The Dividend Cafe - The Real Problem with Jackson Hole

Episode Date: August 27, 2021

I was going to use this week’s Dividend Cafe to continue the discussion on China, one that I more exhaustively began three weeks ago, then expanded upon last week. And in fact, I have done a podcast interview with Louis Gave of Gavekal Research on this very topic, poking him and pushing him around his thesis that China’s strategic objectives in their bond market and currency are aligned with the objectives of U.S. investors. But I am going to hold this for next week, first of all, to give my communications team time to properly curate and edit that interview, but also because I believe there is a more timely message that is needed this week. By the time you are reading this, I presume Federal Reserve Chairman, Jerome Powell, will have given his speech in Jackson Hole, Wyoming. I am very purposely writing this before such a speech has been delivered or pre-speech teasers on its content have been circulated. I am, therefore, obviously writing it before I know the market reaction to the speech (stock or bond market). This is on purpose. I do not want the focus to be on what is or is not said at Jackson Hole today, or what the market does or does not do after such speech. I want Dividend Cafe to be about the extraordinary problem that we even care about so much, to begin with about this speech. Far more than anything that is said today is the fact that there even is such a focus on it to begin with. And this hype, this prioritization, this captivation in financial markets, with one man giving one speech on one day, is symbolic of where I feel so much has gone wrong. And what THAT is and what it specifically means to you is the subject of this week’s 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. Hello and welcome to this week's Dividend Cafe video and podcast. get to cheat a little bit here with the podcast and video participants because now as I'm talking, truth be told, J-Pal's speech in Jackson Hole is out. But when I wrote Dividend Cafe, it was not out. And so I think the prophetic prowess is somewhat diminished here for you all because I'm just going to simply tell you that he said, oh, we're probably going to look to taper later in the year and maybe early in the next year, and we still want to make sure the economy is clear and blah, blah, blah. So he said basically the exact same things I could have told you for a couple of months that he was going to say.

In fact, did say for a couple of months he was going to say. But I purposely wrote Dividend Cafe this morning before his speech because I wanted to do, and I'm about to go into for you all, a broader subject about my critiques of the Fed. And I did not want them in the slightest way polluted by anything that happened or didn't happen at Jackson Hole, which I believe is going to be a nothing burger for some time and was. People can say, well, look, the Dow's up over 200. You know, first of all, that's nothing. Second of all, it was down 200 yesterday. OK, so in 24 hours, it's just we're completely flat in markets as I'm sitting here recording. But see what inspired this topic this week and in fact has caused me to sort of put off into next week ongoing talk about China and Chinese investment opportunity or Chinese investment risk, including kind of pulling in one of the prominent economists on this subject in the world, Louis Gov of GovCal Research. in the world, Louis Gov of GovCal Research. I'm doing that next Friday because I wanted this week to focus around the Fed because I have spent the last four days when we weren't dealing

appropriately with the absolute disaster and tragedy in Afghanistan in financial news. Every single thing has been pointing to, oh, what is Powell going to say in Jackson Hole? is Powell going to stay in Jackson Hole? And I've had this morning in between 3.30 a.m. and 8.30 a.m. a hundred pop-ups, texts, tweets, alerts, Bloombergs, CNBCs, things and various devices I carry on my person about all eyes on Jackson Hole. Okay. And the reason I am so bothered by this is not about the media having a particular obsession, and I wouldn't say a slow news week, but frankly, it hasn't even been that. It's more just symbolic to the fact that we have an economic system that has put central banking at this pedestal for a reason. And I want to talk about what I am concerned about regarding that. Okay. I am a Fed critic, but I try to be a very, very objective and reasonable and fair one.

And I do my best to separate criticism of things that they're doing within the system. In other words, they may be doing things well or not well within a system I don't like. And that's different than talking about things that you just think are always wrong because you don't like the system. OK, we have the system we have. And so there's a separation of category there about where various criticisms may lie. But I also really hold in contempt, to be very honest with you, a lot of the Fed critics who I consider to be very fringe and kind of cranks because I think they have damaged the credibility of those who want to bring more objective, more credible, more constructive critique of the Fed to the table. critique of the Fed to the table. And so my view is not that is not conspiratorial. It is not that there's this evil master plan. There's a lot of just absolutely outlandish things that are said out there. But my view is that there is in the modern central banking era, some real concerns with the ideology that they have adopted and what this means in terms of

the economic order in which we live. And I believe that all these people are incredibly intelligent and that they're incredibly well-meaning and also that they have adopted a philosophy or a system that I think is an error. Let's go back in time first to what the Fed's objective is, and not going back to 1913, not going back to 1940s. We're going to skip over a lot of that because I really am focusing on the modern era. But there is a first problem and a second problem. And the first problem is, to me, what is universally accepted and statutorily scribed as the Fed's objective, which is what we call the dual mandate.

It was amended in a Federal Reserve Act in 1977, recodified in the Humphrey Hawkins Act in 1978. And I go through some of the language of these acts in DividendCafe.com this week. I read the actual original legislation this morning very early. The dual mandate refers to the Fed's goal of dealing with price stability. They really did have inflation in mind when they wrote that because obviously we were in a high inflation period in the 1970s that was doing great economic damage and and then full employment or maximum employment is the statutory language and so effectively they've said to central bank we want you to create an environment that keeps prices stable and at the same time keeps as many

people employed as possible. And in theory, I am critical of it. I don't understand the purpose of telling the Fed to do two things that may be at odds with one another at given points in time. So then in the early 1980s, when Paul Volcker just said, we cannot have this level price instability any longer, yet in order to cure it, we are going to temporarily damage the cause of full employment and he got taken to the carpet for it. He went and defended himself. And I provided a full quote in Dividend Cafe this morning.

And Chair Volcker was right. There was an internal contradiction in the dual mandate. And the notion about prices and inflation, I think, led to an assumption that has been very damaging over time. But most importantly, it takes two things that can at times be at odds. But one of them, when it goes wrong, is very unpopular with the people. And one of them, when it goes wrong, is much less unpopular with the people because it's harder to see and therefore produces an incredible bias to policymakers to favor the one that is going to create less heat. And obviously, I'm referring here to the heat that

comes from real high unemployment being much worse than the heat that comes from price instability. And so I don't believe it is possible for politicos or central bankers to ever hold these things in a perfect tension because one comes with a far greater PR backlash, particularly in the era of modern media, not to mention now social media, than we've ever had. that I want to now transcend into is the third mandate, which is not in law, which is not codified, which is not the Humphrey Hawkins Act, which was not in the Federal Reserve Act, which has not been amended, but is just obvious to anyone paying attention that the Fed has adopted a sort of third objective, which is the coddling of risk assets. Now, when I say risk assets, the most obvious one you could default to is the stock market. And I completely agree. If anybody believes the Fed has not held real estate in that same boat over the last 20 years, I got a condo in Las Vegas to sell you. Let's see what I did there. Listen, credit, in some cases, I recall Chairwoman Yellen in 2015 even actually alluding to the impact a decision may have in emerging markets.

And then obviously various aspects of real estate, both commercial and residential. And we all know about the stock market. This sort of functioning of financial markets is a politically acceptable way to say it. But there is a bias towards protecting asset environments. And there is some economic defense for it that even though it is artificially boosting the assets, the wealth effect allows that to have an impact downstream. There's various forms of truth to some of these defenses and some parts of absurdity. But my point is, this is a third dimension that the Fed has basically said, there are cyclicalities in the business cycle by definition. There are lumps in the business cycle.

cycle by definition. There are lumps in the business cycle. And at times when those things are painful, we will be the sort of adjudicator to help those lumps in the business cycle from hurting employment, from hurting price stability, and from hurting asset prices. And what I believe it has done is create an elevated role with the central bank that has now led to three things I'm going to talk about that I'm very critical of. And now I think a lot of Fed critics are jumping and go, oh, good, finally it's going to hit home inflation. And I most certainly believe that there is a strong desire to create inflation. And I think targeting saying we want to create 2 percent inflation, which is another way of saying we want to have your purchasing power, we want to cut your purchasing power in half by every 36 years, I think is wrong.

I think it's an ill-begotten policy. However, there's a number of ways to look at these things, and I'm on the record. I don't want to spend a lot of time on inflation now because I talk about it so much. I've talked about it so much all year. I'm going to be talking about it. But inflation is not in my three critiques I'm going to get to here. And one of the reasons is I use the example of a can of soup. A can of Campbell's soup in 1971, that's 50 years ago,

was a quarter, and it's a dollar now. So it's gone up by four times in 50 years. And over a 50-year period, that equates to about 2.8% price inflation per year. So a 400% increase sounds really bad. 2.8% per year doesn't sound as bad. That's always the way consumer price inflation works. It's the way policymakers want it to work. But there is another statistic that I'll share with you. The average amount of disposable income an American household spent on food 50 years ago was 13.3% of their disposable income, and it's now about 8%. ways of looking at these things in a period of time that has had real high inflation for part of the 50 years and a lot of disinflation for a lot of the second half of those 50 years.

And so because I'm of the opinion that you end up with a lot of economic stagnation and disinflationary forces that come when not the Fed, but when the fiscal side of the house, the Congress, the government lives above its means and represents a larger portion of the economy through excessive government spending. I think that what that does through time is create downward pressure on economic growth. And I've written about this ad nauseum all year. So the inflation issue is not where I'm going to spend my time here. I want to spend my time on the distortion that this elevated role of central banks creates in the economy, on the dependency on more of it that it creates in the economy, and ultimately

the inequity and the social incohesion that it fosters that is, I think, very problematic. Most certainly the worst of these three is the distortion, the misallocation of capital. The interest rate is a price. And when a price is not allowed to be discovered, but instead is imposed, it can work fine for a period of time. It can work to a lot of people's benefit for a period of time. But nothing can change the fact that the scale isn't working. And over time, when you have a lot of people making decisions that have high consequences to them without all the facts on the table, without all the numbers on the table, the analogy I use in Dividend Cafe was asking someone to go shoot free throws when they can't really see the rim.

Okay, at the end of the day, you get people, economic actors, taking risk without an appreciation for the right measurement of the risk and the reward. And an artificial interest rate distorts that in favor of the risk taker and it exacerbates then a boom and bust cycle. It creates booms and it creates a bust of those cycles that can be really really painful. In the same frame of distortion is misallocation and by that what I mean is money going into things that otherwise wouldn't go into, and not just in a mispricing of risk context, but maintaining. See, capital, when it is maintained in one project that it otherwise wouldn't,

is capital that has not gone into another project that it otherwise would. So there's always an invisible actor here. There is no free lunch. And when we say, well, we've maintained this zombie company by Fed interventions, that it otherwise would. So there's always an invisible actor here. There is no free lunch. And when we say, well, we've maintained this zombie company by Fed interventions, low cost of capital is the great example here. That company that otherwise would die, that is no longer able to innovate, no longer able to compete, the debt or equity capital they get as a result of low cost The debt or equity capital they get as a result of low cost comes from capital that didn't go to another project, that didn't go to another entrepreneur, that didn't go to other innovation. This is creating economic stagnation. This is holding back the cause of human flourishing.

And so in my opinion, it has distorted risk-reward relationships, misallocated capital, and put downward pressure on the economic growth that we as a country are used to. Number two is the dependency factor. I think other people do this all the time, too. I use the expression hair of the dog economics a lot. all the time too. I use the expression hair of the dog economics a lot. But there is this concept out there that you need when you get excessive amounts of monetary interventions, monetary accommodation, central bank interventions to go coddle some aspect of the business cycle, that you then need more of it in the future to get less of an impact. And this diminishing return plays out over time. And yet right now, to use the national housing market as an example,

the entire concept of 5%, 6%, 7%, 8% mortgage rates is gone. It is not coming back. It can't come back. The entire multi-multi-trillion dollar housing industry is totally dependent, irrevocably, irreconcilably dependent on two to three percent interest rates. You can argue how low, how high, what have you. There is not only a generation of people that could not handle a cost of funds higher than that. There's a generation of people that could not handle a cost of funds higher than that. There's a generation of people that don't even know there's such a thing. Like as in all of us who ever bought a house before 2003.

Now, I'm not going to the 19% example in 1978 or something. I'm willing to say late 70s, early 80s had outliers of their own on the upside. But my point is that once rates were brought down artificially in the green spending era, there is absolutely no ability to get off of it. We created a dependency and we didn't just do it with an esoteric financial asset like high yield bonds. We did it with the thing that every single human has, which is a house either that they rent or they live in, right? That every economic actor is striving for is shelter, okay? This is like the most basic of

human needs. And now as a result of monetary interventions, we cannot get back to a normal and healthy and non-interventionist pricing of the mechanism that supports that asset. Another example of dependency is one that I think probably gets more attention now, and that is the government's own spending. Their ability to finance their own deficits requires a very low cost of capital. And in order for that to happen, the Fed has to wink at the Treasury that they're going to play that role. The Treasury has to wink at the Treasury that they're going to play that role. The Treasury has to wink back. And this is something I go into in greater detail in Dividend Cafe out of time. I won't go much into it now. But that whole winking is what I call

the Fed-Treasury accord. And it's also reasonably new in the modern era. And I put in Dividend Cafe a Time magazine cover from 1998, where all of a sudden the Treasury Secretary, the National Economic Council Director, and the Fed Chair are all together being called the Committee to Save the World. And I have a picture from last year with Secretary Mnuchin, who I like, and Chair Powell, who I like, I think are both well-meaning, patriotic people. They're elbow bumping each other because of COVID, you know, at the floor of Congress. And it's sort of the symbolic thing of like, look, there's a heavy interaction. And coordination, I understand.

There's no reason that there wouldn't be communication. But the independence of the central bank was a vital part of the creation of the Federal Reserve. Independence of the central bank was a vital part of the creation of the Federal Reserve. And right now, I could talk to people who aren't in my business, that aren't on my side of the desk from the financial crisis, as I was at Morgan Stanley in 2008. I don't think they would know what hat Hank Paulson was wearing versus Ben Bernanke versus Tim Geithner. You had a New York Fed guy, the Fed head guy, and the Treasury Secretary, and they were all kind of interchangeable because it was just sort of like, this is their portfolio. This is what they're there to do is solve the financial crisis. And I think it's very problematic that the independence of the Fed is practically non-existent, that we not only rely on, but we expect this sort of connectivity between the political class that is elected

and responsible to serve the country under a constitutional order versus central bank that has a separate mandate entirely. And so over time, that breakdown of independence and then this expansion of the Fed's portfolio has created the distortion, the dependency, and then finally I'll end with the inequity. And most people mean by that rich have gotten richer and others have not. And I don't really mean that. It's just, I'm acknowledging the perception though, which I think is a problem. Look, middle class people have gotten richer as a result of Fed interventions too. People who own a $500,000 home have a lower cost of capital just as people

who own a $5 million home do. But those rewards may feel disproportionate. And I get all that. It's just not necessarily the point I'm trying to make though. I'm referring to someone who doesn't own a home. I'm referring to someone who doesn't have a stock portfolio. So you can say like someone had a $100,000 IRA account and someone else had a $30 million stock account. And the $30 million guy has done way better because of Fed interventions than the guy with the smaller portfolio. And one argument would be, yeah, well, they both may be done disproportionately better, but one had more money. I get all that. But what about the guy who had no portfolio?

And now he's entering and a cost of home, a cost of a single family residence with a college degree and a good job is completely unaffordable. And the level of risk assets they want to enter into to begin accumulating is at higher valuations. That's, to me, the inequity argument that has more currency is the asset holder versus the asset non-holder or the future asset holder is a better way of putting it. And so these things create societal tension. They create social angst. I think we're living through a lot of this, okay? Distortion, dependency, and inequity are problems. And it does not mean that we are dealing with a philosophy that has asked for something to be coddled and not understood the economic law of tradeoffs. And the tradeoffs in this case are the distortions I speak to, the boom-bust cycle I speak to,

and this idea that an economy that ought to run off of the free actions of free humans is instead looking constantly to a speech that Jay Powell is going to give at Jackson Hole, Wyoming, that a luxury resort speech from PhD economist, and Powell, by the way, is not, unlike Yellen and Bernanke and Greenspan, he's a lawyer by trade, he was an old private equity guy,

but obviously the entire FOMC is mostly Ph.D. holding economists. These are bright people. But it is not a good thing for anti-fragility, for stability, for robustness, for growth, that we're so dependent on things like a speech they give. And the joke back in the late 90s is when the cameras would focus in on the size of Alan Greenspan's briefcase and wonder what that meant. These things are a distortion that now someone responsible for the stewardship of private capital, for the execution of financial goals, has to take into account, has to understand, has to,

it adds a layer of complexity to the already complex process of managing client capital. So this is my critique of the Fed. This is my frustration with a week of everyone obsessing on Jackson Hole. And I hope you've learned something from this. But if nothing else, I hope it's invited more questions on your part so we can dig deeper into the reality of the Federal Reserve. The role that the Fed plays right now is ginormous in the economy. But the role they're going to play in three, five, seven years, I think, is far higher. And that is probably even greater concern. It speaks to that dependency factor.

We really have no easy way to go backwards from this. And so this is something that I think I have to think about at my desk all day, every day. Thank you, as always, for listening to the Dividend Cafe. Thank you for watching the video, sharing it with those who you please. And please reach out to us with questions or comments you may have. Look forward to coming back to you next week with Louis Gov to talk about China and their situation in both equity, debt and currency markets. And in the meantime, have a wonderful weekend and we look forward to seeing you again next week. Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be

suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The Bonser Group and Hightower shall not in any way be liable for claims and make no express or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

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