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02/28/2020 - The Roundtable Insight: Dr. Lacy Hunt and Yra Harris on the Virus and Economy/Markets Implications
02/28/2020 - The Roundtable Insight: David Rosenberg, Yra Harris, Peter Boockvar & Jim Bianco on the Virus and Economy/Market Implications
02/12/2020 - The Roundtable Insight: Charles Hugh Smith on the Emerging Repo Crisis
12/18/2019 - The Roundtable Insight: Chris Whalen, Yra Harris & Peter Boockvar on the Markets & Views into 2020
12/05/2019 - The Roundtable Insight: Daniel Lacalle and Alejandro Tagliavini on Austrian School Economics, Argentina and the Global Economy
11/30/2019 - The Roundtable Insight: Nick Barisheff on Precious Metals Markets, Trends and Outlook
11/27/2019 - The Roundtable Insight: Charles Hugh Smith on why Eastern Europe may be the Go To Place
11/04/2019 - The Roundtable Insight – Dr. Marc Faber and Yra Harris on the Markets and Investing
10/28/2019 - The Roundtable Insight: David Rosenberg & Yra Harris on Risks and Trends in the Markets & Economy
10/25/2019 - The Roundtable Insight: Charles Hugh Smith new book – Will You Be Richer Or Poorer?
09/26/2019 - The Roundtable Insight – Charles Hugh Smith Part 2 Millennial Advice on Jobs and Affordable Housing
podcast to be posted shortly ..
09/22/2019 - The Roundtable Insight – Yra Harris & Peter Boockvar on Liquidity and Interest Rates
08/28/2019 - The Roundtable Insight: Guy Haselmann & Yra Harris on Central Bank Policies & the Financial End Game
08/22/2019 - The Roundtable Insight: Charles Hugh Smith on Advice for Millennials: Low Cost Education, Affordable Housing and Where the Jobs Are!
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Charles Hugh Smith on Advice for Millennials: Low Cost Education and Where the Jobs Are!
Richard: Hi, this is FRA’s Roundtable Insight .. Today we have Charles Hugh Smith: He’s the author and leading global finance blogger and philosopher. He’s 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.” Also, most recently a book called “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: Hey, thank you Richard! Well I’m really excited about today’s topic.
Richard: Yeah, today I thought we’d have an interesting topic to talk about in terms of what is on the minds of the Millennial Generation and what are their challenges? More specifically in the areas of jobs, education, housing and in just dealing with debt and overall work-life balance. To begin that, there was a recent article today, in the Bloomberg, that actually focused on Hong Kong in terms of what’s happening there with the Millennial Generation and there is a story with a focus on an individual there working very long hours and the real estate situation is quite extreme but it’s essentially symptomatic of most of the world and so what we’d like to do today is to first identify what those challenges are but more specifically to suggest solutions and ideas that while they may not work for everybody, in some cases, they would post really good solutions to some. So, you know what we can do is maybe begin with some topics on education and then go into jobs and then affordable housing and a lot of our discussion can be based on Charles’s books… his writings on the nearly free University, where the jobs are, how technology is affecting the job scene. So just wondering your initial thoughts Charles?
Charles: Well, this is a great topic Richard and for the article on Hong Kong I think what was a key takeaway for me was that many of the protesters are Millennials and the issues are not just legal about extradition and so on, they’re about what the Millennial Generation there feels hopeless about, which is having a middle-class life and that you can be working at you know a job that’s appropriate for a college-educated person like an accountant and all you can afford is a little tiny cubby hole in an apartment that’s been chopped up into six rooms and you’re working six or seven days a week.
So, I think the way that we can describe this and it’s a global problem as you say is social mobility has decayed around the world meaning that if you’re just starting out and you don’t have any huge you know advantages from family connections or family wealth, the ladder of social mobility has become very rickety and meaning that you can work really hard, you can study hard and still come up short because the number of elite jobs, that pay enough to get what we consider a middle-class life like you’d be able to buy a house, those jobs are the competition is so fierce that the meritocracy system that prevails around the world it’s actually failing us because the wealthy simply give their children a boost and ahead of everyone else and it there was actually a new book coming out called “The Meritocracy Trap”, that describes this that elite universities used to accept 30% of their applicants now it’s a you know sub ten percent, eight or nine percent. So, it’s just really hard to establish a middle-class life and this is what the Hong Kong Millennials were expressing that they realized that their parents lifestyle and security is completely out of reach for them and that’s the core problem and I think that we’re trying to address and come up with solutions for.
Richard: Okay, so let’s start with education. So, everybody knows it’s very high and costly and there’s an issue of accreditation that you’ve written a lot about, maybe cartelized industry sector and just the high availability of very low interest rate loans has been fueling that. So, what are some solutions here in terms of trying to lower the cost of education, lower the debt that students can get into but still get a good enough education for good jobs and you know being able to thrive in today’s society.
Charles: Well, that’s a great topic Richard and I think one of the key changes that’s occurring in the economy, that’s beneficial to Millennials who were willing to step out of the conventions, is corporations are realizing that a college diploma is not really a good indicator of productivity on the job and I think one of the vice presidents in Google recently wrote a book about this that Google used to follow you know used to only hire college grads and wanted your, you know, grade point average and all this kind of academic stuff and then they studied it and realized that those were not good indicators of productivity and talent in the job and so they started hiring people with no college diplomas or indeed no college at all and they were hiring them for their skill sets.
So, I think that the core advice I would have is focus on building skills not acquiring credentials because credentials only go so far and they are depreciating in today’s world because employers realize they’re not really good indicators of how productive you’re going to be on the job. So, I would say build your social capital skills like your ability to work with people, management skills, project management skills and in specific you know specialized skills in database management and data mining and the kind of topics that you’re interested in that use digital technology. That’s the solution, don’t even worry about getting a college diploma unless you can afford to do so and of course, the way to do that is go to Community College for the first couple of years if you can and then use the remote learning as much as possible at institutions that offer that and offer huge discounts for that so that you can get a diploma more or less digitally.
Richard: Yes, I would agree with that. In some cases, like a doctor or a lawyer you might need a jurisdiction based you know accredited education with a specific degree so that might be required but, in many cases, not. So, as you mentioned you can study online, there’s lots of internet-based courses, there’s the concept of distance learning and also, the areas to study I would suggest as being engineering, software and business. Those three areas in particular because engineering really gives you the know-how, the how to solve a problem, how to approach solving a problem so that’s quite beneficial in any job, any sector. Then there’s the software aspect, I just read something today about Goldman Sachs how they’re ready and willing to hire coders but that’s a key skill for the future especially given today the Internet is at the application layer so it’s all about inventing and coming up with new apps, the so-called app on anything in ordering services, products, whatever so software is a key skill. Then there’s business, of course, Business Administration whether it be from an MBA but you know how to set up a business, how to conduct business, understanding business drivers. So, I would emphasize those three skill sets. Your thoughts?
Charles: Yeah, I agree Richard and I think we were just before we started recording that you also have some apprentices, essentially they’re called interns, but you know the apprenticeship system it’s often limited to the building trades or perhaps cooking or these kinds of things but actually it works very well in higher-level skill sets and managerial situations. There’s really no better learning situation than the workplace and so if you can get in and find a mentor who’s willing to give you experience in the real world then you can really start seeing what the skill sets that employers want and what I think the criticism that I’ve heard from people, recent college graduates, even in the stem you know science, technology, engineering and math is that the employers wanted skills that they didn’t learn in the classroom, that it
was all well and good but they day ended up not using whatever they learned in college in four years. They learned they basically had to relearn whatever they were going to use on the job on the job so this is the problem with sitting in a classroom or even remotely spending four year of your life you may not be learning what employers really want.
So, I would say the most important thing is to network with actual employers in the field you’re interested in, on day one, don’t start after four years of college or five or six years. That’s what you do on day one and then you tailor your education to what the employers actually want and so we know that one of the deficiencies in our educational system is employers, large employers like famously IBM, used to spend enormous amounts of time and money training their employees and now you know that the general model is you poach your employees from some other corporation right so there’s very little on-site training. Everybody wants you to be able to do the work from day one and they don’t want to train you so you’re going to have to do that part yourself but if you do that part yourself and you manage your own education then you’re going to be well situated.
Richard: Yeah, exactly I can’t emphasize enough this concept and the value of an internship or apprenticeship type program. Europe does it a lot more than in North America, especially in Germany I’ve seen rates as much as 70 percent compared to only 10 percent in North America for apprenticeship approaches. So, it’s quite powerful, low cost and can provide longevity of employment in that sector for that company and that’s something I do personally as well. This sort of leads into our discussion on jobs whereby internship can be coupled with the nature of the job so I have some Millennials working for me as interns that I manage as best I can using an millennial approach. So, they like to work remote, they like to communicate using Whatsapp type of tools with email, with an occasional coffee and they are very happy in that type of model and likely to stay on for a longer period of time.
Charles: Yeah, let’s talk about that model of work and I think it does work well for the Millennial
Generation but also frankly Gen X and Gen Z I think anybody that’s grown up with technology is going to be comfortable with just working digitally and I want to mention that you know the limitations of depending on education, you know higher education, like I was talking to a friend who was consulting with students in a well-respected MBA program in a university on the East Coast and he was appalled to discover
that the students weren’t really interested in learning entrepreneurial skills, they were just trying to get an A.
So, if it’s really important to learn what it really takes to be an entrepreneur or to help an entrepreneur run their business and it’s not a skill set that I think comes through an MBA, which is basically tailored for corporate America and so very few people emerge from an MBA program with actual entrepreneurial skill sets so I would throw that out there too that, you know, entrepreneurial is like a buzz word but it’s really getting down to brass tacks and being able to run a business and keep it afloat until it can scale up and you know all this kind of stuff. It’s a specific skill set and it requires a lot of human capital, a lot of ability to manage projects, budgets, people and so I would encourage people to try to work with entrepreneurs who have been successful and learn the ropes of that and then once you do that then your attractiveness to employers goes up considerably as well as your opportunities.
Richard: And also closely associated with entrepreneurialism is innovation so where there’s
a small burgeoning company there may be elements of innovation involved in terms of some new technology, the use of robotics process automation, intelligent automation, software engineering, you know, for enhancement of services so that actually goes together with entrepreneurialism. Your thoughts?
Charles: Yes, exactly because innovation is another buzzword but it’s implementing the innovation that’s the tough part, right, it’s scaling innovation these are the difficult things. Having the good idea is one thing but getting it into the real world and creating value in the real world that’s the tough part. You know we were talking about remote work and I think that this is really the leverage in the digital economy is that productive people can work largely remotely from anywhere on earth and so and with teleconferencing and all the other communication tool as you mentioned it’s like face to face is like really not necessary and that’s a corporate structure that’s spreading or within corporations it can be divisional where people may be answerable to you know the division head in Amsterdam but they live in Singapore or something so this is the new model and it works really well, I think, because if you’re in a workplace, a physical workplace, there’s a lot of managerial issues that come up, whereas in a remote work world all we care about is you understand the task, you understand the timeline, you get the work done and then you submit it. It’s like, you know, it’s a very clean, less emotionally cumbersome process and I want to mention I’m the same thing that I was just reading a post from a Millennial who was leaving San Francisco Bay Area because of the high expense and you know impossible housing cost and so on and he said in his experience he’s never known a corporate employer to turn down a productive employee who wants to work remotely. So, what he was saying is if you have a couple of years’ experience and you have a track record of being reliable and producing value then no one’s going to turn you down if you say look I want to work mostly remotely and that frees you up to live anywhere you want.
Richard: And that doesn’t necessarily mean living in the middle of nowhere. I myself have a lot of my work decentralized I could go in the office but much more efficient operating out of a millennial café, just
sitting there and doing the actual work, taking conference calls. This particular cafe doesn’t have any music in the background so I’m able to take conference calls as well so it could be there in the middle of the city or it could be in small towns across the country or different countries so remote could mean anything. Your thoughts?
Charles: Yeah and Richard I think that one of the key topics we wanted to talk about was housing in the Hong Kong Millennials profiled in this article we’re referencing I mentioned the impossibility of owning an apartment, a flat in in Hong Kong and, of course, that’s an issue in Vancouver tremendous you know it’s impossible, there many cities in Australia, many cities in the Bay and in the U.S. as well. So, I think the asymmetry here is you can’t earn enough in a big city to buy a house when housing is 11, 12, 15, 20 times your income so you’re going to have to find a cheaper place to live and the weighted working remotely enables that and so we were discussing, before we started recording, the idea that there’s a lot of much cheaper towns and small cities in North America that are starting to get a café scene, starting to get a tech scene, starting to get some nightlife and yet you can still buy a house in these places for under a hundred thousand or if you were going to move to a little more develop place maybe two hundred, you know two hundred and fifty thousand, which is affordable on much less of money then then these out of reach places. So, I think that’s the ultimate solution to housing is find a place that you enjoy living and that you can afford to own a house without working yourself to death.
Richard: Absolutely and this doesn’t necessarily have to be in the middle of nowhere. There is that possibility though for some that may like that in terms of buying 100 acres for hundred fifty thousand, two hundred thousand living on that land but you know far away from the city but at the same time you can pick smaller cities perhaps like Austin, Texas, we were talking about before, is a burgeoning community and lots of Millennials live there, very affordable housing. Your thoughts?
Charles: Right and the tier of towns or smaller cities below Austin, say for instance a lot of people favor Asheville, North Carolina, it has access to some larger cities. Bend, Oregon is a favorite place because of its proximity to, you know, outdoor activities and I just looked up those populations before we started recording and Bend used to have like 36,000 people 20 years ago now it’s got 95,000 and Asheville used to have 70,000 now it’s 95,000. So, these areas are growing rapidly because of the amenities and the cultural scene and there’s still room to grow because they’re relatively small compared to, you know, these huge urban areas and, you know, we you mentioned the idea that it’s even possible and I know some people that are pursuing this model is they actually want like a farm or a rural household and there’s a model in Japan called “Half-Farmer, Half X” and that’s been around a while and the idea of there and mostly Millennials or maybe younger Gen X types is that you take your digital skills, you know, in graphic design or coding or marketing and you work part-time and then you live in the countryside where housing is incredibly cheap and so you only have to work halftime to either rent a really big farmhouse or buy the land and so that’s another model.
Richard: And, a sector of that that makes sense is in the whole development of applications or apps, you
know the APP, for everything or anything. There’s an app now that goes on your cell phone for just about any service but continuously being developed for new services, new innovative services. So that can be applied, you know, the software scale that I mentioned you can use that in those areas, as you mentioned, remote areas, smaller communities and do that development to develop apps.
Charles: Right and speaking of that, you know, those of us outside these specific industries tend to forget that virtually every industry in North America and any other developed country is all being revolutionized digitally. So, you could take a sort of old company say producing chemicals or iron or steel products and you say well that’s an old technology they don’t need but actually those companies are also undergoing tremendous digitization of a CNC machining that’s run by software, that they’re using new tools and apps, you know, all software to rationalize their accounting, to rationalize their supply chain so in other words there’s just practically an unlimited number of software jobs within industries that you wouldn’t think of as high-tech but of course all these old industries require high tech skills as they upgrade their own companies into, you know, the modern economy. So, even old industries have a lot of opportunities.
Richard: Exactly. And the whole idea of low skill, low education required manufacturing jobs are gone. Yeah, you really need to know at minimum three different areas and that’s software engineering, intelligent automation and robotics process automation. Those three areas are just completely revolutionizing the manufacturing sector.
Charles: Right right! And one of the examples that is close to home for me is my niece’s
husband is a welder, he’s especially welder meaning, he has accreditations for various special kinds of welding and of course, there are welding machines and these welding machines are getting, you know, smarter if you want to use that term but there’s a lot of custom jobs where there’s only the welding job is literally one item for say a custom home or replacing a railing or this kind of thing. So, there’s a need there for the trade craft skills, you know, which there’s typically a shortage of those skills and then there’s the other skill set of being able to program the robot to do the part of the job that the robot is best able to do and then whatever the robot can’t do the human takes care of. So, this interface between robot software and the technical skills, that’s another growth opportunity, I think.
Richard: And also think global. So, I myself have done work, lived and worked, overseas in Singapore, Kuala Lumpur, Jakarta, Dubai, Istanbul and in Sydney, Australia, all over Malaysia for two years altogether Indonesia one year and a lot of the work I did had to do with setting up Internet infrastructure, basically in many parts of the world, so I was fortunate to ride that whole internet revolution but yeah think globally and some basic industries also will work in developing markets like Burma, Myanmar. If you just take rental car agency that’ll work there, anything that works in the developed world will work in these emerging markets.
Charles: Yeah, I think you’re so right. Actually, I would have loved to have been your assistant during all your globe trial. All those sound really fun but you know a friend of mine just returned, he lives part time in China in Suzhou, and he was marveling at the way that China is more advanced than the U.S. in many ways, for instance, everybody uses their cell phone apps to pay for everything from tolls on the highway to you know sharing meals to the (Inaudible 27:58), you know, uber type taxi service and so on and so again if you can acquire the skills to apply that kind of technology to existing industries there’s just a lot of opportunity there like I can see that will come to the U.S. with time and it’s just who gets there first.
Richard: Another big area of growth is in ESG/CSR. So, that stands for Environment Social and Governance and CSR Corporate Social Responsibility. So, what this means is how a lot of companies getting into these areas where they’re promoting a very strong corporate social responsibility program towards socially responsible investing or practices within their organization. There’s a lot of international standards where companies can measure themselves to towards this and what it’s characterized by our ESG factor so things like what they’re doing in the environment, social type of things, activities and overall corporate governance. Your thoughts?
Charles: Yeah, interesting that there’s the overlap, if you will, of the social consequences of corporate and government policies sort of, you know, the interplay or the overlap of those sectors which we tend to think of as being separate but which are of course in terms of public policy and environmental impact directly related. You know, one of the topics that you mentioned that you’ve gotten some questions on was like debt and the so-called ‘Fire Phenomenon’, which is financial independence retire early and I don’t claim to have any expertise in this but I’ve noticed that it tends to be the Millennial Generation, which is extremely motivated and interested in the financial independence retire early concept. Have you noticed this too?
Richard: Yeah, the concept of a bleisure in terms of combining business and leisure so traveling the world but at the same time doing work. So, whatever that could mean in terms of maybe consulting work, consulting projects, you know, but at the same time fitting in the travel experience as well to different sites of the world.
Charles: Yeah, that’s a great concept. I think a lot of, again these are just generalizations but, I think that the idea that a college degree was so important so essential that it was worth taking on $100,000 worth of debt I think that idea is becoming increasingly discredited or at least questioned and so for those people who already have that tremendous debt load that is a problem right because you’re going to have to, despite various claims that it’s all going to be paid off or you can default on it and so on, all those things are either speculative or they’re consequential. So, it does complicate life to have a large student loan debt and it’s a burden that it’s better to sort of grasp the nettle and figure out some way to pay it down or pay it off and one avenue that I’ve heard of and I don’t know how available it is but some government agencies have figured out a way to reduce your debt if you work there X number of years so that’s one avenue or the other one is to figure out a way to make enough money and live cheaply enough in these kind of cheaper living areas that we’ve talked about so that you can just kind of pound down that student loan debt and free yourself of that, you know, within a limited number of years of work and just get rid of that. And that kind of fits in with the with the fire concept, which is live really frugally and save 40 percent or more of your salary and that’s one way to eliminate the student loan debt from your life and get rid of it so you can move on.
Richard: Now a related question from a Millennial friend is “should I get
a free education in Germany, Sweden, Denmark, Norway, Austria, Greece, or France not free but very low, Czech Republic and instead of paying lots to educational institutions in the U.S. or Canada that may rank lower in quality.” So, what are your thoughts on that approach?
Charles: Well you know you’re a Globetrotter more than I but I would say that’s a fantastic idea if you can figure out some way to do that like, in other words, get the proper visas or that whatever you know the paperwork you’d need that would be a wonderful option and it would also provide you an education in international living you know you’d have a wonderful experience living in another country and of course, you’d probably need to ramp up your language skills in order to do that because, you know, international programs maybe taught in English but you know maybe not everything so that might be a very attractive option if you are on the way towards fluency in a language other than English. Would you agree with that?
Richard: Oh, absolutely yeah and actually even teaching English itself I’ve seen a lot of jobs internationally, China, everywhere where that’s an opportunity as well to live and work overseas is basically to be an English instructor in different countries.
Charles: Yeah and it’s interesting. That’s a great question because the countries that I’m
most familiar with would be Japan and France where I’ve spent time and a little bit of China and in Japan they’re very interested in attracting more foreign students. Now I don’t know the fee structure and of course Japanese is not a particularly easy language to learn but there may be opportunities in
European countries as well where they’re actually seeking some, you know, overseas or international students as an asset to their university system.
Richard: Another growth area that we haven’t touched upon but that leverages of what we mentioned on software, intelligent automation and robotics process automation is in the whole area of
agriculture and so lots of opportunity here internationally, you know, given the rise of population in the movement towards higher foods requiring higher water content or more protein and also just that the trade triumphs as well, you know, so opportunities for agriculture especially in South America as the Chinese shift towards sourcing more of their soybeans and weeds and all agricultural commodities versus North America so lots of opportunity there but even in North America lots of opportunity and medicinal so I just visited my friend’s farm for cannabis he’s growing 17 acres in a very remote area of Vermont all fully legal but you know strictly for the purpose of medicine. Your thoughts?
Charles: Great topic Richard because a friend of mine just mentioned that he was investing in a farm in the U.S. that was organic but it was automating many of the processes in the sense, say for instance, they were using drone technology to monitor the relative moisture levels in the soil, you know, so that they could turn on the drip irrigation at the right time to conserve water and feed the plants. There’s a sort of optimal levels of water and so again this is all high-tech stuff right I mean you’re talking about drone technology, imaging technology, database management and so on. So, yeah it’s really phenomenal how every industry is being revolutionized and what excites me about this is the model that you and I are describing, which is working remotely and flex work. This is what we need for, you know, sort of the life balance that we talked about and it this book I mentioned “The Meritocracy Trap”, the author goes on about how even if you’re earning, you know, large sums of money but if you’re working yourself to death you know on call, you’re taking work home, you know, you’ve got 24/7 connectivity, you have no time for your spouse or your children this is not living it’s simply not worth it. The goal and I think Millennials in
general realize this and they want live-work balance and so I think the key is find a way to live to work remotely, if at all possible, that aligns the income you can make in a normal workload, not a
crazy seven days a week, you know, 3,000 hours billing 2400 hours etc. No, have a reasonable lifestyle that makes a reasonable amount of money but live somewhere where that can be leveraged into a middle-class lifestyle.
Richard: And I think along with all of this goes as well some of your principles from the books that you’ve written is a movement towards decentralization so you know more local type economy, as well, and I would say also are more and more limited government. So, government is not the answer bigger government is not the answer it’s entrepreneurialism, the fostering of innovation and to do that there needs to be also a whole regulatory review process to eliminate duplicate regulations and also to address this whole concept of regulatory capture whereby you have large organizations, large companies that may do lots of lobbying with governments in order to lessen the teeth of regulations and also making it more difficult for a small entrance to go into that sector. So, that that needs to be addressed this whole regulatory capture phenomenon that that’s just taken over many different sectors and so in doing so that would foster massive innovation and massive entrepreneurial in many sectors. Your thoughts?
Charles: Yeah, absolutely Richard and this is one reason why it’s worth looking at smaller cities or counties with various cities in them because the large urban areas tend to be heavily regulated to where starting a business is simply unaffordable if you’re going to, you know, follow all the regulations and these regulations if they have to do with work safety fine, if they have to do with transparency fine, if they have to do with accountability that’s all great but most of the complexity you’re talking about the regulatory complexity serves no purpose it’s not protecting anybody from harm it’s simply burdening people that are trying to be productive.
So, I think you’re absolutely right when you’re going to look for a place that you want to live or work a place that is actually welcoming to enterprise and innovation in government as opposed to places where they give a lot of (inaudible 41:11) to that and so there’s a lot of (inaudible 41:14) given to things like one-stop permits and so on but it’s like you really have to explore that it when the rubber hits the road do they really expedite you know enterprise related stuff or is it just fancy talk because if they are willing to expedite enterprise stuff and they are interested in innovation in government as well as the private sector then that’s a place you’re going to be really comfortable with because the costs will be low and you’re going to have more opportunity.
Richard: Well, we’ve covered a lot of ground here. What are your final thoughts or can you give us a distinct summary?
Charles: Wow that’s a tough one but I think I would say, based on my own books and attempts to answer a lot of emails I get from Millennials is, don’t be afraid of trying something different, you know, the conventional thing of going to big cities that’s kind of a dead end because you cannot make enough money to have a nice life there and have any lifestyle balance. So, explore even if it takes a couple years of your life explore other options and be willing to experiment out there and that’s the only way to find something that hasn’t been exploited or that hasn’t been so overcrowded that there’s no opportunity there and the costs are just unaffordable. You’re going to have to experiment.
Richard: Yeah and I would say strive for fiscal prudence, continue learning, be very adaptive, take risk, think outside the box and also think globally.
Charles: That’s great advice. I think we should write that down.
Richard: Okay great we’ll end it there. How can our listeners learn more about your work Charles?
Charles: Yeah, visit me at OfTwoMinds.com. There’s lots free chapters of all my most recent books and huge archives on all the topics that Richard and I have discussed today.
Richard: Great. Thank you very much Charles.
Charles: Thank you
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.