FRA: Hi – Welcome to FRA’s Roundtable Insight. Today we have Charles Hugh Smith. He is America’s philosopher as we have called him in the past. He is the author of 9 books on our economy and society including: A Radically Beneficial World: Automation, Technology and Creating Jobs For All, Resistance, Revolution, Liberation: A Model for Positive Change and The Nearly Free University and the Emerging Economy. His blog, OfTwoMinds.com has logged over 55 million page views and is number 7 on CNBC’s top alternative finance sites. Welcome Charles!

C. H. SMITH: Thank you Richard. I always wonder if I can live up to that glowing introduction.

FRA: You always do. You have great insight as always. I thought maybe today we take a look at a topic you have written a lot about and that is on stagnant wages, particularly in the developed world such as the U.S. and Canada, and what the challenges are behind that…Why it’s happening and if there are any solutions to get out of that trend.

C. H. SMITH: Right – Well it’s an excellent topic. It confuses the conventional economic commentators because as of right now we all know in the developed world, at least in North America, the unemployment is quite low – It’s less than 5 percent which is considered full employment. Normally when we have full employment then employers have to start bidding higher wages and benefits to attract the most productive workers. A rising tide raises all ships and in other words wages tend to rise across the board. When you have full employment and a rising gross domestic product, but we have rising GDP and very low unemployment, according to the statistics, and our wages remain stagnant so something has changed. So I think that is the question that we are going to try to explore.

FRA: And as your writings have indicated that there are a lot of explanations that include automation, globalization, offshoring, the high cost of housing, the climb in corporate competition, the failure of the educational complex to keep pace, a global labour arbitrage as a big factor. What do you make of those explanations?

C. H. SMITH: Yeah – I think all elements and part of what we’re proposing here is that there is not just one explanation. If we could just nail it down to one cause then we might be able to change that which policy, but what you’re talking about is these very large structural forces such as globalization and the fact that the economy is changing faster than our higher education systems can change so they are falling behind what employers actually need employees to know. And so these are structural and very difficult to modify or change with just a few policy tweaks here and there. That’s not even mentioning the impact of financialization and financial repression which we all know has kicked into gear in the 21^stcentury. That has also changed the distribution of the gains we’ve made from productivity. I have a chart here that the New York Times published in August indicating that virtually all of the income increases over the last few years are now going to the top half of 1%. That’s completely different than it was in the 80’s and 90’s where the distribution of increasing incomes was skewed to the lower end income and middle income sectors. That to me shows the impact of financialization because we know the top 0.5% are generally not people inventing something wonderful, they are not Steve Jobs, they are people that are simply getting nearly free money from central banks then using that cheap money to leverage it into ownership of income streams. They are not creating any income streams they are simply acquiring them with all the evil fruit of financial repression, cheap money, limited liquidity and high leverage.

FRA: For our listeners, Charles has made a collection of charts that provide good insight and we’ll have those charts in the write up of this podcast as well for everybody to look at. If you could go into what is the need for rising wages – the whole system is based on rising wages, could you go a little bit into that and why stagnant wages is a problem?

C. H. SMITH: Yeah – That is a critical point because our whole economy, the advanced post-industrial developed economies, they are all consumer economies – They depend on consumers buying goods and services on a permanent basis. So you have to have higher wages in order to support more consumer spending and more consumer borrowing because if we are going to borrow more than we need to make more net income so we can service that higher debt. So stagnant wages throw a monkey wrench into the whole permanent growth and expansion of consumption that our economies are based on. Now we can question that model and say what we really need is a growth model where we are actually getting more happiness and satisfaction with using less resources are earning less income, but that’s a discussion for another day. The economy we have is one that starts falling apart if wages stagnate or decline. I have a chart here of wages and salary as a percent of GDP and it’s quite interesting because it goes back to 1960. It’s basically a measure of how much of the economic activity or output of the economy is going to wages and salaries. What we find is is that it’s dropped quite a bit. In the 70’s, about 50% of all the GDP went to wages and salaries such as working and self-employed people, now it is hovering around 42% or 43%. That is a significant chunk because the GDP currently is about 18 trillion, so if you’re talking about 7% of that then you’re talking about a trillion dollars that used to be directed to wages and salaries and now is going to corporate profit or financier profits and basically financialization. So that’s a big change, but it’s secular, in order words it started in the 1970’s with the stagflation of the 70’s then it continued to climb in the financial boom in the 80’s and the only counter trend was in the Dot-com era, then the percentage of the GDP growth that went to wages and salaries actually increased, but when that boom ended it went back to a decline.

So we have to look for answers that don’t just start 5-10 years ago, we have to look back and say something has been happening for a decade or two. One possibility is productivity, that if we look at productivity growth – I have a chart here that goes back to 1980. Obviously it’s a volatile metric, it goes up and down depending on if the economy is entering a recession or not, but recently even though we’ve had strong growth in the GDP, the productivity has been very anemic and not just for a year or two but since 2010. That’s another change that’s undermining wages and salaries because all real growth comes from increases in productivity.

FRA: Now in some parts the local governments, which have growing budgets tied to increased collection of property taxes due to rises in housing prices, that could also become problematic in a similar way in the public sector if the housing prices stagnate or decline. How are property taxes going to be maintained or increase based on budgets that are factored in for growth?

C. H. SMITH: That’s right and an excellent point – And especially for municipalities and states where the majority of the local government income is largely based on property taxes rather than sales or income taxes. And of course if wages stagnate then people have less money to spend so sales taxes stagnate, they have less income so income taxes stagnate and then they can’t afford to move up to more expensive housing if they can’t afford the property tax. I think we can see the local governments around the U.S. are feeling a dwindling, a stagnation of their revenues. Another thing is I have a chart here of the annual change in the number of new firms or in other words how many new companies are emerging and succeeding enough to hire employees and pay taxes and all the good stuff that we expect of new business growth – That has been stagnant or declining since the 2009 global financial crisis as well, compared to the previous decades of very strong growth of new small businesses. That’s another element, it’s becoming more difficult to start a new business and to succeed. That also means that there is less opportunity for wage earners because the fast growing small businesses tend to be the engines of employment because they are growing fast and need talent and are willing to outbid existing corporations for the best talent and so they are a big part of higher wages. That is also causing stagnation in wages and salaries.

FRA: So, if we consider the big reason of financialization as the reason that wages have stagnated and that the economy is optimized for financialization, can we focus on that to explain what is financialization, how does it work, what does it mean to the average consumer and so what’s exactly happening behind financialization?

C. H. SMITH: That’s a great question. It’s a word that has various definitions. My personal definition is that it’s the commodification of everything in the economy into something that can be marketed globally. So for instance, home mortgages in North America, back in the ancient days or 20 year ago banks would originate a mortgage and hold it. It was a very slow, steady, low-risk business with a guaranteed return. Once that financial industry got financialized then the mortgages were packaged into financial instruments that can then be marketed globally as investments and then they could be sold as AAA-rated instruments to credulous investors and huge profits could be spun off of this. So that’s an example of how financialization works, is that it’s basically taking what was once a low risk industry and hyperfinancialzing it so it could be sold off and traded for immense profits. The high risk that is generated from that is then passed onto other people. The role of central banks in financialization is that the cheaper you make money, the more speculation that you enable. For example in the housing bubble of 2007-2008, that speculation was fueled on both ends of the spectrum. You had small-time players getting liar loans, which were of course enabled by central bank liquidity. And then you’ve got financiers that were selling F-rated financial instruments as AAA-rated. Nowadays, because of the credit-tightening and the regulations that were finally imposed on the banking sector, the small fry doesn’t really have the same access to liar loans and easy money, and so now it’s congregated up in the very top of the wealth power pyramid that if you’re a financier or a corporation, then you have almost unlimited access to cheap money. You can sell bonds at low rates or borrow money from a money centre bank at rates that no normal employee can possibly match. So the corporations can do thing that would not have been possible without financial repression because if they had to pay 7% or 8% to borrow the money, then it would no longer make sense to buyback so many millions of shares of their company in order to boost their wealth and capital gains. So it’s the cost of money and the availability of money to the apex of the wealth power pyramid and that’s why the chart from the New York Times shows that the vast majority of income gains over the 21^thcentury are congregated over that very small part of the population that has access to unlimited liquidity at very low interest rates and then they can buy the income streams and outbid everybody else. I think that is one of the devastating impacts of financial repression, that the benefits are not evenly distributed. If you and I could go borrow a billion dollars at 1%, we could do some amazing things because all I would need to do is buy bonds that pay 3% and I would be skimming 2% for nothing. I would be earning 40 million dollars a year simply because I have access to cheap money. That is one of my favourite examples of how financialization works.

FRA: And you’ve got a great quote from one of your blog writings earlier this month saying, “Financialization funnels the economy’s rewards to those with access to opaque financial processes and information flows, cheap central bank credit and private banking leverage.” Those aspects cover what a lot of what financial repression is about such as cheap central bank credit – The whole money printing and quantitative easing aspects of central bank activities.

C. H. SMITH: Right – And the fact that for the 99.95% of us, we can borrow money to do something specific, modest and limited such as buying a house or getting a small business loan if we jump through a lot of hoops, but we can’t go borrow money with the size and leverage that the big players can – That’s why they’re scooping all the income gains. If we look at the chart here of declining wages for all layers of the educational accomplishment, in other words even the workers with advanced degrees, their wages are stagnating too while those with less education may actually be declining once you adjust for inflation. This is quite amazing that even the highest educated workers are no longer making gains. That shows how pervasive the damage is with financial repression.

FRA: That is an interesting chart. And if we can now ask what is the way out of this – Are there any solutions? Could a repeat of the dot-com bubble, where there was a break in the trend, be repeated through the revolutions we have going on like in blockchain, bio-tech, energy & environment, robotics. There are a whole bunch of revolutions that are happening in different industries. Could any one of those or perhaps collectively altogether duplicate a dot-com effect?

C. H. SMITH: That’s a great question and I think the more we learn about each of these scientific and technological revolutions, the more potential we see. Just as a beginning comment: there is a lot of media coverage of the replacement of human-beings such as the self-driving driving vehicles which are going to get rid of millions of drivers, that is definitely a real possibility, but we have to also make mention of something that is less sexy which is that a lot of technology tends to augment human labour. For instance, an industrial robot on a factory floor, it doesn’t just do it’s thing with no human interaction for months on end, years on end. More and more you need to change your product line very quickly and modify your production and so you actually need skilled humans to reprogram the robot. There is a lot of this kind of technology where the tool increases human productivity, but humans are definitely still the key part of the whole chain of production. So I think there is a definite possibility for higher wages which would basically mean the higher productivity that’s flowing from technological advances would go to those doing the work as opposed to those who own the income streams. But I have to say we are going to have to find some way to limit the predation of financialization in order to press those gains down the wealth power pyramid to those who are actually doing the work and creating the advances. That’s going to require certainly a political change that puts limits on financialization so there is more of the nation’s income left to be shared with the workers.

FRA: Could all of these trends have deflationary effect on the economy in terms of the need to sell assets for generating enough income to service debt and to pay ordinary everyday expenses? Do you see that potential in terms of deflationary effects on the economy in general?

C. H. SMITH: That’s a great question because it calls to my mind Japan, which as we know has been sort of in a deflationary cycle for roughly 25 years. When we look at Japan there are many aspects we can comment on and it’s stagnating too in terms of it’s wage structure and it’s growth. But one thing we might posit is that Japan’s export industry, it’s most productive sectors like automotive and various technology sectors, their productivity is increasing enough that Japan’s national economy has been able to stumble forward in a very low growth and stagnate way, but the very high productivity of the industrious sectors of Japan how allowed that to be modified. In other words, without those high productivity industries, then Japan would be in a real perhaps deathbell of deflationary dynamics. My point here is that if you have these very productive revolutionary technologies, they may be a small sector of the overall economy in terms of a percentage of economic activity, but in terms of the gross and productivity that they create, they have an outsized impact. So we might see something like that and we may be already be seeing something like that in the U.S. where the sectors that are growing fast and creating a lot of value are keeping the U.S. economy from entering a deflationary cycle. And because we know one cause of deflation is technology lowers costs and so things get faster, better, cheaper, or at least that’s the idea. That’s not a very complete answer to your question, which I think is a good one, but my point being is that technological revolutions can lower the cost of goods and services which is deflationary, but their productivity gains can increase the GDP which tends to counter that deflationary impact – In other words the whole economy can be growing even as prices decline.

FRA: That’s interesting and great insight – How can our listeners learn more about your work, Charles?

C. H. SMITH: Please visit me at OfTwoMinds.com

FRA: Great – We’ll have you on again. Looking forward to the next discussion.

C. H. SMITH: Thank you so much Richard – It’s been my pleasure.

Transcript by: Daniel Valentin <daniel.valentin@ryerson.ca>

LINK HERE to 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.

FRA: Hi – Welcome to FRA’s Roundtable Insight. Today we have Nick Giambruno. Nick is Doug Casey’s globetrotting companion and is the Senior Editor of Casey Research’s International Man. He writes about economics, offshore banking, second passports, surviving a financial collapse, foreign trusts and companies, geopolitics, and value investing in crisis markets, among other topics. He is also the Senior Analyst of the Crisis Investing publication. He’s lived in Europe and worked in the Middle East, including Beirut and Dubai, where he covered regional banks and other companies for an investment house. Nick is a CFA charterholder and holds a bachelor’s degree in finance, summa cum laude. Nick is a frequent speaker at investment conferences around the world. Welcome, Nick!

NICK GIAMBRUNO: Great to be back with you Richard.

FRA: I thought today we would focus on a number of interesting topics that are in the news and public highlight including what’s happening with the pension crisis in the U.S. and the war on cash with the overall theme of central banks intervening in the economy and in the financial markets. Maybe we could begin with your thoughts on the war on cash. Where do you see that trending? Do you see governments getting involved with cryptocurrencies to move away from cash?

NICK GIAMBRUNO: Well, let’s start by looking at the war on cash. And not to mince words, the war on cash is evil – It’s all about restricting peoples’ choices and forcing them into digital systems that can track, monitor and control every penny you earn, save, borrow and spend. It’s really a totalitarian-type control system and there really is no redeeming values of it whatsoever in terms of benefits that are worth the trade-off of basically looking your absolute financial privacy. So first thing is first – It’s just an awful thing, but nonetheless it is a growing trend. It’s not naturally popular in academia and with governments because it’s all about transferring governments more power and control over people. That is uniformly a bad thing, but nonetheless, it is a growing trend not just in the United States, but around the world. Your listeners might remember back decades ago in the United States there used to be $500 bills, $1,000 bills, and even a $10,000 bill. Those have all been gotten rid of, I think, in the 1960’s and 1970’s with the usual excuse of, it’s only being used by drug dealers, terrorists, money launderers and that sort of thing. So, the largest bill we have since then is the $100 bill and the purchasing power of the $100 bill has gone down drastically since the 1960’s and 1970’s. Inflation is an important component on the war on cash because if the governments don’t issue larger denominations of bills to keep up with inflation, it has the de facto effect of forcing more people to use cards and digital payments than they otherwise would because it’s just not convenient to use cash since the largest valued bill has been inflated away. And I see the same sort of demonization that the governments, the media, and their academic cohorts have used in other areas such as the very large denominations of U.S. dollar bills back in the 1960’s and 1970’s. I see the same language used by the same type of people towards private cryptocurrencies and that is a scary thing because it shows that they are gunning for this. It is important to distinguish between a private cryptocurrency and a cryptocurrency which is controlled by the government. In my opinion, I think it’s a wonderful thing to have these private currencies because the ultimate power and control these systems is not with the state or any government – It is distributed and decentralized. That’s why we see governments talking about how it is only used by terrorists, drug dealers, and money launderers. That why we see people who are intimately involved in the current system, banking and central banking system, which is as you are fully aware a fraudulent system, like Jamie Diamond coming out and saying Bitcoin is a fraud, these are signs that they are gearing up towards an assault on this. And we can go into the reasons why, but I think it’s going to be extremely difficult for them to crackdown on these private blockchain and cryptocurrencies, I think the cat’s out of the bag on this. But nonetheless, all of these issues are intertwined.

FRA: Do you think that governments will allow the private-based cryptocurrencies to coexist? I know you said the cat’s out of the bag and they are uncontrolled, but maybe in the future if governments try to control or regulate then do you see the possibly or allowance by the governments for private-based cryptocurrencies?

NICK GIAMBRUNO: Honestly, I don’t think that they have a choice. They can try to control it and regulate it, but I don’t think that they are going to have much more success than say Venezuela does in trying to control currencies that they don’t like which would be the U.S. dollar and other currencies. So, I think the U.S. government is not going to have a whole heck of a lot more success than say Venezuela does or any government does in regulating currencies that they don’t like their people to use, which in itself is a terrible thing. Why should some bureaucrat tell you what kind of currency you would want to use voluntarily? It’s really a terrible thing. Also another thing to point to, a similar technology, is BitTorrent. Now BitTorrent is a decentralized file-sharing technology that allows people to share any kind of file they want whether it’s a Hollywood movie that just came out in theatres, an E-book or anything, you can share anything. Anyways, this technology has been around for over 15 years and despite the U.S. government’s best efforts to shut down BitTorrent, it’s’ still decentralized. It’s like a game of Whack-A-Mole and despite their best efforts it is still easily accessible to anybody on the internet. Bitcoin is similarly decentralized and maybe even more decentralized. So sure, they can say that Bitcoin is illegal and you cannot convert your dollars into Bitcoin. It will just shut down these exchanges, but it’s not like Bitcoin is going to die or that it’s going to be impossible for you to get Bitcoin – It might be a little harder. I think it’s basically impossible for the U.S. government, Chinese government or any government to totally eliminate these private cryptocurrencies other than shutting off the internet and keeping it shutoff, quite frankly.

FRA: Great points. On central banks – Do you see central banks as being favourable to a war on cash to make it easier for bank bail-ins for central banks to implement their policy, for example, negative interest rate policies and those types of things?

NICK GIAMBRUNO: Certainly – The central banks are all on board and on the same wavelength of the folks who are advocating for the abolition of cash. So, the central banks are fully on board for this and I think one of the main reasons for the war on cash is because central banks want to use negative interest rates, which is a bizarre thing in the first place when you actually think about it, it’s like getting paid to borrow money – It makes absolutely no sense. And it wouldn’t happen in a free market. Negative interest rates basically couldn’t exist in a free market. They only can exist in a manipulated and controlled market such as the system that we have with central banks and fiat money. But the thing is, they want to implement negative interest rates because of their wrongheaded belief that instead of losing money from the sting of negative interest rates, people will think: We better go out and spend it quickly before we lose money from it. And that it will somehow stimulate the economy. It is completely wrongheaded in the sense that it will encourage people to save more money because it will be harder for people to save money to spend on their basic necessities. That’s not going to spur people to spend more, it’s going to spur people to save more because they are going to have less money available to spend on rent, food and so forth. It’s not going to make them go out and buy the iPhone 8 or the next ridiculous fad as they would like them to. Anyways, the whole point of the war on cash is to force people into the banking system because cash represents an escape hatch for people who want to avoid negative interest rates. It’s no coincidence that in countries that have the worst cases of negative interest rates, you see people saving more in cash. Look at Japan. Japan has had record sales of safes that people would install in their house to store cash because Japan has negative interest rates and people don’t want to lose money from negative interest rates. So, it’s a completely wrongheaded and destructive policy, again, that has no redeeming values whatsoever that could not exist in a free market where there are voluntary interactions between buyers and sellers – It can only happen via coercion in a government controlled financial system.

FRA: Do you consider cryptocurrencies to be a store of value or investments? Will Bitcoin, for example, retain its current valuation or will it come down a little bit towards what the cost to produce a Bitcoin in terms of electricity and computers, I think it’s around $1,000 now. What are your thoughts on that?

NICK GIAMBRUNO: Yes – I think the real value of cryptocurrencies, in my opinion, have yet to be established that these are reliable stores of value for anything other than the very, very short term. Nonetheless, they are extremely valuable as transfer mechanisms to move a value from point A to point B instantly. You don’t have to keep it in the cryptocurrency, you can convert it into other things such as goods, services, fiat money, gold or whatever you want. In terms of moving it from point A to point B, I think they have a tremendous amount of value, but as a store of value I think it’s going to take some time to establish that. Personally I favour gold and silver as long-term stores of value. But with the cryptocurrencies which is really, really interesting is that you don’t need anybody’s permission to send money to anybody anywhere in the world and it doesn’t need to be backlogged by the bank and have the compliance department check it out to make sure it’s fine, it doesn’t need the approval of SWIFT, it doesn’t need the approval of the U.S. government. You can simply send cryptocurrencies to anyone in the world and there’s pretty much nothing anyone can do about it and that’s a really wonderful thing.

FRA: Great points. Going on that theme of movement internationally of capital – What are your thoughts on globalism? You’ve written a lot about that and the end of globalism on the economy. Will that lead to protectionism or more local freebased markets?

NICK GIAMBRUNO: Well, I think the jury is still out on that, but I think it’s important to also define our terms because these terms are thrown around a lot and I think it’s important that we have a common definition of these terms so we know what we’re talking about. Globalism, in my view, is simply the centralization of power on a global basis, that’s it. That’s all it means. You look at the people who advocate for these things in centralized global power structures, that is globalism. Now whether globalism has reached it’s venus and is now declining – I think there’s a good chance it is. The European Union is a perfect example of globalism because it’s centralization of power of all these nation states into one global, one giant, super-national institution. So, we are talking all about the centralization of power. And it’s interesting because cryptocurrencies tend to go in the opposite direction – They tend to be centralized power and I am 100% for decentralization. Decentralization is always a good thing and centralization is, generally, always a bad thing. What we’re looking at here is what is going to happen if and when globalism and the ideology behind globalism, which is universally ascribed to by the elites in the academic, the political, the financial, the media elites in the U.S. and the greater Western world. In my view, it is a bankrupt philosophy and I think it’s sort of akin to Communism in terms of, this is a bankrupt ideology that is going to be relegated to the dustbin of history sooner or later. So, what is going to replace that? I think that is an open question. Are we going to move towards a more decentralized, voluntary society? I would like that to happen. Or are we going to move towards nationalism and protectionism which is just replacing centralization of power on a global basis for more of this tribalism and nationalistic feeling which isn’t necessarily a good thing either. So, I think the jury is still out on that whether we are going to move towards a more nationalistic, protectionist type of a world or we’re going to move towards a more voluntary decentralized type of world – I think the jury is still out on that.

FRA: You’ve written a lot recently on the U.S. pension crisis. John Mauldin has pointed out that he thinks the bubble in government promises is arguably the biggest bubble in human history. He gives an estimate of 2 trillion, but says that that’s based on an average 7% compound return, of 2 trillion of unfunded liabilities for state and local governments on the pension crisis. But, assuming the market could go down 40%, then you have unfunded liability in the range of 7-8 trillion so it’s enormous. What are your thoughts on the U.S. pension crisis?

NICK GIAMBRUNO: This is a perfect example of the extreme corruption in the U.S. and the extreme corruption in government and financial markets. It’s a total mess and quite frankly the pension crisis is an unsolvable problem. There’s nothing that can be done to solve this problem – It’s simply too big. The issue at hand here is that the government, these local governments: municipalities and state governments, all over the place, they are making extravagant promises on retirement benefits that they simply can’t deliver on that gets them the support of their government employees, unions, police officer unions, teachers unions and these kinds of things. But they’re really promising these people, their own employees, benefits that they can’t deliver on. What’s interesting is that pensions are pretty nice benefits. I mean think about, you basically get or pretty close to get your last year’s salary adjusted for inflation until you die and that’s a pretty nice benefit. Pensions don’t really exist in the private market anymore. About only 4% of private U.S. companies offer pensions anymore just because it’s not possible for them to do, but for a government they can promise these extravagant things. Another thing is is the accounting method of pensions. Governments get to use different accounting standards than private pensions do. And the single most important number in the whole pension crisis is the assumed rate of return on the assets of the pension because that assumed rate of return is used to discount the future liabilities of the pension. If they use an artificially high assumed rate of return, their liabilities are magically shrunk. These pensions are assuming that they’re going to earn a better return in the stock market than Warren Buffet into perpetuity which is ridiculous. They’re not using anything towards realistic assumptions in their accounting – They are using Bernie Madoff accounting; it’s a fraud. If they were in the private sector they would be going to jail for fraud, but nonetheless they are in the government sector and, magically, what is fraud in the private sector becomes acceptable in the public sector, which is totally unreasonable. Be that as it may, what they’ve done is they’ve promised these extravagant retirement benefits to their employees and now we’re really close to the tipping point because these pensions plans are basically bankrupt and that’s at a time of a stock market bubble and a bond market bubble of historic proportions. That should pump up the value of these and it has pumped up the value of these pension plans, but nonetheless they are still paying out all this money in benefits that even with an enormous stock and bond market bubble these things are still insolvent. And even with using unrealistic return to discount the future liability – They’re still insolvent. So, the next time the market has any sort of minor recession or downtown a lot of these pension plans are going to go bust. What does that mean? That means the taxpayers and the states are going to be on the hook to pay for these extravagant benefits. People in the private sector don’t get to use benefits, so they are extravagant benefits. How are they going to pay for them when the whole thing has gone bust? Well, they’re going to increase taxes and what taxes are they going to increase first? – Property taxes. We’ve seen this in Illinois. Recently property taxes are going through the roof in Illinois. Illinois is hardly the only place that has a pension problem, many many jurisdictions do. If your town or your state or your municipality or your city has a pension problem, the likelihood of your property taxes doubling, tripling or even going higher is very likely. It’s not just in the U.S., any jurisdiction that gets into financial problems always turns to higher taxes and property taxes. Greece is a perfect example. I think Greece’s property taxes have gone up 4 or 5-fold in recent years as they’ve looked to squeeze people for any penny they can get out of it. So, really to me this is an illustrative example of just how rotten the political system is, how rotten the financial system is and it’s all wrapped up into one nice crisis. This thing is going to come to a head sooner than later, certainly within the next cyclical recession which we are way overdue for in the U.S.

FRA: And the same thing here in Ontario, up in Canada. The debt per capita is multiple times worse than in Greece so it’s only a matter of time. We already see the property taxes going up and use fees, for example, licenses across the board going up here and there.

NICK GIAMBRUNO: Yeah – It’s frustrating. And really I think we should take a step back to think about property taxes and property rights because how can you say that you own something and that you are the owner of a piece of property and that you have to pay a never-ending and ever-increasing annual fee on? – It’s ridiculous. Think if you had to pay property taxes on your sofa or your T.V. Could you really say you owned your sofa or your T.V. or are you merely renting it from whoever was charging you that fee? I think it’s the same thing and I think property taxes are a terrible thing and hopefully, I’m not holding my breath, but hopefully they’re done away with at some point in the future, but unlikely, they are probably going up.

FRA: And also, you’ve written on the pension crisis where you’ve suggested two asset classes that investors could consider: gold related and cannabis related investments. Can you elaborate on that rationale?

NICK GIAMBRUNO: Sure, okay. Let’s start with gold. I think the pension crisis is going to be terrific for gold because as I mentioned, this is an unsolvable problem in the traditional sense. These state and local government could double, triple, even quadruple taxes and it’s not even going to make a dent in this problem and that’s assuming that the tax revenue they receive after increasing taxes, the collection rate, would stay the same – It wouldn’t though because higher taxes are going to drive people away from these states. We’ve seen this already in Illinois and Chicago in particular. I think 3,000 millionaires have left Chicago because of higher taxes in recent months and there was a study done that this was like one of the single-most outflows of wealthy people in the entire world, not just in the U.S., not just in North America, in the entire world. So, I think you have to take a step back when you see all of these productive people, these wealthy people fleeing the city that there is an issue here. Certainly there is a point of diminishing return that comes with raising taxes that has already been reached in a lot of these places so they can’t raise taxes and they can’t cut benefits either because a lot of these benefits are enshrined in the state constitutions that they can’t cut these pension benefits. Isn’t that a nice thing? You’ve got the government who says they basically guarantee these benefits and it’s against the state constitution to renegotiate or lower these benefits so it’s already bankrupting these places causing local debt crisis. They are going to default on these obligations one way or another. But ultimately, what’s going to happen is that the federal government is not going to just sit back and let all of these states and cities not make good on their promises to their own employees. It’s just politically going to be impossible for the U.S. federal government to step back and do nothing. That’s the whole point of having the central bank. They are the “lender of last resort”, which really sanitizing what they really do. They print money and give it to people so they basically socialize the cost of these things through money printing and higher prices and inflation. So, that’s what is going to ultimately happen, is that the federal government and the federal reserve is going to step in and paper over this pension crisis by printing money. That’s the bottom line of what is going to happen eventually with this pension crisis and that’s going to be good for gold. So that’s the rationale behind gold because simply, there is no other way to solve the pension crisis besides the printing press. That’s what ultimately is going to happen. Number two, the states are so desperate for any penny they can get. They are going to start to look for alternative means of revenue and I think they are going to look at the states who have recently legalized cannabis and they’re going to find the opportunity too good to pass up. There’s 100’s of millions of dollars being flowed in with new tax revenue from the legalization of cannabis in various states such as Colorado. I think it’s estimated that next year when California goes live with legal recreational cannabis, that they could bring in about a billion dollars in cannabis-related tax revenues. Nonetheless, this is not going to solve the pension crisis. A couple billion here, a couple billion there – It’s not going to solve a multi-trillion dollar issue. And I know that you cited earlier that it was a 2 trillion dollar problem, but that’s using the unrealistically rosy rate of return assumption of a 7% which is what most public pensions use. If you use a realistic discount rate, we’re looking at 5 trillion plus problem. So, a couple of billion here, a couple of billion there from legalizing cannabis is not going to solve this problem, but nonetheless because these states are so desperate it’s not going to hurt. They are going to look to get every penny they can get and cannabis is going to be a beneficiary of their desperation. That’s the rationale for the second investment.

FRA: Very interesting. In addition to cannabis, what controls: monetary policies, fiscal policies, government regulations do you see coming in the near future that governments and central banks will employ to deal with the increasing burden of government debt and unsustainable spending and deficits?

NICK GIAMBRUNO: Well, I think we talked about those a little bit earlier. I think we’re definitely going to be seeing negative interest rates spread because negative interest rates, of course, benefits the borrower and who are the biggest borrowers in the world? – Our governments and they’re the largest borrowers, the U.S. government in particular. I think we already have negative interest rates in the United States, not negative nominal interest rates, but certainly negative real interest rates when you consider the nominal interest rate and the rate of inflation. Sure, they give you this phony CPI number of like 1-point-something percent, – It’s much larger than that. Everybody knows that. Just go to a grocery store and look at how much groceries cost, your medical insurance, your tuition, anything, the prices are going up more than 2%. It’s an insult to peoples’ intelligence that that’s the number that they use. Anyway, I think there already are negative real interest rates in the United States. The little measly couple of basis points you get for putting your money in a bank – that doesn’t keep up with inflation. So there already are negative real interest rates in the United States. I think they’re going to get more negative either with higher inflation or lower nominal rates. I think that’s baked into the cake because that’s going to support the U.S.’s ability to manage that debt. Lower interest rates makes it easier to manage that debt and that debt is going nowhere. I mean there is nowhere but north for where the U.S. debt is going. It’s politically impossible. I think it’s a pretty safe assumption is that we’re going to continue to see that. If we’re going to see more and more negative interest rates that means they’re going to need to ramp up the war on cash because negative interest rates really aren’t effective unless you trap peoples’ money in the banking system. Well you can’t really trap peoples’ money in the banking system if you give them the option of having a bunch of cash stashed under their mattress. So, I think we’re going to see negative interest rates ramped up and that necessarily means we’re going to see the war on cash ramped up. And we already are seeing this. I think the head of the Harvard business school or Economics department, Kenneth Rogoff, he’s a huge advocate for the war on cash. And he’s a trendsetter, obviously being a top academic at a top institution, he kind of sets the trends on this stuff and I wonder what motivates this guy because I don’t think he’s stupid, I think he knows what he is doing. He is like the kind of person who wakes up in the morning and looks for ways to try and restrict peoples’ abilities to use cash and I think he’s clearly a sociopath. Unfortunately, this kind of wrongheaded thinking is gaining current so I think we’ll see more of that.

FRA: As the last question here, do you see any political movements within the U.S. to extreme socialism as a backlash, perhaps led by the millennial generation, that could severely affect the economy or the financial markets?

NICK GIAMBRUNO: I think that’s very likely. For better or for worse, probably for worse, these people are the future generation in the U.S. and who is one of the people that they idolize? – Bernie Sanders. And there is a really interesting article that Bernie Sanders wrote about how Venezuela is the success story of socialism. Obviously this was written a few years ago before their hyperinflation and major problems they have right now, so I encourage your listeners to check that out. Bernie Sanders basically wrote a glowing review of Venezuela and said, “Hey, we gotta bring this to the U.S.”. Well, Bernie Sanders represents the economic views of these people so, yes, I think we are going to see a lot more of socialism, collectivism and all the stuff that entails in the future, unfortunately.

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

NICK GIAMBRUNO: The easiest place to do that is on the International Man website. That is: InternationalMan.com. We talk about all of these issues and more importantly how you can protect yourself and your family from these terrible things that we’ve been talking about today. The situation is not hopeless. There are things you can do to not only protect yourself, but profit from the distortions that will inevitably be caused by all of these wrongheaded policies.

FRA: Great. Thank you very much for all the great points and insight, Nick – Thank you.

NICK GIAMBRUNO: Thank you Richard – Great to be with you.

Transcript by: Daniel Valentin <daniel.valentin@ryerson.ca>

LINK HERE to get the MP3 File

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

FRA: Hi, welcome to FRA’s Roundtable Insight .. Today we have Yra Harris and John Browne. Yra is an independent Floor Trader, successful hedge fund manager, a global macro consultant trading foreign currencies, bonds, commodities, and equities for over 40 years. He was the CME Director from 1997-2003. And John is the Senior Market Strategist for Euro Pacific Capital, he’s a distinguished former member of Britain’s Parliament who served on the Treasury Select Committee as Chairman of the Conservative Small Business Committee. And also as a Principal Advisor to the British government on issues relating to geopolitical matters. He’s worked for Morgan Stanley as an investment banker and he’s also worked for other firms, Barclays Bank and Citigroup. Welcome, gentlemen.

Yra Harris: Thank you, Richard.

John Browne: Thank you, thanks for having me.

FRA: So today I thought we’d discuss the implications of the recent elections in Germany on the EMU, the Euro, ECB policies, financial markets, and the European economy. Your thoughts? I guess we can start with Yra, what you think happened and what are the implications?

Yra Harris: Well you know Richard, we’ve talked about this and you know I’ve written quite a bit about it over longer than I care to think about, but the results were to me a phenomenal loss for Merkel because she not only slipped from the vote totals but it was a very big slap in her face. And like in the Brexit vote, they want to sell it as anti-immigration and I think it’s so much bigger than that. I think this part of the vote .. and if we go back to when the AfD first began, I think in 2013 when it was founded by various economists, the issue is far more financial than anything else. Yeah, the AfD attracted some fringed wackos as we might call them, but most importantly, the Free-Democrats resurrected themselves. I think this is a pretty big statement as to how Germany will face what Macron has been trying to push down, I would say Macron and Draghi have been trying to push down the throats of German taxpayers but of course, it never had the okay from German voters. So, I think that this has a long way to play out, it was a very important vote .. the biggest winner from here may be Theresa May. But we’ll leave that for further discussion.

FRA: And John, your thoughts?

John Browne: Well, I’m very interested by what Yra said because I think you’re absolutely right. Theresa May may be the biggest winner of this because Merkel is very pro-German industry and that points towards a mutually favourable Brexit from Germany at least. And Germany really runs the European Union, although it’s meant to be everybody, but basically Germany runs the whole show. And that’s a very important thing that Yra mentioned. I agree with Yra that Merkel had a big loss, she was elected as forecasted but there was nobody else, she’s weakened significantly. I mean the interesting thing was that combination, again getting back to what Yra said, it wasn’t all immigration. It was partly to do with the financial environment. The Alternative für Deutschland, the Alternative for Germany, went from 0 seats to 88 and the Freedom Democratic Party went from 0 to 69 seats. 132 seats against Merkel’s 217, so it’s a big block in there. And it’s going to sober a lot of the left wing in Germany, the Greens lost and the Left both lost seats. And so, I think that’s very interesting in my view and I agree with what Yra said. I think its going to boost the thing for Brexit because Merkel is going to be favourable to a good deal with German business. As far as the ECB is concerned, I think there’s going to be continued press for EMU, the European Monetary Union. The Euro has faired fatally basically because it doesn’t have a unified economy and so, each threat to the Euro is going to be used by the European elite to force closer and closer fiscal unity on the way to becoming a superstate. And talk about undemocratic, I mean I’d call it the Euro Soviet.  So, a good reason is they say they offer a parliament, which is duly elected and I think quite fair with proportional representation, but of course they give that parliament no power, just as happened in the Soviet Union. And the other thing is they’re already talking now immediately of giving huge amounts of money for electoral reasons rather then taking money away from the politicians to be elected, making it less of a money game, they’re going to give much more. But only to parties that fully support the European ideal, the parties that go against it will have no funding. So, it’s becoming less and less democratic and right down the road of what I think justly called the Euro Soviet. And I think regarding the Euro, it’ll be used as a weapon to increase togetherness and of course a superstate. As regards commodities and things, what we’re living with masses of money, masses of credit and liquidity that’s falling value, bonds are going up because of zero interest rate policy and quantitative easing. And equities have risen on this thing, hugely, record highs in both bonds and equities all over the world. But of course, that is all organized by the swamp. If the swamp starts to get eroded, then the reverse is going to happen. Bonds are going to be probably the biggest bear trap in history, equities are going to be a problem and of course commodities and precious metals will rise, certainly in dollar price and also in value. And so, I think the whole thing depends on how effective it is to get rid of the swamp. Realizing both parties in Britain and America that have ruined the countries in the last hundred years. If you take an actual number of it, in 2014 in January when the Fed opened its doors, that dollar today, it would be only worth, it other words two cents of that dollar would buy a present dollar. The Fed has devalued the dollar by over 98% and in those days, there were 8 Dollars to the Pound, and now there’s 121 .. And this has been done by the swamp which is both parties and the question is, how long will it take for reality to dawn? Whether they can put it off with another type of QE, giving people money, not even QE but just giving us all a cheque like the Republicans did under Bush. But a massive cheque, like $10,000 a piece or that sort of thing, to fend off that awful day that reality may dawn.

FRA: Your thoughts, Yra on this and the possibility of fiscal integration in the EMU?

Yra Harris: Well, it’s like John and I have been talking our whole lives. But he uses this term the European Soviet, and you know Richard I’ve talked about it quite a bit so John, I don’t know if you know Bernard Connolly but he’s a very dear friend of mine. So, when I hear you throw that out it reminds me of his great book, The Rotten Heart of Europe. But I’m going to answer your question Richard, this is all about the fiscal harmonization, this has been the program pushed by the likes of George Soros and what I call the Davos crowd and I don’t mean that as a conspiratorial, that’s just what they’ve been pushing. And now Mario Draghi has a very serious problem. And the speech yesterday was horrendous and stupid, he should have cancelled that press conference that he had scheduled before the German election because its just not going to happen that fast. And it puts Draghi now as I would say the only game in town. Which is why these people or those people including Peter Boockvar and I, have gone back and forth on this. There will be no quantitative tightening yet from the ECB because Draghi is now going to be in a bigger hurry to keep piling on sovereign debt onto the balance sheet of the ECB because only through that effort can he synthetically create the Eurobond that they’re craving for. So keep loading it on, keep loading it on, and then they’re going to the Germans and go “well you can’t possibly not be the guarantor of this bond, you have to. We have all this debt piled on the ECB, you’re going to have to be the one who has to guarantee this.” Otherwise we go into a massive debt default and the world goes into a major Depression. That’s what’s happening and this is all being done by Mario Draghi and if Mario Draghi hears this broadcast and he wants to go head to head with me and argue this, I relish the day.

John Browne: Well I totally agree with Yra. And it’s interesting, I was an investment banker in London and we were asked to be managers of a Eurobond issue. Not a Euro like the currency, but European Bond Issue .. everyone wanted to do it in Europe except for Germany .. Germany said, “we’ve got terrific concerns about inflation from the Weimar we will never forget it, and we certainly are not putting the German signature to a European bond.” And I personally despite all the talk and the movements that are taking place, believe that is at heart in the average German. I mean what Germany has done since the Weimar is to say “Okay, you German women and men work hard, save your money, and we as the government will ensure that saved money is still worth the same as when you put it in. Unlike the Anglo – American governments that have stolen from every saver.” And so, I think Germany, now that Merkel is weakened severely by most interestingly right-wing parties effectively. Both financial and immigration wise, I think she’s going to be under bigger and bigger pressure not to put the German signature to that Eurobond. And I think that’s been pushed back and this is of course is a big problem for Draghi whose been depending on it and it’s going to become a tremendous issue. Germany, as Yra said, is going to be faced with collapse on the one hand if they don’t sign, but a collapse of support politically if they do sign. And I personally think Germany would stand in the long run to win by not signing a bond to hell, because that’s going to go for the birds. I mean its going to just follow the Sterling and the Euro down the drain. And we’ve got bigger challenges then just the rest of the world. We got China that’s now issuing a forward contract in oil, measured in Yuan, which the Yuan will be convertible into gold. So, if you buy your contract for Yuan and then sell it for Yuan at a profit, you can convert all those Yuan back into gold. Now that’s going to really challenge the prime reserves status of the dollar and that’s a huge question mark. And if they do it for oil, what not other important international commodities like copper for example. I think we’re facing severe challenges and China is just waiting her time to strike. Whereas we’re spending fortunes on military equipment, China is spending it on making sure that she’s going to win economically and financially. And as the greatest generals have said, the greatest way to victory and power is to put your enemy in a position where they have to capitulate without firing a single shot. And I think that’s what China will do.

FRA: And John, do you think that there’s a possibility for the ECB to begin to buying Germany equities if German bunds become scarce in the overall ECB asset purchase program?

John Browne: Yes, absolutely. They’ll do anything above the law, around the law, they have no laws. They would do anything to save that Euro against the disaster that I see coming unless the Germans back it. And the price for Germany backing it is German rule of the European Union. Which Germany tried three times an empire, Franco-Prussian war, first World War, second World War. Each time and I think they’ve now realized that the Deutschmark i.e. money, is the key and the key to this is either the Deutschmark or the Euro to win their empire which will be Europe. And Britain is hopefully going to be leaving it.

Yra Harris: I think that John is exactly right and the Chinese are interesting to watch. More interesting is the amount of dollar borrowing that Chinese corporations and individuals are doing, Chinese real estate markets, they’re doing these huge dollar bonds. And I’m paying attention to that because first, it puts the Fed in a terrible situation and this is I think where John goes with not having to fire a shot, because the Fed, you know Bernanke beats his chest to talk about how great he’s been and how great it was. I think Janet Yellen has done a much better job by the way, but he just kept adding on and adding on and adding on, and this money had to go somewhere. And it went into the borrowings of, of course emerging markets. So, we’re so borrowed up in dollars now that if the dollar, if the Fed were to move here aggressively, which they’re not going to do, but we’ll create they’re favourite counterfactuals and let’s say they do that. The rally to the dollar would be fairly severe, especially because Europe is going nowhere now, so the dollar would rally more and because there are all these borrowings in dollars which means people are short dollars essentially, it would put a huge rally to the dollar which would wreak havoc across the Emerging markets, and it’s the Emerging markets that are now driving the global economy. Don’t believe the nonsense of European growth, I still see European unemployment hovering at 10% and I’m being kind because I’m using their numbers, the United States has tepid growth at best. So, it’s the Emerging markets and if they were to get into a situation where the dollar became expensive and the amount of dollars that they’d have to go raise to start paying just the interest on the debt. It would cause a very severe contraction. And that’s with the Chinese, I can’t agree with John more, it’s interesting to see who is hoarding gold here. And again, people say oh you’re a gold bug, I’m not a gold bug and I listen to John, he’s not a gold bug. But I’m not a Fiat currency bug either because I see the games that they play. So, I don’t love any of any  investment that much, there’s nothing that I see but I just try to protect myself and to see where the world is going to have to go to. So, I’m in total agreement with what John is putting out there. And the ECB, Mario Draghi is the most dangerous person right now in the world, right now. Because he’s in a hurry and he’s now lost his key supporter who was Angela Merkel. Merkel is really going to have problems and if you follow the news today Schäuble is already out as Finance Minister which means that its going to be Lindner who’s the head of the FDP who gets the Finance Ministry and he’s already drawn a line in the sand that he won’t go to for fiscal harmonization in Europe. So, this now gets very interesting and nobody is even talking about the fact that Schäuble is going to take the Presidency in of the Bundestag which I haven’t written about but I’m going to write about it this afternoon or later .. You’re going to have Schäuble, whose a fiscal conservative at heart, you’re going to have Lindner .. I think this now gets very interesting.

John Browne: That’s what I think, that’s fascinating what you say, I totally agree with you about Bernanke, Yellen, and those things. China of course has been borrowing hugely in dollars, of course has got a lot of dollars in terms of securities and Treasury bonds as its second largest holder after Japan, well of course the Fed is the largest holder with about 4 trillion, Japan is about 1.05 and China’s about 1.02 trillion and it ties with Japan for being the second holder. And of course, they will be paying back any debts they borrow. It’s like balancing, by borrowing dollars they’re balancing the dollars they own, which I think is entirely sensible. And even if they borrow more then they have, if they borrow more then 1.02 trillion, they’re going to be paying back in peanuts! And so, I see that as a great strategy for Japan. Regarding gold, its rumored, I mean we’re told America has 8300 tons of gold in Fort Knox, and it may still be there .. but nobody knows who owns it anymore. Its rumored and I say rumored, that already over the last five years China’s been accumulating gold by all means possible, through shipments and out of London through Switzerland and so on, that its now the largest holder and now has more gold then America, but that’s a matter for rumor. But I think they’re very gold conscious, and in the end, I think they see a totally depreciated dollar which they will be paying back the excess debt, they can write off the debts they have against the dollars they own and then they can pay the overspill of the debt in depreciated dollars relying on gold. And I think that’s a serious risk for the dollar and the dollar still is one of the most important things in the whole world economy. And so, if the dollar really collapsed it would create mayhem in the world. That’s why people are buying Bitcoin and all this stuff. I mean the average Joe who elected that Doctor yesterday in Alabama over the established swamp Republican, if people are getting sick of it, and that’s why people are saying if big banks like J.P. Morgan won’t even allow us to hold cash in our own safe deposit box, what we’re paying for. They’re now dictating we can’t hold, we can’t hold cash and all that sort of thing. They’re moving to get rid of cash? Well lets get into Bitcoin or gold or precious metals or something where we actually own the thing. And although I think some of these cryptocurrencies are highly speculative and have had fantastic gains recently, but I think highly speculative, that the people are going for it in desperation to get out of clutches of big government, swamp government that’s just robbing them blind.

FRA: And John, what are your thoughts on the current status of Brexit and the potential for other exits in the EU, EMU?

John Browne: Well first of all I thought May, I saw her first speech and met her very briefly. I thought she was terrific when she got in and even when the Brexit vote happened last summer, 2016 I mean. And she was strong and everything. But then she was advised by these two incompetent people to go for an election trusting the polls which were all wrong on both the Trump election and the Brexit vote and to trust those polls. And she went in and got heavily defeated in the polls, she’s still in the government but she’s severely weakened .. I thought her speech in Florence last week was very weak, I mean offering to pay, Britain is the European Union’s second largest contributor, why on earth should Britain pay anything? Let alone billions of dollars and she sort of gave way a bit on that, I thought that was disgraceful. And also lengthening the time of the transition. We want to stick strictly to the two-year transition so that if people want to have a divorce where the divorce is put off until after the financial arraignments, which is the reverse of any other human thing, you have the divorce first and then talk about the finances. They want the reverse. I think that’s obscene for Britain which was the second biggest contributor is outrageous and she’s giving way and that worries me .. this is just as Yra said right at the beginning, I think Merkel’s election has actually strengthened her hand a little. So, she’s almost back to where she started a week ago. But still it’s a touchy business, and you ask what of the other things? I think the European Union if Britain wants to stop Britain getting out, its largest contributor and everything else and I think there are only four countries where Britain enjoys a trade surplus, all the rest have trade deficits, have trade surpluses with Britain. So, it would be a severe blow both tradewise and economically if Britain leaves and they want to make sure Britain doesn’t leave .. they’re going to tie Britain down and punish Britain as an example to anyone else like Spain, Italy, Greece, who wants to leave, or Poland. You can’t leave, you’re going to be crucified, look what we did to Britain, and Britain was rich. And we still smashed her. And so, it’s a huge thing ahead of us now and until this Sunday I felt very depressed that May had given away so much, but then with Merkel’s erosion of her vote I’m feeling slightly more bullish.

FRA: And Yra, your thoughts on the potential for other exits in the EU, EMU?

Yra Harris: 100% I agree with him 100% their going to be punished, to be made an example and the Brits don’t really realize how good they are getting out because when you go to fiscal harmonization if they go to that, and I think it was a weak possibility before I think it’s been much weakened, it’s going to cost them a fortune. Anybody who has any money and the Brits have money. And why do I know that? All you do is have to open your eyes and look to see what’s going on with who is funding through the individual national central banks in Europe. The Germans are accepting the liability for the entire project and nobody ever asked them. Otmar Issing himself wrote that article two years ago they put it in the FT, he talked about no taxation without representation and this is going to become the battle cry in Germany because you cannot escape from it.

John Browne: Exactly, completely agree.

Yra Harris: First of all I wouldn’t pay them a dime, I’d say to them you know what, come and get it. Come and get it. They couldn’t bomb Libya so I don’t even know what Europeans are talking about. They had to get the ordinates and weapons from the United States to bomb Gaddafi. So, this is not 1914 .. you’re not coming to get it, you’re not getting paid because you’ve gotten all you got from us and we’ve got nothing in return, you’re trying to steal the financial centre of Europe out of London the French have had their eyes on this forever and now they think that they have a free pass at it. I’d give them nothing and tell them you know what, you’re lucky I don’t send you a bill for all the aggravation and all the court costs that I’ve had to endure and all the other things that we’ve had to endure. And John’s point about Germany and Britain industrially being tied into it is absolutely right and the Brits should start playing that up more and more. And if I was May I would turn around and give them a bill and say this is what you owe us for our good offices all the time that we’ve had to put. It’s ridiculous.

John Browne: I quite agree, I totally agree I just like that one point, was when that wrenched man Brown was Prime Minister, no relation to me, he was asked to give the British a contribution of gold into the European Central Bank which was the second largest of course. And he was so ashamed of the thing that he didn’t want the television or news picking up truckloads of gold being shipped to Frankford from London. So, he sold half of Britain’s gold reserves at just over $300 an ounce and lost Britain billions and billions of dollars on that transaction alone just to save his face. So, he could wire the money rather then send it in gold. It moved Britain from being the fifth largest owner of gold down to about the tenth. It was staggering, really. All these countries that save money like Germany and France have large gold holdings .. they all have large gold holdings. Switzerland is trying to get rid of its gold because its Swiss Franc is so strong and they’re trying to do everything to weaken and be like members of the deprecation gang to get their Swiss Franc’s cheaper because it’s hurting their trade. But that’s a false indication, Swiss basically are like the Germans and savers and are sound money people and savers as a result. The American world has turned savers into spenders, and for spenders, depreciated money is the name of the game. Financial dishonesty really.

Yra Harris: Yeah, you know the name of this show is “Financial Repression Authority” .. financial repression –  the Fed was number one but now number one of course is the ECB. But to close I just want to pick up with what John talked about with the Chinese hoarding gold. John, I think you will appreciate this, if you go back to I think it was November 2^nd 2009, when the IMF had its last gold sale, it sold 200 tons of gold to the Indian RBI at $1,048. Now that’s been a very important level for me. In fact, the last move down in gold stopped at $1,045 and that’s been a very significant level because the Chinese were furious that the IMF sold that gold to the RBI because the Chinese wanted to buy that gold. So that becomes a very critical level of look at all this into what the Chinese truly want to do. And you know what, I think the 3^rd or 4^th largest gold owner in the world is the IMF even though they cry if they don’t have enough funding, you know I always say oh all those good Keynesians at the IMF and I have no problem with Keynesians, but they have a problem from the gold perspective. Why don’t they monetize that gold and turn it into gold-backed bonds? IMF issued gold backed bonds. And you watch how the Chinese would scoop those up in a minute which is why they won’t do it, because they know who’s waiting there to take and accept that hoard of gold.

John Browne: The net position of gold verses currency is that gold is real money .. It means reality will dawn .. If the central banks of the world are united underneath by making sure reality does not dawn. But history has a habit of eventually something happens and reality does dawn. And of course, one of the countries that’s really interested and very powerful in having reality dawn in the west is China. And that’s why I think China will win this battle without firing a single shot. And it’s a sad thing, I don’t think any shot is going to be used if our currency collapses which is what the real threat is.

Yra Harris: And if we know the Chinese, they’ll be bimetallists and because they got a little evening to settle with the Brits over the silver situation in the 1800s so they’ll probably be bimetallists by that time.

John Browne: Oh yes, the precious metals, but the big boys use gold. That’s why silver is a greater investment at the moment because at the moment if you were to imagine a bell curve we’re on extreme left-hand end very very few people compared to the worlds population own precious metals. And of course, an ounce of gold at $1,300 is a lot of money for the average Joe .. But at $20 for a coin in silver is not so bad. And therefore, the mass market will go for silver and that’s a huge on the bell curve and would drive silver up much faster then gold. But gold is the real money in the end and this will defeat players play.

Yra Harris: Right, and I’ll tell you from a trading standpoint, John and you probably know this, is that there’s not a real precious metal rally that takes place without silver leading the way. That’s a fact. When gold ran up to $1,900 it was silver that lead the first leg of it by a lot. So, I keep waiting for that to happen, somebody has their foot on it but we’ll see.

John Browne: It comes from the average Joe .. If those people are worried about their money they buy silver. And that’s why I still believe in silver so I agree with you entirely.

FRA: Well that’s great insight, gentlemen. I know you have a time constraint John but how can our listeners learn more about your work, John?

John Browne: Well I write for europacificcapital.net (http://www.europac.com/) it’s a website and I write for that and there are a lot of articles and things like that. That’s mainly what I do and I sometimes get asked to go on Fox, CNBC, and CNBC Asia to speak about these things, but I never know when that’s going to happen.

FRA: Great, and Yra?

Yra Harris: You can reach me at Notes From Underground or yragharris.com and you click on notes from underground which is where I blog at, but I’m on the Santelli Exchange all the time, and I gotta tell Rick Santelli to get John Browne on! He needs a British voice.

FRA: Excellent.

John Browne: Thank you very much, Thank you very much Yra.

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

LINK HERE to download the MP3 File

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

FRA: Hi, welcome to FRA’s Roundtable Insight. Today we have Nomi Prins. She is a renowned journalist, author and speaker. She is currently working on a new book, “Collusion”, formally called, “Artisans of Money” that will explore the recent rise of the role of central banks and the global financial and economic hierarchy. Her last book, “All the President’s Bankers”, is a ground-breaking narrative about the relationships of presidents to key bankers over the past century and how they impacted domestic and foreign policy. Before becoming a journalist, Nomi worked on Wall Street as a managing director at Goldman Sachs, ran the international analytics group as a Senior Managing Director at Bear Stearns in London, worked as a strategist at Lehman Brothers and an analyst at Chase Manhattan Bank. Welcome Nomi.

NOMI PRINS: Hi – Thank you very much Richard.

FRA: I thought today that we would focus on a recent writing you have that stems from your emerging book, “Collusion”, it’s titled, “A Decade of G7 Central Bank Collusion – And Counting”. It’s a great piece and it’s available on your website and has been reprinted elsewhere as well. I was just wondering if you would like to give us a brief synopsis of that.

NOMI PRINS: That piece comes from some of the conclusions that relate to ongoing monetary policy globally, particularly with the G7 central banks. When I talk about collusion, in terms of the importance of setting monetary policy to the G7 for the G7, there have been, since the financial crisis of the United States, so many multiple meetings, background meetings, calls, statements between the central bank leaders and so forth which collectively have created a monetary policy that is zero percent interest rate and has also connected to it a substantial amount of asset buying or what we now know under the term, quantitative easing, by the major central banks in particular. It’s not that other central banks haven’t been co-opted or have retaliated by trying to set their own monetary policies in their own countries, but it just so happens that this has been a G7 process that has been led by central bank of the United States, the Federal Reserve, and particularly the G3 central banks: the Federal Reserve, the European Central Bank and the Bank of Japan, that has together kept interest rates on average zero and are set on course, since the last year and a half, have raised interest rates up to one percent. But while that happened, 19 countries in Europe including the ECB have rates at negative as well as does Japan, and the Japanese central bank on average comes out to zero percent. And it’s not an individual policy – it’s a collusive collaborative policy.

FRA: So, it’s almost like the collective set of G7 central banks are acting as a unified central bank. Can that be stated?

NOMI PRINS: Yeah. They are absolutely acting as unified and occasionally they have independent commentary to their regions whether that be throughout Europe, in the United Kingdom, or Japan. But the idea is that, even if you take these individual statements and meetings and media coverage separately, the reality is, this is a coordinated effort. For example, last year when the Fed had raised rates and it caused a lot of chaos in the markets in the beginning of 2016. Immediately, some of the other major central banks in Europe and Japan had cut their rate down and it was like a balancing act. But the way the coverage works in general is that it tends to be independent and so what I looked at for the book is all of the communications, collaborations and the timing of all the various monetary moves, which again, have collectively averaged to zero. But there is a process along the way, after the financial crisis, where the Fed first embarked upon zero percent interest rates – They were the first to embark upon quantitative easing by simply buying US government bonds, treasuries and very soon after that, US mortgage bonds from the private banks that needed the liquidity and capital. But this sort of grew and you have the European central banks buying corporate bonds; you have the Japanese central banks buying collections of equity here and there. So the process segued into different details, but it was very much coordinated and over the years, for example, there was a particular problem with debt in 2012 in Europe with a potential credit crisis, after all of these years of cheap money and the potential for defaults, that’s when again central banks got involved and acted in a unified fashion. So throughout the period in the last 10 years since the US financial crisis began, there have always been these iterations of collaboration and them acting as a unit even though their individual leaders tend to behave within their own countries, to their own government, as if they are acting independently.

FRA: It almost seems sort of like a game of passing the baton like an Olympic team running event. I remember back in 2014 there was a time when the Japanese central bank, the Bank of Japan, seemed to have taken over the baton, if you will, from the Federal Reserve and it almost seems that when one of the countries get into trouble they let that country run with more quantitative easing. Do you feel a lot of examples of that?

NOMI PRINS: Yeah, it’s actually interesting. If you look at just the chart of the easening and then hone that into the G3 from the last 10 years, you will see exactly what you’re saying. And then what began in 2013 is that the central bank governor and the Bank of Japan’s [Haruhiko] Kuroda when on this crazy, very fast accelerated pace of quantitative easing. And so what wound up happening was, if you look at a chart of purchasing of Japanese government bonds by the central bank, all of sudden the line went up in almost a straight-line fashion – A very steep line upward because two things happened: the president of Japan and the central bank of Japan were incoordination as well within the country. So there was coordination between letting the Bank of Japan go nuts on quantitative easing and then it worked within the fiscal policy promises of Shinzō Abe, who had just come in as well as the leader of Japan. He wanted to improve the economy. His concept was that he had 3 pillars of an economic policy, one of which was having cheap money and that worked with what the central bank leader wanted to do because he is quite international as well and saw his opportunity to increase quantitative easing. And that also had the effect of accelerating the Japanese stock market, had the effect of accelerating the flattening of the yield curve, purchasing of government bonds and so forth. As recently as a few weeks ago, the central bank leader of Japan, Kuroda, was talking about this idea of unlimited capacity to continue to buy bonds or to continue the quantitative easing process which also is what Mario Draghi, in slightly different words, was doing in Europe. So, it is a passing of the baton and you would think that after 10 years of what began, according to the Fed anyway, as emergency measures in the wake of the financial crisis and the idea of if we go back then was that there was no liquidity in the banking system, and that there was a fear that was stoked by the Treasury Secretary Henry Paulson, the Federal Reserve head at the time Ben Bernanke and the New York Federal Reserve president Tim Geithner who all basically got together and colluded to indicate that: unless there was an immense amount of liquidity offered to the banking system, everything would seize up and people wouldn’t be able to get their money of out ATMs. And so they created this bailout from the standpoint of congress, but the bigger bailout was what the Federal Reserve and central banks did which was at the time, start to bring bank rates down to zero at the end of 2008 and then start to buy bonds. Then when the Feds stopped, the European central banks started and it accelerated and then the Bank of Japan continued to accelerate. And then you have smaller central banks involved such as the Bank of England who have half a trillion or so assets on their books. They have kind of dibbled in and out, but recently they have talked about expanding their quantitative easing program, Mark Carney did, the head of the central bank there. And they kind of use it as this tool – They promote it as this tool, to either stimulate growth in economies or to create stability in opposition to some type of a problem or a process. When we had the problems with Hikoshimi, we had the other G6 central bank governors get together and promise that they would help with whatever liquidity was needed for Japan to navigate that crisis. So, what began as an emergency measure has become normalized.

FRA: In the collusion article, you mentioned that the central banks have amassed assets on their books worth nearly 14 trillion. Is that for the big 3 central banks or the G7?

NOMI PRINS: Yeah – that is exactly right. The G3 are at about, give or take, 13½, then you add in the UK, Canada and other banks and it’s probably a little bit more than that, but on average it’s between 14-14.3 trillion – It’s a fairly large number. If you consider that that number was basically zero 10 years ago.

FRA: And you mentioned the result of all this is the fuelling of bubbles and money that isn’t serving any productive real economy purpose because it happens to be in lockdown. Can you elaborate on those?

NOMI PRINS: So if I’m a central bank and over some period of years I decide to create electronic money, we refer to it as printing money, but the idea is: creating some fabrication for money that is then used in an exchange process for either government bonds or, in the case for the US for example, mortgage debt from the banks. What that does is puts this fabricated money into the system which didn’t come from tax receipts or organic growth in companies, it was merely manufactured. And it was an offering return for the Fed amassing debt on their books – Debt in the form of treasury bonds and mortgage bonds. So, what that means is that it effectively created 14½ trillion dollars of money that did nothing but an exchange for debt. And if you’re just exchanging debt and you can’t determine how that debt would’ve been spent anyway, then it’s really just sitting there on the books for no apparent purpose. Now it’s not the Fed’s job, technically, to do this, but if you had examples conceived of a process by which instead of exchanging fabricated money for debt, you invested it in some sort of a national bank or you develop roads or railways with it or energy systems or whatever it might be – That is productive. Whatever the process is there could have been productive ways to utilize fabricated money to actually enhance the real economy, but if you’re just buying debt, then you can’t trace that debt to the real economy. In fact, for mortgage bonds, all you’re really doing is giving banks liquidity or giving them capital to do other things with because you’re not telling them what they can or cannot do, you’re not stipulating what kind of loans they can and cannot make, it’s just capital that is given to them – Then, that money is not being used for any productive purpose. It is on lockdown at the Fed because they basically offered it out. They have in exchange received these bonds or this debt and they are not going anywhere – They are just sitting on the books not being used for any financing or any productive purposes, real growth, wages, hiring people, research and development or really anything. And that’s been copied in Europe as well on the European central bank in terms of trillions of dollars, on the books in the Bank of Japan and so forth. So none of that money is really being used, but the way it gets discussed is that it somehow is connected to economic stimulus, but if it was actually stimulating the economy then you wouldn’t have a 10-year policy where it has to keep continuing. So, what you have now after 10 years is the central bank leaders, for example Mario Draghi at the European central bank recently, who is saying, “Hey, you know what? This is the only thing that needs to done. Creating a monetary policy alone or low interest rates and buying bonds alone isn’t enough to stimulate the economy”. So, after 10 years they are saying we have to keep going because what we did wasn’t enough and somehow if we keep doing it and other measures get put into that, such as a type of fiscal policy, then altogether after we have done this for 10 years somehow it will relate to the economy. So, these people themselves are basically saying that this process: their collusions, methods, strategy and policies really haven’t done anything for 10 years.

FRA: You even point out how Stan Fischer who was the Vice Chair of the Federal Reserve, who recently just stepped down from that role, essentially admitted that the Fed caused low interest rates globally while failing to achieve the economic growth as promised.

NOMI PRINS: Right. Stanley Fischer was the academic mentor for the doctorate for both Ben Bernanke and Mario Draghi who ran at different times with some overlap, between the Federal Reserve and the European central bank so it’s interesting that Stanley Fischer, who was also the Vice Chair of the Fed for a number of years before resigning, was one of the supporters of this policy throughout his years of a mentors as well of his years of being at the Fed itself. So he was one of the very people who would’ve voted at various meetings and so forth to continue to keep rates low and the effect of the Feds keeping rates low was that they were kept low globally. Now what he didn’t say was that they were actually kept low globally because they are having communications with each other and that this was not a choice, it was kind of a mutual decision and it unfolded that way in terms of events and in terms of when rates were reduced versus when assets were bought by the various central banks. And at the end admitted that it really didn’t stimulate growth and not only did it not stimulate growth, but even the Federal Reserve itself had a report out a few years ago where it indicated that after a number of years of these policies in the US it actually increased inequality. The way it does that is that this money that is being created is really only going to top bankers and through governments – It’s really not trickling down into the real economy which means that cheap money is also being used to fuel these bubbles. If rates are at zero on a 2-year or close to zero on a 10-year depending on the country, you’re not going to be investing in government bonds – You are going to be looking for something else to get returns out of. And you have this money coming to you cheaply, but not if you’re a regular person. If you’re a regular person, you are not getting money at zero percent or close to zero percent like a bank does, like a bank can give it’s major clients or like major corporations can raise debt for themselves. A regular person is stuck with much higher rates whether it’s personal loans, credit cards, student loans or even mortgages – They don’t have the benefit of the cheap money. They suffer the consequences of not having more secure investments like government bonds or even CB’s or even good rates on a savings account like they would’ve had historically. So, they’re sucked into this vortex of the stock market whether they are actively involved or not whether through their pensions, their life insurance contracts or whatever it might be because there is nowhere else for those pools of money to invest and get a return that even keeps up with a very low inflation that we’ve had globally in the last 10 years and we’ve had very low growth. The bubbles are a result of these policies and even some of the superbanks/development banks such as the IMF indicated that this is a problem, that bubbles are a problem. Everybody is aware that these policies don’t promote growth, create bubbles in the riskier markets and yet they can do nothing else but continue them.

FRA: So with all of these failed policy experiments behind us after what has happened, this brings us to the big question that you ask: Why should we have faith that the Fed or any other central bank has any clue about what to do next?

NOMI PRINS: Right – Because all they’ve done for 10 years is effectively the same policy which they then admit has not gotten them any closer to what they had indicated the policy was initially supposed to do, which was to stimulate growth. In emerging countries it is more volatile, but slightly higher, but in terms of real growth it’s not there. In terms of being able to invest in more secure bonds for the population or for again, pensions and insurance, you can’t do that. And so what are they going to do if there’s an actual crisis. A crisis can come in any form. It could’ve come from, unfortunately, the hurricane that just happened in Florida. I’m not saying that will create a crisis, but you have a situation where a lot of development, real estate, leverage and cheap financing going into these larger development companies and through the main banks and so forth, is hit was a stoppage in occupancy rates. Or having to rebuild and having to wait for money to come in and that trickles in to potentially defaulting on certain payments or loans. It could be anything that starts to crack these asset bubbles whether that’s a natural disaster, a geopolitical thing, a new war or whether it’s simply that rates do get raised enough in one area, and I don’t believe the Feds are going to raise rates again this year for all of these reasons, but all of these things start to become cracks to let the air out of these bubbles at which point what do central banks do? They will double-down or triple-down on what they have done. That could work for a year or two years, but it’s still an artificial stimulant to the global economy. It’s still not healthy. It’s still an external source of capital that is unlimited and unregulated from the standpoint of a policy, and that’s very artificial and creates a lot of ongoing inequality and inability, ultimately, for people to have money invested in the future and be secure about it.

FRA: Given this lessening faith or growing sense of lack of faith in central banks – Could we get a Wile E. Coyote moment in the financial markets where there is all of a sudden a large drop in the equity markets?

NOMI PRINS: You could in the extent that something happens from an external perspective whether that’s a sector that continues to default or something happens to the real estate sector or the energy sector, right now energy is going to be a little better because of what just happened, retail which was just shifted in terms of the way in which people shop such as consumers losing confidence – A lot of external things can happen that deflate confidence in what is actually a stock bubble that could drive things down. Now this policy, these 10 years, has been really unprecedented in terms of this collusion between central banks. If it were not a global policy, it would be more likely to crack in one area which would reverberate throughout the world, but because it’s collaborative, artificial and collusive, there has been this way of keeping the house of cards up. Any major thing that happens can also take that down very quickly. The one thing we learned just studying crises historically is that there has never been a global reaction of this magnitude to a crisis. What tends to happens when something hits the markets is that they do tend to go down faster than they went up. That hasn’t happened yet, but if there’s a confluence of the wrong events, it definitely could.

FRA: If that were to happen, do you foresee the central banks again coming in in a consorted way to save the day? Especially, considering that there’s a concern on pension funds and insurance companies with large holdings of equities and the central banks are not looking forward to bailing them out if there was another financial crisis affecting them.

NOMI PRINS: I don’t think they care so much about pension funds and insurance companies. They care about the financial system as a whole and I do think that the first thing that would happen in the event, this happened in 2016 which showed a precursor to this, is in the event that something catalyzes a very fast day or two fall in the stock market, that central banks do come in and coordinate some sort of policy that boosts them up, but the fact is there is no ideas for them to do that this time simply because they are almost collectively at negative, aside from the Fed. The fed could go down by the point it’s gone up since December 2015 and it could go negative, but there is not much more room to go. It would boost the markets again though if things really fell and the Feds say that they’re going to reinstate quantitative easing in order to stabilize the economy or stabilize the financial system or promote growth or whatever it is they’ll say they’re doing it for. So, then you’ll just have volatility in the markets in that way. You could have a very steep drop followed by the sort of “save the day” efforts on the part of the major central banks and you’ll have an uptick. Then let’s say confidence goes down because there isn’t a lot of room to continue to do that in the same magnitude, then the markets go down again. You can kind of see how that might precipitate a jagged type of bear market with major ups in between when central banks do announce movements, which they would announce to try and save the market. All of this just means that their main function has become to continue to keep these asset bubbles inflated. A couple months ago when the private banks in the US had to give the results of their stress tests, basically stressing their books to the extent of what could happen in certain crises situations, and the Feds said that they all passed with flying colours while having mostly not passed the year before. So, somehow in a year they managed to magically change. They turned around and said that rather than saving extra capital or whatever, we are going to just buy our own stock. That just creates more inflation of these bubbles and that why the financial sector increased by so much more than some of the other sectors because all of a sudden they were given a green light by their own regulatory body, the Federal Reserve, to just use this, effectively 1% or less, money to buy their own stock and to pay themselves dividends that amount to two more than that – Effectively using the Fed’s policy to freely inflate their own stock by paying themselves dividends on their own stock that they bought. It’s kind of market manipulation if you think about it, but it’s legal because the regulatory body that is supposed to control this sort of thing green-lighted it.

FRA: So when does this all end? You mentioned ongoing emergency procedure spells an eventual recipe for disaster if you think about growing levels of central bank assets, you mentioned 14 trillion, and given the coming even much higher numbers on unfunded liabilities that may need to have central banks monetize further debt by governments, but is the end point limited by perhaps the interest rate? Or if you sort of look at it as a lever between debt and interest rates for servicing debt, is the end point involving interest rates?

NOMI PRINS: At some point, what’s going to happen is the interest rates will continue to remain low and again, I don’t think any of these banks are going to move rates up this year, but when a disaster happens, so not necessarily when rates get raised a smidge although that certainly does push that lever when the fact the Feds have moved rates by even just 1%, has created some more instability in terms of defaults and international corporate defaults and so forth because you have companies that have been mostly funded through US banks and other major private banks in dollars. They have multinational operations and have to repay them in dollars, but their currency isn’t worth as much, and the interest rates go up again for them so they lose twice, and they’re not growing as fast so don’t have as much profit to cover it. So that stuff is happening throughout the world organically. The lever is really when those numbers start to tip, but I don’t know when that is. I used to try and find the end point, such as when the European central bank actually stops using their quantitative easing program and then they get to the date where it’s going to stop and then they extend it. They have this ongoing elasticity in terms of their policy, but what will happen besides monetary policy in central banks is that the sheer development and growth of companies that are highly, highly leveraged relative to even how they were before the financial crisis, just simply aren’t making enough money to cover even the minutest of interest rate payments on their debts. That’s when stuff starts to collapse, not necessarily if they’re raised, although that would certainly hasten it and that’s why it’s kind of stopping right now, but when they’re actually simply not growing enough organically to make their own payments. And there’s a lot of that happening. For example the son-in-law of the president of the United States, Jared Kushner, he’s a real estate person; his major building 666 Fifth Avenue in New York City is completely overleveraged and it’s occupancy rates continue to become lower, which means he can’t pay for even the debt he has with the people who are supposed to be renting out space in his building – That’s an organic problem. On one hand it’s because you’ve taken out too much debt, on the other hand it’s because people won’t pay you for the provision, space, service or whatever because they don’t have the money or want to spend that. That’s when things start to collapse from an organic perspective, unless again we have a major war or a major sect or something like that happens more acutely and will more quickly create some sort of collapse.

FRA: But not really in terms of the time frame?

NOMI PRINS: Well if we go back into discussing negativities with North Korea, if the defaults have been increasing in the various sectors throughout the world continue to increase at a more rapid rate – You could see a crisis happening within the next year even though you’ll have the cavalry of central banks attempting to double-down or triple-down on what they’ve done simply because there will at that point be nothing on the gross side at all to enable companies, particularly small-medium sized companies that hire a lot of people, to pay off their debts. And if they don’t hire people they have to fire people. If they fire people and they aren’t paying people, people can’t buy stuff. If people can’t buy stuff, it all goes down very quickly and becomes a very quick spiral. You’re starting to see that. You’re starting to see defaults in various sectors and if that continues it could spiral down within the next year and that would happen naturally.

FRA: That’s great insight Nomi. How can our listeners learn more about your work and also when is your new book, “Collusion”, coming out?

NOMI PRINS: Collusion is slated to come out on May 1^st of 2018 and in terms of anyone who wants to read more of my books or any of my writings I do have online or just in general, you can come to my website which is just my name, NomiPrins.com, and just check it out.

FRA: Great – Thank you very much Nomi.

NOMI PRINS: Thank you so much Richard.

Transcript by: Daniel Valentin <daniel.valentin@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.

FRA: Hello, Welcome to FRA’s Roundtable Insight. Today we have Adam Andrzejewski. He is the CEO and founder of Open the Books (OpenTheBooks.com), a government watchdog organization not funded by government, and he’s a national leader in bringing transparency to government spending. Welcome, Adam.

Adam Andrzejewski: Great to be on the program, Richard. Thank you very much for your interest in our work.

FRA: I notice on your website you initially set up homepages as the nation’s largest publisher of community telephone directories?

Adam Andrzejewski: That’s right, I’m probably the only guy you’ll ever meet anymore that actually monetized a yellow page publishing company in the internet age. So I had the good fortune to sell my shares to my brother and an investor from the east coast back in 2007, that was 1 year before the iPhone was invented.

FRA: Wow. And then you ran for governor of Illinois with a pledge to create this organization, correct? The OpenTheBooks.com?

Adam Andrzejewski: So I ran for governor based on my private sector success. And I knew in Illinois, where we ranked high we should have ranked low and where we ranked low we should have ranked high and I felt we needed new blood, a new day. I ran on two things, both of these things we’ll talk about today. A hard forensic audit of all state and local spending, you know evidentiary, follows the money, holds up in court. If you think about it it’s how we caught Al Capone back in the day and Illinois is horribly corrupted on every level and we needed that audit. And that resonated, that idea resonated on the campaign trail. The second idea I ran on was the tagline slogan “Every dime online in real time” aggressive financial transparency. You know I lost the race. I lost about 5.5% of the vote, I’m comfortable with that. But what we knew was the ideas resonated and I’ve carried those forward at our non-profit charitable organization at OpenTheBooks.com.

FRA: Great, and I just want to point out before we get in some of the details on what you’re saying as well as what your organization is doing about what you’re saying. Just want to point out that every fact, statistic, and development that you’re going to mention, we see as the root cause of increasing central bank and government interventions in the economy and in the financial markets. So all of these spending issues, deficit problems, challenges and overall debt levels the challenge by government to control the burden of that debt, we see as a root cause of increasing central bank and government interventions.

Adam Andrzejewski: Well I think the founders of the country thought the same way. They recognized that knowledge is power, they actually wrote transparency into the United States Constitution. It’s article one section nine, and this gives us at OpenTheBooks.com the authority as citizens from the private sector to open the books on government. So it simply says that a regular statement and account of receipts and expenditures of all public money shall be published from time to time. So Richard this is our information, the people own this government spending information and at OpenTheBooks.com our mission is to post online every dime taxed and spent at every level of government across the entire country. We’ve captured 4 billion federal state and local expenditures and it’s 80 cents on every dollar of spending at every level right now. And we have visibility over the course of the next 18 months to get that first very unique data set so you’ll be able to track every single tax dollar from every level of government.

FRA: And today you’ve compiled some very interesting facts and statistics. First on the state of finances in Chicago and Illinois, how that is evolving. And then also for municipalities, other U.S. states. Do you want to bring some of those up?

Adam Andrzejewski: So I think in the city of Chicago and across the state of Illinois, the number one public policy problem that affects the delivery of all government services whether it’s education, housing, the war on poverty, the soft social safety net, medicine, the delivery of healthcare, it’s quite simply the number one issue, is the extreme level of pay perquisites and pensions for public employees. In Illinois this summer we identified 63,000 highly compensated public employees that make more than $100,000 per year. For instance, in the city of Chicago, Rahm Emanuel paid out nearly $300 million worth of overtime last year. And 1,000 city workers got at least $40,000 in overtime alone. You’ve got people for instance, phone operators in the police department that last year made nearly $200,000 because they got $126,000 worth of overtime.

FRA: Wow.

Adam Andrzejewski: You’ve got 4,800 police officers assigned as detectives that made between $10,000 and $126,000 in overtime last year trying to solve the homicides and thousands of shootings in the city. It’s a mismanagement of public resources, it’s a mismanagement of taxpayer dollars and we’re holding Rahm Emanuel accountable.

FRA: And for overall in Illinois as well?

Adam Andrzejewski: Well it’s just out of control across the whole state. So for instance, there are 30,000 Illinois educators that last year got a check for over $100,000, you know paychecks. Now 20,000 of them are actually currently employed in their school district. But the 10,000 of them, they’re out the door, they’re retired on six figure pensions. So look, you can educate kids, or you can pay a massive education bureaucracy. The delivery of government services is conditional on reasonable levels of compensation. What we’re showing in Chicago and across Illinois, they’re just completely out of control.

FRA: Probably the easiest way to do it is, I remember an example given by Martin Armstrong, he basically said if you have 10 government employees and 4 of those retire, that those 4 need approximately say 3 units of retirement pay pensions and all that benefits, you have to hire for the other 4. So you need a budget then of 13 units. You’re going to raise property taxes 30%, you know it’s unsustainable essentially.

Adam Andrzejewski: In the state of California, when we looked at their highly compensated public employees, and by the way, in California we found 220,000 of them. We took a look at one position, and it was a water management position I believe it was in Los Angeles County. And the position was a million dollar a year position because there were two $350,000 pensions that taxpayers were paying out of the pension plan. And then the current one was hired for about another $350,000 on salary. So you had two out the door, one currently working, and $1,000,000 at stake.

FRA: Wow, that’s in California. So you’ve got some examples you’ve sent also on New York?

Adam Andrzejewski: So in the state of New York it’s not much better than Illinois or California. New York has 170,000 public employees that make over $100,000 a year. And look it’s out of control like every other state. For instance, in the New York City public school system you’ve got 700 janitors, they’re called “custodial engineers” they’re janitors in the public schools. And they can make up to $206,000 a year. Now, we took a look at the average principal salary in those New York City public schools, the average principal makes $125,000 and there’s 700 custodial engineers that out earn the average principals salary.

FRA: Have you also taken a look at projections based on the statistics that you have, projections on unfunded liabilities and sort of unsustainability limits?

Adam Andrzejewski: We leave that for the actuaries. Obviously, those are complicated calculations, but we actually read all the reports. So a number of years ago I remember, this is an interesting story about 2012, I wrote a piece based on what I had read in one of the pension system reports. And it was the Illinois teachers retirement system, that at the time had about a $100 billion unfunded liability and today it’s probably about $130-$140 billion unfunded liability. And we wrote that that system very rapidly was going to run out of money. And I remember getting an email from the spokesperson of the system and he said look, this is scaring people, you are wrong, this is factually incorrect retract it. And we wrote him back we said no, here’s the evidence. About a year and a half later an email was leaked from the executive director of the teacher’s retirement system. And he confirmed and every single year to date he confirms that unless something is done with the system, if the employees need to work a little longer, pay them a little bit more, receive a little less lucrative cost of living adjustment, if these things are not done, the system very very rapidly in the early 2020s will run out of money.

FRA: And so if we look at how governments are coping with this, you know how are they reacting, what draconian measures they are currently resorting to, can you identify some of those measures currently and in the near future?

Adam Andrzejewski: Well I think Illinois is a great example of this. And you know its taxes for as far as the eye can see. So for instance right now there’s huge uproar is in Cook County, Illinois. And that’s the country where- Chicago is encompassed by Cook County. They’re taxing everything, they’re even taxing soda pop. They didn’t tax the Starbucks drinks and things like that, they tax the soda pop. And so regular rank and file people are just in revolt. The soda pop tax in Cook County has a lower poll approval rating then president Donald Trump has in Cook County. It’s very very interesting. So whether it’s ever escalating property taxes, whether its taxes on businesses for a headcount of employees, if they can think of a tax they’re putting in a tax. And of course, that’s what driving everybody out of here, Illinois loses businesses. We’re a very narrow state, there are actually five geographic state borders, we border five states. And it’s very very easy just to move a few miles and jump over a state border to a different state for a future of prosperity.

FRA: And also on sort of a government taking over everything, the militarization of federal agencies, can you go into that?

Adam Andrzejewski: Well I think that once you can’t pay your bills when you have ever escalating taxes, when you have a regulatory regime that continues to regulate everything, tax everything, at a certain point- you know the federal government has 36,000 lawyers enforcing those regulations? Now only 12,000 work for the Department of Justice pursuing crime and criminals. So you got 24,000 federal lawyers enforcing the regulatory states of America, and that’s why people feel over-regulated. So after you grab legal power, and somebody has to enforce the regulations and the taxation. What we have shown, and we broke this on the editorial page on the Wall Street Journal, our honorary chairman is Dr. Tom Coburn, the former U.S. senator from Oklahoma, and we wrote a piece that broke our oversight report. The piece was entitled, and many people still remember this piece, it was called Why does the IRS Need Guns? And there were two major findings in our oversight report, now these were the federal agencies outside of the department of defense. So we found 67 federal agencies bought $1.5 billion in a 7 year period of guns, ammunition, and military style equipment. And 53 of those agencies were not a part of homeland security or the department of justice. These 53 agencies were rank and file, traditional, regulatory, paper pushing agencies like the IRS, like Health and Human Services, like the Animal Health Inspection Services, like the Veratrin’s Affairs. So we found that an IRS special agent can carry an AR15, the Health and Service agents are trained on the same special weapons platforms that our Special Forces military warriors use. They’re trained by the same vendors to use those weapons, and it goes on and on. I just want to point out, Richard, that the second finding in that report was equality as interesting. We quantified for the first time 200,000 plus federal officers with arrest and firearm authority. And that exceeds the number of United States marines at 182,000.

FRA: Wow, amazing. And in terms of what’s happening, you referenced earlier some of the time frame considerations, any idea on how this unfolds timewise? I know Chicago Illinois is sort of fairly the first to have these challenges, but how do you see it playing out between other municipalities, other cities, and states across the country?

Adam Andrzejewski: So, if they follow the lead of Illinois, they’re going to be in trouble. Obviously, the Illinois legislature just hiked taxes with no underline spending reform, the budget they passed with the tax hike is still $1 Billion underfunded. And taxes went up from roughly about 3% to, it was about a 67% tax increase. So the fundamental reforms weren’t there. We had racked up $15 billion worth of unpaid bills, and now Wall Street is going to bear the financing of those bills. To date, Main Street has financed it just waiting to get paid. But now, as of last week, Governor Bruce Rauner has said that he’s going to bond out $6 billion of the $15 billion of unpaid bills. So look, every single day in the state of Illinois we look more and more like Puerto Rico and as a matter of fact, we might be worse than Puerto Rico.

FRA: Wow. And all of this is also causing brain-drain and wealth-drain. Just before we started you gave the example from your hometown.

Adam Andrzejewski: So back in the late 1970s, I grew up in Kankakee County which is about 100 miles south of the city Chicago. And I grew up in a fairly rural area, our County had 100,000 people, and we lost our two main manufacturers. And nearly overnight the population dipped from 100,000 to about 75,000 people. And it took over 20 years before the population recovered. And it was even more than the loss of jobs, it was moral decay. Before I ran for governor in 2010 I took a look at the number of sex offenders in the city of Kankakee and it was 126. And I looked at a similar size town just north of Chicago, and they had 1. So not only do the jobs leave, but capitalism is the best system for honing an individual, keeping them engaged within communities and preventing decay of all types.

FRA: I guess all of this is quite negative, but what your organization has been doing is quite positive, serving as a beacon of light. Can you go into some of the activities that your organization is doing about these developments?

Adam Andrzejewski: Yes. So one of the major issues and lack of transparency at the federal level is the federal pensions and retirement annuities. And with the federal pension systems, taxpayers are on the hook for a $3.5 trillion unfunded liability. But right now Richard, you and I, we have no right to know, we have no ability to see who the retiree is, how long they worked, what they put into this system, what taxpayers put into this system, and what that retiree receives in retirement. We have no ability to look at the federal agencies to see who is confirming the most for instance 6 figure retirement pensions. And we have no right because all of this pension data is not subject to the Freedom of Information Act. And so we have legislation that we’ve put together with Florida Congressman Ron DeSantis and it’s a great bill. The bill is called Federal Pension Disclosure Act and it already has 10 sponsors in the house, in congress. And we’re optimistic that this will pass the house and we’re looking for Senate sponsors. So this would open up all of that.  I mean wouldn’t you like to see Lois Lerner, she was the IRS boss who is rumored to have retired on full pension benefits? She allegedly led, she plead the fifth in front of congress and she allegedly led the targeting scandal of the conservative and tea party groups ahead of the 2012 election for Barrack Obama. I just think all of this needs sunlight and that’s just one of the areas that we are aggressively moving forward to open up.

FRA: Now a lot of people have pointed out the potential for a movement to the far left. I mean you mentioned capitalism just a few minutes ago and there may be some misunderstanding by the millennial generation of the current economic system, especially in the light of what happened during the financial crisis and the causes of that. Do you have any initiatives that can reach out to the millennial generation?

Adam Andrzejewski: Yes we actually use the latest in technology to display all this data. And millennials love having the tools and the ability to hold the political class accountable. So I think it’s a generation that naturally fits our mission and vision of empowering citizens with robust facts and hard data. In the year of, fake news is talked about all the time, well this information actually comes from the government, so it’s true. And I think people like having that ability to just circumvent and ask hard questions demand answers and hold people accountable for tax and spending decisions.

FRA: Great, and how can our listeners learn more about your work? And do you have a service or a newsletter they can subscribe to?

Adam Andrzejewski: Yes, so if you come to OpenTheBooks.com all you have to do is, if you want to give me feedback on this interview just do the contact us, and then you’ll have subscribed to all of our services. So that’s just the easy way to do it, is just come to OpenTheBooks.com and send me an email through the “contact us” function.

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

Adam Andrzejewski: Richard, thank you for your interest in our work, I look forward to keeping you updated.

FRA: Great, and we’ll end it there. And yeah Adam, we’ll do this again. It will be interesting to see how this continues to evolve. And especially on the reaction by governments, what they’ll do, and also perhaps maybe if the federal government steps in to do like a bailout of the states, if that’s going to happen in some way. So it would be interesting to see how this evolves.

Adam Andrzejewski: It really is, and we’re going to be there for it. I mean you and I, we’re young we got a lot of years to go and this probably in states like Illinois won’t take too long. I mean you know the levels of debt, the levels of spending, the lack of- the political structures that have been cemented in place just ensures that all of this continues to a race to the bottom. So it’s not a question of if, it’s just a question of when. And you know the trend can continue for a good bit. But at the end of the day it does stop, and when it stops it’s going to be a painful experience. And I don’t think it’s going to take that long.

FRA: Right, actually I was just talking this morning with an economist who’s originally from Argentina and now is working in Canada. And all the economic devastation down there, he mentioned how prevalent and how the Austrian School of Economics is in trying to sort of bring back the economy positively from down there. So they’re sort of much ahead of the evolutionary process if you will then where we’re at now in the US. I know your partner Matt, he takes a very close view of the Austrian School as well.

Adam Andrzejewski: Right, right. No, I kind of looked at things through more of a political frame. So what I hear or what I see is just further genius of the system instituted by the founders. So it’s conditioned on federalism. So the laboratories of the states, they try out all these different ideas. The successful states over time where a lot of people want to live have the better ideas. That’s what you’re seeing, you’re seeing people moving from California and Illinois and New York and they’re going to states like Texas and Florida. And those states eventually grow in political power, in federal power and the states with bad ideas, they die. And they become less powerful over the course of time. Now, things are so bad in some of these states, you know California is the most populous state and Illinois is the fifth most populous state and New York is the third most populous state. I mean, can these states bring down the good old United States of America before federalism rights the ship? And I think that’s an open question. Federalism may be moving too slow to help us this time.

FRA: Yeah, that’s a very interesting observation.

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

LINK HERE to 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.

FRA: Hi, welcome to FRA’s Roundtable Insight. Today we have Alasdair Macleod and Jayant Bhandari. Alasdair is head of research for GoldMoney and an Austrian economist. He has a background as a stockbroker, banker and fund manager. Jayant is constantly traveling the world looking for investment opportunities, particularly in the natural resources sector. He advises institutional investors about his findings. He worked prior 6 years with U.S. Global Investors in Texas, a boutique natural resource investment firm, and also for one year with Casey Research. He also is a follower of the Austrian School of Economics. Welcome, gentlemen.

Alasdair Macleod: Thank you for having us.

Jayant Bhandari: Thank you very much, Richard.

FRA: Great, today I thought we’d do a discussion on currencies, commodities, cryptocurrencies, what’s happening there. An update from India, and also just what monetary policies are doing by the major central banks, some recent writings by Alasdair in that regard. So to kick things off, just wondering Jayant if you want to give an update, we were just talking about the recent announcement by the Reserve Bank of India?

Jayant Bhandari: Richard, a very funny thing came out a few days back by the Reserve Bank of India. Firstly, the reality is that in this electronic age, when you have deposited all the money into the banking system the government should have released the effect of the demonetization very soon after the end of December 2016. And I’m talking about the demonetization process that has started in November 2016. Now a few days back they came out with a new saying that 99% of the demonetized currency had been deposited with the bank by the end of March 2017 which basically means that more than 100% of the money in circulation was actually deposited. Which basically if you try to understand what this means is, not only legal tender was deposited, the counterfeit currency in circulation also ended up getting deposited with the banking system. So not only did the banking system of India completely failed to stop corruption or black money, they actually converted counterfeit currency into legal currency. Now also if you read the recent news releases, they have also come out with the latest survey reports, which now tell you that the economic growth has fallen to 5.7% which is now much lower than that of China. And it clearly shows that the Indian economy is now starting to stagnate. In my view, it was stagnating 6 months back and it’s actually regressing in my view. Two more things before I go complete my response here Richard. Most of the growth can be attributed to destruction of the informal economy and transfer of that economy to the formal economy. Which in real terms means that they are destroying the economy, not improving the economy. Also, a huge amount of GDP increase is a result of massive increase in government spending. Which is of course as you and I know is not sustainable and it’s actually not helpful to the economy or to the society. So there are constantly negative news coming out of India right now.

FRA: Your thoughts Alasdair?

Alasdair Macleod: Well I find that fascinating. It doesn’t surprise me, before we came on we were just sort of remembering last time we spoke about this, and I think you Richard agreed this is going to be economically destructive. Yet the Reserve Bank of India count money has been sorted, which means that there’s got to be some money that which money in there. And the economic growth figures has been fiddled with. There is no way that you can destroy the money and then expect a growth of any sort to occur because economic growth or contraction is purely a reflection of the money SKIP Economic growth simply collapses. It seems to me that what’s happened is that the figures have been filled one way or another, as Jayant suggests, to come up with something that looks reasonable in the circumstances. I wouldn’t believe for a moment that there’s been economic growth of 5.7%. I don’t actually hold any SKIP. Is completely meaningless, because you can’t get at what is going on in the economy, whether it’s progressing or not. I would say that that figure is completely false and anyway pretty meaningless.

FRA: Jayant, what has been the effect on the currency? The exchange rate and purchasing power and inflation/deflation?

Jayant Bhandari: So food prices in the country have now started to rise. So if you remember, Richard, when we talked initially soon after demonetization, I was telling you that food prices had fallen drastically. Food prices were down about 50% or so. That seems like good information to most people, but the reality is that food prices fell so much because poor people were unable to feed themselves. Hundreds of millions of people had lost their jobs, and they had no option but to reduce the food consumption. Now that also meant that farmers could not really make money, and they did not sow properly for the next season which now means that food prices are now increasing across the country. So that is the harm that has been done to the inflation/deflation situation. Deflation happened for the wrong reason and now inflation is happening for the wrong reason in the country.

FRA: And what has been the effect on gold prices in rupee terms locally?

Jayant Bhandari: So Indian currency has surprisingly done very well in the last 7 months. Now, these are all in the short term. I don’t think should pay attention to the currency prices because these changes tend to be noise. And there is another thing that is happening that Western institutional investors continue to be very euphoric about India; the reason why they keep pumping money into the Indian stock market. And as a result of that more Western money keeps flowing into India which has helped the Indian currency. Now another thing that is happening is the situation with gold and Bitcoin. Bitcoin is being bought by Indian states, a lot of people now come to me asking about Bitcoin and a lot of people have increased their consumption of gold. They have also increased the storage of gold in Hong Kong, Dubai, and Singapore. This is what rich Indians are doing, so in my view from what I see, gold consumption has gone up and Bitcoin consumption has gone up in that country as well.

FRA: And you were mentioning earlier about the rise of other metal prices like the base metals over the last year period, can you provide some commentary on that, Jayant?

Jayant Bhandari: Well I mean this is, of course, a good sign in my view that China continues to consume a huge amount of commodities. Which in my view underpins the future of China which is that China continues to grow. And I continue to be very optimistic about China and therefore commodities and I continue to be optimistic about gold, but for the wrong reasons which is that many of the third world countries continue to stagnate and suffer as a consequence of bad policies.

FRA: Alasdair, your thoughts on the rise of base metals and how that relates to the precious metals?

Alasdair Macleod: I think Jayant is absolutely right about China. China if you like, is a mercantilist economy. It’s driven, if you’d like, by policy from the center. And the policy from the center on various 5-year plans, and they’re on the thirteenth 5-year plan now, is basically to create an industrial revolution throughout Asia. At the same time, the spice route spice road projects the OBOR project is beginning to cut down substantially the transcontinental shipment times. There’s an enormous number of trains now going between China and Europe. And we’re now in a position where SKIP can put a brand new car on a train, ship it over to China on that train and have it in a showroom in Beijing in 15 days. That time is going to come down too, around about 10 or 12 days eventually and probably in the not too distant future. And this compares with sea transport times of at least 30 days for the same thing. At the same time, you have companies in Europe like Zanussi Italian white goods manufacturer. They’ve got factories in China and they’re shipping their white goods by rail now in contain raised shipments. And again they’re getting the benefits of their goods coming into Europe within literally almost a fortnight out of the factory. Now, this is very very beneficial and China is in effect driving the economy of the whole of the Europe and Asian continent. It’s becoming particularly visible in the Asian part, it is becoming more visible in the European part. The German economy is going like a train, it really is. Other Eurozone economies are if you’d like, they don’t have the manufacturing porous but nonetheless, they are beginning to recover. And this is really the story I think for the next 2 or 3 years at least as far as Europe is concerned. So when it comes back to base metals, the demand for base metals I don’t think we’ve seen anything yet. There is another aspect of this and that is the currency aspect. What China basically wants to do is to do away with using the dollar as a settlement currency for her trade. And she’s made enormous strides to achieve this end. And there will come a point where she will take a view on her reserves, which total roundabout $3 trillion equivalent, most of it is in dollars and about a trillion of it is invested in T-bills and bonds, treasury bonds and so on. There come to view about that relative to other currencies. And I think we’re on the edge of China reducing her reserves in favour of buying base metals because she needs copper in particular. She’s redoing the whole of her electric metalwork, her grid. Air conditioning is a huge market in China. And the building of these cities, I mean we think these are just castles in the sky, but they’re not. Actually what China is doing by building these cities is she is seeking to rehouse huge numbers of people, up to 200 million people is the plan, where the get redeployed from low-value agriculture and that sort of subsistence existence into these satellite cities where they will be redeployed in manufacturing. You know in all the sort of activities if you’d like that go with the modern economy. The Chinese economy, it is becoming rather like the European economy if you take a 5-year view on it. It’s going to become service driven, you’ve got middle classes and all the rest of it. And middle classes want things like air conditioning, they want electricity that works. And so this is the demand for copper that we’re seeing. And when it comes to all the construction, the railroads the improvements that are going on, the industrialization of the whole of Asia, that’s where things like iron and steel come in. And of course, you have all the other metals. Golds relation to this, well there are two ways of looking at it I think. The first is that the price of base metals, the price of anything energy as well, is a lot more stable over the centuries measured as gold as it is in paper currency. And I think that’s a very important point to bear in mind. So if you see the base metal complex rising in price, then it is likely that that will put an upward stimulus on the price of gold as well measured in paper currencies. And the reason for that is that its paper currencies that are losing their purchasing power, not gold. So that’s the first point. The second point that I would make about gold is that if China is serious about doing away with the dollar, the Yuan as currently constituted is not a satisfactory substitute for the dollar. So what she must do is offer trade partners if you’d like, the ability to settle in something else. And this is where gold comes in. We’re seeing this on the futures exchanges in Shanghai. There’s a Yuan contract already on the futures market for gold, the next contract that’s coming in, and it’ll come in by the end of this year, is a Yuan contract in oil. So what this means is that a country like Iran who exports a lot of oil to China, because Iran doesn’t want to use the dollar and she is restricted very heavily on what she can do with dollars, she doesn’t want anything to do with the dollar, she doesn’t necessarily want to take Yuan. So what she’ll do is through the futures exchanges she’ll cover her shipments, the payments that she expects her shipments to China through the futures market. First of all converting oil into Yuan, and then another futures contract converting Yuan into gold. And this is going to produce I think a demand for gold which will not be satisfied by China indecently, it will be satisfied through the markets, deliveries through the market which will put quite a drain on global gold resources. So this is another way in which China is going to move away from settlements in the dollar and that is to provide the facilities if you’d like as an entrance stage for her trade partners to accept payment in effect in gold by bridging through the futures. Eventually what she has got to do is she’s got to formalize the relationship between the Yuan and gold. And that I think will happen in time, how long is difficult to say. All I can say is that the moment that is done, almost actually the moment that Iran can go and just literally sell oil to China in return for gold by using the mechanism of the futures markets, then this is almost like a financial nuclear attack on the dollar. And I do see the dollar is very very vulnerable to this. The timing on this I think in a sense has been speeded up by the election of Donald Trump, because that’s produced a huge air of uncertainty in international trade relations. America is isolating herself in this. But I think that the Chinese, they will move cautiously but watch North Korea, watch Afghanistan, that’s another thing. Also watch the relationship between China and Russia which is very very close. And I think Russians might have some input as to the timing on when they if you’d like pull the rug out underneath the dollar. So I think we’re living on sort of a cliff edge if you’d like as far as the dollar is concerned and this is a fascinating time. And I think anyone who basically doesn’t hold any gold or silver for that matter which is a geared play on gold in financial terms, I think could find themselves with egg on their faces. So it’s a very interesting time and I would be very positive I think on what’s going on, on base metals and also on gold and all to do with China. China is developing the most amazing economy for the whole of Asia. I think Europe is a major beneficiary, Europe will overheat very quickly on this by the way so there’s got to be a very sharp reversal in monetary policy by the ECB. But guess who’s not in the game at all? And that’s America. America has just isolated herself from the gold game and she’s sitting there thinking what to do about it.

FRA: Jayant, you spend a lot of time in Asia, do you see the same type of dynamics from your perspective as Alasdair has elaborated on?

Jayant Bhandari: I’m certainly extremely bullish on China, I go to China quite often and I have talked with you about this several times Richard. I continue to see good growth taking place in China. And I see whenever I go to villages, towns, and cities in China I see improvements. Sidewalks get constructed, coffee shops come up, the coffee shops get cleaner and more hygienic as time passes by. So China is actually improving consistently as time has gone by. One thing very interesting to add to what Alasdair was talking about is to look at the currency chart, the comparison of the Yuan with the U.S. dollar. Now, two years back people were starting to feel very pessimistic about the Chinese currency, they were thinking China was going to start regressing or stop growing. And Chinese currency actually did continue to fall for about 1.5 years. But then people don’t really talk much about the Chinese currency because since the beginning of this year, Chinese currency has improved massively and has gained back at least half of the losses it has made in the earlier 1.5 years. So this is also a reflection of the fact that Chinese economies actually doing quite well.

FRA: Alasdair, you’ve recently written about the Jackson Hole speeches of Yellen and Draghi, omitting commentary about the burning issues of the day. And you list a few of those, one is the question: why is the ECB injecting 60 billion per month if the great financial crisis is over? In the same writing you also indicate in reference to the Fed normalizing interest rates: will take nominal rates only 1-2% to set off another financial crisis. So how do you see things playing out? Do you see what you just mentioned earlier as putting more pressure on the ECB and the fed?

Alasdair Macleod: Yes, I do. I think the importance of the China story is that everybody has got commodities to export, everybody who has territory if you’d like on the Euronation continent is going to benefit from what China is doing. America is not, America doesn’t have any friends really in the trade sense. She’s even turning around under NAFTA and telling Canada and Mexico: “we don’t like this arrangement, we’re going to rejig it”. They’ve already given up on any sort of trans-Atlantic and trans-pacific idea. I mean this is absolutely crazy, America has isolated herself. Where this translates into economic performance is that I view the U.S. economy as still being in a recovery stage from the great financial crisis, and by that I mean the credit cycle. The next phase of the credit cycle is the one of expansion. The expansion of credit, when banks actually start competing to lend to the 80% of the economy, which is the medium size and smaller business. We’re not there yet I think in America, and we probably will never get there because of the trade policies and the isolationism of President Trump. But Europe is a very different thing, Europe is turning around very very quickly. And I noticed in the Jackson Hole speech that Mario Draghi made, he made reference to the time difference in terms of recovery between the Eurozone and America. And he got it completely wrong, he said you’re ahead of us in the recovery. No, Europe is actually ahead of America. Europe is now expanding very rapidly, we’ve yet to see it really I suppose, in normal statistics, but the anecdotal evidence-and if you just watch what’s going on and you just look at the situations. I mean I described the situation for a company like SKIP. There is a major Italian company, whose doing incredibly. Got the most manufacturers, particularly the German manufacturers, I mean this is amazing. And the interest in Europe is actually going to go one further, very soon I think you will find that Germany SKIP for the Eurozone. And what that means is there will be a break with the American lead NATO arrangement. Whereby America says “This is who we’re going to have sanctioned, and everybody is going to fall in with us,” I think this is going to stop. And this is terribly important because SKIP. Mario Draghi and the ECB doesn’t seem to recognize SKIP. Here we are, we got banks who despite money at the ECB, have a negative interest rate of -.4% the interest rate from the ECB is 0% so you’ve got somewhere between negative interest rates and zero rates. They are doing quantitative easing of 60 Billion Euros a month. And they’re still doing this. And in my judgment, in a credit cycle, they have moved from recovery and they’re moving into expansion. Monetary policy in the ECB is completely inappropriate for what’s going on. So I see the big shock, if you’d like, by the end of this year has got to be a complete SKIP fast, by the ECB when it comes to monetary policy. We’re already getting wind of this, the Euro has risen from I don’t know, 1.05 against the dollar it’s now currently knocking at 1.20 to the dollar. And of course you’ve got all the manufacturers in Europe turning around and saying “oh the currency is too expensive, how dare you raise interest rates and make the situation worse” so the ECB’s got itself into this hole, which so often central banks who are behind the curve find themselves. And this is going to be very very difficult for them. First of all, stop QE SKIP. Also, and that is with the dollar declining, eventually she’s going to have to think quite seriously about raising interest rates to avoid a huge great debt problem in the economy. Which really means that over in debated business are going to find that the cost of money starts going against them and they are going to start failing. So it’s an interesting one you go back to the Eurozone, you also got the problem SKIP and the banks are all up to their necks at the moment in government debt. And that government debt is wildly overvalued. It’s overvalued on the basis that the ECB is in there buying relatively scarce bonds pushing down yields. The moment that stops, there are going to be huge great losses on the Italian banks, all the losses that they haven’t dealt with from the financial crisis. So I can see the worst nightmare I think for a central banker is that we move from this sort of this recovery phase, which just rumbles on and rumbles on and rumbles on. They don’t have to raise interest rates, they ignore things like unemployment and inflation sort of stays somewhere around about 2% and you know everybody is happy with that. If you actually get an expansion of credit because things are going like a train or beginning to go like a train, SKIP because I think must hope that we are in a permanent stage of repressed recovery. But I don’t think that’s going to be the case unfortunately with the Eurozone because of the Chinese stimulus across the whole of the Asian continent.

FRA: And so from this, what is your outlook on the Euro, the U.S. dollar, and gold prices?

Alasdair Macleod: Dollar down, gold prices up, Euro up. I think there’s going to come a point where the Euro- I don’t know whether the Euro outpaces gold or not. At the moment gold is outpacing the Euro I mean if you look at gold measured in Euros, it’s only up by about something like 3% something of that this year, it was actually down 2% until fairly recently. So basically to answer your question, I think that gold is going to go up. One thing that really really light a fire under gold I think is when the Chinese come in with the oil to Yuan contract on the futures market. And then you’re going to get Russia, you’re going to get Iran, you’re going to get various of the oil producing Asian countries using that facility to not buy dollars, but to just sell their oil for gold. And I think that’s going to make a huge difference.

FRA: Jayant, your views on ECB policy and Fed policy and your outlook for the currencies and gold?

Jayant Bhandari:  Well I’m very optimistic about the gold price and virtually every sign tells me that gold is going to go up. Not only the monetary policies but also what I see as stagnation I see happening, economic stagnation in the third world countries, except for China of course. Also, the North Korea situation is very likely to continue to push the gold price up. I might add some comment on Canada, Canada has recently increased the interest rate. And as we know the housing prices have been going up continuously in Vancouver and Toronto. And the Canadian society is hugely in debate, the private debts are huge. So it will be amusing to see what happens if Canada continues to keep the interest rate at what they have now declared or actually increase it going forward.

FRA: Interesting, great insights gentlemen. Just wondering how our listeners can learn more about your work, Alasdair?

Alasdair Macleod: Well, I publish an article every Thursday, around about midday I guess in Eastern Standard Time. You can access it by the website, or the other way to access it is open an account and we’ll send you an email. But basically yeah, I publish an article once a week on the Thursdays. I also do a market report on the Fridays. And what I try and do is look as dispassionately as possible at both what’s going on if you’d like in the futures market, the physical markets, if I have good information. And I don’t rely on charts at all on that. I mean what I will do is I’ll quote charts because other people use charts. But I try to get to the nitty grittiest of what the balances are and you know, where the interest is in market. And that’s quite fun, that’s on Friday, I write that on a Friday before we get the commitment of traders figures so it’s a slight leap in the dark, but anyway those are my two things, regular contributions if you’d like.

FRA: Great, and Jayant?

Jayant Bhandari:  Everything I do, Richard, is on my website http://jayantbhandari.com/

FRA: Great, thank you very much. We’ll do another session again, thank you, guys.

Alasdair Macleod: Thank you.

Jayant Bhandari:  Thank you very much for the opportunity, Richard.

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

LINK HERE to 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.

FRA: Hi, welcome to FRA’s Roundtable Insight. Today we have Yra Harris. Yra is an independent floor trader, successful hedge fund manager, a global macro consultant trading foreign currencies, bonds, commodities and equities for over 40 years. Also he was the CME Director from 1997-2003. Welcome Yra.

YRA HARRIS: Richard, thanks for having me back again.

FRA: I thought we’d begin today with a discussion of your interview with Rick Santelli back in February of 2016. At that time you mentioned gold and bonds are better plays than the Chinese Yuan. Since then, I think you referenced gold at being 18% higher and also referenced a shift in asset classes taking place – that would be great to get your insight on that.

YRA HARRIS: This is always a cautious zone for me to do this. Sometimes you just have to go back and look at things you said to weed out all the noise that crowds the world of finance and the discussion that takes place. So yes, on February 1^st 2016 I had done a hit which you can find HERE. And it was the Monday after a weekend – I mean it was a scheduled interview, and what took place over that weekend is what I call the four horsemen of the global macro world. People I hold very high regard for their analytical ability: David Tepper, Ian Horton, Kyle Bass and George Soros – These guys came out and made comments over that weekend, it got a lot of media play, that they expected a 30% depreciation in the Chinese Yuan because of all the debt issues in China and other things that were taking place. On that Monday morning with Santelli I discussed that that’s a difficult trade for a lot of people to make .. I said I would rather be long bonds, all kinds of bonds all over the world, sovereign debt not corporate, and gold. It raised Rick’s eyebrows and he said, “Why?” I said, well, because if the Chinese Yuan, and at that time it was trading at about 6.58, which was an okay level, it has certainly weakened over a period of time where it was down to 6.10, so I said if you’re looking for a 30% depreciation from these levels, the impact on the globe will be massive deflation because if the Chinese were depreciating that much that means they would be shoving exports out as fast as they could and it would really put downward pressure on prices all over the world and we already know we had too much slack in the global economy, and that would be the impact. And I would own the gold because it’s deflation that will force the hand of central banks to panic. We are now at zero to negative interest rates. People say they fear inflation; no they don’t, not at this point in time. We go back to Ben Bernanke talking about the lessons of 1937 and that’s the fear of deflation. Central banks fear what happened in Japan for the last 20 years. The fear of deflation weighs upon them, so then, from a hard money perspective, it’s more the issue of what you do in response to that deflation. And that’s why I said gold would be a better play, a safer play and an easier play for most investors and traders to make. So I went back the other day to review it and the Yuan had actually dropped. Right now, it is through the level it was on that weekend and right now it’s trading at 6.48.  So that’s moved where the Yuan is actually higher from that date, but gold is up now 18-19% from then and the bonds are basically steady, maybe they are now 10 basis points higher than they were. But that was the purpose of that trade because again it’s to put the light that central banks fear deflation far more than they fear inflation at this point in time. Now will that change? Well, the Fed hopes it changes, but it’s not changing. And we heard Mario Draghi this morning; he’s much more worried about hitting his inflation targets on the upside than anything else. So that was my point of that. I just wanted to go and revisit that for people who follow my blog and just to put perspective to things.

FRA: Great. And what about your current thoughts on the 2/10 U.S. yield curve? I think you had some concerns that it might be breaching the 73 basis points level.

YRA HARRIS: Yeah, we’re down here again. This 73 basis point level has been an important level for me. I’ve written about it for 4 years and we’ve bounced out of this area several times, but here we are back visiting it so we are getting some flattening in the curve. Now as I warned last night in my blog, this is a critical level for me and it sends a very important message to the banks because this curve ought not to be flattening. If the Fed embarks upon, as our beloved Peter Boockvar calls: Quantitative Tightening (QT), which is a wonderful phrase, but if they begin shrinking their balance sheet that should unleash more supply in the long-run in the market & the curve ought to steepen. But, if the curve chooses not to, I think the Fed will have received a message. We saw the Bank of Canada tighten after we saw the response of the currency which rallied quite a bit because it caught the market off guard because the consensus was that they weren’t expecting a tightening. So we saw that action and this plays right into Lael Brainard’s speech back in June. What Lael Brainard said recently is that she doesn’t want the Fed’s Funds Rate to go up, that the Fed Funds rate is high enough to embark upon quantitative tightening. And with more supply it’s going to be a trickle effect to begin with, just as Janet Yellen has famously said that the quantitative tightening will be like watching paint dry. Peter Boockvar doesn’t believe that, nor do I, once this starts going, but this curve is very interesting. Now, as I warned, and I’m not being a two-fisted economist here, but with the impact from the Bank of Japan and from the ECB still actively involved in quantitative easing programs and because we believe in the global macro world that money is fungible, it might push the long-run US curve lower and lower. And this is really going to cause a problem for the Fed. They’re going to have to sit up here and take note of it because they cannot afford in all their designs for whatever they want to do, for this curve to start flattening more dramatically.

FRA: And that’s what you think would likely happen if the 2/10 reaches 73 basis points then…

YRA HARRIS: Yes, especially if it closes on a weekly basis. In today’s world we can get all kinds of erratic movement, but it closed on a more long-term technical level like a weekly close, that would give me a warning sign. My history of studying this has been that when you get flattening curves, especially in the US dollar, which is of course the most significant part because they are the world’s reserve currency  – That your currency ought, and I emphasize ought, first of all to rally .. now that may seem counter-intuitive but that’s what does happen. I don’t know what the time lag is but the currency does rally. And it’s not good for metals because what does it reflect? It reflects a coming slow-down in the global economies. That’s what flattening yield curves project, that’s historical .. And that’s why historically they have been great predictors of economic and financial outcomes. But, in this world of massive QE, we don’t know that. Again, as we’ve stressed, and I’ve been on with you I think for 3 years on and off – the signalling mechanism has been so badly broken. And this may be one of those times, but it certainly sends a warning sign. And the warning sign this time will be interesting because if I’m right, this time the dollar will not rally and the gold will not break. It may have an initial effect, but there won’t be any significant damage done to these prices levels because the Fed will be in a very difficult situation as to how to respond to this because with interest rates at 1.25% it’s not like they have much latitude on that end. So this gets very interesting. We are at very interesting pivotal points and we’re going to wait to see how this unfolds. But, the market dynamics are telling us that we’re at very precarious points.

FRA: Yeah, and we also talked yesterday on the program show in terms of what’s happening in China on the Silk Road and the rally of base metals over the last 1 year period or so. So in the old world, base metals and precious metals could fall, but now because of all the distortions and new factors such as China’s development, we could still see that trend of rising base metals and precious metals?

YRA HARRIS: Well, yeah. I mean we are still trying to figure this out as we’ve watched copper rally. And I’ve been suspect about the copper rally, but now between the Hurricane Harvey and Irma there is going to be a lot of rebuilding and the copper prices were already moving higher, so we might see some of that fall off from that. With China’s Silk Road initiative it certainly has had some impact, but the way the Chinese securitize some of their debt is with commodities which I’m a big fan of. I think that there should be gold-backed bonds. How this hasn’t taken place is beyond me and I know my friend Bosko up in Canada has been working on this because he trades – he makes markets for people’s gold coins and he has been very interested in this. But this is significant. These are significant events that are taking place here and part of the reality may be that the Chinese are securitizing a lot of commodities and that puts a floor on the pricing and keeps them in demand. The problem is that when you use commodities as securitization, if you haven’t priced them, meaning: if you pledge me 100 ounces of gold and you’ve given too big of a haircut on it, then I’m not really protected if gold prices collapse. But if you figure out the right ratios it does work. Are we embarking upon this? I don’t know as of yet, but we are certainly seeing some interesting responses to all of this.

FRA: As you mentioned earlier about the central bank policies of Europe and Japan factoring into this thinking, do you still see their monetary policies as staying the same like the current program of 60 billion Euros per month by Europe? Do you see that changing?

YRA HARRIS: Well, I think about that. Peter and I have actually disagreed because he thought we were going to see an earlier statement from quantitative tightening, but he was dead right on target in saying that it will probably come in October after it shifted a little bit after Jackson Hole. And from what Draghi talked about today in his press conference, recalibrating the October meeting which fits Peter Boockvar’s timetable now. I don’t know; I think it depends on many things. Number one, I think that Mario Draghi is hoping, he’s fervently hoping, that Merkel does very well in this election because it will give him more latitude because Merkel has been running protection for Mario Draghi in his whole quantitative easing plan since day one. So the stronger she is, the more comfortable he is. So we will see the way this election comes out and we’ll play upon that. I still say that Mario Draghi nets me my premise and I’m sticking to it. He has a far different agenda than the Fed or the Bank of Japan does because he has a political agenda and his political agenda is how to craft a Eurozone bond because it will take a Eurozone bond to create a truly unified European financial system and therefore the bigger he builds that ECB balance sheet, the higher the chance that he is going to be able to synthetically create a Eurozone bond.

FRA: And to continue building that balance sheet if the ECB is running out of bonds to purchase, could it expand or broaden to include German equities?

YRA HARRIS: Well, that’s a very good question. Mario Draghi was actually asked that question today and he danced like he was afraid to answer, he really didn’t give an answer. Could he? – He said they haven’t discussed it – Baloney they haven’t discussed it. They are very aware because this is going to become a legal issue regardless. And if the AFD, the Alternative for Deutschland Party, actually does better in the election than some think, it will for certain become a major legal contention because they are already violating the whole basis of the Maastricht deal to begin with, but everybody has looked beyond that because Mario Draghi’s real mandate is preservation of the Euro. He said that in July of 2012. He keeps talking about inflation, but he has taken that upon himself to be the preserver of the entire EU project regardless of costs. So, we can’t answer that question, we really can’t, until we see certain things start to play out. Everybody is going to develop their own hypothesis and some are going to prove right and some are going to belong in the trash heap of ideas, or as Max Planck would say, science advances one funeral at a time; same with trading.

FRA: The last question is on the Euro. Where do you see that going? We’ve seen a lot of volatility, today for example after Mario Draghi’s speech and also the ECB releasing forecasts on foreign exchange.

YRA HARRIS: In fact, Rick Santelli had John Coulter on and Santelli asked him a great question at the end. Rick asked him about the Euro and he asked would he be buying Euros and Coulter of course dodged the question just as Mario Draghi dodged the question, he dances one with great ability. It’s interesting that he cited the 1.18 Euro level as the number that they use in their projections. So he was being nailed down to that, but he didn’t give it that much credibility. My view on this is that he likes Euro here because it helps Merkel because it quiets the Germans. He wouldn’t come out and say this, but if I was there I would have certainly asked the question: Does the strong Euro represent the successful policies of the ECB? Which of course is what Draghi would say if asked .. I’m not sure where it goes here, but I’ll tell you this, and I’m going to blog about it tonight: so far today in the cash Euro market the high has been 1.2059. This is a real critical area because if you go back to July 2012, and especially July 23^rd when Draghi delivered his famous comments of whatever it takes – Meaning to preserve the Euro. The low that week, when he made that comment, was 1.2042. Then over the next year and a half the Euro proceeds to rally all the way back to 1.40. Now during that time is when the United States when in full quantitative easing mode. And then 2014 when the United States began tapering, the dollar starts to rally and the Euro drops over the next few years from 1.40 to 1.05. So these areas that we’re in are very important and we’ll see what happens.

FRA: Great insight, lots of volatility and moving parts today. How can our listeners learn more about your work Yra?

YRA HARRIS: You can follow me on my blog, “Notes From Underground” at YraGHarris.com. You can register for it; it’s free. You will get a real-time into what I am thinking about

FRA: Great excellent. Thank you very much Yra.

YRA HARRIS: Thanks Richard – I appreciate it.

Transcript by: Daniel Valentin <daniel.valentin@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.

FRA: Hi, welcome to FRA’s Roundtable Insight .. Today we have a very special guest. He’s Morten Arisson. He’s a Canadian economist, whose work in interest focuses on portfolio management, investing history, probability and mathematics. He has worked in strategy consulting, private equity and credit portfolio management. He’s written a book called Investing in the Age of Democracy. In that book he explains how democracy, beginning with the American and French revolutions, shaped the way we currently invest in the 21^st century. He proposes an alternative approach to investing based on 4 key features that are unique to the Austrian School of economics: class probability, the role of entrepreneurship and institutions, and the notion of inter-temporal exchange. Followed by ultimate consequences, these define a unique investing method. So what he has done is structured the book in 10 lessons where history, math, law and economics mix to provide the reader with a rich perspective that stretches from ancient Rome’s first investment vehicles to high frequency trading in the 21st century. So we’re going to explore that today with Morten. Welcome Morten.

MORTEN ARISSON: Hi, thanks for having me Richard – a pleasure.

FRA: Great – so I just want to mention that you were kind enough to put some notes together that we will put into an overall transcript once this podcast is published so we’ll have a transcript plus a podcast that people can either read or listen to the podcast or both. Just wondering a little bit about your background on economics – how you came to look at the world through an Austrian School of economics perspective.

MORTEN ARISSON: Okay – I was educated in Economics. I have a bachelor’s degree in Economics, but it was only recently, a few years ago, that I became very interested in Austrian economics and I went to the conference at the Mises Institute, in Auburn in 2011 – And I did further research and I really liked the work of a gentleman from Spain, Huerta de Soto. He has written extensively about the issues of dynamics, coordination in markets, probability and so forth. And you know, being familiar with the Austrian school, I often heard that it is not clear whether one can say that there is a unique investing method that would define Austrian Economics, in an applied way. This book was a challenge for me. I was going through some pillars, some defining characteristics of the school of thought, and I think that if you follow them to the last consequence you can actually organize a very rigorous structure, a consistent investment method that will be unique. The book obviously asks why, if that is the case, market forces would have not led us there. I argue that we would have been there had it not been for interventions which are of political nature and have a lot to do with the political developments that we have seen since the French and American revolutions. So, broadly speaking, there were two trends: one was centralization – also sometimes understood as big governments – it has been increasingly growing since then, and at the same time Scientism, which is a term that was brought forward by Hayek, if I’m not mistaken, Friedrich Hayek. It mainly describes the abuse of the scientific method; in this case, to humanities. These two have created a lot of situations,  gave place to a lot of interventions by governments that in a way ended up taking us apart from this approach to investing.

FRA: And so what you’ve done is you’ve identified 4 elements from the Austrian School of economics that yield a unique investment method if you want to go into some detail on that.

MORTEN ARISSON: Right. Probably, I should expand a little bit more first on what each, centralization and Scientism, do to the way we look at investing today and how the pillars define that method. So, in terms of centralization, we have seen with increasing tax rates that we have experienced a loss in the saving’s capacity, particularly with the establishment a hundred years ago, approximately, even more, of income taxes. And that’s something that began in a few countries and now it’s widespread all over the world. Then, in parallel to that, we have suffered the loss of private money – also called gold – which was also a very slow process which began in 1913 with the creation of a Federal Reserve and then in 1933 with the expropriation of gold in the United States, we’ve had a system – the gold exchange standard that lasted until 1971. From then on, we have been basically on fiat currency. That also led to a misunderstanding of the concept of liquidity. I think this is important. I’m going to put a few minutes here.

FRA: Sure.

MORTEN ARISSON: The way people look at liquidity today is as if it was an intrinsic characteristic of an asset. So, people can say: “Well this bond is liquid or this stock is liquid.” If you look at the way we used to see it – even until 1936 John Maynard Keynes, who was obviously not an Austrian… – He referred to the concept of liquidity preference. So, we all do have a liquidity preference, which is the preference to be liquid and to own money, which is an asset that sort of protects us from uncertainty. At the same time, the concept that liquidity is characteristic to an asset unfortunately was suggested by Carl Menger, who was an Austrian. He called that, in his words, “Marktgängigkeit” which was sort of “marketability”. And from then on, it was corrupted, and today we understand liquidity as the capacity of an asset to be traded with credit. If we say that a market is liquid, what we are saying today is that there is enough credit in that market to trade an asset, even though as a counterpart we don’t have true savings supporting that. And that is very important, because then, that creates a distortion that shouldn’t be. I mean, if you want to be liquid, Austrians would say, just own money that is the instrument that you need to be liquid. Then, from then on, if you want to invest, invest in capital assets. But the corruption of the concept of liquidity led us to mix everything – money and capital, and create degrees of liquidity in them, and forces to think in terms of paying for risk premiums when in fact there’s an asset available to us at every time, which is money. That too, because money began to be created by the expansion of fiscal deficits which led us to the misunderstanding of sovereign risk as well, – and it is something I discuss in the book. But all of that together created a distortion in favour of public securities versus private securities, the creation of Ponzis, and with central banks, systemic risk. At the private level the rationalization of all that under modern portfolio management – the theory of modern portfolio management. And all of this is a product of that movement in centralization that we have experienced, our big government that we have experienced since 1780s. In terms of Scientism, which can be described as the abuse of the scientific method applied to humanities, you can see that particularly after the 1870s with Walras, you have seen infinitesimal analysis, general equilibrium and the use of probability and the mechanistic view of interest rates that Austrians considered as inter-temporal exchange rates rather than as productivity rates, applied to the valuation of securities which are actually property titles on entrepreneurial processes. So all of that together takes us to where we are today.

However, I think we can make a pause here and think in terms of the 4 pillars of the Austrian School of economics. One of them I think is the most important is entrepreneurship – the role of entrepreneurship. It is completely ignored in mainstream economics; there’s no place for that because, mainly, it cannot be formalized, and that is seen as a disadvantage rather than being considered on a factual basis. There is no reason to believe it is better or not to mathematize entrepreneurship. And somebody, a few years ago, published an article on a Spanish magazine – Procesos de Mercado, edited by Jesús Huerta de Soto, proposing a way to establish whether or not entrepreneurship could be formalized. He concluded that it cannot, – because it’s non-recursive, it cannot. And so why did I bring this up? Because if you establish that human action cannot be mathematized, entrepreneurship cannot be mathematized, then there is no point in saying that you can value equity, which is a property title on said entrepreneurship. And that has profound consequences, because if you cannot value that, if it’s up to the risk management of the entrepreneur, the immediate direct consequence of that is to say that if you’re going to invest in equity you should invest in private equity because it’s something that you can manage. It’s a risk that you can manage. It’s an uncertainty in which you have certain control. And that is not the case solely with public equity. And one of the things I bring up in the book is that at the time of Adam Smith, with the beginning of the concept of limited liability, there was an enormous debate on whether it was advantageous or not for investing. One of the distortions that took us out from the field of private equity that was predominant, I would say, since the fall of the Roman Empire to the times of the trading companies in Holland, was private equity. And it was in the beginning of the trading expansion of Holland that lawyers like [Hugo] Grotius bought up the issue of changing the status quo and establishing the concept of limited liability. There was a lot of reaction against that at the time, and it had to be imposed. And because it was imposed and was properly seen as a privilege, the monarch that did that charged a fee on that privilege. And I would say it stayed that way until the mid-19^th, century when increasingly in the United States it was seen as necessary to fund more ventures. But, like I say – it’s something very, very recent and it has created a distortion in terms of favouring public equity versus private. And at the same time, if you add the other intervention, which is the banning of insider trading, which takes the signal out of the market, it creates the illusion that there is no such thing as insider information –,… It also unlevels the field of private equity versus public equities.

So this would be one of the first pillars – the idea of entrepreneurship, that if you think the Austrian way, literally you think that the best case for you as an investor is always to go for private equity. The other one is the concept of probability. I think it’s a key characteristic of the Austrian School of economics to distinguish between case and class probability. The concept of class probability was actually the mainstream concept of probability up until the 1920’s. And I’m going to try and be brief here, but it basically was the probability that – you can think of in terms of when you roll the dice [here are limited spaces and you know the outcomes. Richard Von Mises, who was the brother of Ludwig Von Mises, wrote a book called “Probability, Statistics and Truth” that I think was published in 1928, and he made the case that that is the only time when one can speak of probability correctly – properly. And that means that, in order to do so, you have to identify a collective, a group of elements or, in this case companies, if you want. And they have to behave in a homogeneous way and converge to a number that you may be looking at, let’s say a return or a ratio. And most importantly, whenever you take different time frames to see that convergence take place, regardless of which time frame you take, you still see that trend taking place. And if you apply that to investing, you will realize that since entrepreneurship is unique – there are unique markets, there are unique companies with unique management, unique capital structures, it’s impossible to apply probabilities here, because, – I mean you can speak of a asset class called equity versus an asset class called debt and I guess you could say that the convergence of the net returns is positive otherwise there would be no entrepreneurs – otherwise they would be always bankrupt. But besides that, I can’t think of any other case. And the proof of that is that rating agencies show every month updated tables on, for instance, migration in risk ratings. I mean, if you could apply probabilities here regardless of which timeframe you see, probabilities of default for, let’s say companies with similar debt-to-equity or similar net debt-to-ebitda ratios, it should not change, – but the fact is that they do change… I’m not surprised. And it’s just, you know, with that scientist approach, with that search for perfect information, you run into the illusion that we can use it.

But it was a movement that began with Keynes in the 1920’s in a book called “The Theory of Probability” and it has really shaped the way we look at portfolio management today. If you use a Bloomberg terminal and you try to value any security that would be a derivative or any structured product, you would immediately see that probability is used without thinking, without a pause. It’s just something very direct. If you use the other concept, the Austrian concept of class probability you realize that unless you actually have control over that security that you want to own for your investment purposes, there is no point in trying to forecast the probability of something happening, because effectively you have no control. I mean you’re running into a tautology where you tell yourself: if such and such a thing happens, I would get this outcome. But I mean, that adds no insights – no further information. So, I don’t know if you have any questions or, if you want, I can go to the 2 other pillars of…

FRA: Yeah, sure. So we’ve covered so far entrepreneurship and sort of the correct theory of probability and we have two more institutions, money, capital and interest rate. Go ahead on those two.

MORTEN ARISSON: In terms of the institutions, I think that the Austrians have an advantage because they can understand the institutional context in which investing takes place. I mean, there are very important institutions like a deposit and a loan that the Austrians can distinguish. They understand that a deposit is not a loan, and that fractional reserve banking corrupts that concept today. They understand what is money and what it’s not, and the qualities that money has to have and that gold is money, so to speak, because it has all those qualities. If you look at, for instance, virtual currencies, I believe that virtual currencies lack two qualities that are quite necessary – I mean fundamental to money. One of them is fungibility. Since Bitcoin by definition is a ledger, a distributed ledger, it will never be fungible.

FRA: Sorry, just to clarify, the virtual currencies you’re meaning the cryptocurrencies right? Such as Bitcoin and –

MORTEN ARISSON: Right, right.

FRA: Okay. Just to be clear.

MORTEN ARISSON: Yeah. So those cryptocurrencies are distributed ledgers. There’s a reason why that happens, because they are not redeemable. So, the two characteristics that define money – I mean that are more but these are fundamental to money: these are fungibility and redeemability. And by definition virtual currencies or cryptocurrencies are not redeemable. You cannot redeem them into any… – you can change them, you can use them as an indirect medium of exchange, but you can never redeem them themselves. Fiat currencies you can do, you get the physical paper bill. Gold you can do, you get the metal. But that’s not the case [with cryptocurrencies] and because possession is not there to show ownership –, Ownership has to be established via the distributed ledger. And that institution [distributed ledgers], if you want, because it has been a spontaneous creation of the market, cannot benefit from fungibility, by definition, because at any point you know what belongs to whom.

FRA: Yeah.

MORTEN ARISSON: So, there can never an established capital market in that sense. And as far as I know, at least to date, the only inter-temporal exchange is peer-to-peer, right? Which some savings are – you know exchanged from one participant to the other, but not to a central institution that collects and then distributes. And I mean that is intrinsic to virtual currencies precisely because .. my understanding that those who created them, actually wanted to avoid that centralization, – But banking has a role, right? I mean, there’s a lot of information to be discovered about those saving and those demanding those savings, and it has value. And banking itself is an institution that has been documented at least since the time of ancient Greece. So, without fungibility you can never have capital markets in cryptocurrencies. And at the same time without the redeemability if there ever is any sort of expansion via credit multiplier, it will have to be unchecked by definition too, because there will be never any run on any Bitcoin banks, for example. And eventually Bitcoin or any cryptocurrency that advances to that stage would devalue. You know, defeating its own purpose, right? Because the credit multiplier would affect an expansion that was not thought of by the traders of the cryptocurrency. So, if you want, you know, in a way you can say that Austrian investing is institutional arbitrage, because you’re always understanding loopholes, interventions on market-driven creations, institutions and arbitrage and sell the bad ones to buy the good ones. You could say the same about structured investments, you could say the same within the space of currencies” you’re arbitraging certain features. Usually scarcity being one of them, we arbitrage scarcity when you see that a currency expands more than another, you’re arbitraging scarcity. If you need to take capital out of a jurisdiction that is pretty restricted, you are arbitraging redeemability. And that’s where Bitcoin gets its value [from], because it’s less redeemable and at the same time less sizable by the authorities.

There is also the issue of public institutions where you recognize, if you are into the Austrian School of economics, you recognize failures in public institutions. One of them is the Eurozone, where mainstream economists took last year’s crisis as a liquidity crisis, while lots of other economists understood that it was an institutional problem and that it was the fact that there’s not a unified bond market in the Eurozone. And the last but not least important of all the pillars is the understanding of what is money and what is capital that is lacking in mainstream Economics. And that interest rate is actually an institution too, whose function is to allow the inter-temporal exchange of resources between people. And the direct consequence of understanding that is that it allows you to differentiate when you invest and when you trade. When you invest is when you exchange your money for capital assets. And so with derivatives that are not used for hedging, for instance, or commodities or fiat currencies, you’re not investing, they don’t yield any produce and that’s the same case for gold. So an Austrian would say that you do not invest in gold, you exchange a fiat currency: one currency for another one. There is also another direct consequence of understanding what an interest rate is, which is that asset allocation is nothing else but inter-temporal preference. So, there’s a direct connection between your inter-temporal preference and the way you allocate your assets, whether you want growth or not. If you want growth you need, like I said, to invest in equity, in entrepreneurial projects. If not, if you want yield, obviously you will go for another part of the capital structure – for debt. And any subjective exchange – I mean any, inter-temporal exchange is completely subjective. There’s no point in trying to benchmark yourself against indices in terms of returns. You have to target your absolute returns, the ones you are comfortable with and the ones that are consistent with your liquidity preference and I’m going back to the concept of liquidity. So that when you put all these four pillars together: the correct understanding of the theory of probability, the correct understanding of the role of entrepreneurs, the correct understanding of the role of institutions, and the correct distinction between money and capital, and understanding of interest rates, then you come up with a particular method that would say to you: Well, you need to think of investing not in the terms you have seen until now, where you have one big diversified portfolio that tries to be optimized in terms of risk and returns, minimizing risk and maximizing return.

You shouldn’t be paying a premium for liquidity. You shouldn’t mix private and public securities. You shouldn’t even try to do any value investing because it’s a tautology. You will never be able to really know the value of any entrepreneurial project unless you have a control of it. And then, the first thing you should do is define your liquidity needs, so your liquidity preferences and separate that into a liquidity portfolio. Then, the second one is, once you establish your inter-temporal preference, you look for a certain component of growth and a certain component of yield and that growth will be represented by equity. But you have to prioritize private equity and in terms of that the same happens once you prioritize bilateral loans. But again the book goes to explain all the distortions that we have suffered that have made the use of bilateral loans, such as lending to someone directly via mortgage, – that took us away from that. We are left with public securities, public equity and public bonds, and we are constantly benchmarking the indices. There is another interesting thing; if you recognize the fact that final value increases with time and the direct consequence of that is that – most of the time with mainstream investing theory – the recommendation comes that when you’re young you should try to go for as much equity as you can for as much growth as you can with your investments, because only after when you’re established you need a stable cash flow. But when you think of that, you are putting yourself through an enormous amount of risk, uncertainty in securities over which you have no control and you lose an enormous amount of compounding value. So, I think that when you go through all this thinking in terms of how to approach investing, one conclusion is that the longer your term horizon, that means, the younger you are, the less you have to invest in equity and the more you have to invest in computable risk that can compound – that you can manage. There were a lot of institutions that we had created before this big increase in government. One of them was the annuity business by the insurance companies. It was a legitimate market-driven, spontaneous invention, but today we don’t have that and with distortion in interest rates it’s pretty expensive if you try to go that way. So, again, the younger you are the more you have to allow for that compounding to work for you. Only when you’re getting older and you see that you don’t get to your target in terms of savings, then you can start risking something, which is completely counterintuitive versus what common knowledge says. So, and after all, yes I devote one third of the book, the last third of the book, to discuss the proper macro themes in Austrian economics. But, as you can see, we just discussed very specific things and I haven’t gone properly into discussing any macro themes. And one of them, I think is most important, is systemic risk, in the chapter where I go to show that there is no such thing as systemic risk. It [systemic risk] is just the natural outcome of the interventions in the market by central banks. The fact that we don’t know when it’s going to happen doesn’t mean it is risk. It is there, and we know it causes, and we know how the process works, the coupling between central banks works, which I describe in a chapter, via cross currency swaps. And I recommend that after you have established your three portfolios, liquidity, equity and debt portfolios, one can think in terms of an aggregate hedge against that systemic risk at the portfolio level. That could sort of address the mainstream view that you have to pay a premium for liquidity. An alternative could be that you do not, again, you separate whatever liquidity you need under your liquidity portfolio. Then once you have established your investing portfolios you put a hedge against systemic risk for them, to protect them.

FRA: And how do you do that exactly in terms of applying a hedge?

MORTEN ARISSON: This is just my own opinion, in the case of Canada that the hedge was the exchange rate between the U.S. dollar and the Canadian dollar. As you see, increasing systemic risk in these particular times, in this particular moment, through the increase in risk from the real estate market, I think that will be translated into sovereign risk and it would push the monetary authorities to devalue the Canadian dollar. So, if you can be long an instrument that would capture that and  would have some convexity properties in that sense, then you’re doing exactly that [hedging systemic risk].

FRA: And just a couple questions. You mentioned on the equity portfolio that you should prioritize private equity. How do you go about doing that in terms of the prioritization process?

MORTEN ARISSON: I think the simplest way to do that, which is accessible to everybody, is to buy a property today. But that has been completely intervened today by the government. There is this push from the government to take you away from any safe haven assets. When you buy a property for investment purposes, obviously you are first avoiding fractional reserve or re-hypothecation of the assets, because there cannot be two similar assets on the same location, because you’re buying location. Then you are free to manage – you have a lot of latitude in terms of managing, and in terms of having control over that. But for real capital assets, I have a chapter devoted to them, but I think the conclusion in the book is that there is never a definitive answer to that. And that is very intrinsic to Austrian Economics: the notion that there is never equilibrium; that you’re always in danger, that you always have to look out for opportunities and for future problems. Like I said, there might be multiple real capital assets. You can have property, cattle, wine, forestry, and farmland. And all of them they serve a purpose at a specific time within a crisis. For instance, in terms of farmland, it’s not a hedge against crisis forever. It will be your equity investment, but to a certain extent if things go really bad, you will be stuck with an immovable asset, a very easily taxable asset. So again, even as I provide examples of ways in which you can invest into private equity, there is never a safe haven asset.

FRA: And in terms of public equity, is your suggestion to diversify due to the non-computable risk?

MORTEN ARISSON: Yes and no. If you say that then anybody could argue well you’re just saying the same as mainstream economics. And here’s the thing: in Mainstream Economics, the exercise of diversification is against the…they have what they call systemic risk component that they claim to be able to measure from observations on what they call risk-free assets, such as sovereign bonds. That diversification comes from the measurement of the sigma, the volatility of all their assets and their correlation and so on. Which again, they go into a circularity because they assume that past performance will be something that you can project into the future and you have to make a lot of assumptions that just revolve around themselves. What I am saying is, yes you have to diversify, but only because you know nothing. You absolutely know nothing and the shot can come from anywhere. If you tell yourself that you need 20 securities to be diversified, well you’re kidding yourself, that is not the case. If these are subject to a currency zone and they are denominated in a currency that because of institutional problems, because the central bank is too weak or prone to suffer from devaluation – there is no remedy to that. So, the diversification comes only as a consequence of the recognition of our ignorance, but only that. I cannot provide you with a specific number [of securities to diversify]. Obviously, the general idea is that all things equal, the more assets you have, the better. But that is not necessarily true and that [diversification] is a very subjective exercise.

FRA: The last question is on – you mentioned these three macro themes and how Austrian Economics has a unique approach to these three macro themes. Can you briefly touch on the inflation/hyperinflation macro theme?

MORTEN ARISSON: Yeah, sure. Obviously the general notion of inflation within mainstream economists is that you have something that is observable, that is a vector which they call an index of prices and that inflation is neutral, that never goes up or down in terms of monetary expansions or reductions. But as an Austrian you recognize two things. First, that it is not neutral, absolutely not. The reason that money expansion is not neutral is precisely what motivates monetary authorities to create, inflation. The second thing is that there is this notion that hyperinflation is simply an arbitrary high number in terms of inflation, and that is not the case. Hyperinflation is not quantitative – that is my point. Hyperinflation is a qualitative phenomenon and it is one in which the central bank finds itself defenseless, in a circularity where they are obligated, they are forced to issue an interest-paying liability. The interest that they pay on the liability is higher than any interest they receive on their assets so that [resulting] deficit, which is called quasi-fiscal deficit, can only be covered by monetizing and by printing money to pay that net interest. Then again, in order to take that money that the central bank just put into circulation, what they have to do is increase the rate, they have to sterilize that money that they have just printed, at a higher rate, which simply enhances that circularity. Today, right now as we speak, there is one country that is suffering from that – Argentina. With an instrument called Lebacs, the central bank began paying something like 38% a year ago and it’s around the high 20’s now. And, unless they have the fiscal deficit in control in Argentina, that will spiral out of control. So, even though you don’t see inflation in the 100’s like you used to in the 80’s maybe, the fact is right now that that central bank is out of control, and they’re in the early stages of a hyperinflationary process. What about us in the first world? Well, what matters here is the relation between the interest income received by the central bank in excess and what they have to pay. It doesn’t have to be too high. What if there was a sovereign problem in the Eurozone and all of a sudden the central bank had to replace sovereign bonds with their own liabilities? Right now what they do is they collateralize, but, what if they actually had to replace it with their own liability, but with an interest-paying liability? On the one hand they have, like any central bank, money supply which bears no interest and then they have to pay 25 bps. Those 25 bps will have to be monetized. So, right there, you have hyperinflation, and I think one has to pay close attention to that, and only if you understand that you will see how, in my opinion, we are at the early stages of a hyperinflationary period. But again, you have to understand that it is a loss of control by the central bank [what causes hyperinflation] and not the inflation rate on its own.

FRA: Wow Morten, great insight on Economics and investing. How can our listeners learn more about getting access to your book “Investing in the Age of Democracy”?

MORTEN ARISSON: The book is already on available now on Amazon. It is under the title “Investing in the Age of Democracy”. And soon, I intend to put it on a digital format for Kindle.

FRA: Great, we look forward to that. Thank you very much Morten for being on our show.

MORTEN ARISSON: You’re very welcome.

Transcript by: Daniel Valentin <daniel.valentin@ryerson.ca>

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In this week’s episode we are joined by both Peter Boockvar and Yra Harris. Peter is the Chief Market Analyst with The Lindsey Group and the Co-Chief Investment Officer for Bookmark Advisors. He runs an economic newsletter product called The Boock Report which offers great macroeconomic insight and important updates on economic indicators. Yra is an independent trader, a successful hedge fund manager, a global macroeconomic consultant and has been trading foreign currencies, bonds commodities and equities for over 40 years. He was also the CME Group Director from 1997-2003.

FRA: Today we would like to talk about a few things, perhaps starting with quantitative tightening. Peter is the first to come up with that term. You’ve written recently about that, Yra, in terms of the relationship of that to steepening curves, the 2-10 spread on the yield curve. Also with the possibility of buying bank stocks; there was a question from a reader. If you want to talk about that?

YRA HARRIS: In following Peter’s line – everything I’ve read from Peter and what he’s talked about – is that the next move by the Fed will be the commencement of quantitative ease before we get the next Fed Funds increase. The dynamic will be very interesting to watch. I know what Peter talks about hinges on that, and now everyone else is talking about Draghi and his upcoming appearance at Jackson Hole. I know Peter’s probably more prone to think that he’s going to lay something out to the market, but I’m not quite there yet. I view the ECB and what their final destination is different from the Fed’s destination.

It was interesting on July 26 when everybody was talking about the five year anniversary of Draghi’s famous ‘Whatever It Takes’ speech. When he said it which was actually July 25, I was on CNBC with 5:30 Chicago time, I’ll never forget it, and Steve Liesman was interviewing me, and I said, “They’re going to have a very big problem in Europe” because all the 2-10 curves, the two year yields on the peripheral bonds were 7% and the curves had flattened dramatically from over a hundred-some odd basis points down to 70, and I said it was all coming because of the pressure. They couldn’t fund anything even in the 2-year market. So it was a bear selloff in two year debt across all of sovereign Europe. I said, they got a problem, and while we were on talking about this, Draghi announces his ‘Whatever It’ll Take’, no taboos. So I find that interesting, but when they quote that speech he said, the mandate was also the preservation of the Euro.

I hang a lot on that; I think Draghi hides behind the veil of inflation now, even though inflation targets for whatever they’re worth – and how they came up with the 2%, that’s a whole other show, I’m sure. But that discussion means he’s got something else. The thing we’ve kind of talked about is that he wants to pile on as much assets onto the ECB balance sheet. I think his end game is that he’s going to do what the EU finance ministers and leaders don’t have the strength to do, and create a Eurozone bond. I think that’s what his plan is, and I’m more reticent to thinking he’s going to give us a wink and a nod to some type of Boockvar QT. That’s what I’m looking at.

Going back to the steepening, if the Fed embarks on this we ought to see a steepening. If the ECB doesn’t pull back and the BOJ doesn’t pull back, then as Peter’s talked about, markets are broken so we’ll never get a real signal. The signaling mechanism truly has been broken by central banks. I tongue-in-cheek use Colin Powell’s phrase that ‘it’s a pottery barn bond market now’ cause central banks have broken it so therefore they own it. That’s where we lie, but we should see a steepening.

FRA: Peter, your thoughts? You were the first to identify that term and what could happen by the Fed QT – quantitative tightening.

PETER BOOCKVAR: I think that long term treasuries are caught in this tug-o-war between the downward dragging yields because of the moderation and inflation and mediocre growth at the same time the Fed’s raising interest rates and there’s a natural inclination to flatten the curve. You have that one hand, and speaking of a mediocre economy we have the very interest rate sensitive auto sector that’s essentially in a recession. On the other hand you have this potential pull upwards as QT begins and maybe Draghi starts buying less bonds on a monthly basis. We’ve seen some days some relationships, some days not, of a move in overseas yields dragging or suppressing upwards downwards US yields.

So if all of a sudden Draghi does say, ‘you know what, starting January we’re trimming our purchases from 60B to 40B Euros, and then three months later it’s gone to 20B, and by the middle of next year it’s gone to 0, we’ll still reinvest but it’ll be over by the middle of next year’, then I don’t think the 10 year German bund yield is going to be 42 basis points. I don’t think that the Italian 10 year is going to be sitting around 200 basis points. I think that the European bond market is tinder for a major selloff if Draghi actually follows through with the 2018 tapering plan that takes him down to near nothing. I can’t imagine the US Treasury yield, regardless of what inflation and growth stat is going to sit there, also 225, if the German 10 year is all of a sudden 1%.

If we rewind the tape back to 2015, over a two month period the German 10 year bund yield went from 7 basis points to 100 basis points in two months. It definitely helped to drag up US interest rates. There is going to be that push and pull back and forth, and we saw when Draghi hinted at the tapering last month, and we saw in eight trading days, the German 10 year yield went from 25 basis points to 54 basis points and it helped to drag up US rates. How this plays out in terms of process obviously remains to be seen, but I’m more worried about US yields based on what the ECB is going to do rather than what Fed QT is going to do.

A combination of them both could be dangerous for longer end bonds, but I think the ECB may be more of a dominant lever in determining that.

YRA HARRIS: I agree with that wholeheartedly. If the ECB were to announce quantitative tightening of any sort, I agree with that. That’ll happen. I’m just not expecting Draghi to go that route yet, but if he does I think we’ll have a tremendously volatile move in the long end of the curve especially. When the Fed talked about ending QE, when they first started QE everyone said, ‘oh these curves, they’re going to flatten it’, and then when they were going to end it the initial thing was to steepen. And people were going, ‘yeah, you’re removing a buyer from the markets’, which everybody who’s been sitting there it’s almost like Greenspan putting it to the stock market. If you pull away the reaction is going to be dramatic because so much risk has been put on for very little premium. Risk premiums are ridiculously low across the board. When Greenspan comes out and talks about his bubble, first off all I don’t give much credibility to it because he might be right, but if I wait for it I’ll probably be broke. It’s a famous Keynes line.

If Draghi ejects all, I will be pinned. I haven’t wanted to be. You’d like to take a European in August, but that becomes so critical if he does deliver that. I think we’ll see a tumultuous move, I agree with Peter, on the long end of the curve. Across the board, and it’ll be led by the Europeans. I know that Gundlach was out talking about, oh, German debt is mispriced, but I would argue that French debt is more mispriced, being only 25 basis points richer than the Germans. At least the Germans have a bid to it automatically because of the repo market. It’s the most desirous high-quality liquid asset, so you always have a little bit of a bid. The French, it doesn’t serve as great a purpose. And certainly not the Italian and certainly not the Spanish. It would really cause some interesting moves in the debt market. From a trader’s point of view, I hope he delivers it. When I analyze it and think about his endgame, possibly which is the creation of a Eurozone bond, I’d be surprised to hear that from him. But if he does deliver that, I agree with Peter. We will have a wild ride in the global bond market.

PETER BOOCKVAR: Central banks generally – and certainly the ECB – believe in what they’re doing. They really believe that negative interest rates has been a good thing. They really believe that essentially nationalizing the European corporate bond market and the region’s bond is a good thing. As long as they continue to believe in what they’re doing, they’ll continue to do it to the greatest extent. Draghi is running up against some logistical challenges where it’s some sort of taper is the default rather than by his choice. It’ll be an interesting hoop that he jumps through.

The program is scheduled to end in December so they have no choice but to lay out a game plan for 2018 for the purpose that the current one is going to expire so they’ve got to renew it in some way and in some fashion. By doing it in September, we’re laying groundwork in August, he’s at least giving the market enough time to say, ‘now we know what the 2018 plan is.’ Basically what Yra is saying is that the plan can continue as is. Instead of saying, ‘we’re just going to extend it a year’, which is very possible, they have to tell us something because it’s supposed to end anyway, even though we know it’s not.

YRA HARRIS: Someone ran a very good article yesterday, talking about the amount by just rolling over. Even if they ended QE, but didn’t start shrinking the balance sheet, it’s still a huge amount of money cause of the duration they have on, when they really started buying this stuff. There is a shortage, and they’re already in violation of every rule that was written about this, because the capital key which is supposed to be sacrosanct? They can’t meet it because there’s just not enough German paper. They could not ever meet that number. It was a design flaw to begin with. Typically in the EU, they circumvent whatever rule there is anyway because the European Court of Justice already determined that the primary thing is the preservation of the entire EU project, which means whatever makes it sustain itself. That seems to be their legal binding principle from the European Court of Justice. So even though in Germany when some of the more stalwart money people had brought cases, they’ve lost in at the German high court because they seem to follow that same principle.

We are getting to crunch time. You can keep pushing and kicking the can down the road but as Peter rightly says, we’re getting to crunch time. They’re going to have to tell us what they’re going to do. I think the biggest surprise is – I’m sure Peter will agree with this – if they said, and this will be a huge surprise, that they were going to start following the rule with the BOJ and start buying actual equities. That would really rock the market; we’d probably see the Euro drop 5-6%. Then they know there’s no end to this and they have no end plan and they’ll keep searching for assets to keep pumping money into the system.

PETER BOOCKVAR: That would uncharted territory. That, I think we’re not going to do because that is a logistical nightmare, that is a political nightmare. At least when you’re buying sovereign bonds you should get paid back, but you start buying equities? I can’t imagine the Bundesbank crossing that line.

YRA HARRIS: Like I said, that would be the greatest surprise there is, especially in August before the German elections. You might hear that in October but you won’t hear it until Merkel is comfortably enthroned upon the Chancellorship of Germany. That would really rock the system.

FRA: But isn’t that what the Swiss National Bank has been doing in terms of financial alchemy buying international bonds and equities?

PETER BOOCKVAR: It’s been extraordinary, and even before they got there they cut short term deposit rates down to minus 70 basis points. Just to emphasize, negative interest rates are just a tax, and someone has to eat it. Whether it’s the bank that eats it or they pass it onto a consumer, it’s confiscating wealth. I call it a weapon of mass confiscation. That’s all it is. So you layer on the Swiss National Bank becoming its own hedge fund, that becomes dangerous. Now the Swiss Franc, outside of today’s rally, has been weakening.

Let’s take this a step further. Let’s say Draghi lays the groundwork for tapering and follows through when the Euro goes north of 120. Well the Swiss Franc will weaken further, reducing the need for the Swiss National Bank to be so aggressive, and maybe that leads to some time in 2018 either reversing negative interest rates or manipulating their currency less and you could see where global monetary policy is potentially heading. At the same time the Bank of Japan is in a subtle taper, they’re only on track by 50T Yen instead of 80T because they’re focussing on yield curve control and we know Kuroda is leaving in April and maybe whoever replaces him is going to change tact. We heard from an ex-deputy Bank of Japan member a few days ago – Owada – who even talked about 10 year yield curve is stupid, because you’re destroying the yield curve for banks, let’s just out the 5 year and give them some steepness of the curve. Well you see a sharp selloff in 10 year, 20 year, 40 year Japanese paper, it’s not going to just be in Japan, it’s going to filter through interest rates throughout the world. I guess we’re sort of paining a scenario where you can get a long term rise in interest rates globally and not for a good reason. It’s for the reasons of the reversal of extreme monetary policy that’s sort of blowing up and central banks are losing control of interest rates on the longer end, which is probably their biggest fear.

FRA: We were under the impression that the Swiss National Bank was doing this for the reason of lowering the currency rate, especially in the Euro-Swiss cross in terms of what that is, but in July that cross rate was making 30 month highs and even then the Swiss National Bank was still buying. Are there any other reasons that they might be continuing to do this?

YRA HARRIS: I just think that they don’t have an action plan. This has been going on and going on because if I’m running the bank, they don’t have to announce it, they’re not under the same mandates as the Fed. I would argue that when I do a weighted average of what they spent to buy in Euros, because the biggest intervention was buying Euros because that’s what they purportedly wanted to do to control the cross rate from appreciating too much in favor of the Swiss, but their average price for all the interventions that they’ve done? They have to be making money on their Euro end, which is unbelievable. You would think that they’d start entering the market. It is interesting that we saw last Friday a substantial move corrective in the Swiss. I thought, hmm, maybe the bank is in. But it didn’t have any staying power. I thought maybe they were coming in and selling their Euros to buy some Swiss back, but now we’re seeing it today – the cross has moved a big way. We’ve gone overnight from 114.5 down to 112.5. It’s a sizable move, but that has to do with the “safe haven” status of the Swiss in the time of Tweetmania from the president and chief, which is ramped up global tensions. So you saw some move there.

We’ll see what that does, but the Swiss… it begs the question, do any of these central banks really have an end to this? It’s really interesting that the Fed went that route, but of course Yellen gave us the ‘relatively soon’ comment in the FOMC in the last statement. ‘Relatively soon’, I’m not sure what that ‘relatively soon’ means. Peter, I have to agree with him, it’ll probably be in September, that’s what relatively soon means. I was hoping it’d be August just so that from a trader’s standpoint I could see some of the action, but markets are too thin and it’s probably right to hold off. This is what the Swiss are telling me. What do you want? This is what your objective was. Now you’ve gotten there. Even though as we learned, the Swiss did intervene with 20B Swiss of new purchases in July, that just came out on Monday morning. We got to see that. That helped push it, but that wasn’t an astronomical amount cause they’ve done that much, but the movement of 4-5% in that cross rate over the last 2-3 months has been very severe and you would think that if they really had an exit strategy they’d be using it at this time. If everybody wants to buy Euros, then sell them Euros. You’ve got them to go and you can unwind some of this position. But they don’t seem to be doing that, so it really causes the question, what is the real objective?

PETER BOOCKVAR: The analogy I give is, to make war analogy, this is like Vietnam for these central banks. Rewind to the mid-60s when the war first started, it was gung ho and we’re going to win and cutting rates and QE and all this, and all of a sudden they realize they’re not really hitting their objectives. Inflation is below their target, growth is not accelerating, let’s just do some more, let’s just send in more troops. And that’s wasn’t enough so let’s send in more troops. And all of a sudden they realize that the war is being lost and they’ve got a full army but they can’t just pull out because the place will collapse. So Nixon wins the presidency in 1968 on okay, we’re going to get out of this war, and the war didn’t end until 1975. It seems like this is sort of what they’ve gotten into.

Just to add on what Yra said, let’s just say they all achieved their objectives. Let’s just say the Eurozone CPI goes to 1.5-2% and the BOJ is successful in generating higher interest rates. Well then what next? You can be sure bond yields won’t be where they are right now; they’d be much higher. The central banks have to get out of what they’ve done. If they create the next recession, if they create the next bond market implosion, was it really all worth it? They’re only good at getting in, and I can’t imagine what will happen if they reach their objectives or now try to get out. There’s no foresight. If you’re a company executive, if these central bankers were company executives, they would’ve been fired ages ago. No director would allow a CEO to remain in place, doing the same thing year after year after year with no results. As any government official, since there’s not really much accountability, they unfortunately get to do what they want, with the consequences to be felt later.

YRA HARRIS: It’s such a great analogy, and fits so well with David Halberstam’s great book of that period, The Best and the Brightest. When you listen to financial media all day and read the papers, they view that every central banker is the best and the brightest. Well, we saw the mess that they’ve got us into, the best and the brightest so to speak, with their models. Of course, those were also rational actor models, the same we’re seeing today in North Korea because the post-WWII period has been built on rational models. We won’t have a nuclear catastrophe because the actors are rational. Which is what economics is based on, and their economic theories and the modelling is based on rational responses. Those are the assumptions that all these models make, that consumers investors savers, everyone do things rationally. We certainly learned that in 2007. Peter’s allegory with the Vietnam War is right, we’re doing more, more, more because they don’t know. Of course the fallback for policy makers, as Peter points out, is counterfactual. I can’t argue with counterfactual, but you’ll be gone when everybody has to unwind this. It’s like Jack Welch running GE – it was great until the classes he built to withstand the 2007-2007 got tested and we see the outcome of GE today. It’s a stagnant, do nothing stock that’s a stagnant investment.

There’s so much yet to play out. That’s why the Swiss model is very interesting. If anyone should be extricating themselves, it should be the Swiss. They’ve purportedly done whatever they needed to do, they’ve been successful, and they’ve made nothing but profits and the world has accepted it. We’ve talked about it on this show plenty of times, it still boggles my mind because I’m still trying to figure out who in their right mind purchases Swiss Francs. Who’s the buyer?

PETER BOOCKVAR: Imagine what happens with them is, they sit around their table at their office at the Swiss National Bank and say it’s time to start backing away, and then all of a sudden you see the Swiss Franc rally and then what do they do? Then it becomes, forget about Vietnam, it becomes Afghanistan. Pull out and the bad guys are going to fill the vacuum, and then we’ve got to get back in again. They’re just trapped; they’re all trapped and they’ve trapped themselves.

YRA HARRIS: I agree with that 100%. And their language is the same – when you listen to Draghi, it’s like he’s just quoting from the FOMC statement. And the Japanese? It’s longer but it’s the same sell. And now Peter talks about it too: this yield curve control, this YCC, has been an absolute disaster because it was meant to steepen the curve. The Japanese curve is at 16 basis points, far from steep, it’s very flat. They’ve failed on every metric, and the currency really hasn’t done anything because of turmoil in the world and of course huge Japanese repatriation of money whenever they so desire because they have so much. They’re like Britain in the 1800s; they’ve got so much money invested all over the world that any time they decide to bring it home it boosts the Yen up.

PETER BOOCKVAR: You have the Japanese Bank TOPIX index, which if the banks were the transmission mechanism for monetary policy, and it’s up to the banks to increase lending and jumps start the economy, well the Japanese Bank stock index is 20% below its peak of 2015.

YRA HARRIS: I know, because I own the individual ones. Between the dividends, it’s been okay; it was a parking spot for me. They’ve had a few ups here and there, but there’s no way that’s a success because those bank stocks would be extraordinarily higher. If you look at the 20 year chart you would gag. If you look at it over 30 years you’re not close to even, and there’s nothing in sight. You look at everything the Bank of Japan has done – disaster. The JJB market is the second largest debt market in the world after the US, and there’s days it doesn’t trade. Imagine that; it does not trade.

PETER BOOCKVAR: There was an article the other day that the Japanese 10 year JJB trades at about 900M a day. The US around 7-11 year traded at 80B a day.

YRA HARRIS: They’ve trapped everyone with them. Now they own so much stock. It was interesting, I was listening to Jamie Dimon talk about how he buys Japanese stocks because the government pension and investment fund, cause they kind of follow their lead because they’re doing all this work behind quality companies, but they’re in a race with the BOJ. The BOJ is buying so much equity that in 4-5 years they would own 70% of the ETF market. What is that? It is absolute insanity and the Swiss show us there’s no way out. They don’t even know how the end the insanity.

Which leads you to where the trading situation is: the markets are very low, volatile, and people are getting paid to sell their premium and that’s what scares me more than anything. It’s not just risk parity traders like AQR and Bridgewater, it’s everyone that follows them buy, because as their models crush the volatility in the markets, everyone’s forced into a short situation. I think there’s so much more risk out there that if equity markets started to correct for whatever reason, and the bonds went with them. For a while last year we had equity markets dropping with bond yields rising, so that was like death for them. I harken back to long term capital – when everyone thinks they know the risk, it’s far bigger because of all the people who are copycatting and mimicking that trade.

FRA: One last question: if we see balance sheet shrinkage by the Federal Reserve and QT, could that result in increased monetary velocity?

PETER BOOCKVAR: That’s a great question. Considering that QE has resulted in the exact opposite, I think eventually. I don’t think immediately. I think that asset price bubble will be pricked when QT begins, along with maybe future rate hikes, but it won’t be until the expansion after the next recession that we’ll get that. If what Bullard said was any indication, and he’s a non-voting member, is in the next recession the Fed will put themselves back in the same hole. They’ll cut rates back to zero and they’ll start increasing the size of their balance sheet again, hoping and praying for different results. The question is whether next time around, the market tolerates that. You’d think a lot about QE is psychology. And we always hear about, oh I have no place to put my money, this and that, but QE1 QE2 QE3 because a lot of that money went right back to the central bank and excess results, a lot of the market reaction was psychology. If you get reverse psychology because people realize, oh that central bank put is much further out of the money than I thought, you get this decline in asset prices. The US economy in particular, the only thing keeping it out of recession is the consumer. Capital spending is defunct, yes trade has picked up a little bit, but it’s predominantly the consumer. Consumer spending is also dominated by middle to upper end, and if you get a decline in markets for example, that could change psychology and that alone could put us in recession. The velocity story may not be sold again until the next recession, but that alone may be dependent on how the central bank responds to that, and if they just continue with the same old tools, thinking they’re going to get some sort of different results, then maybe it won’t be reviving any time soon.

I think the next rate hike will be determined by how the market responds to quantitative tightening of September. If the market’s very nonchalant with it and doesn’t really respond and we get to that December meeting, I think the Fed’s going to raise interest rates again because they’re going to be looking at the employment situation in terms of labor markets being tight and anecdotal evidence in terms of wages popping up here and there and the difficulty in workers. Regardless of what you think of the Phillips Curve, it doesn’t matter because the Fed believes in it. Now if the market has a hissy fit or a tantrum after QT begins in September, they’ll obviously not be raising in December. The irony is that the market can rally itself into another rate hike, or it can sell itself off away from another rate hike. I guess it’s pick your poison, then.

YRA HARRIS: I think that’s right. And to follow it up, Richard, with your question, I know if you start down that path, and nobody has a timeline for when it’ll happen, you put all that money back to work into the collateralized repo market, this may fall right in your face and for all the inflation that everyone said wouldn’t be taking place? You might get some real velocity to this money you haven’t had before because it’s been sitting tart. Again, it’s theoretical and we’ve never been here. There’s a lot of theoretics to it and I want to see. I’m with Peter. That’s why I can’t wait for them to start shrinking it just so we can start to test it. Anybody who’s a scientist, you gotta put these theories to work. Let’s find out what’s going to happen. What scares me about the central banks is that they’re so afraid of going down some exit strategy that that’s what’s probably the most unnerving for me now.

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

LINK HERE to download the podcast in MP3

Summary

Today’s Topics Covered:
• The relationship between Quantitative Tightening (QT) and steepening bond yield curves
• Possible volatility moves in the European bond curve if the European Central Bank (ECB) intends on announcing a QT policy
• The Swiss National Bank’s (SNB) purchases of international bonds and equities and the possible consequences of doing so
• The state of the Bank of Japan (BoJ) and the possible consequences of their current economic strategies
• How the Japanese Government Bond market is fairing in comparison to the United States
• The possibility of a balance sheet shrinkage by the Federal Reserve (FR) and what positive or negative outcomes may arise

Quantitative tightening, a term first identified by Peter Boockvar, is a policy in which the Federal Reserve uses to minimize bonds and shrink their balance sheet. Peter and Yra shed light on the relationship between QT and 10 year bond yield curves. Peter explains that long term treasuries are caught in a tug of war between the downward drag in yields because of natural inclinations to flatten the curve and the potential pull upwards as QT begins and bonds are bought less frequently. If the ECB announces QT then there will be a volatile move in the curve. Peter explains that there is a direction central banks are following in which there will be a rise in global long-term interest rates because of the reversal of extreme monetary policy. This outcome will gradually make the central banks lose control of interest rates.

They then discuss the questionable strategies of the Swiss National Bank to control the EUR/Swiss Franc cross rate. At first it was assumed that the SNB was using aggressive monetary policies in order to lower the EUR/Swiss Franc cross rate, but in July that cross rate was making a 30 month high while the SNB was continuing to buy. Yra went as far to question the actual existence of an exit strategy by the Swiss, “..but the Swiss… it begs the question, do any of these central banks really have an end to this?”. He argues that the SNB initially started off by trying to control the cross rate, but now they do not know what they want to do next or how to do it. He also makes an interesting point on how they should be making money on the euros they purchased and that they should be entering markets. Peter agrees with Yra and adds that central banks seem to only be good at getting towards their objectives, but they are not great at planning exit strategies. He explains that a Director for a commercial bank would be let go if he did not produce any results, but a government official does not face the same consequences. A government official can do as he pleases and not worry about detrimental future consequences. Yra states, “When you listen to financial media all day and read the papers, they view that every central banker is the best and the brightest. Well, we saw the mess that they’ve got us into, the best and the brightest so to speak, with their models.”

“Negative interest rates are just a tax, and someone has to eat it. Whether it’s the bank that eats it or they pass it onto a consumer, it’s confiscating wealth. I call it a weapon of mass confiscation. That’s all it is.” – Peter Boockvar

Peter also gave an insightful analogy comparing the SNB with the U.S. government during the Vietnam War. He explains that when the war started in the mid-60s, the U.S. government was overzealous in their pursuit to defeat the North Vietnam armies. In relation to the SNB, they too felt overconfident in their strategies and began cutting rates and using quantitative easing tactics. During the Vietnam War, the U.S. government realized that they were not progressing and decided to send in more troops. Just like the U.S. government, the SNB was not hitting their inflation target and growth was not accelerating and so they were increasing their amount of purchases. The U.S. Army continued to ramp up their reinforcements to Vietnam and eventually realized that the war was being lost and that they could not pull out of Vietnam because the place would collapse. He notes then noted that after Nixon won the presidency in 1968, the Vietnam War still did not end until 1975. He explains that the SNB has gotten themselves into a similar situation where they have already done so much damage to themselves that it cannot be so easily undone.
Peter also makes a great insight on how the SNB trapped themselves in a potentially disastrous situation. He describes a possible scenario where the SNB begins to back away from their tactics, but the Swiss Franc begins to rally. In regard to this scenario he states, “what do they do? Then it becomes, forget about Vietnam, it becomes Afghanistan. Pull out and the bad guys are going to fill the vacuum, and then we’ve got to get back in again. They’re just trapped; they’re all trapped and they’ve trapped themselves.”

They continue by discussing the poor state of the Bank of Japan and the Japanese Bond Market. Yra states that everything the JCB has done is a disaster and now the Japanese government bond market is the 2nd largest debt market next to the United States. He adds that there are days where the Japanese government bond market does not trade. Peter also adds that the Japanese 10 year government bonds are trading $900 million a day while the U.S. market is trading somewhere around $80 billon each day. They both agree that Japan and Switzerland need to figure out better policies and strategies to combat against potential recessions in both economies.

“The BOJ is buying so much equity that in 4-5 years they would own 70% of the ETF market. What is that? It is absolute insanity..” – Yra Harris

Lastly they discuss the possibility of an increase in monetary velocity if the FR is able to shrink their balance sheet through the use of QT. Peter believes that QT will eventually allow for the FR to shrink their balance sheet and the current asset price bubble will pop along with possible future rate hikes. He speculates that this will not happen until the expansion after the next recession. When asked if the market would thereafter tolerate quantitative easing he argues that the market reaction to QE is revolved around the psychology of the U.S. public. Depending on what tools the FR uses this time around will decide how the people react which affects the effectiveness of QE. Peter emphasizes his belief by stating, “If what Bullard said was any indication, and he’s a non-voting member, is in the next recession the Fed will put themselves back in the same hole. They’ll cut rates back to zero and they’ll start increasing the size of their balance sheet again, hoping and praying for different results. The question is whether next time around, the market tolerates that.”

Summary by Daniel Valentin, email address Daniel.Valentin@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.

FRA: Hi welcome to FRA’s Roundtable Insight .. Today we have Dan Habib. He’s been involved in the mortgage industry for over 15 years. He was an integral part of mortgage market guide where he created and managed the sales team and helped grow their subscriber base. Dan later worked for Morgan Stanley as a financial adviser where he was a member of the number one ranked Barens financial advisory team in New Jersey. He’s held his serious 763 65 31 and life and health insurance licenses. He’s also one of the founders of NBS highway and has been instrumental in its significant growth during the past four years as a senior market analyst. Welcome Dan.

Dan: Hey thanks for having me Richard.

FRA: Yeah, I just was wondering, could you give us some background on NBS highway and mortgage market guide. What they are? What type of services you offer?

Dan: Yeah of course, so mortgage market guide was kind of the original company that my father Barry and myself had started. We had sold that company and we are now running NBS highway air which we created about four years ago. But a similar principle. Really it’s a service for mortgage professionals where we try to help educate them each and every day, help them close more opportunities that they’re given and also gain and protect new and current referral relationships. We do that by really breaking down what’s happening in the market for them each day, breaking down the economic reports and as that pertains to the mortgage industry and interest rates. We also really help them with timing of blocking and floating their loans to avoid costly reprices or get better interest rates for their customers. We have a bunch of proprietary tools on the site and some really great real estate data that I think really helps our customers showcase and quantify the opportunity that exists in homeownership today. We really try to help (really kind of) give some insights and combat a lot of the negativity that you see in the media especially as it pertains to you know the health of the housing market, and you know some of these economic reports that come out. You know it’s our view that we think the media really just doesn’t really understand it. And you know you see all these reports and all these articles on CNBC all the time about how you know it’s more expensive to buy than rent in every state in the United States. And you know you have guys like Greg Carrdon, who was just on a video on CNBC and said that you have no business owning a home unless you have 20 million dollars in the bank and different things like that which you know ultimately our customers are viewing and seeing and you know in a marketplace where you have really tight inventory. Our customer’s customers are saying individual looking to buy a home and you know in a marketplace we have really tight inventory you know across most of the country and you know these customers aren’t getting a lot of bargains because of that. Now a lot of the time that come in at full asking price or maybe several thousand dollars above and they watch this negative media it’s no wonder why it’s easy for them to maybe flake out and maybe go out and rent. But ultimately it may not be the best decision for them. So we help them to really kind of get to the truth and meet behind the strength in the housing market and help explain that to our customers so they can explain it to theirs.

FRA: Can you help us provide insight into that? So you mentioned the mainstream media doesn’t have that sort of more accurate view of what’s happening. What is the current state in the U.S. housing markets?

Dan: So we think the housing market is strong you know a lot of times people have concerns. We’ve seen some good appreciation, are we in bubble like conditions? Well you know if you look at the facts we look back you know during the housing bubble years those 6 years. So we had an oversupply in the market, we had nearly doubled the amount of inventory levels that we have currently. So certainly not seeing an oversupply in the market from that dynamic. When you look at the demand side, the main demand remains extremely strong. You know one of the kind of metrics that we look at, we like to look at demographics and you know one of the most famous guys, if you look at demographics was Lee Iacocca you know and he was very famous. He worked for Ford and he saw that all these baby boomers were getting older and they needed to have a kind of stylish car and he turned up creating the Mustang, and ended up being the most popular car for Ford at the time and it was their most profitable. So it’s important to look at demographics. When we look at the demographics, Zillow says that the median age for first time home buyer is thirty three years old. So if we take a look at the birth tables and we go back 33 years ago, we can see where the birth rates were and that was in about 1984 or so. And then you can see what’s happened the next nine years. There was a huge surge in births each year greater than the previous year. So what that’s telling us is that over the next eight years you’re going to see a greater and greater and greater crop of individuals turning 33 in either coming into the housing market to either buy or rent. So we’re going to see strong demand I think for the next eight years and it doesn’t fall off the cliff after that, it plateaus at some of the highest levels since the baby boomers. So we think that we’re going to see some really strong demand, supply is tight. Obviously the first law of economics you learn as you know, tight supply and strong demand, it’s going to be supportive of home prices. But also we think that the kind of dynamics that we’re seeing in place are going to persist because builders have a lot of challenges out there right now. They’re highly regulated, they’re having a hard time finding labor and you know lenders just aren’t lending to them on spec like they used to. You know they used to be like build it and they will come, but you know they got burned in the past. So we think that the dynamics are going to stay in place. You’re going to have some tight supply, you’re going to have some really strong demand. And you know the media really I think focuses on the amount of sales. Now obviously if we look at the most recent reports that just came out we had existing home sales and new home sales. And you know both of those were decent reports of course we’re not seeing the amount of sales that we saw you know 10 years ago but we’re still seeing sales of new homes so that were we’re up like nine point one percent in the year over year basis and that’s with really tight supply. So you know if there was more inventory out there I think there’d be more sales. But I think that the dynamics are still in place are very strong and healthy housing market.

FRA: And is it localized like do you see differences between what’s happening in Miami New York versus perhaps less volatile markets. You know that I’ve appreciated in the Midwest.

Dan: Yeah. Well sure it certainly is localized. Overall if we were looking at you know as a whole in the U.S. appreciation you know depending on which report you’re looking at it’s been about six and a half to like 6.9 percent over the past year and forecast there for it to be above 5.2 to 5.5 percent depending on where you’re looking at of the nation for the year going forward. Of course you know that can vary in different markets. You know what’s funny is that it seems like the new markets that are doing the best are the ones that have legalized marijuana, you know in Portland and Seattle and Colorado, Denver those are actually leading in the way with depreciation over the last year. So they’ve been pretty hot.

FRA: Is there like a generational change or what about the millennials? We hear stories where they just want to rant or I mean do they want to buy houses at some point maybe because they’re strapped with debt initially but do they have the intention and the desire?

Dan: I believe they do. You know if you take a look// I think obviously the millennials are a different generation. But you know if we look at kind of like a normal life cycle right I mean if we look many years ago it was pretty normal for an individual to kind of get out of high school get married and start a family and have kids and buy a home. And that happened much earlier, you know people were getting married in the 20s, having kids and now it’s just kind of move back. You know obviously life expectancy got a little bit longer too, but millennials are taking longer to do things you know they’re not going to be like you know the guys in Stepbrothers, 40 years old living in their parents basement. I think they still do have they want to buy a home. But I think that you know they’re just taking a little bit longer to do something. So I think there’s some pent up demand there for sure.

FRA: What about the effect of interest rates on the housing market. How do you see that?

Dan: I think right now is a great time to buy a home. Interest rates I think are you know still really attractive you know interest rates on a 30 year fixed you know anywhere probably between about a quarter point a half percent right now. You now its funny, someone might say oh its high. You know I think all of you know the average interest rate will last like 45 years in the quarter. So we’re still at really attractive levels. And I think now’s the time to buy because you know if we take a look at the Fed. We know from the Fed’s latest meetings and their statements that they want to start where Peter Book likes to call “quantitative tightening” where they’re going to start unraveling their balance sheet and they’re going to do it in a measured pace where they’re going to let you know four billion or more in bonds and 6 billion in Treasuries kind of roll up their balance sheet each month and then kind of revisit each corner and I think increase it by those same amounts and once they do that you know I mean the fed’s the biggest buyer of mortgage bonds and treasuries so once you have the biggest buyers start to back out a little bit I think that rates are eventually going to have to start to move up towards the end of the year. If they start doing this in September and out in September. So you know I don’t think rates are going to go crazy because they go up half a percent or so once the Fed starts doing this. Yeah. So I think I think now is really a good time to buy a home.

FRA: As you see the rates going higher would that have a dampening or a negative effect on the housing markets?

Dan: I don’t think it’s going to affect purchase business too much to be honest with you. But obviously refinances of course you know, what’s interesting is if you look at the most recent mortgage application data that we got just actually this morning, it shows that refinances just rates are up about half a percent from the 50 basis points from this time last year and refinances are down 41 percent. So obviously it has a big impact on refinancing interface. They have a percent in of course that’s going to have an impact further on revise. But I think the purchase market’s very strong.

FRA: And in terms of Fed policy, the Federal Reserve on interest rates. How do you see that playing out? What point do they stop raising rates is the big question?

Dan: I think that the Fed wants to get one more hike in December. I think in September, I see them starting the announcer they’re pointed in on their balance sheet a bit and I think it has to. So long as you know we see things remain the way they are now. I think it was over in December and then I think they’ll probably pause a bit until maybe mid next year. Everything is going to depend on the data. Obviously I mean the jobs data I think has been sufficient for what they want to do. I think that inflation has been obviously a little bit stubbornly low. You know if you look at the most recent data from this morning or yesterday was with the personal consumption expenditures came out and that’s the FEDs favourite measure of inflation and that core rate showed only one and a half percent. Obviously below the 2 percent that they’re looking for we think that the Consumer Price Index is a better measure because it has a heavier weighting towards the cost to put a roof over your head as well as out-of-pocket medical expenses. So I think it shows you know true inflation a lot better. But you know for whatever reason it is the Fed likes to focus on the PCE for that has been stubbornly low. And I also think that the Fed expecting to see the labor market tightening, they’re expecting to see some wage pressure at inflation which we haven’t really seen yet either but maybe we’ll start to see that coming. You know on Friday we’re going to be getting the jobs report which is obviously going to be very important for the stock and bond markets, certainly could have a big impact depending on how that comes out. Know we did get the ADP report today which is about in line with expectations. I believe it was about like about a hundred and seventy eight thousand jobs were created last month. So a decent number. I think a strong enough number for the FED. But we’ll have to see how that BLS report comes out. And really I want to be paying close attention to that average hourly earnings numbers see if we’re seeing any wage pressure inflation there but like I said I think the FED is going to try to get one more hike in this year and then kind of see some of the data that comes out from there.

FRA: Do you think there’s a look at the Federal Reserve policy from the perspective of raising interest rates up to a point where it doesn’t go higher than a 10 year Treasury bond yield because that’s some point that could turn the yield curve into an inverted yield curve you know potential recession type of thing.

Dan; Yeah of course, you know the tend to spread is something that we actually have on our site for our subscribers as a good recession indicator. You know it’s been pretty accurate one. You know I think that FEDs going to be careful I think that you know they’ve obviously done this whole QE experiment for many years and I don’t think they’re going to want to raise rates too quickly to you know send the economy into a tailspin.

FRA: And what about the actual purchasing power of a home. Just what are your thoughts on that?  A lot of our commentators have mentioned a distinction between nominal terms and real terms so that if you take the price of a house today and divide by you know how many cups of coffee you can buy today versus how many cups of coffee can buy in the future. You know some measure of inflation. Do you see the actual purchasing power of a home as increasing nominally and in real terms or just perhaps nominally?

Dan: I think I see an increasing in real terms. I think that inflation, you know remains pretty low. I’m not too worried about it getting too out of hand. And any of the reports, you know we’re looking at a we have some great real estate data for every kind of a metro area in the country and you know what I’m seeing out there are some really strong appreciation forecasts. You know I think that it’s going to some really strong power.

FRA: And just your thoughts on the political situation in the USA. How is that affecting the housing market interest rates and the overall financial markets?

Dan: Well I think that initially the financial markets obviously got a really nice push from the new administration and you know we’ve seen the stock market has been on some tear. It’s been unbelievable. You know now and 22000 today. And you know even though the administration has been unsuccessful and you know ….and you see how we do on taxes. You know I guess some would argue that you know markets are moving higher.  Maybe not so much based on Trump anymore on the strength of the stock and the earnings that we’ve been seeing in some of the fundamentals. But you know I would love to see some of the stuff from Dodd-Frank. You know kind of get loosened up a little bit and I think that can have a good impact on the housing market. But you know again, its been a little disappointing to see really nothing pass through, you know so far.

FRA: Just overall, your view of the housing market for the next 5 to 10 years?

Dan: Like I said before, I think the housing market’s going to remain very strong. I think we’re going to see some really strong appreciation levels. I think that you know one of the things that has been encouraging is that if you look over the last several years we’ve seen some really good levels of appreciation and you know the media has been negative on the housing market the last five six years or you would have missed a great opportunity. But you know one of the things I think the media gets wrong is the affordability. You know we have great affordability data for every measure for every country and what I’ve seen is that for most markets affordability has remained pretty level. I think the media makes the mistake of thinking that if a home price goes up automatically affordability has to go down. But obviously there’s a couple of other things that go into that number obviously it’s the home price but it’s also interest rates, it’s also wages and jobs and you know if we were to use the media’s kind of explanation well that would mean that if home prices went down all of a sudden affordability has to go up. But what happens if interest rates skyrocket what happens if you lose your job? Does that home get more or less affordable? Obviously less affordable. So I think we’ve been seeing until homes are still relatively very affordable. I think the dynamics of tight inventory are going to persist. I think demand is going to remain strong. And I think it’s going to be a recipe for a really strong housing market for years to come. Not really seeing any kind of you know conditions that would worry me like any bubble like conditions and you know historically you know even if there were talks of recessions and stuff. If we were to look at the last 10 recessions from World War 2 you know nine out of the last ten of them, housing has actually done really well. And you know obviously the last one, housing prices actually started going down a little bit before the recession and really it was more like the housing bubble I think kind of led us into the recession and not vice versa. So you know I think that housings going to be very strong for the years to come.

FRA: That’s a great insight. Overall the discussion and I appreciate very much having you on the show Dan.

Dan: Thank you so much for having me.

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FRA: Hi, welcome to FRA’s Roundtable Insight .. Today we have Charles Hugh Smith. He’s author leading global finance blogger and philosopher, America’s philosopher, we call him. And he’s the author of nine books on our economy and society, including neurotically beneficial world automation technology in creating jobs for all resistant’s revolution liberation, a model for positive change, and nearly free university in emerging economy. So we will talk about those books today and he also has a blog of twominds.com. That blog has logged over 55 million page views and is number 7 CNBC’s top alternative finance sites. Welcome, Charles.
Charles: Thank you, Richard. Well, let’s hope that impressed your resume, I am able to shed some light with you on education jobs and the impact of automation.
FRA: Yeah. No, sure, yeah great background and insight as always. And you’ve been very generous in providing some charts today, which will make available on the website for people to download and to view if they listen to this podcast and so yeah maybe we begin with the big picture. What you think education is? Why there is a problem? Also maybe how financial repression initially has created a lot of debt in student debt market and then take it from there.
Charles: Ok, well I take a stab at it and you can fill in whatever I miss for which I’m sure will be a lot of changes. You know Richard the thing I concluded and I’m not alone in this, is that higher education throughout most of the developed world and even in fact even in the developing world, like China. It’s a cartel, in another word it functions like a cartel and this is part of the financial repression. aspect there is no competition in the university and college system in the United States. and that every school just boost the tuition based on its peers, and the reason why they have this cartel like pricing power is because they control the credentials. The issuance of credential, diploma, which students have been brainwashed into feeling that they must have or else they are doomed to a life of unfulfilling work and poverty and so this is given in pricing power and that’s completely unconnected to either the value of the credential they are issuing or to their competitive value compared to other universities. And so you’ll have a really pretty nothing special you know state school charging tens and thousands of dollars and not that much less really than Ivy leagues which often give scholarships as well because of their huge fund that they accumulate from you know they’re highly paid graduates. and so this has created a financial repression that focuses solely on the students of higher education.

So we can see that student loans have risen from essentially almost nothing to 1.4 trillion and as this is weight more and more heavily on students and they start defaulting right and so the result of this is that cartel has now handed over the funding of its ridiculously over priced service to the federal government, which has now taken on all this student loan debt as an asset if you can believe that. And Gordon Long and I did a program where we drill down and discover that there is an enormous shadow banking system that which has benefited and profited immensely from processing all these you know trillion student loans.
FRA: yeah absolutely.

Charles: Yeah now as we seen these enormous costs increase, into like three or four hundred percent increases in tuition while the rest of the economy is more or less flat lined. We find it even the most educated worker has declining wages. And the chart I have submitted was from the 2006 era, you know the era of financial crises. and since then despite this so called recovery, wages of all workers have either stagnated, you know zeroed out or they declined as much as 5 percent.

So even college educated people are not reaping any benefits from this enormously expensive higher education and I have another chart that shows as a percentage of the workforce the number of people with a bachelor’s degree and higher has of course been rising for decades and as a substantial part of the workforce now and so now we’ve been told that getting a bachelor’s degree or higher is like a ticket to you know permanent prosperity and all this and the numbers don’t add up with that.

And we also have a chart here that shows student loan debt skyrocketing, but the median income earned by people that have a bachelor’s degree it has been declining. And so there is a mismatch here between the cost of education and the payoff. And people are looking around for answers like why is this? And of course, one reason is that the growth in higher education budgets is largely with results of more administration, more managerial staff being added while the actual teaching staff is not gone up by much.

I have a chart here that happens to be to the University of California system. Probably the largest public system in the US, just due to the size of California having 38 million people. And you can see that the number of management staff has skyrocketed while the number of teaching staff has edged slowly higher and they are about the same now. The system has almost as many administrators as it does professors and of course, as you and I were speaking before we started recording, the salaries in higher education are not in competition in the sense of the real world of entrepreneurism or managing in legitimate companies that turn a profit. A lot of these management positions are like they have assistant dead to an assistant associate dean of student affairs and the guy is making quarter million dollars.
It’s a completely out of touch with the private sector in terms of productivity and value of that position, which is really a net negative because the students are paying for all this additional management of their education and yet the quality of the education is clearly not keeping up with what the economy is demanding. Are you seeing the same thing?

FRA: Yeah the same thing in Canada where salaries could be 250 thousand and these are typically government type roles right positions and even though the University of Toronto, it’s also more than that because of the pensions, it could be 80 or 90 percent after they retire, so it’s just huge salaries and its rehashing and repeating the same course of teaching the same thing over and over again and there’s not much you know excitement to that. And you know you have to wonder what is the issue here, is its accreditation. Is that what is driving this you know partly and also the financial repression aspect of it. You know lower interest rates, the ability for the middle class to make loans right at high numbers so the wealthy could essentially pay cash; the poor have potential grants, so the middle class would have to come up with loans. Effects everybody has a virtually unlimited source of money to pay for the tuition and there is a play on the value of having an education, where everybody realizes that, but it’s gone beyond that where they are taking advantage of that value.
Charles: Right, right, and one pernicious aspect of financial repression is suppression of competition and so you know there is no competition really in higher education. The degree, there’s nothing in this whole system that actually measures in quantifies or compares the supposed education that student has gained or the value of the education and compare it to other competing schools. So studies like academic drift, which was a study that came a few years ago found that a huge percentage of university students in the US gained no appreciable knowledge after found years in a university. In other words, they didn’t really learn all that much, that could be identified. And so this has driven a movement away from businesses relying on credentials and grade point averages. For instance Google very famously used to focus on your grade point average and your course work and those kinds of stuff, and they realized it did not connect it didn’t correlate with the productivity and creativity of the worker so they have now moved away from that model and that the third of their hires don’t have bachelors degree or bachelors of science and no college degree at all, and so this is I think what’s what businesses and even government agencies are finding out that the credentials doesn’t say anything about the student which is why in my book in the university I suggested that the solution is a new model in which we are credit the student and not the institution in shirt the student has to prove that he or she has learned stuff and knowledge basis that are of value to the employers so that we would accredit each student and never mind the institution they would be out of it so if they failed to actually educate the student then they would get nothing.
FRA: so is it more of the alignment of the education towards what is being asked for or needed in the economy?
Charles: Yeah, that is right its aligning the education with what is needed in the economy and also aligning it or realigning it with to the cost of education so worthless education should cost almost nothing. if the institution can’t actually help the student or learn what is needed then the institution doesn’t deserve the tuition and that would revolutionize the higher education but Richard I’m just going to shift just a little bit here, and talk about what do we mean by the emerging economy and how are the skills and the knowledge basis that employers need how is that changing and of course we all know the big deal, automation that a lot of human labor can be automated and or replaced by software and robots and following software and many other jobs are now requiring humans to know how to program robotics and program software so that it’s kind of a cooperative effort if you will between me and the forces of automation and the human laborer right? yeah and so that is a higher level of skills thought to be able to reprogram a robot and that sort of thing right? it’s not simple assembly work anymore and so we’re seeing the job market breakdown into these broad categories, of course, the high skill ones like full programmers and people who design software and who can actual engineer actual robotics, of course, there would be jobs for these people who are highly educated engineering types as it’s the middle sector its everybody below that very highly educated engineering math science kind of a sector, that whole thing is, the larger chunk of the economy is vulnerable to automation the larger chunk of the economy is vulnerable to Automation. Of course we’ve seen this and in many fields at starting with like factory work but it’s moving up the food chain to accounting and even legal work and of course in financial tech too right, haven’t you. I’m sure we have all seen the photo in those trading desks at major investment banks that used to have these huge rooms crowded with traders now there’s twelve people in the whole room,
FRA: Most of it can be done through trade processing platforms like calypso and more these are like derivatives trading platforms that can do pretty much everything front office middle office back office altogether in one system.
Charles: Right, right and so another factor here is Michael Spins, he is the economist who won the noble prize in economics for his work on explaining how work is nowadays in the global economy, some of it tradable and some of them not tradable and so that’s a key factor because if tradable work like programming software, that can be done anywhere in the world right? It’s a digital file so that imminently tradeable. Where like giving someone a hair cut or doing the landscaping like on a yard, you can’t outsource them, you can have immigrant laborer and you can try to import labor if you are short on laborer to do that kind of work but yeah, a lot of people are seeing that there is a dichotomy here that we’re going to divide into low skill non-tradable work like landscaping like perhaps even things like food service that, of course, that’s a mixed example because a lot of food services are already being automated as well. And so we have these two pressures, whatever is tradable is under pressure from globalization, in other words, the employers are going to have to ask can this same work be done elsewhere in the world for a lower price so that puts pressure on wages and high cost to develop world economies. And in the low skill nontradable sector such as yard work and taking care of elderly people and that sort of labor then the pressure there is can we automate some of this and so we are hearing from Japan where they’re really pursuing the idea of having some sort of simple basic robots that would provide some basic services to elderly people that are maybe bedridden. So the robot could come in and make sure that they take their medication on time, that sort of thing. And so again because there are facing a labor shortage and here in north America the pressure is the cost of labors just keeps going up, not so much the wage but the cost of labor overhead to pinch us, disability insurance and the health care at least in the U.S., less so in Canada I think. So we sort of seeing that if we combine these sources we can see there seems to be plenty of jobs that are low skill but they’re also going to be low wage and the non-tradable sector, coz there’s going to be a lot more labor that’s able to do that work then there is the abundance on the labor side, not the job side. There’ll be plenty of jobs but there will be even more people who are qualified to do that, but on the higher skill level there’s going to be perhaps a few more jobs but those jobs are often tradable so there is more global competition and pressure on wages even on highly educated highly trained people, you know salary. so
FRS: What is the future pertaining in terms of where the trend is if you had to advise somebody who is going to college and what they should study or should they go to college or how should they prepare for the world of work.
Charles: Right, right, that’s an excellent question and I did write this book: “get a job and build a real career and defy of the wildering economy” and the reason why I characterize the economy as bewildering is it really is bewildering because there are all these big dynamics which we all touch upon whether the work you are trying to get is tradable whether it’s high enough skill can it be automated all of these things factor into jobs of the future. So there is a great Mackenzie report on automation and I think it sort of echoed what I’ve read else where in researching this topic which is what humans are good at and what machines are not good at is combining knowledge basis from various fields. Computers are really good at what is repeatable and can be broken down into definable task, and what they are not so good at is changing or adapting on the fly to changing circumstances, and so that’s the kind of skill set that everybody would benefit from having is try to develop multiple skill set and multiple knowledge bases so you could bring a couple of different sets of experience and knowledge to bear on problems because those are basically impossible to automate, at least in the existing technology, and that can be in a lot of different fields. It doesn’t have to be just in high end, we are not talking about high finance or programming software, it can be something like on the factory floor, with robotic arms and then the work changes because we got a different order, then the skill set that is going to be highly desirable is a worker who knows how to reprogram that robotic arm on the fly, in other words they can change the robot’s tasks and that with accuracy and speed that kind of skill is going to be valuable, so my point here is the whole range of skills from what we might call blue collars like welding and pipe fitting and construction, there’s going to be a lot of changes in those fields too, working with robotics and software and all the way up to health care and higher education itself. Not to mention industrial design, public relation and all the other fields that we think of as upper middle class.
FRA: Yeah, I see the same thing, I mean in terms of multi-disciplinary areas being brought together so like in the consulting world I see that happening with maybe a project involving compliance to a regulation but you know some aspects would have to do with it if you just look at IT itself a lot of that can be outsourced but once you have that, like an IT control, that needs to be put in place for a regulatory compliance this sort of that aspect to it the legal aspects that need to be considered and thought through and how they can be implemented together with the IT control sort of like a multi-disciplinary type of thinking.
Charles: Yeah, that is an excellent example Richard, and then on the global scale, then you can also add cultural knowledge because of the IT and the legal aspect of regulatory compliance then you also have the cultural issues to show up with making sure that the work force in a particular nation, is up to speed culturally, like why do we have to do this and how you educate each particular work force and so. Yeah, that’s a great example of what I am talking about, multi-disciplinary.
FRA: And just in general as you’ve mentioned earlier the ability to adapt quickly sort of the old idea of the adapt sort of the emphasis on the adaptability versus the big dinosaurs.
Charles: Yeah that is right and I think that Charles Darwin himself, famously said, it doesn’t go to the smartest, it goes to the most adaptable. And so one topic I also want to bring up, is that a lot of people in the automation field or in economics they often refer to the idea that well there is just going to be a lot of great opportunities for creative output, we are going to have a lot of people that are poets, making films and all these kind of stuff that. I just want to point out and I’m sorry if I just splash cold water on that but as we all know all the creative output is in super abundance in other words, everything is free now because there’s limitless number of songs and huge quantity of music and films and comics and cartoons and novels and stories and I mean any kind of creative output is in super abundance on the internet and so it’s very difficult to charge any money. You know to get more than 99 cents for an app or song or even an entire book is becoming a challenge. So it’s nice and I’m all for creative output in terms of self-expression and the fun of life, but in terms of making the middle class living my experience is that the number of people who make decent living at being a creator is pretty minimal and so I think the idea here is not to throw cold water on creativity but to say that learn the skills of creativity, which is often mixing and matching the multi-disciplinary skills we are talking about. Bringing a fresh perspective or looking with fresh eyes, but holding those creativity skills, but be able to bring bear on real world problems as opposed to thinking that I am going to be a poet or writer or you know an artist and I am going to make that my career. It is more likely is say for instance if you were super interested in that and had an act for say painting then you might want to get an internship with a curation staff, in other words, learn the ropes of how you would curate a collection and you’d be gaining skills into your interest in painting and your knowledge base, but you’ll be learning some skills that deal with real world and why people would pay you for the knowledge you have.
FRA: So I guess I mean one theme could be if you going into tradable skills that have to be some element of innovation and adaptability innovation, cutting edge if you will, but in the non-tradable that could also mean the job protection by regulations or jurisdiction based licensing, like you know lawyers can practice within certain jurisdiction, does that make sense.
Charles: Yeah that’s good point Richard and I think when we talked about the millennial generation few programs ago, I mean that’s what we both read was that the millennial generation as a generalization is interested in say government employment because it is more secure, but the downside of that is that the economy that we are talking about it has a certain Darwinian element to it, which is you’re going to lean the skills to be part of the disrupter or you’re going to be the disrupted. and so the problem is all these protected industries, which would include health care, higher education, and the government sector itself; these are the low hanging fruit for disruption because they are extremely high cost and tend to be inefficient and they tend to be cartels or self-serving protectorates. you know that makes sure that their wealth funded and never mind if their productivity is actually declining or they’re not really solving any problems anymore.

And so those are the fields that are more likely to be disrupted then the fields that already been constantly disrupted. For instance, the automotive industry. I mean come on the thing is in constant turmoil already, so there’s not much you could disrupt the auto industry with constant and rapidly changing, but if you look at healthcare it’s still stuck in procedures and bureaucratic mindset that no longer require, technology has gone far beyond what we now deliver health care in the US is so annotated and obsolete, it’s laughable and everybody knows this but we haven’t been able to break out of it and innovate, but that will happen because the costs are crushing, the government and private sector. So I would hardly recommend young people not to count on allegory or a health care job or government sector job as being some sort of guarantee going forward, it’s going to be disrupted too.
FRA: Yeah there’s going to be lots of tension, I mean you already see it in Uber and Airbnb, right all these development going on and doing disruption to that type of cartelized industry.
Charles: That’s right, so in higher education is pretty clear that I mean what the model that I proposed and I’m not, again this is not unique to me, I mean we just have to look and say the German model for the way that they funnel students out of high school into apprenticeships or university, and to me the apprenticeship model works well. We can replace the university of curriculum with that kind of approach even in software or philosophy or anything else. That model would be a lot more affective and a lot cheaper than the way we do now where we sit in classrooms.
FRA: Yeah, I think I saw some statistics where Germany does that at a very high rate like seventy percent of apprenticeship programs, compared to only ten percent in the US, something like that.
Charles: That’s right, and it was just an article in foreign affairs about how the US used to have a much more robust system of what we used to call like trade schools, and that’s been allowed to decline any road in favor of everybody getting a bachelor’s degree. This has actually crippled our economy in some way because we’re lacking the skills that the economy needs and yet we’ve turned down lots of people with degrees that don’t really have a lot of value. You know, art history and gender studies and this kind of stuff, and I myself have a degree in philosophy which you know could qualify as worthless. But it did require a certain amount of rigor in thinking things through, and that has served me well. I would argue that philosophy should not be put into the worthless degree category, but it should be connected if at all possible with some engineering skills, or some finance skills or some other more applicable, would be the ideal multi disciplinary approach we’re talking about. Don’t major only in philosophy, major in something else as well and together the two will probably serve you well.
FRA: Actually myself, I’ve got an engineering degree, but a minor degree in the philosophy of science.
Charles: Oh excellent.
FRA: Yeah that’s interesting. What is the path then going forward, I guess you can mention a number of industries but the path is sort of generic, that people should come with a sort of thinking outside the box, look at potentially disruptive industries, you know where things can be improved and then maybe take courses online, or is that what you’re suggesting in terms of trying to get opportunities from that way not necessarily through the traditional bachelor degree or MBA type of approach?
Charles: Right, the ideal pathway that I’m suggesting for people that either don’t have the money or don’t want to waste four years getting a degree that may or may not actually serve them is to seek out the equivalent of an apprenticeship, and this is not going to be a formalized model that you get to join. You’re going to have to make your own apprenticeship, and that would be to seek out a mentor in the industry in which you think you have an interest, whether it be fashion design or you know some sort of art related field or health care. Whatever it is, I would seek out a working professional who would help design your curriculum so that it would actually serve the needs of the working environment that he or she actually understands, and so that might include getting a BA or a BS, but I would get right out of the gate out of high school, and I would be seeking and apprenticeship with work for nine months or a year for somebody who could layout a curriculum and if I could learn all that stuff online then I might not even need a BA or a BS. So that’s what I would do. And if it turns out they say, “look you really got to get this BA or BS”, then you know what your pathway is at least you know that your work will be rewarded, that its essential for what you want to do in life. You’re not just burning four years and getting a hundred thousand dollars in debt and finding out it doesn’t even really serve the economy or your own career path.
FRA: Maybe also thinking outside the box, I know a lot of people that we talk to on the program show have an international perspective. There’s also the idea of looking where high growth areas of the world are, like you know Myanmar, Burma. If you go there now you can basically start a business, whatever has worked in parts of Southeast Asia will likely work there. So you can set up that business, it could be serviced offices or car rental, whatever works elsewhere in Southeast Asia can be replicated there at this time.
Charles: You know Richard that’s an excellent point or super important point that I failed to mention so far, which is really where the value comes in the global economy is filling a scarcity. Where there’s a problem that hasn’t been solved, if you can bring those skills to bear, then you’ve got a guaranteed and a very exciting career. And I think you’re making a really big point here about places like Myanmar, is that there is a huge amount of developing world economies, you know there is so many scarcities that need to be filled there and there’s often a regulatory burden or a lack of infrastructure. I mean there’s often major problems that need to be overcome to get to fill the scarcity, but being part of those can be very rewarding and will require some research. You don’t just blow into some new culture and new nation and it operates by different rules. But again, if we follow the idea of an apprenticeship, if you get hired by somebody who would send you to another nation. Or if you just go there and try to find work and just say “I’m going to give this six months”, then you’ll probably learn a tremendous amount on the job, far more that you can possibly learn by going to school there.
FRA: I can think of my own experience too with the disruption of the internet. I was one of the first users of the internet back in nineteen eighty-three, and I did the whole internationalization of the internet in the nineteen nineties, so all over the world. Setting up internet service providers in different countries. That type of thinking outside of the box, international in scope and just bringing on a new disruption type of technology or process.
Charles: Right, and I guess in a similar vein, we could also say that these sclerotic, stuck in the past kind of sectors like health care and higher education that we’ve mentioned. There’s also huge scarcities in those industries that just aren’t recognized yet. And also as you say geographically, that if you’re the first into a market and with a first solution, and it could be as something as full as bringing a wealth of web related public relations and social media skills to a small town. And if you’re first there, then you can write your own ticket because you’re solving problems and there’s no body else to solve those problems.
FRA: And I think overall with countries in the past pulling financial oppression method of say currency, devaluation, competitive currency devaluations, it’s now moving into a realm, given that all countries are doing it at the same time. Coming down to a differentiator of innovation and how adaptable can your economy be, and how competitive can your economy be, more and more I think I see that globally.
Charles: Right, I would say that cryptocurrency as another example of how financial oppression can cripple an economy is that there’s going to be a huge expansion of block chain technology. So if someone was technically minded I would recommend they really dig in and burrow in, learn how to understand and code block chain technologies because the nations that enable this and encourage block chains are going to succeed far more than those that are trying to supress of repress it.
FRA: Yeah exactly, and that’s a great way to end our program show for today, and that’s great insights as always. Charles, how can our listeners learn more about your work?
Charles: Please visit oftwominds.com and you can read free chapters of my books and look at my archives and see what else I’ve got on tab. Please visit and I welcome your readership.
FRA: Excellent thank you very much Charles.
Charles: Okay thank you Richard, my pleasure.

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

FRA 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 20^th 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 19^th 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 19^th century as it was going into the early 20^th 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>

LINK HERE to download 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.

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 11^th 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.

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.

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 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 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.

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.

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 1^st 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>

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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.

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

Bill Laggner is the Co-Founder of Bearing Asset Management. He is a graduate of the University of FL (BS in Finance with honors). Bill began in the investment industry in the late 80’s, initially as a stockbroker and then moved to the buy side at Fidelity Investments. He left Fidelity in late 1998 to manage his own investments. Bill cut his teeth on the short side during the tech bubble and after it had burst, formed Bearing with his fund partner Kevin Duffy in the early part of this decade.

 

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>

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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.

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 8^th 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.

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

 

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>

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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.