We Study Billionaires - The Investor’s Podcast Network - TIP 114 : Part II - Jim Rickards ~ The Road to Ruin (Business Podcast)

Starting point is 00:00:00 We study billionaires, and this is episode 114 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 Stig Broderson. Hey, hey, hey, how's everybody doing out there?

Starting point is 00:00:31 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 Seoul, South Korea. Today's show is the second part interview with well-renowned author Jim Ricketts about his new book, The Road to Ruin. We're going to continue where we're left in the previous episode talking about financial history, and Preston, you have the first question. I love your conversation in your book where you're talking about the difference between the Fed's blunder of raising rates back in 1928 and what's happening today. And I wanted to give you this opportunity on the show to talk about this difference between those two time periods.

Starting point is 00:01:10 Well, the point I was making is that, of course, the Fed was created in 1913, didn't really get off the ground until 1914. It took almost a year to, you know, make the appointments and get the institution up and running, couldn't do it overnight. So kind of started then. And of course, here we are in 2016. the Fed just celebrated their 100th anniversary a couple years ago. And you look at one financial cataclysm after another.

Starting point is 00:01:33 And almost all of them can be attributed to the blunders and discretionary monetary policy. I mean, you don't want to point a finger at the Fed. But, you know, they do control the money. And these are monetary systems. And so you have to hold them to account. But of course, what happened in 1928, the U.S. was having enormous inflows of gold. Now, at the time, we were on a gold standard. Now, it didn't mean that there wasn't discretionary monetary policy.

Starting point is 00:01:57 There was, and that's something that's not well understood. People think you have a hard and fast gold standard and you know, a fixed money supply and every dollar can be turned into a certain amount of gold at a fixed conversion ratio or vice versa. And that's what a gold standard is. And then when you get to, you know, monetary policy, we get to a fiat money without a gold standard. It's just the Federal Reserve and they print money and sometimes they reduce the money supply and that's that.

Starting point is 00:02:21 They act as if those two things can't. coexist, but they can coexist, and they did coexist through most of the 20th century. And in fact, most so-called gold standards are really just a ratio of paper money to gold. And you don't walk around with big bags of gold coins. You walk around with, you know, paper currency or bank deposits, but what makes it a gold standard is that you know that you can convert it to gold at a fixed ratio. You don't have to worry about the money devaluing and being, you know, worth less and less in terms of gold, you've got a fixed gold ratio behind it and the money's always going to be worth a certain amount. Well, in order for that to work, to have a discretionary monetary policy and a gold

Starting point is 00:03:00 standard at the same time, which is what we had in the 1920s, 1930s, you need to pay attention to gold. You need to use gold as a market signal to tell you if your policy is too tight or too loose, and then you're supposed to adjust the policy accordingly. And what was happening in the late 1920s is the U.S. was having gold inflows. That meant that the Fed could increase the money supply. And the law at the time, actually was the law all the way through until 1968, was that money supply could be two and a half times the amount of gold. So you would take the amount of physical gold that the Fed had at a fixed price, multiply by, you know, 2.5. And then that result, that's how big the money supply could be. And it could not be more than that. There was a ceiling on it. But in fact,

Starting point is 00:03:44 when the Great Depression, it never got above 100%. The ceiling was a lot. The ceiling was, was 250 percent. It never got close to that. But in 1928, the Fed should have pursued an easier monetary policy. And it was with gold inflows, that meant you should engage in monetary ease, actually try to create some inflation, make the U.S. prices a little bit higher. That would improve the terms of trade for our trading partners. Then the goal would turn around. It would start to leave the United States and go back to our trading partners because their prices would be less expensive. Our prices would be higher. And then, you know, the goal would flow out. Then it would flow back in again. That was something more like an equilibrium system, almost like the way the tide

Starting point is 00:04:22 flows in and flows out. That's how gold was supposed to flow in and flow out. But your monetary policy was supposed to be in sync with that. And gold was just a signal telling you, well, that's not what the Fed did. The Fed tightened. And the reason they tightened is they were worried about stock market bubbles. And we all heard about the roaring 20s and the stock market was a bubble at the time. So the Fed kind of ignored their prime mandate, which is to pay attention to what gold was saying, took it upon themselves to pop a bubble. And doing so, they popped it so hard that they caused the stock market panic in 1929, which led to the Great Depression. So that was a blunder on the part of the Fed. And it was, well, come all the way forward to 2007, 2008, also 2000.

Starting point is 00:05:07 You had the same thing. You know, Greenspan talked about this in the 1990s, with his fans. James said in 1996, he talked about irrational exuberance in the stock market, and he said that 96, and then the market more than doubled between 96 and 99, before it finally popped in 2000, and then, of course, it popped again in 2008. But the point I make in the book is that not all these bubbles that pop are the same. There's an important difference, which is, is the bubble created by enthusiasm and overvaluation of stock prices themselves? Or is the bubble created by credit?

Starting point is 00:05:44 And that's a big difference because what was happening in 1928 and what happened in 2000 when the dot com bubble burst? I remember 2000, the NASDAQ dropped 80%. 80%. It went from the kind of 5,000 level down to around the 2000 level. That was a massive stock market crash. But there was no panic. I mean, yeah, if you happen to buy, you know, Pets.com at $200 a share, you probably got wiped out. and that's no fun for the individual.

Starting point is 00:06:11 But it was not a market panic. It didn't spread around the world. It didn't spread to other markets the way things did in 2008. It was just a bubble popping. That's an example of a bubble not driven by credit. It was just driven by, you know, irrational exuberance and overvaluation and speculation. What happened in 2008 was driven by credit. It was easy money in the mortgage market, no money down, no documents, no background checks, no, you know, no doc, low doc, subprime, all day.

Starting point is 00:06:39 mortgage loans, anybody could get one. That was a credit bubble. When that popped, that does cause contagion. That does spread through the banking system. That does cause bank collapse. It does cause a liquidity crisis. It's a very different dynamic. The problem is Janet Yellen doesn't seem to get the difference.

Starting point is 00:06:54 She doesn't seem to understand the difference between credit-driven bubbles and, let's call it, speculative bubbles. And there's always a little speculation in the credit-driven bubbles, but that's really the danger. And so she's afraid to pop the bubble we have right now. She's looking at the Greenspan model of 2000 and saying, you know, Greenspan was right. He let the thing go. And then it popped,

Starting point is 00:07:18 but it wasn't the end of the world. So I'm not going to worry about asset prices. But she's missing the fact that the bubble going on now is credit driven. It doesn't look like the 2000 bubble. It looks like the 2008 bubble. And that blind spot on her part is extremely dangerous. Well, when bond prices go up for third. 35 years straight, where we're at now, how can people not see that bubble as it hits almost

Starting point is 00:07:44 0% here in the U.S. And over in Europe and over in Japan, it is 0%. It's negative percent in some cases. So when you look at the decisions that these beneficiaries are making, it almost seems like they're making decisions completely off of equity markets, that they're looking how stock prices are going up and down. They're really trying to make decisions. around that and not necessarily the larger bubble that these are all riding on, which is the fixed income market. I mean, do you agree with me on that, Jim? Well, I agree completely that there are huge asset bubbles out there, and I see them in stocks and real estate. Now, they might be in bonds. I'll drop a footnote on the bond market, though. The reason prices have gone up is because

Starting point is 00:08:28 interest rates have gone down. I mess how bond markets work. Prices and interest rates are reciprocal. So lower rates means higher prices and higher rates means lower prices. So that's just bond math 101. And so rates have come down and prices have gone up and it has continued for 35 years. You're right this started in the early 80s and it's still going strong. But when you look at interest rates, you have to distinguish between nominal rates and real rates. Now, it is true that nominal rates are close to all time lows. That's absolutely the case. I mean, your Fed funds target rate is 25 basis points and two-year treasury notes are well below 1% and even the 10-year treasury note is about 1.8% as we speak. These are extremely low, in some cases record low nominal rates.

Starting point is 00:09:15 But they're not that low in real terms because inflation has come down so much. Now, I'll give you an example. In 1980, I got my first mortgage on a condo in New York and I paid 13%. And my mother cried. I mean, her first mortgage was like 3%. And here I am paying 13% on the mortgage. My mother was upset. She thought that was like a dumb decision. But I said, Mom, I'm paying 13% interest, but inflation is 15%. And taxes are 50%.

Starting point is 00:09:43 So my after tax cost of funding is 7. Inflation is 15. My real interest rate is negative 8. The bank is paying me to borrow because I get to pay them back in cheaper dollars. Whereas today, even with, say, a 4% mortgage, if inflation is only 1.5, which it is, that's a positive real rate of two and a half. So when I borrowed at 13%, the real rate was negative 5. Today, when you borrow at 4.5%, the real rate is positive 2 or 2.5%. So nominal rates are at an all time low, but real rates are very high. And that's what drives economic decision making, and that's

Starting point is 00:10:20 what drives economy. And one of the problems that economists and policymakers are wrestling with is how do you get real rates negative? Because that's what? what stimulates borrowing. If I think I can go borrow money and pay it back in cheaper dollars so that the real cost is negative, I actually get free money from the bank or the bank pays me to borrow, that's what a negative interest rate means. That's supposed to be a prod or a stimulus to more investment, more R&D and more consumption and more economic activity and higher aggregate demand. And so the notion is how do we get real interest rates to be negative? But what that means is that the nominal rate has to be below the inflation. Right now it's not. I said the 10-year

Starting point is 00:11:00 note was 1.8 percent, but inflation's running about 1.6. So that's still a positive real rate out to 10 years. And that's for government debt. And then for, you know, when you get a consumer debt, mortgages to real rates even higher. So what do you have to do? You have to get inflation higher than nominal rates. And when you do that, you have a negative real rate. And then that will stimulate some of the activity. Well, I like to say it's a sad day when central banks want inflation and can't get it, but that's exactly where we are. Central banks all have a 2% inflation target. I mean, all of the Bank of Japan, Bank of England, Federal Reserve, you know, other European Central Bank, they all have inflation targets of 2%. They can't get there.

Starting point is 00:11:39 You know, we're at about 1.6% using the Fed's favored measure, a year-over-y-er PC price deflater. There are other measures you can use, but none of the, you know, rates are negative in Japan. They're negative in Europe. None of the banks are anywhere near the 2% target. So we have positive real rates. That's a drag on activity. So you can say rates are low. In nominal space, they are. You can call the bond bubble, and in nominal space it is, but in real space, rates are still

Starting point is 00:12:06 too high. And so they're going to either have to somehow cause inflation. They haven't figured out how. Or they're going to have to get nominal rates to be negative. This is, you know, we can kind of go on and on about this. But this is what happens when you manipulate markets for eight years. When you have this much intervention, this much money printing, when you just store price signals this much, you're in what we call in the intelligence community, the wilderness of mirrors. Like, you just don't know where you are.

Starting point is 00:12:31 And that's kind of where the central bank is today. 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. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists,

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Starting point is 00:16:33 Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. Yeah, I saw a note, I think it was just on Friday with Larry Summers, because I know he's been the big voice on this war on cash and trying to make all accounts electronic so you can create the situation you're describing there. But I saw that he just came out. I believe it was on Friday saying that the Fed now needs to be managed and be brought under the government veil

Starting point is 00:17:05 and not have this autonomy to act on their own. So pretty interesting discussion with all of that, which we won't even go down that path. But I found it to be a very interesting article, especially considering the reason that they wanted them to have the autonomy is the exact opposite reason of where they're at today and it gets into a very ironic situation. For the next question, I would like to shift gears here a bit. And I would like to talk about the concept of world taxation because this was a really interesting concept that I read about in your book. Because as a European, when I hear about a taxation in a grander scale, I often think about harmonization of taxes, which is something that we have discussed here in

Starting point is 00:17:47 single market for decades now. And for an economist, it often has a lot of good arguments while you have a similar tax in terms of creating better environment for businesses. But one of the things that you talk about, Jimmy, your book, is that we're talking not about a European tax, but a global tax for all the big economies. And you're talking about that the way to look at this is not just to look at, is it good for businesses? No, you're talking about how is this basically related to the global debt burden. And it seems to be a concept that very few regulators think about whenever they're talking about this, at least in the media.

Starting point is 00:18:27 So could you elaborate on this idea of a global tax and why you might think it would be a bad idea and how the elite might be doing this to be working on the ICE 9 concept that you talked about before? When you throw out a phrase like world taxation, we talked a little bit earlier about world money, you know, the SDR, and we can get into world government for that matter. And again, the initial reaction on the part of some readers used to roll their eyes to go, well, there goes Jim again with all those crazy conspiracy theories. But these are not conspiracy theories.

Starting point is 00:19:00 Again, I make the point. This is very, very important. This is all documented. This is all happening. You can go to these websites. You can attend these meetings. You can look at these working papers. It's all real.

Starting point is 00:19:11 None of it's kind of made up or fantasized. Now, as far as world taxation are concerned, And we said earlier, they love these crazy acronyms that no one understands unless you're, you're expert on all this. But the key phrase here is BEPS, B EPS. That stands for base erosion and profit shifting. So base erosion and profit shifting are the bad things the corporations do to get out of paying taxes.

Starting point is 00:19:35 And the governments are going to lead an attack on BEPS, attack on base erosion and profit shifting. And this is all being directed by the G20. And of course, the G20 is the, uh, the G20 is, uh, this world leadership is basically the board of directors of the world. That's the easiest way to describe it. The G20 kind of emerged in November 2008 at the height of the panic when Nicholas Sarkozy, who was the head of the G7 that year and President Bush, thought they ought to convene the G20 because they had formerly operated through the G7, which were all the big developed economies, but they knew they were going to need help in cooperation from China and Brazil and India,

Starting point is 00:20:12 some of these large emerging markets. And that's what the G20 is. It's the blend of the developed economies and the major developing economy, so you get these other economies on board. The G20 operates a good board of directors, but they don't have a big staff and directorate. This is, you know, Obama now and, as I say, Merkel and G, and Theresa May I'll be part of it, was David Cameron at the time, and Francois Alon de France, and so forth. But what they do is they farm out these projects to different existing agencies. It could be the United Nations. It could be the IMF.

Starting point is 00:20:42 but we have another group called the OECD, Organization of Economic Cooperation and Development based in Paris. This is a kind of a rich country's think tank, and the G20 have given the OECD, the task of coordinating and implementing BEPS, the BEPS project. And the way it works is, let's say you're a multinational corporation.

Starting point is 00:21:03 By the way, I started my career as an international tax council at Citibank. I did this for 10 years. I mean, 10 years my whole career was just, you know, moving money around the world, So we didn't have to pay taxes. All perfectly legitimate, but we had a lot of tools at our disposal from offshore booking centers in NASA and Hong Kong at the time in the Cayman Islands and treaty networks that ran through Netherlands and the Netherlands and Tilly's. And, you know, no need to get two down in the weeds on that.

Starting point is 00:21:29 But we had triple-dip leasing. I mean, we own the Alaska pipeline and we could write that off. And we had bad debt reserves that were discretion. We just had lots and lots of tools at our disposal. And it wasn't difficult basically not to. to pay any taxes. And today, we see Apple and Google and others doing the same thing. But just give you one simple example. So let's say you have an invention, but you invented in the United States. Well, if you patent that invention and license it for royalties and all those

Starting point is 00:21:56 royalties come to the United States, you're going to pay U.S. tax on it. But what if you take the invention and contribute the intellectual property to an offshore company, and then that company then does all the global licensing. And now all the licensing fees go into Dublin instead of Seattle and you're not paying any tax there because you got a special deal with the Irish government. Well, that's the kind of thing that's going on. Many, many more complicated examples than that. But that's a simple one that makes the point. The other thing that's done is you mess around with debt equity ratios. So I've got an offshore subsidiary. And instead of giving a capital, I borrow a gazillion dollars from it and pay them interest. Well, what's happening with the interest?

Starting point is 00:22:36 Well, it's a deduction in the U.S. and its income in, say, the Bahamas, right? So I get a nice fat tax deduction in the U.S. The money goes to a tax-free jurisdiction like the Bahamas, but I'm just taking it out of one pocket, putting it in the other, right? Because I own both companies. So between intercompany dead and licensing and royalties and depreciation, there's a whole bag of tricks.

Starting point is 00:22:57 But the governments are at a disadvantage because each government is taxing what goes on in its jurisdiction. The U.S. taxes, the U.S. actually has global taxation, so they try to see all over the world. But, you know, Germany taxes what happens in Germany. And the U.K. taxes what happens in the U.K. And the corporations are moving this money around so fast that nobody can keep track. So what the governments have to do is joined forces. And they're going to create this global tax network. And they're going to say to every major corporation, you're going to have a global tax ID,

Starting point is 00:23:28 not just your social security number, the corporate equivalent. You're going to have a global tax ID. and all of your subsidiary is going to have IDs and all of your transactions are going to have IDs. And all this information is going to be reported to a database to whatever country has jurisdiction. But then all the countries are going to share all the data using this unified ID system and then put it into one giant supercomputer and that everybody can access. So now all of a sudden, you know, Germany is going to be able to see the other side of the trade. They may know that a German corporation is paying interest,

Starting point is 00:23:59 but they'll be able to learn that the interest is going to an affiliate, in Hong Kong, it's not paying any taxes, et cetera. So they're going to have the complete picture. And then once you have the picture, you can attack it. You can use anti-avoidance provisions. You can use special laws in Section 269 and Internal Revenue Code. I mean, their equivalence all over the world. They have the tools, but what they don't have is the information.

Starting point is 00:24:21 One of this BEPS project, they're going to get the information. Then they're going to combine the information and the tools, and then they're going to attack these corporations. And they'll be able to run, but they won't be able to hide. And then they're going to raise the rates. And then a lot of people say, you know, well, what's wrong with that? You know, why shouldn't they pay their fair share? And my answer is you should pay your fair share, but what's fair? So this is a full-scale assault on the ability of corporations to legally avoid taxes,

Starting point is 00:24:47 but it's going to segue into something that's much more punitive, much more extractive. 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 AI-powered platform.

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Starting point is 00:28:30 to look at credit expansion and credit contraction, trying to figure out where that top is occurring is really important because it's going to help you reallocate your assets and mitigate a lot of the risk that's occurring. So for me, when I'm looking at where is that topping kind of happening in this credit cycle, I look at things like high yield bonds, once those start to reverse and you start to see the yields on those start to kind of go in the opposite direction. Another indicator that Jeff Gunlock had recently just said is that when he sees unemployment rate basically bottom and you're not seeing it decrease anymore for a 12-month period of time, that's a huge indicator for him that credit might start to contract moving forward. I was curious if you have anything that you

Starting point is 00:29:15 use in your own personal investing approach that gives you some of those indicators of, hey, it's time for me to reallocate my portfolio, maybe start moving out of equities and putting it into different types of asset classes. Well, I do pay attention to those kinds of indicators, Preston, and I follow Jeff Gunlock and others and quite a few others, so I'm familiar with what you're saying. But I would drop a pretty important caveat to that, which is that there's something called Goodhart's Law, named after an economist Charles Goodhart. And just to paraphrase it in plain English, what he said is that when a market indicator

Starting point is 00:29:51 becomes the subject of policy, it loses its meaning as an indicator. In other words, you take economic data, you treat them as signals, whether the market prices or GDP or unemployment or inflation or any of the things that people look at, and you use them as information, and you do exactly the kind of analysis you just described. Well, unemployment's low and it's not getting low or is that a sign of a top of a sudden, and historically, there may be perfectly valid and a good insight. The problem is that so many of these indicators have become. come the targets of policy, and they're manipulated, that they've lost their value as information.

Starting point is 00:30:27 A simple one would be Chinese GDP. Look at Chinese GDP. It was 10, 11%. Then it kind of came down to 9%, 8%, now it's below 7%. But the government is targeting 6.7%. They said, we're targeting 6.7%. Well, you know what? If you target GDP, you can make it whatever you want.

Starting point is 00:30:45 All you have to do is go out and build a $5 billion train station in a town with 100 people. right. So, you know, glass and steel and architect's fees and cement and engineering and workers' salaries, if you build a $5 billion train station, that's $5 billion of GDP. You can make your GDP whatever you want. But it's a complete waste of money. If you put a $5 billion train station in a small town, more people are not going to take the train. They're certainly not going to pay more for their tickets. You might as well just write it off. With respect to productivity, you're saying. It's a complete waste with respect to the productivity that it's actually Correct. Like you can build it, you can do smart things. You can build a highway and put a toll booth on it and people use the highway and collect the tolls. I mean, there is smart infrastructure. I'm not against all government spending and I'm not against infrastructure, but you do have to be smart about it. But my point with regard to China is quite often they're not smart about it. They're just hitting targets. And so when I look at inflation, when I look at interest rates, when I look at unemployment, when I look at GDP, I say to myself, how many of these things are now subject to good hearts law? How many of

Starting point is 00:31:51 them have become targets of policy pursued through manipulation and market intervention so that they've now lost their meaning as valuable pieces of information. And this is a big problem for the Fed because, you know, they're looking at interest rates and credit spreads and inflation on employment as guise to policy without seeming to reflect on the fact that they're manipulating all those things. They're manipulating interest rates. So when we manipulate interest rates, you're going to manipulate inflation. and you're going to get particular results.

Starting point is 00:32:22 You might be able to create some jobs by keeping interest rates artificially low and you might be able to create some investment by doing the same thing. And so I guess I'm at the point where, again, do I pay attention to them? Yeah, and I'm appreciative of all the good work that people do along the lines you described.

Starting point is 00:32:40 But I don't put that much weight on it because I feel that so much of the information is the result of manipulation that it really is not very valuable. as information. What I try to do is look at other metrics and use not equilibrium models or not regressions, but complexity model and base theorem and behavioral economics and some of the other tools in my personal toolkit.

Starting point is 00:33:03 Yeah, I like your point because, you know, last December, that's when the Fed raised the quarter percent on the federal funds rate. And for me, I was really looking at that event saying, this thing's going to start falling apart. This is absolutely going to fall apart at this point because I just think they made a a misstep. Then in January, we saw it. I mean, this thing was unraveling itself. And so that just further confirmed my opinion that, hey, this thing is really starting to fall apart. Now, I didn't know if it was going to be a complete meltdown or we were just going to start to see a pretty strong bear market. And that's when it was probably in February or something like that. And you had

Starting point is 00:33:38 every central banker and their cousin coming out and saying, oh, yeah, we're going to, we're just going to print, we'll print full dove, yeah. Full, I mean, full on. and they were able to bring this thing back online. Like it was, it was like this aircraft that was going to nosedive into the ground, and they were able to bring it back online. And then the market kind of came back up. And then we saw, what, 188 on the Dow or something crazy? And for me, you know, all those indicators were lined up as far as, in my opinion,

Starting point is 00:34:09 where the credit cycle had really peaked. And then they raised rates. And I was like, oh, this thing's going to fall apart. But that change in government policy, or I should say central banker policy, was a complete unknown. It wasn't anything that I could have projected. I mean, they were saying that they were going to raise rates four times at the end of last year. I have appreciation for what you just said, because it really confirms what I've experienced over the last year.

Starting point is 00:34:32 Well, that's the perfect example, Preston. I mean, they took the stock market down by raising rates, and then they took it back up again with forward guidance and happy talk. So to me, the stock market is not a particularly valuable indicator because I can see it's being manipulated by the Fed. So I would draw a straight line between the Fed's rate hike and the market draw now. So what I see coming is an exact replay. They're going to raise rates in December. They're going to sink the stock market. They say they don't care.

Starting point is 00:34:56 By the way, I had the same conversation with Bernanke a little bit earlier. And he said a very interesting thing. He also said they don't care if the stock market goes down. But he said, until it's 15%. What it means is that, you know, 5, 10, maybe even 15%, they're like, too bad. You know, we told you we were going to do it. If you're, like, leveraged up in stocks, that's on you. it's not our job to prop up the stock market.

Starting point is 00:35:20 And that's probably true to an extent. But beyond a certain point, when it falls too far, too fast, it becomes what they call disorderly. Then they worry about contagion. Then they worry about, oh, is this going to spread to banking? Is it going to spread to money markets, et cetera? Is it going to be a replay of 2008? Then they do intervene.

Starting point is 00:35:37 And that's what they were looking at last February, but, you know, from January 1st to February 10th, 2016, it went down 11%. And that was like a five-week period from, start to finish. So did he imply anything beyond the rate hike in December? Because I know last year they were like, hey, we're going to do it another four times this year. Was he just complete, let's just raise it in December and see what happens? He didn't go there. But I have some insights on that. I can tell you how to think about it. It's an exact forecast of every FMC meeting, but here's the way to think about it. The Fed is not neutral when it comes to raising rates. They are biased

Starting point is 00:36:14 in favor of raising rates. So when they, it's not the case. It's not the case. case when they wake up in the morning, they're not asking themselves, you know, do I want to raise rates? Do I not want to raise rates? What's the data? Data dependent, all this stuff. They wake up and say, I want to raise rates. Can I? In other words, just because they want to raise rates doesn't mean the coast is clear. So I analogizes to a little kid who's trying to steal money from mom's wallet. You know, if mom's looking, they won't take it, but if mom's out in the backyard, they'll go grab some money. So the Fed will raise rates whenever they think they can get away with it. But if market conditions are disordial,

Starting point is 00:36:47 as we saw, not just in February 2016, but also, remember August 2015, and after that August 10th, 2015, shocked Chinese Yuan devaluation. That took the market down 11% in three weeks through the end of August. And the Fed had, remember playing the liftoff for September 2015, and they balked. They went to the happy talk, and they didn't do the lift off until three months later in December, 2015. So they want to raise rates. They can't always raise rates if they think things are iffy or the markets don't expect it or financial conditions are already too tight for other reasons. They won't do it.

Starting point is 00:37:25 But if the coast is clear, they will. And so then the question is, you know, what will the situation be in March? My guess is that if they raise in December, which they certainly will. And if the market reacts negatively, which I do expect, that might, again, put it off in March because they'll be in the same place they were last year, which is they'd like to raise them, but the bigger question is, why on earth is the Fed raising rates when the U.S. economy is on the brink of recession? When the U.S. economy is hanging by a thread, you don't raise rates in a weak environment.

Starting point is 00:37:54 You raise rates when, you know, the economy's hot, unemployment's lower than it is, but inflation is taking off. Things look speculative. And then you raise rates to cool it down a little bit. And then when the market pulls down, unemployment goes up, inflation falls, then you ease, then you cut rates. And the Fed never leads the markets. The Fed always follows the market. because the Fed's always working with a lag.

Starting point is 00:38:15 So why on earth are they raising rates in a difficult, challenging economic environment? The answer is they're doing it for the wrong reasons. They are desperately trying to raise rates so they can cut them in the next recession. The history is that you need to cut rates three or 400 basis points, three or four percent, in other words, to get the U.S. out of a recession. And typically the way it works is you go into a recession at, you know, six and a half percent interest rates. You cut them three percent down to three and a half.

Starting point is 00:38:43 maybe a little more, and then that's enough to get the economy out of the recession. Well, how do you cut 300 basis points when you're only at 25 basis points? Well, you can't, obviously. You're trying to raise rates so they can cut them. I say this is like hitting yourself in the head with a hammer because it feels good when you stop. But the Fed's conundrum is how do you raise rates enough so that you can cut them in the next recession without causing the recession you're trying to prevent? That's the conundrum, and I think the answer is you can't do it.

Starting point is 00:39:11 They're going to cause the recession. Now, I totally agree with you. I heard a really interesting analogy where a person was talking about building a campfire. So you start off the fire real small, and in order to keep it going, you just got to keep adding the same amount of wood. But if you grow that fire a little bit bigger than next time, now it's going to require more wood in order to keep it going. Next thing, you know, you got like one of these massive, you know, the diameter and perimeter of this thing is so massive that you're just having trucks deliver the amount of wood. that it requires to keep this thing burning. And then you have, you know, it starts to go out, well, to keep that thing flowing,

Starting point is 00:39:49 and now the size of the investment capital that has to be supplied that the system is so freaking massive. And when you're literally in this zero interest rate environment or close to it, when you do have that economic downturn, I mean, it's going to require such an enormous amount of capital. So the next question, let's go back in history just here shortly. because I would like to talk briefly about long-term capital management, which is one of the most fascinating and scary events here in modern economic history. So the fund collapsed in 1998 and it lost billions in a short period of time.

Starting point is 00:40:27 And Jim, you were heavily involved in this and we touched upon this before because you were the principal negotiator on this bailout. And I think it's interesting to compare what happened back then until today because it really fascinates me that many hedge funds that brand themselves as virtually being risk-free, yet the reality is very different. And the reason why I bring this up is because it really resonates with your idea that we probably shouldn't be looking at the conventional models anymore. You are very critical about the value at-risk model that a lot of these hedge funds

Starting point is 00:41:05 uses because basically traders can keep adding new layers to neutralize swap positions. And when you do that, it kind of seems like it has no risk, but it also means that they require very little capital to initiate these investments. Could you tell us how the structure of many modern hedge funds seem to be risk-free, but in reality, they can be a ticking bomb? Well, you're exactly right. Say again, LTCM was an example of that, but there are many, many others. And this goes to one of the key points I make, which is that most of Wall Street, it's not just hedge funds. Some of the hedge funds are on the wrong track.

Starting point is 00:41:42 Not all of them, but some of them are. But more importantly, the Wall Street firms, the major banks, you know, JPMorgan and others, and the regulators and the central banks, the Fed and ECB, et cetera, they have all got these models wrong. They're all using variations of value at risk. there are some assumptions underlying value at risk. When you test those assumptions, they assume efficient markets. The markets incorporate all information smoothly and that the price of any market represents all the information known. You can't beat the market because you don't have more information than the market itself.

Starting point is 00:42:16 The risk is normally distributed, which means it kind of falls in accordance with the bell curve so that, you know, small impact events happen with great frequency and high impact events happen with extremely low frequency. to the point that once you get out to extreme events, the probability is, you know, once every, pick a number, three million years, five billion years, et cetera, depending on whether you're 10 or 15 so-called standard deviations, out the bell curve, rational expectations, etc. When you actually look at the science, every one of those assumptions is wrong.

Starting point is 00:42:46 Markets are not efficient. There are all kinds of inefficiencies. There are big ones right now. We saw it in Brexit around the U.S. presidential election. You know, massive mispricings, that based on a kind of more. analysis of potential outcomes, risk is not normally distributed. It's distributed in accordance with what's called a power curve or a power law, which is just a different degree distribution,

Starting point is 00:43:07 but it's reflective of an entirely different kind of underlying dynamic. People are not rational, but why people cling to it, why they stick with it in the face of a lot of contradictory evidence is the real mystery. And part of it, there are two main reasons for that. One is simple academic inertia. You know, you're a 60-year-old professor. and you've got a 28-year-old PhD candidate, and that PhD candidate comes to you and says, Professor, like you'd be my thesis advisor on this complexity project I'm working on.

Starting point is 00:43:37 I says it's completely at odds with everything you've been doing for the last few years ago. Are you crazy to get out of here, you know? You'll never get published. You'll never get a faculty appointment. You'll never be in any prominent journals, you know, because you're challenging the orthodoxy. Likewise, on Wall Street, there's a lot of bad motivation

Starting point is 00:43:53 because value at risk for all its flaws does least superficially allow you to take more leverage than you really should? It allows you to take a lot more risk because it tells you the risk isn't there. Objectively, soberly, based on better science and based on cases we've seen from long-term capital management to 2008 and many others, there's enormous risk in these positions, but value of risk says there isn't. So if the regulators are willing to accept it, which they are, you can use more leverage. You can get big profits, pay yourself a big bonus. If the whole world collapses next year, who cares?

Starting point is 00:44:25 I got my $10 million bonus this year, probably take the money and buy gold or land or something that's going to last. And if the whole world collapses, well, too bad for them. I mean, that sadly is the attitude of a lot of hedge fund people and Wall Street participants, particularly if they can trade with other people's money. It's kind of a head's eye wind tells you lose type of bet. So between simple inertia, the inability of people or willingness of people to grasp new ideas, self-interest in terms of preferring a system that may be statistically. invalid, but enriches you personally at the expense of others. These are all bad reasons for why

Starting point is 00:45:00 this stuff persists. But I spent a lot of time on this in my new book, The Road to Ruin, particularly with regard to long-term capital management. I say every lesson we needed to know, every lesson we needed to learn to avoid 2008 was right there in 1998 after long-term capital. And not only did we not learn the lessons, we did the exact opposite. If you laid out here five things we should have done, we did the opposite of everyone. We repealed Glass-Steagel so that commercial banks could get into investment banking and act like hedge funds. We repealed swaps regulations so that everybody could use more leverage, hidden leverage, off-balance sheet leverage. We repealed certain aspects of the broker-deer capital rules so broker-deeros could effectively leverage 30-to-1 instead of 15-to-one, you know, et cetera, et cetera, on down the list.

Starting point is 00:45:47 All right, Jim, I know I speak for not only myself but our entire audience when we say thank you for coming on our show. and being a part of this and helping all of us learn more and become more educated and all the stuff that surrounds the economy today and where it might be going in the future. So I want to give you a quick opportunity to give our audience a handoff to some of your books, your websites, and your Twitter account and things like that. So lay it on them and let them know where they can find you. Thank you, Preston. We have a, my new book, The Road to Ruin, is available for, and I know with podcasts, people listen at different times. If it's after November 15th, the books in the bookstores, but also available on Amazon, Barnes & Noble and independent bookstores.

Starting point is 00:46:28 My Twitter handle is at James G. Rickards. I put out a lot of commentary on the international monetary system, so welcome people to join me on Twitter. All right, Jim. Thank you so much for your time. It's been such a pleasure talking with you. Thank you. At this part of time in the show, we would like to say thank you to a very special person in the TIP community. And his nickname on the forum is Ennis Amanda. His real name is David. And with more than 3,000 registered users on our forum, I just want to say that David, you stand out. In the last year, you have posted 232 times on our forum.

Starting point is 00:47:06 And I just want to say they are just all top quality. So thank you so much for your contribution. And thank you for continuing to be posting all these awesome comments and analysis on a forum. And David, as a token of our gratitude, we would like to give you access to our chapter by chapter video course of the Intelligent Investor and also our new course, How to Emacs in ETF, and we'll reach out to you very shortly after this episode is out. Now, the two courses I just mentioned their paid courses. We actually also have a lot of free courses and you can find all of them at TIP Academy,

Starting point is 00:47:38 which you can find on our navigation bar on our website and you can check everything out in there. But guys, that was all that we had for this week's episode. We'll see each other again next week. Thanks for listening to The Investors podcast. Listen to more shows or access to the tools discussed on the show, be sure to visit www. TheInvesterspodcast.com. Submit your questions or request a guest appearance to The Investors Podcast by going to www.w.com.

Starting point is 00:48:07 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 a commercial application. Thank you.

We Study Billionaires - The Investor’s Podcast Network - TIP 114 : Part II - Jim Rickards ~ The Road to Ruin (Business Podcast)

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