We Study Billionaires - The Investor’s Podcast Network - TIP488: Current Market Conditions W/ Richard Duncan

Starting point is 00:00:00 You're listening to TIP. Hey guys, I'm really excited to share an upcoming event hosted by the Investors Podcast Network. Beginning on Monday, October 17th, we are launching a stock pitch competition for all of you to compete in. And the first place winner will receive $1,000 plus a year-long subscription to our TIP finance tool and more. So don't miss your chance to win $1,000. If you're interested, please visit the investorspodcast.com slash stock-dash competition for more information. The last day to submit your stock analysis will be Sunday, November 27th. And to compete, please make sure you're signed up for our daily newsletter.

Starting point is 00:00:37 We Study Markets, where we'll announce the winners. All entries can be submitted to the email newsletters at the investorspodcast.com. Good luck. On today's show, we welcome back economist Richard Duncan to discuss the current events happening across multiple markets. Richard is the author of four books, the most recent of which is called The Money Revolution, which we discussed back in March, episode 424, Richard has worked for both the World Bank and the IMF, and I always appreciate his ability to teach his ideas very clearly and thoroughly. In this episode, we discuss where the economy is heading now that credit growth has been reversed,

Starting point is 00:01:14 the steep decline in the treasury markets around the world and what's driving it, why the Fed's net income has turned negative for the first time ever, and how it could be reversed if politicians understand the mechanics that Richard lays out. England's pension plan fiasco, the $280 billion chips and science act that was recently signed into law, and much, much more. This one is a doozy as we explore so many happenings across markets, both globally and domestically. I really hope you enjoy it, so without further ado, here's my conversation with Richard Duncan. 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.

Starting point is 00:02:02 Welcome to the Investors podcast. I'm your host, Trey Lockerby, and today I'm super excited to have our friend Richard Duncan back on the show. Richard, welcome back. Hey, Trey, thank you very much for having me back. I'm really looking forward to this conversation. It was so funny, you know, someone on Twitter today wrote me and said, when are you going to have Richard Duncan back on the show? I said, funny you should ask.

Starting point is 00:02:33 We're talking tonight. So good timing on our part. I think a lot of people are eager to hear from you. A lot's happened since our last discussion, which I believe was in February or March timeframe. And it feels like years. We didn't know Russia was going to invade Ukraine. The Fed was just winding up quantitative easing, hadn't started quantitative tightening yet, and interest rates were still very close to 0%.

Starting point is 00:03:00 It feels like a lifetime ago. A lot has changed. I wanted to kind of start out here by talking about something we talked about on our last episode where you were describing the need to continue to drive credit. And the U.S. is hitting, you predicted around 90 trillion in total credit by years. And we're actually above that already, over 91 trillion now. We need 2% credit growth after inflation to not go into a recession. So that's what we discussed on our last episode. If that's the case, why is there any debate right now, whether we're in a recession or not?

Starting point is 00:03:37 You know, I believe that after dollar ceased to be back by gold, our economic system changed, and it started being driven by credit growth. Instead of being driven by investment and savings, the way capitalism had worked forever, suddenly the new growth dynamic was driven by credit creation and consumption. And total credit in the U.S. is also equal to total debt. This is all the debt of all the sectors of the economy, to the government, the households, the corporations, the financial sector, all the debt, it first went through $1 trillion in 1964. It's now increased to $91 trillion, so a 91-fold increase in credit in just 58 years. And that credit growth has been the main driver of economic growth in the United States and all around the world.

Starting point is 00:04:29 And if you look from 1950, roughly, to 2009, anytime total credit adjusted for inflation grew by less than 2% the U.S. went into recession. That happened nine times between 1952 and 2009. Every time credit grew by less than 2% adjusted for inflation on an annual basis, the U.S. went into recession. So now, here we are with $91 trillion of credit, if you need that to grow by 2% adjusted for inflation, If we assume quite generously that the inflation rate will average 7% this year, then 7% plus 2% means that before adjusting for inflation, total credit has to grow by 9%. And 9% of $91 trillion, which is how much debt we have now, is $8 trillion over the next 12 months. And currently, as of the second quarter at least, total credit was just growing by less

Starting point is 00:05:29 roughly, let's say $6 trillion. So I always talk about this 2% adjusted for inflation as the recession threshold. If we don't have 2% credit growth adjusted for inflation, then we go into recession. So I call the 2% credit growth, the recession threshold. Well, we've now been below that 2% recession threshold for the last five quarters. And for the last three quarters, credit has actually contracted. This is year on year. In the second quarter, total credit adjusted for inflation. was down 1.2% year on year. So this is creating a very perilous moment for our economy. Since our economic system, I call it creditism, since it's driven by credit growth.

Starting point is 00:06:12 This poses a real challenge to creditism. Creditism is verging on the brink of crisis and is not at all helped by the fact that asset prices are also now falling. Credit growth wasn't particularly strong after 2009. It was just ranging between two or three percent. a year after adjusting for inflation, despite the government's massive budget deficits all during that period in the government borrowing and government debt going up so sharply. Government debt's roughly quadrupled since 2008.

Starting point is 00:06:43 And that's been driving a lot of the credit growth, but even still, the credit growth was weak. And the Fed intervened to support the economy through very low interest rates and round after around quantitative easing, and that pushed up asset prices, and that created a wealth effect. So the total wealth of the Americans more than doubled between 2008 and the end of last year. It rose $80 trillion between 2008 and the end of last year to $150 trillion. But so far this year, $6 trillion had been wiped out. So we've got not only credit contracting, we've got a negative wealth effect. And moreover, the Fed is tightening monetary.

Starting point is 00:07:25 policy very aggressively with aggressive rate hikes, which we'll see more of. It looks like going forward, plus $95 billion a month of quantitative tightening, which will add up to $1.1 trillion a year if it continues for a year. So little wonder the stock markets have crashed as much as they have, but they're probably going further down. And now property prices are likely to start dropping in a double-digit rate as well. Yeah. You know, in your last macro watch, You were highlighting that as the Fed is continuing to raise rates, we'll see the stock market decline and other risky asset classes. You just mentioned real estate.

Starting point is 00:08:02 So I'm assuming that's kind of what you were alluding to there. But the 20-year treasuries are down year-to-date more than stocks right now. I was kind of curious why they weren't kind of included in your analysis there. This was the fourth worst year after 1721, 1865, and 1920. So the fourth worst year in the last 322 years, this is according to Bank of America research. Do you think that we're just seeing a normal market conditions where old bonds are being discounted due to higher paying bonds being issued and fed now tightening, selling out a loss? Or is there something even more ominous maybe happening here?

Starting point is 00:08:45 I think something more ominous is happening. The major theme that's run through my career over the last 35 years is globalization. and growing U.S. trade deficits, growing U.S. current account deficits. And as the U.S. bought more and more goods from low-wage countries, that was extremely disinflationary. That drove down the inflation rate from 15% in 1981 to not too many years ago. It was negative. In early 2015, we had deflation most recently. And that was all because of globalization.

Starting point is 00:09:19 And so as the interest rates, as the inflation rate came down, then the interest rates, came down and moved lower and lower. And the Fed reduced the federal funds rate to roughly 0% and held it there for most of the time now since 2008 until very recently. But now what we're seeing is a partial reversal of globalization, both resulting from COVID and the global supply chain bottlenecks that produced. And then just when there was some glimmer of hope that that was going to recede before too much longer, Russia invades Ukraine and causing a very big spike in energy prices everywhere in the world, but particularly in Europe, and also food price spikes in food prices as well, which another big inflationary surge throughout the global economy. So the most recent

Starting point is 00:10:04 inflation numbers were terrible, just not too many days ago. Headline CPI is still 8.2%. That didn't improve much. And core CPI, it moved up. It hit a new 40-year high of 6.6%. And so this is creating a disastrous scenario for the Fed. The Fed, it looks like the Fed is going to be compelled to continue increasing interest rates. They've already hiked the federal funds rate by 300 basis points, essentially from zero now to 3.1 percent on the effective federal funds rate. And come November, it looks very likely they're going to do November 2nd, they're likely to announce another 75 basis points.

Starting point is 00:10:42 And then in December, probably 50 basis points more, taking the effective federal funds rate up to 4.3% by the end of the year. And they're probably not going to stop there. I would expect that they're going to keep hiking, and I wouldn't be at all surprised to see the federal funds rate move above 5% in the second quarter of next year. Unless something breaks first, if we see very unordery, disorderly developments in the financial markets that threaten to destabilize the financial sector, then the Fed will have to stop or reverse course or at least hint that it will. But unless that happens, and it very well could happen sooner rather than later, in fact.

Starting point is 00:11:28 We're seeing all kinds of problems in the UK now and credit default swaps are rising on the U.S. banks. So something could break. But until something breaks, the Fed's going to keep tightening because the unemployment rate is still extremely low, 50-year low, 3.5%. And the Fed needs to reduce demand in order to bring supply and demand back into balance and bring the inflation rate back down. So I think that's what they're going to continue to do. So even though the stocks have fallen so far, I suspect they'll fall further because if you look at the overall asset prices, they're still very inflated by historic standards. You know, I always talk about what I call the wealth to income ratio. That's household sector net worth, all the wealth of the Americans minus all their debt, divided by disposable personal income. That's wealth divided by income. The Fed publishes this every quarter. It goes back to 19. the average has been 550%. Well, every time it goes way above that average, as in 2000 with the NASDAQ bubble, 2008 with the property bubble, it pops and it goes back to its average. Well, now, even after the correction in the stock market in the first half of the year, this average

Starting point is 00:12:39 is 16% above its previous peak in 2008. So the average since 1950 has been 550. Currently, this ratio is 780. That's 16% above where it was in 2008. So this is telling us that asset prices are still very stretched relative to income and have the potential to fall much further. Now, that's probably going to take a lot of decline in the property prices to pull that down. But I would also expect the stock prices to continue. I don't think we've seen the bottom. So rather than being brave and diving in now, I think it's best just to wait until something does break, because when it breaks, then we'll probably see lower lows across all asset classes. This has been a common narrative I've been hearing.

Starting point is 00:13:25 You know, the Fed's going to keep increasing rates until something breaks, quote, unquote. And is it a possibility that the Fed, that something that breaks is actually the Fed itself? Because as I understand it, if markets continue to tank, it's fairly inevitable. They're going to have to come in at some point and do some more quantitative easing to shore up the markets. And if they continue to raise rates, then our deficit is just going to continue to continue. need to go up. And at some point, we're going to have to fund that deficit. And that's going to cause the Fed to print more money just to fund the deficit. So they're kind of in a double bind

Starting point is 00:13:57 here, right? Well, the Fed's certainly facing a lot of challenges. But the government debt did, the fiscal year for the government just ended on September 30th. And the debt for the year that just ended was only half. The budget deficit was only half as high as it was the year before. It was still a high number, $1.4 trillion, but the year before it was $2.8 trillion. And the year before that, it was $3.1 trillion. So the amount of money the government is borrowing is much less than it was a couple of years ago, of course, during the worst of the pandemic. Very interesting. So going back to your point about the market possibly going lower, I tend to agree with you on that because for having seen the everything bubble expand as much as we've seen it expand, you would think

Starting point is 00:14:44 there would be some kind of Lehman moment at some point, right? I just don't feel like we have a, you know, scapegoat, if you will, or something that kind of a post sign, you know, if you will, to say, oh, that was the moment. Things went really south. And, you know, now we're seeing Credit Swiss, as you kind of mentioned, the credit default swaps there. They've recently tapped the Fed for $6.27 billion. How concerned are we around this issue with Credit Swiss and the credit default swaps we're seeing on multiple banks? So I think the biggest point of concern right now is in the UK, the recent budget proposals with very large tax cuts spooked the financial markets there and resulted in interest rates

Starting point is 00:15:27 on 10-year UK government bonds on GILS jumping very sharply and very suddenly. And we discovered that apparently most of the UK pension funds, have been using derivatives contracts to leverage up their potential profitability, but were totally unprepared and vulnerable to such a sudden and unprecedented spike in 10-year government bond yields. Suddenly, they started getting very big margin calls when the 10-year government bond yield spiked, and that forced them to start selling any kind of asset, including government bonds there. The more government bonds they sold, the more the yields on those bonds went up and the greater problems they all faced. And so at that point, the Bank of England broke, at least temporarily.

Starting point is 00:16:16 They had intended to start quantitative tightening just around now. But instead, they had to announce that they had to act as the provider of liquidity in the last resort because there was essentially a crisis in the UK pension fund market. So they announced that they would, rather than starting to destroy money, that they would be willing to create an additional 65 billion pounds over a relatively short period of time that they would use to buy UK government bonds to ensure that there was sufficient liquidity available to these pension funds needing to sell government bonds. So there was a real crisis in the UK markets, and it isn't over yet. The poor UK Treasury Secretary, Chancellor of the Exchequer, got sacked a few days ago

Starting point is 00:17:03 for proposing this budget that resulted in such chaos. But the yields are moved down some, but on Friday they were really quite high again. And it's possible they'll spike higher again when the markets reopen on Monday. So who knows how much exposure English banks have to that situation or Swiss banks or even US banks and what the knock-on spill-on effects of all of that could be. This could be the thing that breaks. But when it breaks, a lot of damage is likely to be done before the policymakers come to the rescue. So I don't think pre-break is the time to buy. I think post-break is more prudent. It reminds me of that Buffett quote that it's only when the tide goes out that you learn who's been swimming naked, right? And this story, I don't know how to feel

Starting point is 00:17:50 about it, mainly because, I mean, these are pensions. These are people's retirements. And it seems like the responsibility here is just a lot heavier because of the implications. Is this a canary in the coal mine, if you will, from other pensions across the globe, or you think we would have seen that by now if there are other issues like this? Yes, to some extent, it is a canary and a coal mine. But looking ahead, with some luck, the inflation rate will start coming down everywhere, at least starting in the U.S., perhaps more so than Europe, because Europe has such a crisis going on with Russia and the very high energy prices in Europe that's causing. But in the U.S. is very reasonable to expect that the inflation rate will begin coming down for a number of reasons. Just for instance,

Starting point is 00:18:36 the base effect, the year-on-year base effect, oil shot up to $120 a barrel. Now it's $85, let's say. So year-on-year, at some point, it will appear that there is deflation and oil prices. And even if it stays at $85 a barrel for the next 12 months, there'll be no inflation in energy, if that's the case. So the base effect will bring inflation down from these extraordinarily high levels we're experiencing now. The U.S. CPI peaked at 9.1%. We're also seeing falling commodity prices across most commodities that are pretty significant. And there are a lot of signs that the global supply chain bottlenecks resulting from COVID are being worked out, such as the Baltic Freight Index, which is plunged quite radically. So we should see significantly lower inflation going forward. The one thing that's holding

Starting point is 00:19:28 it up. Another example, semiconductor prices have fallen a lot. That means that car prices should begin to drop and use car prices should drop a lot. So all of those things are pointing to lower rates of inflation. And if that occurs, then the Fed will be able to stop hiking interest rates so aggressively and at some point even begin to cut interest rates. So there will be a point beyond which things begin to improve rather than worsening, which is where we are at the moment. The one thing that's keeping the inflation rate number elevated, one of the main things is the house price inflation that is appearing, particularly in the core CPI numbers. And that's going to take a number of many months to work out any way you look at it.

Starting point is 00:20:13 But we're probably going to see home prices starting to fall quite soon. The 30-year fixed mortgage rate has shot up astonishing 7%. Clearly, that's going to be very damaging for home. prices. So once home prices start dropping, as it appears that they will, then we'll see much less upward pressure on rents. And rents, too, may begin to drop before too much longer. Yeah, I think you're exactly right about that. I actually saw some data here from Redfin with some percentage changes from May of this year to October. And we're already seeing double-digit declines. It's actually the fastest crash they're saying. So Oakland, California, for example,

Starting point is 00:20:51 down 16 and a half percent, San Jose, California, 15 percent, Austin, Texas, 14 percent. So we're seeing drastic declines in housing happening rather quickly. I found this actually kind of surprising, mainly because I figured a lot of people had very low interest rates on their mortgage, and that's a big asset right now. So I understand maybe they're getting cash trapped in other ways, inflation, et cetera, and perhaps it's leading to selling your home. But I don't know exactly where the incentive lies, and I'm sure it's all over the place, but the incentive to sell your home when you have such a low interest rate is kind of surprising to me. Now, one theory I did have is that, you know, let's say you took out a helock on your home to buy an Airbnb or something like that.

Starting point is 00:21:37 I mean, a lot of people kept rolling this over and doing it over and over again. Those hellocks can get margin called, right? And so that could have a cascading effect. And I'm curious what the driver, I guess, is if it's simply the interest rates on mortgages or if it's, maybe there's some more layers to it. Well, of course, anyone who's buying a new home will have to pay the higher mortgage rates, and that's deterring a lot of new buyers. And that's the reason we've seen such a sharp decline in new home sales. So that's taken all the froth out of the market, and it's suddenly changed very suddenly.

Starting point is 00:22:10 That alone is enough. Well, speaking of rapid declines, we talked about the Treasury market. This is actually the largest and most rapid decline ever. And we were kind of speculating on what is driving it. We mentioned a few things. But you have Japan buying their own sovereign debt. So they're obviously selling some treasuries. You've got Hong Kong foreign reserves declining to the lowest levels in history, making a strong case that the Hong Kong dollar is going to be debased. The Eurozone trade deficit for August was recently published and given their increased cost for energy. Their deficit is now at historic

Starting point is 00:22:49 levels and it's another strong case for the euro to decline. These are just a few examples. And all the while, the dollar is now, at least the dollar index is at 113. What are the ramifications you see from the dollar continuing to strengthen while the rest of the world is easing? So not so long ago, the great chorus echoing across the internet space was the dollar was doomed, the dollar was going to collapse, and that was going to be the end of the dollar. Right. Now we've got the dollar index at 113. That's a 20-year high. And as you suggested, it looks like it's probably going to keep moving higher. So the first takeaway from this is the dollar swings up and the dollar swings down. If you go back, it started floating in 1971 with the breakdown

Starting point is 00:23:35 of the Bretton Wood system. It doesn't really swing that far in either direction. Now, during some decades, it's down from the place it started in 1971. Other moments such as now, it's above where it started in 1971, and this is what we should continue to expect for over the decades ahead. The dollar is not going to collapse. The dollar is not going to go away. Sometimes it's going to be stronger. Sometimes it's going to be weaker. And if you can forecast those moves, then that's great, because it does have big implications for the rest of the global economy. Normally, when the dollar gets stronger, commodity prices get weaker. When quantity prices get weaker, normally that's bad for most of the commodity-producing countries in the world, which are normally emerging markets.

Starting point is 00:24:20 Also, when the dollar is very strong, that tends to be bad for U.S. corporate profits, since they earn a significant amount of their profits from abroad, and that since weaker profits suggest that weaker share price, so it tends to be bad for the U.S. stock market. So that's sort of where we are at the moment. And it does appear that the dollar has a good chance of continuing to get stronger, Because as you mentioned, the yield on the 10-year Japanese government bond is 25% of 1%. In other words, it's 25 basis points. The Bank of Japan is creating money and buying Japanese government bonds in order to peg the 10-year

Starting point is 00:24:59 Japanese government bond yield at 25 basis points. Meanwhile, the U.S. rates are going up very sharply and very suddenly. So the yen is at a 20-year low. and it's taken some intervention from the Bank of Japan to prevent it from dropping even further. If you look at Europe, they have a disaster with their energy crisis since they've been cut off from almost all of Russia's energy supply. They have high rates of inflation and their central bank, while it recently did increase interest rates a little bit, they're not going to be able to keep increasing interest rates as much as the Fed is just because Europe's likely to have quite a severe recession. And, well, England's a story unto itself.

Starting point is 00:25:40 So, overall, it does look like the dollar is probably going to continue to appreciate. 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,

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Starting point is 00:29:31 Start your business today with the industry's best business partner, Shopify, and start hearing sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify. All right, back to the show. Yeah, that yield curve control in Japan, it seems like, inevitable in a lot of the other parts of the world. You know, in your most recent book, we were talking about it in our last episode in March. It was episode 424 for those who want to go back and check that out.

Starting point is 00:30:11 You wrote that if the Fed were a corporation, it would be the most profitable corporation in the world, even leading Apple by $30 billion, give or take. And we discussed how the Fed actually makes money. The Fed basically creates money, buys bonds or mortgage-backed securities and earns the interest with relatively low overhead. It's around $8 billion or so, mostly paying probably economists. And in September, the Fed's net income has, for the first time ever, turned negative. So can you describe exactly what's going on here in the change with the Fed? Okay, well, this takes some explanation. Let me begin. by saying that when we spoke in February, the data for last year was not yet available.

Starting point is 00:30:57 So when I said the Fed was the most, if it had been a corporation, it would be the most profitable in the world. That was for 2020 data. That year in 2020, the Fed's profits were $87 billion. And the Fed is required to hand over all of its profits to the government. So that year, the Fed's profits reduced the U.S. budget deficit by $87 billion. Last year, the data now is available for 2021, the profits were much higher than they were the year before. Last year, the Fed's profits were $107 billion that had handed over to the U.S. Treasury Department, reducing the budget deficit last year by $107 billion. So how this works, as you mentioned, the Fed creates money essentially at no cost to itself, and it buys bonds in order to pump money into the financial

Starting point is 00:31:44 markets. Since those bonds pay interest to the Fed, the Fed has a lot of interest income, And since it created the money that it used to buy those bonds for free, it has very little interest expense thus far. And so with a lot of interest income and little interest expense, that's where all the profits come from. Now, what has changed is when the Fed creates money, it does this by it buys a bond, for example, from a bank. And it pays for that bond by making a deposit into that bank's, into that bank's account at the Federal Reserve. All the banks have a bank account at the Fed. And so when the Fed buys a bond from J.P. Morgan, for example, it simply deposits money into J.P. Morgan's bank account, money that it has created is not money that

Starting point is 00:32:34 existed before. And that expands the amount of money in J.P. Morgan's bank account at the Fed. In other words, it expands J.P. Morgan's bank reserves. Now, what's happening is bank reserves, because the Fed has created so much money through quantitative easing starting in 2008, the Fed has created something like, well, at the end of 2007, the Fed's total assets were, let's say, $1 trillion, a little less than a trillion dollars. At the peak, a few months ago, they had increased to $9 trillion. So between 2008 and now, the Fed's assets had increased by $8 trillion, meaning the Fed had created $8 trillion new dollars.

Starting point is 00:33:16 and money that it pumped into the financial system, into the banking system, causing bank reserves to expand. Now, there is massive excess supply of bank reserves. Now, so people become very confused about what bank reserves are, and it is really a bit difficult to get your mind around it. But on the other hand, it's not as complicated as you think. Bank reserves, they're just money. So rather, the money gets transferred around the banking system now electronically. And it becomes very confusing when you think about these digits moving around the banking system and from the banks to loans and the banks might buy bonds or might make investments in stocks.

Starting point is 00:33:56 It all becomes very confusing. But if you think of these bank reserves as just dollar bills and follow where the dollar bills are going or think of them even to make it more dramatic, think of this as pennies. You know, just imagine these mountains of pennies that the Fed is creating. And just watch where the pennies move. That's the same. Bank reserves are the same as dollars or pennies or anything you want to look at it. When the Fed creates bank reserves, those bank reserves are not going to go away until the Fed destroys them with quantitative tightening.

Starting point is 00:34:30 So, for example, the Fed may buy a billion dollars of bonds from JP Morgan and deposit a billion dollars into J.P. Morgan's bank reserves. Now, J.P. Morgan can do anything with those bank reserves that it wants. Those reserves are money. So it could lend that billion dollars to Trey Lockerbie. But Trey Lockerby is not going to keep the billion dollars worth of pennies in his backyard. That would be ridiculous. He's going to deposit them in his bank, Goldman Sachs, perhaps.

Starting point is 00:34:57 And then so the bank reserves moved to Goldman Sachs. They don't disappear. They're not going to disappear no matter how much the banks lend or no matter what they do with those bank reserves. They could buy a building with it. They could buy pork billies. The banks, just because the reserves move around, they don't disappear. And they're never going to disappear until the Fed destroys them through quantitative tightening, which the Fed is now doing.

Starting point is 00:35:22 Now, so in the past, making a long story even longer, in the past, the way the Fed controlled interest rates, the federal funds rate, there didn't used to be massive excess reserves. Banks were required to hold a certain portion of their deposits at the Fed in their bank accounts at the Fed as reserves to make sure that if suddenly their customers came knocking on the door asking for their deposits back, then the banks would have enough reserves to pay the customers their deposit back. So there wouldn't be bank runs back in the 19th century. Sometimes the legally required reserve ratio was as high as 20%. The banks were required to keep reserves of 20% at one point. Over time, this required reserve ratio fell and dropped and dropped and dropped. But so you get the

Starting point is 00:36:13 idea, these bank reserves were legally mandated. And the banks didn't keep excess reserves if they didn't have to. And so reserves were always scarce. And the Fed was able to manage the federal funds rate by making relatively small adjustments in reserve balances. So for example, if it wanted interest rates to go down, then it would buy some bonds from the banking system. And when it buys bonds, it would inject new reserves into the banking system. So that would create the amount, increase the amount of bank reserves, and that would make bank reserves more plentiful. And so the cost of borrowing reserves would drop. And conversely, if it wanted interest rates to move higher, the Fed would sell some of the bonds that had already owed to a bank, and the bank would have to pay the Fed by transferring

Starting point is 00:37:00 its bank reserves to the Fed. And that would make the reserves in the system more scarce. And that would make the federal funds rate move up. So by making relatively small changes in this open market purchases and sales, in other words, by just selling a relatively small amount of bonds or buying a relatively small amount of bonds, it could change the supply and demand dynamic in the market for federal funds, affecting the federal funds rate. And that's how the Fed moved up and down the federal funds rate by small adjustments in making bank reserves more plentiful or more scarce. But after 2008, that doesn't work anymore because the overall level of bank reserves in the system are not scarce anymore. They're super abundant. The Fed has effectively created $8 trillion extra

Starting point is 00:37:47 dollars that are floating around in the financial system. So now the banks have massive excess reserves, any way you look at it. And the only way to get rid of the excess reserves would be for the Fed to entirely reverse all of the money creation that has done over the last 14 years. And that's not going to happen. So the Fed has had to create a new way to control the federal funds rate. And now the way they control the federal funds rate is entirely different than the way they controlled it in the past. Now they control it by paying interest on bank reserves.

Starting point is 00:38:19 So before the Fed started hiking interest rates in March, the federal funds rate was about 25 basis points. And so the Fed paid the banks 25 basis points on their bank reserves so that the banks wouldn't lend money at less than 25 basis points. Why would the banks lend money to anybody else at less than 25 basis points when they can earn 25 basis points interest from the Fed? Well, now the federal funds rate, every time the federal funds rate moves up, the Fed makes it move up by paying a higher interest rate on bank reserves. So now that the federal funds rate is at a range between three and three and a quarter percent, the Fed's currently paying 3.1 percent on all the bank

Starting point is 00:38:59 reserves held by the banks. And therefore, that's why the banks won't lend any money at less than 3.1%. That's how the Fed is moving up the interest rates. If the Fed didn't pay interest on these bank reserves, then there are so many reserves, the banks, there's excess supply of reserves. So that would put downward pressure on interest rates. And the Fed would be unable to push interest rates higher. It would be unable to tighten monetary policy to fight inflation. But by this new policy, that they introduced in 2008 of paying interest on bank reserves for the first time ever.

Starting point is 00:39:36 Before 2008, it was not legal for them to do this. This is how they make the interest rates go up now. So if they increase the federal fund rate by a further 75 basis points in November, then they'll start paying something like 3.8% on bank reserves and so on and so forth. So suddenly, the whole dynamic has changed. Before, up until very recently,

Starting point is 00:39:57 when the federal fund rate was very close to zero, The Fed didn't have to pay any interest on bank reserves or on the money that it created. And so all of its interest income was pure profit. But now it still has the same amount of interest income. But the problem is it's now paying a lot of interest on bank reserves. And so paying 3% interest on all of these bank reserves suddenly means that the Fed has a very high level of interest expense. And apparently, as you mentioned in September, if their net profit turned negative in

Starting point is 00:40:26 September is because their interest expense, 3% on bank reserves, is greater than their interest income on all of the bonds that they own. And so it's possible now that it seems likely that for this full year, they'll probably still have a profit. But for next year, they will probably make a loss. But of course, you've got to keep in mind that the Fed doesn't have a lot of capital. And it doesn't have a lot of capital because it gives all of its profits to the government every year. As I think I mentioned earlier, since the Fed was created, it has given the government $1.8 trillion. And just since 2008, most of that has come since 2008 when they started quantitative easing. The Fed has given the government $1 trillion since 2008. If it were a normal

Starting point is 00:41:11 bank, all of that would have been in their capital account. But now they don't have very much capital because they have to give all their profits to the government. So they're going to make a loss, if they have a loss of negative capital. But that's not, I don't think that's particularly pertinent issue. It's not because I guess my question around that to your point was who is the lender to the Fed, right? As far as they run a deficit now, how are they covering that deficit? So the Fed, of course, can create as much money as it needs. And in the future, it will also have, it will revert to a position where it once again has more interest income than interest expense, assuming that one day interest rates go back down. I think for much of the

Starting point is 00:41:56 money, the Fed has extended through its quantitative easing programs is guaranteed by the government. So the government debt, instead of being lowered by government profits, as it has been practically every year since 1913, the government debt going forward for the next couple of years will probably be higher as a result of the Fed's losses. Is IEOER the interest on excess reserves, basically the technical term for what we're describing there? Yes, so things become even more complicated because, yes, it is. But in addition to bank reserves, bank reserves are on the Fed's their liabilities.

Starting point is 00:42:34 But suddenly there's a new big item on the Fed's liability side that didn't exist very long ago, and that is reverse repurchase agreements. And rather than that, so banks have bank accounts at the Fed, and that's where they keep their bank reserves. Suddenly, in over the last couple of decades, money market mutual funds have become a big new thing, relatively speaking, over the last couple of decades. And these money market mutual funds also need some place to make a profit. They've got, I think last I looked, nearly $5 trillion of assets. And so this forced the Fed to allow them. essentially to all have bank accounts at the Fed also in the form of reverse repurchase agreements.

Starting point is 00:43:19 It's essentially the same thing as bank reserves, except reverse repurchase agreements are where the money market mutual funds can park their money. And they will also be paid 3% interest right now since that's where the federal funds rate is. And that will prevent them from lending to anyone at less than 3%. So the Fed now has to pay interest on not only bank reserves, but on what are effectively the reserves of the money market mutual funds. It has to pay interest on the, both of these bank reserves are around $3 trillion. And money market mutual funds have about $2.2 trillion at the Fed. So that's something like $5.2 trillion that the Fed is now paying interest on. And that is why their interest expenses shot up. And that's why their profits have

Starting point is 00:44:06 dropped from over $100 billion last year to probably a negative number next year. Now, this is a real issue that I think there is a solution to. There's no reason for the Fed to be paying interest on bank reserves because the banks didn't do anything to earn those reserves. They didn't make loans. They didn't speculate in port bellies. They did nothing whatsoever to earn those reserves. The Fed's action created those reserves by creating money and depositing that money into the

Starting point is 00:44:36 bank's reserve accounts. That money is a pure function of the Fed policy. nothing whatsoever to do with what the banks have done. And so all of the profits the banks are earning on this 3% interest payment from the Fed, it's pure windfall profits, which they do not deserve. And therefore, there's a way to resolve this. Right. Over time, I mentioned in the 19th century, bank, the legal required reserve ratio was 20% in some points in some banks and some cities. But over time in the U.S., the Fed continued to reduce the required. reserve ratio year after year after year after year. And the more it reduced the required reserve

Starting point is 00:45:17 ratio that made the money multiplier expand. This may be a bit technical, but through the process of fractional reserve banking, the money multiplier is one divided by the required reserve ratio. And what that means is if the required reserve ratio is 10%, one divided by 10% is 10 times. And that's the money multiplier. What that means is for every new deposit that enters the banking system that can effectively create 10 times that much money through lending and relending and relending and relending that deposit. But over time, the Fed reduced the required reserve ratio again and again and again until it was really in the low single digits. And then in 2020, they reduced it to zero. So there's no longer any required reserve ratio whatsoever for the United States, meaning that

Starting point is 00:46:06 the money multiplier is infinity. The only constraint on how much the banks can create now and money, is their reality that if they lend too much, the people they lend to won't be able to afford to pay the interest on the money that they borrowed. So the solution to this problem of the Fed having to pay such high interest rates is the Fed should just simply reimpose a required reserve ratio on the banks that is high enough to absorb all of their reserves until there are no more excess reserves left. So right now, the required reserves are calculated by the amount of reserves the banks have as a percentage of the bank's deposits. The required reserve ratio is how much reserves the banks have as a percent of their bank deposits. In the past, they were

Starting point is 00:46:51 required to keep a reserve against their deposits. Right now, their amount of reserves, relative to their amount of deposits, is about 16%. Right now, the required reserve ratio is 0%. And the Fed is having to pay 3% interest on all of these reserves. So what the government should do is increase the required reserve ratio from 0% to 16% absorbing all of these excess reserves so that we'd once again be back in the situation where we were before 2008, where reserves were scarce and the Fed was able to control the federal funds rate by making relatively small changes in its bond purchases and bond sales. So we could revert to the old system of having a required reserve ratio.

Starting point is 00:47:36 Then, since the banks would be required to keep 16% percent, of all their deposits as reserves, then it wouldn't be necessary for the Fed to pay interest on the reserves because the banks would be required to keep these reserves. There would be no need to pay them for them. And in that case, the Fed would become immensely profitable again. So this is what the government should do is reimpose very significantly higher required reserve ratio to absorb all of these excess reserves. That would immediately restore the Fed's profitability. And they would ensure that all of the Fed's profits go to the government, which is, in other words, go to the U.S. taxpayers, rather than ending up as windfall profits to the banks who've done nothing whatsoever

Starting point is 00:48:18 to earn them. If you had to speculate, why do you think that's not happening? Well, first of all, just a general lack of understanding. This is not without precedence. In 1936 and 1937, the Fed doubled its required reserve ratio from, I believe, 10,000. 10 to 20% during over a two-year period. So there is precedence for this happening. But, you know, how many of our policymakers, especially in Congress and the Senate, are aware of that or are aware of any of what I've just explained about. So generally, I think why this isn't happening is because

Starting point is 00:48:56 Congress is unaware that this is a possibility. But if I read my book, the money revolution, I spell it out there. And it is a possibility. And as the Fed's losses begin to mount, I think they'll become made aware of this. And hopefully they will enact this legislation. Wow. Makes sense to me. That's that's pretty remarkable. You mentioned the $8 trillion that the Fed has created since 2008. The MOVE index, the move index, which is effectively the volatility index for the bond market is now back up to its COVID high. The last time it reached these levels, the Fed injected one trillion every day to unlock the bond market and launched $120 billion in quantitative easing.

Starting point is 00:49:41 So let's say something does break. What would you expect the response from the Fed to look like, given the excess that we seem to be experiencing? I think that the response would be similar to what we're seeing from the Bank of England. When this dynamic took hold in the UK with the pension funds being forced to sell their government bonds to cover their hedged positions, their driven. exposure. Then that set off a dynamic that pushed the bond yields in the UK even higher and caused them the pension funds to sell even more bonds. It was creating an out-of-control

Starting point is 00:50:18 vicious spiral that was driving up the government bond yields in the UK and the endangering the pension system in the UK. So the Bank of England, central banks are created to be the lender of last resort to prevent banking panics when they occur. That's their main purpose from the beginning of time. And so what the Bank of England did is exactly that. They became the lender of last resort. They announced that over the next, I believe, is a two-week period that they would be willing to buy up to 65 billion pounds of UK government bonds

Starting point is 00:50:52 in order to prevent essentially in order to prevent the bond yields from moving any higher and stopping the panic in the bond market. But in fact, they haven't had to buy 65 billion pounds worth of bonds. I don't have the precise figure. But I think it's more like they actually only have to spend five. Yep. And so by just spending creating five billion pounds and buying five billion pounds they showed everybody in the market that they were there and that they would buy as

Starting point is 00:51:23 many bonds as necessary to stop the interest rates from going any higher. Well, they were supposed to end this on Friday. And maybe they will and maybe they won't. If the bond yields start moving higher again, they'll have to spend some more. And so the same sort of, and that's the way the Bank of Japan controls the Japanese government bond. They've been doing quantitative easing in Japan even longer than we have. But what they discovered is just by the Bank of Japan announcing that we will buy as many

Starting point is 00:51:51 Japanese government bonds as necessary to peg the yield on the 10-year Japanese bond at 25 basis points, they discovered they didn't really have to buy that many bonds. They ended up buying far fewer bonds than they had been earlier on when they had set a fixed amount for buying every month. So the amount of bond buying that they've had to do is much lower than when they were saying they would buy X amount of Japanese government bonds every month. So it doesn't take that much government intervention. It only takes the announcement that we are determined to get the situation under control and we have limitless amounts of resources to do this. When they say that they're going to control the bond yield at a certain level, if the markets believe them,

Starting point is 00:52:31 they don't really have to spend that much money to do it. And if the markets don't believe them and test them out, the central bank creates a little bit more money and burns everybody who tested them out. So that's probably what we would see in a, if we have some sort of financial crisis emerge in the U.S. The Fed would make an announcement similar to the Bank of England that they're prepared to buy, you know, a hundred billion new dollars worth of U.S. government bonds or whatever is required to support that particular crisis to stop that particular run, whether it's in the government bond market or the corporate bond market. And by making that announcement, they would calm the markets again. And so in that sort of crisis, that's what we would most probably see.

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Starting point is 00:56:55 investment and, you know, move away from the dollar hegemony. We've discussed how hard money is a thing of the past in prior episodes and how it'd be kind of impossible to go back to because, or at least we know, without implode, the markets because trade would have to balance. And right now, if the U.S. has $500 billion worth of gold or so, it would only cover maybe six months of trade deficits. So as regarding Russia, do you see this as sort of a fool's errand if they were to pursue this or an actual viable option? Well, you can see why Russia would like to accumulate more gold since it was preparing to invade its neighbor and try to conquer and eliminate the Ukrainian nation in advance rather than

Starting point is 00:57:37 having a lot of dollars because the U.S. is able to impose sanctions that prevent them from using a lot of those dollars. But it's not going to do any good for, I mean, first of all, Russia's economy is going to be in dire straits for decades to come now. They're very dependent on energy exports to start with. They're kind of suffering from the oil producer curse. If you have a lot of money from being a big oil producer, the rest of your economy tends to be lazy and not very effective. And we're looking at a future where 20 years from now, there's not going to be any need for oil. We're going to have renewable energies, and you won't be able to give oil away. Remember when oil prices turn negative in 2020? So Russia's future is bleak. They can peg their

Starting point is 00:58:22 ruble to the gold if they want to, but nobody's going to invest there anyway. And if they try to sell their oil in gold, then that's not going to work because no one has enough gold to buy their oil. And so they'll just simply stop having, they won't be able to sell any more gold and oil because people don't, other countries don't have enough gold to buy it. So it's like the United States has a one billion dollar a day trade deficit with China. If China tried to make the United States pay for that with gold, the U.S. would run out of gold in a few months and it wouldn't be able to buy one more pair of tennis shoes from China. And China's economy would collapse. So we're not going back to a gold standard ever, unless there's some sort of mad-max disaster scenario where the world collapses

Starting point is 00:59:04 and reverts to barter, in which case the warlords would accumulate all the gold. So that's not going to happen. You have, you know, China's interest in Taiwan. I'm sure a lot of it has to do with the semiconductor businesses that are coming out of there and a number of the historical references as well. But there was this $280 billion chips and science act signed into law recently, which, you know, I got to say really echoes the book you wrote and almost the strategy, if you will, around trying to stay competitive with China, trying to invest in the technologies of the future and keeping us competitive. So what were your thoughts when you saw this act be signed into law?

Starting point is 00:59:48 I was really thrilled. I mean, this was such a great positive development for the United States and for our future because I certainly don't have any issues with Chinese people. But the fact is, China is on the verge of overtaking the United States technologically, economically, and militarily. In the year 2000, the United States invested eight times more in research and development than China did. Last year, China invested more than the United States did in R&D. And if current growth rates continue in both countries by the end of this decade in 2030,

Starting point is 01:00:23 China will invest 40% more in research and development than the United States. And if the United States allows that to happen, China is going to develop artificial intelligence before the United States does. And in terms of artificial general intelligence, where computers can do anything humans can do. And then immediately after that, the computers are going to become exponentially smarter, very, very fast. So whichever country develops, gets to that point first, will have the rest of the world at its mercy. And that's going to be China. If we don't radically accelerate our investment in new industries and new technologies starting immediately. So the passage of this 280 in my book, The Money Revolution, how to finance the next American century, that's what

Starting point is 01:01:07 the book is all about. What it calls for is for a multi-trillion dollar investment program to be financed by the U.S. government and carried out by joint venture companies between the U.S. government and the private sector, with scientists and entrepreneurs running the company and the government funding these joint venture companies and keeping a 60% equity stake for the government and a 40% equity stake for the entrepreneurs and scientists managing the companies across industries like artificial intelligence, quantum computing, genetic engineering, biotech, nanotech, robotics, neurosciences, and green energy, etc. So the passage of this $280 billion Act, the Chips and Science Act,

Starting point is 01:01:47 that allocates $52 billion of money for the development of semiconductor manufacturing facilities in the United States, which America desperately needs, because most of them now are located in Taiwan, and Taiwan could be under attack any day, any year, too soon for comfort. And we can't allow that to happen. Who knows how many of our military parts and equipment would not work without sufficient supply of semiconductors. But in addition to that 52 billion, the rest of the $82 billion, the rest of the $280 billion in the Chips and Science Act is going to be, invested in new industries and new technologies, just like I called for in the book. So this was fantastic news. I've been calling for this sort of investment for a very long time now, at least 10

Starting point is 01:02:32 years. And people would always say, you can't believe, I mean, they would say, this is an interesting idea, but you can't believe the government would ever do anything like that. Well, now they've started to do it. The only thing is, is 280 billion. Okay, that's a big number, and that will probably buy us an extra two years ahead of China. That will keep us ahead of China for two years. That's not enough. That only takes us to 2032. This has got to be the first installment. We need now to be making plans for the next installment, which should be even bigger than 280 billion. And then we need to turn this into a multi-trillion dollar investment program over the decade. Now, multi-trillion, it sounds like a very big number, but the U.S. government increased its debt

Starting point is 01:03:12 by $2.8 trillion in the second quarter of 2020 alone. So that's a multi-trillion. dollar increase in government debt in three months. That's not what I'm calling for. That probably overdid it and contributed to the inflation we're now experiencing. Well, what I'm calling for is a multi-trillion dollar program over 10 years. That would not be inflationary in the same way that we're experiencing now by any means. And even if it were, that kind of inflation is a price we would have to be willing to pay to ensure that we're not conquered by China. Well, we're definitely trending towards a populist world where globalization has been minimized. And I'm kind of curious about how that plays into the headwinds to this strategy you're laying out there. Because if a lot of

Starting point is 01:03:58 these countries who are net exporters don't have surpluses, they're not going to have the money to buy treasuries. And we have to fund our continued deficits and things like this will just kind of exacerbate that. Does it just run the risk of more monetary debasement in the long run? or what are some of the risks of doing this, maybe macro and here domestically? So globalization is really essential to my plan for this government investment in new industries and technologies. It would make things so much easier that way. We didn't have that in World War II, and the government had to invest on an extraordinary scale

Starting point is 01:04:34 to win the war, and that led to high rates of inflation and price controls for a few years. And then when the war ended, all that government investment ended up producing a surge in new industries and technologies that resulted in the United States being the undisputed global leader and a huge surge in economic growth during the 1950s and 60s and into the 70s. Now, is globalization going to end? I don't think so. Now, it certainly suffered a setback and a partial reversal because of COVID and supply chain bottlenecks in this war in Russia. But even if our tensions with China become worse, China is not going to send all the American companies home because they desperately need the money that does. There's a lot of manufacturing going on in China and they need that money.

Starting point is 01:05:20 So they're not going to deny the United States the possibility of buying those cheap goods. And meanwhile, more and more manufacturing is going to shift out of China and into places like Vietnam, Bangladesh, India, Mexico, and other places. In India, 1.4 billion people, I would say hundreds of millions of them would work for less than $15 a day. So we're by no means tapped out in terms of the potential for globalization to bring in very low-cost products into the United States. So my base case scenario is that eventually we're going to return within the next few years, we're going to return to pre-COVID status quo more or less where globalization is quite dominant, is once again exerting strong downward pressure on U.S. prices, bringing the inflation rate back down, particularly since we're likely to have quite a serious recession over the next year or two, which will reduce demand and also bring the

Starting point is 01:06:15 inflation rate down. It wouldn't be at all surprising to see U.S. inflation turn negative again within the next three years. And then would be more or less back where we were pre-COVID and everything would be back on track, allowing us to invest on a multi-trillion dollar scale and new industries and technologies in a program that would turbocharge U.S. economic growth, radically enhance U.S. productivity and create a technological revolution and radically improve everyone's health and life expectancy and create all kinds of new technological miracles and marvels. So that recession you just mentioned there, that's kind of how we kicked off this whole conversation. And the reason this keeps coming up is because there seems to be some disconnect here.

Starting point is 01:06:57 For example, a record number of people were employed in August, which seems to suggest that we're a long way from the Fed having higher unemployment as an excuse to ease. So are the markets just way ahead of the real economy in this case? What do you think is driving this disconnect between the real economy and the markets today? So as I said at the beginning, I believe that credit growth drives economic growth. But liquidity determines which way the asset prices move. And what I'm most basically, when the Fed is creating a lot of money and injecting it into the financial markets, then asset prices tend to go up. And when the Fed starts destroying money as it's doing now, it takes money out of the financial markets and asset prices tend to go down.

Starting point is 01:07:41 And also, interest rates are zero. That makes it very easy for people to borrow and speculate, which pushes up asset prices. But when interest rates start moving up to 3%, as they are now, hitting toward 5%, as they may well be in a couple of quarters. and suddenly it becomes a whole lot more expensive for people to borrow and speculate and asset prices fall. So generally, the time to buy is when during QE and the time to sell is during quantitative tightening, which is where we are now. Quantitative tightening at the rate of $95 billion a month is going to destroy $1.1 trillion over the next 12 months if it actually is not stopped before then. And that represents about 13% of all the dollars. So that's extreme

Starting point is 01:08:22 monetary tightening. And that's what is frighten the markets to answer your question. Markets realize that liquidity drives asset prices. And right now, the liquidity is drying up. And we're experiencing very aggressive monetary policy tightening. Now, the economy hasn't quite caught up to the markets. The markets are supposed to discount things in advance. The three rounds of stimulus packages during the pandemic, starting in March 2020, and then December 2020, again in March 2021, that stimulus in total was about $5 trillion. $1.8 trillion of dollars of that went directly to households in terms of stimulus checks. And $1.7 trillion of that went to businesses to paycheck protection programs and such so they wouldn't fire their workers.

Starting point is 01:09:09 And that money allowed the Americans to keep paying their mortgages and their consumer credit card bills. And so they didn't default. Had they defaulted, then the U.S. economy would has spiraled into depression and all the banks would have failed. So that didn't happen. But as it turned out, all of that stimulus was that much new money going and being directly deposited into the consumer's household's bank accounts and the corporation's bank accounts. This led to a big buildup in deposits, a big build up in savings. If you look at the M2 money supply growth, it was 27% year on year at the peak, M2, which reflects, includes demand deposits. In 2008, the M2 only grew by 10%. So that was 27% was, you know, too much and contributed to full employment. And employment rates at a, what,

Starting point is 01:09:59 50 year low. So the way to think of this, I think in terms of the monetary policy is we can think about monetary policy like driving a car. If you drive it too fast, you may have a mishap in terms of higher inflation. And if you drive it too fast, In hazardous conditions, like global supply chain bottlenecks and the war in Russia, which disrupt global supply chains, that increases your chances of having a mishap, such as higher inflation. But the lesson to take away from that is not to stop driving the car and go back to riding in horses and buggies. The lesson is just drive more slowly, or at least drive more slowly when you're experiencing

Starting point is 01:10:37 hazardous conditions. So we ended up driving monetary policy too quickly in hazardous conditions, and that's contributed to the inflation we're experiencing now. That's given everybody more savings than they had. So the unemployment rate is very low. Now, the Fed can't increase demand. I mean, it cannot increase supply. It has to bring supply and demand back into balance to bring inflation down. It can't create more supply. It can't drill more oil wells or plant more wheat. So it has to destroy demand. And to destroy demand, it has to throw people out of work. And so far, that's not working. The job numbers are still rising. They increased by more than 200,000 last month. So the Fed is going to have to creep

Starting point is 01:11:18 hiking until a few million Americans lose their jobs. The other way they can destroy demand is making the stock market fall and asset prices fall. That creates a negative wealth effect. So that's what we're experiencing now. Until we get inflation at a much lower level, the Fed is going to have to keep tightening monetary policy until millions of Americans lose their jobs until asset prices fall further. And that will bring supply and demand back into balance. This may take a year or two more. Could suddenly happen with some sort of big shock and financial crisis. It accelerates everything, or it may take a while. It will work its way out of the system. And a few years from now, we will be back in some sort of equilibrium position again. This is not

Starting point is 01:12:00 going to be the end of the world. I'm with you there. I have a feeling that it's going to take a little longer than people expect. I think people are underappreciating some of the creative ways that the government has been keeping businesses afloat. Everyone was kind of familiar with the PPP loans around the COVID era. There is now the employee retention credit, which I guess was also originated around COVID, but you couldn't get both originally. You couldn't get the PPP and the employee retention credit. And when Biden came into office, he's now authorized that even if you got a PPP loan, you can get an employee retention credit. And that's about 26 grand per employee that you kept. employed. So if you've got 30-something employees, that's a million dollars and it's just free money.

Starting point is 01:12:39 That goes a long way for some businesses to keep them afloat and keeping people employed. So I'm with you, it might take a little bit longer than people expect. You threw out the 5% bed funds rate expectation that we're creeping up to. Is that the terminal rate in your mind? I mean, if you had to guess or bet, do you think we'll even get that high or do you think we're going higher than that? Well, so if we have 75 basis point rate hike in November, 50 basis points in December, that takes us to 4.3. There are four meetings in the first half of next year, FOMC meetings. If they hike 25 basis points every time, that takes us to 5.3.

Starting point is 01:13:16 That would probably do it. And then the economy would be in recession, and they could start cutting interest rates in the second half of the year. And that could potentially bring them back down to 4.6%, which is what they forecast in their dot plot. They said interest, the federal funds rate was likely to be 4.5. 4% at the end of this year and 4.6% at the end of next year. They didn't say it wouldn't be higher in the middle of next year. He said at the end of the next year, 4.6. That may be the way they

Starting point is 01:13:42 get to 4.6% at the end of next year. How would you score J-PAL's performance through all of this? I'm just kind of generally curious about your assessment of the strategies the Fed have been putting into place so far. So everyone, so many people on the internet, love to criticize the Fed and the government and the whole American system now. I think this is probably very well funded by our enemies, Russia and China, through Facebook and all the other social media outlets. But that is a very debilitating attitude for the Americans to have, and it's not right. Now, these people in the Fed are trying to do the best they can possibly do with the situation they inherited. And the situation that Jay Powell inherited was a world in which the Fed had

Starting point is 01:14:32 been unable to make the inflation rate move up to its 2% inflation target. From the year 2000 to 2019, the average inflation rate on the CPI was 1.7% a year for 20 years. So the situation he inherited was globalization was extremely deflationary. It was putting downward pressure on prices, and it was hard to make the inflation grow by 2% a year. Suddenly out of the blue, he gets hit by COVID. The U.S. economy had entirely recovered from the 2008 response to that crisis. During that crisis, the Fed had three rounds of quantitative easing, increased its total assets by five times. And that didn't cause any inflation. The highest rate of inflation then was 3.9% in 2011. By early 2015, we had deflation again. So that had all passed through the system by then. We were back in a disinflationary, low inflation environment. Then suddenly COVID happens. And with COVID, everyone's required. to stay home, no money to pay their rent or their mortgages or anything else. And so the government decides to give them three big rounds of stimulus packages. And the Fed, that required the government to borrow, well, the stimulus programs, they say in total $5 trillion that cost to get through COVID.

Starting point is 01:15:46 The Fed had a choice. If the government had to borrow $5 trillion in the free market, borrowing $5 trillion would have pushed up interest rates to a very high level. And instead of helping the economy, very high interest rates would have crushed the economy. So the Fed really could have decided, okay, you're on your own government, but that's not how it works. The Fed and the government work hand in hand. And the Fed stepped up and agreed to finance, essentially 70% of all that borrowing. The Fed created $5 trillion. So it was the Treasury Department that was the dog and just wagging the tail Fed. Fed was responding to the government policy. And they didn't, they thought like me, they thought globalization, since they'd been able to create so much money after 2008 and get away with it with no inflation, they thought they could probably do it again.

Starting point is 01:16:34 But it turned out that there were big supply chain bottlenecks. And suddenly, and also with everyone staying home and ordering computers across Amazon, the demand for manufactured goods became very high and overwhelmed the supply of such manufactured goods. So semiconductor prices shot up and shipping rates shot up. And this was a perfect storm for the Fed. And then just when there was hope that it was going to go away, Russia invades Ukraine. You know, you can't expect Jay Powell to anticipate that Russia is going to invade Ukraine. That was beyond his control. So, you know, overall, with hindsight, it's easy to say they should have done things differently.

Starting point is 01:17:14 But if you were in the driver's seat at a point where the United States could easily collapse into a new Great Depression, if you didn't provide enough stimulus, and it's better to provide too much stimulus and live with elevated rates of inflation for a while, rather than having a 1930-style depression with 25% unemployment and deep deflation, leading to a global economic calamity leading to third world war potentially, as the Great Depression led to World War II. So overall, I think that, you know, people need to give them a break, realize that these are good people trying to do the best they possibly can with the very difficult cards they've been dealt. And generally, look, the U.S. economy came through this crisis. We got through the other side. In early months of

Starting point is 01:17:58 2020, it wasn't sure what the U.S. economy would look like in late 2022. It could have collapsed by now, but it didn't. The GDP is larger now than it was, and the unemployment rate is at a 50-year low. That's a big accomplishment. And okay, the price we paid for that, the increase in government debt, which in my opinion is not that big of a deal, and inflation, peaking at 9%, which is painful, but that's not going to last. And particularly since so many Americans received such a large amount of stimulus that probably covered some of their losses that have resulted from higher inflation. So overall, I think the policy response was very successful. The downside was higher rates of inflation and enforcing the Fed into, you know, and of course, we had a huge surge in

Starting point is 01:18:45 asset prices, which created a lot of wealth, especially for the wealthiest people. I think in the two, a two-year period after starting in March 2020, U.S. wealth increased by $35 trillion over two years. It was just a mind-boggling increase in U.S. wealth. So overall, the policy worked because our economy didn't collapse. Richard, I always enjoy your insights and our conversations and feel like we could talk forever. Before I let you go, I want to give you an opportunity to hand off to our audience where they can learn more about you and your videos and newsletters. and any other resources you want to share.

Starting point is 01:19:22 Thank you, Trace. Really great talking with you. You always ask such good questions and leave plenty of time for your guest to reply to them. So thank you for that. And first, I hope your listeners will buy my new book. It's called The Money Revolution, How to Finance the Next American Century. And then if I'd like to follow my work more closely, I produce a video newsletter called Macro Watch. Every couple of weeks, I upload a new video, a PowerPoint presentation of me discussing

Starting point is 01:19:49 and what's happening in the global economy and how that's going to impact asset prices. They can find that on my website at Richard Duncanneconomics.com. That's Richard Duncanconomics.com. I hope though to go there and check that out. Richard, it's always a pleasure and an honor to having on the show. I really enjoy it.

Starting point is 01:20:08 So thank you again for coming on and I look forward to our next conversation. I hope next time the things have improved radically relative to now. Amen to that. Cheers. All right, everybody. That's all we had for you this week. If you're loving the show, don't forget to follow us on your

Starting point is 01:20:23 favorite podcast app. And if you'd be so kind, please leave us a review. It really helps the show. If you want to reach out directly, you can find me on Twitter at Trey Lockerbie. And don't forget to check out all of the amazing resources we've built for you at the investorspodcast.com. You can also simply Google TIP finance and it should pop right up. And with that, we'll see you again next time. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence.

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We Study Billionaires - The Investor’s Podcast Network - TIP488: Current Market Conditions W/ Richard Duncan

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