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08/22/2019 - The Roundtable Insight: Charles Hugh Smith on Advice for Millennials: Low Cost Education, Affordable Housing and Where the Jobs Are!
07/31/2019 - The Roundtable Insight: Caroline Miller and Yra Harris on the Global Economy and Financial Markets
Richard: Hi, welcome to FRA RoundTable Insight. Today we have Caroline Miller and Yra Harris. Caroline is currently BCA’s Chief strategist Global strategy since joining BCA in 2012. She has had a cross-functional roll to both contribute to In-Shape the Global Research view while communicating this message to BCA clients at an executive level. Prior to joining BCA, she’s been 20 years as an Institutional Global fixed income asset manager, and Yra is a hedge fund manager, global trade, currencies, bonds, commodities, and equities for over 40 years as a floor trader. He has also served at CME director from 1997 to 2003. Welcome Caroline and Yra.
Caroline: Thank you.
Yra: Thank you, Richard
FRA: Great, I thought we’d begin with what your current global macro themes are, Caroline, at BCA research? If you can take us around the world in and what your views are at the economy level and the financial markets level.
Caroline: Sure, I’ll just start by saying that we see quite a divergence paths in in pricing. Bond market seemed to be at to have a very pessimistic view of the outlook for global growth and yet equity desert are close to recent highs and seem to be benefiting from low rates, but I was interpreting below, complex of interest rates as such an omen for the outlook for the business cycle. We think that that diversions will be resolved by a pickup in global gross into the end of this year. Certainly the manufacturing sector is weak and pretty ubiquitously so it’s as a vertically integrated component the economy, but if you look at the more domestic service areas, for example, of the US economy, it seems to us that it’s Gross still ticking along at an above trends pace and course US economy is a little bit less exposed to global trade then Europe and Asia. We see a lot of the weakness and Global manufacturing as coming out of China and and that this trend really predates the escalation of hostilities in the in the trade sector has been exacerbated by that but really you can trace the recent slowdown and go to manufacturing to type policy in China from a couple years ago that has slowed a fixed asset investment. They’re deliberately I think to a certain extent to control the pace of leverage growth are but the impact has been a reduction in China’s demand for resources and capital goods know that’s a large part of their import activity and that’s had a knock-on effect on Japan, and Europe, and you know most of global trade but we see the recent easing and financial conditions and also likely stimulus from China because it’s be no it does it suits them to prioritize deleveraging and containment of speculative risk when the economy strong, but we see them pivoting to a much more reflationary policy that we expect to manifest in the second half of the year. So we see global growth stabilizing and picking up and I think by the end of the year, the outlook for global growth could look a lot brighter than it does today.
FRA: And Yra, are you seeing the similar trends from your perspective?
Yra: (inaudible) I think the bond markets are so badly distorted by Central Bank action that it’s hard for me to know what the impact they are telling me because of the national arbitrages. So, you know, I don’t go deep into data I’m searching for the geopolitical uncertainty. (inaudible) There is so much pressure put on global rates, especially the long end, because people are searching for yields where ever they can. (inaudible) I think that geopolitical uncertainties are increasing dramatically, and the uncertainty is whether to slow down the capital expenditures and I don’t its because of the trade I think it’s because of other things and the way that they’ll play out, of course. (inaudible)
FRA: And to what extent does your research, Caroline, factor in like Central Bank policies, monetary transactions, monetary policy, fiscal policy into the views that you come up with in terms of the global economy in the financial markets?
Caroline: Well, I would certainly share with Yra’s assessment of the fact that uncertainty is a big feature of the landscape today. And I think you can see that in the global turn Premia that are so unprecedentedly depressed partly as a result of Central Bank intervention, but if you think about what the term Premia embodies, it’s a measure of expectations about inflation and the volatility of inflation, and the volatility of gross. And so I think that uncertainty is has driven a lot of flows into the perceived safety quality government bonds. I think there’s no value in those markets. I think it’s a term premium to wear at a more normal level relative to history than the yield curve would look a lot more like it has in the past. And so I would agree that the signaling mechanism from the curve isn’t what it would it has been but I also think that mean if you think about the fed’s mandate, their mandate is to try to sustain full employment and their statutory definition of ability for you know, most of the time or as much of the time as possible and send the FED’s mandate expanded in 2012, not just to include full employment, but also this inflation target, you know, they haven’t met that. They have not defended the lower bound of that inflation targeting. So I think that’s.The reason that they are most likely tomorrow going to cut interest rates because they are they’re concerned about a lack of attitude based on the fact that interest rates are so low, I would say though that if if it were the case that interest rates were at a distorted low level relative to what you know, the supply and demand for credit then inflation would be a lot higher. So there’s some element of the low term structure of rates that is a reflection of a slower growth environments. I think it could turn out that in fact the US economy is more resilient (inaudible) hindsight we could look back. And they didn’t that monetary policy had been loose for too long. I don’t think that’s a story for now or or really the next 6 to 12 months that’s a story for a couple years from now. But the fact that you have coordinated Central Bank set of signaling in a fairly coordinated fashion the need to support growth and aggregate demand by continuing to keep rates low is partly in response to the political uncertainly, there is no question, but I think that people are ignoring the very high likelihood that the Chinese economy is it is going to turn around as a result of a fairly reflationary policy there. And so that’s Billy’s roof for a positive growth surprise, but I do concede that geopolitical risk is elevated.
FRA: And your thoughts Yra?
Yra: No, I is it just you at least I think that’s the trading the Chinese I think bought that doing certain things because, for the last at any time, he’s been on the cusp of the downturn, I think the Chinese have stepped into the global void and certainly ramped up from where they sit right now. So there is they are they tighten does is trying to talk about in their own methodology last year and it and it has slowed things down and I think you’re getting, you know, there are some people following who are following Trump, because if you look at the Japanese pushing on the South Koreans to the South Korean numbers that turn down, the Singapore numbers are weak. I think those indicators to whatever changes are going to be taking place when we start to see those started to shift and right now. They haven’t they still alive portending in pointing to some weakness. Now. You haven’t gotten to Europe yet, which is problematic in many ways and the fact that you know, I think well, I won’t open up your up until we’re ready to but you know, I I don’t I don’t disagree with that. I just didn’t you know, it’s more than a course interest rate Cuts. There’s that were talking about here. So where we go from here will be critical. And again, with them said tomorrow, I heard an interesting discussion about an hour ago on Bloomberg Radio. They were talking about the possibility that the feta and quantitative tightening tomorrow. So you get 25 basis-point cut – an end to the tightening immediately rather than waiting until September 30th, which gets you to get you almost in my estimation then almost at 37 and 1/2 basis point cut. So Powell will be able to shred the needle on that boom. (inaudible) If Europe really continues to slow, it will put some pressure on Germany for some fiscal stimulus.
FRA: What are your thoughts, Caroline, on Europe? Especially the interplay between what’s happening in the UK and the Euro Zone in terms of monetary, policy fiscal, and the relationships between the two.
Caroline: So I continue to believe that Brexit is in a European issue, but it’s Britain’s problem. I think that it’s convenient but erroneous to do a tribute to weakness on the continent terms of growth president. I think it has a lot more to do with global trade. I recited Singapore Japan and Korea exports slowing. I think a lot of that is related to China if you could say the same thing for Europe, but Europe’s also had some idiosyncratic, you know, domestically sourced headwinds unimportant won. Last year certainly was the election of the populist government in Italy that caused the riot and bond markets and doubling of interest rate there. Well, you know that tightening in financial conditions was with Thursday problematic positions and has since really completely reversed and if you look at some of the floor. If we look at the data, you know, Italian non-financial corporate credit growth on a second derivative basis is it looks like it’s starting to turn around in a very early statement. I think the ECB is as concerned about tighter lending standards in the area and they absolutely want to see more credits flowing to the private sector ,and I think you’re going to see that it’s a high chance that they reinitiate after asset purchase program via by more corporate bond, but I think if you look at France the consumer sentiment data is improving, and I would agree that overall the economy looks very weak. But again if you start to see a pickup in China, I think that will have a knock-on effect on Europe’s export sector. I think you need to see the effect of the recent drop and bond yields later in the year. And I absolutely agree. That fiscal policy is the big elephant in the room and it’s interesting. I think Europe doesn’t have a lot of monetary space left to ease rates are obviously already negative and that’s problematic for the European Banks profitability. European banks are a big part of it, but they do have a lot of physical space and I think it’s sort of the opposite of the U.S. where in the U.S. is a high-yield market. The short rate is it to 2 and 1/4 there’s room to cut. Yet fiscal policy in the states is going to turn out to be kind of maxed out. So if that’s how we see the policy landscape between the two I think over the coming year, if you look at the overnight index swap market, you’ll see that that investors expect the ECB to ease by 22 basis points over the next 12 months and the FED to ease by close to 90 and I think that it’s going to turn out that the FED does less than that and Europe may ratify the market expectations. So we see the spread between billings and treasuries possibly narrowing over the coming year.
FRA: And your thoughts, Yra, especially with the UK as a potential repeat of what happened during the financial crisis with a weakening pound sterling currency?
Yra: Yes, I think I’ll take a different view on Brexit. Not that I am worried about Europe, I just think that the negative aspect of the way that the market is viewed, the whole Brexit has just been wrong. And I think the weaker the pound sterling gets – easier it is for the safety valve and the pressure release for the UK because that’s the advantage of Britain has. The currency will go down, we are almost at 92 on the euro sterling cross today, but in the same vein where the German stock market really go whacked, maybe half percent, maybe .4 points not much for the gilt market has held up beautifully. So if you’re telling me that there’s going to be an absolute financial crisis in Britain due to a hard Brexit, I’m just not seeing it in the financial instruments and I will say that is actually genuine relative to what takes place in the European sovereign market because we know that the bank of England has not bought any QE for a number of years. I think they halted at 475 billion just after and they are not rolling it. If it rolls off, they renew it so just the numbers don’t change but it’s still reflects that people are buying gilts. And if I was worried about some type of really financial calamity some of the hard Brexit meaning of private investor doesn’t buy gilts, I understand that the banks are buying gilt but in Europe, would you really buy a French oath for negative 15 basis points?
It just pure insanity. And I know I know that they go up in value because European Central Bank ensures that they go up in value. It is really a difficult situation in Europe and even more so because of me what the Central Bank you email Richard I’ve been on quite a bit with you, I am not a Mario Draghi fan because I don’t worship the author of loose money driving asset prices. That’s not the game that I play. I think he’s been very dangerous, and it gets more and more dangerous. This is actually an article that we haven’t seen in years. But in the today’s FT by Clair Jones, the piece on the German Court hears AT&T CD bond-buying again and the name of the plaintiffs in the case. The number is 2000, so there is a lot of unhappiness and I’m not sure the way that that is totally going to play out. And I’ll say one more thing about Europe. Between the president Macron and Angela Merkel, Donald Trump is going to make their lives miserable. And as soon as he turns to the tariffs on China going to try to just stir the pot as I would say is easy always you like to do for the pot and will start to record some more conversation towards terrors, which would certainly will not do this. Well, we’ll see how they respond.
FRA: And Caroline, your thoughts on what Yra see?
Caroline: I’m not sure that it’s going to be in Trump’s interest to expand escalate and proliferate is trade conflict the closer we get to the election as we’ve already seen from the CEO round tables in the states that political uncertainty around trade policy does have an impact on capital spending intentions. The closer we get to the election the more business sentiment I think becomes relevant for him and to the extent. It’s clear that interest rates are very low, and if you start to see the typical, but domestic sectors of the US economy performing well and the more globally exposed actors doing poorly because of this concern about trade conflict. I don’t see how that that that lines up with his incentive structure. So I think Macrone is has actually defeated the yellow vest movement. I would just in France. Very clearly that that roar has slowed to a whisper and I think he’s going to get through quite a bit of needed structural reform there. I think in Germany, ironically the more weakness you see in Germany proper the higher the odds that they also abandon this obsession with some with balanced budgets in and it increases the odds of some physical stimulus. As far as Brexit goes, I agree every day that you see the Pound Down you see the relative performance at the ftse 100 which is the large cap multinational index which basically has very little to do with the British economy. But a lot of English domicile firms outperform the ftse 250 which is the more which is the index with the more domestic firms in itself. Is it very clear relationship between the ebon flow of Sterling and those two indices? I think about the uncertainty related to Brexit on a Continuum and a part of that is because I grew up in Quebec which had its own separatist movement for years that also involve to referenda that never actually, from a statutory perspective, was passed. But the drain on business sentiment confident talent and capital from The Province over the last generation is very clear to see and it is no cause to center of Canada finish leadership from Montreal to Toronto and I think the longer this issue stemmers or boils in Britain without resolution the worse it is physically for a country that turning a 4% current account deficit.
FRA: Just running out of time here. But the last question. Yeah, you mention, Carolina, and your global macro and market Outlook that Europe that populism repeat review dated physical austerity more than it has stoked Euro skepticism. And Italy is prioritizing growth over deficit-reduction. Can you elaborate on it?
Caroline: Sure! I think if you look at the polls in Europe on attitude toward EU membership deals support for the Euro area as a as a club is actually pretty strong and it’s what most of the anti-establishment parties the source of their support. Is there their criticism of the parties that have heated to the demands from Brussels for balanced budget? So I think what you’re seeing is more rejection of fiscal austerity then a big statement any individual. Not talking about the UK. But it really thinks that their world and their citizens and their standard of living would be better outside the earlier than inside it. If you look at Italy is an example of the Lega Nord a and the Five Star movement in this coalition government, you know, they really haven’t been champ exiting the area they have just stood up to the demands from the EU in Brussels that they balance their budget and actually I think won that argument. The rules around excessive deficit procedure in the finding that they could technically be subject to, because they’re in violation of the Maastricht treaty, haven’t been invoked. I think that’s a tacit acknowledgement that a country can only service debt by knowledge that they have it. If they’re growing and they grow. If the private sector is in leveraging mode andso in the public sector is as well and slowly, but surely, I’m more permissive attitude for some deficit spending to help support those economies. And I think you know that is the bigger issue than then, you know, wanting to be outside the EU. It’s really just a push to acknowledge that fiscal austerity is to the stationary and I think you’re going to see more of that.
FRA: Interesting. And Yra, your thoughts?
Yra: Well, if I would certainly push back on that because I’ll look to ramp up the deficit he was met with the threats and find some glasses. And I think that the threat is there and had a lot to say that Macrone would like to do that for France’s up against the limits to fax their numbers on our 90% and says the budget deficit as percentage of GDP so you can’t get away from these. So yes, if you relinquish all those I agree that there are two things that can make me very bullish on Europe: the creation of a harmonized fiscal authority coupled with a Euro bar, which is why I think they course, they put the garden because they’re going to try to hold the whole ECB balance sheet into a Euro bond. Europe is already built on the capital of fee, which will be critical to that process. But I think we’ll ways from that and I think the Germans have not been heard from yet as to how they’re going to feel about this because again, they do have that amendment or the statutory law about a balanced budget. They have been running all budget surpluses, which Caroline notes, gives them the flexibility to increase physical spending which would help all of Europe. So I believe that Macrone goes to sleep at night and prays for recession in Europe and that euro per say, in Germany, especially, that export sector turns down and then gets forced into a situation where they’re going to start to expand the deficit spending which one aid all of Europe but I just don’t see it on the rise to yet. I hope I’m proven wrong because Europe needs some reprieve some of the ridiculousness that they embarked upon, but I just see it. Germans are getting angrier
and as you can see this weekend, Merkel, which phone is trying to take advantage of. So, we’ll see how it goes.
FRA: Okay great insight and perspective. I guess we’ll have to end up here, Thank you very much both of you – Caroline and Ira.
Caroline and Ira: Thank you. Bye.
07/16/2019 - FRA – The Roundtable Insight – Charles Hugh Smith on the Market’s Obsession with the Federal Reserve
FRA: Hi, welcome to FRA’s Roundtable Insight .. Today we have Charles Hugh Smith: America’s philosopher, we call him. He is the author, leading global finance blogger and he is the author of several 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 and the Emerging Economy.” And recently, “Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic.” His blog OfTwoMinds.com is one of CNBC’s Top Alternative Finance Sites. Welcome Charles!
Charles: Thank you Richard, it’s always a pleasure!
FRA: Great, I thought today we do a focus on the Federal Reserve. That’s been in the news, you know, quite heavily in recent weeks and even today, we are talking on Wednesday July 10th here.
Just wanted to do a focus on how everybody has an obsession, the market itself has an obsession with the Federal Reserve as being essentially the sole driver of higher valuations. You know, is this healthy or not? It is essentially financial repression taken to an extreme. I just did a podcast yesterday between David Rosenberg, Yra Harris and Peter Boockvar. All three, who frequently appear on CNBC and Bloomberg. And we had a very similar discussion on the very similar theme. Even, David Rosenberg thinks that it is going to be very extreme on what the actions the Federal Reserve would take. Essentially going towards zero interest rates. More and more (Inaudible 1:58). And ultimately, debt monetization where the Federal Reserve buys whatever debt that is issued by the Treasury.
And so, on that theme that you have graciously provided some charts. One of which, is showing how the Federal government expenditures been going through the roof asymptotic and resulting in deficit spending essentially.
So, that will all continue, but essentially the message is there that the Fed is there as a backstop. It’s there to do the monetization, outright monetization of whatever debt is needed. Your thoughts?
Charles: Yeah, thank you for that excellent summary of this situation Richard. I guess my first response is just to go back a bit in history and I have a chart here of the last three bubbles in a S&P 500.
Going back to the 1990s dot-com bubble which burst and then the mortgage housing bubble in the late 2000s which burst. And now, the so-called Everything Bubble. And what strikes me about this, as you say, single-minded obsession with the Federal Reserve Policy. Like, what’s the latest easing going to be to push valuations higher. That strikes me as what happens at the top of equity bubbles, right? Because, when the market seems to be relying on one driver and (Inaudible 3:38) solely on that. That seems to mark a top and when I think back to the 1999 NASDAQ bubble and the dot-com bubble, there was of course the underlying sense that the internet was going to be growing for decades and so, you know, you couldn’t go wrong on investing in internet companies. But there was also like an almost comical obsession with something called the “book-to-bill ratio” which was a measure of orders compared to current billings in the semi – conductor industry. And the semi – conductor industry was part of a proxy for the entire tech sector at that time. And so, you see these huge swings in equity valuations across the entire tech sector, not just semi – conductors based on this week’s book-to-bill ratio.
And so, it was laughable even then, how focused the market was on one indicator, right? Which as valid as it might have been in some certain circumstances, it was like the whole market was being swung up or down by this one indicator. And then in the mortgage housing bubble of mid-late 2000s: 2005, 2006, 2007. Then we were told, well you know, housing never goes down and well people were interested in what the Fed had to say, in terms of the effect on mortgage lending rates and so on. The obsession was really with how fast real estates appreciating this (Inaudible 5:10). And so, I guess that’s part of what I feel is it feels extremely fragile here is this obsessive concern with Fed Policy as the only thing that could possibly push markets higher. So that means higher profits, higher sales, innovation, you know, higher wages. It’s like none of the things actually make a healthy economy are of any concern and that should trouble us.
FRA: Yeah, it is and it’s almost perverse because as you can see in the announcements of labor statistics, for example, the market is keenly looking to those statistics as a driver of monetary policy and ultimately affecting equity valuations. So, that if the labor statistics are bad, then there is a sense that the Fed will be pumping more, easing more, so therefore the markets go higher. On the other hand, if the labor statistics were good, then that would translate to “Oh no, the Fed is not going to give us that drug.” And so, we won’t get it, so therefore equity valuations go lower. So, it’s just totally crazy and perverse. Your thoughts?
Charles: Yeah, and I am glad you brought that up because in terms of labor statistics and whether wages and earned income is rising or not, I have a chart here that shows workers share of the national income.
And what’s really striking is it’s been in decline since the (Inaudible 6:50) 21stcentury here in the U.S. And so, in this period in which the Federal Reserve and other central banks have made the greatest expansion of quantitative easing and the greatest expansion of central bank balance sheets and massive financial repression to keep rates near zero. It hasn’t benefited people with depend on earned income which is the vast majority of people, right? I mean certainly the bottom, say 90% of households, store their wealth based on their income. Not on, you know, their equity ownership. And so, it’s been a disaster for the bottom 80-90% of households and it’s only benefited the top 10% of which the vast majority of that is actually goes to the top 5% and top 1%. So, it hasn’t benefited the economy as a whole or society as a whole. So, you’re right, it’s just massively perverse.
FRA: And even then, it’s very fragile. The whole system, as you can see on your chart, for all sectors; debt securities and loans; liability, level is that little blip in the financial crisis that just seems to be a hiccup, but caused massive financial crisis globally and things are just getting worse.
We are going higher and higher on a swimming pool plank with less and less water and more and more instability. It’s just crazy. Your thoughts?
Charles: Yeah, I’m glad you brought that chart up because this is total systemic debt, basically, you know, public and private. And it’s pushing 70 trillion in the U.S. And GDP is around 21 trillion, so it’s over three times GDP. And what’s really frightening is the rate of increased, you know, that it’s from that little blip in the 2008 – 2009 crisis. Total debt was around 55 trillion and now it’s 70. So, we have added, you know, 15 trillion dollars very quickly and it doesn’t seem to be any reduction in the rate of that debt accumulation. And this rapid rise in debt across public and private is sort of mirrored by the rise here in Federal expenditures, which also this chart I have here from St. Louis Fed database shows Federal spending. It also had a little hiccup, you know, right after the recession. And it resumed very fast increase, so the Federal government is spending 4.7 trillion a year and taking in roughly a trillion less in revenues. And so, here we are floating another trillion a year in Federal debt in so-called “good times.”
And then of course, we would have to add in state of local government are also borrowing a lot of money, in terms of municipal bonds (Inaudible 10:29) and that kind of debt. And then there’s private and corporate debt. So, is this a healthy economy that’s so dependent on debt and therefore dependent on central banks dropping interest rates. How would you say, in terms of financial repression, everybody knows the positive effects of the Federal Reserve dropping interest rates, right? But what about the negative effects? Nobody seems to talk about that. I mean there are negative effects, right?
FRA: Yeah, exactly. It’s in all different aspects: the economy, the financial markets, social implications, widening income, wealth inequality, resulting from all this. And we’re rapidly approaching what central banks can do or have the capability of doing these other charts as well that can show how more and more debt is needed for an incremental increase in economic growth and that is getting bigger and bigger. More and more debt needed for just a slight amount of economic growth and that’s in the economy. And then in the financial markets, if we look at the bond market, more and more of the major central banks are getting into the situation where there they may be the only buyer, the last and only buyer. And, you know we look at, for example, bank of Japan that’s been in the case already for quite some time. European central bank is essentially is there now and the Fed is approaching that situation as well. And those areas are pretty dire situation. If you have the point where only the central banks are buying, basically there’s no market for it. Your thoughts?
Charles: Yeah, it’s interesting. I call that mechanism “a perpetual motion machine.” In that, you know, the Japanese model and what you referenced earlier in our talk that David had said when the central banks are going to monetize debt, then it’s like a perpetual motion machine because your national government can borrow a trillion dollars and spend it. And then your central bank buys those bonds and they basically vanish without a trace into the central bank balance sheet. And there’s no cost to society, in the sense that the Federal Reserve returns much of its income to the Treasury. So, it looks like, well there is nothing here? I mean, why couldn’t the Federal Reserve just go ahead and monetize 2 trillion dollars a year in deficit spending and let the balance sheet go from 4 trillion to 20 trillion or 30 trillion. And of course, a lot of people are looking at Japan as the model for this, as they more or less gotten away with this. And then everyone says, well you know, the train is still run on time and Japan is still a wealthy nation and everything works. And so, why not monetize debt and just let your balance sheet go crazy? Who cares? And so, it’s hard to answer. It’s hard to come up with a reason why that doesn’t work because Japan seems to be proving it does work.
FRA: Yeah, I mean, essentially there’s the two-lever situation with debt, right? So, that you have the quantity of debt and the interest rate. So, as the interest rates have gone down through financial repression, it’s allowed governments to go on a debt binge essentially for more and more debt. Much more debt now than we were at the financial crisis, for example. Problem with that is that is very high levels of debt and as the interest rates creep up ever so slightly, it becomes higher and higher servicing costs and that could get out of hand. So, you could be boxed in, you know, in terms of what governments can spend. Your thoughts on that?
Charles: Yeah, I think that’s a great point Richard. And of course, in Japan, every few years I try to keep track of what percentage of their central government’s tax revenues go to just pay the interests on their enormous sovereign debt. And I believe it was 40%. Now, this interest rates are basically .01 or less, right? I mean, you couldn’t get anything closer to zero than Japanese sovereign debt. And yet, it’s already consuming 40% of their tax revenues. I’m just saying that as an example of the mechanism you are describing, that eventually even at a tenth of one percent interest, you get boxed in because you are just servicing that debt. Makes it more difficult to take care of the rest of your social and government spending. And of course, the other downside is that no one could earn any money safely, right? The only way that anybody could earn money is by speculating that the central bank is going to lower interest rates below zero. So, that your bond that you bought is paying .01% will go up in value because now that the rate is minus .5% or something.
But you know, in terms of like safety and safe returns on investments for insurance companies and pension funds and so on, that’s also been basically destroyed, right? I mean, for people that are much younger, they may not remember that back in the 70s, it was a regulation that savings and loans would pay five and a quarter percent interest on your savings. And so, that was actually fairly hefty. And now of course, it’s impossible to earn five and a quarter percent safely. You know, you’re taking on enormous risks in buying junk bonds or corporate debt to get that. And so, I think that’s another element of fragility, you know. As well as the size of debt, in getting boxed in by the debt. We’re also boxed in because everyone has to gamble now in highly risky dangerous asset markets, in order to earn some sort of return.
FRA: It’s crazy. It’s unsustainable and where do we go from here? What is the way out? Another theme yesterday that was discussed is essentially inflating. There’s only essentially one way is to inflate the way out to make that burden of debt less burdening by increasing the inflation rate to much higher levels. Your thoughts?
Charles: Right. That’s what a lot of us have been anticipating and of course, we know for a variety of reasons governments understate inflation. We think the real-world inflation is, as you and I discussed many times, running more like 6 to 7 to 10%, instead of the 2.1 or whatever the official rate is. But yeah, we have all been anticipating that and I think what’s interesting is there’s got to be a deflationary element in the system that has been offsetting the inflationary impacts it should be registering, in terms of deficit spending and money creation and so on. And so, you know, it could be that like say, going back to Japan as an example that deflation is a factor in Japan because their workforce is shrinking. So, there’s less consumption and there’s fewer drivers to push up real estate and equity. So, there’s just fewer workers. And so, then you get deflation in consumer prices and then in assets. You also have a huge overhang of that debt from the Japanese bubble of the late 80s. And so, as loans are defaulted and get written off, then that’s also deflationary.
So, it makes me wonder what happens when you don’t have any deflationary impacts. Then we might get an inflationary shock, if say, the Federal government decides to pursue modern monetary theory ideas of huge stimulus programs: universal basic income. And, you know, we can (Inaudible 20:05) about numbers in general. It’s like, maybe, a limited universal basic income would probably add about a trillion to Federal spending and it’s pretty easy to add a trillion more in infrastructure and other fiscal spending stimulus. So, if you are going to create and push out 2 trillion a year in a 20 trillion-dollar economy, I think maybe we will finally get inflation.
FRA: Yeah, and if you look at one other great thinker in the Austrian School of Economic tradition, I was talking with Ronald-Peter Stöferle of incrementum a couple weeks ago. He wrote the book on Austrian School Investing and he pointed out that Murray Rothbard has the view of the three phases of inflation. He was one of the great thinkers in the Austrian School and he says first we look at the monetary inflation. We had that. We had a lot of that. That then goes into Asset inflation. Obviously, we had that and still have that. A lot of that. And then, the third phase is consumer price inflation. Eventually, all comes into consumer price inflation. So, that 8-10% a year, roughly, where if you look at the Chapwood Index of inflation more accurately measures inflation than any other index, including government statistics that indicate 8-10% per year in inflation in most of the U.S. cities. That is likely to get higher as time goes on. Your thoughts?
Charles: Yeah, absolutely. I’m glad you brought up Rothbard’s work because a lot of people I think have been lulled into a false confidence that we can basically create essentially endless amounts of money or credit, and there’s never going to be an inflationary impact because we gotten away with it for 20 years. Or, in the case of Japan, 30 years. But that may be a false assumption. You know, I want to mention a social impact here. When we talk about finance, we have to remember (Inaudible 22:32) there’s a social impact to this kind of financial repression of jacking up asset valuations with quantitative easing and super low rates. And so, I spend some of my time in the San Francisco Bay Area. And, as we all know, there’s many real estate bubbles, where you are in Canada and Vancouver as well. Many West and East Coast cities in the U.S. are reaching absurd levels of housing valuations. And so, approximately 5% of the population in the San Fransisco Bay Area can’t afford houses there. And of course, this is a region with very high incomes and say, a top 5% income in the Bay Area is, I believe it’s $400,000. Where in the rest of the U.S., is more like $250,000 or $300,000. So, you have to make really enormous sums of money to afford a bungalow in the Bay Area. And so, what’s the net result of this socially? As well as economically?
One social result was just a poll that was published in the San Jose Mercury News that said, “60% of millennials in the San Franciso Bay Area (now there’s people around 30 or under) want to leave or plan to leave the Bay Area in a few years.” Because there’s just no point in staying in a place where you have no future. Where you are going to be struggling to pay the rent. And that’s it. You will never afford a house. And, they had a young couple that (Inaudible 24:21) and saved and worked two jobs and so on. And bought, like a little bungalow for $700, 000 a few years ago. And their quote was worth thinking about because they said, “We are working at a 150% to maintain a lower middle-class life.” In other words, it wasn’t like they were really getting ahead. So, that’s the social costs of central banks pumping up assets, in order to please the current owners of all these assets, right? And, I think that’s going to cause a social disorder on a massive scale at some point.
FRA: Yeah and also, I have a feedback loop into the whole problem making it worse. Because if you got this effectively brain train happening, as well as some level of wealth train as well. You know, as the millennials believe from some economic activity representing that. And this not just in the Bay Area, I see it here in Toronto. There’s a lot of articles and charts showing it for all over. In particular, by the way with Chicago Illinois, what’s happening there the millennials will not likely be as idealistic as they have been portrayed. But they will believe that it will begin moving out. And this will make the whole problem worse, because then there will be more draconian, financial repression, higher levels of taxation and just making the whole thing worse and so on and so forth. And cause more and more people to drive out. So, that social problem and effect that you just mentioned could get worse. Your thoughts?
Charles: Yeah, no absolutely. I think that’s, as you say, a feedback loop. I just got an email from a reader in Chicago, said she mentioned Chicago, and he said his property tax had gone up by 48%. Partly from valuation, but partly from higher rates. And so, he says, “I don’t know how many people can withstand this kind of increase.” And then, you know, the Federal Reserve we were talking can monetize sovereign debt, right? The Treasury could issue a trillion in bonds and the Federal Reserve can buy that. But what about real estate? There’s roughly 15 trillion in real estate, private real estate in the U.S. Is the Federal Reserve going to start buying houses in Chicago to prop up the house values there? And so, in other words, I guess my point being that the Federal Reserve and other central banks have a pretty easy mechanism for propping up equities and bonds. Because they can just monetize the bonds to debt and they can just print money and buy the stocks, right? As part of Swiss Central bank and so on.
But the vast majority of people’s assets in the middle-class are in their house. And so, if the housing bubble pops, then what’s the Federal Reserve going to do? Well, they are going to lower interest rates to try to create negative mortgages. Where if you take out a mortgage, you end up getting paid. I’m not sure how that’s going to work. But I guess my point is, I think we’re really pushing on a string because you can’t prop up all asset bubbles everywhere without, basically as you say, destroying any notion that there’s a market there at all.
FRA: And so, where does this all end? I mean, it seems like a lot of doom and gloom. And maybe, we could end on a positive note from your recent book, “Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic.” What ideas and concepts that come from that book that can apply to what we have discussed, in terms of positive way out or potential positive outcome? What changes need to be made to the Federal Reserve, to the economy, financial markets in your view?
Charles: Yeah, well, thank you for that question. I think the core concept that a lot of people realize or share the idea that this is the way forward would be: decentralize capital, decentralize banking, decentralize political power and so, that would render the economy and the financial sector much more flexible. And so, you could have in Nassim Taleb’s conception, you would have a more anti-fragile economy and financial system. Because you would have a lot of variation in there because it was free to be a market again. And so, if we had let’s say, a thousand banks instead of 5 or 6, then that would be a way forward I think. And if the Federal Reserve, it is almost impossible to imagine, but we could at least dream of it returning to its original purpose which was to simply to be the lender of last resort in financial panics. Where there would be liquidity crisis, if the Federal Reserve could return to that role and stop being the prop under equity values.
We could restore the flexibility that’s inherent in markets and decentralize political and economic control. Because then you could respond to local conditions and losses when they are created can be taken without putting the entire system at the risk of collapse, which is what happens when you centralize capital control and banking. And so, that’s really the ultimate risk we created here is we centralized everything and made it much more fragile.
FRA: Well, great insight and how do we possibly get out of this? From your recent book, how can I listen and learn more about your work Charles?
Charles: Yeah, visit me at OfTwoMinds.com. There’s free chapters of all my most recent books, so you can read the first couple of chapters for free and see if they are of any interest. And all my archives and essays are free.
FRA: Great. Thank you very much Charles! We’ll do it again.
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.
07/10/2019 - The Roundtable Insight: David Rosenberg, Yra Harris & Peter Boockvar on Global Risks to the Economy and Financial Markets
FRA: Hi, welcome to FRA’s Roundtable Insight .. Today we have David Rosenberg, Yra Harris, and Peter Boockvar. David is the 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 next 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 Ranking. Prior there too, he was Chief economist and strategist for Merrill Lynch Canada based out of Toronto. He is the author of “Breakfast With Dave” and “Espresso With Dave” publications of the economical financial market insights. Yra is a hedge fund manager and a global trader in foreign currencies, bonds, commodities, and equities for over 40 years. He was also Seeing Me director from 1997 to 2003. And Peter is chief investment officer for the Bleakley Financial Group in advisory. He has a newsletter product called Bookreport.com that is spelled b o o c k r e p o t dot com which has great macroeconomic inside and perspective with lots of updates on economic indicators. Welcome gentlemen.
All guests greet Richard.
FRA: That would begin with that discussion on the economy recession views, corporate leveraging cycle. David, your thoughts on that in terms of what is happening overall?
David: Well, I’d be happy to start that off since my call for the year was a corporal led recession. Also it is typical to know which week, month or quarter could line up, and I never found an economist that was actually a very good market timer because if we were we be managing money for a living, but I thought that you know what time we hear, is that this week the New York SAD published its model-based recession odds metric for the coming year and it rose to 33%, which is a at 12 year high. This time last year was 12%. Two years ago it was 10%. 3 years ago was 8%. So, we’re up to 1 in 3 odds on this metric. And what’s interesting is that when you go back in time, you’ll see that once you cross above 30% more often than not you actually get an official recession, of course, nobody receives it at the time, but I think we’ll all look back and say oh yeah, guess what, when yield mean-reverting towards the end of last year, the yield curve got it right once again. You know, we layer on a lot of geo-political and domestic-political constraints on (inaudible) corporate spending right now. You know, the tariff for has yet to really been resolved. So we have these other nagging concerns, but the recession that we’ve had in the post-world War II period – there has been 10 of them. They all were precipitated by the FED Rate hike and cycle. We only had three soft landings. The odd are already 5% that we’ll have a recession this year. The New York SAD model is truly pointing in that direction. I know that people say to me “will how on Earth can you be talking about a recession when, you know, real GDP in the first quarter was 3.1%?”. But remember that GDP is really about spending and it’s the measure a country’s standard of living by income. And a very little-known well fact that we just got out of the past week was that Real Gross Domestic income, which includes profits, and we know that were in a proper to session right now in a good personal income, rents. And that combined income, as well dividend income, but Real Gross Domestic income was 1% in annual rate in the first quarter and that was after .5% in the fourth quarter of last year. So, I would say, already, we are one run away from seeing economy turn into the recession, that we still haven’t seen yet form all the lags from all the typing that has been put into the system, including the policy misstep last December that we going to see in real economy, quarters out. But make no mistake, when you looking at the real income side of the economy, it’s barely growing above zero right now. And that is what the (inaudible) has been telling you for the past voice recorders.
FRA: Yra, your thoughts on that and tying that into that into yield curve indicator is in implications?
Yra: Yeah, I will listen to David. But it brings you the point. So tomorrow, I know I’m jumping ahead a little bit, but we get Powell’s testimony on Wednesday and Thursday. And to make it on David’s point, I would like to hear somebody asked all directly about what he thinks about the yield curve. Cause, you know, I wait for the minute and I know that minutes are always sanitized for whatever view they want to push out after the meeting and I know those minutes are reconstructed. But I know Peter, but I’d like to hear him and his views, and because I’ve been doing these for 35 years out of the time I’ve been trading, the yield curved has been very important and it was very important for me to watch for many different reasons on a Google macro basis. (inaudible) even though my favorite is to trade the 2:10 but it’s been an anomaly. But, I think that David’s right, and what is this telling us and, you know, what’s the time in it, we are going to soon find out, and it won’t all results in the fact that they are more chewy and more liquid. The system is not going to be the cells that many people think and I think that’s (inaudible) right now anyway,.
FRA: And your thoughts Peter?
Peter: Well, just to add them, you can just look at different parts of the economy, I mean, you can argue that the that the growth slow down really began in manufacturing and whether that was trade and tariff related or something else. The problem right now is that it’s now spilling over into the service decide which makes up most of the US economy. So, if the service I didn’t know I was getting infected by the slowdown of manufacturing since obviously a lot of service companies are service manufacturing, there really isn’t much left to lean on since those are the two main areas of the economy. You look at construction, looking commercial real estate, you with the residential, and that’s been softening as well. So, they really aren’t places to hide. So, to speak in terms of growth you can argue. Okay, maybe the consumer with the help of labor market is is one area keeping things up, but then I guess you to the jobs picture and job’s picture is also showing slowing. So, each of the key supports of the economy are now getting infected by a general slowdown. And I don’t see that reversing anytime soon. And I’m sure that begins to accelerate and the next key in sort of quantifying outside of the GDP numbers and other economic statistics will be what company, say, over the next month with respect to earnings and I’m amazed Phillies today that the people sort of blowing off in the US state to be a SS news in Germany yesterday when they lower guidance. And this is not just some fly-by-night industrial company in Germany. It’s one of the biggest chemical companies in the world. You can argue that the products that they make these chemicals going to pretty much everything and they have customers all around the world and that it should have been too much of a surprise that a chemical company in a mixed up a global manufacturing fluid on would have disappointing earnings, but it wasn’t disappoint, you know, if people didn’t assume it was disappointing enough to have it in their estimated and that the stocks would fell short today. So, to me, that is the canary for what we’re going to see with respect to earnings over the next month. Companies want to protect their earnings and that means by not spending as much because it’s cost to send expenses you so, it’s not hiring as much does it cost to do so, and these companies going to do what they can to salvage their profit margins, which also means slowing economic growth. We’re seeing it clearly in small businesses, which sometimes it typically starts at because they are less able to deal with slow down. So, the small business optimism index falls today in a lot of key sectors. We’ve seen that in two months in a row the ADP is reporting that there is an outright decline in small business hiring. This happens in progression and you can just see how the set of dominoes are lining up and how this is playing out and people that are going to rely on the police that somehow, the FED rate cut one or two or three or four somehow going to matter. You won’t because cost of capital is not the binding constraint on any of this. It’s just a general slowdown. It really been affected by tariffs and trade uncertainty, but now once you get a trajectory of growth doesn’t just end immediately, it’s going to continue and once you get to the corporation’s pulling back and let’s just say the stock market somehow begins to respond to this production and learning, and you get a yourself in the market. So that’s going to further once on a consumer spending. So again, dominoes are lining up and I think people should be broadening out there, their perspective on things to see how this is going to be playing out.
Yra: Peter, you’ve been so good at watching the Cast of Freed Index. Where are you on that now?
Peter: Well, I think it’s down to six months in a row year to year. You know, they like to say that it in the beginning that it’s okay. Maybe it was at a rest after strong 2018, and then it continued month after month but that’s just a direct effect from this point on the manufacturing. I mean, it’s measuring, you know, every single good that gets manufactured ends up on a truck to its final destination. But whether it’s a destination to a warehouse, distribution center, or if it’s somebody’s house and you know that slowdown in manufacturing which is making these goods, making these products, before they ship, it’s just a natural by-product for shipping weakness to follow the softness in manufacturing.
FRA: And David, what do you make of the trends and the FED policy? Your thoughts on what Peter mentioned, do you see monetary policy with rates going to zero, more QE and more potential for debt monetization in the future?
David: Well, you know, this is where can I just had dinner with Peter in New York a couple of weeks ago, and we keep in regular contact, and we know each other’s views. I suppose I look at it from a slightly different lens. There’s no question in my mind that interest rates are determined by a wide array of factors, but there is a cyclical component to them. And you know, I would just say, you know in response to Peter that we’re seeing all these signs of economic slowing, there is a real interest rate component to normal interest rates that are going to follow the business cycle. And the business cycle this year has been turning the other direction. We’re in a very intense economic growth slowdown. Now on the stock market is on a completely different orbit. We can talk about that but the relationship between the stock market and the real economy has (inaudible) for most of the cycle. In fact, you know it’s the weakest economic cycle on record in terms of magnitude, and one of the best stock market so that we can talk about some of the factors behind that but when push comes to shove, it’s really the FED who brought (inaudible) the man aid is about the real economy. I think growth is slowing, inflation is low with no apparent upside pressure even with these tariffs, and it would make sense to me that the FED will be cutting interest rates, and I got the question, and we’ll find out more on his testimony and then in the end of the month more in terms of the ton in the press statement is to how (inaudible) any further rate cuts there are going to be. There is quite a bit already priced-in to the curve even with Friday’s employment report. From my lens, you know, I don’t rely. I look at what FED’s telling us. But I do my own research too. I was saying for a long time that the FED made their first critical mistake when they stop cutting their estimate for neutral fund’s rate several years ago. They got as low as two and a half percent. It’s hard to believe actually. Just eight years ago that the FED thought that the neutral fund’s rate that, you know, the fund’s rate that equilibrates the economy full employment price stability that Nirvana States it’s hard to believe that just eight years ago that the FED thought that was it was four and a quarter percent. Imagine if we actually went into four and a quarter, we’d be seeing a lot of tweets of the White House. So that were to happen and then they took the neutral fund’s rate spread over time because they realized that the forces, any inflation forces, from technology, aging demographics, the fundamental constraint globally of too much debt. So, over time for a variety of the structural factors, they took down their neutral fund’s rate, got the two and three quarters percent by the time Jerome Powell took over. And the first thing Jerome Powell does is rise the interest rates in his first meeting in 2018. But he weights the neutral fund’s rate and then took it up to 3%. Look where they are today. There is two and a half as of the last meeting. But you see my work on the on the neutral rate. It’s not two and a half. It’s more like one and a half. So, my contention has been all along with the fat over tightened. Not once not twice even talked about last September, last December, Donald Trump likes to talk about, but the FED is the one thing I will agree with the president on – the FED overtight. And actually, you could see it in the real money supply numbers which slowdown percipiently heading into the latter part of 2018. And you could see that the yield curve you saw on the prior dollar strength, you saw the weakness in the commodity prices – this is all is the stuff by the way that (inaudible) used to see all the time back in the late 80s and early 90s. So, if I had to say that I think that the FED have to take four hikes out just to get to neutral. That’s what that’s what my work shows and then on top of that we’re going to have all the lagged impacts that the Feds already done in terms of their tightening. There are lags that are two to three years long. We have not seen all the full impact that the FED is already done and then we layer that on top with what Peter was talking about the general level of uncertainty. And of course, what was happening abroad right now the Asian economies, the European economy. It looks like the UK economy is going to be contracting in the fast quarter. And what’s interesting to me is when Jerome Powell gave his comments, you know, before the Q&A during the press conference at the last FOMC meeting just after it. You can talk about how great the (inaudible) market was. He talked about global economic weakness three times and he realizes that the only thing separating the weakness abroad to the US economy was just the time lags. So, my sense is that you got to move at least four times for the market to get that price stand. If I’m right in my recession call, we know historically, in recession, the FED’s cut the price rate at least 5%. The starting point this time is about 2.5%. So not only will they go to zero, and we can then talk, and then I and Peter we will debate and I’ll probably be with them as to the efficacy effect it’s going to have on the economy, but I’ll tell you that if we go into the recession, this fund’s rate is going back down to zero probably more quickly than people think and yes, they will do more QE and Peter and I (inaudible) about how crazy this is but please call Tim Akers, he actually believe with all their interventions, and incursions, and balance sheet expansion and all the rest of that. They think that things would have been far worse. So, they live in a counterfactual world, but they’ve already told you when you scan the research of the FED of the different federal reserve banks – they’re already talking about how they going to fight the next recession. And when you think about every single cycle since the (inaudible) balance sheet recession starting a late 1980s. With these dead assets and super cycles, you kind of find out that when we go into the recession, the debt expands more and more and more firepower to get to the recovery phase. So yeah, we are going to go to zero, they’ll try to find some way to generate the FED’s negative interest rate through marquee and they might do more radical things down the road as well when you consider that nobody before 2008 had a clue what’s a QE was. You know, my sons know what QE is. So, anyway, I think that in the recession, that is soon going to get really aggressive, the rate will go to zero, the yield will sweep and it’s going to melt, and there is going to be a lot of other things, perhaps including debt monetization before we climb to the other side of the mountain and get through the next recession.
FRA: Your thoughts, Yra, on that and especially in coordinated Central Bank monetary policies involving other central banks like the European Central Bank, Bank of Japan Bank of China?
Yra: Yeah, there’s no, it’s all done within the week. I guess I could go look at the G30 cuz I always go up to see who sits in that group and there’s no question and all out of his given take takes place. Now that we have Christine Lagarde, who that that’s a whole new phenomenon that’s going to play out there. But David captures the history of it pretty well and where we’re going and again, I had this discussion today with a few people. Has been so many mistakes have been made but to me the most recent the sake of gigantic proportions was Bernanke’s fear of the temper tantrum and then he backtracked all that process to go in that market begin to better reflect what the reality was underneath, which is what David was just speaking too, because you know, I look at the world and I go – what is the Central Banking want to do? They are not about allowing markets to work. We’ve gone from George Kennan concept of containment of the Soviet Union to Ben Bernanke’s concept of the containment of markets by central banks cuz they don’t get on one of those markets really signal to them what needs to be done. They want to contain markets from having episodic reaction that they feel are negative to their control of the business cycle. And that’s the world in which we live in. We all had to adapt to it and change, and we know that it’s there. So, people ask me when is it all going to end? I said, I don’t know when it’s going to end but I know that it’s historically, and I don’t need a model for this, is that when debt expands far greater than economic growth and you’re supporting it through artificially priced interest rates, then how is the market ever going to clear? I’m not talking about Mass liquidation of assets. I’m just talking about allowing the market to do some of its work and clear some of the tender from the bottom of the forest so that it doesn’t ignite into a massive fire and they will not allow it because they are just terrified. And again what we saw with Jerome Powell, what scared Jerome Powell in this late December to make that pivots so quickly and I can’t it’s a binary effect because we had Munching calling them. As it was reported, you know over the Christmas holiday making sure that they were okay or what was bothering these different groups of official. What was it that they were afraid of that causes, but here we are again and every time you undermine the ability of markets to do what they’re supposed to do in send signals, you destroy it and you wind up having to cover yourself over and over again to the fact that monetary policy has become meaningless accept the pain from it is going to be real so, you know, I don’t know what this call was but there are certainly people sitting there who believe that the FED need to go negative, and I will tell you if they will tell you if you look at the European banking sectors, you look at the Japanese banking sector, do you really want to go there? Is that what you want? Okay, then when banks turn them into the utilities. I was just a parking spot. You don’t even have to do that anymore. Because if we actually bank, what’s the name of that you’re trying to put together, then we take deposits and to put everything into the deposit it all at the Federal Reserve, you know, there’s if there’s people working instead of trying to block it from happening because then they could just take my money pay me 2.15 and get 2.35 in interest on excess reserves and you make a 20 basis-point point and you and you are in the safest investment in the world. So, this is where we are at and they’re trying to control the whole thing and they can do it on a day-to-day basis, but I don’t really think that they can and after Peter talks and I want to throw something out on the table for discussion. I’m going to stop there.
FRA: Peter, just wondering on your thoughts on that and you’ve spoken a lot on negative interest rates in Europe and with 64% of sovereign government that they’re being negative yields. What are your thoughts there? Will that trend continue? And what are the effects on the economy and the financial system?
Peter: Well, the effects are obviously is the evidence that was mentioned it on bank profitability on one hand the banks own a lot of these European Sovereign bonds that there are benefiting on that end. But the actual business of banking which is how at least in Europe, these Banks make their money as opposed to being more reliant on Capital markets, where are the U.S. Banks profit from just the standard business banking is obviously impaired by the oak curves disappearing in that area and internally it was a case in Japan and that’s why the Japanese Bank stock indexes down 90% from its top in 1989. I think that we’re not going to negative interest rates here because of the experience they are but also the U.S. has a very large money market interest rate of, I think, it’s 3 trillion dollars of money market money that would essentially disappear if we went to negative interest rate. So, who’s going to finance their commercial paper market, who is going to finance a lot of the overnight tight money. If you blow up the money market industry, which negative interest rates would do. So that’s why I don’t think it will happen here. And what David said, when he mentioned that, and of course, accurately, that each incremental easing cycle is Chiron horsepower than the one prior has same time. Also there is that each of them are less attractive because you come you become sort of desensitized to the changes in the cost of money when they are already low to begin with. So, I agree to also with both that the FED will fight this tooth and nail because that’s just ran, so there is always a pressure to do something, and they still having two models at lower rates are good high rates are not good, lower rates are stimulants, higher rates are anti-growth and it’s very black and white. And they can rely on a low inflation is giving them license and then make him give whatever reason they want for cutting but that is always just their (inaudible) reaction and they’re sort of default setting and we’re going to see it again this time around. I think what separates the next downturn from others and we certainly seeing it in Japan and Europe is we are not going to respond like we have in the past to that easing cycle and that instead of seeing sort of a 12 to 18 months, you know, slow down and gross or a couple of quarters and service V bottom in economic activity and markets. This one is going to be more drawn-out because we’re not going to really respond to the easing and then it’s this, and I refer to his monetary Quagmire. This is Vietnam type mentality when there is not enough troops. Okay, it’s not working. It’s not working because we don’t have enough troops. We need to send more troops and we have to send more troops in more troops in and we have to do more easing, we have to do more easing, we have to do more easing rather than any form of introspection to say, you know what this is not working. Maybe we should try a different tact. So, this economic downturn is any more drawn-out again because we’re not going to have that sort of monetary stimulus that we can react to and certainly there’s not going to be any fiscal stimulus because the U.S. government was already blown. In terms of that, it’s loading as they did last year. So this is going to be more of a, as what I refer to, it would be more of a bathroom type, sorry, I should say a bathtub type recovery that you’re going to do a lot of bouncing along before you going to see any strong growth because we are at credit dependent economy in a credit cycle. And if the cost of money is permanently low, you don’t get the impetus to act and that’s the whole point of lowering rates on taper is to make you buy that car today instead of tomorrow make you buy that house today instead of tomorrow make you invest in that plant today instead of tomorrow, will the rates be constantly low forever? Well, there’s no interest in doing today what you can just wait till tomorrow to do. And I think that’s the experience of what we see overseas and we’re certainly now seeing it here and I think it argues more not just for a higher RPM multiple just because rates are low you look at look at the PE ratio in Japan for the past 30 years. It’s been a steady decline downwards. So, people can confuse their dividend discount model with the present value of future cash flows and discounted whatever they want. It hasn’t worked in Japan you seem compressed valuations for 30 years and I think that people are basically putting their chips on the stock market table here, assuming that multiples at worst will stay where they are and I can possibly expand If the FED starts cutting without really understanding or looking at why is the reason the FED is cutting and what is that going to do to future cash flows.
FRA: Yra, you wanted to comment.
Yra: Just to throw this out there about recession, cause the more you think about it, President Trump uses his tweeting account. I’m beginning to think that if you would stop tweeting and actually use back channels? He can get what he wants out of the FED. You desperately would like, I think, a 50 basis-point cut 25 won’t do it cuz he wants to coerce the massive headlining to look at that controls. But he actually controls this game because if the FED stays on hold in the president’s responses, what the hell, I’m not going to receive any support from the FED. That’s going to throw in some terrors, it’s going to scare everybody into doing the action that I want. Are we on that pass to the collusion and would Jerome Powell be smart enough to head that off, cause the president can certainly throw it out there, and he doesn’t even have to act to tariffs. But imagine, if after the FED meeting or after the testimony this week, when there a bit more a steady course, then the president would like to see, then does he come out and say, well in 45 days or 30 days that will certainly take place after the next FOMC meeting. You know, I’d plan on going ahead with the increase and all those three hundred billion of Chinese products with the 25% tariff. What do you think the impact of the markets are going to be? So, you know, (inaudible) is this another way to see it? And I love, I mean, I love David telling about the yield for what it’s going to happen with all this debt cuz I’m a believer in that too for all the people who think they were into a two ten inversion. I don’t think we’ll see it because I think there’s other issues of play here even with the easy bank. I would like to have the bank that I talked about which the FED is actually going to court. The block is called the Narrow Bank was put together by a previous The Shed Santa Fish on New York Fed and the FED is trying to block it from happening because they just want to collect deposits and put them on reserve, at the side, because the interest reserves are so high, (inaudible) but I’m waiting on other comments from Peter and David.
FRA: David, just first your thoughts on Yra and Peters commentary.
Davie: Well, I mean, just to further the conversation, I guess on the FED. Firstly, I think that’s the problem is that the president has boxed in the Central Bank. And so, Donald Trump is not going to get what he wants by doing that. I know people like to talk about how previous presidents pressured FED chairman, they did it privately and people only found out about it years after the fact. So, this is actually a story State of Affairs. I actually think that the FEDs over tightened enough that they should take the funds rate down 50 basis-point. They’re not going to do it. I thought that for an instant at the press conference after the meeting that Powell sounded so diverse that I thought they were going to go 50. He walked out on that, and of course, we know that Jim Bullard who was the only FOMC border at 12 dissented we find out that supposed that he just wants to cut 25 basis points. So they’re going to cut 25 basis points minutes in the market, but I think that’s what they’re going to do. They’re not going to cut 50. I think that this whole FED bashing and, you know, this is an institution that is run by human beings and they make mistakes and I already said that they are over tightened, and they’d have to walk that back. It’s not the first time that we would have had the sad over tightening rather than over ease. That’s what I told her all about. But I think that if Powell were to get the newest orders demoted. I think that’s going to have a deleterious impact. See, I just don’t think that Donald Trump fully understands the wool and the benefit that the US has globally by being the reserve currency. I think he has absolutely no appreciation of what that means and actually historically the country with the reserve currency status tends to have trade deficits and tends to their core to have a capital account surplus. This whole economics team at the White House, I think, has to go back to school, I’m actually totally missed at the level of economic thinking that goes on today at the White House. I hear Larry Kudlow today talking about how well Powell’s job is safe for now. I’ve never seen a fair chairman so craft, but people have to understand it’s not one man. He might be the chairman, but he has one vote. And it’s a whole committee. So, what happens if Trump fires him and remotes him, and everybody gets up and leaves? Because this is a team, it’s not one person. And then it comes down to who is he going to, you know, put in charge of the FED? I mean he wants to nominate even more previously. And then can you imagine, the trashing that the U.S. dollar will take in that sort of environment. And I know the president was criticizing (inaudible) and here you have Europe, much closer to the recession than the U.S. and (inaudible), of course and then being accused of currency manipulation, which doesn’t even make any sense in the world. Will you do have some semblance of floating exchange rate? We don’t have fixed exchange rate regimes anymore or you actually did write the value and now apparently Europe is devaluing, which is this nonsense, but the risk here is that if there’s a force change at the FED, I’ll tell you this much – you do not want to be long the DXY, the day before that happens. But you do want to be a long goal, that how much I’m telling you.
FRA: A final question for today is what do you see as the biggest risk? So, Central Bank risk, trade risks, Market risks, credit risk, geopolitical risk, to the economy in the financial markets for the rest of the year going into next year, and how do investors and traders protect themselves or look for opportunities in this environment. Maybe we’ll begin with Peter.
Peter: Well, it is a confluent the risks that are all occurring at the same time. I mean it I think if the U.S. economy was strongly be able to handle another spot on the other hand circular because it’s the straits that the FED is made the economy grow slower and to David’s point – I agree that it will always tighten too much and I’ll always he’s too much because they don’t appreciate the different lags that are inherent in any policy in that what you do today may not be sold for another 6 months from now to yeah, they were double tightening shrinking their balance sheet and raising interest rates. They were double tightening because they have this delusional thought that shrinking the balance sheet wasn’t a big deal as watching a paint dry. That had a cumulative impact on economic growth and then I believe also a big risk is going to be there this is falling and possibly declining the earnings story. Because it’s going to feed into actual corporate behavior as companies try to protect profit margins which are at record highs. So, a major risk is that you kept finally for the first time in the cycle mean reversion with respect to profit margins, which means lower hiring, which means lower spending, which means slower earnings growth potential, means lower stock prices, which ends potentially with a problem with consumer spending. So, they all sort of feed into each other and it’s now happening all together and no amount of rate cuts are going to offset that it’s a cycle has begun and it’s going to play itself out notwithstanding all the monetary firepower that will be thrown at it. But at least in the short-term, I’d be very focused on earning season and what companies have to say. We’ve already seen CFO and CU conference members that are getting impacted and then you just put yourself in their feet if they’re worried about the outlets, if they think there’s going to be a recession, or you can be sure that they’re not going to be aggressively expanding their business and then I have to wonder, and a point that I’ve been agreeing with for a while, is that going into this year companies were going to start focusing on their balance sheet because it got over levered and they were going to start making that a priority and we’ve seen a slowdown in corporate buybacks in the first quarter and I believe that that the fourth quarter of 2018 with a peak and in stock buybacks again as a way for companies to try to improve their balance sheet, sort of cord the cash this time around, check the profit margins and deal with what is it when leasing earnings recession that is potentially going to be an economic recession, which will then enhance the downside of the earnings for sale.
FRA: And your thoughts, Yra?
Yra: Peter covered most of what needs to be said. Cause all those events that you talked about, you know, I put it in (inaudible) terms. And it only takes a single potential. I tried (inaudible), you know, geo-political, certainly the economic (inaudible) zero. You got instability throughout the Middle East and you have a lot of the actors out there who would like to like that start because, because of Peter, David, and I had extra most I’m not trying to put words in her mouth. I think it was from what they said today is just huge amount of debt goes up and makes this system, the Global Financial system so vulnerable to this. An then, bottom line is this – the position that exists in the financial community and I’ll tell you this, short volatility plays we should do the backbone of many head private Equity Groups profitability cuz as long as they believe that FED has their back, they sell value and I’m not talking about just selling the value in the equity markets, I’m not talking about selling the value in debt values, (inaudible) currencies are short cross the border because the FED has set this up and I believe that it’s one of the things that I’m your call back in the late December because he had gotten window. The phenomenon that we saw in December partly because of the changing the USA crags under what type of liquidity we need (inaudible) with these enormous amounts of short valve positioning really that’s the biggest pile of drying (inaudible) on the global financial system. And I’ll tell you this – on the CME Forum with the huge option, (inaudible) option groups, there has been a lot of pain for the last three weeks, and they say how about three of the big five trading groups of blowing out that they’ve gotten crushed because I don’t feel they exploded since the Powell’s press conference, mid-June 19th.They really got fractured by that. I think there’s mega amounts of this around the world, but I want to add one more thing because I’m not letting David of the hook. Bank of Canada meets tomorrow. I want I want to know what his, especially he is the Canadian dollars trust and care now. Is there a chance, you know, that this will be the end?
David: Well, I think the if the Bank of Canada does nothing tomorrow, I think it’ll be just a “steady as she goes” press statement because they are lost in this type of war between some of the recent positive economic data flow in Canada, which suggests that second-quarter GDP growth could be a two and a half to three percent. Of course, that comes after 6 months of almost no (inaudible) at all. And of course, we’re caught between that and the duration we’re seeing in the global economic outlook. So, I think they’ll be some improvement in domestic demand. A lot of that is when the gas related from the trop, but of course acknowledging that these global economic and political (inaudible) has gone away. In terms of, you know, some of the things I think that we have to be really concerned about and I say this because you don’t actually towel luxury policy report, the FED’s monetary policy report. You know, not the speech that we are going to hear tomorrow, testimony but the report came out over the weekend and the word risk showed up 34 times and I none of them were high risks. And the word uncertainty showed up 34 * 2. So that’s 68 references to either uncertainty or risks in a 46-page document. And so, I think that you know for me, you know, the retreat that we’re seeing in global trade volumes is a big concern. We have a very fragile trade truce right now between the U.S. and China. But right now, Japan and South Korea are locked into a trade war which is acting is a big impediment to the Asian technology space over the past few weeks. I think that the situation in Iran I mean to me this is really big what Iran is doing and pushing the envelope on its enrichment caps to me as a huge source of potential instability. I’m concerned about the debt globally and primarily, but how about the extreme fragility in China’s financial system? I would add all that to something we didn’t mention but will certainly be making the headlines through the fall which is Boris Johnson and his bravado above his willingness to put his own envelope on a no-deal Brexit coming into the October 31st deadline. I think once again, that Brexit will be on the front pages of the paper that will be alongside these trade issues in Iran and just ongoing source of instability that leaves me with this portfolio recommendation of having the bond bullion Bar Bell in an ongoing search for refuge in trouble times. I think that another risk is the FED dragging its heels and that’s in my heart goes out to Jerome Powell. What do you do certainly cannot be seen to be kowtowing to the president? And I think he should go 50. I think that it’s the risk for me and the risk for the market. The FED tells the market on July 31st that this cut is only an insurance cut. If they can’t see the decay in the leading indicators, then I think they’re going to fall further behind the growth curve then it’ll be much harder to get out of the recession that I think is inevitable. It just a matter of which quarter is going to land in and then I think that you know, once we get through all this, and it was interesting that Peter mentioned, you know, the NFIB small-business 7 index today cuz there’s a component that measures uncertainty. It’s called the uncertainty index and boy did that thing shoot up in the month of June, interesting enough at the same one that the stock market takes off and the uncertainty index took off as well and you kind of start to wonder if businesses are starting to pay attention to the 2020 election. And if you’re looking at Donald Trump’s approval ratings at 40% and you looking at this lineup of democratic candidates – you don’t know, what post 2020 your tax rate going to look like anymore. And that alone is going to cause business at the margin to put money aside for a rainy day. And that just adds more credence to the capex LED recession somatic and I’ve been talking about this year.
Yra: You know, those are really great points and I’m going to throw in one more element that we haven’t discussed but there’s a guy who’s sitting (inaudible) in Moscow, who understands the vulnerability of the global system. I think you see it regularly. And he wants those sections lifted. So, if you want to see somebody who’s potentially could like that start. Vladimir Putin is no fool and he sees the vulnerabilities at hand. So I would think you’re going to see a more aggressive Russia just in an effort to get some of those. He wants those sanctions removed in the worst way. And actually, Russian assets have been holding up very nicely here, but I think it’s one more major element in the in the global instability that exists and it’s not even far below the surface. It’s on the surface.
FRA: Well, great insight gentlemen! How can I learn more about your work Peter?
Peter: For asset management and for wealth management at Bleakley and my daily notes on boockreport.com.
FRA: And, Yra?
Yra: Well, I’ve been a little quiet for a while, but Notes from Underground is my blog. You can also sign up for the yragharris.com and you’ll get an overview of my thinking of potential global macro base trades. It’s discretionary, there is no (inaudible) of trades, there is just the concepts and you have to go do your own risk analysis and do your own work to see if they should.
FRA: And David?
David: Okay, well, for anybody who’s interested in looking at my research – feel free to call me 416-681-8919 or 647-802-4146. Feel free to email me to email is Rosenberg@ Gluskinsheff.com. And you can actually also follow me on Twitter – David Rosenberg (@EconguyRosie). A lot of people think it’s more like Wiseguy Rosie by you can follow me on EconguyRosie my daily snippets on there, too.
FRA: Great. Thank you very much, gentlemen. And we’ll end up there.
05/29/2019 - The Roundtable Insight: Daniel Lacalle and Yra Harris on the Eurozone’s Monetary, Fiscal and Bond Nightmare
FRA: Hi, welcome to FRA’s Roundtable Insight .. today we have Yra Harris and Daniel Lacalle. Yra is an independent trader, successful hedge fund manager, global macro-consultant trading foreign currencies, bonds, commodities for over 40 years. He was also CME director from 1997-2003. And Daniel is an investment manager and has been a professor of economics. He has a PhD in economics, author of “Escape from the Central Bank Trap”, “Life in the Financial Markets” and “The Energy World is Flat”. He writes frequently at the Mises Institute. Welcome Gentlemen!
Daniel: Thank you so much! Always a pleasure.
FRA: Great, today I thought we would do a focus on Europe, what’s happening in Europe, the parliamentary elections and tying that in to some recent writings that both of you have done. We can also touch upon the Chinese-US trade frictions. So maybe to begin with, we get your views on all of the elections that have been happening this past week. Looking like a strong move to nationalist based parties and what your thoughts are on the effects of what this means towards the economies in Europe as well as the financial markets. Yra, would you like to begin?
Yra: Well, in discussing the elections, I think the biggest part of the election story now comes of course, you know I’ll talk about the horse trading. But from my perspective, most important element should be and I’m not sure how Daniel, whether he will agree with this or not, but Jens Weidmann should become the ECB president and my view on that hasn’t changed in several years. But I believe the same back in 2011 that Merkel succumbed to the charms of Sarkozy and settled. It was a mistake because I think it’s important for Europe that a German were to head the ECB now. Because you have to get the German populace to buy in full force into everything that the European Union wants to accomplish. And if you don’t have a German I think running the bank, it will be bad for German domestic political politics. So better to have somebody, especially of the caliber of Jens Weidmann and that will be a very important element because if we look at the flawed of how this all ends, Mario Draghi has built with Angela Merkel’s blessings and others, a massive balance sheet is whatever it takes scenario. What happens to that balance sheet? I think the highest probability is going to be that it gets folded into a euro bond which is what the main stage of the European project want anyway so you may as well have the German at the head, and I will stop there.
Daniel: I actually quite agree with what you are saying. I think that what these elections have shown is two things I believe.
One is that there is an important rise in the number of seats taken by euro-skeptic or nationalistic parties and that is I think very evident in countries that have seen very, very weak growth and the constant erosion of purchasing power from the monetary policy. You see there in Italy, you see it in France, you seen it also in Germany, even in Spain. So, I think that the first take is obviously that there has been a very significant rise in the populace. I don’t like to call it populace- the nationalistic parties.
The second point is that these elections have been about everything except monetary policy. There has been varying interests in the debates that there has been very few comments in the debates about monetary policy, about the role of the European central bank. And you’re very right, looking at the central balance sheet right now is about 40% of the GDP of the Eurozone at the peak of the QE. The US, the federal reserve, central bank was less than 26% of the GDP of the US.
So, it is very important that as you very well said, that the next president of the European Central Bank is a German official. And the reason for it is because the European central bank is already moving to some form of monetization or Euro bond. Because it cannot buy more sovereign debt but it’s buying every maturity and therefore it’s putting a lot of pressure on sovereign bond yields and on spreads. As such, if the Germans who are not very keen on full monetization of debt etc. See (6:14-6:16 Inaudible) European Central Bank under somebody that is not a German it can definitely create some tension in the euro and Europe.
FRA: And you’ve recently written an article called “ECB’s Monetary Trap” Daniel. In which you describe what’s happening in Europe in general and as far as what the objective is, you see that the ECB is looking to make public spending cheap to finance in a sort of financial repression. Can you elaborate on that?
Daniel: Yes, the ECB launched the quantitative (7:03 Inaudible) program as a tool to improve the possibilities of a government going to take structural reforms. However, in this process what has happened is that governments have grown accustomed to very low interest rates and cheap debt. What they have done is the opposite. If you look at the general results of the European elections, with the main parties that have won are demanding is more deficit and then more government spending. So, the ECB funds themselves monetary prep (7:42-7:45 Inaudible) it’s policy, it stops the low rate purchasing of maturities program that they have right now. What ends up happening is that you see massive rise of spread yields in the eurozone that could rock the economy very quickly. On the other hand, if it doesn’t stop and it continues to do what it is doing, instead of buying or telling the governments to undertake structural reform, what it is actually doing is whitewashing the populist agenda. Which is that government spending should be fully monetized and that there is no problem with massive deficit spending.
FRA: And you mention a lot of this basis is that there is no apparent inflation. As you point out, there has been a lot of inflation since 2000. Can you elaborate?
Daniel: This is actually quite humorous, because if you think about it the European Central Bank, most of the economists, most of the censuses is telling us that there is no inflation in the eurozone. As such, monetary policy can be as (8:59-9:01 Inaudible) as needed for as long as it’s needed. However, at the same time, you have every (9:06 Inaudible) France, demonstrations of the Yellow Vests. And what are they demonstrating against? The rise in prices. The rise in consumer prices, the cost of labor and in the polls undertaken by the eurozone, the second biggest concern of households after unemployment is the cost of living. It is a complete fallacy that there is no inflation in the eurozone. And more importantly there is quite a substantial amount of inflation. Prices has risen as I mentioned in my article, 40% since 2000 whilst productivity and salaries have barely risen.
FRA: And your thoughts Yra on ECB’s monetary trap and the perspective of Daniel?
Yra: I couldn’t agree more, and that’s my point about why they need a German to head up the bank. And I see that Daniel seems to have come out of it the same way. I had a conversation yesterday, first time I ever talked to him but I respected him for 40 years, 35 years, Mr. Zulauf. We had a nice long conversation and I raised the same issue with him and we’re having this discussion and I said “Look, if you follow the work of Carmen Reinhart, which I think is very important on financial oppression, which of course is who sponsors this podcast; Financial Repression Authority, nobody in the world has been as financially repressed as the German citizen because of their culture of saving”. That’s just the way it is, they really don’t. When the Germans did step up to speculate in stock markets, they ran right headfirst into the (11:19 Inaudible) market back in 1999, 2000, 2001. They had the lowest housing purchasing ownership because they don’t borrow. They don’t borrow to buy houses.
It’s just not as common so here you have: If I’m a German saver, and let’s say I’m in short money. I’m getting negative 50 basis points, 40 basis points, 30 basis- whatever, it’s negative. And inflation in Germany, I don’t care what it is in the rest of Europe, I live in Germany and we know that’s where it manifested itself and with Merkel’s ridiculous energy program which has driven up energy costs. I have suffered tremendously in order to bail out everybody else. So, the fact that I’ve been so financially oppressed as I feel as a Bavarian burgher and I’ve not been able to vote for any of this. Nobody has ever asked me even (12:27 Inaudible) received piece in the Financial Times talking about taxation, we got representation and of course financial oppression is certainly a form of taxation. So I need to see Jens Weidmann, I want Jens Weidmann because I have to feel that somebody is actually looking out for me. Right now, nobody is looking out for me. Yes, I know Germany has benefited from a weaker currency to the Deutschmark would have been very, very strong. But that’s an asset as well as a liability.
So, this is- Daniel, 100% and I can’t agree with it more; it’s a monetary trap and Draghi following more importantly Bernanke and the Japanese, whether it’s Kuroda or Shirakawa, has walked into this and he has no exit. So, the exit has to be to create the folding of the entire ECB balance sheet into a euro bond. I’ve looked at this and I’m sure Daniel there’s no other way out of this and it builds every day and now of course they’re buying corporate bonds which who Jim Grant did a wonderful piece in Barron’s over the weekend about it. That the ECB has been an enabler of French corporate takeovers because money’s so cheap and that is exactly right. And I will end on that because one thing the Brits are not doing intelligently is they can get the ECB to fund the entire Hinkley Point nuclear project and basically zero interest rates by just selling the damn bonds to the ECB, you know the French would never get it because the EDF would love for that to happen and the Brits ought to do that before they leave and saddle them with the entire cost of it.
FRA: Your thoughts on that, Daniel?
Daniel: That is actually a very, very good point. You mentioned this concept of German benefiting from a weaker euro which has been used quite extensively by consensus as a main benefit for Germany in the monetary union. However, you’re absolutely right. Who has been the other side of the trade and who has (15:08-15:09 Inaudible). And one side, the German savers have been massively and negatively impacted by a weaker currency and the low interest rates. But also, the household consumers have seen a very important rise in consumer prices, the energy (15:31-15:34 Inaudible) power prices more than double for households and as you already said they don’t (15:44 Inaudible) massively like the Spaniards or like the Italians to buy property and what ended up happening as well is that you have riots- well not riots but demonstrations in Berlin because rental prices are going through the roof.
So, the way out for the ECB is evidently some form of rolling the balance sheet into an euro bond, absolutely it is. There is very little else that can be done. However, how do you sell this to a European Union in which the level of its trust between nations has increased when you have the peripheral countries trying to go back to 2008 and have large deficits, even break the European Union. You have had even as recently as a year ago you had the president of the- current vice president of (16:50 Inaudible) talking about the possibility of breaking of the Euro. A euro bond on one side is a solution and the other side is a massive time bomb because if it is successfully launched, what would happen would be that peripheral countries would be screaming for that euro bond to be extended to current deficit. And on the other hand, if it doesn’t it would be entirely a liability for the German household. It is not an option and I think that is why you need to find a way in which with the new president of the ECB, you implement some sort of process in which responsibility and shared responsibility comes also with some form of guarantee that’s going to be effectively implemented.
FRA: You mention also Daniel, that there are 16, ten-year sovereign bonds in Europe now showing negative real yields. Do you see that condition as persisting or maybe getting worse?
Daniel: I think it will get worse, I personally think it will get worse because as we were mentioning before, the problem is it’s very easy to enter into progressive (18:27 Inaudible) monetary policy, very easy to print money. It’s very difficult to get out. And it’s very difficult to get out when you have three factors in the eurozone that differentiate real economy, for example the US. Now in the eurozone, 80% of the real economy is financed by the banking system. In the US it’s 20%. Therefore, shocks in banking system have massive impact on unemployment, on growth, on credit for SMEs, you name it.
The second factor is the level of government spending at a country in the European Union level. Government spending and government liabilities is very, very high and the reason why it’s so very high is also because you have a massive and growing liability on the pension side. So, one side you have the banking system which is still very fragile and financing a large part of the real economy. On the other side, you have very high levels of government spending and governments that- basically, a 1% increase in government debt expense in the eurozone would mean that deficits would balloon in (20:00 Inaudible) 16, 17 countries.
But the third factor is also very important, is that 80% of gross capital formation in the eurozone is recycling of capital. Therefore, you’re not having a dynamic capital expenditure that is driving new technologies, new (20:20-20:23 Inaudible) etc. Productivity growth is very poor, and overcapacity remains very high. That third factor that leads to a very, let’s say perverse incentive from both governments and the ECB to Japanize the economy, to sort of keep it stagnant but let’s say, painless.
FRA: And your thoughts Yra, on negative real yields in Europe?
Yra: Well, I think that’s absolutely right. You see how it’s crushing the banking industry in Europe. The worst performing stocks for 30 years have been the Japanese banks. And that’s been with a lot of the banks being destroyed in Japan, so you think based on the concept of an oligopoly at least, that the profit margins would be great. But of course, the central banks have destroyed that and as Daniel points out, of course Europe has a much more banking sensitive base economy. Not corporate bonds although the issue being is to their benevolent actions creating more corporate bonds causing the incentives of corporations to entertain that.
But you look at the banks, listen. The crown jewel of European banking was Deutsche Bank, that doesn’t even bring a laugh, the Spanish banks have recovered somewhat from the terrible situation they were in, the Italian banks we will never know what the real story is there because especially under Fazio. This is one of the great feedback loops of all time is because Fazio rules sovereign debt is zero-risk weighted. So, unit credit or Sienna whatever I’m loading up on Italian sovereign debt because I earn a decent return relative to everything else. And I don’t have to reserve (22:42 Inaudible) so it’s a beautiful relationship Bob. In fact, I actually asked (22:48 Inaudible) that question. I say when he was at the Bank of Spain, of course he was in favor of zero-risk weightings, but I ask, well I said “now that you’re at the BIS do you have a different viewpoint on that” and he started laughing, the answer of course is self-evident.
This is a giant, giant mistake but it’s more part of what Daniel calls “the money trap” and it is a money trap. And of course, Draghi can’t really get out of there fast enough. You know, October 31st can’t come quick enough because it’s going to be very difficult just like it was for Yellen and now certainly for Jerome Powell in trying to exit from the strategy that is very difficult to exit and then they really had no exit plan. So, I think it’s really worse for Europe and that what’s they’re caught in and if you look at Europe, nothing says it better than of course the stock valuations of European debt.
FRA: And Yra, you frequently made reference to the book by Bernard Connolly called “The Rotten Heart of Europe”. Bernard Connolly used to be a senior economist with the Brussels Commission. How do you see what he foresaw in that book to what’s happening now in Europe?
Yra: As I say, all you have to do is read the fore, he wrote the book in 1995, he updated it with a new foreword in 2012, 2013. If you read that you have to go, get a nice scotch and sit back and think about this through because everything he has talked about has come to fruition. Unfortunately, he is not proud of it, by the way because I know Bernard well. So, he’s not proud of that and it’s always worried him, and this is where it sits. And you know everybody points out ridiculous things. What they worry about, ridiculous things because the Financial Times which used to be a good newspaper has become a joke because they just sit there and nod in agreement with whatever comes out of Brussels and don’t challenge it. The fact that this election is the biggest issue, of course what they wanted to make the biggest issue was nationalism and anti-immigration. I would vehemently at rise of the Alternative for Deutschland and it’s actually at its beginning in 2013 in response to what the ECB actions were.
And this is going to get worse because these are pocket book issues, and nobody has an answer for it. And fiscal, you know as long as the Germans remain (25:59 Inaudible) about fiscal austerity or at least fiscal- I’m going to say more importantly fiscal responsibility. I mean, you see it as we’re sitting here right now Rome and Brussels are going back and forth and I’m willing to bet that as much you know, people think that Brussels is going to place a fine upon Rome, it’ll never happen. It can’t happen because the Italians, you got to give Salvini his due cause he understands. He gives power to the old saying: If you owe the bank a hundred dollars, they own you. If you owe the bank a billion dollars, you own the bank. So that’s exactly what’s going on there and the Italians are not foolish. They understand. And I really think that Salvini must meet all the time with Yanis Varoufakis. He explains to him because he was very upset when Alexis Tsipras sold out the entire movement to get whatever he could out of Brussels but Salvini is going “There is nothing you can do to us” and they’re going to run a much bigger deficit, they have to. They’ve got no choice. So that’s where it lies and going back to Bernard Connolly “The Rotten Heart of Europe” which is still the most important book, I’m sorry if I hurt anybody’s feelings about Europe, it still has relevance and the players he talks about 20 years ago, 25 years ago, are still heavily involved in this now. So the book still has great relevance.
FRA: And your thoughts Daniel?
Daniel: I completely agree with what Salvini is doing. I was in Italy recently, there was a TV debate about this whole to and fro between Brussels and Italian government and one of the members in the league was saying “Hold on a second, you mean that we’re going to get a 4 billion euro fine for having the same deficit as Spain?” It’s become a system of perverse incentives because on one side is (28:25 Inaudible) we cannot exceed the deficit and we cannot break the rules agreed at (28:32 Inaudible) etc. However France has missed those same targets 11 times, Germany itself as well and France for example has not had a balanced budget since the late 70s.
The problem of the eurozone has nothing to do with the lack of government spending. The problem of the eurozone’s very poor productivity, very undynamic growth and very weak levels of employment, comes from the excess of government spending. And obviously yes, they will run larger deficits as you very well said there is no other option because Italy has been stagnant for two decades, France as well. But ultimately the issue here is, is that going to solve anything? And the Germans will finance that deficit at the end of the day, it’s a bit of, sort of a bender-financing type of situation. But if you think about it, from the perspective of whether that is going to help the eurozone countries economies improve in productivity and therefore salaries improve in competitiveness and improve in growth, unfortunately it won’t. Yes you will have deficit spending, more current spending in subsidies and in malinvestment but fortunately that is not the solution. The point that you mentioned before, is at least you will sort of hide the risk of European banks under the rug of the ECB, that is as much as you do. But unfortunately, I don’t think that it’s (30:37 Inaudible) large deficit is going to move the country into growth because it’s been running a massive deficit for many, many years and it hasn’t.
FRA: And finally, a question on the global trade. How do you see the US-China trade frictions and their effects on the financial markets and the global economy and also do you see intensifying US-European trade frictions as well… Daniel?
Daniel: How do I see, I was explaining this to my students the other day. If you have a company and you have the biggest supplier of your company, how do you treat your supplier? You treat your biggest supplier with a little bit of tightening. You demand discounts, and if somebody is your biggest client, you take them for dinner, you treat them nice, you send them presents for Christmas and so what is happening right now is exactly that, is the negotiation between the largest customer and the largest supplier. And what I see is that the rhetoric of consensus is blaming the global slowdown and the problems of the eurozone, the problems of different economies on something that has absolutely nothing to do with it. Which is this trade dispute between the US and China.
The first reason is because people perceive that the trade dispute the US and China is something that is hindering the growth of the rest of the world, and it is not. There is absolutely zero evidence that China is importing less than the rest of the world than what it needs. Actually, there is all the evidence that it is importing a lot more. China has a trade deficit with most of the rest of the world.
The second thing is that there is this perception if there was this agreement with the US and China, it would be an agreement that would sort of kick back growth and the growth mode in the global economy. We tend to forget that if there is an agreement between the US and China, it is a zero-sum game. If China starts importing more soda from the US, it means importing less from Argentina, because there is no evidence that China is importing less than what they need. Actually, there is all the evidence that they’re importing more than what they need in order to boost GDP and it’s evident in the (33:26 Inaudible) bill. The same with natural gas, if China imports more natural gas from the US, that will mean less natural gas imported from Qatar.
So, what I’m trying to get to is that this dispute is a negotiation, and that this negotiation, there will be an agreement reached. However, a lot of Europe, a lot of the excess valuations in the market, excess risk taken of the market etc. Was predicated on the idea that an agreement between the US and China would sort of change the global trend of growth. I think it’s not going to do it. The impact on it right now, we are seeing right now is obviously, you get (34:16 Inaudible) you get very low 10-year sovereign yields. So, you have flight to safety and I think that basically just the trade war has been use as a subterfuge because either we have been in a trade war since the early 2000s. Remember all of us here remember for example, the aluminum war between the Bush administration and what Obama did with for example, solar panels, all these things. Either we have been in a trade war since 2000 or we are not in a trade war now. What we have now is let’s say a less diplomatic negotiation. Will the US go after some of the imbalance afterwards, after reaching an agreement with (35:10 Inaudible), you bet they will, you bet it will. And the reason for it is the reason I always explain to everyone. You go down the street here in Madrid or in London or in Germany, any city in Germany, any city in France, tell me how many US cars you see.
FRA: And your thoughts Yra?
Yra: We are very much in agreement. You know I think this issue is far more of course than trade and it’s long overdue. You have to let the (35:47 Inaudible) whose been screaming about China’s entry into WTO which of course was all laid out by the Clinton administration and the way they were done and the rules that were crafted. In the way that China has skirted around what the WTO’s true intentions were on certain issues and it’s been long overdue. But American corporations and American businesses are not just like European businesses by the way, is not without some liability in this because they are willing to quote-on-quote sell their souls for access to a billion .3 consumers. Anything to get into that market.
So, they knew what the rules were going in, they just didn’t believe them. And I always harken back to 2009 when Jeffrey Immelt was then CEO and Chairman of GE. You know GE started pulling out of some business because they realized they couldn’t make any money in China. It was very difficult, you have to give a lot in the partnerships. So, they realized then it was not working out. These are things that some have been corrected but everybody went into China knowing what the rules were or not, what the rules were not. And the Chinese has been very astute so let me pick up more Daniel, which is I keep saying to people. If you’re right about the outcomes of China, then you should be buying Mexico. And as bad as Mexico can be with all it’s corruption, the whole concept of NAFTA which we are revisiting too was that they were going to build a North American behemoth of Canada, US and Mexico, big population and it would ensure that there would be wage pressure on US unions to keep America somewhat competitive on that basis and the Chinese disrupted it because January 1st in 1994 when NAFTA began, that’s the Chinese devalued the yuan from 5.8 to 8.7. They knew full well what the intentions were and of course that’s created the Asian contagion because you had all this capacity built in Thailand, in Malaysia, Indonesia, Hong Kong, Taiwan. Massive amounts of capacity and now the Chinese were doing their best to disrupt the whole thing anyway, which they did.
And they created what came four years later and of course Mexico suffered immediately with the- what do they call it, the tequila crisis. But if you believe that this has staying power and you’re a large global corporation, a multi-national corporation if we still use that word. When I was in school, the essence of my research was multi-national corporations, that was the 70s. Then it’s time for NAFTA investments into Mexico and actually AMLO, who is from the political left, he understands what’s going on. Can you get the corruption under control? Hopefully he can because he has a huge popular mandate, but I would look to Mexico, Mexico would tell me more about what people really think than anything else. Because there it is, (39:41 Inaudible) that sit on the northern border of Mexico, southern border of the US were built to be the key focal point of the global supply chains which China basically uprooted by design.
So, there are things we don’t have to guess at this, if we watch to see what is going on, we will have a pretty good idea. Right now, it’s not telling me. I look at the peso, I look at what’s going on in Mexico, it wants to happen. But you’re not seeing it yet. I think some people are pulling out of China because they’re fearful so they’re moving some factories across to Vietnam and Thailand and Malaysia again, but we’ll see what happens. But if you look at the value of the peso relative to when the yuan was devalued by 50%, the peso then was I think about 3.3 to the dollar is of course is 19 to the dollar so all kinds of advantages. But let’s see if they work out. I think it’s a little early to make that decision, but it is worth watching and it will tell us more about global trade because Daniel’s point about (40:53-40:56 Inaudible) so what it means is if you don’t buy soybeans from the US, you buy from Argentina, someone will buy the US soybeans. But it’s the same again with LNG but of course in the LNG issue a lot of those long-term contrasts there’s a lot of Asian financing that went to building those huge complexes down on the gulf coast. So, with that comes contractual agreements, a lot of that LNG has to go to Asia, it’s not like Trump will say we are going to sell it to Europe, no you’re not. There are long term structural agreements you will have to adhere to. There’s a lot of things going on and they’re really worth watching and now I have to go and read Daniel’s work because I’m not familiar with it, but this conversation has really elevated that for me so thank you.
Daniel: And thank you!
FRA: Great, this has been great insight and fascinating discussion, how can our listeners learn more about your work, Daniel?
Daniel: Well, the easiest way is to go to my website DLacalle.com. And obviously you can find my books on Amazon and you can also follow me on Twitter at DLacalle_IA.
FRA: Great, and Yra?
Yra: Where I’m writing as usual is at “Notes from Underground” but you can go to YraHarris.com and register for, it’s free. There’s a lot of great discussion that comes from people all over the world, it’s all about discourse and ideas and of course we’re, Daniel in the classroom, I’m in the training arena and investment arena so we try to beat the concepts around and try to create very profitable opportunities for training and investing and that’s what our goal is, again there’s no political agenda, there’s nothing else but trying to generate profitable trades and if that’s what your designs are then it’s the right place for you to come and join the discussion.
FRA: Great, thank you very much gentlemen.
05/23/2019 - The Roundtable Insight: Charles Hugh Smith on the U.S.-China Trade War
05/06/2019 - The Roundtable Insight – Charles Hugh Smith on the Loss of Confidence in Institutions
FRA: Hi, welcome to FRA’s Roundtable Insight .. Today we have Charles Hugh Smith: Author, leading global finance blogger and America’s philosopher we call him. He’s the author of 9 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 and the Emerging Economy”. His blog OfTwoMinds.com has logged millions of page views and is in the top 10 of CNBC’s Top Alternative Finance Sites. Welcome Charles!
Charles Hugh Smith: Thank you Richard, it’s always my pleasure to be on the program.
FRA: Great, I thought today we would do a focus on what many are seeing as a of loss of faith in government institutions. In particular government in general and the thesis behind this: what is driving this and what are the implications to the economy and to the financial markets.
Charles: Sounds like a great topic! I know before we started recording you were explaining that this is one of Martin Armstrong’s core theses about the next few years and so maybe you can take the lead and summarize Armstrong’s perspective on loss of faith in institutions.
FRA: Yes, he’s one of the most vocal people that are mentioning this thesis and so he sees it as stemming from a number of sources and we will explore those. But importantly also he looks at the implications of this two (Inaudible 2:01) economy, two of the financial markets and in particular movement away from public assets towards private assets. Public assets meaning anything government makes or produces like in terms of currencies, bonds whereas private assets would be equities and also things like precious metals.
Yeah, let’s take a look at what is driving this. We can break it down into a number of categories. We got growing political dysfunction, discontent, polarization at the political front that’s driving this loss of faith in government institutions. We also got economic factors in terms of purchasing power loss and you’ve got a number of charts to share on that. We’ve got also the limits of what central banks have been doing and how they painted themselves into a corner. So, we got dysfunction at the central banking point, we have also got dysfunction in government pensions. We see this happening especially in jurisdictions like Chicago or the state of Illinois, other states where municipalities are running into problems with unfunded liabilities and emerging government pension crisis in many jurisdictions of the western world. If you’d like to start off with some of your charts that you’ve shared and how you see the (Inaudible 3:54) pushing the loss of faith in government institutions?
Charles: Great, I think I’ll start out by setting two kind of contexts that seem to be global in their reach. In other words, we can look at every place from China to Japan to the EU to the US to emerging markets and find the same elements or characteristics of the relationship between the public and government. There’s a general sense of the loss of trust in the government’s narrative. In other words, the governments around the world in general are saying “everything’s fine, the status quo is working. Great for everyone and there’s very low inflation, wages are rising, and the economy is doing very well for everybody”. And we get the feeling they’re adjusting these statistics to support their narrative rather than really giving us the truth, which is probably considerably less rosy. So, we feel like we’re being either manipulated or being lied to as a means of supporting those few who are benefiting from the status quo.
Also, to kind of mask the reality that the general public has been politically disenfranchised. In other words, you go to the polls and in a democracy and you vote for somebody else, but the status quo never changes. And so, there’s that sense that we’re politically disenfranchised so if you feel that you really have lost your political voice and your financial voting power as well then you are going to lose faith in those institutions.
And so, I’m going to start with this chart of political polarization and income inequality:
We can see that the two track each other very closely. In other words, political polarization is highly correlated to the rise in income inequality. Which I think we can conclude that political polarization is just one indicator of the stress that occurs when people lose confidence in governance in general. They start trying to vote for someone on the extremes because voting for people in the middle of the spectrum hasn’t changed anything.
I have a chart here about wages and health care costs which are unique to the United States.
But I think in general this loss of purchasing power of earned income is global. In other words, globally governments are understating the loss of purchasing power and the stagnation of wages and we can see this in the worker’s share of national income which has really plummeted in the US but it’s declined even in Europe.
We’re constantly being told that everything is normal and like the federal reserve here in the US has added almost over 3 trillion dollars to its balance sheet and then it reduced it rather modestly. And it already declared that it’s going to end that reduction in its balance sheet and then call it normal.
But it’s clearly not normal so once again we have a sense that we are not really being told the truth. We’re being told what’s politically expedient to support the idea that the status quo is functioning and doing a great job for everyone evolved.
There’s the chart here I have of Financial GDP and GDP and employment.
The basic idea here is if you subtract out the financial sector, most of which flows to the top 1/10th of 1%, then GDP is in the US has actually been flat. In fact, it tracks employment which has also been flat. So once again, we’re told this statistic of GDP is up 42% in the last decade which would sort of make us believe that we’re 42% better off but in actual fact most people are worse off. Their earning are stagnant and they are not 42% better off. That there’s all the gains that have been registered are in the financial manipulation sector and those flow to the top of the wealth power pyramid and we see that in this chart of The Fruits of Financialization.
Most of the income gains over the last decade flowed to the very top of the wealth pyramid, the top 1/10th of 1%. So, is there any wonder why people have lost faith in institutions when you look at all the things that are going on in the real economy that the government is attempting to mask or hide or massage to fit a simplistic and false narrative.
FRA: That’s a great chart and you got some others as well that shows at the same time the overall loss in purchasing power and how income is just not keeping up with rising expenses.
Charles: Right, and so when I hear you describe Martin Armstrong’s thesis, then it includes this idea that the loss of faith and institutional failure is going to occur first in Europe and possibly Japan and that would trigger a massive capital flow into the US, which despite its own loss of public faith is still in better shape economically than Europe or Japan. Maybe you could describe that, how loss of institutional functionality and loss of public faith is going to drive capital flows going forward.
FRA: Sure, so what he is saying is that the highest level is just a movement from public assets to private assets. The idea that if you’re into government bonds or government-based currencies, there will be a movement out of that, away from that and more into equities and into things like tangible assets, precious metals. As you mentioned, with the US being relatively OK compared to other countries due to the fact that they’re willing to kick the can down the road with more money printing, more quantitative using. They could be the last to go in terms of an emerging financial crisis phase 2.
So, what he sees as a scenario of developing where things happen first out of Europe. Europe especially by the problems with the euro currency, there is no fiscal union there. The European central bank has reached its limits of anything it can do. A lot of countries have borrowed from each other. There is a significant amount of debt, emerging pension crisis there as well at a significantly worse state than even with the situation in the US and so what he sees is an emerging euro crisis in Europe, in the European monetary union resulting in overall movement away from the euro and towards the US dollar. Also, this is being driven by a strengthening US dollar due to US dollar denominated debt internationally, so that’s likely to make things worse. We saw today emerging market currencies breaking down different countries as well so it’s all happening quite rapidly now. The end result as you see is an international capital flows towards US markets, US equity markets as well as non-European monetary union markets. So, Switzerland, Scandinavia, Norway, as well. There’s some movement there but generally overall to the US equity market.
Charles: I think that’s fascinating and you know I’ve been a dollar bull for many years which was often an unpopular view. Because people look at the problems in the US and they kind of extrapolate those problems and then they declare that the dollar should collapse right, and in actual fact I think it’s the opposite as you’re describing. I think we can quantify this a little bit in a couple of ways and I’d like to talk to that if we could. If we look at the yields on government bonds, of course the US’ is really up there. You could get almost 3% still compared to getting a quarter of a percent or half a percent elsewhere so it’s just makes financial sense to lock in a higher yield if you can right, if you’re a global money manager.
If you see what you described, which is the US dollar shortage. A scarcity since there’s so much money has been borrowed, denominated in dollars so there’s a global demand for dollars. It’s simply not there for the euro, yen or yuan. It’s just- none of those currencies have been borrowed basically, as heavily as US denominated debt so you’re actually getting a double benefit here if you buy a US treasury because you’re going to pick up any gains in the dollar as the dollar appreciates against other currencies and you’re going to pick up the higher yield. So, there’s that and then if you look at just some of the really basic measures of US central bank leverage and like for instance if you take the balance sheets of the central banks and you compare them with the GDP. You know the US is relatively low, the GDP is 20 trillion and the Feds balance sheet is 3.5 trillion or so. By any measure of generalized security of the economy and the banking system in the US is definitely less leveraged and has more buffer if you will, compared to these other economies. For instance, even China where everybody is feeling very confident that China is growing again and so on but they have over 40 trillion in debt and their GDP by some measure is still smaller than the US so they’re really leveraged out there.
And the other thing we talked about really quickly before we started recording which is that the eurozone is one mechanism right, the shared cross-border trade and employment flows and that kind of thing, the reduction of tariffs and so on. But the euro as a currency is another structure and that many of us have felt for years is flawed because it extends this currency to completely different and diverse nations and there is no fiscal controls over that currency. So, it strips away the power from individual nations to adjust their economy by letting their currency weaken. And it really doesn’t seem to work on a fundamental level. So maybe we can say in a way what many of us have been talking about since 2011-12 crisis in the eurozone. That it’s finally getting to the point where stuff is going to start breaking.
FRA: So, this all is contributing to central banks dysfunction to the point of coming out towards a loss of faith in government institution all of the result of going in that direction. The bond market, especially in Europe is just totally dysfunctional from the European central bank. They have gone to negative interest rates and the limits of what they can do by a quantity of using the same thing in Japan. Those two areas in particular seem to be problem points. At the moment, much worse than what the US situation is.
Charles: Right, and you know I think this is a great comment you just made about the limits of monetary easing policy, of lowering interest rates and buying assets. And so, then the other way that governments attempt to solve problems is through fiscal stimulus. They try to borrow 5% of the GDP or something and flood their economies with government spending. But if your bond market is dysfunctional then you’re not able to sell bonds and support this kind of very high fiscal deficit spending to boost your economy that way. If the bond market stops functioning then governments wouldn’t be able to spend so how do we call it, so generously by borrowing money in the bond market. So that I think could be a real problem and of course people are always looking at interest rates but if nobody wants to buy the bonds and then the central banks is having to monetized the bonds for the government to spend on fiscal stimulus, where is the limit there and of course many of us have looked to Japan and said, well is there any limit on how much money the central bank can monetize government debt. So, we may be running into those limits as well.
FRA: Exactly, and there’s one chart I’d like to contribute as well. It’s from Gallup done a little bit earlier this year, where they did a poll of Americans trying to name what the greatest problem facing the US.
35% of Americans named the government, poor leadership or politicians as the greatest problem facing the US. This number has been increasing over time, there’s a great chart they have from their poll that we will have available on the website. We chose how in the early 2000s that number was only around 8%, 9% range, 10% and it’s just steadily gotten worse over the years, increasing to about 15% in 2010-2011 up to about 20% in 2013, 2015 and then more recently going much higher so from 25 to 30 to 35 currently. And Martin Armstrong also made a point of this, that it was back I believe in the Civil War that once the number gets up to 45% (Inaudible 20:54) or say the revolutionary war against the British. For revolutions to happen, the number gets about to the 45% range, that’s when things happen so we are not that far away from there, between 35%-45%.
Charles: I just want to mention antidotally that this loss of faith in institutions, I think arguably is extending even beyond government. In the sense that say higher education, admission scandal in the US, where private institutions as well as public universities have been caught up basically in this corruption scandal. I think people are looking at even private institutions and feeling that they are no longer trustworthy and so It’s like an erosion of the entire social contract.
One other quick comment about government, loss of faith in government is: I live part-time in California and you know California has very high taxes on virtually everything. I mean it’s got one of the highest sales taxes, really high property tax, really high-income tax and very expensive fees for everything having to do with the state and at the local government. And yet, they’re throwing billions of dollars at things like traffic congestion and public education and homelessness and yet none of these things ever seem to get better. And people’s day-to-day real-world life, they look at that. They’re sitting in tremendous traffic congestion, they’re standing on the subway, they’re seeing all this public infrastructure crumble or decay or simply not work very well and yet they’ve cast billions and billions of dollars’ worth of bonds, taxes keep going up.
And so, there’s a sense I think that’s growing that the government is incapable of solving the problems whether it’s from corruption or incompetence or the problems are simply unsolvable. Whatever the nature of it, people are now saying the government is no longer functioning. So, when you use the word dysfunctional, I think we can apply that extremely broadly. Like people don’t really care if it’s not dysfunctional from personal corruption of the insiders, they knew about that. Or some other insider sweetheart deals or whether it’s just general incompetence. And so whatever the cost people are no longer believing the government can do what it’s supposed to be doing for them and they don’t have a representative voice. They feel like in many states like California, it’s a one-party state right, it’s basically like the equivalent of the Soviet Union or some other communist regime. There’s one party that rules and even in other states that supposedly have two-party representation, whoever you vote for nothing ever gets better. And I think that sense is very wide spread. Which is why these outsiders have won elections in France like Macron, the Ukraine and Italy, around the world people are sort of desperate for representation that they are voting for complete outsiders, people that are outside the party system and so on. We are seeing I think lots of signs of that loss of public faith.
FRA: Exactly, this is a global phenomenon resulting in throwing the encumbrance out everywhere so it’s politicians that have not been career politicians but maybe candidates like in Italy, in the Ukraine that are actually getting elected now so it’s actually a global phenomenon. In your recent book “Pathfinding Our Destiny”, you actually highlight also how government is captive to special interests in big money, threatening the democracy so there is a lot of issues there where it’s driving that disenfranchisement feeling amongst the citizenry.
Charles: Absolutely, we see just example after example of some wealthy, Silicon Valley type or corporation pouring millions of dollars into some lobbying and hiring hot-shot attorneys and so on to basically change the regulatory structure in Washington to basically let them continue to do whatever they need to do to maximize their personal profit at the expense of the public interests. People are obviously- it’s like how you can look at this and not lose faith in these institutions. And a lot of people say the government has always been corrupt and there’s always been private money and it’s a little obvious, but I think the average person is unaware of the explosion. That it’s like an order of magnitude increase in lobbying and money pouring into these politicians’ campaigns and into lobbying. And so there used to be I believe, I don’t recall the exact numbers, but you’ve probably seen the same statistic that there used to be several hundred lobbyists in Washington D.C. and now I believe there’s something like 12,000. And you know they are all just giving away millions and millions of dollars and so something we touched on and I’ve touched on in my book is the system is breaking down because centralization itself is the problem.
If you aggregate all the power and capital into the hands of a few people at the top, where there be government or government private, then they are very liable to corruption and policy errors because you are not drawing upon the expertise you get if the system is decentralized. Where local communities and smaller banks and so on can solve their own problems by being flexible and adjusting and adapting to their local realities. I don’t think that you can say, and this is my personal opinion, I don’t think you can say “oh if only we elected a comedian here or something that the problem is going to be solved. I think that the government is too powerful and has too many controls over capital to be anything other than dysfunctional.” And I think people are starting to awaken to that that it’s the government’s structure, it’s not just who we elected that really just turns out to not really matter that much. Whether you call it the deep state or central state or whatever. So, I think what we are really talking about is a structural problem that has not yet been recognized.
FRA: And in your book you mention that to find that way to a better destiny we must create new localized structures, optimized for resilience and adaptability. As you just mentioned, something that is more flexible, decentralized, sustainable, democratic, opportunity for all, type of characteristics. How can we do the transition from where we are today towards that?
Charles: I don’t want to be cheating here but I want to mention that you and I are going to be talking about agile technologies in our next program next month. But I tend to think that there is going to have to be a disruption of the centralized status quo to kind of open up some room for other solutions. So, you know this crisis we are talking about where people just lose faith in the bond market and then that breaks down and then government funding breaks down. That when these large-scale centralized structures break down, then people are going to be more open to trying some other solution because you know human nature being what it is, if you can just kind of stick with what you know. The devil you know is better than the devil you don’t know. So, people would stick with the dysfunctional system until it breaks down so it’s like too bad, that’s probably the way it’s going to be. But we may need to have a financial and governmental crisis which will open up peoples minds really and willingness to take a look at some more decentralized solutions.
FRA: That’s the way forward as you conclude in your book, that better options are available if we are willing to explore.
Charles: Yes, that’s right.
FRA: Well it’s been a great discussion Charles, and how can our listeners learn more about your work?
Charles: Please visit me at OfTwoMinds.com, there’s free sample chapters of my book and extensive archives. Take a look, it’s all free!
FRA: Excellent, as you mentioned for our next discussion we will go into more detail on actual solutions, technologies that are happening that can be put in place to help meet your vision of a more decentralized, sustainable and democratic institution where there can be an increase of faith in those institutions.
Charles: Terrific summary for next month. Well, thank you very much Richard!
FRA: Great, thank you Charles!
04/01/2019 - The Roundtable Insight: Charles Hugh Smith on the End Game for Monetary and Fiscal Policies
FRA: Hi! Welcome to FRA’s Roundtable Insight .. Today we have Charles Hugh Smith: Author, leading global finance blogger and America’s philosopher we call him. He’s the author of 9 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 and the Emerging Economy”. His blog “OfTwoMinds.com” has logged millions of page views and is number 7 on CNBC’s “Top Alternative Finance Sites”. Welcome Charles!
Charles: Thank you Richard, always a pleasure!
FRA: Great, I thought today we’d discuss a couple of topics that are currently on your mind, based on your recent blog writings. In particular there is two. One is called “Politics has failed, now central banks are failing” and the other is “The coming crisis the FED can’t fix: credit exhaustion”. And they’re very much related so I would like to explore that, what’s going on, why are these trends happening, potential implications for the political landscape and the investment landscape. So Charles, can you give an introduction on these two blog posts and how you see them relating?
Charles: Ok, to me these are timely topics as we look around the world, we see that politics is failing in Britain with the whole controversy- convoluted controversy over Brexit. Then we see in France, we see the yellow vest movement and here in the US we have seen Russiagate and all sorts of manifestations of a failed political system.
And so, I think my key point that I want to start with is: If our politics was able to fix what was broken in our economies, then we wouldn’t be relying so much on central banks. But you know, so what’s happened is our political system is dysfunctional and incapable for a variety of reasons of actually solving the problems that are systemic in our economy and society. And so, the politicians have kind of punted- you know, they passed the baton to the central banks and said, ok now you guys fix it with monetary policy and the problem there is twofold: Monetary policy is only at two levers. You can buy assets, and then you can use that mechanism to adjust interest rates.
But you really can’t affect social policy or how money is spent in the economy. It’s a very simplistic limited model and so the central banks have responded to this political pressure, like do something to fix the economy, especially in the great global financial meltdown of 2008-2009. So the central banks did what they could, which was drop interest rates to near zero and then flood the financial systems with liquidity and credit and we have to remember, those of us who are following this kind of thing, we have gotten kind of accustomed to these tremendous amounts of credit and liquidity that were put into the financial sector in the crisis era. I believe the number is the federal reserve basically backstops 16 trillion dollars of credit and liquidity that it put out to other banks around the world and then of course it created almost 4 trillion dollars here in the US which it used to buy mortgage backed securities and treasury bonds.
And so these are immense sums of money and so they have had an effect but they have had a perverse and unintended effect, which is they have created incredibly difficult-to-reverse income and wealth inequality and of course we are talking about financial repression here right, is that they basically made the wealthy even wealthier and by boosting assets because that’s where all the liquidity and credit went. And they actually reduced the purchasing power of the bottom 90% households earnings because creating all this money and credit did create some inflation and we can see it in healthcare, higher education, rents and so on so they basically beggared the bottom 90% and enriched the top 10% and now this is creating political blowback.
FRA: Yeah, it has exasperated the whole wealth inequality, wealth income, just in general as the idea has been to benefit those that are closest to the money more so than others so people in the banking sector, the financial sector, have befitted more through this asset inflation because essentially the financial sector has the ability to go to the central bank window and borrow at very low interest rates and then turn around and do a carry trade that perhaps even just buying a simple 10 year bond at 3% and borrowing at the 25 basis points at the central bank, then you get 2.75% for free essentially. So that has been levered up, it hasn’t really benefitted much of the regular economy, the real economy. Would you agree?
Charles: Yes, absolutely and I think a lot of financial pundits of this sort of conventional sort, they follow the thinking of the FED that the FED’s idea was to create a wealth effect. In other words, by boosting stocks which- let’s face it, have basically quadrupled in the last decade and real estate that this wealth effect would create a sense of confidence if you will, in the institutions and in the economy so that people would borrow more money and spend more money therefore boosting the economy. And because they felt wealthier and they felt that the system was working for them but the problem with that is the top 10% in America, top 10% households own 85% of the stocks so all that wealth benefit, wealth effect benefit only flowed to the top say, 6-7 million households out of 120 or 110 million households.
So, it actually narrowed the benefits into the top tier and of course if we look at income, we see that the same thing happened. Most of the gains in income went to the top 1/10th of 1% for the reasons you just described. You know that once you can acquire productive assets at bargain basement prices then you get all the income and so I see having living part time in northern California, but you see the same thing in Seattle, Portland, Denver, Brooklyn New York, Boston. In all these really high real estate markets, we see that those with easy access to credit have been able to buy commercial rental properties, commercial properties rental housing, and the rents in these places have gone up 40-50% in the last decade as a consequence of the rapid inflation of those assets.
Because there is money chasing a limited number of rental units and commercial units and so the federal reserve claim that the wages for the bottom 90% have gone up 23% or something in the last decade but then rents are going up 40-50% so the people who are least able to access the benefits of quantitative leasing, they are seeing their wages buy less and less and is creating what I calling a pre-revolutionary state of conditions where the economy is not working for the bottom 90% and is working really great for the top 10% but the bottom 90% are not only losing ground due to inflation and stagnant wages, they don’t own the assets that are skyrocketing and they don’t have political representation. This is what the yellow vest and the Brexit and the Trump supporters are all about. These are people who felt completely disenfranchised by the status quo; you know, ruling elites and so we got this mix of, and since you asked me to tie them together, we have this volatile mix here where we’re seeing the political institutions fail or fall into dysfunction and then there’s a loss of trust that we talked about last time. And then we have that combined with the perverse and unintended consequences of tremendous financial repression, soaring wealth and income inequality and a sense that the system doesn’t work for the bottom 90% which then exasperates the political sense of disenfranchisement.
FRA: And your blog post on the credit exhaustion. Have central banks, do you think, painted themselves into a corner? Are we now at the limit of central bank utility in terms of how much more credit can we create in the system if it is not moving the economy?
Charles: I think it’s a great question Richard and of course we can start with the fact that most of the new money in the economies, the market economies including China is not created by the central bank, it’s created by financial lenders who then create money when they issue a mortgage and so on. It’s very important for the economy, for the FED and the other central banks to stimulate private borrowing. They can’t or don’t anticipate or they don’t consider it a success if they have to create 100% of the credit, and so how can you create private lending?
So they did their part by lowering interest rates which stimulated real estate borrowing and pushed up housing prices and so on. But at some point, in an attempt to normalize it, at least in the US and the FED has allowed interest rates to creep up as they’ve lowered their balance sheet and so now it’s a little more expensive to borrow but there’s also a point at which now so many households can’t afford to buy the house, regardless of the interest rate because of the FED’s financial oppression has pushed housing out of range and if we look at vehicles. Vehicle prices have continued soaring every year, it’s another thousand or two on top of the existing price and so there’s been no deflation in the expensive items in a household’s budget. In other words, higher education costs are continuing to go much higher, healthcare costs continue spiraling higher and vehicles and so all these things keep going up in price and so at some point, people go “I’m not going to borrow, I decided we aren’t going to buy a new vehicle. We are just going to live with the one we have. It’s going to put too much pressure on our budget or we’ve already borrowed too much”.
So, my point here is no central bank can force private individuals or companies to borrow money. If they don’t want to borrow money, then the fed can’t force them to. And so, I think that is the sense of exhaustion. That everybody that has been qualified to borrow money has already done so and there isn’t that many people left who are qualified who want to borrow more or can afford to borrow more. And then on the reverse side of that the feds can’t really force private lenders to lend money to unqualified borrowers, because that’s the whole subprime mortgage situation that blew up in 2008. Is that most of the borrowers in the subprime mortgage sector were simply not qualified to borrow money through the conventional system and so they would wire loans and basically embezzlement and fraud was how the mortgages were initiated and originated, I should say.
In any event, so now how do you force lenders to lend to unqualified borrowers and how can you force people who don’t want to borrow anymore regardless of interest rates? You can’t, and so that is why I am calling it credit exhaustion and as the credit impulse declines, which we are seeing in China as well as other economies then the central banks are really powerless and as you say, they boxed themselves in because they already lowered interest rates and so they can’t go back to that well and there is not really much they can do to force people to lend or borrow.
FRA: So now where we stand if we have a situation where people have lost faith in the political system, government institutions and if they’ve gone to look at what central banks can do and how they can help but nothing is happening there either. Could there be a movement at this point to QE for the people, the so-called modern monetary theory in terms of helicopter money drops to finance infrastructure projects by having the central banks create money out of thin air, or even just direct from the government treasury departments. Could that come into play at this point, given all the backlash especially for helping, using QE to help the financial sector only so could there now be a movement? You know, to push for QE for the people?
Charles: I think you are absolutely right Richard, and we are seeing that with Alexandria…
Charles: Thank you, yeah, Cortez, AOC. She has come out of nowhere and grabbed tremendous media exposure for a number of reasons but one of which is the ideas she is promoting and QE for the people is certainly central to it because that is part of the new green deal which was to borrow and spend money on socially useful infrastructure as opposed to private assets and there is a certain sense, makes a lot of sense that we can go back through history and find many examples where governments funded railroads and dams and various basic infrastructure either by giving collateral, like land to the railroads so they could then borrow the money privately or by just funding it by deficit spending.
So, another way of looking at this movement I think, is that as credit exhaustion or credit saturation kicks in and private borrowing declines, then really what QE for the people is doing is its substituting government borrowing for private borrowing. As the economy spirals down into recession because private individual companies are no longer borrowing then QE for the people is substituting that private credit for government debt. So now the government should go and borrow another trillion a year and spend it and so that’s the sort of fix. And the problem with that as a fix of course, is the government, the public debt will skyrocket to the point where interest becomes crushing and Japan is kind of a lesson in both debt saturation and debt exhaustion and also what happens even at very low interest rates, now a big part of Japan’s tax revenues are just devoted to paying interest on public debt at very low, a quarter percent, not even a 1% interest and yet if you borrow tens of trillions of dollars or in their case, hundreds of trillions of yen, the interest piles up to where it’s starting to squeeze other government spending. Even if you don’t get inflation, which becomes much more likely once you borrow and spend and pump trillions of new money into the economy, even if you don’t get inflation, you’re going to reach a point where the government can no longer fund all of it’s expected activities and pay this ballooning interest on this tens of trillions of new debt.
FRA: So, you see potentially either the idea that there’s that problem of the interest servicing of debt, or at some point large inflation in the real economy in terms of the consumer price inflation?
Charles: Right, and I think the key dynamic here Richard is QE for the financial sector. That money almost all of it flowed into the financial assets that’s why real estate’s gone up 50% and stocks are quadrupled and so on is that that money flowed into financiers and banks and corporations which then bought assets because wealthy people don’t really spend that much of their income. If they get quote free money, they’re going to buy assets with it. But MMT and QE for the people, the whole idea and basic universal income is to put new money into regular households’ pockets and the vast majority of those households are going to spend that new money. Whether it’s a job for infrastructure, for a new green deal or it’s a thousand dollars a month from universal basic income. That money is going to flow into the real economy and the MMT and Keynesian proponents are working on an assumption that is questionable and their assumption is: There’s a huge amount of slack in the economy and once we borrow and spend another trillion or two a year, then the economy can easily expand and pick up that slack and there wouldn’t be any inflation.
But that I think is a theory, not necessarily practical because there is a lot of bottlenecks and limits in the real economy. There is not much more farmland you can add to the US that isn’t already marginal and there is not much more fresh water for new development. In fact, in a lot of places fresh waters on a very severe limit already and theses are just resource limits but there’s also limits on certain kinds of labor and skills and so we may get real world inflation on top of big ticket inflation that I mentioned before in healthcare and higher education, childcare and rent. And so at some point the federal government will have to, perhaps be forced to start recognizing real world inflation which they sort of suppressed with a kind of jury-rigged CPI calculation so what happens when inflation starts running hot like it did in the late 70s, 10-12% a year. And then you’re forced to raise interest rates and then that kills off borrowing and so there’s a lot of perverse incentive created by this idea that we can borrow and spend unlimited sums and it’s all OK as long as it is flowing through QE to the people.
FRA: So, what are the implications of all this politically, economically, investment-wise? So, let’s take the politics first; do you see perhaps most politicians that are offering to finance new projects and all kinds of spending type of activities?
Charles: Yeah, I think that’s one way that you can guarantee your popularity right, is because if you’re borrowing two trillion dollars a year and you’re blowing it on a bunch of stuff, that is going to be politically appealing and of course the interest on that two trillion that you borrowed and spent, that’s for later politicians and people to worry about. So, it’s one of those things, spend now and worry about it later.
But I also think we should go back real quickly to your comment about last time about Martin Armstrong’s focus on loss of faith in the institutions. As MMT and QE for the people, as it fails as it doesn’t create a zero inflation, high growth economy. As it creates inflation, it eats away at people’s purchasing power, there will be an acceleration in the lost of faith in the institutions because right now this is the big hope for the political system is if we can do this QE for the people, a new green deal then it’s all going to be fixed and everyone will have more money, there will be no more inflation, and it’ll all be good. But so if that goes, if that unravels and creates inflation, then there will be even more loss of faith in the political system because that is the political system’s big fix: Borrow and spend another trillion or two a year and so if that doesn’t work out we are going to see more loss of faith and I think there’s also going to be a tremendous loss of faith in central banks because they have been writing on the glory of having inflated a third bubble here over the last decade and so far it’s like “See, it all worked, we created a wealth effect and we saved the world” in Ben Bernanke’s phrase. So, as that starts unravelling and failing then we are going to see a loss of faith in central banks and the last thing is how do you deal with inflation when it finally does arise and there are no good solutions right?
FRA: Exactly. I mean, inflation could also be made worse with climate change so that’s also what Martin Armstrong has written about recently is the effect of climate change on particular agriculture, which could drive food prices much higher, making the overall consumer price inflation much worse.
Charles: That’s right, that’s absolutely a factor. Look at the flooding in the mid-west and the US, the recent flooding as apparently a lot of people feel it’s going to have a tremendous effect on crop yields and so there’s that factor and I think, I would sort of summarize the situation in this way Richard. When the pie is expanding, which it did in post-war era from 1946 through, let’s say 2005-6, when the pie’s expanding, everybody can get more and so then it’s actually enjoyable to be a politician because you’re basically divvying up a pie that’s getting bigger and bigger so you can always satisfy some constituency with a larger slice of the pie and it’s not a zero sum game because the pie’s expanding so everybody can get a little more and there’s of course trading but it’s all good. But when the pie is shrinking, and I think that’s what’s happening now.
The actual real world collateral and real world wealth is actually contracting, then politics becomes no fun at all because it’s become a zero sum game where to give more to one constituency or some special interest you are going to take it away from somebody else and that is why we are seeing this frenzied enthusiasm for MMT and the new green deal is everyone’s looking around going “how can we make the pie get bigger” because if the pie is shrinking then somebody’s going to lose out and that is how you get revolutions.
FRA: Exactly, and the idea of having loss of faith in government institutions at some point will very likely lead to a currency crisis in terms of having the purchasing power of the currency lower to a dramatic extent, do you agree?
Charles: Absolutely, let’s remember inflation starts running at 10 or 12% a year, people can stand that for a year but what happens over 5 years that’s a loss of over 50% and if your wages aren’t rising by the same amount, you’re losing ground tremendously. It really is robbing people of their income and so that’s I think a very serious consequence of inflation that there’s no simple answer to. And if you raise interest rates like Paul Volcker did in the early 1980s, you basically kill off your economy. And when interests go to 10 or 12 or 15%, the US economy was able to survive that blow because we had much less debt and the economy was more resilient. But the economy is much more precarious and fragile and it’s not going to survive 12-15% interest rates and so once inflation rate kicks in it’s the end of FIAT currencies and so hence everyone’s interest in precious metals and cryptocurrencies.
FRA: And how does your new book fit into this, the suggestions made in your book “Pathfinding Our Destiny: Preventing the Final Fall of Our Democratic Republic”, what are some of the suggestions you have from that book?
Charles: Well thank you for letting me summarize that; the basic idea of “Pathfinding Our Destiny” is: Only resilient, flexible systems that can evolve quickly will survive this revolutionary era that we’re entering and so if you have a static, rigid, inflexible system that is going to cling to the status quo at all costs. That’s the system that breaks and breaks down. And so, the system that is decentralized and more of a network of nodes of semi-independent nodes, that kind of system you can say is a small scale capitalism where capital and control is decentralized so everybody can shift and adjust and evolve as needed. That system is going to be much more survivable than one that is very centralized, very hierarchical, where all the control is at the top. And that’s the system that predominates around the world, both in China and Russia, the US and the EU. Basically 400 bureaucrats at the apex run these entire economies and so that’s the penultimate example of a rigid, inflexible system and so that is what the point of the book is. We need to radically decentralize political control and capital and push down the decision making and the capital so that the people can adjust enterprises and communities can adjust much more freely and quickly as conditions change.
FRA: And will this be possible, to implement some of these suggestions. Do you see this happening or what will it take for people to come to that type of realization?
Charles: I think Richard there is one positive thing, which is kind of drawing upon books, Buckminster Fuller’s insight is you can’t really reform a status quo, you basically obsolete it. So I think the technologies like cryptocurrencies and some of these other web/internet-based technologies, they are basically running an endgame around the status quo and so I think we are going to see a lot more peer-to-peer activity which is the kind of networked nodes that I was mentioning and so as the status quo breaks down, people are going to come up with systems that are decentralized by default because that’s the kind of way you obsolete a dysfunctional centralized system is you decentralize and you obsolete the system. So for instance in banking instead of going to these five money center banks, we may see more and more peer-to-peer limit and instead of relying on a government currency we might be seeing a proliferation of cryptocurrencies and possibly gold-backed cryptocurrencies and there is a lot of ferment out there, in ideas that would obsolete government issued FIAT currencies. And say in healthcare, there could be the rise of cash only small-scale clinics that just completely are outside of Medicare and the insurance sector completely and so that would obsolete all those dysfunctional high-cost systems, so I think we can look forward to a lot of information that would obsolete the dysfunctional systems we have.
FRA: Well that’s great insight and very positive view that we can end the discussion on as we have run out of time today but yes, the idea of a movement towards a more flexible, decentralized sustainable democratic opportunity for all nation.
Charles: That’s right.
FRA: Thank you very much Charles, how can our listeners learn more about your work?
Charles: Please visit me at “OfTwoMinds.com” and there’s free samples of my most recent books for you to download and read and lots of other stuff that I hope you’ll find interesting.
FRA: Thank you very much Charles!
Charles: Thank you Richard!
03/07/2019 - The Roundtable Insight: Yra Harris & Peter Boockvar On The Beginning of Central Bank Capitulation
Transcript: Yra Harris & Peter Boockvar On The Beginning of Central Bank Capitulation
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 year. He was also a CME director from 1997 to 2003. And Peter is Chief Investment Officer for the Bleakley Financial Group. 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 Richard!
Yra: Thanks Richard!
FRA: Great! I thought today we’d begin with a discussion on what’s happening in the markets, and it’s the 7th of March, we just had some news from Europe on the ECB, what are your thoughts on the announcements and ECB policy in general? We can start with Peter!
Peter: So, the ECB is basically turning into, and we saw it officially today into the Bank of Japan, and that their obsession with generation higher inflation caused them to go to all extremes of the earth to QE and have negative interest rates to try to generate that inflation, not foreseeing that what do they do if they go into an economic slowdown. Well now they’re in an economic slowdown to the point where they’ve cut their GDP estimates from 2019 to about 1 percent and they still have negative interest rates, they still have a balance sheet that’s 40 percent of the European region economy. So unfortunately, because they actually believe in the ethicacy of negative interest rates, they said they’re going to continue with negative interest rates for longer than what they said beforehand whereas before they said it ended sometime this summer. This would continue through the end of the year. Unfortunately, the European banking system is suffocating from negative interest rates and basically no yield curve and they’re basically bleeding from that and instead of giving them some sort of relief, Draghi stuck them with more blood and that’s why the European Bank stock index fell more than 3 percent today. So we’ve reached a point, today can actually be a very important inflection, where the market is not rallying on further central bank easing. It’s actually now scared of further central bank easing and if that is the case we’re in the new investing world.
FRA: Your thoughts Yra?
Yra: I can’t agree more with what Peter said and not only did the equities not rally today, gold really struggled because the dollar, as we’re talking before and I think Peter (inaudible 3:49 – 3:51) is that the strength of the dollar today kept the gold bulls in check but really what Peter talks about and what we did see is this the beginning of the capitulation of central banks to finally admitting that they really don’t know what’s going on and they’ve made such massive bets about it, and as Peter says, we’re all basically, especially the ECB, is now mimicking the Bank of Japan because it doesn’t know its way out of here. It has no concept of how it gets out of here.
What was interesting today, and I’m planning on blogging about it tonight, is that Draghi, who wasted everybody’s time for 45 minutes because you really had nothing to say and people who were surprise by what was said about the TLTRO and they haven’t been paying attention because I think this was very well telegraphed. There’s no way that they were going to be raising rates and they’re really trapped here and again they play with the numbers because now you know they’ve lowered the GDP forecast down from 1.7% to 1.1% for the Europeans Eurozone and that gives the ECB cover for what’s taking place. What Draghi did, there was a question about the euro bond and we’ve talked about this I know Peter and I’ve talked about this and with you Richard many times over the last four years, you know the euro bond and was that going to come to fruition and Draghi actually handled it by saying look it you know make me he’d love to see it but he admitted it’s a political decision. But I think that’s nonsense because it’s not a political decision; when Mario Draghi himself in July of 2012 said ‘oh we will do whatever it will take’ therefore it can’t be a political decision and the ECB sitting on this massive balance sheet, which is built on the capital key based on the GDP ratios of everybody within the Eurozone. I’m willing to wager that I don’t know when it’s going to be, it won’t be when Mario Draghi’s there, but the wish of George Soros and others is to create a euro bond and they’re going to do it synthetically by just folding the entire ECB balance sheet into a euro bond. It’s almost going to be like what Alexander Hamilton did in 1790 when he took on the debt of all the individual states but it will be interesting because it will have to take a major capitulation by the Germans. If the Germans don’t go along with it it’ll never happen and that’s what Draghi alludes to by saying it’s a political decision. If they get the Germans to do it but if the Germans go kicking and screaming the turmoil that you will see in the global financial markets will be unbelievable but this is the path we’re on but more important I think Peters point about the especially the U.S. stock market and European stock markets not being able to rally today is a sign that the market is starting to get tired of this (inaudible 7:26– 7:30). I said to Peter is Elmer Gantry and it is Elmer Gantry Mario Draghi is when they make the movie of this (inaudible 7:39 – 7:41) so that the role is really reprised to function effectively but I agree with everything that Peter had to say.
FRA: And Peter, what are the implications of this beginning of central bank capitulation? Do you see a new investment environment, as you mentioned, and what does that mean?
Peter: Well, if you believe that the valuations of assets were inflated by what they’ve done well then you should be worried. Now granted this is right now just on the equity side because fixed income is certainly rallying on what Draghi announced, particularly the European bond market where the German 10-year yield ended the day at just under 7 basis points in the 10-year yield and the U.S. is down to 2.64 so bonds are certainly a beneficiary of this, at least for now, but (inaudible 8:37) the stock market that has had a nice rally this year on the Fed backing off and hopes for a China trade deal. Well, if you take away that so-called central bank put and when I say take it away the put is still there but it may not pay out. In other words, if the markets change their viewpoint of the effectiveness of central banks to save the day then that put as I said is not going to pay out and you’ll go right through the strike price. So, I think that’s what people should understand you know there’s ten years of this, everyone’s trained to bond the dips and everything’s going to work out and all we need is a dovish comment and everything’s going to be fine and I want to make a point that this is no longer accommodation, at least in Europe, and Draghi talked about that day. This is, what they announced today, is furthering the accommodation not just keeping things steady-state and I argue that if you are going to damage the profitability of your baking sector, which is the transmission mechanism monetary policy, well then that’s not accommodative having negative interest rates for longer. It’s actually contractionary because the banks are the lifeblood in an economy and if you damage their profitability you’re going to slow growth. So again, monetary policy is not accommodative anymore it’s constructive and unfortunately they don’t yet see that in fact Draghi specifically was talking about the impact of the banks and he still was confident that negative interest rates, which I believe is I’ve said this before the dumbest idea in the history of economics, he thinks that it was an effective tool and remains so.
FRA: And, Yra your thoughts on changing investment environment? How will this affect the steepener type trades that you have been mentioning on U.S. yield curve?
Yra: Thank you Richard for bringing that up. The 530 has made a multi-year high, believe it or not, it got up to about 59.2 I think on the 530. It’s interesting that the 210 sits in here though but I think some of the bid, not some but a lot of the bid on the U.S. long end came because of this, Peter rightly points out, there was a massive rally in the European bond markets today because you know TLTRO does alleviate some of the pressure and especially with banks in Europe who are laden with their sovereign debt. Look at Italy, Italy had a massive rally, usually Peter brings this up so I’ll fill it in for him that the Italian 10-year today is actually 2.46, which is 17 basis points lower than the U.S. 10-year so we’ve had a massive rally. Well, the Italian 10-year yields actually dropped 13 basis points today off of this; it’s an amazing move.
So, we’re starting to see this play out and it is so interesting and I know we’ll get into it more because this is already one of the themes of your work Richard, is that this is all taking place while there’s a huge discussion of course on Modern Monetary Theory, which I know we’ll get to in a little bit, and the fact that these curves can’t steepen (inaudible 12:26) is just mind-boggling. But it is because the central banks are so unified I mean if you listen to Draghi’s words today and you close your eyes you would think you were listening to Jerome Powell because we’re data dependent, data dependent, we’re data dependent! So meanwhile they’re building to manipulate the data to fit whatever the policy that they really want to craft is the key to it and it will take a while. I still say that these curves are going to steepen, we saw a little inversion on the shorter end of it but I think that is really one of the elements that is frightening the Fed here and now they’re all getting in line because as much as what Draghi did today in Europe, to me he absolutely trapped the Fed here because with the Europeans now pivoting back towards not tightening, the Fed cannot possibly tighten and we’ll certainly hear. I’m waiting, while we’re probably recording this, it wouldn’t surprise me to see Donald Trump come out and say you know we’ll wait for (inaudible 13:39 – 13:40) and it’ll be complaining if the dollar is too strong the Fed is too tight yada yada yada and but Draghi has trapped out. The Fed can’t move and of course we had Lael Brainard whose as political as Trump is as far as I’m concerned directly monetary policy talk about that the slowing global growth is a reason for the Fed to hold its fire. So, we have a lot of things in play here but we should certainly hear from the president maybe we’ll wait until after tomorrow’s unemployment number but it is very interesting.
FRA: And if we look at what’s happening in China with a slowdown there and a massive debt problem, could there be a Chinese currency yuan devaluation to address those challenges and what would be the effect on Europe? Could that exacerbate the situation in Europe? Peter?
Peter: I actually I don’t think that the Chinese want to do that. I think well first of all the pressure from the U.S. would be extraordinary and I don’t think they want to invite that and I think number two well maybe a weaker currency is inevitable in China with all their imbalances on the trade side, the current account is going negative, the amount of debt that they have, balanced payments shifting so the weaker yuan may happen anyway but I don’t think there’s going to be an intentional devaluation. It would be more market driven because I think the Chinese know over time they’re going to be shifting their economy away from fixed asset investment as a main driver and more to the services side and consumer spending. Well, they need a stronger currency for that or least a stable one. So that’s how I would put it.
FRA: And Yra, your thoughts?
Yra: I think Peter is absolutely right. If it happens it’ll be because of things around it because I don’t think the Chinese really they don’t want to run a follow of I’m not going to say Trump but Lighthizer and Lighthizer’s one of his favorite tools is currency valuations and I think the Chinese understand that they’re not looking to tangle with Robert Lighthizer and I don’t think it’s in their interests. You know if you’re trying to pivot your own economy into more domestic consumption you don’t want a weaker currency. A weaker currency is not going to (inaudible 16:16 – 16:17) so I agree with Peter. I think that’s not what’s going to be a catalyst and Europe has just enormous problems, political and economical. Well the political I think is really is affecting the economic and they don’t have an answer to it and again going back to the Draghi press conference today, he talked about you know the necessity of a banking union in the capital markets union, which of course is the creation of a euro bond. They did this all backwards and you’re paying a price for (inaudible 16:51 – 16:53) and it will be interesting the way this plays out. But their situation with China is of course you know also spills out from Germany because the Germans are major trade partner with China they do huge business there, there’s the high-end engineer products that Germany does produce especially when it comes to machine tools and automobiles and always have done very well so there’s so much (inaudible 17:30) but I don’t think that the Chinese are looking to depreciate the currency. They don’t want to wrath of the world right now. In fact if anything they’ll avoid it because they’d rather divide and conquer the U.S. and today was interesting because of course we had the Italians come up, which the Italians are interesting to watch now because they came out in support of the Belt and Road Initiative, which angered everybody in Brussels and Washington and other places and it’s interesting to see how the Italians are so in depth now and sticking their fingers in everybody’s eyes in order just to raise the heat on a lot of different issues but I don’t think there’s any need for the Chinese to play with their currency at all.
FRA: Okay, let’s move on to a discussion of Modern Monetary Theory MMT. What is it and could it be applied to infrastructure of spending? Does it make sense to do that, what are the issues and concerns around MMT does it make any sense? Peter?
Peter: It’s more crackpot economics in Keynesian economics to the extreme that money grows on trees and we can use that money that grows on trees and spend it any which way. The problem is it assumed that we have like a closed economy and that foreigners who hold a lot of dollars they’re not going to be bothered by all the money printing. It assumes that we have all these excess resources that can easily be utilized to carry out whatever spending initiatives we have. So yeah let’s print money and go fix roads and bridges well where are the workers for that? Well they’ll have to come off the lots of housing construction. Well then whose going to build the houses? I think and also its potentially hugely inflationary and that you know there’s a fixed level of supply for things and you just spend money that falls from the sky well then that demand will overwhelm supply and you’re going to get much higher inflation. So it’s economic nonsense but you know we live in a world with a lot of economic nonsense.
FRA: And Yra, your thoughts?
Yra: Well I mean there’s so many ways to go at this. Peter you know who was after that way and I agree with that and yet you know I’ve spent a lot of hours trying to look at this and trying to understand this because what am I missing here because I said well it’s getting so much play and actually the proponents of it have gotten exactly what they want because the fact that we’re sitting here discussing it which pales to the fact that Krugman and Rogoff and Summers and now they’re thinking of that there is some giants who are having who are being forced to respond to it so they’re getting a lot of play which is what you know probably part of their issue was. It was interesting today too and this didn’t surprise me to see Paul McCulley who a PIMCO Fame, in fact I’d argue was really the great brains behind PIMCO all those years, Bill Gross would probably take umbrage at that, but I had a lot of respect for Paul McCulley but Paul McCulley came on said well you know what don’t just brush this off so rattle it so quickly there may be something here to it which didn’t surprise me because one of McCulley’s (inaudible 21:23 – 21:24) going back a couple decades is the Keynes concept of the paradox of thrift and was one of the big issues from Paul McCulley.
And the MMT discussion actually falls within that paradox of thrift and how to counteract it, which you know Maynard Keynes was very worried about it because when you anticipate that when things have feedback loop that turns recessions into depressions as people start to save more and demand diminishes dramatically that as you save more there’s less investment and there’s less activity in because nobody’s investing because there’s no demand. So, I could see how McCulley would go that way I just cannot wrap my head. The more I think about it the more ridiculous it becomes and as Peter rightly said the biggest flaw in it is that it depends upon its models built on a closed economy. Well, the United States the dollar is the world’s reserve currency. With that it comes with a fiduciary responsibility and the MMT argument is the most irresponsible form of economic action that I can imagine and it’s you know what but it doesn’t surprise me because it mimics what the Swiss National Bank has done. You know that was going to be the problem is that you cannot create a perpetual money machine. If that’s the case then you know what I may as well quit working, take on as much debt as I can and then wait for them to print money because what’s the difference? So you’re basically telling me that wealth can be created merely in a printing press. Well, if the wealth can be created as a printing press then what are we all working so hard for? And you know what, nothing then matters so I just I can’t get there and I keep trying to struggle as to where these people come from and I know that as Eric Peters pointed out in Ben Hunt that one of the major flaws in this says that it depends upon a engaged and enlightened electorate. I mean that’s what Warren (inaudible 23:54-23:55) talked about and if you think that’s what we have well we’re really in trouble. So I am really I’m nervous about it because the biggest flaw to me of course is that it breaks down the firewall between monetary and fiscal policy and puts it in the hands of one political entity and that should make all of us nervous so I am not a proponent.
FRA: And along with this discussion is usually mention of debt and deficits. Do they matter or should we overlook it or downplay it? When will this become apparent in interest rates in a bigger more apparent way an accelerated way in terms of rising interest rates and U.S. dollar weakening? Peter?
Peter: I mean we’ve been trying to figure that out for 30 years and it was the 1980s when people we’re talking about the exploding budget deficit and rising debts, so it’ll matter when it does and it doesn’t matter until it does and trying to figure out when it does is is really difficult. I mean it mattered in Europe in 2011, 2012 and we saw a spike in yields, an increase in the periphery. It certainly mattered last year when Italy when you saw basically a crash in the Italian bond market. When it’s going to matter for the U.S.? I think it begins to matter not necessarily initially from a market perspective but when interest expense starts to take up a greater portion of the budget and starts to crowd out other things. I think that’s when it will get a lot of attention but until then I’m not really that sure I mean I do have to say well you know Treasuries are rallying today for example in the ten year is down to the 2.64. The 10-year yield is 2.40 at the end of 2017. So here we have a global economy that’s clearly slowing. We have a stock market that hasn’t done anything in basically a year and yields are actually still higher and you know and then that’s with German yields back down again, that’s where the Japanese ten-year below zero again and U.S. yields are still higher so I’m not sure yet what that means I don’t know if that means that people are beginning to care and that the Fed is no longer buying and foreigners have dramatically reduced their purchases of U.S. Treasuries and the Chinese and the Japanese aren’t buying any and we’re beginning to push back against these rising debts and deficits that remains to be seen. But it is something that we should pay attention to because you know nothing matters nothing negative matters when you’re in a 35-year bull market which is what we had in bonds but maybe if things have shifted and it’s no longer a bull market maybe things like debts and deficits actually do matter but timing wise that’s really difficult.
FRA: And Yra, your thoughts?
Yra: I agree with Peter it’s well said and I just look around the world and yes I know people are chasing yields and I shouldn’t I talk to people and I go why would you buy a 10-year note? I said why would you have somebody buy a 10-year note? If I’m wrong and I’ll speak for Peter if he’s wrong about what is going to take place here, what is it going to cost you if I moved everything into a 2-year Treasury from the long end which actually Rogoff talks about to, what’s it costing me? 15, 16, 17 basis points to take on that shorter duration with all the uncertainty and with the growing debt levels? MMT’s music to Donald Trump’s ears because if none of this matters well spend freely and again you know I’m always bothered by the fact that we’re running a trillion dollar deficit in a time you know as the White House would say a booming healthy economy. But there’s something majorly wrong here and then as I maintain the MMT crowd, whose an anti-trump crowd, is actually forming the runway for him to do whatever he wants so I don’t even understand the politics of it and I don’t think they do either, they haven’t thought it through. So there’s so many things afoot here but if I was a foreigner sitting out there and I’m sitting on lots of dollar assets, I would be moving the short end as I could be if not moving totally out of dollars because this discussion the fact that this discussion has reached the level that it has, when I say level I’m talking about the fact that you have some of the top economists the giant’s in the Neo-Keynesian role of economics, people who have won Nobel prizes entertaining the discussion I would be starting to move out of dollar assets just as a safety mechanism. They sit here and I’m not sure whether it’s just the algorithm. I’m not sure what this is but for doing this for as long as I have I scratch my head and I go people are acting very very irresponsibly by not moving and getting ahead of this and waiting for the events to unfold and then it’s going to be a sorry world.
FRA: Fully agree. Recently an Australian economist Satyajit Das wrote about the risk of collateralized loan obligations. These are securities consisting of a pool of loans organized by maturity and risk typically. These CLO’s a lot of them have been purchased by Japanese banks. Do you see this as a risk to the financial markets and the Japanese financial system? Peter?
Peter: I don’t see it as a risk to the system. I see it as an area where there’s been access and in response to lower interest rates and the leveraged loan market is now bigger than the high-yield market and when you have a search for yield you have investors that don’t make the best decision and if this financing spigot gets turned off, because the cycle turns and companies with too much debt and not enough cash flow get hurt, well then there’s going to be a credit crunch and there’s going to be a credit crunch across the spectrum. So that’s the risk and a lot of the credit quality is weak, the covenants are non-existent and this is an important area to focus on and like I said this was an area of access this time around. So you have total business debt, whether its corporate or partnership or private or whatever, as a percentage GDP is the highest on record not including the recession in Q1 of ‘09 and yeah that’s going to matter at some point and you know as he (inaudible 31:28) pointed out, households balance sheets have improved in the cycle that’s where the access was though last time and the excess outside of sovereign balance sheet is certainly in the corporate balance sheet. And that’s why I’m expecting a focus this year on deleveraging and that companies are going to be focused on improving balance sheets and that every conference call you will be hearing the CEOs being asked ‘what are you doing to improve the balance sheet’ so you’re going to hear a lot more about that. Now some companies will be able to get away with that and they’ll be able to cash flow their way to a safer spot but there are going to be plenty of businesses if the slowdown continues that are just going to choke on too much debt.
FRA: And your thoughts Yra?
Yra: Exactly where the world sits right now and I find it more troubling that here in the U.S. rather than building up those counter cyclical buffers that even the Fed voted you know to provide some relief with. I just don’t understand it because you have government quarrels in his role as chair of the Financial Stability Board or actually I don’t know if he’s the chair but he has certainly an important position there they’re talking about this and yet they’re rolling back, their lightening up on some of those rags and that’s the wrong ones. The banks should be building these counter cyclical especially now that your profits are up even though of course some of these policies are so stupid from a central bank perspective (inaudible 33:14-33:16) domestic bank earnings but I would not be rolling back these counter cyclical bluffers I’d actually be mandating that the banks actually roll up their capital base as long as they’re going to be walking down this road. I think it’s not a healthy sign and you know it’s not like the banks are in such great shape. I was showing some people I said you know if we went back 12 years (inaudible 33:39-33:42) is 10 percent the value that it was 12 years ago because they did the reverse split of one to ten. So, the stock trades is sixty-two dollars well on a split adjusted basis it was six hundred and twenty dollars so the banks have really not you know some of course you know that’s a broad brush but a lot of the financial institutions they’d never regained the stress that they saw prior to the onset of the financial crisis. So and these outstanding loans as people are chasing yields and leveraging themselves up in order to find greater returns are very problematic especially with the global economy slowing.
FRA: And finally, what are your thoughts in terms of the other risks to the financial markets and the economy do you see that we haven’t covered as yet? Peter?
Peter: I think one of them is maybe there is a day when the ECB, because it won’t be Draghi because he’s gone in 6 months, that the central bankers wake up and say you know what negative interest rates was a really bad idea, we’re killing our banking system and we need to get out of it. You know problem is that that would tank and pop the balloon of the biggest bubble in the history of the world, that being sovereign bonds and negative yielding securities, which total depending on who you look at eight to eleven trillion dollars and a lot of these banks in Europe hold a lot of these bonds. So, from a systemic and earthquake-type risk it’s that in my opinion.
FRA: And finally Yra your thoughts on that? Other risks that you see?
Yra: Well you know it comes back to the banks and it’s interesting that now the BIS is starting to relook at it again and the fact that these European banks, the domestic banks, are stuck to the (inaudible 35:57) with their own sovereign debt because they carry the zero risk waiting. Are you going to tell me that (inaudible 36:05) 10-year are zero risk weighted? I mean, in what world could that possibly be accepted in the world of the Jabberwocky of Draghi going down the rabbit hole with all the other central bankers. It’s insanity and that’s a serious issue because if you were to change that, which it needs to be changed, the hit to the bank capital would be dramatic but this needs to be dealt with because there is no way in this world that all sovereign debt should be zero risk weighted as an asset just no way and especially with this conversation of MMP. That is ridiculous because you are now telling me that you and if the conversation continues to grow the impact is just going to be phenomenal and you have to deal with this now so I’m right in line following Peter and this zero risk waiting is a very very very dangerous systemic risk and it has to be dealt with by the regulators. Unfortunately the regulator’s are the same one who are benefiting from the fact that you know sovereign bonds are zero risk weighted because it makes them a desirable asset from a lot of different participants. So, there is a very ugly relationship that goes on there and it is systemically very destabilizing.
FRA: Wow great insight gentlemen! How can our listeners learn more about your work? Peter?
Peter: They can go to bleakley.com and reach out to me if they need any help with wealth management and managing money where they can read my daily work at boockreport.com.
FRA: And Yra?
Yra: Just notesfromunderground or yraharris.com and of course these podcasts which I think you know provide a lot of good inside and that’s the feedback I get from people around the world, how much they enjoy them because it brings a level of discussion that needs to be had out there and that people need to understand and get a handle on. So, the markets show great complacency and I think Peter and I would absolutely find camaraderie in the great complacency in the world and yet there are so many things in the boil that right now I’m very nervous and I think todays stock market action should send off some concerns of that but again notesfromunderground and keep reading Peter’s stuff because he’s on top of this stuff as well as anybody else’s.
FRA: Great! Thank you very much gentlemen! Thank you!
03/01/2019 - The Roundtable Insight: Charles Hugh Smith On Debt & Demographics Leading To Government Crisis and Financial Repression
FRA: Hi, welcome to FRA’s Roundtable Insight .. today we have Charles Hugh Smith: author, leading global finance blogger and America’s philosopher, we call him. He is the author of several books on our economy and society including “Erratically Beneficial World”, “Automation, Technology and Creating Jobs for All”, “Resistance, Revolution, Liberation”, “A Model for Positive Change” and “The Nearly Free University and the Emerging Economy”. His blog OfTwoMinds.com has logged millions of page views and is a very high at number 7 on CNBC’s Top Alternative Finance Sites. His recent book is called “Pathfinding Our Destiny: Preventing the Final Fall of Our Democratic Republic”. Welcome Charles!
Charles: Thank you Richard! I’m always impressed by your lead-in and I don’t know if I really match those high expectations, but I think we got a great topic today and will try to add some value.
FRA: Always meet and exceed expectations here, your work is phenomenal. So today, I thought we would do a discussion on bringing together a number of pieces that you have written about, on different types of trends that are happening in the economy, in the financial markets, in our society as a whole and how it all gets dotted together what are the linkages between them and where this is all going. So, we have a number of topics to discuss in this regard but just from the base, from the beginning we see demographics challenges and debt exhaustion as two of the key trends happening and can you elaborate on that based on your recent writings?
Charles: Yes, and just as kind of our context that we are talking about here is demographics are obviously sort of like long wave or long cycles. In other words, the workforce can only go up or down by so much, given that the people who are entering the workforce were born 20 years ago. So, it’s not something like debt or GDP or something. It’s not a statistic that’s a financial statistic that can be manipulated or massaged. It’s like demographics define the society and the economy in a fundamental way. And so, what would people like Chris Hamilton, who is currently writing some great work on demographics and the economy and people like Martin Armstrong and Peter Turchin, people with a long historical view. They all point to basically one issue, which is: promises that are made by the government to the people in boom times.
They cannot be met you know, once the situation starts stagnating. In other words, boom times go to low growth or slow growth or no growth right, because the workforce that has shrunk or has reduced jobs or the reduce in the work force in terms of age. That workforce’s too small to support all the promises that were made to the pensioners and to the government’s other programs and so this shortfall in wages and profits that can be taxed, that forces the government into making some sort of adjustment or attempt to fill in the gap between what’s actually affordable and what was promised and of course there is great political pressure to fulfill what was promised.
So throughout history governments has always tried to borrow money from the future in order to meet their obligations today and that can work in a very short timeframe, like if you need to borrow money from next year and your tax revenue is going up next year and borrow a little bit from the future would be OK but if your tax revenues and your overall economic picture is not growing as fast as your debt than eventually what happens is where we are now, that the debt is growing far faster than the ability to service that debt. And so, I call this ‘debt exhaustion’, some people call it ‘debt saturation’ and so what it means is then the government and the people start demanding even more adjustments and as a result it becomes visible that we can’t meet the promises that have been made. So, then the people start demanding that the government borrow more money and distribute it as universal basic income or some other kinds of programs and the government starts looking at some of it’s trading partners and going “well we need to get some more money out of trade” so then we have tariffs and trade wars. And I think what the linkage to me every so-called solution to the problem is that we no longer have the resources necessary to fulfill the promises that were made in boom times. Every one of those so-called solutions creates even more of a problem and it usually ends up being expressed in debt and social or global discord.
FRA: Yes, and that’s a theme there where this continuous, feedback loop with government getting into more and more debt trying to solve these challenges that happen. Even Illinois the other day has it going into more debt with all kinds of crises, pensions crises, what is their solution? Well let’s create some more debt. And you know, try to buy some more time. So, it’s a continuous cycle and more and more we get to this debt exhaustion phenomenon as you describe it. And then that’s also all-together with demographic challenges leading to essentially a crisis in government and that’s what Martin Armstrong has been talking about a lot recently as we go into 2020 in particular where he sees a crisis in government with the government being a problem, more of a growing awareness that government is the problem. Alongside that would be a loss of confidence in government and government institutions, your thoughts?
Charles: Right, excellent, that’s certainly a good description of what we are seeing already, and I would just want to add that one of the so-called solutions that the central state has attempted recently, which is manifested in the central bank policies as opposed to the treasury or fiscal spending. The central banks of the major economies have attempted to create new growth or spark growth in a stagnate economy by financial oppression by forcing capital into risk assets and generating or inflating these asset bubbles which generate a lot of phony wealth. The house is not providing any more utility value than it was before, but it was once worth $150,000 but now it’s worth $900,000. Some of that is supply and demand and a lot of it is phony wealth that was created by financial oppression and so those people who own the assets that have been heavily inflated of course have benefitted greatly and the people who don’t own those assets have not benefitted from those policies right, and so we know that it’s a fact that roughly the top 10% of US households own 90% of all financial and capital assets. And so that concentration goes up to where you know, 5% of the households own something like 80% of the wealth in the US and I think that’s paralleled in a lot of nations, especially in China. You know that the wealth is generally held by a relatively small percentage of the population. So that wealth inequality which has been driven by central bank policy then creates even more social discord because the have-nots look at these policies that are so blatantly unfair that they favor speculating capital over other kinds of capital investments and over labor and so then they demand redress. So these are the demands for free health care, free higher education, debt forgiveness, universal basic income and then the question becomes: how is the government going to pay for these trillions of dollars and so called QE for the people and you know those demands we understand where they come from right, and in other words this financial oppression does favor a specific form of speculative capital over all other forms of capital and labor so it is unfair and so people are responding to that unfairness but how is the government going to fund that out of a dwindling tax base?
FRA: Yeah and another example of that is how those who are close to the money could be able to borrow from central banks at very low rates, 25 basis points for example. And then turning around and buying bonds paying say, 3% so you’re getting 275 basis points essentially for free. Now you and I can’t do that but those that are close to the money the banks in particular commercial banks are able to do that and then there’s a leveraging process that goes along with that so that has exacerbated the wealth inequality and income inequality.
Charles: Yeah, absolutely and there is another mechanism here that since we’re talking about debt and as peoples’ earned income has stagnated as a generality at least for the bottom 90%. Then they’re borrowing more right, and we see people borrowing huge amounts of money for higher education, for college and for vehicles that are now very expensive, 35 or 50 thousand is not an unusual price anymore, as well as credit card debt and so this- all this debt, whether public, private or corporate is actually sapping the ability of those entities to save and invest in the future right, because as more and more of your income goes to servicing debt you have less and less to invest and so depending on debt for this cheap, easy shot of growth in the present is actually strangling income and investment in the future. And so, where does real wealth arise? It arises from increasing productivity that requires massive investment and skills and equipment and other forms of capital so if you’re basically over-borrowing in the present to fund today’s promises you’re basically strangling your economy’s future hopes of generating higher productivity because the money to invest simply won’t be there. It’s all spent on servicing existing debt.
FRA: And so instead of taking that avenue and the solutions that you detailed in your current book, “Pathfinding Our Destiny: Preventing the Final Fall of Our Democratic Republic”, we seem to be on a different path and that is towards populism, polarization, extreme political views in both directions, to the far right, to the far left. Extreme type of suggestions like universal basic income and MMT, all requiring more spending and more debt as you mentioned. And in particular we see now movements to the far left, as far as socialism is concerned with the millennial Alexandria Ocasio-Cortez and just recently Bernie Sanders announcing that he will be running again for president. Your thoughts?
Charles: Yeah, and again I think the core dynamic I see is the policies of central banks have increased wealth and income inequality, that’s a reality right. And so, what’s our response to that reality and of course for people who feel that the system no longer works for them, that they have been left behind then they want some sort of redress. And so, when we look at the popularity of Bernie Sanders and AOC and their degree in new deal, these are all attempts to redress this rising wealth and income inequality right. And that is understandable impulse right, we understand that. And it’s not a bad impulse in and of itself, it’s a matter of how do we reach that goal of levelling the playing field of redistributing opportunity and capital more fairly than it is now.
So what I think we are really facing is, how do we start facing living within our means, and that means demanding sacrifices of everybody in the system and why there is a lot of resentment in it politically now is people understand intuitively that a certain segment of the population that has been favorited by central banks and financial oppression, they haven’t sacrificed anything. They have actually benefitted enormously from these policies of asset bubbles so on and huge debt, huge accumulations of debt and then it’s everybody, the bottom 95% who have had to make the sacrifices of higher inflation, higher debts, stagnating wages and so on. So I think we need a reset of the system where the solutions are not to borrow more through central banks and central governments but more like decentralized, more flexible, more adaptable, more localized solutions that are more like focused on generating opportunities for everybody that is participating in the economy and trying to find ways to lower costs as opposed to borrowing more money to pay highly inflated costs for things like higher education and health care and so I think the solution set is to use innovation and innovative social policies to try to create a more adaptive, flexible localized decentralized economy. And I think that a lot of these problems will start melting away because it’s a lot harder to manipulate and impose some kind of centralized privilege on a very decentralized system and so these people of the AOCs of the world of course seeing the central government and the central bank as the source of the solution where those of us from a little different point of view see them as the source of the problem that will never be solved by borrowing tens of trillions of dollars into the future because that will eventually destroy the currency and that impoverishes everybody. Rich, poor and the middle alike.
FRA: Exactly, whether it be increasing the size, complexity and cost of government from the left or from the right. Is basically leading to similar end results in terms of loss of, decline in standard of living, loss of purchasing power and ultimately capital wealth drain and brain drain at the same time and this has happened many times in history. So, as you mentioned the answer is more as you have outlined in your new book, more of a limited centralized form of government, more efficient, increased efficiency but at the same time lowered cost of that.
Charles: Right, that’s where innovation is almost intrinsically deflationary right, in other words what was once extremely expensive becomes a lot cheaper once it’s commoditized and innovations arise in both product lines and service lines. I want to mention real quickly there is a lot of talk today of trade and tariffs; trade wars. I just want to fit that into the puzzle we are assembling here is that again as the economy stagnates, so does the government’s revenues right, and so the government is then seeking some redress, like some way to jumpstart the economy you know, or get more growth and then trade comes up. Because if it seems that some other nations are taking advantage of your nation then you want to eliminate that imbalance if you will, and bring back some of the benefits back to your own country so this is the basis of a lot of ideas about reshoring the industrial base back to America; reshoring manufacturing and so on and this is understandable and from the Chinese point of view they have the same concern. They are afraid that if they lose trade, then their economy will stagnate, and they will have all of the same problems that the older western powers are facing because the demographics are not favorable in China either in terms of the one child policy, has created a much smaller workforce than the pensioners who are expecting the government to fund their retirement in China. So, these are global issues and that may be partly why we’ve got global discord.
FRA: Yeah, and I want to mention a book that also recently came out called “The Prosperity Paradox: How Innovation Can Lift Nations Out of Poverty” by Clayton Christensen. It’s a fascinating book, I’m looking forward to getting a copy in the next few weeks here. But essentially what he suggests is a better way of approaching innovation; using innovation to help build a framework of economic growth that is based on entrepreneurship, market-creating type of innovation. So, this is his solution, very inline with what you’re saying in terms of more decentralist, decentralized form of government and being able to apply innovation. I might add also that there’s a new framework today in the economy called Agile, is also a way to help foster this innovation that is more efficient, lower costing overall for governments, so the application of agile technology to innovation in this approach that both you and Clayton are mentioning seems to be the right way to go.
Charles: Right, right, and I guess I would sort of summarize that particular aspect of what we’re talking about, is there’s you hear a lot of talk now about how capitalism has failed right, and you hear other defenses of capitalism and of course the root problem is we’re using one word to describe two different economic systems right, and so called ‘bad capitalism’ is what’s- there’s a lot of that dominates the US economy where I would call the cartel state economy. In other words, cartels which then raise their prices while reducing the quality and quantity of their services.
So, once you get a quasi-economy situation that’s enforced by the state, you get bad capitalism. You get pharmaceuticals that there’s no competition for, that can charge $100,000 a dose and so on. And that’s bad capitalism. And of course in other situations bad capitalism includes crony capitalism where corruption is rife and where the sweetheart deals and soul bids for contracts and so on and so on and this is bad capitalism; it’s not really the entrepreneurial capitalism that you are describing where entrepreneurial capitalism is based on a level playing field where everybody follows the same rules and there’s open access to capital and labor and there is competition because competition is what keeps people honest and it drives innovation and if you could just keep raising prices while producing really poor quality then you got no motivation to improve your quality. So, we’ve allowed a lot of bad capitalist situations to arise where competition’s been stifled or snuffed and there’s a lot of mechanisms for doing this. You raise regulatory barriers so nobody else can afford to compete with you and these kinds of things and there’s a lot of games that involve the central state so in other words I don’t think you can get the worst forms of capitalism that kleptocracy without a central government to enforce them. So when we talk about innovation and decentralization and agility what we really want to see is a very limited form of central government because if you allow the central government to get that much power than they can enforce monopolies for their cronies and this is what we see in industry after industry and so to have a level playing field you have to decentralize power and capital as well as opportunity.
So that’s kind of the foundation to create an agile entrepreneurial society so you have to have a level playing field like enough regulation to make sure you don’t get overwhelmed, a monopoly that ends up being enforced by the central state and you want opportunity and opportunity to gain capital that’s broadly distributed and so a centralized model just really reinforces bad capitalism and it decentralized model reinforces good capitalism.
FRA: And your final thoughts on how we can get there is the question: Do you see us happening through a crash and burn type of scenario or is there a better way, a sort of easier way to get there from point A to point B?
Charles: Well I wish there was, but actually Richard, that’s a great question because we referred to Martin Armstrong and I often refer to historian Peter Turchin and when we look back in history, history doesn’t have many examples of an easy peaceful transition from one social-economic order to the next one and so history suggests that we are going to have to go through a period of turmoil and discord that will see a reset of the system where the system breaks down. And I think what we were talking about today is a system where debt will reach levels that are unsustainable and attempts to service that debt and expand that debt will destroy the currencies that people depend on that will be the crisis which enables a reset of the entire system but it’s gonna be painful for sure.
FRA: And on that note, we’ll end our discussion for today but that’s great insight Charles. How can our listeners learn more about your work?
Charles: Please visit me at OfTwoMinds.com, you can download free chapters of my last couple books and look at my archives and I hope you find some value.
FRA: Great, thank you very much Charles!
Charles: Ok, thank you Richard!
01/31/2019 - The Roundtable Insight: Yra Harris and Bill Laggner on Global Financial and Economic Risks
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!
01/24/2019 - The Roundtable Insight: Charles Hugh Smith On Pathfinding Our Destiny Amidst Social & Political Disunity
12/17/2018 - The Roundtable Insight: Ronald-Peter Stoeferle & Yra Harris On Gold And Geopolitical Risks
11/28/2018 - The Roundtable Insight – Charles Hugh Smith On How & Why Financial Repression Continues
podcast to be posted shortly ..
11/19/2018 - The Roundtable Insight – David Rosenberg, Yra Harris & Peter Boockvar On The Economy, Markets & Investing Going Into 2019
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.
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 firstname.lastname@example.org 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 email@example.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!
10/26/2018 - The Roundtable Insight – Charles Hugh Smith On Why Many Millennials Are Promoting Socialism
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.
10/25/2018 - The Roundtable Insight – Yra Harris & Peter Boockvar On The Volatile Financial Markets & Global Risks
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;
- 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.
- 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
- Lower interest expense, which allowed companies to dramatically reduce that with low interest rates.
- 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.
09/27/2018 - The Roundtable Insight – Yra Harris & Peter Boockvar Assess Global Risks On The Economy & The Financial Markets
09/24/2018 - The Roundtable Insight – Charles Hugh Smith On Insights Into The Jobs For Displaced Workers Affected By Intelligent Automation
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!
08/23/2018 - The Roundtable Insight: Yra Harris & Peter Boockvar On Global Risks And Central Bank Policy Trends
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!