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

Charles Hugh Smith: Thank you, Richard. I don’t know if I can live up to that .. but I’m very excited about our topic today.

FRA: Oh yeah. You always do. Always live up. And today we’re talking about Cryptocurrencies. You’ve written a lot about that on your blog, including today as we speak with the potential Bitcoin price as you suggest going to the $17,000 level.

Charles Hugh Smith: Yeah that was my sort of back of the envelope forecast a year or so ago and last summer. You know I want to start out Richard by saying that you know there’s a lot of people have an emotional connection to this topic of Cryptocurrency. A lot of people are extremely skeptical or feel like it’s really not worth anything and certainly not worth you know $10000 per bitcoin and other people are kind of evangelistic about it and super excited about the Blockchain, you know disrupting all of the intermediaries in our financial system. And so I think what we’re going to try to do in our program is to be skeptical of the whole Cryptocurrency movement and be open to the potential benefits that it offers, but not like we’re not going to accept anything just uncritically. We’re going to look at everything .. We’re not going to put our belief structure in either camp either anti-Bitcoin or pro-Bitcoin. we’re just going to look at it as coolly and rationally and as we can and try to understand the value if there is value here.

FRA: Excellent. And you’ve provided some charts that we will make available on the website .. maybe we can begin there with the technology adoption curve.

Charles Hugh Smith: Right. And you know it’s it’s almost unbelievable when you think about it, at least it is to me. That the whole Cryptocurrency space is only eight years old. I mean that Bitcoin protocol was released in 2009 and it really didn’t do anything for quite a while, it was kind of a hobby of certain people and Bitcoin trading under a dollar for quite a while and then under $10 for quite a while and then it kind of made a splash in 2013 with the Cyprus bailin ..  which was at least one of the triggers that caused Bitcoin to suddenly come out of nowhere and go to about a thousand dollars .. and then various hacks into Bitcoin exchanges caused a complete selloff that drove the price back down into the $200 you know so there was a massive sell off.

But my point is this space is developing very quickly in a lot of different directions that are hard for us amateurs to track. In other words, there’s a proliferation of Cryptocurrencies, but there’s also a lot of development going on ..  And then there’s a lot of development of trying to make the transaction rate of Bitcoin faster. You know for instance Bitcoin cash raised a block size from one megabyte to eight megabytes. And this .. was supposed to add a layer on top of Bitcoin that would process transactions much faster. Well that didn’t go because it was withdrawn because of technical difficulties. But you know it’s going to be very difficult to predict where the Cryptocurrency space will be in eight more years. That’s all I’m saying is that there’s a lot of development and innovation going on. And most of it we know will fail or drop away just as the Internet itself proved. But what we’re trying to do is ascertain the core value here. So that whether there will be some winners that will need to develop as as time goes on to meet the needs of people in our financial system .. That’s basically if it meets a need it will it will survive if it doesn’t really meet it. I mean if it doesn’t really have utility then it will fade in and become a novelty.

FRA: Yeah I agree very much with those observations. I mean you have the growth of the block chain based economy that is just massive potential. And then the use of Cryptocurrencies as a payment mechanism for Blockchain based applications and services. Right now there’s about twelve hundred Cryptocurrencies in the universe. And we can see lots of mergers and acquisitions just like what happened in the Internet.com era. Many of those Cryptocurrency is either going out of existence or many of them merging, some acquiring others, so that space could then dwindle down to a very small number of you know of Cryptocurrencies.

Charles Hugh Smith: Right and one of the other charts I proposed using for our program was a chart of the Venezuelan Bolivar, the national currency of Venezuela. And of course as we all know it used to trade about 10 to 1, in terms of the Bolivar to the U.S. dollar. And now last time I checked which was a few months ago it was trading around 6000 Bolivar to the dollar on the black market. So this currency is as experienced what we call, you know you can call it hyperinflation or a tremendous loss of purchasing power. That’s just basically destroyed the wealth of everybody holding Bolivar right. And so this is what we’re all concerned about with Fiat currencies. You know currencies that are created by Central Banks or national governments and that can be created without any restraints. And so this is what I think part of what’s driving the interest in Bitcoin and the Cryptocurrencies is what other financial mechanism is available to people who are trying to preserve their capital when their own national currencies are in free-fall.

FRA: Yeah exactly. Just recently there’s been a couple of quotes. One from Mike Novogratz on Bitcoin and one from Danielle DiMartino Booth on Bitcoin. And I would just like to read you that that. Mike says “this whole revolution came out of a breakdown of trust. It came out of the ’08 financial crisis when people said we no longer trust financial institutions, we don’t trust governments and in parts of the world today still. If you’re in Venezuela, it’s really hard to trust a Central Bank or in Zimbabwe. So the de-centralized revolution was Bitcoin is really the poster child of a response to the breakdown in trust.” And Danielle DiMartino Booth who is a former Federal Reserve Adviser to the Dallas Federal Reserve President, she mentions that “Bitcoin is a reflection of panic. It’s a reflection of people trying to get into a safe place knowing the major governments of the developed world have got their printing presses running 24 by 7. It’s a reflection of anxiety and fiat currencies and the fact it’s not practical to go back to a gold standard. What scares me most about Bitcoin, if the central bankers are studying it to figure out how the blockchain works. They are going to be controlling our spending with blockchain technology that is being perfected in the Cryptocurrency universe.” Comments?

Charles Hugh Smith: Wow. Yeah I think that those two, you chose quotes very wisely because those express very widely held views that you know we’ve all seen expressed by a number of commentators and observers over the last few years, which is Cryptocurrencies are one of the few avenues that an average person might have to escape the kind of financial repression that you know that you’ve covered in so many programs. In terms of capital controls, bail-ins, expropriations, and massive devaluation of the currencies. You know all these different tricks of financial repression, the elimination of cash. And that’s one of the driving factors, but then the fear on a lot of people’s part is that the central banks and central governments are not going to just stand still. They’re either going to issue their own blockchain currency and require their citizens to use only that Cryptocurrency or that they will try to ban or outlaw the existing Cryptocurrencies as an extension of the financial repression.

FRA: And everybody these days is talking about the price of Bitcoin where is that going .. you mentioned Venezuela on that chart – If we look at the history of the price of Bitcoin .. Going up to sort of the 1000 to 2000-dollar level. A lot of that seems to have coincided with Venezuelans in Venezuela and also Chinese in China looking to get money out of their countries – you know capital outflows and then from there, it seemed to have critical mass taking off to where it is today slightly over $10000 as we speak. Comments on that.

Charles Hugh Smith: Right. Well you know before we started recording you were speaking about the costs of mining Bitcoin and as being one factor in that we could use in its evaluation. And so let’s try to contextualize the discussion about the value of Bitcoin and you know a lot of people feel it should be zero because it’s not backed by anything. And of course then proponents say well there’s nothing backing all these national currencies either, there’s nothing backing the Dollar, the Yuan, the Yen or the Euro either. Which is technically true. And so let’s move on to valuation. One factor that’s in a lot of people refer to Bitcoin in particular as having a big impact on its evaluation is, it’s a scarce entity. In other words, there’s only 21 million Bitcoins that will ever be mined. And beyond that beyond that amount then there will be a fee structure to support the blockchain right. Because currently the whole blockchain is maintained, it’s basically paid for by the issuance of the admittance of new Bitcoins. And I think you had some numbers that you found on the estimates of how much that cost in terms of electricity and computing power to mine one Bitcoin.

FRA: Yeah you know with approximately $1000 US to perhaps $1200 US to mine one bitcoin. And that represents the cost of electricity and computing resources .. It’s similar in the gold world where it costs approximately $500 to $800 per ounce to mine one ounce of gold today. So on that basis, if we look at the value of gold being thirteen hundred dollars today relative to the cost of  mining .. Bitcoin could approximately be valued at something like $1500 to $2500 dollars US relative to its mining cost.

Charles Hugh Smith: Right .. And so in that analysis it’s overvalued you know by a factor of four then. Alternatively, we can say in a world where national currencies and central bank currencies are no longer trustworthy because they’ve been created in vast sums and continue to be created to the tune of like $300 billion a month or more. That may be what’s really happening is gold is lagging and this has of course been frustrating to a lot of people who feel that maybe gold should be $5000 an ounce if Bitcoin is $10000, then gold shouldn’t be $1300 it should be $5000 an ounce. And so it may be that gold is lagging and to where it should be. But you know let’s look at the utility value of some of these alternative currencies and I’m including precious metals are the historical safe haven because they have intrinsic value and in the case of silver they have utility value as well. I mean that we all know that silver is not only pretty and a nice thing to make art out of, it’s also a an industrial metal with you know that it’s widely consumed. So we understand the utility value in the store of value of precious metals and then Bitcoin is obviously it’s a different animal because it’s a digital thing and it has no physical presence and no physical utility, but it is quite handy in terms of transferring capital around the world. And I myself have used it to pay editors and translators in other countries and you know there’s no fooling around with bank fees and you don’t have to fill out any of the capital control forms required by the Federal government. And this is of course why a lot of people feel that Bitcoin you know it’s all about money laundering and drug money. But I am just a little regular person here doing my running my little business and I used it to pay other people doing you know legitimate services for me. I file my tax return you know what little gain I made on my Bitcoin transactions .. So you know I think there’s a legitimate utility to the Bitcoin and the Cryptocurrency phase in terms of regular people transacting business globally.

FRA: Yeah sort of the mobility utility factor. And as mentioned earlier that seemed to what happened to propel the price to go from $1 up to $1000-$2000 dollars per Bitcoin. Especially from Venezuelans and Chinese using it .. Now there is a development just in the last month or two that I’d like to mention. That has to do with the Internet protocol of Bitcoin. So most if not all of the Cryptocurrencies are operating over the Internet, over the IP Internet Protocol space and there are technologies coming out now that are able to detect Bitcoin transactions, Bitcoin traffic, even if the traffic is encrypted. This is quite new. As that develops, this will actually make it possible for banks to look at bringing into regulatory oversight the Cryptocurrencies, the traffic that’s coming to and from the banks .. and even governments as well for Bitcoin traffic into and out of countries. So this mobility advantage initially may not hold as much you know, given this technological development. The government of China has long been looking at this on how to do it .. this technology can be used by banks and by governments.

Charles Hugh Smith: Right. And that’s an excellent topic and observation. I wasn’t aware of this technology, but I think what it raises for me is the regulation of the Cryptocurrency space is inevitable in developed economies. You know in other words like this is a normal trend. And frankly I think it’s a good trend in the sense that if you want to legitimize a new form of money it has to be regulated to some degree so that people won’t get ripped off by fraud, like people selling Bitcoin they don’t actually own or you know this kind of thing. And I also think that you know if people are fortunate enough to make you know a million dollars trading Cryptocurrencies, then why shouldn’t they pay the same taxes somebody that was fortunate enough to make a million dollars trading stocks or bonds or future contracts. So I think the advent of regulation is a positive development. And the reason why I say that also is some countries are embracing the Cryptocurrency space and I mentioned Japan which has legalized Bitcoin I mean fully. Right. And of course this is the third largest economy in the world. And South Koreans have basically given a pass. So they’re not going to ban it which is taken as a form of approval .. the U.S. itself has deemed Bitcoin and Cryptocurrencies as commodities. So in other words they are viewed as, if you’re trading Bitcoin – it’s viewed as equivalent to trading pork bellies or something. Right, it’s a commodity. So I think once a country like Japan, with a huge capital market and a vast economy now that it’s legalized the Cryptocurrencies it’s very difficult for other economies to say oh no we’re going to ban this. And I think we have to draw a distinction between common sense regulation of the Cryptocurrency space, like legalizing it and regulating it and taxing it right, as opposed to banning it. And I’m not so sure that banning it is going to work anymore. Because like I’ve explained on my blog a couple of times, if for instance the United States decided to ban Cryptocurrencies Well I could take my Bitcoin and you know my one Bitcoin or whatever and I could put it on a thumb drive or a so-called hard wallet. And then I could take it with me to Japan or I could mail it in a package with some other stuff. And then I could have an associate or friend in Japan you know upload it and deal with it in a legal country. Where they are legal in a legal setting for Cryptocurrencies and then transfer it into yen or dollars in that country where it’s legal to do so and then transfer it back to the U.S. And so you know if I can figure out a really simple workaround. Pretty much anybody can. So I think where a lot of people fear this tracking of Bitcoin and other Cryptocurrencies and then regulating it, is a bad thing. It doesn’t have to be a bad thing. I think it could be a positive development actually.

FRA: Yeah and it will accompany the growth in Blockchain services as the economy develops around those based services you know. The concept of an encrypted Excel spreadsheet type of ledger that Blockchain is.

Charles Hugh Smith: That’s right. And I’m glad you described it so succinctly. Because a lot of people are confused by it and that’s really what it is. It’s basically a ledger that’s public so everybody gets to see what’s been entered. And so that’s the utility value. Well you know let’s also talk about, go back to the financial repression part because one thing I’ve started to write about and other people have also started to write about is the possibility that we finally get some inflation. We all know that unofficial inflation, real world inflation, is running a lot hotter than official inflation, but so far the central banks of the world have created you know trillions upon trillions upon trillions of new currency and they’ve injected that into the financial sector. And there’s been only asset inflation. Right. In other words, stock markets have doubled and tripled. And you know bonds have risen in value and real estates gone back up to bubble levels but there hasn’t been a lot of real world inflation and certainly no wage inflation. So if we started to get inflation that’s going to create a real problem for the central banks because they won’t be able to emit in the quantities of currency they’ve been emitting because that will fuel inflation and inflation of course destroys capital, it destroys the savings, it destroys the purchasing power of wages and people actually have less money to spend, less purchasing power. You know also that’s I think another driver for the whole Cryptocurrency space is that if Cryptocurrency is perceived as something that is a store of value based on scarcity, then it becomes an attractive hedge against inflation.

FRA: Exactly that’s a good observation. So where do we go from here. Like what will happen? How do you see the Cryptocurrency space evolving? You know I guess we have private based Cryptocurrency. And then they’ll also be government based Cryptocurrency.

Charles Hugh Smith: Right. Right. And my sense is the value of of Cryptocurrencies like Ethereum and Dash and Bitcoin, in other words, we can call these the leading Cryptocurrencies. The value is that they’re non-state, non-central bank, non-government right. And so I don’t see a Cryptocurrency issued by the Bank of China or the Federal Reserve as having any value because the the control of how much of that Cryptocurrency is emitted, is created, is of course still in the hands of the bank and so on. I think the fear of anybody that is at all skeptical of how government and central banks work, as the central bank and say oh well there’s only going to be 21 million of these coins issued and then the next morning they say Oh well actually we’re going to issue $300 billion and then it’s $300 billion. And then that currency has no value at all. And so I think that we have to kind of specify that the value of Bitcoin is that being decentralized, you can’t change the protocol. No one person or agency can say no we’ve decided to issue $210 billion of Bitcoin. Now it doesn’t work like that. And even if somebody claimed that we’re going to do this to the Bitcoin protocol the miners and everybody, the participants in the Bitcoin ecosystem, they would have to follow along and support that. And if they didn’t support it, then that fork would die and others would just vanish. And so if I declare, hey I’m going to start a new version of Bitcoin that there’s a billion coins and nobody comes along to mind that. In other words, maintain the Blockchain, then my version just dies it goes to zero because there’s nobody to support the Blockchain. So there is a rough and ready very free market kind of democracy, if you will, and a lot of people have criticized Bitcoin because it major miners obviously have a lot more influence than people who are mining as a hobby and so on. And so there are blocks of self-interested people who can dominate these Cryptocurrencies. And that’s a danger for sure. But it’s a lot different than having nine people meet in a room and decide to add a zero to the money. Yeah. And so I think that government and central bank versions of Cryptocurrency are going to go nowhere because they’re not again for the elements you described earlier in the program. There’s really no reason to trust them.

FRA: I mean they may be mandated by governments to use just like you know currencies today of the countries of the world. But I guess with the coexistence with private based Cryptocurrencies, the ones that make sense will be ones that are you know operating within the financial system. Even if they’re outside of the banking system, if you will, but still within the financial system. And the ones that are based on sound money, so that they have limited numbers that they can be printed or perhaps they’re based on a commodity like gold.

Charles Hugh Smith: Right. Right. And I think that you raise an excellent point that what people are seeking is sound money and sound money that has utility. In other words, it’s not just a store of value, but it’s a means of exchange and so there’s certainly a role for the precious metals. And that’s why a lot of people are saying if you’re going to go in terms of recommending a hedge that you should have both precious metals and some Cryptocurrency, you know exposure, even if it’s you know one percent or something. But I think you know I would say we’re sort of an equivalent of the Internet or the the world wide web around 1995. You know so we have it back when the first browser emerges. Right. And Mozilla and all that and all the assumptions that we would have drawn that have all turned out differently. Right now there is like Yahoo was the first for the most asked and and and then Yahoo faded and lost all of its advantages. And so we you know to say where will Bitcoin be in eight years. Gosh I would hate to even say. I mean it could it could be surpassed by a new Cryptocurrency or an entirely new Cryptocurrency protocol and then it becomes a legacy system. That’s definitely a possibility right. Something comes in that’s faster better cheaper and it’s going to it’s going to take all the market space away from the existing Cryptocurrencies you know. And that’s what we want. We want innovation, we want faster better cheaper. And that’s part of what we like about the Cryptocurrency space is it’s still open to that kind of thing compared to so much of the developed economies are controlled by monopolies, cartels, central banks, governments, which are only self-serving. You know they only choose policies and enforce policies that protect the few at the expense of the many. On the other hand Bitcoin could transition into being something that’s slow and secure. It’s never going to work in terms of buying a coffee at Starbucks with Bitcoin and that’s just a dead duck. It’s a transaction rate it’s just too small, but it might be useful in interbank transfers or large financial transfers. Maybe Bitcoin will find a home in that space. While other Cryptocurrencies will arise to take care of the the transactions on the level of consumer goods. You know we don’t know.

FRA: You had a chart that shows if Bitcoin replaces or becomes part of reserve currency. We could see prices in the $500000-dollar range:

Charles Hugh Smith: I know and it’s so funny because you know I’ve been following Bitcoin, but I never bought any and I was just kind of an interested observer until I needed it. As for its utility value, in other words, I needed to get some to buy some Bitcoin in order to pay the translators I had in Venezuela because that was the only form of currency that they could they could access right. That made sense. And if you think that the world economy is going to enter a time of instability where a lot of things start falling apart then of course we can say that Bitcoin or other Cryptocurrencies will well maintain their utility value for that reason. In other words, if people can access it and and pay their debts and buy stuff with it or buy other currencies with it, then its going to have utility value.

Charles Hugh Smith: I have another chart here the logarithmic progression of Bitcoin and its obviously kind of a rough guess, but this chart suggests that there is a logarithmic function to the number of days that it takes for Bitcoin to advance tenfold. In other words to go up by ten times and so it was kind of like how long did it take to go from a dollar to 100 an hour to a $10 then to $100 in $2000 and then to ten thousand. And so of course we can play these kind of games and you know those of us who like charts you know we love like tracking charts and projections and stuff, but it certainly we don’t know.

FRABut actually your logarithmic regression chart does seem to be fairly accurate. The November 22 date for $10000 is pretty much on track.

Charles Hugh Smith: Yeah it is. And this was I think the projection was made in late 2014. So by this chart, if we follow if that regression kind of goes continues as charted, then we would be at $100000 Bitcoin in 2021. So while we have to wait a whole four years. Yeah and of course I’m laughing because this is all speculation right, but we really don’t know what’s going to happen and what I like to say is this is the way markets should operate. They shouldn’t be manipulated by central authorities. So they always go higher and there’s never any retrace, there’s no volatility. You know volatility has been destroyed in a stock market, it’s been erased. And so there’s no real price discovery because there’s no volatility, there’s no price discovery. So Bitcoin is extremely volatile and to me, part of that is number one it has a very low float you know that of the 70 million Bitcoin. Several million, at least several million, are estimated to have been lost and in hard drive crashes and things like that. So the founders have about a million Bitcoin that they’ve never touched and never moved. For whatever reason and a lot of people are pursuing the idea of hold on for dear life, otherwise known as HDOL. And so the actual tradable float of Bitcoin is probably a relatively small percentage of that 17 million or 18 billion Bitcoin that are out there. So you got a very small float and like a small float in stocks, you get big volatility when there’s a small float and then if the more open the market is the more volatility you have. Right because you’re exposed to human emotions and there’s more surges of euphoria and panic and all the things that drive volatility, so I don’t see volatility going away.

FRA: Well that’s excellent insight for a balanced view. How can our listeners learn more about your work?

Charles Hugh Smith: Please visit me at oftwominds.com.

FRA: Great thank you very much Charles for being on the show. We’ll do it again.

Charles Hugh Smith: Yeah. Thank you so much Richard. My pleasure. Great topic.

Submitted by Boheira Manochehrzadeh <bmanoche@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 Danielle DiMartino Booth. She is a global thought leader on monetary policy and economics. She is the author of Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America. Her book rose to number 22 on Amazon’s Best Seller List. She founded Money Strong LLC in 2015 which is an economic consultancy firm with a great insightful newsletter. She is also a full-time columnist at Bloomberg View, a business speaker and a commentator frequently featured on CNBC Bloomberg Radio, Fox News, Fox Business News and other major media outlets. Prior to Money Strong she served as Advisor to the Dallas Federal Reserve President Richard Fisher.

Welcome Danielle.

Danielle DiMartino Booth: So happy to be here.

FRA: Great..I’d thought we would begin with your book. Having worked with the Federal Reserve, the title appears to be very strong; An Insider’s Take on Why the Federal Reserve is Bad for America. Your thoughts on that?  Why is it bad for America?

Danielle DiMartino Booth: It’s not so much that I think the Federal Reserve has to go away. I just think that in its current form, or at least the form it’s been in since August 11^th, 1987 when Alan Greenspan took office, has ended up being very bad for our country. We have ended up on a series of booms and busts and I, for one, am tired of being on this rollercoaster and think that it is high time we reinvent the Fed, take it down to the studs, and build it from the ground up and make it an institution that is good for America.

FRA: You recently commented on the Federal Reserve in terms of their biggest fear. Could you elaborate on that?

Danielle DiMartino Booth: There is a fallacy here. We have not just come through an era of deleveraging. If you look back at 2007, there was 150 trillion dollars of credit globally in the market. Today, we have over 220 trillion dollars of debt globally in the credit markets. So what we have actually seen is a very aggressive releveraging, overleveraging, of the global debt markets in order to eke out the economic growth that we have seen. I lay the blame for that at the world’s central bankers printing money to kingdom come, trying to create enough debt to spur economic growth, but the question I have is, at what price? I don’t think the central bankers want to answer that question. I think the 70 trillion dollars in debt build that we’ve seen since the outbreak of the great financial crisis is their greatest fear – It keeps them up at night.

FRA: Do you think central bankers have boxed themselves in a corner – Is there any way out? Can they actually implement quantitative tightening?

Danielle DiMartino Booth: I think that that remains to be seen. I laugh every time I hear that the quantitative tightening, the shrinking of the Fed’s balance sheet, is going to appear on autopilot. They are deluding themselves if they don’t think that this is a form of tightening when on Day 1, headed into this experiment of unravelling and shrinking of the balance sheet, the Fed owned 33% of all mortgage-backed securities in the country – They are deluding themselves. It remains to be seen if the Fed is going to remain agnostic to all data and continue shrinking the balance sheet while they continue to increase interest rates at the same time. It is double tightening if you think about it.

FRA: What about other central banks. What are your thoughts on what they are thinking and potentially doing?

Danielle DiMartino Booth: I’m very dear friends with a regular guest of yours, Peter Boockvar, and he lays out some very simple math. If you add together what the Federal Reserve says it’s going to be shrinking its balance sheet by around 400-some-odd billion dollars, run rate, this time, next year, and what Mario Draghi has committed to doing with the ECB in terms of tapering the ECB’s purchases, at this time as we are looking towards the holidays in 2018, we could theoretically have a trillion dollars less of global quantitative easing liquidity propping up these financial markets. It’s a big number and I think we have to take into context where that’s going to put these markets from the starting point of unprecedented historic overvaluation.

FRA: Is there any connection with the emergence and rise of valuations of cryptocurrencies, such as Bitcoin, to what the central banks have been doing?

Danielle DiMartino Booth: It is an unequivocal, staring straight in the mirror, reflection of investors and citizens worldwide, of their anxiety with what is being done to destroy fiat currencies because of this money printing going on. Bitcoin has risen up in the face of what I call a defacto, but very quiet, stealthy, currency war, in a world where we are beginning to understand, and this is with all due deference to gold bugs, that it’s not practical to go back on a gold standard – So we’re looking for an alternative. But I have deep fears about what central banks are going to do once the cryptocurrency technology is perfected.

FRA: And what are those fears?

Danielle DiMartino Booth: I am not sure if you are familiar with the concept of Fedcoin. And Fedcoin doesn’t bother me to the extent of what Kenneth Rogoff has in mind for the eradication of currency and actually tracking our every move.

FRA: Do you see more pervasive actions by the central banks in terms of blockchain-related services?

Danielle DiMartino Booth: It’s no secret. In fact, Bill Dudley gave a speech that’s on the wires that he is a complete advocate for a Federal Reserve type of currency that ends up being a substitute, if you will, for the dollar bill in your and my wallets. I don’t necessarily have a problem with technological progress as long as that cryptocurrency, as long as the Fedcoin, is just has as anonymous as the dollar bill is when we use it to transact physically. My greatest issue is when big brother steps into the frame, which is why I brought up Kenneth Rogoff, because I think that he would like to see cryptocurrencies not be anonymous such that central bankers were capable, this is the scariest thought I could possibly come up with, of tracking our every single buying transaction, our every purchase consideration and knowing what we are buying on a day-to-day basis. These are the things that truly should keep you up at night.

FRA: But would governments necessarily allow private-based cryptocurrencies to coexist with government-based cryptocurrencies?

Danielle DiMartino Booth: I would have to say no. What we have seen with the parabolic thousand point increase, and we are at a thousand points at 8:26pm EST on November 29^th, Bitcoin crossed the $10,000 mark and it didn’t even take it 12 hours to go across the $11,000 dollar mark. What we are witnessing is clearly a bubble that is going to implode on its own weight. I think that we can all hopefully agree on that; we are all adults in the room. But I think that central bankers know good and well that once these cryptocurrency bubbles burst, laying in their wake will be a very refined technology that allows central bank cryptocurrencies to rise up where they have left off. To your question, do I think that they will be allowed to coexist? – I think not.

FRA: So you see a phasing out or an abolishing of Bitcoin and other types of private-based cryptocurrencies?

Danielle DiMartino Booth: I hate to inflammatory words like abolishing, but you could certainly see a sequence of events whereby if the Bitcoin bubble ends up bleeding into other overvalued asset classes that then bleed into an economic contraction leading to recession, and then causing the central banks of the world, starting with the Fed, to go back to the zero-bounded interest rates. Once we get to that point, and I hope we don’t, I hope that our new chairman, Jay Powell, is going to say, “You know what, zero-interest rates didn’t work. We are not going to go back there.” But if we get to the point where we are back to zero-interest rates or worse, negative interest rates, the next logical step for central bankers is the eradication of cash and controlling our buying which can only really be done electronically with this emerging cryptocurrency technology.

FRA: So in other words, the central banks would consider pushing for government-based cryptocurrencies in order to implement their monetary policies.

Danielle DiMartino Booth: When push comes to shove. I mean we are clearly going in the opposite direction. We are anticipating a rate hike right now and further rate hikes potentially into 2018. So we are not there, but again, you could certainly lay out a sequence of events that would lead to that inevitability – I hope that is not the case.

FRA:  In the interim how do you see the cryptocurrencies behaving? Will there be a rise in prices or a correction or a crash – Any ideas there?

Danielle DiMartino Booth: I mean if you are asking me if I can possibly assign any kind of logic or reasoning to what we are witnessing in a market that has seen a thousand percentage point appreciation since January 1^st, 2017, you’re barking up the wrong tree. I could not explain this price action. In my weekly newsletter that I literally just published, I included a graph of the Tulip mania from 1630 and Bitcoin has almost surpassed the level of that hysteria and mania.

FRA: Yes – Our research team has done some sort of analogous valuations with gold. If you consider the cost to mine one ounce of gold to be approximately $500-$800 per ounce and the current price of gold today to be around $1,200 per ounce, Bitcoin is estimated to cost approximately $1,000-$1,200 to mine, or in other words to create one Bitcoin. So perhaps the fair market value of Bitcoin could be something like $2,000 per Bitcoin in analogy with the gold mining. That would mean there would be a considerable speculation element right now with Bitcoin.

Danielle DiMartino Booth: Well look, if you want to pretend that Bitcoin is not trading where it is and explore the economics of Bitcoin mining versus gold mining – It’s astronomical. I read an article that said that Bitcoin mining costs what the equivalent of 159 countries consumes annually in electricity. But that being said, there is something called quantum computing on the horizon. I do not pretend to understand it, but it involves quantum physics, and it will put to bed all of the bad economics associated with mining cryptocurrencies today and make it much more economical. And again, I’d lay you money that the world central bankers are very much onto what is occurring at the intels and some of the small boutique quantum technology firms that are out there, how they are looking to displace technology as we know it today.

FRA: Could some of the value of Bitcoin and other cryptocurrencies today be attributed to the mobility factor in terms of, for example, Venezuelans or the Chinese in China using cryptocurrencies to move money out of the country.

Danielle DiMartino Booth: I think that that has certainly been the appeal, if you will, of cryptocurrencies. The same could go for some of the nefarious players who have taken advantage of cryptocurrency for criminal means. If you don’t have an alternative, sometimes you turn to the only thing you can find. But again, the train has left the station on any logical subscription of any kind to Bitcoin and these other cryptocurrencies. At current price levels we are just talking about lunacy here, not a means by which to get your money out of the country. Don’t get me wrong, I agree with what you are saying and I think that that is some of the fundamental basis of Bitcoin and why it succeeded the extent that it has and how it has been adopted the way it has. But I have heard stories that former English literature professors are leaving their posts at universities in order to become Bitcoin players – This is a mania.

FRA: Yeah. That is crazy.

And finally, what are your thoughts on Jay Powell? How do you see Federal Reserve policy evolving over the coming years?

Danielle DiMartino Booth: Well, it’s hard to say. Your crystal ball is as good as mine is in the near term. I can’t say when this is going to end. I recently wrote a piece that said we could see the 3,000 on the S&P before this is all said and done because it long stopped feeling like 2007 and started feeling like 1998, I would say, about 6 months ago.

FRA: How can our listeners learn more about your work, Danielle?

Danielle DiMartino Booth: I publish every Wednesday. They can go on my website DiMartinoBooth.com, jump on a trial subscription that gives you a 30-day look back into my archives and see if you like what I write and subscribe to my newsletter. Certainly go on Amazon and buy Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America if you haven’t read it yet. I consider it to be a primer of financial literacy and the adoption has been tremendous and humbling. In the event that you’re bored, follow me on Twitter at @DiMartinoBooth – It is never, ever boring. A full-fledged debate involving Neel Kashkari, Peter Boockvar and I broke out last weekend – Like I said, never boring.

FRA: Okay great! Thank you very much for your great insight Danielle.

Danielle DiMartino Booth: Thank you very much. I appreciate your time.

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

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FRA: Hi welcome to FRA’s Roundtable Insight. This is Richard .. Today we have Yra Harris and Peter Boockvar. Yra is an independent trader, a successful hedge fund manager; global macro consultant trading foreign currencies, bonds commodities in equities for over 40 years. He was also CME director from 1997 to 2003. And Peter is the Chief Market Analyst with The Lindsey Group and the co-chief Investment Officer with Bookmark Advisors. Peter has a newsletter product called The Boock Report. Spell book B-O-O-C-K-REPORT.COM. It offers great macroeconomic insight and perspective with lots of updates on economic indicators. Welcome gentlemen.

Peter Boockvar: Thanks Rich.

Yra Harris: Thanks. Rich.

FRA: It’s great today to start off with a quote that you had in your recent writings, Yra, on flattening yield curve. “It’s the ECB and Bank of Japan policy that is flattening global yield curves as investors search for extra yields” and you made the analogy to something similar which may be happening to the 1994 Orange County bond disaster. Just wondering if you can elaborate on your thoughts.

Yra Harris: OK. So when we look at this you know we were comparing it to Orange County. I do because that was a classic case .. it was actually a meltdown as the Fed started to raise rates and everybody was crowded into a bond trades. We saw first of all the yield curve seeping out dramatically even though it was a shortened because so many people crowded into that trade. But what you really found out what Orange County exposed is that Robert Citron, who was the Treasurer for the Orange County at the time, was busy chasing a little bit extra yield 25-30 basis points and there are many sell side firms who came to him and they were offering him these products and they were exotic products, very exotic at the time. And so in order to please his bosses he chased extra yield, very little. So at 25, 30, 35 basis points and I know this from Sheila Bair’s committee, which I sat on in Washington, in which we analyzed what went wrong there. So I had a pretty good behind the scenes look at it and it reflected in that. So when I look at the world today and I know Peter’s written to me this is a real problem in that people are taking on so much risk in an effort to chase so little return when you’re in a world where Italian bonds are yielding 1.75. You take on all kinds of risk as you search for an extra 30, 35 basis points because 35 basis points in today’s world is a lot. And for those who are trying to outperform the market and these are people who manage institutional money and big pension funds and insurance companies. They are taking on a lot of risk and that’s what keeps me up at night. And I think we’re getting close to crunch time in which some of these trades you know as Warren Buffet would say you know when the tide goes you can find swimmers naked. Well I don’t think there’s many babies who have been sold at all so I think we’re probably more what is it called the hedonism. I’m too old to know and to partake in that. But I think we’ll find out that there’s a lot of nudity in the waters of central bank liquidity.

FRA: Peter do you see a similar 1994 Orange County environment.

Peter Boockvar: I like that analogy. That was great. Yeah I do. It’s good to follow the money. OK so next year even in January when the ECB cuts their QE in half and the Fed goes from draining 10 billion a month to 20 billion a month. Liquidity is going to go to almost zero. Between those two central banks. So that’s a major change. I mean this year on a run rate the ECB was buying net of 700 billion euros of securities and you cut that in half next year and then you subtract what the Fed is taking out and that is almost going to nothing. And that is a really big deal. At the same time the Fed is raising interest rates and the BOJ is buying less ETFs and they’re buying less JGBs. That liquidity flow is going to turn into a drip next year and leaves no room for error anywhere else.

FRA: What about if we look at the U.S. Yra you asked how does the Fed deal with a flattening yield curve in your most recent writing. Noting it’s gone lower than 73 basis points. Any thoughts on that? I mean you did suggest something on the cutting the short term rates on that to make it similar steepened like the German 2/10s.

Yra Harris: Yeah because I compared, Peter and I actually went back and forth of this yesterday on this because I showed them that German 2/10 versus U.S. And if you were a wagering person you say well the ECB is doing all this buying. The Fed is as Peter says has stopped. And in fact is now in contraction. You say well the curve should actually be steepening in the U.S. based on those mechanics. And we should be flattening in Germany, but it’s absolutely the opposite. German curve is out to three year highs and 110 basis points while the U.S. curves was at 70 basis points and flattening. So when you look at this it was a word you used yesterday. You’re absolutely right. They said this is like wild. I said yeah that’s exactly what it is. It makes very little sense and makes in fact no logical sense whatsoever and I don’t know how the Fed, Ron Paul going to have to face this because the Fed has already told us they don’t understand that their models have been wrong and they really don’t understand what’s going on in the inflation world. They don’t understand it. So now they are going to tell us that they don’t understand why the curves are flattening. Because when you look at it and you throw in this tax plan is not tax reform it’s a tax cutting and it’s stimulative by everything that I hold dear to me. This curve should be seeping dramatically. Bond should be getting terrified of what they’re facing. And as Peter says you know next year they’re going to be shrinking. This curve should be steepening and yet it’s not. So if they do and then they’re going to tell us they don’t understand what’s going on with the curve and I know that the curve is one of the big indicators. So if you don’t understand that, you don’t understand inflation. You’ve made a four and a half trillion-dollar wager on the effectiveness of the QE programs. That doesn’t go well with me. So I think that’s what it was. So you can either cut rates which would throw the markets in absolute turmoil. That’s just the way it is there’s nothing else they can do or they can as I say they could increase the amount that you know .. I say if next January if the ECB was cutting to 30 billion or maybe the Fed should be always be selling more than the ECB is buying and you get the curve to steepen and I guarantee that.

FRA: Peter your thoughts?.

Peter Boockvar: Yeah I agree. You know just to quantify the dramatic effect that the ECB had on the entire yield curve in Europe relative to the U.S. and the Fed is that the Fed when they were doing QE infinity, they never bought more than the net issuance of debt that the U.S. government was issuing. In Europe the ECB was buying 7 times the net issuance. It was just so dramatic it was literally the elephant that was stomping everything in its sight. And granted having negative interest rates continuing into 2019 will certainly keep a big anchor on the short end. But because of the dramatic extent that the ECB was buying bonds I have to believe that there is going to be some response when they stop buying bonds. Now again the negative interest rates in the short end will be an anchor. But you know imagine even when that ends. I mean one thing that that we have to take notice, Draghi is now becoming more defensive about negative interest rate. He’s now having to explain himself. Here we are this is three and a half years after he initiated negative interest rates and he is still defending negative interest rates. You have the European Bank Stock Index that is still below where it was three and a half years ago. So I think that the politics around negative interest rates will get more and more difficult as bank profitability continues to be under pressure. And you know that there’s no question that accidents are going to occur here. I just know none of us are smart enough to know how it exactly plays out. But come January when things are shifting in a more dramatic fashion, I think everyone has to be really really careful.

FRA: And so what will happen, your thoughts on the new Federal Reserve chairman nominee Jeremy Powell. How do you see his policies and what will his monetary policies be like in the coming years? Yra you want to start?

Yra Harris: You know I’m not sure .. when I had the opportunity last year to directly ask a question, you know about who guarantees the ECB. It was a two-part question that I asked was who guarantees the ECB and do you think that all sovereigns should be carrying zero weight. Because I know what his expertise, his strength is within the Fed and he was subdued. I was wild about the answer so I would have given him some crap, but I do think that he’s a good choice because he’s very pragmatic and I think he’ll know how to adjust or hopefully. So his response to me on the ECB was they have a printing press, which he didn’t even have to think about that and that came right to him. And the fact that there’s zero weighted. That’s all we have to care about. They are zero weighted and I was never comfortable with those answers, but I think he brings more to the table. I think he is unlike some of the people who do sit in that room with their high level math and Ph.D.’s are too arrogant for the job ..

FRA: And Peter?

Peter Boockvar: Yeah I mean I think while he is very similar to Yellen in that he voted for every QE, he voted for keeping interest rates at zero for as long as they did. So he voted for the committee every single time. There is talk that he was not a big fan of QE. So that’s a positive for the sake of manipulating markets. It won’t necessarily be a positive for markets when we get the next 10 to 20 percent decline and everyone’s screaming oh the Fed save us, the Fed save us. I think he’d be less inclined to be the markets sugar-daddy, which I think is a good thing, but maybe it’s not what the market necessarily wants to hear. Now he’s not going to obviously be as potentially hawkish as Taylor or Warsh would have been. But I think if the market thinks he’s a Yellen look like I think they may be a bit disappointed that he’s going to be thinking more outside the box and he’s not going to believe in John Maynard Keynes to the same extent that Yellen has.

FRA: Just going along the discussion from Europe. Peter you’ve written recently on how higher inflation in the Eurozone is a very under-appreciated risk. Can you elaborate?

Peter Boockvar: Yeah. I follow the market monthly numbers and I like to read their commentary now it’s very anecdotal. So we have to separate the anecdotal commentary from business surveys that they do from the actual consumer price index that the Eurozone comes out with. But on Monday we had the Eurozone services and manufacturing composite index come out and I’ll just read to you what the inflation commentary was. Inflationary pressures have meanwhile lifted higher with price charges for goods and services rising at a rate not seen for over six years. Some price rises merely reflect the pressures of higher cost, but companies are also reporting stronger pricing power as demand conditions continue to improve. Which suggests underlying inflationary pressures are becoming more ingrained than yesterday. Market came out an index on German construction and they talked about intense supply chain constraints contribute to a sharp rise in input costs. The incidence of delivery delays is one of the greatest seen for over a decade while purchase price inflation was pushed to a six and a half year high. And they also reported a retail Purchasing Managers Index for the region and they talked about gross margins facing Eurozone retailers continue to be squeezed. Contributing to this was another rise in average input prices. Moreover, the rate of inflation quickened to a fifty seven month high and remained substantially greater than the long run average. So how that translates into actual inflation. I don’t know what PPI will eventually look, like what CPI will eventually look like I don’t know. But to me when I read that tells you that there’s price pressures that are .. any potential surprise on the inflation numbers in Europe I think will be to the upside using this as as potential evidence. And even with cutting QE by 50 percent there’s still going to be buying 30 billion a month and they still have interest rates deeply negative. So they’re wholly unprepared for a multi-month march to lets just say 2 percent CPI. And I think that that is a major risk for the European bond market. And to me the European bond market is the epicenter of of of the global credit bubble.

FRA: Do you see similar conditions Yra as the biggest bubble being the European bond market?

Yra Harris: Well yeah Peter’s been on the strength of growth and on Europe as he says you know he’s been very bullish in European equity markets, but he’s a more than a little concerned as he’s just talked about about what the banks have done because the interest rate policy is of course the ECB. But you know the issue where we may differ is do I think that Draghi cares about what inflation is? I don’t think so because you know as I’ve talked to Peter and I have discussed I think I’m with you Richard that he has a bigger thing going here and that he’s trying to load that ECB up with as much debt as possible because it’s the only outcome can be of course would be the creation of a Eurozone bond .. The European Commission has not been able to move it forward and you know the talks that came from the Crown was to push it farther and faster. And you know there is of course Germany is more than reticent because they know what’s going to be settled here. So he keeps going and going and going. I agree with Peter once we get over 2 percent inflation. I know what the response is going to be because that’s what you know. They basically use the same kind of dynamic stochastic models that the Fed does and others well you know they’ll call transitory they’ll call this so if it’s the same .. Then if it’s the same for three or four months they’ll have a serious problem and you could see that there is pushback. You know he didn’t talk about it at meetings but there were five dissenting votes to even the cut of 30 of 30 billion, only big movie from 60 to 30 billion and leaving the negative interest rates. And with all that forward guidance so there was pushback and the pushback is coming from just where were the sources from the Dutch the Austrians and now we’ll see even more from Austria because of their political situation. But Merkel’s in severe trouble .. Germany may have to go to a new election because they cannot put together a coalition here because the Free Democrats, they want the Ministry of Finance which, Schäuble used to run and he was fairly hawkish. But they want more. And their issue is you know of course you know with the ECB and their overall policy and that’s the effect on German savers. So this is very very dangerous. In fact, one of Merkel’s ministers, one of her close people came out .. They’re trying to load back the Social Democrats. I don’t think that’s possible. So because the Social Democrats would have to eat such a phenomenal crow it would be it would be the end of them. They could be in this coalition. Well they’ll continue to lose power, but if Germany winds up going into a new election, Merkel is going to get trounced because there’s no way .. So there’s a lot of things yet to play out in Europe again and this is more laid out as Peter and I started the discussion offers her new letters. There were of course was that there’s so much complacency in the world and yet these things are on the boil and I know we haven’t even gotten to the next topic you’re going to go to which puts it more, but Germany is still an unknown yet. And it’s the unknown not because of anything really positive for Europe. It’s a negative for Europe. So she’s got to figure out just what’s going to go on here and who’s going to get one. And she’s trying so hard not to give the free Democrats win there the Ministry of Finance because then he’ll really have a voice. And it’s not going to be a pro-European voice. So a lot of things to be played out here. And as Peter has talked about, where are the banks .. who have really so badly underperformed with this .. the banks are way under-performer as they are in Japan. I mean I’ve been owning Japanese stocks for longer than I care to admit but at least I’ve had some dividends in earnings and they haven’t done anything. But if things are so good why aren’t the banks rising. We’ve seen fairly significant rallies this year in the U.S. Banks and that’s you know even with a quote unquote flattening yield curve. So there are so many uncertainties.

Peter Boockvar: I mean just just to quantify the Japanese TOPIX Bank Index is still 20 percent below its 2015 high. I mean I think the reaction of banks has basically repudiated negative interest rates and central bankers desire to basically destroy their yield curves. And if banks are the transmission mechanism of this sort of policy you wonder how central bankers can contain the circle of damage and profitability of the banks, but continuing on the same path of monetary easing.

FRA: What about now the effect of Saudi Arabia. We’re seeing some incredible events happen over the last week. And you know given all the complacency well how could Saudi Arabia, what’s evolving there affect the financial markets and the global economy. Yra do you want to start.

Yra Harris: Well I believe that you know and I’ve blogged about this the other day too. And this is truly one of my areas is the great strength is the geopolitical events are taking place. And usually it’s for the North Korea statements or nurse those are one off things and I always caution people you know what those moves you can trade them, but don’t look at them as anything longer than a one-day trade or two-day trade because wars don’t push gold higher; wars you know or let’s say some type of conflict. Those are quick one off moves, but what’s going on and I go back to October 5th when we had a seminal event in international relations which is that the King, not the crown prince, but the King of Saudi Arabia went to Russia to meet with Putin for the first time. And as I tongue in cheek say it’s like Nixon going to China. Very unexpected. And ever since that day you can plot a chart take a look at it. Oil prices have risen eight dollars in a steady upward beat and then you had what came out this weekend. But it’s been a steady thing the oil keeps rallying. It’s not a headline grabber. But there are movements of foot here and the Saudis are very concerned about the Shiite influence throughout the Middle East. The role in Syria, the role in Iraq, the role in Lebanon. And then you get of course you know Hariri, who is the Lebanese prime minister, who was in Saudi Arabia and resigned on Saturday night. Now really is interesting because Hezbollah actually assassinated his father. And Hezbollah is a Shiite militia and you know somewhat of a governing group that the Saudis are very worried about as are others in the region. And that has now shown to be even more and then of course you have the downing of a helicopter. So on the Yemen-Saudi Arabian border with some high level Saudi officials supposedly .. You know as I say it’s like the Gulf of Tonkin. We don’t know certain things, but there are movements afoot here and that is you know the Middle East is still a very significant area. It’s significant for China not as much of the United States is used because we don’t get as much oil there. But this is a very dangerous time. And again the equity markets don’t price any of this risk in. It’s like you know I watched Sunday night with what went on and I was amazed that the market was short gold. And I said I’m getting I figured I was going to lose 10 or 20 dollars. It opened basically unchanged and lower. I got this a reprieve I actually turned around and went long. So you know but the market none of this is like if it doesn’t occur on Twitter nobody cares. These are the type of systemic events that take place underneath the radar screens that will when they start to be exposed.

FRA: Peter do you see similar impact from Saudi Arabia and what will be the effect on oil prices?

Peter Boockvar: Well I agree. I think Yra said everything there was to say. I just want to add on that what’s going on with the oil is you know we’ve also had multiple years of a big reduction in the rate of them investment in oil production particularly offshore. You’ve had trillions of dollars of projects get canceled. Yes. And we’ve seen that also in the mining space in the industrial metal space. You know that’s what their markets do and that’s when companies start to focus on returns on capital and cash flow. They spend less on drilling and mining and I think it’s really been the supply side that’s been under more discipline that has created a lift in oil and industrial metals and this rising commodity prices. So I think that’s something to pay attention to that. Yeah this is partly geopolitical, but I think there has been a concerted effort in trying to control at least the supply side and even in yet in the U.S. I think people are waking up to the economics of shale and that markets aren’t necessarily going to be so friendly to continue to finance all the shale drilling where a lot of these companies aren’t generating any cash flows. So while U.S. production will grow over time I think a lot of it’s going to be cash flow driven and less of that just the reckless spending just to drill a hole and create more barrels ..

Yra Harris: And you know what Peter brings up a very good point. For another reason but with the rise in oil prices has pushed the high yield debt of energy companies to the highest levels not yields levels but price levels. And yet when I look I’m looking at JNK the high yield ETF HYG and JNK and those are both have moved underneath the 200 day moving averages which is another warning. There are signs that are developing because what would drag them down, you know last year we did or what sent high yields of course when the energy bonds and all the structured notes that they did were under trouble. Now they rise in the value and yet the high yield indexes, the yields are rising .. So that’s another one of these divergences that really is flashing for me.

Peter Boockvar: Yes, I agree. I think this rise in the cost of capital and expansion .. But you have to remember that the rise in short term interest rates is a really big deal because there’s hundreds of billions of dollars that are seeing a rise in their cost of capital every single day. With this rise in short term interest rates I mean the one-year T-bill is yielding 152 today, the S&P 500 dividend yield is 1.9 percent. These are still obviously very low numbers, but in a world of many years of zero interest rates ..

Yra Harris: In what Peter said that’s such a great point. You know that I’m celebrating 152. I mean world where you know I’m dancing and I’m doing this just because you know.

Peter Boockvar: It’s like shocking to say.

Yra Harris: It’s shocking.

FRA: And maybe we can end with your thoughts on New York Federal Reserve president William Dudley stated “we had a woefully inadequate regulatory regime, it as much better now in place, there is still more work to do” .. In reference to the financial crisis and what’s happened since. Yra you mentioned that was pure rubbish.

Yra Harris: I mean really it’s pure rubbish because the Fed had all the macro prudential tools that they needed, if they wanted to put a halt ..

Peter Boockvar: Yeah and I think Dudley’s comments reflect just an extreme level of delusion that Bernanke had as well. And that for them to, with a straight face, saying that it was regulation that was not in place. That was the cause of the crisis, I’m trying to think the right word, but it’s actually dangerous because they’re deflecting any self blame on monetary policy. I mean monetary policy is the liquor that feed the drunks and where for Dudley and Bernanke before to say well it was the lack of regulation that was the cause. It’s actually scary to hear because it tells you that they don’t understand. They don’t understand and they don’t want to admit the unintended consequences of price fixing the cost of money and that typically goes awry and it has in the past and it is now and it will again. And to think that it’s a regulatory structure in place and that a bunch of bureaucrats are going to somehow manage the economy from that perspective and and create these buffers around economic cycles is just I don’t know if it’s hubris or just complete delusion.

Yra Harris: Really That’s like sums it up and it was a when somebody responded in a blog and I wrote look at Greenspan not only did he not try to curb it he encouraged it. He said use your house as a piggy bank .. refinance it and create demand by spending the money that you can extract from this taking out of course more debt at the same time .. And number two Bernanke he didn’t, as Peter rightly said, they fueled this; this is contained which is no worry here .. They did nothing. I mean at first blush they could have raised reserve requirements to start squeezing the leverage that the banks were employing … Well how do you know it’s a bubble and what if we’re wrong. Because monetary is a blunt instrument you know squeezes the entire economy. Well you know what. Don’t tell me that you didn’t have the tools and you had the tools.

FRA: Exactly agree very much on those thoughts. And that’s great insight. Gentlemen how can our listeners learn more about your work Yra.

Yra Harris: Send money. No Bitcoin .. J just kidding .. I post blogs and Notes From Underground. If you can find register to look up to you but that is a little humor.

FRA: Peter?

Peter Boockvar: You can go to boockreport.com – you can see my daily writings and also you can go to bookmarkadvisors.com.

FRA: Great. Thank you very much gentlemen.

Submitted by Boheira Manochehrzadeh <bmanoche@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. This is Richard ..  Today we have Alasdair MacLeod and Bosko Kacarevic. Alasdair is the head of research for GoldMoney and an Austrian economist. He has a background as a stockbroker, banker, and fund manager. Basko is the president and CEO of Kindigo Capital, a Canadian based private equity firm in Windsor, Ontario, Canada. The whole financial licenses and commodity derivative stocks mutual funds and private equity. Welcome gentlemen.

Alasdair Macleod: Nice to be here.

Bosko Kacarevic: Thank you for having me.

FRA: I thought we’d do a focus today on physical gold. Why physical gold why does it make sense where to store it, how to store it. And then perhaps a comparison to what’s happening in the Cryptocurrency world, sort of Gore versus cryptocurrencies debate and further where we kick it off with if you want Alastair with why physical gold why does it make sense?

Alasdair Macleod: Well the the the basic sense behind physical gold is that it’s nobody else’s liability. It is Money, is money not an investment. And I think that’s an important point. But as money it tends to retain. In fact, over a period of time it tends to increase its purchasing power measured against commodities and if you like the items that are manufactured of commodities. And if you want proof of this basically from 1969 to the present day the dollar priced in gold has lost over 97 percent of its purchasing power. So that’s how strong on gold is. But if you’re going to hold gold in paper form someone can come away and change the rules. Your paper might go bust if let’s say you’re in an ETF, which invests in synthetic gold. If you try and invest in gold on the futures exchanges, sort of rolling contracts. That again is subject to really try and take delivery. You may not get your delivery. The one thing that really matters is that you have the physical gold. Now obviously you can store all your gold at home if you’ve got any significant level of assets. So you need to find if you like a really good LBMA registered faulting company who will store all your gold and that’s basically what we do is go money. We act as custodian; our customer’s gold is not on our balance sheet it’s it. It operates on the Canadian Belman laws. I think that’s the technical term. So if we have some sort of financial accident, there is absolutely no dispute about the ownership of gold which we have as custodians, it belongs to our customers. We have both a metal audit and also financial audit every quarter. So that again you know it’s all recorded, it’s yours and you’ve got a choice of vault around the world. So if you’re an American and you have a fear that the American government might be in a sort of command you to submit your gold in America. It’s not under the American government control, it be put it into a foreign jurisdiction. I mean we you know Switzerland or Singapore or somewhere like that. I wouldn’t say that you break the rules but it just makes it a bit more difficult for your government to get the gold. So there are all sorts of ways in which you can ensure that your money capital if you like is is is safe at all times and that basically is the function of gold stored in a proper vault.

FRA: And your thoughts Bosko.

Bosko Kacarevic: Yeah I have to agree with Alasdair. We approach the gold as a form of currency. We already regulated securities dealer in Canada as an exempt market dealer. So we provide as well storage facilities for investors in physical gold. Our one of our recent announcements was a we have a platform where RSP investors retirement accounts can put physical gold into their retirement accounts and have it stored in LBMA approved vault and they can trade the gold buy and sell it at any time. When the gold is in your RSP account because it’s in trust for the retirement then it can’t and the clients can’t take delivery of it. But the physical gold is there it’s accountable, it’s audited, and there we offer a basically a non fungible system. So when our clients purchased their gold it’s in a specific container, it’s allocated, and segregated to their account. So the exact same gold Maple’s gold bars that someone purchases is the exact same that they’re going to be selling. So we try to explain to people that you know a properly diversified portfolio should have some physical gold and silver in it depending on suitability. You know you might have 10 percent or 20 percent, but it all depends on the rest of the portfolio that the client is holding and at Kindigo we focus on our clients are mostly accredited investors. So there’s considerable due diligence that we do. And the KYC forms that have to be filled out, according to the compliance requirements in Canada.

FRA: And Alasdair what are the risks for for storing gold or ways in which you can have it from your perspective in terms of the industry. Like what are the advantages and disadvantages of different ways of storing gold?

Alasdair Macleod: Well obviously that I think we’ve just agreed the best way to store it, but you know unless you’re talking about small change at home if I can describe it that way is in LBMA registered vault. And again if you have it in a different jurisdiction from the one in which you live that you like is another safeguard. The other safeguard that’s a proper LBMA registered vault gives you is that gold that goes into the gold basically is proper bullion. We ensure that anything that comes in for our customers is bullion and not Tungsten painted gold colour, that unfortunate experience that happened in Canada earlier this week. So that’s terribly important say you’ve got to ensure that you know the gold comes from proper refiner. So it’s not conflict gold. This is another thing which is becoming an increasing issue in our politically correct world. So I would when it comes to dealing with set incentives, such as some of the refiners in Dubai. I sometimes wonder what the source of that gold is. So it is important I think to to deal with reputable people. Storing gold at home does give you potential problems because if you’re careless and you let someone know that you might have an gold at home then you know you’re probably open to being robbed. And if it’s a lot of gold then you know the story gets out then you could actually be robbed by some very very nasty people. So I think that is what I would keep at home is probably fairly limited. I would actually look past having a proper vaulted gold. Physically yes I think we’re OK. But you’ve got to understand that that you don’t have possession of the gold, you have possession of a piece of paper which gives you an entitlement to some gold and you may not even have a direct entitlement to some gold because when it comes to submitting your ETF shares, well stock in return for gold usually it can only be done through authorized banks who are on the list to be able to do it. So that again is is a bit of a problem.

FRA: And your thoughts Bosko.

Bosko Kacarevic: Yeah. You know our system is a closed loop system so we eliminate any possibility of any counterfeit gold products entering our platform because it’s all done through our office. I inspect every product that goes into the vault for my clients and we are providers to the Canadian man to other gold refiners. We have direct relationships. So there’s no that gets out into the public. The the article that Alasdair mentioned regarding the Canadian Mint at RBC you know it seems there was a case I think a few years ago that they found the gold bar or counterfeit bar at a jeweler and always seems that it’s a jeweler or a pawn shop that these things are discovered. You know I haven’t experienced any counterfeit products coming through our business. I don’t think any anyone who wants to pawn off any counterfeit products would go through our business or Alasdair’s business. I’m sure that these people that are attempting this are staying away from reputable dealers because they’ve been caught right away. The Canadian Mint has issued a statement to their defence. I mean I guess we’re an approved a billion and a dealer with the Canadian Mint. So they said that that the gold product was and wasn’t even produced by the Canadian Mint in the Royal Bank is saying that they didn’t even sell their product. So how this came into being I don’t know. But I think people need to understand too that you know the the ownership contract that you own the gold and you know people have to do their due diligence in their background checks on who they’re dealing with. Because at the end of the day when you want to sell you have to make sure that you know the gold is available for you that you’re selling. So when it’s in our vault you have title ownership of the gold and even the clients that are keeping their gold at home. You know we don’t pay out to people when they come into our office right away. We have the gold inspected and we always just to cover ourselves. We tell them they have to wait 24 hours before they receive their funds. So anyone trying to pawn off a fake gold bar isn’t going to leave our office and let us inspect it for 24 hours so we’ve never come across anything like that. And I think this is an isolated incident. But I think people need to be aware of it. If the ownership contract when you’re storing your gold in a vault the title ownership of your gold is what the important thing is.

Alasdair Macleod: Richard can I just add to Bosko saying there, one advantage that you guess of having gold in a proper LBMA vault is that it should be properly insured. And we also have to ensure all our customers gold. So I think that’s a very important point. Another important point to realize is that if you take delivery if you go ahead and you want to sell it, you have to effectively make sure that you know to convince the buyer that it is authentic and that will involve it being tested. So the marketability of gold which leaves the vault is not nearly as good as gold that is kept in the vaults. I just wanted to add those two points.

Bosko Kacarevic: I agree with that it’s very important, the insurance aspect too. We have clients that are storing, some people even for a large quantity of gold and silver at their homes and it’s just too risky and then what eventually happens is when they want to sell it you know in the case of silver. People are holding a few thousand ounces of silver. It gets pretty heavy and it cumbersome moving it you know. And when it’s in the vault for us it’s very easy to identify. Each container has a specific number. I have clients you know across the country and in Europe that they just pick up the phone they call us. We sell the specific holdings and wire them the funds so that people are unable to do that when you have your gold at home and you’re travelling or you’re you want to liquidate it quickly because one of the other issues that comes about is when people call and they want to sell it. If the market’s moving fast or are very volatile I won’t lock in a price for a client unless the gold is in our office. You can’t call me. But if the gold is in the vault I know it’s there. I know the identity of it so I can lock in a price for a client over the telephone and send them the money. But if they have it in their basement and they want to lock in the price you know it’s not possible they have to bring it in person. And once it’s in my possession then we can discuss locking in price.

FRA: Now in this day and age with the advent of cryptocurrencies does physical gold still make sense? So if we look at what’s happening with Bitcoin and other Cryptocurrencies. Is there a migration of investors holding physical gold towards holding cryptocurrencies either together or as an alternative, Alasdair?

Alasdair Macleod: What a fascinating question. I think Richard the answer to your question whether there’s a migration from buying gold into buying Cryptocurrency. I think there must be. Yes. We can’t deny that. The reason I would say that is because so many people who deal in anything really don’t actually understand the underlying economics of what they’re doing. What they understand I think a trend and quite simply if you see a trend moving or speculating you just jump on the trend. So you are going to have people who will see who take the view that gold is less exciting than Cryptocurrencies, has potentially less return over at whatever time frame that they’re putting in their mind. So they will sell gold and buy Cryptocurrencies, of that I have absolutely no doubt whatsoever. What is interesting in this however and I did actually write a piece on this in I think dated August the 10th. So for anyone who’s interested if you go on to Goldmoney sites and go into research and go into the insights then you will find. August 10th I wrote “Cryptocurrency- its status as money”. Now this is very important because I won’t get through the article. Basically my conclusion is that Cryptocurrency are not money. I mean it is not just a question of volatility, its the origins of it and all the rest of it. But cryptic currencies are the media for speculation par excellence. And you know with the limited supply and all the rest of it and the fact is that so far the people who got into it are basically geeks. If I can be that rude to call them that. The hedge funds are beginning to wake up to this. The authorities are beginning to wake up to it. I mean they even bought it yesterday the CMA decided that they’re going to introduce a bit you know a Bitcoin future. Various governments have sort of taken on the technologies, some are being frightened away by the volatility in the things in it. So I think the Chinese have sort of tried to close down Chinese based operators, but basically the public has yet to buy it. And if you look at any bubble which is essentially what the Cryptocurrencies are, it’s only when the public are really into it that you can say this is time to get out. It is getting dangerous. It is going to collapse. We are some way from that. But what I can’t see is what’s going to stop these Cryptocurrency is rising in the meantime because you know if it’s becoming you just my street futures exchanges and so on and so forth you are going to get asked a lot of hedge fund type money, speculative institutional money if you like yet to buy these things. So I see them going considerably higher than this. You know please don’t hold me to that. That if you like is the theory if you like the madness of crowds as Charles Makai wrote back in the 19th century. We are seeing it and this is pure. It’s like tulips without the bulbs. I mean it is amazing. I get very unpopular for saying this by the way because everybody in Cryptocurrency is convinced it’s money, convinced it’s some sort of new paradigm. And it was ever thus, every bubble is like that everybody involved believes that this is a new future and whatever. What fascinates me you know we’ve looked at it so far in terms of Crypto versus gold, which was the basis of your question. But I think at some stage it’s going to move on from there. What we’re going to be looking at is that potential for Cryptocurrencies to destabilize paper currencies. I’m trying to get this one. Trying to get my head on this one at the moment and I’m planning to write an article on this front shortly. So this to me is a fascinating topic. It really is.

FRA: Could the momentum into Cryptocurrencies keep a lid or a cap on the price of gold in U.S. dollar terms Alasdair?

Alasdair Macleod: As a follow-up, no I don’t think so. There is actually a far bigger story going on gold and it’s all to do with the declining use of the dollar in international trade and this is something that’s being forced on to the rest of the world outside of America by China and Russia working together as head of the Shanghai Cooperation Organization. I think that we’re likely to see. I mean my information is that we’re going to get in an oil contract settled in Yuan on the Shanghai futures exchange by the end of this month, November, and between Yuan on contracts countries like Iran, who either off a bit to deal in dollars or out of their choice, would not want to go anywhere near a dollar. Will have the facility to buy gold in Yuan. And that I think is something that is likely to lead to a significant rise in the price of gold. The other thing about the price of gold is that there are an awful lot of dollars outside America. We’ve got some people running around saying well you know the American economy is rubbish and the rest of it is just going to collapse and then the end of the purchasing power of the dollar will go up. But the latest figures we have which are over a year old now is that the total portfolios in dollar cash outside America is in excess of 17 trillion dollars. That was midway through the last year 2016. It was barely changed from the level Midway 2015. My guess is that with the dollar having eased over the course of this year we will already be recording a decline in the total value of foreign portfolios, the dollar elements in foreign portfolios. Those figures will be released in next April or May. So we won’t know until then. But just imagine if you go 17 trillion dollars outside America and you have got an economy you’ve got about 19 trillion dollars GDP something like that. This is too much money outside. I think for the situation to be sustained, so I would say the dollar is weak and that is what’s going to drive gold up. And I think it is something which is independent of the Cryptocurrency story, but what does fascinate me is the potential for the Cryptocurrency is to destabilize paper currencies if you like as well. And as I said I’ve got to get my head around that before I write it.

FRA: And your thoughts Bosko.

Bosko Kacarevic: Alasdair and I seem to be in the same camp. I’ve heard actually a number of my clients who have actually sold their precious metals to purchase Bitcoins because it seems like an alternative currency. But you know it’s not officially a currency, but it seems to be operating like one. And you know judging from what’s happening, the attraction to Bitcoin is similar to the attraction to gold. It’s it’s an alternative currency outside the banking system or in government and so on. But the problem with that is is when you’re when you’re comparing it to gold. Gold is still a physical commodity. You can take possession of it. I have a problem with Bitcoin because it exists on the Internet. It doesn’t exist in the real world. You can’t take physical possession like gold or even paper currencies. So there’s a huge cyber threat to the Bitcoin. I mean I find it strange that the person who invented Bitcoin, Satoshi Nakamoto, is still anonymous, nobody knows who he is or where he came from or whatever. That kind of raises a lot of flags for me. Then when you have issues with Bitcoin or let’s say that there’s a hacker that hacks into Bitcoin who are you going to call. There’s no nobody you can sue. When you invest in a company or you buy gold and silver or invest in the stock there are people behind that. When you invest in currencies, there’s a currency broker. The government issuing the currency, there’s essentially nobody behind bitcoin. It’s operating and it exists on the Internet and apparently from what I understand it’s a series of encrypted keys. But you know I think one of the fundamental changes that Bitcoin is introducing, is the blockchain technology that it’s produced on, which I think that there’s a lot of people in the financial institutions are adopting this new form of a distributed ledger and even that’s questionable as to the advantages of that. I think the credit card companies and the banking system the the technology that’s behind their ledger entries and their software accounting systems are doing fairly well. Introducing a distributed ledger, I’m not sure what the advantages of that are, but it seems that a lot of people are attracted to it. And you know mind you people are always attracted to new things like Alasdair alluded to earlier, but you have to remember that when the Internet was introduced and people were adopting there was a lot of, along with the advantages, it brought in a lot of problems. We have high-frequency trading now. So it’s not always a great thing to not have a central authority. In some cases, you want to have a central authority to be the mediator between two parties. So I’m still sceptical about Bitcoin. Obviously, it’s doing very well on a price level but on a value level. You know I still have a lot of reservations about investing in it, but currently, the CMA group thinks that the futures contract would be in demand and people will have the opportunity to hedge their risk in Bitcoin. So for me, it’s too early to get in. I’d like to see how it develops.

FRA: And I saw today an article by Jim Rickard’s on a new research report out by Goldman Sachs discussing this very issue of gold versus Cryptocurrency. Goldman Sachs appears to be leaning on the side of gold. Well as a preservation of purchasing power. They mentioned that Cryptocurrencies are vulnerable to a hacking, government regulation, and infrastructure failure during a crisis. Those are issues of concern and because of the volatility in Cryptocurrencies, they still see gold as preserving purchasing power better than Cryptocurrency, so that those are the results of the research report by Goldman Sachs and any thoughts on that and. Your final thoughts there.

Alasdair Macleod: Well I’d go along with what Goldman Sachs have concluded. I haven’t read their report, I must say, but as you’ve described it it’s hard to disagree with it. But I don’t know. I know that for people who are trading in it, this is all sort of a big issue. But from an economic point of view there is no doubt about it. Gold is money, always has been money whereas Cryptocurrencies are not then merely a medium for speculation. But you know we don’t actually care about that. Perhaps we always say is Bitcoin going up and we’ve got to get in there or in theory or whatever. We’ve got to go and buy it you know because you can’t stand aside and not buy these things. And this is why I think it’s terribly important to understand that actually it is just a whole load of hot air and nothing else, but this balloon I think, if I’m reading market correctly it is in the early stages rather than the final stages of its inflation. And as I said, I mean so far the people who got into it all the people in the know if you like the people who have been following this story from the outset, the early adopters, the institutions yet to get in. And I think that I mean this is this is the thing about the CMA contract it doesn’t settle in Bitcoin at all. All it does is it uses that bitcoin as a reference price. So that’s actually not going to be anything like gold futures contract where the gold is actually deliverable. This is a very very different thing. So I can’t see really that there is going to be the arbitrage between the futures contract and Bitcoin. I can see how that’s going to happen because there’s nothing deliverable. So that is not going to take demand out of the Bitcoin story so much I don’t think as inflating the number of gold contracts in outstanding on Comix definitely takes demand out of the gold market. So to my way of thinking, you know the the the institutions have yet to get into this. They will get into it because these new instruments look like you know go into contracts themselves so forth are beginning to take place. I think the other thing that’s going to happen is that the regulators are going to come in and insist that anyone maintaining accounts for people with Bitcoins or other Cryptocurrencies are going to have to do their due diligence. And I think the industry as a whole itself is likely to turn round and think we’ve got to clean up our act to make ourselves mainstream. I think all that is still ahead of us. And then you know when you think about the public investing in this, investing is the wrong word, speculating is probably better word, they think they’re investing. This is not just a bubble let’s say in the Shanghai stock market or you know if we go back to the tulips in Amsterdam that’s what 1640s or whatever it was all the Mississippi bubble which was France or the South Sea bubble which was which was England and most particularly, not just you know I mean just sort of England within coaching distance of London. That was the source of this. We’re talking about something that is catching the imagination globally and I mean already we’ve got so many imitators I think there are over a thousand Cryptocurrency I read somewhere. Where is proper paper currencies or something like a 170 only so already we’re you know there’s a lot of funny deals being done around in these icy roads and all the rest of it. This is an act which if it gets cleaned up and they will try and clean it up I’m sure that they will though try and clean it up. They the authorities will want to see cleaned up because they want to tax it apart from anything else. And the other thing is I think that the industry itself will want to see it cleaned up and that will open the gates for everybody to get involved. This is this is a theoretical bubble for any student of psychology in the future. They’re going to look back on this as an absolute wonderful example of a pure speculative bubble which is totally out of thin air.

FRA: And your final thoughts Bosko.

Bosko Kacarevic: You know when you compare the standard deviation of gold versus Bitcoin, I read a report recently that over the past 12 months’ gold has had a 12 percent deviation, where a big coin is over 60 percent. So you know I agree that it is a speculative instrument. It’s going to be quite volatile and the attraction of many people to Bitcoin to elude the financial markets. I think that’s going to be taken care of with the regulators are going to get involved obviously to see him now as is adopting it. So this idea of people being able to have a peer-to-peer and to trade outside of regulation or the government size. I think that’s just an illusion because of you ultimately you have to settle these Bitcoins for currency that’s going to be used in the real world. And you know you have to receive it in a bank. It has to be wired from whatever Bitcoin exchange or so there’s going to be financial institutions involved, regulating it. So I mean is it going to go up further. It’s very possible. I mean I think it is in the early stages and you know it’s it’s going to go through the process like anything else that’s brand new. It’s going to weed out the all the weak currencies and will Bitcoin be the winner in the end. I don’t know. Maybe a theory or the other thousand that are available. Who knows how it’s going to turn out, but there is definitely an attraction to it. And it seems to be distracting some gold investors are distracted and selling their gold and silver for Bitcoin and I disagree with it. But you know people like to follow trends and in some cases, they’re going to have to experience the negative part of following a trend and being wrong. So I don’t really know what’s going to happen but it’s interesting it’s a new technology and we’ll have to see.

FRA: OK great. Great insight gentlemen. How can our listeners learn more about your work, Alasdair?

Alasdair Macleod: Well the easiest way is to have open an account Goldmoney, no, but on Goldmoney site I write weekly is published on Thursdays I usually say if you look if you go onto the site, Goldmoney.com, research and then insight, you’ll find that. I also write a weekly market report and that again can be found under the research column.

FRA: And Bosko?

Bosko Kacarevic: People can reach me at our Website at Kindigo.com and you know on there this information about our company, my background, and they can email us through there. We don’t do a call in, but we do keep in touch with our clients and keep them up to date on what’s happening in the gold market.

FRA: Great thank you very much gentlemen for your insight. Thanks for being on the program show.

Submitted by Boheira Manochehrzadh <bmanoche@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 Charles Hugh Smith. He’s author leading global finance blogger and philosopher, America’s philosopher we call him. He’s the author of nine books on our economy and society including “A Radically Beneficial World Automation Technology and Creating Jobs for All”, “Resistance Revolution Liberation a Model for Positive Change”, and “The Nearly Free University in the Emerging Economy”. His blog of twominds.com has logged over 55 million page views. It is number seven on CNBC top alternative finance site. Welcome Charles.

Charles Hugh Smith (CHS): Thank you Richard. Always a pleasure to join your roundtable.

FRA: Great. And with that today with the focus on the sort of tension between the private sector and the public sector with many types of revolutions, technological revolutions happening in the in the private sector you know in terms of block chain and biotech, energy environment, lots of revolutions happening much like what happened with the with the Internet.com revolution. And the question is will that growth in the private sector be able to to meet the challenges of the public sector in terms of seemingly unsustainable growth and that growth in Entitlement programs. Dr. Albert Friedberg of the Friedberg Mercantile Group recently observed that in the U.S. it’s basically 10 percent of GDP and rising for entitlement programs. So you know that’s the big question. Your initial thoughts.

CHS: Well Richard I think that’s an excellent context for you know the points we’re going to make. And one of the first points I would start with is ultimately the public sector in this state what we call the state all all layers of government and government related entities. They all live off the private sector right. That the private sector has to generate surplus. It has to generate wages for employees and those are taxed by the public sector and that’s the source of the public sectors revenues. And so what we’re really kind of discussing is can the public sector generate enough profit and employment to support this fast ballooning public sector. And you mentioned the entitlements growing by 10 percent. And I have this chart of consumer goods and services.

The price changes what what we might call inflation. But it’s actually not. Not entirely inflation it’s it’s the cost of services being provided and how far above or below they’re rising then like people’s wages which household incomes as we all know if and stagnating for somewhere between 40 years and 10 years and depending on which sector of the economy you’re looking at. But we look at what is soaring in price and we look at like 200 percent increases and we find out it’s college tuition and we look at what’s climbing at a 100 percent or or more and it’s like health care and child care. And of course these are the sectors that are heavily controlled or are funded by by the public sector. And what we find is declining in price is cell phone service, software, TVs the kind of things that the private sector provides. So it’s pretty clear when you have competition and when you have exposure to innovation then you get it lower prices or at least you get more for your money. Or there’s there’s hope that innovation will impact the consumers, either the quality of the goods and they’re receiving or the price of the goods and services they’re receiving. So to sort of summarize everything that the public sector controls is skyrocketing in price and the quality is also now suspect right.

Like I’ve written a lot about higher education and I have another chart here showing that literally all of the the the higher education student loans that are being issued are actually funded by the federal government. So it’s it’s actually the federal government is funding these private sector lenders and guaranteeing them profits to fund these students getting diplomas which are declining and real world value. You know in terms of statistically what the earnings are of college graduates and so on that that’s been stagnating just along with the rest the wages. So I would propose that higher education is actually declining in its utility and value despite the cost soaring and many other people would make the same claim about health care at least in the U.S. Is that the cost keeps soaring but the actual you know measures of health of the American population are continue to decline. So this is a really striking difference. I think that’s really what we’re talking about is an enormous difference between the sectors controlled by the public sector and those controlled by the private sector.

FRA: Yeah you’ve written a lot about that in terms of several industries being sort of cartelized, you know with special interest group, lobbyists and just the interest by the government in them. Can you elaborate a bit on that?

CHS: Yeah I think that’s a great topic. If the public sector controls something like health care which in the US is dominated by the public sector programs: Medicare, Medicaid, and the Veterans Administration. Then the way to maximize your profit is to lobby the public sector, lobby the government agency, to lock in your cartel pricing. And so that’s what we see is that we see these pharmaceutical companies routinely raising prices 30 40 percent or even 400 percent just on a random basis that they make no claims that they’ve invented something new. They simply raise the price on an existing medication and the public sector also imposes a lot of regulations that some of which are of course important and necessary, but many of which are simply you know churn you know they just create more work, but they’re not really creating that not really impacting the patient in any in a positive way.

So I have a chart here of the growth of physicians and administrators in the health care system. And we see that the number of physicians has been flatlines for like 40 years where the growth of administrators from about the early 90s on has has ballooned up like 3000 percent. And so this is there’s no way that a private sector company could could bloat its management by 3000 percent and get away with it unless its revenues and profits were rising even faster.

And we see the same thing and I have a chart here of the faculty and management of the of the University of California system and it shows that while the faculty has risen slightly over the last 30 years from about 7000 to about 8500 the number of administrators has risen from about 3000 to like 7500. So we have these enormous ballooning of bureaucracies and all of which are really highly paid positions. And and yet where is the output. I mean where’s the gain in quality or any output. And of course there isn’t any. None that we can measure.

FRA: And associated with this involvement by government is an increase in government debt. And if you look at just debt in general in recent years in the developed world it’s taken more and more new debt to create $1 in GDP. I mean the figures are something like $4, of between $4 to $18. I’ve seen some estimates of new debt to create $1 in GDP. Your thoughts on that.

CHS: Right. Right. And I just read a report from a blog that showed that China has the same similar, very strong diminishing returns on its vast expansion of debt. That it’s expanding debt at rates that are multiples of its GDP growth. And so it’s also the case that even in the developing world the same diminishing returns that you describe is that is the dominant reality. And of course we have to ask why is there such a low efficiency or low productivity rate to this new debt. And and it’s because there’s no there’s no pressure of innovation and competition on how the governments are spending this money. And so there’s really no adaptive pressure in terms of natural selection for them to find more efficient ways to do whatever it is they’re doing. Right. The pressure simply to raise more revenues. And if they can’t do that then to borrow more money and this is where financial repression comes in because the only way the public sector can keep adding debt and it’s at this fantastic clip is to lower interest rates to zero or near zero. And create all these perverse incentives for speculation that we’re seeing now as a result of that manipulation if you will or intervention to keep interest rates low enough so the public sector can keep borrowing and borrowing and borrowing, you know to infinity.

FRA: Any ideas on what the endgame could be here if we consider the level of debt and the level of interest rates for the two lever’s, you know with rising debt at some point even small increases in interest rates could be disastrous. I mean where does this all end.

CHS: Right. Right. I just saw a statistic which I can’t verify of course but it sounds fairly close to me. Somebody said that the point six percent rise in the U.S. Treasury yields. That’s a kind of recent rise in one part of the Treasury bond yield spectrum generated 1.7 trillion dollars in losses right then and there you know just a relatively modest increase in only one part of the total global bond market created almost 2 trillion in losses. And so yeah if we extrapolate the possibility of of interest rates going up two or three percent then you’re talking about losses that could be in you know 10 trillion and up in the bond market and then of course as yields rise historically people sell stocks with low dividend yields and high risk. And then if they take the benefit of a higher yield in bonds and so stock markets tend to go down when interest rates go up as well. So we are the end game there is can they can they keep creating debt at a fast enough rate as the returns on that debt continue diminishing. And by some measures as you know that some people feel the return is already negative, like there is by the time you include debt service and other factors than actually we’re losing ground here. So eventually that will erode the the real economy. And I think that’s that’s really what we’re talking about here is can the public and the private sector outgrow the debt that’s being piled up by the public sector.

And I have a chart here. It’s kind of interesting that shows the adoption rates of technologies and it goes back into the 19th century and shows how long it took for electricity and telephony and radio and so on to be adopted by the general populace. And of course as we all know from our our own experience the adoption rates are speeding up for things like cell cell phones and the Internet itself and social media. And so we’re seeing like a faster rate of adoption and development and in the private sector and we’re seeing a glacial change in the public sector or actual resistance to any kind of innovation or change. And so I think the one of the endgames is that people the taxpayers might just simply be run out of patience with with having to pay higher taxes for lower quality public services. Right. And this could this could be a problem because as we all know public pensions are many of them are not really solvent and they’re based on unrealistic expectations of earning seven and a half percent, you know forever. And the number of people pulling the pensions drawing on the pension funds is rising fast as the boomers retire and so on and so there’s it’s not just entitlements but the entire pension system public and private is under pressure as the boomers retire and the wages of the millennials and the younger workers remain stagnant. So there’s there’s a whole other dynamic here that the public sector is going to be forced to borrow trillions more to make up these shortfalls in pension funds if it’s going to meet all those all those promises. On top of the public entitlements of you know social welfare, social security, health care, and so on. So yeah there’s there’s a number of pressures building and what’s the endgame? It’s anybody’s guess but if you destroy or or fatally wound the real economy then there’s no way that borrowing more is going to fix what’s broken.

FRA: So you think none of these revolutions in terms of like block chain in biotech and in others is strong enough for it deep enough to overcome with the general trend is in the public sector.

CHS: Well that’s an excellent question Richard because I mean my book that I wrote about higher education and that the nearly free university. The tools to dramatically reduce the cost of a college education are already enhanced. And of course this is not just remote learning but it’s also in my mind the key is not just remote learning and taking the best of what’s available and making it available to students digitally, but there’s a lot of possibilities for public private sector apprenticeships which are much lower cost than than supporting this gigantic campus with a huge bureaucracy and 42 deans of student affairs and his whole it tremendously expensive infrastructure. The way what actually is the most effective way to learn is to get out there in the real world and augment your book learning or your lecture learning or your lab work with actual experience in the field then of course this is how it works with the construction industry and many other trades. But it also works just as well in the scientific community. And I know for many of our young friends who graduated with degrees in biology or computer sciences they discover that they really don’t know what the employers really need them to know. And so that’s just one example of the kind of revolution that could occur in public funded sectors if the sector allows innovation. And so it’s like how do we break down the resistance of the status quo and the insiders who are benefiting. And I don’t know that we can but at some point when a system becomes completely unaffordable then people will flock to some new alternative and you know health care as another example people might just start going around the existing public sector and buying their own health care services at you know 10 percent of the cost of the official public sector fund. So if there’s definitely a battle royal you know over these sectors that are bloated and efficient super high cost and increasingly unaffordable. And so I’m hoping that it’s like a logjam. You know that is blocking the river of innovation and lower costs that something will break that logjam and exactly what that could be would would have to be some public sector agency or state agency that that broke away from the status quo and accepted a much lower cost model. And that’s what I hope for.

FRA: Could there also be maybe a geographic solution to this in terms of certain countries promoting innovation like Chile has has a program to encourage innovation with new immigrants you know could there be that type of solution. Maybe new countries that take on, you know more innovation that are regulatory friendly to business so that perhaps this is you know a brain drain and wealth drain from from the more stressed countries that we’re talking about.

CHS: That’s a great dynamic that you’re describing and it also works within within regions, like the EU or the United States or North America. And so I think that that’s probably the most likely vector or trajectory for real change is somebody somewhere allows or encourages the kind of innovations we’re talking about and they start reaping these tremendous rewards and and capital and talent and then are attracted to to those places. And as they drain away from the high cost places like Illinois and California and some of the developed nations as a whole then those those those places have their tax base has reduced their the profits generated by their private sector go down as talented capital flees. And so then there is a kind of Darwinian competition that the really high cost sclerotic bureaucratic unfriendly to business and innovation places become insolvent and then they’re forced to change or they or they just with her wither away. So that’s an excellent point. And I think the block chain is another example of that dynamic that whatever country fully legalizes block chain technologies and crypto currencies, like Japan appears to be doing. And it’s sort of baby steps. Even the U.S. appears to be integrating the crypto currencies into its investment sort of scheme. Those countries were prosper compared to countries that are trying to ban crypto currencies and block chain or limit them or co-opt them, you know like make a public sector version and force everybody to use it. Those kind of attempts to to stave off innovation will definitely fail and there’ll be a Darwinian selection process, whether it’s really not controllable because you know you can’t really force people to work hard and you can’t force them to put their money in places that that money is treated badly.

FRA: Could the reaction by governments be similar to what has recently happened in what is happening in Spain for example like with Catalonia. Could that be a blueprint for what is to come in terms of preventing brain drain wealth drain? You know the sort of the within the regions you see that potential.

CHS: Yeah definitely that what we’re talking about to some degree here of course is financial repression that the public sector manipulates interest rates and yields and and then and tries to subvert ban or limit innovative technologies like block chain. And then of course that what you’re describing that financial repression if that isn’t enough then they move to direct political repression. And you know one of my favorite quotes and I’m paraphrasing here was from Napoleon Bonaparte. And who is reputed to have said something along the lines of “what amazes me most is how little power can actually achieve”, In other words if you’re going to use force it’s remarkable how little force can actually accomplish. Because you’re you’re having to monitor and enforce something that’s unpopular that’s going to that’s a tremendously high cost of insurance. And so that’s a good way to go broke is trying to force people to do something they don’t really want to do. And that that doesn’t benefit them. And so I think if we had to summarize what we’re talking about it’s the public sector is default setting is to try to force everybody through financial and political repression or propaganda to do what benefits the public sector and it’s cartels and fiefdoms. But you really don’t. You can’t change anything unless you create a benefit for people that they want to adopt a new change or adopt innovation. They want it because it benefits them in some broad fashion. So and that’s really the battle we’re talking about between the public sector which tends to want to force everybody to do what benefits itself and its insiders and the public sector which realizes the only way you’re going to sell anything, whether it’s an idea or a concept or a product or service, is if it benefits the consumer and the citizen. So and of course you know anybody from the outside we would look at the public sector and go why don’t they accept a more public-private sector mentality. Why don’t they understand they have to generate additional benefits for people not by borrowing more money to pay for like a bloated inefficient corrupt system. But to foster and encourage innovation that that lowers the price of goods and services because it’s more productive. So that’s that’s really kind of the battle that’s being played out I think throughout the world.

FRA: Yeah. Well that’s great insight Charles as always. How can our listeners learn more about your work?

CHS: Please visit me. Oftwominds.com. There’s free free chapters of my book and thousands of various rants and essays.

FRA: OK great. Thank you very much. We’ll do it again next month.

CHS: OK. Thank you Richard.

Summary written by Boheira Manochehrzadeh <bmanoche@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 Doug Casey. He’s an American writer, philosopher, investor, and the founder and chairman of Casey Research. He literally wrote the book on profiting from periods of economic turmoil, his book Crisis Investing spent multiple weeks as number one on the New York Times bestseller list and became the best selling financial book of 1980 with over 400,000 copies sold. He’s lived in 10 countries and has visited over 175, today you’re most likely to find him in La Estancia de Cafayate (Casey’s Gulch), an oasis tucked away in the high red mountains outside Salta, Argentina. And recently he’s been writing a series of fiction books as part of a series High Ground Novel Series. The one that is most recent I guess is Drug Lord and just wondering if you’d like to start on that to give us some idea what that book is about, what the meaning and message you’re intending to convey? Welcome, Doug.

Doug Casey: Thanks, Richard I appreciate it. I’m talking to you today from Aspen, Colorado which is where I usually spend the northern summer, and the rest of the year I’m usually down in Argentina and Uruguay. But talking about Drug Lord, it’s the second to the series of 7 novels and when I decided to do novels as opposed to nonfiction is that it’s a different audience, different people buy fiction then buy nonfiction number one. And number two, you can say a lot of things in fiction that you really best not say in nonfiction, and that’s why I decided to do this series. Last year we completed- because I’m working with my coauthor John Hunt who’s a medical doctor who doesn’t really want to be a doctor anymore for all kinds of obvious reasons, Speculator. Which what we’re trying to do is take unjustly besmirched and highly politically incorrect occupations and we form their reputations. So last year was Speculator, which is about a bush war in Africa and a gold mining fraud and so forth and talks about the theories of speculation. This year Charles, after seven years running, or Charles Knight, our hero decides to get into the drug business. Both the legal drug business regulated by the FDA and the illegal drug business that’s kind of regulated by the DEA. And I think its quite interesting because its instructive as to how the drug business works and all these books are morality tales of course. So, we show that you can be a good guy in the illegal drug business dealing in things that are highly illegal. So that’s Drug Lord and I think you’ll find it a very very good read.

FRA: And what type of message did you have in mind in this particular book? Like is there something that you wanted to convey in general?

Doug Casey: Yeah, of course. I’m a philosophical anarchist and I don’t believe that the state as an institution serves a useful purpose or for that matter even have a right to exist. So, I’m naturally for the full legalization of any kind of drugs. The argument that I make is basically that your primary position, the thing that you own most personally, is your own body. And of these government officials to try to dictate what chemical substances you can or can’t use is insane, it’s immoral, and it creates huge distortions in the marketplace. It’s just like what they did in the 1920s with alcohol when they tried to dictate that no one could drink in the U.S. and all it did was double or triple the size of the liquor industry and give the mafia a way to become the creature it is even today. So, everything the government does along these lines is counterproductive. Of course, as far as drugs are concerned, I’m a believer in Aristotle’s golden mean, it’s that some things are- everything is good in moderation and all things. And I don’t advocate that people take potentially destructive drugs such as heroin and cocaine, although our hero Charles Knight comes up with a marvelous new drug which could actually change the face of civilization but that’s another story. But these things shouldn’t be illegal and people forget that before Harrison Act was passed in 1914 that all these things were completely legal. A grade school kid could go down to the corner drugstore and buy heroin or cocaine and it was not a problem, nor was drug addiction a problem in the country. So almost everything the government does whether it be drugs or anything else turns out to be counterproductive.

FRA: What do you make of the trend in the cannabis industry now?

Doug Casey: Ah this is a very interesting thing, it’s going to be huge. I’m not personally a big fan, personally, I don’t do drugs and I generally choose a company of people (inaudible) why? Because most of these popular recreational drugs including alcohol if you would, cloud the mind and keep people from thinking clearly as well. And the problem with pot has always been that it clouds the mind. So, I’m not a huge fan of it personally. But huge medical uses which have been suppressed so far which are coming to the floor and so people that you know some people it just takes the edge off of them psychologically and they don’t have to get goofy by taking too much of it. So, the answer to your question is there have been scores and scores of marijuana stocks that have come public in Canada primarily where cannabis is going to be legal nationwide shortly and its legal now for practical purposes, just as it is in many states in the U.S. right now. But it’s going to be big. I think that the amount of pot grown in North America and the rest of the world after its legalized is going to multiply by a factor of 10, so this is a great place to be at the moment if you can find a quality company run by ethical guys. Yeah, pots going to be big and people are going to make fortunes on these stocks. And of course, many of people have already made fortunes on them and as a result, there are a lot of frauds out there in the cannabis space, but that’s true when anything becomes too popular, the frauds just always step in.

FRA: Interesting. And another big event happening these days is what’s happening in Spain, Catalonia, what do you make of what’s happening there?

Doug Casey: I think its absolutely wonderful. My ideal scenario would be to have 7 billion nation-states on the face of this planet. As I said, I’m a philosophical anarchist, I don’t believe the space has a right to exist. But what is happening in fact, this is what I like to see, but what’s happening, in fact, is that nation-states all over the world now are starting to break up. It’s not just Catalonia and Spain, the Basque region just north of Catalonia I think might be next on the runway for becoming an independent movement. And throughout Europe, there are a couple score of independent movements. For instance, in the Venezia region around Venice, in Lombardy around Milan, Sardinia, even the Pharaoh Islands belonged to Denmark. And of course, Scotland, I think that’s going to come back as an issue for independence. I think it’s great, if you’re going to have a nation-state, then the nation-state should at least have people that share ethnicity, culture, language, perhaps religion so that they’re similar, they share values. If it’s a multicultural enterprise where they don’t share any of these things, then the state just becomes a vehicle for theft of the group that gets in charge of the government. So, I think this a step in the right direction with Catalonia, that’s the good news. The bad news is that most of these independent movements are run by doctrinaire socialists, of course, all European politicians are doctrinaire socialists, but these people they tend to be even more doctrinaire. But I think it will work out very well in the long run.

FRA: And from the perspective of Spain, could this be a blueprint or a precedent on how indebted governments may act in the future against some of their regions or just the private sector in general as for example the pension crisis unfolds entitlement programs crisis unfolds?

Doug Casey: Oh yeah, you’re absolutely right, Richard. Because I think the main reason that the government in Madrid doesn’t want to see Catalonia break off is because Catalonia sends money, twice as much money, to Madrid as Madrid sends back to them in the form of national services. So, Catalonia is like a milk cow for the Spanish government and of course they don’t want it to go away. They want to keep it there, keep it producing so they can allocate the goods. And of course, this is all the more reason why the Catalonians want to break off, but the fact that the Spanish government in Madrid has clamped down so hard and so violently against the Catalans, I think its actually going to, I think reinforce the Catalans so that even the ones that don’t want to see a doctrinaire socialist Catalonian government are probably still going to vote for it simply because they’re so angry at being exploited by Madrid. And eventually I think that even after Catalonia splits off and like I said the Basque region will probably be next anyway, they’ll probably go to more free market style policies and become realistic. Because you can only have a socialist country where there are others to exploit. If we had 7 billion little nation-states in the world, there would be no socialism. Because how can you exploit yourself?

FRA: Yeah, exactly. And from considering your views on the economy and financial markets and the geopolitical landscape, what is on your mind today? Do you see any trends taking shape?

Doug Casey: Well I’ll tell you what’s really surprised me, and this has been true for several years now. It’s that after the world economy entered the eye of the gigantic financial hurricane in 2007, or entered leading edge of the financial hurricane we’re in, in 2007. And then we went through the leading edge in 2008 and 2009 and now we’ve been in the eye of the storm which has been papered over by not just trillions, but hundreds of trillions of new currencies units created not just by the U.S and Europe, but China, Japan, and all the little countries too. And that’s poured oil on the water and what I fear is that even now as we speak we’re entering the trailing edge of the hurricane and it’s going to be much longer lasting and much worse, and much different then what you might recall from 2008 and 2009. So, I think this is a good time to batten the hatches down, I mean the fact that the DOW is trading at new all-time highs and interest rates are still at or near zero, or I think they’re still below zero in some places, actually, as metaphysically impossible as that seems. I think that this isn’t a cause for rejoicing, this is really like the tidal wave going out before it comes in and washes away everything. So, it’s a good time to batten down the hatches and I don’t like the idea of being involved in the stock market or the bond market. Which isn’t just a bubble, it’s a hyper bubble, it’s a super bubble right now the bond market. So that’s my feeling on the economy in general.

FRA: In what ways will this sort of second part or a second phase of the financial crisis be different from the first phase?

Doug Casey: Well, things really went over the edge back in 2007 and 2008 and 2009 as a deflationary collapse. If the governments hadn’t created these trillions of new currency units, you would have seen the collapse of not only Lehman but Goldman Sachs and AIG and Chase, Morgan, all of them, they all would have collapsed. And that would have been deflationary in nature, we would have seen something that would have resembled 1929, it would have been a deflationary collapse. But they forestalled that and this time, since they’ve already shot most of the arrows in their quiver with ultra-low interest rates, increasing and printing up trillions and trillions of new currency units they called quantitative easing, it’s kind of cute that they make up a phrase like this and everybody just parents it rather than just say inflating the currency. I think that what we’re going to see this time around though is going to be much higher levels of inflation. Because all that money went into the financial end of the market as opposed to the consumer end of the market. So, its created a number of bubbles, stock market bubbles, bond market bubbles, real estate bubbles they’re a number of many many cities around the world. So, when those bubbles break, I don’t know the currency, we’re going to see, I think we’re going to see very high levels of inflation. So, it’s going to be very ugly for the average guy I think.

FRA: And speaking of bubbles, a lot of people see a bubble in the cryptocurrencies, what are your thoughts on cryptocurrencies?

Doug Casey: Yes, that’s very interesting. I was introduced to them about, oh how long ago was that? 2013 when somebody actually gave me a physical Bitcoin when I was in Argentina. It was worth $13 at that time and now the bitcoin is worth 5,600 something in that area today. Good news-bad news, look initially I snookered myself. I liked the idea of it as a private currency, a fiat currency created out of nothing, true, but with a limited number of units, unlike these national fiats currencies. And I missed at the time, the value of these cryptocurrencies. I missed the fact that they are excellent transfer devices. In other words, they obviate the SWIFT system which is expensive, which is slow, which is unreliable, where all your money has to go through New York, its horrible. By using cryptocurrencies to send money across borders, its private, instantaneous, cheap. So, this is a really really big thing, this is what gives Bitcoin and others its value. Like gold has value because its one of the 92 naturally occurring elements, so it has many many uses and more everyday in a high-tech world. But the cryptocurrencies are A primarily a transfer device, and then there’s a second thing that I failed to catch back then and that was that 2/3s of the people, 3 quarters of the people in the world live in 3^rd world countries. Where if they want to save, if they want to produce more then they consume and save the difference, you’ve got to save ridiculous things like Zambian Quatches and Argentine Pesos and ridiculous fiats currencies like that. And when they save them, they’re all inflated badly and they’re worthless outside of their home country. But if they save in Bitcoin, its got the same value everywhere in the world, so this is a very big deal. So, I’ve become a convert, cautiously because it is bubbly. Anything that’s gone up 300 times in a few years kind of looks bubbly, but I can see why the bubble going to get a lot bigger. So, the answer to your question, I mean I was a recent investor in something called Hive blockchain which is about the only publicly traded company that mines these cryptocurrencies, this thing’s gone from $.30 to $30 in the last six weeks, I expect it’s going higher. So, it’s a bubble, but it’s going to get to be a bigger bubble, Richard.

FRA: And so, the value you see is being based on the payment transfer utility, but also you sort of referencing as a store of value as well?

Doug Casey: Yes, especially for people in the third world, two-thirds of the human race which don’t really have the opportunity to bank, not that the banks in those third world countries, Africa, Central Asia, places like that, are worth saving in. They’re all insolvent and the local currencies are horrible so this is a boon for the average guy in the third world, this is a very big deal. So, this is the two things, transfer device and a savings device for third world people. Now I don’t know how it’s going to end because eventually there’ll be a Bitcoin version 2.0 and what happens to version 1.0? Does anybody want it? Is everybody going to dump it all of a sudden? So, there’s risks, there’s dangers here. But right now, the trend is still up, the bubble is going to get bigger. In principle, it’s an excellent idea. And its also, I’ve got to point out, it’s going to draw peoples attention to the nature of money. Which people don’t think about, they only thing they’ve got their local currency or the dollar. But then they see oh, Bitcoin, why is Bitcoin worth something? And eventually, it’s going to grow their attention to gold because eventually there’s going to be one of these cryptocurrencies that will become very popular that launches instantaneously going to gold to silver and so forth. So, it’s going to expose a lot of flaws in the current monetary system, it’s good from every point of view.

FRA: Do you see governments getting into cryptocurrencies perhaps as a way of doing away with cash or implanting negative interest rate policies for example?

Doug Casey: Oh yeah, unquestionably that’s going to happen. It’s happening now, all these governments want to get rid of cash. Cash is only paper but at least paper cash allows you privacy, secrecy, it lets you transfer things and own things that are unbeknownst to the authorities. So, they’re trying to get rid of cash, they’re trying to get rid of the U.S. $100 bill, they’re getting rid of the €500 note, they want to get rid of even the U.S. $50, the U.S. $20. So, they’re going to come out, and some governments have come out already with their own digital currencies. And it’s a disaster when governments do that because they will manipulate them and inflate them but worse than that, they’ll know where everything you have is, everything you buy and sell, they’ll know absolutely everything about you financially. And they will control you totally, they can just shut off your iPhone and you’ve got nothing. So as wonderful as cryptocurrencies are when the government gets a hold of them they’ll corrupt and destroy them like everything else, so it’s a huge danger also.

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

Doug Casey: Well, they can go to www.internationalman.com, that’s one website. And the other website is www.internationalman.com they’re both totally different with different products, we have lots of excellent free articles posted on them and so forth, they’re good websites. So, people should check in there and send me a note if you’ve got any reactions or whatever at either of those websites.

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

Doug Casey: Well, thank you, Richard. And I hope that a few listeners decide to go out and pick up a copy of Drug Lord

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

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FRA: Hi ― Welcome to FRA’s Roundtable Insight ….. Today we have Yra Harris and John Browne. Yra is an independent trader, a successful hedge fund manager, a global macroeconomic consultant trading foreign currencies, bonds commodities and equities for over 40 years. He was the CME Group Director from 1997-2003. John is the Senior Market Strategist for Euro Pacific Capital, 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 adviser to the British government on issues relating to geopolitical matters. He has worked at Morgan Stanley as an investment banker also working for other firms such as Barclays Bank and Citigroup. Welcome gentlemen.

JOHN BROWNE: Thank you very much Richard. Hello and to Yra too.

YRA HARRIS: Yeah John, hello to you and thanks Richard for having us and putting us together.

FRA: I thought we’d begin with a discussion on the Chinese oil contract. And just a general theme for today’s discussion are undercurrents geopolitically that are happening which could have implications in factors on the financial markets and the economy. Yra you have recently written on this new crude oil futures contract that is priced in Yuan and is convertible to gold. You wrote, “China’s ability to monetize gold is a direct assault on the US ability to manipulate the global financial system to it’s advantage ― A remnant of the Bretton Woods post-World War II global system.” Any thoughts on that?

YRA HARRIS: Well, as we’ve had the breakdown of the system this is all part of what’s taking place. People who don’t want to admit to themselves that there are major changes afoot. We see what China is doing and I’m not making a qualitative judgment one way or another, that’s just history. I just finished reading a book by Giovanni Arrighi, who people might find that he’s on the left, but in the 20^th century there are changes going on, and there’s always changes going on in the international system. The United States is seeing itself diminished as the global hegemon. These things are taking place and the Chinese are very astute global watchers. We’ve talked about this before last time that when NAFTA started on January 1^st, 1994, China devalued the Yuan from 5.8 to 8.7, where they held it for a long time after that, but that was a 50% devaluation. The Chinese are very astute watchers of the world situation and this is just more of that.

FRA: And John you have also written about the same subject about huge ramifications and a move with little notice outside of the financial world.

JOHN BROWNE: Yes, and interesting enough China is now the largest consumer of oil in the world and it’s two largest suppliers are Saudi Arabia and Russia. Just that fact alone is quite interesting when you think of the Saudi visit to Russia. But what recently happened, and it’s amazing it missed most of the financial media, China created a domestic oil contract that would be traded internationally in Yuan, and that Yuan would be convertible for gold. In other words, people that receive Yuan for their oil like Saudi Arabia or Russia or any other country that sells them oil, maybe even Britain, will be paid in Yuan, not dollars. This is the crucial thing because what Yra referred to after Bretton Woods was that the dollar became the reserve currency and most commodities in the world had to priced in dollars. If you were a German you would have to buy dollars in order to buy pork bellies in the Chicago exchange. What was most interesting is that in the early 1970’s when the oil crisis happened, Dr. Kissinger flew into Saudi Arabia and managed to persuade the Saudis to persuade the rest of OPEC to only sell oil for dollars. In other words, no longer would sterling be any good or any other currencies to buy oil ― Their oil was only to be sold in dollars. That underpinned the U.S. dollar and enabled the enormous expansion of dollar liquidity once Nixon had broken the gold window in August of 1971 and underpinned it. Now this is a very interesting thing here because now Saudi Arabia has stopped using dollars and other countries have stopped using dollars, particularly China. Say Saudi Arabia sells oil for Yuan to be paid rather than for dollars, and it can convert those Yuan into gold. That’s very attractive for all oil exporters to be exporting to China for it’s currency because unlike dollars, it’s convertible into gold. This strikes exactly to what Yra was saying, the hegemony of the United States and the power that it was in 1944 with Bretton Woods, it was by far the most powerful economy in the world and the richest country, and then by 1945 it was the most powerful military nation on Earth, and it has traded on that ever since. If you look at the depreciation of the dollar since 1914 when the federal reserve opened it’s doors, the dollar has depreciated by 90% or more. In other words, 2 cents of that dollar would buy you a present day dollar. And sterling has been even worse because there were 8 dollars to the sterling pound in those days, now it’s 1.2. So you can see that sterling has virtually been depreciated over 99%, and yet nobody has noticed it because all of the other currencies depreciated too, or most of them, because they have all been valued in dollars and not in gold. That particularity happened after 1971 and that’s when the real scam took place. Today we’re left with a world of seeming wealth, but really it’s just huge liquidity. There are dollars swimming everywhere hence these stock markets are rising ― People got to put them to work. You’ve got negative real interest rates, the interest rate in the U.S. is about 1.5% and the inflation rate is just over 2%. So there’s a negative interest rate in the United States as well. And we’ve reached ridiculous things where people are finding somewhere to put their money, even into junk bonds. In 2009, a European junk bond traded at 25% yield, today it yields less than a 10-year U.S. treasury bill ― It’s 2.2% as opposed to 2.3%. That can’t go on, I mean it just doesn’t make sense, and it’s a vast, vast bubble. I think Trump has done a wonderful job on trying to drain this swamp, but when he was in Puerto Rico he said he may wipe out Puerto Rican debt. If he wipes out Puerto Rican debt, and we have great sympathy for these poor people who have been cheated by their local government, if that happens then people will say, “What about Illinois? What about California? What about New York?” is the government going to wipe their debts? Eventually if you extend that argument further, what about America? Maybe a president comes in here and says we’ll wipe out the debt. So you start to get a real beginning of a fear as to whether I should start buying dollars and U.S. debt. That is the beginning of the pricking of this vast balloon, in my opinion.

FRA: Yra, any thoughts on that?

YRA HARRIS: I agree with everything that John has said. When you look at the European high yield index that yields less than 10-year U.S. treasuries, considered to be the safest debt in the world. If you don’t think you have a problem then you must be a central banker. This is an enormous problem and of course the world march is on, but so be it, that’s the way markets work. I think we can all agree that central banks have broken the signaling mechanism of what bond markets are supposed to do, so where they would be offering us warning signals, they can’t, because you cannot overcome the power of their printing press. They can print and print and we know that money in a world in which capital flows freely, all money is fungible, there is nothing to stop it. When you buy 60 billion a month in Europe, that money goes somewhere, it goes to buy other assets and so they’re buying all types of bonds. So we don’t have a market price and we know that the biggest fear for the central banks is for the market to take over the pricing mechanism because then it would reflect some sense of reality. As long as the central banks control we won’t have that sense of reality. That’s just the world that we live in and I think John is a 100% right, especially in what the Chinese want to do here. This is not a mistake and I want to see what their next move is. It’s interesting that Russia came out the other day and they are creating their own Ruble cryptocurrency. Ultimately, if there are these electronic medium of exchange, what we call currency, it will be controlled by the governments. They will not let this out of their control. One of the main things in the U.S. constitution is the government’s ability for currency and coinage, so they will lose control of it. But when we really look at it, and I think this is where John goes, because if we go back to 1960’s when Jacques Rueff was writing The Monetary Sin of the West and he was calling it, “the question”, because what we had was not a gold standard, we had a gold exchange standard. The United States was willing to exchange gold for currencies until the Vietnam War and the war on poverty began, and then there was just too much currency to exchange, so Nixon said that they were going to kill us here and we got to get off this standard. It’s the same thing if you look at Bitcoin. Bitcoin is nothing but a dollar exchange standard because it’s not like someone created Bitcoin out of nothing. If you are buying Bitcoins you are exchanging some underlined value. You might be exchanging gold, but most of the time you are exchanging dollars for those Bitcoins because they are always valued in dollars. The Chinese are really going to try hard to take us away from that. I think John wrote an important article about what China is doing and that we have to be very attentive to it.

JOHN BROWNE: What Yra said I think is so interesting because what we’ve got is an illusion of wealth and unreality. Governments and central banks have just created this incredible unreality and I mentioned those differences in yields, are just beyond belief. But the thing is when we go back to the gold standard we had before, there was real money because of the gold standard, before the first World War. What I find fascinating is that it had a rule of law within money, but it translated into national rule of law. There were very few wars when international currency came in based on gold and it was only when we broke from gold that we suddenly unleashed huge amounts of unrest and irregularity and the breaking of the law. The law is broken by the government all the time. Just look at the illegal immigration and the new secret funding of Obamacare ― illicit and unconstitutional, but it’s still accepted by all these rhino politicians who are corrupt. Populations are getting violent and very depressed and angry with each other ― It’s a great shame. I think it’s because we live in a world of unreality. Yra mentioned cryptocurrencies, of course this is a fantastic thing. A Bitcoin plus it’s blockchain methodology is an offer to clear the financial swamp. President Trump is trying to clear a political swamp in America, but a financial swamp is almost more severe. It offers the individual freedom from government, instant transactions at no cost and a tremendous degree of anonymity. I think it’s a fantastic revolution that’s taking place and that’s Bitcoin which of course is becoming the reserve cryptocurrency of the roughly 1200 cryptocurrencies. They all translate or measure against Bitcoin and Bitcoin is measured in dollars at the moment and the blockchain technology behind it is going to challenge governments and major corporations on how they do business. It is going to, in my view, almost redefine capitalism because it’s going to be a completely new way of doing it. The devoid of regulations where there is so much more freedom for the individual and I think we’re heading to a time of phenomenal change in the financial world because of blockchain. All the big financiers including: Jamie Dimon, who I like and is a tremendous guy, are all decrying Bitcoin because it is such a threat to the financial system that we’ve got now which is so expensive. They used to do everything for free, but they they are charging for everything, even wiring they are charging $15 to wire money. Is it just staggering when it’s all digital stuff I doubt it costs even 15 cents. So all of these things are going to change, in my view, if you just imagine 1850 compared to 1950, who could’ve imagined electricity and machine guns and all this sort of stuff ― It was fantastic. I think we are going to experience that in the next few years that one of the leading things is going to be the technology behind Bitcoin, the block chain, that it’s going to transform the world. It’s going to really face these big corporations, not just governments, on their whole business models. You think the internet was bad enough for brick-and-mortar companies, blockchain is phase 2 of the internet and it’s going to be an even bigger challenge for commerce and the whole of capitalism. So I think that we’re going to see a reversal and a technological draining of the financial swamp. It has huge implications for Wall Street, the city of London and every other financial centre because if I come along and I dial up Germany.com and I deposit $10,000 into an account that I’ve opened and they do due diligence, takes a few days to open the account where the check you out, know your customer, they do all that by regulation to avoid money laundering, I put the $10,000 in and convert it to Bitcoin and that money has come out of the banking system. No longer is it in deposit and leveraged up to make loans ― It’s gone. To the banking system it is dead money. At the beginning it was difficult to get into Bitcoin, but it’s getting very simple now, and if you don’t leave the money on the Bitcoin exchange and put it in your wallet then it is entirely secure. You have remember your password or it vanishes. The thing is it is going to change and the thing it’s going to do is create dead money in the banking system, in other words, taking deposits out of the banks and they’re going to be really strapped. I think Bitcoin is a majoy economic threat to bursting the balloon and then Bitcoin would rise phenomenally if money collapses. The only way you can get into cryptocurrency is through Bitcoin. None of the other currencies accept fiat money. You can put fiat money into Bitcoin and then Bitcoin into the other cryptocurrencies. This is going to siphon money out of the banking system, it’s going to siphon money that people think is real money. The combination of Bitcoin and gold, where the Bitcoin being much more mobile and easily moved around the world at no cost is a thing that I see of the future resulting from the swindle that people have been had by their governments and the banking system ― And that could prick the balloon.

FRA: Speaking of the move away from dollars, we talked about the Chinese, do you think the Russians may move away from accepting dollars for oil?

JOHN BROWNE: They already have done deals with China. That was a ridiculous thing about forcing the Russians which Obama did over the Crimea. Instead of seeing that the Crimea was to Russia as Cuba was to the United States under Kennedy, when Khrushchev put his missiles underneath the soft belly of America next to Florida Kennedy had to get them out even if it meant going to nuclear war. He simply couldn’t accept missiles sitting that close with such a short time fuse to get into the United States, he couldn’t accept it. He had to get it back and luckily Khrushchev realized that and climbed down as America removed their missiles from Turkey. Obama and Kerry hadn’t read their history because they didn’t see that Crimea and the Ukraine was a similar thing for Russia. And instead of accepting it and finding some weasel words typical of politicians to get over this problem, they forced Russia out and into the hands of the Chinese where we’ve spent ages trying to lead them away from the Chinese. Now Russia makes no bones about being awkward with us and one of the things they’ve done is tied up huge deals with China in their mutual currencies avoiding the U.S. dollar ― So they’re out. One of the things to break America is very interesting, we’ve piled up huge amounts of money in military systems, but maybe the Achilles heel of the western world is its money and not it’s forces because if China and Russia could break the dollar, it would smash America without firing a shot. The great generals are the ones who win without actually fighting. Just like in chess you threaten the king with a checkmate, you don’t’ even have to take him because he can’t move. That’s the game is to win with the minimum amount of fighting and the Chinese could be doing that by etching out our fiat currencies. When we’re talking trillions, I mean even a billion is enough to get your head around. I’ve seen a football crowd at Wembley stadium of 100,000 and that’s a huge number, a billion is way out of my comprehension. I went to a funeral in South Korea and there was said to be a million people at the funeral and even then you couldn’t see the size of the crowd, you can’t see a million. A trillion seconds ago was 31,500 years ago. The American government owes 20 trillion in direct debt and another trillion in unfunded liabilities and guarantees. These are staggering figures and people have no comprehension. It’s the big game of bluff that is run by the governments and the central bank ― Ordinary people have no idea. And if that bubble was to burst, the abject poverty that is to be reaped upon everyone as search, as to what Yra said right at the beginning, as the search for real value is way below these prices in almost everything. And we said what we’re trying to do next after oil, what about copper? Probably the most widely used natural resource in the world, other than water, for raw materials is probably copper. If they’ve done it for oil with this instrument then why not do the same thing for copper if the oil one is successful and then gradually spread it around. Who would be buying dollars to buy any commodities? You’d kill the dollar and with the dollar you’d kill the United States.

FRA: And Yra, what are your thoughts on the Russians moving away from accepting dollars for oil, the potential for that. You recently pointed out the Saudi King’s first ever visit to Russia.

YRA HARRIS: John talked about that, he eluded to it. These are major events. These are far more important than any of these Trump tweets. The Saudi King going to Russia for the first time ever ― That’s an enormous event, that a signaling event. When John talks about the Obama thing, they had no idea what was going on. Go read probably the best book on political science, Graham Allison’s The Essence of Decision, and you’d understand first of all everything that is going down in Washington because it’s the greatest study of bureaucratic politics and it’s acknowledged as that. This is all that is going on and Obama and Kerry dropped the ball because the Russians are never going to give up the Crimea. Why is Guantanamo Bay in Cuba? Why does the United States still have a naval base in Cuba? Because Cuba protects New Orleans and New Orleans is the grain-shipping capital of the world. Cuba protects the entire Gulf of Mexico which is huge for oil and food just like Crimea. Why did the Russians always want a base in Crimea? Because it allows it to either threaten or protect. Forget Turkey, if the Russians want to shut that down they can shut that down and that’s why you’re not going to move them out of Crimea. When people look at a map, so much of this becomes logic. The Russians learned a lot from Obama. They red-lined and they saw all the weaknesses and all of the apologies, so they just kept moving in and moving in. When the ambassador of Ukraine was trying to insight Putin with the whole revolution, Putin played that exactly right. Then John McCain, the idiot, sorry John I used to respect you, but when you want to give the Ukrainians advanced weaponry you are setting them up for massacre because Putin was waiting for that to happen. So things have quieted in the Ukraine because the Russians have the eastern part and they have their people in and it will work itself through, but the world is fascinating with all these things with the oil. The Russians are going to squeeze this too which is why they are working with the Saudis and the Saudis are in need of the Russians now that Russia is in control of Syria. What the Saudis fear most is the Shia crescent that extends out of Iran across Iraq into Lebanon. They know now that the Russians are the key players here, not the United States. As soon as the Russians took back that naval base in Syria it was a major game changer. John Kerry was ridiculous ― They had no plan and they got totally blindsided by the events that unfolded. We’ll see what John says about this, but the greatest wild card in the game for the Russians is Gerhard Schroeder. He has an enormous position now. Before it was just the pipelines, but now they’ve actually brought him in to Rosneft as a major director, are you kidding me? This guy was a chancellor. This would be like George W. Bush serving on the the board of Gazprom. There are things afoot here that are so big that nobody is paying attention to them and they will unfold. What’s going to be the market dynamic? I don’t know, but I know these things are in motion and we have to be very attune to them.

JOHN BROWNE: Yes, that Gerhard Schroeder thing is fascinating because obviously Russia and Germany have always had a huge trade and when the sanctions came on organized by Obama, the United States did less than a fifth of the amount of dollar volume trade with Russia than Germany did and so it hurt Germany far more. That threatened to break NATO because the Germans didn’t want to go ahead with these sanctions. That was a threat to NATO and a slit to NATO would’ve been very, very bad, but it risked it and eventually Merkel obeyed what Obama and Kerry had wanted, but it was a dangerous time and the Gerhard Schroeder thing illustrates this great weakness. I am appalled when I think the government here is focused on trying to fix a Russian assassination on the president and meddling around in these silly, unbelievable investigations of people while the big crooks go and these huge events are happening in the world and nothing seems to be done. But I think people are getting really fed up and they’re sick of being financially swindled by their governments and seeing their living standards fall. When I first came to Wall Street in 1969, most people had one family breadwinner, now both parents have to work to have a living wage and yet this huge illusion of wealth is there. Really the ordinary people are being squeezed to death. I think that they are getting fed up with that and also with their governments doing things that people now, thanks especially to the internet, are seeing things happening in the world which are totally against their interests and the government are doing it. It started with a big rebellion in Britain with Brexit, then with the election of President Trump, the people spoke and the financial elite were absolutely staggered that he won as they were staggered by the victory of Brexit. Now you see Catalonia wanting to leave in Spain, you saw the same sort of problem in Greece, in Italy, then in the German elections with the huge movement of right from 0 to 88 seats. They were saying that they were never going to get 1 seat, but they got 88 seats and now you see in Austria the similar sort of thing. The people are speaking and they are very, very fed up with their governments and I believe as I went back to that gold story when you dilute and you create turmoil with the money system it eventually spread to the political system where we had gold that is law and order within money and when that vanished, the law and order in the streets broke down. It has now reached a fever pitch and people have to live on the streets, I mean our leaders live in limousines and chauffeur-driven cars with police escorts and everything else, ordinary people have to live with their children going to school down streets that are dangerous. They are beginning to speak and I think all of these things are beginning to reach a crescendo which is extremely worrying.

FRA: Yra, you have written about the Sunday election in Austria as well, just wondering about your thoughts on that. You also mentioned financial repression will be the next theme for the European ripe.

YRA HARRIS: There’s no question and I know John will agree. The media and the established elites, whatever that means, it exists and I call it the DAVOS crowd who meet amongst themselves and claim their own self-importance, they want to make it into anti-immigration, but it’s so much more than that if you pay attention. I mean, today the German court basically sided with what the ECB has been doing up to a point, but this isn’t going to stay that way forever because they were all economists and yes, they got sidetracked because Merkel made that terrible decision about open immigration, but there are things that are going to re-rise because they are not going to back off of this. If the FDP is brought in and Linda gets the financial ministership, this is going to be a continuing issue because German citizens are paying, by design, the entire bailout of Europe. Right now because the world has enough growth, they are able to smooth it over, but that’s not going to last long either. Japan was able to go through a terrible period of non-growth or very low growth, but a lot of that is because the rest of the world is expanding. That alleviated a lot of the problems. Japan had more problems, of course, when the world went into a major repression in 2008/2009. Ben Hunt writes about it continuously: it’s a narrative. Do I accept the narrative of the mainstream? And it’s not that I’m a fanatic, I’m not, but I read everything that I can because I need to in order to prosper in what I do. I don’t accept that narrative because there are underlining things that are far more powerful going on and it’s outside of the narrative that they want to concoct as the way the world is ― It’s just not so. There is so much disruption going on and now we have the Chinese with the 5 year meeting and of course you have the Japanese elections. The Austrian elections were very important because, as John was talking about with the rise of the right there, this is the second time. The first time was back when the Euro was coming to existence and the Austrian people were not enamored with it. It’s harder to shun people now because you got the Catalans, you’ve got Brexit, you’ve got Poland whose not very happy with the way things are, you have other eastern members of the EU who are not very happy. There is a lot of underlined unhappiness and Merkel is right now in a very wounded position. The only thing that would salvage her would be if she created another coalition with the SPD. But the SPD, who just won an election that they weren’t suppose to do very well in, has no desire and they’ve said that. They do better as an out party than they do as a part of a coalition so Merkel is in a very precarious situation here. This will be interesting to watch.

FRA: John, your final thoughts?

JOHN BROWNE: Just listening to Yra I agree with everything he has said. What I see happening now is what I’ve said before. I think my summary feeling is that we have this illusion of wealth and we’ve built this massive bubble thanks to the Fed and the other central banks that have followed suit ― Absolutely gigantic, trillions of dollars of hot air. If that was to go, the higher the balloon goes, the more devastating the fall and we are really high up at the moment with the 23,000 stock market and everything. I think it’s shocking the way people have been treated and what’s really worrying is that people are beginning to act. And if the balloon is pricked because their actions on the street, and they get politicians who really will prick the balloon, it’s going to be a very nasty financial situation.

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

YRA HARRIS: Notes From Underground is available if you go to YraHarris.com. You can subscribe to it and it costs nothing. You can find me there and there’s a lot of dialogue that goes on.

FRA: And John?

JOHN BROWNE: I write for Euro Pacific Capital on the internet which is EuroPac.net. My articles are on there together along with Peter Schiff on the front page. That’s probably the best way other than lectures that I give every now and again and of course your wonderful podcast.

FRA: Great! Thank you very much gentlemen for being on the show.

Transcript written 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: 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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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.

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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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. 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>

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