The Breakdown - ‘Absolute Raging Mania’: Famed Investor Druckenmiller Thinks 10% Inflation Is Possible

Episode Date: September 10, 2020

Today on the Brief: Markets recover slightly but vaccine trade falters as AstraZeneca pauses trials  Bitcoin and gold correlation increases sharply around dollar instability Mastercard launches simulation tools to help develop central bank digital currencies Our main discussion: Stan Druckenmiller speaks! NLW breaks down the famed investor’s interview with CNBC today, including:  The merging of the Fed and the Treasury Mania in financial assets  A growing fear of future inflation  Why the next three to five years are going to be extremely difficult

For the first time in a long, long time, I'm actually worried about inflation because we actually have the chairman of the Federal Reserve with a $3.5 trillion deficit lobbying Congress to do more spending and guaranteeing those of us on Wall Street that he'll underwrite it. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The Breakdown is sponsored. by Crypto.com, Bitstamp, and nexo.io, and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, September 9th, and today we are talking about

famed investor Stan Druckenmiller and his sense that there is an absolute raging mania in the stock market, and his belief that inflation could reach five or even 10%. First, however, let's do the brief. First up on the brief today, markets rebound, but the vaccine rumor trade has a scary. First of all, the stock market is coming back after three days of decline. The S&P 500 is up 2.1% and NASDAQ is up 3% after an 11% decline over the last three days. Just like tech stocks were out in front of the drop, they are also now helping the return. However, when it comes to markets, there was a worrisome development on the vaccine front. Regular listeners will know that I've talked frequently about the vaccine rumor trade, and basically, I believe that one of the driving forces in markets

is a belief that somehow, some way, science is going to be able to move much faster than it has in the past to actually push out a vaccine that allows us to get back to something like normal pretty quickly. Now, whether this is or is impossible is to be seen, certainly we've never seen. the sort of capital and intensity and energy poured into a single effort at so fast a clip as we're seeing now. On the other hand, developing vaccines is extraordinarily difficult and might simply not come to pass, so color me skeptical about just how fast we can see this. Regardless of the actual speed, markets have been highly reactive to successful early trials and any sort of detail like that, but today we saw the inverse. AstraZeneca paused tests of their experiments.

shot after a patient became ill. From here, they basically need to figure out if that illness is related to the vaccine or is something entirely separate. And once they do, they're going to be able to resume trials, assuming that it's not related to the vaccine itself. The halt says one Bloomberg analyst shows the perils of rushing to market, and this is really the reason that this is worth paying attention to. Politicians everywhere are promising this thing fast and convincing markets that it will be fast, but this is a reminder that this is mostly just political bluster. It's not science, and it doesn't necessarily mean that it will come to pass this way. Next up on the brief today, let's talk Bitcoin and Gold.

Yesterday, we discussed Bitcoin's correlation to the stock market, and Joe Wisenthal from Bloomberg even made this point again today in his markets column, saying that Bitcoin isn't uncorrelated when you want it uncorrelated. Metrics, however, is showing that Bitcoin's 60-day correlation with gold is even higher than the correlation with the NASDAQ or any other stock market index, at over 0.5. An important piece of this is part of the analysis, so this comes from CoinDesk. The positive correlation has strengthened sharply since the beginning of July, as the U.S. dollar started taking a beating against other major currencies. In other words, exactly as we discussed yesterday, what Bitcoin is

supposed to hedge against matters. And the hedge against fiat instability is what matters more than anything having to do with the stock market, which is incidental at best. Last on the brief today, MasterCard and its central bank plans. MasterCard has launched a virtual testing environment for central bank digital currencies. This can simulate issuance, distribution, and exchange with both financial service providers, as well as end consumers. It's designed to help institutions understand the feasibility of central bank digital currencies, including letting them test against existing payment rails, as well as letting them compare different proposed tech stacks. If you'll remember, Mastercard was a founding member of the Libra Association before abandoning the project,

and even then it seemed to me that it was a real keep your enemies closer type of move. It's clear from this that MasterCard's ambitions don't end with Libra and didn't end with their leaving the Libra Association. It is also an indicator to me of just how much more serious the governments of the world and central banks of the world are getting around digital currencies. I continue to expect this to do nothing but accelerate as China gets closer to launching its DeSep currency. But with that, let's turn to our main topic.

No one person's opinion should be overly lionized. However, there are some people who speak infrequently enough and choose precisely enough when to speak that, when they do, you listen. Stan Drucken Miller is one of those people. He is a famed investor and hedge funder and has been observing markets and leading markets for a very long time. Today he went on CNBC's squawk box to discuss the state of the economy, and boy, did he hit a lot of juicy territory. Before we dive in, let's listen to a clip of what he had to say. I think the merging of the Fed and the Treasury, which is effectively what's happening during COVID,

sets the precedent that, well, we've never seen since the Fed got their independence. And it's obviously creating a massive, massive raging mania in financial assets. And as you just pointed out, Joe, it has not spilled over the Main Street. I would just say that I hear a lot of people on the air, boughting Jay Powell, saying he saved the world. And I do think he did a great job in March. I think the follow-up has been excessive, and I just want all you guys cheering him on to remember the maestro in 2005 and how that worked out. Look, everybody loves a party.

Jeff loves a party. Mommy loves a party. I love a party. I assume you guys love a party. But inevitably, after a big party, there's a hangover. And right now, we're in an absolute raging mania. We've got commentators on your network encouraging companies. to do stock splits.

Companies then go up 50%, 30, 40%, big market cap companies on stock splits. As Andrew pointed out early in your show today, that creates no value, but the stocks go up. Look, Joe, I have no clue where the market's going to go in the near term. I don't know whether it's going to go up 10%, I don't know whether it's going to go down 10%.

But I just want to remind people that there is no valuation support because we dropped 10%. That hasn't mattered because we're so far outside of the valuation realm with the Fed doing what they're doing, that doesn't matter. But I would say that the next three to five years are going to be very, very challenging. And what the Fed has done, in my opinion, if you listen to the Jackson Hole speech on the framework, it was quite amazing.

It sounded like an apology because inflation has been 1.6 instead of two the last 10 year Their mandate is price stability, where I think 1.6 is like they hit a home run. They actually sound like they've been too tight the last 10 years. And look what they're risking in terms of financial stability to hit that 2% mark. My own sort of central case is for the first time in a long, long time, I'm actually worried about inflation. Unless everything I learned about at Bowden is incorrect. De facto MMT, which is what we're doing. right now because we actually have the chairman of the Federal Reserve with a three and a half trillion

dollar deficit out lobbying Congress to do more spending and guaranteeing those of us on Wall Street that he'll underwrite it. I think it's dangerous. I think we could easily see five to 10 percent inflation in the next four or five years. Ironically, I also think he's raised the risk of deflation because I cannot find a deflation that happened because you were near that so-called zero bound. Everyone was preceded by an asset bubble, and he's created this massive asset bubble. So ironically, he's raised the two tails. The risk of inflation is much higher than I'd say it was 12 or 24 months ago, and the risk of deflation. I'm talking like minus three or four percent, because if things don't work out and we get a bust here, that is up. I think

the odds of us hitting the sweet spot, which I would say is around the 2 percent area, which is where we've been, have actually gone way down with the Fed activity. So that was a lot in three or four minutes, but let's break down quickly what he discussed. First, there was the idea of merging the Fed and the Treasury and what that might mean for the future. Second was the idea of a raging mania in financial assets, right? He said we're so far out of the valuation realm with the Fed doing what they're doing. A third bit of what he discussed is something that I'm interpreting, which is the role of the media in amplifying. narratives. Specifically, he discussed stock splits and kind of without naming him, took Jim

Kramer to task for pushing people into those stock splits despite the fact that they create no new value. He discussed the separation between short-term and long-term, in that he was making a medium-to-long-term critique of where things were and what today's policies were likely to do, not saying that somehow the market is suddenly going to turn around. In fact, he was very circumspect around his own knowledge of what the market does next. A key piece, and obviously this relates to the headline of this story, this podcast, is that he said for the first time in a long time, he's worried about inflation and believes that we could even see 5 to 10% inflation. At the same time, however, he thinks that the Fed has also increased the risk for deflation simultaneously. His final thought,

his sum up thought was that the next three to five years are going to be very, very challenging. What's going on, guys? I'm excited to share that one of this month's breakdown sponsors is Crypto.com. Crypto.com offers one of the most cost-efficient ways to purchase crypto out there, as they've just waived the 3.5% credit card fee for all crypto purchases. What's more? With crypto.com's MCO Visa card, you can get up to 10% back on things like food and grocery shopping. When you buy gift cards with the crypto.com app, you can get up to 20% back. Download the crypto.com app today, these offers until the end of September. BitStamp is the original global cryptocurrency exchange.

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mistake or they believe it's a huge mistake that is adding significant risk of inflation, while others are scoffing and saying that there's no way that the Fed can hit these new inflation targets when they couldn't even hit 2% over the last decade. Part of the reason that there isn't consensus on this question is that part of the challenge is structural. As Drucken Miller points out, Fed policy in his estimation has increased the tail of the tail of the challenge. risk of both inflation and deflation. In other words, this asset bubble is setting us up for something, but it's not quite clear what. While there might be no consensus on inflation or deflation, there is, however, large agreement on the idea that financial assets are

exceedingly high in valuation, whether you call that a bubble or not. To take one example, the ratio of the total market capitalization of U.S. stocks to GDP is at an all-time high over the dot-com bubble, even when you use pre-pandemic GDP in those calculations. The ratio of total market cap to GDP stands currently between 187% to 190%, whereas at the peak of the dot-com bubble, it was 167%. And even within the agreement about the high valuation, and the asset bubble nature of markets right now, there is still disagreement on whether there's still room to grow,

or rather, how much room to grow there is. There are many, in fact, more and more who have been forced to operate in a stance of, this party will end, but I can't call it too soon. If you look through the comments on Druckenmiller-related posts and threads on Twitter today, it's a lot of people calling him out for missing this rally, which happened to a ton of these big traditional institutional investor type folks. The reality is there is career risk right now in missing the party.

There's career risk in not taking part in the fastest rise in history. And so even people who are structurally extremely concerned about the nature of a financial asset bubble are forced to participate in it, in fact inflating it more. You can see the challenge here. This is why bubbles, even identified bubbles, continue to inflate. It doesn't matter that you know it's a bubble. If enough other people keep participating in it, you're the one who doesn't make money before the music stops.

One last topic that I want to pull out of Drucken Miller's comments has to do with the relationship between the Fed and the Treasury. Those who tend to be on the side of the Fed doesn't have the capacity, to produce enough inflation, or at least not enough velocity of money, tend to want to see a closer relationship with the Treasury. Druck and Miller sort of hinted at this saying that we're in de facto MMT. Even if they don't necessarily want the Fed's independence to be compromised, this group tends not to believe that the Fed has the tools to do what is truly necessary. The risk, of course, is that a closer relationship between the Fed and the Treasury might look good

when what you believe what is needed is more firepower. It looks a lot worse when a theoretically independent Fed needs to unwind policies and comes under intense political pressure from the firms and the industries who want the spigot to remain on. Currently, their independence provides some amount of buffer from those political headwinds. But the closer that relationship gets between the Fed and the Treasury and just the Fed and the rest of the government apparatus, the harder that independence gets, the harder it becomes to do the right thing when the right thing isn't more intervention, but less. We've already seen this sort of political financial mission creep play out as QE moved from a wartime policy to a permanent option. In fact, a permanent

policy in many ways. To reinforce this, I'm going to end with a passage from an op-ed that Kevin Warsh, who is a former member of the Federal Reserve Board, wrote in Monday's Wall Street Journal, titled The Fed puts its independence on the line. This is the closing section. What has been the response to Fed flexing? Most on Wall Street are thrilled. They quite like stimulus for all seasons and all reasons. The Fed will buy assets, others don't, and pay prices others won't. Even if the central bank were to pull back its support for corporate and municipal bonds, traders believe it would step up again in a pinch. Main Street is rightly more circumspect about the Fed's largesse.

Interest rate cuts have a much more direct and significant effect on the real economy than the latest Fed machinations do, but there is no room left to cut interest rates, and Main Street firms are receiving far less fiscal and monetary support than Wall Street. Bipartisan majorities in Congress are praising the Fed's expanded role. The Fed's growing purchases of the government's expanding debt lowers the costs of fiscal spending. Mr. Powell's apolitical demeanor and relationship-building efforts with lawmakers have provided the institution with substantial leeway. But elected representatives can be fickle. If the last crisis is a guide, the recriminations will come once the panic recedes. For now, the Fed sits atop the commanding heights of the economy.

Its growing authority unquestioned, its pride manifest. But over time, citizens in a constitutional system tend to grow wary of omnipotent institutions. The Fed is exercising understandable but unprecedented power at an ahistorical moment. Without vigilance, it will risk morphing into a general-purpose government agency. When all is said and done, I don't think that the comments from Stan Drucken-Miller taught us something new. I think that there are one more piece of evidence about where the head of major Wall Street players are as they survey this very ahistorical moment, as Kevin Warsh put it. I truly believe that the song and dance of right now, the challenge of right now, is how to deal with the reality where you believe that asset prices are significantly inflated,

but at the same time might have room to grow still. How do you participate in that upside while hedging the downside? All that's left now, I guess, is for Drucken Miller to publish his Bitcoin investment thesis. Anyways, guys, hope you enjoyed that show. Until tomorrow, be safe and take care of each other. Peace.