) try to push that into the future as long as they can.

Yra: As far as they can cause that would mean that the German would have to underwrite the whole debt load. I don’t see any unless you had a denaturalization meaning sell off a lot of  publicly held companies, meaning, government held companies in order to be able to buy back some of the bonds with real assets rather than ECP money. It will take a major political upheaval in Germany from those who are (inaudible 16:51) of that because right now the rising forces in Germany, the rising political voices are not in favour of that. In fact, I would say that one of the staunchest platform policies of the (inaudible 17:06) for Germany is less German involvement into the guarantee of the European financial system. The winds are blowing in the opposite direction and Peter exactly is right, they’ll delay that as long as possible. Macron….when he was a rising star couldn’t get her to sign on to a unified financial system, which is the risk that would be absorbed by the European stability mechanism, with the German’s guarantee in that cause the Germans saw through that and she wouldn’t even sign on that when Macron was maybe somebody (inaudible 1742). Right now, he’s a weakened force as she is and it’s the Italians, in my mind, who are holding the cards here.

FRA: So as we go towards the end of the year, could the German-French yield spreads on bonds likely increase as the ECP buys less assets going in to the end of the year? Your thoughts? Peter?

Peter: That’s a good question. I actually just think they’re both going higher, whether the spread widens or not, I’m not sure. As Yra said they both now have political issues. I can’t fully understand why the Macron’s poll numbers are dropping as fast as they are. Maybe it’s the French just don’t like change that he’s trying to bring, but I’m surprised by that. I think either way, you’re going to see a rise in yields in both countries and I think people don’t understand how much of an influence the ECP was and still is barely in terms of their buying in those markets in while they’re continue to reinvest proceed.

They were buying 7 times net issuance of European bonds. The Fed QE at its peak was 25% of net issuance of treasury (inaudible 19:03-19:04). That’s how dominant the ECP was. While we all know what they’re going to do, they told us what they’re going to do, I still think there is this level of nonchalant as somehow European bond yields can stay around these current levels even with the reinvestment. And that’s what I’m most worried about is a rate shock in Europe that could have a ripple effects.

We already seen the Bank of Japan pulling back and you’ve seen a jump in longer (inaudible 19:32) yields there and you’ve seen the 10 year yield creeping closer to 15 basis points as Bank of Japan is more tolerant of that. You’ve seen the US 10-year just a few basis points from breaking out to multi year highs. If you seen these rise in yields, its not for all good reasons, it’s not that the economy is great and the markets are just doing it, it’s that you have this Gorilla in this room thats walking out and buying less and a combination with other things including inflation and others. I think people are way to nonchalant with this move up in the interest rates.

FRA: And Yra, what do you see happening as we go towards the (inaudible 20:09-20:10)?

Yra: I think that’s right. (Inaudible 20:11-20:12) the reason I dig through the plumbing… if you look, German issuance is diminished because they’re running surpluses. France has grown over these last years. The real canary in the coal mine is that their running these budget deficits, meaning France and Italy, with these ultra low interest rates. Lets not minimize that..  

Peter: (inaudible 20:49-20:51) by 2%.

Yra: These deficits haven’t shrunk whatsoever and if interest rates start to rise, as Peter and I believe that they’re going to do, it’s gonna put even greater pressure on these deficits. I don’t know if they will get better growth. I applaud Macron. I think he’s trying to turn the tables on what has been a (inaudible 20:19) economic policy from Halland, and even Sarkozy. They did some stupid things. He’s trying to undo them but the deficit is still growing. Its like with Greece. You hear everybody talk about how Greece turned around. Well the Greece debt to GDP ratio, even with all this austerity, it’s still bigger then when it started down that path of austerity and thats with interest rates dropping dramatically. And that’s where the real risk here lies. And from the (inaudible 21:53) aspect of it, German credits are far better than the rest of the credits. Maybe the Dutch and Austrian certainly without the ECP would be able to stand on their own. But the others, (inaudible 22:06-22:08), and that includes France because France is not without its problems. And if Macron fails, the issues in france are really gonna get worse as Peter points out. Politically they don’t like this type of change. The unions in France still have a lot of power. Macron would like to diminish that power but they still have a lot of power. That’s the reason why I like to be long German and short French because right now the spread on 10 years is about 32 basis points which is about mid range over last 3 or 4 years. But based on the shrinking amount of German assets and the fact that German assets are needed for REPO financing, their high quality liquid assets, that will put demand in there regardless. Unless (inaudible 23:00) openly breaks with the capital key, which he has to be very careful because there are those in Germany that will return back to the German Constitutional court and say that this is illegal because your financing individual countries and in violation of the entire edifice of the Central Banks and what their supposed to do. (inaudible 23: 27) there are things waiting out there.

Peter: It will be a real disappointment if Macron is gone at some point. He was the right guy for that job at the right time for France. It’s amazing people don’t appreciate it.

FRA: Given these thoughts on Europe and what we mentioned earlier in the US, could we see another round of more easing by central banks globally? If we go to China and look at the currency there, if the Yuan weakens and we get global disinflation, could that cause more easing by Central Banks globally? Peter?

Peter: It’s a good question. I don’t think the Chinese want to go down the route of seeing a dramatically weaker currency. They are trying to shift their economy from a manufacturer infrastructure, (inaudible 24:23-24:26) investment type economy to more services and more consumption. You don’t want a weaker currency, if that’s the transition you’re trying to make. You don’t want to damage the purchasing power of consumers if your trying to improve consumer spending. I think they are more interested in having a stable currency not a dramatically weaker one. I’m sure the weakness we’ve seen will be tolerant of because it’s relatively modest and it can help cushion the impact of the tariffs but I wouldn’t look for major decline in the currency.

I think the currency that trades (inaudible 25:07-25:08) is the U.S dollar and people should be asking what’s going on with US dollar considering the out performance economically, the Central Bank that is far ahead of the curb relative to others, and why outside of emerging markets where the dollar has strengthened, why against the Euro or the Yen or some of the others has it not traded well? I’m putting aside the pounds because that’s obviously very Brexit related. That’s where I think people should be asking is What’s going on with the dollar and less so with the Yuan?

FRA: And Yra, your thoughts?

Yra: I think that’s dead right on target. I know Peter that’s the Michael Pettis argument which is, “hey, if your trying to build your domestic economy, and China’s certainly is, if I look at the copper market, the copper market is telling me that China’s going to embark on another round of massive infrastructure project whether it’s in the road initiative or just in China itself but that’s what the market is sensing here. You don’t want a weaker currency. Your trying to ramp up domestic spending. You’d like to have a stronger currency because then you can buy cheaper imports so I’m hundred percent agreement and I agree with Peter with the dollar.

The dollar is interesting here because the cost of carry is quite expensive. If we use overnight money in Europe, let’s say German money, it’s 250 basis points going higher. If we’re using 2 year differential, it’s well over 3 percent because German 2 years are about negative 50 and US is of course 2.8. I don’t ever remember, I wont say ever, it’s been certainly over 3 decades that we’ve seen a spread that wide and 2 years or less. So these are things that should be (inaudible 27:24-27:25) the strengthening dollars as a lot of people are positioning for. Peter, from 107,108, but that was based on the Trump Whitehouse as much as anything. Bob White Heiser, who is the power here, is not afraid to promote a weaker currency. I think the markets are starting to accept to (inaudible 27:52) that in but they really haven’t yet. That may be one of the tools they utilized.

FRA: What about Brazil? Are they intentionally driving their currency lower to help their agricultural exports and hurting U.S grain exports?

Peter: They don’t need the help. It’s a business to them.

Yra: They don’t need the help. Its bad politics. Their in a great position now because the Chinese (inaudible 28:31) knows the US for the moment because their agricultural exports from Brazil are so cheap. Even if though they had a (inaudible 28:42) crop because they’re so cheap, it will be interesting to see how much plant the Brazilian farmer grew this year. Even international prices are lower, priced in terms of Real, which the farmers ultimately get paid in as they take their dollars they receive in the international market and convert to domestic currency. Their not suffering whatsoever. The United States farmers are suffering under Tariffs as well as having to compete against the weakened Brazilian Real. They don’t need any help. I think they believe the currency is to weak relative to other policy aims that they have.

FRA: And the finally moving over to Japan. How will the Bank of Japan be able to extricate itself from five years of QQE, qualitative and quantitative easing, since they’ve accumulated so much Japanese debt and equities? Your thoughts Yra?

Yra: Well, I don’t know if they know how to extricate themselves. They’ve just been muddling along here and I mean muddling. They preceded down this path for way too long. Supposedly we heard last week that Abe was backing away from the inflation targets after his new found political strength is (inaudible 30:07-30:09) although he’s got his plate full but I don’t how they get out of here. They’re not going to do it with a weaker currency. We listen to Trump, the sense that he’s looking to throw tariffs on to the Japanese because they run to large of surpluses with the US, the Japanese have to be very careful here and the Europeans can’t be too happy because the Euro against the Yen has been rallying dramatically. The European auto industry is (inaudible 30:51) head wind of a weaker Yen and US tariffs and some really bad fall for Brexit, which not enough people talk about it but the European auto industry could really get hit. But I don’t know what the Japanese are going to do here. They follow this Bernanke down this rabbit hole for way to long and i don’t know what they do here.

FRA: Peter?

Peter: Yeah it’s a great point. I don’t know what they’re going to do. I think that their acknowledging the squeeze that they’re in by allowing a whole 10 basis points extra of a yield grab (inaudible 31:36-31:37) can get in Japan, which is quite amazing from 10 to 20 basis points. They are certainly slowing the rate of purchases. I think they’ve basically cut QE in half. I think they’ve suddenly realized that they are a dominant player in the ETF market and are a top 10 holder in about 40% of Japanese Nikkei companies. I think they got their fingers crossed on generating some higher inflation so they can further get out of what they’ve done but I don’t see how they can ever get out of what they’ve done. I think they’ll just continue to try to lessens their influence and see what happens but Kuroda….talk about overstaying one’s welcome.

Yra: And to add to that, I think one of their plans was, at some point, that they’ll be able to start buying foreign bonds if they needed to but now that they run in Trump, there is no way that the (inaudible 32:39) or even some of those pension funds have to be very careful. The government pension investment fund. They can’t just willy nilly because that will move to weaken the end and they have to be very careful here.

Peter: That’ll be dangerous.

FRA: On that note, we’ll end it there. How can our listeners learn more about your work? Peter?

Peter: They can search it in wealth management. They can go to bleakley.com and reach out to me. If they want to see my daily (inaudible 33:10-33:11), they can subscribe at boockreport.com.

FRA: And Yra?

Yra: My blog post, notes from underground, and you can go to Yraharris.com. It’ll come up notesfromunderground you can get access to it and join the conversation that takes place on regular basis about many of these same issues. It’s just a discussion on what’s going on in the world and hopefully you can find your way to profitable investment from them.

FRA: Great insight as always. Thank you very much gentlemen! We’ll do it again.

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

FRA Roundtable Insight: Yra and Peter Podcast

By: Tenzin Lekphell

FRA: Hi welcome to FRA’s Roundtable Insight! … Today we have Yra Harris and Peter Boochwar. Yra’s a hedge fund manager, global trader in foreign currencies, bonds, commodities and equities for over 40 years. He was also a CME director from 1997 to 2003, and Peter is Chief investment Officer for the Bleakley Financial Group and advisory. He has a newsletter product called boockreport.com which has great macroeconomic insight and perspective with lots of updates on economic indicators. Welcome gentleman!

Peter: Hey Rich. Hey Yra.

Yra: Hi Rich. Hi Peter.

FRA: Just thought we’d begin. Today is Wednesday September 26th around noon eastern time and we have the Fed statements coming up shortly, even though this program will be published slightly after, but just wondering your thoughts on what could be said that this afternoon? Yra?

Yra: Well I think we’re all baked in at 25 basis points. I just put something out, a little note on the blog, I don’t know what Peter will say to it. I think the one of more interesting aspect is people are looking to remove the line that policy is not (inaudible 1:23-1:26) anymore. I’m not sure about that but I will be watching the way this vote goes because I want to see, there’s some discussion out there, I don’t know who it is out there of course they never put name’s to it, that there are some who are looking for 50 basis points. I know Peter and I have talked about this in meetings previous. We would of liked to see 50 basis points. I don’t think this one is doable because of the closeness to the November elections but, I want to see the Brainard and Williams will because of their recent hawkishness. I don’t know if Charlie Evans is a voting member but he’s been hawkish of lately. So I want to see some of these Hawks vote in favour of 50 basis points increase. That’d be the most interesting thing to me because that would put up much more hawkish tone to the Fed regardless and we’ll wait for the press conference. Outside of that, I’m not looking for anything else.

Fra: And Peter?

Peter: Evan’s actually is an alternate number so he won’t be voting but we will have some new voters. (Inaudible 2:33) will be voting for the first time and then some relatively new members. (inaudible 2:38), I’ll be voting, and (inaudible 2:41-2:42). It’s a newer complexion and I think that because of it, they’ll be raising 25 basis points and leaning towards a December hike as the market is pricing that in. The Market, or at least the Fad, I think follow up on what Yra said on Brainerd and Williams, they want to keep on hiking and you might as well just do it in December because next year you’re wide open in terms of meetings because every meeting has a press conference. Where is before, the next press conference meeting would have been March and if they did not hike in December, they would have to wait till March.

Now there’s a lot more flexibility next year and then went to hike. You might as well move closer to where they want to go, ultimately that’s 3% or more, and get there sooner rather than later because I think a lot of these Fed people they do speak to a lot of contacts and everyone is telling them wages, wages, wages are going to higher and you can’t find any any workers and these academics still focus on the Phillips curve. They still believe that inflation will likely be triggered by that and then you throw in the tariffs. Hiking today they’re only going to get 2 to 2 ¼ and which tells me that maybe they will keep in that wording that being accommodative because to think that 2 to 2 ¼ is not accommodate is quite comical and Yra can probably speak to this better than I can because he’s seen a long-term level of interest rates much higher and it’s laughable that 2 to 2 ¼ would not be considered accommodative at Fed funds level.

I don’t think Powell wants to be that exciting with the statement. I think the statement will be not much different than the prior one so we’re going to have to wait till the press conference in order to gauge some more details in which way he is leaning but again, whether he raises in December, or January, whatever, they want to get to 3 % plus fed funds rate all else equal and based on what they’re saying right now.

FRA: Any thoughts on that Yra?

Yra: I think that’s absolutely right. Powell and, I think the new voice of (inaudible 5:03), well we don’t have Nelly Ling, that’s her name right?

Peter: Yeah.

Yra: Who seemed to be at least beyond academics and aware of the financial ramifications that emanate from the Fed policy and long held Fed policy, which I find interesting. I think Vince Reinhart was on with (inaudible 5:36) today and I thought that was an interesting discussion because I think Vince Reinhart made a good point which is that these later appointments by Trump, who been pretty responsible Fed appointments, which I’m very surprised, because I wouldn’t put them as easy money people whatsoever. While he’s spoken about easy money, who ever is advising him, who’s ever council he’s taking on, maybe is directly from Powell, these have been responsible Fed appointees and I think these are good thing cause as Peter discussed. We need to get away from the academics. Not that academics don’t have a place, but they dominated the Fed. Greenspan certainly relied on (inaudible 6:19) although he had a gut feeling. Powell said in his (inaudible 6:23) hall of speech he applauded that Greenspan had, what I think Powell would say he has which is, some risk management tools so he’s not knee jerk. Although I would certainly argue that Greenspan, with the start of every meeting raising a quarter like he did at a certain period, really set the Fed at a bad course and the world because every other Central Bank has followed that same policy. For the life of me, I really don’t get it. Your willing to cut 1% which will on only raise ¼ point increments.

Peter: Measure and Pace right? That’s what Greenspan said every meeting in the mid 2000s. Measure and Pace.

Yra: Which I think it’s terrible because you’re not listening to the markets. (inaudible 7:14-7:16) I think a set course is a terrible public (Inaudible 7:18). You can have mandated goals but why should you have set course to reach it. I know that Peter agrees to that. They should have raised half a point long ago. This quarter point is nonsense then they could have stepped back and let the market digest. I’m gonna agree with Peter. It’s a long answer to a short question.

Peter: Here we are in the 10th year of this expansion and today’s hike is only going to bring real rates to zero. For them to call zero real rate not accommodative, if they take that wording out, is laughable. So I’d lean to them leaving it in but we’ll see.

FRA: Let’s go to a macro view on a financial markets. Peter you’ve recently mentioned or observed on the disconnect that you see between the US markets and the Emerging Markets. Can you elaborate on that? Like what and what is behind that?

Peter: Yeah it’s been pretty glaring. The out performance of the U.S versus everybody else.  In fact everybody else is down on the year and we know that S&P 500, in particular, has had a great year, even though 40% of S&P 500 revenues are sourced overseas.   

Certainly worries about slowing growth in Europe, certainly in China, and by default the rest of Asia and that’s being reflected in their equity markets and we know same problems with emerging markets. I think to believe that the US is immune to that is silly. But right now at least, US growth is well outperforming most other areas. Earnings growth in the first half of the year are very good, still should be fine in Q3, but I do think you’re going to start to see some issues with earnings related to tariffs, related to higher labour costs, that is the largest input for companies and I don’t see how much longer that discrepancy can last. Either overseas is going to catch up or on the upside, we’re going to catch up to them to some extent on the downside. The differential is pretty glaring.

FRA: Right now, has it been due to international capital flows going into the US from emerging market issues, concerns, challenges, and this global slow down looking to the U.S as a safe haven also considering the U.S dollar getting stronger?

Peter: That can be part of it but I think it’s U.S investors are dominated by machines. They don’t respond to speculation about the possibility of a slowdown driven by what’s going on overseas. They only do it when they actually see evidence of it. Whether that’s in earning season over the next couple weeks, if we begin to see some signs of it, or it’s actually in the economic data. So I think that’s why the US market has sort of shrugged off not only the growth story that’s changing overseas but the rates over here where they continue to rise and we have a over levered global economy. We have a very highly levered, over levered U.S corporate balance sheet outside of (inaudible 10:51) and rising rates is usually not a good set up with that. So I think that there’s this belief that somehow the Fed’s can engineer a soft landing. Historically that’s rarely the case. But until they begin to see evidence of weaker data here or (inaudible 11:11) in earnings, they’re not going to respond. So my point is don’t look at the US equity market as a discounting mechanism. I think it’s mostly reactive instead.

FRA: And your thoughts Yra on this?

Yra: I’m going to take a little bit different tactic here. I mean I agree with him but I see things that are going on. The other day, (inaudible 11:35) comments were a 180 degree from his press conference. (inaudible 11:45) sees vigorous pickup in underlying inflation. (inaudible 11:48-11:50) but the dollar didn’t sell off. Thinking that the European are gonna be, as (inaudible 11:54-11:55) says, vigorous. Well this is totally (inaudible 12:00) of what we heard him at the press conference. It’s really raising my (inaudible 12:07) there’s something going on here.

Are the Europeans now all of a sudden are getting a sense that Trump, that if they don’t do something to raise the level of the Euro, that they’re gonna feel the sting of Trump’s tweet or whatever. That really boggled my mind. I just don’t see it. Everything has been the other way from all the other conversation. Then of course (inaudible 12:37-12:39) walked it back even though Watney from Austria was still adamant (inaudible 12:46) by pulling back.

Yesterday, there was a tweet out by, I don’t know who she is, Dr.Julia (inaudible 12:57) that said, “Hawkish Yellen, Unemployment rate is half the full point below the natural rate (inaudible 13:04-13:05) stabilize it and they need to nudge it higher”. It’s almost a hawkish comment but yet 2 weeks ago on the 14th of September, we had Yellen speaking at bookings in that group meeting. In her speech, it’s been lower for longer, lower for longer, lower for longer!

Peter: (inaudible 13:33-13:34) that don’t work and keep on doing things that doesn’t work is what she’s saying.

Yra: Its sending mixed messages. That’s a great point and it’s all making it to the headlines. I think it’s really confusing for markets even though Yellen carries no weight whatsoever. None. But the way people throws these things out, I don’t see (inaudible 14:02-14:03) that Peter’s talking about. Where’s Europe going? Europe’s going nowhere. As I’ve maintained and I know we’ve discussed this for more than a few years already. (inaudible 14:13) locked himself in this terrible trap here and it gets (inaudible 14:16) more and more. I know Peter talked about it this morning with the Italians and what happens and now the French are really caught in this similar trap because they need Macron’s poll ratings are dropping dramatically and even as Peter pointed out, the (inaudible 14:32) strongest of the majors European stock markets. His poll numbers are dropping and he gonna need to placate some on the left with greater spending but their not going to be able to do it and Germany is really in dire (inaudible 14:49) politically. Merkel is having the legs cut under her all over the place and October brings the election in Bavaria in which the S.C.U (inaudible 15:00) is under dire threat and it’ll be interesting to see if they even hold to be the most popular party because that would really bring pressure on Merkel in many other ways.

Europe is a difficult (inaudible 15:14) and I don’t see them, yes they’re going to end QE at the end of December but even (inaudible 15:20) said, ending QE their not shrinking the balance sheet. He was explicit about that and that made the capital key such a dangerous situation for him because he’s got to abide by definition and buy 18% of the assets ECP buys which are German Bunds or German instruments. Well with German surpluses growing, I don’t know where their going to find that much to buy without pushing German rates, even on the long end, further down. So there’s here’s all these things confronting us.  

FRA: Could that issue, in terms of the amount of German debt being used as diminishing, prompt the emergence of a Eurobond for the ECP?

Yra: Well there are certainly those who won’t (inaudible 16:07) cause I think that’s what the end game is.

Peter: Germans (inaudible 16:12) try to push that into the future as long as they can.

Yra: As far as they can cause that would mean that the German would have to underwrite the whole debt load. I don’t see any unless you had a denaturalization meaning sell off a lot of  publicly held companies, meaning, government held companies in order to be able to buy back some of the bonds with real assets rather than ECP money. It will take a major political upheaval in Germany from those who are (inaudible 16:51) of that because right now the rising forces in Germany, the rising political voices are not in favour of that. In fact, I would say that one of the staunchest platform policies of the (inaudible 17:06) for Germany is less German involvement into the guarantee of the European financial system. The winds are blowing in the opposite direction and Peter exactly is right, they’ll delay that as long as possible. Macron….when he was a rising star couldn’t get her to sign on to a unified financial system, which is the risk that would be absorbed by the European stability mechanism, with the German’s guarantee in that cause the Germans saw through that and she wouldn’t even sign on that when Macron was maybe somebody (inaudible 1742). Right now, he’s a weakened force as she is and it’s the Italians, in my mind, who are holding the cards here.

FRA: So as we go towards the end of the year, could the German-French yield spreads on bonds likely increase as the ECP buys less assets going in to the end of the year? Your thoughts? Peter?

Peter: That’s a good question. I actually just think they’re both going higher, whether the spread widens or not, I’m not sure. As Yra said they both now have political issues. I can’t fully understand why the Macron’s poll numbers are dropping as fast as they are. Maybe it’s the French just don’t like change that he’s trying to bring, but I’m surprised by that. I think either way, you’re going to see a rise in yields in both countries and I think people don’t understand how much of an influence the ECP was and still is barely in terms of their buying in those markets in while they’re continue to reinvest proceed.

They were buying 7 times net issuance of European bonds. The Fed QE at its peak was 25% of net issuance of treasury (inaudible 19:03-19:04). That’s how dominant the ECP was. While we all know what they’re going to do, they told us what they’re going to do, I still think there is this level of nonchalant as somehow European bond yields can stay around these current levels even with the reinvestment. And that’s what I’m most worried about is a rate shock in Europe that could have a ripple effects.

We already seen the Bank of Japan pulling back and you’ve seen a jump in longer (inaudible 19:32) yields there and you’ve seen the 10 year yield creeping closer to 15 basis points as Bank of Japan is more tolerant of that. You’ve seen the US 10-year just a few basis points from breaking out to multi year highs. If you seen these rise in yields, its not for all good reasons, it’s not that the economy is great and the markets are just doing it, it’s that you have this Gorilla in this room thats walking out and buying less and a combination with other things including inflation and others. I think people are way to nonchalant with this move up in the interest rates.

FRA: And Yra, what do you see happening as we go towards the (inaudible 20:09-20:10)?

Yra: I think that’s right. (Inaudible 20:11-20:12) the reason I dig through the plumbing… if you look, German issuance is diminished because they’re running surpluses. France has grown over these last years. The real canary in the coal mine is that their running these budget deficits, meaning France and Italy, with these ultra low interest rates. Lets not minimize that..  

Peter: (inaudible 20:49-20:51) by 2%.

Yra: These deficits haven’t shrunk whatsoever and if interest rates start to rise, as Peter and I believe that they’re going to do, it’s gonna put even greater pressure on these deficits. I don’t know if they will get better growth. I applaud Macron. I think he’s trying to turn the tables on what has been a (inaudible 20:19) economic policy from Halland, and even Sarkozy. They did some stupid things. He’s trying to undo them but the deficit is still growing. Its like with Greece. You hear everybody talk about how Greece turned around. Well the Greece debt to GDP ratio, even with all this austerity, it’s still bigger then when it started down that path of austerity and thats with interest rates dropping dramatically. And that’s where the real risk here lies. And from the (inaudible 21:53) aspect of it, German credits are far better than the rest of the credits. Maybe the Dutch and Austrian certainly without the ECP would be able to stand on their own. But the others, (inaudible 22:06-22:08), and that includes France because France is not without its problems. And if Macron fails, the issues in france are really gonna get worse as Peter points out. Politically they don’t like this type of change. The unions in France still have a lot of power. Macron would like to diminish that power but they still have a lot of power. That’s the reason why I like to be long German and short French because right now the spread on 10 years is about 32 basis points which is about mid range over last 3 or 4 years. But based on the shrinking amount of German assets and the fact that German assets are needed for REPO financing, their high quality liquid assets, that will put demand in there regardless. Unless (inaudible 23:00) openly breaks with the capital key, which he has to be very careful because there are those in Germany that will return back to the German Constitutional court and say that this is illegal because your financing individual countries and in violation of the entire edifice of the Central Banks and what their supposed to do. (inaudible 23: 27) there are things waiting out there.

Peter: It will be a real disappointment if Macron is gone at some point. He was the right guy for that job at the right time for France. It’s amazing people don’t appreciate it.

FRA: Given these thoughts on Europe and what we mentioned earlier in the US, could we see another round of more easing by central banks globally? If we go to China and look at the currency there, if the Yuan weakens and we get global disinflation, could that cause more easing by Central Banks globally? Peter?

Peter: It’s a good question. I don’t think the Chinese want to go down the route of seeing a dramatically weaker currency. They are trying to shift their economy from a manufacturer infrastructure, (inaudible 24:23-24:26) investment type economy to more services and more consumption. You don’t want a weaker currency, if that’s the transition you’re trying to make. You don’t want to damage the purchasing power of consumers if your trying to improve consumer spending. I think they are more interested in having a stable currency not a dramatically weaker one. I’m sure the weakness we’ve seen will be tolerant of because it’s relatively modest and it can help cushion the impact of the tariffs but I wouldn’t look for major decline in the currency.

I think the currency that trades (inaudible 25:07-25:08) is the U.S dollar and people should be asking what’s going on with US dollar considering the out performance economically, the Central Bank that is far ahead of the curb relative to others, and why outside of emerging markets where the dollar has strengthened, why against the Euro or the Yen or some of the others has it not traded well? I’m putting aside the pounds because that’s obviously very Brexit related. That’s where I think people should be asking is What’s going on with the dollar and less so with the Yuan?

FRA: And Yra, your thoughts?

Yra: I think that’s dead right on target. I know Peter that’s the Michael Pettis argument which is, “hey, if your trying to build your domestic economy, and China’s certainly is, if I look at the copper market, the copper market is telling me that China’s going to embark on another round of massive infrastructure project whether it’s in the road initiative or just in China itself but that’s what the market is sensing here. You don’t want a weaker currency. Your trying to ramp up domestic spending. You’d like to have a stronger currency because then you can buy cheaper imports so I’m hundred percent agreement and I agree with Peter with the dollar.

The dollar is interesting here because the cost of carry is quite expensive. If we use overnight money in Europe, let’s say German money, it’s 250 basis points going higher. If we’re using 2 year differential, it’s well over 3 percent because German 2 years are about negative 50 and US is of course 2.8. I don’t ever remember, I wont say ever, it’s been certainly over 3 decades that we’ve seen a spread that wide and 2 years or less. So these are things that should be (inaudible 27:24-27:25) the strengthening dollars as a lot of people are positioning for. Peter, from 107,108, but that was based on the Trump Whitehouse as much as anything. Bob White Heiser, who is the power here, is not afraid to promote a weaker currency. I think the markets are starting to accept to (inaudible 27:52) that in but they really haven’t yet. That may be one of the tools they utilized.

FRA: What about Brazil? Are they intentionally driving their currency lower to help their agricultural exports and hurting U.S grain exports?

Peter: They don’t need the help. It’s a business to them.

Yra: They don’t need the help. Its bad politics. Their in a great position now because the Chinese (inaudible 28:31) knows the US for the moment because their agricultural exports from Brazil are so cheap. Even if though they had a (inaudible 28:42) crop because they’re so cheap, it will be interesting to see how much plant the Brazilian farmer grew this year. Even international prices are lower, priced in terms of Real, which the farmers ultimately get paid in as they take their dollars they receive in the international market and convert to domestic currency. Their not suffering whatsoever. The United States farmers are suffering under Tariffs as well as having to compete against the weakened Brazilian Real. They don’t need any help. I think they believe the currency is to weak relative to other policy aims that they have.

FRA: And the finally moving over to Japan. How will the Bank of Japan be able to extricate itself from five years of QQE, qualitative and quantitative easing, since they’ve accumulated so much Japanese debt and equities? Your thoughts Yra?

Yra: Well, I don’t know if they know how to extricate themselves. They’ve just been muddling along here and I mean muddling. They preceded down this path for way too long. Supposedly we heard last week that Abe was backing away from the inflation targets after his new found political strength is (inaudible 30:07-30:09) although he’s got his plate full but I don’t how they get out of here. They’re not going to do it with a weaker currency. We listen to Trump, the sense that he’s looking to throw tariffs on to the Japanese because they run to large of surpluses with the US, the Japanese have to be very careful here and the Europeans can’t be too happy because the Euro against the Yen has been rallying dramatically. The European auto industry is (inaudible 30:51) head wind of a weaker Yen and US tariffs and some really bad fall for Brexit, which not enough people talk about it but the European auto industry could really get hit. But I don’t know what the Japanese are going to do here. They follow this Bernanke down this rabbit hole for way to long and i don’t know what they do here.

FRA: Peter?

Peter: Yeah it’s a great point. I don’t know what they’re going to do. I think that their acknowledging the squeeze that they’re in by allowing a whole 10 basis points extra of a yield grab (inaudible 31:36-31:37) can get in Japan, which is quite amazing from 10 to 20 basis points. They are certainly slowing the rate of purchases. I think they’ve basically cut QE in half. I think they’ve suddenly realized that they are a dominant player in the ETF market and are a top 10 holder in about 40% of Japanese Nikkei companies. I think they got their fingers crossed on generating some higher inflation so they can further get out of what they’ve done but I don’t see how they can ever get out of what they’ve done. I think they’ll just continue to try to lessens their influence and see what happens but Kuroda….talk about overstaying one’s welcome.

Yra: And to add to that, I think one of their plans was, at some point, that they’ll be able to start buying foreign bonds if they needed to but now that they run in Trump, there is no way that the (inaudible 32:39) or even some of those pension funds have to be very careful. The government pension investment fund. They can’t just willy nilly because that will move to weaken the end and they have to be very careful here.

Peter: That’ll be dangerous.

FRA: On that note, we’ll end it there. How can our listeners learn more about your work? Peter?

Peter: They can search it in wealth management. They can go to bleakley.com and reach out to me. If they want to see my daily (inaudible 33:10-33:11), they can subscribe at boockreport.com.

FRA: And Yra?

Yra: My blog post, notes from underground, and you can go to Yraharris.com. It’ll come up notesfromunderground you can get access to it and join the conversation that takes place on regular basis about many of these same issues. It’s just a discussion on what’s going on in the world and hopefully you can find your way to profitable investment from them.

FRA: Great insight as always. Thank you very much gentlemen! We’ll do it again.

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Download the Podcast in MP3

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Charles Hugh Smith Podcast

By: Tenzin Lekphell

FRA: Hi! Welcome to FRA’s round table insight! This is Richard Bonugli. Today we have Charles Hugh Smith, author, leading global finance blogger, and America’s philosopher. He’s the author of nine books on our economy and society, including A Radically Beneficial World: Automation Technology and Creating Jobs for All, Resistance Revolution Liberation: A Model for Positive Change, and The Nearly Free University & The Emerging Economy. His blog oftwominds.com has logged well over 55 million page views and is number 7 on CNBC’s top alternative finance site. Welcome Charles!

Charles: Thank You Richard! I hope I live up to that very nice introduction!

FRA: Oh you always do. Thank you for being on the show! And so I think today we wanted to do a bit of a change and look at the economy as a whole and some very interesting trends that are happening, namely a software automation and robotics process automation and artificial intelligence and how that is changing the economy, the job market, how organizations are being affected by these changes, what are they doing, and if people cannot be redeployed elsewhere within our organization, what’s the answer? Do we do a lunar Apollo crash program or, you know, just some of your thoughts on that? And just like to point out so you’ve written a book on Radically beneficial world on automation technology and creating jobs so that could be quite relevant here and also a number of articles as well.

Charles: Right! Right! Well this is a fascinating topic to me Richard and so I spent a lot of time trying to get up to speed on it and of course it’s evolving so quickly that those of us that aren’t really in the field, we’re always trying to play a little bit of catch up so I’m not claiming to be cutting edge here but I think I have thought a lot about it and tried to help my readers navigate it. So, I would start with what’s the context of automation, and robotics, and AI, the impact on the economy as a whole? And I called it, this whole sector trend change, the “emerging economy” because it hasn’t yet occupied every sector of the economy but we know it will right? So that’s why I call it the emerging economy. We see it everywhere but it hasn’t yet, it’s still quite a ways from fully manifesting in every sector of the economy. And one of the issues that you raised here is what happens if we can’t employee people in a sustainable fashion at a relatively high rate of pay? Then who’s going to be supporting the consumer economy? Right? In other words, the basic answer for a lot of people is we give everyone universal basic income but that’s like a $1,000 per person per month is for the general gist of that. That’s not the equivalent of a real middle-class job. That’s just survival pay so that’s not really gonna solve that issue. So that’s one issue and that’s I think the impotence behind your question. We really need people to be working. Not only because we need their productive and capacity but we also have to give people a way to generate enough income to have a good life as prices continue to rise and so on.

FRA: Yeah exactly and what’s happening here is generally technology companies will be able to transform an organization or provide some assistance in the areas of software automation robotics, process automation, and artificial intelligence. But what happens is after some work through organizational change management, they’re able to identify other areas of the organization where those affected by the job changes can be redeployed elsewhere in the organization but it doesn’t work for everybody. Some cannot be redeployed elsewhere within the organization and so they would be let go and then it becomes a societal problem or a government problem at that point. So that’s the big question what happens at that point?

Charles: Right! Just to provide some context, I have assembled a few graphics here that will help us, I hope, contextualize your question. The first is the iPhone supply chain, which goes to show just how global the tech economy is.

Now of course, this is not the entire economy because I read somebody noted recently on the internet that you can’t get a haircut on the internet. Right? So my point here is with the iPhone supply chain is to show that automation is a global phenomenon right? Their automating in China despite the lower labour cost because the labour costs is rising there too. So it’s not just an advanced economy problem, it’s global.

And my next chart here is the labour share of the GDP.

In other words, how much of the gross domestic product (inaudible 6:01-6:02) how much does that end up in the hands of labour as opposed to capital or other investment? We can see from this chart that labour share rose considerably in the dot com era because there was a huge expansion of employment to build out the basic infrastructure of the internet and so that created a lot of real employment. But when that got built out then the labour share of the GDP plummeted and it hasn’t recovered despite the so-called global recovery. So my point here is to show that we really need to keep labour share of the GDP high enough to support consumption or else the model of our economy no longer works.

My next chart is the acceleration of technological adoption.

Of course we all feel this intuitively but this points out that it took like 26 years for television to become ubiquitous and then it took social media only 5 years. So this puts a lot pressure on individuals and organizations because we can see this trend of automation is speeding up. It’s accelerating. It’s almost like whatever skill you learned in college, if it’s 4 years later, you’re already behind the curve. It requires, more or less, constant learning because of this accelerating adoption rate.

Although we’re talking about the economy as a whole, I have a graphic here of the United States which is an example of an advanced economy, you could call up a map of China or Japan or Europe and have a similar discussion.

The so called creative class, sort of the generalized term for people with higher education degrees and experience in the emerging economy, these of course are clustered in certain areas. So we’re really talking about two separate economies. So when we try to answer your important question, what do we do with people who aren’t able to transition to an emerging technology kind of economy? It’s a regional thing too because obviously the places like the San Francisco Bay area and equivalent places have the human capital, If you will, to address these issues better then areas with a less educated, with less mobile kind of employment foundation.

My next chart shows, this is in the health care sector in the United States which we all know is troubled for a lot of reasons, that the number of physicians have been added to the sector is minimal in the last 30 to 40 years where the growth of administrators is up about 3000%.

So I bring this chart to our attention as an example of a sector that is obviously ripe for disruption and there’s a lot of low-hanging fruit in terms of work that could be automated or streamlined in sectors like health care. In other words, this is not just high tech like we’re not talking about chip design or social media or mobile apps, we’re looking at these very large sectors that employ millions of people which are ripe for disruption by the forces that we’re talking about here.

My last chart is distribution of family income which shows, that as we all know, the top 10% has basically lifted away from the bottom 90% in terms of income.

The reason why I bring this up is, there is a lot of reasons for that, but one of them is that this top 10% tends to be the most highly educated, the most dynamic sector of the population. They’re the ones that are acquiring the skills and managerial skills to navigate the emerging economy and this is reflected in their much higher income. And this is the danger of a what we’re talking about here is even if we can maintain some generalized employment, if most of the rewards are going into the top ten percent then that also called into question or our whole mass consumption model of our economy. Now having said all that, how are organisations being affected by this change and how is it affecting the job market and how do how do organizations take the initiative to redeploy or train resources affected by these? These are all excellent questions and of course it depends on the sector. Say, just to give a brief example, the construction industry. There’s a certain amount of technological innovation there in terms of components fabricated in a factory and then shipped and assembled on site to reduce labour but there’s a lot of, let’s say, remodelling work. It’s very hard to automate that kind of stuff because it’s unique to each particular dwelling or each project and we still need workers with multiple skill sets.

So I think as a general rule, what we want to train our people for, whether there within our organization or if their students or laid-off workers is we want to give people a menu of skill sets not just a specialty. I mean a specialty skills works great if you are designing really high-end chip sets or you’re a physician but like for the rest of the populist, specialization means that you can be replaced by automation a lot easier than if you can have multiple skills. That’s one issue here is that we want to broaden peoples skill set.  Another thought here is that some labours are hard to automate like creative work, design, editing, etc. But even those kinds of advanced skill sets are being are being automated too as automation eats its way up the food chain.

Another sector of work that’s fairly protected is managing people, you know managerial skills which is really hard to automate and also any kind of employment that’s based on high touch. What’s known as high touch, meaning that your interacting with humans is what creates the value of your employment and so of course it’s going to be like nursing and childcare and so.

I think what we’re really talking about here when talk about how to organization responds, we’re talking not about those professions that are very difficult to automate but we’re talking about the professions that have to work with automation. They may not be completely replaced but it demands the employee’s augment the processes and learn enough to increase productivity because that’s another thing we’re talking about here as automation and A.I spread throughout the economy, we’re finding productivity is still stagnating. So we’re not really getting the gains of that. I mean you must have some thoughts about that too right? Because technology is supposed to enhance productivity. That’s the wealth creation part.

FRA: Yeah, and you’ve also explored in recent writing as well how organizations are being affected by these changes. Not only as you just mentioned on the productivity results but also on profits. Can you elaborate on that? And in recent writings, you mention that the automation doesn’t just destroy jobs, it destroys profits too.

Charles: Right and that’s counterintuitive for a lot of people Richard because they assume that the robot, because it’s replacing human labor and it’s cheaper, that it’s kind of generate huge profits or the other company that replaced their employees with robots but it doesn’t work like that and the reason why is “commoditization”. When we commoditize something, whether it’s labour or capital or goods, it means that they’re interchangeable. They can be produced anywhere in the world and so this is what the globalization phenomenon has (inaudible 15:41)    why it’s reduced cost so much is labour is interchangeable, computer chips are interchangeable, computer design centres are interchangeable so a robot is like a good example of a commoditized tool where anybody can buy the same robot that I bought and they can put it on their line. So therefore where’s my scarcity value? Where’s my Competitive Edge? and so as soon as you get robots involved then profits fall because everything becomes a commodity and we can see this in technology that when something is commoditized, the value drops, the price drops, and the profit margins drop to near 0. Like for instance a tablet. Right now if you have the special software that Apple sells right it’s tightly bound to its Hardware, that’s their scarcity value you can only get the certain features that Apple has by spending $400 on an iPad right? But if you’re going to get a generic tablet, those are like 30 bucks a piece in China with free software loaded and they have to have an 80 or 90% of the capability of the more expensive one. That’s the same thing that’s gonna happen to robotics. Everybody can buy the same Robotics and a lot of the tools why automation are free or software they’re free or they’re very cheap. So that’s why profits are going to plummet as automation enters the supply chain.

FRA: Interesting! And in terms of how organizations are addressing this, I think it’s also interesting to note how you can almost divide the pool of resources into some certain scenarios. One is the resources that need to be trained for extra skill sets on how to manage the increased level of automation or robotic process automation or artificial intelligence that will come into play in the organization. And then there’s others that would need to be redeployed within the organization elsewhere overall increasing productivity in that way. And then there’s the pool that where there’s no opportunities identified. They are not able to do increased levels of activity of services and they’re not in the pool of being able to be redeployed elsewhere. Your thoughts on that?

Charles: Right! It’s an excellent point Richard and this was really why I wrote my book A Radically Beneficial World is what I was proposing was that there is a very large pool of workers who don’t have the value system, the ambition, this sort of background perhaps to take on the extreme challenge of learning a bunch of high technology skills sets. And of those people, many of them have other kinds of intelligence. In other words, we need to help people identify where their strengths are. So for instance, some people have great manual intelligence. They can work with very fine machinery, some of which is of course related to robotics.

FRA: Now what can we do about this? Should governments take a role in redeploying or training resources affected by these changes? So that this would be the pool of resources that are unable to be redeployed within the organization or that’s still continued to have an expanded role in their current positions and job functions. So what can government do in this regard? Does it make sense to have government play a role your thoughts?

Charles: That’s a great question Richard and I think we can discern two approaches here. One is direct government spending, like on infrastructure a lot of people think of that, but it’s also the government could streamline a lot of really clunky processes we have now and in it (inaudible 20:21-20:22) both have, you know, a lower-level high school education and also higher education. So there’s opportunities for the government to contribute to the solutions in two ways; simplifying and enhancing processes that’s already involved in and then direct spending.

FRA: What about Reliance on the Invisible Hand of Adam Smith? So you know would that play a role here in terms of inner resources able to self-identify or self-train into other areas of the economy?

Charles: Right, it’s a great question and it’s always an issue I think in a state market economy which describes most of the global economy now right that the government’s around the world are heavily engaged or involved in managing their private sector. And so a lot of people have a sort of Quasi-religious belief that the market can solve everything but there certainly seems to be examples in which government does need to play a role in terms of providing infrastructure for everybody so that everybody has equal opportunity within a society. It’s something that isn’t necessarily profitable for enterprise to supply those things. Sometimes it is, sometimes it isn’t right? The canals in the early of the 18th century in America were privately-funded. But to use the example you mentioned earlier the Apollo Mission to the moon, obviously there was no a market demand for that and so no one was going to put up money or capital because there was no profit to be earned and because there was no market. In my book A Radically Beneficial World, I talk about the community economy as a place where we, the government, could redeploy capital because there’s lot of work to be done in local communities (inaudible 22:47 to 22:48) do the work because it’s just not profitable enough for them. But governments are often heavy handed and there are a lot of programs like job training end up failing. They don’t produce desired results. That’s not a clear answer but I think there’s multiple levels of opportunity for government. Sometimes just providing some infrastructure, sometimes smoothing the path so that work private capital can get to work without a lot of red tape and regulation.

FRA: And what about the lunar Apollo crash program back in the 1960s? There’s estimates that perhaps somewhere between $4 and $8 in economic growth, economic activity was generated for every $1 invested into that program. So maybe could that be considered in terms of doing another crash type of program but in something else that makes sense today like you know nuclear fusion energy development coupled with the electrification of cars for example. Would that make sense it in create jobs not only in the white collar jobs but also blue collar jobs across the entire nation?

Charles: That’s a great question Richard. I think a lot of people are looking to that idea as a major solution. A big government spending program on something that was particularly useful, which would be energy, because we all know we need to transition away from fossil fuels. There’s a cautionary part of that idea and I looked to Japan as an example of the cautionary part. Japan has spent almost 30 years spending a tremendous amount of fiscal stimulus on infrastructure and what they done is mal-invested much of it in bridges to nowhere and high-ways very few people used and this is a result of their political system which gives a lot of power to the construction industry. Sadly, they in my view, they squandered trillions of Yen on infrastructure that really didn’t serve the entire citizenry as well as if they solarize their economy or done something that was more to the common good instead of just kind of make work projects. So we have to be careful here that we’re not just funding make work jobs, we want to leverage some technology that benefits the greater good. One example, and a lot of people talk about this, is upgrading the electrical grid because this is something that is required in order make use of electrical production from solar and wind. It’s increasing right? That grid has to be completely upgraded. So that’s an example of a program that sort of fits those parameters so that it would leverage government investment to the benefit of the private sector as well as to the citizenry. Of course everybody loves the example of the Arpanet, which was the original little government funded program that spawned the entire internet right? That was a really low cost investment and so I think we can talk about that too like it’s easy to talk about spending a trillion dollars, and everybody wants to spend a trillion, but maybe we should start by just trying to see what we could do with smaller sums to leverage new technologies and make them available to a wider range of people like 3D fabrication technology. That could be beneficial if the government invested in spreading that around and that should be a lot less expensive than big trillion-dollar programs.

FRA: Interesting. And finally how do you see all of this playing out in the long-term? Do you see like a combination of government taking a role, the invisible hand of Adam Smith or potential crash programs in the future?

Charles: Right! It’s a very dynamic situation and I would hesitate to make any predictions but I think the potential for disruption is so large that the government itself should be disrupted. In other words, we need to disrupt, to which we apply the technologies that we were discussing. We need to apply them to lower the cost and increase the effectiveness of government itself. And so when we talk about government spending, one of the first places we should invest in is streamlining government because it’s really, and it in so many ways, inefficient and ineffective and it desperately needs to be disrupted in streamlined. So that that might be a first place to start investing taxpayer money.

FRA: Wow, great insight as always Charles. How can our listeners learn more about your work?

Charles: Yeah, please visit me oftwominds.com, and you can read samples of my most recent books.

FRA: Great! Thank you very much for being on the program show for your insights on this very interesting topic.

Charles: Oh yeah, we barely touched the surface. Thank you so much for inviting me on the program!

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Download the Podcast in MP3

Charles Hugh Smith Podcast

By: Tenzin Lekphell

FRA: Hi! Welcome to FRA’s Roundtable Insight! .. Today we have Charles Hugh Smith, author, leading global finance blogger, and America’s philosopher. He’s the author of nine books on our economy and society, including A Radically Beneficial World: Automation Technology and Creating Jobs for All, Resistance Revolution Liberation: A Model for Positive Change, and The Nearly Free University & The Emerging Economy. His blog oftwominds.com has logged well over 55 million page views and is number 7 on CNBC’s top alternative finance site. Welcome Charles!

Charles: Thank You Richard! I hope I live up to that very nice introduction!

FRA: Oh you always do. Thank you for being on the show! And so I think today we wanted to do a bit of a change and look at the economy as a whole and some very interesting trends that are happening, namely a software automation and robotics process automation and artificial intelligence and how that is changing the economy, the job market, how organizations are being affected by these changes, what are they doing, and if people cannot be redeployed elsewhere within our organization, what’s the answer? Do we do a lunar Apollo crash program or, you know, just some of your thoughts on that? And just like to point out so you’ve written a book on Radically beneficial world on automation technology and creating jobs so that could be quite relevant here and also a number of articles as well.

Charles: Right! Right! Well this is a fascinating topic to me Richard and so I spent a lot of time trying to get up to speed on it and of course it’s evolving so quickly that those of us that aren’t really in the field, we’re always trying to play a little bit of catch up so I’m not claiming to be cutting edge here but I think I have thought a lot about it and tried to help my readers navigate it. So, I would start with what’s the context of automation, and robotics, and AI, the impact on the economy as a whole? And I called it, this whole sector trend change, the “emerging economy” because it hasn’t yet occupied every sector of the economy but we know it will right? So that’s why I call it the emerging economy. We see it everywhere but it hasn’t yet, it’s still quite a ways from fully manifesting in every sector of the economy. And one of the issues that you raised here is what happens if we can’t employee people in a sustainable fashion at a relatively high rate of pay? Then who’s going to be supporting the consumer economy? Right? In other words, the basic answer for a lot of people is we give everyone universal basic income but that’s like a $1,000 per person per month is for the general gist of that. That’s not the equivalent of a real middle-class job. That’s just survival pay so that’s not really gonna solve that issue. So that’s one issue and that’s I think the impotence behind your question. We really need people to be working. Not only because we need their productive and capacity but we also have to give people a way to generate enough income to have a good life as prices continue to rise and so on.

FRA: Yeah exactly and what’s happening here is generally technology companies will be able to transform an organization or provide some assistance in the areas of software automation robotics, process automation, and artificial intelligence. But what happens is after some work through organizational change management, they’re able to identify other areas of the organization where those affected by the job changes can be redeployed elsewhere in the organization but it doesn’t work for everybody. Some cannot be redeployed elsewhere within the organization and so they would be let go and then it becomes a societal problem or a government problem at that point. So that’s the big question what happens at that point?

Charles: Right! Just to provide some context, I have assembled a few graphics here that will help us, I hope, contextualize your question. The first is the iPhone supply chain, which goes to show just how global the tech economy is.

Now of course, this is not the entire economy because I read somebody noted recently on the internet that you can’t get a haircut on the internet. Right? So my point here is with the iPhone supply chain is to show that automation is a global phenomenon right? Their automating in China despite the lower labour cost because the labour costs is rising there too. So it’s not just an advanced economy problem, it’s global.

And my next chart here is the labour share of the GDP.

In other words, how much of the gross domestic product (inaudible 6:01-6:02) how much does that end up in the hands of labour as opposed to capital or other investment? We can see from this chart that labour share rose considerably in the dot com era because there was a huge expansion of employment to build out the basic infrastructure of the internet and so that created a lot of real employment. But when that got built out then the labour share of the GDP plummeted and it hasn’t recovered despite the so-called global recovery. So my point here is to show that we really need to keep labour share of the GDP high enough to support consumption or else the model of our economy no longer works.

My next chart is the acceleration of technological adoption.

Of course we all feel this intuitively but this points out that it took like 26 years for television to become ubiquitous and then it took social media only 5 years. So this puts a lot pressure on individuals and organizations because we can see this trend of automation is speeding up. It’s accelerating. It’s almost like whatever skill you learned in college, if it’s 4 years later, you’re already behind the curve. It requires, more or less, constant learning because of this accelerating adoption rate.

Although we’re talking about the economy as a whole, I have a graphic here of the United States which is an example of an advanced economy, you could call up a map of China or Japan or Europe and have a similar discussion.

The so called creative class, sort of the generalized term for people with higher education degrees and experience in the emerging economy, these of course are clustered in certain areas. So we’re really talking about two separate economies. So when we try to answer your important question, what do we do with people who aren’t able to transition to an emerging technology kind of economy? It’s a regional thing too because obviously the places like the San Francisco Bay area and equivalent places have the human capital, If you will, to address these issues better then areas with a less educated, with less mobile kind of employment foundation.

My next chart shows, this is in the health care sector in the United States which we all know is troubled for a lot of reasons, that the number of physicians have been added to the sector is minimal in the last 30 to 40 years where the growth of administrators is up about 3000%.

So I bring this chart to our attention as an example of a sector that is obviously ripe for disruption and there’s a lot of low-hanging fruit in terms of work that could be automated or streamlined in sectors like health care. In other words, this is not just high tech like we’re not talking about chip design or social media or mobile apps, we’re looking at these very large sectors that employ millions of people which are ripe for disruption by the forces that we’re talking about here.

My last chart is distribution of family income which shows, that as we all know, the top 10% has basically lifted away from the bottom 90% in terms of income.

The reason why I bring this up is, there is a lot of reasons for that, but one of them is that this top 10% tends to be the most highly educated, the most dynamic sector of the population. They’re the ones that are acquiring the skills and managerial skills to navigate the emerging economy and this is reflected in their much higher income. And this is the danger of a what we’re talking about here is even if we can maintain some generalized employment, if most of the rewards are going into the top ten percent then that also called into question or our whole mass consumption model of our economy. Now having said all that, how are organisations being affected by this change and how is it affecting the job market and how do how do organizations take the initiative to redeploy or train resources affected by these? These are all excellent questions and of course it depends on the sector. Say, just to give a brief example, the construction industry. There’s a certain amount of technological innovation there in terms of components fabricated in a factory and then shipped and assembled on site to reduce labour but there’s a lot of, let’s say, remodelling work. It’s very hard to automate that kind of stuff because it’s unique to each particular dwelling or each project and we still need workers with multiple skill sets.

So I think as a general rule, what we want to train our people for, whether there within our organization or if their students or laid-off workers is we want to give people a menu of skill sets not just a specialty. I mean a specialty skills works great if you are designing really high-end chip sets or you’re a physician but like for the rest of the populist, specialization means that you can be replaced by automation a lot easier than if you can have multiple skills. That’s one issue here is that we want to broaden peoples skill set. Another thought here is that some labours are hard to automate like creative work, design, editing, etc. But even those kinds of advanced skill sets are being are being automated too as automation eats its way up the food chain.

Another sector of work that’s fairly protected is managing people, you know managerial skills which is really hard to automate and also any kind of employment that’s based on high touch. What’s known as high touch, meaning that your interacting with humans is what creates the value of your employment and so of course it’s going to be like nursing and childcare and so.

I think what we’re really talking about here when talk about how to organization responds, we’re talking not about those professions that are very difficult to automate but we’re talking about the professions that have to work with automation. They may not be completely replaced but it demands the employee’s augment the processes and learn enough to increase productivity because that’s another thing we’re talking about here as automation and A.I spread throughout the economy, we’re finding productivity is still stagnating. So we’re not really getting the gains of that. I mean you must have some thoughts about that too right? Because technology is supposed to enhance productivity. That’s the wealth creation part.

FRA: Yeah, and you’ve also explored in recent writing as well how organizations are being affected by these changes. Not only as you just mentioned on the productivity results but also on profits. Can you elaborate on that? And in recent writings, you mention that the automation doesn’t just destroy jobs, it destroys profits too.

Charles: Right and that’s counterintuitive for a lot of people Richard because they assume that the robot, because it’s replacing human labor and it’s cheaper, that it’s kind of generate huge profits or the other company that replaced their employees with robots but it doesn’t work like that and the reason why is “commoditization”. When we commoditize something, whether it’s labour or capital or goods, it means that they’re interchangeable. They can be produced anywhere in the world and so this is what the globalization phenomenon has (inaudible 15:41) why it’s reduced cost so much is labour is interchangeable, computer chips are interchangeable, computer design centres are interchangeable so a robot is like a good example of a commoditized tool where anybody can buy the same robot that I bought and they can put it on their line. So therefore where’s my scarcity value? Where’s my Competitive Edge? and so as soon as you get robots involved then profits fall because everything becomes a commodity and we can see this in technology that when something is commoditized, the value drops, the price drops, and the profit margins drop to near 0. Like for instance a tablet. Right now if you have the special software that Apple sells right it’s tightly bound to its Hardware, that’s their scarcity value you can only get the certain features that Apple has by spending $400 on an iPad right? But if you’re going to get a generic tablet, those are like 30 bucks a piece in China with free software loaded and they have to have an 80 or 90% of the capability of the more expensive one. That’s the same thing that’s gonna happen to robotics. Everybody can buy the same Robotics and a lot of the tools why automation are free or software they’re free or they’re very cheap. So that’s why profits are going to plummet as automation enters the supply chain.

FRA: Interesting! And in terms of how organizations are addressing this, I think it’s also interesting to note how you can almost divide the pool of resources into some certain scenarios. One is the resources that need to be trained for extra skill sets on how to manage the increased level of automation or robotic process automation or artificial intelligence that will come into play in the organization. And then there’s others that would need to be redeployed within the organization elsewhere overall increasing productivity in that way. And then there’s the pool that where there’s no opportunities identified. They are not able to do increased levels of activity of services and they’re not in the pool of being able to be redeployed elsewhere. Your thoughts on that?

Charles: Right! It’s an excellent point Richard and this was really why I wrote my book A Radically Beneficial World is what I was proposing was that there is a very large pool of workers who don’t have the value system, the ambition, this sort of background perhaps to take on the extreme challenge of learning a bunch of high technology skills sets. And of those people, many of them have other kinds of intelligence. In other words, we need to help people identify where their strengths are. So for instance, some people have great manual intelligence. They can work with very fine machinery, some of which is of course related to robotics.

FRA: Now what can we do about this? Should governments take a role in redeploying or training resources affected by these changes? So that this would be the pool of resources that are unable to be redeployed within the organization or that’s still continued to have an expanded role in their current positions and job functions. So what can government do in this regard? Does it make sense to have government play a role your thoughts?

Charles: That’s a great question Richard and I think we can discern two approaches here. One is direct government spending, like on infrastructure a lot of people think of that, but it’s also the government could streamline a lot of really clunky processes we have now and in it (inaudible 20:21-20:22) both have, you know, a lower-level high school education and also higher education. So there’s opportunities for the government to contribute to the solutions in two ways; simplifying and enhancing processes that’s already involved in and then direct spending.

FRA: What about Reliance on the Invisible Hand of Adam Smith? So you know would that play a role here in terms of inner resources able to self-identify or self-train into other areas of the economy?

Charles: Right, it’s a great question and it’s always an issue I think in a state market economy which describes most of the global economy now right that the government’s around the world are heavily engaged or involved in managing their private sector. And so a lot of people have a sort of Quasi-religious belief that the market can solve everything but there certainly seems to be examples in which government does need to play a role in terms of providing infrastructure for everybody so that everybody has equal opportunity within a society. It’s something that isn’t necessarily profitable for enterprise to supply those things. Sometimes it is, sometimes it isn’t right? The canals in the early of the 18th century in America were privately-funded. But to use the example you mentioned earlier the Apollo Mission to the moon, obviously there was no a market demand for that and so no one was going to put up money or capital because there was no profit to be earned and because there was no market. In my book A Radically Beneficial World, I talk about the community economy as a place where we, the government, could redeploy capital because there’s lot of work to be done in local communities (inaudible 22:47 to 22:48) do the work because it’s just not profitable enough for them. But governments are often heavy handed and there are a lot of programs like job training end up failing. They don’t produce desired results. That’s not a clear answer but I think there’s multiple levels of opportunity for government. Sometimes just providing some infrastructure, sometimes smoothing the path so that work private capital can get to work without a lot of red tape and regulation.

FRA: And what about the lunar Apollo crash program back in the 1960s? There’s estimates that perhaps somewhere between $4 and $8 in economic growth, economic activity was generated for every $1 invested into that program. So maybe could that be considered in terms of doing another crash type of program but in something else that makes sense today like you know nuclear fusion energy development coupled with the electrification of cars for example. Would that make sense it in create jobs not only in the white collar jobs but also blue collar jobs across the entire nation?

Charles: That’s a great question Richard. I think a lot of people are looking to that idea as a major solution. A big government spending program on something that was particularly useful, which would be energy, because we all know we need to transition away from fossil fuels. There’s a cautionary part of that idea and I looked to Japan as an example of the cautionary part. Japan has spent almost 30 years spending a tremendous amount of fiscal stimulus on infrastructure and what they done is mal-invested much of it in bridges to nowhere and high-ways very few people used and this is a result of their political system which gives a lot of power to the construction industry. Sadly, they in my view, they squandered trillions of Yen on infrastructure that really didn’t serve the entire citizenry as well as if they solarize their economy or done something that was more to the common good instead of just kind of make work projects. So we have to be careful here that we’re not just funding make work jobs, we want to leverage some technology that benefits the greater good. One example, and a lot of people talk about this, is upgrading the electrical grid because this is something that is required in order make use of electrical production from solar and wind. It’s increasing right? That grid has to be completely upgraded. So that’s an example of a program that sort of fits those parameters so that it would leverage government investment to the benefit of the private sector as well as to the citizenry. Of course everybody loves the example of the Arpanet, which was the original little government funded program that spawned the entire internet right? That was a really low cost investment and so I think we can talk about that too like it’s easy to talk about spending a trillion dollars, and everybody wants to spend a trillion, but maybe we should start by just trying to see what we could do with smaller sums to leverage new technologies and make them available to a wider range of people like 3D fabrication technology. That could be beneficial if the government invested in spreading that around and that should be a lot less expensive than big trillion-dollar programs.

FRA: Interesting. And finally how do you see all of this playing out in the long-term? Do you see like a combination of government taking a role, the invisible hand of Adam Smith or potential crash programs in the future?

Charles: Right! It’s a very dynamic situation and I would hesitate to make any predictions but I think the potential for disruption is so large that the government itself should be disrupted. In other words, we need to disrupt, to which we apply the technologies that we were discussing. We need to apply them to lower the cost and increase the effectiveness of government itself. And so when we talk about government spending, one of the first places we should invest in is streamlining government because it’s really, and it in so many ways, inefficient and ineffective and it desperately needs to be disrupted in streamlined. So that that might be a first place to start investing taxpayer money.

FRA: Wow, great insight as always Charles. How can our listeners learn more about your work?

Charles: Yeah, please visit me oftwominds.com, and you can read samples of my most recent books.

FRA: Great! Thank you very much for being on the program show for your insights on this very interesting topic.

Charles: Oh yeah, we barely touched the surface. Thank you so much for inviting me on the program!

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

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Yra & Peter Podcast

By: Tenzin Lekphell

FRA: Hi welcome to FRA’s Roundtable Insight .. Today we have Yra Harris and Peter Boockvar. Yra is a successful hedge fund manager and a global trader in foreign currencies, bonds, commodities, and equities for over 40 years. He was also a CME director from 1997 to 2003. And Peter is Chief Investment Officer for the Bleakley Financial Group and Advisory. He has a newsletter product called the BoockReport.com which has great macro-economic insight and respective with lots of updates of economic indicators. Welcome Gentlemen!

Yra: Hey Richard!

Peter: Hey good afternoon guys!

FRA: Great! I thought we begin with a reflection on the FOMC Minutes today and the observation that you made recently Yra and your blog that Peter Boockvar, Jim Bianco, and the former Bank of India governor, Raghuram Rajan, have all raised concerns about the Feds raising rates while shrinking its balance sheet. This is leading to a rapid rise in borrowing costs for emerging market economies that have high levels of dollars denominated debt. And so what is the consensus today from the FOMC minutes meeting perspective?

Yra: Well I am sure Peter will speak more to the FOMC Minutes. I have read through some and I am sure he’s much more ahead of me on this but you know Peter and Jim and certainly professor Rajan have discussed this and its impact on the ripple effect. You know every central bank because the media is so enamored and the fact the equity market has risen and the central banks all raised the great concept of counter factual wealth we haven’t done this. Well they did do this and I know that Peter and I and Richard you have discussed this for years they have overstayed this hand and did they need Q.E 2 or 3. But the effects of the Bernanke Fed taking this, to me a ridiculous and which prompted the Yishibe and of course The Bank of Japan to take this to ridiculous end, have sent global interest rate to very low levels and I think has enabled, I think that’s the right word, cause when we enable an addiction to this ultra-low interest rate and led this to a huge amount of borrowing because of these low rates. Now that interest rates are moving up as Peter pointed out since he framed the QT or Quantitative tightening, that now liquidity is being withdrawn especially from the world reserve currency, which has greater effects than any other. And it causing some dislocation because interest rates are going up and we feel liquidity is tightening and now this you know, all these people who are borrowed up are now having to paying it back or if they are not paying it back yet, their debt services costs will rise dramatically. So that’s where we sit in the world so I think it has great ramifications but I will leave my voice there and let Peter go on with it.

Peter: Yeah, I agree with Yra’s points and one ironic thing about Monetary Policy is that when you look at that over 20 years ago, each successive cycle saw lower and lower interest rates because the debt build up that has taken over many years meant that we needed lower and lower interest rates not only which encourage the borrowing but meant that higher rates than that would cause a major problems cause of all the debt so here the Feds says I’m going to cover it to zero and I’m going to encourage you guys to go out and borrow and borrow and borrow and now you have taken on a lot of debt now its time to raise interest rates well they can’t raise the interest rates to much because of all the debt that’s accumulated. So we are going to the next recession or down turn whenever that might occur with the fed funds rate well below what it’s been in the past. Likely Europe will go into to the next recession with rates that are negative and Japan will probably do the same. So that’s what going to differentiate the next recession from the previous ones is the inability of central banks to be able deal with it because so many (4:52 Inaudible) have already been expended. So one of the problems there to leave it at that. But with respect to Yra mentioned the Minutes, The Minutes are in a way in addition to FOMC statement, the minutes are not really minutes. When you think of minutes, it’s okay let’s take notes of about what discussed. The fed has turned Minutes into another messaging machine, to be sort of an addendum to the Minutes the actual statements that comes out the day of the meeting. And typically nothing comes of it and I don’t really think nothing really came of it this time but those that think that the Feds are going to be talking about trading and worried about that that there are going to be almost done, well there are plenty of comments within the minutes that talked about company’s having more leverage in raising prices. There is also a great discussion on the yield curve with some saying that we outta to pay attention to the yield curve and we don’t want to invert it. And others have said that you can’t infer economic casualty from some statistics correlation because there global factors that are surpassing long term interest rates such as, as Yra said, very low rates in Europe and Japan. The question is to which side is of that argument is Jay Powell and I’m not sure of that answer.

FRA: Okay and what about the effect of this on the US equities markets Yra you observed that there’s a rallying of the US markets relative to the rest of the world with the (6:32 inaudible) US dollar. Could this be a trend, a change in trend from prior correlation of weak currency and strong equities market?

Yra: Well you know with the algorithmic world and the way we respond to things, can it be a trend? I do not how to define trend anymore. You know it seems 24 hours is a momentum trend so it switches again. So in the big picture, I don’t believe that those fundamental have shifted dramatically and I always find the currency are (7:06 inaudible) interesting because they will roll out, you know I love the different financial media because they will roll out a CEO who when the dollar is rallying or its affecting our outlier that is affecting our profitability of the strong dollar but I yet to hear of a CEO in America who when the dollar is weak and the profits are growing stand up and say, “don’t increase my bonus this year cause its really due to extraordinary circumstances way beyond my control and that’s the dollar is so weak that you couldn’t help but make money”. So the argument about the dollar it’s right now you got both going together because of some theory that the United States is some haven for money flowing in, it’s still the same thing in China with a weak currency but you have a real weak equity market. These are things that we haven’t seen sustain themselves and I don’t believe they will sustain themselves as far as equity markets correlative with currencies that they will have long held view will resurrect itself, But right now we are in a situation where several correlation that we have seen have broken down we also saw oil prices rally with quite a bit with the dollar rally initially. So you know what that’s the thing about correlation they work until they don’t work anymore. But certain along the held relationships we will always reassert themselves. I almost sound like the feds giving enough time (8:56 – 9:01 inaudible)

FRA: And your thoughts Peter?

Peter: Yeah I agree. Even with the European stock markets this year with the recent weakness in the Euro it has done nothing to help the European markets. (Inaudible 9:15) in Germany in which, 40% depended on exports. So and to the point of algorithms, I stopped thinking that equity market was a good discounting mechanism like it used to be and I see it just for responding to events and circumstances that’s smack in the middle of its face and like you take now for example, you see the weakness in overseas economies. Well 40% of the S&P sources goods from overseas but there is not one (Inaudible 9:48) saying that our revenue growth can be clipped here. To think a lot of it does have to do with Algorithms cause in algorithm the input is the data that is out here. It’s not guessing what the data will be. So it’s not saying that China’s growth is falling therefore 6 months from now, it will start to impact the US and I should trim equities today. Its saying, China’s growth is slowing but it hasn’t affected the US and the US is still good therefore buy stocks. So I wouldn’t look at US equity market as a good discounting mechanism just look at 07. The credit markets were literally on fire in the beginning of 07 and the stock market hit an all-time record high in October 2007 because the feds were cutting rates and they thought the feds are here to save us. Buy stocks when they cut rates. In the flipside, buy stocks 2013, 14, 15, don’t fight the feds don’t fight the feds. Well now, you don’t hear anyone talking about, “be careful of feds be careful of feds”. It’s just buy stocks buy stocks things are good! So the narrative always changes and the circle of relationships are difficult to apply now because we never had an experience of negative interest rates. The (inaudible 11:05) 2 years minus 60 basis point historical approximate so don’t give me a seasonal analysis or historical analysis of the yield curve when we are in a rate environment when it’s never been seen in the history of the world before.

Yra: (11:22 inaudible) because you’re in Canada Richard so one of the most interesting things is the flattest yield curve, except outside Iceland which is a different situation, but the Canadian curve is really flat. Flatter than the US. I think its 15 basis points this morning. Which is interesting because they never had a Q.E program. So what is flattening the curve? Is it that the Canadian are now following the US in raising the rates and that the Canadian market a very effective barometer that hey, “you might be wrong here that there are things you ought not to be raising rates in this fashion. I find that very interesting what the Canadian curve is doing and I’m starting to pay attention to it only because it’s a pure view although of course it’s affected by international capital flow which are all affected by the major central banks. But I do find that curve, being as flat as it is, very interesting and something to watch for.

FRA: Yeah could be partly also because on concerns with trade like with NAFTA, with the US and concerns there on discussion on the treaty, revising the terms of the treaty, which could be negative to Canada, and also on real estate, there’s been lot of international capital flow into Canada recently but theres been new measure in terms of taxation or tariffs, penalties imposed on foreign nationals/ foreign entities outside of Canada on the real estate market so it’s no longer as it was before so a lot of jobs recently created due to the real estate boom. So I think maybe those two concerns are bearing on Canada.

Yra: I know it’s worth discussing so you know everybody has ancillary reasons for why this, and what’s interesting because Peter brought it up from the (13:41- 13:42 inaudible) about foreign flow funds are we back to Bernanke argument about the surplus savings. I guess there’s still some people in the feds making that argument for the current state of affairs. That didn’t sit well with me in 2006 and it sits less well with me right now because it fails to take into account the real impact and the damage done by central bank policy but that’s an objective opinion on my part.

FRA: Yeah, exactly. So we talked about the Fed. But what about what about the Japanese central banks. There’s been some potential trends there in terms of the Japanese central bank buying less equities they bought a lot of the in the past and due to changes in the central bank policy, what are your thoughts on that and let’s start with Yra.

Yra: I deferred to Peter and I think he has a better sense of that. So Richard I’ll defer to Peter.

Peter: So what’s most interesting when the Bank of Japan decided to go to Yield curve control, it was there way of saying, “we already broke the Japanese bond market we need to start buying less, lets figure out another way of keeping the rate low. So they went from focusing on the price of money from the quantity of the money they printed. So they said let’s keep the spread the overnight rate and 10 year rate close zero give or take 10 basis points. And that worked in a sense that it allowed them to dramatically cut Q.E. Where they were running at peak 8 trillion yen a month to 50 trillion yen. Problem was that by destroying and flattening the yield curve to nothing, the you damaged profitability of the banking system and if your banking system is your transmission mechanism of your policy, you actually end up tightening via the easing because the banks are reluctant to lend because there’s no yield curve, well you are tightening they are now cutting back on what I’m hearing purchases of stocks. Well when they become dominant holder of Japanese stocks, you actually scare Japanese equity investors because you know it’s not sustainable unless the Japanese want to nationalise the Japanese stock market but I don’t think that’s on the agenda, you actually scare potentially buyers of Japanese stocks because you wonder and fear what’s gonna happen when the Japanese are done buying stocks the markets gonna fall. So their easing becomes into tightening while they still ease and I think that’s why Korota shifted the yield curve control to 20 basis points give or take from 10 but even 20 basis points really isn’t much from 10. So they have a major problem. The end game is somewhat over for the Bank of Japan. I just don’t know how they are gonna figure out a way of getting out of it.

Yra: Yeah I would agree. Peter has that absolutely right. Their QQE, is they refer to it of course, it was quality and quantity as they were buying stocks. I think they have been under buying for a long time that’s why I wasn’t so surprised when they made that announcement in the initial reaction was a quick shutoff of in the equity and a quick reality in the Japanese Yen. So but I don’t think it really was that great of a surprise to the market because they’re not very transparent. It was like watching the Yishibi who would publish where they were at the end of every week and you can kind of follow and map that you knew exactly what they were buying according to the capital keys. The Japanese have really been very secretive here and I think Kuroda has followed. I agree with Peter and I think it’s a terrible policy and I think he was able to do what he was to do because he could do it out of the heels of again Bernanke. I respect Jay Powell and it’s interesting to hear these views but the United states does have a global fiduciary and when it fails, it does things to creates havoc in the system and then everybody else follows as it goes (18:40-18:42 Inaudible) their doing it and (Inaudible) okay I’m going to do this here. So we’ve gone to preposterous measure of central bank activity in the world and I think the first rumblings in the emerging is some of the coming price that’s going to be paid. I can’t tell you when, I wish I could cause then I could retire and then I could do these podcast fulltime. But I think it’s coming to watch out for and I think Peter is picking up on that. With the Bank of Japan, I think they have gotten themselves into a terrible situation.

FRA: Yes and Peter what about the Japanese currency and the last couple of months. It seems to be increasing or strengthening at even faster rate than the US dollar?

Peter: It’s amazing it’s like a conundrum. I mean when you look at the Japanese monetary and fiscal situation you tell yourself, “Why isn’t it 250 instead of a dollar let alone 110 or 112? But I think the recent rally is strictly due to the change in Japanese policy in terms of the yield curve control and continuing to trim Q.E. It’s really as simple as that. Where the end goes from here is, you could flip a coin. As I said on paper, it deserves to be a lot weaker but considering how the US has been handling, its finances. The dollar should be that much stronger than the Yen. So I think what the end results is that printing currency and weakening your currency is not necessarily the pathway to higher inflation. And that was the goal of Bank of Japan was to create 2% inflation even though it’s completely unrealistic benchmark, particularly in a country that had a shrinking population and a growing, aging population that needs to save and really spend less therefore, another reason why you are not going to get the higher inflation. So, here we are with their balance sheet that is almost 100% of their GDP and they are the top 10 holders, 40% of Japanese equities listed on the Nikkei and the CPI number, which comes out tonight, core CPI or core core CPI ex energy and food, is expected to be up all 3/10’s of the year. Astonishing!

FRA: And moving from Japan to China, Yra you referenced the Financial times news item and which it was stated that China’s banking regulator has ordered to boost lending to infrastructure projects and exporter as the government seeks to bolster economic confidence on the eve of a new rounds of trade negotiations with the US. Your thoughts on that?

Yra: Well my thoughts are that is when I wrote that there was a weekend article which I thought was very important article and I did exactly what I thought it would do which is that is coppers and everything that has been down been up all this week. Including everyone was bullish the dollar but this was done to assuage the immediate pressure. I don’t think the Chinese have as much room as they would believe but I thought it was a very interesting switch because they are evidently a little bit nervous about too much slowdown too quickly in the Japanese economy and I know Peter has been watching the Chinese bonds are also approaching are approaching the very low levels they are almost as low as the US ten year. In a country if we believed in numbers, you know over 6% GDP growth. There getting a little worried and their worried about how far Trump’s going to take this Tariff issue? So I thought that was done in way to politically assuage some in the White House and hoping that they would be able to control more of the dialogue between the two and soften some of the rhetoric. It was interesting. Another thing that took place, today or yesterday, the German foreign minister. You know, lets hold off for a bit. Peter you go with China then I will come back with the German foreign minister thing cause he did some interesting things.

Peter: China’s in this tough spot where they acknowledge the success of credit groups that has led to so many imbalances in their economy on top of the massive leverage ratio and that’s why they have been pushing to try to at least bring lending on to bank balance sheets and off the (Inaudible 23:45) outside but at the same time, they don’t want to suffer big decline in GDP growth and they still want the 6.5% type growth and you throw the tariffs in that is a threat to growth which causes another policy conundrum because they want to slow credit growth but they want to speed it up to offset the tariffs. How this plays out is again going to be a mystery because China’s economy overall is a mystery. I think over time, slowing credit growth and trying to maybe privatize is the wrong word but continuing to shift their economy to more private sector dependent area and business’s are a good thing and actually bullish in long term but how they manage this in the next year or two is going to be extraordinarily difficult particularly if Europe is going to slow at the same time because of their own challenges and the end of QE and the Europe is a huge customer there and how they manage further relationships with the US. Now today, delegation comes to US to discuss trade and I’m beginning to now wonder whether China’s saying you know what, we’re not giving in and we’ll wait after the election, the midterm election in the US, because when the democrats takes the house when Trump is going to have less leverage, and maybe we cannot give in as much as he wants us to do. So where the Chinese economy goes is will be how much do they dig in and I think they at least they show some interest in digging in and not giving in to what Trump wants and you throw in this whole Michael Cohen thing and I think that’s kind of irrelevant for the whole US economy and markets and they take this as a sign of vulnerability, which gets them into digging even more. We’ll just have to wait and see.

FRA: Back to the German foreign minister Yra?

YRA: Yesterday, German foreign minister. Hold on one second…It was the only thing I was interested in reading today (Inaudible 26:01- 26:03) it was out and I recently saw this story and nobody really talked about it but discussing it that Europe and others need to break away from the strangle hold of the United States especially office for Foreign Asset Control which is under the US treasury and its ability through sanctions and other mechanisms to control, of course, fund transfers globally which is what the Russians and others, the Iranians, the Turks yelling about, because the US treasury really has the power to affect your ability to move money and the German foreign minister came out and said, they have to be get ready to move beyond this. I thought it was interesting that he came out with that following the Putin and Merkel meeting over the weekend. And Merkel actually this morning came out and supported the article (Inaudible 27:00 27:01) and she came out to supported the foreign minister and those views and it’s really all directed at trying to circumvent the ability of the Swiss system because its price and dollars and the United States has disproportionate amount of power to control a lot of global events because of it. So they want to circumvent it. I think that’s what the Chinese would ultimately like to do and I think that’s what the Russians would really like to get themselves out of which is why I talked about these sanctions they want to remove it is a matter of what negotiating power Putin has with the Trump White House and I’m not talking about the more sorted events, I’m talking about the ability for the Russians to be able to influence and dramatically influence the events in the mid- east. So this is all coming together at an interesting time and I think it’s really a sense of push back against the US “bullying”, as I think the world would say, in regards to foreign exchange flows. This is really nothing new. It really goes back to the 50s and 60s when the French were complaining about the same thing for the different reasons that the US had way to much influence because of dollars rolls reserve currency. But I think this is important and I think it needs to be on everybody’s radar screen to pay attention to.

FRA: Peter any comments on that?

Peter: I agree with Yra, it’s definitely something to watch. All the goings on with the emerging markets right now is important to watch. It’s no coincidence that just within a 6 month time frame that Turkey, Argentina, the time bonding market, the short (Inaudible 28:53) trade is blowing up. The liquidity flow is going the other way and monetary tightening is taking hold and stuff beings to happen and accidents begins to happen and things get more exposed, investors become more discriminating, they become less tolerant to problems. I expect more of these accidents as the months and quarters progress. The questions is how insulated or how (Inaudible 29:18) U.S economy gets impacted by that.

Yra: I think, Richard, that the world is more concerned now because they’ve seen a president or a political leader in the United States who is trying to change the entire narrative of the last 60 years anyway and their going, “wow, we really made our selves sub-servient” because of our needs for dollars but when they see the ability to use this as political leverage, I think the world is very nervous about this important piece of discussion

FRA: Yeah and finally on that relating to the emerging markets, if we look at countries with high risk for currency crisis, like Indonesia, Brazil, Argentina, Turkey, what do you make on Turkey president Erdogan and the possibility of capital controls? Yra?

Yra: Well I think that’s a great possibility. I know everybody you hear all these what I call a (inaudible 30:34) analyst who come out and that’s not going to happen because he’s a rational actor and why would you do that? I would be very careful with Erdogan. First off, he’s very good friends and very close to Mahatir Mohammed, well now he’s was back in prime minister of Malaysia, but back in 1997, 98, during the Asian contagion, Malaysia did put on foreign exchange controls in September, I believe 1998, and it actually aided them and they did it by thumbing their nose at the IMF so everybody else is running to the IMF and dealing with well we’ll borrow money from you but the IMF of course could lend playbook was raise interest rates and cut the spending to reign in the deficit so your basically forcing yourself a severe economic slowdown, Malaysia said no. They went to foreign exchange controls where they tied up money for a longer period of time and if you would do this now, I think first of all, it would cause a lot of havoc in Europe cause so many European banks are involved in Turkey then other banks because of the close ties but the foreign exchange controls are something that this global market really fears because anything that ties up, this whole market is built on the free flow of capital so a country of Turkey size with that much amount of debt, I think that will cause negative reverberation throughout the system and setup a very potential negative feedback loop as far as global liquidity and I think that could really cause problems something that you would have to watch out. Erdogan is, you know, he’s first off foremost curious about Erdogan so I think we should be very attentive to this.

FRA: And Peter?

Peter: I agree with Yra because you can imagine being an emerging market and investor in Turkey and all of a sudden you can’t get your money out. Well you’re going to sell everything you can to offset that so the capital flight from other emerging market could be rather extreme. Now Turkish government has it that there not going to go there but it doesn’t mean they’re not going to change their minds tomorrow. Yra mentioned the precedent that we saw in Malaysia 20 years ago so it would definitely cause a lot of problems and this is all related to excessive leverage, a lot of it at the corporate level, a lot of it dominated in dollar, which is not the currency they collective their revenue in. A classic repeat of this search for yield and okay give me zero interest rates then get me yield. If I can lend money to Turkey for 8%, I’ll take it. Classic search for yield that is now causing a rethink and as I said earlier, a more discriminating view. (Inaudible33:43) Investors when interest rates rise, and monetary tightening picks up.

It’s like we keep repeating this same movie over and over and over again. Just some different colours and different acts the same underlying themes. Over and over and over again in the history of financial markets.

FRA: Yes exactly and we’ll end it there. Great insight as always gentlemen. How can our listener learn more about your work? Yra?

Yra: I blog at the notes from underground and all the podcast I’ve done with Peter, and Financial Repression Authority is a good way to get the discussion out there and I’m very happy to have this opportunity to do this because I think investors needs to hear about these things that you can’t just put on rose coloured glasses and oh earnings are forever and going up and it just doesn’t work that way. Peter just reminded us that things are changing and you have to be attentive to them and whether you agree or disagree, you have to put it into your quiver and at least have the knowledge of it because when these things happen, and it’s not that there not going to happen, it’s just everything else in life is about timing and understanding it. So I just push the idea of understand it so that what you will find in my blog, notes from the underground.

FRA: Yes exactly, and Peter?

Peter: So you may read all my work at the BoockReport.com and if you’re interested in asset management and other financial planning, and you can check us at Bleakley.com.

FRA: Great! Thank you very much gentlemen! Thank you!

Yra: Thank you Richard! Peter good talk with you!

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Central Bank of Indonesia Governor:

“We know every country must decide their policy based on domestic circumstances but look, you have to take account of your actions and the impact of your actions to other countries, especially the emerging markets.

There are three global players that impact the future of interest rates and exchange rates. Now it’s only the U.S. .. That’s why the U.S. and the dollar are king. But next year if Europe starts normalizing, Japan starts normalizing, then I don’t think the U.S. or the dollar will be the only king.”

LINK HERE to the article

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FRA: Hi welcome to FRA’s Round Table Insight .. Today, we have Jayant Bhandari. He is constantly travelling the world to look for investment opportunities. Particularly, in the natural resource sector. He advises institutional investors about his findings. He also worked for six years with US global investors in San Antonio, Texas, a boutique natural resource investment firm and, for one year, with KC Resource. He writes a lot of a number of publications including liberty magazine, the MC Institute, KC Research, Acting Man, International Man, Mining Journal, Zero Hedge, Little Rockwell, Frasier Institute and many others. He is contributing editor of the Liberty Magazine. Welcome Jayant.

JAYANT: Thank you very much for having me, Richard.

FRA: Great. I thought today we’d do a focus on the plight of the emerging markets, and you have graciously come up with a number of charts that can help form the basis of the discussion. We’ll make these charts available through the link on the website. But, yeah, I wanted to focus on what’s happening in the emerging markets considering the trends in oil prices, in the US dollar, interest rates and what they have done in terms of investing in energy in particular, what they have not done is probably a better way to put it. Just wondering your initial thoughts on that to get the discussion going.

JAYANT: What happened, Richard, was that from 1995 onwards for almost 20 years, emerging … What are now known as emerging markets did grow very nicely. They have grown by about 100% between 2002 and 2012 according to one of the charts that I sent you. While this growth was an extremely good growth for the emerging markets, from the base that they were starting at, the problem is that the growth rates of the emerging markets have been falling consistently for the last 10 years. Now, if you pay closer attention to what’s happening in sub-Saharan Africa, the growth rate has fallen to only 1.4%. Now, when growth rate … Economic growth rate is only 1.4% and population growth rate is 2.8%, you actually now suddenly end up with a negative growth rate which is -1.4% per capital for sub-Saharan African.

Growth rates in the third world are falling and in case of sub-Saharan Africa it is negative now—while there is still 1.4% GDP growth rate, population growth rate is 2.8%. The net effect is negative growth rate on per capita basis.

Today, US 10-year treasury yields are inching towards around 3%. WTI crude has gone up from US$48 a barrel to US$68 today.

JAYANT: What also happened in the last 10 years was that, a decade back, the western countries adopted very easy money policies which meant that money managers sitting in London and New York suddenly found it very attractive to invest in the third world countries, which were now known as emerging markets despite the fact that the risks of emerging markets were extremely high. They invested a huge amount of money in Africa; particularly money managers sitting in London did that. This money, while superficially was going to generate good returns for them, they did not really take into account the risks associated with investing in sub-Saharan Africa. These people gave a lot of money in US dollar denominated bonds of African countries. They got a much higher interest rate from these countries, but the problem is that Africa suddenly finds itself hugely indebtness. African was indebted by only about 30% in 2005 and now it is more than 50%. The reason it was only 30% 15 years back was that multilateral agencies forgave a lot of debt that African countries owned, and these people have then, again, taken a lot of debt in the last 10, 15 years, and they’re now hugely indebted. What you also find is that a lot of this debt money that African countries raise did not go into investing in capital. A lot of that money went to deal with budgetary deficits. Then, if you pay closer attention to the investments they made in capital, you also see that a lot of that money was not invested properly which means that now that yields on American dollar is starting to increase the currency values of these third world countries are starting to suffer rather badly, and as a result, their stock markets are falling, their currencies are falling and these countries will face problems paying their debts again.

In 2005 the WB, IMF and ADB forgave debts of the heavily indebted poor countries, 30 of which were in Africa. These countries were growing very nicely during the same time. There was actually synchronous growth happening in the third world.

By early this decade, sub-Saharan Africa’s debt to GDP was 30%. This has now gone up to 50%. Given the past failures to pay, African countries pay higher interest rates. Then commodity prices started to suffer, there wasn’t enough revenue to service debts and the pace of borrowing picked up. Interest rates in the West were very low, which made it possible for increased flow of money from the West to Africa.

Fund Managers in Europe invested hugely in Africa, particularly in their bonds those denominated in US$.

Alas, this money went in to deal with budget deficits rather than in capital investment or in infrastructural investments. When money did go into capital investments, it was often squandered.

FRA: You mentioned the money managers in London didn’t look at the risks at that time, what were those risks at that time in terms of the emerging market risks?

JAYANT: The third world has a history of not honoring their debt payments, but every time there is a euphoria about third world countries, money managers in New York and London start thinking that the past is gone and the future is going to be different. Unfortunately, the future continues to be the repetition of the past which means that they keep giving money to countries like Argentina, Venezuela and countries in sub-Saharan Africa, and then the money refuses to return back to the western countries. These people including people in the World Bank, IMF and development banks around the world continue to lose money by giving too much easy money to these third world countries.

FRA: So, you’re saying the loans made during the last 10 years did not go into capital investment or infrastructure investments. It just went to pay yearly budget deficits?

JAYANT: Most of it, yes. If at all that money went into investing in infrastructure, it actually was mal-invested. There was a very interesting case of Mozambique in which a couple of billion dollars of money that was supposedly have gone through invest in government companies actually got mis-invested in good living of people in those companies. Yes, even the capital money that was invested in capital was mal-invested in many of these countries.

FRA: Given how the US dollar trend has been strengthening recently, as you mentioned, these emerging market currencies have been weakening, and so it makes it more difficult to come up with the money, with the dollars to pay US dollar denominated debt, is that what you’re saying?

JAYANT: Absolutely, and not only US dollar is improving, the problem is oil price has also been improving, so some of these countries that do not produce enough oil, actually not only have higher interest to pay on their debt, they also have to pay more money for their oil imports that they’re doing, which means that their currencies are suffering hugely.

The above means that along with falling growth rates, the third world is facing increased interest rates on dollar-denominated borrowings and are also having to pay more for oil, which can be among the biggest imports of the third world. This is happening exactly when the governments and people of the third world were expecting continual improvements in their economies.

JAYANT: I sent you some charts before our conversation started; Indian currency has fallen by more than 5% in the last few months.

The result: Oil importing India’s currency has fallen by 5% y-to-y. As the recent result of increasing yields of US$, foreign institutional investors have been net sellers of Indian stocks and bonds. This will continue exiting going forward as the days of easy money are now gone.

JAYANT: Turkish currency is in a free fall. It has fallen by 33% in the last one year.

Turkish Lira has fallen by 33% y-o-y.

JAYANT: Even Russian Ruble which has fallen fair bit despite that fact that Russia is a net exporter of oil and gas and Brazilian currency, which again, is a country that exports oil and gas fallen about 13% in the last one year. In fact, Brazil is currently facing a huge amount of problems in the country. My Brazilian friend who I was talking with yesterday was telling that his stores do not have supplies anymore, she cannot find gas anymore, she is not driving anymore in the last two weeks because they don’t really have gas at the gas station.

Brazil has lost 13% value of its currency despite that it is an oil exporting country. It is currently facing an emergency situation with truckers on strike. The stores have gone empty, vital supplies are not available, and gas stations have run out of fuel. As we speak Petrobras workers have gone on strike. Michel Temer, the centre-right President is failing to put things right.

Angola and Venezuela are failing to benefit from increase in oil price, as their exports suffer. Angola has aging fields.

As you can see in the currency graphs above, the fall in Argentinean peso, Indian Rupee, Turkish Lira and Brazilian Real has been most significant over the last few weeks exactly when US$ yields have creeped up.

Even the oil-exporting oil countries (Chad, Venezuela, the Middle East, Angola, etc.) can no longer expect oil price to continue to increase, particularly in the long term. They must restructure their economies.

FRA: Wow.

JAYANT: The hospitals have run out of supplies because truckers are on strike which means that nothing really is moving much in the country, and there is a fear psychosis that has gone into the minds of these people despite that this friend of mine is living in gated community in a nice part of Brazil. Now remember, Brazil is an oil exporting country. Despite all that, these countries, in the third world, are continuing to face problems because they did not really invest properly when the oil prices were low. Remember, they were very dependent on oil revenue, so when oil prices fell down, they did not really have money to invest back into the fields. They actually used up the profit of oil companies for other purposes; for their budgetary purposes, and now that the oil prices have gone up, the problem is that oil prices have gone up but they can’t really produce enough to generate the good cash that they were generating when oil prices were higher in the last decade. For example, Angola was producing about 1.5 million barrels of oil every day and now it has fallen quite a bit from that level. I think it’s close to 1.5 million barrels per day or even less than that today.

FRA: We essentially have a double win in terms of the oil price rising and the US dollar currency strengthening. I’ve read estimates there’s as much as 9 or 10 trillion in the corporate based US dollar denominated debt outside of the US. Is that your understanding and what will happen to this? What is the outcome or how do you see it play out?

JAYANT: Well, I don’t have the exact number with me, but the problem with corporate debt is that, if the US dollar continues to be strong and the money continues to leave the stock market of these third world countries, how are these corporate going to actually pay the debt that they owe the western countries? It will become increasingly difficult, and with oil prices increasing, inflation in the third world countries, particularly those third world countries that do not produce oil that actually import oil, inflation will kick in and the profitabilities of these corporations in the third world will suffer. The end result will be that, in my view, a lot of this money is actually not going to return back to the first world. Also, at the same time, and at least I know data of India, foreign institutional investors were huge. Net investor in the Indian stock market between 2017 and 2018, but in the last three months they have pulled out a significant amount of money out of India and the reason is exactly the same. The reason is that now is much nicer for them to invest in US dollar in North America so they’re pulling their money out of India. The consequence is not just that the stock market is losing money in India, but at the same time because India is losing US dollars, Indian currency is falling as well, and as you can see in the chart, it has fallen quite a bit in the last few months.

FRA: How are they going to address their budget deficits? It seems like it’s going to get worse, especially now with interest rates rising? The dollar rising more difficult to make loans.

JAYANT: Absolutely. I don’t know how they’re going to sort out these problems, but this is a traditional problem of the third world countries. They do not plan for tomorrow. They take as much debt as possible today and they use it up without actually worrying about tomorrow, and the western countries all consistently give the third world countries too much money without really understanding the risks involved in giving all that money. The end result is that the first world does not get its money back and the third world countries continue to suffer the problems they have historically suffered.

FRA: Now, recently Argentina ran into that similar problems and they received some guarantees or a bail out by the IMF, I think, of about $30 billion, if I’m not mistaken. Do you see that as the outcome in other emerging markets?

JAYANT: Well, look at Argentinean peso, it has fallen 40% in the last one year despite that fact that their new president is a pro-free market president, and he has been unable to control inflation in the country. He has been unable to control fall in the value of the local currency. You see the same in Brazil, the president of Brazil is a relatively low pro-market president, and the society has gone against him because he has been trying to implement relatively pro-market policies, so yes, you can actually give them a buffer again. The problem is that these societies are relatively socialistic societies; they’re culturally socialistic societies, which means that they have a tendency to always go back to normal, which is, situations in which they cannot actually pay back their debts.

Argentina continues to suffer despite the seemingly pro-freemarket President, Mauricio Macri. Its currency has fallen by 40% y-to-y.

FRA: What about the situation on the energy? You mentioned the money borrowed over the last 10 years could have gone into infrastructure improvements, especially focused on energy but wasn’t. If you can elaborate on that, how is the situation worsening with some of these, particularly oil exporting nations?

JAYANT: Well, look at Chad and Angola; they are two very interesting cases. Both of these countries have been facing fall in the export of their oil, and the reason is that when oil prices fell in the last decade from $150 to $50 per barrel, these countries because they had created government institutions large enough based on higher prices of oil, were unable to sustain the bureaucracy they had created with when the oil prices fell, the end result was that these people were no longer able to invest capital back into the fields that required capital that they must have invested in the oil fields, which means that they cannot actually increase their oil production now that the oil prices have gone up. But at the same time, oil prices are not going to go back to $150 anymore, and these people are structured to live on the basis of $100 per barrel of oil or higher, and the end result is also what you see in the Middle East, a lot of countries in the Middle East, look at Saudi Arabia, they are now in deficit situation consistently because the current price of oil despite being higher than what it was a year back, is unable to give them enough revenue to the government to deal with, to meet the requirements of the government, and they’re having to use up the money that they have saved over the last many years before the oil price fell.

As you can see while costs of wind and solar energy were the highest ten years back, on relative basis they have become cheapest sources of energy.

FRA: Could commodity prices in general go higher considering that oil is at the apex of the commodity stack, if you will? Could that happen even with the rising US dollar?

JAYANT: Absolutely. Commodity prices can certainly rise higher, but commodity exporting countries have basically … Is still not have to feel confident about being able to benefit from higher commodity prices because when commodity prices go up, the cost of producing commodities tend to go up as well because some of the costs of making commodities are costs like oil and other commodities. But also, if you look at what’s been happening in most of Africa, while commodity prices might have gone up, they have actually increased their taxes and they have made it extremely difficult for mining companies to profit from investing in Africa. I’m talking about virtually every country in Africa. The end result is that African countries have become very difficult countries to invest for mining. You see problems in Ghana, you have always seen problems in Zimbabwe, you have increasing problems in South Africa. Unfortunately, even if commodity prices increase, these countries are very likely not going to benefit from that.

FRA: Could we get a situation where with the rise in the interest rates in the US dollar, could we see a potential situation given the plight of the emerging markets whereby there’s an inflow or international capital flows from the emerging markets to the US equity markets in particular given rising interest rates not being good for the bond market. Could we see that similar to what happened in 1927 and 1929 where interest rates also went up and the US stock market also went up? This has been pointed out observers like Martin Armstrong, for example?

JAYANT: I’m not sure what influence it will have on the US equity market, but I certainly see, before our conversation, I was looking at the increase in yields, and it seems to me that part of the reason why US yields have gone up is because the yields have also gone up in the US, which to me is a signal and a symbol that US economy is likely becoming more competitive, and I can see the reasons why it is becoming competitive; regulations are going down in the US, the tax structure and as a result I would not be surprised if equity prices in the US actually continue to improve. If American companies can bring in money from outside the US; if regulations go down and the corporate tax continue to reduce and the filing of tax requirements continue to become less stringent.

FRA: Finally, what are your thoughts on where can investors protect themselves in this environment, or what makes sense in terms of generic asset class for investors?

JAYANT: Richard, I continue to like East Asia: China, Hong Kong, Taiwan, Singapore, Korea, Japan. These are very good stable countries that continue to grow, and there are places where a stock market tend to be rather cheap. I like these countries to invest in. I like gold because the third world countries across the border are suffering and wealthy people in the third world will continue to invest their money in gold. The end result of which is that gold prices will perform going forward. Remember, gold prices have done very well in the last 10 or 15 year timeframe in the last 10 years in US dollar terms, gold has gone up by more than 100%. I continue to feel reasonably good about what’s happening in the US right now.

FRA: Well, great. That’s awesome insight JAYANT, and thank you very much for the charts. How can our listeners learn more about your work?

JAYANT: Everything I do goes on my website, which is Giantbhandari.com.

FRA: Thank you very much Jayant.

JAYANT: Thank you very much for the opportunity, Richard.

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FRA: Hi. Welcome to FRA’s RoundTable Insight .. Today we have Charles Hugh Smith. He is an author and leading global finance blogger and America’s philosopher – we call him. He’s the author of nine books on our Economy and Society including A Radically Beneficial World; Automation, Technology and Creating Jobs for All, Resistance, Revolution, Liberation: A Model for Positive Change and the Nearly Free University in the Emerging Economy. His blog oftwominds.com has logged over 55 million page views and number 7 on CNBC’s top alternative finance sites. Welcome, Charles!

Smith: Thank you, Richard! Always a pleasure to join your program.

FRA: Great. I thought today that we’d do a discussion on what you actually wrote about recently: the tension between the public sector and the private sector. In particular, between public pensioners and the population that pays for that – mainly in the form of property taxes and other fees. This is happening all over North America – this growing tension. Likely to result in a growing pension crisis across the continent and also globally too. This is a global problem as well and just wondering about your thoughts initially on that from your recent writings.

Smith: Right. Thank you, Richard. I think it has been a topic that has that has been suppressed by the mainstream media because there is no easy solution. In other words, the authorities in charge of the pension funds have tended to down-play it by claiming they’re going to make it up from very high returns on capital and other kinds of peen less means but the reality that is now becoming visible is that the public pensions have to be funded at rates that require the cutting of public services. So, there is a seesaw here – that the more money that is put in to the public pension funds to build up their capital to minimum levels then the less money there is available for public services. It is a win-lose situation or a zero-sum game. You can’t find money for both. As the asset bubble economy that we’ve been living in for decade normalizes, or perhaps even declines, then this is really going to be a case where many municipalities and counties are going to be proverbial as time goes out and we’re going to see who is naked.

FRA: Yeah. I mean many of them have built-in assumptions of trying to get 7% to 8% yields in order to make stakeholder obligations but, as you know in financial repression, the repression of interest rates to low values has made it difficult to get yields. A big part of their holdings has been bonds. So, as yields have gone down, it has been made really difficult for the pension funds to meet their yield goals.

Smith: Right. And what has been their response? If you’re one of the fund managers, then you’re piling in to the FANG (Four High-Performing Technology Stocks) stocks, right? Piling into Apple, Facebook, Google and Netflix as the only way to get those kinds of huge returns that are required to keep the funds solvent. We know what happens. These FANG stocks are a tech-bubble that we’ve seen before in 2008. These pension funds are exposing themselves tremendous risks that are way above that of buying a 30-year treasuries or AAA rated corporate bonds, which is as you say, the normal haven for their safe positive return. They’re exposed to a lot more risk so they could end up suffering tremendous draw downs if bond yields continue to rise as we know the value of the existing portfolio on bonds declines accordingly. If the FANG stocks rollover and decline, then that’s going to hit a lot of these pension funds have counted no technology companies to make up for the low yields that you have described.

FRA: Yeah. There are already warnings on that in terms of what could happen otherwise or what could be their response. For example, the Ontario Municipal Employees Retirement System (OMERS), which is actually Canada’s largest defined benefit pension plan with about $95B in net assets. They actually put on their website that deficits will be funded through a combination of contribution rate increases and benefit reductions. They’re already warning that either they’ll be likely much higher property taxes or a cut in benefits to the actual pensioners.

Smith: Right. And maybe we can put some numbers behind these statistics and dynamics that we have been discussing. I have a couple of charts here that I submitted to you before we started recording and the first one shows that the taxpayer contributions into government pensions and that means public sector pensions has more or less doubled in a decade from $60B annually to over $121B and that is skyrocketing. The rate of increase is far above the rate of growth of the economy. In consequence to raise these sums, then municipalities, states and cities are raising property taxes and I have a chart here of King County which is in the Seattle Municipal area.

The property taxes there are up 43% in four years. Anecdotally, I just heard someone report their taxes in the Seattle area went up 26% in one year. That may have been local taxes on top of the other property taxes but 43% in four years, that’s more than 10% annual gain there. Most people’s wages have gone nowhere and I have a chart here that is dated a few years but nothing really has changed and it shows that the bottom of 90% when adjusted for inflation, the bottom 137 million households in the U.S. have lost income when adjusted for inflation.

So, the vast majority of households that are property owners are not making more net income here. They’re having to cut their other spending in order to pay skyrocketing property taxes.

FRA: Yeah. Exactly. You also have some other charts in here as well on how, on the other side of the fence, the government pensioners have been paying themselves very lavish pensions – awarding themselves which actually only makes the whole problem worse.

Smith: Right. This was a chart from a Sacramento article regarding the Sacramento area’s fire department’s highest paid pensioners and a number of these people are earning over $200 000 a year in pensions. A $200 000 income will put you in the top 5% of American households.

In other words, this is an extraordinarily high income and the number of pensioners in the state of California that earn over $100 000 in pensions annually runs into thousands of people. There is a sense here of great injustice. In other words, the majority of people who are paying property taxes have not seen their income soar by these extraordinary increases that these property taxes are going up by nor do they have pensions in a 6-figure range. So, it feels like exploitation to those of us who aren’t looking for $100 000 – $200 000 in guaranteed pensions. What this is doing is creating huge gaps in pension funding. I have a chart that shows an $18B gap in Calpers which is the largest of pension fund in the state of California.

We also see here that we have a chart of New York City pension contributions which soared from about $1B annually around the year 2000 and now it is pushing $10B.

So you’re talking about a tremendous increase and the rate of increase continues. In other words, this isn’t just a one-time bump up and then the pension contributions stabilized. They continue to rise at these rates that are four or five times the growth rate of the economy as a whole and also of wages. Before the program, you mentioned that if we extrapolated these trends, where would we end up?

FRA: Yeah. I mean in your recent writings, you mentioned that the migration to lower tax jurisdictions. Like when somebody is living in Illinois, they may move to Florida. Can you elaborate on that?

Smith: Right. Right. Just to kind of set a context here. The context of what we’re describing is that cities, counties and states are under legal obligations to fund these pensions at the rates that were promised to the pensioners and the only way out of those legal obligations is bankruptcy and many states have unclear laws regarding municipal bankruptcies. In other words, cities and counties in many states do not have a clear pathway to declare bankruptcy and the only way they can raise money to fund the pension plan is to cut public services. You’re hit with the double whammy. In other words, your property taxes and junk fees are rising rapidly. Meanwhile, your library’s hours are being cut, your police departments are being cut and the roads are filled with potholes that can’t be filled unless you pass a special bond. These places that are being crunched by these pension costs – the public is seeing a deterioration in their lifestyle. The local infrastructure is crumbling and there is no money to fund it because all the money has to go to the pensions. I call the people that are stuck in these areas tax donkeys because they’re loaded up with ever higher taxes and it is difficult for them to escape in many cases because of many reasons: kids are in school, family obligations, can’t quit their jobs, etc. So they’re really stuck but there are a very large number of people who tend to be high-income and are mobile. They can leave. They either are childless or their kids have already left home. They work largely in the digital realm so they can work from anywhere. These people are going to migrate and despite the claims of the status quo of politicians in these high-tech states like California, Illinois and New York that people don’t leave. They don’t leave if the services they’re getting keep increasing in quality and quantity every year. In other words, the past is not a good guide to the future because we’ve had an asset bubble based economy for the last decade. So, municipalities have been scoring huge gains in tax revenues which has allowed them to maintain services at a very high level and fund the pensions. Once there is a recession, that goes away then the public services are going to be slashed. So, people like New York City, San Francisco and Seattle but at some point, as homelessness overtakes their neighborhood, homeless encampments show up in their block, crime starts going up, property crime and theft starts going up, and all of that stuff. Good restaurants close because the taxes are too high for them to survive. All these reasons to stay in these high-tech areas vanish. Literally over night. We’re starting to see anecdotally articles from people saying why they’re leaving their cities, for example, Seattle. We’re seeing more and more of these so migration is difficult to track. We know that there is a leakage of population from California and other cities but what is not being captured is the nature of the people who are leaving and I think that if we could dig down those statistics, we’d find that it is the most productive in terms of paying high taxes. It is those people who are leaving because they are the ones caught in the vice. The people who are staying or who are left behind are the less productive or the people who make less money, pay less taxes and absorb more of the government’s services. We can discern a very destructive feedback loops starting now. This feedback loop will only get stronger as we finally get a recession in which the high tax payers are leaving for low tax claims and leaving the people who are depending more and more on the government’s services which are going to be slashed.

FRA: Right. It seems to be an emerging negative feedback loop as you’ve mentioned that is actually non-linear as these more productive citizens leave, then the ones that are left behind are burdened even more to make up for the loss. So it just gets worse in a non-linear way.

Smith: Right. I think that is an excellent observation, Richard. When we think about small-scale entrepreneurs that make cities livable and this includes restaurants, cafes, small theatres and services for the children and elderly and all of these private sector niceties are going to be under tremendous pressure as their customers flee. So they start closing or those people that try to start a new café or restaurant quickly find that they don’t or won’t make enough money to survive as their tax rates go up. I personally am in communication with a lot of people through emails throughout the U.S. where they’re small businesses and they’re noses are just above the waterline. In other words, they’re staying afloat but just barely. There is a huge number of businesses like this that create that non-linear effect that you’re saying. In other words, if property taxes go up another 10% and a recession causes a 5% decline in consumer spending in a city or a county, you’re not going to see a 5% decline in small businesses. You’re going to see a 30-40% decline. That is a huge impact because there are so many people that are right on the borderline. Of course, we can also throw in other factors in which we can be fans of and we can support minimum wage laws and these kinds of things but they’re accumulative. For the small business owner, it is like the property tax, any other junk fees and then the minimum wage increase, and then the higher health care. Each one seems to be something we believe could be absorbed but when you add up 10%, 10% and 10%, then suddenly you’ve got increases of over 40-50% in their fixed expenses and they can’t survive. I think you’re absolutely right that there is going to be an enormous non-linear effects as these feedback loops eke into the class that pays most of the property taxes.

FRA: And the idea that the pension benefits could be cut. What do you think of that? That alone could cause a lot of social unrest, right? – in terms of people not accepting that or not willing to accept those cuts.

Smith: Right. Well, we’ve seen some examples like the city of Detroit where there was a successful municipal bankruptcy and pensions were cut, what was actually sustainable with the existing pension fund? Of course, that created a lot of unhappiness in the pensioners who felt that they have been promised “X’ and were given half of X. On the other side of the coin, in regions like California, Illinois and New York that are dominated by public unions then the war that is heating up would be first from the public tensions and the public employee’s unions versus the tax payers and in the current arrangement, the taxpayers have very little representation in the local government. They don’t really have a voice. The unions have the political influence so they’re going to fight tooth and nail to keep the pension structure as it is. I think it will require a political crisis, either a tax revolt of some kind or the complete disappearance of all cash where the cities and counties simply no longer have any money. Their accounts have been drained and have zero money to pay people. Until that point comes, then I doubt that the status quo would change. I have a chart here based on Peter Turchin’s work about the disintegrative forces and he identifies integrative eras where people find reasons to work together and disintegrative areas where they find reasons to disagree. He plots this on a political stress index. This is what he calls it. So, what we’re talking about here in the public pension and private sector versus the tax donkeys, we can see the three of the key dynamics that Turchin identified at his work: One of is the stagnating real wages. As I said, for 90% of the workforce that is getting nailed with higher property taxes, wages have not gone up in years and maybe decades. Overproduction of parasitic elites and I think that whether you want to call the parasitic elites public or private, I would lump them all together. People pulling down enormous salaries at the expense of other people – that I think, no matter how you want to describe it, I would call that an overproduction of parasitic elites and the deterioration of state finances. We see that counties and cities have and are struggling now in the second longest economic expansion in history. A tremendous expansion in stock markets and housing values and this is the best of all possible times. If we’re seeing cities and counties struggle with budgets now, then you can imagine what happens when we finally get a real recession. Clearly, we’re seeing point 3 to deterioration in state finances. This dynamic that we’re discussing is definitely increasing the political stress index and it is definitely going to create severe structural, social unrest and social discord.

FRA: Yeah. Exactly. This is very interesting on Turchin’s disintegrative forces. There’s also that idea that as property taxes go higher, we begin to wonder whether you own the property and the concept of property rights comes into question. Is it the government owning the property and you’re just renting the property from the government when property taxes get so high? Your thoughts on that?

Smith: Yeah. I think that’s a great topic, Richard! Before we started recording, you mentioned the model that goes back even to the Roman era when Rome suffered these disintegrative forces that Turchin describes in which people simply abandon their properties. They walk away from it because the taxes are higher than they can afford. The property has lost its value because of this tremendous increase in the tax burden. In my view, places like San Francisco, Seattle and New York (Brooklyn) and a lot of other places, people have tolerated these rapidly rising property taxes because their homes have gone up so much in value. In other words, you’re talking about Seattle – a $500k house a few years ago is now $800k and we see these numbers. So, when you feel like you’ve made $300k in five years or less then you feel like you can afford another five thousand dollars a year in property taxes. But if that $800k house drops to $400k in the next recession, then all of those people are going to suddenly start feeling that it is not so easy anymore to make those taxes. Even more recently than the Roman era, there have been times where cities have gone into decay and this feedback loop that we’ve described and Detroit being a famous example, the value of houses fell to zero. Well, that is an extreme or caused by an extreme depopulation and so on but we have to remember that we’re not talking just about the total value of the home, we’re talking about the home owner’s equity. So, if somebody buys a house for a half million dollar and it drops in value into $400k and their entire equity is forty thousand, they’re now under water by twenty grand. They can walk away and they’ve lost nothing. So, it depends on the debt burden that each of these home owners has taken on. That’s how we could see that even these high value cities start having people jingle mail their mortgage because the property taxes are pushed to fifteen and twenty thousand a year. That’s just a standard in Northern California and many other high value places. As you mentioned before we started recording, there was a news report that one of the branches of the federal reserve suggested a one percent wealth tax on all homes in Illinois to resolve their pension crisis.

FRA: Yes. Exactly. Already I know someone in Illinois paying about 3.3% in property taxes. So something about fifteen thousand dollars per year, over a thousand dollars a month on a house that is approximately $450k in value. To add another one percent on that is a suggestion by the Chicago Federal Reserve to add a proposed one percent on property annually for the next thirty years to cover the pension crisis problem in Illinois. That was just recently proposed by the Chicago Federal Reserve.

Smith: Right. So that one percent – the additional $2500 a year – you can imagine as in a recession, there’s even more as we say in tax revenues start drawing up. The public starts rebelling against the cuts in public services then there’ll be another one percent suggested, then another one percent. This is a dynamic that you’ve mentioned earlier program. We can see the feedback loop here that as tax revenues decline in a recession then they have to raise taxes on those people that are remaining who can’t afford to pay those taxes. Another little dynamic here is that rents in places like Seattle are skyrocketing as well and from the property owner’s point of view, if their property taxes are going up by 10-15%, 20-25% a year, then they feel that there is no option but to raise the rents that they’re charging on their properties. It doesn’t just hit property owners. It eventually bleeds over and hits everybody in a municipality: renters and owners alike.

FRA: It’s interesting when you mentioned how the property values in Detroit went towards zero, this is also been observed by Martin Armstrong who sees Illinois following the exact pattern as the fall of the city of Rome during the Roman Empire era. What he mentions is that more and more people just walked away from their property. There was no bid. Illinois is the number one state that now has a net loss of citizens; people that are fleeing the state. Martin Armstrong writes that there absolutely no hope whatsoever in fixing this problem of a pension crisis in Illinois and every solution like the one from the Chicago Federal Reserve we just discussed will fail in the end. Martin mentions that the state also has colas? (30:24) which insanely increase state employee pensions by an automatic 3% annually regardless of the inflation rate. That’s how crazy things have become. Martin also writes that because Illinois does not have its own currency, it is then bound by the national international value of the dollar. Like Greece, if the dollar rises, Illinois is thrown into deflation. Its institutions are broken and will only be remembered by history. When you plot the actual population of Rome when it emerged, it is very interesting and the stock reality that applies to Illinois is that people could no longer afford to live there. They were forced to just walk away from their homes and the value of real estate went to zero. That’s what Martin writes from the analogy of what happened in history with the city of Rome. One thing to think about in that model is that ultimately, every government or state function, whether it be a city, county, state or federal, the government depends on the private sector to generate the jobs and the income that can be taxed to support the state and its employees. As a general rule, the government in the U.S. is surrounded by 20% of the workforce. It depends on the other 80% of the workforce to generate the taxes to pay the 20% state employees. If you strangle your private sector to where it is impossible to make money, it is almost impossible to start a business that is actually profitable. What happens is that you end depending more on a few large employers. The way that Seattle used to depend on Boeing and now it depends on Microsoft and Amazon. What happens is that these large corporations are also mobile. They are the epitome of mobile capital. They don’t need to stay in these high tax areas. They can leave. They can keep a sort of a façade corporate presence but they can move the 90% of their workforce elsewhere in the U.S. or in the world. Once you become dependent on these very large employers and they move, then your city is absolutely gutted. You go down the Detroit path. Detroit became far too dependent on one industry and a handful of corporations and I see this as extremely likely that Seattle and the San Francisco Bay Area are dependent on these leaders in the tech industry. Once they go away or move elsewhere, then the tax base is going to be cut tremendously because those are the companies that are creating the high income jobs that allow people to buy these over priced homes.

FRA: Ultimately, you see sort of a combination of that with brain drain and wealth drain.

Smith: Right. Exactly. The demographic, we didn’t really talk about this much, but as we know, millennials as a generation are already burdened with tremendous student loan debt and compared to previous generations, their earnings in their 20s and 30s is considerably lower than what was achieved by Generation X and the Baby Boomers. That question comes down to whether the millennials want to marry and have children, unless they’re both brain surgeons or CFOs of a company about to go public or somebody earning extraordinary amounts of money like a quarter million dollars each, that dream is not doable anymore in a lot of places. In other words, they can’t marry and have children, have a decent life and buy a house. Generationally, what we’re going to end up with is that we’re hallowing out these very high cost houses and we’re leaving the baby boomers and people that bought their homes long ago with a lot of equity but we’re putting a lot of incentive for younger families and households to leave because that’s the only way they can afford to buy a house and have a family.

FRA: Wow. That is great insight today from Charles on emerging pension crisis and the growing tension between the public sector and the private sector. Charles, how can our listeners learn more about your work?

Smith: Yeah. Please visit me at oftwominds.com and thank you very much, Richard! Always a pleasure

FRA: Great! Excellent. We’ll end it there and do another one next month.

By Karl De La Cruz

karl.delacruz@ryerson.ca

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.