Download the Podcast in MP3 Here

FRA: Hi welcome to FRA’s Roundtable Insight .. Today we have Nomi Prins and Yra Harris. Nomi has worked on Wall Street as a managing director at Goldman Sachs and ran the international analytics group as a senior managing director at [Bear Stearns] in London before becoming an author. Now a journalists, public speaker and media commentator, she’s the author of 6 books. Her writing has been featured in the New York Times, Forbes, Fortune, The Guardian and The Nation among others. Yra as an independent trader, a successful hedge fund manager, global macro consultants training, foreign currencies, bonds, commodities and equities for over 40 years. He was also CME director from 1997 to 2003. Welcome Nomi and Yra.
NOMI: Thank you very much.
YRA: Thanks Richard.
FRA: Well Nomi is coming out with a new book to be released on May 1st. It’s titled Collusion: How Central Bankers Rigged the World. She focuses on five area, Mexico Brazil china japan and Europe and she’s actually scoured the world to write this. Visiting Mexico city, Guadalajara, Monterrey, Rio de Janeiro, Sao Paulo, Brasilia, Porto Alegre, Beijing shanghai, Tokyo, London, berlin and other cities throughout the united states. That’s a lot of traveling Nomi.
NOMI: That sounded like a lot of travelling when you said it Richard. Yes that happened.
FRA: Is that how it came about? Was it through these struggles that you gained this insight how did you get this inside also through your work?
NOMI: The insight itself yes it came from traveling on the ground and that was a result of really watching what happens since the financial crisis in terms of what the federal reserve has done and what other major central banks have done that we know about publicly in terms of advocating and creating and manifesting … Money policy as well as a quantitative easing or asset purchasing policy. It’s asset purchasing of bonds in the US, it’s the ETFs in japan, it’s corporate bonds in Europe are effectively a collaborative process that really had different effects for the major countries versus the more developing countries and also even as it was coming about in the wake of the financial crisis, had a lot of worries and criticisms been brought up about it. What I wanted to do is discover how those words and criticisms impacts on more of the developing countries. We’re part of the results of the Federal Reserve ECB Bank of Japan process of this particular policy. It was a combination of seeing what was going on and wanting to feel it and examine it and research it from the levels of those countries.
FRA: Is this collusion more of a hand off of a baton for example between central banks or is it actually central bank that are more in close coordination with each other?
NOMI: The main central bank that coordinated in the wake of the financial crisis and even before it became public knowledge in the fall of 2008. This was going on in the beginning of 2007 and throughout 2007 is that they worked together to for example have a lot of dollars in the market , in the central bank reserves system to be available in the case of a crisis. They kind of knew in advance what could be happening but to the public of course a particular federal reserve did this through Ben Bernanke. The face was, we’ve got this, there’s no housing crisis, nothing bad is going to happen, everything is fine. In reality central banks the major ones the G7 ones were already starting to work together to mitigate any potential liquidity or money crises that could result from any financial implosions. That was already going on but then once the financial crisis was in a bit of full mode in the fall of 2008 and the spring of 2009 those conversations became much more frequent, the types of coordinated policies amongst these banks became more frequent, the amounts of them more epic in terms of what was swapped between central banks. Like I’ll give you dollars you give Euros and so forth throughout the process to create a global tranquility on the outside that was really fabricated by these central banks. As the years went on different types of timing periods were used to sort of catalyze this type of collusion or group collaboration again. For example in 2012 when there was a more pronounced credit crisis in Europe and so far and it goes on to this day. If the fed raises rates a bit and it hampers the stock markets and all of a sudden there’s a lot of chaos or turbulence and the European central bank as adjusted will step up and say, “We’re are not touching our rates, our rates are good low where they are. We’re going to continue with our quantitative easing or a corporate buy in process so don’t worry.” That’s where the global collusion comes and of course if you’re outside of this main group of these central banks, you’re either acting with them or against them depending on what you need to do for the domestic situation in your own country. For example Brazil when it has high inflation had to do different managers relative to what the fed was doing but that also hurt it politically? A lot of different pools and studs came in that developed countries throughout this process.
FRA: Yra have you seen similar behavior between the central bucks from your observations?
YRA: Are you throwing fuel on my fire on what didn’t know. How do I know? (unintelligible) We’ve known each other 3 or 4 years but I’ve been discussing this with (unintelligible) for years. Nomi can I just ask you a question? Are you familiar with Bernard Connolly?
NOMI: I’m not. It sounds like I should be.
YRA: You ought to be yes. If you’ll give Richard (unintelligible) I’ll send you (unintelligible) We’ll talk about it later but Bernard Connolly who was at AIG London (unintelligible) He wrote a book called The Rotten Heart of Europe. Written in 1995.
NOMI: Wow, okay.
YRA: Everything that has happened. But because he was on the original group that put together the euro currency so what he saw behind the scenes is similar with what you’re discussing. I’ve come to call him a good friend. We talk. He’s kind of disappeared now for a while but he just needed to rest I think. I can’t wait to read your book but Richard you know that answer. The central banks have, as would I would say what’s going on in Europe especially. We saw with droggy this morning that press conference is one of the greatest acts of (unintelligible) Visitation I’ve seen since David Copperfield. He can dance it but you could see it in Europe, there’s basically been a coup d’état in which the ECB is running its monetary and fiscal policy. You can’t escape it and therefore they are all in this and tonight of course will hear from [Kuroda]. Not that they’ll be any change especially with the political problems of Prime Minister Abbey. It’s such a strong word. I’m not used to hearing the word collusion and it’s interesting that you use that word. I always shy away from it because if I can’t prove a conspiracy then I lose some of my credibility so I don’t like (unintelligible) But I love that you do use that word because I do think it is that. It makes me ask you the question Nomi right back to you and do you have some thoughts on the G30?
NOMI: I do and just to maybe circle back to the wording that’s a really good point to bring up because I mean I also shy away in my research and everything I talk about from the idea of conspiracy because to me even though it has lots of different definitions, the implies definition is that it’s something done inside of a dark corner to other outside groups and therefore it’s not out in the light. To me all of this has been pretty public it’s just that nobody is really or a few people you have of course (unintelligible) A few people have connected the dots. The term collusion and of course it’s used now constantly with respect to the US or Russia and the us elections and trump and Putin and whatever might not be going on with that it’s become a constant word in the vernacular and so it’s come to take up on itself more meaning. I think the collusion, the coordination, the collaboration and its parts of all of those things amongst the major central banks definitely it’s not intentionally being negative definitely was the way of artificially creating a veneer in the financial markets and for the banking systems throughout the world and in particular the largest private banks that are codependent upon each other and upon the liquidity that central banks provide them and look to them. As they did in the crisis and continually for support. That is this manipulation of markets by this huge outside fabricated source of capital really does fall under the definition of collusion because it was done in concert and because their perception around what central banks want their behavior to be and the actuality of how artificial it has been for the financial community and markets are at odds with each other.
YRA: Yeah I think (unintelligible) Sorry Richard. I think that’s absolutely perfect. Let me add just 1 piece to that puzzle. This colluding group is absolutely at odds with thee BIS in so many ways. You can go back to Bill White’s work (unintelligible) And how the BIS is taking a different view. Actually two years ago I went to see (unintelligible) Speak in Chicago and I asked him point blank question because being that he (unintelligible) I said now that you’re at the BIS what’s your view on the zero risk waiting for all sovereign debt? I said I understand what you believed when you are at the bank of Spain but has your views changed? He turned right around and said that’s really a good question. Yes I have a different opinion of it. I thought it so clarified the things that you’re exactly talking about. This group is totally at odds with what they BIS is (unintelligible) They are supposed to be the banker’s banker.
NOMI: Right and the BIS as you know has a lot of reports out on this as well as statements that the collusive fabrication over money and the cheaper negative interest rates the major global economies has had a very negative effect on the rest of the world. It’s had the effect of raise in wealth and equality. By raising equity prices and infusing more debt into the world which at some point will need to be paid off. Because equity prices and other assets prices have risen and people who don’t have that same access to them as the wealthier classes and the participants in those markets get left behind. They borrow more money in order to keep themselves afloat. Then their debt burdens are higher but they’re not participating in the outside of quantitative using (unintelligible) And so forth so it creates these chasms for citizens within the age of the countries and as well as between countries amongst the world. What I find the most egregious at odds, to use your term is that for example the Federal Reserve, all 3 of those should have passed chairs. From Ben Bernanke who started it to Janet Yellen to currently Jerome Paul just do not see any problem in what they’ve done. Same thing with the bank of England. They’ll see inequality has risen but they’ll say inequality it rises for lots of different factors. Who can say it’s because of this massively accommodative monetary policy we’ve just imposed for the last 10 years. But the numbers say it. These individuals (unintelligible) As you mentioned, they don’t see that. They put words around their actions that indicate they’re doing this for the greater good and the main economy and GDP and all sorts of other things. But in reality this money goes to the main participants in the asset market and it has the effect of raising those prices and making certain things look really Rosy and positive and it doesn’t go into the main economy. It can’t. It is tied up on the books of these central banks, so how can it possibly go into the main economy?
YRA: Richard (unintelligible) So perfect. If we go back to Jacksonville 2010 when Bernanke laid out what he was going to do with this portfolio balance channel that’s exactly what it was about. You could see it in real time and yet people said no (unintelligible) I was tongue and cheek asked how is this going to trickledown economics? I’m following this through we’re not even going to get trickle down because there is no separate expenditure coming out of this. This is truly asset price inflation and who controls and owns the assets. (unintelligible) In his book basically it was written by Bernanke in …
FRA: And I mean it can we delve into some examples. Nomi, from your book on, like these areas Europe, Japan, China, Brazil, Mexico. Can we go into some of the details that you’ve provided in the book?
NOMI: For example Mexico with each other issues right now, there’s Canada with the united states relative to trade agreement conversations had this issue in the beginning of the financial crisis which words that its economy is doing pretty well and it really was having decent actual growth and actual growth and a decent amount of multiple forms of foreign investment and so forth and it’s not like wedges were perfect but there was a sense of balance to an extent in the few years before the financial crisis hit. Then all of a sudden you have the US. banking system going crazy on toxic assets and fraud and crime and imploding the entire system and its reaction from the fed and so forth. At the time Ortiz who was the head of the central bank in Mexico said I’ve seen this play out in 1994 with a peso crisis. Where these are external movement, there’s a crisis. The currency gets crash. Certain companies that are contingent on trade between various borders get hurt, they fire people, the economy suffers and so forth and he actually went up to Washington and had a meeting with Ben Bernanke. A meeting that isn’t in Ben Bernanke’s memoirs at all. But was covered by the Wall Street journal and they said you really need to do something to install confidence in general. Not within the banking system but from the banking system that’s just done all this outward into the main citizenry because otherwise these ramifications are going to have very long-term effects. Bernanke ignored him and he didn’t write about him and so forth. Ortiz go back and tries to create a policy at the central bank level where he’s critical of what’s going on in the United States. In terms of what they’re doing rates in terms of not restraining the banks that have just caused all of this chaos and as a result he doesn’t get re-nominated to the post of being a central bank leader. It’s taken over by …. Who has this persona outside of Mexico of being more a part of this elite group of central bankers and therefore able to play ball we them. Ortiz goes around the world in particular to US universities and so forth and talks and tries to warn people that these methods are going to ultimately create problems. In particular he’s concerned about regulating the banking system and the derivatives at the heart of the financial crisis going forward because he felt and it’s true that regulators like that central banks aren’t watching them. Which has been true, it is true and it continues and it looks like what the current set of appointees into the fed on what going on around the world will continues to be true. … He tries to basically keep rates to an extent higher in Mexico. They have to be anyway it’s more of an emerging country but not really follow their policies even though he has friends in Washington (unintelligible) rates even though he’s dropping them tight as he possibly can to score of inflationary problems like food prices and so forth that are going on in Mexico. That are going on Brazil and throughout Latin and Central America. As a result he ultimately does come to odds with his leadership there and with the United States and ultimately with president trump and so the critic came in. No he’s at the senior position at the BIS which as we’ve just pointed out before has a more realistic view of artificial fabrication of capital just for the financial markets of banks versus really caring about the ramification toward a real economy. This was a whole decade of a trajectory through these leaders, these two main leaders. No there’s none but two main leaders at the time of the central bank in Mexico that really tried to both keep their independence and also in different ways very different people critique the Fed and one got kicked out and is doing other things and one is at the BIS where again there’s more oven ability to just say what he thinks. That’s the kind of thing that’s happened. Meanwhile in Mexico there were a lot of problems because of our financial crisis in terms of their economy and now there’s other problems related to trade agreements and so forth but that’s really started with our financial crisis this time around.
YRA: Richard can I pick up here more?
FRA: Yeah, sure. Absolutely.
YRA: I love this conversation. It’s like meeting at Starbucks. Nomi let me ask you something. I have a reason for asking I’m not going to tell you why right now. Tell me where you fit the IMF into this colluding process?
NOMI: This is interesting because they are a mess now under (unintelligible) I think have a more (unintelligible) Is most similar to the BIS critique of this whole process. In fact I was at a conference at the Fed in the summer of 2015. They do an annual conference of the IMF, the Fed and the World Bank regulators. We all mean regulator … The regulatory bodies but the main people that are in charge of the regulation of these central bank. I spoke about this very topic, why the money that has been offered to the financial system haven’t made its way down into the main street arena for real. A very quick summary of my talk was I got up in front of them and I said well because you didn’t make them. You did make that money, you had no stipulations on the money that was given as to where it would or should go. As a result why would you even be asking that question? It was around (unintelligible) Janet Yellen they had spoken just before me of (unintelligible) And I had said everything was fine, we’ve passed the regulation in the United States. Some called out Frank under the Obama administration and they basically had the effect of beating down the bench most egregious risky practices and everything was going to be fine. Without addressing anything that the Fed had done and was still doing to provide capital to these and to the asset markets after that there was a luncheon. This is a long answer but I just want to set the stage here. There was a luncheon at which Christine Lagarde was there speaker. This was right after she was having a public media battle with Janet Yellen about not raising rates yet. They hadn’t yet this is the summer of 2015. Because it would negatively impact the emerging economies and countries that were going to be exposed to the dollar and into punitive way. They had borrowed money over these years because they are been under disadvantage because they kept their rates and had to keep their rates higher to fight inflation and other things in their own countries relative to the main countries keeping money down for their financial system. There’s a dislocation that all this debts has accumulated there but if the dollar were to go up because rates were to go up then all of their repayments that had to be done in dollars would be that much more expensive for corporations or for the governments in these emerging countries and that would have a negative effect on those countries. So that’s where she was coming from. Not that she was advocating quantitative easing but she was saying is if you’ve created this mess and you have to understand what the ramifications will be. She didn’t really come up with a solution as to how to do this in a better manner but she certainly warned that the other side could be potentially really dangerous. What you also did was spend a lot of time working with the leader of the people’s bank of china governor Zhou who is not there now he’s just been replaced or he’s just retired. But he had been a long-standing central bank leader and actually he and her had a very good relationship. One of the things that happened in the recent years is that the Chinese … the currency became part of the basket of currencies that the IMF has. The reason for that is I think the IMF was trying to find a way to diversify away from a essentially this us centric, European centric, Japan ancillary contingent because of what has happened over the last decade and to protect the world going forward. I think this whole decade has seen a big shift in the allegiances of the IMF under her. I’m not sure where that will go in the future but that seems to be what has happened.
YRA: I raised the issue because when they chose her of course (unintelligible) Pushed out and I actually had a letter published in the Financial Times suggesting that … Carson I know he was considered for that post but of course he fell back into them overhang. I thought that they should take Trevor Manuel from South Africa, and elevated him because I thought he probably is one of the best finance ministers I’ve ever seen. It’s time to elevate as you rightly talk about non-European non US. Yes I know that their money basically making up the IMF so that. When it’s your gold you get to make the golden rules. It was time to make that shift. I’m not a Lagarde fan I’m not an IMF fan I think that they have a very short … when it comes to certain things like. I’ll always be appalled that they stepped in, in the Greek situation. I have a sense as to why, that they stepped in. But they were just all wrong because if Greece is part of the EU, and the EU is a developed nation with lots of assets. What is the IMF sticking your nose in there for and I know the Chinese were not happy about it, as a lot of the people who work at the IMF at a higher level. Thought that that was a very bad decision. I think they’re going to come and move it after Laggard is gone. When this stuff a lot of gets played out, it will have proven to be a very poor decision. Thank you for answering that.

FRA: What about Japan … Sorry go ahead.

NOMI: This is a great conversation. I agree that there has to be. That was one of the things I noted in China. China chapter in the book is spending time with the heads of a major development bank and the whole idea of even having other consortiums, whether through trade alliances or the development bank alliances that have other countries outside of the main ones that created the IMF and the world bank and control most of the reserve currencies in the world to basically have something else where they have that strength. There’s been a lot of growth. That really doesn’t get covered. I don’t know what it’s like over there. It’s certainly doesn’t get covered in the US the extent to which non developed countries, non G7 or the outside parts of the G30 beyond that are actually working together to be established in a different way and have more power in the world economy.

YRA: It’s a good point. I’ve suggested in my blog for last eight, nine years. The only time the IMF is crying for more money that they suggest issue gold backed bonds and take their hold on gold that they should have and it’s always bothers me.

FRA: Right.

YRA: When real Keynesians will not … It’s just sitting there, and you can leverage it up. You’re from a banking background. I can take that gold and create all the trillion dollars of bond that people around the world who would like a little hard currency or some sense of security whose 20% backed by gold to the demand would be so great and the volume cost. Don’t come asking me for money, you’ve got plenty of money just put it to use.

FRA: I was going to ask on Japan. You have a section in the on Japan Nomi. What is the real story behind the Bank of Japan’s quantitative and qualitative using program which begun in 2013 augmented with a negative interest rate policy for large scale purchases of Japanese government bonds? You go into some detail on the real story behind such actions.

NOMI: Yes so what was going on of course Shinzo Abe the current leader of Japan was also instilling upon a Japan history. Abe economics. Effectively that was an element of stimulus that he brought in. He needed someone at the Bank of Japan that would mirror that, with the kind of policies that the Fed was doing. The Bank of Japan has been involved in dropping rates along this whole period of time, and in quantitative easing. In fact they invented quantitative easing to an extent back in 2001. They basically came on board when Kuroda who’s the current head of the Bank of Japan was selected to lead it. His philosophy was very much in keeping with the feds philosophy and in keeping with Abe’s philosophy that somehow, if there was just watch of capital made available by the central bank, and it could go wherever it needed to go in the economy or in corporations or in the case of the Bank of Japan the actually buy ETFs or exchange trader funds which are collections of basically stocks. Therefore helps elevate the stock market in Japan. This was going to create politically also positive environment for people in Japan to look to this leader and say he’s doing a great job for us. Japan of course has had a very flat economic situation for a long time and this has been a way to consider it stimulus both from a fiscal perspective and the monetary perspective. Even though technically central banks are supposed to … I don’t even know who said they were supposed to. There’s legal boundaries between us central bank and its government in certain countries. The reality is that central banks by virtue of being able to conduct this policies and impact an entire financial system of these countries, are not independent of governments. What Kuroda did was basically give Abe credibility and vice versa, instead of promoting two sets of policies that they could then spin as being positive for the country. There’s also a back story to that which is more relevant now in the age of heighten trade wars. Again I think trade wars or trade re-agreements have been happening very quickly throughout this decade. For Japan had a new agreement with Europe that was penciled not too long ago and forth. They’re also trying to position themselves towards those types of agreements that have more of a leadership role and not just a shadow role to the US and the global economy. By having a central bank that can very liberally conduct these monetary policy moves, it helps their elevation with counterpart as well. They have the capital to do things. That’s a benefit to their overall staff, see what you’ve done as it benefits Abe.

FRA: Go ahead, Yra you wanted to comment.

YRA: No I’m just … Nomi how do I not know you?

NOMI: Because I travel so much, we both travel so much we’re never the same place at the same time.

YRA: It’s amazing because I believe there are things covered in the same way too. In Japan has made a very good … My son it happen to be fluent in Japanese and covers Japan for this male group out of Washington. I have him do my translations for stuff … supposed to stay more in touch with me. I’ve been training for over 40 years, and the Japanese have always been trusted from a currency perspective. What we’ve seen and we can see it. If you go back to the IMF G20 communique in October of 2012 when the Yen really begins its decent from 76, 77, 78 Yen to the dollar to where we presently exist. That was done. You can read the communique because I actually go to blog on the … October 15^th 2012 because they’ve got the … from the IMF that was okay for them to lose the currency to weaken. That’s when Abe … As the democratic head of Japan who had a short run midway while that was placed again by the LDP and it all begins to fit into place. We’re going to see it tonight. The bank … The BOJ is(unintelligible). Now they’ve been very lucky, and I use that word as we might use the collude, they’ve been lucky. They’ve been very fortunate that world has had enough growth to carry them. Anybody who compares Japan to US … I don’t think that’s right, because Japan started from a different place anyway. They started with an enormous school of savings, when the whole stagnation period for over two decades has taken place. They had savings burn off, and number two they had the great luck … I won’t call that luck, but 97% of Japanese debt was owned by Japanese. During the inflationary period, they’re not being punished, they’re being rewarded. We’re speaking on the financial oppression authority podcast. They weren’t being financially repressed because of the deflationary cycle, but Japan they’re not in it anymore. Now they’ll be financially repressed because interest rates are so low. There’s low return on earnings, and now they’re really been … so how long they will be able to continue this. It’s interesting. I believe that Kuroda is a prisoner of this policy. He’s a prisoner of his own success, and I have no idea how they’re going to really make the way out of here.

NOMI: No I think that’s right, that’s probably why they’ve shifted. The one modification he’s made that the other central banks … The central bank has done, but is to buy stocks and that’s very much. Because they’ve gone so low to negative on rates, and they do have such a contain population and a better savings rate and all of that, just philosophy of how they save so forth. There’s nowhere really else to go, as there is nowhere else to go on the rest of the world. But because of this particular situation in Japan accept into the Japanese stock market which is also a very highly owned by the Japanese. The central bank is trying to push off some of the … Again this is politically motivated. To push off some of the problems that could arise when this population of people that really don’t invest outside of the country, have nowhere else to go. They’re helping to pop up the only game in town which is their stock market. That I think is the reason for the modification of quantitative easing relative to the Fed that doesn’t actually buy the stock market here. What the Fed does is it supplies all this cheap money and gives out all of this green lights to the private banks who then lend it out to the corporation and so forth and so buy their own stock. We’re looking at record of the stock by about … Here there’s a step removed whereas I think the central bank is more directly involved in the stock market.

YRA: (unintelligible) and qualitative.

FRA: Perhaps we can end with some examples on European. You have two chapters on that Nomi in the book and a lot of interaction battles between the European central bank and the German Bundesbank. [intelligible] as German chancellor, Wolfgang Schauble German finance minister, and of course droggy. Can you get some examples and insight on that?

NOMI: Sure, so those chapters are actually before droggy. I say before he was head of the European central bank when it was Jean Claude Touche that was during the time where I… I mentioned Greece was being absolutely punished for having been involved in allowing foreign investment into Greece effectively. Then being punished because of the overall decline in the economy and the fact that these bond holders wanted their money back and everyone from this European central bank to the Bundesbank as you mentioned to the IMF, anyone involved in Europe thought it was a really good idea to punish Greece by providing a bailout that really was an extraction of whatever wealth and assets values were left physically in Greece. That was where that problem came in and … came into that environment advocating that but also really advocating more quantitative easing to wash over everybody’s issues. And massively increase the balanced sheet books of European, central bank through that process. He had very strong relationships also with the US. He had come from Goldmans, he had been at the Bank of Italy, which was having a lot of problems. His fortuitous timing of leaving the Bank of Italy to run the European central bank got him out of that situation. As a result not just by his own, but what was going on at the time. From Greece to Italy to Portugal, Spain, all of these countries were being hurt by this new wash of money that was going into the major banks for example in Germany. What’s interesting is that, even though a lot of the money that was made available through the European central bank to the core countries and banks in Europe relative to the more south and eastern countries in Europe as it happened, had the benefit of helping the part of the German banking system that was private. At the same time the Bundesbank because it seeing, it’s getting this help, but it’s also saying that Germany is doing quite well from a growth perspective relative to all the rest of these debt ridden, problematic country. Germany is relative to the rest of Europe really enjoying a strong benefit in general. They do have some inflation, they do want to reduce the reliance and quantitative easing. They do have a fight that emerges between the Bundesbank and the European central bank. Because the European central bank is now all of a sudden setting policy for all Europe and the Bundesbank it’s like we don’t really adhere to that, because we think rate shouldn’t be this low, we actually think they should be higher and there is growth there, there is a inflation here people are doing fine. There’s been this constant fight again between Germany and the European central bank over monetary policy since droggy has been and he always was trouble and so forth because of that. They have a very different situation because they’re factioned in that way. Then you throw into that England, and the Brexit vote which was a direct result of people within the UK being are the people that voted for Brexit being concerned about all of the mess that was going on European … all sorts of other things rather than, their policies of these competing central bank who are ultimately helping their own banks relative to their own people. In England that was just seen on a ground level, and bank of England of course was doing the same policy within England, so quantitative easing, helping it’s a market and helping its banks while wages have been stagnant and so forth. There’s been a little fracture going on throughout Europe on which is manifested and how people low in their economic anxiety and so forth.

FRA: Thought on that? I know you’ve written a lot for the blog site. Yra, yeah.

YRA: First let me … This is my opinion going back to 2011 when droggy gets the nod because that was Sarkozy guessing Merkel. When they put her as the most influential person Europe on Time Magazine I broke into laughter. I was probably laughing for two days. There was no way the French were going to tolerate … who ought to have been the president of the ECB, because I think the Germans would have felt a lot more comfortable with a German at that helm. If you had to go down this path following the US, it be more comfortable. … Of course goes back to when I lost a lot of money in the early 90s thinking that they would break the … After they broke the British pound link to the Deutschmark that the French … Franc would be next. That they would have to go … People forget that … was the head of the Bank of France at the time. The Bank of France was raising overnight rates to spend the speculative tide to 100% for overnight borrowing. Because, in order to be short for French, you had to borrow. …as I would say was more German than the Germans, and you saw it in 2011 when he raised his interest rates twice in the middle of this great financial crisis going on. Because that was him I think really play … the Germans at the time. It was a grave message which of course we get droggy who ensured that France would never, never support a German at their helm. We’re going to see the battle play out again right now, because there’s going to be (unintelligible) I think the Germans are at the point especially the politics in Germany are heating up. Everybody says, well the … was another immigration. You know Richard, and don’t normally speak this. It has more to do with my mind, and take very close attention that German savers, and Germans are savers. They have the lowest home ownership rate … of any developed nation. It’s like 42 or 43%. Germans don’t traditionally borrow, they’re savers. There’s been nobody more financially repressed than the German citizens. I think that gets brushed away too quickly as to what the rising sentiment is in Germany. Merkel has phenomenally weakened. Even the … Can back her into corner in different ways. The rise of political angst in Germany is great. I would argue vehemently that there is much more to do … The fact that inflation Germany is let’s be kind and save 2% and they’re running this whole thing. The two year note in Germany right now is 55 basis, Negative 55 basis point. The people who are getting homes are German savers. You’ve not seen the rush of … is really under the underperform … because that’s what happened in 2000 when the Germans finally convinced (unintelligible) When the other stock market and then of course is a bad combo in tolerating the German market especially (unintelligible) They’ve been reticent so nobody has borne the grip of ECG policy more than the German savers and this is having great political ramifications.
NOMI: Yeah I totally agree with that. I totally agree. They are concerned and that’s where their politicians are arising and some of those areas are having the most impact because you can’t really save money on negative interest rates and so that’s another reason that they are at odds with the ultra-low rate policy of the European central banks.

FRA: Great I guess running out of time but the book is Collusion: How Central Bankers Rigged the World. New book by Nomi Prins. I guess additionally above that how can listeners learn more about your work Nomi?
NOMI: Well they’re welcome to come to my website which I try and update which is www.nomiPrins.com for anything that I might have knew. I’ll post you if I ever come out there but also just basically the book is available I think it’s on amazon.ca and also in different places.

FRA: Yra?
YRA: (unintelligible) Richard you can go to yrahrris.com and Notes From Underground which is my blog pops up I can initiate, you can subscribe to it for free. No advertising on it nothing just a lot of great directive that goes on between the readers over serious issues. As you know we have leadership all over the world so I hear from people who are boots on the ground when we tackle or some of these end I’m glad we did this because now I have to go search Nomi Prins and I’m going to arrange to send her a copy of Bernard Connelly’s book because the fact that Bill Shepard and I Printed 10,000 copies even back in 2013 when the book was out of print. Bernard actually wrote a new forward for … tries to do that to I have many books to spare. I think it’s the most important book. I will say that Nomi’s book is out now and this is an important read for people who felt afraid (unintelligible) Been doing this so I always add a little books of this nature because you need to understand this. These things don’t end well. I haven’t read Nomi’s book but I certainly will order it. I’m sure that’s what goes … They do not end well. It’s not like this is new in history. It’s been done before and it’s in fact the collusion I wanted to get into that if I have a minute of two. We know we talked about that central banks are really (unintelligible) They’re going to lose their independence where they’ve over shot their self-proclaimed mandates I will say we’re self-proclaimed. I know the US congress gave the Fed but I’d …. We’re coming to a very great reflection point that I blogged about the other day which was about everybody better go dust off their knowledge about the 1951 accord between the treasury and the Fed when the treasury forced the Feds prior to that to keep interest rates artificially low because of the huge amount of debt because of World War II. Then the Fed couldn’t take it anymore after inflation got out of hand and (unintelligible) Had to sit down and negotiate and accord. But we are coming to that going to this great inflection point because the fed is now being trapped by this because if interest rates are said to raise the cost of staining the US debt is going to rise and discretionary programs are going to have to be cut dramatically. Here we come.
FRA: Great it’s a nice little discussion based on history financial discussions end economic perspective thank you so much Nomi and Yra.
NOMI: Thank you so much.

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.

Download the Podcast

FRA:       Hi. Welcome to FRA’s RoundTable Insight .. Today we have Charles Hugh Smith. He is an author and leading global finance blogger and 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 oftwominds.com has logged over 55 million page views and number 7 on CNBC’s top alternative finance sites. Welcome, Charles!

Smith:   Thank you, Richard! Always a pleasure.

FRA:       I thought today that we’d talk about trade potential for developing trade wars. Where this could ultimately lead and what’s behind it. How have we gotten to this point? We see a lot of, not just in the U.S., but in international trade war issues. This week – Brazil accusing the European Union (EU) of instigating trade wars and threatens World Trade Organization complaint. So, it’s all over the globe now. You recently had a discussion with our co-founder, Gordon T. Long, and I’m just wondering if you can relate that in terms of how financial repression has caused the trade wars.

Smith:   Right! It’s a great topic, Richard, and I’m glad you brought up the issue with Brazil and the EU – showing that this is not just the issue between the U.S. and China which gets a lot of publicity but it is a global phenomenon. But the roots are global as well and at least one of the roots is financial repression which is the major central bank’s policies over the last nine years of recovery to drop interest rates to zero to buy risk assets, to push investors into risk assets and generate a lot of liquidity and credit. One of the results of that is corporations have had an easy time borrowing a lot of money and, of course, some of that have been spent on buying back their own shares and so on. There’s also been a great expansion of capacity, especially in emerging economies like China where the government is explicitly trying to create jobs. There’s been a huge amount of money poured in – generating more capacity. In other words, there are more factories, more production and more mines opening. So, the world is awash in most things. There is too much of everything because of this overcapacity. What that has led to in the private sector is the loss of pricing power. In other words, when there is an over-supply or over-capacity, then you can’t really charge enough to make a good profit. Then, the corporations with global exposure, have to start cutting costs. We’ve seen this lead into sort of an endless cycle where they first offshore production, then they offshore back office, then they slash and burn their payroll and then they move from salary to employees to contract labor. There are all these ways of cutting but eventually, you get through the fat to the meat. Then pretty soon you’re cutting the bone, right? Then you end up with zombie corporations which are still producing and are only surviving because they keep borrowing. In China, that’s the whole model of things. This thing so called SOEs (State Owned Enterprises) which they lose money. The state understands they lose money and they just keep borrowing money so they can keep their payroll. Outside of that sort of government subsidy, it creates a world in which nobody can have enough money to justify their evaluations. So, the national governments start turning to trade wars as a way of getting back pricing power and limiting the over capacity and over supply that’s crushing their domestic economies.

FRA:       Do you think that the trade wars could be implemented by tariffs or by global competitive currency devaluations?

Smith:   That’s a great question, Richard. Because part of what makes every discussion of trade so complicated is because different currencies are the sort of foundation of trade. If a currency is greatly devalued, then those products are cheaper for other buyers and other currencies. If a currency gains in relative value, then that nation’s export becomes expensive and their exports suffer. They talk about competitive devaluation, right? And that’s the policy in which everybody tries to weaken their currency but it’s a zero sum game. We can’t all weaken our currency, right? It’s like if one currency loses its value, it’s against a basket of other currencies. There is some question as to whether that’s really going to work. In other words, if you’re the only country that’s devaluing your currency and everybody else is stable, then you can get away with that and gain an advantage. But if everyone else is starting to play the game, then where would that lead? It’s not really a solution.

FRA:       Let’s dwell a little bit more in detail about the U.S. and the U.S. trade deficit. You’ve graciously provided a number of slides. If you can go through those and provide insight on each?

Smith:   Yeah! Another thing that I find fascinating in trade is that it ties in the global trade economy. We talked about financial repression in central bank policies and how that influences it and how currencies influence trade. In terms of tariffs, I think it is important to mention that many countries such as Japan protect their domestic industries without using tariffs. They just simply use bureaucratic mazes and motes. For example, if you’re going to export something to Japan, you have go through a bunch of different hoops with various ministries and the ministries, of course, are well trained to find some reason to put your application aside for six months and for another six months because have more research we need to do. There is more than one way to protect domestic industries and bureaucratic mazes are actually more effective than tariffs and I think we may get into the political side of this later in the program. But, you know, Trump has announced a bunch of tariffs and then he quickly announces a bunch of exemptions. A bureaucratic maze is actually way more effective way to control or protect your domestic industries. To go through my charts, the first chart is of U.S. based corporate profits.

It is kind of interesting that those profits around 2000 which had shot up a lot as a result of the dotcom boom of the late 90s. They were about $700 billion a year and then China enters the WTO (World Trade Organization) in 2001. Very quickly, the U.S corporate profits basically tripled. That tells you that I don’t think this is a coincidence. That’s a stretch. Clearly, who’s benefitted from the expansion of trade in emerging productive markets like China are the U.S corporations. People that have done research and say,” Oh well, the cost of goods at Wal-Mart are cheap because of the production overseas.” They kind of guesstimated that the American consumers might have saved $200 billion or something like that in the last set number of years. However, if you look at the corporate profits going from $700 billion to $2.4 trillion, the corporations have pocketed trillions. Consumers pocketed nickels. Another chart I have here is the U.S. oil production and has gone up quite a bit as everyone knows because of fracking and other technology since.

This has really relieved the pressure on total U.S. trade deficit and much of which was energy. When the U.S. was importing six to eight million barrels of oil a day, that’s hundreds of billions of dollars’ worth of energy, right? Now that U.S. production has increased, it continues to import energy products and its also exporting some of its oil as well. We know that Canada and Mexico – North American Free Trade Agreement – as a whole is an energy exporter. The U.S., bottom line, has been impacted positively by its oil increase. I have a couple of charts here about breaking down the U.S. trade deficit and it is interesting because we tend to think of it as a national thing, right? What is the trade deficit with China or Germany? This tells us that almost half the goods trade deficit is related to autos and vehicles. That’s an interesting kind of fact. Imports and exports are a really broad part of the economy. In other words, it is not just soy beans and steel or aluminum. It’s a lot of different products from different parts of the world. You can see that the U.S. runs trade deficits with most of the world. Another chart I have here is the trade deficit. It is not mine. It is from somebody else.

The trade deficit used to be extremely modest back in the early post 4 years. Once we got a bubble economy, where the central bank was pouring in tremendous amounts of liquidity into the banking sector and in the economy. Then we get a bubble economy. That’s when our trade deficits sky rocketed. Of course, that is a bit simplistic because oil was a big part of our imports and the strength of the dollar made it convenient to buy other people’s products. When your currency increases in relative value, then it becomes even cheaper for you to buy other nation’s output. There’s a lot going on to add to that huge increase in the national trade deficit there. So the last chart is the IPhone supply chain.

The trade is not calculated with any kind of accuracy. It is very difficult now because of the global supply chain to make sense of what trade really is. This is a good example because if an IPhone is shipped from China and lands at the dock in Longbeach, it is credited as a $500 import from China. But if we look at the components, they’re made in Japan, South Korea, Europe, America, and other nations that as much as $480 of that $500 ‘import’ from China is actually imported from elsewhere. As little as $10 or $20 may actually stay in the Chinese economy. If we calculated trade in that way, some people actually claim that the trade deficit with China basically disappears. So much of what China does is assembling components from elsewhere. That huge trade deficit with China is illusory to some degree.

FRA:       It is somewhat misleading in terms of how we measure trade and that’s leading to misunderstanding as well.

Smith:   Yes. That is right. Much like GDP. It includes a lot of stuff that doesn’t mean the economy is becoming more productive.

FRA:       What about what’s happening in terms of the U.S. Trump administration. Do you think their strategy is to use these trade tariffs and potential trade wars as a bargaining chip for trade treaty organization in order to get the U.S. a better deal?

Smith:   Yeah. I think we see some evidence to support that, Richard. That was one of Trump’s campaign kind of promises – to cut a better deal. It is interesting that when he first announced his trade war sort of policy, then companies like BMW suddenly announced they were expanding their assembly of vehicles in the U.S. It’s an interesting dynamic because if you get a political threat, then corporations don’t really have the luxury of waiting around to see how that policy is implemented.  They see the writing on the wall, they see the political narrative shift and trajectory. It makes sense for them to go ahead and increase their production and assembly in the U.S. In other words, be proactive. Don’t wait around for the trade war to heat up. Just go ahead and move your product line and some assembly to the U.S. ahead of it. Ahead of the curve so to speak. We’re starting to see some of that.

FRA:       Yeah. Speaking of the political angle, there was a recent discussion of placing 25% tariff on U.S. soy beans. Could this be a political ploy by China in order to aggravate the backing of Trump supporters in the U.S. Midwest where a lot of the soy beans are grown?

Smith:   Yeah! It’s a fascinating supposition. I’m glad you brought that up because any kind of announcement regarding trade will have a domestic impact on the companies producing those goods. It’s undoubtedly that the Chinese leadership are trying to undermine Trump’s political support with that. If you’ve ever driven through Iowa, for example, much of the state is soy bean fields, wheat fields and corn fields. The U.S. certainly a bread basket of grain and soy bean producer of global proportions. There was some analysis that came out and said that that sounds nice – the Chinese trying to say they’re going to raise the price of U.S. soy beans but the world does not have an over supply of soy beans. So they can buy some from Brazil which is another major producer but their demand is so large that they’re going to end up buying U.S. soy beans anyway.

FRA:       Yeah. There are 400 million pigs in China that need to be fed. So, without the soy beans, they’re going to run into a lot of problems. There’s only about 14 million tonnes of domestic production in China from my understanding.

Smith:   Yeah, exactly. This is where it is fascinating to drill down because people are saying,” What about rare Earth metals?” This is because China has a monopoly on some of those metals and you can get into some electronic components and chemicals that the Japanese have almost a lock on for relatively modest parts of key industries. It turns out there’s only couple of factories in the world that make these things. That’s why we have to be careful about the sledgehammer to drive attack. Politically, it is also interesting to ask if it is really true that the U.S. has just been a dumping ground for the last 30 years. In other words, everybody else can over produce and just dump over their production into the U.S. market. Maybe it has been unfair. Nobody wants to talk about that but I do wonder if that’s actually a valid perception. As I mentioned earlier about the BMW thing and a lot of the Chinese machinations, people don’t want to lose the U.S. market. It is too big and important. There is no substitute. In a way, Trump has little more leverage than the exporters as far as I can see.

FRA:       Do you think that the U.S. and China will follow through on these plans for tariffs? Do you think that they’ll be pushed back in the market in other countries and economic forces in general?

Smith:   It’s a great topic, Richard. Before we started recording, you sent me an interesting article from the economist Barry Eichengreen – whom I understand you’re going to interview in the near future – he was talking about the fact that China and countries like China with higher export to GDP ratios than the U.S. In other words, these are export dependent mercantilist economies. They don’t really want to encourage a trade war because they’re going to be a much a bigger loser than importing countries.

FRA:       They’re sort of more for free trade than the U.S., ironically.

Smith:   Right! Exactly! To me, it is interesting to look at the model that’s often held up as being remarkably successful since the end of WWII which is the mercantilist model that Japan followed which was to protect domestic industries at all costs and then use government money and power to boost your export sector. Do everything you can to make it easier for corporations to expand their production for selling overseas and that enriches your nation. South Korea followed that model, Asian Tigers and China pursued that model with great success. Now, looking back at what has happened to Japan, after that whole export burst ended in a financial bubble, they’ve been stagnant. Part of why they’ve been stagnant for twenty something years is that when you protect your domestic industry, you protect a bunch of inefficient and unproductive industries. Those companies don’t make enough money to become efficient. They become sort of like a zombie sector. There is some employment but they struggle. Since there is no competition from overseas, to say that that model is successful, it is only successful in the boost phase. But once you get to the point where you’ve protected a bunch of inefficient and unproductive domestic sectors and you run into competition in the global stage with your exports sector, then you get stagnation. Japan’s export sector is still large but look at the profitability problems they’re having. It turns out that big electronic industries like Toshiba and Panasonic, they’re riddled with financial scandals because they’ve been overstating their profits by trillions of yen for years. They’re really not profitable anymore. So much for the mercantilist model. It only works for a while. It is not a permanent successful model. There are blow backs and consequences. To put it another way, trees don’t grow to the sky.

FRA:       Rather than imposing these tariffs, could the U.S administration focus action on intellectual property rights dispute between the U.S. and China on IP (Intellectual Property)? Could that happen?

Smith:   It is important because a lot of what the U.S. exports is software, films, entertainment and all of those things are easily pirated. We all know stories that you could get the DVD of the movie in Hong Kong’s streets before it is even released in theatres. We have a lot of friends in China and they report to us. In general, for the Chinese people, software is like air. Everybody should be free to everybody. It is not considered theft as we would see or it as Microsoft and other companies would see it. Trying to control the theft of intellectual property is very difficult. It is worth doing. You have to make an effort if your export sector is heavily dependent on intellectual property like the U.S. is but I just don’t know how much you can really change that dynamic. It is very difficult to stop thievery except at the official level.

FRA:       Where do you see all of this going in terms of the next phase of trade war discussions? Could this cause inflation in consumer prices because now the U.S. actually have to make the dishwasher or microwave oven here rather than importing it because of the large tariffs. Do you see that potentially happening – much higher inflation?

Smith:   Right. I do wonder about that. People are starting to say,” Oh well, you know, you put tariffs on steel and aluminum and that’s going to ripple through the economy.” We have to start asking. What percentage of our products are basic materials like aluminum, steel and soy beans? If you take a box of cold cereal, it turns out that the grain is something like a nickel or a dime. If we look for inflation, it could be in finished goods, if there’s tariffs on finished goods, that could really hurt like auto parts. If people start slapping 25% tariffs on finished goods, that could have a really big impact. The alternative view is if those producers decide to move their production to the U.S. and go ahead and absorb the higher labor costs and taxes here, it might be awash. In other words, the actual sticker price might not go up that much or there would be benefits in terms of supporting U.S. employment that certain number of higher prices would be offset by bringing the supply chain home, stronger employment here, more taxes being paid and so on.

FRA:       Finally, what are your thoughts on how trade wars could potentially lead to physical wars? If we absorb more labor in the U.S. that would take away labor in China and the ruling party, there is concerned about that – causing social unrest. Could all of this morph into physical wars?

Smith:   There’s a famous quote by a French economist, Bastiat (Frédéric Bastiat), from the 19^th century and I’m just paraphrasing. I don’t have it in front of me but it something like this: If goods don’t go across borders, then soldiers will come across borders. Kind of implying that dynamic you’re mentioning. I think trade is about 10-20% of most major economies – imports and exports together. We have to try and remember the scale. We’re not talking about most countries having 50-60% of their economy based on imports and exports. Trade is a critical sector of every economy but I think that the potential for disruption politically is in those countries that are super dependent on trade. Now, that would include Germany of which about 40% of their GDP is related to trade, as I recall. And China and these mercantilists based economies. They are much more likely to suffer political blowback and domestic turmoil and escalating sort of trade war environment. That domestic political turmoil and disorder is much more likely than a shooting war because trade wars are more relatively controllable compared to an actual combat war – where there is really a high risk where things get out of control. It is more likely that there will be domestic turmoil and that’s what politicians will have to focus on – how to deal with their domestic turmoil as a result of trade being disrupted.

FRA:       Wow. That’s great insight, Charles, on this potential for trade wars. How can our listeners learn more about their work?

Smith:   Please visit me in oftwominds.com. I got three chapters of my most recent books and big archives and come visit me at oftwominds.com.

FRA:       Excellent! Thank you very much, Charles.

Smith:   Ok! Thank you, Richard. My pleasure!

By Karl De La Cruz

karl.delacruz@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.

Download the MP3 Here

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.

Dr. Lacy Hunt:

“Important to the long-term investor is the pernicious impact of exploding debt levels. This condition will slow economic growth, and the resulting poor economic conditions will lead to lower inflation and thereby lower long-term interest rates. This suggests that high quality yields may be difficult to obtain within the next decade. In the shorter run, in accordance with Friedman’s established theory, the current monetary deceleration, or restrictive monetary policy, will bring about lower long-term interest rates.”

Download the Full Report

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.

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.

Download the Podcast in MP3 Here

FRA: Hi, Welcome to FRA roundtable insight .. Today we have Peter boockvar, he’s the chief investment officer for the Bleakley Financial Group and advisory, he has a product called the boockreport.com b o o c k report and that has great economic inside in perspective with lots of updates on economic indicators. Welcome Peter.

Peter Boockvar: Thanks Rich for having me again

FRA: Great, I thought we’d begin with some recent observation you made saying –basically we are in on the other side of an unprecedented experience of monetary largesse and experiment. Just wondering if you could elaborate on that.

Peter Boockvar: Yeah so, the liquidity tide is beginning to go out it’s more pronounced in the US with the 6 interest rates that we’ve seen so far in addition to the fed’s balance sheet beginning to roll-off. Beginning on Monday, the trend in terms of that roll up we’ll go from $60 billion a quarter, that was $30 billion in Q4 and it will increase to $90 billion a quarter in Q2. Also as each day and month—week and month goes by when we get closer to the ECB finishing their quantitative easing program and we know the bank of Japan is and buying less JGB as they focus more on yield curve control. Had some couple rate hikes from the Bank of Canada, we’re going to get a rate hike from the Bank of England in May so this is Central Bank attempts to extricate themselves from many years have extraordinary policy so that’s why I refer to this as the other side of the mountain. Easing is very easy throwing that party is very easy trying to control the hangover in a pretty benign way if it is now the hard part.

FRA: And so are all central banks and major central banks in the world doing this or just a portion?

Peter Boockvar: Well the major ones and in in some fashion or I’m even of the ECB still doing QA they cut in half as a January. They’ll probably end up by the end of the year with another sharp Caper come October 1^st. So doing this all together at the same time valuations across the world are stretch both of them fixed income and equities and there’s—creates vulnerability mean anytime central banks run a tightening cycle, the world becomes more vulnerable. Both n terms of growth –economy that’s very dependent on extraordinary low rates and also on asset prices that have become very elevated. So if you believe in a free lunch then everything will be fine, if you don’t believe in a free lunch –to 7 years of zero interest rates it can quintuple Balance sheet and negative interest rates around the world then you should be more circumstanced on how this all turns out.

FRA: Now looking at the Federal Reserve how high can interest rates go before other problems begin to set in namely the challenge of servicing the debt and also on interest rate related to derivatives?

Peter Boockvar: Well, look what happened to the VIX trade, the short VIX trade. We saw 30 basis point in the 10-year yield, 30 basis points that’s it and it blew up an entire trade. So I think that was one sign of how sensitive we are too modest changes in interest rates. Again because we’ve—so many years, attached and addicted and dependent on extraordinarily low rates both In terms of its impact on the economy and certainly asset price. Again one sign of potentially more to come, now the question is the persistent rise interest rate particularly on the short end and certainly with LIBOR. This is the rise in cost of capital, this rise in cost of servicing one debt begin to impact free cash flow and maybe not yet but we seem to be headed in that direction.

FRA: And so at some point will the Federal Reserve over and other Central bank’s be constrained are limited in is normalization process?

Peter Boockvar: Umm…That’s a good question I think that that will the restraint will occur only if something breaks and I think they seem pretty intent on raising at least two more times this year I think they’ll start a front load that to give them the option whether they want to do some fourth one of the end of the year and they claim that the shrinking of the balance sheet is like watching paint dry and then will happen in the background but we know that if something happens—if markets fall and if the economy gets impacted then the FED will certainly reevaluate that policy  but the problem is that if they don’t do the type of tightening that they want to do and that it somehow gets short-circuited by the market, it tells you that the FED is trapped in what they’ve created and that—them and the ECB and the bank of England. We’ve all become Japan and we had many years of lessons to learn from the Japanese by the bank of Japan getting trapped in their monetary policy and we learned none of that lesson Bernanke suppose a student of the great depression in Japan apparently studied the wrong thing because look at the situation that we’re in and 1.625% in the U.S. of the ninth year in an economic recovery and they just started shrinking their balance sheet. So we’re in dangerous land here in terms of the solid line. If things were to fall in terms of the economy or markets. Question is what is the strike price the fed put and hows the FEDs deal with it if we hit that strike—is we going to see more cuts all of the sudden? Well, they don’t have any more rates to cut. So this is going to be an interesting situation in the coming years.

FRA: And if there is a movement into recession territory—also fall in the financial markets with the Federal Reserve and other central banks being in a position to decrease interest rates and would that mean going into negative nominal interest rate territory?

Peter Boockvar: I do not believe the FED will ever go to negative nominal interest rates think you’ll blow up the money market funds. I think they’ll be riots in the streets of Washington, particularly from the AARP. So I don’t see that being politically possible and at the same time, I think that its proven that its really not a good policy. Negative interest rates is a tax on capital. It’s a tax on banks and banks will do their best to pass it on and if they don’t then they eat it themselves, but somebody has to eat the tax. So I don’t know understand the economic model to have negative interest rates is actually a good thing. I mean I understand the concept that it may force banks to go out and lend but still taxes it’s being eaten by somebody.

FRA: What about going into negative real interest rates by maybe forcing inflation to much higher levels?

Peter Boockvar: We’ve been—we’ve been in a negative interest rate environment for 10 years now so that’s like not like anything new. It would just really be more of the same and then in fact it’s negative real interest rate is what got us into this mess anyway in terms of creating all this debt and bubble type environment that we consistently seem to get ourselves into.

FRA: Speaking of tax on capital, what do you make of the recent developments on trade in terms of trade tariffs acting as a sort of the effective tax on the global economy?

Peter Boockvar: well, optically it certainly is I believe a big negative and I say optically because I’m not sure reality wise, I mean look at the steel (Unintelligble), that’s 70% of countries that we do business with has already been exempted. Half of our aluminum imports come from Canada and they’ve already been exempt. So on a dollar basis and I’m not sure it’d have that much of an impact, it will certainly hurt since the users of steel far outweigh those that produce it trying to separate what really what the economic impact is be going to be. It’ll only be felt, I just don’t think it’ll be as much as many fear. Now of course if this spirals and that’s a big problem I’m hoping that at least with China, theres some sort of agreement that this doesn’t become Become such a big deal and then holding out hope for that. So yeah it’s a risk and I’m not comfortable with Wilbur Ross and Peter Navarro making these decisions because I think they’re way off in this obsession with trade deficits, but I’m just hopeful that it won’t be that big of an economic deal— I’m more worried about the direction of interest rates and monetary policy right now even though of course the tariffs are not a good thing.

FRA: What about the last day or two here of the sell-off in the Fang stocks and a tech sector, is some of that due to concerns by the markets on the trade issues?

Peter Boockvar: I’m not sure that’s really on that I mean certainly semiconductor stocks and certainly would be potentially impacted, we certainly export a lot of consumer electronics also to China. So yeah, potentially but I think that the backdrop to the weakness in cap. tech is a few different things that granted we know that they became such outsized portions of the major indices, when you get to 500 + billion dollar market cap you obviously dominate the global market. Evaluations for some of them got expensive, I mean Facebook on a PE ratio basis pretty modest but on a price of sales basis, it was 10 times so it’s—but that was expensive as well and then once you throw in rising interest rates when people become more sensitive to valuation and we know Amazon evaluation is off the charts and then all of the sudden, threat to their business model. You know Facebook is (unintelligible) franchise I’m sure it’ll be fine but if it means that they’re going to grow more slowly if it means that advertisers are going to be more discriminating with their spend. Then not do as much on digital –maybe put it someplace else. That affects the growth rate, that affects the multiple and in stocks that I have been over owned and over loved and for many years this is what you get and obviously today Amazon getting impacted by the talk about the White House and Trump being obsessed with them and what to do about that, there’s no room for error. When you got to the valuation of levels at these companies did and now that you have both interest rate valuation and fundamental chinks in the armor it’s obviously something really important to pay attention to again, because they were such an outsized dominant presence in so many indices, so many ETF and so many mutual funds.

FRA: Do you think the sell-off in the tech sector will continue and deepen ?

Peter Boockvar: Yes I do. I don’t think that this is somehow settled in a week with a with a modest pull-back, considering how much do stocks have run up.

FRA: And what about on the—instead of doing trade tariffs could countries in central banks look at the competitive currency devaluation in terms of making the currency weaker for a trade competitiveness?

Peter Boockvar: I think we should have seen a version of that for many years but certainly the ECB wanted a week Euro and Japan wanted weak yen and we wanted a weak dollar and things like that is always an ongoing issue. Reserve Bank Australia wants a weak USA dollar and Bank of Canada wants a weak Canadian dollar and it seems like everybody wants a weak currency and what they should be really rooting for is not a weak currency, it should be a stable currency. but everyone’s trying to steal each other’s exports and I think it’s just an ongoing thing that there’s no sign of that changing anytime soon.

FRA: Will there be another round of that particularly—for example like in the US, the US administration may be wanting a lower dollar. Do you see that happening and what would be the mechanism to actually effectuate that to happen?

Peter Boockvar: well the (unintelligible) got so beat up, administration that’s so beat up for even raising the prospect of endorsing a week or dollar so I just don’t think that that’s some place that they’re going to go to, really anytime soon. I think I’ll be very implicit and left on said that they don’t mind a weaker dollar more so than anything more out right and overt.

FRA: And what do you make of China in terms of what’s happening credit crisis increase in credit, more infrastructure projects— overall how do you see China playing out ?

Peter Boockvar: I mean China’s—I mean it is so interesting in that terms of the debt accumulation has been extraordinary and banking system has become so big that I go back and forth and how this all plays out. Because the other hand they still have pretty good growth rates and im pretty bullish on China longer-term but certainly acknowledge short-term challenges they face in trying to deliver. Now they’re not going to do an outright deleveraging, their version of the leveraging will just try to be less quick or more slowly and sort of grow into it and I hope they have success but it’s likely going to be bumps in the road.

FRA: Moving to a fast-moving area topic of cryptocurrencies, what are your thoughts on the—on that do you think that governments will allow private base cryptocurrencies to co-exist alongside government currencies. You know from the monopoly power of the government?

Peter Boockvar: I mean, I think only if there was more—use of these cryptos for transactions. I mean if they’re just going to be more speculation sources of buying and selling them I don’t think they’re really going to care, but again I think if it’s stretched replacing that the payment system then I think that’s something that would wake them up.

FRA: And would that be a major driver of what you recently mentioned as potential for 90% of Bitcoin value to get wiped out?

Peter Boockvar: Well when I when I threw that out it’s I was really just talking more technically mean when I was referring to typically when an asset or stock goes parabolic, that usually ends up falling to where the parabolic move began and that was 1 to 3000 so that that’s the number I threw out that was not based on fundamentals. It was really just—okay well this is what happened in previous episodes of massive parabolic moves and you can argue that this was probably the greatest parabolic move ever that you typically give back the entire move. Just as the NASDAQ lost almost 90% of its value in 200 to 2002.

FRA: And on the major currencies—dollar, euro, yen where do you see the trend happening over the next year on that in terms of their trend movement?

Peter Boockvar: I mean, I remain Bearish on the US dollar which I guess implies that I’m bullish on the others, it’s hard to get bullish on a yen in light of the monetary Mayhem that’s going on there. But im not excited about the dollar at all, I think the euro surprises to be on the upside as well. I would not be surprised if we saw 130 or 135 at some point because I’m relatively bullish on Commodities I just don’t like the Austrian and Canadian dollars and actually like the British pound. I think that’s the case and dealing with Brexit is everyone still pretty down on them and I think that actually turns out better than feared.

FRA: And what about gold why do you see that market this being a potential for another leg higher?
Peter Boockvar: It’s in part due to my conscious—my bearishness on the dollar and also my lack of any faith that the FED can somehow pull off this this monetary tightening in any smooth fashion. Self-landing is a rare occurrence and I think there is little to no chance that they accomplish at this time around so then the craziness that’s going on with the ECB and the Bank of Japan and I think the bull market again in December 2015 and I was really just getting started.

FRA: And are you still on agricultural fertilizers?

Peter Boockvar: I am. I am extremely bullish, I think we’re beginning to see a slow down and a decline in (unintelligible) stocks for (unintelligible)… in particular, the global demand for food is still in this perpetual rise upward so if the supply situation—can at least get contained, I think that there is a lot of upside or many asset classes that are down 50-75% from their 2011-2012 peaks and the agriculture and precious metals are two of the few that fall underneath that.

FRA: Any other asset classes that you like at this point?

Peter Boockvar: Umm… Those are the two broad ones that I like. Right now the investing landscape is getting more difficult, I mean they’re plenty of one-off situations that are interesting but in terms of looking at it from a macro perspective those are the two that intrigue me. I think bigger picture longer-term I still like emerging markets. I think that the growth rate is there and continue to be better and I think the valuation are much more attractive than in the US.

FRA: Which emerging markets in particular do you like?

Peter Boockvar: I haven’t felt like—so I still like China, again acknowledging the challenges they face, India, Vietnam, I actually like Brazil as well and I actually am warming up to Greece. The Athens stock market is down 85% from its 2007 peak.

and if the new democracy which of the opposition party—If their leader Mitsotakis wins in a possible early election this year or early next year he’s a business-friendly guy that would be a real game-changer for that country that has basically been through its own great depression over the past couple years.

FRA: Yes indeed, and that’s great insight Peter. Thank you very much your thoughts.

Peter Boockvar: Yeap, thanks for having me Rich.

FRA: And just wondering how can our listeners learn more about the your work, where can they go?

Peter Boockvar: If they’re interesting in reading my daily work, they can subscribe to boockreport.com, again its boockreport.com. B double o c k report.com and also the CIO and portfolio manager at the Bleakley Advisory Group and they can check out the website at Bleakley.com

FRA: Thank you very much Peter

Transcript by Alexander Nguyen

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.

Source

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.

Download the Podcast in MP3

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

Download the Podcast in MP3 Here

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.

Download the Podcast in MP3 here

FRA: Hi, Welcome to FRA Roundtable Insight .. today we have Yra Harris. Yra is a independent trader, successful hedge fund manager, global macro consultant trading foreign currencies, bonds, commodities and equities for over 40 years, he was also a CME director from 1997 to 2003. Welcome Yra.

Yra: Richard, nice to have you back from Argentina, I haven’t seen you the last time since you were in Singapore so–I cant really follow you. You’re like Waldo.

FRA: Ok, sure. Maybe we could begin with a feedback on what happened on this afternoon, federal reserve, FOMC (Federal Open Market Committee) needing your thoughts on fed share, Jay Powell statement and press conference.

YRA: Yeah—you know, It was interesting that I was just watching the CNBC before we starting going on and Rick Santelli hit it right on target. I’m a fan of Rick, but we don’t always agree. But he had it on target. The one good thing Jay Powell did is he basically said stop relying on (unintelligible]\), because when they go out, the main stream media loves them because it’s an easy way to understand the fed for what they think is understanding… The fed so they can ask questions about it and he basically—you know—These are projections you know—they kept asking about it and asking about and Powell was very (unintelligible) when he said we made a decision today, to (unintelligible) projections and projections you know are just there. projections, they’re not worth the paper that they’re written on and if you follow the fed and their history with their dot plot, they’re a joke and as I wrote last night, you can go back 2006. Our cash in was far better at comprehending where the economy was than those dot plot projections and that’s just our—being, you know all that wisdom. So I just cant stand these dot plots I wrote in the blog last night that he should erase 50 basis points today and put to rest by doing that. Put to rest to dot plots and say yeah you know what we’re going to watch things here. But with raising 50 points and holding until the balance sheet shrunk to $3 trillion. I think he would of done the market to a much greater service because he would of let markets be markets and if there’s one thing that I really like about Jay Powell is that he does have an understanding on the way market works and he seems to be more willing to let markets work and get rid of the theoretical nonsense that fill the air ways with the feds press conference. I do applaud what he did except that I really would of like to see 50 basis points in a whole. Not that I would you know, bullish or bearish the stock I care not about that one way or another cause, I’m going to trade what I see anyway and react accordingly. But it would of put feds note to me a much more interesting position and you know what they got to stop cow toeing to the markets. You know I like what he was doing while the markets were correcting back in February. That he even had Dudley say that 10% drop is small potatoes, so we need to become more market focus than fed focus. That is the end of that story.

FRA: Now instead of the 50 basis point, the raise being only 25, do you think that the fed independence is coming under pressure by the US administration by president Donald trump?

YRA: Not yet, but it will, it will and a lot says about it again is that he talked about it last night and ill expound on it is that, look it. You read every central bank release, whether it is the ECB, Swiss National bank last week was the paradigm of it cause all they talked about was setting policies relative to the currency.

The Australian bank discusses the value of the currency, every central bank (unintelligible) everybody is out there parading this concept of independence of central banks. while they’re all discussing the importance of the currency values when setting their interest rate polices.

Certainly the Japanese, so its all being done so—with the—Donald Trump wanting to turn around the trade deficit, you can’t help but say hey maybe they are actually onto something because they have an independent central bank well—(unintelligible) the independent central bank that goes upon its course based on what its seeing here you know based on domestic economic activity, while everybody else is setting it to international standards then tariffs become the—I guess the alternative especially when the feds is raising the interest rates and they’re the only central bank really raising interest rates… I know… the bank of England went half a basis point, quarter basis point and they are project to go a quarter basis point tomorrow which we will see. But everybody is looking at the international situation and when I read the fed today there wasn’t one statement about it. Of course we did have Powell and little brainer discuss head wins to tail wins which is on the growth of the international economy but everybody goes through currency value when discussing interest policies.

FRA: So with the feds shrinking its balance sheet and raising short term rates—Likely making the US dollar stronger, will that promote tariffs more on the trade tariffs?

YRA: well I think that if the dollar got stronger, you would see much more action… But the dollar hasn’t gotten stronger, so there’s something else or a few other things that are seem to be weighing on the dollar. Now Powell was asked about that and he spoke to—you know—enhance growth, I’m not sure that there’s enhance growth over Europe anyways, I’m not… I need to see a lot more because if that’s the case then the European equity market should be out performing but you know what? They’re way underperforming the worlds equity market. So I’m not quite buying into that argument yet, but you know I’m going to wait and see first. I just need to see more before I go down that road. You know there are many things in play here which we will see which is why we are getting an increase volatility on a global basis.

FRA: And you’ve written recently on thoughts by commerce secretary Wilbur ross in terms that there will be no trade war… Trading partner of the us will compromise on trade treaty, how would that factor in the US dollar, like the potential US dollar devaluation?

YRA: well you know that’s right, that’s what I call the Kudlow dilemma, Kudlow of course when he got into his post, chairman—chief economic advisor to the president, he said you know (unintelligible) dollar and short gold. Well, not so fast Larry. First of all, be very careful about this because if you have king dollar which Kudlow means a strong dollar. Now we all like a strong dollar if its done—If its effected by good policies, but bad policies and a strong dollar, well that’s not such a good thing. You know—I’m not (unintelligible) grow your way out. You may inflate your way out of your debt problem but you’re not going to grow your way out of the debt problem, so let’s get behind that and if the dollar got too strong then the impotence from the white house would be to have more tariffs because they are hell bent on shrinking this trade deficit so when Kudlow discusses that, he ought to be very careful about where he is going because this white house, Peter Navarro and Wilbert Ross will push for a weaker dollar because a weaker dollar is Mnuchin and Wilbert Ross both said in Davos, is sending soldiers to the ramparts in the trade war that exists every day. So, Kudlow, that’s the Kudlow dilemma. It’s going to be interesting to see how he deals with this. But if, you were to get a dollar rally or even what (unintelligible) said and pretty sure wrote in earlier the week when he talked about a possible rip your face off dollar rally. He was quoting what’s his name (unintelligible name) about that. I’d be very very careful with this administration, they will not tolerate a strong dollar at this point in time.

FRA: And if that were to happen what would be the mechanism to effectuate that through monetary policy with the fed with its independence be compromised?

YRA: Yes! That’s a very good question, we don’t know but you would have the treasury secretary just like he said in Davos talking the dollar down which everybody took great umbrage at, but we’ve had that before, you know—One of my issues with Kudlow—(unintelligible) I respect him for his intelligence, he’s been around a long time. He was a Reagan guy, but you know what the Reagan white house lead the battle through James Baker with the Plaza Accord. The Plaza Accord was an orchestrated attempt to drive the dollar down and how is it done? Really—by sitting everybody down in the plaza hotel and reaching this compromise. We’ll pay because the trade deficit are now going to become an issue for wall street in a way that they haven’t in many many years and they are going to start to effect the movements in the market. Not quite ready yet but these algorithms who think that they have factored in every variable that you need and every headline, they are going to be disrupted themselves by the coming impact if the trade deficit continues to grow. This white house will not sit quietly and they made it an issue, and coming into the election this is going to be an important issue for Trump to hold onto his core constituency.

FRA: And thinking globally—how do you see everything playing out in terms of trade. Will Europe introduce measures to protect against Chinese trade and Chinese investments? So you got Europe Asia the U.S., how do you see it playing out?

YRA: well—we’ve seen that already. There was that article FT (Financial Times) earlier in the week that was talking about how Germany is upset that China is targeting some of the corporate jewels of Germany and… believe me the French are the most protectionists trade orientated going back to— (unintelligible) and I don’t care what Macron says because he inherited that it’s a long standing French tradition—so you know what? As the United States leave the battle, you will see that they will all start tail coating… What the white house is trying to accomplish, so while the white house gets beat up today, it gets beat up today because its easy to beat up on the Trump white house for so many missteps that they made. You watch that the European will follow right on top of this, because they have as much with the Chinese and they run. you know—pretty good trade deficit with the Chinese themselves so lets pay attention to what really is going to take place here.

FRA: And ultimately could we then get global competitive currency devaluation—another round?

YRA: Well I think we already have them. You know even with the yen at 103, 104 or 105, the yen is weak and fairly dramatic especially against the euro currency as we’ve talked about for 3 or 4 years already. That has been an interesting play and even I think that the Europeans, especially the Germans have had enough of the weakness in the yen. If you listen to (unintelligible) again, (unintelligible) very upset in January that Mnuchin and Ross, you know—for the D20 agreed not to target their currencies. Well you know what? Who you fooling? Of course, go read the Swiss statement from the release last week when they held their interest rates at negative 75 basis points. It’s all directed against the currency and the Japanese, every time when you listen to (unintelligible) talk, well—we’re not quite ready we need to see inflation. It’s just a nice way of saying we are going to keep our interest rate policy as it is because it keeps pressure on the currency. Come on, let’s call it what it is. They’re all targeting their currency values by using their interest policies for domestic purposes, but you know what? Many variables are in play here which is what is leading to the heightened increased in volatility. And as we’re talking right now, gold is up 23 or 24 dollars and silver is up 45 cents. This is after a fed increase. The dollar is on its lows, stone cold on its lows. What’s going on here in the market is were going to find out. There’s definitely some significant moves and most importantly is that there are two ten yield curve steepened today. Because… of course they changed the dot plot where it seems that there are going to be three rate rises this year so everybody thinks it’s going to be pushed out further and the feds is not going to be as aggressive as previously thought. So the yield curve, the two ten actually steepened out about 3 or 4 basis points as I’m sitting here.

FRA: Hmm.. Do you see president Donald Trump implementing section 301 of the 1974 trade act where the president can impose duties—If there’s like a perceived violation of trade agreements?

YRA: Yeah… that’s a great piece (unintelligible) last week when they were or two weeks ago when they were discussing 232 on the trade expansion act in 1962 under Kennedy which was interesting when it was passed in October of 1962, that was during the Cuban missile crisis. But they put in these—section 301 of the act in 1974. They put them in just because it was the only way they could get these trade agreements through, is that there is leverage against what they deemed at target as unfair traders so in order to get congress to be able to sign onto it there has to be opt outs based on sort of penalties. So yeah, they’re going to vote. We’ve seen it before with the Japanese in the 80s and the 90s was one of the strengths of the Reagan movement to enact 301. They’re going to use whatever they can—like yesterday we saw them soften some of their demands about 50% car parts in US auto—for NAFTA but they soften on that. Of course, and we saw that the peso. The peso reality and the Canadian dollar was really strong today. There are all types of mechanisms in place where they’re sending messages. Hey you better sit down an pay attention, were serious. We put the seal of tariffs down. (unintelligible) yes we backed off a little bit. We have a lot of tools at our command and we are serious about writing some of the wrongs that we have deemed to taken place in over the last 30 or 40 years. You must pay attention to it because, they have shown that they are serious about this, so they are trying to get better negotiating in so Trump can stand tall and say see. See what I did? I over turned some of these past malpractices and it’s going to help us as business returns to the United States.

FRA: will any of this affect U.S. agricultural exports to china?

YRA: well—It will—there is some rattling, we can see hog prices go down, cattle prices go down, some grain prices are holding up pretty well. Even as we are coming into the Brazilian and Argentinian year grind, the south American harvest will bring a lot of supply into the market. Prices are holding up very well, now that the Chinese may threaten the U.S. agriculture and as you know Wilbert Ross strategically laid out—you have to give them credit because they have done their homework and said look it, they’re still going to be buying our soy beans, I’m not buying it but what Wilbert Ross—I think is timing is wrong on the steel and aluminum because the Chinese, there’s so much—Brazil at a record crop this year. The timing wise is bad, we should of waited about two months for the crop to be harvested and for those to be all distributed somewhat and then laid it out because then the Chinese would have less flexibility. Right now they have flexibility because they can buy more Brazilian beans right now and stick it to the US farmers which could really hurt trump in the November elections, because the American farmers are doing very well. This has been a discussion since the China lobby back in the 1940s. the American heart land wants to do business with china, they always wanted to do business with China and when they embargo China, in the 1940s and 50s when Mao came into power, it hurt the American farmers because it took all those businesses with Taiwan versus the peoples Republic of China stunted American export to a billion people. The Chinese number one have to feed their people, end of story and their growth of Chinese purchases of soybeans which is huge because of the diet changes and more protein base especially with higher grades of protein. You have to feed those animals and a lot of soy meals and the Chinese eat a lot of soybeans. So that demand curve goes ever higher, that’s just not going to change… we’re seeing 10 dollar soybeans which is historically pretty high soybean prices and that’s with record supply. You know—agriculture responds very well to capitalism as prices go higher they produce more, but the demand from china and other countries that have now reach much higher per capita income they consume much more protein so prices remain high no matter how many beans come onto the market.

FRA: Yeah. And the soybean meal needed to feed the chickens, there used to be a saying that they only had chicken on Chinese new years but now they have it every day. Finally, your thoughts on Italy, recently you mentioned the markets are underestimating the importance of current Italian political situation and your reference to Picaso dream.

YRA: The market has fallen asleep, they think that there’s going to be some type of center based coalition that everybody (unintelligible) and that the league are going to get tired of trying to deal with five stars—I think it’s a gigantic mistake because 69% of the popular vote in Italy went to the center right including 5 star and if you try to push them out in order to form a coalition that pleases the eurocrats in brussels and status quo in Italy. Well—(unintelligible) I think you’re going to be running into a major problem and I think that the markets are way underestimating the influence of this. And you get again (unintelligible) I can take or leave most days, but he’s been very good with this. In fact, he’s been writing his warning about what’s taken place and you better pay attention to it. It’s no—Its nothing that is insignificant but the market seems to want to downplay it but we’ll continue to watch this. You know, I laugh because we’ve discussed the European financial institution have a severe problem and if you look at the stocks on the European bank, the deutsche bank—(unintelligible) but all the banks are suffering because the amount of non-performing loans have no been resolved, especially in Italy. So they need to really work this out and yet the 5 star and the (unintelligible) really want to push into… you know what we don’t care where the restrictions are coming from—(unintelligible)—budget deficits, we need to get the economy going and the Italian economy even with these ridiculous low interest rates is not showing enough growth and more importantly with these low interest rates, the debt to GDP ratio, it will be sitting around 132% which is enormous with a much lower borrowing cost, so Italy as you know—major problems facing it. (unintelligible) knows and 5 star knows they’re going to get their way because Italy is not Greece, Italy is far too big… far too big and their impact upon the entire global financial system therefore becomes much greater and as it is how to all work out. This is a very interesting time and yet the market is complacent trying to look past it. But I’d be very skeptical about that.

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

YRA: Well.. You can certainly go to the financial repression authority, we have a treasure trove of discussion but on a daily and weekly basis. I blog from notes underground which you can get and register for free if you go to YraHarris.com you’ll be able to access it and—as much as I write, respondence to the blog are at such a high level of discourse that, that makes it a must go to place because we really discuss very important things and its done at a very high level I’m proud to say.

FRA: Yeah, excellent. Yeah, great, thank you very much Yra, thank you.

YRA: Richard, thank you as for the opportunity as always, we do get into a good look under the hood as we say.

FRA: Yeap, and we’ll do it again another time. Thank you Yra.

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.

Download the Podcast in MP3

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

“The elephant of unsustainable pension management has been sitting in the theater of retirement planning for at least two decades. Now it is taking center stage. As obligations have soared, contribution levels have not kept up and management has opted for increasingly risky bets in the hopes of ‘winning’ the funds needed. It’s not working.

Plans that were fully funded 20 years ago, today have maybe two-thirds of the capital needed to cover benefit promises– and that optimistic estimate assumes zero bear markets and fantastical average real returns of 7%+ a year going forward.

The reality of the pension crisis was underlined again last week when the board of the largest $330+ billion US public pension plan, California Public Employees Retirement System (CalLPERS), voted to shorten its period for amortizing future investment losses from 30 years to 20 years. After losing $100 billion in 2008, followed by 10 years of QE-enabled capital markets since, the fund still has not recovered.

The net effect is that state and local governments and agencies will have to further increase mandatory contributions by diverting tax revenues needed for education, health care, roads, environmental protection and other public services.

…

Solutions include lowering benefit payments and indexing, delaying retirement ages, increasing saving/contribution levels, and in some cases expunging obligations in bankruptcy. None of these are popular, but this is reality.”

Pension elephant in the room now crushing budgets

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.

“The pension crisis at CalPERS is getting closer by the day. The State looks to be totally bankrupt by 2021-2022. CalPERS has just decided to increase the contribution of local governments and cities to their fund. The cities say they are approaching bankruptcy because of rising subsidies, but CalPERS itself is approaching insolvency. The problem is that there really is no real reform in sight. The choice is clear – CUT pension benefits of government employees or RAISE TAXES!. CalPERS simply needs a bailout and very soon.

Board Member Steve Westly even told The Mercury News that a bailout was needed and soon. Currently, CalPERS manages approximately $350 billion of future pension claims of its members. Recently, CalPERS passed an amendment to the statutes, which resulted in higher contributions for the California municipalities. The amount of contributions has been increased several times over the past few years and this time the cities do not appear to be able to handle the increased costs.

Once CalPERS was 100% funded with assets under management. In fact, they had a surplus in the good old days before Quantitative Easing. Right now, the system no longer has more than two-thirds of future claims. CalPERS itself expects an annual return of 7 percent on its financial investments. Most pension funds run by the States are insolvent or on the brink. This is what I have been warning about that the Quantitative Easing set the stage for the next crisis – the Pension Crisis. The Illinois Pension Fund needs to borrow up to $ 107 billion to meet its payment obligations. Promises to state employees are over the top and off the charts. This is why Janet Yellen at the Fed kept trying to raise rates stating that interest rates had to be ‘normalized’ for this was the crisis she knew was coming. And guess what – Europe is even worse and Draghi will not raise rates for fear that government will be unable to fund themselves.

There is NO WAY out of this crisis. The portfolio would have to be completely restructured and benefits reduced. Jerry Brown will do everything in his power to raise taxes and fees to try to hold CalPERS together. That is by no means a long-term solution.”

CalPERS on the Brink of Insolvency

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.

Grant’s Interest Rate Observer founder on moving rates from CNBC.

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.

Download the Podcast in MP3 Here

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.

Download the Podcast Here

FRA: Hi, welcome to FRA’s Roundtable Insight. Today we have Yra Harris, Peter Boockvar and a new guest, Jim Bianco. Jim is President and Macro Strategist at Bianco Research. Since 1990, Jim’s commentary have offered a unique perspective on the global economy and financial markets. Jim’s wide-ranging commentaries have addressed monetary policy, the intersection markets and politics, the role of government in the economy, fund flows and positioning in financial markets. He is a Chartered Market Technician (CMT) and a member of Market Technician’s Association. Yra Harris is an independent trader, successful hedge fund manager, global macro consultant while trading foreign currencies, bonds, commodities and equities for almost 40 years. Yra is also the CME Director from 1997 to 2003. Peter is Chief Investment Officer for the Bleakely Financial Group and Advisory. He has a newsletter product called the Boockreport.com. His great macroeconomic insight and perspective with lots of updates on economic indicators. Welcome gentlemen!

Jim: Thank you!

Peter: Hey Rich!

Yra: Thank you, Richard!

FRA: Great! I thought we’d begin with a discussion on volatility. We did a podcast recently with Chris Whalen about a week before the volatility began in the financial markets; this year volatility to a significant extent. Jim, have you been seeing that as a trend through your research or what are your thoughts on that?

Jim: Not as a trend. Pretty much the opposite. Volatility events like what we’ve seen over the last couple of weeks are not the creation of a trend, they are the exaggeration of a trend. So there was a trend in place already and that trend in place was a turn towards more volatility. The turn towards more volatility was driven by a belief that, for the first time in the post-crisis era, inflation was returning. I’d get technical on you for fifteen seconds. What happened with the volatility event is we caught a short-ball traders on the wrong side of the trade. They did one simple narrow thing; blew up the VIX Market. The volatility measure on the S&P 500 Index option. That’s all they blew up. When we found that that spiked from 12.5 to 50 in two days, we found out how important the VIX is to everybody else. It was their measure of risk. When they saw it go up 400% in two days, they overreacted and the next thing you know, the DOW is down 1600 points. What I want to emphasize is they didn’t create the trend. The trend is towards higher inflation and that higher inflation would bring higher volatility and they got caught in the wrong side of it. All derivative debacles like this are an exaggeration of a new trend that everybody got caught on, not the creation of it.

FRA: And Yra, your thoughts on that?

Yra: You can’t say it better.

Peter: In 2017, we saw a hiccup in the US. The Fed decided to raise rates three times instead of one. Let’s start shrinking our balance sheet. That was overwhelmed by the Bank of Japan and ECB. In early 2018, when rates continued to rise, when the inflation pressure started becoming more evident that this is not a short-term bliss. Maybe this is the beginning a more normalized interest rate trend. One of the analogies that I’ve given in the past is when the central banks are full on easing, it gives investors goggles and it makes everything look perfect. When that starts to change, when that liquidity flow starts to slow and rates start to move then those goggles start to clear up a little bit. Monetary policy became more important. Markets are very reactive nowadays. (5:03 – 5:06 would not play. The audio automatically skips it). All of the sudden it woke people up and said,” Uh oh. This is a big deal. This is twice the level of what it was in the summer of 2016. I better start reassessing my positioning. I better start reassessing my leverage. I better start reassessing what valuation I want to place on the S&P 500. VIX and all these other things became a symptom, of what I call now, a disease of rising inflation and rising interest rates that then caused this explosion in volatility.

Yra: There’s been an argument in the market place that inflation is rising but so what. Higher interest rates is not a bad thing. They take the idea that when it comes to inflation, it is either Zimbabwe and it is really bad or it does not matter but there is a middle ground in there which is critically important. I’ve been saying people to stop talking about the Fed. Central banks as a collective, are the easiest they’ve ever been in the post-crisis era. Their balance sheets are the highest they’ve ever been in the post-crisis era this week. If inflation returns, it puts into jeopardy that we’re gradual. Bernanke said,” We are going to get balance sheet back to $2T to 2.5T and it could take until 2026. He wrote it in 2016. It will take 8 or 10 years to get that. If we have inflation, maybe that 8 to 10 years is now 2 years. By the end of the year, you’re going to have a contraction out of the ECB and the BOJ. That’s where inflation matters. It’s going to force central banks to pull in a lot faster than people thought. One last thing. Wall Street runs into this trap all the time. Somebody points out a risk, everybody looks at their watch and says,” Well, we waited eight minutes. The market has not blown up. I guess that risk does not matter.” There’s a risk from all of this money printing. For the first time in nine years, we have an inflation fear and is now putting doubt in central banks. Now, what’s the first thing that markets do? They have a ___ (7:41 inaudible and the podcast skips it) over that. I think that this inflation fear that makes everybody say,” Bring it on! 3.25 is really good in interest rates.” Be careful what you wish for because that is going to cause a reversal especially in the BOJ. If we continue to see global inflation fears rise, the Fed is already tightening right now, that’s why I said do not talk about central banks. This should be a big deal for markets in 2018 and most people continue to dismiss it.

Peter: Just to add on, with respect to what you said, Jim, on balance sheets being at record highs. The analogy we have given out is that yes, they are at record highs but balloon with the air being central banks easing. There’s still air going into that balloon but there’s less air going in. If there’s less air going into that balloon, that balloon is still going to contract. I think it’s the rate of change that is really changing dramatically in terms of central bank (8:41 podcast skips it – inaudible).

FRA: Could the return of inflation force all central banks to accelerate their exit strategy or just some?

YRA: (9:03 – 9:07 inaudible) was just reappointed with a very (9:08 inaudible) group around him. (9:10 – 9:22 podcast skips it). … stand on fiscal policy is used on the sales tax. Draghi dug himself into a hole. (9:25 – 9:52 some are skipped and inaudible). … How do you get out of this? Peter and Jim are both right. Forget about the Feds. Everybody follows the Bernanke book but they’re stuck in a situation here. To me, that’s really dangerous.

Jim: One quick thing about the ECB. Draghi’s term has a little bit more than a year to go before he’s done. The tradition in the ECB is that the next ECB Chairman will probably be German. It does not have to be a German but probably will be a German. That’s code word for a very hard money person. If you’re going to get inflation and you’re going to get a German to run the ECB, you’re going to get a violent reversal in the next eighteen months. Look at two weeks ago. Two Thursdays ago when the DOW was down 1000 points, what was the catalyst story that everybody said? There’s inflation in the UK and the BOE (Bank of England) might have to double the rate hikes that they’re going with. When was the last time the BOE moved the US stock market? That might’ve been the first time. It’s all because of this idea that central banks is maybe peaking soon and starting to reverse. We haven’t had to deal with that possibility until the last two or three months. It was only in the last two or three months that we’ve only really started to see inflation. What Yra said is right that maybe Japan continues to pump money but they might not be enough to do it. If everybody else is going to reverse, then those global central bank balance sheet will peak. These markets will have a digestion problem with that.

Peter: Just to add on to what Jim said, even the Riksbank in Sweden, which is not necessarily relevant for the global economy, experimented with negative interest rates along with others. It’s a good symbolic gesture. They said they’re going to start the process of getting out of negative interest rates well before the ECB starts. Just going back to zero from negative is going to cost an extraordinary amount of loss. The ripple effect that that’s going to have on the world, I don’t think the people will appreciate it. I like to remind people in terms of the concept of risk happening fast. It was 2015 when, the German 10-year went from 6 basis points to 60 in one month and from 60 to 100 points a month later. This is Germany. Not Greece. Not a third-world country. This is a country that went from a 6 basis points to 100 in less than 2 months.

FRA: How could all of this translate onto a change in basic relationship between stocks and bonds? Jim, you mentioned there would likely be a change on that once again?

Jim: First of all, just as a point of emphasis. One of the things that could change it back another way is that if the doubt of inflationary fears go away. There was a mild form of inflation fears about a year ago and then it went away. The difference between now and a year ago is that we’re finding out that the market, collectively, is a bunch of Phillips Curvers. They’re looking at the stimulus from tax cuts, possibility of infrastructure spending, strong growth and that they’re concluding we’re not going to have inflation after we spend thirty years trying to say that the Phillips Curve does not creation inflation. If it is decided that there is inflation, then there is inflation. That’s where it is coming from. To your question about the stocks and bonds relationship, it changes all the time between the way that stocks and bonds trade together. In 1998 to 2000, it changed. What I used to call is under the inflation mindset. In the 1960s to 2000, the starting point of every discussion was, are we having inflation? If the answer was yes, if bond prices went down then stock prices went down. If the answer was no, the 80s and 90s, were not having inflation, then bond prices went up, interest rates went down went up. Bond prices and stock prices move together. Starting around 1998 to 2000, we switched that dynamic because we were worried about deflation. During the middle of that dynamic, we had long-term capitals, the Asian crisis, the tech bubble, sounds like the derivative thing we’ve been talking about the last few weeks as well. Throughout the 2000s until very recently, we worried about deflation. Are we having deflation? If the answer was yes, equity prices struggle. If there was no deflation, then equity prices went up. So now bond and stock prices move opposite of each other. What we’ve seen in the last few weeks is the decline of bond prices and stock prices together since the financial crisis that they both went down together. The day the DOW was down off 300 points. Up until 60 days ago, if you just randomly told me in the last nine years that the DOW was down 300 points, I would’ve said (16:40 – 16:42 inaudible). That’s the way we traded every single time. I think we’re shifting to an inflation mindset. Now where does that matter? In the last nine years, Wall Street has pushed this idea of a 60:40 portfolio. That it’s the optimal way to invest your money; sixty percent in equities and forty percent in bonds because something is always going up. Either there is no deflation and stocks are going up or there is deflation and bonds are going up. But under the new scenario, either they’re all going up or they’re all going down. Both of them have been falling together. So this idea where you can take a lot of risk with a 60:40 portfolio is going to be blowing up on people’s faces. This means that the relationship between stocks and bonds are transitioning right now. It takes around two years to fully transition it. I don’t know if it will take fully two years now but it will take at least months to do it. There will be periods where it does look like they’re transitioning but I do think that we’ve started that process.

FRA: And Yra, do you see that relationship also changing?

Yra: Yes. This whole risk parity. To me, what people don’t understand, is especially on the issue on how you get of out this. Ray Dalio said you’re going to shed tears if you earn cash. Talking about a coming change. That’s in a two week time period. It scared me. Ray Dalio is a great thinker.

Jim: Just to emphasize something on what Yra said that the single hardest thing to do for anybody that’s investing is to recognize the regime that the old rules stopped working. Most people can’t and they keep pounding away with the old rules until they are out of business. The single hardest thing to do in any type of investing is say that we’re now in a regime shift. If you’re wrong, you get wiped out and if there’s no regime shift and you say it is, you also get wiped out. If there is a regime shift and you don’t adapt, you get wiped out. That’s why we have this volatility and blow ups along the way.

Yra: That’s right. And what I think people fail to understand is not just Dalio’s position. It is everybody that has handled this book and tail-coated it. I know a lot of people in banks or foreign exchange traders who made a fortune and have tail-coated George Soros in the BOE. If BOE reacted like the Bank of France and raised interest rates to 100% and said,” We’re just going to do whatever we have to do and you have to pay the cost.” He wasn’t successful in breaking the (2:38 – 2:40 inaudible)… to exit that train would’ve been an enormous pain for all the people who followed them in. So whatever you think Dalio’s positions are, which I think are enormous is tail-coated and recreated the same trades in many other ways. I think that’s what we’re told in the last two weeks. He’s got a lot of company in this low volatility place.

FRA: And Peter, your thoughts also?

Peter: I also think a lot of people lost perspective on the markets. When you turn on the T.V or the radio or when you read the paper, while earnings are great in the economy’s trade and therefore stocks are going to go up and I just want to point out that that’s from the end of 2012. So the calendar year at the beginning of 2013, the January 26^th peak at the S&P, the S&P 500 was up 100%. Earnings since then, assuming 2018 assuming $100 to $150 per share, earnings should be up 60%. So the differences is actually multiple (21: 52 Inaudible). When interest rates rise or when people reassess what central banks are doing, why should people pay eighteen times their earnings? All of a sudden, within a week and a half, they decided let’s pay sixteen times with a one dollar change per earnings per share. Every one-term PE is 155 points (22:15 podcast skips, inaudible) while when we’re talking about two-term PEs, that’s 310 points. I think people need to have perspective that the stock market has ran well ahead of the rise in earnings and the difference is PE multiple expansions. It is now compressing because of the new regime change that we were talking about.

FRA: Could the rising interest rates in the U.S. cause us strengthening in the dollar (22:46)… rising defaults in the U.S dollar denominated debt in emerging markets which is estimated approximately $9T? Could that happen or could it also spur a financial crisis in Europe out of the bond markets? Would that mean that international capital flows coming into the U.S. towards U.S. dollar denominated assets? Just some potential scenarios. Jim, your thoughts?

Jim: I would come down on the idea of ‘no’. Let me explain what I mean by ‘no’. There’s this perception in markets that there’s all this money. There is no money heaven. No one ever loses this their money, it just gets allocated around. When the stock market goes down, but all the money from the bond market will come in to replace the stock market money that went down. I do not think you’re going to see some kind of reallocation where everybody is going to come running into the United States and it’s going to (23:53 podcast skips it, inaudible) the U.S. stock market and it is going to hurt them as well. I think the problem with the dollar, and I’ve been wrong with the dollar for several months now, is that the speculative flows are at record highs for some of them. Everybody is selling the dollar or is shorting the dollar right now. This has been keeping it unnaturally strong. If you wanted me to guess why we’re getting a persistent selling of the dollar, foreigners are basing their investments on who the president of the U.S. is. Sell the dollar. Investors have finally realized that it doesn’t matter. Eventually, that’s going to come back to foreigners and make them realize it matters. Your investments in a political idea might see a strengthening in the dollar. But are you going to see some kind of a wholesale run into the dollar that you were suggesting “no, I don’t think I’m going to see that.”

FRA: Yra, your thoughts?

Yra: I haven’t (25:12 – 25:13 Inaudible) … since Mark Fields’ comments back in 2017. Now, I’m fairly neutral towards it because it’s been a (25:24 inaudible) for people because interest rates in the United States are going up and (25:28 – 25:38 podcast skips it and inaudible). I’m scratching my head. If the deficit scare is real, I think what they did here by blowing the budget apart and the stimulus is that the people are a bit nervous. I don’t disagree with Jim because I’m really neutral with the dollar. If we go to real yields, Peter wrote about it today, the least positive on the short end of the paper rate I’d say is about 40 basis points based on the number that we have. The dollar would get a kick especially if the other central banks are just sitting there complacently because they would like their currencies to weaken anyway. I think Mario Draghi would like the Euro to weaken. I think the Japanese policies are driven by the desire for a weaker yen with the Trump agenda. People are being conscious and would like to see the dollar strengthen in relative to their own currencies. So, I’m going to wait. I don’t really have a good sense to where we go from here.

FRA: And Peter, your thoughts?

Peter: I’m bearish on the dollar in the short-term but considering the moves it has had, I’m definitely more uncertain about the very short-term move. We went into the year saying they’re going to increase the rates three times but then the markets really doubted it and now have the rising inflation that is probably happening. Higher inflation that’s not met by a rising Fed funds rate is typically dollar bearish. The Fed is going to raise three times this year. Take the Fed’s fund rate to a real rate of zero. That, of course, is well above where it is overseas, especially in Europe and Japan. But there is a reality that people still think it’s jamming around 2.0 even though maybe he’s not. But it’s still going to be on its gradual path. So there’s no way the Fed is getting ahead of the curve. They’re still going to be playing catch-up on top of better overseas economies that’s drawing dollars into other areas of the world. There are secular headwinds to the dollar but I’m less certain. I was very certain when the euro was 1.05 but much less certain when the euro is 1.25 in the short-term. I would not be surprised if, within the next two years, we see the euro at 1.40. It would not surprise me at all if we see the pound at 1.60. That’s were eventually heading within the next couple of years.

FRA: Jim, you mentioned this whole environment could be like the 90s when the markets went down and everything else. Where do investors and traders go to?

Jim: That’s the old 60:40 risk. Something is always going up. Yeah, I guess somebody is going to win the lottery today too. If an asset class is going to be rising, the answer is that they’re going to be small. Commodities might be rising but 95% of the money in the world is not in commodities. We’re creating a new asset class; cryptocurrencies. I, personally, think is an outgrowth of the rejection of policy. Inflation pressures financial markets. They go down. Stocks go down. Bonds go down. That was, ask Yra, that was the 1970s. I’m not saying we’re going to have high levels of inflation but what we’re going to have is that the stimulus will give you an appearance of high levels of inflation. So, I think that it’s going to be very hard to find, other than special situations like in the commodities markets, beyond that is going to be very difficult to find ideas where you can profit while returning to an inflationary environment.

FRA: And Yra, your thoughts?

Yra: I agree with Jim. What we’re going to see is (31:01 – 31:08 inaudible). Let’s say that the Phillip’s Curve may be able to get it right for a short period of time. We get higher interest rates. And now (31:27 – 31:30 inaudible)… 60:40 because they are both going to go down. I’m not a Phillip’s Curve advocate but if inflation does that. Those are both detrimental for corporate profits because rising wages with rising interest rates (31:42 – 31:53 inaudible). I just don’t see it. I know Peter has looked at this. (31:01 – 32:07). All these companies that borrowed a lot of money (32:09 – 32:15 inaudible). Take the interest rates expense, it is down to a really low level but we know that’s not going to last because for every one percent rise in the cost in borrowing, it’s going to hit discretionary spending levels dramatically. People are in for a shock here. It is really fascinating that (32:39 – 32:52 inaudible). It really does not make any sense. We’re much more worried about inflation. We know how to deal with inflation. In an interview that he did. So, you’re going to get into a feedback where at 60:40, they’re going to be sorry.

FRA: And Peter?

Peter: Just to quantify on what Yra said in terms of profit margins, lower labor costs and lower interest expense are the two biggest contributors for corporate profit growth from the 09 bottom. Just to quantify, there is about $13.5T of total business debt. So for every 100 basis points of interest cost, is $135B. Now, obviously, a lot of companies have turned down debt. But, generically speaking, in terms of labor costs, companies pay about $7T of labor cost every year. Let’s just combine that. (33:50 – 34:00 skips and inaudible)… higher costs that more than offsets the cut in the corporate tax rate from 35% to 21%. A lot of the estimates that is out there for earnings per share are all else equal analysis. It does not take into account higher labor cost and higher interest cost. When a lot of (34:23 – 34:24 inaudible) come out with their year-end price targets, it doesn’t include a lower PE ratio. It is static analysis. In terms of where to survive here, I would not be surprised if a two-year T-Bill paying 2.25% interest rate outperforms the equity market in a broad basket of corporate credit over the next few years. I think the commodity space is very interesting. I know a lot of people like to look at the demand side in terms of dictating prices but since that 2011 – 2012 peak in commodities, the (35:03 skipped) collapsed. Not only industrial metals, but also energy and particularly agriculture, which I’ve been very bullish on and on my belief on the dollar, I think gold and silver will outperform most equities and certainly fixed income within the next couple of years.

Jim: There’s $13T worth of debt and most of it has been turned out. This means rates goes up now but I’ve got 3 – 5 years to maturity. So I don’t see risk immediately. In the last ten years or so, there’s been a lot of people that have been turning up their debt through derivatives markets. They have been engaged in floating or fixed payments or receiving to take shorter-term debt and turn it out into longer-term debt. That is when you get a spike in volatility. Even that is going to start to come back to this day. Well I’ve got all of this short-term debt. The Fed is going to raise its rates. What am I going to do? I’m going to engage in swaps contracts in order to it mimic a 5-year note or a 10-year note but now it is more expensive to buy that swap contract because volatility is going up. That’s going to start hitting their bottom line too.

FRA: Great! Thank you very much gentlemen for your great insight. Just wondering, how can our listeners learn your work or go around? Jim?

Jim: Probably the easiest way is to follow us on twitter @BiancoResearch.com or at our website BiancoResearch.com

FRA: And Yra?

Yra: At YraHarris.com and the blog is from underground (36:58 – 37:10 inaudible). Food for thought.

FRA: And Peter?

Peter: My twitter is Pboockvar and subscribe to my daily writings at boockreport.com and my managing business is bleakley.com

FRA: Great! Thank you very much gentlemen.

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.

Former analyst at the Federal Reserve Bank of Dallas Danielle DiMartino Booth thinks those expecting the Federal Reserve to continue the market support will likely be quite disappointed.

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.

“The Romans never even had a national debt. Today, we have government hawking 100-year bonds. We have pension funds that required 8% returns and then governments ordering that the bulk of such funds if not 100% should be ‘conservative’ and invest in only government bonds. We are reaching a crisis point in longer-dated yields because investors are unwilling to lend money at low rates long-term. Smart money is beginning to wake up to the perpetual mismanagement of the long-term trend by the government. The central banks have been backing off of continually buying government debt and the Fed in the USA has announced it will not reinvest when its holdings of government debt mature .. This is the Sovereign Debt Crisis and Monetary Crises we face in the years ahead.”

Conflict between Fiscal & Monetary Policy

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.

“There is a ‘strong case’ for authorities to rein in digital currencies because of their links to the established financial system, Bank for International Settlements General Manager Agustin Carstens said.

‘If authorities do not act pre-emptively, cryptocurrencies could become more interconnected with the main financial system and become a threat .. Most importantly, the meteoric rise of cryptocurrencies should not make us forget the important role central banks play as stewards of public trust. Private digital tokens masquerading as currencies must not subvert this trust.'”

LINK HERE to the article

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.

DOWNLOAD THE PODCAST IN MP3 HERE

FRA: Hi. Welcome to FRA’s Roundtable Insight .. Today we have Yra Harris, Peter Boockvar and a first time guest, Chris Whalen. 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 Investment Officer for the Bleakley Financial Group and Advisory at Bleakley and he has a newsletter product called The Boock Report. BoockReport.com. It offers great macroeconomic insight and perspective with lots of updates on economic indicators. Chris Whalen is an investment banker, author and Chairman of Whalen Global Advisors LLC which focuses on financial services, mortgage finance and technology sectors. He was a Co-founder and Principal of Institutional Risk Analytics from 2003-2013. He has held positions in organizations such as the House Republican Conference Committee…

Christopher Whalen: Yeah, talking about that.. (laughs). That’s okay. Most recently I ran and built up the Financial Institutions Group at Kroll Bond Rating Agency which was a lot of fun. Kroll is really an ABS house, first and foremost, commercial real estate and the rest of it. It’s still very small from competing with giants, but it was a lot of fun.

FRA: Great. And also he was on the board of directors for the Global Interdependence Center (GIC) in Philadelphia.

Christopher Whalen: Yes, that was David Kotok’s little project. You know it’s fun to mix business with pleasure. Fishing, central bankers go fishing.

FRA: Yes, I am actually going next month to the GIC conference in Buenos Aires and going fishing before that. There’s also fishing afterwards, sort of the Camp Kotok in Argentina.

Christopher Whalen: Well, some of them go to Maine. Ramiro Lopez Larroy and his kids will just show which is about 15 hours by plane. It’s a lot of fun. They are great people – A very diverse group at GIC. We’re going to Germany this year, the Bundesbank, so if you like monetary policy that would be a very good trip to go on. I would recommend that.

So, what would you like to talk about this morning?

Peter Boockvar: The Bundesbank has disappointed me for the last few years how they give Draghi the license to do what he has done.

Christopher Whalen: Well, they kind of had no choice. I find it amusing that northern Europe is cranking, and my relatives in Holland are having a great year, and yet southern Europe is not. That dichotomy is ultimately going to be very difficult for them to deal with. The Germans look at southern Europe and they just see more checks to be written. The politics of that is slowly undermining Merkel. It’s very interesting to watch. And then Berlusconi coming back in Italy – Isn’t that great?

Everyone: (laughs)

Christopher Whalen: I always tell people to read about Berlusconi and you’ll see where America is headed.

Yra Harris: Draghi will be making trips to Italy.

Christopher Whalen: Yeah. Draghi has been trying to keep Europe on ice by pushing debt cost down to zero, but the debt keeps growing. So, what are we really about here? There’s no fiscal discipline anywhere in the Western world and the Chinese don’t care. It doesn’t matter in China – It’s a political issue. That’s why I was writing about H&A recently because ultimately, whether that company survives or not, will be determined by uncle Xi. That’s how it works in China. There is no church and state, there is just the state.

Peter Boockvar: He may want to set an example though.

Christopher Whalen: Yeah, there were a little ostentatious, a little floppy with the parties, pasting their names on the side of office buildings around the world. I think we have 3 of them in New York. It’s quite fascinating.

FRA: A few weeks ago, Chris, you wrote an article, Bank Earnings & Volatility, I thought we could begin with some thoughts there. How have the Federal Reserve and other central banks’ actions affected the credit market, the financial markets and the economy, in general?

Christopher Whalen: Well, what the central banks have done is that they have removed a lot of assets from the market. They’ve gone out with a variety of new money, in the U.S. case: excess bank reserves, and they’ve bought treasury bonds and they’re bought also mortgage bonds. Of recent vintage, Fannie Mae, Freddie Mac, Ginne Mae paper which have 3, 3 ¼ and 3 ½ coupons with very low pre-payment rates. Those bonds are going to be around for a long time. In fact, one thing I remind people of is that about 30% of the market today is the FHA and Ginnie Mae and those loans are assumable so they will stay with the house. And the house will trade and the loan will be conveyed to the new buyer. It could be very interesting, over time, to see how that affects the portfolio. But essentially, the central banks have taken all of this duration out of the market and since they’re end investors, they are basically buying the paper on credit and they don’t hedge it. So the capital markets activity that you used to see around a lot of these positions when they were held by trading firms, banks and other who were going to trade the assets and cared about mark-to-market every quarter has greatly diminished — There’s no hedging. The Fed’s sought out hedging it’s block and it’s a problem now because the Fed is now illiquid. They can’t sell without creating a loss and they dare not do that because it gets them in trouble with the Republicans and the House who don’t understand monetary policy at all, but have a lot of opinions on it. And so you have this weird situation where the Fed essentially has their hands tied. They’re going to wait for the book to run off which they hope is about $20 billion a month. And I think that they could be wrong. I think that they could too wishful in terms of the runoff rate in terms of the mortgage paper. The mortgage companies are going to be around forever and the pre-payment rate is going to be very low, especially if rates continue to move up. That’s kind of what I see. The trading line on Wall Street, the earning will be greatly diminished by this. Then you have the vote to rule. So all of the books, the investment books that the banks use to trade every day, just the value of the assets are passive now. You put those 2 data points together and you will understand why Goldman Sachs and why all of the banks have seen an enormous reduction in their trading buy-ins.

The other issue is that the mortgage market is down so there is less hedging. The forward market for hedges, what’s called the TBA market, has a lot less activity. We’ll do a $1.5 trillion in mortgages this year which is down. The peak was $4.5 trillion during the 2000’s; we don’t want to do that.

Peter Boockvar: Yes and why aren’t we seeing an CNI loan growth?

Christopher Whalen: The banks had to slow down. They had a pretty good run in 2015/2016. We had a little scare from oil which didn’t really materialize. Most U.S. banks did fine on oil credits. There was some restructuring, but the banks we follow like Cadence, which is a small lender that was built to do energy – They have no problems. But now a lot of banks have run up to a regulatory limit on commercial real estate loans, multi-family…there’s a big shtick now for the smaller banks. They’ve essentially run out of customers in certain markets too. The OCC, for example, is forcing regionals to peel back their multi-family exposure because the prices have gone up so much. They just look at that go whoa, wait a minute. And they’re right. Loss rate on these assets, multi-family assets, are negative. So if the loan defaults, you’re going to sell the property for a lot more than the loan and that’s reflected in the ABS numbers too. It’s an interesting time in terms of different asset classes, but I don’t see a lot of growth in the book. I really don’t. BA had a really good quarter at year end, but that was the exception. Most of the big guys were not growing. And of course PMC had a very good quarter and had a nice tax number. I think overall, don’t look for alpha in the banking industry. Between the regulatory changes and just the tenure of the economy you would be in the bond market, right? Anybody could raise money in the bond market in 2016 and part of 2017. So, we had a bull market in fixed income which has driven a lot of strategies and I’m sure Yra has some thoughts on that.

Yra Harris: Let me ask a question in regards to that. I was really taken by it because it was such a good point. With the ECB, BoJ and certainly the Feds, the dynamic hedges are missing from the market, but they are going to resurrect themselves as more paper winds up in the hands of private holdings whether it be by pension funds or insurance companies. But do you think that Jerome Powell…You know I go back and read some of his earlier stuff and of course his initial position as a Fed governor, he had a lot of issues with the massive build-up of the balance sheet. Do you think that he might be quicker to say that we can hold the rate at 2%…Do you think that it’s a possibility?

Christopher Whalen: I think that the snippets from the minutes that have sudden found people’s attention…which is very funny, right? We only pay attention to chairmen. It’s a cult of personality. So here you have Powell saying some very interesting things, very forthright, not an economist, he’s a financial guy, and I’m told he’s fairly decisive although he’s quiet and he listens. He knows how to make decisions. On this he’s got politics because the congress, if you remember years ago, they confiscated the Fed’s surplus to pay for a highway bill. And the idiots in congress, I wrote about this for the American Conservative, keep permittences from the Fed as revenue. They don’t understand that it’s an expense foregone. It’s not revenue. You’re just making the debt go away. Every year they look at this money coming in and the CBO and everyone else say: Oh look, it’s revenue. But it’s a snake eating its tail because the Fed and the treasury are one. It’s like a Hindu god, but in economic terms they are the same. And Bob Eisenbeis, who I interviewed, is wonderful on this issue – He is very funny. I think that Powell is going to be a lot more straight-talking then the others have been and I fault Yellen and Bernanke on this because they should’ve gone out and said to the congress: “No, you can behave like this. This is ridiculous. You don’t go confiscating our surplus.” It was just part of Washington politics, but the Fed didn’t respond. If Paul Volcker was there he would have been up on the hill kicking the shit out of them. And the problem is, these are bureaucrats, they come from academia. They have no money and so they don’t know how to behave in big league politics – It’s a tragedy. I think Powell will be much better. I am very hopeful about his 10-year as chairman. It desperately needed change. We got to get the economists out of the temple, I’m sorry. I love them, but they can’t make financial decisions. You want them on the staff, Yra, you don’t want them trading.

Peter Boockvar: We wish that was the case 10 years ago and now Powell gets to clean up the mess.

Christopher Whalen: Exactly and you know, Volcker cleaned up a lot of messes too. They always clean up other peoples’ messes so it’s a public service.

Peter Boockvar: And this is the biggest mess the world has ever seen.

Christopher Whalen: Oh yeah. No question.

Yra Harris: And with Bernanke he had the courage not to act.

Peter Boockvar: Right. Bailing out people doesn’t take courage. It’s not bailing them out what is courageous.

Christopher Whalen: Well precisely. And the Fed has not said no in a long time. They haven’t said no to accommodating treasury options and they haven’t said no most recently with this lunacy of QE. I mean the first one was fine. They had to reliquify the banking system as Walker Todd put it out to me a while back, but the rest of it was crazy. Selling all the short-dated stuff and loading up the book with long-dated treasuries so they own mortgage backs with an average life of around 12 years now. They have extended a lot, by the way, over the last 18 months. Even if the portfolio gets smaller, the duration has got to go up.

(laughs) How about that?

Peter Boockvar: Chris, what was their thinking in their models with operation twist to say okay, in their models, let’s flatten yield curve and that will be good for growth. And then today they express worries over the flattening yield curve.

Christopher Whalen: Well I know, but this is the point. When you have central banks take all this duration out of the market, nobody is hedging the position; well obviously it’s going to be hard to get those maturities to back up. There is just nobody selling euro/dollars, nobody doing swaps or anything – There’s nothing. So there is market is in stasis and they’re going to push up the short end, but there’s nobody pushing up the long end. So it’s gone up a bit, but I keep wondering…I wrote about it this week. I’m kind of hedged on my bull market 10-year trade, right? But, there is still nobody out there selling it. So I do think you have a flat curve in prospect, I agree. It’s bond market basics. It’s got to be somebody at that table in Washington who understands the bond market and I think Powell does – There’s hope.

Yra Harris: But in understanding the bond market, Chris, do you think that he will move to try and steepen the curve by maybe holding the front end, by saying hey, we don’t have to raise rates. If I get it to 1.75 on the Feds’ fund rate or 2%, I’m basically in a neutral real yield. That’s where I am. That’s probably about neutral on the front end. Maybe the real yield on the front end goes to 50 basis points positive, but I don’t think he goes there. Would it not be in his optimal mindset to say let’s start shrinking the, as Peter would say, quantitative tightening on the longer end on the duration. If the yield curve steepens out to 120-150 basis points it’s not necessarily a bad thing.

Christopher Whalen: I totally agree with you. If the Fed were acting rationally they would be doing all of that. They would have even been hedging a bit of the buck. Just trade it. Go out and hedge on the duration.

Peter Boockvar: Definitely afraid of affecting its bubbling asset prices.

Christopher Whalen: That’s part of it – True.

Peter Boockvar: That’s behind their entire thinking.

Christopher Whalen: But bureaucratically in Washington terms, they don’t want to take a loss because then the remittance to treasury goes away. And believe it or not, in the small minded world of some of these Fed people, that’s what they worry about. So, vector that into your thinking too because he’s absolutely right – They should be trading the book. They should have been doing a lot of things, but they’re not thinking like market people. They are thinking like Keynesian and academic economists and that’s scary — It really is.

FRA: In your article you mention also that this is likely going to result in a volatility returning to the markets that were all short volatility – Can you elaborate on that?

Christopher Whalen: Well that was the comment from Powell. He said at the end of that snippet from 2012 that they were going to unwind their short volatility position. In classical terms, if you buy a portfolio of RMBS it should give you a relatively short position, but in this case I think the other part of it is our perspective, the market. We’re sitting here and he’s got all the duration and we’re buying. Now, all of a sudden, he says that we aren’t going to buy anymore and we’re going to let it run off. So eventually private market participants are going to take up that duration, think of it as the weight that they have to support with capital, and they’ll have to hedge. So you will see market activity return. I think that the Fed has missed an opportunity to get a little bit more of this done quickly and figure out how much the street is willing to support. That’s the thing that we don’t know. The Fed has been supporting everything.

Peter Boockvar: The Fed lost their opportunity. The Fed had a chance to raise 3 times in 2015, 3 times in 2016, now they’re entering a situation where maybe the Fed fund rate tops out at 2-2 ¼. And they have now an issue with this falling dollar and bubbling inflation pressures. Just imagine when we do hit a wall and they start to cut rates and what the dollar is going to do in that scenario.

Christopher Whalen: I think it’s a lot simpler than you put forward which is: go ahead and keep your little quarter point march and if you see spreads start to widen, you stop. It’s the basic Irving Fisher test, right? That was the playbook for Bernanke.

Peter Boockvar: That is too much of a free lunch for me. I think that there is no free lunch in reversing this policy that they have implemented.

Christopher Whalen: So, you think we go to 6%? That’s what Yellen said years ago.

Peter Boockvar: We don’t need to go to 6% to cause a major problem. All the 10-year has to do is go to 3.5%/4% and you’ve got, I believe, a recession on your hands. I think the sensitivity to changes in interest rates is dramatic, as it’s been. You’ve got duration levels that are as high as they’ve ever been globally – That’s where the risk is.

Christopher Whalen: Well you’ll certainly see defaults go up because we’re hiding a lot of defaults with the artificial manipulation.

Peter Boockvar: And it’s not just that. Well you need a zero interest rate to go back to zero and $9 trillion of paper is going to lose a lot of money mark-to-market

Christopher Whalen: Hey, I know that’s why…

Peter Boockvar: Actually, I take that back. It’s more than mark-to-market — It’s real life losses.

Yra Harris: From a trader’s point of view…That position is enormous that they are carrying and more people have synthetically created that. Now you’ve got to realize that all of this volatility selling is all from people who are mimicking that risk parity trick. You can mimic it whatever way…You can recreate this trade synthetically in a million different ways. So when you have to actually start unwinding it, it’s almost like the long-term capital of 1998, we’re not going to be able to get out of that door because a lot of people are going to be racing out that door at the exact same time that you want to go because they have the same position whether you realize it or not.

Christopher Whalen: Well of course. And the VIX is just a popularity contest – There’s no basis for that contract. It’s just a matter of supply and demand. It’s like CDS. There is no basis on the underlying credit anymore.

Peter Boockvar: Well sure, but the VIX is still being determined by a lot of participants placing their bets and puts and calls.

Christopher Whalen: Absolutely. A lot of them weren’t hedging the past few years. Everyone was leaning in one direction.

Peter Boockvar: Of course.

Christopher Whalen: You would see default rates double in Peter’s scenario, easily. I think that’s from latency in the system. If we see the 10-year go up to like 3%, I think the windows will be shaking.

Peter Boockvar: And I read a stat over the weekend that of the roughly 2,000 companies, 40% of the debt is floating rate. And that cost goes up every single day with what LIBOR is doing. Even the 2-year note yield today is up to 2.12.

Christopher Whalen: That’s what I’ve been wondering about is to imagine the reissuance of equity that was bought in by these guys as they desperately try and pay off this debt. That could be a lot of fun.

Peter Boockvar: Yeah. The 1-year bill today is now where the S&P 500 is.

Christopher Whalen: We’ve had 4 years of amazing record bond market activity of each year in terms of new issuance and I would say 1/3 or ½ of it was to fund stock repurchases. It’s been quite something.

Yra Harris: And you know what, there’s another part…When the BoJ and ECB are busy buying corporate assets, there’s no hedging that goes on there either. And there’s also no stock re-lending. Another issue that I’ve raised…

Christopher Whalen: Yeah, that’s true. They may not lend the assets. That’s right. The Asian central banks are very, very conservative on that stuff. They won’t re-hypop.

Yra Harris: Yeah. There’s no rehypothecation of anything so now all of a sudden the game gets even more interesting and the question becomes: Do all the ETFs rehypothecate? Or does that result then with everything in that basket we get way late off the market and make it even more expensive for short sellers. So we’re not getting any short selling for some of these companies that are involved in ETFs are really miserable companies. So the whole dynamic here is shifted. And I don’t know that the players have really shifted.

Christopher Whalen: I don’t know about the ETFs. I would suspect those assets are available, but the central banks are the big thing. When they buy all of this paper and just put it away, you’re right, it doesn’t come out. It doesn’t get loaned. It reduces liquidity – That is, to me, the key thing.

The fascinating part is to look at the Swiss. Swiss National Bank is now buying stocks. Why? Because if they don’t, the currency will appreciate. That is their chronic problem. They just can’t keep the money out and even with penalty rates, they still can’t manage it. So if they stop, it will go up.

Peter Boockvar: That’s what one of the interesting central bank comments this week was from the deputy governor of the Swiss bank in Sweden, who has also gone down that rat hole of negative interest rates, and she said that they are not going to wait for the ECB to start raising rates. They’re going to probably start doing it this year. So I think that there is an end in sight to this negative interest rate experience over the next 2 years.

Christopher Whalen: Well, the whole system has way too much debt and a lot of debt that is mispriced. So like I said, you’ll see the banks start to lean into this too. I think you’ll see provisions gently go up from where they are. I was surprised to see the credit cards up this much this quarter.

The mortgages are still real quiet. And commercial is still really quiet because the collateral values have gone up so much. A loan you made 2 or 3 years ago, the building will get sold easily for the principle on the loan which is typically a 50 LTV (loan-to-value) loan. Look at the equity that has been created in multi-family and commercial real estate over the past 4 or 5 years – It’s ridiculous. And it was all levered up again.

Look at New York. New York is going to be a lot of fun. We have compression underway right now.

Yra Harris: Will the balance bring back foreign buyers to the U.S. market to hold this mark up a little longer?

Christopher Whalen: I don’t know. I’ve been trying to get some good data on that because it depends on a lot of things. There was certainly a gold rush for a while, but then the Chinese shut the door. They changed the rules rather significantly. That’s what H&A is about. I think that for Europeans too, things have calmed down a bit so you don’t have that crazy flight capital that we saw in New York in 2015 and 2016. But the bid for high-end condos, that foreign big is definitely waned. I know a couple of brokers who just do that market and there’s a lot of stuff for sale.

Peter Boockvar: There are a lot of signs that commercial real estate has peaked out in this cycle.

Christopher Whalen: Oh yeah — Definitely. But you know a lot of markets are completely on fire, just look at Denver, downtown Denver…

Peter Boockvar: Yeah, with certain demographics.

Christopher Whalen: Yeah and they’re leasing them.

Peter Boockvar: A lot of population growth.

Christopher Whalen: Yes. That city has exploded. The city has almost reached the airport. And for those of us who remembered when the airport opened, it was really far away.

Peter Boockvar: Yeah, I was at that airport 2 weekends ago.

Christopher Whalen: Yeah, and now (highway) 70 has expanded to the airport. It’s about a 40 minute run. That whole area with Colorado Springs and everything else has just completed exploded in terms of development.

Yra Harris: When they built that airport I said: Why are they taking away the old stable that said, “Stupid”. What vision I had.

Christopher Whalen: Now people are going to start expanding east away from the airport. That’s already happening.

Yra Harris: Wow. It will be in Nebraska.

Christopher Whalen: Exactly. But anyway, markets are going to be very interesting. I think that the fact that the dollar has been trading off the way that it has been is going to make for a very interesting year…

Peter Boockvar: And what we’re seeing in front of our eyes is the air leaking out of the bond bubble. Whether it’s here, whether it’s in Europe with the German 10-year breaking out above this multi-year range. I don’t necessarily know the pace of it from here, but things are changing before our eyes with interest and currencies. If there was going to be a major risk to this whole tranquil environment that it’s perceived to be, it’s the rise in interest rates and certainly a big draw down in the U.S. dollar. I mean commodity prices are at multi-year highs, the CRB printing 200 yesterday and holding them today. I think things are changing and there’s still a lot of nonchalance in the face of that.

Christopher Whalen: Of course. Markets sometime just sort of trade around numbers for a while for no particular reason and then you have an event that wakes everybody up and it moves, like the election. If you look at most charts for the bond market, there’s this big discontinuity around November 2016 and what do you do? Now it’s moved. And it moved again for a variety of reasons. China used to be the excuse, but I don’t think we’ll have that now. It will be a fairly boring inward look at China.

FRA: Chris, on your article you mentioned there could be downward pressure on long-term bond yields as the U.S. treasury concentrates future debt issuance on the short-term majorities.

Christopher Whalen: Yeah, that the schedule. And again, going back to our earlier conversation, you’re the Fed and you see treasury in the market with huge issuance. I can put a lot of pressure on short rates such that they may blow past the targets and keep going. Imagine that. Meanwhile the Fed isn’t going to sell anything outright and they’re not doing anything on the long end. They should be selling the futures at least. You don’t want to sell the cash positions? Fine, but do something because otherwise we’ll flatten just like Peter said. I totally agree with that. And it may happen quickly. It could happen in weeks – Imagine that (laughs).

Peter Boockvar: I still expect a creep higher in long rates.

Christopher Whalen: Yeah, it will bounce up, but it could easily rally. You want to be careful because there is so little paper. If they reopen the old issues which they can do, then you’ll know that somebody is yelling in that building saying, “Hey! You should be issuing longer dated paper.” The pit was planning to take their runoff and invest in the short end stuff the treasury is issuing, right? But their runoff may be so slow that they might not have that much net cash if they want to keep up with that $20 billion decline in the overall portfolio. So, I think it’s a funny situation. It goes to what Peter was saying. We could have a really nasty market environment because the Fed can’t help, the banks can’t help, they’re not allowed to anymore. So the street has no strong hands here that come in and push out a bad auction or push on the dollar if it gets messy. They would just have to intervene.

Yra Harris: And if they were to actually start…If Powell says, “I want to sell off…” to go back to your first point Chris, is that they are going to incur losses. And then they’re going to say, “Hey, we’ve got losses on our books this year because we’re actually taking some losses on the long end stuff that we bought.” So they’re kind of locked in that situation. And the situation on the front end has gotten so interesting that I actually called someone at the CME and said that I think it’s time for them to dust off the old contract and bring it back because it may become useful besides with the euro/dollar.

Christopher Whalen: Well no, this is the thing, the Fed economists in Washington were bragging about the fact that they made money on QE and they don’t understand. To your point though, Yra, what Powell has to do is get up and say, “We’re going to be selling some bits of the portfolio to help accommodate the treasury’s issuance and to rebalance because it’s far too long.” And they can do that in a variety of ways, but then he’s got to look at them square in the eye and say, “By the way, this going to reduce remittances for years.” They have a little account called the negative asset; they came up with it, where they put the losses. The congress capped the Fed’s capital at $40 billion when they confiscated the surplus for highways. So this is the situation you have and they don’t want to be insolvent. If there’s a big number in this contra account and they have $40 billion in equity, people can do the math. That’s the politics of this. It’s very strange. You got to realize that they are central bankers, they are very funny and it’s a big factor.

So, if Powell will change that? That’s a big deal.

Peter Boockvar: I think also a key factor is how much control these central banks can have over their external environment. I am of the belief that markets are going to force their hands. I still believe that cyclical inflation pressures are going to force their hands whether it’s commodity prices, wages or supply chains. I read an article yesterday on the front of the Wall Street Journal on how it’s almost impossible to find a truck to deliver your goods and people are paying hand-over-fist to just try and find drivers. I don’t think it’s necessarily fully in their hands. I mean Powell is going to have to start watching the German 10-year yield every day. Behind the scenes, obviously, a liquidity flow is turning into more of a drip and that all of these central bankers have to look at each other because what one does is really going to influence what the others do both on the upside and downside. When you think about this rise in interest rates, as some of these banks start raising, it gives other central banks cover. So, you’re less inclined to keep rates low if other people are doing it on the upside just as we saw the reverse. Peer pressure cut the rates to nothing and it’s going to do the reverse on the upside. I think that also feeds on itself. I am just amazed at people believing that this is going to be a smooth process and historically it never is.

Christopher Whalen: It’s even worse now because they took cash flow out of the system by forcing rates down. Forcing rates down is a debtor-friendly policy. It’s meant to transfer value from savers to debtors. So now, you have more volatility in the system because it’s less cash flow. People also have very little fat. There’s not a lot of embedded savings in the system from carry because your assets don’t throw off that much cash flow. It’s stunning when you look at Bank of America and the gross yield on their book is 4% — They’re not making money. The whole industry has got a negative risk-adjusted return because the return on assets is so low. In fact, I think that the number for the industry now if 0.75% on earning assets across the board. It used to be over 1.00%. And so the central banks by constantly forcing rates down, they’re taking carry out of the system and it’s not good – It’s deflationary, ultimately.

But I looked at the debt thing, Peter, and I totally agree on it. I’m going to have a lot of fun watching this. I was doing comments today for one of the regulators on whether or not they should allow different credit scores for underwriting loans – What do you guys think? Do you think that’s a good idea to have more than one way of measuring something like that?

Peter Boockvar: It makes sense.

Yra Harris: Yes, it would. I think the whole cycle from a private perspective, you know having my kids go through this stuff, and honestly it’s ridiculous. It’s truly ridiculous in the way that they measure it and they hold everyone accountable to the same standard. I know, it made the banks comfortable with time and there was a need for it, but if I ran a small community bank I would never do business like that. And I know they saddle with them. That’s not how you properly do business.

Christopher Whalen: Well, that’s what I’m telling them Yra. Like you said, the government shouldn’t be in the business of picking one. You let the people who underwrite loans figure this out and then the markets are going to tell them whether they like it or not because they’ll price the pools accordingly. So, I think we can figure this out real fast.

FRA: Just as a final question if you can go around to give your thoughts on where central bank: monetary policy and government fiscal policy is going this year in 2018.

Your thoughts, Chris?

Christopher Whalen: Well, for monetary policy I think that they are going to try and stay on the program as far as rate increases. But you get the 10-year stuck and it keeps moving Fed funds up – You’ll have a flat curve. And I think they’ll have to stop at that point.

Fiscal side: I don’t see any inclination of discipline in Washington – It’s a train wreck. They’re going to have to figure out a way to raise some revenue otherwise we’re staring at some pretty scary deficits. And I think eventually the credibility of the United States will suffer.

FRA: And Peter?

Peter Boockvar: Well, I think the weakness in the dollar is beginning to reflect the worries of those depths and deficits. That maybe we do have a $1 trillion budget deficit again in 2019. Obviously fiscal policies, in terms of tax cuts, are in place. Everyone’s got their fingers crossed that it actually improves economic growth as opposed to just improving earnings per share. We are seeing some wage growth which is a good thing, but one thing that we’ve seen is that the assumption on Wall Street was that the tax cuts all that would flow to the bottom line and we’re seeing that not all that will flow to the bottom line.

Christopher Whalen: Oh yeah. And the repatriation narrative is infantile. I cannot believe that people with PhDs in economics can sit there and go on and on about how cash is going to be brought back and invested in the United States. That’s not the way corporate finance works.

Peter Boockvar: Yeah, and a lot of that cash has been spoken for anyway with all the debt accumulation to buy back stock. So companies have already frontloaded the repatriation by taking on all this debt.

Christopher Whalen: Of course. But if you look at tax shelters like you saw they hit the Goldman because they are the great tax shelter shop. And a lot of that stuff is not going to come to light. You think everybody is going to go to the IRS and turn themselves in? The case with Dow last year that the Supreme Court declined to hear was a big deal. Donald Trump has the same tax lawyers as Dow. Trust me, the IRS now, any corporate they go to sham partnerships with as tax shelters, they basically just have to write a check. They have no appeal. There’s trillions of dollars at stake here. Trust me, these corporates are not going to come forward and say we did this wrong. Nope.

Peter Boockvar: I continue to believe that the other side of the easing mountain is upon and that creates the biggest risk for markets and the economy. People say that we’re not going to have a bear market until the economy goes into a recession and I argue that it’s going to be the rise in interest rates that leads to a decline in stocks that then leads to the recession. A trillion dollars of liquidity coming out from the Fed just in a loan is going to be a big deal as we deeper into the year. That’s what we have to look forward to over the next 2 years. The Fed taking out a trillion in loan the next 2 years after beginning that last year, the ECB ending QE, and that’s a $600 billion reduction in their run rate in 2018. And then the elimination of negative interest rates. So that’s what we have to look forward to over the next 2 years in terms of interest rates and I don’t see risk assets just whistling past that.

Christopher Whalen: Oh no. Look, everything is compressed. The whole curve is going to expand. Yra?

Yra Harris: Yeah, everything that was talked about and then you throw in the infrastructure spending package Trump is going to get through. I mean he’s not only selling the world today. You should watch how he probably hijacked Davos because they couldn’t lick his boots fast enough and he’s disruptive…So he’s got all this more debt coming on. He’s got really got discussions going on, in the United States of course, about financing debt. We are going to find out if his interest rates are going higher. We know the answer to it, but the rate of the world is going to have to find out. You have the ECB who took the Bernanke model and did everything they could to explode it with the amount that he could buy and he’s still…Peter and I know, he’s going to end in September, but it’s going to have a massive amount of assets on that balance sheet in the ECB and with the Germans breathing down their neck…There is nothing good going on there. There is nothing good and it’s going to come back to haunt. Now we have Joe from China and he’s reminding us about Minsky. The Chinese are reminding us about Minsky so we know we are in a very difficult situation and the world is just sleeping through it because you wake up in the morning and you see your stock portfolio is doing a whole lot better so you go, “What’s the difference. We’re all good here.” And they carry on. So, I think it’s going to be this year. I don’t think it’s going to wait for 2019. Some of these issues that people have chosen to pretend don’t exist. And it’s all bound to, we always know it. I think the 3 of us would agree that all crises come up from the debt market. Credit and debt markets determine everything and we’re there. It’s just what’s going to be the actual start that sets it off. I am not sure. I do agree with Peter that it’s going to be central bank oriented and it’s going to come as a change of direction. I think, Christ, you would agree with that too, it’s just how they do it. And Jerome Powell is going to be an interesting guy to see how he reacts to it.

Peter Boockvar: I think a very important question is: Where is the out-of-the-money put strike price right now on the Fed? What level, what percent decline, tells Jerome Powell that he needs to stop his tightening or reverse it? I think that’s going to be an important question.

What’s his tolerance level if these asset markets reverse themselves?

Christopher Whalen: But that’s an important question you’re asking because the tolerance level was very low. In other words, they wouldn’t tolerate any market upset. With Powell, it may be a little different.

Peter Boockvar: Because Powell has more tolerance.

Christopher Whalen: Yeah, I think he does.

Peter Boockvar: I agree.

Yra Harris: …Selloff in the equity markets? I don’t know.

Christopher Whalen: That’s the question Yra.

Yra Harris: Yeah.

Peter Boockvar: The irony is that you get a 20% correction then you’re just back to where you were last year.

Christopher Whalen: Oh, Powell has an easy button on his desk. The question is: Does he push it?

Peter Boockvar: Right.

Yra Harris: Yep, I think that’s absolutely right.

Peter Boockvar: As we speak, interest rates are breaking out today. The 10-year is up to 2.67% now. The 3-year is approaching 2.13%.

Yra Harris: And the Europeans…Today they’re not the catalyst; other times they are the catalysts. I’m interested to see it.

Peter Boockvar: Yeah, the dollar rallied for a couple hours after Trump tried to defend it and went straight back down again.

Yra Harris: And you know what? We didn’t even get into our discussion with the Swiss because they get the alchemy award of the last millennium. The game that they played here and pulled off is unbelievable to me. It tells you about the state of the world…

Christopher Whalen: Well, Peter’s right. They could take a loss on all that corporate exposure that they have. That would be a lot of fun.

Yra Harris: You know what, Richard, they finally admitted now that they are going to be the cryptocurrency capital of the world. They have been the currency capital of the world. But I think that is absolutely right. And it’s interesting, Peter, that is the Yen that turned when Kuroda was speaking at Davos today. The Yen turned very hard.

Peter Boockvar: Yep, it did. He said he’s getting more comfortable as inflation is going to their target.

Yra Harris: Yeah, and I think the Japanese are waking up that the Trump administration is not too happy with the Yen being so relatively weak. And Draghi and Kuroda can pretend all they want…And what was that comment yesterday from that one guy, and I know that they went back to that damn G20 meeting in Washington, which I kind of thought that they would, but he said, “Monetary policies that have a negative effect on currencies, that’s just an effect, that’s not a targeted currency.” Right…And that’s why every central bank when they release the statement about their interest rate intentions cites the level of the currency. Everybody in the United States, that is. Everybody talks about the level of the currency. Everyone discusses the level of their currency as being one variable in determining how they’re going to set interest rates.

FRA: Interesting times and great insight on the credit markets, financial markets and the economy. Thank you very much gentlemen for being on the podcast programmed show.

Great discussion.

Yra Harris: I’d love to do this again. This is great.

FRA: Just as a final word for our interested listeners. How can they find more information about your work, Chris?

Christopher Whalen: Just go to my website: www.RCWhalen.com. It’s the same handle on Twitter. And the Institutional Risk Analytics which is a free newsletter.

Peter Boockvar: Go to www.BoockReport.com and look at the asset management business: www.Bleakley.com.

FRA: Great. And finally, Yra?

Yra Harris: You can find my blog at www.YraGHarris.com and sign up for Notes From Underground which is also free. Whenever I write which is sometimes 4 times a week or sometimes 1 time a week will be sent you. And listen to the FRA podcasts. I think that they are very informative.

FRA: Great, thank you guys and maybe we can all do this together sometime.

Great discussion.

Yra, Peter, Chris: Thank you.

Transcript posted by Daniel Valentin

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.