Odd Lots - Jim Grant Sees an Era of Higher Rates That Could Last For Years

Episode Date: June 5, 2023

If you think interest rates seem high right now, you might be operating with too short of a perspective. For a longer-term perspective, you'd want to talk to someone like Jim Grant. On this episode of the Odd Lots podcast, the founder and editor of Grant's Interest Rate Observer and a long-time financial commentator talks to us about why we're at the beginning of a longer-term trend of higher rates that could last decades. He argues that investors will struggle to shake off years of "buy the dip" behavior, a ZIRP mentality, and a misplaced faith in the Federal Reserve. We also discuss what it means for market behavior today.See omnystudio.com/listener for privacy information.

Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing

corporation distributor. Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, All Thoughts on Amazon Music. So and welcome to another episode of the All Thoughts podcast. I'm Tracy Allaway. And I'm Joe Wexonthal. Joe, did you see the Joltz number that just came out? We are recording this May 31st, 2023. I did. Job openings back up. You know, that's the thing. Like they keep thinking, oh, the labor market's going to cool. It's going to cool. But here we are. Over 10 million job openings again. Right. So job openings far exceeded, I think any analyst. estimate, 10 million openings for the last month. And I guess the question is, the market seems to be

of two minds here, right? You have a lot of people who seem to be talking about the inevitability of recession, and yet you have the data that's still coming in stronger than a lot of people are expecting. And of course, you know, those two things are related because of data keeps coming in stronger than expected, then maybe inflation doesn't start to go down and the Fed has to hike even more, and it pushes the economy into recession. But it does feel, like not only is there a lot of doubt at the moment, but we're sort of heading in two possible polar opposite directions. Well, the thing that I keep coming back to is striking is if you told someone, you know,

at the beginning of, you know, January 2020, you know, when rates were at zero that by spring 2023, we'd be at five and a quarter on the Fed funds rate. Everyone's like, oh, you know, the market would have crashed. We'd be in recession, et cetera. And yet here we are with 10 million, more than 10 million job openings. And something that we've talked a lot about is like, you know, the entire 2010s was sluggish growth. And everyone's like, oh, this is the pickup. This is when inflation is going to come back and it doesn't.

And so far this decade, it feels like, okay, this is finally when inflation is going to roll over. This is when the recession is going to happen, et cetera. And these expectations get kicked forward. Absolutely. And I'm glad you mentioned interest rates just then. And I mean, the implication is kind of we've had years of people warning about what's going to happen when interest rates rise. is it going to lead to an explosion in interest rate costs and things like that? And, you know, we have seen some bankruptcies, but we're still sort of at this inflection point, it feels like.

So I am very pleased to say that we have the perfect guest for this episode. We are going to be speaking with the man, the myth, the legend, Jim Grant, the founder and editor of Grant's interest rate observer and a longtime commenter of financial markets. I've been a fan of his work for many years. So I'm so glad we can finally have them on the show. Jim, thank you for coming on. It is lovely to be here. And yes, interest rates are a thing again. I began to doubt the efficacy of my business model. People are observing, people want interest rates observed again. It is a good time for observation. Well, maybe that's a good starting place, but how would you characterize the current period in markets versus, you know, the trajectory of history? You've been through and written about

many interest rate cycles at this point. Well, first place, I would call it good copy. This is what we're like. It doesn't matter up or down. Just give us some good copy. Yeah, we don't want peace and quiet. Well, there are so many singular features and dogmatism has been, I think, I hope, has been expunged from the conversation.

It's hard to dogmatize after 2020, 21 and etc. What is new and different is, for example, interest. rates have gone from nothing to five plus in the short end of the yield curve, and wouldn't you suppose that the home builders would have taken a big, but instead the home builders are right behind Evidia as the stocks and what you would think that they produced computer chips rather than two-by-fours, but the home builders made new highs recently, and that, you know why? Because rates have kind of put interest rate handcuffs on people who are in possession of one of these sweet mortgages beginning with the numbers two or three or four. I think most of the homeowners now

that have loans have something less than five. So people aren't moving and there's no supply, oh, I exaggerate slightly, but there's little supply and the home builders are hot-footing it into that gap and they are coining money with huge margins and great perplexity all around. So you're speaking our language, like on multiple levels. You mentioned a semiconductor with NVIDIA, two by fours. We talked lumber. We've talked homebuilding. So what does that say then about our efforts to fight inflation? You know, we think of housing as like the ultimate rate sensitive sector. And yet here we have home builders close to all-time highs despite the surge. What does that say about, I don't know, perhaps the Fed's toolkit in fighting this kind of inflation?

Well, the Fed only about two weeks ago was propagating it. All the central banks of the world for years and years were bemoaning the fact that could not hit their 2% arbitrary, mind you, the arbitrary 2% inflation target. And the Fed as recently as the Jackson Hole speech of what, 2020, that remote Jackson Hall conference, Chairman Powell said, you know, we are going to search for a flexible inflation target, and if it's too low, we will overshoot and thereby bring the average over the cycles up to more than 2%. Now, that was, it seems to me, that was kicking sand in the face of the fates.

Right. And so there's a bureaucratic dogmatism in the Fed. They've got these algebraic models, my goodness, how formidable they look on a blackboard, but they don't actually function very well so far as the future is concerned. And the Fed was, in fact, dogmatic through 2021 into 2022 by mortgages recently, I think, is March 22. So you ask about their inflation fighting tools, uh-uh. They're rusty, should be you say. Well, just on that note, I mean, walk us through,

why haven't the interest rate increases fed into the real economy more? Like, why are you not seeing house prices go down? Why are you not seeing the much anticipated wave of bankruptcies that people were warning about for, you know, many, many years after the 2008 financial crisis? Well, I think house prices have, in fact, gone down. Is this phrase, existing house prices? That is the ones that are not imaginary. So existing house prices are down, new house prices are down from their peaks.

You know, 8, 10% of it, memory serves. But the point is well taken, Tracy, that, you know, the phrase I think, something will break. Right. And I was of the view, am of the view, that try as J. Powell might emulate Paul Volker. Mr. Powell is not working with Paul Volker's economy. It's much more dead. therefore much more fragility.

You know, people are head over heels, over private credit. They contend that this is a not quite Navidia quality breakthrough in history of finance, but it's up there. But, you know, private credit is a manifestation of the seem imperative to build leverage, whether it's on the federal level or the corporate level, not quite so much recent years on the individual level. So there's a lot of leverage, and I would say, Tracy, that with respect to the paradox of nothing breaking much yet, just be patient.

I expected it might. It's coming. Where do you see vulnerabilities? You mentioned fragilities. Where are they? Private equity is one. I think private credit will be shown to be rather oversold as a breakthrough. I don't think it's any such thing.

Actually, how do people think about, why do people think that there's something special about private credit? Well, I think the story goes that the vendors of private credit. the lenders of private credit are more flexible. They have commitments by their limited partners to supply funds. They are not constrained by banking regulations. They are kind of a new breed, so the story goes. But, you know, they are lending to an important extent to software companies, which famously lack gap profitability.

They are lending to the very same people that the public credit markets are lending to, they're doing it at a somewhat cheaper rate. They're not doing it on a rated basis. So Moody's is not getting a ratings business it did. I don't know. The whole private credit business sounds to me as if it were the same wine in slightly more presentable bottles. Just on this topic, there's a line that you wrote many years ago now, and it kind of lives for free in my head. And it's slightly random, but it's basically invalient a financialized age has produced a financial.

financialized pharma company. And I used to think about that quite a lot in the context of Valiant, of course, you know, they borrowed a lot from markets cheaply. They bought a lot of companies. They used interesting accounting techniques such as ad backs to boost their valuation so that they could keep borrowing. And I wonder how much that type of financialization, in your opinion, is reflected across the market and across the economy, not just a Valiant specific type thing. I would say that it is rather endemic. I guess we ought to define it. What I mean by it, Tracy, is the finance for the sake of finance, not for the sake of making a better product, but finance for the sake of making money through structure, through fees, and the like.

That's financialization. And you see it, again, in private equity, there's this thing called adbacks. Adbacks are a form of sly manipulation of cost structure. So you do a deal, you buy a company, and you say we will lever it, meaning we will encumber it with debt to the extent of six and a half times EBITDA, this kind of non-gap measure of earnings. And the reason it's 6.5 and not 9.5 is because we project savings through the great managerial improvements. private equity invariably introduces to its... Synergies. Synergies everywhere. Yeah, to its portfolio companies.

And don't you know that S&P does an annual ad-back study? That's the age in which we live. There is an ad-back study from that. You can wait for every year. And it shows that most of these promised savings, Tracy, don't be shocked. Don't materialize. But the fees surrounding them are paid. So that's an example.

One micro example of financializations, I think it's all over the place. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day.

But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio.

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factoramills.ca. Factor, Canada's number one ready-to-eat meal delivery service. Since you mentioned NVIDIA twice already, I feel like the NVIDIA chart would make very, a lot of sense to me in the year 2021, or maybe 28, 2019, you know, during the sort of like ZERP heyday when we associated low interest rates with booming tech stocks. But here we have the chart. It's not ZERP anymore. We're at five and a quarter percent. And yet that hasn't extinguished this sort of like animal spirits of the market to pile into some like really hot area because, you know, AI is really exciting. What does that say about, you know, some of our

assumptions about the relationships between investment and animal spirits and speculation and rates when we see this sort of activity at a time of five and a quarter interest rates? You know, the wonderful thing about financial markets is that we keep on stepping on the same rake. There's in science, you know, progress is cumulative. We stand in shoulders of giants, but financial history is invariably cyclical and recurrent, which helps a lot, if you can recognize patterns. Scott McNeely, who is the CEO of Sun Microsan, I gave that terrific little speech. I guess on Twitter maybe it was an exasperated and rueful expression.

It was kind of a postmortem of the dot-com bubble, which now is so deep in the historical myths. But the son was trading that at 10 times earnings. And Mr. McNeely said, what do you have to do? No, 10 times revenue, right? Oh, sorry, revenue, of course. Sorry, I didn't mean that. I just want, but I think it's important to understand.

That's the laugh line. Darn. Okay, sorry, sorry. So what he would have to do, what do you have to break even with 10 times revenue? Well, of course, 10 years, I would have to send you every single dollar. So no more R&D, no more salaries for the employees, no taxes, oops, no taxes, et cetera. So he went through this exercise and he said, and at the end he said, why did you pay 10 times revenues? Okay.

And if he is like 35 times revenue. So it's 35 years of that. No cost. No employees, no CAPEX, no R&D, no taxes. I read somewhere that Dividea is introduced AI, which is Tanabaat, in fact, equal to, yeah, equal to Tanama, the invention of fire. It's a new fire. Tam on that's got to be huge. That's always the warning sign, right, Tam, when people start talking about total addressable market size.

I have a slightly personal question, but I've always wondered this. Do you consider yourself more of a journalist or more of a financial? analyst? Journalist. Journalist? And how does that influence your work? I hired Evan Lorenz. He's the great financial.

Yeah, he's great. He's very good. But how does that inform your own work? Evan! Well, I started not quite a one-man band. It was never exactly a one-man band. This is our 40th year.

But for many a year, there was no Evan. There was often someone to lend a hand. Yeah, there was a lot of help. I have gravitated to, to journalism, I think, more than the really deep diving financial analysis. I'm interested in history as well, have read a lot, written some. You wrote a book on Badgett, right? Yes, I did.

Walter Badgett is kind of the muse of contemporary central banking. They invoke his dictum about, in a crisis, they will say the contemporary central bankers will say, lend freely to everybody, which is a very much a paraphrase of Badgett's lend at a high rate against suitable banking collateral to solvent institutions, etc. I just want to say, I thought you must have been exaggerating when you said the 35 times revenue, but you're like, I was like, that cannot be right. It can't be 30 X revenue. But no, fiscal year 2024, the estimate for Invidio revenue is 40 billion. It's a trillion-dollar company.

And so, yeah, we're basically at... It looks like a typo. Yeah. But we published it last night, and I say, no, let's, please. This can't be... Because even, like, look at fiscal year 2027, currently on the Bloomberg. I find this, it's totally $77 billion. So even, like, you go out to $27, you're still, like, a 15-X-2020.

Or 14-2027 revenue. Bloomberg, which can get anyone on the phone, ought to call up Scott McNeely and say, what now? Let's do that. Let's do that. That's a really good idea. Scott's really, those earnings calls, back of the day were really fun. Can I ask a question? You know, you mentioned dogma. You mentioned

the Fed's rusty inflation fighting tools, which, you know, maybe understandably because for the previous decade or really even longer, maybe, the impulse was reflation and why are we missing on the downside, et cetera. What did that period teach you as a historian of financial markets, a student and someone who's like, what did the period of like 2009 through 2020 in which we had large deficits. We had this exploding size of the Fed's balance sheet, and yet this sort of inability to generate inflation. Like, what was your sort of like looking back on that decade? What is it? Well, it was very humbling for me. What I took away from it is that the inevitable is always certain, but not always punctual. I looked back in some of my work there,

and I was rather impatient for the inevitable difficulties and crises attending upon this credit creation, jag. I thought certainly it was going to happen like a Tuesday or so. But, but, so it's like the elapsed time between the first signs of house prices going way above trend on the one hand, and the onset of the housing-related credit difficulties of 2007, 8, and 9. That period of six years was approximately 20 years in journalistic time, if you were a little bit too insistent upon. Well, just on this point, let me ask a sort of devil's advocate question, because I had, you know, a similar trajectory sort of, I wouldn't compare myself to you, obviously, but, you know, post-2008, I wrote a lot about excesses in the corporate bond market. And it seemed very clear to me

that eventually this would blow up. It didn't really. And, you know, we could argue that maybe the time is coming for some of those excesses to get flushed out of the market. But it does feel like the solution to a lot of financialization is more financialization, or at least it has been so far. So for instance, with corporate bonds, when there was stress in the market, the central bank comes in, props up the corporate bond market through the bond buying program. Why can't that continue forever? And like what is the tipping point at which financial solutions to financial problems is no longer

viable? A tipping point was six years ago. That's very specific. My impatient clock, it was a long time ago, but it did not tip. So why can't it go on for a ride? I know there are always, these excesses do crop up. They are met with additional stimulus intervention, manipulation, and still we go on. Who was it who said there is a deal of ruin in a country? I guess it was Adam Smith. and there's a great deal of ruin, so to speak, in finance and manipulated finance. One of the singularities of the present time is the American position in international finance. Countries emits the reserve currency, which means that we consume much more than we produce.

We finance the difference with dollar bills that only we can lawfully print at a most reasonable price of like nothing. and we remit the dollars to our creditors, mainly in Asia, say, and those dollars don't leave the country because they come back in the shape of treasuries and mortgages purchased for the portfolio interests of our creditors. So that is kind of a new thing in the long historical.

It's not so new in terms of years, but in terms of phenomena, it's a reserve currency country being a chronic big debtor. That's kind of a different thing. reserve currency country living on the kindness of strangers, so to speak. That's not exactly writ. So the more one learns, the less dogmatic one becomes about timing, certainly. Well, that actually leads to the exact next question, which is, you know, obviously currently today in 2023, there's yet another round of, oh, is the dollar going to lose some,

it's global status. But we've been hearing that forever, right? Like, we, you know, we heard that certainly after the great financial crisis, I think, you know, pre-grade financial crisis. There was a lot of talk about the euro, and we've talked about in the show, and, like, you know, who is the model that flashed euros on the, like, you know, this is not a new thing. So when you think about, like, okay, like timing is really tough with this stuff, like, does it feel new? Does this moment feel different than past times when people had dollar status anxiety? Well, some of the rhetoric's the same, you know, that I guess by definition, the excesses are

greater, the U.S. international financial position, which is a piece of data that comes out every year about this time, ever shows a deepening deficit between what we own of other countries' securities and businesses versus what they own of our securities and businesses and other security and public security. So the deficits deepen, but still what's the competition? Turkey is mad at us wants a different currency. Iran, ditto, China, and the Russia are the same, but I don't see those as strong competitors for an alternative currency. I see gold as a perennial option, unfortunately, too few people share my enthusiasm for that. I wish you, perhaps Bloomberg could help along those lines as well. Well, just on this note, I mean, we were talking about Nvidia,

when you see markets react like that, what do you think is happening there? What is the thought process of an investor who says, I'm going to buy in video when it's up 40% in three weeks? Well, I think a couple of things. First of all, again, under the heading of You Never Know, which I have come to embrace as a sound journalistic and life principle, there is a possibility. This time, it is the invention of fire part two.

So one holds mindshare for that. I think more likely is that this is part of the muscle memory of a generation of zero percent interest rates and all you can eat credit. The great all you can eat credit buffet table was open for business for 10 years. Interest rates fell from 1981 until a couple of, actually a couple of weeks ago. It's called 40 years. So that's a lot of muscle memory. Central banks have intervened predictably. until fairly recently when markets shuttered.

Look what happened in 2019. You know, the repo market, this obscure recondite thing caught a head cold in September, and the Fed resumes QE didn't call it QE. It's not QE. Yeah, it was QI. So naturally people assume that the upside is the side to be on. It takes a true contrarian, most bloody-minded contrarianness to butt one's head against that, but it's a living.

So why do people do it? Because A, because cyclical memories are short and cycles are recurrent, and B, because it has worked. Quote, that phrase ought to be in quotes. Eating well shouldn't be complicated, but somehow it turns into recipes, prep, cleanup, and half your Sunday gone. Factor solves all that. These are fresh, ready-to-eat meals designed by dieticians, delivered to your door, and ready in just minutes. No prep, no cleanup, no excuses.

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right now. It's funny you're talking about like the memory of ZERP or the memory of 40 years of declining interest rates. Right before you walked in, Tracy and I were talking about like, you know, the real estate market and I've sort of been looking at maybe buying a place. And the one thing you always hear from people is like, oh, well, like rates are high now, but you maybe you'll be able to refinance lower in a few years. And when every time I hear that, I'm like, I mean, that would be nice, but like there's no guarantee of mean reversion. And, you know, what were they like 18% in the 1980s? Like, could we go back? Yes.

Could I see teens fed rates in my life? Yes, you could. There's a property about interest rates that I find intriguing. My interest is not widely shared, but here is my reading of the question, the great question, whether rates are mean reverting. So what characterizes interest rate movements is their generation length phasing, not necessarily cycles, where there are phases. The interest rates fell for the last quarter of the 19th century,

rose for the first 20 years of the 20th, fell from 1920, 46, rose from 46 to 81, fell from 81 to call it 19, 20201. So at each juncture, there was some mark of excess, some mark of speculative excess blow off, like certainly in 1981, you know, a 20% plus funds rate seemed excessive, a 14% yield in 1984 in Longbond when the CPI was printing at four or five. that seemed excessive, 10 percentage points of real yield, that seemed a lot. So I speculate that we are embarked on a long cycle of rising rates.

And I say that, first of all, for reasons of pattern recognition, there's no theory behind it, but I observed that in 2020 and 21, some unimaginably large number of debt securities were priced to yield less than nothing. Bloomberg keeps this particular figure. And I bet still, perhaps you could check me on that, I bet still there's like, $100 billion of bonds price to yield less than nothing worldwide. But there were 18 trillion, I think, at the peak. Most extraordinary expression of unqualified bullishness on an asset class

because it had the name of bonds, which had been falling in yield rising in price. So, no, it would not surprise me at all if we were embarked on something resembling a generation-length bare market in bonds, meaning rising yields and falling prices that would fit the form. Could you get, you mentioned the idea of embarking on a long cycle of higher rates. Could that happen even with a recession in the States? Because this seems to be the bet that everyone's making, right? That inflation isn't coming down. And so the Fed's going to have to hike, and inevitably that will lead to recession.

And then cuts. Yeah. Starting in 1958, something strange happened. And people at the time remarked on it, which is that in a recession, prices did not fall or subside. And that marked the, what proved to be, the beginning of the age of inflation. So fast forward to the 70s. Seventies is kind of a trite historical marker. You know, it's never going to repeat exactly. But for what it's worth, in the 70s, interest rates did fall and rise as the business cycle changed. But inflation came and rose and subsided in three

different phases. It wasn't a straight line. So yeah, it was just a we could have a recession and rates pull back and then they resume the rise. So the cycle... So the long-term path would be upwards in terms of interest rates, but not linearly. Yeah, for example, from 1946 to 56, the movement up in the long-dated

was 100 basis points, 1% of it. That was it. Went from 3.5, basically from 2.5 to 3.5, over 10 years. So this is rather glacial. This is kind of geologic. Yeah. So that's why one can forecast these long cycles with, especially if one of the 76 and a half years old without any anxiety about being laughed at.

But to your point, I mean, it makes sense. I mean, look, as you mentioned, that 40-year cycle basically through, I don't know, two dozen, whatever, it's not like it was only down. I mean, we had up cycles in the 80s and the 90s and the pre-DFC. It's just that the long-term trend was lower highs each time. And so potentially the idea here is, okay, maybe we do get a cutting cycle a year, but it's lower lows each time. So what happens? So rates peaked in 1981. In 1984, there was what the technicians called a retest of those highs and yields.

And everyone on Wall Street, who was anyone, was on the side of saying that rates will go back up again. And the Longbond did go to 14 percent in 1984 when inflation was less than, I think, five percent. So I think one of the least appreciated forces in Marble. or factors, as they would say, is simple condition behavior or muscle memory. So just on that note, I was thinking back, I used to have a grandparent who lived through the Great Depression and had food hoarding problems because of this, because she hadn't had a lot of food when she was growing up. And so in her later years when she had access to food, she would buy a lot of it and store it. Are markets, I'm assuming markets are ill-equipped

to deal with this kind of generational shift. You have people, Joe and I, certainly, you know, for 40 years, have been striving for any sort of return, any sort of yield. We've only recently started earning, like, significant bank interest on our savings accounts. Isn't it pleasant? It's so nice. It's lovely being a rentier. Money for nothing.

You could probably make some money if we, like, plug which online bank you did. But don't do it. We've got to get them to pay us. Until they pay us, we're not going to. Right. Hold out for that. Yeah, yeah, exactly. Right. And I'm aware that, you know, the real return is still negative, but it's still nice. But how would you expect markets to adapt to this shift? Well, if it's slow enough, they could adapt easily. The great shift to higher races, as I mentioned, it took 10 years to get started. I remember my first job on Wall Street.

I just got out of the Navy, and I was a, before I went to college, I was a clerk on a Wall Street trading desk, and I came home. And the New York telephone, long-dated sixes, the sexy sixes of the call, and I told my father, what everyone says, Dad, is that the 6% yields are, this is something special and you have to avail yourself. So I'm not sure where the New York telephones were in the year in 1981, but they were not at 6%. So you have to pace yourself, but there's often plenty of time to adapt. But, you know, there's opportunities in the non-adaptation in a great bond bear market.

All sorts of strange things happen. For example, call protection goes for free. because no one expects rates to go back up again. So you can buy call protection without any premium. When you look at these long shifts, these multi-decade moves, how much is it about maybe politics or just shifting ideas? And so, you know, I'm thinking like part of the reason I think many people would say we had such a powerful and aggressive fiscal response to the COVID shock

was the memory of the weak recovery coming out of 2008, 2009, and this sort of like years of slow growth. It's like, okay, we're not going to like make this mistake again. We'll make another one. We'll go, yeah, we're going to overshoot in a different direction. And so how much of like these, like when you look at sort of like long shifts and obviously like that Volcker era and some of those ideas, some of the supply side ideas from the early 80s, like those are ancient, those are old memories. Like people forgot it.

And now people have different ideas. And now people talk about like state capitalism and public investment. How much do these like long cycles sort of correspond with like essentially. ideas that are invoked. You have to wonder whether the direction of causation, Richard Russell, who's a marvelous technician and thinker about markets who was no longer with us, it was the author of the epigram, Markets Make Opinions. And I think there's something to the idea that phases of economic life, whether they be markets or in nine to five world of actually producing things, as it were, that the background music

of enterprise kind of conjures ideas. I'm not sure if ideas cause that maybe they might. These ideas are recurrent. I mean, I'm told that generation, what comes after Z, A? I don't know. I don't know. Whatever my daughter, I don't know, I've got to find out what that is. They're socialist, apparently. So we'll reinvent that one again. I don't know. I've given you a very poor answer to an excellent question, Joe. That's all right. Well, just on the notion of these long-term cycles maybe starting to shift. It does feel like, you know, previous decades were about sort of lower interest rates. And during those previous decades, we basically built the financial system around the assumption that government bonds are the safest thing out there.

Super safe. Yeah. Yeah. Government bonds, you know, the yields don't move around that much. And yet, in the previous year, we have seen big question marks around the safety of government bonds and the stability of yields, which have resulted in a few things breaking to your earlier point. We saw troubles at the bank, the Fed reporting and accounting loss on its own balance sheet. What does it mean for the financial system as we move into potentially a higher rate environment or a higher vol environment for rates? I think one of the ideas that has sustained markets over the past, call it generation, is the idea of Federal Reserve competence,

the notion that people at the Fed know what they're doing and can make things happen. They are weather makers in finance, and they're responsible for the great moderation. They're responsible earlier for Paul Volcker responsible. So I started with Paul Volker and his mastery of the inflation problem.

So I think that the Fed will be revealed as a bunch of well-intended people who are involved in a kind of pseudoscience and people wake up one day and say, I've noticed that my weather app is accurate for a day or two, but out ten days I wouldn't trust. I wouldn't bet my dog's life on it. And yet, we listened patiently, even reverentially,

to the economists at the Fed, to talk about what's going to happen next month or next year. They know nothing. I mean, the future is a closed book. The screenwriter named Goldman Butch Cassidy and the Sundance Kid, now they're such great things. He said, apropos of Hollywood's forecast,

ability. Nobody knows anything, said William Goldman. Correct, correct as in the fashion of future. The difference is that the Fed thinks it knows something. It thought it knew something in 2020 when it was going to try a little harder to produce more inflation. It thought it knew something in 2021 by insisting that the problem in front of its eyes was transitory, etc. I don't mean to ask too much of them, but I would ask of them the confess. The confessing that they really don't know. So we will, I think, have that fact, that simple, humble fact

presented to us in a way we can't deny. Not so long ago, I mean, I remember vividly, 1980, 81, when you should have been interested in owning these, they have something called Lions and Tigers. These are trade names for a zero coupon, treasury securities, price to yield, 12, 13, 14, 14, 15%, internal compounding and no reinvestment risk for

30 years seemed like a good investment. However, such was the burden of accumulated loss and the loathing that people felt towards this unrepaying prudely, punitive asset class. It was certificates of confiscation, was the phrase

that bonds acquired. That was the people hurling anathemas at the bond market and at the Fed. And now, you've Did I mention the Fed's broke? No, it is a hypothetical, theoretical insolvency, but to me, it is a symbolic fact of not a little importance.

The only thing that looks more like the Silicon Valley balance sheet than Silicon Valley is the Fed's balance sheet. They earn at two, and they pay at five these days. And every week, they lose a little bit more of their capital in the form of a promise to the Treasury to one day make it up. People gloss over there, say, oh, the Fed can print money, but can't print net worth, right? So the Fed's not going to go out of business because it is insolvent, unlike some of its charges, the banks, but the fact that it, shouldn't the Fed be, maybe shouldn't it be held to the same accounting and regulatory standards as the private banks?

Wouldn't that have forestall the excesses of ZERP? It can set its own stress test, right? Perhaps Jamie Diamond could write a stress test for the Fed. Yeah, the ultimate recipe. I heard myself going off on rather a sermon. I will stop. No, no, no, no, no. I want to actually, you mentioned how, like, if you had bought in, like, you know,

at some point in the late 70s or early 80s, some of these long-dated zero coupon bonds, they would have done fantastically well over some length of time, like some of the greatest investments ever. But you had to deal with those things. first few years and maybe you took some serious sustained losses. And I was thinking about your point about like contrarianism. This is, I mean, this bedevils everyone in the financial industry, the challenge of like, well, how do you maintain some sort of out of consensus position in a period, especially if you're at, well, there's two, there's multiple things, but A, there's the psychological battle of like, well, am I wrong? Is the market wrong? C, like B, like you want to

make money. And C, you might, if you're managing someone else's money, you might not have a very long leash to lose money. What is sort of like you're thinking about like that process of like, okay, like this might be, you don't know the exact timing of when it's going to work and like reconciling these challenges. Well, I have some experience in this. Mine is a, you know, journalists don't get margin calls. A friends of mine who do this for a living, that is to say this, meaning identify something that is not in favor or in phase, research it, gain conviction, and hold it in spite of the scorn and the vitriol of those positions otherwise. That's kind of the game.

Journalistically, all you have to do is have a hard shell. If you're doing it in real time with real money, you either have to have a very, very loyal base of limited partners or investors or be managing your own money. It's hard. I mean, it's wearing. It is not life-enhancing. But when it's right, it's really sweet.

Yeah, you get to do the victory laps. Well, Jim, on that happy note, we're going to have to leave it there. But thank you so much for coming on all thoughts. Well, you are entirely welcome, Tracy. Joe, thank you. That was incredible. It's such a trade. I really appreciate you coming back on.

I'd have a delight. Thank you. We'll have you back on in 20 years where we see what the interest rate cycle is. We'll see what fed funds in the team. Gee, I hope I'll be here. Likewise. Joe, that conversation was really fun. That was a lot of fun.

I mean, we've both read Jim's stuff for years. It's always educational, always historically fulfilling. It was great getting the talk in person. Also, I love that he can just throw out anecdotes like, oh, yeah, this one set of bonds from like. Well, we, there's the thing we could talk for like three or four hours, you know, about like, oh, what was it like, you know, buying corporate bonds for like, you know, AT&T bonds or New York telephone bonds at 6%. And they said, you know, like there's so many stories it would be fun to go down with. Absolutely. But the point that stood out to me was that muscle.

memory idea. And I do think, I think what's happened is it's not just, it's not just by the dip because the Fed's going to do something and save everyone. It's also that I think a lot of people have figured out that momentum is a thing. And even though something looks like a bubble, if you can get out early enough, you can still make money. So instead of running away from bubbles, people kind of run towards them now. Absolutely. I also just think that like, I mean, I definitely feel this these days where it's like the meme stock era, the Zerp era, the Fang era is so recently that it's like, oh yeah, that's normal. That little dip that we had in 2022 and people shunned tech. That was the aberration. But yeah, you see Nvidia and AI, you got to go back to that.

And then I think this gets back to like the rates thing, which is that like 5% or like a 6% mortgage feels really high to people after 15 years of whatever. But it's not, right? Like it's not Not at all, like 6%. And they were much higher throughout the entirety of the 90s and they were much, much higher throughout entirely the 80s. But, you know, for an entire generation, their entire lives of like potentially home buying lives is like basically the Zerpira. I do wonder if the novelty of earning interest on bank savings is ever going to wear off

for me. You know, it's been almost 40 years of not earning anything. And now it's just amazing to get, you know, a few percentage points. I'm so, like, poisoned by the last decade. I can't be bothered to, like, click the buttons to move over for a couple of years. Joe, you've got to do it. Yeah, no, you can have my interest. Money for nothing and negative real returns.

It's great. All right. Shall we leave it there? Let's leave it there. Okay. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloye.

And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. Follow our producers at Carmen Rodriguez at Carmen Armin and Dashel Bennett at Dashbot. and check out all of the Bloomberg podcasts under the handle at podcasts. And for more Odd Lots content, go to Bloomberg.com slash Oddlots, where we have transcripts, a blog, and a newsletter. And check out the Discord. Discord.g.g. slash oddlots.

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