The Breakdown - Financial Postmodernism and the Great Inflation Debate

Episode Date: September 2, 2020

August has come to a close. In this recap and “best of” episode, NLW looks at the big themes that defined the month. Most notable was the discussion of inflation culminating in the Federal Reserve’s newly announced policy of average inflation targeting.  This episode featured commentary from: Tony Greer - Author, Morning Navigator  Keith McCullough - CEO, Hedgeye Chris McCann - General Partner, Race Capital Adam Tooze - Chair of History, Columbia University  George Selgin - Director at the Cato Institute Center for Monetary and Financial Alternatives Hugh Hendry - Legend

It's a game of psychology, and you can really challenge it and create. If you can change behavior, you can change history. If you can get in people's minds and make them think differently, you change history. 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, BitsSy, stamp and nexo.io and produced and distributed by coin desk. What's going on, guys? It is Tuesday, September 1st. Welcome to a new month. Welcome to when,

in my brain, fall starts. You know, each month, I like to look back at the debates and discussions we've had over the previous four weeks or so and try to understand what they taught us about the economy and the world that we live in more broadly. From a macro perspective, this month was dominated by questions of inflation. We saw gold smashed through its psychological barrier of $2,000 an ounce, and of course, the month culminated in the Fed's policy shift around average inflation targeting. So I want to go back now with a number of the guests from the breakdown and see what we learned. Let's start with Tony Greer, a trader whose episode actually dropped on the last day of July.

He introduced a concept which seems highly useful in understanding the psychic fracture that has characterized this whole year. That concept is financial postmodernism. Figuring out the economy is a very slow-moving process, you know, as you can see by the data that's coming out and sending all kinds of mixed signals. But the market is very immediate right now, you know, with volatility up around 20, you know, the VIX around 25, 30, you know, the market is firing on. off in all kinds of different directions and not being shy about the footprints that it's leaving. So it's really, really intense time to follow the markets. I've been calling it financial postmodernism where we've got this dichotomy between U.S. economy that is likely coming apart at the seams for some period of time and, you know,

the liquidity driven markets, which seem to never back off the highs. So it's really, really, really wild twist on the psyche. We labeled it financial postmodernism because you get these kind of days where, okay, we've got the worst economics. For example, we printed the worst GDP number that we printed in 10 years. And what did the stock market do? Up 5%. Right? And the up 5%, the public can't really deal with that because, you know, maybe there's not a full understanding of considering what the Federal Reserve is doing.

And obviously, their job is to prop this market back up and they're doing that by adding liquidity in historic proportions. So it's created this, you know, crazy dynamic to observe and be a part of and try to trade through. And, you know, as usual, it's like something we've never seen before in the market. Tony also teed up an important conversation about the role of the Fed. Ultimately, all of these questions of inflation relate to interpretations of what the Fed does or doesn't do or, frankly, can or can't do. And then we came to Jerome Powell and we had to live through that super brief period. where Jerome Powell came in with his chin up saying, look, I feel like we need to raise rates in this country. The economy is not in as bad as shape as maybe is being portrayed. You know, we've got to get

off the zero bound because it's not helping anybody in the middle class with no savings rate. And then all of a sudden, the president climbed down his shirt, decided that, you know, he wasn't going to be the president that had the balance sheet normalized under his term and probably made some really strong points with the Federal Reserve there. And next thing you know, we go into that period in September of the fall of last year where there are enormous amounts of money trading at the discount window every day. And people are trying to understand what's going on with that. So now we've got this emergency fund, you know, at the borrowing window and there's as much overnight liquidity as anybody possibly needs. So to me, you know, Jerome Powell did a Jekyll and Hyde thing

and came in as a guy that I totally respected for trying to raise rates. Then he gave to the president, you know, and fast forward to yesterday when he can actually go on a press conference after the, after Congress has literally inflated, you know, giving them the green light to inflate their balance sheet. They added another $3 trillion to their balance sheet. And here is Jerome Powell of the Federal Reserve yesterday saying, well, you know, amazingly enough, after we created all these emergency funds, the market started working again.

And so we didn't really need them. But it's imperative that the funds are there just in case we have a problem in the future. Right. So to me, he is slowly handing over any credibility that he might had as he sort of pivots his way into, you know, quietly trying to support the story that, you know, powerful, forceful and aggressive actions of the Federal Reserve to combat the lockdown damage. And here he is admitting that the markets were actually functioning okay, even as these funds were created. So, you know, now that the Federal Reserve is a huge holder of, you know, high yield bonds, investment grade bond,

ETFs, you know, everybody's looking at each other saying, well, what's going on? You know, if the markets are functioning okay, then why is the Federal Reserve buying all this corporate credit? And so now we're heading toward that moral crevasse, and we don't know how that's going to go either. Hedge-Eyes Keith McCullough talked about that same period a couple years ago of the Fed raising rates and also about how inflation is recognized by people experiencing it in their wallets. Think back when the Fed or the establishment e-cons, when they're telling you that the risk to inflation, when's the last time they actually acknowledged them? Well, they said that at precisely the time that But my model said we were about to have deflation, which was in Q4 of 2018.

The Fed raised interest rates because they were concerned about inflationary pressures at precisely the peak of the sign curve on inflation. That's when headline or CBI inflation, the one that you called out, it was right around 2.8%. Some of the monthly's got to 3%. So well above their quote-of-quote target, oh, so therefore now we're worried about it, right when you should be worried about a reversal. The thing about inflation is that it's mean reverting. It goes up, then it goes down.

It goes up, then it goes down. It's actually one of the easiest things. Again, I've built predictive tracking algorithms to front run it. So I use a commodity, to your point, with, like, a lot of these different callouts, and human beings really do see, like, if you're a carpenter, like my dad was, you're going to have seen the cost of lumber has risen dramatically in the last month and a half. Or, you know, to your point, if you drink coffee, you're going to realize that. And that's the thing about the people.

The people figure out systematically that things are inflating because they're paying the price of those things. Whereas investors, or people like me, are already front-run them, you know, that's the whole point. You've got to get long inflation before the people at large realize it. And by the time some government guy, central planning gal, by the time they tell us that inflation's here, you know, the investment opportunity to have been long commodities or Bitcoin for that matter is way in the rearview mirror. McCullough also connected the dots between inflation, a devalued dollar, and growing commodities prices. Well, I think generally, like, a lot of narratives are bullshit.

I mean, there's a lot of people that have a narrative that fits their permanent position, if you will, and whether that permanent position be a political position on one side or the other of the aisle or a marketing position of an asset class, you know, people are just constantly spewing an area. Now, the thing with Wall Street is that they're not. narrative is always moving. So we follow that, you know, there's narrative drift. The reality is that the dollar moves with deflation, but moves within the quads. The only time the dollar goes up is in quad four. So again, that perpetuates deflationary pressures. That's why there's something like

Bitcoin got smoked when you had quad four deep quad four deflation into the thralls of March. And that surprised some people. Didn't surprise me. I mean, we weren't long Bitcoin at that point. We went bullish on it in April when it became very obvious that the Fed was willing to devalue the dollar. and do it in a way that nobody, even beyond the wildest, I think the bulls, the people that love the Fed lovers, they call it creative and innovative in a ways. So at that point, it started to become clear that the dollar was done going up

because the Fed was, and the fiscal side was committed to devaluing it. So by May, our signal and our model said that the dollar was done going up, starts the breakdown, and you finally get that dollar-based inflation. If you pull back a long-term time series of the dollar, We're just getting started.

I mean, I think that that's why you see such a parabolic move. Like, I'm not just bullish on Bitcoin. I'm bullish on a lot of things. And if it offends people that I call Bitcoin a commodity, that's fine. I mean, but I don't think of it as a currency. I think of it as a commodity that trades in dollars. So again, I think of silver the same way. People that think of silver as a currency, they might get offended.

I'm not trying to offend people. It's just what my model calls these out as. And I call it a commodity because it has the volatility characteristics of some commodities. If you want to go through that, we can too. But what happens when the dollar starts to develop this intense inverse correlation to commodity prices. Currently, Nathaniel, it's 98% on a 30-day duration. Like the machine, the modern-day machine and asset management, purely algorithmic doesn't care about narratives, absolutely chomps on that all day long.

So it just sells dollars and buys things inversely correlated to dollars. That 98% level on gold and on the CRV commodities index broadly that you have now, it's just unbelievably strong, almost unprecedented. Those are the things that I really care about. It's like, what is the math do, not what is somebody telling me a story about. I can tell you a story about, you know, Pump coming out and saying, look, I'm going to print another whatever and do this for whoever ahead of the election. I mean, I get the story, but the reality is if the dollar's not doing what it's doing,

then I won't be as grossed up, if you will, on the invested side of long commodities and big ones. Speaking of rising prices, venture capitalization. Chris McCann discussed how asset price inflation was a phenomenon not just for public markets, but also in the private market valuations of early stage venture startups. Sort of the interest gap, if you will, show up across all financial assets. You saw that very dramatically in the public markets post-COVID and post a lot of the government action.

You're seeing it now in Bitcoin. You see it show up on a residential real estate side, which really should have a lot of negative downward pressure, but you're seeing actually like a rise in a lot of key markets. Like, of course, this is going to show up in the early stage private market side. I think it just, it's a little messier. It lags a little bit more. It takes a little bit more time. And at the end of the day, for many of these companies, you know, if they do take 10-year

horizons, the time cycle will take a lot longer to play out. But yeah, of course, it's going to show up on the early stage private market side. Preston Pish made a related point about how. how the most recent round of money printing is showing up in the valuations of tech companies. I think the biggest indicator of all the printing is so like they dropped $5 trillion worth of printing into the system and where did it go? Well, it went into all these tech companies that hold a ton of IP, the intellectual property that has an impenetrable barrier around it that is very difficult to defeat. And when you look at, well, why does some of this technology have

such a strong moat? You know, the terminology that Warren Buffett famously uses all the time for having a competitive advantage. I would argue that the that the ones that have performed the best are the ones that have the biggest network effect. The technology that has a network effect that's very difficult to replicate. And you can see that's where all the money, that's where all the fresh printing is going. So why would somebody not think that that's going to somehow not manifest itself and nest itself into currency itself that has a strong network effect?

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While some shouted at the fear of hyperinflation, others acted, frankly, with skepticism of the Fed's ability to follow through. Historian Adam Tews provided a version of that second perspective. It's just not obvious how the monetary expansion fees through into inflation in a world in which the money just sits on bank, ballot streets and has been doing so now for the best part of 10 years. I don't think that the supply side deterioration is sufficient to allow them to believe that we'll see sustained price increases, above all because we don't have a wage price spiral. We don't have powerful trade unions that motivate and drive sustained price increases. And the pressure of global competition remains serious. So to my mind, given the other priorities that we have right now and given the severity of the

that we're under, it would be a huge mistake to prioritize inflation fighting. It would be preparing to fight the last war, whereas our problem is, in fact, to sustain demands, to restore production and to think through the structural implications of the shop for his entire service sector and so on. Tews also explored the question of who inflation benefits and who bears the cost. In a 1970s framework where you have powerful organized labor, inflation can, and actually be to the benefit of working people because their wages are protected. They don't have very many savings, certainly not savings in the form of nominal assets, which are subject to price erosion.

And so historically speaking, all the way back to the great inflation, say the Vimer Republic, inflations are a progressive in the sense of the technical sense of progressive redistributive mechanism for handling a very big bill. So if you ask, who paid for World War I, in the end it was overwhelmingly middle class and other middle class Germans who did not working class Germans because the inflation burns off those people's assets. That's one way of thinking about it, so long as you do have large-scale organised labour to protect people's nominal incomes. If you don't, then of course the balance is much, much more difficult to figure out. And it's really a gamble on the possibility of

indexing various types of income streams so that those who are most vulnerable are not profoundly damaged by rapidly rising costs living, basically. With all of this inflation conversation swirling, it is maybe not surprising that gold saw a breakout early in the month. What's more, there was even some bluster around the gold standard, particularly in the context of a potential nomination of Judy Shelton to the Fed. Economic historian George Selgin joined for a long-form historical look at central banks, and one of his conclusions had to do with where we place our energy when it comes to trying to fix the system. I think the amount of intellectual energy to call it that, because quite frankly in some cases,

how much intellect goes into it, that is spent on talking about getting back to a gold standard, would be much better directed at other possible things for all kinds of reasons. I've already, I think, I hope, made it clear to your listeners. I'm not a critic of the old gold standard. On the contrary, I think it was a pretty good system while it lasted. Unfortunately, the road we took to get away from it is not a road you can head back along very easily. You can't in particular, the biggest thing that has happened, not to just, forget about all the little technical issues involved. Forget even about whether it's possible to

imagine getting a whole bunch of countries to cooperate, which you have to if you're going to have an international gold standard. Forget all that. Just think about the credibility of government commitments to honor promises to pay gold. Just think about that. Just think about that. Think about fixed exchange rates in other currencies and their credibility, if you like. What What's happened over the course of the 20th century mainly, but it's more true today, as true as ever today, is that government's promises to maintain fixed convertibility commitments for the currencies. No one trusts them anymore. No one, that's gone. No one trusts them.

If the Fed today promised a fixed exchange rate in euros, eventually would become the object of a speculative attack at some point, where people would. said, we don't think you're going to be able to maintain this. And if the pass is any guide, those speculators will eventually be right. And the Fed will toss up its hands, and that'll be the end of that. They did it to Britain. They did it to the Thai bot. They did it all kinds of places, the Russia. Well, what about gold? Same thing. That's exactly the same kind of commitment that the Fed would be making. And it would be subject to the same speculative pressures that would eventually succeed in breaking it down. And the very fact that that's likely, it means it's more likely because we all know it's not going to last. So unless you can stuff the credibility or confidence

genie back into the bottle that flew out of in 1934 or three, you can't have a gold standard today like we had in the past. Seljan also took aim at slogans masquerading as solutions, asking instead for deeper discussion of real paths forward. Sure, let's think about ending the Fed. Let's consider it. But consider how you could possibly do that in a way that will succeed, both in the sense that you really do end up with a lot less federal reserve than you have today, if not zero federal reserve, whatever that might mean.

But you also end up with a U.S. dollar that preserves its value and is a good medium of exchange in other ways. Now, if you can figure out how to do that, then please do it. I've been thinking about it a lot. But I'm not going around with a T-shirt that says end the Fed until I've really figured it out. And I'm certainly not going to pretend that that's a policy solution when it's just a slogan so far. One of the unique things about this moment that we're living through, and this is certainly something that this month showed very clearly, is just how big a debate about the role of central

banks and inflation there truly is. Really smart people have really wildly different perspectives on what's actually happening and what's likely to happen in the future. For former hedge fund manager Hugh Hendry, the issue for the Fed isn't so much about how much they've printed, it's that they're still showing too much restraint. So tell me again, I make dollars plentiful. I massively increase the spigot. You know, I just pump dollars into my economy. And therefore, isn't the consequence of that would be that the price of a marginal

dollar unit would fall? But the weird thing is that since you've been doing this, each marginal dollar that you produce is becoming more precious and more valuable. So you're just making this up. Your heart's not in it. There's still an ideology that's holding you back. And so they've jettisoned a lot of ideology. But I kind of reason that perhaps the central might just, we're asking an impossible thing.

We're asking it to be like really, really irresponsible. And these guys were not made to be irresponsible. Put me in charge or like as I put Joe Rogan, someone like, you know, a caricature. I'm not being tough on Joe. The Joe would be fun. But it's like it's a game of psychology. you can really challenge it and create. If you can change behavior, you can change history.

If you can get in people's minds and make them think differently, you change history. We'll close now with Preston Pish again, who thinks that ideology or not, the more printing, more aggressive policy that Hugh is talking about is coming, whether central bankers want it or not. they've been able to get away with just doing QE for 10 years, right? And they've already just conducted their ammunition, like they shot all their ammunition on the QE side without balancing it with UBI. And now that they've pushed rates already down to zero, and now they're saying, oh, we got to pump more into this UBI stuff to keep things civil, right?

What they're really doing is now they're having to continue to do the QE at even larger scale. order to keep the interest rates low enough, even though that they're seeing the inflation. That's going to be the thing that's really fascinating that's going to blow people's minds, and it's going to cause the printing to accelerate. And I think people that are looking at it today are saying, how could we accelerate the printing from where we're already at? Well, that's how you're going to do it, because once the inflation starts setting in, they have to offset that on the yields.

And the only way they're going to do that is through even more QB. No matter what one thinks about where we head next, it is impossible to deny just how intensely this year feels like a moment of transition. As we go through that, I appreciate your listens every single day. I appreciate those of you who take the time to rate and review the show to engage on social media and share ideas for shows you'd like to hear. So hopefully the breakdown helps you make a little bit more sense of just what's going on and different interpretations thereof. and as always, until tomorrow, be safe and take care of each other. Peace.