New York | Last week in The Institutional Risk Analyst, we gave you a taste of today’s interview with author and consultant Jim Rickards to talk about his latest book, “Aftermath: Seven Secrets of Wealth Preservation in the Coming Chaos.” As usual, Jim has a commanding view of the ebb and flow of the global political economy. His first chapter in which he describes the fateful role of former Fed Chairman Ben Bernanke in choosing the current monetary policy mix sets the stage for an important discussion of the future risks facing investors. Jim is a good friend, fellow member of The Lotos Club of New York and among the most prolific authors writing about global finance and economics today.
The IRA: Thank you for taking the time Jim. In the beginning of your book, you use the metaphor of The Odyssey to describe the choices facing the Federal Reserve Board going back to Alan Greenspan, who we knew as “Uncle Alan” in Washington years ago. You talk about how the Fed went from deflating bubbles before Greenspan, as with the “taking away the punch bowl” image, then to trying to maintain bubbles, and now overtly using monetary policy to stoke inflation and huge asset bubbles. Where does that leave us today?
Rickards: In the book I talk about how Greenspan defeated deflation in 2005 before he left office, but, this was a Pyrrhic victory. Low rates gave rise to the housing bubble and subprime debt crisis. Since 2008, we’ve had more of the same but a more extreme version of Greenspan’s anti-deflation medicine. If Greenspan’s three-year experiment with sub 2% rates gave rise to the Global Financial Crisis, what was the world to make of the Bernanke-Yellen policy of 0% for seven years? Bernanke’s Federal Reserve also engaged in a completely unprecedented money printing binge called quantitative easing.
The IRA: Well said. In the book, you talk a good bit about how the US economy has experienced increasing difficulty achieving the perceived levels of potential growth. This leads to the FOMC “doing more” to boost employment and now inflation under its 50-year old mandate. Yet the Fed also seems to be making some of the very same mistakes that were made in the 1920s and 1930s.
Rickards: Going back to the 1929-1937 period, the old rule was to prick bubbles to relieve speculative pressures. But, this ended up causing recessions rather than preventing them. By the 1998 - 2001 period, the conventional wisdom was to let bubbles run their course and then clean up the mess afterwards. But the Fed has failed to distinguish between credit driven bubbles and mania driven bubbles. The former are dangerous because they are connected with the credit system, the latter less so because people loose money but the crisis is not systemic. The 2000 dot.com bubble was speculative, but not credit driven so it did not turn into a systemic crisis when it popped. Of course 2008 was credit driven and it did metastasize throughout the system right up to the top of the food chain with large banks and the housing GSEs failing. When you are kicking around the idea of should I or should I not pop the bubble, this is a key distinction and the threshold question for policy. You should pop or defuse credit driven bubbles, but perhaps let speculative bubbles (most recently Bitcoin) run their course. The problem is that Fed policymakers do not seem to grasp this fundamental distinction. This leads to credit bubbles being allowed to spin out of control into systemic crises.
The IRA: You clearly lay the authorship of the 2008 crisis on Greenspan. But how do you distinguish between a market bubble and a credit bubble when the latter is made to seem less problematic because the central bank is actively creating asset bubbles? Loss given default for most bank owned real estate loans has been negative for three years or more. When banks are profiting from loan defaults, is this not a red flag? The Fed has explicitly embraced a policy of stoking asset prices in stocks and real estate to fight deflation, even if it means market instability as a result.
Rickards: That is a profound question you raise about the impact of monetary policy on visible credit metrics. The answer very simply is that you can’t get out. It's one thing when loose monetary policy results in private credit extremes. The Fed can reign that in. But, what happens when public credit from the Fed is the source of the problem? The Bernanke choice of stoking asset price inflation via zero rates and QE is not something that can be reversed without a great deal of pain. Once you make that trade-off between promoting inflation and future market instability, you have no way out. You’re much better off taking the pain and accepting a lower level of economic growth in the short-run rather than deferring the pain but creating far larger asset bubbles down the road. There is no way out of the Bernanke policy choice without bigger bubbles and much larger market crash that results. This is why I believe that we face a financial market crash as bad or worse than 1929 or 2008.
The IRA: American politics over the past half century has not been very accepting of limitations on growth or spending or debt. Are you saying that we need to prepare the survival strategy for the coming Mad Max era of financial ruin? We are struck by the parallels between the 1920s and today that you highlight in the book, the lack of clarity from supposed political leaders on economic choices.
Rickards: One of the points of “Aftermath” is that we have already made that choice of greater and greater swings in boom and bust. Now we’re stuck with it. How you navigate these treacherous waters and protect wealth is now a crucial question for investors and professional advisors. The key point of the book is that we made the choice, we ran out the tape for 10 years, but now we cannot get out of this cycle. The proverbial punch bowl is now glued to the table and the Fed is forced to keep refilling it.
The IRA: Or as our friend Jim Grant has written, Fed Chairman Jay Powell is truly a prisoner of history and the choices made by his predecessors.
Rickards: Precisely. In the beginning of the Reagan presidency, we had the worst recession since the 1930s. But by 1983 we were growing at over 5% annually. Ronald Reagan said get the recession over early and then won the biggest reelection landslide in the 20th Century. Looking at today, we’ve been in a depression since 2008, at least as defined by John Maynard Keynes. But going back to the question of actual vs. potential growth, it seems to me that we face three big headwinds. First is the issue of demographics. We have stagnant to down populations in major nations around the world. Second, debt is a major drag on economic growth today, including things like student debt. Young people with big debt loads have lower FICO scores, making it difficult to get a job or buy a house. This delays household formation, which is a major driver of consumption. And thirdly we have the negative interest rates, which is an explicit transfer of wealth from creditors to debtors, especially governments and other public sector debtors.
The IRA: So would you agree that negative interest rates have actually been a drag on growth, essentially a regressive tax on all savers and investors?
Rickards: Yes, absolutely. And this is why I spent so much time talking about Reinhart and Rogoff and the 90% rule. When a country’s debt rises above 90% of GDP, growth suffers and additional policy actions meant to boost growth loose their effectiveness. Once you get past 90%, all of the rules regarding economic policy change. Why is the 10-year note at 2.1% this morning? And this is only going to get worse by the way. Reagan got a huge bump up in growth because he increased spending and deficits, but the same policy actions 35 years later gets barely any uptick in growth. The White House today is ecstatic about 3.1% growth in the first quarter, but go back and look at the Obama years and the wide swings in GDP that we experienced. Low rates and stimulus had some effect in terms of boosting growth but it was not sustainable. There was no real difference between Trump and Obama in terms of growth. The tax cuts gave us a bump, but only just a bump. It was not a paradigm shift, just a bump that is not sustainable. We are back to that 2.2% trend growth of the past ten years that is lower than the post-war average and thus qualifies the past decade as a depression using Keynes’s measure.
The IRA: Growth also seems to be below the rate where you can keep the politics under control, thus we have all sorts of manic responses from bitcoin to MMT and other new age “solutions” to the problem of low growth. How do you see the future given your views of the likelihood of greater market volatility?
Rickards: When all of the solutions from Washington and all of the big ideas about economic growth fail, then we may need to fall back on a community based, semi-agrarian model that resembles austerity in today’s terms. Such a model is far more stable than the radical boom and bust model of Greenspan and Bernanke. Larry Kudlow is right to think that we can do better in terms of growth, but the headwinds we spoke about are daunting and the policies are not well-designed to achieve that kind of growth.
The IRA: So what is the path back to some type of sanity regarding economic growth?
Rickards: We need to move beyond ideology and towards a more pragmatic discussion about how we measure and describe growth. Let’s do what works. The great philosopher William James invented pragmatism and taught us not to get hung up on one school of ideas or another. I’ve always been an admirer of Keynes and a fierce critic of what we call “Keynesianism” today. As soon as Keynes was dead, the economist Robert Samuelson hijacked his legacy and created something completely new called Keynesianism. But what I admire about Keynes is that he was pragmatic, a man who understood the art of policy but also knew the workings of markets intimately. In 1914 at the start of WWI, Keynes was a gold bug because he saw it as a way to preserve Britain’s credit standing and let them win the war. By 1925, Keynes was opposed to gold because he saw it as a constraint on growth. But by the end of WWII, he supported a modified gold standard to underpin the global monetary system. He believed in what worked. That is the kind of thinking we need today.
The IRA: Thanks Jim