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Grant's Current Yield Podcast
NOT SO GOOD NEWS
00:32:22
With special guest Lakshman Achuthan, co-founder of Economic Cycle Research Institute.
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- [00:00]
A
Foreign welcome to Grant's Interest Rate observer of the Air. This is Jim Grant and with me as is our want is the great deputy editor of Grant's, Evan Lorenz. Good morning Evan. It's morning is it? Yep, yeah, good morning and Henry French is our sound engineer as per always welcome to you Henry. And with us today is none other than Lakshman Ashuthan who was the co founder of the Economic Cycle Research Institute ecri. And we'll be talking with Lakshman in just a moment. Evan, you sent the the headline of the day, the headline du jour and could you regale our listeners with what it said? I'm not sure if you have it at hand but I remember it's only a few minutes ago so I do remember that it's one of your fine fine headlines. All right, here it is, give me one second.
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B
Socialist experiment unravels in Bolivia as natural gas runs out.
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A
Yeah, that's not a first is it?
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B
No, although usually the headline is cash runs out.
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A
Well it's always a bracing way to start the day. The headline I think the day before today yesterday was something about 4% is now the new normal on the treasury yield curve.
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B
Yeah. Despite the fact that the Fed actually did a jumbo sized rate cut you know, in mid September over that Same period the 10 year yield has increased by 40 basis points to just about 4% right now.
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A
Yeah, well to me it is very gratifying. First of all I love to see the Fed confounded and secondly it's nice to know, it's nice to have interest rates to observe. Yes, we had a 10 year drought of observable interest rates, I remember it all too well but it's very timely is the 4% number for this morning's discussion. Lakshman, as a keen observer of business cycles and as the co author of beating the business cycle out of predicted and profit from turning points in the economy the same Lachman is a student of the rate of inflation and has developed with his colleagues at ECRI an indicator that is telling a story that I think neither. Well, only one of the political candidates this coming presidential welcomes so the other wants no part of it. But Lakshman, good morning to you and tell us please in headline form whether according to your careful and well documented work the rate of inflation is more likely to surprise on the upside or the downside.
- [02:32]
C
Good morning Jim and thank you for having me to answer your question. According to our analysis of the inflation cycle quite different from cycles in growth, the not so good news is that inflation is still simmering. We've, we've certainly had a come down in the pace of inflation, but it's just not subsiding as quickly as I think many have hoped.
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A
You know, I would, I would.
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C
That's the headline.
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A
I would like to preface this discussion with the observation that economic science is not yet solved the mystery of the basic cause of inflation. I mean, we have. Evan, we have, let's see, we have. Inflation is always and everywhere a monetary phenomenon. That's Milton Friedman and that's something that the Fed chair, Jerome Powell said it was important to unlearn. This is about the year 2001, 2021. And then we have competing theory by John H. Cochran, formerly of the University of Chicago now out at Stanford, who says that inflation. He says not this way, not quite so dogmatically, but inflation is always and everywhere, in so many words, a fiscal phenomenon. Right. And, and then we have a theory popular at the Fed a couple years ago. I'm not sure if it's still so popular, but the Inflation is always and everywhere a phenomenon of expectations. And, and you know, it's almost. Lakshman. It's almost as if the physicists were still arguing about whether there is such a thing as a law of gravity. Why can't.
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C
Yeah.
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A
The stewards of this most rigorous social science, with so many mathematical appendices and so many learned papers, why is there no helpful and, and usable consensus concerning the cause of this phenomenon, let alone its diagnosis and cure?
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C
That's a deep, deep question.
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A
Okay, never mind, never mind that.
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C
So what, that's it.
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A
So where's the CPI going?
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C
Married to these theories and things like that, which they just don't hold water, as you know.
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A
And wait, wait, we can't, we can't slide by that. So quick. Theories are, is what, that's, that's the hallmark of science, right?
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C
Yeah.
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A
Okay. It's a social science. Like a social disease.
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C
Social science.
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A
Yeah, social diseases.
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C
Well, you've got these economies. The economists are, are burdened with this physics envy, as you alluded to, where they want to make a model that'll tell you everything. And, and as you and all the listeners know, fear and greed are alive and well and, and they're tough to model when they get going in these markets. Now what we're doing, it's kind of like what old is. What's old is new. What we're doing is, is an idea that's, that's, it's not new. We're, we're executing it. I Think better and better, but it's monitoring cycles, monitoring patterns that show up at cycle turns. Our premise is that there's a cycle in a free market oriented economy where fear and greed is let loose. People overdo it and they underdo it and it helps along with other mistakes they compound and you get feedback loops and things swing up and down. And so our leading indicators of inflation are trying to pick up on hey, what's the direction likely to be in front of us? Not what did CPI do yesterday but what's the direction likely to be in front of us in the future? Inflation gauge having duly nailed the upturn in 2020 and the downturn in 2022, it nailed it even though everybody was confounded. As you said, right now, having come down, it's flattened out, it stopped falling.
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B
Okay.
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C
And for quite a while it's been going sideways to edging up. And when I'm thinking about your question at the beginning of the talk here. Yeah. The surprises are more apt to be to the upside. Especially if everybody thinks inflation is going down towards the Fed's target and it's going to hang out there. Inflation doesn't act that way.
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B
Lakshman, you said that inflation is still on the simmer. And to Jim's point, there have been a lot of theories about what causes inflation, whether it's monetarism, but right now the, the Fed is still shrinking its balance sheet and broad money aggregates, depending on which one you look at, are flat to slightly down.
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A
Well, they've turned up.
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B
Yeah, they have.
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A
According to Graham's interest rate, they've turned up.
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B
So they've turned up. We do have fiscal profligacy, I think deficits around 6 to 7% of GDP. We do have confusion. I think the NFIB's survey in terms of economic certainty came out to the most uncertain ever for small businesses. What's driving this kind of still simmering under the headline inflation?
- [07:27]
C
Well, I think really big picture, there's no hard landing. That's one factor. We have a slowdown without a hard landing. The other factor is that globally inflation cycles are kind of bottoming and edging to the upside and we are still part of the globe. So we are swimming in that larger ocean when we look at inside the US economy. Look, the manufacturing sector is a tiny bit soft here. It may soften up a bit, but the rest of it in aggregate is doing fine. The services are holding up, construction is on a tear. And even though the low energy prices over the summer kind of flattered the headline Numbers, the core numbers are downright sticky, if not ticking up, and no one wants to talk about that. And so right now you could open the paper and you see that there's something happening in the Middle east and there's something happening in Florida, and all of these things might disrupt the price of oil, which has been flattering things for a while. So I'm not going to be blind that inflation could tick to the upside more than people expect in the coming months and, and maybe even quarters. And that's not necessarily on, on the game plan for most people right now.
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A
Well, the bond market perhaps is picking up on some of what you see large. But, you know. Yeah, there are all these notions that if you identify one plausible source of inflation, you have solved the, the mystery. For example, many people focus on price of oil is the most important commodity, and as long as it's under control, so will inflation be. And others. This gets back to the question of all these, these competing theories. There's another notion that demographics are a kind of dispositive. But before we settled in for our talk today, Evan checked his. One of his favorite documents was the historical statistics of the United States. Right, you take that.
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B
Yeah. From colonial times to 1976.
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A
I think it's, yeah, it's funny to see Evan walking around with us under his arm.
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B
It's like, it's two volumes. It's like one under each arm.
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A
Yeah. Going back to class, the University of Chicago. But I said, Evan, you know, tell me what, what happened this apropos of demographics, what happened to American population between 1880 and, and 1900?
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B
It went up about 50%. I, I don't have the number exactly in front of me, but population went from basically 50 million to about 76 million, I think.
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A
Yeah, okay, 50%. Okay, 51%. And Evan, over the same period, what happened to consumer prices?
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B
They went down about 14%.
- [10:18]
A
Right. So, Lashman, the other day we were noodling over this very question here at Grant's, and it occurred to me that back in 1967, 1968, 1969, when the great inflation of the 70s was getting up ahead of steam, that many people were surprised by its surfacing, because in American history until that point, there had never been a serious protracted inflation, except in a time of a GDP scale war and Vietnam. 1967 was certainly a thing, especially for the people involved in it, but it was not really that GDP scale conflict. And defense spending peaked late in the 60s and declined throughout the 70s. So defense spending. So that was a Change in the patterns of American history that until the time there had been really no such a thing as peacetime inflation. So here we are. What's the year, Evan? 2024 still, last I checked. Yeah. Okay. And we have a $1.8 trillion deficit fiscal year. I read in the Wall Street Journal. And Evan, what's the unemployment rate Approximately?
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B
It's like 4.1%, I think, in the old days.
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A
What was that called?
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B
It was called the. What is it full. There was like a Nehru natural.
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C
No, this was natural rate.
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A
Let's not get fancy, fellows. This was full employment. Okay? So Locksman here, we have 1.8 trillion deficit in a time of ostensible near full employment. So.
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C
Yeah, yeah, yeah, you're, you're right on as, as, as. Hey, I know why we like talking with each other. You're on point here. You're, you're, you're, you're giving me pause for a minute because I've talked about this so much that I feel like we just talked about it this morning. But there's two elephants in the room with us post Covid. One is, you know, I don't know, it's hard to count, but 7 or 8 trillion dollars of excess spending post Covid. And this huge disruption, structural disruption to the labor market, where you have people who are older leaving the labor market. You had a disruption in legal immigration even pre Covid. And so there was a lot of turbulence and basically a labor shortage collided with a lot like more stimulus than any of us have seen before. And so what do you expect? Of course it's going to get tight. I mean, there's not, that's not a, that's not a complicated thing.
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A
Except, except the Fed, which is as employees like 800 doctors of economics, could not believe its eyes because it's, it's mathematical appendices showed that.
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C
Yeah, you know, I think they, you know, they, I think I don't know what happens, but, you know, they look at these spreadsheets and they move things around and you could make things fit. And as you know, you can, you can fit. You could torture data to say whatever you want. You're making me think about the genesis of the future inflation gauge, which I think you'll appreciate. So post 70s into the early 80s, Moore, my teacher, Jeffrey Moore, who's the father of leading indicators, is thinking about cycles as he did, and he's saying, wait a minute, there's a lot more to this thing called the economy than simply cycles and growth. What's going on with Inflation, it's doing something different. And so that started a whole investigation into inflation cycles and it has a different chronology, it's a very different thing than the business cycle. And as he's developing the early leading indicators of inflation, future inflation gauges, back in the early 80s, there's stuff in there like inventories and commodities and, and, and jobs, right? The Phillips curve reigns supreme and stuff like that. And the indicator worked okay, but it goofed up a little bit around some currency stuff that was going on in the 80s and, and, and more in the summer would, would he be up in Vermont with Milton Friedman? They each lived on a hill next to each other. And Freefin's like okay, you got to get your money in there and how are you going to get the money in your cyclical indicators which is different from a model and your currency fluctuations? So all of that is in the future inflation gauge which is telling us today that the forward direction in risk on inflation is not to the downside. It's extremely sticky and it's edging to the upside. And God forbid that things start to move, if it starts to move, I don't know what the story is everybody's going to tell. They might fit a narrative around it that it was the oil or the hurricane or something. But I got to tell you, the antecedents are plain as day when you look at the future inflation gauge.
- [15:32]
A
I have a pop quiz for everyone around the table and I'm going to read you a quote and I'm going to give you the year and you got to tell me the speaker. Ready? Okay. The momentum of inflation has clearly been checked. The year is 1971. Who said it? All right, okay, I'll answer this please. That was Paul A. Volcker who then was Under Secretary of the treasury for Monetary affairs.
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C
So he learned his lesson.
- [16:00]
A
Well, you know this, this speaks a, to the ignorance of, of, of our species, of mankind, about the future's closed book. Always has been. And so you know, Grant's interest rate observer is not going to throw rocks at the glass house of market timing. But the Great Volcker spoke 10 years too soon. Now what happened in the 70s was not a steady ramp up inflation but a succession of kind of sine waves. And as I think there were three of them and as each pulled back there was a great sigh of relief because really glad that's over. But no, it persisted and it was actually a kind of a close to a 15 year phenomenon. So have you back tested your inflation gauge for how it would have seen things in the 60s and 70s?
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C
Yeah, yeah. Well just as you have the picture of the sine waves in your head, the other feature of that period is that each trough in the sine wave is higher than the previous trough and yeah, yeah, it's, it's back tested quite a ways and it's been running real time since the mid-80s. That's a long time. How did it do it, that's a long time.
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A
How did it do on a back test basis in the 70s, do you happen to recall?
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C
Yeah, it does quite well. Yeah, it gets, it gets the directional swings. And to be clear, these are not fitted. And so your model oriented listeners, we're not optimizing some correlation among indicators, rather we're looking at the directional change in the vicinity of a cycle turning point, which is a very different filter. And also we're not just throwing the kitchen sink in and see what fits. We're again looking at what should turn ahead of a turning point in inflation. For example, wages don't turn in front of a turning point in inflation. Those lag, I mean these are interesting things when you focus in on what happens.
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A
Give us an idea of what does precede a turn in the rate of inflation. Well, sure.
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C
Hey, one of your favorites would be money and credit.
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A
Right.
- [18:27]
C
There's also bottlenecks in the system, some early input prices, there are some tensions in the labor market, which is a little different than wages. As the world has become more and more global, there's quite a bit of interaction with the rest of the world in terms of the value of money and fiat currencies. So all of those things, we're not dogmatic. I don't say, hey, it's got to be one of these. I am totally willing to be surprised and I am almost all the time. So we don't predict the predictors, we track them, we monitor them. And a horrible, horrible economist pun here is that we're monetarists with an eye, we're monitoring the indicators.
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A
Yeah. So the phenomenon of inflation is kind of an overstraining of the productive apparatus.
- [19:30]
C
No, it can be, yeah, of course, but it has to. What's required by the cyclical framework is that what we're observing around a turning point in our forward looking data is pronounced pervasive and persistent compared to past turning points. So one offs and, and things that happen that don't persist very long are not going to rate things that are too concentrated in one driver of inflation. If that's the only thing. Yeah, the indexes.
- [20:16]
A
Let me give you an example of a one off that is nonetheless perhaps indicative of something or other happening in society. So 1981, I think around the fall of 81, the air traffic controllers go on strike. President Reagan says no you won't. Yes we will. Big showdown. He fired the union, you know, dis, whatever stripped the union of its, its organizational charter. And, and that was a, in retrospect and certainly all at the time, it seemed a milestone in, in the attitude of society towards labor, therefore towards allowable, I don't know, towards the rate of inflation. So okay, so that, that was then and now we have the longshoremen settling a strike for a substantial increase in pay, warranted or not. We don't, I'm not in a position to say. But the longshoremen were in a position to hold up the US economy in ways that much same ways as the air traffic controllers were. And President Biden, rather than taking a page from the book of Ronald Reagan said you, you go guys, we're with you. And let's don't know, Taft, Hartley, et cetera, et cetera. So one would characterize them in your language, Lakshman, as one offs. But are they part of the history rhyming approach to cyclical affairs?
- [21:48]
C
Yeah, thank you for that. When you're recounting that episode, it certainly reminds me again back to our sine waves in the 1970s of inflation. Early on, people by and large and certainly politically were not that in tune with, oh, inflation's high. In the earlier part of the decade, even though it was high because it kind of felt okay. There was a lot of stuff happening, if you dig in the Arthur Burns diaries and things like that and what they were saying about him when he would try to raise rates, they called him basically the devil. Right. For doing this. And he gave it up. And it was only toward the end of the 70s and into the 80s that people were so fed up with inflation that it was possible to be aggressive against any, you know, expressions of, of this inflationary stuff.
- [23:05]
A
So yeah, that was, it was, that is true. However, as early on as August 15, 1971, Richard Nixon, and anxious about the upcoming presidential election, you know, announced the end of the Bretton woods monetary regime and imposed wage price controls in reaction to a measured rate of inflation slightly in excess of 4%. So there was inflation.
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C
You have an echo of that now in the, in the political rhetoric. Right.
- [23:38]
A
So there, there's a, there was a certain amount of perhaps justifiable, I would say justifiable inflation phobia as early on in the cycle as 1971. But just as you say Lakshman, there was not a universal disgust as came to light in the decade and early in the 1980s.
- [23:59]
C
Yeah, so it just, I think there is a rhyme going on there and maybe, you know, here we are, the story is oh okay. I mean I think almost the Fed is, is kind of ready to do a victory lap, right? Hey, inflation's down, we can cut and so on and so forth and, and in that environment the long shortman getting what they get. And again I'm not judging it. Yeah, it's okay. You know, nobody's calling foul like they, like they did against the air traffic controllers like Reagan did then if inflation has troughed and we are beginning some increase in inflation in retrospect that'll be looked at differently. Right.
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B
Lakshman, you said that the inflation cycle is distinct and different from the economic cycle, that the Fed has two mandates. It's declared victory on the inflation front with a 50 basis point cut and it seems to be worried about the economic front. It's worried that there's going to be a slow creeping up of unemployment and it doesn't want to miss that in the same way that it missed the kind of not so slow rise in inflation from 2020 through 2022. Looking at other indicators we have the yield curve that's been inverted for like the longest time ever. We have the conference board's leading indicator index basically saying the economy should be in a recession. Everything's negative except for the economic data which keep coming up positive. What's happening in the economy and what does that mean?
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C
Well, I mean in the ancient history of this summer there was a recession scare. Remember it roiled the markets in end of July and August and our forward looking leading indicators of growth were saying no way we have a slowdown but the economy is resilient. I dare say the US economy looks better than most economies around the world on a relative basis. And I think the recent jobs data supports that view. And part of that recent jobs data supporting the view is that that labor shortage that we had post Covid when all the money was laid on top of a labor shortage, the muscle memory from that pain that employers had finding workers, it's still present and active. I see plenty of evidence in our forward looking indicators on jobs growth that yeah, we're slowing our hiring but we're not firing. So that labor hoarding is very much in full force still. When you try to reconcile what I'm saying about the overall economy holding up and the jobs market holding up with fears about the economy getting weaker or unemployment rate rising or whatever. What we really see, and you may have talked about this earlier, is a continuation of this K shaped economy. So wage earners are certainly squeezed by high prices, especially around food and rents and things. However, asset owners and people who have a little bit of money in their homes or in markets are actually doing really well. And as a result, when you look at aggregate consumption, it's not faltering that much.
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B
So Lakshman, I want to pose a hypothetical to you. So let's say it's November and somebody wins the election. Oh no, everybody wins.
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C
Oh, that's a hypothetical.
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B
They're dissatisfied with Chairman Powell, they decide to chunk him out and they hire you, Locksman Ashuth on to be the next Fed chairman. What do you do?
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C
Well, I, you know, honestly, I resign. Yeah, yeah, I resigned. But you know, I think I remember there were times when a policymaker faced with these kind of questions would consider the inflation cycle. And I think I would do that. And so looking at the forward looking inflation indicators, they're not falling. So I would be quite cautious here. I mean maybe if I was a political animal I would claim victory. Hey, it came down and do what I could to claim victory in anticipation of the fact this is not debatable. Inflation is cyclical. It doesn't go somewhere and hang out. It likes to move and sooner or later it's going to trough and turn up.
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A
You know, one of our speakers at the Grants conference last week, Stan Druckenmiller said apropos of what would one do as the chairman of the Fed said he doesn't fault Powell for his errors. He says goodness knows we all make them. He said I make my share. And he said what he does fault the chairman for is a lack of risk management skills and risk management. He went 50 basis points when he didn't really have to and he's locked himself into two consecutive 25 basis points reductions in the next two Fed meetings, FOMC meetings. And one had thought that the Fed was data driven. But if, let us hypothesize, the surprises would come in the direction and the upside direction. One could imagine a succession of rather hot inflation readings in the context of continued Fed ease. And what would, you know, what would that do to things?
- [29:57]
C
Well, okay, so he's locked in as much as a, I guess he could pivot, he's pivoted before. But let's say he's locked in and someone wins the election. It doesn't matter who it is in terms of which way the deficit is going. It's just a matter of degrees. The deficit is rising. So all of that is in play. And let's not. You know, you don't want to leave Janet Yellen out of this. Right. So she's been busy, too. And this deficit spending is a feature. The fact that inflation is cyclical is a truth. That's a truism. And as far as we can tell now, I'm out on a limb. I'm forecasting. Right. There's no hard landing in front of us, and we're still dealing with the labor hoarding aftermath of COVID So all of that tells me you'd be doing very well to get a soft landing with a little bit of inflation. And the danger is that be careful what you wish for. If you get a stronger economy and more inflation, you may get more inflation. And then many assumptions are challenged, including.
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A
The solvency of the great private equity industry. Yeah, yeah.
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C
I mean, the half point helps the CRE got the commercial real estate guys, right, because they have a lot of debt rolling soon. So that helped them on the margin. And I think that they want to avoid all that regional bank stuff. Remember that happened a few years ago, and they want to avoid any of that popping up.
- [31:51]
A
Yeah. Well, Lakshman, thank you. This has been scintillating as one just knew it was going to be. Evan, nice to see you bright and early. Henry, thank you. And ladies and gentlemen, thank you for listening on behalf of Grant's Interest Rate Observer. Come again. Talk to you soon.