We Study Billionaires - The Investor’s Podcast Network - TIP 029 : What is the Federal Reserve doing? (Investing Podcast)

Starting point is 00:00:00 This is episode 29 of The Investors Podcast. Broadcasting from Bel Air, Maryland. This is The Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish and Sting Broderson. All right, how's everybody doing?

Starting point is 00:00:28 This is Preston Pish, and I'm your host for The Investors Podcast. and as usual, I'm accompanied by my co-host Stig Broderson out in Denmark. And today we got a really fun one for you because we're going to be talking about the Federal Reserve, the Fed, to help everybody understand the current circumstances that we're in and kind of give you a history of how everything kind of developed and has built into the current circumstances that we are experiencing. So without further delay, I'm going to open up this episode with a quote from just this past week by Charlie Munger.

Starting point is 00:00:59 And just so if you're listening to this in the future, we are at the end of March 2015. And the executive vice chairman of Berkshire Hathaway, Charlie Munger, whose net worth is over a billion dollars and is one of Warren Buffett's best friends, had this quote whenever he was addressing a crowd. And I got this from Forbes. So this is Charlie's quote.

Starting point is 00:01:22 He says, This is basically never happened before in my whole life. I can't remember 1.5% rates. It's certainly surprised all the economists. It surprised the people who created the life insurance industry in Japan, who basically all went broke because they guaranteed to pay a 3% interest rate. I think everybody's been surprised by it, including all the people who are in the economics profession, who kind of pretend they knew it all along. But I think practically everybody was flabbergasted. I was flabbergasted when they went low, when they went negative in Europe, talking about

Starting point is 00:01:55 the interest rates in Europe. I'm really flabbergasted. How many in this room would have predicted negative interest rates in Europe? Raise your hands. And nobody raised their hands. That's exactly the way I feel. How can I be an expert in something I've never even thought about that seems so unlikely? It's new territory. I think something so strange and so important is likely to have consequences.

Starting point is 00:02:21 I think it's highly likely that the people who confidently think they know the consequences, none of whom predicted this, now they know what's going to happen next. Again, the witch doctors. You ask me what's going to happen? Hell, I don't know what's going to happen. I regard it all as very weird. If interest rates go to zero

Starting point is 00:02:40 and all the governments in the world start printing money like crazy and prices go down, of course I'm confused. Anybody who is intelligent, who is not confused, doesn't understand the situation very well. If you find it puzzling, your brain is working correctly.

Starting point is 00:02:55 So that's Charlie Munger's quote just from this past week, and he's referencing our current economic condition. So we're going to start off with that quote to kind of throw it out there. Charlie Munger, 91 years old, one of the greatest investors of all time. I mean, this guy's just phenomenal. He works with Warren Buffett and has helped him create Berkshire Hathaway. So that's how these guys are looking at this. They don't necessarily know what in the world's coming next. They just know that there's something coming, and they have no idea how it's going to mature

Starting point is 00:03:24 and how it's going to fall out. So, Stig, do you have any comments there on the start with Charlie's quote before we get into the hot and heavy piece of the Fed? No, only that I'm really looking forward to predict a lot of things in this episode. So everyone have a good laugh when they're listening to this in the future. Oh, I know. We'll be the witch doctors for you, folks. But anyway, let's go ahead and kick this thing off.

Starting point is 00:03:48 So the first thing I want to talk about before we really start talking about the history of the Fed and how we got into the position that. we're at. I want to talk about this difference between economic inflation versus currency inflation, because I think a lot of people get that terminology confused. A lot of people hear the word inflation, and they immediately think, or at least I used to think, that it was just talking about currency inflation. Whenever you hear inflation, oh, the dollar is losing value because it's being inflated because the Fed is printing more money. But that term is often used interchangeably, where you hear a lot of people saying, oh, well, we got to worry about deflation right now.

Starting point is 00:04:25 And the terms really get confusing. And here, I'm going to make it real simple for folks. So there's an economic inflation and deflation that occurs. And what that is caused by is the addition of credit into the economy. So when you look back at like the 1950s, 1960s, 70s, during that time frame, the United States was going through an enormous economic inflation where the economy was growing and booming, and this was all because of the fact that the Fed was increasing the supply of money or the credit in the system, not real dollars, but the credit in the system, and this was making the economy just go like crazy. And when that's happening, you didn't necessarily

Starting point is 00:05:09 see the currency inflating during that period. You actually didn't into the 70s and into the 80s, you did. But prior to that, it wasn't real noticeable that the currency was being inflated. And this is also because it was tied to gold back during that period. So it's really important to know, though, that the economic inflation occurred and then passed in 1981 and on, you had this economic deflation that was occurring where the currency was starting to inflate. Okay. So there's a terminology gap that I think a lot of people get confused on.

Starting point is 00:05:44 And so when we discuss some of the things in here, we're going to try real hard to make sure that we say economic inflation versus currency inflation and deflation. and deflation whenever we're discussing these topics. So the first thing that I think people need to understand before we get into this is the idea of a money multiplier, because in my personal opinion, that's really the critical variable to all of this. Whenever you listen to Ray Dalio and some of these other folks, hopefully you've watched the video that Stig and I have been talking about because we just find that to be insanely

Starting point is 00:06:15 important for your own education as we go through this. But the critical variable, in my opinion, is this money multiplier because that's what separates real dollars, the ones that you find in your wallet, versus credit that is created through the reserve ratio and through the Federal Reserve. And so what's the common term, if you were going to Google money multiplier, what that is is that's the Fed's tool that they use in order to allow banks to lend more than the dollars that they're actually. sitting on. Okay. So let's use an example. Let's say that Stig goes to the bank here in the U.S., which he can't because he's from Denmark, but let's just say that he can. And he deposits $10 into the bank. Whenever he makes that deposit of $10, he's actually holding those $10 and he deposits that into the bank, the bank then takes that in, puts it into his account, and then they can lend out money based on that $10 deposit that Stig just gave them. So the amount

Starting point is 00:07:18 they can lend out is based off of the reserve ratio or also called the money multiplier. And that money multiplier is adjusted by the Federal Reserve. So Ben Bernacki, who I think a lot of people know, now it's Janet Yellen, Alan Greenspan. They were all the chairman of the Federal Reserve. And so they were the ones actually calling the shot saying, hey, the money multiplier is now whatever. Okay. So let me give you an idea of this example with Stig depositing $10 into the bank. If the money multiplier was $10, that means that the bank could then lend out $100, even though that they were only sitting on $10 on the deposit.

Starting point is 00:08:02 And so you might be asking, well, where in the world are they going to get $100 if they only got $10 from Stig? And there's no other money at play here. Well, they get it from the Federal Reserve. the Federal Reserve would supply the bank with that extra money and then they could make out that loan. So the money is really created from thin air from the Federal Reserve in order to do that. So as you might imagine, if the Federal Reserve changes that money multiplier down to five, that contraction of the money that's available, the credit, the key word is credit. And I think we need to distinguish between money and credit. And it's used interchangeably.

Starting point is 00:08:38 And that's what causes all the confusion. if that money multiplier changes to five, now the bank is only able to lend out $50 for every $10 that would be deposited to it. And that has a tremendous impact on the economy. And that's what I think a lot of people don't realize. They see the stock market go crazy. They say Wall Street, this and that. They say, oh, it's big business. But truly, at the heart of this, it's the money multiplier. And the way that the Fed adjusts that money multiplier. And that's what's really controlling the way our economy interacts from time to time. So what is really interesting is we go back in time and we look at history over the last

Starting point is 00:09:19 hundred years, we can see how we arrived at the current situation that we're at. So I'm going to throw it over to stick because I think he has a point he wants to add. You know, one thing I think is extremely interesting here is the credit thing that you're talking about, Preston, because when we're talking about money is money really credit. So if we think about money in terms of, you know, green dollar bills, I mean, that's one thing. But we have something like, what is it, three trillion dollars printed, something like that. But in terms of credit, we actually have $50 trillion. So, you know, there's a huge difference between what you might be thinking is money and then

Starting point is 00:09:56 what is credit, what is basically just produced in the system. And that's also one of the reasons why we have these cycles, because we have this credit that can just go crazy and all over the place. And that is basically what you're seeing right now. and really understanding the difference between, you know, money that you can touch and then credit in the system. I think that's probably one of the first steps you really have to pay close attention to for this podcast episode. And so people might ask, well, if there's only $3 trillion of real money and there's $50 trillion of this credit or fake money, what happens is if everybody calls the bank on their loans and they make a bank run,

Starting point is 00:10:37 which was commonly referred to back in the early 1900s. Well, the fact of the matter is that the bank, you know, the Federal Reserve would have to print money. They'd have to make those real. And then what you'd see is you'd see a drastic inflation. So what the Fed's banking on, and no pun intended, is that there isn't a run on those dollars and that the psychology of the overall economy takes place and just holds everything in the place. And this is really a serious concern. This is actually the reason why the Fed was created back in early 1900s.

Starting point is 00:11:13 It's because they wanted to prevent these bank runs. And we don't see them that often. We actually saw it in Greece a few years ago, but we don't see that often in Western Europe and in the US. But it's a serious concern. Today the Fed has a lot of other obligations. But basically the whole reason why Fed was created was to avoid these bank runs, which is extremely important to avoid for any. developed economy because it would completely ruin the financial system, which is the

Starting point is 00:11:39 basis for the economic growth for the country. So Stig brings up a good point about the history of how the central banks came to existence today. So back in 1907 in the United States, there was a really bad panic. It was called the panic of 1907. There was no central bank at the time. And there was bank runs. And this persisted.

Starting point is 00:12:01 I want to say this persisted for like two years that they had a really deep. Recession. Whenever the United States looked around the world, they saw that Great Britain, Germany, all these different countries had their own central banks, and they were able to alleviate these constant downturns by basically using this system where they would put an influx of money into the system during the recession, and it would subside it a lot faster. So during that time frame, during that 1910 to 1914 time frame in the United States is whenever the Federal Reserve came to fruition, There's a really interesting book called The Creature from Jekyll Island where this gentleman goes and he describes the formation of the Federal Reserve. It's a really good start and he does a great job describing finance and making it interesting, unlike most finance books.

Starting point is 00:12:53 And it's really interesting that he talks about one fourth of the entire world's wealth met at this Jekyll Island in order to create the Fed with the few representatives that they had from all these big wealthy banks. out of New York. So kind of a really interesting story. And we'll have that book up on the show notes and if you guys are interested in reading it. So anyway, 1914 hits and that's the World War I. And this allowed Europe, Great Britain, Germany specifically to incur large amounts of debt whenever they abandoned the gold standard during this first World War. This opened the door for the U.S. to come in as a world economic power. So that was kind of the foundation of the Federal Reserve. As we progress in time and we look at what happened with the Federal Reserve, we could talk about the Great Depression, but we're really not going to talk about that very much because by the end of the Great Depression in the 1940 time frame, the U.S. had actually done pretty well at reducing their amount of total debt to the GDP at that time. By 1940, the federal debt to GDP was only 50 percent during that time. So that's actually really good. When you look around the world right now, I mean, we're at, what, 330-odd percent? Yeah, something like that.

Starting point is 00:14:10 Yeah, it's very high. Total debt to GDP. The federal debt to GDP, I think, is still under 100 percent, but still very high. So when you look at that time frame coming out of the Great Depression, the U.S. was actually in a very good position as far as their management of debt. And the key factor, that money multiplier that we had talked about, the money multiplier, in 1940 was a four. That means for every dollar they could lend out four, four dollars. That's where the bank stood.

Starting point is 00:14:39 And what you're going to see is as this progression takes place from 1940, clear up to where we're at right now, you're going to see that money multiplier totally balloon and at its peak in the early 1980s when inflation was at its highest, that money multiplier was huge. It was at a 12, okay? and that's the highest that it got over the last 100 years. And so what's really interesting is when that money multiplier is high, the credit's high, everyone thinks there's real dollars in the system, even though there's not.

Starting point is 00:15:10 And that's what's causing this economic inflation to occur. That's why you saw the U.S. just take off during that period from 1940s. And we'll briefly talk about World War II in its impact, but from 1940s up to 1981, you saw this economic inflation occur. So what's interesting in 1940, like we said, the federal debt to GDP was only 50%. But you fast forward just six years later, because of World War II, the U.S. went on an enormous spending binge. And the federal debt to GDP went up to 115%. So it more than doubled in a six-year period in what you saw, in order for the U.S. to account for that, they had to adjust this money multiplier.

Starting point is 00:15:57 So like I said, 1940 money multiplier was four. So they lend out four for every $1. By 1946, just six years later, that money multiplier had increased to a $6. So they're now lending out $6 for every $1 in there. That is a very high money multiplier. But what didn't help things, in order for them to pay down that debt, that high debt from World War II, they kept increasing that money multiplier, increasing more credit into the system. So some of our older listeners that might be from the era of the 1960s, they're going to remember that era as being a very amazing time when everything was really kind of booming because you had all this economic inflation.

Starting point is 00:16:37 And if you look at the money multiplier in the 1960s, mid-1960s, it was at an eight. So just in 20 years from 1940 to 1960, you had the money supply literally double. And it doubled because of the credit creation. It wasn't like they were adding more dollars here. They were just adding more credit into the system through the Federal Reserve. So that was the reason for this economic inflation. That's why you saw things taking off during that period. And the reason that we're talking about this,

Starting point is 00:17:09 you might be like, why in the world is Preston talking about the 1940s and 60s? How does that have anything to do with today? But it has everything to do with today because that economic inflation, think of currency inflation and economic inflation as being like a, a rope on a pulley. Whenever you pull on one side, the other side has to go up. And when you pull on the other side to go back down, it just works in tandem, this pulley system. So when economic inflation starts going up, okay, no one's seeing the currency inflation. But whenever you start pulling that economic inflation down, that's when the currency inflation has to

Starting point is 00:17:45 start coming up. So what's really ironic is when we talk about this economic inflation and how it was really grown through 1960 into 1970. 1971, when the money multiplier was a 10, this is when President Nixon came on and he said that we're coming off the gold standard right in 1971. So you saw that money multiplier keep tricking up, keep going up, keep going up. And then in 1971, that's when he came in and said, you know what, we can't even back these 10 times the real dollars that are in the system. And we can't back this up anymore.

Starting point is 00:18:21 So we have to come off the gold standard because we can't actually fulfill our obligation here. So he comes off the gold standard. And that's where things really got interesting. The important part, I think, that a lot of people need to understand because they're probably thinking, why in the world would these leaders of that generation do this? And it really comes down to one thing. I think that the United States was stunned so much by the Great Depression and having, you know, unemployment at just epic proportions that they remembered that as they were going through this.

Starting point is 00:18:54 And they basically used the Federal Reserve as a tool to prevent these unemployment rates. And so throughout that entire period, especially during Johnson's administration in the mid-1960s, it was all about this idea of his great society, of no one being out of work. And you saw that carry on for decades where they were just like, you know what, let's just use the Fed. you know, increase the money supply through the money multiplier. And we won't have to ever have people unemployed ever again was pretty much the mindset. And unfortunately, that mindset over decades has been what really created this oversupply of money and the consequence that we're kind of facing today and how it's all shaking out. So like I said, 1971 Nixon comes off the gold standard.

Starting point is 00:19:44 The money multiplier at that point in time was a 10. Now, this is where it got really bad because you had a Fed chairman, Arthur Burns, from 1971 to 1981. And Burns goes, and he just keeps things going. He just, he keeps increasing the money multiplier through the 70s and into the 80s, really doing nothing to try to stunt this oversupply of money. And you saw the money multiplier go from 10 to 12 over that 10-year period. This is also the first decade that we came off the gold standard. And what you saw was the value of the dollar go from $1 down to 45 cents when compared to the gold that it used to represent.

Starting point is 00:20:24 So in just a decade, you saw the value of the dollar literally get cut in half. And this is where you started seeing the currency start to just inflate. Really interesting time. And this is when you had a person coming to the Fed for the first time that recognized, hey, this is not. sustainable. We just can't keep printing money until we have an epic failure. And that person was Paul Volcker. And Paul Volcker came in in 1979, and he was the Fed chairman from 1979 to 1987. And he made some very hard decisions. And during this time period, if people will remember back then, this is when inflation was just through the roof. 16%. You want to go out.

Starting point is 00:21:14 and buy a house. Those were the interest rates they were dealing with back then. And interest rates peaked in the 1981. Now, what you're going to find, and this is what's really interesting, when you go back and you look at all these charts and you see these 100-year bubbles or these 75-year bubbles, you're going to see a common theme. You're going to see that the money multiplier changed from 1940 till right now. And it looks like a big giant bubble.

Starting point is 00:21:40 And the bubble peaked in 1981. And if you look at interest rates, it looks like a big giant bubble and the bubble peaked in 1981 and then they've come back down ever since. And they've been going down ever since 1981. And if you look at GDP growth, it was a big bubble from 1940, clear up the 1981 and then back down. We're going to have these charts in the show notes so you can see exactly what I'm talking about, how the interest rates moved in this 100 year cycle, how the GDP moved in this 100 year cycle, how the money multiplier moved in this 100 year cycle. It's all. interrelated. So when Paul Volcker came in, he made these hard decisions and he basically started contracting the money supply, this money multiplier. And that had a shock to the system, particularly by 1987, you saw the biggest stock market downturn of all time. And it was a total shock to the system.

Starting point is 00:22:34 This is also when Alan Greenspan came in. And this was like one of his first economic emergencies that he handled. and what people got to realize is it's very easy, and this is very easy for me to say, this is another Monday morning quarterback kind of thing. It's very easy to spark the economy when you have a very big interest rate lever that you can adjust moving it down. So in 1987, whenever they had this big stock market crash, Alan Greenspan comes in. Interest rates were at that 8 to 10% range. And so Alan Greenspan had a very big stock market crash.

Starting point is 00:23:10 very big lever to play with as the as the stock market took a big hit in the in the economy's contracting. All he has to do is lower the interest rates and it immediately sparks it back up again and he's able to control that very easily. So this persists and Alan Greenspan stays there for a very long time, clear up to what was it, 2006 Alan Greenspan was in there. And what you had was he had this lever, this interest rate lever to continue it to adjust as each time the U.S. went through another business cycle, if you will, he was able to adjust those interest rates and control it. But here's where it gets scary. If you look at these charts that

Starting point is 00:23:49 we're going to have on the show notes, you can see how the interest rates peaked in 1981 and they've consistently been coming down at a very steady rate. And the reason that it's been doing that is because the Fed has to do that. They have to keep that interest rate lower than your GDP growth because if they do not, that's what's going to set off a very large economic collapse if they do not try to keep those interest rates below the GDP growth. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is.

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Starting point is 00:28:25 So, Stig, do you have anything, I've been talking for a long time? Well, do you have anything you want to add for some of the stuff that I've been saying. I was on a roll. You are on a roll. Yeah, I actually want to like to talk about the stock market. Sorry about that. I can't help talking about the stock market. But what is actually extremely interesting is what you'll see happen to the stock market after 81. Because something that we also discussed early on the podcast, not this episode, though, is the interest rate impact on asset prices. And asset prices that surely also includes the stock market. So what you would see from 81, and then 70 years later is that the stock market would increase but more than 11 fold.

Starting point is 00:29:07 And this is a period of time where I think the GDP growth in the U.S. was something like, I think it's triple or something during that period. But still you saw 11 times as high as stock market. And then you can compare that from the period from 64 to 81, where you had, you know, instead of increasing in the interest rate, then the stock market barely didn't move. And I mean, it didn't move at all. It moved from something like 874 to 875, that's the dollar we're talking about.

Starting point is 00:29:40 So clearly nothing really happened. And a lot of the reason for this is really the interest rate. The interest rate has an enormous impact on how the asset prices goes. And one thing, another thing I would like to comment is Greenspan's ideology in terms of the stock market. because one quote he's very famous for saying is that as long as the stock market increases in price, this was probably be the most, or he's actually not saying probably, he's saying this is the most important factor for simulating the economy. And I know it's easy to look back at that now and as President said, being one in one quarterback, but I think that's a very dangerous approach to have to the stock market.

Starting point is 00:30:22 Just as long as price increases stocks, they would do more than anything to stimulate the economy. Now, it might do that in the very short run, but in the long run, it's a dangerous approach to have. So as you come down off of this economic inflation, okay, the economy was growing from the 40s clear up into the 1980s. And as Paul Volcker started this trend of changing that money multiplier and bringing it back down, that's whenever we started coming off this ledge, and it's been a slippery slope ever since. and what you've seen is that the prices of assets is where the money kind of started plugging itself into into the 1990s, as you saw the stock market just explode. It did not help that Allen Greenspan really did nothing at the 1995-96 timeframe to do something about these insane stock market values. I mean, you saw PE ratios as high as I think the average PE ratio was what, like 70 or 80? it was totally insane.

Starting point is 00:31:27 I mean, your average P.E. ratio is like 15, 14, somewhere around in there, over a 100-year period. So for it to be at 80, a P of 80 is literally totally nuts. And for the Fed to not be raising rates through the nose at that point for over a four-year period is very, I don't know. I don't even have words for it, to be quite honest for you. It's very upsetting. And I think that historians, as they look back at this, are definitely going to look at a few Fed chairmen and really place a lot of blame on some other actions. And I think Alan Greenspan is probably going to be one of those people. So what you saw was that there was an asset bubble that happened in the 1990s time frame.

Starting point is 00:32:14 And then what happened is after the 2000 crash, which was definitely inevitable, you saw that bubble basically shut. shift straight into real estate. And then that bubble started growing and expanding. And then that's whenever Greenspan left in 2006, you had Ben Bernacki come in. And surprisingly, Bernacki, for the first two years, didn't even think that there was a housing bubble at all. I mean, there was, I saw some videos with Bernacki where there was these different correspondence asking him questions about the real estate bubble. And he goes, I don't, I don't really necessarily see that bubble. I mean, it's right there proof.

Starting point is 00:32:57 And what's really crazy is that you have Shilling, Gary Schilling, he's one of the best economic professors out there. He had been calling this housing bubble for an extremely long period of time. He had charts showing that it had grown like a hundredfold. And so it was really kind of frustrating to see the money multiplier kind of tick up from 2006 through 2008 with Ben Bernacki. trying to, I guess, still stimulate the economy from the 2003 crash, which is just crazy, that the money multiplier would still be going up.

Starting point is 00:33:33 But that's one of the main reasons that you saw a significant shift in these housing bubbles, not to mention a lot of government policy and a bunch of other things. I mean, there's so many variables in this stuff. We're talking the really big chunks and pieces of it. So what we're going to talk about at this point, and I made a video on YouTube, on this. So if you've watched this video, it's probably a little bit better than probably just listening to me. But, and for those people that want to watch the video, we'll have it up in the show notes where I describe kind of what happened here in 2008 and to the present with the way that

Starting point is 00:34:09 the money multiplier changed after the 2008 crash. So because there was all this credit in the system, we had a money multiplier that was very high leading up to the 2008 crash. And after the that crash had occurred, the money multiplier was basically cut in half. And when they did that to ensure that we didn't have massive deflation at that point, I'm sorry, currency deflation at that point, they had to print an enormous amount of money to make up for all that credit that was in the system. So it was basically trading one for one where they were taking credit out of the system and then they have to put real dollars behind it in order to offset it. And that's exactly what Ben Bernacki did with the quantitative easing. So now you're at a point where the money multiplier

Starting point is 00:34:56 is so low that you don't have a very large door of credit for people to borrow money. And businesses require credit in order to operate. You've got companies that got to go out and buy inventory. They've got to do, they have to have a revolving door of credit in order to operate their business in order to pay their bills and to pay their employees and all sorts of things. So you've gotten in a position where this money multiplier is so low. Now, the thing that I find really intriguing and really interesting, and I see patterns, you know, when you've been doing it for a few years, you start to see patterns. I found it really interesting.

Starting point is 00:35:32 Before 2008, right before the crash in 2008, you saw oil just go through the roof. Oil was like at $150 a barrel. Now, right now, in 2015, we're seeing oil at epic lows. And I find that pattern really ironic. I don't know if there's some type of correlation there, but I do find it very interesting. And I, you know, if I had to pin something to it or where my interest is for more research, I'm interested in looking at how that reduced amount of credit in the system, how that money multiplier is shrinking to very low levels at this point, how that's impacting these oil companies,

Starting point is 00:36:11 because they rely on a very large revolving door of credit in order to exercise their monstrous companies. So if their credit is reduced and they don't have that ability, what is an oil producer going to do? Well, they're going to produce more oil because they've got to, that's their inventory. If they pull more oil out of the ground and they start producing more, then they have more capital to pay their bills and to function. And so what you've seen, I think, what you've seen since 2008 is you've seen the supply and demand of oil change drastically. And I think this is a hard theory. And I would really appreciate if people email me or start something on the forum to have this discussion, I think there's a potential that because this money

Starting point is 00:36:52 multiplier was adjusted so significantly and you don't have that revolving door of credit available, that you see these oil companies oversupplying, even though that there's no demand for it, and that's why you're seeing the price of oil just kind of go through the floor. So that's my theory. I don't know if I'm right. Well, Stig, what do you think? You used to cover some of this stuff. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. And customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one

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Starting point is 00:40:42 oil, not really to go too much of topic, is that the oil market is very different now that it was, especially in the 70s and 80s, 90s, because we don't have those huge produce like the OPEC, for instance, that we're controlling the supply. So as you probably all know, if we have a lower supply, then we have a higher price. So right now, we don't have anyone who is determining the supply. You know, everyone can just, you know, go out there and produce a lot of oil. And clearly, that would drag down the price. Another thing we're seeing, especially right now, is that we have an extremely strong dollar. And when we have a very strong dollar, it has a negative correlation to the oil price because it's a counter for a dollar.

Starting point is 00:41:23 So you'll see that has a negative correlation. And for instance, just compared to the euro, the dollars has appreciated like 23% over the last year. So that is really also what you're seeing. So there's a lot of different factors, including the money multiplier that is really pushing down the oil price at the moment. Now, whether or not that oil price in equilibrium, you know, that's always really hard to say. But I think there's a lot of psychology at the moment and there's a lot of macroeconomic factors that are really pushing the oil price down at the moment. Okay, so we really didn't plan on talking about oil. That just kind of came out as we were doing this.

Starting point is 00:41:58 But we'll go back to the Fed. So we were talking about different money multiplier levels through the years. And so when we're talking about that, when the money multiplier post-2008 drop down to around the, the three mark whenever you're talking about M2 money multiplier. And you have M1, you got M2. We won't get into all the specifics of that because it gets kind of confusing. But the money multiplier that we've been talking about throughout this episode is the M2 money multiplier. So after 2008, you're down below a three, which is the lowest that that money multiplier has been in the last hundred years. So that's kind of an interesting thing. What that means, who knows? I mean, again, we'll go back to the

Starting point is 00:42:39 Charlie Munger quote. Who knows what that means? We just know that there's going to be some type of ramifications because of it. So that puts us in a pretty unique situation where here we are, 2015, we're getting all these senses that there's something happening. We don't necessarily know what it is. All the billionaires that we track are sitting on an enormous amount of cash. And we just don't really know how this is going to end. We just know that we're upon interesting times. When you listen to Ray Dalio, he talks about the product curve and how productivity progresses at a very linear rate of about 2% annually. And I guess my concern is this, as we adjusted this money multiplier over this past 75-year period

Starting point is 00:43:23 to very high levels, 12 times the actual dollars that were ever sitting in account, what we had was GDP that grew at a very high rate through that period, much higher than 2%. And so my concern, I guess I should say, is that as we artificially adjusted this money multiplier higher and we basically created GDP growth far in excess of that 2% mark annually, I think we maybe put ourselves in a situation where we might have to pay that price later on down the road. I don't necessarily know if that's going to come to fruition or not, but that's kind of my concern, I guess I should say.

Starting point is 00:44:02 You know, I really hate always to agree with the president. Redalia likes to surround herself with people that disagree with him all the time and they just always have to agree with the president. Or as I like to think so, he always liked to agree with me. That's probably more of what it is, stick. Okay. But in any case, asset prices, at least in my opinion, are drastically overinflated at the moment. So the 2% real GDP growth of Preston is talking about, when you look at that, That has nothing to do with the realities that you're seeing right now when you look at the other prices. And I just want to put in another statistic here.

Starting point is 00:44:38 Stocks border margin is very near an all-time high. So even though you adjust for inflation, currency inflation, we are looking at almost an all-time high stocks-bott-on margin. So let me just give you a tell you a very short story. I received an email, actually multiple emails from my broker here in the last few weeks. and they want me to take on loans. They're saying that you have a very nice portfolio so you can borrow against your portfolio down to 1%. And then, you know, no question is asked in terms of, you know,

Starting point is 00:45:11 where you will place that money. I guess my broker would probably hope I would invest in more stocks. Also, there was this suggestion about mortgages, take a mortgage and then inflate the housing prices in Denmark. I mean, I haven't seen anything as crazy. as this before, well, except before the last crash when I saw something similar. So there's a lot of crazy things going on because there's so much credit in the system and there's nowhere to put all that money. I always like to ask myself whenever I'm involved in a deal,

Starting point is 00:45:46 am I the smart person on the end of this deal or am I the dumb person on the end of this deal? So when the bank comes knocking on your door and are saying, hey, we really want to lend you money and it's at a lower interest rate than what you're already paying. You have to ask yourself, why do they want to do that? What is the reason? Is it because they want to have lower earnings in the future? I highly doubt that's the reason. And so you have to ask yourself, what do they know that I don't know?

Starting point is 00:46:13 And I think until you answer that question, I think you need to really be, you really got a question whether you're doing the right thing when you're presented with something that seems so obvious. I'm not here to tell you what to do. just telling you, I guess, to try to educate yourself as much as possible, learn about this as much as you can before you make any large financial decisions, whether you're going and buying a house, whether you're going and buying a commercial real estate or whatever. Because I share your concern sting. When you look at things, the obvious choice at this point is real estate because

Starting point is 00:46:48 interest rates are low. But I guess the concern is, let's say you buy a house or you buy some type of commercial real estate right now. And we do go through another crash. And the symptoms are very similar to 2008 in that asset values lose a considerable amount of money. And then you're faced with the Fed not having any tools at their disposal to bark the economy again, except for drastic inflation of the currency. So I share your concern. I don't really know what else to say other than I agree with Charlie Munger.

Starting point is 00:47:21 We're a pun interesting times here. and I can't tell people one way or the other. But I do think that if you were a person giving a loan to somebody else, you better really understand how they are going to pay you back in the future. I think that's something that people really need to fully understand. So if you're buying bonds, you are lending money. That's what you are doing. You are lending money.

Starting point is 00:47:47 So you better have a firm understanding of how that person is going to pay your coupons your principal back whenever that bond matures. You might want to look at the duration of it or the term of it. So, go ahead, Stig. Yeah, so there was really a great point, Preston, about being concerned because I think that if you look at people's balance sheet, it might look like they have a lot of equity. So it might look like they have a lot more of value than have a debt. But what's really interesting is that when asset prices will decline and there will at some

Starting point is 00:48:16 point in time, all of this moves in cycles, then you have this problem because the debt is real, but the asset value is not. So you have an asset that is inflated and they might be cut in half. Now, your debt is still the same outstanding. So what will you do? Well, you'll probably force to sell some of your assets, even in career loss. And that was just dragged down the whole system. So there was a lot of good reasons to be really careful at the moment. And sorry for predicting too much, Charlie. That's not my attention. You witch doctor. Hey, so we're going to be talking about kind of the topic that Stiggs referring to in a later episode. We're reading the book by Richard Koo that I had mentioned in last week's episode where he talks about these balance sheet recessions.

Starting point is 00:49:05 And so that's one of the reasons that we're talking about that a little bit more. We're not going to be doing that book for probably a month. So we've got some time before we're actually going to be doing that because we have some other things that we're going to be doing in between that. But just so you know, if you want to get a jump. head and start reading that book. We'll have that in the show notes as well for you. But that's about all we have for you this week where we were talking about the Fed, talking about this money multiplier and how adjusted. I highly encourage you to go to our show notes and look at these charts. Look at how these have adjusted and how they've gone in lockstep with this money

Starting point is 00:49:36 multiplier over this 75 to 100 year period and how that's actually controlling how everything is shaking out and how we're at the end of this cycle right now. And we don't really know how it's going to progress as we go into the next decade. So really interesting discussion. It's really fun to talk about. And if you guys have any comments at all, please come to our Warren Buffett Forum. That's Warren Buffettforum.com. The very top post in there is where we're having the ongoing discussion about this de-leveraging, this long-term debt cycle. And we're really looking for people to shoot holes through some of our analysis, just like Ray Dalio. You know, we're looking for those type of people to provide value to the community and to the

Starting point is 00:50:23 group and to have this one big giant mastermind discussion of this topic. So everyone out there that's been helping to educate us on this, we truly appreciate it. In fact, I had a person email me just last night. His name is Anup Sasakumar, and he sent me an email for a four-part lecture of Ben Bernacki at George Washington University, and it's very good. It's like four hours worth of information of Ben Bernacki. The discussion happened back in 2012, so it was basically Ben Bernacki talking about all of his decisions during the 2008 crisis.

Starting point is 00:50:57 But we want people to submit questions. We've actually been not receiving a lot of voice recordings of questions lately. So please send in your questions at AsktheInvesters.com. We'll play it on the air if you guys ask your question. and we'll send you a free sign copy of our book. So go on there and submit your questions and we'll try to answer them on the air for you. All right. So that's all we have for you this week and we'll see you guys next week. Thanks for listening to The Investors Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www. www.com. Submit your questions

Starting point is 00:51:34 or request a guest appearance to the Investors podcast by going to www.com. If your question is answered during the show, you will receive a free autographed copy of the Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before commercial application. Thank you.

We Study Billionaires - The Investor’s Podcast Network - TIP 029 : What is the Federal Reserve doing? (Investing Podcast)

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