We Study Billionaires - The Investor’s Podcast Network - TIP233: Dr. Jim Rickards - Central Banks, QT, QE, & the FFR (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we bring you a longtime friend and guests of the show, Dr. James Rickards. Dr. Rickards is the New York Times bestselling author three times over for his book's currency wars, the death of money, and the road to ruin. He's an op-ed contributor for the New York Times, Washington Post, and he's a regular contributor on CNBC, Bloomberg, and the Wall Street Journal. Dr. Rickards is an alumni of Johns Hopkins University, UPenn, and NYU. you. On today's show, we'll be talking to Dr. Rickards about current central banking decisions

Starting point is 00:00:33 around the world and the potential impact on the bond and stock markets. So without further delay, let's get started. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, everyone, welcome to the show. This is the Investors podcast, and I'm your host Preston Pish, and as always, I'm accompanied by my co-host, Stig Broterson. Like we said in the introduction, we're joined with our good friend Jim Rickards. Jim, welcome back to the show. We're always so thrilled to have you here.

Starting point is 00:01:18 Thank you, Preston. Thank you, Stig. It's great to be with you. So, Jim, I want to hop into the thing that I personally enjoy talking to you the most about. And that's just central banking in general. Because each time you come on the show, you just always have such a wealth of information to kind of give people a little bit of foresight as to what they can explain. in the coming quarter in the coming six months. So what I would ask you is, what are you hearing? What's the story you're hearing today with respect, specifically with respect to quantitative

Starting point is 00:01:47 tightening, with respect to the federal funds rate, things like that. What's the word on the street? That's topic number one, whether you like the Fed or don't like the Fed, the fact is they sort of run the world. It's, you know, people know the basic statistics on the dollar. It's about round numbers. It's about 60% of global reserves. It's about 80% of global. payments. It's about 100% of the oil market, not quite but close to 100%. So you just look at those numbers and you go, wow, the dollar dominates. It gives the U.S. a huge political weapon, a huge, actually a military weapon because a lot of the payment system has been weaponized. This is how we impose sanctions. You know, you hear about sanctions all the time. Well, how do we actually do sanctions?

Starting point is 00:02:26 Well, one of the ways we do it is we kick you out of the payment system. We freeze your accounts, seize your assets. We do secondary boycott. So if you're a Swiss bank or a French bank and you do business with someone who's the target of our sanctions could be, you know, Russia, North Korea, Venezuela, a lot of other countries will kick you out of the payment system. So if you're a UBS or Credit Suisse or Deutsche Bank, you don't dare go near any of our adversaries who are being sanctioned, even if you're not doing sanctions yourself because you'll end up on the wrong side of that. So it's a very powerful weapon. But even that, even what I just described, does not capture the full extent of dollar power because there's so much that goes on behind the scenes and actually

Starting point is 00:03:05 the Bank of England just had a new report on this. This gets into the world of currency swaps. And a currency swap is simple, but unbelievably important. It gives the U.S. even more leverage than most people realize. For example, just go back to the 2008 financial crisis. What was that the heart of the crisis? I mean, it started with mortgages, but that wasn't really why it got so bad. It was the contagion effect.

Starting point is 00:03:25 It spread to government securities, junk bonds, corporate stock, international payment, which just spread in every direction. But one of the biggest problems was the European banks made more money-lending dollars, than they did lending, you know, euros or Swiss francs or any other currency. Well, if you're a European bank and you're going to lend dollars, you have to finance the dollars. You need dollar liabilities to go along with those dollar assets. And one of the things they did was issued commercial paper. They had deposits.

Starting point is 00:03:50 They issued commercial paper. And there was a huge appetite in the U.S. money market funds, which bought U.S. dollar to nominate a commercial paper from European banks. Well, when Lehman Brothers failed, a couple of money market funds failed right around the same time, All the money market fund operators refused to roll over that European bank commercial paper. They said, hey, Deutsche Bank, we're not going to take any more of your paper or unit credit or UBS or any of the others. So when any commercial bank is in that situation, they turn to their central bank. The central bank is the lender of last resort.

Starting point is 00:04:19 But the problem was the ECB doesn't print dollars. They print euros. These banks needed dollars. The Fed prints dollars, but they weren't the principal regulators. So what did they do? The Fed printed up $5 trillion. dollars and the ECB printed up five trillion euros or equivalent and they swapped so the euros all of a sudden the Fed has all these euros the ECB got the dollars at that point the ECB was able to lend

Starting point is 00:04:43 dollars to the European banks to bail out the European banking system so not only did the Fed bail out Wall Street and indirectly bail out General Motors and Chrysler and a lot of a general electric and the entire stock market and all the US institutions they bailed out the European banking system through these swaps. Since then, these swap arrangements have proliferated. The U.S. has about 20 or so partners among major central banks, including obviously ECB, Bank of Japan, but many others, the Central Bank of South Korea and kind of our allies and friends throughout the world. And China has put some of them in place. China has a swap arrangement with Switzerland regarding Swiss francs and Chinese you want. But the point is, these foreign central banks are even more

Starting point is 00:05:22 dependent on the Fed than people realize because of these swap arrangements, which are off the books, do not require any congressional approval, et cetera. So the dollar, is, it's not King Dollar anymore, it's more like an emperor. So having said that, my view has been for a long time that that system is more vulnerable to people realize that whenever you're that powerful, you're always going to cause a reaction. So that's the action, King Dollar, but the reaction, if you're Russia or you're China or you're, for that matter, North Korea or Iran or Turkey or any of these other countries, you're sitting there saying, well, okay, I get it. What can I do to work around the system? What can I do to create an alternative? How do I get out from under

Starting point is 00:05:57 dollar hegemony. And they're very far down that road. Russia, China, they're building their on internet that's not connected to what we regard as the internet or the World Wide Web. They're stockpiling gold. We can talk some more about that. They're working on cryptocurrencies. I'm not talking about Bitcoin. I'm not saying go out and buy Bitcoin. They're working on their own. So, it called a Putin coin or a G-coin, whatever you like. They're getting close to rolling out a system that would work a little bit as follows. So, you know, Iran could buy missile technology from North Korea. Russia could buy infrastructure from China. China could buy weapons from Russia. Iran could buy weapons from Russia. Russia is a big export of nuclear power plants. Turkey's a good intermediary, a big

Starting point is 00:06:37 tourist destination. That's a big part of their economy. The big one would be China buying oil from Iran. So you have all these bilateral trade relations going on. All of a sudden, you don't price them in dollars because oil and some of these other things are pricing. You don't price them in dollars. You price them in these new coins. They could have a stable value of, you know, one Putin coin is worth one SDR. You don't have to use the US dollar as your anchor. And then you just keep score. You know, so I ship stuff to you. You ship stuff back to me. One of us, I was the other at the end of the day, periodically, monthly, quarterly, twice a year. You look at the scorecard and you settle up in physical gold. And you can actually move the gold around. You put it on a plane and fly.

Starting point is 00:07:13 That's how you move gold. There's no wire transfer, nothing digital, nothing to hack. So all of a sudden, you've got this whole system. You've got an alternative currency. It's backed by gold. But the goal would only have to move on a net basis. See, that's the key. It wouldn't have to move on a gross basis. On a net basis, you'd keep score with these coins, but on a net basis, you would just convert it to gold at some SDR rate and settle up. And what's important about that system is there are no dollars involved. You can't sanction it. You can't hack it. You can't shut it down. And the world moves on without the dollar. So that's, is the dollar extremely powerful? Yes. Has it been weaponized to pursue foreign policy goals, military goals? Yes. But like any powerful weapon, it invites a

Starting point is 00:07:50 response. And that's in the process of happening. So it's an interesting time. the years ahead to see this play out. So when I look at the actions that we've all seen from the Fed recently, so we had the big Christmas drop in the stock market there on Christmas Eve, I mean, it was down 20% very abruptly. And you saw surprisingly Powell through that drop was really not indicating that he was going to change course in any direction. But then right there at around Christmas time, maybe slightly after Christmas time, you had everyone in the equity market just squealing as to the pain.

Starting point is 00:08:25 that they were feeling. And I think a lot of people were looking back to previous cycles and saying, hey, at this point in time, the U.S. Central Bank was starting to ease. What is your take on some of that maneuvering? Because as soon as that happened, then we saw the market. I mean, this has to be one of the biggest bounces I think we've ever seen in the U.S. stock market with, I mean, it's probably bounced, what, 17 percent or something like that. The backstory is very deep. It involves a lot of wordsmithing, a lot of psychology, a lot of headfakes. But let me just give you the quick version. of it. So we all know what happened in 2008, 2009. QE1, I don't think they did it the right way, but it had to be done. That is a central bank's job. You are the lender of last resource.

Starting point is 00:09:04 And no one really argues with QE1. I personally would have been a lot tougher. I would have nationalized the banks and cleaned out the balance. She stripped out the assets, put them in trust for the American people, sold them off over whatever, 20 years. And then IPO the clean banks. You know, you don't want a government-run banking system. It could be privately held. But you had to clean it up. But QE2 and QE3 were different. And I was on CNBCC and all. August of 2009, 2009, literally just six months after the depth of the crisis, which was March, three months after the end of the recession, there was a Fed meeting coming up. And I think he's Joe Karen and asked me what they should do. I said, they should raise rates. I was in 2000. I said, just a little,

Starting point is 00:09:41 you know, 25 basis points. You don't have to do a whole sequence, just to let the world know we're going to get back to normal. They did not do that. They didn't raise rates until 2015, the six years of zero interest rate policy. And then QE2 and QE3. Now, the important thing to know about, that completely unprecedented. We've never done anything like that in the history of the United States and the history of the Federal Reserve from 1913. They had never done anything like that. This was an experiment. And I talked to Bernanke about it. And he's a great admirer of FDR. Franklin Delano Roosevelt and as a close student, he sort of made his academic reputation on studying the Great Depression in the footsteps of Anna Schwartz and Milton Freeman. And what he admired about Roosevelt,

Starting point is 00:10:21 Roosevelt was no economist, but he was always willing to try something. He was. He was a lot of He thought doing something was better than doing nothing. Was he just going to sit there and let the recession or let the Great Depression somehow unwind itself? He was going to do something. If that didn't work, he would do something else. Now, that's the opposite of the Hippocratic oath in medicine. You know, it's first do no harm.

Starting point is 00:10:39 Doctors, don't do anything unless you know what you're doing. They can't see how it did much good. It didn't necessarily do a lot of harm, but it didn't do much good either. It's just sort of a, most of the action was not in GDP, not in rising wages, not in strong economic growth. The action was inflated asset values. The auction said, well, the money goes somewhere. If it's not going into consumer prices and velocity, it's going into asset prices. And that's what happened at real estate and stock. So they got that reflation, if you want to call it that. Now, they got to 2013 and they said, okay, now we have to get out of this.

Starting point is 00:11:12 They pinned themselves in the corner and how do you get out? That was the taper talk. That was sort of a near meltdown of emerging market. It's just the suggestion that they were going to do it. So September 13, September 2013, everyone's ready for the liftoff. It doesn't have. That was, you know, in response to this meltdown, but it did happen in later that year. So they started the taper, finished a year later in 2014. Now you're ready for a liftoff, which is the first interest rate hike. That didn't happen until December 2015. And they started a tightening cycle.

Starting point is 00:11:41 But the whole time from 2009, even actually to today until 2019, we're almost 10 years into this expansion. Average growth, annual average growth in GDP over the last 10 years has been 2.24%. 2.24. All the recovery since 1980, the average is 3.24. It's a full point higher. This is why I call it a depression. This is using John Maynard Keynes' definition. A depression doesn't mean the GDP is always going down. That's not going to happen. Depression means that you have depressed growth. Your actual growth is below potential. It's below trend. And if you think one percentage point doesn't sound like a lot, it is. We've left in a $20 trillion economy, take a point off for 10 years. You're talking. talking five trillion dollars, five trillion dollars of wealth left on the table.

Starting point is 00:12:28 Imagine someone walking into the Oval Office today handing the president a check for five trillion dollars saying, here, Mr. President, do what you want with this for the good of the American people. That's how much wealth we've lost because of this depressed growth. And they still can't get out of it. So why was the Fed, even though I thought they should raise rates in 2009, why were they scared to death to raise rates in 2015, 2016? They wanted to. They wanted to raise rates. The path the Fed is on now, again, as I said before, it's completely unprecedented. Why would you raise rates in a weak economy? Well, normally you wouldn't.

Starting point is 00:12:59 But they have to get rates high enough so that when the next recession hits, they can cut them. This is like, you know, hitting yourself on the head with a hammer because it feels good when you stop. So how much do you have to cut them to get out of a recession? Well, economic history shows a long time series that it takes four to five percentage points of cuts to get the U.S. economy out of a recession. Let's just take the low end. Let's take 4%, 400 basis points. How do you cut 400 basis points when you're only at 225 basis points, 2 and a quarter percent? The answer is you can't.

Starting point is 00:13:30 But you're not even close. So if we go into a recession today, and I'm not predicting it, the economy's weak, but we're going to have recession sooner than later. If they can't get rates to 4 or 4.5, 5%, they're not going to be able to cut them enough to get out of a recession. So then what do you do? So let's just say it happened tomorrow and you cut them from 2 and a quarter and back down to zero. What do you do next if you're not out of the recession?

Starting point is 00:13:50 QE4, that's exactly right. And by the way, that's the reason they're reducing the balance sheet. That's the reason they started QT, quantitative tightening. During QE, there was a very famous cartoon image of it was Ben Bernanke with a manic look on his face, hanging out of a helicopter, holding the strut with one hand and throwing out $100 bills with the other hand. I'm sure you've seen it on the web or whatever. Well, imagine a new cartoon is it's a furnace with a stack of $100 bills, and J.

Starting point is 00:14:16 Pell's sitting there with a shovel throwing the money into the furnace. that's what he's doing. That's what QT is. You reduce base money. You're reducing M0. Somehow we're supposed to believe that printing money was good for the economy and inflated asset values, but burning money is not going to take the asset values down. Of course it will.

Starting point is 00:14:32 So why are they doing it? Well, they're doing it because they want to get the balance sheet down so they can go back up again in QE4, and they want to get interest rates up so they can cut them again in the next recession. So they're trying to reload the gun or fill up the toolkit as the case may be to get ready for recession. The conundrum is, how do you get ready for the next recession without causing the recession you're trying to cure? 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.

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Starting point is 00:19:05 Now, Jim, I'm looking at this chart from Yadini Research Group. and it shows the aggregated global level of central bank's balance sheet. And that was growing as one I expect after QE1. And then what you see here at the end of 2017, when the Fed was starting to tighten or burning money as you've referred to a gym, then you saw the global balance sheet contract. But then what you recently have seen is that it's going in reverse. The US is not, but we have the ECB and the Bank of Japan that is back in print mode. Do you expect this trend to persist and why is important for us as investors to track the progress?

Starting point is 00:19:45 No, this is going to persist. The thing that's important understand about ease is that there's a very important behavioral and psychological component to it. And here's what I mean by that. The Fed path starting in 2015 has been raised rates four times a year, 25 basis points each, every March, June, September, December, like clockwork until you get to this target of, say, 4%. However, they do pause.

Starting point is 00:20:11 They have paused occasionally. And what are the conditions under which they pause? This is why actually forecasting central bank policy is very easy. It's just so your baseline scenario is four times a year like clockwork for to at least 20, 21. So the trick is, well, okay, but we know they pause. Yes, they do. What are the conditions under which they pause?

Starting point is 00:20:29 One is disorderly markets. When you have stock markets, not only going down, but going down in a way that risks getting out of control, building on a. itself going down. The Fed doesn't care if the markets go down 15% in six months, but they do care if it goes down 15% in three or four weeks. And that was the kind of drawdown we were saying last fall, as you correctly described it up until Christmas. That's one. The other one is very powerful disinflation or even deflation. Their target is 2%. They use core PCE year over year. So personal consumption expenditure, core prices year over year. That's their benchmark and they've said it

Starting point is 00:21:04 2%. Well, if it's 1.9, they figure they're closed, they worry about it. But if you see that going down, and right now it is going down, 1.9, 1.8, certainly a year and a half ago was down as low as 1.5, that's enough to get them to pause. And the third element, if job creation dries up. Well, look at the score. Job creation is strong, continues to be strong, despite the government shut down, despite some natural disasters and a lot of other things. So job creation is strong, so they're okay with that. The price deflator has been pretty strong, but it's up to 1.1. They got to like two for, they've been in two for one or two months in the last six years. So they have not been sticking the landing, but it's been close enough.

Starting point is 00:21:42 But the thing that spooked them three times in the last four years is a disorderly market. And we saw this in September 2015. So the Fed did not raise rates in September 2015. Why? Because the U.S. stock market declined 11% in the last three weeks of August. That was the shock Chinese devaluation. And U.S. stock markets fell completely out of bed. I don't know where people were on Labor Day weekend in 2015.

Starting point is 00:22:04 but a lot of people had a sick feeling in the stomach. It looked like there was no bottom. And the Fed paused. Then the market turned around, which was a form of ease. And then they finally did raise in December 2015. No sooner was that done. Then we had another stock market collapse from January 1st of February 10th, 2016. Stock market went down 11% again.

Starting point is 00:22:24 That was also caused by Chinese evaluation. The Chinese hadn't learned their lesson. So in March, the G20 finance ministers met Shanghai. They cooked up with Shanghai Accord. And the Fed did not. not raise rates in March of 2016. Again, that was a reaction to a disorderly market. So they do this occasionally, and of course, they're not going to raise rates in March.

Starting point is 00:22:44 This month, March of 2019, that's pretty much baked in the pie. We'll see what happens in June. But they haven't cut rates. What does it mean to ease? What it means is your expectations are going to raise, but then they let you know that they're not going to raise. And relative expectations, that's the form of ease. But look at what's going on here.

Starting point is 00:23:01 It's a psychological game. They don't actually cut rates. They don't want to give any of this back because they still want to get to 4%. But they don't want to cause a recession so they'll ease when they have to. I happen to have some one-on-one conversations with the guy behind the scenes on all this. He's not a member of the Board of Governors, but he might as well be. He's been tapped three times by Bernanke, Yellen and Al Powell. Every time he tries to go back to his day job, the Fed calls him back.

Starting point is 00:23:25 He does the wordsmithing. When I say wordsmithing, I don't mean writing the press releases. I mean, it's practically like encryption. There are code words. And everyone's picked up on patients. But if you go back to March 2015, that was when the taper was over. We were getting ready for so-called liftoff, and then Janet Yellen gave a press conference and they issued a statement, and she did not use the word patient.

Starting point is 00:23:47 If you look at all the prior FOMC statements, the word patient was in. Their patient was code for, we are not raising rates till further notice, and we will let you know when we will, which means risk on. You can do the carry trade. When you do a carry trade, you're shorting the dollar. You're borrowing dollars and you're investing in something else. else and set means you short dollars. And how do you lose money in that? Well, you can do a carry trade, leverage you 10 to 1 and make nice 20% returns on equity, but you better have a bomb shelter when the

Starting point is 00:24:13 Fed raises rates because all of your short positions are going to go underwater very quickly. Your cost of funds is going to go way up. So what the Fed says is, okay, when they use the word patient, they mean, we're not raising rates until further notice. You can do the carry trades safely. You can be risk gone safely. Go out and make some money and we'll signal you. How do they signal you? One of these days, and this is what happened in March of 2015, they leave out the word patience. And then that says, okay, we're going to possibly raise rates at the next meeting. Maybe the meeting after that. But if you get caught on the wrong side of a carry trade, shame on you, because we told you

Starting point is 00:24:46 what we're going to do. You got your warning with at least three months, maybe six months to respond. Now, I think a lot of people have picked up on this. I'm going back four years and they've been using this word patient exactly as I described. It's code. Now, lately, everyone's picked up on it. and Bloomberg and everybody is like, oh, they used the word patient. Well, yeah, they started doing it five years ago.

Starting point is 00:25:06 It is a signaling mechanism. So if they use the word patient in March, that tells you they will not raise rates in June. If they leave the word patient out, it doesn't mean they will raise race in June, but it means that they might. They're saying the coast is clear. But it's all driven by the same thing, which is they have not given up on raising race. There are some people I respect, and they're like, well, the next Fed move is going to be a rate cut.

Starting point is 00:25:28 We don't know when, but probably by 2020. And I say, no, they're going to pause. They're not going to raise rates until further notice. But they have not given up on this bigger goal of getting rates up to 4%. They have to because otherwise they can't fix a recession. Keeping your response in mind and knowing that the other central banks, including ECB and Bank of Japan, like we talked about, they're losing their monetary policy. The U.S. is holding firm, perhaps even contracting a little.

Starting point is 00:25:55 What is the future implication of the situation right now in regards to the U.S. dollar? What we're seeing is the continuation of the currency wars. Now, unlike the 1920s and 1930s, where it was really cutthroat, Bernanke reinvented currency wars as a game of past the canteen. So we've got five Marines, they're assaulting a position. It's 100 degrees out. They've got no water. They've got one canteen.

Starting point is 00:26:18 Each guy would like to drink the whole canteen, but they don't. You take a sip, hand to the next guy, takes a sip, and you pass it on. That's how Bernanke reinvented the currency wars. The U.S. is looking around the world. We're a global player, of course, and Europe looks very weak. Japan is either in a recession. Actually, Japan is in a recession. Germany is flirting with recession.

Starting point is 00:26:38 Italy's in a recession. I mean, we're complaining about 2% growth versus 3% growth, and it is a big deal. But these other countries I just mentioned, including some of the major economies in the world, are looking at actual recessions. China, which is not quite in the club, but they're obviously the second largest economy in the world, so they're an important player. their growth is slowing down. Now they have such high growth that they're not in a recession, but when you take China from 10% to 6%, that's a big deal. I mean, second largest economy in the world,

Starting point is 00:27:08 about 15% of global output, and you slow them down by 20% going from 10 to 8 or 8 to 6 or more. That's a big deal. That really haircuts global growth. So the whole world slowing down. The U.S. is, if it's not quite the little engine that could, it's at least the only source of growth. So what we say is, okay, guys, here's the deal. We'll have a stronger dollar. You weaken your currencies. You ease, we'll tighten, or at least just stand still, and you go ahead with your easing policies, you'll get a cheaper currency.

Starting point is 00:27:36 That'll help your exports, pay some jobs, give you a boost. Maybe it comes out of our pocket a little bit, but it's not in our interest to see all these other economies start another financial panic. So you're exactly right. It means a stronger dollar or at least continue to strengthen the dollar. And we already see a weak euro and a weak yen. the yuan's a little different because it's there's a political factor there that's a that's a weapon in the trade wars we haven't really talked about the trade wars but china's in the trade war with the united states the last thing they want to do is cheaping their currencies promote exports has enough to make uh you know bob lighthizer go ballistic so uh so they won't do that at least in the short run but in the longer run i expect they will so yeah the dollar strength is going to maintain not because we like a strong dollar but because if we don't give those other guys a break if we don't pass the canteen the world's going to be in a much worse place when we saw this dynamic play out starting in 2015, where the ECB started easing like crazy. Because at this point, you could maybe

Starting point is 00:28:29 argue this is where the U.S. stopped drinking from the canteen and then handed it over to the ECB. The market in Europe from 2015 up until like the late 2017 timeframe, the equity market went bananas over there. So with the U.S. in a tightening position and the ECB kind of demonstrating that they might be loosening or at least loosening heavily relative to the U.S. Is the European equity market a good place to be? You have to be selective. So the short answer is yes. With the ECB definitely not tightening anytime soon and still de facto easing,

Starting point is 00:29:08 maybe extending long-term asset purchases longer than expected. Japan's easing like crazy. And people say, well, your rates are below zero. You have negative rates. How can easing give you any more relief? The answer is, cheapens the currency. So that's how Japan's getting boost. Chinese are easing like crazy.

Starting point is 00:29:26 By the way, everything I've said about the Fed, take all this other central banks times two. They've printed more money, more central bank, leverage cheap balance, more ease. So China's easing, Japan's easing, Europe is easing, we're delaying, tightening, the same thing, in effect, all very aggressively. And in theory, it's good for European exporters. So it's good for heavy equipment manufacturers, arms manufacturers. It's good for tourism. It's good for certain sectors.

Starting point is 00:29:54 But then again, you know, with global supply chains, you may be an exporter, but you're probably importing your components. So if you get a little more exports based on your cheap currency, remember you've got to pay more for your inputs. The other thing that's going on is that because of the U.S.-China trade war and the impact that has on China, and a lot of the impact by this is playing out in Japan, because Japan sells a lot of stuff to China. See, everyone looks at China's this export powerhouse.

Starting point is 00:30:20 well, yeah, in gross terms, but in net terms, you know, when China exports an iPhone, they bought the glass from Japan, they bought the processor from South Korea, they bought other components from Germany, and then they just assembled them. So the Chinese value added in an iPhone is like 5%. The people making the money are the Japanese and Chinese and the South Koreans. Well, if you put on tariffs and you slow down Chinese exports to the United States, the real people who suffer are Japan, South Korea, and Germany, because they have the high value added exports that go to China for the assembly process.

Starting point is 00:30:54 By the way, it goes through the recession, Japan, Germany, and we just saw the South Korea market implode because of the truncated talks with North Korea. Again, it's complex, needless to say, you can almost never look at a country in isolation. You can talk about policy and policy makers, but if you don't connect the dots, say, well, how does what the U.S. is doing with China affect Germany or Japan or South Korea, the countries I mentioned? You have to take the threat all the way back to see the impact of this. But the big picture is the U.S. is deeply concerned that the entire world goes into recession.

Starting point is 00:31:26 You remember a little over two years ago, 2017, remember Christine Lagarde, head of the IMF talking about global synchronized growth. And every elite, you know, Davo, IMF meetings, annual meetings, G7, global synchronized growth at last. You know, we were waiting for this for nine years. At last it's about six months. And how we're getting global synchronized slowdowns or outright recessions in every country I mentioned. including the United States. By the way, just a quick footnote on the U.S. because we just saw the fourth quarter of GDP numbers come out the other day.

Starting point is 00:31:58 2018 was supposed to be the year of, you know, 4% growth. And the recession was over, you know, almost 10 years ago. That's not the point. But we were stuck in this depression, depressed growth all the way along. Well, second quarter of 2018 GDP growth annualized year every year was 4.2%. And everyone's happy days are here again. You know, third quarter was 3.4%. Still strong.

Starting point is 00:32:19 but down significantly. Fourth quarter is 2.6%. Not horrible, but look at that trend. 4.2, 3.4, 2.6. What does that sound like? Sounds like we're going right back to the 2.249-year average. We had a little pop. I hate to use cliches. You hear sugar high a lot. But yeah, that's second quarter number. That was a direct consequence of the tax cut. Trillions of dollars coming back to the United States. It was always here. It was here all along, by the way. I was just invested in treasury bills. Now they can, they're free to do stock buybacks. And, you know, a lot of companies, they wouldn't give you a raise, but they gave you a thousand dollar bonus or whatever. Yeah, so we got a pop. It didn't last long. Fourth quarter was weak. Looks like early read first quarter of 2019

Starting point is 00:33:01 will be even weaker. Car sales have fallen off a cliff. Retail sales are down. So first quarter might be, you know, 1.6, 1.9%. It's not the end of the world, but we are back in this draft that the Obama track record now, sorry, the Trump track record over two years old. looks like the Obama track record. During the eight years of Obama, we had some 4% quarters. We had more than one. And we had a couple quarters over 4% back to back. But what happened is they very quickly went back to, you know, 1.5%. So when you averaged it out over the entire time, it came to, as I say, 2.24%, which is this very weak growth. It looks like we had a couple good quarters in the middle of 2018, and we're right back in the trough. No reason to believe that we escaped it. And, of course,

Starting point is 00:33:45 Are we getting a tax cut in 2019? No, we had it. So now the year-over-year comparison starts to suffer. People are paying higher taxes and they thought because of the state and local tax reduction. We don't have to tear that all apart and get into the details. But the bottom line is it was a one-time pop. We got it. It's over.

Starting point is 00:34:02 We're back in the trough. Nobody has a solution for this. Meanwhile, so if you take, say, 2.5% real growth and throw on 1.5% inflation, that gets you to 4% nominal growth. How much is the debt going on, 6%? Soon on its way to 7%, 8%. So we're just digging a deeper hole. Let's take a quick break and hear from today's sponsors. No, it's not your imagination.

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Starting point is 00:37:43 Back to the show. Yeah. This was the thing Jesse Felder was telling us. He's like, never have you been at the top of the cycle and seen these dynamics kind of playing out at how fast we're accumulating debt? We had Howard Marks on the show and he said something really interesting to Stig and I. He said, you know, I just, and I forget how he phrased it, but he effectively said, I think that this cycle is going to be not as pronounced as ones we've seen in the past, and it's going to be

Starting point is 00:38:09 like this big, giant movement as far as the business cycle. Then I'm hearing an interview where Ray Dalio is talking about his opinions on the credit cycle, and he suggested that this is going to be kind of a longer drawn-out process. When you look at the coordination from a global perspective of all these central banks, coordinating the management of how they're inflating all this fiat currency. ask yourself, would you rather have a five-year expansion with three and a half percent growth, followed by a six-month recession with negative one percent growth, and then another five-year expansion of three and a half. That's scenario A.

Starting point is 00:38:46 Scenario B is a 10-year expansion with two and a quarter percent growth. The first example gives you higher total growth and you quickly get back to trend. And by the way, that's the history of most recess, well, actually all the recessions, other than the one in 2008, 2009, since the end of World War II. Yeah, you do have recessions. you do have a business cycle. You know, from 1983 to 1986 during the Reagan administration, real growth was 16%.

Starting point is 00:39:09 We were banging it out 5% a year real. So we had a 16% growth in three years. Yeah, and then, okay, 1989, a recession came along, was fairly shallow. Then 10 years of growth at the end of the Bush administration and eight years of Clinton. Then another fairly shallow recession in 2000. So these are normal business cycles and normal numbers.

Starting point is 00:39:30 What's important about all of them? is you fall into recession, but you spring back with a lot of strength and you get back to trend. It's like a great runner who trips, gets up, but still a great runner and keeps going at a record pace. That's not what happened this time because the 2008 panic and recession was so bad. The worst since the Great Depression, it was so bad that they couldn't let it play itself out. I mean, playing itself out would have meant city bank was nationalized, Goldman Sachs was nationalized, etc. That didn't happen. They truncated it.

Starting point is 00:40:01 Well, the problem is there's a cost with central bank intervention to truncate. The cost is if you don't hit the bottom, you never get the bounce back. If you don't let the V go all the way down and Bernanke wouldn't, you don't get back to trend. What happens is it's an L. You stop the bleeding, but you just go kind of sideways. And that's what we're done. What that means, getting back to Dahlio and Howard Marks, is that there's really no precedent for what we're experiencing right now. I would be very wary of that kind of forecasting.

Starting point is 00:40:28 And I'm in the forecasting business. you have to be really careful here because there's no precedent for any of this. Now, the other important thing in terms of what Marks and Dahlia said, failed to separate the business cycle and a financial panic. You can have a business cycle recession without a panic. We had that in 89. You can have a panic without a business cycle recession. We had that in 1987, October 19, 1987.

Starting point is 00:40:54 Stock market falls 22% in one day. One day. If that happened today, it would be the equivalent of five. thousand Dow points, not 500, $5,000 in one day. But there was no recession. Actually, there was no better time to buy than the day after because the market came back slowly. So you can have business cycle recessions with no panic. You can have panics with no business cycle recession. But every now and then they come together. It's, again, I hate cliches, but it is a perfect storm. It's like two hurricanes conversion. And that's what we had in 2008, 2009. We had a recession,

Starting point is 00:41:29 the severe one, but we also had a panic. So when Dalia says, oh, this is going to go on for a long time, he might be right about that, and then we're going to have this sharp break, but it's going to build. I would say you're really confusing the business cycle and the panic. Panic could happen tomorrow for any one of a hundred reasons. I use complexity theory. I use behavioral economics, behavioral psychology. I use base in statistics, base theorem.

Starting point is 00:41:55 But what that tells you is that a panic can happen at any time. for reasons that cannot be predicted. You can see them after the fact, but people ask me all the time, well, Jim, when's the next panic going to be here? When should I sell my stocks? That's how they praise it. When should I sell my stocks?

Starting point is 00:42:10 As if I'm going to call them up at 3 o'clock in the afternoon the day before and say, well, sell them now because it's going to happen tomorrow. I said, look, I'm not going to know what happens. No one's going to know what it happens. That's what a panic is. It comes out of nowhere, it catches you by surprise. You get a predictable behavioral response, sell everything. I remember I was in Japan in September of 2007.

Starting point is 00:42:29 And the Japanese stock market was tanking. And my Japanese friend said, Jim, we don't get it. We understand you Americans have a mortgage problem. But why are our stocks tanking? I said, well, that's because the hedge funds are getting margin calls on their mortgage positions. They want to sell the mortgages. They can't.

Starting point is 00:42:44 They've gone no bid. So they have to sell good stuff to get money to pay the margin. And good stuff is Japanese stocks. But the reason they went out of business was because people say, well, I know that guy's good for the money. So I'll call him. This is how contagion works. I said, the contagion has come to the Japanese stock market.

Starting point is 00:42:59 because people need money to meet margin calls on bad mortgages. And that's just how it spreads around the world. So you can't, now, having said that you can't predict it with high precision in terms of timing and you won't know what it is. That's the other thing. People say, well, I've got a whole long list of causes the next panic. But I promise you it will be something that's not on your list or my list or anybody's list because if it's on our list, we've kind of thought about it.

Starting point is 00:43:24 We're doing something about it. So things you don't foresee. So my question, I turn the question. around, I say, don't ask me when it's going to happen or what's going to cause it. I will promise you it will happen. My question is, are you ready? What are you waiting for? In other words, if you agree it's going to happen and we won't be able to see it very far in advance, why aren't you prepare for it right now? You just have to separate the business cycle and the panic. There are two different things. I think this is a great opportunity to talk about your new

Starting point is 00:43:51 book, aftermath. When you're talking about how the stock market has changed, even though your book is not out on the street yet, correct? That's correct. I'm very excited about it. It's coming out July 23rd. After math, I have a whole chapter on passive versus active investing. Now, Jack Vogel just died recently and he was the father of indexing. He said, look, you can't beat the market. Just buy an index fund, pay lower fees, buy and hold, sit back, you'll get rich. Well, there's a little something to that. The fees are lower. Buying and holding has been better. Most people panic, they buy high and sell low. That's a good way to lose money. So there's something to it. But the premises, two things were wrong about it.

Starting point is 00:44:29 Number one, the premise was wrong. You can beat the market. Most managers don't. Most managers don't, but some do, and how they do it is interesting, and I explore that. But more to the point, passive investing and index investing is really a parasite on the body of capital committers. It's the people who actually make, you know, they buy when everyone else wants to sell. They sell when everyone else wants to buy.

Starting point is 00:44:50 They stand up against the market. They're contrarians. They look for trend reversals. They commit capital and they win or lose. And as I say, they can't beat the market. but they're price makers. The passive investors are price takers. What happens when passive investing is 70 or 80% of the market and so on the way?

Starting point is 00:45:08 All of a sudden, you don't have the capital committers. Everybody's a parasite. Nobody's a healthy body, you know, putting out the blood. And then now you have a panic. As I say, it could happen any time. And all the passive guys are, well, we got to sell because we're indexers. You know, we got to get out of this. It's all robots.

Starting point is 00:45:23 And when I say robots, I mean real robots. And what I mean by that is an order matching system. So you want to buy something, I want to sell something. We want anonymity. We put our orders in and the computer matches our orders and we're done. That's been around since the 90s. That's instant ed. That's a lot of other systems.

Starting point is 00:45:39 That's not what I'm talking about. I'm talking about the computers actually make the decision. The computer decides to buy or the computer decides to sell based on the high R squared of some regression that between, you know, Rain and Brussels and Ford Motor Company stock. And, you know, James Simon's great insight and Robert Mercer was, the first thing you learn in statistics, your first week of class, they say, well, correlation does not mean causation. And they beat it into you and you got to separate it. Correlations, high, R squared is 0.9, but it's not causation. And what Simon and Mercer said was who cares?

Starting point is 00:46:13 We don't care about causation. All we care about is correlation. Because if you can find it, you can trade it. It's like, you know, umbrellas don't cause rain. They're highly correlated like 100%. But umbrellas don't cause rain. But they're like, who? Who cares? If I see umbrellas, I know it's raining, you know, so buy the rain. You know, that was a revolution in that itself. And of course, they've made, you know, tens of billions of dollars. But that's the world we're living in. The robots are over 90% of the trading. They train them to, say train as if they're organic, which they're not. But they use artificial intelligence, big data, and they scan, like every document in the world for keywords.

Starting point is 00:46:49 And I can guarantee you the patient is programmed into every computer, and they look for that in these Fed statements. But the problem is, they're all the coding. and all the algorithms on the word recognition software are done by the same like 28-year-old engineers from Caltech or Bangalore or wherever who know a lot more about coding than they do about markets and they all write the code the same way. All the robots move in the same direction. They feed on each other at microsecond speeds

Starting point is 00:47:18 and at least so far we've been able to survive the flash crashes but one of these days it's going to go down and it's going to keep going down because one computer is going to erase the other to the bottom. Investors are not ready for that. So I go through two things. Number one, what are the clues, staring at the face that we're not paying enough attention to? We're not putting enough weight on that are going to sink the markets, cause a panic. But we could have stopped it, but we didn't.

Starting point is 00:47:44 Awesome. Well, when it comes out, I'll be sure to tweet about it and remind our audience because it is always a pleasure to sit down with one of your books and read through it because you always have such insightful things to comment about and just really kind of spark a lot of thought. So I just want to thank you personally for always making time to come on our show. I know Stig and I are just thrilled when we get a message back from Allie saying that you're going to come on. So, Jim, thank you so much for making time tonight to chat with us. Thanks for inviting me. All right, guys, that was all the press down I had for this week's episode of the Ammasters podcast.

Starting point is 00:48:20 We see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to Asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network.

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