Interviews

07/26/2017 - The Roundtable Insight – George Bragues On How The Financial Markets Are Influenced By Politics

FRA is joined by George Bragues in discussing his book Money, Markets, and Democracy: Politically Skewed Financial Markets and How to Fix Them, along with a thorough overview of the Austrian school of economics.

George Bragues is the Assistant Vice-Provost and Program Head of Business at the University of Guelph-Humber, Canada. His writings have spanned the disciplines of economics, politics, and philosophy. He has published op-ed pieces in Canada’s Financial Post.  He has also published a wide variety of scholarly articles and reviews in journals such as The Journal of Business Ethics, Qualitative Research in Financial Markets, The Quarterly Journal of Austrian Economics, The Independent Review, History of Philosophy Quarterly, Episteme, and Business Ethics Quarterly.

 

FRA: Just thought we’d begin with the book that you have: It’s called Money, Markets, and Democracy: Politically Skewed Financial Markets and How to Fix Them. Can you give us an elaboration on what the basic messages are, the themes of your book?

BRAGUES: Sure. The key thing I wanted to get across in my book is the importance of politics for understanding the financial markets. This is something that gets often missed in your typical courses that are taught at the MBA and also the undergraduate level. When a student takes a course in investment finance or financial economics, they don’t get exposed a lot to the political factors that drive prices, that drive trends, that drive decisions of monetary policy and interest rates, as was made abundantly clear with the 2008 financial crisis. Though one could have seen evidence of the role of politics in finance earlier than that, but it became much more obvious after 2008. This is definitely a gap in the way financial markets are taught to students, and the way they’re discussed by economists in general. The book is designed to address the flaw that the economics professor tends to be the only one that studies the financial markets. The dominate it, they practically hold the monopoly in it, and other disciplines, specifically politics, need to be part of the mix.

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As the title suggests, it’s not just politics per say, or politics in general that needs to be considered, but the regime. The regime is defined as the fundamental rules of the political game. This is actually a term that comes from the Ancient Greek philosopher Aristotle. He wrote a book – still very well known, still discussed among political philosophers – called The Politics and he distinguishes regimes into three types. He distinguishes it by who rules: if you want to know what a political system is like, you ask yourself who’s running the show, who’s making the decisions. Three basic different types of regimes that are possible: ruled by the one, which we would call autocracy or sometimes monarchy or dictatorship; there’s ruled by the few, which we would call aristocracy or sometimes oligarchy; and then there’s ruled by many. Democracy would be the example of that.

Financial markets around the world today, with only a few exceptions – China primarily among them – most of the major financial markets today are operating within democratic political contexts. The argument I make in the book is that democracy, because of the political incentives that it imposes on politicians because the values – the types of norms and morality a democracy has, these two factors, the value system and political incentives, what politicians need to do to get elected in a democracy – these fundamentally structure the nature of the financial markets. They don’t do it necessarily on a daily basis, you can’t day trade on this information or even swing trade on this information, but it definitely will illuminate anybody who’s involved in investing on the financial markets to help them better understand the force that drive prices over the long haul.

So my thesis is that democracy, while probably the best political system relative to the alternatives, despite it being the best of the available alternatives, it does create problems in the financial markets, it does distort the ability of the financial markets to do social good, and so a lot of the problems that we have are because of the fact that the markets are operating in a democracy.


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FRA: How does that happen? How does democracy distort the financial markets? Could you give some specific examples?

BRAGUES: The big example that I discuss in the book is the money supply. The main argument that I make is that democracies tend to oversupply money into the economy, and that has an impact on the financial system. I distinguish two factors that drive democracy’s overproduction of money, this excess liquidity. One factor is this class conflict between taxpayers and tax consumers. This notion of a class conflict between taxpayers and tax consumers is a notion within Austrian economics and it is meant to replace the Marxist view that the fundamental class divide in society is between bourgeoisie, the capitalists who own property, and the labour working classes who don’t own property. The Austrian view is that the main class division is between those who on net pay more taxes than they receive in services from the government – this group would be the taxpayers – and the tax consumers are those who on net receive more from the government than they pay. In terms of what a tax consumer can receive, this can range to anything from unemployment insurance payments, social assistance payments, favors provided by the government in terms of inhibiting competitors in your industry. The argument is that in a democracy, if a politician wants to get elected, the name of the game is to get 50%+1. Given that the distribution of the income in modern commercial societies tends to be such that there’s a few rich and wealth tend to be a small segment of the population, and the middle class and lower classes tend to be the majority, the best way to get elected is to offer mostly the middle class all sorts of public goods in terms of social programs and so forth, and then have those financed by the well-to-do who would function as the taxpaying class. That way you get your majority and get elected.


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All politicians, whether the left or the right, both sides of the political spectrum do this. Perhaps the left does this with a bit more conviction guiding their efforts, but on both sides of the political spectrum this happens. So politicians engage in this bidding war every time election time comes, trying to offer the majority all these goodies with the idea that they don’t have to pay for it, someone else will. What ends up happening, I argue in the books, is that after a while of this bidding war where politicians offer more and more public goods, someone has to finance this. Eventually you run out of taxpayers or you run into taxpayer resistance. At that point politicians then resort to the bond market and the bond market has proven historically quite eager to lend funds to the government. Government bonds are very attractive investments for a lot of folks because of the safety. This is money that’s backed up by the power of the state, unlike corporate bonds which are not. Corporate bonds are only paid ultimately if the corporation is successful at attracting people to voluntarily buy their goods and services.

I argue in the book that we now have a kind of financial market-government complex, or a bond market-government complex. The bond market has emerged as a kind of handmaiden to the welfare state, this growth of government. At a certain point, even the bond market will say ‘we can’t lend more’ and at that point politicians will appeal to the money press and they will enlist the central bank to print money, essentially, though it’s more complex how liquidity is injected into the economy, but that’s basically what happens. So essentially democracy leads to fiscal profligacy, too much spent relative to the revenues politicians are willing to collect from people. They then have to go to the bond market; public debt rises. And then to increase their options of financing this deficit that is inherent to democracy, they require control over the monetary supply. My argument in the book is that the gold standard, which existed for a good part of the 20th century in one form in another, which ultimately ended in the early 1970s – August 1971 if you want to get exact – that was in a way written in the DNA of democracy; that democracy ultimately is intentioned with a monetary constraint like the gold standard. That’s one of the ways I make this argument that democracies do damage to the financial markets.


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FRA: It sounds like the endgame is either a no bid situation in the bond market, or as you mentioned they could go to the printing presses. The other endgame is the loss of purchasing power in the currency. Either way, I guess that’s likely to be the only way to stop the politicians’ continuous profligate spending.

BRAGUES: Either the bond market has to say no, and historically as mentioned before they’re not very good at saying that. In the book I discuss the historical record of the bond market’s ability to keep governments to account. I remember in the past, I think he’s still around, Ed Yardeni coined the term ‘the bond vigilante’, which was a popular term in the 1990s. The bond vigilante is this creature that’s supposedly watching over governments, closely scrutinizing budgets and if they see any sign that they’re letting public debt out of control these bond vigilantes then start selling off the bonds of the country that’s engaging in this poor fiscal policy. The record, especially with developing economies, is that bond markets only react to excessive public debt very late in the game, when it’s become quite obvious and traders seem very eager to provide money to governments who are spending above their means while the debt is building up. And only when a certain threshold is hit – it’s really hard to find that threshold, Kenneth Rogoff wrote a book a few years ago when he went through the history of it and said, well if it’s a developing country it appears to be about 60% of GDP, that’s when the bond vigilantes come out; developed countries tend to have more tolerance. Even that threshold doesn’t seem to have held, because we now have countries – Japan principally among them – they’re well above 100% GDP and there’s no sign bond markets are growing less willing to finance their debts. The bond markets will have to have a shift in how they approach their investments into bonds.

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The other constraint would be the gold standard, but as I talked about in the book, I don’t totally foreclose the return of the gold standard. I agree that we should try to do as much as possible to bring that back, but democratic politicians don’t want to have the constraints posed by a gold standard because it makes their lives difficult. It means they have to say no to people, it means they can’t win elections by simply promising all sorts of goodies. It’s no surprise to me that the gold standard ultimately disappeared as democracy progressed.

FRA: You’ve included a number of slides, including one slide with a quote from James Grant, editor of Grant’s Interest Rate Observer where he highlights that you not only diagnosed the problem but also proscribed a solution to the problem. As you mentioned on the gold standard, what you’re saying is while not likely to happen, or not likely to come about, you do identify the solution. What is more the endgame: no bid in the bond market or gradual loss of purchasing power in the currency?

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BRAGUES: I would probably say the latter. Especially with the next 20-40 years or so, you have an aging demographic, a greater proportion of people who are older and they will seek safety, and I think that keeps up the bid in the bond market. I would say we have very slow decrease in purchasing power.

The thing is, in part of 1954 inflation was practically nonexistent. You’d have inflation only in certain periods, usually after a war, after substantive crisis, when the government is compelled to appeal to the monetary press to finance conflict. If you look at the data from early 19th century to 1945, I think in Britain for example there was really no change in purchasing power. The Pound was worth around the same in the early 19th century as it was going into the early 20th century. But that’s all changed since 1945. We now live with a situation which we think is normal, but which from a grander scheme of things is not, and people in democracy seems to be willing to live with an inflation rate of around 2% a year. I think governments are going to try to keep that going and if necessary, perhaps tolerate a somewhat higher rate – 3,4,5%. Some economists have talked about that, tolerating a different rate for inflation rate. I think all the incentives are for politicians to continue to take advantage of the bond markets’ generosity, if you want to use that term, and try to finance this via the inflation tax at the highest level of tax that is possible without incurring significant public protest.

FRA: I think we’ve seen figures of if you have inflation at 4% a year for 10 years, it can reduce the burden of debt by one half, something like that.

BRAGUES: Yeah. If you look at history, when we look at how the debt after WWII was dealt with, it was a form of financial repression that took place, where the inflation rate was held higher than the rates that most people be able to gain on deposit. I think they’ll try to appeal to that strategy again.

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FRA: Yeah, very likely. Just switching gears slightly, we’ve talked about the Austrian school of economics and you’ve also provide a set of slides on the investment potential of Austrian economics in investing. Just wondering if you can give some highlights of those slides and how you see the Austrian school of economics compared to the Keynesian school of economics.

BRAUGES: In terms of Austrian investing, I think it’s a promising approach. In order to succeed in investing, you do need to have an approach that is different from other people because if you’re just doing what everyone else does you’re just going to get at best the average rate of return. You’ll get the same rate of return that you might, say, if passed an investing vehicle like an index fund minus the cost of running your investment, the commissions and so on. Because most people in the financial markets are essentially Keynesians – they may not be conscious fully of their beholden to Keynesian principles, but anyone who follows the markets on a regular basis, specifically on issues of how the Federal Reserve or ECB is expected to react to certain data points, it’s clear that when you see a lot of these analysts get quoted in the Wall Street Journal or the Globe and Mail and so on, that they effectively are operating with a Keynesian worldview. In terms of having a unique point of view that can offer above average returns, I think Austrian economics offers something certainly worth looking at.

In terms of what it boils down to, I’m the first one to admit there’s not set Austrian approach. You can have five Austrians in a room and they’ll have five different approaches, although they’ll come from a common base, that common base being the commitment to certain Austrian economic principles. I say the two biggest ones that are relevant in terms of investing are A: the rejection of the efficient markets hypothesis, which is very common in the academic treatment of finance even though it’s losing some of its support to another field called behavioural finance, which argues that psychology needs to be considered in understanding how markets move. Efficient markets hypothesis still looms large, especially in academia, and it argues that in any point in time prices reflect all available information so that everything that is known or can be known is already in the price. So there’s no point doing any sort of analysis to try and beat the market if you believe in this theory because everyone else has already  looked at the financial statements, they’ve already considered the company’s strategy, already looked at the technicals and moving averages and trend lines and all that, it’s already in the price.

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The Austrian view rejects EMH and it’s because of its theory of entrepreneurship. Austrians are very big on the notion that what drives economic activity and specifically economic growth is the activity of entrepreneurs. What entrepreneurs do is they find arbitrage opportunities; they find profit potential that other people aren’t seeing. We can transplant the entrepreneurial function to the financial markets and say that there are similar arbitrage opportunities, similar opportunities that people aren’t seeing, that with good analysis and some work can be grasped. That’s point number one that differentiates the Austrian approach from more mainstream approaches that are taught in academia.

The second component that differentiates the Austrian approach from academic and certainly Keynesian approach, which tends to be dominant among financial market practitioners, is the notion of Austrian Business Cycle Theory (ABCT). This is the argument that central banks, through their policies in terms of money supply and interest rates, artificially induce booms and busts. Booms and busts are not on the Austrian view as simply sort of random events, facts of life of capitalism, or caused as some of the old Keynesians would argue by a lack of aggregate demand. They would argue that the reason we have bull markets and bear markets is large in part because of the actions of central banks. They would argue that central banks have a tendency to run overly loose monetary policies because all of the political incentives are there for that and reinforces that. What happens is that they tend to set the interest rate below what’s called the natural rate. The natural rate would be the rate that the market would set if the interest rate market were free, which it is not when you have a big central bank regularly intervening in the money markets. The argument is that when interest rates go below the natural rate, whenever they’re below what the market would dictate, it gives false signals to investors that future goods, goods with long term – real estate would be the classic example here, but also technology stocks, anything where the payoff is way in the future – those kinds of companies, companies that engage in those products, tend to get overbid. Too much investment tends to flow there and the Austrian view is that this will initially sustain a boom, especially in these areas of the economy, but then at some point one of two things or a combination of both happens: either people realize these investments are not going to work out, that the demand isn’t going to be there, that these future goods everyone’s producing for there isn’t going to be sufficient demand for them so you get a shakeout in that industry. Or two, the central bank decides to tighten monetary policy cause they can sense that things are getting a little too frothy, or a combination of the two. Then you have the bust and the market goes down. The idea is then the central banks will come in while the bust is taking place, aggressively lower interest rates to try to revive things, and the whole cycle starts over again. That’s probably the most important component to the Austrian approach of investment, this acknowledgement that central banks are the ones ultimately behind the longer term ups and downs of the market.

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FRA: In terms of other indicators or other aspects of the Austrian school that could help investing, you mentioned a few here like the Q ratio from Mark Spitznagel?

BRAGUES: Because the Austrian school recognizes there are going to be different phases of the stock market where things either get overvalued or undervalued, then the question arises, how do you recognize when we’re in a phase when things are overvalued and where things are undervalued? One approach has been put forward, by Spitznagel as you pointed out – his book is called The Tao of Investing – and he argues that we look at the Q ratio. The Q ratio goes back to James Tobin, a Keynesian economist. Tobin’s Q ratio is based on the numerator being the market value of companies, roughly stock market capitalization, divided by their real asset value, measured by the replacement cost of the assets of the firm. So basically you’re looking at the Q ratio measures how much it would cost to buy all the companies on, say, the S&P500, and you take that number and divide it by what would it cost me if I were to replace all the assets, going out into the real asset market and trying to replace all the assets that are on the balance sheets of S&P500 companies. In theory, it should be 1. That is to say, the market should be valuing the assets at the replacement value. That way you get avoid an arbitrage opportunity. In theory if the market value is higher than the replacement, you can sell stocks and buy the assets. Conversely, if the market value is below the asset value you can buy shares and sell the assets. Historically that ratio has been around 0.7, so Spitznagel suggests we use that as the anchor. If you’re about 0.7, that is suggestive of an overvalued market, and if you’re under 0.7 that would suggest an undervalued market.

Currently I looked at that ratio today and it’s 1.07. It’s not the highest that it’s been historically; it’s been as high as 1.78 in the early 2000s at the height of the Dot Com boom. Currently at the 1.07 level it’s at similar highs at other turning points if we just take the early 2000s out of the picture. If we look at early ‘70s was another high, another high was just before 1929. If you look at the Q ratio that is suggestive that we may be at a key inflection point here. My only concern with the Q ratio, just like I would have any concern with any other fundamental type of metric, whether it’s P ratio or price-to-sales ratio or peg ratio, is that they can show for a long time that an asset is overvalued or undervalued, and if you were to take a position in accordance with that signal it could take a long time for it to actually go in the predicted direction. It’s a notorious problem with these kinds of signals, so I suggest that Austrians can apply technical analysis and the approach here would be you use some sort of long term moving average – this would be just one technique among several that you could use to gauge the long term trend – and you take advantage of the trend and you wait until the trend is broken. If you’re using, say, a 10 month moving average then you wait for the index – here the S&P500 – to close below that average at the end of the month and that would be your signal that, okay, it’s a frothy market but other people are recognizing it, it’s not me with my Austrian analysis and now that the market seems to be coming to realize what’s going on I will get out. And conversely when things are looking undervalued. So an Austrian analysis could tell you things are looking undervalued now, the bust has perhaps gotten a little too far, people have gotten a little too fearful, a little too anxious, but you wouldn’t immediately go in. You would wait until the market went about the 10 month moving average.

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I would argue this would avoid the problem of using something like the Q ratio or some sort of P/E ratio. You could also use the 10 year P/E ratio, which is like Shiller’s – Robert Shiller has that indicator – that you allow the market to tell you when the trend is over, when the frothiness is really done. I’ve done some back-testing on; it seems to work fairly well. There’s also a number of people out there that follow this method, but most people follow the method of just look at the moving average; they don’t come to it with an Austrian understanding of where the market is temperamentally, as it were – whether it’s undervalued or overvalued, just looking at pure trend.

FRA: Another aspect of the Austrian school would be the focus on stores of value. You mentioned you have a slide here about gold, if you want to talk to that a bit in terms of how that can play into a store of value.

BRAGUES: Sure. One thing that Austrians can sometimes fall into the trap of is becoming excessively pessimistic. There are good reasons to be excessively pessimistic when one considers the fiscal state of our governments, and that what central banks have been doing to finance that fiscal profligacy. The reality is that markets seem to do different things that what some Austrians who are really negative would predict. Spitznagel makes this point in his book as well, that Austrians need to be careful of getting a little too pessimistic. That might translate into going into 100% gold; I would not be in favor of that going into 100% gold position. I do believe that it is a good store of value, to use your phrase, and at least some portion of one’s portfolio should be in gold for several reasons:

We really don’t know how this whole thing is going to play out in terms of these highly indebted states and central bank excess liquidity that’s been provided, so we’re not sure how that’s going to play out. It could play out very ugly; my Austrian friends are among those that are very negative and they may turn out to be correct. You want to have a position in your portfolio where you profit from that, or you protect yourself from that. Also two, if as I expect, we’re going to have this continuous slow reduction in purchasing power, whether it’s 2%, 3%, 4%, whatever it is, that does have a long term impact. That does compound and gold has proven able, when looked at form a longer term trajectory, to preserve your purchasing power against that.

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I just did this calculation today, but if you look at the returns of the S&P500 index, total returns assuming you invest all your dividends? From 1971 when the gold standard ended and you compare it to gold, I think there’s only about a—If you put your money in the S&P500 and invested your funds when the gold standard was abandoned in August 1971, you would have made about 10.38% a year, just over 10%. If you had just put it in gold, you would have been at 7.58%. So you’re only looking at about just under 3% differential. That’s not bad. Gold is… You’re not risking your money and businesses, when you invest in gold you really can’t expect that you’re going to earn a risk premium that a firm would typically be expected to earn for assuming risk in the marketplace and offering goods and services. There’d only be about 3% behind, and this is from the current day when gold is relatively low and well off its highs from 2011 and the S&P500 is at near all-time highs. Right now this calculation is very much favoring the S&P500 but over time gold doesn’t do too badly, even though things right now might not look too great in terms of its performance vis a vis the S&P500 index. But looked at it from a longer term? It does trail, but you’d expect that because the S&P500 is a different kind of investment; you’re investing in companies and there’s a risk there. You should be compensated for that.

From a crisis protection point of view, and also from a protection from this continuous reduction in purchasing power, I think that argues for some proportion of portfolio being in gold.

FRA: Excellent comments, excellent view. I guess to close out, if we take the Austrian school of economics and the basic messages and themes of your book on money markets and democracy, how do you see the situation today in terms of perhaps the millennial generation? Where they’re going, where they’re leading politics with respect to economics, finance? What are the millennial views and perspectives on the economy and financial markets currently? How are these views being formed by political, financial, and economic trends?

BRAGUES: The millennials… That’s a pretty slippery term to define; we’ll go with 18-29 year olds. This has been a talking point for the last year or so and it’s certainly became a major point of discussion with the success of the Bernie Sanders campaign – they didn’t win the nomination, he didn’t win that, but he certainly put forward quite a battle to Hilary Clinton. There was a survey done by Harvard University, it came out just over a year ago, which showed that millennials in the United States – so these are young people from 18 to 29 – for the first time since they’ve been doing surveys, that a majority of them no longer supported capitalism. The number was actually 51% no longer supported capitalism, 42% still supported capitalism – I’m not exactly sure with the remainder, I’m assuming they were undecided. Certainly with Bernie Sanders, who is a self-professed socialist or social democratic or ‘democratic socialist’ as he put it, certainly this played out politically. This is a concern though we shouldn’t make too much of it, but it is definitely a concern. I think the reason why we should not overplay it is that traditionally young people have veered more toward the left. If you look at voting patterns, for example Britain, the likelihood of someone who is young voting Conservative – I’m not saying the Conservative Party in Britain are perfect pro-capitalists or pro-markets, but they’re more likely to be pro-market than the Labour Party on the left on the political spectrum. Going back to the end of WWII, younger people were much more likely to vote for Labour or for some other party on the left than for the Conservative Party. As people get older, they tend to veer conservative. There’s this saying that if you’re not Liberal before leaning left when you’re under 30, you have no heart, but if you’re still Liberal after 30 you have no head. It nicely captures out how age affects political and ideological affiliations.

When we consider that, that means we should moderate some of our concern, but it’s still a concern. The question arises, why? I think there are a number of reasons: one is they’re just young, they’re more moved by their passions, morality is very much implicated with their passions or moral sensibilities and young people tend to be quite idealistic. When you look at capitalism, it – at least on the face of it, I wouldn’t say this is the definitive interpretation of it – it looks like it’s driven by selfishness or self-interest. If you’re idealistic that’s not a good motive to have, that’s not a good motive for society to be energized by. That, I think, is a factor that leads the young away from capitalism.

Another factor is just the educational system. Despite all the work that the Milton Friedmans and the Hayeks and the Miseses of the world – which is great work, great books, great arguments – all that effort still hasn’t made its way into the educational system where young minds are formed. I think too there’s certain factors of the way the human mind works against the proponents of capitalism and makes it more difficult for the pro-capitalist side to make its argument. The human mind is structured in such a way that we tend to favor the concrete over the distant, the specific over the vague. Whenever you make a case for capitalism you have to make arguments that are abstract, that tend to emphasize longer term benefits, things that are not immediately evident. That’s a problem that the opposite side, the side that the government is having a greater role in the economy, they don’t have that problem.

My favorite example is, let’s say you think there’s a problem with wages, that some people don’t make enough money. The free marketeer could tell you the story, well if you let wages be free eventually people will acquire skills, will have an incentive to do so, will invest in education or work harder to get promoted, and eventually they’ll get up the income scale. That’s sort of a more longer term view and it can be mentally grasped, but it’s a lot more clear and vivid if you could just tell people, or we could pass a law and we can set a minimum wage at x level where we think people are going to be less poor. And there’s the end of the story. There’s an easier story that the other side has to tell, and I think that plays into this situation with the millennials.

Transcript by: Annie Zhou <a2zhou@ryerson.ca>

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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.


07/09/2017 - The Roundtable Insight: Ronald-Peter Stoeferle On “In Gold and Bitcoin We Trust”

FRA: Hi, welcome to FRA’s Roundtable Insight .. Today we have Ronald-Peter Stoeferle. He is managing partner and investment manager at Incrementum. Together with Mark Valek, he manages a global macro fund which is based on the principles of the Austrian School of Economics. He’s also the co-publisher of In Gold we Trust report, and that is the focus of our discussion today. Welcome, Ronnie.

Ronald-Peter Stoeferle: Richard, thanks for being here again.

FRA: Great to have you. And so today we thought we’d do a focus on the report in terms of the highlights, the key messages as you see them. So just wondering about that if you want to give us a high-level broad overview?

Ronald-Peter Stoeferle: Well just to give you a quick note on the report itself, we’re publishing it for the 11th time now so I started writing the report when I was a research analyst at Erste Group in Vienna, and then I set up my own company together with some colleagues from Switzerland and Mark Valek who’s from the institutional fund management side. And what we try to do with this In Gold we Trust report is we want to deliver what we call the holistic view. So we don’t care about the annual supply demand of gold itself because we found out there are factors that are much more important for a gold price development such as opportunity costs, such as real interest rates, inflation, the debt situation. We also write about mining stocks, about the technical analysis, about the capital structure, very much based on the Austrian School. We’re writing about financial repression, the war against cash for example. We’re writing of course about Bitcoin and its advantages but also disadvantages over gold. We had a fascinating interview with Dr. Judy Shelton who is an economic advisor to Donald Trump. We’re writing quite a lot about the history of our monetary system, so as you can see it’s always quite a read, this year we had more than 160 pages. But if you don’t have a weekend or a whole vacation to spend reading the report, there’s also a compact version.

FRA: Yeah, it’s quite an international recognition with 1.2 million readers and is used extensively as a reference work for everybody in the precious metals sector.

Ronald-Peter Stoeferle: Yeah only this year, and we published it on the first of June, we had more than 1.2 million readers already. We were quoted in 60 countries all over the world from Phuket, Mali, Vietnam, of course, China, India. So we’ve got readers everywhere and it seems people are interested in the topics that we’re writing. And that makes us honestly very proud and is also good motivation to invest and dedicate so much time and energy into this publication.

FRA: Great, so let’s get started. You’ve been very kind in providing a number of slides that we will make available on the website in the write-up, so you can link to the website to download that. And we’ll also do a summary that will interweave the slides as a transcript. And so I urge all the listeners to look at that and that can form the basis of our discussion today. So you’ve got an executive summary slide that highlights the key messages if you want to start with that, that would be great.

Ronald-Peter Stoeferle: Yeah of course. Well, I think even though nobody is really interested it seems in gold at the moment, I think last year we made the lows, I think we’re at the beginning of a new bull market, very early stage. Gold was up 8.5% last year and since the beginning of 2017 we’re up again, I think in dollar terms it’s slightly less than 8% now. The important thing is that we’re up in basically every currency. But nobody is really recognizing it, Mark called it once a sitting bull. It’s a bull market that nobody is recognizing, and the bull market will get going. Now the question is, what’s the trigger going to be? And from my point of view, the trigger will be a U-turn by the Federal Reserve. Once the market realizes that the emperor has no clothes, I think this will be the point when gold will really pick up momentum. And from my point of view, we’re pretty close to that. We’re seeing that inflation numbers, price inflation is way too low. So the Fed will have a hard time continuing rising rates. We’re seeing many signs that the U.S. economy is actually doing much worse than the mainstream economists see it. And therefore I think this in combination with the U.S. dollar that made its highs and that is at the beginning of a new bear market. And this is actually what Donald Trump, he says it very openly, he wants and he needs a weak dollar. He’s very very open about it, it’s no secret. So I think this is a very good combination for gold. Actually also given the fact that the sentiment at the moment is so low. So from a technical point of view, it’s interesting, yesterday marked the seasonal low in gold. So from a seasonal perspective, we’re having quite some tailwind in the next couple of months. I think the sentiment is negative and so I think from a short but also from a long-term point of view I think it’s an excellent setup.

FRA: Yeah, exactly. And I think as well that the idea that everybody has been expecting fiscal policy, fiscal stimulus policy. But it hasn’t really happened yet or not much. There was talk about infrastructure spending but it’s either been delayed or there hasn’t been much of it. So maybe monetary policy might still be the only approach by central banks and governments. Your thoughts?

Ronald-Peter Stoeferle: Yeah I mean I was kind of wondering that. Actually last year gold had a tremendous run and then came Donald Trump. And from one point to the other, the markets change was such a big reversal. And there was so much confidence in Donald Trump, you know the reflation trade and so much hope for fiscal stimulus. But so far nothing really happened, I think it’s a complete disaster. He didn’t deliver on anything that is really important actually. So from my point of view, there will, as soon as the market or the economy gets weaker and there’s lots of signs Richard. We’ve got retail sales being very weak, we’ve got lots of numbers from the industrial sector being weak, we’ve got text receipts basically stagnating, we’ve got most importantly from my point of view credit growth for commercial loans but also for consumer credit is very very weak. And other sales of course. So from my point of view, we’re already in the downturn. So the Fed is actually tightening into the weakness as Jim Rickards always says. And therefore I think we will see this U-turn by the Federal Reserve. They will talk about lowering rates again, they will at some point consider implementing another round of QE. And believe me, 85 billion won’t be enough, it will have to be above 100 billion per month of course because there’s a declining marginal utility. And of course, as soon as the recession fears come up there will also be massive fiscal stimulus. So I think, and this is really going to be the point when gold will probably go a few hundred bucks higher within a couple of days or weeks.

FRA: In your executive summary you reference an exclusive interview with Dr. Judy Shelton, the economic advisor to Donald Trump. Can you speak to that?

Ronald-Peter Stoeferle: Yeah, it’s definitely one of the highlights of the report I would say. I’ve been following Judy Shelton for a while now, she wrote some really good books, for example Fixing the Dollar Now is a tremendous book, and A Guide to Sound Money is excellent. And I think it was really really encouraging to see that she was on the transition team of Donald Trump. Now I think many people get that wrong, she’s not like, and she said that to us, it’s not like their talking every day about implementing the gold standard. But I think that within the Trump administration there’s quite a lot of people actually knowing that many of the flaws that we are having and many many of the issues and problems are basically coming from our monetary system. So I think it was very interesting to see a speech by the vice president for example where he talked about sound money. We called the chapter in the report, we called it: Good-bye Dollar, hello gold? And we quoted Donald Trump for example quite often as well. He said, for example, I think we’ve never really heard it from a U.S. president in the last couple of decades probably, he said we used to have a very solid country because it was based on a gold standard, we don’t have the gold, other places have the gold. He said that the dollar is too strong, our companies can’t compete with them now because our currency is too strong and it’s killing us. So I think this is also one of the impressions I had after talking to Judy Shelton. I think sooner or later there will be a point in time when, probably on a weekend, there’s going to be some sort of speech by the president that the dollar will be weaker. I don’t know, 20-30% due to whatever reasons, but I think that the U.S. to succeed with this reindustrialisation, they actually will need a significantly lower and weaker U.S. dollar. And of course, on the flip side, that’s going to be a very very positive environment. And we know that this would really kick off the currency wars, because what would the Japanese do then? What would the Eurozone do then if the U.S. significantly weakened their currencies? I think they would basically imitate that and against what you value against hard assets and especially against gold.

FRA: You’ve got some very interesting slides in terms of charts showing monetary surrealism, so the combined balance sheets of major central banks vs. the gold price. So it shows while the Fed has leveled off a bit, the other central banks of China, Switzerland, Japan, Europe are still increasing. Do you think there will be sort of a realignment of the gold price to that trend as there was for many years as shown on your chart?

Ronald-Peter Stoeferle: Yeah, there’s a strong correlation between gold prices and the direction of the monetary aggregate, so sooner or later this will happen. We should not forget, we also got in the report that actually the gold backing of the U.S. dollar is very close to its all-time lows. So actually due to all this money printing, gold got significantly cheaper in monetary terms. And as you can see here on the chart, I mean we really crunched the numbers very thoroughly and we thought that we had miscalculated it so we double checked it. But the number is right, so the largest central banks only in the first quarter printed the amount of 1 trillion, so 1,000 billion U.S. dollars just in one quarter. And they printed it out of thin air of course, and I think therefore it’s no wonder that stocks, real estate, of course bonds are at or close to the all-time highs because of this massive monetary inflation that leads to asset price inflation. Now just to give you one perspective, or one comparison, what you could do with this 1 trillion of money printed just in one quarter, you could buy 20 Big Macs in Switzerland which is according to the Big Mac index the most expensive worldwide. You can buy for every person on earth, 20 big macs in Switzerland out of this I think 7.5 trillion people living at the moment. Perhaps a bit smarter investment would be you could buy one Ducat coin, it’s a beautiful coin from Austria which is one-tenth of an ounce of gold for every person on the planet. Just from the money that was printed in one quarter. Of course, we would recommend the ladder, buying the gold and not the big macs, but I think this gives you a perspective about this as we call it monetary surrealism. And we all know that basically, the central banks printed themselves into a corner, and they won’t get out of that because as you can see most countries really desperately need a weak currency. And as you’ve said the Federal Reserve their printing is kind of leveling off, the consequence is a very strong dollar which is obviously negative for the U.S. economy and for inflation numbers because it’s acting disinflationary or actually deflationary. So that’s some sort of a spiral that is getting out of hand, and this is a very very dangerous game, and basically a game that nobody will win.

FRA: Another very interesting chart here, commodities vs. stocks lowest relative valuation since 1999. I know in the financial technical analysis world, analysts will look to commodities or gold in particular as a leading indicator for commodities. So this is an indicator that there showing a bottom for gold as well as commodities. Your thoughts?

Ronald-Peter Stoeferle: Yeah I mean I think as you know the Austrian School has got a different view when it comes to prices and it says there are no fair values and so on. So prices are always subjective and therefore for us it’s important to focus not only on absolute prices but also on relative prices because one of the most important laws in finance and in the economy is probably the mean reversion. And as you can see on this chart, commodities vs. stocks were at the lowest level, we only had that twice in history, we had that in 1971 and we had that in 2000. So on a relative basis commodities are just extremely cheap vs. stocks. Of course, that means we’re far away from the median which is 4.1, we’re far away from the highs that are between 8 and 9 in this ratio. And of course this can happen in different ways, it can mean that commodities stay stable and stocks fall off the cliff, that can happen. It can happen with stocks being stable and commodities going through the roof or it can happen in both ways, so stocks going weaker and commodities going stronger. But what I want to say is there’s probably more from a relative perspective it’s just a more obvious trade being long commodities vs. stocks and I think we should not forget that last year despite a very strong dollar, the dollar I think the dollar index made a 40 year high, something like that. But still, many many commodities were actually really strong despite the fact that the dollar was that strong as well. So I think that’s a very positive sign and also similar to gold, this is a bull market that’s in the making that’s probably very very early, and as soon as price inflation will become a topic I think people will start getting bullish on commodities again.

FRA: Yeah and speaking of bull markets, you have on the next slide the comparison between the 1970s gold bull market and the 2000s bull market still ongoing. Your thoughts on that?

Ronald-Peter Stoeferle: Well, of course, bull and bear markets are never the same. However, there’s quite a lot of similarities and then we showed this chart already in the last couple of gold reports and what you can obviously see is that this bull market is definitely longer than the 70s bull market.

But there’s quite a lot of similarities because there was this big mid-cycle correction in the 70s from 1974-1976 when gold sold off from $200 down to $100 when disinflation was the name of the game, when everybody was gaining confidence in the U.S. economy again. And then we showed that last year there was a great article in the Wall Street Journal in I think August 1976, and you could really see the same article nowadays again. It’s just really bad bashing of gold and why it’s useless, and so we know what happened afterwards, gold went from $100 up to $850. So I think there’s quite a lot of similarities, I think in the 70s of course the big driver of gold was negative real interest rates and high inflation. And I think this is going to be the big driver going forward again because as you know we need negative real interest rates more than ever because the debt situation is getting out of control. So I’ve always said the level, as well as the direction of real interest rates, is the most important driver of gold. And if one believes that due to the debt situation we cannot afford high real interest rates again, then I think the consequence must be being bullish on gold, and that’s basically one of my main assumptions.

FRA: And the next few slides describe what you were talking about earlier in terms of how the Fed is becoming boxed in, the potential for a recession and the rate hike cycles, how that links with recessions. Can you provide some insight on those slides?

Ronald-Peter Stoeferle: Yeah, of course. That’s out of one of my favourite chapters in the report, it’s called: White, Grey, and Black Swans. And we’re starting off this chapter with a fantastic quote by Ray Dalio, the founder of Bridgewater. I don’t know if it’s still the biggest, but one of the biggest hedge funds out there. And he said, “The two main risk factors for the average portfolio are less than expected growth and more than expected inflation.” And for us, some sort of stagflationary environment similar to the 1970s is definitely in the cards. And as I’ve said before, from our point of view, a recession will happen in the U.S. sooner or later. Of course, that’s quite an easy call. And don’t get me wrong, a recession is from our point of view something normal, something healthy within a business cycle it’s like breathing in and breathing out, you need both parts. And a recession although it hurts, it hurts on many participants, it lays the foundation for a sound recovery, for a more healthy system actually. But I think the most interesting number in that chapter was that we checked on Bloomberg and it said out of 89 analysts that are surveyed by Bloomberg, not a single one, not a single economist currently expects a GDP contraction in 20017, 2018, or 2019.

So nobody is seeing a recession within the next few years and everybody basically thinks we’re going to see growth rates between 2.2% and 2.4%. That’s such a strong consensus, I’ve never seen something like that before. And of course, if the positioning is that strong, if everybody is sitting on one side of the boat, there will be tremendous opportunities and tremendous moves as soon as people are switching to the other side of the boat. Meaning okay, there are recessionary fears and recessionary tendencies coming up, this will be a moment that it’s going to be very interesting in financial markets. And I think that there’s quite a lot of signs and we’re quoting some of them in the report. First of all, we’re seeing as I’ve said before, quite a lot of numbers are actually showing us that a recession will happen sooner or later. Another one of my favourite charts it shows the interest rates since 1914, and actually in the past 100 years, 16 out of 19 rate hike cycles were followed by recessions. Only three cases turned out to be the exception to the rule.

Now we’re in a hiking cycle and I actually think that the tightening already started when Ben Bernanke announced tapering. So we’re seeing a tightening environment for quite a while now. And this normally leads to recessions or a combination of a recession and major market disruptions. Then we’re seeing this massive artificial asset price inflation. I mean the idea was that there was some sort of wealth effect meaning due to rising stock prices and real estate prices it would trickle down and then everybody would do well and will start spending. It didn’t really work that way, we all know that this wealth effect is something that economists want to see but it’s actually not really happening. So from our point of view, we’re in the everything bubble. It’s not only specific sectors of the market, now it’s real estate, it’s stocks, especially tech stocks, it’s bonds of course which are all at their all-time highs and being what we call the everything bubble. So this makes it even more dramatic than the subprime bubble or the tech bubble of 1999-2000. So this shows that the next recession or the next crash will probably make the preceding ones look like a kindergarten party. We’re seeing that consumer debt levels are extremely high and we’re seeing a massive slowdown in monetary growth which always leads to recessions. We’re seeing that the duration of the economic upswing is already extremely long. So although Janet Yellen said recently in her lifetime we won’t see any financial crisis again and so on, I think the duration of this boom or this upswing that we’re seeing, it’s already very very very long. So should the current economic expansion go for another 23 months, it would actually become the longest in history. So therefore I think that there’s quite a lot of reasons actually that we will enter a recession sooner or later, from my point of view sooner. And this will have massive consequences for financial markets and also massive consequences for gold of course.

FRA: And the next couple of slides are very interesting, you talk about gray swans and their possible effect on gold.

So you’ve got a table showing different gray swans and the effects on the U.S. dollar and gold prices. One slide also mentions a gold swan of high leverage showing where China is relative to other past events, financial events, financial crisis’s, Russia, Argentina, Mexico. Can you speak to that and do you see the possibility of one or more of these gray swans happening?

Ronald-Peter Stoeferle: Yeah, of course. I think that’s the beginning of the chapter, by definition it’s impossible to anticipate a black swan because if it would be possible then it wouldn’t be a black swan. For grey swans, this is something highly unlikely but this can kind of be anticipated. And you know what’s happening in China at the moment it’s just a massive credit bubble and the Peoples Bank of China reacted in 2008 and 2009 acted much much more aggressive than every other central bank so they acted much more aggressive than the Federal Reserve, then the ECB, even then the bank of Japan. And of course it leads to growth, but low-quality growth. And from my point of view just from an intuitive GDP perspective their up 210% which we’ve never seen in a let’s say emerging market in the last couple of decades. So, of course, this might go on a bit longer but it’s already really extreme. So this is probably going to be a credit crisis in China, would be some sort of a grey swan. We also got some other grey swans like stagflation, a scenario that we are talking about for quite a while now. And we dedicated a big chapter in our last book to stagflation which would basically be the pain trade for every investor, especially for institutional investors because times of strongly rising inflation and weak growth are actually the worst environment you can imagine for bonds, as well as for stocks. And the only asset classes that do well in the stagflation environment are actually gold and silver and commodities, especially energy and soft commodities. What else do we have as a grey swan? A political crisis in the U.S. some sort of impeachment of Donald Trump, probably not unlikely. A geopolitical escalation, well we had a very interesting discussion with Jim Rickards quite recently and he very openly said he expects a war between the U.S. and North Korea in 2017 or 2018 at the latest. So he’s absolutely sure about that. That makes me pretty nervous actually because we’ve got no idea how that’s going to develop, if it’s going to be just the U.S. against North Korea, I don’t think so. This is actually really really dangerous and I don’t know what this might mean for the U.S. dollar, perhaps a stronger dollar. Not sure about it but I think it would definitely be inflationary and it would be a positive environment for gold. Then we’ve got hyperinflation I think the effect on gold would be negative but only for nominal prices.

FRA: This would be hyperdeflation, right? Hyperdeflation.

Ronald-Peter Stoeferle: Hyperdeflation, yes. The nominal prices wouldn’t do really well but on a real basis, I think it would be an excellent environment for gold. An inflationary boom of course, strongly positive for gold and negative for the U.S. dollar. And the monetary reset, actually something that also Judy Shelton is talking about, and something that will happen sooner or later, it’s inevitable. There will be a reset, there have always been monetary resets in economic and monetary history. And in every reset gold played a major role. And I think this is also the reason why the big guys like the U.S. but also the Eurozone but also the Chinese, the Russians and so on. They all hold massive amounts of gold and those nations that don’t hold too much yet, especially the Chinese and the Russians, they’re constantly accumulating gold. And Rickards said if you want to play poker with the big guys, you have to bring enough chips to the table. And those chips are actually gold. And Therefore I think that within the context of a monetary reset there will be a revaluation of gold, I’m absolutely sure of that.

FRA: And that seems to be a key message theme of your report in terms of dollar, de-dollarization, goodbye dollar hello gold. So those are the next few slides, how is this happening? What is the mechanism, is it through geopolitical alliances in Asia along the Silk Road route or like the Shanghai Corporation Organization counsel there, the sort of NATO of the East if you will, is it happening through that mechanism or how do you see that playing out?

Ronald-Peter Stoeferle: Well the thing is there’s actually so much going on at the moment, it’s really hard to follow and we had our advisory report discussion yesterday with Luke Gromen who’s writing Forest for the Trees it’s a tremendous newsletter focusing on those topics and I think there’s just so much going on at the moment. For example, with the first oil contract trading in Chinese Huajin now, it will start at the end of July. We’ve got the whole Qatar crisis which is no coincidence, I think it’s no coincidence that Donald Trump’s first trip abroad, that he went to Saudi Arabia and they signed like a $300 billion deal on aircrafts and military equipment. I think that the big picture is extremely interesting and we’re seeing this de-dollarization for a couple of years now. And I think it’s now definitely picking up momentum because we’ve got the Shanghai gold exchange which is becoming more and more important. I think that gold plays a key role for the Chinese, the Chinese don’t want to develop or implement a reserve currency, but a trade currency. And so many things are happening at the moment, bilateral trade agreements between the Chinese and basically every important emerging market, new stock exchanges and trading platforms being set up. There’s just so much going on at the moment, but I think we’re seeing this de-dollarization and of course the central role of the U.S. dollar plays a crucial role for financial markets. And I think that this is also something that Judy Sheldon mentions, there will have to be some sort of new agreement because the U.S. they actually realized that they cannot afford the current situation and they need a significantly weaker dollar. So the big question is if the new currency system architecture will be introduced through a former process like a conference in a G20 framework, G20 is actually meeting now in Hamburg, or through a revaluation of gold reserves by the market. Will the U.S. adopt a proposal of Judy Sheldon and issue for example gold backed bonds? It can happen. Or perhaps, the U.S. will join what we call the Euro model and will it mark its gold reserves to market? Because the Eurozone gold reserves on a quarterly basis are marked to market in the U.S. they’re still valued at I think $42 for some reason. Or a third way would probably be, will the rest of the world just abandon the valuation of gold reserves based on market prices and follow the U.S. into a system of fixed exchange rates similar to some sort of classical gold standard? So we’ve written a couple of pages about that and there’s still so much to follow regarding those topics. I think it’s really interesting to follow at the moment what’s going on with the big picture, especially Russia, China, and the U.S. and as I’ve said before I think that gold will play a major role in that game.

FRA: And you’ve got a slide on in Bitcoin we trust, playing on the in gold we trust report. Your thoughts on the cryptocurrency movement? Bitcoin, do they have value, are they seen as a currency, are they seen as a store of value or simply a payment system? And how does the value and the utility of gold as a currency compare to Bitcoin and other cryptocurrencies?

Ronald-Peter Stoeferle: Well, first of all, I think that if you read the white paper by Satoshi Nakamoto there are many similarities and I think that they really want to create some sort of digital gold. For example, stock to flow ratio but also the logo and some other terms like “mining” Bitcoin. That already shows that the creators of Bitcoin, they actually have gold in mind. And they’ve got a sound understanding of money, they know the Austrian School of Economics. So I think there’s many similarities, there’s also many many differences. For example, gold has a track record of many of thousands of years, Bitcoin’s been around for only a couple of years. But I think that you know, from my point of view, first of all what I love about the whole discussion is, and I said that in the discussion with Yra Harris a couple of days ago, I love the fact that people are actually thinking and talking about money again. What is money? What are the characteristics of good and sound money? So that’s definitely very positive.

I don’t know if Bitcoin will be around in 2 or 3 years, probably yes. I’m pretty sure that all of those ICOs that are happening at the moment that probably 95% or 99% of them are rubbish and they won’t be around in a couple of years. But the market will decide which currencies to choose and I think from an Austrian point of view, we’re seeing competing currencies and market participants are deciding if they prefer to hold or pay with Bitcoin, gold, euros, dollars whatever. So I really want to let the market decide. But I think we should not forget, we should not underestimate the fact that Bitcoin and the cryptocurrencies, they didn’t go through a business cycle yet. So we actually don’t know what the characteristics of Bitcoin and other cryptocurrencies will be in a massive downturn, in a recession, in a crash. Will Bitcoin significantly stronger or weaker? Richard, I don’t know, I can imagine both ways. So this is going to be interesting, but for us in Incrementum, at the beginning, it was just from an intellectual point of view just interesting. But we’re developing quite a lot of things in the crypto space, and you should expect some big news from our side regarding Bitcoin and cryptocurrencies. Because as I’ve said before, it is some sort of digital gold. And I think of course Bitcoin faces several hurdles, but I think the technology that is being developed now will change many industries. And there will be losers and there will be winners of this technological process and of the innovation, we try to be on the winning side of course.

FRA: And let’s close our discussion with the last slide you have scenarios for the gold price. So you list four scenarios, A, B, C, and D. And then you circle C and D, indicating I guess what’s likely to happen, scenario C and scenario D. Just what are your thoughts, why do you think that? And scenario C is showing prices from 1,400-2,300 U.S. dollars per ounce, and scenario D is 1,800-5,000 U.S. dollars per ounce.

Ronald-Peter Stoeferle: Yeah, well of course the Austrian School is quite different when it comes to forecasting because it’s basically, and that’s a very modest call I would say, it’s impossible to forecast the future. You can analyze what’s happening and you can read from history of course and make assumptions but it’s impossible to forecast the future. And this is also why we’re thinking in scenarios and we’re weighing those scenarios. And of course there’s the Goldilocks scenario when everything is just going fine, we’re seeing perfect inflation rates below 2%, we’re seeing high growth, everything is fine, deleveraging and so on. Then you probably don’t need any gold and this would lead to gold price between $700-$1,000. This is basically the scenario that many market participants expect at the moment. Then there would be scenario B which is muddling through, with weak growth but inflation not really picking up. We wouldn’t see any real monetary nominalization so rates would rise but not significantly, there would be talks about this quantitative tightening but we all know that it’s kind of a joke. In this environment, we’re seeing gold between $1,000 and $1,400. And then scenario C and scenario D, and scenario C is the inflationary boom. High growth and high inflation, probably some sort of stagflationary environment. Then gold could go up to $2,300. And D, scenario D would be the adverse scenario. When there would be a contraction or recession, there would be another round of QE significantly higher than the round before. And we don’t know what else central bankers have in their toolbox, probably negative rates, probably more financial repression. There’s probably many more things to expect, buying stocks, whatever. And in this environment, that’s obviously the most positive environment for gold, we would see it between $1,800-$5,000. So for the timing, we say this is our scenarios for the term of Donald Trump, until 2021 if there’s no impeachment or anything else. So those are basically the main scenarios that we’re having but I think what is also really interesting if you’re taking it from a different perspective and if you ask yourself, when will I not need any gold in my portfolio? And our assumptions would be you don’t need any gold in your portfolio when the debt levels can be sustained or are reduced, when the threat of inflation is small, when real interest rates are high, when the confidence in monetary authority is strong, when the political environment is steady and predictable. When the geopolitical situation is stable, and when governments deregulate, markets simplify tax regulations and respect civil liberties. From my point of view, unfortunately, we don’t see any of those points. And therefore I think gold should be in every portfolio. And if it’s 2%, 5%, or 50%, it just depends, it depends on your scenarios, on your risk taking, on your time horizon and so on. But I think one should definitely own gold at the moment.

FRA: Well that’s great insight, charts, and analysis. How can our listeners learn more about your work, Ronnie?

Ronald-Peter Stoeferle: Well we’ve got a completely new web page https://www.incrementum.li/ where we’ve got a journal with all our publications. You can sign up for free for our in gold we trust report, we’ve got a special web page just dedicated to the in gold we trust report with an archive where you can find all the prior issues of the report, it’s ingoldwetrust.report. And of course, we’re regular guests at your services. So yeah, just google it up and find out more about what we’re doing, what we’re thinking and what we’re actually also selling our clients.

FRA: Great, thank you very much for being on the program, Ronnie.

Ronald-Peter Stoeferle: Thank you, Richard, thanks for inviting me. It’s been a great pleasure, thanks.

Podcast will be posted shortly ..

Transcript written by Jake Dougherty <jdougherty@ryerson.ca>

 

Summary

Today we are joined by Ronald-Peter Stoeferle. He is managing partner and investment manager at Incrementum. Together with Mark Valek, he manages a global macro fund which is based on the principles of the Austrian School of Economics. He’s also the co-publisher of In Gold we Trust report, and that is the focus of our discussion today.

Key messages from the report

We seem to be at the very early stage of a new bull market. Gold was up 8.5% last year and since the beginning of 2017 it has continued to rise, gold is up in basically every currency. It’s a bull market that nobody is recognizing and it will get going. We’re seeing price inflation is way too low, so the Fed will have a hard time continuing rising rates. There are many signs that the U.S. economy is actually doing much worse than the mainstream economists see it, and the U.S. dollar is far too strong. Donald Trump says very openly that he wants and he needs a weak dollar, it’s no secret. So there is an expectation that the dollar will become weaker in the near future. This is a very good combination for gold also given the fact that the sentiment at the moment is so low. Gold has an excellent setup both from a long-term and a short-term perspective.

Commodities vs. Stocks

Gold is typically a good indicator of commodities, and the valuation of Commodities vs. Stocks are at their lowest relative valuation since 1999. The Austrian School has got a different view on prices, it says there are no fair values. So prices are always subjective and it’s important to focus not only on absolute prices but also relative prices because of the mean reversion. And as you can see on this chart, commodities vs. stocks are at a historically low level.

We’ve only seen levels like this twice in history, in 1971 and just before 2000. So on a relative basis commodities are just extremely cheap vs. stocks. We’re still far away from the median which is 4.1 and we’re very far away from the highs that are between 8 and 9 in this ratio. The ratio can even out in a few different ways. Commodities could stay stable and stocks could fall off the cliff, or stocks could be stable and commodities go through the roof. Or it could be a mixture of both with stocks becoming weaker and commodities becoming stronger. It’s also important to remember that last year despite the dollar index making a 40 year high, many commodities were actually really strong. So that’s a very positive sign and also similar to gold, this is a bull market that’s in the making. As soon as price inflation will become a topic I think people will start getting bullish on commodities again.

An Incoming Recession

A survey by Bloomberg showed out of 89 analysts that are surveyed, not a single one currently expects a GDP contraction in 20017, 2018, or 2019.

So nobody is seeing a recession within the next few years, and many of them expect growth rates between 2.2% and 2.4%. Despite all of this confidence, there are still many signs a recession may indeed be looming. We’ve got retail sales being very weak, lots of numbers from the industrial sector being weak, and most importantly credit growth for both commercial loans and consumer credit is very weak. Another one of my favourite charts it shows the interest rates since 1914, and actually in the past 100 years, 16 out of 19 rate hike cycles were followed by recessions.

Only three cases turned out to be the exception to the rule. Now we’re in a hiking cycle and I actually think that the tightening already started when Ben Bernanke announced tapering. We’re seeing that consumer debt levels are extremely high and we’re seeing a massive slowdown in monetary growth which always leads to recessions. The duration of the economic upswing is already extremely long, should the current economic expansion go for another 23 months, it would actually become the longest in history. So there’s quite a lot of reasons actually that we will enter a recession sooner or later, and maybe sooner rather than later. And this will have massive consequences for financial markets and also massive consequences for gold.

Future Scenarios For The Gold Price

 

Forecasting future prices using the Austrian School is quite different than using more traditional methods because they recognize that it’s nearly impossible to forecast the future. You can analyze what’s happening and you can read from history and make assumptions, but it’s impossible to perfectly forecast the future. This is why it’s so useful to think in scenarios and weigh those scenarios. Scenario A, or the Goldilocks scenario, is when everything is going well within an economy. We’re seeing perfect inflation rates below 2%, high growth, deleveraging and so on. You probably don’t need any gold in this case and we would expect gold to be priced between $700 and $1,000 per ounce. This seems to be the scenario that many market participants expect at the moment. Scenario B, muddling through, expects weak growth but inflation not really picking up. We wouldn’t see any real monetary nominalization so rates would rise but not significantly, there would be talks about this quantitative tightening but we all know that it’s kind of a joke. In this environment, we’re seeing gold between $1,000 and $1,400 per ounce. Scenario C is the inflationary boom, high growth, and high inflation, probably some sort of stagflationary environment. Then gold could go up to $2,300 per ounce. Scenario D would be the adverse scenario, when there would be a contraction or recession. There would be another round of QE significantly higher than the round before and we don’t know what else central bankers have in their toolbox, probably negative rates, probably more financial repression. This is the most positive environment for gold, we would expect to see it between $1,800 and $5,000 per ounce. We say this is our scenarios for the term of Donald Trump, so until 2021 if there’s no impeachment or anything else. However, if you’re taking it from a different perspective and if you ask yourself, when will I not need any gold in my portfolio? Our assumptions would be you don’t need any gold in your portfolio when the debt levels can be sustained or are reduced, when the threat of inflation is small, when real interest rates are high, when the confidence in monetary authority is strong, when the political environment is steady and predictable. When the geopolitical situation is stable, and when governments deregulate, markets simplify tax regulations and respect civil liberties. Unfortunately, we don’t see any of those points happening today. And no matter the scope, it seems one should definitely own gold at the moment.

If you would like to learn more about Ronald-Peter Stoeferle and Incrementum you can visit https://www.incrementum.li/ where you can find a journal with of their publications. You can sign up for free for the in gold we trust report, they’ve got a special web page just dedicated to the in gold we trust report with an archive where you can find all the prior issues of the report.

LINK HERE to the mp3 Podcast

Summary written by Jake Dougherty <jdougherty@ryerson.ca>

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


07/01/2017 - The Roundtable Insight: Yra Harris, Ronald-Peter Stoeferle, Jayant Bhandari On What Interest Rates And Gold Prices Are Saying

FRA is joined by Yra Harris, Ronald-Peter Stoeferle, and Jayant Bhandari in a discussion on the possible shift toward populism and on the future of cryptocurrencies.

Yra Harris is a world-recognized Trader with over 40 years of experience in areas of commodities and futures trading, with broad expertise in currency markets. He has a proven track record of successful trading through combination of technical work and fundamental analysis of global trends; historically based analysis on global money flows. He has served as a member of the Board of the Chicago Mercantile Exchange (CME). Yra Harris is a Floor Broker and Floor Trader. He is a regular guest on Bloomberg and CNBC.

Ronald is a Managing Partner and Investment Manager of Incrementum AG. Together with Mark Valek, he manages a global macro fund which is based on the principles of the Austrian School of Economics. Previously he worked seven years for Vienna-based Erste Group Bank where he began writing extensive reports on gold and oil. His benchmark reports called ‘In Gold We Trust’ draw international coverage and interest. Next to his work at Incrementum he is a lecturing member of the Institute of Value based Economics and lecturer at the Academy of the Vienna Stock Exchange.

Jayant Bhandari is constantly traveling the world looking for investment opportunities, particularly in the natural resource sector. He advises institutional investors about his finds. Earlier, he worked for six years with US Global Investors (San Antonio, Texas), a boutique natural resource investment firm, and for one year with Casey Research. Before emigrating from India, he started and ran Indian subsidiary operations of two European companies. He still travels multiple times a year to India. He has an MBA from Manchester Business School (UK) and B. Engineering from SGSITS (India). He has written on political, economic and cultural issues for the Liberty magazine, the Mises Institute (USA), Mises Institute (Canada), Casey Research, International Man, Mining Journal, Zero Hedge, Lew Rockwell, the Dollar Vigilante, Fraser Institute, Le Québécois Libre, Mauldin Economics, Northern Miner, Mining Markets etc. He is a contributing editor of the Liberty magazine.

POPULISM

A big theme in Bernanke’s recent speech was the rise of populism. Bernanke uses phrasing similar to Karl Marx in 1844. His speech paints the Fed into a corner. Why is Yellen so concerned about wage inflation as the Fed’s reason for raising rates when wages have been so stagnant? You’re going to kick the American worker and workers all over the world; even Draghi picked up on that theme as well as Japan and even Mark Carney. Wages have certainly not picked up, and it’s only asset values that have increased.

Populism is a consequence of the economy. It’ just a symptom and one very disturbing number that shows 70% of all households in developed countries have stagnating or declining household income. It’s no wonder that populism is going up because people are actually not doing very well, so of course they vote for change and not the status quo. That’s the same in the US, and with Brexit, and all over Europe. Populism going up is just a consequence of the economic mess we’re in, and historically it’s always been like that.

When it comes to the Fed, they’re quite desperate because they’ve lost an enormous amount of credibility over the last couple of years. Now they kind of want to appear very hawkish. We all know the Fed is tightening into weakness. We’re also seeing massive recession threats come in: tax receipts are very weak, industrial production is weak, credit growth is collapsing. We’re seeing so many economic numbers get weaker and weaker, sooner or later the Fed will have to make a U-turn, and that’s the point where gold will pick up momentum and rise 5-10% within a matter of a few weeks or even days.

We are in an advance stage of democracy around the world. Democracy automatically leads to populism and over-regulation. The reason is if the masses don’t understand the devastation over-regulation and populism lead us to. Over-regulation means there are too many regulations imposed on the businesses and populism means they are taxed to death if they are doing business. The result is decay in economic growth.

INTEREST RATES/YIELD CURVE SIGNALLING

The yield curves are difficult signals because of the destruction of the signalling mechanism of debt markets. Real yields are the normative measures. Now we just don’t know yet what’s going on in the markets: the 2-10 and 5-30 yield curves are both flattening in sync. That hasn’t been true until about 3-4 months ago, and now they’ve both flattened. The Fed could be raising rates but that has more of an effect on the short term rates than anything beyond two years. It would traditionally mean the Fed would be wrong for tightening here. Everyone’s making a big deal about what Draghi said, but there wasn’t any hawkishness in his speech and the ECB is still going to be buying $60B a month until December.

The yield curve in China is flattening significantly as well. A recession is something normal; it’s just a normal cleaning process within a cycle and afterwards the economy will be on a more solid base. However, we all know what central bankers and politicians will do, as soon as the word ‘recession’ comes up, there will be actions by central banks. They’re not out of ammunition yet, but it has to become more extreme. In Europe, the market recognizes that the Federal Reserve will have to stop the rate hike cycle sooner or later. On the other hand, the ECB will have to become slightly more hawkish. There’s enormous pressure on the ECB, especially from the Germans, as real estate prices go nuts. If Trump really wants to succeed with his reindustrialization of the US economy, he needs a weak Dollar. At the moment it seems the bull market in the USD is over for now, which would be a pretty good environment for gold and commodities.

Usually flattening yield curves are bullish for a currency, but we’re not seeing it. The Germans realize a strong economy needs a strong currency, and you only have to look at the most prosperous countries to see they’re all hot currencies. Most of the time, weak currency countries are usually on the bottom of all those statistics. A strong currency is like a fitness program for the economy.

UPDATE ON INDIA 

Indians have almost completely refused to use electronic money because the transaction costs are huge, and the money keeps disappearing. Businesses continue to fail, and then next week they are rolling out a new indirect taxation system which will be completely different from what India has had so far, which will require even small businesses to submit a minimum of 40 tax returns a year. There are all sorts of regulations the government is imposing on businesses.

The wealthy part of the population is interested in cryptocurrencies. About 10% of the trade in BitCoin is because of Indians, but this is still going to be a marginal part of India because Indians are technically backward. The only way they can run that mainstream economy is by using physical cash.

A lot of people are getting into cryptocurrencies because they’ve gone up in the recent past, and that is always a bad way to trade. For people in emerging markets who have no way to move their money outside their own jurisdictions, cryptocurrencies are a great way to move their money and preserve their wealth. Unfortunately, there is no inherent value in cryptocurrencies

The market cap of BitCoin at the moment is roughly $50B USD while the total market cap of all gold is $7T. There should be competing currencies, and cryptocurrencies make people start questioning and discussing money, which is an important discussion. The technology behind cryptocurrencies will be changing whole industries in the next couple of years. There’s a real revolution going on in the crypto-space.

POTENTIAL GOVERNMENT RESTRICTIONS

When push comes to shove, governments do not like competition. When there are alternatives, the Fed doesn’t have monopoly power. If they think BitCoin is ‘funding’ terrorists, the government has the ability to force it to stop.

Blockchain technology is going to change the future of many things. The problem is that blockchain-based cryptocurrencies are not backed by anything physical and it can be easy for governments to cause troubles in the cryptocurrency space. If crytocurrencies become too big, there will be government interventions. At some point governments will realize this is competition for their monopoly on money.

It’s likely that governments will get into the cryptocurrency space and turning fiat currencies into a cryptocurrency of some sort and at the same time allowing private-based cryptocurrencies to exist as long as they’re able to do it based on regulatory compliance with the financial system. While they may be outside of the banking system they’ll still be within the financial system. That’s a big distinction there. It’s in the interest of governments to go to cryptocurrencies, in particular central banks to implement negative interest rates because of the problems of having physical cash in implementing central bank policy.

Wall Street makes a lot of money on the rehypothecation of so many assets that have collateral base to it. If people could hold their stocks through blockchain technology in their name and not at the DTCC anymore, and Wall Street wouldn’t have access, that would destroy a big profit center – especially of Wall Street.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

LINK HERE to get the MP3 Podcast

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.


06/25/2017 - The Roundtable Insight: Charles Hugh Smith On Central Bank Buying Of Equities

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

Charles Hugh Smith: Thank you, Richard. That makes me seem larger than I actually am in real life.

FRA: You’ve got a great blog, I mean I read it avidly. A wide range of topics from a very philosophical perspective

Charles Hugh Smith: Well thank you. Yeah, we’re living in extremely interesting times and it’s a struggle to contextualize all the information and news that we read you know? Like how does this fit together? And that’s one of the topics that we’re going to discuss today, how does this all fit into our era and the global economy?

FRA: Yeah so I thought today we might take a look at Central Bank buying of private assets, in particular equities. But there’s also buying of corporate bonds as well. What exactly is the extent of that and potential implications to the economy, to our overall economic system, moral hazard issues in terms of what that means philosophically?

Charles Hugh Smith: Right, right. I think we all know that Central Banks have been buying just immense sums for like over 8 years now of sovereign bonds, corporate bonds, and more recently corporate equities either directly in specific companies like the Swiss Central Banks been buying Apple and Amazon I know. And then the Bank of Japan has been making huge purchases of ETFs, you know exchange traded funds which are basically index funds, pools of corporate equities. But nonetheless, enormous purchases of private sector equities which is unprecedented in a non-crisis situation.

FRA: Yeah, they’re some statistics out there that indicate this year alone there’s been so far somewhere between one and two trillion of financial assets purchased by Central Banks, especially the European Central Bank and the Bank of Japan.

And a certain subset of that includes the buying of equities. And it’s not just those Central Banks, its Central Banks such as the Swiss National Bank as well. So those are major buyers of equities and the ECB is focused on corporate debts, so specific company bonds.

Charles Hugh Smith: Right, and let’s discuss that a bit. So to explain as I understand it, and I’m not an expert, but as I understand it when Central Banks go to buy corporate bonds, they can go to the marketplace. They might be buying bonds that were issued a year or two or three years before by the corporation right? It’s the open market for corporate bonds. Or recently it appears they’ve been buying directly from the issuer, from the corporation. And this is quite a bit different because they’re basically funding corporations by snapping up their bond issuance without even going to the marketplace where they’d have to compete with other buyers and sellers and the market would price the risk factor in that bond. And so they’re really overstepping the market by buying directly from corporations. Do I have that basically right?

FRA: Yeah, I mean there’s all kinds of risks that come from this. I mean you can think of the distortions to the market in terms of valuations, price discovery, risk, the price of risk if you will. And then overall the associated issue philosophically is does it make sense for governments to buy specific company assets? Are they not then picking and choosing particular companies over above other companies? You know favouring certain companies by buying their stocks, by buying their bonds and not others, versus others.

Charles Hugh Smith: Right, and I think before we started recording you used the phrase “picking winners” right? And of course, all the stocks their buying are winners as long as their buying.

And I’m looking right now at a chart that showed the Central Bank balance sheet for the last say about 9 months and then the FANG stocks, you know the Facebook, Apple, Netflix, and Google. And they’re extremely correlated, extremely correlated.

So it suggests that Central Banks are buying these hot very large cap tech stocks and in a way, picking them as winners. Because if there’s steady buying by Central Banks in the hundreds of billions of dollars, then you basically created a floor under all these stocks that the Central Bank has picked as winners and that’s distorting the market. I recently wrote a piece that tried to describe a fairly subtle, at least to me, dynamic which is the markets are based on transparent information being available to all participants, right? And so when insiders say have an information asymmetry, like they know something the rest of us don’t, then of course that’s considered illegal because they can then benefit from that asymmetric knowledge. And so the market requires a free flow of information if it’s going to have the necessary foundation for price discover, risk assessment, pricing of risk and so on. So when Central Banks are setting a floor under the stocks they’ve picked as winners, they’ve actually deprived the market of essential information. And so my view is when you rob the market of information, then you’ve crippled all the participant’s ability to make a realistic assessment. And this may be part of the reason why we see stocks just lofting ever higher is there’s no information that would suggest risk might be rising beneath the surface because of all this Central Bank buying. So they’re basically stripping out the essential information from the market. And that’s making the market kind of beneath the surface much more fragile and much more unstable because the buying and selling is not an open market, it’s intentionally favouring a few large kept stocks. So we have to ask, what happens if Central Banks ever stop buying for whatever reason? What happens if the market starts falling? The Central Banks will sell, are they going to be bag holders or they’ll hold forever and buy more? I mean all these issues are unprecedented, right? Because in the past, Central Banks would famously buy the market in crisis. You know like when the market was crashing or going through a severe downturn they would institute the plunge protection team, right? Which would go in and buy enough equities or bonds to seize up the market and stop the crash and reverse that. And then all the computer programs would recognize the reversal and jump in and start buying. And so that kind of plunge protection team buying is one thing, but here we are eight and a half years into a supposed recovery, and they’re still buying a trillion and a half dollars in five months? I mean that’s unprecedented.

FRA: Yeah, and in terms of being able to get out, that’s a good question but maybe they cannot get out or they don’t want to get out. I mean you got issues of the baby boomers retiring, they may be looking to sell their stocks. So who is going to be the buyer in that case if there’s a large selling by the baby boomers? Pension funds as well, if there were to be a large selloff in the markets that would negatively severely affect the pension funds insurance companies. And the governments don’t want to have to bail those guys out like they had to bailout the banks back in the first financial crisis. Your thoughts?

Charles Hugh Smith: Right, well Richard we recently spoke about the millennial generation and some of the issues connected with it. And you’re absolutely right, as sort of a generalization, it’s fairly clear that the millennials income is lagging from previous generations and they have much higher student loan debt. So they’re not going to be able to fund their IRAs and 401Ks to the same degree as previous generations because even if they’re frugal they’re having to devote a lot of their income to pay down their student debt. And so that suggests there’s not going to be any secular movement generationally to buy equities because millennials simply don’t have enough money to buy a lot of equities to counterbalance the tremendous selling that will be going on over the next ten years as baby boomers retire and start drawing on pension funds which as you say have been invested in equities and will now have to be unloading them in order to fund their retirees. So if the Central Banks are going to replace an entire generation and all the pension funds globally, then they’re going to be owning a significant percentage of the entire bond stock market. And I’ve read numbers and I don’t know if they’re accurate or not, but apparently the bank of Japan owns roughly 30% of the entire Japanese equity market already. I mean that’s a significant percentage. And so what happens when that goes up to 50% or higher? And as you said before we started recording you used the term “financial alchemy” and there is an element, isn’t there, of what I call perpetual motion machine. The Central Banks just create money out of nothing, then they buy equities and bonds, and they can continue to do that with apparently no friction. There’s no risk and no friction, but is that really true?

FRA: Yeah, that’s a good question. I mean from the perspective of the Central Banks, if we look at the Swiss National Bank SNB, their driving factor of doing this, buying equity’s is a tool in the Central Bank policy tool chest in terms of trying to maintain their currency. So there’s a tendency for the Swiss Franc to get stronger. So by buying in particular U.S. equities you’re essentially buying the U.S. dollar thereby decreasing the strength or the value of the Swiss Franc. So what is essentially happening is a sort of financial alchemy. Whereby the Swiss National Bank is printing money out of thin air and then using that to buy real assets, stakes in real companies. I mean this can go on ad infinitum until they own all companies that are publicly listed.

Charles Hugh Smith: Right, right and then that’s an interesting point you raised about the sessity of Central Banks to maintain their currencies or in many cases attempt to devalue their currencies to keep their exports up. And so that’s certainly a driver for purchases of U.S. dollar based bonds and stocks. And of course, that also offers the benefit to other Central Banks of great liquidity, right? Like you can buy quite a bit of U.S. treasuries and unload them without pushing the market around much.

And the same is true of huge large kept stocks like Apple or Google and so on. So it’s interesting how stocks, equities, and bonds have become tools of currency manipulation. But the currency market is so much larger than bonds and equities, and of course, bonds are larger than equities. And so we see this sort of pyramid where when you’re going to play around with currencies you’re dealing with several trillion dollars moving around every day and then you move up to the bonds and it’s smaller and the equities are considerably smaller. I think that again it’s raising the risk in the equities market because the amount of capital that could be moving into stocks and bonds from Central Banks is unprecedented in size. And so we have to ask, what is the consequence of that in a crisis situation? Will Central Banks then have to buy another $5 trillion worth to stem the market crash? Or how are they going to respond? If they start selling then that alone can trigger a serious decline because they have now become buyers of size.

FRA: Yeah, we have several charts that we’ll put up on our write-up showing a very strong correlation between the level of Central Bank buying and the associated markets, it’s quite correlated.

Charles Hugh Smith: Right, and if we look there’s a chart that I submitted, it’s called total system leverage, it’s from Real Investment Advice. Total system leverage which is really a proxy for liquidity provided by Central Banks and then GDP.

And we see that Central Banks have generated a tremendous increase in total financial system leverage, you know credit and liquidity. And yet GDP has been in a secular downtrend since the 80s. And so we’re also in a situation where the Central Banks are taking these unprecedented actions of interventions and manipulations in the market and yet actual growth is still declining. So we’re seemed to be getting less actual growth for the buck, right? For the Central Banks, there’s a definite element of diminishing returns in their purchases of private equities and bonds.

FRA: And there’s also another interesting study that was put into the Wall Street Journal EBSCO, they have some interesting results whereby what they did as a pole and they came up with a figure of 80% of Central Banks plan to buy more stocks. So this came out earlier at the beginning of the year. And then they did some survey on asking what areas equities, corporate bonds, government bonds, deposits with Central Banks and so on in terms of asset classes. They looked at the net percentage points of Central Banks saying whether they will increase or decrease future allocations in each asset class. And equities came right up at the top, plus 80. Corporate bonds number two at plus 43. So those are the two asset classes where there’s a focus by the Central Banks. And then after those two asset classes are government bonds, so that’s quite interesting. On the decrease side are deposits with Central Banks and deposits with commercial banks, so that’s quite interesting results.

Charles Hugh Smith: Yeah Richard that is extremely interesting. And it obviously speaks to the current uptrend shall we say in global stocks. And so clearly if Central Banks have prioritized buying equities, that’s very likely a driver of the current reflation as it’s called. And so what do we do in that kind of situation? Well, the easy thing to do it just go long equities and ride the thing higher, right? But how long can that go? And that of course is an open question.

FRA: Yeah that’s the big question, where is this all leading to? Does it end? Or due to the need to implement their monetary policies will Central Banks even perhaps accelerate their buying of equities? Not so much for trying to get ownership of companies but just as a tool in their policy chest of implementing policies. So if there’s sort of more currency devaluation, competitive currency devaluations in the world going on and the need for quantitative easing for monetizing debt. I mean this whole process can accelerate I think.

Charles Hugh Smith: In my view what the Central Banks are doing is creating a widening divide between the actual real economy of sales, profits, and productivity that once drove equity valuations. And so now the more it’s based on Central Bank buying then there’s a gulf that’s widening between the real economy and the stock market. And Central Banks view the stock market as a singling device, that’s part of the reason for this purchasing as you say, it’s to support equity valuations held by pensions but it’s also to signal to everyone that the economy is healthy because the stock market keeps going up. And so as the real economy stagnates and falters and the stock market keeps rising, then the stock market starts losing its signaling capacity because people will eventually catch on that the stock markets rising from Central Bank purchases but the real economy is stagnating or in decline. And so there’s a certain element of trust in this whole idea that a market is an open transparent market. And if you lose that trust and people think that it’s just being manipulated as a signaling device, then the Central Banks may lose that whole belief of the general public that the stock market actually does reflect the real economy. And so once that trust or faith has been lost, then the stock market is no longer a reliable signaling device and the Central Banks will kind of have been revealed as the power behind the curtain.

FRA: Yeah, exactly. Okay, that’s great insight Charles thank you very much. How can our listeners learn more about your work?

Charles Hugh Smith: Please visit me at http://www.oftwominds.com and you can read free chapters of my books and take a look at my archives and see what I’m coming up with in terms of solutions.

FRA: Excellent, excellent great insight and we’ll be having another discussion in about a month.

Charles Hugh Smith: Yes, look forward to it Richard, thank you very much.

Transcript written by Jake Dougherty <jdougherty@ryerson.ca>

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


06/22/2017 - The Roundtable Insight: Uli Kortsch On The Monetary Trust Initiative – Why/How It Could Address The Underlying Problems With The Financial System

FRA is joined by Uli Kortsch in a discussion of the Monetary Trust Initiative and the underlying problems with the monetary system that lead to its creation.

Uli Kortsch is the Founder of both the Monetary Trust Initiative (MTI) and Global Partners Investments (GPI).  Currently most of his time is spent on MTI whose mission is to bring transparency and authentic principles to our monetary system. As President of Global Partners Investments and other ventures, he has worked in over 50 countries, written a bill for Congress, and conferred with approximately 15 national presidents, ministers of finance, and ministers of commerce.  He has served on numerous corporate boards with both for-profit and not-for-profit organizations.

Monetary Trust Initiative: Fixing Our Money

 

HOW MONEY IS CREATED

Almost everyone thinks it’s the Fed that creates money, but it’s not. It’s the commercial, normal banks around the corner from which you borrow money. Almost everyone thinks that money came from a prior saver; it didn’t.

Let’s say you want to buy a Ford for $30,000. You walk in and the banker lends you the money. When you sign the contract that’s an asset to the bank, and let’s assume we now do an intermediation process. The bank takes that $30,000 from a prior saver and moves it into your account. This doesn’t happen, but it’s what most people think. Where did that $30,000 come from? It came from a man who saved the money. But who is that man? It happened to be a man that’s working for Ford and Ford paid the money to the employee, who saved the $30,000 which you now have. What do you do? You give your dealer the $30,000 so you can get the car, and the dealer gives that money to Ford, which gives it to the worker, which gives it to the bank, which gives it to you and—It’s one big circle. The money hasn’t come from anywhere. People don’t think about this. We’re not intermediating money from the previous saver, because the previous saver didn’t exist. Where did they get the money from? The same place you did: the bank.

Then most people think the money came from the Fed, who printed approximately $3T of money over a period of a year and a half, and we run a fractional reserve banking system. Well, no. Those are reserves, and reserves never hit the street. None of us have ever gotten a penny of that. So where does the money come from? Let’s go back to the Ford.

You sign your contract for $30,000 and the bank, out of nothing, creates that $30,000 deposit.  That is true in the aggregate and the overall system how it works. In the bank’s bookkeeping, it looks different, but that’s in effect what happens. Let’s reverse the whole process and say the bank charges you 10% interest. You have a really good year and haven’t made any payment. At the end of the year, you pay your whole loan off: you owe the $30,000 loan plus $3,000 in interest. That’s a total of $33,000. What happens with that money? The $3,000 is income to the bank from the money it created out of nothing, the $30,000 that you have now payed off ends up as nothing. The bank, in its bookkeeping, in its aggregate, destroys the $30,000.

We’ve got several things here that are now obvious: 100% of our money is created by debt. It’s what we call bank money verses cash. Almost everything is based on bank money; there’s very little cash out there. There are a few implications to this. We must have an ever increasing level of debt in order to have price stability. In order to have price stability, if GDP grows by 2%, then the monetary aggregates have to grow by 2%. We have to have an ever increasing level of debt, but a lot of economists say one person’s debt is another person’s asset. No, debt creates saving, not the other way around. You have to turn the whole thing on its head: if there was no debt, there’d be no savings.

We know the $30,000 was created by the bank, but where did the $3,000 come from? We’re always short. There is never enough because we always create debt but not interest. The first users of money are always the greatest beneficiaries. In this case, it’s the banks or the people wealthy enough to borrow these funds at ridiculously low interest rates.

INEQUALITIES

Back to reserves, it’s a dual cycle system where two cycles run simultaneously and do not interact. When the Fed creates $3T, we run a fractional reserve banking system at about at 10% reserve ratio. In theory, if it were the Fed creating money through their reserve system, $3T would be the equivalent of $30T on the street. Well, that didn’t happen. What happens is that the FOMC create this “money” on their balance sheets and go out and buy paper – Treasuries and agencies – and goes to the bank because they have to buy from a primary dealer. The bank hands over the Treasury for $1000. Where does that money go? It goes nowhere because it’s an accounting entry that goes from an asset to the Fed to an asset to the bank, but it stays as a reserve.

The effect of inequalities is unbelievable. Agencies are houses and Treasuries are bonds. What we’ve done is forced the market into higher risk and the people who own those assets have gone through the roof. The top 1/10th of 1% is almost the exclusive beneficiary of these trillions of Dollars that have been created. The banking system favors assets. It does not favor labor. It preserves assets and preserves their value. The way to solve this is to change our whole system for greater equality.

These are the biggest issues, and what do we do about it? The question really comes down to money creation. We can get into arguments with the Austrian economists about gold standards or methods of limiting the amount of money production, but that’s secondary.

There are two separate issues: how money is created and how we control that.

You cannot have the second issue without solving the first issue. The first issue, how money is created, we have to take out of the hands of private banks. It is an extraordinary privilege they have: they’re allowed to create money, and they’re allowed to merge their funds with their customer’s funds. No one else is allowed to do that and this is why we have bank runs.

How do we then create money? Some minor examples historically were through sovereign money, the power of the state to create money. The control level is actually much better, because currently we’re printing money and bankers are trying to maximize loans. The only reason they do not issue loans is when they don’t trust the customer or economy. So you have these huge ups and downs in the business cycle as a result of this kind of system. If you get away from banks creating money, you stabilize the system. How do you distribute it? You can do it directly through the government. In theory, the government represents everyone, so if you want to equally hand the money to everyone you give it to the government. Then banks become true intermediaries and depositors. It creates stability in the system because when you have a decreasing economic situation, the government can create the amount of distribution and pull it back later on.

This happened during the American Revolution, when they created Greenbacks to pay for the Civil War and to rebuild the country’s infrastructure after. We could do the same today for infrastructure and not create inflation. It has to be done carefully, and if it does you can stop it or sterilize the funds. We would not be left indebted.

CHALLENGES AND BOTTLENECKS – THE NEXT STEP

The bottlenecks are the smaller banks. Since Dodd-Frank was enacted, about 2000 community banks had gone bust or been forced to merge, because the regulatory expenses are so burdensome that they can’t handle it. Dodd-Frank is not needed under a system of sovereign money, so you don’t need a regulatory oversight like we have now because the system is internally stable. Lawyers and the employees involved in the regulatory system are opposed to this, along with the large banks that disproportionately gain. It’s regulatory capture.

What’s interesting politically is that people who are fairly strongly on the left or right are in favor of this. It’s the people in the middle who aren’t a whole lot that don’t care much socially, who need to be persuaded. There’s a rising level of interest as people start to understand that in effect, we’ve been lied to for the last hundred years about how the system really works. People are starting to get angry.

MONETARY TRUST INITIATIVE

The Monetary Trust Initiative’s goal has been to create a model. Four years ago the plan was Puerto Rico, now it’s New Zealand and some other small places whereby there is monetary autonomy and we can change the system such that it’s a demonstrable model that can be studied. All the attention is going toward that.

It is not currently operational there.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

LINK HERE to download the MP3 Podcast

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.


06/20/2017 - The Roundtable Insight: Brett Rentmeester On Cryptocurrencies In An Era Of Financial Repression

FRA: Hi, welcome to FRA’s Roundtable Insight. Today we have Brett Rentmeester, he is the president and Chief Investment Officer of WindRock Wealth Management. He founded WindRock Wealth Management to bring tailored investment solutions to investors seeking an edge in an increasingly uncertain world, he’s a veteran in the industry. He was a founding partner of Altair Advisers, a $3 billion investment firm and he served on the Investment Committee with a specialty in alternative investments opportunities. Prior to that, he was a manager at Arthur Andersen, helping to build their Investment Advisory and Private Client Services practice. He’s a CFA and also earned a Chartered Alternative Investment Analyst designation and he has an MBA from Northwestern University’s Kellogg Graduate School of Management. He also has activities as a philanthropic donor in areas of serving as the founding Board Member of the Northwestern Center for Integrative Medicine and a member of the Major Gifts Committee of the Edward Hospital Foundation in Naperville. Welcome, Brett.

Brett Rentmeester: Hey thanks for having me, Richard.

FRA: Great, today we would like to discuss with you a topic that you have keenly on your mind and that is in the area of cryptocurrencies. First, before we begin would you like to give a disclaimer?

Brett Rentmeester: Yeah, I think it’s important to just mention that we’re going to be talking about the theme cryptocurrencies in general, and in no way should this be considered investment advice in that people are always encouraged to talk to their investment advisors.  The interviewee personally owns cryptocurrencies including bitcoin and ethereum.

FRA: Great, thank you. And so yeah, we’d like to go over a number of developments in the cryptocurrencies space. What’s happening and the technology behind that, the blockchain technology, what are the advantages of the technology, the power, the features that it is bringing to the economy? And what are merging applications that you see coming about? Also, we can go into a bit on the actual cryptocurrencies, your thoughts on Bitcoin, Ethereum, and others.

Brett Rentmeester: Sounds great.

FRA: So I guess to begin with can you give us an overview of cryptocurrencies in terms of the history and evolution?

Brett Rentmeester: Yeah, and it’s a great place to start because what we find is there’s a lot of misunderstanding. And as you and I were talking earlier, Richard, it is quite analogous to the early days of the internet. And when you think back to the perception in say 1994, if you said the word internet, most people had heard that word but probably associated it with this idea of some online college chat room. And then a couple years later they realized that it was a great place to find information and now they’ve realized that it’s changed the whole world and most business models along with it. So we think cryptocurrencies are really at that same stage, that the first reaction is people have heard of Bitcoin but associate it either with criminal activity or maybe think of it as internet monopoly money. But then they dig deeper and they find there is something to Bitcoin which is pretty unique which we’ll talk about, and then as they get past Bitcoin they realize Bitcoin is really just the beginning of this whole wave of cryptocurrencies and blockchain technology that’s going to change a lot of how businesses operate globally. So when we go back in the story of Bitcoin which was the first cryptocurrency, it dates back to 2008, and we think of it most easily as a sort of virtual money and payment system. So if you think of payment systems like PayPal or Western Union, you know it’s got some of those elements. And it was started by a mysterious founder that nobody really knows named Satoshi Nakamoto. And by owning Bitcoin you’re essentially owning a piece of the system, which again some people associate with a store of value, but at its core, it’s a payment system globally. But the real key behind Bitcoin and all these cryptocurrencies is the technology which is referred to as blockchain. And what’s really interesting if you think of Bitcoin is, compared to a bank, if you go to a bank and try to get your money, we’re long past the days where they go to the vault and pull out real physical money. It’s really a private accounting ledger, that the bank has, and they’re the middleman and they have to give you access to your money. Well, Bitcoin has taken that and made it a public accounting ledger. Something that’s transparent that gives you control of your own money where instead of having a bank as a middleman, it’s really a system that’s peer to peer. So the system’s maintained by all of these users and a group of people referred to as miners that help audit the system. So every transaction is seen in the light of day and it takes a number of people almost auditing it to confirm a transaction. So you get rid of the bank and the middleman. And what this really creates and has created in Bitcoin is this idea of a trustless system. The idea that for you and I to transact, I don’t really need to know who you are or trust who you are as a person, do my background check, all I need to know is I need to trust the Bitcoin system itself that if I’m receiving a payment from you that the payments been received, or I’ve sent the payment to you. So in this way it’s really revolutionized money and payment systems because now I don’t need a bank, I don’t need a middleman standing between me and my money. So as I mentioned earlier we’ll go into some of the tenants of blockchain in more detail. This movement is really much bigger than Bitcoin. Bitcoin is kind of the beginning, the application of a payment system and maybe a store of value. The next big wave in the development was really the founding of Ethereum in 2014. Which in layman terms I’d call kind of a technology protocol or open source systems where developers can actually build applications or so-called smart contracts that are using blockchain technology in different business applications to get rid of the middleman. So this time not in banking and money transfer, but in other industries where we’ve long relied on a middleman or gatekeeper in the middle that’s taking a fee. So it’s almost like a Microsoft operating system for blockchain applications, and that’s given way now to really a rush of new companies in almost every industry.

FRA: And you’ve kindly provided a couple of interesting charts which we’ll make available in the write-up, the transcript to this interview discussion on Bitcoin and Ethereum very interesting fact that you have there is that the total market capitalization attributed to Bitcoin and Ethereum is 73% out of a total number of cryptocurrencies of over 700, that’s quite fascinating.

 

Brett Rentmeester: Yes, yes absolutely. And yet the entire space is only about $100 Billion which although a big number, pales in comparison to some public companies out there. So it’s really in its early innings.

FRA: And so, what is exactly blockchain if someone was to ask, inquire. What is the nature of that technology? Is it sort of like a secure spreadsheet? Like an Excel spreadsheet that’s secure in some way?

Brett Rentmeester: Yeah, well I’m not a programmer but conceptually I think it’s an accounting ledger. It’s a record keeping mechanism, a program, an algorithm that’s keeping record of all transactions. So if I send Bitcoin to you it’s transacting that I used to be the owner of that block on the chain or node and now you are. So it’s a way to make something where you used to need a middleman keeping tally of all of that to allowing a computer program to do it. But really the genius behind it is empowering the users to verify transactions. So if you and I have a transaction, before it can complete it takes a certain number of users that are active and supporting the network, those are referred to as miners, almost like gold miners in a gold analogy, to actually audit and confirm that transaction. So it’s almost like I can feel secure in the fact that we made a transaction in Bitcoin and I got my money because a dozen people did an audit on it before it could go through. So the chance of them all colluding or something happening is pretty low. That’s the best way I can describe it to someone who’s not a programmer.

FRA: And what are some of the emerging blockchain applications that are currently out there and that are coming out in the near future?

Brett Rentmeester: Yeah, well I guess to give a little perspective to that, maybe just back to the internet analogy for a minute can kind of give the framework of what’s coming out because obviously the internet is probably the most sweeping technology of our time, and it did liberalize information sharing and collaboration. But it had two primary problems that blockchain helped solve. The first was, even though it’s the system we all use, it’s still controlled by big corporate users. Meaning if you’re on YouTube, YouTube gets most advertising revenue, not the posters of content or the active users. Same thing with Facebook, most of the economics go to Facebook the company, not the most value add users and active users. We’ll talk about how blockchain solves that, but the second thing with the internet is everything went digital in the world, but we still don’t have a way to feel great about the security of data. So cybersecurity is still a huge issue. So what the blockchain has allowed and where these businesses are popping up are in a couple of areas, but blockchain has allowed: 1 the power to come back to the hands of the people as we’ve talked about. So, instead of Facebook getting all the economic benefit, there are models out there now where the users get the most economic benefit. If you post a video or an article and it has a huge amount of hits, you’re actually going to be rewarded in the token or currency of that system. And if you’re a contributor and you make value added comments you’re going to get a reward; it’s not going to go to a platform provider like YouTube or Facebook. So I think that key concept of it being peer to peer has a real power to it, because fundamentally it cuts out the middleman, and we’ll talk in a minute about other areas, but I think social media is ripe for this. The idea of these are peer to peer social networks, why are all the economics going to be companies? So again, this is as you and I talked from a financial repression perspective, this is a very empowering concept because it’s putting control back in the hands of individuals and really away from governments and big companies because they’re not needed as the middleman. The second big problem of security, we think the blockchain helps solve. I don’t want to say it’s an unhackable technology, but let’s call it virtually unhackable. Meaning there’s no corporation, no CEO, no central server that can be hacked. It’s literally a web of users, a whole ecosystem where the blockchain is copied and replicated on all the user computers such that if one or two computers or one server is infected with a virus, it’ll be identified by the remainder of the network. So it’s possible to be hacked, but it would be much harder than today where people are hacking into single servers. So when you start going one step deeper on what are the applications coming out, we talked about some of the social media ones, and they go by names like Steemit and LBRY credits and SingularDTV – I mean there’s all these upstart ones that are replicating YouTube and Facebook and other things. And again incenting the users and the content providers. There’s also people out there in the esteem of giving power back to the people of allowing you to earn money on things you have to lease out. One of the more interesting ones is Golem where if you have extra computing power you can basically lease it out and somebody can garner all the world’s computing power into probably the biggest supercomputer in the world. And you, the person lending out your CPU power in getting incentive for it in Golems coin or token. So you’ve got some really innovative things, you’ve got gaming coins coming out, the idea that maybe fantasy sports, maybe normal gaming will start rewarding winners and users using their own coins. So you have this whole element of peer to peer coins and things that we’ve already got natural networks. On the other side though, back to the cybersecurity, we talked about the issues of sensitive data and all these hacks and cybersecurity issues we’re finding. And so I really believe any sensitive data in the future is going to run through some sort of blockchain technology. Now that may be blockchain technology developed by private corporations for their own company, maybe some of these other applications. But you’ve now got companies out there trying to use blockchain to make healthcare records unhackable, you’ve got companies out there like Storj coin (note:  I keep say companies but I’m really referring to coins or tokens) where their trying to create an unhackable cloud storage service. So if you’re backing stuff up, personal information, pictures, things to the cloud, that can’t be easily hacked in the way it can today. Those are two things that I think solve the issues you talked about, but this idea of a trustless system in eliminating the middleman goes even further and can disrupt almost any industry with a middleman. So think of industries like real estate where you’ve got escrow companies and title companies, all these people in the middle of a transaction just to make sure you’re both good parties and both parties makes good on their promises. Blockchain technologies could end up eliminating all of those middlemen in the future. Or even things as common as stock exchanges today, I mean why can’t there be a global network of peer to peer users trading Apple stock where there’s no middle centralized exchange taking a fee from every transaction. Now, I think you might have a couple of thoughts with the regulatory issues with that, but conceptually this idea of getting rid of the middleman.  Instead of seeing all these IPOs on Wall Street where Wall Street takes a huge fee, we’re starting to see this new phenomenon referred to as Initial Coin Offerings (ICOs) which are these businesses coming out and not paying fees to Wall Street, but coming out and issuing a coin, almost like a crowdfunding where people that put money in get a coin which inherently is a piece of the system. So the value in the coin is you own a piece of the platform. And interestingly enough, Richard, this year alone the initial coin offering market has raised $327 million whereas the venture space has invested $295 million in these technologies (source:  Coindesk). So you’re starting to see this initial coin offering market take off and maybe that’s the future of fundraising. Again, unless there are regulatory issues that pop up but they haven’t thus far.

FRA: That’s all fascinating. So this represents potentially incredible opportunities in a number of areas?

Brett Rentmeester: Yes absolutely. And it’s really just beginning so you know irrespective as to whether somebody wants to be an investor in this space I think you can step back and think about our economy today and look at industries that are likely to be disrupted and think critically about what to do about it if you work in one of those industries. Or it could be an opportunity for entrepreneurs to disrupt many industries.

FRA: And a key point on these blockchain applications is that a number of cryptocurrencies can be applied to each application, we’re not mandated to use Bitcoin or fixed upon one cryptocurrency. It’s all likely to be interoperable, your thoughts on that?

Brett Rentmeester: Yeah well that’s right, I mean that’s what makes it so exciting, it’s true entrepreneurial spirit at its best. Bitcoin right now is, by market cap, the largest payment store value system, but this is technology so it doesn’t have to stay that way. Just like Myspace disappeared and Facebook came out of second or third place or wherever it was, it is uncertain who will be the winner. But because these are not corporations and centrally controlled enterprises these platforms as I’ll call them evolve themselves meaning Bitcoin today and Bitcoin five years from now could be very different things. And it’s really up to the Bitcoin user base and again these more active miners who are maintaining the system and collectively kind of voting to make changes to see what things evolve. So if there’s an upstart coin that’s competing with Bitcoin, Bitcoin itself could decide to change to be more competitive. So it really is this amazing free market experiment right now that’s a little bit like the Wild West. And I mean that’s part of the caution because you’ve got a lot of ideas being funded that are simply ideas. And you’ve got other businesses that might be great ideas but are at the very beginning. Now again if we were critical and went back and looked at the first week of YouTube being out there and the early days of Facebook, I’m sure it would leave a lot to be desired too from where they’re at today. But it is an area that’s highly volatile and very exciting, but it’s definitely the Wild West.

FRA: So if we focused down on the actual cryptocurrency landscape, what does that look like today in terms of the types of cryptocurrencies, what they are, and what their potential is?

Brett Rentmeester:  Right now by most counts there are about 750 cryptocurrencies, so more than anybody probably thinks there are. But collectively, it’s only about $100 billion of value. So again, imagine if you could have gone back in the early days and someone told you all Internet stocks together are $100 billion, it may seem like a big number but now that we sit here today in 2017, if you could have bought the internet for $100 billion you would have done it. So I think there are a lot of companies, there’s only a handful with scale right now, and that’s why when you cited earlier Richard that Bitcoin and Ethereum together are over 73% of that market capitalization they’re the big ones, but the space is just beginning. I mean a lot of these coins a lot of these ideas I’ve referenced are things that have just come out in the last six months. So this is brand new. So just like YouTube started with a couple million dollars invested and it’s now probably a $10 billion plus enterprise within Google, you know some of these things will likely be big disrupters. Now that’s not to say that the entrenched powers won’t evolve and try to engrain blockchain technology in their systems as well, but I think what makes this exciting and so disruptive is that the whole concept is peer to peer. That means users and content providers should get paid, and not just the corporations. So I think it’s a fundamental shift we’re seeing. You know, we’re seeing a lot of people really interested in blockchain and not quite sure how to navigate the space as they look into it because it is brand new.

FRA: And what is the potential evolution? Do you see governments getting into this in terms of establishing cashless societies based on cryptocurrencies by using government based cryptocurrencies? And will governments allow the use of non-government cryptocurrencies like Bitcoin or BitGold, other types of cryptocurrencies, do you see that happening?

Brett Rentmeester: Yeah, I mean you’re right. The risks out there, the primary risk is what governments do because there is no telling how far they can go to stop it. But I use the same analogy back to the internet, even if they wanted to stop the internet, could they have? I don’t know.  And would they have shot themselves in the foot so much by giving up that economic benefit? So it’s tough to say, I mean the central banks andgovernments we know want control. On the other hand, right now you’re starting to see more and more countries kind of throw the towel in and say we can’t control this because it’s not a central entity it’s not just something local, it’s a global market. So if we shut it down in America and everybody else adopts it, they have a huge technological lead over us. And so you’ve seen some really interesting developments, you saw Russia go from very adverse to all these cryptocurrencies to being very open about it. In fact Putin just met with Vitalik Buterin, the founder of Ethereum I think last week, so that’s an interesting sign. Japan just on April 1st made Bitcoin legal tender, you know as good as the yen in the country, so think of that impact. So if you’re a Japanese investor under that system and burdened with that debt with negative interest rates, you’d think everybody would put a piece of their money in something like that. And you’ve even got countries like Australia slated this summer to make Bitcoin and other cryptocurrencies legal tender. So I don’t know, you would think it’s one of two things. Either governments are letting this happen to allow people to become used to a cashless thing and then might come in and try to enforce their own system, or they’ve conceded they can’t control it. I don’t know, do you have a point of view on that?

FRA: I think that it’s likely that the cryptocurrencies which are based or regulated within the financial system and perhaps privatized would likely be allowed to coexist with government based cryptocurrencies. So if you have a cryptocurrency like BitGold which provides compliance to regulations within the financial system, even though it is outside of the banking system, it does comply with the banking type of regulations for deposits. So I would say in that case the governments would allow those types of cryptocurrencies to coexist. And in that sense, it’s better to have or to be into cryptocurrencies which are either backed by some type of commodity like gold or perhaps just private based relative to government fiat based cryptocurrencies.

Brett Rentmeester: Right, but it does bring up a good fact. I mean given that the fractional reserve banking system is so over-levered, globally, but just thinking about the U.S. for a minute if everybody put 5%-10% of their money in Bitcoin or some other cryptocurrencies, the whole banking system implodes on itself. So you’re right, it’s really unknown forces ahead. But right now, even in the U.S. there hasn’t been a big move to crack down on it. I mean even though it’s not treated as currency and tax-free, it is given capital gain treatment for long-term holding which is more beneficial than some other assets. So I don’t know, again I’m back to it’s a global world, so a country that chooses to really crack down on it faces a big technological disadvantage relative to other countries that are endorsing it. And so I think you’re going to have a race for countries wanting to endorse it. But maybe the risk is a big global clampdown at some point, it’s hard to say. But for right now the future looks really bright from a technological point of view.

FRA: What are your thoughts on these cryptocurrencies as being stores of value? Do you see them as more of payment systems? Are they deriving a lot of their value from the ability to move money around? Like many have pointed out the use of Bitcoin by Chinese and China looking to diversify outside of China in terms of their asset holdings? So perhaps some of the value has been derived from that utility value, being able to move money around. What are your thoughts on that? Is it a real store of value?

Brett Rentmeester: Yeah, well it’s an excellent question because I think one of the biggest questions most people new to this space have is why do these things have any value? Explain to me why Bitcoin is worth what it is, or Ethereum. And so when you step back, I guess the way I view it is owning a coin, a Bitcoin or an Ethereum token, is essentially owning a piece of the platform they’ve created. So it’s not that different then if Facebook, instead of being a public stock had Facebook coin. And if you owned 10% of the Facebook coin it was like you own 10% of Facebook. So I view it very analogous to owning equity. It’s almost like you own a piece of the system. So if the system is Bitcoin and you believe it’s a valuable payment system and more people will come on board, that in of itself is a form of store value. Now, that may be different than owning gold and other things, I don’t think we have to say they’re the same, they’re not, but just say it’s a payment system for a moment. The current market capitalization or size of Bitcoin is about $43 billion, so it’s grown a lot, it’s done tremendously well. But the market capitalization of PayPal, another payment system is $61 billion. Visa is $211 billion. So I step back and say, okay is the value assigned to all of Bitcoin reasonable? It sure seems like it to me, because I would imagine Bitcoin’s got the potential to be much much bigger than PayPal, and probably surpass a lot of these credit card valuations over time. So I look at it that way, but it is a hard thing to assess. Same thing with Ethereum, I don’t have the number in front of me I think there may be $34 billion, but you compare that $500 billion for Microsoft, you know could they be the next “operating system for blockchain applications” they could be, they may or may not be. But you know I think you have to look at value on a relative basis and acknowledge that what you’re really owning when you own a coin is a piece of the system. I think once you get to that level of understanding, it’s a little easier to think about how value works and why people are assigning value to these tokens or coins.

FRA: So is it in a bubble or is it just volatile just like the other currencies?

Brett Rentmeester: Yeah, I think it’s just inherently volatile because it’s unregulated and it’s the Wild West and it’s got a trajectory that’s going to happen quicker than the tech boom did. So if technology stocks started surfacing around 1994-1995 and ran to 2000, so five to six years, maybe this is a tighter cycle. I think we’re going to see a bubble perhaps, but I don’t think we’re there yet. And I say that because in all the anecdotal evidence we get we find that still, most people don’t really understand this space. In polling people almost nobody’s an investor even in Bitcoin and Ethereum.  If you really ask 1,000 friends that are pretty well to do with money, very few people actually have money in. So I think the space from an investor point of view has been dominated by kind of techies. People that knew the technology and got involved early and get it. Or some traders. And it’s a difficult space to navigate, it’s not as easy as just going to your Fidelity account at least today, or Schwab and just buying the stock, you have to navigate these private exchanges, you have to hold it in these things called private wallets, there’s a lot of security issues you’ve got to be aware of. So it’s a pretty treacherous thing, it’s taken us a long time as investors to get up to speed on how you navigate it. So I think given how rough the landscape is of doing it, it just seems to me like the demand side is just beginning. That if the door starts opening for easier ways for people and institutions to put money in, you’re going to see the demand side grow and you’re also going to see the supply side grow as these disruptive businesses shake up other industries. So I think again the analogy’s pretty good with the internet boom, you’re going to see probably a big boom ahead. And somewhere down the road, you’re going to see a washout of a lot of the ideas that should have never been funded or really had no use. So like the modern day Pets.com, some of that. But out of those ashes will come the Facebooks, the Googles, the Amazons and everybody else. So, it’s going to be a highly volatile area, but I think for people that are looking for the next growth engine in the world, there’s no more exciting place than this. I think the blockchain tsunami has really just begun to sweep over the world.

FRA: Yes, and as you mentioned, we are in the second inning only. And also you mentioned this technology will revolutionize almost every business.

Brett Rentmeester: Yeah, it’s pretty remarkable. The more time I spend on it the more excited I get about the prospects for blockchain and in all the applications in the future. So I think for those people that aren’t taking the time to really understand it, they’re missing something arguably as big as the internet revolution where they can take the time and understand it today they will have such an edge ahead.

FRA: Well great, thank you very much for your insight, Brett. How can our listeners learn more about your work?

Brett Rentmeester: Yeah, they can go to https://windrockwealth.com/ that’s our wealth management company, we have a research and analysis section. Or they can reach out, I’ve got a long email but it might be in the reposting. I’ll leave my phone number which is 312-650-9593. We’re investors in this space and we spend a lot of time understanding the structure of the space, and it’s very unstructured, like we said it’s the Wild West. So anybody dabbling in it needs to be very careful, but by the same token, it’s a very exciting space to be part of.

FRA: Excellent, great, thank you very much Brett.

Brett Rentmeester: Thank you Richard.

Transcript written by Jake Dougherty jdougherty@ryerson.ca>

LINK HERE to download the MP3

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


06/08/2017 - The Roundtable Insight: Bill Laggner On Debt Bubbles & The Emerging FinTech Revolution

FRA is joined by Bill Laggner to discuss non-housing debt, auto loans, and FinTech.

Non-housing debt is being driven mainly by student debt and the auto loan, which are part of the echo bubbles created post ’09, and the figures are alarming. We know that some of the student loan industry is underwritten by the government and the large banks, but there’s an auto loan bubble where the figures range up to $1.5T. A lot of this industry is not securitized. There’s a chunk of the industry that’s essentially private automobile loans, and they’re bundled and sold among high net worth investors. The number is larger than what the graph reflects to the right.

The government is intervening with student debt to recast the debt, alter the terms of the debt, extend the terms etc. We know we’ve never had a true recovery; we’ve had asset bubbles but the real economy is still struggling. What’s happened is that now there’s been lobbying efforts where they essentially want to allow these people to file bankruptcy, and of course the taxpayers would eat it. It’s just another example of the Austrians’ looking at the idea of monetary fiscal distortions where the governments subsidize credit, and when you subsidize credit you end up getting a lot of these takers that take the debt and worry about repaying them later.

When Obama left office, they had one set of default figures, and subsequent to his departure another set were introduced and the figures were significantly higher. What is the real default rate? It’s likely that half of the loans are highly delinquent over 60 days or defaulted.

Looking at bubbles, in 1988 Kevin Duffy wrote a piece with the Wall Street Journal about how Japan isn’t going to take over the world for a number of reasons, one of which being that their economy is a bubble. They had owned a lot of US real estate etc., and what was interesting about their bubble and real estate is that real estate prices became wildly inflated and they were issuing 100 year mortgages. If the person borrowing money died, his wife could inherit the mortgage and when she died the children would inherit. That’s how you underwrite a bubble: you create these lunatic fringe-type policies underwritten by policy makers. We’ve seen this go on for longer than most people would’ve thought; altering the mortgages, altering the terms, the taxpayers were subsidizing the programs, they’d recast the mortgage with lower interest rates and try to paper over this. But the real economy is hollowed out. By essentially destroying the foundation of a true vibrant economy with low or no regulation, little or no taxes, and incentive for capital to be formed and reinvested, you wouldn’t see this.

The economy is fragile. We’re seeing sectors of the economy roll over, and asset prices following suit, but the broad market is levitating – these large platform-like companies have been levitating the market – and central banks are raising interest rates. Credit is starting to tighten in parts of the economy; usually when you have credit tightening and there are bubbles that it’s set upon, that’s usually a recipe for disaster. But we don’t know. We could see a scenario where the economy rapidly slows in the second half of the year, and the Fed could start cutting interest rates. Who’s to say the central banks don’t collectively go to negative 100 or 200 basis points to try and put a floor under housing? When you let your mind get creative in a fiat system, there’s no limit to what they could do. It’s a confidence game and as more and more people start fleeing the system and buying gold or Bitcoin or a farm, you could end up having a major currency crisis in a developed world.

The governments have come in and created various fiscal interventions to try and provide credit to different groups, and when banks and governments provide credit people either take it or don’t. In this case they took it, especially in the west, and we got to see nine year car loans, some of which were sold off to Wall Street and securitized while others were held by respective automobile dealers. Or a secondary market was formed. When you have a pool of savings, the central banks have pushed people into the deep end of the pool and people started doing things with safe money that they would not typically do. When enough people do it, and you’ve got a bit of momentum from this massive credit echo boom, part of this whole boom in subprime and non-subprime lending has been underwritten by historically safe money.

What’s happening is that someone will originate a loan that is non-securitized, and the default rates start going up. It’s a bizarre world of credit finding its way into a part of the market that would typically charge a high rate of interest and it wouldn’t attract as much capital as it has. Again, another distortion from central bank folly.

The lease bubble is primarily underwritten by the automobile companies themselves. The ability for these companies to, post ’09, go to the bond market to become credit providers of these “leases”, and then the terms in the lease market became loose. So it flows through on the purchase side or the lease side, and you get more of these cars leased.

Almost 4M vehicles are coming off lease in ’17 and ’18. There’s been enough leases coming off in ’16 where prices have rolled over, and at the end of this year and start of next year you’ll get a significant repricing of cars.

With regards to lending in the non-securitized, non-banking market, peer-to-peer lending has been massive over the last these years. Then you have these wealth advisers that offer credit lines against your stock and bond portfolio. Robo-advisors and these security lenders that are non-brokered dealers, non-bank lenders, have been lending money against securities. When you look at the peer-to-peer lending world, and then at some of the anecdotal pieces on other non-bank, non-securitization lenders against asset securities, you can see a number easily close to 300-400B based on all the new credit created in the last five years. Add that to the margin debt figures and then you’re talking about margin debt approaching $1T.

On the banking side, the bail-in model is going to be implemented throughout the developed world. The Fed is going to allow more failures this round and likely won’t step in for a non-bank lender. For housing, the government will do everything imaginable to prop up housing, but that’s not going to stop it from going down. They will come up with all types of creative ways to keep people in their homes. They’re not going to sit idle and watch housing go down 60-70%, but they’re not going to interfere with car loans and student loans and credit cards.

Housing prices in Canada will go down a lot. The government will lower rates and figure out ways to provide credit to people, but that’s not going to stop housing prices from going down to something closer to the norm in terms of wages. Over the last 6-7 years, we’ve essentially underwritten a casino-like economy. It’s amazing how many people are in this casino, gambling.

FinTech is one of the most fascinating things we’ve seen in the last 25 years. There’s a lot of crypto-currency being created that are suspect, but some of it is real. It’s a borderless way of transacting value through the rail system known as the public bloc chain. What’s happening is that you have really smart entrepreneurs that are throwing technology and decentralization to create alternative ways of holding and sending value. It’s an industry run by centralized parties that take somewhere between $3-4T out of the global economy through foreign exchange fees, credit card fees, ATM fees, etc. By creating these alternative forms of exchanging value that are decentralized and innovative and creative, you create an ecosystem where more and more people are exchanging products and services without traditional friction points from all these authorities. You have these fiat currencies and people are losing confidence in them, and a parallel ecosystem competing with a fiat system that’s flawed and centralized.

It’s very volatile, but there are very interesting entrepreneurs throwing a lot of human and financial capital at it. What’s happening with smart contracts and peer-to-peer value exchange is interesting. A lot of these companies are private; there’s a company in Russia that’s toying with the idea of accepting Bitcoin and making it available to buy and sell. You’re probably a year or two away from these companies going public. There’s a lot that needs to get sorted out in terms of security, scalability issues, and trying to take something technical and very complex and filtering it down to something that’s convenient and user-friendly for people. People are moving to these platforms and the regulators are lightly regulating them, so you’ll see evolution happen.

The takeaway is that we now have true competition to fiat currency.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

LINK HERE to get the MP3 Podcast

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.


06/04/2017 - The Roundtable Insight: Jayant Bhandari On The Economic Effects Of Going Cashless

FRA: Hi, welcome to FRA’s roundtable insight today we have Jayant Bhandari. Jayant is a specialist in the natural resources sector, he travels the world looking for investment opportunities in this sector. He advises institutional investors about his findings and he worked for 6 years with U.S. Global Investors, a boutique natural resource investment firm, and also for one year with Casey Research. Welcome, Jayant.

Jayant Bhandari: Thanks very much for having me, Richard.

FRA: Great, so I thought we’d start with an update on the situation in India, as you know we’re trying to keep an eye on this as what’s happening there could affect other locations or could evolve in a similar way in terms of what’s happening to physical cash and the currency there. Any updates from your end?

Jayant Bhandari: Sure, though Richard, as I have talked with you in the past, on the 8th of November 2016 Indian Prime Minister demonetized 86% of monetary value of cash in circulation. The result was that the economy started to stagnate, this was my experience and this has been my experience in the last 6-7 months. The World Bank, the IMF, and the Indian government continued to claim that Indian economy was actually starting to do better. Now, yesterday they came out with new numbers and they now accept that the economy is starting to show signs of the stagnation. Instead of the economy growing at 7.5% according to them, it is now growing at only 6.1%, again according to them. In my view, the growth is negative not even positive. I see, as I have repeatedly said on your show, India is actually becoming a police state. And this police state is going to be a horribly chaotic place because Indians are very chaotic people. Trying to propose a totalitarian system on this country will lead to a disaster in India.

FRA: And you see the Totalitarian approach as being indicative from the developments on physical cash, is that directly related to that? And in turn is that what is causing the slowdown in the economy?

Jayant Bhandari: Well, that is one part of the story in a country where 95% of consumer transactions are cash based transactions. You cannot really impose internet and banking on these people, this led to a massive slowdown in the economy. Now Richard, one funny example I want to tell you about and that will give you a glimpse of what is actually happening; I bought a New Delhi to London plane ticket two months back, I paid for it using my debit card, not my credit card because I refuse to have a credit card in India. The money left my bank account, I got no ticket. And no one knows where my money is today two months after the event.

FRA: Wow.

Jayant Bhandari: Now in a society like this, you can’t really impose digitalization and banking because Indians are not capable of, and it’s totally not structured for high-tech movement of cash, they have to have physical cash to do transactions, physical cash invariably will come back into existence. But in the meantime, Indian government will have destroyed the economy, lives of hundreds of millions of people, old people are going hungry in my opinion because food prices continue to be half as much priced as they should be.

FRA: So what are the trends at this point or recently in the areas of the inflation-deflation situation in terms of inflation on food prices or consumer prices in general? And also the trend in the currency strength or value as well, like what is it relative say to the U.S. dollar, any trend you are seeing there?

Jayant Bhandari: Sure, so what has been happening with inflation is that this has because of demonetization it has created a deflationary environment. People are simply not buying anything. Now, deflation is a good thing as long as it happens because of excess supply. The reality with India is that deflation is happening because of significant reduction in demand. People are simply not buying anything that they don’t need right now. But that also includes food now, so this deflation is a horrible deflation which is destroying businesses and the economy. And I keep meeting the small businesses who tell me that they are shutting down, not just because of the cash crunch, which is a major part of course, but regulations have increased, the rapaciousness the corruption of the bureaucrats has increased very significantly. Now the other side of this story is the Indian stock market is booming and Indian currency has gained a lot of value in the few months. Now firstly talking about the stock market, the stock market is not necessarily correlated with the growth of the economy which a lot of people erroneously believe. Now the thing with the stock market is that people’s cash is stuck with the bank, so they have really no option but to buy stock. At the same time there is an increased bullishness about India in the Western countries which is completely wrong, these people will eventually lose a lot of their money but because they have continued to send more money into India, Indian currency has improved and the Indian stock market has improved but as I said, Indian economy is stagnating and in my view, passing through a negative growth rate right now.

FRA: And what about inflation? Do you see consumer price inflation happening? Any trends there?

Jayant Bhandari: Well it will eventually happen because once they have destroyed the economy, once businesses are shut down, the supply won’t be there anymore. So inflation has to happen, and also the cost structure of creating everything has gone up because of the rapaciousness of the government, the bureaucracy and the regulation and the enforcement of digitalized cash on people. Which people are incompetent to use if at all the system works which has increased to cost of doing business, eventually it will lead to huge inflation in my view, but for the moment its deflation but this is only in the transitionary time, and that is mostly because the mint has been destroyed, it’s a horrible sign for the future of the economy in my view.

FRA I see, and what about elsewhere in Asia? Any trends there in terms of an economic slowdown or inflation-deflation, other parts of Asia?

Jayant Bhandari: I see the same thing in the rest of the Asian countries; Sri Lanka, Thailand, Myanmar Pakistan, Bangladesh, Nepal, they are all starting to stagnate, the East is blowing up. So I think that the economic future of these countries is not good at all, the only place where I see optimism and actual growth happening that’s in China, Korea, Singapore, and Hong Kong.

FRA: In what areas is that growth happening?

Jayant Bhandari: In China I see growth happening everywhere, in the infrastructure the investment continues to exist. I think the cities the manufacturing continues to grow, consumption of commodities continue to grow in China. Now the reality is that the perception among resource investors is that China is slowing down and Chinese demand for these commodities is falling, which is actually not true. What is happening is Chinese consumption of commodities continues to grow, the problem is that we have increased supply more than the demand has increased in commodities, hence the destruction of pricing of commodities. But the Chinese continue to buy a lot of commodities, and maybe they have reduced the chasing of iron ore, but that’s only because recycled steel is now coming back to the market which means that iron ore needs might have fallen off a bit, but that is not a result of a fall in economic growth, it’s just a result of increased recycling.

FRA: From that perspective, what opportunities are you seeing in the natural resources sector, are there opportunities in Asia or elsewhere in the world?

Jayant Bhandari: Again, China is still heading growth around the world in my view. And in both cases, in the case of precious metals and in terms of commodities. Commodities because they continue to grow, China is putting into place this one road, one belt road. Which is the Chinese attempt to link countries in Asia and Africa economically which I think will be a great thing for these countries because China is the only country in my view which has the capability for leadership among the third world. So commodity consumption I think will continue, I just hope natural resource investors do not pump up the supply more than the demand goes up. At the same time, in my view precious metals consumption will continue to grow in China, not actually because of volatility partially because of increased political risk, but mostly because the Chinese need to diversify. These people are diversifying their world for the very first time really. I mean, China was a completely closed economy 30 years back, it’s only in the last 10-15 years the Chinese are internationalizing themselves. It’s not necessarily a bad sign in my view, neither is it a sign of their increased fear about China, but they are merely diversifying. If you and I become rich, we want to diversify.

FRA: And will this leadership by China still be maintained given their current challenges with lots of government and corporate based debt? You know the shadow banking system, the non-banking sector has a lot of non-performing loans, and then overall there’s a problem with the wealth management products in terms of a potential bubble there from sort of a Ponzi nature of WMP products. Any thoughts there? Like will China still be able to maintain their development on the Silk Road?

Jayant Bhandari: I think that China will continue to grow. And the reason is that the rest of the emerging markets are in much much worse shape. Look at what’s happening in Venezuela, Brazil, which actually comprises almost half of South America, more than half of South America probably. Yes, there are problems with China. There’s a shadow banking system, there’s a problem with corruption in China, there’s a problem with overcentralized politics of China. But really, China has continued to grow for the last 30 years and this must mean that overheating must have happened in parts of the economy and parts of the society and politics. Corrections will happen, but again it’s a centrally managed system. I don’t think they will have a major crisis anytime soon. They will be able to deal with some of these smaller issues, they do have to deal with too much credit given to state government-run companies, and all those kind of things. But I think China has the capabilities and the resources to deal with the short-term crisis. In the long term, certainly, but who has seen the long term? In the long term maybe there will be more problems.

FRA: And in terms of investment opportunities, which countries in Asia, Southeast Asia, East Asia do you see as offering opportunities in different areas?

Jayant Bhandari: I love China. I love China I invest in China, I invest in China via Hong Kong. Hong Kong is a great place, Singapore in my view continues to be a great place. Singapore and Hong Kong continue to be places where the wealth goes to for protection. I also like Australia and New Zealand, I think both these countries despite that they are very socialistic in their orientation, have done a lot of good work in their countries and their societies are relatively stable societies far from the problems of the world, problems of the western world, problems of Europe and huge problems of the emerging markets in my view.

FRA: And are the opportunities in areas of industrial commodities or agricultural commodities or other sectors of the economy?

Jayant Bhandari: In Australia and New Zealand, yes. Australia continues to grow big at providing a huge amount of commodities. Iron ore, coal, gold and the rest actually to China and the rest of the world. And these commodities have been extremely helpful to Australia in terms of the growth in their economy. They have also been able to attract a lot of wealthy, good investors and migrants into Australia where it might not have been the case with Europe. So yes, I think natural resources continue to be a big part of Australian economy today.

FRA: Moving to North America, we were talking just before our discussion began today on what’s happening politically and the ramifications of that on the economy. Can you bring us up to speed? What’s recently happened politically in British Columbia, Canada?

Jayant Bhandari: Sure, Richard. I’m currently in Vancouver and it’s very sad to see that as much as 17% of the votes in the recent provincial elections went to the green party. Now the vote green probably made the party very attractive to a lot of people, 17% which is a massive increase from less than 1% that they used to get in the past. And it is twice as many votes than what they got in the last elections. So there’s a huge shift towards the left in British Columbia from what I see. Now, the results will be that the next government will very likely be a leftist government, a combination of the Green party and NDP which is left to the center party. Now, these people have already promised in their election manifesto that they would want to kill Kingdom Morgan gas pipeline which is going to be a pipeline from British Columbia to Alberta. Now, this is supposed to be a $7.5 billion pipeline and they want to destroy construction of this pipeline despite that most of the permits have already been issued. They also want to destroy a hydroelectric project in British Columbia, they want to increase minimum wages to $15.00 per hour in British Columbia, and they want to impose massive taxes on foreign buys of properties in British Columbia. So far there’s a 15% tax on foreign buyers just in Vancouver, now they want to make it 30% and they want to impose it across the province. These are not good news in my view for the future of British Columbia.

FRA: Wow, 30%. In Ontario, the percentage has gone to 15 like they have there now. Is this having any effect on the Canadian housing market? Is there any indications it’s slowing down or prices are falling?

Jayant Bhandari: Well from what I have seen in the media, no the prices aren’t necessarily falling, they did stagnate for a while when they imposed the taxes, but from what I see, the prices continue to go up. So no, it hasn’t really made any real impact onto the housing market.

FRA:  And coming back to our point on the movement to the left in British Columbia, do you see this as a trend overall in North America, a sort of backlash if you will against the recent elections in the U.S. with U.S. President Donald Trump, we are apolitical, we don’t take sides but just what are your thoughts on that? Do you see as we mentioned on other shows a potential for a movement to the far left in the sense of socialism perhaps led by the millennial generation?

Jayant Bhandari: I think that’s actually happening Richard. And it seems to me from whatever number I see that most of the leftist votes tend to come from relatively educated urban people. Richard such an irony because educated people should know better that socialism does not work and it is the free market that has given us all these nice things that we enjoy in our lives. But I guess urban environment and schooling system has a dyadic effect on people’s minds, it makes them simplistic in their thinking, they start to forget about second order consequences. And the problem is, when I wake up in Vancouver and when I switch on my light, they always switch on. And so life becomes so predictable in rich technologically advanced countries, particularly in urban centers, but people tend to become simplistic because they don’t really have to deal with chaos on a day to day basis. I don’t know how you can change that, but simplistic thinking also leads to leftists, because the promises of leftists are simplistic promises, and they look attractive to simplistic people.

FRA: And what would be the effects of this on the economy, economic development, and the financial markets in North America?

Jayant Bhandari: Well I am, Richard, optimistic about Trump, I think he’s trying to change a few things. I am increasingly pessimistic about Canada. We have to remember Canadian currency has fallen about 30%-35% or even more in the last four or five years. This has seriously hurt the Canadian economy I guess, now that of course has made Canada more attractive to foreigners, foreign tourists, foreign investments, and foreigners who want to buy housing in Canada. But despite just the short term gain for Canada economically, it might come at a huge cost in the future. Given that now we have leftist governments in many provinces, many important provinces like Alberta, British Columbia, and of course in the federal government with Justin Trudeau, who in my view has no understanding of economics or pretty much anything actually.

FRA: And what about just overall like in the U.S. North America? Do you see this as a trend and a negative effect on the economy, slowing it down?

Jayant Bhandari: I think so, yes. I think people in the western world are becoming increasingly leftist, and we also have to accept that most of the migrants who have come to the Western society tend to predominately vote for the left, the left in any governments, and they want to covert the Western governments into many governments. And that means that our politics is increasingly becoming leftist and you go to the government offices, government offices are over-represented, have a higher proportion of migrants working in government offices then the proportion of migrants in the society. So I think there’s a clear trend in the society in all of the west to become increasingly leftist, and this will have a harmful effect on our society going forward.

FRA: And how would the emerging pension prices, government in particular government pensions, especially in the U.S. initially before Canada, although it’s likely to affect Canada as well. Is this all going to be exacerbated by that in terms of these trends happening and an overall slowdown? There’s been some recent reports like the wealthy are now leaving Connecticut due to the pension crisis already, so do you see that happening?

Jayant Bhandari:  Well from what I read it does not look like as if people are really going to have access to their pensions 10-15 years from now, and maybe much sooner than that. So, people who are hoping to benefit from their pensions in the future, it’s probably not going to happen. Particularly when unemployment is increasing hugely in the west, peoples need for welfare from the government is increasing. So government really does not have the resources to continue to give money to people when the tax revenues might actually start to fall at a certain point in time given mostly stagnant economies in the western society.

FRA: Great insight, wow that’s great as always Jayant, how can our listeners learn more about your work?

Jayant Bhandari:  Richard, I have a website, www.jayantbhandari.com/ and everything I do is on that website.

FRA: Great, thank you very much once again, thank you Jayant.

Jayant Bhandari:  Thanks very much for the opportunity Richard.

FRA: Yup, we’ll do it again, thank you, take care.

LINK HERE to download the MP3 Podcast

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.


05/26/2017 - The Roundtable Insight – Yra Harris On Currencies – Central Banks Can Promote Crypto/Electronic Currencies To Help Implement Negative Interest Rates

FRA is joined by Yra Harris to discuss the current state of currencies – crypto currencies, USD, Yen, and Euro.

Yra Harris is a recognized Trader with over 40 years of experience in all areas of commodity trading, with broad expertise in cash currency markets. He has a proven track record of successful trading through a combination of technical work and fundamental analysis of global trends; historically based analysis on global hot money flows. He is recognized by peers as an authority on foreign currency. In addition to this he has specific achievements as a member of the Board of the Chicago Mercantile Exchange (CME). Yra Harris is a Registered Commodity Trading Advisor, Registered Floor Broker and a Registered Pool Operator. He is a regular guest analysis on Currency & Global Interest Markets on Bloomberg and CNBC.

Yra highly recommends reading The Rotten Heart of Europe – send an email to rottenheartofeurope@gmail.com to order

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RECENT RUN-UP OF CRYPTO CURRENCIES

It seems to have caught on for people who are trading gold and treat it like a haven. It’s difficult to understand how the crypto currency market works and why we can be secure that it will hold value when it seems to just move around in huge gyrations. We saw the movement of when it had a fall of almost 50% a few months ago when it appeared that the guys from Facebook were behind the push for creating a Bitcoin ETF; when it looked like it wouldn’t get approved, the currency dropped significantly in value. In some way, central banks would love to go to a crypto currency or an electronic currency, because then they can control what people do with their money when they need to go to negative interest rates. There’s a lot to understand and learn here and too many uncertainties here. If you’re looking to secure your money, you should stick with precious metals.

The concept of crypto currencies in the form of Bitcoin and Ethereum don’t appear to be based on anything in terms of either a commodity like gold or precious metals or the faith and credit in a government, so it’s a bit of a wonder how it’s getting its value.

Governments don’t like competition. If the Chinese wanted to shut this down they could shut it down whenever they wanted; they still have tendencies toward repression. If there was a movement by governments to get into crypto currencies, then it would make more preferable sense to have some type of crypto currency that would be backed by a commodity, preferably gold, verses nothing like Bitcoin or Ethereum. Otherwise you would need to use a government-based crypto currency – which would be another form of fiat currency. In other words,  it would be preferable to use a crypto currency based on a commodity instead, as long as that commodity-based crypto currency is still regulated by the financial system.

In a fiat currency dominated world, central banks have not acted in the best interests of holders of the currency – that has forced people to reconsider things. Shariah-compliant crypto gold is a potentially interesting movement.

RECENT CURRENCY SHIFTS

Yra offers his perspective on the US Dollar (USD) currency, offering his counterarguments relative to recent observations by Russell Napier who takes a bullish view on the USD:

Russell points out  that Japan is running out of savings so there’s an insufficient private savings level to fund its government. The counterargument to insufficient savings rate is the fact that Japan traditionally has a tremendously high savings rate and phenomenal investment all around the world. They run current account surpluses not just because of trade balances, but from investment income. If their savings are drawn down, the Yen won’t collapse even though the underlying fundamentals are terrible in other ways. When the Japanese get nervous about the world, they bring money home, and they have huge amounts to bring home.

Russell also points out how China for a weaker Chinese currency (and relatively stronger USD) for export competitiveness. Yra points out that if the Chinese are going to move to a more domestic-based economy, it will not be in their interest to depreciate their currency. Will the currency go down because China has troubles? Maybe, but it’s already depreciated over the last 18 months in anticipation of a lot of those troubles. It depends on how much the Chinese move toward enhancing themselves in a domestic-based economy instead of on exports – from that view, the Yuan will likely appreciate.

Yra points out the Yuan-Peso currency exchange rate is a much more interesting relationship because Mexico stands to be a real competitor to China for the US economy, whatever way NAFTA is treated. The Yuan needs to not appreciate against the Peso.

INTERNATIONAL USD DENOMINATED DEBT

Russell thinks the USD will strengthen also because of the high levels of USD denominated debt held internationally outside of the US, saying that at some point in the event of a recession, there could be higher demand for USD to pay back USD denominated debt.

Yra asks will the global recession cause a run in the Dollar? If the US equity market is a flows argument, and global flows are headed there, the Dollar hasn’t performed that well over the last 4-5 months. That one’s not going to play out and if the world gets into that type of financial difficulty because of the debt, some of the old true relationships are going to break down dramatically. That’s really when you want to start buying gold – if that’s the case, the Dollar isn’t going to be bullish, and you just load up on precious metals instead of any currency.

We know the US President can lower the value of the Dollar, but it’s not an easy task when everyone wants a weaker currency. What can the  US President do? He has to explain to his friends and trading partners why he wants a lower Dollar and get them to sign off on it as what’s best for the global financial system. That’s what we’re discussing here. He could do it by having bad policies.

ON THE EURO CURRENCY

After the French elections are over, we can probably look for the Euro to rally. The Euro is too weak for where the Germans are at. The question for the EU is “whose Euro is it”. France, Italy, and Spain don’t need a stronger Euro, but will it go up? Maybe. As Germany now presses onto this election, the discussion seems to change a little bit. With all the problems the US has, it’s scary what the discussion is. But the equity market continues rallying so no one cares. The fact that the Dollar cannot gain any type of strength with everything else that’s going on in the world and other geopolitical problems, that is a warning sign that things are not good here and the Euro can go higher.

Draghi isn’t going to announce any tapering of the QE plan, and he needs to keep building the ECB balance sheet because that’s what’s going to pave the path for a Eurozone bond. That’s the real game and it’s capturing the Germans. That’s where they’re going and it won’t be easy. They’ll bail out Greece because they don’t want this to be an issue in the German elections because it’ll undermine Merkel a bit. The stronger she gets, the better it’ll be for her after the election.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

LINK HERE to download the MP3 Podcast

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.


05/19/2017 - The Roundtable Insight: Peter Boockvar and Alasdair Macleod On The Risks Of Central Bank Policies To The Financial Markets

FRA is joined by Alasdair Macleod and Peter Boockvar in a discussion of geopolitics, central bank monetary trends, and their impact on the global economy and markets.

Alasdair Macleod writes for Goldmoney. He has been a celebrated stockbroker and Member of the London Stock Exchange for over four decades. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy.

Prior to joining The Lindsey Group, Peter spent a brief time at Omega Advisors, a New York based hedge fund, as a macro analyst and portfolio manager. Before this, he was an employee and partner at Miller Tabak + Co for 18 years where he was recently the equity strategist and a portfolio manager with Miller Tabak Advisors. He joined Donaldson, Lufkin and Jenrette in 1992 in their corporate bond research department as a junior analyst. He is also president of OCLI, LLC and OCLI2, LLC, farmland real estate investment funds. He is a CNBC contributor and appears regularly on their network. Peter graduated Magna Cum Laude with a B.B.A. in Finance from George Washington University. Check out Peter’s new newsletter service at www.boockreport.com.

THE TRUMP FACTOR

Up until recently, the market was laser focused on tax reform, health reform, and policies. But Trump’s behavior in his tweets crossed a line that the market couldn’t ignore it any longer. The market knows that he needs all the credibility and stature in order to get the tax reform that the market has been anticipating. The market has been solely focused on tax reform and not paying attention to central banks pulling back and the issues with the US economy and mediocre growth. It’s all been chips on the table of ‘Trump’s going to make things great with tax reform and I don’t care about anything else’, and this is a gigantic wake-up call that the belief that everything is going to go smoothly was incredibly naïve.

This is much more than a one-day event. Now you have a dark cloud over the Trump agenda. You take that away at the same time the Fed is raising interest rates, the US economy is mediocre at best, and the yield curve keeps flattening? There’s no room for error in terms of valuations, and it’s that kind of cocktail that gives us a sell-off like we’re having today.

Trump’s problem is that there’s a turf war raging in the White House. On one side you’ve got established security and on the other you’ve got Trump and his men. The central point about this is that you’ve got the McCain type faction hell bent on continuing to wage a cold war against Russia and China, and you’ve got Trump coming in as a peacenik. He’s turned into someone who’s started quite a few actions around the world. What’s interesting is that President Shi came over, and the result now is that there’s a dialogue between him and Trump. Trump wants to do the same with Putin, but he’s being prevented because there’s so many leaks accusing him of leaking things to Russia, or appointing someone who’s said the wrong things to Russia, etc. The unfortunate thing about it is that it’s moved away from that into the public domain, and now it’s become an issue and they’re talking about impeachment. The fallout from the turf war is starting to destabilize things, and it’s likely that Trump has lines of communication with Shi and Putin, which in the final analysis is going to be very good for all of us. Continuing with the cold war is fundamentally a mistake.

THE EFFECTS ON INTEREST RATE POLICIES

Rate hike odds have gone down, but at the end of the day the Fed is still going to focus on the numbers that they see, and in their eyes they’ve reached their ‘mandates’ in terms of employment and inflation and they’re going to raise interest rates. It’s going to be interesting to see how they manage the political landscape verses what they should be doing on the economy because even if Trump gets impeached, Mike Pence will just carry out what Trump did. The Fed should not be focssed on politics and focus more on what policies will come this year and next. Even so, the Fed seems intent on raising a few more times and shrinking their balance sheet.

The possibility of impeachment does throw into the air when tax reform and health care reform is going to be done. The policy people working on tax and health care reform are going to do that regardless of what shows up in the newspaper and on TV. As Trump is losing credibility, everyone has to ask the question of what moral suasion is he going to have on this process to get something passed. If he doesn’t get this passed and it bleeds into next year, that’s going to have economic implications because corporate CEOs and CFOs are going to freeze some decision making on capital spending or anything else. That’s what the market is questioning; they couldn’t care less about whether Trump is president, they’re just worried about what happens to his agenda.

The basic job of the Fed is to try and manage monetary policy in the context of what the economy is actually doing. Having driven interest rates down to zero, there comes a point where the Fed should try and normalize. Unemployment and employment statistics have come back to target, and that means interest rates should be normalized. The problem the Fed has is that there’s so much debt in the US economy that to raise interest rates very much would destabilize the situation. This is why they’re being very cautious about the rate at which they increase interest rates. If they raise the Fed fund’s rate to 2.5%, they could bring on the next credit crisis. The Fed is very much aware of the debt situation and they don’t want to raise rates like they did in 2006/2007. Assuming that people in the Fed have a sort of inkling, that’s as far as they’re willing to go.

NORTH AMERICA’S EFFECT ON EUROPE

They’ve been beating to a different drummer. While we have political challenges with Trump, their political situation has actually gotten cleaned up with the elections in Austria, the Netherlands, and France. Then we have Italy next year, but the political worries that were becoming widespread have calmed down. We’re seeing better economic activity, and at the same time there’s a growing pressure on Mario Draghi to further taper. Europe is enjoying some calm, but it’s going to be the European central bank and Draghi that completely disrupts that sometime this year and certainly into next year.

There is growing antagonism in Europe about the whole of the EU project. The real problem the ECB has is that it has completely mispriced the bond markets. The prices are way overinflated, but under Basel II and Basel III, these debts are risk free as far as the regulators are concerned. They’re not risk free. The problem now is that as things begin to normalize in the EU, what’s going to happen is that substantial losses are going to appear in the bond market. This could be better absorbed in the US banking system, but not the European banking system. The banks are horribly weak: their balance sheets are rubbish, dressed up to look good for regulators. If you dig down, most of those banks are barely solvent and they cannot afford to take the losses on the bond market which accompany an economic recovery. That is going to be the big, big problem.

Moving on, we’ve got the Brexit negations and the general election. There’s little doubt that Theresa May will have a strong mandate to negotiate as she sees fit with the EU. The EU does want to get a settlement done because they’ve got other problems. The potential Brexit offers the UK is absolutely enormous. If interest rates start rising in the US, there is going to be a tendency for the Euro to be weak. Sterling could also recover against the Dollar are people begin to understand that Britain’s position in negotiating Brexit is actually pretty good, and an agreement is going to be achieved.

The only other currency that needs to be considered in this context is the Yen. Japan is beginning to move, joining the Asian Infrastructure Investment Bank for example, which indicates that business in Japan is starting to drive the government in a different direction from the pockets of the US. There’s lots of change going on, but the big danger is raising interest rates in the EU, which is going to be difficult to do without casualties in the banking sector.

The Fed is going to create policies here irrespective of what goes on overseas. They’re not going to run out of things to buy, but you run into restraints where you start to break the market. The Bank of Japan has certainly broken the JGB market, and the more ETFs they’re going to buy the more they break the stock market. You do reach a natural wall, and that’s not even talking about the limits they reached in terms of the inflation they’re creating and the goals that they’ve met. The level of central bank activity for the sole reason of 2% inflation is a scorched earth monetary policy, and now they have to live with the consequence that they can’t reverse themselves. It’s going to be a nightmare to get out; look at the Fed: here we are in the ninth year of the expansion and the balance sheet hasn’t shrunk one Dollar after raising three times.

OVERALL EFFECTS ON GOLD AND LONG END OF BOND MARKET

The Dollar Index has given back the entire Trump trade; it’s gone back to where it was on Election Day. Now you have the yield curve below where it was on Election Day. Half of that is the Fed raising interest rates and people worried about the economic implications, but at the same time we’re seeing a drop in long yields because they were worried about US growth and the Trump reform not happening. The only real outlier here is the stock market, that’s really on a different planet in terms of its perception of the macro economy and what Trump can do.

The reason that the stock market is so overvalued is that no one is valuing anything in the stock market anymore. The vast majority of investors today are just buying ETFs. It sort of insulates them from reality, but at some stage the market will turn and you’re going to get an awful lot of liquidation. You can’t say the stock market is overvalued; it’s just not valued.

China has tried to take a lot of speculation out of the wealth management products because they’ve been frontrunning the Chinese government’s purchases of commodities. Everyone in China knows the government is stockpiling commodities for its plan to industrialize the whole of Asia. She’s easing down her US Treasuries in order to buy commodities. Basically China’s shaken this out and that process is coming to an end. This is an important signal in gold and silver today. This year so far, silver has risen less than gold, likely because of China unwinding these wealth management products. If you put together the thought that this liquidation in the commodity holdings in the wealth management products, plus the weakness in the Dollar, the potential for gold to rise is pretty good. Base metals and precious metals will move up from there, possibly extended to mid-year. The background for gold and other precious metals is looking pretty good.

The Dollar’s been nothing like a safe haven, so people have found a different save haven. The whole thing with geopolitics is that usually it has a very short impact on markets. It still comes down to what affects markets over a longer period time than currencies, commodities, and fixed income: monetary policy and economic growth. That’s what people should focus on the most.

The Dollar will continue to weaken in the short term, because the rallies we’ve seen in both the Euro and Sterling aren’t over yet. Measuring the Dollar against a basket of commodities, you get a different situation: the Dollar is fundamentally weak against the major commodities and raw materials. Energy is interesting because it refuses to weaken, the purchasing power of the Dollar measured in oil will tend to go down.

FINAL THOUGHTS

This is the first year that all five central banks are either raising rates, ending QE, shrinking their balance sheet, or tightening liquidity. The only reason this market is trading is because of central bank policy. The second concern is what Trump is going to be able to pass, assuming he remains in office, because obsession with tax reform and regulatory relief has blinded people to other growing risks. These are the two things people should focus on the most, instead of geopolitics. People have to understand that we have credit cycles, not business cycles. If central banks didn’t exist, we wouldn’t have these cycles at all! We’re getting quite close to the crisis phase in the cycle, and this time around this crisis could even be bigger than the great financial crisis 8-9 years ago.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

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


05/16/2017 - The Roundtable Insight: Charles Hugh Smith On How Financial Repression Is Affecting Millennial Generation Values

Charles Hugh Smith is an author, leading global finance blogger, and America’s philosopher we call him. The author of nine books on our economy and society including A Radically Beneficial World: Automation, Technology and Creating Jobs for AllResistance, Revolution, Liberation: A Model for Positive Change, and The Nearly Free University and the Emerging Economy. His blog, http://www.oftwominds.com has logged over 55 million page views, probably more by now, and is #7 on CNBC’s top finance sites.

Last time we talked about the commercial real estate bubble and we thought today we’d do a special focus on the millennial generation and how financial repression through repressed interest rates and quantitative easing has resulted in asset bubbles that ultimately have affected the millennial generation in terms of their values, how they look at the economy and life and the way they’re conducting themselves in the economy: what they’re facing in terms of the housing market and the job situation.

Many millennials are carrying student loan debt, nowadays a small student loan debt is $25,000-$30,000. If someone can escape with a bachelor’s diploma and only have $30,000 in debt, they’re considered to have done quite well. But in reality, that’s a pretty large debt for somebody who doesn’t even have a full-time job yet.

In cases where the central state guarantees any sort of lending and the lender can’t lose money because the government will step in and cover any losses, there’s a huge incentive to lend out to marginal borrowers and to really push every loan you can. And that’s exactly what we have with student loans: anybody that is breathing can get a student loan in an immense amount, and these are non-recourse loans right? Talk about financial repression, you can’t take them to bankruptcy court or reduce them in any way short of a few government programs. The interest rates on student loans are not that low, sometimes they’re as high as 7.5%-8.5%, so millennials have that burden on them right from the start.

Many of the millennials grew up seeing their parents under a lot of financial stress mostly due to the bubble pop global financial meltdown in 2008-2009. So this has made them very wary of debt. And consumer debt still continues to climb. The total consumer credit owned and securitized chart shows a minor dip in the 2009 time frame, but has since rocketed even higher by another 1.2 trillion.

Marc Faber explores the concept that the millennial generation is much more risk adverse. We can see why, they’ve observed the damage and the stress and the losses that can result from taking on way too much debt and not having enough income or collateral to support it. So, they’re very cautious about taking on gigantic mortgages that their parents did and buying new cars and adding debt on top of debt on top of debt. And so as a generalization, they’re less willing to take the risk of taking on a gigantic mortgage, and I mean by that in the $700,000-$800,000 range, right? That risk aversion, it carries several potential consequences. One that was being discussed in the essay was that there’s less entrepreneurial activity for the same reason: why risk everything on a business that might fail?

Seattle and Portland top the list of where students would like to move after college, based on various surveys. And according to the Case-Shiller home price index, these two cities now have exceeded the 2007 bubble in terms of housing valuation.

And many other favoured cities that are attractive to millennials like the San Francisco Bay area is also exhibiting this enormous home valuation bubbles or expansions. So then that raises the question, what are the millennials going to do? I don’t think there’s any evidence at this point to presume that the millennials are going to suddenly in some magical point in the future start making a lot more money and be able to afford overvalued housing. There’s no evidence for that, all the trends are the opposite: stagnating incomes and a millennial income trend that will stay sub-par, below that of previous incomes for decades to come.

Joel Kotkin, who studies demographics and the economy, thinks millennials do want to buy and own homes, but they’re only willing to do so if they can afford them. So the opportunities could lie within some of the smaller cities. For example, a house in Columbus Ohio, which is a classic college town in the upper Midwest can sell for less than $50,000.

It will also more difficult for the millennial generation to inherit their parents’ home, because the cost of retirement is so high, and most of their parents are forced to sell their homes instead of just giving it to their children. Housing is becoming increasingly expensive to build due to government fees and regulations on building in most cities, and government programs merely subsidize this process at a cost to the taxpayers; and rent control has been a disaster because that immediately kills off any new construction and reduces the incentive for land owners and landlords to maintain their property because their income is fixed.

Because of this, we’re seeing many innovative alternative housing solutions such as the tiny house movement and retro-fitting dying malls, using them used for housing instead. In addition, there’s an increasing trend of millennials moving towards smaller cities and working at home, telecommuting, and utilizing internet online based businesses. Because of this, local governments that are willing to accept innovations and ease building regulations are the ones who are more likely to prosper.

Summary by Jacob Dougherty jdougherty@Ryerson.ca

LINK HERE to download the MP3 Podcast

FULL TRANSCRIPT

Richard: Today we have Charles Hugh Smith. He’s an author, leading global finance blogger, and America’s philosopher we call him. The author of nine books on our economy and society including A Radically Beneficial World: Automation, Technology and Creating Jobs for All, Resistance, Revolution, Liberation: A Model for Positive Change, and The Nearly Free University and the Emerging Economy. His blog, http://www.oftwominds.com has logged over 55 million page views, probably more by now, and is #7 on CNBC’s top finance sites. Welcome, Charles.

Charles: Thank you, Richard. That’s an introduction that’s going to be hard to live up to. I’m a beginner here, we’re just exploring interesting topics okay? I don’t have all the answers but we have some interesting topics.

Richard: Great insight as always, and last time we talked about the commercial real estate bubble and we thought today we’d do a special focus on the millennial generation and how financial repression through repressed interest rates and quantitative easing has resulted in asset bubbles that ultimately have affected the millennial generation in terms of their values, how they look at the economy and life and the way they’re conducting themselves in the economy: what they’re facing in terms of the housing market and the job situation.

Charles: Right, and you know Richard it’s hard to know where to start, but I think we could profitably start with the basic context of the economy and the millennial generation. And so in terms of financial repression, perhaps the one key sector that we need to look at is student loan debt because so many millennials are carrying student loan debt, and you know a small student loan debt is like $25,000-$30,000 if someone can escape with a bachelor’s diploma and only have $30,000 in debt they’re considered to have done quite well, but when you think about it that’s a pretty large debt for somebody who doesn’t even have a full-time job yet.

Richard: Yeah, mine was $13,000 I think when I came out, $13,500

Charles: Wow that was very low. And nowadays, 10 times that is not uncommon especially if you go to graduate school. And so we all know why this is but it’s worth touching on because the financial repression part is when the central state, you know the central government and its central bank, when the central state guarantees any sort of lending where a lender can’t lose money because the government will step in and cover any losses. Well, then there’s a huge incentive to lend out to marginal borrowers and to really push every loan you can. And that’s exactly what we have with student loans: anybody that is breathing can get a student loan in an immense amount, and these are non-recourse loans right? Talk about financial repression, you can’t take them to bankruptcy court or reduce them in any way short of a few government programs such as if you join the government service and then you get a reduction and so on. So it’s like the financial system on financial repression steroids. And so they’ve really tasted the worst of neoliberal banking, the interest rates on student loans are not that low, sometimes they’re as high as 7.5%-8.5%, and then the higher level education system, which is supposed to be concerned with educating the youth have just gorged on all this free money, built fabulous buildings on campus. And the administration, I just looked at this statistic, the number of administrators in higher administration in America went up 34 fold in like 30 years where the number of students barely rose, or that was much more modest. So anyways this is like the worst possible combination of financial repression and state guarantees, and so the millennials have that burden on them right from the start.

Richard: Yeah, just trying to get out of the gate in terms of leaving the nest or getting a family formation how can they do that? How can they buy a home or a car, just getting out, right? A lot of them have difficulty even getting a job even given the large amount of debt to begin with.

Charles: Right, right. And you sent me several interesting articles talking about the impact of the last decade’s financial stagnation on the millennial frame of mind or their value system. And of course, a lot of them grew up seeing their parents under a lot of financial stress, during the bubble pop global financial meltdown in 2008-2009. And so this has made them wary of debt and again just for context, consumer debt continues to climb, and this of course is mostly people who are older than their early twenties, it’s hard for them to acquire much more debt than their student loans. I have a chart here from the St. Louis Fed, and it’s the total consumer credit owned and securitized. And it shows a minor dip in the 2009 time frame, and then it’s rocketed even higher, it’s rocketed another 1.2 trillion.

So I think that the millennials are well aware that the entire system, not just the student loans that they’re under, but the entire system is incredibly burdened with debt.

Richard: And so how does this resulting in their views, their values, how they’ve grown up, and what they see as prospects for jobs, and just where to live in general, does it make sense to live in the inner city or out in the suburbs exurbs?

Charles: Right, right. Well one of the essays you sent me was an excerpt from Marc Faber’s recent essay kind of exploring the concept that the millennial generation is much more risk adverse and we can see why, because they’ve seen the damage and the stress and the losses that can result from taking on way too much debt and not having enough income or collateral to support that debt. So, they’re obviously wary of taking on these gigantic mortgages that their parents did and buying new cars and adding debt on top of debt on top of debt. And so I think as a generalization, they’re less willing to take the risk of taking on a gigantic mortgage, and I mean by that in the $700,000-$800,000 range, right? You and I were speaking, a one million dollar house in Toronto or Vancouver or Seattle or the San Francisco bay area or Boston; you know you name it, I mean a million bucks you have to put down a quarter million, and so you’re on the hook for $750,000 that’s a lot of money. And so that risk aversion, it carries several potential consequences. One that was being discussed in the essay was that there’s less entrepreneurial activity for the same reason: why risk everything on a business that might fail?

Richard: Yeah, I mean the millennial generation is the least entrepreneurial.

Charles: Right, and that’s at odds with this sort of tech hub environment in which the assumption is here’s a bunch of 23-year-olds or 25-year-olds starting a billion dollar company in the living room. But that’s actually just the bleeding edge of a generation that’s generally risk adverse. So then we go look at housing, and I submitted a couple of charts that showed two of the millennials favourite cities at least judging by surveys of where you’d like to move after college, Seattle and Portland are quite high on that list. And according to the Case-Shiller home price index, those two cities now have exceeded the 2007 bubble in terms of housing valuation.

And I think that many other favoured cities, cities that are attractive to millennials like Austin Texas and San Francisco Bay area, I mean there’s a lot of other places that are exhibiting the same kind of enormous home valuation bubbles or expansions to the point that only the top earners can afford that, and so then that raises the question, what are the millennials going to do?

And so Joel Kotkin who’s a demographer, you know studies demographics and the economy, his view is millennials do want to buy and own homes, but they’re only willing to do so if they can afford them. And so that basically eliminates most of the super desirable core city centers of Seattle, Portland, Austin, San Francisco and so on, and Boston, Brooklyn, Manhattan you know. And so where do they go to buy a home? And his theory, he proposed that they are willing to move to the suburbs if that’s where it’s affordable. But my question on that is, I don’t think that suburban homes in super desirable urban areas like greater Seattle and around Austin, around the San Francisco Bay area, those houses are not much cheaper than the core houses, so I’m sure that that’s really an opportunity. So I kind of think that the opportunities at least in North America are in smaller cities. In the range of 50,000-100,000, maybe a quarter million residents, not these megalopoleis. And the only millennial I know, well I know a few millennials that have purchased homes, one bought a house in Portland for I think it was around $400,000 or $450,000. And they both work and they had a condo that had purchased a while ago so they had some equity. And then another couple bought a house in Columbus Ohio, which is a classic college town in the Midwest, the upper Midwest for less than $50,000. Now this was not a large house, and it was an old house, and you know it needed some work and all that. But I mean we’re talking about a house for less than 50,000 roughly a tenth of the values of these hot desirable core cities. So that raises some interesting investment questions about where the millennials going to go and where is real estate going to be desirable to them.

Richard: Yeah and it also factors into who are the baby boomers going to sell to, because if there’s nobody there or no demand to buy these houses due to lack of income or insufficient income, that could also pose some challenges to baby boomers looking to sell their house nest egg.

Charles: Right, I think that’s a huge demographic question that I haven’t seen any really good statistics on because of course most of the boomers are still in their late 50s or 60s, early 70s and they’re not yet to the point where the older generation like the boomer parents, the so-called silent generation, which has sold their houses or given them to their offspring, their adult children. But we’re talking about such huge numbers, and just for context, in general roughly two-thirds of the baby boom generation owns homes, about 65%, low 60s. So there’s a large percentage of the boomers who own homes, and typically they bought these homes when they were younger and had families and so there’s going to be a huge incentive for them as they age to unload these houses. And in the good old days when there was more family wealth, they might have been able to afford to basically give that house to their children, and then retire somewhere else on their income. But now, with the cost of retirement so high, and I know because I’m 63 and my mom is in a retirement home so I know if you can get into $4,000 or $5,000 a month on assisted living that’s usually quite reasonable and it can go as high as $7,000 $8,000 $9,000 a month. So almost everybody facing that kind of sum of money is going to have to sell their house in order to liquidate their equity in order to retire on that. So they’re not going to be able just to hand the keys over to their adult children. So that’s a question that I don’t think we know the answer to, but if millennials can’t buy the boomers house at the current value than basic supply and demand economics suggests that prices will have to fall to the point at which they’re affordable to millennials. Which in many areas suggests a 50% drop, right.

Richard: Yeah, yeah exactly. I mean they may be initially thinking perhaps I’ll just get the house through inheritance and therefore I can focus my current income on things like coffee at Starbucks and looking for trips to Machu Picchu or something, you know Patagonia. This is where their values and emphasis seem to be. So they might be saying let me just spend that money there and then I’ll eventually get the house. But the house is now likely going to be needed for retirement by the baby boomers, is what you’re saying.

Charles: Right, and so they won’t be able to inherit. The parents are going to be selling that house in order to extract the equity to retire on or downsize. In which case they’ll be competing with their children for affordable housing, small apartments and that kind of thing. So the other key element here is what can we expect in the future for millennial incomes? And every indication that we have currently, statistically, is that millennials are making considerably less money at the same age compared to the gen X and boomers made in their early to mid-20s and early 30s. And what we do see is a great concentration, a skewing of national income to the top 1% and 5%. I mean this is well established that the top 5% what we might call the techno-crack professional entrepreneurial class, is their income is continuing to grow ahead of inflation and expenses, but everybody else below that, their income is stagnating. I don’t think there’s any evidence at this point to presume that the millennials are going to suddenly in some magical point in the future start making a lot more money and be able to afford overvalued housing. There’s no evidence for that, all the trends are the opposite: stagnating incomes and a millennial income trend that will stay sub-par, below that of previous incomes for decades to come. So I don’t think there’s any magic bullet on that, and if we look at what’s the other magic bullet in financial repression armory, well it’s lowering interest rates to zero. Hey, we’ve been there for 8 years, right. Or near zero, and mortgage rates below 4% were basically unprecedented lows and they’re starting to click back up above 4, 4.5. So we’ve already used up all that ammunition about lowering interest rates to near zero, to push mortgages down to make very overvalued homes affordable, that’s done. In fact, the trend suggests we’re at a bottom there and mortgage rates may continue to click higher and put another sort of pressure on the incomes of millennials.

Richard: Yeah, so the repressed interest rates is sort of affecting a large number of age groups because the inability to get sufficient income off of fixed income assets and investments as baby boomers retire, looking maybe more to go into bonds or fixed income type of investments, with the interest rates being so low, that’s very difficult. And therefore maybe you go to the house and reverse mortgage and all that. But at the same time that’s all secondarily affecting the millennial generation as well so there’s not much discussion in that regard, you know how repressed interest rates have negatively affected the millennial generation.

Charles: That’s right, that’s right. If you’re a borrower, if you’re a saver then of course you’re receiving very little income. And that’s hurt the older generations which have been saving money for their retirement.

But the millennials who are the borrowers of student loans and auto loans and so on, other than the teaser rates that have been offered for auto loans, if you’re paying a student loan or a credit card, I mean the interest rates are sky high still, they’re very high. As we know credit cards are often 15%-16%. And so the millennials aren’t really getting an enormous benefit from this so-called zero rates because much of their debt is not at 1%. Yeah, you can get a 1% auto loan if you qualify, but most of the debt out there is at much high rates.

Richard: Yeah, exactly.

Charles: So, Richard maybe one of the key questions here going forward is, what happens to the United States, and perhaps we can include Canada with at least the high value cities of Toronto and Vancouver where young people that just have regular normal income jobs are priced out of buying a single family homes in those areas. What happens to the society and the economy when people can’t afford to buy a home, that they’re just renters? I mean what impact does that have socially, economically, and politically? I don’t think we’ve really explored that too much. And what Joel Kotkin was arguing against was the idea that oh the millennials will be perfectly happy to be renters their whole lives. And he was suggesting that well maybe that’s just a happy story without any actual basis, maybe they’ll be quite angry that they can’t afford to buy a house.

Richard: Yeah and just the sense of ownership that goes along with that, I mean there’s some other points that go to that regard in that Marc Faber article where he references a number of authors, so that we talked before about the risk aversion that’s infecting even now corporate America in terms of in the old days there was budgets for doing research and development. And now it’s being more money is spent on legal compliance and human resources instead and less on training less on research and development. That’s also related to the fall in entrepreneurial activity, innovation. And then Marc quotes Edward Gibbon in terms of how it ended up like in Athens in Greece in the ancient history where in the end more than they wanted freedom, they wanted security when the Athenians finally wanted not to give to society, but for society to give to them, when the freedom they wished for was freedom from responsibility, then Athens ceased to be free. And so that is a big issue in terms of what could happen resulting from the spirit of risk aversion and a sense of greater entitlement from the government.

Charles: Yes, that’s an excellent point, Richard. And kind of following that up, Joel Kotkin also mentioned that there’s a generational conflict brewing in land use and how we provide housing how we build housing. And as we all know that the last I’d say 20 some years has been dominated by nimbyism, like not in my backyard right. Don’t build any new housing, don’t build any high-density housing, don’t build a new complex by my house, right. And so that has really stifled construction in a lot of cities, especially those with very little open land left. And then, of course, the local governments have raised the fees on building, and so it can cost I think the number that he mentioned was $50,000 per unit just for the development costs, you know the permits and sewer connection, and you know there’s a $10,000 fee for everything right. For each item, and so if it costs 50,000 just to get a permit basically before you’ve even spent a dollar on the land, and then the whole process is dragged down so you spend two years basically paying interest and principal on the land you purchase before you actually get permission to build. All these things have made it so the housing that is built is super unaffordable. And so if we’re going to look at the millennial sort of tendency some people say towards socialism, like well the government is the entity that can fix this, if we look at what the government has done with housing, for instance rent control has been a disaster because that immediately kills off any new construction and reduces the incentive for land owners and landlords to maintain their property because their income is fixed. And the other thing that the government has done in response to this affordable housing crisis is it’s built so-called affordable housing, but the vast majority of cases that is merely subsidizing housing. In other words, it still costs $250,000 to build that tiny apartment per unit. And then the taxpayers subsidize $150,000 of it, making it affordable. But that’s only a subsidy, they didn’t do anything to lower the cost of construction or ownership. And so obviously there’s extreme limits on that kind of thing. And so many cities end up patting themselves on the back for building like 400 units because this subsidy cost is so extreme. And so maybe what the millennials could do, and I don’t know if there’s any potential for this, but if they took a political voice, they might do better than instead that government builds subsidize housing that just adds burden to the taxpayers, maybe they can overturn a lot of these super restrictive codes and nimbyism, you know that’s choking the construction of new affordable housing.

Richard: Yeah I think the regulation issue is big, and it’s also affecting if you look at the positive side of some of what’s happening, like this move towards tiny houses where you have maybe 160-1,000 square feet type, very small houses that can be almost like mobile homes. And then maybe the retro-fitting also of dying malls to have them go into housing, to housing developments to be retro-fitted from malls and just other things like containers that are being retro-fitted into houses as well, all of that. But there’s a lot of regulations in many communities that prohibit that type of thing to happen in terms of putting these tiny houses on property.

Charles: That’s right, there has to be a change in as you say the regulatory spirit of the law, and that’s a political process. But you know, Richard, to speak briefly in an investment potential here, where is there an opportunity here for people that want to participate in this huge demographic economic housing shift we’re talking about. Well, just anecdotally, I can’t give you national statistics, but just from people I talk to, it seems like the opportunity is in these small cities that have some assets. In other words, they have a port, you know they’re on the seacoast or they have a riverfront or they have some state universities, these kinds of assets that tend to be institutional or profoundly economic. Those small cities seem to be where the millennials can afford and where they’re interested in revitalizing. I was speaking with another blogger podcaster, and he was saying Buffalo New York, which was for quite a few years considered a poster child for urban decay upstate New York. And he said it’s actually becoming a happening place because young people are moving there and opening brewpubs because it’s cheap. And so I think the key here is to find places where housing and commercial space to open a restaurant of café or some sort of business, if you can find a place with super cheap rent super cheap housing you can buy for like I said in a neighborhood of $40,000 $50,000 $60,000 $70,000 $80,000 than that’s going to be a magnet for young people for the affordability and as we all know the trend for many decades has been the artist and creative types will go to a rundown neighborhood or town and then they will revitalize it because it’s affordable to them. And so that may be the opportunity going forward, is in smaller cities that have some assets, and by that I mean compared to a place that was dependent on one auto assembly plant, and so when the plant closes the whole place is shut down and there’s no other assets to draw on. But if you have institutions then there’s some foundation there that can support a revitalization and so just people have told me Buffalo New York seems to have some magnet potential and Columbus Ohio is two examples and I’m sure there’s many others, dozens. And so if I were a real estate investor I would start looking at places like that.

Richard: Yeah, no I think you’re right. And that’s also consistent with the trend towards a move to the center, the so called fly over America land between the coasts in the interior in the Midwest where there was places that have been very depressed, Buffalo, maybe Detroit. Very very low cost and the cost base is already beginning from a very low point. But at the same time you’ve got resources, you’ve got land, arable land for agriculture potential. And then the potential for fiscal spending on infrastructure, so you’ve got the Midwest that has the potential there, where it’s traditionally played a role. So that sort of whole manufacturing infrastructure agriculture in the interior of the U.S. that trend. And certainly, people moving out of California for various reasons in high-cost areas, highly taxed areas, going more towards the favourable areas in the interior.

 

Charles: Yes, absolutely, and you mentioned agriculture and arable land, well I also just, I don’t know them personally but through other millennials I know it turns out there’s quite a few millennials who are homesteady. In other words, they’re buying abandoned farms or they’re buying rural land and starting to raise pigs and chickens. And again, the cost is so much lower, and I want to make a last point here which is this could be a global trend. In other words, it may not be isolated to the U.S. or North America. Because I know, again anecdotally, that there’s evidence of this in Japan. Which is highly urbanized, highly expensive, you know basically housing is not affordable in Kanto plain around Tokyo. That there’s millennials there who are just giving up their full-time job, moving to these abandoned villages, or almost abandoned, there’s only a few old people left, and they’re renting these beautiful old farm homes for like 200 bucks a month including the land around it, starting a garden, and then they’re working part time online. Because a lot of them they’re illustrators or they’re graphic designers, or they’re programmers. And so that’s that other aspect of our economy, what I call the emerging economy or what a lot of people call the fourth industrial revolution, the digital economy for a lot of young people with technical skills, they can work anywhere. So they can actually afford to live in a small town that’s super cheap and just work part time online. So there’s a lot of positive things that the government can’t destroy here with over regulation. And there may be ways to get around the damage of the financial repression. And so anyways, those are the potential positives.

Richard: Yep, exactly ending on a positive note that through some type of regulatory reform process as we discussed earlier together with innovative ideas on housing in terms of tiny houses, container housing, retrofitted malls, with the trend of working at home, telecommuting, internet online based businesses, the whole retail sector, malls dying but everybody setting up businesses that are online through Amazon or Shopify. Maybe that’s the positive trend to allow more affordable housing and opportunities.

Charles: That’s right, that’s a good summary Richard because if it’s not affordable it’s not going to work for the millennials. They’re not interested in overextending themselves on debt. And so it has to be affordable and that’s where the opportunity is for everybody who wants to be part of this, I think is to provide affordable retail space and affordable housing and get in on that as you say with things like tiny homes. And maybe my final comment would be, the local governments, the local city governments, and the county governments who get in on this are going to prosper. The ones who allow tiny homes and make it easy for young people to start businesses, low-cost low fees, they’re going to prosper. And everybody who is in this high regulatory barrier, high cost, high expenses, overregulation, they’re going to die. And we already see that, and I’d say Chicago is probably a good prospect for a city on the way down from just too many expenses and overregulation. So, yeah.

Richard: Well, that’s great insight Charles, and how can our listeners learn more about your work?

Charles: Yeah, please visit me at oftwominds.com (http://www.oftwominds.com)

Richard: Great, and we’ll do another session on another topic in about a month.

Charles: Yes, looking forward to it.

Richard: Great, thank you very much, Charles.

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.


05/12/2017 - The Roundtable Insight – Alasdair Macleod On How The International Coordination Of Monetary Policies Has Increased The Potential Scale Of The Next Credit Crisis

FRA is joined by Alasdair Macleod in a discussion of international monetary policies, particularly China and the Eurozone.

Alasdair Macleod writes for Goldmoney. He has been a celebrated stockbroker and Member of the London Stock Exchange for over four decades. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy.

 

INTERNATIONAL COORDINATION OF MONETARY POLICIES

The business cycle that the banks are trying to manage isn’t actually a business cycle, but a cycle of credit created by the banks themselves. Assuming you have an economy working with sound money, under those circumstances there can’t be what we call a business cycle because everything is random. You get creative destruction of businesses which are ill-founded. When they go to the wall, they do so on a random basis. There’s no cyclical behavior. Then the central bank comes in and feels that the economy isn’t performing strongly enough so it encourages the banks to create credit. Suddenly you have extra money going into the economy. Instead of people having to make a choice, they can have both. The creative destruction you see in an economy gets postponed, and accumulates the whole time under the hood. Eventually what happens is that the excess credit in the economy has to come to a halt.

The cycle of credit is what creates what we believe to be a business cycle. Central banks coordinate their stimulation of the economy to stop the economy from overheating. The effect of this is that they all do the same thing at the same time.

EFFECT ON CURRENCIES AND GOLD

It depends on the stimulation an individual central bank gives to its economy. On top of that, you’ve got what people actually do with the currency and the cycle is basically the change in purchasing power of the currencies the whole time. Underneath this you get an accumulation of debt that never gets washed out on this credit cycle. When you raise interest rates to the point where the economy suddenly shudders to a halt, you start lowering interest rates to try and expand the quantity of money in the economy to prevent people from going bankrupt. Generally central banks succeed in that, but the effect of this is to defer the destruction of debt which is completely unproductive. This rolls into the next cycle, and every time it just gets bigger and bigger. Then you look at statistics and you see the amount of debt built up has increased immeasurably, so the next financial crisis will be worse than the last one.

The protection the ordinary person has against fiat currency losing its purchasing power is to hold some money in gold. You want to be able to use this money when paper currencies either lose most or all of its value. In that sense, gold gives the most protection. If you want to insulate yourself from the collapse of the paper currency, then gold is the only thing you can use. Maybe silver, but silver has been demonetized. The only sound money in the market at the moment is physical gold.

You ask yourself, to what level would the Fed fund’s rate have to rise to trigger the next credit crisis, and that level is in the region of 2.5%. The credit cycle is really comprised of stimulation, inflation, and having to destimulate. You destimulate to the point where you collapse things, because there’s no fine line between slowing things down and creating the next crisis. You can’t just slow things down because it’s not enough of a response to kill price inflation; if you raise interest rates a bit, the market thinks the central banks are too afraid and then continue to advance purchases and dispose of money in favor of goods. The only way the central banks can stop this is to raise interest rates to the level where we change our behaviour.

The central banks raise interest rates to the point where the collapse occurs, then they crash interest rates and chuck money into the economy to ensure nobody goes bust. The idea that the central banks think they can manage what they think is a business cycle is just completely bizarre. Governments are effectively stuck in a debt trap as well. What we’ve got to look through is next time, is how much money does the Fed have to write an open cheque for this time, and what will be the effect on the Dollar. The Dollar, after all, is the currency to which other currencies tie themselves, and if the Dollar falls we all fall. This time around it will be considerably worse than last time.

TIMING OF NEXT CRISIS

The whole situation has become quite unstable. In Europe, there’s a movement of money away from the banking system and into principally Germany, Luxenberg, and the Netherlands. These banking systems are, as far as large depositors are concerned, safe relative to the banks in the Mediterranean countries.  The flight of capital from these weaker countries has hit record levels. The ECB is sitting on the situation and saying it’s not a problem, but the ECB has the eventual liability for the settlement system which is reflecting these imbalances. The total imbalance is in the region of 1.3T Euros. The important part is that the statistics coming out of the Eurozone indicate that there’s economic recovery going on. If there’s economic recovery going on, why do we have the continuing flight of capital?

Lots of people would say that China is a problem. What it’s now trying to do is deflate a bubble in the domestic market while inflating another bubble as it’s indulging in infrastructure spending. The annual spend on infrastructure is now in the order of $750B equivalent. That’s why you’ve got the demand for commodities coming out of China. But China finds that the wealth funds have been frontrunning her by buying commodities. This credit is getting more difficult for central banks to manage, and whole situation is becoming very unstable.

EFFECT OF USD INTERPOLITICALLY

If you pick up on China’s view as to what America is dong, you get a very different view from what’s reported in mainstream media in the West. The Chinese have worked out that America gains a huge amount from exporting the Dollar for value. They take it one step further and say that when Americans to raise funds, they encourage those Dollars back by destabilizing the region those Dollars have gone to. We’re now in a situation where Trump has been elected, but one of the problems he has is that he can’t raise any money because the debt limit has been reached and it’s not being extended. So how would you extend the debt? The Chinese would say that you destabilize a region where the Dollars are, and those Dollars are going to come flooding back. How do you get Congress on your side? You play the patriotic card and threaten to wage war with North America. No American can actually go against the idea of patriotism, so he got the extension up to October. This also explains why Trump moved from peace-making to warmonger in the space of less than 100 days.

Iran is also likely to be targeted later on this year, when Trump wants to increase the budget deficit after October, because the Middle East is one of the areas where there are lots of Dollars owned.

The Shanghai Cooperation Organization is set up by China and Russia, which started as an intention and security agreement and morphed into an economic unit. The idea is that the whole of Asia would become a free trade area. Between them, they are creating an industrial revolution throughout the most populous continent in the world. We’re talking about 40% of the world’s population suddenly having an industrial revolution that will link the whole continent. This is also impinging on Europe. It takes roughly two weeks to get a container from Beijing to Madrid right now, and it will be cut down. Compared to shipping by sea, which takes three weeks, you can see how the investment in these rail communications is massive. All the capital investment that is going to create this industrial revolution in Asia has to be financed, which is why the Asian infrastructure investment bank was set up by China and Russia jointly. All that infrastructure development has to be financed, and London is the center from which it is going to be financed. As far as the Chinese and Russians are concerned, they don’t want America to be involved at all. New York is completely frozen out of this for the reason that everything they do is reflected in bank balances back in the American banking system; they don’t want American interference or Dollars. London, working with Hong Kong, is how this is going to be financed. The big, big game is no longer Europe, it’s the whole of Asia.

EFFECT ON EXCHANGES IN SHANGHAI

China has been trying to promote the Yuan as an international trade settlement currency. It’s got a long way to go; the Dollar dominates this market. But one way they can promote the Yuan is by ensuring there are efficient financial markets that would allow people to do with the Yuan what they do with the Dollar. One of the things they have done at the outset is to set up a Yuan-gold contract in the futures market in Shanghai, settled in physical gold. We now have another thing that has been postponed: an oil contract in Yuan, that could result in oil priced in gold. America’s response to this is to be seen, but it’s clear that the future major economy in the world is going to be the whole of Asia.

In order to promote the Yuan at the expense of the Dollar, there has got to be some form of a gold conversion for trade purposes. Only when that happens can the Dollar be knocked off its pedestal as the major trade settlement currency.

There will be a point where China offers a gold option on trade settlements. If you want to do it at a gold price it has to be a far higher level, so the Chinese would move toward a higher level. But they don’t want to destabilize the world economically, so they’re reluctant to do it. As things evolve, they’re getting closer toward having to take that decision. To an extent it depends on what America does. China owns an awful lot of US Treasuries, which will have to be written off at some stage. Either America stops them selling, in which case China simply waits for them to mature and doesn’t reinvest their proceeds, or China forces the pace. We’re getting closer to the point where some decision has to be taken.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

LINK HERE to download the MP3 Podcast

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.


05/06/2017 - The Roundtable Insight: Yra Harris On The Bond, Currency, Equity and Commodity Markets

FRA is joined by Yra Harris to discuss the current state of bond, currency, equity, and commodity markets.

Yra Harris is a recognized Trader with over 40 years of experience in all areas of commodity trading, with broad expertise in cash currency markets. He has a proven track record of successful trading through a combination of technical work and fundamental analysis of global trends; historically based analysis on global hot money flows. He is recognized by peers as an authority on foreign currency. In addition to this he has specific measurable achievements as a member of the Board of the Chicago Mercantile Exchange (CME). Yra Harris is a Registered Commodity Trading Advisor, Registered Floor Broker and a Registered Pool Operator. He is a regular guest analysis on Currency & Global Interest Markets on Bloomberg and CNBC.

Yra highly recommends reading The Rotten Heart of Europe – send an email to rottenheartofeurope@gmail.com to order

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BOND AND CURRENCY MARKETS

We’re just coming off a Fed meeting in which they called the first quarter transitory, which means they’re not worried about it, yet they made no change to the current policy of maintaining the Fed balance sheet. The $4T will remain at $4T, and whatever expires will be renewed by the purchasing of whatever duration expires by the new instrument. With the Fed raising rates, even though GDP turned out to be low, there are other elements that are slowing down. Right now, if the Fed was looking to start unwinding its balance sheet, which would mean a dynamic act of actually starting to sell some of their assets, the first move would be for the curve to start to steepen. A lot of potential buyers would step back, and market would say ‘show me what you’re going to be doing’. You’re going to have others trying to front run the Fed, because the Fed model says there should be no problem. But what the Fed doesn’t model is the effect on the marketplace, and they’re hoping the marketplace allows them to do this. What the Fed is worried about is whether the market will be cooperative with what they want to do. It’s why they don’t want to acknowledge any pre-program. It’s the same problem the ECB has. A lot of people front run the ECB, and the market tries to rush ahead of it.

If the Fed tries to unwind by an aggressive type of action, which is selling the debt to unwind in a quicker way, the long end of the curve will go up higher than the short end in the immediate period, because the market will race ahead of them. We don’t know how the curve ought to be steepening in that environment. With the Fed doing nothing but raising rates, the curve has actually flattened quite a bit.

It’s interesting how the US 2-10 curve, the ‘investor’s curve’, just mirrors the German 2-10 despite negative rates in Germany. These two just continuously mirror each other. Ultimately, if the Fed is too aggressive in unwinding the balance sheet, that’ll tip us into a very flattening curve, which will fly in the face of what we think should happen. There’s going to be all sorts of things here because the market is going to set the tone. If the Fed were to actually embark upon an unwinding, the market will then set the tone unlike QE. Right now the curves are telling us that the Fed is a little too aggressive, and that’s why it’s flattening.

Everything is ‘transitory’. The Fed is not going to do this in a vacuum. If Marine Le Pen wins the election and throws the entire financial system into turmoil, the Fed has to change their perspective too. So we have a lot of things in play here. Yellen will be very reticent to raise rates too quickly; they want to see more from Trump and Congress before they get more aggressive.

OTHER FACTORS THAT COULD INFLUENCE USD AND BOND MARKETS

In the first quarter, central bank buying totaled a trillion Dollars in assets. The amount of liquidity is huge. The Dollar and all currency markets are all relative value plays. Even if everyone is moderately up, some are doing better and offering a higher return, but the US equity market is close to what we may discern as full value based on historical metrics. In a fairly stable world, the US is not where we should be chasing assets right now. The Mexican Peso and stock market is probably the most undervalued asset class in the world.  People are pushing India as a great place to invest, but India has a lot of enormous infrastructural and political problems that they’re trying to work on.

The best place for investment right now is Germany. If the Germans agreed to do whatever it takes to hold the EU project together, you’ll experience some inflation in Germany but the currency will be weak. On the other hand, if things got so bad that the whole EU project fell apart, you’re buying Germany with a low currency. If it were to pull out for some reason, German assets would convert to Deutschmarks. Germany could be bullish on assets, and you get the use of a weak currency. We get a cheaper currency with a much stronger economy. This is not an easy world to invest in. The political risks are phenomenally great; Italy is still a massive problem for Europe, Greece has not gone away, and there’s no trade in Japan’s JJB.

When you look at how central banks have single handedly destroyed the bond market, you don’t have to look very far. The Fed may be too self-confident, but their models have no respect for market reaction and they still think they can extract themselves with very little pain. If they deem to shrink their balance sheet, they’re going to find out the pent up power of the market and its ability to cause them a lot of pain.

THE GLOBAL MINSKY MOMENT

At the end of the day, interest rates aren’t high enough to attract people into leaving the comfort zone. They won’t let interest rates go high enough to ease some of this burden, so people take comfort in the equity market. Minsky must be spinning in his grave that we’ve gotten to this point and it’s so controlled by the central bank. The central banks have created a global Minsky moment because everyone is complacent. It’s everything approaching the Minsky moment because where are you going to go? There is a cost to everything; just because you don’t see it today doesn’t mean it won’t pop up tomorrow. This is all the outcome of central banks not knowing when enough is enough. QE1 in the US was absolutely needed to prevent a mass liquidation of US assets, but after that it stopped making sense. QE2 and QE3 were totally unnecessary and has created this mess that we are now in.

SILVER-COPPER RATIO TO EQUITY MARKET

Gold has depreciated against silver significantly over the last few weeks, while the equity markets have been holding up pretty strong. Usually silver tends to outperform because it also has industrial usage. Copper has a tendency to outperform the other metals when the equity markets are doing well, because people correlate it to the economy. Copper has been dramatically outperforming silver over the same period, which is highly unusual when the equity markets are holding.

The Chinese have gigantic warehouses full of commodities, which wreaks havoc on that market. You do hear some bad things about what’s happening in the Chinese economy. If that’s the case, commodity prices may come under pressure as some of the lenders call the collateral and start pushing it on the market to raise some cash to secure loans.

INVESTMENT POTENTIAL OF COMMODITY ASSET CLASS

The agricultural sector is a good sector to be in. We have massive crops around the world and prices are relatively strong historically. We’ve had a bit of a rally in the agricultural products in the last few weeks, but it’s something to pay attention to. You should take a look and see if there’s an opportunity for you. The one thing that we’re sure of is that China and India need grain, end of story. As their income levels move up, agricultural products and higher protein products are in demand.

The great thing about the commodity market, unlike the commodity markets which are manipulated, is that farmers and miners react to price. The markets do work.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

LINK HERE to download the podcast in MP3

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


05/03/2017 - The Roundtable Insight: Megan Greene On The Current Status Of The European Economy

Tonight’s podcast includes some insight on Europe’s current economic and political states, and how it translates into current economic trends.  We have seen the rise of the anti-European and anti-EU mindset all across Europe. This movement not only impacts European politics, but the entire state of the European economy as well, and has direct influence over Western economics in terms of trade agreements, investments in the European market, and the value of our currencies.

Megan Greene, an accomplished economist with a specialty in European economics, explores what Europe needs at the moment and what is most likely coming up in the European economy.

FRA:    Hi, welcome to FRA’s Roundtable Insight. Today we have Megan Greene. She is [the] Managing Director and Chief Economist of Manulife Asset Management. She’s responsible for forecasting global macroeconomic and financial trends, and analyzing the potential opportunities and impacts to support the firm’s investment teams around the world. Formally, she was with Roubini Global Economics, where she had a focus on the Eurozone, and she also holds a Masters [degree] in European politics from Oxford University. So, quite a focus on Europe and we would like to explore Megan’s thoughts on Europe. Welcome, Megan.

Megan Greene:    Thanks for having me.

FRA:    What are your thoughts, what’s happening in Europe? The political situation there, the rise of anti-Europe parties, how that all affects what’s happening as far as the economics and the financial situation of the Eurozone and the European central bank?

Megan:    Sure. So I would say, first of all, that the far greatest risk coming out of Europe for this year, probably the next year (too) is the political risk. Europe has an incredibly busy election schedule over the next year-the next election coming up is actually in France. It’s coming up quite soon; their two-round presidential election. It seemed at first very likely that it would be a runoff in the second round between the right-wing populist national front’s candidate, Marine Le Pen, and the independent candidate Emmanuel Macron. But more recently, actually, two other candidates had a lot of momentum and those are the right candidate Fillon, and the communist candidate Melenchon.  This matters in large part because Le Pen and Melenchon both are running on a platform that’s very anti-European, very populist, and both have said in some form that they would like to renegotiate France’s relationship with the Eurozone, and potentially hold a referendum to see if France might want to leave the Eurozone. There is a chance that the second round of that election could be a “Le Pen, Melenchon” runoff, and that would be a market event for sure; it would be dramatic. More likely is still a “Le Pen, Macron” runoff, and it does seem most likely that Macron will end up winning. Even if Le Pen, the most anti-European candidate won, there’s a parliamentary election at the end of this year, and it seems very unlikely that her party would do well in those elections. It does seem that parliament would still be controlled, in which case it might be very difficult for Le Pen to actually have a referendum on France’s membership in the Eurozone. Even if they had a referendum, actually, the most recent opinion polls suggest that the French would vote to keep France in the Euro(zone). I don’t think that it’s very likely that, first of all, Le Pen would win, but secondly, that even if she did, that France would go ahead and exit the Eurozone. It’s a very low probability event, but such a high impact event-it’s something worth looking at.

The much bigger risk of a Le Pen win isn’t actually exiting the Eurozone, it’s just a series of bank runs starting in France but maybe spreading a bit wider. That would obviously have implications on the markets. Even bigger as a risk for the Eurozone than the French elections, I think, are the Italian elections which are due to be held by March of next year. It’s possible they might be held early…but probably not before the fourth quarter of this year. In any case, according to most opinion polls, the populist, anti-European five star movement isn’t in the top slot. It’s unlikely in an Italian election that the five star movement would actually win in absolute majority. They would have to find coalition partners and that won’t be easy given their ideology and the ideologies of the other political parties in Italy that might want to form a coalition with them. So even if the five star movement were to win the Italian elections, it’s not totally clear if they would make it into government. But if they did make it into government, they said that they too would like to have a referendum on Italy’s membership of the Euro(zone). Unlike in France, Europe is much less popular in Italy so it does seem plausible that if there were a referendum in Italy that Italy could end up choosing to leave the Euro(zone), and that would be dramatic-to have Europe’s third-largest country leaving the European project, that could really pose an existential challenge for the Eurozone. So those are two countries that could end up following in the footsteps of the UK in terms of leaving the European project.

Scotland is another country that could end up, actually, leaving the EU in its attempt to leave the UK. Its hopes given, of course, how pro-European Scotland is would be to rejoin the EU but they might end up having to get in the back of the line. That’s one concern. And then of course one issue that has been at the forefront of European risks since the beginning of the crisis, the global financial crisis, is Greece. Greece hasn’t been solved by any stretch of the imagination, it’s just garnering a lot less attention from the markets these days. Whereas before, the real concern was that there would be a stand-off between Greece and its creditors, and Greece would end up leaving the Eurozone almost by accident. Now, it’s very different. It’s very clear that the Greek government will just end up caving every time its creditors ask new reforms of this government, and just recently they came up with a deal for another round of funding  to ensure the government is signed up to what the creditors demanded. The problem now is that creditors themselves can’t agree on what they want, so the IMF would really like to see Greece have debt relief, which is necessary in my view. The other creditors, particularly Germany, don’t want to commit to debt relief now, particularly not in advance of the German elections coming up. If they don’t come up with a solution, the IMF could end up leaving the bailout program in which case there is a real risk that Germany, and more recently the Netherlands, has said that they wouldn’t participate without the participation of the IMF. If these countries don’t participate, then the bailout program would fall apart. Greece would have no means for funding, and could end up leaving the Eurozone, not because it was specific strategy on the part of the government or even on the part of the creditors, but again, almost by accident. There is a risk that you could have some EU and Eurozone breakup, even though the risk isn’t as high as it once was.

In terms of the actual economy in the Eurozone, in aggregate, I think that the Eurozone is roughly a 1.5% growth economy, but again that’s in aggregate so it masks the big divisions between the core countries like Germany and the weaker countries like Greece and Portugal, and Italy as well. Data has been looking better; much as in the US, much of the confidence data has looked good, a lot of the soft data, the PMI data for example, has been really improving. It’s the hard data that’s not looking as great so things like industrial production, new factory orders, that hasn’t really come in yet. Lending is actually expanding, so we might expect some improvement of the hard data such that there is a sustainable economic recovery in the Eurozone. That recovery can only really be so strong as long as the approach remains that if all the weaker countries doing all the adjusting and all the core countries just carrying along as they always had. Evidence in that is Germany’s current account surplus which continues to hit new record highs every month. Germany and other core countries aren’t adjusting at all and the weaker countries continue to cut their wages and pensions. In Greece’s case at least, we haven’t seen much wager-pinching growth, and they continue to try to increase their national savings as a percentage of their GDP to match Germany’s again, and that just means there’s not a lot of consumption or investment happening in the weaker parts of the Eurozone. That really cuts off any avenue towards domestic demand, it means that most of the Eurozone is relying on exports for growth. There is an economic recovery happening in the Eurozone, it’s just muted by the fact that it’s all the weaker countries doing all the adjusting and none of the stronger ones. I think that we can expect that to continue in the absence of any major policy change, so I think the Eurozone in aggregate will continue to be a 2% growth economy.

In terms of what the ECB is doing, the ECB would love to normalize monetary policy but it’s just taking them a while because the recovery is so weak and because inflation isn’t coming in. I think that the ECB will probably announce a tapering of their QE program at the end of this year, and at the end of next year, they might have to wait until the beginning of the following year. The ECB is very much going in the footsteps of the US in trying to very, very gradually normalize monetary policy. I think that if some of these political risks I mentioned materialize, then it’ll be incredibly difficult for the ECB to hike rates in to that for sure. There are other risks, in the banking sector for example, particularly in Italy, that might make it really difficult for the ECB to tighten monetary policy.

FRA:    You mentioned earlier on bank runs, could those be initiated from a catalyst of something other than one of the countries pulling out, like Italy or France, pulling out of the European monetary union? Would it be other factors potentially, in terms of the bank runs?

Megan:    Yeah, you could see bank runs happening as a result of financial instability in in of itself. Particularly in Italy, there are a lot of banks that are still requiring recapitalization, non-performing loans in Italian banks. Portuguese, Irish, Greek, even French banks are really elevated and it used to be that they would work at their non-performing loans by creating bad banks because they can’t create the same bad bank that they used to be able to. That’s no longer a solution which means that none of these countries really know what to do with the massive heap of MPL’s that are sitting on their balance sheets, and so if you see those non-performing loans start to be realized and turned into defaults you could end up having a real scare.

The Eurozone has made some progress on institutional change in terms of creating a banking union, but they haven’t gotten all the way there yet so rather than saying they have a banking union I’d say they have a loose banking federation. There’s still no risk sharing in terms of banks in Europe so that means that not only is there not a common deposit guarantee in Europe, but I do think that if any country that has a big bank that really needs to be wound down. Now, governments aren’t allowed to step in and bail them out, and I think that wounding down a big bank is absolutely politically toxic for any leader so faced with that choice, most leaders would just break the rules and completely undermine the banking union and that in itself could spark off bank runs as well.

FRA:    Do you see the potential for a move towards a fiscal union in terms of creating an actual European bond or just conducting fiscal policy across the entire Eurozone?

Megan:    I think part of a fiscal union is needed, though I don’t think we need, for example, a common fiscal authority. I think we do need to see asset class in Europe that is liquid and deep enough to withstand any sudden stops, so I do think they need to create mutualized debt like a Eurobond. But then actually I think that the private sector can go ahead and step in rather than having a fiscal authority. If we had a capital markets union, I think that that could go a long way towards achieving what a public fiscal union could achieve and I think that’s necessary because I just don’t think that there’s any political will either in the core or in the periphery to actually have a fiscal authority and have everyone sign up to the same rules. So I think that it’s unlikely and would be a waste of political capital to try to create a fiscal authority.

One way of explaining what I think that the Eurozone needs is a mutualized debt so a Eurobond, but then in terms of the private markets governing cross border investments and exposure, it’s a bit like our credit card companies like VISA and MasterCard, that’s mutualized debt with no real central authority to manage it. There is some precedent for, I think it’s possible, but I don’t think it’s possible to see a full fiscal union with a single fiscal authority. Unfortunately, Eurobonds aren’t at all on the agenda now. It would require several more acute crises, and existential crises in the Eurozone to get the core members and the peripheral members to sign up for it, but particularly Germany because Germany doesn’t really see why they should accept other countries’ risk, and they’re worries about creating a moral hazard by going ahead and mutualizing bonds. So I think it’s very unlikely, but I do think that we need Eurobonds eventually for the European project to stay together.

FRA:    And actually just recently this week US president Donald Trump made some comments on the dollar that it was too strong and so there was some movement on the dollar going lower; pushing the euro higher. Could that be a trend, and if that were to happen, if the euro would strengthen, could that cause global havoc and the countries’ struggle on their economy and debt burden?

Megan:    Well, I think that’s its really unlikely that the general trend will be that the dollar weakens, I think that it’s much more likely that the dollar ends up a bit stronger even though the US president is trying to talk down the dollar at the moment. It’s really hard to conceive of a situation in which it’s in the US government’s best interest to see the dollar depreciate. The only scenario I can really think of is if there were huge problems in other economies, and the US fed opened up slop lines with other central banks to essentially fund their QE program so the Bank of Japan and the ECB, and the Bank of England. I think that’s really unlikely. We have seen the dollar weaken a little bit but the general trend is for the dollar to strengthen and that’s relative to a basket of currencies but that includes the Euro. I think generally the Euro will be weaker. Also, we will have movements, depends on your time frame of course, but I think if the French election results in Macron at the helm of government, then I think that the Euro could strengthen off the back of that.  But if Le Pen were to win for example, I think the Euro would weaken off the back if that, so it will depend to some degree of political developments and in the long term, I do think that the Euro will probably weaken relative to the dollar. Not so much necessarily because of the factors that mean the Euro should be weak but in large part because of what the US and the fed are doing.

FRA:    Given these political developments, do you see Germany continuing to bear the debt of the rest of Europe in terms of transferring its current account surplus to the less fortunate states of the union…or could it be that Germany considers on leaving the Eurozone?

Megan:    I think that Germany has really been taking on risk through the target to balance this at the ECB, so the target to imbalances is now at record high, or higher than they were back in 2012, when there were much greater concerns about countries leaving the Eurozone. That’s largely because of Italy, actually, so it’s largely because of German investors pulling out of Italy. Now that only becomes a problem if a country actually leaves the Eurozone and that seems unlikely, I think. It’s certainly not my base case scenario over the next couple of years. Otherwise, Germany isn’t really funding everybody else’s debt, but I do think that there is a discussion about whether it’s really in Germany’s best  interests to stay in this project. I think that it definitely is. Germany benefits from an artificially weak currency because it is connected to so many weaker countries, and that’s been really helpful for Germany given that their growth model has been pretty reliant on exports for the past several years so the domestic demand now stand for a slightly larger percentage of GDP than it has in the past, but its only really slightly larger. Germany is still dependent on exports for growth. If Germany were to go ahead and leave the Eurozone, it would probably see its currency appreciate massively and that would completely undermine its entire growth model so it would have to come up with an entire new model and that’s not really in Germany’s best interests so I do think it’s in Germany’s best interests to stick in the Eurozone.

I will say that I’ve spent a lot of time talking to the EU governments and my argument with them has always been that Germany always had a very high national savings rate, and so they’ve had a really low national investment rate, which hasn’t really served them well. I mean they’ve invested in Greek government bonds, and Portuguese retail, and Irish property, which (those investments) turned out to be really bad investments. It also means that German investment domestically has been really low, so Germany suffers from chronic underinvestment and as a result their roads are in bad shape, their bridges are in bad shape, so my argument has always been that maybe the German government should encourage domestic investment and that would boost Germany’s growth, and that would also trickle out and help the growth of the rest of the Eurozone. The German government’s response to me every time is to ask me why they should care about growth, which as an economist you can imagine, seems like a weird question but according to them, they don’t have incredibly high growth but they have a really high standard of living and very low unemployment. In their view, growth is kind of an Anglo-Saxon obsession and they’re doing just fine. So this approach to growth in Germany, and this approach in the entire region whereby Germany does the same as its always done and everybody else tries to look more like Germany, I think that’s here to stay for a number of years.

FRA:    Interesting. And what are your thoughts on the UK and Brexit, how that’s playing out, and could there be any changes between now and the next two years after they receive their Article 50 notice like a few weeks ago?

Megan:    I think there are still some that are hoping that the UK will take back triggering Article 50. I spoke with the guy who wrote Article 50, John Kerr, and he says you can and he intentionally left wiggle room in it. I think it’s very unlikely that the government will do that given that they’re acting on a mandate that was given to them by the people. Also if they were to go ahead and revoke it, they probably would have already damaged their relations with the rest of the EU given that they’re negotiating to leave.

I did a lot of consulting on Brexit and testified in the House of Lords, and before Brexit I would’ve said that the worst possible option was the UK going for a so-called “hard Brexit”, which means leaving the single market all together. Now, I think that’s no longer the worst option, I actually think it’s the most likely option. The prime minister has said that’s what they’ll pursue. I think there’s a worse option out there which is that after two years of negotiating, both their divorce from the EU and their new relationship with the EU, they actually don’t have any agreement on what their new relationship with the EU should be, at which point the UK would just kind of stumble out of the EU. They would have to rely on the WTO for their trade relationships. The problem with that is that right now the WTO has relatively robust rules and some credibility, but in two years from now it actually might not, so, you could conceive for example the US government trying to implement a border adjustment tax which is most likely illegal according to WTO rules. Having the WTO turn around and say, “Well, that’s illegal you can’t do that” and the US administration could just reply by saying well, “We don’t care anyhow”. That would completely declaw the WTO. That’s just one example and there are a number of potential trade policies coming out of the US in particular that could really undermine the WTO, so the UK’s plan is to actually rely on WTO rules so that at the end of two years the WTO might be severely undermined by then, in which case, that’s a terrible plan for the UK. I think that’s the worst scenario.

The only way, I think, that the UK could actually have a deal at the end of two years is if they cut and paste it from somewhere else. Two years is not a lot of time to negotiate their divorce from the EU first, and of course not much will get done before the French elections, and then the German elections in September, and then the Italian elections in March, so, there will have to be breaks in negotiations. They’ll have to negotiate the divorce and then they’ll have to negotiate an entirely new relationship-that’s a lot to do in two years. If they can cut and paste a new relationship from somewhere else, they might be able to pull it off. One way to do that is to copy the deal that Canada and the EU struck: the Ceta deal. The problem with that is that it doesn’t include anything on services and more than half of the UK’s economy is services so they’d have to write an entire new chapter to cover services, and that in itself could take two years. That’s problematic. There’s one other option that’s currently being discussed behind closed doors in the UK and that’s to copy the deal that the EU just struck with the Ukraine which does include services so that is really feasible. It is mainly being talked about behind closed doors because the UK doesn’t want anyone to realize that they’re trying to follow the Ukraine as a model. That is one option but it’s too early to say whether really is possible or not but it’s something that they’re looking at.

FRA:    Finally, just wondering your thoughts on the investment environment, what this all means, not mentioning any specific companies or securities, any thoughts on asset classes or types of investments that could make sense in Europe given all the scenarios, assuming there could be some investments that could make sense regardless of all the different scenarios like whether Germany stays, whether they pull out and different countries leaving, the effect of political parties getting elected. And would it make sense for Europe in general now from a contrarian perspective? Perhaps like German corporations or German real estate, if they were to pull out their currency would appreciate, but if they stay in there could be more inflation generated to ease to burden of debt across the Eurozone. Your thoughts?

Megan:    German real estate certainly is one potential opportunity but generally I would say given even all the risks that I’ve highlighted particularly the political risks, I think that the most likely scenario over the next year or two is that we go through all these elections and actually in the end we just have the status quo, which would be market-positive. I’m hesitant to get too excited about that because I do think that there are real restraints on the economic recovery in Europe because of the politics as they currently stand, so the status quo means that would continue. Still, I think that would be a risk on development in which case given that you have the ECB continuing to ease now and I think that they’ll continue to maintain accommodative monetary policy going forward, and you have the fed in the US tightening actually, that does means that there might be opportunities and equities in Europe generally so I do think that that is one place that investors could look. In terms of banks in Europe, there are some real problems in terms of the health of bank balance sheets particularly in Italy, Portugal, even France, but banks are incredibly cheap so there might be some valuable investments there. Generally I do think that the valuations for companies in Europe will go up so I would say that European equities are probably a good opportunity now.

FRA:    Great. Great insight. How can our listeners learn more about your work?

Megan:    You can follow me on twitter, its @economistmeg to not only see what I write myself but to also see my commentary on the latest, greatest in Europe and the rest of the world.

FRA:    Great, thank you very much for being on the show and again, thank you.

Megan:    Pleasure, thanks for having me.

Abstract by Tatiana Paskovataia, tatiana-p28@hotmail.com

LINK HERE to the podcast

 

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.


04/26/2017 - Dr. Marc Faber: Indebted Western World Economies Are More Fragile Than Ever Before

Marc Faber thinks there will be 20 – 40% pull back in the markets, we are still in the Trump euphoria stage. He goes on to say that Trump will beg Janet Yellen not to raise interest rates and to keep on printing. Tax reform will not really help the U.S. The U.S. and western economies are terminally sick. The Debt loads are huge and the economic conditions are more fragile than ever before.

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.


04/26/2017 - The Roundtable Insight: Richard Duncan On A Recipe For Disaster

Richard Duncan is the Chief Economist at Blackhorse Asset Management in Singapore. He is the author of numerous books including, The New Depression: The Breakdown of the Paper Money Economy, and The Dollar Crisis: Causes, Consequences, Cures, an international bestseller that predicted the current global economic disaster with extraordinary accuracy. Since beginning his career as an equities analyst in Hong Kong in 1986, Richard has served as global head of investment strategy at ABN AMRO Asset Management in London, worked as a financial sector specialist for the World Bank in Washington D.C., and headed equity research departments for James Capel Securities and Salomon Brothers in Bangkok. He also worked as a consultant for the IMF in Thailand during the Asia Crisis.

Richard has appeared frequently on CNBC, CNN, BBC and Bloomberg Television, as well as on BBC World Service Radio. He has published articles in The Financial Times, The Far East Economic Review, FinanceAsia and CFO Asia. He is also a well-known speaker whose audiences have included The World Economic Forum’s East Asia Economic Summit in Singapore, The EuroFinance Conference in Copenhagen, The Chief Financial Officers’ Roundtable in Shanghai, and The World Knowledge Forum in Seoul. He runs a blog called https://www.richardduncaneconomics.com/ where he has a video newsletter service called Macro Watch, which is available to our listeners at a 50% discount using the code word: authority

I coined the term ‘Creditism’ to describe an economic system driven by credit creation and consumption, in contrast to Capitalism, which was driven by investment and savings. Creditism replaced Capitalism when money ceased to be backed by gold nearly five decades ago. But Creditism requires Credit growth to survive. The evidence presented in this video suggests that Creditism is in crisis globally because Credit is no longer increasing fast enough to drive global growth, even with record low interest rates. It is not possible to understand the global economic crisis without taking account of the exhaustion of Creditism.”
– Richard Duncan

Current Creditism trends:

Once we stopped backing money with gold in 1968, the nature of our economic system changed very profoundly. Credit growth became the driver of economic growth. When we were still on a gold standard, there were constraints as to how much credit could be created, but after we stopped backing money with gold, all those constraints were removed and credit absolutely exploded. Total credit or total debt in the United States first went through one trillion dollars in 1964, and now it’s 66 trillion.

So it’s expanded 66 times in just over 50 years. This extraordinary explosion of credit in the US has completely transformed the global economy. It ushered in the age of globalization, it allowed countries like China to be revolutionized from a very poor, developing country, to the second largest economy in the world. What I’ve seen is even adjusted for inflation, every time credit has risen by less than 2% in the US going back to 1950, the US goes into a recession. And the recession doesn’t end until we get another big surge of credit expansion. So it’s crucial to be able to forecast credit growth if you want to be able to understand what’s going to happen in terms of economic growth. And it’s been very weak since 2008; we’ve now hit the point now where the private sector, the households, are so heavily in debt that they just can’t continue taking on new or additional debt to make credit expand enough to drive the economy.

So this is the real point: once credit started to contract in 2008, the global economy began to spiral into a new great depression. And it was only the expansion of government debt that prevented that from occurring. US government debt has more or less doubled since 2008, it is roughly $19 trillion now. It was the expansion of government debt that kept total credit expanding, and that prevented the world from collapsing into a depression.

The key as to what is going to happen next to the US economy and the global economy is interest rates. Interest rates are crucial to the future of Creditism as I call it. Going back to 1980, interest rates in the United States have gone down very steadily.

The 10-Year US Government Bond Yield in the early 80s was as high as 15% and now it’s gone down to around 2.2% today. And as the interest rate fell, this made borrowing more affordable, so the Americans were able to afford more debt. They became increasingly indebted, and we can see this by looking at the ratio of total debt to GDP in the United States. Now when I talk about total debt or total credit, I mean all the debt in the country. The government debt, the household sector debt, the corporate debt, financial sector debt, all debt. In 1980, it was only around 150% total debt to GDP, now it’s about 350%. So as credit expanded, the credit growth drove the economic growth in the United States. And as the US economy expanded, US imports from other countries grew, and that drove the global economy.

As interest rates have fallen, Asset prices have gone up. The stock market, property market, bond prices, they’ve all gone higher as interest rates have gone lower. The best measure of total wealth in the United States is household sector net worth.

Household net worth is now $90 trillion, it’s gone up by 60% since the post-crisis low in 2009. The reason this wealth has expanded is that the government and the fed took very aggressive action to reflate the global economy after 2008. The fed and the central banks around the world had interest rates to near 0% and reflated the global economy.

Going back to 1950, the ratio of wealth to income has averaged about 525%. During the property bubble, this ratio went up to about 650%, and of course, the property bubble blew up, and the ratio went back down to its normal level of about 525%. But now this ratio has once again expanded and is now at its back at its all-time peak level at 650% once again. And this is telling us that asset prices are very high, and the stock market is very expensive, property prices are expensive. And that means interest rates now begin to move higher, then asset prices are very likely to fall. So we’re seeing a situation now where interest rates are the key, because if interest rates move higher then credit is going to contract.  That’s going to throw the economy into a severe recession, and on top of that asset prices would have a very significant correction or crash, that would cause a negative wealth effect, and that would also cause a US economy and the global economy to go back into severe recession, or worse.

The US budget deficit

When the government borrows money it tends to push up interest rates. For instance, if the government doesn’t borrow anything then there’s less demand for money and interest rates will be lower. But if the government were suddenly to borrow $3 trillion, then that would suck up all the money available in the economy and that would push interest rates to very high levels. So when the government borrows more, it tends to push up interest rates. This is assuming all else is unchanged, but over the last many decades, something very important has changed. Once the Bretton Woods system broke down in 1971, the United States discovered they could run very large trade deficits with the rest of the world. This is important because it means the US will have very large capital inflows. When the US has a large trade deficit, it will have an equally large amount of capital inflows coming into the country to finance that trade deficit. The larger the capital inflows are, the easier it is to finance the government’s budget deficit at low interest rates.

In 2006 we had about $800 billion in capital inflow, and that was enough to finance the entire government budget deficit that year a few times over. So these inflows are very important financing the budget deficit at low interest rates. If Trump is successful in his promises to cut taxes and increase government spending, then it’s going to make their budget deficit considerably larger.

The Capital Inflows are the mirror image of the Current Account deficit.  When the Current Account Deficit grows larger, the Capital Inflows also grow larger, making it easier to finance the budget deficit. But, when the Current Account Deficit shrinks, Capital Inflows also shrink, making it more difficult to finance the budget deficit at low interest rates.

President Trump’s plans to force US companies to bring their factories back to the US, to renegotiate trade deals and/or to impose trade tariffs on China and Mexico would all cause the US Current Account deficit to shrink. A smaller Current Account deficit would cause the capital inflows into the United States to shrink, too.  Less capital inflows would mean less demand for US government bonds. That would push up interest rates and pop the asset price bubble. So, we must keep a close eye on the US Current Account Deficit because it will determine the size of the capital inflows.

What Could Cause Inflation to Rise?

Inflation has fallen since the early 1980s because increasing trade with low wage countries has pushed down US wages and the price of consumer goods. Now, however, if the US imports less from low wage countries, the price of manufactured goods will rise, US wages will rise, and inflation will rise. Forcing companies to bring their factories back to the United States or imposing trade tariffs on imported goods would cause inflation to increase. Increased government spending could also cause inflation to pick up.

The Undesirable Consequences of Eliminating the Trade Deficit

If the US reduces its imports, the global economy will shrink. If the US eliminates its $1 billion a day trade deficit with China, China’s economy could collapse into a depression that would severely impact all of China’s trading partners, and potentially lead to social instability within China and to military conflict between China, its neighbors, and the US. Additionally, if the US Current Account deficit returns to balance, the global economy will suffer from insufficient Dollar liquidity, which could cause economic stagnation or worse. A reduction of imports from low wage countries would cause US inflation to rise, which would push up US interest rates. The elimination of the Current Account deficit would cause a sharp reduction in capital inflows into the US, which would also cause US interest rates to rise. Higher interest rates would cause credit to contract and a sharp fall in US asset prices, which could cause the economy to go into recession. It could also cause a wave of credit defaults in the US and around the world, potentially leading to a new systemic financial sector crisis.

Moving Forward

The US could stimulate the economy “the old fashion way” by increasing military spending and starting a war, or they could invest in 21st century industries and technologies. We could invest a trillion dollars over the next 10 years in developing renewable, green, solar energy. And if we did that, we could then re-structure the entire US economy, and induce a new technological revolution that would be so profitable, that we would pay off these investments many times over. We could grow out of this crisis, rather than collapsing into a new great depression.

Conclusions

The proposals outlined thus far by President Trump suggest that:

  1. The budget deficit would grow larger (due to tax cuts and increase government spending);
  2. The current account deficit would shrink (due to renegotiating trade deals, bringing US factory jobs back to the US and possibly trade tariffs);
  3. And inflation would pick up (due to increased government spending, higher US wages, pressure on China to push up the RMB and, possibly, tariffs).

More about Macro Watch

Macro Watch is a video newsletter published by Richard Duncan. Every two weeks a new video is uploaded describing something important going on in the global economy, and how that’s likely to impact asset prices. Macro Watch monitors and forecasts credit growth and liquidity to measure and anticipate economic growth. You can subscribe to Macro Watch at https://www.richardduncaneconomics.com/ where you can save 50% with the discount code: authority

LINK HERE to download the MP3 Podcast

Summary by Jacob Dougherty jdougherty@Ryerson.ca

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


04/16/2017 - The Roundtable Insight: Charles Hugh Smith On The Commercial Real Estate Bubble Caused By Financial Repression

“What we’re really discussing is a mismatch between the amount of money pouring into commercial real estate and the actual return on that investment”

We have a large supply of commercial real estate out there but the supply is still increasing, they’re continuing to build and have overbuilt in many areas. Meanwhile, the demand side is low and is still moving downwards. There have been very high vacancy rates in the U.S. specifically in the office and retail sectors.

There is also generational trends in play, there is less demand for office and retail space because millennials are causing the office space standard to rise and retail is more often done online at websites such as amazon. At the same time, there are valuations that are sky-high, even higher than the financial crisis. This could boil over as soon as 2018, but the central banks should have enough tricks up their sleeves to save the system one more time, but they’re running out of rope to do that a third time.

From the podcast:

Charles: The commercial property price index has now exceeded the previous bubble top in the 2007-2008 period by about 25%. So we’ve got a bubble that exceeds the previous high, and that should alert us to the potential for some downside here.
And if we look at commercial real estate loans at banks, then we see the chart is almost just an exact overlay of the price action. In other words, we’ve got more loans by about 25%, basically $2 trillion of U.S. commercial real estate loans. What makes that sobering is if we look at the retail square footage per capita.

We find that the United States has multiples, and so does Canada actually, has multiples of what other countries, advanced post-industrial companies like France and Italy. They have 2 or 3 of square foot per person and the U.S. has almost 25 and Canada has almost 15. So it looks like we’ve got a situation where there’s a lot of leverage debt on an overbuilt sector.

FRA: And you mention also that they’re still building and a lot of places have been overbuilt?

Charles: Yeah, I dug up a chart called Retail Space under Construction, and this was a year ago first quarter 2016, but there are millions of square feet of shopping centers, malls, and specialty centers still under construction.

Now if these are all in extremely hot markets like Toronto, or Vancouver, Silicon Valley, Brooklyn, then of course there’s going to be a demand for this kind of space, but these white-hot markets are fairly limited and so there’s a suspicion that there’s a lot of space being added to an already extended inventory.

Charles: We can see that the residential vacancy rate has plummeted from the 2010 post financial crisis peak. And it’s essentially near zero, around 3% or 4%. But the retail and office vacancy rates are still hovering around 9% or 10% which is way above where they were in 2007 and 2008. So this vast expansion of credit and some of that money is pouring into retail and office commercial real estate, but the demand really isn’t there. And we know that because of these high vacancy rates.

FRA: You also add a chart on commercial real estate credit derivatives which gives an indication of the risk inherent in commercial real estate, is this indicative of rising risk in that sector?

Charles: Right, this chart is credit derivatives and it’s a fairly high-risk series, its BBB not AAA, so this is the kind of credit derivatives that are sensitive to risk and interest rates. And there was a very steep decline, a spike down about a year ago, the first quarter of 2016 in these commercial real estate credit derivatives which showed that there was a heightened sense of “we better get out now” and limit our exposure to the credit derivatives on the commercial real estate sector. And it’s recovered, but it’s recovered to a lower high then it was. It was quite stable all the way through 2015. So this is telling us that the financial people that are exposed to the commercial real estate sector are starting to hedge their bets and starting to pull the trigger to minimize their exposure, which means they see a heightened risk.

Charles: This chart shows how much space employers now provide to each of their employees. And that number is plummeting from 2010 as businesses have to get more efficient, they need less office space. And if you combine that with flex work and working at home and teleconferencing its hard not to conclude that we as an economy are going to need less office space. And in the retail sector, the number of stores closing is at an all-time high, it’s far exceeded the 2008 financial crisis peak.

So what we’re seeing is a huge fleeing and closure of the retail sector, and a lot of subletting going on in the office space sector, so there are corporations and retail business which are shedding space because that space is no longer generating sales and profits.

If you would like to learn more about Charles Hugh Smith’s work, you can visit his website at http://www.oftwominds.com/ where you can look at his archives and read free samples of his books.

Summary written by Jake Dougherty<jdougherty@ryerson.ca>

LINK HERE to download the podcast in MP3 format

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.


04/14/2017 - The Roundtable Insight: 5 Top Money Managers Discuss Austrian School Investing – Now Published

LINK HERE to download the MP3 PODCAST

LINK HERE to download the Summary and Transcript in PDF

SUMMARY – also see FULL TRANSCRIPT BELOW

Today we have five panelists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Liechtenstein, Chris Casey from Chicago, Bill Laggner from Dallas, and Mark Whitmore from Seattle.

Chris is the Managing Director of WindRock Wealth Management. He combines a degree in Economics from the University of Illinois with a specialty in the Austrian school of Economics. He advises clients on their investment portfolios in today’s world of significant economics and financial intervention. He’s Also written a number of publications on a number of publications on websites including the Ludwig von Mises Institute, Zero Hedge, Family Business, Casey Research, and Laissez Faire Books. He is a board member of the Economics Development Council with the University of Illinois, a Policy Advisor for The Heartland Institute’s Center on Finance, Insurance, and Real Estate.

Bill is a Co-founder of Bearing Asset Management, he’s a partner with Kevin Duffy that manage the Bearing fund using an Austrian School of Economics lenses in terms of identifying boom-bust cycles, value in the marketplace, bubbles, and distortions created by both fiscal and monetary authorities. He’s a graduate at University of Florida, began his investment industry career in the late 1980s initially as a stockbroker, and then moved to the buy side at fidelity investments. He’s been featured also in Barrons, Reuters, and CFA magazine.

Russ Lamberti is the founder and chief strategist of ETM Macro Advisors. Which provides Macroeconomic intelligence and strategy services to asset managers, family offices, and high net worth individuals. He is the Co-Author of “When Money Destroys Nations”, a book about Zimbabwe’s hyper-inflation, and he’s a contributing author at the mises.org institute.

Mark Valek is a partner investment manager of incrementum, he’s a Chartered Alternative Investment Analyst (CAIA) and has studied business administration and finance at the Vienna University of Economics. From 1999 he worked at Raiffeisen Zentralbank (RZB) as an intern in the Equity Trading division and at the private banking unit of Merrill Lynch in Vienna and Frankfurt. In 2002, he joined Raiffeisen Capital Management and in 2014 he published a book on Austrian Investing. He’s one of the authors of “Austrian School for investors”.

Mark Whitmore is the Principal, Chief Executive Officer of Whitmore Capital. Mark has been managing personal portfolio assets, periodically publishing newsletters and blogs, and providing pro bono financial planning/investment consulting since leaving law in 2002. His specialties are currencies and international economic analysis. He obtained a B.A. in Political Studies from Gordon College, graduated Summa Cum Laude at the University of Washington he earned a Masters of International Studies (MAIS) at the Jackson School and a J.D. from the School of Law.

Austrian School of Economics Explained:

Mark Valek defines some basic points and differences of the Austrian School as: Economics about the behavior of individuals and human action, The Subjective value theory, under consumption of savings is necessary for sound investing and growth, capital structure being key to a sustainable economy, and price mechanic mechanism coordinates the centralized knowledge. Perhaps the most important distinction of Austrian Economics is its view towards the monetary system. Some of these points are inflation being defined as expansion of the money supply and finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory.

He points out that these are the typical differentiating points, but this is by no means a complete list, and you can discuss the differences between the Austrian School and traditional Keynesian theory.

Russell Lamberti thinks that one of the key differentiators from a practical analytical and investment perspective was that the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. He notes that at the microeconomics level, Keynesianism is very similar, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental break down there. He ends the thought by saying in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s why he thinks the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

Chris Casey discusses why Austrian Economics can provide new insight, saying that Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint to create a consistent and sound economic school and economic philosophy. And that’s what really makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

Mark Whitmore adds that specifically, the role of central banking is something that is really distinct from an Austrian perspective vs Keynesianism.  Specifically the asset price inflation that you’ve seen has largely been ignored by Keynesians in the last two bubbles.  Now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to there being really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates meaningfully. And I think that from an Austrian standpoint, this exacerbates this boom-bust cycle which we’ve seen which has been really compressed in terms of time lately versus what has historically been the case. Since the mid to late 90s the amplitude of bubbles to the upside has just been far greater. He highlights Henry Hazlitt’s two points as far as critiques of Keynesianism. The first one being that fundamental flaw in terms of interest, with Keynesians tending to service the visible minority at the cost of the invisible majority and again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, in its view, the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the accuracy of that. And second,the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

How it’s used in past, present and future Economies including how and why the 2007-2008 financial crisis happened:

Bill Laggner says what was interesting was that the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. He also points out that the distortions are epic, and that this won’t end well.

Mark Whitmore chimes in discussing Kurt Rickenbacker’s idea of “Ponzi finance” which is a powerful analytical insight that essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place.Credit can thus becomes increasingly untethered to any kind of historic connectors such as sound collateral. One increasingly witnessed these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic.


 

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

He notes that the curve and amplitude of the line showing the increase in central bank assets seen above is almost exactly the same as the line showing the increase in the S&P 500. He calls this the engine that’s driving what’s been taking place in terms of asset price inflation and ends by calling it highly unstable, and saying again that this will not end well.

Russell Lamberti emphasizes the importance in looking at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. He also discusses this unwritten law against recessions, saying this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. He ends by saying: we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again, I hope we get there soon.

Chris Casey adds that when discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what can not explain the 08 crisis, and that is mainstream economics. And it’s worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the great depression, and he basically said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. “They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call ‘the cluster of error’, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical than say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off.”

The Austrian School Investing, Investments/Asset Classes/Investment Strategies

Bill Laggner discusses how knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, he wrote an article with a colleague called “collateral damage”. And what he found fascinating about writing the article was the Bearing Credit bubble index created back in 2004 when it was pretty obvious that we were segueing into this new bubble. He says: I kept looking at the types of asset backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think  what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle, because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going.

Chris Casey discusses how it’s unclear if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. He goes on to say “They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up for most people the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s a very limited set. The people here on the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind.”

Mark Whitmore also tends to be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. What he think is incredibly valuable is how you explain the efficient market theory; this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups in asset prices that leads to catastrophic losses.

Russell Lamberti thinks it’s about creating a coherent perspective of macro-reality, saying how there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. He goes on to say “I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality to compare it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things: one is that an Austrian perspective gives you an understanding that you’re not in a free, unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be at the sense of you are defending your wealth against the plunderers”.

Mark Valek thinks knowing Austrian Economics provides you with a potentially huge edge. He points out that even though you can read about it online at mises.org or on other websites, many people don’t care enough or are not aware of it. He thinks another large edge is that Austrian Economists in general are able to understand alternative currencies much better. They are able to think about it outside of the money system just as we all think so much about the current system, that helps us for instance when bitcoin currency came up. So knowledge of Austrian Economics can provide a good investing edge sometimes in an indirect way as long as it’s utilized properly. He also discusses the potential weaknesses of using the Austrian system, saying that strictly speaking from an Austrian School, you don’t get any help regarding the timing of when we would expect to happen, however, you can still use other theories to help with that aspect.  The last potential risk he discusses is that Austrians have a dogmatic bias and tend to be very cautious in an investment space.

Ethical Issues:

Russell Lamberti points out that “We all have to make a decision about leverage. In a system where debt is created by fractional reserve banks, we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course when you participate in that system, there’s two ways you can look at that. You’re ether participating in the bank and leverage system as a defence mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage.” Bill Laggner agrees and adds “I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out”.

How Austrian Economics help you when looking at investments from a risk-return standpoint:

Chris Casey recalls what Mark Whitmore pointed out and added “hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value.”

Mark Whitmore adds “this notion of efficient market theory which attempts to just buy and hold the market no matter what, being completely price indifferent is clearly suboptimal. And that’s really key, as that Austrians, I think, have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action if you’re somebody who’s sort of a trend follower or you’re simply buying and holding, there’s a greater tendency among Austrian investors to appreciate value.”

Websites and other information on the panelists:

Russell Lamberti: www.etmmacro.com where you can sign up for a free newsletter called “The Macro Outsider”: http://etmmacro.com/the-macro-outsider/

Bill Laggner: http://www.bearingasset.com/ and a blog at http://www.bearingasset.com/blog

Chris Casey: https://windrockwealth.com/ includes podcasts, articles, blogs and more

Mark Whitmore: http://whitmorecapitalmanagement.com includes a quarterly newsletter

Mark Valek: http://www.incrementum.li/ and he has a book called Austrian School for Investors” available on amazon.

 

Abstract:

Austrian Economics takes into account the behavior of man, and has different views than traditional economic theories on monetary policy, and differs from Keynesian economics greatly on the macro level. It can also be used to identify when there is too much debt and when bubbles are in danger of bursting. Austrian Economics can be very useful for observing the overall behavior of the economy and can often help an investor make more informed decisions.

FULL TRANSCRIPT

FRA: Hi, Welcome to FRA’s Roundtable Insight. Today we have a special treat for our listeners, it’s a discussion on the principals of the Austrian School of Economics and how those principals can be used in investing. Today we have five panellists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Lichtenstein, Chris Casey from Chicago, Bill Laggner form Dallas, and Mark Whitmore from Seattle.

Welcome Gentlemen

So I thought we’d have a discussion initially about what exactly is the Austrian School of Economics and how does this school of economics differ from other schools such as the Keynesian School of economics. Mark Valek, would you like to begin?

Mark Valek: I’d love to, thanks for having me, very excited to discuss basically an economic school which is from Vienna, my hometown, unfortunately Vienna, in the University doesn’t really teach Austrian Economics anymore. However, I think the topic of the Austrian School is a big one, one can talk for hours on end on how it differs, we actually tried to make the Austrian School to list the 11 of 10 bullet points, we came up with an 11th one so we could describe the Austrian school in 11 bullet points. And this is by no means a complete observational but just some basic concepts we put together, we refer to them:

  • Economics is about behavior of individuals, it’s basically about human action
  • They can point human innovation and entrepreneurial action of a source of wealth creation
  • Private property is preconditioned for sensible resource allocation
  • Trading is mutually beneficial (The Subjective value theory. Theory of Value)
  • Another point would be under consumption of savings is necessary for sound investing and growth
  • Also, very important point I think which differentiates the Austrian school is its view towards capital structure. So capital structure is key to a sustainable economy. Thinking about Hayek‘s triangle for the guys who know what I’m talking about here.
  • And price mechanic mechanism coordinates the centralized knowledge.

So these were some basic, basic concepts and they are not only found in the Austrian School, perhaps what does differ more is the view towards the monetary system. And I just want to add 3 or 4 points regarding the Austrian view on the monetary system:

  • Inflation, for instance, is defined as expansion of money supply, something very central to Austrian Economists
  • Inflationary monetary systems chronically transfer wealth, I’m talking about the Cantillon effect, something I think the other schools really don’t talk about at length and it’s something very interesting for society also these days.
  • And finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory

So these are perhaps the more typically differentiating points, especially from the Austrians, but this list is by no means complete, just a few thoughts perhaps to put on a discussion.

FRA: And Russ you’re perspective on the Austrian School of Economics

Russell Lamberti: Yeah, well everything Mark said was valid, I would, you know at a high level I think that one of the key differentiators from a practical analytical and investment perspective was that, the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. In fact strictly speaking the Austrians wouldn’t differentiate between the two, whereas what you see in Keynesian and monetarist schools is that they have relatively sound microeconomic principals, although they do still differ with the Austrians in one or two key areas, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental breakdown there, Austrians are far more consistent there, I think part of the sense of that is also that the Austrians school derives its lineage from the classical schools of the 1700 and 1800s. And I think we must never forget that because a very key distinction in macroeconomics, a very key departure point between the different schools of thought is what’s known as Say’s law of markets. And you know Say’s law essentially is probably a poorly named concept because Jean-Baptiste Say was not necessarily the best articulator of Say’s law. But nonetheless, Say’s law essentially says that you know, properly allocated production, production that is sustainable is ultimately what finances the ability to demand. You know, and I think that in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s I think why the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

FRA: And Chris, your thoughts?

Chris Casey: Well the Austrian school certainly has a number of conclusions in Macroeconomic explanations that my colleagues have discussed, but if you boil it down and ask the true question as far as what makes Austrian Economics different I’m reminded of Ayn Randwhen she was describing, or criticizing I should say, other philosophiess and philosophers. And I remember her comment I forget which writing it was, it was something to the effect of: these philosophies have excluded man from their theories, and in so doing it’s no different than, let’s say, an astrophysicist that has no concept of gravity or a doctor that has no concept of germ theory. And the same could be said with other economic philosophies. Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint, create a consistent and sound economic school and economic philosophy. And that’s what really, I think, makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

FRA: And Bill, your perspective on the Austrian School?

Bill: Well, look I think everyone here has covered quite a bit of the main points, I would add that the world we’re living in today where we’re very far from any Austrian practices, you cannot have a healthy economy without savings, and by artificially setting the interest rate through central banking, you set in motion numerous distortions. And I think everyone at this table would agree that we’re living at a time where the distortions have never been greater. We have nothing resembling a natural rate anywhere around the world as far as I know. And so what’s happening is your setting in motion layers and layers of malinvestment and then every time there’s a crisis in the Keynesian way of looking at things, they come to the rescue and try and either bail something out through monetary or fiscal policy and/or socialize it directly or indirectly. And I would say we’re living in a time today where so much of the credit expansion that we’ve witnessed especially coming out of the great financial crisis in 2008-2009 is a function of either zero or negative interest rates and/or socializing some aspect of credit that’s entered the economy, and when you have that, clearly there’s no feedback loop. There’s no clear natural feedback loop you have a very distorted picture of things, and I think what makes today’s investing environment very challenging.

FRA: and Mark Whitmore, your thoughts on the Austrian school?

Mark Whitmore: Well, batting clean-up here is a little tough, because as Bill mentioned, I think that people have really nicely covered a lot of the main, sort of theoretical tenants of Austrian Economics, I guess I would add that specifically the role of central banking is something that I think is really distinct from an Austrian perspective vs Keynesianism, specifically the asset price inflation that you’ve seen has largely been ignored specifically in the last two bubbles, and now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to well there’s really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates. And I think that from an Austrian standpoint exacerbates this boom-bust cycle which we’ve seen really compressed in terms of time verses what has historically been the case since maybe the mid to late 90s and the amplitude of bubbles to the upside has just been far greater. And I guess I would just add Henry Hazlitt’s kind of 2 points as far as critiques of Keynesianism. The first  fundamental flaws being that it highlights in terms of interest, the visible minority at the cost of the invisible majority.And again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, you know, in its view the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the efficacy of that. And second of all, the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

FRA: Great, let’s move to a discussion on how the Austrian School of economics is helpful in understanding how and why the 2007-2008 financial crisis happened. And then sort of in parallel to that, what is the Austrian School saying today about the global economy, are there any trends or outcomes that could be identified using the Austrian school. Just general question opened to the floor. Anybody?

Bill Laggner: This is Bill, I would say that all of the Austrians I’m sure on this call saw the crisis building coming out of the reflation right after the tech bubble that burst. It was interesting, the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course I think it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. I think distortions are epic, I think we’re living in a fascinating time. It’s not going to end well, but I think along the way, there has been a continuation of decentralization, innovation, that’s the positive that I think we’re seeing today is as well, that’s just the natural order of the entrepreneurs and the ecosystem, they’re up.

Mark Whitmore: This is Mark chiming in here, I would say that in terms of leading up to the Global Financial Crisis I feel tremendously bad for Kurt Rickenbacker.  He was I think a really fine economist, informed by sort of the Austrian School perspective and he had done a great job identifying the perils of the tech bubble that I think Bill mentioned, a lot of us who are Austrians saw coming, and died right before the bursting of the second bubble.  And what he had talked about is this notion of “Ponzi finance” that I think is good analytical insight that Hayak also talks about which is essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place, and this credit can become increasingly untether any kind of historic connectors to things such as sound collateral and whatnot you saw increasingly these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic, there’s one slide that I drew up which essentially overlays the growth of S&P 500 with the growth of central bank assets in Japan, the Eurozone, and the United States.

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

The assets of these central banks have been expanded a little bit more jagged but the curve, the direction and amplitude of the line is almost exactly the same and so you see this again, unsustainable credit fueled engine that’s driving what’s been taking place in terms of asset price inflation.It’s just highly unstable, and again this will not end well.

Russell Lamberti: Hey it’s Russ, I just wanted to chime in on what Bill had mentioned, I think it’s really critical to look at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. There’s basically been since, I don’t know how long, maybe it was the Greenspan era that essentially ushered us in. But there’s essentially an unwritten law against recessions. And this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. But of course, as Bill rightly says, you have the countervailing forces of progress constantly working, the market is constantly trying to figure out how to make the best of its present reality and its present situations. This is why I think you have inherent paradoxes when you look at these big cycles, because there is so much to be bearish about, and yet there’s also a lot to be bullish about, and I guess that’s the essence and the nature of risk and opportunity. You know Mark Thornton once mentioned that Murry Rothbard used to say he was permanently bearish about the short term and permanently bullish about the long term. And I think that it’s an aphorism, but it kind of speaks to this notion that state intervention can really mess up markets and financial markets in the short term. But over time the power of the free market and of private enterprise is extremely pervasive and eventually seems to win out at the end of the day. Of course in the interim what that means is that because you have such disinflationary forces because of private enterprise and technology, it kind of emboldens the policymakers to run these bubbles longer and larger than they should be, so no question that the last two bubbles have been a symptom of these kind of policies, and I agree, we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again. I hope we get there soon.

Chris: This is Chris, I’ll just add that in discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what does not explain the 08 crisis, and that is mainstream economics. Whether it’s so-called Chicago or Keynesian schools. And it’s probably worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the Great Depression, and he basically said “We’re never going to have a significant recession again.” I believe he said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call “the cluster of error”, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical then say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off. The response by the government and central banks should be to not re-inflate the money supply, do not create bailouts, not have deficits which only will spur consumer spending at the expense of savings. So if that’s the antidote for recessions, the governments since the 08 crisis has done the exact opposite and it’s simply set up the economy for far, far greater downturn then what we even experienced (in 2008), with the possibility of significant inflation. So the 08 crisis gives great lessons and basically proves out the Austrian theory, the business cycle. And it really demonstrates errors and issues with other explanations from other economic schools of thought.

FRA: and Mark Valek, any thoughts on applying the Austrian school to the financial crisis and where we’re potentially heading today and the Global economy?

Mark Valek: Definitely some thoughts, very short though because again, a lot has been said already. Where are we going in the Global Economy? Providing you have the Austrian perspective as we all obviously have, you actually know that there are significantly high (inaudible) to the capital structure, and this is not a sustainable state. But there lies the problem for investing obviously, the timing question, but sooner or later this state of capital structure will not last, it’s absolutely not sustainable. Just on a side note, as an asset manager, I encounter sustainability so many times a year, it’s kind of a hyperinflated world, everybody wants to invest sustainably and what bugs me that is nobody things about if our, for instance, monetary system is sustainable, and I would argue against it. So this is to me, really a very superficial discussion here. However, I think if this cleansing process starts the next time, we will probably will not see the big fear we saw the last time, which was basically the fear of deflation of debt deflation if you want to call it, like debt. I think the authorities have proven that they just will not let this happen so market participants probably are not going to have fear that will be too little money going around or being printed, but perhaps we’ll start to fear that this is going to be an overdose the next time, and I think as soon as this psychology changes, you have (Inaudible) things like price inflation look much more realistic in such an environment if you ask me.

FRA: Great insight, and so given this view of applying the Austrian school to the economics environment, if we can consider that as far as the investment environment, does it make sense to look at the principals of the Austrian school in investing, I mean, we see some of the principals, of being stores of value, indirect exchange method, meaning exchanging fiat currency for investments that are real assets that provide cash flows, investments with little or no debt, high free discounted cash flows as well. Little or no leverage, also scarcity in innovative industries, and then perhaps cryptocurrencies that are outside of the banking system but are still regulated within the financial system. So does it make sense to apply those principals in investing, and what are those principals? Also, are there any empirical studies or analysis that taking this approach can provide an edge or an enhanced investment management performance? This question is for the floor.

Bill Laggner: This is Bill, I could say I think knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, I wrote an article with a colleague called “collateral damage”. And what was fascinating about writing the article was we had created the Bearing Credit bubble index back in 2004 when it was pretty obvious that we were segueing into this new bubble, and I kept looking at the types of asset-backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage-backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going. So ultimately I think you know gold, we own a lot of gold, we’ve owned gold since 2002, I mean gold will continue to act well, and may become one of the best performing asset classes over the next several years until we ether get some kind of boom or something close to it. So that’s how it’s helped us and how we employ it in day to day portfolio management.

Chris Casey: This is Chris, I’ll say that I’m not sure if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up, for most people, the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s very limited set. The people here in the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind. So there are very limited data points out there.

Mark Whitmore: This is Mark, I would sort of follow up on Chris’s comments. I tend to also be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. And I think that’s a harder thing to make a case for. What I think is incredibly valuable, is how do you explain reality and in essence, the kind of the largest school out there in terms of money management is the efficient market theory, this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups that leads to catastrophic losses. And if investors can simply, instead of, and I remember reading one of the most tortured treatments by Burton Malkiel who wrote the seminal Random Walk Down Wall Street which is sort of like the bible of efficient market theory, and soon after the edition following the 1987 stock market crash where the Dow went down 20% in a day, he attempted to try to explain how this was a rational response to changing monetary conditions, and the market was kind of correctly pricing things all the way along. And you find these things which, I think Chris mentioned earlier simply that Keynesians and the people who look at kind of classical economics and efficient market theory, they can’t explain reality. But the power, the strength of Austrian Economics you can see bubbles when they’re coming. And like Bill, I’ve leaned into the defensive positive in the last few years, so in the short run you might seem to be looking like a fool, but if you can help your investors avoid and maybe even profit from bubbles as they unwind, you’re going to be far better off than the vast majority of investors out there that are just being caught up and are losing 50% of their portfolio in multiple stretches.

Russell: Hey guys, its Russell here, Mark you’ve just made some really great points. And I think I would echo a lot of what you said. I think it’s about creating a coherent perspective of macro-reality, you know there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets, because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality and comparing it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things one is that an Austrian perspective gives you an understanding that you’re not in a free unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be the sense that you are defending your wealth against the plunderers. The second component is that business opportunities can be false, and that’s something that’s embodied in the essence of boom-bust cycles, subsidization, and the principals of Say’s Law, you know expecting consumer markets to boom when in fact you’ve got misallocated productive capital, those consumer markets are not going to perform how you expect. And the flip side of that of course is that you get overestimated business risk, because some people are avoiding sectors that look unattractive when in fact they are fundamentally attractive, particularly if they can exploit state failure. And then finally Hayek spoke about the pretense of knowledge in his famous Nobel acceptance speech, and you know one of the things that none of us, whether you’re an Austrian or not, none of us have the entirety of knowledge that we need to make very precise and accurate calls about the investment world. And that’s one of the reasons why, and it’s spoken about in the book “Austrian School for Investors” but you know you’ve got to start off by exploiting opportunities as an investor that are close to you. That you’re capable of having knowledge about, and that’s why before you invest in public companies and in funds, you probably have to invest in yourself, in your own entrepreneurship or in private equity opportunities that are very close to you and where you have some special knowledge. Because you don’t have any more knowledge then the central planners do either. So I think those are some really key objectives. I think there’s some ethical issues as well but I don’t want to go into that right now, but I do think that when we talk about Austrian Economics being free of value judgment, that’s very much in the theoretical analytical sense. But once you’ve derived conclusions from that, value judgments definitely come to the fore, and I think there’s a strong ethical component that can be informed across a range of asset classes and how you invest and how you go about investing. I’m going to not go into that right now, we can maybe circle back to that a bit later.

FRA: Then Mark Valek, as Russ refers to your co-authored book on the Austrian School for investors, can you provide some insight from that book on these principals?

Mark Valek: Yeah thanks. Just a small supplement here, we thought about this topic very hard and we thought, where potential opportunities lie in Austrian investing and where do potential risks lie in such a discipline. Just a few words on opportunities we’ve heard I think already in that direction. The fact that it’s not read among investors. I think that’s potentially a huge edge, it’s a huge edge in a marketplace where it’s not really a secret, it’s out there, you just have to read it on the internet, go on mises.org or wherever, but most of the people just don’t care or know about this so it’s not read. Second edge knowledge about Austrian business cycle theory we also talked about, but I just want to point out the third edge which we identified and I think Austrians in general are able to understand alternative currencies much better they are able to think about it outside of the money system just as we all think so much about the current system that helps us for instance when bitcoin currency came up, I was not even as a tech guy but just from an Austrian view I was able to pretty fast wrap my head around the basic concepts. And I knew if this thing monetizes then it’s huge financial gain and if it doesn’t well until it does it’s speculation on a potential alternative money, but now I think it’s more clear to the rich investor too, but such thing I think come with an Austrian mindset. On the other hand just also to talk about the risks perhaps for one moment with Austrian investing, generally, and I’m sure all of us know about this potential risk, is a bearish bias is associated to the Austrians. I think that’s because Austrian investors are sensitive to these flaws in the capital structure we already talked about. And they always kind of think perhaps this boom will be bust sooner than later and so on, and we know the problems I think associated with that. Another problem I also touched already is the Austrian School statistic it does not make timing calls. So this is a predictive problem obviously, especially in finance. I think one can circumvent this problem with the help of other techniques from the quantitative side take the analysis, whatever. But strictly speaking from an Austrian School, you don’t get any help regarding the timing problem. Just to mention the last potential risk, Austrians do tend to be very convinced, it’s like what we call potentially a dogmatic bias, and dogmatism is probably a thing where one should be cautious in an investment space. So there are other opportunities, but there’s also risks and one should be aware of these risks and find some ways to manage these risks as an Austrian investor.

FRA: If we could do one more round on bringing it all together and providing some examples of investments or asset classes or perhaps investment strategies that exemplify using the principals of the Austrian School in investing or the outcomes as Chris mentions, of the Austrian School. Let’s do a round based on that to close out. No specific companies or securities, but just generically speaking. Anybody?

Russell: It’s Russell here, maybe I can come in and say one or two things about some of the ethics around investing. I mean, we all have to make decisions about leverage. In the system where debt is created by fractional reserve banks we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course, when you participate in that system, there’s two ways you can look at that. You’re either participating in the bank leverage system as a defense mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage. I think from an Austrian perspective, you would typically favor equity over debt and you would favor non-bank debt over bank debt. The other big ethical question, of course, is to talk about government bonds – financing the state. The state is essentially a mechanism of wealth destruction, you know do you really want to be financing plunder, but in another sense, by funding the state, you’re again, aiding and abetting a fairly large degree of wealth destruction. And ultimately getting your coupon payments in part by being taxed more and your friends and family being taxed more. So one’s got to think about that, some of these issues. And then, we know that Ludwig von Mises was one of the greatest advocates for peace, and anti-war, and you have to think about what firms are doing in terms of financing and funding and equipping governments to fight unjust wars. These are obviously very tricky and murky. And I’m not trying to make any kind of high-brow ethical statements here, I just think that these are the kind of things that have to be considered and Austrians do think a lot about these things. So I just wanted to kind of lay that out there, because ethics and feeling personally good about your investments, not just intellectually, but emotionally as well, I think is an important part of an investment strategy.

Bill: This is Bill, I’d like to just touch on something Russell mentioned, great points by the way, the state has grown immensely around the world subsequent to 2009. And I don’t want to get to far into the metrics we all know what played out in certain parts of the world, I think one of the beauties of the internet and the search for the truth and leading us to the election in the United States for example last year in WikiLeaks, the internet is essentially exposing a lot of the fiction that we’ve all grown up around over the last number of decades. And with that comes almost an awaking, a move to higher consciousness. So people are, I see it every day, I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out. Cryptocurrencies, I’ve spent a lot of time looking at the economic actors within this interesting ecosystem and you think about not being a participant in the plunder if you look at just the banking system and all of the friction within the banking system, let alone the leverage, you’re looking at a couple trillion dollars a year just in general friction that’s being stripped out of the ecosystem. So the movement towards the internet of value as opposed to what we witnessed the last couple of decades, the internet of information knowledge I think is another fascinating innovation playing out. So I think more and more people per Russell’s point, don’t want to participate in the plunder and are actually spending time and capital creating these new economic fabrics and I think it’s quite exciting to witness.

Chris: This is Chris, if we take out the ethical considerations that a couple of my colleagues just mentioned, the question is how Austrian Economics help you when looking at investments from a risk-return standpoint. And I think Mark mentioned this earlier, hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. So maybe in America you want to consider the cannabis space. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value. I’ll also say that I think Austrian Economics lends itself naturally to contrarian investing which I think is a great way to make money. It’s pretty obvious that there’s not a lot of people out there managing money that believe in Austrian Economics. So we hold a key, we understand something that few people embrace or have any kind of knowledge of. And I think that really is a key factor in contrarian investing which really just means you’re looking for extreme market value questions on the high or low side, and identifying the catalysts that will bring that prices back to its historical mean or median. And I think the explanation and conclusions of Austrian Economics do that quite well.

Data Courtesy of the St. Louis Federal Reserve

Mark Whitmore: This is Mark Whitmore, I keep forgetting we have two Mark’s on the line here, and Chris you absolutely interpreted what I was trying to say correctly, and kind of to follow up a little bit, I think one of the things that the other Mark pointed out is the issue of timing, and whereas the two prevailing investing paradigms out there seem to be this notion of efficient market theory which attempts to just buy and hold the market no matter what, completely price indifferent. And that’s really key, is that Austrians I think have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action, if you’re somebody who’s sort of a trend follower, or you’re simply buying and holding, there’s a greater tendency among Austrians to appreciate value. And this point dovetails with the other point as far as since we don’t pretend to know the precise timing of when bubbles kind of unwind or when the busts will finally reach a bottom, the idea is that we can actually be in the right quartile of activity, in other words I never try to catch the very top of a bubble, I don’t try to ride things to the very end, and similarly I don’t mind catching falling knifes. Because as investors if you’re looking at this current contemporary global macroeconomic backdrop from the 10-12 year perspective, I find it with the typical disclosure here that I’m not able to see with a perfect crystal ball or anything but it’s hard to believe that traditional assets, that global equities, will be thriving in this environment just from the simple perspective of how overstretched they are from any reasonable measure of valuation.  And similarly, the global bond market which has been the classic offset to unwinding stocks in the past, is also so stretched.Because just like bond prices are inversely related to interest rates, you have interest rates around the world, I mean you have negative interest rates in Sweden, in Japan, in Switzerland, and back last July you have negative interest rates over a swath of different developed markets so there’s simply not a lot of room basically for bond appreciation. I think it’s a very careless time for equity and bond investors from a longer term perspective whereas those of us who are Austrian have a bend for the idea of real money, sound money, and one of the things that looks pretty attractive in a Ponzi finance global macroeconomic backdrop would be precious metals I would say. And I particularly play in the currency space and one of the thing that’s attractive there is the idea that in eras where you have reckless central banking there’s huge distinction between reckless central bankers and those who are engaged in reckless central banking with abadon and as a result I think that there becomes some real value disparities from a currency standpoint as well. But I mean I think that’s how I at least use Economic principals from the Austrian school to inform overall investing decisions in the marketplace.

FRA: And finally, the other Mark?

Mark Valek: Yeah, I think that most points have been touched seriously. Yeah I just don’t want to drag it out unnecessarily, but I think there were very interesting comments in all kind of directions, really enjoying this discussion, I don’t know if we have anything else on the plate?

FRA: Nope, that’s it. Just wanted to close out with regard to giving everybody a chance to identify how our listeners can learn more about your work, if you have a website or perhaps a newsletter?

Russell Lamberti: Yeah my website, ETM macro advisors website is www.etmmacro.com and I am starting a new newsletter called the macro outsider, and you can sign up for it for free on www.etmmacro.com and you’ll get a free essay called “The real currency war” which is subtitled “monopoly money vs real money” and essentially there I just go into a lot of what we’ve spoken about today in terms of chronic malinvestment, the weakness of fiat currency reserve systems, and then ultimately where I think the real currency war is, which is in centralized vs. decentralized money, and I talk a little bit about cryptocurrencies there as well, so that’s www.etmmacro.com you can sign up for that free newsletter.

Bill Laggner: This is Bill, so Kevin Duffy and I, we manage a couple of funds, long short-biased, I should say long short strategy macro oriented funds, bearing asset, like ball bearing .com, http://www.bearingasset.com/ and then we also write a blog http://www.bearingasset.com/blog and then Kevin and I are on twitter as well, we post some comments from time to time.

Chris Casey: This is Chris Casey with WindRock Wealth Management, we manage money for high net worth individuals. I would encourage anyone that wants to check us out just to visit our website https://windrockwealth.com/ We have our contact information there, we have all of our content, meaning podcasts, articles, blogs etc. That’s been posted since we started the firm and the people can feel free to read more about our philosophy on various issues.

Mark Whitmore: Great, and this is Mark Whitmore in Seattle, I have a website at http://whitmorecapitalmanagement.com there’s a research and article section which has, I do a quarterly newsletter and would be happy to put anyone interested on the mailing list for that, and basically we have a strategic currency fund that is again, informed largely by Austrian Economic principles that I operate. I also will make a plug here for one of my co-panellists, Mark Valek, who has his book “Austrian School for Investors” is essentially that he co-authored is one of the only kind of resources out there that’s an outstanding resource and really well researched and thought out, so I want to complement the fine work you’ve done on that.

FRA: Great, and now Mark Valek

Mark Valek: Thanks so much, thank you if you’re interested the book is on amazon I guess, Austrian School for Investors” our homepage is http://www.incrementum.li/ we’ve got lots of good stuff which is relevant up there, first of June our annual “In gold we Trust” report is going to be published as well. You’ll find that on the homepage as well.

Summary and Transcript by Jacob Dougherty jdougherty@Ryerson.ca

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


04/11/2017 - The Roundtable Insight: 5 Top Money Managers Discuss Austrian School Investing – Now Published

LINK HERE to download the MP3 PODCAST

SUMMARY – also see FULL TRANSCRIPT BELOW

Today we have five panelists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Liechtenstein, Chris Casey from Chicago, Bill Laggner from Dallas, and Mark Whitmore from Seattle.

Chris is the Managing Director of WindRock Wealth Management. He combines a degree in Economics from the University of Illinois with a specialty in the Austrian school of Economics. He advises clients on their investment portfolios in today’s world of significant economics and financial intervention. He’s Also written a number of publications on a number of publications on websites including the Ludwig von Mises Institute, Zero Hedge, Family Business, Casey Research, and Laissez Faire Books. He is a board member of the Economics Development Council with the University of Illinois, a Policy Advisor for The Heartland Institute’s Center on Finance, Insurance, and Real Estate.

Bill is a Co-founder of Bearing Asset Management, he’s a partner with Kevin Duffy that manage the Bearing fund using an Austrian School of Economics lenses in terms of identifying boom-bust cycles, value in the marketplace, bubbles, and distortions created by both fiscal and monetary authorities. He’s a graduate at University of Florida, began his investment industry career in the late 1980s initially as a stockbroker, and then moved to the buy side at fidelity investments. He’s been featured also in Barrons, Reuters, and CFA magazine.

Russ Lamberti is the founder and chief strategist of ETM Macro Advisors. Which provides Macroeconomic intelligence and strategy services to asset managers, family offices, and high net worth individuals. He is the Co-Author of “When Money Destroys Nations”, a book about Zimbabwe’s hyper-inflation, and he’s a contributing author at the mises.org institute.

Mark Valek is a partner investment manager of incrementum, he’s a Chartered Alternative Investment Analyst (CAIA) and has studied business administration and finance at the Vienna University of Economics. From 1999 he worked at Raiffeisen Zentralbank (RZB) as an intern in the Equity Trading division and at the private banking unit of Merrill Lynch in Vienna and Frankfurt. In 2002, he joined Raiffeisen Capital Management and in 2014 he published a book on Austrian Investing. He’s one of the authors of “Austrian School for investors”.

Mark Whitmore is the Principal, Chief Executive Officer of Whitmore Capital. Mark has been managing personal portfolio assets, periodically publishing newsletters and blogs, and providing pro bono financial planning/investment consulting since leaving law in 2002. His specialties are currencies and international economic analysis. He obtained a B.A. in Political Studies from Gordon College, graduated Summa Cum Laude at the University of Washington he earned a Masters of International Studies (MAIS) at the Jackson School and a J.D. from the School of Law.

Austrian School of Economics Explained:

Mark Valek defines some basic points and differences of the Austrian School as: Economics about the behavior of individuals and human action, The Subjective value theory, under consumption of savings is necessary for sound investing and growth, capital structure being key to a sustainable economy, and price mechanic mechanism coordinates the centralized knowledge. Perhaps the most important distinction of Austrian Economics is its view towards the monetary system. Some of these points are inflation being defined as expansion of the money supply and finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory.

He points out that these are the typical differentiating points, but this is by no means a complete list, and you can discuss the differences between the Austrian School and traditional Keynesian theory.

Russell Lamberti thinks that one of the key differentiators from a practical analytical and investment perspective was that the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. He notes that at the microeconomics level, Keynesianism is very similar, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental break down there. He ends the thought by saying in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s why he thinks the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

Chris Casey discusses why Austrian Economics can provide new insight, saying that Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint to create a consistent and sound economic school and economic philosophy. And that’s what really makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

Mark Whitmore adds that specifically, the role of central banking is something that is really distinct from an Austrian perspective vs Keynesianism.  Specifically the asset price inflation that you’ve seen has largely been ignored by Keynesians in the last two bubbles.  Now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to there being really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates meaningfully. And I think that from an Austrian standpoint, this exacerbates this boom-bust cycle which we’ve seen which has been really compressed in terms of time lately versus what has historically been the case. Since the mid to late 90s the amplitude of bubbles to the upside has just been far greater. He highlights Henry Hazlitt’s two points as far as critiques of Keynesianism. The first one being that fundamental flaw in terms of interest, with Keynesians tending to service the visible minority at the cost of the invisible majority and again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, in its view, the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the accuracy of that. And second,the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

How it’s used in past, present and future Economies including how and why the 2007-2008 financial crisis happened:

Bill Laggner says what was interesting was that the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. He also points out that the distortions are epic, and that this won’t end well.

Mark Whitmore chimes in discussing Kurt Rickenbacker’s idea of “Ponzi finance” which is a powerful analytical insight that essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place.Credit can thus becomes increasingly untethered to any kind of historic connectors such as sound collateral. One increasingly witnessed these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic.


 

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

He notes that the curve and amplitude of the line showing the increase in central bank assets seen above is almost exactly the same as the line showing the increase in the S&P 500. He calls this the engine that’s driving what’s been taking place in terms of asset price inflation and ends by calling it highly unstable, and saying again that this will not end well.

Russell Lamberti emphasizes the importance in looking at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. He also discusses this unwritten law against recessions, saying this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. He ends by saying: we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again, I hope we get there soon.

Chris Casey adds that when discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what can not explain the 08 crisis, and that is mainstream economics. And it’s worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the great depression, and he basically said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. “They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call ‘the cluster of error’, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical than say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off.”

The Austrian School Investing, Investments/Asset Classes/Investment Strategies

Bill Laggner discusses how knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, he wrote an article with a colleague called “collateral damage”. And what he found fascinating about writing the article was the Bearing Credit bubble index created back in 2004 when it was pretty obvious that we were segueing into this new bubble. He says: I kept looking at the types of asset backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think  what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle, because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going.

Chris Casey discusses how it’s unclear if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. He goes on to say “They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up for most people the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s a very limited set. The people here on the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind.”

Mark Whitmore also tends to be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. What he think is incredibly valuable is how you explain the efficient market theory; this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups in asset prices that leads to catastrophic losses.

Russell Lamberti thinks it’s about creating a coherent perspective of macro-reality, saying how there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. He goes on to say “I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality to compare it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things: one is that an Austrian perspective gives you an understanding that you’re not in a free, unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be at the sense of you are defending your wealth against the plunderers”.

Mark Valek thinks knowing Austrian Economics provides you with a potentially huge edge. He points out that even though you can read about it online at mises.org or on other websites, many people don’t care enough or are not aware of it. He thinks another large edge is that Austrian Economists in general are able to understand alternative currencies much better. They are able to think about it outside of the money system just as we all think so much about the current system, that helps us for instance when bitcoin currency came up. So knowledge of Austrian Economics can provide a good investing edge sometimes in an indirect way as long as it’s utilized properly. He also discusses the potential weaknesses of using the Austrian system, saying that strictly speaking from an Austrian School, you don’t get any help regarding the timing of when we would expect to happen, however, you can still use other theories to help with that aspect.  The last potential risk he discusses is that Austrians have a dogmatic bias and tend to be very cautious in an investment space.

Ethical Issues:

Russell Lamberti points out that “We all have to make a decision about leverage. In a system where debt is created by fractional reserve banks, we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course when you participate in that system, there’s two ways you can look at that. You’re ether participating in the bank and leverage system as a defence mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage.” Bill Laggner agrees and adds “I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out”.

How Austrian Economics help you when looking at investments from a risk-return standpoint:

Chris Casey recalls what Mark Whitmore pointed out and added “hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value.”

Mark Whitmore adds “this notion of efficient market theory which attempts to just buy and hold the market no matter what, being completely price indifferent is clearly suboptimal. And that’s really key, as that Austrians, I think, have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action if you’re somebody who’s sort of a trend follower or you’re simply buying and holding, there’s a greater tendency among Austrian investors to appreciate value.”

Websites and other information on the panelists:

Russell Lamberti: www.etmmacro.com where you can sign up for a free newsletter called “The Macro Outsider”: http://etmmacro.com/the-macro-outsider/

Bill Laggner: http://www.bearingasset.com/ and a blog at http://www.bearingasset.com/blog

Chris Casey: https://windrockwealth.com/ includes podcasts, articles, blogs and more

Mark Whitmore: http://whitmorecapitalmanagement.com includes a quarterly newsletter

Mark Valek: http://www.incrementum.li/ and he has a book called Austrian School for Investors” available on amazon.

 

Abstract:

Austrian Economics takes into account the behavior of man, and has different views than traditional economic theories on monetary policy, and differs from Keynesian economics greatly on the macro level. It can also be used to identify when there is too much debt and when bubbles are in danger of bursting. Austrian Economics can be very useful for observing the overall behavior of the economy and can often help an investor make more informed decisions.

FULL TRANSCRIPT

FRA: Hi, Welcome to FRA’s Roundtable Insight. Today we have a special treat for our listeners, it’s a discussion on the principals of the Austrian School of Economics and how those principals can be used in investing. Today we have five panellists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Lichtenstein, Chris Casey from Chicago, Bill Laggner form Dallas, and Mark Whitmore from Seattle.

Welcome Gentlemen

So I thought we’d have a discussion initially about what exactly is the Austrian School of Economics and how does this school of economics differ from other schools such as the Keynesian School of economics. Mark Valek, would you like to begin?

Mark Valek: I’d love to, thanks for having me, very excited to discuss basically an economic school which is from Vienna, my hometown, unfortunately Vienna, in the University doesn’t really teach Austrian Economics anymore. However, I think the topic of the Austrian School is a big one, one can talk for hours on end on how it differs, we actually tried to make the Austrian School to list the 11 of 10 bullet points, we came up with an 11th one so we could describe the Austrian school in 11 bullet points. And this is by no means a complete observational but just some basic concepts we put together, we refer to them:

  • Economics is about behavior of individuals, it’s basically about human action
  • They can point human innovation and entrepreneurial action of a source of wealth creation
  • Private property is preconditioned for sensible resource allocation
  • Trading is mutually beneficial (The Subjective value theory. Theory of Value)
  • Another point would be under consumption of savings is necessary for sound investing and growth
  • Also, very important point I think which differentiates the Austrian school is its view towards capital structure. So capital structure is key to a sustainable economy. Thinking about Hayek‘s triangle for the guys who know what I’m talking about here.
  • And price mechanic mechanism coordinates the centralized knowledge.

So these were some basic, basic concepts and they are not only found in the Austrian School, perhaps what does differ more is the view towards the monetary system. And I just want to add 3 or 4 points regarding the Austrian view on the monetary system:

  • Inflation, for instance, is defined as expansion of money supply, something very central to Austrian Economists
  • Inflationary monetary systems chronically transfer wealth, I’m talking about the Cantillon effect, something I think the other schools really don’t talk about at length and it’s something very interesting for society also these days.
  • And finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory

So these are perhaps the more typically differentiating points, especially from the Austrians, but this list is by no means complete, just a few thoughts perhaps to put on a discussion.

FRA: And Russ you’re perspective on the Austrian School of Economics

Russell Lamberti: Yeah, well everything Mark said was valid, I would, you know at a high level I think that one of the key differentiators from a practical analytical and investment perspective was that, the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. In fact strictly speaking the Austrians wouldn’t differentiate between the two, whereas what you see in Keynesian and monetarist schools is that they have relatively sound microeconomic principals, although they do still differ with the Austrians in one or two key areas, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental breakdown there, Austrians are far more consistent there, I think part of the sense of that is also that the Austrians school derives its lineage from the classical schools of the 1700 and 1800s. And I think we must never forget that because a very key distinction in macroeconomics, a very key departure point between the different schools of thought is what’s known as Say’s law of markets. And you know Say’s law essentially is probably a poorly named concept because Jean-Baptiste Say was not necessarily the best articulator of Say’s law. But nonetheless, Say’s law essentially says that you know, properly allocated production, production that is sustainable is ultimately what finances the ability to demand. You know, and I think that in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s I think why the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

FRA: And Chris, your thoughts?

Chris Casey: Well the Austrian school certainly has a number of conclusions in Macroeconomic explanations that my colleagues have discussed, but if you boil it down and ask the true question as far as what makes Austrian Economics different I’m reminded of Ayn Randwhen she was describing, or criticizing I should say, other philosophiess and philosophers. And I remember her comment I forget which writing it was, it was something to the effect of: these philosophies have excluded man from their theories, and in so doing it’s no different than, let’s say, an astrophysicist that has no concept of gravity or a doctor that has no concept of germ theory. And the same could be said with other economic philosophies. Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint, create a consistent and sound economic school and economic philosophy. And that’s what really, I think, makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

FRA: And Bill, your perspective on the Austrian School?

Bill: Well, look I think everyone here has covered quite a bit of the main points, I would add that the world we’re living in today where we’re very far from any Austrian practices, you cannot have a healthy economy without savings, and by artificially setting the interest rate through central banking, you set in motion numerous distortions. And I think everyone at this table would agree that we’re living at a time where the distortions have never been greater. We have nothing resembling a natural rate anywhere around the world as far as I know. And so what’s happening is your setting in motion layers and layers of malinvestment and then every time there’s a crisis in the Keynesian way of looking at things, they come to the rescue and try and either bail something out through monetary or fiscal policy and/or socialize it directly or indirectly. And I would say we’re living in a time today where so much of the credit expansion that we’ve witnessed especially coming out of the great financial crisis in 2008-2009 is a function of either zero or negative interest rates and/or socializing some aspect of credit that’s entered the economy, and when you have that, clearly there’s no feedback loop. There’s no clear natural feedback loop you have a very distorted picture of things, and I think what makes today’s investing environment very challenging.

FRA: and Mark Whitmore, your thoughts on the Austrian school?

Mark Whitmore: Well, batting clean-up here is a little tough, because as Bill mentioned, I think that people have really nicely covered a lot of the main, sort of theoretical tenants of Austrian Economics, I guess I would add that specifically the role of central banking is something that I think is really distinct from an Austrian perspective vs Keynesianism, specifically the asset price inflation that you’ve seen has largely been ignored specifically in the last two bubbles, and now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to well there’s really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates. And I think that from an Austrian standpoint exacerbates this boom-bust cycle which we’ve seen really compressed in terms of time verses what has historically been the case since maybe the mid to late 90s and the amplitude of bubbles to the upside has just been far greater. And I guess I would just add Henry Hazlitt’s kind of 2 points as far as critiques of Keynesianism. The first  fundamental flaws being that it highlights in terms of interest, the visible minority at the cost of the invisible majority.And again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, you know, in its view the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the efficacy of that. And second of all, the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

FRA: Great, let’s move to a discussion on how the Austrian School of economics is helpful in understanding how and why the 2007-2008 financial crisis happened. And then sort of in parallel to that, what is the Austrian School saying today about the global economy, are there any trends or outcomes that could be identified using the Austrian school. Just general question opened to the floor. Anybody?

Bill Laggner: This is Bill, I would say that all of the Austrians I’m sure on this call saw the crisis building coming out of the reflation right after the tech bubble that burst. It was interesting, the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course I think it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. I think distortions are epic, I think we’re living in a fascinating time. It’s not going to end well, but I think along the way, there has been a continuation of decentralization, innovation, that’s the positive that I think we’re seeing today is as well, that’s just the natural order of the entrepreneurs and the ecosystem, they’re up.

Mark Whitmore: This is Mark chiming in here, I would say that in terms of leading up to the Global Financial Crisis I feel tremendously bad for Kurt Rickenbacker.  He was I think a really fine economist, informed by sort of the Austrian School perspective and he had done a great job identifying the perils of the tech bubble that I think Bill mentioned, a lot of us who are Austrians saw coming, and died right before the bursting of the second bubble.  And what he had talked about is this notion of “Ponzi finance” that I think is good analytical insight that Hayak also talks about which is essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place, and this credit can become increasingly untether any kind of historic connectors to things such as sound collateral and whatnot you saw increasingly these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic, there’s one slide that I drew up which essentially overlays the growth of S&P 500 with the growth of central bank assets in Japan, the Eurozone, and the United States.

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

The assets of these central banks have been expanded a little bit more jagged but the curve, the direction and amplitude of the line is almost exactly the same and so you see this again, unsustainable credit fueled engine that’s driving what’s been taking place in terms of asset price inflation.It’s just highly unstable, and again this will not end well.

Russell Lamberti: Hey it’s Russ, I just wanted to chime in on what Bill had mentioned, I think it’s really critical to look at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. There’s basically been since, I don’t know how long, maybe it was the Greenspan era that essentially ushered us in. But there’s essentially an unwritten law against recessions. And this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. But of course, as Bill rightly says, you have the countervailing forces of progress constantly working, the market is constantly trying to figure out how to make the best of its present reality and its present situations. This is why I think you have inherent paradoxes when you look at these big cycles, because there is so much to be bearish about, and yet there’s also a lot to be bullish about, and I guess that’s the essence and the nature of risk and opportunity. You know Mark Thornton once mentioned that Murry Rothbard used to say he was permanently bearish about the short term and permanently bullish about the long term. And I think that it’s an aphorism, but it kind of speaks to this notion that state intervention can really mess up markets and financial markets in the short term. But over time the power of the free market and of private enterprise is extremely pervasive and eventually seems to win out at the end of the day. Of course in the interim what that means is that because you have such disinflationary forces because of private enterprise and technology, it kind of emboldens the policymakers to run these bubbles longer and larger than they should be, so no question that the last two bubbles have been a symptom of these kind of policies, and I agree, we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again. I hope we get there soon.

Chris: This is Chris, I’ll just add that in discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what does not explain the 08 crisis, and that is mainstream economics. Whether it’s so-called Chicago or Keynesian schools. And it’s probably worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the Great Depression, and he basically said “We’re never going to have a significant recession again.” I believe he said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call “the cluster of error”, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical then say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off. The response by the government and central banks should be to not re-inflate the money supply, do not create bailouts, not have deficits which only will spur consumer spending at the expense of savings. So if that’s the antidote for recessions, the governments since the 08 crisis has done the exact opposite and it’s simply set up the economy for far, far greater downturn then what we even experienced (in 2008), with the possibility of significant inflation. So the 08 crisis gives great lessons and basically proves out the Austrian theory, the business cycle. And it really demonstrates errors and issues with other explanations from other economic schools of thought.

FRA: and Mark Valek, any thoughts on applying the Austrian school to the financial crisis and where we’re potentially heading today and the Global economy?

Mark Valek: Definitely some thoughts, very short though because again, a lot has been said already. Where are we going in the Global Economy? Providing you have the Austrian perspective as we all obviously have, you actually know that there are significantly high (inaudible) to the capital structure, and this is not a sustainable state. But there lies the problem for investing obviously, the timing question, but sooner or later this state of capital structure will not last, it’s absolutely not sustainable. Just on a side note, as an asset manager, I encounter sustainability so many times a year, it’s kind of a hyperinflated world, everybody wants to invest sustainably and what bugs me that is nobody things about if our, for instance, monetary system is sustainable, and I would argue against it. So this is to me, really a very superficial discussion here. However, I think if this cleansing process starts the next time, we will probably will not see the big fear we saw the last time, which was basically the fear of deflation of debt deflation if you want to call it, like debt. I think the authorities have proven that they just will not let this happen so market participants probably are not going to have fear that will be too little money going around or being printed, but perhaps we’ll start to fear that this is going to be an overdose the next time, and I think as soon as this psychology changes, you have (Inaudible) things like price inflation look much more realistic in such an environment if you ask me.

FRA: Great insight, and so given this view of applying the Austrian school to the economics environment, if we can consider that as far as the investment environment, does it make sense to look at the principals of the Austrian school in investing, I mean, we see some of the principals, of being stores of value, indirect exchange method, meaning exchanging fiat currency for investments that are real assets that provide cash flows, investments with little or no debt, high free discounted cash flows as well. Little or no leverage, also scarcity in innovative industries, and then perhaps cryptocurrencies that are outside of the banking system but are still regulated within the financial system. So does it make sense to apply those principals in investing, and what are those principals? Also, are there any empirical studies or analysis that taking this approach can provide an edge or an enhanced investment management performance? This question is for the floor.

Bill Laggner: This is Bill, I could say I think knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, I wrote an article with a colleague called “collateral damage”. And what was fascinating about writing the article was we had created the Bearing Credit bubble index back in 2004 when it was pretty obvious that we were segueing into this new bubble, and I kept looking at the types of asset-backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage-backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going. So ultimately I think you know gold, we own a lot of gold, we’ve owned gold since 2002, I mean gold will continue to act well, and may become one of the best performing asset classes over the next several years until we ether get some kind of boom or something close to it. So that’s how it’s helped us and how we employ it in day to day portfolio management.

Chris Casey: This is Chris, I’ll say that I’m not sure if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up, for most people, the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s very limited set. The people here in the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind. So there are very limited data points out there.

Mark Whitmore: This is Mark, I would sort of follow up on Chris’s comments. I tend to also be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. And I think that’s a harder thing to make a case for. What I think is incredibly valuable, is how do you explain reality and in essence, the kind of the largest school out there in terms of money management is the efficient market theory, this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups that leads to catastrophic losses. And if investors can simply, instead of, and I remember reading one of the most tortured treatments by Burton Malkiel who wrote the seminal Random Walk Down Wall Street which is sort of like the bible of efficient market theory, and soon after the edition following the 1987 stock market crash where the Dow went down 20% in a day, he attempted to try to explain how this was a rational response to changing monetary conditions, and the market was kind of correctly pricing things all the way along. And you find these things which, I think Chris mentioned earlier simply that Keynesians and the people who look at kind of classical economics and efficient market theory, they can’t explain reality. But the power, the strength of Austrian Economics you can see bubbles when they’re coming. And like Bill, I’ve leaned into the defensive positive in the last few years, so in the short run you might seem to be looking like a fool, but if you can help your investors avoid and maybe even profit from bubbles as they unwind, you’re going to be far better off than the vast majority of investors out there that are just being caught up and are losing 50% of their portfolio in multiple stretches.

Russell: Hey guys, its Russell here, Mark you’ve just made some really great points. And I think I would echo a lot of what you said. I think it’s about creating a coherent perspective of macro-reality, you know there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets, because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality and comparing it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things one is that an Austrian perspective gives you an understanding that you’re not in a free unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be the sense that you are defending your wealth against the plunderers. The second component is that business opportunities can be false, and that’s something that’s embodied in the essence of boom-bust cycles, subsidization, and the principals of Say’s Law, you know expecting consumer markets to boom when in fact you’ve got misallocated productive capital, those consumer markets are not going to perform how you expect. And the flip side of that of course is that you get overestimated business risk, because some people are avoiding sectors that look unattractive when in fact they are fundamentally attractive, particularly if they can exploit state failure. And then finally Hayek spoke about the pretense of knowledge in his famous Nobel acceptance speech, and you know one of the things that none of us, whether you’re an Austrian or not, none of us have the entirety of knowledge that we need to make very precise and accurate calls about the investment world. And that’s one of the reasons why, and it’s spoken about in the book “Austrian School for Investors” but you know you’ve got to start off by exploiting opportunities as an investor that are close to you. That you’re capable of having knowledge about, and that’s why before you invest in public companies and in funds, you probably have to invest in yourself, in your own entrepreneurship or in private equity opportunities that are very close to you and where you have some special knowledge. Because you don’t have any more knowledge then the central planners do either. So I think those are some really key objectives. I think there’s some ethical issues as well but I don’t want to go into that right now, but I do think that when we talk about Austrian Economics being free of value judgment, that’s very much in the theoretical analytical sense. But once you’ve derived conclusions from that, value judgments definitely come to the fore, and I think there’s a strong ethical component that can be informed across a range of asset classes and how you invest and how you go about investing. I’m going to not go into that right now, we can maybe circle back to that a bit later.

FRA: Then Mark Valek, as Russ refers to your co-authored book on the Austrian School for investors, can you provide some insight from that book on these principals?

Mark Valek: Yeah thanks. Just a small supplement here, we thought about this topic very hard and we thought, where potential opportunities lie in Austrian investing and where do potential risks lie in such a discipline. Just a few words on opportunities we’ve heard I think already in that direction. The fact that it’s not read among investors. I think that’s potentially a huge edge, it’s a huge edge in a marketplace where it’s not really a secret, it’s out there, you just have to read it on the internet, go on mises.org or wherever, but most of the people just don’t care or know about this so it’s not read. Second edge knowledge about Austrian business cycle theory we also talked about, but I just want to point out the third edge which we identified and I think Austrians in general are able to understand alternative currencies much better they are able to think about it outside of the money system just as we all think so much about the current system that helps us for instance when bitcoin currency came up, I was not even as a tech guy but just from an Austrian view I was able to pretty fast wrap my head around the basic concepts. And I knew if this thing monetizes then it’s huge financial gain and if it doesn’t well until it does it’s speculation on a potential alternative money, but now I think it’s more clear to the rich investor too, but such thing I think come with an Austrian mindset. On the other hand just also to talk about the risks perhaps for one moment with Austrian investing, generally, and I’m sure all of us know about this potential risk, is a bearish bias is associated to the Austrians. I think that’s because Austrian investors are sensitive to these flaws in the capital structure we already talked about. And they always kind of think perhaps this boom will be bust sooner than later and so on, and we know the problems I think associated with that. Another problem I also touched already is the Austrian School statistic it does not make timing calls. So this is a predictive problem obviously, especially in finance. I think one can circumvent this problem with the help of other techniques from the quantitative side take the analysis, whatever. But strictly speaking from an Austrian School, you don’t get any help regarding the timing problem. Just to mention the last potential risk, Austrians do tend to be very convinced, it’s like what we call potentially a dogmatic bias, and dogmatism is probably a thing where one should be cautious in an investment space. So there are other opportunities, but there’s also risks and one should be aware of these risks and find some ways to manage these risks as an Austrian investor.

FRA: If we could do one more round on bringing it all together and providing some examples of investments or asset classes or perhaps investment strategies that exemplify using the principals of the Austrian School in investing or the outcomes as Chris mentions, of the Austrian School. Let’s do a round based on that to close out. No specific companies or securities, but just generically speaking. Anybody?

Russell: It’s Russell here, maybe I can come in and say one or two things about some of the ethics around investing. I mean, we all have to make decisions about leverage. In the system where debt is created by fractional reserve banks we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course, when you participate in that system, there’s two ways you can look at that. You’re either participating in the bank leverage system as a defense mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage. I think from an Austrian perspective, you would typically favor equity over debt and you would favor non-bank debt over bank debt. The other big ethical question, of course, is to talk about government bonds – financing the state. The state is essentially a mechanism of wealth destruction, you know do you really want to be financing plunder, but in another sense, by funding the state, you’re again, aiding and abetting a fairly large degree of wealth destruction. And ultimately getting your coupon payments in part by being taxed more and your friends and family being taxed more. So one’s got to think about that, some of these issues. And then, we know that Ludwig von Mises was one of the greatest advocates for peace, and anti-war, and you have to think about what firms are doing in terms of financing and funding and equipping governments to fight unjust wars. These are obviously very tricky and murky. And I’m not trying to make any kind of high-brow ethical statements here, I just think that these are the kind of things that have to be considered and Austrians do think a lot about these things. So I just wanted to kind of lay that out there, because ethics and feeling personally good about your investments, not just intellectually, but emotionally as well, I think is an important part of an investment strategy.

Bill: This is Bill, I’d like to just touch on something Russell mentioned, great points by the way, the state has grown immensely around the world subsequent to 2009. And I don’t want to get to far into the metrics we all know what played out in certain parts of the world, I think one of the beauties of the internet and the search for the truth and leading us to the election in the United States for example last year in WikiLeaks, the internet is essentially exposing a lot of the fiction that we’ve all grown up around over the last number of decades. And with that comes almost an awaking, a move to higher consciousness. So people are, I see it every day, I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out. Cryptocurrencies, I’ve spent a lot of time looking at the economic actors within this interesting ecosystem and you think about not being a participant in the plunder if you look at just the banking system and all of the friction within the banking system, let alone the leverage, you’re looking at a couple trillion dollars a year just in general friction that’s being stripped out of the ecosystem. So the movement towards the internet of value as opposed to what we witnessed the last couple of decades, the internet of information knowledge I think is another fascinating innovation playing out. So I think more and more people per Russell’s point, don’t want to participate in the plunder and are actually spending time and capital creating these new economic fabrics and I think it’s quite exciting to witness.

Chris: This is Chris, if we take out the ethical considerations that a couple of my colleagues just mentioned, the question is how Austrian Economics help you when looking at investments from a risk-return standpoint. And I think Mark mentioned this earlier, hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. So maybe in America you want to consider the cannabis space. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value. I’ll also say that I think Austrian Economics lends itself naturally to contrarian investing which I think is a great way to make money. It’s pretty obvious that there’s not a lot of people out there managing money that believe in Austrian Economics. So we hold a key, we understand something that few people embrace or have any kind of knowledge of. And I think that really is a key factor in contrarian investing which really just means you’re looking for extreme market value questions on the high or low side, and identifying the catalysts that will bring that prices back to its historical mean or median. And I think the explanation and conclusions of Austrian Economics do that quite well.

Data Courtesy of the St. Louis Federal Reserve

Mark Whitmore: This is Mark Whitmore, I keep forgetting we have two Mark’s on the line here, and Chris you absolutely interpreted what I was trying to say correctly, and kind of to follow up a little bit, I think one of the things that the other Mark pointed out is the issue of timing, and whereas the two prevailing investing paradigms out there seem to be this notion of efficient market theory which attempts to just buy and hold the market no matter what, completely price indifferent. And that’s really key, is that Austrians I think have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action, if you’re somebody who’s sort of a trend follower, or you’re simply buying and holding, there’s a greater tendency among Austrians to appreciate value. And this point dovetails with the other point as far as since we don’t pretend to know the precise timing of when bubbles kind of unwind or when the busts will finally reach a bottom, the idea is that we can actually be in the right quartile of activity, in other words I never try to catch the very top of a bubble, I don’t try to ride things to the very end, and similarly I don’t mind catching falling knifes. Because as investors if you’re looking at this current contemporary global macroeconomic backdrop from the 10-12 year perspective, I find it with the typical disclosure here that I’m not able to see with a perfect crystal ball or anything but it’s hard to believe that traditional assets, that global equities, will be thriving in this environment just from the simple perspective of how overstretched they are from any reasonable measure of valuation.  And similarly, the global bond market which has been the classic offset to unwinding stocks in the past, is also so stretched.Because just like bond prices are inversely related to interest rates, you have interest rates around the world, I mean you have negative interest rates in Sweden, in Japan, in Switzerland, and back last July you have negative interest rates over a swath of different developed markets so there’s simply not a lot of room basically for bond appreciation. I think it’s a very careless time for equity and bond investors from a longer term perspective whereas those of us who are Austrian have a bend for the idea of real money, sound money, and one of the things that looks pretty attractive in a Ponzi finance global macroeconomic backdrop would be precious metals I would say. And I particularly play in the currency space and one of the thing that’s attractive there is the idea that in eras where you have reckless central banking there’s huge distinction between reckless central bankers and those who are engaged in reckless central banking with abadon and as a result I think that there becomes some real value disparities from a currency standpoint as well. But I mean I think that’s how I at least use Economic principals from the Austrian school to inform overall investing decisions in the marketplace.

FRA: And finally, the other Mark?

Mark Valek: Yeah, I think that most points have been touched seriously. Yeah I just don’t want to drag it out unnecessarily, but I think there were very interesting comments in all kind of directions, really enjoying this discussion, I don’t know if we have anything else on the plate?

FRA: Nope, that’s it. Just wanted to close out with regard to giving everybody a chance to identify how our listeners can learn more about your work, if you have a website or perhaps a newsletter?

Russell Lamberti: Yeah my website, ETM macro advisors website is www.etmmacro.com and I am starting a new newsletter called the macro outsider, and you can sign up for it for free on www.etmmacro.com and you’ll get a free essay called “The real currency war” which is subtitled “monopoly money vs real money” and essentially there I just go into a lot of what we’ve spoken about today in terms of chronic malinvestment, the weakness of fiat currency reserve systems, and then ultimately where I think the real currency war is, which is in centralized vs. decentralized money, and I talk a little bit about cryptocurrencies there as well, so that’s www.etmmacro.com you can sign up for that free newsletter.

Bill Laggner: This is Bill, so Kevin Duffy and I, we manage a couple of funds, long short-biased, I should say long short strategy macro oriented funds, bearing asset, like ball bearing .com, http://www.bearingasset.com/ and then we also write a blog http://www.bearingasset.com/blog and then Kevin and I are on twitter as well, we post some comments from time to time.

Chris Casey: This is Chris Casey with WindRock Wealth Management, we manage money for high net worth individuals. I would encourage anyone that wants to check us out just to visit our website https://windrockwealth.com/ We have our contact information there, we have all of our content, meaning podcasts, articles, blogs etc. That’s been posted since we started the firm and the people can feel free to read more about our philosophy on various issues.

Mark Whitmore: Great, and this is Mark Whitmore in Seattle, I have a website at http://whitmorecapitalmanagement.com there’s a research and article section which has, I do a quarterly newsletter and would be happy to put anyone interested on the mailing list for that, and basically we have a strategic currency fund that is again, informed largely by Austrian Economic principles that I operate. I also will make a plug here for one of my co-panellists, Mark Valek, who has his book “Austrian School for Investors” is essentially that he co-authored is one of the only kind of resources out there that’s an outstanding resource and really well researched and thought out, so I want to complement the fine work you’ve done on that.

FRA: Great, and now Mark Valek

Mark Valek: Thanks so much, thank you if you’re interested the book is on amazon I guess, Austrian School for Investors” our homepage is http://www.incrementum.li/ we’ve got lots of good stuff which is relevant up there, first of June our annual “In gold we Trust” report is going to be published as well. You’ll find that on the homepage as well.

Summary and Transcript by Jacob Dougherty jdougherty@Ryerson.ca

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


04/07/2017 - The Roundtable Insight (Full Version) – Yra Harris, Peter Boockvar and Uli Kortsch On Central Bank Distortions

FRA is joined by Yra Harris, Peter Boockvar, and Uli Kortsch in discussing central bank distortions, global currency trends, along with protectionism and infrastructure spending in the US.

Yra Harris is a recognized Trader with over 40 years of experience in all areas of commodity trading, with broad expertise in cash currency markets. He has a proven track record of successful trading through a combination of technical work and fundamental analysis of global trends; historically based analysis on global hot money flows. He is recognized by peers as an authority on foreign currency. In addition to this he has specific measurable achievements as a member of the Board of the Chicago Mercantile Exchange (CME). Yra Harris is a Registered Commodity Trading Advisor, Registered Floor Broker and a Registered Pool Operator. He is a regular guest analysis on Currency & Global Interest Markets on Bloomberg and CNBC.

Yra highly recommends reading The Rotten Heart of Europe – send an email to rottenheartofeurope@gmail.com to order

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Prior to joining The Lindsey Group, Peter spent a brief time at Omega Advisors, a New York based hedge fund, as a macro analyst and portfolio manager. Before this, he was an employee and partner at Miller Tabak + Co for 18 years where he was recently the equity strategist and a portfolio manager with Miller Tabak Advisors. He joined Donaldson, Lufkin and Jenrette in 1992 in their corporate bond research department as a junior analyst. He is also president of OCLI, LLC and OCLI2, LLC, farmland real estate investment funds. He is a CNBC contributor and appears regularly on their network. Peter graduated Magna Cum Laude with a B.B.A. in Finance from George Washington University. Check out Peter’s new newsletter service at www.boockreport.com.

Uli Kortsch is the Founder of both the Monetary Trust Initiative (MTI) and Global Partners Investments (GPI).  Currently most of his time is spent on MTI whose mission is to bring transparency and authentic principles to our monetary system. As President of Global Partners Investments and other ventures, he has worked in over 50 countries, written a bill for Congress, and conferred with approximately 15 national presidents, ministers of finance, and ministers of commerce.  He has served on numerous corporate boards with both for-profit and not-for-profit organizations.

EFFECTS ON THE EQUITY MARKET

The Swiss National Bank (SNB) has been printing money to buy equities for years now. They have interest rates that are deeply negative, all because they’re afraid of the negative economic impact of a stronger Swiss Franc against the Euro. But the SNB is about to get lucky because the ECB has decided it’s time to take a step back from their policies. Maybe it’ll be a time out with respect to the Swiss and what they’ve done fighting tooth and nail to prevent a rally in the Swiss Franc. They have become one of the largest shareholders of a lot of companies, what with all the money they’ve printed trying to find a home somewhere. They’ve essentially become their own S&P500 fund and are behaving like a hedge fund overall .. like a sovereign wealth fund, but unlike Norway or Singapore, the only thing the Swiss mine is a printing press.

If you look at what the world is doing – basically trying to weaken their own currencies – we’re taking the wealth of the country and moving it to exporters. Everyone loses since the currency that we hold has a certain value with respect to the rest of the world when it comes to imports. The exporters aren’t just corporations, they’re also workers. What is the gain verses the loss on a national average?

The concept of weakening one’s currency is tremendously mistaken. We only have to look at Japan and see their experiment of weakening their currency since 2013. The ideal currency is a stable one.

If you drive your currency lower, your consumers are going to be losers, especially if you’re buying a lot of imports, because the prices of your imports are going to go up. This is a discussion that’s also plaguing Germany. It’s an established policy that they promote exports and keep a low currency, which burdens the purchase of imported goods around the world.

If China were to move to a consumer based economy, they would do better with a stronger currency. That’s why the Yuan is such an important denominator in what China wants to do. If they’re making the shift to a much more domestically oriented economy to soak up all that excess capacity, they should promote a stronger currency as that would be better for their consumers.

THE EFFECT ON THE US DOLLAR

Trade flows are only a small percentage of the daily moves in currencies. The foreign currency market is $5T in debt, so what’s $500B of a trade deficit in the US? Nothing. What’s going to drive the dollar is real interest rates, not nominal interest rates. The Fed started raising rates in Dec 2015, and the 5yr real rate is +50 basis points. Here we are, three hikes later, and it’s -19 basis points. Anyone who looks at nominal rates is not really looking under the hood, and it’s the steep decline in real rates that’s what’s kept a lid on the Dollar, which is at a level that’s no different than where it was a couple of years ago. Look at everything that’s been thrown at other currencies. These currencies have stop going down. It says a lot about the flaws of the Dollar and the impact that negative real interest rates have, notwithstanding the rise in the Fed funds rate. Real rates in the US are negative, and that will bear on the currency.

If you’ve been a saver-investor for the last five years, it’s very difficult to find a way to protect yourself in this environment. If you put your money into two year US Treasuries, with negative nominal real rates, you’re losing money. And that’s where their safety zone is. There is about $11-12T sitting in zero interest rate bearing savings accounts. At a 1% yield, that’s $100B extra of interest income. Multiply that by 8 years of zero interest rates, and you’re talking savers that have been deprived of almost $1T through this monetary policy the Fed said would promote growth.

It’s always a policy where someone gets paid and someone suffers. In the world we live in, savers have been punished and borrowers have been rewarded. With QE it’s the ultra-rich that gained tremendously from the rise in asset prices.  The political left which complains about capitalism is the source of the problem. They’re driving asset prices through the roof.

EFFECT ON THE BALANCE SHEET

We’re up to the point where the Fed funds rate was historically 200-300 basis points above the rate of inflation. If inflation was at 2% right now, historically the Fed funds rate would be 4-5%. The problem is that with the enormous amount of leverage built up in the financial system, getting to that Fed funds rate would literally blow up the system. So the question now is, where should the Fed funds rate be in light of that? Let’s just get it to a 0 real interest rate, so we have a 2% Fed funds rate. Right now they’re at 0.875%. One of the rules of the central banks is that you don’t wait until after you get to your supposed mandate targets to then start normalizing interest rates, you should be at normalized interest rates when you get to your target. So it’s clear the Fed is well behind the curve. It’s only in the halls of academia that “neutral interest rates” exist, and it’s their way of rationalizing this very slow growth in interest rates. They waited for the perfect world to end QE and raise interest rates, but none of that exists so now they’re playing catch up.

They want to slowly raise interest rates and keep everyone calm, but that means they are getting behind the curve. Then they want to shrink their balance sheets to not be disruptive, and normalize interest rates at the same time they created another credit bubble. If the Fed announced that they were going to actively shrink their balance sheet, and think the market won’t punish them, they don’t know how the market works.

Let’s say we start unwinding the balance sheet. That curve ought to straighten out quite a bit on paper, with one large buyer exiting the market on top of foreigners who are net sellers of US Treasuries. If people start worrying about what this will do to the stock market, do we then get an actual flattening of the curve instead because everyone is freaked out about growth? If this curve does not steepen, it’ll be a signal that there are many other things afoot here.

THE AUTO SECTOR

The auto sector was a main driver of growth post-recession, and it’s interest rate credit sensitive, second only to housing. Look what’s happening in the auto sector. This is another sequel called boom and bust, and it’s written and directed by easy money. We now have the Fed who may continue to shrink their balance sheet – at the same time a major driver of growth is now rolling over. The auto sector itself can’t necessarily put us into recession, but the ripple effects could be extraordinary. 45% of all jobs touch the auto sector in some way, and this is a big canary in the coal mine.

We’re not only at high auto sales but also record repossession of autos. It’s a classic case of intertemporal misallocation. Through the use of credit, they keep borrowing all this demand from the future and the future is now.

INFRASTRUCTURE AND UNEMPLOYMENT

Especially now, when labour is especially tight, who are you going to find to build that bridge? All those construction workers are building other things, so it’s just a transfer of resources. The infrastructure will ultimately create more productivity.

Our reliance on U3 numbers is really inappropriate in today’s economy. The appropriate number is U6, which includes people who would like to get a job who have not actively looked for a job over the last four weeks and the people with part time jobs. Thirty years ago we lived in a U3 economy where people had steady, stable jobs and you were employed by someone full time. We don’t live in that world anymore.

Since 2007, U6 has not dropped. It’s been around 10%. Things are better than they were a few years ago, but there’s still a huge percentage who are not participating for one reason or another. Right now it’s about 9.2%. The average since the 90s is over 10%, so even though the U6 is very high, it’s not out of the ordinary.

US NOTES FOR INFRASTRUCTURE

Uli’s proposal .. create US Notes for infrastructure spending .. They are not part of the debt limitation legislation and create no real debt. They are no interest bearing, non-repayable, and are created by Treasury and transferred into the Treasury account at the Fed, which creates no inflation whatsoever as long as it stays at the Fed. Once they’re in circulation they’re no different from any other US Dollar, it’s just the way they’re created is radically different. Our Fed notes are created through debt where US notes are driven by value.

Most of the spending is on the state level. The point is to use federal US Notes to fund states and municipalities on a debt free interest free basis. The $300B Obama infrastructure bill is all debt based money. All of that money increases the $20T total output in Treasuries, whether they’re owed internally or not.

There’s nothing sustainable in terms of growth when there’s money spent on infrastructure. It’s short term in nature. Once the job is done, the workers still have to find something else to do. Hopefully the focus on infrastructure spending doesn’t distract us from creating more sustainable long term growth and that gets through to tax and regulatory policy.

Trump has talked about mimicking the German method of really training people so they’re going into apprentice programs. When you look at the outcome from education, for the most part it’s hyperinflation. In the general American population, if you go into an apprenticeship program you tend to be seen as a loser, which is terrible. That’s what Germany does well. They train tradespeople, and there’s a lot of pride to it. Here, we push college at everybody and all it does is multiply the debt levels exorbitantly.

TRENDS IN PROTECTIONISM

They talk about protectionism because Trump and some of his administration don’t understand trade. They see deficits as a negative, but consumers in the US who can buy things cheaper overseas have their standard of living improved. There are some things that we should make and some things that other countries should make, and what we have to do is make ourselves as competitive as possible and let the chips fall where they may. Trump is taking this mentality of deficit = bad, surplus = good and then goes into a meeting with the Chinese with that mentality.
We should be embracing the second largest economy in the world because they are our partner in a sense of creating healthy, sustainable, quicker growth. But to battle with them over a trade deficit number is just a misunderstanding of the benefits of trade. The “curse” of being a global reserve currency is that you have to export Dollars. It’s impossible to do anything else, especially as other countries build up their USD reserves. If some other currency becomes strong from a global currency perspective, which makes it easier for the US to not run a deficit. The emerging markets have built up their dollar reserves to an astronomical level over the last few years because they’ve been afraid from a stability perspective.

When you’re the reserve currency of the world, you have a different role to play and you’re not just like everyone else. That’s the basis of Pax Americana. Instead of gold, the global currency became the Dollar. The world is in this situation, and if you rip that bandage off and say, no, we’re not supplying Dollars to the world, we will embark on a global depression of huge magnitude. Trump wants to roll back Pax Americana and the cost of being imperial America, but that better be done in a timely way. The Americans filled the void when the Brits abdicated their empire and the role of the British pound, but who’s going to fill that void now?

The Chinese will bring all sorts of gifts to placate Trump, but that pushes the stock market higher in the hopes of there being some rational discussion.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

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