The Dividend Cafe - A Natural Way of Seeing Things

Episode Date: August 12, 2022

I kind of like this week's Dividend Cafe.  We are going to do a very quick look into how the Fed fuels Japanification, but more specifically, how low-interest rates hurt growth.  It is one thing (and a more severe one at that) that monetary policymakers generally view artificially low rates as a really good thing to fuel economic growth, but at this stage in my life and career, there is little I can do about that.  It is another thing altogether that so many investors think is a great thing.  Today I want to do a quick lesson on why it is not just wrong but a dangerous fallacy, that is, wait for it, undermining economic growth. Speaking of growth, many want to know when the Emerging Markets will deliver it.  I think you will benefit from that lesson today as well.  Unfortunately, the EM gain is likely to be Europe's pain, so get ready for a case of hot-cold. And finally, I want to add to last week's talk about "gross domestic product" in how we think about economic growth.  You may find it illuminating. Jump on into the Dividend Cafe. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to another Dividend Cafe. I'm actually back in the exact same spot I was a week ago, Friday, but I've barely been here all week. Friday, but I've barely been here all week. Spent a lot of the last week, well, a couple of days out in the Hamptons and then went to Portland, Maine with my wife. We picked up our son, a lot of back and forth. I'm now in the city, have a big full day ahead and I'm going to record this podcast and video quickly and then head off for a day of work and then head back to California on Sunday. I am kind of excited, though, about today's Dividend Cafe. I want to talk to you about something that I don't talk about a lot. Now, in an indirect way, I do. This subject about Japanification and about downward pressure on growth is probably the thing I talk about the most. If it isn't, it should be.

It's a massive topic. And those of you who listen to Dividend Cafe frequently know it is one I talk about a lot. But my primary focus on it is, understandably so, the role that excessive indebtedness has played in creating it. And though this topic today is very much related to that and intersects with it and unfortunately feeds off of it, I want to focus today on particularly the monetary side of downward pressure on growth. I've addressed in the past how financial repression is created by the Fed, low interest rates, and particularly the quantitative easing we've had since the great financial crisis, the effects that those things have had. But in general, the low interest rate phenomena is completely misunderstood in its impact on growth. Now, I believe it's misunderstood by

policymakers. I think central bankers, for the most part, American, European, Japanese, really do believe the low interest rates are stimulative for growth. And I make the, well, it's not a joke, I say the line in Dividend Cafe today. There's just not a lot I can do about what policymakers think at this stage of my life and career. I'll keep trying. But I don't want you believing that great lie. And maybe there's a little bit I can do about that. Now, of course, prima facie, it makes sense.

Lower rates. People can invest more, you get more bang for your buck. This all sounds very stimulative to growth. It incentivizes people to buy real estate, to buy stocks, to invest in businesses, etc. This is the very specific reason, though, that that logic doesn't hold up. And I'm hoping you come away today with a little better understanding. It has everything to do with what we're going to call the market rate, which is just the amount people are paying in interest, the amount of actual yields, whether it's the Fed funds rate or a short-term treasury rate or the 10-year rate, a corporate bond yield. There's some

market rate that we can consistently use to refer to what is really being paid and received in the marketplace. And then we're going to call it the natural rate, which is different than the Fed's neutral rate. I don't believe in a neutral rate. A neutral rate is this alleged policy level at which you're neither stimulating nor contracting economic activity. And it's just sort of this myth that I'm not really sure exactly where it has ever taken place. The natural rate is, for lack of a better word, what the real rate of growth in the society is. Like if the market rate were to meet the natural rate, what would that natural rate be? And I believe as good of any definition

is the growth rate of corporate profits. It's hard to imagine something being more real to measure activity than profits, right? And so a growth rate of profits is a consistent and empirical and measurable and logical way to look at a natural rate. And what I want to suggest to you is that when the market rate is much lower than the natural rate, what it does is incentivize people to reinvest in, to lever up, basically, to borrow, to buy legacy assets, incumbent assets, which is to say assets already in existence, real estate, rentals, stocks, stock buybacks for companies. And the logic is simple. You can borrow at X and you're going to get more than X. So you're collecting a free spread. A market rate below a natural rate incentivizes financial engineering, period. It's that simple. But then, of course, the opposite is when the

market rate is higher than the natural rate. And that generally, of course, can become recessionary. The problem when the market rate is below the natural rate for a sustained period of time, and the incentive is to do financial engineering, leveraging up investing into incumbent assets, as opposed to investing into new growth, new productivity, new assets, creation of new wealth, levering up incumbent assets versus, why wouldn't you do it? It's profitable, right? Borrow X, get more than X. This is just a tautology. The problem is that you guarantee the natural rate eventually dropping because by not investing in more productivity, you limit the growth rate of profits.

Eventually, you cannot have an economy. You cannot have a society that is not getting enough productive behavior to keep those activities going. So the natural rate drops. So while you enjoy the period of the market rate being lower than the natural rate, and I'll tell you, people watching the video have an advantage right now over people listening to the podcast because my hands are trying to act out what I'm doing here. The market rate lower than the natural rate is a self-fulfilling prophecy

for eventually the natural rate dropping because it will compress profits. It will compress output. It will compress economic activity. So you don't get the investment into future growth. So the artificially low interest rates that you think is going to stimulate growth actually undermines the real economic growth that we need. It's that simple. That's exactly what financial repression is. It's exactly what has happened in Japan. It's exactly what has happened in the United States,

that there's not enough investment in real organic growth because it's too easy, it's too logical, it's too self-interested. There's no reason not to take advantage of the free money that a market rate, sub and natural rate is giving you. So what is it that we want to do to go get actual real organic growth? Well, I've talked a lot about how there's actually growth at a reasonable price in emerging markets, but of course, emerging markets get pinched into their own dynamic as well. It has to do with the dollar. They borrow money. They do so generally heavily in U.S. dollar. So you end up

getting a market rate right now, the U.S. dollar, that has gone higher, dollar-denominated assets like treasuries, interest rate-bearing vehicles, that is higher than the natural rate of emerging markets activity. And so that ends up creating the natural rate of emerging markets activity. And so that ends up creating a liquidity crisis in emerging markets. So until the dollar drops, it's hard for emerging markets to get going. But when the dollar does drop, that dynamic, I think, is very exciting. One of the things I talk about, and I just don't have time to do it right now on the podcast, but in the written Dividend Cafe today, is I lay out how energy plays into a bullish story for emerging markets. They don't really have the same environmental pressures to not use coal. They're willing to

go buy from Russia. They, in a lot of cases, can produce their own sources of energy. And it's very bearish right now for Europe. They most certainly still need Russia. They don't have ability to do a lot of their own production. Some countries do have nuclear, but most do not. Very few have ability to generate fossil directly. They turned off coal plants 30, 40 years ago. So you have kind of a, if you think this energy story is sticking around, you have an advantage in emerging markets and a real disadvantage in Europe. And I think that speaks to where growth opportunities may lie. I've talked a lot about where that stands for North America. Kind of anecdotal to everything else, just want to close out.

Do read Dividend Cafe for a closing thought that I think is kind of a postscript to what i talked about last week regarding the definition of recession and particularly how we measured around something called gross domestic product gdp um i want you to understand a little better this idea of gross output and it's a concept that um my friend mark skousen who is economic fellow at chapman university has been a prolific economic writer for a long time. I spoke at a conference he did this summer in Las Vegas. He was published in the Wall Street Journal this week about this subject, but he's been talking about now for seven or eight years, the notion of gross output potentially being a better measure of economic output, economic activity, economic

health than GDP, go to DibbonCafe.com to look at that. I think you'll find it interesting. I do have to leave it there. I'm sorry. I generally try to go 20 to 30 minutes here in the podcast video, but I cut myself short on time today. So I'm going to have to leave it here. I look forward to come back to you from California next week. Low interest rates may seem like your friend for a while, but they end up being the very thing that undermines what we think they're creating. The natural rate we want growing, manipulating the market rate eventually creates distortions and yes, undermining of growth, Japanification. Thank you for listening to and watching the Dividend Cafe. Look forward to seeing you back in California next week. A registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC.

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