The Dividend Cafe - Honesty and Policy

Episode Date: April 1, 2022

I love the topic of this week’s Dividend Cafe. I believe one of the most powerful people in global finance gave me the chance to address a topic today that desperately needs to be addressed. And through this topic we have profound takeaways to inform our understanding of economics, and to apply such understanding to the emphases we put in our portfolios. I will leave the introduction there, and hopefully with enough suspense to push you into the Dividend Cafe. This is important stuff. 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. It is very nice to be here in the Newport Beach office studio. I will be heading out to New York City tomorrow night and I'll be out in New York for a couple weeks before returning for a few weeks back in California. But nevertheless, the comforts of recording in the studio are better for me, but I think you like it better, too, in terms of the audio and video quality of things. And so there's been a lot of jumping around here lately. And so there's been a lot of jumping around here lately.

But what there hasn't been a lot of jumping around with is my focus in terms of what we're writing about at Dividend Cafe, what I want to talk to you about here today on this podcast and video. It is funny. I was rereading what I wrote this morning at Dividend Cafe, and there's a part of me that thinks it is a very complicated subject, and maybe I bit off a lot in terms of what you are going to want to chew. But then I think there's a part of me that does feel that potentially I was able to communicate with some clarity around some topics that often are not very clear. And we'll see how I do here for you right now.

The issue that kind of inspired the Dividend Cafe was a comment that I read that did not get a lot of financial press. I did not find the comment in financial media. media, but nevertheless, I consider it to be a really inspiring quote in terms of inspiring me in how I'm thinking about these things and where my inspiration for Dividend Cafe subjects came from. From the head of the Bank of Japan, essentially think of it like the Jerome Powell of Japan. And he made the comment that right now, a lot of you hopefully know that the yen has been depreciating this month in Japan and that depreciation has kind of accelerated a bit. And he has talked up the idea of depreciation. He basically had said, we believe that depreciation

versus the alternative of our currency is really a good and noble thing as long as it's done gradually and in line with economic fundamentals. And I don't think you historically hear a lot of central bankers say, yeah, we like the idea of depreciating, devaluing the currency that we're here to defend. You can have politicians say it. you can have politicians do things that enact it without explicitly saying it, but a central banker kind of undermining their own existence on

planet Earth with rare moments of candor and honesty comes from a certain place. And then that qualification of as long as it's gradual, I believe is somewhat correlated on the Venn diagram with the way that people think about inflation, which is that hyper levels of inflation become problematic for central bankers because the people revolt. Almost any level of deflation becomes problematic for central bankers because deflation is intolerable for those who own assets. and the real aspiration is a gradual inflation that doesn't allow what is in the pot boiling to know it is getting boiled. And the same concept when it comes to currency depreciation exists, that there is a tempo at which these things can become acceptable. Now, people say, come on, you're politicking or you're commentating. You think that the net effect of central bank

policy is to allow these moderate inflations, but that obviously they understand that part of the dual mandate is price stability. But see, here's the thing. I do believe that if they didn't explicitly tell us, I would still believe this is the case and that I would look to the empirical evidence of history and the policy implications of what they do. But I don't have to here because they do explicitly say that I'm right. The stated and published policy goal of the Federal Reserve is a 2% inflation rate and to run hotter than that if need be to overcompensate for periods that are below 2%, which I would point out was running below 2% for the vast majority of the last 13 years. So this is not where the policy decisions bring them. This is not that whole question I've written about a lot as to what's causing current inflations.

This is simply the Fed's stating that they desire a 2% inflation rate. And that's the end of the sentence. We have a policy goal of 2% per year inflation period. But by Rule of 72, what that means is that they are talking about cutting your purchasing power in half every 36 years. Cutting your purchasing power in half every 36 years. If they ended up at a 3% inflation rate, they're talking about cutting your purchasing power in half in 24 years. Okay? So this is a substantial thing.

This matters, but it is not the end of the subject because the need to have an investment portfolio that accounts for 2% to 3% annual inflation, that accounts for what the kind of net effect of inflation is, even moderate inflation over time, that's known, that's baked into most competent investment planning. And it's certainly really instrumental behind dividend growth and the desire to get a return above the risk-free rate that we talk about a lot at the Bonson Group. But what I am bringing this up for is that we are living in a world where I refer to it in Dividend Cafe today as whack-a-mole. I refer to it in Dividend Cafe today as whack-a-mole, that you can say, look, a central bank is now openly talking about wanting to depreciate currency.

And this has been out there forever. It's not new. But they're not wrong in pointing out that one of their policy objectives is, in fact, going to benefit from a currency depreciation and yet it ignores the fact and this is an economic principle that I am trying more and more to share with readers of Dividend Cafe, listeners to this podcast because it is important people to understand. The Fed has a bit of control over the price of money and they have a bit of control over the price of money. And they have a bit of control over the supply of money. They control the price of money through their impacting of the Fed funds rate. It's not perfect at the 10-year and the 30-year, but the overnight rate that banks will charge,

they have the ability to impact policy through the administration of that short-term interest rate, what we would refer to as a policy rate. And they have the ability to impact liquidity in financial markets, this mechanism that we call quantitative easing. There's other renditions. But buying bonds, using their balance sheet up and down to control liquidity in the market, so the supply of money. Whether you're talking about the cost of money or the supply of money,

the Fed has an impact, but they can't control both at the same time. And when Japan says our rate's going to be this, and the U.S. says our rate's going to be this, in a global economy, they can't control the exchange rate between the two, which is a supply side, right? The amount of money that one can buy at a certain price that can be controlled by a central bank loses control when people are interacting. And you say, well, I don't care about yen or I don't care about euro. I'm not going to Europe. I'm not buying things denominated in yen. But of course, you're

buying things from American multinational companies that care very much about the global exchange rate. So the economic principle of being able to control the cost of capital and control the supply of capital, but not both at the same time, becomes profoundly important when you start talking about other currencies, what we refer to as exchange rates. And it doesn't stop there, because let's say it was just as simple as getting American leadership and Japanese leadership in the same room and saying, come on, let's make a deal. By the way, this was famously done at a treasury summit. I think it was 1985. It's referred to as the Plaza Accord, and it may have been 86 now that I say it out loud. But former Treasury Secretary James Baker,

who, by the way, is still living, and one of the rare people who served as Secretary of State and Secretary of Treasury, and is a rather behemoth name in American 20th century politics. But the so-called Plaza Accord, this is exactly what did happen with America and Japan, is their interests were able to be coordinated and collaborated. So they come to an arrangement. So you go, okay, see, they were able to plug the dam a little bit and allow some interventions

that kind of got a couple countries cooperating. Well, but there's more than two countries on earth. And in fact, competitive countries. And particularly right now, we import more from China than we do from Japan, which is also to say China exports more to us than Japan exports to us. So Japan playing with their currency impacts Chinese interest. And does anyone want to say that what China does with their exchange rate doesn't impact American policy? So the point I'm making is not to get concerned about a currency war that I have been aware

of as a precondition of modern economic life for a long time that is mostly held together by varying cooperative interest that to the extent that they align end up being mutually beneficial in periods where they fall out of alignment can be very damaging and we try our very best to run currency neutral portfolios but you cannot be currency neutral when you're talking about cost of capital when you're talking about the economic impact. And this is the point I want to make about broader Federal Reserve policy, that the reason we get into these things on currency depreciation plays into the overall inflation story, that there is a need to control excessive indebtedness and using the currency as a tool to do it. And the belief which the Japanese bank explicitly stated, the Bank of Japan, that look, we think it's better for our policy interest to depreciate, is a reference to their desire to pay back

globally denominated debt, which Japan has plenty of, in a weaker currency. It's very similar to inflation of purchasing power, inflation of a currency that diminishes purchasing power. You want to pay back a dollar with 70 cents. It's a great deal. Anyone would take it. And currency depreciation globally and uh purchasing power that we call inflation domestically they both achieve that and yet every time you do something to game the system

with this excessive level of intervention with excessive level of discretion into the administration of monetary policy you invite invite another side effect that invites another problem. That's why I refer to this as whack-a-mole. So first you're dealing with this, then you're dealing with that, and it goes all over the map. And yet, the predominant thing to be whack-a-mole, if you will, is as long as you believe that you live in a period of excessive indebtedness, there cannot be any question that the biggest fear to the central

banks of the world is deflation. Because ultimately, high levels of debt for households, for companies, and for governments, getting to pay back that debt with inflated dollars is a great thing. Paying back debt with deflated dollars is a disaster. its fundamental value and it incentivizes non-payment of debt and not just incentivizes but sometimes creates the inability to pay back the debt as its costs outweigh the ability to do so and then leads to declining productivity which leads to decline of goods and services decline of revenue that is there the actual fodder for paying back the debt. So you get this debt deflation cycle. This is the whole entire point of post-Great Depression economics,

domestically but also globally for that matter, is that central banks cannot suffer deflation. And yet, to create a non-deflationary world where they invite and accept moderate inflation, they then have periods of time where you go, well, what if there's higher levels of inflation? And they have to keep that genie in the bottle. Because as much as the people won't tolerate deflation, including those of you listening to this podcast right now, people won't tolerate hyperinflation either, especially lower income earners and those with less wealth assets. Whereas deflation declines asset values and then leads to a decline of productivity, which leads to a decline of bank lending, which leads to a further decline of productivity, which leads to further decline of asset prices and so forth and so on. So at the end of the day, when the economic precondition is excessive debt, what's always over you is a bias towards central banks being paranoid of deflation. The predicament we were

in in the Great Depression, in the Great Financial Crisis, in Japan's big implosion, these are the historical economic moments that central banks cannot allow to happen. And when you look at inflationary pressures, it's back to what Bank of Japan, Kurudo said this week that we can deal with depreciation if it's gradual and not just deal with it that we like it. And that is, in fact, what the real need here. It's not to care for sound money. It's not to care for price stability.

It's that they can't have an inflation rate running to a point where people start revolting. Now, I've already written about and talked about a lot over the last year, year and a half, that it's a very complicated matter with current inflation because some of it is so heavily tilted on the supply side that the Federal Reserve is somewhat limited in what they can do. But the investment paradigm we're in, whether central bankers are being totally honest like they were at BOJ this week or not, the investment paradigm we're in is that there is an unending game of whack-a-mole,

where today we have to talk about inflation, and tomorrow we have to talk about deflation, and today we have to talk about how we need a stronger dollar, and the next week we have to talk about why we need a weaker dollar. And it's not so much day by day and week by week, but I mean season by season, cycle by cycle. And these things are rotating because we have invited heavy intervention and heavy discretion into the central banks of the world, the Fed, BOJ, European Central Bank, etc. And this requires us to be far more diligent than just assuming that there is stability in peripheral circumstances guiding financial markets. And then it's just simply a matter of everything being on an even playing field. It's fragile.

It's unstable. And what we have to have is a discernment for quality because of the nature of where we are with central banking. And it forces us to be very humble in how we assess currency matters when we recognize that one day you could say the dollar and the yen are squaring off, and another day, because of that square off, you could realize that China has their own agenda to deal with. Not to mention we talked last week about the petrodollar reality as to

how far as how oil is denominated globally. We know of the ongoing nature of challenges for the euro. All of this stuff is very complicated, but it does come down to simple principles that those that are tasked with stewarding price stability, stewarding the currency, the strengthening and stability of a currency, they recognize that there are other policy objectives generally related to facilitating and enabling excessive indebtedness that force them to have to go off script. And that forcing of that going of off script oftentimes leads to some very tricky dynamics. And so this is the world in which we live. I hope this is helpful, gives you some better understanding of what we're dealing with.

But there is no question, in my opinion, that a central bank admitting that what they want is something that seems to be a negative event and yet it can be more palatable if it's done gradually that what they're stating is it is going to be a negative to you but they can get away with it if they do it gradually that's essentially the world we're living in. And your investment advisors and managers have got to be aware of it and counteract those dynamics. Thank you for listening to Dividend Cafe. Thank you for bearing with me on what I understand is a bit more complex of a topic. I do hope and believe that DividendCafe.com and the written commentary provides maybe even better clarity than I've been able to give you here verbally on the video and podcast. And I'll look forward to coming to you back next week with a whole other topic.

And we'll continue our job of doing our best to keep investors informed and particularly those of your clients in the Bonson Group to appreciate something that is very much at play in our macro stewardship of your asset allocation and your financial affairs. And that is the reality of the world we're living in where central banks can now just tell the truth. There's a lot of big things going on. Thank you for listening to, watching the Dividend Cafe, rating us, subscribing, forwarding to those you know. Appreciate your support and have a wonderful weekend go coach k the bonson group is a group of investment professionals registered

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